[Senate Report 104-279]
[From the U.S. Government Publishing Office]



104th Congress                                                   Report
                                 SENATE

 2d Session                                                     104-279
_______________________________________________________________________


 
              ADOPTION PROMOTION AND STABILITY ACT OF 1996

                                _______


                 June 13, 1996.--Ordered to be printed

_______________________________________________________________________


    Mr. Roth, from the Committee on Finance, submitted the following

                              R E P O R T

                        [To accompany H.R. 3286]

    The Committee on Finance, to which was referred the bill 
(H.R. 3286) to help families defray adoption costs, and to 
promote the adoption of minority children, having considered 
the same, reports favorably thereon with amendments and 
recommends that the bill as amended do pass.

                                CONTENTS

                                                                   Page
  I. LEGISLATIVE BACKGROUND AND SUMMARY...............................1
          A. Legislative Background..............................     1
          B. Summary.............................................     2
 II. EXPLANATION OF THE BILL..........................................2
          A. Tax Credit and Exclusion for Adoption Expenses......     2
          B. Removal of Barriers to Interethnic Adoptions........     5
          C. Revenue Offsets.....................................     6
              1. Treatment of bad debt deductions of thrift 
                  institutions...................................     6
              2. Depreciation under the income forecast method...    16
III. BUDGET EFFECTS OF THE BILL......................................20
          A. Committee Estimates.................................    20
          B. Budget Authority and Tax Expenditures...............    22
          C. Consultation with Congressional Budget Office.......    22
 IV. VOTE OF THE COMMITTEE...........................................22
  V. REGULATORY IMPACT AND OTHER MATTERS.............................22
          A. Regulatory Impact...................................    22
          B. Information Relating to Unfunded Mandates...........    23
 VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED...........24

                 I. LEGISLATIVE BACKGROUND AND SUMMARY

                       A. Legislative Background

    The Senate Committee on Finance marked up H.R. 3286 
(``Adoption Promotion and Stability Act of 1996'') on June 12, 
1996. The Committee on Finance amended Titles, I, II, and IV of 
the bill.
    H.R. 3286 was passed by the House of Representatives on May 
10, 1996. As passed by the House, title I of the bill would 
provide a tax credit for certain adoption expenses and an 
exclusion for certain employer-provided adoption expenses; 
title II of the bill would remove certain barriers to 
interethnic adoptions; Title III of the bill would modify child 
custody proceedings affected by the Indian Child Welfare Act of 
1978; and Title IV of the bill would provide two revenue 
offsets: (1) remove business exclusion for energy subsidies 
provided by public utilities, and (2) modify treatment of 
foreign trusts.
    The Committee on Finance ordered the bill, as amended, 
favorably reported by voice vote on June 12, 1996. The bill is 
to be referred to the Senate Committee on Indian Affairs for a 
period of 10 legislative days for consideration of Title III of 
the bill.

                               B. Summary

    H.R. 3286, as amended by the Committee on Finance, 
provides: (1) a tax credit for certain adoption expenses and an 
exclusion for amounts received by an employee for certain 
adoption expenses under an employer adoption assistance program 
(Title I); (2) removal of barriers to interethnic adoptions 
(Title II); and (3) revenue offsets for the bill (repeal of bad 
debt deduction for certain thrift institutions and modification 
of the depreciation rules under the income forecast method of 
accounting). The Committee on finance only acted on titles I, 
II, and IV of the bill. Title III (relating to child custody 
proceedings affected by the Indian Child Welfare Act of 1978) 
will be referred to the Committee on Indian Affairs for a 
period of 10 legislative days.

                      II. EXPLANATION OF THE BILL

A. Tax Credit and Exclusion for Adoption Expenses (Sec. 101 of the Bill 
                 and New Secs. 23 and 137 of the Code)

Present law

    Under present law, the Federal Adoption Assistance program 
(a Federal outlay program) provides financial assistance for 
the adoption of certain special needs children. In general, a 
special needs child is defined as a child who (1) according to 
a State determination, could not or should not be returned to 
the home of the natural parents and (2) on account of a 
specific factor or condition (such as ethnic background, age, 
membership in a minority or sibling group, medical conditions, 
or physical, mental or emotional handicap), could not 
reasonably be expected to be adopted unless adoption assistance 
is provided. Specifically, the program provides assistance for 
adoption expenses for those special needs children receiving 
Federally assisted adoption assistance payments as well as 
special needs children in private and State-funded programs. 
The maximum Federal reimbursement is $1,000 per special needs 
child. Reimbursable expenses include those nonrecurring costs 
directly associated with the adoption process such as legal 
costs, social service review, and transportation costs.
    Present law provides no specific Federal tax benefits to 
encourage adoption.

Reason for change

    The Committee believes that the financial costs of the 
adoption process should not be barrier to adoption. In 
addition, the Committee wishes to encourage further the 
adoption of special needs children, as defined under present 
law section 473(c) of the Social Security Act. Therefore in the 
case of special needs adoptions, the maximum tax credit is 
increased from $5,000 to $6,000, and it is not subject to the 
sunset. Similarly, the allowable exclusion under an employer 
adoption assistance program is increased from $5,000 to $6,000 
in the case of a special needs adoption
    The Committee believes that encouraging adoptions in an 
efficient manner requires a continuous effort to improve the 
delivery of Federal subsidies. For this reason, the Committee 
believes that a Treasury Department study is necessary to 
determine whether the adoption credit and exclusion are an 
efficient Federal subsidy.

Explanation of provision

            Tax credit
    The bill provides taxpayers with a maximum nonrefundable 
credit against income tax liability of $5,000 per child for 
qualified adoption expenses paid or incurred by the taxpayer. 
In the case of a special needs adoption, the maximum credit 
amount is $6,000. Any unused adoption credit may be carried 
forward by the taxpayer for up to five years. Qualified 
adoption expenses are reasonable and necessary adoption fees, 
court costs, attorneys' fees, and other expenses that are 
directly related to the legal adoption of an eligible child. 
All reasonable and necessary expenses required by a State as a 
condition of adoption and qualified adoption expenses. For 
example, expenses may include the cost of construction, 
renovations, alterations of purchases specifically required by 
the State to meet the needs of the child. In the case of an 
adoption of a child who is not a citizen or a resident of the 
United States (foreign adoption), the credit is not available 
unless the adoption is finalized. In the case of otherwise 
qualified expenses that are incurred in an adoption that is not 
yet identified as either a domestic or a foreign adoption, the 
credit would not be available until the expenses are identified 
as either relating to a domestic adoption (whether or not 
finalized) or to a finalized foreign adoption. In some 
instances that may require the filing of an amended tax return. 
An eligible child is an individual (1) who has not attained age 
18 or (2) who is physically or mentally incapable of caring for 
himself or herself. After December 31, 2000, the credit will be 
available only for special needs adoptions. No credit is 
allowed for expenses incurred (1) in violation of State or 
Federal law, (2) in carrying out any surrogate parenting 
arrangement, (3) in connection with the adoption assistance 
program or otherwise. The credit is phased out ratably for 
taxpayers with modified adjusted gross income (AGI) above 
$75,000, and is fully phased out at $115,000 of modified AGI.
    The $5,000 limit is a per child limit, not an annual 
limitation. For example, if in the case of an attempt to adopt 
a child a taxpayer incurs $3,000 of qualified adoption expenses 
in year one and $3,000 of qualified adoption expenses in year 
two, then the taxpayer would receive a $3,000 credit in year 
one and a $2,000 credit in year two. To illustrate further, if 
a taxpayer incurs $1,000 of otherwise qualified adoption 
expenses at each of three agencies in unsuccessful attempts to 
adopt a child before incurring $4,000 of otherwise qualified 
adoption expenses in a successful domestic adoption, the 
taxpayer's maximum adoption credit is $5,000, not $7,000.
    To avoid a double benefit, the bill denies the credit to 
taxpayers to the extent the taxpayer may use otherwise 
qualified adoption expenses as the basis of another credit or 
deduction. Similarly, the credit is not allowed for any 
expenses for which a grant is received under any Federal, 
State, or local program. This denial of the credit also applies 
in the case of special needs adoptions.
    The bill provides that individuals who are married at the 
end of the taxable year must file a joint return to receive the 
credit unless they lived apart from each other for the last six 
months of the taxable year and the individual claiming the 
credit (1) maintained as his or her home a household for the 
child for more than one-half of the taxable year and (2) 
furnished over one-half of the cost of maintaining that 
household in that taxable year. Further, the bill provides that 
an individual legally separated from his or her spouse under a 
decree of divorce or separate maintenance is not considered 
married for purposes of this provision.
            Exclusion from income
    The bill provides a maximum $5,000 exclusion from the gross 
income of an employee for qualified adoption expenses (as 
defined above) paid by the employer. The $5,000 limit is a per 
child limit, not an annual limitation. In the case of a special 
needs adoption, the maximum exclusion from income is $6,000. No 
exclusion is allowed for expenses paid by an employer after 
December 31, 2000. In order for the exclusion to apply, the 
expenses would have to be paid under an adoption assistance 
program in connection with an adoption of an eligible child (as 
described above) by an employee.
    An adoption assistance program is a nondiscriminatory plan 
of an employer under which the employer provides employees with 
adoption assistance. Also, not more than 5 percent of the 
benefits under the program for any year may benefit a class of 
individuals consisting of more than 5-percent owners of the 
employer and the spouses or dependents of such more than 5-
percent owners. An adoption assistance program is not required 
to be funded but must provide reasonable notification of the 
availability and terms of the program to eligible employees. An 
adoption reimbursement program operated under section 1052 of 
title 10 of the U.S. Code (relating to the armed forces) or 
section 514 of title 14 of the U.S. Code (relating to members 
of the Coast Guard) is treated as an adoption assistance 
program for these purposes. Adoption assistance is a qualified 
benefit under a cafeteria plan. The exclusion is phased out 
ratably for taxpayers with modified AGI above $75,000 and is 
fully phased out at $115,000 of modified AGI. Employees are not 
entitled to claim the adoption tax credit with respect to 
excludable adoption expenses paid or reimbursed under an 
employer's adoption assistance program.
    Under the bill, the Secretary has the authority to issue 
regulations to carry out these provisions, including 
regulations treating unmarried individuals as one taxpayer with 
respect to the same child.
            Treasury study
    The Secretary of the Treasury is directed to prepare a 
study of the effects of the tax credit and exclusion on both 
non-special needs adoptions and special needs adoptions, to be 
submitted to the House Committee on Ways and Means and the 
Senate Committee on Finance by January 1, 2000.

Effective date

    The provision is effective for taxable years beginning 
after December 31, 1996.

 B. Removal of Barriers to Interethnic Adoptions (Sec. 201 of the Bill 
          and Secs. 471(a) and 474 of the Social Security Act)

Present law

    State law governs adoption and foster care placement. Many 
States permit race matching of foster and adoptive parents with 
children either by regulation, statute, policy, or practice. 
The Howard M. Metzenbaum Multiethnic Placement Act of 1994, 
Public Law 103-382 (``Metzenbaum Act''), permits States to 
consider race and ethnicity in selecting a foster care or 
adoptive home, but States cannot delay or deny the placement of 
the child solely on the basis of race, color, or national 
origin.
    Noncompliance with the Metzenbaum Act is deemed a violation 
of Title VI of the Civil Rights Act of 1964.

Reasons for change

    The Committee is concerned that Public Law 103-382 was not 
having the intended effect of facilitating the adoption of 
minority children. In addition, Public Law 103-382 lacked an 
enforcement provision backed by serious penalties. As a result, 
the law was ineffective in promoting the best interests of 
children by decreasing the length of time they wait to be 
adopted.
    Under the terms of the Committee bill, ``race, color or 
national origin'' cannot be used to delay or deny the placement 
of a child into a foster or adoptive placement. The Committee 
agreed that any delay is clearly not in the child's best 
interest and must not be tolerated for the purposes of race-
matching. The major concern of the Committee is to ensure that 
States that can be shown to pursue policies that lead to any 
delay in the adoption of any child be subjected to the penalty 
terms of this legislation.

Explanation of provision

    Under the bill, ``race, color or national origin'' cannot 
be used to delay or deny the placement of a child into a foster 
or adoptive placement. Under the bill, section 558 of the 
Metzenbaum Act is repealed. In addition, the bill amends the 
State plan requirements of section 471 of the Social Security 
Act to prohibit a State or other entity that receives Federal 
assistance from denying to any person the opportunity to become 
an adoptive or a foster parent on the basis of the race, color, 
or national origin of the person or of the child involved. 
Similarly, no State or other entity receiving Federal funds can 
delay or deny the placement of a child for adoption or foster 
care in making a placement decision, on the basis of the race, 
color, or national origin of the adoptive or foster parent or 
the child involved.
    Section 474 of the Social Security Act is amended to 
require the Secretary of Health and Human Services (``HHS'') to 
reduce the amount of Federal foster care and adoption funds 
provided to the State through Title IV-E if the State program 
is found in violation of this provision as a result of a review 
conducted under section 1123 of the Social Security Act. States 
found to be in violation will have their quarterly funds 
reduced by 2 percent for the first violation, by 5 percent for 
the second violation, and by 10 percent for the third or 
subsequent violation.
    The bill clarifies that the Secretary of HHS shall apply 
penalties in conformance with section 1123 procedures. The bill 
clarifies that penalties will be assessed on a fiscal year 
basis. The bill limits to 25 percent the maximum amount the 
Secretary of HHS can reduce a State's grant in a quarter.
    Private entities found to be in violation of this provision 
for a quarter will be required to return to the Secretary of 
HHS all federal funds received from the State during the 
quarter.
    Any individual who is harmed by a violation of this title 
of the bill could seek redress in any United States District 
Court. An action under this title could not be brought more 
than two years after the alleged violation occurred.
    Noncompliance with Title II of the bill will constitute a 
violation of Title VI of the Civil Rights Act of 1964. The 
Indian Child Welfare Act of 1978 will not be affected by 
changes made by the bill.

Effective date

    The provisions related to civil rights enforcement are 
effective upon enactment. The provisions related to State plan 
requirements are effective on January 1, 1997.

                           C. Revenue Offsets

1. Treatment of bad debt deductions of thrift institutions (sec. 401 of 
                   the bill and sec. 593 of the Code)

Present law and background

            Reserve method of accounting for bad debts of thrift 
                    institutions
    Generally, a taxpayer engaged in a trade or business may 
deduct the amount of any debt that becomes wholly or partially 
worthless during the year (the ``specific charge-off'' method 
of sec. 166). Certain thrift institutions (building and loan 
associations, mutual savings banks, or cooperative banks) are 
allowed deductions for bad debts under rules more favorable 
than those granted to other taxpayers (and more favorable than 
the rules applicable to other financial institutions). 
Qualified thrift institutions may compute deductions for bad 
debts using either the specific charge-off method or the 
reserve method of section 593. To qualify for this reserve 
method, a thrift institution must meet an asset test, requiring 
that 60 percent of its assets consist of ``qualifying assets'' 
(generally cash, government obligations, and loans secured by 
residential real property). This percentage must be computed at 
the close of the taxable year, or at the option of the 
taxpayer, as the annual average of monthly, quarterly, or 
semiannual computations of similar percentages.
    If a thrift institution uses the reserve method of 
accounting, it must establish and maintain a reserve for bad 
debts and charge actual losses against the reserve, and is 
allowed a deduction for annual additions to restore the reserve 
to its permitted balance. Under section 593, a thrift 
institution annually may elect to calculate its addition to its 
bad debt reserve under either (1) the ``percentage of taxable 
income'' method applicable only to thrift institutions, or (2) 
the ``experience'' method that also is available to small 
banks.
    Under the ``percentage of taxable income'' method, a thrift 
institution generally is allowed a deduction for an addition to 
its bad debt reserve equal to 8 percent of its taxable income 
(determined without regard to this deduction and with 
additional adjustments). Under the experience method, a thrift 
institution generally is allowed a deduction for an addition to 
its bad debt reserve equal to the greater of: (1) an amount 
based on its actual average experience for losses in the 
current and five preceding taxable years, or (2) an amount 
necessary to restore the reserve to its balance as of the close 
of the base year. For taxable years beginning before 1988, the 
``base year'' was the last taxable year before the most recent 
adoption of the experience method (i.e., generally, the last 
year the taxpayer was on the percentage of taxable income 
method). For taxable years beginning after 1987, the base year 
is the last taxable year beginning before 1988. Prior to 1988, 
computing bad debts under a ``base year'' rule allowed a thrift 
institution to claim a deduction for bad debts for an amount at 
least equal to the institution's actual losses that were 
charged off during the taxable year.
            Bad debt methods of commercial banks
    A small commercial bank (i.e., one with adjusted bases of 
assets of $500 million or less) may use the experience method 
or the specific charge-off method for purposes of computing its 
deduction for bad debts. A large commercial bank only may use 
the specific charge-off method of section 166. If a small bank 
becomes a large bank, it must recapture its existing bad debt 
reserve (i.e., include the amount of the reserve in income) 
through one of two elective methods. Under the 4-year recapture 
method, the bank generally includes 10 percent of the reserve 
in income in the first taxable year, 20 percent in the second 
year, 30 percent in the third year, and 40 percent in the 
fourth year. Under the cut-off method, the bank generally 
neither restores it bad debt reserve to income nor may it 
deduct losses relating to loans held by the bank as of the date 
of the required change in the method of accounting. Rather, the 
amount of such losses are charged against and reduce the 
existing bad debt reserve, any losses in excess of the reserve 
are deductible. Any reserve balance in excess of the balance of 
related loans is included in income.
            Recapture of bad debt reserves by thrift institutions
    If a thrift institution becomes a commercial bank, or if 
the institution fails to satisfy the 60-percent qualified asset 
test, it is required to change its method of account for bad 
debts and, under proposed Treasury regulations,\1\ is required 
to recapture its bad debt reserve. The percentage-of-taxable-
income portion of the reserve generally is included in income 
ratably over a 6-taxable year period. The experience method 
portion of the reserve is not restored to income if the former 
thrift institution qualifies as a small bank. If the former 
thrift institution is treated as a large bank, the experience 
method portion of the reserve is restored to income ratably 
over a 6-taxable year period, or under the 4-year recapture 
method or the cut-off method described above.
---------------------------------------------------------------------------
    \1\ Prop. Treas. reg. sec. 1.593-13.
---------------------------------------------------------------------------
    In addition, a thrift institution may be subject to a form 
of reserve recapture even if the institution continues to 
qualify for the percentage of taxable income method. 
Specifically, if a thrift institution distributes to its 
shareholders an amount in excess of its post-1951 earnings and 
profits, such excess is deemed to be distributed from the non-
experience portion of the institution's bad debt reserve and is 
restored to income. In the case of any distribution in 
redemption of stock or in partial or complete liquidation of an 
institution, the distribution is treated as first coming from 
the nonexperience portion of the bad debt reserves of the 
institution (sec. 593(e)).
            Financial accounting treatment of tax reserves of bad debts 
                    of thrift institutions
    The recapture of a bad debt reserve for Federal income tax 
purposes may have significant financial and regulatory 
accounting implications for a thrift institution. In general, 
for financial accounting purposes, a corporation must record a 
deferred tax liability with respect to items that are deducted 
for tax purposes in a period earlier than they are expensed for 
book purposes. The deferred tax liability signifies that, 
although a corporation may be reducing its current tax expense 
because of the accelerated tax deduction, the corporation will 
become liable for tax in a future period when the timing item 
``reverses'' (i.e., when the item is expensed for book purposes 
but for which the tax deduction had already been allowed). 
Under the applicable accounting standard (Accounting Principles 
Board Opinion 23), deferred tax liabilities generally were not 
required for pre-1988 tax deductions attributable to the bad 
debt reserve method of thrift institutions because the 
potential reversal of the bad debt reserve was indefinite 
(i.e., generally, a reversal only would occur by operation of 
sec. 593(e), a condition within the control of a thrift 
institution). However, the establishment of 1987 as a base year 
increased the likelihood of bad debt reserve reversals with 
respect to post-1987 additions to the reserve and it appears 
that thrift institutions generally have recorded additional 
deferred tax liabilities for these additions under the current 
generally accepted accounting principles.\2\
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    \2\ For taxable years beginning before 1988, the base year balance 
of a thrift institution was the reserve balance whenever the 
institution changed from one bad debt method to another (e.g., from the 
percentage of taxable income method to the experience method). How the 
establishment of 1987 as a permanent base year changed the nature of 
the bad debt reserves of thrift institutions between pre-1988 years and 
post-1987 years (which, in turn, contributed to the change in the 
financial accounting treatment of such reserves) can be illustrated by 
the following example:
    Assume that a thrift institution (``T'') always had used the 
percentage of taxable income (``PTI'') method to deduct bad debts 
through 1986 when its reserve balance was $10,000. Further assume that 
in 1987, T: (1) has insufficient taxable income to use the PTI method, 
(2) has actual bad debt losses of $1,000, and (3) under the six-year 
average formula of the experience method, would be allowed a deduction 
of $900. Under these facts, T would be allowed a bad debt deduction of 
$1,000 (rather than $900) in 1987 because $1,000 is the amount 
necessary to restore the reserve to its base year (PTI) level. 
Specifically, in 1987, T would charge the year-end 1986 reserve of 
$10,000 for the $1,000 actual loss and then add (and deduct) $1,000 to 
the reserve so that the balance of the reserve at year end 1987 is once 
again $10,000. Thus, T's former PTI deductions, which gave rise to the 
$10,000 reserve balance, generally would not be restored to income 
(unless subject to sec. 593(e)).
    Further assume that in 1988, T has sufficient taxable income to be 
allowed a PTI deduction of $1,500, increasing the balance of the 
reserve to $11,500 at year-end 1988. Further assume that in 1989, T: 
(1) again has insufficient taxable income to use the PTI method, (2) 
has actual bad debts of $2,500, and (3) under the six-year average 
formula of the experience method would be allowed a deduction of $900. 
Under these facts, T would be allowed a deduction of $1,000 (i.e., the 
amount necessary to restore the reserve to its base year (year-end 
1987) level). Specifically, T would charge the year-end 1988 reserve 
balance of $11,500 for the $2,500 actual loss and then add (and deduct) 
$1,000 to the reserve to restore the balance to the $10,000 base year 
amount. Thus, T's post-1987 PTI deduction of $1,500 is restored to 
income (i.e., T actually had losses of $2,500 in 1989, but only was 
allowed to deduct $1,000).
    The Committee also understands that a thrift institution may record 
a current or deferred tax liability in cases where the institution's 
deduction for bad debts may be limited under section 585(b)(2)(B)(ii) 
because the amount of institution's loans outstanding diminished from 
the close of the base year to the close of the current year.
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    Under proposed Treasury regulations, if a thrift 
institution becomes a commercial bank (or is otherwise 
ineligible to use the bad debt reserve method of sec. 593), the 
institution would be required to recapture all or a portion of 
its bad debt reserve. As described in detail below, it appears 
that such recapture would require the institution immediately 
to record, for financial accounting purposes, a current or 
deferred tax liability for the amount of bad debt recapture for 
which liabilities previously had not been recorded (generally, 
with respect to the pre-1988 reserves), regardless of when such 
recapture is taken into account for Federal income tax 
purposes. To the extent regulatory accounting principles follow 
these financial accounting principles, the recording of this 
liability generally would decrease the regulatory capital of 
the institution.

Reasons for change

    The Committee believes that the reserve method of bad debts 
accorded to qualified thrift institutions under present law 
results in a mismeasurement of economic income and provides 
those institutions with a tax benefit not provided to 
similarly-situated depository institutions.
    The Committee also believes that whenever a taxpayer 
changes its method of accounting, it is appropriate to 
implement the change in a manner so that items of income or 
expense are not taken into account twice--once under the old 
method and again under the new method. Thus, under present law, 
most accounting method changes are implemented under section 
481 which requires the calculation of an adjustment that 
reflects the cumulative effect of the method change and is 
restored to income over a specified period of time. 
Specifically, under present law, whenever a thrift institution 
no longer qualifies for the reserve method of accounting for 
bad debts, the bad debt reserve of the thrift institution must 
be restored to income.
    The Committee believes that, in order to provide treatment 
to similarly-situated depository institutions, the special bad 
debt reserve methods available to qualified thrift institutions 
should be repealed. However, the Committee understands that 
requiring full recapture of the bad debt reserves of thrift 
institutions in implementing this change in accounting method 
may impose significant financial accounting and regulatory 
capital burdens on institutions that have not recorded the 
appropriate amount of deferred tax liabilities with respect to 
such recapture. Thus, the Committee believes it is appropriate 
to provide relief from the recapture of the portion of the bad 
debt reserves that arose prior to 1988. The Committee believes 
that this relief should not directly benefit the shareholders 
of the institutions in a manner similar to the way in which 
present-law section 593(e) provides a limitation on the direct 
enjoyment of the benefits of section 593 by shareholders of 
thrift institutions.
    Further, because of the thrift industry's traditional role 
as home mortgage lenders, the Committee is concerned that the 
repeal of section 593 may result in a temporary shortage in the 
availability of mortgage loans in some regions. The Committee 
bill addresses this issue by providing an incentive for 
institutions to continue to provide a level of residential 
mortgage financing for a period of time.

Explanation of provision

            Repeal of section 593
    The bill repeals the section 593 reserve method of 
accounting for bad debts by thrift institutions, effective for 
taxable years beginning after 1995. Thrift institutions that 
would be treated as small banks \3\ are allowed to utilize the 
experience method applicable to such institutions, while thrift 
institutions that are treated as large banks are required to 
use only the specific charge-off method. Thus, the percentage 
of taxable income method of accounting for bad debts is no 
longer available for any financial institution. The bill also 
repeals the following present-law provisions that only apply to 
thrift institutions to which section 593 applies: (1) the 
denial of a portion of certain tax credits to a thrift 
institution (sec. 50(d)(1)); (2) the special rules with respect 
to the foreclosure of property securing loans of a thrift 
institution (sec. 595); (3) the reduction in the dividends 
received reduction of a thrift institution (sec. 596); and (4) 
the ability of a thrift institution to use a net operating loss 
to offset its income from a residual interest in a REMIC (sec. 
860E(a)(2)).
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    \3\ Under present-law section 581, the definition of a ``bank'' 
includes a thrift institution.
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            Treatment of recapture of bad debt reserves
    In general.--A thrift institution required to change its 
method of computing reserves for bad debts will treat such 
change as a change in a method of accounting, initiated by the 
taxpayer, and having been made with the consent of the 
Secretary of the Treasury.\4\ Any section 481(a) adjustment 
required to be taken into account with respect to such change 
generally with be determined solely with respect to the 
``applicable excess reserves'' of the taxpayer. The amount of 
applicable excess reserves shall be taken into account ratably 
over a six-taxable year period, beginning with the first 
taxable year beginning after 1995, subject to the residential 
loan requirement described below. In the case of a thrift 
institution that becomes a ``large bank'' (as determined under 
sec. 585(c)(2)), the amount of the institution's applicable 
excess reserves generally is the excess of (1) the balance of 
its reserves described in section 593(c)(1) other than its 
supplemental reserve for losses on loans (i.e., its reserve for 
losses on qualifying real property loans and its reserve for 
losses on nonqualifying loans) as of the close of its last 
taxable year beginning before January 1, 1996, over (2) the 
balance of such reserves (i.e., its reserve for losses on 
qualifying real property loans and its reserve for losses on 
nonqualifying loans) as of the close of its last taxable year 
beginning before January 1, 1988 (i.e., the ``pre-1988 
reserves'').\5\ Thus, a thrift institution that is treated as a 
large bank generally is required to recapture its post-1987 
additions to its bad debt reserves, whether such additions are 
made pursuant to the percentage of taxable income method or the 
experience method. The timing of this recapture may be delayed 
for a one- or two-year period to the extent the residential 
loan requirement described below applies.
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    \4\ The provisions of the bill will apply to a thrift institution 
that has a taxable year that begins after December 31, 1995, even if 
such taxable year is a short taxable year that comes to a close because 
the thrift institution is acquired by a non-thrift institution.
    In addition, a thrift institution that uses a reserve method 
described in section 593 will be deemed to have changed its method of 
computing reserves for bad debts even though such institution will be 
allowed to use the reserve method of section 585. Similarly, a large 
thrift institution will be deemed to have changed its method of 
computing reserves for bad debts even through such institution used the 
experience-method portion of section 593 in lieu of the percentage-of-
taxable-income method of section 593.
    \5\ The balance of a taxpayer's pre-1988 reserves is reduced if the 
taxpayer's loan portfolio had decreased since 1988. The permitted 
balance of a taxpayer's pre-1988 reserves is reduced by multiplying 
such balance by the ratio of the balance of the taxpayer's loans 
outstanding at the close of the last taxable beginning before 1996, to 
the balance of the taxpayer's loans outstanding at the close of the 
last taxable beginning before 1988. This reduction is required for both 
large and small banks.
---------------------------------------------------------------------------
    In the case of a thrift institution that becomes a ``small 
bank'' (as determined under sec. 585(c)(2)), the amount of the 
institution's applicable excess reserves will be the excess of 
(1) the balance of its reserves described in section 593(c)(1) 
as of the close of its last taxable year beginning before 
January 1, 1996, over (2) the greater of the balance of: (a) 
its pre-1988 reserves or (b) what the institution's reserves 
would have been at the close of its last taxable year beginning 
before January 1, 1996, had the institution always used the 
experience method described in section 585(b)(2)(A) (i.e., the 
six-year average method). For purposes of the future 
application of section 585, the beginning balance of the small 
bank's reserve for its first taxable year beginning after 
December 31, 1995, will be the greater of the two amounts 
described in (2) in the preceding sentence, and the balance of 
the reserve at the close of the base year (for purposes of sec. 
585(b)(2)(B)) will be the amount of its pre-1988 reserves. The 
residential loan requirement described below also applies to 
small banks. If such small bank later becomes a large bank, any 
section 481(a) adjustment amount required to be taken into 
account under section 585(c)(3) will not include any portion of 
the bank's pre-1988 reserve. Similarly, if the bank elects the 
cut-off method to implement its conversion to large bank 
status, the amount of the reserve against which the bank 
charges its actual losses will not include any portion of the 
bank's pre-1988 reserve and the amount by which the pre-1988 
reserve exceeds actual losses will not be included in gross 
income.
    The balance of the pre-1988 reserves is subject to the 
provisions of section 593(e), as modified by the bill 
(requiring recapture in the case of certain excess distribution 
to, and redemptions of, shareholders. Thus, section 593(e) will 
apply to an institution regardless of whether the institution 
becomes a commercial bank or remains a thrift institution. In 
addition, the balances of the pre-1988 reserve and the 
supplemental reserve will be treated as tax attributes to which 
section 381 applies. The Committee expects that Treasury 
regulations will provide rules for the application of section 
593(e) in the case of mergers, acquisitions, spin-offs, and 
other reorganizations of thrift and other institutions.\6\ The 
Committee believes that any such regulation should provide 
that, if the stock of an institution with a pre-1988 reserve is 
acquired by another depository institution, the pre-1988 
reserve will not be restored to income by reason of the 
acquisition. Similarly, if an institution with a pre-1988 
reserve is merged or liquidated tax-free into a bank, the pre-
1988 reserve should not be restored to income by reason of the 
merger or liquidation. Rather, the bank will inherit the pre-
1988 reserve and the post-1951 earnings and profits of the 
former thrift institution and section 593(e) will apply to the 
bank as if it were a thrift institution. That is, the pre-1988 
reserve will be restored into income in the case of any 
distribution in redemption of the stock of the bank or in 
partial or complete liquidation of the bank following the 
merger of liquidation. In the case of any other distribution, 
the pre-1988 reserve will not be restored to income unless the 
distribution is in excess of the sum of the post-1951 earnings 
and profits inherited from the thrift institution and the post-
1913 earnings and profits of the acquiring bank.\7\ The 
Committee expects that Treasury regulations will address the 
case where the shareholders of an institution with a pre-1988 
reserve are ``cashed out'' in a taxable merger of the 
institution and a bank. Such regulations may provide that the 
pre-1988 reserve may be restored to income if such redemption 
represents a concealed distribution from the former thrift 
institution. For example, cash received by former thrift 
shareholders pursuant to a taxable reverse merger may represent 
a concealed distribution if, immediately preceding the merger, 
the acquiring bank had no available resources to distribute and 
its existing debt structure, indenture restrictions, financial 
condition, or regulatory capital requirements precluded it from 
borrowing money for purposes of making the cash payment to the 
former thrift shareholders. No inference is intended by the 
Committee as to the application of section 593(e) to these and 
similar transactions under present law.
---------------------------------------------------------------------------
    \6\ The Committee expects that in the case of the merger, 
acquisition, spin-off, or other reorganization involving only thrift 
institutions, section 593(e) as modified by the bill, will continue to 
be applied in a manner similar to the way section 593(e) is applied 
under present law. However, guidance will be needed in the case of 
transactions where one of the parties to the transaction is not a 
thrift institution. For example, the issue of whether section 593(e) 
applies in the case where a thrift institution is merged into a bank 
generally does not arise under present law because such merger results 
in a charter change and, under proposed Treasury regulations, requires 
full bad debt reserve recapture.
    \7\ If the acquiring bank is a former thrift institution itself and 
the pre-1988 reserves of neither institution are restored to income 
pursuant to the merger, the Committee expects that the pre-1988 
reserves and the post-1951 earnings and profits of the two institutions 
will be combined for purposes of the continued application of section 
593(e) with respect to the combined institution.
---------------------------------------------------------------------------
    Further, if a taxpayer no longer qualifies as a bank (as 
defined by sec. 581), the balances of the taxpayer's pre-1988 
reserve and supplemental reserves are restored to income 
ratably over a six-year period, beginning in the taxable year 
the taxpayer no longer qualifies as a bank.
    Residential loan requirement.--Under a special rule, if the 
taxpayer meets the ``residential loan requirement'' for a 
taxable year, the recapture of the applicable excess reserves 
otherwise required to be taken into account as a section 481(a) 
adjustment for such year will be suspended. A taxpayer meets 
the residential loan requirement if, for the taxable year, the 
principal amount of residential loans made by the taxpayer 
during the year is not less than its base account. The 
residential loan requirement is applicable only for taxable 
years that begin after December 31, 1995, and before January 1, 
1998, and must be applied separately with respect to each such 
year. Thus, all taxpayers are required to recapture their 
applicable excess reserves within six, seven or eight years 
after the effective date of the provision.
    The ``base amount'' of a taxpayer means the average of the 
principal amounts of the residential loans made by the taxpayer 
during the six most recent taxable years beginning before 
January 1, 1996. At the election of the taxpayer, the base 
amount may be computed by disregarding the taxable years within 
that six-year period in which the principal amounts of loans 
made during such years were highest and lowest. This election 
must be made for the first taxable year beginning after 
December 31, 1995, and applies to the succeeding taxable year 
unless revoked with the consent of the Secretary of the 
Treasury or his delegate.
    For purposes of the residential loan requirement, a loan 
will be deemed to be ``made'' by a financial institution to the 
extent the institution is, in fact, the principal source of the 
loan financing. Thus, any loan only can be ``made'' once. The 
Committee expects that loans ``made'' by a financial 
institution may include, but are not limited to, loans (1) 
originated directly by the institution through its place of 
business or its employees, (2) closed in the name of the 
institution, (3) originated by a broker that acts as an agent 
for the institution, and (4) originated by another person 
(other than a financial institution) and that are acquired by 
the institution pursuant to a pre-existing, enforceable 
agreement to acquire such loans. In addition, Treasury 
regulations also may provide that loans ``made'' by a financial 
institution may include loans originated by another person 
(other than a financial institution) acquired by the 
institution soon after origination if such acquisition is 
pursuant to a customary practice of acquiring such loans from 
such person. A loan acquired by a financial institution from 
another financial institution generally will be considered to 
be made by the transferor rather than the transferee of the 
loan; however, such loan may be completely disregarded if a 
principal purpose of the transfer was to allow the transferor 
to meet the residential loan requirement. A loan may be 
considered to be made by a financial institution even if such 
institution has an arrangement to transfer such loan to the 
Federal National Mortgage Association or the Federal Home Loan 
Mortgage Corporation.
    For purposes of the residential loan requirement, a 
``residential loan'' described in section 7701(a)(19)(C)(v) 
(generally, loans secured by residential real and church 
property and certain mobile homes),\8\ but only to the extent 
the loan is made to the owner of the property to acquire, 
construct, or improve the property. Thus, mortgage refinancings 
and home equity loans are not considered to be residential 
loans, except to the extent the proceeds of the loan are used 
to acquire, construct, or improve qualified residential real 
property. The Committee understands that pursuant to the Home 
Mortgage Disclosure Act, financial institutions are required to 
disclose the purpose for which loans are made. The Committee 
further understands that for purposes of this disclosure, 
institutions are required to classify loans as home purchase 
loans, home improvement loans, refinancings, and multifamily 
dwelling loans (whether for purchase, improvement or 
refinancing of such property). The Committee expects that 
taxpayers (and the Secretary of the Treasury in promulgating 
guidance) may take such reporting into account, and make such 
adjustments as are appropriate,\9\ in determining: (1) whether 
or not a loan qualifies as a ``residential loan'' and (2) 
whether the institution ``made'' the loan. A taxpayer must use 
consistent standards for determining whether loans qualify as 
residential loans made by the institution both for purposes of 
determining its base amount and for purposes of determining 
whether it met the residential loan requirement for a taxable 
year.
---------------------------------------------------------------------------
    \8\ For this purpose, as under present law, if a multifamily 
structure securing a loan is used in part for nonresidential purposes, 
the entire loan will be deemed a residential real property loan if the 
planned residential use exceeds 80 percent of the property's planned 
use (determined as of the time the loan is made). In addition, loans 
made to finance the acquisition or development of land will be deemed 
to be loans secured by an interest in residential real property if, 
under regulations prescribed by the Secretary of the Treasury, there is 
a reasonable assurance that the property will become residential real 
property within a period of three years from the date of acquisition of 
the land.
    \9\ For example, adjustments will be required with respect to the 
reporting of multifamily dwellings in order to distinguish home 
purchase, home improvement, and refinancing loans.
---------------------------------------------------------------------------
    The residential loan requirement is determined on a 
controlled group basis. Thus, for example, if a controlled 
group consists of two thrift institutions with applicable 
excess reserves that are wholly-owned by a bank, the 
residential loan requirement will be met (or not met) with 
respect to both thrift institutions by comparing the principal 
amount of the residential loans made by all three members of 
the group during the taxable year to the group's base amount. 
The group's base amount will be the average principal amount of 
residential loans made by all three members of the group during 
the base period. The election to disregard the high and low 
taxable years during the 6-year base period also would be 
applied on a controlled group basis (i.e., generally by 
treating the members of the group as one taxpayer so that all 
members of the group must join in the election, and the same 
corresponding years of each member would be so disregarded).
    Treasury regulations may provide rules for the application 
of the residential loan requirement in the case of mergers, 
acquisitions, and other reorganizations of thrift and other 
institutions. For example, the balance of a taxpayer's 
applicable excess reserve will be treated as a tax attribute to 
which section 381 applies. Thus, if an institution with an 
applicable excess reserve is acquired in a tax-free 
reorganization, the Committee expects that balance of such 
reserve will not be immediately restored to income but will 
continue to be subject to the residential loan requirement in 
the hands of the acquirer. The Committee further expects that 
if a financial institution joins or merges into (or leaves) a 
group of financial institutions, the base amount of the 
acquiring (or remaining) group will be appropriately adjusted 
to reflect the base amount of the acquired (or departing) 
institution for purposes of determining whether the group meets 
the residential loan requirement for the year of the 
acquisition (or departure) and subsequent years. Similarly, if 
a controlled group of institutions had made an election to 
disregard its high and low years in computing its base amount, 
it is anticipated that such election shall be binding on any 
institution that subsequently joins the group and the election 
shall be applied to the new member by disregarding the high and 
low years of the new member even if such years do not 
correspond to the years applicable to the other members of the 
group.
            Treatment of conversions to credit unions
    The bill provides that if a thrift institution to which the 
repeal of section 593 applies becomes a credit union, the 
credit union will be treated as an institution that is not a 
bank and any section 481(a) adjustment required to be included 
in gross income will be treated as derived from an unrelated 
trade or business. Thus, if a thrift institution becomes a 
credit union in its first taxable year beginning after December 
31, 1995, the entire balance of the institution's bad debt 
reserve will be included in income, and subject to tax, over a 
six-year period beginning with such taxable year. No inference 
is intended as to the Federal income tax treatment of any other 
aspect of the conversion of a financial institution to a credit 
union.

Effective date

    The repeal of section 593 is effective for taxable years 
beginning after December 31, 1995. The repeal of section 595 is 
effective for property acquired in taxable years beginning 
after December 31, 1995. The amendment to section 860E does not 
apply to any residual interest in a REMIC held by the taxpayer 
on October 31, 1995, and at all times thereafter.
    The amendment to section 593(e)(1)(B) does not apply to any 
distributions with respect to preferred stock (including 
redemptions of such stock) if: (1) such stock was issued and 
outstanding as of November 1, 1995, and at all times thereafter 
before the distribution and (2) such distribution is made 
within the later of (a) one year after the date of enactment of 
this Act or (b) if the stock is redeemable by the issuer or a 
related party, 30 days after the date such stock first may be 
redeemed. For this purpose, the first date a preferred stock 
may be redeemed is the day upon which the issuer or a related 
party has the right to call the stock, regardless of the amount 
of call premium.

2. depreciation under the income forecast method (sec. 402 of the bill 
                       and sec. 167 of the Code)

Present law

            In general
    A taxpayer generally must capitalize the cost of property 
used in a trade or business and is allowed to recover such cost 
over time through allowances for depreciation or amortization. 
Depreciation allowances for tangible property generally are 
determined under the modified Accelerated Cost Recovery System 
(``MACRS'') of section 168, which provides that depreciation is 
computed by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of 
various types of depreciable property. Intangible property 
generally is amortized under section 197, which provides a 15-
year recovery period and the straight-line method to the cost 
of applicable property.
            Treatment of film, video tape, and similar property
    MACRS does not apply to certain property, including any 
motion picture film, video tape, or sound recording or to other 
any property if the taxpayer elects to exclude such property 
from MACRS and the taxpayer applies a unit-of-production method 
or other method of depreciation not expressed in a term of 
years. Section 197 does not apply to certain intangible 
property, including property produced by the taxpayer or any 
interest in a film, sound recording, video tape, book or 
similar property not acquired in transaction (or a series of 
related transactions) involving the acquisition of assets 
constituting a trade or business or substantial portion 
thereof. Thus, the recovery of the cost of a film, video tape, 
or similar property that is produced by the taxpayer or is 
acquired on a ``stand-alone'' basis by the taxpayer may not be 
determined under either the MACRS depreciation provisions or 
under the section 197 amortization provisions. The cost of such 
property may be determined under section 167, which allows a 
depreciation deduction for the reasonable allowance for the 
exhaustion, wear and tear, or obsolescence of the property.
    The ``income forecast'' method is an allowable method for 
calculating depreciation under section 167 for certain 
property. Under the income forecast method, the depreciation 
deduction for a taxable year for a property is determined by 
multiplying the cost of the property \10\ (less estimated 
salvage value) 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 to be derived from the property during its useful life. 
The income forecast method has been held to be applicable for 
computing depreciation deductions for motion picture films, 
television films and taped shows, books, patents, master sound 
recording and video games.\11\ The total forecasted or 
estimated income to be derived from a property is to be based 
on the conditions known to exist at the end of the period for 
which depreciation is claimed. This estimate can be revised 
upward or downward at the end of a subsequent taxable period on 
additional information that becomes available after the last 
prior estimate. These revisions, however, do not affect the 
amount of depreciation claimed in a prior taxable year.
---------------------------------------------------------------------------
    \10\ In Transamerica Corp. v. U.S., 999 F.2d 1362, (9th Cir. 1993), 
the Ninth Circuit overturned the District Court and held that, for 
purposes of applying the income forecast method to a film, the ``cost 
of a film'' includes ``participation'' and ``residual'' payments (i.e., 
payments to producers, writers, directors, actors, guilds, and others 
based on a percentage of the profits from the film) even though these 
payments were contingent on the occurrence of future events. It is 
unclear to what extent, if any, the Transamerica decision applies to 
amounts incurred after the enactment of the economic performance rules 
of Code section 461(h), as contained in the Deficit Reduction Act of 
1984.
    \11\ See, e.g., Rev. Rul. 60-358, 1960-2 C.B. 68; Rev. Rul. 64-273, 
1964-2 C.B. 62; Rev. Rul. 79-285, 1979-2 C.B. 91; and Rev. Rul. 89-62, 
1989-1 C.B. 78. Conversely, the courts have held that certain tangible 
personal property was not of a character to which the income forecast 
method was applicable. See, e.g., ABC Rentals of San Antonio v. Comm., 
68 TCM 1362 (1994) (consumer durable property subject to short-term, 
``rent-to-own'' leases not eligible) and Carland, Inc. v. Comm., 90 
T.C. 505 (1988), affd. on this issue, 909 F.2d 1101 (8th Cir. 1990) 
railroad rolling stock subject to a lease not eligible).
---------------------------------------------------------------------------
    In the case of a film, income to be taken into account 
under the income forecast method means income from the film 
less the expense of distributing the film, including estimated 
income from foreign distribution or other exploitation of the 
film.\12\ In the case of a motion picture released for 
theatrical exhibition, income does not include estimated income 
from future television exhibition of a film (unless an 
arrangement for domestic television exhibition has been entered 
into before the film has been depreciated to its reasonable 
salvage value). In the case of a series or a motion picture 
produced for television exhibition, income does not include 
estimated income from domestic syndication of a series or the 
film (unless an arrangement for syndication has been entered 
into before the series or film has been depreciated to its 
reasonable salvage value).\13\ The Internal Revenue Service 
also has ruled that income does not include net merchandising 
revenue received from the exploitation of film characters.\14\
---------------------------------------------------------------------------
    \12\ Rev. Rul. 60-358, 1960-2 C.B. 68.
    \13\ Rev. Proc. 71-29, 1971-2 C.B. 568.
    \14\ Private letter ruling 7918012, January 24, 1979. Private 
letter rulings do not have precedential authority and may not be relied 
upon by any taxpayer other than the taxpayer receiving the ruling but 
are some indication of IRS administrative practice.
---------------------------------------------------------------------------

Reasons for change

    The Committee believes that, in theory, the income forecast 
method is an appropriate method for matching the capitalized 
cost of certain property with the income produced by such 
property. However, the Committee believes that the application 
of the income forecast method under present law does not meet 
the theoretical objective. In addition, the Committee 
recognizes that the reliance of the operation of the income 
forecast method upon estimated income may result in a mismatch 
between income and depreciation deductions when future income 
is over- or under-estimated. The Committee bill attempts to 
address these issues.

Explanation of provision

    The bill makes several amendments to the income forecast 
method of determining depreciation deductions.
            Determinations of estimated income
    First, the bill provides that income to be taken into 
account under the income forecast method includes all estimated 
income generated by the property. In applying this rule, a 
taxpayer generally need not take into account income expected 
to be generated after the close of the tenth taxable year after 
the year the property was placed in service. In the case of a 
film, television show, or similar property, such income 
includes, but is not necessarily limited to, income from 
foreign and domestic theatrical, television, and other releases 
and syndications; and video tape releases, sales, rentals, and 
syndications.
    Pursuant to a special rule, in the case of television and 
motion picture films, the income from the property shall 
include income from the financial exploitation of characters, 
designs, scripts, scores, and other incidental income 
associated with such films, but only to the extent the income 
is earned in connection with the ultimate use of such items by, 
or the ultimate sale of merchandise to, persons who are not 
related to the taxpayer (within the meaning of sec. 267(b)). As 
an example of this special rule, assume a taxpayer produces a 
motion picture the subject of which is the adventures of a 
newly-created fictional character. If the taxpayer produces 
dolls or T-shirts using the character's image, income from the 
sales of these products by the taxpayer to consumers would be 
taken into account in determining depreciation for the motion 
picture under the income forecast method. Similarly, if the 
taxpayer enters into any licensing or similar agreement with an 
unrelated party with respect to the use of the image, such 
licensing income would be taken into account in determining 
depreciation for the motion picture. However, if the taxpayer 
uses the character's image to promote a ride at an amusement 
park that is wholly-owned by the taxpayer, no portion of the 
admission fees for the amusement park are to be taken into 
account under the income forecast method with respect to the 
motion picture.
    In addition, pursuant to another special rule, if a 
taxpayer produces a television series and initially does not 
anticipate syndicating the episodes from the series, the 
forecasted income for the episodes of the first three years of 
the series need not take into account any future syndication 
fees (unless the taxpayer enters into an arrangement to 
syndicate such episodes during such period).
    The 10th-taxable-year rule, the financial exploitation 
rule, and the syndication rule apply for purposes of the look-
back method described below.
            Determination and treatment of costs of property
    The adjusted basis of property that may be taken into 
account under the income forecast method only will include 
amounts that satisfy the economic performance standard of 
section 461(h).\15\ For this purpose, if the taxpayer incurs a 
noncontingent liability to acquire property subject to the 
income forecast method from another person, economic 
performance will be deemed to occur with respect to such 
noncontingent liability when the property is provided to the 
taxpayer. In addition, the recurring item exception of section 
461(h)(3) will apply in a manner similar to the way such 
exception applies under present law. Thus, expenditures that 
relate to an item of property that are incurred in the taxable 
year following the taxable year in which the property is placed 
in service may be taken into account in the year the property 
is placed in service to the extent such expenditures meet the 
recurring item exception for such year.
---------------------------------------------------------------------------
    \15\ No inference is intended as to the proper application of 
section 461(h) to the income forecast method under present law.
---------------------------------------------------------------------------
    Any costs that are taken into account after the property is 
placed in service are treated as a separate piece of property 
to the extent (1) such amounts are significant and are expected 
to give rise to a significant increase in the income from the 
property that was not included in the estimated income from the 
property, or (2) such costs are incurred more than 10 years 
after the property was placed in service. To the extent costs 
are incurred more than 10 years after the property was placed 
in service and give rise to a separate piece of property for 
which no income is generated, such costs may be written off and 
deducted they are incurred. For example, assume a taxpayer 
places a property subject to the income forecast method in 
service during a taxable year and all income from the property 
is generated in the following four-year period. If the taxpayer 
incurs additional costs with respect to that property more than 
10 years later (e.g., a payment pursuant to a deferred 
contingent compensation arrangement to a person that produced 
the property), such costs may be deducted in the year incurred 
provided no more income is generated with respect to such costs 
or the original property.
    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.
            Look-back method
    Finally, taxpayers that claim depreciation deductions under 
the income forecast method are required to pay (or would 
receive) interest based on the recalculation of deprecation 
under a ``look-back'' method.\16\ The ``look-back'' method is 
applied in any ``recomputation year'' by (1) comparing 
depreciation deductions that had been claimed in prior periods 
to depreciation deductions that would have been claimed had the 
taxpayer used actual, rather than estimated, total income from 
the property; (2) determining the hypothetical overpayment or 
underpayment of tax based on this recalculated depreciation, 
and (3) applying the overpayment rate of section 6621 of the 
Code.
---------------------------------------------------------------------------
    \16\ The ``look-back'' method of the provision resembles the look-
back method applicable to long-term contracts accounted for under the 
percentage-of-completion method of present-law sec. 460.
---------------------------------------------------------------------------
    Except as provided in Treasury regulations, a 
``recomputation year'' is the third and tenth taxable year 
after the taxable year the property was place 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. The Secretary of the Treasury has the authority to allow 
a taxpayer to delay the initial application of the look-back 
method where the taxpayer may be expected to have significant 
income from the property after the third taxable year after the 
taxable year the property was placed in service (e.g., the 
Treasury Secretary may exercise such authority where the 
depreciable life of the property is expected to be longer than 
three years).
    In applying the look-back method, any cost that is taken 
into account after the property was placed in service may be 
taken into account by discounting (using the Federal mid-term 
rate determined under sec. 1274(d) as of the time the costs 
were taken into account) such cost to its value as of the date 
the property was place in service.
    Property that had an unadjusted basis of $100,000 or less 
is not subject to the look-back method. For this purpose, 
``unadjusted basis'' means the total capitalized cost of a 
property as of the close of a recomputation year.
    The provision provides a simplified look-back method for 
pass-through entities.

Effective date

    The provision is effective for property placed in service 
after September 13, 1995, unless produced or acquired pursuant 
to a binding written contract in effect on such date and all 
times thereafter. For this purpose, the binding contract 
exception may apply to a written contract in effect on the 
relevant dates if that contract binds a taxpayer to produce 
property that will be used by the other party to the contract 
once the property is produced.
    The provision may apply to property place in service in 
taxable years that ended before the date of enactment of this 
Act. The provision waives additions to tax imposed under 
sections 6654, 6655, and 6662(d) for any underpayments of tax 
or estimated tax for any taxable year ending before the date of 
enactment of this Act to the extent the underpayment was 
created or increased by the changes made to the income forecast 
method of depreciation by the provision. The application of the 
provision (including the look-back method) is not waived for 
any taxable year that ends after the date of enactment of this 
Act.

                    III. BUDGET EFFECTS OF THE BILL

                         A. Committee Estimates

    In compliance with paragraph 11(a) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the estimated budget effects of the revenue 
provisions of the bill as reported.

     ESTIMATED BUDGET EFFECTS OF THE REVENUE PROVISIONS OF H.R. 3286, THE ``ADOPTION PROMOTION AND STABILITY ACT OF 1996,'' AS REPORTED BY THE COMMITTEE ON FINANCE, FISCAL YEARS 1996-2005     
                                                                                    [In millions of dollars]                                                                                    
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
              Provision                       Effective           1996      1997      1998      1999      2000      2001      2002      2003      2004      2005     1996-00   2001-05   1996-05
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
1. $5,000 credit and exclusion for     tyba 12/31/96..........  ........       -33      -329      -351      -375      -342      -108      -108      -104      -101    -1,088      -762    -1,850
 employer-provided assistance for                                                                                                                                                               
 regular adoption expenses, $6,000                                                                                                                                                              
 for special needs adoptions; sunset                                                                                                                                                            
 employer assistance exclusion and                                                                                                                                                              
 non-special needs credit after 2000.                                                                                                                                                           
2. Repeal section 593-deduction for    tyba 12/31/95..........        47       111       216       280       277       272       260       247       111        36       931       926     1,857
 bad debt reserves for thrift                                                                                                                                                                   
 institutions.                                                                                                                                                                                  
3. Corporate accounting--reform of     ppisa 9/13/95..........        32        69        29        13        14        16        19        22        28        31       157       116       273
 income forecast method.                                                                                                                                                                        
                                                               ---------------------------------------------------------------------------------------------------------------------------------
      Net totals.....................  .......................        79       147       -84       -58       -84       -54       171       161        35       -34  ........       280      280 
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Note: Details may not add to totals due to rounding.                                                                                                                                            
Legend for ``Effective'' column: ppisa = property placed in service after, tyba = taxable years beginning after.                                                                                
                                                                                                                                                                                                
Source: Joint Committee on Taxation.                                                                                                                                                            

                B. Budget Authority and Tax Expenditures

Budget authority

    In compliance with section 308(a)(1) of the Budget Act, the 
Committee states that the revenue provisions of the bill as 
reported involve no new or increased budget authority. Title II 
(interethnic adoptions) will have a negligible effect on budget 
outlays and budget authority.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that the adoption credit and exclusion 
provisions of Title I involve new tax expenditures (see revenue 
table in Part III. A., above), and that the revenue offset 
provisions of Title IV involve reduced tax expenditures (see 
Part III, A., above).

            C. Consultation with Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has not 
yet submitted a statement on this bill at the time of filing 
this report.

                       IV. VOTE OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the vote on the motion to report the bill. The bill 
(H.R. 3286) was ordered favorably reported, as amended by the 
Chairman's proposed substitute amendment to Titles I, II, and 
IV, by unanimous voice vote on June 12, 1996. A quorum was 
present for the vote. (The bill is to be referred to the Senate 
Committee on Indian Affairs for a period of 10 legislative days 
for consideration of Title III of the bill.)

                 V. REGULATORY IMPACT AND OTHER MATTERS

                          A. Regulatory Impact

    Pursuant to paragraph 11(b) of rule XXVI of the Standing 
Rules of the Senate, the Committee makes the following 
statement concerning the regulatory impact that might be 
incurred in carrying out the bill as reported.

Impact on individuals and businesses

    Title I of the bill as reported provides for a new tax 
credit and exclusion for certain adoption expenses. This will 
defray part of the cost of adoption. There is a $5,000 per 
child limit on the credit and exclusion ($6,000 for adoption of 
a special needs child).
    Title II of the bill will remove bureaucratic barriers to 
interethnic adoptions by providing that not later than January 
1, 1997, States receiving funds from the Federal Government for 
adoption or foster care placements may not deny any person the 
opportunity to become an adoptive or foster parent on the basis 
of race, color, or national origin of the person or of the 
child, nor may the State delay or deny the placement of a child 
for adoption or into foster care on the basis of race, color, 
or national origin of the adoptive or foster parent or of the 
child. Noncompliance with Title II of the bill would constitute 
a violation of Title VI of the Civil Rights Act of 1964.
    The Committee action does not address Title III of the bill 
(relating to Indian child custody and adoptions).
    Title IV provides two revenue offsets for the bill: (1) 
repeal of Code section 593 reserve method of accounting for bad 
debts by thrift institutions and (2) revision of the income 
forecast method of determining depreciation deductions.

Impact on personal privacy and paperwork

    The revenue provisions of the bill (Titles I and IV) will 
have little, if any, impact on personal privacy and little 
impact on taxpayer paperwork. The adoption tax credit will 
cause individual taxpayers to keep track of all eligible 
adoption expenses for the credit.

              B. Information Relating to Unfunded Mandates

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995 (Public Law 104-4).
    The Committee has determined that two of the revenue 
provisions of the bill contain Federal mandates on the private 
sector: (1) The provision relating to treatment of bad debt 
deductions of thrift institutions (repeal of Internal Revenue 
Code section 593); and (2) the provision to reform the income 
forecast method of accounting. In general, the first provision 
repeals a special rule regarding the treatment of bad debt 
reserves by thrift institutions and conforms the treatment of 
such reserves to the manner in which such reserves are required 
to be treated by banks. The second provision makes several 
changes to the income forecast method of determining 
depreciation deductions. These provisions will increase the 
Federal tax liabilities of certain taxpayers.
    The cost required to comply with each mandate generally is 
no greater than the revenue estimate for the provision. 
Benefits from the provisions include improved administration of 
the Federal income tax laws and a more accurate measurement of 
gross income for Federal income tax purposes. The Committee 
believes that the benefits of the provisions are greater than 
the cost required to comply with the mandates.
    The provision relating to bad debt reserves of thrift 
institutions corrects a present-law provision that results in a 
mismeasurement of economic income and provides thrift 
institutions with a tax benefit not provided to similarly 
situated depository institutions. The provision to reform the 
income forecast method of accounting results in a better 
matching between income and depreciation deductions with 
respect to certain types of depreciable property.
    These revenue-raising provisions are used to offset the 
cost of providing a tax credit to individuals who adopt a 
child. This tax credit furthers the social policy goal of 
ensuring that families who desire to adopt a child have the 
financial resources to do so. The revenue-raising provisions 
are critical to achieving this goal.
    The revenue provisions of the bill do not contain any 
intergovernmental mandates.
    The revenue-raising provisions of the bill affect 
activities that are only engaged in by the private sector and, 
thus, do not affect the competitive balance between State, 
local, or tribal governments and the private sector. Because 
the adoption tax credit and exclusion for employer-provided 
adoption expenses provide a larger benefit in the case of 
special needs adoptions, it may encourage more adoptions 
through State or local agencies and thus affect the competitive 
balance between State, local, or tribal governments and the 
private sector.

       VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

    In the opinion of the Committee, it is necessary in order 
to expedite the business of the Senate, to dispense with the 
requirements of paragraph 12 of rule XXVI of the Standing Rules 
of the Senate (relating to the showing of changes in existing 
law made by the bill as reported by the Committee).

                                
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