Senate Report 105-33 - REVENUE RECONCILIATION ACT OF 1997

[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

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

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

Student loan forgiveness

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

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

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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
\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.
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\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.
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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.
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\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.
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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.
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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.
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\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.
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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.
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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.
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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.
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\92\ Code sec. 6331(b).
\93\ Code sec. 6331(c).
\94\ Code sec. 6331(e).
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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\
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\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\103\ The Treasury Department is directed to publish an annual list
of qualified rural airports, based on passenger enplanements for the
requisite calendar year.
---------------------------------------------------------------------------
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

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

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

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

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

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)).
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\122\ Projected to be $700 for 1998.
\123\ Projected to be $700 for 1998.
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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.
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\124\ Projected to be $700 for 1998.
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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.
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\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.''
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\126\ Treas. reg. sec. 1.471-2(d).
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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.
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\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.
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\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.
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\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.
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\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.
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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.
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\139\ Tax Equity and Fiscal Responsibility Act of 1982.
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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

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

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\
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\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.
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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

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

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

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

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

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).