[Congressional Record Volume 152, Number 55 (Tuesday, May 9, 2006)]
[House]
[Pages H2209-H2299]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
CONFERENCE REPORT ON H.R. 4297, TAX INCREASE PREVENTION AND
RECONCILIATION ACT OF 2005
Mr. THOMAS submitted the following conference report and statement on
the bill (H.R. 4297) to provide for reconciliation pursuant to section
201(b) of the concurrent resolution on the budget for fiscal year 2006:
Conference Report (H. Rept. 109-455)
The committee of conference on the disagreeing votes of the
two Houses on the amendment of the Senate to the bill (H.R.
4297), to provide for reconciliation pursuant to section
201(b) of the concurrent resolution on the budget for fiscal
year 2006, having met, after full and free conference, have
agreed to recommend and do recommend to their respective
Houses as follows:
That the House recede from its disagreement to the
amendment of the Senate and agree to the same with an
amendment as follows:
In lieu of the matter proposed to be inserted by the Senate
amendment, insert the following:
SECTION 1. SHORT TITLE, ETC.
(a) Short Title.--This Act may be cited as the ``Tax
Increase Prevention and Reconciliation Act of 2005''.
(b) Amendment of 1986 Code.--Except as otherwise expressly
provided, whenever in this Act an amendment or repeal is
expressed in terms of an amendment to, or repeal of, a
section or other provision, the reference shall be considered
to be made to a section or other provision of the Internal
Revenue Code of 1986.
(c) Table of Contents.--The table of contents for this Act
is as follows:
Sec. 1. Short title, etc.
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
Sec. 101. Increased expensing for small business.
Sec. 102. Capital gains and dividends rates.
Sec. 103. Controlled foreign corporations.
TITLE II--OTHER PROVISIONS
Sec. 201. Clarification of taxation of certain settlement funds.
Sec. 202. Modification of active business definition under section 355.
Sec. 203. Veterans' mortgage bonds.
Sec. 204. Capital gains treatment for certain self-created musical
works.
Sec. 205. Vessel tonnage limit.
Sec. 206. Modification of special arbitrage rule for certain funds.
Sec. 207. Amortization of expenses incurred in creating or acquiring
music or music copyrights.
Sec. 208. Modification of effective date of disregard of certain
capital expenditures for purposes of qualified small
issue bonds.
Sec. 209. Modification of treatment of loans to qualified continuing
care facilities.
TITLE III--ALTERNATIVE MINIMUM TAX RELIEF
Sec. 301. Increase in alternative minimum tax exemption amount for
2006.
Sec. 302. Allowance of nonrefundable personal credits against regular
and alternative minimum tax liability.
TITLE IV--CORPORATE ESTIMATED TAX PROVISIONS
Sec. 401. Time for payment of corporate estimated taxes.
TITLE V--REVENUE OFFSET PROVISIONS
Sec. 501. Application of earnings stripping rules to partners which are
corporations.
Sec. 502. Reporting of interest on tax-exempt bonds.
Sec. 503. 5-year amortization of geological and geophysical
expenditures for certain major integrated oil companies.
Sec. 504. Application of FIRPTA to regulated investment companies.
Sec. 505. Treatment of distributions attributable to FIRPTA gains.
Sec. 506. Prevention of avoidance of tax on investments of foreign
persons in United States real property through wash sale
transactions.
Sec. 507. Section 355 not to apply to distributions involving
disqualified investment companies.
Sec. 508. Loan and redemption requirements on pooled financing
requirements.
Sec. 509. Partial payments required with submission of offers-in-
compromise.
Sec. 510. Increase in age of minor children whose unearned income is
taxed as if parent's income.
Sec. 511. Imposition of withholding on certain payments made by
government entities.
Sec. 512. Conversions to Roth IRAs.
Sec. 513. Repeal of FSC/ETI binding contract relief.
Sec. 514. Only wages attributable to domestic production taken into
account in determining deduction for domestic production.
Sec. 515. Modification of exclusion for citizens living abroad.
[[Page H2210]]
Sec. 516. Tax involvement of accommodation parties in tax shelter
transactions.
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
SEC. 101. INCREASED EXPENSING FOR SMALL BUSINESS.
Subsections (b)(1), (b)(2), (b)(5), (c)(2), and
(d)(1)(A)(ii) of section 179 (relating to election to expense
certain depreciable business assets) are each amended by
striking ``2008'' and inserting ``2010''.
SEC. 102. CAPITAL GAINS AND DIVIDENDS RATES.
Section 303 of the Jobs and Growth Tax Relief
Reconciliation Act of 2003 is amended by striking ``December
31, 2008'' and inserting ``December 31, 2010''.
SEC. 103. CONTROLLED FOREIGN CORPORATIONS.
(a) Subpart F Exception for Active Financing.--
(1) Exempt insurance income.--Paragraph (10) of section
953(e) (relating to application) is amended--
(A) by striking ``January 1, 2007'' and inserting ``January
1, 2009'', and
(B) by striking ``December 31, 2006'' and inserting
``December 31, 2008''.
(2) Exception to treatment as foreign personal holding
company income.--Paragraph (9) of section 954(h) (relating to
application) is amended by striking ``January 1, 2007'' and
inserting ``January 1, 2009''.
(b) Look-Through Treatment of Payments Between Related
Controlled Foreign Corporations Under the Foreign Personal
Holding Company Rules.--
(1) In general.--Subsection (c) of section 954 (relating to
foreign personal holding company income) is amended by adding
at the end the following new paragraph:
``(6) Look-thru rule for related controlled foreign
corporations.--
``(A) In general.--For purposes of this subsection,
dividends, interest, rents, and royalties received or accrued
from a controlled foreign corporation which is a related
person shall not be treated as foreign personal holding
company income to the extent attributable or properly
allocable (determined under rules similar to the rules of
subparagraphs (C) and (D) of section 904(d)(3)) to income of
the related person which is not subpart F income. For
purposes of this subparagraph, interest shall include
factoring income which is treated as income equivalent to
interest for purposes of paragraph (1)(E). The Secretary
shall prescribe such regulations as may be appropriate to
prevent the abuse of the purposes of this paragraph.
``(B) Application.--Subparagraph (A) shall apply to taxable
years of foreign corporations beginning after December 31,
2005, and before January 1, 2009, and to taxable years of
United States shareholders with or within which such taxable
years of foreign corporations end.''.
(2) Effective date.--The amendment made by this subsection
shall apply to taxable years of foreign corporations
beginning after December 31, 2005, and to taxable years of
United States shareholders with or within which such taxable
years of foreign corporations end.
TITLE II--OTHER PROVISIONS
SEC. 201. CLARIFICATION OF TAXATION OF CERTAIN SETTLEMENT
FUNDS.
(a) In General.--Subsection (g) of section 468B (relating
to clarification of taxation of certain funds) is amended to
read as follows:
``(g) Clarification of Taxation of Certain Funds.--
``(1) In general.--Except as provided in paragraph (2),
nothing in any provision of law shall be construed as
providing that an escrow account, settlement fund, or similar
fund is not subject to current income tax. The Secretary
shall prescribe regulations providing for the taxation of any
such account or fund whether as a grantor trust or otherwise.
``(2) Exemption from tax for certain settlement funds.--An
escrow account, settlement fund, or similar fund shall be
treated as beneficially owned by the United States and shall
be exempt from taxation under this subtitle if--
``(A) it is established pursuant to a consent decree
entered by a judge of a United States District Court,
``(B) it is created for the receipt of settlement payments
as directed by a government entity for the sole purpose of
resolving or satisfying one or more claims asserting
liability under the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980,
``(C) the authority and control over the expenditure of
funds therein (including the expenditure of contributions
thereto and any net earnings thereon) is with such government
entity, and
``(D) upon termination, any remaining funds will be
disbursed to such government entity for use in accordance
with applicable law.
For purposes of this paragraph, the term `government entity'
means the United States, any State or political subdivision
thereof, the District of Columbia, any possession of the
United States, and any agency or instrumentality of any of
the foregoing.
``(3) Termination.--Paragraph (2) shall not apply to
accounts and funds established after December 31, 2010.''.
(b) Effective Date.--The amendment made by subsection (a)
shall apply to accounts and funds established after the date
of the enactment of this Act.
SEC. 202. MODIFICATION OF ACTIVE BUSINESS DEFINITION UNDER
SECTION 355.
Subsection (b) of section 355 (defining active conduct of a
trade or business) is amended by adding at the end the
following new paragraph:
``(3) Special rule relating to active business
requirement.--
``(A) In general.--In the case of any distribution made
after the date of the enactment of this paragraph and on or
before December 31, 2010, a corporation shall be treated as
meeting the requirement of paragraph (2)(A) if and only if
such corporation is engaged in the active conduct of a trade
or business.
``(B) Affiliated group rule.--For purposes of subparagraph
(A), all members of such corporation's separate affiliated
group shall be treated as one corporation. For purposes of
the preceding sentence, a corporation's separate affiliated
group is the affiliated group which would be determined under
section 1504(a) if such corporation were the common parent
and section 1504(b) did not apply.
``(C) Transition rule.--Subparagraph (A) shall not apply to
any distribution pursuant to a transaction which is--
``(i) made pursuant to an agreement which was binding on
the date of the enactment of this paragraph and at all times
thereafter,
``(ii) described in a ruling request submitted to the
Internal Revenue Service on or before such date, or
``(iii) described on or before such date in a public
announcement or in a filing with the Securities and Exchange
Commission.
The preceding sentence shall not apply if the distributing
corporation elects not to have such sentence apply to
distributions of such corporation. Any such election, once
made, shall be irrevocable.
``(D) Special rule for certain pre-enactment
distributions.--For purposes of determining the continued
qualification under paragraph (2)(A) of distributions made on
or before the date of the enactment of this paragraph as a
result of an acquisition, disposition, or other restructuring
after such date and on or before December 31, 2010, such
distribution shall be treated as made on the date of such
acquisition, disposition, or restructuring for purposes of
applying subparagraphs (A) through (C) of this paragraph.''.
SEC. 203. VETERANS' MORTGAGE BONDS.
(a) Expansion of Definition of Veterans Eligible for State
Home Loan Programs Funded by Qualified Veterans' Mortgage
Bonds.--
(1) In general.--Paragraph (4) of section 143(l) (defining
qualified veteran) is amended to read as follows:
``(4) Qualified veteran.--For purposes of this subsection,
the term `qualified veteran' means--
``(A) in the case of the States of Alaska, Oregon, and
Wisconsin, any veteran--
``(i) who served on active duty, and
``(ii) who applied for the financing before the date 25
years after the last date on which such veteran left active
service, and
``(B) in the case of any other State, any veteran--
``(i) who served on active duty at some time before January
1, 1977, and
``(ii) who applied for the financing before the later of--
``(I) the date 30 years after the last date on which such
veteran left active service, or
``(II) January 31, 1985.''.
(2) Effective date.--The amendments made by this subsection
shall apply to bonds issued on or after the date of the
enactment of this Act.
(b) Revision of State Veterans Limit.--
(1) In general.--Subparagraph (B) of section 143(l)(3)
(relating to volume limitation) is amended--
(A) by redesignating clauses (i) and (ii) as subclauses (I)
and (II), respectively, and moving such clauses 2 ems to the
right,
(B) by amending the matter preceding subclause (I), as
designated by subparagraph (A), to read as follows:
``(B) State veterans limit.--
``(i) In general.--In the case of any State to which clause
(ii) does not apply, the State veterans limit for any
calendar year is the amount equal to--'', and
(C) by adding at the end the following new clauses:
``(ii) Alaska, oregon, and wisconsin.--In the case of the
following States, the State veterans limit for any calendar
year is the amount equal to--
``(I) $25,000,000 for the State of Alaska,
``(II) $25,000,000 for the State of Oregon, and
``(III) $25,000,000 for the State of Wisconsin.
``(iii) Phasein.--In the case of calendar years beginning
before 2010, clause (ii) shall be applied by substituting for
each of the dollar amounts therein an amount equal to the
applicable percentage of such dollar amount. For purposes of
the preceding sentence, the applicable percentage shall be
determined in accordance with the following table:
------------------------------------------------------------------------
``For Calendar Year: Applicable percentage is:
------------------------------------------------------------------------
2006....................................... 20 percent
2007....................................... 40 percent
2008....................................... 60 percent
2009....................................... 80 percent.
------------------------------------------------------------------------
``(iv) Termination.--The State veterans limit for the
States specified in clause (ii) for any calendar year after
2010 is zero.''.
(2) Effective date.--The amendments made by this subsection
shall apply to allocations of State volume limit after April
5, 2006.
SEC. 204. CAPITAL GAINS TREATMENT FOR CERTAIN SELF-CREATED
MUSICAL WORKS.
(a) In General.--Subsection (b) of section 1221 (relating
to capital asset defined) is amended by redesignating
paragraph (3) as paragraph (4) and by inserting after
paragraph (2) the following new paragraph:
``(3) Sale or exchange of self-created musical works.--At
the election of the taxpayer, paragraphs (1) and (3) of
subsection (a) shall not apply to musical compositions or
copyrights in musical works sold or exchanged before January
1, 2011, by a taxpayer described in subsection (a)(3).''.
[[Page H2211]]
(b) Limitation on Charitable Contributions.--Subparagraph
(A) of section 170(e)(1) is amended by inserting
``(determined without regard to section 1221(b)(3))'' after
``long-term capital gain''.
(c) Effective Date.--The amendments made by this section
shall apply to sales and exchanges in taxable years beginning
after the date of the enactment of this Act.
SEC. 205. VESSEL TONNAGE LIMIT.
(a) In General.--Paragraph (4) of section 1355(a) (relating
to qualifying vessel) is amended by inserting ``(6,000, in
the case of taxable years beginning after December 31, 2005,
and ending before January 1, 2011)'' after ``10,000''.
(b) Effective Date.--The amendment made by subsection (a)
shall apply to taxable years beginning after December 31,
2005.
SEC. 206. MODIFICATION OF SPECIAL ARBITRAGE RULE FOR CERTAIN
FUNDS.
In the case of bonds issued after the date of the enactment
of this Act and before August 31, 2009--
(1) the requirement of paragraph (1) of section 648 of the
Deficit Reduction Act of 1984 (98 Stat. 941) shall be treated
as met with respect to the securities or obligations referred
to in such section if such securities or obligations are held
in a fund the annual distributions from which cannot exceed 7
percent of the average fair market value of the assets held
in such fund except to the extent distributions are necessary
to pay debt service on the bond issue, and
(2) paragraph (3) of such section shall be applied by
substituting ``distributions from'' for ``the investment
earnings of'' both places it appears.
SEC. 207. AMORTIZATION OF EXPENSES INCURRED IN CREATING OR
ACQUIRING MUSIC OR MUSIC COPYRIGHTS.
(a) In General.--Section 167(g) (relating to depreciation
under income forecast method) is amended by adding at the end
the following new paragraph:
``(8) Special rules for certain musical works and
copyrights.--
``(A) In general.--If an election is in effect under this
paragraph for any taxable year, then, notwithstanding
paragraph (1), any expense which--
``(i) is paid or incurred by the taxpayer in creating or
acquiring any applicable musical property placed in service
during the taxable year, and
``(ii) is otherwise properly chargeable to capital account,
shall be amortized ratably over the 5-year period beginning
with the month in which the property was placed in service.
The preceding sentence shall not apply to any expense which,
without regard to this paragraph, would not be allowable as a
deduction.
``(B) Exclusive method.--Except as provided in this
paragraph, no depreciation or amortization deduction shall be
allowed with respect to any expense to which subparagraph (A)
applies.
``(C) Applicable musical property.--For purposes of this
paragraph--
``(i) In general.--The term `applicable musical property'
means any musical composition (including any accompanying
words), or any copyright with respect to a musical
composition, which is property to which this subsection
applies without regard to this paragraph.
``(ii) Exceptions.--Such term shall not include any
property--
``(I) with respect to which expenses are treated as
qualified creative expenses to which section 263A(h) applies,
``(II) to which a simplified procedure established under
section 263A(j)(2) applies, or
``(III) which is an amortizable section 197 intangible (as
defined in section 197(c)).
``(D) Election.--An election under this paragraph shall be
made at such time and in such form as the Secretary may
prescribe and shall apply to all applicable musical property
placed in service during the taxable year for which the
election applies.
``(E) Termination.--An election may not be made under this
paragraph for any taxable year beginning after December 31,
2010.''.
(b) Effective Date.--The amendments made by this section
shall apply to expenses paid or incurred with respect to
property placed in service in taxable years beginning after
December 31, 2005.
SEC. 208. MODIFICATION OF EFFECTIVE DATE OF DISREGARD OF
CERTAIN CAPITAL EXPENDITURES FOR PURPOSES OF
QUALIFIED SMALL ISSUE BONDS.
(a) In General.--Section 144(a)(4)(G) is amended by
striking ``September 30, 2009'' and inserting ``December 31,
2006''.
(b) Conforming Amendment.--Section 144(a)(4)(F) is amended
by striking ``September 30, 2009'' and inserting ``December
31, 2006''.
SEC. 209. MODIFICATION OF TREATMENT OF LOANS TO QUALIFIED
CONTINUING CARE FACILITIES.
(a) In General.--Section 7872 is amended by redesignating
subsection (h) as subsection (i) and inserting after
subsection (g) the following new subsection:
``(h) Exception for Loans to Qualified Continuing Care
Facilities.--
``(1) In general.--This section shall not apply for any
calendar year to any below-market loan owed by a facility
which on the last day of such year is a qualified continuing
care facility, if such loan was made pursuant to a continuing
care contract and if the lender (or the lender's spouse)
attains age 62 before the close of such year.
``(2) Continuing care contract.--For purposes of this
section, the term `continuing care contract' means a written
contract between an individual and a qualified continuing
care facility under which--
``(A) the individual or individual's spouse may use a
qualified continuing care facility for their life or lives,
``(B) the individual or individual's spouse will be
provided with housing, as appropriate for the health of such
individual or individual's spouse--
``(i) in an independent living unit (which has additional
available facilities outside such unit for the provision of
meals and other personal care), and
``(ii) in an assisted living facility or a nursing
facility, as is available in the continuing care facility,
and
``(C) the individual or individual's spouse will be
provided assisted living or nursing care as the health of
such individual or individual's spouse requires, and as is
available in the continuing care facility.
The Secretary shall issue guidance which limits such term to
contracts which provide only facilities, care, and services
described in this paragraph.
``(3) Qualified continuing care facility.--
``(A) In general.--For purposes of this section, the term
`qualified continuing care facility' means 1 or more
facilities--
``(i) which are designed to provide services under
continuing care contracts,
``(ii) which include an independent living unit, plus an
assisted living or nursing facility, or both, and
``(iii) substantially all of the independent living unit
residents of which are covered by continuing care contracts.
``(B) Nursing homes excluded.--The term `qualified
continuing care facility' shall not include any facility
which is of a type which is traditionally considered a
nursing home.
``(4) Termination.--This subsection shall not apply to any
calendar year after 2010.''.
(b) Conforming Amendments.--
(1) Section 7872(g) is amended by adding at the end the
following new paragraph:
``(6) Suspension of application.--Paragraph (1) shall not
apply for any calendar year to which subsection (h)
applies.''.
(2) Section 142(d)(2)(B) is amended by striking ``Section
7872(g)'' and inserting ``Subsections (g) and (h) of section
7872''.
(c) Effective Date.--The amendment made by this section
shall apply to calendar years beginning after December 31,
2005, with respect to loans made before, on, or after such
date.
TITLE III--ALTERNATIVE MINIMUM TAX RELIEF
SEC. 301. INCREASE IN ALTERNATIVE MINIMUM TAX EXEMPTION
AMOUNT FOR 2006.
(a) In General.--Section 55(d)(1) (relating to exemption
amount for taxpayers other than corporations) is amended--
(1) by striking ``$58,000'' and all that follows through
``2005'' in subparagraph (A) and inserting ``$62,550 in the
case of taxable years beginning in 2006'', and
(2) by striking ``$40,250'' and all that follows through
``2005'' in subparagraph (B) and inserting ``$42,500 in the
case of taxable years beginning in 2006''.
(b) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2005.
SEC. 302. ALLOWANCE OF NONREFUNDABLE PERSONAL CREDITS AGAINST
REGULAR AND ALTERNATIVE MINIMUM TAX LIABILITY.
(a) In General.--Paragraph (2) of section 26(a) is
amended--
(1) by striking ``2005'' in the heading thereof and
inserting ``2006'', and
(2) by striking ``or 2005'' and inserting ``2005, or
2006''.
(b) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2005.
TITLE IV--CORPORATE ESTIMATED TAX PROVISIONS
SEC. 401. TIME FOR PAYMENT OF CORPORATE ESTIMATED TAXES.
Notwithstanding section 6655 of the Internal Revenue Code
of 1986--
(1) in the case of a corporation with assets of not less
than $1,000,000,000 (determined as of the end of the
preceding taxable year)--
(A) the amount of any required installment of corporate
estimated tax which is otherwise due in July, August, or
September of 2006 shall be 105 percent of such amount,
(B) the amount of any required installment of corporate
estimated tax which is otherwise due in July, August, or
September of 2012 shall be 106.25 percent of such amount,
(C) the amount of any required installment of corporate
estimated tax which is otherwise due in July, August, or
September of 2013 shall be 100.75 percent of such amount, and
(D) the amount of the next required installment after an
installment referred to in subparagraph (A), (B), or (C)
shall be appropriately reduced to reflect the amount of the
increase by reason of such subparagraph,
(2) 20.5 percent of the amount of any required installment
of corporate estimated tax which is otherwise due in
September 2010 shall not be due until October 1, 2010, and
(3) 27.5 percent of the amount of any required installment
of corporate estimated tax which is otherwise due in
September 2011 shall not be due until October 1, 2011.
TITLE V--REVENUE OFFSET PROVISIONS
SEC. 501. APPLICATION OF EARNINGS STRIPPING RULES TO PARTNERS
WHICH ARE CORPORATIONS.
(a) In General.--Section 163(j) (relating to limitation on
deduction for interest on certain indebtedness) is amended by
redesignating paragraph (8) as paragraph (9) and by inserting
after paragraph (7) the following new paragraph:
``(8) Treatment of corporate partners.--Except to the
extent provided by regulations, in applying this subsection
to a corporation which owns (directly or indirectly) an
interest in a partnership--
[[Page H2212]]
``(A) such corporation's distributive share of interest
income paid or accrued to such partnership shall be treated
as interest income paid or accrued to such corporation,
``(B) such corporation's distributive share of interest
paid or accrued by such partnership shall be treated as
interest paid or accrued by such corporation, and
``(C) such corporation's share of the liabilities of such
partnership shall be treated as liabilities of such
corporation.''.
(b) Additional Regulatory Authority.--Section 163(j)(9)
(relating to regulations), as redesignated by subsection (a),
is amended by striking ``and'' at the end of subparagraph
(B), by striking the period at the end of subparagraph (C)
and inserting ``, and'', and by adding at the end the
following new subparagraph:
``(D) regulations providing for the reallocation of shares
of partnership indebtedness, or distributive shares of the
partnership's interest income or interest expense.''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning on or after the date
of the enactment of this Act.
SEC. 502. REPORTING OF INTEREST ON TAX-EXEMPT BONDS.
(a) In General.--Section 6049(b)(2) (relating to
exceptions) is amended by striking subparagraph (B) and by
redesignating subparagraphs (C) and (D) as subparagraphs (B)
and (C), respectively.
(b) Conforming Amendment.--Section 6049(b)(2)(C), as
redesignated by subsection (a), is amended by striking
``subparagraph (C)'' and inserting ``subparagraph (B)''.
(c) Effective Date.--The amendments made by this section
shall apply to interest paid after December 31, 2005.
SEC. 503. 5-YEAR AMORTIZATION OF GEOLOGICAL AND GEOPHYSICAL
EXPENDITURES FOR CERTAIN MAJOR INTEGRATED OIL
COMPANIES.
(a) In General.--Section 167(h) (relating to amortization
of geological and geophysical expenditures) is amended by
adding at the end the following new paragraph:
``(5) Special rule for major integrated oil companies.--
``(A) In general.--In the case of a major integrated oil
company, paragraphs (1) and (4) shall be applied by
substituting `5-year' for `24 month'.
``(B) Major integrated oil company.--For purposes of this
paragraph, the term `major integrated oil company' means,
with respect to any taxable year, a producer of crude oil--
``(i) which has an average daily worldwide production of
crude oil of at least 500,000 barrels for the taxable year,
``(ii) which had gross receipts in excess of $1,000,000,000
for its last taxable year ending during calendar year 2005,
and
``(iii) to which subsection (c) of section 613A does not
apply by reason of paragraph (4) of section 613A(d),
determined--
``(I) by substituting `15 percent' for `5 percent' each
place it occurs in paragraph (3) of section 613A(d), and
``(II) without regard to whether subsection (c) of section
613A does not apply by reason of paragraph (2) of section
613A(d).
For purposes of clauses (i) and (ii), all persons treated as
a single employer under subsections (a) and (b) of section 52
shall be treated as 1 person and, in case of a short taxable
year, the rule under section 448(c)(3)(B) shall apply.''.
(b) Effective Date.--The amendment made by this section
shall apply to amounts paid or incurred after the date of the
enactment of this Act.
SEC. 504. APPLICATION OF FIRPTA TO REGULATED INVESTMENT
COMPANIES.
(a) In General.--Subclause (II) of section 897(h)(4)(A)(i)
(defining qualified investment entity) is amended by
inserting ``which is a United States real property holding
corporation or which would be a United States real property
holding corporation if the exceptions provided in subsections
(c)(3) and (h)(2) did not apply to interests in any real
estate investment trust or regulated investment company''
after ``regulated investment company''.
(b) Effective Date.--The amendment made by this section
shall take effect as if included in the provisions of section
411 of the American Jobs Creation Act of 2004 to which it
relates.
SEC. 505. TREATMENT OF DISTRIBUTIONS ATTRIBUTABLE TO FIRPTA
GAINS.
(a) Qualified Investment Entity.--
(1) In general.--Section 897(h)(1) is amended--
(A) by striking ``a nonresident alien individual or a
foreign corporation'' in the first sentence and inserting ``a
nonresident alien individual, a foreign corporation, or other
qualified investment entity'',
(B) by striking ``such nonresident alien individual or
foreign corporation'' in the first sentence and inserting
``such nonresident alien individual, foreign corporation, or
other qualified investment entity'', and
(C) by striking the second sentence and inserting the
following new sentence: ``Notwithstanding the preceding
sentence, any distribution by a qualified investment entity
to a nonresident alien individual or a foreign corporation
with respect to any class of stock which is regularly traded
on an established securities market located in the United
States shall not be treated as gain recognized from the sale
or exchange of a United States real property interest if such
individual or corporation did not own more than 5 percent of
such class of stock at any time during the 1-year period
ending on the date of such distribution.''.
(2) Exception to termination of application of section 897
rules to regulated investment companies.--Clause (ii) of
section 897(h)(4)(A) is amended by adding at the end the
following new sentence: ``Notwithstanding the preceding
sentence, an entity described in clause (i)(II) shall be
treated as a qualified investment entity for purposes of
applying paragraphs (1) and (5) and section 1445 with respect
to any distribution by the entity to a nonresident alien
individual or a foreign corporation which is attributable
directly or indirectly to a distribution to the entity from a
real estate investment trust.''.
(b) Withholding on Distributions Treated as Gain From
United States Real Property Interests.--Section 1445(e)
(relating to special rules for distributions, etc. by
corporations, partnerships, trusts, or estates) is amended by
redesignating paragraph (6) as paragraph (7) and by inserting
after paragraph (5) the following new paragraph:
``(6) Distributions by regulated investment companies and
real estate investment trusts.--If any portion of a
distribution from a qualified investment entity (as defined
in section 897(h)(4)) to a nonresident alien individual or a
foreign corporation is treated under section 897(h)(1) as
gain realized by such individual or corporation from the sale
or exchange of a United States real property interest, the
qualified investment entity shall deduct and withhold under
subsection (a) a tax equal to 35 percent (or, to the extent
provided in regulations, 15 percent (20 percent in the case
of taxable years beginning after December 31, 2010)) of the
amount so treated.''.
(c) Treatment of Certain Distributions as Dividends.--
(1) In general.--Section 852(b)(3) (relating to capital
gains) is amended by adding at the end the following new
subparagraph:
``(E) Certain distributions.--In the case of a distribution
to which section 897 does not apply by reason of the second
sentence of section 897(h)(1), the amount of such
distribution which would be included in computing long-term
capital gains for the shareholder under subparagraph (B) or
(D) (without regard to this subparagraph)--
``(i) shall not be included in computing such shareholder's
long-term capital gains, and
``(ii) shall be included in such shareholder's gross income
as a dividend from the regulated investment company.''.
(2) Conforming amendment.--Section 871(k)(2) (relating to
short-term capital gain dividends) is amended by adding at
the end the following new subparagraph:
``(E) Certain distributions.--In the case of a distribution
to which section 897 does not apply by reason of the second
sentence of section 897(h)(1), the amount which would be
treated as a short-term capital gain dividend to the
shareholder (without regard to this subparagraph)--
``(i) shall not be treated as a short-term capital gain
dividend, and
``(ii) shall be included in such shareholder's gross income
as a dividend from the regulated investment company.''.
(d) Effective Dates.--The amendments made by this section
shall apply to taxable years of qualified investment entities
beginning after December 31, 2005, except that no amount
shall be required to be withheld under section 1441, 1442, or
1445 of the Internal Revenue Code of 1986 with respect to any
distribution before the date of the enactment of this Act if
such amount was not otherwise required to be withheld under
any such section as in effect before such amendments.
SEC. 506. PREVENTION OF AVOIDANCE OF TAX ON INVESTMENTS OF
FOREIGN PERSONS IN UNITED STATES REAL PROPERTY
THROUGH WASH SALE TRANSACTIONS.
(a) In General.--Section 897(h) (relating to special rules
for certain investment entities) is amended by adding at the
end the following new paragraph:
``(5) Treatment of certain wash sale transactions.--
``(A) In general.--If an interest in a domestically
controlled qualified investment entity is disposed of in an
applicable wash sale transaction, the taxpayer shall, for
purposes of this section, be treated as having gain from the
sale or exchange of a United States real property interest in
an amount equal to the portion of the distribution described
in subparagraph (B) with respect to such interest which, but
for the disposition, would have been treated by the taxpayer
as gain from the sale or exchange of a United States real
property interest under paragraph (1).
``(B) Applicable wash sales transaction.--For purposes of
this paragraph--
``(i) In general.--The term `applicable wash sales
transaction' means any transaction (or series of
transactions) under which a nonresident alien individual,
foreign corporation, or qualified investment entity--
``(I) disposes of an interest in a domestically controlled
qualified investment entity during the 30-day period
preceding the ex-dividend date of a distribution which is to
be made with respect to the interest and any portion of
which, but for the disposition, would have been treated by
the taxpayer as gain from the sale or exchange of a United
States real property interest under paragraph (1), and
``(II) acquires, or enters into a contract or option to
acquire, a substantially identical interest in such entity
during the 61-day period beginning with the 1st day of the
30-day period described in subclause (I).
For purposes of subclause (II), a nonresident alien
individual, foreign corporation, or qualified investment
entity shall be treated as having acquired any interest
acquired by a person related (within the meaning of section
267(b) or 707(b)(1)) to the individual, corporation, or
entity, and any interest which such person has entered into
any contract or option to acquire.
[[Page H2213]]
``(ii) Application to substitute dividend and similar
payments.--Subparagraph (A) shall apply to--
``(I) any substitute dividend payment (within the meaning
of section 861), or
``(II) any other similar payment specified in regulations
which the Secretary determines necessary to prevent avoidance
of the purposes of this paragraph.
The portion of any such payment treated by the taxpayer as
gain from the sale or exchange of a United States real
property interest under subparagraph (A) by reason of this
clause shall be equal to the portion of the distribution such
payment is in lieu of which would have been so treated but
for the transaction giving rise to such payment.
``(iii) Exception where distribution actually received.--A
transaction shall not be treated as an applicable wash sales
transaction if the nonresident alien individual, foreign
corporation, or qualified investment entity receives the
distribution described in clause (i)(I) with respect to
either the interest which was disposed of, or acquired, in
the transaction.
``(iv) Exception for certain publicly traded stock.--A
transaction shall not be treated as an applicable wash sales
transaction if it involves the disposition of any class of
stock in a qualified investment entity which is regularly
traded on an established securities market within the United
States but only if the nonresident alien individual, foreign
corporation, or qualified investment entity did not own more
than 5 percent of such class of stock at any time during the
1-year period ending on the date of the distribution
described in clause (i)(I).''.
(b) No Withholding Required.--Section 1445(b) (relating to
exemptions) is amended by adding at the end the following new
paragraph:
``(8) Applicable wash sales transactions.--No person shall
be required to deduct and withhold any amount under
subsection (a) with respect to a disposition which is treated
as a disposition of a United States real property interest
solely by reason of section 897(h)(5).''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2005, except that such amendments shall not apply to any
distribution, or substitute dividend payment, occurring
before the date that is 30 days after the date of the
enactment of this Act.
SEC. 507. SECTION 355 NOT TO APPLY TO DISTRIBUTIONS INVOLVING
DISQUALIFIED INVESTMENT COMPANIES.
(a) In General.--Section 355 (relating to distributions of
stock and securities of a controlled corporation) is amended
by adding at the end the following new subsection:
``(g) Section Not to Apply to Distributions Involving
Disqualified Investment Corporations.--
``(1) In general.--This section (and so much of section 356
as relates to this section) shall not apply to any
distribution which is part of a transaction if--
``(A) either the distributing corporation or controlled
corporation is, immediately after the transaction, a
disqualified investment corporation, and
``(B) any person holds, immediately after the transaction,
a 50-percent or greater interest in any disqualified
investment corporation, but only if such person did not hold
such an interest in such corporation immediately before the
transaction.
``(2) Disqualified investment corporation.--For purposes of
this subsection--
``(A) In general.--The term `disqualified investment
corporation' means any distributing or controlled corporation
if the fair market value of the investment assets of the
corporation is--
``(i) in the case of distributions after the end of the 1-
year period beginning on the date of the enactment of this
subsection, \2/3\ or more of the fair market value of all
assets of the corporation, and
``(ii) in the case of distributions during such 1-year
period, \3/4\ or more of the fair market value of all assets
of the corporation.
``(B) Investment assets.--
``(i) In general.--Except as otherwise provided in this
subparagraph, the term `investment assets' means--
``(I) cash,
``(II) any stock or securities in a corporation,
``(III) any interest in a partnership,
``(IV) any debt instrument or other evidence of
indebtedness,
``(V) any option, forward or futures contract, notional
principal contract, or derivative,
``(VI) foreign currency, or
``(VII) any similar asset.
``(ii) Exception for assets used in active conduct of
certain financial trades or businesses.--Such term shall not
include any asset which is held for use in the active and
regular conduct of--
``(I) a lending or finance business (within the meaning of
section 954(h)(4)),
``(II) a banking business through a bank (as defined in
section 581), a domestic building and loan association
(within the meaning of section 7701(a)(19)), or any similar
institution specified by the Secretary, or
``(III) an insurance business if the conduct of the
business is licensed, authorized, or regulated by an
applicable insurance regulatory body.
This clause shall only apply with respect to any business if
substantially all of the income of the business is derived
from persons who are not related (within the meaning of
section 267(b) or 707(b)(1)) to the person conducting the
business.
``(iii) Exception for securities marked to market.--Such
term shall not include any security (as defined in section
475(c)(2)) which is held by a dealer in securities and to
which section 475(a) applies.
``(iv) Stock or securities in a 20-percent controlled
entity.--
``(I) In general.--Such term shall not include any stock
and securities in, or any asset described in subclause (IV)
or (V) of clause (i) issued by, a corporation which is a 20-
percent controlled entity with respect to the distributing or
controlled corporation.
``(II) Look-thru rule.--The distributing or controlled
corporation shall, for purposes of applying this subsection,
be treated as owning its ratable share of the assets of any
20-percent controlled entity.
``(III) 20-percent controlled entity.--For purposes of this
clause, the term `20-percent controlled entity' means, with
respect to any distributing or controlled corporation, any
corporation with respect to which the distributing or
controlled corporation owns directly or indirectly stock
meeting the requirements of section 1504(a)(2), except that
such section shall be applied by substituting `20 percent'
for `80 percent' and without regard to stock described in
section 1504(a)(4).
``(v) Interests in certain partnerships.--
``(I) In general.--Such term shall not include any interest
in a partnership, or any debt instrument or other evidence of
indebtedness, issued by the partnership, if 1 or more of the
trades or businesses of the partnership are (or, without
regard to the 5-year requirement under subsection (b)(2)(B),
would be) taken into account by the distributing or
controlled corporation, as the case may be, in determining
whether the requirements of subsection (b) are met with
respect to the distribution.
``(II) Look-thru rule.--The distributing or controlled
corporation shall, for purposes of applying this subsection,
be treated as owning its ratable share of the assets of any
partnership described in subclause (I).
``(3) 50-percent or greater interest.--For purposes of this
subsection--
``(A) In general.--The term `50-percent or greater
interest' has the meaning given such term by subsection
(d)(4).
``(B) Attribution rules.--The rules of section 318 shall
apply for purposes of determining ownership of stock for
purposes of this paragraph.
``(4) Transaction.--For purposes of this subsection, the
term `transaction' includes a series of transactions.
``(5) Regulations.--The Secretary shall prescribe such
regulations as may be necessary to carry out, or prevent the
avoidance of, the purposes of this subsection, including
regulations--
``(A) to carry out, or prevent the avoidance of, the
purposes of this subsection in cases involving--
``(i) the use of related persons, intermediaries, pass-thru
entities, options, or other arrangements, and
``(ii) the treatment of assets unrelated to the trade or
business of a corporation as investment assets if, prior to
the distribution, investment assets were used to acquire such
unrelated assets,
``(B) which in appropriate cases exclude from the
application of this subsection a distribution which does not
have the character of a redemption which would be treated as
a sale or exchange under section 302, and
``(C) which modify the application of the attribution rules
applied for purposes of this subsection.''.
(b) Effective Dates.--
(1) In general.--The amendments made by this section shall
apply to distributions after the date of the enactment of
this Act.
(2) Transition rule.--The amendments made by this section
shall not apply to any distribution pursuant to a transaction
which is--
(A) made pursuant to an agreement which was binding on such
date of enactment and at all times thereafter,
(B) described in a ruling request submitted to the Internal
Revenue Service on or before such date, or
(C) described on or before such date in a public
announcement or in a filing with the Securities and Exchange
Commission.
SEC. 508. LOAN AND REDEMPTION REQUIREMENTS ON POOLED
FINANCING REQUIREMENTS.
(a) Strengthened Reasonable Expectation Requirement.--
Subparagraph (A) of section 149(f)(2) (relating to reasonable
expectation requirement) is amended to read as follows:
``(A) In general.--The requirements of this paragraph are
met with respect to an issue if the issuer reasonably expects
that--
``(i) as of the close of the 1-year period beginning on the
date of issuance of the issue, at least 30 percent of the net
proceeds of the issue (as of the close of such period) will
have been used directly or indirectly to make or finance
loans to ultimate borrowers, and
``(ii) as of the close of the 3-year period beginning on
such date of issuance, at least 95 percent of the net
proceeds of the issue (as of the close of such period) will
have been so used.''.
(b) Written Loan Commitment and Redemption Requirements.--
Section 149(f) (relating to treatment of certain pooled
financing bonds) is amended by redesignating paragraphs (4)
and (5) as paragraphs (6) and (7), respectively, and by
inserting after paragraph (3) the following new paragraphs:
``(4) Written loan commitment requirement.--
``(A) In general.--The requirement of this paragraph is met
with respect to an issue if the issuer receives prior to
issuance written loan commitments identifying the ultimate
potential borrowers of at least 30 percent of the net
proceeds of such issue.
``(B) Exception.--Subparagraph (A) shall not apply with
respect to any issuer which--
``(i) is a State (or an integral part of a State) issuing
pooled financing bonds to make or finance loans to
subordinate governmental units of such State, or
``(ii) is a State-created entity providing financing for
water-infrastructure projects
[[Page H2214]]
through the federally-sponsored State revolving fund program.
``(5) Redemption requirement.--The requirement of this
paragraph is met if to the extent that less than the
percentage of the proceeds of an issue required to be used
under clause (i) or (ii) of paragraph (2)(A) is used by the
close of the period identified in such clause, the issuer
uses an amount of proceeds equal to the excess of--
``(A) the amount required to be used under such clause,
over
``(B) the amount actually used by the close of such period,
to redeem outstanding bonds within 90 days after the end of
such period.''.
(c) Elimination of Disregard of Pooled Bonds in Determining
Eligibility for Small Issuer Exception to Arbitrage Rebate.--
Section 148(f)(4)(D)(ii) (relating to aggregation of issuers)
is amended by striking subclause (II) and by redesignating
subclauses (III) and (IV) as subclauses (II) and (III),
respectively.
(d) Conforming Amendments.--
(1) Section 149(f)(1) is amended by striking ``paragraphs
(2) and (3)'' and inserting ``paragraphs (2), (3), (4), and
(5)''.
(2) Section 149(f)(7)(B), as redesignated by subsection
(b), is amended by striking ``paragraph (4)(A)'' and
inserting ``paragraph (6)(A)''.
(3) Section 54(l)(2) is amended by striking ``section
149(f)(4)(A)'' and inserting ``section 149(f)(6)(A)''.
(e) Effective Date.--The amendments made by this section
shall apply to bonds issued after the date of the enactment
of this Act.
SEC. 509. PARTIAL PAYMENTS REQUIRED WITH SUBMISSION OF
OFFERS-IN-COMPROMISE.
(a) In General.--Section 7122 (relating to compromises) is
amended by redesignating subsections (c) and (d) as
subsections (d) and (e), respectively, and by inserting after
subsection (b) the following new subsection:
``(c) Rules for Submission of Offers-in-Compromise.--
``(1) Partial payment required with submission.--
``(A) Lump-sum offers.--
``(i) In general.--The submission of any lump-sum offer-in-
compromise shall be accompanied by the payment of 20 percent
of the amount of such offer.
``(ii) Lump-sum offer-in-compromise.--For purposes of this
section, the term `lump-sum offer-in-compromise' means any
offer of payments made in 5 or fewer installments.
``(B) Periodic payment offers.--
``(i) In general.--The submission of any periodic payment
offer-in-compromise shall be accompanied by the payment of
the amount of the first proposed installment.
``(ii) Failure to make installment during pendency of
offer.--Any failure to make an installment (other than the
first installment) due under such offer-in-compromise during
the period such offer is being evaluated by the Secretary may
be treated by the Secretary as a withdrawal of such offer-in-
compromise.
``(2) Rules of application.--
``(A) Use of payment.--The application of any payment made
under this subsection to the assessed tax or other amounts
imposed under this title with respect to such tax may be
specified by the taxpayer.
``(B) Application of user fee.--In the case of any assessed
tax or other amounts imposed under this title with respect to
such tax which is the subject of an offer-in-compromise to
which this subsection applies, such tax or other amounts
shall be reduced by any user fee imposed under this title
with respect to such offer-in-compromise.
``(C) Waiver authority.--The Secretary may issue
regulations waiving any payment required under paragraph (1)
in a manner consistent with the practices established in
accordance with the requirements under subsection (d)(3).''.
(b) Additional Rules Relating to Treatment of Offers.--
(1) Unprocessable offer if payment requirements are not
met.--Paragraph (3) of section 7122(d) (relating to standards
for evaluation of offers), as redesignated by subsection (a),
is amended by striking ``; and'' at the end of subparagraph
(A) and inserting a comma, by striking the period at the end
of subparagraph (B) and inserting ``, and'', and by adding at
the end the following new subparagraph:
``(C) any offer-in-compromise which does not meet the
requirements of subparagraph (A)(i) or (B)(i), as the case
may be, of subsection (c)(1) may be returned to the taxpayer
as unprocessable.''.
(2) Deemed acceptance of offer not rejected within certain
period.--Section 7122, as amended by subsection (a), is
amended by adding at the end the following new subsection:
``(f) Deemed Acceptance of Offer Not Rejected Within
Certain Period.--Any offer-in-compromise submitted under this
section shall be deemed to be accepted by the Secretary if
such offer is not rejected by the Secretary before the date
which is 24 months after the date of the submission of such
offer. For purposes of the preceding sentence, any period
during which any tax liability which is the subject of such
offer-in-compromise is in dispute in any judicial proceeding
shall not be taken into account in determining the expiration
of the 24-month period.''.
(c) Conforming Amendment.--Section 6159(f) is amended by
striking ``section 7122(d)'' and inserting ``section
7122(e)''.
(d) Effective Date.--The amendments made by this section
shall apply to offers-in-compromise submitted on and after
the date which is 60 days after the date of the enactment of
this Act.
SEC. 510. INCREASE IN AGE OF MINOR CHILDREN WHOSE UNEARNED
INCOME IS TAXED AS IF PARENT'S INCOME.
(a) In General.--Section 1(g)(2)(A) (relating to child to
whom subsection applies) is amended by striking ``age 14''
and inserting ``age 18''.
(b) Treatment of Distributions From Qualified Disability
Trusts.--Section 1(g)(4) (relating to net unearned income) is
amended by adding at the end the following new subparagraph:
``(C) Treatment of distributions from qualified disability
trusts.--For purposes of this subsection, in the case of any
child who is a beneficiary of a qualified disability trust
(as defined in section 642(b)(2)(C)(ii)), any amount included
in the income of such child under sections 652 and 662 during
a taxable year shall be considered earned income of such
child for such taxable year.''.
(c) Conforming Amendment.--Section 1(g)(2) is amended by
striking ``and'' at the end of subparagraph (A), by striking
the period at the end of subparagraph (B) and inserting ``,
and'', and by inserting after subparagraph (B) the following
new subparagraph:
``(C) such child does not file a joint return for the
taxable year.''.
(d) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2005.
SEC. 511. IMPOSITION OF WITHHOLDING ON CERTAIN PAYMENTS MADE
BY GOVERNMENT ENTITIES.
(a) In General.--Section 3402 is amended by adding at the
end the following new subsection:
``(t) Extension of Withholding to Certain Payments Made by
Government Entities.--
``(1) General rule.--The Government of the United States,
every State, every political subdivision thereof, and every
instrumentality of the foregoing (including multi-State
agencies) making any payment to any person providing any
property or services (including any payment made in
connection with a government voucher or certificate program
which functions as a payment for property or services) shall
deduct and withhold from such payment a tax in an amount
equal to 3 percent of such payment.
``(2) Property and services subject to withholding.--
Paragraph (1) shall not apply to any payment--
``(A) except as provided in subparagraph (B), which is
subject to withholding under any other provision of this
chapter or chapter 3,
``(B) which is subject to withholding under section 3406
and from which amounts are being withheld under such section,
``(C) of interest,
``(D) for real property,
``(E) to any governmental entity subject to the
requirements of paragraph (1), any tax-exempt entity, or any
foreign government,
``(F) made pursuant to a classified or confidential
contract described in section 6050M(e)(3),
``(G) made by a political subdivision of a State (or any
instrumentality thereof) which makes less than $100,000,000
of such payments annually,
``(H) which is in connection with a public assistance or
public welfare program for which eligibility is determined by
a needs or income test, and
``(I) to any government employee not otherwise excludable
with respect to their services as an employee.
``(3) Coordination with other sections.--For purposes of
sections 3403 and 3404 and for purposes of so much of
subtitle F (except section 7205) as relates to this chapter,
payments to any person for property or services which are
subject to withholding shall be treated as if such payments
were wages paid by an employer to an employee.''.
(b) Effective Date.--The amendment made by this section
shall apply to payments made after December 31, 2010.
SEC. 512. CONVERSIONS TO ROTH IRAS.
(a) Repeal of Income Limitations.--
(1) In general.--Paragraph (3) of section 408A(c) (relating
to limits based on modified adjusted gross income) is amended
by striking subparagraph (B) and redesignating subparagraphs
(C) and (D) as subparagraphs (B) and (C), respectively.
(2) Conforming amendment.--Clause (i) of section
408A(c)(3)(B) (as redesignated by paragraph (1)) is amended
by striking ``except that--'' and all that follows and
inserting ``except that any amount included in gross income
under subsection (d)(3) shall not be taken into account,
and''.
(b) Rollovers to a Roth IRA From an IRA Other Than a Roth
IRA.--
(1) In general.--Clause (iii) of section 408A(d)(3)(A)
(relating to rollovers from an IRA other than a Roth IRA) is
amended to read as follows:
``(iii) unless the taxpayer elects not to have this clause
apply, any amount required to be included in gross income for
any taxable year beginning in 2010 by reason of this
paragraph shall be so included ratably over the 2-taxable-
year period beginning with the first taxable year beginning
in 2011.''.
(2) Conforming amendments.--
(A) Clause (i) of section 408A(d)(3)(E) is amended to read
as follows:
``(i) Acceleration of inclusion.--
``(I) In general.--The amount otherwise required to be
included in gross income for any taxable year beginning in
2010 or the first taxable year in the 2-year period under
subparagraph (A)(iii) shall be increased by the aggregate
distributions from Roth IRAs for such taxable year which are
allocable under paragraph (4) to the portion of such
qualified rollover contribution required to be included in
gross income under subparagraph (A)(i).
``(II) Limitation on aggregate amount included.--The amount
required to be included
[[Page H2215]]
in gross income for any taxable year under subparagraph
(A)(iii) shall not exceed the aggregate amount required to be
included in gross income under subparagraph (A)(iii) for all
taxable years in the 2-year period (without regard to
subclause (I)) reduced by amounts included for all preceding
taxable years.''.
(B) The heading for section 408A(d)(3)(E) is amended by
striking ``4-year'' and inserting ``2-year''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2009.
SEC. 513. REPEAL OF FSC/ETI BINDING CONTRACT RELIEF.
(a) FSC Provisions.--Paragraph (1) of section 5(c) of the
FSC Repeal and Extraterritorial Income Exclusion Act of 2000
is amended by striking ``which occurs--'' and all that
follows and inserting ``which occurs before January 1,
2002.''.
(b) ETI Provisions.--Section 101 of the American Jobs
Creation Act of 2004 is amended by striking subsection (f).
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after the date of the
enactment of this Act.
SEC. 514. ONLY WAGES ATTRIBUTABLE TO DOMESTIC PRODUCTION
TAKEN INTO ACCOUNT IN DETERMINING DEDUCTION FOR
DOMESTIC PRODUCTION.
(a) In General.--Paragraph (2) of section 199(b) (relating
to W-2 wages) is amended to read as follows:
``(2) W-2 wages.--For purposes of this section--
``(A) In general.--The term `W-2 wages' means, with respect
to any person for any taxable year of such person, the sum of
the amounts described in paragraphs (3) and (8) of section
6051(a) paid by such person with respect to employment of
employees by such person during the calendar year ending
during such taxable year.
``(B) Limitation to wages attributable to domestic
production.--Such term shall not include any amount which is
not properly allocable to domestic production gross receipts
for purposes of subsection (c)(1).
``(C) Return requirement.--Such term shall not include any
amount which is 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.''.
(b) Simplification of Rules for Determining W-2 Wages of
Partners and S Corporation Shareholders.--
(1) In general.--Clause (iii) of section 199(d)(1)(A) is
amended to read as follows:
``(iii) each partner or shareholder shall be treated for
purposes of subsection (b) as having W-2 wages for the
taxable year in an amount equal to such person's allocable
share of the W-2 wages of the partnership or S corporation
for the taxable year (as determined under regulations
prescribed by the Secretary).''.
(2) Conforming amendment.--Paragraph (2) of section 199(a)
is amended by striking ``and subsection (d)(1)''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after the date of the
enactment of this Act.
SEC. 515. MODIFICATION OF EXCLUSION FOR CITIZENS LIVING
ABROAD.
(a) Inflation Adjustment of Foreign Earned Income
Limitation.--Clause (ii) of section 911(b)(2)(D) (relating to
inflation adjustment) is amended--
(1) by striking ``2007'' and inserting ``2005'', and
(2) by striking ``2006'' in subclause (II) and inserting
``2004''.
(b) Modification of Housing Cost Amount.--
(1) Modification of housing cost floor.--Clause (i) of
section 911(c)(1)(B) is amended to read as follows:
``(i) 16 percent of the amount (computed on a daily basis)
in effect under subsection (b)(2)(D) for the calendar year in
which such taxable year begins, multiplied by''.
(2) Maximum amount of exclusion.--
(A) In general.--Subparagraph (A) of section 911(c)(1) is
amended by inserting ``to the extent such expenses do not
exceed the amount determined under paragraph (2)'' after
``the taxable year''.
(B) Limitation.--Subsection (c) of section 911 is amended
by redesignating paragraphs (2) and (3) as paragraphs (3) and
(4), respectively, and by inserting after paragraph (1) the
following new paragraph:
``(2) Limitation.--
``(A) In general.--The amount determined under this
paragraph is an amount equal to the product of--
``(i) 30 percent (adjusted as may be provided under
subparagraph (B)) of the amount (computed on a daily basis)
in effect under subsection (b)(2)(D) for the calendar year in
which the taxable year of the individual begins, multiplied
by
``(ii) the number of days of such taxable year within the
applicable period described in subparagraph (A) or (B) of
subsection (d)(1).
``(B) Regulations.--The Secretary may issue regulations or
other guidance providing for the adjustment of the percentage
under subparagraph (A)(i) on the basis of geographic
differences in housing costs relative to housing costs in the
United States.''.
(C) Conforming amendments.--
(i) Section 911(d)(4) is amended by striking ``and
(c)(1)(B)(ii)'' and inserting ``, (c)(1)(B)(ii), and
(c)(2)(A)(ii)''.
(ii) Section 911(d)(7) is amended by striking ``subsection
(c)(3)'' and inserting ``subsection (c)(4)''.
(c) Rates of Tax Applicable to Nonexcluded Income.--Section
911 (relating to exclusion of certain income of citizens and
residents of the United States living abroad) is amended by
redesignating subsection (f) as subsection (g) and by
inserting after subsection (e) the following new subsection:
``(f) Determination of Tax Liability on Nonexcluded
Amounts.--For purposes of this chapter, if any amount is
excluded from the gross income of a taxpayer under subsection
(a) for any taxable year, then, notwithstanding section 1 or
55--
``(1) the tax imposed by section 1 on the taxpayer for such
taxable year shall be equal to the excess (if any) of--
``(A) the tax which would be imposed by section 1 for the
taxable year if the taxpayer's taxable income were increased
by the amount excluded under subsection (a) for the taxable
year, over
``(B) the tax which would be imposed by section 1 for the
taxable year if the taxpayer's taxable income were equal to
the amount excluded under subsection (a) for the taxable
year, and
``(2) the tentative minimum tax under section 55 for such
taxable year shall be equal to the excess (if any) of--
``(A) the amount which would be such tentative minimum tax
for the taxable year if the taxpayer's taxable excess were
increased by the amount excluded under subsection (a) for the
taxable year, over
``(B) the amount which would be such tentative minimum tax
for the taxable year if the taxpayer's taxable excess were
equal to the amount excluded under subsection (a) for the
taxable year.
For purposes of this subsection, the amount excluded under
subsection (a) shall be reduced by the aggregate amount of
any deductions or exclusions disallowed under subsection
(d)(6) with respect to such excluded amount.''.
(d) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31,
2005.
SEC. 516. TAX INVOLVEMENT OF ACCOMMODATION PARTIES IN TAX
SHELTER TRANSACTIONS.
(a) Imposition of Excise Tax.--
(1) In general.--Chapter 42 (relating to private
foundations and certain other tax-exempt organizations) is
amended by adding at the end the following new subchapter:
``Subchapter F--Tax Shelter Transactions
``Sec. 4965. Excise tax on certain tax-exempt entities entering into
prohibited tax shelter transactions.
``SEC. 4965. EXCISE TAX ON CERTAIN TAX-EXEMPT ENTITIES
ENTERING INTO PROHIBITED TAX SHELTER
TRANSACTIONS.
``(a) Being a Party to and Approval of Prohibited
Transactions.--
``(1) Tax-exempt entity.--
``(A) In general.--If a transaction is a prohibited tax
shelter transaction at the time any tax-exempt entity
described in paragraph (1), (2), or (3) of subsection (c)
becomes a party to the transaction, such entity shall pay a
tax for the taxable year in which the entity becomes such a
party and any subsequent taxable year in the amount
determined under subsection (b)(1).
``(B) Post-transaction determination.--If any tax-exempt
entity described in paragraph (1), (2), or (3) of subsection
(c) is a party to a subsequently listed transaction at any
time during a taxable year, such entity shall pay a tax for
such taxable year in the amount determined under subsection
(b)(1).
``(2) Entity manager.--If any entity manager of a tax-
exempt entity approves such entity as (or otherwise causes
such entity to be) a party to a prohibited tax shelter
transaction at any time during the taxable year and knows or
has reason to know that the transaction is a prohibited tax
shelter transaction, such manager shall pay a tax for such
taxable year in the amount determined under subsection
(b)(2).
``(b) Amount of Tax.--
``(1) Entity.--In the case of a tax-exempt entity--
``(A) In general.--Except as provided in subparagraph (B),
the amount of the tax imposed under subsection (a)(1) with
respect to any transaction for a taxable year shall be an
amount equal to the product of the highest rate of tax under
section 11, and the greater of--
``(i) the entity's net income (after taking into account
any tax imposed by this subtitle (other than by this section)
with respect to such transaction) for such taxable year
which--
``(I) in the case of a prohibited tax shelter transaction
(other than a subsequently listed transaction), is
attributable to such transaction, or
``(II) in the case of a subsequently listed transaction, is
attributable to such transaction and which is properly
allocable to the period beginning on the later of the date
such transaction is identified by guidance as a listed
transaction by the Secretary or the first day of the taxable
year, or
``(ii) 75 percent of the proceeds received by the entity
for the taxable year which--
``(I) in the case of a prohibited tax shelter transaction
(other than a subsequently listed transaction), are
attributable to such transaction, or
``(II) in the case of a subsequently listed transaction,
are attributable to such transaction and which are properly
allocable to the period beginning on the later of the date
such transaction is identified by guidance as a listed
transaction by the Secretary or the first day of the taxable
year.
``(B) Increase in tax for certain knowing transactions.--In
the case of a tax-exempt entity which knew, or had reason to
know, a transaction was a prohibited tax shelter transaction
at the time the entity became a party to the transaction, the
amount of the tax imposed under subsection (a)(1)(A) with
respect to any transaction for a taxable year shall be the
greater of--
[[Page H2216]]
``(i) 100 percent of the entity's net income (after taking
into account any tax imposed by this subtitle (other than by
this section) with respect to the prohibited tax shelter
transaction) for such taxable year which is attributable to
the prohibited tax shelter transaction, or
``(ii) 75 percent of the proceeds received by the entity
for the taxable year which are attributable to the prohibited
tax shelter transaction.
This subparagraph shall not apply to any prohibited tax
shelter transaction to which a tax-exempt entity became a
party on or before the date of the enactment of this section.
``(2) Entity manager.--In the case of each entity manager,
the amount of the tax imposed under subsection (a)(2) shall
be $20,000 for each approval (or other act causing
participation) described in subsection (a)(2).
``(c) Tax-Exempt Entity.--For purposes of this section, the
term `tax-exempt entity' means an entity which is--
``(1) described in section 501(c) or 501(d),
``(2) described in section 170(c) (other than the United
States),
``(3) an Indian tribal government (within the meaning of
section 7701(a)(40)),
``(4) described in paragraph (1), (2), or (3) of section
4979(e),
``(5) a program described in section 529,
``(6) an eligible deferred compensation plan described in
section 457(b) which is maintained by an employer described
in section 4457(e)(1)(A), or
``(7) an arrangement described in section 4973(a).
``(d) Entity Manager.--For purposes of this section, the
term `entity manager' means--
``(1) in the case of an entity described in paragraph (1),
(2), or (3) of subsection (c)--
``(A) the person with authority or responsibility similar
to that exercised by an officer, director, or trustee of an
organization, and
``(B) with respect to any act, the person having authority
or responsibility with respect to such act, and
``(2) in the case of an entity described in paragraph (4),
(5), (6), or (7) of subsection (c), the person who approves
or otherwise causes the entity to be a party to the
prohibited tax shelter transaction.
``(e) Prohibited Tax Shelter Transaction; Subsequently
Listed Transaction.--For purposes of this section--
``(1) Prohibited tax shelter transaction.--
``(A) In general.--The term `prohibited tax shelter
transaction' means--
``(i) any listed transaction, and
``(ii) any prohibited reportable transaction.
``(B) Listed transaction.--The term `listed transaction'
has the meaning given such term by section 6707A(c)(2).
``(C) Prohibited reportable transaction.--The term
`prohibited reportable transaction' means any confidential
transaction or any transaction with contractual protection
(as defined under regulations prescribed by the Secretary)
which is a reportable transaction (as defined in section
6707A(c)(1)).
``(2) Subsequently listed transaction.--The term
`subsequently listed transaction' means any transaction to
which a tax-exempt entity is a party and which is determined
by the Secretary to be a listed transaction at any time after
the entity has become a party to the transaction. Such term
shall not include a transaction which is a prohibited
reportable transaction at the time the entity became a party
to the transaction.
``(f) Regulatory Authority.--The Secretary is authorized to
promulgate regulations which provide guidance regarding the
determination of the allocation of net income or proceeds of
a tax-exempt entity attributable to a transaction to various
periods, including before and after the listing of the
transaction or the date which is 90 days after the date of
the enactment of this section.
``(g) Coordination With Other Taxes and Penalties.--The tax
imposed by this section is in addition to any other tax,
addition to tax, or penalty imposed under this title.''.
(2) Conforming amendment.--The table of subchapters for
chapter 42 is amended by adding at the end the following new
item:
``Subchapter F. Tax Shelter Transactions.''.
(b) Disclosure Requirements.--
(1) Disclosure by entity to the internal revenue service.--
(A) In general.--Section 6033(a) (relating to organizations
required to file) is amended by redesignating paragraph (2)
as paragraph (3) and by inserting after paragraph (1) the
following new paragraph:
``(2) Being a party to certain reportable transactions.--
Every tax-exempt entity described in section 4965(c) shall
file (in such form and manner and at such time as determined
by the Secretary) a disclosure of--
``(A) such entity's being a party to any prohibited tax
shelter transaction (as defined in section 4965(e)), and
``(B) the identity of any other party to such transaction
which is known by such tax-exempt entity.''.
(B) Conforming amendment.--Section 6033(a)(1) is amended by
striking ``paragraph (2)'' and inserting ``paragraph (3)''.
(2) Disclosure by other taxpayers to the tax-exempt
entity.--Section 6011 (relating to general requirement of
return, statement, or list) is amended by redesignating
subsection (g) as subsection (h) and by inserting after
subsection (f) the following new subsection:
``(g) Disclosure of Reportable Transaction to Tax-Exempt
Entity.--Any taxable party to a prohibited tax shelter
transaction (as defined in section 4965(e)(1)) shall by
statement disclose to any tax-exempt entity (as defined in
section 4965(c)) which is a party to such transaction that
such transaction is such a prohibited tax shelter
transaction.''.
(c) Penalty for Nondisclosure.--
(1) In general.--Section 6652(c) (relating to returns by
exempt organizations and by certain trusts) is amended by
redesignating paragraphs (3) and (4) as paragraphs (4) and
(5), respectively, and by inserting after paragraph (2) the
following new paragraph:
``(3) Disclosure under section 6033(a)(2).--
``(A) Penalty on entities.--In the case of a failure to
file a disclosure required under section 6033(a)(2), there
shall be paid by the tax-exempt entity (the entity manager in
the case of a tax-exempt entity described in paragraph (4),
(5), (6), or (7) of section 4965(c)) $100 for each day during
which such failure continues. The maximum penalty under this
subparagraph on failures with respect to any 1 disclosure
shall not exceed $50,000.
``(B) Written demand.--
``(i) In general.--The Secretary may make a written demand
on any entity or manager subject to penalty under
subparagraph (A) specifying therein a reasonable future date
by which the disclosure shall be filed for purposes of this
subparagraph.
``(ii) Failure to comply with demand.--If any entity or
manager fails to comply with any demand under clause (i) on
or before the date specified in such demand, there shall be
paid by such entity or manager failing to so comply $100 for
each day after the expiration of the time specified in such
demand during which such failure continues. The maximum
penalty imposed under this subparagraph on all entities and
managers for failures with respect to any 1 disclosure shall
not exceed $10,000.
``(C) Definitions.--Any term used in this section which is
also used in section 4965 shall have the meaning given such
term under section 4965.''.
(2) Conforming amendment.--Paragraph (1) of section 6652(c)
is amended by striking ``6033'' each place it appears in the
text and heading thereof and inserting ``6033(a)(1)''.
(d) Effective Dates.--
(1) In general.--Except as provided in paragraph (2), the
amendments made by this section shall apply to taxable years
ending after the date of the enactment of this Act, with
respect to transactions before, on, or after such date,
except that no tax under section 4965(a) of the Internal
Revenue Code of 1986 (as added by this section) shall apply
with respect to income or proceeds that are properly
allocable to any period ending on or before the date which is
90 days after such date of enactment.
(2) Disclosure.--The amendments made by subsections (b) and
(c) shall apply to disclosures the due date for which are
after the date of the enactment of this Act.
And the Senate agree to the same.
William Thomas,
Jim McCrery,
Dave Camp,
Managers on the Part of the House.
Chuck Grassley,
Jon Kyl,
Managers on the Part of the Senate.
JOINT EXPLANATORY STATEMENT OF THE COMMITTEE OF CONFERENCE
The managers on the part of the House and the Senate at the
conference on the disagreeing votes of the two Houses on the
amendment of the Senate to the bill (H.R. 4297), to provide
for reconciliation pursuant to section 201(b) of the
concurrent resolution on the budget for fiscal year 2006,
submit the following joint statement to the House and the
Senate in explanation of the effect of the action agreed upon
by the managers and recommended in the accompanying
conference report:
The Senate amendment struck all of the House bill after the
enacting clause and inserted a substitute text.
The House recedes from its disagreement to the amendment of
the Senate with an amendment that is a substitute for the
House bill and the Senate amendment. The differences between
the House bill, the Senate amendment, and the substitute
agreed to in conference are noted below, except for clerical
corrections, conforming changes made necessary by agreements
reached by the conferees, and minor drafting and clarifying
changes.
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
A. Allowance of Nonrefundable Personal Credits Against Regular and
Alternative Minimum Tax Liability
(Sec. 101 of the House bill, sec. 107 of the Senate
amendment, and sec. 26 of the Code)
present law
Present law provides for certain nonrefundable personal tax
credits (i.e., the dependent care credit, the credit for the
elderly and disabled, the adoption credit, the child tax
credit, the credit for interest on certain home mortgages,
the HOPE Scholarship and Lifetime Learning credits, the
credit for savers, the credit for certain nonbusiness energy
property, the credit for residential energy efficient
property, and the D.C. first-time homebuyer credit). The
Energy Tax Incentives Act of 2005 enacted, effective for
2006, nonrefundable tax credits for alternative motor
vehicles, and alternative motor vehicle refueling
property.\1\
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\1\ The portion of these credits relating to personal use
property is subject to the same tax liability limitation as
the nonrefundable personal tax credits (other than the
adoption credit, child credit, and saver's credit).
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For taxable years beginning in 2005, the nonrefundable
personal credits are allowed to the extent of the full amount
of the individual's regular tax and alternative minimum tax.
[[Page H2217]]
For taxable years beginning after 2005, the nonrefundable
personal credits (other than the adoption credit, child
credit and saver's credit) are allowed only to the extent
that the individual's regular income tax liability exceeds
the individual's tentative minimum tax, determined without
regard to the minimum tax foreign tax credit. The adoption
credit, child credit, and saver's credit are allowed to the
full extent of the individual's regular tax and alternative
minimum tax.
The alternative minimum tax is the amount by which the
tentative minimum tax exceeds the regular income tax. An
individual's tentative minimum tax is the sum of (1) 26
percent of so much of the taxable excess as does not exceed
$175,000 ($87,500 in the case of a married individual filing
a separate return) and (2) 28 percent of the remaining
taxable excess. The taxable excess is so much of the
alternative minimum taxable income (``AMTI'') as exceeds the
exemption amount. The maximum tax rates on net capital gain
and dividends used in computing the regular tax are used in
computing the tentative minimum tax. AMTI is the individual's
taxable income adjusted to take account of specified
preferences and adjustments.
The exemption amount is: (1) $45,000 ($58,000 for taxable
years beginning before 2006) in the case of married
individuals filing a joint return and surviving spouses; (2)
$33,750 ($40,250 for taxable years beginning before 2006) in
the case of other unmarried individuals; (3) $22,500 ($29,000
for taxable years beginning before 2006) in the case of
married individuals filing a separate return; and (4) $22,500
in the case of an estate or trust. The exemption amount is
phased out by an amount equal to 25 percent of the amount by
which the individual's AMTI exceeds (1) $150,000 in the case
of married individuals filing a joint return and surviving
spouses, (2) $112,500 in the case of other unmarried
individuals, and (3) $75,000 in the case of married
individuals filing separate returns, an estate, or a trust.
These amounts are not indexed for inflation.
House Bill
The House bill extends for one year the present-law
provision allowing nonrefundable personal credits to the full
extent of the individual's regular tax and alternative
minimum tax (through taxable years beginning on or before
December 31, 2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
senate amendment
The Senate amendment extends for two years the present-law
provision allowing nonrefundable personal credits to the full
extent of the individual's regular tax and alternative
minimum tax (through taxable years beginning on or before
December 31, 2007).
The provision also applies to the personal credits for
alternative motor vehicles, and alternative motor vehicle
refueling property.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
conference agreement
The conference agreement includes the House bill provision.
B. Tax Incentives for Business Activities on Indian Reservations
1. Indian employment tax credit (Sec. 102(a) of the House
bill, sec. 115 of the Senate amendment, and sec. 45A of
the Code)
Present Law
In general, a credit against income tax liability is
allowed to employers for the first $20,000 of qualified wages
and qualified employee health insurance costs paid or
incurred by the employer with respect to certain employees
(sec. 45A).\2\ The credit is equal to 20 percent of the
excess of eligible employee qualified wages and health
insurance costs during the current year over the amount of
such wages and costs incurred by the employer during 1993.
The credit is an incremental credit, such that an employer's
current-year qualified wages and qualified employee health
insurance costs (up to $20,000 per employee) are eligible for
the credit only to the extent that the sum of such costs
exceeds the sum of comparable costs paid during 1993. No
deduction is allowed for the portion of the wages equal to
the amount of the credit.
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\2\ All section references are to the Internal Revenue Code
of 1986, unless otherwise indicated.
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Qualified wages means wages paid or incurred by an employer
for services performed by a qualified employee. A qualified
employee means any employee who is an enrolled member of an
Indian tribe or the spouse of an enrolled member of an Indian
tribe, who performs substantially all of the services within
an Indian reservation, and whose principal place of abode
while performing such services is on or near the reservation
in which the services are performed. An ``Indian
reservation'' is a reservation as defined in section 3(d) of
the Indian Financing Act of 1974 or section 4(1) of the
Indian Child Welfare Act of 1978. For purposes of the
preceding sentence, section 3(d) is applied by treating
``former Indian reservations in Oklahoma'' as including only
lands that are (1) within the jurisdictional area of an
Oklahoma Indian tribe as determined by the Secretary of the
Interior, and (2) recognized by such Secretary as an area
eligible for trust land status under 25 C.F.R. Part 151 (as
in effect on August 5, 1997).
An employee is not treated as a qualified employee for any
taxable year of the employer if the total amount of wages
paid or incurred by the employer with respect to such
employee during the taxable year exceeds an amount determined
at an annual rate of $30,000 (which after adjusted for
inflation after 1993 is currently $35,000). In addition, an
employee will not be treated as a qualified employee under
certain specific circumstances, such as where the employee is
related to the employer (in the case of an individual
employer) or to one of the employer's shareholders, partners,
or grantors. Similarly, an employee will not be treated as a
qualified employee where the employee has more than a 5
percent ownership interest in the employer. Finally, an
employee will not be considered a qualified employee to the
extent the employee's services relate to gaming activities or
are performed in a building housing such activities.
The wage credit is available for wages paid or incurred on
or after January 1, 1994, in taxable years that begin before
January 1, 2006.
house bill
The provision extends for one year the present-law
employment credit provision (through taxable years beginning
on or before December 31, 2006).
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
Senate Amendment
The Senate amendment extends for two years the present-law
employment credit provision (through taxable years beginning
on or before December 31, 2007).
Effective date.--Same as the House bill provision.
conference agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
2. Accelerated depreciation for business property on Indian
reservations (sec. 102(b) of the House bill, sec. 116 of
the Senate amendment, and sec. 168(j) of the Code)
present law
With respect to certain property used in connection with
the conduct of a trade or business within an Indian
reservation, depreciation deductions under section 168(j) are
determined using the following recovery periods:
Years
3-year property.......................................................2
5-year property.......................................................3
7-year property.......................................................4
10-year property......................................................6
15-year property......................................................9
20-year property.....................................................12
Nonresidential real property.........................................22
``Qualified Indian reservation property'' eligible for
accelerated depreciation includes property which is (1) used
by the taxpayer predominantly in the active conduct of a
trade or business within an Indian reservation, (2) not used
or located outside the reservation on a regular basis, (3)
not acquired (directly or indirectly) by the taxpayer from a
person who is related to the taxpayer (within the meaning of
section 465(b)(3)(C)), and (4) described in the recovery-
period table above. In addition, property is not ``qualified
Indian reservation property'' if it is placed in service for
purposes of conducting gaming activities. Certain ``qualified
infrastructure property'' may be eligible for the accelerated
depreciation even if located outside an Indian reservation,
provided that the purpose of such property is to connect with
qualified infrastructure property located within the
reservation (e.g., roads, power lines, water systems,
railroad spurs, and communications facilities).
An ``Indian reservation'' means a reservation as defined in
section 3(d) of the Indian Financing Act of 1974 or section
4(1) of the Indian Child Welfare Act of 1978. For purposes of
the preceding sentence, section 3(d) is applied by treating
``former Indian reservations in Oklahoma'' as including only
lands that are (1) within the jurisdictional area of an
Oklahoma Indian tribe as determined by the Secretary of the
Interior, and (2) recognized by such Secretary as an area
eligible for trust land status under 25 CFR. Part 151 (as in
effect on August 5, 1997).
The depreciation deduction allowed for regular tax purposes
is also allowed for purposes of the alternative minimum tax.
The accelerated depreciation for Indian reservations is
available with respect to property placed in service on or
after January 1, 1994, and before January 1, 2006.
House Bill
The provision extends for one year the present-law
incentive relating to depreciation of qualified Indian
reservation property (to apply to property placed in service
through December 31, 2006).
Effective date.--The provision applies to property placed
in service after December 31, 2005.
Senate Amendment
The Senate amendment extends for two years the present-law
incentive relating to depreciation of qualified Indian
reservation property (to apply to property placed in service
through December 31, 2007).
Effective date.--The Senate amendment is the same as the
House bill.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
[[Page H2218]]
C. Work Opportunity Tax Credit and Welfare-To-Work Tax Credit
(Secs. 103 and 104 of the House bill, sec. 109 of the Senate
amendment and secs. 51 and 51A of the Code)
Present Law
Work opportunity tax credit
Targeted groups eligible for the credit
The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of
eight targeted groups. The eight targeted groups are: (1)
certain families eligible to receive benefits under the
Temporary Assistance for Needy Families Program; (2) high-
risk youth; (3) qualified ex-felons; (4) vocational
rehabilitation referrals; (5) qualified summer youth
employees; (6) qualified veterans; (7) families receiving
food stamps; and (8) persons receiving certain Supplemental
Security Income (SSI) benefits.
A high-risk youth is an individual aged 18 but not aged 25
on the hiring date who is certified by a designated local
agency as having a principal place of abode within an
empowerment zone, enterprise community, or renewal community.
The credit is not available if such youth's principal place
of abode ceases to be within an empowerment zone, enterprise
community, or renewal community.
A qualified ex-felon is an individual certified by a
designated local agency as: (1) having been convicted of a
felony under State or Federal law; (2) being a member of an
economically disadvantaged family; and (3) having a hiring
date within one year of release from prison or conviction.
A food stamp recipient is an individual aged 18 but not
aged 25 on the hiring date certified by a designated local
agency as being a member of a family either currently or
recently receiving assistance under an eligible food stamp
program.
Qualified wages
Generally, qualified wages are defined as cash wages paid
by the employer to a member of a targeted group. The
employer's deduction for wages is reduced by the amount of
the credit.
Calculation of the credit
The credit equals 40 percent (25 percent for employment of
400 hours or less) of qualified first-year wages. Generally,
qualified first-year wages are qualified wages (not in excess
of $6,000) attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual began work for the employer. Therefore,
the maximum credit per employee is $2,400 (40 percent of the
first $6,000 of qualified first-year wages). With respect to
qualified summer youth employees, the maximum credit is
$1,200 (40 percent of the first $3,000 of qualified first-
year wages).
Minimum employment period
No credit is allowed for qualified wages paid to employees
who work less than 120 hours in the first year of employment.
Coordination of the work opportunity tax credit and the
welfare-to-work tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The work opportunity tax credit is not allowed for wages
paid to a relative or dependent of the taxpayer. Similarity
wages paid to replacement workers during a strike or lockout
are not eligible for the work opportunity tax credit. Wages
paid to any employee during any period for which the employer
received on-the-job training program payments with respect to
that employee are not eligible for the work opportunity tax
credit. The work opportunity tax credit generally is not
allowed for wages paid to individuals who had previously been
employed by the employer. In addition, many other technical
rules apply.
Expiration
The work opportunity tax credit is not available for
individuals who begin work for an employer after December 31,
2005.
Welfare-to-work tax credit
Targeted group eligible for the credit
The welfare-to-work tax credit is available on an elective
basis to employers of qualified long-term family assistance
recipients. Qualified long-term family assistance recipients
are: (1) members of a family that has received family
assistance for at least 18 consecutive months ending on the
hiring date; (2) members of a family that has received such
family assistance for a total of at least 18 months (whether
or not consecutive) after August 5, 1997 (the date of
enactment of the welfare-to-work tax credit) if they are
hired within 2 years after the date that the 18-month total
is reached; and (3) members of a family who are no longer
eligible for family assistance because of either Federal or
State time limits, if they are hired within 2 years after the
Federal or State time limits made the family ineligible for
family assistance.
Qualified wages
Qualified wages for purposes of the welfare-to-work tax
credit are defined more broadly than the work opportunity tax
credit. Unlike the definition of wages for the work
opportunity tax credit which includes simply cash wages, the
definition of wages for the welfare-to-work tax credit
includes cash wages paid to an employee plus amounts paid by
the employer for: (1) educational assistance excludable under
a section 127 program (or that would be excludable but for
the expiration of sec. 127); (2) health plan coverage for the
employee, but not more than the applicable premium defined
under section 4980B(f)(4); and (3) dependent care assistance
excludable under section 129. The employer's deduction for
wages is reduced by the amount of the credit.
Calculation of the credit
The welfare-to-work tax credit is available on an elective
basis to employers of qualified long-term family assistance
recipients during the first two years of employment. The
maximum credit is 35 percent of the first $10,000 of
qualified first-year wages and 50 percent of the first
$10,000 of qualified second-year wages. Qualified first-year
wages are defined as qualified wages (not in excess of
$10,000) attributable to service rendered by a member of the
targeted group during the one-year period beginning with the
day the individual began work for the employer. Qualified
second-year wages are defined as qualified wages (not in
excess of $10,000) attributable to service rendered by a
member of the targeted group during the one-year period
beginning immediately after the first year of that
individual's employment for the employer. The maximum credit
is $8,500 per qualified employee.
Minimum employment period
No credit is allowed for qualified wages paid to a member
of the targeted group unless they work at least 400 hours or
180 days in the first year of employment.
Coordination of the work opportunity tax credit and the
welfare-to-work tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The welfare-to-work tax credit incorporates directly or by
reference many of these other rules contained on the work
opportunity tax credit.
Expiration
The welfare-to-work credit is not available for individuals
who begin work for an employer after December 31, 2005.
House Bill
Work opportunity tax credit
The House bill extends the work opportunity credit for one
year (through December 31, 2006). Also, the House bill raises
the maximum age limit for the food stamp recipient category
to include individuals who are at least age 18 but under age
35 on the hiring date.
Effective date
The provision is effective for wages paid or incurred to a
qualified individual who begins work for an employer after
December 31, 2005, and before January 1, 2007.
Welfare-to-work tax credit
The House bill extends the welfare-to-work tax credit for
one year (through December 31, 2006).
Effective date.--The provision is effective for wages paid
or incurred to a qualified individual who begins work for an
employer after December 31, 2005, and before January 1, 2007.
Senate Amendment
In general
The Senate amendment combines the work opportunity and
welfare-to-work tax credits and extends the combined credit
for one year. The welfare-to-work credit is repealed.
Targeted groups eligible for the combined credit
The combined credit is available on an elective basis for
employers hiring individuals from one or more of all nine
targeted groups. The nine targeted groups are the present-law
eight groups with the addition of the welfare-to-work credit/
long-term family assistance recipient as the ninth targeted
group.
The Senate amendment raises the age limit for the high-risk
youth category to include individuals aged 18 but not aged 40
on the hiring date. The Senate amendment also renames the
high-risk youth category to be the designated community
resident category.
The Senate amendment repeals the requirement that a
qualified ex-felon be an individual certified as a member of
an economically disadvantaged family.
The Senate amendment raises the age limit for the food
stamp recipient category to include individuals aged 18 but
not aged 40 on the hiring date.
Qualified wages
Qualified first-year wages for the eight work opportunity
tax credit categories remain capped at $6,000 ($3,000 for
qualified summer youth employees). No credit is allowed for
second-year wages. In the case of long-term family assistance
recipients, the cap is $10,000 for both qualified first-year
wages and qualified second-year wages. The combined credit
follows the work opportunity tax credit definition of wages
which does not include amounts paid by the employer for: (1)
educational assistance excludable under a section 127 program
(or that would be excludable but for the expiration of sec.
127); (2) health plan coverage for the employee, but not more
than the applicable premium defined under section
4980B(f)(4); and (3) dependent care assistance excludable
under section 129. For all targeted groups, the employer's
deduction for wages is reduced by the amount of the credit.
[[Page H2219]]
Calculation of the credit
First-year wages.--For the eight work opportunity tax
credit categories, the credit equals 40 percent (25 percent
for employment of 400 hours or less) of qualified first-year
wages. Generally, qualified first-year wages are qualified
wages (not in excess of $6,000) attributable to service
rendered by a member of a targeted group during the one-year
period beginning with the day the individual began work for
the employer. Therefore, the maximum credit per employee for
members of any of the eight work opportunity tax credit
targeted groups generally is $2,400 (40 percent of the first
$6,000 of qualified first-year wages). With respect to
qualified summer youth employees, the maximum credit remains
$1,200 (40 percent of the first $3,000 of qualified first-
year wages). For the welfare-to-work/long-term family
assistance recipients, the maximum credit equals $4,000 per
employee (40 percent of $10,000 of wages).
Second year wages.--In the case of long-term family
assistance recipients the maximum credit is $5,000 (50
percent of the first $10,000 of qualified second-year wages).
Minimum employment period
No credit is allowed for qualified wages paid to employees
who work less than 120 hours in the first year of employment.
Coordination of the work opportunity tax credit and the
welfare-to-work tax credit
Coordination is no longer necessary once the two credits
are combined.
Effective date.--The provision is effective for wages paid
or incurred to a qualified individual who begins work for an
employer after December 31, 2005, and before January 1, 2007.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
D. Deduction for Corporate Donations of Computer Technology and
Equipment
(Sec. 105 of the House bill, sec. 111 of the Senate amendment
and sec. 170 of the Code)
Present Law
In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property,
the amount of the charitable deduction generally is limited
to the taxpayer's basis in the property. In the case of a
charitable contribution of tangible personal property, the
deduction is limited to the taxpayer's basis in such property
if the use by the recipient charitable organization is
unrelated to the organization's tax-exempt purpose. In cases
involving contributions to a private foundation (other than
certain private operating foundations), the amount of the
deduction is limited to the taxpayer's basis in the property.
Under present law, a taxpayer's deduction for charitable
contributions of computer technology and equipment generally
is limited to the taxpayer's basis (typically, cost) in the
property. However, certain corporations may claim a deduction
in excess of basis for a ``qualified computer contribution.''
This enhanced deduction is equal to the lesser of (1) basis
plus one-half of the item's appreciation (i.e., basis plus
one half of fair market value minus basis) or (2) two times
basis. The enhanced deduction for qualified computer
contributions expires for any contribution made during any
taxable year beginning after December 31, 2005.
A qualified computer contribution means a charitable
contribution of any computer technology or equipment, which
meets standards of functionality and suitability as
established by the Secretary of the Treasury. The
contribution must be to certain educational organizations or
public libraries and made not later than three years after
the taxpayer acquired the property or, if the taxpayer
constructed the property, not later than the date
construction of the property is substantially completed. The
original use of the property must be by the donor or the
donee, and in the case of the donee, must be used
substantially for educational purposes related to the
function or purpose of the donee. The property must fit
productively into the donee's education plan. The donee may
not transfer the property in exchange for money, other
property, or services, except for shipping, installation, and
transfer costs. To determine whether property is constructed
by the taxpayer, the rules applicable to qualified research
contributions apply. That is, property is considered
constructed by the taxpayer only if the cost of the parts
used in the construction of the property (other than parts
manufactured by the taxpayer or a related person) does not
exceed 50 percent of the taxpayer's basis in the property.
Contributions may be made to private foundations under
certain conditions.
House Bill
The present-law provision is extended for one year to apply
to contributions made during any taxable year beginning after
December 31, 2005, and before January 1, 2007.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005.
Senate Amendment
Same as House bill.
Effective date.--The provision is effective on the date of
enactment.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
E. Availability of Archer Medical Savings Accounts
(Sec. 106 of the House bill and sec. 220 of the Code)
Present Law
Archer medical savings accounts
In general
Within limits, contributions to an Archer medical savings
account (``Archer MSA'') are deductible in determining
adjusted gross income if made by an eligible individual and
are excludable from gross income and wages for employment tax
purposes if made by the employer of an eligible individual.
Earnings on amounts in an Archer MSA are not currently
taxable. Distributions from an Archer MSA for medical
expenses are not includible in gross income. Distributions
not used for medical expenses are includible in gross income.
In addition, distributions not used for medical expenses are
subject to an additional 15-percent tax unless the
distribution is made after age 65, death, or disability.
Eligible individuals
Archer MSAs are available to employees covered under an
employer-sponsored high deductible plan of a small employer
and self-employed individuals covered under a high deductible
health plan. An employer is a small employer if it employed,
on average, no more than 50 employees on business days during
either the preceding or the second preceding year. An
individual is not eligible for an Archer MSA if he or she is
covered under any other health plan in addition to the high
deductible plan.
Tax treatment of and limits on contributions
Individual contributions to an Archer MSA are deductible
(within limits) in determining adjusted gross income (i.e.,
``above-the-line''). In addition, employer contributions are
excludable from gross income and wages for employment tax
purposes (within the same limits), except that this exclusion
does not apply to contributions made through a cafeteria
plan. In the case of an employee, contributions can be made
to an Archer MSA either by the individual or by the
individual's employer.
The maximum annual contribution that can be made to an
Archer MSA for a year is 65 percent of the deductible under
the high deductible plan in the case of individual coverage
and 75 percent of the deductible in the case of family
coverage.
Definition of high deductible plan
A high deductible plan is a health plan with an annual
deductible of at least $1,800 and no more than $2,700 in the
case of individual coverage and at least $3,650 and no more
than $5,450 in the case of family coverage (for 2006). In
addition, the maximum out-of-pocket expenses with respect to
allowed costs (including the deductible) must be no more than
$3,650 in the case of individual coverage and no more than
$6,650 in the case of family coverage (for 2006). A plan does
not fail to qualify as a high deductible plan merely because
it does not have a deductible for preventive care as required
by State law. A plan does not qualify as a high deductible
health plan if substantially all of the coverage under the
plan is for certain permitted coverage. In the case of a
self-insured plan, the plan must in fact be insurance (e.g.,
there must be appropriate risk shifting) and not merely a
reimbursement arrangement.
Cap on taxpayers utilizing Archer MSAs and expiration of
pilot program
The number of taxpayers benefiting annually from an Archer
MSA contribution is limited to a threshold level (generally
750,000 taxpayers). The number of Archer MSAs established has
not exceeded the threshold level.
After 2005, no new contributions may be made to Archer MSAs
except by or on behalf of individuals who previously made (or
had made on their behalf) Archer MSA contributions and
employees who are employed by a participating employer.
Trustees of Archer MSAs are generally required to make
reports to the Treasury by August 1 regarding Archer MSAs
established by July 1 of that year. If the threshold level is
reached in a year, the Secretary is required to make and
publish such determination by October 1 of such year.
Health savings accounts
Health savings accounts (``HSAs'') were enacted by the
Medicare Prescription Drug, Improvement, and Modernization
Act of 2003. Like Archer MSAs, an HSA is a tax-exempt trust
or custodial account to which tax-deductible contributions
may be made by individuals with a high deductible health
plan. HSAs provide tax benefits similar to, but more
favorable than, those provide by Archer MSAs. HSAs were
established on a permanent basis.
House Bill
The House bill extends for one year the present-law Archer
MSA provisions (through December 31, 2006).
The report required by Archer MSA trustees is treated as
timely filed if made before the close of the 90-day period
beginning on the date of enactment. The determination and
publication whether the threshold level has been exceeded is
treated as timely if made before the close of the 120-day
period beginning on the date of enactment.
Effective date.--The provision is effective on the date of
enactment.
Senate Amendment
No provision.
Conference Agreement
The conference agreement does not include the House bill
provision.
[[Page H2220]]
F. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold
Improvements and Qualified Restaurant Improvements
(Sec. 107 and sec. 108 of the House bill, sec. 117 of the
Senate amendment, and sec. 168 of the Code)
Present Law
In general
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which
determines depreciation by applying specific recovery
periods, placed-in-service conventions, and depreciation
methods to the cost of various types of depreciable property
(sec. 168). The cost of nonresidential real property is
recovered using the straight-line method of depreciation and
a recovery period of 39 years. Nonresidential real property
is subject to the mid-month placed-in-service convention.
Under the mid-month convention, the depreciation allowance
for the first year property is placed in service is based on
the number of months the property was in service, and
property placed in service at any time during a month is
treated as having been placed in service in the middle of the
month.
Depreciation of leasehold improvements
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. 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 exist for certain qualified
leasehold improvements and certain qualified restaurant
property.
Qualified leasehold improvement property
Section 168(e)(3)(E)(iv) provides a statutory 15-year
recovery period for qualified leasehold improvement property
placed in service before January 1, 2006. Qualified leasehold
improvement property is recovered using the straight-line
method. Leasehold improvements placed in service in 2006 and
later will be subject to the general rules described above.
Qualified leasehold improvement property is any improvement
to an interior portion of a building that is nonresidential
real property, provided certain requirements are met. The
improvement must be made under or pursuant to a lease either
by the lessee (or sublessee), or by the lessor, of that
portion of the building to be occupied exclusively by the
lessee (or sublessee). The improvement must be placed in
service more than three years after the date the building was
first placed in service. Qualified leasehold improvement
property does not include any improvement for which the
expenditure is attributable to the enlargement of the
building, any elevator or escalator, any structural component
benefiting a common area, or the internal structural
framework of the building. However, if a lessor makes an
improvement that qualifies as qualified leasehold improvement
property, such improvement does not qualify as qualified
leasehold improvement property to any subsequent owner of
such improvement. An exception to the rule applies in the
case of death and certain transfers of property that qualify
for non-recognition treatment.
Qualified restaurant property
Section 168(e)(3)(E)(v) provides a statutory 15-year
recovery period for qualified restaurant property placed in
service before January 1, 2006. For purposes of the
provision, qualified restaurant property means any
improvement to a building if such improvement is placed in
service more than three years after the date such building
was first placed in service and more than 50 percent of the
building's square footage is devoted to the preparation of,
and seating for on-premises consumption of, prepared meals.
Qualified restaurant property is recovered using the
straight-line method.
House Bill
Under the House bill, the present-law provisions relating
to qualified leasehold improvement property and qualified
restaurant improvement property are extended for one year
(through December 31, 2006).
Effective date.--The House bill applies to property placed
in service after December 31, 2005.
Senate Amendment
Under the Senate amendment, the present-law provisions are
extended for two years (through December 31, 2007).
Effective date.--The Senate amendment applies to property
placed in service after December 31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
G. Taxable Income Limit on Percentage Depletion for Oil and Natural Gas
Produced From Marginal Properties
(Sec. 109 of the House bill and sec. 613A(c)(6)(H) of the
Code)
Present Law
The Code permits taxpayers to recover their investments in
oil and gas wells through depletion deductions. Two methods
of depletion are currently allowable under the Code: (1) the
cost depletion method, and (2) the percentage depletion
method. Under the cost depletion method, the taxpayer deducts
that portion of the adjusted basis of the depletable property
which is equal to the ratio of units sold from that property
during the taxable year to the number of units remaining as
of the end of taxable year plus the number of units sold
during the taxable year. Thus, the amount recovered under
cost depletion may never exceed the taxpayer's basis in the
property.
The Code generally limits the percentage depletion method
for oil and gas properties to independent producers and
royalty owners. Generally, under the percentage depletion
method, 15 percent of the taxpayer's gross income from an
oil- or gas-producing property is allowed as a deduction in
each taxable year. The amount deducted generally may not
exceed 100 percent of the taxable income from that property
in any year. For marginal production, the 100-percent taxable
income limitation has been suspended for taxable years
beginning after December 31, 1997, and before January 1,
2006.
Marginal production is defined as domestic crude oil and
natural gas production from stripper well property or from
property substantially all of the production from which
during the calendar year is heavy oil. Stripper well property
is property from which the average daily production is 15
barrel equivalents or less, determined by dividing the
average daily production of domestic crude oil and domestic
natural gas from producing wells on the property for the
calendar year by the number of wells. Heavy oil is domestic
crude oil with a weighted average gravity of 20 degrees API
or less (corrected to 60 degrees Fahrenheit).
House Bill
The provision extends for one year the present-law taxable
income limitation suspension provision for marginal
production (through taxable years beginning on or before
December 31, 2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
Senate Amendment
No provision.
Conference Agreement
The conference agreement does not include the House bill
provision.
H. Tax Incentives for Investment in the District of Columbia
(Sec. 110 of the House bill, sec. 114 of the Senate amendment
and secs. 1400, 1400A, 1400B, and 1400C of the Code)
Present Law
In general
The Taxpayer Relief Act of 1997 designated certain
economically depressed census tracts within the District of
Columbia as the District of Columbia Enterprise Zone (the
``D.C. Zone''), within which businesses and individual
residents are eligible for special tax incentives. The census
tracts that compose the D.C. Zone are (1) all census tracts
that presently are part of the D.C. enterprise community
designated under section 1391 (i.e., portions of Anacostia,
Mt. Pleasant, Chinatown, and the easternmost part of the
District), and (2) all additional census tracts within the
District of Columbia where the poverty rate is not less than
20 percent. The D.C. Zone designation remains in effect for
the period from January 1, 1998, through December 31, 2005.
In general, the tax incentives available in connection with
the D.C. Zone are a 20-percent wage credit, an additional
$35,000 of section 179 expensing for qualified zone property,
expanded tax-exempt financing for certain zone facilities,
and a zero-percent capital gains rate from the sale of
certain qualified D.C. zone assets.
Wage credit
A 20-percent wage credit is available to employers for the
first $15,000 of qualified wages paid to each employee (i.e.,
a maximum credit of $3,000 with respect to each qualified
employee) who (1) is a resident of the D.C. Zone, and (2)
performs substantially all employment services within the
D.C. Zone in a trade or business of the employer.
Wages paid to a qualified employee who earns more than
$15,000 are eligible for the wage credit (although only the
first $15,000 of wages is eligible for the credit). The wage
credit is available with respect to a qualified full-time or
part-time employee (employed for at least 90 days),
regardless of the number of other employees who work for the
employer. In general, any taxable business carrying out
activities in the D.C. Zone may claim the wage credit,
regardless of whether the employer meets the definition of a
``D.C. Zone business.'' \3\
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\3\ However, the wage credit is not available for wages paid
in connection with certain business activities described in
section 144(c)(6)(B) or certain farming activities. In
addition, wages are not eligible for the wage credit if paid
to (1) a person who owns more than five percent of the stock
(or capital or profits interests) of the employer, (2)
certain relatives of the employer, or (3) if the employer is
a corporation or partnership, certain relatives of a person
who owns more than 50 percent of the business.
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An employer's deduction otherwise allowed for wages paid is
reduced by the amount of
[[Page H2221]]
wage credit claimed for that taxable year.\4\ Wages are not
to be taken into account for purposes of the wage credit if
taken into account in determining the employer's work
opportunity tax credit under section 51 or the welfare-to-
work credit under section 51A.\5\ In addition, the $15,000
cap is reduced by any wages taken into account in computing
the work opportunity tax credit or the welfare-to-work
credit.\6\ The wage credit may be used to offset up to 25
percent of alternative minimum tax liability.\7\
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\4\ Sec. 280C(a).
\5\ Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2).
\6\ Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2).
\7\ Sec. 38(c)(2).
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Section 179 expensing
In general, a D.C. Zone business is allowed an additional
$35,000 of section 179 expensing for qualifying property
placed in service by a D.C. Zone business.\8\ The section 179
expensing allowed to a taxpayer is phased out by the amount
by which 50 percent of the cost of qualified zone property
placed in service during the year by the taxpayer exceeds
$200,000 ($400,000 for taxable years beginning after 2002 and
before 2008). The term ``qualified zone property'' is defined
as depreciable tangible property (including buildings),
provided that (1) the property is acquired by the taxpayer
(from an unrelated party) after the designation took effect,
(2) the original use of the property in the D.C. Zone
commences with the taxpayer, and (3) substantially all of the
use of the property is in the D.C. Zone in the active conduct
of a trade or business by the taxpayer.\9\ Special rules are
provided in the case of property that is substantially
renovated by the taxpayer.
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\8\ Sec. 1397A.
\9\ Sec. 1397D.
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Tax-exempt financing
A qualified D.C. Zone business is permitted to borrow
proceeds from tax-exempt qualified enterprise zone facility
bonds (as defined in section 1394) issued by the District of
Columbia.\10\ Such bonds are subject to the District of
Columbia's annual private activity bond volume limitation.
Generally, qualified enterprise zone facility bonds for the
District of Columbia are bonds 95 percent or more of the net
proceeds of which are used to finance certain facilities
within the D.C. Zone. The aggregate face amount of all
outstanding qualified enterprise zone facility bonds per
qualified D.C. Zone business may not exceed $15 million and
may be issued only while the D.C. Zone designation is in
effect.
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\10\ Sec. 1400A.
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Zero-percent capital gains
A zero-percent capital gains rate applies to capital gains
from the sale of certain qualified D.C. Zone assets held for
more than five years.\11\ In general, a qualified ``D.C. Zone
asset'' means stock or partnership interests held in, or
tangible property held by, a D.C. Zone business. For purposes
of the zero-percent capital gains rate, the D.C. Enterprise
Zone is defined to include all census tracts within the
District of Columbia where the poverty rate is not less than
10 percent.
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\11\ Sec. 1400B.
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In general, gain eligible for the zero-percent tax rate
means gain from the sale or exchange of a qualified D.C. Zone
asset that is (1) a capital asset or property used in the
trade or business as defined in section 1231(b), and (2)
acquired before January 1, 2006. Gain that is attributable to
real property, or to intangible assets, qualifies for the
zero-percent rate, provided that such real property or
intangible asset is an integral part of a qualified D.C. Zone
business.\12\ However, no gain attributable to periods before
January 1, 1998, and after December 31, 2010, is qualified
capital gain.
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\12\ However, sole proprietorships and other taxpayers
selling assets directly cannot claim the zero-percent rate on
capital gain from the sale of any intangible property (i.e.,
the integrally related test does not apply).
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District of Columbia homebuyer tax credit
First-time homebuyers of a principal residence in the
District of Columbia are eligible for a nonrefundable tax
credit of up to $5,000 of the amount of the purchase price.
The $5,000 maximum credit applies both to individuals and
married couples. Married individuals filing separately can
claim a maximum credit of $2,500 each. The credit phases out
for individual taxpayers with adjusted gross income between
$70,000 and $90,000 ($110,000-$130,000 for joint filers). For
purposes of eligibility, ``first-time homebuyer'' means any
individual if such individual did not have a present
ownership interest in a principal residence in the District
of Columbia in the one-year period ending on the date of the
purchase of the residence to which the credit applies. The
credit is scheduled to expire for residences purchased after
December 31, 2005.\13\
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\13\ Sec. 1400C(i).
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house bill
The provision extends the designation of the D.C. Zone for
one year (through December 31, 2006), thus extending the wage
credit and section 179 expensing for one year.
The provision extends the tax-exempt financing authority
for one year, applying to bonds issued during the period
beginning on January 1, 1998, and ending on December 31,
2006.
The provision extends the zero-percent capital gains rate
applicable to capital gains from the sale of certain
qualified D.C. Zone assets for one year.
The provision extends the first-time homebuyer credit for
one year, through December 31, 2006.
Effective date.--The amendment generally is effective on
January 1, 2006, except the provision relating to bonds is
effective for obligations issued after the date of enactment.
senate amendment
The Senate amendment is the same as the House bill.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
I. Possession Tax Credit With Respect to American Samoa
(Sec. 111 of the House bill and sec. 936 of the Code)
Present Law
In general
Certain domestic corporations with business operations in
the U.S. possessions are eligible for the possession tax
credit.\14\ This credit offsets the U.S. tax imposed on
certain income related to operations in the U.S.
possessions.\15\ For purposes of the section 936 credit,
possessions include, among other places, American Samoa.
Income eligible for the section 936 credit includes non-U.S.
source income from (1) the active conduct of a trade or
business within a U.S. possession, (2) the sale or exchange
of substantially all of the assets that were used in such a
trade or business, or (3) certain possessions investments.
The section 936 credit expires for taxable years beginning
after December 31, 2005.
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\14\ Secs. 27(b), 936.
\15\ Domestic corporations with activities in Puerto Rico are
eligible for the seciton 30A economic activity credit. That
credit is calculated under the rules set forth in section
936.
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To qualify for the possession tax credit for a taxable
year, a domestic corporation must satisfy two conditions.
First, the corporation must derive at least 80 percent of its
gross income for the three-year period immediately preceding
the close of the taxable year from sources within a
possession. Second, the corporation must derive at least 75
percent of its gross income for that same period from the
active conduct of a possession business. A domestic
corporation that has elected the possession tax credit and
that satisfies these two conditions for a taxable year
generally is entitled to a credit against the U.S. tax
attributable to the taxpayer's income that is eligible for
the section 936 credit.
The possession tax credit applies only to a corporation
that qualifies as an existing credit claimant. The
determination of whether a corporation is an existing credit
claimant is made separately for each possession. The
possession tax credit is computed separately for each
possession with respect to which the corporation is an
existing credit claimant, and the credit is subject to either
an economic activity-based limitation or an income-based
limit.
Qualification as existing credit claimant
A corporation is an existing credit claimant with respect
to a possession if (1) the corporation was engaged in the
active conduct of a trade or business within the possession
on October 13, 1995, and (2) the corporation elected the
benefits of the possession tax credit in an election in
effect for its taxable year that included October 13,
1995.\16\ A corporation that adds a substantial new line of
business (other than in a qualifying acquisition of all the
assets of a trade or business of an existing credit claimant)
ceases to be an existing credit claimant as of the close of
the taxable year ending before the date on which that new
line of business is added.
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\16\ A corporation will qualify as an existing credit
claimant if it acquired all the assets of a trade or business
of a corporation that (1) actively conducted that trade or
business in a possession on October 13, 1995, and (2) had
elected the benefits of the possession tax credit in an
election for the taxable year that includes October 13, 1995.
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Economic activity-based limit
Under the economic activity-based limit, the amount of the
credit determined under the rules described above may not
exceed an amount equal to the sum of (1) 60 percent of the
taxpayer's qualifying possession wage and fringe benefit
expenses, (2) 15 percent of depreciation allowances with
respect to short-life qualifying tangible property, plus 40
percent of depreciation allowances with respect to medium-
life qualifying tangible property, plus 65 percent of
depreciation allowances with respect to long-life tangible
property, and (3) in certain cases, a portion of the
taxpayer's possession income taxes.
Income-based limit
As an alternative to the economic activity-based limit, a
taxpayer may elect to apply a limit equal to the applicable
percentage of the credit that would otherwise be allowable
with respect to possession business income; the applicable
percentage currently is 40 percent.
Repeal and phase out
In 1996, the section 936 credit was repealed for new
claimants for taxable years beginning after 1995 and was
phased out for existing credit claimants over a period
including taxable years beginning before 2006. The amount of
the available credit during the phaseout period generally is
reduced by special limitation rules. These phaseout period
[[Page H2222]]
limitation rules do not apply to the credit available to
existing credit claimants for income from activities in Guam,
American Samoa, and the Northern Mariana Islands. The section
936 credit is repealed for all possessions, including Guam,
American Samoa, and the Northern Mariana Islands, for all
taxable years beginning after 2005.
house bill
The House bill extends for one year the present-law section
936 credit as applied to American Samoa; it thus allows
existing credit claimants to claim the credit for income from
activities in American Samoa in taxable years beginning on or
before December 31, 2006.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
Senate Amendment
No provision.
Conference Agreement
The conference agreement does not include the House bill
provision.
J. Parity in the Application of Certain Limits to Mental Health
Benefits
(Sec. 112 of the House bill and sec. 9812 of the Code)
Present Law \17\
The Code, the Employee Retirement Income Security Act of
1974 (``ERISA'') and the Public Health Service Act (``PHSA'')
contain provisions under which group health plans that
provide both medical and surgical benefits and mental health
benefits cannot impose aggregate lifetime or annual dollar
limits on mental health benefits that are not imposed on
substantially all medical and surgical benefits (``mental
health parity requirements''). In the case of a group health
plan which provides benefits for mental health, the mental
health parity requirements do not affect the terms and
conditions (including cost sharing, limits on numbers of
visits or days of coverage, and requirements relating to
medical necessity) relating to the amount, duration, or scope
of mental health benefits under the plan, except as
specifically provided in regard to parity in the imposition
of aggregate lifetime limits and annual limits.
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\17\ This description of present law refers to the law in
effect at the time the bill passed the House of
Representatives, which was before the enactment of Pub. L.
No. 109-151, which extended the mental health parity
requirements of the Code, ERISA, and the PHSA through
December 31, 2006.
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The Code imposes an excise tax on group health plans which
fail to meet the mental health parity requirements. The
excise tax is equal to $100 per day during the period of
noncompliance and is generally imposed on the employer
sponsoring the plan if the plan fails to meet the
requirements. The maximum tax that can be imposed during a
taxable year cannot exceed the lesser of 10 percent of the
employer's group health plan expenses for the prior year or
$500,000. No tax is imposed if the Secretary determines that
the employer did not know, and in exercising reasonable
diligence would not have known, that the failure existed.
The mental health parity requirements do not apply to group
health plans of small employers nor do they apply if their
application results in an increase in the cost under a group
health plan of at least one percent. Further, the mental
health parity requirements do not require group health plans
to provide mental health benefits.
The Code, ERISA and PHSA mental health parity requirements
are scheduled to expire with respect to benefits for services
furnished after December 31, 2005.
house bill
The House bill extends for one year the present-law Code
excise tax for failure to comply with the mental health
parity requirements (through December 31, 2006).
Effective date.--The provision is effective on the date of
enactment.
senate amendment
No provision.
Conference Agreement
The conference agreement does not include the House bill
provision.
K. Research Credit
(Sec. 113 of the House bill, sec. 108 of the Senate
amendment, and sec. 41 of the Code)
present law
General rule
Prior to January 1, 2006, a taxpayer could claim a research
credit equal to 20 percent of the amount by which the
taxpayer's qualified research expenses for a taxable year
exceeded its base amount for that year.\18\ Thus, the
research credit was generally available with respect to
incremental increases in qualified research.
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\18\ Sec. 41.
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A 20-percent research tax credit was also available with
respect to the excess of (1) 100 percent of corporate cash
expenses (including grants or contributions) paid for basic
research conducted by universities (and certain nonprofit
scientific research organizations) over (2) the sum of (a)
the greater of two minimum basic research floors plus (b) an
amount reflecting any decrease in nonresearch giving to
universities by the corporation as compared to such giving
during a fixed-base period, as adjusted for inflation. This
separate credit computation was commonly referred to as the
university basic research credit (see sec. 41(e)).
Finally, a research credit was available for a taxpayer's
expenditures on research undertaken by an energy research
consortium. This separate credit computation was commonly
referred to as the energy research credit. Unlike the other
research credits, the energy research credit applied to all
qualified expenditures, not just those in excess of a base
amount.
The research credit, including the university basic
research credit and the energy research credit, expired on
December 31, 2005.\19\
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\19\ The research tax credit initially was enacted in the
Economic Recovery Tax Act of 1981 as a credit equal to 25
percent of the excess of qualified research expenses incurred
in the current taxable year over the average of qualified
research expenses incurred in the prior three taxable years.
The research tax credit was modified in the Tax Reform Act of
1986, which (1) extended the credit through December 31,
1988, (2) reduced the credit rate to 20 percent, (3)
tightened the definition of qualified research expenses
eligible for the credit, and (4) enacted the separate
university basic credit.
The Technical and Miscellaneous Revenue Act of 1988 (``1988
Act'') extended the research tax credit for one additional
year, through December 31, 1989. The 1988 Act also reduced
the deduction allowed under section 174 (or any other
section) for qualified research expenses by an amount equal
to 50 percent of the research tax credit determined for the
year.
The Omnibus Budget Reconciliation Act of 1989 (``1989 Act'')
effectively extended the research credit for nine months (by
prorating qualified expenses incurred before January 1,
1991). The 1989 Act also modified the method for calculating
a taxpayer's base amount (i.e., by substituting the present-
law method which uses a fixed-base percentage for the prior-
law moving base which was calculated by reference to the
taxpayer's average research expenses incurred ion the
preceding three taxable years). The 1989 Act further reduced
the deduction allowed under section 174 (or any other
section) for qualified research expenses by an amount equal
to 100 percent of the research tax credit determined for the
year.
The Omnibus Budget Reconciliation Act of 1990 extended the
research tax credit through December 31, 1991 (and repealed
the special rule to prorate qualified expenses incurred
before January 1, 1991).
The Tax Extension Act of 1991 extended the research tax
credit for six months (i.e., for qualified expenses incurred
through June 30, 1992).
The Omnibus Budget Reconciliation Act of 1993 (``1993 Act'')
extended the research tax credit for three years--i.e.,
retroactively from July 1, 1992 through June 30, 1995. The
1993 Act also provided a special rule for start-up firms, so
that the fixed-base ratio of such firms eventually will be
computed by reference to their actual research experience.
Although the research tax credit expired during the period
July 1, 1995, through June 30, 1996, the Small Business Job
Protection Act of 1996 (``1996 Act'') extended the credit for
the period July 1, 1996, through May 31, 1997 (with a special
11-month extension for taxpayers that elect to be subject to
the alternative incremental research credit regime). In
addition, the 1996 Act expanded the definition of start-up
firms under section 41(c)(3)(B)(i), enacted a special rule
for certain research consortia payments under section
41(b)(3)(C), and provided that taxpayers may elect an
alternative research credit regime (under which the taxpayer
is assigned a three-tiered fixed-base percentage that is
lower than the fixed-base percentage otherwise applicable and
the credit rate likewise is reduced) for the taxpayer's first
taxable year beginning after June 30, 1996, and before July
1, 1997.
The Taxpayer Relief Act of 1997 (``1997 Act'') extended the
research credit for 13 months--i.e, generally for the period
June 1, 1997, through June 30, 1998. The 1997 Act also
provided that taxpayers are permitted to elect the
alternative incremental research credit regime for any
taxable year beginning after June 30, 1996 (and such election
will apply to that taxable year and all subsequent taxable
years unless revoked with the consent of the Secretary of the
Treasury). The Tax and Trade Relief Extension Act of 1998
extended the research credit for 12 months, i.e., through
June 30, 1999.
The Ticket to Work and Work Incentive Improvement Act of 1999
extended the research credit for five years, through June 30,
2004, increased the rates of credit under the alternative
incremental research credit regime, and expanded the
definition of research to include research undertaken in
Puerto Rico and possessions of the United States.
The Working Families Tax Relief Act of 224 extended the
research credit through December 31, 2005.
The Energy Tax Incentives Act of 2005 added the energy
research credit.
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Computation of allowable credit
Except for energy research payments and certain university
basic research payments made by corporations, the research
tax credit applied only to the extent that the taxpayer's
qualified research expenses for the current taxable year
exceeded its base amount. The base amount for the current
year generally was computed by multiplying the taxpayer's
fixed-base percentage by the average amount of the taxpayer's
gross receipts for the four preceding years. If a taxpayer
both incurred qualified research expenses and had gross
receipts during each of at least three years from 1984
through 1988, then its fixed-base percentage was the ratio
that its total qualified research expenses for the 1984-1988
period bore to its total gross receipts for that period
(subject to a maximum fixed-base percentage of 16 percent).
All other taxpayers (so-called start-up firms) were assigned
a fixed-base percentage of three percent.\20\
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\20\ The Small Business Job Protection Act of 1996 expanded
the definition of start-up firms under section 41(c)(3)(B)(i)
to include any firm if the first taxable year in which such
firm had both gross receipts and qualified research expenses
began after 1983. A special rule (enacted in 1993) was
designed to gradually recompute a start-up firm's fixed-base
percentage based on its actual research experience. Under
this special rule, a start-up firm would be assigned a fixed-
base percentage of three percent for each of its first five
taxable years after 1993 in which it incurs qualified
research expenses. In the event that the research credit is
extended beyond its expiration date, a start-up date, a
start-up firm's fixed-base percentage for its sixth through
tenth taxable years after 1993 in which it incurs qualified
research expenses will be a phased-in ratio based on its
actual research experience. For all subsequent taxable years,
the taxpayer's fixed-base percentage will be its actual ratio
of qualified research expenses to gross receipts for any five
years selected by the taxpayer from its fifth through tenth
taxable years after 1993 (sec. 41(c)(3)(B)).
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[[Page H2223]]
In computing the credit, a taxpayer's base amount could not
be less than 50 percent of its current-year qualified
research expenses.
To prevent artificial increases in research expenditures by
shifting expenditures among commonly controlled or otherwise
related entities, a special aggregation rule provided that
all members of the same controlled group of corporations were
treated as a single taxpayer (sec. 41(f)(1)). Under
regulations prescribed by the Secretary, special rules
applied for computing the credit when a major portion of a
trade or business (or unit thereof) changed hands, under
which qualified research expenses and gross receipts for
periods prior to the change of ownership of a trade or
business were treated as transferred with the trade or
business that gave rise to those expenses and receipts for
purposes of recomputing a taxpayer's fixed-base percentage
(sec. 41(f)(3)).
Alternative incremental research credit regime
Taxpayers were allowed to elect an alternative incremental
research credit regime.\21\ If a taxpayer elected to be
subject to this alternative regime, the taxpayer was assigned
a three-tiered fixed-base percentage (that was lower than the
fixed-base percentage otherwise applicable) and the credit
rate likewise was reduced. Under the alternative incremental
credit regime, a credit rate of 2.65 percent applied to the
extent that a taxpayer's current-year research expenses
exceeded a base amount computed by using a fixed-base
percentage of one percent (i.e., the base amount equaled one
percent of the taxpayer's average gross receipts for the four
preceding years) but did not exceed a base amount computed by
using a fixed-base percentage of 1.5 percent. A credit rate
of 3.2 percent applied to the extent that a taxpayer's
current-year research expenses exceeded a base amount
computed by using a fixed-base percentage of 1.5 percent but
did not exceed a base amount computed by using a fixed-base
percentage of two percent. A credit rate of 3.75 percent
applied to the extent that a taxpayer's current-year research
expenses exceeded a base amount computed by using a fixed-
base percentage of two percent. An election to be subject to
this alternative incremental credit regime could be made for
any taxable year beginning after June 30, 1996, and such an
election applied to that taxable year and all subsequent
years unless revoked with the consent of the Secretary of the
Treasury.
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\21\ Sec. 41(c)(4).
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Eligible expenses
Qualified research expenses eligible for the research tax
credit consisted of: (1) in-house expenses of the taxpayer
for wages and supplies attributable to qualified research;
(2) certain time-sharing costs for computer use in qualified
research; and (3) 65 percent of amounts paid or incurred by
the taxpayer to certain other persons for qualified research
conducted on the taxpayer's behalf (so-called contract
research expenses).\22\ Notwithstanding the limitation for
contract research expenses, qualified research expenses
included 100 percent of amounts paid or incurred by the
taxpayer to an eligible small business, university, or
Federal laboratory for qualified energy research.
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\22\ Under a special rule enacted as part of the Small
Business Job Protection Act of 1996, 75 percent of amounts
paid to a research consortium for qualified research were
treated as qualified research expenses eligible for the
research credit (rather than 65 percent under the general
rule under section 41(b)(3) governing contract research
expenses) if (1) such research consortium was a tax-exempt
organization that is described in section 501(c)(3) (other
than a private foundation) or section 501(c)(6) and was
organized and operated primarily to conduct scientific
research, and (2) such qualified research was conducted by
the consortium on behalf of the taxpayer and one or more
persons not related to the taxpayer. Sec. 41(b)(3)(C).
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To be eligible for the credit, the research did not only
have to satisfy the requirements of present-law section 174
(described below) but also had to be undertaken for the
purpose of discovering information that is technological in
nature, the application of which was intended to be useful in
the development of a new or improved business component of
the taxpayer, and substantially all of the activities of
which had to constitute elements of a process of
experimentation for functional aspects, performance,
reliability, or quality of a business component. Research did
not qualify for the credit if substantially all of the
activities related to style, taste, cosmetic, or seasonal
design factors (sec. 41(d)(3)). In addition, research did not
qualify for the credit: (1) if conducted after the beginning
of commercial production of the business component; (2) if
related to the adaptation of an existing business component
to a particular customer's requirements; (3) if related to
the duplication of an existing business component from a
physical examination of the component itself or certain other
information; or (4) if related to certain efficiency surveys,
management function or technique, market research, market
testing, or market development, routine data collection or
routine quality control (sec. 41(d)(4)). Research did not
qualify for the credit if it was conducted outside the United
States, Puerto Rico, or any U.S. possession.
Relation to deduction
Under section 174, taxpayers may elect to deduct currently
the amount of certain research or experimental expenditures
paid or incurred in connection with a trade or business,
notwithstanding the general rule that business expenses to
develop or create an asset that has a useful life extending
beyond the current year must be capitalized.\23\ While the
research credit was in effect, however, deductions allowed to
a taxpayer under section 174 (or any other section) were
reduced by an amount equal to 100 percent of the taxpayer's
research tax credit determined for the taxable year (sec.
280C(c)). Taxpayers could alternatively elect to claim a
reduced research tax credit amount (13 percent) under section
41 in lieu of reducing deductions otherwise allowed (sec.
280C(c)(3)).
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\23\ Taxpayers may elect 10-year amortization of certain
research expenditures allowable as a deduction under section
174(a). Secs. 174(f)(2) and 59(e).
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House Bill
The provision extends for one year and modifies the
present-law research credit provision (for amounts paid or
incurred through December 31, 2006).
The provision increases the rates of the alternative
incremental credit: (1) a credit rate of three percent
(rather than 2.65 percent) applies to the extent that a
taxpayer's current-year research expenses exceed a base
amount computed by using a fixed-base percentage of one
percent (i.e., the base amount equals one percent of the
taxpayer's average gross receipts for the four preceding
years) but do not exceed a base amount computed by using a
fixed-base percentage of 1.5 percent; (2) a credit rate of
four percent (rather than 3.2 percent) applies to the extent
that a taxpayer's current-year research expenses exceed a
base amount computed by using a fixed-base percentage of 1.5
percent but do not exceed a base amount computed by using a
fixed-base percentage of two percent; and (3) a credit rate
of 5 percent (rather than 3.75 percent) applies to the extent
that a taxpayer's current-year research expenses exceed a
base amount computed by using a fixed-base percentage of two
percent.
The provision also creates, at the election of the
taxpayer, an alternative simplified credit for qualified
research expenses. The alternative simplified research is
equal to 12 percent of qualified research expenses that
exceed 50 percent of the average qualified research expenses
for the three preceding taxable years. The rate is reduced to
6 percent if a taxpayer has no qualified research expenses in
any one of the three preceding taxable years.
An election to use the alternative simplified credit
applies to all succeeding taxable years unless revoked with
the consent of the Secretary. An election to use the
alternative simplified credit may not be made for any taxable
year for which an election to use the alternative incremental
credit is in effect. A special transition rule applies which
permits a taxpayer to elect to use the alternative simplified
credit in lieu of the alternative incremental credit if such
election is made during the taxable year which includes the
date of enactment of the provision. The transition rule only
applies to the taxable year which includes the date of
enactment.
Effective date.--The extension of the research credit
applies to amounts paid or incurred after December 31, 2005.
The modification of the alternative incremental credit and
the creation of the alternative simplified credit are
effective for taxable years ending after date of enactment.
Senate Amendment
The Senate amendment generally follows the House bill but
provides for a two-year extension of the modified research
credit. It also adds a provision that broadens the research
credit as it applies to research consortia. Under the Senate
amendment, a 20 percent credit would be available for a
taxpayer's expenditures on research carried out by any
research consortium, rather than being limited to research
carried out by an energy research consortium.
Effective date.--The Senate amendment applies to amounts
paid or incurred after December 31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
L. Qualified Zone Academy Bonds
(Sec. 114 of the House bill, sec. 110 of the Senate amendment
and sec. 1397E of the Code)
Present Law
Tax-exempt bonds
Interest on State and local governmental bonds generally is
excluded from gross income for Federal income tax purposes if
the proceeds of the bonds are used to finance direct
activities of these governmental units or if the bonds are
repaid with revenues of these governmental units. Activities
that can be financed with these tax-exempt bonds include the
financing of public schools (sec. 103).
Qualified zone academy bonds
As an alternative to interest-bearing tax-exempt bonds,
States and local governments are given the authority to issue
``qualified zone academy bonds'' (sec. 1397E). A total of
$400 million of qualified zone academy bonds may be issued
annually in calendar years 1998 through 2005. The $400
million aggregate bond cap is allocated each year to the
States according to their respective populations of
individuals below the poverty line. Each State, in turn,
allocates the credit authority to qualified zone academies
within such State.
[[Page H2224]]
Financial institutions that hold qualified zone academy
bonds are entitled to a nonrefundable tax credit in an amount
equal to a credit rate multiplied by the face amount of the
bond. A taxpayer holding a qualified zone academy bond on the
credit allowance date is entitled to a credit. The credit is
includable in gross income (as if it were a taxable interest
payment on the bond), and may be claimed against regular
income tax and AMT liability.
The Treasury Department sets the credit rate at a rate
estimated to allow issuance of qualified zone academy bonds
without discount and without interest cost to the issuer. The
maximum term of the bond is determined by the Treasury
Department, so that the present value of the obligation to
repay the bond is 50 percent of the face value of the bond.
``Qualified zone academy bonds'' are 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'' (``qualified zone
academy property'') and (2) private entities have promised to
contribute to the qualified zone academy certain equipment,
technical assistance or training, employee services, or other
property or services with a value equal to at least 10
percent of the bond proceeds.
A school is a ``qualified zone academy'' if: (1) the school
is a public school that provides education and training below
the college level, (2) the school operates a special academic
program in cooperation with businesses to enhance the
academic curriculum and increase graduation and employment
rates, and (3) either (a) the school is located in an
empowerment zone or enterprise community designated under the
Code or (b) it is reasonably expected that at least 35
percent of the students at the school will be eligible for
free or reduced-cost lunches under the school lunch program
established under the National School Lunch Act.
Arbitrage restrictions on tax-exempt bonds
To prevent States and local governments from issuing more
tax-exempt bonds than is necessary for the activity being
financed or from issuing such bonds earlier than needed for
the purpose of the borrowing, the Code includes arbitrage
restrictions limiting the ability to profit from investment
of tax-exempt bond proceeds. In general, arbitrage profits
may be earned only during specified periods (e.g., defined
``temporary periods'' before funds are needed for the purpose
of the borrowing) or on specified types of investments (e.g.,
``reasonably required reserve or replacement funds'').
Subject to limited exceptions, profits that are earned during
these periods or on such investments must be rebated to the
Federal Government. Governmental bonds are subject to less
restrictive arbitrage rules than most private activity bonds.
The arbitrage rules do not apply to qualified zone academy
bonds.
House Bill
The House bill extends for one year the present-law
provision relating to qualified zone academy bonds (through
December 31, 2006).
Effective date.--The provision is effective for bonds
issued after December 31, 2005.
Senate Amendment
The Senate amendment extends for two years the present-law
provision relating to qualified zone academy bonds (through
December 31, 2007).
In addition, the Senate amendment imposes the arbitrage
requirements of section 148 that apply to tax-exempt bonds to
qualified zone academy bonds. Principles under section 148
and the regulations thereunder shall apply for purposes of
determining the yield restriction and arbitrage rebate
requirements applicable to qualified zone academy bonds. For
example, for arbitrage purposes, the yield on an issue of
qualified zone academy bonds is computed by taking into
account all payments of interest, if any, on such bonds,
i.e., whether the bonds are issued at par, premium, or
discount. However, for purposes of determining yield, the
amount of the credit allowed to a taxpayer holding qualified
zone academy bonds is not treated as interest, although such
credit amount is treated as interest income to the taxpayer.
The provision imposes new spending requirements for
qualified zone academy bonds. An issuer of qualified zone
academy bonds must reasonably expect to and actually spend 95
percent or more of the proceeds of such bonds on qualified
zone academy property within the five-year period that begins
on the date of issuance. To the extent less than 95 percent
of the proceeds are used to finance qualified zone academy
property during the five-year spending period, bonds will
continue to qualify as qualified zone academy bonds if
unspent proceeds are used within 90 days from the end of such
five-year period to redeem any ``nonqualified bonds.'' For
these purposes, the amount of nonqualified bonds is to be
determined in the same manner as Treasury regulations under
section 142. In addition, the provision provides that the
five-year spending period may be extended by the Secretary
upon the issuer's request if reasonable cause for such
extension is established.
Under the provision, qualified private business
contributions must be in the form of cash or cash
equivalents, rather than property or services as permitted
under present law. The provision also requires an equal
amount of principal is to be paid by the issuer during each
calendar year that the issue is outstanding.
Under the provision, issuers of qualified zone academy
bonds are required to report issuance to the IRS in a manner
similar to that required for tax-exempt bonds.
Effective date.--The provision is effective for bonds
issued after December 31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
M. Above-the-Line Deduction for Certain Expenses of Elementary and
Secondary School Teachers
(Sec. 115 of the House bill, sec. 112 of the Senate amendment
and sec. 62 of the Code)
Present Law
In general, ordinary and necessary business expenses are
deductible (sec. 162). However, in general, unreimbursed
employee business expenses are deductible only as an itemized
deduction and only to the extent that the individual's total
miscellaneous deductions (including employee business
expenses) exceed two percent of adjusted gross income. An
individual's otherwise allowable itemized deductions may be
further limited by the overall limitation on itemized
deductions, which reduces itemized deductions for taxpayers
with adjusted gross income in excess of $145,950 (for 2005).
In addition, miscellaneous itemized deductions are not
allowable under the alternative minimum tax.
Certain expenses of eligible educators are allowed an
above-the-line deduction. Specifically, for taxable years
beginning prior to January 1, 2006, an above-the-line
deduction is allowed for up to $250 annually of expenses paid
or incurred by an eligible educator for books, supplies
(other than nonathletic supplies for courses of instruction
in health or physical education), computer equipment
(including related software and services) and other
equipment, and supplementary materials used by the eligible
educator in the classroom. To be eligible for this deduction,
the expenses must be otherwise deductible under 162 as a
trade or business expense. A deduction is allowed only to the
extent the amount of expenses exceeds the amount excludable
from income under section 135 (relating to education savings
bonds), 529(c)(1) (relating to qualified tuition programs),
and section 530(d)(2) (relating to Coverdell education
savings accounts).
An eligible educator is a kindergarten through grade 12
teacher, instructor, counselor, principal, or aide in a
school for at least 900 hours during a school year. A school
means any school which provides elementary education or
secondary education, as determined under State law.
The above-the-line deduction for eligible educators is not
allowed for taxable years beginning after December 31, 2005.
House Bill
The present-law provision is extended for one year, through
December 31, 2006.
Effective date.--The provision is effective for expenses
paid or incurred in taxable years beginning after December
31, 2005.
Senate Amendment
The present-law provision is extended for two years,
through December 31, 2007.
Effective date.--The provision is effective for expenses
paid or incurred in taxable years beginning after December
31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
N. Above-the-Line Deduction for Higher Education Expenses
(Sec. 116 of the House bill, sec. 103 of the Senate amendment
and sec. 222 of the Code)
Present Law
An individual is allowed an above-the-line deduction for
qualified tuition and related expenses for higher education
paid by the individual during the taxable year. Qualified
tuition and related expenses include tuition and fees
required for the enrollment or attendance of the taxpayer,
the taxpayer's spouse, or any dependent of the taxpayer with
respect to whom the taxpayer may claim a personal exemption,
at an eligible institution of higher education for courses of
instruction of such individual at such institution. Charges
and fees associated with meals, lodging, insurance,
transportation, and similar personal, living, or family
expenses are not eligible for the deduction. The expenses of
education involving sports, games, or hobbies are not
qualified tuition and related expenses unless this education
is part of the student's degree program.
The amount of qualified tuition and related expenses must
be reduced by certain scholarships, educational assistance
allowances, and other amounts paid for the benefit of such
individual, and by the amount of such expenses taken into
account for purposes of determining any exclusion from gross
income of: (1) income from certain United States Savings
Bonds used to pay higher education tuition and fees; and (2)
income from a Coverdell education savings account.
Additionally, such expenses must be reduced by the earnings
portion (but not the return of principal) of distributions
from a qualified tuition program if an exclusion under
section 529 is claimed with respect to expenses eligible for
exclusion under section 222. No deduction is allowed for any
expense
[[Page H2225]]
for which a deduction is otherwise allowed or with respect to
an individual for whom a Hope credit or Lifetime Learning
credit is elected for such taxable year.
The expenses must be in connection with enrollment at an
institution of higher education during the taxable year, or
with an academic term beginning during the taxable year or
during the first three months of the next taxable year. The
deduction is not available for tuition and related expenses
paid for elementary or secondary education.
For taxable years beginning in 2004 and 2005, the maximum
deduction is $4,000 for an individual whose adjusted gross
income for the taxable year does not exceed $65,000 ($130,000
in the case of a joint return), or $2,000 for other
individuals whose adjusted gross income does not exceed
$80,000 ($160,000 in the case of a joint return). No
deduction is allowed for an individual whose adjusted gross
income exceeds the relevant adjusted gross income
limitations, for a married individual who does not file a
joint return, or for an individual with respect to whom a
personal exemption deduction may be claimed by another
taxpayer for the taxable year. The deduction is not available
for taxable years beginning after December 31, 2005.
House Bill
The provision extends the tuition deduction for one year,
through December 31, 2006.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
Senate Amendment
The provision extends the tuition deduction for four years,
through December 31, 2009.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
Conference Agreement
The conference agreement does not include the House
provision or the Senate amendment provision.
O. Deduction of State and Local General Sales Taxes
(Sec. 117 of the House bill, sec. 105 of the Senate
amendment, and sec. 164 of the Code)
Present Law
For purposes of determining regular tax liability, an
itemized deduction is permitted for certain State and local
taxes paid, including individual income taxes, real property
taxes, and personal property taxes. The itemized deduction is
not permitted for purposes of determining a taxpayer's
alternative minimum taxable income. For taxable years
beginning in 2004 and 2005, at the election of the taxpayer,
an itemized deduction may be taken for State and local
general sales taxes in lieu of the itemized deduction
provided under present law for State and local income taxes.
As is the case for State and local income taxes, the itemized
deduction for State and local general sales taxes is not
permitted for purposes of determining a taxpayer's
alternative minimum taxable income. Taxpayers have two
options with respect to the determination of the sales tax
deduction amount. Taxpayers may deduct the total amount of
general State and local sales taxes paid by accumulating
receipts showing general sales taxes paid. Alternatively,
taxpayers may use tables created by the Secretary of the
Treasury that show the allowable deduction. The tables are
based on average consumption by taxpayers on a State-by-State
basis taking into account filing status, number of
dependents, adjusted gross income and rates of State and
local general sales taxation. Taxpayers who use the tables
created by the Secretary may, in addition to the table
amounts, deduct eligible general sales taxes paid with
respect to the purchase of motor vehicles, boats and other
items specified by the Secretary. Sales taxes for items that
may be added to the tables are not reflected in the tables
themselves.
The term ``general sales tax'' means a tax imposed at one
rate with respect to the sale at retail of a broad range of
classes of items. However, in the case of items of food,
clothing, medical supplies, and motor vehicles, the fact that
the tax does not apply with respect to some or all of such
items is not taken into account in determining whether the
tax applies with respect to a broad range of classes of
items, and the fact that the rate of tax applicable with
respect to some or all of such items is lower than the
general rate of tax is not taken into account in determining
whether the tax is imposed at one rate. Except in the case of
a lower rate of tax applicable with respect to food,
clothing, medical supplies, or motor vehicles, no deduction
is allowed for any general sales tax imposed with respect to
an item at a rate other than the general rate of tax.
However, in the case of motor vehicles, if the rate of tax
exceeds the general rate, such excess shall be disregarded
and the general rate is treated as the rate of tax.
A compensating use tax with respect to an item is treated
as a general sales tax, provided such tax is complimentary to
a general sales tax and a deduction for sales taxes is
allowable with respect to items sold at retail in the taxing
jurisdiction that are similar to such item.
House Bill
The present-law provision allowing taxpayers to elect to
deduct State and local sales taxes in lieu of State and local
income taxes is extended for one year (through December 31,
2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
Senate Amendment
The present-law provision allowing taxpayers to elect to
deduct State and local sales taxes in lieu of State and local
income taxes is extended for two years (through December 31,
2007).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
P. Extension and Expansion to Petroleum Products of Expensing for
Environmental Remediation Costs
(Sec. 201 of the House bill, sec. 113 of the Senate
amendment, and sec. 198 of the Code)
Present Law
Present law allows a deduction for ordinary and necessary
expenses paid or incurred in carrying on any trade or
business.\24\ Treasury regulations provide that the cost of
incidental repairs that neither materially add to the value
of property nor appreciably prolong its life, but keep it in
an ordinarily efficient operating condition, may be deducted
currently as a business expense. Section 263(a)(1) limits the
scope of section 162 by prohibiting a current deduction for
certain capital expenditures. Treasury regulations define
``capital expenditures'' as amounts paid or incurred to
materially add to the value, or substantially prolong the
useful life, of property owned by the taxpayer, or to adapt
property to a new or different use. Amounts paid for repairs
and maintenance do not constitute capital expenditures. The
determination of whether an expense is deductible or
capitalizable is based on the facts and circumstances of each
case.
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\24\ Sec. 162.
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Taxpayers may elect to treat certain environmental
remediation expenditures that would otherwise be chargeable
to capital account as deductible in the year paid or
incurred.\25\ The deduction applies for both regular and
alternative minimum tax purposes. The expenditure must be
incurred in connection with the abatement or control of
hazardous substances at a qualified contaminated site. In
general, any expenditure for the acquisition of depreciable
property used in connection with the abatement or control of
hazardous substances at a qualified contaminated site does
not constitute a qualified environmental remediation
expenditure. However, depreciation deductions allowable for
such property, which would otherwise be allocated to the site
under the principles set forth in Commissioner v. Idaho Power
Co.\26\ and section 263A, are treated as qualified
environmental remediation expenditures.
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\25\ Sec. 198.
\26\ 418 U.S. 1 (1974).
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A ``qualified contaminated site'' (a so-called
``brownfield'') generally is any property that is held for
use in a trade or business, for the production of income, or
as inventory and is certified by the appropriate State
environmental agency to be an area at or on which there has
been a release (or threat of release) or disposal of a
hazardous substance. Both urban and rural property may
qualify. However, sites that are identified on the national
priorities list under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980
(``CERCLA'') \27\ cannot qualify as targeted areas. Hazardous
substances generally are defined by reference to sections
101(14) and 102 of CERCLA, subject to additional limitations
applicable to asbestos and similar substances within
buildings, certain naturally occurring substances such as
radon, and certain other substances released into drinking
water supplies due to deterioration through ordinary use.
Petroleum products generally are not regarded as hazardous
substances for purposes of section 198 (except for purposes
of determining qualified environmental remediation
expenditures in the ``Gulf Opportunity Zone'' under section
1400N(g), as described below).\28\
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\27\ Pub. L. No. 96-510 (1980).
\28\ Section 101(14) of CERCLA specifically excludes
``petroleum, including crude oil or any fraction thereof
which is not otherwise specifically listed or designated as a
hazardous substance under subparagraphs (A) through (F) of
this paragraph,'' from the definition of ``hazardous
substance.''
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In the case of property to which a qualified environmental
remediation expenditure otherwise would have been
capitalized, any deduction allowed under section 198 is
treated as a depreciation deduction and the property is
treated as section 1245 property. Thus, deductions for
qualified environmental remediation expenditures are subject
to recapture as ordinary income upon a sale or other
disposition of the property. In addition, sections 280B
(demolition of structures) and 468 (special rules for mining
and solid waste reclamation and closing costs) do not apply
to amounts that are treated as expenses under this provision.
Eligible expenditures are those paid or incurred before
January 1, 2006.
Under section 1400N(g), the above provisions apply to
expenditures paid or incurred to abate contamination at
qualified contaminated sites in the Gulf Opportunity Zone
(defined as that portion of the Hurricane Katrina Disaster
Area determined by
[[Page H2226]]
the President to warrant individual or individual and public
assistance from the Federal Government under the Robert T.
Stafford Disaster Relief and Emergency Assistance Act by
reason of Hurricane Katrina) before January 1, 2008; in
addition, within the Gulf Opportunity Zone section 1400N(g)
broadens the definition of hazardous substance to include
petroleum products (defined by reference to section
4612(a)(3)).
House Bill
The House bill extends for two years the present-law
provisions relating to environmental remediation expenditures
(through December 31, 2007).
In addition, the provision expands the definition of
hazardous substance to include petroleum products. Under the
provision, petroleum products are defined by reference to
section 4612(a)(3), and thus include crude oil, crude oil
condensates and natural gasoline.\29\
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\29\ The present law exceptions for sites on the national
priorities list under CERCLA, and for substances with respect
to which a removal or remediation is not permitted under
section 104 of CERCLA by reason of subsection (a)(3) thereof,
would continue to apply to all hazardous substances
(including petroleum products).
---------------------------------------------------------------------------
Effective date.--The provision applies to expenditures paid
or incurred after December 31, 2005.
Senate Amendment
The Senate amendment modifies the House bill to provide for
only a one-year extension of the present-law provisions
relating to environmental remediation expenditures (through
December 31, 2006). The Senate amendment follows the House
bill in expanding the definition of hazardous substances to
include petroleum products.
Effective date.--The provision applies to expenditures paid
or incurred after December 31, 2005.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
Q. Controlled Foreign Corporations
1. Subpart F exception for active financing (Sec. 202(a) of
the House bill and secs. 953 and 954 of the Code)
Present Law
Under the subpart F rules, 10-percent U.S. shareholders of
a controlled foreign corporation (``CFC'') are subject to
U.S. tax currently on certain income earned by the CFC,
whether or not such income is distributed to the
shareholders. The income subject to current inclusion under
the subpart F rules includes, among other things, insurance
income and foreign base company income. Foreign base company
income includes, among other things, foreign personal holding
company income and foreign base company services income
(i.e., income derived from services performed for or on
behalf of a related person outside the country in which the
CFC is organized).
Foreign personal holding company income generally consists
of the following: (1) dividends, interest, royalties, rents,
and annuities; (2) net gains from the sale or exchange of (a)
property that gives rise to the preceding types of income,
(b) property that does not give rise to income, and (c)
interests in trusts, partnerships, and REMICs; (3) net gains
from commodities transactions; (4) net gains from certain
foreign currency transactions; (5) income that is equivalent
to interest; (6) income from notional principal contracts;
(7) payments in lieu of dividends; and (8) amounts received
under personal service contracts.
Insurance income subject to current inclusion under the
subpart F rules includes any income of a CFC attributable to
the issuing or reinsuring of any insurance or annuity
contract in connection with risks located in a country other
than the CFC's country of organization. Subpart F insurance
income also includes income attributable to an insurance
contract in connection with risks located within the CFC's
country of organization, as the result of an arrangement
under which another corporation receives a substantially
equal amount of consideration for insurance of other country
risks. Investment income of a CFC that is allocable to any
insurance or annuity contract related to risks located
outside the CFC's country of organization is taxable as
subpart F insurance income.\30\
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\30\ Prop. Treas. Reg. sec. 1.953-1(a).
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Temporary exceptions from foreign personal holding company
income, foreign base company services income, and insurance
income apply for subpart F purposes for certain income that
is derived in the active conduct of a banking, financing, or
similar business, or in the conduct of an insurance business
(so-called ``active financing income'').\31\
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\31\ Temporary exceptions from the subpart F provisions for
certain active financing income applied only for taxable
years beginning in 1998. Those exceptions were modified and
extended for one year, applicable only for taxable years
beginning in 1999. The Tax Relief Extension Act of 1999 (Pub.
L. No. 106-170) clarified and extended the temporary
exceptions for two years, applicable only for taxable years
beginning after 1999 and before 2002. The Job Creation and
Worker Assistance Act of 2002 (Pub. L. No. 107-147) modified
and extended the temporary exceptions for five years, for
taxable years beginning after 2001 and before 2007.
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With respect to income derived in the active conduct of a
banking, financing, or similar business, a CFC is required to
be predominantly engaged in such business and to conduct
substantial activity with respect to such business in order
to qualify for the exceptions. In addition, certain nexus
requirements apply, which provide that income derived by a
CFC or a qualified business unit (``QBU'') of a CFC from
transactions with customers is eligible for the exceptions
if, among other things, substantially all of the activities
in connection with such transactions are conducted directly
by the CFC or QBU in its home country, and such income is
treated as earned by the CFC or QBU in its home country for
purposes of such country's tax laws. Moreover, the exceptions
apply to income derived from certain cross border
transactions, provided that certain requirements are met.
Additional exceptions from foreign personal holding company
income apply for certain income derived by a securities
dealer within the meaning of section 475 and for gain from
the sale of active financing assets.
In the case of insurance, in addition to a temporary
exception from foreign personal holding company income for
certain income of a qualifying insurance company with respect
to risks located within the CFC's country of creation or
organization, certain temporary exceptions from insurance
income and from foreign personal holding company income apply
for certain income of a qualifying branch of a qualifying
insurance company with respect to risks located within the
home country of the branch, provided certain requirements are
met under each of the exceptions. Further, additional
temporary exceptions from insurance income and from foreign
personal holding company income apply for certain income of
certain CFCs or branches with respect to risks located in a
country other than the United States, provided that the
requirements for these exceptions are met.
In the case of a life insurance or annuity contract,
reserves for such contracts are determined as follows for
purposes of these provisions. The reserves equal the greater
of: (1) the net surrender value of the contract (as defined
in section 807(e)(1)(A)), including in the case of pension
plan contracts; or (2) the amount determined by applying the
tax reserve method that would apply if the qualifying life
insurance company were subject to tax under Subchapter L of
the Code, with the following modifications. First, there is
substituted for the applicable Federal interest rate an
interest rate determined for the functional currency of the
qualifying insurance company's home country, calculated
(except as provided by the Treasury Secretary in order to
address insufficient data and similar problems) in the same
manner as the mid-term applicable Federal interest rate
(within the meaning of section 1274(d)). Second, there is
substituted for the prevailing State assumed rate the highest
assumed interest rate permitted to be used for purposes of
determining statement reserves in the foreign country for the
contract. Third, in lieu of U.S. mortality and morbidity
tables, mortality and morbidity tables are applied that
reasonably reflect the current mortality and morbidity risks
in the foreign country. Fourth, the Treasury Secretary may
provide that the interest rate and mortality and morbidity
tables of a qualifying insurance company may be used for one
or more of its branches when appropriate. In no event may the
reserve for any contract at any time exceed the foreign
statement reserve for the contract, reduced by any
catastrophe, equalization, or deficiency reserve or any
similar reserve.
Present law permits a taxpayer in certain circumstances,
subject to approval by the IRS through the ruling process or
in published guidance, to 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. In seeking a ruling, the
taxpayer is required to provide the IRS with necessary and
appropriate information as to the method, interest rate,
mortality and morbidity assumptions and other assumptions
under the foreign reserve rules so that a comparison can be
made to the reserve amount determined by applying the tax
reserve method that would apply if the qualifying insurance
company were subject to tax under Subchapter L of the Code
(with the modifications provided under present law for
purposes of these exceptions). The IRS also may issue
published guidance indicating its approval. Present law
continues to apply with respect to reserves for any life
insurance or annuity contract for which the IRS has not
approved the use of the foreign statement reserve. An IRS
ruling request under this provision is subject to the
present-law provisions relating to IRS user fees.
house bill
The House bill extends for two years (for taxable years
beginning before 2009) the present-law temporary exceptions
from subpart F foreign personal holding company income,
foreign base company services income, and insurance income
for certain income that is derived in the active conduct of a
banking, financing, or similar business, or in the conduct of
an insurance business.
Effective date.--The provision is effective for taxable
years of foreign corporations beginning after December 31,
2006, and before
[[Page H2227]]
January 1, 2009, and for taxable years of U.S. shareholders
with or within which such taxable years of such foreign
corporations end.
senate amendment
No provision.
conference agreement
The conference agreement includes the House bill provision.
2. Look-through treatment of payments between related
controlled foreign corporations under foreign personal
holding company income rules (sec. 202(b) of the House
bill and sec. 954(c) of the Code)
present law
In general, the rules of subpart F (secs. 951-964) require
U.S. shareholders with a
10 percent or greater interest in a controlled foreign
corporation (``CFC'') to include certain income of the CFC
(referred to as ``subpart F income'') on a current basis for
U.S. tax purposes, regardless of whether the income is
distributed to the shareholders.
Subpart F income includes foreign base company income. One
category of foreign base company income is foreign personal
holding company income. For subpart F purposes, foreign
personal holding company income generally includes dividends,
interest, rents, and royalties, among other types of income.
However, foreign personal holding company income does not
include dividends and interest received by a CFC from a
related corporation organized and operating in the same
foreign country in which the CFC is organized, or rents and
royalties received by a CFC from a related corporation for
the use of property within the country in which the CFC is
organized. Interest, rent, and royalty payments do not
qualify for this exclusion to the extent that such payments
reduce the subpart F income of the payor.
house bill
Under the House bill, for taxable years beginning after
2005 and before 2009, dividends, interest,\32\ rents, and
royalties received by one CFC from a related CFC are not
treated as foreign personal holding company income to the
extent attributable or properly allocable to non-subpart-F
income of the payor. For this purpose, a related CFC is a CFC
that controls or is controlled by the other CFC, or a CFC
that is controlled by the same person or persons that control
the other CFC. Ownership of more than 50 percent of the CFC's
stock (by vote or value) constitutes control for these
purposes. The bill provides that the Secretary shall
prescribe such regulations as are appropriate to prevent the
abuse of the purposes of this provision.
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\32\ Interest for this purpose includes factoring income
which is treated as equivalent to interest under sec.
954(c)(1)(E).
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The provision in the House bill is effective for taxable
years of foreign corporations beginning after December 31,
2005, but before January 1, 2009, and for taxable years of
U.S. shareholders with or within which such taxable years of
such foreign corporations end.
senate amendment
No provision.
conference agreement
The conference agreement includes the House bill provision.
R. Reduced Rates for Capital Gains and Dividends of Individuals
(Sec. 203 of the House bill and sec. 1(h) of the Code)
present law
Capital gains
In general
In general, gain or loss reflected in the value of an asset
is not recognized for income tax purposes until a taxpayer
disposes of the asset. On the sale or exchange of a capital
asset, any gain generally is included in income. Any net
capital gain of an individual is generally taxed at maximum
rates lower than the rates applicable to ordinary income. Net
capital gain is the excess of the net long-term capital gain
for the taxable year over the net short-term capital loss for
the year. Gain or loss is treated as long-term if the asset
is held for more than one year.
Capital losses generally are deductible in full against
capital gains. In addition, individual taxpayers may deduct
capital losses against up to $3,000 of ordinary income in
each year. Any remaining unused capital losses may be carried
forward indefinitely to another taxable year.
A capital asset generally means any property except (1)
inventory, stock in trade, or property held primarily for
sale to customers in the ordinary course of the taxpayer's
trade or business, (2) depreciable or real property used in
the taxpayer's trade or business, (3) specified literary or
artistic property, (4) business accounts or notes receivable,
(5) certain U.S. publications, (6) certain commodity
derivative financial instruments, (7) hedging transactions,
and (8) business supplies. In addition, the net gain from the
disposition of certain property used in the taxpayer's trade
or business is treated as long-term capital gain. Gain from
the disposition of depreciable personal property is not
treated as capital gain to the extent of all previous
depreciation allowances. Gain from the disposition of
depreciable real property is generally not treated as capital
gain to the extent of the depreciation allowances in excess
of the allowances that would have been available under the
straight-line method of depreciation.
Tax rates before 2009
Under present law, for taxable years beginning before
January 1, 2009, the maximum rate of tax on the adjusted net
capital gain of an individual is 15 percent. Any adjusted net
capital gain which otherwise would be taxed at a 10- or 15-
percent rate is taxed at a 5-percent rate (zero for taxable
years beginning after 2007). These rates apply for purposes
of both the regular tax and the alternative minimum tax.
Under present law, the ``adjusted net capital gain'' of an
individual is the net capital gain reduced (but not below
zero) by the sum of the 28-percent rate gain and the
unrecaptured section 1250 gain. The net capital gain is
reduced by the amount of gain that the individual treats as
investment income for purposes of determining the investment
interest limitation under section 163(d).
The term ``28-percent rate gain'' means the amount of net
gain attributable to long-term capital gains and losses from
the sale or exchange of collectibles (as defined in section
408(m) without regard to paragraph (3) thereof), an amount of
gain equal to the amount of gain excluded from gross income
under section 1202 (relating to certain small business
stock), the net short-term capital loss for the taxable year,
and any long-term capital loss carryover to the taxable year.
``Unrecaptured section 1250 gain'' means any long-term
capital gain from the sale or exchange of section 1250
property (i.e., depreciable real estate) held more than one
year to the extent of the gain that would have been treated
as ordinary income if section 1250 applied to all
depreciation, reduced by the net loss (if any) attributable
to the items taken into account in computing 28-percent rate
gain. The amount of unrecaptured section 1250 gain (before
the reduction for the net loss) attributable to the
disposition of property to which section 1231 (relating to
certain property used in a trade or business) applies may not
exceed the net section 1231 gain for the year.
An individual's unrecaptured section 1250 gain is taxed at
a maximum rate of 25 percent, and the 28-percent rate gain is
taxed at a maximum rate of 28 percent. Any amount of
unrecaptured section 1250 gain or 28-percent rate gain
otherwise taxed at a 10- or 15-percent rate is taxed at the
otherwise applicable rate.
Tax rates after 2008
For taxable years beginning after December 31, 2008, the
maximum rate of tax on the adjusted net capital gain of an
individual is 20 percent. Any adjusted net capital gain which
otherwise would be taxed at a 10- or 15-percent rate is taxed
at a 10-percent rate.
In addition, any gain from the sale or exchange of property
held more than five years that would otherwise have been
taxed at the 10-percent rate is taxed at an 8-percent rate.
Any gain from the sale or exchange of property held more than
five years and the holding period for which began after
December 31, 2000, that would otherwise have been taxed at a
20-percent rate is taxed at an 18-percent rate.
The tax rates on 28-percent gain and unrecaptured section
1250 gain are the same as for taxable years beginning before
2009.
Dividends
In general
A dividend is the distribution of property made by a
corporation to its shareholders out of its after-tax earnings
and profits.
Tax rates before 2009
Under present law, dividends received by an individual from
domestic corporations and qualified foreign corporations are
taxed at the same rates that apply to capital gains. This
treatment applies for purposes of both the regular tax and
the alternative minimum tax. Thus, for taxable years
beginning before 2009, dividends received by an individual
are taxed at rates of five (zero for taxable years
beginning after 2007) and 15 percent.
If a shareholder does not hold a share of stock for more
than 60 days during the 121-day period beginning 60 days
before the ex-dividend date (as measured under section
246(c)), dividends received on the stock are not eligible for
the reduced rates. Also, the reduced rates are not available
for dividends to the extent that the taxpayer is obligated to
make related payments with respect to positions in
substantially similar or related property.
Qualified dividend income includes otherwise qualified
dividends received from qualified foreign corporations. The
term ``qualified foreign corporation'' includes a foreign
corporation that is eligible for the benefits of a
comprehensive income tax treaty with the United States which
the Treasury Department determines to be satisfactory and
which includes an exchange of information program. In
addition, a foreign corporation is treated as a qualified
foreign corporation with respect to any dividend paid by the
corporation with respect to stock that is readily tradable on
an established securities market in the United States.
Dividends received from a corporation that is a passive
foreign investment company (as defined in section 1297) in
either the taxable year of the distribution, or the preceding
taxable year, are not qualified dividends.
Special rules apply in determining a taxpayer's foreign tax
credit limitation under section 904 in the case of qualified
dividend income. For these purposes, rules similar to the
rules of section 904(b)(2)(B) concerning adjustments to the
foreign tax credit limitation to reflect any capital gain
rate differential will apply to any qualified dividend
income.
[[Page H2228]]
If a taxpayer receives an extraordinary dividend (within
the meaning of section 1059(c)) eligible for the reduced
rates with respect to any share of stock, any loss on the
sale of the stock is treated as a long-term capital loss to
the extent of the dividend.
A dividend is treated as investment income for purposes of
determining the amount of deductible investment interest only
if the taxpayer elects to treat the dividend as not eligible
for the reduced rates.
The amount of dividends qualifying for reduced rates that
may be paid by a regulated investment company (``RIC'') for
any taxable year in which the qualified dividend income
received by the RIC is less than 95 percent of its gross
income (as specially computed) may not exceed the sum of (i)
the qualified dividend income of the RIC for the taxable year
and (ii) the amount of earnings and profits accumulated in a
non-RIC taxable year that were distributed by the RIC during
the taxable year.
The amount of dividends qualifying for reduced rates that
may be paid by a real estate investment trust (``REIT'') for
any taxable year may not exceed the sum of (i) the qualified
dividend income of the REIT for the taxable year, (ii) an
amount equal to the excess of the income subject to the taxes
imposed by section 857(b)(1) and the regulations prescribed
under section 337(d) for the preceding taxable year over the
amount of these taxes for the preceding taxable year, and
(iii) the amount of earnings and profits accumulated in a
non-REIT taxable year that were distributed by the REIT
during the taxable year.
The reduced rates do not apply to dividends received from
an organization that was exempt from tax under section 501 or
was a tax-exempt farmers' cooperative in either the taxable
year of the distribution or the preceding taxable year;
dividends received from a mutual savings bank that received a
deduction under section 591; or deductible dividends paid on
employer securities.\33\
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\33\ In addition, for taxable years beginning before 2009,
amounts treated as ordinary income on the disposition of
certain preferred stock (sec. 306) are treated as dividends
for purposes of applying the reduced rates; the tax rate for
the accumulated earnings tax (sec. 531) and the personal
holding company tax (sec. 541) is reduced to 15 percent; and
the collapsible corporation rules (sec. 341) are repealed.
---------------------------------------------------------------------------
Tax rates after 2008
For taxable years beginning after 2008, dividends received
by an individual are taxed at ordinary income tax rates.
House Bill
The House bill extends for two years the present-law
provisions relating to lower capital gain and dividend tax
rates (through taxable years beginning on or before December
31, 2010).
Effective date.--The provision applies to taxable years
beginning after December 31, 2008.
Senate Amendment
No provision.
Conference Agreement
The conference agreement includes the House bill provision.
S. Credit for Elective Deferrals and IRA Contributions (the ``Saver's
Credit'')
(Sec. 204 of the House bill, sec. 102 of the Senate
amendment, and sec. 25B of the Code)
Present Law
Present law provides a temporary nonrefundable tax credit
for eligible taxpayers for qualified retirement savings
contributions, referred to as the ``saver's credit.'' The
maximum annual contribution eligible for the credit is
$2,000. The credit rate depends on the adjusted gross income
(``AGI'') of the taxpayer. Taxpayers filing joint returns
with AGI of $50,000 or less, head of household returns of
$37,500 or less, and single returns of $25,000 or less are
eligible for the credit. The AGI limits applicable to single
taxpayers apply to married taxpayers filing separate returns.
The credit is in addition to any deduction or exclusion that
would otherwise apply with respect to the contribution. The
credit offsets minimum tax liability as well as regular tax
liability. The credit is available to individuals who are 18
or over, other than individuals who are full-time students or
claimed as a dependent on another taxpayer's return.
The credit is available with respect to: (1) elective
deferrals to a qualified cash or deferred arrangement (a
``section 401(k) plan''), a tax-sheltered annuity (a
``section 403(b)'' annuity), an eligible deferred
compensation arrangement of a State or local government (a
``governmental section 457 plan''), a SIMPLE plan, or a
simplified employee pension (``SEP''); (2) contributions to a
traditional or Roth IRA; and (3) voluntary after-tax employee
contributions to a tax-sheltered annuity or qualified
retirement plan.
The amount of any contribution eligible for the credit is
generally reduced by distributions received by the taxpayer
(or by the taxpayer's spouse if the taxpayer filed a joint
return with the spouse) from any plan or IRA to which
eligible contributions can be made during the taxable year
for which the credit is claimed, the two taxable years prior
to the year the credit is claimed, and during the period
after the end of the taxable year for which the credit is
claimed and prior to the due date for filing the taxpayer's
return for the year. Distributions that are rolled over to
another retirement plan do not affect the credit.
The credit rates based on AGI are provided below.
TABLE 1.--CREDIT RATES FOR SAVER'S CREDIT
----------------------------------------------------------------------------------------------------------------
Heads of Credit rate
Joint filers households All other filers (percent)
----------------------------------------------------------------------------------------------------------------
$0-$30,000............................................. $0-$22,500 $0-$15,000 50
30,001-32,500.................................................. 22,501-24,375 15,001-16,250 20
32,501--50,000................................................. 24,376-37,500 16,251-25,000 10
Over $50,000................................................... Over $37,500 Over $25,000 0
----------------------------------------------------------------------------------------------------------------
The credit does not apply to taxable years beginning after
December 31, 2006.\34\
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\34\ The saver's credit was enacted as part of the Economic
Growth and Tax Relief Reconciliation Act of 2001
(``EGTRRA''), Pub. L. No. 107-16. The provisions of EGTRRA
generally do not apply for years beginning after December 31,
2010.
---------------------------------------------------------------------------
House Bill
The House bill extends the saver's credit for two years,
through December 31, 2008.
Effective date.--The provision is effective on the date of
enactment.
Senate Amendment
The Senate amendment extends the saver's credit for three
years, through December 31, 2009.
Effective date.--The provision is effective on the date of
enactment.
Conference Agreement
The conference agreement does not include the House bill
provision or the Senate amendment provision.
T. Extension of Increased Expensing for Small Business
(Sec. 205 of the House bill, sec. 101 of the Senate
amendment, and sec. 179 of the Code)
present law
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs. Present law provides that the
maximum amount a taxpayer may expense, for taxable years
beginning in 2003 through 2007, is $100,000 of the cost of
qualifying property placed in service for the taxable
year.\35\ In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business. Off-the-
shelf computer software placed in service in taxable years
beginning before 2008 is treated as qualifying property. The
$100,000 amount is reduced (but not below zero) by the amount
by which the cost of qualifying property placed in service
during the taxable year exceeds $400,000. The $100,000 and
$400,000 amounts are indexed for inflation for taxable years
beginning after 2003 and before 2008.
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\35\ Additional section 179 incentives are provided with
respect to a qualified property used by a business in the New
York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec.
1397A), or a renewal community (sec. 1400J).
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The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount
that is not allowed as a deduction because of the taxable
income limitation may be carried forward to succeeding
taxable years (subject to similar limitations). No general
business credit under section 38 is allowed with respect to
any amount for which a deduction is allowed under section
179. An expensing election is made under rules prescribed by
the Secretary.\36\
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\36\ Sec. 179(c)(1). Under Treas. Reg. sec. 179-5, applicable
to property placed in service in taxable years beginning
after 2002 and before 2008, a taxpayer is permitted to make
or revoke an election under section 179 without the consent
of the Commissioner on an amended Federal tax return for that
taxable year. This amended return must be filed within the
time prescribed by law for filing an amended return for the
taxable year. T.D. 9209, July 12, 2005.
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For taxable years beginning in 2008 and thereafter (or
before 2003), the following rules apply. A taxpayer with a
sufficiently small amount of annual investment may elect to
deduct up to $25,000 of the cost of qualifying property
placed in service for the taxable year. The $25,000 amount is
reduced (but not below zero) by the amount by which the cost
of qualifying property placed in service during the taxable
year exceeds $200,000. The $25,000 and $200,000 amounts are
not indexed. In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business (not
including off-the-shelf computer software). An expensing
election may be revoked only with consent of the
Commissioner.\37\
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\37\ Sec. 179(c)(2).
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[[Page H2229]]
house bill
The provision extends for two years the increased amount
that a taxpayer may deduct and the other section 179 rules
applicable in taxable years beginning before 2008. Thus,
under the provision, these present-law rules continue in
effect for taxable years beginning after 2007 and before
2010.
Effective date.--The provision is effective for taxable
years beginning after 2007 and before 2010.
senate amendment
The Senate amendment provision is the same as the House
bill.
conference agreement
The conference agreement includes the provision in the
House bill and the Senate amendment.
U. Extend and Increase Alternative Minimum Tax Exemption Amount for
Individuals
(Sec. 106 of the Senate amendment and sec. 55 of the Code)
present law
Present law imposes an alternative minimum tax. The
alternative minimum tax is the amount by which the tentative
minimum tax exceeds the regular income tax. An individual's
tentative minimum tax is the sum of (1) 26 percent of so much
of the taxable excess as does not exceed $175,000 ($87,500 in
the case of a married individual filing a separate return)
and (2) 28 percent of the remaining taxable excess. The
taxable excess is so much of the alternative minimum taxable
income (``AMTI'') as exceeds the exemption amount. The
maximum tax rates on net capital gain and dividends used in
computing the regular tax are used in computing the tentative
minimum tax. AMTI is the individual's taxable income adjusted
to take account of specified preferences and adjustments.
The exemption amount is: (1) $45,000 ($58,000 for taxable
years beginning before 2006) in the case of married
individuals filing a joint return and surviving spouses; (2)
$33,750 ($40,250 for taxable years beginning before 2006) in
the case of unmarried individuals other than surviving
spouses; (3) $22,500 ($29,000 for taxable years beginning
before 2006) in the case of married individuals filing a
separate return; and (4) $22,500 in the case of estates and
trusts. The exemption amount is phased out by an amount equal
to 25 percent of the amount by which the individual's AMTI
exceeds (1) $150,000 in the case of married individuals
filing a joint return and surviving spouses, (2) $112,500 in
the case of unmarried individuals other than surviving
spouses, and (3) $75,000 in the case of married individuals
filing separate returns, estates, and trusts. These amounts
are not indexed for inflation.
house bill
No provision.
senate amendment
Under the Senate amendment, for taxable years beginning in
2006, the exemption amounts are increased to: (1) $62,550 in
the case of married individuals filing a joint return and
surviving spouses; (2) $42,500 in the case of unmarried
individuals other than surviving spouses; and (3) $31,275 in
the case of married individuals filing a separate return.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
conference agreement
The conference agreement includes the provision in the
Senate amendment.
V. Extension and Modification of the New Markets Tax Credit
(Sec. 204 of the Senate amendment and sec. 45D of the Code)
present law
Section 45D provides a new markets tax credit for qualified
equity investments made to acquire stock in a corporation, or
a capital interest in a partnership, that is a qualified
community development entity (``CDE'').\38\ The amount of the
credit allowable to the investor (either the original
purchaser or a subsequent holder) is (1) a five-percent
credit for the year in which the equity interest is purchased
from the CDE and for each of the following two years, and (2)
a six-percent credit for each of the following four years.
The credit is determined by applying the applicable
percentage (five or six percent) to the amount paid to the
CDE for the investment at its original issue, and is
available for a taxable year to the taxpayer who holds the
qualified equity investment on the date of the initial
investment or on the respective anniversary date that occurs
during the taxable year. The credit is recaptured if at any
time during the seven-year period that begins on the date of
the original issue of the investment the entity ceases to be
a qualified CDE, the proceeds of the investment cease to be
used as required, or the equity investment is redeemed.
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\38\ Section 45D was added by section 121(a) of the Community
Renewal Tax Relief Act of 2000, P.L. No. 106-554 (December
21, 2000).
---------------------------------------------------------------------------
A qualified CDE is any domestic corporation or partnership:
(1) whose primary mission is serving or providing investment
capital for low-income communities or low-income persons; (2)
that maintains accountability to residents of low-income
communities by their representation on any governing board of
or any advisory board to the CDE; and (3) that is certified
by the Secretary as being a qualified CDE. A qualified equity
investment means stock (other than nonqualified preferred
stock) in a corporation or a capital interest in a
partnership that is acquired directly from a CDE for cash,
and includes an investment of a subsequent purchaser if such
investment was a qualified equity investment in the hands of
the prior holder. Substantially all of the investment
proceeds must be used by the CDE to make qualified low-income
community investments. For this purpose, qualified low-income
community investments include: (1) capital or equity
investments in, or loans to, qualified active low-income
community businesses; (2) certain financial counseling and
other services to businesses and residents in low-income
communities; (3) the purchase from another CDE of any loan
made by such entity that is a qualified low-income community
investment; or (4) an equity investment in, or loan to,
another CDE.
A ``low-income community'' is a population census tract
with either (1) a poverty rate of at least 20 percent or (2)
median family income which does not exceed 80 percent of the
greater of metropolitan area median family income or
statewide median family income (for a non-metropolitan census
tract, does not exceed 80 percent of statewide median family
income). In the case of a population census tract located
within a high migration rural county, low-income is defined
by reference to 85 percent (rather than 80 percent) of
statewide median family income. For this purpose, a high
migration rural county is any county that, during the 20-year
period ending with the year in which the most recent census
was conducted, has a net out-migration of inhabitants from
the county of at least 10 percent of the population of the
county at the beginning of such period.
The Secretary has the authority to designate ``targeted
populations'' as low-income communities for purposes of the
new markets tax credit. For this purpose, a ``targeted
population'' is defined by reference to section 103(20) of
the Riegle Community Development and Regulatory Improvement
Act of 1994 (12 U.S.C. 4702(20)) to mean individuals, or an
identifiable group of individuals, including an Indian tribe,
who (A) are low-income persons; or (B) otherwise lack
adequate access to loans or equity investments. Under such
Act, ``low-income'' means (1) for a targeted population
within a metropolitan area, less than 80 percent of the area
median family income; and (2) for a targeted population
within a non-metropolitan area, less than the greater of 80
percent of the area median family income or 80 percent of the
statewide non-metropolitan area median family income.\39\
Under such Act, a targeted population is not required to be
within any census tract. In addition, a population census
tract with a population of less than 2,000 is treated as a
low-income community for purposes of the credit if such tract
is within an empowerment zone, the designation of which is in
effect under section 1391, and is contiguous to one or more
low-income communities.
---------------------------------------------------------------------------
\39\ 12. U.S.C. 4702(17) (defines ``low-income'' for purposes
of 12 U.S.C. 4702(20)).
---------------------------------------------------------------------------
A qualified active low-income community business is defined
as a business that satisfies, with respect to a taxable year,
the following requirements: (1) at least 50 percent of the
total gross income of the business is derived from the active
conduct of trade or business activities in any low-income
community; (2) a substantial portion of the tangible property
of such business is used in a low-income community; (3) a
substantial portion of the services performed for such
business by its employees is performed in a low-income
community; and (4) less than five percent of the average of
the aggregate unadjusted bases of the property of such
business is attributable to certain financial property or to
certain collectibles.
The maximum annual amount of qualified equity investments
is capped at $2.0 billion per year for calendar years 2004
and 2005, and at $3.5 billion per year for calendar years
2006 and 2007.
house bill
No provision.
senate amendment
The provision extends through 2008 the $3.5 billion maximum
annual amount of qualified equity investments. The provision
also requires that the Secretary prescribe regulations to
ensure that non-metropolitan counties receive a proportional
allocation of qualified equity investments.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
W. Phasedown of Credit for Electric Vehicles
(Sec. 118 of the Senate amendment and sec. 30 of the Code)
Present Law
A 10-percent tax credit is provided for the cost of a
qualified electric vehicle, up to a maximum credit of $4,000.
A qualified electric vehicle generally is a motor vehicle
that is powered primarily by an electric motor drawing
current from rechargeable batteries, fuel cells, or other
portable sources of electrical current. The full amount of
the credit is available for purchases prior to 2006. The
credit is reduced to 25 percent of the otherwise allowable
amount for purchases in 2006,
[[Page H2230]]
and is unavailable for purchases after December 31, 2006.
House Bill
No provision.
Senate Amendment
Under the Senate amendment, the full amount of the credit
for qualified electric vehicles is available for purchases
prior to 2006. As under present law, the credit is
unavailable for purchases after December 31, 2006.
Effective date.--The provision is effective for property
placed in service after December 31, 2005.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
X. Application of EGTRRA Sunset to Title II of the Senate Amendment
(Sec. 231 of the Senate amendment)
Present Law
Reconciliation is a procedure under the Congressional
Budget Act of 1974 (the ``Budget Act'') by which Congress
implements spending and tax policies contained in a budget
resolution. The Budget Act contains numerous rules enforcing
the scope of items permitted to be considered under the
budget reconciliation process. One such rule, the so-called
``Byrd rule,'' was incorporated into the Budget Act in 1990.
The Byrd rule, named after its principal sponsor, Senator
Robert C. Byrd, is contained in section 313 of the Budget
Act. The Byrd rule generally permits members to raise a point
of order against extraneous provisions (those which are
unrelated to the goals of the reconciliation process) from
either a reconciliation bill or a conference report on such
bill.
Under the Byrd rule, a provision is considered to be
extraneous if it falls under one or more of the following six
definitions:
1. It does not produce a change in outlays or revenues;
2. It produces an outlay increase or revenue decrease when
the instructed committee is not in compliance with its
instructions;
3. It is outside of the jurisdiction of the committee that
submitted the title or provision for inclusion in the
reconciliation measure;
4. It produces a change in outlays or revenues which is
merely incidental to the nonbudgetary components of the
provision;
5. It would increase the deficit for a fiscal year beyond
those covered by the reconciliation measure; and
6. It recommends changes in Social Security.
The Economic Growth and Tax Relief Reconciliation Act of
2001 (EGTRRA) contains sunset provisions to ensure compliance
with the Budget Act. Under title IX of EGTRRA, the provisions
of, and amendments made by that Act that are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011, except that all provisions of, and
amendments made by, the Act generally do not apply for
taxable, plan or limitation years beginning after December
31, 2010. With respect to the estate, gift, and generation-
skipping provisions of the Act, the provisions do not apply
to estates of decedents dying, gifts made, or generation-
skipping transfers, after December 31, 2010. The Code and the
Employee Retirement Income Security Act of 1974 are applied
to such years, estates, gifts and transfers after December
31, 2010, as if the provisions of and amendments made by the
Act had never been enacted.
House Bill
No provision.
Senate Amendment
Sunset of provisions
To ensure compliance with the Budget Act, the Senate
amendment provides that all provisions of, and amendments
made by title II of the Senate amendment shall be subject to
the sunset provisions of EGTRRA to the same extent and in the
same manner as the provision of such Act to which the Senate
amendment provision relates.
Effective date.--The provision is effective on the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
TITLE II--OTHER PROVISONS
A. Taxation of Certain Settlement Funds
(Sec. 301 of the House bill and sec. 468B of the Code)
Present Law
Present law provides that if a taxpayer makes a payment to
a designated settlement fund pursuant to a court order, the
deduction timing rules that require economic performance
generally are deemed to be met as the payments are made by
the taxpayer to the fund. A designated settlement fund means
a fund which: is established pursuant to a court order;
extinguishes completely the taxpayer's tort liability arising
out of personal injury, death or property damage; is
administered by persons a majority of whom are independent of
the taxpayer; and under the terms of the fund the taxpayer
(or any related person) may not hold any beneficial interest
in the income or corpus of the fund.
Generally, a designated or qualified settlement fund is
taxed as a separate entity at the maximum trust rate on its
modified income. Modified income is generally gross income
less deductions for administrative costs and other incidental
expenses incurred in connection with the operation of the
settlement fund.
The cleanup of hazardous waste sites is sometimes funded by
environmental ``settlement funds'' or escrow accounts. These
escrow accounts are established in consent decrees between
the Environmental Protection Agency (``EPA'') and the
settling parties under the jurisdiction of a Federal district
court. The EPA uses these accounts to resolve claims against
private parties under Comprehensive Environmental Response,
Compensation and Liability Act of 1980 (``CERCLA'').
Present law provides that nothing in any provision of law
is to be construed as providing that an escrow account,
settlement fund, or similar fund is not subject to current
income tax.
House Bill
The provision provides that certain settlement funds
established in consent decrees for the sole purpose of
resolving claims under CERCLA are to be treated as
beneficially owned by the United States government and
therefore not subject to Federal income tax.
To qualify the settlement fund must be: (1) established
pursuant to a consent decree entered by a judge of a United
States District Court; (2) created for the receipt of
settlement payments for the sole purpose of resolving claims
under CERCLA; (3) controlled (in terms of expenditures of
contributions and earnings thereon) by the government or an
agency or instrumentality thereof; and (4) upon termination,
any remaining funds will be disbursed to such government
entity and used in accordance with applicable law. For
purposes of the provision, a government entity means the
United States, any State of political subdivision thereof,
the District of Columbia, any possession of the United
States, and any agency or instrumentality of the foregoing.
The provision does not apply to accounts or funds
established after December 31, 2010.
Effective date.--The provision is effective for accounts
and funds established after the date of enactment.
Senate Amendment
No provision.
Conference Agreement
The conference agreement includes the House bill provision.
B. Modifications to Rules Relating to Taxation of Distributions of
Stock and Securities of a Controlled Corporation
(Sec. 302 of the House bill, sec. 467 of the Senate amendment
and sec. 355 of the Code)
Present Law
A corporation generally is required to recognize gain on
the distribution of property (including stock of a
subsidiary) to its shareholders as if the corporation had
sold such property for its fair market value. In addition,
the shareholders receiving the distributed property are
ordinarily treated as receiving a dividend of the value of
the distribution (to the extent of the distributing
corporation's earnings and profits), or capital gain in the
case of a stock buyback that significantly reduces the
shareholder's interest in the parent corporation.
An exception to these rules applies if the distribution of
the stock of a controlled corporation satisfies the
requirements of section 355 of the Code. If all the
requirements are satisfied, there is no tax to the
distributing corporation or to the shareholders on the
distribution.
One requirement to qualify for tax-free treatment under
section 355 is that both the distributing corporation and the
controlled corporation must be engaged immediately after the
distribution in the active conduct of a trade or business
that has been conducted for at least five years and was not
acquired in a taxable transaction during that period (the
``active business test'').\40\ For this purpose, a
corporation is engaged in the active conduct of a trade or
business only if (1) the corporation is directly engaged in
the active conduct of a trade or business, or (2) the
corporation is not directly engaged in an active business,
but substantially all its assets consist of stock and
securities of one or more corporations that it controls that
are engaged in the active conduct of a trade or business.\41\
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\40\ Section 355(b).
\41\ Section 355(b)(2)(A). The IRS takes the position that
the statutory test requires that at least 90 percent of the
fair market value of the corporation's gross assets consist
of stock and securities of a controlled corporation that is
engaged in the active conduct of a trade or business. Rev.
Proc. 96-30, sec. 4.03(5), 1996-1 C.B. 696; Rev. Proc. 77-37,
sec. 3.04, 1977-2 C.B. 568.
---------------------------------------------------------------------------
In determining whether a corporation is directly engaged in
an active trade or business that satisfies the requirement,
old IRS guidelines for advance ruling purposes required that
the value of the gross assets of the trade or business being
relied on must ordinarily constitute at least five percent of
the total fair market value of the gross assets of the
corporation directly conducting the trade or business.\42\
More recently, the IRS has suspended this specific rule in
connection with its general administrative practice of moving
IRS resources away from advance rulings on factual aspects of
section 355 transactions in general.\43\
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\42\ Rev. Proc. 2003-3, sec. 4.01(30), 2003-1 I.R.B. 113.
\43\ Rev. Proc. 2003-48, 2003-29 I.R.B. 86.
---------------------------------------------------------------------------
If the distributing or controlled corporation is not
directly engaged in an active trade or business, then the IRS
takes the position that the ``substantially all'' test as
applied to that corporation requires that at
[[Page H2231]]
least 90 percent of the fair market value of the
corporation's gross assets consist of stock and securities of
a controlled corporation that is engaged in the active
conduct of a trade or business.\44\
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\44\ Rev. Proc. 96-30, sec. 4.03(5), 1996-1 C.B. 696; Rev.
Proc. 77-37, sec. 3.04, 1977-2 C.B. 568.
---------------------------------------------------------------------------
In determining whether assets are part of a five-year
qualifying active business, assets acquired more recently
than five years prior to the distribution, in a taxable
transaction, are permitted to qualify as five-year ``active
business'' assets if they are considered to have been
acquired as part of an expansion of an existing business that
does so qualify.\45\
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\45\ Treas. Reg. sec. 1.355-3(b)(ii).
---------------------------------------------------------------------------
When a corporation holds an interest in a partnership, IRS
revenue rulings have allowed an active business of the
partnership to count as an active business of a corporate
partner in certain circumstances. One such case involved a
situation in which the corporation owned at least 20 percent
of the partnership, was actively engaged in management of the
partnership, and the partnership itself had an active
business.\46\
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\46\ Rev. Rul. 92-17, 1002-1 C.B. 142; see also, Rev. Rul.
2002-49, 2002-2 C.B. 50.
---------------------------------------------------------------------------
In addition to its active business requirements, section
355 does not apply to any transaction that is a ``device''
for the distribution of earnings and profits to a shareholder
without the payment of tax on a dividend. A transaction is
ordinarily not considered a ``device'' to avoid dividend tax
if the distribution would have been treated by the
shareholder as a redemption that was a sale or exchange of
its stock, rather than as a dividend, if section 355 had not
applied.\47\
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\47\ Treas. Reg. sec. 1.355-2(d)(5)(iv).
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House Bill
Under the House bill provision, the active business test is
determined by reference to the relevant affiliated group. For
the distributing corporation, the relevant affiliated group
consists of the distributing corporation as the common parent
and all corporations affiliated with the distributing
corporation through stock ownership described in section
1504(a)(1)(B) (regardless of whether the corporations are
includible corporations under section 1504(b)), immediately
after the distribution. The relevant affiliated group for a
controlled corporation is determined in a similar manner
(with the controlled corporation as the common parent).
Effective date.--The provision applies to distributions
after the date of enactment and before December 31, 2010,
with three exceptions. The provision does not apply to
distributions (1) made pursuant to an agreement which is
binding on the date of enactment and at all times thereafter,
(2) described in a ruling request submitted to the IRS on or
before the date of enactment, or (3) described on or before
the date of enactment in a public announcement or in a filing
with the Securities and Exchange Commission. The distributing
corporation may irrevocably elect not to have the exceptions
described above apply.
The provision also applies, solely for the purpose of
determining whether, after the date of enactment, there is
continuing qualification under the requirements of section
355(b)(2)(A) of distributions made before such date, as a
result of an acquisition, disposition, or other restructuring
after such date and before December 31, 2010.\48\
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\48\ For example, a holding company taxpayer that had
distributed a controlled corporation in a spin-off prior to
the date of enactment, in which spin-off the taxpayer
satisfied the ``substantially all'' active business stock
test of present law section 355(b)(2)(A) immediately after
the distribution, would not be deemed to have failed to
satisfy any requirement that it continue that same qualified
structure for any period of time after the distribution,
solely because of a restructuring that occurs after the date
of enactment and before January 1, 2010, and that would
satisfy the requirements of new section 355(b)(2)(A).
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Senate Amendment
The Senate amendment provision is the same as the House
bill with respect to the House bill provision described
above, except for the date on which that provision
sunsets.\49\
---------------------------------------------------------------------------
\49\ See ``Effective date'' for the Senate Amendment, infra.
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In addition, the Senate amendment contains another
provision that denies section 355 treatment if either the
distributing or distributed corporation is a disqualified
investment corporation immediately after the transaction
(including any series of related transactions) and any person
that did not hold 50 percent or more of the voting power or
value of stock of such distributing or controlled corporation
immediately before the transaction does hold such a 50
percent or greater interest immediately after such
transaction. The attribution rules of section 318 apply for
purposes of this determination.
A disqualified investment corporation is any distributing
or controlled corporation if the fair market value of the
investment assets of the corporation is 75 percent or more of
the fair market value of all assets of the corporation.
Except as otherwise provided, the term ``investment assets''
for this purpose means (i) cash, (ii) any stock or securities
in a corporation, (iii) any interest in a partnership, (iv)
any debt instrument or other evidence of indebtedness; (v)
any option, forward or futures contract, notional principal
contract, or derivative; (vi) foreign currency, or (vii) any
similar asset.
The term ``investment assets'' does not include any asset
which is held for use in the active and regular conduct of
(i) a lending or finance business (as defined in section
954(h)(4)); (ii) a banking business through a bank (as
defined in section 581), a domestic building and loan
association (within the meaning of section 7701(a)(19), or
any similar institution specified by the Secretary; or (iii)
an insurance business if the conduct of the business is
licensed, authorized, or regulated by an applicable insurance
regulatory body. These exceptions only apply with respect to
any business if substantially all the income of the business
is derived from persons who are not related (within the
meaning of section 267(b) or 707(b)(1) to the person
conducting the business.
The term ``investment assets'' also does not include any
security (as defined in section 475(c)(2)) which is held by a
dealer in securities and to which section 475(a) applies.
The term ``investment assets'' also does not include any
stock or securities in, or any debt instrument, evidence of
indebtedness, option, forward or futures contract, notional
principal contract, or derivative issued by, a corporation
which is a 25-percent controlled entity with respect to the
distributing or controlled corporation. Instead, the
distributing or controlled corporation is treated as owning
its ratable share of the assets of any 25-percent controlled
entity.
The term 25-percent controlled entity means any corporation
with respect to which the corporation in question
(distributing or controlled) owns directly or indirectly
stock possessing at least 25 percent of voting power and
value, excluding stock that is not entitled to vote, is
limited and preferred as to dividends and does not
participate in corporate growth to any significant extent,
has redemption and liquidation rights which do not exceed the
issue price of such stock (except for a reasonable redemption
or liquidation premium), and is not convertible into another
class of stock.
The term ``investment assets'' also does not include any
interest in a partnership, or any debt instrument or other
evidence of indebtedness issued by the partnership, if one or
more trades or businesses of the partnership are, (or without
regard to the 5-year requirement of section 355(b)(2)(B),
would be) taken into account by the distributing or
controlled corporation, as the case may be, in determining
whether the active business test of section 355 is met by
such corporation.
The Treasury department shall provide regulations as may be
necessary to carry out, or prevent the avoidance of, the
purposes of the provision, including regulations in cases
involving related persons, intermediaries, pass-through
entities, or other arrangements; and the treatment of assets
unrelated to the trade or business of a corporation as
investment assets if, prior to the distribution, investment
assets were used to acquire such assets. Regulations may also
in appropriate cases exclude from the application of the
provision a distribution which does not have the character of
a redemption and which would be treated as a sale or exchange
under section 302, and may modify the application of the
attribution rules.
Effective date.--The effective date of the first provision
of the Senate amendment generally is the same as the
effective date of the identical provision of the House bill,
except that the Senate amendment provision sunsets for
distributions (and for acquisitions, dispositions, or other
restructurings as relating to continuing qualification of
pre-effective date distributions) after December 31, 2009,
rather than for distributions (and for acquisitions,
dispositions, or other restructurings as relating to
continuing qualification of pre-effective date distributions)
on or after December 31, 2010.
The second provision of the Senate amendment is effective
for distributions after the date of enactment, except in
transactions which are (i) made pursuant to an agreement
which was binding on such date of enactment and at all times
thereafter; (ii) described in a ruling request submitted to
the Intetnal Revenue Service on or before such date, or (iii)
described on or before such date in a public announcement or
in a filing with the Securities and Exchange Commission.
Conference Agreement
The conference agreement includes the House bill and the
Senate amendment with modifications.
With respect to the provision that applies the active
business test by reference to the relevant affiliated group,
the conference agreement provision is the same as the House
bill and the Senate amendment except for the date on which
the conference agreement provision sunsets.\50\
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\50\ See ``Effective date'' of the conference agreement
provision, infra.
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With respect to the provision that affects transactions
involving disqualified investment corporations, the
conference agreement reduces the percentage of investment
assets of a corporation that will cause such corporation to
be a disqualified investment corporation, from 75 percent
(three-quarters) to two-thirds of the fair market value of
the corporation's assets, for distributions occurring after
one year after the date of enactment.
The conference agreement also reduces from 25 percent to 20
percent the percentage stock ownership in a corporation that
will cause such ownership to be disregarded as an investment
asset itself, instead requiring ``look-through'' to the
ratable share of the underlying assets of such corporation
attributable to such stock ownership.
[[Page H2232]]
The conferees wish to clarify that the disqualified
investment corporation provision applies when a person
directly or indirectly holds 50 percent of either the vote or
the value of a company immediately following a distribution,
and such person did not hold such 50 percent interest
directly or indirectly prior to the distribution. As one
example, the provision applies if a person that held 50
percent or more of the vote, but not of the value, of a
distributing corporation immediately prior to a transaction
in which a controlled corporation that was 100 percent owned
by that distributing corporation is distributed, directly or
indirectly holds 50 percent of the value of either the
distributing or controlled corporation immediately following
such transaction.
The conferees further wish to clarify that the enumeration
in subsection 355(g)(5)(A) through (C) of specific situations
that Treasury regulations may address is not intended to
restrict or limit any other situations that Treasury may
address under the general authority of new section 355(g)(5)
to carry out, or prevent the avoidance of, the purposes of
the disqualified investment corporation provision.
Effective date.--The starting effective date of the
provision that applies the active business test by reference
to the relevant affiliated group is the same as that of the
House bill and the Senate amendment provisions. The
conference agreement changes the date on which the provision
sunsets so that the provision does not apply for
distributions (or for acquisitions, dispositions, or other
restructurings as relating to continuing qualification of
pre-effective date distributions) occurring after December
31, 2010.
The effective date of the provision that affects
transactions involving disqualified investment corporations
is the same as that of the Senate amendment provision, except
for the conference agreement reduction in the amount of
investment assets of a corporation that will cause it to be a
disqualified investment corporation, from three-quarters to
two thirds of the fair market value of all assets of the
corporation. The two-thirds test applies for distributions
occurring after one year after the date of enactment.
C. Qualified Veteran's Mortgage Bonds
(Sec. 303 of the House bill and sec. 143 of the Code)
Present Law
Private activity bonds are bonds that nominally are issued
by States or local governments, but the proceeds of which are
used (directly or indirectly) by a private person and payment
of which is derived from funds of such private person. The
exclusion from income for State and local bonds does not
apply to private activity bonds, unless the bonds are issued
for certain permitted purposes (``qualified private activity
bonds''). The definition of a qualified private activity bond
includes both qualified mortgage bonds and qualified
veterans' mortgage bonds.
Qualified veterans' mortgage bonds are private activity
bonds the proceeds of which are used to make mortgage loans
to certain veterans. Authority to issue qualified veterans'
mortgage bonds is limited to States that had issued such
bonds before June 22, 1984. Qualified veterans' mortgage
bonds are not subject to the State volume limitations
generally applicable to private activity bonds. Instead,
annual issuance in each State is subject to a State volume
limitation based on the volume of such bonds issued by the
State before June 22, 1984. The five States eligible to issue
these bonds are Alaska, California, Oregon, Texas, and
Wisconsin. Loans financed with qualified veterans' mortgage
bonds can be made only with respect to principal residences
and can not be made to acquire or replace existing mortgages.
Mortgage loans made with the proceeds of these bonds can be
made only to veterans who served on active duty before 1977
and who applied for the financing before the date 30 years
after the last date on which such veteran left active service
(the ``eligibility period'').
Qualified mortgage bonds are issued to make mortgage loans
to qualified mortgagors for owner-occupied residences. The
Code imposes several limitations on qualified mortgage bonds,
including income limitations for homebuyers and purchase
price limitations for the home financed with bond proceeds.
In addition, qualified mortgage bonds generally cannot be
used to finance a mortgage for a homebuyer who had an
ownership interest in a principal residence in the three
years preceding the execution of the mortgage (the ``first-
time homebuyer'' requirement).
House Bill
The House bill repeals the requirement that veterans
receiving loans financed with qualified veterans' mortgage
bonds must have served before 1977. It also reduces the
eligibility period to 25 years (rather than 30 years)
following release from the military service. The bill
provides new State volume limits for these bonds for the five
eligible States. In 2010, the new annual limit on the total
volume of veterans' bonds is $25 million for Alaska, $66.25
million for California, $25 million for Oregon, $53.75
million for Texas, and $25 million for Wisconsin. These
volume limits are phased-in over the four-year period
immediately preceding 2010 by allowing the applicable
percentage of the 2010 volume limits. The following table
provides those percentages.
Calendar Year: Applicable Percentage is:
2006.................................................................20
2007.................................................................40
2008.................................................................60
2009.................................................................80
The volume limits are zero for 2011 and each year
thereafter. Unused allocation cannot be carried forward to
subsequent years.
Effective date.--The provision generally applies to bonds
issued after December 31, 2005. The provision expanding the
definition of eligible veterans applies to financing provided
after date of enactment.
Senate Amendment
No provision.
Conference Agreement
The conference agreement includes the House bill with the
following modifications. The conference agreement does not
amend present law as it relates to qualified veterans'
mortgage bonds issued by the States of California and Texas.
In the case of qualified veterans' mortgage bonds issued by
the States of Alaska, Oregon, and Wisconsin, (1) the
requirement that veterans must have served before 1977 is
repealed and (2) the eligibility period for applying for a
loan following release from the military service is reduced
from 30 years to 25 years.
In addition, the annual issuance of qualified veterans'
mortgage bonds in the States of Alaska, Oregon and Wisconsin
is subject to new State volume limitations which are phased
in between the years 2006 and 2010. The State volume limit in
these States for any calendar year after 2010 is zero.
Effective date.--The provision expanding the definition of
eligible veterans applies to bonds issued on or after date of
enactment. The provision amending State volume limitations
applies to allocations of volume limitation made after April
5, 2006.
D. Capital Gains Treatment for Certain Self-Created Musical Works
(Sec. 304 of the House bill and sec. 1221 of the Code)
present law
Capital gains
The maximum tax rate on the net capital gain income of an
individual is 15 percent for taxable years beginning in 2006.
By contrast, the maximum tax rate on an individual's ordinary
income is 35 percent. The reduced 15-percent rate generally
is available for gain from the sale or exchange of a capital
asset for which the taxpayer has satisfied a holding-period
requirement. Capital assets generally include all property
held by a taxpayer with certain specified exclusions.
An exclusion from the definition of a capital asset applies
to inventory property or property held by a taxpayer
primarily for sale to customers in the ordinary course of the
taxpayer's trade or business. Another exclusion from capital
asset status applies to copyrights, literary, musical, or
artistic compositions, letters or memoranda, or similar
property held by a taxpayer whose personal efforts created
the property (or held by a taxpayer whose basis in the
property is determined by reference to the basis of the
taxpayer whose personal efforts created the property).
Consequently, when a taxpayer that owns copyrights in, for
example, books, songs, or paintings that the taxpayer created
(or when a taxpayer to which the copyrights have been
transferred by the works' creator in a substituted basis
transaction) sells the copyrights, gain from the sale is
treated as ordinary income, not capital gain.
Charitable contributions
A taxpayer generally is allowed a deduction for the fair
market value of property contributed to a charity. If a
taxpayer makes a contribution of property that would have
generated ordinary income (or short-term capital gain), the
taxpayer's charitable contribution deduction generally is
limited to the property's adjusted basis.
House Bill
The House bill provides that at the election of a taxpayer,
the sale or exchange before January 1, 2011 of musical
compositions or copyrights in musical works created by the
taxpayer's personal efforts (or having a basis determined by
reference to the basis in the hands of the taxpayer whose
personal efforts created the compositions or copyrights) is
treated as the sale or exchange of a capital asset. The House
bill provision does not change the present law limitation on
a taxpayer's charitable deduction for the contribution of
those compositions or copyrights.
Effective date.--The provision is effective for sales or
exchanges in taxable years beginning after the date of
enactment.
Senate Amendment
No provision.
Conference Agreement
The conference agreement includes the House bill provision.
E. Decrease Minimum Vessel Tonnage Limit to 6,000 Deadweight Tons
(Sec. 305 of the House bill and sec. 1355 of the Code)
Present Law
The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all
income, including income from shipping operations, whether
derived in the United States or abroad. In order to mitigate
double taxation, a foreign tax credit for income taxes paid
to foreign countries is provided to reduce or eliminate the
U.S. tax owed on such income, subject to certain limitations.
[[Page H2233]]
Generally, the United States taxes foreign corporations
only on income that has a sufficient nexus to the United
States. Thus, a foreign corporation is generally subject to
U.S. tax only on income, including income from shipping
operations, which is ``effectively connected'' with the
conduct of a trade or business in the United States (sec.
882). Such ``effectively connected income'' generally is
taxed in the same manner and at the same rates as the income
of a U.S. corporation.
The United States imposes a four percent tax on the amount
of a foreign corporation's U.S. source gross transportation
income (sec. 887). Transportation income includes income from
the use (or hiring or leasing for use) of a vessel and income
from services directly related to the use of a vessel. Fifty
percent of the transportation income attributable to
transportation that either begins or ends (but not both) in
the United States is treated as U.S. source gross
transportation income. The tax does not apply, however, to
U.S. source gross transportation income that is treated as
income effectively connected with the conduct of a U.S. trade
or business. U.S. source gross transportation income is not
treated as effectively connected income unless (1) the
taxpayer has a fixed place of business in the United States
involved in earning the income, and (2) substantially all the
income is attributable to regularly scheduled transportation.
The tax imposed by section 882 or 887 on income from
shipping operations may be limited by an applicable U.S.
income tax treaty or by an exemption of a foreign
corporation's international shipping operations income in
instances where a foreign country grants an equivalent
exemption (sec. 883).
Notwithstanding the general rules described above, the
American Jobs Creation Act of 2004 (``AJCA'') \51\ generally
allows corporations that are qualifying vessel operators \52\
to elect a ``tonnage tax'' in lieu of the corporate income
tax on taxable income from certain shipping activities.
Accordingly, an electing corporation's gross income does not
include its income from qualifying shipping activities (and
items of loss, deduction, or credit are disallowed with
respect to such excluded income), and electing corporations
are only subject to tax on these activities at the maximum
corporate income tax rate on their notional shipping income,
which is based on the net tonnage of the corporation's
qualifying vessels.\53\ No deductions are allowed against the
notional shipping income of an electing corporation, and no
credit is allowed against the notional tax imposed under the
tonnage tax regime. In addition, special deferral rules apply
to the gain on the sale of a qualifying vessel, if such
vessel is replaced during a limited replacement period.
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\51\ Pub. L. No. 108-357, sec. 248. The tonnage tax regime is
effective for taxable years beginning after the date of
enactment of AJCA (October 22, 2004).
\52\ Generally, a qualifying vessel operator is a corporation
that (1) operates one or more qualifying vessels and (2)
meets certain requirements with respect to its shipping
activities.
\53\ An electing corporation's notional shipping income for
the taxable year is the product of the following amounts for
each of the qualifying vessels it operates: (1) the daily
notional shipping income from the operation of the qualifying
vessel, and (2) the number of days during the taxable year
that the electing corporation operated such vessel as a
qualifying vessel in the United States foreign trade. The
daily notional shipping income from the operation of a
qualifying vessel is (1) 40 cents for each 100 tons of so
much of the net tonnage of the vessel as does not exceed
25,000 net tons, and (2) 20 cents for each 100 tons of so
much of the net tonnage of the vessel as exceeds 25,000 net
tons. ``United States foreign trade'' means the
transportation of goods or passengers between a place in the
United States and a foreign place or between foreign places.
The temporary use in the United States domestic trade (i.e.,
the transportation of goods or passengers between places in
the United States) of any qualifying vessel or the temporary
ceasing to use a qualifying vessel may be disregarded, under
special rules.
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Generally, a ``qualifying vessel'' is defined as a self-
propelled (or a combination of self-propelled and non-self-
propelled) U.S.-flag vessel of not less than 10,000
deadweight tons \54\ that is used exclusively in the U.S.
foreign trade.
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\54\ Deadweight measures the lifting capacity of a ship
expressed in long tons (2,240 lbs.), including cargo, crew,
and consumables such as fuel, lube oil, drinking water, and
stores. It is the difference between the number of tons of
water a vessel displaces without such items on board and the
number of tons it displaces when fully loaded.
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House Bill
The House bill expands the definition of ``qualifying
vessel'' to include self-propelled (or a combination of self-
propelled and non-self-propelled) U.S. flag vessels of not
less than 6,000 deadweight tons used exclusively in the
United States foreign trade. The modified definition applies
for taxable years beginning after December 31, 2005 and
ending before January 1, 2011.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005 and ending before January
1, 2011.
Senate Amendment
No provision.
Conference Agreement
The conference agreement includes the provision in the
House bill.
F. Modification of Special Arbitrage Rule for Certain Funds
(Sec. 306 of the House bill and sec. 307 of the Senate
amendment)
Present Law
In general, present-law tax-exempt bond arbitrage
restrictions provide that interest on a State or local
government bond is not eligible for tax-exemption if the
proceeds are invested, directly or indirectly, in materially
higher yielding investments or if the debt service on the
bond is secured by or paid from (directly or indirectly) such
investments. An exception to the arbitrage restrictions,
enacted in 1984, provides that the pledge of income from
investments in the Texas Permanent University Fund (the
``Fund'') as security for a limited amount of tax-exempt
bonds will not cause interest on those bonds to be taxable.
The terms of this exception are limited to State
constitutional or statutory restrictions continuously in
effect since October 9, 1969. In addition, the exception only
applies to an amount of tax-exempt bonds that does not exceed
20 percent of the value of the Fund.
The Fund consists of certain State lands that were set
aside for the benefit of higher education, the income from
mineral rights to these lands, and certain other earnings on
Fund assets. The Texas constitution directs that monies held
in the Fund are to be invested in interest-bearing
obligations and other securities. Income from the Fund is
apportioned between two university systems operated by the
State. Tax-exempt bonds issued by the university systems to
finance buildings and other permanent improvements were
secured by and payable from the income of the Fund.
Prior to 1999, the constitution did not permit the
expenditure or mortgage of the Fund for any purpose. In 1999,
the State constitutional rules governing the Fund were
modified with regard to the manner in which amounts in the
Fund are distributed for the benefit of the two university
systems. The State constitutional amendments allow for the
possibility that in the event investment earnings are less
than annual debt service on the bonds some of the debt
service could be considered as having been paid with the Fund
corpus. The 1984 exception refers only to bonds secured by
investment earnings on securities or obligations held by the
Fund. Despite the constitutional amendments, the IRS has
agreed to continue to apply the 1984 exception to the Fund
through August 31, 2007, if clarifying legislation is
introduced in the 109th Congress prior to August 31, 2005.
Clarifying legislation was introduced in the 109th Congress
on May 26, 2005.\55\
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\55\ H.R. 2661.
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House Bill
The provision codifies and extends the IRS agreement until
August 31, 2009. The 1984 exception is conformed to the State
constitutional amendments to permit its continued
applicability to bonds of the two university systems. The
limitation on the aggregate amount of bonds which may benefit
from the exception is not modified, and remains at 20 percent
of the value of the Fund. The provision sunsets August 31,
2009.
Effective date.--The provision is effective for bonds
issued after the date of enactment and before August 31,
2009.
Senate Amendment
The Senate amendment follows the House bill provision, and
also increases the amount of bonds that may benefit from the
exception to 30 percent of the value of the Fund.
Effective date.--The Senate amendment is the same as the
House bill.
Conference Agreement
The conference agreement includes the House bill provision.
G. Amortization of Expenses Incurred in Creating or Acquiring Music or
Music Copyrights
(Sec. 468 of the Senate amendment and secs. 167(g) and 263A
of the Code)
Present Law
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in
a trade or business or for the production of income. Section
167(g) provides that the cost of motion picture films, sound
recordings, copyrights, books, patents, and other property
specified in regulations is eligible to be recovered using
the income forecast method of depreciation.
Under the income forecast method, the depreciation
deduction with respect to eligible property for a taxable
year is determined by multiplying the adjusted basis of the
property by a fraction, the numerator of which is the income
generated by the property during the year, and the
denominator of which is the total forecasted or estimated
income expected to be generated prior to the close of the
tenth taxable year after the year the property was placed in
service. Any costs that are not recovered by the end of the
tenth taxable year after the property was placed in service
may be taken into account as depreciation in such year.
The adjusted basis of property that may be taken into
account under the income forecast method includes only
amounts that satisfy the economic performance standard of
section 461(h) (except in the case of certain participations
and residuals). In addition, taxpayers that claim
depreciation deductions under the income forecast method are
required to pay (or receive) interest based on a
recalculation of depreciation under a ``look-back'' method.
The ``look-back'' method is applied in any ``recomputation
year'' by (1) comparing depreciation deductions that had been
claimed in prior periods to depreciation deductions that
would have been claimed had the taxpayer used actual, rather
than estimated,
[[Page H2234]]
total income from the property; (2) determining the
hypothetical overpayment or underpayment of tax based on this
recalculated depreciation; and (3) applying the overpayment
rate of section 6621 of the Code. Except as provided in
Treasury regulations, a ``recomputation year'' is the third
and tenth taxable year after the taxable year the property
was placed in service, unless the actual income from the
property for each taxable year ending with or before the
close of such years was within 10 percent of the estimated
income from the property for such years.
A special rule is provided under Treasury guidance in the
case of certain authors and other taxpayers, with respect to
their capitalization of costs under section 263A and with
respect to the recovery or amortization of such costs.
Specifically, IRS Notice 88-62 (1988-1 C.B. 548) provides an
elective safe harbor under which eligible taxpayers
capitalize qualified created costs incurred during the
taxable year and amortize 50 percent of the costs in the
taxable year incurred, and 25 percent in each of the two
successive taxable years. Under the Notice, qualified
creative costs generally are those incurred by a self-
employed individual in the production of creative properties
(such as films, sound recordings, musical and dance
compositions including accompanying words, and other similar
properties), provided the personal efforts of the individual
predominantly create the properties. An eligible taxpayer is
an individual, and also a corporation or partnership,
substantially all of which is owned by one qualified
employee owner (an individual and family members).
House Bill
No provision.
Senate Amendment
The Senate amendment provides that if any expense is paid
or incurred by the taxpayer in creating or acquiring any
musical composition (including accompanying words) or any
copyright with respect to a musical composition that is
required to be capitalized, then the income forecast method
does not apply to such expenses, but rather, the expenses are
amortized over a five-year period. The five-year period is
the period beginning with the month in which the composition
or copyright was acquired (or if created, the five-taxable-
year period beginning with the taxable year in which the
expenses were paid or incurred).
The provision does not apply to certain expenses. The
expenses to which it does not apply are expenses: (1) that
are qualified creative expenses under section 263A(h); (2) to
which a simplified procedure established under section
263A(j)(2) applies; (3) that are an amortizable section 197
intangible; or (4) that, without regard to this provision,
would not be allowable as a deduction.
Effective date.--The provision is effective for expenses
paid or incurred after December 31, 2005, in taxable years
ending after that date.
Conference Agreement
The conference agreement includes the Senate amendment
provision with the following modifications. Under the
conference agreement, the five-year amortization period is
elective for the taxable year. Thus, a taxpayer that places
in service any musical composition or copyright with respect
to a musical composition in a taxable year may elect to apply
the provision with respect to all musical compositions and
musical composition copyrights placed in service in that
taxable year. An eligible taxpayer that does not make the
election may recover the costs under any method allowable
under present law, including the income forecast method.
Under the conference agreement, the election may be made
for any taxable year which begins before January 1, 2011.
In addition, the conference agreement provides that the
five-year amortization period begins in the month the
property is placed in service.
Effective date.--The conference agreement is effective for
expenses paid or incurred with respect to property placed in
service in taxable years beginning after December 31, 2005
and before January 1, 2011.
TITLE III--CHARITABLE PROVISIONS
A. Charitable Giving Incentives
1. Charitable deduction for nonitemizers; floor on
deductions for itemizers (Sec. 201 of the Senate amendment
and secs. 63 and 170 of the Code)
Present Law
In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property
contributed to a charity described in section 501(c)(3), to
certain veterans' organizations, fraternal societies, and
cemetery companies,\56\ or to a Federal, State, or local
governmental entity for exclusively public purposes.\57\ The
deduction also is allowed for purposes of calculating
alternative minimum taxable income.
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\56\ Secs. 170(c)(3)-(5).
\57\ Sec. 170(c)(1).
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The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the
type of charitable organization to which the property is
contributed, and the income of the taxpayer.\58\
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\58\ Secs. 170(b) and (e).
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A taxpayer who takes the standard deduction (i.e., who does
not itemize deductions) may not take a separate deduction for
charitable contributions.\59\
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\59\ Sec. 170(a). The Economic Recovery Tax Act of 1981
adopted a temporary provision that permitted individual
taxpayers who did not itemize income tax deductions to claim
a deduction from gross income for a specified percentage of
their charitable contributions. The maximum deduction was $25
for 1982 and 1983, $75 for 1984, 50 percent of the amount of
the contribution for 1985, and 100 percent of the amount of
the contribution for 1986. The nonitemizer deduction
terminated for contributions made after 1986.
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A payment to a charity (regardless of whether it is termed
a ``contribution'') in exchange for which the donor receives
an economic benefit is not deductible, except to the extent
that the donor can demonstrate that the payment exceeds the
fair market value of the benefit received from the charity.
To facilitate distinguishing charitable contributions from
purchases of goods or services from charities, present law
provides that 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.\60\ In addition, present law requires
that any charity that receives 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.\61\
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\60\ Sec. 170(f)(8).
\61\ Sec. 6115.
---------------------------------------------------------------------------
Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating
loss carryback). To the extent a taxpayer has not exceeded
the 50-percent limitation, (1) contributions of capital gain
property to public charities generally may be deducted up to
30 percent of the taxpayer's contribution base, (2)
contributions of cash to private foundations and certain
other charitable organizations generally may be deducted up
to 30 percent of the taxpayer's contribution base, and (3)
contributions of capital gain property to private foundations
and certain other charitable organizations generally may be
deducted up to 20 percent of the taxpayer's contribution
base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limit may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes
a reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2006 is
$150,500 ($77,250 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount,
but not by more than 80 percent of itemized deductions
subject to the limit. Beginning in 2006, the overall
limitation on itemized deductions phases out for all
taxpayers. The overall limitation on itemized deductions is
reduced by one-third in taxable years beginning in 2006 and
2007, and by two-thirds in taxable years beginning in 2008
and 2009. The overall limitation on itemized deductions is
eliminated for taxable years beginning after December 31,
2009; however, this elimination of the limitation sunsets on
December 31, 2010.
House Bill
No provision.
Senate Amendment
Deduction for nonitemizers
In the case of an individual taxpayer who does not itemize
deductions, the provision allows a ``direct charitable
deduction'' from adjusted gross income for charitable
contributions paid in cash during the taxable year. This
deduction is allowed in addition to the standard
deduction. The direct charitable deduction is the amount
of the deduction allowable under section 170(a) for the
taxable year for cash contributions (determined without
regard to any carryover). The amount deductible under the
provision is subject to the rules normally governing
charitable contribution deductions, such as the
substantiation requirements. In addition, the amount of
the deduction is available only to the extent that the
otherwise allowable direct charitable deduction exceeds
the floor on charitable contributions, described below
(i.e., $210 ($420 in the case of a joint return)). The
deduction is allowed in computing alternative minimum
taxable income.
The provision does not change the present-law rules
regarding the carryover of charitable contributions to or
from a taxable year, including a taxable year in which the
taxpayer is allowed the direct contribution deduction.
Floor on itemized deductions
Under the provision, the amount of an individual's
charitable contribution deduction
[[Page H2235]]
(cash and noncash) is subject to a floor. The floor is $210
($420 in the case of a joint return). In the case of an
individual who elects to itemize deductions, the floor
applies to the deduction otherwise allowed under section 170
for all contributions. In the case of an individual who does
not elect to itemize deductions, the floor applies in
determining the amount of the direct charitable deduction.
The provision does not otherwise change the present-law rules
pertaining to charitable contributions.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005, and before January 1, 2008.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Tax-free distributions from individual retirement plans
for charitable purposes (Sec. 202 of the Senate amendment
and secs. 408, 6034, 6104, and 6652 of the Code)
Present Law
In general
If an amount withdrawn from a traditional individual
retirement arrangement (``IRA'') or a Roth IRA is donated to
a charitable organization, the rules relating to the tax
treatment of withdrawals from IRAs apply to the amount
withdrawn and the charitable contribution is subject to the
normally applicable limitations on deductibility of such
contributions.
Charitable contributions
In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property
contributed to a charity described in section 501(c)(3), to
certain veterans' organizations, fraternal societies, and
cemetery companies,\62\ or to a Federal, State, or local
governmental entity for exclusively public purposes.\63\ The
deduction also is allowed for purposes of calculating
alternative minimum taxable income.
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\62\ Secs. 170(c)(3)-(5).
\63\ Sec. 170(c)(1).
---------------------------------------------------------------------------
The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the
type of charitable organization to which the property is
contributed, and the income of the taxpayer.\64\
---------------------------------------------------------------------------
\64\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
A taxpayer who takes the standard deduction (i.e., who does
not itemize deductions) may not take a separate deduction for
charitable contributions.\65\
---------------------------------------------------------------------------
\65\ Sec. 170(a).
---------------------------------------------------------------------------
A payment to a charity (regardless of whether it is termed
a ``contribution'') in exchange for which the donor receives
an economic benefit is not deductible, except to the extent
that the donor can demonstrate, among other things, that the
payment exceeds the fair market value of the benefit received
from the charity. To facilitate distinguishing charitable
contributions from purchases of goods or services from
charities, present law provides that 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.\66\ In
addition, present law requires that any charity that receives
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
may be deductible as a charitable contribution.\67\
---------------------------------------------------------------------------
\66\ Sec. 170(f)(8).
\67\ Sec. 6115.
---------------------------------------------------------------------------
Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating
loss carryback). To the extent a taxpayer has not exceeded
the 50-percent limitation, (1) contributions of capital gain
property to public charities generally may be deducted up to
30 percent of the taxpayer's contribution base, (2)
contributions of cash to private foundations and certain
other charitable organizations generally may be deducted up
to 30 percent of the taxpayer's contribution base, and
(3) contributions of capital gain property to private
foundations and certain other charitable organizations
generally may be deducted up to 20 percent of the
taxpayer's contribution base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limits may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes
a reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2006 is
$150,500 ($75,250 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount,
but not by more than 80 percent of itemized deductions
subject to the limit. Beginning in 2006, the overall
limitation on itemized deductions phases-out for all
taxpayers. The overall limitation on itemized deductions is
reduced by one-third in taxable years beginning in 2006 and
2007, and by two-thirds in taxable years beginning in 2008
and 2009. The overall limitation on itemized deductions is
eliminated for taxable years beginning after December 31,
2009; however, this elimination of the limitation sunsets on
December 31, 2010.
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 (e.g., a remainder)
while also either retaining an interest in that property
(e.g., an income interest) or transferring an interest in
that property to a noncharity for less than full and adequate
consideration.\68\ Exceptions to this general rule are
provided for, among other interests, remainder interests in
charitable remainder annuity trusts, charitable remainder
unitrusts, and pooled income funds, and present interests in
the form of a guaranteed annuity or a fixed percentage of the
annual value of the property.\69\ For such interests, a
charitable deduction is allowed to the extent of the present
value of the interest designated for a charitable
organization.
---------------------------------------------------------------------------
\68\ Secs. 170(f), 2055(e)(2), and 2522(c)(2).
\69\ Sec. 170(f)(2).
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IRA rules
Within limits, individuals may make deductible and
nondeductible contributions to a traditional IRA. Amounts in
a traditional IRA are includible in income when withdrawn
(except to the extent the withdrawal represents a return of
nondeductible contributions). Individuals also may make
nondeductible contributions to a Roth IRA. Qualified
withdrawals from a Roth IRA are excludable from gross income.
Withdrawals from a Roth IRA that are not qualified
withdrawals are includible in gross income to the extent
attributable to earnings. Includible amounts withdrawn from a
traditional IRA or a Roth IRA before attainment of age 59\1/
2\ are subject to an additional 10-percent early withdrawal
tax, unless an exception applies. Under present law, minimum
distributions are required to be made from tax-favored
retirement arrangements, including IRAs. Minimum required
distributions from a traditional IRA must generally begin by
the April 1 of the calendar year following the year in which
the IRA owner attains age 70\1/2\.\70\
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\70\ Minimum distribution rules also apply in the case of
distributions after the death of a traditional or Roth IRA
owner.
---------------------------------------------------------------------------
If an individual has made nondeductible contributions to a
traditional IRA, a portion of each distribution from an IRA
is nontaxable until the total amount of nondeductible
contributions has been received. In general, the amount of a
distribution that is nontaxable is determined by multiplying
the amount of the distribution by the ratio of the remaining
nondeductible contributions to the account balance. In making
the calculation, all traditional IRAs of an individual are
treated as a single IRA, all distributions during any taxable
year are treated as a single distribution, and the value of
the contract, income on the contract, and investment in the
contract are computed as of the close of the calendar year.
In the case of a distribution from a Roth IRA that is not a
qualified distribution, in determining the portion of the
distribution attributable to earnings, contributions and
distributions are deemed to be distributed in the following
order: (1) regular Roth IRA contributions; (2) taxable
conversion contributions;\71\ (3) nontaxable conversion
contributions; and (4) earnings. In determining the amount of
taxable distributions from a Roth IRA, all Roth IRA
distributions in the same taxable year are treated as a
single distribution, all regular Roth IRA contributions for a
year are treated as a single contribution, and all conversion
contributions during the year are treated as a single
contribution.
---------------------------------------------------------------------------
\71\ Conversion contributions refer to conversions of amounts
in a traditional IRA to a Roth IRA.
---------------------------------------------------------------------------
Distributions from an IRA (other than a Roth IRA) are
generally subject to withholding unless the individual elects
not to have withholding apply.\72\ Elections not to have
withholding apply are to be made in the time and manner
prescribed by the Secretary.
---------------------------------------------------------------------------
\72\ Sec. 3405.
---------------------------------------------------------------------------
Split-interest trust filing requirements
Split-interest trusts, including charitable remainder
annuity trusts, charitable remainder unitrusts, and pooled
income funds, are required to file an annual information
return (Form 1041A).\73\ Trusts that are not split-interest
trusts but that claim a charitable deduction for amounts
permanently set aside for a charitable purpose\74\ also are
required to file Form 1041A. The returns are required to be
made publicly available.\75\ A trust that is required to
distribute all trust net income currently to trust
beneficiaries in a taxable
[[Page H2236]]
year is exempt from this return requirement for such taxable
year. A failure to file the required return may result in a
penalty on the trust of $10 a day for as long as the failure
continues, up to a maximum of $5,000 per return.
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\73\ Sec. 6034. This requirement applies to all split-
interest trusts described in section 4947(a)(2).
\74\ Sec. 642(c).
\75\ Sec. 6104(b).
---------------------------------------------------------------------------
In addition, split-interest trusts are required to file
annually Form 5227.\76\ Form 5227 requires disclosure of
information regarding a trust's noncharitable beneficiaries.
The penalty for failure to file this return is calculated
based on the amount of tax owed. A split-interest trust
generally is not subject to tax and therefore, in general, a
penalty may not be imposed for the failure to file Form 5227.
Form 5227 is not required to be made publicly available.
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\76\ Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
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House Bill
No provision.
Senate Amendment
Qualified charitable distributions from IRAs
The provision provides an exclusion from gross income for
otherwise taxable IRA distributions from a traditional or a
Roth IRA in the case of qualified charitable
distributions.\77\ Special rules apply in determining the
amount of an IRA distribution that is otherwise taxable. The
present-law rules regarding taxation of IRA distributions and
the deduction of charitable contributions continue to apply
to distributions from an IRA that are not qualified
charitable distributions. Qualified charitable distributions
are taken into account for purposes of the minimum
distribution rules applicable to traditional IRAs to the same
extent the distribution would have been taken into account
under such rules had the distribution not been directly
distributed under the provision. An IRA does not fail to
qualify as an IRA merely because qualified charitable
distributions have been made from the IRA. It is intended
that the Secretary will prescribe rules under which IRA
owners are deemed to elect out of withholding if they
designate that a distribution is intended to be a qualified
charitable distribution.
---------------------------------------------------------------------------
\77\ The provision does not apply to distributions from
employer-sponsored retirements plans, including SIMPLE IRAs
and simplified employee pensions (``SEPs'').
---------------------------------------------------------------------------
A qualified charitable distribution is any distribution
from an IRA that is made after December 31, 2005, and before
January 1, 2008, directly by the IRA trustee either to (1) an
organization to which deductible contributions can be made (a
``direct distribution'') or (2) a ``split-interest entity.''
A split-interest entity means a charitable remainder annuity
trust or charitable remainder unitrust (together referred to
as a ``charitable remainder trust''), a pooled income fund,
or a charitable gift annuity. Direct distributions are
eligible for the exclusion only if made on or after the date
the IRA owner attains age 70\1/2\. Distributions to a split
interest entity are eligible for the exclusion only if made
on or after the date the IRA owner attains age 59\1/2\. In
the case of distributions to split-interest distributions, no
person may hold an income interest in the amounts in the
split-interest entity attributable to the charitable
distribution other than the IRA owner, the IRA owner's
spouse, or a charitable organization.
The exclusion applies to direct distributions only if a
charitable contribution deduction for the entire distribution
otherwise would be allowable (under present law), determined
without regard to the generally applicable percentage
limitations. Thus, for example, if the deductible amount is
reduced because of a benefit received in exchange, or if a
deduction is not allowable because the donor did not obtain
sufficient substantiation, the exclusion is not available
with respect to any part of the IRA distribution. Similarly,
the exclusion applies in the case of a distribution directly
to a split-interest entity only if a charitable contribution
deduction for the entire present value of the charitable
interest (for example, a remainder interest) otherwise would
be allowable, determined without regard to the generally
applicable percentage limitations.
If the IRA owner has any IRA that includes nondeductible
contributions, a special rule applies in determining the
portion of a distribution that is includible in gross income
(but for the provision) and thus is eligible for qualified
charitable distribution treatment. Under the special rule,
the distribution is treated as consisting of income first, up
to the aggregate amount that would be includible in gross
income (but for the provision) if the aggregate balance of
all IRAs having the same owner were distributed during the
same year. In determining the amount of subsequent IRA
distributions includible in income, proper adjustments are to
be made to reflect the amount treated as a qualified
charitable distribution under the special rule.
Special rules apply for distributions to split-interest
entities. For distributions to charitable remainder trusts,
the provision provides that subsequent distributions from the
charitable remainder trust are treated as ordinary income in
the hands of the beneficiary, notwithstanding how such
amounts normally are treated under section 664(b). In
addition, for a charitable remainder trust to be eligible to
receive qualified charitable distributions, the charitable
remainder trust has to be funded exclusively by such
distributions. For example, an IRA owner may not make
qualified charitable distributions to an existing charitable
remainder trust any part of which was funded with assets that
were not qualified charitable distributions.
Under the provision, a pooled income fund is eligible to
receive qualified charitable distributions only if the fund
accounts separately for amounts attributable to such
distributions. In addition, all distributions from the pooled
income fund that are attributable to qualified charitable
distributions are treated as ordinary income to the
beneficiary. Qualified charitable distributions to a pooled
income fund are not includible in the fund's gross income.
In determining the amount includible in gross income by
reason of a payment from a charitable gift annuity purchased
with a qualified charitable distribution from an IRA, the
portion of the distribution from the IRA used to purchase the
annuity is not an investment in the annuity contract.
Any amount excluded from gross income by reason of the
provision is not taken into account in determining the
deduction for charitable contributions under section 170.
Qualified charitable distribution examples
The following examples illustrate the determination of the
portion of an IRA distribution that is a qualified charitable
distribution and the application of the special rules for a
qualified charitable distribution to a split-interest entity.
In each example, it is assumed that the requirements for
qualified charitable distribution treatment are otherwise met
(e.g., the applicable age requirement and the requirement
that contributions are otherwise deductible) and that no
other IRA distributions occur during the year.
Example 1.--Individual A has a traditional IRA with a
balance of $100,000, consisting solely of deductible
contributions and earnings. Individual A has no other IRA.
The entire IRA balance is distributed in a direct
distribution to a charitable organization. Under present law,
the entire distribution of $100,000 would be includible in
Individual A's income. Accordingly, under the provision, the
entire distribution of $100,000 is a qualified charitable
distribution. As a result, no amount is included in
Individual A's income as a result of the distribution and the
distribution is not taken into account in determining the
amount of Individual A's charitable deduction for the year.
Example 2.--The facts are the same as in Example 1, except
that the entire IRA balance of $100,000 is distributed to a
charitable remainder unitrust, which contains no other assets
and which must be funded exclusively by qualified charitable
distributions. Under the terms of the trust, Individual A is
entitled to receive five percent of the net fair market value
of the trust assets each year. As explained in Example 1, the
entire $100,000 distribution is a qualified charitable
distribution, no amount is included in Individual A's income
as a result of the distribution, and the distribution is not
taken into account in determining the amount of Individual
A's charitable deduction for the year. In addition, under a
special rule in the provision for charitable remainder
trusts, any distribution from the charitable remainder
unitrust to Individual A is includible in gross income as
ordinary income, regardless of the character of the
distribution under the usual rules for the taxation of
distributions from such a trust.
Example 3.--Individual B has a traditional IRA with a
balance of $100,000, consisting of $20,000 of nondeductible
contributions and $80,000 of deductible contributions and
earnings. Individual B has no other IRA. In a direct
distribution to a charitable organization, $80,000 is
distributed from the IRA. Under present law, a portion of the
distribution from the IRA would be treated as a nontaxable
return of nondeductible contributions. The nontaxable portion
of the distribution would be $16,000, determined by
multiplying the amount of the distribution ($80,000) by the
ratio of the nondeductible contributions to the account
balance ($20,000/$100,000). Accordingly, under present law,
$64,000 of the distribution ($80,000 minus $16,000) would be
includible in Individual B's income.
Under the provision, notwithstanding the present-law tax
treatment of IRA distributions, the distribution is treated
as consisting of income first, up to the total amount that
would be includible in gross income (but for the provision)
if all amounts were distributed from all IRAs otherwise taken
into account in determining the amount of IRA distributions.
The total amount that would be includible in income if all
amounts were distributed from the IRA is $80,000.
Accordingly, under the provision, the entire $80,000
distributed to the charitable organization is treated as
includible in income (before application of the provision)
and is a qualified charitable distribution. As a result, no
amount is included in Individual B's income as a result of
the distribution and the distribution is not taken into
account in determining the amount of Individual B's
charitable deduction for the year. In addition, for purposes
of determining the tax treatment of other distributions from
the IRA, $20,000 of the amount remaining in the IRA is
treated as Individual B's nondeductible contributions (i.e.,
not subject to tax upon distribution).
Split-interest trust filing requirements
The provision increases the penalty on split-interest
trusts for failure to file a return and for failure to
include any of the information required to be shown on such
return and to show the correct information.
[[Page H2237]]
The penalty is $20 for each day the failure continues up to
$10,000 for any one return. In the case of a split-interest
trust with gross income in excess of $250,000, the penalty is
$100 for each day the failure continues up to a maximum of
$50,000. In addition, if a person (meaning any officer,
director, trustee, employee, or other individual who is under
a duty to file the return or include required information)
\78\ knowingly failed to file the return or include required
information, then that person is personally liable for such a
penalty, which would be imposed in addition to the penalty
that is paid by the organization. Information regarding
beneficiaries that are not charitable organizations as
described in section 170(c) is exempt from the requirement to
make information publicly available. In addition, the
provision repeals the present-law exception to the filing
requirement for split-interest trusts that are required in a
taxable year to distribute all net income currently to
beneficiaries. Such exception remains available to trusts
other than split-interest trusts that are otherwise subject
to the filing requirement.
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\78\ Sec. 6652(c)(4)(C).
---------------------------------------------------------------------------
Effective date
The provision relating to qualified charitable
distributions is effective for distributions made in taxable
years beginning after December 31, 2005, and before January
1, 2008. The provision relating to information returns of
split-interest trusts is effective for returns for taxable
years beginning after December 31, 2005.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
3. Charitable deduction for contributions of food inventory
(sec. 203 of the Senate amendment and sec. 170 of the
Code)
Present Law
Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory, or if
less the fair market value of the inventory.
For certain contributions of inventory, C corporations may
claim an enhanced deduction equal to the lesser of (1) basis
plus one-half of the item's appreciation (i.e., basis plus
one half of fair market value in excess of basis) or (2) two
times basis (sec. 170(e)(3)). In general, a C corporation's
charitable contribution deductions for a year may not exceed
10 percent of the corporation's taxable income (sec.
170(b)(2)). To be eligible for the enhanced deduction, the
contributed property generally must be inventory of the
taxpayer, contributed to a charitable organization described
in section 501(c)(3) (except for private nonoperating
foundations), and the donee must (1) use the property
consistent with the donee's exempt purpose solely for the
care of the ill, the needy, or infants, (2) not transfer the
property in exchange for money, other property, or services,
and (3) provide the taxpayer a written statement that the
donee's use of the property will be consistent with such
requirements. In the case of contributed property subject to
the Federal Food, Drug, and Cosmetic Act, the property must
satisfy the applicable requirements of such Act on the date
of transfer and for 180 days prior to the transfer.
A donor making a charitable contribution of inventory must
make a corresponding adjustment to the cost of goods sold by
decreasing the cost of goods sold by the lesser of the fair
market value of the property or the donor's basis with
respect to the inventory (Treas. Reg. sec. 1.170A-4A(c)(3)).
Accordingly, if the allowable charitable deduction for
inventory is the fair market value of the inventory, the
donor reduces its cost of goods sold by such value, with the
result that the difference between the fair market value and
the donor's basis may still be recovered by the donor other
than as a charitable contribution.
To use the enhanced deduction, the taxpayer must establish
that the fair market value of the donated item exceeds basis.
The valuation of food inventory has been the subject of
disputes between taxpayers and the IRS.\79\
---------------------------------------------------------------------------
\79\ Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995)
(holding that the value of surplus bread inventory donated to
charity was the full retail price of the bread rather than
half the retail price, as the IRS asserted).
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Under the Katrina Emergency Tax Relief Act of 2005, any
taxpayer, whether or not a C corporation, engaged in a trade
or business is eligible to claim the enhanced deduction for
certain donations made after August 28, 2005, and before
January 1, 2006, of food inventory. For taxpayers other than
C corporations, the total deduction for donations of food
inventory in a taxable year generally may not exceed 10
percent of the taxpayer's net income for such taxable year
from all sole proprietorships, S corporations, or
partnerships (or other entity that is not a C corporation)
from which contributions of ``apparently wholesome food'' are
made. ``Apparently wholesome food'' is defined as food
intended for human consumption that meets all quality and
labeling standards imposed by Federal, State, and local laws
and regulations even though the food may not be readily
marketable due to appearance, age, freshness, grade, size,
surplus, or other conditions.
House Bill
No provision.
Senate Amendment
Extension of Katrina Emergency Tax Relief Act of 2005
The provision extends the provision enacted as part of the
Katrina Emergency Tax Relief Act of 2005. As under such Act,
under the provision, any taxpayer, whether or not a C
corporation, engaged in a trade or business is eligible to
claim the enhanced deduction for donations of food inventory.
For taxpayers other than C corporations, the total deduction
for donations of food inventory in a taxable year generally
may not exceed 10 percent of the taxpayer's net income for
such taxable year from all sole proprietorships, S
corporations, or partnerships (or other non C corporation)
from which contributions of apparently wholesome food are
made. For example, as under the Katrina Emergency Tax Relief
Act of 2005, if a taxpayer is a sole proprietor, a
shareholder in an S corporation, and a partner in a
partnership, and each business makes charitable contributions
of food inventory, the taxpayer's deduction for donations of
food inventory is limited to 10 percent of the taxpayer's net
income from the sole proprietorship and the taxpayer's
interests in the S corporation and partnership. However, if
only the sole proprietorship and the S corporation made
charitable contributions of food inventory, the taxpayer's
deduction would be limited to 10 percent of the net income
from the trade or business of the sole proprietorship and the
taxpayer's interest in the S corporation, but not the
taxpayer's interest in the partnership.\80\
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\80\ The 10 percent limitation does not affect the
application of the generally applicable percentage
limitations. For example, if 10 percent of a sole
proprietor's net income from the proprietor's trade or
business was greater than 50 percent of the proprietor's
contribution base, the available deduction for the taxable
year (with respect to contributions to public charities)
would be 50 percent of the proprietor's contribution base.
Consistent with present law, such contributions may be
carried forward because they exceed the 50 percent
limitation. Contributions of food inventory by a taxpayer
that is not a C corporation that exceed the 10 percent
limitation but not the 50 percent limitation could not be
carried forward.
---------------------------------------------------------------------------
Under the provision, the enhanced deduction for food is
available only for food that qualifies as ``apparently
wholesome food.'' ``Apparently wholesome food'' is defined as
it is defined under the Katrina Emergency Tax Relief Act of
2005.
Modifications to enhanced deduction for food inventory
Under the provision, for purposes of calculating the
enhanced deduction, taxpayers that do not account for
inventories under section 471 and that are not required to
capitalize indirect costs under section 263A are able to
elect to treat the basis of the contributed food as being
equal to 25 percent of the food's fair market value.\81\
---------------------------------------------------------------------------
\81\ This includes, for example, taxpayers who are eligible
for administrative relief under Revenue Procedures 2002-28
and 2001-10.
---------------------------------------------------------------------------
The provision changes the amount of the enhanced deduction
for eligible contributions of food inventory to the lesser of
fair market value or twice the taxpayer's basis in the
inventory. For example, a taxpayer who makes an eligible
donation of food that has a fair market value of $10 and a
basis of $4 could take a deduction of $8 (twice basis). If
the taxpayer's basis is $6 instead of $4, then the deduction
would be $10 (fair market value). By contrast, under present
law, a C corporation's deduction in the first example would
be $7 (fair market value less half the appreciation) and in
the second example would be $8. (Except for contributions
made after August 28, 2005, and before January 1, 2006,
taxpayers other than C corporations generally could take a
deduction for a contribution of food inventory only for the
$4 basis in either example.)
The provision provides that the fair market value of
donated apparently wholesome food that cannot or will not be
sold solely due to internal standards of the taxpayer or lack
of market is determined without regard to such internal
standards or lack of market and by taking into account the
price at which the same or substantially the same food items
(as to both type and quality) are sold by the taxpayer at the
time of the contribution or, if not so sold at such time, in
the recent past.
Effective date
The provision is effective for contributions made in
taxable years beginning after December 31, 2005, and before
January 1, 2008.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
4. Basis adjustment to stock of S corporation contributing
property (Sec. 204 of the Senate amendment and sec. 1367
of the Code)
Present Law
Under present law, if an S corporation contributes money or
other property to a charity, each shareholder takes into
account the shareholder's pro rata share of the contribution
in determining its own income tax liability.\82\ A
shareholder of an S corporation reduces the basis in the
stock of the S corporation by the amount of the charitable
contribution that flows through to the shareholder.\83\
---------------------------------------------------------------------------
\82\ Sec. 1366(a)(1)(A).
\83\ Sec. 1367(a)(2)(B).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision provides that the amount of a shareholder's
basis reduction in the stock
[[Page H2238]]
of an S corporation by reason of a charitable contribution
made by the corporation will be equal to the shareholder's
pro rata share of the adjusted basis of the contributed
property.\84\
---------------------------------------------------------------------------
\84\ See Rev. Rul. 96-11 (1996-1 C.B. 140) for a rule
reaching a similar result in the case of charitable
contributions made by a partnership.
---------------------------------------------------------------------------
Thus, for example, assume an S corporation with one
individual shareholder makes a charitable contribution of
stock with a basis of $200 and a fair market value of $500.
The shareholder will be treated as having made a $500
charitable contribution (or a lesser amount if the special
rules of section 170(e) apply), and will reduce the basis of
the S corporation stock by $200.\85\
---------------------------------------------------------------------------
\85\ This example assumes that basis of the S corporation
stock (before reduction) is at least $200.
---------------------------------------------------------------------------
Effective date.--The provision applies to contributions
made in taxable years beginning after December 31, 2005, and
before January 1, 2008.
conference agreement
The conference agreement does not include the Senate
amendment provision.
5. Charitable deduction for contributions of book inventory
(Sec. 205 of the Senate amendment and sec. 170 of the
Code)
present law
Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory, or if
less the fair market value of the inventory.
For certain contributions of inventory, C corporations may
claim an enhanced deduction equal to the lesser of (1) basis
plus one-half of the item's appreciation (i.e., basis plus
one half of fair market value in excess of basis) or (2) two
times basis (sec. 170(e)(3)). In general, a C corporation's
charitable contribution deductions for a year may not exceed
10 percent of the corporation's taxable income (sec.
170(b)(2)). To be eligible for the enhanced deduction, the
contributed property generally must be inventory of the
taxpayer, contributed to a charitable organization described
in section 501(c)(3) (except for private nonoperating
foundations), and the donee must (1) use the property
consistent with the donee's exempt purpose solely for the
care of the ill, the needy, or infants, (2) not transfer the
property in exchange for money, other property, or services,
and (3) provide the taxpayer a written statement that the
donee's use of the property will be consistent with such
requirements. In the case of contributed property subject to
the Federal Food, Drug, and Cosmetic Act, the property must
satisfy the applicable requirements of such Act on the date
of transfer and for 180 days prior to the transfer.
A donor making a charitable contribution of inventory must
make a corresponding adjustment to the cost of goods sold by
decreasing the cost of goods sold by the lesser of the fair
market value of the property or the donor's basis with
respect to the inventory (Treas. Reg. sec. 1.170A-4A(c)(3)).
Accordingly, if the allowable charitable deduction for
inventory is the fair market value of the inventory, the
donor reduces its cost of goods sold by such value, with the
result that the difference between the fair market value and
the donor's basis may still be recovered by the donor other
than as a charitable contribution.
To use the enhanced deduction, the taxpayer must establish
that the fair market value of the donated item exceeds basis.
The Katrina Emergency Tax Relief Act of 2005 extended the
present-law enhanced deduction for C corporations to certain
qualified book contributions made after August 28, 2005, and
before January 1, 2006. For such purposes, a qualified book
contribution means a charitable contribution of books to a
public school that provides elementary education or secondary
education (kindergarten through grade 12) and that is an
educational organization that normally maintains a regular
faculty and curriculum and normally has a regularly enrolled
body of pupils or students in attendance at the place where
its educational activities are regularly carried on. The
enhanced deduction under the Katrina Emergency Tax Relief Act
of 2005 is not allowed unless the donee organization
certifies in writing that the contributed books are suitable,
in terms of currency, content, and quantity, for use in the
donee's educational programs and that the donee will use the
books in such educational programs.
house bill
No provision.
senate amendment
The provision modifies the present-law enhanced deduction
for C corporations so that it is equal to the lesser of fair
market value or twice the taxpayer's basis in the case of
qualified book contributions. The provision provides that the
fair market value for this purpose is determined by reference
to a bona fide published market price for the book. Under the
provision, a bona fide published market price of a book is a
price of a book, determined using the same printing and same
edition, published within seven years preceding the
contribution, determined as a result of an arm's length
transaction, and for which the book was customarily sold. For
example, a publisher's listed retail price for a book would
not meet the standard if the publisher could not demonstrate
to the satisfaction of the Secretary that the price was one
at which the book was customarily sold and was the result of
an arm's length transaction. If a publisher entered into a
contract with a local school district to sell newly published
textbooks six years prior to making a qualified book
contribution of such textbooks, the publisher could use as a
bona fide published market price, the price at which such
books regularly were sold to the school district under the
contract. By contrast, if a publisher listed in a catalogue
or elsewhere a ``suggested retail price,'' but books were not
in fact customarily sold at such price, the publisher could
not use the ``suggested retail price'' to determine the fair
market value of the book for purposes of the enhanced
deduction. Thus, in general, a bona fide published market
price must be independently verifiable by reference to actual
sales within the seven-year period preceding the
contribution, and not to a publisher's own price list.
As an illustration of the mechanics of calculating the
enhanced deduction under the provision, a C corporation that
made a qualified book contribution with a bona fide published
market price of $10 and a basis of $4 could take a deduction
of $8 (twice basis). If the taxpayer's basis is $6 instead of
$4, then the deduction is $10. Also, in such latter case, if
the book's bona fide published market price was $5 at the
time of the contribution but was $10 five years before the
contribution, then the deduction is $10.
A qualified book contribution means a charitable
contribution of books to: (1) an educational organization
that normally maintains a regular faculty and curriculum and
normally has a regularly enrolled body of pupils or students
in attendance at the place where its educational activities
are regularly carried on; (2) a public library; or (3) an
organization described in section 501(c)(3) (except for
private nonoperating foundations), that is organized
primarily to make books available to the general public at no
cost or to operate a literacy program. The donee must: (1)
use the property consistent with the donee's exempt purpose;
(2) not transfer the property in exchange for money, other
property, or services; and (3) provide the taxpayer a written
statement that the donee's use of the property will be
consistent with such requirements and also that the books are
suitable, in terms of currency, content, and quantity, for
use in the donee's educational programs and that the donee
will use the books in such educational programs.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005, and before January 1, 2008.
conference agreement
The conference agreement does not include the Senate
amendment provision.
6. Modify tax treatment of certain payments to controlling
exempt organizations and public disclosure of information
relating to UBIT (Sec. 206 of the Senate amendment and
secs. 512, 6011, 6104, and new sec. 6720C of the Code)
present law
Payments to controlling exempt organizations
In general, interest, rents, royalties, and annuities are
excluded from the unrelated business income of tax-exempt
organizations. However, section 512(b)(13) generally treats
otherwise excluded rent, royalty, annuity, and interest
income as unrelated business income if such income is
received from a taxable or tax-exempt subsidiary that is 50
percent controlled by the parent tax-exempt organization. In
the case of a stock subsidiary, ``control'' means ownership
by vote or value of more than 50 percent of the stock. In the
case of a partnership or other entity, control means
ownership of more than 50 percent of the profits, capital or
beneficial interests. In addition, present law applies the
constructive ownership rules of section 318 for purposes of
section 512(b)(13). Thus, a parent exempt organization is
deemed to control any subsidiary in which it holds more than
50 percent of the voting power or value, directly (as in the
case of a first-tier subsidiary) or indirectly (as in the
case of a second-tier subsidiary).
Under present law, interest, rent, annuity, or royalty
payments made by a controlled entity to a tax-exempt
organization are includable in the latter organization's
unrelated business income and are subject to the unrelated
business income tax to the extent the payment reduces the net
unrelated income (or increases any net unrelated loss) of the
controlled entity (determined as if the entity were tax
exempt).
The Taxpayer Relief Act of 1997 (the ``1997 Act'') made
several modifications to the control requirement of section
512(b)(13). In order to provide transitional relief, the
changes made by the 1997 Act do not apply to any payment
received or accrued during the first two taxable years
beginning on or after the date of enactment of the 1997
Act (August 5, 1997) if such payment is received or
accrued pursuant to a binding written contract in effect
on June 8, 1997, and at all times thereafter before such
payment (but not pursuant to any contract provision that
permits optional accelerated payments).
Public disclosure of returns
In general, an organization described in section 501(c) or
(d) is required to make available for public inspection a
copy of its annual information return (Form 990) and
exemption application materials.\86\ A penalty may be imposed
on any person who does not
[[Page H2239]]
make an organization's annual returns or exemption
application materials available for public inspection. The
penalty amount is $20 for each day during which a failure
occurs. If more than one person fails to comply, each person
is jointly and severally liable for the full amount of the
penalty. The maximum penalty that may be imposed on all
persons for any one annual return is $10,000. There is no
maximum penalty amount for failing to make exemption
application materials available for public inspection. Any
person who willfully fails to comply with the public
inspection requirements is subject to an additional penalty
of $5,000.\87\
---------------------------------------------------------------------------
\86\ Sec. 6104(d).
\87\ Sec. 6685.
---------------------------------------------------------------------------
These requirements do not apply to an organization's annual
return for unrelated business income tax (generally Form 990-
T).\88\
---------------------------------------------------------------------------
\88\ Treas. Reg. sec. 301.6104(d)-1(b)(4)(ii).
---------------------------------------------------------------------------
house bill
No provision.
senate amendment
Payments to controlling exempt organizations
The provision provides that the general rule of section
512(b)(13), which includes interest, rent, annuity, or
royalty payments made by a controlled entity to a tax-exempt
organization in the latter organization's unrelated business
income to the extent the payment reduces the net unrelated
income (or increases any net unrelated loss) of the
controlled entity, applies only to the portion of payments
received or accrued in a taxable year that exceed the amount
of the specified payment that would have been paid or accrued
if such payment had been determined under the principles of
section 482. Thus, if a payment of rent by a controlled
subsidiary to its tax-exempt parent organization exceeds fair
market value, the excess amount of such payment over fair
market value (as determined in accordance with section 482)
is included in the parent organization's unrelated business
income, to the extent that such excess reduced the net
unrelated income (or increased any net unrelated loss) of
the controlled entity (determined as if the entity were
tax exempt). In addition, the provision imposes a 20-
percent penalty on the larger of such excess determined
without regard to any amendment or supplement to a return
of tax, or such excess determined with regard to all such
amendments and supplements.
The provision provides that if modifications to section
512(b)(13) made by the 1997 Act did not apply to a contract
because of the transitional relief provided by the 1997 Act,
then such modifications also do not apply to amounts received
or accrued under such contract before January 1, 2001.
Require public availability of unrelated business income tax
returns
The provision extends the present-law public inspection and
disclosure requirements and penalties applicable to the Form
990 to the unrelated business income tax return (Form 990-T)
of organizations described in section 501(c)(3). The
provision provides that certain information may be withheld
by the organization from public disclosure and inspection if
public availability would adversely affect the organization,
similar to the information that may be withheld under present
law with respect to applications for tax exemption and the
Form 990 (e.g., information relating to a trade secret,
patent, process, style of work, or apparatus of the
organization, if the Secretary determines that public
disclosure of such information would adversely affect the
organization).
Require a UBIT certification for certain large charitable
organizations
Under the provision, a charitable organization that has
annual total gross income and receipts (including, e.g.,
contributions and grants, program service revenue, investment
income, and revenues from an unrelated trade or business or
other sources) or gross assets of at least $10 million on the
last day of the taxable year must include with its Form 990
and Form 990-T filings (if any) a statement by an independent
auditor or an independent counsel that (1) contains a
certification that the information contained in the return
has been reviewed by the auditor or counsel and, to the best
of his or her knowledge, is accurate; (2) to the best of the
auditor's or counsel's knowledge, the allocation of expenses
between the exempt and the unrelated business income
activities of the organization comply with the requirements
set forth by the Secretary under section 512; and (3)
indicates whether the auditor or counsel has provided a tax
opinion to the organization regarding the classification of
any trade or business of the organization as an unrelated
trade or business or the treatment of any income as unrelated
business taxable income and a description of any material
facts with respect to any such opinion.
Failure to file the required statement results in a
penalty, imposed on the organization, of one half of one
percent (0.5 percent) of the organization's total gross
revenues for the taxable year, excluding revenues from
contributions and grants. No penalty is imposed with respect
to any failure that is due to reasonable cause.
Effective date.--The provision related to payments to
controlling organizations applies to payments received or
accrued after December 31, 2000. The public availability
requirements of the provision apply to returns filed after
the date of enactment. The certification requirement applies
to returns for taxable years beginning after the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
7. Encourage contributions of real property made for
conservation purposes (Sec. 207 of the Senate amendment
and sec. 170 of the Code)
Present Law
Charitable contributions generally
In general, a deduction is permitted for charitable
contributions, subject to certain limitations that depend on
the type of taxpayer, the property contributed, and the donee
organization. The amount of deduction generally equals the
fair market value of the contributed property on the date of
the contribution. Charitable deductions are provided for
income, estate, and gift tax purposes.\89\
---------------------------------------------------------------------------
\89\ Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
In general, in any taxable year, charitable contributions
by a corporation are not deductible to the extent the
aggregate contributions exceed 10 percent of the
corporation's taxable income computed without regard to net
operating or capital loss carrybacks. For individuals, the
amount deductible is a percentage of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income computed without regard to any net operating loss
carryback. The applicable percentage of the contribution base
varies depending on the type of donee organization and
property contributed. Cash contributions of an individual
taxpayer to public charities, private operating foundations,
and certain types of private nonoperating foundations may not
exceed 50 percent of the taxpayer's contribution base. Cash
contributions to private foundations and certain other
organizations generally may be deducted up to 30 percent of
the taxpayer's contribution base.
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 also either
retaining an interest in that property or transferring an
interest in that property to a noncharity for less than full
and adequate consideration. Exceptions to this general rule
are provided for, among other interests, remainder interests
in charitable remainder annuity trusts, charitable remainder
unitrusts, and pooled income funds, present interests in the
form of a guaranteed annuity or a fixed percentage of the
annual value of the property, and qualified conservation
contributions.
Capital gain property
Capital gain property means any capital asset or property
used in the taxpayer's trade or business the sale of which at
its fair market value, at the time of contribution, would
have resulted in gain that would have been long-term capital
gain. Contributions of capital gain property to a qualified
charity are deductible at fair market value within certain
limitations. Contributions of capital gain property to
charitable organizations described in section 170(b)(1)(A)
(e.g., public charities, private foundations other than
private non-operating foundations, and certain
governmental units) generally are deductible up to 30
percent of the taxpayer's contribution base. An individual
may elect, however, to bring all these contributions of
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 capital
gain property to charitable organizations described in
section 170(b)(1)(B) (e.g., private non-operating
foundations) are deductible up to 20 percent of the
taxpayer's contribution base.
For purposes of determining whether a taxpayer's aggregate
charitable contributions in a taxable year exceed the
applicable percentage limitation, contributions of capital
gain property are taken into account after other charitable
contributions. Contributions of capital gain property that
exceed the percentage limitation may be carried forward for
five years.
Qualified conservation contributions
Qualified conservation contributions are not subject to the
``partial interest'' rule, which generally bars deductions
for charitable contributions of partial interests in
property. A qualified conservation contribution is a
contribution of a qualified real property interest to a
qualified organization exclusively for conservation purposes.
A qualified real property interest is defined as: (1) the
entire interest of the donor other than a qualified mineral
interest; (2) a remainder interest; or (3) a restriction
(granted in perpetuity) on the use that may be made of the
real property. Qualified organizations include certain
governmental units, public charities that meet certain public
support tests, and certain supporting organizations.
Conservation purposes include: (1) the preservation of land
areas for outdoor recreation by, or for the education of, the
general public; (2) the protection of a relatively natural
habitat of fish, wildlife, or plants, or similar ecosystem;
(3) the preservation of open space (including farmland and
forest land) where such preservation will yield a significant
public benefit and is either for the scenic enjoyment of the
general public or pursuant to a clearly delineated Federal,
State, or local governmental conservation policy; and (4) the
preservation of
[[Page H2240]]
an historically important land area or a certified historic
structure.
Qualified conservation contributions of capital gain
property are subject to the same limitations and carryover
rules of other charitable contributions of capital gain
property.
House Bill
No provision.
Senate Amendment
In general
Under the provision, the 30-percent contribution base
limitation on contributions of capital gain property by
individuals does not apply to qualified conservation
contributions (as defined under present law). Instead,
individuals may deduct the fair market value of any qualified
conservation contribution to an organization described in
section 170(b)(1)(A) to the extent of the excess of 50
percent of the contribution base over the amount of all other
allowable charitable contributions. These contributions are
not taken into account in determining the amount of other
allowable charitable contributions.
Individuals are allowed to carryover any qualified
conservation contributions that exceed the 50-percent
limitation for up to 15 years.
For example, assume an individual with a contribution base
of $100 makes a qualified conservation contribution of
property with a fair market value of $80 and makes other
charitable contributions subject to the 50-percent limitation
of $60. The individual is allowed a deduction of $50 in the
current taxable year for the non-conservation contributions
(50 percent of the $100 contribution base) and is allowed to
carryover the excess $10 for up to 5 years. No current
deduction is allowed for the qualified conservation
contribution, but the entire $80 qualified conservation
contribution may be carried forward for up to 15 years.
Farmers and ranchers
Individuals
In the case of an individual who is a qualified farmer or
rancher for the taxable year in which the contribution is
made, a qualified conservation contribution is allowable up
to 100 percent of the excess of the taxpayer's contribution
base over the amount of all other allowable charitable
contributions.
In the above example, if the individual is a qualified
farmer or rancher, in addition to the $50 deduction for non-
conservation contributions, an additional $50 for the
qualified conservation contribution is allowed and $30 may be
carried forward for up to 15 years as a contribution subject
to the 100-percent limitation.
Corporations
In the case of a corporation (other than a publicly traded
corporation) that is a qualified farmer or rancher for the
taxable year in which the contribution is made, any qualified
conservation contribution is allowable up to 100 percent of
the excess of the corporation's taxable income (as computed
under section 170(b)(2)) over the amount of all other
allowable charitable contributions. Any excess may be carried
forward for up to 15 years as a contribution subject to the
100-percent limitation.
Definition
A qualified farmer or rancher means a taxpayer whose gross
income from the trade of business of farming (within the
meaning of section 2032A(e)(5)) is greater than 50 percent of
the taxpayer's gross income for the taxable year.
Effective date.--The provision applies to contributions
made in taxable years beginning after December 31, 2005, and
before January 1, 2008.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
8. Enhanced deduction for charitable contributions of
literary, musical, artistic, and scholarly compositions
(sec. 208 of the Senate amendment and sec. 170 of the
Code)
Present Law
In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property,
the amount of the deduction generally is limited to the
taxpayer's basis in the property.\90\ In the case of a
charitable contribution of tangible personal property, the
deduction is limited to the taxpayer's basis in such property
if the use by the recipient charitable organization is
unrelated to the organization's tax-exempt purpose. In cases
involving contributions of tangible personal property to a
private foundation (other than certain private
foundations),\91\ the amount of the deduction is limited to
the taxpayer's basis in the property.
---------------------------------------------------------------------------
\90\ Sec. 170(e)(1).
\91\ Sec. 170(e)(1)(B)(ii).
---------------------------------------------------------------------------
Under present law, charitable contributions of literary,
musical, and artistic compositions created or prepared by the
donor are considered ordinary income property and a
taxpayer's deduction of such property is limited to the
taxpayer's basis (typically, cost) in the property. A
charitable contribution of a literary, musical, or artistic
composition by a person other than the person who created or
prepared the work generally is eligible for a fair market
value deduction if the donee organization's use of the
property is related to such organization's exempt purposes.
To be eligible for the deduction, the contribution must be
of an undivided portion of the donor's entire interest in the
property.\92\ For purposes of the charitable income tax
deduction, the copyright and the work in which the copyright
is embodied are not treated as separate property interests.
Accordingly, if a donor owns a work of art and the copyright
to the work of art, a gift of the artwork without the
copyright or the copyright without the artwork will
constitute a gift of a ``partial interest'' and will not
qualify for the income tax charitable deduction.
---------------------------------------------------------------------------
\92\ Sec. 170(f)(3).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision provides that a deduction for ``qualified
artistic charitable contributions'' generally is increased
from the value under present law (generally, basis) to the
fair market value of the property contributed, measured at
the time of the contribution. However, the amount of the
increase of the deduction provided by the provision may not
exceed the amount of the donor's adjusted gross income for
the taxable year attributable to: (1) income from the sale or
use of property created by the personal efforts of the donor
that is of the same type as the donated property; and (2)
income from teaching, lecturing, performing, or similar
activities with respect to such property. In addition, the
increase to the present-law deduction provided by the
provision may not be carried over and deducted in other
taxable years.
The provision defines a qualified artistic charitable
contribution to mean a charitable contribution of any
literary, musical, artistic, or scholarly composition, or
similar property, or the copyright thereon (or both) that
meets certain requirements. First, the contributed property
must have been created by the personal efforts of the donor
at least 18 months prior to the date of contribution. Second,
the donor must obtain a qualified appraisal of the
contributed property, a copy of which is required to be
attached to the donor's income tax return for the taxable
year in which such contribution is made. The appraisal must
include evidence of the extent (if any) to which property
created by the personal efforts of the taxpayer and of the
same type as the donated property is or has been owned,
maintained, and displayed by certain charitable organizations
and sold to or exchanged by persons other than the taxpayer,
donee, or any related person. Third, the contribution must be
made to a public charity or to certain limited types of
private foundations (i.e., an organization described in
section 170(b)(1)(A)). Finally, the use of donated property
by the recipient organization must be related to the
organization's charitable purpose or function, and the donor
must receive a written statement from the organization
verifying such use.
Under the provision, the tangible property and the
copyright on such property are treated as separate properties
for purposes of the ``partial interest'' rule; thus, a gift
of artwork without the copyright or a copyright without the
artwork does not constitute a gift of a partial interest and
is deductible. Contributions of letters, memoranda, or
similar property that are written, prepared, or produced by
or for an individual while the individual is an officer or
employee of any person (including a government agency or
instrumentality) do not qualify for a fair market value
deduction unless the contributed property is entirely
personal.
Effective date.--The deduction for qualified artistic
charitable contributions applies to contributions made after
December 31, 2005, and before January 1, 2008.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
9. Mileage reimbursements to charitable volunteers excluded
from gross income (sec. 209 of the Senate amendment and
new sec. 139B of the Code)
Present Law
In general, an itemized deduction is permitted for
charitable contributions, subject to certain limitations that
depend on the type of taxpayer, the property contributed, and
the donee organization. Unreimbursed out-of-pocket
expenditures made incident to providing donated services to a
qualified charitable organization--such as out-of-pocket
transportation expenses necessarily incurred in performing
donated services--may qualify as a charitable
contribution.\93\ No charitable contribution deduction is
allowed for traveling expenses (including expenses for meals
and lodging) while away from home, whether paid directly or
by reimbursement, unless there is no significant element of
personal pleasure, recreation, or vacation in such
travel.\94\
---------------------------------------------------------------------------
\93\ Treas. Reg. sec. 1.170A-1(g).
\94\ Sec. 170(j).
---------------------------------------------------------------------------
In determining the amount treated as a charitable
contribution where a taxpayer operates a vehicle to provide
donated services to a charity, the taxpayer either may deduct
actual out-of-pocket expenditures or, in the case of a
passenger automobile, may use the charitable standard mileage
rate. The charitable standard mileage rate is set by statute
at 14 cents per mile.\95\ The taxpayer may also deduct (under
either computation method), any parking fees and tolls
incurred in rendering the services, but may not deduct any
amount (regardless of the computation
[[Page H2241]]
method used) for general repair or maintenance expenses,
depreciation, insurance, registration fees, etc. Regardless
of the computation method used, the taxpayer must keep
reliable written records of expenses incurred. For example,
where a taxpayer uses the charitable standard mileage rate to
determine a deduction, the IRS has stated that the taxpayer
generally must maintain records of miles driven, time, place
(or use), and purpose of the mileage. If the charitable
standard mileage rate is not used to determine the deduction,
the taxpayer generally must maintain reliable written records
of actual expenses incurred.
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\95\ Sec. 170(i).
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In lieu of actual operating expenses, an optional standard
mileage rate may be used in computing the deductible costs of
business use of an automobile. The business standard mileage
rate is determined by the IRS and updated periodically. For
business use occurring on or after January 1, 2006, the
business standard mileage rate specified by the IRS is 44.5
cents per mile.
The standard mileage rate for charitable purposes is lower
than the standard business rate because the charitable rate
covers only the out-of-pocket operating expenses (including
gasoline and oil) directly related to the use of the
automobile in performing the donated services that a taxpayer
may deduct as a charitable contribution. The charitable rate
does not include costs that are not deductible as a
charitable contribution such as general repair or maintenance
expenses, depreciation, insurance, and registration fees.
Such costs are, however, included in computing the business
standard mileage rate.
Volunteer drivers who are reimbursed for mileage expenses
have taxable income to the extent the reimbursement exceeds
deductible travel expenses. Employees who are reimbursed for
mileage expenses under a qualified arrangement that pays a
mileage allowance in lieu of reimbursing actual expenses
generally have taxable income to the extent the reimbursement
exceeds the amount of the business standard mileage rate
multiplied by the actual business miles.
Under section 6041, information reporting generally is
required with respect to payments of $600 or more in any
taxable year.
Under the Katrina Emergency Tax Relief Act of 2005,
reimbursement by an organization described in section 170(c)
(including public charities and private foundations) to a
volunteer for the costs of using a passenger automobile in
providing donated services to charity solely for the
provision of relief related to Hurricane Katrina is
excludable from the gross income of the volunteer up to an
amount that does not exceed the business standard mileage
rate prescribed for business use (as periodically adjusted),
provided that recordkeeping requirements applicable to
deductible business expenses are satisfied. The Katrina
Emergency Tax Relief Act of 2005 does not permit a volunteer
to claim a deduction or credit with respect to such amounts
excluded. The provision applies for purposes of use of a
passenger automobile during the period beginning on August
25, 2005, and ending on December 31, 2006.
House Bill
No provision.
Senate Amendment
The provision extends the provision enacted as part of the
Katrina Emergency Tax Relief Act of 2005. Under the
provision, reimbursement by an organization described in
section 170(c) (including public charities and private
foundations) to a volunteer for the costs of using a
passenger automobile in providing donated services to charity
is excludable from the gross income of the volunteer up to an
amount that does not exceed the business standard mileage
rate prescribed for business use (as periodically adjusted),
provided that recordkeeping requirements applicable to
deductible business expenses are satisfied. Unlike the
provision enacted as part of the Katrina Emergency Tax Relief
Act of 2005, the provision is not limited to use solely for
the provision of relief related to Hurricane Katrina. The
provision does not permit a volunteer to claim a deduction or
credit with respect to amounts excluded under the provision.
Information reporting required by section 6041 is not
required with respect to reimbursements excluded under the
provision.
Effective date.--The provision applies for taxable years
beginning after December 31, 2005, and beginning before
January 1, 2008.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
10. Alternative percentage limitation for corporate
charitable contributions to the mathematics and science
partnership program (sec. 210 of the Senate amendment and
sec. 170 of the Code)
Present Law
Under present law, a corporation is allowed to deduct
charitable contributions up to 10 percent of the
corporation's modified taxable income for the year. For this
purpose, taxable income is determined without regard to (1)
the charitable contributions deduction, (2) any net operating
loss carryback, (3) deductions for dividends received, and
(4) any capital loss carryback for the taxable year.\96\ Any
charitable contribution by a corporation that is not
currently deductible because of the percentage limitation may
be carried forward for up to five taxable years.
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\96\ Sec. 170(b)(2).
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House Bill
No provision.
Senate Amendment
Under the provision, the corporate percentage limitation is
applied separately to eligible mathematics and science
contributions and to all other charitable contributions. In
addition, the applicable percentage limitation for purposes
of eligible mathematics and science contributions is 15
percent; the applicable percentage limitation for all other
corporate charitable contributions remains 10 percent.
In general, an eligible mathematics and science
contribution is a charitable contribution (other than a
contribution of used equipment) to a qualified partnership
for the purpose of an activity described in section 2202(c)
of the Elementary and Secondary Education Act of 1965. Such
activities include, for example, creating opportunities for
enhanced and ongoing professional development of mathematics
and science teachers and promoting strong teaching skills for
mathematics and science teachers and teacher educators. A
qualified partnership is an eligible partnership within the
meaning of section 2201(b)(1) of the Elementary and Secondary
Education Act of 1965, but only to the extent that such
partnership does not include a person other than a person
described in section 170(b)(1)(A) (describing organizations
to which individuals may make charitable contributions
deductible up to 50 percent of such individual's contribution
base).
Effective date.--The provision applies for contributions
made in taxable years beginning after December 31, 2005, and
beginning before January 1, 2007.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
B. Reforming Charitable Organizations
1. Tax involvement of accommodation parties in tax-shelter
transactions (Sec. 211 of the Senate amendment and secs.
6011, 6033, 6652, and new sec. 4965 of the Code)
Present Law
Disclosure of listed and other reportable transactions by
taxpayers
Present law provides that a taxpayer that participates in a
reportable transaction (including a listed transaction) and
that is required to file a tax return must attach to its
return a disclosure statement in the form prescribed by the
Secretary.\97\ For this purpose, the term taxpayer includes
any person, including an individual, trust, estate,
partnership, association, company, or corporation.\98\
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\97\ Treas. Reg. sec. 1.6011-4(a).
\98\ Sec. 7701(a)(1); Treas. Reg. sec. 1.6011-4(c)(1).
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Under present Treasury regulations, a reportable
transaction includes a listed transaction and five other
categories of transactions: (1) confidential transactions,
which are transactions offered to a taxpayer under conditions
of confidentiality and for which the taxpayer has paid an
advisor a minimum fee; (2) transactions with contractual
protection, which include transactions for which the taxpayer
or a related party has the right to a full or partial refund
of fees if all or part of the intended tax consequences from
the transaction are not sustained, or for which fees are
contingent on the taxpayer's realization of tax benefits from
the transaction; (3) loss transactions, which are
transactions resulting in the taxpayer claiming a loss under
section 165 that exceeds certain thresholds, depending upon
the type of taxpayer; (4) transactions with a significant
book-tax difference; and (5) transactions involving a brief
asset holding period.\99\ A listed transaction means a
reportable transaction which is the same as, or substantially
similar to, a transaction specifically identified by the
Secretary as a tax avoidance transaction for purposes of
section 6011 (relating to the filing of returns and
statements), and identified by notice, regulation, or other
form of published guidance as a listed transaction.\100\ The
fact that a transaction is a reportable transaction does not
affect the legal determination of whether the taxpayer's
treatment of the transaction is proper.\101\ Present law
authorizes the Secretary to define a reportable transaction
on the basis of such transaction being of a type which the
Secretary determines as having a potential for tax avoidance
or evasion.\102\
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\99\ Treas. Reg. sec. 1.6011-4(b). In Notice 2006-6 (January
6, 2006), the Service indicated that it was removing
transactions with a significant book-tax difference from the
categories of reportable transactions.
\100\ Sec. 6707A(c)(2); Treas. Reg. sec. 1.6011-4(b)(2).
\101\ Treas. Reg. sec. 1.6011-4(a).
\102\ Sec. 6707A(c)(1).
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Treasury regulations provide guidance regarding the
determination of when a taxpayer participates in a
transaction for these purposes.\103\ A taxpayer has
participated in a listed transaction if the taxpayer's tax
return reflects tax consequences or a tax strategy described
in the published guidance that lists the transaction, or if
the taxpayer knows or has reason to know that the taxpayer's
tax benefits are derived directly or indirectly from tax
consequences of a tax strategy described in published
guidance that lists a transaction. A taxpayer has
participated in a confidential transaction if the taxpayer's
tax return reflects a tax benefit from the transaction and
the taxpayer's disclosure of the tax treatment or tax
structure of the transaction is limited under conditions of
confidentiality. A taxpayer has participated in a transaction
with contractual
[[Page H2242]]
protection if the taxpayer's tax return reflects a tax
benefit from the transaction, and the taxpayer has the right
to the full or partial refund of fees or the fees are
contingent.
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\103\ Treas. Reg. sec. 1.6011-4(c)(3).
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Present law provides a penalty for any person who fails to
include on any return or statement any required information
with respect to a reportable transaction.\104\ The penalty
applies without regard to whether the transaction ultimately
results in an understatement of tax, and applies in addition
to any other penalty that may be imposed.
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\104\ Sec. 6707A.
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The penalty for failing to disclose a reportable
transaction is $10,000 in the case of a natural person and
$50,000 in any other case. The amount is increased to
$100,000 and $200,000, respectively, if the failure is with
respect to a listed transaction. The penalty cannot be waived
with respect to a listed transaction. As to reportable
transactions, the IRS Commissioner may rescind all or a
portion of the penalty if rescission would promote compliance
with the tax laws and effective tax administration.
Disclosure of listed and other reportable transactions by
material advisors
Present law requires each material advisor with respect to
any reportable transaction (including any listed transaction)
to timely file an information return with the Secretary (in
such form and manner as the Secretary may prescribe).\105\
The information return must include (1) information
identifying and describing the transaction, (2) information
describing any potential tax benefits expected to result from
the transaction, and (3) such other information as the
Secretary may prescribe. The return must be filed by the date
specified by the Secretary.
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\105\ Sec. 6707(a), as added by the American Jobs Creation
Act of 2004, Pub. L. No. 108-357, sec. 816(a).
---------------------------------------------------------------------------
A ``material advisor'' means any person (1) who provides
material aid, assistance, or advice with respect to
organizing, managing, promoting, selling, implementing,
insuring, or carrying out any reportable transaction, and (2)
who directly or indirectly derives gross income in excess of
$250,000 ($50,000 in the case of a reportable transaction
substantially all of the tax benefits from which are provided
to natural persons) or such other amount as may be prescribed
by the Secretary for such advice or assistance.\106\
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\106\ Sec. 6707(b)(1).
---------------------------------------------------------------------------
The Secretary may prescribe regulations which provide (1)
that only one material advisor is required to file an
information return in cases in which two or more material
advisors would otherwise be required to file information
returns with respect to a particular reportable transaction,
(2) exemptions from the requirements of this section, and (3)
other rules as may be necessary or appropriate to carry out
the purposes of this section.\107\
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\107\ Sec. 6707(c).
---------------------------------------------------------------------------
Present law imposes a penalty on any material advisor who
fails to timely file an information return, or who files a
false or incomplete information return, with respect to a
reportable transaction (including a listed transaction).\108\
The amount of the penalty is $50,000. If the penalty is with
respect to a listed transaction, the amount of the penalty is
increased to the greater of (1) $200,000, or (2) 50 percent
of the gross income derived by such person with respect to
aid, assistance, or advice which is provided with respect to
the transaction before the date the information return that
includes the transaction is filed. An intentional failure or
act by a material advisor with respect to the requirement to
disclose a listed transaction increases the penalty to 75
percent of the gross income derived from the transaction.
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\108\ Sec. 6707(b).
---------------------------------------------------------------------------
The penalty cannot be waived with respect to a listed
transaction. As to reportable transactions, the IRS
Commissioner can rescind all or a portion of the penalty if
rescission would promote compliance with the tax laws and
effective tax administration.
House Bill
No provision.
Senate Amendment
In general
In general, under the provision, certain tax-exempt
entities are subject to penalties for being a party to a
prohibited tax shelter transaction. A prohibited tax shelter
transaction is a transaction that the Secretary determines is
a listed transaction (as defined in section 6707A(c)(2)) or a
prohibited transaction. A prohibited reportable transaction
is a confidential transaction or a transaction with
contractual protection (as defined by the Secretary in
regulations) which is a reportable transaction as defined in
sec. 6707A(c)(1). Under the provision, a tax-exempt entity is
an entity that is described in section 501(c), 501(d), or
170(c) (not including the United States), Indian tribal
governments, and tax qualified pension plans, individual
retirement arrangements (``IRAs''), and similar tax-favored
savings arrangements (such as Coverdell education savings
accounts, health savings accounts, and qualified tuition
plans).
Entity level tax
Under the provision, if a tax-exempt entity is a party at
any time to a transaction during a taxable year and knows or
has reason to know that the transaction is a prohibited tax
shelter transaction, the entity is subject to a tax for such
year equal to the greater of (1) 100 percent of the entity's
net income (after taking into account any tax imposed with
respect to the transaction) for such year that is
attributable to the transaction or (2) 75 percent of the
proceeds received by the entity that are attributable to the
transaction.
In addition, if a transaction is not a listed transaction
at the time a tax-exempt entity enters into the transaction
(and is not otherwise a prohibited tax shelter transaction),
but the transaction subsequently is determined by the
Secretary to be a listed transaction (a ``subsequently listed
transaction''), the entity must pay each taxable year an
excise tax at the highest unrelated business taxable income
rate times the greater of (1) the entity's net income (after
taking into account any tax imposed) that is attributable to
the subsequently listed transaction and that is properly
allocable to the period beginning on the later of the date
such transaction is listed by the Secretary or the first day
of the taxable year or (2) 75 percent of the proceeds
received by the entity that are attributable to the
subsequently listed transaction and that are properly
allocable to the period beginning on the later of the date
such transaction is listed by the Secretary or the first day
of the taxable year. The Secretary has the authority to
promulgate regulations that provide guidance regarding the
determination of the allocation of net income of a tax-exempt
entity that is attributable to a transaction to various
periods, including before and after the listing of the
transaction or the date which is 90 days after the date of
enactment of the provision.
The entity level tax does not apply if the entity's
participation is not willful and is due to reasonable cause,
except that the willful and reasonable cause exception does
not apply to the tax imposed for subsequently listed
transactions. The entity level taxes do not apply to tax
qualified pension plans, IRAs, and similar tax-favored
savings arrangements (such as Coverdell education savings
accounts, health savings accounts, and qualified tuition
plans).
Disclosure of participation in prohibited tax shelter
transactions
The provision requires that a taxable party to a prohibited
tax shelter transaction disclose to the tax-exempt entity
that the transaction is a prohibited tax shelter transaction.
Failure to make such disclosure is subject to the present-law
penalty for failure to include reportable transaction
information under section 6707A. Thus, the penalty is $10,000
in the case of a natural person or $50,000 in any other case,
except that if the transaction is a listed transaction, the
penalty is $100,000 in the case of a natural person and
$200,000 in any other case.\109\
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\109\ The IRS Commissioner may rescind all or any portion of
any such penalty if the violation is with respect to a
prohibited tax shelter transaction other than a listed
transaction and doing so would promote compliance with the
requirements of the Code and effective tax administration.
See sec. 6707A(d).
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The provision requires disclosure by a tax-exempt entity to
the IRS of each participation in a prohibited tax shelter
transaction and disclosure of other known parties to the
transaction. The penalty for failure to disclose is imposed
on the entity (or entity manager, in the case of qualified
pension plans and similar tax favored retirement
arrangements) at $100 per day the failure continues, not to
exceed $50,000. If any person fails to comply with a demand
on the tax-exempt entity by the Secretary for disclosure,
such person or persons shall pay a penalty of $100 per day
(beginning on the date of the failure to comply) not to
exceed $10,000 per prohibited tax shelter transaction. As
under present-law section 6652, no penalty is imposed with
respect to any failure if it is shown that the failure is due
to reasonable cause.
Penalty on entity managers
A tax of $20,000 is imposed on an entity manager that
approves or otherwise causes a tax-exempt entity to be a
party to a prohibited tax shelter transaction at any time
during the taxable year, knowing or with reason to know that
the transaction is a prohibited tax shelter transaction. An
entity manager is defined as a person with authority or
responsibility similar to that exercised by an officer,
director, or trustee of an organization, except: (1) in the
case of an entity described in section 501(c)(3) or (c)(4)
(other than a private foundation), an entity manager is an
organization manager as defined in section 4958(f)(2); and
(2) in the case of a private foundation, an entity manager is
a foundation manager as defined in section 4946(b). The
reasonable cause (or no willful participation) exception
applies to this tax.
Effective date.--The provision generally is effective for
transactions after the date of enactment, except that no tax
applies with respect to income that is properly allocable to
any period on or before the date that is 90 days after the
date of enactment. The disclosure provisions apply to
disclosures the due date for which are after the date of
enactment.
Conference Agreement
The conference agreement includes the Senate amendment
provision, with modifications.
The conference agreement does not include the provision
that the entity level or entity manager tax does not apply if
the entity's participation is not willful and is due to
reasonable cause.
In addition, the conference agreement adds a tax in the
event that a tax-exempt entity
[[Page H2243]]
becomes a party to a prohibited tax shelter transaction
without knowing or having reason to know that the transaction
is a prohibited tax shelter transaction. In that case, the
tax-exempt entity is subject to a tax in the taxable year the
entity becomes a party and any subsequent taxable year of the
highest unrelated business taxable income rate times the
greater of (1) the entity's net income (after taking into
account any tax imposed with respect to the transaction) for
such year that is attributable to the transaction or (2) 75
percent of the proceeds received by the entity that are
attributable to the transaction for such year.\110\
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\110\ The conference agreement clarifies that in all cases
the 75 percent of proceeds received by the entity that are
attributable to the transaction are with respect to the
taxable year.
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The conference agreement clarifies that the entity level
tax rate that applies if the entity knows or has reason to
know that a transaction is a prohibited tax shelter
transaction does not apply to subsequently listed
transactions.
The conference agreement modifies the definition of an
entity manager to provide that: (1) in the case of tax
qualified pension plans, IRAs, and similar tax-favored
savings arrangements (such as Coverdell education savings
accounts, health savings accounts, and qualified tuition
plans) an entity manager is the person that approves or
otherwise causes the entity to be a party to a prohibited tax
shelter transaction, and (2) in all other cases the entity
manager is the person with authority or responsibility
similar to that exercised by an officer, director, or trustee
of an organization, and with respect to any act, the person
having authority or responsibility with respect to such act.
In the case of a qualified pension plan, IRA, or similar
tax-favored savings arrangement (such as a Coverdell
education savings account, health savings account, or
qualified tuition plan), the conferees intend that, in
general, a person who decides that assets of the plan, IRA,
or other savings arrangement are to be invested in a
prohibited tax shelter transaction is the entity manager
under the provision. Except in the case of a fully self-
directed plan or other savings arrangement with respect to
which a participant or beneficiary decides to invest in the
prohibited tax shelter transaction, a participant or
beneficiary generally is not an entity manager under the
provision. Thus, for example, a participant or beneficiary is
not an entity manager merely by reason of choosing among pre-
selected investment options (as is typically the case if a
qualified retirement plan provides for participant-directed
investments).\111\ Similarly, if an individual has an IRA and
may choose among various mutual funds offered by the IRA
trustee, but has no control over the investments held in the
mutual funds, the individual is not an entity manager under
the provision.
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\111\ Depending on the circumstances, the person who is
responsible for determining the pre-selected investment
options may be an entity manager under the provision.
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Under the provision, certain taxes are imposed if the
entity or entity manager knows or has reason to know that a
transaction is a prohibited tax shelter transaction. In
general, the conferees intend that in order for an entity or
entity manager to have reason to know that a transaction is a
prohibited tax shelter transaction, the entity or entity
manager must have knowledge of sufficient facts that would
lead a reasonable person to conclude that the transaction is
a prohibited tax shelter transaction. If there is justifiable
reliance on a reasoned written opinion of legal counsel
(including in-house counsel) or of an independent accountant
with expertise in tax matters, after making full disclosure
of relevant facts about a transaction to such counsel or
accountant, that a transaction is not a prohibited tax
shelter transaction, then absent knowledge of facts not
considered in the reasoned written opinion that would lead a
reasonable person to conclude that the transaction is a
prohibited tax shelter transaction, the reason to know
standard is not met.
Not obtaining a reasoned written opinion of legal counsel
does not alone indicate whether a person has reason to know.
However, if a transaction is extraordinary for the entity,
promises a return for the organization that is exceptional
considering the amount invested by, the participation of, or
the absence of risk to the organization, or the transaction
is of significant size, either in an absolute sense or
relative to the receipts of the entity, then, in general, the
presence of such factors may indicate that the entity or
entity manager has a responsibility to inquire further about
whether a transaction is a prohibited tax shelter
transaction, or, absent such inquiry, that the reason to know
standard is satisfied. For example, if a tax-exempt entity's
investment in a transaction is $1,000, and the entity is
promised or expects to receive $10,000 in the near term, in
general, the rate of return would be considered exceptional
and the entity should make inquiries with respect to the
transaction. As another example, if a tax-exempt entity's
expected income from a transaction is greater than five
percent of the entity's annual receipts, or is in excess of
$1,000,000, and the entity fails to make appropriate
inquiries with respect to its participation in such
transaction, such failure is a factor tending to show that
the reason to know standard is met. Appropriate inquiries
need not involve obtaining a reasoned written opinion. In
general, if a transaction does not present the factors
described above and the organization is small (measured by
receipts and assets) and described in section 501(c)(3), it
is expected that the reason to know standard will not be met.
In general, the conferees intend that in determining
whether a tax-exempt entity is a ``party'' to a prohibited
tax shelter transaction all the facts and circumstances
should be taken into account. Absence of a written agreement
is not determinative. Certain indirect involvement in a
prohibited tax shelter transaction would not result in an
entity being considered a party to the transaction. For
example, investment by a tax-exempt entity in a mutual fund
that in turn invests in or participates in a prohibited tax
shelter transaction does not, in general, make the tax-exempt
entity a party to such transaction, absent facts or
circumstances that indicate that the purpose of the tax
exempt entity's investment in the mutual fund was
specifically to participate in such a transaction. However,
whether a tax-exempt entity is a party to such a transaction
will be informed by whether the entity or entity manager knew
or had reason to know that an investment of the entity would
be used in a prohibited tax shelter transaction. Presence of
such knowledge or reason to know may indicate that the
purpose of the investment was to participate in the
prohibited tax shelter transaction and that the tax-exempt
entity is a party to such transaction.
The conference agreement clarifies that a subsequently
listed transaction means any transaction to which a tax-
exempt entity is a party and which is determined by the
Secretary to be a listed transaction at any time after the
entity has ``become a party to'' the transaction, and not, as
under the Senate amendment, when the entity ``entered into''
the transaction. The conference agreement provides that a
subsequently listed transaction does not include a
transaction that is a prohibited reportable transaction. The
conference agreement provides that the Secretary has the
authority to allocate proceeds as well as income of a tax-
exempt entity to various periods. The conference agreement
also provides that the disclosure by tax-exempt entities to
the Internal Revenue Service required under the provision is
based on an entity's being a party to a prohibited tax
shelter transaction and not, as under the Senate amendment,
on an entity's ``participation'' in a prohibited tax shelter
transaction. The conference agreement further provides that
the Secretary may make a demand for disclosure on any
entity manager subject to the tax, as well as on any tax
exempt entity, and also provides that such managers and
entities and not, as under the Senate amendment,
``persons'' are subject to the penalty for failure to
comply with the demand.
Effective date.--In general, the provision is effective for
taxable years ending after the date of enactment, with
respect to transactions before, on, or after such date,
except that no tax shall apply with respect to income or
proceeds that are properly allocable to any period ending on
or before the date that is 90 days after the date of
enactment. The tax on certain knowing transactions does not
apply to any prohibited tax shelter transaction to which a
tax-exempt entity became a party on or before the date of
enactment. The disclosure provisions apply to disclosures the
due date for which are after the date of enactment.
2. Apply an excise tax to acquisitions of interests in
insurance contracts in which certain exempt organizations
hold interests (sec. 212 of the Senate amendment and new
secs. 4966 and 6050V of the Code)
Present Law
Amounts received under a life insurance contract
Amounts received under a life insurance contract paid by
reason of the death of the insured are not includible in
gross income for Federal tax purposes.\112\ No Federal income
tax generally is imposed on a policyholder with respect to
the earnings under a life insurance contract (inside
buildup).\113\
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\112\ Sec. 101(a).
\113\ This favorable tax treatment is available only if a
life insurance contract meets certain requirements designed
to limit the investment character of the contract. Sec. 7702.
---------------------------------------------------------------------------
Distributions from a life insurance contract (other than a
modified endowment contract) that are made prior to the death
of the insured generally are includible in income to the
extent that the amounts distributed exceed the taxpayer's
investment in the contract (i.e., basis). Such distributions
generally are treated first as a tax-free recovery of basis,
and then as income.\114\
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\114\ Sec. 72(e). In the case of a modified endowment
contract, however, in general, distributions are treated as
income first, loans are treated as distributions (i.e.,
income rather than basis recovery first), and an additional
10-percent tax is imposed on the income portion of
distributions made before age 59\1/2\ and in certain other
circumstances. Secs. 72(e) and (v). A modified endowment
contract is a life insurance contract that does not meet a
statutory ``7-pay'' test, i.e., generally is funded more
rapidly than seven annual level premiums. Sec. 7702A.
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Transfers for value
A limitation on the exclusion for amounts received under a
life insurance contract is provided in the case of transfers
for value. If a life insurance contract (or an interest in
the contract) is transferred for valuable consideration, the
amount excluded from income by reason of the death of the
insured is limited to the actual value of the consideration
plus the premiums and other amounts
[[Page H2244]]
subsequently paid by the acquiror of the contract.\115\
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\115\ Section 101(a)(2). The transfer-for-value rule does not
apply, however, in the case of a transfer in which the life
insurance contract (or interest in the contract) transferred
has a basis in the hands of the transferee that is determined
by reference to the transferor's basis. Similarly, the
transfer-for-value rule generally does not apply if the
transfer is between certain parties (specifically, if the
transfer is to the insured, a partner of the insured, a
partnership in which the insured is a partner, or a
corporation in which the insured is a shareholder or
officer).
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Tax treatment of charitable organizations and donors
Present law generally provides tax-exempt status for
charitable, educational and certain other organizations, no
part of the net earnings of which inures to the benefit of
any private shareholder or individual, and which meet certain
other requirements.\116\ Governmental entities, including
some educational organizations, are exempt from tax on income
under other tax rules providing that gross income does not
include income derived from the exercise of any essential
governmental function and accruing to a State or any
political subdivision thereof.\117\
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\116\ Section 501(c)(3).
\117\ Section 115.
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In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity for exclusively public
purposes.\118\
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\118\ Section 170.
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State-law insurable interest rules
State laws generally provide that the owner of a life
insurance contract must have an insurable interest in the
insured person when the life insurance contract is issued.
State laws vary as to the insurable interest of a charitable
organization in the life of any individual. Some State laws
provide that a charitable organization meeting the
requirements of section 501(c)(3) of the Code is treated as
having an insurable interest in the life of any donor,\119\
or, in other States, in the life of any individual who
consents (whether or not the individual is a donor).\120\
Other States' insurable interest rules permit the purchase of
a life insurance contract even though the person paying the
consideration has no insurable interest in the life of the
person insured if a charitable, benevolent, educational or
religious institution is designated irrevocably as the
beneficiary.\121\
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\119\ See, e.g., Mass. Gen. Laws Ann. ch. 175, sec. 123A(2)
(West 2005); Iowa Code Ann. sec. 511.39 (West 2004) (``a
person who, when purchasing a life insurance policy, makes a
donation to the charitable organization or makes the
charitable organization the beneficiary of all or a part of
the proceeds of the policy . . . ).
\120\ See, e.g., Cal. Ins. Code sec. 10110.1(f) (West 2005);
40 Pa. Cons. Stat. Ann. sec. 40-512 (2004); Fla. Stat. Ann.
sec. 27.404 (2) (2004); Mich. Comp. Laws Ann. sec. 500.2212
(West 2004).
\121\ Or. Rev. Stat. sec. 743.030 (2003); Del. Code Ann. Tit.
18, sec. 2705(a) (2004).
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Transactions involving charities and non-charities acquiring
life insurance
Recently, there has been an increase in transactions
involving the acquisition of life insurance contracts using
arrangements in which both exempt organizations, primarily
charities, and private investors have an interest in the
contract.\122\ The exempt organization has an insurable
interest in the insured individuals, either because they are
donors, because they consent, or otherwise under applicable
State insurable interest rules. Private investors provide
capital used to fund the purchase of the life insurance
contracts, sometimes together with annuity contracts. Both
the private investors and the charity have an interest in the
contracts, directly or indirectly, through the use of trusts,
partnerships, or other arrangements for sharing the rights to
the contracts. Both the charity and the private investors
receive cash amounts in connection with the investment in the
contracts while the life insurance is in force or as the
insured individuals die.
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\122\ Davis, Wendy, ``Death-Pool Donations,'' Trusts and
Estates, May 2004, 55; Francis, Theo, ``Tax May Thwart
Investment Plans Enlisting Charities,'' Wall St. J., Feb. 8,
2005, A-10.
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House Bill
No provision.
Senate Amendment
The provision imposes an excise tax, equal to 100 percent
of the acquisition costs, on the taxable acquisition of any
interest in an applicable insurance contract. An applicable
insurance contract is any life insurance, annuity or
endowment contract in which both an applicable exempt
organization and any person that is not an applicable exempt
organization have, directly or indirectly, held an interest
in the contract (whether or not the interests are held at the
same time).
An applicable exempt organization is any organization
described in section 170(c), 168(h)(2)(A)(iv), 2055(a), or
2522(a). Thus, for example, an applicable exempt organization
generally includes an organization that is exempt from
Federal income tax by reason of being described in section
501(c)(3) (including one organized outside the United
States), a government or political subdivision of a
government, and an Indian tribal government.
A taxable acquisition is the acquisition of any direct or
indirect interest in an applicable insurance contract by an
applicable exempt organization, or by any other person if the
interest in the contract in that person's hands is not
described in the specific exceptions to ``applicable
insurance contract.''
Under the provision, acquisition costs mean the direct or
indirect costs (including premiums, commissions, fees,
charges, or other amounts) of acquiring or maintaining an
interest in an applicable insurance contract. Except as
provided in regulations, if acquisition costs of any taxable
acquisition are paid or incurred in more than one calendar
year, the excise tax under the provision is imposed each time
such costs are paid or incurred. In the case of an
acquisition of an interest in an entity that directly or
indirectly holds an interest in an applicable insurance
contract, acquisition costs are intended to include the
amount of money or value of property (including an applicable
insurance contract) contributed to an entity or otherwise
transferred or paid to acquire or increase an interest in the
entity, that directly or indirectly holds an interest in an
applicable insurance contract.
For example, acquisition costs include (1) each premium,
commission, or fee with respect to the contract, (2) each
amount paid or incurred to acquire or increase an interest in
the contract, (3) each amount paid or incurred to acquire or
increase an interest in an entity (such as a partnership,
trust, corporation, or other type of entity or arrangement)
that has a direct or indirect interest in the contract, and
(4) if the contract is contributed to an entity, the greater
of the value of the contract or the total amount of premiums,
commissions, and fees paid or incurred to acquire and
maintain the insurance contract. It is intended that, under
regulatory authority provided as necessary to carry out the
purposes of the provision, any other similar or economically
equivalent amount paid or incurred is to be treated as
acquisition costs.
Under the provision, an interest in an applicable insurance
contract includes any right with respect to the contract,
whether as an owner, beneficiary, or otherwise. An indirect
interest in a contract includes an interest in an entity
that, directly or indirectly, holds an interest in the
contract. In the case of a section 1035 exchange of an
applicable insurance contract, any interest in any of the
contracts involved in the exchange is treated as an interest
in all such contracts. An increase in an interest in an
applicable insurance contract is treated as a separate
acquisition, for purposes of application of the excise tax
under the provision.
If an interest of an applicable exempt organization exists
solely because the organization holds, as part of a
diversified investment strategy, a de minimis interest in an
entity which directly or indirectly holds an interest in the
contract, such interest is not taken into account for
purposes of the provision. For example, if an applicable
exempt organization owns a de minimis amount of stock in a
corporation which in turn owns life insurance contracts
covering key employees, the excise tax under the provision
does not apply because the stock ownership is not treated as
an indirect interest in this circumstance. It is intended
that Treasury regulations provide guidance as to the
application of this rule so that it does not permit
circumvention of the provision.
Except as provided in regulations, if a person acquires an
interest in a contract before the contract is treated as an
applicable insurance contract, the acquisition is treated as
a taxable acquisition of an interest in applicable insurance
contract as of the date the contract becomes an applicable
insurance contract.
It is intended that an interest in an applicable insurance
contract includes, for example, (1) a right with respect to
the applicable insurance contract pursuant to a side contract
or other similar arrangement, (2) an interest as a trust
beneficiary in distributions from or income of a trust
holding an interest in a contract, and (3) a right to
distributions, guaranteed payments, or income of a
partnership that holds an interest in a contract. It is not
intended that a right with respect to the contract include
typical rights of issuers of applicable insurance contracts.
Exceptions to the term ``applicable insurance contract''
apply under the provision. First, the term does not apply if
each person (other than an applicable exempt organization)
with a direct or indirect interest in the contract has an
insurable interest in the insured independent of any interest
of the exempt organization in the contract. Second, the term
does not apply if the sole interest in the contract of each
person other than the applicable exempt organization is as a
named beneficiary. Third, the term does not apply if the sole
interest in the contract of each person other than the
applicable exempt organization is either (1) as a beneficiary
of a trust holding an interest in the contract, but only if
the person's designation as such a beneficiary was made
without consideration and solely on a purely gratuitous
basis, or (2) as a trustee who holds an interest in the
contract in a fiduciary capacity solely for the benefit of
applicable exempt organizations or of persons otherwise
meeting one of the first two exceptions.
An exception to the term ``applicable insurance contract''
also is provided under the provision in certain cases in
which a person other than an applicable exempt organization
has an interest solely as a lender \123\ with respect to the
contract, and the contract covers only one individual who is
an officer, director, or employee of the applicable exempt
organization with an interest in the
[[Page H2245]]
contract, provided other requirements are met. This exception
applies only if the number of insured persons under loans by
such lenders with respect to such contracts does not exceed
the greater of: (1) the lesser of five percent of the total
officers, directors, and employees of the organization or 20,
or (2) five. Under this exception, the aggregate amount of
indebtedness with respect to 1 or more contracts covering a
single individual may not exceed $50,000.
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\123\ For this purpose, an interest as a lender includes a
security interest in the insurance contract to which the loan
relates.
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In addition, Treasury regulatory authority is provided to
except certain contracts from treatment as applicable
insurance contracts. Contracts may be excepted based on
specific factors including (1) whether the transaction is at
arms' length, (2) whether the economic benefits to the
applicable exempt organization substantially exceed the
economic benefits to all other persons with an interest in
the contract (determined without regard to whether, or the
extent to which, such organization has paid or contributed
with respect to the contract), and (3) the likelihood of
abuse.
The application of the exceptions can be illustrated as
follows. Assume that an individual acquires a life insurance
contract in which the individual is the insured person, and
the named beneficiaries are the individual's son and a
university that is an organization described in section
170(c). The contract is not an applicable insurance contract
because the first exception applies. That is, because both
the individual and his son have an insurable interest in the
individual, all persons holding any interest in the contract
(other than applicable exempt organizations) have
an insurable interest in the insured independent of any
interest of an applicable exempt organization in the
contract. The second exception also applies in this
situation.
As another example, assume that the three named
beneficiaries are the insured's son, an unrelated friend, and
a charity. The contract is not an applicable insurance
contract because the second exception applies. That is, each
beneficiary's sole interest is as a named beneficiary. In
addition, the first exception also applies in this situation.
As a further example, assume that the insured individual
creates an irrevocable trust for the benefit of the insured's
descendants, and that the trustee of the trust uses trust
funds to purchase a life insurance policy on the insured's
life, and the trust is both the owner and beneficiary of the
insurance policy. The insured individual's naming of his or
her descendants as trust beneficiaries is a gratuitous act,
done without consideration. As a result, the contract is not
an applicable insurance contract under the third exception.
No Federal income tax deduction is permitted for the excise
tax payable under the provision, as provided under the rule
of Code section 275(a)(6). The amount of the excise tax
payable under the provision is not included in the investment
in the contract for purposes of section 72.
Treasury regulatory authority is provided to carry out the
purposes of the provision. This includes authority to provide
appropriate rules in the case in which a person acquires an
interest before a contract is treated as an applicable
insurance contract. This also includes authority to prevent,
in cases the Treasury Secretary determines appropriate, the
imposition of more than one tax if the same interest is
acquired more than once (otherwise, the tax under the
provision applies to each acquisition). Treasury regulatory
authority is also provided to prevent avoidance of the
provision, including through the use of intermediaries.
The provision provides reporting rules requiring an
applicable exempt organization or other person that makes a
taxable acquisition of an applicable insurance contract to
file a return containing required information and such other
information as is prescribed by the Treasury Secretary. Under
these rules, a statement is required to be furnished to each
person whose taxpayer identification information is required
to be reported on the return. Penalties apply for failure to
file the return or furnish the statement, including, in the
case of intentional disregard of the return filing
requirement, a penalty equal to the amount of the excise tax
that has not been paid with respect to the items required to
be included on the return.
Effective date.--The provision is effective for contracts
issued after May 3, 2005.
The application of the effective date with respect to prior
acquisitions of interests may be illustrated as follows.
Assume that an exempt organization and a person that is not
an exempt organization described in section 170(c) form a
partnership before May 3, 2005. After May 3, 2005, the
partnership acquires an interest in a life insurance contract
that is issued after May 3, 2005. The acquisition by the
partnership of the interest in the contract is treated as a
taxable acquisition under the provision by each of the
partners (i.e., the exempt organization and the other
person).
The provision also requires reporting of existing life
insurance, endowment and annuity contracts issued on or
before that date, in which an applicable exempt organization
holds an interest on that date and which would be treated as
an applicable insurance contract under the provision. This
reporting is required within one year after the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
3. Increase the amounts of excise taxes imposed on public
charities, social welfare organizations, and private
foundations (sec. 213 of the Senate amendment and secs.
4941, 4942, 4943, 4944, 4945, and 4958 of the Code)
present law
Public charities and social welfare organizations
The Code imposes excise taxes on excess benefit
transactions between disqualified persons (as defined in
section 4958(f)) and charitable organizations (other than
private foundations) or social welfare organizations (as
described in section 501(c)(4)).\124\ An excess benefit
transaction generally is a transaction in which an economic
benefit is provided by a charitable or social welfare
organization directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including
the performance of services) received for providing such
benefit.
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\124\ Sec. 4958. The excess benefit transaction tax is
commonly referred to as ``intermediate sanctions,'' because
it imposes penalties generally considered to be less punitive
than revocation of the organization's exempt status.
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The excess benefit tax is imposed on the disqualified
person and, in certain cases, on the organization manager,
but is not imposed on the exempt organization. An initial tax
of 25 percent of the excess benefit amount is imposed on the
disqualified person that receives the excess benefit. An
additional tax on the disqualified person of 200 percent of
the excess benefit applies if the violation is not corrected.
A tax of 10 percent of the excess benefit (not to exceed
$10,000 with respect to any excess benefit transaction) is
imposed on an organization manager that knowingly
participated in the excess benefit transaction, if the
manager's participation was willful and not due to reasonable
cause, and if the initial tax was imposed on the disqualified
person.\125\ If more than one person is liable for the tax on
disqualified persons or on management, all such persons are
jointly and severally liable for the tax.\126\
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\125\ Sec. 4958(d)(2). Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\126\ Sec. 4958(d)(1).
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Private foundations
Self-dealing by private foundations
Excise taxes are imposed on acts of self-dealing between a
disqualified person (as defined in section 4946) and a
private foundation.\127\ In general, self-dealing
transactions are any direct or indirect: (1) sale or
exchange, or leasing, of property between a private
foundation and a disqualified person; (2) lending of money or
other extension of credit between a private foundation and a
disqualified person; (3) the furnishing of goods, services,
or facilities between a private foundation and a disqualified
person; (4) the payment of compensation (or payment or
reimbursement of expenses) by a private foundation to a
disqualified person; (5) the transfer to, or use by or for
the benefit of, a disqualified person of the income or assets
of the private foundation; and (6) certain payments of money
or property to a government official.\128\ Certain exceptions
apply.\129\
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\127\ Sec. 4941.
\128\ Sec. 4941(d)(1).
\129\ See sec. 4941(d)(2).
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An initial tax of five percent of the amount involved with
respect to an act of self-dealing is imposed on any
disqualified person (other than a foundation manager acting
only as such) who participates in the act of self-dealing. If
such a tax is imposed, a 2.5-percent tax of the amount
involved is imposed on a foundation manager who participated
in the act of self-dealing knowing it was such an act (and
such participation was not willful and was due to reasonable
cause) up to $10,000 per act. Such initial taxes may not be
abated.\130\ Such initial taxes are imposed for each year in
the taxable period, which begins on the date the act of self-
dealing occurs and ends on the earliest of the date of
mailing of a notice of deficiency for the tax, the date on
which the tax is assessed, or the date on which correction of
the act of self-dealing is completed. A government official
(as defined in section 4946(c)) is subject to such initial
tax only if the official participates in the act of self-
dealing knowing it is such an act. If the act of self-dealing
is not corrected, a tax of 200 percent of the amount involved
is imposed on the disqualified person and a tax of 50 percent
of the amount involved (up to $10,000 per act) is imposed on
a foundation manager who refused to agree to correcting the
act of self-dealing. Such additional taxes are subject to
abatement.\131\
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\130\ Sec. 4962(b).
\131\ Sec. 4961.
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Tax on failure to distribute income
Private nonoperating foundations are required to pay out a
minimum amount each year as qualifying distributions. In
general, a qualifying distribution is an amount paid to
accomplish one or more of the organization's exempt purposes,
including reasonable and necessary administrative
expenses.\132\ Failure to pay out the minimum results in an
initial excise tax on the foundation of 15 percent of the
undistributed amount. An additional tax of 100 percent of the
undistributed amount applies if an initial tax is imposed and
the required distributions have
[[Page H2246]]
not been made by the end of the applicable taxable
period.\133\ A foundation may include as a qualifying
distribution the salaries, occupancy expenses, travel costs,
and other reasonable and necessary administrative expenses
that the foundation incurs in operating a grant program. A
qualifying distribution also includes any amount paid to
acquire an asset used (or held for use) directly in carrying
out one or more of the organization's exempt purposes and
certain amounts set-aside for exempt purposes.\134\ Private
operating foundations are not subject to the payout
requirements.
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\132\ Sec. 4942(g)(1)(A).
\133\ Sec. 4942(a) and (b). Taxes imposed may be abated if
certain conditions are met. Secs. 4961 and 4962.
\134\ Sec. 4942(g)(1)(B) and 4942(g)(2). In general, an
organization is permitted to adjust the distributable amount
in those cases where distributions during the five preceding
years have exceeded the payout requirements. Sec. 4942(i).
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Tax on excess business holdings
Private foundations are subject to tax on excess business
holdings.\135\ In general, a private foundation is permitted
to hold 20 percent of the voting stock in a corporation,
reduced by the amount of voting stock held by all
disqualified persons (as defined in section 4946). If it is
established that no disqualified person has effective control
of the corporation, a private foundation and disqualified
persons together may own up to 35 percent of the voting stock
of a corporation. A private foundation shall not be treated
as having excess business holdings in any corporation if it
owns (together with certain other related private
foundations) not more than two percent of the voting stock
and not more than two percent in value of all outstanding
shares of all classes of stock in that corporation. Similar
rules apply with respect to holdings in a partnership
(``profits interest'' is substituted for ``voting stock'' and
``capital interest'' for ``nonvoting stock'') and to other
unincorporated enterprises (by substituting ``beneficial
interest'' for ``voting stock''). Private foundations are not
permitted to have holdings in a proprietorship. Foundations
generally have a five-year period to dispose of excess
business holdings (acquired other than by purchase) without
being subject to tax.\136\ This five-year period may be
extended an additional five years in limited
circumstances.\137\
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\135\ Sec. 4943. Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\136\ Sec. 4943(c)(6).
\137\ Sec. 4943(c)(7).
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The initial tax is equal to five percent of the value of
the excess business holdings held during the foundation's
applicable taxable year. An additional tax is imposed if an
initial tax is imposed and at the close of the applicable
taxable period, the foundation continues to hold excess
business holdings. The amount of the additional tax is equal
to 200 percent of such holdings.
Tax on jeopardizing investments
Private foundations and foundation managers are subject to
tax on investments that jeopardize the foundation's
charitable purpose.\138\ In general, an initial tax of five
percent of the amount of the investment applies to the
foundation and to foundation managers who participated in the
making of the investment knowing that it jeopardized the
carrying out of the foundation's exempt purposes. The initial
tax on foundation managers may not exceed $5,000 per
investment. If the investment is not removed from jeopardy
(e.g., sold or otherwise disposed of), an additional tax of
25 percent of the amount of the investment is imposed on the
foundation and five percent of the amount of the investment
on a foundation manager who refused to agree to removing the
investment from jeopardy. The additional tax on foundation
managers may not exceed $10,000 per investment. An
investment, the primary purpose of which is to accomplish a
charitable purpose and no significant purpose of which is the
production of income or the appreciation of property, is not
considered a jeopardizing investment.\139\
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\138\ Sec. 4944. Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\139\ Sec. 4944(c).
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Tax on taxable expenditures
Certain expenditures of private foundations are subject to
tax.\140\ In general, taxable expenditures are expenses: (1)
for lobbying; (2) to influence the outcome of a public
election or carry on a voter registration drive (unless
certain requirements are met); (3) as a grant to an
individual for travel, study, or similar purposes unless made
pursuant to procedures approved by the Secretary; (4) as a
grant to an organization that is not a public charity or
exempt operating foundation unless the foundation exercises
expenditure responsibility \141\ with respect to the grant;
or (5) for any non-charitable purpose. For each taxable
expenditure, a tax is imposed on the foundation of 10 percent
of the amount of the expenditure, and an additional tax of
100 percent is imposed on the foundation if the expenditure
is not corrected. A tax of 2.5 percent of the expenditure (up
to $5,000) also is imposed on a foundation manager who agrees
to making a taxable expenditure knowing that it is a taxable
expenditure. An additional tax of 50 percent of the amount of
the expenditure (up to $10,000) is imposed on a foundation
manager who refuses to agree to correction of such
expenditure.
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\140\ Sec. 4945. Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\141\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish
reasonable procedures to ensure that the grant is spent
solely for the purpose for which it was made, to obtain
reports from the grantee on the expenditure of the grant, and
to make reports to the Secretary regarding such expenditures.
Sec. 4945(h).
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House Bill
No provision.
Senate Amendment
Self-dealing and excess benefit transaction initial taxes and
dollar limitations
For acts of self-dealing other than the payment of
compensation by a private foundation to a disqualified
person, the provision increases the initial tax on the self-
dealer from five percent of the amount involved to 10 percent
of the amount involved. For acts of self-dealing regarding
the payment of compensation by a private foundation to a
disqualified person, the provision increases the initial tax
on the self-dealer from five percent of the amount involved
(none of which is subject to abatement) to 25 percent of the
amount involved (15 percent of which is subject to
abatement). The provision increases the initial tax on
foundation managers from 2.5 percent of the amount involved
to five percent of the amount involved and increases the
dollar limitation on the amount of the initial and additional
taxes on foundation managers per act of self-dealing from
$10,000 per act to $20,000 per act. Similarly, the provision
doubles the dollar limitation on organization managers of
public charities and social welfare organizations for
participation in excess benefit transactions from $10,000 per
transaction to $20,000 per transaction.
Failure to distribute income, excess business holdings,
jeopardizing investments, and taxable expenditures
The provision doubles the amounts of the initial taxes and
the dollar limitations on foundation managers with respect to
the private foundation excise taxes on the failure to
distribute income, excess business holdings, jeopardizing
investments, and taxable expenditures.
Specifically, for the failure to distribute income, the
initial tax on the foundation is increased from 15 percent of
the undistributed amount to 30 percent of the undistributed
amount.
For excess business holdings, the initial tax on excess
business holdings is increased from five percent of the value
of such holdings to 10 percent of such value.
For jeopardizing investments, the initial tax of five
percent of the amount of the investment that is imposed on
the foundation and on foundation managers is increased to 10
percent of the amount of the investment. The dollar
limitation on the initial tax on foundation managers of
$5,000 per investment is increased to $10,000 and the dollar
limitation on the additional tax on foundation managers of
$10,000 per investment is increased to $20,000.
For taxable expenditures, the initial tax on the foundation
is increased from 10 percent of the amount of the expenditure
to 20 percent, the initial tax on the foundation manager is
increased from 2.5 percent of the amount of the expenditure
to five percent, the dollar limitation on the initial tax on
foundation managers is increased from $5,000 to $10,000, and
the dollar limitation on the additional tax on foundation
managers is increased from $10,000 to $20,000.
Effective date
The provision is effective for taxable years beginning
after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
4. Reform rules for charitable contributions of easements on
buildings in registered historic districts (Sec. 214 of
the Senate amendment and sec. 170 of the Code)
Present Law
In general
Present law provides special rules that apply to charitable
deductions of qualified conservation contributions, which
include conservation easements and facade easements.\142\
Qualified conservation contributions are not subject to the
``partial interest'' rule, which generally bars deductions
for charitable contributions of partial interests in
property.\143\ Accordingly, qualified conservation
contributions are contributions of partial interests that are
eligible for a fair market value charitable deduction.
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\142\ Sec. 170(h).
\143\ Sec. 170(f)(3).
---------------------------------------------------------------------------
A qualified conservation contribution is a contribution of
a qualified real property interest to a qualified
organization exclusively for conservation purposes. A
qualified real property interest is defined as: (1) the
entire interest of the donor other than a qualified mineral
interest; (2) a remainder interest; or (3) a restriction
(granted in perpetuity) on the use that may be made of the
real property.\144\ Qualified organizations include certain
governmental units, public charities that meet certain public
support tests, and certain supporting organizations.
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\144\ Charitable contributions of interests that constitute
the taxpayer's entire interest in the property are not
regarded as qualified real property interests within the
meaning of section 170(h), but instead are subject to the
general rules applicable to charitable contributions of
entire interests of the taxpayer (i.e., generally are
deductible at fair market value, without regard to
satisfaction of the requirements of section 170(h)).
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Conservation purposes include: (1) the preservation of land
areas for outdoor recreation
[[Page H2247]]
by, or for the education of, the general public; (2) the
protection of a relatively natural habitat of fish, wildlife,
or plants, or similar ecosystem; (3) the preservation of open
space (including farmland and forest land) where such
preservation will yield a significant public benefit and is
either for the scenic enjoyment of the general public or
pursuant to a clearly delineated Federal, State, or local
governmental conservation policy; and (4) the preservation of
an historically important land area or a certified historic
structure.\145\
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\145\ Sec. 170(h)(4)(A).
---------------------------------------------------------------------------
In general, no deduction is available if the property may
be put to a use that is inconsistent with the conservation
purpose of the gift.\146\ A contribution is not deductible if
it accomplishes a permitted conservation purpose while also
destroying other significant conservation interests.\147\
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\146\ Treas. Reg. sec. 1.170A-14(e)(2).
\147\ Treas. Reg. sec. 1.170A-14(e)(2).
---------------------------------------------------------------------------
Taxpayers are required to obtain a qualified appraisal for
donated property with a value of $5,000 or more, and to
attach an appraisal summary to the tax return.\148\ Under
Treasury regulations, a qualified appraisal means an
appraisal document that, among other things: (1) relates to
an appraisal that is made not earlier than 60 days prior to
the date of contribution of the appraised property and not
later than the due date (including extensions) of the return
on which a deduction is first claimed under section 170;\149\
(2) is prepared, signed, and dated by a qualified appraiser;
(3) includes (a) a description of the property appraised; (b)
the fair market value of such property on the date of
contribution and the specific basis for the valuation; (c) a
statement that such appraisal was prepared for income tax
purposes; (d) the qualifications of the qualified appraiser;
and (e) the signature and taxpayer identification number of
such appraiser; and (4) does not involve an appraisal fee
that violates certain prescribed rules.\150\
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\148\ Sec. 170(f)(11)(C).
\149\ In the case of a deduction first claimed or reported on
an amended return, the deadline is the date on which the
amended return is filed.
\150\ Treas. Reg. sec. 1.170A-13(c)(3).
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Valuation
The value of a conservation restriction granted in
perpetuity generally is determined under the ``before and
after approach.'' Such approach provides that the fair market
value of the restriction is equal to the difference (if any)
between the fair market value of the property the restriction
encumbers before the restriction is granted and the fair
market value of the encumbered property after the restriction
is granted.\151\
---------------------------------------------------------------------------
\151\ Treas. Reg. sec. 1.170A-14(h)(3).
---------------------------------------------------------------------------
If the granting of a perpetual restriction has the effect
of increasing the value of any other property owned by the
donor or a related person, the amount of the charitable
deduction for the conservation contribution is to be reduced
by the amount of the increase in the value of the other
property.\152\ In addition, the donor is to reduce the amount
of the charitable deduction by the amount of financial or
economic benefits that the donor or a related person receives
or can reasonably be expected to receive as a result of the
contribution.\153\ If such benefits are greater than those
that will inure to the general public from the transfer, no
deduction is allowed.\154\ In those instances where the grant
of a conservation restriction has no material effect on the
value of the property, or serves to enhance, rather than
reduce, the value of the property, no deduction is
allowed.\155\
---------------------------------------------------------------------------
\152\ Treas. Reg. sec. 1.170A-14(h)(3)(i).
\153\ Id.
\154\ Id.
\155\ Treas. Reg. sec. 1.170A-14(h)(3)(ii).
---------------------------------------------------------------------------
Preservation of a certified historic structure
A certified historic structure means any building,
structure, or land which is (i) listed in the National
Register, or (ii) located in a registered historic district
(as defined in section 47(c)(3)(B)) and is certified by the
Secretary of the Interior to the Secretary of the Treasury as
being of historic significance to the district.\156\ For this
purpose, a structure means any structure, whether or not it
is depreciable, and, accordingly, easements on private
residences may qualify.\157\ If restrictions to preserve a
building or land area within a registered historic district
permit future development on the site, a deduction will be
allowed only if the terms of the restrictions require that
such development conform with appropriate local, State, or
Federal standards for construction or rehabilitation within
the district.\158\
---------------------------------------------------------------------------
\156\ Sec. 170(h)(4)(B).
\157\ Treas. Reg. sec. 1.170A-14(d)(5)(iii).
\158\ Treas. Reg. sec. 1.170A-14(d)(5)(i).
---------------------------------------------------------------------------
The IRS and the courts have held that a facade easement may
constitute a qualifying conservation contribution.\159\ In
general, a facade easement is a restriction the purpose of
which is to preserve certain architectural, historic, and
cultural features of the facade, or front, of a building. The
terms of a facade easement might permit the property owner to
make alterations to the facade of the structure if the owner
obtains consent from the qualified organization that holds
the easement.
---------------------------------------------------------------------------
\159\ Hillborn v. Commissioner, 85 T.C. 677 (1985) (holding
the fair market value of a facade donation generally is
determined by applying the ``before and after'' valuation
approach); Richmond v. U.S., 699 F. Supp. 578 (E.D. La.
1988); Priv. Ltr. Rul. 199933029 (May 24, 1999) (ruling that
a preservation and conservation easement relating to the
facade and certain interior portions of a fraternity house
was a qualified conservation contribution).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision revises the rules for qualified conservation
contributions with respect to property for which a charitable
deduction is allowable under section 170(h)(4)(B)(ii) by
reason of a property's location in a registered historic
district. Under the provision, a charitable deduction is not
allowable with respect to a structure or land area located in
such a district (by reason of the structure or land area's
location in such a district). A charitable deduction is
allowable with respect to buildings (as is the case under
present law) but the qualified real property interest that
relates to the exterior of the building must preserve the
entire exterior of the building, including the space above
the building, the sides, the rear, and the front of the
building. In addition, such qualified real property interest
must provide that no portion of the exterior of the building
may be changed in a manner inconsistent with the historical
character of such exterior.
For any contribution relating to a registered historic
district made after the date of enactment of the provision,
taxpayers must include with the return for the taxable year
of the contribution a qualified appraisal of the qualified
real property interest (irrespective of the claimed value of
such interest) and attach the appraisal with the taxpayer's
return, photographs of the entire exterior of the building,
and descriptions of all current restrictions on development
of the building, including, for example, zoning laws,
ordinances, neighborhood association rules, restrictive
covenants, and other similar restrictions. Failure to obtain
and attach an appraisal or to include the required
information results in disallowance of the deduction. In
addition, the donor and the donee must enter into a written
agreement certifying, under penalty of perjury, that the
donee is a qualified organization, with a purpose of
environmental protection, land conservation, open space
preservation, or historic preservation, and that the donee
has the resources to manage and enforce the restriction and a
commitment to do so.
Taxpayers claiming a deduction for a qualified conservation
contribution with respect to the exterior of a building
located in a registered historic district in excess of the
greater of three percent of the fair market value of the
underlying property or $10,000 must pay a $500 fee to the
Internal Revenue Service or the deduction is not allowed.
Amounts paid are required to be dedicated to Internal Revenue
Service enforcement of qualified conservation contributions.
Effective date.--The provision relating to deductions for
contributions relating to structures and land areas is
effective for contributions made after the date of enactment.
The limitation on the amount that may be deducted and the
filing fee is effective for contributions made 180 days after
the date of enactment. The rest of the provision is effective
for contributions made after November 15, 2005.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
5. Reform rules relating to charitable contributions of
taxidermy and recapture tax benefit on property not used
for an exempt use (secs. 215 and 216 of the Senate
amendment and secs. 170, 6050L, and new sec. 6720B of the
Code)
Present Law
Deductibility of charitable contributions
In general
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity.\160\ The amount of the
deduction allowable for a taxable year with respect to a
charitable contribution of property may be reduced or limited
depending on the type of property contributed, the type of
charitable organization to which the property is contributed,
and the income of the taxpayer.\161\ In general, more
generous charitable contribution deduction rules apply to
gifts made to public charities than to gifts made to private
foundations. Within certain limitations, donors also are
entitled to deduct their contributions to section 501(c)(3)
organizations for Federal estate and gift tax purposes. By
contrast, contributions to nongovernmental, non-charitable
tax-exempt organizations generally are not deductible by the
donor,\162\ though such organizations are eligible for the
exemption from Federal income tax with respect to such
donations.
---------------------------------------------------------------------------
\160\ The deduction also is allowed for purposes of
calculating alternative minimum taxable income.
\161\ Secs. 170(b) and (e).
\162\ Exceptions to the general rule of non-deductibility
include certain gifts made to a veterans' organization or to
a domestic fraternal society. In addition, contributions to
certain nonprofit cemetery companies are deductible for
Federal income tax purposes, but generally are not deductible
for Federal estate and gift tax purposes. Secs. 170(c)(3),
170(c)(4), 170(c)(5), 2055(a)(3), 2055(a)(4),
2106(a)(2)(A)(iii), 2522(a)(3), and 2522(a)(4).
---------------------------------------------------------------------------
Contributions of property
The amount of the deduction for charitable contributions of
capital gain property generally equals the fair market value
of the contributed property on the date of the contribution.
Capital gain property means any capital asset, or property
used in the taxpayer's trade or business, the sale of which
[[Page H2248]]
at its fair market value, at the time of contribution, would
have resulted in gain that would have been long-term capital
gain. Contributions of capital gain property are subject to
different percentage limitations (i.e., limitations based on
the donor's income) than other contributions of property.
For certain contributions of property, the deductible
amount is reduced from the fair market value of the
contributed property by the amount of any gain, generally
resulting in a deduction equal to the taxpayer's basis. This
rule applies to contributions of: (1) ordinary income
property, e.g., property that, at the time of contribution,
would not have resulted in long-term capital gain if the
property was sold by the taxpayer on the contribution date;
\163\ (2) tangible personal property that is used by the
donee in a manner unrelated to the donee's exempt (or
governmental) purpose; and (3) property to or for the use of
a private foundation (other than a foundation defined in
section 170(b)(1)(E)).
---------------------------------------------------------------------------
\163\ For certain contributions of inventory, C corporations
may claim an enhanced deduction equal to the lesser of (1)
basis plus one-half of the item's appreciation (i.e., basis
plus one half of fair market value in excess of basis) or (2)
two times basis. Sec. 170(e)(3), 170(e)(4), 170(e)(6).
---------------------------------------------------------------------------
Charitable contributions of taxidermy are subject to the
tangible personal property rule (number (2) above). For
example, for appreciated taxidermy, if the property is used
to further the donee's exempt purpose, the deduction is fair
market value. But if the property is not used to further the
donee's exempt purpose, the deduction is the donor's basis.
If the taxidermy is depreciated, i.e., the value is less than
the taxpayer's basis in such property, taxpayers generally
deduct the fair market value of such contributions,
regardless of whether the property is used for exempt or
unrelated purposes by the donee.
Substantiation
No charitable deduction is allowed for any contribution of
$250 or more unless the taxpayer substantiates the
contribution by a contemporaneous written acknowledgement of
the contribution by the donee organization.\164\ 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).
---------------------------------------------------------------------------
\164\ Sec. 170(f)(8).
---------------------------------------------------------------------------
In general, if the total charitable deduction claimed for
non-cash 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.\165\ C
corporations (other than personal service corporations and
closely-held corporations) are required to file Form 8283
only if the deduction claimed is more than $5,000.
Information required on the Form 8283 includes, among other
things, a description of the property, the appraised fair
market value (if an appraisal is required), the donor's basis
in the property, how the donor acquired the property, a
declaration by the appraiser regarding the appraiser's
general qualifications, an acknowledgement by the donee that
it is eligible to receive deductible contributions, and an
indication by the donee whether the property is intended for
an unrelated use.
---------------------------------------------------------------------------
\165\ Sec. 170(f)(11).
---------------------------------------------------------------------------
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.\166\ Under
Treasury regulations, a qualified appraisal means an
appraisal document that, among other things: (1) relates to
an appraisal that is made not earlier than 60 days prior to
the date of contribution of the appraised property and not
later than the due date (including extensions) of the return
on which a deduction is first claimed under section 170;\167\
(2) is prepared, signed, and dated by a qualified appraiser;
(3) includes (a) a description of the property appraised; (b)
the fair market value of such property on the date of
contribution and the specific basis for the valuation; (c) a
statement that such appraisal was prepared for income tax
purposes; (d) the qualifications of the qualified appraiser;
and (e) the signature and taxpayer identification number of
such appraiser; and (4) does not involve an appraisal fee
that violates certain prescribed rules.\168\ In the case of
contributions of art valued at more than $20,000 and other
contributions of more than $500,000, taxpayers are required
to attach the appraisal to the tax return. Taxpayers may
request a Statement of Value from the Internal Revenue
Service in order to substantiate the value of art with an
appraised value of $50,000 or more for income, estate, or
gift tax purposes.\169\ The fee for such a Statement is
$2,500 for one, two, or three items or art plus $250 for each
additional item.
---------------------------------------------------------------------------
\166\ Id.
\167\ In the case of a deduction first claimed or reported on
an amended return, the deadline is the date on which the
amended return is filed.
\168\ Treas. Reg. sec. 1.170A-13(c)(3). Sec. 170(f)(11)(E).
\169\ Rev. Proc. 96-15, 1996-1 C.B. 627.
---------------------------------------------------------------------------
If a donee organization sells, exchanges, or otherwise
disposes of contributed property with a claimed value of more
than $5,000 (other than publicly traded securities) within
two years of the property's receipt, the donee is required to
file a return (Form 8282) with the Secretary, and to furnish
a copy of the return to the donor, showing the name, address,
and taxpayer identification number of the donor, a
description of the property, the date of the contribution,
the amount received on the disposition, and the date of the
disposition.\170\
---------------------------------------------------------------------------
\170\ Sec. 6050L(a)(1).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
Contributions of taxidermy
For contributions of taxidermy property with a claimed
value of more than $500, the individual must include with the
individual's return a photograph of the taxidermy and
comparable sales data for similar items. It is intended that
valuation must be based on comparable sales and that a
deduction is not allowable if sufficient comparable sales are
not provided.
For claims of more than $5,000, the taxpayer must notify
the IRS of the deduction and include with the taxpayer's
return a statement of value from the IRS, similar to that
available under present law for items of art, or a request
for such a statement and a fee of $500. The provision defines
taxidermy property as a mounted work of art which contains
any part of a dead animal.
It is intended that for purposes of the charitable
contribution deduction, a taxpayer may not include in the
taxpayer's basis of the contributed taxidermy any costs
attributable to travel.
Recapture of tax benefit upon subsequent disposition of
tangible personal property intended for an exempt use
In general, the provision recovers the tax benefit for
charitable contributions of tangible personal property with
respect to which a fair market value deduction is claimed and
which is not used for exempt purposes. The provision applies
to appreciated tangible personal property that is identified
by the donee organization as for a use related to the purpose
or function constituting the donee's basis for tax exemption,
and for which a deduction of more than $5,000 is claimed
(``applicable property'').\171\
---------------------------------------------------------------------------
\171\ Present law rules continue to apply to any contribution
of exempt use property for which a deduction of $5,000 or
less is claimed.
---------------------------------------------------------------------------
Under the provision, if a donee organization disposes of
applicable property within three years of the contribution of
the property, the donor is subject to an adjustment of the
tax benefit. If the disposition occurs in the tax year of the
donor in which the contribution is made, the donor's
deduction generally is basis and not fair market value.\172\
If the disposition occurs in a subsequent year, the donor
must include as ordinary income for its taxable year in which
the disposition occurs an amount equal to the excess (if any)
of (i) the amount of the deduction previously claimed by the
donor as a charitable contribution with respect to such
property, over (ii) the donor's basis in such property at the
time of the contribution.
---------------------------------------------------------------------------
\172\ The disposition proceeds are regarded as relevant to a
determination of fair market value.
---------------------------------------------------------------------------
There is no adjustment of the tax benefit if the donee
organization makes a certification to the Secretary, by
written statement signed under penalties of perjury by an
officer of the organization. The statement must either (1)
certify that the use of the property by the donee was related
to the purpose or function constituting the basis for the
donee's exemption, and describe how the property was used and
how such use furthered such purpose or function; or (2) state
the intended use of the property by the donee at the time of
the contribution and certify that such use became impossible
or infeasible to implement. The organization must furnish a
copy of the certification to the donor.
A penalty of $10,000 applies to a person that identifies
applicable property as having a use that is related to a
purpose or function constituting the basis for the donee's
exemption knowing that it is not intended for such a
use.\173\
---------------------------------------------------------------------------
\173\ Other present-law penalties also may apply, such as the
penalty for aiding and abetting the understatement of tax
liability under section 6701.
---------------------------------------------------------------------------
Reporting of exempt use property contributions
The provision modifies the present-law information return
requirements that apply upon the disposition of contributed
property by a charitable organization (Form 8282, sec.
6050L). The return requirement is extended to dispositions
made within three years after receipt (from two years). The
donee organization also must provide, in addition to the
information already required to be provided on the return, a
description of the donee's use of the property, a statement
of whether use of the property was related to the purpose or
function constituting the basis for the donee's exemption,
and, if applicable, a certification of any such use
(described above).
Effective date
With respect to contributions of taxidermy property, the
provision is effective for contributions made after November
15, 2005. With respect to exempt use property generally, the
provision is effective for contributions made and returns
filed after June 1, 2006.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
[[Page H2249]]
6. Limit charitable deduction for contributions of clothing
and household items and modify recordkeeping and
substantiation requirements for certain charitable
contributions (secs. 217 and 218 of the Senate amendment
and sec. 170 of the Code)
Present Law
Deductibility of charitable contributions
In general
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity.\174\ The amount of the
deduction allowable for a taxable year with respect to a
charitable contribution of property may be reduced or limited
depending on the type of property contributed, the type of
charitable organization to which the property is contributed,
and the income of the taxpayer.\175\ In general, more
generous charitable contribution deduction rules apply to
gifts made to public charities than to gifts made to private
foundations. Within certain limitations, donors also are
entitled to deduct their contributions to section 501(c)(3)
organizations for Federal estate and gift tax purposes. By
contrast, contributions to nongovernmental, non-charitable
tax-exempt organizations generally are not deductible by the
donor,\176\ though such organizations are eligible for the
exemption from Federal income tax with respect to such
donations.
---------------------------------------------------------------------------
\174\ The deduction also is allowed for purposes of
calculating alternative minimum taxable income.
\175\ Secs. 170(b) and (e).
\176\ Exceptions to the general rule of non-deductibility
include certain gifts made to a veterans' organization or to
a domestic fraternal society. In addition, contributions to
certain nonprofit cemetery companies are deductible for
Federal income tax purposes, but generally are not deductible
for Federal estate and gift tax purposes. Secs. 170(c)(3),
170(c)(4), 170(c)(5), 2055(a)(3), 2055(a)(4),
2106(a)(2)(A)(iii), 2522(a)(3), and 2522(a)(4).
---------------------------------------------------------------------------
Contributions of property
The amount of the deduction for charitable contributions of
capital gain property generally equals the fair market value
of the contributed property on the date of the contribution.
Capital gain property means any capital asset or property
used in the taxpayer's trade or business the sale of which at
its fair market value, at the time of contribution, would
have resulted in gain that would have been long-term capital
gain. Contributions of capital gain property are subject to
different percentage limitations than other contributions of
property.
For certain contributions of property, the deductible
amount is reduced from the fair market value of the
contributed property by the amount of any gain, generally
resulting in a deduction equal to the taxpayer's basis. This
rule applies to contributions of: (1) ordinary income
property, e.g., property that, at the time of contribution,
would not have resulted in long-term capital gain if the
property was sold by the taxpayer on the contribution date;
\177\ (2) tangible personal property that is used by the
donee in a manner unrelated to the donee's exempt (or
governmental) purpose; and (3) property to or for the use of
a private foundation (other than a foundation defined in
section 170(b)(1)(E)).
---------------------------------------------------------------------------
\177\ For certain contributions of inventory and other
property, C corporations may claim an enhanced deduction
equal to the lesser of (1) basis plus one-half of the item's
appreciation (i.e., basis plus one half of fair market value
in excess of basis) or (2) two times basis. Sec. 170(e)(3),
170(e)(4), 170(e)(6).
---------------------------------------------------------------------------
Charitable contributions of clothing and household items
are subject to the tangible personal property rule (number
(2) above). If such contributed property is appreciated
property in the hands of the taxpayer, and is not used to
further the donee's exempt purpose, the deduction is basis.
In general, however, the value of clothing and household
items is less than the taxpayer's basis in such property,
with the result that taxpayers generally deduct the fair
market value of such contributions, regardless of whether the
property is used for exempt or unrelated purposes by the
donee.
Substantiation
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. For a contribution of money, the donor
generally must maintain one of the following: (1) a cancelled
check; (2) a receipt (or a letter or other written
communication) from the donee showing the name of the donee
organization, the date of the contribution, and the amount of
the contribution; or (3) in the absence of a cancelled check
or a receipt, other reliable written records showing the name
of the donee, the date of the contribution, and the amount of
the contribution. For a contribution of property other than
money, the donor generally must maintain a receipt from the
donee organization showing the name of the donee, the date
and location of the contribution, and a detailed description
(but not the value) of the property.\178\ A donor of property
other than money need not obtain a receipt, however, if
circumstances make obtaining a receipt impracticable. Under
such circumstances, the donor must maintain reliable written
records regarding the contribution. The required content of
such a record varies depending upon factors such as the type
and value of property contributed.\179\
---------------------------------------------------------------------------
\178\ Treas. Reg. sec. 1.170A-13(a).
\179\ Treas. Reg. sec. 1.170A-13(b).
---------------------------------------------------------------------------
In addition to the foregoing recordkeeping requirements,
substantiation requirements apply in the case of charitable
contributions with a value of $250 or more. No charitable
deduction is allowed for any contribution of $250 or more
unless the taxpayer substantiates the contribution by a
contemporaneous written acknowledgement of the contribution
by the donee organization. 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.\180\ In general, if the total
charitable deduction claimed for non-cash 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.\181\ 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.
---------------------------------------------------------------------------
\180\ Sec. 170(f)(8).
\181\ Sec. 170(f)(11).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
General rule relating to clothing and household items
The provision requires the Secretary to prepare and publish
an itemized list of clothing and household items and to
assign an amount to each item on the list. The assigned
amount is treated as the fair market value of the item for
purposes of the charitable contribution deduction and is
based on an assumption that the item is in good used
condition or better. Any deduction for a charitable
contribution of each such item may not exceed the item's
assigned amount. Any deduction for an item not in good used
condition or better may not exceed 20 percent of the item's
assigned amount. Any deduction for an item that is not
functional with respect to the use for which it was designed
is not allowed. The list must be published by the
Secretary at least once each calendar year and is
applicable to contributions of clothing and household
items made while the list is effective. The Secretary has
discretion to determine the effective dates for each
published list. The list should be prepared in
consultation with donee organizations that accept
charitable contributions of clothing and household items.
In assigning amounts to particular items, the Secretary
should take into account the sales price of such
contributed item when sold by the donee organizations,
whether through an exempt program of such organizations or
otherwise. If an item of clothing or household item is not
included on the list published by the Secretary, present
law rules apply to the contribution of the item.
The provision does not apply to contributions for which the
donor has obtained a qualified appraisal. The provision also
does not apply to contributions for which a deduction of more
than $500 is claimed if (1) the donee sells the contributed
item before the earlier of the due date (including
extensions) for filing the return of tax for the taxable year
of the donor in which the contribution was made or the date
such return was filed; (2) the donee reports the sales price
of the contributed item to the donor; and (3) the amount
claimed as a deduction with respect to the contributed item
does not exceed the amount of the sales price reported to the
donor.
The provision does not apply to contributions by C
corporations. The provision applies to new and used items.
Household items include furniture, furnishings, electronics,
appliances, linens, and other similar items. Food, paintings,
antiques, and other objects of art, jewelry and gems, and
collections are excluded from the provision.
Substantiation
Clothing and household items
As under present law, for contributions with a claimed
value of $250 or more, the taxpayer must obtain
contemporaneous substantiation from the donee organization,
which must include a description of the property contributed.
The provision provides that, as part of such substantiation,
the taxpayer obtain an indication of the condition of the
item(s), a description of the type of item, and either a copy
of the published list or instructions as to how to find such
list.
Under present law, if a taxpayer claims that the total
value of charitable contributions of noncash property is more
than $500, the taxpayer must include with the taxpayer's
return a description of the property contributed and such
other information as the Secretary may require in order to
claim a charitable deduction (sec. 170(f)(11)(B)). This
requirement presently is satisfied through completion by the
taxpayer of the Form 8283 and attachment of the form to the
taxpayer's return. The provision requires that the donor
include the information about the contribution that is
contained in the contemporaneous substantiation obtained from
the donee organization (for gifts of $250 or more) as part of
such requirement.
Contributions of cash
In addition, in the case of a charitable contribution of
money, regardless of the amount, applicable recordkeeping
requirements are satisfied under the provision only
[[Page H2250]]
if the donor maintains a cancelled check or a receipt (or a
letter or other written communication) from the donee showing
the name of the donee organization, the date of the
contribution, and the amount of the contribution. The
recordkeeping requirements may not be satisfied by
maintaining other written records.
Effective date
The provision relating to clothing and household items is
effective for contributions made after December 31, 2006. The
provision relating to substantiation more generally is
effective for contributions made in taxable years beginning
after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
7. Contributions of fractional interests in tangible personal
property (sec. 219 of the Senate amendment and sec. 170
of the Code)
Present Law
In general, a charitable deduction is not allowable for a
contribution of a partial interest in property, such as an
income interest, a remainder interest, or a right to use
property.\182\ A gift of an undivided portion of a donor's
entire interest in property generally is not treated as a
nondeductible gift of a partial interest in property.\183\
For this purpose, an undivided portion of a donor's entire
interest in property must consist of a fraction or percentage
of each and every substantial interest or right owned by the
donor in such property and must extend over the entire term
of the donor's interest in such property.\184\ A gift
generally is treated as a gift of an undivided portion of a
donor's entire interest in property if the donee is given the
right, as a tenant in common with the donor, to possession,
dominion, and control of the property for a portion of each
year appropriate to its interest in such property.\185\
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\182\ Secs. 170(f)(3)(A) (income tax), 2055(e)(2) (estate
tax), and 2522(c)(2) (gift tax).
\183\ Sec. 170(f)(3)(B)(ii).
\184\ Treas. Reg. sec. 1.170A-7(b)(1).
\185\ Treas. Reg. sec. 1.170A-7(b)(1).
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Consistent with these requirements, a charitable
contribution deduction generally is not allowable for a
contribution of a future interest in tangible personal
property.\186\ For this purpose, a future interest is one
``in which a donor purports to give tangible personal
property to a charitable organization, but has an
understanding, arrangement, agreement, etc., whether written
or oral, with the charitable organization which has the
effect of reserving to, or retaining in, such donor a right
to the use, possession, or enjoyment of the property.'' \187\
Treasury regulations provide that section 170(a)(3), which
generally denies a deduction for a contribution of a future
interest in tangible personal property, ``[has] no
application in respect of a transfer of an undivided present
interest in property. For example, a contribution of an
undivided one-quarter interest in a painting with respect to
which the donee is entitled to possession during three months
of each year shall be treated as made upon the receipt by the
donee of a formally executed and acknowledged deed of gift.
However, the period of initial possession by the donee may
not be deferred in time for more than one year.'' \188\
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\186\ Sec. 170(a)(3).
\187\ Treas. Reg. sec. 1.170A-5(a)(4).
\188\ Treas. Reg. sec. 1.170A-5(a)(2).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
Require consistent valuation of fractional interests in the
same item of property
In general, under present law and the provision a donor may
take a deduction for a charitable contribution of a
fractional interest in tangible personal property (such as an
artwork), provided the donor satisfies the requirements for
deductibility (including the requirements concerning
contributions of partial interests and future interests in
property), and in subsequent years make additional charitable
contributions of interests in the same property.\189\ Under
the provision, a donor's charitable deduction for the initial
contribution of a fractional interest in an item of tangible
personal property (or collection of such items) shall be
determined as under current law (e.g., based upon the fair
market value of the artwork at the time of the contribution
of the fractional interest and considering whether the use of
the artwork will be related to the donee's exempt purposes).
For purposes of determining the deductible amount of each
additional contribution of an interest (whether or not a
fractional interest) in the same item of property, under the
provision, the fair market value of the item shall be the
lesser of: (1) the value used for purposes of determining the
charitable deduction for the initial fractional contribution;
or (2) the fair market value of the item at the time of the
subsequent contribution. This portion of the provision
applies for income, gift, and estate tax purposes.
---------------------------------------------------------------------------
\189\ See, e.g., Winokur v. Commissioner, 90 T.C. 733 (1988).
---------------------------------------------------------------------------
Require actual possession by the donee
The provision provides for recapture of the income tax
charitable deduction or gift tax charitable deduction under
certain circumstances. Specifically, if, during any one-year
period following a contribution of a fractional interest in
an item of tangible personal property, the donee fails to
take actual possession of the item for a period of time
corresponding substantially to the donee's then-existing
percentage interest in the item, then the donee's charitable
deduction for all previous contributions of interests in the
item shall be recaptured (plus interest).
Under the provision, the Secretary of the Treasury is
authorized to promulgate rules to prevent the circumvention
of the provision by, for example, engaging in a transaction
in which a donor first transfers one or more items of
tangible personal property to a separate entity in exchange
for ownership interests in the entity, and subsequently makes
charitable contributions of such ownership interests.
Effective date
The provision is applicable for contributions, bequests,
and gifts made after the date of enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
8. Provisions relating to substantial and gross overstatement
of valuations of property (Sec. 220 of the Senate
amendment and secs. 6662 and 6664 of the Code)
present law
Taxpayer penalties
Present law imposes accuracy-related penalties on a
taxpayer in cases involving a substantial valuation
misstatement or gross valuation misstatement relating to an
underpayment of income tax.\190\ For this purpose, a
substantial valuation misstatement generally means a value
claimed that is at least twice (200 percent or more) the
amount determined to be the correct value, and a gross
valuation misstatement generally means a value claimed that
is at least four times (400 percent or more) the amount
determined to be the correct value.
---------------------------------------------------------------------------
\190\ Sec. 6662(b)(3) and (h).
---------------------------------------------------------------------------
The penalty is 20 percent of the underpayment of tax
resulting from a substantial valuation misstatement and rises
to 40 percent for a gross valuation misstatement. No penalty
is imposed unless the portion of the underpayment
attributable to the valuation misstatement exceeds $5,000
($10,000 in the case of a corporation other than an S
corporation or a personal holding company). Under present
law, no penalty is imposed with respect to any portion of the
understatement attributable to any item if (1) the treatment
of the item on the return is or was supported by substantial
authority, or (2) facts relevant to the tax treatment of the
item were adequately disclosed on the return or on a
statement attached to the return and there is a reasonable
basis for the tax treatment. Special rules apply to tax
shelters.
In addition, the accuracy-related penalty does not apply if
a taxpayer shows there was reasonable cause for an
underpayment and the taxpayer acted in good faith.\191\
---------------------------------------------------------------------------
\191\ Sec. 6664(c).
---------------------------------------------------------------------------
Penalty for aiding and abetting understatement of tax
A penalty is imposed on a person who: (1) aids or assists
in or advises with respect to a tax return or other document;
(2) knows (or has reason to believe) that such document will
be used in connection with a material tax matter; and (3)
knows that this would result in an understatement of tax of
another person. In general, the amount of the penalty is
$1,000. If the document relates to the tax return of a
corporation, the amount of the penalty is $10,000.
Qualified appraisals
Present law requires a taxpayer 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.\192\ Treasury Regulations state that a qualified
appraisal means an appraisal document that, among other
things: (1) relates to an appraisal that is made not earlier
than 60 days prior to the date of contribution of the
appraised property and not later than the due date (including
extensions) of the return on which a deduction is first
claimed under section 170; (2) is prepared, signed, and dated
by a qualified appraiser; (3) includes (a) a description of
the property appraised; (b) the fair market value of such
property on the date of contribution and the specific basis
for the valuation; (c) a statement that such appraisal was
prepared for income tax purposes; (d) the qualifications of
the qualified appraiser; and (e) the signature and taxpayer
identification number of such appraiser; and (4) does not
involve an appraisal fee that violates certain prescribed
rules.\193\
---------------------------------------------------------------------------
\192\ Sec. 170(f)(11).
\193\ Treas. Reg. sec. 1.170A-13(c)(3).
---------------------------------------------------------------------------
Qualified appraisers
Treasury Regulations define a qualified appraiser as a
person who holds himself or herself out to the public as an
appraiser or performs appraisals on a regular basis, is
qualified to make appraisals of the type of property being
valued (as determined by the appraiser's background,
experience, education and membership, if any, in professional
appraisal associations), is independent, and understands that
an intentionally false or fraudulent overstatement of the
value of the appraised property may subject the appraiser to
civil penalties.\194\
---------------------------------------------------------------------------
\194\ Treas. Reg. sec. 1.170A-13(c)(5)(i).
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[[Page H2251]]
Appraiser oversight
The Secretary is authorized to regulate the practice of
representatives of persons before the Department of the
Treasury (``Department'').\195\ After notice and hearing, the
Secretary is authorized to suspend or disbar from practice
before the Department or the Internal Revenue Service
(``IRS'') a representative who is incompetent, who is
disreputable, who violates the rules regulating practice
before the Department or the IRS, or who (with intent to
defraud) willfully and knowingly misleads or threatens the
person being represented (or a person who may be
represented).
---------------------------------------------------------------------------
\195\ 31 U.S.C. sec. 330.
---------------------------------------------------------------------------
The Secretary also is authorized to bar from appearing
before the Department or the IRS, for the purpose of offering
opinion evidence on the value of property or other assets,
any individual against whom a civil penalty for aiding and
abetting the understatement of tax has been assessed. Thus,
an appraiser who aids or assists in the preparation or
presentation of an appraisal will be subject to disciplinary
action if the appraiser knows that the appraisal will be used
in connection with the tax laws and will result in an
understatement of the tax liability of another person. The
Secretary has authority to provide that the appraisals of an
appraiser who has been disciplined have no probative effect
in any administrative proceeding before the Department or the
IRS.
house bill
No provision.
senate amendment
Taxpayer penalties
The provision lowers the thresholds for imposing accuracy-
related penalties on a taxpayer who claims a deduction for
donated property for which a qualified appraisal is required.
Under the provision, a substantial valuation misstatement
exists when the claimed value of donated property is 150
percent or more of the amount determined to be the correct
value. A gross valuation misstatement occurs when the claimed
value of donated property is 200 percent or more the amount
determined to be the correct value. Under the provision, the
reasonable cause exception to the accuracy-related penalty
does not apply in the case of gross valuation misstatements.
Appraiser oversight
Appraiser penalties
The provision establishes a civil penalty on any person who
prepares an appraisal that is to be used to support a tax
position if such appraisal results in a substantial or gross
valuation misstatement. The penalty is equal to the greater
of $1,000 or 10 percent of the understatement of tax
resulting from a substantial or gross valuation misstatement,
up to a maximum of 125 percent of the gross income derived
from the appraisal. Under the provision, the penalty does not
apply if the appraiser establishes that it was ``more likely
than not'' that the appraisal was correct.
Disciplinary proceeding
The provision eliminates the requirement that the Secretary
assess against an appraiser the civil penalty for aiding and
abetting the understatement of tax before such appraiser may
be subject to disciplinary action. Thus, the Secretary is
authorized to discipline appraisers after notice and hearing.
Disciplinary action may include, but is not limited to,
suspending or barring an appraiser from: preparing or
presenting appraisals on the value of property or other
assets to the Department or the IRS; appearing before the
Department or the IRS for the purpose of offering opinion
evidence on the value of property or other assets; and
providing that the appraisals of an appraiser who have
been disciplined have no probative effect in any
administrative proceeding before the Department or the
IRS.
Qualified appraisers
The provision defines a qualified appraiser as an
individual who (1) has earned an appraisal designation from a
recognized professional appraiser organization or has
otherwise met minimum education and experience requirements
to be determined by the IRS in regulations; (2) regularly
performs appraisals for which he or she receives
compensation; (3) can demonstrate verifiable education and
experience in valuing the type of property for which the
appraisal is being performed; (4) has not been prohibited
from practicing before the IRS by the Secretary at any time
during the three years preceding the conduct of the
appraisal; and (5) is not excluded from being a qualified
appraiser under applicable Treasury regulations.
Qualified appraisals
The provision defines a qualified appraisal as an appraisal
of property prepared by a qualified appraiser (as defined by
the provision) in accordance with generally accepted
appraisal standards and any regulations or other guidance
prescribed by the Secretary.
Effective date
The provision amending the accuracy-related penalty applies
to returns filed after the date of enactment. The provision
establishing a civil penalty that may be imposed on any
person who prepares an appraisal that is to be used to
support a tax position if such appraisal results in a
substantial or gross valuation misstatement applies to
appraisals prepared with respect to returns or submissions
filed after the date of enactment. The provisions relating to
appraiser oversight apply to appraisals prepared with respect
to returns or submissions filed after the date of enactment.
With respect to any contribution of a qualified real property
interest which is a restriction with respect to the exterior
of a building described in section 170(h)(4)(C)(ii)
(currently designated section 170(h)(4)(B)(ii), relating to
certain property located in a registered historic district
and certified as being of historic significance to the
district), and any appraisal with respect to such
contribution, the provision generally applies to returns
filed after December 16, 2004.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
9. Establish additional exemption standards for credit
counseling organizations (Sec. 221 of the Senate
amendment and secs. 501 and 513 of the Code)
Present Law
Under present law, a credit counseling organization may be
exempt as a charitable or educational organization described
in section 501(c)(3), or as a social welfare organization
described in section 501(c)(4). The IRS has issued two
revenue rulings holding that certain credit counseling
organizations are exempt as charitable or educational
organizations or as social welfare organizations.
In Revenue Ruling 65-299,\196\ an organization whose
purpose was to assist families and individuals with financial
problems, and help reduce the incidence of personal
bankruptcy, was determined to be a social welfare
organization described in section 501(c)(4). The organization
counseled people in financial difficulties, advised
applicants on payment of debts, and negotiated with creditors
and set up debt repayment plans. The organization did not
restrict its services to the poor, made no charge for
counseling services, and made a nominal charge for certain
services to cover postage and supplies. For financial
support, the organization relied on voluntary contributions
from local businesses, lending agencies, and labor unions.
---------------------------------------------------------------------------
\196\ Rev. Rul. 65-299, 1965-2 C.B. 165.
---------------------------------------------------------------------------
In Revenue Ruling 69-441,\197\ the IRS ruled an
organization was a charitable or educational organization
exempt under section 501(c)(3) by virtue of aiding low-income
people who had financial problems and providing education to
the public. The organization in that ruling had two
functions: (1) educating the public on personal money
management, such as budgeting, buying practices, and the
sound use of consumer credit through the use of films,
speakers, and publications; and (2) providing individual
counseling to low-income individuals and families without
charge. As part of its counseling activities, the
organization established debt management plans for clients
who required such services, at no charge to the clients.\198\
The organization was supported by contributions primarily
from creditors, and its board of directors was comprised of
representatives from religious organizations, civic groups,
labor unions, business groups, and educational institutions.
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\197\ Rev. Rul. 65-441, 1969-2 C.B. 115.
\198\ Debt management plans are debt payment arrangements,
including debt consolidation arrangements, entered into by a
debtor and one or more of the debtor's creditors, generally
structured to reduce the amount of a debtor's regular ongoing
payment by modifying the interest rate, minimum payment,
maturity or other terms of the debt. Such plans frequently
are promoted as a means for a debtor to restructure debt
without filing for bankruptcy.
---------------------------------------------------------------------------
In 1976, the IRS denied exempt status to an organization,
Consumer Credit Counseling Service of Alabama, whose
activities were distinguishable from those in Revenue Ruling
69-441 in that (1) it did not restrict its services to the
poor, and (2) it charged a nominal fee for its debt
management plans.\199\ The organization provided free
information to the general public through the use of
speakers, films, and publications on the subjects of
budgeting, buying practices, and the use of consumer credit.
It also provided counseling to debt-distressed individuals,
not necessarily poor or low-income, and provided debt
management plans at the cost of $10 per month, which was
waived in cases of financial hardship. Its debt management
activities were a relatively small part of its overall
activities. The district court determined the organization
qualified as charitable and educational within section
501(c)(3), finding the debt management plans to be an
integral part of the agency's counseling function, and that
its debt management activities were incidental to its
principal functions, as only approximately 12 percent of the
counselors' time was applied to such programs and the charge
for the service was nominal. The court also considered the
facts that the agency was publicly supported, and that it had
a board dominated by members of the general public, as
factors indicating a charitable operation.\200\
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\199\ Consumer Credit Counseling Services of Alabama, Inc. v.
U.S., 44 A.F.T.R. 2d (RIA) 5122 (D.D.C. 1978). The case
involved 24 agencies throughout the United States.
\200\ See also, Credit Counseling Centers of Oklahoma, Inc.
v. U.S., 45 A.F.T.R. 2d (RIA) 1401 (D.D.C. 1979) (holding the
same on virtually identical facts).
---------------------------------------------------------------------------
A recent estimate shows the number of credit counseling
organizations increased from approximately 200 in 1990 to
over 1,000 in 2002.\201\ During the period from 1994 to late
[[Page H2252]]
2003, 1,215 credit counseling organizations applied to the
IRS for tax exempt status under section 501(c)(3), including
810 during 2000 to 2003.\202\ The IRS has recognized more
than 850 credit counseling organizations as tax exempt under
section 501c)((3).\203\ Few credit counseling organizations
have sought section 501(c)(4) status, and the IRS reports it
has not seen any significant increase in the number or
activity of such organizations operating as social welfare
organizations.\204\ As of late 2003, there were 872 active
tax-exempt credit counseling agencies operating in the United
States.\205\
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\201\ Opening Statement of The Honorable Max Sandlin, Hearing
on Non-Profit Credit Counseling Organizations, House Ways and
Means Committee, Subcommittee on Oversight (November 20,
2003).
\202\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs,
Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, Report Prepared by the Majority & Minority
Staffs of the Permanent Subcommittee on Investigations and
Released in Conjunction with the Permanent Subcommittee
Investigations' Hearing on March 24, 2004, p. 3 (citing
letter dated December 18, 2003, to the Subcommittee from IRS
Commissioner Everson).
\203\ Testimony of Commissioner Mark Everson before the House
Ways and Means Committee, Subcommittee on Oversight (November
20, 2003).
\204\ Testimony of Commissioner Mark Everson before the House
Ways and Means Committee, Subcommittee on Oversight (November
20, 2003).
\205\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs,
Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, Report Prepared by the Majority & Minority
Staffs of the Permanent Subcommittee on Investigations and
Released in Conjunction with the Permanent Subcommittee
Investigations' Hearing on March 24, 2004, p. 3 (citing
letter dated December 18, 2003 to the Subcommittee from IRS
Commissioner Everson).
---------------------------------------------------------------------------
A credit counseling organization described in section
501(c)(3) is exempt from certain Federal and State consumer
protection laws that provide exemptions for organizations
described therein.\206\ Some believe that these exclusions
from Federal and State regulation may be a primary motivation
for the recent increase in the number of organizations
seeking and obtaining exempt status under section
501(c)(3).\207\ Such regulatory exemptions generally are not
available for social welfare organizations described in
section 501(c)(4).
---------------------------------------------------------------------------
\206\ E.g., The Credit Repair Organizations Act, 15 U.S.C.
section 1679 et seq., effective April 1, 1997 (imposing
restrictions on credit repair organizations that are enforced
by the Federal Trade Commission, including forbidding the
making of untrue or misleading statements and forbidding
advance payments; section 501(c)(3) organizations are
explicitly exempt from such regulation). Testimony of
Commissioner Mark Everson before the House Ways and Means
Committee, Subcommittee on Oversight (November 20, 2003)
(California's consumer protections laws that impose strict
standards on credit service organizations and the credit
repair industry do not apply to nonprofit organizations that
have received a final determination from the IRS that they
are exempt from tax under section 501(c)(3) and are not
private foundations).
\207\ Testimony of Commissioner Mark Everson before the House
Ways and Means Committee, Subcommittee on Oversight (November
20, 2003).
---------------------------------------------------------------------------
Congress recently conducted hearings investigating the
activities of credit counseling organizations under various
consumer protection laws,\208\ such as the Federal Trade
Commission Act.\209\ In addition, the IRS has commenced a
broad examination and compliance program with respect to the
credit counseling industry, pursuant to which the IRS has
initiated audits of 50 credit counseling organizations,
including nine of the 15 largest in terms of gross
receipts.\210\
---------------------------------------------------------------------------
\208\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs,
Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, Report Prepared by the Majority & Minority
Staffs of the Permanent Subcommittee on Investigations and
Released in Conjunction with the Permanent Subcommittee
Investigations' Hearing on March 24, 2004.
\209\ 15 U.S.C. sec. 45(a) (prohibiting unfair and deceptive
acts or practices in or affecting commerce; although the
Federal Trade Commission generally lacks jurisdiction to
enforce consumer protection laws against bona fide nonprofit
organizations, it may assert jurisdiction over a nonprofit,
including a credit counseling organization, if it
demonstrates the organization is organized to carry on
business for profit, is a mere instrumentality of a for-
profit entity, or operates through a common enterprise with
one or more for-profit entities).
\210\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs,
Profiteering in a Non-Profit Industry: Abusive Practices in
Credit Counseling, Report Prepared by the Majority & Minority
Staffs of the Permanent Subcommittee on Investigations and
Released in Conjunction with the Permanent Subcommittee
Investigations' Hearing on March 24, 2004, p. 31.
---------------------------------------------------------------------------
Under the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, an individual generally may not be a
debtor in bankruptcy unless such individual has, within 180
days of filing a petition for bankruptcy, received from an
approved nonprofit budget and credit counseling agency an
individual or group briefing that outlines the opportunities
for available credit counseling and assists the individual in
performing a related budget analysis.\211\ The clerk of the
court must maintain a publicly available list of nonprofit
budget and credit counseling agencies approved by the U.S.
Trustee (or bankruptcy administrator). In general, the U.S.
Trustee (or bankruptcy administrator) shall only approve an
agency that demonstrates that it will provide qualified
counselors, maintain adequate provision for safekeeping and
payment of client funds, provide adequate counseling with
respect to client credit problems, and deal responsibly and
effectively with other matters relating to the quality,
effectiveness, and financial security of the services it
provides. The minimum qualifications for approval of such an
agency include: (1) in general, having an independent board
of directors; (2) charging no more than a reasonable fee, and
providing services without regard to ability to pay; (3)
adequate provision for safekeeping and payment of client
funds; (4) provision of full disclosures to clients; (5)
provision of adequate counseling with respect to a client's
credit problems; (6) trained counselors who receive no
commissions or bonuses based on the outcome of the counseling
services; (7) experience and background in providing credit
counseling; and (8) adequate financial resources to provide
continuing support services for budgeting plans over the life
of any repayment plan. An individual debtor must file with
the court a certificate from the approved nonprofit budget
and credit counseling agency that provided the required
services describing the services provided, and a copy of the
debt management plan, if any, developed through the
agency.\212\
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\211\ This requirement does not apply in certain
circumstances, such as: (1) in general, where a debtor
resides in a district for which the U.S. Trustee has
determined that the approved counseling agencies for such
district are not reasonably able to provide adequate services
to additional individuals; (2) where exigent circumstances
merit a waiver, the individual seeking bankruptcy protection
files an appropriate certification with the court, and the
certification is acceptable to the court; and (3) in general,
where a court determines, after notice and hearing, that the
individual is unable to complete the requirement because of
incapacity, disability, or active military duty in a military
combat zone.
\212\ The Act also requires that, prior to discharge of
indebtedness under chapter 7 or chapter 13, a debtor complete
an approved instructional course concerning personal
financial management, which course need not be conducted by a
nonprofit agency.
---------------------------------------------------------------------------
house bill
No provision.
Senate Amendment
Requirements for exempt status of credit counseling
organizations
Under the provision, an organization that provides credit
counseling services as a substantial purpose of the
organization (``credit counseling organization'') is eligible
for exemption from Federal income tax only as a charitable or
educational organization under section 501(c)(3) or as a
social welfare organization under section 501(c)(4), and
only if (in addition to present-law requirements) the
credit counseling organization is organized and operated
in accordance with the following:
1. The organization provides credit counseling services
tailored to the specific needs and circumstances of the
consumer;
2. The organization makes no loans to debtors and does not
negotiate the making of loans on behalf of debtors;
3. The organization generally does not promote, or charge
any separate fee for any service for the purpose of improving
any consumer's credit record, credit history, or credit
rating;
4. The organization does not refuse to provide credit
counseling services to a consumer due to inability of the
consumer to pay, the ineligibility of the consumer for debt
management plan enrollment, or the unwillingness of a
consumer to enroll in a debt management plan;
5. The organization establishes and implements a fee policy
to require that any fees charged to a consumer for its
services are reasonable, and prohibits charging any fee based
in whole or in part on a percentage of the consumer's debt,
the consumer's payments to be made pursuant to a debt
management plan, or on the projected or actual savings to the
consumer resulting from enrolling in a debt management plan;
6. The organization at all times has a board of directors
or other governing body (a) that is controlled by persons who
represent the broad interests of the public, such as public
officials acting in their capacities as such, persons having
special knowledge or expertise in credit or financial
education, and community leaders; (b) not more than 20
percent of the voting power of which is vested in persons who
are employed by the organization or who will benefit
financially, directly or indirectly, from the organization's
activities (other than through the receipt of reasonable
directors' fees or the repayment of consumer debt to
creditors other than the credit counseling organization or
its affiliates) and (c) not more than 49 percent of the
voting power of which is vested in persons who are employed
by the organization or who will benefit financially, directly
or indirectly, from the organization's activities (other than
through the receipt of reasonable directors' fees);
7. The organization receives no amount for providing
referrals to others for financial services (including debt
management services) or credit counseling services to be
provided to consumers, and pays no amount to others for
obtaining referrals of consumers; and
8. The organization does not own more than 35 percent of
the total combined voting power of a corporation (or profits
or beneficial interest in the case of a partnership or trust
or estate) that is in the business of lending money,
repairing credit, or providing debt management plan services,
payment processing, and similar services.
The Secretary may require any credit counseling
organization to submit such information as the Secretary
requires to verify that such organization meets the
requirements of the provision.
[[Page H2253]]
Additional requirements for charitable and educational
organizations
Under the provision, a credit counseling organization is
described in section 501(c)(3) only if, in addition to
satisfying the above requirements, the organization is
organized and operated such that the organization (1) charges
no fees (other than nominal fees) for debt management plan
services and waives any fees if the consumer is unable to pay
such fees; (2) does not solicit contributions from consumers
during the initial counseling process or while the consumer
is receiving services from the organization; (3) normally
limits debt management plan services (in the aggregate) to 25
percent of the organization's total activities (determined by
taking into account time, resources, source of revenues or
effort expended by the organization, and any other measures
prescribed by the Secretary).\213\
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\213\ If, under any such measure, the organization's debt
management plan services exceed 25 percent of the
organization's total activities, the organization is treated
as exceeding the 25-percent limit. For example, an
organization that devotes 30 percent of its total staff time
to debt management plan services is regarded as exceeding the
25-percent limit, even if the organization devotes less than
15 percent of its total financial resources to debt
management plan services.
---------------------------------------------------------------------------
Additional requirements for social welfare organizations
Under the provision, a credit counseling organization is
described in section 501(c)(4) only if, in addition to
satisfying the above requirements applicable to such
organizations, it is organized and operated such that the
organization charges no fees (other than nominal fees) for
its credit counseling services, and waives any fees if the
consumer is unable to pay such fees. In addition, a credit
counseling organization shall not be treated as an
organization described in section 501(c)(4) unless such
organization notifies the Secretary, in such manner as the
Secretary may by regulations prescribe, that it is applying
for recognition as a credit counseling organization.
Debt management plan services treated as an unrelated trade
or business
Under the provision, debt management plan services are
treated as an unrelated trade or business for purposes of the
tax on income from an unrelated trade or business to the
extent such services are not substantially related to the
provision of credit counseling services to a consumer or are
provided by an organization that is not a credit counseling
organization.
Definitions
Credit counseling services
Credit counseling services are (a) the provision of
educational information to the general public on budgeting,
personal finance, financial literacy, saving and spending
practices, and the sound use of consumer credit; (b) the
assisting of individuals and families with financial
problems by providing them with counseling; or (c) any
combination of such activities.
Debt management plan services
Debt management plan services are services related to the
repayment, consolidation, or restructuring of a consumer's
debt, and includes the negotiation with creditors of lower
interest rates, the waiver or reduction of fees, and the
marketing and processing of debt management plans.
Effective date
In general the provision applies to taxable years beginning
after the date of enactment. For a credit counseling
organization that is described in section 501(c)(3) or
501(c)(4) on the date of enactment, the provision is
effective for taxable years beginning after the date that is
one year after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
10. Expand the base of the tax on private foundation net
investment income (sec. 222 of the Senate amendment and
sec. 4940 of the Code)
Present Law
In general
Under section 4940(a) of the Code, private foundations that
are recognized as exempt from Federal income tax under
section 501(a) of the Code are subject to a two-percent
excise tax on their net investment income. Private
foundations that are not exempt from tax, such as certain
charitable trusts,\214\ also are subject to an excise tax
under section 4940(b) based on net investment income and
unrelated business income. The two-percent rate of tax is
reduced to one-percent if certain requirements are met in a
taxable year.\215\ Unlike certain other excise taxes imposed
on private foundations, the tax based on investment income
does not result from a violation of substantive law by the
private foundation; it is solely an excise tax.
---------------------------------------------------------------------------
\214\ See sec. 4947(a)(1).
\215\ Sec. 4940(e).
---------------------------------------------------------------------------
The tax on taxable private foundations under section
4940(b) 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 unrelated
business income tax 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.
Net investment income
Internal Revenue Code
In general, net investment income is defined as the amount
by which the sum of gross investment income and capital gain
net income exceeds the deductions relating to the production
of gross investment income.\216\
---------------------------------------------------------------------------
\216\ Sec. 4940(c)(1). Net investment income also is
determined by applying section 103 (generally providing an
exclusion for interest on certain State and local bonds) and
section 265 (generally disallowing the deduction for interest
and certain other expenses with respect to tax-exempt
income). Sec. 4940(c)(5).
---------------------------------------------------------------------------
Gross investment income is the gross amount of income from
interest, dividends, rents, payments with respect to
securities loans, and royalties. Gross investment income does
not include any income that is included in computing a
foundation's unrelated business taxable income.\217\
---------------------------------------------------------------------------
\217\ Sec. 4940(c)(2).
---------------------------------------------------------------------------
Capital gain net income takes into account only gains and
losses from the sale or other disposition of property used
for the production of interest, dividends, rents, and
royalties, and property used for the production of income
included in computing the unrelated business income tax
(except to the extent the gain or loss is taken into account
for purposes of such tax). Losses from sales or other
dispositions of property are allowed only to the extent of
gains from such sales or other dispositions, and no capital
loss carryovers are allowed.\218\
---------------------------------------------------------------------------
\218\ Sec. 4940(c)(4).
---------------------------------------------------------------------------
Treasury Regulations and case law
The Treasury regulations elaborate on the Code definition
of net investment income. The regulations cite items of
investment income listed in the Code, and in addition clarify
that net investment income includes interest, dividends,
rents, and royalties derived from all sources, including from
assets devoted to charitable activities. For example,
interest received on a student loan is includible in the
gross investment income of a foundation making the loan.\219\
---------------------------------------------------------------------------
\219\ Treas. Reg. sec. 53.4940-1(d)(1).
---------------------------------------------------------------------------
The regulations further provide that gross investment
income includes certain items of investment income that are
described in the unrelated business income tax
regulations.\220\ Such additional items include payments with
respect to securities loans (an item added to the Code in
1978), annuities, income from notional principal contracts,
and other substantially similar income from ordinary and
routine investments to the extent determined by the
Commissioner.\221\ These latter three categories of income
are not enumerated as net investment income in the Code.
---------------------------------------------------------------------------
\220\ Id.
\221\ Treas. Reg. sec. 1.512(b)-1(a)(1).
---------------------------------------------------------------------------
The Treasury regulations also elaborate on the Code
definition of capital gain net income. The regulations
provide that the only capital gains and losses that are taken
into account are (1) gains and losses from the sale or other
disposition of property held by a private foundation for
investment purposes (other than program related investments),
and (2) property used for the production of income included
in computing the unrelated business income tax (except to the
extent the gain or loss is taken into account for purposes of
such tax).
This definition of capital gain net income builds on the
definition provided in the Code by providing an exception for
gain and loss from program related investments and by
stating, in addition, that ``gains and losses from the sale
or other disposition of property used for the exempt purposes
of the private foundation are excluded.'' \222\ As an
example, the regulations provide that gain or loss on the
sale of buildings used for the foundation's exempt activities
are not taken into account for purposes of the section 4940
tax. If a foundation uses exempt income for exempt purposes
and (other than incidentally) for investment purposes, then
the portion of the gain or loss received upon sale or other
disposition that is allocable to the investment use is taken
into account for purposes of the tax.
---------------------------------------------------------------------------
\222\ Treas. Reg. sec. 53.4940-1(f)(1).
---------------------------------------------------------------------------
The regulations further provide that ``property shall be
treated as held for investment purposes even though such
property is disposed of by the foundation immediately upon
its receipt, if it is property of a type which generally
produces interest, dividends, rents, royalties, or capital
gains through appreciation (for example, rental real estate,
stock, bonds, mineral interest, mortgages, and securities).''
\223\
---------------------------------------------------------------------------
\223\ Id.
---------------------------------------------------------------------------
This regulation has been challenged in the courts. The
regulation says that property is treated as held for
investment purposes if it is of a type that ``generally
produces'' certain types of income. By contrast, the Code
provides that the property be ``used'' to produce such
income. In Zemurray Foundation v. United States, 687 F.2d 97
(5th Cir. 1982), the taxpayer foundation challenged the
Treasury's attempt to tax under section 4940 capital gain on
the sale of timber property. The taxpayer asserted that the
property was not actually used to produce investment income,
and that the Treasury Regulation was invalid because the
regulation would subject to tax property that is of a type
that could generally be used to produce investment income. On
this issue, the court upheld the Treasury regulation,
reasoning that the regulation's use of the phrase ``generally
used,'' though permitting taxation ``so long as the property
sold is usable to produce the applicable types of income,
regardless of whether
[[Page H2254]]
the property is actually used to produce income or not'' was
not unreasonable or plainly inconsistent with the
statute.\224\ However, on remand to the district court, the
district court concluded that the timber property at issue,
though a type of property generally used to produce
investment income, was not susceptible for such use.\225\
Thus, the district court concluded that the Treasury could
not tax the gain under this portion of the regulation.
---------------------------------------------------------------------------
\224\ Zemurray Foundation v. United States, 687 F.2d 97, 100
(5th Cir. 1982).
\225\ Zemurray Foundation v. United States, 53 A.F.T.R. 2d
(RIA) 842 (E. D. La. 1983).
---------------------------------------------------------------------------
The question then turned to the taxpayer's second challenge
to the regulation. At issue was the meaning of the regulatory
phrase ``capital gains through appreciation.'' The regulation
provides that if property is of a type that generally
produces capital gains through appreciation, then the gain is
subject to tax. The Treasury argued that the timber property
at issue, although held by the court not to be property (in
this case) susceptible for use to produce interest,
dividends, rents, or royalties, still was held by the
taxpayer to produce capital gain through appreciation and
therefore the gain should be subject to tax under the
regulation.
On this issue, the court held for the taxpayer, reasoning
that the language of the Code clearly is limited to certain
gains and losses, e.g., the court cited the Code language
providing that ``there shall be taken into account only gains
and losses from the sale or other disposition of property
used for the production of interest, dividends, rents, and
royalties. . . .'' \226\ The court noted that ``capital gains
through appreciation'' is not enumerated in the statute. The
court used as an example a jade figurine held by a
foundation. Jade figurines do not generally produce interest,
dividends, rents, or royalties, but gain on the sale of such
a figurine would be taxable under the ``capital gains through
appreciation'' standard, yet such standard does not appear in
the statute. After Zemurray, the Treasury generally conceded
this issue.\227\
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\226\ Zemurray Foundation v. United States, 755 F.2d 404 (5th
Cir. 1985), 413 (citing Code sec. 4940(c)(4)(A).
\227\ G.C.M. 39538 (July 23, 1986).
---------------------------------------------------------------------------
With respect to capital losses, the Code provides that
carryovers are not permitted, whereas the regulations state
that neither carryovers nor carrybacks are permitted.\228\
---------------------------------------------------------------------------
\228\ Treas. Reg. sec. 53.4940-1(f)(3).
---------------------------------------------------------------------------
Application of Zemurray to the Code and the regulations
Applying the Zemurray case to the Code and regulations
results in a general principle for purposes of present law:
private foundations are subject to tax under section 4940
only on the items of income and only on gains and losses
specifically enumerated therein. Under this principle,
private foundations generally are not subject to the section
4940 tax on other substantially similar types of income from
ordinary and routine investments, notwithstanding Treasury
regulations to the contrary. In addition, the regulations
provide that gain or loss from the sale or other disposition
of assets used for exempt purposes, with specific reference
to program-related investments, is excluded. The Code
provides for no such blanket exclusion; thus, under the
language of the Code and the reasoning of Zemurray, if a
foundation provided office space at below market rent to a
charitable organization for use in the organization's exempt
purposes, gain on the sale of the building by the foundation
should be subject to the section 4940 tax despite the
Treasury regulations.\229\
---------------------------------------------------------------------------
\229\ See also the example in Treas. Reg. sec. 53.4940-
1(f)(1).
---------------------------------------------------------------------------
In addition, under the logic of Zemurray, capital loss
carrybacks arguably are permitted, notwithstanding Treasury
regulations to the contrary, because the Code mentions only a
bar on use of carryovers and says nothing about carrybacks.
house bill
No provision.
senate amendment
The provision amends the definition of gross investment
income (including for purposes of capital gain net income) to
include items of income that are similar to the items
presently enumerated in the Code. Such similar items include
income from notional principal contracts, annuities, and
other substantially similar income from ordinary and routine
investments, and, with respect to capital gain net income,
capital gains from appreciation, including capital gains and
losses from the sale or other disposition of assets used to
further an exempt purpose.
The provision provides that there are no carrybacks of
losses from sales or other dispositions of property.
Effective date.--The provision is effective for taxable
years beginning after the date of enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
11. Definition of convention or association of churches (sec.
223 of the Senate amendment and sec. 7701 of the Code)
present law
Under present law, an organization that qualifies as a
``convention or association of churches'' (within the meaning
of sec. 170(b)(1)(A)(i)) is not required to file an annual
return,\230\ is subject to the church tax inquiry and church
tax examination provisions applicable to organizations
claiming to be a church,\231\ and is subject to certain other
provisions generally applicable to churches.\232\ The
Internal Revenue Code does not define the term ``convention
or association of churches.''
---------------------------------------------------------------------------
\230\ Sec. 6033(a)(2)(A)(i).
\231\ Sec. 7611(h)(1)(B).
\232\ See, e.g., Sec. 402(g)(8)(B) (limitation on elective
deferrals); sec. 403(b)(9)(B) (definition of retirement
income account); sec. 410(d) (election to have participation,
vesting, funding, and certain other provisions apply to
church plans); sec. 414(e) (definition of church plan); sec.
415(c)(7) (certain contributions by church plans); sec.
501(h)(5) (disqualification of certain organizations from
making the sec. 501(h) election regarding lobbying
expenditure limits); sec. 501(m)(3) (definition of
commercial-type insurance); sec. 508(c)(1)(A) (exception from
requirement to file application seeking recognition of exempt
status); sec. 512(b)(12) (allowance of up to $1,000 deduction
for purposes of determining unrelated business taxable
income); sec. 514(b)(3)(E) (definition of debt-financed
property); sec. 3121(w)(3)(A) (election regarding exemption
from social security taxes); sec. 3309(b)(1) (application of
federal unemployment tax provisions to services performed in
the employ of certain organizations); sec. 6043(b)(1)
(requirement to file a return upon liquidation or dissolution
of the organization); and sec. 7702(j)(3)(A) (treatment of
certain death benefit plans as life insurance).
---------------------------------------------------------------------------
house bill
No provision.
senate amendment
The provision provides that an organization that otherwise
is a convention or association of churches does not fail to
so qualify merely because the membership of the organization
includes individuals as well as churches, or because
individuals have voting rights in the organization.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
12. Notification requirement for exempt entities not
currently required to file an annual information return
(sec. 224 of the Senate amendment and secs. 6033, 6104,
6652, and 7428 of the Code)
present law
Under present law, the requirement that an exempt
organization file an annual information return does not apply
to several categories of exempt organizations. Organizations
excepted from the filing requirement include organizations
(other than private foundations), the gross receipts of which
in each taxable year normally are not more than $25,000.\233\
Also exempt from the requirement are churches, their
integrated auxiliaries, and conventions or associations of
churches; the exclusively religious activities of any
religious order; section 501(c)(1) instrumentalities of the
United States; section 501(c)(21) trusts; an interchurch
organization of local units of a church; certain mission
societies; certain church-affiliated elementary and high
schools; certain state institutions whose income is excluded
from gross income under section 115; certain governmental
units and affiliates of governmental units; and other
organizations that the IRS has relieved from the filing
requirement pursuant to its statutory discretionary
authority.
---------------------------------------------------------------------------
\233\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i);
Treas. Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii)
provides a $5,000 annual gross receipts exception from the
annual reporting requirements for certain exempt
organizations. In Announcement 82-88, 1982-25 I.R.B. 23, the
IRS exercised its discretionary authority under section 6033
to increase the gross receipts exception to $25,000, and
enlarge the category of exempt organizations that are not
required to file Form 990.
---------------------------------------------------------------------------
house bill
No provision.
senate amendment
The provision provides that organizations that are excused
from filing an information return by reason of normally
having gross receipts below a certain specified amount
(generally, under $25,000) shall furnish to the Secretary
annually the legal name of the organization, any name under
which the organization operates or does business, the
organization's mailing address and Internet web site address
(if any), the organization's taxpayer identification number,
the name and address of a principal officer, and evidence of
the organization's continuing basis for its exemption from
the generally applicable information return filing
requirements. Upon such organization's termination of
existence, the organization is required to furnish notice of
such termination.
The provision provides that if an organization fails to
provide the required notice for three consecutive years, the
organization's tax-exempt status is revoked. In addition, if
an organization that is required to file an annual
information return under section 6033(a) (Form 990) fails to
file such an information return for three consecutive years,
the organization's tax-exempt status is revoked. If an
organization fails to meet its filing obligation to the IRS
for three consecutive years in cases where the organization
is subject to the information return filing requirement in
one or more years during a three-year period and also is
subject to the notice requirement for one or more years
during the same three-year period, the organization's tax-
exempt status is revoked.
A revocation under the provision is effective from the date
that the Secretary determines was the last day the
organization could have timely filed the third required
information return or notice. To again be recognized as tax-
exempt, the organization must apply to the Secretary for
recognition
[[Page H2255]]
of tax-exemption, irrespective of whether the organization
was required to make an application for recognition of tax-
exemption in order to gain tax-exemption originally.
If upon application for tax-exempt status after a
revocation under the provision, the organization shows to the
satisfaction of the Secretary reasonable cause for failing to
file the required annual notices or returns, the
organization's tax-exempt status may, in the discretion of
the Secretary, be reinstated retroactive to the date of
revocation. An organization may not challenge under the
Code's declaratory judgment procedures (section 7428) a
revocation of tax-exemption made pursuant to the provision.
There is no monetary penalty for failure to file the
notice. The provision does not require that the notices be
made available to the public under the public disclosure and
inspection rules generally applicable to exempt
organizations. The provision does not affect an
organization's obligation under present law to file required
information returns or existing penalties for failure to file
such returns.
The Secretary is required to notify in a timely manner
every organization that is subject to the notice filing
requirement of the new filing obligation. Notification by the
Secretary shall be by mail, in the case of any organization
the identity and address of which is included in the list of
exempt organizations maintained by the Secretary, and by
Internet or other means of outreach, in the case of any other
organization. In addition, the Secretary is required to
publicize in a timely manner in appropriate forms and
instructions and other means of outreach the new penalty
imposed for consecutive failures to file the information
return.
The Secretary is authorized to publish a list of
organizations whose exempt status is revoked under the
provision.
Effective date.--The provision is effective for notices and
returns with respect to annual periods beginning after 2005.
conference agreement
The conference agreement does not include the Senate
amendment provision.
13. Disclosure to state officials of proposed actions related
to section 501(c) organizations (sec. 225 of the Senate
amendment and secs. 6103, 6104, 7213, 7213A, and 7431 of
the Code)
present law
In the case of organizations that are described in section
501(c)(3) and exempt from tax under section 501(a) or that
have applied for exemption as an organization so described,
present law (sec. 6104(c)) requires the Secretary to notify
the appropriate State officer of (1) a refusal to recognize
such organization as an organization described in section
501(c)(3), (2) a revocation of a section 501(c)(3)
organization's tax-exempt status, and (3) the mailing of a
notice of deficiency for any tax imposed under section 507,
chapter 41, or chapter 42.\234\ In addition, at the request
of such appropriate State officer, the Secretary is required
to make available for inspection and copying, such returns,
filed statements, records, reports, and other information
relating to the above-described disclosures, as are relevant
to any State law determination. An appropriate State officer
is the State attorney general, State tax officer, or any
State official charged with overseeing organizations of the
type described in section 501(c)(3).
---------------------------------------------------------------------------
\234\ The applicable taxes include the termination tax on
private foundations; taxes on public charities for certain
excess lobbying expenses; taxes on a private foundation's net
investment income, self-dealing activities, undistributed
income, excess business holdings, investments that jeopardize
charitable purposes, and taxable expenditures (some of these
taxes also apply to certain non-exempt trusts); taxes on the
political expenditures and excess benefit transactions of
section 501(c)(3) organizations; and certain taxes on black
lung benefit trusts and foreign organizations.
---------------------------------------------------------------------------
In general, returns and return information (as such terms
are defined in section 6103(b)) are confidential and may not
be disclosed or inspected unless expressly provided by
law.\235\ Present law requires the Secretary to keep records
of disclosures and requests for inspection \236\ and requires
that persons authorized to receive returns and return
information maintain various safeguards to protect such
information against unauthorized disclosure.\237\ Willful
unauthorized disclosure or inspection of returns or return
information is subject to a fine and/or imprisonment.\238\
The knowing or negligent unauthorized inspection or
disclosure of returns or return information gives the
taxpayer a right to bring a civil suit.\239\ Such present-law
protections against unauthorized disclosure or inspection of
returns and return information do not apply to the
disclosures or inspections, described above, that are
authorized by section 6104(c).
---------------------------------------------------------------------------
\235\ Sec. 6103(a).
\236\ Sec. 6103(p)(3).
\237\ Sec. 6103(p)(4).
\238\ Secs. 7213 and 7213A.
\239\ Sec. 7431.
---------------------------------------------------------------------------
house bill
No provision.
senate amendment
The provision provides that upon written request by an
appropriate State officer, the Secretary may disclose: (1) a
notice of proposed refusal to recognize an organization as a
section 501(c)(3) organization; (2) a notice of proposed
revocation of tax-exemption of a section 501(c)(3)
organization; (3) the issuance of a proposed deficiency of
tax imposed under section 507, chapter 41, or chapter 42; (4)
the names, addresses, and taxpayer identification numbers of
organizations that have applied for recognition as section
501(c)(3) organizations; and (5) returns and return
information of organizations with respect to which
information has been disclosed under (1) through (4)
above.\240\ Disclosure or inspection is permitted for the
purpose of, and only to the extent necessary in, the
administration of State laws regulating section 501(c)(3)
organizations, such as laws regulating tax-exempt status,
charitable trusts, charitable solicitation, and fraud. Such
disclosure or inspection may be made only to or by an
appropriate State officer or to an officer or employee of the
State who is designated by the appropriate State officer, and
may not be made by or to a contractor or agent. The Secretary
also is permitted to disclose or open to inspection the
returns and return information of an organization that is
recognized as tax-exempt under section 501(c)(3), or that has
applied for such recognition, to an appropriate State officer
if the Secretary determines that disclosure or inspection may
facilitate the resolution of Federal or State issues relating
to the tax-exempt status of the organization. For this
purpose, appropriate State officer means the State attorney
general, the State tax official, or any other State official
charged with overseeing organizations of the type described
in section 501(c)(3).
---------------------------------------------------------------------------
\240\ Such returns and return information also may be open to
inspection by an appropriate State officer.
---------------------------------------------------------------------------
In addition, the provision provides that upon the written
request by an appropriate State officer, the Secretary may
make available for inspection or disclosure returns and
return information of an organization described in section
501(c)(2) (certain title holding companies), 501(c)(4)
(certain social welfare organizations), 501(c)(6) (certain
business leagues and similar organizations), 501(c)(7)
(certain recreational clubs), 501(c)(8) (certain fraternal
organizations), 501(c)(10) (certain domestic fraternal
organizations operating under the lodge system), and
501(c)(13) (certain cemetery companies). Such returns and
return information are available for inspection or disclosure
only for the purpose of, and to the extent necessary in, the
administration of State laws regulating the solicitation or
administration of the charitable funds or charitable assets
of such organizations. Such disclosure or inspection may be
made only to or by an appropriate State officer or to an
officer or employee of the State who is designated by the
appropriate State officer, and may not be made by or to a
contractor or agent. For this purpose, appropriate State
officer means the State attorney general, the State tax
officer, and the head of an agency designated by the State
attorney general as having primary responsibility for
overseeing the solicitation of funds for charitable purposes
of such organizations.
In addition, the provision provides that any returns and
return information disclosed under section 6104(c) may be
disclosed in civil administrative and civil judicial
proceedings pertaining to the enforcement of State laws
regulating the applicable tax-exempt organization in a manner
prescribed by the Secretary. Returns and return information
are not to be disclosed under section 6104(c), or in such an
administrative or judicial proceeding, to the extent that the
Secretary determines that such disclosure would seriously
impair Federal tax administration. The provision makes
disclosures of returns and return information under section
6104(c) subject to the disclosure, recordkeeping, and
safeguard provisions of section 6103, including the
requirements that the Secretary maintain a permanent system
of records of requests for disclosure (sec. 6103(p)(3)), and
that the appropriate State officer maintain various
safeguards that protect against unauthorized disclosure (sec.
6103(p)(4)). The provision provides that the willful
unauthorized disclosure of returns or return information
described in section 6104(c) is a felony subject to a fine of
up to $5,000 and/or imprisonment of up to five years (sec.
7213(a)(2)), the willful unauthorized inspection of returns
or return information described in section 6104(c) is subject
to a fine of up to $1,000 and/or imprisonment of up to one
year (sec. 7213A), and provides the taxpayer the right to
bring a civil action for damages in the case of knowing or
negligent unauthorized disclosure or inspection of such
information (sec. 7431(a)(2)).
Effective date.--The provision is effective on the date of
enactment but does not apply to requests made before such
date.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
14. Improve accountability of donor advised funds (secs. 231
through 234 of the Senate amendment and secs. 170 and
4958 and new secs. 4967, 4968, and 4969 of the Code)
Present Law
Requirements for section 501(c)(3) tax-exempt status
Charitable organizations, i.e., organizations described in
section 501(c)(3), generally are exempt from Federal income
tax and are eligible to receive tax deductible contributions.
A charitable organization must operate primarily in pursuance
of one or more tax-exempt purposes constituting the basis
[[Page H2256]]
of its tax exemption.\241\ In order to qualify as operating
primarily for a purpose described in section 501(c)(3), an
organization must satisfy the following operational
requirements: (1) the net earnings of the organization may
not inure to the benefit of any person in a position to
influence the activities of the organization; (2) the
organization must operate to provide a public benefit, not a
private benefit;\242\ (3) the organization may not be
operated primarily to conduct an unrelated trade or
business;\243\ (4) the organization may not engage in
substantial legislative lobbying; and (5) the organization
may not participate or intervene in any political campaign.
---------------------------------------------------------------------------
\241\ Treas. Reg. sec. 1.501(c)(3)-1(c)(1). The Code
specifies such purposes as religious, charitable, scientific,
testing for public safety, literary, or educational purposes,
or to foster international amateur sports competition, or for
the prevention of cruelty to children or animals. In general,
an organization is organized and operated for charitable
purposes if it provides relief for the poor and distressed or
the underprivileged. Treas. Reg. sec. 1.501(c)(3)-1(d)(2).
\242\ Treas. Reg. sec. 1.501(c)(3)-1(d)(1)(ii).
\243\ Treas. Reg. sec. 1.501(c)(3)-1(e)(1). Conducting a
certain level of unrelated trade or business activity will
not jeopardize tax-exempt status.
---------------------------------------------------------------------------
Classification of section 501(c)(3) organizations
Section 501(c)(3) organizations are classified either as
``public charities'' or ``private foundations.'' \244\
Private foundations generally are defined under section
509(a) as all organizations described in section 501(c)(3)
other than an organization granted public charity status by
reason of: (1) being a specified type of organization (i.e.,
churches, educational institutions, hospitals and certain
other medical organizations, certain organizations providing
assistance to colleges and universities, or a governmental
unit); (2) receiving a substantial part of its support from
governmental units or direct or indirect contributions from
the general public; or (3) providing support to another
section 501(c)(3) entity that is not a private foundation. In
contrast to public charities, private foundations generally
are funded from a limited number of sources (e.g., an
individual, family, or corporation). Donors to private
foundations and persons related to such donors together often
control the operations of private foundations.
---------------------------------------------------------------------------
\244\ Sec. 509(a). Private foundations are either private
operating foundations or private non-operating foundations.
In general, private operating foundations operate their own
charitable programs in contrast to private non-operating
foundations, which generally are grant-making organizations.
Most private foundations are non-operating foundations.
---------------------------------------------------------------------------
Because private foundations receive support from, and
typically are controlled by, a small number of supporters,
private foundations are subject to a number of anti-abuse
rules and excise taxes not applicable to public
charities.\245\ For example, the Code imposes excise taxes on
acts of ``self-dealing'' between disqualified persons
(generally, an enumerated class of foundation insiders \246\)
and a private foundation. Acts of self-dealing include, for
example, sales or exchanges, or leasing, of property; lending
of money; or the furnishing of goods, services, or facilities
between a disqualified person and a private foundation.\247\
In addition, private non-operating foundations are required
to pay out a minimum amount each year as qualifying
distributions. In general, a qualifying distribution is an
amount paid to accomplish one or more of the organization's
exempt purposes, including reasonable and necessary
administrative expenses.\248\ Certain expenditures of private
foundations are also subject to tax.\249\ In general, taxable
expenditures are expenditures: (1) for lobbying; (2) to
influence the outcome of a public election or carry on a
voter registration drive (unless certain requirements are
met); (3) as a grant to an individual for travel, study, or
similar purposes unless made pursuant to procedures approved
by the Secretary; (4) as a grant to an organization that is
not a public charity or exempt operating foundation unless
the foundation exercises expenditure responsibility \250\
with respect to the grant; or (5) for any non-charitable
purpose. Additional excise taxes may also apply in the event
a private foundation holds certain business interests
(``excess business holdings'') \251\ or makes an investment
that jeopardizes the foundation's exempt purposes.\252\
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\245\ Secs. 4940-4945.
\246\ See sec. 4946(a).
\247\ Sec. 4941.
\248\ Sec. 4942(g)(1)(A). A qualifying distribution also
includes any amount paid to acquire an asset used (or held
for use) directly in carrying out one or more of the
organization's exempt purposes and certain amounts set-aside
for exempt purposes. Sec. 4942(g)(1)(B) and 4942(g)(2).
\249\ Sec. 4945. Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\250\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish
reasonable procedures to ensure that the grant is spent
solely for the purpose for which it was made, to obtain
reports from the grantee on the expenditure of the grant, and
to make reports to the Secretary regarding such expenditures.
Sec. 4945(h).
\251\ Sec. 4943.
\252\ Sec. 4944.
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Supporting organizations
The Code provides that certain ``supporting organizations''
(in general, organizations that provide support to another
section 501(c)(3) organization that is not a private
foundation) are classified as public charities rather than
private foundations.\253\ To qualify as a supporting
organization, an organization must meet all three of the
following tests: (1) it must be organized and at all times
operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of one or more
``publicly supported organizations'' \254\ (the
``organizational and operational tests'');\255\ (2) it must
be operated, supervised, or controlled by or in connection
with one or more publicly supported organizations (the
``relationship test'');\256\ and (3) it must not be
controlled directly or indirectly by one or more disqualified
persons (as defined in section 4946) other than foundation
managers and other than one or more publicly supported
organizations (the ``lack of outside control test'').\257\
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\253\ Sec. 509(a)(3).
\254\ In general, supported organizations of a supporting
organization must be publicly supported charities described
in sections 509(a)(1) or (a)(2).
\255\ Sec. 509(a)(3)(A).
\256\ Sec. 509(a)(3)(B).
\257\ Sec. 509(a)(3)(C).
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To satisfy the relationship test, a supporting organization
must hold one of three statutorily described close
relationships with the supported organization. The
organization must be: (1) operated, supervised, or controlled
by a publicly supported organization (commonly referred to as
``Type I'' supporting organizations); (2) supervised or
controlled in connection with a publicly supported
organization (``Type II'' supporting organizations); or (3)
operated in connection with a publicly supported organization
(``Type III'' supporting organizations).\258\
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\258\ Treas. Reg. sec. 1.509(a)-4(f)(2).
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Type I supporting organizations
In the case of supporting organizations that are operated,
supervised, or controlled by one or more publicly supported
organizations (Type I supporting organizations), one or more
supported organizations must exercise a substantial degree of
direction over the policies, programs, and activities of the
supporting organization.\259\ The relationship between the
Type I supporting organization and the supported organization
generally is comparable to that of a parent and subsidiary.
The requisite relationship may be established by the fact
that a majority of the officers, directors, or trustees of
the supporting organization are appointed or elected by the
governing body, members of the governing body, officers
acting in their official capacity, or the membership of one
or more publicly supported organizations.\260\
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\259\ Treas. Reg. sec. 1.509(a)-4(g)(1)(i).
\260\ Id.
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Type II supporting organizations
Type II supporting organizations are supervised or
controlled in connection with one or more publicly supported
organizations. Rather than the parent-subsidiary relationship
characteristic of Type I organizations, the relationship
between a Type II organization and its supported
organizations is more analogous to a brother-sister
relationship. In order to satisfy the Type II relationship
requirement, generally there must be common supervision or
control by the persons supervising or controlling both the
supporting organization and the publicly supported
organizations.\261\ An organization generally is not
considered to be ``supervised or controlled in connection
with'' a publicly supported organization merely because the
supporting organization makes payments to the publicly
supported organization, even if the obligation to make
payments is enforceable under state law.\262\
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\261\ Treas. Reg. sec. 1.509(a)-4(h)(1).
\262\ Treas. Reg. sec. 1.509(a)-4(h)(2).
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Type III supporting organizations
Type III supporting organizations are ``operated in
connection with'' one or more publicly supported
organizations. To satisfy the ``operated in connection with''
relationship, Treasury regulations require that the
supporting organization be responsive to, and significantly
involved in the operations of, the publicly supported
organization. This relationship is deemed to exist where the
supporting organization meets both a ``responsiveness test''
and an ``integral part test.'' \263\ In general, the
responsiveness test requires that the Type III supporting
organization be responsive to the needs or demands of the
publicly supported organizations. In general, the integral
part test requires that the Type III supporting organization
maintain significant involvement in the operations of one or
more publicly supported organizations, and that such publicly
supported organizations are in turn dependent upon the
supporting organization for the type of support which it
provides.
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\263\ Treas. Reg. sec. 1.509(a)-4(i)(1).
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Charitable contributions
Contributions to organizations described in section
501(c)(3) are deductible, subject to certain limitations, as
an itemized deduction from Federal income taxes.\264\ Such
contributions also generally are deductible for estate and
gift tax purposes.\265\ However, if the taxpayer retains
control over the assets transferred to charity, the transfer
may not qualify as a completed gift for purposes of claiming
an income, estate, or gift tax deduction.
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\264\ Sec. 170.
\265\ Secs. 2055 and 2522.
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Public charities enjoy certain advantages over private
foundations regarding the deductibility of contributions. For
example, contributions of appreciated capital gain property
to a private foundation generally are deductible only to the
extent of the donor's cost basis.\266\ In contrast,
contributions
[[Page H2257]]
to public charities generally are deductible in an amount
equal to the property's fair market value, except for gifts
of inventory and other ordinary income property, short-term
capital gain property, and tangible personal property the use
of which is unrelated to the donee organization's exempt
purpose. In addition, under present law, a taxpayer's
deductible contributions generally are limited to specified
percentages of the taxpayer's contribution base, which
generally is the taxpayer's adjusted gross income for a
taxable year. The applicable percentage limitations vary
depending upon the type of property contributed and the
classification of the donee organization. In general,
contributions to non-operating private foundations are
limited to a smaller percentage of the donor's contribution
base (up to 30 percent) than contributions to public
charities (up to 50 percent).\267\
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\266\ A special rule in section 170(e)(5) provides that
taxpayers are allowed a deduction equal to the fair market
value of certain contributions of appreciated, publicly
traded stock contributed to a private foundation.
\267\ Sec. 170(b).
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In general, taxpayers who make contributions and claim a
charitable deduction must satisfy recordkeeping and
substantiation requirements.\268\ The requirements vary
depending on the type and value of property contributed. A
deduction generally may be denied if the donor fails to
satisfy applicable recordkeeping or substantiation
requirements.
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\268\ Sec. 170(f)(8).
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Intermediate sanctions (excess benefit transaction tax)
The Code imposes excise taxes on excess benefit
transactions between disqualified persons and public
charities.\269\ An excess benefit transaction generally is a
transaction in which an economic benefit is provided by a
public charity directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including
the performance of services) received for providing such
benefit.
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\269\ Sec. 4958. The excess benefit transaction tax is
commonly referred to as ``intermediate sanctions,'' because
it imposes penalties generally considered to be less punitive
than revocation of the organization's exempt status. The tax
also applies to transactions between disqualified persons and
social welfare organizations (as described in section
501(c)(4)).
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For purposes of the excess benefit transaction rules, a
disqualified person is any person in a position to exercise
substantial influence over the affairs of the public charity
at any time in the five-year period ending on the date of the
transaction at issue.\270\ Persons holding certain powers,
responsibilities, or interests (e.g., officers, directors, or
trustees) are considered to be in a position to exercise
substantial influence over the affairs of the public charity.
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\270\ Sec. 4958(f)(1). A disqualified person also includes
certain family members of such a person, and certain entities
that satisfy a control test with respect to such persons.
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An excess benefit transaction tax is imposed on the
disqualified person and, in certain cases, on the
organization managers, but is not imposed on the public
charity. An initial tax of 25 percent of the excess benefit
amount is imposed on the disqualified person that receives
the excess benefit. An additional tax on the disqualified
person of 200 percent of the excess benefit applies if the
violation is not corrected within a specified period. A tax
of 10 percent of the excess benefit (not to exceed $10,000
with respect to any excess benefit transaction) is imposed on
an organization manager that knowingly participated in the
excess benefit transaction, if the manager's participation
was willful and not due to reasonable cause, and if the
initial tax was imposed on the disqualified person.
Community foundations
Community foundations generally are broadly supported
section 501(c)(3) public charities that make grants to other
charitable organizations located within a community
foundation's particular geographic area. Donors sometimes
make contributions to a community foundation through
transfers to a separate trust or fund, the assets of which
are held and managed by a bank or investment company.
Certain community foundations are subject to special rules
that permit them to treat the separate funds or trusts
maintained by the community foundation as a single entity for
tax purposes. This ``single entity'' status allows the
community foundation to be classified as a public charity.
One of the requirements that community foundations must meet
is that funds maintained by the community foundation may not
be subject by the donor to any material restrictions or
conditions. The prohibition against material restrictions or
conditions is designed to prevent a donor from encumbering a
fund in a manner that prevents the community foundation from
freely distributing the assets and income from it in
furtherance of the community foundation's charitable
purposes. Under Treasury regulations, whether a particular
restriction or condition placed by the donor on the transfer
of assets is material must be determined from all of the
facts and circumstances of the transfer. The regulations set
out some of the more significant facts and circumstances to
be considered in making a determination, including: (1)
whether the transferee public charity is the fee owner of the
assets received; (2) whether the assets are held and
administered by the public charity in a manner consistent
with its own exempt purposes; (3) whether the governing body
of the public charity has the ultimate authority and control
over the assets and the income derived from them; and (4)
whether the governing body of the public charity is
independent from the donor. The regulations provide several
non-adverse factors for determining whether a particular
restriction or condition placed by the donor on the transfer
of assets is material. In addition, the regulations list
numerous factors and subfactors that indicate that the
community foundation is prevented from freely and effectively
employing the donated assets and the income thereon.
Donor advised funds
Some charitable organizations (including community
foundations) establish accounts to which donors may
contribute and thereafter provide nonbinding advice or
recommendations with regard to distributions from the fund or
the investment of assets in the fund. Such accounts are
commonly referred to as ``donor advised funds.'' Donors
who make contributions to charities for maintenance in a
donor advised fund generally claim a charitable
contribution deduction at the time of the contribution.
Although sponsoring charities frequently permit donors (or
other persons appointed by donors) to provide nonbinding
recommendations concerning the distribution or investment
of assets in a donor advised fund, sponsoring charities
generally must have legal ownership and control of such
assets following the contribution. If the sponsoring
charity does not have such control (or permits a donor to
exercise control over amounts contributed), the donor's
contributions may not qualify for a charitable deduction,
and, in the case of a community foundation, the
contribution may be treated as being subject to a material
restriction or condition by the donor.
In recent years, a number of financial institutions have
formed charitable corporations for the principal purpose of
offering donor advised funds, sometimes referred to as
``commercial'' donor advised funds. In addition, some
established charities have begun operating donor advised
funds in addition to their primary activities. The IRS has
recognized several organizations that sponsor donor advised
funds, including ``commercial'' donor advised funds, as
section 501(c)(3) public charities. The term ``donor advised
fund'' is not defined in statute or regulations.
Under the Katrina Emergency Tax Relief Act of 2005, certain
of the above-described percent limitations on contributions
to public charities are temporarily suspended for purposes of
certain ``qualified contributions'' to public charities.
Under the Act, qualified contributions do not include a
contribution if the contribution is for establishment of a
new, or maintenance in an existing, segregated fund or
account with respect to which the donor (or any person
appointed or designated by such donor) has, or reasonably
expects to have, advisory privileges with respect to
distributions or investments by reason of the donor's status
as a donor.
House Bill
No provision.
Senate Amendment
Definitions
Donor advised fund
The provision defines a ``donor advised fund'' as a fund or
account that is: (1) separately identified by reference to
contributions of a donor or donors \271\ (2) owned and
controlled by a sponsoring organization and (3) with respect
to which a donor (or any person appointed or designated by
such donor (a ``donor advisor'')) has, or reasonably expects
to have, advisory privileges with respect to the distribution
or investment of amounts held in the separately identified
fund or account by reason of the donor's status as a donor.
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\271\ The requirement that a donor advised fund be separately
identified by reference to contributions of a donor or donors
is intended to exclude from the definition of ``donor advised
fund'' certain types of funds or accounts maintained by
community foundations and other charities, such as field-of-
interest funds and scholarship funds, provided such funds or
accounts are not separately identified by reference to
contributions of a donor or donors.
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Notwithstanding the foregoing, the term ``donor advised
fund'' does not include a fund or account from which are made
grants to individuals for travel, study, or other similar
purposes by such individual, provided that (1) a donor's or
donor advisor's advisory privileges are performed exclusively
by such donor or donor advisor in such person's capacity as a
member of a committee appointed by the sponsoring
organization, (2) no combination of a donor and persons
related to or appointed by such donor, control, directly or
indirectly, such committee, and (3) all grants from such fund
or account satisfy requirements similar to those described in
section 4945(g) (concerning grants to individuals by private
foundations). In addition, the Secretary may exempt a fund or
account from treatment as a donor advised fund if such fund
or account (1) is advised by a committee not directly or
indirectly controlled by a donor, donor advisor, or persons
related to a donor or donor advisor or (2) will benefit a
single identified organization or governmental entity or a
single identified charitable purpose.
Sponsoring organization
The provision defines a ``sponsoring organization'' as an
organization that: (1) is described in section 170(c) \272\
(other than a governmental entity described in section
[[Page H2258]]
170(c)(1), and without regard to any requirement that the
organization be organized in the United States \273\); and
(2) maintains one or more donor advised funds.
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\272\ Section 170(c) describes organizations to which
charitable contributions that are deductible for income tax
purposes can be made.
\273\ See sec. 170(c)(2)(A).
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Investment advisor
Under the provision, the term ``investment advisor'' means,
with respect to any sponsoring organization, any person
(other than an employee of the sponsoring organization)
compensated by the sponsoring organization for managing the
investment of, or providing investment advice with respect
to, assets maintained in donor advised funds owned by the
sponsoring organization.
Deductibility of contributions to a sponsoring organization
for maintenance in a donor advised fund
Contributions to certain sponsoring organizations for
maintenance in a donor advised fund not eligible for a
charitable deduction
Under the provision, contributions to a sponsoring
organization for maintenance in a donor advised fund are not
eligible for a charitable deduction for income tax purposes
if the sponsoring organization is a veterans' organization
described in section 170(c)(3), a fraternal society described
in section 170(c)(4), or a cemetery company described in
section 170(c)(5); for gift tax purposes if the sponsoring
organization is a fraternal society described in section
2522(a)(3) or a veterans' organization described in
section 2522(a)(4); or for estate tax purposes if the
sponsoring organization is a fraternal society described
in section 2055(a)(3) or a veterans' organization
described in section 2055(a)(4). In addition,
contributions to a sponsoring organization for maintenance
in a donor advised fund are not eligible for a charitable
deduction if the sponsoring organization is a Type III
supporting organization; a deduction is allowed for such a
contribution to a Type I or Type II supporting
organization to the extent not prohibited by regulations.
Regulations generally shall prohibit such a deduction
where the donor of the contribution directly or indirectly
controls a supported organization of the Type I or Type II
supporting organization.
Additional substantiation requirements
In addition to satisfying present-law substantiation
requirements under section 170(f), a donor must obtain, with
respect to each charitable contribution to a sponsoring
organization to be maintained in a donor advised fund, a
contemporaneous written acknowledgment from the sponsoring
organization providing that the sponsoring organization has
exclusive legal control over the assets contributed.
Minimum distributions
Aggregate distribution requirement
Under the provision, a sponsoring organization is required,
for each taxable year of the organization, to make qualifying
distributions, from the assets of donor advised funds
maintained by the organization, equivalent to the applicable
percentage of the aggregate asset value of donor advised
funds maintained by the sponsoring organization as determined
on the last day of the immediately preceding taxable year.
Such qualifying distributions generally must be made by the
first day of the second taxable year following the taxable
year. The provision excludes from the computation of the
required distributable amount for a taxable year the assets
of donor advised funds that have been in existence for less
than one full year as of the end of the immediately preceding
taxable year.\274\ The aggregate payout rule does not apply
in the case of a donor advised fund maintained by a private
foundation that is subject to the requirements of section
4942. The applicable percentage is three percent for the
first taxable year beginning after the date of enactment,
four percent for the second such taxable year, and five
percent for any such taxable year thereafter.
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\274\ Assume, for example, that a sponsoring organization
initially maintained 10 donor advised funds, each established
in Year 1. In Year 3, a new donor advised fund is
established. For purposes of determining the sponsoring
organization's aggregate payout requirement for Year 4, the
donor advised fund established in Year 3 is excluded, because
it was in existence for less than a year as of the end of
Year 3. For these purposes, a donor advised fund is
considered created when the account is first established
(rather than, for example, when a donor achieves the minimum
account balance required under the sponsoring organization's
rules to begin grantmaking).
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Generally applicable account-level activity requirement
Under the provision, a sponsoring organization must
distribute from each of its donor advised funds at least a
certain amount in qualifying distributions during any
applicable three-year period by the 181st day of the first
taxable year following such period. The required
distributable amount is the greater of (1) $250 or (2) two
and one-half percent of the sponsoring organization's average
required minimum initial contribution amount for such period
\275\ (or average required minimum balance, if greater) for
the type of donor \276\ at issue. An applicable three-year
period must correspond with three consecutive taxable years
of the sponsoring organization. The first applicable three-
year period for a donor advised fund begins only after the
fund has been in existence for one full year.\277\
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\275\ For purposes of the provision, the required minimum
initial contribution amount is the minimum contribution
amount required by the sponsoring organization in order to
open a donor advised fund.
\276\ Under some circumstances, for example, a sponsoring
organization may establish higher minimum initial
contribution amounts for corporate donors than for individual
donors.
\277\ Applicable three-year periods for any donor advised
fund run consecutively, such that the second three-year
period begins immediately after the first three-year period
ends. For example, assume donor advised fund X is established
on March 30 of Year 1, and the sponsoring organization's
taxable year corresponds to the calendar year. As of the end
of Year 1, X has not been in existence for one full year;
therefore, X's first applicable three-year period does not
begin in Year 2. Instead, the first such period begins on
January 1 of Year 3 and runs through December 31 of Year 5.
X's second applicable three-year period begins on January 1
of Year 6 and ends on December 31 of Year 8.
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Account-level distribution requirement for accounts that
hold illiquid assets
If, as of the end of any taxable year of the sponsoring
organization, a donor advised fund holds assets other than
cash and marketable securities (i.e., ``illiquid assets'')
that equal more than 10 percent of the total value of assets
in the fund (determined using the valuation procedures
described below), the donor advised fund is considered to be
an ``illiquid asset donor advised fund'' for the subsequent
taxable year of the sponsoring organization. A sponsoring
organization must distribute from each illiquid asset donor
advised fund as qualifying distributions by the 181st day of
the second taxable year following such subsequent taxable
year an amount equal to the applicable percentage of the
value of the assets in the donor advised fund as of the end
of such year (the ``illiquid asset payout requirement''). The
applicable percentage is three percent for the first taxable
year beginning after the date of enactment, four percent for
the second such taxable year, and five percent for any such
taxable year thereafter.
If, as of the end of a taxable year of the sponsoring
organization, an illiquid asset in a donor advised fund has
not been held for a period of 12 months, such asset is not
considered an illiquid asset for such year. However, if an
illiquid asset has been exchanged for another illiquid asset,
then the holding period for any such other illiquid asset
includes the period during which the illiquid asset that was
exchanged was held. The Secretary is authorized to promulgate
anti- abuse rules to prevent the circumvention of the
provision through transactions designed to avoid
application of illiquid asset payout requirement, such as
through exchanges of illiquid assets for other assets.
Qualifying distributions
For purposes of all of the distribution requirements
described in the provision, qualifying distributions are
amounts paid to organizations described in section
170(b)(1)(A) (other than Type III supporting organizations or
a sponsoring organization if the amount is for maintenance in
a donor advised fund). Distributions to Type I or Type II
supporting organizations may be qualifying distributions if
not prohibited by regulations.\278\ Distributions to the
sponsoring organization generally are qualifying
distributions; however, a distribution to the sponsoring
organization in satisfaction of the aggregate distribution
requirement is a qualifying distribution only if the
distribution is designated for use in connection with a
charitable program of the sponsoring organization (e.g., if
funds are transferred to a scholarship fund (that does not
meet the definition of donor advised fund because, for
example, the scholarship fund is not separately identified by
reference to donors) for the awarding of scholarships
consistent with the sponsoring organization's exempt
purposes). Amounts permanently set aside for purposes, and
under procedures similar to those, described in section
4942(g) are treated as qualifying distributions. Qualifying
distributions also include amounts paid during a taxable year
for reasonable and necessary administrative expenses charged
to a donor advised fund by a sponsoring organization.
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\278\ Regulations generally shall prohibit such a
distribution where the donor or donor advisor of the amounts
distributed directly or indirectly controls a supported
organization of the Type I or Type II supporting
organization.
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Valuation
Special valuation rules apply for purposes of determining
the required distributable amount for a taxable year under
the aggregate payout requirement and the account-level payout
requirement applicable to accounts that hold illiquid assets.
For such purposes, the fair market values of cash and of
securities for which market quotations are readily available
are determined on a monthly basis. All other assets
(``illiquid assets'') transferred by a donor to a sponsoring
organization for maintenance in a donor advised fund are
valued at the sum of (1) the value claimed by the donor for
purposes of determining the donor's charitable deduction for
the contribution of such assets to the sponsoring
organization,\279\ and (2) an assumed annual rate of return
of five percent. If a donor advised fund purchases an
illiquid asset, such asset is valued at the sum of (1) the
purchase price paid for the assets, and (2) an assumed annual
rate of return of five percent. The Secretary of the Treasury
is authorized to specify the requirements for making such
computations. Under the provision, the Secretary of the
Treasury is also
[[Page H2259]]
authorized to promulgate rules permitting adjustments in the
value of an illiquid asset in situations where the asset
declines significantly in value following a contribution or
purchase of the asset.
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\279\ The donor is required to report to the sponsoring
organization the value of the asset claimed by the donor for
charitable deduction purposes either by supplying to the
sponsoring organization a copy of the donor's completed Form
8283 related to the deduction (if applicable) or by following
any alternative procedures specified by the Secretary.
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Treatment of qualifying distributions
Distributions made in satisfaction of any of the above-
described distribution requirements are counted for purposes
of all payout requirements described in the provision. For
purposes of any distribution requirement described in this
provision, the taxpayer may designate a qualifying
distribution as being made out of the undistributed amount
remaining from any prior taxable year or as being made in
satisfaction of the distribution requirement for the current
taxable year. Amounts distributed in excess of the
undistributed amount for the current year and all previous
taxable years may be carried forward for up to five taxable
years following the taxable year in which the excess payment
is made.
Excise tax for failure to distribute
In the event of a failure to distribute the required amount
in connection with any of the above-described distribution
requirements within the prescribed time period, the provision
imposes excise taxes similar to the private foundation excise
taxes under section 4942. Specifically, a first-tier excise
tax equal to 30 percent of the undistributed amount is
imposed. If the failure is not corrected within the taxable
period (as defined in existing section 4942(j)(1)), a second-
tier tax equal to 100 percent of the undistributed amount is
imposed. The first and second tier taxes are subject to
abatement under generally applicable present law rules.
Taxable period means, with respect to any undistributed
amount for any taxable year or applicable 3-year period, the
period beginning with the first day of the taxable year or
applicable period and ending on the earlier of the date of
mailing of a notice of deficiency with respect to the
imposition of the initial tax or the date on which such tax
is assessed.
Disqualified persons, excess benefit transactions, and other
sanctions
Disqualified persons
The provision provides that donors, donor advisors, and
investment advisors to donor advised funds (as well as
persons related to the foregoing persons \280\) are treated
as disqualified persons with respect to the sponsoring
organization under section 4958 or under section 4946(a).
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\280\ For purposes of the provision, a person is treated as
related to another person if (1) such person bears a
relationship to such other person similar to the
relationships described in sections 4958(f)(1)(B) and
4958(f)(1)(C).
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Excess benefit transactions
The provision also provides that distributions from a donor
advised fund to a person that with respect to such fund is a
donor, donor adviser, or a person related to a donor or donor
adviser (though not an investment advisor) is treated as an
excess benefit transaction under section 4958, with the
entire amount paid to any such person treated as the amount
of the excess benefit. This rule applies regardless of
whether the sponsoring organization is a public charity or a
private foundation and regardless of whether, but for this
rule, the transaction would have been subject to the section
4941 self-dealing rules.\281\
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\281\ This rule includes any distribution to a donor, donor
advisor, or a related person, whether in the form of a grant,
loan, compensation arrangement, expense reimbursement, or
other payment. If the excess benefit results from the payment
of compensation, the entire amount paid as compensation will
be deemed the amount of the excess benefit, whether the
sponsoring organization is a private foundation or a public
charity.
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Any amount repaid as a result of correcting such an excess
benefit transaction shall not be held in or credited to any
donor advised fund.
Other sanctions
Under the provision, distributions from a donor advised
fund (as opposed to a sponsoring organization's non donor
advised funds or accounts) to any person other than the
sponsoring organization's non donor advised funds or accounts
or organizations described in section 170(b)(1)(A)\282\
(other than Type III supporting organizations \283\ or
sponsoring organizations for maintenance in a donor advised
fund) are prohibited.\284\ The provision provides for a
penalty in the event a distribution is made from a donor
advised fund to an ineligible person, such as a private non-
operating foundation or a Type III supporting organization.
In the event of such a distribution, an excise tax equal to
20 percent of the amount of the distribution is imposed
against any donor or donor advisor who advised that such
distribution be made. In addition, an excise tax equal to
five percent of the amount of the distribution is imposed
against any manager of the sponsoring organization (defined
in a manner similar to the term ``foundation manager'' under
section 4945) who knowingly approved the distribution. The
taxes described in this paragraph are subject to abatement
under generally applicable present law rules.
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\282\ By requiring that distributions from a donor advised
fund be made only to certain entities, the provision
prohibits distributions from a donor advised fund to a donor
or donor advisor (or person related to a donor or donor
advisor), whether as compensation, loans, or reimbursement of
expenses.
\283\ Distributions to Type I and Type II supporting
organizations generally are not prohibited unless prohibited
under regulations. Regulations generally shall prohibit such
distributions where the donor or donor advisor of the amounts
distributed directly or indirectly controls a supported
organization of the Type I or Type II supporting
organization.
\284\ Under the provision, distributions from donor advised
funds to individuals are prohibited. However, sponsoring
organizations may make grants to individuals from amounts not
held in donor advised funds and may establish scholarship
funds that are not donor advised funds. A donor may choose to
make a contribution directly to such a scholarship fund (or
advise that a donor advised fund make a distribution to such
a scholarship fund).
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Under the provision, if a donor, a donor advisor, or a
person related to a donor or donor advisor of a donor advised
fund advises as to a distribution that results in any such
person receiving, directly or indirectly, a more than
incidental benefit, excise taxes are imposed against any
donor or donor advisor who advised as to the distribution,
and against the recipient of the benefit. The amount of
the tax is determined by multiplying the rate of the
initial tax imposed against a disqualified person under
section 4958 by the amount of the distribution that gave
rise to the more-than-incidental benefit. Persons subject
to the tax are jointly and severally liable for the entire
amount of the tax. In addition, if a manager of the
sponsoring organization (defined in a manner similar to
the term ``foundation manager'' under section 4945) who
agreed to the making of the distribution knowing that the
distribution would confer a more than incidental benefit
on a donor, a donor advisor, or a person related to a
donor or donor advisor of a donor advised fund, the
manager also is subject to an excise tax, calculated by
multiplying the rate of the initial tax specified under
section 4958 with respect to organization managers by the
amount of the distribution that gave rise to the more than
incidental benefit. The taxes on more than incidental
benefit are subject to abatement under generally
applicable present law rules.
Reporting and disclosure
The provision requires each sponsoring organization to
disclose on its information return: (1) the total number of
donor advised funds it owns; (2) the aggregate value of
assets held in those funds at the end of the organization's
taxable year; and (3) the aggregate contributions to and
grants made from those funds during the year. The statute of
limitations for assessing any tax arising under the provision
in any year with respect to which the required information
has not been provided shall not expire before three years
after the date on which the required information is disclosed
to the IRS.
In addition, when seeking recognition of its tax-exempt
status, a sponsoring organization must disclose whether it
intends to maintain donor advised funds.
Effective date
The provision generally is effective for taxable years
beginning after the date of enactment. Distribution
requirements are effective for taxable years beginning after
the date of enactment. Information return requirements are
effective for taxable years ending after the date of
enactment. The requirements concerning disclosures on an
organization's application for tax exemption are effective
for organizations applying for recognition of exempt status
after the date of enactment. Requirements relating to
charitable contributions to donor advised funds are effective
for contributions made after 180 days from the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
15. Improve accountability of supporting organizations (secs.
241-246 of the Senate amendment and secs. 509, 4942,
4943, 4945, 4958, and 6033 and new sec. 4959 of the Code)
Present Law
Requirements for section 501(c)(3) tax-exempt status
Charitable organizations, i.e., organizations described in
section 501(c)(3), generally are exempt from Federal income
tax and are eligible to receive tax deductible contributions.
A charitable organization must operate primarily in pursuance
of one or more tax-exempt purposes constituting the basis of
its tax exemption.\285\ In order to qualify as operating
primarily for a purpose described in section 501(c)(3), an
organization must satisfy the following operational
requirements: (1) the net earnings of the organization may
not inure to the benefit of any person in a position to
influence the activities of the organization; (2) the
organization must operate to provide a public benefit, not a
private benefit; \286\ (3) the organization may not be
operated primarily to conduct an unrelated trade or business;
\287\ (4) the organization may not engage in substantial
legislative lobbying; and (5) the organization may not
participate or intervene in any political campaign.
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\285\ Treas. Reg. sec. 1.501(c)(3)-1(c)(1). The Code
specifies such purposes as religious, charitable, scientific,
testing for public safety, literary, or educational purposes,
or to foster international amateur sports competition, or for
the prevention of cruelty to children or animals. In general,
an organization is organized and operated for charitable
purposes if it provides relief for the poor and distressed or
the underprivileged. Treas. Reg. sec. 1.501(c)(3)-1(d)(2).
\286\ Treas. Reg. sec. 1.501(c)(3)-1(d)(1)(ii).
\287\ Treas. Reg. sec. 1.501(c)(3)-1(e)(1). Conducting a
certain level of unrelated trade or business activity will
not jeopardize tax-exempt status.
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Section 501(c)(3) organizations (with certain exceptions)
are required to seek formal recognition of tax-exempt status
by filing an application with the IRS (Form 1023). In
response to the application, the IRS issues a
[[Page H2260]]
determination letter or ruling either recognizing the
applicant as tax-exempt or not.
In general, organizations exempt from Federal income tax
under section 501(a) are required to file an annual
information return with the IRS.\288\ Under present law, the
information return requirement does not apply to several
categories of exempt organizations. Organizations exempt from
the filing requirement include organizations (other than
private foundations), the gross receipts of which in each
taxable year normally are not more than $25,000.\289\
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\288\ Sec. 6033(a)(1).
\289\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i);
Treas. Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii)
provides a $5,000 annual gross receipts exception from the
annual reporting requirements for certain exempt
organizations. In Announcement 82-88, 1982-25 I.R.B. 23, the
IRS exercised its discretionary authority under section 6033
to increase the gross receipts exception to $25,000, and
enlarge the category of exempt organizations that are not
required to file Form 990.
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Classification of section 501(c)(3) organizations
In general
Section 501(c)(3) organizations are classified either as
``public charities'' or ``private foundations.'' \290\
Private foundations generally are defined under section
509(a) as all organizations described in section 501(c)(3)
other than an organization granted public charity status by
reason of: (1) being a specified type of organization (i.e.,
churches, educational institutions, hospitals and certain
other medical organizations, certain organizations providing
assistance to colleges and universities, or a governmental
unit); (2) receiving a substantial part of its support from
governmental units or direct or indirect contributions from
the general public; or (3) providing support to another
section 501(c)(3) entity that is not a private foundation. In
contrast to public charities, private foundations generally
are funded from a limited number of sources (e.g., an
individual, family, or corporation). Donors to private
foundations and persons related to such donors together often
control the operations of private foundations.
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\290\ Sec. 509(a). Private foundations are either private
operating foundations or private non-operating foundations.
In general, private operating foundations operate their own
charitable programs in contrast to private non-operating
foundations, which generally are grant-making organizations.
Most private foundations are non-operating foundations.
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Because private foundations receive support from, and
typically are controlled by, a small number of supporters,
private foundations are subject to a number of anti-abuse
rules and excise taxes not applicable to public
charities.\291\ For example, the Code imposes excise taxes on
acts of ``self-dealing'' between disqualified persons
(generally, an enumerated class of foundation insiders \292\)
and a private foundation. Acts of self-dealing include, for
example, sales or exchanges, or leasing, of property; lending
of money; or the furnishing of goods, services, or facilities
between a disqualified person and a private foundation.\293\
In addition, private non-operating foundations are required
to pay out a minimum amount each year as qualifying
distributions. In general, a qualifying distribution is an
amount paid to accomplish one or more of the organization's
exempt purposes, including reasonable and necessary
administrative expenses.\294\ Certain expenditures of private
foundations are also subject to tax.\295\ In general, taxable
expenditures are expenditures: (1) for lobbying; (2) to
influence the outcome of a public election or carry on a
voter registration drive (unless certain requirements are
met); (3) as a grant to an individual for travel, study, or
similar purposes unless made pursuant to procedures approved
by the Secretary; (4) as a grant to an organization that is
not a public charity or exempt operating foundation unless
the foundation exercises expenditure responsibility \296\
with respect to the grant; or (5) for any non-charitable
purpose. Additional excise taxes may apply in the event a
private foundation holds certain business interests (``excess
business holdings'') \297\ or makes an investment that
jeopardizes the foundation's exempt purposes.\298\
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\291\ Secs. 4940-4945.
\292\ See sec. 4946(a).
\293\ Sec. 4941.
\294\ Sec. 4942(g)(1)(A). A qualifying distribution also
includes any amount paid to acquire an asset used (or held
for use) directly in carrying out one or more of the
organization's exempt purposes and certain amounts set-aside
for exempt purposes. Sec. 4942(g)(1)(B) and 4942(g)(2).
\295\ Sec. 4945. Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\296\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish
reasonable procedures to ensure that the grant is spent
solely for the purpose for which it was made, to obtain
reports from the grantee on the expenditure of the grant, and
to make reports to the Secretary regarding such expenditures.
Sec. 4945(h).
\297\ Sec. 4943.
\298\ Sec. 4944.
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Public charities also enjoy certain advantages over private
foundations regarding the deductibility of contributions. For
example, contributions of appreciated capital gain property
to a private foundation generally are deductible only to the
extent of the donor's cost basis.\299\ In contrast,
contributions to public charities generally are deductible in
an amount equal to the property's fair market value, except
for gifts of inventory and other ordinary income property,
short-term capital gain property, and tangible personal
property the use of which is unrelated to the donee
organization's exempt purpose. In addition, under present
law, a taxpayer's deductible contributions generally are
limited to specified percentages of the taxpayer's
contribution base, which generally is the taxpayer's adjusted
gross income for a taxable year. The applicable percentage
limitations vary depending upon the type of property
contributed and the classification of the donee organization.
In general, contributions to non-operating private
foundations are limited to a smaller percentage of the
donor's contribution base (up to 30 percent) than
contributions to public charities (up to 50 percent).\300\
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\299\ A special rule in section 170(e)(5) provides that
taxpayers are allowed a deduction equal to the fair market
value of certain contributions of appreciated, publicly
traded stock contributed to a private foundation.
\300\ Sec. 170(b).
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Supporting organizations (section 509(a)(3))
The Code provides that certain ``supporting organizations''
(in general, organizations that provide support to another
section 501(c)(3) organization that is not a private
foundation) are classified as public charities rather than
private foundations.\301\ To qualify as a supporting
organization, an organization must meet all three of the
following tests: (1) it must be organized and at all times
operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of one or more
``publicly supported organizations'' \302\ (the
``organizational and operational tests''); \303\ (2) it must
be operated, supervised, or controlled by or in connection
with one or more publicly supported organizations (the
``relationship test''); \304\ and (3) it must not be
controlled directly or indirectly by one or more disqualified
persons (as defined in section 4946) other than foundation
managers and other than one or more publicly supported
organizations (the ``lack of outside control test'').\305\
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\301\ Sec. 509(a)(3).
\302\ In general, supported organizations of a supporting
organization must be publicly supported charities described
in sections 509(a)(1) or (a)(2).
\303\ Sec. 509(a)(3)(A).
\304\ Sec. 509(a)(3)(B).
\305\ Sec. 509(a)(3)(C).
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To satisfy the relationship test, a supporting organization
must hold one of three statutorily described close
relationships with the supported organization. The
organization must be: (1) operated, supervised, or controlled
by a publicly supported organization (commonly referred to as
``Type I'' supporting organizations); (2) supervised or
controlled in connection with a publicly supported
organization (``Type II'' supporting organizations); or (3)
operated in connection with a publicly supported organization
(``Type III'' supporting organizations).\306\
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\306\ Treas. Reg. sec. 1.509(a)-4(f)(2).
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Type I supporting organizations
In the case of supporting organizations that are operated,
supervised, or controlled by one or more publicly supported
organizations (Type I supporting organizations), one or more
supported organizations must exercise a substantial degree of
direction over the policies, programs, and activities of the
supporting organization.\307\ The relationship between the
Type I supporting organization and the supported organization
generally is comparable to that of a parent and subsidiary.
The requisite relationship may be established by the fact
that a majority of the officers, directors, or trustees of
the supporting organization are appointed or elected by the
governing body, members of the governing body, officers
acting in their official capacity, or the membership of one
or more publicly supported organizations.\308\
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\307\ Treas. Reg. sec. 1.509(a)-4(g)(1)(i).
\308\ Id.
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Type II supporting organizations
Type II supporting organizations are supervised or
controlled in connection with one or more publicly supported
organizations. Rather than the parent-subsidiary relationship
characteristic of Type I organizations, the relationship
between a Type II organization and its supported
organizations is more analogous to a brother-sister
relationship. In order to satisfy the Type II relationship
requirement, generally there must be common supervision or
control by the persons supervising or controlling both the
supporting organization and the publicly supported
organizations.\309\ An organization generally is not
considered to be ``supervised or controlled in connection
with'' a publicly supported organization merely because the
supporting organization makes payments to the publicly
supported organization, even if the obligation to make
payments is enforceable under state law.\310\
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\309\ Treas. Reg. sec. 1.509(a)-4(h)(1).
\310\ Treas. Reg. sec. 1.509(a)-4(h)(2).
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Type III supporting organizations
Type III supporting organizations are ``operated in
connection with'' one or more publicly supported
organizations. To satisfy the ``operated in connection with''
relationship, Treasury regulations require that the
supporting organization be responsive to, and significantly
involved in the operations of, the publicly supported
organization. This relationship is deemed to exist where the
supporting organization meets both a ``responsiveness test''
and an ``integral part test.'' \311\
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\311\ Treas. Reg. sec. 1.509(a)-4(i)(1).
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In general, the responsiveness test requires that the Type
III supporting organization be responsive to the needs or
demands of the publicly supported organizations. The
responsiveness test may be satisfied in one of two ways.\312\
First, the supporting organization may demonstrate that:
(1)(a) one or
[[Page H2261]]
more of its officers, directors, or trustees are elected or
appointed by the officers, directors, trustees, or membership
of the supported organization; (b) one or more members of the
governing bodies of the publicly supported organizations are
also officers, directors, or trustees of the supporting
organization; or (c) the officers, directors, or trustees of
the supporting organization maintain a close continuous
working relationship with the officers, directors, or
trustees of the publicly supported organizations; and (2) by
reason of such arrangement, the officers, directors, or
trustees of the supported organization have a significant
voice in the investment policies of the supporting
organization, the timing and manner of making grants, the
selection of grant recipients by the supporting organization,
and otherwise directing the use of the income or assets of
the supporting organization.\313\ Alternatively, the
responsiveness test may be satisfied if the supporting
organization is a charitable trust under state law, each
specified supported organization is a named beneficiary under
the trust's governing instrument, and the beneficiary
organization has the power to enforce the trust and compel an
accounting under state law.\314\
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\312\ For an organization that was supporting or benefiting
one or more publicly supported organizations before November
20, 1970, additional facts and circumstances, such as an
historic and continuing relationship between organizations,
also may be taken into consideration to establish compliance
with either of the responsiveness tests. Treas. Reg. sec.
1.509(a)-4(i)(1)(ii).
\313\ Treas. Reg. sec. 1.509(a)-4(i)(2)(ii).
\314\ Treas. Reg. sec. 1.509(a)-4(i)(2)(iii).
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In general, the integral part test requires that the Type
III supporting organization maintain significant involvement
in the operations of one or more publicly supported
organizations, and that such publicly supported organizations
are in turn dependent upon the supporting organization for
the type of support which it provides. There are two
alternative methods for satisfying the integral part test.
The first alternative is to establish that (1) the activities
engaged in for or on behalf of the publicly supported
organization are activities to perform the functions of, or
carry out the purposes of, such organizations; and (2) these
activities, but for the involvement of the supporting
organization, normally would be engaged in by the publicly
supported organizations themselves.\315\ The second method
for satisfying the integral part test is to establish that:
(1) the supporting organization pays substantially all of its
income to or for the use of one or more publicly supported
organizations; \316\ (2) the amount of support received by
one or more of the publicly supported organizations is
sufficient to insure the attentiveness of the organization or
organizations to the operations of the supporting
organization (this is known as the ``attentiveness
requirement''); \317\ and (3) a significant amount of the
total support of the supporting organization goes to those
publicly supported organizations that meet the attentiveness
requirement.\318\
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\315\ Treas. Reg. sec. 1.509(a)-4(i)(3)(ii).
\316\ For this purpose, the IRS has defined the term
``substantially all'' of an organization's income to mean 85
percent or more. Rev. Rul. 76-208, 1976-1 C.B. 161.
\317\ Although the regulations do not specify the requisite
level of support in numerical or percentage terms, the IRS
has suggested that grants that represent less than 10 percent
of the beneficiary's support likely would be viewed as
insufficient to ensure attentiveness. Gen. Couns. Mem. 36379
(August 15, 1975). As an alternative to satisfying the
attentiveness standard by the foregoing method, a supporting
organization may demonstrate attentiveness by showing that,
in order to avoid the interruption of the carrying on of a
particular function or activity, the beneficiary organization
will be sufficiently attentive to the operations of the
supporting organization. Treas. Reg. sec. 1.509(a)-
4(i)(3)(iii)(b).
\318\ Treas. Reg. sec. 1.509(a)-4(i)(3)(iii).
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Intermediate sanctions (excess benefit transaction tax)
The Code imposes excise taxes on excess benefit
transactions between disqualified persons and public
charities.\319\ An excess benefit transaction generally is a
transaction in which an economic benefit is provided by a
public charity directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including
the performance of services) received for providing such
benefit.
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\319\ Sec. 4958. The excess benefit transaction tax is
commonly referred to as ``intermediate sanctions,'' because
it imposes penalties generally considered to be less punitive
than revocation of the organization's exempt status. The tax
also applies to transactions between disqualified persons and
social welfare organizations (as described in section
501(c)(4)).
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For purposes of the excess benefit transaction rules, a
disqualified person is any person in a position to exercise
substantial influence over the affairs of the public charity
at any time in the five-year period ending on the date of the
transaction at issue.\320\ Persons holding certain powers,
responsibilities, or interests (e.g., officers, directors, or
trustees) are considered to be in a position to exercise
substantial influence over the affairs of the public charity.
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\320\ Sec. 4958(f)(1). A disqualified person also includes
certain family members of such a person, and certain entities
that satisfy a control test with respect to such persons.
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An excess benefit transaction tax is imposed on the
disqualified person and, in certain cases, on the
organization managers, but is not imposed on the public
charity. An initial tax of 25 percent of the excess benefit
amount is imposed on the disqualified person that receives
the excess benefit. An additional tax on the disqualified
person of 200 percent of the excess benefit applies if the
violation is not corrected within a specified period. A tax
of 10 percent of the excess benefit (not to exceed $10,000
with respect to any excess benefit transaction) is imposed on
an organization manager that knowingly participated in the
excess benefit transaction, if the manager's participation
was willful and not due to reasonable cause, and if the
initial tax was imposed on the disqualified person.
House Bill
No provision.
Senate Amendment
Provisions relating to all (Type I, Type II, and Type III)
supporting organizations
Excess benefit transactions
Under the provision, if a supporting organization (Type I,
Type II, or Type III) makes a grant, loan, payment of
compensation, or other similar payment to a substantial
contributor (or person related to the substantial
contributor) of the supporting organization, for purposes of
the excess benefit transaction rules (sec. 4958), the
substantial contributor is treated as a disqualified person
and the payment is treated as an excess benefit transaction
with the entire amount of the payment treated as the excess
benefit.
A substantial contributor means any person who contributed
or bequeathed an aggregate amount of more than $5,000 to the
organization, if such amount is more than two percent of the
total contributions and bequests received by the organization
before the close of the taxable year of the organization in
which the contribution or bequest is received by the
organization from such person. In the case of a trust, a
substantial contributor also includes the creator of the
trust. A substantial contributor does not include a public
charity (other than a supporting organization).
A person is a related person (``related person'') if a
person is a member of the family (determined under section
4958(f)(4)) of a substantial contributor, or a 35 percent
entity, defined as a corporation, partnership, trust, or
estate in which a substantial contributor or family member
thereof own more than 35 percent of the total combined voting
power, profits interest, or beneficial interest, as the case
may be.
In addition, under the provision, loans by any supporting
organization (Type I, Type II, or Type III) to a disqualified
person (as defined in section 4958) of the supporting
organization are treated as an excess benefit transaction
under section 4958 and the entire amount of the loan is
treated as an excess benefit. For this purpose, a
disqualified person does not include a public charity (other
than a supporting organization).
Disclosure requirements
All supporting organizations are required to file an annual
information return (Form 990 series) with the Secretary,
regardless of the organization's gross receipts. A supporting
organization must indicate on such annual information return
whether it is a Type I, Type II, or Type III supporting
organization and must identify its supported organizations.
Supporting organizations must demonstrate annually that the
organization is not controlled directly or indirectly by one
or more disqualified persons (other than foundation managers
and other than one or more publicly supported organizations)
through a certification on the annual information return.
Disqualified person
For purposes of the excess benefit transaction rules (sec.
4958), a disqualified person of a supporting organization is
treated as a disqualified person of the supported
organization.
Provisions that apply to Type III supporting organizations
Modify payout requirement of Type III supporting
organizations
A Type III supporting organization must pay each taxable
year, to or for the use of one or more public charities
described in section 509(a)(1) or 509(a)(2) (``qualifying
distributions''), the sum of (1) the greater of (i) 85
percent of its adjusted net income (as defined in section
4942(f)) for the preceding taxable year or (ii) the
applicable percentage \321\ of the aggregate fair market
value of all of the assets of the organization other than
assets that are used (or held for use) directly in supporting
the charitable programs of the supporting organization or one
or more supported organizations, determined as of the last
day of the preceding taxable year, and (2) any amount
received or accrued in such year as repayments of amounts
that were taken into account as support provided by the
supporting organization in prior years. Qualifying
distributions are treated as made first to satisfy the pay
out requirement of the immediately preceding taxable year,
and then of the taxable year, unless the taxpayer elects to
have an amount as satisfying the payout of any prior taxable
year. Amounts distributed in excess of the required payout
for the current year and all previous taxable years may be
carried forward for up to five taxable years following the
taxable year in which the excess payment is made.
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\321\ The percentage is three percent for the first taxable
year beginning after the date of enactment, four percent for
the second such taxable year, and five percent for any such
taxable year thereafter.
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A supporting organization's administrative expenses count
as expenses to or for the use of a supported organization.
The holding of
[[Page H2262]]
assets for investment purposes, or to operate an unrelated
trade or business, is not considered a use or holding for use
directly to support a supported organization's charitable
programs. The Secretary may provide guidance as to types of
uses of assets that are considered to be directly in support
of a supported organization's charitable programs similar to
guidance provided under Treasury Regulation section
53.4942(a)-2(c)(3)(i).
An organization that fails to meet the payout requirement
is subject to an initial tax of 30 percent of the unpaid
amount, increased to 100 percent of the unpaid amount if the
payout requirement is not met by the earlier of the date of
mailing of a notice of deficiency with respect to the initial
tax or the date on which the initial tax is assessed.
Excess business holdings
The excess business holdings rules of section 4943 are
applied to Type III supporting organizations. In applying
such rules, the term disqualified person has the meaning
provided in section 4958, and also includes substantial
contributors and related persons and any organization that is
effectively controlled by the same person or persons who
control the supporting organization or any organization
substantially all of the contributions to which were made by
the same person or persons who made substantially all of the
contributions to the supporting organization. The excess
business holdings rules do not apply if the holdings are held
for the benefit of the community pursuant to the direction of
a State attorney general or a State official with
jurisdiction over the Type III supporting organization. The
Secretary has the authority not to impose the excess business
holding rules if the organization establishes to the
satisfaction of the Secretary that the excess holdings are
consistent with the exempt purposes of the organization.
Transition rules apply to the present holdings of an
organization similar to those of section 4943(c)(4)-(6).
The excess business holdings rules also apply to Type II
supporting organizations but only if such organization
accepts any gift or contribution from a person (other than a
public charity, not including a supporting organization) who
(1) controls, directly or indirectly, either alone or
together (with persons described below) the governing body of
a supported organization of the supporting organization; (2)
is a member of the family of such a person; or (3) is a 35
percent controlled entity.
Organizational and operational requirements
In general, after the date of enactment of the provision, a
Type III supporting organization may not support more than
five organizations. A transition rule applies to Type III
supporting organizations that support more than five
organizations on such date. Such organizations are not
required to reduce the number of supported organizations, but
may not increase the number of organizations supported above
the number of organizations supported on the date of
enactment, and may not add new supported organizations as
beneficiaries unless no more than five organizations are
supported by the supporting organization following such
addition.
A Type III supporting organization may not support an
organization that is not organized in the United States on
any date after the date which is 180 days after the date of
enactment,\322\ and may not be a donor with respect to a
donor advised fund.
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\322\ U.S. charities established principally to provide
financial and other assistance to a foreign charity,
sometimes referred to as ``friends of'' organizations, may
not be established as supporting organizations under the
provision. Such organizations may continue to obtain public
charity status, however, by virtue of demonstrating broad
public support (as described in sections 509(a)(1) and
509(a)(2)).
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Relationship to supported organization(s)
A Type III supporting organization must, as part of its
exemption application (Form 1023) attach a letter from each
supported organization acknowledging that the supported
organization has been designated by such organization as a
supported organization.
On the annual information return filed by a Type III
supporting organization, the organization must indicate that
it has obtained letters from organizations that received its
support. It is intended that all such letters must be signed
by a senior officer or a member of the Board of the supported
organization. The letters must show (1) that the supported
organization agrees to be supported by the supporting
organization, (2) the type of support provided or to be
provided, and (3) how such support furthers the supported
organization's charitable purposes.
A Type III supporting organization must apprise each
organization it supports of information regarding the
supporting organization in order to help ensure the
supporting organization's responsiveness. Such a showing
could be satisfied, for example, through provision of
documentation such as a copy of the supporting organization's
governing documents, any changes made to the governing
documents, the organization's annual information return filed
with the Secretary (Form 990 series), any tax return (Form
990-T) filed with the Secretary, and an annual report
(including a description of all of the support provided by
the supporting organization, how such support was calculated,
and a projection of the next year's support). Failure to make
a sufficient showing is a factor in determining whether the
responsiveness test of present law is met.
A Type III supporting organization that is organized as a
trust must, in addition to present law requirements,
establish to the satisfaction of the Secretary, that it has a
close and continuous relationship with the supported
organization such that the trust is responsive to the needs
or demands of the supported organization.
Other provisions
Under the provision, if a Type I or Type III supporting
organization accepts any gift or contribution from a person
(other than a public charity, not including a supporting
organization) who (1) controls, directly or indirectly,
either alone or together (with persons described below) the
governing body of a supported organization of the supporting
organization; (2) is a member of the family of such a person;
or (3) is a 35 percent controlled entity, then the supporting
organization is treated as a private foundation for all
purposes until such time as the organization can demonstrate
to the satisfaction of the Secretary that it qualifies as a
public charity other than as a supporting organization.
Under the provision, a non-operating private foundation may
not count as a qualifying distribution under section 4942 any
amount paid to a supporting organization. In addition, any
such amount is treated as a taxable expenditure under section
4945.
Effective date
The provision generally is effective on the date of
enactment. The distribution requirements are effective for
taxable years beginning after the date of enactment. The
prohibited transaction rules are effective for transactions
occurring after the date of enactment. The excess business
holdings requirements are effective for taxable years
beginning after the date of enactment. The provision relating
to distributions by nonoperating private foundations is
effective for distributions and expenditures made after the
date of enactment. The return requirements are effective for
returns filed for taxable years ending after the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
TITLE IV--MISCELLANEOUS PROVISIONS
A. Restructure New York Liberty Zone Tax Incentives
(Sec. 301 of the Senate amendment)
Present Law
In general
Present law includes a number of incentives to invest in
property located in the New York Liberty Zone (``NYLZ''),
which is the area located on or south of Canal Street, East
Broadway (east of its intersection with Canal Street), or
Grand Street (east of its intersection with East Broadway) in
the Borough of Manhattan in the City of New York, New York.
These incentives were enacted following the terrorist attack
in New York City on September 11, 2001.\323\
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\323\ In addition to the NYLZ provisions described above,
other NYLZ incentives are provided: (1) $8 billion of tax-
exempt private activity bond financing for certain
nonresidential real property, residential rental property and
public utility property is authorized to be issued after
March 9, 2002, and before January 1, 2010; and (2) $9 billion
of additional tax-exempt advance refunding bonds is available
after March 9, 2002, and before January 1, 2006, with respect
to certain State or local bonds outstanding on September 11,
2001.
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Special depreciation allowance for qualified New York Liberty
Zone property
Section 1400L(b) allows an additional first-year
depreciation deduction equal to 30 percent of the adjusted
basis of qualified NYLZ property.\324\ In order to qualify,
property generally must be placed in service on or before
December 31, 2006 (December 31, 2009 in the case of
nonresidential real property and residential rental
property).
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\324\ The amount of the additional first-year depreciation
deduction is not affected by a short taxable year.
---------------------------------------------------------------------------
The additional first-year depreciation deduction is allowed
for both regular tax and alternative minimum tax purposes for
the taxable year in which the property is placed in service.
A taxpayer is allowed to elect out of the additional first-
year depreciation for any class of property for any taxable
year.
In order for property to qualify for the additional first-
year depreciation deduction, it must meet all of the
following requirements. First, the property must be property
to which the general rules of the Modified Accelerated Cost
Recovery System (``MACRS'') \325\ apply with (1) an
applicable recovery period of 20 years or less, (2) water
utility property (as defined in section 168(e)(5)), (3)
certain nonresidential real property and residential rental
property, or (4) computer software other than computer
software covered by section 197. A special rule precludes the
additional first-year depreciation under this provision for
(1) qualified NYLZ leasehold improvement property \326\ and
(2) property eligible for the additional first-year
depreciation deduction under section 168(k) (i.e., property
is eligible
[[Page H2263]]
for only one 30 percent additional first-year depreciation).
Second, substantially all of the use of such property must be
in the NYLZ. Third, the original use of the property in the
NYLZ must commence with the taxpayer on or after September
11, 2001. Finally, the property must be acquired by
purchase\327\ by the taxpayer after September 10, 2001 and
placed in service on or before December 31, 2006. For
qualifying nonresidential real property and residential
rental property the property must be placed in service on or
before December 31, 2009 in lieu of December 31, 2006.
Property will not qualify if a binding written contract for
the acquisition of such property was in effect before
September 11, 2001.\328\
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\325\ A special rule precludes the additional first-year
depreciation deduction for property that is required to be
depreciated under the alternative depreciation system of
MACRS.
\326\ Qualified NYLZ leasehold improvement property is
defined in another provision. Leasehold improvements that do
not satisfy the requirements to be treated as ``qualified
NYLZ leasehold improvement property'' maybe eligible for the
30 percent additional first-year depreciation deduction
(assuming all other conditions are met).
\327\ For purposes of this provision, purchase is defined as
under section 179(d).
\328\ Property is not precluded from qualifying for the
additional first-year depreciation merely because a binding
written contract to acquire a component of the property is in
effect prior to September 11, 2001.
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Nonresidential real property and residential rental
property is eligible for the additional first-year
depreciation only to the extent such property rehabilitates
real property damaged, or replaces real property destroyed or
condemned as a result of the terrorist attacks of September
11, 2001.
Property that is manufactured, constructed, or produced by
the taxpayer for use by the taxpayer qualifies for the
additional first-year depreciation deduction if the taxpayer
begins the manufacture, construction, or production of the
property after September 10, 2001, and the property is placed
in service on or before December 31, 2006 \329\ (and all
other requirements are met). Property that is manufactured,
constructed, or produced for the taxpayer by another person
under a contract that is entered into prior to the
manufacture, construction, or production of the property is
considered to be manufactured, constructed, or produced by
the taxpayer.
---------------------------------------------------------------------------
\329\ December 31, 2009 with respect to qualified
nonresidential real property and residential rental property.
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Depreciation of New York Liberty Zone 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.\330\ This rule applies regardless of
whether the lessor or the lessee places the leasehold
improvements in service.\331\ 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 is placed in service.\332\
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\330\ Sec. 168(i)(8). The Tax Reform Act of 1986 modified the
Accelerated Cost Recovery System (``ACRS'') to institute
MACRS. Prior to the adoption of ACRS by the Economic Recovery
Tax Act of 1981, taxpayers were allowed to depreciate the
various components of a building as separate assets with
separate useful lives. The use of component depreciation was
repealed upon the adoption of ACRS. The Tax Reform Act of
1986 also denied the use of component depreciation under
MACRS.
\331\ Former sections 168(f)(6) and 178 provided that, in
certain circumstances, a lessee could recover the cost of
leasehold improvements made over the remaining term of the
lease. The Tax Reform Act of 1986 repealed these provisions.
\332\ Secs. 168(b)(3), (c), (d)(2), and (i)(6). If the
improvement is characterized as tangible personal property,
ACRS or MACRS depreciation is calculated using the shorter
recovery periods, accelerated methods, and conventions
applicable to such property. The determination of whether
improvements are characterized as tangible personal property
or as nonresidential real property often depends on whether
or not the improvements constitute a ``structural component''
of a building (as defined by Treas. Reg. sec. 1.48-1(e)(1)).
See, e.g., Metro National Corp v. Commissioner, 52 TCM (CCH)
1440 (1987); King Radio Corp Inc. v. U.S., 486 F.2d 1091
(10th Cir. 1973); Mallinckrodt, Inc. v. Commissioner, 778
F.2d 402 (8th Cir. 1985) (with respect to various leasehold
improvements).
---------------------------------------------------------------------------
A special rule exists for qualified NYLZ leasehold
improvement property, which is recovered over five years
using the straight-line method. The term qualified NYLZ
leasehold improvement property means property defined in
section 168(e)(6) that is acquired and placed in service
after September 10, 2001, and before January 1, 2007 (and not
subject to a binding contract on September 10, 2001), in the
NYLZ. For purposes of the alternative depreciation system,
the property is assigned a nine-year recovery period. A
taxpayer may elect out of the 5-year (and 9-year) recovery
period for qualified NYLZ leasehold improvement property.
Increased section 179 expensing for qualified New York
Liberty Zone property
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct the
cost of qualifying property. For taxable years beginning in
2003 through 2007, a taxpayer may deduct up to $100,000 of
the cost of qualifying property placed in service for the
taxable year. In general, qualifying property for this
purpose is defined as depreciable tangible personal property
(and certain computer software) that is purchased for use in
the active conduct of a trade or business. The $100,000
amount is reduced (but not below zero) by the amount by which
the cost of qualifying property placed in service during the
taxable year exceeds $400,000. The $100,000 and $400,000
amounts are indexed for inflation.
For taxable years beginning in 2008 and thereafter, a
taxpayer with a sufficiently small amount of annual
investment may elect to deduct up to $25,000 of the cost of
qualifying property placed in service for the taxable year.
The $25,000 amount is reduced (but not below zero) by the
amount by which the cost of qualifying property placed in
service during the taxable year exceeds $200,000. In general,
qualifying property for this purpose is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business.
The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount
that is not allowed as a deduction because of the taxable
income limitation may be carried forward to succeeding
taxable years (subject to similar limitations). No general
business credit under section 38 is allowed with respect to
any amount for which a deduction is allowed under section
179.
The amount a taxpayer can deduct under section 179 is
increased for qualifying property used in the NYLZ.
Specifically, the maximum dollar amount that may be deducted
under section 179 is increased by the lesser of (1) $35,000
or (2) the cost of qualifying property placed in service
during the taxable year. This amount is in addition to the
amount otherwise deductible under section 179.
Qualifying property for purposes of the NYLZ provision
means section 179 property \333\ purchased and placed in
service by the taxpayer after September 10, 2001 and before
January 1, 2007, where (1) substantially all of the use of
such property is in the NYLZ in the active conduct of a trade
or business by the taxpayer in the NYLZ, and (2) the original
use of which in the NYLZ commences with the taxpayer after
September 10, 2001.\334\
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\333\ As defined in sec. 179(d)(1).
\334\ See Rev. Proc. 2002-33, 2002-20 I.R.B. 963 (May 20,
2002), for procedures on claiming the increased section 179
expensing deduction by taxpayers who filed their tax returns
before June 1, 2002.
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The phase-out range for the section 179 deduction
attributable to NYLZ property is applied by taking into
account only 50 percent of the cost of NYLZ property that is
section 179 property. Also, no general business credit under
section 38 is allowed with respect to any amount for which a
deduction is allowed under section 179.
The provision is effective for property placed in service
after September 10, 2001 and before January 1, 2007.
Extended replacement period for New York Liberty Zone
involuntary conversions
A taxpayer may elect not to recognize gain with respect to
property that is involuntarily converted if the taxpayer
acquires within an applicable period (the ``replacement
period'') property similar or related in service or use
(section 1033). If the taxpayer does not replace the
converted property with property similar or related in
service or use, then gain generally is recognized. If the
taxpayer elects to apply the rules of section 1033, gain on
the converted property is recognized only to the extent that
the amount realized on the conversion exceeds the cost of the
replacement property. In general, the replacement period
begins with the date of the disposition of the converted
property and ends two years after the close of the first
taxable year in which any part of the gain upon conversion is
realized.\335\ The replacement period is extended to three
years if the converted property is real property held for the
productive use in a trade or business or for investment.\336\
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\335\ Section 1033(a)(2)(B).
\336\ Section 1033(g)(4).
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The replacement period is extended to five years with
respect to property that was involuntarily converted within
the NYLZ as a result of the terrorist attacks that occurred
on September 11, 2001. However, the five-year period is
available only if substantially all of the use of the
replacement property is in New York City. In all other cases,
the present-law replacement period rules continue to apply.
House Bill
No provision.
Senate Amendment
Repeal of certain NYLZ incentives
The provision repeals the four NYLZ incentives relating to
the additional first-year depreciation allowance of 30
percent, the five-year depreciation of leasehold
improvements, the additional section 179 expensing, and the
extended replacement period for involuntary conversions.\337\
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\337\ The provision does not change the present-law rules
relating to certain NYLZ private activity bond financing and
additional advance refunding bonds.
---------------------------------------------------------------------------
Creation of New York Liberty Zone tax credits
The provision provides a credit against tax imposed (other
than taxes of section 3111(a), 3403, or subtitle D) paid or
incurred by any governmental unit of the State of New York
and the City of New York equal to the lesser of (1) the total
expenditures during such year by such governmental unit for
qualifying projects, or (2) the amount allocated to such
governmental unit for such calendar year.
Qualifying projects means any transportation infrastructure
project, including highways, mass transit systems, railroads,
airports, ports, and waterways, in or connecting with the New
York Liberty Zone, which is
[[Page H2264]]
designated as a qualifying project jointly by the Governor of
the State of New York and the Mayor of the City of New York.
The Governor of the State of New York and the Mayor of the
City of New York shall jointly allocate to a governmental
unit the amount of expenditures which may be taken into
account for purposes of the credit for any calendar year in
the credit period with respect to a qualifying project. The
aggregate limit that may be allocated for all calendar years
in the credit period is two billion dollars. The annual limit
for any calendar year in the credit period shall not exceed
the sum of 200 million dollars plus the aggregate amount
authorized to be allocated for all preceding calendar years
in the credit period which was not allocated. The credit
period is the ten-year period beginning on January 1, 2006.
If, at the close of the credit period, the aggregate
amounts allocated are less than the 2 billion dollar
aggregate limit, the Governor of the State of New York and
the Mayor of the City of New York may jointly allocate, for
any calendar year following the credit period, for
expenditures with respect to qualifying projects, amounts
that in sum for all years following the credit period would
equal such shortfall.
Under the provision, any expenditure for a qualifying
project taken into account for purposes of the credit shall
be considered State and local funds for the purpose of any
Federal program.
Effective date
The provision is effective on the date of enactment, with
an exception for property subject to a written binding
contract in effect on the date of enactment which is placed
in service prior to the original sunset dates under present
law. The extended replacement period for involuntarily
converted property ends on the earlier of (1) the date of
enactment or (2) the last day of the five-year period
specified in the Jobs Creation and Worker Assistance Act of
2002 (``JCWAA'').\338\
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\338\ Pub. L. No. 107-147, sec. 301 (2002).
---------------------------------------------------------------------------
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
B. Modification of S Corporation Passive Investment Income Rules
(Sec. 302 of the Senate amendment and secs. 1362 and 1375 of
the Code)
Present Law
An S corporation is subject to corporate-level tax, at the
highest corporate tax rate, on its excess net passive income
if the corporation has (1) accumulated earnings and profits
at the close of the taxable year and (2) gross receipts more
than 25 percent of which are passive investment income.
Excess net passive income is the net passive income for a
taxable year multiplied by a fraction, the numerator of which
is the amount of passive investment income in excess of 25
percent of gross receipts and the denominator of which is the
passive investment income for the year. Net passive income is
defined as passive investment income reduced by the allowable
deductions that are directly connected with the production of
that income. Passive investment income generally means gross
receipts derived from royalties, rents, dividends, interest,
annuities, and sales or exchanges of stock or securities (to
the extent of gains). Passive investment income generally
does not include interest on accounts receivable, gross
receipts that are derived directly from the active and
regular conduct of a lending or finance business, gross
receipts from certain liquidations, or gain or loss from any
section 1256 contract (or related property) of an options or
commodities dealer.
In addition, an S corporation election is terminated
whenever the S corporation has accumulated earnings and
profits at the close of each of three consecutive taxable
years and has gross receipts for each of those years more
than 25 percent of which are passive investment income.
House Bill
No provision.
Senate Amendment
The Senate amendment increases the 25-percent threshold to
60 percent; eliminates gains from the sale or exchange of
stock or securities from the definition of passive investment
income; and eliminates the rule terminating an S election by
reason of having excess passive investment income for three
consecutive taxable years.
Effective date.--The provision applies to taxable years
beginning after December 31, 2006, and before October 1,
2009.
Conference Agreement
The conference agreement does not contain the Senate
amendment provision.
C. Capital Expenditure Limitation for Qualified Small Issue Bonds
(Sec. 303 of the Senate amendment and sec. 144 of the Code)
Present Law
Qualified small-issue bonds are tax-exempt State and local
government bonds used to finance private business
manufacturing facilities (including certain directly related
and ancillary facilities) or the acquisition of land and
equipment by certain farmers. In both instances, these bonds
are subject to limits on the amount of financing that may be
provided, both for a single borrowing and in the aggregate.
In general, no more than $1 million of small-issue bond
financing may be outstanding at any time for property of a
business (including related parties) located in the same
municipality or county. Generally, this $1 million limit may
be increased to $10 million if all other capital expenditures
of the business in the same municipality or county are
counted toward the limit over a six-year period that begins
three years before the issue date of the bonds and ends three
years after such date. Outstanding aggregate borrowing is
limited to $40 million per borrower (including related
parties) regardless of where the property is located.
For bonds issued after September 30, 2009, the Code permits
up to $10 million of capital expenditures to be disregarded,
in effect increasing from $10 million to $20 million the
maximum allowable amount of total capital expenditures by an
eligible business in the same municipality or county.\339\
However, no more than $10 million of bond financing may be
outstanding at any time for property of an eligible business
(including related parties) located in the same municipality
or county. Other limits (e.g., the $40 million per borrower
limit) also continue to apply.
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\339\ Sec. 144(a)(4)(G) as added by sec. 340(a) of the
American Jobs Creation Act of 2004, Pub. L. No. 108-357
(2004).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision accelerates the application of the $20
million capital expenditure limitation from bonds issued
after September 30, 2009, to bonds issued after December 31,
2006.
Effective date.--The provision is effective on the date of
enactment for bonds issued after December 31, 2006.
Conference Agreement
The conference agreement includes the Senate amendment
provision.
D. Premiums for Mortgage Insurance
(Sec. 304 of the Senate amendment and secs. 163(h) and 6050H
of the Code)
Present Law
Present law provides that qualified residence interest is
deductible notwithstanding the general rule that personal
interest is nondeductible (sec. 163(h)).
Qualified residence interest is interest on acquisition
indebtedness and home equity indebtedness with respect to a
principal and a second residence of the taxpayer. The maximum
amount of home equity indebtedness is $100,000. The maximum
amount of acquisition indebtedness is $1 million. Acquisition
indebtedness means debt that is incurred in acquiring
constructing, or substantially improving a qualified
residence of the taxpayer, and that is secured by the
residence. Home equity indebtedness is debt (other than
acquisition indebtedness) that is secured by the taxpayer's
principal or second residence, to the extent the aggregate
amount of such debt does not exceed the difference between
the total acquisition indebtedness with respect to the
residence, and the fair market value of the residence.
House Bill
No provision.
Senate Amendment
The Senate amendment provision provides that premiums paid
or accrued for qualified mortgage insurance by a taxpayer
during the taxable year in connection with acquisition
indebtedness on a qualified residence of the taxpayer are
treated as interest that is qualified residence interest and
thus deductible. The amount allowable as a deduction under
the provision is phased out ratably by 10 percent for each
$1,000 by which the taxpayer's adjusted gross income exceeds
$100,000 ($500 and $50,000, respectively, in the case of a
married individual filing a separate return). Thus, the
deduction is not allowed if the taxpayer's adjusted gross
income exceeds $110,000 ($55,000 in the case of married
individual filing a separate return).
For this purpose, qualified mortgage insurance means
mortgage insurance provided by the Veterans Administration,
the Federal Housing Administration, or the Rural Housing
Administration, and private mortgage insurance (defined in
section 2 of the Homeowners Protection Act of 1998 as in
effect on the date of enactment of the Senate amendment
provision).
Amounts paid for qualified mortgage insurance that are
properly allocable to periods after the close of the taxable
year are treated as paid in the period to which they are
allocated. No deduction is allowed for the unamortized
balance if the mortgage is paid before its term (except in
the case of qualified mortgage insurance provided by the
Department of Veterans Affairs or Rural Housing
Administration).
Reporting rules apply under the provision.
Effective date.--The Senate amendment provision is
effective for amounts paid or accrued in taxable years
beginning after December 31, 2006, and ending before January
1, 2008, and properly allocable to that period, with respect
to mortgage insurance contracts issued after December 31,
2006.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
E. Sense of the Senate on Use of No-Bid Contracting by Federal
Emergency Management Agency
(Sec. 305 of the Senate amendment)
present law
Present law does not provide for the special rules
contemplated in the Sense of the Senate provision described
below.
[[Page H2265]]
house bill
No provision.
senate amendment
The Senate Amendment provision provides that it is the
sense of the Senate that the Federal Emergency Management
Agency should (1) rebid certain contracts entered into
following Hurricane Katrina for which competing bids were not
solicited; (2) implement its planned competitive contracting
strategy and, in carrying out that strategy, prioritize local
and small disadvantaged businesses in contracting and
subcontracting; and (3) immediately after awarding any
contract, make public the dollar amount of the contract and
whether competing bids were solicited.
Effective date.--The Senate amendment provision is
effective upon enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
F. Sense of Congress Regarding Doha Round
(Sec. 306 of the Senate amendment)
present law
Present law does not provide a sense of Congress regarding
the Doha Round of trade negotiations.
house bill
No provision.
senate amendment
The Senate amendment provision provides that it is the
sense of Congress that the United States should not be a
signatory to an agreement or protocol with respect to the
Doha Development Round of the World Trade Organization (WTO)
negotiations or any other bilateral or multilateral trade
negotiations if the agreement or protocol (1) adopts any
provision to lessen the effectiveness of domestic and
international disciplines on unfair trade or safeguard
provisions or (2) would lessen in any manner the ability of
the United States to enforce rigorously its trade laws,
including the antidumping, countervailing duty, and safeguard
laws. The provision also provides that it is the sense of
Congress that (1) the United States trade laws and
international rules appropriately serve the public interest
by offsetting injurious unfair trade, and that further
balancing modifications or other similar provisions are
unnecessary and would add to the complexity and difficulty of
achieving relief against injurious unfair trade practices,
and (2) the United States should ensure that any new
agreement relating to international disciplines on unfair
trade or safeguard provisions fully rectifies and corrects
decisions by WTO dispute settlement panels or the Appellate
Body that have unjustifiably and negatively impacted, or
threaten to negatively impact, United States law or practice,
including a law or practice with respect to foreign dumping
or subsidization.
Effective date.--The Senate amendment provision is
effective upon enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
G. Treatment of Certain Stock Option Plans Under Nonqualified Deferred
Compensation Rules
(Sec. 308 of the Senate amendment)
present law
Amounts deferred under a nonqualified deferred compensation
plan for all taxable years are currently includible in gross
income to the extent not subject to a substantial risk of
forfeiture and not previously included in gross income,
unless certain requirements are satisfied.\340\ For example,
distributions from a nonqualified deferred compensation plan
may be allowed only upon certain times and events. Rules also
apply for the timing of elections. If the requirements are
not satisfied, in addition to current income inclusion,
interest at the underpayment rate plus one percentage point
is imposed on the underpayments that would have occurred had
the compensation been includible in income when first
deferred, or if later, when not subject to a substantial risk
of forfeiture. The amount required to be included in income
is also subject to a 20-percent additional tax.
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\340\ Section 409A.
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The rules governing the tax treatment of nonqualified
deferred compensation generally apply to stock options
granted to employees. However, exceptions apply to incentive
stock options and options granted under employee stock
purchase plans.\341\
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\341\ Sections 422 and 423, respectively.
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house bill
No provision.
senate amendment
Under the Senate amendment, the Secretary of the Treasury
is directed to modify the regulations relating to
nonqualified deferred compensation to extend to applicable
foreign option plans the exceptions for incentive stock
options and options granted under employee stock purchase
plans. The exception for applicable foreign option plans is
subject to such terms and conditions as may be prescribed in
the regulations.
An applicable foreign option plan means a plan that (1)
provides for the issuance of employee stock options; (2) is
established under the laws of a foreign jurisdiction; and (3)
under such laws or the terms of the plan (or both), is
subject to requirements substantially similar to the
requirements applicable to incentive stock options and
options granted under employee stock purchase plans.
For this purpose, a foreign option plan is not treated as
subject to requirements substantially similar to the
requirements applicable to incentive stock options and
options granted under employee stock purchase plans unless
the foreign option plan: (1) is required to cover
substantially all employees; (2) in the case of an option
under an employee stock purchase plan, is required to provide
an option price of not less than the lesser of not less than
80 percent of the fair market value of the stock at the time
the option is granted or an amount which, under the terms of
the option, cannot be less than 80 percent of the fair market
value of the stock at the time the option is exercised; (3)
is required to provide coverage of individuals who, but for
the exception under the provision, would be subject to tax
under the nonqualified deferred compensation rules with
respect to the plan; and (4) meets such other requirements as
prescribed in regulations issued under the provision.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
H. Sense of the Senate Regarding the Dedication of Excess Funds
(Sec. 309 of the Senate amendment)
Present Law
Present law does not provide a sense of the Senate
regarding the dedication of Treasury revenues that exceed
amounts specified in the reconciliation instructions for this
bill.
House Bill
No provision.
Senate Amendment
The Senate amendment provides that it is the sense of the
Senate that any Federal revenue increases resulting from the
Senate amendment and exceeding the amounts specified in
applicable reconciliation instructions are to be dedicated to
the Low-Income Home Energy Assistance Program. The amount so
dedicated is not to exceed by more than $2.9 billion the
funding level established for the program for fiscal year
2005.
Effective date.--The Senate amendment provision is
effective upon enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
I. Modification of Treatment of Loans to Qualified Continuing Care
Facilities
(Sec. 310 of the Senate amendment and sec. 7872(g) of the
Code)
Present Law
Present law provides generally that certain loans that bear
interest at a below-market rate are treated as loans bearing
interest at the market rate, accompanied by imputed payments
characterized in accordance with the substance of the
transaction (for example, as a gift, compensation, a
dividend, or interest).\342\
---------------------------------------------------------------------------
\342\ Sec. 7872.
---------------------------------------------------------------------------
An exception to this imputation rule is provided for any
calendar year for a below-market loan made by a lender to a
qualified continuing care facility pursuant to a continuing
care contract, if the lender or the lender's spouse attains
age 65 before the close of the calendar year.\343\
---------------------------------------------------------------------------
\343\ Sec. 7872(g).
---------------------------------------------------------------------------
The exception applies only to the extent the aggregate
outstanding loans by the lender (and spouse) to any qualified
continuing care facility do not exceed $163,300 (for
2006).\344\
---------------------------------------------------------------------------
\344\ Rev. Rul. 2005-75, 2005-49 I.R.B. 1073.
---------------------------------------------------------------------------
For this purpose, a continuing care contract means a
written contract between an individual and a qualified
continuing care facility under which: (1) the individual or
the individual's spouse may use a qualified continuing care
facility for their life or lives; (2) the individual or the
individual's spouse will first reside in a separate,
independent living unit with additional facilities outside
such unit for the providing of meals and other personal care
and will not require long-term nursing care, and then will be
provided long-term and skilled nursing care as the health of
the individual or the individual's spouse requires; and (3)
no additional substantial payment is required if the
individual or the individual's spouse requires increased
personal care services or long-term and skilled nursing care.
For this purpose, a qualified continuing care facility
means one or more facilities that are designed to provide
services under continuing care contracts, and substantially
all of the residents of which are covered by continuing care
contracts. A facility is not treated as a qualified
continuing care facility unless substantially all facilities
that are used to provide services required to be provided
under a continuing care contract are owned or operated by the
borrower. For these purposes, a nursing home is not a
qualified continuing care facility.
House Bill
No provision.
Senate Amendment
The Senate amendment provision modifies the present-law
exception under section 7872(g) relating to loans to
continuing care facilities by eliminating the dollar cap on
aggregate outstanding loans and making other modifications.
The Senate amendment provision provides an exception to the
imputation rule of section 7872 for any calendar year for any
[[Page H2266]]
below-market loan owed by a facility which on the last day of
the year is a qualified continuing care facility, if the loan
was made pursuant to a continuing care contract and if the
lender or the lender's spouse attains age 62 before the close
of the year.
For this purpose, a continuing care contract means a
written contract between an individual and a qualified
continuing care facility under which: (1) the individual or
the individual's spouse may use a qualified continuing care
facility for their life or lives; (2) the individual or the
individual's spouse will be provided with housing in an
independent living unit (which has additional available
facilities outside such unit for the provision of meals and
other personal care), an assisted living facility or nursing
facility, as is available in the continuing care facility, as
appropriate for the health of the individual or the
individual's spouse; and (3) the individual or the
individual's spouse will be provided assisted living or
nursing care as the health of the individual or the
individual's spouse requires, and as is available in the
continuing care facility.
For this purpose, a qualified continuing care facility
means one or more facilities: (1) that are designed to
provide services under continuing care contracts; (2) that
include an independent living unit, plus an assisted living
or nursing facility, or both; and (3) substantially all of
the independent living unit residents of which are covered by
continuing care contracts. For these purposes, a nursing home
is not a qualified continuing care facility.
Effective date.--The provision is effective for loans made
after December 31, 2005.
Conference Agreement
The conference agreement includes the Senate amendment
provision, with modifications. The conference agreement
provision provides that a continuing care contract is a
written contract between an individual and a qualified
continuing care facility under which: (1) the individual or
the individual's spouse may use a qualified continuing care
facility for their life or lives; (2) the individual or the
individual's spouse will be provided with housing, as
appropriate for the health of such individual or individual's
spouse, (i) in an independent living unit (which has
additional available facilities outside such unit for the
provision of meals and other personal care), and (ii) in an
assisted living facility or a nursing facility, as is
available in the continuing care facility; and (3) the
individual or the individual's spouse will be provided
assisted living or nursing care as the health of the
individual or the individual's spouse requires, and as is
available in the continuing care facility. The Secretary is
required to issue guidance that limits the term ``continuing
care contract'' to contracts that provide only facilities,
care, and services described in the preceding sentence.
For purposes of defining the terms ``continuing care
contract'' and ``qualified continuing care facility'' under
the conference agreement provision, the term ``assisted
living facility'' is intended to mean a facility at which
assistance is provided (1) with activities of daily living
(such as eating, toileting, transferring, bathing, dressing,
and continence) or (2) in cases of cognitive impairment, to
protect the health or safety of an individual. The term
``nursing facility'' is intended to mean a facility that
offers care requiring the utilization of licensed nursing
staff.
Effective date.--The conference agreement provision is
generally effective for calendar years beginning after
December 31, 2005, with respect to loans made before, on, or
after such date. The conference agreement provision does not
apply to any calendar year after 2010. Thus, the conference
agreement provision does not apply with respect to interest
imputed after December 31, 2010. After such date, the law as
in effect prior to enactment applies.
J. Exclusion of Gain on Sale of a Principal Residence by a Member of
the Intelligence Community
(Sec. 311 of the Senate amendment and sec. 121 of the Code)
Present Law
Under present law, an individual taxpayer may exclude up to
$250,000 ($500,000 if married filing a joint return) of gain
realized on the sale or exchange of a principal residence. To
be eligible for the exclusion, the taxpayer must have owned
and used the residence as a principal residence for at least
two of the five years ending on the sale or exchange. A
taxpayer who fails to meet these requirements by reason of a
change of place of employment, health, or, to the extent
provided under regulations, unforeseen circumstances is able
to exclude an amount equal to the fraction of the $250,000
($500,000 if married filing a joint return) that is equal to
the fraction of the two years that the ownership and use
requirements are met.
Present law also contains special rules relating to members
of the uniformed services or the Foreign Service of the
United States. An individual may elect to suspend for a
maximum of 10 years the five-year test period for ownership
and use during certain absences due to service in the
uniformed services or the Foreign Service of the United
States. The uniformed services include: (1) the Armed Forces
(the Army, Navy, Air Force, Marine Corps, and Coast Guard);
(2) the commissioned corps of the National Oceanic and
Atmospheric Administration; and (3) the commissioned corps of
the Public Health Service. If the election is made, the five-
year period ending on the date of the sale or exchange of a
principal residence does not include any period up to five
years during which the taxpayer or the taxpayer's spouse is
on qualified official extended duty as a member of the
uniformed services or in the Foreign Service of the United
States. For these purposes, qualified official extended duty
is any period of extended duty while serving at a place of
duty at least 50 miles away from the taxpayer's principal
residence or under orders compelling residence in Government
furnished quarters. Extended duty is defined as any period of
duty pursuant to a call or order to such duty for a period in
excess of 90 days or for an indefinite period. The election
may be made with respect to only one property for a
suspension period.
House Bill
No provision.
Senate Amendment
Under the provision, specified employees of the
intelligence community may elect to suspend the running of
the five-year test period during any period in which they are
serving on extended duty. The term ``employee of the
intelligence community'' means an employee of the Office of
the Director of National Intelligence, the Central
Intelligence Agency, the National Security Agency, the
Defense Intelligence Agency, the National Geospatial-
Intelligence Agency, or the National Reconnaissance Office.
The term also includes employment with: (1) any other office
within the Department of Defense for the collection of
specialized national intelligence through reconnaissance
programs; (2) any of the intelligence elements of the Army,
the Navy, the Air Force, the Marine Corps, the Federal Bureau
of Investigation, the Department of the Treasury, the
Department of Energy, and the Coast Guard; (3) the Bureau of
Intelligence and Research of the Department of State; and (4)
the elements of the Department of Homeland Security concerned
with the analyses of foreign intelligence information. To
qualify, a specified employee must move from one duty station
to another and at least one of such duty stations must be
located outside of the Washington, D.C. and Baltimore
metropolitan statistical areas, as defined by the Secretary
of Commerce. As under present law, the five-year period may
not be extended more than 10 years.
Effective date.--The provision is effective for sales and
exchanges after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
K. Sense of the Senate Regarding the Permanent Extension of EGTRRA and
JGTRRA Provisions Relating to the Child Tax Credit
(Sec. 312 of the Senate amendment)
Present Law
Present law provides for the sunset of the child tax credit
provisions under Economic Growth and Tax Relief
Reconciliation Act of 2001 (``EGTRRA'') and Jobs and Growth
Tax Relief Reconciliation Act of 2003 (``JGTRRA'').
House Bill
No provision.
Senate Amendment
The Senate amendment includes a provision stating that it
is the sense of the Senate that the conferees for the Tax
Relief Act of 2006 should strive to permanently extend the
amendments to the child tax credit made by EGTRRA and JGTRRA.
Effective date.--The Senate amendment provision is
effective on the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
L. Partial Expensing for Advanced Mine Safety Equipment
(Sec. 313 of the Senate amendment)
Present Law
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the Modified
Accelerated Cost Recovery System (``MACRS''), which
determines depreciation by applying specific recovery
periods, placed-in-service conventions, and depreciation
methods to the cost of various types of depreciable property
(sec. 168).
Personal property is classified under MACRS based on the
property's class life unless a different classification is
specifically provided in section 168. The class life
applicable for personal property is the asset guideline
period (midpoint class life as of January 1, 1986). Based on
the property's classification, a recovery period is
prescribed under MACRS. In general, there are six classes of
recovery periods to which personal property can be assigned.
For example, personal property that has a class life of four
years or less has a recovery period of three years, whereas
personal property with a class life greater than four years
but less than 10 years has a recovery period of five years.
The class lives and recovery periods for most property are
contained in Revenue Procedure 87-56.\345\
---------------------------------------------------------------------------
\345\ 1987-2 C.B. 674 (as clarified and modified by Rev.
Proc. 88-22, 1988-1 C.B. 785).
---------------------------------------------------------------------------
[[Page H2267]]
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs. Present law provides that the
maximum amount a taxpayer may expense, for taxable years
beginning in 2003 through 2007, is $100,000 of the cost of
qualifying property placed in service for the taxable year.
In general, qualifying property is defined as depreciable
tangible personal property that is purchased for use in the
active conduct of a trade or business. The $100,000 amount is
reduced (but not below zero) by the amount by which the cost
of qualifying property placed in service during the taxable
year exceeds $400,000.
House Bill
No provision.
Senate Amendment
The Senate amendment provides that the taxpayer may elect
to treat 50 percent of the cost of any qualified advanced
mine safety equipment property as a deduction in the taxable
year in which the equipment is placed in service.
Advanced mine safety equipment property means any of the
following: (1) emergency communication technology or devices
used to allow a miner to maintain constant communication with
an individual who is not in the mine; (2) electronic
identification and location devices that allow individuals
not in the mine to track at all times the movements and
location of miners working in or at the mine; (3) emergency
oxygen-generating, self-rescue devices that provide oxygen
for at least 90 minutes; (4) pre-positioned supplies of
oxygen providing each miner on a shift the ability to survive
for at least 48 hours; and (5) comprehensive atmospheric
monitoring systems that monitor the levels of carbon
monoxide, methane and oxygen that are present in all areas of
the mine and that can detect smoke in the case of a fire in a
mine.
To be treated as qualified advanced mine safety equipment
property under the provision, the original use of the
property must have commenced with the taxpayer, and the
taxpayer must have placed the property in service after the
date of enactment.
The portion of the cost of any property with respect to
which an expensing election under section 179 is made may not
be taken into account for purposes of the 50-percent
deduction allowed under this provision. For Federal tax
purposes, the basis of property is reduced by the portion of
its cost that is taken into account for purposes of the 50-
percent deduction allowed under the provision.
The provision requires the taxpayer to report information
required by the Treasury Secretary with respect to the
operation of mines of the taxpayer, in order for the
deduction to be allowed for the taxable year.
The provision includes a termination rule providing that it
does not apply to property placed in service after the date
that is three years after the date of enactment.
Effective date.--The provision applies to costs paid or
incurred after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
M. Mine Rescue Team Training Credit
(Sec. 314 of the Senate amendment and new sec. 45N of the
Code)
Present Law
There is no present law credit for expenditures incurred by
a taxpayer to train mine rescue workers. In general, a
deduction is allowed for all ordinary and necessary expenses
that are paid or incurred by the taxpayer during the taxable
year in carrying on any trade or business.\346\ A taxpayer
that employs individuals as miners in underground mines will
generally be permitted to deduct as ordinary and necessary
expenses the educational expenditures such taxpayer incurs to
train its employees in the principles, procedures, and
techniques of mine rescue, as well as the wages paid by the
taxpayer for the time its employees were engaged in such
training.
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\346\ Sec. 162(a).
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House Bill
No provision.
Senate Amendment
The Senate amendment provides that a taxpayer which is an
eligible employer may claim a credit equal to the lesser of
(1) 20 percent of the amount paid or incurred by the taxpayer
during the taxable year with respect to the training program
costs of each qualified mine rescue team employee (including
wages of the employee), or (2) $10,000.\347\ An eligible
employer is any taxpayer which employs individuals as miners
in underground mines in the United States. No deduction is
allowed for the amount of the expenses otherwise deductible
which is equal to the amount of the credit.
---------------------------------------------------------------------------
\347\ The credit is part of the general business credit (sec.
38).
---------------------------------------------------------------------------
A qualified mine rescue team employee is any full-time
employee of the taxpayer who is a miner eligible for more
than six months of a taxable year to serve as a mine rescue
team member by virtue of either having completed the initial
20-hour course of instruction prescribed by the Mine Safety
and Health Administration's Office of Educational Policy and
Development, or receiving at least 40 hours of refresher
training in such instruction.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005, and before January
1, 2009.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
N. Funding for Veterans Health Care and Disability Compensation and
Hospital Infrastructure for Veterans
(Sec. 315 of the Senate amendment)
Present Law
Within the U.S. Department of Veterans Affairs, the
Veterans Health Administration provides a broad spectrum of
medical, surgical, and rehabilitative care to veterans. The
Veteran Benefits Administration provides services to
veterans, including services related to compensation and
pensions.
House Bill
No provision.
Senate Amendment
The Senate amendment authorizes the appropriation of funds
for the Department of Veterans Affairs for the Veterans
Health Administration for Medical Care as well as the
Veterans Benefits Administration for Compensation and
Pensions for fiscal years 2006 through 2010 in the amounts
listed below. The amounts authorized are in addition to any
other amounts authorized for these Administrations under any
other provision of law.
------------------------------------------------------------------------
Veterans health Veterans benefits
Fiscal year administration administration
------------------------------------------------------------------------
2006.............................. $900,000,000 $2,300,000,000
2007.............................. 1,300,000,000 2,700,000,000
2008.............................. 1,500,000,000 3,000,000,000
2009.............................. 1,600,000,000 3,000,000,000
2010.............................. 1,600,000,000 3,000,000,000
------------------------------------------------------------------------
The Senate amendment also establishes the Veterans Hospital
Improvement Fund, with an initial balance of $1,000,000,000,
to be administered by the Secretary of Veterans Affairs. The
funds are to be used for improvements of health facilities
treating veterans.
Effective date.--The Senate amendment is effective upon the
date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
O. Sense of the Senate Regarding Protecting Middle-Class Families From
the Alternative Minimum Tax
(Sec. 316 of the Senate amendment)
Present Law
Present law imposes an alternative minimum tax. The
alternative minimum tax is the amount by which the tentative
minimum tax exceeds the regular income tax. An individual's
tentative minimum tax is the sum of (1) 26 percent of so much
of the taxable excess as does not exceed $175,000 ($87,500 in
the case of a married individual filing a separate return)
and (2) 28 percent of the remaining taxable excess. The
taxable excess is so much of the alternative minimum taxable
income (``AMTI'') as exceeds an exemption amount. AMTI is the
individual's taxable income adjusted to take account of
specified preferences and adjustments.
Under present law, for taxable years beginning before
January 1, 2009, the maximum rate of tax on the adjusted net
capital gain of an individual is 15 percent, and dividends
received by an individual from domestic corporations and
qualified foreign corporations are taxed at the same rates
that apply to capital gains. For taxable years beginning
after December 31, 2008, the maximum rate of tax on the
adjusted net capital gain of an individual is 20 percent, and
dividends received by an individual are taxed as ordinary
income at rates of up to 35 percent.
House Bill
No provision.
Senate Amendment
The Senate amendment provides that it is the sense of the
Senate that protecting middle-class families from the
alternative minimum tax should be a higher priority for
Congress in 2006 than extending a tax cut that does not
expire until the end of 2008.
Effective date.--The provision is effective on the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
TITLE V--REVENUE OFFSET PROVISIONS
A. Provisions Designed to Curtail Tax Shelters
1. Understatement of taxpayer's liability by income tax
return preparer (Sec. 401 of the Senate amendment and
sec. 6694 of the Code)
Present Law
An income tax return preparer who prepares a return with
respect to which there is an understatement of tax that is
due to an undisclosed position for which there was not a
realistic possibility of being sustained on its merits, or a
frivolous position, is liable for a penalty of $250, provided
the preparer knew or reasonably should have known of the
position. An income tax return preparer who prepares a return
and engages in specified willful or reckless conduct with
respect to preparing such a return is liable for a penalty of
$1,000.
House Bill
No provision.
Senate Amendment
The provision alters the standards of conduct that must be
met to avoid imposition of
[[Page H2268]]
the first penalty described above by replacing the realistic
possibility standard with a requirement that there be a
reasonable belief that the tax treatment of the position was
more likely than not the proper treatment. The provision also
replaces the not-frivolous standard with the requirement that
there be a reasonable basis for the tax treatment of the
position, increases the present-law $250 penalty to $1,000,
and increases the present-law $1,000 penalty to $5,000.
Effective date.--The provision is effective for documents
prepared after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Frivolous tax submissions (Sec. 402 of the Senate
amendment and sec. 6702 of the Code)
Present Law
The Code provides that an individual who files a frivolous
income tax return is subject to a penalty of $500 imposed by
the IRS (sec. 6702). The Code also permits the Tax Court
\348\ to impose a penalty of up to $25,000 if a taxpayer has
instituted or maintained proceedings primarily for delay or
if the taxpayer's position in the proceeding is frivolous or
groundless (sec. 6673(a)).
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\348\ Because in general the Tax Court is the only pre-
payment forum available to taxpayers, it deals with most of
the frivolous, groundless, or dilatory arguments raised in
tax cases.
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment modifies the IRS-imposed penalty by
increasing the amount of the penalty to up to $5,000 and by
applying it to all taxpayers and to all types of Federal
taxes.
The Senate amendment also modifies present law with respect
to certain submissions that raise frivolous arguments or that
are intended to delay or impede tax administration. The
submissions to which the Senate amendment applies are
requests for a collection due process hearing, installment
agreements, offers-in-compromise, and taxpayer assistance
orders. First, the Senate amendment permits the IRS to
disregard such requests. Second, the Senate amendment permits
the IRS to impose a penalty of up to $5,000 for such
requests, unless the taxpayer withdraws the request after
being given an opportunity to do so.
The Senate amendment requires the IRS to publish a list of
positions, arguments, requests, and submissions determined to
be frivolous for purposes of these provisions.
Effective date.--The Senate amendment applies to
submissions made and issues raised after the date on which
the Secretary first prescribes the required list of frivolous
positions.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
3. Penalty for promoting abusive tax shelters (Sec. 403 of
the Senate amendment and sec. 6700 of the Code)
Present Law
A penalty is imposed on any person who organizes, assists
in the organization of, or participates in the sale of any
interest in, a partnership or other entity, any investment
plan or arrangement, or any other plan or arrangement, if in
connection with such activity the person makes or furnishes a
qualifying false or fraudulent statement or a gross valuation
overstatement.\349\ A qualified false or fraudulent statement
is any statement with respect to the allowability of any
deduction or credit, the excludability of any income, or the
securing of any other tax benefit by reason of holding an
interest in the entity or participating in the plan or
arrangement which the person knows or has reason to know is
false or fraudulent as to any material matter. A ``gross
valuation overstatement'' means any statement as to the value
of any property or services if the stated value exceeds 200
percent of the correct valuation, and the value is directly
related to the amount of any allowable income tax deduction
or credit.
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\349\ Sec. 6700.
---------------------------------------------------------------------------
In the case of a gross valuation overstatement, the amount
of the penalty is $1,000 (or, if the person establishes that
it is less, 100 percent of the gross income derived or to be
derived by the person from such activity). A penalty
attributable to a gross valuation misstatement can be waived
on a showing that there was a reasonable basis for the
valuation and it was made in good faith. In the case of any
activity that involves a qualified false or fraudulent
statement, the penalty amount is equal to 50 percent of the
gross income derived by the person from the activity.
House Bill
No provision.
Senate Amendment
The Senate amendment modifies the penalty rate imposed on
any person who organizes, assists in the organization of, or
participates in the sale of any interest in, a partnership or
other entity, any investment plan or arrangement, or any
other plan or arrangement, if in connection with such
activity the person makes or furnishes a qualifying false or
fraudulent statement or a gross valuation overstatement. The
penalty is equal to 100 percent of the gross income derived
(or to be derived) from the activity. The penalty amount is
calculated with respect to each instance of an activity
subject to the penalty, each instance in which income was
derived by the person or persons subject to the penalty, and
each person who participated in an activity subject to the
penalty.
Under the Senate amendment, if more than one person is
liable for the penalty, all such persons are jointly and
severally liable for the penalty. In addition, the Senate
amendment provides that the penalty, as well as amounts paid
to settle or avoid the imposition of the penalty, is not
deductible for tax purposes.
Effective date.--The provision is effective for activities
occurring after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
4. Penalty for aiding and abetting the understatement of tax
liability (Sec. 404 of the Senate amendment and sec. 6701
of the Code)
Present Law
A penalty is imposed on a person who: (1) aids or assists
in, procures, or advises with respect to a tax return or
other document; (2) knows (or has reason to believe) that
such document will be used in connection with a material tax
matter; and (3) knows that this would result in an
understatement of tax of another person. In general, the
amount of the penalty is $1,000. If the document relates to
the tax return of a corporation, the amount of the penalty is
$10,000.
House Bill
No provision.
Senate Amendment
The Senate amendment expands the scope of the penalty in
several ways. First, it applies the penalty to aiding or
assisting with respect to tax liability reflected in a tax
return. Second, it applies the penalty to each instance of
aiding or abetting. Third, it increases the amount of the
penalty to a maximum of 100 percent of the gross income
derived (or to be derived) from the aiding or abetting.
Fourth, if more than one person is liable for the penalty,
all such persons are jointly and severally liable for the
penalty. Fifth, the penalty, as well as amounts paid to
settle or avoid the imposition of the penalty, is not
deductible for tax purposes.
Effective date.--The provision is effective for activities
occurring after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
B. Economic Substance Doctrine
1. Clarification of the economic substance doctrine (sec. 411
of the Senate amendment)
present law
In general
The Code provides specific rules regarding the computation
of taxable income, including the amount, timing, source, and
character of items of income, gain, loss and deduction. These
rules are designed to provide for the computation of taxable
income in a manner that provides for a degree of specificity
to both taxpayers and the government. Taxpayers generally may
plan their transactions in reliance on these rules to
determine the federal income tax consequences arising from
the transactions.
In addition to the statutory provisions, courts have
developed several doctrines that can be applied to deny the
tax benefits of tax motivated transactions, notwithstanding
that the transaction may satisfy the literal requirements of
a specific tax provision. The common-law doctrines are not
entirely distinguishable, and their application to a given
set of facts is often blurred by the courts and the IRS.
Although these doctrines serve an important role in the
administration of the tax system, invocation of these
doctrines can be seen as at odds with an objective, ``rule-
based'' system of taxation. Nonetheless, courts have applied
the doctrines to deny tax benefits arising from certain
transactions.\350\
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\350\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d
231 (3d Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert.
denied 526 U.S. 1017 (1999).
---------------------------------------------------------------------------
A common-law doctrine applied with increasing frequency is
the ``economic substance'' doctrine. In general, this
doctrine denies tax benefits arising from transactions that
do not result in a meaningful change to the taxpayer's
economic position other than a purported reduction in federal
income tax.\351\
---------------------------------------------------------------------------
\351\ Closely related doctrines also applied by the courts
(sometimes interchangeable with the economic substance
doctrine) include the ``sham transaction doctrine'' and the
``business purpose doctrine''. See, e.g., Knetsch v. United
States, 364 U.S. 361 (1960) (denying interest deductions on a
``sham transaction'' whose only purpose was to create the
deductions).
---------------------------------------------------------------------------
Economic substance doctrine
Courts generally deny claimed tax benefits if the
transaction that gives rise to those benefits lacks economic
substance independent of tax considerations--notwithstanding
that the purported activity actually occurred. The tax court
has described the doctrine as follows:
The tax law . . . requires that the intended transactions
have economic substance separate and distinct from economic
benefit achieved solely by tax reduction. The doctrine of
economic substance becomes applicable, and a judicial remedy
is warranted,
[[Page H2269]]
where a taxpayer seeks to claim tax benefits, unintended by
Congress, by means of transactions that serve no economic
purpose other than tax savings.\352\
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\352\ ACM Partnership v. Commissioner, 73 T.C.M. at 2215.
---------------------------------------------------------------------------
Business purpose doctrine
Another common law doctrine that overlays and is often
considered together with (if not part and parcel of) the
economic substance doctrine is the business purpose doctrine.
The business purpose test is a subjective inquiry into the
motives of the taxpayer--that is, whether the taxpayer
intended the transaction to serve some useful non-tax
purpose. In making this determination, some courts have
bifurcated a transaction in which independent activities with
non-tax objectives have been combined with an unrelated item
having only tax-avoidance objectives in order to disallow the
tax benefits of the overall transaction.\353\
---------------------------------------------------------------------------
\353\ ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
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Application by the courts
Elements of the doctrine
There is a lack of uniformity regarding the proper
application of the economic substance doctrine.\354\ Some
courts apply a conjunctive test that requires a taxpayer to
establish the presence of both economic substance (i.e., the
objective component) and business purpose (i.e., the
subjective component) in order for the transaction to survive
judicial scrutiny.\355\ A narrower approach used by some
courts is to conclude that either a business purpose or
economic substance is sufficient to respect the
transaction).\356\ A third approach regards economic
substance and business purpose as ``simply more precise
factors to consider'' in determining whether a transaction
has any practical economic effects other than the creation of
tax benefits.\357\
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\354\ ``The casebooks are glutted with [economic substance]
tests. Many such tests proliferate because they give the
comforting illusion of consistency and precision. They often
obscure rather than clarify.'' Collins v. Commissioner, 857
F.2d 1383, 1386 (9th Cir. 1988).
\355\ See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898
(6th Cir. 1993) (``The threshold question is whether the
transaction has economic substance. If the answer is yes, the
question becomes whether the taxpayer was motivated by profit
to participate in the transaction.'').
\356\ See, e.g., Rice's Toyota World v. Commissioner, 752
F.2d 89, 91-92 (4th Cir. 1985) (``To treat a transaction as a
sham, the court must find that the taxpayer was motivated by
no business purposes other than obtaining tax benefits in
entering the transaction, and, second, that the transaction
has no economic substance because no reasonable possibility
of a profit exists.''); IES Industries v. United States, 253
F.3d 350, 358 (8th Cir. 2001) (``In determining whether a
transaction is a sham for tax purposes [under the Eighth
Circuit test], a transaction will be characterized as a sham
if it is not motivated by any economic purpose out of tax
considerations (the business purpose test), and if it is
without economic substance because no real potential for
profit exists (the economic substance test).''). As noted
earlier, the economic substance doctrine and the sham
transaction doctrine are similar and sometimes are applied
interchangeably. For a more detailed discussion of the sham
transaction doctrine, see, e.g., Joint Committee on Taxation,
Study of Present-Law Penalty and Interest Provisions as
Required by Section 3801 of the Internal Revenue Service
Restructuring and Reform Act of 1998 (including Provisions
Relating to Corporate Tax Shelters) (JCS-3-99) at 182.
\357\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at
247; James v. Commissioner, 899 F.2d 905, 908 (10th Cir.
1995); Sacks v. Commissioner, 69 F.3d 982, 985 (9th Cir.
1995) (``Instead, the consideration of business purpose and
economic substance are simply more precise factors to
consider . . . We have repeatedly and carefully noted that
this formulation cannot be used as a `rigid two-step
analysis'.'').
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Recently, the Court of Federal Claims questioned the
continuing viability of the doctrine.\358\ The court also
stated that ``the use of the `economic substance' doctrine to
trump `mere compliance with the Code' would violate the
separation of powers.'' \359\
---------------------------------------------------------------------------
\358\ Coltec Industries, Inc. v. United States, 62 Fed. Cl.
716 (2004) (slip opinion at 123-124). The court also found,
however, that the doctrine was satisfied in that case. Id. at
128.
\359\ Id. at 128.
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Nontax economic benefits
There also is a lack of uniformity regarding the type of
non-tax economic benefit a taxpayer must establish in order
to satisfy economic substance. Several courts have denied tax
benefits on the grounds that the subject transactions lacked
profit potential.\360\ In addition, some courts have applied
the economic substance doctrine to disallow tax benefits in
transactions in which a taxpayer was exposed to risk and the
transaction had a profit potential, but the court concluded
that the economic risks and profit potential were
insignificant when compared to the tax benefits.\361\ Under
this analysis, the taxpayer's profit potential must be more
than nominal. Conversely, other courts view the application
of the economic substance doctrine as requiring an objective
determination of whether a ``reasonable possibility of
profit'' from the transaction existed apart from the tax
benefits.\362\ In these cases, in assessing whether a
reasonable possibility of profit exists, it is sufficient if
there is a nominal amount of pre-tax profit as measured
against expected net tax benefits.
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\360\ See, e.g., Knetsch, 364 U.S. at 361; Goldstein v.
Commissioner, 364 F.2d 734 (2d Cir. 1966) (holding that an
unprofitable, leveraged acquisition of Treasury bills, and
accompanying prepaid interest deduction, lacked economic
substance).
\361\ See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-
40 (disallowing deduction even though taxpayer had a
possibility of small gain or loss by owning Treasury bills);
Sheldon v. Commissioner, 94 T.C. 738, 768 (1990) (stating
that ``potential for gain . . . is infinitesimally nominal
and vastly insignificant when considered in comparison with
the claimed deductions'').
\362\ See, e.g., Rice's Toyota World v. Commissioner, 752
F.2d at 94 (the economic substance inquiry requires an
objective determination of whether a reasonable possibility
of profit from the transaction existed apart from tax
benefits); Compaq Computer Corp. v. Commissioner, 277 F.3d at
781 (applied the same test, citing Rice's Toyota World); IES
Industries v. United States, 253 F.3d 350, 354 (8th Cir.
2001).
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Financial accounting benefits
In determining whether a taxpayer had a valid business
purpose for entering into a transaction, at least one court
has concluded that financial accounting benefits arising from
tax savings do not qualify as a non-tax business
purpose.\363\ However, based on court decisions that
recognize the importance of financial accounting treatment,
taxpayers have asserted that financial accounting benefits
arising from tax savings can satisfy the business purpose
test.\364\
---------------------------------------------------------------------------
\363\ See, American Electric Power, Inc. v. U.S., 136 F.
Supp. 2d 762, 791-92 (S.D. Ohio 2001); aff'd 326 F.3d.737
(6th Cir. 2003).
\364\ See, e.g., Joint Committee on Taxation, Report of
Investigation of Enron Corporation and Related Entities
Regarding Federal Tax and Compensation Issues, and Policy
Recommendations (JSC-3-03) February, 2003 (``Enron Report''),
Volume III at C-93, 289. Enron Corporation relied on Frank
Lyon Co. v. United States, 435 U.S. 561, 577-78 (1978), and
Newman v. Commissioner, 902 F.2d 159, 163 (2d Cir. 1990) to
argue that financial accounting benefits arising from tax
savings constitutes a good business purpose.
---------------------------------------------------------------------------
House bill
No provision.
Senate Amendment
The Senate amendment provision clarifies and enhances the
application of the economic substance doctrine. Under the
provision, in a case in which a court determines that the
economic substance doctrine is relevant to a transaction (or
a series of transactions), such transaction (or series of
transactions) has economic substance (and thus satisfies the
economic substance doctrine) only if the taxpayer establishes
that (1) the transaction changes in a meaningful way (apart
from Federal income tax consequences) the taxpayer's economic
position, and (2) the taxpayer has a substantial non-tax
purpose for entering into such transaction and the
transaction is a reasonable means of accomplishing such
purpose.\365\
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\365\ If the tax benefits are clearly contemplated and
expected by the language and purpose of the relevant
authority, it is not intended that such tax benefits be
disallowed if the only reason for such disallowance is that
the transaction fails the economic substance doctrine as
defined in this provision.
---------------------------------------------------------------------------
The provision does not change current law standards used by
courts in determining when to utilize an economic substance
analysis.\366\ Also, the provision does not alter the court's
ability to aggregate, disaggregate or otherwise
recharacterize a transaction when applying the doctrine.\367\
The provision provides a uniform definition of economic
substance, but does not alter the flexibility of the courts
in other respects.
---------------------------------------------------------------------------
\366\ See, e.g., Treas. Reg. sec. 1.269-2, stating that
characteristic of circumstances in which a deduction
otherwise allowed will be disallowed are those in which the
effect of the deduction, credit, or other allowance would be
to distort the liability of the particular taxpayer when the
essential nature of the transaction or situation is examined
in the light of the basic purpose or plan which the
deduction, credit, or other allowance was designed by the
Congress to effectuate.
\367\ See, e.g., Minnesota Tea Co. v. Helvering, 302 U.S.
609, 613 (1938) (``A given result at the end of a straight
path is not made a different result because reached by
following a devious path.'').
---------------------------------------------------------------------------
Conjunctive analysis
The provision clarifies that the economic substance
doctrine involves a conjunctive analysis--there must be an
objective inquiry regarding the effects of the transaction on
the taxpayer's economic position, as well as a subjective
inquiry regarding the taxpayer's motives for engaging in the
transaction. Under the provision, a transaction must satisfy
both tests--i.e., it must change in a meaningful way (apart
from Federal income tax consequences) the taxpayer's economic
position, and the taxpayer must have a substantial non-tax
purpose for entering into such transaction (and the
transaction is a reasonable means of accomplishing such
purpose)--in order to satisfy the economic substance
doctrine. This clarification eliminates the disparity that
exists among the circuits regarding the application of the
doctrine, and modifies its application in those circuits in
which either a change in economic position or a non-tax
business purpose (without having both) is sufficient to
satisfy the economic substance doctrine.
Non-tax business purpose
Under the provision, a taxpayer's non-tax purpose for
entering into a transaction (the second prong in the
analysis) must be ``substantial,'' and the transaction must
be ``a reasonable means'' of accomplishing such purpose.
Under this formulation, the non-tax purpose for the
transaction must bear a reasonable relationship to the
taxpayer's normal business operations or investment
activities.\368\
---------------------------------------------------------------------------
\368\ See, e.g., Treas. Reg. sec. 1.269-2(b) (stating that a
distortion of tax liability indicating the principal purpose
of tax evasion or avoidance might be evidenced by the fact
that ``the transaction was not undertaken for reasons germane
to the conduct of the business of the taxpayer''). Similarly,
in ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189
(1997), the court stated:
``Key to [the determination of whether a transaction has
economic substance] is that the transaction must be
rationally related to a useful nontax purpose that is
plausible in light of the taxpayer's conduct and useful in
light of the taxpayer's economic situation and intentions.
Both the utility of the stated purpose and the rationality of
the means chosen to effectuate it must be evaluated in
accordance with commercial practices in the relevant
industry. A rational relationship between purpose and means
ordinarily will not be found unless there was a reasonable
expectation that the nontax benefits would be at least
commensurate with the transaction costs.'' [citations
omitted]
---------------------------------------------------------------------------
[[Page H2270]]
In determining whether a taxpayer has a substantial non-tax
business purpose, an objective of achieving a favorable
accounting treatment for financial reporting purposes will
not be treated as having a substantial non-tax purpose.\369\
Furthermore, a transaction that is expected to increase
financial accounting income as a result of generating tax
deductions or losses without a corresponding financial
accounting charge (i.e., a permanent book-tax difference)
\370\ should not be considered to have a substantial non-tax
purpose unless a substantial non-tax purpose exists apart
from the financial accounting benefits.\371\
---------------------------------------------------------------------------
\369\ However, if the tax benefits are clearly contemplated
and expected by the language and purpose of the relevant
authority, such tax benefits should not be disallowed solely
because the transaction results in a favorable accounting
treatment. An example is the repealed foreign sales
corporation rules.
\370\ This includes tax deductions or losses that are
anticipated to be recognized in a period subsequent to the
period the financial accounting benefit is recognized. For
example, FAS 109 in some cases permits the recognition of
financial accounting benefits prior to the period in which
the tax benefits are recognized for income tax purposes.
\371\ Claiming that a financial accounting benefit
constitutes a substantial non-tax purpose fails to consider
the origin of the accounting benefit (i.e., reduction of
taxes) and significantly diminishes the purpose for having a
substantial non-tax purpose requirement. See, e.g., American
Electric Power, Inc. v. U.S., 136 F. Supp. 2d 762, 791-92
(S.D. Ohio, 2001) (``AEP's intended use of the cash flows
generated by the [corporate-owned life insurance] plan is
irrelevant to the subjective prong of the economic substance
analysis. If a legitimate business purpose for the use of the
tax savings 'were sufficient to breathe substance into a
transaction whose only purpose was to reduce taxes, [then]
every sham tax-shelter device might succeed,''') (citing
Winn-Dixie v. Commissioner, 113 T.C. 254, 287 (1999)); aff'd
326 F3d 737 (6th Cir. 2003).
---------------------------------------------------------------------------
By requiring that a transaction be a ``reasonable means''
of accomplishing its non-tax purpose, the provision
reiterates the present-law ability of the courts to bifurcate
a transaction in which independent activities with non-tax
objectives are combined with an unrelated item having only
tax-avoidance objectives in order to disallow the tax
benefits of the overall transaction.\372\
---------------------------------------------------------------------------
\372\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at
256 n.48.
---------------------------------------------------------------------------
Profit potential
Under the provision, a taxpayer may rely on factors other
than profit potential to demonstrate that a transaction
results in a meaningful change in the taxpayer's economic
position; the provision merely sets forth a minimum threshold
of profit potential if that test is relied on to demonstrate
a meaningful change in economic position. If a taxpayer
relies on a profit potential, however, the present value of
the reasonably expected pre-tax profit must be substantial in
relation to the present value of the expected net tax
benefits that would be allowed if the transaction were
respected.\373\ Moreover, the profit potential must exceed a
risk-free rate of return. In addition, in determining pre-tax
profit, fees and other transaction expenses and foreign taxes
are treated as expenses.
---------------------------------------------------------------------------
\373\ Thus, a ``reasonable possibility of profit'' will not
be sufficient to establish that a transaction has economic
substance.
---------------------------------------------------------------------------
In applying the profit potential test to a lessor of
tangible property, depreciation, applicable tax credits (such
as the rehabilitation tax credit and the low income housing
tax credit), and any other deduction as provided in guidance
by the Secretary are not taken into account in measuring tax
benefits.
Transactions with tax-indifferent parties
The provision also provides special rules for transactions
with tax-indifferent parties. For this purpose, a tax-
indifferent party means any person or entity not subject to
Federal income tax, or any person to whom an item would have
no substantial impact on its income tax liability. Under
these rules, the form of a financing transaction will not be
respected if the present value of the tax deductions to be
claimed is substantially in excess of the present value of
the anticipated economic returns to the lender. Also, the
form of a transaction with a tax-indifferent party will not
be respected if it results in an allocation of income or gain
to the tax-indifferent party in excess of the tax-indifferent
party's economic gain or income or if the transaction results
in the shifting of basis on account of overstating the income
or gain of the tax-indifferent party.
Other rules
The Secretary may prescribe regulations which provide (1)
exemptions from the application of the provision, and (2)
other rules as may be necessary or appropriate to carry out
the purposes of the provision.
No inference is intended as to the proper application of
the economic substance doctrine under present law. In
addition, except with respect to the economic substance
doctrine, the provision shall not be construed as altering or
supplanting any other common law doctrine (including the sham
transaction doctrine), and the provision shall be construed
as being additive to any such other doctrine.
Effective date.--The provision applies to transactions
entered into after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Penalty for understatements attributable to transactions
lacking economic substance, etc. (Sec. 412 of the Senate
amendment)
Present Law
General accuracy-related penalty
An accuracy-related penalty under section 6662 applies to
the portion of any underpayment that is attributable to (1)
negligence, (2) any substantial understatement of income tax,
(3) any substantial valuation misstatement, (4) any
substantial overstatement of pension liabilities, or (5) any
substantial estate or gift tax valuation understatement. If
the correct income tax liability exceeds that reported by the
taxpayer by the greater of 10 percent of the correct tax or
$5,000 (or, in the case of corporations, by the lesser of (a)
10 percent of the correct tax (or $10,000 if greater) or (b)
$10 million), then a substantial understatement exists and a
penalty may be imposed equal to 20 percent of the
underpayment of tax attributable to the understatement.\374\
Except in the case of tax shelters,\375\ the amount of any
understatement is reduced by any portion attributable to an
item if (1) the treatment of the item is supported by
substantial authority, or (2) facts relevant to the tax
treatment of the item were adequately disclosed and there was
a reasonable basis for its tax treatment. The Treasury
Secretary may prescribe a list of positions which the
Secretary believes do not meet the requirements for
substantial authority under this provision.
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\374\ Sec. 6662.
\375\ A tax shelter is defined for this purpose as a
partnership or other entity, an investment plan or
arrangement, or any other plan or arrangement if a
significant purpose of such partnership, other entity, plan,
or arrangement is the avoidance or evasion of Federal income
tax. Sec. 6662(d)(2)(C).
---------------------------------------------------------------------------
The section 6662 penalty generally is abated (even with
respect to tax shelters) in cases in which the taxpayer can
demonstrate that there was ``reasonable cause'' for the
underpayment and that the taxpayer acted in good faith.\376\
The relevant regulations provide that reasonable cause exists
where the taxpayer ``reasonably relies in good faith on an
opinion based on a professional tax advisor's analysis of the
pertinent facts and authorities [that] . . . unambiguously
concludes that there is a greater than 50-percent likelihood
that the tax treatment of the item will be upheld if
challenged'' by the IRS.\377\
---------------------------------------------------------------------------
\376\ Sec. 6664(c).
\377\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
---------------------------------------------------------------------------
Listed transactions and reportable avoidance transactions
In general
A separate accuracy-related penalty under section 6662A
applies to ``listed transactions'' and to other ``reportable
transactions'' with a significant tax avoidance purpose
(hereinafter referred to as a ``reportable avoidance
transaction''). The penalty rate and defenses available to
avoid the penalty vary depending on whether the transaction
was adequately disclosed.
Both listed transactions and reportable transactions are
allowed to be described by the Treasury Department under
section 6707A(c), which imposes a penalty for failure
adequately to report such transactions under section 6011. A
reportable transaction is defined as one that the Treasury
Secretary determines is required to be disclosed because it
is determined to have a potential for tax avoidance or
evasion.\378\ A listed transaction is defined as a reportable
transaction which is the same as, or substantially similar
to, a transaction specifically identified by the Secretary as
a tax avoidance transaction for purposes of the reporting
disclosure requirements.\379\
---------------------------------------------------------------------------
\378\ Sec. 6707A(c)(1).
\379\ Sec. 6707A(c)(2).
---------------------------------------------------------------------------
Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction.\380\ The only exception to the penalty is if the
taxpayer satisfies a more stringent reasonable cause and good
faith exception (hereinafter referred to as the
``strengthened reasonable cause exception''), which is
described below. The strengthened reasonable cause exception
is available only if the relevant facts affecting the tax
treatment are adequately disclosed, there is or was
substantial authority for the claimed tax treatment, and the
taxpayer reasonably believed that the claimed tax treatment
was more likely than not the proper treatment.
---------------------------------------------------------------------------
\380\ Sec. 6662A(a).
---------------------------------------------------------------------------
Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause exception is
not available (i.e., a strict-liability penalty generally
applies), and the taxpayer is subject to an increased penalty
equal to 30 percent of the understatement.\381\ However, a
taxpayer will be
[[Page H2271]]
treated as having adequately disclosed a transaction for this
purpose if the IRS Commissioner has separately rescinded the
separate penalty under section 6707A for failure to disclose
a reportable transaction.\382\ The IRS Commissioner is
authorized to do this only if the failure does not relate to
a listed transaction and only if rescinding the penalty would
promote compliance and effective tax administration.\383\
---------------------------------------------------------------------------
\381\ Sec. 6662A(c).
\382\ Sec. 6664(d).
\383\ Sec. 6707A(d).
---------------------------------------------------------------------------
A public entity that is required to pay a penalty for an
undisclosed listed or reportable transaction must disclose
the imposition of the penalty in reports to the SEC for such
periods as the Secretary shall specify. The disclosure to the
SEC applies without regard to whether the taxpayer determines
the amount of the penalty to be material to the reports in
which the penalty must appear; and any failure to disclose
such penalty in the reports is treated as a failure to
disclose a listed transaction. A taxpayer must disclose a
penalty in reports to the SEC once the taxpayer has exhausted
its administrative and judicial remedies with respect to the
penalty (or if earlier, when paid).\384\
---------------------------------------------------------------------------
\384\ Sec. 6707A(e).
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Determination of the understatement amount
The penalty is applied to the amount of any understatement
attributable to the listed or reportable avoidance
transaction without regard to other items on the tax return.
For purposes of this provision, the amount of the
understatement is determined as the sum of: (1) the product
of the highest corporate or individual tax rate (as
appropriate) and the increase in taxable income resulting
from the difference between the taxpayer's treatment of the
item and the proper treatment of the item (without regard to
other items on the tax return); \385\ and (2) the amount of
any decrease in the aggregate amount of credits which results
from a difference between the taxpayer's treatment of an item
and the proper tax treatment of such item.
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\385\ For this purpose, any reduction in the excess of
deductions allowed for the taxable year over gross income for
such year, and any reduction in the amount of capital losses
which would (without regard to section 1211) be allowed for
such year, shall be treated as an increase in taxable income.
Sec. 6662A(b).
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Except as provided in regulations, a taxpayer's treatment
of an item shall not take into account any amendment or
supplement to a return if the amendment or supplement is
filed after the earlier of when the taxpayer is first
contacted regarding an examination of the return or such
other date as specified by the Secretary.\386\
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\386\ Sec. 6662A(e)(3).
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Strengthened reasonable cause exception
A penalty is not imposed under the provision with respect
to any portion of an understatement if it is shown that there
was reasonable cause for such portion and the taxpayer acted
in good faith. Such a showing requires: (1) adequate
disclosure of the facts affecting the transaction in
accordance with the regulations under section 6011; \387\ (2)
that there is or was substantial authority for such
treatment; and (3) that the taxpayer reasonably believed that
such treatment was more likely than not the proper treatment.
For this purpose, a taxpayer will be treated as having a
reasonable belief with respect to the tax treatment of an
item only if such belief: (1) is based on the facts and law
that exist at the time the tax return (that includes the
item) is filed; and (2) relates solely to the taxpayer's
chances of success on the merits and does not take into
account the possibility that (a) a return will not be
audited, (b) the treatment will not be raised on audit, or
(c) the treatment will be resolved through settlement if
raised.\388\
---------------------------------------------------------------------------
\387\ See the previous discussion regarding the penalty for
failing to disclose a reportable transaction.
\388\ Sec. 6664(d).
---------------------------------------------------------------------------
A taxpayer may (but is not required to) rely on an opinion
of a tax advisor in establishing its reasonable belief with
respect to the tax treatment of the item. However, a taxpayer
may not rely on an opinion of a tax advisor for this purpose
if the opinion (1) is provided by a ``disqualified tax
advisor'' or (2) is a ``disqualified opinion.''
Disqualified tax advisor
A disqualified tax advisor is any advisor who: (1) is a
material advisor \389\ and who participates in the
organization, management, promotion or sale of the
transaction or is related (within the meaning of section
267(b) or 707(b)(1)) to any person who so participates; (2)
is compensated directly or indirectly \390\ by a material
advisor with respect to the transaction; (3) has a fee
arrangement with respect to the transaction that is
contingent on all or part of the intended tax benefits from
the transaction being sustained; or (4) as determined under
regulations prescribed by the Secretary, has a disqualifying
financial interest with respect to the transaction.
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\389\ The term ``material advisor'' means any person who
provides any material aid, assistance, or advice with respect
to organizing, managing, promoting, selling, implementing, or
carrying out any reportable transaction, and who derives
gross income in excess of $50,000 in the case of a reportable
transaction substantially all of the tax benefits from which
are provided to natural persons ($250,000 in any other case).
Sec. 6111(b)(1).
\390\ This situation could arise, for example, when an
advisor has an arrangement or understanding (oral or written)
with an organizer, manager, or promoter of a reportable
transaction that such party will recommend or refer potential
participants to the advisor for an opinion regarding the tax
treatment of the transaction.
---------------------------------------------------------------------------
A material advisor is considered as participating in the
``organization'' of a transaction if the advisor performs
acts relating to the development of the transaction. This may
include, for example, preparing documents: (1) establishing a
structure used in connection with the transaction (such as a
partnership agreement); (2) describing the transaction (such
as an offering memorandum or other statement describing the
transaction); or (3) relating to the registration of the
transaction with any federal, state or local government
body.\391\ Participation in the ``management'' of a
transaction means involvement in the decision-making process
regarding any business activity with respect to the
transaction. Participation in the ``promotion or sale'' of a
transaction means involvement in the marketing or
solicitation of the transaction to others. Thus, an advisor
who provides information about the transaction to a potential
participant is involved in the promotion or sale of a
transaction, as is any advisor who recommends the transaction
to a potential participant.
---------------------------------------------------------------------------
\391\ An advisor should not be treated as participating in
the organization of a transaction if the advisor's only
involvement with respect to the organization of the
transaction is the rendering of an opinion regarding the tax
consequences of such transaction. However, such an advisor
may be a ``disqualified tax advisor'' with respect to the
transaction if the advisor participates in the management,
promotion or sale of the transaction (or if the advisor is
compensated by a material advisor, has a fee arrangement that
is contingent on the tax benefits of the transaction, or as
determined by the Secretary, has a continuing financial
interest with respect to the transaction).
---------------------------------------------------------------------------
Disqualified opinion
An opinion may not be relied upon if the opinion: (1) is
based on unreasonable factual or legal assumptions (including
assumptions as to future events); (2) unreasonably relies
upon representations, statements, findings or agreements of
the taxpayer or any other person; (3) does not identify and
consider all relevant facts; or (4) fails to meet any other
requirement prescribed by the Secretary.
Coordination with other penalties
To the extent a penalty on an understatement is imposed
under section 6662A, that same amount of understatement is
not also subject to the accuracy-related penalty under
section 6662(a) or to the valuation misstatement penalties
under section 6662(e) or 6662(h). However, such amount of
understatement is included for purposes of determining
whether any understatement (as defined in sec. 6662(d)(2)) is
a substantial understatement as defined under section
6662(d)(1) and for purposes of identifying an underpayment
under the section 6663 fraud penalty.
The penalty imposed under section 6662A does not apply to
any portion of an understatement to which a fraud penalty is
applied under section 6663.
House Bill
No provision.
Senate Amendment
The Senate amendment provision imposes a new, stronger
penalty for an understatement attributable to any transaction
that lacks economic substance (referred to in the statute as
a ``non-economic substance transaction
understatement'').\392\ The penalty rate is 40 percent
(reduced to 20 percent if the taxpayer adequately discloses
the relevant facts in accordance with regulations prescribed
under section 6011). No exceptions (including the reasonable
cause or rescission rules) to the penalty are available
(i.e., the penalty is a strict-liability penalty).
---------------------------------------------------------------------------
\392\ Thus, unlike the present-law accuracy-related penalty
under section 6662A (which applies only to listed and
reportable avoidance transactions), the new penalty under the
provision applies to any transaction that lacks economic
substance.
---------------------------------------------------------------------------
A ``non-economic substance transaction'' means any
transaction if (1) the transaction lacks economic substance
(as defined in the Senate amendment provision regarding the
clarification of the economic substance doctrine),\393\ (2)
the transaction was not respected under the rules relating to
transactions with tax-indifferent parties (as described in
the Senate amendment provision regarding the clarification of
the economic substance doctrine),\394\ or (3) any similar
rule of law. For this purpose, a similar rule of law would
include, for example, an understatement attributable to a
transaction that is determined to be a sham transaction.
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\393\ That Senate amendment provision generally provides that
in any case in which a court determines that the economic
substance doctrine is relevant, a transaction has economic
substance only if: (1) the transaction changes in a
meaningful way (apart from Federal income tax effects) the
taxpayer's economic position, and (2) the taxpayer has a
substantial non-tax purpose for entering into such
transaction and the transaction is a reasonable means of
accomplishing such purpose. Specific other rules also apply.
See ``Explanation of Provision'' for the immediately
preceding Senate amendment provision, ``Clarification of the
economic substance doctrine.''
\394\ That Senate amendment provision provides that the form
of a transaction that involves a tax-indifferent party will
not be respected in certain circumstances. See ``Explanation
of Provision'' for the immediately preceding Senate amendment
provision, ``Clarification of the economic substance
doctrine.''
---------------------------------------------------------------------------
For purposes of the bill, the calculation of an
``understatement'' is made in the same manner as in the
present law provision relating to accuracy-related penalties
for listed and reportable avoidance transactions (sec.
6662A). Thus, the amount of the understatement under the
provision would be determined as the sum of (1) the product
of the
[[Page H2272]]
highest corporate or individual tax rate (as appropriate) and
the increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the
tax return),\395\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper
tax treatment of such item. In essence, the penalty will
apply to the amount of any understatement attributable solely
to a non-economic substance transaction.
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\395\ For this purpose, any reduction in the excess of
deductions allowed for the taxable year over gross income for
such year, and any reduction in the amount of capital losses
that would (without regard to section 1211) be allowed for
such year, would be treated as an increase in taxable income.
---------------------------------------------------------------------------
As in the case of the understatement penalty for reportable
and listed transactions under present law section
6662A(e)(3), except as provided in regulations, the
taxpayer's treatment of an item will not take into account
any amendment or supplement to a return if the amendment or
supplement is filed after the earlier of the date the
taxpayer is first contacted regarding an examination of such
return or such other date as specified by the Secretary.
As in the case of the understatement penalty for
undisclosed reportable transactions under present law section
6707A, a public entity that is required to pay a penalty
under the provision (but in this case, regardless of whether
the transaction was disclosed) must disclose the imposition
of the penalty in reports to the SEC for such periods as the
Secretary shall specify. The disclosure to the SEC applies
without regard to whether the taxpayer determines the amount
of the penalty to be material to the reports in which the
penalty must appear, and any failure to disclose such penalty
in the reports is treated as a failure to disclose a listed
transaction. A taxpayer must disclose a penalty in reports to
the SEC once the taxpayer has exhausted its administrative
and judicial remedies with respect to the penalty (or if
earlier, when paid).
Regardless of whether the transaction was disclosed, once a
penalty under the provision has been included in the first
letter of proposed deficiency which allows the taxpayer an
opportunity for administrative review in the IRS Office of
Appeals, the penalty cannot be compromised for purposes of a
settlement without approval of the Commissioner personally.
Furthermore, the IRS is required to keep records summarizing
the application of this penalty and providing a description
of each penalty compromised under the provision and the
reasons for the compromise.
Any understatement on which a penalty is imposed under the
provision will not be subject to the accuracy-related penalty
under section 6662 or under 6662A (accuracy-related penalties
for listed and reportable avoidance transactions). However,
an understatement under the provision is taken into account
for purposes of determining whether any understatement (as
defined in sec. 6662(d)(2)) is a substantial understatement
as defined under section 6662(d)(1). The penalty imposed
under the provision will not apply to any portion of an
understatement to which a fraud penalty is applied under
section 6663.
Effective date.--The provision applies to transactions
entered into after the date of enactment.
Conference Agreement
The conference agreement does not contain the Senate
amendment provision.
3. Denial of deduction for interest on underpayments
attributable to noneconomic substance transactions (sec.
413 of the Senate amendment and sec. 163(m) of the Code)
Present Law
No deduction for interest is allowed for interest paid or
accrued on any underpayment of tax which is attributable to
the portion of any reportable transaction understatement with
respect to which the relevant facts were not adequately
disclosed.\396\ The Secretary of the Treasury is authorized
to define reportable transactions for this purpose.\397\
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\396\ Sec. 163(m). Under section 6664(d)(2)(A), in such a
case of nondisclosure, the taxpayer also is not entitled to
the ``reasonable cause and good faith'' exception to the
section 6662A penalty for a reportable transaction
understatement.
\397\ See the description of present law with respect to the
immediately preceding Senate amendment provision, ``Penalty
for understatements attributable to transactions lacking
economic substance, etc.''
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment provision extends the disallowance of
interest deductions to interest paid or accrued on any
underpayment of tax which is attributable to any noneconomic
substance underpayment (whether or not disclosed).
Effective date.--The provision applies to transactions
after the date of enactment in taxable years ending after
such date.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
C. Improvements in Efficiency and Safeguards in Internal Revenue
Service Collections
1. Waiver of user fee for installment agreements using
automated withdrawals (Sec. 421 of the Senate amendment
and sec. 6159 of the Code)
Present Law
The Code authorizes the IRS to enter into written
agreements with any taxpayer under which the taxpayer is
allowed to pay taxes owed, as well as interest and penalties,
in installment payments if the IRS determines that doing so
will facilitate collection of the amounts owed.\398\ An
installment agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the period
installment payments are being made, other IRS enforcement
actions (such as levies or seizures) with respect to the
taxes included in that agreement are held in abeyance.
---------------------------------------------------------------------------
\398\ Sec. 6159.
---------------------------------------------------------------------------
The IRS charges a user fee if a request for an installment
agreement is approved.
House Bill
No provision.
Senate Amendment
The Senate amendment waives the user fee for installment
agreements in which the parties agree to the use of automated
installment payments (such as automated debits from a bank
account).
Effective date.--The provision is effective with respect to
agreements entered into on or after the date which is 180
days after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Termination of installment agreements (Sec. 422 of the
Senate amendment and sec. 6159 of the Code)
Present Law
The Code authorizes the IRS to enter into written
agreements with any taxpayer under which the taxpayer is
allowed to pay taxes owed, as well as interest and penalties,
in installment payments, if the IRS determines that doing so
will facilitate collection of the amounts owed.\399\ An
installment agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the period
installment payments are being made, other IRS enforcement
actions (such as levies or seizures) with respect to the
taxes included in that agreement are held in abeyance.
---------------------------------------------------------------------------
\399\ Sec. 6159.
---------------------------------------------------------------------------
Under present law, the IRS is permitted to terminate an
installment agreement only if: (1) the taxpayer fails to pay
an installment at the time the payment is due; (2) the
taxpayer fails to pay any other tax liability at the time
when such liability is due; (3) the taxpayer fails to provide
a financial condition update as required by the IRS; (4) the
taxpayer provides inadequate or incomplete information when
applying for an installment agreement; (5) there has been a
significant change in the financial condition of the
taxpayer; or (6) the collection of the tax is in
jeopardy.\400\
---------------------------------------------------------------------------
\400\ Sec. 6159(b)(2), (3), and (4).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment grants the IRS authority to terminate
installment agreement when a taxpayer fails to timely make a
required Federal tax deposit or fails to timely file a tax
return (including extensions). Under the provision, the IRS
may terminate an installment agreement even if the taxpayer
remained current with payments under the installment
agreement.
Effective date.--The provision is effective for failures
occurring on or after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
3. Partial payments required with submissions of offers-in-
compromise (Sec. 423 of the Senate amendment and sec.
7122 of the Code)
Present Law
The IRS has the authority to compromise any civil or
criminal case arising under the internal revenue laws.\401\
In general, taxpayers initiate this process by making an
offer-in-compromise, which is an offer by the taxpayer to
settle an outstanding tax liability for less than the total
amount due. The IRS currently imposes a user fee of $150 on
most offers, payable upon submission of the offer to the IRS.
Taxpayers may justify their offers on the basis of doubt as
to collectibility or liability or on the basis of effective
tax administration. In general, enforcement action is
suspended during the period that the IRS evaluates an offer.
In some instances, it may take the IRS 12 to 18 months to
evaluate an offer.\402\ Taxpayers are permitted (but not
required) to make a deposit with their offer; if the offer is
rejected, the deposit is generally returned to the taxpayer.
There are two general categories \403\ of offers-in-
compromise, lump-sum offers and periodic payment offers.
Taxpayers making lump-sum offers propose to make one lump-sum
payment of a specified dollar amount in settlement of their
outstanding liability.
[[Page H2273]]
Taxpayers making periodic payment offers propose to make a
series of payments over time (either short-term or long-term)
in settlement of their outstanding liability.
---------------------------------------------------------------------------
\401\ Sec. 7122.
\402\ Olsen v. United States, 326 F. Supp. 2d 184 (D. Mass.
2004).
\403\ The IRS categorizes payment plans with more
specificity, which is generally not significant for purposes
of the provision. See Form 656, Offer in Compromise, page 6
of instruction booklet (revised July 2004).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision requires a taxpayer to make partial payments
to the IRS while the taxpayer's offer is being considered by
the IRS. For lump-sum offers, taxpayers must make a down
payment of 20 percent of the amount of the offer with any
application. For purposes of this provision, a lump-sum offer
includes single payments as well as payments made in five or
fewer installments. For periodic payment offers, the
provision requires the taxpayer to comply with the taxpayer's
own proposed payment schedule while the offer is being
considered. Offers submitted to the IRS that do not comport
with these payment requirements are returned to the taxpayer
as unprocessable and immediate enforcement action is
permitted. The provision eliminates the user fee requirement
for offers submitted with the appropriate partial payment.
The provision also provides that an offer is deemed
accepted if the IRS does not make a decision with respect to
the offer within two years from the date the offer was
submitted.
The Senate amendment authorizes the Secretary to issue
regulations providing exceptions to the partial payment
requirements in the case of offers from certain low-income
taxpayers and offers based on doubt as to liability.
Effective date.--The provision is effective for offers-in-
compromise submitted on and after the date which is 60 days
after the date of enactment.
Conference Agreement
The conference agreement includes the Senate amendment
provision, with the following modifications. Under the
conference agreement, any user fee imposed by the IRS for
participation in the offer-in-compromise program must be
submitted with the appropriate partial payment. The user fee
is applied to the taxpayer's outstanding tax liability. In
addition, under the conference agreement, offers submitted to
the IRS that do not comport with the payment requirements may
be returned to the taxpayer as unprocessable.
D. Penalties and Fines
1. Increase in criminal monetary penalty limitation for the
underpayment or overpayment of tax due to fraud (Sec. 431
of the Senate amendment and secs. 7201, 7203, and 7206 of
the Code)
Present Law
Attempt to evade or defeat tax
In general, section 7201 imposes a criminal penalty on
persons who willfully attempt to evade or defeat any tax
imposed by the Code. Upon conviction, the Code provides that
the penalty is up to $100,000 or imprisonment of not more
than five years (or both). In the case of a corporation, the
Code increases the monetary penalty to a maximum of $500,000.
Willful failure to file return, supply information, or pay
tax
In general, section 7203 imposes a criminal penalty on
persons required to make estimated tax payments, pay taxes,
keep records, or supply information under the Code who
willfully fails to do so. Upon conviction, the Code provides
that the penalty is up to $25,000 or imprisonment of not more
than one year (or both). In the case of a corporation, the
Code increases the monetary penalty to a maximum of $100,000.
Fraud and false statements
In general, section 7206 imposes a criminal penalty on
persons who make fraudulent or false statements under the
Code. Upon conviction, the Code provides that the penalty is
up to $100,000 or imprisonment of not more than three years
(or both). In the case of a corporation, the Code increases
the monetary penalty to a maximum of $500,000.
Uniform sentencing guidelines
Under the uniform sentencing guidelines established by 18
U.S.C. 3571, a defendant found guilty of a criminal offense
is subject to a maximum fine that is the greatest of: (a) the
amount specified in the underlying provision, (b) for a
felony \404\ $250,000 for an individual or $500,000 for an
organization, or (c) twice the gross gain if a person derives
pecuniary gain from the offense. This Title 18 provision
applies to all criminal provisions in the United States Code,
including those in the Internal Revenue Code. For example,
for an individual, the maximum fine under present law upon
conviction of violating section 7206 is $250,000 or, if
greater, twice the amount of gross gain from the offense.
---------------------------------------------------------------------------
\404\ Section 7206 states that making fraudulent or false
statements under the Code is a felony. In addition, this
offense is a felony pursuant to the classification guidelines
of 18 U.S.C. 3559(a)(5).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
Attempt to evade or defeat tax
The provision increases the criminal penalty under section
7201 of the Code for individuals to $500,000 and for
corporations to $1,000,000. The provision increases the
maximum prison sentence to ten years.
Willful failure to file return, supply information, or pay
tax
The provision increases the criminal penalty under section
7203 of the Code for individuals from $25,000 to $50,000 and,
in the case of an ``aggravated failure to file'' (defined as
a failure to file a return for a period of three or more
consecutive taxable years if the aggregated tax liability for
such period is at least $100,000), changes the crime from a
misdemeanor to a felony and increases the maximum prison
sentence to ten years.
Fraud and false statements
The provision increases the criminal penalty for making
fraudulent or false statements to $500,000 for individuals
and $1,000,000 for corporations. The provision increases the
maximum prison sentence for making fraudulent or false
statements to five years. The provision provides that in no
event shall the amount of the monetary penalty under the
provision be less than the amount of the underpayment or
overpayment attributable to fraud.
Effective date
The provision is effective for actions and failures to act
occurring after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Doubling of certain penalties, fines, and interest on
underpayments related to certain offshore financial
arrangements (Sec. 432 of the Senate amendment)
Present Law
In general
The Code contains numerous civil penalties, such as the
delinquency, accuracy-related, fraud, and assessable
penalties. These civil penalties are in addition to any
interest that may be due as a result of an underpayment of
tax. If all or any part of a tax is not paid when due, the
Code imposes interest on the underpayment, which is assessed
and collected in the same manner as the underlying tax and is
subject to the respective statutes of limitations for
assessment and collection.
Delinquency penalties
Failure to file.--Under present law, a taxpayer who fails
to file a tax return on a timely basis is generally subject
to a penalty equal to 5 percent of the net amount of tax due
for each month that the return is not filed, up to a maximum
of five months or 25 percent. An exception from the penalty
applies if the failure is due to reasonable cause. In the
case of fraudulent failure to file, the penalty is increased
to 15 percent of the net amount of tax due for each month
that the return is not filed, up to a maximum of five months
or 75 percent. The net amount of tax due is the excess of the
amount of the tax required to be shown on the return over the
amount of any tax paid on or before the due date prescribed
for the payment of tax.
Failure to pay.--Taxpayers who fail to pay their taxes are
subject to a penalty of 0.5 percent per month on the unpaid
amount, up to a maximum of 25 percent. If a penalty for
failure to file and a penalty for failure to pay tax shown on
a return both apply for the same month, the amount of the
penalty for failure to file for such month is reduced by the
amount of the penalty for failure to pay tax shown on a
return. If an income tax return is filed more than 60 days
after its due date, then the penalty for failure to pay tax
shown on a return may not reduce the penalty for failure to
file below the lesser of $100 or 100 percent of the amount
required to be shown on the return. For any month in which an
installment payment agreement with the IRS is in effect, the
rate of the penalty is half the usual rate (0.25 percent
instead of 0.5 percent), provided that the taxpayer filed the
tax return in a timely manner (including extensions).
Failure to make timely deposits of tax.--The penalty for
the failure to make timely deposits of tax consists of a
four-tiered structure in which the amount of the penalty
varies with the length of time within which the taxpayer
corrects the failure. A depositor is subject to a penalty
equal to 2 percent of the amount of the underpayment if the
failure is corrected on or before the date that is five days
after the prescribed due date. A depositor is subject to a
penalty equal to 5 percent of the amount of the underpayment
if the failure is corrected after the date that is five days
after the prescribed due date but on or before the date that
is 15 days after the prescribed due date. A depositor is
subject to a penalty equal to 10 percent of the amount of the
underpayment if the failure is corrected after the date that
is 15 days after the due date but on or before the date that
is 10 days after the date of the first delinquency notice to
the taxpayer (under sec. 6303). Finally, a depositor is
subject to a penalty equal to 15 percent of the amount of the
underpayment if the failure is not corrected on or before
earlier of 10 days after the date of the first delinquency
notice to the taxpayer and 10 days after the date on which
notice and demand for immediate payment of tax is given in
cases of jeopardy.
An exception from the penalty applies if the failure is due
to reasonable cause. In addition, the Secretary may waive the
penalty for an inadvertent failure to deposit any tax by
specified first-time depositors.
Accuracy-related penalties
In general.--The accuracy-related penalties are imposed at
a rate of 20 percent of the portion of any underpayment that
is attributable, in relevant part, to (1) negligence, (2) any
substantial understatement of income tax, (3) any substantial
valuation misstatement, and (4) any reportable transaction
understatement. The penalty for a
[[Page H2274]]
substantial valuation misstatement is doubled for certain
gross valuation misstatements. In the case of a reportable
transaction understatement for which the transaction is not
disclosed, the penalty rate is 30 percent. These penalties
are coordinated with the fraud penalty. This statutory
structure operates to eliminate any stacking of the
penalties.
No penalty is to be imposed if it is shown that there was
reasonable cause for an underpayment and the taxpayer acted
in good faith, and in the case of a reportable transaction
understatement the relevant facts of the transaction have
been disclosed, there is or was substantial authority for the
taxpayer's treatment of such transaction, and the taxpayer
reasonably believed that such treatment was more likely than
not the proper treatment.
Negligence or disregard for the rules or regulations.--If
an underpayment of tax is attributable to negligence, the
negligence penalty applies only to the portion of the
underpayment that is attributable to negligence. Negligence
means any failure to make a reasonable attempt to comply with
the provisions of the Code. Disregard includes any careless,
reckless, or intentional disregard of the rules or
regulations.
Substantial understatement of income tax.--Generally, an
understatement is substantial if the understatement exceeds
the greater of (1) 10 percent of the tax required to be shown
on the return for the tax year, or (2) $5,000. In determining
whether a substantial understatement exists, the amount of
the understatement is reduced by any portion attributable to
an item if (1) the treatment of the item on the return is or
was supported by substantial authority, or (2) facts relevant
to the tax treatment of the item were adequately disclosed on
the return or on a statement attached to the return.
Substantial valuation misstatement.--A penalty applies to
the portion of an underpayment that is attributable to a
substantial valuation misstatement. Generally, a substantial
valuation misstatement exists if the value or adjusted basis
of any property claimed on a return is 200 percent or more of
the correct value or adjusted basis. The amount of the
penalty for a substantial valuation misstatement is 20
percent of the amount of the underpayment if the value or
adjusted basis claimed is 200 percent or more but less than
400 percent of the correct value or adjusted basis. If the
value or adjusted basis claimed is 400 percent or more of the
correct value or adjusted basis, then the overvaluation is a
gross valuation misstatement.
Reportable transaction understatement.--A penalty applies
to any item that is attributable to any listed transaction,
or to any reportable transaction (other than a listed
transaction) if a significant purpose of such reportable
transaction is tax avoidance or evasion.
Fraud penalty
The fraud penalty is imposed at a rate of 75 percent of the
portion of any underpayment that is attributable to fraud.
The accuracy-related penalty does not apply to any portion of
an underpayment on which the fraud penalty is imposed.
Assessable penalties
In addition to the penalties described above, the Code
imposes a number of additional penalties, including, for
example, penalties for failure to file (or untimely filing
of) information returns with respect to foreign trusts, and
penalties for failure to disclose any required information
with respect to a reportable transaction.
Interest provisions
Taxpayers are required to pay interest to the IRS whenever
there is an underpayment of tax. An underpayment of tax
exists whenever the correct amount of tax is not paid by the
last date prescribed for the payment of the tax. The last
date prescribed for the payment of the income tax is the
original due date of the return.
Different interest rates are provided for the payment of
interest depending upon the type of taxpayer, whether the
interest relates to an underpayment or overpayment, and the
size of the underpayment or overpayment. Interest on
underpayments is compounded daily.
Offshore Voluntary Compliance Initiative
In January 2003, Treasury announced the Offshore Voluntary
Compliance Initiative (``OVCI'') to encourage the voluntary
disclosure of previously unreported income placed by
taxpayers in offshore accounts and accessed through credit
card or other financial arrangements. A taxpayer had to
comply with various requirements in order to participate in
the OVCI, including sending a written request to participate
in the program by April 15, 2003. This request had to include
information about the taxpayer, the taxpayer's introduction
to the credit card or other financial arrangements and the
names of parties that promoted the transaction. A taxpayer
entering into a closing agreement under the OVCI is not
liable for the civil fraud penalty, the fraudulent failure to
file penalty, or the civil information return penalties. Such
a taxpayer is responsible for back taxes, interest, and
certain accuracy-related and delinquency penalties.\405\
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\405\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------
Voluntary disclosure policy
A taxpayer's timely, voluntary disclosure of a substantial
unreported tax liability has long been an important factor in
deciding whether the taxpayer's case should ultimately be
referred for criminal prosecution. The voluntary disclosure
must be truthful, timely, and complete. The taxpayer must
show a willingness to cooperate (as well as actual
cooperation) with the IRS in determining the correct tax
liability. The taxpayer must make good-faith arrangements
with the IRS to pay in full the tax, interest, and any
penalties determined by the IRS to be applicable. A voluntary
disclosure does not guarantee immunity from prosecution. It
creates no substantive or procedural rights for
taxpayers.\406\ The IRS treats participation in the OVCI as a
voluntary disclosure.\407\
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\406\ Internal Revenue News Release 2002-135, IR-2002-135
(December 11, 2002).
\407\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment doubles the amounts of civil
penalties, interest, and fines related to taxpayers'
underpayments of U.S. income tax liability through the direct
or indirect use of certain offshore financial arrangements.
The provision applies to taxpayers who did not (or do not)
voluntarily disclose such arrangements through the OVCI or
otherwise. Under the Senate amendment, the determination of
whether any civil penalty is to be applied to such
underpayment is made without regard to whether a return has
been filed, whether there was reasonable cause for such
underpayment, and whether the taxpayer acted in good faith.
The proscribed financial arrangements include, but are not
limited to, the use of certain foreign leasing corporations
for providing domestic employee services,\408\ certain
arrangements whereby the taxpayer may hold securities trading
accounts through offshore banks or other financial
intermediaries, certain arrangements whereby the taxpayer may
access funds through the use of offshore credit, debit, or
charge cards, and offshore annuities or trusts.
---------------------------------------------------------------------------
\408\ These arrangements were described and classified as
listed transactions in Notice 2003-22, 2003-1 C.B. 851.
---------------------------------------------------------------------------
The Secretary of the Treasury is granted the authority to
waive the application of the provision if the use of the
offshore financial arrangements is incidental to the
transaction and, in the case of a trade or business, such use
is conducted in the ordinary course of the type of trade or
business in which the taxpayer is engaged.
Effective date.--The provision generally is effective with
respect to a taxpayer's open tax years on or after the date
of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
3. Denial of deduction for certain fines, penalties, and
other amounts (Sec. 433 of the Senate Amendment and sec.
162 of the Code)
Present Law
Under present law, no deduction is allowed as a trade or
business expense under section 162(a) for the payment of a
fine or similar penalty to a government for the violation of
any law (sec. 162(f)). The enactment of section 162(f) in
1969 codified existing case law that denied the deductibility
of fines as ordinary and necessary business expenses on the
grounds that ``allowance of the deduction would frustrate
sharply defined national or State policies proscribing the
particular types of conduct evidenced by some governmental
declaration thereof.'' \409\
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\409\ S. Rep. No. 91-552, 91st Cong, 1st Sess., 273-74
(1969), referring to Tank Truck Rentals, Inc. v.
Commissioner, 356 U.S. 30 (1958).
---------------------------------------------------------------------------
Treasury regulation section 1.162-21(b)(1) provides that a
fine or similar penalty includes an amount: (1) paid pursuant
to conviction or a plea of guilty or nolo contendere for a
crime (felony or misdemeanor) in a criminal proceeding; (2)
paid as a civil penalty imposed by Federal, State, or local
law, including additions to tax and additional amounts and
assessable penalties imposed by chapter 68 of the Code; (3)
paid in settlement of the taxpayer's actual or potential
liability for a fine or penalty (civil or criminal); or (4)
forfeited as collateral posted in connection with a
proceeding which could result in imposition of such a fine or
penalty. Treasury regulation section 1.162-21(b)(2) provides,
among other things, that compensatory damages (including
damages under section 4A of the Clayton Act (15 U.S.C. 15a),
as amended) paid to a government do not constitute a fine or
penalty.
House Bill
No provision.
Senate Amendment
The Senate amendment provision modifies the rules regarding
the determination whether payments are nondeductible payments
of fines or penalties under section 162(f). In particular,
the provision generally provides that amounts paid or
incurred (whether by suit, agreement, or otherwise) to, or at
the direction of, a government in relation to the violation
of any law or the investigation or inquiry into the potential
violation of any law \410\ are nondeductible under
[[Page H2275]]
any provision of the income tax provisions.\411\ The
provision applies to deny a deduction for any such payments,
including those where there is no admission of guilt or
liability and those made for the purpose of avoiding further
investigation or litigation. 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, and that are
identified in the court order or settlement as restitution,
remediation, or required to come into compliance.\412\ The
IRS remains free to challenge the characterization of an
amount so identified; however, no deduction is allowed unless
the identification is made.\413\
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\410\ The provision does not affect amounts paid or incurred
in performing routine audits or reviews such as annual audits
that are required of all organizations or individuals in a
similar business sector, or profession, as a requirement for
being allowed to conduct business. However, if the government
or regulator raised an issue of compliance and a payment is
required in settlement of such issue, the provision would
affect that payment.
\411\ The provision provides that such amounts are
nondeductible under chapter 1 of the Internal Revenue Code.
\412\ The provision does not affect the treatment of
antitrust payments made under section 4 of the Clayton Act,
which continue to be governed by the provisions of section
162(g).
\413\ If a settlement agreement does not specify a specific
amount to be paid for the purpose of coming into compliance
but instead simply requires the taxpayer to come into
compliance, it is sufficient identification to so state.
Amounts expended by the taxpayer for that purpose would then
be considered identified. However, if an agreement specifies
a specific dollar amount that must be paid or incurred, the
amount would not be eligible to be deducted without a
specification that it is for restitution (including
remediation of property), or coming into compliance.
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An exception also applies to any amount paid or incurred as
taxes due.\414\
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\414\ 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).
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The provision is intended to apply only where a government
(or other entity treated in a manner similar to a government
under the amendment) is a complainant or investigator with
respect to the violation or potential violation of any
law.\415\
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\415\ Thus, for example, the provision would 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 a payment to be
made ``at the direction of a government'' for purposes of the
provision.
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It is intended that a payment will be treated as
restitution (including remediation of property) only if
substantially all of the payment is required to be paid to
the specific persons, or in relation to the specific
property, actually harmed by the conduct of the taxpayer that
resulted in the payment. Thus, a payment to or with respect
to a class substantially broader than the specific persons or
property that were actually harmed (e.g., to a class
including similarly situated persons or property) does not
qualify as restitution or included remediation of
property.\416\ Restitution and included remediation of
property is limited to the amount that bears a substantial
quantitative relationship to the harm caused by the past
conduct or actions of the taxpayer that resulted in the
payment in question. If the party harmed is a government or
other entity, then restitution and included remediation of
property includes payment to such harmed government or
entity, provided the payment bears a substantial quantitative
relationship to the harm. However, restitution or included
remediation of property does not include reimbursement of
government investigative or litigation costs, or payments to
whistleblowers.
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\416\ Similarly, a payment to a charitable organization
benefiting a broader class than the persons or property
actually harmed, or to be paid out without a substantial
quantitative relationship to the harm caused, would not
qualify as restitution. Under the provision, such a payment
not deductible under section 162 would also not be deductible
under section 170.
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It is intended that a payment will be treated as an amount
required to come into compliance only if it directly corrects
a violation with respect to a particular requirement of law
that was under investigation. For example, if the law
requires a particular emission standard to be met or
particular machinery to be used, amounts required to be paid
under a settlement agreement to meet the required standard or
install the machinery are deductible to the extent otherwise
allowed. Similarly, if the law requires certain practices and
procedures to be followed and a settlement agreement requires
the taxpayer to pay to establish such practices or
procedures, such amounts would be deductible. However,
amounts paid for other purposes not directly correcting a
violation of law are not deductible. For example, amounts
paid to bring other machinery that is already in compliance
up to a standard higher than required by the law, or to
create other benefits (such as a park or other action not
previously required by law), are not deductible if required
under a settlement agreement. Similarly, amounts paid to
educate consumers or customers about the risks of doing
business with the taxpayer or about the field in which the
taxpayer does business generally, which education efforts are
not specifically required under the law, are not deductible
if required under a settlement agreement.
The provision requires government agencies to report to the
IRS and to the taxpayer the amount of each settlement
agreement or order entered where the aggregate amount
required to be paid or incurred to or at the direction of the
government under such settlement agreements and orders with
respect to the violation, investigation, or inquiry is 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
reports must be made within 30 days of the date the court
order is issued or the settlement agreement is entered into,
or such other time as may be required by Secretary. The
report must separately identify any amounts that are
restitution or remediation of property, or correction of
noncompliance.\417\
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\417\ As in the case of the identification requirement, if
the agreement does not specify a specific amount to be
expended to come into compliance but simply requires that to
occur, it is expected that the report may state simply that
the taxpayer is required to come into compliance but no
specific dollar amount has been specified for that purpose in
the settlement agreement.
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The IRS is encouraged to require taxpayers to identify
separately on their tax returns the amounts of any such
settlements with respect to which reporting is required under
the provision, including separate identification of the
nondeductible amount and of any amount deductible as
restitution, remediation, or required to correct
noncompliance.\418\
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\418\ For example, the IRS might require such reporting as
part of the schedule M-3, whether or not the particular
amounts create a book-tax difference.
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Amounts paid or incurred (whether by suit, agreement, or
otherwise) to, or at the direction of, any self-regulatory
entity that regulates a financial market or other market that
is a qualified board or exchange under section 1256(g)(7),
and that is authorized to impose sanctions (e.g., the
National Association of Securities Dealers) are likewise
subject to the provision if paid in relation to a violation,
or investigation or inquiry into a potential violation, of
any law (or any rule or other requirement of such entity). To
the extent provided in regulations, amounts paid or incurred
to, or at the direction of, any other nongovernmental entity
that exercises self-regulatory powers as part of performing
an essential governmental function are similarly subject to
the provision. The exception for payments that the taxpayer
establishes are paid or incurred for restitution, remediation
of property, or coming into compliance and that are
identified as such in the order or settlement agreement
likewise applies in these cases. The requirement of reporting
to the IRS and the taxpayer also applies in these cases.
No inference is intended as to the treatment of payments as
nondeductible fines or penalties under present law. In
particular, the provision is not intended to limit the scope
of present-law section 162(f) or the regulations thereunder.
Effective date.--The provision is effective for amounts
paid or incurred on or after the date of enactment; however
the provision does not apply to amounts paid or incurred
under any binding order or agreement entered into before such
date. Any order or agreement requiring court approval is not
a binding order or agreement for this purpose unless such
approval was obtained before the date of enactment.
Conference Agreement
The conference agreement does not contain the Senate
amendment provision.
4. Denial of deduction for punitive damages (Sec. 434 of the
Senate amendment and sec. 162 of the Code)
Present Law
In general, a deduction is allowed for all ordinary and
necessary expenses that are paid or incurred by the taxpayer
during the taxable year in carrying on any trade or
business.\419\ However, no deduction is allowed for any
payment that is made to an official of any governmental
agency if the payment constitutes an illegal bribe or
kickback or if the payment is to an official or employee of a
foreign government and is illegal under Federal law.\420\ In
addition, no deduction is allowed under present law for any
fine or similar payment made to a government for violation of
any law.\421\ Furthermore, no deduction is permitted for two-
thirds of any damage payments made by a taxpayer who is
convicted of a violation of the Clayton antitrust law or any
related antitrust law.\422\
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\419\ Sec. 162(a).
\420\ Sec. 162(c).
\421\ Sec. 162(f).
\422\ Sec. 162(g).
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In general, gross income does not include amounts received
on account of personal physical injuries and physical
sickness.\423\ However, this exclusion does not apply to
punitive damages.\424\
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\423\ Sec. 104(a).
\424\ Sec. 104(a)(2).
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House Bill
No provision.
Senate Amendment
The provision denies any deduction for punitive damages
that are paid or incurred by the taxpayer as a result of a
judgment or in settlement of a claim. If the liability for
punitive damages is covered by insurance, any such punitive
damages paid by the insurer are included in gross income of
the insured person and the insurer is required to report such
amounts to both the insured person and the IRS.
Effective date.--The provision is effective for punitive
damages that are paid or incurred on or after the date of
enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
[[Page H2276]]
5. Increase in penalty for bad checks and money orders (Sec.
435 of the Senate amendment and sec. 6657 of the Code)
Present Law
The Code \425\ imposes a penalty for bad checks and money
orders on the person who tendered it. The penalty is two
percent of the amount of the bad check or money order. For
checks that are less than $750, the minimum penalty is $15
(or, if less, the amount of the check).
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\425\ Sec. 6657.
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House Bill
No provision.
Senate Amendment
The provision increases the minimum penalty to $25 (or, if
less, the amount of the check), applicable to checks that are
less than $1,250.
Effective date.--The provision is effective with respect to
checks or money orders received after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
E. Provisions to Discourage Expatriation
1. Tax treatment of inverted corporate entities (Sec. 441 of
the Senate amendment and sec. 7874 of the Code)
Present Law
Determination of corporate residence
The U.S. tax treatment of a multinational corporate group
depends significantly on whether the parent corporation of
the group is domestic or foreign. For purposes of U.S. tax
law, a corporation is treated as domestic if it is
incorporated under the law of the United States or of any
State. Other corporations (i.e., those incorporated under the
laws of foreign countries or U.S. possessions) generally are
treated as foreign.
U.S. taxation of domestic corporations
The United States employs a ``worldwide'' tax system, under
which domestic corporations generally are taxed on all
income, whether derived in the United States or abroad. In
order to mitigate the double taxation that may arise from
taxing the foreign-source income of a domestic corporation, a
foreign tax credit for income taxes paid to foreign countries
is provided to reduce or eliminate the U.S. tax owed on such
income, subject to certain limitations.
Income earned by a domestic parent corporation from foreign
operations conducted by foreign corporate subsidiaries
generally is subject to U.S. tax when the income is
distributed as a dividend to the domestic corporation. Until
such repatriation, the U.S. tax on such income generally is
deferred, and U.S. tax is imposed on such income when
repatriated. However, certain anti-deferral regimes may cause
the domestic parent corporation to be taxed on a current
basis in the United States with respect to certain categories
of passive or highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has been
distributed as a dividend to the domestic parent corporation.
The main anti-deferral regimes in this context are the
controlled foreign corporation rules of subpart F (secs. 951-
964) and the passive foreign investment company rules (secs.
1291-1298). A foreign tax credit is generally available to
offset, in whole or in part, the U.S. tax owed on this
foreign-source income, whether such income is repatriated as
an actual dividend or included under one of the anti-deferral
regimes.
U.S. taxation of foreign corporations
The United States taxes foreign corporations only on income
that has a sufficient nexus to the United States. Thus, a
foreign corporation is generally subject to U.S. tax only on
income that is ``effectively connected'' with the conduct of
a trade or business in the United States. Such ``effectively
connected income'' generally is taxed in the same manner and
at the same rates as the income of a U.S. corporation. An
applicable tax treaty may limit the imposition of U.S. tax on
business operations of a foreign corporation to cases in
which the business is conducted through a ``permanent
establishment'' in the United States.
In addition, foreign corporations generally are subject to
a gross-basis U.S. tax at a flat 30-percent rate on the
receipt of interest, dividends, rents, royalties, and certain
similar types of income derived from U.S. sources, subject to
certain exceptions. The tax generally is collected by means
of withholding by the person making the payment. This tax may
be reduced or eliminated under an applicable tax treaty.
U.S. tax treatment of inversion transactions prior to the
American Jobs Creation Act of 2004
Prior to the American Jobs Creation Act of 2004 (``AJCA''),
a U.S. corporation could reincorporate in a foreign
jurisdiction and thereby replace the U.S. parent corporation
of a multinational corporate group with a foreign parent
corporation. These transactions were commonly referred to as
inversion transactions. Inversion transactions could take
many different forms, including stock inversions, asset
inversions, and various combinations of and variations on the
two. Most of the known transactions were stock inversions. In
one example of a stock inversion, a U.S. corporation forms a
foreign corporation, which in turn forms a domestic merger
subsidiary. The domestic merger subsidiary then merges into
the U.S. corporation, with the U.S. corporation surviving,
now as a subsidiary of the new foreign corporation. The U.S.
corporation's shareholders receive shares of the foreign
corporation and are treated as having exchanged their U.S.
corporation shares for the foreign corporation shares. An
asset inversion could be used to reach a similar result, but
through a direct merger of the top-tier U.S. corporation into
a new foreign corporation, among other possible forms. An
inversion transaction could be accompanied or followed by
further restructuring of the corporate group. For example, in
the case of a stock inversion, in order to remove income from
foreign operations from the U.S. taxing jurisdiction, the
U.S. corporation could transfer some or all of its foreign
subsidiaries directly to the new foreign parent corporation
or other related foreign corporations.
In addition to removing foreign operations from U.S. taxing
jurisdiction, the corporate group could seek to derive
further advantage from the inverted structure by reducing
U.S. tax on U.S.-source income through various earnings
stripping or other transactions. This could include earnings
stripping through payment by a U.S. corporation of deductible
amounts such as interest, royalties, rents, or management
service fees to the new foreign parent or other foreign
affiliates. In this respect, the post-inversion structure
could enable the group to employ the same tax-reduction
strategies that are available to other multinational
corporate groups with foreign parents and U.S. subsidiaries,
subject to the same limitations (e.g., secs. 163(j) and 482).
Inversion transactions could give rise to immediate U.S.
tax consequences at the shareholder and/or the corporate
level, depending on the type of inversion. In stock
inversions, the U.S. shareholders generally recognized gain
(but not loss) under section 367(a), based on the difference
between the fair market value of the foreign corporation
shares received and the adjusted basis of the domestic
corporation stock exchanged. To the extent that a
corporation's share value had declined, and/or it had many
foreign or tax-exempt shareholders, the impact of this
section 367(a) ``toll charge'' was reduced. The transfer of
foreign subsidiaries or other assets to the foreign parent
corporation also could give rise to U.S. tax consequences at
the corporate level (e.g., gain recognition and earnings and
profits inclusions under secs. 1001, 311(b), 304, 367, 1248
or other provisions). The tax on any income recognized as a
result of these restructurings could be reduced or eliminated
through the use of net operating losses, foreign tax credits,
and other tax attributes.
In asset inversions, the U.S. corporation generally
recognized gain (but not loss) under section 367(a) as though
it had sold all of its assets, but the shareholders generally
did not recognize gain or loss, assuming the transaction met
the requirements of a reorganization under section 368.
U.S. tax treatment of inversion transactions under AJCA
In general
AJCA added new section 7874 to the Code, which defines two
different types of corporate inversion transactions and
establishes a different set of consequences for each type.
Certain partnership transactions also are covered.
Transactions involving at least 80 percent identity of
stock ownership
The first type of inversion is a transaction in which,
pursuant to a plan \426\ or a series of related transactions:
(1) a U.S. corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all
of its properties to such an entity in a transaction
completed after March 4, 2003; (2) the former shareholders of
the U.S. corporation hold (by reason of holding stock in the
U.S. corporation) 80 percent or more (by vote or value) of
the stock of the foreign-incorporated entity after the
transaction; and (3) the foreign-incorporated entity,
considered together with all companies connected to it by a
chain of greater than 50 percent ownership (i.e., the
``expanded affiliated group''), does not have substantial
business activities in the entity's country of incorporation,
compared to the total worldwide business activities of the
expanded affiliated group. The provision denies the intended
tax benefits of this type of inversion by deeming the top-
tier foreign corporation to be a domestic corporation for all
purposes of the Code.\427\
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\426\ Acquisitions with respect to a domestic corporation or
partnership are deemed to be ``pursuant to a plan'' if they
occur within the four-year period beginning on the date which
is two years before the ownership threshold under the
provision is met with respect to such corporation or
partnership.
\427\ Since the top-tier foreign corporation is treated for
all purposes of the Code as domestic, the shareholder-level
``toll charge'' of sec. 367(a) does not apply to these
inversion transactions.
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In determining whether a transaction meets the definition
of an inversion under the provision, stock held by members of
the expanded affiliated group that includes the foreign
incorporated entity is disregarded. For example, if the
former top-tier U.S. corporation receives stock of the
foreign incorporated entity (e.g., so-called ``hook'' stock),
the stock would not be considered in determining whether the
transaction meets the definition. Similarly, if a U.S. parent
corporation converts an existing wholly owned U.S. subsidiary
into a new wholly owned controlled foreign corporation, the
stock of the
[[Page H2277]]
new foreign corporation would be disregarded, with the result
that the transaction would not meet the definition of an
inversion under the provision. Stock sold in a public
offering related to the transaction also is disregarded for
these purposes.
Transfers of properties or liabilities as part of a plan a
principal purpose of which is to avoid the purposes of the
provision are disregarded. In addition, the Treasury
Secretary is to provide regulations to carry out the
provision, including regulations to prevent the avoidance of
the purposes of the provision, including avoidance through
the use of related persons, pass-through or other
noncorporate entities, or other intermediaries, and through
transactions designed to qualify or disqualify a person as a
related person or a member of an expanded affiliated group.
Similarly, the Treasury Secretary has the authority to treat
certain non-stock instruments as stock, and certain stock as
not stock, where necessary to carry out the purposes of the
provision.
Transactions involving at least 60 percent but less than 80
percent identity of stock ownership
The second type of inversion is a transaction that would
meet the definition of an inversion transaction described
above, except that the 80-percent ownership threshold is not
met. In such a case, if at least a 60-percent ownership
threshold is met, then a second set of rules applies to the
inversion. Under these rules, the inversion transaction is
respected (i.e., the foreign corporation is treated as
foreign), but any applicable corporate-level ``toll charges''
for establishing the inverted structure are not offset by tax
attributes such as net operating losses or foreign tax
credits. Specifically, any applicable corporate-level income
or gain required to be recognized under sections 304, 311(b),
367, 1001, 1248, or any other provision with respect to the
transfer of controlled foreign corporation stock or the
transfer or license of other assets by a U.S. corporation as
part of the inversion transaction or after such transaction
to a related foreign person is taxable, without offset by any
tax attributes (e.g., net operating losses or foreign tax
credits). This rule does not apply to certain transfers of
inventory and similar property. These measures generally
apply for a 10-year period following the inversion
transaction.
Other rules
Under section 7874, inversion transactions include certain
partnership transactions. Specifically, the provision applies
to transactions in which a foreign-incorporated entity
acquires substantially all of the properties constituting a
trade or business of a domestic partnership, if after the
acquisition at least 60 percent (or 80 percent, as the case
may be) of the stock of the entity is held by former partners
of the partnership (by reason of holding their partnership
interests), provided that the other terms of the basic
definition are met. For purposes of applying this test, all
partnerships that are under common control within the meaning
of section 482 are treated as one partnership, except as
provided otherwise in regulations. In addition, the modified
``toll charge'' rules apply at the partner level.
A transaction otherwise meeting the definition of an
inversion transaction is not treated as an inversion
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more
than half of the properties held directly or indirectly by
the domestic corporation, or more than half of the properties
constituting the partnership trade or business, as the case
may be.
House Bill
No provision.
senate amendment
The Senate amendment makes several changes to the
inversions regime of section 7874. First, the provision
applies the rules of section 7874 to transactions completed
after March 20, 2002 (as opposed to March 4, 2003 under
present law). A transaction otherwise meeting the definition
of an inversion transaction under the provision is not
treated as an inversion transaction if, on or before March
20, 2002, the foreign-incorporated entity had acquired
directly or indirectly more than half the properties held
directly or indirectly by the domestic corporation, or more
than half the properties constituting the partnership trade
or business, as the case may be.
The Senate amendment also lowers the present-law 60-percent
ownership threshold for the second category of inversion
transactions to greater-than-50-percent, and increases the
accuracy-related penalties and tightens the earnings
stripping rules of section 163(j) with respect to companies
involved in this type of transaction. Specifically, the 20-
percent penalty for negligence or disregard of rules or
regulations, substantial understatement of income tax, and
substantial valuation misstatement is increased to 30 percent
with respect to the inverting entity and taxpayers related to
the inverting entity, and the 40-percent penalty for gross
valuation misstatement is increased to 50 percent with
respect to such taxpayers. In applying section 163(j) to
taxpayers related to the inverted entity, the generally
applicable debt-equity threshold is eliminated, and the 50-
percent thresholds for ``excess interest expense'' and
``excess limitation'' are lowered to 25 percent.
The Senate amendment also excludes from the inversions
regime the acquisition of a U.S. corporation in cases in
which none of the stock of the U.S. corporation was readily
tradable on an established securities market at any time
during the four-year period ending on the date of the
acquisition, except as provided in regulations.
Effective date.--The provision in the Senate amendment is
effective for taxable years ending after March 20, 2002.
conference agreement
The conference agreement does not include the Senate
amendment provision.
2. Revision of tax rules on expatriation of individuals (Sec.
442 of the Senate amendment and secs. 102, 877, 2107,
2501, 7701, and 6039G of the Code)
present law
In general
U.S. citizens and residents generally are subject to U.S.
income taxation on their worldwide income. The U.S. tax may
be reduced or offset by a credit allowed for foreign income
taxes paid with respect to foreign source income. Nonresident
aliens are taxed at a flat rate of 30 percent (or a lower
treaty rate) on certain types of passive income derived from
U.S. sources, and at regular graduated rates on net profits
derived from a U.S. trade or business. The estates of
nonresident aliens generally are subject to estate tax on
U.S.-situated property (e.g., real estate and tangible
property located within the United States and stock in a U.S.
corporation). Nonresident aliens generally are subject to
gift tax on transfers by gift of U.S.-situated property
(e.g., real estate and tangible property located within the
United States), but excluding intangibles, such as stock,
regardless of where they are located.
Income tax rules with respect to expatriates
For the 10 taxable years after an individual relinquishes
his or her U.S. citizenship or terminates his or her U.S.
long-term residency, unless certain conditions are met, the
individual is subject to an alternative method of income
taxation than that generally applicable to nonresident aliens
(the ``alternative tax regime''). Generally, the individual
is subject to income tax for the 10-year period at the rates
applicable to U.S. citizens, but only on U.S.-source
income.\428\
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\428\ For this purpose, however, U.S.-source income has a
broader scope than it does typically in the Code.
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A ``long-term resident'' is a noncitizen who is a lawful
permanent resident of the United States for at least eight
taxable years during the period of 15 taxable years ending
with the taxable year during which the individual either
ceases to be a lawful permanent resident of the United States
or commences to be treated as a resident of a foreign country
under a tax treaty between such foreign country and the
United States (and does not waive such benefits).
A former citizen or former long-term resident is subject to
the alternative tax regime for a 10-year period following
citizenship relinquishment or residency termination, unless
the former citizen or former long-term resident: (1)
establishes that his or her average annual net income tax
liability for the five preceding years does not exceed
$124,000 (adjusted for inflation after 2004) and his or her
net worth is less than $2 million, or alternatively satisfies
limited, objective exceptions for certain dual citizens and
minors who have had no substantial contacts with the United
States; and (2) certifies under penalties of perjury that he
or she has complied with all U.S. Federal tax obligations for
the preceding five years and provides such evidence of
compliance as the Secretary of the Treasury may require.
Anti-abuse rules are provided to prevent the circumvention
of the alternative tax regime.
Estate tax rules with respect to expatriates
Special estate tax rules apply to individuals who die
during a taxable year in which he or she is subject to the
alternative tax regime. Under these special rules, certain
closely-held foreign stock owned by the former citizen or
former long-term resident is includible in his or her gross
estate to the extent that the foreign corporation owns U.S.-
situated assets. The special rules apply if, at the time of
death: (1) the former citizen or former long-term resident
directly or indirectly owns 10 percent or more of the total
combined voting power of all classes of stock entitled to
vote of the foreign corporation; and (2) directly or
indirectly, is considered to own more than 50 percent of (a)
the total combined voting power of all classes of stock
entitled to vote in the foreign corporation, or (b) the total
value of the stock of such corporation. If this stock
ownership test is met, then the gross estate of the former
citizen or former long-term resident includes that proportion
of the fair market value of the foreign stock owned by the
individual at the time of death, which the fair market
value of any assets owned by such foreign corporation and
situated in the United States (at the time of death) bears
to the total fair market value of all assets owned by such
foreign corporation (at the time of death).
Gift tax rules with respect to expatriates
Special gift tax rules apply to individuals who make gifts
during a taxable year in which he or she is subject to the
alternative tax regime. The individual is subject to gift tax
on gifts of U.S.-situated intangibles made during the 10
years following citizenship relinquishment or residency
termination. In addition, gifts of stock of certain closely-
held foreign corporations by a former
[[Page H2278]]
citizen or former long-term resident are subject to gift tax,
if the gift is made during the time that such person is
subject to the alternative tax regime. The operative rules
with respect to these gifts of closely-held foreign stock are
the same as described above relating to the estate tax,
except that the relevant testing and valuation date is the
date of gift rather than the date of death.
Termination of U.S. citizenship or long-term resident status
for U.S. Federal income tax purposes
An individual continues to be treated as a U.S. citizen or
long-term resident for U.S. Federal tax purposes, including
for purposes of section 7701(b)(10), until the individual:
(1) gives notice of an expatriating act or termination of
residency (with the requisite intent to relinquish
citizenship or terminate residency) to the Secretary of State
or the Secretary of Homeland Security, respectively; and (2)
provides a statement to the Secretary of the Treasury in
accordance with section 6039G.
Sanction for individuals subject to the individual tax regime
who return to the United States for extended periods
The alternative tax regime does not apply to any individual
for any taxable year during the 10-year period following
citizenship relinquishment or residency termination if such
individual is present in the United States for more than 30
days in the calendar year ending in such taxable year. Such
individual is treated as a U.S. citizen or resident for such
taxable year and, therefore, is taxed on his or her worldwide
income.
Similarly, if an individual subject to the alternative tax
regime is present in the United States for more than 30 days
in any calendar year ending during the 10-year period
following citizenship relinquishment or residency
termination, and the individual dies during that year, he or
she is treated as a U.S. resident, and the individual's
worldwide estate is subject to U.S. estate tax. Likewise, if
an individual subject to the alternative tax regime is
present in the United States for more than 30 days in any
year during the 10-year period following citizenship
relinquishment or residency termination, the individual is
subject to U.S. gift tax on any transfer of his or her
worldwide assets by gift during that taxable year.
For purposes of these rules, an individual is treated as
present in the United States on any day if such individual is
physically present in the United States at any time during
that day. The present-law exceptions from being treated as
present in the United States for residency purposes \429\
generally do not apply for this purpose. However, for
individuals with certain ties to countries other than the
United States \430\ and individuals with minimal prior
physical presence in the United States,\431\ a day of
physical presence in the United States is disregarded if the
individual is performing services in the United States on
such day for an unrelated employer (within the meaning of
sections 267 and 707(b)), who meets the requirements the
Secretary of the Treasury may prescribe in regulations. No
more than 30 days may be disregarded during any calendar year
under this rule.
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\429\ Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
\430\ An individual has such a relationship to a foreign
country if (1) the individual becomes a citizen or resident
of the country in which the individual was born, such
individual's spouse was born, or either of the individual's
parents was born, and (2) the individual becomes fully liable
for income tax in such country.
\431\ An individual has a minimal prior physical presence in
the United States if the individual was physically present
for no more than 30 days during each year in the ten-year
period ending on the date of loss of United States
citizenship or termination of residency. However, for
purposes of this test, an individual is not treated as being
present in the United States on a day if the individual
remained in the United States because of a medical condition
that arose while the individual was in the United States.
Sec. 7701(b)(3)(D)(ii).
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Annual return
Former citizens and former long-term residents are required
to file an annual return for each year following citizenship
relinquishment or residency termination in which they are
subject to the alternative tax regime. The annual return is
required even if no U.S. Federal income tax is due. The
annual return requires certain information, including
information on the permanent home of the individual, the
individual's country of residence, the number of days the
individual was present in the United States for the year, and
detailed information about the individual's income and assets
that are subject to the alternative tax regime. This
requirement includes information relating to foreign stock
potentially subject to the special estate and gift tax rules.
If the individual fails to file the statement in a timely
manner or fails correctly to include all the required
information, the individual is required to pay a penalty of
$10,000. The $10,000 penalty does not apply if it is shown
that the failure is due to reasonable cause and not to
willful neglect.
house bill
No provision.
Senate Amendment
In general
The Senate amendment creates new section 877A, that
generally subjects certain U.S. citizens who relinquish their
U.S. citizenship and certain long-term U.S. residents who
terminate their U.S. residence to tax on the net unrealized
gain in their property as if such property were sold for fair
market value on the day before the expatriation or residency
termination (``mark-to-market tax''). Gain from the deemed
sale is taken into account at that time without regard to
other Code provisions. Any loss from the deemed sale
generally is taken into account to the extent otherwise
provided in the Code, except that the wash sale rules of
section 1091 do not apply. Any net gain on the deemed sale,
is recognized to the extent it exceeds $600,000 ($1.2 million
in the case of married individuals filing a joint return,
both of whom relinquish citizenship or terminate residency).
The $600,000 amount is increased by a cost of living
adjustment factor for calendar years after 2005.
Individuals covered
Under the Senate amendment, the mark-to-market tax applies
to U.S. citizens who relinquish citizenship and long-term
residents who terminate U.S. residency (collectively,
``covered expatriates''). The definition of ``long-term
resident'' under the provision is the same as that under
present law. As under present law, an individual is
considered to terminate long-term residency when the
individual either ceases to be a lawful permanent resident
(i.e., loses his or her green card status), or is treated as
a resident of another country under a tax treaty and does not
waive the benefits of the treaty.
Exceptions to an individual's classification as a covered
expatriate are provided in two situations. The first
exception applies to an individual who was born with
citizenship both in the United States and in another country;
provided that (1) as of the expatriation date the individual
continues to be a citizen of, and is taxed as a resident of,
such other country, and (2) the individual was not a resident
of the United States for the five taxable years ending with
the year of expatriation. The second exception applies to a
U.S. citizen who relinquishes U.S. citizenship before
reaching age 18\1/2\, provided that the individual was a
resident of the United States for no more than five taxable
years before such relinquishment.
For purposes of the mark-to-market tax, an individual is
treated as having relinquished U.S. citizenship on the
earliest of four possible dates: (1) the date that the
individual renounces U.S. nationality before a diplomatic or
consular officer of the United States (provided that the
voluntary relinquishment is later confirmed by the issuance
of a certificate of loss of nationality); (2) the date that
the individual furnishes to the State Department a signed
statement of voluntary relinquishment of U.S. nationality
confirming the performance of an expatriating act (again,
provided that the voluntary relinquishment is later confirmed
by the issuance of a certificate of loss of nationality); (3)
the date that the State Department issues a certificate of
loss of nationality; or (4) the date that a U.S. court
cancels a naturalized citizen's certificate of
naturalization.
In addition, the provision provides that, for all tax
purposes (i.e., not limited to the mark-to-market tax), a
U.S. citizen continues to be treated as a U.S. citizen for
tax purposes until that individual's citizenship is treated
as relinquished under the rules of the immediately preceding
paragraph. However, under Treasury regulations,
relinquishment may occur earlier with respect to an
individual who became at birth a citizen of the United Sates
and of another country.
Election to be treated as a U.S. citizen
Under the provision, a covered expatriate is permitted to
make an irrevocable election to continue to be taxed as a
U.S. citizen with respect to all property that otherwise is
covered by the expatriation tax. This election is an ``all or
nothing'' election; an individual is not permitted to elect
this treatment for some property but not for other property.
The election, if made, applies to all property that would be
subject to the expatriation tax and to any property the basis
of which is determined by reference to such property. Under
this election, following expatriation the individual
continues to pay U.S. income taxes at the rates applicable to
U.S. citizens on any income generated by the property and on
any gain realized on the disposition of the property. In
addition, the property continues to be subject to U.S. gift,
estate, and generation-skipping transfer taxes. In order to
make this election, the taxpayer is required to waive any
treaty rights that would preclude the collection of the tax.
The individual is also required to provide security to
ensure payment of the tax under this election in such form,
manner, and amount as the Secretary of the Treasury requires.
The amount of mark-to-market tax that would have been owed
but for this election (including any interest, penalties, and
certain other items) becomes a lien in favor of the United
States on all U.S.-situated property owned by the individual.
This lien arises on the expatriation date and continues until
the tax liability is satisfied, the tax liability has become
unenforceable by reason of lapse of time, or the Secretary of
the Treasury is satisfied that no further tax liability may
arise by reason of this provision. The rules of section
6324A(d)(1), (3), and (4) (relating to liens arising in
connection with the deferral of estate tax under section
6166) apply to liens arising under this provision.
Deemed sale of property upon expatriation or residency
termination and tentative tax
The deemed sale rule of the provision generally applies to
all property interests held
[[Page H2279]]
by the individual on the date of relinquishment of
citizenship or termination of residency. Special rules apply
in the case of trust interests, as described below. U.S. real
property interests (which remain subject to U.S. tax in the
hands of nonresident noncitizens), with the exception of
stock of certain former U.S. real property holding
corporations, are exempted from the provision. Regulatory
authority is granted to the Treasury to exempt other types of
property from the provision.
Under the provision, an individual who is subject to the
mark-to-market tax is required to pay a tentative tax equal
to the amount of tax that would be due for a hypothetical
short tax year ending on the date the individual relinquishes
citizenship or terminates residency. Thus, the tentative tax
is based on all income, gains, deductions, losses, and
credits of the individual for the year through such date,
including amounts realized from the deemed sale of property.
Moreover, notwithstanding any other provision of the Code,
any period during which recognition of income or gain had
been deferred terminates on the day before relinquishment
of citizenship or termination of residency (and,
therefore, such income or gain recognition becomes part of
the tax base of the tentative tax). The tentative tax is
due on the 90th day after the date of relinquishment of
citizenship or termination of residency, subject to the
election, described below, to defer payments of the mark-
to-market tax. In addition, notwithstanding any other
provision of the Code, any extension of time for payment
of tax ceases to apply on the day before relinquishment of
citizenship or termination of residency, and the unpaid
portion of such tax becomes due and payable at the time
and in the manner prescribed by the Secretary of the
Treasury.
Deferral of payment of mark-to-market tax
Under the provision, an individual is permitted to elect to
defer payment of the mark-to-market tax imposed on the deemed
sale of property. Interest is charged for the period the tax
is deferred at a rate two percentage points higher than the
rate normally applicable to individual underpayments. The
election is irrevocable and is made on a property-by-property
basis. Under the election, the deferred tax attributable to a
particular property is due when the property is disposed of
(or, if the property is disposed of in a transaction in which
gain is not recognized in whole or in part, at such other
time as the Secretary of the Treasury may prescribe). The
deferred tax attributable to a particular property is an
amount that bears the same ratio to the total mark-to-market
tax as the gain taken into account with respect to such
property bears to the total gain taken into account under
these rules. The deferral of the mark-to-market tax may not
be extended beyond the due date of the return for the taxable
year which includes the individual's death.
In order to elect deferral of the mark-to-market tax, the
individual is required to provide a bond in the amount of the
deferred tax to the Secretary of the Treasury. Other security
mechanisms are permitted provided that the individual
establishes to the satisfaction of the Secretary of the
Treasury that the security is adequate. In the event that the
security provided with respect to a particular property
subsequently becomes inadequate and the individual fails to
correct the situation, the deferred tax and the interest with
respect to such property will become due. As a further
condition to making the election, the individual is required
to consent to the waiver of any treaty rights that would
preclude the collection of the tax.
The deferred tax amount (including any interest, penalties,
and certain other items) becomes a lien in favor of the
United States on all U.S.-situated property owned by the
individual. This lien arises on the expatriation date and
continues until the tax liability is satisfied, the tax
liability has become unenforceable by reason of lapse of
time, or the Secretary is satisfied that no further tax
liability may arise by reason of this provision. The rules of
section 6324A(d)(1), (3), and (4) (relating to liens arising
in connection with the deferral of estate tax under section
6166) apply to such liens.
Retirement plans and similar arrangements
Subject to certain exceptions, the provision applies to all
property interests held by covered expatriates at the time of
relinquishment of citizenship or termination of residency.
Accordingly, such property includes an interest in an
employer-sponsored qualified plan or deferred compensation
arrangement as well as an interest in an individual
retirement account or annuity (i.e., an IRA).\432\ However,
the provision contains a special rule for an interest in a
``retirement plan.'' For purposes of the provision, a
``retirement plan'' includes an employer-sponsored qualified
plan (sec. 401(a)), a qualified annuity (sec. 403(a)), a tax-
sheltered annuity (sec. 403(b)), an eligible deferred
compensation plan of a governmental employer (sec. 457(b)),
an individual retirement account (sec. 408(a)), and an
individual retirement annuity (sec. 408(b)). The special
retirement plan rule also applies, to the extent provided in
regulations, to any foreign plan or similar retirement
arrangement or program. An interest in a trust that is part
of a retirement plan is subject to the special retirement
plan rules and not to the rules for interests in trusts
(discussed below).
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\432\ Application of the provision is not limited to an
interest that meets the definition of property under section
83 (relating to property transferred in connection with the
performance of services).
---------------------------------------------------------------------------
Under the special retirement plan rules, in lieu of the
deemed sale rule, an amount equal to the present value of the
individual's vested, accrued benefit under a retirement plan
is treated as having been received by the individual as a
distribution under the retirement plan on the day before the
individual's relinquishment of citizenship or termination of
residency. In the case of any later distribution to the
individual from the retirement plan, the amount otherwise
includible in the individual's income as a result of the
distribution is reduced to reflect the amount previously
included in income under the special retirement plan rule.
The amount of the reduction applied to a distribution is the
excess of: (1) the amount included in income under the
special retirement plan rule, over (2) the total reductions
applied to any prior distributions. It is not intended that
the retirement plan would be deemed to have made a
distribution at the time of expatriation for purposes of the
tax-favored status of the retirement plan, such as whether a
plan may permit distributions before a participant has
severed employment. However, the retirement plan, and any
person acting on the plan's behalf, will treat any later
distribution in the same manner as the distribution would be
treated without regard to the special retirement plan rule.
It is expected that the Treasury Department will provide
guidance for determining the present value of an individual's
vested, accrued benefit under a retirement plan, such as the
individual's account balance in the case of a defined
contribution plan or an IRA, or present value determined
under the qualified joint and survivor annuity rules
applicable to a defined benefit plan (sec. 417(e)).
Interests in trusts
Detailed rules apply under the provision to trust interests
held by an individual at the time of relinquishment of
citizenship or termination of residency. The treatment of
trust interests depends on whether the trust is a ``qualified
trust.'' A trust is a qualified trust if a court within the
United States is able to exercise primary supervision over
the administration of the trust and one or more U.S. persons
have the authority to control all substantial decisions of
the trust.
Constructive ownership rules apply to a trust beneficiary
that is a corporation, partnership, trust, or estate. In such
cases, the shareholders, partners, or beneficiaries of
the entity are deemed to be the direct beneficiaries of
the trust. In addition, an individual who holds (or who is
treated as holding) a trust instrument at the time of
relinquishment of citizenship or termination of residency
is required to disclose on his or her tax return the
methodology used to determine his or her interest in the
trust, and whether such individual knows (or has reason to
know) that any other beneficiary of the trust uses a
different method.
Nonqualified trusts.--If an individual holds an interest in
a trust that is not a qualified trust, a special rule applies
for purposes of determining the amount of the mark-to-market
tax due with respect to such trust interest. The individual's
interest in the trust is treated as a separate trust
consisting of the trust assets allocable to such interest.
Such separate trust is treated as having sold its net assets
for their fair market value on the day before the date of
relinquishment of citizenship or termination of residency and
having distributed the assets to the individual, who then is
treated as having recontributed the assets to the trust. Any
income, gain, or loss of the individual arising from the
deemed distribution from the trust is taken into account as
if it had arisen under the deemed sale rules.
The election to defer payment is available for the mark-to-
market tax attributable to a nonqualified trust interest. A
beneficiary's interest in a nonqualified trust is determined
under all the facts and circumstances, including the trust
instrument, letters of wishes, historical patterns of trust
distributions, and the existence of, and function performed
by, a trust protector or any similar advisor.
Qualified trusts.--If an individual has an interest in a
qualified trust, the amount of mark-to-market tax on
unrealized gain allocable to the individual's trust interest
(``allocable expatriation gain'') is calculated at the time
of expatriation or residency termination, but is collected as
the individual receives distributions from the qualified
trust. The allocable expatriation gain is the amount of gain
which would be allocable to the individual's trust interest
if the individual directly held all the assets allocable to
such interest.\433\ If any individual's interest in a trust
is vested as of the day before the expatriation date (e.g.,
if the individual's interest in the trust is non-contingent
and non-discretionary), the gain allocable to the
individual's trust interest is determined based on the trust
assets allocable to his or her trust interest. If the
individual's interest in the trust is not vested as of the
expatriation date (e.g., if the individual's trust interest
is a contingent or discretionary interest), the gain
allocable to his or her trust interest is determined based on
all of the trust assets that could be allocable to his or her
trust interest, determined by resolving all contingencies and
discretionary powers in the individual's favor (i.e., the
individual is allocated the maximum amount that he or she
could receive).
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\433\ Allocable expatriation gain is subject to the $600,000
exemption (adjusted for cost of living increases).
---------------------------------------------------------------------------
Taxes are imposed on each distribution from a qualified
trust. These distributions
[[Page H2280]]
also may be subject to other U.S. income taxes. If a
distribution from a qualified trust is made after the
individual relinquishes citizenship or terminates residency,
the mark-to-market tax is imposed in an amount equal to the
amount of the distribution multiplied by the highest tax rate
generally applicable to trusts and estates for the taxable
year which includes the date of expatriation, but in no event
will the tax imposed exceed the balance in the ``deferred tax
account'' with respect to the trust interest. For this
purpose, the balance in the deferred tax account is equal to
(1) the hypothetical tax calculated under the ``regular''
deemed sale rules with respect to the allocable expatriation
gain, (2) increased by interest charged on the balance in the
deferred tax account at a rate two percentage points higher
than the rate normally applicable to individual
underpayments, for periods beginning after the 90th day after
the expatriation date and calculated up to 30 days prior to
the date of the distribution, (3) reduced by any mark-to-
market tax imposed on prior trust distributions to the
individual, and (4) to the extent provided in Treasury
regulations, in the case of a covered expatriate holding a
nonvested interest, reduced by mark-to-market taxes imposed
on trust distributions to other persons holding nonvested
interests.
The tax that is imposed on distributions from a qualified
trust generally is to be deducted and withheld by the
trustees. If the individual does not agree to waive treaty
rights that would preclude collection of the tax, the tax
with respect to such distributions is imposed on the trust,
the trustee is personally liable for the tax, and any other
beneficiary has a right of contribution against such
individual with respect to the tax.
Mark-to-market taxes become due immediately if the trust
ceases to be a qualified trust, the individual disposes of
his or her qualified trust interest, or the individual dies.
In such cases, the amount of mark-to-market tax equals the
lesser of (1) the tax calculated under the rules for
nonqualified trust interests as of the date of the triggering
event, or (2) the balance in the deferred tax account with
respect to the trust interest immediately before that date.
Such tax is imposed on the trust, the trustee is personally
liable for the tax, and any other beneficiary has a right of
contribution against such individual (or his or her estate)
with respect to such tax.
Regulatory authority
The provision authorizes the Secretary of the Treasury to
prescribe such regulations as may be necessary or appropriate
to carry out the purposes of section 877A. In addition, the
Secretary of the Treasury may provide for adjustments to the
bases of assets in a trust or a deferred tax account, and the
timing of such adjustments, to ensure that gain is taxed only
once.
Income tax treatment of gifts and inheritances from a former
citizen or former long-term resident
Under the provision, the exclusion from income provided in
section 102 (relating to exclusions from income for the value
of property acquired by gift or inheritance) does not apply
to the value of any property received by gift or inheritance
from a covered expatriate. Accordingly, a U.S. taxpayer who
receives a gift or inheritance from such an individual is
required to include the value of such gift or inheritance in
gross income and is subject to U.S. tax on such amount.
Having included the value of the property in income, the
recipient takes a basis in the property equal to that value.
The tax does not apply to property that is shown on a timely
filed gift tax return and that is a taxable gift by the
former citizen or former long-term resident, or property that
is shown on a timely filed estate tax return and included in
the gross U.S. estate of the former citizen or former long-
term resident (regardless of whether the tax liability shown
on such a return is reduced by credits, deductions, or
exclusions available under the estate and gift tax rules). In
addition, the tax does not apply to property in cases in
which no estate or gift tax return was filed, but no such
return would have been required to be filed if the former
citizen or former long-term resident had not relinquished
citizenship or terminated residency, as the case may be.
Coordination with present-law alternative tax regime
The provision provides a coordination rule with the
present-law alternative tax regime. Under the provision, the
expatriation income tax rules under section 877, and the
special present-law expatriation estate and gift tax rules
under sections 2107 and 2501(a)(3) (generally described
above), do not apply to a covered expatriate whose
expatriation or residency termination occurs on or after the
date of enactment.
Information reporting
Certain information reporting requirements under the law
presently applicable to former citizens and former long-term
residents (sec. 6039G) also apply for purposes of the
provision.
Immigration rules
The provision denies former citizens reentry into the
United States if the individual is determined not to be in
compliance with his or her tax obligations under the
provision's expatriation tax rules (regardless of the
subjective motive for expatriating). For this purpose, the
provision permits the IRS to disclose certain items of return
information of an individual, upon written request of the
Attorney General or his delegate, as is necessary for making
a determination under section 212(a)(10)(E) of the
Immigration and Nationality Act. Specifically, the provision
permits the IRS to disclose to the agency administering
section 212(a)(10)(E) whether such taxpayer is in compliance
with section 877A, and to identify the items of any
noncompliance. Recordkeeping requirements, safeguards, and
civil and criminal penalties for unauthorized disclosure or
inspection apply to return information disclosed under this
provision.
Effective date
The provision generally is effective for U.S. citizens who
relinquish citizenship or long-term residents who terminate
their residency on or after the date of enactment. The due
date for tentative tax, however, may not occur before the
90th day after the date of enactment. The provision relating
to income taxes on gifts and inheritances is effective for
gifts and inheritances received from former citizens or
former long-term residents (or their estates) on or after the
date of enactment, whose relinquishment of citizenship or
residency termination occurs after such date. The immigration
and disclosure provisions relating to former citizens are
effective with respect to individuals who relinquish
citizenship on or after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
F. Miscellaneous Provisions
1. Treatment of contingent payment convertible debt
instruments (Sec. 451 of the Senate amendment and sec.
1275 of the Code)
Present Law
Under present law, a taxpayer generally deducts the amount
of interest paid or accrued within the taxable year on
indebtedness issued by the taxpayer. In the case of original
issue discount (``OID''), the issuer of a debt instrument
generally accrues and deducts, as interest, the OID over the
life of the obligation, even though the amount of the OID may
not be paid until the maturity of the instrument.
The amount of OID with respect to a debt instrument is
equal to the excess of the stated redemption price at
maturity over the issue price of the debt instrument. The
stated redemption price at maturity includes all amounts that
are payable on the debt instrument by maturity. The amount of
OID with respect to a debt instrument is allocated over the
life of the instrument through a series of adjustments to the
issue price for each accrual period. The adjustment to the
issue price is determined by multiplying the adjusted issue
price (i.e., the issue price increased or decreased by
adjustments prior to the accrual period) by the instrument's
yield to maturity, and then subtracting any payments on the
debt instrument (other than non-OID stated interest) during
the accrual period. Thus, in order to compute the amount of
OID and the portion of OID allocable to a particular period,
the stated redemption price at maturity and the time of
maturity must be known. Issuers of debt instruments with OID
accrue and deduct the amount of OID as interest expense in
the same manner as the holders of such instruments accrue and
include in gross income the amount of OID as interest income.
Treasury regulations provide special rules for determining
the amount of OID allocated to a period with respect to
certain debt instruments that provide for one or more
contingent payments of principal or interest.\434\ The
regulations provide that a debt instrument does not provide
for contingent payments merely because it provides for an
option to convert the debt instrument into the stock of the
issuer, into the stock or debt of a related party, or into
cash or other property in an amount equal to the approximate
value of such stock or debt.\435\ The regulations also
provide that a payment is not a contingent payment merely
because of a contingency that, as of the issue date of the
debt instrument, is either remote or incidental.\436\
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\434\ Treas. Reg. sec. 1.1275-4.
\435\ Treas. Reg. sec. 1.1275-4(a)(4).
\436\ Treas. Reg. sec. 1.1275-4(a)(5).
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In the case of contingent payment debt instruments that are
issued for money or publicly traded property,\437\ the
regulations provide that interest on a debt instrument must
be taken into account (as OID) whether or not the amount of
any payment is fixed or determinable in the taxable year. The
amount of OID that is taken into account for each accrual
period is determined by constructing a comparable yield and a
projected payment schedule for the debt instrument, and then
accruing the OID on the basis of the comparable yield and
projected payment schedule by applying rules similar to those
for accruing OID on a noncontingent debt instrument (the
``noncontingent bond method''). If the actual amount of a
contingent payment is not equal to the projected amount,
appropriate adjustments are made to reflect the difference.
The comparable yield for a debt instrument is the yield at
which the issuer would be able to issue a fixed-rate
noncontingent debt instrument with terms and conditions
similar to those of the contingent payment debt instrument
(i.e., the comparable fixed-rate debt instrument), including
the level of subordination, term, timing of payments, and
general market conditions.\438\
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\437\ Treas. Reg. sec. 1.1275-4(b).
\438\ Treas. Reg. sec. 1.1275-4(b)(4)(i)(A).
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[[Page H2281]]
With respect to certain debt instruments that are
convertible into the common stock of the issuer and that also
provide for contingent payments (other than the conversion
feature)--often referred to as ``contingent convertible''
debt instruments--the IRS has stated that the noncontingent
bond method applies in computing the accrual of OID on the
debt instrument.\439\ In applying the noncontingent bond
method, the IRS has stated that the comparable yield for a
contingent convertible debt instrument is determined by
reference to a comparable fixed-rate nonconvertible debt
instrument, and the projected payment schedule is determined
by treating the issuer stock received upon a conversion of
the debt instrument as a contingent payment.
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\439\ Rev. Rul. 2002-31, 2002-1 C.B. 1023.
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment provides that, in the case of a
contingent convertible debt instrument,\440\ any Treasury
regulations which require OID to be determined by reference
to the comparable yield of a noncontingent fixed-rate debt
instrument shall be applied as requiring that such comparable
yield be determined by reference to a noncontingent fixed-
rate debt instrument which is convertible into stock. For
purposes of applying the provision, the comparable yield
shall be determined without taking into account the yield
resulting from the conversion of a debt instrument into
stock. Thus, the noncontingent bond method in the Treasury
regulations shall be applied in a manner such that the
comparable yield for contingent convertible debt instruments
shall be determined by reference to comparable noncontingent
fixed-rate convertible (rather than nonconvertible) debt
instruments.
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\440\ Under the provision, a contingent convertible debt
instrument is defined as a debt instrument that: (1) is
convertible into stock of the issuing corporation, or a
corporation in control of, or controlled by, the issuing
corporation; and (2) provides for contingent payments.
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Effective date.--The provision is effective for debt
instruments issued on or after date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
2. Grant Treasury regulatory authority to address foreign tax
credit transactions involving inappropriate separation of
foreign taxes from related foreign income (sec. 452 of
the Senate amendment and sec. 901 of the Code)
Present Law
The United States employs a ``worldwide'' tax system, under
which residents generally are taxed on all income, whether
derived in the United States or abroad. In order to mitigate
the possibility of double taxation arising from overlapping
claims of the United States and a source country to tax the
same item of income, the United States provides a credit for
foreign income taxes paid or accrued, subject to several
conditions and limitations.
For purposes of the foreign tax credit, regulations provide
that a foreign tax is treated as being paid by ``the person
on whom foreign law imposes legal liability for such tax.''
\441\ Thus, for example, if a U.S. corporation owns an
interest in a foreign partnership, the U.S. corporation can
claim foreign tax credits for the tax that is imposed on it
as a partner in the foreign entity. This would be true under
the regulations even if the U.S. corporation elected to treat
the foreign entity as a corporation for U.S. tax purposes. In
such a case, if the foreign entity does not meet the
definition of a controlled foreign corporation or does not
generate income that is subject to current inclusion under
the rules of subpart F, the income generated by the foreign
entity might never be reported on a U.S. return, and yet the
U.S. corporation might take the position that it can claim
credits for taxes imposed on that income. This is one example
of how a taxpayer might attempt to separate foreign taxes
from the related foreign income, and thereby attempt to claim
a foreign tax credit under circumstances in which there is no
threat of double taxation.
---------------------------------------------------------------------------
\441\ Treas. Reg. sec. 1.901-2(f)(1).
---------------------------------------------------------------------------
The Treasury Department currently has the authority to
promulgate regulations under section 901 and other provisions
of the Code to address transactions and structures that
produce inappropriate foreign tax credit results.
House Bill
No provision.
Senate Amendment
The Senate amendment enhances the regulatory authority of
the Treasury Department to address transactions that involve
the inappropriate separation of foreign taxes from the
related foreign income or in which foreign taxes are imposed
on any person in respect of income of another person. This
grant of regulatory authority supplements existing Treasury
Department authority and thereby provide greater flexibility
in addressing a wide range of transactions and structures.
Regulations issued pursuant to this authority could, for
example, provide for the disallowance of a credit for all or
a portion of the foreign taxes, or for the allocation of the
foreign taxes among the participants in the transaction in a
manner more consistent with the economics of the transaction.
Effective date.--The provision generally is effective for
transactions entered into after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision. No inference is intended as to the scope
of the Treasury Department's existing regulatory authority to
address transactions that involve the inappropriate
separation of foreign taxes from the related foreign income.
3. Modifications of effective dates of leasing provisions of
the American Jobs Creation Act of 2004 (sec. 453 of the
Senate amendment and sec. 470 of the Code)
Present Law
Present law provides for the deferral of losses
attributable to certain tax exempt use property, generally
effective for leases entered into after March 12, 2004.
However, the deferral provision does not apply to property
located in the United States that is subject to a lease with
respect to which a formal application: (1) was submitted for
approval to the Federal Transit Administration (an agency of
the Department of Transportation) after June 30, 2003, and
before March 13, 2004; (2) is approved by the Federal Transit
Administration before January 1, 2006; and (3) includes a
description and the fair market value of such property (the
``qualified transportation property exception'').
House Bill
No provision.
Senate Amendment
The Senate amendment makes two changes to the effective
date of the loss deferral rules. First, the Senate amendment
repeals the qualified transportation property exception.
Second, the Senate amendment applies the loss deferral rules
to leases entered into on or before March 12, 2004, if the
lessee is a foreign person or entity. With respect to such
leases, losses are deferred starting in taxable years
beginning after December 31, 2005.
Effective date.--The Senate amendment is effective as if
included in the provisions of the American Jobs Creation Act
of 2004, Pub. L. No. 108-357 (2004), to which it relates.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
4. Application of earnings stripping rules to partners which
are corporations (sec. 454 of the Senate amendment and
sec. 163 of the Code)
Present Law
Present law provides rules to limit the ability of U.S.
corporations to reduce the U.S. tax on their U.S.-source
income through earnings stripping transactions. Section
163(j) specifically addresses earnings stripping involving
interest payments, by limiting the deductibility of interest
paid to certain related parties (``disqualified
interest''),\442\ if the payor's debt-equity ratio exceeds
1.5 to 1 and the payor's net interest expense exceeds 50
percent of its ``adjusted taxable income'' (generally taxable
income computed without regard to deductions for net interest
expense, net operating losses, and depreciation,
amortization, and depletion). Disallowed interest amounts can
be carried forward indefinitely. In addition, excess
limitation (i.e., any excess of the 50-percent limit over a
company's net interest expense for a given year) can be
carried forward three years.
---------------------------------------------------------------------------
\442\ This interest also may include interest paid to
unrelated parties in certain cases in which a related party
guarantees the debt.
---------------------------------------------------------------------------
Proposed Treasury regulations provide that a partner's
proportionate share of partnership liabilities is treated as
liabilities incurred directly by the partner, for purposes of
applying the earnings stripping limitation to interest
payments by a corporate partner of a partnership.\443\ The
proposed Treasury regulations provide that interest paid or
accrued to a partnership is treated as paid or accrued to the
partners of the partnership in proportion to each partner's
distributive share of the partnership's interest income for
the taxable year.\444\ In addition, the proposed Treasury
regulations provide that interest expense paid or accrued by
a partnership is treated as paid or accrued by the partners
of the partnership in proportion to each partner's
distributive share of the partnership's interest
expense.\445\
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\443\ Prop. Treas. Reg. sec. 1.163(j)-3(b)(3).
\444\ Prop. Treas. Reg. sec. 1.163(j)-2(e)(4).
\445\ Prop. Treas. reg. sec. 1.163(j)-2(e)(5).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The Senate amendment provision codifies the approach of the
proposed Treasury regulations by providing that, except to
the extent provided by regulations, in the case of a
corporation that owns, directly or indirectly, an interest in
a partnership, the corporation's share of partnership
liabilities is treated as liabilities of the corporation for
purposes of applying the earnings stripping rules to the
corporation. The provision provides that the corporation's
distributive share of interest income of the partnership, and
of interest expense of the partnership, is treated as
interest income or interest expense of the corporation.
The provision provides Treasury regulatory authority to
reallocate shares of partnership debt, or distributive shares
of the
[[Page H2282]]
partnership's interest income or interest expense, as may be
appropriate to carry out the purposes of the provision. For
example, it is not intended that the application of the
earnings stripping rules to corporations with direct or
indirect interests in partnerships be circumvented through
the use of allocations of partnership interest income or
expense (or partnership liabilities) to or away from
partners.
Effective date.--The provision is effective for taxable
years beginning on or after the date of enactment.
Conference Agreement
The conference agreement includes the Senate amendment
provision.
5. Limitation on employer deduction for certain entertainment
expenses (sec. 455 of the Senate amendment and sec.
274(e) of the Code)
Present Law
In general
Under present law, no deduction is allowed with respect to
(1) an activity generally considered to be entertainment,
amusement or recreation, unless the taxpayer establishes that
the item was directly related to (or, in certain cases,
associated with) the active conduct of the taxpayer's trade
or business, or (2) a facility (e.g., an airplane) used in
connection with such activity.\446\ The Code includes a
number of exceptions to the general rule disallowing
deductions of entertainment expenses. Under one exception,
the deduction disallowance rule does not apply to expenses
for goods, services, and facilities to the extent that the
expenses are reported by the taxpayer as compensation and
wages to an employee.\447\ The deduction disallowance rule
also does not apply to expenses paid or incurred by the
taxpayer for goods, services, and facilities to the extent
that the expenses are includible in the gross income of a
recipient who is not an employee (e.g., a nonemployee
director) as compensation for services rendered or as a prize
or award.\448\ The exceptions apply only to the extent that
amounts are properly reported by the company as compensation
and wages or otherwise includible in income. In no event can
the amount of the deduction exceed the amount of the actual
cost, even if a greater amount is includible in income.
---------------------------------------------------------------------------
\446\ Sec. 274(a).
\447\ Sec. 274(e)(2). As discussed below, a special rule
applies in the case of specified individuals.
\448\ Sec. 274(e)(9).
---------------------------------------------------------------------------
Except as otherwise provided, gross income includes
compensation for services, including fees, commissions,
fringe benefits, and similar items. In general, an employee
or other service provider must include in gross income the
amount by which the fair value of a fringe benefit exceeds
the amount paid by the individual. Treasury regulations
provide rules regarding the valuation of fringe benefits,
including flights on an employer-provided aircraft.\449\ In
general, the value of a non-commercial flight is determined
under the base aircraft valuation formula, also known as the
Standard Industry Fare Level formula or ``SIFL''.\450\ If the
SIFL valuation rules do not apply, the value of a flight on a
company-provided aircraft is generally equal to the amount
that an individual would have to pay in an arm's-length
transaction to charter the same or a comparable aircraft for
that period for the same or a comparable flight.\451\
---------------------------------------------------------------------------
\449\ Treas. Reg. sec. 1.61-21.
\450\ Treas. Reg. sec. 1.61-21(g).
\451\ Treas. Reg. sec. 1.61-21(b)(6).
---------------------------------------------------------------------------
In the context of an employer providing an aircraft to
employees for nonbusiness (e.g., vacation) flights, the
exception for expenses treated as compensation was
interpreted in Sutherland Lumber-Southwest, Inc. v.
Commissioner (``Sutherland Lumber'') as not limiting the
company's deduction for operation of the aircraft to the
amount of compensation reportable to its employees,\452\
which can result in a deduction many times larger than the
amount required to be included in income. In many cases, the
individual including amounts attributable to personal travel
in income directly benefits from the enhanced deduction,
resulting in a net deduction for the personal use of the
company aircraft.
---------------------------------------------------------------------------
\452\ Sutherland Lumber-Southwest, Inc. v. Comm., 114 T.C.
197 (2000), aff'd, 255 F.3d 495 (8th Cir. 2001), acq., AOD
2002-02 (Feb. 11, 2002).
---------------------------------------------------------------------------
Specified individuals
In the case of specified individuals, the exceptions to the
general entertainment expense disallowance rule for expenses
treated as compensation or includible in income apply only to
the extent of the amount of expenses treated as compensation
or includible in income of 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. Sutherland Lumber is thus overturned with respect
to specified individuals.
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 and Exchange Act of 1934, or would be subject to
such requirements if the employer or service recipient (or
the related party) were an issuer of equity securities
referred to in section 16(a).\453\ Such individuals generally
include officers (as defined by section 16(a)),\454\
directors, and 10-percent-or-greater owners of private and
publicly-held companies.
---------------------------------------------------------------------------
\453\ For purposes of this definition, a person is a related
party with respect to another person if such person bears a
relationship to such other person described in section 267(b)
or 707(b).
\454\ 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.
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
Under the Senate amendment, in the case of all individuals,
the exceptions to the general entertainment expense
disallowance rule for expenses treated as compensation or
includible in income apply only to the extent of the amount
of expenses treated as compensation or includible in income.
Thus, under those exceptions, 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. The
provision is intended to overturn Sutherland Lumber for all
individuals. As under present law, the exceptions apply only
if amounts are properly reported by the company as
compensation and wages or otherwise includible in income.
Effective date.--The provision is effective for expenses
incurred after the date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
6. Increase in age of minor children whose unearned income is
taxed as if parent's income (Sec. 456 of the Senate
amendment and sec. 1(g) of the Code)
Present Law
Filing requirements for children
A single unmarried individual eligible to be claimed as a
dependent on another taxpayer's return generally must file an
individual income tax return if he or she has: (1) earned
income only over $5,150 (for 2006); (2) unearned income only
over the minimum standard deduction amount for dependents
($850 in 2006); or (3) both earned income and unearned income
totaling more than the smaller of (a) $5,150 (for 2006) or
(b) the larger of (i) $850 (for 2006), or (ii) earned income
plus $300.\455\ Thus, if a dependent child has less than $850
in gross income, the child does not have to file an
individual income tax return for 2006.\456\
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\455\ Sec. 6012(a)(1)(C). Other filing requirements apply to
dependents who are married, elderly, or blind. See, Internal
Revenue Service, Publication 929, Tax Rules for Children and
Dependents, at 2, Table 1 (2005).
\456\ A taxpayer generally need not file a return if he or
she has gross income in an amount less than the standard
deduction (and, if allowable to the taxpayer, the personal
exemption amount). An individual who may be claimed as a
dependent of another taxpayer is not eligible to claim the
dependency exemption relating to that individual. Sec.
151(d)(2). For taxable years beginning in 2006, the standard
deduction amount for an individual who may be claimed as a
dependent by another taxpayer may not exceed the greater of
$850 or the sum of $300 and the individual's earned income.
---------------------------------------------------------------------------
A child who cannot be claimed as a dependent on another
person's tax return is subject to the generally applicable
filing requirements. Such a child generally must file a
return if the individual's gross income exceeds the sum of
the standard deduction and the personal exemption amount
($3,300 for 2006).
Taxation of unearned income under section 1(g)
Special rules (generally referred to as the ``kiddie tax'')
apply to the unearned income of a child who is under age
14.\457\ The kiddie tax applies if: (1) the child has not
reached the age of 14 by the close of the taxable year; (2)
the child's unearned income was more than $1,700 (for 2006);
and (3) the child is required to file a return for the year.
The kiddie tax applies regardless of whether the child may be
claimed as a dependent on the parent's return.
---------------------------------------------------------------------------
\457\ Sec. 1(g).
---------------------------------------------------------------------------
For these purposes, unearned income is income other than
wages, salaries, professional fees, or other amounts received
as compensation for personal services actually rendered.\458\
For children under age 14, net unearned income (for 2006,
generally unearned income over $1,700) is taxed at the
parent's rate if the parent's rate is higher than the child's
rate. The remainder of a child's taxable income (i.e., earned
income, plus unearned income up to $1,700 (for 2006), less
the child's standard deduction) is taxed at the child's
rates, regardless of whether the kiddie tax applies to the
child. In general, a child is eligible to use the
preferential tax rates for qualified dividends and capital
gains.\459\
---------------------------------------------------------------------------
\458\ Sec. 1(g)(4) and sec. 911(d)(2).
\459\ 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 ($850 for 2006), and
(2) the greater of (a) such minimum standard deduction amount
or (b) the amount of allowable itemized deductions
[[Page H2283]]
that are directly connected with the production of the
unearned income.\460\ A child's net unearned income cannot
exceed the child's taxable income.
---------------------------------------------------------------------------
\460\ 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. 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.
Special rules apply to determine which parent's tax return
and rate is used to calculate the kiddie tax. If the parents
file a joint return, the allocable parental tax is calculated
using the income reported on the joint return. In the case of
parents who are married but file separate returns, the
allocable parental tax is calculated using the income of the
parent with the greater amount of taxable income. In the case
of unmarried parents, the child's custodial parent is the
parent whose taxable income is taken into account in
determining the child's liability. If the custodial parent
has remarried, the stepparent is treated as the child's other
parent. Thus, if the custodial parent and stepparent file a
joint return, the kiddie tax is calculated using that joint
return. If the custodial parent and stepparent file separate
returns, the return of the one with the greater taxable
income is used. If the parents are unmarried but lived
together all year, the return of the parent with the greater
taxable income is used.\461\
---------------------------------------------------------------------------
\461\ Sec. 1(g)(5); Internal Revenue Service, Publication
929, Tax Rules for Children and Dependents, at 6 (2005).
---------------------------------------------------------------------------
Unless the parent elects to include the child's income on
the parent's return (as described below) the child files a
separate return to report the child's income.\462\ In this
case, items on the parent's return are not affected by the
child's income. The total tax due from a child is the greater
of:
---------------------------------------------------------------------------
\462\ The child must attach to the return Form 8615, Tax for
Children Under Age 14 With Investment Income of More Than
$1,700 (2006).
---------------------------------------------------------------------------
1. the sum of (a) the tax payable by the child on the
child's earned income and unearned income up to $1,700 (for
2006), 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.
Parental election to include child's dividends and interest
on parent's return
Under certain circumstances, a parent may elect to report a
child's dividends and interest on the parent's return. If the
election is made, the child is treated as having no income
for the year and the child does not have to file a return.
The parent makes the election on Form 8814, Parents' Election
to Report Child's Interest and Dividends. The requirements
for the parent's election are that:
1. the child has gross income only from interest and
dividends (including capital gains distributions and Alaska
Permanent Fund Dividends); \463\
---------------------------------------------------------------------------
\463\ Internal Revenue Service, Publication 929, Tax Rules
for Children and Dependents, at 6 (2005).
---------------------------------------------------------------------------
2. such income is more than the minimum standard deduction
amount for dependents ($850 in 2006) and less than 10 times
that amount ($8500 in 2006);
3. no estimated tax payments for the year were made in the
child's name and taxpayer identification number;
4. no backup withholding occurred; and
5. the child is required to file a return if the parent
does not make the election.
Only the parent whose return must be used when calculating
the kiddie tax may make the election. The parent includes in
income the child's gross income in excess of twice the
minimum standard deduction amount for dependents (i.e., the
child's gross income in excess of $1,700 for 2007). This
amount is taxed at the parent's rate. The parent also must
report an additional tax liability equal to the lesser of:
(1) $85 (in 2006), or (2) 10 percent of the child's gross
income exceeding the child's standard deduction ($850 in
2006).
Including the child's income on the parent's return can
affect the parent's deductions and credits that are based on
adjusted gross income, as well as income-based phaseouts,
limitations, and floors.\464\ In addition, certain deductions
that the child would have been entitled to take on his or her
own return are lost.\465\ Further, if the child received tax-
exempt interest from a private activity bond, that item is
considered a tax preference of the parent for alternative
minimum tax purposes.\466\
---------------------------------------------------------------------------
\464\ Internal Revenue Service, Publication 929, Tax Rules
for Children and Dependents, at 7 (2005).
\465\ Internal Revenue Service, Publication 929, Tax Rules
for Children and Dependents, at 7 (2005).
\466\ Sec. 1(g)(7)(B).
---------------------------------------------------------------------------
Taxation of compensation for services under section 1(g)
Compensation for a child's services is considered the gross
income of the child, not the parent, even if the compensation
is not received or retained by the child (e.g. is the
parent's income under local law).\467\ If the child's income
tax is not paid, however, an assessment against the child
will be considered as also made against the parent to the
extent the assessment is attributable to amounts received for
the child's services.\468\
---------------------------------------------------------------------------
\467\ Sec. 73(a).
\468\ Sec. 6201(c).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision increases the age to which the kiddie tax
provisions apply from under 14 to under 18 years of age. The
provision also creates an exception to the kiddie tax for
distributions from certain qualified disability trusts,
defined by cross-reference to sections 1917 and 1614(a)(3) of
the Social Security Act.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
Conference Agreement
The conference agreement includes the Senate amendment
provision with one modification. This modification provides
that the kiddie tax does not apply to a child who is married
and files a joint return for the taxable year.
7. Impose loan and redemption requirements on pooled
financing bonds (sec. 457 of the Senate amendment and
sec. 149 of the Code)
Present Law
In general
Interest on bonds issued by State and local governments
generally is excluded from gross income for Federal income
tax purposes if the proceeds of such bonds are used to
finance direct activities of governmental units or if such
bonds are repaid with revenues of governmental units. These
bonds are called ``governmental bonds.'' Interest on State or
local government bonds issued to finance activities of
private persons is taxable unless a specific exception
applies. These bonds are called ``private activity bonds.''
The exclusion from income for State and local bonds does not
apply to private activity bonds, unless the bonds are issued
for certain permitted purposes. In addition, the Code imposes
qualification requirements that apply to all State and local
bonds. Arbitrage restrictions, for example, limit the ability
of issuers to profit from investment of tax-exempt bond
proceeds. The Code also imposes requirements that only apply
to specific types of bond issues. For instance, pooled
financing bonds (defined below) are not tax-exempt unless the
issuer meets certain requirements regarding the expected use
of proceeds.
Pooled financing bond restrictions
State or local governments also issue bonds to provide
financing for the benefit of a third party (a ``conduit
borrower''). Pooled financing bonds are bond issues that are
used to make or finance loans to two or more conduit
borrowers, unless the conduit loans are to be used to finance
a single project.\469\ The Code imposes several requirements
on pooled financing bonds if more than $5 million of proceeds
are expected to be used to make loans to conduit borrowers.
For purposes of these rules, a pooled financing bond does not
include certain private activity bonds.\470\
---------------------------------------------------------------------------
\469\ Treas. Reg. sec. 1.150-1(b).
\470\ Sec. 149(f)(4)(B).
---------------------------------------------------------------------------
A pooled financing bond is not tax-exempt unless the issuer
reasonably expects that at least 95 percent of the net
proceeds will be lent to ultimate borrowers by the end of the
third year after the date of issue. The term ``net proceeds''
is defined to mean the proceeds of the issue less the
following amounts: 1) proceeds used to finance issuance
costs; 2) proceeds necessary to pay interest on the bonds
during a three-year period; and 3) amounts in reasonably
required reserves.\471\
---------------------------------------------------------------------------
\471\ Sec. 149(f)(2)(C).
---------------------------------------------------------------------------
An issuer's past experience regarding loan origination is a
criterion upon which the reasonableness of the issuer's
expectations can be based. As an additional requirement for
tax exemption, all legal and underwriting costs associated
with the issuance of pooled financing bonds may not be
contingent and must be substantially paid within 180 days of
the date of issuance.
Arbitrage restrictions on tax-exempt bonds
To prevent the issuance of more Federally subsidized tax-
exempt bonds than necessary; the tax exemption for State and
local bonds does not apply to any arbitrage bond.\472\ An
arbitrage bond is defined as any bond that is part of an
issue if any proceeds of the issue are reasonably expected to
be used (or intentionally are used) to acquire higher
yielding investments or to replace funds that are used to
acquire higher yielding investments. In general, arbitrage
profits may be earned only during specified periods (e.g.,
defined ``temporary periods'') before funds are needed for
the purpose of the borrowing or on specified types of
investments (e.g., ``reasonably required reserve or
replacement funds''). Subject to limited exceptions,
investment profits that are earned during these periods or on
such investments must be rebated to the Federal Government
(``arbitrage rebate'').
---------------------------------------------------------------------------
\472\ Secs. 103(a) and (b)(2).
---------------------------------------------------------------------------
The Code contains several exceptions to the arbitrage
rebate requirement, including an exception for bonds issued
by small governments (the ``small issuer exception''). For
this purpose, small governments are defined as general
purpose governmental units that
[[Page H2284]]
issue no more than $5 million of tax-exempt governmental
bonds in a calendar year.\473\
---------------------------------------------------------------------------
\473\ The $5 million limit is increased to $15 million if at
least $10 million of the bonds are used to finance public
schools.
---------------------------------------------------------------------------
Pooled financing bonds are subject to the arbitrage
restrictions that apply to all tax-exempt bonds, including
arbitrage rebate. Under certain circumstances, however, small
governments may issue pooled financing bonds without those
bonds counting towards the determination of whether the
issuer qualifies for the small issuer exception to arbitrage
rebate. In the case of a pooled financing bond where the
ultimate borrowers are governmental units with general taxing
powers not subordinate to the issuer of the pooled bond, the
pooled bond does not count against the issuer's $5 million
limitation, provided the issuer is not a borrower from the
pooled bond.\474\ However, the issuer of the pooled financing
bond remains subject to the arbitrage rebate requirement for
unloaned proceeds.\475\
---------------------------------------------------------------------------
\474\ Sec. 148(f)(4)(D)(ii)(II).
\475\ Treas. Reg. sec. 1.148-8(d)(1).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
In general
The provision imposes new requirements on pooled financing
bonds as a condition of tax-exemption. First, the provision
imposes a written loan commitment requirement to restrict the
issuance of pooled bonds where potential borrowers have not
been identified (``blind pools''). Second, in addition to the
current three-year expectations requirement, the issuer must
reasonably expect that at least 50 percent of the net
proceeds of the pooled bond will be lent to borrowers one
year after the date of issue. Third, the provision requires
the redemption of outstanding bonds with proceeds that are
not loaned to borrowers within the expected loan origination
periods. Finally, the provision eliminates the rule allowing
an issuer of pooled financing bonds to disregard the pooled
bonds for purposes of determining whether the issuer
qualifies for the small issuer exception to rebate.
Borrower identification
Under the provision, interest on a pooled financing bond is
tax exempt only if the issuer obtains written commitments
with ultimate borrowers for loans equal to at least 50
percent of the net proceeds of the pooled bond prior to
issuance. The loan commitment requirement does not apply to
bonds issued by States (or an integral part of a State) to
provide loans to subordinate governmental units or State
entities created to provide financing for water-
infrastructure projects through the federally-sponsored State
revolving fund program.
Loan origination expectations
The provision imposes new reasonable expectations
requirements for loan originations. The issuer must expect
that at least 50 percent of the net proceeds of a pooled
financing bond will be lent to ultimate borrowers one year
after the date of issue. This is in addition to the present-
law requirement that at least 95 percent of the net proceeds
will be lent to ultimate borrowers by the end of the third
year after the date of issue.
Redemption requirement
Under the provision, if bond proceeds are not loaned to
borrowers within prescribed periods, outstanding bonds equal
to the amount of proceeds that were not loaned within the
required period must be redeemed with 90 days. The bond
redemption requirement applies with respect to proceeds that
are unloaned as of expiration of the one-year and three-year
loan origination periods. For example, if an amount equal to
45 percent of the net proceeds of an issue are used to make
loans to ultimate borrowers as of one year after the bonds
are issued, an amount equal to five percent of the net
proceeds of the issue is no longer available for lending and
must be used to redeem bonds within the following six-month
period. Similarly, if only 85 percent of the net proceeds of
the issue are used to make qualifying loans (or to redeem
bonds) as of three years after the bonds are issued, 10
percent of the remaining net proceeds is no longer available
for lending and must be used to redeem bonds within the
following six months.
Small issuer exception
The provision eliminates the rule disregarding pooled
financing bonds from the issuer's $5,000,000 annual
limitation for purposes of the small issuer exception to
arbitrage rebate.
Effective date.--The provision is effective for bonds
issued after the date of enactment.
Conference Agreement
The conference agreement includes the Senate amendment
provision, with the following modifications.
Under the conference agreement, issuers of pooled financing
bonds must reasonably expect that at least 30 percent of the
net proceeds of such bonds will be loaned to ultimate
borrowers one year after the date of issue. The present-law
requirement that issuers must reasonably expect to loan at
least 95 percent of the net proceeds of a pooled financing
bond to ultimate borrowers three years after the date of
issue is unchanged. Bond proceeds that are not loaned to
borrowers as required under the one- and three-year rules
must be used to redeem outstanding bonds within 90 days of
the expiration of such one- and three-year periods.
The conference agreement requires issuers of pooled
financing bonds to obtain, prior to issuance, written
commitments from borrowers equal to at least 30 percent of
the net proceeds of the pooled financing bond. The conference
agreement includes the Senate amendment's exception to the
written loan commitment requirement. Thus, the loan
commitment requirement does not apply to pooled financing
bonds issued by States (or an integral part of a State) to
provide loans to subordinate governmental units or State
entities created to provide financing for water-
infrastructure projects through the federally-sponsored State
revolving fund program.
8. Amend information reporting requirements to include
interest on tax-exempt bonds (sec. 458 of the Senate
amendment and sec. 6049 of the Code)
Present Law
Tax-exempt bonds
Generally, gross income does not include interest on State
or local bonds.\476\ 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). The exclusion from income
for State and local bonds does not apply to private activity
bonds, unless the bonds are issued for certain purposes
(``qualified private activity bonds'') permitted by the
Code.\477\
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\476\ Sec. 103.
\477\ Secs. 103(b)(1) and 141.
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Tax-exempt interest reporting by taxpayers
The Code provides that every person required to file a
return must report the amount of tax-exempt interest received
or accrued during any taxable year.\478\ There are a number
of reasons why the amount of tax-exempt interest received is
relevant to determining tax liability despite the general
exclusion from income. For example, the interest income from
qualified private activity bonds (other than qualified
501(c)(3) bonds) issued after August 7, 1986, is a preference
item for purposes of calculating the alternative minimum tax
(``AMT'').\479\ Tax-exempt interest also is relevant for
determining eligibility for the earned income credit (the
``EIC'') \480\ and the amount of Social Security benefits
includable in gross income.\481\ Moreover, determining
includable Social Security benefits is necessary for
calculating either adjusted or modified adjusted gross income
under several Code sections.\482\
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\478\ Sec. 6012(d).
\479\ Sec. 57(a)(5). Special rules apply to exclude
refundings of bonds issued before August 8, 1986, and certain
bonds issued before September 1, 1986.
\480\ Sec. 32(i).
\481\ Sec. 86.
\482\ See Secs. 135, 219, and 221.
---------------------------------------------------------------------------
Information reporting by payors
The Code generally requires every person who makes payments
of interest aggregating $10 or more or receives payments of
interest as a nominee and who makes payments aggregating $10
or more to file an information return setting forth the
amount of interest payments for the calendar year and the
name, address, and TIN \483\ of the person to whom interest
is paid.\484\ Treasury regulations prescribe the form and
manner for filing interest payment information returns.
Penalties are imposed for failures to file interest payment
information returns or payee statements.\485\ Treasury
Regulations also impose recordkeeping requirements on any
person required to file information returns.\486\ The Code
excludes interest paid on tax-exempt bonds from interest
reporting requirements.\487\
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\483\ The taxpayer's identification number, generally, for
individuals is the taxpayer's social security number. Sec.
7701(a)(41).
\484\ Sec. 6049.
\485\ Secs. 6721 and 6722.
\486\ Treas. Reg. sec. 1.6001-1(a).
\487\ Sec. 6049.
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House Bill
No provision.
Senate Amendment
The provision eliminates the exception from information
reporting requirements for interest paid on tax-exempt bonds.
Effective date.--The provision is effective for interest
paid on tax-exempt bonds after December 31, 2005.
Conference Agreement
The conference agreement includes the Senate amendment
provision.
9. Modification of credit for fuel from a non-conventional
source (sec. 459 of the Senate amendment and sec. 45K of
the Code)
Present Law
Certain fuels produced from ``non-conventional sources''
and sold to unrelated parties are eligible for an income tax
credit equal to $3 (generally adjusted for inflation) \488\
per barrel or Btu oil barrel equivalent (``non-
[[Page H2285]]
conventional source fuel credit'').\489\ Qualified fuels must
be produced within the United States.
---------------------------------------------------------------------------
\488\ The inflation adjustment is generally calculated using
1979 as the base year. Generally, the value of the credit for
fuel produced in 2005 was $6.79 per barrel-of-oil equivalent
produced, which is approximately $1.20 per thousand cubic
feet of natural gas. The credit for coke or coke gas is
indexed for inflation using 2004 as the base year instead of
1979.
\489\ Sec. 29 (for tax years ending before 2006); sec. 45K
(for tax years ending after 2005).
---------------------------------------------------------------------------
Qualified fuels include:
--oil produced from shale and tar sands;
--gas produced from geopressured brine, Devonian shale,
coal seams, tight formations, or biomass; and
--liquid, gaseous, or solid synthetic fuels produced from
coal (including lignite).
Generally, the non-conventional source fuel credit has
expired, except for certain biomass gas and synthetic fuels
sold before January 1, 2008, and produced at facilities
placed in service after December 31, 1992, and before July 1,
1998. The non-conventional source fuel credit provision also
includes a credit for producing coke or coke gas at qualified
facilities placed in service before 1993 or after June 30,
1998, and before 2010. The coke production credit is
available for coke or coke gas produced over the four-year
period beginning on January 1, 2006, or the date the facility
was placed in service, if later. The amount of credit-
eligible coke produced at any one facility may not exceed an
average barrel-of-oil equivalent of 4,000 barrels per day.
The non-conventional source fuel credit is reduced (but not
below zero) over a $6 (inflation-adjusted) phase-out period
as the reference price for oil exceeds $23.50 per barrel
(also adjusted for inflation). The reference price is the
Secretary's estimate of the annual average wellhead price per
barrel for all domestic crude oil. The credit did not phase-
out for 2004 because the reference price for that year of
$50.26 did not exceed the inflation adjusted threshold of
$51.35.
Beginning with taxable years ending after December 31,
2005, the non-conventional source fuel credit is part of the
general business credit (sec. 38).
House Bill
No provision.
Senate Amendment
The provision modifies the manner in which the phase-out of
the non-conventional source fuel credit is calculated.
Specifically, in calculating the phase-out of the credit
rather than relying upon the reference price for the calendar
year in which the sale of qualified non-conventional fuel
occurs, the provision uses the reference price for the
calendar year preceding the calendar year in which the sale
occurs. Thus, under the provision, whether the credit is
phased out in 2005 is determined by reference to 2004
wellhead prices, whether the credit is phased out in 2006 is
determined by reference to 2005 wellhead prices, and so on.
In addition, the provision repeals the phase-out limitation
entirely for coke and coke gas produced under section 45K(g).
The provision eliminates the inflation adjustment for all
fuels other than coke and coke gas for 2005, 2006, and 2007.
Thus, the current credit amount of $6.79 per barrel of oil
equivalent would be retroactively reduced to $6.56 per barrel
of oil equivalent, and that reduced amount would remain in
effect through the December 31, 2007. Under the provision,
the credit amount of $3 per barrel of oil equivalent for coke
and coke gas produced under section 45K(g) would continue to
be adjusted for inflation using 2004 as the base year.
Finally, the provision clarifies that qualifying facilities
producing coke and coke gas under section 45K(g) do not
include facilities that produce petroleum-based coke or coke
gas.
Effective date.--The provision applies to fuel sold after
December 31, 2004.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
10. Modification of individual estimated tax safe harbor
(sec. 460 of the Senate Amendment and sec. 6654 of the
Code)
Present Law
An individual taxpayer generally is subject to an addition
to tax for any underpayment of estimated tax. An individual
generally does not have an underpayment of estimated tax if
he or she makes timely estimated tax payments equal to the
lesser of: (1) 90 percent of the tax shown on the current
year's return or (2) 100 percent of the prior year's tax. For
individuals with a prior year's AGI above $150,000, however,
the rule that allows payment of 100 percent of prior year's
tax is modified. Individuals with prior-year AGI above
$150,000 generally must make estimated payments equal to the
lesser of (1) 90 percent of the tax shown on the current
year's return or (2) 110 percent of the tax shown on the
prior year's return.
House Bill
No provision.
Senate Amendment
The Senate amendment provides that individuals with prior
year's AGI above $150,000 who make estimated tax payments
based on prior year's tax must do so based on 120 percent of
the tax shown on the prior year's return, for estimated tax
payments for taxable years beginning in 2006. That percentage
will revert back to 110 percent for taxable years beginning
after 2006.
Effective date.--The provision is effective for estimated
tax payments for taxable years beginning after December 31,
2005.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
11. Revaluation of LIFO inventories of large integrated oil
companies (sec. 461 of the Senate amendment)
Present Law
A taxpayer is generally permitted to use a last-in, first-
out (LIFO) method to inventory goods, on the condition that
the taxpayer also uses the LIFO method in reporting to
shareholders, partners, other proprietors, and beneficiaries,
and for credit purposes.\490\ Under the LIFO method, a
taxpayer (i) treats goods on hand at the close of the taxable
year as being: first, those goods included in the opening
inventory of the taxable year (in the order of acquisition)
to the extent thereof; and second, those acquired in the
taxable year; (ii) inventories the goods at cost; and (iii)
treats those goods included in the opening inventory of the
taxable year in which the LIFO method was first used as
having been acquired at the same time, and determines their
cost by the average cost method.\491\
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\490\ Sec. 472(c).
\491\ Sec. 472.
---------------------------------------------------------------------------
In periods during which a taxpayer produces or purchases
more goods than the taxpayer sells (such excess, an
``inventory increment''), a LIFO method taxpayer generally
records the inventory cost of such excess (and separately
tracks such amount as the ``LIFO layer'' for such period),
adds it to the cost of inventory at the start of the period,
and carries such total inventory cost forward to the
beginning inventory of the following year.
In periods during which the taxpayer sells more goods than
the taxpayer produces or purchases (such decrease, an
``inventory decrement''), a LIFO method taxpayer generally
determines the cost of goods sold of the amount of the
decrement by treating such sales as occurring out of the most
recent LIFO layer (or the most recent LIFO layers, if the
amount of the decrement exceeds the amount of inventory in
the most recent LIFO layer) in reverse chronological
order.
House Bill
No provision.
Senate Amendment
The provision disallows a portion of the benefit of the
LIFO method to integrated oil companies \492\ which have an
average daily production of crude oil of at least 500,000
barrels of oil and which have in excess of $1 billion for the
last taxable year ending during 2005.
---------------------------------------------------------------------------
\492\ The provision defines an ``integrated oil company'' by
cross-reference to section 291(b)(4), which generally
includes retailers and large refiners of oil or natural gas
or any product derived from oil or natural gas.
---------------------------------------------------------------------------
Specifically, the provision requires such taxpayers to
revalue each historic LIFO layer of crude oil inventories by
adding to each layer an amount equal to $18.75 multiplied by
the number of barrels of crude oil represented by such LIFO
layer; the taxpayer must reduce its cost of sales for such
taxable year by a like amount.
For example, suppose a taxpayer, which is an integrated oil
company with average daily production of at least 500,000
barrels of oil and revenues in excess of $1 billion, has a
2005 starting inventory of 200x barrels, comprised of a 1955
LIFO layer with 50x barrels valued at $5 per barrel (with a
total cost of $250x); a 1985 LIFO layer with 100x barrels
valued at $18 per barrel (with a total cost $1800x); a 2000
LIFO layer with 30x barrels valued at $25 per barrel (with a
total cost of $750x), and a 2004 LIFO layer with 20x barrels
valued at $35 per barrel (with a total cost $700x), for a
total inventory value of $3500x. Suppose further that the
taxpayer's ending inventory is 200x barrels, i.e., the same
as the starting inventory, so the taxpayer has neither an
inventory increment nor an inventory decrement for the
taxable year.
Under the provision, the taxpayer will revalue each layer
upwards by $18.75/barrel. Thus, the taxpayer will increase
its 1955 LIFO layer by $937.50x; its 1985 LIFO layer by
$1875x; its 2000 LIFO layer by $562.50x; and its 2004 LIFO
layer by $375x. The taxpayer will offset this $3750x increase
in inventory by reducing by $3750x the taxpayer's cost of
goods sold for the last taxable year ending in 2005. In the
event the taxpayer's cost of goods sold for such taxable year
prior to such reduction is less than $3750x, the taxpayer
will reduce its cost of goods sold to zero and increase its
gross income for such taxable year by such difference.
Effective date.--The provision is effective for the last
taxable year of a taxpayer ending in 2005.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
12. Amortization of geological and geophysical expenditures
(sec. 462 of the Senate amendment and sec. 167(h) of the
Code)
Present Law
Geological and geophysical expenditures (``G&G costs'') are
costs incurred by a taxpayer for the purpose of obtaining and
accumulating data that will serve as the basis for the
acquisition and retention of mineral properties by taxpayers
exploring for minerals. G&G costs incurred in connection with
oil and gas exploration in the United States may be amortized
over two years.\493\ In the
[[Page H2286]]
case of abandoned property, remaining basis may not be
recovered in the year of abandonment of a property as all
basis is recovered over the two-year amortization period.
---------------------------------------------------------------------------
\493\ Sec. 167(h).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The provision repeals the two-year amortization period with
respect to G&G costs paid or incurred by certain large
integrated oil companies, defined to include integrated oil
companies (as defined in section 291(b)(4) of the Code) that
have an average daily worldwide production of crude oil of at
least 500,000 barrels. Thus, affected oil companies are
required to capitalize their G&G costs associated with
successful exploration projects that result in the
acquisition of property. Such companies can recover any G&G
costs associated with abandoned property in the year of
abandonment.
Effective date.--The provision is effective for G&G costs
paid or incurred in taxable years beginning after August 8,
2005.
Conference Agreement
The conference agreement extends the two-year amortization
period for G&G costs to five years for certain major
integrated oil companies. Under the conference agreement, the
five-year amortization rule for G&G costs applies only to
integrated oil companies that have an average daily worldwide
production of crude oil of at least 500,000 barrels for the
taxable year, gross receipts in excess of $1 billion in the
last taxable year ending during calendar year 2005, and an
ownership interest in a crude oil refiner of 15 percent or
more.
Effective date.--The provision applies to amounts paid or
incurred after the date of enactment.
13. Valuation of employee personal use of noncommercial
aircraft (sec. 463 of the Senate amendment)
Present Law
Unless an exception applies, gross income includes
compensation for services, including fees, commissions,
fringe benefits, and similar items. In general, an employee
or other service provider must include in gross income the
amount by which the fair value of a fringe benefit exceeds
the amount paid by the individual. Treasury regulations
provide rules regarding the valuation of fringe benefits,
including flights on an employer-provided aircraft.\494\ In
general, the value of a non-commercial flight is determined
under the base aircraft valuation formula, also known as the
Standard Industry Fare Level formula or ``SIFL''.\495\ If the
SIFL valuation rules do not apply, the value of a flight on a
company-provided aircraft is generally equal to the amount
that an individual would have to pay in an arm's-length
transaction to charter the same or a comparable aircraft for
that period for the same or a comparable flight.\496\
---------------------------------------------------------------------------
\494\ Treas. Reg. sec. 1.61-21.
\495\ Treas. Reg. sec. 1.61-21(g).
\496\ Treas. Reg. sec. 1.61-21(b)(6).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
Under the Senate amendment, for purposes of income
inclusion, the value of any employee personal use of
noncommercial aircraft is equal to the excess of (1) the
greater of the fair market value of such use or actual cost
of such use (including all fixed and variable costs), over
(2) the amount paid by or on behalf of the employee for such
use. Thus, the SIFL valuation rules may no longer be used to
determine the value of such use.
Effective date.--The provision applies to use after the
date of enactment.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
14. Application of Foreign Investment in Real Property Tax
Act (``FIRPTA'') to Regulated Investment Companies
(``RICs'') (sec. 464 of the Senate amendment and sec.
897(h)(4) of the Code)
In general
A nonresident alien individual or foreign corporation is
taxable on its taxable income which is effectively connected
with the conduct of a trade or business within the United
States, at the income tax rates applicable to U.S. persons. A
nonresident alien individual is taxed (at a 30-percent rate)
on gains, derived from sources within the United States, from
the sale or exchange of capital assets if the individual is
present in the United States for 183 days or more during the
taxable year.
In addition, the Foreign Investment in Real Property Tax
Act (FIRPTA) \497\ generally treats a nonresident alien
individual or foreign corporation's gain or loss from the
disposition of a U.S. real property interest (USRPI) as
income that is effectively connected with a U.S. trade or
business, and thus taxable at the income tax rates applicable
to U.S. persons, including the rates for net capital gain. A
foreign investor subject to tax on this income is required to
file a U.S. income tax return under the normal rules relating
to receipt of income effectively connected with a U.S. trade
or business.
---------------------------------------------------------------------------
\497\ FIRPTA is codified in section 897 of the Code.
---------------------------------------------------------------------------
The payor of FIRPTA effectively connected income to a
foreign person is generally required to withhold U.S. tax
from the payment. Withholding is generally 10 percent of the
sales price in the case of a direct sale by the foreign
person of a USRPI, and 35 percent of the amount of a
distribution to a foreign person of proceeds attributable to
such sales from an entity such as a partnership.\498\ The
foreign person can request a refund with its U.S. tax return,
if appropriate based on that person's total U.S. effectively
connected income and deductions (if any) for the taxable
year.
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\498\ Sec. 1445 and Treasury regulations thereunder. The
Treasury department is authorized to issue regulations that
would reduce the 35 percent withholding on distributions to
15 percent during the time that the maximum income tax rate
on dividends and capital gains of U.S. persons is 15 percent.
Section 1445 statutorily requires the 10 percent withholding
by the purchaser of a USRPI and the 35 percent withholding
(or less if directed by Treasury) on certain distributions by
partnerships, trusts, and estates, among other situations.
Treasury regulations prescribe the 35 percent withholding
requirement for distributions by REITs to foreign
shareholders. Treas. Reg. sec. 1.1445-8. No regulations have
been issued relating specifically to RIC distributions, which
first became subject to FIRPTA in 2005.
---------------------------------------------------------------------------
USRPIs include interests in real property located in the
United States or the U.S. Virgin Islands, and stock of a
domestic U.S. real property holding company (USRPHC),
generally defined as any corporation, unless the taxpayer
established that the fair market value of its U.S. real
property interests is less than 50 percent of the combined
fair market value of all its real property interests (U.S.
and worldwide) and of all its assets used or held for use in
a trade or business.\499\ However, any class of stock that is
regularly traded on an established securities market located
in the U.S. is treated as a U.S. real property interest only
if the seller held more than 5 percent of the stock at any
time during the 5-year period ending on the date of
disposition of the stock.\500\
---------------------------------------------------------------------------
\499\ Sec. 897(c)(2).
\500\ Sec. 897(c)(3).
---------------------------------------------------------------------------
Special rules for certain investment entities
Real estate investment trusts and regulated investment
companies are generally passive investment entities. They are
organized as U.S. domestic entities and are taxed as U.S.
domestic corporations. However, because of their special
status, they are entitled to deduct amounts distributed to
shareholders and, in some cases, to allow the shareholders to
characterize these amounts based on the type of income the
REIT or RIC received. Among numerous other requirements for
qualification as a REIT or RIC, the entity is required to
distribute to shareholders at least 90 percent of its income
(excluding net capital gain) annually.\501\ A REIT or RIC may
designate a capital gain dividend to its shareholders, who
then treat the amount designated as capital gain.\502\ A REIT
or RIC is taxed at regular corporate rates on undistributed
income; but the combination of the requirement to distribute
income other than net capital gain, plus the ability to
declare a capital gain dividend and avoid corporate level tax
on such income, can result in little, if any, corporate level
tax paid by a REIT or RIC. Instead, the shareholder-level tax
on distributions is the principal tax paid with respect to
income of these entities. The requirements for REIT
eligibility include primary investment in real estate assets
(which assets can include mortgages). The requirements for
RIC eligibility include primary investment in stocks and
securities (which can include stock of REITs or of other
RICs).
---------------------------------------------------------------------------
\501\ Secs. 852(a)(1) and 852(b)(2)(A); 857(a)(1).
\502\ Secs. 852(b)(3); 857(b)(3).
---------------------------------------------------------------------------
FIRPTA contains special rules for real estate investment
trusts (REITs) and regulated investment companies
(RICs).\503\
---------------------------------------------------------------------------
\503\ Sec. 897(h).
---------------------------------------------------------------------------
Stock of a ``domestically controlled'' REIT is not a USRPI.
The term ``domestically controlled'' is defined to mean that
less than 50 percent in value of the REIT has been owned by
non-U.S. shareholders during the 5-year period ending on the
date of disposition.\504\ For 2005, 2006, and 2007, a similar
exception applies to RIC stock. Thus, stock of a domestically
controlled REIT or RIC can be sold without FIRPTA
consequences. This exception applies regardless of whether
the sale of stock is made directly by a foreign person, or by
a REIT or RIC whose distributions to foreign persons of gain
attributable to the sale of USRPI's would be subject to
FIRPTA as described below.
---------------------------------------------------------------------------
\504\ Sec. 897(h)(2) and (h)(4)(B).
---------------------------------------------------------------------------
A distribution by a REIT to a foreign shareholder, to the
extent attributable to gain from the REIT's sale or exchange
of USRPIs, is generally treated as FIRPTA gain to the
shareholder. An exception enacted in 2004 applies if the
distribution is made on a class of REIT stock that is
regularly traded on an established securities market located
in the United States and the foreign shareholder has not held
more than 5 percent of the class of stock at any time during
the one-year period ending on the date of the
distribution.\505\ Where the exception applies, the
distribution to the foreign shareholder is treated as the
distribution of an ordinary dividend (rather than as a
capital gain dividend), subject to 30-percent (or lower
treaty rate) withholding.\506\
---------------------------------------------------------------------------
\505\ This exception, effective beginning in 2005, was added
by section 418 of the American Jobs Creation Act of 2004
(``AJCA''), Pub. L. No. 108-357, and modified by section
403(p) of the Tax Technical Corrections Act of 2005.
\506\ Sec. 857(b)(3)(F).
---------------------------------------------------------------------------
Prior to 2005, distributions by RICs to foreign
shareholders, to the extent attributable to the RIC's sale or
exchange of USRPIs, were not treated as FIRPTA gain. If
distributions were attributable to long-term
[[Page H2287]]
capital gains, the RIC could designate the distributions as
long-term capital gain dividends that would not be subject to
any tax to the foreign shareholder, rather than as a regular
dividends subject to 30-percent (or lower treaty rate)
withholding.\507\ For 2005, 2006, and 2007, RICs are subject
to the rule that had applied to REITs prior to 2005, i.e.,
any distribution to a foreign shareholder attributable to
gain from the RIC's sale of a USRPI is characterized as
FIRPTA gain, without any exceptions.\508\
---------------------------------------------------------------------------
\507\ Sec. 852(b)(3)(C); Treas. Reg. sec. 1.1441-3(c)(2)(D).
\508\ This requirement for RICs was added by section 411 of
the American Jobs Creation Act of 2004 (``AJCA''), in
connection with the enactment of other rules that allow RICs
to identify certain types of distributions to foreign
shareholders, attributable to the RIC's receipt of short-term
capital gains or interest income, as distributions to such
shareholders of such short-term gains or interest income and
thus not taxed to the foreign shareholders, rather than as
regular dividends that would be subject to withholding. See
Secs. 871(k), 881(e), 1441(c)(12) and 1442(a). All these
rules are scheduled to expire at the end of 2007, as is the
rule subjecting to FIRPTA all distributions of RIC gain
attributable to sales of U.S. real property interests and the
rule excepting from FIRPTA a foreign person's sale of stock
of a ``domestically controlled'' RIC.
---------------------------------------------------------------------------
house Bill
No provision.
Senate Amendment
The Senate amendment provision provides that distributions
by a RIC to foreign shareholders of amounts attributable to
the sale of USRPIs are not treated as FIRPTA income unless
the RIC itself is a U.S. real property holding corporation
(i.e. 50 percent or more of its value is represented by
its U.S. real property interests, including investments in
U.S. real property holding corporations). In determining
whether a RIC is a real property holding company for this
purpose, a special rule applies that requires the RIC to
include as U.S. real property interests its holdings of
RIC or REIT stock if such RIC or REIT is a U.S. real
property holding corporation, even if such stock is
regularly traded on an established securities market and
even if the RIC owns less than 5 percent of such stock.
Another special rule requires the RIC to include as U.S.
real property interests its interests in any domestically
controlled RIC or REIT that is a U.S. real property
holding corporation.
Effective date.--The provision applies to distributions
with respect to taxable years beginning after December 31,
2004.
Conference Agreement
The conference agreement includes the Senate amendment
provision with a clarification to the effective date. Under
the clarification, the provision takes effect as if included
in the provisions of section 411 of the American Jobs
Creation Act of 2004 to which it relates.
15. Treatment of REIT and RIC distributions attributable to
FIRPTA gains (secs. 465 and 466 of the Senate amendment
and secs. 897, 852, and 871 of the Code)
Present Law
General treatment of U.S.-source income of foreign investors
Fixed and determinable annual and periodical income
The United States generally imposes a flat 30-percent tax,
collected by withholding, on the gross amount of U.S.-source
investment income payments, such as interest, dividends,
rents, royalties and similar types of fixed and determinable
annual and periodical income, to nonresident alien
individuals and foreign corporations (``foreign
persons'').\509\ Under treaties, the United States may reduce
or eliminate such taxes.
---------------------------------------------------------------------------
\509\ Secs. 871(a), 881, 1441, and 1442.
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Dividends
Even taking into account U.S. treaties, the tax on a
dividend generally is not entirely eliminated. Instead, U.S.-
source portfolio investment dividends received by foreign
persons generally are subject to U.S. withholding tax at a
rate of at least 15 percent.
Interest
Although payments of U.S.-source interest that is not
effectively connected with a U.S. trade or business generally
are subject to the 30-percent withholding tax, there are
exceptions to that rule. For example, interest from certain
deposits with banks and other financial institutions is
exempt from tax.\510\ Original issue discount on obligations
maturing in 183 days or less from the date of original issue
(without regard to the period held by the taxpayer) is also
exempt from tax.\511\ An additional exception is provided for
certain interest paid on portfolio obligations.\512\ Such
``portfolio interest'' generally is defined as any U.S.-
source interest (including original issue discount), not
effectively connected with the conduct of a U.S. trade or
business, (i) on an obligation that satisfies certain
registration requirements or specified exceptions thereto
(i.e., the obligation is ``foreign targeted''), and (ii) that
is not received by a 10-percent shareholder.\513\ With
respect to a registered obligation, a statement that the
beneficial owner is not a U.S. person is required.\514\ This
exception is not available for any interest received either
by a bank on a loan extended in the ordinary course of its
business (except in the case of interest paid on an
obligation of the United States), or by a controlled foreign
corporation from a related person.\515\ Moreover, this
exception is not available for certain contingent interest
payments.\516\ For 2005, 2006 and 2007, a regulated
investment company (``RIC'') may designate certain
distributions to foreign shareholders that are attributable
to the RIC's qualified interest income as non-taxable
interest distributions to such foreign persons.\517\
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\510\ Secs. 871(i)(2)(A) and 881(d).
\511\ Sec. 871(g).
\512\ Secs. 871(h) and 881(c).
\513\ Secs. 871(h)(3) and 881(c)(3).
\514\ Secs. 871(h)(2), (5) and 881(c)(2).
\515\ Sec. 881(c)(3).
\516\ Secs. 871(h)(4) and 881(c)(4).
\517\ This interest distribution rule was added by section
411 of the American Jobs Creation Act of 2004 (``AJCA''),
Pub. L. No. 108-357.
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Capital gains
A foreign person generally is not subject to U.S. tax on
capital gain, including gain realized on the disposition of
stock or securities issued by a U.S. person, unless the gain
is effectively connected with the conduct of a trade or
business in the United States or such person is an individual
present in the United States for a period or periods
aggregating 183 days or more during the taxable year.\518\ A
regulated investment company (RIC) can generally designate
dividends to foreign persons that are attributable to the
RIC's long term capital gain as a long-term gain dividends
that are not subject to withholding.\519\ For 2005, 2006 and
2007, RICs may also designate short-term capital gain
dividends.\520\
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\518\ Secs. 871(a)(2) and 881.
\519\ Treas. Reg. sec. 1.1441-3(c)(2)(D).
\520\ This short-term gain distribution rule was added by
section 411 of AJCA.
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For the years 2005, 2006 and 2007, RIC capital gain
dividends that are attributable to the sale of U.S. real
property interests (which can include stock of companies that
are U.S. real property holding companies) are subject to
special rules described below.
Real estate investment trusts (REITs) can also designate
long-term capital gain dividends to shareholders; but when
made to a foreign person such distributions attributable to
the sale of U.S. real property interests are also subject to
the special rules described below.
Foreign Investment in Real Property Tax Act (``FIRPTA'')
Unlike most other U.S. source capital gains, which are
generally not taxed to a foreign investor, the Foreign
Investment in Real Property Tax Act of 1980 (FIRPTA) subjects
gain or loss of a foreign person from the disposition of a
U.S. real property interest (USRPI) to tax as if the taxpayer
were engaged in a trade or business within the United States
and the gain or loss were effectively connected with such
trade or business.\521\ In addition to an interest in real
property located in the United States or the Virgin Islands,
USRPIs include (among other things) any interest in a
domestic corporation unless the taxpayer establishes that the
corporation was not, during a five-year period ending on the
date of the disposition of the interest, a U.S. real property
holding corporation (which is defined generally to mean any
corporation the fair market value of whose U.S. real property
interests equals or exceeds 50 percent of the sum of the fair
market values of its real property interests and any other of
its assets used or held for use in a trade or business).
---------------------------------------------------------------------------
\521\ Sec. 897.
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Distributions by a REIT to its foreign shareholders
attributable to the sale of USRPI's are generally treated as
income from the sale of USRPIs.\522\ Treasury regulations
require the REIT to withhold at 35 percent on such a
distribution.\523\ However, there is an exception for
distributions by a REIT with respect to stock of the REIT
that is regularly traded on an established securities market
located in the U.S., to a foreign shareholder that has not
held more than 5 percent of the stock of the REIT for the one
year period ending with the date of the distribution.\524\ In
such cases, the REIT and the shareholder treat the
distribution to a foreign shareholder as the distribution of
an ordinary dividend,\525\ subject to the 30-percent (or
lower treaty rate) withholding applicable to dividends.
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\522\ Sec. 897(h)(1).
\523\ Treas. Reg. sec. 1.1445-8.
\524\ Sec. 897(h)(1)(second sentence).
\525\ Sec. 857(b)(3)(F).
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For 2005, 2006, and 2007, any RIC distribution to a foreign
shareholder attributable to the sale of USRPIs is treated as
FIRPTA income, without any exceptions.\526\ However, no
Treasury regulations have been issued addressing withholding
obligations with respect to such distributions.
---------------------------------------------------------------------------
\526\ Sec. 897(h)(1)
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A more complete description of the provisions of FIRPTA and
the special rules under FIRPTA that apply to RICs and REITs
is contained under ``Present Law'' for the provision
``Application of Foreign Investors in Real Property Tax Act
(FIRPTA) to Regulated Investment Companies (RICS).
Although the law thus provides rules for taxing foreign
persons under FIRPTA on distributions of gain from the sale
of USRPIs by RICs or REITs, some taxpayers may be taking the
position that if a foreign person invests in a RIC or REIT
that, in turn, invests in a lower-tier RIC or REIT that is
the entity that disposes of USRPIs and distributes the
proceeds, then the proceeds from such disposition by the
lower-tier RIC or REIT cease to be FIRPTA income when
distributed to the upper-tier RIC or REIT (which is not
itself a foreign person), and can thereafter be distributed
by that latter entity to its foreign shareholders as non-
[[Page H2288]]
FIRPTA income of such RIC or REIT, rather than continuing to
be categorized as FIRPTA income. Furthermore, RICs may take
the position that in the absence of regulations or a specific
statutory rule addressing the withholding rules for FIRPTA
capital gain that is treated as effectively connected with a
U.S. trade or business, such gain should be considered
capital gain for which no withholding is required.
In addition, some foreign persons may be attempting to
avoid FIRPTA tax on a distribution from a RIC or a REIT, by
selling the RIC or REIT stock shortly before the distribution
and buying back the stock shortly after the distribution. If
the stock is not a U.S. real property interest in the hands
of the foreign seller, that person would take the position
that the gain on the sale of the stock is capital gain not
subject to U.S. tax. Stock of a RIC or REIT that is
``domestically controlled'' is not a U.S. real property
interest.\527\
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\527\ Sec. 897(g)(3). A RIC or REIT is ``domestically
controlled'' if less than 50 percent in value of the entity's
stock is held by foreign persons. RIC stock ceases to be
eligible for this exception as of the end of 2007.
Distributions by a domestically controlled RIC or REIT, if
attributable to the sale of U.S. real property interests, are
not exempt from FIRPTA by reason of such domestic control. A
foreign person that would be subject to FIRPTA on receipt of
a distribution from such an entity might sell its stock
before the distribution and repurchase stock after the
distribution in an attempt to avoid FIRPTA consequences.
Under a different exception from FIRPTA, applicable to stock
of all entities, neither RIC nor REIT stock is a U.S. real
property interest if the RIC or REIT stock is regularly
traded on an established securities market located in the
United States and if the stock sale is made by a foreign
shareholder that has not owned more than five percent of the
stock during the five years ending with the date of the sale.
Sec. 897(c)(3). Distributions by a REIT to a foreign person,
attributable to the sale of U.S. real property interests, are
also not subject to FIRPTA if made with respect to stock that
is regularly traded on an established securities market
located in the United States and made to a foreign person
that has not held more than five percent of the REIT stock
for the one-year period ending on the date of distribution.
(Sec. 897(h)(1), second sentence.) Thus, any foreign
shareholder of such a regularly traded REIT that would be
exempt from FIRPTA on a sale of the REIT stock immediately
before a distribution would also generally be exempt from
FIRPTA on a distribution from the REIT if such shareholder
held the stock through the date of the distribution, due to
the holding period requirements. Distributions that are not
subject to FIRPTA under this five percent exception are
recharacterized as ordinary dividends and thus would normally
be subject to ordinary dividend withholding rules. Secs.
857(b)(3)(F) and 1441.
---------------------------------------------------------------------------
If the stock is a USRPI in the hands of the foreign person,
the transferee generally is required to withhold 10 percent
of the gross sales price under general FIRPTA withholding
rules.\528\
---------------------------------------------------------------------------
\528\ Secs. 1445(a) and 1445(e).
---------------------------------------------------------------------------
House Bill
No provision.
Senate Amendment
The first part of the Senate amendment provision requires
any distribution that is made by a RIC or a REIT that would
otherwise be subject to FIRPTA because the distribution is
attributable to the disposition of a U.S. real property
interest (USRPI) to retain its character as FIRPTA income
when distributed to any other RIC or REIT, and to be treated
as if it were from the disposition of a USRPI by that other
RIC or REIT. Under the provision, a RIC continues to be
subject to FIRPTA, even after December 31, 2007, in any case
in which a REIT makes a distribution to the RIC that is
attributable to gain from the sale of U.S. real property
interests.
The second part of the Senate amendment provision provides
that a distribution by a RIC to a foreign shareholder, or to
a RIC or REIT shareholder, attributable to sales of USRPIs is
not treated as gain from the sale of a USRPI by that
shareholder if the distribution is made with respect to a
class of RIC stock that is regularly traded on an established
securities market \529\ located in the U.S. and if such
shareholder did not hold more than 5 percent of such stock
within the one year period ending on the date of the
distribution. Such distributions instead are treated as
dividend distributions.\530\
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\529\ It is intended that the rules generally applicable for
this purpose under section 897 also apply under the provision
in determining whether a class of interests is regularly
traded on an established securities market located in the
United States. For example, at the present time the rules
currently in force for this purpose include Temp. Reg. sec.
1.897-9T(d)(2).
\530\ The provision treats such distributions as ordinary
dividend distributions rather than as distributions of long
term capital gain. This rule is the same as the present law
rule for publicly traded REITs making a distribution to a
foreign shareholder. In addition, under the immediately
preceding provision (sec. 464) of the Senate amendment, for
the years 2005, 2006 and 2007 that RICs are subject to
FIRPTA, a RIC can make distributions from sales of USRPIs to
shareholders who do not meet this rule, and such
distributions will be treated not as dividends but as non-
taxable long- or short-term capital gain, if so designated by
the RIC, as long as the RIC itself is not a USRPHC after
applying the special rules for counting the RIC's ownership
of REIT or other RIC stock.
---------------------------------------------------------------------------
The third part of the Senate amendment provision requires a
foreign person that disposes of stock of a RIC or REIT during
the 30-day period preceding a distribution on that stock that
would have been treated as a distribution from the
disposition of a USRPI, that acquires an identical stock
interest during the 60 day period beginning the first day of
such 30-day period preceding the distribution, and that does
not in fact receive the distribution in a manner that
subjects the person to tax under FIRPTA, to pay FIRPTA tax on
an amount equal to the amount of the distribution that was
not taxed under FIRPTA as a result of the disposition. A
foreign person is treated as having acquired any interest
acquired by any person treated as related to that foreign
first person under section 465(b)(3)(C).\531\
---------------------------------------------------------------------------
\531\ These relationships generally include persons that are
engaged in trades or businesses under common control
(generally, a more than 50 percent relationship) and also
include persons that have a more than 10 percent
relationship, such as (for example) a corporation and an
individual owning more than 10 percent of the corporation; or
a corporation and a partnership if the same persons own more
than 10 percent of the interests in each.
---------------------------------------------------------------------------
This third part of the Senate amendment provision applies
only in the case of a shareholder that would have been
treated as receiving FIRPTA income on the distribution if
that shareholder had in fact received the distribution, but
that would not have been treated as receiving FIRPTA income
if the form of the disposition transaction were respected.
This category of persons consists of persons that are
shareholders in a domestically controlled RIC or REIT (since
sales of shares of such an entity are not subject to FIRPTA
tax), but does not include a person who sells stock that is
regularly traded on an established securities market located
in the U.S. and who did not own more than five percent of
such stock during the one year period ending on the date of
the distribution (since such a person would not have been
subject to FIRPTA tax under present law for REITs and under
the second part of the Senate amendment provision for RICs,
supra., if that person had received the dividend instead of
disposing of the stock).
Notwithstanding the recharacterization of the disposition
as involving a FIRPTA distribution to the foreign person, no
withholding on disposition proceeds to the foreign person on
the disposition of such stock would be required. No inference
is intended as to what situations under present law would or
would not be respected as dispositions.
Effective dates.--The first part of the Senate amendment
provision is effective for distributions with respect to
taxable years of a RIC or REIT beginning after the date of
enactment.
The second part of the Senate amendment provision applies
to dividends with respect to taxable years of regulated
investment companies beginning after December 31, 2004.
The third part of the Senate amendment provision is
effective for dispositions after December 31, 2005, in
taxable years ending after that date.
Conference Agreement
The conference agreement includes the Senate amendment
provision with modifications and clarifications.
The conference agreement provides that the second part of
the Senate amendment provision, treating certain
distributions attributable to sales of U.S. real property
interests as dividends subject to dividend withholding,
applies when the distribution is made to a foreign
shareholder of a RIC or REIT, but does not apply when the
distribution is made to another RIC or a REIT. In such cases,
the character of the distribution as FIRPTA gain is retained
and must be tracked by the recipient RIC or REIT, but the
distribution itself does not become dividend income in the
hands of such RIC or REIT. Therefore, such recipient RIC or
REIT can in turn distribute amounts attributable to that
distribution (attributable to the sale of USRPIs) to its U.S
shareholders as capital gain. However, if any recipient RIC
or REIT in turn distributes to a foreign shareholder amounts
that are attributable to a sale by a lower tier RIC or REIT
of USRPIs, such amounts distributed to a foreign shareholder
shall be treated as FIRPTA gain or as dividend income,
according to whether or not such distribution to such foreign
shareholder qualifies for dividend treatment.
The conference agreement amends section 1445 so that it
explicitly requires withholding on RIC and REIT distributions
to foreign persons, attributable to the sale of USRPIs, at 35
percent, or, to the extent provided by regulations, at 15
percent.\532\
---------------------------------------------------------------------------
\532\ This provision is similar to present law section
1445(c)(1). The regulatory authority to reduce the
withholding to 15 percent sunsets in accordance with the same
sunset that applies to section 1445(c)(1), at the time that
the present law maximum 15 percent rate on dividends is
scheduled to sunset.
Treasury regulations under section 1445 already impose FIRPTA
withholding on REITs under present law. Treasury has not yet
written regulations applicable to RICs. No inference is
intended regarding the existing Treasury regulations in force
under section 1445 with respect to REITs.
---------------------------------------------------------------------------
The conference agreement clarifies that the treatment of a
RIC as a qualified investment entity continues after December
2007 with respect to a RIC that receives a distribution from
a REIT, not only for purposes of the distribution rules,
including withholding on distributions to foreign
shareholders, but also for purposes of the new ``wash sale''
rules of the provision.
The conference agreement modifies the new ``wash sale''
rule. The period within which the basic ``wash-sale'' rule
applies is changed from 60 days to 61 days.\533\ The
definition of ``applicable wash sales transaction'' is
expanded to cover not only situations in which the taxpayer
acquires a substantially
[[Page H2289]]
identical interest, but also situations in which the taxpayer
enters into a contract or option to acquire such an interest.
The related party rule is also modified to apply the 50-
percent relationship test under section 267(b) and 707(b)(1)
rather than a 10-percent test.
---------------------------------------------------------------------------
\533\ Thus the period includes the 30 days before and the 30
days after the ex-dividend date, in addition to the ex-
dividend date itself.
---------------------------------------------------------------------------
In addition, treatment of a foreign shareholder of a RIC or
REIT as if it had received a FIRPTA distribution that is
treated as U.S. effectively connected income is extended to
transactions that meet the definition of ``substitute
dividend payments'' provided for purposes of section 861 and
that would be properly treated by the foreign taxpayer as
receipt of a distribution of FIRPTA gain if the distribution
from the RIC or REIT had itself been received by the
taxpayer, but that, by virtue of the substitute dividend
payment, is not so treated but for the provision,\534\ as
well as to other similar arrangements to which Treasury may
extend the rules.
---------------------------------------------------------------------------
\534\ The conference agreement adopts the definition of
``substitute dividend payment'' used for purposes of section
861, which definition applies to determine substitute
dividend payments under the conference agreement provision,
even though the recipient may not be an individual and even
though the underlying payment would not have been treated as
a dividend to the recipient but as a distribution of FIRPTA
gain. Treasury regulations section 1.861-3(a)(6) defines a
``substitute dividend payment'' as a payment, made to the
transferor of a security in a securities lending transaction
or a sale-repurchase transaction, of an amount equivalent to
a dividend distribution which the owner of the transferred
security is entitled to receive during the term of the
transaction. The regulation applies to amounts received or
accrued by the taxpayer. The regulation defines a securities
lending transaction as a transfer of one or more securities
that is described in section 1058(a) or a substantially
similar transaction. The regulation defines a sale-repurchase
transaction as an agreement under which a person transfers a
security in exchange for cash and simultaneously agrees to
receive substantially identical securities from the
transferee in the future in exchange for cash. Under the
regulation, a ``substitute dividend payment'' is generally
sourced and in many instances characterized in the same
manner as the underlying distribution with respect to the
transferred security.
---------------------------------------------------------------------------
Effective date.--The first part of the conference agreement
provision, relating to distributions generally, applies to
distributions with respect to taxable years of RICs and REITs
beginning after December 31, 2005, except that no withholding
is required under sections 1441, 1442, or 1445 with respect
to any distribution before the date of enactment if such
amount was not otherwise required to be withheld under any
such section as in affect before the amendments made by the
conference agreement.
The second part of the conference agreement, relating to
the ``wash sale'' and substitute dividend payment
transactions, is applicable to distributions and substitute
dividend payments occurring on or after the 30th day
following the date of enactment.
No inference is intended regarding the treatment under
present law of any transactions addressed by the conference
agreement.
16. Credit to holders of rural renaissance bonds (sec. 469 of
the Senate amendment)
Present Law
In general
Interest on bonds issued by State and local governments
generally is excluded from gross income for Federal income
tax purposes if the proceeds of such bonds are used to
finance direct activities of governmental units or if such
bonds are repaid with revenues of governmental units. These
bonds are called ``governmental bonds.'' Interest on State or
local government bonds issued to finance activities of
private persons is taxable unless a specific exception
applies. These bonds are called ``private activity bonds.''
The term ``private person'' generally includes the Federal
Government and all other individuals and entities other than
States or local governments.
Private activity bonds are eligible for tax-exemption if
issued for certain purposes permitted by the Code
(``qualified private activity bonds''). Generally, qualified
private activity bonds are subject to restrictions on the use
of proceeds for the acquisition of land and existing
property, use of proceeds to finance certain specified
facilities (e.g., airplanes, skyboxes, other luxury boxes,
health club facilities, gambling facilities, and liquor
stores), and use of proceeds to pay costs of issuance (e.g.,
bond counsel and underwriter fees). Small issue and
redevelopment also are subject to additional restrictions on
the use of proceeds for certain facilities (e.g., golf
courses and massage parlors). Moreover, the term of qualified
private activity bonds generally may not exceed 120 percent
of the economic life of the property being financed and
certain public approval requirements (similar to requirements
that typically apply under State law to issuance of
governmental debt) apply under Federal law to issuance of
private activity bonds.
Tax-credit bonds
As an alternative to traditional tax-exempt bonds, States
and local governments may issue tax-credit bonds for certain
purposes. Rather than receiving interest payments, a taxpayer
holding a tax-credit bond on an allowance date is entitled to
a credit. Generally, the credit amount is includible in gross
income (as if it were a taxable interest payment on the
bond), and the credit may be claimed against regular income
tax and alternative minimum tax liability. The following
types of tax-credit bonds may be issued under present law:
``qualified zone academy bonds,'' which are bonds issued for
the purpose of renovating, providing equipment to, developing
course materials for use at, or training teachers and other
personnel at certain school facilities; ``clean renewable
energy bonds,'' which are bonds issued to finance for
facilities that would qualify for the tax credit under
section 45 without regard to the placed in service date
requirements of that section; and ``gulf tax credit bonds,''
which are bonds issued by the States of Louisiana,
Mississippi, and Alabama to pay principal, interest, or
premium on certain prior bonds.
Arbitrage restrictions on tax-exempt bonds
To prevent States and local governments from issuing more
tax-exempt bonds than is necessary for the activity being
financed or from issuing such bonds earlier than needed for
the purpose of the borrowing, the Code includes arbitrage
restrictions limiting the ability to profit from investment
of tax-exempt bond proceeds. In general, arbitrage profits
may be earned only during specified periods (e.g., defined
``temporary periods'' before funds are needed for the purpose
of the borrowing) or on specified types of investments (e.g.,
``reasonably required reserve or replacement funds'').
Subject to limited exceptions, profits that are earned during
these periods or on such investments must be rebated to the
Federal Government. Governmental bonds are subject to less
restrictive arbitrage rules than most private activity bonds.
House Bill
No provision.
Senate Amendment
The Senate amendment creates a new category of tax-credit
bonds to finance certain projects located in rural areas
(``Rural Renaissance Bonds''). As with present law tax-credit
bonds, the taxpayer holding Rural Renaissance Bonds on the
allowance date would be entitled to a tax credit. The amount
of the credit would be determined by multiplying the bond's
credit rate by the face amount on the holder's bond. The
credit would be includible in gross income (as if it were an
interest payment on the bond) and could be claimed against
regular income tax liability and alternative minimum tax
liability.
Under the Senate amendment, Rural Renaissance Bonds are
defined as any bonds issued by a qualified issuer if, in
addition to the requirements discussed below, 95 percent or
more of the proceeds of such bonds are used to finance
capital expenditures incurred for one or more qualified
projects. ``Qualified projects'' include any of the following
projects located in a rural area: (i) a water or waste
treatment project, (ii) an affordable housing project, (iii)
a community facility project, including hospitals, fire and
police stations, and nursing and assisted-living facilities,
(iv) a value-added agriculture or renewable energy facility
project for agricultural producers or farmer-owned entities,
including any project to promote the production, processing,
or retail sale of ethanol (including fuel at least 85 percent
of the volume of which consists of ethanol), bio-diesel,
animal waste, biomass, raw commodities, or wind as a fuel,
(v) a distance learning or telemedicine project, (vi) a rural
utility infrastructure project, including any electric or
telephone system, (vii) a project to expand broadband
technology, (viii) a rural teleworks project, and (ix) any of
the previously described projects if carried out by the Delta
Regional Authority. A ``rural area'' means any area other
than a city or town which has a population of greater than
50,000 inhabitants or the urbanized area contiguous and
adjacent to such a city or town.
For purposes of the provision, the term ``qualified
issuer'' means any not-for-profit cooperative lender which,
as of the date of enactment of this provision, has received a
guarantee under the Rural Electrification Act. A qualified
issuer must also meet a user fee requirement during the
period any Rural Renaissance Bond issued by such qualified
issuer is outstanding. The user fee requirement is met if the
qualified issuer makes semi-annual grants for qualified
projects equal to the outstanding principal of Rural
Renaissance Bond issued by such issuer multiplied by one-
half the rate on United States Treasury securities of the
same maturity.
The Senate amendment imposes a maximum maturity limitation
on Rural Renaissance Bonds. The maximum maturity is the term
which the Secretary estimates will result in the present
value of the obligation to repay the principal on any bonds
being equal to 50 percent of the face amount of such bond.
The provision also requires level amortization of Rural
Renaissance Bonds during the period such bonds are
outstanding.
To qualify as Rural Renaissance Bonds, the qualified issuer
of such bonds must reasonably expect to and actually spend 95
percent or more of the proceeds of such bonds on qualified
projects within the five-year period that begins on the date
of issuance. To the extent less than 95 percent of the
proceeds are used to finance qualified projects during the
five-year spending period, bonds will continue to qualify as
Rural Renaissance Bonds if unspent proceeds are used within
90 days from the end of such five-year period to redeem any
``nonqualified bonds.'' For these purposes, the amount of
nonqualified bonds is to be determined in the same manner as
Treasury regulations under section 142. In addition, the
provision provides that the five-year spending period may be
extended by the Secretary upon the qualified issuer's
request.
[[Page H2290]]
Under the provision, Rural Renaissance Bonds are subject to
the arbitrage requirements of section 148 that apply to
traditional tax-exempt bonds. Principles under section 148
and the regulations thereunder shall apply for purposes of
determining the yield restriction and arbitrage rebate
requirements applicable to Rural Renaissance Bonds. For
example, for arbitrage purposes, the yield on an issue of
Rural Renaissance Bonds is computed by taking into account
all payments of interest, if any, on such bonds, i.e.,
whether the bonds are issued at par, premium, or discount.
However, for purposes of determining yield, the amount of the
credit allowed to a taxpayer holding Rural Renaissance Bonds
is not treated as interest, although such credit amount is
treated as interest income to the taxpayer.
Rural Renaissance Bonds must be designated as such by the
qualified issuer and must be issued in registered form. The
provision also requires issuers of Rural Renaissance Bonds to
report issuance to the IRS in a manner similar to that
required for tax-exempt bonds. There is a national limitation
of $200 million of Rural Renaissance Bonds that the Secretary
may allocate, in the aggregate, to qualified projects. The
authority to issue Rural Renaissance Bonds expires December
31, 2009.
Effective date.--The provision is effective for bonds
issued after the date of enactment and before January 1,
2010.
Conference Agreement
The conference agreement does not include the Senate
amendment provision.
17. Modify foreign tax credit rules for large integrated oil
companies which are dual capacity taxpayers (sec. 470 of
the Senate amendment and sec. 901 of the Code)
Present Law
U.S. persons are subject to U.S. income tax on their
worldwide income. A credit against U.S. tax on foreign source
income is allowed for foreign taxes that are paid or
accrued.\535\ In addition, a domestic corporation which owns
10 percent or more of the voting stock of a foreign
corporation from which it receives dividends or with respect
to which it is taxed under the rules of subpart F is deemed
to have paid a portion of the foreign taxes of such foreign
corporation.\536\ The foreign tax credit is available only
for foreign income, war profits, and excess profits taxes,
and for certain taxes that qualify under section 903 as
imposed ``in lieu'' of such taxes. Other foreign levies
generally are treated as deductible expenses only.
---------------------------------------------------------------------------
\535\ Sec. 901. Foreign taxes include taxes imposed by
possessions.
\536\ Secs. 902 and 960. Foreign corporations include
corporations created or organized in possessions.
---------------------------------------------------------------------------
The amount of foreign tax credits that a taxpayer may claim
in a year is subject to a limitation that prevents taxpayers
from using foreign tax credits to offset U.S. tax on U.S.
source income. The foreign tax credit limitation is
calculated separately for specific categories of income. The
amount of creditable taxes paid or accrued (or deemed paid)
in any taxable year which exceeds the foreign tax credit
limitation is permitted to be carried back one year and
carried forward 10 years.
Treasury regulations provide detailed rules for determining
whether a foreign levy is a creditable income tax. A levy
generally is a tax if it is a compulsory payment under the
authority of a foreign country to levy taxes and is not
compensation for a specific economic benefit provided by a
foreign country. A taxpayer that is subject to a foreign levy
and also receives a specific economic benefit from such
country is considered a ``dual capacity taxpayer.'' \537\
Treasury regulations provide that the portion of a foreign
levy paid by a dual capacity taxpayer that is considered a
tax is determined based on all the facts and
circumstances.\538\ Alternatively, under a safe harbor
provided in the regulations, the portion of a foreign levy
paid by a dual capacity taxpayer that is creditable is
determined based on the foreign country's generally imposed
income tax or, if the foreign country has no generally
imposed income tax, the U.S. tax.\539\
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\537\ Treas. Reg. sec. 1.901-2(a)(2)(ii)(A).
\538\ Treas. Reg. sec. 1.901-2A(c)(2)(i).
\539\ Treas. Reg. sec. 1.901-2A(e).
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house bill
No provision.
senate amendment
The Senate amendment denies the foreign tax credit with
respect to all amounts paid or accrued (or deemed paid) to
any foreign country or possession by a large integrated oil
company which is a dual capacity taxpayer if the country or
possession does not impose a generally applicable income tax.
The provision modifies the safe harbor rule currently
provided by Treasury Regulations. Under the provision, as
under present law, a dual capacity taxpayer is a person who
is subject to a levy in a foreign country or possession and
also directly or indirectly receives (or will receive) a
specific economic benefit (as determined in accordance with
regulations) from such foreign country or possession. A
generally applicable income tax is an income tax that is
generally imposed on income derived from a trade or business
conducted within that foreign country or possession (which
may include taxes qualifying under section 903 as imposed in
lieu of income taxes), provided that the tax has substantial
application (by its terms and in practice) to persons who are
not dual capacity taxpayers and to persons who are citizens
or residents of the foreign country or possession.
If the country does impose a generally applicable income
tax, the foreign tax credit is denied to the extent that such
amounts exceed the amount (as determined under regulations)
which is paid by the dual capacity taxpayer pursuant to such
generally applicable income tax, or which would have been
paid if such generally applicable income tax were applicable
to the dual capacity taxpayer. Amounts not in excess of the
amount calculated under the generally applicable income tax
are subject to all other rules pertaining to foreign tax
credits. Amounts for which the foreign tax credit is denied
under the provision are not subject to carryback or
carryforward, but could constitute deductible expenses if
such amounts qualify under the relevant deduction provisions.
The provision does not apply to the extent contrary to any
treaty obligation of the United States.
The provision applies only to ``large integrated oil
companies.'' These are persons that meet all of the following
requirements for a particular taxable year: (1) the person is
a producer of crude oil; (2) the person has gross receipts in
excess of one billion dollars; (3) the person or persons
related to such person has an average daily worldwide
production of crude oil of at least 500,000 barrels; and (4)
either (a) the person or persons related to such person sells
at retail oil or natural gas (excluding bulk sales of such
items to commercial or industrial users), or any product
derived from oil or natural gas (excluding bulk sales of
aviation fuels to the Department of Defense), in an aggregate
amount of five million dollars or greater, or (b) the person
or persons related to such person engage in the refining of
crude oil, if the aggregate average daily refinery runs for
that taxable year exceeds 75,000 barrels. For purposes of
requirement (4), a person is a related person with respect to
another person if either one owns a five percent or greater
interest in the other, or if a third person owns such an
interest in both.
Effective date.--The provision applies to taxes paid or
accrued in taxable years beginning after the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
18. Disability preference program for tax collection
contracts (sec. 471 of the Senate amendment)
present law
Under present law, the IRS may use private debt collection
companies to locate and contact taxpayers owing outstanding
tax liabilities of any type and to arrange payment of those
taxes by the taxpayers.
There are several procedural conditions applicable to the
use of private debt collection contracts. First, provisions
of the Fair Debt Collection Practices Act apply to the
private debt collection company. Second, taxpayer protections
that are statutorily applicable to the IRS are also made
statutorily applicable to the private sector debt collection
companies. In addition, taxpayer protections that are
statutorily applicable to IRS employees also are made
statutorily applicable to employees of private sector debt
collection companies. Third, subcontractors are prohibited
from having contact with taxpayers, providing quality
assurance services, and composing debt collection notices;
any other service provided by a subcontractor must receive
prior approval from the IRS.
house bill
No provision.
senate amendment
The Senate amendment provides that the IRS may not enter a
contract with a private debt collection company after April
1, 2006, until the Secretary implements a qualified
disability preference program. A qualified disability
preference program is a program that requires qualified
employers to receive not less than 10 percent of taxpayer
accounts (based on dollar value) awarded to private debt
collection companies. A qualified employer is an employer
who, as of the date the private debt collection contract is
awarded, employs not less than 50 severely disabled
individuals or not less than 30 percent of such employer's
employees are severely disabled. In addition, a qualified
employer must agree that not more than 90 days after being
awarded a private debt collection contract not less than 35
percent of the employees providing services under the private
debt collection contract shall be severely disabled
individuals and hired after the date the contract is awarded.
For purposes of the provision, a severely disabled
individual means (i) a veteran of the United States armed
forces with a disability of 50 percent or greater determined
by law or the Secretary of Veterans Affairs to be service-
connected or (ii) any individual who is a disabled
beneficiary as defined by the Social Security Act or would be
considered to such a disabled beneficiary but for having
income or resources in excess of limits established by the
Social Security Act.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
TITLE VI--SUNSET OF CERTAIN PROVISIONS AND AMENDMENTS
(Sec. 501 of the Senate amendment)
present law
Reconciliation is a procedure under the Congressional
Budget Act of 1974 (the ``Budget Act'') by which Congress
implements
[[Page H2291]]
spending and tax policies contained in a budget resolution.
The Budget Act contains numerous rules enforcing the scope of
items permitted to be considered under the budget
reconciliation process. One such rule, the so-called ``Byrd
rule,'' was incorporated into the Budget Act in 1990. The
Byrd rule, named after its principal sponsor, Senator Robert
C. Byrd, is contained in section 313 of the Budget Act. The
Byrd rule generally permits members to raise a point of order
against extraneous provisions (those which are unrelated to
the goals of the reconciliation process) from either a
reconciliation bill or a conference report on such bill.
Under the Byrd rule, a provision is considered to be
extraneous if it falls under one or more of the following six
definitions:
1. It does not produce a change in outlays or revenues;
2. It produces an outlay increase or revenue decrease when
the instructed committee is not in compliance with its
instructions;
3. It is outside of the jurisdiction of the committee that
submitted the title or provision for inclusion in the
reconciliation measure;
4. It produces a change in outlays or revenues which is
merely incidental to the nonbudgetary components of the
provision;
5. It would increase the deficit for a fiscal year beyond
those covered by the reconciliation measure; and
6. It recommends changes in Social Security.
house bill
No provision.
senate amendment
To ensure compliance with the Budget Act, the Senate
amendment provides that the provisions of, and amendments
made by, title I, subtitle A of title II, and title III of
the Senate amendment shall not apply to taxable years
beginning after September 30, 2010, and that the Code shall
be applied and administered to such years as if those
provisions and amendments had never been enacted.
Effective date.--The provision is effective on the date of
enactment.
conference agreement
The conference agreement does not include the Senate
amendment provision.
TITLE VII--FUNDING FOR MILITARY OPERATIONS
(Secs. 601 and 602 of the Senate amendment)
present law
Present law does not include the Senate amendment
provision.
house bill
No provision.
senate amendment
The Senate amendment provides that there is to be
appropriated, out of any money in the Treasury that is not
otherwise appropriated, for the fiscal years 2006 through
2010, the following amounts, to be used for resetting and
recapitalizing equipment being used in theaters of
operations: (1) $16,900,000,000 for operations and
maintenance of the Army; (2) $1,800,000,000 for aircraft for
the Army; (3) $6,300,000,000 for other Army procurement; (4)
$10,000,000,000 for wheeled and tracked combat vehicles for
the Army; (5) $467,000,000 for the Army working capital fund;
(6) $6,000,000 for missiles for the Department of Defense;
(7) $100,000,000 for defense wide procurement for the
Department of Defense; (8) $4,500,000,000 for Marine Corps
procurement; (9) $4,500,000,000 for operations and
maintenance of the Marine Corps; and (10) $2,700,000,000 for
Navy aircraft procurement.
conference agreement
The conference agreement does not include the Senate
amendment provision.
TITLE VIII--OTHER REVENUE OFFSET PROVISIONS
A. Imposition of Withholding on Certain Payments Made by Government
Entities
(Sec. 3402 of the Code)
Present Law
Withholding requirements
Employers are required to withhold income tax on wages paid
to employees, including wages and salaries of employees or
elected officials of Federal, State, and local government
units. Withholding rates vary depending on the amount of
wages paid, the length of the payroll period, and the number
of withholding allowances claimed by the employee.
Certain non-wage payments also are subject to mandatory or
voluntary withholding. For example:
--Employers are required to withhold FICA and Railroad
Retirement taxes from wages paid to their employees.
Withholding rates are generally uniform.
--Payors of pensions are required to withhold from payments
made to payees, unless the payee elects no withholding.\540\
Withholding from periodic payments is at variable rates,
parallel to income tax withholding from wages, whereas
withholding from nonperiodic payments is at a flat 10-percent
rate.
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\540\ Withholding at a rate of 20 percent is required in the
case of an eligible rollover distribution that is not
directly rolled over.
---------------------------------------------------------------------------
--A variety of payments (such as interest and dividends)
are subject to backup withholding if the payee has not
provided a valid taxpayer identification number (TIN).
Withholding is at a flat rate based on the fourth lowest rate
of tax applicable to single taxpayers.
--Certain gambling proceeds are subject to withholding.
Withholding is at a flat rate based on the third lowest rate
of tax applicable to single taxpayers.
--Voluntary withholding applies to certain Federal
payments, such as Social Security payments. Withholding is at
rates specified by Treasury regulations.
--Voluntary withholding applies to unemployment
compensation benefits. Withholding is at a flat 10-percent
rate.
--Foreign taxpayers are generally subject to withholding on
certain U.S.-source income which is not effectively connected
with the conduct of a U.S. trade or business. Withholding is
at a flat 30-percent rate (14-percent for certain items of
income).
Many payments, including payments made by government
entities, are not subject to withholding under present law.
For example, no tax is generally withheld from payments made
to workers who are not classified as employees (i.e.,
independent contractors).
Information reporting
Present law imposes numerous information reporting
requirements that enable the Internal Revenue Service
(``IRS'') to verify the correctness of taxpayers' returns.
For example, every person engaged in a trade or business
generally is required to file information returns for each
calendar year for payments of $600 or more made in the course
of the payor's trade or business. Special information
reporting requirements exist for employers required to deduct
and withhold tax from employees' income. In addition, any
service recipient engaged in a trade or business and paying
for services is required to make a return according to
regulations when the aggregate of payments is $600 or more.
Government entities are specifically required to make an
information return, reporting certain payments to
corporations as well as individuals. Moreover, the head of
every Federal executive agency that enters into certain
contracts must file an information return reporting the
contractor's name, address, TIN, date of contract action,
amount to be paid to the contractor, and any other
information required by Forms 8596 (Information Return for
Federal Contracts) and 8596A (Quarterly Transmittal of
Information Returns for Federal Contracts).
House Bill
No provision.
Senate Amendment
No provision.
Conference Agreement
The conference agreement requires withholding on certain
payments to persons providing property or services made by
the Government of the United States, every State, every
political subdivision thereof, and every instrumentality of
the foregoing (including multi-State agencies). The
withholding requirement applies regardless of whether the
government entity making such payment is the recipient of the
property or services. Political subdivisions of States (or
any instrumentality thereof) with less than $100 million of
annual expenditures for property or services that would
otherwise be subject to withholding under this provision are
exempt from the withholding requirement.
The rate of withholding is three percent on all payments
regardless of whether the payments are for property or
services. Payments subject to withholding under the provision
include any payment made in connection with a government
voucher or certificate program which functions as a payment
for property or services. For example, payments to a
commodity producer under a government commodity support
program are subject to the withholding requirement. The
provision imposes information reporting requirements on the
payments that are subject to withholding under the provision.
The provision does not apply to any payments made through a
Federal, State, or local government public assistance or
public welfare program for which eligibility is determined by
a needs or income test. For example, payments under
government programs providing food vouchers or medical
assistance to low-income individuals are not subject to
withholding under the provision. However, payments under
government programs to provide health care or other services
that are not based on the needs or income of the recipients
are subject to withholding, including programs where
eligibility is based on the age of the beneficiary.
The provision does not apply to payments of wages or to any
other payment with respect to which mandatory (e.g., U.S.-
source income of foreign taxpayers) or voluntary (e.g.,
unemployment benefits) withholding applies under present law.
The provision does not exclude payments that are potentially
subject to backup withholding under section 3406. If,
however, payments are actually being withheld under backup
withholding, withholding under the provision does not apply.
The provision also does not apply to the following:
payments of interest; payments for real property; payments to
tax-exempt entities or foreign governments; intra-
governmental payments; payments made pursuant to a classified
or confidential contract (as defined in section 6050M(e)(3));
and payments to government employees that are not otherwise
excludable from the new withholding provision with respect to
the employees' services as an employees.
Effective date.--The provision applies to payments made
after December 31, 2010.
[[Page H2292]]
B. Eliminate Income Limitations on Roth IRA Conversions
(Sec. 408A of the Code)
Present Law
There are two general types of individual retirement
arrangements (``IRAs''): traditional IRAs and Roth IRAs. The
total amount that an individual may contribute to one or more
IRAs for a year is generally limited to the lesser of: (1) a
dollar amount ($4,000 for 2006); and (2) the amount of the
individual's compensation that is includible in gross income
for the year. In the case of an individual who has attained
age 50 before the end of the year, the dollar amount is
increased by an additional amount ($1,000 for 2006). 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 that is includible in gross income is at least
equal to the contributed amount. IRA contributions in excess
of the applicable limit are generally subject to an excise
tax of six percent per year until withdrawn.
Contributions to a traditional IRA may or may not be
deductible. The extent to which contributions to a
traditional IRA are deductible depends on whether or not the
individual (or the individual's spouse) is an active
participant in an employer-sponsored retirement plan and the
taxpayer's AGI. An individual may deduct his or her
contributions to a traditional IRA 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 AGI over certain levels. To the extent an
individual does not or cannot make deductible contributions,
the individual may make nondeductible contributions to a
traditional IRA, subject to the maximum contribution limit.
Distributions from a traditional IRA are includible in gross
income to the extent not attributable to a return of
nondeductible contributions.
Individuals with adjusted gross income (``AGI'') below
certain levels may make contributions to a Roth IRA (up to
the maximum IRA contribution limit). The maximum Roth IRA
contribution is phased out between $150,000 to $160,000 of
AGI in the case of married taxpayers filing a joint return
and between $95,000 to $105,000 in the case of all other
returns (except a separate return of a married
individual).\541\ Contributions to a Roth IRA are not
deductible. Qualified distributions from a Roth IRA are
excludable from gross income. Distributions from a Roth IRA
that are not qualified distributions are includible in gross
income to the extent attributable to earnings. In general, a
qualified distribution is a distribution that is made on or
after the individual attains age 59\1/2\, death, or
disability or which is a qualified special purpose
distribution. A distribution is not a qualified distribution
if it is made within the five-taxable year period beginning
with the taxable year for which an individual first made a
contribution to a Roth IRA.
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\541\ In the case of a married taxpayer filing a separate
return, the phaseout range is $0 to $10,000 of AGI.
---------------------------------------------------------------------------
A taxpayer with AGI of $100,000 or less may convert all or
a portion of a traditional IRA to a Roth IRA.\542\ The amount
converted is treated as a distribution from the traditional
IRA for income tax purposes, except that the 10-percent
additional tax on early withdrawals does not apply.
---------------------------------------------------------------------------
\542\ Married taxpayers filing a separate return may not
convert amounts in a traditional IRA into a Roth IRA.
---------------------------------------------------------------------------
In the case of a distribution from a Roth IRA that is not a
qualified distribution, certain ordering rules apply in
determining the amount of the distribution that is includible
in income. For this purpose, a distribution that is not a
qualified distribution is treated as made in the following
order: (1) regular Roth IRA contributions; (2) conversion
contributions (on a first in, first out basis); and (3)
earnings. To the extent a distribution is treated as made
from a conversion contribution, it is treated as made first
from the portion, if any, of the conversion contribution that
was required to be included in income as a result of the
conversion.
Includible amounts withdrawn from a traditional IRA or a
Roth IRA before attainment of age 59\1/2\, death, or
disability are subject to an additional 10-percent early
withdrawal tax, unless an exception applies.
House Bill
No provision.
Senate Amendment
No provision.
Conference Agreement
The conference agreement eliminates the income limits on
conversions of traditional IRAs to Roth IRAs.\543\ Thus,
taxpayers may make such conversions without regard to their
AGI.
---------------------------------------------------------------------------
\543\ Under the conference agreement, married taxpayers
filing a separate return may convert amounts in a traditional
IRA into a Roth IRA.
---------------------------------------------------------------------------
For conversions occurring in 2010, unless a taxpayer elects
otherwise, the amount includible in gross income as a result
of the conversion is included ratably in 2011 and 2012. That
is, unless a taxpayer elects otherwise, none of the amount
includible in gross income as a result of a conversion
occurring in 2010 is included in income in 2010, and half of
the income resulting from the conversion is includible in
gross income in 2011 and half in 2012. However, income
inclusion is accelerated if converted amounts are distributed
before 2012.\544\ In that case, the amount included in income
in the year of the distribution is increased by the amount
distributed, and the amount included in income in 2012 (or
2011 and 2012 in the case of a distribution in 2010) is the
lesser of: (1) half of the amount includible in income as a
result of the conversion; and (2) the remaining portion of
such amount not already included in income. The following
example illustrates the application of the accelerated
inclusion rule.
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\544\ Whether a distribution consists of converted amounts is
determined under the present-law ordering rules.
---------------------------------------------------------------------------
Example.--Taxpayer A has a traditional IRA with a value of
$100, consisting of deductible contributions and earnings. A
does not have a Roth IRA. A converts the traditional IRA to a
Roth IRA in 2010, and, as a result of the conversion, $100 is
includible in gross income. Unless A elects otherwise, $50 of
the income resulting from the conversion is included in
income in 2011 and $50 in 2012. Later in 2010, A takes a $20
distribution, which is not a qualified distribution and all
of which, under the ordering rules, is attributable to
amounts includible in gross income as a result of the
conversion. Under the accelerated inclusion rule, $20 is
included in income in 2010. The amount included in income in
2011 is the lesser of (1) $50 (half of the income resulting
from the conversion) or (2) $70 (the remaining income from
the conversion), or $50. The amount included in income in
2012 is the lesser of (1) $50 (half of the income resulting
from the conversion) or (2) $30 (the remaining income from
the conversion, i.e., $100--$70 ($20 included in income in
2010 and $50 included in income in 2011)), or $30.
Effective date.---he provision is effective for taxable
years beginning after December 31, 2009.
C. Repeal of FSC/ETI Binding Contract Relief
Prior and Present Law
For most of the last two decades, the United States
provided export-related tax benefits under the foreign sales
corporation (``FSC'') regime. In 2000, the World Trade
Organization (``WTO'') held that the FSC regime constituted a
prohibited export subsidy under the relevant trade
agreements. In response to this WTO finding, the United
States repealed the FSC rules and enacted a new regime, under
the FSC Repeal and Extraterritorial Income (``ETI'')
Exclusion Act of 2000. Transition rules delayed the repeal of
the FSC rules and the effective date of ETI for transactions
in the ordinary course of a trade or business occurring
before January 1, 2002, or after December 31, 2001 pursuant
to a binding contract between the taxpayer and an unrelated
person which was in effect on September 30, 2000 and at all
times thereafter (the ``FSC binding contract relief'').\545\
In 2002, the WTO held that the ETI regime also constituted a
prohibited export subsidy.
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\545\ An election was provided, however, under which
taxpayers could adopt ETI at an earlier date for transactions
after September 30, 2000. This election allowed the ETI rules
to apply to transactions after September 30, 2000, including
transactions occurring pursuant to pre-existing binding
contracts.
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In general, under the ETI regime, an exclusion from gross
income applied with respect to ``extraterritorial income,''
which was a taxpayer's gross income attributable to ``foreign
trading gross receipts.'' This income was eligible for the
exclusion to the extent that it was ``qualifying foreign
trade income.'' Qualifying foreign trade income was the
amount of gross income that, if excluded, would result in a
reduction of taxable income by the greatest of: (1) 1.2
percent of the foreign trading gross receipts derived by the
taxpayer from the transaction; (2) 15 percent of the
``foreign trade income'' derived by the taxpayer from the
transaction; \546\ or (3) 30 percent of the ``foreign sale
and leasing income'' derived by the taxpayer from the
transaction.\547\
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\546\ ``Foreign trade income'' was the taxable income of the
taxpayer (determined without regard to the exclusion of
qualifying foreign trade income) attributable to foreign
trading gross receipts.
\547\ ``Foreign sale and leasing income'' was the amount of
the taxpayer's foreign trade income (with respect to a
transaction) that was properly allocable to activities
constituting foreign economic processes. Foreign sale and
leasing income also included foreign trade income derived by
the taxpayer in connection with the lease or rental of
qualifying foreign trade property for use by the lessee
outside the United States.
---------------------------------------------------------------------------
Foreign trading gross receipts were gross receipts derived
from certain activities in connection with ``qualifying
foreign trade property'' with respect to which certain
economic processes had taken place outside of the United
States. Specifically, the gross receipts must have been: (1)
from the sale, exchange, or other disposition of qualifying
foreign trade property; (2) from the lease or rental of
qualifying foreign trade property for use by the lessee
outside the United States; (3) for services which were
related and subsidiary to the sale, exchange, disposition,
lease, or rental of qualifying foreign trade property (as
described above); (4) for engineering or architectural
services for construction projects located outside the United
States; or (5) for the performance of certain managerial
services for unrelated persons. A taxpayer could elect to
treat gross receipts from a transaction as not being foreign
trading gross receipts. As a result of such an
[[Page H2293]]
election, a taxpayer could use any related foreign tax
credits in lieu of the exclusion.
Qualifying foreign trade property generally was property
manufactured, produced, grown, or extracted within or outside
the United States that was held primarily for sale, lease, or
rental in the ordinary course of a trade or business for
direct use, consumption, or disposition outside the United
States. No more than 50 percent of the fair market value of
such property could be attributable to the sum of: (1) the
fair market value of articles manufactured outside the United
States; and (2) the direct costs of labor performed outside
the United States. With respect to property that was
manufactured outside the United States, certain rules were
provided to ensure consistent U.S. tax treatment with respect
to manufacturers.
The American Jobs Creation Act of 2004 (``AJCA'') repealed
the ETI exclusion,\548\ generally effective for transactions
after December 31, 2004. AJCA provides a general transition
rule under which taxpayers retain 100 percent of their ETI
benefits for transactions prior to 2005, 80 percent of their
otherwise-applicable ETI benefits for transactions during
2005, and 60 percent of their otherwise-applicable ETI
benefits for transactions during 2006.
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\548\ Pub. L. No. 108-357, sec. 101. In addition, foreign
corporations that elected to be treated for all Federal tax
purposes as domestic corporations in order to facilitate the
claiming of ETI benefits were allowed to revoke such
elections within one year of the date of enactment of the
repeal without recognition of gain or loss, subject to anti-
abuse rules.
---------------------------------------------------------------------------
In addition to the general transition rule, AJCA provides
that the ETI exclusion provisions remain in effect for
transactions in the ordinary course of a trade or business if
such transactions are pursuant to a binding contract \549\
between the taxpayer and an unrelated person and such
contract is in effect on September 17, 2003, and at all times
thereafter (the ``ETI binding contract relief'').
---------------------------------------------------------------------------
\549\ This rule also applies to a purchase option, renewal
option, or replacement option that is included in such
contract. For this purpose, a replacement option is
considered enforceable against a lessor notwithstanding the
fact that a lessor retained approval of the replacement
lessee.
---------------------------------------------------------------------------
In early 2006, the WTO Appellate Body held that the ETI
general transition rule and the FSC and ETI binding contract
relief measures are prohibited export subsidies.
House Bill
No provision.
Senate Amendment
No provision.
Conference Agreement
The conference agreement repeals both the FSC binding
contract relief and the ETI binding contract relief. The
general transition rule remains in effect.
Effective date.--The provision is effective for taxable
years beginning after date of enactment.
D. Modification of Wage Limit for Purposes of Domestic Production
Activities Deduction
(Sec. 199 of the Code)
Present Law
In general
Present law provides a deduction from taxable income (or,
in the case of an individual, adjusted gross income) that is
equal to a portion of the taxpayer's qualified production
activities income. For taxable years beginning after 2009,
the deduction is nine percent of such income. For taxable
years beginning in 2005 and 2006, the deduction is three
percent of income and, for taxable years beginning in 2007,
2008 and 2009, the deduction is six percent of income.
However, the deduction for a taxable year is limited to 50
percent of the wages paid by the taxpayer during the calendar
year that ends in such taxable year.\550\
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\550\ For purposes of the provision, ``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, for taxable years
beginning after December 31, 2005, designated Roth
contributions (as defined in section 402A).
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Qualified production activities income
In general, ``qualified production activities income'' is
equal to domestic production gross receipts (defined by
section 199(c)(4)), reduced by the sum of: (1) the costs of
goods sold that are allocable to such receipts; and (2) other
expenses, losses, or deductions which are properly allocable
to such receipts.
Application of wage limitation to passthrough entities
For purposes of applying the wage limitation, a
shareholder, partner, or similar person who is allocated
components of qualified production activities income from a
passthrough entity also is treated as having been allocated
wages from such entity in an amount that is equal to the
lesser of: (1) such person's allocable share of wages, as
determined under regulations prescribed by the Secretary; or
(2) twice the qualified production activities income that
actually is allocated to such person for the taxable year.
House Bill
No provision.
Senate Amendment
No provision.
Conference Agreement
Under the conference agreement, the wage limitation is
modified such that taxpayers may only include amounts which
are properly allocable to domestic production gross
receipts.\551\ Thus, the wage limitation is 50 percent of
those wages which are deducted in arriving at qualified
production activities income.
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\551\ As under present law, the Secretary shall provide rules
for the proper allocation of items (including wages) in
determining qualified production activities income. Section
199(c)(2).
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In addition, the conference agreement repeals the special
limitation on wages treated as allocated to partners or
shareholders of passthrough entities. Accordingly, for
purposes of the wage limitation, a shareholder, partner, or
similar person who is allocated components of qualified
production activities income from a passthrough entity is
treated as having been allocated wages from such entity in an
amount that is equal to such person's allocable share of
wages as determined under regulations prescribed by the
Secretary, even if such amount is more than twice the
qualified production activities income that actually is
allocated to such person for the taxable year. The
shareholder, partner, or similar person will then include in
its wage limitation only those wages which are deducted in
arriving at qualified production activities income.
Effective date.--The conference agreement is effective with
respect to taxable years beginning after the date of
enactment.
E. Modification of Exclusion for Citizens Living Abroad
(Sec. 911 of the Code)
Present Law
In general
U.S. citizens generally are subject to U.S. income tax on
all their income, whether derived in the United States or
elsewhere. A U.S. citizen who earns income in a foreign
country also may be taxed on that income by the foreign
country. The United States generally cedes the primary right
to tax a U.S. citizen's non-U.S. source income to the foreign
country in which the income is derived. This concession is
effected by the allowance of a credit against the U.S. income
tax imposed on foreign-source income for foreign taxes paid
on that income. The amount of the credit for foreign income
tax paid on foreign-source income generally is limited to the
amount of U.S. tax otherwise owed on that income.
Accordingly, if the amount of foreign tax paid on foreign-
source income is less than the amount of U.S. tax owed on
that income, a foreign tax credit generally is allowed in an
amount not exceeding the amount of the foreign tax, and a
residual U.S. tax liability remains.
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.\552\ This exclusion applies
regardless of whether any foreign tax is paid on the foreign
earned income or housing costs. To qualify for these
exclusions, an individual (a ``qualified individual'') must
have his or her tax home in a foreign country and must be
either (1) a U.S. citizen \553\ who is a bona fide resident
of a foreign country or countries for an uninterrupted period
that includes an entire taxable year, or (2) a U.S. citizen
or resident present in a foreign country or countries for at
least 330 full days in any 12-consecutive-month period.
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\552\ Sec. 911.
\553\ Generally, only U.S. citizens may qualify under the
bona fide residence test. A U.S. resident alien who is a
citizen of a country with which the United States has a tax
treaty may, however, qualify for the section 911 exclusions
under the bona fide residence test by application of a
nondiscrimination provision of the treaty.
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Exclusion for compensation
The foreign earned income exclusion generally is available
for a qualified individual's non-U.S. source earned income
attributable to personal services performed by that
individual during the period of foreign residence or presence
described above. The maximum exclusion amount for any
calendar year is $80,000 in 2002 through 2007 and is indexed
for inflation after 2007.
Exclusion for housing costs
A qualified individual is allowed an exclusion from gross
income (or, as described below, a deduction) for certain
foreign housing costs paid or incurred by or on behalf of the
individual. The amount of this housing cost exclusion is
equal to the excess of a taxpayer's ``housing expenses'' over
a base housing amount. The term ``housing expenses'' means
the reasonable expenses paid or incurred during the taxable
year for a taxpayer's housing (and, if they live with the
taxpayer, for the housing of the taxpayer's spouse and
dependents) in a foreign country. The term includes expenses
attributable to housing such as utilities and insurance, but
it does not include separately deductible interest and taxes.
If the taxpayer maintains a second household outside the
United States for a spouse or dependents who do not reside
with the taxpayer because of dangerous, unhealthful, or
otherwise adverse living conditions, the housing expenses of
the second household also are eligible for exclusion. The
base housing amount above which costs are eligible for
exclusion in a taxable year is 16 percent of the annual
salary (computed on a daily basis) of a grade GS-14, step 1,
U.S. government employee, multiplied by the number of days of
foreign residence or presence (as described above) in the
taxable year.
[[Page H2294]]
For 2006 this salary is $77,793; the current base housing
amount therefore is $12,447 (assuming the taxpayer is a bona
fide resident of or is present in a foreign country every day
during the year).
To the extent otherwise excludable housing costs are not
paid or reimbursed by a taxpayer's employer, these costs
generally are allowed as a deduction in computing adjusted
gross income.
Exclusion limitation amounts
The combined foreign earned income exclusion and housing
cost exclusion (including the amount of any deductible
housing costs) may not exceed the taxpayer's total foreign
earned income for the taxable year. The taxpayer's foreign
tax credit is reduced by the amount of the credit that is
attributable to excluded income.
Tax brackets
A taxpayer with excludable income under section 911 is
subject to tax on the taxpayer's other income, after
deductions, starting in the lowest tax rate bracket.
house bill
No provision.
senate amendment
No provision.
conference agreement
Exclusion for compensation
The conference agreement provision adjusts for inflation
the maximum amount of the foreign earned income exclusion in
taxable years beginning in calendar years after 2005 (rather
than, as under present law, after 2007). The limitation in
2006 therefore is $82,400.\554\
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\554\ This $82,400 amount is calculated under section
911(b)(2)(D)(ii), as amended by the conference agreement
provision, using current U.S. Bureau of Labor Statistics
(``BLS'') Consumer Price Index data.
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Exclusion for housing costs
Under the conference agreement, the base housing amount
used in calculating the foreign housing cost exclusion in a
taxable year is 16 percent of the amount (computed on a daily
basis) of the foreign earned income exclusion limitation
(instead of the present law 16 percent of the grade GS-14,
step 1 amount), multiplied by the number of days of foreign
residence or presence (as previously described) in that year.
Reasonable foreign housing expenses in excess of the base
housing amount remain excluded from gross income (or, if paid
by the taxpayer, are deductible) under the conference
agreement, but the amount of the exclusion is limited to 30
percent of the maximum amount of a taxpayer's foreign earned
income exclusion.\555\ The Secretary is given authority to
issue regulations or other guidance providing for the
adjustment of this 30-percent housing cost limitation based
on geographic differences in housing costs relative to
housing costs in the United States. The conferees intend that
the Secretary be permitted to use publicly available data,
such as the Quarterly Report Indexes published by the U.S.
Department of State or any other information deemed reliable
by the Secretary, in making adjustments. The conferees also
intend that the Secretary may adjust the 30-percent amount
upward or downward. The conferees intend that the Secretary
make adjustments annually.
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\555\ In certain programs including grant-making to subsidize
rents, the U.S. Department of Housing and Urban Development
considers maximum affordable housing costs to be 30 percent
of a household's income. See, e.g., United States Housing Act
of 1937, 42 U.S.C. sec. 1437a (a)(1)(A), as amended.
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Under the 30-percent rule described above, the maximum
amount of the foreign housing cost exclusion in 2006 is
(assuming foreign residence or presence on all days in the
year) $11,536 (= ($82,400 x 30 percent)--($82,400 x 16
percent)).\556\
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\556\ The $11,536 amount is based on a calculation under
section 911(b)(2)(D)(ii), as amended by the conference
agreement, using the BLS data described above.
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Tax brackets
Under the conference agreement, if an individual excludes
an amount from income under section 911, any income in excess
of the exclusion amount determined under section 911 is taxed
(under the regular tax and alternative minimum tax) by
applying to that income the tax rates that would have been
applicable had the individual not elected the section 911
exclusion. For example, an individual with $80,000 of foreign
earned income that is excluded under section 911 and with
$20,000 in other taxable income (after deductions) would be
subject to tax on that $20,000 at the rate or rates
applicable to taxable income in the range of $80,000 to
$100,000.
Effective date
The conference agreement provision is effective for taxable
years beginning after December 31, 2005.
TITLE IX--CORPORATE ESTIMATED TAX PROVISIONS
present law
In general, corporations are required to make quarterly
estimated tax payments of their income tax liability. For a
corporation whose taxable year is a calendar year, these
estimated tax payments must be made by April 15, June 15,
September 15, and December 15.
house bill
No provision.
senate amendment
No provision.
conference agreement
In case of a corporation with assets of at least $1
billion, payments due in July, August, and September, 2006,
shall be increased to 105 percent of the payment otherwise
due and the next required payment shall be reduced
accordingly.
In case of a corporation with assets of at least $1
billion, the payments due in July, August, and September,
2012, shall be increased to 106.25 percent of the payment
otherwise due and the next required payment shall be reduced
accordingly.
In case of a corporation with assets of at least $1
billion, the payments due in July, August, and September,
2013, shall be increased to 100.75 percent of the payment
otherwise due and the next required payment shall be reduced
accordingly.
With respect to corporate estimated tax payments due on
September 15, 2010, 20.5 percent shall not be due until
October 1, 2010.
With respect to corporate estimated tax payments due on
September 15, 2011, 27.5 percent shall not be due until
October 1, 2011.
Effective date.--The provision is effective on the date of
enactment.
TITLE X--COMPLEXITY ANALYSIS
Section 4022(b) of the Internal Revenue Service Reform and
Restructuring Act of 1998 (the ``IRS Reform Act'') requires
the Joint Committee on Taxation (in consultation with the
Internal Revenue Service (``IRS'') and the Department of the
Treasury) to provide a tax complexity analysis. The
complexity analysis is required for all legislation reported
by the Senate Committee on Finance, the House Committee on
Ways and Means, or any committee of conference if the
legislation includes a provision that directly or indirectly
amends the Internal Revenue Code (the ``Code'') and has
widespread applicability to individuals or small businesses.
For each such provision identified by the staff of the Joint
Committee on Taxation, a summary description of the provision
is provided along with an estimate of the number and type of
affected taxpayers, and a discussion regarding the relevant
complexity and administrative issues.
Following the analysis of the staff of the Joint Committee
on Taxation are the comments of the IRS and Treasury
regarding each of the provisions included in the complexity
analysis.
Capital gain and dividend rate reduction (sec. 102 of the
conference agreement)
Summary description of provision
The conference agreement extends the zero- and 15-percent
capital gain and dividend rates to taxable years beginning in
2009 and 2010.
Number of affected taxpayers
It is estimated that the provision will affect 33 million
individual tax returns.
Discussion
The extension of the provision means that for 2009 and 2010
individual taxpayers and the IRS will continue to use the
same forms for capital gains and dividends.
The extension of the lower rates for net capital gain will
achieve simplification because the extension prevents the
separate five-year holding periods from going into effect in
2009 and 2010. On the other hand, the extension of the lower
rates for dividends will continue requiring dividends to be
classified as qualified dividends and nonqualified dividends
in 2009 and 2010 and will continue to require the tax to be
computed using the capital gains forms.
Increase in the AMT exemption amount (sec. 301 of the
conference agreement)
Summary description of the provision
The alternative minimum tax exemption amounts for 2006 are
increased.
Number of affected taxpayers
It is estimated that the provisions will affect
approximately 19 million individual tax returns.
Discussion
Many individuals will not have to compute their alternative
minimum tax and file the IRS forms relating to that tax.
TITLE XI--UNFUNDED MANDATES
The staff of the Joint Committee on Taxation has reviewed
the tax provisions in the conference agreement for H.R. 4297,
the ``Tax Relief Extension Reconciliation Act of 2005'' as
agreed to by the conferees. This information is provided in
accordance with the requirements of Public Law 104-04, the
Unfunded Mandates Reform Act of 1995, which provides that if
a conference agreement contains (1) a mandate that was not
previously considered by either the House or the Senate, or
(2) an increase in the direct cost of a previously considered
mandate, then the committee of conference is to ensure, to
the greatest extent practicable, that a mandates statement is
prepared.
We have determined that the tax provisions of the
conference agreement contain two unfunded private sector
mandates that were not previously considered by either the
House or the Senate: (1) repeal of FSC-ETI grandfather rule,
and (2) amend section 911 housing exclusion. In addition, the
provision relating to withholding on certain government
payments imposes an intergovernmental mandate not previously
considered by either the House or the Senate.
The costs required to comply with each Federal private
sector mandate and Federal intergovernmental mandate
generally are no greater than the aggregate estimated budget
[[Page H2295]]
effects of the provision as indicated on the enclosed revenue
table. Benefits from the provisions include improved
administration of the tax laws and a more accurate
measurement of income for Federal income tax purposes.
[[Page H2296]]
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[[Page H2299]]
William Thomas,
Jim McCrery,
Dave Camp,
Managers on the Part of the House.
Chuck Grassley,
Jon Kyl,
Managers on the Part of the Senate.
____________________