[Senate Report 105-33]
[From the U.S. Government Publishing Office]



105th Congress                                                   Report
                                 SENATE

 1st Session                                                     105-33
_______________________________________________________________________


 
                   REVENUE RECONCILIATION ACT OF 1997

                                _______

                          (AS REPORTED BY THE
                         COMMITTEE ON FINANCE)

                               ----------                              

                                 S. 949

                               ----------                              

                          COMMITTEE ON FINANCE
                          UNITED STATES SENATE

      [Including cost estimate of the Congressional Budget Office]




                 June 20, 1997.--Ordered to be printed



                   REVENUE RECONCILIATION ACT OF 1997




105th Congress                                                   Report
                                 SENATE

 1st Session                                                     105-33
_______________________________________________________________________


                      REVENUE RECONCILIATION ACT

                                OF 1997

                          (AS REPORTED BY THE

                         COMMITTEE ON FINANCE)

                               __________

                                 S. 949

                               __________

                          COMMITTEE ON FINANCE

                          UNITED STATES SENATE

      [Including cost estimate of the Congressional Budget Office]




                 June 20, 1997.--Ordered to be printed


                            C O N T E N T S

                              ----------                              
                                                                   Page
 I. Legislative Background............................................2

II. Explanation of the Bill...........................................3

        Title I. Child Tax Credit and Other Family Tax Relief....     3

            A. Child Tax Credit For Children Under Age 17 (sec. 
                101 of the bill and new sec. 24 of the Code).....     3
            B. Increase Exemption Amounts Applicable to 
                Individual Alternative Minimum Tax (sec. 102 of 
                the bill and sec. 55 of the Code)................     4

        Title II. Education Tax Incentives.......................     6

            A. Tax Benefits Relating to Education Expenses.......     6

                1. HOPE credit for higher education tuition 
                    expenses (sec. 201 of the bill and new sec. 
                    25A of the Code).............................     6
                2. Exclusion from gross income for amounts 
                    distributed from qualified tuition programs 
                    and education IRAs to cover qualified higher 
                    education expenses (secs. 211, 212, and 213 
                    of the bill and sec. 529 and new sec. 530 of 
                    the Code)....................................    12
                3. Deduction for student loan interest (sec. 202 
                    of the bill and new sec. 211 of the Code)....    20
                4. Penalty-free withdrawals from IRAs for higher 
                    education expenses (sec. 203 of the bill and 
                    sec. 72(t) of the Code)......................    22
            B. Other Education-Related Tax Provisions............    23
                1. Extension of exclusion for employer-provided 
                    educational assistance (sec. 221 of the bill 
                    and sec. 127 of the Code)....................    23
                2. Modification of $150 million limit on 
                    qualified 501(c)(3) bonds other than hospital 
                    bonds (sec. 222 of the bill and sec. 145(b) 
                    of the Code).................................    24
                3. Expansion of arbitrage rebate exception for 
                    certain bonds (sec. 223 of the bill and sec. 
                    148 of the Code).............................    25
                4. Certain teacher education expenses not subject 
                    to 2 percent limit on miscellaneous itemized 
                    deductions (sec. 224 of the bill and sec. 67 
                    (b) of the Code).............................    26

        Title III. Savings and Investment Incentives.............    28

            A. Individual Retirement Arrangements (secs. 301-304 
                of the bill and secs. 72 and 408 of the Code and 
                new sec. 408A of the Code).......................    28
            B. Capital Gains Provisions..........................    32
                1. Maximum rate of tax on net capital gain of 
                    individuals (sec. 311 of the bill and sec. 
                    1(h) of the Code)............................    32
                2. Small business stock (secs. 312 and 313 of the 
                    bill and secs. 1045 and 1202 of the Code)....    34
                3. Exclusion of gain on sale of principal 
                    residence (sec. 314 of the bill and secs. 121 
                    and 1034 of the Code)........................    35

        Title IV. Estate, Gift, and Generation-Skipping Tax 
            Provisions...........................................    38

            A. Increase in Estate and Gift Tax Unified Credit 
                (sec. 401(a) of the bill and sec. 2010 of the 
                Code)............................................    38

            B. Indexing of Certain Other Estate and Gift Tax 
                Provisions (sec. 401(b)-(e) of the bill and secs. 
                2032A, 2503, 2631, and 6601(j) of the Code)......    39
            C. Estate Tax Exclusion for Qualified Family-Owned 
                Businesses (sec. 402 of the bill and new sec. 
                2033A of the Code)...............................    40
            D. Reduction in Estate Tax for Certain Land Subject 
                to Permanent Conservation Easement (sec. 403 of 
                the bill and sec. 2031 of the Code)..............    45
            E. Installment Payments of Estate Tax Attributable to 
                Closely Held Businesses (secs. 404 and 405 of the 
                bill and secs. 6601(j) and 66166 of the Code)....    47
            F. Estate Tax Recapture from Cash Leases of 
                Specially-Valued Property (sec. 406 of the bill 
                and sec. 2032A of the Code)......................    49
            G. Modification of Generation-Skipping Transfer Tax 
                for Transfers to Individuals with Deceased 
                Parents (sec. 407 of the bill and sec. 2651 of 
                the Code)........................................    50

        Title V. Extension of Certain Expiring Tax Provisions....    52

            A. Research Tax Credit (sec. 501 of the bill and sec. 
                41 of the Code)..................................    52
            B. Contributions of Stock to Private Foundations 
                (sec. 502 of the bill and sec. 170(e)(5) of the 
                Code)............................................    55
            C. Work Opportunity Tax Credit (sec. 503 of the bill 
                and sec. 51 of the Code).........................    56
            D. Orphan Drug Tax Credit (sec. 504 of the bill and 
                sec. 45C of the Code)............................    60

        Title VI. District of Columbia Tax Incentives (secs. 601 
            and 602 of the bill and new secs. 1400-1400B of the 
            Code)................................................    61

        Title VII. Miscellaneous Provisions......................    68

            A. Excise Tax Provisions.............................    68
                1. Repeal excise tax on diesel fuel used in 
                    recreational motorboats (sec. 901 of the bill 
                    and secs. 4041 and 6427 of the Code).........    68
                2. Create Intercity Passenger Rail Fund (sec. 702 
                    of the bill and new sec. 9901 of the Code)...    68
                3. Provide a lower rate of alcohol excise tax on 
                    certain hard ciders (sec. 703 and sec. 5041 
                    of the Code).................................    70
                4. Transfer of General Fund highway fuels tax to 
                    the Highway Trust Fund (sec. 704 of the bill 
                    and sec. 9503 of the Code)...................    71
                5. Tax certain alternative fuels based on energy 
                    equivalency to gasoline (sec. 705 of the bill 
                    and sec. 4041 of the Code)...................    73
                6. Study feasibility of moving collection point 
                    for distilled spirits excise tax (sec. 706 of 
                    the bill)....................................    73
                7. Extend and modify tax benefits for ethanol 
                    (sec. 707 of the bill and secs. 40, 4041, 
                    4081, 4091, and 6427 of the Code)............    74
                8. Codify Treasury Department regulations 
                    regulating wine labels (sec. 708 of the bill 
                    and sec. 5388 of the Code)...................    75
            B. Provisions Relating to Pensions...................    76
                1. Treatment of multiemployer plans under section 
                    415 (sec. 711 of the bill and sec. 415(b) of 
                    the Code)....................................    76
                2. Modification of partial termination rules 
                    (sec. 712 of the bill and sec. 552 of the 
                    Deficit Reduction Act of 1984)...............    76
                3. Increase in full funding limit (sec. 713 of 
                    the bill and sec. 412 of the Code)...........    77
                4. Spousal consent required for distributions 
                    from section 401(k) plans (sec. 714 of the 
                    bill and secs. 411 and 417 of the Code)......    77
                5. Contributions on behalf of a minister to a 
                    church plan (sec. 715 of the bill and sec. 
                    414(e) of the Code)..........................    78
                6. Exclusion of ministers from discrimination 
                    testing of certain non-church retirement 
                    plans (sec. 715 of the bill and sec. 414(e) 
                    of the Code).................................    79
                7. Repeal application of UBIT to ESOPs of S 
                    corporations (sec. 716 of the bill and sec. 
                    512 of the Code).............................    79
            C. Provisions Relating to Disasters..................    80
                1. Treatment of livestock sold on account of 
                    weather-related conditions (sec. 721 of the 
                    bill and secs. 451 and 1033 of the Code).....    80
                2. Rules relating to denial of earned income 
                    credit on basis of disqualified income (sec. 
                    722 of the bill and sec. 32(i) of the Code)..    81
                3. Mortgage financing for residences located in 
                    Presidentially declared disaster areas (sec. 
                    723 of the bill and sec. 143 of the Code)....    82
            D. Provisions Relating to Small Business.............    82
                1. Delay imposition of penalties for failure to 
                    make payments electronically through EFTPS 
                    until after June 30, 1998 (sec. 731 of the 
                    bill and sec. 6302 of the Code)..............    82
                2. Repeal installment method adjustment for 
                    farmers (sec. 732 of the bill and sec. 56 of 
                    the Code)....................................    84
            E. Foreign Tax Provisions............................    84
                1. Eligibility of licenses of computer software 
                    for foreign sales corporation benefits (sec. 
                    741 of the bill and sec. 927 of the Code)....    84
                2. Regulations to limit treaty benefits for 
                    payments to hybrid entities (sec. 742 of the 
                    bill and sec. 892 of the Code)...............    86
                3. Treatment of certain securities positions 
                    under the subpart F investment in U.S. 
                    property rules (sec. 743 of the bill and sec. 
                    956 of the Code).............................    87
                4. Exception from foreign personal holding 
                    company income under subpart F for active 
                    financing income (sec. 744 of the bill and 
                    sec. 954 of the Code)........................    89
                5. Treat service income of nonresident alien 
                    individuals earned on foreign ships as 
                    foreign source income and disregard the U.S. 
                    presence of such individuals (sec. 745 of the 
                    bill and secs. 861, 863, 872, 3401, and 7701 
                    of the Code).................................    91
                6. Modification of passive foreign investment 
                    company provisions to eliminate overlap with 
                    subpart F and to allow mark-to-market 
                    election (sec. 751-753 of the bill and secs 
                    1291-1297 of the Code).......................    92
            F. Other Provisions..................................    97
                 1. Tax-exempt status for certain State workmen's 
                    compensation act companies (sec. 761 of the 
                    bill and sec. 501(c)(27) of the Code)........    97
                 2. Election to continue exception from treatment 
                    of publicly traded partnerships as 
                    corporations (sec. 762 of the bill and sec. 
                    7704 of the Code.............................    99
                 3. Exclusion from UBIT for certain corporate 
                    sponsorship payments (sec. 763 of the bill 
                    and sec. 513 of the Code)....................   101
                 4. Timeshare associations (sec. 764 of the bill 
                    and sec. 528 of the Code)....................   103
                 5. Deduction for business meals for individuals 
                    operating under Department of Transportation 
                    hours of service limitations and certain 
                    seafood processors (sec. 765 of the bill and 
                    sec. 274(n) of the Code).....................   106
                 6. Provide above-the-line deduction for certain 
                    business expenses (sec. 766 of the bill and 
                    sec. 62 of the Code).........................   107
                 7. Increase in standard mileage rate for 
                    purposes of computing charitable deduction 
                    (sec. 767 of the bill and sec. 170(i) of the 
                    Code)........................................   107
                 8. Expensing of environmental remediation costs 
                    (``brownfields'') (sec. 768 of the bill and 
                    sec. 162 of the Code)........................   108
                 9. Combined employment tax reporting 
                    demonstration project (sec. 769 of the bill).   111
                10. Qualified small-issue bonds (sec. 770 of the 
                    bill and sec. 144(a) of the Code)............   112
                11. Extend production credit for electricity 
                    produced from wind and ``closed loop'' 
                    biomass (sec. 505 of the bill and sec. 45 of 
                    the Code)....................................   113
                12. Suspension of net income property limitation 
                    for production from marginal wells (sec. 772 
                    of the bill and sec. 613(a) of the Code).....   114
                13. Purchasing of receivables by tax-exempt 
                    hospital cooperative service organizations 
                    (sec. 773 of the bill and sec. 501(e) of the 
                    Code)........................................   114
                14. Treatment of bonds issued by the Federal Home 
                    Loan Bank Board under the Federal guarantee 
                    rules (sec. 774 of the bill and sec. of the 
                    Code)........................................   115
                15. Increased period of deduction of traveling 
                    expenses while working away from home on 
                    qualified construction projects (sec. 775 of 
                    the bill and sec. 162 of the Code)...........   116
                16. Charitable contribution deduction for certain 
                    expenses incurred in support of Native 
                    Alaskan subsistence whaling (sec. 776 of the 
                    bill and sec. 170 of the Code)...............   117
                17. Modification of empowerment zone and 
                    enterprise community criteria in the event of 
                    future designations of additional zones and 
                    communities (sec. 777 of the bill and sec. 
                    1392 of the Code)............................   118
                18. Deductibility of meals provided for the 
                    convenience of the employer (sec. 778 of the 
                    bill and sec. 132 of the Code)...............   119
                19. Clarification of standard to be used in 
                    determining tax status of retail securities 
                    brokers (sec. 779 fo the bill)...............   120
        Title VIII. Revenue-Increase Provisions..................   122
            A. Financial Products................................   122
                 1. Require recognition of gain on certain 
                    appreciated positions in personal property 
                    (sec. 801 (a) of the bill and new sec. 1259 
                    of the Code).................................   122
                 2. Election of mark to market for securities 
                    traders and for traders and dealers in 
                    commodities (sec. 801(b) of the bill and new 
                    sec. 475(d) of the Code).....................   128
                 3. Limitation on exception for investment 
                    companies under section 351 (sec. 802 of the 
                    bill and sec. 351(e) of the Code.............   130
                 4. Gains and losses from certain terminations 
                    with respect to property (sec. 803 of the 
                    bill and sec. 1234A of the Code).............   132
            B. Corporate Organizations and Reorganizations.......   136
                 1. Require gain recognition for certain 
                    extraordinary dividends (sec. 811 of the bill 
                    and sec. 1059 of the Code)...................   136
                 2. Require gain recognition on certain 
                    distributions of controlled corporations 
                    stock (sec. 812 of the bill and secs. 355, 
                    351(c), and 368(a)(2)(H) of the Code)........   139
                 3. Reform tax treatment of certain corporate 
                    stock transfer (sec. 813 of the bill and 
                    secs. 304 and 1059 of the Code)..............   143
                 4. Modify holding period for dividends-received 
                    deduction (sec. 814 of the bill and sec. 
                    246(c) of the Code...........................   145
            C. Other Corporate Provisions........................   146
                 1. Registration of confidential corporate tax 
                    shelters and substantial understatement 
                    penalty (sec. 821 of the bill and secs. 6111 
                    and 6662 of the Code)........................   146
                 2. Treat certain preferred stock as ``boot'' 
                    (sec. 822 of the bill and secs. 351, 354, 
                    355, 356 and 1036 of the Code)...............   150
            D. Administrative Provisions.........................   152
                 1. Information reporting on persons receiving 
                    contract payments from certain Federal 
                    agencies (sec. 831 of the bill and sec. 6041 
                    A of the Code)...............................   152
                 2. Disclosure of tax return information for 
                    administration of certain veterans programs 
                    (sec. 832 of the bill and sec. 6103 of the 
                    Code)........................................   153
                 3. Consistency rule for beneficiaries of trusts 
                    and estates (sec. 833 of the bill and sec. 
                    6034A of the Code)...........................   154
                 4. Establish IRS continuous levy and improve 
                    debt collection (secs. 834, 835, and 836 of 
                    the bill and secs. 6331 and 6334 of the Code)   155
            E. Excise Tax Provisions.............................   157
                 1. Extension and modification of Airport and 
                    Airway Trust Fund excise taxes (sec. 841 of 
                    the bill and secs. 4081, 4091, and 4261 of 
                    the Code)....................................   157
                 2. Reinstate Leaking Underground Storage Tank 
                    Trust Fund excise tax (sec. 842 of the bill 
                    and secs. 4041(d), 4081(a)(2), and 4081(d)(2) 
                    of the Code).................................   163
                 3. Application of communications tax to long-
                    distance prepaid telephone cards (sec. 843 of 
                    the bill and sec. 4251 of the Code)..........   163
                 4. Uniform rate of excise tax on vaccines (sec. 
                    844 of the bill and secs. 4131 and 4132 of 
                    the Code)....................................   164
                 5. Modify treatment of tires under the heavy 
                    highway vehicle retail excise tax (sec. 845 
                    of the bill and sec. 4071 of the Code).......   166
                 6. Increase tobacco excise taxes (sec. 846 of 
                    the bill and sec. 5701 of the Code)..........   167
            F. Provisions Relating to Tax-Exempt Entities........   168
                 1. Extend UBIT rules to second-tier subsidiaries 
                    and amend control test (sec. 851 of the bill 
                    and sec. 512(b)(13) of the Code).............   168
                 2. Limitation on increase in basis of property 
                    resulting from sale by tax-exempt entity to 
                    related person (sec. 852 of the bill and sec. 
                    1061 of the Code)............................   170
                 3. Repeal grandfather rule with respect to 
                    pension business of insurer (sec. 853 of the 
                    bill and sec. 1012(c) of the Tax Reform Act 
                    of 1986).....................................   171
            G. Foreign Provisions................................   172
                 1. Inclusion of income from notional principal 
                    contracts and stock lending transactions 
                    under subpart F (sec. 861 of the bill and 
                    sec. 954 of the Code)........................   172
                 2. Restrict like-kind exchange rules for certain 
                    personal property (sec. 862 of the bill and 
                    sec. 1031 of the Code).......................   174
                 3. Holding period requirement for certain 
                    foreign taxes (sec. 863 of the bill and new 
                    sec. 901(k) of the Code).....................   175
                 4. Treatment of income from certain sales of 
                    inventory as U.S. source (sec. 864 of the 
                    bill and sec. 865 of the Code)...............   177
                 5. Interest on underpayment reduced by foreign 
                    tax credit carryback (sec. 865 of the bill 
                    and secs. 6601 and 6611 of the Code).........   178
                 6. Determination of period of limitations 
                    relating to foreign tax credits (sec. 866 of 
                    the bill and sec. 6511(d) of the Code).......   179
                 7. Modify foreign tax credit carryover rules 
                    (sec. 867 of the bill and sec. 904 of the 
                    Code)........................................   180
                 8. Repeal special exception to foreign tax 
                    credit limitation for alternative minimum tax 
                    purposes (sec. 864 of the bill and sec. 59 of 
                    the Code)....................................   181
            H. Other Revenue-Increase Provisions.................   182
                 1. Phase out suspense accounts for certain large 
                    farm corporations (sec. 871 of the bill and 
                    sec. 477 of the Code)........................   182
                 2. Modify net operating loss carryback and 
                    carryforward rules (sec. 872 of the bill and 
                    sec. 172 of the Code)........................   183
                 3. Expand the limitations on deductibility of 
                    premiums and interest with respect to life 
                    insurance, endowment and annuity contracts 
                    (sec. 873 of the bill and sec. 264 of the 
                    Code)........................................   184
                 4. Allocation of basis of properties distributed 
                    to a partner by a partnership (sec. 874 of 
                    the bill and sec. 732(c) of the Code)........   189
                 5. Treatment of inventory items of a partnership 
                    (sec. 875 of the bill and sec. 751 of the 
                    Code)........................................   192
                 6. Eligibility for income forecast method (sec. 
                    876 of the bill and secs. 167 and 168 of the 
                    Code)........................................   193
                 7. Modify the exception to the related party 
                    rule of section 1033 for individuals to only 
                    provide an exception for de minimis amounts 
                    (sec. 877 of the bill and sec. 1033 of the 
                    Code)........................................   195
                 8. Repeal of exception for certain sales by 
                    manufacturers to dealer (sec. 878 of the bill 
                    and sec. 811(c)(9) of the Tax Reform Act of 
                    1986 (P.L. 99-514))..........................   196
                 9. Cash out of certain accrued benefits (sec. 
                    879 of the bill and secs. 411 and 417 of the 
                    Code)........................................   197
                10. Election to receive taxable cash compensation 
                    in lieu of nontaxable parking benefits (sec. 
                    880 of the bill and sec. 132 of the Code)....   198
                11. Extension of Federal unemployment surtax 
                    (sec. 881 of the bill and sec. 3301 of the 
                    Code)........................................   198
                12. Repeal of excess distribution and excess 
                    retirement accumulation taxes (sec. 882 of 
                    the bill and sec. 4980A of the Code).........   199
                13. Treatment of charitable remainder trusts with 
                    greater than 50 percent annual payout (sec. 
                    883 of the bill and sec. 664 of the Code)....   200
                14. Tax on prohibited transactions (sec. 884 of 
                    the bill and sec. 4975 of the Code)..........   202
                15. Basis recovery rules (sec. 885 of the bill 
                    and sec. 72 of the Code).....................   202

        Title IX. Foreign-Related Simplification Provisions......   204

                 1. General provisions affecting treatment of 
                    controlled foreign corporations (secs. 911-
                    913 of the bill and secs. 902, 904, 951, 952, 
                    959, 960, 961, 964, and 1248 of the Code)....   204
                 2. Simplify formation and operation of 
                    international joint ventures (secs. 921, 931-
                    935, and 941 of the bill and secs. 367, 721, 
                    1491-1494, 6031, 6038, 6038B, 6046A, and 6501 
                    of the Code).................................   208
                 3. Modification of reporting threshold for stock 
                    ownership of a foreign corporation (sec. 936 
                    of the bill and sec. 6046 of the Code).......   211
                 4. Simplify translation of foreign taxes (sec. 
                    902 of the bill and secs. 905(c) and 986 of 
                    the Code)....................................   211
                 5. Election to use simplified foreign tax credit 
                    limitation for alternative minimum tax 
                    purposes (sec. 903 of the bill and sec. 59 of 
                    the Code)....................................   214
                 6. Simplify stock and securities trading safe 
                    harbor (sec. 952 of the bill and sec. 
                    864(6)(2)(A) of the Code)....................   216
                 7. Simplify foreign tax credit limitation for 
                    individuals (sec. 901 of the bill and sec. 
                    904 of the Code).............................   217
                 8. Simplify treatment of personal transactions 
                    in foreign currency (sec. 904 of the bill and 
                    sec. 988 of the Code)........................   217
                 9. Transition rule for certain trusts (sec. 951 
                    of the bill and sec. 7701(a)(30) of the Code)   217
                10. Clarification of determination of foreign 
                    taxes deemed paid (sec. 953(a) of the bill 
                    and sec. 902 of the Code)....................   220
                11. Clarification of foreign tax credit 
                    limitation for financial services income 
                    (sec. 953(b) of the bill and sec. 904 of the 
                    Code)........................................   220

        Title X. Simplification Provisions Relating to 
            Individuals and Business.............................   222

            A. Provisons Relating to Individuals.................   222
                 1.  Modifications to standard deduction of 
                    dependents; AMT treatment of certain minor 
                    children (sec. 1001 of the bill and secs. 
                    59(j) and 63(c)(5) of the Code)..............   222
                 2. Increase de minimis threshold for estimated 
                    tax to $1,000 for individuals (sec. 1002 of 
                    the bill and sec. 6654 of the Code)..........   223
                 3. Treatment of certain reimbursed expenses of 
                    rural letter carriers' vehicles (sec. 1003 of 
                    the bill and sec. 162 of the Code)...........   224
                 4. Travel expenses of Federal employees 
                    participating in a Federal criminal 
                    investigation (sec. 1004 of the bill and sec. 
                    162 of the Code).............................   225
            B. Provisions Relating to Business Generally.........   226
                 1. Modifications to look-back method for long-
                    term contracts (sec. 1011 of the bill and 
                    secs. 460 and 167(g) of the Code)............   226
                 2. Minimum tax treatment of certain property and 
                    casualty insurance companies (sec. 1012 of 
                    the bill and sec. 56(g)(4)(B) of the Code)...   228
                 3. Shrinkage for inventory accounting (sec. 1013 
                    of the bill and sec. 471 of the Code)........   229
                 4. Treatment of construction allowances provided 
                    to lessees (sec. 1014 of the bill and new 
                    sec. 110 of the Code)........................   231
            C. Partnership Simplification Provisions.............   234
                 1. General provisions (secs. 1021-1025 of the 
                    bill)........................................   234
                 2. Other partnership audit rules (secs. 1031-
                    1043 of the bill)............................   252
                 3. Closing of partnership taxable year with 
                    respect to deceased partner (sec. 1046 of the 
                    bill and sec 706(c)(2)(A) of the Code).......   265
            D. Modifications of Rules for Real Estate Investment 
                Trusts (secs. 1051-1063 of the bill and secs. 856 
                and 857 of the Code..............................   266
            E. Repeal of the 30-percent (``Short-short'') Test 
                for Regulation Investment Companies (sec. 1071 of 
                the Bill and sec. 851(b)(3) of the Code).........   274
            F. Taxpayer Protections..............................   275
                 1. Provide reasonable cause exception for 
                    additional penalties (sec. 1081 of the bill 
                    and secs. 6652, 6683, 7519 of the Code)......   275
                 2. Clarification of period for filing claims for 
                    refunds (sec. 1082 of the bill and sec. 6512 
                    of the Code).................................   275
                 3. Repeal of authority to disclose whether a 
                    prospective juror has been audited (sec. 1083 
                    of the bill sec. 6103 of the Code............   276
                 4. Clarify statute of limitations for items from 
                    pass-through entities (sec. 1084 of the bill 
                    and sec 6501 of the Code.....................   277
                 5. Prohibition on browsing (secs. 1084 and 1085 
                    of the bill and secs 7213A and 7431 of the 
                    Code)........................................   278

        Title XI. Estate, Gift, and Trust Tax Simplification.....   280

                6 1. Eliminate gift tax filing requirements for 
                    gifts to charities (sec. 1101 of the bill and 
                    sec. 6019 of the Code).......................   280
                 2. Clarification of waiver of certain rights of 
                    recovery (sec. 1102 of the bill and secs. 
                    2207A and 2207B of the Code).................   280
                 3. Transitional rule under section 2056A (sec. 
                    1103 of the bill and sec. 2056A of the Code).   281
                 4. Treatment for estate tax purposes of short-
                    term obligations held by nonresident aliens 
                    (sec. 1104 of the bill and sec. 2105 of the 
                    Code)........................................   282
                 5. Distributions during first 65 days of taxable 
                    year of estate (sec. 1105 of the bill and 
                    sec. 663(b) of the Code).....................   283
                 6. Separate share rules available to estates 
                    (sec. 1106 of the bill and sec 663(c) of the 
                    Code)........................................   284
                 7. Executor of estate and beneficiaries treated 
                    as related persons for disallowance of losses 
                    (sec. 1107 of the bill and secs. 267(b) and 
                    1239(b) of the Code).........................   285
                 8. Simplified taxation of earnings of pre-need 
                    funeral trusts (sec. 1108 of the bill and 
                    sec. 684 of the Code)........................   285
                 9. Adjustments for gifts within three years of 
                    decedent's death sec. 1109 of the bill and 
                    secs. 2035 and 2038 of the Code).............   287
                10. Clarify relationship between community 
                    property rights and retirement benefits (sec. 
                    1110 of the bill and sec. 2056(b)(7)(C) of 
                    the Code)....................................   288
                11. Treatment under qualified domestic trust 
                    rules of forms of ownership which are not 
                    trusts (sec. 1111 of the bill and sec. 
                    2056A(c) of the Code)........................   289
                12. Opportunity to correct certain failures under 
                    section 2032A (sec. 1112 of the bill and sec. 
                    2032A of the Code)...........................   290
                13. Authority to waive requirement of U.S. 
                    trustee for qualified domestic trusts (sec. 
                    1113 of the bill and sec. 2056A(a)(1)(A) of 
                    the Code)....................................   291
        Title XII. Excise Tax and Other Simplification Provisions   292

            A Increase De Minimis Limit for After-Market 
                Alterations Subject to Heavy Truck and Luxury 
                Automobile Excise Taxes (sec. 1201 of the bill 
                and secs. 4001 and 4051 of the Code).............   292
            B. Simplification of Excise Taxes on Distilled 
                Spirits, Wine, and Beer (secs. 1211-1222 of the 
                bill and secs. 5008, 5053, 5055, 5115, 5175, and 
                5207, and new secs. 5222 and 5418 of the Code)...   293
            C. Other Excise Tax Provisions.......................   295
                 1. Authority for Internal Revenue Service to 
                    grant exemptions from excise tax registration 
                    requirements (sec. 1231 of the bill and sec. 
                    4222 of the Code)............................   295
                 2. Repeal of excise tax deadwood provisions 
                    (sec. 1232 of the bill and secs. 4051, 4495-
                    4498, and 4681-4682 of the Code).............   296
                 3. Modifications to excise tax on certain arrows 
                    (sec. 1233 of the bill and sec. 4161 of the 
                    Code)........................................   296
                 4. Modifications to heavy highway vehicle retail 
                    excise tax (sec. 1234 of the bill and sec. 
                    4051 of the Code)............................   297
                 5. Treatment of skydiving flights as 
                    noncommercial aviation (sec. 1235 of the bill 
                    and sec. 4081 and 4261 of the Code)..........   298
                 6. Eliminate double taxation of certain aviation 
                    fuels sold to producers by ``fixed base 
                    operators'' (sec. 1236 of the bill and sec. 
                    4091 of the Code)............................   298
            D. Tax-Exempt Bond Provisions........................   299
                 1. Repeal of $100,000 limitation on unspent 
                    proceeds under 1-year exception from rebate 
                    (sec. 1241 of the bill and sec. 148 of Code).   299
                 2. Exception from rebate for earnings on bona 
                    fide debt service fund under construction 
                    bond rules (sec. 1242 of the bill and sec. 
                    148 of the Code).............................   300
                 3. Repeal of debt service-based limitation on 
                    investment in certain nonpurpose investments 
                    (sec. 1243 of the bill and sec. 148 of the 
                    Code)........................................   301
                 4. Repeal of expired provisions relating to 
                    student loan bonds (sec. 1244 of the bill and 
                    sec. 148 of the Code)........................   302
            E. Tax Court Procedures..............................   302
                 1. Overpayment determinations of Tax Court (sec. 
                    1251 of the bill and sec. 6512 of the Code)..   302
                 2. Redetermination of interest pursuant to 
                    motion (sec. 1252 of the bill and and sec. 
                    7481 of the Code)............................   303
                 3. Application of net worth requirement for 
                    awards of litigation costs (sec. 1253 of the 
                    bill and sec. 7430 of the Code)..............   303
                 4. Tax Court jurisdiction for determination of 
                    employment status (sec. 1254 of the bill and 
                    new sec. 7435 of the Code)...................   304
            F. Other Provisions..................................   305
                 1. Due date for first quarter estimated tax 
                    payments by private foundations (sec. 1261 of 
                    the bill and sec. 6655(g)(3) of the Code)....   305
                 2. Withholding of Commonwealth income taxes from 
                    the wages of Federal employees (sec. 1262 of 
                    the bill and sec. 5517 of title 5, United 
                    States Code).................................   306
                 3. Certain notices disregarded under provision 
                    increasing interest rate on large corporate 
                    underpayments (sec. 1263 of the bill and sec. 
                    6621 of the Code)............................   306

        Title XIII. Pension Simplification.......................   308

                 1. Matching contributions of self-employed 
                    individuals not treated as elective deferrals 
                    (sec. 1301 of the bill and sec. 402(g) of the 
                    Code)........................................   308
                 2. Contributions to IRAs through payroll 
                    deductions (sec. 1302 of the bill)...........   308
                 3. Plans not disqualified merely by accepting 
                    rollover contributions (sec. 1303 of the bill 
                    and sec. 401(a) of the Code).................   309
                 4. Modification of prohibition on assignment or 
                    alienation (sec. 1304 of the bill, sec. 
                    401(a)(13) of the Code)......................   310
                 5. Elimination of paperwork burdens on plans 
                    (sec. 1305 of the bill and sec. 101 of ERISA)   311
                 6. Modification of section 403(b) exclusion 
                    allowance to conform to section 415 
                    modifications (sec. 1306 of the bill and sec. 
                    403(b) of the Code)..........................   311
                 7. New technologies in retirement plans (sec. 
                    1307 of the bill)............................   312
                 8. Permanent moratorium on application of 
                    nondiscrimination rules to governmental plans 
                    (sec. 1308 of the bill and secs. 401 and 
                    403(b) of the Code)..........................   313
                 9. Clarification of certain rules relating to 
                    employee stock ownership plans of S 
                    corporations (sec. 1309 of the bill and sec. 
                    409 of the Code).............................   314
                10. Modification of 10-percent tax on 
                    nondeductible contributions (sec. 1310 of the 
                    bill and sec. 4972 of the Code)..............   315
                11. Modify funding requirements for certain plans 
                    (sec. 1311 of the bill and sec. 412 of the 
                    Code)........................................   316

        Title XIV. Technical Correction Provisions...............   318

        I. Technical Corrections to the Small Business Job 
            Protection Act of 1996...............................   318

            A. Small Business-Related Provisions.................   318
                 1. Returns relating to purchases of fish (sec. 
                    1401(a)(1) of the bill and sec. 6050R(c)(1) 
                    of the Code).................................   318
                 2. Charitable remainder trusts not eligible to 
                    be electing small business trusts (sec. 
                    1402(c)(1) of the bill and sec. 1361(c)(1)(B) 
                    of the Code).................................   318
                 3. Clarify the effective date for post-
                    termination transition period provision (sec. 
                    1401(c)(2) of the bill)......................   318
                 4. Treatment of qualified subchapter S 
                    subsidiaries (sec. 1401(c)(3) of the bill and 
                    sec. 1361(b)(3) of the Code).................   319
            B. Pension Provisions................................   320
                 1. Salary reduction simplified employee pensions 
                    (``SARSEPS'') (sec. 1401(d)(1)(B) of the bill 
                    and sec. 408(k)(6) of the Code)..............   320
                 2. SIMPLE retirement plans (sec. 1401(d)(1)(A) 
                    and (d)(1) (C)-(F) and 1401(d)(2) of the 
                    bill)........................................   320
            C. Foreign Provision.................................   325
                 1. Measurement of earnings of controlled foreign 
                    corporations (sec. 1401(e) of the bill, 
                    subtitle E of the Act, and section 956 of the 
                    Code)........................................   325
                 2. Transfers to foreign trusts at fair market 
                    value (sec. 1401(i)(2) of the bill, sec. 1903 
                    of the Act, and sec. 679 of the Code.........   325
                 3. Treatment of trust as U.S. person (sec. 
                    1401(i)(3) of the bill, sec. 1907 of the Act, 
                    and secs. 641 and 7701(a)(30) of the Code)...   326
            E. Other Provisions..................................   326
                 1. Treatment of certain reserves of thrift 
                    institutions (sec. 1401(f)(5) of the bill and 
                    secs. 593(e) and 1374 of the Code)...........   326
                 2. ``FASIT'' technical corrections (sec. 
                    1401(f)(6) of the bill and sec. 860L of the 
                    Code)........................................   327
                 3. Qualified State tuition plans (sec. 
                    1401(h)(1) of the bill and sec. 529 of the 
                    Code)........................................   329
                 4. Adoption credit (sec. 1401(h)(2) of the bill, 
                    sec. 1807 of the Small Business Act, and sec. 
                    23 of the Code)..............................   329
                 5. Phaseout of adoption assistance exclusion 
                    (sec. 1401(h)(2) of the bill, sec. 1807 of 
                    the Small Business Act, and sec. 137 of the 
                    Code)........................................   330

        II. Health Insurance Portability and Accountability Act 
            of 1996..............................................   331

             1. Medical savings accounts (sec. 1402(a) of the 
                bill and sec. 220 of the Code)...................   331
             2. Definition of chronically ill individual under a 
                qualified long-term care insurance contract (sec. 
                1402(b) of the bill and sec. 7702B(c)(2) of the 
                Code)............................................   332
             3. Deduction for long-term care insurance of self-
                employed individuals (sec. 1402(c) of the bill 
                and sec. 162(1)(2) of the Code)..................   333
             4. Applicability of reporting requirements of long-
                term care contracts and accelerated death 
                benefits (sec. 1402(d) of the bill and sec. 6050Q 
                of the Code).....................................   333
             5. Consumer protection provisions for long-term care 
                insurance contracts (sec. 1402(e) of the bill and 
                sec. 7702B(g)(4)(b) of the Code).................   334
             6. Insurable interests under the COLI provision 
                (sec. 1402(f)(1) of the bill and sec. 264(a)(4) 
                of the Code).....................................   335
             7. Applicable period for purposes of applying the 
                interest rate for a variable rate contract under 
                the COLI rules (sec. 1402(f)(2) of the bill and 
                sec. 264(d)(2)(B)(ii) of the Code)...............   335
             8. Definition of 20-percent owner for purposes of 
                key person exception under COLI rule (sec. 
                1402(f)(3) of the bill and sec. 264(d)(4) of the 
                Code)............................................   336
             9. Effective date of interest rate cap on key 
                persons and pre-1986 contracts under the COLI 
                rule (sec. 1402(f)(4) of the bill and sec. 501(c) 
                of HIPA).........................................   336
            10. Clarification of contract lapses under effective 
                date provisions of the COLI rule (sec. 1402(f)(5) 
                of the bill and sec. 501(d)(2) of HIPA)..........   337
            11. Requirement of gain recognition on certain 
                exchanges (sec. 1402(g)(1) and (2) of the bill, 
                sec. 511 of the Act, and sec. 877(d)(2) of the 
                Code)............................................   338
            12. Suspension of 10-year period in case of 
                substantial diminution of risk of loss (sec. 
                1402(g)(3) of the bill, sec. 511 of the Act, and 
                sec. 877(d)(3) of the Code)......................   338
            13. Treatment of property contributed to certain 
                foreign corporations (sec. 1402(g)(4) of the 
                bill, sec. 511 of the Act, and sec. 877(d)(4) of 
                the Code)........................................   339
            14. Credit for foreign estate tax (sec. 1402(g)(6) of 
                the bill, sec. 511 of the Act, and sec. 2107(c) 
                of the Code).....................................   339

        III. Technical Corrections to the Taxpayer Bill of Rights 
            2....................................................   341

             1. Reasonable cause abatement for first-tier 
                intermediate sanctions excise tax (sec. 1403(a) 
                of the bill and section 4962 of the Code)........   341
             2. Reporting by public charities with respect to 
                intermediate sanctions and certain other excise 
                tax penalties (sec. 1403(b) of the bill and sec. 
                6033 of the Code)................................   342

        IV. Technical Corrections to Other Acts..................   344

             1. Correction of GATT interest and mortality rate 
                provisions in the Retirement Protection Act (sec. 
                1404(b)(3) of the bill and sec. 1449(a) of the 
                Small Business Act)..............................   344
             2. Related parties determined by reference to 
                section 267 (sec. 1404(d) of the bill and sec. 
                267(f) of the Code)..............................   245

III. Budget Effects of the Bill.....................................346

 IV. Votes of the Committee.........................................370

  V. Regulatory Impact and Other Matters............................371

 VI. Changes in Existing Law Made by the Bill as Reported...........376



105th Congress                                                   Report
                                 SENATE

 1st Session                                                     105-33
_______________________________________________________________________


                   REVENUE RECONCILIATION ACT OF 1997

                                _______
                                

    June 20 (legislative day, June   ), 1997. Ordered to be printed

_______________________________________________________________________


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

                              R E P O R T

                         [To accompany S. 949]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Finance, to which was referred the bill 
(S. 949) to provide for revenue reconciliation pursuant to 
section 104(b) of the concurrent resolution on the budget for 
fiscal year 1998, having considered the same, reports favorably 
thereon without amendment and recommends that the bill do pass.
                       I. LEGISLATIVE BACKGROUND

Overview
    The Senate Committee on Finance (the ``Committee'') marked 
up revenue reconciliation provisions on June 19, 1997, and 
approved the provisions by a roll call vote of 18 yeas and 2 
noes. The Committee's revenue reconciliation recommendations 
are in response to the instructions in the Fiscal Year 1998 
Budget Resolution (H. Con. Res. 84) to provide net tax 
reductions of not more than $85 billion for fiscal years 1998-
2002, and not more than $250 billion for fiscal years 1998-
2007. (For details on estimated budget effects of the revenue 
reconciliation provisions as approved by the Committee, see 
Part III, below.)
Committee hearings
    The Committee and subcommittees held public hearings during 
the 105th Congress on various topics related to the provisions 
included in the Committee's revenue reconciliation 
recommendations.
            Full committee hearings
    The Committee held hearings on the following topics:
          Status of the Airport and Airway Trust Fund (February 
        4, 1997)
          Administration's Fiscal Year 1998 Budget Proposal 
        (February 12-13, 1997)
          IRA Proposals (March 6, 1997)
          Capital Gains and Losses (March 13, 1997)
          Estate and Gift Taxes (April 10, 1997)
          ``Tax Freedom Day'' (April 14, 1997)
          Education Tax Proposals (April 16, 1997)
          Revenue Proposals in the Administration's Fiscal Year 
        1998 Budget (April 17, 1997)
          Amtrak Financing (April 23, 1997)
          Children's Access to Health Care (April 30, 1997).
            Subcommittee hearings
    Subcommittee hearings were held on the following topics:
          Administration's Fiscal Year 1998 Health-Related 
        Budget Proposals (Subcommittee on Health, February 12, 
        1997)
          Small Business Tax Proposals (Subcommittee on 
        Taxation and Oversight of the IRS, June 5, 1997).
                      II. EXPLANATION OF THE BILL

         TITLE I. CHILD TAX CREDIT AND OTHER FAMILY TAX RELIEF

A. Child Tax Credit For Children Under Age 17 (sec. 101 of the bill and 
                        new sec. 24 of the Code)

                              Present Law

In general
    Present law does not provide tax credits based solely on 
the taxpayer's number of dependent children. Taxpayers with 
dependent children, however, generally are able to claim a 
personal exemption for each of these dependents. The total 
amount of personal exemptions is subtracted (along with certain 
other items) from adjusted gross income (``AGI'') in arriving 
at taxable income. The amount of each personal exemption is 
$2,650 for 1997, and is adjusted annually for inflation. In 
1997, the amount of the personal exemption is phased out for 
taxpayers with AGI in excess of $121,200 for single taxpayers, 
$151,500 for heads of household, and $181,800 for married 
couples filing joint returns. These phaseout threshold are 
adjusted annually for inflation.

                           Reasons for Change

    The Committee believes that the individual income tax 
structure does not reduce tax liability by enough to reflect a 
family's reduced ability to pay taxes as family size increases. 
In part, this is because over the last 50 years the value of 
the dependent personal exemption has declined in real terms by 
over one-third. The Committee believes that a tax credit for 
families with dependent children will reduce the individual 
income tax burden of those families, will better recognize the 
financial responsibilities of raising dependent children, and 
will promote family values. In addition, the Committee believes 
that the credit is an appropriate vehicle to encourage 
taxpayers to save for their children's education.

                        Explanation of Provision

    The bill allows taxpayers a maximum nonrefundable tax 
credit of $500 (pro rate amount of $250 in 1997 for children 
under the age of 13) for each qualifying child under the age of 
17. For taxable years beginning after December 31, 2002, the 
credit is allowed for each qualifying child under the age of 
18. A qualifying child is defined as an individual for whom the 
taxpayer can claim a dependency exemption and who is a son or 
daughter of the taxpayer (or a descendent of either), a stepson 
or stepdaughter of the taxpayer or an eligible foster child of 
the taxpayer. The credit amount is not indexed for inflation.
    In the case of each child age 13 to 16 (13 to 17 for 
taxable years beginning after December 31, 2002), the credit is 
available only for amounts contributed to savings for education 
with respect to that child. Specifically, the credit is allowed 
only to the extent of the net amount deposited into a qualified 
tuition program or an education IRA (as described below) on or 
before April 15 of the year following the year with respect to 
which the credit is claimed. Generally, if amounts are 
withdrawn, other than for qualified educational expenses, on or 
before April 15 of the second year following the year with 
respect to which the credit is claimed, the credit is subject 
to a 100-percent recapture. Exceptions from the 100-percent 
recapture are provided in certain circumstances including 
withdrawals made due to death, disability, and receipt of 
certain scholarships by the beneficiary.
    For taxpayers with AGI in excess of certain threshold, the 
otherwise allowable child credit is phased out. Specifically, 
the otherwise allowable child credit is reduced by $25 for each 
$1,000 of modified AGI (or fraction thereof) in excess of the 
threshold (``the modified AGI phase-out''). For these purposes 
modified AGI is computed by increasing the taxpayer's AGI by 
the amount otherwise excluded from gross income under Code 
sections 911, 931, or 933 (relating to the exclusion of income 
of U.S. citizens or residents living abroad; residents of Guam, 
American Samoa, and the Northern Marina Islands; and residents 
of Puerto Rico, respectively). For married taxpayers filing 
joint returns, the threshold is $110,000. For taxpayers filing 
single or head of household returns, the threshold is $75,000. 
For married taxpayers filing separate returns, the threshold is 
$55,000. These threshold are not indexed for inflation.
    The maximum amount of the child credit for each taxable 
year can not exceed an amount equal to the excess of: (1) the 
taxpayer's regular income tax liability (net of applicable 
credits) over (2) the sum of the taxpayer's tentative minimum 
tax liability (determined without regard to the alternative 
minimum foreign tax credit) and one-half of the earned income 
credit allowed.

                             Effective Date

    The child tax credit is effective July 1, 1997, for taxable 
years beginning after December 31, 1996.

  B. Increase Exemption Amounts Applicable to Individual Alternative 
       Minimum Tax (sec. 102 of the bill and sec. 55 of the Code)

                              Present Law

    Present law imposes a minimum tax on an individual to the 
extent the taxpayer's minimum tax liability exceeds his or her 
regular tax liability. This alternative minimum tax is imposed 
upon individuals at rates of (1) 26 percent on the first 
$175,000 of alternative minimum taxable income in excess of a 
phased-out exemption amount and (2) 28 percent on the amount in 
excess of $175,000. The exemptions amounts are $45,000 in the 
case of married individuals filing a joint return and surviving 
spouses; $33,750 in the case of other unmarried individuals; 
and $22,500 in the case of married individuals filing a 
separate return. These exemption amounts are phased-out by an 
amount equal to 25 percent of the amount that the individual's 
alternative minimum taxable income exceeds a threshold amount. 
These threshold amounts are $150,000 in the case of married 
individuals filing a joint return and surviving spouses; 
$112,500 in the case of other unmarried individuals; and 
$75,000 in the case of married individuals filing a separate 
return, estates, and trusts. The exemption amounts, the 
threshold phase-out amounts, and the $175,000 break-point 
amount are not indexed for inflation.

                           Reasons for Change

    The Committee is concerned about the projected trend that 
significantly more individuals without tax preferences or 
adjustments will become subject to the alternative minimum tax 
in the near future. This trend is projected, in part, because 
the exemption amounts applicable to the individual alternative 
minimum tax are not increased for inflation, while the standard 
deduction, personal exemptions, rate brackets and other 
features of the regular tax are so increased.

                        Explanation of Provision

    For taxable years beginning after 2000 and before 2003, the 
exemption amounts of the individual alternative minimum tax are 
increased as follows in each year: (1) by $600 in the case of 
married individuals filing a joint return and surviving 
spouses; (2) by $450 in the case of other unmarried 
individuals; and (3) by $300 in the case of married individuals 
filing separate returns. For taxable years beginning after 
2003, the exemption amounts of the individual alternative 
minimum tax are increased as follows in each year: (1) by $950 
in the case of married individuals filing a joint return and 
surviving spouses; (2) by $700 in the case of other unmarried 
individuals; and (3) by $475 in the case of married individuals 
filing separate returns.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 2000.
                   TITLE II. EDUCATION TAX INCENTIVES

             A. Tax Benefits Relating to Education Expenses

1. HOPE credit for higher education tuition expenses (sec. 201 of the 
        bill and new sec. 25A of the Code)

                               Present Law

Deductibility of education expenses

    Taxpayers generally may not deduct education and training 
expenses. However, a deduction for education expenses generally 
is allowed under section 162 if the education or training (1) 
maintains or improves a skill required in a trade or business 
currently engaged in by the taxpayer, or (2) meets the express 
requirements of the taxpayer's employer, or requirements of 
applicable law or regulations, imposed as a condition of 
continued employment (Treas. Reg. sec. 1.162-5). However, 
education expenses are not deductible if they relate to certain 
minimum educational requirements or to education or training 
that enables a taxpayer to begin working in a new trade or 
business. In the case of an employee, education expenses (if 
not reimbursed by the employer) may be claimed as an itemized 
deduction only if such expenses meet the above- described 
criteria for deductibility under section 162 and only to the 
extent that the expenses, along with other miscellaneous 
deductions, exceed 2 percent of the taxpayer's adjusted gross 
income (AGI).

Exclusion for employer-provided educational assistance

     A special rule allows an employee to exclude from gross 
income for income tax purposes and from wages for employment 
tax purposes up to $5,250 annually paid by his or her employer 
for educational assistance (sec. 127). In order for the 
exclusion to apply certain requirements must be satisfied, 
including a requirement that not more than 5 percent of the 
amounts paid or incurred by the employer during the year for 
educational assistance under a qualified educational assistance 
program can be provided for the 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. This special 
rule for employer-provided educational assistance expires with 
respect to courses beginning after June 30, 1997 (and does not 
apply to graduate level courses beginning after June 30, 1996).
    For purposes of the special exclusion, educational 
assistance means the payment by an employer of expenses 
incurred by or on behalf of the employee for education of the 
employee including, but not limited to, tuition, fees, and 
similar payments, books, supplies, and equipment. Educational 
assistance also includes the provision by the employer of 
courses of instruction for the employee (including books, 
supplies, and equipment). Educational assistance does not 
include tools or supplies which may be retained by the employee 
after completion of a course or meals, lodging, or 
transportation. The exclusion does not apply to any education 
involving sports, games, or hobbies.
    In the absence of the special exclusion, employer-provided 
educational assistance is excludable from gross income and 
wages as a working condition fringe benefit (sec. 132(d)) only 
to the extent the education expenses would be deductible under 
section 162.

Exclusion for interest earned on savings bonds

    Another special rule (sec. 135) provides that interest 
earned on a qualified U.S. Series EE savings bond issued after 
1989 is excludable from gross income if the proceeds of the 
bond upon redemption do not exceed qualified higher education 
expenses paid by the taxpayer during the taxable year.\1\ 
``Qualified higher education expenses'' include tuition and 
fees (but not room and board expenses) required for the 
enrollment or attendance of the taxpayer, the taxpayer's 
spouse, or a dependent of the taxpayer at certain colleges, 
universities, or vocational schools. The exclusion provided by 
section 135 is phased out for certain higher-income taxpayers, 
determined by the taxpayer's modified AGI during the year the 
bond is redeemed. For 1996, the exclusion was phased out for 
taxpayers with modified AGI between $49,450 and $64,450 
($74,200 and $104,200 for joint returns). To prevent taxpayers 
from effectively avoiding the income phaseout limitation 
through issuance of bonds directly in the child's name, section 
135(c)(1)(B) provides that the interest exclusion is available 
only with respect to U.S. Series EE savings bonds issued to 
taxpayers who are at least 24 years old.
---------------------------------------------------------------------------
    \1\ If the aggregate redemption amount (i.e., principal plus 
interest) of all Series EE bonds redeemed by the taxpayer during the 
taxable year exceeds the qualified education expenses incurred, then 
the excludable portion of interest income is based on the ratio that 
the education expenses bears to the aggregate redemption amount (sec. 
135(b)).
---------------------------------------------------------------------------

Qualified scholarships

    Section 117 excludes from gross income amounts received as 
a qualified scholarship by an individual who is a candidate for 
a degree and used for tuition and fees required for the 
enrollment or attendance (or for fees, books, supplies, and 
equipment required for courses of instruction) at a primary, 
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to 
scholarship amounts covering regular living expenses, such as 
room and board. There is, however, no dollar limitation for the 
section 117 exclusion, provided that the scholarship funds are 
used to pay for tuition and required fees. In addition to the 
exclusion for qualified scholarships, section 117 provides an 
exclusion from gross income for qualified tuition reductions 
for education below the graduate level provided to employees of 
certain educational organizations. Section 117(c) specifically 
provides that the exclusion for qualified scholarships does not 
apply to any amount received by a student that represents 
payment for teaching, research, or other services by the 
student required as a condition for receiving the scholarship.

Student loan forgiveness

    In the case of an individual, section 108(f) provides that 
gross income subject to Federal income tax does not include any 
amount from the forgiveness (in whole or in part) of certain 
student loans, provided that the forgiveness is contingent on 
the student's working for a certain period of time in certain 
professions for any of a broad class of employers (e.g., 
providing health care services to a nonprofit organization). 
Student loans eligible for this special rule must be made to an 
individual to assist the individual in attending an education 
institution that normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of 
students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses (in contrast to tax-free scholarships under 
section 117, which are limited to tuition and required fees). 
In addition, the loan must be made by (1) the United States (or 
an instrumentality or agency thereof), (2) a State (or any 
political subdivision thereof), (3) certain tax-exempt public 
benefit corporations that control a State, county, or municipal 
hospital and whose employees have been deemed to be public 
employees under State law, or (4) an educational organization 
that originally received the funds from which the loan was made 
from the United States, a State, or a tax-exempt public benefit 
corporation. Thus, loans made with private, nongovernmental 
funds are not qualifying student loans for purposes of the 
section 108(f) exclusion. As with section 117, there is no 
dollar limitation for the section 108(f) exclusion.

Qualified State prepaid tuition programs

    Section 529 (enacted as part of the Small Business Job 
Protection Act of 1996) provides tax-exempt status to 
``qualified State tuition programs,'' meaning certain programs 
established and maintained by a State (or agency or 
instrumentality thereof) under which persons may (1) purchase 
tuition credits or certificates on behalf of a designated 
beneficiary that entitle the beneficiary to a waiver or payment 
of qualified higher education expenses of the beneficiary, or 
(2) make contributions to an account that is established for 
the purpose of meeting qualified higher education expenses of 
the designated beneficiary of the account. ``Qualified higher 
education expenses'' are defined as tuition, fees, books, 
supplies, and equipment required for the enrollment or 
attendance at a college or university (or certain vocational 
schools). Qualified higher education expenses do not include 
room and board expenses. Section 529 also provides that no 
amount shall be included in the gross income of a contributor 
to, or beneficiary of, a qualified State tuition program with 
respect to any distribution from, or earnings under, such 
program, except that (1) amounts distributed or educational 
benefits provided to a beneficiary (e.g., when the beneficiary 
attends college) will be included in the beneficiary's gross 
income (unless excludable under another Code section) to the 
extent such amounts or the value of the educational benefits 
exceed contributions made on behalf of the beneficiary, and (2) 
amounts distributed to a contributor (e.g., when a parent 
receives a refund) will be included in the contributor's gross 
income to the extent such amounts exceed contributions made by 
that person.\2\
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    \2\ Specifically, section 529(c)(3)(A) provides that any 
distribution under a qualified State tuition program shall be 
includible in the gross income of the distributee in the same manner as 
provided under present-law section 72 to the extent not excluded from 
gross income under any other provision of the Code.
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                           Reasons for Change

    To assist low- and middle-income families and students in 
paying for the costs of post-secondary education, the Committee 
believes that taxpayers should be allowed to claim a credit 
(referred to as a ``HOPE'' credit) against Federal income taxes 
for certain tuition and related expenses incurred during a 
student's first two years of attendance (on at least a half-
time basis) at a college, university, or certain vocational 
schools.

                        Explanation of Provision

                               In general

    Under the bill, individual taxpayers are allowed to claim a 
non-refundable HOPE credit against Federal income taxes up to 
$1,500 per student per year for 50 percent of qualified tuition 
and related expenses (but not room and board expenses) paid for 
the first two years of the student's post-secondary education 
in a degree or certificate program. In the case of a student 
attending a community college (i.e., a so-called ``two-year'' 
or ``junior'' college) or vocational school, the maximum HOPE 
credit equals 75 percent (rather than 50 percent) of qualified 
tuition and related expenses, subject to a maximum credit of 
$1,500 per student per year.\3\ The qualified tuition and 
related expenses must be incurred on behalf of the taxpayer, 
the taxpayer's spouse, or a dependent. The HOPE credit will be 
available with respect to an individual student for two taxable 
years, provided that the student has not completed the first 
two years of post-secondary education. Beginning in 1999, the 
maximum HOPE credit amount of $1,500 will be indexed for 
inflation, rounded down to the closest multiple of $50.\4\
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    \3\ Thus, students attending community colleges or vocational 
schools may be eligible for the $1,500 maximum HOPE credit if they 
incur $2,000 of qualified tuition and related expenses. In contrast, 
students attending other institutions (e.g., four-year colleges) may be 
eligible for the $1,500 maximum HOPE credit if they incur $3,000 of 
qualified tuition and related expenses.
    For purposes of the 75-percent credit rate, ``community colleges'' 
are defined as any institution of higher education (as defined in sec. 
1201 of the Higher Education Act of 1965 (20 U.S.C. 1141)) that awards 
an associate's degree. ``Vocational schools'' are defined as post-
secondary vocational institutions (as defined in sec. 481 of the Higher 
Education Act of 1965 (20 U.S.C. 1088)).
    \4\ The HOPE credit may not be claimed against a taxpayer's 
alternative minimum tax (AMT) liability.
---------------------------------------------------------------------------
    The HOPE credit amount that a taxpayer may otherwise claim 
will be phased out ratably for taxpayers with modified AGI 
between $40,000 and $50,000 ($80,000 and $100,000 for joint 
returns). Modified AGI includes amounts otherwise excluded with 
respect to income earned abroad (or income from Puerto Rico or 
U.S. possessions). Beginning in 2001, the income phase-out 
ranges will be indexed for inflation, rounded down to the 
closest multiple of $5,000.
    The HOPE credit will be available for the taxable year in 
which the expenses are paid, subject to the requirement that 
the education commence or continue during that year or during 
the first three months of the next year. Qualified tuition 
expenses paid with the proceeds of a loan generally will be 
eligible for the HOPE credit (rather than repayment of the loan 
itself).\5\
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    \5\ The Treasury Department will have authority to issue 
regulations providing that the HOPE credit will be recaptured in cases 
where the student or taxpayer receives a refund of tuition and related 
expenses with respect to which a credit was claimed in a prior year.
---------------------------------------------------------------------------

Dependent students

    A taxpayer may claim the HOPE credit with respect to an 
eligible student who is not the taxpayer or the taxpayer's 
spouse (e.g., in cases where the student is the taxpayer's 
child) only if the taxpayer claims the student as a dependent 
for the taxable year for which the credit is claimed. If a 
student is claimed as a dependent by the parent or other 
taxpayer, the eligible student him- or herself is not entitled 
to claim a HOPE credit for that taxable year on the student's 
own tax return. If a parent (or other taxpayer) claims a 
student as a dependent, any qualified tuition and related 
expenses paid by the student are treated as paid by the parent 
(or other taxpayer) for purposes of the provision.

Election of HOPE credit or proposed exclusion for distributions from a 
        qualified tuition program or education IRA

    For a taxable year, a taxpayer may elect with respect to an 
eligible student either the HOPE credit (assuming that all the 
requirements of the HOPE credit are satisfied) or the exclusion 
for distributions from a qualified tuition program or education 
IRA used to cover qualified higher education expenses 
(described below).\6\ If a child is not claimed as a dependent 
by the parent (or by any other taxpayer) for the taxable year, 
then the child him- or herself will have the option of electing 
either the HOPE credit or proposed exclusion for distributions 
from a qualified tuition program or education IRA used to cover 
qualified higher education expenses.
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    \6\ For any taxable year, a taxpayer may claim the HOPE credit for 
qualified tuition and related expenses paid with respect to one student 
and also claim the proposed exclusion for distributions made from a 
qualified tuition program or education IRA (described below) used to 
cover higher education expenses paid with respect to one or more other 
students. If the HOPE credit is claimed with respect to one student for 
one or two taxable years, then the exclusion for distributions from a 
qualified tuition program or education IRA may be available with 
respect to that same student for subsequent taxable years.
---------------------------------------------------------------------------

Qualified tuition and related expenses

    The HOPE credit is available for ``qualified tuition and 
related expenses,'' meaning tuition, fees, and books required 
for the enrollment or attendance of an eligible student at an 
eligible educational institution. Charges and fees associated 
with meals, lodging, student activities, athletics, insurance, 
transportation, and similar personal, living or family expenses 
are not eligible for the HOPE credit. The expenses of education 
involving sports, games, or hobbies are not qualified tuition 
expenses unless this education is part of the student's degree 
program.
    Qualified tuition and related expenses generally include 
only out-of-pocket expenses. Qualified tuition expenses do not 
include expenses covered by educational assistance that is not 
required to be included in the gross income of either the 
student or the taxpayer claiming the credit. Thus, total 
tuition and related expenses are reduced by scholarship or 
fellowship grants excludable from gross income under present-
law section 117, as well as any other tax-free educational 
benefits, such as employer-provided educational assistance that 
is excludable from the employee's gross income under section 
127. No reduction of qualified tuition expenses is required for 
a gift, bequest, devise, or inheritance within the meaning of 
section 102(a). Under the bill, a HOPE credit will not be 
allowed with respect to any education expenses for which a 
deduction is claimed under section 162 or any other section of 
the Code.\7\
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    \7\ In addition, the bill amends present-law section 135 to provide 
that the amount of qualified higher education expenses taken into 
account for purposes of that section is reduced by the amount of such 
expenses taken into account in determining the HOPE credit allowed to 
any taxpayer with respect to the student for the taxable year.
---------------------------------------------------------------------------

Eligible student

    An eligible student is an individual who is enrolled in a 
degree, certificate, or other program (including a program of 
study abroad approved for credit by the institution at which 
such student is enrolled) leading to a recognized educational 
credential at an eligible educational institution. The student 
must pursue a course of study on at least a half-time basis. 
(In other words, for at least one academic period which begins 
during the taxable year, the student must carry at least one-
half the normal full-time work load for the course of study the 
student is pursuing.) An eligible student is required to have 
earned a high-school diploma (or equivalent degree) prior to 
attending any post-secondary classes with respect to which a 
HOPE credit is claimed, with the exception of students who did 
not receive a high-school degree by reason of enrollment in an 
early admission program to an eligible educational institution. 
An eligible student may not have been convicted of a Federal or 
State felony consisting of the possession or distribution of a 
controlled substance.

Eligible educational institution

    Under the bill, eligible educational institutions are 
defined by reference to section 481 of the Higher Education Act 
of 1965. Such institutions generally are accredited post-
secondary educational institutions offering credit toward a 
bachelor's degree, an associate's degree, or another recognized 
post-secondary credential. Certain proprietary institutions and 
post-secondary vocational institutions also are eligible 
educational institutions. The institution must be eligible to 
participate in Department of Education student aid programs.

Regulations

    The Secretary of the Treasury (in consultation with the 
Secretary of Education) will have authority to issue 
regulations to implement the provision, including regulations 
providing appropriate rules for recordkeeping and information 
reporting. These regulations will address the information 
reports that eligible educational institutions will be required 
to file to assist students and the IRS in calculating the 
amount of the HOPE credit potentially available.

Effective Date

    The provision applies to expenses paid after December 31, 
1997, for education furnished in academic periods beginning 
after such date.

2. Exclusion from gross income for amounts distributed from qualified 
        tuition programs and education IRAs to cover qualified higher 
        education expenses (secs. 211, 212, and 213 of the bill and 
        sec. 529 and new sec. 530 of the Code)

Present Law

Deductibility of education expenses

    Taxpayers generally may not deduct education and training 
expenses. However, a deduction for education expenses generally 
is allowed under section 162 if the education or training (1) 
maintains or improves a skill required in a trade or business 
currently engaged in by the taxpayer, or (2) meets the express 
requirements of the taxpayer's employer, or requirements of 
applicable law or regulations, imposed as a condition of 
continued employment (Treas. Reg. sec. 1.162-5). However, 
education expenses are not deductible if they relate to certain 
minimum educational requirements or to education or training 
that enables a taxpayer to begin working in a new trade or 
business. In the case of an employee, education expenses (if 
not reimbursed by the employer) may be claimed as an itemized 
deduction only if such expenses meet the above-described 
criteria for deductibility under section 162 and only to the 
extent that the expenses, along with other miscellaneous 
deductions, exceed 2 percent of the taxpayer's adjusted gross 
income (AGI).

Exclusion for employer-provided educational assistance

    A special rule allows an employee to exclude from gross 
income for income tax purposes and from wages for employment 
tax purposes up to $5,250 annually paid by his or her employer 
for educational assistance (sec. 127). In order for the 
exclusion to apply certain requirements must be satisfied, 
including a requirement that not more than 5 percent of the 
amounts paid or incurred by the employer during the year for 
educational assistance under a qualified educational assistance 
program can be provided for the 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. This special 
rule for employer-provided educational assistance expires with 
respect to courses beginning after June 30, 1997 (and does not 
apply to graduate level courses beginning after June 30, 1996).
    For purposes of the special exclusion, educational 
assistance means the payment by an employer of expenses 
incurred by or on behalf of the employee for education of the 
employee including, but not limited to, tuition, fees, and 
similar payments, books, supplies, and equipment. Educational 
assistance also includes the provision by the employer of 
courses of instruction for theemployee (including books, 
supplies, and equipment). Educational assistance does not include tools 
or supplies which may be retained by the employee after completion of a 
course or meals, lodging, or transportation. The exclusion does not 
apply to any education involving sports, games, or hobbies.
    In the absence of the special exclusion, employer-provided 
educational assistance is excludable from gross income and 
wages as a working condition fringe benefit (sec. 132(d)) only 
to the extent the education expenses would be deductible under 
section 162.

Exclusion for interest earned on savings bonds

    Another special rule (sec. 135) provides that interest 
earned on a qualified U.S. Series EE savings bond issued after 
1989 is excludable from gross income if the proceeds of the 
bond upon redemption do not exceed qualified higher education 
expenses paid by the taxpayer during the taxable year.\8\ 
``Qualified higher education expenses'' include tuition and 
fees (but not room and board expenses) required for the 
enrollment or attendance of the taxpayer, the taxpayer's 
spouse, or a dependent of the taxpayer at certain colleges, 
universities, or vocational schools. The exclusion provided by 
section 135 is phased out for certain higher-income taxpayers, 
determined by the taxpayer's modified AGI during the year the 
bond is redeemed. For 1996, the exclusion was phased out for 
taxpayers with modified AGI between $49,450 and $64,450 
($74,200 and $104,200 for joint returns). To prevent taxpayers 
from effectively avoiding the income phaseout limitation 
through issuance of bonds directly in the child's name, section 
135(c)(1)(B) provides that the interest exclusion is available 
only with respect to U.S. Series EE savings bonds issued to 
taxpayers who are at least 24 years old.
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    \8\ If the aggregate redemption amount (i.e., principal plus 
interest) of all Series EE bonds redeemed by the taxpayer during the 
taxable year exceeds the qualified education expenses incurred, then 
the excludable portion of interest income is based on the ratio that 
the education expenses bears to the aggregate redemption amount (sec. 
135(b)).
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Qualified scholarships

    Section 117 excludes from gross income amounts received as 
a qualified scholarship by an individual who is a candidate for 
a degree and used for tuition and fees required for the 
enrollment or attendance (or for fees, books, supplies, and 
equipment required for courses of instruction) at a primary, 
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to 
scholarship amounts covering regular living expenses, such as 
room and board. There is, however, no dollar limitation for the 
section 117 exclusion, provided that the scholarship funds are 
used to pay for tuition and required fees. In addition to the 
exclusion for qualified scholarships, section 117 provides an 
exclusion from gross income for qualified tuition reductions 
for education below the graduate level provided to employees of 
certain educational organizations. Section 117(c) specifically 
provides that the exclusion for qualified scholarships does not 
apply to any amount received by a student that represents 
payment for teaching, research, or other services by the 
student required as a condition for receiving the scholarship.

Student loan forgiveness

    In the case of an individual, section 108(f) provides that 
gross income subject to Federal income tax does not include any 
amount from the forgiveness (in whole or in part) of certain 
student loans, provided that the forgiveness is contingent on 
the student's working for a certain period of time in certain 
professions for any of a broad class of employers (e.g., 
providing health care services to a nonprofit organization). 
Student loans eligible for this special rule must be made to an 
individual to assist the individual in attending an education 
institution that normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of 
students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses (in contrast to tax-free scholarships under 
section 117, which are limited to tuition and required fees). 
In addition, the loan must be made by (1) the United States (or 
an instrumentality or agency thereof), (2) a State (or any 
political subdivision thereof), (3) certain tax-exempt public 
benefit corporations that control a State, county, or municipal 
hospital and whose employees have been deemed to be public 
employees under State law, or (4) an educational organization 
that originally received the funds from which the loan was made 
from the United States, a State, or a tax-exempt public benefit 
corporation. Thus, loans made with private, nongovernmental 
funds are not qualifying student loans for purposes of the 
section 108(f) exclusion. As with section 117, there is no 
dollar limitation for the section 108(f) exclusion.

Qualified State prepaid tuition programs

    Section 529 (enacted as part of the Small Business Job 
Protection Act of 1996) provides tax-exempt status to 
``qualified State tuition programs,'' meaning certain programs 
established and maintained by a State (or agency or 
instrumentality thereof) under which persons may (1) purchase 
tuition credits or certificates on behalf of a designated 
beneficiary that entitle the beneficiary to a waiver or payment 
of qualified higher education expenses of the beneficiary, or 
(2) make contributions to an account that is established for 
the purpose of meeting qualified higher education expenses of 
the designated beneficiary of the account. ``Qualified higher 
education expenses'' are defined as tuition, fees, books, 
supplies, and equipment required for the enrollment or 
attendance at a college or university (or certain vocational 
schools). Qualified higher education expenses do not include 
room and board expenses. Section 529 also provides that no 
amount shall be included in the gross income of a contributor 
to, or beneficiary of, a qualified State tuition program with 
respect to any distribution from, or earnings under, such 
program, except that (1) amounts distributed or educational 
benefits provided to a beneficiary (e.g., when the beneficiary 
attends college) will be included in the beneficiary's gross 
income (unless excludable under another Code section) to the 
extent such amounts or the value of the educational benefits 
exceed contributions made on behalf of the beneficiary, and (2) 
amounts distributed to a contributor (e.g., when a parent 
receives a refund) will be included in the contributor's gross 
income to the extent such amounts exceed contributions made by 
that person.\9\
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    \9\ Specifically, section 529(c)(3)(A) provides that any 
distribution under a qualified State tuition program shall be 
includible in the gross income of the distributee in the same manner as 
provided under present-law section 72 to the extent not excluded from 
gross income under any other provision of the Code.
---------------------------------------------------------------------------
    Contributions made to a qualified State tuition program are 
treated as incomplete gifts for Federal gift tax purposes (sec. 
529(c)(2)). Thus, any Federal gift tax consequences are 
determined at the time that a distribution is made from an 
account under the program. The waiver (or payment) of qualified 
higher education expenses of a designated beneficiary by (or 
to) an educational institution under a qualified State tuition 
program is treated as a qualified transfer for purposes of 
present-law section 2503(e). Amounts contributed to a qualified 
State tuition program (and earnings thereon) are includible in 
the contributor's estate for Federal estate tax purposes in the 
event that the contributor dies before such amounts are 
distributed under the program (sec. 529(c)(4)).

Individual retirement arrangements (``IRAs'')

    An individual may make deductible contributions to an 
individual retirement arrangement (``IRA'') for each taxable 
year up to the lesser of $2,000 or the amount of the 
individual's compensation for the year if the individual is not 
an active participant in an employer-sponsored qualified 
retirement plan (and, if married, the individual's spouse also 
is not an active participant). Contributions may be made to an 
IRA for a taxable year up to April 15th of the following year. 
An individual who makes excess contributions to an IRA, i.e., 
contributions in excess of $2,000, is subject to an excise tax 
on such excess contributions unless they are distributed from 
the IRA before the due date for filing the individual's tax 
return for the year (including extensions). If the individual 
(or his or her spouse, if married) is an active participant, 
the $2,000 limit is phased out between $40,000 and $50,000 of 
adjusted gross income (``AGI'') for married couples and between 
$25,000 and $35,000 of AGI for single individuals.
    Present law permits individuals to make nondeductible 
contributions (up to $2,000 per year) to an IRA to the extent 
an individual is not permitted to (or does not) make deductible 
contributions. Earnings on such contributions are includible in 
gross income when withdrawn.
    An individual generally is not subject to income tax on 
amounts held in an IRA, including earnings on contributions, 
until the amounts are withdrawn from the IRA. Amounts withdrawn 
from an IRA are includible in gross income (except to the 
extent of nondeductible contributions). In addition, a 10-
percent additional tax generally applies to distributions from 
IRAs made before age 59\1/2\, unless the distribution is made 
(1) on account of death or disability, (2) in the form of 
annuity payments, (3) for medical expenses of the individual 
and his or her spouse and dependents that exceed 7.5 percent of 
AGI, or (4) for medical insurance of the individual and his or 
her spouse and dependents (without regard to the 7.5 percent of 
AGI floor) if the individual has received unemployment 
compensation for at least 12 weeks, and the withdrawal is made 
in the year such unemployment compensation is received or the 
following year.

                           Reasons for Change

    To encourage families and students to save for future 
education expenses, the Committee believes that tax-exempt 
status should be granted to certain prepaid tuition programs 
operated by States or private educational institutions and to 
certain education investment accounts (referred to as 
``education IRAs'') established by taxpayers on behalf of 
future students. The Committee further believes that 
distributions from such programs and accounts should not be 
subject to Federal income tax to the extent that the amounts 
distributed are used to pay for qualified higher education 
expenses of an undergraduate or graduate student who is 
attending a college, university, or certain vocational schools 
on at least a half-time basis.

                        Explanation of Provision

In general

    Under the bill, amounts distributed from qualified tuition 
programs and certain education investment accounts (referred to 
as ``education IRAs'') are excludable from gross income to the 
extent that the amounts distributed do not exceed qualified 
higher education expenses of an eligible student incurred 
during the year the distribution is made.\10\ An exclusion is 
not allowed under the bill with respect to an otherwise 
eligible student if the HOPE credit (as described previously) 
is claimed with respect to that student for the taxable year 
the distribution is made.\11\
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    \10\ The exclusion will not be a preference item for alternative 
minimum tax (AMT) purposes.
    \11\ If a HOPE credit was claimed with respect to a student for an 
earlier taxable year (i.e., the student's first or second year of post-
secondary education), the exclusion provided for by the bill may be 
claimed with respect to that student for a subsequent taxable year.
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    Under the bill, distributions from a qualified tuition 
program or education IRA generally will be deemed to consist of 
distributions of principal (which, under all circumstances, are 
excludable from gross income) and earnings (which may be 
excludable from gross income under the bill) by applying the 
ratio that the aggregate amount of contributions to the program 
or account for the beneficiary bears to the total balance (or 
value) of the program or account for the beneficiary at the 
time the distribution is made.\12\ If the qualified higher 
education expenses ofthe student for the year are at least 
equal to the total amount of the distribution (i.e., principal and 
earnings combined) from a qualified tuition program or education IRA, 
then the earnings in their entirety will be excludable from gross 
income. If, on the other hand, the qualified higher education expenses 
of the student for the year are less than the total amount of the 
distribution (i.e., principal and earnings combined) from a qualified 
tuition program or education IRA, then the qualified higher education 
expenses will be deemed to be paid from a pro-rata share of both the 
principal and earnings components of the distribution. Thus, in such a 
case, only a portion of the earnings will be excludable under the bill 
(i.e., a portion of the earnings based on the ratio that the qualified 
higher education expenses bear to the total amount of the distribution) 
and the remaining portion of the earnings will be includible in the 
gross income of the distributee.\13\
---------------------------------------------------------------------------
    \12\ Specifically, the bill provides as a general rule that 
distributions from a qualified tuition program or education IRA are 
includible in gross income to the extent allocable to income on the 
program or account and are not includible in gross income to the extent 
allocable to the investment (i.e., contributions) in the program or 
account. However, the bill further provides that, if the HOPE credit is 
not claimed with respect to the student for the taxable year, then a 
distribution from a qualified tuition program or education IRA will not 
be includible in gross income to the extent that the distribution does 
not exceed the qualified higher expenses of the student for the year. 
If a distribution consists of providing in-kind education benefits to 
the student which, if paid for by the student, would constitute payment 
of qualified higher education expenses, then no portion of such 
distribution will be includible in gross income.
    At the time that a final distribution is made for a qualified 
tuition program or education IRA, the distribution will be deemed to 
include the full amount of any basis remaining with respect to the 
program or account.
    \13\ For example, if a $1,000 distribution from a qualified tuition 
program or education IRA consists of $600 of principal (i.e., 
contributions) and $400 of earnings, and if the student incurs $750 of 
qualified higher education expenses during the year, then $300 of the 
earnings will be excludable from gross income under the bill (i.e., an 
exclusion will be provided for the pro-rata portion of the earnings, 
based on the ratio that the $750 of qualified expenses bears to the 
$1,000 total distribution) and the remaining $100 of earnings will be 
includible in the distributee's gross income.
---------------------------------------------------------------------------

Eligible students

    To be an eligible student under the bill, an individual 
must be at least a half-time student in a degree or certificate 
undergraduate or graduate program at an eligible educational 
institution. For this purpose, a student is at least a half-
time student if he or she is carrying at least one-half the 
normal full-time work load for the course of study the student 
is pursuing. An eligible student may not have been convicted of 
a Federal or State felony consisting of the possession or 
distribution of a controlled substance.

Eligible educational institution

    Under the bill, eligible educational institutions are 
defined by reference to section 481 of the Higher Education Act 
of 1965. Such institutions generally are accredited post-
secondary educational institutions offering credit toward a 
bachelor's degree, an associate's degree, a graduate-level or 
professional degree, or another recognized post-secondary 
credential. Certain proprietary institutions and post-secondary 
vocational institutions also are eligible institutions. The 
institution must be eligible to participate in Department of 
Education student aid programs.

Qualified higher education expenses

    Under the bill, the definition of ``qualified higher 
education expenses'' include tuition, fees, books, supplies, 
and equipment required for the enrollment or attendance of a 
student at an eligible education institution, as well as room 
and board expenses (meaning the minimum room and board 
allowance applicable to the student as determined by the 
institution in calculating costs of attendance for Federal 
financial aid programs under sec. 472 of the Higher Education 
Act of 1965) for any period during which the student is at 
least a half-time student. Qualified higher education expenses 
include expenses with respect to undergraduate or graduate-
level courses.
    Qualified higher education expenses generally include only 
out-of-pocket expenses. Qualified higher education expenses do 
not include expenses covered by educational assistance that is 
not required to be included in the gross income of either the 
student or the taxpayer claiming the credit. Thus, total 
qualified higher education expenses are reduced by scholarship 
or fellowship grants excludable from gross income under 
present-law section 117, as well as any other tax-free 
educational benefits, such as employer-provided educational 
assistance that is excludable from the employee's gross income 
under section 127. In addition, qualified higher education 
expenses do not include expenses paid with amounts that are 
excludible under section 135. No reduction of qualified higher 
education expenses is required for a gift, bequest, devise, or 
inheritance within the meaning of section 102(a). If education 
expenses for a taxable year are deducted under section 162 or 
any other section of the Code, then such expenses are not 
qualified higher education expenses under the bill.

Qualified tuition programs and education IRAs

    Under the bill, a ``qualified tuition program'' means any 
qualified State-sponsored tuition program, defined under 
section 529 (as modified by the bill), as well as any program 
established and maintained by one or more eligible educational 
institutions (which could be private institutions) that satisfy 
the requirements under section 529 (other than present-law 
State ownership rule). An ``education IRA'' means a trust (or 
custodial account) which is created or organized in the United 
States exclusively for the purpose of paying the qualified 
higher education expenses of the account holder and which 
satisfies certain other requirements.
    Contributions to qualified tuition programs or education 
IRAs may be made only in cash.\14\ Such contributions may not 
be made after the designated beneficiary or account holder 
reaches age 18. Annual contributions to a qualified tuition 
program not maintained by a State (i.e., a qualified tuition 
program operated by one or more private schools) or to an 
education IRA are limited to $2,000 per beneficiary or account 
holder, plus the amount of any child credit (as provided for by 
the bill and described above) that is allowed for the taxable 
year with respect to the beneficiary or account holder.\15\ 
Thus, in the case of any child with respect to whom the maximum 
$500 child credit is allowed for the taxable year, the 
contribution limit with respect to such child for the year will 
be $2,500.\16\ Trustees of qualified tuition programs not 
maintained by a State and trustees of education IRAs are 
prohibited from accepting contributions to any account on 
behalf of a beneficiary in excess of $2,500 for any year 
(except in cases involving certain tax-free rollovers, as 
described below).\17\
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    \14\ The bill allows taxpayers to redeem U.S. Savings Bonds and be 
eligible for the exclusion under section 135 (as if the proceeds were 
used to pay qualified higher education expenses) if the proceeds from 
the redemption are contributed to a qualified tuition program or 
education IRA on behalf of the taxpayer, the taxpayer's spouse, or a 
dependent. In such a case, the beneficiary's or account holder's basis 
in the bond proceeds contributed on his or her behalf to the qualified 
tuition program or education IRA will be the contributor's basis in the 
bonds (i.e., the original purchase price paid by the contributor for 
such bonds).
    The bill also provides that funds from an education IRA are deemed 
to be distributed to pay qualified higher education expenses if the 
funds are used to make contributions to (or purchase tuition credits 
from) a qualified tuition program for the benefit of the account 
holder.
    \15\ State-sponsored qualified tuition programs will continue to be 
governed by the rule contained in present-law section 529(b)(7) that 
such programs provide adequate safeguards to prevent contributions on 
behalf of a designated beneficiary in excess of those necessary to 
provide for the qualified higher education expenses of the beneficiary. 
State-sponsored qualified tuition programs will not be subject to a 
specific dollar limit on annual contributions that can be made under 
the program on behalf of a designated beneficiary.
    \16\ The maximum contribution limit for the year is increased even 
if the child is younger than age 13--that is, even in cases where the 
parent is not required (under the provision described previously) but 
may elect to deposit an amount equal to the child credit into a 
qualified tuition program or education IRA on behalf of the child.
    \17\ The annual $2,000 to $2,500 contribution limit is applied by 
taking into account all contributions made to any qualified tuition 
program not maintained by a State and any education IRA on behalf of a 
designated individual (but not any contributions made to State-
sponsored qualified tuition programs). To the extent contributions 
exceed the annual contribution limit, an excise tax penalty may be 
imposed on the contributor under present-law section 4973, unless the 
excess contributions (and any earnings thereon) are returned to the 
contributor before the due date for the return for the taxable year 
during which the excess contribution is made.
---------------------------------------------------------------------------
    If any balance remaining in an education IRA is not 
distributed by the time that the account holder becomes 30 
years old, then the account will be deemed to be an IRA Plus 
account (as provided for by the bill and described below) 
established on behalf of the same account holder.\18\ The bill 
allows (but does not require) tax-free transfers or rollovers 
of account balances from a qualified tuition program to an IRA 
Plus account when the beneficiary becomes 30 years old, 
provided that the funds from the qualified tuition program 
account are deposited in the IRA Plus account within 60 days 
after being distributed from the qualified tuition program.\19\ 
In addition, the bill allows tax-free transfers or rollovers of 
credits or account balances from one qualified tuition program 
or education IRA account benefiting one beneficiary to another 
program or account benefiting another beneficiary (as well as 
redesignations of the named beneficiary), provided that the new 
beneficiary is a member of the family of the old 
beneficiary.\20\
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    \18\ In such cases, the 5-year holding period applicable to IRA 
Plus accounts begins with the taxable year in which the education IRA 
is deemed to be an IRA Plus account.
    \19\ In the event of such a rollover, the 5-year holding period 
applicable to IRA Plus accounts begins with the taxable year in which 
the rollover occurs.
    \20\ For this purpose, a ``member of the family'' means persons 
described in paragraphs (1) through (8) of section 152(a), and any 
spouse of such persons.
---------------------------------------------------------------------------
    Qualified tuition programs and education IRAs (as separate 
legal entities) will be exempt from Federal income tax, other 
than taxes imposed under the present-law unrelated business 
income tax (UBIT) rules.\21\
---------------------------------------------------------------------------
    \21\ An interest in a qualified tuition program is not treated as 
debt for purposes of the debt-financed property UBIT rules of section 
514.
---------------------------------------------------------------------------
    Under the bill, an additional 10-percent penalty tax will 
be imposed on any distribution from a qualified tuition program 
not maintained by a State or from an education IRA to the 
extent that the distribution exceeds qualified higher education 
expenses incurred by the taxpayer (and is not made on account 
of the death, disability, or scholarship received by the 
designated beneficiary or account holder).\22\
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    \22\ Distributions from State-sponsored qualified tuition programs 
will not be subject to this 10-percent additional penalty tax, but will 
continue to be governed by the present-law section 529(b)(3) rule that 
the State-sponsored programs themselves are required to impose a ``more 
than de minimis penalty'' on any refund of earnings not used for 
qualified higher education expenses (other than in cases where the 
refund is made on account of death or disability of, or receipt of a 
scholarship by, the beneficiary).
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Estate and gift tax treatment

    Contributions to qualified tuition programs and education 
IRAs will not be considered taxable gifts for Federal gift tax 
purposes, and in no event will distributions from qualified 
tuition programs or education IRAs be treated as a taxable 
gifts.\23\ For estate tax purposes, the value of any interest 
in a qualified tuition program or education IRA will be 
includible in the estate of the designated beneficiary. In no 
event will such an interest be includible in the estate of the 
contributor.
---------------------------------------------------------------------------
    \23\ Contributions to only one State-sponsored qualified tuition 
program per beneficiary will be excluded from the gift tax by reason of 
the bill (although a contributor may also make contributions excluded 
from the gift tax on behalf of other beneficiaries to the same State- 
sponsored program or any other State-sponsored program).
---------------------------------------------------------------------------

                             Effective Date

    The provision applies to distributions made, and qualified 
higher education expenses paid, after December 31, 1997, for 
education furnished in academic periods beginning after such 
date. The provisions governing contributions to, and the tax-
exempt status of, qualified tuition plans and education IRAs 
generally apply after December 31, 1997. The gift tax 
provisions areeffective for contributions (or transfers) made 
after the date of enactment, and the estate tax provisions are 
effective for decedents dying after June 8, 1997.

3. Deduction for student loan interest (sec. 202 of the bill and new 
        sec. 221 of the Code)

                              Present Law

    The Tax Reform Act of 1986 repealed the deduction for 
personal interest. Student loan interest generally is treated 
as personal interest and thus is not allowable as an itemized 
deduction from income.
    Taxpayers generally may not deduct education and training 
expenses. However, a deduction for education expenses generally 
is allowed under section 162 if the education or training (1) 
maintains or improves a skill required in a trade or business 
currently engaged in by the taxpayer, or (2) meets the express 
requirements of the taxpayer's employer, or requirements of 
applicable law or regulations, imposed as a condition of 
continued employment (Treas. Reg. sec. 1.162-5). Education 
expenses are not deductible if they relate to certain minimum 
educational requirements or to education or training that 
enables a taxpayer to begin working in a new trade or business. 
In the case of an employee, education expenses (if not 
reimbursed by the employer) may be claimed as an itemized 
deduction only if such expenses relate to the employee's 
current job and only to the extent that the expenses, along 
with other miscellaneous deductions, exceed two percent of the 
taxpayer's adjusted gross income (AGI).

                           Reasons for Change

    The Committee is aware that many students incur 
considerable debt in the course of obtaining undergraduate and 
graduate education. The Committee believes that permitting a 
deduction for interest on certain student loans will help to 
ease the financial burden that such obligations represent.

                        Explanation of Provision

    Under the bill, certain individuals who have paid interest 
on qualified education loans may claim an above-the-line 
deduction for such interest expenses, up to a maximum deduction 
of $2,500 per year. The deduction is allowed only with respect 
to interest paid on a qualified education loan during the first 
60 months in which interest payments are required. Months 
during which the qualified education loan is in deferral or 
forbearance do not count against the 60-month period. No 
deduction is allowed to an individual if that individual is 
claimed as a dependent on another taxpayer's return for the 
taxable year. Beginning in 1999, the maximum deduction of 
$2,500 is indexed for inflation, rounded down to the closest 
multiple of $50.
    A qualified education loan generally is defined as any 
indebtedness incurred to pay for the qualified higher education 
expenses of the taxpayer, the taxpayer's spouse, or any 
dependent of the taxpayer as of the time the indebtedness was 
incurred in attending (1) post-secondary educational 
institutions and certain vocational schools defined by 
reference to section 481 of the Higher Education Act of 1965, 
or (2) institutions conducting internship or residency programs 
leading to a degree or certificate from an institution of 
higher education, a hospital, or a health care facility 
conducting postgraduate training. Qualified higher education 
expenses are defined as the student's cost of attendance as 
defined in section 472 of the Higher Education Act of 1965 
(generally, tuition, fees, room and board, and related 
expenses), reduced by (1) any amount excluded from gross income 
under section 135 (i.e., United States savings bonds used to 
pay higher education tuition and fees), (2) any amount 
distributed from a qualified tuition program or education 
investment account and excluded from gross income (under the 
provision described above), and (3) the amount of any 
scholarship or fellowship grants excludable from gross income 
under present-law section 117, as well as any other tax-free 
educational benefits, such as employer-provided educational 
assistance that is excludable from the employee's gross income 
under section 127. Such expenses must be paid or incurred 
within a reasonable period before or after the indebtedness is 
incurred, and must be attributable to a period when the student 
is at least a half-time student.
    The deduction is phased out ratably for taxpayers with 
modified adjusted gross income (AGI) between $40,000 and 
$50,000 ($80,000 and $100,000 for joint returns). Modified AGI 
includes amounts otherwise excluded with respect to income 
earned abroad (or income from Puerto Rico or U.S. possessions), 
and is calculated after application of section 86 (income 
inclusion of certain Social Security benefits), section 219 
(deductible IRA contributions), and section 469 (limitation on 
passive activity losses and credits).\24\ Beginning in 2001, 
the income phase-out ranges are indexed for inflation, rounded 
down to the closest multiple of $5,000.
---------------------------------------------------------------------------
    \24\ For purposes of sections 86, 135, 219, and 469, adjusted gross 
income is determined without regard to the deduction for student loan 
interest.
---------------------------------------------------------------------------
    Any person in a trade or business or any governmental 
agency that receives $600 or more in qualified education loan 
interest from an individual during a calendar year must provide 
an information report on such interest to the IRS and to the 
payor.

                             Effective Date

    The provision is effective for payments of interest due 
after December 31, 1996, on any qualified education loan. Thus, 
in the case of already existing qualified education loans, 
interest payments qualify for the deduction to the extent that 
the 60-month period has not expired. For purposes of counting 
the 60 months, any qualified education loan and all refinancing 
(that is treated as a qualified education loan) of such loan 
are treated as a single loan.

4. Penalty-free withdrawals from IRAs for higher education expenses 
        (sec. 203 of the bill and sec. 72(t) of the Code)

                              Present Law

    An individual may make deductible contributions to an 
individual retirement arrangement (``IRA'') for each taxable 
year up to the lesser of $2,000 or the amount of the 
individual's compensation for the year if the individual is not 
an active participant in anemployer-sponsored qualified 
retirement plan (and, if married, the individual's spouse also is not 
an active participant). In the case of a married couple, deductible IRA 
contributions of up to $2,000 can be made for each spouse (including, 
for example, a homemaker who does not work outside the home) if the 
combined compensation of both spouses is at least equal to the 
contributed amount.
    If the individual (or the individual's spouse) is an active 
participant in an employer-sponsored retirement plan, the 
$2,000 deduction limit is phased out over certain adjusted 
gross income (``AGI'') levels. The limit is phased out between 
$40,000 and $50,000 of AGI for married taxpayers, and between 
$25,000 and $35,000 of AGI for single taxpayers. An individual 
may make nondeductible IRA contributions to the extent the 
individual is not permitted to make deductible IRA 
contributions. Contributions cannot be made to an IRA after age 
70\1/2\.
    Amounts held in an IRA are includible in income when 
withdrawn (except to the extent the withdrawal is a return of 
nondeductible contributions). Amounts withdrawn prior to 
attainment of age 59\1/2\ are subject to an additional 10-
percent early withdrawal tax, unless the withdrawal is due to 
death or disability, is made in the form of certain periodic 
payments, is used to pay medical expenses in excess of 7.5 
percent of AGI, or is used to purchase health insurance of an 
unemployed individual.

                           Reasons for Change

    The Committee believes that it is both appropriate and 
important to allow individuals to withdraw amounts from their 
IRAs for purposes of paying higher education expenses without 
incurring an additional 10-percent early withdrawal tax.

                        Explanation of Provision

    The bill provides that the 10-percent early withdrawal tax 
does not apply to distributions from IRAs (including IRA Plus 
accounts created by the bill) if the taxpayer uses the amounts 
to pay qualified higher education expenses (including those 
related to graduate-level courses) of the taxpayer, the 
taxpayer's spouse, or any child, or grandchild of the taxpayer 
or the taxpayer's spouse.
    The penalty-free withdrawal is available for ``qualified 
higher education expenses,'' meaning tuition, fees, books, 
supplies, equipment required for enrollment or attendance, and 
room and board at a post-secondary educational institution 
(defined by reference to sec. 481 of the Higher Education Act 
of 1965). Qualified higher education expenses are reduced by 
any amount excludable from gross income under section 135 
relating to the redemption of a qualified U.S. savings bond and 
certain scholarships and veterans benefits.

                             Effective Date

    The provision is effective for distributions after December 
31, 1997, with respect to expenses paid after such date for 
education furnished in academic periods beginning after such 
date.

               B. Other Education-Related Tax Provisions

1. Extension of exclusion for employer-provided educational assistance 
        (sec. 221 of the bill and sec. 127 of the Code)

                              Present Law

    Under present law, an employee's gross income and wages do 
not include amounts paid or incurred by the employer for 
educational assistance provided to the employee if such amounts 
are paid or incurred pursuant to an educational assistance 
program that meets certain requirements. This exclusion is 
limited to $5,250 of educational assistance with respect to an 
individual during a calendar year. The exclusion does not apply 
to graduate level courses beginning after June 30, 1996. The 
exclusion expires with respect to courses beginning after June 
30, 1997.\25\ In the absence of the exclusion, educational 
assistance is excludable from income only if it is related to 
the employee's current job.
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    \25\ The legislative history reflects congressional intent that the 
provision expire with respect to courses beginning after May 31, 1997.
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that the exclusion for employer-
provided educational assistance has enabled millions of workers 
to advance their education and improve their job skills without 
incurring additional taxes and a reduction in take-home pay. In 
addition, the exclusion lessens the complexity of the tax laws. 
Without the special exclusion, a worker receiving educational 
assistance from his or her employer is subject to tax on the 
assistance, unless the education is related to the worker's 
current job. Because the determination of whether particular 
educational assistance is job-related is based on the facts and 
circumstances, it may be difficult to determine with certainty 
whether the educational assistance is excludable from income. 
This uncertainty may lead to disputes between taxpayers and the 
Internal Revenue Service.
    The Committee believes that reinstating the exclusion for 
graduate-level employer-provided educational assistance will 
enable more individuals to seek higher education, and that a 
permanent extension of the exclusion is important. The past 
experience of allowing the exclusion to expire and subsequently 
retroactively extending it has created burdens for employers 
and employees. Employees may have difficulty planning for their 
educational goals if they do not know whether their tax bills 
will increase. For employers, the fits and starts of the 
legislative history of the provision have caused severe 
administrative problems. Uncertainty about the exclusion's 
future may discourage some employers from providing educational 
benefits.

                        Explanation of Provision

    The bill permanently extends the exclusion for employer-
provided educational assistance. Beginning in 1997, the 
exclusion applies to graduate-level courses as well as 
undergraduate courses.

                             Effective Date

    The extension of the exclusion with respect to 
undergraduate courses applies to taxable years beginning after 
December 31, 1996. The extension of the exclusion to graduate-
level courses applies to courses of instruction beginning after 
December 31, 1996.

2. Modification of $150 million limit on qualified 501(c)(3) bonds 
        other than hospital bonds (sec. 222 of the bill and sec. 145(b) 
        of the Code)

                              Present Law

    Interest on State and local government bonds generally is 
excluded from income if the bonds are issued to finance 
activities carried out and paid for with revenues of these 
governments. Interest on bonds issued by these governments to 
finance activities of other persons, e.g., private activity 
bonds, is taxable unless a specific exception is included in 
the Code. One such exception is for private activity bonds 
issued to finance activities of private, charitable 
organizations described in Code section 501(c)(3) (``section 
501(c)(3) organizations'') when the activities do not 
constitute an unrelated trade or business.
    Present law treats section 501(c)(3) organizations as 
private persons; thus, bonds for their use may only be issued 
as private activity ``qualified 501(1)(3) bonds,'' subject to 
the restrictions of Code section 145. The most significant of 
these restrictions limits the amount of outstanding bonds from 
which a section 501(c)(3) organization may benefit to $150 
million. In applying this ``$150 million limit,'' all section 
501(c)(3) organizations under common management or control are 
treated as a single organization. The limit does not apply to 
bonds for hospital facilities, defined to include only acute 
care, primarily inpatient, organizations.

                           Reasons for Change

    The Committee believes a distinguishing feature of American 
society is the singular degree to which the United States 
maintains a private, non-profit sector of private higher 
education and other charitable institutions in the public 
service. The Committee believes it is important to assist these 
private institutions in their advancement of the public good. 
The Committee finds particularly inappropriate the restrictions 
of present law which place these section 501(c)(3) 
organizations at a financial disadvantage relative to 
substantially identical governmental institutions. For example, 
a public university generally has unlimited access to tax-
exempt bond financing, while a private, non-profit university 
is subject to a $150 million limitation on outstanding bonds 
from which it may benefit. The Committee is concerned that this 
and other restrictions inhibit the ability of America's 
private, non-profit institutions to modernize their educational 
facilities. The Committee believes the tax-exempt bond rules 
should treat more equally State and local governments and those 
private organizations which are engaged in similar actions 
advancing the public good.

                        Explanation of Provision

    The $150 million limit is repealed for bonds issued after 
the date of enactment to finance capital expenditures incurred 
after date of the enactment.

                             Effective Date

    The provision is effective for bonds issued after the date 
of enactment to finance capital expenditures incurred after the 
date of enactment.

3. Expansion of arbitrage rebate exception for certain bonds (sec. 223 
        of the bill and sec. 148 of the Code)

                              Present Law

    Generally, all arbitrage profits earned on investments 
unrelated to the purpose of the borrowing (``nonpurpose 
investments'') when such earnings are permitted must be rebated 
to the Federal Government.
    An exception is provided for bonds issued by governmental 
units having general taxing powers if the governmental unit 
(and all subordinate units) issues $5 million or less of 
governmental bonds during the calendar year (``the small-issuer 
exception'). This exception does not apply to private activity 
bonds.

                           Reasons for Change

    The Committee recognizes the need for additional monies to 
address the needs of our crumbling public school 
infrastructure. It believes that this provision will reduce the 
compliance costs of issuers of tax-exempt debt issued for 
public school construction.

                        Explanation of Provision

    The bill provides that up to $5 million dollars of bonds 
used to finance public school capital expenditures incurred 
after December 31, 1997, are excluded from application of the 
present-law $5 million limit. Thus, small issuers will continue 
to benefit from the small issue exception from arbitrage rebate 
if they issue no more than $10 million in governmental bonds 
per calendar year and no more than $5 million of the bonds is 
used to finance expenditures other than for public school 
capital expenditures.

                             Effective Date

    The provision is effective for bonds issued after December 
31, 1997.

4. Certain teacher education expenses not subject to 2 percent limit on 
        miscellaneous itemized deductions (sec. 224 of the bill and 
        sec. 67(b) of the Code)

                              Present Law

    In general, taxpayers are not permitted to deduct education 
expenses. However, employees may deduct the cost of certain 
work-related education. For costs to be deductible, the 
education must either be required by the taxpayer's employer or 
by law to retain taxpayer's current job or be necessary to 
maintain or improve skills required in the taxpayer's current 
job. Expenses incurred for education that is necessary to meet 
minimum education requirements of an employee's present trade 
or business or that can qualify an employee for a new trade or 
business are not deductible.
    An employee is allowed to deduct work-related education and 
other business expenses only to the extent such expenses 
(together with other miscellaneous itemized deductions) exceed 
2 percent of the taxpayer's adjusted gross income.

                           Reasons for Change

    The Committee believes that, in addition to making higher 
education accessible and affordable through various tax 
incentives, it is important to encourage elementary and 
secondary school teachers to obtain the necessary academic 
skills and training to prepare their students successfully to 
pursue higher education.

                        Explanation of Provision

    Under the bill, qualified professional development expenses 
incurred by an elementary or secondary school teacher 
26 with respect to certain courses of instruction 
are not subject to the 2 percent floor on miscellaneous 
itemized deductions. Qualified professional development 
expenses mean expenses for tuition, fees, books, supplies, 
equipment and transportation required for enrollment or 
attendance in a qualified course, provided that such expenses 
are otherwise deductible under present law section 162. A 
qualified course of instruction means a course at an 
institution of higher education (as defined in section 481 of 
the Higher Education Act of 1965) which is part of a program of 
professional development that is approved and certified by the 
appropriate local educational agency as furthering the 
individual's teaching skills.
---------------------------------------------------------------------------
    \26\ To be eligible, a teacher must have completed at least two 
academic years as a K-12 teacher in an elementary or secondary school 
before the qualified professional development expenses are incurred.
---------------------------------------------------------------------------

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.
              TITLE III. SAVINGS AND INVESTMENT INCENTIVES

 A. Individual Retirement Arrangements (secs. 301-304 of the bill and 
      secs. 72 and 408 of the Code and new sec. 408A of the Code)

                              Present Law

    Under present law, an individual may make deductible 
contributions to an individual retirement arrangement (``IRA'') 
up to the lesser of $2,000 or the individual's compensation if 
the individual is not an active participant in an employer-
sponsored retirement plan (and, if married, the individual's 
spouse also is not an active participant in such a plan). If 
the case of a married couple, deductible IRA contributions of 
up to $2,000 can be made for each spouse (including, for 
example, a home maker who does not work outside the home) if 
the combined compensation of both spouses is at least equal to 
the contributed amount.
    If the individual (or the individual's spouse) is an active 
participant in an employer-sponsored retirement plan, the 
$2,000 deduction limit is phased out over certain adjusted 
gross income (``AGI'') levels. The limit is phased out between 
$40,000 and $50,000 of AGI for married taxpayers, and between 
$25,000 and $35,000 of AGI for single taxpayers. An individual 
may make nondeductible IRA contributions to the extent the 
individual is not permitted to make deductible IRA 
contributions. Contributions cannot be made to an IRA after age 
70\1/2\.
    Amounts held in an IRA are includible in income when 
withdrawn (except to the extent the withdrawal is a return of 
nondeductible contributions). Amounts withdrawn prior to 
attainment of age 59\1/2\ are subject to an additional 10-
percent early withdrawal tax, unless the withdrawal is due to 
death or disability, is made in the form of certain periodic 
payments, is used to pay medical expenses in excess of 7.5 
percent of AGI, or is used to purchase health insurance of an 
unemployed individual.
    In general, distributions from an IRA are required to begin 
at age 70\1/2\. An excise tax is imposed if the minimum 
required distributions are not made. Distributions to the 
beneficiary of an IRA are generally required to begin within 5 
years of the death of the IRA owner, unless the beneficiary is 
the surviving spouse.
    A 15-percent excise tax is imposed on excess distributions 
with respect to an individual during any calendar year from 
qualified retirement plans, tax-sheltered annuities, and IRAs. 
In general, excess distributions are defined as the aggregate 
amount of retirement distributions (i.e., payments from 
applicable retirement plans) made with respect to an individual 
during any calendar year to the extent such amounts exceed 
$160,000 (for 1997) or 5 times that amount in the case of a 
lump-sum distribution. The dollar limit is indexed for 
inflation. A similar 15-percent additional estate tax applies 
to excess retirement accumulations upon the death of the 
individual. The 15-percent tax on excess distributions (but not 
the 15-percent additional estate tax) does not apply to 
distributions in 1997, 1998 or 1999.
    IRAs may not be invested in collectibles. A collectible is 
defined as any piece of art, rug or antique, metal or gem, 
stamp or coin, alcoholic beverage, or other personal property 
as specified by the Treasury. This prohibition does not apply 
to coins issued by a State.

                           Reasons for Change

    The Committee is concerned about the national savings rate, 
and believes that individuals should be encouraged to save. The 
Committee believes that the ability to make deductible 
contributions to an IRA is a significant savings incentive. 
However, this incentive is not available to all taxpayers under 
present law. Further, the present-law income thresholds for IRA 
deductions are not indexed for inflation so that fewer 
Americans will be eligible to make a deductible IRA 
contribution each year. The Committee believes it is 
appropriate to encourage individual saving and that deductible 
IRAs should be available to more individuals.
    In addition, the Committee believes that some individuals 
would be more likely to save if funds set aside in a tax-
favored account could be withdrawn without tax after a 
reasonable holding period for retirement or certain special 
purposes. Some taxpayers may find such a vehicle more suitable 
for their savings needs.
    The Committee believes that providing an incentive to save 
for certain special purposes is appropriate. The Committee 
believes that many Americans may have difficulty saving enough 
to ensure that they will be able to purchase a home. Home 
ownership is a fundamental part of the American dream.
    The Committee believes that individuals who are unemployed 
for a substantial period of time should have access to their 
retirement savings.
    The Committee believes that the present-law rules relating 
to deductible IRAs penalize American homemakers. The Committee 
believes that an individual should not be precluded from making 
a deductible IRA contribution merely because his or her spouse 
participates in an employer-sponsored retirement plan.
    Finally, the Committee believes that IRAs should not be 
precluded from investing in bullion.

                        Explanation of Provision

In general

    The bill (1) increases the AGI phase-out limits for 
deductible IRAs, (2) provides that an individual is not 
considered an active participant in an IRA merely because the 
individual's spouse is an active participant, (3) provides an 
exception from the early withdrawal tax for withdrawals for 
first-time home purchase (up to $10,000) and long-term 
unemployed individuals, and (4) replaces present-law 
nondeductible IRAs with a new IRA called the IRA Plus. All 
individuals may make nondeductible contributions of up to 
$2,000 annually to an IRA Plus. No income limitations apply to 
IRA Plus accounts; however, the $2,000 maximum contribution 
limit is reduced to the extent an individual makes deductible 
contributions to an IRA. An IRA Plus is an IRA which is 
designated at the time of establishment as an IRA Plus in the 
manner prescribed by the Secretary. Qualified distributions 
from an IRA Plus are not includible in income.

Increase income phase-out ranges for deductible IRAs

    The bill increases the AGI phase-out range for deductible 
IRA contributions as follows:

                        [In thousands of dollars]                       
                                                                        
                                              Phase-Out Range           
   Taxable years beginning in:                                          
                                   Single Taxpayers      Joint Returns  
                                                                        
1998 and 1999...................       30,000-40,000       50,000-60,000
2000 and 2001...................       35,000-45,000       60,000-70,000
2002 and 2003...................       40,000-50,000       70,000-80,000
2004 and thereafter.............       50,000-60,000      80,000-100,000
                                                                        

Active participant rule

    The bill provides that an individual is not considered an 
active participant in an employer-sponsored plan merely because 
the individual's spouse is an active participant.

Modifications to early withdrawal tax

    The bill provides that the 10-percent early withdrawal tax 
does not apply to withdrawals from an IRA (including an IRA 
Plus) for (1) up to $10,000 of first-time homebuyer expenses 
and (2) distributions for long-term unemployed individuals.\27\
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    \27\ The bill also provides for penalty-free withdrawals from IRAs 
for education expenses (see above).
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    Under the bill, qualified first-time homebuyer 
distributions are withdrawals of up to $10,000 during the 
individual's lifetime that are used within 120 days to pay 
costs (including reasonable settlement, financing, or other 
closing costs) of acquiring, constructing, or reconstructing 
the principal residence of a first-time homebuyer who is the 
individual, the individual's spouse, or a child, grandchild, or 
ancestor of the individual or individual's spouse. A first-time 
homebuyer is an individual who has not had an ownership 
interest in a principal residence during the 2-year period 
ending on the date of acquisition of the principal residence to 
which the withdrawal relates. The bill requires that the spouse 
of the individual also meet this requirement as of the date the 
contract is entered into or construction commences. The date of 
acquisition is the date the individual enters into a binding 
contract to purchase a principal residence or begins 
construction or reconstruction of such a residence. Principal 
residence is defined as under the provisions relating to the 
rollover of gain on the sale of a principal residence.
    Under the bill, any amount withdrawn for the purchase of a 
principal residence is required to be used within 120 days of 
the date of withdrawal. The 10-percent additional income tax on 
early withdrawals is imposed with respect to any amount not so 
used. If the 120-day rule cannot be satisfied due to a delay in 
the acquisition of the residence, the taxpayer may recontribute 
all or part of the amount withdrawn to an IRA Plus prior to the 
end of the 120-day period without adverse tax consequences.
    Under the bill, the 10-percent early withdrawal tax does 
not apply to distributions to an individual after separation 
from employment if the individual has received unemployment 
compensation for 12 consecutive weeks under any Federal or 
State unemployment compensation law and the distribution is 
made during any taxable year during which the unemployment 
compensation is paid or the succeeding taxable year. This 
exception does not apply to any distribution made after the 
individual has been employed for at least 60 days after the 
separation of employment. To the extent provided in 
regulations, the provision applies to a self-employed 
individual if, under Federal or State law, the individual would 
have received unemployment compensation but for the fact the 
individual was self employed.

IRA investments in bullion

    Under the bill, IRA assets may be invested in certain 
bullion. The bill applies to any gold, silver, platinum or 
palladium bullion of a fineness equal to or exceeding the 
minimum fineness required for metals which may be delivered in 
satisfaction of a regulated futures contract subject to 
regulation by the Commodity Futures Trading Commission. The 
provision does not apply unless the bullion is in the physical 
possession of the IRA trustee.\28\
---------------------------------------------------------------------------
    \28\ The bill does not modify the present-law rule permitting IRAs 
to be invested in certain State coins.
---------------------------------------------------------------------------

IRA Plus accounts

            Contributions to IRA Plus accounts
    The maximum annual contribution that may be made to an IRA 
Plus is the lesser of $2,000 (reduced by deductible IRA 
contributions) or the individual's compensation for the year. 
As under the present-law rules relating to deductible IRAs, a 
contribution of up to $2,000 for each spouse may be made to an 
IRA Plus provided the combined compensation of the spouses is 
at least equal to the contributed amount.
    Contributions to an IRA Plus may be made even after the 
individual for whom the account is maintained has attained age 
70\1/2\.
             Taxation of distributions
    Qualified distributions from an IRA Plus are not includible 
in gross income, nor subject to the additional 10-percent tax 
on early withdrawals. A qualified distribution is a 
distribution that (1) is made after the 5-taxable year period 
beginning with the first taxable year in which the individual 
made a contribution to an IRA Plus, 29 and (2) which 
is (a) made on or after the date on which the individual 
attains age 59\1/2\, (b) made to a beneficiary (or to the 
individual's estate) on or after the death of the individual, 
(c) attributable to the individual's being disabled, or (d) a 
qualified special purpose distribution. Qualified special 
purpose distributions are distributions that are exempt from 
the 10-percent early withdrawal tax because they are for first-
time homebuyer expenses or long-term unemployed individuals.
---------------------------------------------------------------------------
    \29\ As is the case with IRAs generally, contributions to an IRA 
Plus may be made for a year by the due date for the individual's tax 
return for the year (determined without regard to extensions). In the 
case of a contribution to an IRA Plus made after the end of the taxable 
year, the 5-year holding period begins with the taxable year to which 
the contribution relates, rather than the year in which the 
contribution is actually made.
---------------------------------------------------------------------------
    Distributions from an IRA Plus that are not qualified 
distributions are includible in income to the extent 
attributable to earnings, and subject to the 10-percent early 
withdrawal tax (unless an exception applies). The same 
exceptions to the early withdrawal tax that apply to IRAs apply 
to IRA Plus accounts.
    An ordering rule applies for purposes of determining what 
portion of a distribution that is not a qualified distribution 
is includible in income. Under the ordering rule, distributions 
from an IRA Plus are treated as made from contributions first, 
and all an individual's IRA Plus accounts are treated as a 
single IRA Plus. Thus, no portion of a distribution from an IRA 
Plus is treated as attributable to earnings (and therefore 
includible in gross income) until the total of all 
distributions from all the individual's IRA Plus accounts 
exceeds the amount of contributions.
    Distributions from an IRA Plus may be rolled over tax free 
to another IRA Plus.
            Conversions of an IRA to an IRA Plus
    All or any part of amounts in a present-law deductible or 
nondeductible IRA may be converted into an IRA Plus. If the 
conversion is made before January 1, 1999, the amount that 
would have been includible in gross income if the individual 
had withdrawn the converted amounts is included in gross income 
ratably over the 4-taxable year period beginning with the 
taxable year in which the conversion is made. The early 
withdrawal tax does not apply to such conversions.\30\
---------------------------------------------------------------------------
    \30\ In the case of conversions from an IRA to an IRA Plus, the 5-
taxable year holding period begins with the taxable year in which the 
conversion was made.
---------------------------------------------------------------------------
    A conversion of an IRA into an IRA Plus can be made in a 
variety of different ways and without taking a distribution. 
For example, an individual may make a conversion simply by 
notifying the IRA trustee. Or, an individual may make the 
conversion in connection with a change in IRA trustees through 
a rollover or a trustee-to-trustee transfer. If a part of an 
IRA balance is converted into an IRA Plus, the IRA Plus amounts 
may have to be held separately.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

                      B. Capital Gains Provisions

1. Maximum rate of tax on net capital gain of individuals (sec. 311 of 
        the bill and sec. 1(h) of the Code)

                              Present Law

    In general, gain or loss reflected in the value of an asset 
is not recognized for income tax purposes until a taxpayer 
disposes of the asset. On the sale or exchange of capital 
assets, the net capital gain is taxed at the same rate as 
ordinary income, except that individuals are subject to a 
maximum marginal rate of 28 percent of the net capital gain. 
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.
    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, 
or (5) certain U.S. publications. 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.

                           Reasons for Change

    The Committee believes it is important that tax policy be 
conducive to economic growth. Economic growth cannot occur 
without saving, investment, and the willingness of individuals 
to take risks. The greater the pool of savings, the greater the 
monies available for business investment. It is through such 
investment that the United States' economy can increase output 
and productivity. It is through increases in productivity that 
workers earn higher real wages. Hence, greater saving is 
necessary for all Americans to benefit through a higher 
standard of living.
    The Committee believes that, by reducing the effective tax 
rates on capital gains, American households will respond by 
increasing saving. The Committee believes it is important to 
encourage risk taking and believes a reduction in the taxation 
of capital gains will have that effect. The Committee also 
believes that a reduction in the taxation of capital gains will 
improve the efficiency of the capital markets, because the 
taxation of capital gains upon realization encourages investors 
who have accrued past gains to keep their monies ``locked in'' 
to such investment even when better investment opportunities 
present themselves. A reduction in the taxation of capital 
gains should reduce this ``lock in'' effect.

                        Explanation of Provision

    Under the bill, the maximum rate of tax on the net capital 
gain of an individual is reduced from 28 percent to 20 percent. 
In addition, any net capital gain which otherwise would be 
taxed at a 15 percent rate is taxed at a 10 percent rate. These 
rates apply for purposes of both the regular tax and the 
minimum tax.
    The tax on the net capital gain attributable to any long-
term gain from the sale or exchange of collectibles (as defined 
in section 408(m) without regard to paragraph (3) thereof) will 
remain at 28 percent; and any gain from the sale or exchange of 
section 1250 property (i.e., depreciable real estate) to the 
extent of the gain that would have been treated as ordinary 
income if the property had been section 1245 property will be 
taxed at a maximum rate of 24 percent.

                             Effective Date

    The provision applies to taxable years ending after May 6, 
1997.
    For a taxpayer's taxable year that includes May 7, 1997, 
the lower rates will not apply to an amount equal to the net 
capital gain determined by including only gain or loss properly 
taken into account for the portion of the year before May 7, 
1997. This generally has the effect of applying the lower rates 
to capital assets sold or exchanged (or installment payments 
received) on or after May 7, 1997, and subjecting the remaining 
portion of the net capital gain to a maximum rate of 28 
percent.
    In the case of gain taken into account by a pass-through 
entity (i.e., a RIC, a REIT, a partnership, an estate or trust, 
or a common trust fund), the date taken into account by the 
entity is the appropriate date for applying the rule in the 
preceding paragraph to the individual taxpayer's taxable year 
which includes May 7, 1997.

2. Small business stock (secs. 312 and 313 of the bill and secs. 1045 
        and 1202 of the Code)

                              Present Law

    The Revenue Reconciliation Act of 1993 provided individuals 
a 50-percent exclusion for the sale of certain small business 
stock acquired at original issue and held for at least five 
years. One-half of the excluded gain is a minimum tax 
preference.
    The amount of gain eligible for the 50-percent exclusion by 
an individual with respect to any corporation is the greater of 
(1) ten times the taxpayer's basis in the stock or (2) $10 
million.
    In order to qualify as a small business, when the stock is 
issued, the gross assets of the corporation may not exceed $50 
million. The corporation also must meet an active trade or 
business requirement.

                           Reasons for Change

    The Committee believes it is important to maintain a larger 
exclusion for stock in small, start-up enterprises. Such 
enterprises are inherently risky and may not have easy access 
to thecapital necessary to launch a new venture. The Committee 
believes that it is important to foster such entrepreneurial activities 
and believes targeted reduction in capital gains taxation will help 
provide access to needed capital.
    The Committee also understands that the present law 
restrictions on working capital may often be inappropriate in 
the context of a venture start up enterprise.

                        Explanation of Provision

    Under the bill, the 50-percent exclusion will apply to 
small business stock (other than stock of a subsidiary 
corporation) held by a corporation. The minimum tax preference 
is repealed. Under the bill, in the case of a qualifying sale 
of small business stock by an individual, the maximum rate of 
tax (taking together the 50-percent exclusion and the maximum 
20-percent capital gains rate added by the bill) will be 10 
percent.
    The bill increases the size of an eligible corporation from 
gross assets of $50 million to gross assets of $100 million. 
The bill also repeals the limitation on the amount of gain a 
taxpayer can exclude with respect to the stock of any 
corporation.
    The bill provides that certain working capital must be 
expended within five years (rather than two years) in order to 
be treated as used in the active conduct of a trade or 
business. No limit on the percent of the corporation's assets 
that are working capital is imposed.
    The bill provides that if the corporation establishes a 
business purpose for a redemption of its stock, that redemption 
is disregarded in determining whether other newly issued stock 
could qualify as eligible stock.
    The bill allows a taxpayer to roll over gain from the sale 
or exchange of small business stock otherwise qualifying for 
the exclusion where the taxpayer uses the proceeds to purchase 
other qualifying small business stock within 60 days of the 
sale of the original stock. If the taxpayer sells the 
replacement stock, the gain attributable to the original stock 
is eligible for the small business stock exclusion and the 
capital gain rates, and any remaining gain is eligible for the 
capital gain rates if held more than one year and the small 
business exclusion if held for at least five years. In 
addition, any gain that otherwise would be recognized from the 
sale of the replacement stock can be rolled over to other small 
business stock purchased within 60 days.

                             Effective Date

    The increase in the size of corporations whose stock is 
eligible for the exclusion and the provisions applicable to 
corporate shareholders applies to stock issued after the date 
of the enactment of the proposal. The remaining provisions 
apply to stock issued after August 10, 1993 (the original 
effective date of the small business stock provision).

 3. Exclusion of gain on sale of principal residence (sec. 314 of the 
                bill and secs. 121 and 1034 of the Code)

                               Present Law

                            Rollover of gain

    No gain is recognized on the sale of a principal residence 
if a new residence at least equal in cost to the sales price of 
the old residence is purchased and used by the taxpayer as his 
or her principal residence within a specified period of time 
(sec. 1034). This replacement period generally begins two years 
before and ends two years after the date of sale of the old 
residence. The basis of the replacement residence is reduced by 
the amount of any gain not recognized on the sale of the old 
residence by reason of this gain rollover rule.

One-time exclusion

    In general, an individual, on a one-time basis, may exclude 
from gross income up to $125,000 of gain from the sale or 
exchange of a principal residence if the taxpayer (1) has 
attained age 55 before the sale, and (2) has owned the property 
and used it as a principal residence for three or more of the 
five years preceding the sale (sec. 121).

                           Reasons for Change

    Calculating capital gain from the sale of a principal 
residence is among the most complex tasks faced by a typical 
taxpayer. Many taxpayers buy and sell a number of homes over 
the course of a lifetime, and are generally not certain of how 
much housing appreciation they can expect. Thus, even though 
most homeowners never pay any income tax on the capital gain on 
their principal residences, as a result of the rollover 
provisions and the $125,000 one-time exclusion, detailed 
records of transactions and expenditures on home improvements 
must be kept, in most cases, for many decades. To claim the 
exclusion, many taxpayers must determine the basis of each home 
they have owned, and appropriately adjust the basis of their 
current home to reflect any untaxed gains from previous housing 
transactions. This determination may involve augmenting the 
original cost basis of each home by expenditures on 
improvements. In addition to the record-keeping burden this 
creates, taxpayers face the difficult task of drawing a 
distinction between improvements that add to basis, and repairs 
that do not. The failure to account accurately for all 
improvements leads to errors in the calculation of capital 
gains, and hence to an under- or over-payment of the capital 
gains on principal residences. By excluding from taxation 
capital gains on principal residences below a relatively high 
threshold, few taxpayers would have to refer to records in 
determining income tax consequences of transactions related to 
their house.
    To postpone the entire capital gain from the sale of a 
principal residence, the purchase price of a new home must be 
greater than the sales price of the old home. This provision of 
present law encourages some taxpayers to purchase larger and 
more expensive houses than they otherwise would in order to 
avoid a tax liability, particularly those who move from areas 
where housing costs are high to lower-cost areas. This promotes 
an inefficient use of taxpayer's financial resources.
    Present law also may discourage some older taxpayers from 
selling their homes. Taxpayers who would realize a capital gain 
in excess of $125,000 if they sold their home and taxpayers who 
have already used the exclusion may choose to stay in their 
homes even though the home no longer suits their needs. By 
raising the $125,000 limit and by allowing multiple exclusions, 
this constraint to the mobility of the elderly would be 
removed.
    While most homeowners do not pay capital gains tax when 
selling their homes, current law creates certain tax traps for 
the unwary that can result in significant capital gains taxes 
or loss of the benefits of the current exclusion. For example, 
an individual is not eligible for the one-time capital gains 
exclusion if the exclusion was previously utilized by the 
individual's spouse. This restriction has the unintended effect 
of penalizing individuals who marry someone who has already 
taken the exclusion. Households that move from a high housing-
cost area to a low housing-cost area may incur an unexpected 
capital gains tax liability. Divorcing couples may incur 
substantial capital gains taxes if they do not carefully plan 
their house ownership and sale decisions.

                        Explanation of Provision

     Under the bill a taxpayer generally is able to 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. The 
exclusion is allowed each time a taxpayer selling or exchanging 
a principal residence meets the eligibility requirements, but 
generally no more frequently than once every two years. The 
bill provides that gain would be recognized to the extent of 
any depreciation allowable with respect to the rental or 
business use of such principal residence for periods after May 
6, 1997.
    To be eligible for the exclusion, a taxpayer must have 
owned the residence and occupied it as a principal residence 
for at least two of the five years prior to the sale or 
exchange. A taxpayer who fails to meet these requirements by 
reason of a change of place of employment, health, or unforseen 
circumstances is able to exclude the fraction of the $250,000 
($500,000 if married filing a joint return) equal to the 
fraction of two years that these requirements are met.
    In the case of joint filers not sharing a principal 
residence, an exclusion of $250,000 is available on a 
qualifying sale or exchange of the principal residence of one 
of the spouses. Similarly, if a single taxpayer who is 
otherwise eligible for an exclusion marries someone who has 
used the exclusion within the two years prior to the marriage, 
the bill would allow the newly married taxpayer a maximum 
exclusion of $250,000. Once both spouses satisfy the 
eligibility rules and two years have passed since the last 
exclusion was allowed to either of them, the taxpayers may 
exclude $500,000 of gain on their joint return.
    Under the bill, the gain from the sale or exchange of the 
remainder interest in the taxpayer's principal residence may 
qualify for the otherwise allowable exclusion.

                             Effective Date

    The provision is available for all sales or exchanges of a 
principal residence occurring on or after May 7, 1997, and 
replaces the present-law rollover and one-time exclusion 
provisions applicable to principal residences.
    A taxpayer may elect to apply present law (rather than the 
new exclusion) to a sale or exchange (1) made before the date 
of enactment of the Act, (2) made after the date of enactment 
pursuant to a binding contract in effect on the date or (3) 
where the replacement residence was acquired on or before the 
date of enactment (or pursuant to a binding contract in effect 
of the date of enactment) and the rollover provision would 
apply. If a taxpayer acquired his or her current residence in a 
rollover transaction, periods of ownership and use of the prior 
residence would be taken into account in determining ownership 
and use of the current residence.
     TITLE IV. ESTATE, GIFT, AND GENERATION-SKIPPING TAX PROVISIONS

 A. Increase in Estate and Gift Tax Unified Credit (sec. 401(a) of the 
                    bill and sec. 2010 of the Code)

                              Present Law

    A gift tax is imposed on lifetime transfers by gift and an 
estate tax is imposed on transfers at death. Since 1976, the 
gift tax and the estate tax have been unified so that a single 
graduated rate schedule applies to cumulative taxable transfers 
made by a taxpayer during his or her lifetime and at death.\31\ 
A unified credit of $192,800 is provided against the estate and 
gift tax, which effectively exempts the first $600,000 in 
cumulative taxable transfers from tax (sec. 2010). For 
transfers in excess of $600,000, estate and gift tax rates 
begin at 37 percent and reach 55 percent on cumulative taxable 
transfers over $3 million (sec. 2001(c)). In addition, a 5-
percent surtax is imposed upon cumulative taxable transfers 
between $10 million and $21,040,000, to phase out the benefits 
of the graduated rates and the unified credit (sec. 
2001(c)(2)).\32\
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    \31\ Prior to 1976, separate tax rate schedules applied to the gift 
tax and the estate tax.
    \32\ Thus, if a taxpayer has made cumulative taxable transfers 
equaling $21,040,000 or more, his or her average transfer tax rate is 
55 percent. The phaseout has the effect of creating a 60-percent 
marginal transfer tax rate on transfers in the phaseout range.
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that increasing the amount of the 
estate and gift tax unified credit will encourage saving, 
promote capital formation and entrepreneurial activity, and 
help to preserve existing family-owned farms and businesses. 
The Committee further believes that indexing the unified credit 
exemption equivalent amount for inflation is appropriate to 
reduce the transfer tax consequences that result from increases 
in asset value attributable solely to inflation.

                        Explanation of Provision

    The bill increases the present-law unified credit beginning 
in 1998, from an effective exemption of $600,000 to an 
effective exemption of $1,000,000 in 2006. The increase in the 
effective exemption is phased in according to the following 
schedule: the effective exemption is $625,000 for decedents 
dying and gifts made in 1998; $640,000 in 1999; $660,000 in 
2000; $675,000 in 2001; $725,000 in 2002; $750,000 in 2003; 
$800,000 in 2004; $900,000 in 2005; and $1 million in 2006. 
After 2006, the effective exemption is indexed annually for 
inflation. The indexed exemption amount is rounded to the next 
lowest multiple of $10,000.
    Conforming amendments to reflect the increased unified 
credit are made (1) to the 5-percent surtax to conform the 
phase out of the increased unified credit and graduated rates, 
(2) to the general filing requirements for an estate tax return 
under section 6018(a), and (3) to the amount of the unified 
credit allowed under section 2102(c)(3) with respect to 
nonresident aliens with U.S. situs property who are residents 
of certain treaty countries.

                             Effective Date

    The provision is effective for decedents dying, and gifts 
made, after December 31, 1997.

 B. Indexing of Certain Other Estate and Gift Tax Provisions (sec. 401 
  (b)-(e) of the bill and secs. 2032A, 2503, 2631, and 6601(j) of the 
                                 Code)

                              Present Law

    Annual exclusion for gifts.--A taxpayer may exclude $10,000 
of gifts of present interests in property made by an individual 
($20,000 per married couple) to each donee during a calendar 
year (sec. 2503).
    Special use valuation.--An executor may elect for estate 
tax purposes to value certain qualified real property used in 
farming or a closely-held trade or business at its current use 
value, rather than its ``highest and best use'' value (sec. 
2032A). The maximum reduction in value under such an election 
is $750,000.
    Generation-skipping transfer (``GST'') tax.--An individual 
is allowed an exemption from the GST tax of up to $1,000,000 
for generation-skipping transfers made during life or at death 
(sec. 2631).
    Installment payment of estate tax.--An executor may elect 
to pay the Federal estate tax attributable to an interest in a 
closely held business in installments over, at most, a 14-year 
period (sec. 6166). The tax on the first $1,000,000 in value of 
a closely-held business is eligible for a special 4-percent 
interest rate (sec. 6601(j)).

                           Reasons for Change

    The Committee believes that it is appropriate to index for 
inflation the annual exclusion for gifts, the ceiling on 
special use valuation, the generation-skipping transfer tax 
exemption, and the ceiling on the value of a closely-held 
business eligible for the special low interest rate, to reduce 
the transfer tax consequences that result from increases in 
asset value attributable solely to inflation.

                        Explanation of Provision

    The bill provides that, after 1998, the $10,000 annual 
exclusion for gifts, the $750,000 ceiling on special use 
valuation, the $1,000,000 generation-skipping transfer tax 
exemption, and the $1,000,000 ceiling on the value of a 
closely-held business eligible for the special low interest 
rate (as modified below), are indexed annually for inflation. 
Indexing of the annual exclusion is rounded to the next lowest 
multiple of $1,000 and indexing of the other amounts is rounded 
to the next lowest multiple of $10,000.

                             Effective Date

    The provision is effective for decedents dying, and gifts 
made, after December 31, 1998.

C. Estate Tax Exclusion for Qualified Family-Owned Businesses (sec. 402 
              of the bill and new sec. 2033A of the Code)

                              Present Law

    There are no special estate tax rules for qualified family-
owned businesses. All taxpayers are allowed a unified credit in 
computing the taxpayer's estate and gift tax, which effectively 
exempts a total of $600,000 in cumulative taxable transfers 
from the estate and gift tax (sec. 2010). An executor also may 
elect, under section 2032A, to value certain qualified real 
property used in farming or another qualifying closely-held 
trade or business at its current use value, rather than its 
highest and best use value (up to a maximum reduction of 
$750,000). In addition, an executor may elect to pay the 
Federal estate tax attributable to a qualified closely-held 
business in installments over, at most, a 14-year period (sec. 
6166). The tax attributable to the first $1,000,000 in value of 
a closely-held business is eligible for a special 4-percent 
interest rate (sec. 6601(j)).

                           Reasons for Change

    The Committee believes that a reduction in estate taxes for 
qualified family-owned businesses will protect and preserve 
family farms and other family-owned enterprises, and prevent 
the liquidation of such enterprises in order to pay estate 
taxes. The Committee further believes that the protection of 
family enterprises will preserve jobs and strengthen the 
communities in which such enterprises are located.

                        Explanation of Provision

    The bill allows an executor to elect special estate tax 
treatment for qualified ``family-owned business interests'' if 
such interests comprise more than 50 percent of a decedent's 
estate and certain other requirements are met. In general, the 
provision excludes the first $1 million of value in qualified 
family-owned business interests from a decedent's taxable 
estate.
    This new exclusion for qualified family-owned business 
interests is provided in addition to the unified credit (which 
presently effectively exempts $600,000 of taxable transfers 
from the estate and gift tax, and will be increased to an 
effective exemption of $1,000,000 of taxable transfers under 
other provisions of the bill), the special-use provisions of 
section 2032A (which permit the exclusion of up to $750,000 in 
value of a qualifying farm or other closely-held business from 
a decedent's estate), and the provisions of section 6166 (which 
provide for the installment payment of estate taxes 
attributable to closely held businesses).

Qualified family-owned business interests

    For purposes of the bill, a qualified family-owned business 
interest is defined as any interest in a trade or business 
(regardless of the form in which it is held) with a principal 
place of business in the United States if ownership of the 
trade or business is held at least 50 percent by one family, 70 
percent by two families, or 90 percent by three families, as 
long as the decedent's family owns at least 30 percent of the 
trade or business. Under the provision, members of an 
individual's family are defined using the same definition as is 
used for the special-use valuation rules of section 2032A, and 
thus include (1) the individual's spouse, (2) the individual's 
ancestors, (3) lineal descendants of the individual, of the 
individual's spouse, or of the individual's parents, and (4) 
the spouses of any such lineal descendants. For purposes of 
applying the ownership tests in the case of a corporation, the 
decedent and members of the decedent's family are required to 
own the requisite percentage of the total combined voting power 
of all classes of stock entitled to vote and the requisite 
percentage of the total value of all shares of all classes of 
stock of the corporation. In the case of a partnership, the 
decedent and members of the decedent's family are required to 
own the requisite percentage of the capital interest, and the 
requisite percentage of the profits interest, in the 
partnership.
    In the case of a trade or business that owns an interest in 
another trade or business (i.e., ``tiered entities''), special 
look-through rules apply. Each trade or business owned 
(directly or indirectly) by the decedent and members of the 
decedent's family is separately tested to determine whether 
that trade or business meets the requirements of a qualified 
family-owned business interest. In applying these tests, any 
interest that a trade or business owns in another trade or 
business is disregarded in determining whether the first trade 
or business is a qualified family-owned business interest. The 
value of any qualified family-owned business interest held by 
an entity is treated as being proportionately owned by or for 
the entity's partners, shareholders, or beneficiaries. In the 
case of a multi-tiered entity, such rules are sequentially 
applied to look through each separate tier of the entity.
    For example, if a holding company owns interests in two 
other companies, each of the three entities will be separately 
tested under the qualified family-owned business interest 
rules. In determining whether the holding company is a 
qualified family-owned business interest, its ownership 
interest in the other two companies is disregarded. Even if the 
holding company itself does not qualify as a family-owned 
business interest, the other two companies still may qualify if 
the direct and indirect interests held by the decedent and his 
or her family members satisfy the requisite ownership 
percentages and other requirements of a qualified family-owned 
business interest. If either (or both) of the lower-tier 
entities qualify, the value of the qualified family-owned 
business interests owned by the holding company are treated as 
proportionately owned by the holding company's shareholders.
    An interest in a trade or business does not qualify if the 
business's (or a related entity's) stock or securities were 
publicly-traded at any time within three years of the 
decedent's death. An interest in a trade or business also does 
not qualify if more than 35 percent of the adjusted ordinary 
gross income of the business for the year of the decedent's 
death was personal holding company income (as defined in 
section 543). This personal holding company restriction does 
not apply to banks or domestic building and loan associations.
    The value of a trade or business qualifying as a family-
owned business interest is reduced to the extent the business 
holds passive assets or excess cash or marketable securities. 
Under the bill, the value of qualified family-owned business 
interests does not include any cash or marketable securities in 
excess of the reasonably expected day-to-day working capital 
needs of the trade or business. For this purpose, it is 
intended that day-to-day working capital needs be determined 
based on a historical average of the business's working capital 
needs in the past,using an analysis similar to that set forth 
in Bardahl Mfg. Corp., 24 T.C.M. 1030 (1965). It is further intended 
that accumulations for capital acquisitions not be considered ``working 
capital'' for this purpose. The value of the qualified family-owned 
business interests also does not include certain other passive assets. 
For this purpose, passive assets include any assets that (a) produce 
dividends, interest, rents, royalties, annuities and certain other 
types of passive income (as described in sec. 543(a)); (b) are an 
interest in a trust, partnership or REMIC (as described in sec. 
954(c)(1)(B)(ii)); (c) produce no income (as described in sec. 
954(c)(1)(B)(iii)); (d) give rise to income from commodities 
transactions or foreign currency gains (as described in sec. 954(c)(1) 
(C) and (D)); (e) produce income equivalent to interest (as described 
in sec. 954(c)(1)(E)); or (f) produce income from notional principal 
contracts or payments in lieu of dividends (as described in new secs. 
954(c)(1) (F) and (G), added elsewhere in the bill). In the case of a 
regular dealer in property, such property is not considered to produce 
passive income under these rules, and thus, is not considered to be a 
passive asset.

Qualifying estates

    A decedent's estate qualifies for the special treatment 
only if the decedent was a U.S. citizen or resident at the time 
of death, and the aggregate value of the decedent's qualified 
family-owned business interests that are passed to qualified 
heirs exceeds 50 percent of the decedent's adjusted gross 
estate (the ``50-percent liquidity test''). For this purpose, 
qualified heirs include any individual who has been actively 
employed by the trade or business for at least 10 years prior 
to the date of the decedent's death, and members of the 
decedent's family. If a qualified heir is not a citizen of the 
United States, any qualified family-owned business interest 
acquired by that heir must be held in a trust meeting 
requirements similar to those imposed on qualified domestic 
trusts (under present-law sec. 2056A(a)), or through certain 
other security arrangements that meet the satisfaction of the 
Secretary. The 50-percent liquidity test generally is applied 
by adding all transfers of qualified family-owned business 
interests made by the decedent to qualified heirs at the time 
of the decedent's death, plus certain lifetime gifts of 
qualified family-owned business interests made to members of 
the decedent's family, and comparing this total to the 
decedent's adjusted gross estate. To the extent that a decedent 
held qualified family-owned business interests in more than one 
trade or business, all such interests are aggregated for 
purposes of applying the 50-percent liquidity test.
    The 50-percent liquidity test is calculated using a ratio, 
the numerator and denominator of which are described below.
    The numerator is determined by aggregating the value of all 
qualified family-owned business interests that are includible 
in the decedent's gross estate and are passed from the decedent 
to a qualified heir, plus any lifetime transfers of qualified 
business interests that are made by the decedent to members of 
the decedent's family (other than the decedent's spouse), 
provided such interests have been continuously held by members 
of the decedent's family and were not otherwise includible in 
the decedent's gross estate. For this purpose, qualified 
business interests transferred to members of the decedent's 
family during the decedent's lifetime are valued as of the date 
of such transfer. This amount is then reduced by all 
indebtedness of the estate, except for the following: (a) 
indebtedness on a qualified residence of the decedent 
(determined in accordance with the requirements for 
deductibility of mortgage interest set forth in section 
163(h)(3)); (b) indebtedness incurred to pay the educational or 
medical expenses of the decedent, the decedent's spouse or the 
decedent's dependents; (c) other indebtedness of up to $10,000.
    The denominator is equal to the decedent's gross estate, 
reduced by any indebtedness of the estate, and increased by the 
amount of the following transfers, to the extent not already 
included in the decedent's gross estate: (a) any lifetime 
transfers of qualified business interests that were made by the 
decedent to members of the decedent's family (other than the 
decedent's spouse), provided such interests have been 
continuously held by members of the decedent's family, plus (b) 
any other transfers from the decedent to the decedent's spouse 
that were made within 10 years of the date of the decedent's 
death, plus (c) any other transfers made by the decedent within 
three years of the decedent's death, except non-taxable 
transfers made to members of the decedent's family. The 
Secretary of Treasury is granted authority to disregard de 
minimis gifts. In determining the amount of gifts made by the 
decedent, any gift that the donor and the donor's spouse 
elected to have treated as a split gift (pursuant to sec. 2513) 
is treated as made one-half by each spouse for purposes of this 
provision.

Participation requirements

    To qualify for the beneficial treatment provided under the 
bill, the decedent (or a member of the decedent's family) must 
have owned and materially participated in the trade or business 
for at least five of the eight years preceding the decedent's 
date of death. In addition, each qualified heir (or a member of 
the qualified heir's family) is required to materially 
participate in the trade or business for at least five years of 
any eight-year period within ten years following the decedent's 
death. For this purpose, ``material participation'' is defined 
as under present-law section 2032A (special use valuation) and 
the regulations promulgated thereunder. See, e.g., Treas. Reg. 
sec. 20.2032A-3. Under such regulations, no one factor is 
determinative of the presence of material participation and the 
uniqueness of the particular industry (e.g., timber, farming, 
manufacturing, etc.) must be considered. Physical work and 
participation in management decisions are the principal factors 
to be considered. For example, an individual generally is 
considered to be materially participating in the business if he 
or she personally manages the business fully, regardless of the 
number of hours worked, as long as any necessary functions are 
performed.
    If a qualified heir rents qualifying property to a member 
of the qualified heir's family on a net cash basis, and that 
family member materially participates in the business, the 
material participation requirement will be considered to have 
been met with respect to the qualified heir for purposes of 
this provision.

Recapture provisions

    The benefit of the exclusions for qualified family-owned 
business interests are subject to recapture if, within 10 years 
of the decedent's death and before the qualified heir's death, 
one of the following ``recapture events'' occurs: (1) the 
qualified heir ceases to meet the material participation 
requirements (i.e., if neither the qualified heir nor any 
member of his or her family has materially participated in the 
trade or business for at least five years of any eight-
yearperiod); (2) the qualified heir disposes of any portion of his or 
her interest in the family-owned business, other than by a disposition 
to a member of the qualified heir's family or through a conservation 
contribution under section 170(h); (3) the principal place of business 
of the trade or business ceases to be located in the United States; or 
(4) the qualified heir loses U.S. citizenship. A qualified heir who 
loses U.S. citizenship may avoid such recapture by placing the 
qualified family-owned business assets into a trust meeting 
requirements similar to a qualified domestic trust (as described in 
present law section 2056A(a)), or through certain other security 
arrangements.
    If one of the above recapture events occurs, an additional 
tax is imposed on the date of such event. As under section 
2032A, each qualified heir is personally liable for the portion 
of the recapture tax that is imposed with respect to his or her 
interest in the qualified family-owned business. Thus, for 
example, if a brother and sister inherit a qualified family-
owned business from their father, and only the sister 
materially participates in the business, her participation will 
cause both her and her brother to meet the material 
participation test. If she ceases to materially participate in 
the business within 10 years after her father's death (and the 
brother still does not materially participate), the sister and 
brother would both be liable for the recapture tax; that is, 
each would be liable for the recapture tax attributable to his 
or her interest.
    The portion of the reduction in estate taxes that is 
recaptured would be dependent upon the number of years that the 
qualified heir (or members of the qualified heir's family) 
materially participated in the trade or business after the 
decedent's death. If the qualified heir (or his or her family 
members) materially participated in the trade or business after 
the decedent's death for less than six years, 100 percent of 
the reduction in estate taxes attributable to that heir's 
interest is recaptured; if the participation was for at least 
six years but less than seven years, 80 percent of the 
reduction in estate taxes is recaptured; if the participation 
was for at least seven years but less than eight years, 60 
percent is recaptured; if the participation was for at least 
eight years but less than nine years, 40 percent is recaptured; 
and if the participation was for at least nine years but less 
than ten years, 20 percent of the reduction in estates taxes is 
recaptured. In general, there is no requirement that the 
qualified heir (or members of his or her family) continue to 
hold or participate in the trade or business more than 10 years 
after the decedent's death. As under present-law section 2032A, 
however, the 10-year recapture period may be extended for a 
period of up to two years if the qualified heir does not begin 
to use the property for a period of up to two years after the 
decedent's death.
    If a recapture event occurs with respect to any qualified 
family-owned business interest (or portion thereof), the amount 
of reduction in estate taxes attributable to that interest is 
determined on a proportionate basis. For example, if the 
decedent's estate included $2 million in qualified family-owned 
business interests and $1 million of such interests received 
beneficial treatment under this proposal, one-half of the value 
of the interest disposed of is deemed to have received the 
benefits provided under this proposal.

                             Effective Date

    The provision is effective with respect to the estates of 
decedents dying after December 31, 1997.

   D. Reduction in Estate Tax for Certain Land Subject to Permanent 
 Conservation Easement (sec. 403 of the bill and sec. 2031 of the Code)

                              Present Law

    A deduction is allowed for estate and gift tax purposes for 
a contribution of a qualified real property interest to a 
charity (or other qualified organization) exclusively for 
conservation purposes (secs. 2055(f), 2522(d)). For this 
purpose, a qualified real property interest means the entire 
interest of the transferor in real property (other than certain 
mineral interests), a remainder interest in real property, or a 
perpetual restriction on the use of real property (sec. 
170(h)). A ``conservation purpose'' is (1) preservation of land 
for outdoor recreation by, or the education of, the general 
public, (2) preservation of natural habitat, (3) preservation 
of open space for scenic enjoyment of the general public or 
pursuant to a governmental conservation policy, and (4) 
preservation of historically important land or certified 
historic structures. Also, a contribution will be treated as 
``exclusively for conservation purposes'' only if the 
conservation purpose is protected in perpetuity.\33\
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    \33\ A member of the transferor's family includes: (1) his or her 
ancestors; (2) his or her spouse; (3) a lineal descendant of the 
decedent, the decedent's spouse or the decedent's parents; and (4) the 
spouse of any of the foregoing lineal descendants.
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    A donor making a qualified conservation contribution 
generally is not allowed to retain an interest in minerals 
which may be extracted or removed by any surface mining method. 
However, deductions for contributions of conservation interests 
satisfying all of the above requirements will be permitted if 
two conditions are satisfied. First, the surface and mineral 
estates in the property with respect to which the contribution 
is made must have been separated before June 13, 1976 (and 
remain so separated) and, second, the probability of surface 
mining on the property with respect to which a contribution is 
made must be so remote as to be negligible (sec. 170(h)(5)(B)).
    The same definition of qualified conservation contributions 
also applies for purposes of determining whether such 
contributions qualify as charitable deductions for income tax 
purposes.

                           Reasons for Change

    The Committee believes that a reduction in estate taxes for 
land subject to a qualified conservation easement will ease 
existing pressures to develop or sell off open spaces in order 
to raise funds to pay estate taxes, and will thereby help to 
preserve environmentally significant land.

                        Explanation of Provision

Reduction in estate taxes for certain land subject to permanent 
        conservation easement

    The provision allows an executor to elect to exclude from 
the taxable estate 40 percent of the value of any land subject 
to a qualified conservation easement that meets the following 
requirements: (1) the land is located within 25 miles of a 
metropolitan area (as defined by the Office of Management and 
Budget) or a national park or wilderness area, or within 10 
miles of an Urban National Forest (as designated by the Forest 
Service of the U.S. Department of Agriculture); (2) the land 
has been owned by the decedent or a member of the decedent's 
family at all times during the three-year period ending on the 
date of the decedent's death; and (3) a qualified conservation 
contribution (within the meaning of section 170(h)) of a 
qualified real property interest (as generally defined in 
section 170(h)(2)(C)) was granted by the transferor or a member 
of his or her family. For purposes of the provision, 
preservation of a historically important land area or a 
certified historic structure does not qualify as a conservation 
purpose. To the extent that the value of such land is excluded 
from the taxable estate, the basis of such land acquired at 
death is a carryover basis (i.e., the basis is not stepped-up 
to its fair market value at death). Debt-financed property is 
not eligible for the exclusion.
    The exclusion amount is calculated based on the value of 
the property after the conservation easement has been placed on 
the property. The exclusion from estate taxes does not extend 
to the value of any development rights retained by the decedent 
or donor, although payment for estate taxes on retained 
development rights may be deferred for up to two years, or 
until the disposition of the property, whichever is earlier. 
For this purpose, retained development rights are any rights 
retained to use the land for any commercial purpose which is 
not subordinate to and directly supportive of farming purposes, 
as defined in section 6420 (e.g., tree farming, ranching, 
viticulture, and the raising of other agricultural or 
horticultural commodities).

Maximum benefit allowed

    The 40-percent estate tax exclusion for land subject to a 
qualified conservation easement (described above) may be taken 
only to the extent that the total exclusion for qualified 
conservation easements, plus the exclusion for qualified 
family-owned business interests (described in C., above), does 
not exceed $1 million. The executor of an estate holding land 
subject to a qualified conservation easement and/or qualified 
family-owned business interests is required to designate which 
of the two benefits is being claimed with respect to each 
property on which a benefit is claimed.
    If the value of the conservation easement is less than 30 
percent of (a) the value of the land without the easement, 
reduced by (b) the value of any retained development rights, 
then the exclusion percentage is reduced. The reduction in the 
exclusion percentage is equal to two percentage points for each 
point that the above ratio falls below 30 percent. Thus, for 
example, if the value of the easement is 25 percent of the 
value of the land before the easement less the value of the 
retained development rights, the exclusion percentage is 30 
percent (i.e., the 40 percent amount is reduced by twice the 
difference between 30 percent and 25 percent). Under this 
calculation, if the value of the easement is 10 percent or less 
of the value of the land before the easement less the value of 
the retained development rights, the exclusion percentage is 
equal to zero.

Treatment of land subject to a conservation easement for purposes of 
        special-use valuation

    The granting of a qualified conservation easement (as 
defined above) is not treated as a disposition triggering the 
recapture provisions of section 2032A. In addition, the 
existence of a qualified conservation easement does not prevent 
such property from subsequently qualifying for special-use 
valuation treatment under section 2032A.

Retained mineral interests

    The provision also allows a charitable deduction (for 
income tax purposes or estate tax purposes) to taxpayers making 
a contribution of a permanent conservation easement on property 
where a mineral interest has been retained and surface mining 
is possible, but its probability is ``so remote as to be 
negligible.'' Present law provides for a charitable deduction 
in such a case if the mineral interests have been separated 
from the land prior to June 13, 1976. The provision allows such 
a charitable deduction to be taken regardless of when the 
mineral interests had been separated.

                             Effective Date

    The estate tax exclusion applies to decedents dying after 
December 31, 1997. The rules with respect to the treatment of 
conservation easements under section 2032A and with respect to 
retained mineral interests are effective for easements granted 
after December 31, 1997.

  E. Installment Payments of Estate Tax Attributable to Closely Held 
Businesses (secs. 404 and 405 of the bill and secs. 6601(j) and 6166 of 
                               the Code)

                              Present Law

    In general, the Federal estate tax is due within nine 
months of a decedent's death. Under Code section 6166, an 
executor generally may elect to pay the estate tax attributable 
to an interest in a closely held business in installments over, 
at most, a 14-year period. If the election is made, the estate 
may pay only interest for the first four years, followed by up 
to 10 annual installments of principal and interest. Interest 
generally is imposed at the rate applicable to underpayments of 
tax under section 6621 (i.e., the Federal short-term rate plus 
3 percentage points). Under section 6601(j), however, a special 
4-percent interest rate applies to the amount of deferred 
estate tax attributable to the first $1,000,000 in value of the 
closely-held business.
    To qualify for the installment payment election, the 
business must be an active trade or business and the value of 
the decedent's interest in the closely held business must 
exceed 35 percent of the decedent's adjusted gross estate. An 
interest in a closely held business includes: (1) any interest 
as a proprietor in a business carried on as a proprietorship; 
(2) any interest in a partnership carrying on a trade or 
business if the partnership has 15 or fewer partners, or if at 
least 20 percent of the partnership's assets are included in 
determining the decedent's gross estate; or (3) stock in a 
corporation if the corporation has 15 or fewer shareholders, or 
if at least 20 percent of the value of the voting stock is 
included in determining the decedent's gross estate.

                           Reasons for Change

    The Committee believes that the installment payment 
provisions need to be expanded in order to better address the 
liquidity problems of estates holding farms and closely held 
businesses, to prevent the liquidation of such businesses in 
order to pay estate taxes. The Committee further believes that 
the protection of closely held businesses will preserve jobs 
and strengthen the communities in which such businesses are 
located.
    In addition, by eliminating the deductibility of interest 
paid on estate taxes deferred under section 6166 (and reducing 
the interest rate accordingly), the bill eliminates the need to 
file annual supplemental estate tax returns and make complex 
iterative computations to claim an estate tax deduction for 
interest paid.

                        Explanation of Provision

    The bill extends the period for which Federal estate tax 
installments may be made under section 6166 to a maximum period 
of 24 years. If the election is made, the estate pays only 
interest for the first four years, followed by up to 20 annual 
installments of principal and interest.
    In addition, the bill provides that no interest is imposed 
on the amount of deferred estate tax attributable to the first 
$1,000,000 in taxable value of the closely held business (i.e., 
the first $1,000,000 in value in excess of the effective 
exemption provided by the unified credit and any other 
exclusions). Thus, for example, in 1998, when the unified 
credit is increased to provide an effective exemption of 
$625,000 (as described above), if the business also qualifies 
for the new $1 million exclusion for qualified family-owned 
business interests (as described above), and the executor so 
elects, the amount of estate tax attributable to the value of 
the closely held business between $1,625,000 and $2,625,000 
would be eligible for the zero-percent interest rate.
    The interest rate imposed on the amount of deferred estate 
tax attributable to the taxable value of the closely held 
business in excess of $1,000,000 is reduced to an amount equal 
to 45 percent of the rate applicable to underpayments of tax. 
The interest paid on estate taxes deferred under section 6166 
is not deductible for estate or income tax purposes.

                             Effective Date

    The provision is effective for decedents dying after 
December 31, 1997.

 F. Estate Tax Recapture from Cash Leases of Specially-Valued Property 
           (sec. 406 of the bill and sec. 2032A of the Code)

                              Present Law

    A Federal estate tax is imposed on the value of property 
passing at death. Generally, such property is included in the 
decedent's estate at its fair market value. Under section 
2032A, the executor may elect to value certain ``qualified real 
property'' used in farming or other qualifying trade or 
business at its current use value rather than its highest and 
best use. If, after the special-use valuation election is made, 
the heir who acquired the real property ceases to use it in its 
qualified use within 10 years (15 years for individuals dying 
before 1982) of the decedent's death, an additional estate tax 
is imposed in order to ``recapture'' the benefit of the 
special-use valuation (sec. 2032A(c)).
    Some courts have held that cash rental of specially-valued 
property after the death of the decedent is not a qualified use 
under section 2032A because the heirs no longer bear the 
financial risk of working the property, and, therefore, results 
in the imposition of the additional estate tax under section 
2032A(c). See Martin v. Commissioner, 783 F.2d 81 (7th Cir. 
1986) (cash lease to unrelated party not qualified use); 
Williamson v. Commissioner, 93 T.C. 242 (1989), aff'd, 974 F.2d 
1525 (9th Cir. 1992) (cash lease to family member not a 
qualified use); Fisher v. Commissioner, 65 T.C.M. 2284 (1993) 
(cash lease to family member not a qualified use); cf. Minter 
v. U.S., 19 F.3d 426 (8th Cir. 1994) (cash lease to family's 
farming corporation is qualified use); Estate of Gavin v. U.S., 
1997 U.S. App. Lexis 10383 (8th Cir. 1997) (heir's option to 
pay cash rent or 50 percent crop share is qualified use).
    With respect to a decedent's surviving spouse, a special 
rule provides that the surviving spouse will not be treated as 
failing to use the property in a qualified use solely because 
the spouse rents the property to a member of the spouse's 
family on a net cash basis. (sec. 2032A(b)(5)). Under section 
2032A, members of an individual's family include (1) the 
individual's spouse, (2) the individual's ancestors, (3) lineal 
descendants of the individual, of the individual's spouse, or 
of the individual's parents, and (4) the spouses of any such 
lineal descendants.

                           Reasons for Change

    The Committee believes that cash leasing of farmland among 
family members is consistent with the purposes of the special-
use valuation rules, which are intended to prevent family farms 
(and other qualifying businesses) from being liquidated to pay 
estate taxes in cases where members of the decedent's family 
continue to participate in the business.

                        Explanation of Provision

    The bill provides that the cash lease of specially-valued 
real property by a lineal descendant of the decedent to a 
member of the lineal descendant's family, who continues to 
operate the farm or closely held business, does not cause the 
qualified use of such property to cease for purposes of 
imposing the additional estate tax under section 2032A(c).

                             Effective Date

    The provision is effective for cash rentals occurring after 
December 31, 1976.

 G. Modification of Generation-Skipping Transfer Tax for Transfers to 
 Individuals with Deceased Parents (sec. 407 of the bill and sec. 2651 
                              of the Code)

                              Present Law

    Under the ``predeceased parent exception,'' a direct skip 
transfer to a transferor's grandchild is not subject to the 
generation-skipping transfer (``GST'') tax if the child of the 
transferor who was the grandchild's parent is deceased at the 
time of the transfer (sec. 2612(c)(2)). This ``predeceased 
parent exception'' to the GST tax is not applicable to (1) 
transfers to collateral heirs, e.g., grandnieces or 
grandnephews, or (2) taxable terminations or taxable 
distributions.

                           Reasons for Change

    The Committee believes that a transfer to a collateral 
relative whose parent is dead should qualify for the 
predeceased parent exception in situations where the transferor 
decedent has no lineal heirs, because no motive or opportunity 
to avoid transfer tax exists. For similar reasons, the 
Committee believes that transfers to trusts should be permitted 
to qualify for the predeceased parent exclusion where the 
parent of the beneficiary is dead at the time that the transfer 
is first subject to estate or gift tax. The Committee also 
understands that this treatment will remove a present law 
impediment to the establishment of charitable lead trusts.

                        Explanation of Provision

    The bill extends the predeceased parent exception to 
transfers to collateral heirs, provided that the decedent has 
no living lineal descendants at the time of the transfer. For 
example, the exception applies to a transfer made by an 
individual (with no living lineal heirs) to a grandniece where 
the transferor's nephew or niece who is the parent of the 
grandniece is deceased at the time of the transfer.
    In addition, the bill extends the predeceased parent 
exception (as modified by the change in the preceding 
paragraph) to taxable terminations and taxable distributions, 
provided that the parent of the relevant beneficiary was dead 
at the earliest time that the transfer (from which the 
beneficiary's interest in the property was established) was 
subject to estate or gift tax. For example, where a trust was 
established to pay an annuity to a charity for a term for years 
with a remainder interest granted to a grandson, the 
termination of the term for years is not a taxable termination 
subject to the GST tax if the grandson's parent (who is the son 
or daughter of the transferor) was deceased at the time the 
trust was created and the transfer creating the trust was 
subject to estate or gift tax.

                             Effective Date

    The provision is effective for generation-skipping 
transfers occurring after December 31, 1997.
         TITLE V. EXTENSION OF CERTAIN EXPIRING TAX PROVISIONS

 A. Research Tax Credit (sec. 501 of the bill and sec. 41 of the Code)

                              Present Law

General rule

    Section 41 provides for a research tax credit equal to 20 
percent of the amount by which a taxpayer's qualified research 
expenditures for a taxable year exceeded its base amount for 
that year. The research tax credit expired and generally will 
not apply to amounts paid or incurred after May 31, 1997.\34\
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    \34\ When originally enacted, the research tax credit applied to 
qualified expenses incurred after June 30, 1981. The credit was 
modified several times and was extended through June 30, 1995. The 
credit later was extended 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).
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    A 20-percent research tax credit also applied to the excess 
of (1) 100 percent of corporate cash expenditures (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 is commonly referred to as the ``university basic 
research credit'' (see sec. 41(e)).

Computation of allowable credit

    Except for certain university basic research payments made 
by corporations, the research tax credit applies only to the 
extent that the taxpayer's qualified research expenditures for 
the current taxable year exceed its base amount. The base 
amount for the current year generally is 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 
expenditures and had gross receipts during each of at least 
three years from 1984 through 1988, then its ``fixed-base 
percentage'' is the ratio that its total qualified research 
expenditures for the 1984-1988 period bears to its total gross 
receipts for that period (subject to a maximum ratio of .16). 
All other taxpayers (so-called ``start-up firms'') are assigned 
a fixed-base percentage of 3 percent.\35\
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    \35\ 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) is 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 will be assigned a 
fixed-base percentage of 3 percent for each of its first five taxable 
years after 1993 in which it incurs qualified research expenditures. In 
the event that the research credit is extended beyond the scheduled 
expiration date, a start-up firm's fixed-base percentage for its sixth 
through tenth taxable years after 1993 in which it incurs qualified 
research expenditures 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 
expenditures 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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    In computing the credit, a taxpayer's base amount may not 
be less than 50 percent of its current-year qualified research 
expenditures.
    To prevent artificial increases in research expenditures by 
shifting expenditures among commonly controlled or otherwise 
related entities, research expenditures and gross receipts of 
the taxpayer are aggregated with research expenditures and 
gross receipts of certain related persons for purposes of 
computing any allowable credit (sec. 41(f)(1)). Special rules 
apply for computing the credit when a major portion of a 
business changes hands, under which qualified research 
expenditures and gross receipts for periods prior to the change 
of ownership of a trade or business are treated as transferred 
with the trade or business that gave rise to those expenditures 
and receipts for purposes of recomputing a taxpayer's fixed-
base percentage (sec. 41(f)(3)).

Alternative incremental research credit regime

    As part of the Small Business Job Protection Act of 1996, 
taxpayers are allowed to elect an alternative incremental 
research credit regime. If a taxpayer elects to be subject to 
this alternative regime, the taxpayer is assigned a three-
tiered fixed-base percentage (that is lower than the fixed-base 
percentage otherwise applicable under present law) and the 
credit rate likewise is reduced. Under the alternative credit 
regime, a credit rate of 1.65 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 1 percent 
(i.e., the base amount equals 1 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. A credit rate of 2.2 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 2 percent. A credit rate of 2.75 
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 2 percent. An election to be subject 
to this alternative incremental credit regime may be made only 
for a taxpayer's first taxable year beginning after June 30, 
1996, and before July 1, 1997, and such an election applies to 
that taxable year and all subsequent years (in the event that 
the credit subsequently is extended by Congress) unless revoked 
with the consent of the Secretary of the Treasury. If a 
taxpayer elects the alternative incremental research credit 
regime for its first taxable year beginning after June 30, 
1996, and before July 1, 1997, then allqualified research 
expenses paid or incurred during the first 11 months of such taxable 
year are treated as qualified research expenses for purposes of 
computing the taxpayer's credit.

Eligible expenditures

    Qualified research expenditures eligible for the research 
tax credit consist 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 by the 
taxpayer for qualified research conducted on the taxpayer's 
behalf (so-called ``contract research expenses'').\36\
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    \36\ 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 is 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 is a tax-exempt organization 
that is described in section 501(c)(3) (other than a private 
foundation) or section 501(c)(6) and is organized and operated 
primarily to conduct scientific research, and (2) such qualified 
research is conducted by the consortium on behalf of the taxpayer and 
one or more persons not related to the taxpayer.
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    To be eligible for the credit, the research must not only 
satisfy the requirements of present-law section 174 (described 
below) but must be undertaken for the purpose of discovering 
information that is technological in nature, the application of 
which is intended to be useful in the development of a new or 
improved business component of the taxpayer, and must pertain 
to functional aspects, performance, reliability, or quality of 
a business component. Research does not qualify for the credit 
if substantially all of the activities relate to style, taste, 
cosmetic, or seasonal design factors (sec. 41(d)(3)). In 
addition, research does not qualify for the credit if conducted 
after the beginning of commercial production of the business 
component, if related to the adaptation of an existing business 
component to a particular customer's requirements, if related 
to the duplication of an existing business component from a 
physical examination of the component itself or certain other 
information, or if related to certain efficiency surveys, 
market research or development, or routine quality control 
(sec. 41(d)(4)).
    Expenditures attributable to research that is conducted 
outside the United States do not enter into the credit 
computation. In addition, the credit is not available for 
research in the social sciences, arts, or humanities, nor is it 
available for research to the extent funded by any grant, 
contract, or otherwise by another person (or governmental 
entity).

Relation to deduction

    Under section 174, taxpayers may elect to deduct currently 
the amount of certain research or experimental expenditures 
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. However, 
deductions allowed to a taxpayer under section 174 (or any 
other section) are reduced by an amount equal to 100 percent of 
the taxpayer's research tax credit determined for the taxable 
year. Taxpayers may alternatively elect to claim a reduced 
research tax credit amount under section 41 in lieu of reducing 
deductions otherwise allowed (sec. 280C(c)(3)).

                           Reasons for Change

    Businesses may not find it profitable to invest in some 
research activities because of the difficulty in capturing the 
full benefits from the research. Costly technological advances 
made by one firm are often cheaply copied by its competitors. A 
research tax credit can help promote investment in research, so 
that research activities undertaken approach the optimal level 
for the overall economy. Therefore, the Committee believes 
that, in order to encourage research activities, it is 
appropriate to reinstate the research tax credit.

                        Explanation of Provision

    The research tax credit is extended for 31 months--i.e., 
generally for the period June 1, 1997, through December 31, 
1999.
    Under the provision, taxpayers are permitted to elect the 
alternative incremental research credit regime under section 
41(c)(4) 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.

                             Effective Date

    The provision generally is effective for qualified research 
expenditures paid or incurred during the period June 1, 1997, 
through December 31, 1999.
    A special rule provides that, notwithstanding the general 
termination date for the research credit of December 31, 1999, 
if a taxpayer elects to be subject to the alternative 
incremental research credit regime for its first taxable year 
beginning after June 30, 1996, and before July 1, 1997, the 
alternative incremental research credit will be available 
during the entire 42-month period beginning with the first 
month of such taxable year--i.e., the equivalent of the 11-
month extension provided for by the Small Business Job 
Protection Act of 1996 plus an additional 31-month extension 
provided for by this bill. However, to prevent taxpayers from 
effectively obtaining more than 42-months of research credits 
from the Small Business Job Protection Act of 1996 and this 
bill, the 42-month period for taxpayers electing the 
alternative incremental research credit regime is reduced by 
the number of months (if any) after June 1996 with respect to 
which the taxpayer claimed research credit amounts under the 
regular, 20-percent research credit rules.

B. Contributions of Stock to Private Foundations (sec. 502 of the bill 
                    and sec. 170(e)(5) of the Code)

                              Present Law

    In computing taxable income, a taxpayer who itemizes 
deductions generally is allowed to deduct the fair market value 
of property contributed to a charitable organization.\37\ 
However, in the case of a charitable contribution of short-term 
gain, inventory, or other ordinary income property, the amount 
of the 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.\38\
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    \37\ The amount of the deduction allowable for a taxable year with 
respect to a charitable contribution 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 
(secs. 170(b) and 170(e)).
    \38\ As part of the Omnibus Budget Reconciliation Act of 1993, 
Congress eliminated the treatment of contributions of appreciated 
property (real, personal, and intangible) as a tax preference for 
alternative minimum tax (AMT) purposes. Thus, if a taxpayer makes a 
gift to charity of property (other than short-term gain, inventory, or 
other ordinary income or property, or gifts to private foundations) 
that is real property, intangible property, or tangible personal 
property the use of which is related to the donee's tax-exempt purpose, 
the taxpayer is allowed to claim the same fair-market-value deduction 
for both regular tax and AMT purposes (subject to present-law 
percentage limitations).
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    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. However, under a special rule contained in section 
170(e)(5), taxpayers are allowed a deduction equal to the fair 
market value of ``qualified appreciated stock'' contributed to 
a private foundation prior to May 31, 1997.\39\ Qualified 
appreciated stock is defined as publicly traded stock which is 
capital gain property. The fair-market-value deduction for 
qualified appreciated stock donations applies only to the 
extent that total donations made by the donor to private 
foundations of stock in a particular corporation did not exceed 
10 percent of the outstanding stock of that corporation. For 
this purpose, an individual is treated as making all 
contributions that were made by any member of the individual's 
family.
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    \39\ The special rule contained in section 170(e)(5), which was 
originally enacted in 1984, expired January 1, 1995. The Small Business 
Job Protection Act of 1996 reinstated the rule for 11 months--for 
contributions of qualified appreciated stock made to private 
foundations during the period July 1, 1996, through May 31, 1997.
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                           Reasons for Change

    The Committee believes that, to encourage donations to 
charitable private foundations, it is appropriate to extend the 
rule that allows a fair market value deduction for certain 
gifts of appreciated stock to private foundations.

                        Explanation of Provision

    The bill extends the special rule contained in section 
170(e)(5) for contributions of qualified appreciated stock made 
to private foundations during the period June 1, 1997, through 
December 31, 1999.

                             Effective Date

    The provision is effective for contributions of qualified 
appreciated stock to private foundations made during the period 
June 1, 1997, through December 31, 1999.

C. Work Opportunity Tax Credit (sec. 503 of the bill and sec. 51 of the 
                                 Code)

                              Present Law

In general

    The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of 
seven targeted groups. The credit generally is equal to 35 
percent of qualified wages. Qualified wages consist of wages 
attributable to service rendered by a member of a targeted 
group during the one-year period beginning with the day the 
individual begins work for the employer. For a vocational 
rehabilitation referral, however, the period will begin on the 
day the individual begins work for the employer on or after the 
beginning of the individual's vocational rehabilitation plan as 
under prior law.
    Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual. Thus, the maximum credit per 
individual is $2,100. With respect to qualified summer youth 
employees, the maximum credit is 35 percent of up to $3,000 of 
qualified first-year wages, for a maximum credit of $1,050.
    The deduction for wages is reduced by the amount of the 
credit.

Targeted groups eligible for the credit

            (1) Families receiving AFDC
    An eligible recipient is an individual certified by the 
designated local employment agency as being a member of a 
family eligible to receive benefits under AFDC or its successor 
program for a period of at least nine months part of which is 
during the 9-month period ending on the hiring date. For these 
purposes, members of the family are defined to include only 
those individuals taken into account for purposes of 
determining eligibility for the AFDC or its successor program.
            (2) Qualified ex-felon
    A qualified ex-felon is an individual certified as: (1) 
having been convicted of a felony under any State or Federal 
law, (2) being a member of a family that had an income during 
the six months before the earlier of the date of determination 
or the hiring date which on an annual basis is 70 percent or 
less of the Bureau of Labor Statistics lower living standard, 
and (3) having a hiring date within one year of release from 
prison or date of conviction.
            (3) High-risk youth
    A high-risk youth is an individual certified as being at 
least 18 but not yet 25 on the hiring date and as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). Qualified wages will not include wages 
paid or incurred for services performed after the individual 
moves outside an empowerment zone or enterprise community.
            (4) Vocational rehabilitation referral
    Vocational rehabilitation referrals are those individuals 
who have a physical or mental disability that constitutes a 
substantial handicap to employment and who have been referred 
to the employer while receiving, or after completing, 
vocational rehabilitation services under an individualized, 
written rehabilitation plan under a State plan approved under 
the Rehabilitation Act of 1973 or under a rehabilitation plan 
for veterans carried out under Chapter 31 of Title 38, U.S. 
Code. Certification will be provided by the designated local 
employment agency upon assurances from the vocational 
rehabilitation agency that the employee has met the above 
conditions.
            (5) Qualified summer youth employee
    Qualified summer youth employees are individuals: (1) who 
perform services during any 90-day period between May 1 and 
September 15, (2) who are certified by the designated local 
agency as being 16 or 17 years of age on the hiring date, (3) 
who have not been an employee of that employer before, and (4) 
who are certified by the designated local agency as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). As with high-risk youths, no credit is 
available on wages paid or incurred for service performed after 
the qualified summer youth moves outside of an empowerment zone 
or enterprise community. If, after the end of the 90-day 
period, the employer continues to employ a youth who was 
certified during the 90-day period as a member of another 
targeted group, the limit on qualified first-year wages will 
take into account wages paid to the youth while a qualified 
summer youth employee.
            (6) Qualified veteran
    A qualified veteran is a veteran who is a member of a 
family certified as receiving assistance under: (1) AFDC for a 
period of at least nine months part of which is during the 12-
month period ending on the hiring date, or (2) a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least three months part of which is during the 12-month period 
ending on the hiring date. For these purposes, members of a 
family are defined to include only those individuals taken into 
account for purposes of determining eligibility for: (i) the 
AFDC or its successor program, and (ii) a food stamp program 
under the Food Stamp Act of 1977, respectively.
    Further, a qualified veteran is an individual who has 
served on active duty (other than for training) in the Armed 
Forces for more than 180 days or who has been discharged or 
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served 
for a period of more than 90 days during which the individual 
was on active duty (other than for training) is not an eligible 
employee if any of this active duty occurred during the 60-day 
period ending on the date the individual was hired by the 
employer. Thislatter rule is intended to prevent employers who 
hire current members of the armed services (or those departed from 
service within the last 60 days) from receiving the credit.
            (7) Families receiving food stamps
    An eligible recipient is an individual aged 18 but not yet 
25 certified by a designated local employment agency as being a 
member of a family receiving assistance under a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least six months ending on the hiring date. In the case of 
families that cease to be eligible for food stamps under 
section 6(o) of the Food Stamp Act of 1977, the six-month 
requirement is replaced with a requirement that the family has 
been receiving food stamps for at least three of the five 
months ending on the date of hire. For these purposes, members 
of the family are defined to include only those individuals 
taken into account for purposes of determining eligibility for 
a food stamp program under the Food Stamp Act of 1977.

Minimum employment period

    No credit is allowed for wages paid unless the eligible 
individual is employed by the employer for at least 180 days 
(20 days in the case of a qualified summer youth employee) or 
400 hours (120 hours in the case of a qualified summer youth 
employee).

Expiration date

    The credit is effective for wages paid or incurred to a 
qualified individual who begins work for an employer after 
September 30, 1996, and before October 1, 1997.

                           Reasons for Change

    The Committee believes that this short-term program with 
modifications will provide the Congress and the Treasury and 
Labor Departments an opportunity to assess fully the operation 
and effectiveness of the credit as a hiring incentive. It will 
also extend application of the credit to a larger group of 
eligible individuals pending that evaluation.

                        Explanation of Provision

    The bill extends for 22 months the work opportunity tax 
credit. The bill also modifies the credit in four additional 
ways. First, the bill modifies the eligibility definition for 
the AFDC families targeted group. Specifically, under the bill 
an otherwise eligible member of a family receiving AFDC 
benefits for any 9-month period (whether or not consecutive) 
during the 18-month period ending on the hiring date would 
qualify as a member of this targeted group (this expansion 
applies whether or not the individual is a qualified veteran). 
Second, the proposal adds another targeted group to the credit. 
The new targeted group is persons certified by the designated 
local agency as receiving certain Supplemental Security Income 
(SSI) benefits for any month ending within the 60 day period 
ending on the hiring date. For these purposes, SSI benefits 
would mean benefits under title XVI of the Social Security Act 
(including supplemental security income benefits of the type 
described in section 1616 of such Act or section 212 of Public 
Law 93-66). Third, the bill reduces the minimum employment 
period to 120 hours. Finally, the bill modifies the credit 
percentage so that it is 25% for the first 400 hours and 40% 
thereafter (assuming the minimum employment period is satisfied 
with respect to that employee.

                             Effective Date

    The provisions to extend and modify the work opportunity 
tax credit are effective for wages paid or incurred to 
qualified individuals who begin work for the employer after 
September 30, 1997, and before August 1, 1999.

  D. Orphan Drug Tax Credit (sec. 504 of the bill and sec. 45C of the 
                                 Code)

                               Present Law

    A 50-percent nonrefundable tax credit is allowed for 
qualified clinical testing expenses incurred in testing of 
certain drugs for rare diseases or conditions, generally 
referred to as ``orphan drugs.'' Qualified testing expenses are 
costs incurred to test an orphan drug after the drug has been 
approved for human testing by the Food and Drug Administration 
(``FDA'') but before the drug has been approved for sale by the 
FDA. A rare disease or condition is defined as one that (1) 
affects less than 200,000 persons in the United States, or (2) 
affects more than 200,000 persons, but for which there is no 
reasonable expectation that businesses could recoup the costs 
of developing a drug for such disease or condition from U.S. 
sales of the drug. These rare diseases and conditions include 
Huntington's disease, myoclonus, ALS (Lou Gehrig's disease), 
Tourette's syndrome, and Duchenne's dystrophy (a form of 
muscular dystrophy).
    As with other general business credits (sec. 38), taxpayers 
are allowed to carry back unused credits to three years 
preceding the year the credit is earned (but not to a taxable 
year ending before July 1, 1996) and to carry forward unused 
credits to 15 years following the year the credit is earned. 
The credit cannot be used to offset a taxpayer's alternative 
minimum tax liability.
    The orphan drug tax credit expired and does not apply to 
expenses paid or incurred after May 31, 1997.\40\
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    \40\ The orphan drug tax credit originally was enacted in 1983 and 
was extended on several occasions. The credit expired on December 31, 
1994, and later was reinstated for the period July 1, 1996, through May 
31, 1997.
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                           Reasons for Change

    In order to encourage the socially optimal level of 
research to develop drugs to treat rare diseases and 
conditions--and because the research and clinical testing of 
such drugs often must be conducted over several years--the 
Committee believes that the orphan drug tax credit should be 
permanently extended.

                        Explanation of Provision

    The orphan drug tax credit provided for by section 45C is 
permanently extended.

                             Effective Date

    The provision is effective for qualified clinical testing 
expenses paid or incurred after May 31, 1997.
TITLE VI. DISTRICT OF COLUMBIA TAX INCENTIVES (secs. 601 and 602 of the 
               bill and new secs. 1400-1400B of the Code)

                              Present Law

Empowerment zones and enterprise communities

            In general
    Pursuant to the Omnibus Budget Reconciliation Act of 1993 
(OBRA 1993), the Secretaries of the Department of Housing and 
Urban Development (HUD) and the Department of Agriculture 
designated a total of nine empowerment zones and 95 enterprise 
communities on December 21, 1994. As required by law, six 
empowerment zones are located in urban areas (with aggregate 
population for the six designated urban empowerment zones 
limited to 750,000) and three empowerment zones are located in 
rural areas.\41\ Of the enterprise communities, 65 are located 
in urban areas and 30 are located in rural areas (sec. 1391). 
Designated empowerment zones and enterprise communities were 
required to satisfy certain eligibility criteria, including 
specified poverty rates and population and geographic size 
limitations (sec. 1392). Portions of the District of Columbia 
were designated as an enterprise community.
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    \41\ The six designated urban empowerment zones are located in New 
York City, Chicago, Atlanta, Detroit, Baltimore, and Philadelphia-
Camden (New Jersey). The three designated rural empowerment zones are 
located in Kentucky Highlands (Clinton, Jackson, and Wayne counties, 
Kentucky), Mid-Delta Mississippi (Bolivar, Holmes, Humphreys, Leflore 
counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo, 
Starr, and Willacy counties, Texas).
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    The following tax incentives are available for certain 
businesses located in empowerment zones: (1) an annual 20-
percent wage credit for the first $15,000 of wages paid to a 
zone resident who works in the zone; (2) an additional $20,000 
of expensing under Code section 179 for ``qualified zone 
property'' placed in service by an ``enterprise zone business'' 
(accordingly, certain businesses operating in empowerment zones 
are allowed up to $38,000 of expensing for 1997; the allowable 
amount will increase to $38,500 for 1998); and (3) special tax-
exempt financing for certain zone facilities.
    The 95 enterprise communities are eligible for the special 
tax-exempt financing benefits but not the other tax incentives 
available in the nine empowerment zones. In addition to these 
tax incentives, OBRA 1993 provided that Federal grants would be 
made to designated empowerment zones and enterprise 
communities.
    The tax incentives for empowerment zones and enterprise 
communities generally will be available during the period that 
the designation remains in effect, i.e., a 10-year period.
            Definition of ``qualified zone property''
    Present-law section 1397C defines ``qualified zone 
property'' as depreciable tangible property (including 
buildings), provided that: (1) the property is acquired by the 
taxpayer (from an unrelated party) after the zone or community 
designation took effect; (2) the original use of the property 
in the zone or community commences with the taxpayer; and (3) 
substantially all of the use of the property is in the zone or 
community in the active conduct of a trade or business by the 
taxpayer in the zone or community. In the case of property 
which is substantially renovated by the taxpayer, however, the 
property need not be acquired by the taxpayer after zone or 
community designation or originally used by the taxpayer within 
the zone or community if, during any 24-month period after zone 
or community designation, the additions to the taxpayer's basis 
in the property exceed the greater of 100 percent of the 
taxpayer's basis in the property at the beginning of the 
period, or $5,000.
            Definition of ``enterprise zone business''
    Present-law section 1397B defines the term ``enterprise 
zone business'' as a corporation or partnership (or 
proprietorship) if for the taxable year: (1) the sole trade or 
business of the corporation or partnership is the active 
conduct of a qualified business within an empowerment zone or 
enterprise community; (2) at least 80 percent of the total 
gross income is derived from the active conduct of a 
``qualified business'' within a zone or community; (3) 
substantially all of the business's tangible property is used 
within a zone or community; (4) substantially all of the 
business's intangible property is used in, and exclusively 
related to, the active conduct of such business; (5) 
substantially all of the services performed by employees are 
performed within a zone or community; (6) at least 35 percent 
of the employees are residents of the zone or community; and 
(7) no more than five percent of the average of the aggregate 
unadjusted bases of the property owned by the business is 
attributable to (a) certain financial property, or (b) 
collectibles not held primarily for sale to customers in the 
ordinary course of an active trade or business.
    A ``qualified business'' is defined as any trade or 
business other than a trade or business that consists 
predominantly of the development or holding of intangibles for 
sale or license.\42\ In addition, the leasing of real property 
that is located within the empowerment zone or community to 
others is treated as a qualified business only if (1) the 
leased property is not residential property, and (2) at least 
50 percent of the gross rental income from the real property is 
from enterprise zone businesses. The rental of tangible 
personal property to others is not a qualified business unless 
substantially all of the rental of such property is by 
enterprise zone businesses or by residents of an empowerment 
zone or enterprise community.
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    \42\ Also, a qualified business does not include certain facilities 
described in section 144(c)(6)(B) (e.g., massage parlor, hot tub 
facility, or liquor store) or certain large farms.
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Taxation of capital gains

    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 capital 
assets, the net capital gain generally is taxed at the same 
rate as ordinary income, except that the maximum rateof tax is 
limited to 28 percent of the net capital gain.\43\ 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.
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    \43\ The Revenue Reconciliation Act of 1993 added Code section 
1202, which provides a 50-percent exclusion for gain from the sale of 
certain small business stock acquired at original issue and held for at 
least five years.
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    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, 
and (5) certain publications of the Federal Government.
    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 generally is 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.

                           Reasons for Change

    The Committee believes that the District of Columbia faces 
two key problems--inability to attract and retain a stable 
residential base and insufficient economic activity. To this 
end, the Committee has provided certain tax incentives to 
attract new homeowners to the District and to encourage 
economic development in those areas of the District where 
development has been inadequate. However, the Committee is 
aware that the efficacy of tax incentives to address one or 
both problems is severely limited absent fundamental structural 
reform of the District's government and economy. Thus, the 
availability of the tax incentives is contingent on the passage 
of other Federal legislation that will implement such critical 
structural reforms.

                        Explanation of Provision

    The following tax incentives take effect only if, prior to 
January 1, 1998, a Federal law is enacted creating a District 
of Columbia economic development corporation that is an 
instrumentality of the District of Columbia government.

First-time homebuyer credit

    The bill provides first-time homebuyers of a principal 
residence in the District a tax credit of up to $5,000 of the 
amount of the purchase price. The $5,000 maximum credit amount 
applies both to individuals and married couples. Married 
individuals filing separately can claim a maximum credit of 
$2,500 each. The Secretary of Treasury is directed to prescribe 
regulations allocating the credit among unmarried purchasers of 
a residence.\44\
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    \44\ The provision of the bill that excludes sales of certain 
personal residences from the real estate transaction reporting 
requirement would not apply to sales of personal residences in the 
District of Columbia. In addition, the Committee anticipates that the 
Secretary of Treasury will require such information as may be necessary 
to verify eligibility for the D.C. first-time homebuyer credit.
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    To qualify as a ``first-time homebuyer,'' neither the 
individual (nor the individual's spouse, if married) can have 
had a present ownership interest in a principal residence in 
the District for the one-year period prior to the date of 
acquisition of the principal residence.\45\
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    \45\ Special rules apply to members of the Armed Forces and certain 
individuals with tax homes outside the United States with respect to 
whom the rollover period available under section 1034 (as in effect 
prior to the enactment of the bill) is suspended pursuant to sections 
1034(h) or (k).
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    A taxpayer will be treated as a first-time homebuyer with 
respect to only one residence--i.e., the credit may be claimed 
one time only. The date of acquisition is the date on which a 
binding contract to purchase the principal residence is entered 
into or the date on which construction or reconstruction of 
such residence commences.
    The credit applies to purchases after the date of enactment 
and before January 1, 2002. Any excess credit may be carried 
forward indefinitely to succeeding taxable years.

Tax credits for equity investments in and loans to businesses located 
        in the District of Columbia

    A newly created economic development corporation is 
authorized to allocate $75 million in tax credits to taxpayers 
that make certain equity investments in, or loans to, 
businesses (either corporations or partnerships) engaged in an 
active trade or business in the District of Columbia. Factors 
to be considered in the allocation of credits include whether 
the project would provide job opportunities for low and 
moderate income residents of, and whether the business is 
located in, certain targeted areas. These areas 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 at least 35 
percent. Eligible businesses are not be required to satisfy the 
criteria of a qualified D.C. business, described below. Such 
credits are nonrefundable and can be used to offset a 
taxpayer's alternative minimum tax (AMT) liability.
    Under the bill, the amount of credit cannot exceed 25 
percent of the amount invested (or loaned) by the taxpayer. 
Thus, the economic development corporation is permitted to 
allocate the full $75 million in tax credits to no less than 
$300 million in equity investments in, or loans, to eligible 
businesses.
    Under the bill, credits may be allocated to loans made to 
an eligible business only if the business uses the loan 
proceeds to purchase depreciable tangible property and any 
functionally related and subordinate land. Credits may be 
allocated to equity investments only if the equity interest was 
acquired for cash. Any credits allocated to a taxpayer making 
an equity investment are subject to recapture if the equity 
interest is disposed of by the taxpayer within five years. A 
taxpayer's basis in an equity investment is reduced by the 
amount of the credit.
    The bill applies to credit amounts allocated for taxable 
years beginning after December 31, 1997, and before January 1, 
2003.\46\
---------------------------------------------------------------------------
    \46\ As a general business credit, the credit can be carried back 
three years (but not before January 1, 1998) and forward for fifteen 
years.
---------------------------------------------------------------------------

Zero-percent capital gains rate

    The bill provides a zero-percent capital gains rate for 
capital gains from the sale of certain qualified D.C. assets 
held for more than five years. In general, qualified D.C. 
assets mean stock or partnership interests held in, or tangible 
property held by, a qualified D.C. business.

Qualified D.C. business

    A ``qualified D.C. business'' generally is required to 
satisfy the requirements of an ``enterprise zone business'' 
under present law, applied as if the District (in its entirety) 
were an empowerment zone. Thus, a corporation or partnership is 
a qualified D.C. business if (1) its sole trade or business is 
the active conduct of a ``qualified business'' within the 
District; (2) at least 80 percent of the total gross income is 
derived from the active conduct of a ``qualified business'' 
within the District; (3) substantially all of the business's 
tangible property is used within the District; (4) 
substantially all of the business's intangible property is used 
in, and exclusively related to, the active conduct of such 
business; (5) substantially all of the services performed by 
employees are performed within the District; and (6) no more 
than five percent of the average of the aggregate unadjusted 
bases of the property owned by the business is attributable to 
(a) certain financial property, or (b) collectibles not held 
primarily for sale to customers in the ordinary course of an 
active trade or business.\47\ A ``qualified business'' means 
any trade or business other than a trade or business that 
consists predominantly of the development or holding of 
intangibles for sale or license.\48\ In addition, the leasing 
of real property that is located within the District to others 
is treated as a qualified business only if (1) the leased 
property is not residential property, and (2) at least 50 
percent of the gross rental income from the real property is 
from qualified D.C. businesses. The rental of tangible personal 
property to others is not be a qualified business unless 
substantially all of the rental of such property is by 
qualified D.C. businesses or by residents of the District.
---------------------------------------------------------------------------
    \47\ The requirement under present-law section 1397B(b)(6) that at 
least 35 percent of the employees of the business be zone residents 
does not apply when determining whether an entity is a qualified D.C. 
business.
    \48\ Also, as under present law, a qualified business does not 
include certain facilities described in section 144(c)(6)(B) (e.g., 
massage parlor, hot tub facility, or liquor store) or certain large 
farms.
---------------------------------------------------------------------------
            Qualified D.C. assets
    For purposes of the bill, ``qualified D.C. assets'' include 
(1) D.C. business stock, (2) D.C. partnership interests, and 
(3) D.C. business property.
    ``D.C. business stock'' means stock in a domestic 
corporation originally issued after December 31, 1997, that, at 
the time of issuance \49\ and during substantially all of the 
taxpayer's holding period, was a qualified D.C. business, 
provided that such stock was acquired by the taxpayer on 
original issue from the corporation solely in exchange for cash 
before January 1, 2003.\50\ A ``D.C. partnership interest'' 
means a domestic partnership interest originally issued after 
December 31, 1997, that is acquired by the taxpayer from the 
partnership solely in exchange for cash before January 1, 2003, 
provided that, at the time such interest was acquired \51\ and 
during substantially all of the taxpayer's holding period, the 
partnership was a qualified D.C. business. Finally, ``D.C. 
business property'' means tangible property acquired by the 
taxpayer by purchase (within the meaning of present law section 
179(d)(2)) after December 31, 1997, and before January 1, 2003, 
provided that the original use of such property in the District 
commences with the taxpayer and substantially all of the use of 
such property during substantially all of the taxpayer's 
holding period was in a qualified D.C. business of the 
taxpayer.
---------------------------------------------------------------------------
    \49\ In the case of a new corporation, it is sufficient if the 
corporation is being organized for purposes of being a qualified D.C. 
business.
    \50\ As under section 1202(c)(3), qualified D.C. business stock 
does not include any stock acquired from a corporation which made a 
substantial stock redemption or distribution (without a bona fide 
business purpose therefore) in an attempt to avoid the purposes of the 
provision. A similar rule applies with respect to qualified D.C. 
partnership interests.
    \51\ In the case of a new partnership, it is sufficient if the 
partnership is being formed for purposes of being a D.C. business.
---------------------------------------------------------------------------
    A special rule provides that, in the case of business 
property that is ``substantially renovated,'' such property 
need not be acquired by the taxpayer after December 31, 1997, 
nor need the original use of such property in the District 
commence with the taxpayer. For these purposes, property is 
treated as ``substantially renovated'' if, prior to January 1, 
2003, additions to basis with respect to such property in the 
hands of the taxpayer during any 24-month period beginning 
after December 31, 1997, exceed the greater of (1) an amount 
equal to the adjusted basis at the beginning of such 24-month 
period in the hands of the taxpayer, or (2) $5,000. Thus, 
substantially renovated real estate located in the District can 
constitute D.C. business property. However, the bill 
specifically excludes land that is not an integral part of a 
D.C. business from the definition of D.C. business property.
    In addition, qualified D.C. assets include property that 
was a qualified D.C. asset in the hands of a prior owner, 
provided that at the time of acquisition, and during 
substantially all of the subsequent purchaser's holding period, 
either (1) substantially all of the use of the property is in a 
qualified D.C. business, or (2) the property is an ownership 
interest in a qualified D.C. business.
    In general, gain eligible for the zero-percent tax rate 
means gain from the sale or exchange of a qualified D.C. asset 
that is (1) a capital asset or (2) property used in the trade 
or business as defined in section 1231(b). Gain attributable to 
periods before December 31, 1997, is not qualified capital 
gain. No gain attributable to real property, or an intangible 
asset, which is not an integral part of a D.C. business 
qualifies for the zero-percent rate.
    The bill provides that property that ceases to be a 
qualified D.C. asset because the property is no longer used in 
(or no longer represents an ownership interest in) a qualified 
D.C. business after the five-year period beginning on the date 
the taxpayer acquired such property continues to be treated as 
a qualified D.C. asset. Under this rule, the amount of gain 
eligible for the zero-percent capital gains rate cannot exceed 
the amount which would be qualified capital gain had the 
property been sold on the date of such cessation.
    Special rules are provided for pass-through entities (i.e., 
partnerships, S corporations, regulated investment companies, 
and common trust funds). In the case of a sale or exchange of 
an interest in a pass-through entity that was not a qualified 
D.C. business during substantially all of the period that the 
taxpayer held the interest, the zero-percent capital gains rate 
applies to the extent that the gain is attributable to amounts 
that would have been qualified capital gain had the underlying 
assets been sold for their fair market value on the date of the 
sale or exchange of the interest in the pass-through entity. 
This rule applies only if the interest in the pass-through 
entity were held by the taxpayer for more than five years. In 
addition, the rule applies apply only to qualified D.C. assets 
that were held by the pass-through entity for more than five 
years, and throughout the period that the taxpayer held the 
interest in the pass-through entity.
    The bill also provides that, in the case of a transfer of a 
qualified D.C. asset by gift, at death, or from a partnership 
to a partner that held an interest in the partnership at the 
time that the qualified D.C. asset was acquired, (1) the 
transferee is to be treated as having acquired the asset in the 
same manner as the transferor, and (2) the transferee's holding 
period includes that of the transferor. In addition, rules 
similar to those contained in section 1202(i)(2) regarding 
treatment of contributions to capital after the original 
issuance date and section 1202(j) regarding treatment of 
certain short positions apply.

                             Effective Date

    The D.C. first-time homebuyer credit is effective for 
purchases after the date of enactment and before January 1, 
2002. The tax credit for equity investments and loans applies 
to credit amounts allocated for taxable years beginning after 
December 31, 1997, and before January 1, 2003. The zero-percent 
tax rate for capital gains is effective for qualified D.C. 
assets purchased (or substantially renovated) during the period 
January 1, 1998, through December 31, 2002, for any gain 
accruing with respect to such assets after the date or purchase 
(or substantial renovation).
                  TITLE VII. MISCELLANEOUS PROVISIONS

                        A. Excise Tax Provisions

1. Repeal excise tax on diesel fuel used in recreational motorboats 
        (sec. 901 of the bill and secs. 4041 and 6427 of the Code)

                              Present Law

    Before a temporary suspension through December 31, 1997 was 
enacted in 1996, diesel fuel used in recreational motorboats 
was subject to the 24.3-cents-per-gallon diesel fuel excise 
tax. Revenues from this tax were retained in the General Fund. 
The tax was enacted by the Omnibus Budget Reconciliation Act of 
1993 as a revenue offset for repeal of the excise tax on 
certain luxury boats.

                           Reasons for Change

    Many marinas have found it uneconomical to carry both 
undyed (taxed) and dyed (untaxed) diesel fuel because the 
majority of their market is for uses not subject to tax. As a 
result, some recreational boaters have experienced difficulty 
finding fuels. In 1996, Congress suspended imposition of the 
tax on recreational boating while alternative collection 
methods were evaluated. No satisfactory alternative has been 
found; therefore, the Committee determined that competing needs 
for boat fuel availability and preservation of the integrity of 
the diesel fuel tax compliance structure are best served by 
repealing the diesel fuel tax on recreational motorboat use.

                        Explanation of Provision

    The bill repeals the application of the diesel fuel tax to 
fuel used in recreational motorboats.

                             Effective Date

    The provision is effective for fuel sold after December 31, 
1997.

2. Create Intercity Passenger Rail Fund (sec. 702 of the bill and new 
        sec. 9901 of the Code)

                              Present Law

    Separate Federal excise taxes are imposed on specified 
transportation motor fuels. Taxable fuels include gasoline, 
diesel fuel, and special motor fuels used for highway 
transportation, gasoline and diesel fuel used in motorboats, 
diesel fuel used in trains, fuels used in inland waterway 
transportation, and aviation fuel (gasoline and jet fuel). 
Motor fuels used by all of these transportation sectors are 
subject to a permanent 4.3-cents-per-gallon excise tax, enacted 
by the Omnibus Budget Reconciliation Act of 1993. Revenues from 
the 4.3-cents-per-gallon excise tax are retained in the General 
Fund of the Treasury.
    The aggregate tax rate varies for each transportation 
sector. For example, diesel fuel used in trains is subject to 
an aggregate General Fund tax rate of 5.55 cents per gallon. 
Transportation sectors that benefit from Federal public works 
and environmental programs also are subject to additional tax 
rates (beyond the 4.3-cents-per-gallon General Fund rate) to 
finance Federal Trust Funds established as a financing source 
for those programs. All motor fuels excise taxes other than the 
4.3-cents-per-gallon General Fund excise tax are temporary 
(i.e., have scheduled expiration dates). Table 1, below, shows 
the tax rates applicable to various transportation sectors, by 
Trust Fund and General Fund component.

  Table 1.--Present-Law Federal Motor Fuels Excise Tax Rates on Various 
                         Transportation Sectors                         
                    [Rates shown in cents per gallon]                   
------------------------------------------------------------------------
                                                  General               
      Transportation sector         Trust fund      fund      Total tax 
------------------------------------------------------------------------
Highway Transportation:                                                 
    In general (trucks,                                                 
     automobiles):                                                      
      Gasoline...................         14.0          4.3         18.3
      Diesel fuel................         20.0          4.3         24.3
      Special motor fuels........         14.0          4.3         18.3
    Private intercity bus:                                              
      Gasoline...................          (*)          (*)          (*)
      Diesel fuel................          3.0          4.3          7.3
Rail Transportation..............          (*)         5.55         5.55
Water Transportation:                                                   
    Inland waterway..............         20.0          4.3         24.3
    Recreational boats:                                                 
      Gasoline...................         14.0          4.3         18.3
      Diesel fuel................          (*)      \52\(*)          (*)
Air Transportation:                                                     
    Commercial aviation..........          (*)          4.3          4.3
    Noncommercial aviation:                                             
      Gasoline...................         15.0          4.3         19.3
      Jet fuel...................         17.5          4.3        21.8 
------------------------------------------------------------------------
* No tax.                                                               

                           Reasons for Change

    The Committee believes that the provision of viable 
intercity passenger rail service is an important national 
objective. At present, that objective is threatened by capital 
needs of the principal passenger rail service provider. 
Accordingly, the bill provides for transfer of a portion of 
transportation motor fuels tax revenues to promote needed 
modernization of passenger rail service facilities.
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    \52\ A General Fund tax rate of 24.3 cents per gallon, enacted in 
1993 to be effective through December 31, 1999, was suspended through 
December 31, 1997, by the Small Business Job Protection Tax Act of 
1996. Another proposal in the Chairman's Mark would repeal this tax on 
diesel fuel used in recreational motorboats.
---------------------------------------------------------------------------

                        Explanation of Provision

Intercity Rail Fund provisions

    The bill establishes an Intercity Passenger Rail Fund (the 
``Rail Fund'') in the Internal Revenue Code. The Rail Fund will 
be financed with amounts equivalent to 0.5 cent per gallon of 
the excise taxes imposed on all gasoline, diesel fuel, special 
motor fuels, inland waterway fuels, and aviation fuels after 
September 30, 1997, and before April 16, 2001.
    Amounts deposited in the Rail Fund are divided between 
Amtrak and States not receiving Amtrak passenger rail service 
to finance obligations incurred after September 30, 1997, and 
before April 16, 2001. Although transfers to the Rail Fund and 
authority to enter into new obligations would terminate after 
April 15, 2001, monies deposited in the Fund will remain 
available to satisfy outstanding obligations.
    Each State not receiving Amtrak rail service will receive 
an allocation each fiscal year not exceeding one percent of the 
lesser of (1) Rail Fund revenues for the year or (2) the 
aggregate amount appropriated from the Rail Fund for the year. 
Allocations to these non- Amtrak States will be pro-rated on a 
monthly basis if Amtrak service is provided in the State during 
a portion of a fiscal year. Non-Amtrak States may use the 
amounts they receive for capital improvements and maintenance 
expenditures related to intercity passenger rail and bus 
service provided within their respective jurisdictions 
(including purchase of intercity passenger rail services from 
Amtrak) and certified by the Department of Transportation as 
eligible. The balance of the Rail Fund revenues are available, 
as certified by the Department of Transportation, to Amtrak for 
financing capital improvements, including equipment, rolling 
stock, and maintenance facilities, as well as for maintenance 
of existing equipment.
    Pursuant to section 207 of H. Con. Res. 84, of the total 
revenues raised in the bill, the amounts equal to the amounts 
deposited in the Intercity Passenger Rail Fund each year, are 
dedicated to finance that Fund.

Tax treatment of Rail Fund expenditures

    Amounts received from the Rail Fund by Amtrak and other 
taxable entities are not included in gross income when 
received. However, the basis of any property financed with 
themonies will be reduced by the tax-free amounts received, and no 
deduction will be allowed for any expenditures attributable to those 
amounts.

                             Effective Date

    The provision is effective on October 1, 1997.

3. Provide a lower rate of alcohol excise tax on certain hard ciders 
        (sec. 703 and sec. 5041 of the Code)

                              Present Law

    Distilled spirits are taxed at a rate of $13.50 per proof 
gallon; beer is taxed at a rate of $18 per barrel 
(approximately 58 cents per gallon); and still wines of 14 
percent alcohol or less are taxed at a rate of $1.07 per wine 
gallon. Higher rates of tax are applied to wines with greater 
alcohol content and sparkling wines.
    Certain small wineries may claim a credit against the 
excise tax on wine of 90 cents per wine gallon on the first 
100,000 gallons of wine produced annually. Certain small 
breweries pay a reduced tax of $7.00 per barrel (approximately 
22.6 cents per gallon) on the first 60,000 barrels of beer 
produced annually.
    Apple cider containing alcohol (``hard cider'') is 
classified and taxed as wine.

                           Reasons for Change

    The Committee understands that as an alcoholic beverage, 
hard cider competes more as a substitute for beer than as a 
substitute for table wine. If most consumers of alcoholic 
beverages choose between hard cider and beer, rather than 
between hard cider and wine, taxing hard cider at tax rates 
imposed on other wine products may distort consumer choice and 
unfairly disadvantage producers of hard cider in the market 
place. The Committee also understands that producers of hard 
cider generally are small businesses and has concluded that it 
would improve market efficiency and fairness to tax this 
beverage at a rate equivalent to the tax imposed on the 
production of beer by small brewers.

                        Explanation of Provision

    The bill adjusts the tax rate on apple cider having an 
alcohol content of no more than seven percent to 22.6 cents per 
gallon for those persons who produce more than 100,000 gallons 
of apple cider during a calendar year. The tax rate applicable 
to apple cider produced by persons who produce 100,000 gallons 
or less in a calendar year will remain as under present law and 
those persons may continue to claim the credit permitted for 
small wineries. Apple cider production will continue to be 
counted in determining whether other production of a producer 
qualifies for the tax credit for small producers. The bill does 
not change the classification of qualifying apple cider as 
wine.

                             Effective Date

    The provision is effective for hard cider removed after 
September 30, 1997.

4. Transfer of General Fund highway fuels tax to the Highway Trust Fund 
        (sec. 704 of the bill and sec. 9503 of the Code)

                              Present Law

    Federal excise taxes are imposed on highway motor fuels to 
finance the Highway Trust Fund (currently, through September 
30, 1999): 14 cents per gallon on highway gasoline and special 
motor fuels, 20 cents per gallon on highway diesel fuel, and 3 
cents per gallon on diesel fuel used by intercity buses. Buses 
pay no Federal gasoline tax. Reduced tax rates apply to ethanol 
and methanol fuels. In addition, a permanent General Fund tax 
of 4.3 cents per gallon applies to highway and other motor 
fuels (other than intercity bus gasoline and recreational 
motorboat diesel fuels, which are not subject to the tax, and 
rail diesel fuel, which pays a General Fund tax of 5.55 cents 
per gallon).
    Amounts equivalent to 2 cents per gallon of the Highway 
Trust Fund motor fuels tax revenues are credited to the Mass 
Transit Account of the Trust Fund for capital-related 
expenditures on mass transit programs; the balance of the 
highway motor fuels tax revenues are credited to the Highway 
Account of the Trust Fund for highway-related programs 
generally.
    Transfers are made from the Highway Trust Fund of up to $70 
million per fiscal year (through September 30, 1997) to the 
Boat Safety Account of the Aquatic Resources Trust Fund of 
amounts equivalent to 11.5 cents per gallon from recreational 
motorboat gasoline and special motor fuels revenues, plus up to 
$1 million per fiscal year to the Land and Water Conservation 
Fund. Any excess revenues attributable to the tax on motorboat 
fuels is to be transferred from the Highway Trust Fund to the 
Sport Fish Restoration Account in the Aquatic Resources Trust 
Fund.

                           Reasons for Change

    The Committee determined that the balance of the existing 
General Fund excise tax on highway fuels, after the transfer of 
0.5 cent per gallon to the new Intercity Passenger Rail Fund 
established under section 702 of this bill, should be 
transferred to the Highway Trust Fund to ensure that more funds 
will be available for needed Highway Trust Fund programs in the 
future. It is widely suggested by transportation officials and 
users that there is an urgent need for improved and enhanced 
highway and transit systems in the nation to meet the needs of 
a growing transportation system.

                        Explanation of Provision

    The bill transfers the existing General Fund excise tax of 
4.3 cents per gallon on motor fuels used in highway 
transportation to the Highway Trust Fund, beginning on October 
1, 1997, except for the temporary transfer of the 0.5 cent per 
gallon that will go to the Intercity PassengerRail Fund under 
section 702 of the bill for the period October 1, 1997 through April 
15, 2001. Of the amounts transferred to the Highway Trust fund (3.8 
cents or 4.3 cents), 20 percent is to go to the Mass Transit Account 
and 80 percent to the Highway Account.
    The increased deposits to the Highway Trust Fund may not be 
used to cause an increase in the allocations under section 157 
of Title 23 of the U.S. Code or any other increase beyond in 
direct spending other than by enactment of future legislation 
in compliance with the Budget Enforcement Act.

                             Effective Date

    The provision is effective on October 1, 1997.

5. Tax certain alternative fuels based on energy equivalency to 
        gasoline (sec. 705 of the bill and sec. 4041 of the Code)

                              Present Law

    Excise taxes are imposed on gasoline, diesel fuel, and 
special motor fuels used in highway vehicles. 4.3 cents per 
gallon of each of these taxes is retained in the General Fund, 
with the balance of the revenues being dedicated to one or more 
Trust Funds. The tax on gasoline is 18.3 cents per gallon; the 
tax on diesel fuel is 24.3 cents per gallon; and the tax on 
special motor fuels generally is 18.3 cents per gallon. Taxable 
special motor fuels include liquefied petroleum gas 
(``propane''), liquefied natural gas (``LNG''), methanol from 
natural gas, and compressed natural gas (``CNG''). Special 
rates apply to methanol from natural gas (exempt from 7 cents 
of the 14-cents-per-gallon Highway Trust Fund component of the 
special motor fuels tax), and compressed natural gas (exempt 
from the entire Highway Trust Fund component of the tax).
    In general, these four special motor fuels contain less 
energy (i.e., fewer Btu's) per gallon than does gasoline.

                           Reasons for Change

    The largest portion of the excise tax on propane, LNG, and 
methanol from natural gas is imposed to finance Federal highway 
programs through the Highway Trust Fund. A basic principle of 
the highway taxes is that users of the highway system should be 
taxed in relation to their use of the system. Adjusting the tax 
rates on these three special motor fuels is consistent with 
that principle because consumers must purchase more gallons of 
these lower-energy-content fuels than gallons of gasoline to 
travel the same number of miles.

                        Explanation of Provision

    The tax rates on propane, LNG, and methanol from natural 
gas are adjusted to reflect the respective energy equivalence 
of the fuels to gasoline. The revised tax rates on these fuels 
are: propane, 13.6 cents per gallon; LNG 11.9 cents per gallon, 
and methanol from natural gas, 9.15 cents per gallon.

                             Effective Date

    The provision is effective for fuels sold or used after 
September 30, 1997.

6. Study feasibility of moving collection point for distilled spirits 
        excise tax (sec. 706 of the bill)

                              Present Law

    Distilled spirits are subject to tax at $13.50 per proof 
gallon. (A proof gallon is a liquid gallon consisting of 50 
percent alcohol.) In the case of domestically produced 
distilled spirits and distilled spirits imported in to the 
United States in bulk containers for domestic bottling, the tax 
is imposed on removal of the beverage from the distillery 
(without regard to whether a sale occurs at that time). Bottled 
distilled spirits that are imported into the United States 
comprise approximately 15 percent of the current market for 
these beverages; tax is imposed on these imports when the 
distilled spirits are removed from the first customs bonded 
warehouse in which they are deposited upon entry into the 
United States.
    In the case of certain distilled spirits products, a tax 
credit for alcohol derived from fruit is allowed. This credit 
reduces the effective tax paid on those beverages. The credit 
is determined when the tax is paid (i.e., at the distillery or 
on importation).

                        Explanation of Provision

    The Treasury Department is directed to study options for 
changing the point at which the distilled spirits excise tax is 
collected. One of the options evaluated should be collecting 
the tax at the point at which the distilled spirits are removed 
from registered wholesale warehouses. As part of this study, 
the Treasury is to focus on administrative issues associated 
with the identified options, including the effects on tax 
compliance. For example, the Treasury is to evaluate the actual 
compliance record of wholesale dealers that currently paid the 
excise tax on imported bottled distilled spirits, and the 
compliance effects of allowing additional wholesale dealers to 
be distilled spirts taxpayers. The study also is to address the 
number of taxpayers involved, the types of financial 
responsibility requirements that might be needed, any special 
requirements regarding segregation of non-tax-paid distilled 
spirits from other products carried by the potential new 
taxpayers. The study further is to review the effects of the 
options on Treasury staffing and other budgetary resources as 
well as projections of the time between when tax currently is 
collected and the time when tax otherwise would be collected.
    The study is required to be completed and transmitted to 
the Committee on Finance and the Committee on Ways and Means no 
later than January 31, 1998.

7. Extend and modify tax benefits for ethanol (sec. 707 of the bill and 
        secs. 40, 4041, 4081, 4091, and 6427 of the Code)

                              Present Law

    Present law provides a 54-cents-per-gallon income tax 
credit for ethanol and a 60-cents-per-gallon income tax credit 
for methanol produced from renewable sources (e.g., biomass) 
that are used as a motor fuel or that are blended with other 
fuels (e.g., gasoline) for such a use. As an alternative to 
claiming the income tax credits directly, these tax benefits 
may be claimed as a reduction in the amount of excise tax paid 
on gasoline or diesel fuel with which the ethanol or renewable 
source methanol are blended or as a reduction in the special 
motor fuels rate applicable to ``neat'' ethanol or renewable 
source methanol fuels. The excise tax delivery of the benefits 
occurs either through reduced tax rate sales to registered 
blenders of e.g., gasoline or diesel fuel, or through expedited 
refunds of gasoline or diesel fuel tax paid.
    In addition to these general ethanol benefits, a separate 
10-cents-per-gallon credit is provided for small ethanol 
producers, defined generally as persons whose production does 
not exceed 15 million gallons per year and whose production 
capacity does not exceed 30 million gallons per year. No 
comparable small producer credit is provided for small 
renewable source methanol producers.
    Treasury Department regulations provide that ethyl tertiary 
butyl ether (``ETBE''), which is made using ethanol, qualifies 
for the blender income tax credit and the excise tax exemption.
    The alcohol fuels tax benefits are scheduled to expire 
after December 31, 2000. The provision allowing the ethanol 
blender benefits to be claimed through the motor fuels excise 
tax system is scheduled to expire after September 30, 2000.

                           Reasons for Change

    The Committee believes that continued assurance of tax 
benefits for ethanol are an important signal to encourage the 
use of alternative fuels.

                        Explanation of Provision

    The bill extends the 54-cents-per-gallon income tax credit 
for ethanol through December 31, 2007, and the excise tax 
provisions allowing that benefit to be claimed through reduced-
tax-rate gasoline sales (or expedited refunds of gasoline tax 
paid) through September 30, 2007. In addition, the bill phases 
down the rates of the benefits during the period 2001 through 
2007. Under the bill, the tax benefit per gallon of ethanol 
will be: 2001 and 2002--53 cents per gallon, 2003 and 2004--52 
cents per gallon, 2005, 2006, and 2007--51 cents per gallon.

                             Effective Date

    The provision is effective on the date of enactment.

8. Codify Treasury Department regulations regulating wine labels (sec. 
        708 of the bill and sec. 5388 of the Code)

                              Present Law

    The Code includes provisions regulating the labeling of 
wine when it is removed from a winery for marketing. In 
general, the regulations under these provisions allow the use 
of semi-generic names for wine that reflect geographic 
identifications understood in the industry, provided that the 
labels include clear indication of any deviation from that 
which is generally understood in the source of the grapes or 
the process by which the wine is produced.

                           Reasons for Change

    The Committee determined that the Treasury Department 
regulations governing the use of semi-generic designations such 
as ``Chablis'' and ``burgundy'' in wine labeling should be 
codified to add clarity to the existing Code provisions.

                        Explanation of Provision

    The current Treasury Department regulations governing the 
use of semi-generic wine designations which reflect geographic 
origin are codified into the Code's wine labeling provisions.

                             Effective Date

    The provision is effective on the date of enactment.

                   B. Provisions Relating to Pensions

1. Treatment of multiemployer plans under section 415 (sec. 711 of the 
        bill and sec. 415(b) of the Code)

                              Present Law

    Present law imposes limits on contributions and benefits 
under qualified plans based on the type of plan. In the case of 
defined benefit pension plans, the limit on the annual 
retirement benefit is the lesser of (1) 100 percent of 
compensation or (2) $125,000 (indexed for inflation).

                           Reasons for Change

    The limits on contributions and benefits create unique 
problems for multiemployer defined benefit pension plans.

                        Explanation of Provision

    The bill eliminates the application of the 100 percent of 
compensation limitation for multiemployer defined benefit 
pension plans. Such plans will only be subject to the dollar 
limitation.

                             Effective Date

    The provision is effective for years beginning after 
December 31, 1997.

2. Modification of partial termination rules (sec. 712 of the bill and 
        sec. 552 of the Deficit Reduction Act of 1984)

                              Present Law

    Under the Internal Revenue Code, pension plan benefits are 
required to become fully vested upon termination or partial 
termination of the plan. The plan document is required to 
contain a provision reflecting this rule. Under section 552 of 
the Deficit Reduction Act of 1984 (``DEFRA''), for purposes of 
this rule, a partial termination is treated as not occurring if 
(1) the partial termination is a result of a decline in plan 
participation which occurs by reason of the completion of the 
Trans-Alaska Oil Pipeline construction project and occurred 
after December 31, 1975, and before January 1, 1980, with 
respect to participants employed in Alaska; (2) no 
discrimination occurred with respect to the partial 
termination; and (3) it is established to the satisfaction of 
the Secretary of the Treasury that the benefits of the 
provision will not accrue to the employers under the plan.

                           Reasons for Change

    The Committee is concerned that section 552 of DEFRA has 
not operated as intended because of a conflict between section 
552 and the requirement that a plan document provide that plan 
benefits become nonforfeitable upon a full or partial plan 
termination. The Committee bill eliminates this conflict by 
clarifying that section 552 of DEFRA applies notwithstanding 
any other provision of law or of the plan or trust.

                        Explanation of Provision

    The bill clarifies that section 552 of DEFRA applies for 
the Code, any other provision of law, and any plan or trust 
provision.

                             Effective Date

    The provision is effective as if included in section 552 of 
DEFRA.

3. Increase in full funding limit (sec. 713 of the bill and sec. 412 of 
        the Code)

                              Present Law

    Under present law, defined benefit pension plans are 
subject to minimum funding requirements. In addition, there is 
a maximum limit on contributions that can be made to a plan, 
called the full funding limit. The full funding limit is the 
lesser of a plan's accrued liability and 150 percent of current 
liability. In general, current liability is all liabilities to 
plan participants and beneficiaries. Current liability 
represents benefits accrued to date, whereas the accrued 
liability full funding limit is based on projected benefits.

                           Reasons for Change

    The 150-percent of full funding limit was enacted to limit 
and allocate efficiently the Federal tax revenue associated 
with the special tax treatment provided to tax-qualified plans. 
However, the Committee believes that the 150-percent of current 
liability full funding limit unduly restricts funding.

                        Explanation of Provision

    The bill increases the 150-percent of full funding limit as 
follows: 155 percent for plan years beginning in 1999 or 2000, 
160 percent for plan years beginning in 2001 or 2002, 165 
percent for plan years beginning in 2003 and 2004, and 170 
percent for plan years beginning in 2005 and thereafter.

                             Effective Date

    The provision is effective for plan years beginning after 
December 31, 1998.

4. Spousal consent required for distributions from section 401(k) plans 
        (sec. 714 of the bill and secs. 411 and 417 of the Code)

                              Present Law

    Under present law, pension plans that provide automatic 
survivor benefits (i.e., joint and survivor annuities and 
preretirement survivor annuities) require spousal consent to 
the payment of a participant's benefit in a form other than a 
survivor annuity. A qualified cash or deferred arrangement (a 
``section 401(k) plan'') is not subject to the automatic 
survivor benefit rules if the plan provides that the spouse of 
a participant is the beneficiary of the participant's entire 
account under the plan, the participant's benefit is not paid 
in the form or an annuity, and the participant's account does 
not include amounts transferred from another plan that was 
subject to the automatic survivor benefit rules. In general, 
spousal consent is not required for an involuntary cash-out of 
a participant's benefit or distributions made to satisfy the 
minimum distribution rules.

                           Reasons for Change

    The Committee believes that spouses of participants in 
401(k) plans who are entitled to benefits under the plan should 
be afforded similar protection as spouses in pension plans that 
provide automatic survivor benefits.

                        Explanation of Provision

    The bill provides that written spousal consent is required 
for all distributions, including plan loans, from plans 
containing a qualified cash or deferred arrangement. As under 
present law, spousal consent is not required for an involuntary 
cash-out of a participant's benefit or for the payment of 
distributions required under the minimum distribution rules. If 
spousal consent is not obtained, the benefit must be 
distributed in equal periodic payments over the life (or life 
expectancy) of the participant, the lives (or life 
expectancies) of the participant and beneficiary, or over a 
period of 10 years or more. A plan which complies with the 
spousal consent requirement will not be treated as failing to 
satisfy the anti-cutback rules related to optional forms of 
benefit. The bill also will make the corresponding changes to 
the Employment Income Security Act of 1974, as amended 
(``ERISA'').

                             Effective Date

    The provision is effective for plan years beginning after 
December 31, 1998.

5. Contributions on behalf of a minister to a church plan (sec. 715 of 
        the bill and sec. 414(e) of the Code)

                              Present Law

    Under present law, contributions made to retirement plans 
by ministers who are self-employed are deductible to the extent 
such contributions do no exceed certain limitations applicable 
to retirement plans. These limitations include the limit on 
elective deferrals, the exclusion allowance, and the limit on 
annual additions to a retirement plan.

                           Reasons for Change

    The Committee believes that the unique characteristics of 
church plans and the procedures associated with contributions 
made by ministers who are self-employed create particular 
problems with respect to plan administration.

                        Explanation of Provision

    The bill provides that in the case of a contribution made 
on behalf of a minister who is self-employed to a church plan, 
the contribution will be excludable from the income of the 
minister to the extent that the contribution would be 
excludable if the minister was an employee of a church and the 
contribution was made to the plan.

                             Effective Date

    The provision is effective for years beginning after 
December 31, 1997.

6. Exclusion of ministers from discrimination testing of certain non-
        church retirement plans (sec. 715 of the bill and sec. 414(e) 
        of the Code)

                              Present Law

    Under present law ministers who are employed by an 
organization other than a church are treated as if employed by 
the church and may participate in the retirement plan sponsored 
by the church. If the organization also sponsors a retirement 
plan, such plan does not have to include the ministers as 
employees for purposes of satisfying the nondiscrimination 
rules applicable to qualified plans provided the organization 
is not eligible to participate in the church plan.

                           Reasons for Change

    The Committee believes it is appropriate to extend the same 
relief to other non-church organizations that may be eligible 
to participate in a church plan but elect not to do so. Such 
organizations will not be required to treat ministers as 
employees for purposes of satisfying the nondiscrimination 
rules applicable to their retirement plan.

                        Explanation of Provision

    The bill provides that if a minister is employed by an 
organization other than a church and the organization is not 
otherwise participating in the church plan then, the minister 
does not have to be included as an employee under the 
retirement plan of the organization for purposes of the 
nondiscrimination rules.

                             Effective Date

    The provision is effective for years beginning after 
December 31, 1997.

7. Repeal application of UBIT to ESOPs of S corporations (sec. 716 of 
        the bill and sec. 512 of the Code)

                              Present Law

    Under present law, for taxable years beginning after 
December 31, 1997, certain tax-exempt organizations, including 
employee stock ownership plans (``ESOPs'') can be a shareholder 
of an S corporation. Items of income or loss of the S 
corporation will flow through to qualified tax-exempt 
shareholders as unrelated business taxable income (``UBTI''), 
regardless of the source of the income.

                           Reasons for Change

    The Committee believes that treating S corporation income 
as UBTI is not appropriate because such amounts would be 
subject to tax at the ESOP level, and also again when benefits 
are distributed to ESOP participants.

                        Explanation of Provision

    The bill repeals the provision treating items of income or 
loss of an S corporation as unrelated business taxable income 
in the case of an employee stock ownership plan that is an S 
corporation shareholder.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

                  C. Provisions Relating to Disasters

1. Treatment of livestock sold on account of weather-related conditions 
        (sec. 721 of the bill and secs. 451 and 1033 of the Code)

                              Present Law

    In general, cash-method taxpayers report income in the year 
it is actually or constructively received. However, present law 
contains two special rules applicable to livestock sold on 
account of drought conditions. Code section 451(e) provides 
that a cash-method taxpayer whose principal trade or business 
is farming who is forced to sell livestock due to drought 
conditions may elect to include income from the sale of the 
livestock in the taxable year following the taxable year of the 
sale. This elective deferral of income is available only if the 
taxpayer establishes that, under the taxpayer's usual business 
practices, the sale would not have occurred but for drought 
conditions that resulted in the area being designated as 
eligible for Federal assistance. This exception is generally 
intended to put taxpayers who receive an unusually high amount 
of income in one year in the position they would have been in 
absent the drought.
    In addition, the sale of livestock (other than poultry) 
that is held for draft, breeding, or dairy purposes in excess 
of the number of livestock that would have been sold but for 
drought conditions is treated as an involuntary conversion 
under section 1033(e). Consequently, gain from the sale of such 
livestock could be deferred by reinvesting the proceeds of the 
sale in similar property within a two-year period.

                           Reasons for Change

    The Committee believes that the present-law exceptions to 
gain recognition for livestock sold on account of drought 
should apply to livestock sold on account of floods and other 
weather-related conditions as well.

                        Explanation of Provision

    The bill amends Code section 451(e) to provide that a cash-
method taxpayer whose principal trade or business is farming 
and who is forced to sell livestock due not only to drought (as 
under present law), but also to floods or other weather-related 
conditions, may elect to include income from the sale of the 
livestock in the taxable year following the taxable year of the 
sale. This elective deferral of income is available only if the 
taxpayer establishes that, under the taxpayer's usual business 
practices, the sale would not have occurred but for the 
drought, flood or other weather-related conditions that 
resulted in the area being designated as eligible for Federal 
assistance.
    In addition, the bill amends Code section 1033(e) to 
provide that the sale of livestock (other than poultry) that 
are held for draft, breeding, or dairy purposes in excess of 
the number of livestock that would have been sold but for 
drought (as under present law), flood or other weather-related 
conditions is treated as an involuntary conversion.

                             Effective Date

    The provision applies to sales and exchanges after December 
31, 1996.

2. Rules relating to denial of earned income credit on basis of 
        disqualified income (sec. 722 of the bill and sec. 32(i) of the 
        Code)

                              Present Law

    For taxable years beginning after December 31, 1995, an 
individual is not eligible for the earned income credit if the 
aggregate amount of ``disqualified income'' of the taxpayer for 
the taxable year exceeds $2,200. This threshold is indexed for 
inflation. Disqualified income is the sum of:
          (1) interest (taxable and tax-exempt);
          (2) dividends;
          (3) net rent and royalty income (if greater than 
        zero);
          (4) capital gain net income and;
          (5) net passive income (if greater than zero) that is 
        not self-employment income.

                           Reasons for Change

    The Committee believes that lower-income farmers should not 
be disqualified from the earned income credit due to certain 
sales of livestock.

                        Explanation of Provision

    The bill clarifies that gain or loss from the sale of 
livestock (as defined under section 1231(b)(3) of the Code) is 
disregarded for purposes of the calculation of capital gain net 
income under the disqualified income test of the earned income 
credit.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1995.

3. Mortgage financing for residences located in Presidentially declared 
        disaster areas (sec. 723 of the bill and sec. 143 of the Code)

                              Present Law

    Qualified mortgage bonds are private activity tax-exempt 
bonds issued by States and local governments acting as conduits 
to provide mortgage loans to first-time home buyers who satisfy 
specified income limits and who purchase homes that cost less 
than statutory maximums.
    Present law waives the three buyer targeting requirements 
for a portion of the loans made with proceeds of a qualified 
mortgage bond issue if the loans are made to finance homes in 
statutorily prescribed economically distressed areas.

                           Reasons for Change

    The Committee believes that availability of mortgage 
subsidy financing may help survivors of Presidentially declared 
disasters rebuild their homes.

                        Explanation of Provision

    The bill waives the first time homebuyer requirement, the 
income limits, and the purchase price limits for loans to 
finance homes in certain Presidentially declared disaster 
areas. The waiver applies only during the one-year period 
following the date of the disaster declaration.

                             Effective Date

    The provision applies to loans financed with bonds issued 
after December 31, 1996, and before January 1, 1999.

                D. Provisions Relating to Small Business

1. Delay imposition of penalties for failure to make payments 
        electronically through EFTPS until after June 30, 1998 (sec. 
        731 of the bill and sec. 6302 of the Code)

                              Present Law

    Employers are required to withhold income taxes and FICA 
taxes from wages paid to their employees. Employers also are 
liable for their portion of FICA taxes, excise taxes, and 
estimated payments of their corporate income tax liability.
    The Code requires the development and implementation of an 
electronic fund transfer system to remit these taxes and convey 
deposit information directly to the Treasury (Code sec. 6302(h) 
53). The Electronic Federal Tax Payment System 
(``EFTPS'') was developed by Treasury in response to this 
requirement.\54\ Employers must enroll with one of two private 
contractors hired by the Treasury. After enrollment, employers 
generally initiate deposits either by telephone or by computer.
---------------------------------------------------------------------------
    \53\ This requirement was enacted in 1993 (sec. 523 of P.L. 103-
182).
    \54\ Treasury had earlier developed TAXLINK as the prototype for 
EFTPS. TAXLINK has been operational for several years; EFTPS is 
currently operational. Employers currently using TAXLINK will 
ultimately be required to participate in EFTPS.
---------------------------------------------------------------------------
    The new system is phased in over a period of years by 
increasing each year the percentage of total taxes subject to 
the new EFTPS system. For fiscal year 1994, 3 percent of the 
total taxes are required to be made by electronic fund 
transfer. These percentages increased gradually for fiscal 
years 1995 and 1996. For fiscal year 1996, the percentage was 
20.1 percent (30 percent for excise taxes and corporate 
estimated tax payments). For fiscal year 1997, these 
percentages increased significantly, to 58.3 percent (60 
percent for excise taxes and corporate estimated tax payments). 
The specific implementation method required to achieve the 
target percentages is set forth in Treasury regulations. 
Implementation began with the largest depositors.
    Treasury had originally implemented the 1997 percentages by 
requiring that all employers who deposit more than $50,000 in 
1995 must begin using EFTPS by January 1, 1997. The Small 
Business Job Protection Act of 1996 provided that the increase 
in the required percentages for fiscal year 1997 (which, 
pursuant to Treasury regulations, was to take effect on January 
1, 1997) will not take effect until July 1, 1997.\55\ This was 
done to provide additional time prior to implementation of the 
1997 requirements so that employers could be better informed 
about their responsibilities.
---------------------------------------------------------------------------
    \55\ Sec. 1809 of P.L. 104-188.
---------------------------------------------------------------------------
    On June 2, 1997, the IRS announced 56 that it 
will not impose penalties through December 31, 1997, on 
businesses that make timely deposits using paper federal tax 
deposit coupons while converting to the EFTPS system.
---------------------------------------------------------------------------
    \56\ IR-97-32.
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that it is necessary to provide 
small businesses with additional time prior to implementation 
of the requirements so that these employers may be better 
informed about their responsibilities.

                        Explanation of Provision

    The bill provides that no penalty shall be imposed solely 
by reason of a failure to use EFTPS prior to July 1, 1998, if 
the taxpayer was first required to use the EFTPS system on or 
after July 1, 1997.

                             Effective Date

    The provision is effective on the date of enactment.

2. Repeal installment method adjustment for farmers (sec. 732 of the 
        bill and sec. 56 of the Code)

                              Present Law

    The installment method allows gain on the sale of property 
to be recognized as payments are received. Under the regular 
tax, dealers in personal property are not allowed to defer the 
recognition of income by use of the installment method on the 
installment sale of such property. For this purpose, dealer 
dispositions do not include sales of any property used or 
produced in the trade or business of farming. For alternative 
minimum tax purposes, the installment method is not available 
with respect to the disposition of any property that is the 
stock in trade of the taxpayer or any other property of a kind 
which would be properly included in the inventory of the 
taxpayer if held at year end, or property held by the taxpayer 
primarily for sale to customers. No explicit exception is 
provided for installment sales of farm property under the 
alternative minimum tax.

                           Reasons for Change

    The Committee understands that the Internal Revenue Service 
(``IRS'') takes the position that the installment method may 
not be used for sales of property produced on a farm for 
alternative minimum tax purposes. The Committee further 
understands that the IRS has announced that it generally will 
not enforce this position for taxable years beginning before 
January 1, 1997, so long as the farmer changes its method of 
accounting for installment sales for taxable years beginning 
after December 31, 1996.\57\ The Committee disagrees with the 
IRS position and believes that this issue should be clarified 
in favor of the farmer.
---------------------------------------------------------------------------
    \57\ Notice 97-13, January 28, 1997.
---------------------------------------------------------------------------

                        Explanation of Provision

    The bill generally provides that for purposes of computing 
alternative minimum taxable income, taxpayers may use the 
installment method of accounting.

                             Effective Date

    The provision generally is effective for dispositions in 
taxable years beginning after December 31, 1987.

                       E. Foreign Tax Provisions

1. Eligibility of licenses of computer software for foreign sales 
        corporation benefits (sec. 741 of the bill and sec. 927 of the 
        Code)

                              Present Law

    Under special tax provisions that provide an export 
benefit, a portion of the foreign trade income of an eligible 
foreign sales corporation (``FSC'') is exempt from Federal 
income tax. Foreign trade income is defined as the gross income 
of a FSC that is attributable to foreign trading gross 
receipts. The term ``foreign trading gross receipts'' includes 
the gross receipts of a FSC from the sale, lease, or rental of 
export property and from services related and subsidiary to 
such sales, leases, or rentals.
    For purposes of the FSC rules, export property is defined 
as property (1) which is manufactured, produced, grown, or 
extracted in the United States by a person other than a FSC; 
(2) which is held primarily for sale, lease, or rental in the 
ordinary conduct of a trade or business by or to a FSC for 
direct use, consumption, or disposition outside the United 
States; and (3) not more than 50 percent of the fair market 
value of which is attributable to articles imported into the 
United States. Intangible property generally is excluded from 
the definition of export property for purposes of the FSC 
rules; this exclusion applies to copyrights other than films, 
tapes, records, or similar reproductions for commercial or home 
use. The temporary Treasury regulations provide that a license 
of a master recording tape for reproduction outside the United 
States is not excluded from the definition of export property 
(Treas. Reg. sec. 1.927(a)-1T(f)(3)). The statutory exclusion 
for intangible property does not contain any specific reference 
to computer software. However, the temporary Treasury 
regulations provide that a copyright on computer software does 
not constitute export property, and that standardized, mass 
marketed computer software constitutes export property if such 
software is not accompanied by a right to reproduce for 
external use (Treas. Reg. sec. 1.927(a)-1T(f)(3)).

                           Reasons for Change

    For purposes of the FSC provisions, films, tapes, records 
and similar reproductions explicitly are included within the 
definition of export property. In light of technological 
developments, the Committee believes that computer software is 
virtually indistinguishable from the enumerated films, tapes, 
and records. Accordingly, the Committee believes that the 
benefits of the FSC provisions similarly should be available to 
computer software.

                        Explanation of Provision

    The bill provides that computer software licensed for 
reproduction abroad is not excluded from the definition of 
export property for purposes of the FSC provisions. 
Accordingly, computer software that is exported with a right to 
reproduce is eligible for the benefits of the FSC provisions. 
In light of the rapid innovations in the computer and software 
industries, the Committee intends that the term ``computer 
software'' be construed broadly to accommodate technological 
changes in the products produced by both industries. No 
inference is intended regarding the qualification as export 
property of computer software licensed for reproduction abroad 
under present law.

                             Effective Date

    The provision applies to gross receipts from computer 
software licenses attributable to periods after December 31, 
1997. Accordingly, in the case of a multi-year license, the 
provision applies to gross receipts attributable to the period 
of such license that is after December 31, 1997.

2. Regulations to limit treaty benefits for payments to hybrid entities 
        (sec. 742 of the bill and sec. 894 of the Code)

                              Present Law

    Nonresident alien individuals and foreign corporations 
(collectively, foreign persons) that are engaged in business in 
the United States are subject to U.S. tax on the income from 
such business in the same manner as a U.S. person. In addition, 
the United States imposes tax on certain types of U.S. source 
income, including interest, dividends and royalties, of foreign 
persons not engaged in business in the United States. Such tax 
is imposed on a gross basis and is collected through 
withholding. The statutory rate of this withholding tax is 30 
percent. However, most U.S. income tax treaties provide for a 
reduction in the rate, or elimination, of this withholding tax. 
Treaties generally provide for different applicable withholding 
tax rates for different types of income. Moreover, the 
applicable withholding tax rates differ among treaties. The 
specific withholding tax rates pursuant to a treaty are the 
result of negotiations between the United States and the treaty 
partner.
    The application of the withholding tax is more complicated 
in the case of income derived through an entity, such as a 
limited liability company, that is treated as a partnership for 
U.S. tax purposes but may be treated as a corporation for 
purposes of the tax laws of a treaty partner. The Treasury 
regulations include specific rules that apply in the case of 
income derived through an entity that is treated as a 
partnership for U.S. tax purposes. In the case of a payment of 
an item of U.S. source income to a U.S. partnership, the 
partnership is required to impose the withholding tax to the 
extent the item of income is includible in the distributive 
share of a partner who is a foreign person. Tax-avoidance 
opportunities may arise in applying the reduced rates of 
withholding tax provided under a treaty to cases involving 
income derived through a limited liability company or other 
hybrid entity (e.g., an entity that is treated as a partnership 
for U.S. tax purposes but as a corporation for purposes of the 
treaty partner's tax laws). Regulations that have been proposed 
but not yet finalized would address certain aspects of this 
issue in the case of an item received by a foreign entity by 
allowing an interest holder in that entity to claim a reduced 
rate of withholding tax with respect to that item under a 
treaty only if the treaty partner requires the interest holder 
to include in income its distributive share of the entity's 
income on a flow-through basis (Prop. Treas. Reg. Sec. 1.1441-
6(b)(4)). This provision in the proposed regulations does not 
apply in the case of a U.S. entity.

                           Reasons for Change

    The Committee is concerned about the potential tax-
avoidance opportunities available for foreign persons that 
invest in the United States through hybrid entities. In 
particular, the Committee understands that the interaction of 
the tax laws and the applicable tax treaty may provide a 
business structuring opportunity that would allow foreign 
corporations with U.S. subsidiaries to avoid both U.S. and 
foreign income taxes with respect to those U.S. operations. The 
Committee believes that the Secretary of the Treasury should 
prescribe regulations to eliminate such tax-avoidance 
opportunities.

                        Explanation of Provision

    The bill provides that the Secretary of the Treasury shall 
prescribe regulations to determine the extent to which a 
taxpayer shall be denied benefits under an income tax treaty of 
the United States with respect to any payment received by, or 
income attributable to activities of, an entity that is treated 
as a partnership for U.S. federal income tax purposes (or is 
otherwise treated as fiscally transparent for such purposes) 
but is treated as fiscally non-transparent for purposes of the 
tax laws of the jurisdiction of residence of the taxpayer.
    The bill addresses the potential tax-avoidance opportunity 
that may arise in applying the reduced rates of withholding tax 
provided under a treaty to cases involving income derived 
through a limited liability company or other hybrid entity 
(e.g., an entity that is treated as a partnership for U.S. tax 
purposes but as a corporation for purposes of the treaty 
partner's tax laws). Such a tax-avoidance opportunity may 
arise, for example, for Canadian corporations with U.S. 
subsidiaries because of the interaction between the U.S. tax 
law, the Canadian tax law, and the income tax treaty between 
the United States and Canada. Through the use of a U.S. limited 
liability company, which is treated as a partnership for U.S. 
tax purposes but as a corporation for Canadian tax purposes, a 
payment of interest (which is deductible for U.S. tax purposes) 
may be converted into a dividend (which is excludable for 
Canadian tax purposes). Accordingly, interest paid by a U.S. 
subsidiary through a U.S. limited liability company to a 
Canadian parent corporation would be deducted by the U.S. 
subsidiary for U.S. tax purposes and would be excluded by the 
Canadian parent corporation for Canadian tax purposes; the only 
tax on such interest would be a U.S. withholding tax, which may 
be imposed at a reduced rate of 10 percent (rather than the 
full statutory rate of 30 percent) pursuant to the income tax 
treaty between the United States and Canada. It is expected 
that the regulations will impose withholding tax at the full 
statutory rate of 30 percent in such case.

                             Effective Date

    The provision is effective upon date of enactment.

   3. Treatment of certain securities positions under the subpart F 
investment in U.S. property rules (sec. 743 of the bill and sec. 956 of 
                               the Code)

                              Present Law

    Under the rules of subpart F (secs. 951-964), the U.S. 10-
percent shareholders of a controlled foreign corporation (CFC) 
are required to include in income currently for U.S. tax 
purposes certain earnings of the CFC, whether or not such 
earnings are distributed currently to the shareholders. The 
U.S. 10-percent shareholders of a CFC are subject to current 
U.S. tax on their shares of certain income earned by the CFC 
(referred to as ``subpart F income''). The U.S. 10-percent 
shareholders also are subject to current U.S. tax on their 
shares of the CFC's earnings to the extent invested by the CFC 
in certain U.S. property.
    A shareholder's current income inclusion with respect to a 
CFC's investment in U.S. property for a taxable year is based 
on the CFC's average investment in U.S. property for such year. 
For this purpose, the U.S. property held by the CFC must be 
measured as of the close of each quarter in the taxable year. 
U.S. property generally is defined to include tangible property 
located in the United States, stock of a U.S. corporation, 
obligations of a U.S. person, and the right to use certain 
intellectual property in the United States. Exceptions are 
provided for, among other things, obligations of the United 
States, U.S. bank deposits, certain trade or business 
obligations, and stock or debts of certain unrelated U.S. 
corporations.

                           Reasons for Change

    The Committee believes that guidance is needed regarding 
the treatment of certain transactions entered into by 
securities dealers in the ordinary course of business under the 
investment in U.S. property provisions of subpart F. The 
Committee believes that deposits of collateral or margin in the 
ordinary course of business should not give rise to an income 
inclusion as an investment in U.S. property under the 
provisions of subpart F. Similarly, the Committee believes that 
repurchase agreements entered into in the ordinary course of 
business should not give rise to an income inclusion as an 
investment in U.S. property.

                        Explanation of Provision

    The bill provides two additional exceptions from the 
definition of U.S. property for purposes of the subpart F 
rules. Both exceptions relate to transactions entered into by a 
securities or commodities dealer in the ordinary course of its 
business as a securities or commodities dealer.
    The first exception covers the deposit of collateral or 
margin by a securities or commodities dealer, or the receipt of 
such a deposit by a securities or commodities dealer, if such 
deposit is made or received on commercial terms in the ordinary 
course of the dealer's business as a securities or commodities 
dealer. This exception applies to deposits of margin or 
collateral for securities loans, notional principal contracts, 
options contracts, forward contracts, futures contracts, and 
any other financial transaction with respect to which the 
Secretary of the Treasury determines that the posting of 
collateral or margin is customary.
    The second exception covers repurchase agreement 
transactions and reverse repurchase agreement transactions 
entered into by or with a securities or commodities dealer in 
the ordinary course of its business as a securities or 
commodities dealer. The exception applies only to theextent 
that the obligation under the transaction does not exceed the fair 
market value of readily marketable securities transferred or otherwise 
posted as collateral.

                             Effective Date

    The provision is effective for taxable years of foreign 
corporations beginning after December 31, 1997, and taxable 
years of U.S. shareholders with or within which such taxable 
years of foreign corporations end.

4. Exception from foreign personal holding company income under subpart 
        F for active financing income (sec. 744 of the bill and sec. 
        954 of the Code)

                              Present Law

    Under the subpart F rules, certain 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, ``foreign personal holding 
company income'' and insurance income. The U.S. 10-percent 
shareholders of a CFC also are subject to current inclusion 
with respect to their shares of the CFC's foreign base company 
services income (i.e., income derived from services performed 
for a related person outside the country in which the CFC is 
organized).
    Foreign personal holding company income generally consists 
of the following: dividends, interest, royalties, rents and 
annuities; net gains from sales or exchanges of (1) property 
that gives rise to the preceding types of income, (2) property 
that does not give rise to income, and (3) interests in trusts, 
partnerships, and REMICs; net gains from commodities 
transactions; net gains from foreign currency transactions; and 
income that is equivalent to interest.
    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 (Prop. 
Treas. reg. sec. 1.953-1(a)). Investment income allocable to 
risks located within the CFC's country of organization 
generally is taxable as foreign personal holding company 
income.

                           Reasons for Change

    The subpart F rules historically have been aimed at 
requiring current inclusion by the U.S. shareholders of income 
of a CFC that is either passive or easily movable. Prior to the 
enactment of the 1986 Act, exceptions from foreign personal 
holding company income were provided for income derived in the 
conduct of a banking, financing, or similar business or derived 
from certain investments made by an insurance company. The 
Committee is concerned that the 1986 Act's repeal of these 
exceptions has resulted in the extension of the subpart F 
provisions to income that is neither passive nor easily 
moveable. The Committee believes that the provision of 
exceptions from foreign personal holding company income for 
income from the active conduct of an insurance, banking, 
financing or similar business is appropriate.

                        Explanation of Provision

    The bill provides a temporary exception from foreign 
personal holding company income for subpart F purposes for 
certain income that is derived in the active conduct of an 
insurance, banking, financing or similar business. Such 
exception is applicable only for taxable years beginning in 
1998.
    Under the bill, foreign personal holding company income 
does not include income that is derived in or incident to the 
active conduct of a banking, financing or similar business by a 
CFC that is predominantly engaged in the active conduct of such 
business. For this purpose, income derived in the active 
conduct of a banking, financing, or similar business generally 
is determined under the principles applicable in determining 
financial services income for foreign tax credit limitation 
purposes. Moreover, the Secretary of the Treasury shall 
prescribe regulations applying look-through treatment in 
characterizing for this purpose dividends, interest, income 
equivalent to interest, rents, and royalties from related 
persons. A CFC is considered to be predominantly engaged in the 
active conduct of a banking, financing, or similar business if 
(1) more than 70 percent of its gross income is derived from 
transactions with unrelated persons and more than 20 percent of 
its gross income from that business is derived from 
transactions with unrelated persons located within the country 
in which the CFC is organized or incorporated, or (2) the CFC 
is predominantly engaged in the active conduct of a banking or 
securities business, or is a qualified bank or securities 
affiliate, as defined for purposes of the passive foreign 
investment company provisions.
    Under the bill, foreign personal holding company income 
also does not include certain investment income of a qualifying 
insurance company with respect to risks located within the 
CFC's country of organization. These exceptions apply to income 
derived from investments of assets equal to the total of (1) 
unearned premiums and reserves ordinary and necessary for the 
proper conduct of the CFC's insurance business, (2) one-third 
of premiums earned during the taxable year on insurance 
contracts regulated in the country in which sold as property, 
casualty, or health insurance contracts, and (3) the greater of 
$10 million or 10 percent of reserves for insurance contracts 
regulated in the country in which sold as life insurance or 
annuity contracts. For this purpose, a qualifying insurance 
company is an entity that is subject to regulation as an 
insurance company under the laws of its country of 
incorporation and that realizes at least 50 percent of its 
gross income (other than income from investments) from premiums 
related to risks located within such country. The bill's 
exceptions for insurance investment income do not apply to 
investment income which is received by the CFC from a related 
person. Similarly, the exceptions do not apply to investment 
income that is attributable directly or indirectly to the 
insurance or reinsurance of risks of related persons. The bill 
does not change the rule of present law that investment income 
of a CFC that is attributable to the issuing or reinsuring 
anyinsurance or annuity contract related to risks outside of its 
country of organization is taxable as Subpart F insurance income.
    The bill also provides an exception from foreign base 
company services income for income derived from services 
performed in connection with the active conduct of a banking, 
financing, insurance or similar business by a CFC that is 
predominantly engaged in the active conduct of such business.

                             Effective Date

    The provision applies only to taxable years of foreign 
corporations beginning in 1998, and to taxable years of United 
States shareholders with or within which such taxable years of 
foreign corporations end.

5. Treat service income of nonresident alien individuals earned on 
        foreign ships as foreign source income and disregard the U.S. 
        presence of such individuals (sec. 745 of the bill and secs. 
        861, 863, 872, 3401, and 7701 of the Code)

                              Present Law

    Nonresident alien individuals generally are subject to U.S. 
taxation and withholding on their U.S. source income. 
Compensation for labor and personal services performed within 
the United States is considered U.S. source unless such income 
qualifies for a de minimis exception. To qualify for the 
exception, the compensation paid to a nonresident alien 
individual must not exceed $3,000, the compensation must 
reflect services performed on behalf of a foreign employer, and 
the individual must be present in the United Sates for not more 
than 90 days during the taxable year. Special rules apply to 
exclude certain items from the gross income of a nonresident 
alien. An exclusion applies to gross income derived by a 
nonresident alien individual from the international operation 
of a ship if the country in which such individual is resident 
provides a reciprocal exemption for U.S. residents. However, 
this exclusion does not apply to income from personal services 
performed by an individual crew member on board a ship. 
Consequently, wages exceeding $3,000 in a taxable year that are 
earned by nonresident alien individual crew members of a 
foreign ship while the vessel is within U.S. territory are 
subject to income taxation by the United States.
    U.S. residents are subject to U.S. tax on their worldwide 
income. In general, a non-U.S. citizen is considered to be a 
resident of the United States if the individual (1) has entered 
the United States as a lawful permanent U.S. resident or (2) is 
present in the United States for 31 or more days during the 
current calendar year and has been present in the United States 
for a substantial period of time--183 or more days--during a 
three-year period computed by weighting toward the present year 
(the ``substantial presence test'). An individual generally 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 the day. Certain categories of individuals (e.g., 
foreign government employees and certain students) are not 
treated as U.S. residents even if they are present in the 
United States for the requisite period of time. Crew members of 
a foreign vessel who are on board the vessel while it is 
stationed within U.S. territorial waters are treated as present 
in the United States.

                           Reasons for Change

    The Committee understands that U.S. tax rules impose a 
significant compliance burden on nonresident alien individuals 
who are present in the United States for short periods of time 
as members of the regular crew of a foreign vessel and who may 
not be permitted to leave such vessel during those periods. The 
Committee believes that an exemption from U.S. tax is 
appropriate for the income earned by a nonresident alien 
individual from personal services performed as a member of the 
regular crew of a foreign vessel. Moreover, the Committee 
believes that such an individual's presence in the United 
States as a regular crew member of a foreign vessel should not 
be taken into account for purposes of determining whether the 
individual is treated as a resident alien for U.S. tax 
purposes.

                        Explanation of Provision

    The bill treats gross income of a nonresident alien 
individual, who is present in the United States as a member of 
the regular crew of a foreign vessel, from the performance of 
personal services in connection with the international 
operation of a ship as income from foreign sources. Thus, such 
income is exempt from U.S. income and withholding tax. However, 
such persons are not excluded for purposes of applying the 
minimum participation standards of section 410 to a plan of the 
employer. In addition, for purposes of determining whether an 
individual is a U.S. resident under the substantial presence 
test, the bill provides that the days that such individual is 
present as a member of the regular crew of a foreign vessel are 
disregarded.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

6. Modification of passive foreign investment company provisions to 
        eliminate overlap with subpart F and to allow mark-to-market 
        election (secs. 751-753 of the bill and secs. 1291-1297 of the 
        Code)

                              Present Law

Overview

    U.S. citizens and residents and U.S. corporations 
(collectively, ``U.S. persons'') are taxed currently by the 
United States on their worldwide income, subject to a credit 
against U.S. tax on foreign income based on foreign income 
taxes paid with respect to such income. A foreign corporation 
generally is not subject to U.S. tax on its income from 
operations outside the United States.
    Income of a foreign corporation generally is taxed by the 
United States when it is repatriated to the United States 
through payment to the corporation's U.S. shareholders, subject 
to a foreign tax credit. However, a variety of regimes imposing 
current U.S. tax on income earned through a foreign corporation 
have been reflected in the Code. Today the principal anti-
deferral regimes set forth in the Code are the controlled 
foreign corporation rules of subpart F (secs. 951-964) and the 
passive foreign investment company rules (secs. 1291-1297). 
Additional anti-deferral regimes set forth in the Code are the 
foreign personal holding company rules (secs. 551-558); the 
personal holding company rules (secs. 541-547); the accumulated 
earnings tax (secs. 531-537); and the foreign investment 
company and electing foreign investment company rules (secs. 
1246-1247). The anti-deferral regimes included in the Code 
overlap such that a given taxpayer may be subject to multiple 
sets of anti-deferral rules.

Controlled foreign corporations

    A controlled foreign corporation (CFC) is defined generally 
as any foreign corporation if U.S. persons own more than 50 
percent of the corporation's stock (measured by vote or value), 
taking into account only those U.S. persons that own at least 
10 percent of the stock (measured by vote only) (sec. 957). 
Stock ownership includes not only stock owned directly, but 
also stock owned indirectly or constructively (sec. 958).
    Certain income of a CFC (referred to as ``subpart F 
income'') is subject to current U.S. tax. The United States 
generally taxes the U.S. 10-percent shareholders of a CFC 
currently on their pro rata shares of the subpart F income of 
the CFC. In effect, the Code treats those U.S. shareholders as 
having received a current distribution out of the CFC's subpart 
F income. Such shareholders also are subject to current U.S. 
tax on their pro rata shares of the CFC's earnings invested in 
U.S. property. The foreign tax credit may reduce the U.S. tax 
on these amounts.

Passive foreign investment companies

    The Tax Reform Act of 1986 established an anti-deferral 
regime for passive foreign investment companies (PFICs). A PFIC 
is any foreign corporation if (1) 75 percent or more of its 
gross income for the taxable year consists of passive income, 
or (2) 50 percent or more of the average fair market value of 
its assets consists of assets that produce, or are held for the 
production of, passive income. Two alternative sets of income 
inclusion rules apply to U.S. persons that are shareholders in 
a PFIC. One set of rules applies to PFICs that are ``qualified 
electing funds,'' under which electing U.S. shareholders 
include currently in gross income their respective shares of 
the PFIC's total earnings, with a separate election to defer 
payment of tax, subject to an interest charge, on income not 
currently received. The second set of rules applies to PFICs 
that are not qualified electing funds (``nonqualified funds''), 
under which the U.S. shareholders pay tax on income realized 
from the PFIC and an interest charge that is attributable to 
the value of deferral.

Overlap between subpart F and the PFIC provisions

    A foreign corporation that is a CFC is also a PFIC if it 
meets the passive income test or the passive asset test 
described above. In such a case, the 10-percent U.S. 
shareholders are subject both to the subpart F provisions 
(which require current inclusion of certain earnings of the 
corporation) and to the PFIC provisions (which impose an 
interest charge on amounts distributed from the corporation and 
gains recognized upon the disposition of the corporation's 
stock, unless an election is made to include currently all of 
the corporation's earnings).

                           Reasons for Change

    The anti-deferral rules for U.S. persons owning stock in 
foreign corporations are very complex. Moreover, the 
interactions between the anti-deferral regimes cause additional 
complexity. The overlap between the subpart F rules and the 
PFIC provisions is of particular concern to the Committee. The 
PFIC provisions, which do not require a threshold level of 
ownership by U.S. persons, apply where the U.S.-ownership 
requirements of subpart F are not satisfied. However, the PFIC 
provisions also apply to a U.S. shareholder that is subject to 
the current inclusion rules of subpart F with respect to the 
same corporation. The Committee believes that the additional 
complexity caused by this overlap is unnecessary.
    The Committee also understands that the interest-charge 
method for income inclusion provided in the PFIC rules is a 
substantial source of complexity for shareholders of PFICs. 
Even without eliminating the interest-charge method, 
significant simplification can be achieved by providing an 
alternative income inclusion method for shareholders of PFICs. 
Further, some taxpayers have argued that they would have 
preferred choosing the current-inclusion method afforded by the 
qualified fund election, but were unable to do so because they 
could not obtain the necessary information from the PFIC. 
Accordingly, the Committee believes that a mark-to-market 
election would provide PFIC shareholders with a fair 
alternative method for including income with respect to the 
PFIC.

                        Explanation of Provision

Elimination of overlap between subpart F and the PFIC provisions

    In the case of a PFIC that is also a CFC, the bill 
generally treats the corporation as not a PFIC with respect to 
certain 10-percent shareholders. This rule applies if the 
corporation is a CFC (within the meaning of section 957(a)) and 
the shareholder is a U.S. shareholder (within the meaning of 
section 951(b)) of such corporation (i.e., if the shareholder 
is subject to the current inclusion rules of subpart F with 
respect to such corporation). Moreover, the rule applies for 
that portion of the shareholder's holding period with respect 
to the corporation's stock which is after December 31, 1997 and 
during which the corporation is a CFC and the shareholder is a 
U.S. shareholder. Accordingly, a shareholder that is subject to 
current inclusion under the subpart F rules with respect to 
stock of a PFIC that is also a CFC generally is not subject 
also to the PFIC provisions with respect to the same stock. The 
PFIC provisions continue to apply in the case of a PFIC that is 
also a CFC to shareholders that are not subject to subpart F 
(i.e., to shareholders that are U.S. persons and that own 
(directly, indirectly, or constructively) less than 10 percent 
of the corporation's stock by vote).
    If a shareholder of a PFIC is subject to the rules 
applicable to nonqualified funds before becoming eligible for 
the special rules provided under the proposal for shareholders 
that aresubject to subpart F, the stock held by such 
shareholder continues to be treated as PFIC stock unless the 
shareholder makes an election to pay tax and an interest charge with 
respect to the unrealized appreciation in the stock or the accumulated 
earnings of the corporation.
    If, under the bill, a shareholder is not subject to the 
PFIC provisions because the shareholder is subject to subpart F 
and the shareholder subsequently ceases to be subject to 
subpart F with respect to the corporation, for purposes of the 
PFIC provisions, the shareholder's holding period for such 
stock is treated as beginning immediately after such cessation. 
Accordingly, in applying the rules applicable to PFICs that are 
not qualified electing funds, the earnings of the corporation 
are not attributed to the period during which the shareholder 
was subject to subpart F with respect to the corporation and 
was not subject to the PFIC provisions.

Mark-to-market election

    The bill allows a shareholder of a PFIC to make a mark-to-
market election with respect to the stock of the PFIC, provided 
that such stock is marketable (as defined below). Under such an 
election, the shareholder includes in income each year an 
amount equal to the excess, if any, of the fair market value of 
the PFIC stock as of the close of the taxable year over the 
shareholder's adjusted basis in such stock. The shareholder is 
allowed a deduction for the excess, if any, of the adjusted 
basis of the PFIC stock over its fair market value as of the 
close of the taxable year. However, deductions are allowable 
under this rule only to the extent of any net mark-to-market 
gains with respect to the stock included by the shareholder for 
prior taxable years.
    Under the bill, this mark-to-market election is available 
only for PFIC stock that is ``marketable.'' For this purpose, 
PFIC stock is considered marketable if it is regularly traded 
on a national securities exchange that is registered with the 
Securities and Exchange Commission or on the national market 
system established pursuant to section 11A of the Securities 
and Exchange Act of 1934. In addition, PFIC stock is considered 
marketable if it is regularly traded on any exchange or market 
that the Secretary of the Treasury determines has rules 
sufficient to ensure that the market price represents a 
legitimate and sound fair market value. Any option on stock 
that is considered marketable under the foregoing rules is 
treated as marketable, to the extent provided in regulations. 
PFIC stock also is treated as marketable, to the extent 
provided in regulations, if the PFIC offers for sale (or has 
outstanding) stock of which it is the issuer and which is 
redeemable at its net asset value in a manner comparable to a 
U.S. regulated investment company (RIC).
    In addition, the bill treats as marketable any PFIC stock 
owned by a RIC that offers for sale (or has outstanding) any 
stock of which it is the issuer and which is redeemable at its 
net asset value. The bill treats as marketable any PFIC stock 
held by any other RIC that otherwise publishes net asset 
valuations at least annually, except to the extent provided in 
regulations. It is believed that even for RICs that do not make 
a market in their own stock, but that do regularly report their 
net asset values in compliance with the securities laws, 
inaccurate valuation may bring exposure to legal liabilities, 
and this exposure may ensure the reliability of the values such 
RICs assign to the PFIC stock they hold.
    The shareholder's adjusted basis in the PFIC stock is 
adjusted to reflect the amounts included or deducted under this 
election. In the case of stock owned indirectly by a U.S. 
person through a foreign entity (as discussed below), the basis 
adjustments for mark-to-market gains and losses apply to the 
basis of the PFIC in the hands of the intermediary owner, but 
only for purposes of the subsequent application of the PFIC 
rules to the tax treatment of the indirect U.S. owner. In 
addition, similar basis adjustments are made to the adjusted 
basis of the property actually held by the U.S. person by 
reason of which the U.S. person is treated as owning PFIC 
stock.
    Amounts included in income pursuant to a mark-to-market 
election, as well as gain on the actual sale or other 
disposition of the PFIC stock, is treated as ordinary income. 
Ordinary loss treatment also applies to the deductible portion 
of any mark-to-market loss on PFIC stock, as well as to any 
loss realized on the actual sale or other disposition of PFIC 
stock to the extent that the amount of such loss does not 
exceed the net mark-to-market gains previously included with 
respect to such stock. The source of amounts with respect to a 
mark-to-market election generally is determined in the same 
manner as if such amounts were gain or loss from the sale of 
stock in the PFIC.
    An election to mark to market applies to the taxable year 
for which made and all subsequent taxable years, unless the 
PFIC stock ceases to be marketable or the Secretary of the 
Treasury consents to the revocation of such election.
    Under constructive ownership rules, U.S. persons that own 
PFIC stock through certain foreign entities may make this 
election with respect to the PFIC. These constructive ownership 
rules apply to treat PFIC stock owned directly or indirectly by 
or for a foreign partnership, trust, or estate as owned 
proportionately by the partners or beneficiaries, except as 
provided in regulations. Stock in a PFIC that is thus treated 
as owned by a person is treated as actually owned by that 
person for purposes of again applying the constructive 
ownership rules. In the case of a U.S. person that is treated 
as owning PFIC stock by application of this constructive 
ownership rule, any disposition by the U.S. person or by any 
other person that results in the U.S. person being treated as 
no longer owning the PFIC stock, as well as any disposition by 
the person actually owning the PFIC stock, is treated as a 
disposition by the U.S. person of the PFIC stock.
    In addition, a CFC that owns stock in a PFIC is treated as 
a U.S. person that may make the election with respect to such 
PFIC stock. Any amount includible (or deductible) in the CFC's 
gross income pursuant to this mark-to-market election is 
treated as foreign personal holding company income (or a 
deduction allocable to foreign personal holding company 
income). The source of such amounts, however, is determined by 
reference to the actual residence of the CFC.
    In the case of a taxpayer that makes the mark-to-market 
election with respect to stock in a PFIC that is a nonqualified 
fund after the beginning of the taxpayer's holding period with 
respect to such stock, a coordination rule applies to ensure 
that the taxpayer does not avoid the interest charge with 
respect to amounts attributable to periods before such 
election. A similar rule applies to RICs that make the mark-to-
market election under this bill after the beginning of their 
holding period with respect to PFIC stock (to the extent that 
the RIC had not previously marked to market the stock of the 
PFIC).
    Except as provided in the coordination rules described 
above, the rules of section 1291 (with respect to nonqualified 
funds) do not apply to a shareholder of a PFIC if a mark-to-
market election is in effect for the shareholder's taxable 
year. Moreover, in applying section 1291 in a case where a 
mark-to-market election was in effect for any prior taxable 
year, the shareholder's holding period for the PFIC stock is 
treated as beginning immediately after the last taxable year 
for which such election applied.
    A special rule applicable in the case of a PFIC shareholder 
that becomes a U.S. person treats the adjusted basis of any 
PFIC stock held by such person on the first day of the year in 
which such shareholder becomes a U.S. person as equal to the 
greater of its fair market value on such date or its adjusted 
basis on such date. Such rule applies only for purposes of the 
mark-to-market election.

                             Effective Date

    The provision is effective for taxable years of U.S. 
persons beginning after December 31, 1997, and taxable years of 
foreign corporations ending with or within such taxable years 
of U.S. persons.

                          F. Other Provisions

1. Tax-exempt status for certain State workmen's compensation act 
        companies (sec. 761 of the bill and sec. 501(c)(27) of the 
        Code)

                              Present Law

    In general, the Internal Revenue Service (``IRS'') takes 
the position that organizations that provide insurance for 
their members or other individuals are not considered to be 
engaged in a tax-exempt activity. The IRS maintains that such 
insurance activity is either (1) a regular business of a kind 
ordinarily carried on for profit, or (2) an economy or 
convenience in the conduct of members' businesses because it 
relieves the members from obtaining insurance on an individual 
basis.
    Certain insurance risk pools have qualified for tax 
exemption under Code section 501(c)(6). In general, these 
organizations (1) assign any insurance policies and 
administrative functions to their member organizations 
(although they may reimburse their members for amounts paid and 
expenses); (2) serve an important common business interest of 
their members; and (3) must be membership organizations 
financed, at least in part, by membership dues.
    State insurance risk pools may also qualify for tax exempt 
status under section 501(c)(4) as a social welfare 
organizations or under section 115 as serving an essential 
governmental function of a State. In seeking qualification 
under section 501(c)(4), insurance organizations generally are 
constrained by the restrictions on the provision of 
``commercial-type insurance'' contained in section 501(m). 
Section 115 generally provides 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.

                           Reasons for Change

    The Committee believes that eliminating uncertainty 
concerning the eligibility of certain State workmen's 
compensation act companies for tax-exempt status will assist 
States in ensuring that workmen's compensation coverage is 
provided for employers with respect to employees in the State. 
While tax exemption may be available under present law for many 
of these entities, the Committee believes that it is 
appropriate to clarify standards for tax-exempt status.

                        Explanation of Provision

    The bill clarifies the tax-exempt status of any 
organization that is created by State law, and organized and 
operated exclusively to provide workmen's compensation 
insurance and related coverage that is incidental to workmen's 
compensation insurance,58 and that meets certain 
additional requirements. The workmen's compensation insurance 
must be required by State law, or be insurance with respect to 
which State law provides significant disincentives if it is not 
purchased by an employer (such as loss of exclusive remedy or 
forfeiture of affirmative defenses such as contributory 
negligence). The organization must provide workmen's 
compensation to any employer in the State (for employees in the 
State or temporarily assigned out-of-State) seeking such 
insurance and meeting other reasonable requirements. The State 
must either extend its full faith and credit to debt of the 
organization or provide the initial operating capital of such 
organization. For this purpose, the initial operating capital 
can be provided by providing the proceeds of bonds issued by a 
State authority; the bonds may be repaid through exercise of 
the State's taxing authority, for example. For periods after 
the date of enactment, the assets of the organization must 
revert to the State upon dissolution. Finally, the majority of 
the board of directors (or comparable oversight body) of the 
organization must be appointed by an official of the executive 
branch of the State or by the State legislature, or by both.
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    \58\ Related coverage that is incidental to workmen's compensation 
insurance includes liability under Federal workmen's compensation laws, 
the Jones Act, and the Longshore and Harbor Workers Compensation Act, 
for example.
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                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997. Many organizations described in the 
provision have been operating as tax-exempt organizations. No 
inference is intended that organizations described in the 
provision are not tax-exempt under present law.

2. Election to continue exception from treatment of publicly traded 
        partnerships as corporations (sec. 762 of the bill and sec. 
        7704 of the Code)

                              Present Law

    A publicly traded partnership generally is treated as a 
corporation for Federal tax purposes (sec. 7704). An exception 
to the rule treating the partnership as a corporation applies 
if 90 percent of the partnership's gross income consists of 
``passive-type income,'' which includes (1) interest (other 
than interest derived in a financial or insurance business, or 
certain amounts determined on the basis of income or profits), 
(2) dividends, (3) real property rents (as defined for purposes 
of the provision), (4) gain from the sale or other disposition 
of real property, (5) income and gains relating to minerals and 
natural resources (as defined for purposes of the provision), 
and (6) gain from the sale or disposition of a capital asset 
(or certain trade or business property) held for the production 
of income of the foregoing types (subject to an exception for 
certain commodities income).
    The exception for publicly traded partnerships with 
``passive-type income'' does not apply to any partnership that 
would be described in section 851(a) of the Code (relating to 
regulated investment companies, or ``RICs''), if that 
partnership were a domestic corporation. Thus, a publicly 
traded partnership that is registered under the Investment 
Company Act of 1940 generally is treated as a corporation under 
the provision. Nevertheless, if a principal activity of the 
partnership consists of buying and selling of commodities 
(other than inventory or property held primarily for sale to 
customers) or futures, forwards and options with respect to 
commodities, and 90 percent of the partnership's income is such 
income, then the partnership is not treated as a corporation.
    A publicly traded partnership is a partnership whose 
interests are (1) traded on an established securities market, 
or (2) readily tradable on a secondary market (or the 
substantial equivalent thereof).
    Treasury regulations provide detailed guidance as to when 
an interest is treated as readily tradable on a secondary 
market or the substantial equivalent. Generally, an interest is 
so treated ``if, taking into account all of the facts and 
circumstances, the partners are readily able to buy, sell, or 
exchange their partnership interests in a manner that is 
comparable, economically, to trading on an established 
securities market'' (Treas. Reg. sec. 1.7704-1(c)(1)).
    When the publicly traded partnership rules were enacted in 
1987, a 10-year grandfather rule provided that the provisions 
apply to certain existing partnerships only for taxable years 
beginning after December 31, 1997.\59\ An existing publicly 
traded partnership is any partnership, if (1) it was a publicly 
traded partnership on December 17, 1987, (2) a registration 
statement indicating that the partnership was to be a publicly 
traded partnership was filed with the Securities and Exchange 
Commission with respect to the partnership on or before 
December 17, 1987, or (3) with respect to the partnership, an 
application was filed with a State regulatory commission on or 
before December 31, 1987, seeking permission to restructure a 
portion of a corporation as a publicly traded partnership. A 
partnership that otherwise would be treated as an existing 
publicly traded partnership ceases to be so treated as of the 
first day after December 17, 1987, on which there has been an 
addition of a substantial new line of business with respect to 
such partnership. A rule is provided to coordinate this 
grandfather rule with the exception to the rule treating the 
partnership as a corporation applies if 90 percent of the 
partnership's gross income consists of passive-type income. The 
coordination rule provides that passive-type income exception 
applies only after the grandfather rule ceases to apply 
(whether by passage of time or because the partnership ceases 
to qualify for the grandfather rule).
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    \59\ Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203), sec. 
10211(c).
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that, in important respects, 
publicly traded partnerships generally resemble corporations 
and should be subject to tax as corporations, so long as the 
current corporate income tax applies to corporate entities. 
Nevertheless, in the case of certain publicly traded 
partnerships that were existing on December 17, 1987, and that 
are treated as partnerships under the grandfather rule until 
December 31, 1997, it is appropriate to permit the continuation 
of their status as partnerships, so long as they elect to be 
subject to a tax that is intended to approximate the corporate 
tax they would pay if they were treated as corporations for 
Federal tax purposes.

                        Explanation of Provision

    In the case of an existing publicly traded partnership that 
elects under the provision to be subject to a tax on gross 
income from the active conduct of a trade or business, the rule 
of present law treating a publicly traded partnership as a 
corporation does not apply. An existing publicly traded 
partnership is any publicly traded partnership that is not 
treated as a corporation, so long as such treatment is not 
determined under the passive-type income exception of Code 
section 7704(c)(1). The election to be subject to the tax on 
gross trade or business income, once made, remains in effect 
until revoked by the partnership, and cannot be reinstated.
    The tax is 3.5 percent of the partnership's gross income 
from the active conduct of a trade or business. The 
partnership's gross trade or business income includes its share 
of gross trade or business income of any lower-tier 
partnership. The tax imposed under the provision may not be 
offset by tax credits.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

3. Exclusion from UBIT for certain corporate sponsorship payments (sec. 
        763 of the bill and sec. 513 of the Code)

                              Present Law

    Although generally exempt from Federal income tax, tax-
exempt organizations are subject to the unrelated business 
income tax (``UBIT'') on income derived from a trade or 
business regularly carried on that is not substantially related 
to the performance of the organization's tax-exempt functions 
(secs. 511-514). Contributions or gifts received by tax-exempt 
organizations generally are not subject to the UBIT. However, 
present-law section 513(c) provides that an activity (such as 
advertising) does not lose its identity as a separate trade or 
business merely because it is carried on within a larger 
complex of other endeavors.\60\ If a tax-exempt organization 
receives sponsorship payments in connection with an event or 
other activity, the solicitation and receipt of such 
sponsorship payments may be treated as a separate activity. The 
Internal Revenue Service (IRS) has taken the position that, 
under some circumstances, such sponsorship payments are subject 
to the UBIT.\61\
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    \60\ See United States v. American College of Physicians, 475 U.S. 
834 (1986) (holding that activity of selling advertising in medical 
journal was not substantially related to the organization's exempt 
purposes and, as a separate business under section 513(c), was subject 
to tax).
    \61\ See Prop. Treas. Reg. sec. 1.513-4 (issued January 19, 1993, 
EE-74-92, IRB 1993-7, 71). These proposed regulations generally exclude 
from the UBIT financial arrangements under which the tax-exempt 
organization provides so-called ``institutional'' or ``good will'' 
advertising to a sponsor (i.e., arrangements under which a sponsor's 
name, logo, or product line is acknowledged by the tax-exempt 
organization). However, specific product advertising (e.g., 
``comparative or qualitative descriptions of the sponsor's products'') 
provided by a tax-exempt organization on behalf of a sponsor is not 
shielded from the UBIT under the proposed regulations.
---------------------------------------------------------------------------

                           Reasons for Change

    In order to reduce the uncertainty regarding the treatment 
for UBIT purposes of corporate sponsorship payments received by 
tax-exempt organizations, the Committee believes that it is 
appropriate to distinguish sponsorship payments for which the 
donor receives no substantial return benefit other than the use 
or acknowledgment of the donor's name or logo as part of a 
sponsored event (which should not be subject to the UBIT) from 
payments made in exchange for advertising provided by the 
recipient organization (which should be subject to the UBIT).

                        Explanation of Provision

    Under the bill, qualified sponsorship payments received by 
a tax-exempt organization (or State college or university 
described in section 511(a)(2)(B)) are exempt from the UBIT.
    ``Qualified sponsorship payments'' are defined as any 
payment made by a person engaged in a trade or business with 
respect to which the person will receive no substantial return 
benefit other than the use or acknowledgment of the name or 
logo (or product lines) of the person's trade or business in 
connection with the organization's activities.\62\ Such a use 
or acknowledgment does not include advertising of such person's 
products or services--meaning qualitative or comparative 
language, price information or other indications of savings or 
value, or an endorsement or other inducement to purchase, sell, 
or use such products or services. Thus, for example, if, in 
return for receiving a sponsorship payment, an organization 
promises to use the sponsor's name or logo in acknowledging the 
sponsor's support for an educational or fundraising event 
conducted by the organization, such payment will not be subject 
to the UBIT. In contrast, if the organization provides 
advertising of a sponsor's products, the payment made to the 
organization by the sponsor in order to receive such 
advertising will be subject to the UBIT (provided that the 
other, present-law requirements for UBIT liability are 
satisfied).
---------------------------------------------------------------------------
    \62\ In determining whether a payment is a qualified sponsorship 
payment, it is irrelevant whether the sponsored activity is related or 
unrelated to the organization's exempt purpose.
---------------------------------------------------------------------------
    The bill specifically provides that a qualified sponsorship 
payment does not include any payment where the amount of such 
payment is contingent, by contract or otherwise, upon the level 
of attendance at an event, broadcast ratings, or other factors 
indicating the degree of public exposure to an activity. 
However, the fact that a sponsorship payment is contingent upon 
an event actually taking place or being broadcast, in and of 
itself, will not cause the payment to fail to be a qualified 
sponsorship payment. Moreover, mere distribution or display of 
a sponsor's products by the sponsor or the tax-exempt 
organization to the general public at a sponsored event, 
whether for free or for remuneration, will be considered to be 
``use or acknowledgment'' of the sponsor's product lines (as 
opposed to advertising), and thus will not affect the 
determination of whether a payment made by the sponsor is a 
qualified sponsorship payment.
    The provision does not apply to the sale of advertising or 
acknowledgments in tax-exempt organization periodicals. For 
this purpose, the term ``periodical'' means regularly scheduled 
and printed material published by (or on behalf of) the payee 
organization that is not related to and primarily distributed 
in connection with a specific event conducted by the payee 
organization. For example, the provision will not apply to 
payments that lead to acknowledgments in a monthly journal, but 
will apply if a sponsor receives an acknowledgment in a program 
or brochure distributed at a sponsored event.
    The provision specifically provides that, to the extent 
that a portion of a payment would (if made as a separate 
payment) be a qualified sponsorship payment, such portion of 
the payment will be treated as a separate payment. Thus, if a 
sponsorship payment made to a tax-exempt organization entitles 
the sponsor to both product advertising and use or 
acknowledgment of the sponsor's name or logo by the 
organization, then the UBIT will not apply to the amount of 
such payment that exceeds the fair market value of the product 
advertising provided to the sponsor. Moreover, the provision of 
facilities, services or other privileges by an exempt 
organization to a sponsor or the sponsor's designees (e.g., 
complimentary tickets, pro-am playing spots in golf 
tournaments, or receptions for major donors) in connection with 
a sponsorship payment will not affect the determination of 
whether the payment is a qualified sponsorship payment. Rather, 
the provision of such goods or services will be evaluated as a 
separate transaction in determining whether the organization 
has unrelated business taxable income from the event. In 
general, if such services or facilities do not constitute a 
substantial return benefit or if the provision of such services 
or facilities is a related business activity, then the payments 
attributable to such services or facilities will not be subject 
to the UBIT. Moreover, just as the provision of facilities, 
services or other privileges by a tax-exempt organization to a 
sponsor or the sponsor's designees (complimentary tickets, pro-
am playing spots in golf tournaments, or receptions for major 
donors) will be treated as a separate transaction that does not 
affect the determination of whether a sponsorship payment is a 
qualified sponsorship payment, a sponsor's receipt of a license 
to use an intangible asset (e.g., trademark, logo, or 
designation) of the tax-exempt organization likewise will be 
treated as separate from the qualified sponsorship transaction 
in determining whether the organization has unrelated business 
taxable income.
    The exemption provided by the provision will be in addition 
to other present-law exceptions from the UBIT (e.g., the 
exceptions for activities substantially all the work for which 
is performed by volunteers and for activities not regularly 
carried on). No inference is intended as to whether any 
sponsorship payment received prior to 1998 was subject to the 
UBIT.

                             Effective Date

    The provision applies to qualified sponsorship payments 
solicited or received after December 31, 1997.

4. Timeshare associations (sec. 764 of the bill and sec. 528 of the 
        Code)

                              Present Law

    Taxation of homeowners associations making the section 528 
election.--Under present law (sec. 528), condominium management 
associations and residential real estate management 
associations may elect to be taxable at a 30 percent rate on 
their ``homeowners association income'' if they meet certain 
income, expenditure, and organizational requirements.
    ``Homeowners association income'' is the excess of the 
association's gross income, excluding ``exempt function 
income,'' over allowable deductions directly connected with 
non-exempt function gross income. ``Exempt function income'' 
includes membership dues, fees, and assessments for a common 
activity undertaken by association members or owners of 
residential units in the condominium or subdivision. Homeowners 
association income includes passive income (e.g., interest and 
dividends) earned on reserves and fees for use of association 
property (e.g., swimming pools, meeting rooms, etc.).
    For an association to qualify for this treatment, (1) at 
least 60 percent of the association's gross income must consist 
of membership dues, fees, or assessments on owners, (2) at 
least 90 percent of its expenditures must be for the 
acquisition, management, maintenance, or care of ``association 
property,'' and (3) no part of its net earnings can inure to 
the benefit of any private shareholder. ``Association 
property'' means: (1) property held by the association; (2) 
property commonly held by association members; (3) property 
within the association privately held by association members; 
and (4) property held by a governmental unit for the benefit of 
association members. In addition to these statutory 
requirements, Treasury regulations require that the units of 
the association be used for residential purposes. Use is not a 
residential use if the unit is occupied by a person or series 
of persons less than 30 days for more than half of the 
association's taxable year. Treas. Reg. sec. 1.528-4(d).
    Taxation of homeowners associations not making the section 
528 election.--Homeowners associations that do not (or cannot) 
make the section 528 election are taxed either as a tax-exempt 
social welfare organization under section 501(c)(4) or as a 
regular C corporation. In order for an organization to qualify 
as a tax-exempt social welfare organization, the organization 
must meet the following three requirements: (1) the association 
must serve a ``community'' which bears a reasonable, 
recognizable relationship to an area ordinarily identified as a 
governmental subdivision or unit; (2) the association may not 
conduct activities directed to exterior maintenance of any 
private residence, and (3) common areas of association 
facilities must be for the use and enjoyment of the general 
public (Rev. Rul. 74-99, 1974-1 C.B. 131).
    Non-exempt homeowners associations are taxed as C 
corporations, except that (1) the association may exclude 
excess assessments that it refunds to its members or applies to 
the subsequent year's assessments (Rev. Rul. 70-604, 1970-2 
C.B. 9); (2) gross income does not include special assessments 
held in a special bank account (Rev. Rul. 75-370, 75-2 C.B. 
25), and (3) assessments for capital improvements are treated 
as non-taxable contributions to capital (Rev. Rul. 75-370, 
1975-2 C.B. 25).
    Taxation of timeshare associations.--Under present law, 
timeshare associations are taxed as regular C corporations 
because (1) they cannot meet the requirement of the Treasury 
regulations for the section 528 election that the units be used 
for residential purposes (i.e., the 30-day rule) and they have 
relatively large amount of services performed for its owners 
(e.g., maid and janitorial services) and (2) they cannot meet 
any of requirements of Rev. Rul. 74-99 for tax-exempt status 
under section 501(c)(4).

                           Reasons for Change

    The committee understands that the IRS recently has 
challenged the exclusions from gross income of timeshare 
associations of refunds of excess assessments, special 
assessments held in a segregated account, and capital 
assessments as contributions to capital. See P.L.R. 9539001 
(June 8, 1995). The committee believes that the activities of 
timeshare associations are sufficiently similar to those of 
homeowners associations that they should be similarly taxed. 
Accordingly, the committee bill would extend the rules for the 
taxation of homeowners associations to timeshare associations, 
except that the rate of tax on timeshare associations is 32 
percent, instead of the 30-percent rate that applies to 
homeowner's associations.

                        Explanation of Provision

    The bill amends section 528 to permit timeshare 
associations to qualify for taxation under that section. 
Timeshare associations would have to meet the requirements of 
section 528 (e.g., the 60 percent gross income, 90 percent 
expenditure, and the non-profit organizational and operational 
requirements). Timeshare associations electing to be taxed 
under section 528 are subject to a tax on their ``timeshare 
association income'' at a rate of 32 percent.

60-Percent Test

    A qualified timeshare association must receive at least 60 
percent of its income from membership dues, fees and 
assessments from owners of either (a) timeshare rights to use 
of, or (b) timeshare ownership in, property the timeshare 
association.

90-Percent Test

    At least 90 percent of the expenditures of the timeshare 
association must be for the acquisition, management, 
maintenance, or care of ``association property,'' and 
activities provided by the association to, or on behalf of, 
members of the timeshare association. ``Activities provided to 
or on behalf of members of the [timeshare] association'' 
includes events located on association property (e.g., member's 
meetings at the association's meeting room, parties at the 
association's swimming pool, golf lessons on association's golf 
range, transportation to and from association property, etc.).

Organizational and Operational Tests

    No part of the net earnings of the timeshare association 
can inure to the benefit (other than by acquiring, 
constructing, or providing management, maintenance, and care of 
property of the timeshare association or rebate of excess 
membership dues, fees, or assessments) of any private 
shareholder or individual. A member of a qualified timeshare 
association must hold a timeshare right to use (or timeshare 
ownership in) real property of the association. Property of a 
timeshare association includes property in which a timeshare 
association or members of the association have rights arising 
out of recorded easements, covenants, and other recorded 
instruments to use property related to the timeshare project. A 
qualified timeshare association cannot be a condominium 
management association. Lastly, the timeshare association must 
elect to be taxed under section 528.

                             Effective Date

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

5. Deduction for business meals for individuals operating under 
        Department of Transportation hours of service limitations and 
        certain seafood processors (sec. 765 of the bill and sec. 
        274(n) of the Code)

                              Present Law

    Ordinary and necessary business expenses, as well as 
expenses incurred for the production of income, are generally 
deductible, subject to a number of restrictions and 
limitations. Generally, the amount allowable as a deduction for 
food and beverage is limited to 50 percent of the otherwise 
deductible amount. Exceptions to this 50 percent rule are 
provided for food and beverages provided to crew members of 
certain vessels and offshore oil or gas platforms or drilling 
rigs.

                           Reasons for Change

    Individuals subject to the hours of service limitations of 
the Department of Transportation, as well as workers at remote 
seafood processing facilities in Alaska, are frequently forced 
to eat meals away from home in circumstances where their choice 
is limited, prices comparatively high and the opportunity for 
lavish meals remote. The Committee believes that it is 
appropriate to allow a higher percentage of the cost of food 
and beverages consumed while away from home by these 
individuals to be deducted than is allowed under the general 
rule.

                        Explanation of Provision

    The bill increases to 80 percent the deductible percentage 
of the cost of food and beverages consumed (1) while away from 
home by an individual during, or incident to, a period of duty 
subject to the hours of service limitations of the Department 
of Transportation and (2) by workers at remote seafood 
processing facilities located in the United States north of 53 
degrees north latitude. A seafood processing facility is remote 
when there are insufficient eating facilities in the vicinity 
of the employer's premises.\63\
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    \63\ See Treas. Reg. sec. 1.119-1(a)(2)(ii)(c) and 1.119-1(f) 
(Example 7).
---------------------------------------------------------------------------
    Individuals subject to the hours of service limitations of 
the Department of Transportation include:
          (1) certain air transportation employees such as 
        pilots, crew, dispatchers, mechanics, and control tower 
        operators pursuant to Federal Aviation Administration 
        regulations,
          (2) interstate truck operators and interstate bus 
        drivers pursuant to Department of Transportation 
        regulations,
          (3) certain railroad employees such as engineers, 
        conductors, train crews, dispatchers and control 
        operations personnel pursuant to Federal Railroad 
        Administration regulations, and
          (4) certain merchant mariners pursuant to Coast Guard 
        regulations.
    The increase in the deductible percentage is phased in 
according to the following schedule:

Taxable years beginning in:
                                                   Deductible percentage
    1998, 1999................................................        55
    2000, 2001................................................        60
    2002, 2003................................................        65
    2004, 2005................................................        70
    2006, 2007................................................        75
    2008 and thereafter.......................................        80

                             Effective Date

    The provision is effective for taxable years beginning 
after 1997.

6. Provide above-the-line deduction for certain business expenses (sec. 
        766 of the bill and sec. 62 of the Code)

                              Present Law

    Under present law, individuals may generally deduct 
ordinary and necessary business expenses in determining 
adjusted gross income (``AGI'). This deduction does not apply 
in the case of an individual performing services as an 
employee. Employee business expenses are generally deductible 
only as a miscellaneous itemized deduction, i.e., only to the 
extent all the taxpayer's miscellaneous itemized deductions 
exceed 2 percent of the taxpayer's AGI. Employee business 
expenses are not allowed as a deduction for alternative minimum 
tax purposes.

                           Reasons for Change

    The Committee is aware that certain State and local 
government officials are compensated (in whole or in part) on a 
fee basis to provide certain services to the government. These 
officials hire employees and incur expenses in connection with 
their official duties. These expenses may be subject, under 
present law, to the 2-percent floor on itemized deductions. The 
Committee believes these expenses should be deductible.

                        Explanation of Provision

    Under the bill, employee business expenses relating to 
service as an official of a State or local government (or 
political subdivision thereof) are deductible in computing AGI 
(``above the line'), provided the official is compensated in 
whole or in part on a fee basis. Consequently, such expenses 
are also deductible for minimum tax purposes.

                             Effective Date

    The provision applies to expenses paid or incurred in 
taxable years beginning after December 31, 1997.

7. Increase in standard mileage rate for purposes of computing 
        charitable deduction (sec. 767 of the bill and sec. 170(i) of 
        the Code)

                              Present Law

    In general, individuals who itemize their deductions may 
deduct charitable contributions. For purposes of computing the 
charitable deduction for the use of a passenger automobile, the 
standard mileage rate is 12 cents per mile (sec. 170(i)).

                           Reasons for Change

    The Committee believes that this rate should be increased 
and indexed for inflation.

                        Explanation of Provision

    The bill increases this mileage rate to 15 cents per mile. 
This rate is indexed for inflation, rounded down to the nearest 
whole cent.

                             Effective Date

    The increase to 15 cents is effective for taxable years 
beginning after December 31, 1997. The indexation is effective 
for inflation occurring after 1997. Accordingly, the first 
adjustment for indexing will occur in 1999 to reflect inflation 
in 1998.

8. Expensing of environmental remediation costs (``brownfields'') (sec. 
        768 of the bill and sec. 162 of the Code)

                              Present Law

    Code section 162 allows a deduction for ordinary and 
necessary expenses paid or incurred in carrying on any trade or 
business. Treasury Regulations provide that the cost of 
incidental repairs which 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.
    Treasury regulations provide that capital expenditures 
include the costs of acquiring or substantially improving 
buildings, machinery, equipment, furniture, fixtures and 
similar property having a useful life substantially beyond the 
current year. In INDOPCO, Inc. v. Commissioner, 112 S. Ct. 1039 
(1992), the Supreme Court required the capitalization of legal 
fees incurred by a taxpayer in connection with a friendly 
takeover by one of its customers on the grounds that the merger 
would produce significant economic benefits to the taxpayer 
extending beyond the current year; capitalization of the costs 
thus would match the expenditures with the income produced. 
Similarly, the amount paid for the construction of a filtration 
plant, with a life extending beyond the year of completion, and 
as a permanent addition to the taxpayer's mill property, was a 
capital expenditure rather than an ordinary and necessary 
current business expense. Woolrich Woolen Mills v. United 
States, 289 F.2d 444 (3d Cir. 1961).
    Although Treasury regulations provide that expenditures 
that materially increase the value of property must be 
capitalized, they do not set forth a method of determining how 
and when value has been increased. In Plainfield-Union Water 
Co. v. Commissioner, 39 T.C. 333 (1962), nonacq., 1964-2 C.B. 
8, the U.S. Tax Court held that increased value was determined 
by comparing the value of an asset after the expenditure with 
its value before the condition necessitating the expenditure. 
The Tax Court stated that ``an expenditure which returns 
property to the state it was in before the situation prompting 
the expenditure arose, and which does not make the relevant 
property more valuable, more useful, or longer-lived, is 
usually deemed a deductible repair.''
    In several Technical Advice Memoranda (TAM), the Internal 
Revenue Service (IRS) declined to apply the Plainfield Union 
valuation analysis, indicating that the analysis represents 
just one of several alternative methods of determining 
increases in the value of an asset. In TAM 9240004 (June 29, 
1992), the IRS required certain asbestos removal costs to be 
capitalized rather than expensed. In that instance, the 
taxpayer owned equipment that was manufactured with insulation 
containing asbestos; the taxpayer replaced the asbestos 
insulation with less thermally efficient, non-asbestos 
insulation. The IRS concluded that the expenditures resulted in 
a material increase in the value of the equipment because the 
asbestos removal eliminated human health risks, reduced the 
risk of liability to employees resulting from the 
contamination, and made the property more marketable. 
Similarly, in TAM 9411002 (November 19, 1993), the IRS required 
the capitalization of expenditures to remove and replace 
asbestos in connection with the conversion of a boiler room to 
garage and office space. However, the IRS permitted deduction 
of costs of encapsulating exposed asbestos in an adjacent 
warehouse.
    In 1994, the IRS issued Rev. Rul. 94-38, 1994-1 C.B. 35, 
holding that soil remediation expenditures and ongoing water 
treatment expenditures incurred to clean up land and water that 
a taxpayer contaminated with hazardous waste are deductible. In 
this ruling, the IRS explicitly accepted the Plainfield Union 
valuation analysis.\64\ However, the IRS also held that costs 
allocable to constructing a groundwater treatment facility are 
capital expenditures.
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    \64\ Rev. Rul. 94-38 generally rendered moot the holding in TAM 
9315004 (December 17, 1992) requiring a taxpayer to capitalize certain 
costs associated with the remediation of soil contaminated with 
polychlorinated biphenyls (PCBs).
---------------------------------------------------------------------------
    In 1995, the IRS issued TAM 9541005 (October 13, 1995) 
requiring a taxpayer to capitalize certain environmental study 
costs, as well as associated consulting and legal fees. The 
taxpayer acquired the land and conducted activities causing 
hazardous waste contamination. After the contamination, but 
before it was discovered, the company donated the land to the 
county to be developed into a recreational park. After the 
county discovered the contamination, it reconveyed the land to 
the company for $1. The company incurred the costs in 
developing a remediation strategy. The IRS held that the costs 
were not deductible under section 162 because the company 
acquired the land in a contaminated state when it purchased the 
land from the county. In January, 1996, the IRS revoked and 
superseded TAM 9541005 (PLR 9627002). Noting that the company's 
contamination of the land and liability for remediation were 
unchanged during the break in ownership by the county, the IRS 
concluded that the break in ownership should not, in and of 
itself, operate to disallow a deduction under section 162.

                           Reasons for Change

    To encourage the cleanup of contaminated sites, as well as 
to eliminate uncertainty regarding the appropriate treatment of 
environmental remediation expenditures for Federal tax law 
purposes, the Committee believes that it is appropriate to 
provide clear and consistent rules regarding the Federal tax 
treatment of certain environmental remediation expenses.

                        Explanation of Provision

    The bill provides that taxpayers could elect to treat 
certain environmental remediation expenditures that would 
otherwise be chargeable to capital account as deductible in the 
year paid or incurred. 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 Comm'r v. Idaho Power Co.\65\ and 
section 263A are treated as qualified environmental remediation 
expenditures.
---------------------------------------------------------------------------
    \65\ Comm'r v. Idaho Power Co., 418 U.S. 1 (1974) (holding that 
equipment depreciation allocable to the taxpayer's construction of 
capital facilities must be capitalized under section 263(a)(1)).
---------------------------------------------------------------------------
    A ``qualified contaminated site'' generally is any property 
that (1) is held for use in a trade or business, for the 
production of income, or as inventory; (2) is certified by the 
appropriate State environmental agency to be located within a 
targeted area; and (3) contains (or potentially contains) a 
hazardous substance (so-called ``brownfields''). Targeted areas 
would mean (1) empowerment zones and enterprise communities (as 
designated under present law and the D.C. Enterprise Zone 
designated under the bill); and (2) sites announced before 
February, 1997, as being subject to one of the 76 Environmental 
Protection Agency (EPA) Brownfields Pilots.
    Both urban and rural sites qualify. However, sites that are 
identified on the national priorities list under the 
Comprehensive Environmental Response, Compensation, and 
Liability Act of 1980 (CERCLA) cannot be targeted areas. 
Appropriate State environmental agencies are designated by the 
EPA; if no State agency is designated, the EPA is responsible 
for providing the certification. 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.
    The bill further provides that, in the case of property to 
which a qualified environmental remediation expenditure 
otherwise would have be capitalized, any deduction allowed 
under the bill would be treated as a depreciation deduction and 
the property would be treated as subject to section 1245. Thus, 
deductions for qualified environmental remediation expenditures 
would be subject to recapture as ordinary income upon sale or 
other disposition of the property.

                             Effective Date

    The provision applies to eligible expenditures incurred 
after the date of enactment.

9. Combined employment tax reporting demonstration project (sec. 769 of 
        the bill)

                              Present Law

    Traditionally, Federal tax forms are filed with the Federal 
government and State tax forms are filed with individual 
states. This necessitates duplication of items common to both 
returns. Some States have recently been working with the IRS to 
implement combined State and Federal reporting of certain types 
of items on one form as a way of reducing the burdens on 
taxpayers. The State of Montana and the IRS have cooperatively 
developed a system to combine State and Federal employment tax 
reporting on one form. The one form would contain exclusively 
Federal data, exclusively State data, and information common to 
both: the taxpayer's name, address, TIN, and signature.
    The Internal Revenue Code prohibits disclosure of tax 
returns and return information, except to the extent 
specifically authorized by the Internal Revenue Code (sec. 
6103). Unauthorized disclosure is a felony punishable by a fine 
not exceeding $5,000 or imprisonment of not more than five 
years, or both (sec. 7213). An action for civil damages also 
may be brought for unauthorized disclosure (sec. 7431). No tax 
information may be furnished by the Internal Revenue Service 
(``IRS'') to another agency unless the other agency establishes 
procedures satisfactory to the IRS for safeguarding the tax 
information it receives (sec. 6103(p)).
    Implementation of the combined Montana-Federal employment 
tax reporting project has been hindered because the IRS 
interprets section 6103 to apply that provision's restrictions 
on disclosure to information common to both the State and 
Federal portions of the combined form, although these 
restrictions would not apply to the State with respect to the 
State's use of State-requested information if that information 
were supplied separately to both the State and the IRS.

                           Reasons for Change

    The Committee believes it is appropriate to permit a 
demonstration project to assess the feasibility and 
desirability of expanding combined reporting in the future.

                       Explanation of Provisions

    The bill permits implementation of a demonstration project 
to assess the feasibility and desirability of expanding 
combined reporting in the future. There are several limitations 
on the demonstration project. First, it is limited to the State 
of Montana and the IRS. Second, it is limited to employment tax 
reporting. Third, it is limited to disclosure of the name, 
address, TIN, and signature of the taxpayer, which is 
information common to both the Montana and Federal portions of 
the combined form. Fourth, it is limited to a period of five 
years.

                             Effective Date

    The provision is effective on the date of enactment, and 
will expire on the date five years after the date of enactment.

10. Qualified small-issue bonds (sec. 770 of the bill and sec. 144(a) 
        of the Code)

                              Present Law

    Interest on certain small issues of private activity bonds 
issued by State or local governments (``qualified small-issue 
bonds'') is excluded from gross income if certain conditions 
are met. First, at least 95 percent of the bond proceeds must 
be used to finance manufacturing facilities or certain 
agricultural land or equipment. Second, the bond issue must 
have an aggregate face amount of $1 million or less, or 
alternatively, the aggregate face amount of the issue, together 
with the aggregate amount of certain related capital 
expenditures during the six-year period beginning three years 
before the date of the issue and ending three years after that 
date, must not exceed $10 million. (The maximum face amount of 
bonds would not be increased over present-law amounts.)
    Issuance of qualified small-issue bonds, like most other 
private activity bonds, is subject to annual State volume 
limitations and to other rules.

                           Reasons for Change

    The Committee believes that the $10 million total capital 
expenditure limit has come to deny the benefits of tax-exempt 
bonds to certain projects that deserve them. At the same time, 
the Committee maintains its position that the maximum size of 
the tax-exempt bond issue for all eligible small-issue bond 
projects should be retained.

                        Explanation of Provision

    The bill increases the maximum capital expenditure limit 
under present law from $10 million to $20 million. The maximum 
amount of bonds is not to be increased over present-law 
amounts.

                             Effective Date

    The provision is effective for bonds issued after December 
31, 1997.

11. Extend production credit for electricity produced from wind and 
        ``closed loop'' biomass (sec. 771 of the bill and sec. 45 of 
        the Code)

                              Present Law

    An income tax credit is allowed for the production of 
electricity from either qualified wind energy or qualified 
``closed-loop'' biomass facilities (sec. 45). The credit is 
equal to 1.5 cents (plus adjustments for inflation since 1992) 
per kilowatt hour of electricity produced from these qualified 
sources during the 10-year period after the facility is placed 
in service.
    The credit applies to electricity produced by a qualified 
wind energy facility placed in service after December 31, 1993, 
and before July 1, 1999, and to electricity produced by a 
qualified closed-loop biomass facility placed in service after 
December 31, 1992, and before July 1, 1999. Closed-loop biomass 
is the use of plant matter, where the plants are grown for the 
sole purpose of being used to generate electricity. It does not 
apply to the use of waste materials (including, but not limited 
to, scrap wood, manure, and municipal or agricultural waste). 
It also does not apply to taxpayers who use standing timber to 
produce electricity. In order to claim the credit, a taxpayer 
must own the facility and sell the electricity produced by the 
facility to an unrelated party.
    The credit for electricity produced from wind or closed-
loop biomass is a component of the general business credit 
(sec. 38(b)(1)). This credit, when combined with all other 
components of the general business credit, generally may not 
exceed for any taxable year the excess of the taxpayer's net 
income tax over the greater of (1) 25 percent of net regular 
tax liability above $25,000 or (2) the tentative minimum tax. 
An unused general business credit generally may be carried back 
3 taxable years and carried forward 15 taxable years.

                           Reasons for Change

    The Committee believes that the production of electricity 
from renewable sources should be encouraged, and that by 
extending the placed-in-service date, more entrepreneurs will 
have the opportunity to develop these renewable energy sources.

                        Explanation of Provision

    The bill extends the income tax credit for electricity 
produced from wind and closed-loop biomass for two years. Thus, 
the credit is available for qualifying electricity produced 
fromfacilities placed in service before July 1, 2001. As under 
present law, the credit is allowable for a period of ten years after 
the facility is placed in service.

                             Effective Date

    The provision is effective as of the date of enactment.

12. Suspension of net income property limitation for production from 
        marginal wells (sec. 772 of the bill and sec. 613(a) of the 
        Code)

                              Present Law

    The Code permits taxpayers to recover their investments in 
oil and gas wells through depletion deductions (sec. 613A). In 
the case of certain properties, the deductions may be 
determined using the percentage depletion method. Among the 
limitations that apply in calculating percentage depletion 
deductions is a restriction that the amount deducted may not 
exceed 100 percent of the net income from that property in any 
year (sec. 613(a)).
    Specific percentage depletion rules apply to oil and gas 
production from ``marginal'' properties. 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.

                           Reasons for Change

    The Committee believes that a suspension of the net income 
property limitation for marginal oil and gas production is 
appropriate if the price of oil falls to unexpectedly low 
levels, to prevent such wells from being plugged and 
potentially losing their production in the long run.

                        Explanation of Provision

    The 100-percent-of-net-income property limitation does not 
apply for any taxable year beginning in a calendar year in 
which the annual average wellhead price per barrel for crude 
oil (within the meaning of section 29(d)(2)(C)) is below $14 
per barrel.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

13. Purchasing of receivables by tax-exempt hospital cooperative 
        service organizations (sec. 773 of the bill and sec. 501(e) of 
        the Code)

                              Present Law

    Section 501(e) provides that an organization organized on a 
cooperative basis by tax-exempt hospitals will itself be tax-
exempt if the organization is operated solely to perform, on a 
centralized basis, one or more of certain enumerated services 
for its members. These services are: data processing, 
purchasing (including the purchase of insurance on a group 
basis), warehousing, billing and collection, food, clinical, 
industrial engineering, laboratory, printing, communications, 
record center, and personnel services. An organization does not 
qualify under section 501(e) if it performs services other than 
the enumerated services. (Treas. reg. sec. 1.501(e)(-1(c)).

                           Reasons for Change

    The Committee believes that it is important to clarify that 
permissible billing and collection services that can be carried 
out by hospital cooperative services organizations under 
section 501(e) include the purchase of patron accounts 
receivable on a recourse basis.

                        Explanation of Provision

    The bill clarifies that, for purposes of section 501(e), 
billing and collection services include the purchase of patron 
accounts receivable on a recourse basis. Thus, hospital 
cooperative service organizations are permitted to advance cash 
on the basis of member accounts receivable, provided that each 
member hospital retains the risk of non-payment with respect to 
its accounts receivable.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1996. No inference is intended with respect 
to taxable years prior to the effective date.

14. Treatment of bonds issued by the Federal Home Loan Bank Board under 
        the Federal guarantee rules (sec. 774 of the bill and sec. 149 
        of the Code)

                              Present Law

    Generally, interest on bonds which are Federally guaranteed 
do not qualify for tax-exemption for Federal income tax 
purposes. Certain exceptions are provided including otherwise 
qualifying bonds guaranteed by the Federal Housing 
Administration, the Veterans' Administration, the Federal 
National Mortgage Association, the Federal Home Loan Mortgage 
Corporation, and the Government National Mortgage Association.

                           Reasons for Change

    The Committee believes that because of a unique set of 
circumstances it is appropriate for the Federal Home Loan Bank 
Board (FHLBB) to be given this treatment. This should 
facilitate the FHLBB in meeting its obligations under the 
Community Redevelopment Act in a manner not unlike that 
currently available to the Federal National Mortgage 
Association and the Federal Home Loan Mortgage Corporation.

                        Explanation of Provision

    Bonds guaranteed by the Federal Home Loan Bank Board are 
not treated as Federally guaranteed for purposes of the Federal 
guarantee prohibition generally applicable to tax-exempt bonds.

                             Effective Date

    The provision is effective for bonds issued after the date 
of enactment.

15. Increased period of deduction of traveling expenses while working 
        away from home on qualified construction projects (sec. 775 of 
        the bill and sec. 162 of the Code)

                              Present Law

    A taxpayer is allowed, subject to limitations, to deduct 
the ordinary and necessary expenses of carrying on a trade or 
business, including the trade or business of being an employee. 
Expenses of carrying on the trade or business of being an 
employee are miscellaneous itemized deductions, deductible only 
to the extent they exceed 2 percent of adjusted gross income.
    Deductible expenses include travel expenses (including 
amounts expended for meals and lodging) while temporarily away 
from home in pursuit of a trade or business. In the absence of 
facts and circumstances indicating otherwise, a taxpayer is 
considered to be temporarily away from home if the period of 
employment away from home does not exceed one year. If the 
period of employment away from home exceeds one year, the 
taxpayer is considered to be on an indefinite or permanent work 
assignment, and travel expenses (including amounts expended for 
meals and lodging) are not deductible.

                           Reasons for Change

    The Committee believes that construction workers on 
qualified projects, who by the nature of their jobs are 
required to be on site, should be subject to a more liberal 
standard in determining whether they are temporarily away from 
home.

                        Explanation of Provision

    The bill provides that, in the absence of facts and 
circumstances indicating otherwise, taxpayers employed on 
qualified construction projects will be considered to be 
temporarily away from home if the period of their employment 
away from home does not exceed 18 months (24 months if the 
qualified construction project is in a remote location), rather 
than one year as under present law. A qualified construction 
project is one that is identifiable and that has a completion 
date that is reasonably expected to occur within five years of 
its starting date. A qualified construction project is 
considered to be in a remote location if it is located in an 
area which lacks adequate housing, educational, medical or 
other facilities necessary for families.
    The revised standards established by the bill apply to 
taxpayers who continue to maintain a household, and therefore 
incur duplicative expenses, at their place of principal 
residence.

                             Effective Date

    The provision is effective for amounts paid or incurred in 
taxable years beginning after December 31, 1997.

16. Charitable contribution deduction for certain expenses incurred in 
        support of Native Alaskan subsistence whaling (sec. 776 of the 
        bill and sec. 170 of the Code)

                              Present Law

    In computing taxable income, individuals who do not elect 
the standard deduction may claim itemized deductions, including 
a deduction (subject to certain limitations) for charitable 
contributions or gifts made during the taxable year to a 
qualified charitable organization or governmental entity (sec. 
170). Individuals who elect the standard deduction may not 
claim a deduction for charitable contributions made during the 
taxable year.
    No charitable contribution deduction is allowed for a 
contribution of services. However, unreimbursed expenditures 
made incident to the rendition of services to an organization, 
contributions to which are deductible, may constitute a 
deductible contribution (Treas. Reg. sec. 1.170A-1(g)). 
Specifically, section 170(j) provides that no charitable 
contribution deduction is allowed for traveling expenses 
(including amounts expended for meals and lodging) while away 
from home, whether paid directly or be reimbursement, unless 
there is no significant element of personal pleasure, 
recreation, or vacation in such travel.

                           Reasons for Change

    The Committee believes that it is appropriate to provide a 
charitable contribution deduction up to $7,500 per year for 
certain expenses incurred by individuals engaging in sanctioned 
subsistence whaling activities.

                        Explanation of Provision

    The bill allows individuals to claim a deduction under 
section 170 not exceeding $7,500 per taxable year for certain 
expenses incurred in carrying out sanctioned whaling 
activities. The deduction is available only to an individual 
who is recognized by the Alaska Eskimo Whaling Commission as a 
whaling captain charged with the responsibility of maintaining 
and carrying out sanctioned whaling activities. The deduction 
is available for reasonable and necessary expenses paid by the 
taxpayer during the taxable year for (1) the acquisition and 
maintenance of whaling boats, weapons, and gear used in 
sanctioned whaling activities, (2) the supplying of food for 
the crew and other provisions for carrying out such activities, 
and (3) storage and distribution of the catch from such 
activities.
    For purposes of the provision, the term ``sanctioned 
whaling activities'' means subsistence bowhead whale hunting 
activities conducted pursuant to the management plan of the 
AlaskaEskimo Whaling Commission. No inference is intended 
regarding the deductibility of any whaling expenses incurred in a 
taxable year ending before the date of enactment of the bill.

                             Effective Date

    The provision is effective for taxable years ending after 
the date of enactment.

17. Modification of empowerment zone and enterprise community criteria 
        in the event of future designations of additional zones and 
        communities (sec. 777 of the bill and sec. 1392 of the Code)

                              Present Law

    Pursuant to the Omnibus Budget Reconciliation Act of 1993 
(OBRA 1993), the Secretaries of the Department of Housing and 
Urban Development (HUD) and the Department of Agriculture 
designated a total of nine empowerment zones and 95 enterprise 
communities on December 21, 1994. As required by law, six 
empowerment zones are located in urban areas (with aggregate 
population for the six designated urban empowerment zones 
limited to 750,000) and three empowerment zones are located in 
rural areas.\66\ Of the enterprise communities, 65 are located 
in urban areas and 30 are located in rural areas (sec. 1391). 
Designated empowerment zones and enterprise communities were 
required to satisfy certain eligibility criteria, including 
specified population limitations (sec. 1392(a)(1)), geographic 
size limitations (sec. 1392(a)(3)), and poverty rate criteria 
for census tracts within the empowerment zone or enterprise 
community (sec. 1392(a)(4)) as determined by the most recent 
decennial census data available.
---------------------------------------------------------------------------
    \66\ The six designated urban empowerment zones are located in New 
York City, Chicago, Atlanta, Detroit, Baltimore, and Philadelphia-
Camden (New Jersey). The three designated rural empowerment zones are 
located in Kentucky Highlands (Clinton, Jackson, and Wayne counties 
Kentucky), Mid-Delta Mississippi (Bolivar, Homes, Humphreys, Leflore 
counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo, 
Starr, and Willacy counties, Texas).
---------------------------------------------------------------------------
    The following tax incentives are available for certain 
businesses located in empowerment zones: (1) a 20-percent wage 
credit for the first $15,000 of wages paid to a zone resident 
who works in the zone; (2) an additional $20,000 of section 179 
expensing for ``qualified zone property'' placed in service by 
an ``enterprise zone business'' (accordingly, certain 
businesses operating in empowerment zones are allowed up to 
$38,500 of expensing for 1998); and (3) special tax-exempt 
financing for certain zone facilities.
    The 95 enterprise communities are eligible for the special 
tax-exempt financing benefits but not the other tax incentives 
available in the nine empowerment zones. In addition to these 
tax incentives, OBRA 1993 provided that Federal grants would be 
made to designated empowerment zones and enterprise 
communities.
    The tax incentives for empowerment zones and enterprise 
communities generally will be available during the period that 
the designation remains in effect, i.e., a 10-year period. 
Under present law, no additional empowerment zones or 
enterprise communities may be designated.

                           Reasons for Change

    In view of the unique characteristics of the States of 
Alaska and Hawaii, and the economically depressed areas within 
those States, the Committee believes that the generally 
applicable criteria for empowerment zones and enterprise 
communities should be modified in the event that Congress 
decides to provide for additional designations of such zones or 
communities.

                        Explanation of Provision

    The bill modifies the present-law empowerment zone and 
enterprise community designation criteria under section 1392 so 
that, in the event that additional empowerment zones or 
enterprise communities are authorized to be designated in the 
future, any zones or communities designated in the States of 
Alaska or Hawaii will not be subject to the general size 
limitations under section 1392(a)(3), nor will such zones or 
communities be subject to the general poverty-rate criteria 
under section 1392(a)(4). Instead, nominated areas in either 
State will be eligible for designation as an empowerment zone 
or enterprise community if, for each census tract or block 
group within such area, at least 20 percent of the families 
have incomes which are 50 percent or less of the State-wide 
median family income. Such zones and communities will be 
subject to the population limitations under present-law section 
1392(a)(1).

                             Effective Date

    The provision is effective on the date of enactment.

18. Deductibility of meals provided for the convenience of the employer 
        (sec. 778 of the bill and sec. 132 of the Code)

                              Present Law

    In general, subject to several exceptions, only 50 percent 
of business meal and entertainment expenses are allowed as a 
deduction (sec. 274(n)). Under one exception, the value of 
meals that are excludable from employees'' incomes as a de 
minimis fringe benefit (sec. 132) are fully deductible by the 
employer.
    In addition, the courts that have considered the issue have 
held that if meals are provided for the convenience of the 
employer pursuant to section 119 they are fully deductible 
(Boyd Gaming Corp. v. Commissioner \67\ and Gold 
Coast Hotel & Casino v. I.R.S. \68\ ).
---------------------------------------------------------------------------
    \67\106 T.C. No. 19 (May 23, 1996).
    \68\U.S.D.C. Nev. CV-5-94-1146-HDM(LRL) (September 26, 1996).
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that it is consistent with the case 
law to provide for full deductibility of business meals that 
are excludible from employees' incomes because they are 
provided for the convenience of the employer.

                        Explanation of Provision

    The bill provides that meals that are excludable from 
employees'' incomes because they are provided for the 
convenience of the employer pursuant to section 119 of the Code 
are excludable as a de minimis fringe benefit and therefore are 
fully deductible by the employer. No inference is intended as 
to whether such meals are fully deductible under present law.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

19. Clarification of standard to be used in determining tax status of 
        retail securities brokers (sec. 779 of the bill)

                              Present Law

    Under present law, whether a worker is an employee or 
independent contractor is generally determined under a common-
law facts and circumstances test. An employer-employee 
relationship is generally found to exist if the service 
recipient has not only the right to control the result to be 
accomplished by the work, but also the means by which the 
result is to be accomplished. The Internal Revenue Service 
(``IRS'') generally takes the position that the presence and 
extent of instructions is important in reaching a conclusion as 
to whether a business retains the right to direct and control 
the methods by which a worker performs a job, but that it is 
also important to consider the weight to be given those 
instructions if they are imposed by the business only in 
compliance with governmental or governing body regulations. The 
IRS training manual provides that if a business requires its 
workers to comply with rules established by a third party 
(e.g., municipal building codes related to construction), the 
fact that such rules are imposed should be given little weight 
in determining the worker's status.

                           Reasons for Change

    Broker-dealers are required to supervise the activities of 
their affiliated registered representatives in order to comply 
with State and Federal investor protection laws. The Committee 
believes that compliance with duty-to-supervise requirements 
does not constitute evidence of control for purposes of the 
common-law test for determining worker classification.

                        Explanation of Provision

    Under the bill, in determining the status of a registered 
representative of a broker-dealer for Federal tax purposes, no 
weight is to be given to instructions from the service 
recipient which are imposed only in compliance with 
governmental investor protection standards or investor 
protection standards imposed by a governing body pursuant to a 
delegation by a Federal or State agency. It is intended that 
the provision be interpreted to apply for all Federal tax 
purposes.

                             Effective Date

    The provision is effective with respect to services 
performed after December 31, 1997. No inference is intended 
that the treatment under the proposal is not present law.
                TITLE VIII. REVENUE-INCREASE PROVISIONS

                         A. Financial Products

1. Require recognition of gain on certain appreciated positions in 
        personal property (sec. 801(a) of the bill and new sec. 1259 of 
        the Code)

                              Present Law

    In general, gain or loss is taken into account for tax 
purposes when realized. Gain or loss generally is realized with 
respect to a capital asset at the time the asset is sold, 
exchanged, or otherwise disposed of. Gain or loss is determined 
by comparing the amount realized with the adjusted basis of the 
particular property sold. In the case of corporate stock, the 
basis of shares purchased at different dates or different 
prices generally is determined by reference to the actual lot 
sold if it can be identified. Special rules under the Code can 
defer or accelerate recognition in certain situations.
    The recognition of gain or loss is postponed for open 
transactions. For example, in the case of a ``short sale'' 
(i.e., when a taxpayer sells borrowed property such as stock 
and closes the sale by returning identical property to the 
lender), no gain or loss on the transaction is recognized until 
the closing of the borrowing.
    Transactions designed to reduce or eliminate risk of loss 
on financial assets generally do not cause realization. For 
example, a taxpayer may lock in gain on securities by entering 
into a ``short sale against the box,'' i.e., when the taxpayer 
owns securities that are the same as, or substantially 
identical to, the securities borrowed and sold short. The form 
of the transaction is respected for income tax purposes and 
gain on the substantially identical property is not recognized 
at the time of the short sale. Pursuant to rules that allow 
specific identification of securities delivered on a sale, the 
taxpayer can obtain open transaction treatment by identifying 
the borrowed securities as the securities delivered. When it is 
time to close out the borrowing, the taxpayer can choose to 
deliver either the securities held or newly-purchased 
securities. The Code provides rules only to prevent taxpayers 
from using short sales against the box to accelerate loss or to 
convert short-term capital gain into long-term capital gain or 
long-term capital loss into short-term capital loss (sec. 
1233(b)).
    Taxpayers also can lock in gain on certain property by 
entering into offsetting positions in the same or similar 
property. Under the straddle rules, when a taxpayer realizes a 
loss on one offsetting position in actively-traded personal 
property, the taxpayer generally can deduct this loss only to 
the extent the loss exceeds the unrecognized gain in the other 
positions in the straddle. In addition, rules similar to the 
short sale rules prevent taxpayers from changing the tax 
character of gains and losses recognized on the offsetting 
positions in a straddle (sec. 1092).
    Taxpayers may engage in other arrangements, such as 
``futures contracts,'' ``forward contracts,'' ``equity swaps'' 
and other ``notional principal contracts'' where the risk of 
loss and opportunity for gain with respect to property are 
shifted to another party (the ``counterparty''). These 
arrangements do not result in the recognition of gain by the 
taxpayer.
    The Code accelerates the recognition of gains and losses in 
certain cases. For example, taxpayers are required each year to 
mark to market certain regulated futures contracts, foreign 
currency contracts, non-equity options, and dealer equity 
options, and to take any capital gain or loss thereon into 
account as 40 percent short-term gain and 60 percent long-term 
gain (sec. 1256).

                           Reasons for Change

    In general, a taxpayer cannot completely eliminate risk of 
loss (and opportunity for gain) with respect to property 
without disposing of the property in a taxable transaction. In 
recent years, however, several financial transactions have been 
developed or popularized which allow taxpayers to substantially 
reduce or eliminate their risk of loss (and opportunity for 
gain) without a taxable disposition. Like most taxable 
dispositions, many of these transactions also provide the 
taxpayer with cash or other property in return for the interest 
that the taxpayer has given up.
    One of these transactions is the ``short sale against the 
box.'' In such a transaction, a taxpayer borrows and sells 
shares identical to the shares the taxpayer holds. By holding 
two precisely offsetting positions, the taxpayer is insulated 
from economic fluctuations in the value of the stock. While the 
short against the box is in place, the taxpayer generally can 
borrow a substantial portion of the value of the appreciated 
long stock so that, economically, the transaction strongly 
resembles a sale of the long stock.
    Other transactions that have been used by taxpayers to 
transfer risk of loss (and opportunity for gain) involve 
entering into notional principal contracts or futures or 
forward contracts to deliver the same stock. For example, a 
taxpayer holding appreciated stock may enter into an ``equity 
swap'' which requires the taxpayer to make payments equal to 
the dividends and any increase in the stock's value for a 
specified period, and entitles the taxpayer to receive payments 
equal to any depreciation in value. The terms of such swaps 
also frequently entitle the shareholder to receive payments 
during the swap period of a market rate of return (e.g., the 
Treasury-bill rate) on a notional principal amount equal to the 
value of the shareholder's appreciated stock, making the 
transaction strongly resemble a taxable exchange of the 
appreciated stock for an interest-bearing asset.

                        Explanation of Provision

General rule

    The bill requires a taxpayer to recognize gain (but not 
loss) upon entering into a constructive sale of any appreciated 
position in stock, a partnership interest or certain debt 
instruments as if such position were sold, assigned or 
otherwise terminated at its fair market value on the date of 
the constructive sale.
    If the requirements for a constructive sale are met, the 
taxpayer would recognize gain in a constructive sale as if the 
position were sold at its fair market value on the date of the 
sale and immediately repurchased. Except as provided in 
Treasury regulations, a constructive sale would generally not 
be treated as a sale for other Code purposes. An appropriate 
adjustment in the basis of the appreciated financial position 
would be made in the amount of any gain realized on 
aconstructive sale, and a new holding period of such position would 
begin as if the taxpayer had acquired the position on the date of the 
constructive sale.
    A taxpayer is treated as making a constructive sale of an 
appreciated position when the taxpayer (or, in certain 
circumstances, a person related to the taxpayer) does one of 
the following: (1) enters into a short sale of the same 
property, (2) enters into an offsetting notional principal 
contract with respect to the same property, or (3) enters into 
a futures or forward contract to deliver the same property. A 
constructive sale under any part of the definition occurs if 
the two positions are in property that, although not the same, 
is substantially identical. In addition, in the case of an 
appreciated financial position that is a short sale, a notional 
principal contract or a futures or forward contract, the holder 
is treated as making a constructive sale when it acquires the 
same property as the underlying property for the position. 
Finally, to the extent provided in Treasury regulations, a 
taxpayer is treated as making a constructive sale when it 
enters into one or more other transactions, or acquires one or 
more other positions, that have substantially the same effect 
as any of the transactions described.
    The positions of two related persons are treated as 
together resulting in a constructive sale if the relationship 
is one described in section 267 or section 707(b) and the 
transaction is entered into with a view toward avoiding the 
purposes of the provision.
    Whether any part of the constructive sale definition is met 
by one or more appreciated financial positions and offsetting 
transactions generally will be determined as of the date the 
last of such positions or transactions is entered into. More 
than one appreciated financial position or more than one 
offsetting transaction can be aggregated to determine whether a 
constructive sale has occurred. For example, it is possible 
that no constructive sale would result if one appreciated 
financial position and one offsetting transaction were 
considered in isolation, but that a constructive sale would 
result if the appreciated financial position were considered in 
combination with two transactions. Where the standard for a 
constructive sale is met with respect to only a pro rata 
portion of a taxpayer's appreciated financial position (e.g., 
some, but not all, shares of stock), that portion would be 
treated as constructively sold under the provision. If there is 
a constructive sale of less than all of any type of property 
held by the taxpayer, the specific property deemed sold would 
be determined under the rules governing actual sales, after 
adjusting for previous constructive sales under the bill. Under 
the regulations to be issued by the Treasury, either a 
taxpayer's appreciated financial position or its offsetting 
transaction might in some circumstances be disaggregated on a 
non-pro rata basis for purposes of the constructive sale 
determination.
    The bill provides an exception from constructive sale 
treatment for any transaction that is closed before the end of 
the 30th day after the close of the taxable year in which it 
was entered into. This exception does not apply, however, where 
a transaction is closed during the last 60 days of the taxable 
year or within 30 days thereafter (the ``90-day period'') 
unless (1) the taxpayer holds the appreciated financial 
position to which the transaction relates (e.g., the stock 
where the offsetting transaction is a short sale) throughout 
the 60-day period beginning on the date the transaction is 
closed and (2) at no time during such 60-day period is the 
taxpayer's risk of loss reduced (under the principles of 
section 246(c)(4)) by holding positions with respect to 
substantially similar or related property. These requirements 
do not apply to a transaction that is closed during the 90-day 
period where a similar transaction is reopened during such 
period, so long as the reopened transaction is closed during 
the 90-day period and the requirements of the previous sentence 
are met after such closing.
    A transaction that has resulted in a constructive sale of 
an appreciated financial position (e.g., a short sale) is not 
treated as resulting in a constructive sale of another 
appreciated financial position so long as the taxpayer holds 
the position which was treated as constructively sold. However, 
when that position is assigned, terminated or disposed of by 
the taxpayer, the taxpayer immediately thereafter is treated as 
entering into the transaction that resulted in the constructive 
sale (e.g., the short sale) if it remains open at that time. 
Thus, the transaction can cause a constructive sale of another 
appreciated financial position at any time thereafter. For 
example, assume a taxpayer holds two appreciated stock 
positions and one offsetting short sale, and the taxpayer 
identifies the short sale as offsetting one of the stock 
positions. If the taxpayer then sells the stock position that 
was identified, the identified short position would cause a 
constructive sale of the taxpayer's other stock position at 
that time.

Definitions

    An appreciated financial position is defined as any 
position with respect to any stock, debt instrument, or 
partnership interest, if there would be gain upon a taxable 
disposition of the position for its fair market value. A 
``position'' is defined as an interest, including a futures or 
forward contract, short sale, or option. An exception is 
provided for debt instruments that are not convertible and the 
interest on which is either fixed, payable at certain variable 
rates (Treas. reg. sec. 1.860G-1(a)(3)) or is based on certain 
interest payments on a pool of mortgages. Other debt 
instruments, including those identified as part of a hedging or 
straddle transaction, are appreciated financial positions.
    A notional principal contract is treated as an offsetting 
notional principal contract, and thus, results in a 
constructive sale of an appreciated financial position, if it 
requires the holder of the appreciated financial position to 
pay (or provide a contractual credit for) all or substantially 
all of the investment yield and appreciation on the position 
for a specified period and also gives the holder a right to be 
reimbursed for (or receive credit for) all or substantially all 
of any decline in value of the position.
    A forward contract results in a constructive sale of an 
appreciated financial position only if the forward contract 
provides for delivery of a substantially fixed amount of 
property and a substantially fixed price. Thus, a forward 
contract providing for delivery of an amount of property, such 
as shares of stock, that is subject to significant variation 
under the contract terms does not result in a constructive 
sale.
    A constructive sale does not include a transaction 
involving an appreciated financial position that is marked to 
market, including positions governed by section 475 (mark to 
market for securities dealers) or section 1256 (mark to market 
for futures contracts, options and currency contracts). Nor 
does a constructive sale include any contract for sale of an 
appreciated financial position which is not a ``marketable 
security'' (as defined in section 453(f)) if the contract 
settles within one year after the date it is entered into.

Treasury guidance

    The bill provides regulatory authority to the Treasury to 
treat as constructive sales certain transactions that have 
substantially the same effect as those specified (i.e., short 
sales, offsetting notional principal contracts and futures or 
forward contracts to deliver the same or substantially similar 
property).
    It is anticipated that the Treasury will use the 
provision's authority to treat as constructive sales other 
financial transactions that, like those specified in the 
provision, have the effect of eliminating substantially all of 
the taxpayer's risk of loss and opportunity for income or gain 
with respect to the appreciated financial position. Because 
this standard requires reduction of both risk of loss and 
opportunity for gain, it is intended that transactions that 
reduce only risk of loss or only opportunity for gain will not 
be covered. Thus, for example, it is not intended that a 
taxpayer who holds an appreciated financial position in stock 
will be treated as having made a constructive sale when the 
taxpayer enters into a put option with an exercise price equal 
to the current market price (an ``at the money'' option). 
Because such an option reduces only the taxpayer's risk of 
loss, and not its opportunity for gain, the above standard 
would not be met.
    For purposes of the provision, it is not intended that risk 
of loss and opportunity for gain be considered separately. 
Thus, if a transaction has the effect of eliminating a portion 
of the taxpayer's risk of loss and a portion of the taxpayer's 
opportunity for gain with respect to an appreciated financial 
position which, taken together, are substantially all of the 
taxpayer's risk of loss and opportunity for gain, it is 
intended that Treasury regulations will treat this transaction 
as a constructive sale of the position.
    It is anticipated that the Treasury regulations, when 
issued, will provide specific standards for determining whether 
several common transactions will be treated as constructive 
sales. One such transaction is a ``collar.'' In a collar, a 
taxpayer commits to an option requiring him to sell a financial 
position at a fixed price (the ``call strike price'') and has 
the right to have his position purchased at a lower fixed price 
(the ``put strike price''). For example, a shareholder may 
enter into a collar for a stock currently trading at $100 with 
a put strike price of $95 and a call strike price of $110. The 
effect of the transaction is that the seller has transferred 
the rights to all gain above the $110 call strike price and all 
loss below the $95 put strike price; the seller has retained 
all risk of loss and opportunity for gain in the range price 
between $95 and $110. A collar can be a single contract or can 
be effected by using a combination of put and call options.
    In order to determine whether collars have substantially 
the same effect as the transactions specified in the provision, 
it is anticipated that Treasury regulations will provide 
specific standards that take into account various factors with 
respect to the appreciated financial position, including its 
volatility. Similarly, it is expected that several aspects of 
the collar transaction will be relevant, including the spread 
between the put and call prices, the period of the transaction, 
and the extent to which the taxpayer retains the right to 
periodic payments on the appreciated financial position (e.g., 
the dividends on collared stock). The Committee expects that 
the Treasury regulations with respect to collars will be 
applied prospectively, except in cases to prevent abuse.
    Another common transaction for which a specific regulatory 
standard may be appropriate is a so-called ``in-the-money'' 
option, i.e., a put option where the strike price is 
significantly above the current market price or a call option 
where the strike price is significantly below the current 
market price. For example, if a shareholder purchases a put 
option exercisable at a future date (a so-called ``European'' 
option) with a strike price of $120 with respect to stock 
currently trading at $100, the shareholder has eliminated all 
risk of loss on the position for the option period and assured 
himself of all gain on the stock for any appreciation up to 
$120. In determining whether such a transaction will be treated 
as a constructive sale, it is anticipated that Treasury 
regulations will provide a specific standard that takes into 
account many of the factors described above with respect to 
collars, including the yield and volatility of the stock and 
the period and other terms of the option.
    For collars, options and some other transactions, one 
approach that Treasury might take in issuing regulations is to 
rely on option prices and option pricing models. The price of 
an option represents the payment the market requires to 
eliminate risk of loss (for a put option) and to purchase the 
right to receive yield and gain (for a call option). Thus, 
option pricing offers one model for quantifying both the total 
risk of loss and opportunity for gain with respect to an 
appreciated financial position, as well as the proportions of 
these total amounts that the taxpayer has retained.
    In addition to setting specific standards for treatment of 
these and other transactions, it may be appropriate for 
Treasury regulations to establish ``safe harbor'' rules for 
common financial transactions that do not result in 
constructive sale treatment. An example might be a collar with 
a sufficient spread between the put and call prices, a 
sufficiently limited period and other relevant terms such that, 
regardless of the particular characteristics of the stock, the 
collar probably would not transfer substantially all risk of 
loss and opportunity for gain.

                             Effective Date

    The provision is effective for constructive sales entered 
into after June 8, 1997. A special rule is provided for 
transactions before this date which would have been 
constructive sales under the provision. The positions in such a 
transaction will not be taken into account in determining 
whether a constructive sale after June 8, 1997, has occurred, 
provided that the taxpayer identifies the offsetting positions 
of the earlier transaction within 30 days after the date of 
enactment. The special rule will cease to apply on the date the 
taxpayer ceases to hold any of the offsetting positions so 
identified.
    In the case of a decedent dying after June 8, 1997, if (1) 
a constructive sale of an appreciated financial position (as 
defined in the provision) occurred before such date, (2) the 
transaction remains open for not less than two years, and (3) 
the transaction is not closed in a taxable transaction within 
30 days after the date of enactment, such position (and any 
property related to it, under the principles of the provision) 
will be treated as property constituting rights to receive 
income in respect of a decedent under section 691.

2. Election of mark to market for securities traders and for traders 
        and dealers in commodities (sec. 801(b) of the bill and new 
        sec. 475(d) of the Code)

                              Present Law

    A dealer in securities must compute its income pursuant to 
a mark-to-market method of accounting (sec. 475). Any security 
that is inventory must be included in inventory at its fair 
market value, and any security that is not inventory and that 
is held at year end is treated as sold for its fair market 
value. There is an exception to mark-to-market treatment for 
any security identified as held for investment or not held for 
sale to customers (or a hedge of such a security). For this 
purpose, a ``dealer in securities'' is a person who (1) 
regularly purchases securities from or sells securities to 
customers in the ordinary course of a trade or business, or (2) 
regularly offers to enter into, assume, offset, assign or 
otherwise terminate positions in securities with customers in 
the ordinary course of a trade or business. For this purpose, 
``security'' means any stock in a corporation; any partnership 
or beneficial ownership interest in a widely-held or publicly-
traded partnership or trust; any note, bond, debenture, or 
other evidence of indebtedness; an interest rate, currency or 
equity notional principal contract; any evidence of an interest 
in, or a derivative financial instrument of any security 
described above; and certain positions identified as hedges of 
any of the above. Any gain or loss taken into account under 
these provisions generally is treated as ordinary gain or loss.
    Traders in securities generally are taxpayers who engage in 
a trade or business involving active sales or exchanges of 
securities on the market, rather than to customers. The mark-
to- market treatment applicable to securities dealers does not 
apply to traders in securities or to dealers in other property.

                           Reasons for Change

    Mark-to-market accounting generally provides a clear 
reflection of income with respect to assets that are traded in 
established markets. For market-valued assets, mark-to-market 
accounting imposes few burdens and offers few opportunities for 
manipulation. Securities and exchange- traded commodities have 
determinable market values, and securities traders and 
commodities traders and dealers regularly calculate year-end 
values of their assets in determining their income for 
financial statement purposes. Many commodities dealers also 
utilize year-end values in adjusting their inventory using the 
lower-of-cost-or-market method for Federal income tax purposes.

                        Explanation of Provision

    The bill allows securities traders and commodities traders 
and dealers to elect application of the mark-to-market 
accounting rules, which apply only to securities dealers under 
present law. All securities held by an electing taxpayer in 
connection with a trade or business as a securities trader, and 
all commodities held by an electing taxpayer in connection with 
a trade or business as a commodities dealer or trader, are 
subject to mark-to-market treatment. The taxpayer is allowed to 
identify property not held in connection with its trade or 
business as not subject to the election. As for securities 
dealers under present law, gain or loss recognized by an 
electing taxpayer under the provision is ordinary gain or loss.
    With respect to a commodities dealer, all of the provisions 
of present law section 475 apply as if commodities were 
securities. Commodities for purposes of the provision would 
include only commodities of a kind customarily dealt in on an 
organized commodities exchange. It is anticipated that Treasury 
regulations will provide that section 475(c)(4), which prevents 
a dealer from treating certain notional principal contracts and 
other derivative financial instruments as held for investment, 
will apply only to contacts and instruments referenced to 
commodities in the case of a commodities dealer.
    For securities traders, some of the provisions of present 
law section 475 apply, but others that are specific to dealers 
do not. For example, because a securities trader does not hold 
inventory, the mark-to-market rules for inventory are not 
applicable to traders. In addition, securities that are not 
held in connection with the trade or business of a securities 
trader are excluded from mark-to-market treatment if the trader 
identifies the securities in the trader's records before the 
close of the day on which they are acquired under rules similar 
to those of section 475(b)(2) for dealers. For purposes of the 
bill, a security that hedges another security that is held in 
connection with the trade or business would be treated as so 
held. The provisions applicable to securities traders apply to 
commodities traders as if commodities were securities.
    The election is to be made separately with respect to the 
taxpayer's entire business as (1) a securities trader, (2) a 
commodities trader, or (3) a commodities dealer. Thus, a 
taxpayer that is both a commodities dealer and a securities 
trader may make the election with respect to one business, but 
not the other. The election will be made in the time and manner 
prescribed by the Secretary of the Treasury and will be 
effective for the taxable year for which it is made and all 
subsequent taxable years, unless revoked with the consent of 
the Secretary.

                             Effective Date

    The provision applies to taxable years of traders or 
dealers ending after the date of enactment. For a taxpayer 
making the election, the adjustments required under section 481 
as a result of the change in accounting method are required to 
be taken into account ratably over the four-year period 
beginning in the first taxable year for which the election is 
in effect.
    For elections made for the first taxable year ending after 
the date of enactment, the taxpayer must identify the 
securities or commodities to which the election will apply 
within 30 days of the date of enactment.

3. Limitation on exception for investment companies under section 351 
        (sec. 802 of the bill and sec. 351(e) of the Code)

                              Present Law

    A contribution of property to a corporation does not result 
in gain or loss to the contributing shareholder if the 
contributor is part of a group of contributors who own 80 
percent of the voting stock of each class of stock entitled to 
vote. A contribution of property to a partnership generally 
does not result in recognition of gain or loss to the 
contributing partner.
    Certain Code sections provide exceptions to the general 
rule for deferral of pre-contribution gain and loss. Gain or 
loss is recognized upon a contribution by a shareholder to a 
corporation that is an investment company (sec. 351(e)(1)). 
Gain, but not loss, is recognized upon a contribution by a 
partner to a partnership that would be treated as an investment 
company if the partnership were a corporation (sec. 721(b)). 
Under Treasury regulations, a contribution of property by a 
shareholder to a corporation, or by a partner to a partnership, 
is treated as a transfer to an investment company only if (1) 
the contribution results, directly or indirectly, in a 
diversification of the transferor's interests, and (2) the 
transferee is (a) a regulated investment company (``RIC''), (b) 
a real estate investment trust (``REIT''), or (c) a corporation 
more than 80 percent of the assets of which by value (excluding 
cash and non-convertible debt instruments) are readily 
marketable stocks or securities or interests in RICs or REITs 
that are held for investment (Treas. reg. sec. 1.351-1(c)(1)).

                           Reasons for Change

    Under present law and regulations, a partnership or a 
corporation is not treated as an investment company even though 
more than 80 percent of its assets are a combination of readily 
marketable stock and securities and other high-quality 
investment assets of determinable values, such as non-
convertible debt instruments, notional principal contracts, 
foreign currency and interests in metals. Thus, under present 
law, a partner may contribute stock, securities or other assets 
to an investment partnership, and a shareholder may contribute 
such assets to a corporation (e.g., a RIC) and, without current 
taxation, receive an interest in an entity that is essentially 
a pool of high-quality investment assets. Where, as a result of 
such a transaction, the partner or shareholder has diversified 
or otherwise changed the nature of the financial assets in 
which it has an interest, the transaction has the effect of a 
taxable exchange. Of particular concern to the Committee is the 
reappearance of so-called ``swap funds,'' which are 
partnerships or RICs that are structured to fall outside the 
definition of an investment company, and thereby allow 
contributors to make tax-free contributions of stock and 
securities in exchange for an interest in an entity that holds 
similar assets.

                        Explanation of Provision

    The bill modifies the definition of an investment company 
for purposes of determining whether a transfer of property to a 
partnership or corporation results in gain recognition (secs. 
351(e) and 721(b)) by requiring that certain assets be taken 
into account for purposes of the definition, in addition to 
readily marketable stock and securities as under present law.
    Under the bill, an investment company includes a RIC or 
REIT as under present law. In addition, under the bill, an 
investment company includes any corporation or partnership if 
more than 80 percent of its assets by value consist of money, 
stocks and other equity interests in a corporation, evidences 
of indebtedness, options, forward or futures contracts, 
notional principal contracts or derivatives, foreign currency, 
certain interests in precious metals, interests in REITs, RICs, 
common trust funds and publicly-traded partnerships or other 
interests in non-corporate entities that are convertible into 
or exchangeable for any of the assets listed. Other assets that 
count toward the 80-percent test are an interest in an entity 
substantially all of the assets of which are assets listed, and 
to the extent provided in Treasury regulations, interests in 
other entities, but only to the extent of the value of the 
interest that is attributable to assets listed.\69\ Finally, 
the bill grants regulatory authority to the Treasury to add 
other assets to the list set out in the provision, or, under 
certain circumstances, to remove items from the list.
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    \69\ Until such regulations are issued, it is intended that the 
Treasury regulations promulgated under the similar provisions of 
section 731(c)(2) generally will apply. Specifically, it is intended 
that an entity will meet the ``substantially all'' requirement if 90 
percent or more of its assets are listed assets (Treas. reg. sec. 
1.731-2(c)(3)(i)). Similarly, with respect to partnerships and other 
non-corporate entities, it is intended that, where 20 percent or more 
(but less than 90 percent) of the entity's assets consist of listed 
assets, a pro rata portion of the interest in the entity will be 
treated as a listed asset. (Treas. reg. sec. 1.731-2(c)(3)(ii))
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    The bill is intended to change only the types of assets 
considered in the definition of an investment company in the 
present Treasury regulations (Treas. reg. sec. 1.351-
1(c)(1)(ii)) and not to override the other provisions of those 
regulations. For example, the bill does not override (1) the 
requirement that only assets held for investment are considered 
for purposes of the definition (Treas. reg. sec. 1.351-
1(c)(3)), (2) the rule treating the assets of a subsidiary as 
owned proportionally by a parent owning 50 percent or more of 
its stock (Treas. reg. sec. 1.351-1(c)(4)), (3) the requirement 
that the investment company determination consider any plan 
with regard to an entity's assets in existence at the time of 
transfer (Treas. reg. sec. 1.351-1(c)(2) 70), and 
(4) the requirement that a contribution of property to an 
investment company result in diversification in order for gain 
to be recognized (Treas. reg. sec. 1.351-1(c)(1)(i)).
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    \70\ Although money is counted toward the 80-percent test under the 
bill, this provision in the regulations should have the effect that 
where money is contributed and, pursuant to a plan, assets not treated 
as stock or securities under the bill are either purchased or 
contributed by other parties, the investment company determination 
would be made only on the basis of the entity's assets after such 
events.
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                             Effective Date

    The provision applies to all transfers after June 8, 1997, 
in taxable years ending after such date. An exception is 
provided for transfers of a fixed amount of securities made 
pursuant to a binding written contract in effect on June 8, 
1997, and at all times thereafter until the transfer.

4. Gains and losses from certain terminations with respect to property 
        (sec. 803 of the bill and sec. 1234A of the Code)

                              Present Law

    Treatment of gains and losses.--Gain from the ``sale or 
other disposition'' is the excess of the amount realized 
therefrom over its adjusted basis; loss is the excess of 
adjusted basis over the amount realized. The definition of 
capital gains and losses in section 1222 requires that there be 
a ``sale or exchange'' of a capital asset.\71\ The U.S. Supreme 
Court has held that the term ``sale or exchange'' is a narrower 
term than ``sale or other disposition.'' 72 Thus, it 
is possible from there to be a taxable income from the sale or 
other disposition of an asset without that gain being treated 
as a capital gain.
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    \71\ Code section 1221 defines a capital asset to mean property 
held by the taxpayer other than (1) property properly includible in 
inventory of the taxpayer or primarily held for sale to customers in 
the ordinary course of the taxpayer's trade or business, (2) 
depreciable and real property used in the taxpayer's trade of business, 
(3) a copyright, a literary musical; or artistic composition, letter or 
memorandum, or similar property that was created by the taxpayer (or 
whose basis is determined, in whole or in part, the basis of the 
creator, (4) accounts or notes receivable acquired in the ordinary 
course of the taxpayer's trade or business, and (5) a publication of 
the United States Government which was received from the Government 
other than by sale.
    \72\ Helvering v. William Flaccus Oak Leather Co., 313 U.S. 247 
(1941).
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    Treatment of capital gains and losses.--Long-term capital 
gains of individuals are subject to a maximum rate of tax of 28 
percent.\73\ Capital losses of individuals are allowed to the 
extent of capital gains or the lower of those gains or $3,000.
---------------------------------------------------------------------------
    \73\ See bill section 311, which provides an alternative tax rates 
on long-term capital gains of 10 percent or 20 percent for taxpayers 
otherwise marginal bracket is 15 percent or greater than 15 percent, 
respectively.
---------------------------------------------------------------------------
    Long-term capital gains of corporations are subject to the 
same rate of tax as ordinary income.\74\ Capital losses of 
corporations are allowed only to the extent of the 
corporation's capital gains; excess capital losses may be 
carried back to the 3 preceding years and carried forward for 
the succeeding years.
---------------------------------------------------------------------------
    \74\ See bill section 321, which provides an alternative tax rate 
of 30 percent on corporate capital gains on assets held lower than 5 
years.
---------------------------------------------------------------------------
    In the case of gains and losses from the sale or exchange 
of property used in a trade or business, net gains generally 
are treated as capital gain while net losses are treated as 
ordinary losses (sec. 1231).
    Court decisions interpreting the ``sale or exchange'' 
requirement.--There has been a considerable amount of 
litigation dealing with whether modifications of legal 
relationships between taxpayers is to be treated as a ``sale or 
exchange.'' For example, in Douglass Fairbanks v. U.S., 306 
U.S. 436 (1939), the U.S. Supreme Court held that gain realized 
on the redemption of bonds before their maturity is not 
entitled to capital gain treatment because the redemption was 
not a ``sale or exchange''.\75\ Several court decisions 
interpreted the ``sale or exchange'' requirement to mean that a 
disposition, that occurs as a result of a lapse, cancellation, 
or abandonment, is not a sale or exchange of a capital asset, 
but produces ordinary income or loss. For example, in 
Commissioner v. Pittston Co., 252 F. 2d 344 (2d Cir), cert. 
denied, 357 U.S. 919 (1958), the taxpayer was treated as 
receiving ordinary income from amounts received for acquisition 
from the mine owner of a contract that the taxpayer had made 
with mine owner to buy all of the coal mined at a particular 
mine for a period of 10 years on the grounds that the payments 
were in lieu of subsequent profits that would have been taxed 
as ordinary income. Similarly, Commissioner v. Starr Brothers, 
205 F. 2d 673 (1953), the Second Circuit held that a payment 
that a retail distributor received from a manufacturer in 
exchange for waiving a contract provision prohibiting the 
manufacturer from selling to the distributor's competition was 
not a sale or exchange. Likewise, in General Artists Corp. v. 
Commissioner, 205 F. 2d 360, cert. denied 346 U.S. 866 (1953), 
the Second Circuit held that amounts received by a booking 
agent for cancellation of a contract to be the exclusive agent 
of a singer was not a sale or exchange. In National-Standard 
Company v. Commissioner, 749 F. 2d 369, the Sixth Circuit held 
that a loss incurred the transfer of foreign currency to 
discharge the taxpayer's liability was an ordinary loss, since 
transfer was not a ``sale or exchange'' of that currency. More 
recently, in Stoller v. Commissioner, 994 F. 2d 855, 93-1 
U.S.T.C. par. 50349 (1993), the Court of Appeals for the 
District of Columbia held, in a transaction that preceded the 
effective date of section 1234A, that losses incurred on the 
cancellation of forward contracts to buy and sell short-term 
Government securities that formed a straddle were ordinary 
because the cancellation of the contracts was not a ``sale or 
exchange.''
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    \75\ The result in this case was overturned by enactment in 1934 of 
the predecessor of present law sec. 1271(a), see below. See section 117 
of the Revenue Act of 1934, 28 Stat. 680, 714-715.
---------------------------------------------------------------------------
    The U.S. Tax Court has held that the abandonment of 
property subject to non-recourse indebtedness is a ``sale'' 
and, therefore, any resulting loss is a capital loss. Freeland 
v. Commissioner, 74 T.C. 970 (1980); Middleton v. Commissioner, 
77 T.C. 310 (1981), aff'd per curiam 693 F.2d 124 (11th Cir. 
1982); and Yarbro v. Commissioner 45 T.C.M. 170, aff'd. 737 
F.2d 479 (5th Cir. 1984), cert. denied, 105 S.Ct. 959.
    Extinguishment treated as sale or exchange--The Internal 
Revenue Code contains provisions that deem certain transactions 
to be a sale or exchange and, therefore, any resulting gain or 
loss is to be treated as a capital gain or loss. These rules 
generally provide for ``sale or exchange'' treatment as a way 
of extending capital gain or loss treatment of those 
transactions. Under one special provision, gains and losses 
attributable to the cancellation, lapse, expiration, or other 
termination of a right or obligation with respect to certain 
personal property are treated as gains or losses from the sale 
of a capital asset (sec. 1234A). Personal property subject to 
this rule is (1) personal property of a type which is actively 
traded \76\ and which is, or would be onacquisition, a capital 
asset in the hands of the taxpayer (other than stock that is not part 
of straddle or of a corporation that is not formed or availed of to 
take positions which offset positions in personal property of its 
shareholders) and (2) a ``section 1256 contract'' \77\ which is capital 
asset in the hands of the taxpayer.\78\ Section 1234A does not apply to 
the retirement of a debt instrument.
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    \76\ Treasury Regulations generally define ``actively traded'' as 
any personal property for which there is an established financial 
market. In addition, those regulations provided that ``notional 
principal contract constitutes personal property of a type that is 
actively traded if contracts based on the same or substantially similar 
specified indices are purchased, sold, or entered into on an 
established financial market'' and that ``rights and obligations of a 
party to a notional principal contract are rights and obligations with 
respect to personal property and constitute an interest is personal 
property.'' Treas. Reg. sec. 1.092(d)-1(c).
    \77\ A ``Section 1256 contract'' means (1) any regulated futures 
contract, (2) foreign currency contract, (3) nonequity option, or (4) 
dealer equity option.
    \78\ The prsent law provisions (sec. 1234A) which treats 
cancellation, lapse, expiration, or other termination of a right or 
obligation with respect to personal property as a sale of a capital 
asset was added by Congress in 1981 when Congress adopted a number of 
provisions dealing with tax straddles. There are two components or 
``legs'' to a straddle, where the value of one leg changes inversely 
with the value of the other leg. Without a special rule, taxpayers were 
able to ``leg-out'' of the loss leg of the straddle, while retaining 
the gain leg, resulting the creation of an ordinary loss. In 1981, 
Congress believed that the effective ability of taxpayer to elect the 
character of a gain or loss leg of a straddle was unwarranted and 
provided the present law rule that a cancellation, lapse, expiration or 
other termination of a right is a sale or exchange. However, since 
straddles were the focus the 1981 legislation, that legislation was 
limited to types of property which were the subject of straddles, i.e., 
personal property (other than stock) of a type which is actively traded 
whihc is, or would be on acquisition, a capital asset in the hands of 
the taxpayer. The provision subsequently was extended to section 1256 
contracts.
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    Retirement of debt obligations treated as sale or 
exchange.--Amounts received on the retirement of any debt 
instrument are treated as amounts received in exchange therefor 
(sec. 1271(a)(1)). In addition, gain on the sale or exchange of 
a debt instrument with OID \79\ generally is treated as 
ordinary income to the extent of its OID if there was an 
intention at the time of its issuance to call the debt 
instrument before maturity (sec. 1271(a)(2)). These rules do 
not apply to (1) debt issued by a natural person or (2) debt 
issued before July 2, 1982, by a noncorporate or nongovernment 
issuer. As a result of this exemption, the character of gain or 
loss realized on retirement of an obligation issued by a 
natural person under present law is governed by case law.
---------------------------------------------------------------------------
    \79\ The issuer of a debt instrument with OID generally accrues and 
deducts the discount, as interest, over the life of the obligation even 
though the amount of such interest is not paid until the debt matures. 
The holder of such a debt instrument also generally incldues the OID in 
income as it accrues as intrest on an accrual basis. The mandatory 
inclusion of OID in income does not apply, among other exceptions, to 
debt obligations issued by natural persons before March 2, 1984, and 
loans of less than $10,000 between natural persons if such loan is not 
made in the ordinary course of business of the lender (secs. 1272(a)(2) 
(D) and (E)).
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                           Reasons for Change

    Extinguishment treated as sale or exchange.--In general, 
the Committee believes that present law is deficient since it 
(1) taxes similar economic transactions differently, (2) 
effectively provides some, but not all, taxpayers with an 
election, and (3) its lack of certainty makes the tax laws 
unnecessarily difficult to administer.
    The Committee believes that some transactions, such as 
settlements of contracts to deliver a capital asset, are 
economically equivalent to a sale or exchange of such contracts 
since the value of any asset is the present value of the future 
income that such asset will produce. In addition, to the extent 
that present law treats modifications of property rights as not 
being a sale or exchange, present law effectively provides, in 
many cases, taxpayers with an election to treat the transaction 
as giving rise to capital gain, subject to more favorable rates 
than ordinary income, or an ordinary loss that can offset 
higher-taxed ordinary income and not be subject to limitations 
on use of capital losses. The effect of an election can be 
achieved by selling the property right if the resulting 
transaction results in a gain or providing for the 
extinguishment of the property right if the resulting 
transaction results in a loss.
    Courts have given different answers as to whether 
transactions which terminate contractual interests are treated 
as a ``sale or exchange.'' This lack of uniformity has caused 
uncertainty to both taxpayers and the Internal Revenue Service 
in the administration of the tax laws.
    Accordingly, the Committee bill treats the cancellation, 
lapse, expiration, or other termination of a right or 
obligation with respect to property which is (or on acquisition 
would be) a capital asset in the hands of the taxpayer to all 
types of property as a ``sale or exchange.'' A major effect of 
the Committee bill would be to remove the effective ability of 
a taxpayer to elect the character of gains and losses from 
certain transactions. Another significant effect of the 
Committee bill would be to reduce the uncertainty concerning 
the tax treatment of modifications of property rights.
    Character of gain on retirement of debt obligations issued 
by natural persons.--Similar objections can be raised about the 
rule which exempts debt of natural persons from the deemed sale 
or exchange rule applicable to debt of other taxpayers. The 
Committee believes that the debt of natural persons and other 
taxpayers is sufficiently economically similar to be similarly 
taxed upon their retirement. Accordingly, the Committee 
believes that the exception to the deemed sale or exchange rule 
on retirement of debt of a natural person should be repealed.

                        Explanation of Provision

    Extension of relinquishment rule to all types of 
property.--The bill extends to all types of property the rule 
which treats gain or loss from the cancellation, lapse, 
expiration, or other termination of a right or obligation with 
respect to property which is (or on acquisition would be) a 
capital asset in the hands of the taxpayer.
    By definition, the extension of the ``sale or exchange 
rule'' of present law section 1234A to all property will only 
affect property that is not personal property which is actively 
traded on an established exchange. Thus, the committee bill 
will apply to (1) interests in real property and (2) non-
actively traded personal property. An example of the first type 
of property interest that will be affected by the committee 
bill is the tax treatment of amounts received to release a 
lessee from arequirement that the premise be restored on 
termination of the lease.\80\ An example of the second type of property 
interest that is affected by the committee bill is the forfeiture of a 
down payment under a contract to purchase stock.\81\ The committee bill 
does not affect whether a right is ``property'' or whether property is 
a ``capital asset.''
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    \80\ See Billy Rose Diamond Horseshoe, Inc. v. Commissioner, 448 F. 
2d 549(1971), where the Second Circuit held that payments were not 
entitled to capital gain treatment because there was no sale or 
exchange. See also, Sirbo Holdings, Inc. v. Commissioner, 509 F.2d 1220 
(2d Cir. 1975).
    \81\ See U.S. Freight Co. v. U.S. F.2d 887 (Ct. Cl. 1970), holding 
that forfeiture was an ordinary loss.
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    Character of gain or loss on retirement of debt obligations 
issued by natural persons.--The committee bill repeals the 
provision that exempts debt obligations issued by natural 
persons effective for obligations issued after June 8, 1997. In 
addition, the committee bill terminates the grandfather of debt 
issued before July 2, 1982, by noncorporations or 
nongovernments and by natural persons before June 9, 1997, from 
the rule which treats gain or loss realized on retirement of 
such debt as gain or loss realized on an exchange effective for 
obligations acquired after June 8, 1997, unless the acquirer's 
basis in the obligation is a carryover basis (i.e., the basis 
is determined soley by reference to the basis from whom the 
acquirer acquired the obligation). Thus, under the bill, gain 
or loss on the retirement of such debt will be capital gain or 
loss.

                             Effective Date

    Extension of relinquishment rule to all types of 
property.--The extension of the extinguishment rule applies to 
terminations occurring more than 30 days after the date of 
enactment of the provision.
    Character of gain or loss on retirement of debt obligations 
issued by natural persons, etc.--The provision is effective for 
dispositions after the date of enactment. Thus, any gain or 
loss occurring after the date of enactment on (1) an obligation 
of a natural person issued after June 8, 1997, or (2) an 
obligation issued by a natural person on or before that date to 
which section 1271(b) currently applies and which is acquired 
after that date other than in a carryover basis transaction 
will be treated as a gain or loss from the exchange of the 
obligation.

             B. Corporate Organizations and Reorganizations

1. Require gain recognition for certain extraordinary dividends (sec. 
        811 of the bill and sec. 1059 of the Code)

                               Present Law

     A corporate shareholder generally can deduct at least 70 
percent of a dividend received from another corporation. This 
dividends received deduction is 80 percent if the corporate 
shareholder owns at least 20 percent of the distributing 
corporation and generally 100 percent if the shareholder owns 
at least 80 percent of the distributing corporation.
    Section 1059 of the Code requires a corporate shareholder 
that receives an ``extraordinary dividend'' to reduce the basis 
of the stock with respect to which the dividend was received by 
the nontaxed portion of the dividend. Whether a dividend is 
``extraordinary'' is determined, among other things, by 
reference to the size of the dividend in relation to the 
adjusted basis of the shareholder's stock. Also, a dividend 
resulting from a non pro rata redemption or a partial 
liquidation is an extraordinary dividend. If the reduction in 
basis of stock exceeds the basis in the stock with respect to 
which an extraordinary dividend is received, the excess is 
taxed as gain on the sale or disposition of such stock, but not 
until that time (sec. 1059(a)(2)). The reduction in basis for 
this purpose occurs immediately before any sale or disposition 
of the stock (sec. 1059(d)(1)(A)). The Treasury Department has 
general regulatory authority to carry out the purposes of the 
section.
    Except as provided in regulations, the extraordinary 
dividend provisions do not apply to result in a double 
reduction in basis in the case of distributions between members 
of an affiliated group filing consolidated returns, where the 
dividend is eliminated or excluded under the consolidated 
return regulations. Double inclusion of earnings and profits 
(i.e., from both the dividend and from gain on the disposition 
of stock with a reduced basis) also should generally be 
prevented.\82\ Treasury regulations provide for application of 
the provision when a corporation is a partner in a partnership 
that receives a distribution.\83\
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    \82\ See H. Rept. 99-841, II-166, 99th Cong. 2d Sess. (September 
18, 1986).
    \83\ See Treas. reg. sec. 1.701-2(f), Example (2).
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    In general, a distribution in redemption of stock is 
treated as a dividend, rather than as a sale of the stock, if 
it is essentially equivalent to a dividend (sec. 302). A 
redemption of the stock of a shareholder generally is 
essentially equivalent to a dividend if it does not result in a 
meaningful reduction in the shareholder's proportionate 
interest in the distributing corporation. Section 302(b) also 
contains several specific tests (e.g., a substantial reduction 
computation and a termination test) to identify redemptions 
that are not essentially equivalent to dividends. The 
determination whether a redemption is essentially equivalent to 
a dividend includes reference to the constructive ownership 
rules of section 318, including the option attribution rules of 
section318(a)(4). The rules relating to treatment of cash or 
other property received in a reorganization contain a similar reference 
(sec. 356(a)(2)).

                           Reasons for Change

    Corporate taxpayers have attempted to dispose of stock of 
other corporations in transactions structured as redemptions, 
where the redeemed corporate shareholder apparently expects to 
take the position that the transactions are dividends that 
qualify for the dividends received deduction. Thus, the 
redeemed corporate shareholder attempts to exclude from income 
a substantial portion of the amount received. In some cases, it 
appears that the taxpayers' interpretations of the option 
attribution rules of section 318(a)(4) are important to the 
taxpayers' contentions that their interests in the distributing 
corporation are not meaningfully reduced, and are, therefore, 
dividends.\84\ Some taxpayers may argue that certain options 
have sufficient economic reality that they should be recognized 
as stock ownership for purposes of determining whether a 
taxpayer has substantially reduced its ownership.
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    \84\ For example, it has been reported that Seagram Corporation 
intends to take the position that the corporate dividends-received will 
eliminate tax on significant distributions received from DuPont 
Corporation in a redemption of almost all the DuPont stock held by 
Seagram, coupled with the issuance of certain rights to reacquire 
DuPont stock. (See, e.g., Landro and Shapiro, ``Hollywood Shuffle,'' 
Wall Street Journal, pp. A1 and A11 (April 7, 1995); Sloan, ``For 
Seagram and DuPont, a Tax Deal that No One Wants to Brandy About,'' 
Washington Post, p. D3 (April 11, 1995); Sheppard, ``Can Seagram Bail 
Out of DuPont without Capital Gain Tax,'' Tax Notes Today, (April 10, 
1995, 95 TNT 75-4).
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    Even in the absence of options, the present law rules 
dealing with extraordinary dividends may permit inappropriate 
deferral of gain recognition when the portion of the 
distribution that is excluded due to the dividends received 
deduction exceeds the basis of the stock with respect to which 
the extraordinary dividend is received.

                        Explanation of Provision

    Under the bill, except as provided in regulations, a 
corporate shareholder recognizes gain immediately with respect 
to any redemption treated as a dividend (in whole or in part) 
when the nontaxed portion of the dividend exceeds the basis of 
the shares surrendered, if the redemption is treated as a 
dividend due to options being counted as stock ownership.\85\
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    \85\ Thus, for example, where a portion of such a distribution 
would not have been treated as a dividend due to insufficient earnings 
and profits, the rules applies to the portion treated as a dividend.
---------------------------------------------------------------------------
    In addition, the bill requires immediate gain recognition 
whenever the basis of stock with respect to which any 
extraordinary dividend was received is reduced below zero. The 
reduction in basis of stock would be treated as occurring at 
the beginning of the ex-dividend date of the extraordinary 
dividend to which the reduction relates.
    Reorganizations or other exchanges involving amounts that 
are treated as dividends under section 356 of the Code are 
treated as redemptions for purposes of applying the rules 
relating to redemptions under section 1059(e). For example, if 
a recapitalization or other transaction that involves a 
dividend under section 356 has the effect of a non pro rata 
redemption or is treated as a dividend due to options being 
counted as stock, the rules of section 1059 apply. Redemptions 
of shares, or other extraordinary dividends on shares, held by 
a partnership will be subject to section 1059 to the extent 
there are corporate partners (e.g., appropriate adjustments to 
the basis of the shares held by the partnership and to the 
basis of the corporate partner's partnership interest will be 
required).
    Under continuing section 1059(g) of present law, the 
Treasury Department is authorized to issue regulations where 
necessary to carry out the purposes and prevent the avoidance 
of the provision.

                             Effective Date

    The provision generally is effective for distributions 
after May 3, 1995, unless made pursuant to the terms of a 
written binding contract in effect on May 3, 1995 and at all 
times thereafter before such distribution, or a tender offer 
outstanding on May 3, 1995.\86\ However, in applying the new 
gain recognition rules to any distribution that is not a 
partial liquidation, a non pro rata redemption, or a redemption 
that is treated as a dividend by reason of options, September 
13, 1995 is substituted for May 3, 1995 in applying the 
transition rules.
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    \86\ Thus, for example, in the case of a distribution prior to the 
effective date, the provisions of present law would continue to apply, 
including the provisions of present-law sections 1059(a) and 
1059(d)(1), requiring reduction in basis immediately before any sale or 
disposition of the stock, and requiring recognition of gain at the time 
of such sale or disposition.
---------------------------------------------------------------------------
    No inference is intended regarding the tax treatment under 
present law of any transaction within the scope of the 
provision, including transactions utilizing options.
    In addition, no inference is intended regarding the rules 
under present law (or in any case where the treatment is not 
specified in the provision) for determining the shares of stock 
with respect to which a dividend is received or that experience 
a basis reduction.

2. Require gain recognition on certain distributions of controlled 
        corporation stock (sec. 812 of the bill and secs. 355, 351(c), 
        and 368(a)(2)(H) of the Code)

                              Present Law

    A corporation generally is required to recognize gain on 
the distribution of property (including stock of a subsidiary) 
as if such property had been sold for its fair market value. 
The shareholders generally treat the receipt of property as a 
taxable event as well. Section 355 of the Internal Revenue Code 
provides an exception to this rule for certain ``spin-off'' 
type distributions of stock of a controlled corporation, 
provided that various requirements are met, including 
certainrestrictions relating to acquisitions and dispositions of stock 
of the distributing corporation (``distributing'') or the controlled 
corporation (``controlled'') prior and subsequent to a distribution.
    In cases where the form of the transaction involves a 
contribution of assets to the particular controlled corporation 
that is distributed in connection with the distribution, there 
are specific Code requirements that distributing corporation's 
shareholders own ``control'' of the distributed corporation 
immediately after the distribution. Control is defined for this 
purpose as 80 percent of the voting power of all classes of 
stock entitled to vote and 80 percent of each other class of 
stock. (secs. 368(a)(1)(D), 368(c), and 351(a) and (c)). In 
addition, it is a requirement for qualification of any section 
355 distribution that the distributing corporation distribute 
control of the controlled corporation (defined by reference to 
the same 80-percent test).\87\ Present law has the effect of 
imposing more restrictive requirements on certain types of 
acquisitions or other transfers following a distribution if the 
company involved is the controlled corporation rather than the 
distributing corporation.
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    \87\ If as controlled corporation is acquired after a distribution, 
an issue may arise whether the acquisition can be viewed under step-
transaction concepts as having occurred before the distribution, with 
the result that the distributing corporation would not be viewed as 
having distributed the necessary 80 percent control. The Internal 
Revenue Service has indicated that it will not rule on requests for 
section 355 treatment in cases in which there have been negotiations 
agreements or arrangements with respect to transactions or events 
which, if consummated before the distribution, would result in the 
distribution of stock or securities of a corporation which is not 
``controlled'' by the distributing corporation. Rev. Proc 96-39, 1996-
33 I.R.B. 11; see also Rev. Rul. 96-30, 1996-1 C.B. 36; Rev. Rul. 70-
225, 1970-1 C.B. 80.
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                           Reasons for Change

    The Committee believes that section 355 was intended to 
permit the tax-free division of existing business arrangements 
among existing shareholders. In cases in which it is intended 
that new shareholders will acquire ownership of a business in 
connection with a spin off, the transaction more closely 
resembles a corporate level disposition of the portion of the 
business that is acquired.
    The Committee also believes that the difference in 
treatment of certain transactions following a spin-off, 
depending upon whether the distributing or controlled 
corporation engages in the transaction, should be minimized.
    The Committee also is concerned that spin-off transactions 
within a single corporate group can have the effect of avoiding 
other present law rules that create or recapture excess loss 
accounts in affiliated groups filing consolidated returns.\88\
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    \88\ Excess loss accounts in consolidation generally are created 
when a subsidiary corporation makes a distribution (or has a loss that 
is used by other members of the group) that exceeds the parent's basis 
in the stock of the subsidiary. In general, such excess loss accounts 
in consolidation are permitted to be deferred rather than causing 
immediate taxable gain. Nevertheless, they are recaptured when a 
subsidiary leaves the group or in certain other situations. However, 
such excess loss accounts are not recaptured in certain cases where 
there is an internal spin-off prior to the subsidiary leaving the 
group. See. Treas. reg. sec. 1.1502-19(g). In addition, an excess loss 
account may not be created at all in certain cases that are similar 
economically to a distribution that would reduce the stock basis of the 
distributing subsidiary corporation, if the distribution from the 
subsidiary is structured to meet the form of a section 355 
distribution.
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    Such intra-group distributions also can have the effect of 
permitting possibly inappropriate basis increases (or 
preventing basis decreases) following a distribution, due to 
the differences between the basis allocation rules that govern 
spin-offs and those that apply to other distributions. In the 
case of an affiliated group not filing a consolidated return, 
it is also possible that section 355 distributions could in 
effect permit similar inappropriate basis results.

                        Explanation of Provision

    The bill adopts additional restrictions under section 355 
on acquisitions and dispositions of the stock of the 
distributing or controlled corporation.
    Under the bill, if either the controlled or distributing 
corporation is acquired pursuant to a plan or arrangement in 
existence on the date of distribution, gain is recognized by 
the other corporation as of the date of the distribution.
    In the case of an acquisition of a controlled corporation, 
the amount of gain recognized by the distributing corporation 
is the amount of gain that the distributing corporation would 
have recognized had stock of the controlled corporation been 
sold for fair market value on the date of distribution. In the 
case of an acquisition of the distributing corporation, the 
amount of gain recognized by the controlled corporation is the 
amount of net gain that the distributing corporation would have 
recognized had it sold its assets for fair market value 
immediately after the distribution. This gain is treated as 
long-term capital gain. No adjustment to the basis of the stock 
or assets of either corporation is allowed by reason of the 
recognition of the gain.
    Whether a corporation is acquired is determined under rules 
similar to those of present law section 355(d), except that 
acquisitions would not be restricted to ``purchase'' 
transactions. Thus, an acquisition occurs if one or more 
persons acquire 50 percent or more of the vote or value of the 
stock of the controlled or distributing corporation pursuant to 
a plan or arrangement. For example, assume a corporation 
(``P'') distributes the stock of its wholly owned subsidiary 
(``S'') to its shareholders. If, pursuant to a plan or 
arrangement, 50 percent or more of the vote or value of either 
P or S is acquired by one or more persons, the bill proposal 
requires gain recognition by the corporation not acquired. 
Except as provided in Treasury regulations, if the assets of 
the distributing or controlled corporation are acquired by a 
successor in a merger or other transaction under section 
368(a)(1) (A), (C) or (D) of the Code, the shareholders 
(immediately before the acquisition) of the corporation 
acquiring such assets are treated as acquiring stock in the 
corporation from which the assets were acquired. Under Treasury 
regulations, other asset transfers also could be subject to 
this rule. However, in any transaction, stock received directly 
or indirectlyby former shareholders of distributing or 
controlled, in a successor or new controlling corporation of either, is 
not treated as acquired stock if it is attributable to such 
shareholders'' stock in distributing or controlled that was not 
acquired as part of a plan or arrangement to acquire 50 percent or more 
of such successor or other corporation.
    Acquisitions occurring within the four-year period 
beginning two years before the date of distribution are 
presumed to have occurred pursuant to a plan or arrangement. 
Taxpayers can avoid gain recognition by showing that an 
acquisition occurring during this four-year period was 
unrelated to the distribution.
    The bill does not apply to distributions that would 
otherwise be subject to section 355(d) of present law, which 
imposes corporate level tax on certain disqualified 
distributions.
    The bill does not apply to a distribution pursuant to a 
title 11 or similar case.
    The Treasury Department is authorized to prescribe 
regulations as necessary to carry out the purposes of the 
proposal, including regulations to provide for the application 
of the proposal in the case of multiple transactions.
    Except as provided in Treasury regulations, in the case of 
distributions of stock within an affiliated group of 
corporations (as defined in section 1504(a)), section 355 does 
not apply to any distribution of the stock of one member of the 
group to another member if it is part of a transaction that 
results in an acquisition that would be taxable to either the 
distributing or the controlled corporation.
    In addition, in the case of any distribution of stock of 
one member of an affiliated group of corporations to another 
member, the Secretary of the Treasury is authorized under 
section 358(c) to provide adjustments to the basis of any stock 
in a corporation which is a member of such group, to reflect 
appropriately the proper treatment of such distribution.
    As one example, the Secretary of the Treasury may consider 
providing rules that require a carryover basis within the group 
for the stock of the distributed corporation (including a 
carryover of an excess loss account, if any, in a consolidated 
return) and that also provide a reduction in the basis of the 
stock of the distributing corporation to reflect the change in 
the value and basis of the distributing corporation's assets. 
The Treasury Department may determine that the aggregate stock 
basis of distributing and controlled after the distribution may 
be adjusted to an amount that is less than the aggregate basis 
of the stock of the distributing corporation before the 
distribution, to prevent inappropriate potential for artificial 
losses or diminishment of gain on disposition of any of the 
corporations involved in the spin off.
    The bill also modifies certain rules for determining 
control immediately after a distribution in the case of certain 
divisive transactions in which a controlled corporation is 
distributed and the transaction meets the requirements of 
section 355. In such cases, under section 351 and modified 
section 368(a)(2)(H) with respect to certain reorganizations 
under section 368(a)(1)(D), those shareholders receiving stock 
in the distributed corporation are treated as in control of the 
distributed corporation immediately after the distribution if 
they hold stock representing a greater than 50 percent interest 
in the vote and value of stock of the distributed corporation.
    The bill does not change the present-law requirement under 
section 355 that the distributing corporation must distribute 
80 percent of the voting power and 80 percent of each other 
class of stock of the controlled corporation. It is expected 
that this requirement will be applied by the Internal Revenue 
Service taking account of the provisions of the bill regarding 
plans that permit certain types of planned restructuring of the 
distributing corporation following the distribution, and to 
treat similar restructurings of the controlled corporation in a 
similar manner. Thus, the 80-percent control requirement is 
expected to be administered in a manner that would prevent the 
tax-free spin-off of a less-than-80-percent controlled 
subsidiary, but generally would not impose additional 
restrictions on post-distribution restructurings of the 
controlled corporation if such restrictions would not apply to 
the distributing corporation.

                             Effective Date

    The bill is generally effective for distributions after 
April 16, 1997. However, the part of the bill providing a 
greater-than-50-percent control requirement immediately after 
certain section 351 and 368(a)(1)(D) distributions will be 
effective for transfers after the date of enactment.
    The bill will not apply to a distribution after April 16, 
1997 that is part of an acquisition that would otherwise cause 
gain recognition to the distributing or controlled corporation 
under the bill, if such acquisition is (1) made pursuant to a 
written agreement which was binding on April 16, 1997 and at 
all times thereafter; (2) described in a ruling request 
submitted to the Internal Revenue Service on or before such 
date; or (3) described on or before such date in a public 
announcement or in a filing with the Securities and Exchange 
Commission (``SEC'') required solely by reason of the 
distribution or acquisition. Any written agreement, ruling 
request, or public announcement or SEC filing is not within the 
scope of these transition provisions unless it identifies the 
acquiror of the distributing corporation or of any controlled 
corporation, whichever is applicable.
    The part of the bill providing a greater-than-50-percent 
control provision for certain transfers after the date of 
enactment will not apply if such transfer meets the 
requirements of (1), (2), or (3) of the preceding paragraph.

3. Reform tax treatment of certain corporate stock transfers (sec. 813 
        of the bill and secs. 304 and 1059 of the Code)

                              Present Law

    Under section 304, if one corporation purchases stock of a 
related corporation, the transaction generally is 
recharacterized as a redemption. In determining whether a 
transaction so recharacterized is treated as a sale or a 
dividend, reference is made to the changes in the selling 
corporation's ownership of stock in the issuing corporation 
(applying the constructive ownership rules of section 318(a) 
with modifications under section 304(c)). Sales proceeds 
received by a corporate transferor that are characterized as a 
dividend may qualify for the dividends receiveddeduction under 
section 243, and such dividend may bring with it foreign tax credits 
under section 902. Section 304 does not apply to transfers of stock 
between members of a consolidated group.
    Section 1059 applies to ``extraordinary dividends,'' 
including certain redemption transactions treated as dividends 
qualifying for the dividends received deduction. If a 
redemption results in an extraordinary dividend, section 1059 
generally requires the shareholder to reduce its basis in the 
stock of the redeeming corporation by the nontaxed portion of 
such dividend.

                           Reasons for Change

    Section 304 is directed primarily at preventing a 
controlling shareholder from claiming basis recovery and 
capital gain treatment on transactions that result in a 
withdrawal of earnings from corporate solution. These concerns 
are most relevant where the shareholder is an individual. 
Different concerns may be present if the shareholder is a 
corporation, due in part to the availability of the dividends 
received deduction. A corporation often may prefer a 
transaction to be characterized as a dividend, as opposed to a 
sale or exchange. Accordingly, a corporation may intentionally 
seek to apply section 304 to a transaction which is in 
substance a sale or exchange. Corporations that are related for 
purposes of section 304 need not be 80-percent controlled by a 
common parent. The separate rules for corporations filing a 
consolidated return, that would generally reduce basis for 
untaxed dividends received, do not apply. Furthermore, in some 
situations where the selling corporation does not in fact own 
any stock of the acquiring corporation before or after the 
transaction (except by attribution), it is possible that 
current law may lead to inappropriate results.
    As one example, in certain related-party sales the selling 
corporation may take the position that its basis in any shares 
of stock it may have retained (or possibly in any shares of the 
acquiring corporation that it may own) need not be reduced by 
the amount of its dividends received deduction. This could 
result in an inappropriate shifting of basis. The result can be 
artificial reduction of gain or creation of loss on disposition 
of any such retained shares.
    As one example, assume that domestic corporation X owns 70 
percent of the shares of domestic corporation S and all the 
shares of domestic corporation B. S owns all the shares of 
domestic corporation T with a basis of $100. Assume that 
corporation B has sufficient earnings and profits so that any 
distribution of property would be treated as a dividend. Assume 
that S sells all but one of its shares in T to B for $99, their 
fair market value. Under present law, the transfer is treated 
as a redemption of shares of B, which redemption is treated as 
dividend to S because, even though S in fact owns no shares of 
B, it is deemed to own all the shares of B before and after the 
transaction through attribution from X. Taxpayers may contend 
that the one share of T retained (worth $1) retains the entire 
original basis of $100. Although S has received $99 from B for 
its other shares of T, and has not paid full tax on that 
receipt due to the dividends received deduction, S may now 
attempt to claim a $99 loss on disposing of the remaining share 
of T.
    In international cases, a U.S. corporation owned by a 
foreign corporation may inappropriately claim foreign tax 
credits from a section 304 transaction. For example, if a 
foreign-controlled domestic corporation sells the stock of a 
subsidiary to a foreign sister corporation, the domestic 
corporation may take the position that it is entitled to credit 
foreign taxes that were paid by the foreign sister corporation. 
See Rev. Rul. 92-86, 1992-2 C.B. 199; Rev. Rul. 91-5, 1991-1 
C.B. 114. However, if the foreign sister corporation had 
actually distributed its earnings and profits to the common 
foreign parent, no foreign tax credits would have been 
available to the domestic corporation.

                        Explanation of Provision

    Under the bill, to the extent that a section 304 
transaction is treated as a distribution under section 301, the 
transferor and the acquiring corporation are treated as if (1) 
the transferor had transferred the stock involved in the 
transaction to the acquiring corporation in exchange for stock 
of the acquiring corporation in a transaction to which section 
351(a) applies, and (2) the acquiring corporation had then 
redeemed the stock it is treated as having issued. Thus, the 
acquiring corporation is treated for all purposes as having 
redeemed the stock it is treated as having issued to the 
transferor. In addition, the bill amends section 1059 so that, 
if the section 304 transaction is treated as a dividend to 
which the dividends received deduction applies, the dividend is 
treated as an extraordinary dividend in which only the basis of 
the transferred shares would be taken into account under 
section 1059.
    Under the bill, a special rule applies to section 304 
transactions involving acquisitions by foreign corporations. 
The bill limits the earnings and profits of the acquiring 
foreign corporation that are taken into account in applying 
section 304. The earnings and profits of the acquiring foreign 
corporation to be taken into account will not exceed the 
portion of such earnings and profits that (1) is attributable 
to stock of such acquiring corporation held by a corporation or 
individual who is the transferor (or a person related thereto) 
and who is a U.S. shareholder (within the meaning of sec, 
951(b)) of such corporation, and (2) was accumulated during 
periods in which such stock was owned by such person while such 
acquiring corporation was a controlled foreign corporation. For 
purposes of this rule, except as otherwise provided by the 
Secretary of the Treasury, the rules of section 1248(d) 
(relating to certain exclusions from earnings and profits) 
would apply. The Secretary of the Treasury is to prescribe 
regulations as appropriate, including regulations determining 
the earnings and profits that are attributable to particular 
stock of the acquiring corporation.
    No inference is intended as to the treatment of any 
transaction under present law.

                             Effective Date

    The provision is effective for distributions or 
acquisitions after June 8, 1997 except that the provision will 
not apply to any such distribution or acquisition (1) made 
pursuant to a written agreement which was binding on such date 
and at all times thereafter, (2) described in a ruling request 
submitted to the Internal Revenue Service on or before such 
date, or (3) described in a public announcement or filing with 
the Securities and Exchange Commission on or before such date.

4. Modify holding period for dividends-received deduction (sec. 814 of 
        the bill and sec. 246(c) of the Code)

                              Present Law

    If an instrument issued by a U.S. corporation is classified 
for tax purposes as stock, a corporate holder of the instrument 
generally is entitled to a dividends received deduction for 
dividends received on that instrument. This deduction is 70 
percent of dividends received if the recipient owns less than 
20 percent (by vote and value) of stock of the payor. If the 
recipient owns more than 20 percent of the stock the deduction 
is increased to 80 percent. If the recipient owns more than 80 
percent of the payor's stock, the deduction is further 
increased to 100 percent for qualifying dividends.
    The dividends-received deduction is allowed to a corporate 
shareholder only if the shareholder satisfies a 46-day holding 
period for the dividend-paying stock (or a 91-day period for 
certain dividends on preferred stock). The 46- or 91-day 
holding period generally does not include any time in which the 
shareholder is protected from the risk of loss otherwise 
inherent in the ownership of an equity interest. The holding 
period must be satisfied only once, rather than with respect to 
each dividend received.

                           Reasons for Change

    Under present law, dividend-paying stocks can be marketed 
to corporate investors with accompanying attempts to hedge or 
relieve the holder from risk for much of the holding period of 
the stock, after the initial holding period has been satisfied. 
In addition, because of the limited application of section 1059 
of the Code requiring basis reduction, many investors whose 
basis includes a price paid with the expectation of a dividend 
may be able to sell the stock after the receipt of a dividend 
not subject to tax at an artificial loss, even though the 
holder may actually have been relieved of the risk of loss for 
much of the period it has held the stock.
    The Committee believes that no deduction for a distribution 
on stock should be allowed when the owner of stock does not 
bear the risk of loss otherwise inherent in the ownership of an 
equity interest at a time proximate to the time the 
distribution is made.

                        Explanation of Provision

    The bill provides that a taxpayer is not entitled to a 
dividends-received deduction if the taxpayer's holding period 
for the dividend-paying stock is not satisfied over a period 
immediately before or immediately after the taxpayer becomes 
entitled to receive the dividend.

                             Effective Date

    The provision is generally effective for dividends paid or 
accrued after the 30th day after the date of the enactment of 
the bill. However, the provision will not apply to dividends 
received within two years of the date of enactment if (1) the 
dividend is paid with respect to stock held on June 8, 1997, 
and all times thereafter until the dividend is received; (2) 
the stock is continuously subject to a position described in 
section 246(c)(4) on June 8, 1997, and all times thereafter 
until the dividend is received; and (3) such stock and related 
position is identified by the taxpayer within 30 days after 
enactment of this Act. A stock will not be considered to be 
continuously subject to a position if such position is sold, 
closed or otherwise terminated and is reestablished.

                     C. Other Corporate Provisions

1. Registration of confidential corporate tax shelters and substantial 
        understatement penalty (sec. 821 of the bill and secs. 6111 and 
        6662 of the Code)

                              Present Law

Tax shelter registration

    An organizer of a tax shelter is required to register the 
shelter with the Internal Revenue Service (IRS) (sec. 6111). If 
the principal organizer does not do so, the duty may fall upon 
any other participant in the organization of the shelter or any 
person participating in its sale or management. The shelter's 
identification number must be furnished to each investor who 
purchases or acquires an interest in the shelter. Failure to 
furnish this number to the tax shelter investors will subject 
the organizer to a $100 penalty for each such failure (sec. 
6707(b)).
    A penalty may be imposed against an organizer who fails 
without reasonable cause to timely register the shelter or who 
provides false or incomplete information with respect to it. 
The penalty is the greater of one percent of the aggregate 
amount invested in the shelter or $500. Any person claiming any 
tax benefit with respect to a shelter must report its 
registration number on her return. Failure to do so without 
reasonable cause will subject that person to a $250 penalty 
(sec. 6707(b)(2)).
    A person who organizes or sells an interest in a tax 
shelter subject to the registration rule or in any other 
potentially abusive plan or arrangement must maintain a list of 
the investors (sec. 6112). A $50 penalty may be assessed for 
each name omitted from the list. The maximum penalty per year 
is $100,000 (sec. 6708).
    For this purpose, a tax shelter is defined as any 
investment that meets two requirements. First, the investment 
must be (1) required to be registered under a Federal or state 
law regulating securities, (2) sold pursuant to an exemption 
from registration requiring the filing of a notice with a 
Federal or state agency regulating the offering or sale of 
securities, or (3) a substantial investment. Second, it must be 
reasonable to infer that the ratio of deductions and 350 
percent of credits to investment for any investor (i.e., the 
tax shelter ratio) may be greater than two to one as of the 
close of any of the first five years ending after the date on 
which the investment is offered for sale. An investment that 
meets these requirements will be considered a tax shelter 
regardless of whether it is marketed or customarily designated 
as a tax shelter (sec. 6111(c)(1)).

Accuracy-related penalty

    The accuracy-related penalty, which is imposed at a rate of 
20 percent, 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.
    The substantial understatement penalty applies in the 
following manner. If the correct income tax liability of a 
taxpayer for a taxable year exceeds that reported by the 
taxpayer by the greater of 10 percent of the correct tax or 
$5,000 ($10,000 in the case of most corporations), then a 
substantial understatement exists and a penalty may be imposed 
equal to 20 percent of the underpayment of tax attributable to 
the understatement. 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 and there was a 
reasonable basis for the tax treatment of the item. Special 
rules apply to tax shelters.
    With respect to tax shelter items of non-corporate 
taxpayers, the penalty may be avoided only if the taxpayer 
establishes that, in addition to having substantial authority 
for his position, he reasonably believed that the treatment 
claimed was more likely than not the proper treatment of the 
item. This reduction in the penalty is unavailable to corporate 
tax shelters. The reduction in the understatement for items 
disclosed on the return is inapplicable to both corporate and 
non-corporate tax shelters. For this purpose, a tax shelter is 
a partnership or other entity, plan, or arrangement the 
principal purpose of which is the avoidance or evasion of 
Federal income tax.
    The Secretary may waive the penalty with respect to any 
item if the taxpayer establishes reasonable cause for his 
treatment of the item and that he acted in good faith.

                           Reasons for Change

    The provision will improve compliance with the tax laws by 
giving the Treasury Department earlier notification than it 
generally receives under present law of transactions that may 
not comport with the tax laws. In addition, the provision will 
improve compliance by discouraging taxpayers from entering into 
questionable transactions. Also, the provision will improve 
economic efficiency, because investments that are not 
economically motivated, but that are instead tax-motivated, may 
reduce the supply of capital available for economically 
motivated activities, which could cause a loss of economic 
efficiency.

                        Explanation of Provision

Tax shelter registration

    The provision requires a promoter of a corporate tax 
shelter to register the shelter with the Secretary. 
Registration is required not later than the next business day 
after the day when the tax shelter is first offered to 
potential users. If the promoter is not a U.S. person, or if a 
required registration is not otherwise made, then any U.S. 
participant is required to register the shelter. An exception 
to this special rule provides that registration would not be 
required if the U.S. participant notifies the promoter in 
writing not later than 90 days after discussions began that the 
U.S. participant will not participate in the shelter and the 
U.S. person does not in fact participate in the shelter.
    A corporate tax shelter is any investment, plan, 
arrangement or transaction (1) a significant purpose of the 
structure of which is tax avoidance or evasion by a corporate 
participant, (2) that is offered to any potential participant 
under conditions of confidentiality, and (3) for which the tax 
shelter promoters may receive total fees in excess of $100,000.
    A transaction is offered under conditions of 
confidentiality if: (1) an offeree (or any person acting on its 
behalf) has an understanding or agreement with or for the 
benefit of any promoter to restrict or limit its disclosure of 
the transaction or any significant tax features of the 
transaction; or (2) the promoter claims, knows or has reason to 
know (or the promoter causes another person to claim or 
otherwise knows or has reason to know that a party other than 
the potential offeree claims) that the transaction (or one or 
more aspects of its structure) is proprietary to the promoter 
or any party other than the offeree, or is otherwise protected 
from disclosure or use. The promoter includes specified related 
parties.
    Registration will require the submission of information 
identifying and describing the tax shelter and the tax benefits 
of the tax shelter, as well as such other information as the 
Treasury Department may require.
    Tax shelter promoters are required to maintain lists of 
those who have signed confidentiality agreements, or otherwise 
have been subjected to nondisclosure requirements, with respect 
to particular tax shelters. In addition, promoters must retain 
lists of those paying fees with respect to plans or 
arrangements that have previously been registered (even though 
the particular party may not have been subject to 
confidentiality restrictions).
    All registrations will be treated as taxpayer information 
under the provisions of section 6103 and will therefore not be 
subject to any public disclosure.
    The penalty for failing to timely register a corporate tax 
shelter is the greater of $10,000 or 50 percent of the fees 
payable to any promoter with respect to offerings prior to the 
date of late registration (i.e., this part of the penalty does 
not apply to fee payments with respect to offerings after late 
registration). A similar penalty is applicable to actual 
participants in any corporate tax shelter who were required to 
register the tax shelter but did not. With respect to 
participants, however, the 50-percent penalty is based only on 
fees paid by that participant. Intentional disregard of the 
requirement to register by either a promoter or a participant 
increases the 50-percent penalty to 75 percent of the 
applicable fees.

Substantial understatement penalty

    The provision makes two modifications to the substantial 
understatement penalty. The first modification affects the 
reduction in the amount of the understatement which is 
attributable to an item if there is a reasonable basis for the 
treatment of the item. The provision provides that in no event 
would a corporation have a reasonable basis for its tax 
treatment of an item attributable to a multi-party financing 
transaction if such treatment does not clearly reflect the 
income of the corporation. No inference is intended that such a 
multi-party financing transaction could not also be a tax 
shelter as defined under the modification described below or 
under present law.
    The second modification affects the special tax shelter 
rules, which define a tax shelter as an entity the principal 
purpose of which is the avoidance or evasion of Federal income 
tax. The provision instead provides that a significant purpose 
(rather than the principal purpose) of the entity must be the 
avoidance or evasion of Federal income tax for the entity to be 
considered a tax shelter. This modification conforms the 
definition of tax shelter for purposes of the substantial 
understatement penalty to the definition of tax shelter for 
purposes of these new confidential corporate tax shelter 
registration requirements.

Treasury report

    The provision also directs the Treasury Department, in 
consultation with the Department of Justice, to issue a report 
to the tax-writing committees on the following tax shelter 
issues: (1) a description of enforcement efforts under section 
7408 of the Code (relating to actions to enjoin promoters of 
abusive tax shelters) with respect to corporate tax shelters 
and the lawyers, accountants, and others who provide opinions 
(whether or not directly addressed to the taxpayer) regarding 
aspects of corporate tax shelters; (2) an evaluation of whether 
the penalties regarding corporate tax shelters are generally 
sufficient; and (3) an evaluation of whether confidential tax 
shelter registration should be extended to transactions where 
the investor (or potential investor) is not a corporation. The 
report is due one year after the date of enactment.

                             Effective Date

    The tax shelter registration provision applies to any tax 
shelter offered to potential participants after the date the 
Treasury Department issues guidance with respect to the filing 
requirements. The modifications to the substantial 
understatement penalty apply to items with respect to 
transactions entered into after the date of enactment.

2. Treat certain preferred stock as ``boot'' (sec. 822 of the bill and 
        secs. 351, 354, 355, 356 and 1036 of the Code)

                              Present Law

    In reorganization transactions within the meaning of 
section 368 and certain other retructurings, no gain or loss is 
recognized except to the extent ``other property'' (often 
called ``boot'') is received, that is, property other than 
certain stock, including preferred stock. Thus, preferred stock 
can be received tax-free in a reorganization. Upon the receipt 
of ``other property,'' gain but not loss can be recognized. A 
special rule permits debt securities to be received tax-free, 
but only to the extent debt securities of no lesser principal 
amount are surrendered in the exchange. Other than this debt-
for-debt rule, similar rules generally apply to transactions 
described in section 351.

                           Reasons for Change

    Certain preferred stocks have been widely used in corporate 
transactions to afford taxpayers non-recognition treatment, 
even though the taxpayer may receive relatively secure 
instruments in exchange for relatively risky instruments.
    As one example, a shareholder of a corporation that is to 
be acquired for cash may not wish to recognize gain on a sale 
of his or her stock at that time. Transactions are structured 
so that a new holding company is formed, to which the 
shareholder contributes common stock of the company to be 
acquired, and receives in exchange preferred stock. The 
acquiring corporation contributes cash to a holding company, 
which uses the cash to acquire the stock of the other 
shareholders. Similar results might also be obtained if the 
corporation to be acquired recapitalized by issuing the 
preferred stock in exchange for the common stock of the 
shareholder. Features such as puts and calls may effectively 
determine the period within which total payment is to occur. In 
the case of an individual shareholder, the preferred stock may 
be puttable or redeemable only at death, in which case the 
shareholder obtains a basis step-up and never recognizes gain 
on the transaction.
    Similarly, as another type of example, so called ``auction 
rate'' preferred stock has a mechanism to reset the dividend 
rate on preferred stock so that it tracks changes in interest 
rates over the term of the instrument, thus diminishing any 
risk that the ``principal'' amount of stock would change if 
interest rates changed.
    The Committee believes that when such preferred stock 
instruments are received in certain exchange transactions, it 
is appropriate to view such instruments as taxable 
consideration since the investor has often obtained a more 
secure form of investment.

                        Explanation of Provision

    The bill amends the relevant provisions (secs. 351, 354, 
355, 356 and 1036) to treat certain preferred stock as ``other 
property'' (i.e., ``boot'') subject to certain exceptions. 
Thus, when a taxpayer exchanges property for this preferred 
stock in a transaction that qualifies under either section 351, 
355, 368, or 1036, gain but not loss is recognized.
    The bill applies to preferred stock (i.e., stock that is 
limited and preferred as to dividends and does not participate, 
including through a conversion privilege, in corporate growth 
to any significant extent), where (1) the holder has the right 
to require the issuer or a related person (within the meaning 
of secs. 267(b) and 707(b)) to redeem or purchase the stock, 
(2) the issuer or a related person is required to redeem or 
purchase the stock, (3) the issuer (or a related person) has 
the right to redeem or purchase the stock and, as of the issue 
date, it is more likely than not that such right will be 
exercised, or (4) the dividend rate on the stock varies in 
whole or in part (directly or indirectly) with reference to 
interest rates, commodity prices, or other similar indices, 
regardless of whether such varying rate is provided as an 
express term of the stock (for example, in the case of an 
adjustable rate stock) or as a practical result of other 
aspects of the stock (for example, in the case of auction rate 
stock). For this purpose, the rules of (1), (2), and (3) apply 
if the right or obligation may be exercised within 20 years of 
the date the instrument is issued and such right or obligation 
is not subject to a contingency which, as of the issue date, 
makes remote the likelihood of the redemption or purchase. In 
addition, if neither the stock surrendered nor the stock 
received in the exchange is stock of a corporation any class of 
stock of which (or of a related corporation) is publicly 
traded, a right or obligation is disregarded if it may be 
exercised only upon the death, disability, or mental 
incompetency of the holder. Also, a right or obligation 
isdisregarded in the case of stock transferred in connection with the 
performance of services if it may be exercised only upon the holder's 
separation from service.
    The following exchanges are excluded from this gain 
recognition: (1) certain exchanges of preferred stock for 
comparable preferred stock of the same or lesser value; (2) an 
exchange of preferred stock for common stock; (3) certain 
exchanges of debt securities for preferred stock of the same or 
lesser value; and (4) exchanges of stock in certain 
recapitalizations of family-owned corporations. For this 
purpose, a family-owned corporation is defined as any 
corporation if at least 50 percent of the total voting power 
and value of the stock of such corporation is owned by members 
of the same family for five years preceding the 
recapitalization. In addition, a recapitalization does not 
qualify for the exception if the same family does not own 50 
percent of the total voting power and value of the stock 
throughout the three-year period following the 
recapitalization. Members of the same family are defined by 
reference to the definition in section 447(e). Thus, a family 
includes children, parents, brothers, sisters, and spouses, 
with a limited attribution for directly and indirectly owned 
stock of the corporation. Shares held by a family member are 
treated as not held by a family member to the extent a non-
family member had a right, option or agreement to acquire the 
shares (directly or indirectly, for example, through 
redemptions by the issuer), or with respect to shares as to 
which a family member has reduced its risk of loss with respect 
to the share, for example, through an equity swap. Even though 
the provision excepts certain family recapitalizations, the 
special valuation rules of section 2701 for estate and gift tax 
consequences continue to apply.
    An exchange of nonqualified preferred stock for 
nonqualified preferred stock in an acquiring corporation may 
qualify for tax-free treatment under section 354, but not 
section 351. In cases in which both sections 354 and 351 may 
apply to a transaction, section 354 generally will apply for 
purposes of this proposal. Thus, in that situation, the 
exchange would be tax free.
    The Treasury Secretary has regulatory authority to (1) 
apply installment sale-type rules to preferred stock that is 
subject to this proposal in appropriate cases and (2) prescribe 
treatment of preferred stock subject to this provision under 
other provisions of the Code (e.g., secs. 304, 306, 318, and 
368(c)). Until regulations are issued, preferred stock that is 
subject to the proposal shall continue to be treated as stock 
under other provisions of the Code.

                             Effective Date

    The provision is effective for transactions after June 8, 
1997, but will not apply to such transactions (1) made pursuant 
to a written agreement which was binding on such date and at 
all times thereafter, (2) described in a ruling request 
submitted to the Internal Revenue Service on or before such 
date, or (3) described in a public announcement or filing with 
the Securities and Exchange Commission on or before such date.

                      D. Administrative Provisions

1. Information reporting on persons receiving contract payments from 
        certain Federal agencies (sec. 831 of the bill and sec. 6041A 
        of the Code)

                              Present Law

    A service recipient (i.e., a person for whom services are 
performed) engaged in a trade or business who makes payments of 
remuneration in the course of that trade or business to any 
person for services performed must file with the IRS an 
information return reporting such payments (and the name, 
address, and taxpayer identification number of the recipient) 
if the remuneration paid to the person during the calendar year 
is $600 or more (sec. 6041A(a)). A similar statement must also 
be furnished to the person to whom such payments were made 
(sec. 6041A(e)). Treasury regulations explicitly exempt from 
this reporting requirement payments made to a corporation 
(Treas. reg. sec. 1.6041A-1(d)(2)).
    The head of each Federal executive agency must file an 
information return indicating the name, address, and taxpayer 
identification number (TIN) of each person (including 
corporations) with which the agency enters into a contract 
(sec. 6050M). The Secretary of the Treasury has the authority 
to require that the returns be in such form and be made at such 
time as is necessary to make the returns useful as a source of 
information for collection purposes. The Secretary is given the 
authority both to establish minimum amounts for which no 
reporting is necessary as well as to extend the reporting 
requirements to Federal license grantors and subcontractors of 
Federal contracts. Treasury regulations provide that no 
reporting is required if the contract is for $25,000 or less 
(Treas. reg. sec. 1.6050M-1(c)(1)(i)).

                           Reasons for Change

    Lowering the information reporting threshold from $25,000 
to $600 will improve compliance because additional, small-
dollar value contracts will be reported.

                        Explanation of Provision

    The provision requires reporting of all payments of $600 or 
more made by a Federal executive agency to any person 
(including a corporation) for services. In addition, the 
provision requires that a copy of the information return be 
sent by the Federal agency to the recipient of the payment. An 
exception is provided for certain classified or confidential 
contracts.

                             Effective Date

    The provision is effective for returns the due date for 
which (without regard to extensions) is more than 90 days after 
the date of enactment.

 2. Disclosure of tax return information for administration of certain 
   veterans programs (sec. 832 of the bill and sec. 6103 of the Code)

                              Present Law

    The Internal Revenue Code prohibits disclosure of tax 
returns and return information, except to the extent 
specifically authorized by the Internal Revenue Code (sec. 
6103). Unauthorized disclosure is a felony punishable by a fine 
not exceeding $5,000 or imprisonment of not more than five 
years, or both (sec. 7213). An action for civil damages also 
may be brought for unauthorized disclosure (sec. 7431). No tax 
information may be furnished by the Internal Revenue Service 
(``IRS'') to another agency unless the other agency establishes 
procedures satisfactory to the IRS for safeguarding the tax 
information it receives (sec. 6103(p)).
    Among the disclosures permitted under the Code is 
disclosure to the Department of Veterans Affairs (``DVA'') of 
self-employment tax information and certain tax information 
supplied to the Internal Revenue Service and Social Security 
Administration by third parties. Disclosure is permitted to 
assist DVA in determining eligibility for, and establishing 
correct benefit amounts under, certain of its needs-based 
pension, health care, and other programs (sec. 
6103(1)(7)(D)(viii)). The income tax returns filed by the 
veterans themselves are not disclosed to DVA.
    The DVA is required to comply with the safeguards currently 
contained in the Code and in section 1137(c) of the Social 
Security Act (governing the use of disclosed tax information). 
These safeguards include independent verification of tax data, 
notification to the individual concerned, and the opportunity 
to contest agency findings based on such information.
    The DVA disclosure provision is scheduled to expire after 
September 30, 1998.

                           Reasons for Change

    It is appropriate to permit disclosure of otherwise 
confidential tax information to ensure the correctness of 
government benefits payments.

                        Explanation of Provision

    The provision permanently extends the DVA disclosure 
provision.

                             Effective Date

    The provision is effective on the date of enactment.

3. Consistency rule for beneficiaries of trusts and estates (sec. 833 
        of the bill and sec. 6034A of the Code)

                              Present Law

    An S corporation is required to file a return for the 
taxable year and is required to furnish to its shareholders a 
copy of certain information shown on such return. The 
shareholder is required to file its return in a manner that is 
consistent with the information received from the S 
corporation, unless the shareholder files with the Secretary of 
the Treasury a notification of inconsistent treatment (sec. 
6037(c)). Similar rules apply in the case of partnerships and 
their partners (sec. 6222).
    The fiduciary of an estate or trust that is required to 
file a return for any taxable year is required to furnish to 
beneficiaries certain information shown on such return 
(generally via a Schedule K-1) (sec. 6034A). In addition, a 
U.S. person that is treated as the owner of any portion of a 
foreign trust is required to ensure that the trust files a 
return for the taxable year and furnishes certain required 
information to each U.S. person who is treated as an owner of a 
portion of the trust or who receives any distribution from the 
trust (sec. 6048(b)). However, rules comparable to the 
consistency rules that apply to S corporation shareholders and 
partners in partnerships are not specified in the case of 
beneficiaries of estates and trusts.

                           Reasons for Change

    Both partners in partnerships and shareholders of S 
corporations are required either to file their returns on a 
basis that is consistent with the information received from the 
partnership or S corporation or to identify any inconsistent 
treatment. The Committee believes that it is appropriate to 
apply such requirement also to beneficiaries of estates and 
trusts.

                        Explanation of Provision

    Under the bill, a beneficiary of an estate or trust is 
required to file its return in a manner that is consistent with 
the information received from the estate or trust, unless the 
beneficiary files with its return a notification of 
inconsistent treatment identifying the inconsistency.

                             Effective Date

    The provision is effective for returns filed after date of 
enactment.

4. Establish IRS continuous levy and improve debt collection (secs. 
        834, 835, and 836 of the bill and secs. 6331 and 6334 of the 
        Code)

            a. Continuous levy

                              Present Law

    If any person is liable for any internal revenue tax and 
does not pay it within 10 days after notice and demand \89\ by 
the IRS, the IRS may then collect the tax by levy upon all 
property and rights to property belonging to the person,\90\ 
unless there is an explicit statutory restriction on doing so. 
A levy is the seizure of the person's property or rights to 
property. Property that is not cash is sold pursuant to 
statutory requirements.\91\
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    \89\ Notice and demand is the notice give to a person liable for 
tax stating that the tax has been assessed and demanding that payment 
be made. The notice and demand must be mailed to the person's last 
known address or left at the person's dwelling or usual place of 
business (Code sec. 6303).
    \90\ Code sec. 6331.
    \91\ Code secs. 6335-6343.
---------------------------------------------------------------------------
    In general, a levy does not apply to property acquired 
after the date of the levy,\92\ regardless of whether the 
property is held by the taxpayer or by a third party (such as a 
bank) on behalf of a taxpayer. Successive seizures may be 
necessary if the initial seizure is insufficient to satisfy the 
liability.\93\ The only exception to this rule is for salary 
and wages.\94\ A levy on salary and wages is continuous from 
the date it is first made until the date it is fully paid or 
becomes unenforceable.
---------------------------------------------------------------------------
    \92\ Code sec. 6331(b).
    \93\ Code sec. 6331(c).
    \94\ Code sec. 6331(e).
---------------------------------------------------------------------------
    A minimum exemption is provided for salary and wages.\95\ 
It is computed on a weekly basis by adding the value of the 
standard deduction plus the aggregate value of personal 
exemptions to which the taxpayer is entitled, divided by 
52.\96\ For a family of four for taxable year 1996, the weekly 
minimum exemption is $325.\97\
---------------------------------------------------------------------------
    \95\ Code sec. 6334(a)(9).
    \96\ Code sec. 6334(d)
    \97\ Standard deduction of $6,700 plus four personal exemptions at 
$2,550 each equals $16,900, which when divided by 52 equals $325.
---------------------------------------------------------------------------

                           Reasons for Change

    The extension of the continuous levy provisions will 
substantially ease the administrative burdens of collecting 
taxes by levy. The Committee anticipates that taxpayers who 
already comply with the tax laws will have a positive view of 
increased collections of taxes owed by taxpayers who have not 
complied with the tax laws.

                        Explanation of Provision

    The provision amends the Code to provide that a continuous 
levy is also applicable to non-means tested recurring Federal 
payments. This is defined as a Federal payment for which 
eligibility is not based on the income and/or assets of a 
payee. For example, Social Security payments, which are subject 
to levy under present law, would become subject to continuous 
levy.
    In addition, the provision provides that this levy would 
attach up to 15 percent of any specified payment due the 
taxpayer. This rule explicitly replaces the other specifically 
enumerated exemptions from levy in the Code. A continuous levy 
of up to 15 percent would also apply to unemployment benefits 
and means-tested public assistance.
    The bill also permits the disclosure of otherwise 
confidential tax return information to the Treasury 
Department's Financial Management Service only for the purpose 
of, and to the extent necessary in, implementing these levy 
provisions.

                             Effective Date

    The provision is effective for levies issued after the date 
of enactment.
            b. Modifications of levy exemptions

                              Present Law

    The Code exempts from levy workmen's compensation 
payments,\98\ unemployment benefits \99\ and means-tested 
public assistance.\100\
---------------------------------------------------------------------------
    \98\ Code sec. 6334(a)(7).
    \99\ Sec. 6334(a)(4).
    \100\ Sec 6334(a)(11).
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that if wages are subject to levy, 
wage replacement payments should also be subject to levy.

                        Explanation of Provision

    The provision provides that the following property is not 
exempt from continuous levy if the Secretary of the Treasury 
(or his delegate) approves the levy of such property:
          (1) workmen's compensation payments,
          (2) unemployment benefits, and
          (3) means-tested public assistance.

                             Effective Date

    The provision applies to levies issued after the date of 
enactment.

                        E. Excise Tax Provisions

1. Extension and modification of Airport and Airway Trust Fund excise 
        taxes (sec. 841 of the bill and secs. 4081, 4091, and 4261 of 
        the Code)

                              Present Law

    Present law imposes a variety of excise taxes on air 
transportation to finance the Airport and Airway Trust Fund 
programs administered by the Federal Aviation Administration 
(the ``FAA''). In general, the full cost of FAA capital 
programs is financed from the Airport and Airway Trust Fund, 
while only a portion of FAA operational expenses is Trust Fund-
financed. Overall, the portion of total FAA expenditures that 
has been financed from the Trust Fund has declined from 75 
percent through the early 1990s to 62 percent for the 1997 
fiscal year. The balance is financed by general taxpayers, 
rather than directly by program users. Each of the Airport and 
Airway Trust Fund excise taxes is scheduled to expire after 
September 30, 1997.

Commercial air passenger transportation taxes

    Domestic air passenger transportation is subject to an ad 
valorem excise tax equal to 10 percent of the amount paid for 
the transportation. Taxable domestic air transportation 
includes both travel within the United States and certain 
travel between the United States and points in Canada or Mexico 
that are within 225 miles of the U.S. border (the ``225-mile 
zone'').
    Special rules apply to air transportation between the 
continental United States and Alaska or Hawaii and between 
Alaska and Hawaii. The portion of such transportation which is 
not within the United States (e.g., the portion over the 
Pacific Ocean between the continental West Coast and Hawaii) is 
not subject to the 10-percent air passenger excise tax.\101\ 
The 10-percent excise tax applies in full, however, to air 
transportation within the States of Alaska and Hawaii.
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    \101\ The $6 per passenger international departure excise tax, 
described below, does apply to this transportation.
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    The 10-percent air passenger transportation excise tax also 
does not apply to domestic U.S. segments of uninterrupted 
international air transportation. Uninterrupted international 
air transportation includes only travel (entirely by air) that 
does not both begin and end in the United States (or in the 
225-mile zone) and during which there is no more than a 12-hour 
scheduled period between arrival and departure at any 
intermediate point in the United States. For example, assume 
that a passenger travels from New York to Tokyo, with a four-
hour stop and aircraft change in Seattle. The domestic segment 
of the flight (i.e., New York to Seattle) is not subject to the 
domestic air passenger transportation excise tax because that 
segment is a part of uninterrupted international air 
transportation.
    International air passenger transportation is subject to a 
$6 departure excise tax imposed on passengers departing the 
United States for other countries. No tax is imposed on 
passengers arriving in the United States from other countries. 
As with passengers departing the United States, separate 
domestic flights of arriving passengers that connect from 
international flights are exempt from tax, provided that 
stopover time at any point within the United States does not 
exceed 12 hours.
    Because both the domestic and international air passenger 
excise taxes are imposed only on transportation for which an 
amount is paid, no tax is imposed on ``free'' travel (e.g., 
frequent flyer travel and airline industry employee travel for 
which the passenger is not directly charged).
    The air passenger transportation excise taxes are imposed 
on passengers; transportation providers (generally airlines) 
are responsible for collecting and remitting the taxes to the 
Federal Government. In general, both the domestic and 
international air passenger transportation excise taxes are 
imposed without regard to whether the transportation is 
purchased within the United States. An exception provides that 
travel between the United States and the 225-mile zone is 
subject to the ad valorem domestic tax only if it is purchased 
within the United States.
    The amount of air passenger transportation excise tax 
collected from a passenger must be stated separately on the 
ticket.

Commercial air cargo transportation

    Domestic air cargo transportation is subject to a 6.25-
percent ad valorem excise tax. This tax, like the air passenger 
excise taxes, is imposed on the consumer, with the 
transportation provider being required to collect and remit the 
tax to the Federal Government. However, there is no requirement 
that the tax be stated separately on shipping invoices.

Noncommercial aviation

    Noncommercial aviation, or transportation on private 
aircraft which is not ``for hire,'' is subject to excise taxes 
imposed on fuel in lieu of the commercial air passenger ticket 
and air cargo excise taxes. The current Airport and Airway 
Trust Fund tax rates on these fuels are 15 cents per gallon on 
aviation gasoline and 17.5 cents per gallon on jet fuel.
    The aviation gasoline excise tax is imposed on removal of 
the fuel from a registered terminal facility (the same point as 
the highway gasoline excise tax). The jet fuel excise tax is 
imposed on sale of the fuel by a wholesale distributor. Many 
larger airports have dedicated pipeline facilities that 
directly service aircraft; in such a case, the tax effectively 
is imposed at the retail level. The person removing the 
gasoline from a terminal facility or the wholesale distributor 
of the jet fuel is liable for these taxes.

Deposit of air transportation excise taxes

    Under present law, the air passenger ticket and freight 
excise taxes are collected from passengers and freight shippers 
by the commercial air carriers. The air carriers then remit the 
funds to the Treasury Department; however, the air carriers are 
not required to remit monies immediately. Excise tax returns 
are filed quarterly (similar to annual income tax returns), 
with taxes being deposited on a semi-monthly basis (similar to 
estimated income taxes). For airtransportation sold during a 
semi-monthly period, air carriers may elect to treat the taxes as 
collected on the last day of the first week of the second following 
semi-monthly period. Under these ``deemed collected'' rules, for 
example, the taxes on air transportation sold between August 1 and 
August 15, are treated as collected by the air carriers on or before 
September 7, with the amounts generally being deposited with the 
Treasury Department by September 10. A special rule requires certain 
amounts deemed collected during the second half of September to be 
deposited by September 29.
    Semi-monthly deposits and quarterly excise tax returns also 
are required with respect to the fuels excise taxes imposed on 
air transportation.

Overflight user fees

    Non-tax user fees are imposed on air transportation (both 
commercial and noncommercial aviation) that travels through 
airspace for which the United States provides air traffic 
control services, but that neither lands in nor takes off from 
a point in the United States. These fees are imposed and 
collected by the FAA with respect to mileage actually flown, 
and apply both to travel within U.S. territorial airspace and 
to travel within international oceanic airspace for which the 
United States is responsible for providing air traffic control 
services.

                           Reasons for Change

    The Committee determined that provisions to ensure a long-
term, stable funding source for the Airport and Airway Trust 
Fund should be enacted at this time. As illustrated by the 
recent events when a shortfall in fiscal year 1997 FAA funding 
was narrowly averted by an emergency extension of the present-
law excise taxes through September 30, 1997, longer-term 
assurance of these funding needs is imperative. Therefore, the 
bill extends (with certain modifications) the current Airport 
and Airway Trust Fund excise taxes for a 10-year period, a move 
that it is believed will resolve, for this 10-year period, 
concerns about the availability of adequate user tax revenues 
to fund the portion of FAA programs to be appropriated from the 
Airport and Airway Trust Fund.
    The Committee determined that limited modifications to the 
current passenger excise tax structure are warranted to improve 
the perceived fairness of these taxes. First, the Committee was 
very concerned that, under present law, passengers traveling in 
international transportation pay significantly less tax for 
transportation involving comparable FAA services than do 
entirely domestic passengers. The Committee believes it unfair 
for American families traveling domestically on, e.g., family 
vacations, to be required to subsidize persons engaged in this 
international travel. In particular, the Committee is extremely 
concerned that domestic passengers flying on entirely domestic 
flights currently are exempt from tax if they connect to or 
from another, international flight while passengers on the same 
flight who do not go on to or arrive from an international 
destination are fully taxed. Similarly, the Committee believes 
it is inappropriate that passengers arriving in the United 
States should not pay any tax for the FAA services they 
receive. To achieve greater equity in the air transportation 
user taxes, the bill extends the tax to internationally 
arriving passengers, reclassifies domestic segments of 
international travel as domestic transportation, and clarifies 
that the tax applies to payments to airlines (and related 
parties) from credit card and other companies in exchange for 
the right to award frequent flyer miles or other reduced air 
travel rights.
    The Committee further believes that continued availability 
of air transportation services to rural areas is an important 
national objective. Accordingly, the bill provides a special, 
reduced tax rate for flight segments to and from smaller rural 
airports.

                       Explanation of Provisions

Extension of Airport and Airway Trust Fund taxes

    The Airport and Airway Trust Fund excise taxes, as modified 
below, are extended for 10 years, for the period October 1, 
1997, through September 30, 2007. The taxes that are extended 
include the domestic and international air passenger excise 
taxes, the air cargo excise tax, and the noncommercial aviation 
fuels taxes. Gross receipts from these taxes will continue to 
be deposited in the Airport and Airway Trust Fund.

Modification of commercial air passenger transportation taxes

    Tax on international arrivals and departures; treatment of 
domestic flight segments associated with international 
travel.--The current $6 international departure tax is 
increased to $8 per departure, and an identical $8 per 
passenger tax is imposed on arrivals in the United States from 
international locations. The definition of international 
transportation is modified to eliminate domestic flight 
segments associated with that travel (which are taxed the same 
as other domestic transportation under the bill). Thus, the $8 
per passenger tax applies to all uninterrupted flight segments 
between a point in the United States and a point in a foreign 
country.
    Under the bill, domestic flight segments associated with 
international transportation are taxed the same as other 
domestic flights. Domestic flight segments are flight segments 
between two U.S. points (or between a U.S. point and a point 
within the 225-mile zone) from which the passenger continues to 
or from an international flight. The 10-percent domestic tax 
rate applies to all such flight segments. The portion of a 
passenger's fare that is subject to this tax is equal to the 
percentage of total travel miles covered by the fare 
(determined based on the aggregate number of miles in all of 
the flight segments) that the domestic flight segment miles 
comprise. For this purpose, flight miles are ``Great Circle'' 
miles unless the Treasury Department develops another measure 
(such as predominate routed mileage). Great Circle miles are 
based on the shortest distance (i.e., ``as the crow flies'') 
between two points. In general, this mileage calculation is 
identical to that which is used by frequent flyer programs 
offered by all major U.S. airlines today. Computer programs are 
readily available for calculating ``Great Circle'' miles 
between origin and destination points for flights.
    These provisions are illustrated by the following example. 
Assume that a passenger travels from Paris to Los Angeles with 
a intermediate stop and aircraft change in New York. The 
passenger is subject to an $8 tax on the flight segment from 
Paris to New York. Assume further that 50 percent of the 
aggregate miles on the London to Los Angeles trip are 
attributable to travel between New York and Los Angeles. In 
this case, 50 percent of the fare is subject to the10-percent 
ad valorem tax for the flight segment between New York and Los Angeles. 
The combined tax amount (international and domestic rate portions) are 
calculated by the airline and stated on the passenger's ticket.
    Special rules applicable to certain transportation.--
Transportation between the 48 contiguous States and Alaska or 
Hawaii (or between those States) remains subject to the special 
rules provided in present law. Thus, this transportation is 
taxed on apportioned mileage in U.S. territorial airspace plus 
$6 per passenger per one-way flight.\102\ Clarification is 
provided that only one $6 per passenger tax is imposed on a 
single flight segment (despite the fact that such a flight 
segment technically constitutes both an international departure 
and an international arrival).
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    \102\ This special rule also applies to domestic segments between 
the contiguous 48 states and Alaska or Hawaii which are associated with 
international arrivals or departures to or from those States. Thus, the 
flight segment between the 48 contiguous States and Alaska or Hawaii is 
subject to a tax of $6 plus 10 percent of the apportioned mileage in 
U.S. territorial airspace, and the flight segment between Alaska or 
Hawaii and a foreign country is subject to the new $8 international 
arrival and departure tax rate.
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    Additionally, the current special provisions governing 
transportation between the United States and points within the 
225-mile zone of Canada or Mexico are retained, with that 
transportation being taxed on the same basis as other domestic 
transportation in the circumstances provided under present law 
(as modified by the provisions of the bill recharacterizing 
certain domestic flight segments associated with international 
transportation).
    A further special rule is provided for certain flight 
segments to or from qualified rural airports. A qualified rural 
airport is an airport that (1) in the second preceding calendar 
year had fewer than 100,000 commercial passenger enplanements 
(i.e., departures), and (2) either (a) is not located within 75 
miles of another airport that had more than 100,000 such 
passenger enplanements in that year, or (b) is eligible for 
payments under the Federal ``essential air services'' program 
(as in effect on the date of enactment). Flight segments to or 
from a qualified rural airport are subject to a reduced, 7.5-
percent ad valorem rate (in lieu of the general 10-percent 
rate).\103\ The term flight segment is defined as 
transportation involving a single take-off and a single 
landing. In the case of transportation involving multiple 
flight segments, the portion of the fare allocable to the rural 
segment is determined based on the number of Great Circle miles 
in the rural flight segment as compared to the aggregate number 
of miles in all of the flight segments. This is the same 
calculation that is used in apportioning international 
transportation between taxable international travel and 
associated domestic flight segments.
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    \103\ The Treasury Department is directed to publish an annual list 
of qualified rural airports, based on passenger enplanements for the 
requisite calendar year.
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    Extension of tax to certain currently exempt passengers.--
As described above, passengers arriving in the United States 
from other countries, who currently are the only group of 
travelers whose transportation is subject neither to an excise 
tax nor a user fee for U.S.-provided aviation services, are 
subject to tax on their arriving international flights. 
Similarly, passengers traveling on domestic flight segments 
that either connect to or from international flight segments 
are subject to tax in the same manner as other, entirely 
domestic passengers.
    Clarification further is provided that any amounts paid to 
air carriers (in cash or in kind) for the right to award or 
otherwise distribute free or reduced-rate air transportation 
are treated as amounts paid for taxable air transportation, 
subject to the 10-percent ad valorem tax rate. Examples of such 
taxable amounts include (1) payments for frequent flyer miles 
purchased by credit card companies, telephone companies, rental 
car companies, television networks, restaurants and hotels, and 
other businesses for distribution to their customers and others 
(e.g., employees) and (2) amounts received by airlines pursuant 
to joint venture credit card or other marketing arrangements. 
The Treasury Department is authorized specifically to disregard 
accounting allocations or other arrangements which have the 
effect of reducing artificially the base to which the 10-
percent tax is applied. (No inference is intended from this 
provision as to the proper treatment of these payments under 
present law.)
    Liability for tax.--The present-law provision imposing 
liability for the tax on passengers (with transportation 
providers being liable for collecting and remitting revenues to 
the Federal Government) are modified to impose secondary 
liability on air carriers. As with the current tax, the 
aggregate tax will continue to be required to be stated 
separately on passenger tickets.
    Modification of air passenger excise tax deposit rules.--
The deposit rules with respect to the commercial air passenger 
excise taxes are modified to permit payment of these taxes that 
otherwise would have been required to be deposited during the 
period August 15, 1997 through September 30, 1997, to be 
deposited on October 10, 1997. Similarly, tax deposits that 
would be due during the period July 1, 2001, through September 
30, 2001, are required to be made no later than October 10, 
2001.

                             Effective Date

    These provisions generally are effective on the date of 
enactment, for air transportation beginning after September 30, 
1997.
    Present law requires transportation providers to continue 
collecting the commercial aviation excise taxes (at the current 
rates) on transportation to be provided after September 30, 
1997, if the transportation is purchased before October 1, 
1997. The bill requires transportation providers to collect the 
taxes at the modified rates for transportation purchased after 
the date of enactment for travel beginning after September 30, 
1997.
    The extension of the general aviation fuels excise taxes is 
effective for fuels removed or sold after September 30, 1997.
    The provision clarifying application of the commercial air 
passenger excise tax to certain amounts paid for the right to 
award air transportation is effective for amounts paid (or 
benefits transferred) after September 30, 1997. A special rule 
provides that payments (or transfers) between related parties 
occurring after June 16, 1997 and before October 1, 1997, are 
subject totax if the payments relate to rights to 
transportation to be awarded or otherwise distributed after September 
30, 1997.
    The modifications to the commercial air passenger excise 
tax deposit rules are effective on the date of enactment.

2. Reinstate Leaking Underground Storage Tank Trust Fund excise tax 
        (sec. 842 of the bill and secs. 4041(d), 4081(a)(2), and 
        4081(d)(2) of the Code)

                              Present Law

    Before January 1, 1996, an excise tax of 0.1 cent per 
gallon was imposed on gasoline, diesel fuel (including train 
diesel fuel), special motor fuels (other than liquefied 
petroleum gas), aviation fuels, and inland waterways fuels. 
Revenues from the tax were dedicated to the Leaking Underground 
Storage Tank Trust Fund to finance cleanups of leaking 
underground storage tanks.

                           Reasons for Change

    The Committee determined that the Leaking Underground 
Storage Tank Trust Fund excise tax should be reinstated to 
ensure the availability of funds to pay cleanup costs of 
leaking underground storage tanks.

                        Explanation of Provision

    The bill reinstates the prior-law Leaking Underground 
Storage Tank Trust Fund excise tax through September 30, 2007.

                             Effective Date

    The provision is effective on October 1, 1997.

3. Application of communications tax to long-distance prepaid telephone 
        cards (sec. 843 of the bill and sec. 4251 of the Code)

                              Present Law

    A 3-percent excise tax is imposed on amounts paid for local 
and toll (long-distance) telephone service and teletypewriter 
exchange service. The tax is collected by the provider of the 
service from the consumer (business and residential 
custormers).

                           Reasons for Change

    The Committee understands that communication service 
providers sometimes sell units of long-distance service to 
third parties who, in turn, resell or distribute these units of 
long-distance telephone service to the ultimate customer in the 
form of prepaid telephone cards or similar arrangements. The 
Committee believes that such payments clearly represent 
payments for long-distance telephone service and clarifies that 
such payments are subject to the communications excise tax.

                        Explanation of Provision

    The bill provides that any amounts paid to telephone 
carriers (in cash or in kind) for the right to award or 
otherwise distribute long-distance telephone service, including 
free or reduced-rate service, are treated as amounts paid for 
taxable communication services, subject to the 3-percent ad 
valorem tax rate. Examples of such taxable amounts include (1) 
prepaid telephone cards offered through service stations, 
convenience stores and other businesses to their customers and 
others (e.g., employees) and (2) amounts received by telephone 
carriers pursuant to joint venture credit card or other 
marketing arrangements.
    For example, company A, which is a telephone carrier that 
owns telephone transmission and switching equipment and 
generally offers telephone service to the public, may sell a 
block of long-distance message units to company B for X 
dollars. Company B owns no transmission or switching equipment, 
but rather acts as a reseller of long distance telephone 
services and also is a telephone carrier. Company B, in turn, 
resells all or part of the long-distance message units 
purchased from Company A to Company C for Y dollars. Company C 
operates a chain of convenience stores. Company C resells some 
of the long-distance message units in the form of prepaid 
telephone cards to its convenience store customers and also 
makes some of the message units available to its employees as a 
benefit by the free distribution of such prepaid telephone 
cards to the employees. The amount Y will be considered an 
amount paid for telecommunications services subject to the 3-
percent telephone excise tax. Alternatively, if company C had 
purchased the block of message units directly from company A 
for X dollars, the amount X will be considered an amount paid 
for telecommunications services subject to the 3-percent 
telephone excise tax.
    In the case of amounts received by telecommunications 
carriers pursuant to joint venture credit card or other 
marketing arrangements, the Treasury Department is authorized 
specifically to disregard accounting allocations or other 
arrangements which have the effect of reducing artificially the 
base to which the 3-percent tax is applied.
    No inference is intended from this provision as to the 
proper treatment of these payments under present law.

                             Effective Date

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

4. Uniform rate of excise tax on vaccines (sec. 844 of the bill and 
        secs. 4131 and 4132 of the Code)

                              Present Law

    Under section 4131, a manufacturer's excise tax is imposed 
on the following vaccines routinely recommended for 
administration to children: DPT (diphtheria, pertussis, 
tetanus,), $4.56 per dose; DT (diphtheria, tetanus), $0.06 per 
dose; MMR (measles, mumps, or rubella), $4.44 per dose; and 
polio, $0.29 per dose. In general, if any vaccine is 
administered by combining more than one of the listed taxable 
vaccines, the amount of tax imposed is the sum of the amounts 
of tax imposed for each taxable vaccine. However, in the case 
of MMR and its components, any component vaccine of MMR is 
taxed at the same rate as the MMR-combined vaccine.
    Amounts equal to net revenues from this excise tax are 
deposited in the Vaccine Injury Compensation Trust Fund to 
finance compensation awards under the Federal Vaccine Injury 
Compensation Program for individuals who suffer certain 
injuries following administration of the taxable vaccines. This 
program provides a substitute Federal, ``no fault'' insurance 
system for the State-law tort and private liability insurance 
systems otherwise applicable to vaccine manufacturers. All 
persons immunized after September 30, 1998, with covered 
vaccines must pursue compensation under this Federal program 
before bringing civil tort actions under State law.

                           Reasons for Change

    The Committee understands that the present-law tax rates 
applicable to taxable vaccines were chosen to reflect estimated 
probabilities of adverse reactions and the severity of the 
injury that might result from such reactions. The Committee 
understands that medical researchers believe that there is 
insufficient data to support fine gradations of estimates of 
potential harm from the various different childhood vaccines. 
In the light of this scientific assessment, the Committee 
believes some simplicity can be achieved by taxing such 
vaccines at the same rate per dose.
    The Committee further believes it is appropriate to review 
the list of taxable vaccines from time to time as medical 
science advances. The Center for Disease Control has 
recommended that the vaccines for HIB (haemophilus influenza 
type B), Hepatitis B, and varicella (chicken pox) be widely 
administered among the nation's children. In light of the 
growing number of immunizations using these vaccines, the 
Committee adds these vaccines to the list of taxable vaccines.

                        Explanation of Provision

    The bill replaces the present-law excise tax rates, that 
differ by vaccine, with a single rate tax of $0.84 per dose on 
any listed vaccine component. Thus, the bill provides that the 
tax applied to any vaccine that is a combination of vaccine 
components is 84 cents times the number of components in the 
combined vaccine. For example, the MMR vaccine is to be taxed 
at a rate of $2.52 per dose and the DT vaccine is to be taxed 
at rate of $1.68 per dose.
    In addition, the provision adds three new taxable vaccines 
to the present-law taxable vaccines: (1) HIB (haemophilus 
influenza type B); (2) Hepatitis B; and (3) varicella (chicken 
pox). The three newly listed vaccines also are subject to the 
84-cents per dose excise tax.
    Lastly, the Committee directs the Secretary of the Treasury 
to undertake a study of the efficacy of the new flat-rate 
vaccine tax system as a means to finance the Vaccine Injury 
Compensation Trust Fund. Among other issues that the Secretary 
might find pertinent, the Committee directs the Secretary to 
explore the following questions. For each taxable vaccine, how 
does the magnitude of the tax compare to the total price of the 
vaccine that is charged to the patient (or the patient's 
insurance company)? Have any changes in the prices of taxable 
vaccines that might have resulted from the changes in tax 
enacted by this bill altered the use of taxable vaccines (i.e., 
what is the price elasticity of demand for the various taxable 
vaccines)? Does scientific evidence exist to permit a vaccine 
tax structure that reflects possibly different medical risks 
from the different vaccines? Does the flat-rate structure 
generate savings in compliance costs for taxpayers and 
administrative cost savings for the Internal Revenue Service? 
The Committee welcomes recommendations regarding possible 
changes in this tax structure. However, the Committee reminds 
the Secretary that determination of the tax base and the tax 
rate are the constitutional prerogative of the Congress and 
that recommendations for delegation of such authority to the 
executive branch are inappropriate. The results of the study 
are to be reported to the Senate Committee on Finance and the 
House Committee on Ways and Means by September 30, 1999.

                             Effective Date

    The provision is effective for vaccine purchases after 
September 30, 1997. No floor stocks tax is to be collected or 
refunds permitted for amounts held for sale on October 1, 1997. 
Returns to the manufacturer occurring on or after October 1, 
1997, are assumed to be returns of vaccines to which the new 
rates of tax apply.

5. Modify treatment of tires under the heavy highway vehicle retail 
        excise tax (sec. 845 of the bill and sec. 4071 of the Code)

                              Present Law

    A 12-percent retail excise tax is imposed on certain heavy 
highway trucks and trailers, and on highway tractors. A 
separate manufacturers' excise tax is imposed on tires weighing 
more than 40 pounds. This tire tax is imposed as a fixed dollar 
amount which varies based on the weight of the tire. Because 
tires are taxed separately, the value of tires installed on a 
highway vehicle is excluded from the 12-percent excise tax on 
heavy highway vehicles. The determination of value is factual 
and has given rise to numerous tax audit challenges.

                           Reasons for Change

    Allowing a credit for the tire tax actually paid on truck 
tires will simplify the application of the retail truck tax.

                        Explanation of Provision

    The current exclusion of the value of tires installed on a 
taxable highway vehicle is repealed. Instead, a credit for the 
amount of manufacturers' excise tax actually paid on the tires 
is allowed.

                             Effective Date

    The provision is effective after December 31, 1997.

6. Increase tobacco excise taxes (sec. 846 of the bill and sec. 5701 of 
        the Code)

                              Present Law

    The following is a listing of the Federal excise taxes 
imposed on tobacco products under present law:

                                                                        
                  Article                            Tax imposed        
                                                                        
Cigars:                                                                 
  Small cigars............................  $1.125 per thousand.        
  Large cigars............................  12.75% of manufacturer's    
                                             price, up to $30 per       
                                             thousand.                  
Cigarettes:                                                             
  Small cigarettes........................  $12.00 per thousand (24     
                                             cents per pack of 20       
                                             cigarettes).               
  Large cigarettes........................  $25.20 per thousand.        
Cigarette papers..........................  $0.0075 per 50 papers.      
Cigarette tubes...........................  $0.15 per 50 tubes.         
Chewing tobacco...........................  $0.12 per pound.            
Snuff.....................................  $0.36 per pound.            
Pipe tobacco..............................  $0.675 per pound.           
                                                                        

                           Reasons for Change

    The Committee believes it is appropriate to increase taxes 
on tobacco products. Raising such taxes will have the positive 
effect of discouraging smoking, particularly smoking by 
children and teenagers, thereby helping millions of Americans 
avoid the health hazards that accompany long-term tobacco use.

                        Explanation of Provision

In general

    The bill increases the current excise tax rates on all 
tobacco products, including cigarettes, cigars, chewing 
tobacco, snuff, and pipe tobacco, effective October 1, 1997. 
Floor stocks taxes are imposed on tobacco products at the time 
of the rate increase (including tobacco products in foreign 
trade zones).

Specific tax rate increases

    The following table shows the specific tobacco excise tax 
rates under the bill as of October 1, 1997:

                                                                        
                  Article                    Tax rate (October 1, 1997) 
                                                                        
Cigars:                                                                 
  Small cigars............................  $2.063 per thousand.        
  Large cigars............................  23.375% of manufacturer's   
                                             price, up to $55 per       
                                             thousand.                  
Cigarettes:                                                             
  Small cigarettes........................  $22.00 per thousand (44     
                                             cents per pack of 20       
                                             cigarettes).               
  Large cigarettes........................  $46.20 per thousand.        
Cigarette papers..........................  $0.0138 per 50 papers.      
Cigarette tubes...........................  $0.0275 per 50 tubes.       
Chewing tobacco...........................  $0.22 per pound.            
Snuff.....................................  $0.66 per pound.            
Pipe tobacco..............................  $1.2375 per pound.          
Roll-your-own tobacco.....................  $0.66 per pound.            
                                                                        


     The bill also includes expanded compliance measures 
designed to prevent diversion of non-tax-paid tobacco products 
nominally destined for export for use within the United States.

                             Effective Date

    The provision is effective on October 1, 1997.

             F. Provisions Relating to Tax-Exempt Entities

1. Extend UBIT rules to second-tier subsidiaries and amend control test 
        (sec. 851 of the bill and sec. 512(b)(13) of the Code)

                              Present Law

    In general, interest, rents, royalties and annuities 
received by tax-exempt organizations are not subject to the 
unrelated business income tax (UBIT). However, section 
512(b)(13) treats otherwise excluded rent, royalty, annuity, 
and interest income as potentially subject to UBIT if such 
income is received from a taxable or tax-exempt subsidiary that 
is 80 percent controlled by the parent tax-exempt 
organization.\104\ Rent, royalty, annuity, and interest 
payments received from a controlled subsidiary are treated as 
unrelated business income (UBTI) in the hands of the parent 
organization based on the percentage of the subsidiary's income 
that is unrelated business taxable income (either in the hands 
of the subsidiary if the subsidiary is tax-exempt, or in the 
hands of the parent organization if the subsidiary is taxable).
---------------------------------------------------------------------------
    \104\ For this purpose, a ``controlled organization'' is defined 
under section 368(c).
---------------------------------------------------------------------------
    In the case of a stock subsidiary, the 80 percent control 
test under section 512(b)(13) is met if the parent organization 
owns 80 percent or more of the voting stock and all other 
classes of stock of the subsidiary.\105\ In the case of a non-
stock subsidiary, the applicable Treasury regulations look to 
factors such as the representation of the parent corporation on 
the board of directors of the nonstock subsidiary, or the power 
of the parent corporation to appoint or remove the board of 
directors of the subsidiary.\106\
---------------------------------------------------------------------------
    \105\ Treas. reg. sec. 1.512(b)-1(1)(4)(I)(a).
    \106\ Treas. reg. sec. 1.512(b)-1(1)(4)(I)(b).
---------------------------------------------------------------------------
    The control test under section 512(b)(13) does not, 
however, incorporate any indirect ownership rules.\107\ 
Consequently, rents, royalties, annuities and interest derived 
from second-tier subsidiaries generally do not constitute UBTI 
to the tax-exempt parent organization.\108\
---------------------------------------------------------------------------
    \107\ See PLR 9338003 (June 16, 1993) (holding that because no 
indirect ownership rules are applicable under section 512(b)(13), rents 
paid by a second-tier taxable subsidiary are not UBTI to a tax-exempt 
organization). In contrast, an example of an indirect ownership rule 
can be found in Code section 318. Section 318(a)(2)(C) provides that if 
50 percent or more in value of the stock in a corporation is owned, 
directly or indirectly, by or for any person, such person shall be 
considered as owning the stock owned, directly or indirectly by or for 
such corporation, in the proportion the value of the person's stock 
ownership bears to the total value of all stock in the corporation.
    \108\ See PLR 9542045 (July 28, 1995) (holding that first-tier 
holding company and second-tier operating subsidiary were organized 
with bona fied business functions and were not agents of the tax-exempt 
parent organization; therefore, rents, royalties, and interest received 
by tax-exempt parent organization from second-tier subsidiary were not 
UBTI).
---------------------------------------------------------------------------

                           Reasons for Change

    Section 512(b)(13) was enacted to prevent subsidiaries of 
tax-exempt organizations from reducing their otherwise taxable 
income by borrowing, leasing, or licensing assets from a tax-
exempt parent organization at inflated levels. Because section 
512(b)(13) was narrowly drafted, organizations were able to 
circumvent its application through, for example, the issuance 
of 21 percent of nonvoting stock with nominal value to a 
separate friendly party or through the use of tiered or 
brother/sister subsidiaries. The Committee believes that the 
modifications to the control requirement and inclusion of 
attribution rules will ensure that section 512(b)(13) operate 
consistent with its intended purpose.

                        Explanation of Provision

    The bill modifies the test for determining control for 
purposes of section 512(b)(13). Under the bill, ``control'' 
means (in the case of a stock corporation) 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, the bill 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).
    The bill also makes technical modifications to the method 
provided in section 512(b)(13) for determining how much of an 
interest, rent, annuity, or royalty payment made by a 
controlled entity to a tax-exempt organization is includible in 
the latter organization's UBTI. Such payments are subject to 
UBIT to the extent the payment reduces the net unrelated income 
(or increases any net unrelated loss) of the controlled entity.

                             Effective Date

    The modification of the control test to one based on vote 
or value, the application of the constructive ownership rules 
of section 318, and the technical modifications to the flow-
through method apply to taxable years beginning after the date 
of enactment. The reduction of the ownership threshold for 
purposes of the control test from 80 percent to more than 50 
percent applies to taxable years beginning after December 31, 
1998.

2. Limitation on increase in basis of property resulting from sale by 
        tax-exempt entity to related person (sec. 852 of the bill and 
        sec. 1061 of the Code)

                              Present law

    If a tax-exempt entity transfers assets to a controlled 
taxable entity in a transaction that is treated as a sale, the 
transferee taxable entity obtains a fair market value basis in 
the assets. Because the transferor is tax-exempt, no gain is 
recognized on the transfer except to the extent of certain 
unrelated business taxable income, if any.
    Other provisions of the Code deny certain tax benefits when 
a transferor and transferee are related parties. For example, 
losses on sales between related parties are not recognized 
(sec. 267). As another example, ordinary income treatment, 
rather than capital gain treatment, is required on a sale of 
depreciable property between related parties.(sec.1239).

                           Reasons for Change

    The Committee recognizes that a tax-exempt entity can sell 
assets to a taxable party without recognition of gain, while 
that party receives a fair market value basis in the property. 
However, the Committee is concerned that tax-exempt entities 
may in effect structure transactions in which assets are 
transferred to taxable entities controlled by the tax-exempt 
entity, in a form such that a stepped-up basis and depreciation 
are available to reduce the amount that would otherwise have 
been taxable unrelated business income, if the tax-exempt 
entity had converted the same assets to taxable operation and 
operated the business itself.

                        Explanation of Provision

    In the case of a sale or exchange of property directly or 
indirectly between a tax-exempt entity and a related person, 
the basis of the related person in the property will not exceed 
the adjusted basis of such property immediately before the sale 
in the hands of the tax-exempt entity, increased by the amount 
of any gain recognized to the tax-exempt entity under the 
unrelated business taxable income rules of section 511.
    A tax-exempt entity for this purpose is defined as in 
section 168(h)(2)(A), without regard to section (iii) of that 
section.
    A related person means any person having a relationship to 
the tax-exempt entity described in section 267(b) or 707(b)(1) 
(generally, certain more-than-50-percent relationships, with 
specified attribution rules). For purposes of applying section 
267(b)(2), such an entity is treated as if it were an 
individual.

                             Effective Date

    The provision applies to sales or exchanges after June 8, 
1997; except that it will not apply to a sale or exchange made 
pursuant to a written agreement which was binding on such date 
and at all times thereafter.

3. Repeal grandfather rule with respect to pension business of insurer 
        (sec. 853 of the bill and sec. 1012(c) of the Tax Reform Act of 
        1986)

                              Present Law

    Present law provides that an organization described in 
sections 501(c)(3) or (4) of the Code is exempt from tax only 
if no substantial part of its activities consists of providing 
commercial-type insurance. When this rule was enacted in 1986, 
certain treatment (described below) applied to Blue Cross and 
Blue Shield organizations providing health insurance that (1) 
were in existence on August 16, 1986; (2) were determined at 
any time to be tax-exempt under a determination that had not 
been revoked; and (3) were tax-exempt for the last taxable year 
beginning before January 1, 1987 (when the present-law rule 
became effective), provided that no material change occurred in 
the structure or operations of the organizations after August 
16, 1986, and before the close of 1986 or any subsequent 
taxable year.
    The treatment applicable to such organizations, which 
became taxable organizations under the provision, is as 
follows. A special deduction applies with respect to health 
business equal to 25 percent of the claims and expenses 
incurred during the taxable year less the adjusted surplus at 
the beginning of the year. An exception is provided for such 
organizations from the application of the 20-percent reduction 
in the deduction for increases in unearned premiums that 
applies generally to property and casualty insurance companies. 
A fresh start was provided with respect to changes in 
accounting methods resulting from the change from tax-exempt to 
taxable status. Thus, no adjustment was made under section 481 
on account of an accounting method change. Such an organization 
was required to compute its ending 1986 loss reserves without 
artificial changes that would reduce 1987 income. Thus, any 
reserve weakening after August 16, 1986 was treated as 
occurring in the organization's first taxable year beginning 
after December 31, 1986. The basis of such an organization's 
assets was deemed to be equal to the amount of the assets' fair 
market value on the first day of the organization's taxable 
year beginning after December 31, 1986, for purposes of 
determining gain or loss (but not for determining depreciation 
or for other purposes).
    Grandfather rules were provided in the 1986 Act relating to 
the provision. It was provided that the provision does not 
apply with respect to that portion of the business of Mutual of 
America which is attributable to pension business. Pension 
business means the administration of any plan described in 
section 401(a) of the Code which includes a trust exempt from 
tax under section 501(a), and plan under which amounts are 
contributed by an individual's employer for an annuity contract 
described in section 403(b) of the Code, any individual 
retirement plan described in section 408 of the Code, and any 
eligible deferred compensation plan to which section 457(a) of 
the Code applies.

                           Reasons for Change

    The Committee is concerned that the continued tax-exempt 
status of an organization that engages in insurance activities 
with respect pension business gives such an organization an 
unfair competitive advantage. Thus, the Committee believes, it 
is no longer appropriate to continue the grandfather rule.

                        Explanation of Provision

    The provision repeals the grandfather rule applicable to 
that portion of the business of Mutual of America which is 
attributable to pension business. Mutual of America is to be 
treated for Federal tax purposes as a life insurance company.
    A fresh start is provided with respect to changes in 
accounting methods resulting from the change from tax-exempt to 
taxable status. Thus, no adjustment is made under section 481 
on account of an accounting method change. Mutual of America is 
required to compute ending 1997 loss reserves without 
artificial changes that would reduce 1998 income. Thus, any 
reserve weakening after June 8, 1997, is treated as occurring 
in the organization's first taxable year beginning after 
December 31, 1997. The basis of assets of Mutual of America is 
deemed to be equal to the amount of the assets' fair market 
value on the first day of the organization's taxable year 
beginning after December 31, 1997, for purposes of determining 
gain or loss (but not for determining depreciation, 
amortization or for other purposes).

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

                         G. Foreign Provisions

1. Inclusion of income from notional principal contracts and stock 
        lending transactions under subpart F (sec. 861 of the bill and 
        sec. 954 of the Code)

                              Present Law

    Under the subpart F rules, the U.S. 10-percent 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, ``foreign personal holding 
company income.''
    Foreign personal holding company income generally consists 
of the following: dividends, interest, royalties, rents and 
annuities; net gains from sales or exchanges of (1) property 
that gives rise to the foregoing types of income, (2) property 
that does not give rise to income, and (3) interests in trusts, 
partnerships, and REMICs; net gains from commodities 
transactions; net gains from foreign currency transactions; and 
income that is equivalent to interest. Income from notional 
principal contracts referenced to commodities, foreign 
currency, interest rates, or indices thereon is treated as 
foreign personal holding company income; income from equity 
swaps or other types of notional principal contracts is not 
treated as foreign personal holding company income. Income 
derived from transfers of debt securities (but not equity 
securities) pursuant to the rules governing securities lending 
transactions (sec. 1058) is treated as foreign personal holding 
company income.
    Income earned by a CFC that is a regular dealer in the 
property sold or exchanged generally is excluded from the 
definition of foreign personal holding company income. However, 
no exception is available for a CFC that is a regular dealer in 
financial instruments referenced to commodities.
    A U.S. shareholder of a passive foreign investment company 
(``PFIC'') is subject to U.S. tax and an interest charge with 
respect to certain distributions from the PFIC and gains on 
dispositions of the stock of the PFIC, unless the shareholder 
elects to include in income currently for U.S. tax purposes its 
share of the earnings of the PFIC. A foreign corporation is a 
PFIC if it satisfies either a passive income test or a passive 
assets test. For this purpose, passive income is defined by 
reference to foreign personal holding company income.

                           Reasons for Change

    The Committee understands that income from notional 
principal contracts and stock-lending transactions is 
economically equivalent to types of income that are treated as 
foreign personal holding company income under present law. 
Accordingly, the Committee believes that the categories of 
foreign personal holding company income should be expanded to 
cover such income. In addition, the Committee believes that an 
exception from the foreign personal holding company income 
rules should be available for dealers in financial instruments 
referenced to commodities.

                        Explanation of Provision

    The bill treats net income from all types of notional 
principal contracts as a new category of foreign personal 
holding company income. However, income, gain, deduction or 
loss from a notional principal contract entered into to hedge 
an item of income in another category of foreign personal 
holding company income is included in that other category.
    The bill treats payments in lieu of dividends derived from 
equity securities lending transactions pursuant to section 1058 
as another new category of foreign personal holding company 
income.
    The bill provides an exception from foreign personal 
holding company income for certain income, gain, deduction, or 
loss from transactions (including hedging transactions) entered 
into in the ordinary course of a CFC's business as a regular 
dealer in property, forward contracts, options, notional 
principal contracts, or similar financial instruments 
(including instruments referenced to commodities).
    These modifications to the definition of foreign personal 
holding company income apply for purposes of determining a 
foreign corporation's status as a PFIC.

                             Effective Date

    The provision applies to taxable years beginning after the 
date of enactment.

2. Restrict like-kind exchange rules for certain personal property 
        (sec. 862 of the bill and sec. 1031 of the Code)

                              Present Law

Like-kind exchanges

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like-kind'' which 
is to be held for productive use in a trade or business or for 
investment (sec. 1031). In general, any kind of real estate is 
treated as of a like-kind with other real property as long as 
the properties are both located either within or both outside 
the United States. In addition, certain types of property, such 
as inventory, stocks and bonds, and partnership interests, are 
not eligible for nonrecognition treatment under section 1031.
    If section 1031 applies to an exchange of properties, the 
basis of the property received in the exchange is equal to the 
basis of the property transferred, decreased by any money 
received by the taxpayer, and further adjusted for any gain or 
loss recognized on the exchange.

Application of depreciation rules

    Tangible personal property that is used predominantly 
outside the United States generally is accorded a less 
favorable depreciation regime than is property that is used 
predominantly within the United States. Thus, under present 
law, if a taxpayer exchanges depreciable U.S. property with a 
low adjusted basis (relative to its fair market value) for 
similar property situated outside the United States, the 
adjusted basis of the acquired property will be the same as the 
adjusted basis of the relinquished property, but the 
depreciation rules applied to such acquired property generally 
will be different than the rules that were applied to the 
relinquished property.

                           Reasons for Change

    The committee believes that the depreciation rules 
applicable to foreign- and domestic-use are sufficiently 
dissimilar so as to treat such property as not ``like-kind'' 
property for purposes of section 1031.

                        Explanation of Provision

    The bill provides that personal property predominantly used 
within the United States and personal property predominantly 
used outside the United States are not ``like-kind'' 
properties. For this purpose, the use of the property 
surrendered in the exchange will be determined based upon the 
use during the 24 months immediately prior to the exchange. 
Similarly, for section 1031 to apply, property received in the 
exchange must continue in the same use (i.e., foreign or 
domestic) for the 24 months immediately after the exchange.
    The 24-month period is reduced to such lesser time as the 
taxpayer held the property, unless such shorter holding period 
is a result of a transaction (or series of transactions) 
structured to avoid the purposes of the provision. Property 
described in section 168(g)(4) (generally, property used both 
within and without the United States that is eligible for 
accelerated depreciation as if used in the United States) will 
be treated as property predominantly used in the United States.

                             Effective Date

    The provision is effective for exchanges after June 8, 
1997, unless the exchange is pursuant to a binding contract in 
effect on such date and all times thereafter. A contract will 
not fail to be considered to be binding solely because (1) it 
provides for a sale in lieu of an exchange or (2) either the 
property to be disposed of as relinquished property or the 
property to be acquired as replacement property (whichever is 
applicable) was not identified under the contract before June 
9, 1997.

3. Holding period requirement for certain foreign taxes (sec. 863 of 
        the bill and new sec. 901(k) of the Code)

                              Present Law

    A U.S. person that receives a dividend from a foreign 
corporation generally is entitled to a credit for income taxes 
paid to a foreign government on the dividend, regardless of the 
U.S. person's holding period for the foreign corporation's 
stock. A U.S. corporation that receives adividend from a 
foreign corporation in which it has a 10-percent or greater voting 
interest may be entitled to a credit for the foreign taxes paid by the 
foreign corporation, also without regard to the U.S. shareholder's 
holding period for the corporation's stock (secs. 902 and 960).
    As a consequence of the foreign tax credit limitations of 
the Code, certain taxpayers are unable to utilize their 
creditable foreign taxes to reduce their U.S. tax liability. 
U.S. shareholders that are tax-exempt receive no U.S. tax 
benefit for foreign taxes paid on dividends they receive.

                           Reasons for Change

    Although present law imposes a holding period requirement 
for the dividends-received deduction for a corporate 
shareholder (sec. 246), there is no similar holding period 
requirement for foreign tax credits with respect to dividends. 
As a result, some U.S. persons have engaged in tax-motivated 
transactions designed to transfer foreign tax credits from 
persons that are unable to benefit from such credits (such as a 
tax-exempt entity or a taxpayer whose use of foreign tax 
credits is prevented by the limitation) to persons that can use 
such credits. These transactions sometimes involve a short-term 
transfer of ownership of dividend-paying shares. Other 
transactions involve the use of derivatives to allow a person 
that cannot benefit from the foreign tax credits with respect 
to a dividend to retain the economic benefit of the dividend 
while another person receives the foreign tax credit benefits.

                        Explanation of Provision

    The bill denies a shareholder the foreign tax credits 
normally available with respect to a dividend from a 
corporation or a regulated investment company (``RIC'') if the 
shareholder has not held the stock for a minimum period during 
which it is not protected from risk of loss. Under the bill, 
the minimum holding period for dividends on common stock is 16 
days. The minimum holding period for preferred stock is 46 
days.
    Where the holding period requirement is not met for stock 
of a foreign corporation, the bill disallows the foreign tax 
credits for the foreign withholding taxes that are paid with 
respect to a dividend. Such credits are denied both to the 
shareholder and any other taxpayer who would otherwise be 
entitled to claim foreign tax credits for such withholding 
taxes. In addition, the bill applies to all foreign tax credits 
otherwise allowable for taxes paid by a lower-tier foreign 
corporation and for foreign tax credits of a RIC that elects to 
treat its foreign taxes as paid by the shareholders. The bill 
denies such credits where any of the stock in the chain of 
ownership that is a requirement for claiming the credits is 
held for less than the required holding period.
    The bill denies these same foreign tax credit benefits, 
regardless of the shareholder's holding period for the stock, 
to the extent that the taxpayer has an obligation to make 
payments related to the dividend (whether pursuant to a short 
sale or otherwise) with respect to substantially similar or 
related property.
    The 16- or 46-day holding period under the bill (whichever 
applies) must be satisfied over a period immediately before or 
immediately after the shareholder becomes entitled to receive 
each dividend. For purposes of determining whether the required 
holding period is met, any period during which the shareholder 
has protected itself from risk of loss (under the rules of 
section 246(c)(4)) would not be included. For example, assume a 
taxpayer buys foreign common stock. Assume also that, the day 
after the stock is purchased, the taxpayer enters into an 
equity swap under which the taxpayer is entitled to receive 
payments equal to the losses on the stock, and the taxpayer 
retains the swap position for the entire period it holds the 
stock. Under the bill, the taxpayer would not be able to claim 
any foreign tax credits with respect to dividends on the stock 
because the taxpayer's holding period is limited to the single 
day during which the loss on the stock was not protected. For 
purposes of entitlement to certain indirect foreign tax credits 
(secs. 902 and 960), the bill provides an exception from the 
risk reduction rule for a bona fide contract to sell stock.
    The bill also provides an exception for foreign tax credits 
with respect to certain dividends received by active dealers in 
securities. In order to qualify for the exception, the 
following requirements must be met: (1) The dividend must be 
received by the entity on stock which it holds in its capacity 
as a dealer in securities, (2) the entity must be subject to 
net income taxation on the dividend (on either a residence or 
worldwide income basis) in a foreign country, and (3) the 
foreign taxes to which the exception applies must be taxes that 
are creditable under the foreign county's tax system. A 
securities dealer for purposes of the exception must be an 
entity which (1) is engaged in the active conduct of a 
securities business in a foreign country and (2) is registered 
as a securities broker or dealer under the Securities Exchange 
Act of 1934 or is licensed or authorized to conduct securities 
activities in such foreign county and subject to bona fide 
regulation by the securities regulatory authority of the 
foreign country. Under the bill, the Secretary of the Treasury 
is granted authority to issue regulations appropriate to 
prevent abuse of this exception.
    If a taxpayer is denied foreign tax credits under the bill 
because the 16- or 46-day holding period requirement is not 
satisfied, the taxpayer would be entitled to a deduction for 
the foreign taxes for which the credit is disallowed. This 
deduction would be available even if the taxpayer claimed the 
foreign tax credit for other taxes in the same taxable year.
    No inference is intended as to the treatment under present 
law of tax-motivated transactions intended to transfer foreign 
tax credit benefits.

                             Effective Date

    The provision is effective for dividends paid or accrued 
more than 30 days after the date of enactment.

4. Treatment of income from certain sales of inventory as U.S. source 
        (sec. 864 of the bill and sec. 865 of the Code)

                              Present Law

    U.S. persons are subject to U.S. tax on their worldwide 
income. A credit against U.S. tax on foreign source income is 
allowed for foreign taxes. The amount of foreign tax credits 
that can be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax creditsto offset U.S. 
tax on U.S. source income. Specific rules apply in determining whether 
income is from U.S. or foreign sources. Income from the sale or 
exchange of inventory property generally is sourced where the sale 
occurs. In Liggett Group, Inc. v. Commissioner, 58 T.C.M. 1167 (1990), 
the court concluded that a sale of inventory property by a U.S. 
corporation to U.S. customers gave rise to foreign source income 
because the sale occurred outside the United States.

                           Reasons for Change

    The Committee believes that when a U.S. person sells 
inventory to its U.S. customers, the resulting income is 
inherently domestic, regardless of the site of the particular 
transaction. The Committee believes that income from sales of 
inventory property by a U.S. resident to another U.S. resident 
for use in the United States should be treated as income from 
U.S. sources, without regard to where the sale occurs.

                        Explanation of Provision

    Under the bill, income from a sale of inventory property by 
a U.S. resident to another U.S. resident for use, consumption, 
or disposition in the United States is treated as U.S. source 
income, if the sale is not attributable to an office or other 
fixed place of business maintained by the seller outside the 
United States.

                             Effective Date

    The provision is effective for taxable years beginning 
after date of enactment.

5. Interest on underpayment reduced by foreign tax credit carryback 
        (sec. 865 of the bill and secs. 6601 and 6611 of the Code)

                              Present Law

    U.S. persons may credit foreign taxes against U.S. tax on 
foreign source income. The amount of foreign tax credits that 
can be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax credits to offset 
U.S. tax on U.S. source income. Separate limitations are 
applied to specific categories of income. The amount of 
creditable taxes paid or accrued in any taxable year which 
exceeds the foreign tax credit limitation is permitted to be 
carried back two years and carried forward five years.
    For purposes of the computation of interest on overpayments 
of tax, if an overpayment for a taxable year results from a 
foreign tax credit carryback from a subsequent taxable year, 
the overpayment is deemed not to arise prior to the filing date 
for the subsequent taxable year in which the foreign taxes were 
paid or accrued (sec. 6611(g)). Accordingly, interest does not 
accrue on the overpayment prior to the filing date for the year 
of the carryback that effectively created such overpayment. In 
Fluor Corp. v. United States, 35 Fed. Cl. 520 (1996), the court 
held that in the case of an underpayment of tax (rather than an 
overpayment) for a taxable year that is eliminated by a foreign 
tax credit carryback from a subsequent taxable year, interest 
does not accrue on the underpayment that is eliminated by the 
foreign tax credit carryback. The Government has filed an 
appeal in the Fluor case.

                           Reasons for Change

    The Committee believes that the application of the interest 
rules in the case of a deficiency that is reduced or eliminated 
by a foreign tax credit carryback must be consistent with the 
application of the interest rules in the case of an overpayment 
that is created by a foreign tax credit carryback. The 
Committee believes that in such cases the deficiency cannot be 
considered to have been eliminated, and the overpayment cannot 
be considered to have been created, until the filing date for 
the taxable year in which the foreign tax credit carryback 
arises. Accordingly, interest should continue to accrue on the 
deficiency through such date. In addition, the Committee 
believes that it is appropriate to clarify the interest rules 
that apply in the case of a foreign tax credit carryback that 
is itself triggered by another carryback from a subsequent 
year.

                        Explanation of Provision

    Under the bill, if an underpayment for a taxable year is 
reduced or eliminated by a foreign tax credit carryback from a 
subsequent taxable year, such carryback does not affect the 
computation of interest on the underpayment for the period 
ending with the filing date for such subsequent taxable year in 
which the foreign taxes were paid or accrued. The bill also 
clarifies the application of the interest rules of both section 
6601 and section 6611 in the case of a foreign tax credit 
carryback that is triggered by a net operating loss or net 
capital loss carryback; in such a case, a deficiency is not 
considered to have been reduced, and an overpayment is not 
considered to have been created, until the filing date for the 
subsequent year in which the loss carryback arose. No inference 
is intended regarding the computation of interest under present 
law in the case of a foreign tax credit carryback (including a 
foreign tax credit carryback that is triggered by a net 
operating loss or net capital loss carryback).

                             Effective Date

    The provision is effective for foreign taxes actually paid 
or accrued in taxable years beginning after date of enactment.

6. Determination of period of limitations relating to foreign tax 
        credits (sec. 866 of the bill and sec. 6511(d) of the Code)

                              Present Law

    U.S. persons may credit foreign taxes against U.S. tax on 
foreign source income. The amount of foreign tax credits that 
can be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax credits to offset 
U.S. tax on U.S. source income. Separate limitations are 
applied to specific categories of income. The amount of 
creditable taxes paid or accrued in any taxable year which 
exceeds the foreign tax credit limitation is permitted to be 
carried back two years and carried forward five years.
    For purposes of the period of limitations on filing claims 
for credit or refund, in the case of a claim relating to an 
overpayment attributable to foreign tax credits, the 
limitations period is ten years from the filing date for the 
taxable year with respect to which the claim is made. The 
Internal Revenue Service has taken the position that, in the 
case of a foreign tax credit carryforward, the period of 
limitations is determined by reference to the year in which the 
foreign taxes were paid or accrued (and not the year to which 
the foreign tax credits are carried ) (Rev. Rul. 84-125, 1984-2 
C.B. 125). However, the court in Ampex Corp. v. United States, 
620 F.2d 853 (1980), held that, in the case of a foreign tax 
credit carryforward, the period of limitations is determined by 
reference to the year to which the foreign tax credits are 
carried (and not the year in which the foreign taxes were paid 
or accrued).

                           Reasons for Change

    The Committee believes that it is appropriate to identify 
clearly the date on which the ten-year period of limitations 
for claims with respect to foreign tax credits begins.

                        Explanation of Provision

    Under the bill, in the case of a claim relating to an 
overpayment attributable to foreign tax credits, the 
limitations period is determined by reference to the year in 
which the foreign taxes were paid or accrued (and not the year 
to which the foreign tax credits are carried). No inference is 
intended regarding the determination of such limitations period 
under present law.

                             Effective Date

    The provision is effective for foreign taxes paid or 
accrued in taxable years beginning after date of enactment.

7. Modify foreign tax credit carryover rules (sec. 867 of the bill and 
        sec. 904 of the Code)

                              Present Law

    U.S. persons may credit foreign taxes against U.S. tax on 
foreign source income. The amount of foreign tax credits that 
can be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax credits to offset 
U.S. tax on U.S. source income. Separate foreign tax credit 
limitations are applied to 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 two years and 
forward five years. The amount carried over may be used as a 
credit in a carryover year to the extent the taxpayer otherwise 
has excess foreign tax credit limitation for such year. The 
separate foreign tax credit limitations apply for purposes of 
the carryover rules.

                           Reasons for Change

    The Committee believes that reducing the carryback period 
for foreign tax credits to one year and increasing the 
carryforward period to seven years will reduce some of the 
complexity associated with carrybacks while continuing to 
address the timing differences between U.S. and foreign tax 
rules.

                        Explanation of Provision

    The bill reduces the carryback period for excess foreign 
tax credits from two years to one year. The bill also extends 
the excess foreign tax credit carryforward period from five 
years to seven years.

                             Effective Date

    The provision applies to foreign tax credits arising in 
taxable years beginning after December 31, 1997.

8. Repeal special exception to foreign tax credit limitation for 
        alternative minimum tax purposes (sec. 864 of the bill and sec. 
        59 of the Code)

                              Present Law

    Present law imposes a minimum tax on a corporation to the 
extent the taxpayer's minimum tax liability exceeds its regular 
tax liability. The corporate minimum tax is imposed at a rate 
of 20 percent on alternative minimum taxable income in excess 
of a phased-out $40,000 exemption amount.
    The combination of the taxpayer's net operating loss 
carryover and foreign tax credits cannot reduce the taxpayer's 
alternative minimum tax liability by more than 90 percent of 
the amount determined without these items.
    The Omnibus Budget Reconciliation Act of 1989 (``1989 
Act'') provided a special exception to the limitation on the 
use of the foreign tax credit against the tentative minimum 
tax. In order to qualify for this exception, a corporation must 
meet four requirements. First, more than 50 percent of both the 
voting power and value of the stock of the corporation must be 
owned by U.S. persons who are not members of an affiliated 
group which includes such corporation. Second, all of the 
activities of the corporation must be conducted in one foreign 
country with which the United States has an income tax treaty 
in effect and such treaty must provide for the exchange of 
information between such country and the United States. Third, 
the corporation generally must distribute to its shareholders 
all current earnings and profits (except for certain amounts 
utilized for normal maintenance or capital expenditures related 
to its existing business). Fourth, all of such distributions 
which are received by U.S. persons must be utilized by such 
persons in a U.S. trade or business. This exception applies to 
taxable years beginning after March 31, 1990 (with a proration 
rule effective for certain taxable years which include March 
31, 1990).

                           Reasons for Change

    The committee believes that taxpayers should be treated the 
same with respect to the foreign tax credit limitation of the 
alternative minimum tax.

                        Explanation of Provision

    The special exception regarding the use of foreign tax 
credits for purposes of the alternative minimum tax, as 
provided by the 1989 Act, is repealed.

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment.

                  H. Other Revenue-Increase Provisions

1. Phase out suspense accounts for certain large farm corporations 
        (sec. 871 of the bill and sec. 477 of the Code)

                              Present Law

    A corporation (or a partnership with a corporate partner) 
engaged in the trade or business of farming must use an accrual 
method of accounting for such activities unless such 
corporation (or partnership), for each prior taxable year 
beginning after December 31, 1975, did not have gross receipts 
exceeding $1 million. If a farm corporation is required to 
change its method of accounting, the section 481 adjustment 
resulting from such change is included in gross income ratably 
over a 10-year period, beginning with the year of change. This 
rule does not apply to a family farm corporation.
    A provision of the Revenue Act of 1987 (``1987 Act'') 
requires a family corporation (or a partnership with a family 
corporation as a partner) to use an accrual method of 
accounting for its farming business unless, for each prior 
taxable year beginning after December 31, 1985, such 
corporation (and any predecessor corporation) did not have 
gross receipts exceeding $25 million. A family corporation is 
one where at 50 percent or more of the stock of the corporation 
is held by one (or in some limited cases, two or three) 
families.
    A family farm corporation that must change to an accrual 
method of accounting as a result of the 1987 Act provision is 
to establish a suspense account in lieu of including the entire 
amount of the section 481 adjustment in gross income. The 
initial balance of the suspense account equals the lesser of 
(1) the section 481 adjustment otherwise required for the year 
of change, or (2) the section 481 adjustment computed as if the 
change in method of accounting had occurred as of the beginning 
of the taxable year preceding the year of change.
    The amount of the suspense account is required to be 
included in gross income if the corporation ceases to be a 
family corporation. In addition, if the gross receipts of the 
corporation attributable to farming for any taxable year 
decline to an amount below the lesser of (1) the gross receipts 
attributable to farming for the last taxable year for which an 
accrual method of accounting was not required, or (2) the gross 
receipts attributable to farming for the most recent taxable 
year for which a portion of the suspense account was required 
to be included in income, a portion of the suspense account is 
required to be included in gross income.

                           Reasons for Change

    The committee believes that an accrual method of accounting 
more accurately measures the economic income of a corporation 
than does the cash receipts and disbursements method and that 
changes from one method of accounting to another should be 
taken into account under section 481. However, the committee 
believes that it may be appropriate for a family farm 
corporation to retain the use of the cash method of accounting 
until such corporation reaches a certain size. At that time, 
the corporation should be subject to tax accounting rules to 
which other corporations are so subject. In addition, the 
committee believes that the present-law suspense account 
provision applicable to large family farm corporations may 
effectively provide an exclusion for, rather than a deferral 
of, amounts otherwise properly taken into account under section 
481 upon the required change in the method of accounting for 
such corporations. However, the committee recognizes that 
requiring the recognition of previously established suspense 
accounts may impose liquidity concerns upon some farm 
corporations. Thus, the committee provides an extended period 
over which existing suspense accounts must be restored to 
income and provides further deferral where the corporation has 
insufficient income for the year.

                        Explanation of Provision

    The bill repeals the ability of a family farm corporation 
to establish a suspense account when it is required to change 
to an accrual method of accounting. Thus, under the bill, any 
family farm corporation required to change to an accrual method 
of accounting would restore the section 481 adjustment 
applicable to the change in gross income ratably over a 10-year 
period beginning with the year of change.
    In addition, any taxpayer with an existing suspense account 
is required to restore the account into income ratably over a 
20-year period beginning in the first taxable year beginning 
after June 8, 1997, subject to the present-law requirements to 
restore such accounts more rapidly. The amount required to be 
restored to income for a taxable year pursuant to the 20-year 
spread period shall not exceed the net operating loss of the 
corporation for the year (in the case of a corporation with a 
net operating loss) or 50 percent of the net income of the 
taxpayer for the year (for corporations with taxable income). 
For this purpose, a net operating loss or taxable income is 
determined without regard to the amount restored to income 
under the bill. Any reduction in the amount required to be 
restored to income is taken into account ratably over the 
remaining years in the 20-year period or, if applicable, after 
the end of the 20-year period. Amounts that extend beyond the 
20-year period remain subject to the net operating loss and 50-
percent-of- taxable income rules.
    Finally, the present-law requirement that a portion of a 
suspense account be restored to income if the gross receipts of 
the corporation diminishes is repealed.

                             Effective Date

    The provision is effective for taxable years ending after 
June 8, 1997.

2. Modify net operating loss carryback and carryforward rules (sec. 872 
        of the bill and sec. 172 of the Code)

                              Present Law

    The net operating loss (``NOL'') of a taxpayer (generally, 
the amount by which the business deductions of a taxpayer 
exceeds its gross income) may be carried back three years and 
carried forward 15 years to offset taxable income in such 
years. A taxpayer may elect to forgo the carryback of an NOL. 
Special rules apply to real estate investment trusts 
(``REITs'') (nocarrybacks), specified liability losses (10-year 
carryback), and excess interest losses (no carrybacks).

                           Reason for Change

    The committee recognizes that while Federal income tax 
reporting requires a taxpayer to report income and file returns 
based on a 12-month period, the natural business cycle of a 
taxpayer may exceed 12 months. However, the committee believes 
that allowing a two-year carryback of NOLs is sufficient to 
account for these business cycles, particularly since (1) many 
deductions allowed for tax purposes relate to future, rather 
than past, income streams and (2) certain deductions that do 
relate to past income streams are granted special, longer 
carryback periods under present law (which are retained by the 
bill).

                        Explanation of Provision

    The bill limits the NOL carryback period to two years and 
extends the NOL carryforward period to 20 years. The bill does 
not apply to the carryback rules relating to REITs, specified 
liability losses, excess interest losses, and corporate capital 
losses.
    The bill does not apply to NOLs arising from casualty 
losses of individual taxpayers. In addition, the bill does not 
apply to NOLs attributable to losses incurred in Presidentially 
declared disaster areas by taxpayers engaged in a farming 
business or a small business. For this purpose, a ``small 
business'' means any trade or business (including one conducted 
in or through a corporation, partnership, or sole 
proprietorship) the average annual gross receipts (as 
determined under sec. 448(c)) of which are $5 million or less, 
and a ``farming business'' is defined as in section 263A(e)(4).

                             Effective Date

    The provision is effective for NOLs for taxable years 
beginning after the date of enactment. The provision does not 
apply to NOLs carried forward from prior taxable years.

3. Expand the limitations on deductibility of premiums and interest 
        with respect to life insurance, endowment and annuity contracts 
        (sec. 873 of the bill and sec. 264 of the Code)

                              Present Law

Exclusion of inside buildup and amounts received by reason of death

    No Federal income tax generally is imposed on a 
policyholder with respect to the earnings under a life 
insurance contract (``inside buildup'').\109\ Further, an 
exclusion from Federal income tax is provided for amounts 
received under a life insurance contract paid by reason of the 
death of the insured (sec. 101(a)).
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    \109\ This favorable tax treatment is available only if the 
policyholder has an insurable interest in the insured when the contract 
is issued and if the 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 basis in the contract; such 
distributions generally are treated first as a tax-free recovery of 
basis, and then as income (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 7 
annual level premiums (sec. 7702A). Certain amounts received under a 
life insurance contract on the life of a terminally or chronically ill 
individual, and certain amounts paid for the sale or assignment to a 
viatical settlement provider of a life insurance contract on the life 
of a terminally ill or chronically ill individual, are treated as 
excludable as if paid on the death of the insured (sec. 101(g)).
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Premium deduction limitation

    No deduction is permitted for premiums paid on any life 
insurance policy covering the life of any officer or employee, 
or of any person financially interested in any trade or 
business carried on by the taxpayer, when the taxpayer is 
directly or indirectly a beneficiary under such policy (sec. 
264(a)(1)).

Interest deduction disallowance with respect to life insurance

    Present law provides generally that no deduction is allowed 
for interest paid or accrued on any indebtedness with respect 
to one or more life insurance contracts or annuity or endowment 
contracts owned by the taxpayer covering any individual who is 
or was (1) an officer or employee of, or (2) financially 
interested in, any trade or business currently or formerly 
carried on by the taxpayer (the ``COLI'' rules).
    This interest deduction disallowance rule generally does 
not apply to interest on debt with respect to contracts 
purchased on or before June 20, 1986; rather, an interest 
deduction limit based on Moody's Corporate Bond Yield Average--
Monthly Average Corporates applies in the case of such 
contracts.\110\
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    \110\ Phase-in rules apply generally with respect to otherwise 
deductible interest paid or accrued after December 31, 1995, and before 
January 1, 1999, in the case of debt incurred before January 1, 1996. 
In addition, transition rules apply.
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    An exception to this interest disallowance rule is provided 
for interest on indebtedness with respect to life insurance 
policies covering up to 20 key persons. A key person is an 
individual who is either an officer or a 20-percent owner of 
the taxpayer. The number of individuals that can betreated as 
key persons may not exceed the greater of (1) 5 individuals, or (2) the 
lesser of 5 percent of the total number of officers and employees of 
the taxpayer, or 20 individuals. For determining who is a 20-percent 
owner, all members of a controlled group are treated as one taxpayer. 
Interest paid or accrued on debt with respect to a contract covering a 
key person is deductible only to the extent the rate of interest does 
not exceed Moody's Corporate Bond Yield Average--Monthly Average 
Corporates for each month beginning after December 31, 1995, that 
interest is paid or accrued.
    The foregoing interest deduction limitation was added in 
1996 to existing interest deduction limitations with respect to 
life insurance and similar contracts.\111\
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    \111\ Since 1942, a limitation has applied to the deductibility of 
interest with respect to single premium contracts (sec. 264(a)(2)). For 
this purpose, a contract is treated as a single premium contract if (1) 
substantially all the premiums on the contract are paid within a period 
of 4 years from the date on which the contract is purchased, or (2) an 
amount is deposited with the insurer for payment of a substantial 
number of future premiums on the contract. Further, under a limitation 
added in 1964, no deduction is allowed for any amount paid or accrued 
on debt incurred or continued to purchase or carry a life insurance, 
endowment, or annuity contract pursuant to a plan of purchase that 
contemplates the systematic direct or indirect borrowing of part or all 
of the increases in the cash value of the contract (sec. 264(a)(3)). An 
exception to the latter rule is provided, permitting deductibility of 
interest on bona fide debt that is part of such a plan, if no part of 
the annual premiums due during the first 7 years is paid by means of 
debt (the ``4-out-of-7 rule'') (sec. 264(c)(1)). In addition to the 
specific disallowance rules of section 264, generally applicable 
principles of tax law apply.
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Interest deduction limitation with respect to tax-exempt interest 
        income

    Present law provides that no deduction is allowed for 
interest on debt incurred or continued to purchase or carry 
obligations the interest on which is wholly exempt from Federal 
income tax (sec. 265(a)(2)). In addition, in the case a 
financial institution, a proration rule provides that no 
deduction is allowed for that portion of the taxpayer's 
interest that is allocable to tax-exempt interest (sec. 
265(b)). The portion of the interest deduction that is 
disallowed under this rule generally is the portion determined 
by the ratio of the taxpayer's (1) average adjusted bases of 
tax- exempt obligations acquired after August 7, 1986, to (2) 
the average adjusted bases for all of the taxpayer's assets 
(sec. 265(b)(2)).\112\
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    \112\ Special rules apply for certain tax-exempt obligations of 
small issuers (sec. 165(b)(3)).
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                           Reasons for Change

    The Committee understands that, under applicable State 
laws, the holder of a life insurance policy generally is 
required to have an insurable interest in the life of the 
insured individual only when the policyholder purchases the 
life insurance policy. The Committee understands that under 
State laws relating to insurable interests, a taxpayer 
generally has an insurable interest in the lives of its 
debtors. Further, rules governing permitted investments of 
financial institutions may allow the institutions to acquire 
cash value life insurance covering the lives of debtors, as 
well as the lives of individuals with other relationships to 
the taxpayer such as shareholders, employees or officers. In 
addition, insurable interest laws in many States have been 
expanded in recent years, and States could decide in the future 
to expand further the range of persons in whom a taxpayer has 
an insurable interest.
    For example, a business could purchase cash value life 
insurance on the lives of its debtors, and increase the 
investment in these contracts as the debt diminishes and even 
after the debt is repaid. If a mortgage lender can (under 
applicable State law and banking regulations) buy a cash value 
life insurance policy on the lives of mortgage borrowers, the 
lender may be able to deduct premiums or interest on debt with 
respect to such a contract, if no other deduction disallowance 
rule or principle of tax law applies to limit the deductions. 
The premiums or interest could be deductible even after the 
individual's mortgage loan is sold to another lender or to a 
mortgage pool. If the loan were sold to a second lender, the 
second lender might also be able to buy a cash value life 
insurance contract on the life of the same borrower, and to 
deduct premiums or interest with respect to that contract. The 
Committee bill addresses this issue by providing that no 
deduction is allowed for premiums on any life insurance policy, 
or endowment or annuity contract, if the taxpayer is directly 
or indirectly a beneficiary under the policy or contract, and 
by providing that no deduction is allowed for interest paid or 
accrued on any indebtedness with respect to life insurance 
policy, or endowment or annuity contract, covering the life of 
any individual.
    In addition, the Committee understands that taxpayers may 
be seeking new means of deducting interest on debt that in 
substance funds the tax-free inside build-up of life insurance 
or the tax-deferred inside buildup of annuity and endowment 
contracts.\113\ The Committee believes that present law was not 
intended to promote tax arbitrage by allowing financial or 
other businesses that have the ongoing ability to borrow funds 
from depositors, bondholders, investors or other lenders to 
concurrently invest a portion of their assets in cash value 
life insurance contracts, or endowment or annuity contracts. 
Therefore, the bill provides that, for taxpayers other than 
natural persons, no deduction is allowed for the portion of the 
taxpayer's interest expense that is allocable to unborrowed 
policy cash values of any life insurance policy or annuity or 
endowment contract issued after June 8, 1997.
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    \113\ See ``Fannie Mae Designing a Program to Link Life Insurance, 
Loans, ``Washington Post, p. E3, February 8, 1997; ``Fannie Mae 
Considers Whether to Bestow Mortgage Insurance,'' Wall St. Journal, p. 
C1, April 22, 1997.
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                        Explanation of Provision

Expansion of premium deduction limitation to individuals in whom 
        taxpayer has an insurable interest

    Under the provision, the present-law premium deduction 
limitation is modified to provide that no deduction is 
permitted for premiums paid on any life insurance, annuity or 
endowment contract, if the taxpayer is directly or indirectly a 
beneficiary under the contract.

Expansion of interest disallowance to individuals in whom taxpayer has 
        insurable interest

    Under the provision, no deduction is allowed for interest 
paid or accrued on any indebtedness with respect to life 
insurance policy, or endowment or annuity contract, covering 
the life of any individual. Thus, the provision limits interest 
deductibility in the case of such a contract covering any 
individual in whom the taxpayer has an insurable interest when 
the contract is first issued under applicable State law, except 
as otherwise provided under present law with respect to key 
persons and pre-1986 contracts.

Pro rata disallowance of interest on debt to fund life insurance

    In the case of a taxpayer other than a natural person, no 
deduction is allowed for the portion of the taxpayer's interest 
expense that is allocable to unborrowed policy cash surrender 
values with respect to any life insurance policy or annuity or 
endowment contract issued after June 8, 1997. Interest expense 
is so allocable based on the ratio of (1) the taxpayer's 
average unborrowed policy cash values of life insurance 
policies, and annuity and endowment contracts, issued after 
June 8, 1997, to (2) the average adjusted bases for all assets 
of the taxpayer. This rule does not apply to any policy or 
contract owned by an entity engaged in a trade or business, 
covering any individual who is an employee, officer or director 
of the trade or business at the time first covered by the 
policy or contract. Such a policy or contract is not taken into 
account in determining unborrowed policy cash values.
    The unborrowed policy cash values means the cash surrender 
value of the policy or contract determined without regard to 
any surrender charge, reduced by the amount of any loan with 
respect to the policy or contract. The cash surrender value is 
to be determined without regard to any other contractual or 
noncontractual arrangement that artificially depresses the cash 
value of a contract.
    If a trade or business (other than a sole proprietorship or 
a trade or business of performing services as an employee) is 
directly or indirectly the beneficiary under any policy or 
contract, then the policy or contract is treated as held by the 
trade or business. For this purpose, the amount of the 
unborrowed cash value is treated as not exceeding the amount of 
the benefit payable to the trade or business. In the case of a 
partnership or S corporation, the provision applies at the 
partnership or corporate level. The amount of the benefit is 
intended to take into account the amount payable to the 
business under the contract (e.g., as a death benefit) or 
pursuant to another agreement (e.g., under a split dollar 
agreement). The amount of the benefit is intended also to 
include any amount by which liabilities of the business would 
be reduced by payments under the policy or contract (e.g., when 
payments under the policy reduce the principal or interest on a 
liability owed to or by the business).
    As provided in regulations, the issuer or policyholder of 
the life insurance policy or endowment or annuity contract is 
required to report the amount of the amount of the unborrowed 
cash value in order to carry out this rule.
    If interest expense is disallowed under other provisions of 
section 264 (limiting interest deductions with respect to life 
insurance policies or endowment or annuity contracts) or under 
section 265 (relating to tax-exempt interest), then the 
disallowed interest expense is not taken into account under 
this provision, and the average adjusted bases of assets is 
reduced by the amount of debt, interest on which is so 
disallowed. The provision is applied before present-law rules 
relating to capitalization of certain expenses where the 
taxpayer produces property (sec. 263A).
    An aggregation rule is provided, treating related persons 
as one for purposes of the provision.
    The provision does not apply to any insurance company 
subject to tax under subchapter L of the Code. Rather, the 
rules reducing certain deductions for losses incurred, in the 
case of property and casualty companies, and reducing reserve 
deductions or dividends received deductions of life insurance 
companies, are modified to take into account the increase in 
cash values of life insurance policies or annuity or endowment 
contracts held by insurance companies.

                             Effective Date

    The provisions apply with respect to contracts issued after 
June 8, 1997. For this purpose, a material increase in the 
death benefit or other material change in the contract causes 
the contract to be treated as a new contract. To the extent of 
additional covered lives under a contract after June 8, 1997, 
the contract is treated as a new contract. In the case of an 
increase in the death benefit of a contract that is converted 
to extended term insurance pursuant to nonforfeiture 
provisions, in a transaction to which section 501(d)(2) of the 
Health Insurance Portability and Accountability Act of 1996 
applies, the contract is not treated as a new contract.

4. Allocation of basis of properties distributed to a partner by a 
        partnership (sec. 874 of the bill and sec. 732(c) of the Code)

                              Present Law

In general

    The partnership provisions of present law generally permit 
partners to receive distributions of partnership property 
without recognition of gain or loss (sec. 731).\114\ Rules are 
provided for determining the basis of the distributed property 
in the hands of the distributee, and for allocating basis among 
multiple properties distributed, as well as for determining 
adjustments to thedistributee partner's basis in its 
partnership interest. Property distributions are tax-free to a 
partnership. Adjustments to the basis of the partnership's remaining 
undistributed assets are not required unless the partnership has made 
an election that requires basis adjustments both upon partnership 
distributions and upon transfers of partnership interests (sec. 754).
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    \114\ Exceptions to this nonrecognition rule apply: (1) when money 
(and the fair market value of marketable securities) received exceeds a 
partner's adjusted basis in the partnership (sec. 731(a)(1)); (2) when 
only money, inventory and unrealized receivables are received in 
liquidation of a partner's interest and loss is realized (sec. 
731(a)(2)); (3) to certain disproportionate distributions involving 
inventory and unrealized receivables (sec. 751(b)); and (4) to certain 
distributions relating to contributed property (secs. 704(c) and 737). 
In addition, if a partner engages in a transaction with a partnership 
other than in its capacity as a member of the partnership, the 
transaction generally is considered as occurring between the 
partnership and one who is not a partner (sec. 707).
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Partner's basis in distributed properties and partnership interest

    Present law provides two different rules for determining a 
partner's basis in distributed property, depending on whether 
or not the distribution is in liquidation of the partner's 
interest in the partnership. Generally, a substituted basis 
rule applies to property distributed to a partner in 
liquidation. Thus, the basis of property distributed in 
liquidation of a partner's interest is equal to the partner's 
adjusted basis in its partnership interest (reduced by any 
money distributed in the same transaction) (sec. 732(b)).
    By contrast, generally, a carryover basis rule applies to 
property distributed to a partner other than in liquidation of 
its partnership interest, subject to a cap (sec. 732(a)). Thus, 
in a non- liquidating distribution, the distributee partner's 
basis in the property is equal to the partnership's adjusted 
basis in the property immediately before the distribution, but 
not to exceed the partner's adjusted basis in its partnership 
interest (reduced by any money distributed in the same 
transaction). In a non-liquidating distribution, the partner's 
basis in its partnership interest is reduced by the amount of 
the basis to the distributee partner of the property 
distributed and is reduced by the amount of any money 
distributed (sec. 733).

Allocating basis among distributed properties

    In the event that multiple properties are distributed by a 
partnership, present law provides allocation rules for 
determining their bases in the distributee partner's hands. An 
allocation rule is needed when the substituted basis rule for 
liquidating distributions applies, in order to assign a portion 
of the partner's basis in its partnership interest to each 
distributed asset. An allocation rule is also needed in a non-
liquidating distribution of multiple assets when the total 
carryover basis would exceed the partner's basis in its 
partnership interest, so a portion of the partner's basis in 
its partnership interest is assigned to each distributed asset.
    Present law provides for allocation in proportion to the 
partnership's adjusted basis. The rule allocates basis first to 
unrealized receivables and inventory items in an amount equal 
to the partnership's adjusted basis (or if the allocated basis 
is less than partnership basis, then in proportion to the 
partnership's basis), and then among other properties in 
proportion to their adjusted bases to the partnership (sec. 
732(c)).\115\ Under this allocation rule, in the case of a 
liquidating distribution, the distributee partner can have a 
basis in the distributed property that exceeds the 
partnership's basis in the property.
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    \115\ A special rule allows a partner that acquired a partnership 
interest by transfer within two years of a distribution to elect to 
allocate the basis of property received in the distribution as if the 
partnership had a section 754 election in effect (sec. 732(d)). The 
special rule also allows the Service to require such an allocation 
where the value at the time of transfer of the property received 
exceeds 110 percent of its adjusted basis to the partnership (sec. 
732(d)). Treas. Reg. sec. 1.732-1(d)(4) generally requires the 
application of section 732(d) where the allocation of basis under 
section 732(c) upon a liquidation of the partner's interest would have 
resulted in a shift of basis from non-depreciable property to 
depreciable property.
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                           Reasons for Change

    The rule providing that distributee partners allocate basis 
in proportion to the partnership's adjusted basis in the 
distributed property gives rise to problems in 
application.\116\ The Committee is concerned that the present-
law rule permits basis shifting transactions in which basis is 
allocated so as to increase basis artificially, giving rise to 
inflated depreciation deductions or artificially large losses, 
for example. The Committee believes that these problems would 
be significantly reduced by taking into account the fair market 
value of property distributed by a partnership for purposes of 
allocating basis in the hands of the distributee partner.
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    \116\ ``The failure of these rules to take fair market value into 
account puts a high premium on tax planning in connection with in-kind 
liquidating distributions. Allocation of the portion of the basis in 
excess of the partnership's basis in the distributed assets according 
to their relative market values would be a conceptually sound approach, 
and would eliminate the strange results and manipulation possibilities 
. . .'' W. McKee, W. Nelson and R. Whitmire, Federal Taxation of 
Partnerships and Partners (3rd ed. 1997), para. 19.06.
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                        Explanation of Provision

    The provision modifies the basis allocation rules for 
distributee partners. It allocates a distributee partner's 
basis adjustment among distributed assets first to unrealized 
receivables and inventory items in an amount equal to the 
partnership's basis in each such property (as under present 
law). If the basis to be allocated is less than the sum of the 
adjusted bases of the properties in the hands of the 
partnership, then, to the extent a decrease is required to make 
the total adjusted bases of the properties equal the basis to 
be allocated, the decrease is allocated as described below for 
adjustments that are decreases.
    Under the provision, to the extent of any basis not 
allocated under the above rules, basis is allocated first to 
the extent of each distributed property's adjusted basis to the 
partnership. Any remaining basis adjustment, if an increase, is 
allocated among properties with unrealized appreciation in 
proportion to their respective amounts of unrealized 
appreciation (to the extent of each property's appreciation), 
and then in proportion to their respective fair market values. 
For example, assume that a partnership with two assets, A and 
B, distributes them both in liquidation to a partner whose 
basis in its interest is 55. Neither asset consists of 
inventory or unrealized receivables. Asset A has a basis to the 
partnership of 5 and a fair market value of 40, and asset B has 
a basis to the partnership of 10 and a fair market value of 10. 
Under the provision, basis is first allocated to asset A in the 
amount of 5 and to asset B in the amount of 10 (their adjusted 
bases to the partnership). The remaining basis adjustment is an 
increase totaling 40 (the partner's 55 basis minus the 
partnership's total basis in distributed assets of 15). Basis 
is then allocated to asset A inthe amount of 35, its unrealized 
appreciation, with no allocation to asset B attributable to unrealized 
appreciation because its fair market value equals the partnership's 
adjusted basis. The remaining basis adjustment of 5 is allocated in the 
ratio of the assets' fair market values, i.e., 4 to asset A (for a 
total basis of 44) and 1 to asset B (for a total basis of 11).
    If the remaining basis adjustment is a decrease, it is 
allocated among properties with unrealized depreciation in 
proportion to their respective amounts of unrealized 
depreciation (to the extent of each property's depreciation), 
and then in proportion to their respective adjusted bases 
(taking into account the adjustments already made). A remaining 
basis adjustment that is a decrease arises under the provision 
when the partnership's total adjusted basis in the distributed 
properties exceeds the amount of the partner's basis in its 
partnership interest, and the latter amount is the basis to be 
allocated among the distributed properties. For example, assume 
that a partnership with two assets, C and D, distributes them 
both in liquidation to a partner whose basis in its partnership 
interest is 20. Neither asset consists of inventory or 
unrealized receivables. Asset C has a basis to the partnership 
of 15 and a fair market value of 15, and asset D has a basis to 
the partnership of 15 and a fair market value of 5. Under the 
provision, basis is first allocated to the extent of the 
partnership's basis in each distributed property, or 15 to each 
distributed property, for a total of 30. Because the partner's 
basis in its interest is only 20, a downward adjustment of 10 
(30 minus 20) is required. The entire amount of the 10 downward 
adjustment is allocated to the property D, reducing its basis 
to 5. Thus, the basis of property C is 15 in the hands of the 
distributee partner, and the basis of property D is 5 in the 
hands of the distributee partner.

                             Effective Date

    The provision applies to partnership distributions after 
the date of enactment.

5. Treatment of inventory items of a partnership (sec. 875 of the bill 
        and sec. 751 of the Code)

                              Present Law

    Under present law, upon the sale or exchange of a 
partnership interest, any amount received that is attributable 
to unrealized receivables, or to inventory that has 
substantially appreciated, is treated as an amount realized 
from the sale or exchange of property that is not a capital 
asset (sec. 751(a)).
    Present law provides a similar rule to the extent that a 
distribution is treated as a sale or exchange of a partnership 
interest. A distribution by a partnership in which a partner 
receives substantially appreciated inventory or unrealized 
receivables in exchange for its interest in certain other 
partnership property (or receives certain other property in 
exchange for its interest in substantially appreciated 
inventory or unrealized receivables) is treated as a taxable 
sale or exchange of property, rather than as a nontaxable 
distribution (sec. 751(b)).
    For purposes of these rules, inventory of a partnership 
generally is treated as substantially appreciated if the fair 
market value of the inventory exceeds 120 percent of adjusted 
basis of the inventory to the partnership (sec. 751(d)(1)(A)). 
In applying this rule, inventory property is excluded from the 
calculation if a principal purpose for acquiring the inventory 
property was to avoid the rules relating to inventory (sec. 
751(d)(1)(B)).

                           Reasons for Change

    The substantial appreciation requirement with respect to 
inventory of a partnership has been criticized as both 
ineffective at insulating partnerships from the potential 
complexity of the disproportionate distribution rules of 
section 751(b), and also ineffective at properly treating 
income attributable to inventory as ordinary income under the 
section 751 rules for partnerships with profit margins below 20 
percent.\117\ Because the Committee believes that income 
attributable to inventory should be treated as ordinary income, 
the bill repeals the substantial appreciation requirement with 
respect to inventory, in the case of partnership sales, 
exchanges and distributions.
---------------------------------------------------------------------------
    \117\ The 1984 ALI study on partnership rules referred to the 
substantial appreciation requirement as subject to manipulation and tax 
planning (American Law Institute, Federal Income Tax Project: 
Subchapter K: Proposals on the Taxation of Partners (R. Cohen, reporter 
1984), 26. In 1993, the definition of substantially appreciated 
inventory was modified, and the present-law test relating to a 
principal purpose of avoidance was added (Omnibus Budget Reconciliation 
Act of 1993, P.L. 103-66, sec. 13206(e)(1)). Nevertheless, the 
substantial appreciation requirement is still criticized as ineffective 
(W. McKee, W. Nelson and R. Whitmire, Federal Taxation of Partners and 
Partnerships. (3rd ed. 1997) para. 16.04[2]).
---------------------------------------------------------------------------

                        Explanation of Provision

    The provision eliminates the requirement that inventory be 
substantially appreciated in order to give rise to ordinary 
income under the rules relating to sales and exchanges of 
partnership interests and certain partnership distributions. 
This conforms the treatment of inventory to the treatment of 
unrealized receivables under these rules.

                             Effective Date

    The provision is effective for sales, exchanges, and 
distributions after the date of enactment.

6. Eligibility for income forecast method (sec. 876 of the bill and 
        secs. 167 and 168 of the Code)

                              Present Law

    A taxpayer generally recovers the cost of property used in 
a trade or business through depreciation or amortization 
deductions over time. Tangible property generally is 
depreciated under the modified Accelerated Cost Recovery System 
(``MACRS'') of section 168, which applies specific recovery 
periods and depreciation methods to the cost of various types 
of depreciable property. Intangible property generally is 
amortized under section 197, which applies a 15-year recovery 
period and the straight-line method to the cost of applicable 
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 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 recovered 
under either the MACRS depreciation provisions or under the 
section 197 amortization provisions. The cost of such property 
may be depreciated under the ``income forecast'' method.
    The income forecast method is considered to be a method of 
depreciation not expressed in a term of years. Under the income 
forecast method, the depreciation deduction for a taxable year 
for a property is determined by multiplying the cost of the 
property (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 is available 
to any property if (1) the taxpayer elects to exclude such 
property from MACRS and (2) for the first taxable year for 
which depreciation is allowable, the property is properly 
depreciated under such method. 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 recordings and video 
games.\118\ Most recently, the income forecast method has been 
held applicable to consumer durable property subject to short-
term ``rent-to-own'' leases.\119\
---------------------------------------------------------------------------
    \118\ 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.
    \119\ See, ABC Rentals of San Antonio v. Comm., No. 95-9008 (10th 
Cir. 9/27/96), where the Tenth Circuit decision reversed the holding of 
ABC Rentals of San Antonio v. Comm., 68 TCM 1362 (1994) and held that 
consumer durable property subject to short-term, ``rent-to-own'' leases 
were eligible for the income forecast method. For decisions supporting 
the Tax Court memorandum decision denying eligibility for certain 
tangible personal property, see El Charro TV Rental v. Comm., No. 95-
60301 (5th Cir., 1995) (rent-to-own property not eligible) and Carland, 
Inc. v. Comm., 90 T.C. 505 (1988), aff'd on this issue, 909 F.2d 1101 
(8th Cir., 1990) (railroad rolling stock subject to a lease not 
eligible))
---------------------------------------------------------------------------

                           Reasons for Change

    Depreciation allowances attempt to measure the decline in 
the value of property due to wear, tear, and obsolescence and 
to match the cost recovery for the property with the income 
stream produced by the property. The committee believes that 
the income forecast method of depreciation is, in theory, an 
appropriate method to match the recovery of cost of property 
with the income stream produced by the property. However, when 
compared to MACRS, the income forecast method involves 
significant complexities, including the determination of the 
income estimated to be generated by the property, the 
determination of the residual value of the property, and the 
application of the look-back method. Thus, the committee 
believes that the availability of the income forecast method 
should be limited to instances where the economic depreciation 
of the property cannot be adequately reflected by the passage 
of time alone or where the income stream from the property is 
sufficiently unpredictable or uneven such that the application 
of another method of depreciation may result in the distortion 
of income. In addition, because the income forecast method is 
elective, the committee is concerned about taxpayer 
selectivity.
    Finally, the committee provides a MACRS class life for 
certain depreciable consumer durables subject to rent-to-own 
contracts, in order to avoid future controversies with respect 
to the proper treatment of such property.

                        Explanation of Provision

    The bill clarifies the types of property to which the 
income forecast method may be applied. Under the bill, the 
income forecast method is available to motion picture films, 
television films and taped shows, books, patents, master sound 
recordings, copyrights, and other such property as designated 
by the Secretary of the Treasury. It is expected that the 
Secretary will exercise this authority such that the income 
forecast method will be available to property the economic 
depreciation of which cannot be adequately measured by the 
passage of time alone or to property the income from which is 
sufficiently unpredictable or uneven so as to result in the 
distortion of income. The mere fact that property is subject to 
a lease should not make the property eligible for the income 
forecast method. The income forecast method is not applicable 
to property to which section 197 applies.
    In addition, consumer durables subject to rent-to-own 
contracts are provided a three-year recovery period and a four-
year class life for MACRS purposes (and would not be eligible 
for the income forecast method). Such property generally is 
described in Rev. Proc. 95-38, 1995-34 I.R.B. 25.

                             Effective Date

    The provision is effective for property placed in service 
after the date of enactment.

7. Modify the exception to the related party rule of section 1033 for 
        individuals to only provide an exception for de minimis amounts 
        (sec. 877 of the bill and sec. 1033 of the Code)

                              Present Law

    Under section 1033, gain realized by a taxpayer from 
certain involuntary conversions of property is deferred to the 
extent the taxpayer purchases property similar or related in 
service or use to the converted property within a specified 
replacement period of time. Pursuant to a provision of Public 
Law 104-7, subchapter C corporations (and certain partnerships 
with corporate partners) are not entitled to defer gain under 
section 1033 if the replacement property or stock is purchased 
from a related person. A person is treated as related to 
another person if the person bears a relationship to the other 
person described in section 267(b) or 707(b)(1). An exception 
tothis related party rule provides that a taxpayer could 
purchase replacement property or stock from a related person and defer 
gain under section 1033 to the extent the related person acquired the 
replacement property or stock from an unrelated person within the 
replacement period.

                           Reasons for Change

    The committee believes that, except for de minimis cases, 
individuals should be subject to the same rules with respect to 
the acquisition of replacement property from a related person 
as are other taxpayers.

                        Explanation of Provision

    The bill expands the present-law denial of the application 
of section 1033 to any other taxpayer (including an individual) 
that acquires replacement property from a related party (as 
defined by secs. 267(b) and 707(b)(1)) unless the taxpayer has 
aggregate realized gain of $100,000 or less for the taxable 
year with respect to converted property with aggregate realized 
gains. In the case of a partnership (or S corporation), the 
annual $100,000 limitation applies to both the partnership (or 
S corporation) and each partner (or shareholder).

                             Effective Date

    The provision applies to involuntary conversions occurring 
after June 8, 1997.

8. Repeal of exception for certain sales by manufacturers to dealer 
        (sec. 878 of the bill and sec. 811(c)(9) of the Tax Reform Act 
        of 1986 (P.L. 99-514))

                              Present Law

    In general, the installment sales method of accounting may 
not be used by dealers in personal property. Present law 
provides an exception which permits the use of the installment 
method for installment obligations arising from the sale of 
tangible personal property by a manufacturer of the property 
(or an affiliate of the manufacturer) to a dealer,\120\ but 
only if the dealer is obligated to make payments of principal 
only when the dealer resells (or rents) the property, the 
manufacturer has the right to repurchase the property at a 
fixed (or ascertainable) price after no longer than a nine 
month period following the sale to the dealer, and certain 
other conditions are met. In order to meet the other 
conditions, the aggregate face amount of the installment 
obligations that otherwise qualify for the exception must equal 
at least 50 percent of the total sales to dealers that gave 
rise to such receivables (the ``fifty percent test'') in both 
the taxable year and the preceding taxable year, except that, 
if the taxpayer met all of the requirements for the exception 
in the preceding taxable year, the taxpayer would not be 
treated as failing to meet the fifty percent test before the 
second consecutive year in which the taxpayer did not actually 
meet the test. For purposes of applying the fifty percent test, 
the aggregate face amount of the taxpayer's receivables is 
computed using the weighted average of the taxpayer's 
receivables outstanding at the end of each month during the 
taxpayer's taxable year. In addition, these requirements must 
be met by the taxpayer in its first taxable year beginning 
after October 22, 1986, except that obligations issued before 
that date are treated as meeting the applicable requirements if 
such obligations were conformed to the requirements of the 
provision within 60 days of that date.
---------------------------------------------------------------------------
    \120\ I.e., the sale of the property must be intended to be for 
resale or leasing by the dealer.
---------------------------------------------------------------------------

                           Reasons for Change

    The committee believes that the special exception that 
permitted certain dealers to use the installment method is no 
longer necessary or approriate and the installment sale method 
of accounting should not be available to such dealers. 
Accordingly, the committee bill repeals that exception.

                        Explanation of Provision

    The bill repeals the exception that permits the use of the 
installment method of accounting for certain sales by 
manufacturers to dealers.

                             Effective Date

    The provision is effective for taxable years beginning one 
year after the date of enactment. Any resulting adjustment from 
a required change in accounting will be includible ratably over 
the 4-year taxable years beginning after that date.

9. Cash out of certain accrued benefits (sec. 879 of the bill and secs. 
        411 and 417 of the Code)

                              Present Law

    Under present law, in the case of an employee whose plan 
participation terminates, a qualified plan may involuntarily 
``cash out'' the benefit (i.e., pay out the balance to the 
credit of a plan participant without the participant's consent, 
and, if applicable, the consent of the participant's spouse) if 
the present value of the benefit does not exceed $3,500. If a 
benefit is cashed out under this rule and the participant 
subsequently returns to employment covered by the plan, then 
service taken into account in computing benefits payable under 
the plan after the return need not include service with respect 
to which benefits were cashed out unless the employee ``buys 
back'' the benefit.
    Generally, a cash-out distribution from a qualified plan to 
a plan participant can be rolled over, tax free, to an IRA or 
to another qualified plan.

                           Reasons for Change

    The Committee believes that the limit on involuntary cash-
outs should be raised to $5,000 in recognition of the effects 
of inflation and the value of small benefits payable under a 
qualified pension plan.

                        Explanation of Provision

    The bill increases the limit on involuntary cash-outs to 
$5,000 from $3,500. The $5,000 amount is adjusted annually for 
inflation beginning after 1997 in $50 increments. The bill will 
also make the corresponding changes to the Employee Retirement 
Income Security Act of 1974, as amended (``ERISA'').

                             Effective Date

    The provision is effective for plan years beginning on and 
after the date of enactment.

10. Election to receive taxable cash compensation in lieu of nontaxable 
        parking benefits (sec. 880 of the bill and sec. 132 of the 
        Code)

                              Present Law

    Under present law, up to $165 per month of employer-
provided parking is excludable from gross income. In order for 
the exclusion to apply, the parking must be provided in 
addition to and not in lieu of any compensation that is 
otherwise payable to the employee. Employer-provided parking 
cannot be provided as part of a cafeteria plan.

                           Reasons for Change

    The Committee believes that the present-law rules relating 
to employer-provided parking result in an overutilization of 
parking as a fringe benefit. By permitting employers to offer 
cash compensation in lieu of parking, the Committee believes 
that employees will be more likely to elect to receive cash 
compensation, which will increase the electing employees' 
taxable income. In addition, the election to take cash may 
promote sound energy policy by increasing the use of mass 
transit and reduce the amount of commuting by car.

                        Explanation of Provision

    Under the bill, no amount is includible in the income of an 
employee merely because the employer offers the employee a 
choice between cash and employer-provided parking. The amount 
of cash offered is includible in income only if the employee 
chooses the cash instead of parking.

                             Effective Date

    The provision is effective with respect to taxable years 
beginning after December 31, 1997.

11. Extension of Federal unemployment surtax (sec. 881 of the bill and 
        sec. 3301 of the Code)

                              Present Law

    The Federal Unemployment Tax Act (FUTA) imposes a 6.2-
percent gross tax rate on the first $7,000 paid annually by 
covered employers to each employee. Employers in States with 
programs approved by the Federal Government and with no 
delinquent Federal loans may credit 5.4-percentage points 
against the 6.2-percent tax rate, making the minimum, net 
Federal unemployment tax rate 0.8 percent. Since all States 
have approved programs, 0.8 percent is the Federal tax rate 
that generally applies. This Federal revenue finances 
administration of the system, half of the Federal-State 
extended benefits program, and a Federal account for State 
loans. The States use the revenue turned back to them by the 
5.4 percent credit to finance their regular State programs and 
half of the Federal-State extended benefits program.
    In 1976, Congress passed a temporary surtax of 0.2 percent 
of taxable wages to be added to the permanent FUTA tax rate. 
Thus, the current 0.8 percent FUTA tax rate has two components: 
a permanent tax rate of 0.6 percent, and a temporary surtax 
rate of 0.2 percent. The temporary surtax has been subsequently 
extended through 1998.

                           Reasons for Change

    The Committee believes that the surtax extension will 
increase the Federal Unemployment Trust Fund to provide a 
cushion against future expenditures. The monies retained in the 
Federal Unemployment Account of the Federal Unemployment Trust 
Fund can then be used to make loans to the 53 State 
Unemployment Compensation benefit accounts as needed.

                        Explanation of Provision

    The bill extends the temporary surtax rate through December 
31, 2007. The bill also increases the limit from 0.25 percent 
to 0.50 percent of covered wages on the Federal Unemployment 
Account (FUA) in the Unemployment Trust Fund.

                             Effective Date

    The provision is effective for labor performed on or after 
January 1, 1999.

12. Repeal of excess distribution and excess retirement accumulation 
        taxes (sec. 882 of the bill and sec. 4980A of the Code)

                              Present Law

    Under present law, a 15-percent excise tax is imposed on 
excess distributions from qualified retirement plans, tax-
sheltered annuities, and IRAs. Excess distributions are 
generally the aggregate amount of retirement distributions from 
such plans during any calendar year in excess of $160,000 (for 
1997) or 5 times that amount in the case of a lump-sum 
distribution. The 15-percent excise tax does not apply to 
distributions received in 1997, 1998, and 1999.
    An additional 15-percent estate tax is imposed on an 
individual's excess retirement accumulations. Excess retirement 
accumulations are generally the balance in retirement plans in 
excess of the present value of a benefit that would not be 
subject to the 15-percent tax in excess distributions.

                           Reasons for Change

    The excess distribution and retirement accumulation taxes 
are designed to limit the overall tax-deferred savings by 
individuals, as well as to help ensure that tax-favored 
retirement vehicles are used primarily for retirement purposes. 
The Committee believes that the limits on contributions and 
benefits applicable to each type of vehicle are sufficient 
limits on tax-deferred savings. Additional penalties are 
unnecessary, and may also deter individuals from saving. The 
excess accumulation and distribution taxes also inappropriately 
penalize favorable investment returns.

                        Explanation of Provision

    The bill repeals both the 15-percent excise tax on excess 
distributions and the 15-percent estate tax on excess 
retirement accumulations.

                             Effective Date

    The provision repealing the excess distribution tax is 
effective with respect to excess distributions received after 
December 31, 1996. The repeal of the excess accumulation tax is 
effective with respect to decedents dying after December 31, 
1996.

13. Treatment of charitable remainder trusts with greater than 50 
        percent annual payout (sec. 883 of the bill and sec. 664 of the 
        Code)

                              Present Law

In general

    Sections 170(f), 2055(e)(2) and 2522(c)(2) disallow a 
charitable deduction for income, estate or gift tax purposes, 
respectively, where 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. Exceptions to this 
general rule are provided for (1) remainder interests in 
charitable remainder annuity trusts, charitable remainder 
unitrusts, pooled income funds, farms, and personal residences; 
(2) present interests in the form of a guaranteed annuity or a 
fixed percentage of the annual value of the property, (3) an 
undivided portion of the donor's entire interest in the 
property, and (4) a qualified conservation easement.

Charitable remainder annuity trusts and charitable remainder unitrusts

    A charitable remainder annuity trust is a trust which is 
required to pay, at least annually, a fixed dollar amount at 
least 5 percent of the initial value of the trust to a non-
charity for the life of an individual or period of less than 20 
years, with the remainder passing to charity. A charitable 
remainder unitrust is a trust which generally is required to 
pay, at least annually, a fixed percentage of the fair market 
value of the trust's assets determined at least annually to a 
non-charity for the life of an individual or period less than 
20 years, with the remainder passing to charity. Sec. 664(d).
    Distributions from a charitable remainder annuity trust or 
charitable remainder unitrust are treated in the following 
order as: (1) ordinary income to the extent of the trust's 
current and previously undistributed ordinary income for the 
trust's year in which the distribution occurred, (2) capital 
gains to the extent of the trust's current capital gain and 
previously undistributed capital gain for the trust's year in 
which the distribution occurred; (3) other income (e.g., tax-
exempt income) to the extent of the trust's current and 
previously undistributed other income for the trust's year in 
which the distribution occurred, and (4) corpus. Sec. 664(b).
    Distributions are includible in the income of the 
beneficiary for the year that the annuity or unitrust amount is 
required to be distributed even though the annuity or unitrust 
amount is not distributed until after the close of the trust's 
taxable year. Treas. Reg. sec. 1.664-1(d)(4).

                           Reasons for Change

    The Committee is concerned that the interplay of the rules 
governing the timing of income from distributions from 
charitable remainder trusts (i.e., Treas. Reg. sec. 1.664-
1(d)(4)) and the rules governing the character of distributions 
(i.e., sec. 664(b)) have created opportunities for abuse where 
the required annual payments are a large portion of the trust 
and realization of income and gain can be postponed until a 
year later than the accrual of such large payments. For 
example, some taxpayers have been creating charitable remainder 
unitrusts with a required annual payout of 80 percent of the 
trust's assets and then funding the trust with highly 
appreciated nondividend paying stock which the trust sells in a 
year subsequent to when the required distribution is includible 
in the beneficiary's income, and using proceeds from that sale 
to pay the required distribution attributable to the prior 
year. Those taxpayers have treated the distribution of 80 
percent of the trust's assets attributable to the trust's first 
required distribution as non-taxable distributions of corpus 
because the trust had not realized any income in its first 
taxable year. The Committee believes that such treatment is 
abusive and is inconsistent with the purpose of the charitable 
remainder trust rules. In order to limit this kind of abuse, 
the Committee bill provides that a trust cannot be a charitable 
remainder trust if the required payout is greater than 50 
percent of the initial fair market value of the trusts assets 
(in the case of a charitable remainder annuity trust) or 50 
percent of the annual value of the trusts assets (in the case 
of a charitable remainder unitrust).
    On April 18, 1997, the Treasury Department proposed 
regulations providing additional rules under sections 664 and 
2702 to address the abuse described above and other perceived 
abuses involving distributions from charitable remainder 
trusts. One of those proposed rules would require that payment 
of any required annuity or unitrust amount by a charitable 
remainder trust be made by the close of the trust's taxable 
year in which such payments are due. See Prop. Treas. Reg. 
secs. 1.664-2(a)(1)(i) and 1.664-3(a)(1)(i). The Committee 
intends that the provision of the Committee bill does not limit 
or alter the validity of the regulations proposed by the 
Treasury Department on April 18, 1997, or the Treasury 
Department's authority to address this or other abuses of the 
rules governing the taxation of charitable remainder trusts or 
their beneficiaries.

                        Explanation of Provision

    Under the provision, a trust would not qualify as 
charitable remainder annuity trust if the annuity for a year is 
greater than 50 percent of the initial fair market value of the 
trust's assets or a trust would not qualify as a charitable 
remainder unitrust if the percentage of assets that are 
required to be distributed at least annually is greater than 50 
percent. Any trust that fails this 50 percent rule will not be 
a charitable remainder trust whose taxation is governed under 
section 664, but will be treated as a complex trust and, 
accordingly, all of its income will be taxed to its 
beneficiaries or to the trust.

                             Effective Date

    The provision applies to transfers to a trust made after 
June 18, 1997.

14. Tax on prohibited transactions (sec. 884 of the bill and sec. 4975 
        of the Code)

                              Present Law

    Present law prohibits certain transactions (prohibited 
transactions) between a qualified plan and a disqualified 
person in order to prevent persons with a close relationship to 
the qualified plan from using that relationship to the 
detriment of plan participants and beneficiaries. A two-tier 
excise tax is imposed on prohibited transactions. The initial 
level tax was equal to 10-percent of the amount involved with 
respect to the transaction. If the transaction is not corrected 
within a certain period, a tax equal to 100 percent of the 
amount involved may be imposed.

                           Reasons for Change

    The Committee believes it is appropriate to increase the 
initial level prohibited transaction tax to discourage 
disqualified persons from engaging in such transactions.

                        Explanation of Provision

    The bill increases the initial-level prohibited transaction 
tax from 10-percent to 15-percent. No changes were made to the 
prohibited transaction provisions of title I of the Employee 
Retirement Income Security Act of 1974, as amended (``ERISA').

                             Effective Date

    The provision is effective with respect to prohibited 
transactions occurring after the date of enactment.

15. Basis recovery rules (sec. 885 of the bill and sec. 72 of the Code)

                              Present Law

    Under present law, amounts received as an annuity under a 
tax-qualified pension plan generally are includible in income 
in the year received, except to the extent the amount received 
represents return of the recipient's investment in the contract 
(i.e., basis). The portion of each annuity payment that 
represents a return of basis generally is determined by a 
simplified method. Under this method, the portion of each 
annuity payment that is a return to basis is equal to the 
employee's total basis as of the annuity starting date, divided 
by the number of anticipated payments under a specified table, 
shown below. The number of anticipated payments listed in the 
table is based on the age of the primary annuitant on the 
annuity starting date.
                                                               Number of
Age of primary annuitant:                                       Payments
    55 or less................................................       360
    56-60.....................................................       310
    61-65.....................................................       260
    66-70.....................................................       210
    71 or more................................................       160

    If the number of payments is fixed under the terms of the 
annuity, that number is used instead of the number of 
anticipated payments listed in the table. The simplified method 
is not available if the primary annuitant has attained age 75 
on the annuity starting date unless there are fewer than 5 
years of guaranteed payments under the annuity. If, in 
connection with commencement of annuity payments, the recipient 
receives a lump-sum payment that is not part of the annuity 
stream, such payment is taxable under the rules relating to 
annuities (sec. 72) as if received before the annuity starting 
date, and the investment in the contract used to calculate the 
simplified exclusion ratio for the annuity payments is reduced 
by the amount of the payment. In no event is the total amount 
excluded from income as nontaxable return of basis greater than 
the recipient's total investment in the contract.

                           Reasons for Change

    The table for determining anticipated payments does not 
differ depending on whether the annuity is payable in the form 
of a single life annuity or a joint and survivor annuity. 
Applying the table for single life annuities to joint and 
survivor annuities understates the expected payments under a 
joint and survivor annuity.

                        Explanation of Provision

    Under the bill, the present-law table would apply to 
benefits based on the life of one annuitant. A separate table 
would apply to benefits based on the life of more than one 
annuitant, as follows:
                                                               Number of
Combined age of annuitants:                                     payments
    110 or less...............................................       410
    111-120...................................................       360
    121-130...................................................       310
    131-140...................................................       260
    141 and over..............................................       210

                             Effective Date

    The provision is effective with respect to annuity starting 
dates beginning after December 31, 1997.
          TITLE IX. FOREIGN-RELATED SIMPLIFICATION PROVISIONS

1. General provisions affecting treatment of controlled foreign 
        corporations (secs. 911-913 of the bill and secs. 902, 904, 
        951, 952, 959, 960, 961, 964, and 1248 of the Code)

                              Present Law

    If an upper-tier controlled foreign corporation (``CFC'') 
sells stock of a lower-tier CFC, the gain generally is included 
in the income of U.S. 10-percent shareholders as subpart F 
income and such U.S. shareholder's basis in the stock of the 
first-tier CFC is increased to account for the inclusion. The 
inclusion is not characterized for foreign tax credit 
limitation purposes by reference to the nature of the income of 
the lower-tier CFC; instead it generally is characterized as 
passive income.
    For purposes of the foreign tax credit limitations 
applicable to so-called 10/50 companies, a CFC is not treated 
as a 10/50 company with respect to any distribution out of its 
earnings and profits for periods during which it was a CFC and, 
except as provided in regulations, the recipient of the 
distribution was a U.S. 10-percent shareholder in such 
corporation.
    If subpart F income of a lower-tier CFC is included in the 
gross income of a U.S. 10-percent shareholder, no provision of 
present law allows adjustment of the basis of the upper-tier 
CFC's stock in the lower-tier CFC.
    The subpart F income earned by a foreign corporation during 
its taxable year is taxed to the persons who are U.S. 10-
percent shareholders of the corporation on the last day, in 
that year, on which the corporation is a CFC. In the case of a 
U.S. 10-percent shareholder who acquired stock in a CFC during 
the year, such inclusions are reduced by all or a portion of 
the amount of dividends paid in that year by the foreign 
corporation to any person other than the acquiror with respect 
to that stock.
    As a general rule, subpart F income does not include income 
earned from sources within the United States if the income is 
effectively connected with the conduct of a U.S. trade or 
business by the CFC. This general rule does not apply, however, 
if the income is exempt from, or subject to a reduced rate of, 
U.S. tax pursuant to a provision of a U.S. treaty.
    A U.S. corporation that owns at least 10 percent of the 
voting stock of a foreign corporation is treated as if it had 
paid a share of the foreign income taxes paid by the foreign 
corporation in the year in which the foreign corporation's 
earnings and profits become subject to U.S. tax as dividend 
income of the U.S. shareholder. A U.S. corporation also may be 
deemed to have paid taxes paid by a second- or third-tier 
foreign corporation if certain conditions are satisfied.

                           Reasons for Change

    The Committee believes that complexities are caused by 
uncertainties and gaps in the present statutory schemes for 
taxing gains on dispositions of stock in CFCs as dividend 
income or subpart F income. The Committee believes that it is 
appropriate to reduce complexities by rationalizing these 
rules.
    The Committee also understands that certain arbitrary 
limitations placed on the operation of the indirect foreign tax 
credit may have resulted in taxpayers undergoing burdensome and 
sometimes costly corporate restructuring. In other cases, there 
is concern that these limitations may have contributed to 
decisions by U.S. companies against acquiring foreign 
subsidiaries. The Committee deems it appropriate to ease these 
restrictions.

                        Explanation of Provision

Lower-tier CFCs

            Characterization of gain on stock disposition
    Under the bill, if a CFC is treated as having gain from the 
sale or exchange of stock in a foreign corporation, the gain is 
treated as a dividend to the same extent that it would have 
been so treated under section 1248 if the CFC were a U.S. 
person. This provision, however, does not affect the 
determination of whether the corporation whose stock is sold or 
exchanged is a CFC.
    Thus, for example, if a U.S. corporation owns 100 percent 
of the stock of a foreign corporation, which owns 100 percent 
of the stock of a second foreign corporation, then under the 
bill, any gain of the first corporation upon a sale or exchange 
of stock of the second corporation is treated as a dividend for 
purposes of subpart F income inclusions to the U.S. 
shareholder, to the extent of earnings and profits of the 
second corporation attributable to periods in which the first 
foreign corporation owned the stock of the second foreign 
corporation while the latter was a CFC with respect to the U.S. 
shareholder.
    Gain on disposition of stock in a related corporation 
created or organized under the laws of, and having a 
substantial part of its assets in a trade or business in, the 
same foreign country as the gain recipient, even if 
recharacterized as a dividend under the proposal, is not 
excluded from foreign personal holding company income under the 
same-country exception that applies to actual dividends.
    Under the bill, for purposes of this rule, a CFC is treated 
as having sold or exchanged stock if, under any provision of 
subtitle A of the Code, the CFC is treated as having gain from 
the sale or exchange of such stock. Thus, for example, if a CFC 
distributes to its shareholder stock in a foreign corporation, 
and the distribution results in gain being recognized by the 
CFC under section 311(b) as if the stock were sold to the 
shareholder for fair market value, the bill makes clear that, 
for purposes of this rule, the CFC is treated as having sold or 
exchanged the stock.
    The bill also repeals a provision added to the Code by the 
Technical and Miscellaneous Revenue Act of 1988 that, except as 
provided by regulations, requires a recipient of a distribution 
from a CFC to have been a U.S. 10-percent shareholder of that 
CFC for the period during which the earnings and profits which 
gave rise to the distribution were generated in order to avoid 
treating the distribution as one coming from a 10/50 company. 
Thus, under the bill, a CFC is nottreated as a 10/50 company 
with respect to any distribution out of its earnings and profits for 
periods during which it was a CFC, whether or not the recipient of the 
distribution was a U.S. 10-percent shareholder of the corporation when 
the earnings and profits giving rise to the distribution were 
generated.
            Adjustments to basis of stock
    Under the bill, when a lower-tier CFC earns subpart F 
income, and stock in that corporation is later disposed of by 
an upper-tier CFC, the resulting income inclusion of the U.S. 
10-percent shareholders, under regulations, is to be adjusted 
to account for previous inclusions, in a manner similar to the 
adjustments provided to the basis of stock in a first-tier CFC. 
Thus, just as the basis of a U.S. 10-percent shareholder in a 
first-tier CFC rises when subpart F income is earned and falls 
when previously taxed income is distributed, so as to avoid 
double taxation of the income on a later disposition of the 
stock of that company, the subpart F income from gain on the 
disposition of a lower-tier CFC generally is reduced by income 
inclusions of earnings that were not subsequently distributed 
by the lower-tier CFC.
    For example, assume that a U.S. person is the owner of all 
of the stock of a first-tier CFC which, in turn, is the sole 
shareholder of a second-tier CFC. In year 1, the second-tier 
CFC earns $100 of subpart F income which is included in the 
U.S. person's gross income for that year. In year 2, the first-
tier CFC disposes of the second-tier CFC's stock and recognizes 
$300 of income with respect to the disposition. All of that 
income constitutes subpart F foreign personal holding company 
income. Under the bill, the Secretary is granted regulatory 
authority to reduce the U.S. person's year 2 subpart F 
inclusion by $100--the amount of year 1 subpart F income of the 
second-tier CFC that was included, in that year, in the U.S. 
person's gross income. Such an adjustment, in effect, allows 
for a step-up in the basis of the stock of the second-tier CFC 
to the extent of its subpart F income previously included in 
the U.S. person's gross income.

Subpart F inclusions in year of acquisition

    If a U.S. 10-percent shareholder acquires the stock of a 
CFC from another U.S. 10-percent shareholder during a taxable 
year of the CFC in which it earns subpart F income, the 
proposal reduces the acquiror's subpart F income inclusion for 
that year by a portion of the amount of the dividend deemed 
(under sec. 1248) to be received by the transferor. The portion 
by which the inclusion is reduced (as is the case if a dividend 
was paid to the previous owner of the stock) does not exceed 
the lesser of the amount of dividends with respect to such 
stock deemed received (under sec. 1248) by other persons during 
the year or the amount determined by multiplying the subpart F 
income for the year by the proportion of the year during which 
the acquiring shareholder did not own the stock.

Treatment of U.S. income earned by a CFC

    Under the bill, an exemption or reduction by treaty of the 
branch profits tax that would be imposed under section 884 on a 
CFC does not affect the general statutory exemption from 
subpart F income that is granted for U.S. source effectively 
connected income. For example, assume a CFC earns income of a 
type that generally would be subpart F income, and that income 
is earned from sources within the United States in connection 
with business operations therein. Further assume that 
repatriation of that income is exempted from the U.S. branch 
profits tax under a provision of an applicable U.S. income tax 
treaty. The bill provides that, notwithstanding the treaty's 
effect on the branch tax, the income is not treated as subpart 
F income as long as it is not exempt from U.S. taxation (or 
subject to a reduced rate of tax) under any other treaty 
provision.

Extension of indirect foreign tax credit

    The bill extends the application of the indirect foreign 
tax credit (secs. 902 and 960) to taxes paid or accrued by 
certain fourth-, fifth-, and sixth-tier foreign corporations. 
In general, three requirements are required to be satisfied by 
a foreign company at any of these tiers to qualify for the 
credit. First, the company must be a CFC. Second, the U.S. 
corporation claiming the credit under section 902(a) must be a 
U.S. shareholder (as defined in sec. 951(b)) with respect to 
the foreign company. Third, the product of the percentage 
ownership of voting stock at each level from the U.S. 
corporation down must equal at least 5 percent. The bill limits 
the application of the indirect foreign tax credit below the 
third tier to taxes paid or incurred in taxable years during 
which the payor is a CFC. Foreign taxes paid below the sixth 
tier of foreign corporations remain ineligible for the indirect 
foreign tax credit.

                            Effective Dates

    Lower-tier CFCs.--The provision that treats gains on 
dispositions of stock in lower-tier CFCs as dividends under 
section 1248 principles applies to gains recognized on 
transactions occurring after the date of enactment.
    The provision that expands look-through treatment, for 
foreign tax credit limitation purposes, of dividends from CFCs 
is effective for distributions after the date of enactment.
    The provision that provides for regulatory adjustments to 
U.S. shareholder inclusions, with respect to gains of CFCs from 
dispositions of stock in lower-tier CFCs is effective for 
determining inclusions for taxable years of U.S. shareholders 
beginning after December 31, 1997. Thus, the bill permits 
regulatory adjustments to an inclusion occurring after the 
effective date to account for income that was previously taxed 
under the subpart F provisions either prior to or subsequent to 
the effective date.
    Subpart F inclusions in year of acquisition.--The provision 
that permits dispositions of stock to be taken into 
consideration in determining a U.S. shareholder's subpart F 
inclusion for a taxable year is effective with respect to 
dispositions occurring after the date of enactment.
    Treatment of U.S. source income earned by a CFC.--The 
provision concerning the effect of treaty exemptions from, or 
reductions of, the branch profits tax on the determination of 
subpart F income is effective for taxable years beginning after 
December 31, 1986.
    Extension of indirect foreign tax credit.--The provision 
that extends application of the indirect foreign tax credit to 
certain CFCs below the third tier is effective for foreign 
taxes paid or incurred by CFCs for taxable years of such 
corporations beginning after the date of enactment.
    In the case of any chain of foreign corporations, the taxes 
of which would be eligible for the indirect foreign tax credit, 
under present law or under the bill, but for the denial of 
indirect credits below the third or sixth tier, as the case may 
be, no liquidation, reorganization, or similar transaction in a 
taxable year beginning after the date of enactment will have 
the effect of permitting taxes to be taken into account under 
the indirect foreign tax credit provisions of the Code which 
could not have been taken into account under those provisions 
but for such transaction.

2. Simplify formation and operation of international joint ventures 
        (secs. 921, 931-935, and 941 of the bill and secs. 367, 721, 
        1491-1494, 6031, 6038, 6038B, 6046A, and 6501 of the Code)

                              Present Law

    Under section 1491, an excise tax generally is imposed on 
transfers of property by a U.S. person to a foreign corporation 
as paid-in surplus or as a contribution to capital or to a 
foreign partnership, estate or trust. The tax is 35 percent of 
the amount of gain inherent in the property transferred but not 
recognized for income tax purposes at the time of the transfer. 
However, several exceptions to the section 1491 excise tax are 
available. Under section 1494(c), a substantial penalty applies 
in the case of a failure to report a transfer described in 
section 1491.
    Section 367 applies to require gain recognition upon 
certain transfers by U.S. persons to foreign corporations. 
Under section 367(d), a U.S. person that contributes intangible 
property to a foreign corporation is treated as having sold the 
property to the corporation and is treated as receiving deemed 
royalty payments from the corporation. These deemed royalty 
payments are treated as U.S. source income. A U.S. person may 
elect to apply similar rules to a transfer of intangible 
property to a foreign partnership that otherwise would be 
subject to the section 1491 excise tax.
    A foreign partnership may be required to file a partnership 
return. If a foreign partnership fails to file a required 
return, losses and credits with respect to the partnership may 
be disallowed to the partnership. A U.S. person that acquires 
or disposes of an interest in a foreign partnership, or whose 
proportional interest in the partnership changes substantially, 
may be required to file an information return with respect to 
such event.
    A partnership generally is considered to be a domestic 
partnership if it is created or organized in the United States 
or under the laws of the United States or any State. A foreign 
partnership generally is any partnership that is not a domestic 
partnership.

                           Reasons for Change

    The Committee understands that the present-law rules 
imposing an excise tax on certain transfers of appreciated 
property to a foreign entity unless the requirements for an 
exception from such excise tax are satisfied operate as a trap 
for the unwary. The Committee further understands that the 
special source rule of present law for deemed royalty payments 
with respect to a transfer of an appreciated intangible to a 
foreign corporation was intended to discourage such transfers. 
The Committee believes that the imposition of enhanced 
information reporting obligations with respect to both foreign 
partnerships and foreign corporations would eliminate the need 
for both of these sets of rules.

                        Explanation of Provision

    The bill repeals the sections 1491-1494 excise tax and 
information reporting rules that apply to certain transfers of 
appreciated property by a U.S. person to a foreign entity. 
Instead of the excise tax that applies under present law to 
transfers to a foreign estate or trust, gain recognition is 
required upon a transfer of appreciated property by a U.S. 
person to a foreign estate or trust. Instead of the excise tax 
that applies under present law to certain transfers to foreign 
corporations, regulatory authority is granted under section 367 
to deny nonrecognition treatment to such a transfer in a 
transaction that is not otherwise described in section 367. 
Instead of the excise tax that applies under present law to 
transfers to foreign partnerships, regulatory authority is 
granted to provide for gain recognition on a transfer of 
appreciated property to a partnership in cases where such gain 
otherwise would be transferred to a foreign partner. In 
addition, regulatory authority is granted to deny the 
nonrecognition treatment that is provided under section 1035 to 
certain exchanges of insurance policies, where the transfer is 
to a foreign person.
    The bill repeals the rule that treats as U.S. source income 
any deemed royalty arising under section 367(d). Under the 
bill, in the case of a transfer of intangible property to a 
foreign corporation, the deemed royalty payments under section 
367(d) are treated as foreign source income to the same extent 
that an actual royalty payment would be considered to be 
foreign source income. Regulatory authority is granted to 
provide similar treatment in the case of a transfer of 
intangible property to a foreign partnership.
    The bill provides detailed information reporting rules in 
the case of foreign partnerships. A foreign partnership 
generally is required to file a partnership return for a 
taxable year if the partnership has U.S. source income or is 
engaged in a U.S. trade or business, except to the extent 
provided in regulations.
    Under the bill, reporting rules similar to those applicable 
under present law in the case of controlled foreign 
corporations apply in the case of foreign partnerships. A U.S. 
partner that controls a foreign partnership is required to file 
an annual information return with respect to such partnership. 
For this purpose, a U.S. partner is considered to control a 
foreign partnership if the partner holds a more than 50 percent 
interest in the capital, profits, or, to the extent provided in 
regulations, losses, of the partnership. Similar information 
reporting also will be required from a U.S. 10-percent partner 
of a foreign partnership that is controlled by U.S. 10-percent 
partners. A $10,000 penalty applies to a failure to comply with 
these reporting requirements; additional penalties of up to 
$50,000 apply in the case of continued noncompliance after 
notification by the Secretary of the Treasury. Under the bill, 
the penalties for failure to report information with respect to 
a controlled foreign corporation are conformed with these 
penalties.
    Under the bill, reporting by a U.S. person of an 
acquisition or disposition of an interest in a foreign 
partnership, or a change in the person's proportional interest 
in the partnership, is required only in the case of 
acquisitions, dispositions, or changes involving at least a 10-
percent interest. A$10,000 penalty applies to a failure to 
comply with these reporting requirements; additional penalties of up to 
$50,000 apply in the case of continued noncompliance after notification 
by the Secretary. Under the bill, the penalties for failure to report 
information with respect to a foreign corporation are conformed with 
these penalties.
    Under the bill, reporting rules similar to those applicable 
under present law in the case of transfers by U.S. persons to 
foreign corporations apply in the case of transfers to foreign 
partnerships. These reporting rules apply in the case of a 
transfer to a foreign partnership only if the U.S. person holds 
at least a 10-percent interest in the partnership or the value 
of the property transferred by such person to the partnership 
during a 12-month period exceeded $100,000. A penalty equal to 
10 percent of the value of the property transferred applies to 
a failure to comply with these reporting requirements. Under 
the bill, the penalty under present law for failure to report 
transfers to a foreign corporation is conformed with this 
penalty. In the case of a transfer to a foreign partnership, 
failure to comply also results in gain recognition with respect 
to the property transferred.
    Under the bill, in the case of a failure to report required 
information with respect to a foreign corporation, partnership, 
or trust, the statute of limitations with respect to any event 
or period to which such information relates not expire before 
the date that is three years after the date on which such 
information is provided.
    Under the bill, regulatory authority is granted to provide 
rules treating a partnership as a domestic or foreign 
partnership, where such treatment is more appropriate, without 
regard to where the partnership is created or organized. It is 
expected that a recharterization of a partnership under such 
regulations will be based only on material factors such as the 
residence of the partners and the extent to which the 
partnership is engaged in business in the United States or 
earns U.S. source income. It also is expected that such 
regulations will provide guidance regarding the determination 
of whether an entity that is a partnership for Federal income 
tax purposes is to be considered to be created or organized in 
the United States or under the law of the United States or any 
State.

                             Effective Date

    The provisions with respect to the repeal of sections 1491-
1494 are effective upon date of enactment. The provisions with 
respect to the source of a deemed royalty under section 367(d) 
also are effective for transfers made and royalties deemed 
received after date of enactment.
    The provisions regarding information reporting with respect 
to foreign partnerships generally are effective for partnership 
taxable years beginning after date of enactment. The provisions 
regarding information reporting with respect to interests in, 
and transfers to, foreign partnerships are effective for 
transfers to, and changes in interest in, foreign partnerships 
after date of enactment. Taxpayers may elect to apply these 
rules to transfers made after August 20, 1996 (and thereby 
avoid a penalty under section 1494(c)) and the Secretary may 
prescribe simplified reporting requirements for these cases. 
The provision with respect to the statute of limitations in the 
case of noncompliance with reporting requirements is effective 
for information returns due after date of enactment.
    The provision granting regulatory authority with respect to 
the treatment of partnerships as foreign or domestic is 
effective for partnership taxable years beginning after date of 
enactment.

3. Modification of reporting threshold for stock ownership of a foreign 
        corporation (sec. 936 of the bill and sec. 6046 of the Code)

                              Present Law

    Several provisions of the Code require U.S. persons to 
report information with respect to a foreign corporation in 
which they are shareholders or officers or directors. Sections 
6038 and 6035 generally require every U.S. citizen or resident 
who is an officer, or director, or who owns at least 10 percent 
of the stock, of a foreign corporation that is a controlled 
foreign corporation or a foreign personal holding company to 
file Form 5471 annually.
    Section 6046 mandates the filing of information returns by 
certain U.S. persons with respect to a foreign corporation upon 
the occurrence of certain events. U.S. persons required to file 
these information returns are those who acquire 5 percent or 
more of the value of the stock of a foreign corporation, others 
who become U.S. persons while owning that percentage of the 
stock of a foreign corporation, and U.S. citizens and residents 
who are officers or directors of foreign corporations with such 
U.S. ownership.
    A failure to file the required information return under 
section 6038 may result in monetary penalties or reduction of 
foreign tax credit benefits. A failure to file the required 
information returns under sections 6035 or 6046 may result in 
monetary penalties.

                           Reasons for Change

    The Committee believes that it is appropriate to make the 
stock ownership threshold at which reporting with respect to an 
ownership interest in a foreign corporation is required 
generally parallel to the thresholds that apply in the case of 
other annual information reporting with respect to foreign 
corporations. The Committee believes that increasing the 
threshold for such reporting from 5 percent to 10 percent will 
reduce the compliance burdens on taxpayers.

                        Explanation of Provision

    The bill increases the threshold for stock ownership of a 
foreign corporation that results in information reporting 
obligations under section 6046 from 5 percent (based on value) 
to 10 percent (based on vote or value).

                             Effective Date

    The provision is effective for reportable transactions 
occurring after December 31, 1997.

4. Simplify translation of foreign taxes (sec. 902 of the bill and 
        secs. 905(c) and 986 of the Code)

                              Present Law

Translation of foreign taxes

    Foreign income taxes paid in foreign currencies are 
required to be translated into U.S. dollar amounts using the 
exchange rate as of the time such taxes are paid to the foreign 
country or U.S. possession. This rule applies to foreign taxes 
paid directly by U.S. taxpayers, which taxes are creditable in 
the year paid or accrued, and to foreign taxes paid by foreign 
corporations that are deemed paid by a U.S. corporation that is 
a shareholder of the foreign corporation, and hence creditable, 
in the year that the U.S. corporation receives a dividend or 
has an income inclusion from the foreign corporation.

Redetermination of foreign taxes

    For taxpayers that utilize the accrual basis of accounting 
for determining creditable foreign taxes, accrued and unpaid 
foreign tax liabilities denominated in foreign currencies are 
translated into U.S. dollar amounts at the exchange rate as of 
the last day of the taxable year of accrual. If a difference 
exists between the dollar value of accrued foreign taxes and 
the dollar value of those taxes when paid, a redetermination of 
foreign taxes arises. A foreign tax redetermination may occur 
in the case of a refund of foreign taxes. A foreign tax 
redetermination also may arise because the amount of foreign 
currency units actually paid differs from the amount of foreign 
currency units accrued. In addition, a redetermination may 
arise due to fluctuations in the value of the foreign currency 
relative to the dollar between the date of accrual and the date 
of payment.
    As a general matter, a redetermination of foreign tax paid 
or accrued directly by a U.S. person requires notification of 
the Internal Revenue Service and a redetermination of U.S. tax 
liability for the taxable year for which the foreign tax was 
claimed as a credit. The Treasury regulations provide 
exceptions to this rule for de minimis cases. In the case of a 
redetermination of foreign taxes that qualify for the indirect 
(or ``deemed-paid'') foreign tax credit under sections 902 and 
960, the Treasury regulations generally require taxpayers to 
make appropriate adjustments to the payor foreign corporation's 
pools of earnings and profits and foreign taxes.

                           Reasons for Change

    The Committee believes that the administrative burdens 
associated with the foreign tax credit can be reduced 
significantly by permitting foreign taxes to be translated 
using reasonably accurate average translation rates for the 
period in which the tax payments are made. This approach will 
reduce, sometimes substantially, the number of translation 
calculations that are required to be made. In addition, the 
Committee believes that taxpayers that are on the accrual basis 
of accounting for purposes of determining creditable foreign 
taxes should be permitted to translate those taxes into U.S. 
dollar amounts in the year to which those taxes relate, and 
should not be required to make adjustments or redetermination 
to those translated amounts, if actual tax payments are made 
within a reasonably short period of time after the close of 
such year. Moreover, the Committee believes that it is 
appropriate to use an average exchange rate for the taxable 
year with respect to which such foreign taxes relate for 
purposes of translating those taxes. On the other hand, the 
Committee believes that a foreign tax not paid within a 
reasonably short period after the close of the year to which 
the taxes relate should not be treated as a foreign tax for 
such year. By drawing a bright line between those foreign tax 
payment delays that do and do not require a redetermination, 
the Committee believes that a reasonable degree of certainty 
and clarity will be added to the law in this area.

                        Explanation of Provision

Translation of foreign taxes

            Translation of certain accrued foreign taxes
    With respect to taxpayers that take foreign income taxes 
into account when accrued, the bill generally provides for 
foreign taxes to be translated at the average exchange rate for 
the taxable year to which such taxes relate. This rule does not 
apply (1) to any foreign income tax paid after the date two 
years after the close of the taxable year to which such taxes 
relate, (2) with respect to taxes of an accrual-basis taxpayer 
that are actually paid in a taxable year prior to the year to 
which they relate, or (3) to tax payments that are denominated 
in an inflationary currency (as defined by regulations).
            Translation of all other foreign taxes
    Under the bill, foreign taxes not eligible for application 
of the preceding rule generally are translated into U.S. 
dollars using the exchange rates as of the time such taxes are 
paid. The bill provides the Secretary of the Treasury with 
authority to issue regulations that would allow foreign tax 
payments to be translated into U.S. dollar amounts using an 
average exchange rate for a specified period.

Redetermination of foreign taxes

    Under the bill, a redetermination is required if: (1) 
accrued taxes when paid differ from the amounts claimed as 
credits by the taxpayer, (2) accrued taxes are not paid before 
the date two years after the close of the taxable year to which 
such taxes relate, or (3) any tax paid is refunded in whole or 
in part. Thus, for example, the bill provides that if at the 
close of the second taxable year after the taxable year to 
which an accrued tax relates, any portion of the tax so accrued 
has not yet been paid, a foreign tax redetermination under 
section 905(c) is required for the amount representing the 
unpaid portion of that accrued tax. In other words, the 
previous accrual of any tax that is unpaid as of that date is 
denied. In cases where a redetermination is required, as under 
present law, the bill specifies that the taxpayer must notify 
the Secretary, who will redetermine the amount of the tax for 
the year or years affected. In the case of indirect foreign tax 
credits, regulatory authority is granted to prescribe 
appropriate adjustments to the foreign corporation's pool of 
post-1986 foreign income taxes in lieu of such a 
redetermination.
    The bill provides specific rules for the treatment of 
accrued taxes that are paid more than two years after the close 
of the taxable year to which such taxes relate. In the case of 
the direct foreign tax credit, any such taxes subsequently paid 
are taken into account for the taxable year to which such taxes 
relate, but would be translated into U.S. dollar amounts using 
the exchange ratesin effect as of the time such taxes are paid. 
In the case of the indirect foreign tax credit, any such taxes 
subsequently paid are taken into account for the taxable year in which 
paid, and would be translated into U.S. dollar amounts using the 
exchange rates as of the time such taxes are paid.
    For example, assume that in year 1 a taxpayer accrues 1,000 
units of foreign tax that relate to year 1 and that give rise 
to a foreign tax credit under section 901 and assume that the 
currency involved is not inflationary . Further assume that as 
of the end of year 1 the tax is unpaid. In this case, the bill 
provides that the taxpayer translates 1,000 units of accrued 
foreign tax into U.S. dollars at the average exchange rate for 
year 1. If the 1,000 units of tax are paid by the taxpayer in 
either year 2 or year 3, no redetermination of foreign tax is 
required. If any portion of the tax so accrued remains unpaid 
as of the end of year 3, however, the taxpayer is required to 
redetermine its foreign tax accrued in year 1 to eliminate the 
accrued but unpaid tax, thereby reducing its foreign tax credit 
for such year. If the taxpayer pays the disallowed taxes in 
year 4, the taxpayer again redetermines its foreign taxes (and 
foreign tax credit) for year 1, but the taxes paid in year 4 
are translated into U.S. dollars at the exchange rate for year 
4.

                             Effective Date

    The provision generally is effective for foreign taxes paid 
(in the case of taxpayers using the cash basis for determining 
the foreign tax credit) or accrued (in the case of taxpayers 
using the accrual basis for determining the foreign tax credit) 
in taxable years beginning after December 31, 1997. The 
provision's changes to the foreign tax redetermination rules 
apply to foreign taxes which relate to taxable years beginning 
after December 31, 1997.

5. Election to use simplified foreign tax credit limitation for 
        alternative minimum tax purposes (sec. 903 of the bill and sec. 
        59 of the Code)

                              Present Law

    Computing foreign tax credit limitations requires the 
allocation and apportionment of deductions between items of 
foreign source income and items of U.S. source income. Foreign 
tax credit limitations must be computed both for regular tax 
purposes and for purposes of the alternative minimum tax (AMT). 
Consequently, the allocation and apportionment of deductions 
must be done separately for regular tax foreign tax credit 
limitation purposes and AMT foreign tax credit limitation 
purposes.

                           Reasons for Change

    The process of allocating and apportioning deductions for 
purposes of calculating the regular and AMT foreign tax credit 
limitations can be complex. Taxpayers that have allocated and 
apportioned deductions for regular tax purposes generally must 
reallocate and reapportion the same deductions for AMT foreign 
tax credit purposes, based on assets and income that reflect 
AMT adjustments (including depreciation). However, the 
differences between regular taxable income and alternative 
minimum taxable income often are relevant primarily to U.S. 
source income. The Committee believes that permitting taxpayers 
to use foreign source regular taxable income in computing their 
AMT foreign tax credit limitation would provide an appropriate 
simplification of the necessary computations by eliminating the 
need to reallocate and reapportion every deduction.

                        Explanation of Provision

    The provision permits taxpayers to elect to use as their 
AMT foreign tax credit limitation fraction the ratio of foreign 
source regular taxable income to entire alternative minimum 
taxable income, rather than the ratio of foreign source 
alternative minimum taxable income to entire alternative 
minimum taxable income. Under this election, foreign source 
regular taxable income is used, however, only to the extent it 
does not exceed entire alternative minimum taxable income. In 
the event that foreign source regular taxable income does 
exceed entire alternative minimum taxable income, and the 
taxpayer has income in more than one foreign tax credit 
limitation category, the Committee intends that the foreign 
source taxable income in each such category generally would be 
reduced by a pro rata portion of that excess.
    The election is available only in the first taxable year 
beginning after December 31, 1997 for which the taxpayer claims 
an AMT foreign tax credit. The Committee intends that a 
taxpayer will be treated, for this purpose, as claiming an AMT 
foreign tax credit for any taxable year for which the taxpayer 
chooses to have the benefits of the foreign tax credit and in 
which the taxpayer is subject to the alternative minimum tax or 
would be subject to the alternative minimum tax but for the 
availability of the AMT foreign tax credit. The election, once 
made, will apply to all subsequent taxable years, and may be 
revoked only with the consent of the Secretary of the Treasury.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 1997.

6. Simplify stock and securities trading safe harbor (sec. 952 of the 
        bill and sec. 864(b)(2)(A) of the Code)

                              Present Law

    A nonresident alien individual or foreign corporation that 
is engaged in a trade or business within the United States is 
subject to U.S. taxation on its net income that is effectively 
connected with the trade or business, at graduated rates of 
tax. Under a ``safe harbor'' rule, foreign persons that trade 
in stocks or securities for their own accounts are not treated 
as engaged in a U.S. trade or business for this purpose.
    For a foreign corporation to qualify for the safe harbor, 
it must not be a dealer in stock or securities. In addition, if 
the principal business of the foreign corporation is trading in 
stock or securities for its own account, the safe harbor 
generally does not apply if the principal office of the 
corporation is in the United States.
    For foreign persons who invest in securities trading 
partnerships, the safe harbor applies only if the partnership 
is not a dealer in stock and securities. In addition, if the 
principal businessof the partnership is trading stock or 
securities for its own account, the safe harbor generally does not 
apply if the principal office of the partnership is in the United 
States.
    Under Treasury regulations which apply to both corporations 
and partnerships, the determination of the location of the 
entity's principal office turns on the location of various 
functions relating to operation of the entity, including 
communication with investors and the general public, 
solicitation and acceptance of sales of interests, and 
maintenance and audits of its books of account (Treas. reg. 
sec. 1.864-2(c)(2)(ii) and (iii)). Under the regulations, the 
location of the entity's principal office does not depend on 
the location of the entity's management or where investment 
decisions are made.

                           Reasons for Change

    The foreign principal office requirement does not promote 
any important tax policy and has been easily circumvented. The 
stock and securities trading safe harbor serves to promote 
foreign investment in U.S. capital markets. The Committee 
believes that the elimination of the principal office rule 
would facilitate foreign investment in U.S. markets. Because 
the location of a partnership's or foreign corporation's 
principal office is determined by the location of certain 
administrative functions rather than the location of management 
and investment decisions, the requirement of a foreign 
principal office is met even if only administrative functions 
are performed abroad.

                        Explanation of Provision

    The bill modifies the stock and securities trading safe 
harbor by eliminating the requirement for both partnerships and 
foreign corporations that trade stock or securities for their 
own accounts that the entity's principal office not be within 
the United States.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

7. Simplify foreign tax credit limitation for individuals (sec. 901 of 
        the bill and sec. 904 of the Code)

                              Present Law

    In order to compute the foreign tax credit, a taxpayer 
computes foreign source taxable income and foreign taxes paid 
in each of the applicable separate foreign tax credit 
limitation categories. In the case of an individual, this 
requires the filing of IRS Form 1116.
     In many cases, individual taxpayers who are eligible to 
credit foreign taxes may have only a modest amount of foreign 
source gross income, all of which is income from investments. 
Taxable income of this type ordinarily is includible in the 
single foreign tax credit limitation category for passive 
income. However, under certain circumstances, the Code treats 
investment-type income (e.g., dividends and interest) as income 
in one of several other separate limitation categories (e.g., 
high withholding tax interest income or general limitation 
income). For this reason, any taxpayer with foreign source 
gross income is required to provide sufficient detail on Form 
1116 to ensure that foreign source taxable income from 
investments, as well as all other foreign source taxable 
income, is allocated to the correct limitation category.

                           Reasons for Change

    The Committee believes that a significant number of 
individuals are entitled to credit relatively small amounts of 
foreign tax imposed at modest effective tax rates on foreign 
source investment income. For taxpayers in this class, the 
applicable foreign tax credit limitations typically exceed the 
amounts of taxes paid. Therefore, exempting these taxpayers 
from the foreign tax credit limitation rules significantly 
reduces the complexity of the tax law without significantly 
altering actual tax liabilities. At the same time, however, the 
Committee believes that this exemption should be limited to 
those cases where the taxpayer receives a payee statement 
showing the amount of the foreign source income and the foreign 
tax.

                        Explanation of Provision

    The bill allows individuals with no more than $300 ($600 in 
the case of married persons filing jointly) of creditable 
foreign taxes, and no foreign source income other than passive 
income, an exemption from the foreign tax credit limitation 
rules. (The Committee intends that an individual electing this 
exemption will not be required to file Form 1116 in order to 
obtain the benefit of the foreign tax credit.) An individual 
making this election is not entitled to any carryover of excess 
foreign taxes to or from a taxable year to which the election 
applies.
    For purposes of this election, passive income generally is 
defined to include all types of income that is foreign personal 
holding company income under the subpart F rules, plus income 
inclusions from foreign personal holding companies and passive 
foreign investment companies, provided that the income is shown 
on a payee statement furnished to the individual. For purposes 
of this election, creditable foreign taxes include only foreign 
taxes that are shown on a payee statement furnished to the 
individual.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 1997.

8. Simplify treatment of personal transactions in foreign currency 
        (sec. 904 of the bill and sec. 988 of the Code)

                              Present Law

    When a U.S. taxpayer makes a payment in a foreign currency, 
gain or loss (referred to as ``exchange gain or loss'') 
generally arises from any change in the value of the foreign 
currency relative to the U.S. dollar between the time the 
currency was acquired (or the obligation to pay was incurred) 
and the time that the payment is made. Gain or loss results 
because foreign currency, unlike the U.S. dollar, is treated as 
property for Federal income tax purposes.
    Exchange gain or loss can arise in the course of a trade or 
business or in connection with an investment transaction. 
Exchange gain or loss also can arise where foreign currency was 
acquired for personal use. For example, the IRS has ruled that 
a taxpayer who converts U.S. dollars to a foreign currency for 
personal use while traveling abroad realizes exchange gain or 
loss on reconversion of appreciated or depreciated foreign 
currency (Rev. Rul. 74-7, 1974-1 C.B. 198).
    Prior to the Tax Reform Act of 1986 (``1986 Act''), most of 
the rules for determining the Federal income tax consequences 
of foreign currency transactions were embodied in a series of 
court cases and revenue rulings issued by the IRS. Additional 
rules of limited application were provided by Treasury 
regulations. Pre-1986 law was believed to be unclear regarding 
the character, the timing of recognition, and the source of 
gain or loss due to fluctuations in the exchange rate of 
foreign currency. The 1986 Act provided a comprehensive set of 
rules for the U.S. tax treatment of transactions involving 
foreign currencies.
    However, the 1986 Act provisions designed to clarify the 
treatment of currency transactions, primarily found in section 
988 of the Code, apply to transactions entered into by an 
individual only to the extent that expenses attributable to 
such transactions are deductible under section 162 (as a trade 
or business expense) or section 212 (as an expense of producing 
income). Therefore, the principles of pre-1986 law continue to 
apply to personal currency transactions.

                           Reasons for Change

    An individual who lives or travels abroad generally cannot 
use U.S. dollars to make all of the purchases incident to daily 
life. If an individual must treat foreign currency in this 
instance as property giving rise to U.S.-dollar income or loss 
every time the individual, in effect, ``barters'' the foreign 
currency for goods or services, the U.S. individual living in 
or visiting a foreign country will have a significant 
administrative burden that may bear little or no relation to 
whether U.S.-dollar measured income has increased or decreased. 
The Committee believes that individuals should be given relief 
from the requirement to keep track of exchange gains on a 
transaction-by-transaction basis in de minimis cases.

                        Explanation of Provision

    If an individual acquires foreign currency and disposes of 
it in a personal transaction and the exchange rate changes 
between the acquisition and disposition of such currency, the 
provision applies nonrecognition treatment to any resulting 
exchange gain, provided that such gain does not exceed $200. 
The provision does not change the treatment of resulting 
exchange losses. The Committee understands that under other 
Code provisions such losses typically are not deductible by 
individuals (e.g., sec. 165(c)).

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 1997.

9. Transition rule for certain trusts (sec. 951 of the bill and sec. 
        7701(a)(30) of the Code)

                              Present Law

    Under rules enacted with the Small Business Job Protection 
Act of 1996, a trust is considered to be a U.S. trust if two 
criteria are met. First, a court within the United States must 
be able to exercise primary supervision over the administration 
of the trust. Second, U.S. fiduciaries of the trust must have 
the authority to control all substantial decisions of the 
trust. A trust that does not satisfy both of these criteria is 
considered to be a foreign trust. These rules for defining a 
U.S. trust generally are effective for taxable years of a trust 
that begin after December 31, 1996. A trust that qualified as a 
U.S. trust under prior law could fail to qualify as a U.S. 
trust under these new criteria.

                           Reasons for Change

    The change in the criteria for qualification as a U.S. 
trust could cause large numbers of existing domestic trusts to 
become foreign trusts, unless they are able to make the 
modifications necessary to satisfy the new criteria. The 
Committee believes that an election is appropriate for those 
existing domestic trusts that prefer to continue to be subject 
to tax as U.S. trusts.

                        Explanation of Provision

    Under the bill, the Secretary of the Treasury is granted 
authority to allow nongrantor trusts that had been treated as 
U.S. trusts under prior law to elect to continue to be treated 
as U.S. trusts, notwithstanding the new criteria for 
qualification as a U.S. trust.

                             Effective Date

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

10. Clarification of determination of foreign taxes deemed paid (sec. 
        953(a) of the bill and sec. 902 of the Code)

                              Present Law

    Under section 902, a domestic corporation that receives a 
dividend from a foreign corporation in which it owns 10 percent 
or more of the voting stock is deemed to have paid a portion of 
the foreign taxes paid by such foreign corporation. The 
domestic corporation that receives a dividend is deemed to have 
paid a portion of the foreign corporation's post-1986 foreign 
income taxes based on the ratio of the amount of such dividend 
to the foreign corporation's post-1986 undistributed earnings. 
The foreign corporation's post-1986 foreign income taxes is the 
sum of the foreign income taxes with respect to the taxable 
year in which the dividend is distributed plus certain foreign 
income taxes with respect to prior taxable years (beginning 
after December 31, 1986).

                           Reasons for Change

    The Committee believes that it is appropriate to clarify 
the determination of foreign taxes deemed paid for purposes of 
the indirect foreign tax credit.

                        Explanation of Provision

    The bill clarifies that, for purposes of the deemed paid 
credit under section 902 for a taxable year, a foreign 
corporation's post-1986 foreign income taxes includes foreign 
income taxes with respect to prior taxable years (beginning 
after December 31, 1986) only to the extent such taxes are not 
attributable to dividends distributed by the foreign 
corporation in prior taxable years. No inference is intended 
regarding the determination of foreign taxes deemed paid under 
present law.

                             Effective Date

    The provision is effective on date of enactment.

11. Clarification of foreign tax credit limitation for financial 
        services income (sec. 953(b) of the bill and sec. 904 of the 
        Code)

                              Present Law

    Under section 904, separate foreign tax credit limitations 
apply to various categories of income. Two of these separate 
limitation categories are passive income and financial services 
income. For purposes of the separate foreign tax credit 
limitation applicable to passive income, certain income that is 
treated as high-taxed income is excluded from the definition of 
passive income. For purposes of the separate foreign tax credit 
limitation applicable to financial services income, the 
definition of financial services income generally incorporates 
passive income as defined for purposes of the separate 
limitation applicable to passive income.

                           Reasons for Change

    The Committee believes that it is appropriate to clarify 
that high-taxed income is not excluded from the separate 
foreign tax credit limitation for financial services income.

                        Explanation of Provision

    The bill clarifies that the exclusion of income that is 
treated as high-taxed income does not apply for purposes of the 
separate foreign tax credit limitation applicable to financial 
services income. No inference is intended regarding the 
treatment of high-taxed income for purposes of the separate 
foreign tax credit limitation applicable to financial services 
income under present law.

                             Effective Date

    The provision is effective on date of enactment.
    TITLE X. SIMPLIFICATION PROVISIONS RELATING TO INDIVIDUALS AND 
                               BUSINESSES

                 A. Provisions Relating to Individuals

1. Modifications to standard deduction of dependents; AMT treatment of 
        certain minor children (sec. 1001 of the bill and secs. 59(j) 
        and 63(c)(5) of the Code)

                              Present Law

    Standard deduction of dependents.--The standard deduction 
of a taxpayer for whom a dependency exemption is allowed on 
another taxpayer's return can not exceed the lesser of (1) the 
standard deduction for an individual taxpayer (projected to be 
$4,250 for 1998) or (2) the greater of $500 (indexed) 
121 or the dependent's earned income (sec. 
63(c)(5)).
---------------------------------------------------------------------------
    \121\ The indexed amount is projected to be $700 for 1998.
---------------------------------------------------------------------------
    Taxation of unearned income of children under age 14.--The 
tax on a portion of the unearned income (e.g., interest and 
dividends) of a child under age 14 is the additional tax that 
the child's custodial parent would pay if the child's unearned 
income were included in that parent's income. The portion of 
the child's unearned income which is taxed at the parent's top 
marginal rate is the amount by which the child's unearned 
income is more than the sum of (1) $500 122 
(indexed) plus (2) the greater of (a) $500 123 
(indexed) or (b) the child's itemized deductions directly 
connected with the production of the unearned income (sec. 
1(g)).
---------------------------------------------------------------------------
    \122\ Projected to be $700 for 1998.
    \123\ Projected to be $700 for 1998.
---------------------------------------------------------------------------
    Alternative minimum tax (``AMT'') exemption for children 
under age 14.--Single taxpayers are entitled to an exemption 
from the alternative minimum tax (``AMT'') of $33,750. However, 
in the case of a child under age 14, his exemption from the 
AMT, in substance, is the unused alternative minimum tax 
exemption of the child's custodial parent, limited to sum of 
earned income and $1,400 (sec. 59(j)).

                           Reasons for Change

    The committee believes that significant simplification of 
the existing income tax system can be achieved by providing 
larger exemptions such that taxpayers with incomes less than 
the exemption are not required to compute and pay any tax. The 
committee particularly believes that the present-law exemptions 
of dependent children are too small.

                        Explanation of Provision

    Standard deduction of dependents.--The bill increases the 
standard deduction for a taxpayer with respect to whom a 
dependency exemption is allowed on another taxpayer's return to 
the lesser of (1) the standard deduction for individual 
taxpayers or (2) the greater of: (a) $500 124 
(indexed for inflation as under present law), or (b) the 
individual's earned income plus $250. The $250 amount is 
indexed for inflation after 1998.
---------------------------------------------------------------------------
    \124\ Projected to be $700 for 1998.
---------------------------------------------------------------------------
    Alternative minimum tax exemption for children under age 
14.--The bill increases the AMT exemption amount for a child 
under age 14 to the lesser of (1) $33,750 or (2) the sum of the 
child's earned income plus $5,000. The $5,000 amount is indexed 
for inflation after 1998.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

2. Increase de minimis threshold for estimated tax to $1,000 for 
        individuals (sec. 1002 of the bill 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 (sec. 6654). An 
individual generally does not have an underpayment of estimated 
tax if he or she makes timely estimated tax payments at least 
equal to: (1) 100 percent of the tax shown on the return of the 
individual for the preceding year (the ``100 percent of last 
year's liability safe harbor'') or (2) 90 percent of the tax 
shown on the return for the current year. The 100 percent of 
last year's liability safe harbor is modified to be a 110 
percent of last year's liability safe harbor for any individual 
with an AGI of more than $150,000 as shown on the return for 
the preceding taxable year. Income tax withholding from wages 
is considered to be a payment of estimated taxes. In general, 
payment of estimated taxes must be made quarterly. The addition 
to tax is not imposed where the total tax liability for the 
year, reduced by any withheld tax and estimated tax payments, 
is less than $500.

                           Reasons for Change

    Raising the individual estimated tax de minimis threshold 
will simplify the tax laws for a number of taxpayers.

                        Explanation of Provision

    The bill increases the $500 individual estimated tax de 
minimis threshold to $1,000.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

3. Treatment of certain reimbursed expenses of rural letter carriers' 
        vehicles (sec. 1003 of the bill and sec. 162 of the Code)

                              Present Law

    A taxpayer who uses his or her automobile for business 
purposes may deduct the business portion of the actual 
operation and maintenance expenses of the vehicle, plus 
depreciation (subject to the limitations of sec. 280F). 
Alternatively, the taxpayer may elect to utilize a standard 
mileage rate in computing the deduction allowable for business 
use of an automobile that has not been fully depreciated. Under 
this election, the taxpayer's deduction equals the applicable 
rate multiplied by the number of miles driven for business 
purposes and is taken in lieu of deductions for depreciation 
and actual operation and maintenance expenses.
    An employee of the U.S. Postal Service may compute his 
deduction for business use of an automobile in performing 
services involving the collection and delivery of mail on a 
rural route by using, for all business use mileage, 150 percent 
of the standard mileage rate.
    Rural letter carriers are paid an equipment maintenance 
allowance (EMA) to compensate them for the use of their 
personal automobiles in delivering the mail. The tax 
consequences of the EMA are determined by comparing it with the 
automobile expense deductions that each carrier is allowed to 
claim (using either the actual expenses method or the 150 
percent of the standard mileage rate). If the EMA exceeds the 
allowable automobile expense deductions, the excess generally 
is subject to tax. If the EMA falls short of the allowable 
automobile expense deductions, a deduction is allowed only to 
the extent that the sum of this shortfall and all other 
miscellaneous itemized deductions exceeds two percent of the 
taxpayer's adjusted gross income.

                           Reasons for Change

    The filing of tax returns by rural letter carriers can be 
complex. Under present law, those who are reimbursed at more 
than the 150 percent rate must report their reimbursement as 
income and deduct their expenses as miscellaneous itemized 
deductions (subject to the two-percent floor). Permitting the 
income and expenses to wash, so that neither will have to be 
reported on the rural letter carrier's tax return, will 
simplify these tax returns.

                        Explanation of Provision

    The bill repeals the special rate for Postal Service 
employees of 150 percent of the standard mileage rate. In its 
place, the bill requires that the rate of reimbursement 
provided by the Postal Service to rural letter carriers be 
considered to be equivalent to their expenses. The rate of 
reimbursement that is considered to be equivalent to their 
expenses is the rate of reimbursement contained in the 1991 
collective bargaining agreement, which may be increased by no 
more than the rate of inflation.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

4. Travel expenses of Federal employees participating in a Federal 
        criminal investigation (sec. 1004 of the bill and sec. 162 of 
        the Code)

                              Present Law

    Unreimbursed ordinary and necessary travel expenses paid or 
incurred by an individual in connection with temporary 
employment away from home (e.g., transportation costs and the 
cost of meals and lodging) are generally deductible, subject to 
the two-percent floor on miscellaneous itemized deductions. 
Travel expenses paid or incurred in connection with indefinite 
employment away from home, however, are not deductible. A 
taxpayer's employment away from home in a single location is 
indefinite rather than temporary if it lasts for one year or 
more; thus, no deduction is permitted for travel expenses paid 
or incurred in connection with such employment (sec. 162(a)). 
If a taxpayer's employment away from home in a single location 
lasts for less than one year, whether such employment is 
temporary or indefinite is determined on the basis of the facts 
and circumstances.

                           Reasons for Change

    The Committee believes that it would be inappropriate if 
this provision in the tax laws were to be a hindrance to the 
investigation of a Federal crime.

                        Explanation of Provision

    The one-year limitation with respect to deductibility of 
expenses while temporarily away from home does not include any 
period during which a Federal employee is certified by the 
Attorney General (or the Attorney General's designee) as 
traveling on behalf of the Federal Government in a temporary 
duty status to investigate or provide support services to the 
investigation of a Federal crime. Thus, expenses for these 
individuals during these periods are fully deductible, 
regardless of the length of the period for which certification 
is given (provided that the other requirements for 
deductibility are satisfied).

                             Effective Date

    The provision is effective for amounts paid or incurred 
with respect to taxable years ending after the date of 
enactment.

             B. Provisions Relating to Businesses Generally

1. Modifications to look-back method for long-term contracts (sec. 1011 
        of the bill and secs. 460 and 167(g) of the Code)

                              Present Law

    Taxpayers engaged in the production of property under a 
long-term contract generally must compute income from the 
contract under the percentage of completion method. Under the 
percentage of completion method, a taxpayer must include in 
gross income for any taxable year an amount that is based on 
the product of (1) the gross contract price and (2) the 
percentage of the contract completed as of the end of the year. 
The percentage of the contract completed as of the end of the 
year is determined by comparing costs incurred with respect to 
the contract as of the end of the year with estimated total 
contract costs.
    Because the percentage of completion method relies upon 
estimated, rather than actual, contract price and costs to 
determine gross income for any taxable year, a ``look-back 
method'' is applied in the year a contract is completed in 
order to compensate the taxpayer (or the Internal Revenue 
Service) for the acceleration (or deferral) of taxes paid over 
the contract term. The first step of the look-back method is to 
reapply the percentage of completion method using actual 
contract price and costs rather than estimated contract price 
and costs. The second step generally requires the taxpayer to 
recompute its tax liability for each year of the contract using 
gross income as reallocated under the look-back method. If 
there is any difference between the recomputed tax liability 
and the tax liability as previously determined for a year, such 
difference is treated as a hypothetical underpayment or 
overpayment of tax to which the taxpayer applies a rate of 
interest equal to the overpayment rate, compounded daily.\125\ 
The taxpayer receives (or pays) interest if the net amount of 
interest applicable to hypothetical overpayments exceeds (or is 
less than) the amount of interest applicable to hypothetical 
underpayments.
---------------------------------------------------------------------------
    \125\ The overpayment rate equals the applicable Federal short-term 
rate plus two percentage points. This rate is adjusted quarterly by the 
IRS. Thus, in applying the look-back method for a contract year, a 
taxpayer may be required to use the different interests rates.
---------------------------------------------------------------------------
    The look-back method must be reapplied for any item of 
income or cost that is properly taken into account after the 
completion of the contract.
    The look-back method does not apply to any contract that is 
completed within two taxable years of the contract commencement 
date and if the gross contract price does not exceed the lesser 
of (1) $1 million or (2) one percent of the average gross 
receipts of the taxpayer for the preceding three taxable years. 
In addition, a simplified look-back method is available to 
certain pass-through entities and, pursuant to Treasury 
regulations, to certain other taxpayers. Under the simplified 
look-back method, the hypothetical underpayment or overpayment 
of tax for a contract year generally is determined by applying 
the highest rate of tax applicable to such taxpayer to the 
change in gross income as recomputed under the look-back 
method.

                           Reasons for Change

    Present law may require multiple applications of the look-
back method with respect to a single contract or may otherwise 
subject contracts to the look-back method even though amounts 
necessitating the look-back calculations are de minimis 
relative to the aggregate contract income. In addition, the use 
of multiple interest rates complicates the mechanics of the 
look-back calculation. The committee wishes to address these 
concerns.

                        Explanation of Provision

Election not to apply the look-back method for de minimis amounts

    The provision provides that a taxpayer may elect not to 
apply the look-back method with respect to a long-term contract 
if for each prior contract year, the cumulative taxable income 
(or loss) under the contract as determined using estimated 
contract price and costs is within 10 percent of the cumulative 
taxable income (or loss) as determined using actual contract 
price and costs.
    Thus, under the election, upon completion of a long-term 
contract, a taxpayer would be required to apply the first step 
of the look-back method (the reallocation of gross income using 
actual, rather than estimated, contract price and costs), but 
is not required to apply the additional steps of the look-back 
method if the application of the first step resulted in de 
minimis changes to the amount of income previously taken into 
account for each prior contract year.
    The election applies to all long-term contracts completed 
during the taxable year for which the election is made and to 
all long-term contracts completed during subsequent taxable 
years, unless the election is revoked with the consent of the 
Secretary of the Treasury.
    Example 1.--A taxpayer enters into a three-year contract 
and upon completion of the contract, determines that annual net 
income under the contract using actual contract price and costs 
is $100,000, $150,000, and $250,000, respectively, for Years 1, 
2, and 3 under the percentage of completion method. An electing 
taxpayer need not apply the look-back method to the contract if 
it had reported cumulative net taxable income under the 
contract using estimated contract price and costs of between 
$90,000 and $110,000 as of the end of Year 1; and between 
$225,000 and $275,000 as of the end of Year 2.

Election not to reapply the look-back method

    The provision provides that a taxpayer may elect not to 
reapply the look-back method with respect to a contract if, as 
of the close of any taxable year after the year the contract is 
completed, the cumulative taxable income (or loss) under the 
contract is within 10 percent of the cumulative look-back 
income (or loss) as of the close of the most recent year in 
which the look-back method was applied (or would have applied 
but for the other de minimis exception described above). In 
applying this rule, amounts that are taken into account after 
completion of the contract are not discounted.
    Thus, an electing taxpayer need not apply or reapply the 
look-back method if amounts that are taken into account after 
the completion of the contract are de minimis.
    The election applies to all long-term contracts completed 
during the taxable year for which the election is made and to 
all long-term contracts completed during subsequent taxable 
years, unless the election is revoked with the consent of the 
Secretary of the Treasury.
    Example 2.--A taxpayer enters into a three-year contract 
and reports taxable income of $12,250, $15,000 and $12,750, 
respectively, for Years 1 through 3 with respect to the 
contract. Upon completion of the contract, cumulative look-back 
income with respect to the contract is $40,000, and 10 percent 
of such amount is $4,000. After the completion of the contract, 
the taxpayer incurs additional costs of $2,500 in each of the 
next three succeeding years (Years 4, 5, and 6) with respect to 
the contract. Under the provision, an electing taxpayer does 
not reapply the look-back method for Year 4 because the 
cumulative amount of contract taxable income ($37,500) is 
within 10 percent of contract look-back income as of the 
completion of the contract ($40,000). However, the look-back 
method must be applied for Year 5 because the cumulative amount 
of contract taxable income ($35,000) is not within 10 percent 
of contract look-back income as of the completion of the 
contract ($40,000). Finally, the taxpayer does not reapply the 
look-back method for Year 6 because the cumulative amount of 
contract taxable income ($32,500) is within 10 percent of 
contract look-back income as of the last application of the 
look-back method ($35,000).

Interest rates used for purposes of the look-back method

    The provision provides that for purposes of the look-back 
method, only one rate of interest is to apply for each accrual 
period. An accrual period with respect to a taxable year begins 
on the day after the return due date (determined without regard 
to extensions) for the taxable year and ends on such return due 
date for the following taxable year. The applicable rate of 
interest is the overpayment rate in effect for the calendar 
quarter in which the accrual period begins.

                             Effective Date

    The provision applies to contracts completed in taxable 
years ending after the date of enactment. The change in the 
interest rate calculation also applies for purposes of the 
look-back method applicable to the income forecast method of 
depreciation for property placed in service after September 13, 
1995.

2. Minimum tax treatment of certain property and casualty insurance 
        companies (sec. 1012 of the bill and sec. 56(g)(4)(B) of the 
        Code)

                              Present Law

    Present law provides that certain property and casualty 
insurance companies may elect to be taxed only on taxable 
investment income for regular tax purposes (sec. 831(b)). 
Eligible property and casualty insurance companies are those 
whose net written premiums (or if greater, direct written 
premiums) for the taxable year exceed $350,000 but do not 
exceed $1,200,000.
    Under present law, all corporations including insurance 
companies are subject to an alternative minimum tax. 
Alternative minimum taxable income is increased by 75 percent 
of the excess of adjusted current earnings over alternative 
minimum taxable income (determined without regard to this 
adjustment and without regard to net operating losses).

                           Reasons for Change

    The Committee believes that property and casualty companies 
small enough to be eligible to simplify their regular tax 
computation by electing to be taxed only on taxable investment 
income should be accorded comparable simplicity in the 
calculation of their alternative minimum tax. Under present 
law, the simplicity under the regular tax is nullified because 
electing companies must calculate underwriting income for tax 
purposes under the alternative minimum tax. The provision thus 
simplifies the entire Federal income tax calculation for a 
group of small taxpayers whom Congress has previously 
determined merit a simpler tax calculation.

                        Explanation of Provision

    The provision provides that a property and casualty 
insurance company that elects for regular tax purposes to be 
taxed only on taxable investment income determines its adjusted 
current earnings under the alternative minimum tax without 
regard to any amount not taken into account in determining its 
gross investment income under section 834(b). Thus, adjusted 
current earnings of an electing company is determined without 
regard to underwriting income (or underwriting expense, as 
provided in sec. 56(g)(4)(B)(i)(II)).

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

3. Shrinkage for inventory accounting (sec. 1013 of the bill and sec. 
        471 of the Code)

                              Present Law

    Section 471(a) provides that ``(w)henever in the opinion of 
the Secretary the use of inventories is necessary in order 
clearly to determine the income of any taxpayer, inventories 
shall be taken by such taxpayer on such basis as the Secretary 
may prescribe as conforming as nearly as may be to the best 
accounting practice in the trade or business and as most 
clearly reflecting income.'' Where a taxpayer maintains book 
inventories in accordance with a sound accounting system, the 
net value of the inventory will be deemed to be the cost basis 
of the inventory, provided that such book inventories are 
verified by physical inventories at reasonable intervals and 
adjusted to conform therewith.\126\ The physical count is used 
to determine and adjust for certain items, such as undetected 
theft, breakage, and bookkeeping errors, collectively referred 
to as ``shrinkage.''
---------------------------------------------------------------------------
    \126\ Treas. reg. sec. 1.471-2(d).
---------------------------------------------------------------------------
    Some taxpayers verify and adjust their book inventories by 
a physical count taken on the last day of the taxable year. 
Other taxpayers may verify and adjust their inventories by 
physical counts taken at other times during the year. Still 
other taxpayers take physical counts at different locations at 
different times during the taxable year (cycle counting).
    If a physical inventory is taken at year-end, the amount of 
shrinkage for the year is known. If a physical inventory is not 
taken at year-end, shrinkage through year-end will have to be 
based on an estimate, or not taken into account until the 
following year. In the first decision in Dayton Hudson v. 
Commissioner,\127\ the U.S. Tax Court held that a taxpayer's 
method of accounting may include the use of an estimate of 
shrinkage occurring through year-end, provided the method is 
sound and clearly reflects income. In the second decision in 
Dayton Hudson v. Commissioner,\128\ the U.S. Tax Court adhered 
to this holding. However, the U.S. Tax Court in the second 
decision determined that this taxpayer had not established that 
its method of accounting clearly reflected income. Other cases 
decided by the U.S. Tax Court \129\ have held that taxpayers' 
methods of accounting that included shrinkage estimates do 
clearly reflect income.
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    \127\ 101 T.C. 462 (1993).
    \128\ T.C. Memo (filed June 11, 1997).
    \129\ Wal-Mart v. Commissioner, T.C. Memo 1997-1 and Kroger v. 
Commissioner, T.C. Memo 1997-2.
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    The U.S. Tax Court in the second Dayton Hudson opinion 
noted that ``(I)n most cases, generally accepted accounting 
principles (GAAP), consistently applied, will pass muster for 
tax purposes. The Supreme Court has made clear, however, that 
GAAP does not enjoy a presumption of accuracy that must be 
rebutted by the Commissioner.''

                           Reasons for Change

    The Committee believes that inventories should be kept in a 
manner that clearly reflects income. The Committee also 
believes that it is inappropriate to require a physical count 
of a taxpayer's entire inventory to be taken exactly at year-
end, provided that physical counts are taken on a regular and 
consistent basis. Where physical inventories are not taken at 
year-end, the Committee believes that income will be more 
clearly reflected if the taxpayer makes a reasonable estimate 
of the shrinkage occurring through year-end, rather than simply 
ignoring it.
    The Committee believes that a taxpayer should have the 
opportunity to change its method of accounting to a method that 
keeps inventories using shrinkage estimates, so long as such 
method is sound and clearly reflects income. The Committee does 
not believe that it is appropriate to deny a taxpayer access to 
such a method solely because its current, acceptable method of 
accounting does not utilize shrinkage estimates.

                        Explanation of Provision

    The bill provides that a method of keeping inventories will 
not be considered unsound, or to fail to clearly reflect 
income, solely because it includes an adjustment for the 
shrinkage estimated to occur through year-end, based on 
inventories taken other than at year-end. Such an estimate must 
be based on actual physical counts. Where such an estimate is 
used in determining ending inventory balances, the taxpayer is 
required to take a physical count of inventories at each 
location on a regular and consistent basis. A taxpayer is 
required to adjust its ending inventory to take into account 
all physical counts performed through the end of its taxable 
year.

                             Effective Date

    The provision is effective for taxable years ending after 
the date of enactment.
    A taxpayer is permitted to change its method of accounting 
by this section if the taxpayer is currently using a method 
that does not utilize estimates of inventory shrinkage and 
wishes to change to a method for inventories that includes 
shrinkage estimates based on physical inventories taken other 
than at year-end. Such a change is treated as a voluntary 
change in method of accounting, initiated by the taxpayer with 
the consent of the Secretary of the Treasury, provided the 
taxpayer changes to a permissible method of accounting. The 
period for taking into account any adjustment required under 
section 481 as a result of such a change in method is 4 years.
    No inference is intended by the Committee by the adoption 
of this provision with regard to whether any particular method 
of accounting for inventories is permissible under present law.

4. Treatment of construction allowances provided to lessees (sec. 1014 
        of the bill and new sec. 110 of the Code)

                              Present Law

    Depreciation allowances for property used in a trade or 
business generally are determined under the modified 
Accelerated Cost Recovery System (``MACRS'') of section 168. 
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 (sec. 168(i)(8)).\130\ This rule applies whether the 
lessor or lessee places the leasehold improvements in 
service.\131\ If a leasehold improvement constitutes an 
addition or improvement to nonresidential real property already 
placed in service, the improvement is depreciated using the 
straight-line method over a 39-year recovery period, beginning 
in the month the addition or improvement was placed in service 
(secs. 168 (b)(3), (c)(1), (d)(2), and (l)(6)). A lessor of 
leased property that disposes of a leasehold improvement that 
was made by the lessor for the lessee of the property may take 
the adjusted basis of the improvement into account for purposes 
of determining gain or loss if the improvement is irrevocably 
disposed of or abandoned by the lessor at the termination of 
the lease (sec. 168(i)(8)).
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    \130\ 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 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 denial of component depreciation also 
applies under MACRS, as provided by the Tax Reform Act of 1986.
    \131\ Former Code 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. These 
provisions were repealed by the Tax Reform Act of 1986.
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    The gross income of a lessor of real property does not 
include any amount attributable to the value of buildings 
erected, or other improvements made by, a lessee that revert to 
the lessor at the termination of a lease (sec. 109).
    Issues have arisen as to the proper treatment of amounts 
provided to a lessee by a lessor for property to be constructed 
and used by the lessee pursuant to the lease (``construction 
allowances''). In general, incentive payments are includible in 
income as accessions to wealth.\132\ A coordinated issue paper 
issued by the Internal Revenue Service (``IRS'') on October 7, 
1996, states the IRS position that construction allowances 
should generally be included in income in the year received. 
However, the paper does recognize that amounts received by a 
lessee from a lessor and expended by the lessee on assets owned 
by the lessor were not includible in the lessee's income. The 
issue paper provides that tax ownership is determined by 
applying a ``benefits and burdens of ownership'' test that 
includes an examination of the following factors: (1) whether 
legal title passes; (2) how the parties treat the transaction; 
(3) whether an equity interest was acquired in the property; 
(4) whether the contract creates present obligations on the 
seller to execute and deliver a deed and on the buyer to make 
payments; (5) whether the right of possession is vested; (6) 
who pays property taxes; (7) who bears the risk of loss or 
damage to the property; (8) who receives the profits from the 
operation and sale of the property; (9) who carries insurance 
with respect to the property; (9) who is responsible for 
replacing the property; and (10) who has the benefits of any 
remainder interests in the property.
---------------------------------------------------------------------------
    \132\ John B. White, Inc. v. Comm., 55 T.C. 729 (1971), aff'd per 
curiam 458 F. 2d 989 (3d Cir.), cert. denied, 409 U.S. 876 (1972).
---------------------------------------------------------------------------

                           Reasons for Change

    The committee understands that it is common industry 
practice for a lessor to custom improve retail space for the 
use by a lessee pursuant to a lease. Such leasehold 
improvements may be provided by the lessor directly 
constructing the improvements to the lessee's specifications. 
Alternatively, the lessee may receive a construction allowance 
from the lessor pursuant to the lease in order for the lessee 
to build or improve the property. The committee believes that 
the tax treatment of lessors and lessees in either case should 
be the same. The committee understands that the IRS issue paper 
reaches a similar conclusion in cases where the lessor is 
treated as the tax owner of the constructed or improved 
property. However, the committee is concerned that the 
traditional factors cited by the IRS in making the 
determination of who is the tax owner of the property may be 
applied differently by the lessor and the lessee and may lead 
to controversies between the IRS and taxpayers. Thus, the bill 
provides, in effect, a safe harbor such that it will beassumed 
that a construction allowance is used to construct or improve lessor 
property (and is properly excludible by the lessee) when long-lived 
property is constructed or improved and used pursuant to a short-term 
lease. In addition, the bill provides safeguards to ensure that lessors 
and lessees consistently treat the property subject to the construction 
allowance as nonresidential real property.

                        Explanation of Provision

    The bill provides that the gross income of a lessee does 
not include amounts received in cash (or treated as a rent 
reduction) from a lessor under a short-term lease of retail 
space for the purpose of the lessee's construction or 
improvement of qualified long-term real property for use in the 
lessee's trade or business at such retail space. The exclusion 
only applies to the extent the allowance does not exceed the 
amount expended by the lessee on the construction or 
improvement of qualified long-term real property. For this 
purpose, ``qualified long-term real property'' means 
nonresidential real property that is part of, or otherwise 
present at, retail space used by the lessee and that reverts to 
the lessor at the termination of the lease. A ``short-term 
lease'' means a lease or other agreement for the occupancy or 
use of retail space for a term of 15 years or less (as 
determined pursuant to sec. 168(i)(3)). ``Retail space'' means 
real property leased, occupied, or otherwise used by the lessee 
in its trade or business of selling tangible personal property 
or services to the general public.
    The bill provides that the lessor must treat the amounts 
expended on the construction allowance as nonresidential real 
property owned by the lessor. However, the lessee's exclusion 
is not dependent upon the lessor's treatment of the property as 
nonresidential real property.
    The bill contains reporting requirements to ensure that 
both the lessor and lessee treat such amounts consistently as 
nonresidential real property. Under regulations, the lessor and 
the lessee shall, at such times and in such manner as provided 
by the regulations, furnish to the Secretary of the Treasury 
information concerning the amounts received (or treated as a 
rent reduction), the amounts expended on qualified long-term 
real property, and such other information as the Secretary 
deems necessary to carry out the provisions of the bill. It is 
expected that the Secretary, in promulgating such regulations, 
will attempt to minimize the administrative burdens of 
taxpayers while ensuring compliance with the bill.

                             Effective Date

    The provision applies to leases entered into after the date 
of enactment. No inference is intended as to the treatment of 
amounts that are not subject to the provision.

                C. Partnership Simplification Provisions

1. General provisions

            a. Simplified flow-through for electing large partnerships 
                    (sec. 1021 of the bill and new secs. 771-777 of the 
                    Code)

                              Present Law

Treatment of partnerships in general

    A partnership generally is treated as a conduit for Federal 
income tax purposes. Each partner takes into account separately 
his distributive share of the partnership's items of income, 
gain, loss, deduction or credit. The character of an item is 
the same as if it had been directly realized or incurred by the 
partner. Limitations affecting the computation of taxable 
income generally apply at the partner level.
    The taxable income of a partnership is computed in the same 
manner as that of an individual, except that no deduction is 
permitted for personal exemptions, foreign taxes, charitable 
contributions, net operating losses, certain itemized 
deductions, or depletion. Elections affecting the computation 
of taxable income derived from a partnership are made by the 
partnership, except for certain elections such as those 
relating to discharge of indebtedness income and the foreign 
tax credit.

Capital gains

    The net capital gain of an individual is taxed generally at 
the same rates applicable to ordinary income, subject to a 
maximum marginal rate of 28 percent. Net capital gain is the 
excess of net long-term capital gain over net short-term 
capital loss. Individuals with a net capital loss generally may 
deduct up to $3,000 of the loss each year against ordinary 
income. Net capital losses in excess of the $3,000 limit may be 
carried forward indefinitely.
    A special rule applies to gains and losses on the sale, 
exchange or involuntary conversion of certain trade or business 
assets (sec. 1231). In general, net gains from such assets are 
treated as long-term capital gains but net losses are treated 
as ordinary losses.
    A partner's share of a partnership's net short-term capital 
gain or loss and net long-term capital gain or loss from 
portfolio investments is separately reported to the partner. A 
partner's share of a partnership's net gain or loss under 
section 1231 generally is also separately reported.

Deductions and credits

    Miscellaneous itemized deductions (e.g., certain investment 
expenses) are deductible only to the extent that, in the 
aggregate, they exceed two percent of the individual's adjusted 
gross income.
    In general, taxpayers are allowed a deduction for 
charitable contributions, subject to certain limitations. The 
deduction allowed an individual generally cannot exceed 50 
percent of the individual's adjusted gross income for the 
taxable year. The deduction allowed a corporation generally 
cannot exceed 10 percent of the corporation's taxable income. 
Excess contributions are carried forward for five years.
    A partner's distributive share of a partnership's 
miscellaneous itemized deductions and charitable contributions 
is separately reported to the partner.
    Each partner is allowed his distributive share of credits 
against his taxable income.

Foreign taxes

    The foreign tax credit generally allows U.S. taxpayers to 
reduce U.S. income tax on foreign income by the amount of 
foreign income taxes paid or accrued with respect to that 
income. In lieu of electing the foreign tax credit, a taxpayer 
may deduct foreign taxes. The total amount of the credit may 
not exceed the same proportion of the taxpayer's U.S. tax which 
the taxpayer's foreign source taxable income bears to the 
taxpayer's worldwide taxable income for the taxable year.

Unrelated business taxable income

    Tax-exempt organizations are subject to tax on income from 
unrelated businesses. Certain types of income (such as 
dividends, interest and certain rental income) are not treated 
as unrelated business taxable income. Thus, for a partner that 
is an exempt organization, whether partnership income is 
unrelated business taxable income depends on the character of 
the underlying income. Income from a publicly traded 
partnership, however, is treated as unrelated business taxable 
income regardless of the character of the underlying income.

Special rules related to oil and gas activities

    Taxpayers involved in the search for and extraction of 
crude oil and natural gas are subject to certain special tax 
rules. As a result, in the case of partnerships engaged in such 
activities, certain specific information is separately reported 
to partners.
    A taxpayer who owns an economic interest in a producing 
deposit of natural resources (including crude oil and natural 
gas) is permitted to claim a deduction for depletion of the 
deposit as the minerals are extracted. In the case of oil and 
gas produced in the United States, a taxpayer generally is 
permitted to claim the greater of a deduction for cost 
depletion or percentage depletion. Cost depletion is computed 
by multiplying a taxpayer's adjusted basis in the depletable 
property by a fraction, the numerator of which is the amount of 
current year production from the property and the denominator 
of which is the property's estimated reserves as of the 
beginning of that year. Percentage depletion is equal to a 
specified percentage (generally, 15 percent in the case of oil 
and gas) of gross income from production. Cost depletion is 
limited to the taxpayer's basis in the depletable property; 
percentage depletion is not so limited. Once a taxpayer has 
exhausted its basis in the depletable property, it may continue 
to claim percentage depletion deductions (generally referred to 
as ``excess percentage depletion'').
    Certain limitations apply to the deduction for oil and gas 
percentage depletion. First, percentage depletion is not 
available to oil and gas producers who also engage (directly or 
indirectly) in significant levels of oil and gas retailing or 
refining activities (so-called ``integrated producers'' of oil 
and gas). Second, the deduction for percentage depletion may be 
claimed by a taxpayer only with respect to up to 1,000 barrels-
per-day of production. Third, the percentage depletion 
deduction may not exceed 100 percent of the taxpayer's net 
income for the taxable year from the depletable oil and gas 
property. Fourth, a percentage depletion deduction may not be 
claimed to the extent that it exceeds 65 percent of the 
taxpayer's pre-percentage depletion taxable income.
    In the case of a partnership that owns depletable oil and 
gas properties, the depletion allowance is computed separately 
by the partners and not by the partnership. In computing a 
partner's basis in his partnership interest, basis is increased 
by the partner's share of any partnership-related excess 
percentage depletion deductions and is decreased (but not below 
zero) by the partner's total amount of depletion deductions 
attributable to partnership property.
    Intangible drilling and development costs (``IDCs'') 
incurred with respect to domestic oil and gas wells generally 
may be deducted at the election of the taxpayer. In the case of 
integrated producers, no more than 70 percent of IDCs incurred 
during a taxable year may be deducted. IDCs not deducted are 
capitalized and generally are either added to the property's 
basis and recovered through depletion deductions or amortized 
on a straight-line basis over a 60-month period.
    The special treatment granted to IDCs incurred in the 
pursuit of oil and gas may give rise to an item of tax 
preference or (in the case of corporate taxpayers) an adjusted 
current earnings (``ACE'') adjustment for the alternative 
minimum tax. The tax preference item is based on a concept of 
``excess IDCs.'' In general, excess IDCs are the excess of IDCs 
deducted for the taxable year over the amount of those IDCs 
that would have been deducted had they been capitalized and 
amortized on a straight-line basis over 120 months commencing 
with the month production begins from the related well. The 
amount of tax preference is then computed as the difference 
between the excess IDC amount and 65 percent of the taxpayer's 
net income from oil and gas (computed without a deduction for 
excess IDCs). For IDCs incurred in taxable years beginning 
after 1992, the ACE adjustment related to IDCs is repealed for 
taxpayers other than integrated producers. Moreover, beginning 
in 1993, the IDC tax preference generally is repealed for 
taxpayers other than integrated producers. In this case, 
however, the repeal of the excess IDC preference may not result 
in more than a 40 percent reduction (30 percent for taxable 
years beginning in 1993) in the amount of the taxpayer's 
alternative minimum taxable income computed as if that 
preference had not been repealed.

Passive losses

    The passive loss rules generally disallow deductions and 
credits from passive activities to the extent they exceed 
income from passive activities. Losses not allowed in a taxable 
year are suspended and treated as current deductions from 
passive activities in the next taxable year. These losses are 
allowed in full when a taxpayer disposes of the entire interest 
in the passive activity to an unrelated person in a taxable 
transaction. Passive activities include trade or business 
activities in which the taxpayer does not materially 
participate. (Limited partners generally do not materially 
participate in the activities of a partnership.) Passive 
activities also include rental activities (regardless of the 
taxpayer's material participation).\133\ Portfolio income (such 
as interest and dividends), and expenses allocable to such 
income, are not treated as income or loss from a passive 
activity.
---------------------------------------------------------------------------
    \133\ An individual who actively participates in a rental real 
estate activity and holds at least a 10-percent interest may deduct up 
to $25,000 of passive losses. The $25,000 amount phases out as the 
individual's income increases from $100,000 to $150,000.
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    The $25,000 allowance also applies to low-income housing 
and rehabilitation credits (on a deduction equivalent basis), 
regardless of whether the taxpayer claiming the credit actively 
participates in the rental real estate activity generating the 
credit. In addition, the income phaseout range for the $25,000 
allowance for rehabilitation credits is $200,000 to $250,000 
(rather than $100,000 to $150,000). For interests acquired 
after December 31, 1989 in partnerships holding property placed 
in service after that date, the $25,000 deduction-equivalent 
allowance is permitted for the low-income housing credit 
without regard to the taxpayer's income.
    A partnership's operations may be treated as multiple 
activities for purposes of the passive loss rules. In such 
case, the partnership must separately report items of income 
and deductions from each of its activities.
    Income, loss and other items from a publicly traded 
partnership are treated as separate from income and loss from 
any other publicly traded partnership, and also as separate 
from any income or loss from passive activities.
    The Omnibus Budget Reconciliation Act of 1993 added a rule, 
effective for taxable years beginning after December 31, 1993, 
treating a taxpayer's rental real estate activities in which he 
materially participates as not subject to limitation under the 
passive loss rules if the taxpayer meets eligibility 
requirements relating to real property trades or businesses in 
which he performs services (sec. 469(c)(7)). Real property 
trade or business means any real property development, 
redevelopment, construction, reconstruction, acquisition, 
conversion, rental, operation, management, leasing, or 
brokerage trade or business. An individual taxpayer generally 
meets the eligibility requirements if (1) more than half of the 
personal services the taxpayer performs in trades or business 
during the taxable year are performed in real property trades 
or businesses in which the taxpayer materially participates, 
and (2) such taxpayer performs more than 750 hours of services 
during the taxable year in real property trades or businesses 
in which the taxpayer materially participates.

                                 REMICs

    A tax is imposed on partnerships holding a residual 
interest in a real estate mortgage investment conduit 
(``REMIC''). The amount of the tax is the amount of excess 
inclusions allocable to partnership interests owned by certain 
tax-exempt organizations (``disqualified organizations'') 
multiplied by the highest corporate tax rate.

Contribution of property to a partnership

    In general, a partner recognizes no gain or loss upon the 
contribution of property to a partnership. However, income, 
gain, loss and deduction with respect to property contributed 
to a partnership by a partner must be allocated among the 
partners so as to take into account the difference between the 
basis of the property to the partnership and its fair market 
value at the time of contribution. In addition, the 
contributing partner must recognize gain or loss equal to such 
difference if the property is distributed to another partner 
within five years of its contribution (sec. 704(c)), or if 
other property is distributed to the contributor within the 
five year period (sec. 737).

Election of optional basis adjustments

    In general, the transfer of a partnership interest or a 
distribution of partnership property does not affect the basis 
of partnership assets. A partnership, however, may elect to 
make certain adjustments in the basis of partnership property 
(sec. 754). Under a section 754 election, the transfer of a 
partnership interest generally results in an adjustment in the 
partnership's basis in its property for the benefit of the 
transferee partner only, to reflect the difference between that 
partner's basis for his interest and his proportionate share of 
the adjusted basis of partnership property (sec. 743(b)). Also 
under the election, a distribution of property to a partner in 
certain cases results in an adjustment in the basis of other 
partnership property (sec. 734(b)).

Terminations

    A partnership terminates if either (1) All partners cease 
carrying on the business, financial operation or venture of the 
partnership, or (2) within a 12-month period 50 percent or more 
of the total partnership interests are sold or exchanged (sec. 
708).

                           Reasons for Change

    The requirement that each partner take into account 
separately his distributive share of a partnership's items of 
income, gain, loss, deduction and credit can result in the 
reporting of a large number of items to each partner. The 
schedule K-1, on which such items are reported, contains space 
for more than 40 items. Reporting so many separately stated 
items is burdensome for individual investors with relatively 
small, passive interests in large partnerships. In many 
respects such investments are indistinguishable from those made 
in corporate stock or mutual funds, which do not require 
reporting of numerous separate items.
    In addition, the number of items reported under the current 
regime makes it difficult for the Internal Revenue Service to 
match items reported on the K-1 against the partner's income 
tax return. Matching is also difficult because items on the K-1 
are often modified or limited at the partner level before 
appearing on the partner's tax return.
    By significantly reducing the number of items that must be 
separately reported to partners by an electing large 
partnership, the provision eases the reporting burden of 
partners and facilitates matching by the IRS. Moreover, it is 
understood that the Internal Revenue Service is considering 
restricting the use of substitute reporting forms by large 
partnerships. Reduction of the number of items makes possible a 
short standardized form.

                       Explanation of Provisions

In general

    The bill modifies the tax treatment of an electing large 
partnership (generally, any partnership that elects under the 
provision, if the number of partners in the preceding taxable 
year is 100 or more) and its partners. The provision provides 
that each partner takes into account separately the partner's 
distributive share of the following items, which are determined 
at the partnership level: (1) taxable income or loss from 
passive loss limitation activities; (2) taxable income or loss 
from other activities (e.g., portfolio income or loss); (3) net 
capital gain or loss to the extent allocable to passive loss 
limitation activities and other activities; (4) tax-exempt 
interest; (5) net alternative minimum tax adjustment separately 
computed for passive loss limitation activities and other 
activities; (6) general credits; (7) low-income housing credit; 
(8) rehabilitation credit; (9) credit for producing fuel from a 
nonconventional source; (10) creditable foreign taxes and 
foreign source items; and (11) any other items to the extent 
that the Secretary determines that separate treatment of such 
items is appropriate.\134\ Separate treatment may be 
appropriate, for example, should changes in the law necessitate 
such treatment for any items.
---------------------------------------------------------------------------
    \134\ In determining the amounts required to be separately taken 
into account by a partner, those provisions of the large partnership 
rules governing computations of taxable income are applied separately 
with respect to that partner by taking into account that partner's 
distributive share of the partnership's items of income, gain, loss, 
deduction or credit. This rule permits partnerships to make otherwise 
valid special allocations of partnership items to partners.
---------------------------------------------------------------------------
    Under the bill, the taxable income of an electing large 
partnership is computed in the same manner as that of an 
individual, except that the items described above are 
separately stated and certain modifications are made. These 
modifications include disallowing the deduction for personal 
exemptions, the net operating loss deduction and certain 
itemized deductions.\135\ All limitations and other provisions 
affecting the computation of taxable income or any credit 
(except for the at risk, passive loss and itemized deduction 
limitations, and any other provision specified in regulations) 
are applied at the partnership (and not the partner) level.
---------------------------------------------------------------------------
    \135\ An electing large partnership is allowed a deduction under 
section 212 for expenses incurred for the production of income, subject 
to 70-percent disallowance. No income from an electing large 
partnership is treated as fishing or farming income.
---------------------------------------------------------------------------
    All elections affecting the computation of taxable income 
or any credit generally are made by the partnership.

Capital gains

    Under the bill, netting of capital gains and losses occurs 
at the partnership level. A partner in a large partnership 
takes into account separately his distributive share of the 
partnership's net capital gain or net capital loss.\136\ Such 
net capital gain or loss is treated as long-term capital gain 
or loss.
---------------------------------------------------------------------------
    \136\ The term ``net capital gain'' has the same meaning as in 
section 1222(11). The term ``net capital loss'' means the excess of the 
losses from sales or exchanges of capital assets over the gains from 
sales or exchanges of capital assets. Thus, the partnership cannot 
offset any portion of capital losses against ordinary income.
---------------------------------------------------------------------------
    Any excess of net short-term capital gain over net long-
term capital loss is consolidated with the partnership's other 
taxable income and is not separately reported.
    A partner's distributive share of the partnership's net 
capital gain is allocated between passive loss limitation 
activities and other activities. The net capital gain is 
allocated to passive loss limitation activities to the extent 
of net capital gain from sales and exchanges of property used 
in connection with such activities, and any excess is allocated 
to other activities. A similar rule applies for purposes of 
allocating any net capital loss.
    Any gains and losses of the partnership under section 1231 
are netted at the partnership level. Net gain is treated as 
long-term capital gain and is subject to the rules described 
above. Net loss is treated as ordinary loss and consolidated 
with the partnership's other taxable income.

Deductions

    The bill contains two special rules for deductions. First, 
miscellaneous itemized deductions are not separately reported 
to partners. Instead, 70 percent of the amount of such 
deductions is disallowed at the partnership level; \137\ the 
remaining 30 percent is allowed at the partnership level in 
determining taxable income, and is not subject to the two-
percent floor at the partner level.
---------------------------------------------------------------------------
    \137\ The 70 percent figure is intended to approximate the amount 
of such deductions that would be denied at the partner level as a 
result of the two-percent floor.
---------------------------------------------------------------------------
    Second, charitable contributions are not separately 
reported to partners under the bill. Instead, the charitable 
contribution deduction is allowed at the partnership level in 
determining taxable income, subject to the limitations that 
apply to corporate donors.

Credits in general

    Under the bill, general credits are separately reported to 
partners as a single item. General credits are any credits 
other than the low-income housing credit, the rehabilitation 
credit and the credit for producing fuel from a nonconventional 
source. A partner's distributive share of general credits is 
taken into account as a current year general business credit. 
Thus, for example, the credit for clinical testing expenses is 
subject to the present law limitations on the general business 
credit. The refundable credit for gasoline used for exempt 
purposes and the refund or credit for undistributed capital 
gains of a regulated investment company are allowed to the 
partnership, and thus are not separately reported to partners.
    In recognition of their special treatment under the passive 
loss rules, the low-income housing and rehabilitation credits 
are separately reported.\138\ In addition, the credit for 
producing fuel from a nonconventional source is separately 
reported.
---------------------------------------------------------------------------
    \138\ It is understood that the rehabilitation and low-income 
housing credits which are subject to the same passive loss rules (i.e., 
in the case of the low-income housing credit, where the partnership 
interest was acquired or the property was placed in service before 
1990) could be reported together on the same line.
---------------------------------------------------------------------------
    The bill imposes credit recapture at the partnership level 
and determines the amount of recapture by assuming that the 
credit fully reduced taxes. Such recapture is applied first to 
reduce the partnership's current year credit, if any; the 
partnership is liable for any excess over that amount. Under 
the bill, the transfer of an interest in an electing large 
partnership does not trigger recapture.

Foreign taxes

    The bill retains present-law treatment of foreign taxes. 
The partnership reports to the partner creditable foreign taxes 
and the source of any income, gain, loss or deduction taken 
into account by the partnership. Elections, computations and 
limitations are made by the partner.

Tax-exempt interest

    The bill retains present-law treatment of tax-exempt 
interest. Interest on a State or local bond is separately 
reported to each partner.

Unrelated business taxable income

    The bill retains present-law treatment of unrelated 
business taxable income. Thus, a tax-exempt partner's 
distributive share of partnership items is taken into account 
separately to the extent necessary to comply with the rules 
governing such income.

Passive losses

    Under the bill, a partner in an electing large partnership 
takes in an electing to account separately his distributive 
share of the partnership's taxable income or loss from passive 
loss limitation activities. The term ``passive loss limitation 
activity'' means any activity involving the conduct of a trade 
or business (including any activity treated as a trade or 
business under sec. 469(c) (5) or (6)) and any rental activity. 
A partner's share of an electing large partnership's 
taxableincome or loss from passive loss limitation activities is 
treated as an item of income or loss from the conduct of a trade or 
business which is a single passive activity, as defined in the passive 
loss rules. Thus, an electing large partnership generally is not 
required to separately report items from multiple activities.
    A partner in an electing large partnership also takes into 
account separately his distributive share of the partnership's 
taxable income or loss from activities other than passive loss 
limitation activities. Such distributive share is treated as an 
item of income or expense with respect to property held for 
investment. Thus, portfolio income (e.g., interest and 
dividends) is reported separately and is reduced by portfolio 
deductions and allocable investment interest expense.
    In the case of a partner holding an interest in an electing 
large partnership which is not a limited partnership interest, 
such partner's distributive share of any items are taken into 
account separately to the extent necessary to comply with the 
passive loss rules. Thus, for example, income of an electing 
large partnership is not treated as passive income with respect 
to the general partnership interest of a partner who materially 
participates in the partnership's trade or business.
    Under the bill, the requirement that the passive loss rule 
be separately applied to each publicly traded partnership (sec. 
469(k) of the Code) continues to apply.

Alternative minimum tax

    Under the bill, alternative minimum tax (``AMT'') 
adjustments and preferences are combined at the partnership 
level. An electing large partnership would report to partners a 
net AMT adjustment separately computed for passive loss 
limitation activities and other activities. In determining a 
partner's alternative minimum taxable income, a partner's 
distributive share of any net AMT adjustment is taken into 
account instead of making separate AMT adjustments with respect 
to partnership items. The net AMT adjustment is determined by 
using the adjustments applicable to individuals (in the case of 
partners other than corporations), and by using the adjustments 
applicable to corporations (in the case of corporate partners). 
Except as provided in regulations, the net AMT adjustment is 
treated as a deferral preference for purposes of the section 53 
minimum tax credit.

Discharge of indebtedness income

    If an electing large partnership has income from the 
discharge of any indebtedness, such income is separately 
reported to each partner. In addition, the rules governing such 
income (sec. 108) are applied without regard to the large 
partnership rules. Partner-level elections under section 108 
are made by each partner separately. Thus, for example, the 
large partnership provisions do not affect section 108(d)(6), 
which provides that certain section 108 rules apply at the 
partner level, or section 108(b)(5), which provides for an 
election to reduce the basis of depreciable property. The large 
partnership provisions also do not affect the election under 
108(c) (added by the Omnibus Budget Reconciliation Act of 1993) 
to exclude discharge of indebtedness income with respect to 
qualified real property business indebtedness.

REMICs

    For purposes of the tax on partnerships holding residual 
interests in REMICs, all interests in an electing large 
partnership are treated as held by disqualified organizations. 
Thus, an electing large partnership holding a residual interest 
in a REMIC is subject to a tax equal to the excess inclusions 
multiplied by the highest corporate rate. The amount subject to 
tax is excluded from partnership income.

Election of optional basis adjustments

    Under the bill, an electing large partnership may still 
elect to adjust the basis of partnership assets with respect to 
transferee partners. The computation of an electing large 
partnership's taxable income is made without regard to the 
section 743(b) adjustment. As under present law, the section 
743(b) adjustment is made only with respect to the transferee 
partner. In addition, an electing large partnership is 
permitted to adjust the basis of partnership property under 
section 734(b) if property is distributed to a partner, as 
under present law.

Terminations

    The bill provides that an electing large partnership does 
not terminate for tax purposes solely because 50 percent of its 
interests are sold or exchanged within a 12-month period.

Partnerships and partners subject to large partnership rules

            Definition of electing large partnership
    An ``electing large partnership'' is any partnership that 
elects under the provision, if the number of partners in the 
preceding taxable year is 100 or more. The number of partners 
is determined by counting only persons directly holding 
partnership interests in the taxable year, including persons 
holding through nominees; persons holding indirectly (e.g., 
through another partnership) are not counted. Regulations may 
provide, however, that if the number of partners in any taxable 
year falls below 100, the partnership may not be treated as an 
electing large partnership. The election applies to the year 
for which made and all subsequent years and cannot be revoked 
without the Secretary's consent.
            Special rules for certain service partnerships
    An election under this provision is not effective for any 
partnership if substantially all the partners are: (1) 
individuals performing substantial services in connection with 
the partnership's activities, or personal service corporations 
the owner-employees of which perform such services; (2) retired 
partners who had performed such services; or (3) spouses of 
partners who had performed such services. In addition, the term 
``partner'' does not include any individual performing 
substantial services in connection with the partnership's 
activities and holding a partnership interest, or an individual 
who formerly performed such services and who held a partnership 
interest at the time the individual performed such services.

Exclusion for commodity partnerships

    An election under this provision is not effective for any 
partnership the principal activity of which is the buying and 
selling of commodities (not described in sec. 1221(1)), or 
options, futures or forwards with respect to commodities.

Special rules for partnerships holding oil and gas properties

            Simplified reporting treatment of electing large 
                    partnerships with oil and gas activities
    The bill provides special rules for electing large 
partnerships with oil and gas activities that operate under the 
simplified reporting regime. These partnerships are 
collectively referred to herein as ``oil and gas large 
partnerships.'' Generally, the bill provides that an oil and 
gas large partnership reports information to its partners under 
the general simplified large partnership reporting regime 
described above. To prevent the extension of percentage 
depletion deductions to persons excluded therefrom under 
present law, however, certain partners are treated as 
disqualified persons under the bill.
    The treatment of a disqualified person's distributive share 
of any item of income, gain, loss, deduction, or credit 
attributable to any partnership oil or gas property is 
determined under the bill without regard to the special rules 
applicable to large partnerships. Thus, an oil and gas large 
partnership reports information related to oil and gas 
activities to a partner who is a disqualified person in the 
same manner and to the same extent that it reports such 
information to that partner under present law. The simplified 
reporting rules of the bill, however, apply with respect to 
reporting such a partner's share of items not related to oil 
and gas activities.
    The bill defines two categories of taxpayers as 
disqualified persons. The first category encompasses taxpayers 
who do not qualify for the deduction for percentage depletion 
under section 613A (i.e., integrated producers of oil and gas). 
The second category includes any person whose average daily 
production of oil and gas (for purposes of determining the 
depletable oil and natural gas quantity under section 
613A(c)(2)) is at least 500 barrels for its taxable year in 
which (or with which) the partnership's taxable year ends. In 
making this computation, all production of domestic crude oil 
and natural gas attributable to the partner is taken into 
account, including such partner's proportionate share of any 
production of the large partnership.
    A taxpayer that falls within a category of disqualified 
person has the responsibility of notifying any large 
partnership in which it holds a direct or indirect interest 
(e.g., through a pass-through entity) of its status as such. 
Thus, for example, if an integrated producer owns an interest 
in a partnership which in turn owns an interest in an oil and 
gas large partnership, it is responsible for providing the 
management of the electing large partnership information 
regarding its status as a disqualified person and details 
regarding its indirect interest in the electing large 
partnership.
    Under the bill, an oil and gas large partnership computes 
its deduction for oil and gas depletion under the general 
statutory rules (subject to certain exceptions described below) 
under the assumptions that the partnership is the taxpayer and 
that it qualifies for the percentage depletion deduction. The 
amount of the depletion deduction, as well as other oil and gas 
related items, generally are reported to each partner (other 
than to partners who are disqualified persons) as components of 
that partner's distributive share of taxable income or loss 
from passive loss limitation activities. The bill provides that 
in computing the partnership's oil and gas percentage depletion 
deduction, the 1,000-barrel-per-day limitation does not apply. 
In addition, an oil and gas large partnership is allowed to 
compute percentage depletion under the bill without applying 
the 65-percent-of-taxable-income limitation under section 
613A(d)(1).
    As under present law, an election to deduct IDCs under 
section 263(c) is made at the partnership level. Since the bill 
treats those taxpayers required by the Code (sec. 291) to 
capitalize 30 percent of IDCs as disqualified persons, an oil 
and gas large partnership may pass through a full deduction of 
IDCs to its partners who are not disqualified persons. In 
contrast to present law, an oil and gas large partnership also 
has the responsibility with respect to its partners who are not 
disqualified persons for making an election under section 59(e) 
to capitalize and amortize certain specified IDCs. Partners who 
are disqualified persons are permitted to make their own 
separate section 59(e) elections under the bill.
    Consistent with the general reporting regime for electing 
large partnerships, the bill provides that a single AMT 
adjustment (under either corporate or non-corporate principles, 
as the case may be) is made and reported to the partners (other 
than disqualified persons) of an oil and gas large partnership 
as a separate item. This separately-reported item is affected 
by the limitation on the repeal of the tax preference for 
excess IDCs. For purposes of computing this limitation, the 
bill treats an oil and gas large partnership as the taxpayer. 
Thus, the limitation on repeal of the IDC preference is applied 
at the partnership level and is based on the cumulative 
reduction in the partnership's alternative minimum taxable 
income resulting from repeal of that preference.
    The bill provides that in making partnership-level 
computations, any item of income, gain, loss, deduction, or 
credit attributable to a partner who is a disqualified person 
is disregarded. For example, in computing the partnership's net 
income from oil and gas for purposes of determining the IDC 
preference (if any) to be reported to partners who are not 
disqualified persons as part of the AMT adjustment, 
disqualified persons' distributive shares of the partnership's 
net income from oil and gas are not to be taken into account.

Regulatory authority

    The Secretary of the Treasury is granted authority to 
prescribe such regulations as may be appropriate to carry out 
the purposes of the provisions.

                             Effective Date

    The provisions generally applies to partnership taxable 
years beginning after December 31, 1997.
            b. Simplified audit procedures for electing large 
                    partnerships (sec. 1022 of the bill and secs. 6240, 
                    6241, 6242, 6245, 6246, 6247, 6249, 6251, 6255, and 
                    6256 of the Code)

                              Present Law

In general

    Prior to 1982, regardless of the size of a partnership, 
adjustments to a partnership's items of income, gain, loss, 
deduction, or credit had to be made in separate proceedings 
with respect to each partner individually. Because a large 
partnership sometimes had many partners located in different 
audit districts, adjustments to items of income, gains, losses, 
deductions, or credits of the partnership had to be made in 
numerous actions in several jurisdictions, sometimes with 
conflicting outcomes.
    The Tax Equity and Fiscal Responsibility Act of 1982 
(``TEFRA'') established unified audit rules applicable to all 
but certain small (10 or fewer partners) partnerships. These 
rules require the tax treatment of all ``partnership items'' to 
be determined at the partnership, rather than the partner, 
level. Partnership items are those items that are more 
appropriately determined at the partnership level than at the 
partner level, as provided by regulations.
    Under the TEFRA rules, a partner must report all 
partnership items consistently with the partnership return or 
must notify the IRS of any inconsistency. If a partner fails to 
report any partnership item consistently with the partnership 
return, the IRS may make a computational adjustment and 
immediately assess any additional tax that results.

Administrative proceedings

    Under the TEFRA rules, a partner must report all 
partnership items consistently with the partnership return or 
must notify the IRS of any inconsistency. If a partner fails to 
report any partnership item consistently with the partnership 
return, the IRS may make a computational adjustment and 
immediately assess any additional tax that results.
    The IRS may challenge the reporting position of a 
partnership by conducting a single administrative proceeding to 
resolve the issue with respect to all partners. But the IRS 
must still assess any resulting deficiency against each of the 
taxpayers who were partners in the year in which the 
understatement of tax liability arose.
    Any partner of a partnership can request an administrative 
adjustment or a refund for his own separate tax liability. Any 
partner also has the right to participate in partnership-level 
administrative proceedings. A settlement agreement with respect 
to partnership items binds all parties to the settlement.

Tax Matters Partner

    The TEFRA rules establish the ``Tax Matters Partner'' as 
the primary representative of a partnership in dealings with 
the IRS. The Tax Matters Partner is a general partner 
designated by the partnership or, in the absence of 
designation, the general partner with the largest profits 
interest at the close of the taxable year. If no Tax Matters 
Partner is designated, and it is impractical to apply the 
largest profits interest rule, the IRS may select any partner 
as the Tax Matters Partner.

Notice requirements

    The IRS generally is required to give notice of the 
beginning of partnership-level administrative proceedings and 
any resulting administrative adjustment to all partners whose 
names and addresses are furnished to the IRS. For partnerships 
with more than 100 partners, however, the IRS generally is not 
required to give notice to any partner whose profits interest 
is less than one percent.

Adjudication of disputes concerning partnership items

    After the IRS makes an administrative adjustment, the Tax 
Matters Partner (and, in limited circumstances, certain other 
partners) may file a petition for readjustment of partnership 
items in the Tax Court, the district court in which the 
partnership's principal place of business is located, or the 
Claims Court.

Statute of limitations

    The IRS generally cannot adjust a partnership item for a 
partnership taxable year if more than 3 years have elapsed 
since the later of the filing of the partnership return or the 
last day for the filing of the partnership return.

                           Reasons for Change

    Present audit procedures for large partnerships are 
inefficient and more complex than those for other large 
entities. The IRS must assess any deficiency arising from a 
partnership audit against a large number of partners, many of 
whom cannot easily be located and some of whom are no longer 
partners. In addition, audit procedures are cumbersome and can 
be complicated further by the intervention of partners acting 
individually.

                        Explanation of Provision

    The bill creates a new audit system for electing large 
partnerships. The provision defines ``electing large 
partnership'' the same way for audit and reporting purposes 
(generally, any partnership that elects under the reporting 
provisions, if the number of partners in the preceding taxable 
year is 100 or more).
    As under present law, electing large partnerships and their 
partners are subject to unified audit rules. Thus, the tax 
treatment of ``partnership items'' are determined at the 
partnership, rather than the partner, level. The term 
``partnership items'' is defined as under present law.
    Unlike present law, however, partnership adjustments 
generally will flow through to the partners for the year in 
which the adjustment takes effect. Thus, the current-year 
partners' share ofcurrent-year partnership items of income, 
gains, losses, deductions, or credits will be adjusted to reflect 
partnership adjustments that take effect in that year. The adjustments 
generally will not affect prior-year returns of any partners (except in 
the case of changes to any partner's distributive shares).
    In lieu of flowing an adjustment through to its partners, 
the partnership may elect to pay an imputed underpayment. The 
imputed underpayment generally is calculated by netting the 
adjustments to the income and loss items of the partnership and 
multiplying that amount by the highest tax rate (whether 
individual or corporate). A partner may not file a claim for 
credit or refund of his allocable share of the payment. A 
partnership may make this election only if it meets 
requirements set forth in Treasury regulations designed to 
ensure payment (for example, in the case of a foreign 
partnership).
    Regardless of whether a partnership adjustment flows 
through to the partners, an adjustment must be offset if it 
requires another adjustment in a year after the adjusted year 
and before the year the offsetted adjustment takes effect. For 
example, if a partnership expensed a $1,000 item in year 1, and 
it was determined in year 4 that the item should have been 
capitalized and amortized ratably over 10 years, the adjustment 
in year 4 would be $700, apart from any interest or penalty. 
(The $900 adjustment for the improper deduction would be offset 
by $200 of adjustments for amortization deductions.) The year 4 
partners would be required to include an additional $700 in 
income for that year. The partnership may ratably amortize the 
remaining $700 of expenses in years 4-10.
    In addition, the partnership, rather than the partners 
individually, generally is liable for any interest and 
penalties that result from a partnership adjustment. Interest 
is computed for the period beginning on the return due date for 
the adjusted year and ending on the earlier of the return due 
date for the partnership taxable year in which the adjustment 
takes effect or the date the partnership pays the imputed 
underpayment. Thus, in the above example, the partnership would 
be liable for 4 years' worth of interest (on a declining 
principal amount).
    Penalties (such as the accuracy and fraud penalties) are 
determined on a year-by-year basis (without offsets) based on 
an imputed underpayment. All accuracy penalty criteria and 
waiver criteria (such as reasonable cause, substantial 
authority, etc.) are determined as if the partnership were a 
taxable individual. Accuracy and fraud penalties are assessed 
and accrue interest in the same manner as if asserted against a 
taxable individual.
    Any payment (for Federal income taxes, interest, or 
penalties) that an electing large partnership is required to 
make is non-deductible.
    If a partnership ceases to exist before a partnership 
adjustment takes effect, the former partners are required to 
take the adjustment into account, as provided by regulations. 
Regulations are also authorized to prevent abuse and to enforce 
efficiently the audit rules in circumstances that present 
special enforcement considerations (such as partnership 
bankruptcy).

Administrative proceedings

    Under the electing large partnership audit rules, a partner 
is not permitted to report any partnership items inconsistently 
with the partnership return, even if the partner notifies the 
IRS of the inconsistency. The IRS may treat a partnership item 
that was reported inconsistently by a partner as a mathematical 
or clerical error and immediately assess any additional tax 
against that partner.
    As under present law, the IRS may challenge the reporting 
position of a partnership by conducting a single administrative 
proceeding to resolve the issue with respect to all partners. 
Unlike under present law, however, partners will have no right 
individually to participate in settlement conferences or to 
request a refund.

Partnership representative

    The bill requires each electing large partnership to 
designate a partner or other person to act on its behalf. If an 
electing large partnership fails to designate such a person, 
the IRS is permitted to designate any one of the partners as 
the person authorized to act on the partnership's behalf. After 
the IRS's designation, an electing large partnership could 
still designate a replacement for the IRS-designated partner.

Notice requirements

    Unlike under present law, the IRS is not required to give 
notice to individual partners of the commencement of an 
administrative proceeding or of a final adjustment. Instead, 
the IRS is authorized to send notice of a partnership 
adjustment to the partnership itself by certified or registered 
mail. The IRS could give proper notice by mailing the notice to 
the last known address of the partnership, even if the 
partnership had terminated its existence.

Adjudication of disputes concerning partnership items

    As under present law, an administrative adjustment could be 
challenged in the Tax Court, the district court in which the 
partnership's principal place of business is located, or the 
Claims Court. However, only the partnership, and not partners 
individually, can petition for a readjustment of partnership 
items.
    If a petition for readjustment of partnership items is 
filed by the partnership, the court with which the petition is 
filed will have jurisdiction to determine the tax treatment of 
all partnership items of the partnership for the partnership 
taxable year to which the notice of partnership adjustment 
relates, and the proper allocation of such items among the 
partners. Thus, the court's jurisdiction is not limited to the 
items adjusted in the notice.

Statute of limitations

    Absent an agreement to extend the statute of limitations, 
the IRS generally could not adjust a partnership item of an 
electing large partnership more than 3 years after the later of 
the filing ofthe partnership return or the last day for the 
filing of the partnership return. Special rules apply to false or 
fraudulent returns, a substantial omission of income, or the failure to 
file a return. The IRS would assess and collect any deficiency of a 
partner that arises from any adjustment to a partnership item subject 
to the limitations period on assessments and collection applicable to 
the year the adjustment takes effect (secs. 6248, 6501 and 6502).

Regulatory authority

    The Secretary of the Treasury is granted authority to 
prescribe regulations as may be necessary to carry out the 
simplified audit procedure provisions, including regulations to 
prevent abuse of the provisions through manipulation. The 
regulations may include rules that address transfers of 
partnership interests, in anticipation of a partnership 
adjustment, to persons who are tax-favored (e.g., corporations 
with net operating losses, tax-exempt organizations, and 
foreign partners) or persons who are expected to be unable to 
pay tax (e.g., shell corporations). For example, if prior to 
the time a partnership adjustment takes effect, a taxable 
partner transfers a partnership interest to a nonresident alien 
to avoid the tax effect of the partnership adjustment, the 
rules may provide, among other things, that income related to 
the partnership adjustment is treated as effectively connected 
taxable income, that the partnership adjustment is treated as 
taking effect before the partnership interest was transferred, 
or that the former partner is treated as a current partner to 
whom the partnership adjustment is allocated.

                             Effective Date

    The provision applies to partnership taxable years 
beginning after December 31, 1997.
            c. Due date for furnishing information to partners of 
                    electing large partnerships (sec. 1023 of the bill 
                    and sec. 6031(b) of the Code)

                              Present Law

    A partnership required to file an income tax return with 
the Internal Revenue Service must also furnish an information 
return to each of its partners on or before the day on which 
the income tax return for the year is required to be filed, 
including extensions. Under regulations, a partnership must 
file its income tax return on or before the fifteenth day of 
the fourth month following the end of the partnership's taxable 
year (on or before April 15, for calendar year partnerships). 
This is the same deadline by which most individual partners 
must file their tax returns.

                           Reasons for Change

    Information returns that are received on or shortly before 
April 15 (or later) are difficult for individuals to use in 
preparing their tax returns (or in computing their payments) 
that are due on that date.

                        Explanation of Provision

    The bill provides that an electing large partnership must 
furnish information returns to partners by the first March 15 
following the close of the partnership's taxable year. Electing 
large partnerships are those partnerships subject to the 
simplified reporting and audit rules (generally, any 
partnership that elects under the reporting provision, if the 
number of partners in the preceding taxable year is 100 or 
more).
    The provision also provides that, if the partnership is 
required to provide copies of the information returns to the 
Internal Revenue Service on magnetic media, each schedule (such 
as each Schedule K-1) with respect to each partner is treated 
as a separate information return with respect to the corrective 
periods and penalties that are generally applicable to all 
information returns.

                             Effective Date

    The provision is effective for partnership taxable years 
beginning after December 31, 1997.
            d. Partnership returns required on magnetic media (sec. 
                    1024 of the bill and sec. 6011 of the Code)

                              Present Law

    Partnerships are permitted, but not required, to provide 
the tax return of the partnership (Form 1065), as well as 
copies of the schedules sent to each partner (Form K-1), to the 
Internal Revenue Service on magnetic media.

                           Reasons for Change

    Most entities that file large numbers of documents with the 
Internal Revenue Service must do so on magnetic media. 
Conforming the reporting provisions for partnerships to the 
generally applicable information reporting rules will 
facilitate integration of partnership information into already 
existing data systems.

                        Explanation of Provision

    The bill provides generally that any partnership is 
required to provide the tax return of the partnership (Form 
1065), as well as copies of the schedule sent to each partner 
(Form K-1), to the Internal Revenue Service on magnetic media. 
An exception is provided for partnerships with 100 or fewer 
partners.

                             Effective Date

    The provision is effective for partnership taxable years 
beginning after December 31, 1997.
            e. Treatment of partnership items of individual retirement 
                    arrangements (sec. 1025 of the bill and sec. 6012 
                    of the Code)

                              Present Law

Return filing requirements

    An individual retirement account (``IRA'') is a trust which 
generally is exempt from taxation except for the taxes imposed 
on income from an unrelated trade or business. A fiduciary of a 
trust that is exempt from taxation (but subject to the taxes 
imposed on income from an unrelated trade or business) 
generally is required to file a return on behalf of the trust 
for a taxable year if the trust has gross income of $1,000 or 
more included in computing unrelated business taxable income 
for that year (Treas. Reg. sec. 1.6012-3(a)(5)).
    Unrelated business taxable income is the gross income 
(including gross income from a partnership) derived by an 
exempt organization from an unrelated trade or business, less 
certain deductions which are directly connected with the 
carrying on of such trade or business (sec. 512(a)(1). In 
calculating unrelated business taxable income, exempt 
organizations (including IRAs) generally also are permitted a 
specific deduction of $1,000 (sec. 512(b)(12)).

Unified audits of partnerships

    All but certain small partnerships are subject to unified 
audit rules established by the Tax Equity and Fiscal 
Responsibility Act of 1982. These rules require the tax 
treatment of all ``partnership items'' to be determined at the 
partnership, rather than the partner, level. Partnership items 
are those items that are more appropriately determined at the 
partnership level than at the partner level, including such 
items as gross income and deductions of the partnership.

                           Reasons for Change

    Under present law, tax returns often must be filed for IRAs 
that have no taxable income and, consequently, no tax 
liability. The filing of these returns by taxpayers, and the 
processing of these returns by the IRS, impose significant 
costs. Imposing this burden is unnecessary to the extent that 
the income of the IRA has been derived from an interest in a 
partnership that is subject to partnership-level audit rules. 
In these circumstances, the appropriateness of any deductions 
may be determined at the partnership level, and an additional 
filing is unnecessary to facilitate this determination.

                        Explanation of Provision

    The bill modifies the filing threshold for an IRA with an 
interest in a partnership that is subject to the partnership-
level audit rules. A fiduciary of such an IRA could treat the 
trust's share of partnership taxable income as gross income, 
for purposes of determining whether the trust meets the $1,000 
gross income filing threshold. A fiduciary of an IRA that 
receives taxable income from a partnership that is subject to 
partnership-level audit rules of less than $1,000 (before the 
$1,000 specific deduction) is not required to file an income 
tax return if the IRA does not have any other income from an 
unrelated trade or business.

                             Effective Date

    The provision applies to taxable years beginning after 
December 31, 1997.

2. Other partnership audit rules

            a. Treatment of partnership items in deficiency proceedings 
                    (sec. 1031 of the bill and sec. 6234 of the Code)

                              Present Law

    Partnership proceedings under rules enacted in TEFRA 
139 must be kept separate from deficiency 
proceedings involving the partners in their individual 
capacities. Prior to the Tax Court's opinion in Munro v. 
Commissioner, 92 T.C. 71 (1989), the IRS computed deficiencies 
by assuming that all items that were subject to the TEFRA 
partnership procedures were correctly reported on the 
taxpayer's return. However, where the losses claimed from TEFRA 
partnerships were so large that they offset any proposed 
adjustments to nonpartnership items, no deficiency could arise 
from a non-TEFRA proceeding, and if the partnership losses were 
subsequently disallowed in a partnership proceeding, the non-
TEFRA adjustments might be uncollectible because of the 
expiration of the statute of limitations with respect to 
nonpartnership items.
---------------------------------------------------------------------------
    \139\ Tax Equity and Fiscal Responsibility Act of 1982.
---------------------------------------------------------------------------
    Faced with this situation in Munro, the IRS issued a notice 
of deficiency to the taxpayer that presumptively disallowed the 
taxpayer's TEFRA partnership losses for computational purposes 
only. Although the Tax Court ruled that a deficiency existed 
and that the court had jurisdiction to hear the case, the court 
disapproved of the methodology used by the IRS to compute the 
deficiency. Specifically, the court held that partnership items 
(whether income, loss, deduction, or credit) included on a 
taxpayer's return must be completely ignored in determining 
whether a deficiency exists that is attributable to 
nonpartnership items.

                           Reasons for Change

    The opinion in Munro creates problems for both taxpayers 
and the IRS. For example, a taxpayer would be harmed in the 
case where he has invested in a TEFRA partnership and is also 
subject to the deficiency procedures with respect to 
nonpartnership item adjustments, since computing the tax 
liability without regard to partnership items will have the 
same effect as if the partnership items were disallowed. If the 
partnership items were losses, the effect will be a greatly 
increased deficiency for the nonpartnership items. If, when the 
partnership proceedings are completed, the taxpayer is 
ultimately allowed any part of the losses, the taxpayer will 
receive part of the increased deficiency back in the form of an 
overpayment. However, in the interim, thetaxpayer will have 
been subject to assessment and collection of a deficiency inflated by 
items still in dispute in the partnership proceeding. In essence, a 
taxpayer in such a case would be deprived of a prepayment forum with 
respect to the partnership item adjustments. The IRS would be harmed if 
a taxpayer's income is primarily from a TEFRA partnership, since the 
IRS may be unable to adjust nonpartnership items such as medical 
expense deductions, home mortgage interest deductions on charitable 
contribution deductions because there would be no deficiency since, 
under Munro, the income must be ignored.

                        Explanation of Provision

    The bill overrules Munro and allow the IRS to return to its 
prior practice of computing deficiencies by assuming that all 
TEFRA items whose treatment has not been finally determined had 
been correctly reported on the taxpayer's return. This 
eliminates the need to do special computations that involve the 
removal of TEFRA items from a taxpayer's return, and will 
restore to taxpayers a prepayment forum with respect to the 
TEFRA items. In addition, the provision provides a special rule 
to address the factual situation presented in Munro.
    Specifically, the bill provides a declaratory judgment 
procedure in the Tax Court for adjustments to an oversheltered 
return. An oversheltered return is a return that shows no 
taxable income and a net loss from TEFRA partnerships. In such 
a case, the IRS is authorized to issue a notice of adjustment 
with respect to non-TEFRA items, notwithstanding that no 
deficiency would result from the adjustment. However, the IRS 
could only issue such a notice if a deficiency would have 
arisen in the absence of the net loss from TEFRA partnerships.
    The Tax Court is granted jurisdiction to determine the 
correctness of such an adjustment as well as to make a 
declaration with respect to any other item for the taxable year 
to which the notice of adjustment relates, except for 
partnership items and affected items which require partner-
level determinations. No tax is due upon such a determination, 
but a decision of the Tax Court is treated as a final decision, 
permitting an appeal of the decision by either the taxpayer or 
the IRS. An adjustment determined to be correct would thus have 
the effect of increasing the taxable income that is deemed to 
have been reported on the taxpayer's return. If the taxpayer's 
partnership items were then adjusted in a subsequent 
proceeding, the IRS has preserved its ability to collect tax on 
any increased deficiency attributable to the nonpartnership 
items.
    Alternatively, if the taxpayer chooses not to contest the 
notice of adjustment within the 90-day period, the bill 
provides that when the taxpayer's partnership items are finally 
determined, the taxpayer has the right to file a refund claim 
for tax attributable to the items adjusted by the earlier 
notice of adjustment for the taxable year. Although a refund 
claim is not generally permitted with respect to a deficiency 
arising from a TEFRA proceeding, such a rule is appropriate 
with respect to a defaulted notice of adjustment because 
taxpayers may not challenge such a notice when issued since it 
does not require the payment of additional tax.
    In addition, the bill incorporates a number of provisions 
intended to clarify the coordination between TEFRA audit 
proceedings and individual deficiency proceedings. Under these 
provisions, any adjustment with respect to a non-partnership 
item that caused an increase in tax liability with respect to a 
partnership item would be treated as a computational adjustment 
and assessed after the conclusion of the TEFRA proceeding. 
Accordingly, deficiency procedures do not apply with respect to 
this increase in tax liability, and the statute of limitations 
applicable to TEFRA proceedings are controlling.

                             Effective Date

    The provision is effective for partnership taxable years 
ending after the date of enactment.
            b. Partnership return to be determinative of audit 
                    procedures to be followed (sec. 1032 of the bill 
                    and sec. 6231 of the Code)

                              Present Law

    TEFRA established unified audit rules applicable to all 
partnerships, except for partnerships with 10 or fewer 
partners, each of whom is a natural person (other than a 
nonresident alien) or an estate, and for which each partner's 
share of each partnership item is the same as that partner's 
share of every other partnership item. Partners in the exempted 
partnerships are subject to regular deficiency procedures.

                           Reasons for Change

    The IRS often finds it difficult to determine whether to 
follow the TEFRA partnership procedures or the regular 
deficiency procedures. If the IRS determines that there were 
fewer than 10 partners in the partnership but was unaware that 
one of the partners was a nonresident alien or that there was a 
special allocation made during the year, the IRS might 
inadvertently apply the wrong procedures and possibly 
jeopardize any assessment. Permitting the IRS to rely on a 
partnership's return would simplify the IRS' task.

                        Explanation of Provision

    The bill permits the IRS to apply the TEFRA audit 
procedures if, based on the partnership's return for the year, 
the IRS reasonably determines that those procedures should 
apply. Similarly, the provision permits the IRS to apply the 
normal deficiency procedures if, based on the partnership's 
return for the year, the IRS reasonably determines that those 
procedures should apply.

                             Effective Date

    The provision is effective for partnership taxable years 
ending after the date of enactment.
            c. Provisions relating to statute of limitations
              i. Suspend statute when an untimely petition is filed 
                    (sec. 1033(a) of the bill and sec. 6229 of the 
                    Code)

                              Present Law

    In a deficiency case, section 6503(a) provides that if a 
proceeding in respect of the deficiency is placed on the docket 
of the Tax Court, the period of limitations on assessment and 
collection is suspended until the decision of the Tax Court 
becomes final, and for 60 days thereafter. The counterpart to 
this provision with respect to TEFRA cases is contained in 
section 6229(d). That section provides that the period of 
limitations is suspended for the period during which an action 
may be brought under section 6226 and, if an action is brought 
during such period, until the decision of the court becomes 
final, and for 1 year thereafter. As a result of this 
difference in language, the running of the statute of 
limitations in a TEFRA case will only be tolled by the filing 
of a timely petition whereas in a deficiency case, the statute 
of limitations is tolled by the filing of any petition, 
regardless of whether the petition is timely.

                           Reasons for Change

    Under present law, if an untimely petition is filed in a 
TEFRA case, the statute of limitations can expire while the 
case is still pending before the court. To prevent this from 
occurring, the IRS must make assessments against all of the 
investors during the pendency of the action and if the action 
is in the Tax Court, presumably abate such assessments if the 
court ultimately determines that the petition was timely. These 
steps are burdensome to the IRS and to taxpayers.

                        Explanation of Provision

    The bill conforms the suspension rule for the filing of 
petitions in TEFRA cases with the rule under section 6503(a) 
pertaining to deficiency cases. Under the provision, the 
statute of limitations in TEFRA cases is suspended by the 
filing of any petition under section 6226, regardless of 
whether the petition is timely or valid, and the suspension 
will remain in effect until the decision of the court becomes 
final, and for one year thereafter. Hence, if the statute of 
limitations is open at the time that an untimely petition is 
filed, the limitations period would no longer continue to run 
and possibly expire while the action is pending before the 
court.

                             Effective Date

    The provision is effective with respect to all cases in 
which the period of limitations has not expired under present 
law as of the date of enactment.
              ii. Suspend statute of limitations during bankruptcy 
                    proceedings (sec. 1033(b) of the bill and sec. 6229 
                    of the Code)

                              Present Law

    The period for assessing tax with respect to partnership 
items generally is the longer of the periods provided by 
section 6229 or section 6501. For partnership items that 
convert to nonpartnership items, section 6229(f) provides that 
the period for assessing tax shall not expire before the date 
which is 1 year after the date that the items become 
nonpartnership items. Section 6503(h) provides for the 
suspension of the limitations period during the pendency of a 
bankruptcy proceeding. However, this provision only applies to 
the limitations periods provided in sections 6501 and 6502.
    Under present law, because the suspension provision in 
section 6503(h) applies only to the limitations periods 
provided in section 6501 and 6502, some uncertainty exists as 
to whether section 6503(h) applies to suspend the limitations 
period pertaining to converted items provided in section 
6229(f) when a petition naming a partner as a debtor in a 
bankruptcy proceeding is filed. As a result, the limitations 
period provided in section 6229(f) may continue to run during 
the pendency of the bankruptcy proceeding, notwithstanding that 
the IRS is prohibited from making an assessment against the 
debtor because of the automatic stay provisions of the 
Bankruptcy Code.

                           Reasons for Change

    The ambiguity in present law makes it difficult for the IRS 
to adjust partnership items that convert to nonpartnership 
items by reason of a partner going into bankruptcy. In 
addition, any uncertainty may result in increased requests for 
the bankruptcy court to lift the automatic stay to permit the 
IRS to make an assessment with respect to the converted items.

                        Explanation of Provision

    The bill clarifies that the statute of limitations is 
suspended for a partner who is named in a bankruptcy petition. 
The suspension period is for the entire period during which the 
IRS is prohibited by reason of the bankruptcy proceeding from 
making an assessment, and for 60 days thereafter. The provision 
does not purport to create any inference as to the proper 
interpretation of present law.

                             Effective Date

    The provision is effective with respect to all cases in 
which the period of limitations has not expired under present 
law as of the date of enactment.
              iii. Extend statute of limitations for bankrupt TMPs 
                    (sec. 1033(c) of the bill and sec. 6229 of the 
                    Code)

                              Present Law

    Section 6229(b)(1)(B) provides that the statute of 
limitations is extended with respect to all partners in the 
partnership by an agreement entered into between the tax 
matters partner (TMP) and the IRS. However, Temp. Treas. Reg. 
secs. 301.6231(a)(7)-1T(1)(4) and 301.6231(c)-7T(a) provide 
that upon the filing of a petition naming a partner as a debtor 
in a bankruptcy proceeding, that partner's partnership items 
convert to nonpartnership items, and if the debtor was the tax 
matters partner, such status terminates. These rules are 
necessary because of the automatic stay provision contained in 
11 U.S.C. sec. 362(a)(8). As a result, if a consent to extend 
the statute of limitations is signed by a person who would be 
the TMP but for the fact that at the time that the agreement is 
executed the person was a debtor in a bankruptcy proceeding, 
the consent would notbe binding on the other partners because 
the person signing the agreement was no longer the TMP at the time that 
the agreement was executed.

                           Reasons for Change

    The IRS is not automatically notified of bankruptcy filings 
and cannot easily determine whether a taxpayer is in 
bankruptcy, especially if the audit of the partnership is being 
conducted by one district and the taxpayer resides in another 
district, as is frequently the situation in TEFRA cases. If the 
IRS does not discover that a person signing a consent is in 
bankruptcy, the IRS may mistakenly rely on that consent. As a 
result, the IRS may be precluded from assessing any tax 
attributable to partnership item adjustments with respect to 
any of the partners in the partnership.

                        Explanation of Provision

    The bill provides that unless the IRS is notified of a 
bankruptcy proceeding in accordance with regulations, the IRS 
can rely on a statute extension signed by a person who is the 
tax matters partner but for the fact that said person was in 
bankruptcy at the time that the person signed the agreement. 
Statute extensions granted by a bankrupt TMP in these cases are 
binding on all of the partners in the partnership. The 
provision is not intended to create any inference as to the 
proper interpretation of present law.

                             Effective Date

    The provision is effective for extension agreements entered 
into after the date of enactment.
            d. Expansion of small partnership exception (sec. 1034 of 
                    the bill and sec. 6231 of the Code)

                              Present Law

    TEFRA established unified audit rules applicable to all 
partnerships, except for partnerships with 10 or fewer 
partners, each of whom is a natural person (other than a 
nonresident alien) or an estate, and for which each partner's 
share of each partnership item is the same as that partner's 
share of every other partnership item. Partners in the exempted 
partnerships are subject to regular deficiency procedures.

                           Reasons for Change

    The mere existence of a C corporation as a partner or of a 
special allocation does not warrant subjecting the partnership 
and its partners of an otherwise small partnership to the TEFRA 
procedures.

                        Explanation of Provision

    The bill permits a small partnership to have a C 
corporation as a partner or to specially allocate items without 
jeopardizing its exception from the TEFRA rules. However, the 
provision retains the prohibition of present law against having 
a flow-through entity (other than an estate of a deceased 
partner) as a partner for purposes of qualifying for the small 
partnership exception.

                             Effective Date

    The provision is effective for partnership taxable years 
ending after the date of enactment.
            e. Exclusion of partial settlements from 1-year limitation 
                    on assessment (sec. 1035 of the bill and sec. 
                    6229(f) of the Code)

                              Present Law

    The period for assessing tax with respect to partnership 
items generally is the longer of the periods provided by 
section 6229 or section 6501. For partnership items that 
convert to nonpartnership items, section 6229(f) provides that 
the period for assessing tax shall not expire before the date 
which is 1 year after the date that the items become 
nonpartnership items. Section 6231(b)(1)(C) provides that the 
partnership items of a partner for a partnership taxable year 
become nonpartnership items as of the date the partner enters 
into a settlement agreement with the IRS with respect to such 
items.

                           Reasons for Change

    When a partial settlement agreement is entered into, the 
assessment period for the items covered by the agreement may be 
different than the assessment period for the remaining items. 
This fractured statute of limitations poses a significant 
tracking problem for the IRS and necessitates multiple 
computations of tax with respect to each partner's investment 
in the partnership for the taxable year.

                        Explanation of Provision

    The bill provides that if a partner and the IRS enter into 
a settlement agreement with respect to some but not all of the 
partnership items in dispute for a partnership taxable year and 
other partnership items remain in dispute, the period for 
assessing any tax attributable to the settled items is 
determined as if such agreement had not been entered into. 
Consequently, the limitations period that is applicable to the 
last item to be resolved for the partnership taxable year is 
controlling with respect to all disputed partnership items for 
the partnership taxable year. The provision does not purport to 
create any inference as to the proper interpretation of present 
law.

                             Effective Date

    The provision is effective for settlements entered into 
after the date of enactment.
            f. Extension of time for filing a request for 
                    administrative adjustment (sec. 1036 of the bill 
                    and sec. 6227 of the Code)

                              Present Law

    If an agreement extending the statute is entered into with 
respect to a non-TEFRA statute of limitations, that agreement 
also extends the statute of limitations for filing refund 
claims (sec. 6511(c)). There is no comparable provision for 
extending the time for filing refund claims with respect to 
partnership items subject to the TEFRA partnership rules.

                           Reasons for Change

    The absence of an extension for filing refund claims in 
TEFRA proceedings hinders taxpayers that may want to agree to 
extend the TEFRA statute of limitations but want to preserve 
their option to file a refund claim later.

                        Explanation of Provision

    The bill provides that if a TEFRA statute extension 
agreement is entered into, that agreement also extends the 
statute of limitations for filing refund claims attributable to 
partnership items or affected items until 6 months after the 
expiration of the limitations period for assessments.

                             Effective Date

    The provision is effective as if included in the amendments 
made by section 402 of the Tax Equity and Fiscal Responsibility 
Act of 1982.
            g. Availability of innocent spouse relief in context of 
                    partnership proceedings (sec. 1037 of the bill and 
                    sec. 6230 of the Code)

                              Present Law

    In general, an innocent spouse may be relieved of liability 
for tax, penalties and interest if certain conditions are met 
(sec. 6013(e)). However, existing law does not provide the 
spouse of a partner in a TEFRA partnership with a judicial 
forum to raise the innocent spouse defense with respect to any 
tax or interest that relates to an investment in a TEFRA 
partnership.

                           Reasons for Change

    Providing a forum in which to raise the innocent spouse 
defense with respect to liabilities attributable to adjustments 
to partnership items (including penalties, additions to tax and 
additional amounts) would make the innocent spouse rules more 
uniform.

                        Explanation of Provision

    The bill provides both a prepayment forum and a refund 
forum for raising the innocent spouse defense in TEFRA cases.
    With respect to a prepayment forum, the provision provides 
that within 60 days of the date that a notice of computational 
adjustment relating to partnership items is mailed to the 
spouse of a partner, the spouse could request that the 
assessment be abated. Upon receipt of such a request, the 
assessment is abated and any reassessment will be subject to 
the deficiency procedures. If an abatement is requested, the 
statute of limitations does not expire before the date which is 
60 days after the date of the abatement. If the spouse files a 
petition with the Tax Court, the Tax Court only has 
jurisdiction to determine whether the requirements of section 
6013(e) have been satisfied. In making this determination, the 
treatment of the partnership items that gave rise to the 
liability in question is conclusive.
    Alternatively, the bill provides that the spouse of a 
partner could file a claim for refund to raise the innocent 
spouse defense. The claim has to be filed within 6 months from 
the date that the notice of computational adjustment is mailed 
to the spouse. If the claim is not allowed, the spouse could 
file a refund action. For purposes of any claim or suit under 
this provision, the treatment of the partnership items that 
gave rise to the liability in question is conclusive.

                             Effective Date

    The provision is effective as if included in the amendments 
made by section 402 of the Tax Equity and Fiscal Responsibility 
Act of 1982.
            h. Determination of penalties at partnership level (sec. 
                    1038 of the bill and sec. 6221 of the Code)

                              Present Law

    Partnership items include only items that are required to 
be taken into account under the income tax subtitle. Penalties 
are not partnership items since they are contained in the 
procedure and administration subtitle. As a result, penalties 
may only be asserted against a partner through the application 
of the deficiency procedures following the completion of the 
partnership-level proceeding.

                           Reasons for Change

    Many penalties are based upon the conduct of the taxpayer. 
With respect to partnerships, the relevant conduct often occurs 
at the partnership level. In addition, applying penalties at 
the partner level through the deficiency procedures following 
the conclusion of the unified proceeding at the partnership 
level increases the administrative burden on the IRS and can 
significantly increase the Tax Court's inventory.

                        Explanation of Provision

    The bill provides that the partnership-level proceeding is 
to include a determination of the applicability of penalties at 
the partnership level. However, the provision allows partners 
to raise any partner-level defenses in a refund forum.

                             Effective Date

    The provision is effective for partnership taxable years 
ending after the date of enactment.
            i. Provisions relating to Tax Court jurisdiction (sec. 1039 
                    of the bill and secs. 6225 and 6226 of the Code)

                              Present Law

    Improper assessment and collection activities by the IRS 
during the 150-day period for filing a petition or during the 
pendency of any Tax Court proceeding, ``may be enjoined in the 
proper court.'' Present law may be unclear as to whether this 
includes the Tax Court.
    For a partner other than the Tax Matters Partner to be 
eligible to file a petition for redetermination of partnership 
items in any court or to participate in an existing case, the 
period for assessing any tax attributable to the partnership 
items of that partner must not have expired. Since such a 
partner would only be treated as a party to the action if the 
statute of limitations with respect to them was still open, the 
law is unclear whether the partner would have standing to 
assert that the statute of limitations had expired with respect 
to them.

                           Reasons for Change

    Clarifying the Tax Court's jurisdiction simplifies the 
resolution of tax cases.

                        Explanation of Provision

    The bill clarifies that an action to enjoin premature 
assessments of deficiencies attributable to partnership items 
may be brought in the Tax Court. The provision also permits a 
partner to participate in an action or file a petition for the 
sole purpose of asserting that the period of limitations for 
assessing any tax attributable to partnership items has expired 
for that person. Additionally, the provision clarifies that the 
Tax Court has overpayment jurisdiction with respect to affected 
items.

                             Effective Date

    The provision is effective for partnership taxable years 
ending after the date of enactment.
            j. Treatment of premature petitions filed by notice 
                    partners or 5-percent groups (sec. 1040 of the bill 
                    and sec. 6226 of the Code)

                              Present Law

    The Tax Matters Partner is given the exclusive right to 
file a petition for a readjustment of partnership items within 
the 90-day period after the issuance of the notice of a final 
partnership administrative adjustment (FPAA). If the Tax 
Matters Partner does not file a petition within the 90-day 
period, certain other partners are permitted to file a petition 
within the 60-day period after the close of the 90-day period. 
There are ordering rules for determining which action goes 
forward and for dismissing other actions.

                           Reasons for Change

    A petition that is filed within the 90-day period by a 
person who is not the Tax Matters Partner is dismissed. Thus, 
if the Tax Matters Partner does not file a petition within the 
90-day period and no timely and valid petition is filed during 
the succeeding 60-day period, judicial review of the 
adjustments set forth in the notice of FPAA is foreclosed and 
the adjustments are deemed to be correct.

                        Explanation of Provision

    The bill treats premature petitions filed by certain 
partners within the 90-day period as being filed on the last 
day of the following 60-day period under specified 
circumstances, thus affording the partnership with an 
opportunity for judicial review that is not available under 
present law.

                             Effective Date

    The provision is effective with respect to petitions filed 
after the date of enactment.
            k. Bonds in case of appeals from certain proceedings (sec. 
                    1041 of the bill and sec. 7485 of the Code)

                              Present Law

    A bond must be filed to stay the collection of deficiencies 
pending the appeal of the Tax Court's decision in a TEFRA 
proceeding. The amount of the bond must be based on the court's 
estimate of the aggregate deficiencies of the partners.

                           Reasons for Change

    The Tax Court cannot easily determine the aggregate changes 
in tax liability of all of the partners in a partnership who 
will be affected by the Court's decision in the proceeding. 
Clarifying the calculation of the bond amount would simplify 
the Tax Court's task.

                        Explanation of Provision

    The bill clarifies that the amount of the bond should be 
based on the Tax Court's estimate of the aggregate liability of 
the parties to the action (and not all of the partners in the 
partnership). For purposes of this provision, the amount of the 
bond could be estimated by applying the highest individual rate 
to the total adjustments determined by the Tax Court and 
doubling that amount to take into account interest and 
penalties.

                             Effective Date

    The provision is effective as if included in the amendments 
made by section 402 of the Tax Equity and Fiscal Responsibility 
Act of 1982.
            l. Suspension of interest where delay in computational 
                    adjustment resulting from certain settlements (sec. 
                    1042 of the bill and sec. 6601 of the Code)

                              Present Law

    Interest on a deficiency generally is suspended when a 
taxpayer executes a settlement agreement with the IRS and 
waives the restrictions on assessments and collections, and the 
IRS does not issue a notice and demand for payment of such 
deficiency within 30 days. Interest on a deficiency that 
results from an adjustment of partnership items in TEFRA 
proceedings, however, is not suspended.

                           Reasons for Change

    Processing settlement agreements and assessing the tax due 
takes a substantial amount of time in TEFRA cases. A taxpayer 
is not afforded any relief from interest during this period.

                        Explanation of Provision

    The bill suspends interest where there is a delay in making 
a computational adjustment relating to a TEFRA settlement.

                             Effective Date

    The provision is effective with respect to adjustments 
relating to taxable years beginning after the date of 
enactment.
            m. Special rules for administrative adjustment requests 
                    with respect to bad debts or worthless securities 
                    (sec. 1043 of the bill and sec. 6227 of the Code)

                              Present Law

    The non-TEFRA statute of limitations for filing a claim for 
credit or refund generally is the later of (1) three years from 
the date the return in question was filed or (2) two years from 
the date the claimed tax was paid, whichever is later (sec. 
6511(b)). However, an extended period of time, seven years from 
the date the return was due, is provided for filing a claim for 
refund of an overpayment resulting from a deduction for a 
worthless security or bad debt (sec. 6511(d)).
    Under the TEFRA partnership rules, a request for 
administrative adjustment (``RAA'') must be filed within three 
years after the later of (1) the date the partnership return 
was filed or (2) the due date of the partnership return 
(determined without regard to extensions) (sec. 6227(a)(1)). In 
addition, the request must be filed before a final partnership 
administrative adjustment (``FPAA'') is mailed for the taxable 
year (sec. 6227(a)(2)). There is no special provision for 
extending the time for filing an RAA that relates to a 
deduction for a worthless security or an entirely worthless bad 
debt.

                           Reasons for Change

    Whether and when a stock or debt becomes worthless is a 
question of fact that may not be determinable until after the 
year in which it appears the loss has occurred. An extended 
statute of limitations allows partners in a TEFRA partnership 
the same opportunity to file a delayed claim for refund in 
these difficult factual situations as other taxpayers are 
permitted.
    Further, on past occasions, the IRS issued FPAAs that did 
not adjust the partnership's tax return. This action created 
wasteful paperwork, and may have, in some cases truncated the 
appeals rights of individual partners. A special rule is 
necessary to permit partners who may have been adversely 
impacted by this past practice of the IRS to avail themselves 
of the extended period irrespective of whether an FPAA has been 
issued.

                        Explanation of Provision

    The bill extends the time for the filing of an RAA relating 
to the deduction by a partnership for a worthless security or 
bad debt. In these circumstances, in lieu of the three-year 
period provided in sec. 6227(a)(1), the period for filing an 
RAA is seven years from the date the partnership return was due 
with respect to which the request is made (determined without 
regard to extensions). The RAA is still required to be filed 
before the FPAA is mailed for the taxable year.

                             Effective Date

    The provision is effective as if included in the amendments 
made by section 402 of the Tax Equity and Fiscal Responsibility 
Act of 1982.

3. Closing of partnership taxable year with respect to deceased partner 
        (sec. 1046 of the bill and sec. 706(c)(2)(A) of the Code)

                              Present Law

    The partnership taxable year closes with respect to a 
partner whose entire interest is sold, exchanged, or 
liquidated. Such year, however, generally does not close upon 
the death of a partner. Thus, a decedent's entire share of 
items of income, gain, loss, deduction and credit for the 
partnership year in which death occurs is taxed to the estate 
or successor in interest rather than to the decedent on his or 
her final income tax return. See Estate of Hesse v. 
Commissioner, 74 T.C. 1307, 1311 (1980).

                           Reasons for Change

    The rule leaving open the partnership taxable year with 
respect to a deceased partner was adopted in 1954 to prevent 
the bunching of income that could occur with respect to a 
partnership reporting on a fiscal year other than the calendar 
year. Without this rule, as many as 23 months of income might 
have been reported on the partner's final return. Legislative 
changes occurring since 1954 have required most partnerships to 
adopt a calendar year, reducing the possibility of bunching. 
Consequently, income and deductions are better matched if the 
partnership taxable year closes upon a partner's death and 
partnership items are reported on the decedent's last return.
    Present law closes the partnership taxable year with 
respect to a deceased partner only if the partner's entire 
interest is sold or exchanged pursuant to an agreement existing 
at the time of death. By closing the taxable year automatically 
upon death, the provision reduces the need for such agreements.

                        Explanation of Provision

    The provision provides that the taxable year of a 
partnership closes with respect to a partner whose entire 
interest in the partnership terminates, whether by death, 
liquidation or otherwise. The provision does not change present 
law with respect to the effect upon the partnership taxable 
year of a transfer of a partnership interest by a debtor to the 
debtor's estate (under Chapters 7 or 11 of Title 11, relating 
to bankruptcy).

                             Effective Date

    The provision applies to partnership taxable years 
beginning after December 31, 1997.

  D. Modifications of Rules for Real Estate Investment Trusts (secs. 
        1051-1063 of the bill and secs. 856 and 857 of the Code)

                              Present Law

Overview

    In general, a real estate investment trust (``REIT'') is an 
entity that receives most of its income from passive real 
estate related investments and that receives conduit treatment 
for income that is distributed to shareholders. If an entity 
meets the qualifications for REIT status, the portion of its 
income that is distributed to the investors each year generally 
is taxed to the investors without being subjected to a tax at 
the REIT level; the REIT generally is subject to a corporate 
tax only on the income that it retains and on certain income 
from property that qualifies as foreclosure property.

Election to be treated as a REIT

    In order to qualify as a REIT, and thereby receive conduit 
treatment, an entity must elect REIT status. A newly-electing 
entity generally cannot have earnings and profits accumulated 
from any year in which the entity was in existence and not 
treated as a REIT (sec. 857(a)(3)). To satisfy this 
requirement, the entity must distribute, during its first REIT 
taxable year, any earnings and profits that were accumulated in 
non-REIT years. For this purpose, distributions by the entity 
generally are treated as being made from the most recently 
accumulated earnings and profits.

Taxation of REITs

            Overview
    In general, if an entity qualifies as a REIT by satisfying 
the various requirements described below, the entity is taxable 
as a corporation on its ``real estate investment trust taxable 
income'' (``REITTI''), and also is taxable on certain other 
amounts (sec. 857). REITTI is the taxable income of the REIT 
with certain adjustments (sec. 857(b)(2)). The most significant 
adjustment is a deduction for dividends paid. The allowance of 
this deduction is the mechanism by which the REIT becomes a 
conduit for income tax purposes.
            Capital gains
    A REIT that has a net capital gain for a taxable year 
generally is subject to tax on such capital gain under the 
capital gains tax regime generally applicable to corporations 
(sec. 857(b)(3)). However, a REIT may diminish or eliminate its 
tax liability attributable to such capital gain by paying a 
``capital gain dividend'' to its shareholders (sec. 
857(b)(3)(C)). A capital gain dividend is any dividend or part 
of a dividend that is designated by the payor REIT as a capital 
gain dividend in a written notice mailed to shareholders. 
Shareholders who receive capital gain dividends treat the 
amount of such dividends as long-term capital gain regardless 
of their holding period of the stock (sec. 857(b)(3)(C)).
    A regulated investment company (``RIC''), but not a REIT, 
may elect to retain and pay income tax on net long-term capital 
gains it received during the tax year. If a RIC makes this 
election, the RIC shareholders must include in their income as 
long-term capital gains their proportionate share of these 
undistributed long-term capital gains as designated by the RIC. 
The shareholder is deemed to have paid the shareholder's share 
of the tax, which can be credited or refunded to the 
shareholder. Also, the basis of the shareholder's shares is 
increased by the amount of the undistributed long-term capital 
gains (less the amount of capital gains tax paid by the RIC) 
included in the shareholder's long-term capital gains.
            Income from foreclosure property
    In addition to tax on its REITTI, a REIT is subject to tax 
at the highest rate of tax paid by corporations on its net 
income from foreclosure property (sec. 857(b)(4)). Net income 
from foreclosure property is the excess of the sum of gains 
from foreclosure property that is held for sale to customers in 
the ordinary course of a trade or business and gross income 
from foreclosure property (other than income that otherwise 
would qualify under the 75-percent income test described below) 
over all allowable deductions directly connected with the 
production of such income.
    Foreclosure property is any real property or personal 
property incident to such real property that is acquired by a 
REIT as a result of default or imminent default on a lease of 
such property or indebtedness secured by such property, 
provided that (unless acquired as foreclosure property), such 
property was not held by the REIT for sale to customers (sec. 
856(e)). A property generally may be treated as foreclosure 
property for a period of two years after the date the property 
is acquired by the REIT. The IRS may grant extensions of the 
period for treating the property as foreclosure property if the 
REIT establishes that an extension of the grace period is 
necessary for the orderly liquidation of the REIT's interest in 
the property. The grace period cannot be extended beyond six 
years from the date the property is acquired by the REIT.
    Property will cease to be treated as foreclosure property 
if, after 90 days after the date of acquisition, the REIT 
operates the foreclosure property in a trade or business other 
than through an independent contractor from whom the REIT does 
not derive or receive any income (sec. 856(e)(4)(C)).
            Income or loss from prohibited transactions
    In general, a REIT must derive its income from passive 
sources and not engage in any active trade or business. 
Accordingly, in addition to the tax on its REITTI and on its 
net income from foreclosure property, a 100 percent tax is 
imposed on the net income of a REIT from ``prohibited 
transactions'' (sec. 857(b)(6)). A prohibited transaction is 
the sale or other disposition of property described in section 
1221(1) of the Code (property held for sale in the ordinary 
course of a trade or business) other than foreclosure property. 
Thus, the 100 percent tax on prohibited transactions helps to 
ensure that the REIT is a passive entity and may not engage in 
ordinary retailing activities such as sales to customers of 
condominium units or subdivided lots in a development project. 
A safe harbor is provided for certain sales that otherwise 
might be considered prohibited transactions (sec. 
857(b)(6)(C)). The safe harbor is limited to seven or fewer 
sales ayear or, alternatively, any number of sales provided 
that the aggregate adjusted basis of the property sold does not exceed 
10 percent of the aggregate basis of all the REIT's assets at the 
beginning of the REIT's taxable year.

Requirements for REIT status

    A REIT must satisfy four tests on a year-by-year basis: 
organizational structure, source of income, nature of assets, 
and distribution of income. These tests are intended to allow 
conduit treatment in circumstances in which a corporate tax 
otherwise would be imposed, only if there really is a pooling 
of investment arrangement that is evidenced by its 
organizational structure, if its investments are basically in 
real estate assets, and if its income is passive income from 
real estate investment, as contrasted with income from the 
operation of business involving real estate. In addition, 
substantially all of the entity's income must be passed through 
to its shareholders on a current basis.

Organizational structure requirements

    To qualify as a REIT, an entity must be for its entire 
taxable year a corporation or an unincorporated trust or 
association that would be taxable as a domestic corporation but 
for the REIT provisions, and must be managed by one or more 
trustees (sec. 856(a)). The beneficial ownership of the entity 
must be evidenced by transferable shares or certificates of 
ownership. Except for the first taxable year for which an 
entity elects to be a REIT, the beneficial ownership of the 
entity must be held by 100 or more persons, and the entity may 
not be so closely held by individuals that it would be treated 
as a personal holding company if all its adjusted gross income 
constituted personal holding company income. A REIT is 
disqualified for any year in which it does not comply with 
regulations to ascertain the actual ownership of the REIT's 
outstanding shares.

Income requirements

            Overview
    In order for an entity to qualify as a REIT, at least 95 
percent of its gross income generally must be derived from 
certain passive sources (the ``95-percent test''). In addition, 
at least 75 percent of its income generally must be from 
certain real estate sources (the ``75-percent test''), 
including rents from real property.
    In addition, less than 30 percent of the entity's gross 
income may be derived from gain from the sale or other 
disposition of stock or securities held for less than one year, 
real property held less than four years (other than foreclosure 
property, or property subject to an involuntary conversion 
within the meaning of sec. 1033), and property that is sold or 
disposed of in a prohibited transaction (sec. 856(c)(4)).
            Definition of rents
    For purposes of the income requirements, rents from real 
property generally include rents from interests in real 
property, charges for services customarily rendered or 
furnished in connection with the rental of real property, 
whether or not such charges are separately stated, and rent 
attributable to personal property that is leased under or in 
connection with a lease of real property, but only if the rent 
attributable to such personal property does not exceed 15 
percent of the total rent for the year under the lease (sec. 
856(d)(1)).
    Services provided to tenants are regarded as customary if, 
in the geographic market within which the building is located, 
tenants in buildings that are of a similar class (for example, 
luxury apartment buildings) are customarily provided with the 
service. The furnishing of water, heat, light, and air 
conditioning, the cleaning of windows, public entrances, exits, 
and lobbies, the performance of general maintenance, and of 
janitorial and cleaning services, the collection of trash, the 
furnishing of elevator services, telephone answering services, 
incidental storage space, laundry equipment, watchman or guard 
service, parking facilities and swimming pool facilities are 
examples of services that are customarily furnished to tenants 
of a particular class of buildings in many geographical 
marketing areas (Treas. Reg. sec. 1.856-4(b)).
    In addition, amounts are not treated as qualifying rent if 
received from certain parties in which the REIT has an 
ownership interest of 10 percent or more (sec. 856(d)(2)(B)). 
For purposes of determining the REIT's ownership interest in a 
tenant, the attribution rules of section 318 apply, except that 
10 percent is substituted for 50 percent where it appears in 
subparagraph (C) of section 318(a)(2) and 318(a)(3) (sec. 
856(d)(5)).
    Finally, where a REIT furnishes or renders services to the 
tenants of rented property, amounts received or accrued with 
respect to such property generally are not treated as 
qualifying rents unless the services are furnished through an 
independent contractor (sec. 856(d)(2)(C)). A REIT may furnish 
or render a service directly, however, if the service would not 
generate unrelated business taxable income under section 
512(b)(3) if provided by an organization described in section 
511(a)(2). In general, an independent contractor is a person 
who does not own more than a 35 percent interest in the REIT, 
and in which no more than a 35 percent interest is held by 
persons with a 35 percent or greater interest in the REIT (sec. 
856(d)(3)).
            Hedging instruments
    Interest rate swaps or cap agreements that protect a REIT 
from interest rate fluctuations on variable rate debt incurred 
to acquire or carry real property are treated as securities 
under the 30-percent test and payments under these agreements 
are treated as qualifying under the 95-percent test (sec. 
856(c)(6)(G)).
            Treatment of shared appreciation mortgages
    For purposes of the income requirements for qualification 
as a REIT, and for purposes of the prohibited transaction 
provisions, any income derived from a ``shared appreciation 
provision'' is treated as gain recognized on the sale of the 
``secured property.'' For these purposes, a shared appreciation 
provision is any provision that is in connection with an 
obligation that is held by the REIT and secured by an interest 
in real property, which provision entitles the REIT to receive 
a specified portion of any gain realized on the sale or 
exchange of such real property (or of any gain that would be 
realized if the property were sold on a specified date). 
Secured property for thesepurposes means the real property that 
secures the obligation that has the shared appreciation provision.
    In addition, for purposes of the income requirements for 
qualification as a REIT, and for purposes of the prohibited 
transactions provisions, the REIT is treated as holding the 
secured property for the period during which it held the shared 
appreciation provision (or, if shorter, the period during which 
the secured property was held by the person holding such 
property), and the secured property is treated as property 
described in section 1221(1) if it is such property in the 
hands of the obligor on the obligation to which the shared 
appreciation provision relates (or if it would be such property 
if held by the REIT). For purposes of the prohibited 
transaction safe harbor, the REIT is treated as having sold the 
secured property at the time that it recognizes income on 
account of the shared appreciation provision, and any 
expenditures made by the holder of the secured property are 
treated as made by the REIT.

Asset requirements

    To satisfy the asset requirements to qualify for treatment 
as a REIT, at the close of each quarter of its taxable year, an 
entity must have at least 75 percent of the value of its assets 
invested in real estate assets, cash and cash items, and 
government securities (sec. 856(c)(5)(A)). Moreover, not more 
than 25 percent of the value of the entity's assets can be 
invested in securities of any one issuer (other than government 
securities and other securities described in the preceding 
sentence). Further, these securities may not comprise more than 
five percent of the entity's assets or more than 10 percent of 
the outstanding voting securities of such issuer (sec. 
856(c)(5)(B)). The term real estate assets is defined to mean 
real property (including interests in real property and 
mortgages on real property) and interests in REITs (sec. 
856(c)(6)(B)).

REIT subsidiaries

    Under present law, all the assets, liabilities, and items 
of income, deduction, and credit of a ``qualified REIT 
subsidiary'' are treated as the assets, liabilities, and 
respective items of the REIT that owns the stock of the 
qualified REIT subsidiary. A subsidiary of a REIT is a 
qualified REIT subsidiary if and only if 100 percent of the 
subsidiary's stock is owned by the REIT at all times that the 
subsidiary is in existence. If at any time the REIT ceases to 
own 100 percent of the stock of the subsidiary, or if the REIT 
ceases to qualify for (or revokes an election of) REIT status, 
such subsidiary is treated as a new corporation that acquired 
all of its assets in exchange for its stock (and assumption of 
liabilities) immediately before the time that the REIT ceased 
to own 100 percent of the subsidiary's stock, or ceased to be a 
REIT as the case may be.

Distribution requirements

    To satisfy the distribution requirement, a REIT must 
distribute as dividends to its shareholders during the taxable 
year an amount equal to or exceeding (i) the sum of 95 percent 
of its REITTI other than net capital gain income and 95 percent 
of the excess of its net income from foreclosure property over 
the tax imposed on that income minus (ii) certain excess 
noncash income (described below).
    Excess noncash items include (a) the excess of the amounts 
that the REIT is required to include in income under section 
467 with respect to certain rental agreements involving 
deferred rents, over the amounts that the REIT otherwise would 
recognize under its regular method of accounting, (2) in the 
case of a REIT using the cash method of accounting, the excess 
of the amount of original issue discount and coupon interest 
that the REIT is required to take into account with respect to 
a loan to which section 1274 applies, over the amount of money 
and fair market value of other property received with respect 
to the loan, and (3) income arising from the disposition of a 
real estate asset in certain transactions that failed to 
qualify as like-kind exchanges under section 1031.

                           Reasons for Change

    The REIT serves as a means whereby numerous small investors 
can have a practical opportunity to invest in a diversified 
portfolio of real estate assets and have the benefit of 
professional management. The committee believes that the asset 
requirements of present law ensure that a REIT acts as a pass-
through entity for taxpayers wishing to invest in real estate. 
Therefore, the committee finds the 30-percent gross income test 
unnecessary and administratively burdensome. The committee 
further finds that financial markets have changed over the past 
decade such that interest risk can be managed by many 
strategies other than swaps and caps. Recognizing these 
developments in the financial markets, the committee believes 
it necessary to modify the classification of income from 
certain hedging instruments to provide flexibility to REITs in 
managing risk for their shareholders. The committee also 
believes that, as a pass- through entity, REITs should be 
permitted to retain the proceeds of realized capital gains in a 
manner comparable to that accorded to RICs.

                       Explanation of Provisions

Overview

    The bill modifies many of the provisions relating to the 
requirements for qualification as, and the taxation of, a REIT. 
In particular, the modifications relate to the general 
requirements for qualification as a REIT, the taxation of a 
REIT, the income requirements for qualification as a REIT, and 
certain other provisions.

Clarification of limitation on maximum number of shareholders (sec. 
        1051 of the bill and secs. 856 (k), 857(a), and 857(f) of the 
        Code)

    The bill replaces the rule that disqualifies a REIT for any 
year in which the REIT failed to comply with Treasury 
regulations to ascertain its ownership, with an intermediate 
penalty for failing to do so. The penalty would be $25,000 
($50,000 for intentional violations) for any year in which the 
REIT did not comply with the ownership regulations. The REIT 
also is required, when requested by the IRS, to send curative 
demand letters.
    In addition, a REIT that complied with the Treasury 
regulations for ascertaining its ownership, and which did not 
know, or have reason to know, that it was so closely held as to 
beclassified as a personal holding company, is treated as 
meeting the requirement that it not be a personal holding company.

De minimis rule for tenant service income (sec. 1052 of the bill and 
        sec. 856(d) of the Code)

    The bill permits a REIT to render a de minimis amount of 
impermissible services to tenants, or in connection with the 
management of property, and still treat amounts received with 
respect to that property as rent. The value of the 
impermissible services may not exceed one percent of the gross 
income from the property. For these purposes, the services may 
not be valued at less than 150 percent of the REIT's direct 
cost of the services.

Attribution rules applicable to tenant ownership (sec. 1053 of the bill 
        and sec. 856(d)(5) of the Code)

    The bill modifies the application of section 318(a)(3)(A) 
(attribution to partnerships) for purposes of defining rent in 
section 856(d)(2), so that attribution occurs only when a 
partner owns a 25 percent or greater interest in the 
partnership.

Credit for tax paid by REIT on retained capital gains (sec. 1054 of the 
        bill and sec. 857(b)(3) of the Code)

    The bill permits a REIT to elect to retain and pay income 
tax on net long-term capital gains it received during the tax 
year, just as a RIC is permitted under present law. Thus, if a 
REIT made this election, the REIT shareholders would include in 
their income as long-term capital gains their proportionate 
share of the undistributed long-term capital gains as 
designated by the REIT. The shareholder would be deemed to have 
paid the shareholder's share of the tax, which would be 
credited or refunded to the shareholder. Also, the basis of the 
shareholder's shares would be increased by the amount of the 
undistributed long-term capital gains (less the amount of 
capital gains tax paid by the REIT) included in the 
shareholder's long-term capital gains.

Repeal of 30-percent gross income requirement (sec. 1055 of the bill 
        and sec. 856(c) of the Code)

    The bill repeals the rule that requires less than 30 
percent of a REIT's gross income be derived from gain from the 
sale or other disposition of stock or securities held for less 
than one year, certain real property held less than four years, 
and property that is sold or disposed of in a prohibited 
transaction.

Modification of earnings and profits for determining whether REIT has 
        earnings and profits from non-REIT year (sec. 1056 of the bill 
        and sec. 857(d) of the Code)

    The bill changes the ordering rule for purposes of the 
requirement that newly-electing REITs distribute earnings and 
profits that were accumulated in non-REIT years. Under the 
bill, distributions of accumulated earnings and profits 
generally are treated as made from the entity's earliest 
accumulated earnings and profits, rather than the most recently 
accumulated earnings and profits. These distributions are not 
treated as distributions for purposes of calculating the 
dividends paid deduction.

Treatment of foreclosure property (sec. 1057 of the bill and sec. 
        856(e) of the Code)

    The bill lengthens the original grace period for 
foreclosure property until the last day of the third full 
taxable year following the election. The grace period also 
could be extended for an additional three years by filing a 
request to the IRS. Under the bill, a REIT could revoke an 
election to treat property as foreclosure property for any 
taxable year by filing a revocation on or before its due date 
for filing its tax return.
    In addition, the bill conforms the definition of 
independent contractor for purposes of the foreclosure property 
rule (sec. 856(e)(4)(C)) to the definition of independent 
contractor for purposes of the general rules (sec. 
856(d)(2)(C)).

Payments under hedging instruments (sec. 1058 of the bill and sec. 
        856(c)(5)(G) of the Code)

    The bill treats income from all hedges that reduce the 
interest rate risk of REIT liabilities, not just from interest 
rate swaps and caps, as qualifying income under the 95-percent 
test. Thus, payments to a REIT under an interest rate swap, cap 
agreement, option, futures contract, forward rate agreement or 
any similar financial instrument entered into by the REIT to 
hedge its indebtedness incurred or to be incurred (and any gain 
from the sale or other disposition of these instruments) are 
treated as qualifying income for purposes of the 95-percent 
test.

Excess noncash income (sec. 1059 of the bill and sec. 857(e)(2) of the 
        Code)

    The bill (1) expands the class of excess noncash items that 
are not subject to the distribution requirement to include 
income from the cancellation of indebtedness and (2) extends 
the treatment of original issue discount and coupon interest as 
excess noncash items to REITs that use an accrual method of 
taxation.

Prohibited transaction safe harbor (sec. 1060 of the bill and sec. 
        856(b)(6)(C) of the Code)

    The bill excludes from the prohibited sales rules property 
that was involuntarily converted.

Shared appreciation mortgages (sec. 10-61 of the bill and sec. 856(j) 
        of the Code)

    The bill provides that interest received on a shared 
appreciation mortgage is not subject to the tax on prohibited 
transactions where the property subject to the mortgage is sold 
within 4 years of the REIT's acquisition of the mortgage 
pursuant to a bankruptcy plan of the mortgagor unless the REIT 
that acquired the mortgage knew or had reason to know that the 
property subject to the mortgage would be sold in a bankruptcy 
proceeding.

Wholly-owned REIT subsidiaries (sec. 1062 of the bill and sec. 
        856(i)(2) of the Code)

    The bill permits any corporation wholly-owned by a REIT to 
be treated as a qualified subsidiary, regardless of whether the 
corporation had always been owned by the REIT. Where the REIT 
acquired an existing corporation, the bill treats any such 
corporation as being liquidated as of the time of acquisition 
by the REIT and then reincorporated (thus, any of the 
subsidiary's pre-REIT built-in gain would be subject to tax 
under the normal rules of section 337). In addition, any pre-
REIT earnings and profits of the subsidiary must be distributed 
before the end of the REIT's taxable year.

                             Effective Date

    The bill is effective for taxable years beginning after the 
date of enactment.

   E. Repeal of the 30-percent (``Short-short'') Test for Regulated 
 Investment Companies (sec. 1071 of the Bill and sec. 851(b)(3) of the 
                                 Code)

                              Present Law

    To qualify as a Regulated Investment Company (RIC), a 
company must derive less than 30 percent of its gross income 
from the sale or other disposition of stock or securities held 
for less than 3 months (the ``30-percent test'' or ``short-
short rule'').

                           Reasons for Change

    The short-short rule restricts the investment flexibility 
of RICs. The rule can, for example, limit a RIC's ability to 
``hedge'' its investments (e.g., to use options to protect 
against adverse market moves).
    The rule also burdens a RIC with significant recordkeeping, 
compliance, and administration costs. The RIC must keep track 
of the holding periods of assets and the relative percentages 
of short-term gain that it realizes throughout the year. The 
committee believes that the short-short test places unnecessary 
limitations upon a RIC's activities.

                        Explanation of Provision

    The 30-percent test (or short-short rule) is repealed.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

                        F. Taxpayer Protections

1. Provide reasonable cause exception for additional penalties (sec. 
        1081 of the bill and secs. 6652, 6683, 7519 of the Code)

                              Present Law

    Many penalties in the Code may be waived if the taxpayer 
establishes reasonable cause. For example, the accuracy-related 
penalty (sec. 6662) may be waived with respect to any item if 
the taxpayer establishes reasonable cause for his treatment of 
the item and that he acted in good faith (sec. 6664(c)).

                           Reasons for Change

    The Committee believes that it is appropriate to provide a 
reasonable cause exception for several additional penalties 
where one does not currently exist.

                        Explanation of Provision

    The bill provides that the following penalties may be 
waived if the failure is shown to be due to reasonable cause 
and not willful neglect:
          (1) the penalty for failure to make a report in 
        connection with deductible employee contributions to a 
        retirement savings plan (sec. 6652(g));
          (2) the penalty for failure to make a report as to 
        certain small business stock (sec. 6652(k));
          (3) the penalty for failure of a foreign corporation 
        to file a return of personal holding company tax (sec. 
        6683); and
          (4) the penalty for failure to make required payments 
        for entities electing not to have the required taxable 
        year (sec. 7519).

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment.

2. Clarification of period for filing claims for refunds (sec. 1082 of 
        the bill and sec. 6512 of the Code)

                              Present Law

    The Code contains a series of limitations on tax refunds. 
Section 6511 of the Code provides both a limitation on the time 
period in which a claim for refund can be made (section 
6511(a)) and a limitation on the amount that can be allowed as 
a refund (section 6511(b)). Section 6511(a) provides the 
general rule that a claim for refund must be filed within 3 
years of the date ofthe return or 2 years of the date of 
payment of the taxes at issue, whichever is later. Section 6511(b) 
limits the refund amount that can be covered: if a return was filed, a 
taxpayer can recover amounts paid within 2 years before the claim. 
Section 6512(b)(3) incorporates these rules where taxpayers who 
challenge deficiency notices in Tax Court are found to be entitled to 
refunds.
    In Commissioner v. Lundy, 116 S. Ct. 647 (1996), the 
taxpayer had not filed a return, but received a notice of 
deficiency within 3 years after the date the return was due and 
challenged the proposed deficiency in Tax Court. The Supreme 
Court held that the taxpayer could not recover overpayments 
attributable to withholding during the tax year, because no 
return was filed and the 2-year ``look back'' rule applied. 
Since overwithheld amounts are deemed paid as of the date the 
taxpayer's return was first due (i.e., more than 2 years before 
the notice of deficiency was issued), such overpayments could 
not be recovered. By contrast, if the same taxpayer had filed a 
return on the date the notice of deficiency was issued, and 
then claimed a refund, the 3-year ``look back'' rule would 
apply, and the taxpayer could have obtained a refund of the 
overwithheld amounts.

                           Reasons for Change

    The Committee believes that it is appropriate to eliminate 
this disparate treatment.

                        Explanation of Provision

    The bill permits taxpayers who initially fail to file a 
return, but who receive a notice of deficiency and file suit to 
contest it in Tax Court during the third year after the return 
due date, to obtain a refund of excessive amounts paid within 
the 3-year period prior to the date of the deficiency notice.

                             Effective Date

    The provision applies to claims for refund with respect to 
tax years ending after the date of enactment.

3. Repeal of authority to disclose whether a prospective juror has been 
        audited (sec. 1083 of the bill and sec. 6103 of the Code)

                              Present Law

    In connection with a civil or criminal tax proceeding to 
which the United States is a party, the Secretary must 
disclose, upon the written request of either party to the 
lawsuit, whether an individual who is a prospective juror has 
or has not been the subject of an audit or other tax 
investigation by the Internal Revenue Service (sec. 
6103(h)(5)).

                           Reasons for Change

    This disclosure requirement, as it has been interpreted by 
several recent court decisions, has created significant 
difficulties in the civil and criminal tax litigation process. 
First, the litigation process can be substantially slowed. It 
can take the Secretary a considerable period of time to compile 
the information necessary for a response (some courts have 
required searches going back as far as 25 years). Second, 
providing early release of the list of potential jurors to 
defendants (which several recent court decisions have required, 
to permit defendants to obtain disclosure of the information 
from the Secretary) can provide an opportunity for harassment 
and intimidation of potential jurors in organized crime, drug, 
and some tax protester cases. Third, significant judicial 
resources have been expended in interpreting this procedural 
requirement that might better be spent resolving substantive 
disputes. Fourth, differing judicial interpretations of this 
provision have caused confusion. In some instances, defendants 
convicted of criminal tax offenses have obtained reversals of 
those convictions because of failures to comply fully with this 
provision.

                        Explanation of Provision

    The bill repeals the requirement that the Secretary 
disclose, upon the written request of either party to the 
lawsuit, whether an individual who is a prospective juror has 
or has not been the subject of an audit or other tax 
investigation by the Internal Revenue Service.

                             Effective Date

     The provision is effective for judicial proceedings 
commenced after the date of enactment.

4. Clarify statute of limitations for items from pass-through entities 
        (sec. 1084 of the bill and sec. 6501 of the Code)

                              Present Law

    Pass through entities (such as S corporations, 
partnerships, and certain trusts) generally are not subject to 
income tax on their taxable income. Instead, these entities 
file information returns and the entities' shareholders (or 
beneficial owners) report their pro rata share of the gross 
income and are liable for any taxes due.
    Some believe that, prior to 1993, it may have been unclear 
as to whether the statute of limitations for adjustments that 
arise from distributions from passthrough entities should be 
applied at the entity or individual level (i.e., whether the 3-
year statute of limitations for assessments runs from the time 
that the entity files its information return or from the time 
that a shareholder timely files his or her income tax return). 
In 1993, the Supreme Court held that the limitations period for 
assessing the income tax liability of an S corporation 
shareholder runs from the date the shareholder's return is 
filed (Bufferd v. Comm., 113 S. Ct. 927 (1993)).

                           Reasons for Change

    Uncertainty regarding the correct statute of limitations 
hinders the resolution of factual and legal issues and creates 
needless litigation over collateral matters.

                        Explanation of Provision

    The bill clarifies that the return that starts the running 
of the statute of limitations for a taxpayer is the return of 
the taxpayer and not the return of another person from whom the 
taxpayer has received an item of income, gain, loss, deduction, 
or credit.

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment.

5. Prohibition on browsing (secs. 1084 and 1085 of the bill and secs. 
        7213A and 7431 of the Code)

                              Present Law

    The Internal Revenue Code prohibits disclosure of tax 
returns and return information, except to the extent 
specifically authorized by the Internal Revenue Code (sec. 
6103). Unauthorized willful disclosure is a felony punishable 
by a fine not exceeding $5,000 or imprisonment of not more than 
five years, or both (sec. 7213). An action for civil damages 
also may be brought for unauthorized disclosure (sec. 7431).
    There is no explicit criminal penalty in the Internal 
Revenue Code for unauthorized inspection (absent subsequent 
disclosure) of tax returns and return information. Such 
inspection is, however, explicitly prohibited by the Internal 
Revenue Service (``IRS'').\140\ In a recent case, an individual 
was convicted of violating the Federal wire fraud statute (18 
U.S.C. 1343 and 1346) and a Federal computer fraud statute (18 
U.S.C. 1030) for unauthorized inspection. However, the U.S. 
First Circuit Court of Appeals overturned this conviction.\141\ 
Unauthorized inspection of information of any department or 
agency of the United States (including the IRS) via computer 
was made a crime under 18 U.S.C. 1030 by the Economic Espionage 
Act of 1996.\142\ This provision does not apply to unauthorized 
inspection of paper documents.
---------------------------------------------------------------------------
    \140\ IRS Declaration of Privacy Principles, May 9, 1994.
    \141\ U.S. v. Czubinski, DTR 2/25/97, p. K-2.
    \142\ P.L. 104-294, sec. 201 (October 11, 1996).
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee believes that it is important to have a 
criminal penalty in the Internal Revenue Code to punish this 
type of behavior. The Committee also believes that it is 
appropriate to provide for civil damages for unauthorized 
inspection parallel to civil damages for unauthorized 
disclosure.

                       Explanation of Provisions

Criminal penalties

    The bill creates a new criminal penalty in the Internal 
Revenue Code. The penalty is imposed for willful inspection 
(except as authorized by the Code) of any tax return or return 
information by any Federal employee or IRS contractor. The 
penalty also applies to willful inspection (except as 
authorized) by any State employee or other person who acquired 
the tax return or return information under specific provisions 
of section 6103. Upon conviction, the penalty is a fine in any 
amount not exceeding $1,000, 143 or imprisonment of 
not more than 1 year, or both, together with the costs of 
prosecution. In addition, upon conviction, an officer or 
employee of the United States would be dismissed from office or 
discharged from employment.
---------------------------------------------------------------------------
    \143\ Pursuant to 18 U.S.C. sec. 3571 (added by the Sentencing 
Reform Act of 1984), the amount of the fine is not more than the 
greater of the amount specified in this new Code section or $100,000.
---------------------------------------------------------------------------
    The Congress views any unauthorized inspection of tax 
returns or return information as a very serious offense; this 
new criminal penalty reflects that view. The Congress also 
believes that unauthorized inspection warrants very serious 
personnel sanctions against IRS employees who engage in 
unauthorized inspection, and that it is appropriate to fire 
employees who do this.

Civil damages

    The bill amends the provision providing for civil damages 
for unauthorized disclosure by also providing for civil damages 
for unauthorized inspection. Damages are available for 
unauthorized inspection that occurs either knowingly or by 
reason of negligence. Accidental or inadvertent inspection that 
may occur (such as, for example, by making an error in typing 
in a TIN) would not be subject to damages because it would not 
meet this standard. The bill also provides that no damages are 
available to a taxpayer if that taxpayer requested the 
inspection or disclosure.
    The bill also requires that, if any person is criminally 
charged by indictment or information with inspection or 
disclosure of a taxpayer's return or return information in 
violation of section 7213(a) or (b), section 7213A (as added by 
the bill), or 18 USC section 1030(a)(2)(B), the Secretary 
notify that taxpayer as soon as practicable of the inspection 
or disclosure.

                             Effective Date

    The bill is effective for violations occurring on or after 
the date of enactment.
          TITLE XI. ESTATE, GIFT, AND TRUST TAX SIMPLIFICATION

1. Eliminate gift tax filing requirements for gifts to charities (sec. 
        1101 of the bill and sec. 6019 of the Code)

                              Present Law

    A gift tax generally is imposed on lifetime transfers of 
property by gift (sec. 2501). In computing the amount of 
taxable gifts made during a calendar year, a taxpayer generally 
may deduct the amount of any gifts made to a charity (sec. 
2522). Generally, this charitable gift deduction is available 
for outright gifts to charity, as well as gifts of certain 
partial interests in property (such as a remainder interest). A 
gift of a partial interest in property must be in a prescribed 
form in order to qualify for the deduction.
    Individuals who make gifts in excess of $10,000 to any one 
donee during the calendar year generally are required to file a 
gift tax return (sec. 6019). This filing requirement applies to 
all gifts, whether charitable or noncharitable, and whether or 
not the gift qualifies for a gift tax charitable deduction. 
Thus, under current law, a gift tax return is required to be 
filed for gifts to charity in excess of $10,000, even though no 
gift tax is payable on the transfer.

                           Reasons for Change

    Because a charitable gift does not give rise to a gift tax 
liability, many donors are unaware of the requirement to file a 
gift tax return for charitable gifts in excess of $10,000. 
Failure to file a gift tax return under these circumstances 
could expose the donor to penalties. The bill eliminates this 
potential trap for the unwary.

                        Explanation of Provision

    The bill provides that gifts to charity are not subject to 
the gift tax filing requirements of section 6019, as long as 
the entire value of the transferred property qualifies for the 
gift tax charitable deduction under section 2522. The filing 
requirements for gifts of partial interests in property remain 
unchanged.

                             Effective Date

    The provision is effective for gifts made after the date of 
enactment.

2. Clarification of waiver of certain rights of recovery (sec. 1102 of 
        the bill and secs. 2207A and 2207B of the Code)

                              Present Law

    For estate and gift tax purposes, a marital deduction is 
allowed for qualified terminable interest property (QTIP). Such 
property generally is included in the surviving spouse's gross 
estate upon his or her death. The surviving spouse's estate is 
entitled to recover the portion of the estate tax attributable 
to inclusion of QTIP from the person receiving the property, 
unless the spouse directs otherwise by will (sec. 2207A). For 
this purpose, a will provision specifying that all taxes shall 
be paid by the estate is sufficient to waive the right of 
recovery.
    A decedent's gross estate includes the value of previously 
transferred property in which the decedent retains enjoyment or 
the right to income (sec. 2036). The estate is entitled to 
recover from the person receiving the property a portion of the 
estate tax attributable to the inclusion (sec. 2207B). This 
right may be waived only by a provision in the will (or 
revocable trust) specifically referring to section 2207B.

                           Reasons for Change

    It is understood that persons utilizing standard 
testamentary language often inadvertently waive the right of 
recovery with respect to QTIP. Similarly, persons waiving a 
right to contribution are unlikely to refer to the code section 
granting the right. Accordingly, allowing the right of recovery 
(or right of contribution) to be waived only by specific 
reference should simplify the drafting of wills by better 
conforming with the testator's likely intent.

                        Explanation of Provision

    The bill provides that the right of recovery with respect 
to QTIP is waived only to the extent that language in the 
decedent's will or revocable trust specifically so indicates 
(e.g., by a specific reference to QTIP, the QTIP trust, section 
2044, or section 2207A). Thus, a general provision specifying 
that all taxes be paid by the estate is no longer sufficient to 
waive the right of recovery.
    The bill also provides that the right of contribution for 
property over which the decedent retained enjoyment or the 
right to income is waived by a specific indication in the 
decedent's will or revocable trust, but specific reference to 
section 2207B is no longer required.

                             Effective Date

    The provision applies to decedents dying after the date of 
enactment.

3. Transitional rule under section 2056A (sec. 1103 of the bill and 
        sec. 2056A of the Code)

                              Present Law

    A ``marital deduction'' generally is allowed for estate and 
gift tax purposes for the value of property passing to a 
spouse. The Technical and Miscellaneous Revenue Act of 1988 
(``TAMRA'') denied the marital deduction for property passing 
to an alien spouse outside a qualified domestic trust 
(``QDT''). An estate tax generally is imposed on corpus 
distributions from a QDT.
    TAMRA defined a QDT as a trust that, among other things, 
required all trustees be U.S. citizens or domestic 
corporations. This provision was modified in the Omnibus Budget 
Reconciliation Acts of 1989 and 1990 to require that at least 
one trustee be a U.S. citizen or domestic corporation andthat 
no corpus distribution be made unless such trustee has the right to 
withhold any estate tax imposed on the distribution (the ``withholding 
requirement'').

                           Reasons for Change

    Wills drafted under the TAMRA rules must be revised to 
conform with the withholding requirement, even though both the 
TAMRA rule and its successor ensure that a U.S. trustee is 
personally liable for the estate tax on a QDT. Reinstatement of 
the TAMRA rule for wills drafted in reliance upon it reduces 
the number of will revisions necessary to comply with statutory 
changes, thereby simplifying estate planning.

                        Explanation of Provision

    Certain trusts created before the enactment of the Omnibus 
Budget Reconciliation Act of 1990 are treated as satisfying the 
withholding requirement if the governing instruments require 
that all trustees be U.S. citizens or domestic corporations.

                             Effective Date

    The provision applies as if included in the Omnibus Budget 
Reconciliation Act of 1990.

4. Treatment for estate tax purposes of short-term obligations held by 
        nonresident aliens (sec. 1104 of the bill and sec. 2105 of the 
        Code)

                              Present Law

    The United States imposes estate tax on assets of 
noncitizen nondomiciliaries that were situated in the United 
States at the time of the individual's death. Debt obligations 
of a U.S. person, the United States, a political subdivision of 
a State, or the District of Columbia are considered property 
located within the United States if held by a nonresident not a 
citizen of the United States (sec. 2014(c)).
    Special rules apply to treat certain bank deposits and debt 
instruments the income from which qualifies for the bank 
deposit interest exemption and the portfolio interest exemption 
as property from without the United States despite the fact 
that such items are obligations of a U.S. person, the United 
States, a political subdivision of a State, or the District of 
Columbia (sec. 2105(b)). Income from such items is exempt from 
U.S. income tax in the hands of the nonresident recipient 
(secs. 871(h) and 871(i)(2)(A)). The effect of these special 
rules is to exclude these items from the U.S. gross estate of a 
nonresident not a citizen of the United States. However, 
because of an amendment to section 871(h) made by the Tax 
Reform Act of 1986, these special rules no longer cover 
obligations that generate short-term OID income despite the 
fact that such income is exempt from U.S. income tax in the 
hands of the nonresident recipient (sec. 871(g)(1)(B)(i)).

                           Reasons for Change

    The Committee believes that the income and estate tax 
treatments of short-term OID obligations held by nonresident 
aliens should conform. A purpose of exempting short-term OID 
income derived by nonresident aliens from U.S. income tax is to 
enhance the ability of U.S. borrowers to raise funds from 
foreign lenders, and such purpose is hindered by the lack of a 
corresponding exemption for U.S. estate tax. Moreover, to the 
extent the interest from such an obligation is exempt from U.S. 
income tax, the inclusion of the instrument in the nonresident 
noncitizen's U.S. estate would be a trap for the unwary.

                        Explanation of Provision

    The bill provides that any debt obligation, the income from 
which would be eligible for the exemption for short-term OID 
under section 871(g)(1)(B)(i) if such income were received by 
the decedent on the date of his death, is treated as property 
located outside of the United States in determining the U.S. 
estate tax liability of a nonresident not a U.S. citizen. No 
inference is intended with respect to the estate tax treatment 
of such obligations under present law.

                             Effective Date

    The provision is effective for estates of decedents dying 
after the date of enactment.

5. Distributions during first 65 days of taxable year of estate (sec. 
        1105 of the bill and sec. 663(b) of the Code)

                              Present Law

    In general, trusts and estates are treated as conduits for 
Federal income tax purposes; income received by a trust or 
estate that is distributed to a beneficiary in the trust or 
estate's taxable year ``ending with or within'' the taxable 
year of the beneficiary is taxable to the beneficiary in that 
year; income that is retained by the trust or estate is 
initially taxable to the trust or estate. In the case of 
distributions of previously accumulated income by trusts (but 
not estates), there may be additional tax under the so-called 
``throwback'' rules if the beneficiary to whom the 
distributions were made has marginal rates higher than those of 
the trust. Under the ``65-day rule,'' a trust may elect to 
treat distributions paid within 65 days after the close of its 
taxable year as paid on the last day of its taxable year. The 
65-day rule is not applicable to estates.

                           Reasons for Change

    In order to minimize the tax differences between estates 
and revocable trusts, the Committee believes that the 65-day 
rule should be allowed to estates as well as to trusts.

                        Explanation of Provision

    The bill extends application of the 65-day rule to 
distributions by estates. Thus, an executor can elect to treat 
distributions paid within 65 days after the close of the 
estate's taxable year as having been paid on the last day of 
such taxable year.

                             Effective Date

    The provision applies to taxable years beginning after the 
date of enactment.

6. Separate share rules available to estates (sec. 1106 of the bill and 
        sec. 663(c) of the Code)

                              Present Law

    Trusts with more than one beneficiary must use the 
``separate share'' rule in order to provide different tax 
treatment of distributions to different beneficiaries to 
reflect the income earned by different shares of the trust's 
corpus.\144\ Treasury regulations provide that ``[t]he 
application of the separate share rule * * * will generally 
depend upon whether distributions of the trust are to be made 
in substantially the same manner as if separate trusts had been 
created. * * * Separate share treatment will not be applied to 
a trust or portion of a trust subject to a power to distribute, 
apportion, or accumulate income or distribute corpus to or for 
the use of one or more beneficiaries within a group or class of 
beneficiaries, unless the payment of income, accumulated 
income, or corpus of a share of one beneficiary cannot affect 
the proportionate share of income, accumulated income, or 
corpus of any shares of the other beneficiaries, or unless 
substantially proper adjustment must thereafter be made under 
the governing instrument so that substantially separate and 
independent shares exist.'' (Treas. Reg. sec. 1.663(c)-3). The 
separate share rule presently does not apply to estates.
---------------------------------------------------------------------------
    \144\ Application of the separate share rule is not elective; it is 
mandatory if there are separate shares in the trust.
---------------------------------------------------------------------------

                           Reasons for Change

    The Committee understands that estates typically do not 
have separate shares. Nonetheless, where separate shares do 
exist in an estate, the inapplicability of the separate share 
rule to estates may result in one beneficiary or class of 
beneficiaries being taxed on income payable to, or accruing to, 
a separate beneficiary or class of beneficiaries. Accordingly, 
the Committee believes that a more equitable taxation of an 
estate and its beneficiaries would be achieved with the 
application of the separate share rule to an estate where, 
under the provisions of the decedent's will or applicable local 
law, there are separate shares in the estate.

                        Explanation of Provision

    The bill extends the application of the separate share rule 
to estates. There are separate shares in an estate when the 
governing instrument of the estate (e.g., the will and 
applicable local law) creates separate economic interests in 
one beneficiary or class of beneficiaries such that the 
economic interests of those beneficiaries (e.g., rights to 
income or gains from specified items of property) are not 
affected by economic interests accruing to another separate 
beneficiary or class of beneficiaries. For example, a separate 
share in an estate would exist where the decedent's will 
provides that all of the shares of a closely-held corporation 
are devised to one beneficiary and that any dividends paid to 
the estate by that corporation should be paid only to that 
beneficiary and any such dividends would not affect any other 
amounts which that beneficiary would receive under the will. As 
in the case of trusts, the application of the separate share 
rule is mandatory where separate shares exist.

                             Effective Date

    The provision applies to decedents dying after the date of 
enactment.

7. Executor of estate and beneficiaries treated as related persons for 
        disallowance of losses (sec. 1107 of the bill and secs. 267(b) 
        and 1239(b) of the Code)

                              Present Law

    Section 267 disallows a deduction for any loss on the sale 
of an asset to a person related to the taxpayer. For the 
purposes of section 267, the following parties are related 
persons: (1) a trust and the trust's grantor, (2) two trusts 
with the same grantor, (3) a trust and a beneficiary of the 
trust, (4) a trust and a beneficiary of another trust, if both 
trusts have the same grantor, and (5) a trust and a corporation 
the stock of which is more than 50 percent owned by the trust 
or the trust's grantor.
    Section 1239 disallows capital gain treatment on the sale 
of depreciable property to a related person. For purposes of 
section 1239, a trust and any beneficiary of the trust are 
treated as related persons, unless the beneficiary's interest 
is a remote contingent interest.
    Neither section 267 nor section 1239 presently treat an 
estate and a beneficiary of the estate as related persons.

                           Reasons for Change

    The Committee believes that the disallowance rules under 
sections 267 and 1239 with respect to transactions between 
related parties should apply to an estate and a beneficiary of 
that estate for the same reasons that such rules apply to a 
trust and a beneficiary of that trust.

                        Explanation of Provision

    Under the bill, an estate and a beneficiary of that estate 
are treated as related persons for purposes of sections 267 and 
1239, except in the case of a sale or exchange in satisfaction 
of a pecuniary bequest.

                             Effective Date

    The provision applies to taxable years beginning after the 
date of enactment.

8. Simplified taxation of earnings of pre-need funeral trusts (sec. 
        1108 of the bill and sec. 684 of the Code)

                              Present Law

    A pre-need funeral trust is an arrangement where an 
individual purchases funeral or burial services or merchandise 
from a funeral home or cemetery in advance of the individual's 
death. The individual enters into a contract with the provider 
of such services or merchandise whereby the individual selects 
the services or merchandise to be provided upon his or her 
death, and agrees to payfor them in advance of his or her 
death. Such amounts (or a portion thereof) are held in trust during the 
individual's lifetime and are paid to the seller upon the individual's 
death.
    Under present law, pre-need funeral trusts generally are 
treated as grantor trusts, and the annual income earned by such 
trusts is taxed to the purchaser/grantor of the trust. Rev. 
Rul. 87-127. Any amount received from the trust by the seller 
(as payment for services or merchandise) is includible in the 
gross income of the seller.

                           Reasons for Change

    To the extent that pre-need funeral trusts are treated as 
grantor trusts under present law, numerous individual taxpayers 
are required to account for the earnings of such trusts on 
their tax returns, even though the earnings with respect to any 
one taxpayer may be small. The Committee believes that this 
recordkeeping burden on individuals could be eased, and that 
compliance with the tax laws would be improved, if such trusts 
instead were taxed at the entity level, with one simplified 
annual return filed by the trustee reporting the aggregate 
income from all such trusts administered by the trustee.

                        Explanation of Provision

    The bill allows the trustee of a pre-need funeral trust to 
elect special tax treatment for such a trust, to the extent the 
trust would otherwise be treated as a grantor trust. A 
qualified funeral trust is defined as one which meets the 
following requirements: (1) the trust arises as the result of a 
contract between a person engaged in the trade or business of 
providing funeral or burial services or merchandise and one or 
more individuals to have such services or property provided 
upon such individuals' death; (2) the only beneficiaries of the 
trust are individuals who have entered into contracts to have 
such services or merchandise provided upon their death; (3) the 
only contributions to the trust are contributions by or for the 
benefit of the trust beneficiaries; (4) the trust's only 
purpose is to hold and invest funds that will be used to make 
payments for funeral or burial services or merchandise for the 
trust beneficiaries; and (5) the trust has not accepted 
contributions totaling more than $7,000 by or for the benefit 
of any individual. For this purpose, ``contributions'' include 
all amounts transferred to the trust, regardless of how 
denominated in the contract. Contributions do not, however, 
include income or gain earned with respect to property in the 
trust. For purposes of applying the $7,000 limit, if a 
purchaser has more than one contract with a single trustee (or 
related trustees), all such trusts are treated as one trust. 
Similarly, if the Secretary of Treasury determines that a 
purchaser has entered into separate contracts with unrelated 
trustees to avoid the $7,000 limit described above, the 
Secretary may require that such trusts be treated as one trust. 
For contracts entered into after 1998, the $7,000 limit is 
indexed annually for inflation.
    The trustee's election to have this provision apply to a 
qualified funeral trust is to be made separately with respect 
to each purchaser's trust. It is anticipated that the 
Department of Treasury will issue prompt guidance with respect 
to the simplified reporting requirements so that if the 
election is made, a single annual trust return may be filed by 
the trustee, separately listing the amount of income earned 
with respect to each purchaser. If the election is made, the 
trust is not treated as a grantor trust and the amount of tax 
paid with respect to each purchaser's trust is determined in 
accordance with the income tax rate schedule generally 
applicable to estates and trusts (Code sec. 1(e)), but no 
deduction is allowed under section 642(b). The tax on the 
annual earnings of the trust is payable by the trustee.
    As under present law, amounts received from the trust by 
the seller are treated as payments for services and merchandise 
and are includible in the gross income of the seller. No gain 
or loss is recognized to the beneficiary of the trust for 
payments from the trust to the beneficiary upon cancellation of 
the contract, and the beneficiary takes a carryover basis in 
any assets received from the trust upon cancellation.

                             Effective Date

    The provision is effective for taxable years beginning 
after the date of enactment.

9. Adjustments for gifts within three years of decedent's death (sec. 
        1109 of the bill and secs. 2035 and 2038 of the Code)

                              Present Law

    The first $10,000 of gifts of present interests to each 
donee during any one calendar year are excluded from Federal 
gift tax.
    The value of the gross estate includes the value of any 
previously transferred property if the decedent retained the 
power to revoke the transfer (sec. 2038). The gross estate also 
includes the value of any property with respect to which such 
power is relinquished during the three years before death (sec. 
2035). There has been significant litigation as to whether 
these rules require that certain transfers made from a 
revocable trust within three years of death be includible in 
the gross estate. See, e.g., Jalkut Estate v. Commissioner, 96 
T.C. 675 (1991) (transfers from revocable trust includible in 
gross estate); McNeely v. Commissioner, 16 F.3d 303 (8th Cir. 
1994) (transfers from revocable trust not includible in gross 
estate); Kisling v. Commissioner, 32 F.3d 1222 (8th Cir. 1994) 
(acq.) (transfers from revocable trust not includible in gross 
estate).

                           Reasons for Change

    The inclusion of certain property transferred during the 
three years before death is directed at transfers that would 
otherwise reduce the amount subject to estate tax by more than 
the amount subject to gift tax, disregarding appreciation 
between the times of gift and death. Because all amounts 
transferred from a revocable trust are subject to the gift tax, 
the Committee believes that inclusion of such amounts is 
unnecessary where the transferor has retained no power over the 
property transferred out of the trust. The Committee believes 
that clarifying these rules statutorily will lend certainty to 
these rules.

                        Explanation of Provision

    The provision codifies the rule set forth in the McNeely 
and Kisling cases to provide that a transfer from a revocable 
trust (i.e., a trust described under section 676) is treated as 
if made directly by the grantor. Thus, an annual exclusion gift 
from such a trust is not included in the gross estate.
    The provision also revises section 2035 to improve its 
clarity.

                             Effective Date

    The provision applies to decedents dying after the date of 
enactment

10. Clarify relationship between community property rights and 
        retirement benefits (sec. 1110 of the bill and sec. 
        2056(b)(7)(C) of the Code)

                              Present Law

Community property

    Under state community property laws, each spouse owns an 
undivided one-half interest in each community property asset. 
In community property jurisdictions, a nonparticipant spouse 
may be treated as having a vested community property interest 
in either his or her spouse's qualified plan, individual 
retirement arrangement (``IRA''), or simplified employee 
pension (``SEP'') plan.

Transfer tax treatment of qualified plans

    In the Retirement Equity Act of 1984 (``REA''), qualified 
retirement plans were required to provide automatic survivor 
benefits (1) in the case of a participant who retires under the 
plan, in the form of a qualified joint and survivor annuity, 
and (2) in the case of a vested participant who dies before the 
annuity starting date and who has a surviving spouse, in the 
form of a preretirement survivor annuity. A participant 
generally is permitted to waive such annuities, provided he or 
she obtains the written consent of his or her spouse.
    The Tax Reform Act of 1986 repealed the estate tax 
exclusion, formerly contained in sections 2039(c) and 2039(d), 
for certain interests in qualified plans owned by a 
nonparticipant spouse attributable to community property laws 
and made certain other changes to conform the transfer tax 
treatment of qualified and nonqualified plans.
    As a result of these changes made by REA and the Tax Reform 
Act of 1986, the transfer tax treatment of married couples 
residing in a community property state is unclear where either 
spouse is covered by a qualified plan.

                           Reasons for Change

    The Committee believes that survivorship interests in 
annuities in community property States should be accorded 
similar treatment to the tax treatment of interests in such 
annuities in non-community property States. Accordingly, the 
bill would clarify that the transfer at death of a survivorship 
interest in an annuity to a surviving spouse will be a 
deductible marital transfer under the QTIP rules regardless of 
whether the decedent's annuity interest arose out of his or her 
employment or arose under community property laws by reason of 
the employment of his or her spouse.

                        Explanation of Provision

    The bill clarifies that the marital deduction is available 
with respect to a nonparticipant spouse's interest in an 
annuity attributable to community property laws where he or she 
predeceases the participant spouse. Under the bill, the 
nonparticipant spouse's interest in an annuity arising under 
the community property laws of a State that passes to the 
surviving participant spouse may qualify for treatment as QTIP 
under section 2056(b)(7).
    The provision is not intended to create an inference 
regarding the treatment under present law of a transfer to a 
surviving spouse of the decedent spouse's interest in an 
annuity arising under community property laws.

                             Effective Date

    The provision applies to decedents dying, or waivers, 
transfers and disclaimers made, after the date of enactment.

11. Treatment under qualified domestic trust rules of forms of 
        ownership which are not trusts (sec. 1111 of the bill and sec. 
        2056A(c) of the Code)

                              Present Law

    A marital deduction generally is allowed for estate and 
gift tax purposes for the value of property passing to a 
spouse. The marital deduction is not available for property 
passing to an alien spouse outside a qualified domestic trust 
(``QDT''). An estate tax generally is imposed on corpus 
distributions from a QDT.
    Trusts are not permitted in some countries (e.g., many 
civil law countries).\145\ As a result, it is not possible to 
create a QDT in those countries.
---------------------------------------------------------------------------
    \145\ Note that in some civil law States (e.g., Louisiana) an 
entity similar to a trust, called a usufruct, exits.
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal would provide the Treasury Department with 
regulatory authority to treat as trusts legal arrangements that 
have substantially the same effect as a trust.

                             Effective Date

    The proposal would apply to decedents dying after the date 
of enactment.

12. Opportunity to correct certain failures under section 2032A (sec. 
        1112 of the bill and sec. 2032A of the Code)

                              Present Law

    For estate tax purposes, an executor may elect to value 
certain real property used in farming or other closely held 
business operations at its current use value rather than its 
highest and best use (sec. 2032A). A written agreement signed 
by each person with an interest in the property must be filed 
with the election.
    Treasury regulations require that a notice of election and 
certain information be filed with the Federal estate tax return 
(Treas. Reg. sec. 20.2032A-8). The administrative policy of the 
Treasury Department is to disallow current use valuation 
elections unless the required information is supplied.
    Under procedures prescribed by the Treasury Department, an 
executor who makes the election and substantially complies with 
the regulations but fails to provide all required information 
or the signatures of all persons with an interest in the 
property may supply the missing information within a reasonable 
period of time (not exceeding 90 days) after notification by 
the Treasury Department.

                           Reasons for Change

    It is understood that executors commonly fail to include 
with the filed estate tax return a recapture agreement signed 
by all persons with an interest in the property or all 
information required by Treasury regulations. It is believed 
that allowing such signatures or information to be supplied 
later is consistent with the legislative intent of section 
2032A and eases return filing.

                        Explanation of Provision

    The bill extends the procedures allowing subsequent 
submission of information to any executor who makes the 
election and submits the recapture agreement, without regard to 
compliance with the Treasury regulations. Thus, the bill allows 
the current use valuation election if the executor supplies the 
required information within a reasonable period of time (not 
exceeding 90 days) after notification by the IRS. During that 
time period, the bill also allows the addition of signatures to 
a previously filed agreement.

                             Effective Date

    The provision applies to decedents dying after the date of 
enactment.

13. Authority to waive requirement of U.S. trustee for qualified 
        domestic trusts (sec. 1113 of the bill and sec. 2056A(a)(1)(A) 
        of the Code)

                              Present Law

    In order for a trust to be a QDT, a U.S. trustee must have 
the power to approve all corpus distributions from the trust. 
In some countries, trusts cannot have any U.S. trustees. As a 
result, trusts established in those countries cannot qualify as 
a QDT.

                           Reasons for Change

    The estate of a decedent with a nonresident spouse should 
not be precluded from qualifying for the marital deduction in 
situations where the use of a U.S. trustee is prohibited by 
another country. Accordingly, the Committee believes it is 
appropriate to grant regulatory authority to allow 
qualification for the marital deduction in such situations 
where the Treasury Department determines that the U.S. can 
retain jurisdiction and other adequate security has been 
provided for the payment of U.S. transfer taxes on subsequent 
transfers by the surviving spouse of the property transferred 
by the decedent.

                        Explanation of Provision

    In order to permit the establishment of a QDT in those 
situations where a country prohibits a trust from having a U.S. 
trustee, the bill provides the Treasury Department with 
regulatory authority to waive the requirement that a QDT have a 
U.S. trustee. It is anticipated that such regulations, if any, 
provide an alternative mechanism under which the U.S. would 
retain jurisdiction and adequate security to impose U.S. 
transfer tax on transfers by the surviving spouse of the 
property transferred by the decedent. For example, one possible 
mechanism would be a closing agreement process under which the 
surviving spouse waives treaty benefits, allows the U.S. to 
retain taxing jurisdiction and provides adequate security with 
respect to such transfer taxes.

                             Effective Date

    The provision applies to decedents dying after the date of 
enactment.
       TITLE XII. EXCISE TAX AND OTHER SIMPLIFICATION PROVISIONS

 A. Increase De Minimis Limit for After-Market Alterations Subject to 
 Heavy Truck and Luxury Automobile Excise Taxes (sec. 1201 of the bill 
                  and secs. 4001 and 4051 of the Code)

                              Present Law

    An excise tax is imposed on retail sales of truck chassis 
and truck bodies suitable for use in a vehicle with a gross 
vehicle weight of over 33,000 pounds. The tax is equal to 12 
percent of the retail sales price. An excise tax also is 
imposed on retail sales of luxury automobiles. The tax 
currently is equal to 8 percent of the amount by which the 
retail sales price exceeds an inflation-adjusted $30,000 base. 
(The rate is reduced by 1 percentage point per year through 
2002, and the tax is not imposed after 2002.) Anti-abuse rules 
prevent the avoidance of these taxes through separate purchases 
of major component parts. With certain exceptions, tax at the 
rate applicable to the vehicle is imposed on the subsequent 
installation of parts and accessories within six months after 
purchase of a taxable vehicle. The exceptions include a de 
minimis exception for parts and accessories with an aggregate 
price that does not exceed $200 (or such other amount as 
Treasury may by regulation prescribe).

                           Reasons for Change

    Retailers generally are responsible for taxes on truck 
chassis and bodies and luxury automobiles. In the case of a 
subsequent installation, however, the owner or operator of the 
vehicle is responsible for paying the tax attributable to the 
installation and the installer is secondarily liable. 
Increasing the de minimis amount should significantly reduce 
the number of return filers and relieve many persons from the 
administrative burden of filing an excise tax return reporting 
a very small amount of tax.

                        Explanation of Provision

    The tax on subsequent installation of parts and accessories 
does not apply to parts and accessories with an aggregate price 
that does not exceed $1,000. Parts and accessories installed on 
a vehicle on or before that date are taken into account in 
determining whether the $1,000 threshold is exceeded. If the 
aggregate price of the pre-effective date parts and accessories 
does not exceed $200, they are not subject to tax unless the 
aggregate price of all additions exceeds $1,000.

                             Effective Date

    The increase in the threshold for taxing after-market 
additions under the heavy truck and luxury car excise taxes is 
effective on January 1, 1998.

B. Simplification of Excise Taxes on Distilled Spirits, Wine, and Beer 
 (secs. 1211-1222 of the bill and secs. 5008, 5053, 5055, 5115, 5175, 
           and 5207, and new secs. 5222 and 5418 of the Code)

                              Present Law

    Imported distilled spirits returned to plant.--Excise tax 
that has been paid on domestic distilled spirits is credited or 
refunded if the spirits are later returned to bonded premises. 
Tax is imposed on imported bottled spirits when they are 
withdrawn from customs custody, but the tax is not refunded or 
credited if the spirits are later returned to bonded premises.
    Cancellation of export bonds.--An exporter that withdraws 
distilled spirits from bonded warehouses for export or 
transportation to a customs bonded warehouse without the 
payment of tax must furnish a bond to cover the withdrawal. The 
required bonds are canceled ``on the submission of such 
evidence, records, and certification indicating exportation as 
the Secretary may by regulations prescribe.''
    Location of records of distilled spirits plant.-- 
Proprietors of distilled spirits plants are required to 
maintain records and reports relating to their production, 
storage, denaturation, and processing activities on the 
premises where the operations covered by the record are carried 
on.
    Transfers from brewery to distilled spirits plant.--A 
distilled spirits plant may receive on its bonded premises beer 
to be used in the production of distilled spirits only if the 
beer is produced on contiguous brewery premises.
    Sign not required for wholesale dealers.--Wholesale liquor 
dealers are required to post a sign identifying the firm as 
such. Failure to do so is subject to a penalty.
    Refund on returns of merchantable wine.--Excise tax paid on 
domestic wine that is returned to bond as unmerchantable is 
refunded or credited, and the wine is once again treated as 
wine in bond on the premises of a bonded wine cellar.
    Increased sugar limits for certain wine.--Natural wines may 
be sweetened to correct high acid content. For most wines, 
however, sugar cannot constitute more than 35 percent (by 
volume) of the combined sugar and juice used to produce the 
wine. Up to 60 percent sugar may be used in wine made from 
loganberries, currants, and gooseberries. If the amount of 
sugar used exceeds the applicable limitation, the wine must be 
labeled ``substandard.''
    Beer withdrawn for embassy use.--Imported beer to be used 
for the family and official use of representatives of foreign 
governments or public international organizations may be 
withdrawn from customs bonded warehouses without payment of 
excise tax. No similar exemption applies to domestic beer 
withdrawn from a brewery or entered into a bonded customs 
warehouse for the same authorized use.
    Beer withdrawn for destruction.--Removals of beer from a 
brewery are exempt from tax if the removal is for export, 
because the beer is unfit for beverage use, for laboratory 
analysis, research,development and testing, for the brewer's 
personal or family use, or as supplies for certain vessels and 
aircraft.
    Drawback on exported beer.--A domestic producer that 
exports beer may recover the tax (receive a ``drawback'') found 
to have been paid on the exported beer upon the ``submission of 
such evidence, records and certificates indicating 
exportation'' required by regulations.
    Imported beer transferred in bulk to brewery and imported 
wine transferred in bulk to wineries.--Imported beer and wine 
are subject to tax when removed from customs custody.

                           Reasons for Change

    Until 1980, the method of collecting alcohol excise taxes 
required the regular presence of Treasury Department inspectors 
at alcohol production facilities. In 1980, the method of 
collecting tax was changed to a bonded premises system under 
which examinations and collection procedures are similar to 
those used in connection with other Federal excise taxes.
    A number of reporting and recordkeeping requirements need 
to be modified to conform to the current collection system. 
Appropriate modification will allow the Bureau of Alcohol, 
Tobacco and Firearms to administer alcohol excise taxes more 
efficiently and relieve taxpayers of unnecessary paperwork 
burdens.
    The current rules under which the Code permits tax-free 
removals of alcoholic beverages (or allows a credit or refund 
of tax on a return to bonded premises) result in inappropriate 
disparities in the treatment of different types of alcoholic 
beverages. In addition, these rules unduly limit available 
options for complying with environmental and other laws that 
regulate the destruction and disposition of alcoholic 
beverages. Under the bonded premises system, these rules scan 
be liberalized without jeopardizing the collection of tax 
revenues.
    Other provisions of current law (i.e., the sign requirement 
and the sugar limits for certain wine) are outdated and should 
be repealed or revised.

                       Explanation of Provisions

    Imported distilled spirits returned to plant.--Refunds or 
credits of the tax are available for imported bottled spirits 
that are returned to distilled spirits plants.
    Cancellation of export bonds.--The certification 
requirements are relaxed to allow the bonds to be canceled if 
there is such proof of exportation as the Secretary may 
require.
    Location of records of distilled spirits plant.--Records 
and reports are permitted to be maintained elsewhere other than 
on the plant premises
    Transfers from brewery to distilled spirits plant.--Beer 
may be brought from any brewery for use in the production of 
spirits. Such beer is exempt from excise tax, subject to 
Treasury regulations.
    Sign not required for wholesale dealers.--The requirement 
that a sign be posted is repealed.
    Refund on returns of merchantable wine.--A refund or credit 
is available in the case of all domestic wine returned to bond, 
whether or not unmerchantable.
    Increased sugar limits for certain wine.--Up to 60 percent 
sugar is permitted in any wine made from juice, such as 
cranberry or plum juice, with an acid content of 20 or more 
parts per thousand.
    Beer withdrawn for embassy use.--Subject to Treasury's 
regulatory authority, an exemption similar to that currently 
available for imported beer is provided for domestic beer.
    Beer withdrawn for destruction.--An exemption from tax is 
added for removals for destruction, subject to Treasury 
regulations.
    Drawback on exported beer.--The certification requirement 
is relaxed to allow a drawback of tax paid if there is such 
proof of exportation as the Secretary may by regulations 
require.
    Imported beer transferred in bulk to brewery and imported 
wine transferred in bulk to wineries.--Subject to Treasury 
regulations, beer and wine imported in bulk may be withdrawn 
from customs custody and transferred in bulk to a brewery 
(beer) or a winery (wine) without payment of tax. The 
proprietor of the brewery to which the beer is transferred or 
of the winery to which the wine is transferred is liable for 
the tax imposed on the withdrawal from customs custody and the 
importer is relieved of liability.

                             Effective Date

    The provision to repeal the requirement that wholesale 
liquor dealers post a sign outside their place of business 
takes effect on the date of enactment. The other provisions 
take effect on the first day of the calendar quarter that 
begins at least 90 days after the date of enactment.

                     C. Other Excise Tax Provisions

1. Authority for Internal Revenue Service to grant exemptions from 
        excise tax registration requirements (sec. 1231 of the bill and 
        sec. 4222 of the Code)

                              Present Law

    The Code exempts certain types of sales (e.g., sales for 
use in further manufacture, sales for export, and sales for use 
by a State or local government or a nonprofit educational 
organization) from excise taxes imposed on manufacturers and 
retailers. These exemptions generally apply only if the seller, 
the purchaser, and any person to whom the article is resold by 
the purchaser (the second purchaser) are registered with the 
Internal Revenue Service. The IRS can waive the registration 
requirement for the purchaser and second purchaser in some but 
not all cases.

                           Reasons for Change

    Allowing the Internal Revenue Service to waive the 
registration requirement for purchasers and second purchasers 
in all cases will permit more efficient administration of the 
exemptions and reduce paperwork burdens on taxpayers.

                        Explanation of Provision

    The IRS is authorized to waive the registration requirement 
for purchasers and second purchasers in all cases.

                             Effective Date

    The provision applies to sales made pursuant to waivers 
issued after the date of enactment.

2. Repeal of excise tax deadwood provisions (sec. 1232 of the bill and 
        secs. 4051, 4495-4498, and 4681-4682 of the Code)

                              Present Law

    The Code includes a provision relating to a temporary 
reduction in the tax on piggyback trailers sold before July 18, 
1985, and provisions relating to the tax on the removal of hard 
minerals from the deep seabed before June 28, 1990.
    An excise tax is imposed on the sale or use by the 
manufacturer or importer of certain ozone-depleting chemicals 
(sec. 4681). The amount of the tax generally is determined by 
multiplying the base tax amount applicable for the calendar 
year by an ozone-depleting factor assigned to each taxable 
chemical. The base tax amount was $5.80 per pound in 1996 and 
will increase by 45 cents per pound per year thereafter. The 
Code contains provisions for special rates of tax applicable to 
years before 1996 (e.g., sec. 4282(g) (1), (2), (3), and (5)).

                           Reasons for Change

    The elimination of out-of-date, ``deadwood'' provisions 
will simplify the Code by removing unneeded Code sections.

                        Explanation of Provision

    These provisions are repealed, as deadwood.

                             Effective Date

    The provisions are effective on the date of enactment.

3. Modifications to excise tax on certain arrows (sec. 1233 of the bill 
        and sec. 4161 of the Code)

                              Present Law

    An 11-percent manufacturer's excise tax is imposed on bows 
having a draw weight of more than 10 pounds and on arrows that 
either are greater than 18 inches in length or are suitable for 
use with a taxable bow. The tax is imposed on the 
manufacturer's sales price of the completed arrow.

                           Reasons for Change

    Imposing the excise tax on the component parts of the arrow 
before they are shipped to the assembler of the arrow will 
improve compliance with, and collection of, the tax by reducing 
the potential number of tax collection points.

                        Explanation of Provision

    Under the bill, the current excise tax on arrows tax is 
replaced with a manufacturer's excise tax on the four component 
parts of the arrow: shafts, points, nocks, and vanes. The tax 
rate is increased to 12.4 percent of the value of each of these 
four components to offset the reduction in aggregate value 
subjected to tax compared to present-law valuation of the 
completed arrow.

                             Effective Date

    The provision is effective for arrow components sold after 
September 30, 1997.

4. Modifications to heavy highway vehicle retail excise tax (sec. 1234 
        of the bill and sec. 4051 of the Code)

                              Present Law

    A 12-percent retail excise tax is imposed on certain heavy 
highway trucks and trailers, and on highway tractors. Small 
trucks (those with a gross vehicle weight not over 33,000 
pounds) and lighter trailers (those with a gross vehicle weight 
not over 26,000 pounds) are exempt from the tax. The tax 
applies to the first retail sale of a new or remanufactured 
vehicle. The determination under present law of whether a 
particular modification to an existing vehicle constitutes 
remanufacture (taxable) or arepair (nontaxable) is factual and 
generally is based on whether the function of the vehicle is changed 
or, in the case of worn vehicles, whether the cost of the modification 
exceeds 75 percent of the value of the modified vehicle.
    No tax is imposed on trucks, tractors, and trailers when 
they are sold for resale or long-term lease, if the purchaser 
is registered with the Treasury Department. In such cases, 
purchasers are liable for the tax when the vehicle is sold or 
leased. The tax is based on the sales price in the transaction 
to which it applies.

                           Reasons for Change

    Clarification is needed concerning the application of the 
75-percent-of value threshold in determining whether repairs to 
a wrecked vehicle constitutes remanufacture. A certification 
requirement for resales of trucks, tractors, and trailers will 
simplify administration of the tax.

                        Explanation of Provision

    The bill makes two changes to the heavy vehicle excise tax:
    (1) Clarification is provided that the 75-percent-of-value 
threshold applies in determining whether repairs to a wrecked 
vehicle constitute remanufacture; and
    (2) The registration requirement currently applicable to 
certain sales of trucks, tractors, and trailers for resale is 
replaced with a certification requirement.

                             Effective Date

    The provision is effective after December 31, 1997.

5. Treatment of skydiving flights as noncommercial aviation (sec. 1235 
        of the bill and sec. 4081 and 4261 of the Code)

                              Present Law

    Commercial passenger aviation, or air transportation for 
which a fare is charged, is subject to a 10-percent ad valorem 
excise tax for the Airport and Airway Trust Fund. General 
aviation, or air transportation which is not ``for hire'' is 
subject to a fuels tax for the Trust Fund. In the case of 
skydiving flights, questions have arisen as to when the flight 
is commercial aviation subject to the ticket tax and when it is 
noncommercial aviation subject to the fuels tax. In general, if 
instruction is offered, the flight is general aviation. 
Otherwise, the flight is treated as commercial aviation. Many 
skydiving flights carry both persons receiving instruction and 
others not receiving instruction.

                           Reasons for Change

    The tax treatment of skydiving flights as commercial or 
noncommercial needs to be clarified.

                        Explanation of Provision

    The bill specifies that flights which are exclusively 
dedicated to skydiving are taxed as noncommercial aviation 
flights, regardless of whether instruction is offered to any of 
the passengers.

                             Effective Date

    The provision is effective for flights beginning after 
September 30, 1997.

6. Eliminate double taxation of certain aviation fuels sold to 
        producers by ``fixed base operators'' (sec. 1236 of the bill 
        and sec. 4091 of the Code)

                              Present Law

    Section 4091 imposes a tax on the sale of aviation fuel by 
any producer (defined to include a wholesale distributor). Fuel 
sold at many rural airports is sold by retail dealers who do 
not qualify as wholesale distributors. This fuel is purchased 
by the retailers tax-paid. In certain instances, fuel which has 
been purchased tax-paid by a retailer will be re-sold to a 
producer, e.g., to enable the producer to serve one of its 
customers at the airport. When this fuel is resold at retail by 
the producer, a second tax is imposed. The Code contains no 
provision allowing a refund of the first tax in such cases.

                           Reasons for Change

    Permitting a refund of the tax previously paid on aviation 
fuel when a producer resells the fuel and pays tax on the 
resale will improve the fairness of the tax collection for such 
fuel.

                        Explanation of Provision

    The bill will permit a refund of the tax previously paid on 
aviation fuel when a producer acquires the fuel, resells it, 
and pays tax on the second sale.

                             Effective Date

    The provision is effective for fuel sold after September 
30, 1997.

                     D. Tax-Exempt Bond Provisions

Overview

    Interest on State and local government bonds generally is 
excluded from gross income for purposes of the regular 
individual and corporate income taxes if the proceeds of the 
bonds are used to finance direct activities of these 
governmental units (Code sec. 103).
    Unlike the interest on governmental bonds, described above, 
interest on private activity bonds generally is taxable. A 
private activity bond is a bond issued by a State or local 
governmental unit acting as a conduit to provide financing for 
private parties in a manner violating either (1) a private 
business use and payment test or (2) a private loan 
restriction. However, interest on private activity bonds is not 
taxable if (1) the financed activity is specified in the Code 
and (2) at least 95 percent of the net proceeds of the bond 
issue is used to finance the specified activity.
    Issuers of State and local government bonds must satisfy 
numerous other requirements, including arbitrage restrictions 
(for all such bonds) and annual State volume limitations (for 
most private activity bonds) for the interest on these bonds to 
be excluded from gross income.

1. Repeal of $100,000 limitation on unspent proceeds under 1-year 
        exception from rebate (sec. 1241 of the bill and sec. 148 of 
        Code)

                              Present Law

    Subject to limited exceptions, arbitrage profits from 
investing bond proceeds in investments unrelated to the 
governmental purpose of the borrowing must be rebated to the 
Federal Government. No rebate is required if the gross proceeds 
of an issue are spent for the governmental purpose of the 
borrowing within six months after issuance.
    This six-month exception is deemed to be satisfied by 
issuers of governmental bonds (other than tax and revenue 
anticipation notes) and qualified 501(c)(3) bonds if (1) all 
proceeds other than an amount not exceeding the lesser of five 
percent or $100,000 are so spent within six months and (2) the 
remaining proceeds are spent within one year after the bonds 
are issued.

                           Reasons for Change

    Exemption of interest paid on State and local bonds from 
Federal income tax provides an implicit subsidy to State and 
local governments for their borrowing costs. The principal 
Federal policy concern underlying the arbitrage rebate 
requirement is to discourage the earlier and larger than 
necessary issuance of tax-exempt bonds to take advantage of the 
opportunity to profit by investing funds borrowed at low-cost 
tax-exempt rates in higher yielding taxable investments. If at 
least 95 percent of the proceeds of an issue is spent within 
six months, and the remainder is spent within one year, 
opportunities for such arbitrage profit are significantly 
limited.

                        Explanation of Provision

    The $100,000 limit on proceeds that may remain unspent 
after six months for certain governmental and qualified 
501(c)(3) bonds otherwise exempt from the rebate requirement is 
deleted. Thus, if at least 95 percent of the proceeds of these 
bonds is spent within six months after their issuance, and the 
remainder is spent within one year, the six-month exception is 
deemed to be satisfied.

                             Effective Date

    The provision applies to bonds issued after the date of 
enactment.

2. Exception from rebate for earnings on bona fide debt service fund 
        under construction bond rules (sec. 1242 of the bill and sec. 
        148 of the Code)

                              Present Law

    In general, arbitrage profits from investing bond proceeds 
in investments unrelated to the governmental purpose of the 
borrowing must be rebated to the Federal Government. An 
exception is provided for certain construction bond issues if 
the bonds are governmental bonds, qualified 501(c)(3) bonds, or 
exempt-facility private activity bonds for governmentally-owned 
property.
    This exception is satisfied only if the available 
construction proceeds of the issue are spent at minimum 
specified rates during the 24-month period after the bonds are 
issued. The exception does not apply to bond proceeds invested 
after the 24-month expenditure period as part of a reasonably 
required reserve or replacement fund, a bona fide debt service 
fund, or to certain other investments (e.g., sinking funds). 
Issuers of these construction bonds also may elect to comply 
with a penalty regime in lieu of rebating arbitrage profits if 
they fail to satisfy the exception's spending requirements.

                           Reasons for Change

    Bond proceeds invested in a bona fide debt service fund 
generally must be spent at least annually for current debt 
service. The short-term nature of investments in such funds 
results in only limited potential for generating arbitrage 
profits. If the spending requirements of the 24-month rebate 
exception are satisfied, the administrative complexity of 
calculating rebate on these proceeds outweighs the other 
Federal policy concerns addressed by the rebate requirement.

                        Explanation of Provision

    The bill exempts earnings on bond proceeds invested in bona 
fide debt service funds from the arbitrage rebate requirement 
and the penalty requirement of the 24-month exception if the 
spending requirements of that exception are otherwise 
satisfied.

                             Effective Date

    The provision applies to bonds issued after the date of 
enactment.

3. Repeal of debt service-based limitation on investment in certain 
        nonpurpose investments (sec. 1243 of the bill and sec. 148 of 
        the Code)

                              Present Law

    Issuers of all tax-exempt bonds generally are subject to 
two sets of restrictions on investment of their bond proceeds 
to limit arbitrage profits. The first set requires that tax-
exempt bond proceeds be invested at a yield that is not 
materially higher (generally defined as 0.125 percentage 
points) than the bond yield (``yield restrictions''). 
Exceptions are provided to this restriction for investments 
during any of several ``temporary periods'' pending use of the 
proceeds and, throughout the term of the issue, for proceeds 
invested as part of a reasonably required reserve or 
replacement fund or a ``minor'' portion of the issue proceeds.
    Except for temporary periods and amounts held pending use 
to pay current debt service, present law also limits the amount 
of the proceeds of private activity bonds (other than qualified 
501(c)(3) bonds) that may be invested at materially higher 
yields at any time during a bond year to 150 percent of the 
debt service for that bond year. This restriction affects 
primarily investments in reasonably required reserve or 
replacement funds. Present law further restricts the amount of 
proceeds from the sale of bonds that may be invested in these 
reserve funds to ten percent of such proceeds.
    The second set of restrictions requires generally that all 
arbitrage profits earned on investments unrelated to the 
governmental purpose of the borrowing be rebated to the Federal 
Government (``arbitrage rebate''). Arbitrage profits include 
all earnings (in excess of bond yield) derived from the 
investment of bond proceeds (and subsequent earnings on any 
such earnings).

                           Reasons for Change

    The 150-percent of debt service limit was enacted before 
enactment of the arbitrage rebate requirement and the ten-
percent limit on the size of reasonably required reserve or 
replacement funds. It was intended to eliminate arbitrage-
motivated activities available from investment of such reserve 
funds. Provided that comprehensive yield restriction and 
arbitrage rebate requirements and the present-law overall size 
limit on reserve funds are maintained, the 150-percent of debt 
service yield restriction limit is duplicative.

                        Explanation of Provision

    The bill repeals the 150-percent of debt service yield 
restriction.

                             Effective Date

    The provision applies to bonds issued after the date of 
enactment.

4. Repeal of expired provisions relating to student loan bonds (sec. 
        1244 of the bill and sec. 148 of the Code)

                              Present Law

    Present law includes two special exceptions to the 
arbitrage rebate and pooled financing temporary period rules 
for certain qualified student loan bonds. These exceptions 
applied only to bonds issued before January 1, 1989.

                        Explanation of Provision

    These special exceptions are deleted as ``deadwood.''

                             Effective Date

    The provision applies to bonds issued after the date of 
enactment. It has no effect on bonds issued prior to the date 
of enactment.

                        E. Tax Court Procedures

1. Overpayment determinations of Tax Court (sec. 1251 of the bill and 
        sec. 6512 of the Code)

                               Present Law

    The Tax Court may order the refund of an overpayment 
determined by the Court, plus interest, if the IRS fails to 
refund such overpayment and interest within 120 days after the 
Court's decision becomes final. Whether such an order is 
appealable is uncertain.
    In addition, it is unclear whether the Tax Court has 
jurisdiction over the validity or merits of certain credits or 
offsets (e.g., providing for collection of student loans, child 
support, etc.) made by the IRS that reduce or eliminate the 
refund to which the taxpayer was otherwise entitled.

                           Reasons for Change

    Clarification of the jurisdiction of the Tax Court and the 
ability to appeal orders of the Tax Court would provide for 
greater certainty for taxpayers and the government in 
conducting cases before the Tax Court. Clarification will also 
reduce litigation.

                        Explanation of Provision

    The bill clarifies that an order to refund an overpayment 
is appealable in the same manner as a decision of the Tax 
Court. The bill also clarifies that the Tax Court does not have 
jurisdiction over the validity or merits of the credits or 
offsets that reduce or eliminate the refund to which the 
taxpayer was otherwise entitled.

                             Effective Date

    The provision is effective on the date of enactment.

2. Redetermination of interest pursuant to motion (sec. 1252 of the 
        bill and sec. 7481 of the Code)

                              Present Law

    A taxpayer may seek a redetermination of interest after 
certain decisions of the Tax Court have become final by filing 
a petition with the Tax Court.

                           Reasons for Change

    It would be beneficial to taxpayers if a proceeding for a 
redetermination of interest supplemented the original 
deficiency action brought by the taxpayer to redetermine the 
deficiency determination of the IRS. A motion, rather than a 
petition, is a more appropriate pleading for relief in these 
cases.

                        Explanation of Provision

    The bill provides that a taxpayer must file a ``motion'' 
(rather than a ``petition'') to seek a redetermination of 
interest in the Tax Court.

                             Effective Date

    The provision is effective on the date of enactment.

3. Application of net worth requirement for awards of litigation costs 
        (sec. 1253 of the bill and sec. 7430 of the Code)

                              Present Law

    Any person who substantially prevails in any action brought 
by or against the United States in connection with the 
determination, collection, or refund of any tax, interest, or 
penalty may be awarded reasonable administrative costs incurred 
before the IRS and reasonable litigation costs incurred in 
connection with any court proceeding. A person who 
substantially prevails must meet certain net worth requirements 
to be eligible for an award of administrative or litigation 
costs. In general, only an individual whose net worth does not 
exceed $2,000,000 is eligible for an award, and only a 
corporation or partnership whose net worth does not exceed 
$7,000,000 is eligible for an award. (The net worth 
determination with respect to a partnership or S corporation 
applies to all actions that are in substance partnership 
actions or S corporation actions, including unified entity-
level proceedings under sections 6226 or 6228, that are 
nominally brought in the name of a partner or a shareholder.)

                           Reasons for Change

    Although the net worth requirements are explicit for 
individuals, corporations, and partnerships, it is not clear 
which net worth requirement is to apply to other potential 
litigants. It is also unclear how the individual net worth 
rules are to apply to individuals filing a joint tax return. 
Clarifying these rules will provide certainty for potential 
claimants and will decrease needless litigation over procedural 
issues.

                        Explanation of Provision

    The bill provides that the net worth limitations currently 
applicable to individuals also apply to estates and trusts. The 
bill also provides that individuals who file a joint tax return 
shall be treated as separate individuals for purposes of 
computing the net worth limitations.

                             Effective Date

    The provision applies to proceedings commenced after the 
date of enactment.

4. Tax Court jurisdiction for determination of employment status (sec. 
        1254 of the bill and new sec. 7435 of the Code)

                              Present Law

    The Tax Court is a court of limited jurisdiction, 
established under Article I of the Constitution. The Tax Court 
only has the jurisdiction that is expressly conferred on it by 
statute (sec. 7442).

                           Reasons for Change

    It will be advantageous to taxpayers to have the option of 
going to the Tax Court to resolve certain disputes regarding 
employment status.

                        Explanation of Provision

    The bill provides that, in connection with the audit of any 
person, if there is an actual controversy involving a 
determination by the IRS as part of an examination that (a) one 
or more individuals performing services for that person are 
employees of that person or (b) that person is not entitled to 
relief under section 530 of the Revenue Act of 1978, the Tax 
Court would have jurisdiction to determine whether the IRS is 
correct. For example, one way the IRS could make the required 
determination is through a mechanism similar to the employment 
tax early referral procedures.\146\ A failure to agree would 
also be considered a determination for this purpose.
---------------------------------------------------------------------------
    \146\ See Announcement 96-13 and Announcement 97-52.
---------------------------------------------------------------------------
    The bill provides for de novo review (rather than review of 
the administrative record). Assessment and collection of the 
tax would be suspended while the matter is pending in the Tax 
Court. Any determination by the Tax Court would have the force 
and effect of a decision of the Tax Court and would be 
reviewable as such; accordingly, it would be binding on the 
parties. Awards of costs and certain fees (pursuant to section 
7430) would be available to eligible taxpayers with respect to 
Tax Court determinations pursuant to this proposal. The bill 
also provides a number of procedural rules to incorporate this 
new jurisdiction within the existing procedures applicable in 
the Tax Court.

                             Effective Date

    The provision takes effect on the date of enactment.

                          F. Other Provisions

1. Due date for first quarter estimated tax payments by private 
        foundations (sec. 1261 of the bill and sec. 6655(g)(3) of the 
        Code)

                              Present Law

    Under section 4940, tax-exempt private foundations 
generally are required to pay an excise tax equal to two 
percent of their net investment income for the taxable year. 
Under section 6655(g)(3), private foundations are required to 
pay estimated tax with respect to their excise tax liability 
under section 4940 (as well as any unrelated business income 
tax (UBIT) liability under section 511).\147\ Section 6655(c) 
provides that this estimated tax is payable in quarterly 
installments and that, for calendar-year foundations, the first 
quarterly installment is due on April 15th. Under section 
6655(I), foundations with taxable years other than the calendar 
year must make their quarterly estimated tax payments no later 
than the dates in their fiscal years that correspond to the 
dates applicable to calendar-year foundations.
---------------------------------------------------------------------------
    \147\ Generally, the amount of the first quarter payment must be at 
least 25 percent of the lesser of (1) the preceding year's tax 
liability, as shown on the foundation's Form 990-PF, or (2) 95 percent 
of the foundation's current-year tax liability.
---------------------------------------------------------------------------

                           Reasons for Change

    Because a private foundation's estimated tax payments are 
determined, in part, by reference to the foundation's tax 
liability for the preceding year, the due date of a 
foundation's first-quarter estimated tax payment should be the 
same date for filing the foundation's annual return (Form 990-
PF) for the preceding year.

                        Explanation of Provision

    The bill amends section 6655(g)(3) to provide that a 
calendar-year foundation's first-quarter estimated tax payment 
is due on May 15th (which is the same day that its annual 
return, Form 990-PF, for the preceding year is due). As a 
result of the operation of present-law section 6655(I), fiscal-
year foundations would be required to make their first-quarter 
estimated tax payment no later than the 15th day of the fifth 
month of their taxable year.

                             Effective Date

    The provision applies to taxable years beginning after the 
date of enactment.

2. Withholding of Commonwealth income taxes from the wages of Federal 
        employees (sec. 1262 of the bill and sec. 5517 of title 5, 
        United States Code)

                              Present Law

    If State law provides generally for the withholding of 
State income taxes from the wages of employees in a State, the 
Secretary of the Treasury shall (upon the request of the State) 
enter into an agreement with the State providing for the 
withholding of State income taxes from the wages of Federal 
employees in the State. For this purpose, a State is a State, 
territory, or possession of the United States. The Court of 
Appeals for the Federal Circuit recently held in Romero v. 
United States (38 F.3d 1204 (1994)) that Puerto Rico was not 
encompassed within this definition; consequently, the court 
invalidated an agreement between the Secretary of the Treasury 
and Puerto Rico that provided for the withholding of Puerto 
Rico income taxes from the wages of Federal employees.

                           Reasons for Change

    The Committee believes that employees of the United States 
should be in no better or worse position than other employees 
vis-a-vis local withholding.

                        Explanation of Provision

    The bill makes any Commonwealth eligible to enter into an 
agreement with the Secretary of the Treasury that would provide 
for income tax withholding from the wages of Federal employees.

                             Effective Date

    The provision is effective January 1, 1998.

3. Certain notices disregarded under provision increasing interest rate 
        on large corporate underpayments (sec. 1263 of the bill and 
        sec. 6621 of the Code)

                              Present Law

    The interest rate on a large corporate underpayment of tax 
is the Federal short-term rate plus five percentage points. A 
large corporate underpayment is any underpayment by a 
subchapter C corporation of any tax imposed for any taxable 
period, if the amount of such underpayment for such period 
exceeds $100,000. The large corporate underpayment rate 
generally applies to periods beginning 30 days after the 
earlier of the date on which the first letter of proposed 
deficiency, a statutory notice of deficiency, or a 
nondeficiency letter or notice of assessment or proposed 
assessment is sent. For this purpose, a letter or notice is 
disregarded if the taxpayer makes a payment equal to the amount 
shown on the letter or notice within that 30 day period.

                           Reasons for Change

    The large corporate underpayment rate generally applies if 
the underpayment of tax for a taxable period exceeds $100,000, 
even if the initial letter or notice of deficiency, proposed 
deficiency, assessment, or proposed assessment is for an amount 
less than $100,000. Thus, for example, under present law, a 
nondeficiency notice relating to a relatively minor 
mathematical error by the taxpayer may result in the 
application of the large corporate underpayment rate to a 
subsequently identified income tax deficiency.

                        Explanation of Provision

    For purposes of determining the period to which the large 
corporate underpayment rate applies, any letter or notice is 
disregarded if the amount of the deficiency, proposed 
deficiency, assessment, or proposed assessment set forth in the 
letter or notice is not greater than $100,000 (determined by 
not taking into account any interest, penalties, or additions 
to tax).

                             Effective Date

    The provision is effective for purposes of determining 
interest for periods after December 31, 1997.
                   TITLE XIII. PENSION SIMPLIFICATION

1. Matching contributions of self-employed individuals not treated as 
        elective deferrals (sec. 1301 of the bill and sec. 402(g) of 
        the Code)

                              Present Law

    A qualified cash or deferred arrangement (a ``section 
401(k) plan'') is a type of tax-qualified pension plan under 
which employees can elect to make pre-tax contributions. An 
employee's annual elective contributions are subject to a 
dollar limit ($9,500 for 1997). Employers may make matching 
contributions based on employees' elective contributions. In 
the case of employers, such matching contributions are not 
subject to the $9,500 limit on elective contributions.
    Under present law, matching contributions made for a self-
employed individual are generally treated as additional 
elective contributions by the self-employed individual who 
receives the matching contribution. Accordingly, elective 
contributions and matching contributions for such self-employed 
individual are subject to the section 401(k) limits on elective 
contributions.

                           Reasons for Change

    The Committee believes it is appropriate to treat self-
employed individuals in the same manner as other employees with 
regard to the limitations on matching contributions.

                        Explanation of Provision

    The bill provides that matching contributions for self-
employed individuals are treated the same as matching 
contributions for employees, i.e., they are not treated as 
elective contributions and are not subject to the elective 
contribution limit.

                             Effective Date

    The provision is effective for years beginning after 
December 31, 1997.

2. Contributions to IRAs through payroll deductions (sec. 1302 of the 
        bill)

                              Present Law

    Under present law, employer involvement in the 
establishment or maintenance of individual retirement 
arrangements (``IRAs'') of its employees can result in the 
employer being considered to maintain a retirement plan for 
purposes of title I of the Employee Retirement Income Security 
Act of 1974, as amended (``ERISA''), thus subjecting the 
employer to ERISA's fiduciary rules.

                           Reasons for Change

    Some employers would like to assist their employees by 
providing payroll withholding for IRA contributions but are 
concerned that if they do so they will be subject to ERISA. The 
Committee would like to encourage employers to facilitate 
savings for their employees.

                        Explanation of Provision

    The bill provides that an employer that facilitates IRA 
contributions by its employees by establishing a system under 
which employees, through employer payroll deductions, may make 
contributions to IRAs will not be considered to sponsor a 
retirement plan subject to ERISA. Under the system, employees 
would be required to provide their employer with a contribution 
certificate which establishes the IRA and specifies the 
contribution amount to be deducted from the employee's wages 
and remitted to the employee's IRA. As under present law, the 
amount contributed through payroll deduction would be 
includible in the employee's gross income and wages for 
employment tax purposes, and deductible by the employee in 
accordance with the rules relating to IRAs.
    The provision does not apply to an employee employed by an 
employer who maintains a tax-qualified retirement plan.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

3. Plans not disqualified merely by accepting rollover contributions 
        (sec. 1303 of the bill and sec. 401(a) of the Code)

                              Present Law

    Under present law, a qualified retirement plan that accepts 
rollover contributions from other plans will not be 
disqualified because the plan making the distribution is, in 
fact, not qualified at the time of the distribution, if, prior 
to accepting the rollover, the receiving plan reasonably 
concluded that the distributing plan was qualified. The 
receiving plan can reasonably conclude that the distributing 
plan was qualified if, for example, prior to accepting the 
rollover, the distributing plan provided a statement that the 
distributing plan had a favorable determination letter issued 
by the Internal Revenue Service (``IRS''). The receiving plan 
is not required to verify this information.

                           Reasons for Change

    In order to encourage employers to accept rollovers from 
other qualified retirement plans, the Committee believes that 
the receiving plans should be insulated from disqualification 
based on the subsequent qualified status of the distributing 
plan.

                        Explanation of Provision

    The bill clarifies the circumstances under which a 
qualified plan could accept rollover contributions without 
jeopardizing its qualified status. Under the provision, if the 
trustee of the plan making the distribution notifies the 
recipient plan that the distributing plan is intended to be a 
qualifiedplan, the plan receiving the rollover will not be 
disqualified if the distributing plan was not in fact a qualified plan.

                             Effective Date

    The provision is effective for rollover contributions made 
after December 31, 1997.

4. Modification of prohibition on assignment or alienation (sec. 1304 
        of the bill, sec. 401(a)(13) of the Code)

                              Present Law

    Under present law, amounts held in a qualified retirement 
plan for the benefit of a participant are not, except in very 
limited circumstances, assignable or available to personal 
creditors of the participant. A plan may permit a participant, 
at such time as benefits under the plan are in pay status, to 
make a voluntary revocable assignment of an amount not in 
excess of 10-percent of any benefit payment, provided the 
purpose is not to defray plan administration costs. In 
addition, a plan may comply with a qualified domestic relations 
order issued by a state court requiring benefit payments to 
former spouses or other ``alternate payees'' even if the 
participant is not in pay status.
    There is no specific exception under the Employee 
Retirement Income Security Act of 1974, as amended (``ERISA'') 
or the Internal Revenue Code which would permit the offset of a 
participant's benefit against the amount owed to a plan by the 
participant as a result of a breach of fiduciary duty to the 
plan or criminality involving the plan. Courts have been 
divided in their interpretation of the prohibition on 
assignment or alienation in these cases. Some courts have ruled 
that there is no exception in ERISA for the offset of a 
participant's benefit to make a plan whole in the case of a 
fiduciary breach. Other courts have reached a different result 
and permitted an offset of a participant's benefit for breach 
of fiduciary duties.

                           Reasons for Change

    The Committee believes that the assignment and alienation 
rules should be clarified by creating a limited exception that 
permits participants' benefits under a qualified plan to be 
reduced under certain circumstances including the participant's 
breach of fiduciary duty to the plan.

                        Explanation of Provision

    The bill permits a participant's benefit in a qualified 
plan to be reduced to satisfy liabilities of the participant to 
the plan due to (1) the participant being convicted of 
committing a crime involving the plan, (2) a civil judgment (or 
consent order or decree) entered by a court in an action 
brought in connection with a violation of the fiduciary 
provisions of ERISA, or (3) a settlement agreement between the 
Secretary of Labor or the Pension Benefit Guaranty Corporation 
and the participant in connection with a violation of the 
fiduciary provisions of ERISA. The court order establishing 
such liability must require that the participant's benefit in 
the plan be applied to satisfy the liability. If the 
participant is married at the time his or her benefit under the 
plan is offset to satisfy the liability, spousal consent to 
such offset is required unless the spouse is also required to 
pay an amount to the plan in the judgment, order, decree or 
settlement or the judgment, order, decree or settlement 
provides a 50-percent survivor annuity for the spouse. The bill 
will make the corresponding changes to ERISA.

                             Effective Date

    The provision is effective for judgments, orders, and 
degrees issued, and settlement agreements entered into, on or 
after the date of enactment.

5. Elimination of paperwork burdens on plans (sec. 1305 of the bill and 
        sec. 101 of ERISA)

                              Present Law

    Under present law, employers are required to prepare 
summary plan descriptions of employee benefit plans (``SPDs'), 
and summaries of material modifications to such plans 
(``SMMs'). The SPDs and SMMs generally provide information 
concerning the benefits provided by the plan and the 
participants' rights and obligations under the plan. The SPDs 
and SMMs must be furnished to plan participants and 
beneficiaries and filed with the Secretary of Labor.

                           Reasons for Change

    The Committee believes it is appropriate to alleviate the 
cost and burden of paperwork associated with employee benefit 
plans.

                        Explanation of Provision

    The bill eliminates the requirement that SPDs and SMMs be 
filed with the Secretary of Labor. Employers would be required 
to furnish these documents to the Secretary of Labor upon 
request. A civil penalty could be imposed by the Secretary of 
Labor on the plan administrator for failure to comply with such 
requests. The penalty would be up to $100 per day of failure, 
up to a maximum of $1,000 per request. No penalty would be 
imposed if the failure was due to matters reasonably outside 
the control of the plan administrator.

                             Effective Date

    The provision is effective on the date of enactment.

6. Modification of section 403(b) exclusion allowance to conform to 
        section 415 modifications (sec. 1306 of the bill and sec. 
        403(b) of the Code)

                              Present Law

    Under present law, annual contributions to a section 403(b) 
annuity cannot exceed the exclusion allowance. In general, the 
exclusion allowance for a taxable year is the excess, if any, 
of (1) 20 percent of the employee's includible compensation 
multiplied by his or her years of service, over (2) the 
aggregate employer contributions for an annuity excludable for 
any prior taxable years. Includiblecompensation means the 
amount of compensation from the employer that is includible in gross 
income for the most recent year that can be counted as a year of 
service.
    Alternatively, an employee may elect to have the exclusion 
allowance determined under the rules relating to tax-qualified 
defined contribution plans (sec. 415). Under those rules, the 
maximum annual addition that can be made to a defined 
contribution plan is the lesser of (1) $30,000 or 25 percent of 
compensation. For years beginning after December 31, 1996, 
compensation for this purpose includes certain elective 
deferrals of the employee. An overall limitation applies if the 
employee is a participant in both a defined contribution plan 
and a defined benefit plan of the same employer. This overall 
limitation may further reduce the maximum annual addition that 
could be made to a defined contribution plan. The overall 
limitation is repealed with respect to years beginning after 
December 31, 1999. Existing Treasury regulations relating to 
the alternative method of determining the exclusion allowance 
refer to the overall limit.

                           Reasons for Change

    The exclusion allowance for tax-sheltered annuities should 
be modified to reflect recent changes to the corresponding 
limits on benefits under tax-qualified plans.

                        Explanation of Provision

    The bill conforms the exclusion allowance to the way in 
which the section 415 limit is calculated by providing that 
includible compensation includes elective deferrals of the 
employee, and contributions made at the election of the 
employee to an unfunded deferred compensation plan of a tax-
exempt or State or local government (a sec. 457 plan) or a 
cafeteria plan.
    The bill directs the Secretary to revise the regulations 
regarding the exclusion allowance to reflect the fact that the 
overall limit on benefits and contributions is repealed. The 
revised regulations are to be effective for limitation years 
beginning after December 31, 1999.

                             Effective Date

    The modification to the definition of includible 
compensation is effective for years beginning after December 
31, 1997. The direction to the Secretary is effective on the 
date of enactment.

7. New technologies in retirement plans (sec. 1307 of the bill)

                               Present Law

    Under present law it is not clear if sponsors of employee 
benefit plans may use new technologies (telephonic response 
systems, computers, email) to satisfy the various ERISA 
requirements for notice, election, consent, record keeping, and 
participant disclosure.

                           Reasons for Change

    The Committee believes it is appropriate to review existing 
guidance for purposes of permitting the use of new technologies 
for notice and record keeping requirements for retirement 
plans.

                        Explanation of Provision

    The bill directs the Secretaries of the Treasury and Labor 
to each issue guidance facilitating the use of new technology 
for plan purposes. The guidance will be designed to (1) 
interpret the notice, election, consent, disclosure, and time 
requirements (and related recordkeeping requirements) under the 
Internal Revenue Code of 1986 (``IRC'') and the Employee 
Retirement Income Security Act of 1974, as amended (``ERISA'') 
relating to retirement plans as applied to the use of new 
technologies by plan sponsors and administrators while 
maintaining the protection of the rights of participants and 
beneficiaries, and (2) clarify the extent to which writing 
requirements under the IRC shall be interpreted to permit 
paperless transactions.

                             Effective Date

    The provision is effective on the date of enactment and 
requires that the guidance be issued not later than December 
31, 1998.

8. Permanent moratorium on application of nondiscrimination rules to 
        governmental plans (sec. 1308 of the bill and secs. 401 and 
        403(b) of the Code)

                              Present Law

    Under present law, the rules applicable to governmental 
plans require that such plans satisfy certain nondiscrimination 
and minimum participation rules. In general, the rules require 
that a plan not discriminate in favor of highly compensated 
employees with regard to the contribution and benefits provided 
under the plan, participation in the plan, coverage under the 
plan, and compensation taken into account under the plan. The 
nondiscrimination rules apply to all governmental plans; 
qualified retirement plans (including cash or deferred 
arrangements (sec. 401(k) plans) in effect before May 6, 1986) 
and annuity plans (sec. 403(b) plans).
    For purposes of satisfying the nondiscrimination rules, the 
Internal Revenue Service has issued several Notices which 
extended the effective date for compliance for governmental 
plans. Governmental plans will be required to comply with the 
nondiscrimination rules beginning with plan years beginning on 
or after the later of January 1, 1999, or 90 days after the 
opening of the first legislative session beginning on or after 
January 1, 1999, of the governing body with authority to amend 
the plan, if that body does not meet continuously. For plan 
years beginning before the extended effective date, 
governmental plans are deemed to satisfy the nondiscrimination 
requirements.

                           Reasons for Change

    The Committee believes that, because of the unique 
circumstances applicable to governmental plans and the 
complexity of compliance, the moratorium on compliance with the 
nondiscrimination rules should be made permanent.

                        Explanation of Provision

    The bill provides that governmental plans are exempt from 
the nondiscrimination and minimum participation rules.

                             Effective Date

    The provision is effective for taxable years beginning on 
and after the date of enactment.

9. Clarification of certain rules relating to employee stock ownership 
        plans of S corporations (sec. 1309 of the bill and sec. 409 of 
        the Code)

                              Present Law

    Under present law, an S corporation can have no more than 
75 shareholders. For taxable years beginning after December 31, 
1997, certain tax-exempt organizations, including employee 
stock ownership plans (``ESOPs'') can be a shareholder of an S 
corporation.
    ESOPs are generally required to make distributions in the 
form of employer securities. If the employer securities are not 
readily tradable, the employee has a right to require the 
employer to buy the securities. In the case of an employer 
whose bylaws or charter restricts ownership of substantially 
all employer securities to employees or a pension plan, the 
plan may provide that benefits are distributed in the form of 
cash. Such a plan may distribute employer securities, if the 
employee has a right to require the employer to purchase the 
securities.
     ESOPs are subject to certain prohibited transaction rules 
designed to prohibit certain transactions between the plan and 
certain persons close to the plan. A number of statutory 
exceptions are provided to the prohibited transaction rules, 
including exceptions for loans between the plan and plan 
participants and certain sales of stock to the ESOP. These 
statutory exceptions do not apply to shareholder-employees of S 
corporations. However, such individuals can obtain an 
administrative exception from such rules from the Department of 
Labor.

                           Reasons for Change

    It is possible that an S corporation may lose its status as 
such if the ESOP is required to give stock to plan 
participants, rather than cash equal to the value of the stock. 
Changes to the prohibited transactions rules are appropriate to 
facilitate the maintenance of an ESOP by an S corporation.

                        Explanation of Provision

    The bill provides that ESOPs of S corporations may 
distribute cash to plan participants as long as the employee 
has a right to require the employer to purchase the securities 
(as under the present-law rules). In addition, the bill extends 
the exception to certain prohibited transactions rules to S 
corporations.

                             Effective Date

    The provision is effective for taxable years beginning 
after December 31, 1997.

10. Modification of 10-percent tax on nondeductible contributions (sec. 
        1310 of the bill and sec. 4972 of the Code)

                              Present Law

    Under present law, contributions to qualified pension plans 
are deductible within certain limits. In the case of a single-
employer defined benefit plan which has more than 100 
participants during the year, the maximum amount deductible is 
not less than the plan's unfunded current liability as 
determined under the minimum funding rules. Limits are also 
imposed on the amount of annual deductible contributions if an 
employer sponsors both a defined benefit plan and a defined 
contribution plan that covers some of the same employees. Under 
the combined plan limitation, the total deduction for all plans 
for a plan year is generally limited to the greater of (1) 25 
percent of compensation or (2) the contribution necessary to 
meet the minimum funding requirements of the defined benefit 
plan for the year.
    A 10-percent nondeductible excise tax is imposed on 
contributions that are not deductible. This excise tax does not 
apply to contributions to one or more defined contribution 
plans that are nondeductible because they exceed the combined 
plan deduction limit to the extent such contributions do not 
exceed 6 percent of compensation in the year for which the 
contribution is made.

                           Reasons for Change

    The Committee believes that present law unfairly penalizes 
employers by imposing an excise tax on employer plan 
contributions that are required to be made and that are not 
deductible because the employer is fully funding its pension 
plan. In particular, the Committee does not believe that the 
excise tax on nondeductible contributions should be imposed 
when an employer is required to make contributions attributable 
to elective deferrals under a section 401(k) plan and employer 
matching contributions.

                        Explanation of Provision

    The bill adds an additional exception to the 10-percent 
excise tax on nondeductible contributions. Under the provision, 
the excise tax does not apply to contributions to one or more 
defined contribution plans that are not deductible because they 
exceed the combined plan deduction limit to the extent such 
contributions do not exceed the amount of the employer's 
matching contributions plus the elective deferral contributions 
to a section 401(k) plan.

                             Effective Date

    The provision is effective with respect to taxable years 
beginning after December 31, 1997.

11. Modify funding requirements for certain plans (sec. 1311 of the 
        bill and sec. 412 of the Code)

                              Present Law

    Under present law, defined benefit pension plans are 
required to meet certain minimum funding rules. Underfunded 
plans are required to satisfy certain faster funding 
requirements. In general, these additional requirements do not 
apply in the case of plans with a funded current liability 
percentage of at least 90 percent.
    The Pension Benefit Guaranty Corporation (``PBGC'') insures 
benefits under most defined benefit pension plans in the event 
the plan is terminated with insufficient assets to pay for plan 
benefits. The PBGC is funded in part by a flat-rate premium per 
plan participant, and a variable rate premium based on plan 
underfunding.

                           Reasons for Change

    Certain interstate bus companies have pension plans that 
are closed to new participants and the participants in these 
plans have demonstrated mortality significantly greater than 
that predicted by the mortality tables that the plans are 
required to use for minimum funding purposes. As a result, the 
sponsors of such plans are required to make contributions that 
cause the plan to be substantially overfunded. The Committee 
believes it appropriate to modify the minimum funding 
requirements for such plans, while at the same time ensuring 
that pension benefits are adequately funded.

                        Explanation of Provision

    The bill modifies the minimum funding requirements in the 
case of certain plans. The bill applies in the case of plans 
that (1) were not required to pay a variable rate PBGC premium 
for the plan year beginning in 1996, (2) do not, in plan years 
beginning after 1995 and before 2009, merge with another plan 
(other than a plan sponsored by an employer that was a member 
of the controlled group of the employer in 1996), and (3) are 
sponsored by a company that is engaged primarily in the 
interurban or interstate passenger bus service.
    The bill treats a plan to which it applies as having a 
funded current liability percentage of at least 90 percent for 
plan years beginning after 1996 and before 2005. For plan years 
beginning after 2004, the funded current liability percentage 
will be deemed to be at least 90 percent if the actual funded 
current liability percentage is at least as follows:

Plan year beginning in:
                                                      Minimum percentage
    2005......................................................        86
    2006......................................................        87
    2007......................................................        88
    2008......................................................        89
    2009 and thereafter.......................................        90

    If the funded current liability percentage falls below 85 
percent for a plan year beginning before 2005, the rule 
described above still applies if contributions for any such 
year are made to the plan in an amount equal to the lesser of: 
(1) the amount necessary to bring the funded current liability 
percentage to 85 percent, or (2) the greater of (a) 2 percent 
of the plan's current liability as of the beginning of such 
plan year or (b) the amount necessary to bring the funded 
current liability percentage to 80 percent as of the end of 
such plan year.
    The relief from the minimum funding requirements applies 
for the plan year beginning in 2005, 2006, 2007, and 2008 only 
if contributions to the plan equal at least the expected 
increase in current liability due to benefits accruing during 
the plan year.

                             Effective Date

    The provision is effective with respect to contributions 
due after December 31, 1997.
               TITLE XIV. TECHNICAL CORRECTION PROVISIONS

 I. TECHNICAL CORRECTIONS TO THE SMALL BUSINESS JOB PROTECTION ACT OF 
                                  1996

                  A. Small Business-Related Provisions

1. Returns relating to purchases of fish (sec. 1401(a)(1) of the bill 
        and sec. 6050R(c)(1) of the Code)

                              Present Law

    Every person engaged in the trade or business of purchasing 
fish for resale must file an informational return reporting its 
purchases from any person that is engaged in the trade or 
business of catching fish which are in excess of $600 for any 
calendar year. Persons filing such an informational return 
relating to the purchase of fish must furnish a statement 
showing the name and address of the person filing the return, 
as well as the amount shown on the return, to each person whose 
name is required to be disclosed on the return.

                        Explanation of Provision

    Every person filing an informational return relating to the 
purchase of fish must furnish a statement showing the phone 
number of the person filing the return, as well as such 
person's name, address and the amount shown on the return, to 
each person whose name is required to be disclosed on the 
return.

2. Charitable remainder trusts not eligible to be electing small 
        business trusts (sec. 1402(c)(1) of the bill and sec. 
        1361(c)(1)(B) of the Code)

                              Present Law

    Under present law, an electing small business trust may be 
a shareholder in an S corporation. In order to qualify for this 
treatment, all beneficiaries of the electing small business 
trust generally must be individuals or estates eligible to be S 
corporation shareholders. An exempt trust may not qualify as an 
electing small business trust.

                        Description of Provision

    The provision clarifies that charitable remainder annuity 
trusts and charitable remainder unitrusts may not be electing 
small business trusts.

3. Clarify the effective date for post-termination transition period 
        provision (sec. 1401(c)(2) of the bill)

                              Present Law

    Distributions made by a former S corporation during its 
post-termination period are treated in the same manner as if 
the distributions were made by an S corporation (e.g., treated 
by shareholders as nontaxable distributions to the extent of 
the accumulated adjustment account). Distributions made after 
the post-termination period are generally treated as made by a 
C corporation (i.e., treated by shareholders as taxable 
dividends to the extent of earnings and profits).
    The ``post-termination period'' is the period beginning on 
the day after the last day of the last taxable year of the S 
corporation and ending on the later of: (1) a date that is one 
year later, or (2) the due date for filing the return for the 
last taxable year and the 120-day period beginning on the date 
of a determination that the corporation's S corporation 
election had terminated for a previous taxable year.
    The Small Business Act expanded the post-termination period 
to include the 120-day period beginning on the date of any 
determination pursuant to an audit of the taxpayer that follows 
the termination of the S corporation's election and that 
adjusts a subchapter S item of income, loss or deduction of the 
S corporation during the S period. In addition, the definition 
of ``determination'' was expanded to include a final 
disposition of the Secretary of the Treasury of a claim for 
refund and, under regulations, certain agreements between the 
Secretary and any person, relating to the tax liability of the 
person. The Small Business Act provision was effective for 
taxable years beginning after December 31, 1996.

                        Explanation of Provision

    The technical correction clarifies that the effective date 
for the Small Business Act provision affecting the post-
termination transition period is for determinations after 
December 31, 1996, not for determinations with respect to 
taxable years beginning after December 31, 1996. However, in no 
event will the post-termination transition period expanded by 
the Small Business Act end before the end of the 120-day period 
beginning after the date of enactment of this Act.

4. Treatment of qualified subchapter S subsidiaries (sec. 1401(c)(3) of 
        the bill and sec. 1361(b)(3) of the Code)

                              Present Law

    Pursuant to a provision of the Small Business Act, an S 
corporation is allowed to own a qualified subchapter S 
subsidiary. The term ``qualified subchapter S subsidiary'' 
means a domestic corporation that (1) is not an ineligible 
corporation (i.e., a corporation that would be eligible to be 
an S corporation if the stock of the corporation were held 
directly by the shareholders of its parent S corporation) if 
100 percent of the stock of the subsidiary were held by its S 
corporation parent and (2) which the parent elects to treat as 
a qualified subchapter S subsidiary. Under the election, for 
all purposes of the Code, the qualified subchapter S subsidiary 
is not treated as a separate corporation and all the assets, 
liabilities, and items of income, deduction, and credit of the 
subsidiary are treated as the assets, liabilities, and items of 
income, deduction, and credit of the parent S corporation.
    The legislative history of the provision provides that if 
an election is made to treat an existing corporation as a 
qualified subchapter S subsidiary, the subsidiary will be 
deemed to have liquidated under sections 332 and 337 
immediately before the election is effective.

                        Explanation of Provision

    The technical correction provides that the Secretary of the 
Treasury may provide, by regulations, instances where the 
separate corporate existence of a qualified subchapter S 
subsidiary may be taken into account for purposes of the Code. 
Thus, if an S corporation owns 100 percent of the stock of a 
bank (as defined in sec. 581) and elects to treat the bank as a 
qualified subchapter S subsidiary, it is expected that Treasury 
regulations would treat the bank as a separate legal entity for 
purposes of those Code provisions that apply specifically to 
banks (e.g., sec. 582).
    Treasury regulations also may provide exceptions to the 
general rule that the qualified subchapter S subsidiary 
election is treated as a deemed section 332 liquidation of the 
subsidiary in appropriate cases. In addition, if the effect of 
a qualified subchapter S subsidiary election is to invalidate 
an election to join in the filing of a consolidated return for 
a group of subsidiaries that formerly joined in such filing, 
Treasury regulations may provide guidance as to the 
consolidated return effects of the S election.

                         B. Pension Provisions

1. Salary reduction simplified employee pensions (``SARSEPS'') (sec. 
        1401(d)(1)(B) of the bill and sec. 408(k)(6) of the Code)

                              Present Law

    SARSEPs were repealed for years beginning after December 
31, 1996, unless the SARSEP was established before January 1, 
1997. Consequently, an employer was not permitted to establish 
a SARSEP after December 31, 1996. SARSEPs established before 
January 1, 1997, may continue to receive contributions under 
the rules in effect prior to January 1, 1997.

                        Explanation of Provision

    The bill amends Code section 408(k)(6) to clarify that new 
employees of an employer hired after December 31, 1996, may 
participate in a SARSEP of an employer established before 
January 1, 1997.

2. SIMPLE retirement plans (secs. 1401(d)(1)(A) and (d)(1)(C)-(F) and 
        1401(d)(2) of the bill)

            a. Reporting requirements for SIMPLE IRAs (sec. 
                    1401(d)(1)(A) of the bill and sec. 408(i) of the 
                    Code)

                              Present Law

    A trustee of an individual retirement account and the 
issuer of an individual retirement annuity must furnish reports 
regarding the account or annuity to the individual for whom the 
account or annuity is maintained not later than January 31 of 
the calendar year following the year to which the reports 
relate. In the case of a SIMPLE IRA, such reports are to be 
furnished within 30 days after each calendar year.

                        Explanation of Provision

    The bill conforms the time for providing reports for SIMPLE 
IRAs to that for IRA reports generally. Thus, the bill would 
provide that the report required to be furnished to the 
individual under a SIMPLE IRA would be provided within 31 days 
after each calendar year.
            b. Notification requirement for SIMPLE IRAs (sec. 
                    1401(d)(1)(C) of the bill and secs. 408(l)(2) and 
                    6693(c) of the Code)

                              Present Law

    The trustee of any SIMPLE IRA is required to provide the 
employer maintaining the arrangement a summary plan description 
containing basic information about the plan. At least once a 
year, the trustee is also required to furnish an account 
statement to each individual maintaining a SIMPLE account. In 
addition, the trustee is required to file an annual report with 
the Secretary. A trustee who fails to provide any of such 
reports or descriptions will be subject to a penalty of $50 per 
day until such failure is corrected, unless the failure is due 
to reasonable cause.

                        Explanation of Provision

    The bill provides that issuers of annuities for SIMPLE IRAs 
have the same reporting requirements as SIMPLE IRA trustees.
            c. Maximum dollar limitation for SIMPLE IRAs (sec. 
                    1401(d)(1)(D) of the bill and sec. 408(p) of the 
                    Code)

                              Present Law

    The Small Business Act created a simplified retirement plan 
for small business called the savings incentive match plan for 
employees (``SIMPLE'') retirement plan. A SIMPLE plan can be 
either an individual retirement arrangement (``IRA'') for each 
employee or part of a qualified cash or deferred arrangement 
(``a 401(k) plan''). A SIMPLE IRA permits employees to make 
elective contributions up to $6,000 per year to their IRA. The 
employer is required to satisfy one of two contribution 
formulas. Under the matching contribution formula, the employer 
generally is required to match employee elective contributions 
on a dollar-for-dollar basis up to 3 percent of the employee's 
compensation, unless the employer elects a lower percentage 
matching contribution (but not less than 1 percent of each 
employee's compensation). Alternatively, an employer is 
permitted to elect, in lieu of making matching contributions, 
to make a 2 percent of compensation nonelective contribution on 
behalf of each eligible employee. The employer contribution 
amounts are contributed to the employee's IRA. The maximum 
contribution limitation to an IRA is $2,000.

                        Explanation of Provision

    The bill provides that in the case of a SIMPLE IRA, the 
$2,000 maximum limitation applicable to IRAs is increased to 
the limitations in effect for contributions made under a 
qualified salary reduction arrangement. This includes employee 
elective contributions and required employer contributions.
            d. Application of exclusive plan requirement for SIMPLE 
                    IRAs to noncollectively bargained employees (sec. 
                    1401(d)(1)(E) of the bill and sec. 408(p)(2)(D) of 
                    the Code)

                              Present Law

     A SIMPLE IRA will be treated as a qualified salary 
reduction arrangement provided the employer does not maintain a 
qualified plan during the same time period the SIMPLE IRA is 
maintained. Collectively bargained employees can be excluded 
from participation in the SIMPLE IRA and may be covered under a 
plan established by the employer as a result of a good faith 
bargaining agreement.

                        Explanation of Provision

    The bill provides that an employer who maintains a plan for 
collectively bargained employees is permitted to maintain a 
SIMPLE IRA for noncollectively bargained employees.
            e. Application of exclusive plan requirement for SIMPLE 
                    IRAs in the case of mergers and acquisitions (sec. 
                    1401(d)(1)(F) of the bill and sec. 408(p)(2) of the 
                    Code)

                              Present Law

    Only employers who employ 100 or fewer employees who 
received compensation for the preceding year of at least $5,000 
are eligible to establish a SIMPLE IRA. An eligible employer 
maintaining a SIMPLE IRA who fails to be an eligible employer 
due to an acquisition, disposition or similar transaction is 
treated as an eligible employer for the 2 years following the 
last year the employer was eligible provided rules similar to 
the special coverage rules of section 410(b)(6)(C)(i) apply. 
There is no parallel provision with respect to an employer who, 
because of an acquisition, disposition or similar transaction, 
maintains a qualified plan and a SIMPLE IRA at the same time.

                        Explanation of Provision

    The bill provides that if an employer maintains a qualified 
plan and a SIMPLE IRA in the same year due to an acquisition, 
disposition or similar transaction the SIMPLE IRA is treated as 
a qualified salary reduction arrangement for the year of the 
transaction and the following calendar year.
            f. Top-heavy exemption for SIMPLE 401(k) arrangements (sec. 
                    1401(d)(2)(A) of the bill and sec. 401(k)(11)(D) of 
                    the Code)

                              Present Law

    A plan meeting the SIMPLE 401(k) requirements for any year 
is not treated as a top-heavy plan under section 416 for the 
year. This rule was intended to apply only to SIMPLE 401(k)s, 
and not other plans maintained by the employer.

                        Explanation of Provision

    The bill provides that the top-heavy exemption applies to a 
plan which permits only contributions required to satisfy the 
SIMPLE 401(k) requirements.
            g. Cost of living adjustments for SIMPLE 401(k) 
                    arrangements (sec. 1401(d)(2)(B) of the bill and 
                    sec. 401(k)(11) of the Code)

                              Present Law

    The $6,000 limit on deferrals to a SIMPLE IRA is subject to 
a cost-of-living adjustment. There is no parallel provision 
applicable to a SIMPLE 401(k) arrangement.

                        Explanation of Provision

    The bill provides that the $6,000 limit on elective 
deferrals under a SIMPLE 401(k) arrangement will be adjusted at 
the same time and in the same manner as for SIMPLE IRAs.
            h. Employer deduction for SIMPLE 401(k) arrangements (sec. 
                    1401(d)(2)(C) of the bill and sec. 404(a)(3) of the 
                    Code)

                              Present Law

    Contributions paid by an employer to a profit sharing or 
stock bonus plan are deductible by the employer for a taxable 
year to the extent the contributions do not exceed 15-percent 
of the compensation otherwise paid or accrued during the 
taxable year to the participants under the plan. Contributions 
paid by an employer to a profit sharing or stock bonus plan 
that are not deductible because they are in excess of the 15-
percent limitation are subject to a 10-percent excise tax 
payable by the employer making the contribution.

                        Explanation of Provision

    The bill provides that to the extent that contributions 
paid by an employer to a SIMPLE 401(k) arrangement satisfy the 
contribution requirements of section 401(k)(11)(B), such 
contributions is deductible by the employer for the taxable 
year.
            i. Notification and election periods for SIMPLE 401(k) 
                    arrangements (sec. 1401(d)(2)(D) of the bill and 
                    sec. 401(k)(11) of the Code)

                              Present Law

    An employer maintaining a SIMPLE 401(k) arrangement is 
required to make a matching contribution for employees making 
elective deferrals of up to 3-percent of compensation (or, 
alternatively, elect to make a 2-percent of compensation 
nonelective contribution on behalf of all eligible employees). 
An employer electing to make a 2-percent nonelective 
contribution is required to notify all employees of such 
election within a reasonable period of time before the 60th day 
before the beginning of the year.
    An employer maintaining a SIMPLE IRA is required to notify 
each employee of the employee's opportunity to make or modify 
salary reduction contributions as well as the contribution 
alternative chosen by the employer within a reasonable period 
of time before the employee's election period. The employee's 
election period is the 60-day period before the beginning of 
any year (and the 60-day period before the first day such 
employee is eligible to participate).

                        Explanation of Provision

    The bill extends the employer notice and employee election 
requirements of SIMPLE IRAs to SIMPLE 401(k) arrangements.

                             Effective Date

    The bill is effective with respect to calendar years 
beginning after the date of enactment.
            j. Treatment of Indian tribal governments under section 
                    403(b) (sec. 1401(d)(5) of the bill and sec. 403(b) 
                    of the Code)

                              Present Law

    Any 403(b) annuity contract purchased in a plan year 
beginning before January 1, 1995, by an Indian tribal 
government is treated as purchased by an entity permitted to 
maintain a tax-sheltered annuity plan. Such contracts may be 
rolled over into a section 401(k) plan maintained by the Indian 
tribal government in accordance with the rollover rules of 
section 403(b)(8).

                        Explanation of Provision

    The bill clarifies that an employee participating in a 
403(b) annuity contract of the Indian tribal government would 
be permitted to roll over amounts from such contract to a 
section 401(k) plan maintained by the Indian tribal government 
whether or not the annuity contract is terminated.

                         C. Foreign Provisions

1. Measurement of earnings of controlled foreign corporations (sec. 
        1401(e) of the bill, subtitle E of the Act, and section 956 of 
        the Code)

                              Present Law

    U.S. 10-percent shareholders of a controlled foreign 
corporation (CFC) are subject to current U.S. tax on their pro 
rata shares of the CFC's earnings invested in United States 
property. For this purpose, earnings include both current 
earnings and profits (not including a deficit) referred to in 
section 316(a)(1) and accumulated earnings and profits referred 
to in section 316(a)(2). It could be argued that this 
definition of earnings takes current year earnings into account 
twice.

                        Explanation of Provision

    The technical correction clarifies that accumulated 
earnings and profits of a CFC taken into account for purposes 
of determining the CFC's earnings invested in United States 
property do not include current earnings (which are taken into 
account separately). A similar technical correction to the 
definition of earnings for purposes of prior-law section 956A 
(relating to a CFC's earnings invested in excess passive 
assets) was enacted with the Small Business Job Protection Act 
of 1996 (section 1703(i)(2)).

2. Transfers to foreign trusts at fair market value (sec. 1401(i)(2) of 
        the bill, sec. 1903 of the Act, and sec. 679 of the Code)

                              Present Law

    A U.S. person who transfers property to a foreign trust 
which has U.S. beneficiaries generally is treated as the owner 
of such trust. However, this rule does not apply where the U.S. 
person transfers property to a trust in exchange for fair 
market value consideration. In determining whether the U.S. 
person receives fair market value consideration, obligations of 
certain related persons are not taken into account. For this 
purpose, related persons include the trust, any grantor or 
beneficiary of the trust, and certain persons who are related 
to any such grantor or beneficiary.

                        Explanation of Provision

    The technical correction clarifies that, for purposes of 
determining whether a U.S. person's transfer to a trust is for 
fair market value consideration, the related persons whose 
obligations are disregarded include any owner of the trust and 
certain persons who are related to any such owner.

3. Treatment of trust as U.S. person (sec. 1401(i)(3) of the bill, sec. 
        1907 of the Act, and secs. 641 and 7701(a)(30) of the Code)

                              Present Law

    A trust is considered to be a U.S. person if two criteria 
are met. First, a court within the United States must be able 
to exercise primary supervision over the administration of the 
trust. Second, one or more U.S. fiduciaries must have the 
authority to control all substantial decisions of the trust.
    These criteria regarding the treatment of a trust as a U.S. 
person are effective for taxable years beginning after December 
31, 1996. The Internal Revenue Service announced procedures 
under which a U.S. trust in existence on August 20, 1996 may 
continue to file returns as a U.S. trust for taxable years 
beginning after December 31, 1996. To qualify for such 
treatment, the trustee (1) must initiate modification of the 
trust to conform to the new criteria by the due date for filing 
the trust's return for its first taxable year beginning after 
1996, (2) must complete the modification within two years of 
such date, and (3) must attach the required statement to the 
trust returns for the taxable years beginning after 1996.\148\
---------------------------------------------------------------------------
    \148\ Notice 96-65, I.R.B. 1996-52. See Joint Committee on 
Taxation, General Explanation of Tax Legislation Enacted in the 104th 
Congress (JCS-12-96), December 12, 1996, pp. 277-278.
---------------------------------------------------------------------------

                        Explanation of Provision

    The technical correction clarifies that a trust is treated 
as a U.S. person as long as one or more U.S. persons have the 
authority to control all substantial decisions of the trust 
(and a U.S. court can exercise primary supervision). 
Accordingly, the fact that a substantial decision of the trust 
is controlled by a U.S. person who is not a fiduciary would not 
cause the trust not to be treated as a U.S. person. In 
addition, the technical correction clarifies that a trust that 
is a foreign trust under these criteria is not considered to be 
present or resident in the United States at any time. Finally, 
the technical correction provides the Secretary of Treasury 
with authority to allow reasonable time for U.S. trusts in 
existence on August 20, 1996 to make modifications in order to 
comply with the new criteria for treatment of a trust as a U.S. 
person.

                          E. Other Provisions

1. Treatment of certain reserves of thrift institutions (sec. 
        1401(f)(5) of the bill and secs. 593(e) and 1374 of the Code)

                              Present Law

    A provision of the Small Business Act repealed the 
percentage-of-taxable-income method for deducting bad debts 
applicable to thrift institutions. The portion of the section 
481(a) adjustment applicable to pre-1988 reserves of an 
institution required to change its method of accounting 
generally is not restored to income unless the institution 
makes a distribution to which section 593(e) applies. Section 
593(e) provides that if an institution makes a nonliquidating 
distribution in an amount in excess of its post-1951 
accumulated earnings and profits, such excess will be treated 
as a distribution of the post-1987 reserve for bad debts, 
requiring recapture of such amount.
    Another provision of the Small Business Act allows a bank 
or a thrift institution to elect to be treated as an S 
corporation so long as the entity does not use a reserve method 
of accounting for bad debts. The earnings of an S corporation 
increase the corporation's accumulated adjustments account, but 
do not increase its accumulated earnings and profits (sec. 
1368). In addition, any net unrealized built-in gains of a C 
corporation that converts to S corporation status that are 
recognized during the 10-year period beginning with the date of 
such conversion generally are subject to corporate-level tax 
(sec. 1374). Section 481(a) adjustments taken into account 
during the 10-year period generally are subject to section 
1374.

                        Explanation of Provision

    The bill provides rules to clarify the section 593(e) 
treatment of pre-1988 bad debt reserves of thrift and former 
thrift institutions that become S corporations. The technical 
corrections provide that (1) the accumulated adjustments 
account of an S corporation would be treated the same as post-
1951 earnings and profits for purposes of section 593(e) and 
(2) section 593(e) would apply irrespective of section 1374 
(e.g., distributions that trigger section 593(e) would be 
subject to corporate-level recapture even if such distributions 
occur after the 10-year period of section 1374).

2. ``FASIT'' technical corrections (sec. 1401(f)(6) of the bill and 
        sec. 860L of the Code)

                              Present Law

In general

    A ``financial asset securitization investment trust'' 
(``FASIT'') is designed to facilitate the securitization of 
debt obligations such as credit card receivables, home equity 
loans, and auto loans. A FASIT generally is not taxable; the 
FASIT's taxable income or net loss flows through to the owner 
of the FASIT.
    The ownership interest of a FASIT generally is required to 
be entirely held by a single domestic C corporation. In 
addition, a FASIT generally must hold only qualified debt 
obligations, and certain other specified assets, and is subject 
to certain restrictions on its activities. An entity that 
qualifies as a FASIT can issue instruments (called ``regular 
interests'') that meet certain specified requirements and treat 
those instruments as debt for Federal income tax purposes. In 
general, those requirements must be met ``after the startup 
date.'' Instruments bearing yields to maturity over 5 
percentage points above the yield to maturity on specified 
United States Government obligations (i.e., ``high-yield 
interests'') may be held only by domestic C corporations that 
are not exempt from income tax.

Income from prohibited transactions

    The owner of a FASIT is required to pay a penalty excise 
tax equal to 100 percent of net income derived from (1) an 
asset that is not a permitted asset, (2) any disposition of an 
asset other than a permitted disposition, (3) any income 
attributable to loans originated by the FASIT, and (4) 
compensation for services (other than fees for a waiver, 
amendment, or consent under permitted assets not acquired 
through foreclosure). A permitted disposition is any 
disposition of any permitted asset (1) arising from complete 
liquidation of a class of regular interests (i.e., a qualified 
liquidation) 149; (2) incident to the foreclosure, 
default, or imminent default of the asset; (3) incident to the 
bankruptcy or insolvency of the FASIT; (4) necessary to avoid a 
default on any indebtedness of the FASIT attributable to a 
default (or imminent default) on an asset of the FASIT; (5) to 
facilitate a clean-up call; (6) to substitute a permitted debt 
instrument for another such instrument; or (7) in order to 
reduce over-collateralization where a principal purpose of the 
disposition was not to avoid recognition of gain arising from 
an increase in its market value after its acquisition by the 
FASIT.
---------------------------------------------------------------------------
    \149\ For this purpose, a ``qualified liquidation'' has the same 
meaning as it does for purposes of the exemption from the tax on 
prohibited transactions of a real estate mortgage investment conduit 
(``REMIC'') in section 860F(a)(4).
---------------------------------------------------------------------------

Definition of ``FASIT''

    For an entity or arrangement to qualify as a FASIT, 
substantially all of its assets must consist of the following 
``permitted assets'': (1) cash and cash equivalents; (2) 
certain permitted debt instruments; (3) certain foreclosure 
property; (4) certain instruments or contracts that represent a 
hedge or guarantee of debt held or issued by the FASIT; (5) 
contract rights to acquire permitted debt instruments or 
hedges; (6) a regular interest in another FASIT; and (7) a 
regular interest in a REMIC. A FASIT must meet the asset test 
at the 90th day after its formation and at all times 
thereafter. Permitted assets may be acquired at any time by a 
FASIT, including any time after its formation.

                        Explanation of Provision

Definition of regular interest

    The bill provides that the requirement of a ``regular 
interest'' must be met ``on or after the startup date,'' 
instead of just ``after the startup date.''

Correction of cross reference

    The bill corrects an incorrect cross reference in section 
860L(d) from section 860L(c)(2) to section 860L(b)(2).

Tax on prohibited transactions

    The bill provides that the tax on prohibited transactions 
would not apply to dispositions of foreclosure property or 
hedges using the similar exception applicable to REMICs.

3. Qualified State tuition plans (sec. 1401(h)(1) of the bill and sec. 
        529 of the Code)

                              Present Law

    Section 529 provides tax-exempt status to certain qualified 
State tuition programs and provides rules governing the tax 
treatment of distributions from such programs. Section 529 was 
effective on the date of enactment of the Small Business Job 
Protection Act of 1996, but a special transition rule provides 
that if (1) a State maintains (on the date of enactment) a 
program under which persons may purchase tuition credits on 
behalf of, or make contributions for educational expenses of, a 
designated beneficiary, and (2) such program meets the 
requirements of a qualified State tuition program before the 
later of (a) one year after the date of enactment, or (b) the 
first day of the first calendar quarter after the close of the 
first regular session of the State legislature that begins 
after the date of enactment, then the provisions of the Small 
Business Act will apply to contributions (and earnings 
allocable thereto) made before the date the program meets the 
requirements of a qualified State tuition program, without 
regard to whether the requirements of a qualified State tuition 
program are satisfied with respect to such contributions and 
earnings (e.g., even if the interest in the tuition or 
educational savings program covers not only qualified higher 
education expenses but also room and board expenses).

                        Explanation of Provision

    The provision clarifies that, if a State program under 
which persons may purchase tuition credits comes into 
compliance with the requirements of a ``qualified State tuition 
program'' as defined in section 529 within a specified time 
period, then such program will be treated as a qualified State 
tuition program with respect to any contributions (and earnings 
allocable thereto) made pursuant to a contract entered into 
under the program before the date on which the program comes 
into compliance with the present-law requirements of a 
qualified State tuition program under section 529.

4. Adoption credit (sec. 1401(h)(2) of the bill, sec. 1807 of the Small 
        Business Act, and sec. 23 of the Code)

                              Present Law

    Taxpayers are allowed a maximum nonrefundable tax credit 
against income tax liability of $5,000 per child for qualified 
adoption expenses ($6,000 in the case of certain domestic 
adoptions) paid or incurred by the taxpayer. 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.
    Otherwise qualified adoption expenses paid or incurred in 
one taxable year are not taken into account for purposes of the 
credit until the next taxable year unless the expenses are paid 
or incurred in the year the adoption becomes final.

                        Explanation of Provision

    The technical correction conforms the treatment of 
otherwise qualified adoption expenses paid or incurred in years 
after the year the adoption becomes final to the treatment of 
expenses paid or incurred in the year the adoption becomes 
final. Another technical correction repeals as ``deadwood'' an 
ordering rule inadvertently included in the credit.

5. Phaseout of adoption assistance exclusion (sec. 1401(h)(2) of the 
        bill, sec. 1807 of the Small Business Act, and sec. 137 of the 
        Code)

                              Present Law

    The adoption tax credit and the exclusion for employer 
provided adoption assistance are generally phased out ratably 
for taxpayers with modified adjusted gross income (AGI) above 
$75,000, and are fully phased out at $115,000 of modified AGI. 
For these purposes modified AGI is computed by increasing the 
taxpayer's AGI by the amount otherwise excluded from gross 
income under Code sections 911, 931, or 933 (relating to the 
exclusion of income of U.S. citizens or residents living 
abroad; residents of Guam, American Samoa, and the Northern 
Mariana Islands, and residents of Puerto Rico, respectively).

                        Explanation of Provision

    The technical correction conforms the phaseout range of the 
adoption assistance exclusion to the phaseout range of the 
credit for qualified adoption expenses.
    II. HEALTH INSURANCE PORTABILITY AND ACCOUNTABILITY ACT OF 1996

1. Medical savings accounts (sec. 1402(a) of the bill and sec. 220 of 
        the Code)

            a. Additional tax on distributions not used for medical 
                    purposes

                              Present Law

    Under present law, distributions from a medical savings 
account (``MSA'') that are not used for medical expenses are 
includible in gross income and subject to a 15-percent 
additional tax unless the distribution is after age 65 or death 
or on account of disability. A similar additional 10-percent 
tax is imposed on early withdrawals from individual retirement 
arrangements and qualified pension plans. The 10-percent 
additional tax on early withdrawals is not treated as tax 
liability for purposes of the minimum tax. No such rule applies 
to the 15-percent additional tax applicable to MSAs.

                        Explanation of Provision

    The bill provides that the 15-percent tax on nonmedical 
withdrawals from an MSA is not treated as tax liability for 
purposes of the minimum tax.
            b. Definition of permitted coverage

                              Present Law

    Under present law, in order to be eligible to have an MSA 
an individual must be covered under a high deductible health 
plan and no other health plan, except for plans that provide 
certain permitted coverage. Medicare supplemental plans are one 
of the types of permitted coverage, even though an individual 
covered by Medicare is not eligible to have an MSA.

                        Explanation of Provision

    Under the bill, Medicare supplemental plans would be 
deleted from the types of permitted coverage an individual may 
have and still qualify for an MSA.
            c. Taxation of distributions

                              Present Law

    Under present law, in order to be eligible to have a 
medical savings account (``MSA'') an individual must be covered 
under a high deductible health plan and no other health plan, 
except for plans that provide certain permitted coverage and 
must be either (1) a self-employed individual, or (2) employed 
by a small employer. Distributions from an MSA for the medical 
expenses of the MSA account holder and his or her spouse or 
dependents are generally excludable from income. However, in 
any year for which a contribution is made to an MSA, 
withdrawals from the MSA are excludable from income only if the 
individual for whom the expenses were incurred was an eligible 
individual for the month in which the expenses were incurred. 
This rule is designed to ensure that MSAs are used in 
conjunction with a high deductible plan and that they are not 
primarily used by other individuals who have health plans that 
are not high deductible plans.

                        Explanation of Provision

    The bill would clarify that, in any year for which a 
contribution is made to an MSA, withdrawals from the MSA are 
excludable from income only if the individual for whom the 
expenses were incurred was covered under a high deductible 
health plan (and no other health plan except for plans that 
provide certain permitted coverage) in the month in which the 
expenses were incurred. That is, the individual for whom the 
expenses were incurred does not have to be self employed or 
employed by a small employer in order for a withdrawal for 
medical expenses to be excludible.
            d. Penalty for failure to provide required reports

                              Present Law

    Trustees of an MSA are required to provide such reports to 
the Secretary and the account holder as the Secretary may 
require. A penalty of $50 applies with respect to each failure 
to provide a required report. Under present law, separate 
penalties apply to information returns required by the Code.

                        Explanation of Provision

    The bill provides that the $50 penalty does not apply to 
information returns.

2. Definition of chronically ill individual under a qualified long-term 
        care insurance contract (sec. 1402(b) of the bill and sec. 
        7702B(c)(2) of the Code)

                              Present Law

    Under the long-term care insurance rules, a chronically ill 
individual is one who has been certified within the previous 12 
months by a licensed health care practitioner as (1) being 
unable to perform (without substantial assistance) at least 2 
activities of daily living for at least 90 days due to a loss 
of functional capacity, (2) having a level of disability 
similar (as determined under regulations prescribed by the 
Secretary in consultation with the Secretary of Health and 
Human Services) to the level of disability described above, or 
(3) requiring substantial supervision to protect the individual 
from threats to health and safety due to severe cognitive 
impairment. A contract is not treated as a qualified long-term 
care insurance contract unless the determination of whether an 
individual is a chronically ill individual takes into account 
at least 5 of such activities.

                        Explanation of Provision

    The technical correction clarifies that the five-activity 
requirement--i.e., that the number of activities of daily 
living that are taken into account not be less than five--
applies only for purposes of the first of three alternative 
definitions of a chronically ill individual (Code sec. 
7702B(c)(2)(A)(i)), that is, by reason of the individual being 
unable to perform (without substantial assistance) at least 
2activities of daily living for at least 90 days due to a loss of 
functional capacity. Thus, the requirement does not apply to the 
determination of whether an individual is a chronically ill individual 
either (1) by virtue of severe cognitive impairment, or (2) if the 
insured satisfies a standard (if any) that is not based upon activities 
of daily living, as determined under regulations.

3. Deduction for long-term care insurance of self-employed individuals 
        (sec. 1402(c) of the bill and sec. 162(l)(2) of the Code)

                              Present Law

    Present law provides that the deduction for health 
insurance expenses of a self-employed individual is not 
available for a month for which the individual is eligible to 
participate in any subsidized health plan maintained by any 
employer of the individual or the individual's spouse. Present 
law also provides that in the case of a qualified long-term 
care insurance contract, only eligible long-term care premiums 
(as defined for purposes of the medical expense deduction) are 
taken into account in determining the deduction for health 
insurance expenses of a self-employed individual.

                        Explanation of Provision

    The technical correction applies the rules for the 
deduction for health insurance expenses of a self-employed 
individual separately with respect to (1) plans that include 
coverage for qualified long- term care services or that are 
qualified long-term care insurance contracts, and (2) plans 
that do not include such coverage and are not such contracts. 
Thus, the provision clarifies that the fact that an individual 
is eligible for employer-subsidized health insurance does not 
affect the ability of such an individual to deduct long-term 
care insurance premiums, so long as the individual is not 
eligible for employer-subsidized long-term care insurance.

4. Applicability of reporting requirements of long-term care contracts 
        and accelerated death benefits (sec. 1402(d) of the bill and 
        sec. 6050Q of the Code)

                              Present Law

    Present law provides that amounts (other than policyholder 
dividends or premium refunds) received under a long-term care 
insurance contract generally are excludable as amounts received 
for personal injuries and sickness, subject to a dollar cap on 
per diem contracts only. If the aggregate amount of periodic 
payments under all qualified long-term care contracts exceeds 
the dollar cap for the period, then the amount of such excess 
payments is excludable only to the extent of the individual's 
costs (that are not otherwise compensated for by insurance or 
otherwise) for long-term care services during the period.
    Present law also provides an exclusion from gross income as 
an amount paid by reason of the death of an insured for (1) 
amounts received under a life insurance contract and (2) 
amounts received for the sale or assignment of any portion of 
the death benefit under a life insurance contract to a 
qualified viatical settlement provider, provided that the 
insured under the life insurance contract is either terminally 
ill or chronically ill (the accelerated death benefit rules).
    A payor of long-term care benefits (defined for this 
purpose to include any amount paid under a product advertised, 
marketed or offered as long-term care insurance), and a payor 
of amounts treated as subject to reporting under the 
accelerated death benefit rules, is required to report to the 
IRS the aggregate amount of such benefits paid to any 
individual during any calendar year, and the name, address and 
taxpayer identification number of such individual. A payor is 
also required to report the name, address, and taxpayer 
identification number of the chronically ill individual on 
account of whose condition the amounts are paid, and whether 
the contract under which the amount is paid is a per diem-type 
contract. A copy of the report must be provided to the payee by 
January 31 following the year of payment, showing the name of 
the payor and the aggregate amount of benefits paid to the 
individual during the calendar year. Failure to file the report 
or provide the copy to the payee is subject to the generally 
applicable penalties for failure to file similar information 
reports.

                        Explanation of Provision

    The technical correction clarifies that the reporting 
requirements include the need to report the address and phone 
number of the information contact. This conforms these 
reporting requirements to the requirements of the Taxpayer Bill 
of Rights 2.

5. Consumer protection provisions for long-term care insurance 
        contracts (sec. 1402(e) of the bill and sec. 7702B(g)(4)(b) of 
        the Code)

                              Present Law

    The long-term care insurance rules of present law include 
consumer protection provisions (sec. 7702B(g)). Among these 
provisions is a requirement that the issuer of a contract offer 
to the policyholder a nonforfeiture provision that meets 
certain requirements. The requirements include a rule that the 
nonforfeiture provision shall provide for a benefit available 
in the event of a default in the payment of any premiums and 
the amount of the benefit may be adjusted subsequent to being 
initially granted only as necessary to reflect changes in 
claims, persistency, and interest as reflected in changes in 
rates for premium paying policies approved by the Secretary for 
the same contract form.

                        Explanation of Provision

    The technical correction clarifies that the nonforfeiture 
provision shall provide for a benefit available in the event of 
a default in the payment of any premiums and the amount of the 
benefit may be adjusted subsequent to being initially granted 
only as necessary to reflect changes in claims, persistency, 
and interest as reflected in changes in rates for premium 
paying policies approved by the appropriate State regulatory 
authority (not by the Secretary) for the same contract form.

6. Insurable interests under the COLI provision (sec. 1402(f)(1) of the 
        bill and sec. 264(a)(4) of the Code)

                              Present Law

    No deduction is allowed for interest paid or accrued on any 
indebtedness with respect to one or more life insurance 
policies or annuity or endowment contracts owned by the 
taxpayer covering anyindividual who is (1) an officer or 
employee of, or (2) is financially interested in, any trade or business 
carried on by the taxpayer (the COLI rule). An exception is provided 
for interest on indebtedness with respect to life insurance policies 
covering up to 20 key persons, subject to an interest rate cap.

                        Explanation of Provision

    The technical correction is intended to prevent unintended 
avoidance of the COLI rule by clarifying that the rule relates 
to life insurance policies or annuity or endowment contracts 
covering any individual who (1) is or was an officer or 
employee of, or (2) is or was financially interested in, any 
trade or business carried on currently or formerly by the 
taxpayer. Thus, for example, the provision would clarify the 
treatment of interest on debt with respect to contracts 
covering former employees of the taxpayer. As another example, 
the provision would clarify the treatment of interest on debt 
with respect to a business formerly conducted by the taxpayer 
and transferred to an affiliate of the taxpayer. No inference 
is intended as the interpretation of this provision under prior 
law.

7. Applicable period for purposes of applying the interest rate for a 
        variable rate contract under the COLI rules (sec. 1402(f)(2) of 
        the bill and sec. 264(d)(2)(B)(ii) of the Code)

                              Present Law

    No deduction is allowed for interest paid or accrued on any 
indebtedness with respect to one or more life insurance 
policies or annuity or endowment contracts owned by the 
taxpayer covering any individual who is (1) an officer or 
employee of, or (2) is financially interested in, any trade or 
business carried on by the taxpayer. An exception is provided 
for interest on indebtedness with respect to life insurance 
policies covering up to 20 key persons, subject to an interest 
rate cap.
    This provision generally does not apply to interest on debt 
with respect to contracts purchased on or before June 20, 1986. 
If the policy loan interest rate under such a contract does not 
provide for a fixed rate of interest, then interest on such a 
contract paid or accrued after December 31, 1995, is allowable 
only to the extent the rate of interest for each fixed period 
selected by the taxpayer does not exceed Moody's Corporate Bond 
Yield Average--Monthly Average Corporates, for the third month 
preceding the first month of the fixed period. The fixed period 
must be 12 months or less.

                        Explanation of Provision

    The technical correction provides that an election of an 
applicable period for purposes of applying the interest rate 
for a variable rate contract can be made no later than the 90th 
date after the date of enactment of the proposal, and applies 
to the taxpayer's first taxable year ending on or after October 
13, 1995. If no election is made, the applicable period is the 
policy year. The policy year is the 12-month period beginning 
on the anniversary date of the policy.

8. Definition of 20-percent owner for purposes of key person exception 
        under COLI rule (sec. 1402(f)(3) of the bill and sec. 264(d)(4) 
        of the Code)

                              Present Law

    No deduction is allowed for interest paid or accrued on any 
indebtedness with respect to one or more life insurance 
policies or annuity or endowment contracts owned by the 
taxpayer covering any individual who is (1) an officer or 
employee of, or (2) is financially interested in, any trade or 
business carried on by the taxpayer. An exception is provided 
for interest on indebtedness with respect to life insurance 
policies covering up to 20 key persons, subject to an interest 
rate cap.
    A key person is an individual who is either an officer or a 
20-percent owner of the taxpayer. The number of individuals 
that can be treated as key persons may not exceed the greater 
of (1) 5 individuals, or (2) the lesser of 5 percent of the 
total number of officers and employees of the taxpayer, or 20 
individuals. Employees are to be full-time employees, for this 
purpose. A 20-percent owner is an individual who directly owns 
20 percent or more of the total combined voting power of the 
corporation. If the taxpayer is not a corporation, the statute 
states that a 20-percent owner is an individual who directly 
owns 20 percent or more of the capital or profits interest of 
the employer.

                        Explanation of Provision

    The technical correction clarifies that, in determining a 
key person, if the taxpayer is not a corporation, a 20-percent 
owner is an individual who directly owns 20 percent or more of 
the capital or profits interest of the taxpayer.

9. Effective date of interest rate cap on key persons and pre-1986 
        contracts under the COLI rule (sec. 1402(f)(4) of the bill and 
        sec. 501(c) of HIPA)

                              Present Law

    No deduction is allowed for interest paid or accrued on any 
indebtedness with respect to one or more life insurance 
policies or annuity or endowment contracts owned by the 
taxpayer covering any individual who is (1) an officer or 
employee of, or (2) is financially interested in, any trade or 
business carried on by the taxpayer. An exception is provided 
for interest on indebtedness with respect to life insurance 
policies covering up to 20 key persons, subject to an interest 
rate cap.
    This provision generally does not apply to interest on debt 
with respect to contracts purchased on or before June 20, 1986. 
If the policy loan interest rate under such a contract does not 
provide for a fixed rate of interest, then interest on such a 
contract paid or accrued after December 31, 1995, is allowable 
only to the extent the rate of interest for each fixed period 
selected by the taxpayer does not exceed Moody's Corporate Bond 
Yield Average--Monthly Average Corporates, for the third month 
preceding the first month of the fixed period. The fixed period 
must be 12 months or less.
    The interest rate cap on key persons and pre-1986 contracts 
is effective with respect to interest paid or accrued for any 
month beginning after December 31, 1995. Another part of the 
provision provides that the interest rate cap on key employees 
and pre-1986 contracts applies to interest paid or accrued 
after October 13, 1995.

                        Explanation of Provision

    The technical correction clarifies that, under the COLI 
rule, the interest rate cap on key persons and pre-1986 
contracts applies to interest paid or accrued for any month 
beginning after December 31, 1995. This technical correction 
eliminates the discrepancy between the October and the December 
dates in the grandfather rule for pre-1986 contracts.

10. Clarification of contract lapses under effective date provisions of 
        the COLI rule (sec. 1402(f)(5) of the bill and sec. 501(d)(2) 
        of HIPA)

                              Present Law

    No deduction is allowed for interest paid or accrued on any 
indebtedness with respect to one or more life insurance 
policies or annuity or endowment contracts owned by the 
taxpayer covering any individual who is (1) an officer or 
employee of, or (2) is financially interested in, any trade or 
business carried on by the taxpayer. An exception is provided 
for interest on indebtedness with respect to life insurance 
policies covering up to 20 key persons, subject to an interest 
rate cap.
    Additional limitations are imposed on the deductibility of 
interest with respect to single premium contracts, and interest 
on debt incurred or continued to purchase or carry a life 
insurance, endowment, or annuity contract pursuant to a plan of 
purchase that contemplates the systematic direct or indirect 
borrowing of part or all of the increases in the cash value of 
the contract. An exception to the latter rule is provided, 
permitting deductibility of interest on bona fide debt that is 
part of such a plan, if no part of 4 of the annual premiums due 
during the first 7 years is paid by means of debt (the ``4-out-
of-7'' rule).
    Present law provides that the COLI rule is phased in. In 
connection with the phase-in rule, a transition rule provides 
that any amount included in income during 1996, 1997, or 1998, 
that is received under a contract described in the provision on 
the complete surrender, redemption or maturity of the contract 
or in full discharge of the obligation under the contract that 
is in the nature of a refund of the consideration paid for the 
contract, is includable ratably over the first 4 taxable years 
beginning with the taxable year the amount would otherwise have 
been includable. The lapse of a contract after October 13, 
1995, due to nonpayment of premiums does not cause interest 
paid or accrued prior to January 1, 1999, to be nondeductible 
solely by reason of (1) failure to meet the 4-out-of-7 rule of 
present law, or (2) causing the contract to be treated as a 
single premium contract within the meaning of section 
264(b)(1). This lapse provision states that the relief is 
provided in the following case: solely by reason of no 
additional premiums being received by reason of a lapse.

                        Explanation of Provision

    The technical correction clarifies that, under the 
transition relief provided under the COLI rule, the 4-out-of-7 
rule and the single premium rule of present law are not to 
apply solely by reason of a lapse occurring by reason of no 
additional premiums being received under the contract after 
October 13, 1995.

11. Requirement of gain recognition on certain exchanges (sec. 
        1402(g)(1) and (2) of the bill, sec. 511 of the Act, and sec. 
        877(d)(2) of the Code)

                              Present Law

    Under the expatriation tax provisions in section 877, 
special tax treatment applies to certain former U.S. citizens 
and former long-term U.S. residents for 10 years following the 
date of loss of U.S. citizenship or U.S. residency status. Gain 
recognition is required on certain exchanges of property 
following loss of U.S. citizenship or U.S. residency status, 
unless a gain recognition agreement is entered into. In 
addition, regulatory authority is granted to apply this rule to 
the 15-year period beginning 5 years before the loss of U.S. 
citizenship or U.S. residency status.

                        Explanation of Provision

    The technical correction clarifies that the period to which 
the general rule requiring gain recognition on certain 
exchanges applies is the 10-year period that begins on the date 
of loss of U.S. citizenship or U.S. residency status. In 
addition, the technical correction clarifies that in the case 
of an exchange occurring during the 5-year period before the 
loss of U.S. citizenship or U.S. residency status, any gain 
required to be recognized under regulations is to be recognized 
immediately after the date of such loss of U.S. citizenship.

12. Suspension of 10-year period in case of substantial diminution of 
        risk of loss (sec. 1402(g)(3) of the bill, sec. 511 of the Act, 
        and sec. 877(d)(3) of the Code)

                              Present Law

    Under the expatriation tax provisions in section 877, 
special tax treatment applies to certain former U.S. citizens 
and former long-term U.S. residents for 10 years following the 
date of loss of U.S. citizenship or U.S. residency status. The 
running of this period with respect to gain on the sale or 
exchange of any property is suspended for any period during 
which the individual's risk of loss with respect to the 
property is substantially diminished.

                        Explanation of Provision

    The technical correction clarifies that the period to which 
the rule suspending such period in the case of a substantial 
diminution of risk of loss applies is the 10-year period that 
begins on the date of loss of U. S. citizenship or U.S. 
residency status.

13. Treatment of property contributed to certain foreign corporations 
        (sec. 1402(g)(4) of the bill, sec. 511 of the Act, and sec. 
        877(d)(4) of the Code)

                              Present Law

    Under the expatriation tax provisions in section 877, 
special tax treatment applies to certain former U.S. citizens 
and former long-term U.S. residents for 10 years following the 
date of loss of U.S. citizenship or U.S. residency status. 
Special rules apply in the case of certain contributions of 
U.S. property by such an individual to a foreign corporation 
during such period.

                        Explanation of Provision

    The technical correction clarifies that the period to which 
the rule regarding certain contributions to foreign 
corporations applies is the 10-year period that begins on the 
date of loss of U.S. citizenship or U.S. residency status. The 
technical correction also clarifies that the rule applies in 
the case of property the income from which, immediately before 
the contribution, was from U.S. sources.

14. Credit for foreign estate tax (sec. 1402 (g)(6) of the bill, sec. 
        511 of the Act, and sec. 2107(c) of the Code)

                              Present Law

    Under the expatriation tax provisions in section 2107, 
special estate tax treatment applies to certain former U.S. 
citizens and former long-term U.S. residents who die within 10 
years following the date of loss of U.S. citizenship or U.S. 
residency status. Special rules provide a credit against the 
U.S. estate tax for foreign estate taxes paid with respect to 
property that is includible in the decedent's U.S. estate 
solely by reason of the expatriation estate tax provisions.

                        Explanation of Provision

    The technical correction clarifies the formula for 
determining the amount of the foreign tax credit allowable 
against U.S. estate taxes on property includible in the 
decedent's U.S. estate solely by reason of the expatriation 
estate tax provisions. The credit for the estate taxes paid to 
any foreign country generally is limited to the lesser of (1) 
the foreign estate taxes attributable to the property 
includible in the decedent's U.S. estate solely by reason of 
the expatriation estate tax provisions or (2) the U.S. estate 
tax attributable to property that is subject to estate tax in 
such foreign country and is includible in the decedent's U.S. 
estate solely by reason of the expatriation tax provisions. The 
amount of taxes attributable to such property is determined on 
a pro rata basis.
      III. TECHNICAL CORRECTIONS TO THE TAXPAYER BILL OF RIGHTS 2

1. Reasonable cause abatement for first-tier intermediate sanctions 
        excise tax (sec. 1403(a) of the bill and section 4962 of the 
        Code)

                              Present Law

    Section 4958 imposes penalty excise taxes as an 
intermediate sanction in cases where organizations exempt from 
tax under sections 501(c)(3) or 501(c)(4) (other than private 
foundations) engage in an ``excess benefit transaction.'' The 
excise tax may be imposed on certain disqualified persons 
(i.e., insiders) who improperly benefit from an excess benefit 
transaction and on organization managers who participate in 
such a transaction knowing that it is improper.
    A disqualified person who benefits from an excess benefit 
transaction is subject to a first-tier penalty tax equal to 25 
percent of the amount of the excess benefit. Organization 
managers who participate in an excess benefit transaction 
knowing that it is improper are subject to a first-tier penalty 
tax of 10 percent of the amount of the excess benefit. 
Additional second-tier taxes equal to 200 percent of the amount 
of the excess benefit may be imposed on a disqualified person 
if there is no correction of the transaction within a specified 
time period.
    Under section 4962, the IRS has the authority to abate 
certain first-tier taxes if the taxable event was due to 
reasonable cause and not to willful neglect and the event was 
corrected within the applicable correction period. First-tier 
taxes which may be abated include, among others, the taxes 
imposed under sections 4941 (on acts of self-dealing between 
private foundations and disqualified persons), 4942 (for 
failure by private foundations to distribute a minimum amount 
of income), and 4943 (on private foundations with excess 
business holdings).
    In enacting the new excise taxes on excess benefit 
transactions, Congress explicitly intended to provide the IRS 
with abatement authority under section 4962.\150\ However, the 
abatement rules of section 4962 apply only to qualified first-
tier taxes imposed by subchapter A or C of Chapter 42. The 
section 4958 excise tax is located in subchapter D of Chapter 
42. The failure to cross reference subchapter D in section 4962 
means that IRS does not have such abatement authority with 
respect to the section 4958 excise taxes.
---------------------------------------------------------------------------
    \150\ See Ways and Means Committee Report 104-506 accompanying H.R. 
2377, p. 59.
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                        Explanation of Provision

    The bill amends section 4962(b) to include a cross-
reference to first-tier taxes imposed by subchapter D (i.e., 
the section 4958 excise taxes on excess benefit transactions). 
Thus, the IRS has authority to abate the first-tier excise 
taxes on excess benefit transactions in cases where it is 
established that the violation was due to reasonable cause and 
not due to willful neglect and the transaction at issue was 
corrected within the specified period.

2. Reporting by public charities with respect to intermediate sanctions 
        and certain other excise tax penalties (sec. 1403(b) of the 
        bill and sec. 6033 of the Code)

                              Present Law

    Section 4958 imposes penalty excise taxes as an 
intermediate sanction in cases where organizations exempt from 
tax under sections 501(c)(3) or 501(c)(4) (other than private 
foundations) engage in an ``excess benefit transaction.'' The 
excise tax may be imposed on certain disqualified persons 
(i.e., insiders) who improperly benefit from an excess benefit 
transaction and on organization managers who participate in 
such a transaction knowing that it is improper. No tax is 
imposed on the organization itself with respect under section 
4958.
    Section 4911 imposes an excise tax penalty on excess 
lobbying expenditures made by public charities. The tax is 
imposed on the organization itself. Section 4912 imposes a 
penalty excise tax on certain public charities that make 
disqualifying lobbying expenditures and section 4955 imposes a 
penalty excise tax on political expenditures of section 
501(c)(3) organizations. Both of these penalty taxes are 
imposed not only on the affected organization, but also on 
organization managers who agree to an expenditure knowing that 
it is improper.
    Under section 4962, the IRS has the authority to abate 
certain first-tier taxes if the taxable event was due to 
reasonable cause and not to willful neglect and the event was 
corrected within the applicable correction period. First-tier 
taxes which may be abated include, among others, the taxes 
imposed under section 4955.\151\
---------------------------------------------------------------------------
    \151\ A separate provision in the bill makes a technical correction 
to section 4962(b) to permit the abatement of first-tier penalty excise 
taxes imposed under section 4958.
---------------------------------------------------------------------------
    Under section 6033(b)(10), 501(c)(3) organizations are 
required to report annually on Form 990 any amounts paid by the 
organization under section 4911, 4912, and 4955. Thus, although 
sections 4912 and 4955 impose excise taxes on organization 
managers, organizations technically are not required to report 
any such excise taxes paid by such managers.
    In addition, under section 6033(b)(11), an organization 
exempt from tax under section 501(c)(3) must report on Form 990 
any amount of excise tax on excess benefit transactions paid by 
the organization, or any disqualified person with respect to 
such organization, during the taxable year. The Code does not 
explicitly require the reporting of any excess benefit excise 
taxes paid by an organization manager solely in his or her 
capacity as such (i.e., an organization manager might also be a 
disqualified person with respect to an excess benefit 
transaction, in which case any tax paid would be reported).

                        Explanation of Provision

    The bill makes the reporting requirements of section 
6033(b)(10) and (11) consistent with the excise tax penalty 
provisions to which they relate. Thus, section 6033(b)(10) is 
amended to require 501(c)(3) organizations to report any 
amounts of tax imposed under sections 4911, 4912, and 4955 on 
the organization or any organization manager of the 
organization. In addition, the bill requires reporting with 
respect to any reimbursements paid by an organization with 
respect to taxes imposed under sections 4912 or 4955 on any 
organization manager of the organization. Section 6033(b)(11) 
is amended to require 501(c)(3) organizations to report any 
amounts of tax imposed under section 4958 on any organization 
manager or any disqualified person, as well as any 
reimbursements of section 4958 excise tax liability paid by the 
organization to such organization managers or disqualified 
persons.
    In addition, the bill clarifies that no reporting is 
required under sections 6033(b)(10) or (11) in the event a 
first-tier penalty excise tax imposed under section 4955 or 
section 4958 is abated by the IRS pursuant to its authority 
under section 4962.
                IV. TECHNICAL CORRECTIONS TO OTHER ACTS

1. Correction of GATT interest and mortality rate provisions in the 
        Retirement Protection Act (sec. 1404(b)(3) of the bill and sec. 
        1449(a) of the Small Business Act)

                              Present Law

    The Retirement Protection Act of 1994, enacted as part of 
the implementing legislation for the General Agreements on 
Tariffs and Trade (``GATT''), modified the actuarial 
assumptions that must be used in adjusting benefits and 
limitations under section 415. In general, in adjusting a 
benefit that is payable in a form other than a straight life 
annuity and in adjusting the dollar limitation if benefits 
begin before age 62, the interest rate to be used cannot be 
less than the greater of 5 percent or the rate specified by the 
plan. Under GATT, the benefit is payable in a form subject to 
the requirements of section 417(e)(3), then the interest rate 
on 30-year Treasury securities is substituted for 5 percent. 
Also under GATT, for purposes of adjusting any limit or 
benefit, the mortality table prescribed by the Secretary must 
be used. This provision of GATT was generally effective as of 
the first day of the limitation year beginning in 1995.
    The Small Business Act conformed the effective date of 
these changes to the effective date of similar changes by 
providing generally that, in the case of a plan that was 
adopted and in effect before December, 8, 1994, the GATT change 
is not effective with respect to benefits accrued before the 
earlier of (1) the later of the date a plan amendment applying 
the amendments is adopted or made effective or (2) the first 
day of the first limitation year beginning after December 31, 
1999. The Small Business Act provides that ``Determinations 
under section 415(b)(2)(E) before such earlier date are to be 
made with respect to such benefits on the basis of such section 
as in effect on December 7, 1994 (except that the modification 
made by section 1449(b) of the Small Business Job Protection 
Act of 1996 shall be taken into account), and the provisions of 
the plan as in effect on December 7, 1994, but only if such 
provisions of the plan meet the requirements of such section 
(as so in effect).''

                        Explanation of Provision

    The provision in the Small Business Act was intended to 
permit plans to apply pre-GATT law under section 415(b)(2)(E) 
for a transition period. The bill conforms the statute to this 
intent by providing that determinations under section 
415(b)(2)(E) before such earlier date are to be made with 
respect to such benefits on the basis of such section as in 
effect on December 7, 1994 and the provisions of the plan as in 
effect on December 7, 1994, but only if such provisions of the 
plan meet the requirements of such section (as so in effect).

2. Related parties determined by reference to section 267 (sec. 1404(d) 
        of the bill and sec. 267(f) of the Code)

                              Present Law

    Section 267 disallows losses arising in transactions 
between certain defined related parties. In the case of related 
corporations, such losses may be deferred. Several Code 
provisions, in defining related parties, often incorporate the 
relationships described in section 267 by cross-reference to 
such section.

                        Explanation of Provision

    Any provision of the Internal Revenue Code of 1986 that 
refers to a relationship that would result in loss disallowance 
under section 267 also refers to relationships where loss is 
deferred, where such relationship is applicable to the 
provision.
                    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 
reconciliation provisions in the bill.


                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 reconciliation provisions of 
the bill involve new budget authority with respect to the 
funding of the new Intercity Passenger Rail Fund.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that the income tax reduction provisions 
generally involve increased tax expenditures and that the 
income tax increase provisions generally involve decreased tax 
expenditures. (See revenue table in Part III.A., above.) Non-
income tax provisions are not classified as tax expenditures 
under the Budget Act. Certain of the compliance-related income 
tax and simplification provisions do not involve tax 
expenditures.

            C. Consultation With Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has 
submitted the following statement with respect to the 
Committee's revenue reconciliation provisions.

                                     U.S. Congress,
                               Congressional Budget Office,
                                     Washington, DC, June 20, 1997.
Hon. William V. Roth, Jr.,
Chairman, Committee on Finance
U.S. Senate, Washington, DC
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for the revenue 
reconciliation recommendations of the Senate Committee on 
Finance.
    The estimate shows the budgetary effects of the committee's 
proposals over the 1998-2007 period. CBO understands that the 
Committee on the Budget will be responsible for interpreting 
how these proposals compare with the reconciliation 
instructions in the budget resolution.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Stephanie 
Weiner.
            Sincerely,
                                          Paul Van de Water
                                    (For June E. O'Neil, Director).
    Enclosures.

               Congressional Budget Office Cost Estimate

Revenue Reconciliation Recommendations of the Senate Committee on 
        Finance

    Summary: The revenue reconciliation provisions recommended 
by the Committee on Finance would make many changes to the 
Internal Revenue Code. A new credit for children under age 17 
would result in the largest reduction in revenue. Other major 
reductions in revenue would result from a new tax credit for 
students, changes in IRAs, educational investment accounts, 
lower taxation of capital gains realizations, and modifications 
to the alternative minimum tax and to the estate and gift tax. 
The provisions also include changes that would generate 
revenue. About half of the extra revenue would come from 
extending and modifying aviation excise taxes. In addition, the 
excise tax on cigarettes would be increased by 20 cents per 
pack.
    Estimated cost to the Federal Government: The Joint 
Committee on Taxation (JCT) provided estimates for most of the 
revenue reconciliation provisions, and CBO concurs with their 
estimates. CBO and JCT estimate that these provisions would 
reduce governmental receipts by $74.5 billion over the 1997-
2002 period. In addition, CBO estimates that the bill, 
including the committee amendment on child health, would 
increase direct spending by $7.9 billion in fiscal year 1999 
through 2002. The provision establishing the Intercity 
Passenger Rail Fund would be financed with receipts from a 
half-cent of the 4.3 cents-per gallon excise tax. Based on JCT 
estimates, CBO estimates that this legislation would dedicate 
revenues of $2.3 billion to this fund for the 1998 to 2001 
period. Please refer to the enclosed CBO and JCT tables for a 
more detailed estimate of the provisions.
    Intergovernmental and private-sector impact: In accordance 
with the requirements of Public Law 104-4, the Unfunded 
Mandates Reform Act of 1995, JCT has determined that the bill 
contains several private-sector mandates. Please refer to the 
enclosed letter for a more detailed account of these 
provisions. These provisions would impose direct costs on the 
private sector of more than $100 million in each year from 
1998-2002. The JCT estimates the direct mandate cost of tax 
increases in the bill would total $10.8 billion in 1998, and 
$61.1 billion over the 1998-2002 period, as shown below:

   ESTIMATED FEDERAL PRIVATE-SECTOR MANDATE IMPACT OF THE REVENUE RECONCILIATION RECOMMENDATIONS OF THE SENATE  
                                              COMMITTEE ON FINANCE                                              
                                    [By fiscal year, in billions of dollars]                                    
----------------------------------------------------------------------------------------------------------------
                                                                       1998     1999     2000     2001     2002 
----------------------------------------------------------------------------------------------------------------
Private Sector Mandates............................................   10.752   11.442   12.600   10.441   15.993
----------------------------------------------------------------------------------------------------------------

    In addition, JCT has determined that the provision to 
extend and modify the Airport and Airway Trust Fund excise 
taxes and the provision to modify the vaccine excise tax may 
impose an intergovernmental mandate on State, local, and tribal 
governments. JCT estimates that the direct cost of complying 
with these intergovernmental mandates will not exceed $50 
million in either the first fiscal year or in any of the 4 
fiscal years following the first fiscal year.
    Estimate prepared by: Stephanie Weiner.
    Estimate approved by: Rick Kasten, Deputy Assistant 
Director for Tax Analysis.


                     Congress of the United States,
                               Joint Committee on Taxation,
                                     Washington, DC, June 20, 1997.
Mrs. June O'Neil,
Director, Congressional Budget Office, U.S. Congress, Washington, DC.
    Dear Mrs. O'Neil: The staff of the Joint Committee on 
Taxation has reviewed the revenue reconciliation provisions 
ordered to be reported by the Senate Committee on Finance on 
June 19, 1997. In accordance with the requirements of Public 
Law 104-4, the Unfunded Mandates Reform Act of 1995 (the 
``Unfunded Mandates Act''), we have determined that the 
following provisions contain Federal private sector mandates:
          Extend Airport and Airway Trust Fund excise taxes 
        through 9/30/07.
          Require gain recognition for certain extraordinary 
        dividends.
          Require gain recognition on certain distributions of 
        controlled corporation stock.
          Require recognition of gain on certain appreciated 
        positions in personal property.
          Modify net operating loss carryover rules.
          Modify foreign tax credit carryover rules.
          Modify holding period for dividends received 
        deduction.
          Inclusion of income from notational principal 
        contracts and stock lending transactions under subpart 
        F.
          Further restrict like-kind exchanges involving 
        foreign personal property.
          Extend LUST excise tax through 9/30/07.
          Treatment of preferred stock as ``boot''.
          Extend FUTA surtax.
          Expansion of requirement that involuntarily converted 
        property be replaced with property acquired from an 
        unrelated person.
          Require registration of confidential corporate tax 
        shelters.
          Modify holding period for certain foreign tax 
        credits.
          Reform tax treatment of redemptions involving related 
        corporations.
          Restrict income forecast method and allow 3-year 
        MACRS for rent-to-own property.
          Gains or losses from certain terminations with 
        respect to property.
          Interest on underpayment reduced by foreign tax 
        credit carryback.
          Modify the basis allocation rules for distributee 
        partners.
          Eliminate the substantial appreciation requirement 
        for inventory of a partnership.
          Extend UBIT rules to second tier subsidiaries of tax-
        exempt organizations and modify control test.
          Carryover basis on sale of property by tax-exempt 
        related party.
          Modification of treatment of company-owned life 
        insurance-prorata disallowance of interest on debt to 
        fund life insurance.
          Termination of suspense accounts for family farm 
        corporations required to use accrual method of 
        accounting.
          Repeal installment sales grandfather rules of 1986 
        Act.
          Repeal 1986 Act grandfather rules for pension 
        business of Mutual of America.
          Apply 3% telephone excise tax to certain prepaid 
        phone cards.
          Consistency requirement for returns of beneficiaries 
        of estates and trusts.
          Determination of period of limitations relating to 
        foreign tax credits.
          Uniform excise tax on vaccines, add 3 new vaccines 
        ($0.84 per dose).
          Repeal of 15% excess distribution and excess 
        accumulation taxes.
          Repeal special rule which permits certain companies 
        to eliminate their AMT liability.
          Replace truck tax deduction for tire value with tax 
        credit for excise tax paid on tires.
          Increase of $.20 per pack cigarette excise tax with 
        proportionate increases in other tobacco products.
          Limit charitable remainder trusts eligibility for 
        certain trusts.
          Treatment of income from certain sales of inventory 
        as U.S. source income.
          Reduce ethanol subsidy.
    The attached revenue table (items indicated in bold) 
generally reflects amounts that are no greater than the 
aggregate estimated amounts that the private sector will be 
required to spend in order to comply with these Federal private 
sector mandates.
    There are two provisions that may impose a Federal 
intergovernmental mandate on State, local, and tribal 
governments. These provisions are the following:
          Extend Airport and Airways Trust Fund excise taxes.
          Modify vaccine excise tax.
    The staff of the Joint Committee on Taxation estimates that 
the direct costs of complying with these Federal 
intergovernmental mandates will not exceed $50,000,000 in 
either the first fiscal year or in any of the 4 fiscal years 
following the first fiscal year.
    If you would like to discuss this information in further 
detail, please feel free to contact me at 225-3621. Thank you 
for your cooperation in this matter.
            Sincerely,
                                              Kenneth Kies,
                                                    Chief of Staff.


                       IV. VOTES 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 approve the Committee's 
revenue reconciliation recommendations.

Vote on motion to report

    The Committee's revenue reconciliation recommendations were 
approved by a roll call vote of 18 yeas and 2 noes (a quorum 
present). The roll call vote was as follows:
    Yeas.--Roth, Chafee, Grassley, Hatch, D'Amato, Murkowski, 
Lott, Jeffords, Mack, Moynihan, Baucus, Rockefeller, Breaux, 
Conrad, Graham, Moseley-Braun, Bryan, Kerrey.
    Noes.--Nickles, Gramm.

Votes on amendments

    Votes on amendments were as follows:
    Amendment by Mr. Gramm to transfer the 4.3-cents-per-gallon 
deficit reduction fuels tax to the Highway Trust Fund (with 0.5 
cent per gallon going to the new Intercity Passenger Rail Fund) 
was passed by a roll call vote of 16 yeas and 5 noes.
    Amendment by Mr. Mack to allow a one-time $5,000 first home 
buyer Federal income tax credit for the purchase of a principal 
residence in the District of Columbia (expiring in 2002) was 
passed by voice vote.
    Amendment by Mr. Conrad to exempt Fannie Mae life insurance 
from COLI disallowance rule was defeated by voice vote.
    Amendment by Mr. Grassley to extend and modify the current 
law partial excise tax exemption for ethanol was passed by a 
roll call vote of 16 yeas and 4 noes.
    Amendment by Mr. Jeffords to strike the D.C. investment 
incentives (except for $5,000 first home buyer tax credit) and 
create a trust fund for District of Columbia school renovations 
was defeated by a roll call vote of 9 yeas and 11 noes.
    Amendment by Mr. Gramm to eliminate IRA deposit requirement 
for the $500 child credit for children over age 12 and reduce 
the 1997 partial child credit to $180 was defeated by a roll 
call of 8 yeas and 12 noes.
    Amendment by Mr. Chafee to replace the current work 
opportunity tax credit with a two-tiered system was passed by a 
roll call vote of 11 yeas and 9 noes.
    Amendment by Mr. Graham to increase the small arbitrage 
rebate exemption to $25 million for qualified education 
facilities, provide a simplified 3-year safe harbor for 
exemption from the arbitrage rebate rules for financing the 
construction of qualified facilities, exclude up to $25 million 
in construction of qualified education facilities from the $10 
million limit in the amount of bonds a governmental issuer may 
issue annually, create a category of exempt facility bonds for 
qualified education facilities and make it subject to a 
separate volume cap equal to $10 per capita per year, offset by 
a cutback in the Hope scholarship tax credit was defeated by a 
roll call vote of 10 yeas and 10 noes.
                 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 provisions of the bill as 
reported.

Impact on individuals and businesses

    Title I of the revenue reconciliation provisions provides a 
new tax credit for families with children under age 17 
beginning in 1997, and including age 17 after 2002. Title I 
also provides an increase in the individual alternative minimum 
tax (AMT) exemption level, beginning in 2001.
    Title II provides several education tax incentives, 
including a new HOPE scholarship tax credit, an above-the-line 
deduction for student loan interest, permanent extension of the 
exclusion for employer-provided education assistance for 
undergraduate and graduate students, penalty-free withdrawals 
from IRAs for higher education expenses, exclusion from income 
of education distributions from qualified tuition programs, 
eligible educational institutions permitted to maintain 
qualified tuition programs, repeal of limitation on qualified 
501(c)(3) bonds (other than hospitals), increase in arbitrage 
rebate exception for governmental bonds used to finance 
education facilities, and the 2-percent floor on miscellaneous 
itemized deductions not to apply to certain continuing 
education expenses of elementary and secondary school teachers.
    Title III provides increased retirement savings incentives, 
including increased availability of the IRA deduction, 
establishment of nondeductible ``IRA Plus'' accounts, and 
permits distributions from certain retirement plans without 
penalty to purchase first homes and when unemployed. Title III 
also provides for reduced capital gains tax rates for 
individuals, modifications to the exclusion of gain on certain 
small business stock and rollover of gain from sale of 
qualified stock, and an increased exemption from tax for gain 
on sale of principal residences.
    Title IV provides for estate and gift tax relief for 
families by increasing the unified credit exemption amount 
gradually and indexing certain provisions, exclusion for 
qualified family farms and businesses (up to $1 million), and 
certain other estate and gift tax changes.
    Title V extends four expiring tax provisions: (1) research 
tax credit (through December 31, 1999); (2) contributions of 
appreciated stock to private foundations (through December 31, 
1999); (3) work opportunity tax credit (through December 31, 
1999); and (4) permanent extension of the orphan drug tax 
credit.
    Title VI provides various tax incentives for certain 
District of Columbia investments and residents by designating 
existing D.C. enterprise communities and census tracts with 
greater than 35 percent poverty as the ``D.C. Enterprise 
Zone,'' an exclusion for capital gains for new investment in 
qualified D.C. business property held for at least 5 years, and 
tax credits for taxpayers providing equity and loans to certain 
D.C. businesses.
    Title VII provides various miscellaneous revenue 
provisions, including repeal of the excise tax on recreational 
motorboat diesel fuel, creating a new Intercity Passenger Rail 
Fund (``Rail Fund'') financed by 0.5 cent of the current 4.3-
cents-per-gallon General Fund excise tax on all motor fuels 
(October 1, 1997-April 15, 2001), transferring the 4.3-cents-
per-gallon General Fund tax on motor fuels (other than the 0.5 
cent per gallon going to the Rail Fund) to the Highway Trust 
Fund on October 1, 1997, adjusting the excise tax rates on 
propane, liquefied natural gas, and methanol from natural gas 
to reflect the respective energy equivalence of the fuels to 
the tax on gasoline, disaster relief provisions, waiver of 
penalty (through June 30, 1998) on small businesses not making 
electronic fund transfers of tax payments, minimum tax not to 
apply to farmers' installment sales, treatment of computer 
software as FSC export property, other foreign provisions, tax-
exempt status for certain State worker's compensation funds, 
increase in the standard mileage expense deduction rate for 
charitable use of passenger automobile, and several other 
miscellaneous tax provisions.
    Title VIII provides the revenue offset provisions for the 
bill. These include provisions relating to financial products, 
corporate provisions, extension and modifications of Airport 
and Airway Trust Fund excise taxes (through September 30, 2007) 
to finance the Federal Aviation Administration airport and 
airway programs, reinstatement (through September 30, 2007) of 
the prior-law 0.1-cent-per-gallon fuels tax for the Leaking 
Underground Storage Tank Trust Fund, an increase in tobacco 
excise tax rates, application of the existing 3-percent 
communications excise tax to long-distance prepaid telephone 
cards, several foreign tax provisions, and several other 
revenue-increase provisions.
    Titles IX, X, XI, XII, and XIII provide various tax 
simplification provisions, many of which have been considered 
and passed by the Congress in the 104th Congress in the 
Balanced Budget Act of 1995, which was not enacted.
    Title IX provides numerous foreign-related simplification 
provisions.
    Title X provides simplification provisions relating to 
individuals, partnerships, real estate investment trusts, 
regulated investment companies, taxpayer protections, and 
businesses generally.
    Title XI provides simplification provisions relating to 
estate and gift taxes.
    Title XII provides simplification provisions relating to 
excise taxes, tax-exempt bonds, Tax Court procedures, and other 
matters.
    Title XIII provides simplification provisions relating to 
pensions.
    Finally, Title XIV provides technical corrections to 
certain recent tax legislation.

Impact on personal privacy and paperwork

    The revenue reconciliation provisions will not adversely 
affect personal privacy. The provisions will result in some 
increased paperwork for individuals and businesses as they 
comply with the new or modified tax provisions. There are 
numerous tax simplification provisions, which will reduce 
paperwork for individuals and businesses.

                     B. Unfunded Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995 (P.L. 104-4).
    The Committee has determined that the following provisions 
of the bill contain Federal mandates on the private sector:
          Extend Airport and Airway Trust Fund excise taxes 
        through 9/30/07.
          Require gain recognition for certain extraordinary 
        dividends.
          Require gain recognition on certain distributions of 
        controlled corporation stock.
          Require recognition of gain on certain appreciated 
        positions in personal property.
          Modify net operating loss carryover rules.
          Modify foreign tax credit carryover rules.
          Modify holding period for dividends received 
        deduction.
          Inclusion of income from notational principal 
        contracts and stock lending transactions under subpart 
        F.
          Further restrict like-kind exchanges involving 
        foreign personal property.
          Extend LUST excise tax through 9/30/07.
          Treatment of preferred stock as ``boot''.
          Extend FUTA surtax.
          Expansion of requirement that involuntarily converted 
        property be replaced with property acquired from an 
        unrelated person.
          Require registration of confidential corporate tax 
        shelters.
          Modify holding period for certain foreign tax 
        credits.
          Reform tax treatment of redemptions involving related 
        corporations.
          Restrict income forecast method and allow 3-year 
        MACRS for rent-to-own property.
          Gains or losses from certain terminations with 
        respect to property.
          Interest on underpayment reduced by foreign tax 
        credit carryback.
          Modify the basis allocation rules for distributee 
        partners.
          Eliminate the substantial appreciation requirement 
        for inventory of a partnership.
          Extend UBIT rules to second tier subsidiaries of tax-
        exempt organizations and modify control test.
          Carryover basis on sale of property by tax-exempt 
        related party.
          Modification of treatment of company-owned life 
        insurance-pro rata disallowance of interest on debt to 
        fund life insurance.
          Termination of suspense accounts for family farm 
        corporations required to use accrual method of 
        accounting.
          Repeal installment sales grandfather rules of 1986 
        Act.
          Repeal 1986 Act grandfather rules for pension 
        business of Mutual of America.
          Apply 3% telephone excise tax to certain prepaid 
        phone cards.
          Consistency requirement for returns of beneficiaries 
        of estates and trusts.
          Determination of period of limitations relating to 
        foreign tax credits.
          Uniform excise tax on vaccines, add 3 new vaccines 
        ($0.84 per dose).
          Repeal of 15% excess distribution and excess 
        accumulation taxes.
          Repeal special rule which permits certain companies 
        to eliminate their AMT liability.
          Replace truck tax deduction for tire value with tax 
        credit for excise tax paid on tires.
          Increase cigarette excise tax by $.20 per pack with 
        proportionate increase in tax on other tobacco 
        products.
          Limit charitable remainder trusts eligibility for 
        certain trusts.
          Treatment of income from certain sales of inventory 
        as U.S. source income.
          Reduce ethanol subsidy.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the estimated 
budget effects of the provision. Benefits from the provisions 
include improved administration of the Federal income tax laws 
and a more accurate measurement of income for Federal income 
tax purposes. In addition, the extension and modification of 
the Airport and Airway Trust Fund excise taxes are designed to 
fund Federal administration of the airways and other important 
air services. The Committee believes the benefits of the bill 
are greater than the costs required to comply with the Federal 
private sector mandates contained in the bill.
    The revenue-raising provisions of the bill are used to 
offset partially the costs of a child credit for certain low- 
and middle-income taxpayers, tax incentives for higher 
education (including the Administration's HOPE credit), capital 
gains tax relief, reduced estate and gift taxes, alternative 
minimum tax relief, and other important tax incentives. These 
provisions are generally designed to ease the burdens of 
Federal income and estate taxation on individuals and small 
business and the revenue-raising provisions of the bill are 
critical to achieving these goals.
    The provision to extend the Airport and Airway Trust Fund 
taxes and the modifications to the vaccine excise tax impose 
Federal intergovernmental mandates. The staff of the Joint 
Committee on Taxation estimates that the direct costs of 
complying with these Federal intergovernmental mandates will 
not exceed $50,000,000 in either the first fiscal year or in 
any one of the 4 fiscal years following the first fiscal year. 
The Committee intends that the Federal intergovernmental 
mandates be unfunded because, in the case of the Airport and 
Airway Trust Fund taxes, the mandates fund the maintenance of 
U.S. airports and airways and the Committee believes that it is 
appropriate for State, local, and tribal governments to bear 
their allocable share of the responsibility for such funding. 
In the case of the vaccine excise tax, the Committee believes 
it appropriate for all purchasers of vaccines to pay the excise 
tax, which is used to compensate victims for injuries suffered 
from vaccines.
    The revenue provisions of the bill generally affect 
activities that are only engaged in by the private sector. The 
provision extending the Airport and Airway Trust Fund excise 
taxes and the modifications to the vaccine excise tax are 
imposed both on the private sector and on State, local, and 
tribal governments and, thus, do not affect the competitive 
balance between such 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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