[Senate Report 108-11]
[From the U.S. Government Publishing Office]



                                                        Calendar No. 22
108th Congress                                                   Report
 1st Session                     SENATE                          108-11
======================================================================
 
                            CARE ACT OF 2003

                                _______
                                

               February 27, 2003.--Ordered to be printed

                                _______
                                

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

                              R E P O R T

                         [To accompany S. 476]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Finance reported an original bill S. 476, 
to provide incentives for charitable contributions by 
individuals and businesses, to improve the public disclosure of 
activities of exempt organizations, and to enhance the ability 
of low-income Americans to gain financial security by building 
assets, and for other purposes, having considered the same, 
reports favorably thereon and recommends that the bill do pass.







                                CONTENTS

                                                                   Page
 I. Legislative Background............................................5
II. Explanation of the Bill...........................................5
    Title I. Charitable Giving Incentives..............................
        A. Charitable Deduction for Nonitemizers (sec. 101 of the 
            bill and sec. 63 and 170 of the Code)................     5
        B. Tax-Free Distributions From Individual Retirement 
            Arrangements for Charitable Purposes (sec. 102 of the 
            bill and secs. 408 and 6034 of the Code).............     8
        C. Charitable Deduction for Contributions of Food 
            Inventory (sec. 103 of the bill and sec. 170 of the 
            Code)................................................    15
        D. Charitable Deduction for Contributions of Book 
            Inventory (sec. 104 of the bill and sec. 170 of the 
            Code)................................................    17
        E. Expand Charitable Contribution Allowed for Scientific 
            Property Used for Research and for Computer 
            Technology and Equipment (sec. 105 of the bill and 
            sec. 170 of the Code)................................    19
        F. Encourage Contributions of Capital Gain Real Property 
            Made for Conservation Purposes (sec. 106 of the bill 
            and sec. 170 of the Code)............................    21
        G. Exclusion of 25 Percent of Capital Gain for Certain 
            Sales Made for Qualifying Conservation Purposes (sec. 
            107 of the bill and new sec. 121A of the Code).......    24
        H. Cost Sharing Payments under the Partners for Fish and 
            Wildlife Program (sec. 108 of the bill and sec. 126 
            of the Code).........................................    30
        I. Basis Adjustment to Stock of S Corporation 
            Contributing Property (sec. 109 of the bill and sec. 
            1367 of the Code)....................................    31
        J. Enhanced Deduction for Charitable Contributions of 
            Literary, Musical, Artistic, and Scholarly 
            Compositions (sec. 110 of the bill and sec. 170 of 
            the Code)............................................    32
        K. Exclusion for Certain Mileage Reimbursements to 
            Charitable Volunteers (sec. 111 of the bill and new 
            sec. 139A of the Code)...............................    34
        L. Extend Enhanced Deduction for Inventory to Include 
            Public Schools (sec. 112 of the bill and sec. 170 of 
            the Code)............................................    35
    Title II. Provisions Improving the Oversight of Tax-Exempt 
    Organizations....................................................37
        A. Disclosure of Written Determinations (sec. 201 of the 
            bill and sec. 6110 of the Code)......................    37
        B. Disclosure of Internet Web Site and Name Under Which 
            Organization Does Business sec. 202 of the bill and 
            sec. 6033 of the Code)...............................    39
        C. Modification to Reporting of Capital Transactions 
            (sec. 203 of the bill and secs. 6033 and 6104 of the 
            Code)................................................    40
        D. Disclosure that Form 990 is Publicly Available (sec. 
            204 of the bill).....................................    42
        E. Disclosure to State Officials of Proposed Actions 
            Related to Section 501(c) Organizations (sec. 205 of 
            the bill and sec. 6104 of the Code)..................    42
        F. Expansion of Penalties to Preparers of Form 990 (sec. 
            206 of the bill and sec. 6695 of the Code)...........    45
        G. Notification Requirement for Exempt Entities not 
            Currently Required to File an Annual Information 
            Return (sec. 207 of the bill and sec. 6033 of the 
            Code)................................................    46
        H. Suspension of Tax-Exempt Status of Terrorist 
            Organizations (sec. 208 of the bill and sec. 501 of 
            the Code)............................................    48
    Title III. Other Charitable and Exempt Organization Provisions...50
        A. Modify Tax on Unrelated Business Taxable Income of 
            Charitable Remainder Trusts (sec. 301 of the bill and 
            sec. 664 of the Code)................................    50
        B. Modify Tax Treatment of Certain Payments to 
            Controlling Exempt Organizations (sec. 302 of the 
            bill and sec. 512 of the Code).......................    52
        C. Simplification of Lobbying Expenditure Limitation 
            (sec. 303 of the bill and secs. 501 and 4911 of the 
            Code)................................................    53
        D. Expedited Review Process for Certain Tax-Exemption 
            Applications (sec. 304 of the bill)..................    57
        E. Clarification of Definition of Church Tax Inquiry 
            (sec. 305 of the bill and sec. 7611 of the Code).....    59
        F. Extension of Declaratory Judgment Procedures to Non-
            501(c)(3) Tax-Exempt Organizations (sec. 306 of the 
            bill and sec. 7428 of the Code)......................    60
        G. Definition of Convention or Association of Churches 
            (sec. 307 of the bill and sec. 7701 of the Code).....    61
        H. Payments by Charitable Organizations to Victims of War 
            on Terrorism and Families of Astronauts (sec. 308 of 
            the bill)............................................    63
        I. Increase Percentage Limits for Certain Employer-
            Related Scholarship Programs (sec. 309 of the bill)..    64
        J. Treatment of Certain Hospital Support Organizations in 
            Determining Acquisition Indebtedness (sec. 310 of the 
            bill and sec. 514 of the Code).......................    67
        K. Charitable Contribution Deduction for Certain Expenses 
            in Support of Native Alaskan Subsistence Whaling 
            (sec. 311 of the bill and sec. 170 of the Code)......    68
        L. Matching grants to low-income taxpayer clinics for 
            return preparation (sec. 312 of the bill and new sec. 
            7526A of the Code)...................................    69
    Title IV. Social Services Block Grant (Secs 401-403 of the Bill).70
    Title V. Individual Development Accounts (Sec. 501-512 of the Bil71
    Title VI. Management of Exempt Organizations (Sec. 601 of the Bil75
    Title VII. Revenue Provisions....................................76
        A. Provisions Designed to Curtail Tax Shelters...........    76
            1. Clarification of the economic substance doctrine 
                (sec. 701 of the bill and sec. 7701 of the Code).    76
            2. Penalty for failure to disclose reportable 
                transactions (sec. 702 of the bill and new sec. 
                6707A of the Code)...............................    81
            3. Modifications to the accuracy-related penalties 
                for listed transactions and reportable 
                transactions having a significant tax avoidance 
                purpose (sec. 703 of the bill and new sec. 6662A 
                of the Code).....................................    84
            4. Penalty for understatements from transactions 
                lacking economic substance (sec. 704 of the bill 
                and new sec. 6662B of the Code)..................    89
            5. Modifications to the substantial understatement 
                penalty (sec. 705 of the bill and sec. 6662 of 
                the Code)........................................    91
            6. Tax shelter exception to confidentiality 
                privileges relating to taxpayer communications 
                (sec. 706 of the bill and sec. 7525 of the Code).    93
            7. Disclosure of reportable transactions by material 
                advisors (secs. 707 and 708 of the bill and secs. 
                6111 and 6707 of the Code).......................    93
            8. Investor lists and modification of penalty for 
                failure to maintain investor lists (secs. 707 and 
                709 of the bill and secs. 6112 and 6708 of the 
                Code)............................................    97
            9. Actions to enjoin conduct with respect to tax 
                shelters and reportable transactions (sec. 710 of 
                the bill and sec. 7408 of the Code)..............    99
            10. Understatement of taxpayer's liability by income 
                tax return preparer (sec. 711 of the bill and 
                sec. 6694 of the Code)...........................    99
            11. Penalty for failure to report interests in 
                foreign financial accounts (sec. 712 of the bill 
                and sec. 5321 of Title 31, United States Code)...   100
            12. Frivolous tax returns and submissions (sec. 713 
                of the bill and sec. 67021 of the Code)..........   102
            13. Regulation of individuals practicing before the 
                Department of the Treasury (sec. 714 of the bill 
                and sec. 330 of Title 31, United States Code)....   103
            14. Penalties on promoters of tax shelters (sec. 715 
                of the bill and sec. 6700 of the Code)...........   104
            15. Extend statute of limitations for certain 
                undisclosed transactions (sec. 716 of the bill 
                and sec. 6501 of the Code).......................   105
            16. Deny deduction for interest paid to IRS on 
                underpayments involving certain tax-motivated 
                transactions (sec. 717 of the bill and sec. 163 
                of the Code).....................................   106
            17. Authorize additional $300 million per year to the 
                IRS to combat abusive tax avoidance transactions 
                (sec. 718 of the bill)...........................   106
        B. Other Provisions......................................   107
            1. Affirmation of consolidated return regulation 
                authority (sec. 721 of the bill and sec. 1502 of 
                the Code)........................................   107
            2. Chief Executive Officer Required To Sign Corporate 
                Income Tax Returns (sec. 722 of the bill and sec. 
                6062 of the Code)................................   111
III.Budget Effects of the Bill......................................112

        A. Committee Estimates...................................   112
        B. Budget Authority and Tax Expenditures.................   116
        C. Consultation with Congressional Budget Office.........   116
IV. Votes of the Committee..........................................121
 V. Regulatory Impact and Other Matters.............................122
        A. Regulatory Impact.....................................   122
        B. Unfunded Mandates Statement...........................   122
        C. Tax Complexity Analysis...............................   123
VI. Changes in Existing Law Made by the Bill as Reported............125



                       I. LEGISLATIVE BACKGROUND

    The ``CARE Act of 2003'' was referred to the Senate 
Committee on Finance on January 30, 2003. The Senate Committee 
on Finance marked up an original bill the ``CARE Act of 2003'' 
on February 5, 2003, and ordered the bill, as amended, 
favorably reported by voice vote.

                      II. EXPLANATION OF THE BILL


                 TITLE I. CHARITABLE GIVING INCENTIVES


                A. Charitable Deduction for Nonitemizers


(Sec. 101 of the bill and sec. 63 and 170 of the Code)

                              PRESENT LAW

    In computing taxable income, an individual taxpayer who 
itemizes deductions generally is allowed to deduct the amount 
of cash and up to the fair market value of property contributed 
to a charity described in section 501(c)(3),\1\ to certain 
veterans' organizations, fraternal societies, and cemetery 
companies,\2\ or to a Federal, State, or local governmental 
entity for exclusively public purposes\3\ The deduction also is 
allowed for purposes of calculating alternative minimum taxable 
income.
---------------------------------------------------------------------------
    \1\ All section references are to the Internal Revenue Code of 
1986, unless otherwise indicated.
    \2\ Secs. 170(c)(3)-(5).
    \3\ Sec. 170(c)(1).
---------------------------------------------------------------------------
    The amount of the deduction allowable for a taxable year 
with respect to a charitable contribution of property may be 
reduced depending on the type of property contributed, the type 
of charitable organization to which the property is 
contributed, and the income of the taxpayer.\4\
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    \4\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
    A taxpayer who takes the standard deduction (i.e., who does 
not itemize deductions) may not take a separate deduction for 
charitable contributions.\5\
---------------------------------------------------------------------------
    \5\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a 
temporary provision that permitted individual taxpayers who did not 
itemize income tax deductions to claim a deduction from gross income 
for a specified percentage of their charitable contributions. The 
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent 
of the amount of the contribution for 1985, and 100 percent of the 
amount of the contribution for 1986. The nonitemizer deduction 
terminated for contributions made after 1986.
---------------------------------------------------------------------------
    A payment to a charity (regardless of whether it is termed 
a ``contribution'') in exchange for which the donor receives an 
economic benefit is not deductible, except to the extent that 
the donor can demonstrate that the payment exceeds the fair 
market value of the benefit received from the charity. To 
facilitate distinguishing charitable contributions from 
purchases of goods or services from charities, present law 
provides that no charitable contribution deduction is allowed 
for a separate contribution of $250 or more unless the donor 
obtains a contemporaneous written acknowledgement of the 
contribution from the charity indicating whether the charity 
provided any good or service (and an estimate of the value of 
any such good or service) to the taxpayer in consideration for 
the contribution.\6\ In addition, present law requires that any 
charity that receives a contribution exceeding $75 made partly 
as a gift and partly as consideration for goods or services 
furnished by the charity (a ``quid pro quo'' contribution) is 
required to inform the contributor in writing of an estimate of 
the value of the goods or services furnished by the charity and 
that only the portion exceeding the value of the goods or 
services is deductible as a charitable contribution.\7\
---------------------------------------------------------------------------
    \6\ Sec. 170(f)(8).
    \7\ Sec. 6115.
---------------------------------------------------------------------------
    Under present law, total deductible contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50 percent of the taxpayer's 
contribution base, which is the taxpayer's adjusted gross 
income for a taxable year (disregarding any net operating loss 
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property 
to public charities generally may be deducted up to 30 percent 
of the taxpayer's contribution base, (2) contributions of cash 
to private foundations and certain other charitable 
organizations generally may be deducted up to 30 percent of the 
taxpayer's contribution base, and (3) contributions of capital 
gain property to private foundations and certain other 
charitable organizations generally may be deducted up to 20 
percent of the taxpayer's contribution base.
    Contributions by individuals in excess of the 50-percent, 
30-percent, and 20-percent limit may be carried over and 
deducted over the next five taxable years, subject to the 
relevant percentage limitations on the deduction in each of 
those years.
    In addition to the percentage limitations imposed 
specifically on charitable contributions, present law imposes a 
reduction on most itemized deductions, including charitable 
contribution deductions, for taxpayers with adjusted gross 
income in excess of a threshold amount, which is indexed 
annually for inflation. The threshold amount for 2003 is 
$139,500 ($69,750 for married individuals filing separate 
returns). For those deductions that are subject to the limit, 
the total amount of itemized deductions is reduced by three 
percent of adjusted gross income over the threshold amount, but 
not by more than 80 percent of itemized deductions subject to 
the limit. Beginning in 2006, the overall limitation on 
itemized deductions phases-out for all taxpayers. The overall 
limitation on itemized deductions is reduced by one-third in 
taxable years beginning in 2006 and 2007, and by two-thirds in 
taxable years beginning in 2008 and 2009. The overall 
limitation on itemized deductions is eliminated for taxable 
years beginning after December 31, 2009; however, this 
elimination of the limitation sunsets on December 31, 2010.

                           REASONS FOR CHANGE

    The Committee recognizes that the Administration believes 
that providing a charitable deduction for taxpayers who do not 
itemize deductions will result in an increase in charitable 
giving. In addition, the Committee appreciates that the 
charitable deduction is an important part of the President's 
faith-based initiative. The provision is for a two-year period. 
To provide Congress adequate information in considering 
extending the provision, the Committee requires the Secretary 
of the Treasury to submit a report on the effectiveness of the 
provision. The report should consider the extent to which 
charitable giving has increased, the burdens of complexity to 
taxpayers, and the impact on tax compliance.

                        EXPLANATION OF PROVISION

    In the case of an individual taxpayer who does not itemize 
deductions, the provision allows a ``direct charitable 
deduction'' from adjusted gross income for charitable 
contributions paid in cash during the taxable year. This 
deduction is allowed in addition to the standard deduction. The 
deduction is available only for that portion of contributions 
actually made during the year that in the aggregate exceed $250 
($500 in the case of a joint return). The maximum deduction is 
$250 ($500 in the case of a joint return). Contributions that 
are below the minimum amount or that exceed the maximum 
deduction may not be carried over for purposes of a subsequent 
taxable year's calculation of the direct charitable deduction. 
Under the provision, an individual is not entitled to a 
charitable deduction for the first $250 of cash contributions 
made during the tax year, is entitled to a deduction on a 
dollar-for-dollar basis for contributions of $251 to $500 
(e.g., a $1 contribution deduction in the case of $251 of 
contributions, and a $250 deduction in the case of $500 of 
contributions), and is not entitled to a deduction for 
contributions exceeding $500.
    The provision does not alter present-law rules regarding 
the carryover of contributions to or from a taxable year, 
including a taxable year in which the taxpayer elects the 
standard deduction. The direct charitable deduction generally 
is subject to the tax rules normally governing charitable 
contribution deductions, such as the substantiation 
requirements. The deduction is allowed in computing alternative 
minimum taxable income.
    The provision requires the Secretary of the Treasury to 
complete a study by December 31, 2004, of the effect of the 
provision on increased charitable giving, and of taxpayer 
compliance, for example, by comparing compliance by taxpayers 
who itemize their charitable contributions with compliance by 
those who claim the direct charitable deduction. The Secretary 
shall report on the study to the Committee on Finance of the 
Senate and the Committee on Ways and Means of the House of 
Representatives.

                             EFFECTIVE DATE

    The direct charitable deduction is effective for taxable 
years beginning after December 31, 2002, and before January 1, 
2005. The Treasury study is required by December 31, 2004.

 B. Tax-Free Distributions From Individual Retirement Arrangements for 
                          Charitable Purposes


(Sec. 102 of the bill and secs. 408 and 6034 of the Code)

                              PRESENT LAW

In general

    If an amount withdrawn from a traditional individual 
retirement arrangement (``IRA'') or a Roth IRA is donated to a 
charitable organization, the rules relating to the tax 
treatment of withdrawals from IRAs apply to the amount 
withdrawn and the charitable contribution is subject to the 
normally applicable limitations on deductibility of such 
contributions.

Charitable contributions

    In computing taxable income, an individual taxpayer who 
itemizes deductions generally is allowed to deduct the amount 
of cash and up to the fair market value of property contributed 
to a charity described in section 501(c)(3),\8\ to certain 
veterans' organizations, fraternal societies, and cemetery 
companies,\9\ or to a Federal, State, or local governmental 
entity for exclusively public purposes.\10\ The deduction also 
is allowed for purposes of calculating alternative minimum 
taxable income.
---------------------------------------------------------------------------
    \8\ All section references are to the Internal Revenue Code of 
1986, unless otherwise indicated.
    \9\ Secs. 170(c)(3)-(5).
    \10\ Sec. 170(c)(1).
---------------------------------------------------------------------------
    The amount of the deduction allowable for a taxable year 
with respect to a charitable contribution of property may be 
reduced depending on the type of property contributed, the type 
of charitable organization to which the property is 
contributed, and the income of the taxpayer.\11\
---------------------------------------------------------------------------
    \11\ Secs. 170(b) and (e).
---------------------------------------------------------------------------
    A taxpayer who takes the standard deduction (i.e., who does 
not itemize deductions) may not take a separate deduction for 
charitable contributions.\12\
---------------------------------------------------------------------------
    \12\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a 
temporary provision that permitted individual taxpayers who did not 
itemize income tax deductions to claim a deduction from gross income 
for a specified percentage of their charitable contributions. The 
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent 
of the amount of the contribution for 1985, and 100 percent of the 
amount of the contribution for 1986. The nonitemizer deduction 
terminated for contributions made after 1986.
---------------------------------------------------------------------------
    A payment to a charity (regardless of whether it is termed 
a ``contribution'') in exchange for which the donor receives an 
economic benefit is not deductible, except to the extent that 
the donor can demonstrate that the payment exceeds the fair 
market value of the benefit received from the charity. To 
facilitate distinguishing charitable contributions from 
purchases of goods or services from charities, present law 
provides that no charitable contribution deduction is allowed 
for a separate contribution of $250 or more unless the donor 
obtains a contemporaneous written acknowledgement of the 
contribution from the charity indicating whether the charity 
provided any good or service (and an estimate of the value of 
any such good or service) to the taxpayer in consideration for 
the contribution.\13\ In addition, present law requires that 
any charity that receives a contribution exceeding $75 made 
partly as a gift and partly as consideration for goods or 
services furnished by the charity (a ``quid pro quo'' 
contribution) is required to inform the contributor in writing 
of an estimate of the value of the goods or services furnished 
by the charity and that only the portion exceeding the value of 
the goods or services is deductible as a charitable 
contribution.\14\
---------------------------------------------------------------------------
    \13\ Sec. 170(f)(8).
    \14\ Sec. 6115.
---------------------------------------------------------------------------
    Under present law, total deductible contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50 percent of the taxpayer's 
contribution base, which is the taxpayer's adjusted gross 
income for a taxable year (disregarding any net operating loss 
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property 
to public charities generally may be deducted up to 30 percent 
of the taxpayer's contribution base, (2) contributions of cash 
to private foundations and certain other charitable 
organizations generally may be deducted up to 30 percent of the 
taxpayer's contribution base, and (3) contributions of capital 
gain property to private foundations and certain other 
charitable organizations generally may be deducted up to 20 
percent of the taxpayer's contribution base.
    Contributions by individuals in excess of the 50-percent, 
30-percent, and 20-percent limit may be carried over and 
deducted over the next five taxable years, subject to the 
relevant percentage limitations on the deduction in each of 
those years.
    In addition to the percentage limitations imposed 
specifically on charitable contributions, present law imposes a 
reduction on most itemized deductions, including charitable 
contribution deductions, for taxpayers with adjusted gross 
income in excess of a threshold amount, which is indexed 
annually for inflation. The threshold amount for 2003 is 
$139,500 ($69,750 for married individuals filing separate 
returns). For those deductions that are subject to the limit, 
the total amount of itemized deductions is reduced by three 
percent of adjusted gross income over the threshold amount, but 
not by more than 80 percent of itemized deductions subject to 
the limit. Beginning in 2006, the overall limitation on 
itemized deductions phases-out for all taxpayers. The overall 
limitation on itemized deductions is reduced by one-third in 
taxable years beginning in 2006 and 2007, and by two-thirds in 
taxable years beginning in 2008 and 2009. The overall 
limitation on itemized deductions is eliminated for taxable 
years beginning after December 31, 2009; however, this 
elimination of the limitation sunsets on December 31, 2010.
    In general, a charitable deduction is not allowed for 
income, estate, or gift tax purposes if the donor transfers an 
interest in property to a charity (e.g., a remainder) while 
also either retaining an interest in that property (e.g., an 
income interest) or transferring an interest in that property 
to a noncharity for less than full and adequate 
consideration.\15\ Exceptions to this general rule are provided 
for, among other interests, remainder interests in charitable 
remainder annuity trusts, charitable remainder unitrusts, and 
pooled income funds, and present interests in the form of a 
guaranteed annuity or a fixed percentage of the annual value of 
the property.\16\ For such interests, a charitable deduction is 
allowed to the extent of the present value of the interest 
designated for a charitable organization.
---------------------------------------------------------------------------
    \15\ Secs. 170(f), 2055(e)(2), and 2522(c)(2).
    \16\ Sec. 170(f)(2).
---------------------------------------------------------------------------

IRA rules

    Within limits, individuals may make deductible and 
nondeductible contributions to a traditional IRA. Amounts in a 
traditional IRA are includible in income when withdrawn (except 
to the extent the withdrawal represents a return of 
nondeductible contributions). Individuals also may make 
nondeductible contributions to a Roth IRA. Qualified 
withdrawals from a Roth IRA are excludable from gross income. 
Withdrawals from a Roth IRA that are not qualified withdrawals 
are includible in gross income to the extent attributable to 
earnings. Includible amounts withdrawn from a traditional IRA 
or a Roth IRA before attainment of age 59\1/2\ are subject to 
an additional 10-percent early withdrawal tax, unless an 
exception applies.
    If an individual has made nondeductible contributions to a 
traditional IRA, a portion of each distribution from an IRA is 
nontaxable, until the total amount of nondeductible 
contributions has been received. In general, the amount of a 
distribution that is nontaxable is determined by multiplying 
the amount of the distribution by the ratio of the remaining 
nondeductible contributions to the account balance. In making 
the calculation, all traditional IRAs of an individual are 
treated as a single IRA, all distributions during any taxable 
year are treated as a single distribution, and the value of the 
contract, income on the contract, and investment in the 
contract are computed as of the close of the calendar year.
    In the case of a distribution from a Roth IRA that is not a 
qualified distribution, in determining the portion of the 
distribution attributable to earnings, contributions and 
distributions are deemed to be distributed in the following 
order: (1) regular Roth IRA contributions; (2) taxable 
conversion contributions;\17\ (3) nontaxable conversion 
contributions; and (4) earnings. In determining the amount of 
taxable distributions from a Roth IRA, all Roth IRA 
distributions in the same taxable year are treated as a single 
distribution, all regular Roth IRA contributions for a year are 
treated as a single contribution, and all conversion 
contributions during the year are treated as a single 
contribution.
---------------------------------------------------------------------------
    \17\ Conversion contributions refer to conversions of amounts in a 
traditional IRA to a Roth IRA.
---------------------------------------------------------------------------

Split-interest trust filing requirements

    Split-interest trusts, including charitable remainder 
annuity trusts, charitable remainder unitrusts, and pooled 
income funds, are required to file an annual information return 
\18\ (Form 1041A). Trusts that are not split-interest trusts 
but that claim a charitable deduction for amounts permanently 
set aside for a charitable purpose \19\ also are required to 
file Form 1041A. The returns are required to be made publicly 
available.\20\ A trust that is required to distribute all trust 
net income currently to trust beneficiaries in a taxable year 
is exempt from this return requirement for such taxable year. A 
failure to file the required return may result in a penalty on 
the trust of $10 a day for as long as the failure continues, up 
to a maximum of $5,000 per return.
---------------------------------------------------------------------------
    \18\ Sec. 6034. This requirement applies to all split-interest 
trusts described in section 4947(a)(2).
    \19\ Sec. 642(c).
    \20\ Sec. 6104(b).
---------------------------------------------------------------------------
    In addition, split-interest trusts are required to file 
annually Form 5227.\21\ Form 5227 requires disclosure of 
information regarding a trust's noncharitable beneficiaries. 
The penalty for failure to file this return is calculated based 
on the amount of tax owed. A split-interest trust generally is 
not subject to tax and therefore, in general, a penalty may not 
be imposed for the failure to file Form 5227. Form 5227 is not 
required to be made publicly available.
---------------------------------------------------------------------------
    \21\ Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, an individual who wants to use IRA 
proceeds to make charitable contributions must treat the IRA 
distribution as a withdrawal subject to IRA income recognition 
rules and is subject to deduction limitation provisions on the 
contributions made to the charity. In some cases, this can 
result in taxable income even though the individual used the 
entire IRA distribution to make the charitable contribution. 
The Committee believes that taxpayers who want to make 
charitable contributions from IRAs generally should be 
permitted to do so without recognizing income because of the 
distribution from the IRA, whether such contribution is made 
directly to the charitable organization or indirectly through 
the use of a split-interest entity. The Committee believes that 
facilitating charitable contributions from IRAs will help 
increase giving to charitable organizations.

                        EXPLANATION OF PROVISION

Qualified charitable distributions from IRAs

    The provision provides an exclusion from gross income for 
otherwise taxable IRA distributions from a traditional or a 
Roth IRA in the case of qualified charitable distributions. 
Special rules apply in determining the amount of an IRA 
distribution that is otherwise taxable. The present-law rules 
regarding taxation of IRA distributions and the deduction of 
charitable contributions continue to apply to distributions 
from an IRA that are not qualified charitable distributions.
    A qualified charitable distribution is defined as any 
distribution from an IRA that is made directly by the IRA 
trustee either to (1) an organization to which deductible 
contributions can be made (a ``direct distribution'') or (2) a 
``split-interest entity.'' A split-interest entity means a 
charitable remainder annuity trust or charitable remainder 
unitrust (together referred to as a ``charitable remainder 
trust''), a pooled income fund, or a charitable gift annuity. 
Direct distributions are eligible for the exclusion only if 
made on or after the date the IRA owner attains age 70\1/2\. 
Distributions to a split interest entity are eligible for the 
exclusion only if made on or after the date the IRA owner 
attains age 59\1/2\ (or, if later, January 1, 2004). In the 
case of split-interest distributions, no person may hold an 
income interest in the amounts in the split-interest entity 
attributable to the charitable distribution other than the IRA 
owner, his or her spouse, or a charitable organization.
    The exclusion applies to direct distributions only if a 
charitable contribution deduction for the entire distribution 
otherwise would be allowable, determined without regard to the 
generally applicable percentage limitations. Thus, for example, 
if the deductible amount is reduced because of a benefit 
received in exchange, or if a deduction is not allowable 
because the donor did not obtain sufficient substantiation, the 
exclusion is not available with respect to any part of the IRA 
distribution. Similarly, the exclusion applies in the case of a 
distribution directly to a split-interest entity only if a 
charitable contribution deduction for the entire present value 
of the charitable interest (for example, a remainder interest) 
otherwise would be allowable, determined without regard to the 
generally applicable percentage limitations.
    If the IRA owner has any IRA that includes nondeductible 
contributions, a special rule applies in determining the 
portion of a distribution that is includible in gross income 
(but for the provision) and thus is eligible for qualified 
charitable distribution treatment. In such case, the IRA owner 
aggregates all IRAs to determine eligibility for the exclusion. 
Under the special rule, the distribution is treated as 
consisting of income first, up to the aggregate amount that 
would be includible in gross income (but for the provision) if 
the aggregate balance of all IRAs having the same owners were 
distributed during the same year. In determining the amount of 
subsequent IRA distributions includible in income, proper 
adjustments are made to reflect the amount treated as a 
qualified charitable distribution under the special rule.
    Special rules apply for distributions to split-interest 
entities. For distributions to charitable remainder trusts, the 
provision provides that subsequent distributions from the 
charitable remainder trust are treated as ordinary income in 
the hands of the beneficiary, notwithstanding how such amounts 
normally are treated under section 664(b). In addition, for a 
charitable remainder trust to be eligible to receive qualified 
charitable distributions, the charitable remainder trust has to 
be funded exclusively by such distributions. For example, an 
IRA owner may not make qualified charitable distributions to an 
existing charitable remainder trust any part of which was 
funded with assets that were not qualified charitable 
distributions.
    Under the provision, a pooled income fund is eligible to 
receive qualified charitable distributions only if the fund 
accounts separately for amounts attributable to such 
distributions. In addition, all distributions from the pooled 
income fund that are attributable to qualified charitable 
distributions are treated as ordinary income to the 
beneficiary. Qualified charitable distributions to a pooled 
income fund are not includible in the fund's gross income.
    In determining the amount includible in gross income by 
reason of a payment from a charitable gift annuity purchased 
with a qualified charitable distribution from an IRA, the 
portion of the distribution from the IRA used to purchase the 
annuity is not an investment in the annuity contract.
    Any amount excluded from gross income by reason of the 
provision is not taken into account in determining the 
deduction for charitable contributions under section 170.

Qualified charitable distribution examples

    The following examples illustrate the determination of the 
portion of an IRA distribution that is a qualified charitable 
distribution and the application of the special rules for a 
qualified charitable distribution to a split-interest entity. 
In each example, it is assumed that the requirements for 
qualified charitable distribution treatment are otherwise met 
(e.g., the applicable age requirement and the requirement that 
contributions are otherwise deductible) and that no other IRA 
distributions occur during the year.
    Example 1. Individual A has a traditional IRA with a 
balance of $100,000, consisting solely of deductible 
contributions and earnings. Individual A has no other IRA. The 
entire IRA balance is distributed in a direct distribution to a 
charitable organization. Under present law, the entire 
distribution of $100,000 would be includible in Individual A's 
income. Accordingly, under the provision, the entire 
distribution of $100,000 is a qualified charitable 
distribution. As a result, no amount is included in Individual 
A's income as a result of the distribution and the distribution 
is not taken into account in determining the amount of 
Individual A's charitable deduction for the year.
    Example 2. The facts are the same as in Example 1, except 
that the entire IRA balance of $100,000 is distributed to a 
charitable remainder unitrust, which contains no other assets 
and which must be funded exclusively by qualified charitable 
distributions. Under the terms of the trust, Individual A is 
entitled to receive five percent of the value of the trust each 
year. As explained in Example l, the entire $100,000 
distribution is a qualified charitable distribution, no amount 
is included in Individual A's income as a result of the 
distribution, and the distribution is not taken into account in 
determining the amount of Individual A's charitable deduction 
for the year. In addition, under a special rule in the 
provision for charitable remainder trusts, any distribution 
from the charitable remainder unitrust to Individual A is 
includible in gross income as ordinary income, regardless of 
the character of the distribution under the usual rules for the 
taxation of distributions from such a trust.
    Example 3. Individual B has a traditional IRA with a 
balance of $100,000, consisting of $20,000 of nondeductible 
contributions and $80,000 of deductible contributions and 
earnings. Individual B has no other IRA. In a direct 
distribution to a charitable organization, $80,000 is 
distributed from the IRA. Under present law, a portion of the 
distribution from the IRA would be treated as a nontaxable 
return of nondeductible contributions. The nontaxable portion 
of the distribution would be $16,000, determined by multiplying 
the amount of the distribution ($80,000) by the ratio of the 
nondeductible contributions to the account balance ($20,000/
$100,000). Accordingly, under present law, $64,000 of the 
distribution ($80,000 minus $16,000) would be includible in 
Individual B's income.
    Under the provision, notwithstanding the present-law tax 
treatment of IRA distributions, the distribution is treated as 
consisting of income first, up to the total amount that would 
be includible in gross income (but for the provision) if all 
amounts were distributed from all IRAs otherwise taken into 
account in determining the amount of IRA distributions. The 
total amount that would be includible in income if all amounts 
were distributed from the IRA is $80,000. Accordingly, under 
the provision, the entire $80,000 distributed to the charitable 
organization is treated as includible in income (before 
application of the provision) and is a qualified charitable 
distribution. As a result, no amount is included in Individual 
B's income as a result of the distribution and the distribution 
is not taken into account in determining the amount of 
Individual B's charitable deduction for the year. In addition, 
for purposes of determining the tax treatment of other 
distributions from the IRA, $20,000 of the amount remaining in 
the IRA is treated as Individual B's nondeductible 
contributions.

Split-interest trust filing requirements

    The provision increases the penalty on split-interest 
trusts for failure to file a return and for failure to include 
any of the information required to be shown on such return and 
to show the correct information. The penalty is $20 for each 
day the failure continues up to $10,000 for any one return. In 
the case of a split-interest trust with gross income in excess 
of $250,000, the penalty is $100 for each day the failure 
continues up to a maximum of $50,000. In addition, if a person 
(meaning any officer, director, trustee, employee, or other 
individual who is under a duty to file the return or include 
required information) \22\ knowingly failed to file the return 
or include required information, then that person is personally 
liable for such a penalty, which would be imposed in addition 
to the penalty that is paid by the organization. Information 
regarding beneficiaries that are not charitable organizations 
as described in section 170(c) is exempt from the requirement 
to make information publicly available. In addition, the 
provision repeals the present-law exception to the filing 
requirement for split-interest trusts that are required in a 
taxable year to distribute all net income currently to 
beneficiaries. Such exception remains available to trusts other 
than split-interest trusts that are otherwise subject to the 
filing requirement.
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    \22\ Sec. 6652(c)(4)(C).
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                             EFFECTIVE DATE

    The provision relating to qualified charitable 
distributions is effective for distributions made after the 
date of enactment. The provision relating to information 
returns of split-interest trusts is effective for returns for 
taxable years beginning after December 31, 2003.

      C. Charitable Deduction for Contributions of Food Inventory


(Sec. 103 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer's deduction for charitable 
contributions of inventory generally is limited to the 
taxpayer's basis (typically, cost) in the inventory.
    However, for certain contributions of inventory, C 
corporations may claim an enhanced deduction equal to the 
lesser of (1) basis plus one-half of the item's appreciated 
value (i.e., basis plus one half of fair market value in excess 
of basis) or (2) two times basis.\23\ To be eligible for the 
enhanced deduction, the contributed property generally must be 
inventory of the taxpayer, contributed to a charitable 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), and the donee must (1) use the 
property consistent with the donee's exempt purpose solely for 
the care of the ill, the needy, or infants, (2) not transfer 
the property in exchange for money, other property, or 
services, and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements. In the case of contributed property subject to 
the Federal Food, Drug, and Cosmetic Act, the property must 
satisfy the applicable requirements of such Act on the date of 
transfer and for 180 days prior to the transfer.
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    \23\ Sec. 170(e)(3). In general, a C corporation's charitable 
contribution deductions for a year may not exceed 10 percent of the 
corporation's taxable income. Sec. 170(b)(2).
---------------------------------------------------------------------------
    To use the enhanced deduction, the taxpayer must establish 
that the fair market value of the donated item exceeds basis. 
The valuation of food inventory has been the subject of ongoing 
disputes between taxpayers and the IRS. In one case, the Tax 
Court held that the value of surplus bread inventory donated to 
charity was the full retail price of the bread rather than half 
the retail price, as the IRS asserted.\24\
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    \24\ Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that expanding the present-law 
enhanced deduction for contributions of food inventory to non-C 
corporations and raising the amount of the enhanced deduction 
will increase charitable contributions of food to those in 
need. By clarifying the definition of fair market value, the 
Committee believes that taxpayers will be better able to avoid 
disputes with the IRS about the valuation of food and receive 
an appropriate deduction for their contribution. In addition, 
the Committee believes that providing certain low-basis 
taxpayers with a deemed basis equal to one quarter of the fair 
market value of the food will increase food donations, thus 
further providing needed nourishment to the nation's hungry.

                        EXPLANATION OF PROVISION

    Under the provision, any taxpayer, whether or not a C 
corporation, engaged in a trade or business is eligible to 
claim the enhanced deduction for donations of food inventory. 
For taxpayers other than C corporations, the total deduction 
for donations of food inventory in a taxable year generally may 
not exceed 10 percent of the taxpayer's net income for such 
year from its trade or business (or interest therein) from 
which contributions are made. For example, if a taxpayer is a 
sole proprietor, a shareholder in an S corporation, and a 
partner in a partnership, and each business makes charitable 
contributions of food inventory, the taxpayer's deduction for 
donations of food inventory is limited to 10 percent of the 
taxpayer's net income from the sole proprietorship and the 
taxpayer's interests in the S corporation and partnership. 
However, if only the sole proprietorship and the S corporation 
made charitable contributions of food inventory, the taxpayer's 
deduction would be limited to 10 percent of the net income from 
the trade or business of the sole proprietorship and the S 
corporation, but not the partnership.
    The 10 percent limitation does not affect the application 
of the generally applicable percentage limitations. For 
example, if 10 percent of a sole proprietor's net income from 
the proprietor's trade or business was greater than 50 percent 
of the proprietor's contribution base, the available deduction 
for the taxable year (with respect to contributions to public 
charities) would be 50 percent of the proprietor's contribution 
base. Consistent with present law, such contributions may be 
carried forward because they exceed the 50 percent limitation. 
Contributions of food inventory by a taxpayer that is not a C 
corporation that exceed the 10 percent limitation but not the 
50 percent limitation could not be carried forward.
    For purposes of calculating the enhanced deduction, 
taxpayers who do not account for inventories under section 471 
and who are not required to capitalize indirect costs under 
section 263A are able to elect to treat the basis of the 
contributed food as being equal to 25 percent of the food's 
fair market value.\25\
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    \25\ This includes, for example, taxpayers who are eligible for 
administrative relief under Revenue Procedures 2002-28 and 2001-10.
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    The provision changes the amount of the present-law 
enhanced deduction for eligible contributions of food inventory 
to the lesser of fair market value or twice the taxpayer's 
basis in the inventory. For example, a taxpayer who makes an 
eligible donation of food that has a fair market value of $10 
and a basis of $4 could take a deduction of $8 (twice basis). 
If the taxpayer's basis was $6 instead of $4, then the 
deduction would be $10 (fair market value). By contrast, under 
present law, a C corporation's deduction in the first example 
would be $7 (fair market value less half the appreciation) and 
in the second example would be $8. (Under present law, 
taxpayers other than C corporations generally could take a 
deduction for a contribution of food inventory only for the $4 
basis in either example.) Taxpayers that do not account for 
inventories under section 471 and who are not required to 
capitalize indirect costs under section 263A would be able to 
elect to treat the basis of the contributed food as being equal 
to 25 percent of the food's fair market value.
    Under the provision, the enhanced deduction is available 
only for food that qualifies as ``apparently wholesome food.'' 
``Apparently wholesome food'' is defined as food intended for 
human consumption that meets all quality and labeling standards 
imposed by Federal, State, and local laws and regulations even 
though the food may not be readily marketable due to 
appearance, age, freshness, grade, size, surplus, or other 
conditions.
    In addition, the provision provides that the fair market 
value of donated apparently wholesome food that cannot or will 
not be sold solely due to internal standards of the taxpayer or 
lack of market is determined without regard to such internal 
standards or lack of market and by taking into account the 
price at which the same or substantially the same food items 
(as to both type and quality) are sold by the taxpayer at the 
time of the contribution or, if not so sold at such time, in 
the recent past.

                             EFFECTIVE DATE

    The provision is effective for contributions made after the 
date of enactment.

      D. Charitable Deduction for Contributions of Book Inventory


(Sec. 104 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer's deduction for charitable 
contributions of inventory generally is limited to the 
taxpayer's basis (typically, cost) in the inventory.
    However, for certain contributions of inventory, C 
corporations may claim an enhanced deduction equal to the 
lesser of (1) basis plus one-half of the item's appreciated 
value (i.e., basis plus one half of fair market value in excess 
of basis) or (2) two times basis.\26\ To be eligible for the 
enhanced deduction, the contributed property generally must be 
inventory of the taxpayer, contributed to a charitable 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), and the donee must: (1) use the 
property consistent with the donee's exempt purpose solely for 
the care of the ill, the needy, or infants, (2) not transfer 
the property in exchange for money, other property, or 
services, and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements.
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    \26\ Sec. 170(e)(3).
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                           REASONS FOR CHANGE

    Under present law, taxpayers sometimes are prohibited from 
receiving an enhanced deduction for charitable contributions of 
their book inventory, in part because of the requirement that 
the inventory be used for care of the ill, the needy, or 
infants. For example, such requirement generally prohibits 
donations to public libraries and adult literacy programs. The 
Committee believes that suitable book inventory should be 
eligible for an enhanced deduction in cases where a 
contribution is made to an appropriate educational 
organization. To minimize disputes between taxpayers and the 
IRS about the value of books and to encourage contributions of 
books that are suitable in terms of currency, content, and 
quantity, the Committee provides a special rule for determining 
the amount of the contribution of such books. A clear rule is 
needed so that taxpayers know that if they donate books to 
schools, libraries, and literacy programs, they will receive an 
enhanced deduction that more adequately reflects the costs of 
the donation.

                        EXPLANATION OF PROVISION

    The provision modifies the present-law enhanced deduction 
for C corporations so that it is equal to the lesser of fair 
market value or twice the taxpayer's basis in the case of 
qualified book contributions. The provision provides that the 
fair market value for this purpose is determined by reference 
to a bona fide published market price for the book. Under the 
provision, a bona fide published market price of a book means a 
price: (1) determined using the same printing and edition; (2) 
determined in the usual market in which such a book has been 
customarily sold by the taxpayer; and (3) for which the 
taxpayer can demonstrate to the satisfaction of the Secretary 
that the taxpayer customarily sold such books in arm's length 
transactions within 7 years preceding the contribution. For 
example, a publisher's listed retail price for a book would not 
meet the standard if the publisher could not demonstrate to the 
satisfaction of the Secretary that the price was one at which 
the publisher customarily sold the book in its usual market in 
arm's length transactions occurring within the 7-year period 
prior to the contribution. If a publisher entered into a 
contract with a local school district to sell newly published 
textbooks six years prior to making a qualified book 
contribution of such textbooks, the publisher could use as a 
bona fide published market price, the price at which such books 
regularly were sold to the school district under the contract. 
By contrast, if a publisher listed in a catalogue or elsewhere 
a ``suggested retail price,'' but the publisher did not in fact 
customarily sell the books at such price, the publisher could 
not use the ``suggested retail price'' to determine the fair 
market value of the book for purposes of the enhanced 
deduction. Thus, in general, a bona fide published market price 
must be independently verifiable by reference to actual sales 
within the seven-year period preceding the contribution, and 
not to a publisher's own price list.
    As an illustration of the mechanics of calculating the 
enhanced deduction under the provision, a C corporation that 
made a qualified book contribution with a bona fide published 
market price of $10 and a basis of $4 could take a deduction of 
$8 (twice basis). If the taxpayer's basis is $6 instead of $4, 
then the deduction is $10. Also, in such latter case, if the 
book's bona fide market published market price was $5 at the 
time of the contribution but was $10 five years before the 
contribution, then the deduction is $10.
    A qualified book contribution means a charitable 
contribution of books to: (1) an educational organization that 
normally maintains a regular faculty and curriculum and 
normally has a regularly enrolled body of pupils or students in 
attendance at the place where its educational activities are 
regularly carried on; (2) a public library; or (3) an 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), that is organized primarily to make 
books available to the general public at no cost or to operate 
a literacy program. The donee must: (1) use the property 
consistent with the donee's exempt purpose; (2) not transfer 
the property in exchange for money, other property, or 
services; and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements and also that the books are suitable, in terms of 
currency, content, and quantity, for use in the donee's 
educational programs and that the donee will use the books in 
such educational programs.

                             EFFECTIVE DATE

    The provision is effective for contributions made after the 
date of enactment.

E. Expand Charitable Contribution Allowed for Scientific Property Used 
         for Research and for Computer Technology and Equipment


(Sec. 105 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    In the case of a charitable contribution of inventory or 
other ordinary-income or short-term capital gain property, the 
amount of the charitable deduction generally is limited to the 
taxpayer's basis in the property. In the case of a charitable 
contribution of tangible personal property, the deduction is 
limited to the taxpayer's basis in such property if the use by 
the recipient charitable organization is unrelated to the 
organization's tax-exempt purpose. In cases involving 
contributions to a private foundation (other than certain 
private operating foundations), the amount of the deduction is 
limited to the taxpayer's basis in the property.\27\
---------------------------------------------------------------------------
    \27\ Sec. 170(e)(1).
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    Under present law, a taxpayer's deduction for charitable 
contributions of scientific property used for research and for 
contributions of computer technology and equipment generally is 
limited to the taxpayer's basis (typically, cost) in the 
property. However, certain corporations may claim a deduction 
in excess of basis for a ``qualified research contribution'' or 
a ``qualified computer contribution.'' \28\ This enhanced 
deduction is equal to the lesser of (1) basis plus one-half of 
the item's appreciated value (i.e., basis plus one half of fair 
market value minus basis) or (2) two times basis. The enhanced 
deduction for qualified computer contributions expires for any 
contribution made during any taxable year beginning after 
December 31, 2003.
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    \28\ Secs. 170(e)(4) and 170(e)(6).
---------------------------------------------------------------------------
    A qualified research contribution means a charitable 
contribution of inventory that is tangible personal property. 
The contribution must be to a qualified educational or 
scientific organization and be made not later than two years 
after construction of the property is substantially completed. 
The original use of the property must be by the donee, and be 
used substantially for research or experimentation, or for 
research training, in the U.S. in the physical or biological 
sciences. The property must be scientific equipment or 
apparatus, constructed by the taxpayer, and may not be 
transferred by the donee in exchange for money, other property, 
or services. The donee must provide the taxpayer with a written 
statement representing that it will use the property in 
accordance with the conditions for the deduction. For purposes 
of the enhanced deduction, property is considered constructed 
by the taxpayer only if the cost of the parts used in the 
construction of the property (other than parts manufactured by 
the taxpayer or a related person) do not exceed 50 percent of 
the taxpayer's basis in the property.
    A qualified computer contribution means a charitable 
contribution of any computer technology or equipment, which 
meets standards of functionality and suitability as established 
by the Secretary of the Treasury. The contribution must be to 
certain educational organizations or public libraries and made 
not later than three years after the taxpayer acquired the 
property or, if the taxpayer constructed the property, not 
later than the date construction of the property is 
substantially completed.\29\ The original use of the property 
must be by the donor or the donee,\30\ and in the case of the 
donee, must be used substantially for educational purposes 
related to the function or purpose of the donee. The property 
must fit productively into the donee's education plan. The 
donee may not transfer the property in exchange for money, 
other property, or services, except for shipping, installation, 
and transfer costs. To determine whether property is 
constructed by the taxpayer, the rules applicable to qualified 
research contributions apply. Contributions may be made to 
private foundations under certain conditions.\31\
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    \29\ If the taxpayer constructed the property and reacquired such 
property, the contribution must be within three years of the date the 
original construction was substantially completed. Sec. 
170(e)(6)(D)(i).
    \30\ This requirement does not apply if the property was reacquired 
by the manufacturer and contributed. Sec. 170(e)(6)(D)(ii).
    \31\ Sec. 170(e)(6)(C).
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                           REASONS FOR CHANGE

    The Committee believes that extension of the enhanced 
deduction to include property assembled by the taxpayer will 
lead to increased charitable contributions of scientific 
property used for research and computer technology and 
equipment and will help to eliminate confusion in determining 
whether property is ``constructed'' or ``assembled'' for 
purposes of claiming the enhanced deduction. The Committee 
believes it is appropriate to extend temporarily the enhanced 
deduction for qualified computer contributions.

                        EXPLANATION OF PROVISION

    Under the provision, property assembled by the taxpayer, in 
addition to property constructed by the taxpayer, is eligible 
for either enhanced deduction. The Committee does not intend 
that old or used components assembled by the taxpayer into 
scientific property or computer technology or equipment are 
eligible for the enhanced deduction.
    The provision extends the enhanced deduction for qualified 
computer contributions to contributions made during any taxable 
year beginning before January 1, 2006.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002.

   F. Encourage Contributions of Capital Gain Real Property Made for 
                         Conservation Purposes


(Sec. 106 of the bill and sec. 170 of the Code)

                              PRESENT LAW

Charitable contributions generally

    In general, a deduction is permitted for charitable 
contributions, subject to certain limitations that depend on 
the type of taxpayer, the property contributed, and the donee 
organization. The amount of deduction generally equals the fair 
market value of the contributed property on the date of the 
contribution. Charitable deductions are provided for income, 
estate, and gift tax purposes.\32\
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    \32\ Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
    In general, in any taxable year, charitable contributions 
by a corporation are not deductible to the extent the aggregate 
contributions exceed 10 percent of the corporation's taxable 
income computed without regard to net operating or capital loss 
carrybacks. For individuals, the amount deductible is a 
percentage of the taxpayer's contribution base, which is the 
taxpayer's adjusted gross income computed without regard to any 
net operating loss carryback. The applicable percentage of the 
contribution base varies depending on the type of donee 
organization and property contributed. Cash contributions of an 
individual taxpayer to public charities, private operating 
foundations, and certain types of private nonoperating 
foundations may not exceed 50 percent of the taxpayer's 
contribution base. Cash contributions to private foundations 
and certain other organizations generally may be deducted up to 
30 percent of the taxpayer's contribution base.
    In general, a charitable deduction is not allowed for 
income, estate, or gift tax purposes if the donor transfers an 
interest in property to a charity while also either retaining 
an interest in that property or transferring an interest in 
that property to a noncharity for less than full and adequate 
consideration. Exceptions to this general rule are provided 
for, among other interests, remainder interests in charitable 
remainder annuity trusts, charitable remainder unitrusts, and 
pooled income funds, present interests in the form of a 
guaranteed annuity or a fixed percentage of the annual value of 
the property, and qualified conservation contributions.

Capital gain property

    Capital gain property means any capital asset or property 
used in the taxpayer's trade or business the sale of which at 
its fair market value, at the time of contribution, would have 
resulted in gain that would have been long-term capital gain. 
Contributions of capital gain property to a qualified charity 
are deductible at fair market value within certain limitations. 
Contributions of capital gain property to charitable 
organizations described in section 170(b)(1)(A) (e.g., public 
charities, private foundations other than private non-operating 
foundations, and certain governmental units) generally are 
deductible up to 30 percent of the taxpayer's contribution 
base. An individual may elect, however, to bring all these 
contributions of capital gain property for a taxable year 
within the 50-percent limitation category by reducing the 
amount of the contribution deduction by the amount of the 
appreciation in the capital gain property. Contributions of 
capital gain property to charitable organizations described in 
section 170(b)(1)(B) (e.g., private non-operating foundations) 
are deductible up to 20 percent of the taxpayer's contribution 
base.
    For purposes of determining whether a taxpayer's aggregate 
charitable contributions in a taxable year exceed the 
applicable percentage limitation, contributions of capital gain 
property are taken into account after other charitable 
contributions. Contributions of capital gain property that 
exceed the percentage limitation may be carried forward for 
five years.

Qualified conservation contributions

    Qualified conservation contributions are not subject to the 
``partial interest'' rule, which generally bars deductions for 
charitable contributions of partial interests in property. A 
qualified conservation contribution is a contribution of a 
qualified real property interest to a qualified organization 
exclusively for conservation purposes. A qualified real 
property interest is defined as: (1) the entire interest of the 
donor other than a qualified mineral interest; (2) a remainder 
interest; or (3) a restriction (granted in perpetuity) on the 
use that may be made of the real property. Qualified 
organizations include certain governmental units, public 
charities that meet certain public support tests, and certain 
supporting organizations. Conservation purposes include: (1) 
the preservation of land areas for outdoor recreation by, or 
for the education of, the general public; (2) the protection of 
a relatively natural habitat of fish, wildlife, or plants, or 
similar ecosystem; (3) the preservation of open space 
(including farmland and forest land) where such preservation 
will yield a significant public benefit and is either for the 
scenic enjoyment of the general public or pursuant to a clearly 
delineated Federal, State, or local governmental conservation 
policy; and (4) the preservation of an historically important 
land area or a certified historic structure.
    Qualified conservation contributions of capital gain 
property are subject to the same limitations and carryover 
rules of other charitable contributions of capital gain 
property.

                           REASONS FOR CHANGE

    The Committee desires to provide additional incentives for 
charitable donations of real property made for qualified 
conservation purposes. The Committee believes that increasing 
the percentage limitations applicable to qualified conservation 
contributions of real property, and increasing the carryover 
period applicable to such contributions from five to fifteen 
years, will increase donations made for qualified conservation 
purposes. The Committee also believes that special incentives 
are required to encourage qualified conservation contributions 
of farm and ranch properties.

                        EXPLANATION OF PROVISION

In general

    Under the provision, the 30-percent contribution base 
limitation on contributions of capital gain property by 
individuals does not apply to qualified conservation 
contributions (as defined under present law). Thus, individuals 
may include the fair market value of any qualified conservation 
contribution of capital gain property in determining the amount 
of the charitable contributions subject to the 50-percent 
contribution base limitation.
    Individuals are allowed to carryover any qualified 
conservation contributions that exceed the 50-percent 
limitation for up to 15 years. The 50-percent contribution base 
limitation applies first to contributions other than qualified 
conservation contributions and then to qualified conservation 
contributions. For example, assume an individual with a 
contribution base of $100 makes a qualified conservation 
contribution of property with a fair market value of $80 and 
makes other charitable contributions of $60. The individual is 
allowed a deduction of $50 in the current taxable year for the 
other contributions (50 percent of the $100 contribution base) 
and is allowed to carryover the excess $10 for up to 5 years. 
No current deduction is allowed for the qualified conservation 
contribution but the entire $80 qualified conservation 
contribution may be carried forward for up to 15 years.

Farmers and ranchers

    In the case of an eligible farmer or rancher, a qualified 
conservation contribution is allowable up to 100 percent of the 
taxpayer's contribution base (after taking into account other 
charitable contributions). This rule applies both to 
individuals and corporations. In addition, corporate (as well 
as non-corporate) eligible farmers and ranchers are allowed to 
carryover any excess qualified conservation contributions for 
up to 15 years. The 100-percent contribution base limitation 
applies first to contributions other than qualified 
conservation contributions (to the extent allowable under other 
percentage limitations) and then to qualified conservation 
contributions. For example, assume an individual farmer or 
rancher with a contribution base of $100 makes a qualified 
conservation contribution of property with a fair market value 
of $80 and makes other charitable contributions of $60. The 
individual is allowed a deduction of $50 in the current taxable 
year for the other contributions (50 percent of the $100 
contribution base) and is allowed to carryover the excess $10 
for up to 5 years. The individual also is allowed a deduction 
of $50 in the current taxable year for the qualified charitable 
contribution (the amount of the remaining contribution base). 
The remaining $30 qualified conservation contribution may be 
carried forward for up to 15 years.
    For this purpose, an eligible farmer or rancher means a 
taxpayer (other than a publicly traded C corporation) whose 
gross income from the trade of business of farming is at least 
51 percent of the taxpayer's gross income for the taxable year.

                             EFFECTIVE DATE

    The provision is effective for contributions made after the 
date of enactment.

 G. Exclusion of 25 Percent of Capital Gain for Certain Sales Made for 
                    Qualifying Conservation Purposes


(Sec. 107 of the bill and new sec. 121A of the Code)

                              PRESENT LAW

Sales of capital gain property

    Gain from the sale or exchange of land held more than one 
year generally is treated as long-term capital gain. Generally, 
the net capital gain of an individual (i.e., long-term capital 
gain less short-term capital loss) is subject to a maximum tax 
rate of 20 percent.

Charitable contributions of capital gain property for conservation 
        purposes

    Special rules apply to charitable contributions of 
qualified conservation contributions. Qualified conservation 
contributions are not subject to the ``partial interest'' rule, 
which generally bars deductions for charitable contributions of 
partial interests in property. A qualified conservation 
contribution is a contribution of a qualified real property 
interest to a qualified organization exclusively for 
conservation purposes. A qualified real property interest is 
defined as: (1) the entire interest of the donor other than a 
qualified mineral interest; (2) a remainder interest; or (3) a 
restriction (granted in perpetuity) on the use that may be made 
of the real property. Charitable contributions of interests 
that constitute the taxpayer's entire interest in the property 
are not regarded as qualified real property interests within 
the meaning of section 170(h),\33\ but instead are subject to 
the general rules applicable to charitable contributions of 
entire interests of the taxpayer. Qualified organizations 
include certain governmental units, public charities that meet 
certain public support tests, and certain supporting 
organizations. Conservation purposes include: (1) the 
preservation of land areas for outdoor recreation by, or for 
the education of, the general public; (2) the protection of a 
relatively natural habitat of fish, wildlife, or plants, or 
similar ecosystem; (3) the preservation of open space 
(including farmland and forest land) where such preservation 
will yield a significant public benefit and is either for the 
scenic enjoyment of the general public or pursuant to a clearly 
delineated Federal, State, or local governmental conservation 
policy; and (4) the preservation of an historically important 
land area or a certified historic structure.
---------------------------------------------------------------------------
    \33\ Ltr. Rul. 8626029.
---------------------------------------------------------------------------
    Treasury regulations provide that a deduction for a 
qualified conservation contribution is allowed only if the 
donor prohibits in the instrument of conveyance the donee from 
subsequently transferring the qualified real property interest, 
whether or not for consideration, unless the donee 
organization, as a condition of the subsequent transfer, 
requires that the conservation purpose which the contribution 
was originally intended to advance continues to be carried 
out.\34\ Moreover, subsequent transfers of such interests are 
restricted to organizations that are qualified conservation 
organizations.\35\
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    \34\ Treas. Reg. sec. 1.170A-14(c)(2).
    \35\ Id.
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                           REASONS FOR CHANGE

    Some landowners may want their land to be protected for 
conservation purposes but cannot afford simply to donate either 
the land or an easement on the land, especially if the land is 
the landowner's primary asset. The Committee desires to 
encourage the sale of appreciated, environmentally sensitive 
land and real property interests in land or water, as well as 
controlling stock interests in certain land corporations, to 
qualified conservation organizations and governments, thus 
achieving conservation goals through voluntary sales of 
property. The Committee believes that providing taxpayers a 
partial exclusion of capital gain derived from the voluntary 
sale of properties for conservation purposes will increase the 
number of properties dedicated to conservation purposes. The 
Committee desires to facilitate the transfers of properties to 
conservation organizations in a manner that will, to the extent 
practicable, preserve the value of the properties once they are 
acquired by the conservation organizations, while providing 
safeguards designed to ensure the protection of the 
conservation purposes for which the properties are intended to 
be used.

                        EXPLANATION OF PROVISION

In general

    The provision provides a 25-percent exclusion from gross 
income of long-term capital gain from the qualifying sale or 
exchange of land, or an interest in land or water rights, 
provided that the land or interest in land or water rights 
constitutes an interest in real property that has been held by 
the taxpayer or the taxpayer's family at all times during the 
five years preceding the date of sale. The qualifying sale must 
be made to a qualified organization that intends that the 
acquired property be used for qualified conservation purposes 
in perpetuity.\36\
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    \36\ The exclusion is mandatory if all of the requirements of the 
provision are satisfied, and a taxpayer need not file an election to 
take advantage of the exclusion. A taxpayer who transfers qualifying 
property to a qualified organization may opt out of the 25-percent 
exclusion by choosing not to satisfy one or more of the provision's 
requirements without having to file a formal election with the 
Secretary, such as by failing to obtain the requisite letter of intent 
from the qualified organization.
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Qualifying interests

    The exclusion applies only to sales or exchanges of real 
property interests in land or water rights that constitute the 
entire interest of the taxpayer in such land or water rights, 
or that constitute qualified real property interests as defined 
in section 170(h), specifically: (1) the entire interest of the 
taxpayer other than a qualified mineral interest; (2) a 
remainder interest; or (3) a restriction (granted in 
perpetuity) on the use which may be made of the real property. 
Partial interests in property that are not the entire interest 
of the taxpayer or a qualified real property interest do not 
qualify for the exclusion. For example, a taxpayer who owns 
land and related mineral rights but who sells only the mineral 
rights is not eligible for the exclusion. However, a taxpayer 
who owns only mineral rights is eligible for the 25-percent 
exclusion if the taxpayer sells his or her entire interest in 
the mineral rights and satisfies the other requirements of the 
provision.
    Generally, an undivided interest that constitutes the 
taxpayer's entire interest in the property is eligible for the 
exclusion. A partial interest that constitutes the taxpayer's 
entire interest in the property, however, does not qualify for 
the exclusion if the property in which such partial interest 
exists was divided in an attempt to avoid the partial interest 
rules. The Committee intends that the partial interest rules 
contained in Treasury Regulations section 1.170A-7(a)(2)(i) and 
generally applicable to contributions of partial interests be 
applied similarly for purposes of this provision. For example, 
if a taxpayer transfers an undivided interest in property to a 
spouse and immediately thereafter sells the remaining undivided 
interest to a qualified organization, the exclusion will not 
apply to the taxpayer's sale to the qualified organization.
    Under the provision, the exclusion is available for long-
term capital gain from certain sales or exchanges of stock in a 
C corporation if the qualified organization ultimately obtains 
a controlling stock interest (generally a stock interest that 
provides the qualified organization at least 90 percent of the 
total voting power and total value of the corporation's stock) 
and if at least 90 percent of the fair market value of the C 
corporation's assets at the time of the sale or exchange 
consists of land or water rights, or interests in land or water 
rights, that were held by the corporation at all times during 
the five years preceding the sale. Stock in a corporation will 
not qualify if at the time of the sale or exchange the fair 
market value of water rights and infrastructure relating to the 
delivery of water constitutes more than 50 percent of the fair 
market value of all of the corporation's assets. Only a stock 
interest held by the taxpayer or the taxpayer's family at all 
times during the five years preceding the sale qualifies for 
the 25-percent exclusion. The Committee intends that in 
appropriate circumstances a controlling stock interest may be 
acquired by the qualified organization from multiple persons in 
multiple transactions, and authorizes the Secretary to issue 
guidance regarding the availability of the exclusion in such 
cases.

Qualifying gain

    The exclusion applies only to long-term capital gain. Gain 
treated as ordinary income, such as under depreciation 
recapture provisions, is not eligible for the exclusion. Gain 
attributable to certain improvements, such as buildings or 
structures that do not further a qualified conservation purpose 
(``disqualified improvements''), also does not qualify for the 
exclusion.\37\ The provision provides that the maximum amount 
of gain that may be excluded by a shareholder in the case of a 
sale or exchange of a controlling stock interest is 25 percent 
of the shareholder's proportionate share of the C corporation's 
underlying gain attributable to qualifying land, water rights, 
or interests therein held by the C corporation.
---------------------------------------------------------------------------
    \37\ The Committee intends that soil and water conservation 
expenditures in the nature of those described in section 175, 
determined without regard to whether the taxpayer is engaged in a 
farming business and that the land be used for farming, generally shall 
be treated as furthering a qualified conservation purpose.
---------------------------------------------------------------------------
    Consistent with present law, the determination of gain or 
loss is to be calculated on an asset-by-asset basis whenever 
that is required for other purposes of the Code (such as for 
purposes of section 1245 or section 1250). To minimize 
administrative complexity and assist taxpayers in the 
preparation of their returns, the Committee intends that in 
those cases where the Code does not otherwise require a 
separate determination of gain or loss for the disqualified 
improvement, the gain allocable to the disqualified improvement 
shall be determined by reference to the fair market value of 
the disqualified improvement relative to the fair market value 
of all assets for which a gain or loss determination is not 
otherwise required by the Code.\38\
---------------------------------------------------------------------------
    \38\ The Committee intends that the taxpayer be required to use 
this gain allocation rule unless the taxpayer has adequate records to 
substantiate the adjusted basis and fair market value to support a 
separate calculation.
---------------------------------------------------------------------------
    For example, if a taxpayer sells a qualifying land interest 
with a fair market value of $100 and a basis of $30, that 
includes a building or structure that does not further a 
conservation purpose (a disqualified improvement) and that has 
a fair market value of $40, the taxpayer must determine the 
portion of the gain that is attributable to the eligible land 
and to the disqualified improvement. If determination of gain 
or loss on the sale of the improvement is required for other 
purposes of the Code, then the gain or loss determined for 
those purposes governs, and the taxpayer must determine his or 
her basis of the disqualified improvement (in this case, 
assumed to be zero), with the result that the $40 gain on the 
disqualified improvement is not eligible for the 25-percent 
exclusion and the gain of $30 on the land is eligible for the 
25-percent exclusion. On the other hand, if the determination 
of gain or loss on the sale of the improvement is not required 
for other purposes of the Code, then the Committee intends that 
the taxpayer allocate the aggregate gain of $70 attributable to 
the land and the disqualified improvement between the land and 
the improvement on the basis of their respective fair market 
values (i.e., 40 percent to the improvement and 60 percent to 
the land). Under this gain allocation rule, the $28 of gain 
allocable to the improvement is not eligible for the 25-percent 
exclusion, and the $42 of gain allocable to the land qualifies 
for the 25-percent exclusion.

Eligible sales

    An eligible sale is a sale or exchange (excluding a 
transfer made by order of condemnation or eminent domain) \39\ 
that may be made only to a qualified organization, defined as a 
Federal, State, or local government, or an agency or department 
thereof or a section 501(c)(3) organization that is organized 
and operated primarily to meet a qualified conservation 
purpose. In addition, to be an eligible sale, the organization 
acquiring the property interest must provide the taxpayer with 
a letter stating that the intent of such organization in 
acquiring the property is to further a qualified conservation 
purpose and that any subsequent transfer of the acquired 
interest will be to a qualified organization and made to 
protect the conservation purpose in perpetuity. A qualified 
conservation purpose is: (1) the preservation of land areas for 
outdoor recreation by, or the education of, the general public; 
(2) the protection of a relatively natural habitat of fish, 
wildlife, or plants, or similar ecosystem; or (3) the 
preservation of open space (including farmland and forest land) 
where the preservation is for the scenic enjoyment of the 
general public or pursuant to a clearly delineated Federal, 
State, or local governmental conservation policy and will yield 
a significant public benefit.
---------------------------------------------------------------------------
    \39\ A sale or exchange made prior to the issuance of an order, but 
that is the result of a threat of condemnation or eminent domain, may 
qualify for the exclusion.
---------------------------------------------------------------------------

Protection of conservation purposes

    The provision provides for the imposition of penalty excise 
taxes in appropriate cases where a qualified organization fails 
to take steps consistent with the protection of conservation 
purposes. Because the penalty taxes are imposed on an 
organization that fails to protect the conservation purpose, 
and do not serve to encumber the property in the same manner as 
a restriction contained in an instrument of conveyance, the 
Committee believes that the penalty taxes will adequately 
protect conservation purposes without decreasing the value of 
the property in the hands of the conservation organizations.
    If ownership or possession of the property is transferred 
by a qualified organization other than to another qualified 
organization that provides the requisite letter of intent, or a 
legal restriction contained in an instrument of conveyance that 
protects the qualified conservation purpose is removed, then: 
(1) a 20-percent excise tax applies to the proceeds or fair 
market value of the property; (2) any realized gain or income 
is subject to an additional excise tax imposed at the highest 
income tax rate applicable to C corporations; and (3) any 
otherwise applicable non-recognition provisions of the Code 
shall not apply to the transferor. The Committee intends that 
the excise taxes apply to all cases involving the transfer of 
ownership or possession of the property to a transferee that is 
not a qualified organization unless the transferring qualified 
organization demonstrates to the satisfaction of the Secretary 
that qualified conservation purposes will be protected in 
perpetuity. In the case of a removal of a legal restriction 
contained in an instrument of conveyance, the qualified 
organization must demonstrate to the satisfaction of the 
Secretary that a later unexpected change in the conditions 
surrounding the property makes retaining the conservation 
restriction impossible or impractical and that any proceeds 
derived from the removal of the restriction will be used to 
further qualified conservation purposes. The Committee 
authorizes the Secretary to provide guidance to identify 
appropriate cases where transfers to persons other than 
qualified organizations are regarded as protecting a 
conservation purpose in perpetuity. The Committee intends, for 
example, that a qualified organization may acquire a fee simple 
interest in real property operated as a farm and then transfer, 
without imposition of the penalty taxes, the real property 
subject to a conservation easement that constitutes a qualified 
real property interest if, in a recorded instrument of 
conveyance, the transferor prohibits the transferee from 
subsequently transferring the real property unless the 
transferee, as a condition of the subsequent transfer, requires 
that the qualified conservation purpose of preserving the 
property as open space farmland will continue to be carried 
out.
    In the case of a transfer by a qualified organization to 
another qualified organization, the transferee must provide the 
transferor at the time of the transfer a letter stating that 
the intent of the transferee is to further a qualified 
conservation purpose and that any subsequent transfer of the 
acquired interest will be made to protect the conservation 
purpose in perpetuity, and the transferee becomes subject to 
the excise tax provisions for subsequent transfers. The 
Committee intends that in the case of a sale or exchange of 
stock of a C corporation in which a qualified organization 
acquires a controlling stock interest, all of the stock of such 
corporation acquired by the qualified organization (including 
any stock which did not qualify for the exclusion), as well as 
the property held by such C corporation, becomes subject to the 
penalty tax provisions.
    The provision provides that the Secretary may require such 
reporting as may be necessary or appropriate to further the 
purpose that any conservation use be in perpetuity.

Relationship with other provisions

    In the case of an individual, the exclusion applies both 
for purposes of the regular tax and the alternative minimum 
tax. In the case of a corporation, the present-law alternative 
minimum tax provisions apply without modification.
    If a taxpayer sells a real property interest to a qualified 
organization for less than the property's fair market value, 
the amount of any charitable contribution deduction is 
determined in accordance with the bargain sale rules,\40\ and 
the taxpayer shall not fail to qualify for a contribution 
deduction under those rules solely because the taxpayer derives 
a tax benefit from the partial exclusion of long-term capital 
gain from the sale. For example, if a taxpayer sells qualifying 
land with a fair market value of $100 and an adjusted basis of 
$10 to a qualified organization for a sales price of $95 (or 
alternatively, for a sale price of $50), the taxpayer's basis 
of $10 shall be allocated between the sale and the contribution 
components of the transfer under the bargain sale rules, and 
the tax savings resulting from the 25-percent exclusion of 
long-term capital gain on the sale will not reduce the portion 
of the transfer treated as a charitable contribution under the 
bargain sale rules. The present-law requirements applicable to 
the charitable contribution component of the transfer, 
including, for example, the recordkeeping, substantiation, and 
appraisal provisions of Treasury Regulations section 1.170A-13, 
must be satisfied.
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    \40\ Sec. 1011(b) and Treas. Reg. sec. 1.1011-2.
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                             EFFECTIVE DATE

    The provision is effective for sales or exchanges occurring 
after the date of enactment.

   H. Cost Sharing Payments Under the Partners for Fish and Wildlife 
                                Program


(Sec. 108 of the bill and sec. 126 of the Code)

                              PRESENT LAW

    Under present law, gross income does not include the 
excludable portion of payments made to taxpayers by federal and 
state governments for a share of the cost of improvements to 
property under certain conservation programs. These programs 
include payments received under (1) the rural clean water 
program authorized by section 208(j) of the Federal Water 
Pollution Control Act, (2) the rural abandoned mine program 
authorized by section 406 of the Surface Mining Control and 
Reclamation Act of 1977, (3) the water bank program authorized 
by the Water Bank Act, (4) the emergency conservation measures 
program authorized by title IV of the Agricultural Credit Act 
of 1978, (5) the agriculture conservation program authorized by 
the Soil Conservation and Domestic Allotment Act, (6) the great 
plains conservation program authorized by section 16 of the 
Soil Conservation and Domestic Policy Act, (7) the resource 
conservation and development program authorized by the 
Bankhead-Jones Farm Tenant Act and by the Soil Conservation and 
Domestic Allotment Act, (8) the forestry incentives program 
authorized by section 4 of the Cooperative Forestry Assistance 
Act of 1978, (9) any small watershed program administered by 
the Secretary of Agriculture which is determined by the 
Secretary of the Treasury or his delegate to be substantially 
similar to the type of programs described in items (1) through 
(8), and (10) any program of a State, possession of the United 
States, a political subdivision of any of the foregoing, or the 
District of Columbia under which payments are made to 
individuals primarily for the purpose of conserving soil, 
protecting or restoring the environment, improving forests, or 
providing a habitat for wildlife.

                           REASONS FOR CHANGE

    The Committee believes that payments received by taxpayers 
under the Partners for Fish and Wildlife Program are similar to 
payments made under other government programs that are 
excludable from gross income under present law. Accordingly, 
the Committee believes it is appropriate to extend the present-
law exclusion to payments under this program.

                        EXPLANATION OF PROVISION

    The provision expands the types of qualified cost-sharing 
payments to include payments under the Partners for Fish and 
Wildlife Program.

                             EFFECTIVE DATE

    The provision applies to payments received after the date 
of enactment.

  I. Basis Adjustment to Stock of S Corporation Contributing Property


(Sec. 109 of the bill and sec. 1367 of the Code)

                              PRESENT LAW

    Under present law, if an S corporation contributes money or 
other property to a charity, each shareholder takes into 
account the shareholder's pro rata share of the contribution in 
determining its own income tax liability.\41\ A shareholder of 
an S corporation reduces the basis in the stock of the S 
corporation by the amount of the charitable contribution that 
flows through to the shareholder.\42\
---------------------------------------------------------------------------
    \41\ Sec. 1366(a)(1)(A).
    \42\ Sec. 1367(a)(2)(B).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, if an S corporation makes a charitable 
contribution of appreciated property, the shareholder may be 
taxed on an amount equal to the appreciation in the contributed 
property when the S corporation stock is sold. Thus, under 
present law, a charitable contribution of appreciated property 
made by an S corporation receives less favorable tax treatment 
than other contributions of appreciated property.
    The Committee wishes to preserve the benefit of providing a 
charitable contribution deduction for contributions of property 
by an S corporation with a fair market value in excess of its 
adjusted basis. Thus, the bill provides that the basis 
adjustment to the stock of an S corporation for charitable 
contributions made by the corporation will be in an amount 
equal to the shareholder's pro rata share of the adjusted basis 
of the property contributed. This adjustment will prevent the 
later recognition of gain attributable to the appreciation in 
the contributed property on the disposition of the S 
corporation stock.

                        EXPLANATION OF PROVISION

    The provision provides that the amount of a shareholder's 
basis reduction in the stock of an S corporation by reason of a 
charitable contribution made by the corporation will be equal 
to the shareholder's pro rata share of the adjusted basis of 
the contributed property.\43\
---------------------------------------------------------------------------
    \43\ See Rev. Rul. 96-11 (1996-1 C.B. 140) for a rule reaching a 
similar result in the case of charitable contributions made by a 
partnership.
---------------------------------------------------------------------------
    Thus, for example, assume an S corporation with one 
individual shareholder makes a charitable contribution of stock 
with a basis of $200 and a fair market value of $500. The 
shareholder will be treated as having made a $500 charitable 
contribution (or a lesser amount if the special rules of 
section 170(e) apply), and will reduce the basis of the S 
corporation stock by $200.

                             EFFECTIVE DATE

    The provision applies to contributions made after the date 
of enactment.

    J. Enhanced Deduction for Charitable Contributions of Literary, 
             Musical, Artistic, and Scholarly Compositions


(Sec. 110 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    In the case of a charitable contribution of inventory or 
other ordinary-income or short-term capital gain property, the 
amount of the deduction generally is limited to the taxpayer's 
basis in the property.\44\ In the case of a charitable 
contribution of tangible personal property, the deduction is 
limited to the taxpayer's basis in such property if the use by 
the recipient charitable organization is unrelated to the 
organization's tax-exempt purpose. In cases involving 
contributions of tangible personal property to a private 
foundation (other than certain private foundations),\45\ the 
amount of the deduction is limited to the taxpayer's basis in 
the property.
---------------------------------------------------------------------------
    \44\ Sec. 170(e)(1).
    \45\ Sec. 170(e)(1)(B)(ii).
---------------------------------------------------------------------------
    Under present law, charitable contributions of literary, 
musical, and artistic compositions created or prepared by the 
donor are considered ordinary income property and a taxpayer's 
deduction of such property is limited to the taxpayer's basis 
(typically, cost) in the property. A charitable contribution of 
a literary, musical, or artistic composition by a person other 
than the person who created or prepared the work generally is 
eligible for a fair market value deduction if the donee 
organization's use of the property is related to such 
organization's exempt purposes.
    To be eligible for the deduction, the contribution must be 
of an undivided portion of the donor's entire interest in the 
property.\46\ For purposes of the charitable income tax 
deduction, the copyright and the work in which the copyright is 
embodied are not treated as separate property interests. 
Accordingly, if a donor owns a work of art and the copyright to 
the work of art, a gift of the artwork without the copyright or 
the copyright without the artwork will constitute a gift of a 
``partial interest'' and will not qualify for the income tax 
charitable deduction.
---------------------------------------------------------------------------
    \46\ Sec. 170(f)(3).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to provide an 
enhanced deduction for charitable contributions of certain 
literary, musical, artistic, and scholarly compositions created 
by the personal efforts of the donor. In many cases, such works 
have a low basis, and because present law generally limits the 
deduction for such contributions to basis, the creators of 
literary, musical, artistic, and scholarly compositions do not 
have an appropriate incentive to contribute their works to 
charity. In addition, the Committee believes that the present-
law rule that a charitable contribution deduction generally is 
not available for contributions of less than the taxpayer's 
entire property interest is an inappropriate disincentive for 
contributions of such works.

                        EXPLANATION OF PROVISION

    The provision provides that a deduction for ``qualified 
artistic charitable contributions'' generally is increased from 
the value under present law (generally, basis) to the fair 
market value of the property contributed, measured at the time 
of the contribution. However, the amount of the increase of the 
deduction provided by the provision may not exceed the amount 
of the donor's adjusted gross income for the taxable year 
attributable to: (1) income from the sale or use of property 
created by the personal efforts of the donor that is of the 
same type as the donated property; and (2) income from 
teaching, lecturing, performing, or similar activities with 
respect to such property. In addition, the increase to the 
present-law deduction provided by the provision may not be 
carried over and deducted in other taxable years.
    The provision defines a qualified artistic charitable 
contribution to mean a charitable contribution of any literary, 
musical, artistic, or scholarly composition, or similar 
property, or the copyright thereon (or both) that meets certain 
requirements. First, the contributed property must have been 
created by the personal efforts of the donor at least 18 months 
prior to the date of contribution. Second, the donor must 
obtain a qualified appraisal of the contributed property, a 
copy of which is required to be attached to the donor's income 
tax return for the taxable year in which such contribution is 
made. The appraisal must include evidence of the extent (if 
any) to which property created by the personal efforts of the 
taxpayer and of the same type as the donated property is or has 
been owned, maintained, and displayed by certain charitable 
organizations and sold to or exchanged by persons other than 
the taxpayer, donee, or any related person. Third, the 
contribution must be made to a public charity or to certain 
limited types of private foundations. Finally, the use of 
donated property by the recipient organization must be related 
to the organization's charitable purpose or function, and the 
donor must receive a written statement from the organization 
verifying such use.
    Under the provision, the tangible property and the 
copyright on such property are treated as separate properties 
for purposes of the ``partial interest'' rule; thus, a gift of 
artwork without the copyright or a copyright without the 
artwork does not constitute a gift of a partial interest and is 
deductible. Contributions of letters, memoranda, or similar 
property that are written, prepared, or produced by or for an 
individual while the individual is an officer or employee of 
any person (including a government agency or instrumentality) 
do not qualify for a fair market value deduction unless the 
contributed property is entirely personal.

                             EFFECTIVE DATE

    The deduction for qualified artistic charitable 
contributions applies to contributions made after the date of 
enactment.

     K. Exclusion for Certain Mileage Reimbursements to Charitable 
                               Volunteers


(Sec. 111 of the bill and new sec. 139A of the Code)

                              PRESENT LAW

    Unreimbursed out-of-pocket expenditures made incident to 
providing donated services to a qualified charitable 
organization--such as out-of-pocket transportation expenses 
necessarily incurred in performing donated services--may 
constitute an itemized deduction for charitable 
contributions.\47\ No charitable contribution deduction is 
allowed for traveling expenses (including expenses for meals 
and lodging) while away from home, whether paid directly or by 
reimbursement, unless there is no significant element of 
personal pleasure, recreation, or vacation in such travel.\48\ 
In determining the amount treated as a charitable contribution 
where a taxpayer operates a vehicle in providing services to a 
charity, the taxpayer either may deduct actual out-of-pocket 
expenditures or may use the charitable standard mileage rate. 
The taxpayer may also deduct (under either computation method), 
any parking fees and tolls incurred in rendering the services, 
but may not deduct any amount (regardless of the computation 
method used) for general repair or maintenance expenses, 
depreciation, insurance, registration fees, etc.
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    \47\ Treas. Reg. sec. 1.170A-1(g).
    \48\ Sec. 170(j).
---------------------------------------------------------------------------
    The charitable standard mileage rate is set by statute at 
14 cents per mile.\49\ The standard mileage rate for charitable 
purposes is lower than the standard business rate because the 
charitable rate covers only the out-of-pocket operating 
expenses (including gasoline and oil) directly related to the 
use of the car in performing the donated services that a 
taxpayer may deduct as a charitable contribution. The 
charitable rate does not include costs that are not deductible 
as a charitable contribution such as general repair or 
maintenance expenses, depreciation, insurance, and registration 
fees. Such costs are, however, included in computing the 
business standard mileage rate (the rate allowed for business 
use of an automobile), which is 36 cents per mile.
---------------------------------------------------------------------------
    \49\ Sec. 170(i).
---------------------------------------------------------------------------
    Volunteer drivers who are reimbursed for mileage expenses 
have taxable income to the extent the reimbursement exceeds 
deductible travel expenses. Employees who are reimbursed for 
mileage expenses under a qualified arrangement that pays a 
mileage allowance in lieu of reimbursing actual expenses 
generally have taxable income to the extent the reimbursement 
exceeds the amount of the business standard mileage rate 
multiplied by the actual business miles.

                           REASONS FOR CHANGE

    The Committee believes that it is important to recognize 
the valuable contributions made by volunteers to charitable 
organizations by providing an exclusion from income up to the 
applicable business standard mileage rate for volunteers who 
receive reimbursements for the costs of using their automobiles 
while performing services for charitable organizations.

                        EXPLANATION OF PROVISION

    Under the provision, reimbursement by an organization 
described in section 170(c) (including public charities and 
private foundations) to a volunteer for the costs of using an 
automobile in connection with providing donated services is 
excludable from the gross income of the volunteer, provided 
that (1) the reimbursement does not exceed the business 
standard mileage rate prescribed for business use (as 
periodically adjusted), and (2) recordkeeping requirements 
applicable to deductible business expenses are satisfied. The 
provision does not permit a volunteer to claim a deduction or 
credit with respect amounts excluded under the provision. 
Information reporting required by section 6041 is not required 
with respect to reimbursements excluded under the provision.

                             EFFECTIVE DATE

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

  L. Extend Enhanced Deduction for Inventory To Include Public Schools


(Sec. 112 of the bill and sec. 170 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer's deduction for charitable 
contributions of inventory generally is limited to the 
taxpayer's basis (typically, cost) in the inventory.
    However, for certain contributions of inventory, C 
corporations may claim an enhanced deduction equal to the 
lesser of (1) basis plus one-half of the item's appreciated 
value (i.e., basis plus one half of fair market value in excess 
of basis) or (2) two times basis.\50\ To be eligible for the 
enhanced deduction, the contributed property generally must be 
inventory of the taxpayer, contributed to a charitable 
organization described in section 501(c)(3) (except for private 
nonoperating foundations), and the donee must: (1) use the 
property consistent with the donee's exempt purpose solely for 
the care of the ill, the needy, or infants, (2) not transfer 
the property in exchange for money, other property, or 
services, and (3) provide the taxpayer a written statement that 
the donee's use of the property will be consistent with such 
requirements. In the case of contributed property subject to 
the Federal Food, Drug, and Cosmetic Act, the property must 
satisfy the applicable requirements of such Act on the date of 
transfer and for 180 days prior to the transfer.
---------------------------------------------------------------------------
    \50\ Sec. 170(e)(3). In general, a C corporation's charitable 
contribution deductions for a year may not exceed 10 percent of the 
corporation's taxable income. Sec. 170(b)(2).
---------------------------------------------------------------------------
    Donations to educational organizations described in section 
170(b)(1)(A)(ii) (and that are not described in section 
501(c)(3) and exempt under section 501(a)) are not eligible to 
receive the enhanced deduction. An organization is described in 
section 170(b)(1)(A)(ii) if it normally maintains a regular 
faculty and curriculum and normally has a regularly enrolled 
body of pupils or students in attendance at the place where its 
educational activities are regularly carried on. Donations to 
such organizations are eligible to receive an enhanced 
deduction if the donation qualifies as a qualified computer 
contribution.\51\
---------------------------------------------------------------------------
    \51\ Sec. 170(e)(6).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that charitable contributions of 
inventory to public schools should receive the same treatment 
as charitable contributions of inventory to private schools and 
therefore should be eligible for the enhanced deduction. The 
Committee intends that contributions to a public school, like 
contributions to any other eligible donee, must be used solely 
for the care of the ill, the needy, or infants in order to 
qualify for the enhanced deduction.

                        EXPLANATION OF PROVISION

    The provision would extend the enhanced deduction for 
inventory property to donations to educational organizations 
described in section 170(b)(1)(A)(ii) (to the extent such 
organizations are not described in section 501(c)(3) and exempt 
under section 501(a)). Charitable contributions of computer 
technology and equipment continue to be covered by the present 
law enhanced deduction of section 170(e)(6) and are not 
eligible property for an enhanced deduction under the 
provision.
    The provision retains present law requirements: (1) that 
use of the donated property by the donee is related to the 
donee's exempt purposes (or, in the case of a section 
170(b)(1)(A)(ii) organization, to educational purposes) and is 
used solely for the care of the ill, the needy, or infants, (2) 
that the organization not transfer the property in exchange for 
money, other property, or services, and (3) that the 
organization provide the taxpayer a written statement that the 
donee's use of the property will be consistent with such 
requirements.
    The Committee believes that the enhanced deduction 
continues to provide a useful incentive for charitable 
contributions of inventory, but also emphasizes that the 
enhanced deduction is available only for inventory that is used 
by the donee in the direct provision of care to the ill, the 
needy or infants. Thus, for example, the Committee does not 
intend that inventory property that may be useful to a school 
in maintaining its physical plant (e.g., paint, electrical 
supplies, equipment not used directly for educational purposes) 
or administrative offices but that is not used directly for the 
educational benefit of the ill, the needy, or infants is 
eligible for the enhanced deduction.

                             EFFECTIVE DATE

    The provision is effective for contributions made after 
December 31, 2003.

      TITLE II. PROVISIONS IMPROVING THE OVERSIGHT OF TAX-EXEMPT 
                             ORGANIZATIONS


                A. Disclosure of Written Determinations


(Sec. 201 of the bill and sec. 6110 of the Code)

                              PRESENT LAW

In general

    Three provisions of present law govern the disclosure of 
information relating to tax-exempt organizations. First, 
section 6103 provides a general rule that tax returns and 
return information generally are not subject to disclosure 
unless authorized by the Code.\52\ Second, in order to allow 
the public to scrutinize the activities of tax-exempt 
organizations, section 6104 grants an exception to the 
confidentiality rule of section 6103 for certain categories of 
tax-exempt organization documents and information. Third, 
section 6110 provides that written determinations by the IRS 
and related background file documents generally are open to 
public inspection in redacted form. Section 6110 does not apply 
to any matter to which section 6104 applies.\53\
---------------------------------------------------------------------------
    \52\ Sec. 6103(a).
    \53\ Sec. 6110(l)(1).
---------------------------------------------------------------------------

Disclosure of applications for recognition of tax exemption and annual 
        information returns

    Under present law, the IRS is required to make approved 
applications for recognition of tax-exempt status (and certain 
related documents) \54\ and annual information returns (Form 
990 or Form 990-PF) available for public inspection, except 
that the IRS is not authorized to disclose the names and 
addresses of contributors (other than contributors to a private 
foundation).
---------------------------------------------------------------------------
    \54\ Section 6104(a)(1)(A) provides that ``any papers submitted in 
support of'' an application for tax-exempt status must be available for 
inspection. Treasury regulations limit the definition of supporting 
documents to papers submitted by the organization. Treas. Reg. sec. 
301.6104(a)-1(e).
---------------------------------------------------------------------------
    The Secretary may withhold disclosure of certain 
information described in an organization's application for tax-
exempt status if disclosure would: (1) divulge a trade secret, 
patent, process, style of work, or apparatus of the 
organization, and the Secretary determines that such disclosure 
would harm the organization; or (2) that the Secretary 
determines would harm the national defense.\55\ The 
organization must apply to the Commissioner for a determination 
that the disclosure would violate one of these criteria. The 
organization will be given 15 days to contest an adverse 
determination before the information is made available for 
public inspection.\56\
---------------------------------------------------------------------------
    \55\ Sec. 6104(a)(1)(D).
    \56\ Treas. Reg. sec. 301.6104(a)-5(a)(1).
---------------------------------------------------------------------------

Disclosure of written determinations

    Section 6110 provides that the text of any written 
determination by the IRS and related background file document 
is open to public inspection.\57\ The term ``written 
determination'' means a ruling, determination letter, technical 
advice memorandum, or Chief Counsel advice. Closing agreements, 
which are final and conclusive written agreements entered into 
by the IRS and a taxpayer in order to settle the taxpayer's tax 
liability with respect to a taxable year, do not constitute 
written determinations.\58\
---------------------------------------------------------------------------
    \57\ Sec. 6110(a). A background file document includes the request 
for a written determination, any written material submitted by the 
taxpayer in support of the request, and any communications between the 
IRS and other persons in connection with the written determination 
received before issuance of the written determination. Sec. 6110(b)(2).
    \58\ Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B).
---------------------------------------------------------------------------
    Before releasing any written determination or background 
file document, the IRS must delete identifying details of the 
person about whom the written determination pertains and 
certain other private information.\59\
---------------------------------------------------------------------------
    \59\ Sec. 6110(c).
---------------------------------------------------------------------------
    The application of section 6110 to guidance relating to 
tax-exempt organizations is limited to written determinations 
unrelated to an organization's tax-exempt status. Section 
6110(l)(1) provides, ``this section shall not apply to any 
matter to which section 6104 applies.'' The regulations under 
section 6110 clarify which matters are within the ambit of 
section 6104 and, therefore, are not subject to disclosure 
under section 6110:

        [a]ny application filed with the Internal Revenue 
        Service with respect to the qualification or exempt 
        status of an organization * * *; any document issued by 
        the Internal Revenue Service in which the qualification 
        or exempt status of an organization is * * * granted, 
        denied or revoked or the portion of any document in 
        which technical advice with respect thereto is given to 
        a district director; * * * the portion of any document 
        issued by the Internal Revenue Service in which is 
        discussed the effect on the qualification or exempt 
        status of an organization * * * of proposed 
        transactions by such organization * * *; and any 
        document issued by the Internal Revenue Service in 
        which is discussed the qualification or status of a 
        [private foundation or private operating 
        foundation].\60\
---------------------------------------------------------------------------
    \60\ Treas. Reg. sec. 301.6110-1(a).

    In addition, the regulations under section 6104 provide 
that some documents relating to tax exemption that are not open 
to public inspection under section 6104(a)(1)(A) are 
nevertheless ``within the ambit'' of section 6104 for purposes 
of the disclosure provisions of section 6110.\61\ The 
regulation explains that the following documents are, 
therefore, not available for public inspection under either 
section 6104 or 6110:
---------------------------------------------------------------------------
    \61\ Treas. Reg. sec. 301.6104(a)-1(i).
---------------------------------------------------------------------------
          (1) Unfavorable rulings or determination letters 
        issued in response to applications for tax exemption;
          (2) Rulings or determination letters revoking or 
        modifying a favorable determination letter;
          (3) Technical advice memoranda relating to a 
        disapproved application for tax exemption or the 
        revocation or modification of a favorable determination 
        letter;
          (4) Any letter or document filed with or issued by 
        the IRS relating to whether a proposed or accomplished 
        transaction is a prohibited transaction under section 
        503;
          (5) Any letter or document filed with or issued by 
        the IRS relating to an organization's status as a 
        private foundation or private operating foundation, 
        unless the letter or document relates to the 
        organization's application for tax exemption; and
          (6) Any other letter or document filed with or issued 
        by the IRS which, although it relates to an 
        organization's tax exempt status as an organization 
        described in section 501(c), does not relate to that 
        organization's application for tax exemption.\62\
---------------------------------------------------------------------------
    \62\ Id.
---------------------------------------------------------------------------
    The effect of these limitations is that written 
determinations relating to exempt status issues are not 
released, even in redacted form. The IRS does, however, release 
under section 6110 written determinations issued to tax-exempt 
organizations that include issues that clearly are not within 
the ambit of section 6104, such as the application of the 
unrelated business income tax to a particular proposed 
transaction.

                           REASONS FOR CHANGE

    The Committee believes that written determinations and 
background file documents that ordinarily would be disclosed 
under section 6110 but for the nondisclosure provided by 
section 6104 should be disclosed in redacted form, and that 
such disclosure will provide additional guidance to taxpayers 
as to the views of the IRS on certain issues.

                        EXPLANATION OF PROVISION

    The provision provides that the provisions of section 6110 
apply to written determinations and related background file 
documents relating to an organization described in section 
501(c) or (d) (including any written determination denying an 
organization exempt status under such subsection), or to a 
political organization described in section 527, that are not 
required to be disclosed by section 6104(a)(1)(A).

                             EFFECTIVE DATE

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

 B. Disclosure of Internet Web Site and Name Under Which Organization 
                             Does Business


(Sec. 202 of the bill and sec. 6033 of the Code)

                              PRESENT LAW

    Most types of tax-exempt organizations are required to file 
annually an information return.\63\ The Internal Revenue Code 
does not specifically require an exempt organization to furnish 
on the applicable information return any name under which the 
organization operates or does business, if such name differs 
from the legal name of the organization, or the organization's 
Internet web site address, if any.\64\
---------------------------------------------------------------------------
    \63\ Sec. 6033(a). See, e.g., Form 990--Return of Organization 
Exempt From Income Tax. An organization that is required to file Form 
990, but that has gross receipts of less than $100,000 during its 
taxable year, and total assets of less than $250,000 at the end of its 
taxable year, may file Form 990-EZ instead of Form 990. Private 
foundations are required to file Form 990-PF rather than Form 990.
    \64\ The IRS requires disclosure of an organization's Internet web 
site address on Forms 990 and 990-EZ.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Some tax-exempt organizations do business and solicit 
contributions under a name that is different from the 
organization's legal name. This can cause confusion to 
individuals and others seeking information about the 
organization. Further, although much information regarding the 
operations and activities of tax-exempt organizations is 
available on the Internet web sites of such organizations, some 
members of the public might experience difficulties obtaining 
access to an organization's web site if they do not know the 
organization's web site address. The Committee believes that 
reducing confusion and increasing public access to relevant 
information regarding a tax-exempt organization would be 
achieved by requiring a tax-exempt organization to report on 
its annual return any name under which such organization 
operates or does business, and the Internet web site address 
(if any) of such organization.\65\
---------------------------------------------------------------------------
    \65\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
96-97.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision requires a tax-exempt organization subject to 
reporting requirements under section 6033(a) to include on its 
annual return any name under which such organization operates 
or does business, and the Internet web site address (if any) of 
such organization.

                             EFFECTIVE DATE

    The provision applies to returns filed after December 31, 
2003.

          C. Modification to Reporting of Capital Transactions


(Sec. 203 of the bill and secs. 6033 and 6104 of the Code)

                              PRESENT LAW

    Private foundations are required to file an annual 
information return (Form 990-PF).\66\ Part IV of the Form 990-
PF requires that private foundations report detailed 
information regarding the gain or loss from the sale or other 
disposition of property, including a description of the 
property sold, how it was acquired (purchase or donation), the 
date acquired, the date sold, the gross sales price, the amount 
of depreciation allowed or allowable, and the cost or other 
basis plus expenses of the sale. Such information generally is 
required for the IRS to calculate the tax on the private 
foundation's net investment income. The Form 990-PF is required 
to be made available to the public.
---------------------------------------------------------------------------
    \66\ Sec. 6033(a).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Under present law, private foundations that engage in 
capital transactions must report detailed information about 
each transaction on Form 990-PF, which is filed with the IRS 
and available to the public. For some foundations, listing 
these transactions involves hundreds of pages. The Committee 
believes that automatic disclosure of such voluminous 
information does not necessarily benefit the public, and may in 
fact reduce the level of meaningful disclosure by obscuring 
other important information. The Committee believes that 
meaningful disclosure to the public will be increased if the 
version of the Form 990-PF that automatically is available to 
the public summarizes rather than lists the securities 
transactions that affect the calculation of the organization's 
net investment income. In order to preserve the public's access 
to more specific information regarding such securities 
transactions, the Committee believes that the more detailed 
information provided to the IRS on the Form 990-PF should be 
made available to those members of the public that explicitly 
request such information.\67\
---------------------------------------------------------------------------
    \67\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
99.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision requires that any information regarding 
capital gains and losses from the sale or disposition of stock 
or securities that are listed on an established securities 
market that is required to be furnished by private foundations 
in order to calculate the tax on net investment income be 
furnished also in summary form.
    In addition, information regarding capital gains and losses 
from the sale or disposition of stock or securities that are 
listed on an established securities market that is required to 
be filed with the IRS but that is not in summary form is not 
required to be made available to the public by the IRS or by 
the private foundation except by the explicit request of a 
member of the public to the IRS or to the foundation. A member 
of the public may request disclosure of such information from 
the Secretary, who shall prescribe the manner of making such 
request and the manner of disclosure. A member of the public 
also may request disclosure of the private foundation, which 
must be made in person or in writing. If the request is made in 
person, the foundation shall provide a copy of the information 
immediately and, if the request is made in writing, the 
foundation shall provide the information within 30 days.
    The provision also provides that private foundations are 
required to state on the furnished summary that the more 
detailed description is available upon request.

                             EFFECTIVE DATE

    The provision applies to returns filed after December 31, 
2003.

           D. Disclosure that Form 990 is Publicly Available


(Sec. 204 of the bill)

                              PRESENT LAW

    Under present law, there is no requirement that the IRS 
notify the public that the Form 990 is publicly available.

                           REASONS FOR CHANGE

    The information provided on Forms 990 is useful to the 
public only to the extent that the public is aware that the 
forms are publicly available. The Committee believes that the 
availability of Forms 990 that have been filed by exempt 
organizations will be increased by requiring the IRS to inform 
the public regarding the availability of such forms.

                        EXPLANATION OF PROVISION

    The provision requires the IRS to notify the public in 
appropriate publications and other materials of the extent to 
which Form 990, Form 990-EZ, or Form 990-PF are publicly 
available.

                             EFFECTIVE DATE

    The provision applies to publications or other materials 
issued or revised after the date of enactment.

E. Disclosure to State Officials of Proposed Actions Related to Section 
                          501(c) Organizations


(Sec. 205 of the bill and sec. 6104 of the Code)

                              PRESENT LAW

    In the case of organizations that are described in section 
501(c)(3) and exempt from tax under section 501(a) or that have 
applied for exemption as an organization so described, present 
law (sec. 6104(c)) requires the Secretary to notify the 
appropriate State officer of (1) a refusal to recognize such 
organization as an organization described in section 501(c)(3), 
(2) a revocation of a section 501(c)(3) organization's tax-
exempt status, and (3) the mailing of a notice of deficiency 
for any tax imposed under section 507, chapter 41, or chapter 
42.\68\ In addition, at the request of such appropriate State 
officer, the Secretary is required to make available for 
inspection and copying, such returns, filed statements, 
records, reports, and other information relating to the above-
described disclosures, as are relevant to any State law 
determination. An appropriate State officer is the State 
attorney general, State tax officer, or any State official 
charged with overseeing organizations of the type described in 
section 501(c)(3).
---------------------------------------------------------------------------
    \68\ The applicable taxes include the termination tax on private 
foundations; taxes on public charities for certain excess lobbying 
expenses; taxes on a private foundation's net investment income, self-
dealing activities, undistributed income, excess business holdings, 
investments that jeopardize charitable purposes, and taxable 
expenditures (some of these taxes also apply to certain non-exempt 
trusts); taxes on the political expenditures and excess benefit 
transactions of section 501(c)(3) organizations; and certain taxes on 
black lung benefit trusts and foreign organizations.
---------------------------------------------------------------------------
    In general, return and return information (as such terms 
are defined in sec. 6103(b)) is confidential and may not be 
disclosed or inspected unless expressly provided by law.\69\ 
Present law requires the Secretary to keep records of 
disclosures and requests for inspection \70\ and requires that 
persons authorized to receive return and return information 
maintain various safeguards to protect such information against 
unauthorized disclosure.\71\ Willful unauthorized disclosure or 
inspection of return or return information is subject to a fine 
and/or imprisonment.\72\ The knowing or negligent unauthorized 
inspection or disclosure of returns or return information gives 
the taxpayer a right to bring a civil suit.\73\ Such present-
law protections against unauthorized disclosure or inspection 
of return and return information do not apply to the 
disclosures or inspections, described above, that are 
authorized by section 6104(c).
---------------------------------------------------------------------------
    \69\ Sec. 6103(a).
    \70\ Sec. 6103(p)(3).
    \71\ Sec. 6103(p)(4).
    \72\ Secs. 7213 and 7213A.
    \73\ Sec. 7431.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that State officials that are 
charged with oversight of certain organizations described in 
section 501(c) have an important and legitimate interest in 
receiving certain information about such organizations' tax-
exempt status and tax filings, in some cases before the IRS has 
made a final determination with respect to an organization's 
tax-exempt status or liability for tax. By providing 
appropriate State officials with earlier access to information 
about the activities of certain section 501(c) organizations, 
State officials will be able to monitor such organizations more 
effectively and better protect the public's interest in 
assuring that organizations that have been given the benefit of 
tax-exemption operate consistently with their exempt 
purposes.\74\
---------------------------------------------------------------------------
    \74\ The staff of the Joint Committee on Taxation recommended the 
adoption of a similar provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
101-105.
---------------------------------------------------------------------------
    The Committee stresses the importance of maintaining the 
confidentiality of taxpayer return and return information and 
believes it is important to extend existing protections against 
unauthorized disclosure or inspection of return and return 
information to disclosures made or inspections allowed by the 
Secretary of return and return information regarding such 
section 501(c) organizations.

                        EXPLANATION OF PROVISION

    The provision provides that upon written request by an 
appropriate State officer, the Secretary may disclose: (1) a 
notice of proposed refusal to recognize an organization as a 
section 501(c)(3) organization; (2) a notice of proposed 
revocation of tax-exemption of a section 501(c)(3) 
organization; (3) the issuance of a proposed deficiency of tax 
imposed under section 507, chapter 41, or chapter 42; (4) the 
names, addresses, and taxpayer identification numbers of 
organizations that have applied for recognition as section 
501(c)(3) organizations; and (5) returns and return information 
of organizations with respect to which information has been 
disclosed under (1) through (4) above.\75\ Disclosure or 
inspection is permitted for the purpose of, and only to the 
extent necessary in, the administration of State laws 
regulating section 501(c)(3) organizations, such as laws 
regulating tax-exempt status, charitable trusts, charitable 
solicitation, and fraud. Disclosure or inspection may be made 
only to or by designated representatives of the appropriate 
State officer, which does not include any contractor or agent. 
The Secretary also is permitted to disclose or open to 
inspection the return and return information of an organization 
that is recognized as tax-exempt under section 501(c)(3), or 
that has applied for such recognition, to an appropriate State 
officer if the Secretary determines that disclosure or 
inspection may facilitate the resolution of Federal or State 
issues relating to the tax-exempt status of the organization. 
For this purpose, appropriate State officer means the State 
attorney general or any other State official charged with 
overseeing organizations of the type described in section 
501(c)(3).
---------------------------------------------------------------------------
    \75\ Such returns and return information also may be open to 
inspection by an appropriate State officer.
---------------------------------------------------------------------------
    In addition, the provision provides that upon the written 
request by an appropriate State officer, the Secretary may make 
available for inspection or disclosure returns and return 
information of an organization described in section 501(c)(2) 
(certain title holding companies), 501(c)(4) (certain social 
welfare organizations), 501(c)(6) (certain business leagues and 
similar organizations), 501(c)(7) (certain recreational clubs), 
501(c)(8) (certain fraternal organizations), 501(c)(10) 
(certain domestic fraternal organizations operating under the 
lodge system), and 501(c)(13) (certain cemetery companies). 
Such return and return information is available for inspection 
or disclosure only for the purpose of, and to the extent 
necessary in, the administration of State laws regulating the 
solicitation or administration of the charitable funds or 
charitable assets of such organizations. Disclosure or 
inspection may be made only to or by designated representatives 
of the appropriate State officer, which does not include any 
contractor or agent. For this purpose, appropriate State 
officer means the State attorney general and the head of an 
agency designated by the State attorney general as having 
primary responsibility for overseeing the solicitation of funds 
for charitable purposes of such organizations.
    In addition, the provision provides that any return and 
return information disclosed under section 6104(c) may be 
disclosed in civil administrative and civil judicial 
proceedings pertaining to the enforcement of State laws 
regulating the applicable tax-exempt organization in a manner 
prescribed by the Secretary. Returns and return information are 
not to be disclosed under section 6104(c), or in such an 
administrative or judicial proceeding, to the extent that the 
Secretary determines that such disclosure would seriously 
impair Federal tax administration. The provision makes 
disclosures of returns and return information under section 
6104(c) subject to the disclosure, recordkeeping, and safeguard 
provisions of section 6103, including the requirements that 
such information remain confidential (sec. 6103(a)(2)), that 
the Secretary maintain a permanent system of records of 
requests for disclosure (sec. 6103(p)(3)), and that the 
appropriate State officer maintain various safeguards that 
protect against unauthorized disclosure (sec. 6103(p)(4)). The 
provision provides that the willful unauthorized disclosure of 
returns or return information described in section 6104(c) is a 
felony subject to a fine of up to $5,000 and/or imprisonment of 
up to five years (sec. 7213(a)(2)), the willful unauthorized 
inspection of returns or return information described in 
section 6104(c) is subject to a fine of up to $1,000 and/or 
imprisonment of up to one year (sec. 7213A), and provides the 
taxpayer the right to bring a civil action for damages in the 
case of knowing or negligent unauthorized disclosure or 
inspection of such information (sec. 7431(a)(2)).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment but 
does not apply to requests made before such date.

           F. Expansion of Penalties to Preparers of Form 990


(Sec. 206 of the bill and sec. 6695 of the Code)

                              PRESENT LAW

    Under present law, income tax return preparers are subject 
to a penalty of $250 with respect to any return if a portion of 
an understatement of tax liability is due to a position for 
which there was not a realistic possibility of success on the 
merits, the preparer knew or reasonably should have known of 
the position, and the position was not disclosed or was 
frivolous.\76\ In addition, present law imposes a penalty on 
income tax return preparers of $1,000 with respect to a tax 
return if a portion of an understatement of tax liability is 
due to a willful attempt to understate liability or to reckless 
or intentional disregard of rules or regulations.\77\
---------------------------------------------------------------------------
    \76\ Sec. 6694(a).
    \77\ Sec. 6694(b).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that information returns play a 
critical role in the oversight of exempt organizations, but 
that many returns are not filed with complete and accurate 
information. The Committee believes that imposing a penalty on 
paid preparers of information returns will help to improve the 
accuracy of the return.\78\
---------------------------------------------------------------------------
    \78\ The staff of the Joint Committee on Taxation recommended the 
adoption of this provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
99-101.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision provides that a preparer (for compensation) 
of an information return of an exempt organization is subject 
to a penalty of $250 if the preparer omits or misrepresents any 
information with respect to such return that was known or 
should have been known by the preparer. The penalty does not 
apply to minor, inadvertent omissions.
    In addition, a preparer of such an information return is 
subject to a penalty of $1,000 if the preparer recklessly or 
intentionally misrepresents any information or recklessly or 
intentionally disregards any rule or regulation with respect to 
such return. With respect to any return, the $1,000 penalty is 
reduced by the amount of any penalty paid by such person with 
respect to the return for omissions and misrepresentations (the 
$250 penalty imposed by the provision) or a penalty imposed by 
section 6694.

                             EFFECTIVE DATE

    The provision is effective for documents prepared after the 
date of enactment.

G. Notification Requirement for Exempt Entities Not Currently Required 
                  To File an Annual Information Return


(Sec. 207 of the bill and sec. 6033 of the Code)

                              PRESENT LAW

    Under present law, the requirement that an exempt 
organization file an annual information return does not apply 
to several categories of exempt organizations. Organizations 
excepted from the filing requirement include organizations 
(other than private foundations), the gross receipts of which 
in each taxable year normally are not more than $25,000.\79\ 
Also exempt from the requirement are churches, their integrated 
auxiliaries, and conventions or associations of churches; the 
exclusively religious activities of any religious order; 
section 501(c)(1) instrumentalities of the United States; 
section 501(c)(21) trusts; an interchurch organization of local 
units of a church; certain mission societies; certain church-
affiliated elementary and high schools; certain state 
institutions whose income is excluded from gross income under 
section 115; certain governmental units and affiliates of 
governmental units; and other organizations that the IRS has 
relieved from the filing requirement pursuant to its statutory 
discretionary authority.
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    \79\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i); Treas. 
Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii) provides a $5,000 
annual gross receipts exception from the annual reporting requirements 
for certain exempt organizations. In Announcement 82-88, 1982-25 I.R.B. 
23, the IRS exercised its discretionary authority under section 6033 to 
increase the gross receipts exception to $25,000, and enlarge the 
category of exempt organizations that are not required to file Form 
990.
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                           REASONS FOR CHANGE

    The Committee believes that it is appropriate under present 
law that certain small exempt organizations not be required to 
file an annual information return. However, as a result, the 
Secretary of the Treasury is not able to maintain a record of 
the continuing existence of such organizations and the public 
is unable to easily obtain basic information about the 
organization, such as the organization's current address. The 
absence of a record is especially problematic for charitable 
exempt organizations. Although the Secretary publishes the 
names of organizations to which charitable contributions may be 
made, if the organization is not required to file with the 
Secretary and alert the Secretary of its termination, the 
Secretary does not know when to omit the organization from its 
list of names. Accordingly, the Committee believes that exempt 
organizations that do not have to file an annual information 
return by virtue of the amount of their gross receipts should 
file with the Secretary a simple, short annual notice. The 
Committee does not intend that the annual filing be burdensome 
and does not believe that a monetary penalty is appropriate for 
a failure to file the notice. However, if an organization is 
unable to file a notice with the Secretary for three 
consecutive years, the Committee believes that revocation of 
the organization's exempt status is an appropriate sanction 
under the circumstances. In addition, to ensure equitable 
treatment among exempt organizations, the sanction of loss of 
exempt status is extended to consecutive failures to file a 
required information return. \80\
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    \80\ The staff of the Joint Committee on Taxation recommended the 
adoption of a similar provision. Joint Committee on Taxation, Study of 
Present-Law Taxpayer Confidentiality and Disclosure Provisions as 
Required by Section 3802 of the Internal Revenue Service Restructuring 
and Reform Act of 1998, Volume II: Study of Disclosure Provisions 
Relating to Tax-Exempt Organizations (JCS-1-00), January 28, 2000 at 
98.
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                        EXPLANATION OF PROVISION

    The provision provides that organizations that are excused 
from filing an information return by reason of normally having 
gross receipts below a certain specified amount (generally, 
under $25,000) shall furnish to the Secretary annually the 
legal name of the organization, any name under which the 
organization operates or does business, the organization's 
mailing address and Internet web site address (if any), the 
organization's taxpayer identification number, the name and 
address of a principal officer, and evidence of the 
organization's continuing basis for its exemption from the 
generally applicable information return filing requirements. 
Upon such organization's termination of existence, the 
organization is required to furnish notice of such termination.
    The provision provides that if an organization fails to 
provide the required notice for three consecutive years, the 
organization's tax-exempt status is revoked. In addition, if an 
organization that is required to file an annual information 
return under section 6033(a) (Form 990) fails to file such an 
information return for three consecutive years, the 
organization's tax-exempt status is revoked. If an organization 
fails to meet its filing obligation to the IRS for three 
consecutive years in cases where the organization is subject to 
the information return filing requirement in one or more years 
during a three-year period and also is subject to the notice 
requirement for one or more years during the same three-year 
period, the organization's tax-exempt status is revoked.
    A revocation under the provision is effective from the date 
that the Secretary determines was the last day the organization 
could have timely filed the third required information return 
or notice. To again be recognized as tax-exempt, the 
organization must apply to the Secretary for recognition of 
tax-exemption, irrespective of whether the organization was 
required to make an application for recognition of tax-
exemption in order to gain tax-exemption originally.
    If upon application for tax-exempt status after a 
revocation under the provision, the organization shows to the 
satisfaction of the Secretary reasonable cause for failing to 
file the required annual notices or returns, the organization's 
tax-exempt status may, in the discretion of the Secretary, be 
reinstated retroactive to the date of revocation. An 
organization may not challenge under the Code's declaratory 
judgment procedures (section 7428) a revocation of tax-
exemption made pursuant to the provision.
    There is no monetary penalty for failure to file the 
notice. The provision does not require that the notices be made 
available to the public under the public disclosure and 
inspection rules generally applicable to exempt organizations. 
The provision does not affect an organization's obligation 
under present law to file required information returns or 
existing penalties for failure to file such returns.
    The Secretary is required to notify in a timely manner 
every organization that is subject to the notice filing 
requirement of the new filing obligation. Notification by the 
Secretary shall be by mail, in the case of any organization the 
identity and address of which is included in the list of exempt 
organizations maintained by the Secretary, and by Internet or 
other means of outreach, in the case of any other organization. 
In addition, the Secretary is required to publicize in a timely 
manner in appropriate forms and instructions and other means of 
outreach the new penalty imposed for consecutive failures to 
file the information return.
    The Secretary is authorized to publish a list of 
organizations whose exempt status is revoked under the 
provision.

                             EFFECTIVE DATE

    The provision is effective for notices with respect to 
annual periods beginning after 2003.

     H. Suspension of Tax-Exempt Status of Terrorist Organizations


(Sec. 208 of the bill and sec. 501 of the Code)

                              PRESENT LAW

    Under present law, the Internal Revenue Service generally 
issues a letter revoking recognition of an organization's tax-
exempt status only after (1) conducting an examination of the 
organization, (2) issuing a letter to the organization 
proposing revocation, and (3) allowing the organization to 
exhaust the administrative appeal rights that follow the 
issuance of the proposed revocation letter. In the case of an 
organization described in section 501(c)(3), the revocation 
letter immediately is subject to judicial review under the 
declaratory judgment procedures of section 7428. To sustain a 
revocation of tax-exempt status under section 7428, the IRS 
must demonstrate that the organization is no longer entitled to 
exemption. There is no procedure under current law for the IRS 
to suspend the tax-exempt status of an organization.
    To combat terrorism, the Federal government has designated 
a number of organizations as terrorist organizations or 
supporters of terrorism under the Immigration and Nationality 
Act, the International Emergency Economic Powers Act, and the 
United Nations Participation Act of 1945.

                           REASONS FOR CHANGE

    An organization that has been designated or otherwise 
identified by the Federal government as a terrorist 
organization pursuant to certain authority should not be exempt 
from Federal income tax and contributions to such organizations 
should not be deductible for Federal income tax purposes. The 
Committee believes that the Federal government's designation or 
identification of an organization as a terrorist organization 
is grounds for suspension of tax-exempt status, and that in 
such cases a separate investigation of the organization by the 
Internal Revenue Service is not necessary. Further, because a 
terrorist organization may challenge the Federal government's 
designation or identification of the organization under the law 
authorizing the designation or identification, recourse to the 
declaratory judgment procedures of the Internal Revenue Code to 
challenge the suspension of tax-exemption is not appropriate.

                        EXPLANATION OF PROVISION

    The provision suspends the tax-exempt status of an 
organization that is exempt from tax under section 501(a) for 
any period during which the organization is designated or 
identified by U.S. Federal authorities as a terrorist 
organization or supporter of terrorism. The provision also 
makes such an organization ineligible to apply for tax 
exemption under section 501(a). The period of suspension runs 
from the date the organization is first designated or 
identified (or from the date of enactment of the provision, 
whichever is later) to the date when all designations or 
identifications with respect to the organization have been 
rescinded pursuant to the law or Executive order under which 
the designation or identification was made.
    The provision describes a terrorist organization as an 
organization that has been designated or otherwise individually 
identified (1) as a terrorist organization or foreign terrorist 
organization under the authority of section 
212(a)(3)(B)(vi)(II) or section 219 of the Immigration and 
Nationality Act; (2) in or pursuant to an Executive order that 
is related to terrorism and issued under the authority of the 
International Emergency Economic Powers Act or section 5 of the 
United Nations Participation Act for the purpose of imposing on 
such organization an economic or other sanction; or (3) in or 
pursuant to an Executive order that refers to the provision and 
is issued under the authority of any Federal law if the 
organization is designated or otherwise individually identified 
in or pursuant to such Executive order as supporting or 
engaging in terrorist activity (as defined in section 
212(a)(3)(B) of the Immigration and Nationality Act) or 
supporting terrorism (as defined in section 140(d)(2) of the 
Foreign Relations Authorization Act, Fiscal Years 1988 and 
1989). During the period of suspension, no deduction for any 
contribution to a terrorist organization is allowed under the 
Code, including under sections 170, 545(b)(2), 556(b)(2), 
642(c), 2055, 2106(a)(2), or 2522.
    No organization or other person may challenge, under 
section 7428 or any other provision of law, in any 
administrative or judicial proceeding relating to the Federal 
tax liability of such organization or other person, the 
suspension of tax-exemption, the ineligibility to apply for 
tax-exemption, a designation or identification described above, 
the timing of the period of suspension, or a denial of 
deduction described above. The suspended organization may 
maintain other suits or administrative actions against the 
agency or agencies that designated or identified the 
organization, for the purpose of challenging such designation 
or identification (but not the suspension of tax-exempt status 
under this provision).
    If the tax-exemption of an organization is suspended and 
each designation and identification that has been made with 
respect to the organization is determined to be erroneous 
pursuant to the law or Executive order making the designation 
or identification, and such erroneous designation results in an 
overpayment of income tax for any taxable year with respect to 
such organization, a credit or refund (with interest) with 
respect to such overpayment shall be made. If the operation of 
any law or rule of law (including res judicata) prevents the 
credit or refund at any time, the credit or refund may 
nevertheless be allowed or made if the claim for such credit or 
refund is filed before the close of the one-year period 
beginning on the date that the last remaining designation or 
identification with respect to the organization is determined 
to be erroneous.
    The provision directs the IRS to update the listings of 
tax-exempt organizations to take account of organizations that 
have had their exemption suspended and to publish notice to 
taxpayers of the suspension of an organization's tax-exemption 
and the fact that contributions to such organization are not 
deductible during the period of suspension.

                             EFFECTIVE DATE

    The provision is effective for designations made before, 
on, or after the date of enactment.

     TITLE III. OTHER CHARITABLE AND EXEMPT ORGANIZATION PROVISIONS


   A. Modify Tax on Unrelated Business Taxable Income of Charitable 
                            Remainder Trusts


(Sec. 301 of the bill and sec. 664 of the Code)

                              PRESENT LAW

    Charitable remainder annuity trusts and charitable 
remainder unitrusts are exempt from Federal income tax for a 
tax year unless the trust has any unrelated business taxable 
income for the year. Unrelated business taxable income includes 
certain debt financed income. A charitable remainder trust that 
loses exemption from income tax for a taxable year is taxed as 
a regular complex trust. As such, the trust is allowed a 
deduction in computing taxable income for amounts required to 
be distributed in a taxable year, not to exceed the amount of 
the trust's distributable net income for the year. Taxes 
imposed on the trust are required to be allocated to 
corpus.\81\
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    \81\ Treas. Reg. sec. 1.664-1(d)(2).
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    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.\82\
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    \82\ Sec. 664(b).
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    In general, distributions to the extent they are 
characterized as income 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.\83\
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    \83\ Treas. Reg. sec. 1.664-1(d)(4).
---------------------------------------------------------------------------
    A charitable remainder annuity trust is a trust that is 
required to pay, at least annually, a fixed dollar amount of at 
least five percent of the initial value of the trust to a 
noncharity for the life of an individual or for a period of 20 
years or less, with the remainder passing to charity. A 
charitable remainder unitrust is a trust that generally is 
required to pay, at least annually, a fixed percentage of at 
least five percent of the fair market value of the trust's 
assets determined at least annually to a noncharity for the 
life of an individual or for a period 20 years or less, with 
the remainder passing to charity.\84\
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    \84\ Sec. 664(d).
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    A trust does not qualify as a 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. A trust 
does 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. A trust does not 
qualify as a charitable remainder annuity trust or a charitable 
remainder unitrust unless the value of the remainder interest 
in the trust is at least 10 percent of the value of the assets 
contributed to the trust.

                           REASONS FOR CHANGE

    The Committee believes that in years that a charitable 
remainder trust has unrelated business income, an excise tax of 
100 percent on such income is a more appropriate remedy than 
loss of tax exemption for the year.

                        EXPLANATION OF PROVISION

    The provision imposes a 100-percent excise tax on the 
unrelated business taxable income of a charitable remainder 
trust. This replaces the present-law rule that takes away the 
income tax exemption of a charitable remainder trust for any 
year in which the trust has any unrelated business taxable 
income. Consistent with present law, the tax is treated as paid 
from corpus. The unrelated business taxable income is 
considered income of the trust for purposes of determining the 
character of the distribution made to the beneficiary.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002.

   B. Modify Tax Treatment of Certain Payments to Controlling Exempt 
                             Organizations


(Sec. 302 of the bill and sec. 512 of the Code)

                              PRESENT LAW

    In general, interest, rents, royalties, and annuities are 
excluded from the unrelated business income of tax-exempt 
organizations. However, section 512(b)(13) generally treats 
otherwise excluded rent, royalty, annuity, and interest income 
as unrelated business income if such income is received from a 
taxable or tax-exempt subsidiary that is 50 percent controlled 
by the parent tax-exempt organization. In the case of a stock 
subsidiary, ``control'' means ownership by vote or value of 
more than 50 percent of the stock. In the case of a partnership 
or other entity, control means ownership of more than 50 
percent of the profits, capital or beneficial interests. In 
addition, present law applies the constructive ownership rules 
of section 318 for purposes of section 512(b)(13). Thus, a 
parent exempt organization is deemed to control any subsidiary 
in which it holds more than 50 percent of the voting power or 
value, directly (as in the case of a first-tier subsidiary) or 
indirectly (as in the case of a second-tier subsidiary).
    Under present law, interest, rent, annuity, or royalty 
payments made by a controlled entity to a tax-exempt 
organization are includable in the latter organization's 
unrelated business income and are subject to the unrelated 
business income tax to the extent the payment reduces the net 
unrelated income (or increases any net unrelated loss) of the 
controlled entity (determined as if the entity were tax 
exempt).
    The Taxpayer Relief Act of 1997 (the ``1997 Act'') made 
several modifications to the control requirement of section 
512(b)(13). In order to provide transitional relief, the 
changes made by the 1997 Act do not apply to any payment 
received or accrued during the first two taxable years 
beginning on or after the date of enactment of the 1997 Act 
(August 5, 1997) if such payment is received or accrued 
pursuant to a binding written contract in effect on June 8, 
1997, and at all times thereafter before such payment (but not 
pursuant to any contract provision that permits optional 
accelerated payments).

                           REASONS FOR CHANGE

    The present-law rule that requires a controlling entity to 
include as unrelated business income certain payments made by a 
controlled entity applies without regard to whether the amount 
of the payment is fair and reasonable under the circumstances 
or would otherwise constitute unrelated business income if paid 
by an organization not controlled by the exempt organization. 
The Committee believes that the controlling organization should 
not be subject to the unrelated business income tax if the 
amount of the payment from the controlled entity is determined 
in accordance with established arm's-length principles. The 
Committee intends that the controlling organization be subject 
to the present-law rule only to the extent that a payment made 
by a controlled entity exceeds the amount that would have been 
paid if the payment had been determined under established 
arm's-length principles. In order to discourage controlled 
entities from claiming deductions in excess of the arm's-length 
amount, the Committee believes that it is appropriate to 
subject the controlling organization to a penalty tax for 
making excess payments.

                        EXPLANATION OF PROVISION

    The provision provides that the general rule of section 
512(b)(13), which includes interest, rent, annuity, or royalty 
payments made by a controlled entity to a tax-exempt 
organization in the latter organization's unrelated business 
income to the extent the payment reduces the net unrelated 
income (or increases any net unrelated loss) of the controlled 
entity, applies only to the portion of payments received or 
accrued in a taxable year that exceed the amount of the 
specified payment that would have been paid or accrued if such 
payment had been determined under the principles of section 
482. Thus, if a payment of rent by a controlled subsidiary to 
its tax-exempt parent organization exceeds fair market value, 
the excess amount of such payment over fair market value (as 
determined in accordance with section 482) is included in the 
parent organization's unrelated business income, to the extent 
that such excess reduced the net unrelated income (or increased 
any net unrelated loss) of the controlled entity (determined as 
if the entity were tax exempt). In addition, the provision 
imposes a 20-percent penalty on the larger of such excess 
determined without regard to any amendment or supplement to a 
return of tax, or such excess determined with regard to all 
such amendments and supplements.
    The provision provides that if modifications to section 
512(b)(13) made by the 1997 Act did not apply to a contract 
because of the transitional relief provided by the 1997 Act, 
then such modifications also do not apply to amounts received 
or accrued under such contract before January 1, 2001.

                             EFFECTIVE DATE

    The provision applies to payments received or accrued after 
December 31, 2000.

          C. Simplification of Lobbying Expenditure Limitation


(Sec. 303 of the bill and secs. 501 and 4911 of the Code)

                              PRESENT LAW

In general

    An organization does not qualify for tax-exempt status 
under section 501(c)(3) unless ``no substantial part'' of the 
activities of the organization is ``carrying on propaganda, or 
otherwise attempting, to influence legislation,'' except as 
provided by section 501(h). \85\ Carrying on propaganda and 
attempting to influence legislation commonly are referred to as 
``lobbying'' activities. Thus, section 501(c)(3) permits a 
limited amount of lobbying activity without loss of tax-exempt 
status.
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    \85\ Sec. 501(c)(3).
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    For purposes of determining whether lobbying activities are 
a substantial part of an organization's overall functions, an 
organization generally may choose between two standards, the 
``no substantial part'' test of section 501(c)(3) or the 
``expenditure'' test of section 501(h).
    Whether an organization meets the ``no substantial part'' 
test is based on all the facts and circumstances. There is no 
statutory or regulatory guidance, and it is not clear whether 
the determination is based on the organization's activities, 
its expenditures, or both. Alternatively, under section 501(h), 
certain organizations described in section 501(c)(3) can elect 
to be subject to the expenditure test, \86\ which consists of 
bright-line rules that specify the dollar amount of permitted 
expenditures on lobbying activities.
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    \86\ Organizations that do not make a section 501(h) election are 
subject to the ``no substantial part'' test.
---------------------------------------------------------------------------

Consequences of excess lobbying under section 501(h)

    Organizations that make a section 501(h) election 
(``electing charities'') are subject to tax if the electing 
charity makes either ``lobbying expenditures'' or ``grass roots 
expenditures'' in excess of a certain amount established for 
each type of expenditure for each taxable year. Lobbying 
expenditures are the sum of grass-roots expenditures and 
``direct lobbying'' expenditures. \87\
---------------------------------------------------------------------------
    \87\ Secs. 501(h)(2)(A), 4911(c)(1), 4911(d).
---------------------------------------------------------------------------
    The expenditure limits are based on a ``lobbying nontaxable 
amount'' for the taxable year and a ``grass roots nontaxable 
amount'' for the taxable year. The lobbying nontaxable amount 
is the lesser of $1 million or an amount determined as a 
percentage of an organization's exempt purpose expenditures. 
\88\ The grass-roots nontaxable amount is 25 percent of the 
organization's lobbying nontaxable amount. An electing charity 
that exceeds either of the spending limitations is subject to a 
25 percent tax on the excess. An electing charity that exceeds 
both of the spending limitations is subject to a 25 percent tax 
on the greater of the excess of the lobbying expenditures or 
the grass-roots expenditures.
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    \88\ Exempt purpose expenditures generally are expenses incurred 
for exempt purposes, such as amounts paid to accomplish exempt 
purposes, administrative expenses such as overhead, lobbying expenses, 
and certain fundraising expenses. Exempt purpose expenditures do not 
include, for example, expenses not for exempt purposes, payments of 
unrelated business income tax, or capital expenses in connection with 
an unrelated business. See Treas. Reg. sec. 56.4911-4.
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    An electing charity that normally exceeds either of two 
``ceiling amounts,'' which are based on the expenditure limits, 
will lose its tax exemption. \89\ The ``lobbying ceiling 
amount'' is 150 percent of the electing charity's lobbying 
nontaxable amount for the taxable year and the ``grass roots 
ceiling amount'' is 150 percent of the grass-roots nontaxable 
amount for the taxable year. For this purpose, ``normal'' 
expenditures are calculated based on a four-year averaging 
mechanism. \90\
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    \89\ Sec. 501(h)(1).
    \90\ Treas. Reg. sec. 1.501(h)-3.
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Definitions

    Grass-roots expenditures are defined as ``any attempt to 
influence any legislation through an attempt to affect the 
opinions of the general public or any segment thereof.'' \91\ 
For a communication to constitute grass-roots lobbying, it must 
refer to ``specific legislation,'' reflect a view on such 
legislation, and encourage the recipient of the communication 
to take action with respect to such legislation (a ``call to 
action''). \92\ A communication includes a call to action if it 
incorporates one of four elements: (1) it urges the recipient 
to contact a legislator, employee of a government body, or any 
other government official or employee who may participate in 
the formulation of legislation with the principal purpose of 
influencing legislation; (2) it states the address, telephone 
number, or similar information of a legislator or an employee 
of a legislative body; (3) it provides a petition, tear-off 
postcard, or similar device for the recipient to communicate 
with government officials or employees who participate in the 
formulation of legislation with the principal purpose of 
influencing legislation; or (4) it states the position of one 
or more legislators on the legislation, except that a 
communication may name the main sponsors of legislation for 
purposes of identifying the legislation without constituting a 
call to action. \93\ In addition, a communication is presumed 
to be grass-roots lobbying if the communication is a paid 
advertisement that: (1) appears in the mass media within two 
weeks before a vote by a legislative body or committee (but not 
a subcommittee) on a highly publicized piece of legislation; 
(2) reflects a view on the general subject of the legislation; 
and (3) either refers to the legislation or encourages the 
public to communicate with legislators on the general subject 
of such legislation. \94\ The presumption is rebuttable if the 
electing charity demonstrates that the timing of the 
communication was not related to the legislation or that the 
advertisement was of a type regularly made by the electing 
charity without regard to the timing of the legislation (a 
customary course of business exception). \95\
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    \91\ Secs. 501(h)(2)(C) & 4911(d)(1)(A)
    \92\ Treas. Reg. sec. 56.4911-2(b)(2)(i).
    \93\ Treas. Reg. sec. 56.4911-2(b)(2)(iii). The regulations provide 
that the first three elements constitute ``direct'' encouragement, 
whereas the fourth element is ``indirect'' encouragement. This 
distinction becomes relevant in determining whether a communication 
meets one of the prescribed exceptions to lobbying, i.e., an indirect 
call to action in a grass-roots communication may qualify as 
``nonpartisan analysis, study or research'' (Treas. Reg. sec. 56.4911-
2(b)(2)(iv)), and in determining the proper allocation of expenses 
between grass-roots and direct lobbying. Treas. Reg. sec. 56.4911-5(e).
    \94\ Treas. Reg. sec. 56.4911-2(b)(5)(ii).
    \95\ Id.
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    Direct lobbying expenditures are ``any attempt to influence 
any legislation through communication with any member or 
employee of a legislative body, or with any government official 
or employee who may participate in the formulation of the 
legislation'' if the principal purpose of the communication is 
to influence legislation. \96\ A communication would constitute 
direct lobbying only if the communication ``refers to specific 
legislation'' and reflects a view on such legislation.
---------------------------------------------------------------------------
    \96\ Sec. 501(h)(2)(A) and 4911(d)(1)(B) and Treas. Reg. sec. 
56.4911-2(b)(1).
---------------------------------------------------------------------------
    Certain specified activities do not constitute attempts to 
influence legislation and therefore expenditures for such 
activities are not subject to the expenditure limits for 
lobbying expenditures or grass-roots expenditures. In general, 
such activities include: (1) making available the results of 
nonpartisan analysis, study, or research; (2) providing 
technical advice or assistance to a governmental body or to a 
committee in response to a written request; (3) appearances 
before, or communications to, any legislative body with respect 
to a possible decision of such body that might affect the 
existence of the organization, its powers and duties, tax-
exempt status, or the deduction of contributions to the 
organization (so-called ``self-defense'' expenditures); (4) 
certain communications to members of the electing charity; and 
(5) communications with governmental officials or employees 
that are not intended to influence legislation. \97\
---------------------------------------------------------------------------
    \97\ Sec. 4911(d)(2).
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Special rules for mixed lobbying expenditures

    Expenses that serve both direct and grass-roots lobbying 
purposes, e.g., communications that are sent to members and 
nonmembers, or ``mixed lobbying'' expenditures, are subject to 
special rules. The regulations specify how an electing charity 
is to allocate mixed lobbying expenditures between direct and 
grass-roots lobbying purposes. \98\ For example, for a mixed 
lobbying communication that is designed primarily for members 
(i.e., more than half the recipients are members) and that 
directly encourages grass-roots lobbying (even if it also 
encourages direct lobbying), the grass-roots expenditure amount 
includes all the costs of preparing the material used for 
purposes of grass-roots lobbying plus the mechanical and 
distributional costs associated with the communication. If a 
mixed lobbying communication encourages direct lobbying, but 
only indirectly encourages grass-roots lobbying, then the 
entire costs of the communication are allocated based on the 
proportion of members and nonmembers receiving the 
communication.
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    \98\ Treas. Reg. sec. 56.4911-5(e).
---------------------------------------------------------------------------

Disclosure of lobbying expenditures

    An electing charity must disclose lobbying expenditures 
annually on Schedule A of Form 990. In order to meet disclosure 
requirements, electing charities are required to keep detailed 
records of direct and grass-roots lobbying expenditures. 
Required records of grass-roots expenditures include: (1) all 
amounts directly paid or incurred for grass-roots lobbying; (2) 
payments to other organizations earmarked for grass-roots 
lobbying; (3) fees and expenses paid for grass-roots lobbying; 
(4) the printing, mailing, and other costs of reproducing and 
distributing materials used in grass-roots lobbying; (5) the 
portion of amounts paid or incurred as current or deferred 
compensation for an employee's grass-roots lobbying services; 
(6) any amount paid for out-of-pocket expenditures incurred on 
behalf of the electing charity for grass-roots lobbying; (7) 
the allocable portion of administrative, overhead and other 
general expenditures attributable to grass-roots lobbying; and 
(8) expenditures for grass-roots lobbying of a controlled 
organization. \99\
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    \99\ See Treas. Reg. sec. 56.4911-6.
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                           REASONS FOR CHANGE

    The Committee believes that the separate limitation on 
grass-roots lobbying expenditures is an unnecessary 
complication for electing charities. The Committee believes 
that the overall limit on lobbying expenditures is a sufficient 
ceiling on the lobbying activities of electing charities, 
irrespective of the proportion of lobbying activities that are 
grass-roots lobbying or direct lobbying.

                        EXPLANATION OF PROVISION

    The provision eliminates the separate limitation for grass-
roots lobbying expenditures applicable to electing charities. 
Electing charities remain subject to the overall limitation on 
lobbying expenditures, which does not change in amount, but 
electing charities are not required to limit grass roots 
expenditures as a percentage of overall lobbying. Thus, an 
electing charity is able to make tax-free any combination of 
grass-roots and direct lobbying expenditures up to the lobbying 
non-taxable amount and does not risk loss of tax-exemption as a 
result of such expenditures until total lobbying expenditures 
normally exceed the lobbying ceiling amount. For purposes of 
the section 501(h) election, electing charities are not 
required to distinguish between grass-roots lobbying and direct 
lobbying, whether for mixed lobbying expenditures or otherwise.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2002.

   D. Expedited Review Process for Certain Tax-Exemption Applications


(Sec. 304 of the bill)

                              PRESENT LAW

    Most organizations that seek tax-exempt status as a 
charitable organization are required to file an Application for 
Recognition of Exemption (Form 1023) with the IRS.\100\ 
Organizations that are not required to file Form 1023 include 
churches, their integrated auxiliaries, and conventions or 
associations of churches, and any organization (other than a 
private foundation) that normally has gross receipts of $5,000 
or less in a taxable year. Organizations that file Form 1023 
within 15 months of the end of the month of the organization's 
formation will, if the application is approved, be recognized 
as tax-exempt from the date of formation. The IRS will 
automatically grant an organization's request for an additional 
12-month extension of the 15-month period. Otherwise, exemption 
normally will be recognized as of the date the application was 
received by the IRS. In appropriate circumstances, upon written 
request, the IRS will expedite consideration of applications 
for tax-exemption. For example, organizations formed to provide 
relief to victims of disasters or other emergencies often 
receive expedited consideration.
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    \100\ Sec. 508(a).
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                           REASONS FOR CHANGE

    Many social service organizations that want to apply for 
government funding through grants or contracts are required as 
a condition of application to have been recognized as an exempt 
charitable organization. The Committee wishes to facilitate the 
formation of charitable organizations that intend to work with 
Federal, State and local governments to provide vital social 
services to many of the neediest members of society by 
implementing an expedited review procedure for exempt status 
applications, and by waiving IRS user fees pertaining to such 
applications filed by smaller social service organizations.

                        EXPLANATION OF PROVISION

    The provision provides that the Secretary or his delegate 
shall adopt procedures to expedite consideration of 
applications for exempt status by organizations that are 
organized and operated for the primary purpose of providing 
social services. To be eligible, the organization must: (1) be 
seeking a contract or grant under a Federal, State, or local 
program that provides funding for social service programs; (2) 
establish that tax-exempt status is a condition of applying for 
such contract or grant; (3) include a completed copy of the 
contract or grant application with the application for 
exemption; and (4) meet such other criteria as the Secretary 
may provide. Organizations that meet the eligibility 
requirements described above (except for the requirement that 
tax-exempt status is a condition of the contract or grant 
application), and that certify that the organization's average 
annual gross receipts over the four-year period preceding the 
application was not more than $50,000 (or, in the case of an 
organization in existence less than four years, is not expected 
to be more than $50,000 during the organization's first four 
years) are entitled to a waiver of any fee for application of 
tax-exempt status.
    For this purpose, social services is defined as services 
directed at helping people in need, reducing poverty, improving 
outcomes of low-income children, revitalizing low-income 
communities, and empowering low-income families and low-income 
individuals to become self-sufficient, including: (1) child 
care services, protective services for children and adults, 
services for children and adults in foster care, adoption 
services, services related to the management and maintenance of 
the home, day care services for adults, and services to meet 
the special needs of children, older individuals, and 
individuals with disabilities (including physical, mental, or 
emotional disabilities); (2) transportation services; (3) job 
training and related services, and employment services; (4) 
information, referral, and counseling services; (5) the 
preparation and delivery of meals, and services related to soup 
kitchens or food banks; (6) health support services; (7) 
literacy and mentoring programs; (8) services for the 
prevention and treatment of juvenile delinquency and substance 
abuse, services for the prevention of crime and the provision 
of assistance to the victims and the families of criminal 
offenders, and services related to the intervention in, and 
prevention of, domestic violence; and (9) services related to 
the provision of assistance for housing under Federal law. 
Social services does not include a program having the purpose 
of delivering educational assistance under the Elementary and 
Secondary Education Act of 1965 or under the Higher Education 
Act of 1965.

                             EFFECTIVE DATE

    The provision applies to applications for tax-exempt status 
filed after December 31, 2003.

          E. Clarification of Definition of Church Tax Inquiry


(Sec. 305 of the bill and sec. 7611 of the Code)

                              PRESENT LAW

    Under present law, the IRS may begin a church tax inquiry 
only if an appropriate high-level Treasury official reasonably 
believes, on the basis of the facts and circumstances recorded 
in writing, that an organization (1) may not qualify for tax 
exemption as a church, (2) may be carrying on an unrelated 
trade or business, or (3) otherwise may be engaged in taxable 
activities.\101\ A church tax inquiry is defined as any inquiry 
to a church (other than an examination) that serves as a basis 
for determining whether the organization qualified for tax 
exemption as a church or whether it is carrying on an unrelated 
trade or business or otherwise is engaged in taxable 
activities. An inquiry is considered to commence when the IRS 
requests information or materials from a church of a type 
contained in church records, other than routine requests for 
information or inquiries regarding matters that do not 
primarily concern the tax status or liability of the church 
itself.
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    \101\ Sec. 7611. Prior to the year 2000 IRS restructuring, the 
lowest level official who could initiate a church tax inquiry was an 
IRS Regional Commissioner.
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                           REASONS FOR CHANGE

    The Committee believes that the present-law church tax 
inquiry procedures provide important safeguards against the IRS 
engaging in unnecessary and intrusive examinations of churches. 
However, the church tax inquiry procedures also have the effect 
of hampering IRS efforts to educate churches with respect to 
actions that are not permissible under section 501(c)(3). The 
Committee believes that a clarification of the scope of the 
church tax inquiry procedures to make it clear that the IRS may 
undertake educational outreach efforts with respect to specific 
churches (e.g., initiating meetings with representatives of a 
particular church to discuss the rules that apply to such 
church) will improve compliance with the law by churches.

                        EXPLANATION OF PROVISION

    The provision clarifies that the church tax inquiry 
procedures do not apply to contacts made by the IRS for the 
purpose of educating churches with respect to the Federal 
income tax law governing tax-exempt organizations. For example, 
the IRS does not violate the church tax inquiry procedures when 
written materials are provided to a church or churches for the 
purpose of educating such church or churches with respect to 
the types of activities that are not permissible under section 
501(c)(3).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

 F. Extension of Declaratory Judgment Procedures to Non-501(c)(3) Tax-
                          Exempt Organizations


(Sec. 306 of the bill and sec. 7428 of the Code)

                              PRESENT LAW

    In order for an organization to be granted tax exemption as 
a charitable entity described in section 501(c)(3), it 
generally must file an application for recognition of exemption 
with the IRS and receive a favorable determination of its 
status. Similarly, for most organizations, a charitable 
organization's eligibility to receive tax-deductible 
contributions is dependent upon its receipt of a favorable 
determination from the IRS. In general, a section 501(c)(3) 
organization can rely on a determination letter or ruling from 
the IRS regarding its tax-exempt status, unless there is a 
material change in its character, purposes, or methods of 
operation. In cases in which an organization violates one or 
more of the requirements for tax exemption under section 
501(c)(3), the IRS is authorized to revoke an organization's 
tax exemption, notwithstanding an earlier favorable 
determination.
    In situations in which the IRS denies an organization's 
application for recognition of exemption under section 
501(c)(3) or fails to act on such application, or in which the 
IRS informs a section 501(c)(3) organization that it is 
considering revoking or adversely modifying its tax-exempt 
status, present law authorizes the organization to seek a 
declaratory judgment regarding its tax status (sec. 7428). 
Section 7428 provides a remedy in the case of a dispute 
involving a determination by the IRS with respect to: (1) the 
initial qualification or continuing qualification of an 
organization as a charitable organization for tax exemption 
purposes or for charitable contribution deduction purposes; (2) 
the initial classification or continuing classification of an 
organization as a private foundation; (3) the initial 
classification or continuing classification of an organization 
as a private operating foundation; or (4) the failure of the 
IRS to make a determination with respect to (1), (2), or (3). A 
``determination'' in this context generally means a final 
decision by the IRS affecting the tax qualification of a 
charitable organization, although it also can include a 
proposed revocation of an organization's tax-exempt status or 
public charity classification. Section 7428 vests jurisdiction 
over controversies involving such a determination in the U.S. 
District Court for the District of Columbia, the U.S. Court of 
Federal Claims, and the U.S. Tax Court.
    Prior to utilizing the declaratory judgment procedure, an 
organization must have exhausted all administrative remedies 
available to it within the IRS. An organization is deemed to 
have exhausted its administrative remedies at the expiration of 
270 days after the date on which the request for a 
determination was made if the organization has taken, in a 
timely manner, all reasonable steps to secure such 
determination.
    If an organization (other than a section 501(c)(3) 
organization) files an application for recognition of exemption 
and receives a favorable determination from the IRS, the 
determination of tax-exempt status is usually effective as of 
the date of formation of the organization if its purposes and 
activities during the period prior to the date of the 
determination letter were consistent with the requirements for 
exemption. However, if the organization files an application 
for recognition of exemption and later receives an adverse 
determination from the IRS, the IRS may assert that the 
organization is subject to tax on some or all of its income for 
open taxable years. In addition, as with charitable 
organizations, the IRS may revoke or modify an earlier 
favorable determination regarding an organization's tax-exempt 
status.
    Under present law, a non-charity (i.e., an organization not 
described in section 501(c)(3)) may not seek a declaratory 
judgment with respect to an IRS determination regarding its 
tax-exempt status. The only remedies available to such an 
organization are to petition the U.S. Tax Court for relief 
following the issuance of a notice of deficiency or to pay any 
tax owed and sue for refund in federal district court or the 
U.S. Court of Federal Claims.

                           REASONS FOR CHANGE

    The Committee believes that it is important to provide 
certainty for organizations that have sought a determination of 
their tax-exempt status. Thus, the Committee finds it 
appropriate to extend the present-law declaratory judgment 
procedures to all organizations that apply for tax-exempt 
status as organizations described in section 501(c) or 501(d).

                        EXPLANATION OF PROVISION

    The provision extends declaratory judgment procedures 
similar to those currently available only to charities under 
section 7428 to other section 501(c) and 501(d) determinations. 
The provision limits jurisdiction over controversies involving 
such other determinations to the United States Tax Court.\102\
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    \102\ This limitation currently applies to declaratory judgments 
relating to tax qualification for certain employee retirement plans 
(sec. 7476).
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The extension of the declaratory judgment procedures to 
organizations other than section 501(c)(3) organizations is 
effective for pleadings filed with respect to determinations 
(or requests for determinations) made after December 31, 2002.

         G. Definition of Convention or Association of Churches


(Sec. 307 of the bill and sec. 7701 of the Code)

                              PRESENT LAW

    Under present law, an organization that qualifies as a 
``convention or association of churches'' (within the meaning 
of sec. 170(b)(1)(A)(i)) is not required to file an annual 
return,\103\ is subject to the church tax inquiry and church 
tax examination provisions applicable to organizations claiming 
to be a church,\104\ and is subject to certain other provisions 
generally applicable to churches.\105\ The Internal Revenue 
Code does not define the term ``convention or association of 
churches.''
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    \103\ Sec. 6033(a)(2)(A)(i).
    \104\ Sec. 7611(h)(1)(B).
    \105\ See, e.g., Sec. 402(g)(8)(B) (limitation on elective 
deferrals); sec. 403(b)(9)(B) (definition of retirement income 
account); sec. 410(d) (election to have participation, vesting, 
funding, and certain other provisions apply to church plans); sec. 
414(e) (definition of church plan); sec. 415(c)(7) (certain 
contributions by church plans); sec. 501(h)(5) (disqualification of 
certain organizations from making the sec. 501(h) election regarding 
lobbying expenditure limits); sec. 501(m)(3) (definition of commercial-
type insurance); sec. 508(c)(1)(A) (exception from requirement to file 
application seeking recognition of exempt status); sec. 512(b)(12) 
(allowance of up to $1,000 deduction for purposes of determining 
unrelated business taxable income); sec. 514(b)(3)(E) (definition of 
debt-financed property); sec. 3121(w)(3)(A) (election regarding 
exemption from social security taxes); sec. 3309(b)(1) (application of 
federal unemployment tax provisions to services performed in the employ 
of certain organizations); sec. 6043(b)(1) (requirement to file a 
return upon liquidation or dissolution of the organization); and sec. 
7702(j)(3)(A) (treatment of certain death benefit plans as life 
insurance).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The term ``convention or association of churches'' was 
added to the Code to ensure that hierarchical churches and 
congregational churches would not be treated dissimilarly for 
Federal income tax purposes merely because of their 
organizational and governance structures. The Committee 
understands that some congregational church organizations have 
only churches as members, and that others have both churches 
and individuals as members. The Committee is concerned that an 
organization with the characteristics of a convention or 
association of churches, including having a substantial number 
of churches as members, might fail to be regarded as a 
convention or association of churches merely because it 
includes individuals in its membership. The Committee intends 
that a congregational church organization that otherwise 
constitutes a convention or association of churches not be 
denied recognition as such merely because its membership 
includes individuals as well as churches.

                        EXPLANATION OF PROVISION

    The provision provides that an organization that otherwise 
is a convention or association of churches does not fail to so 
qualify merely because the membership of the organization 
includes individuals as well as churches, or because 
individuals have voting rights in the organization.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

H. Payments by Charitable Organizations to Victims of War on Terrorism 
                       and Families of Astronauts


(Sec. 308 of the bill)

                              PRESENT LAW

    In general, organizations described in section 501(c)(3) of 
the Code are exempt from taxation. Contributions to such 
organizations generally are tax deductible.\106\ Section 
501(c)(3) organizations must be organized and operated 
exclusively for exempt purposes and no part of the net earnings 
of such organizations may inure to the benefit of any private 
shareholder or individual. An organization is not organized or 
operated exclusively for one or more exempt purposes unless the 
organization serves a public rather than a private interest. 
Thus, an organization described in section 501(c)(3) generally 
must serve a charitable class of persons that is indefinite or 
of sufficient size.
---------------------------------------------------------------------------
    \106\ Sec. 170.
---------------------------------------------------------------------------
    Tax-exempt private foundations are a type of organization 
described in section 501(c)(3) and are subject to special 
rules. Private foundations are subject to excise taxes on acts 
of self-dealing between the private foundation and a 
disqualified person with respect to the foundation.\107\ For 
example, it is self-dealing if assets of a private foundation 
are used for the benefit of a disqualified person, such as a 
substantial contributor to the foundation or a person in 
control of the foundation, and the benefit is not incidental or 
tenuous.
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    \107\ Sec. 4941.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that payments by charities to 
members of the Armed Forces of the United States (and their 
immediate families) made by reason of death, injury, wounding 
or illness and incurred as a result of our nation's military 
response to the terrorist attacks of September 11, 2001, and to 
individuals of the immediate families of astronauts killed in 
the line of duty after December 31, 2002, should be treated as 
consistent with the charity's exempt purpose, to the extent the 
payments are made in good faith and pursuant to a reasonable 
and objective formula that is consistently applied.

                        EXPLANATION OF PROVISION

    The provision provides that organizations described in 
section 501(c)(3) that make certain payments are not required 
to make a specific assessment of need for the payments to be 
related to the purpose or function constituting the basis for 
the organization's exemption, provided that the organization 
makes the payments in good faith and uses an objective formula 
that is consistently applied in making the payments.
    The provision applies to payments to a member of the Armed 
Forces of the United States (as defined in section 
7701(a)(15)), or to a member of such person's immediate family 
(including spouses, parents, children, and foster children), by 
reason of the death, injury, wounding, or illness of a member 
of the Armed Forces of the United States that was incurred as a 
result of the military response of the United States to the 
terrorist attacks against the United States on September 11, 
2001. The provision also applies to payments to an individual 
of an astronaut's immediate family by reason of the death of 
such astronaut occurring in the line of duty after December 31, 
2002.
    As under present law, such payments must be for public and 
not private benefit and therefore must serve a charitable 
class. For example, a charitable organization that assists the 
families of members of the Armed Forces killed in the line of 
duty may make pro-rata distributions to the families of those 
killed, even though the specific financial needs of each family 
are not directly considered. Similarly, if the amount of a 
distribution is based on the number of dependents of a 
charitable class of persons killed in the military response to 
the attacks and this standard is applied consistently among 
distributions, the specific needs of each recipient do not have 
to be taken into account. However, it is not appropriate for a 
charity to make pro-rata payments based on the recipients' 
living expenses before the harm occurred if the result 
generally provides significantly greater assistance to persons 
in a better position to provide for themselves than to persons 
with fewer financial resources. Although such a distribution 
might be based on objective criteria, it is not a reasonable 
formula for distributing assistance in an equitable manner. 
Similarly, although specific assessments of need are not 
required, payments that do not further public purposes are not 
permitted. The provision does not change the substantive 
standards for exemption under section 501(c)(3), including the 
prohibition on private inurement. The provision also provides 
that if a private foundation makes payments under the 
conditions described above, the payment is not treated as made 
to a disqualified person for purposes of section 4941.

                             EFFECTIVE DATE

    For payments related to members of the Armed Forces, the 
provision applies to payments made after the date of enactment 
and before September 11, 2004. For payments related to 
astronauts, the provision applies to payments made after 
December 31, 2002.

I. Increase Percentage Limits for Certain Employer-Related Scholarship 
                                Programs


(Sec. 309 of the bill)

                              PRESENT LAW

    Gross income does not include any amount received as a 
qualified scholarship by an individual who is a candidate for a 
degree at an educational organization (sec. 117(a)). For this 
purpose, a scholarship generally means an amount paid or 
allowed to, or for the benefit of, a student to aid that 
student in pursuing studies.\108\ However, an amount paid or 
allowed to, or on behalf of, an individual to enable the 
individual to pursue studies is not treated as a scholarship if 
the amount represents compensation for past, present, or future 
services.\109\ The determination of whether an amount is 
properly treated as a scholarship or compensation for services 
is made in light of all the relevant facts and circumstances.
---------------------------------------------------------------------------
    \108\ Treas. Reg. sec. 1.117-3(a).
    \109\ Treas. Reg. sec. 1.117-4(c).
---------------------------------------------------------------------------
    Present law imposes excise taxes on the taxable 
expenditures of a private foundation.\110\ A taxable 
expenditure includes, among other things, any amount paid or 
incurred by a private foundation as a grant to an individual 
for travel, study, or other similar purposes by such 
individual, unless such grant is awarded on an objective and 
nondiscriminatory basis pursuant to a procedure approved in 
advance by the Secretary.\111\ In the case of individual grants 
to be made as scholarships or fellowships, the private 
foundation must demonstrate to the satisfaction of the 
Secretary that the grant: (1) constitutes a scholarship or 
fellowship which would be subject to the provisions of section 
117(a),\112\ and (2) is to be used for study at an educational 
organization which normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of pupils 
or students in attendance at the place where its educational 
activities are regularly carried on.\113\
---------------------------------------------------------------------------
    \110\ Secs. 4945(a) and (b).
    \111\ Secs. 4945(d)(3) and (g).
    \112\ For the purpose of section 4945(g), the term ``scholarship or 
fellowship'' refers to the provisions of section 117(a) as in effect 
before the Tax Reform Act of 1986. Sec. 4945(g)(1).
    \113\ Secs. 4945(g)(1) and 170(b)(1)(A)(ii).
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    Private foundations may in the course of their activities 
make scholarship or fellowship grants to individuals to be used 
for educational purposes. However, a private foundation's grant 
program may not provide compensation, an employment incentive, 
or an employee fringe benefit to persons employed by the 
foundation or by another employer (including, for example, 
employees of a ``related'' employer organization). Revenue 
Procedure 76-47 provides advance approval guidelines to 
determine whether grants made by private foundations under 
employer-related grant programs to an employee or to a child of 
an employee of the employer to which the program relates is 
considered a scholarship or fellowship grant subject to the 
provisions of section 117(a).\114\ To the extent that such 
grants are considered scholarships or fellowships under these 
guidelines, the Secretary will assume the grants are not 
taxable expenditures subject to section 4945 taxes. Educational 
grants that are not scholarships or fellowships under these 
guidelines might, depending upon the circumstances, be taxable 
under Chapter 42 of the Code.\115\
---------------------------------------------------------------------------
    \114\ Rev. Proc. 76-47, 1976-2 C.B. 670. The revenue procedure 
defines an employer-related program as a program that treats some or 
all of the employees, or children of some or all of the employees, of 
an employer as a group from which grantees of some or all of the grants 
will be selected, limits the potential grantees for some or all of the 
grants to individuals who are employees or children of employees of an 
employer, or otherwise gives such individuals a preference or priority 
over others in being selected as grantees.
    \115\ Treas. Reg. sec. 53.4941(d)-2(f)(2).
---------------------------------------------------------------------------
    Under Revenue Procedure 76-47, a grant made under an 
employer-related grant program that satisfies seven conditions 
and a percentage test is considered a scholarship or 
fellowship.\116\ Grants awarded to children of employees and to 
employees are considered as having been awarded under separate 
programs for purposes of the revenue procedure, regardless of 
whether they are awarded under separately administered 
programs. All such grants must satisfy each of the seven 
conditions to obtain advance approval of the grant program. The 
percentage test applicable to grants to children of employees 
requires that the number of grants awarded not exceed either 25 
percent of the eligible applicants considered by the selection 
committee in selecting grant recipients or 10 percent of those 
eligible for grants (regardless of whether they submitted grant 
applications). The percentage test applicable to grants to 
employees requires that the number of grants awarded not exceed 
10 percent of eligible applicants considered by the selection 
committee in selecting grant recipients. If the seven 
conditions are met, but the relevant percentage test is not 
satisfied, then the question of whether the grants constitute 
scholarships or fellowships is based upon all of the facts and 
circumstances.
---------------------------------------------------------------------------
    \116\ The seven conditions include: (1) the program must not be 
used to recruit employees, to induce employees to continue their 
employment, or to compel a course of action sought by the employer; (2) 
the selection of grant recipients must be made by a committee 
consisting of independent individuals; (3) the program must impose 
identifiable minimum requirements for grant eligibility; (4) the 
selection of grant recipients must be based solely upon substantial 
objective standards that are completely unrelated to employment and to 
the employer's line of business; (5) a grant may not be terminated 
because the recipient or the recipient's parent terminates employment 
with the employer; (6) the courses of study for which grants are 
available must not be limited to those would be of particular benefit 
to the employer or the foundation; and (7) the terms of the grant and 
the courses of study for which grants are available must meet all other 
requirements of section 117 and must be consistent with the 
disinterested purpose of education for personal benefit rather than for 
the benefit of the employer or the foundation.
---------------------------------------------------------------------------
    Similar requirements and percentage limits apply to 
determine whether educational loans made by a private 
foundation under an employer-related loan program are taxable 
expenditures.\117\ If an employer-related program encompasses 
educational loans and scholarship or fellowship grants to the 
same group of eligible employees or employees' children, the 
percentage tests applicable to the loan program apply to the 
total number of individuals receiving combined grants of 
scholarships, fellowships, and educational loans.\118\
---------------------------------------------------------------------------
    \117\ Rev. Proc. 80-39, 1980-2 C.B. 772.
    \118\ Id.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the quantitative limits set 
forth in Revenue Procedure 76-47 are too low for employer-
related grant programs that provide scholarships or fellowships 
to children of employees. The Committee believes that higher 
percentage limits will encourage increases in grants made for 
educational purposes. The Committee also believes that the 
higher percentage limits should be available only in cases 
where the foundation maintains a comparable grant program for 
children who are not affiliated with the employer to which the 
employer-related grant program relates.

                        EXPLANATION OF PROVISION

    The percentage limits set forth in Revenue Procedure 76-47 
for grants to children of employees are increased to 35 percent 
of eligible applicants considered by the selection committee or 
20 percent of those eligible for the grants. However, the 
higher percentage limits are available only if the private 
foundation meets the other requirements of the Revenue 
Procedure and demonstrates that the foundation provides a 
comparable number and aggregate amount of grants during the 
same grant-program year to individuals who are not such 
employees, children or dependents of such employees, or 
affiliated with the employer of such employees. The provision 
does not amend the percentage limits for grants to employees, 
or the percentage limits of Revenue Procedure 80-39 relating to 
loan programs or programs which encompass both loans and 
grants.

                             EFFECTIVE DATE

    Revenue Procedure 76-47 is to be amended effective for 
grants awarded after the date of enactment.

 J. Treatment of Certain Hospital Support Organizations in Determining 
                        Acquisition Indebtedness


(Sec. 310 of the bill and sec. 514 of the Code)

                              PRESENT LAW

    In general, income of a tax-exempt organization that is 
produced by debt-financed property is treated as unrelated 
business income in proportion to the acquisition indebtedness 
on the income-producing property. Acquisition indebtedness 
generally means the amount of unpaid indebtedness incurred by 
an organization to acquire or improve the property and 
indebtedness that would not have been incurred but for the 
acquisition or improvement of the property. However, under an 
exception, acquisition indebtedness does not include 
indebtedness incurred by certain qualified organizations to 
acquire or improve real property. Qualified organizations 
include pension trusts, educational institutions, and title-
holding companies.

                           REASONS FOR CHANGE

    The Committee believes that certain indebtedness of 
qualified hospital support organizations should not be 
considered acquisition indebtedness for purposes of the tax on 
debt-financed income.

                        EXPLANATION OF PROVISION

    The provision expands the exception to the definition of 
acquisition indebtedness in the case of a qualified hospital 
support organization. The exception applies to eligible 
indebtedness (or the qualified refinancing thereof) of the 
qualified hospital support organization.
    A qualified hospital support organization is a supporting 
organization (under section 509(a)(3)) of a hospital that is an 
academic health center (under section 119(d)(4)(B)). The assets 
of the supporting organization have to meet certain 
requirements. First, more than half of the value of the 
organization's assets at any time since its organization (1) 
have to have been acquired, directly or indirectly, by 
testamentary gift or devise, and (2) have to consist of real 
property. In addition, the fair market value of the 
organization's real estate acquired by gift or devise has to 
exceed 25 percent of the fair market value of all investment 
assets held by the organization immediately prior to the time 
that the eligible indebtedness was incurred. These requirements 
have to be met each time eligible indebtedness was incurred or 
a qualified refinancing thereof occurs.
    Eligible indebtedness means indebtedness secured by real 
property acquired directly or indirectly by gift or devise, the 
proceeds of which are used exclusively to acquire a leasehold 
interest in or to improve or repair the property. A qualified 
refinancing of eligible indebtedness occurs if the refinancing 
does not exceed the amount of refinanced eligible indebtedness 
immediately before the refinancing.

                             EFFECTIVE DATE

    The provision applies to indebtedness incurred after 
December 31, 2003.

K. Charitable Contribution Deduction for Certain Expenses in Support of 
                   Native Alaskan Subsistence Whaling


(Sec. 311 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.\119\ 
Individuals who elect the standard deduction may not claim a 
deduction for charitable contributions made during the taxable 
year.
---------------------------------------------------------------------------
    \119\ Sec. 170. Section references are to the Internal Revenue Code 
of 1986 unless otherwise indicated.
---------------------------------------------------------------------------
    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.\120\ 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 by 
reimbursement, unless there is no significant element of 
personal pleasure, recreation, or vacation in such travel.
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    \120\ Treas. Reg. sec. 1.170A-1(g).
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                           REASONS FOR CHANGE

    The Committee believes that subsistence bowhead whale 
hunting activities are important to certain native peoples of 
Alaska and further charitable purposes. The Committee believes 
that certain expenses paid by individuals recognized as whaling 
captains by the Alaska Eskimo Whaling Commission in the conduct 
of sanctioned whaling activities conducted pursuant to the 
management plan of that Commission should be deductible as 
charitable contributions even though they are paid other than 
directly to a charitable organization.

                        EXPLANATION OF PROVISION

    The provision allows individuals to claim a deduction under 
section 170 not exceeding $10,000 per taxable year for certain 
expenses incurred in carrying out sanctioned whaling 
activities. The deduction would be 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 would be 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. The Committee intends that the Secretary shall 
require that the taxpayer substantiate deductible expenses by 
maintaining appropriate written records that show, for example, 
the time, place, date, amount, and nature of the expense, as 
well as the taxpayer's eligibility for the deduction. In 
addition, the Committee believes that it is appropriate for the 
taxpayer to provide such substantiation as part of the 
taxpayer's income tax return, to the extent provided by the 
Secretary.
    For purposes of the provision, the term ``sanctioned 
whaling activities'' means subsistence bowhead whale hunting 
activities conducted pursuant to the management plan of the 
Alaska Eskimo Whaling Commission.

                             EFFECTIVE DATE

    The provision is effective for contributions made after 
December 31, 2003.

     L. Matching Grants to Low-Income Taxpayer Clinics for Return 
                              Preparation


(Sec. 312 of the bill and new sec. 7526A of the Code)

                              PRESENT LAW

    The Code provides that the Secretary is authorized to 
provide up to $6 million per year in matching grants to certain 
low-income taxpayer clinics. Eligible clinics \121\ are those 
that charge no more than a nominal fee to either represent low-
income taxpayers in controversies with the IRS or provide tax 
information to individuals for whom English is a second 
language. No clinic can receive more than $100,000 per year.
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    \121\ Eligible clinics must be either: (1) part of an accredited 
law, business, or accounting school; or (2) a tax-exempt organization.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the existing low-income 
taxpayer clinics provide an invaluable service to taxpayers and 
have increased compliance with the Code by providing 
representation and guidance to taxpayers who might otherwise be 
uncertain about their rights and obligations under the Code. 
Therefore, the Committee believes that creating a new matching 
grant program, focused entirely on assisting taxpayers with the 
preparation of their Federal tax returns, will also increase 
compliance with our tax laws.

                        EXPLANATION OF PROVISION

    The bill authorizes up to $10 million annually in matching 
grants for low-income taxpayer assistance clinics. These 
clinics may provide routine tax return preparation and filing 
services to low income taxpayers.

                             EFFECTIVE DATE

    The provision is effective for grants made after the date 
of enactment.

                 TITLE IV. SOCIAL SERVICES BLOCK GRANT


(Secs. 401-403 of the bill)

                              PRESENT LAW

    Social Services Block Grant Funding (``SSBG''), also known 
as ``Title XX'' (because it is Title XX of the Social Security 
Act), is a flexible funding stream, providing states with 
resources to support a variety of social services. SSBG funds 
can be used to assist the elderly and disabled so that they do 
not need to enter institutions, to prevent child and elder 
abuse, to provide child care, to promote and support adoption, 
and for several other services. There are certain specified 
limitations so that SSBG cannot fund most medical care, for 
example, or cash welfare payments. It is a mandatory capped 
entitlement, distributed by a population-based formula among 
the states.
    States use SSBG in differing ways. Much of the funding 
supports local social service providers, including faith-
related organizations, through contracts with state and local 
governments. Overall, in fiscal year 1999, SSBG spending was as 
follows: 13.4 percent for ``prevention'' and case management; 
13 percent for day care; 12.4 percent for child and adult 
protective services; 10.9 percent for foster care; 7.4 percent 
for home-based services. There are several other categories in 
the expenditure data as well.
    Prior to the 1996 welfare reform law, SSBG was funded at 
$2.8 billion. That legislation reduced SSBG to $2.38 billion, 
as part of achieving budgetary savings, and permitted states to 
transfer up to 10 percent of their new Temporary Assistance for 
Needy Families (TANF) welfare block grant allocations to SSBG. 
(Any transferred funds are required to be spent on behalf of 
families below 200 percent of poverty.) In 1998, as part of the 
TEA-21 highway legislation, SSBG funding as further reduced, 
declining to $1.7 billion for fiscal year 2001 and fiscal year 
2002. The TANF transfer was further limited to 4.25 percent.

                           REASONS FOR CHANGE

    The Committee believes that an increase in funding for SSBG 
will allow social service organizations to provide more 
assistance to families in need and disadvantaged individuals. 
The flexible nature of SSBG permits states and localities to 
choose their own priorities for the uses of the increased 
funding.

                        EXPLANATION OF PROVISION

    The provision increases SSBG funding to $1.975 billion for 
fiscal year 2003 and $2.8 billion for fiscal year 2004. In 
addition, the TANF transfer limit is restored to 10 percent. 
These two measures provide additional resources to faith-
related social service organizations. Finally, the Secretary of 
HHS is required to submit annual reports on SSBG expenditures 
to the Congress.

                             EFFECTIVE DATE

    The provision is effective for amounts made available for 
fiscal year 2003 and for amounts made available each fiscal 
year thereafter. The provision requiring annual reports applies 
to such reports with respect to fiscal year 2002 and each 
fiscal year thereafter.

                TITLE V. INDIVIDUAL DEVELOPMENT ACCOUNTS


(Sec. 501-512 of the bill)

                              PRESENT LAW

    Individual development accounts were first authorized by 
the Personal Work and Responsibility Act of 1996. In 1998, the 
Assets for Independence Act established a five-year $125 
million demonstration program to permit certain eligible 
individuals to open and make contributions to an individual 
development account. Contributions by an individual to an 
individual development account do not receive a tax preference 
but are matched by contributions from a State program, a 
participating nonprofit organization, or other ``qualified 
entity.'' The IRS has ruled that matching contributions by a 
qualified entity are a gift and not taxable to the account 
owner.\122\ The qualified entity chooses a matching rate, which 
must be between 50 and 400 percent. Withdrawals from individual 
development accounts can be made for certain higher education 
expenses, a first home purchase, or small-business 
capitalization expenses. Matching contributions (and earnings 
thereon) typically are held separately from the individuals' 
contributions (and earnings thereon) and must be paid directly 
to a mortgage provider, university, or business capitalization 
account at a financial institution. The Department of Health 
and Human Services administers the individual development 
account program.
---------------------------------------------------------------------------
    \122\ Rev. Rul. 99-44, 1999-2 C.B. 549.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee recognizes that the rate of private savings 
in the United States is too low. In particular, many low-income 
individuals either have inadequate savings or no savings at 
all. The Committee believes that a tax-subsidized match by 
financial institutions may help encourage more savings by low-
income working individuals. The program is intended to 
encourage a pattern of individual savings and wealth 
accumulation. Finally, the Committee believes that the program 
will allow individuals to use their savings for three important 
purposes: (1) to afford better educations; (2) to achieve home 
ownership; and (3) to start their own businesses.

                        EXPLANATION OF PROVISION

    The provision provides for a nonrefundable tax credit for 
an eligible entity (i.e., a qualified financial institution) 
that has an individual development account program in a taxable 
year. The tax credit equals the amount of matching 
contributions made by the eligible entity under the program (up 
to $500 per taxable year) plus $50 for each individual 
development account maintained during the taxable year under 
the program. Except in the first year that each account is 
open, the $50 credit is available only for accounts with a 
balance of more than $100 at year-end (including matching 
funds). The $50 credit is limited to seven years (the year the 
account is created and the six years immediately thereafter). 
The credit for matching funds is not allowed with respect to an 
individual's account if such individual has outstanding student 
loans, child support payments, or Federal tax liability. No 
deduction or other credit is available with respect to the 
amount of matching funds taken into account in determining the 
credit.
    The credit applies with respect to the first 300,000 
individual development accounts opened before January 1, 2012, 
and with respect to matching funds for participant 
contributions that are made after December 31, 2004, and before 
January 1, 2012. An account is considered open if at any time 
the balance in the account exceeds $100 (including matching 
amounts). The maximum amount of annual contributions to an 
individual development account by an otherwise eligible 
individual is limited to three times the maximum credit amount 
for matching contributions for such year. The individual 
development accounts will be available on the following basis: 
(1) a maximum of 100,000 accounts may be opened after December 
31, 2004 and before January 1, 2008; (2) a second 100,000 
accounts may be opened after December 31, 2007 and before 
January 1, 2010, if the entire 100,000 of authorized accounts 
are opened after December 31, 2004 and before January 1, 2008 
and the Secretary of the Treasury determines that these 
accounts are being reasonably and responsibly administered; 
\123\ and (3) a third 100,000 accounts may be opened after 
December 31, 2009 and before January 1, 2012 if the previous 
cohorts of 100,000 accounts have been opened under the schedule 
described above and the Secretary of the Treasury makes a four-
part determination. Specifically, the Secretary will have to 
determine: (1) that all previously opened accounts have been 
reasonably and responsibly administered to date; (2) that the 
individual development account program has increased net 
savings of participants in the program; (3) whether 
participants in the individual development account program have 
increased Federal income tax liability and decreased 
utilization of Federal assistance programs (e.g., Temporary 
Assistance to Needy Families and Food Stamps) relative to 
similarly situated individuals that did not participate in the 
individual development account program; and (4) that the sum of 
the increased Federal tax liability and reduction of Federal 
assistance program benefits to participants in the individual 
development account program is greater than the cost of the 
individual development account program to the Federal 
government. If the Secretary finds that any of the four 
determinations has not been satisfied, the Congress will have 
the discretion to authorize the third 100,000 accounts after 
the Secretary makes his or her report to the Congress regarding 
the four determinations. The third 100,000 accounts must be 
equally divided among the States. For all accounts, the 
Secretary will take steps to encourage use of individual 
development accounts in rural areas.
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    \123\ If less than 100,000 accounts are opened before January 1, 
2008, then the number of accounts that can be opened after December 31, 
2007 and before January 1, 2010 will be reduced to the lesser of 75,000 
accounts or three times the number of accounts opened before January 1, 
2007.
---------------------------------------------------------------------------
    Nonstudent U.S. citizens or lawful permanent residents 
between the ages of 18 and 60 (inclusive) who meet certain 
income requirements are eligible to open and contribute to an 
individual development account. The income limit for 
participation is modified adjusted gross income of $18,000 for 
single filers, $38,000 for joint filers, and $30,000 for head-
of-household filers.\124\ Eligibility in a taxable year 
generally is based on the previous year's modified adjusted 
gross income and circumstances (e.g., status as a student). 
Modified adjusted gross income is adjusted gross income plus 
certain items that are not includible in gross income. The 
items added are tax-exempt interest and the amounts otherwise 
excluded from gross income under Code sections 86, 893, 911, 
931, and 933 (relating to the exclusion of certain social 
security and Tier 1 railroad retirement benefits; the exclusion 
of compensation of employees of foreign governments and 
international organizations; the exclusion of income of U.S. 
citizens or residents living abroad; the exclusion of income 
for residents of Guam, American Samoa, and the Northern Mariana 
Islands; and the exclusion of income for residents of Puerto 
Rico). The income limits are adjusted for inflation after 2003. 
These amounts are rounded to the nearest multiple of 50 
dollars.
---------------------------------------------------------------------------
    \124\ Married taxpayers filing separate returns are not eligible to 
open an IDA or to receive matching funds for an IDA that is already 
open.
---------------------------------------------------------------------------
    Under the provision, an individual development account 
must: (1) be owned by the eligible individual for whom the 
account was established; (2) consist only of cash 
contributions; (3) be held by a person authorized to be a 
trustee of any individual retirement account under section 
408(a)(2); and (4) not commingle account assets with other 
property (except in a common trust fund or common investment 
fund). These requirements must be reflected in the written 
governing instrument creating the account. The entity 
establishing the program is required to maintain separate 
accounts for the individual's contributions (and earnings 
thereon) and for matching funds and earnings thereon (a 
``parallel account'').
    Contributions to individual development accounts by 
individuals are not deductible and earnings thereon are taxable 
to the account holder. Matching contributions and earnings 
thereon are not taxable to the account holder. Any amount 
(including earnings) in an individual development account and 
matching contributions are disregarded for purposes of any 
means-tested Federal programs.
    The provision permits individuals to withdraw amounts from 
an individual development account for qualified expenses of the 
account owner, owner's spouse, or dependents as well as for 
nonqualified expenses, subject to certain restrictions. 
Qualified expenses include qualified: (1) higher education 
expenses (as generally defined in section 529(e)(3)); (2) 
first-time homebuyer costs (as generally provided in section 72 
(t)(8)); (3) business capitalization or expansion costs 
(expenditures made pursuant to a business plan that has been 
approved by the financial institution); (4) rollovers of the 
balance of the account (including the parallel account) to 
another individual development account for the benefit of the 
same owner; and (5) final distributions in the case of a 
deceased account owner. Withdrawals for qualified expenses must 
be made from funds that have been in the account for at least 
one year and must be paid directly to the unrelated third party 
to whom the amount is due, except in the case of expenses under 
a qualified business plan, rollover, or final distribution. 
Such withdrawals generally are not permitted until the account 
owner completes a financial education course offered by a 
qualified financial institution. The Secretary of the Treasury 
(the ``Secretary'') is required to establish minimum standards 
for such courses. Withdrawals for nonqualified expenses may 
result in the account owner's forfeiture of matching funds. The 
amount of the forfeiture is the lesser of: (1) an amount equal 
to the nonqualified withdrawal; or (2) the excess of the amount 
in the parallel account (excluding earnings on matching funds) 
over the amount remaining in the individual development account 
after the nonqualified withdrawal. If the individual 
development account (or a portion thereof) is pledged as 
security for a loan, then the portion so used will be treated 
as a nonqualified withdrawal and will result in the loss of an 
equal amount of matching funds from the parallel account. At 
age 65, an individual may withdraw the balance of his or her 
individual development account for nonqualified purposes 
without losing matching amounts.
    The qualified entity administering the individual 
development account program generally is required to make 
quarterly payments of matching funds to a parallel account on a 
dollar-for-dollar basis for the first $500 contributed by the 
account owner in a taxable year. Matching funds also may be 
provided by State, local, or private sources. Balances of the 
individual development account and parallel account must be 
reported annually to the account owner. If an account owner 
ceases to meet eligibility requirements, matching funds 
generally may not be contributed during the period of 
ineligibility. Any amount withdrawn from a parallel account is 
not includible in an eligible individual's gross income or the 
account sponsor's gross income.
    Qualified entities administering a qualified program are 
required to report to the Secretary that the program is 
administered in accordance with legal requirements. If the 
Secretary determines that the program was not so operated, the 
Secretary would have the power to terminate the program. 
Qualified entities also are required to report annually to the 
Secretary information about: (1) the number of individuals 
making contributions to individual development accounts; (2) 
the amounts contributed by such individuals; (3) the amount of 
matching funds contributed; (4) the amount of funds withdrawn 
and for what purpose; (5) balance information; and (6) any 
other information that the Secretary deems necessary. The 
fiduciary requirements of Title 12 of the United States Code 
with respect to insured depository institutions and insured 
credit unions (as defined therein) continue to apply to those 
financial institutions participating in the individual 
development account program. Qualified entities are prohibited 
from charging any fees with regard to the individual 
development accounts.
    The Secretary is authorized to prescribe necessary 
regulations, including rules to permit individual development 
account program sponsors to verify eligibility of individuals 
seeking to open accounts and rules to allow a financial 
institution (e.g., a tax-exempt credit union) to transfer those 
credits to another taxpayer. The Secretary also is authorized 
to provide rules to recapture credits claimed with respect to 
individuals who forfeit matching funds.
    The Secretary must submit annual reports to Congress on the 
status of the qualified individual account program.

                             EFFECTIVE DATE

    The provision is effective for taxable years ending after 
December 31, 2004, and beginning before January 1, 2012.

              TITLE VI. MANAGEMENT OF EXEMPT ORGANIZATIONS


(Sec. 601 of the bill)

                        EXPLANATION OF PROVISION

    The provision authorizes $80 million to be appropriated to 
the Secretary of the Treasury for each fiscal year to carry out 
the administration of exempt organizations by the IRS.
    The provision authorizes $3 million to be appropriated to 
the Secretary of the Treasury to carry out the provisions of 
Public Laws 106-230 and 107-276, relating to section 527.

                           REASONS FOR CHANGE

    The Committee believes that the oversight and 
administration of exempt organizations by the IRS is critical 
to ensuring that exempt organizations operate consistent with 
their exempt purposes and do not abuse the public trust. The 
Committee believes that the IRS currently is underfunded in 
this regard.
    Public Laws 106-230 and 107-276 imposed substantial new 
filing requirements on section 527 organizations and required 
the IRS to establish and maintain electronic filing capability 
and a searchable on-line database for public use. The Committee 
believes that the efficient and successful completion of this 
task requires separate funding by the Congress.

                             EFFECTIVE DATE

    The authorizations are effective on the date of enactment.

                     TITLE VII. REVENUE PROVISIONS


             A. Provisions Designed To Curtail Tax Shelters


          1. Clarification of the Economic Substance Doctrine


(Sec. 701 of the bill and sec. 7701 of the Code)

                              PRESENT LAW

In general

    The Code provides specific rules regarding the computation 
of taxable income, including the amount, timing, source, and 
character of items of income, gain, loss and deduction. These 
rules are designed to provide for the computation of taxable 
income in a manner that provides for a degree of specificity to 
both taxpayers and the government. Taxpayers generally may plan 
their transactions in reliance on these rules to determine the 
federal income tax consequences arising from the transactions.
    In addition to the statutory provisions, courts have 
developed several doctrines that can be applied to deny the tax 
benefits of tax motivated transactions, notwithstanding that 
the transaction may satisfy the literal requirements of a 
specific tax provision. The common-law doctrines are not 
entirely distinguishable, and their application to a given set 
of facts is often blurred by the courts and the IRS. Although 
these doctrines serve an important role in the administration 
of the tax system, invocation of these doctrines can be seen as 
at odds with an objective, ``rule-based'' system of taxation. 
Nonetheless, courts have applied the doctrines to deny tax 
benefits arising from certain transactions.\125\
---------------------------------------------------------------------------
    \125\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d 
Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert. denied 526 U.S. 
1017 (1999).
---------------------------------------------------------------------------
    A common-law doctrine applied with increasing frequency is 
the ``economic substance'' doctrine. In general, this doctrine 
denies tax benefits arising from transactions that do not 
result in a meaningful change to the taxpayer's economic 
position other than a purported reduction in federal income 
tax.\126\
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    \126\ Closely related doctrines also applied by the courts 
(sometimes interchangeable with the economic substance doctrine) 
include the ``sham transaction doctrine'' and the ``business purpose 
doctrine''. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960) 
(denying interest deductions on a ``sham transaction'' whose only 
purpose was to create the deductions).
---------------------------------------------------------------------------
            Economic substance doctrine
    Courts generally deny claimed tax benefits if the 
transaction that gives rise to those benefits lacks economic 
substance independent of tax considerations--notwithstanding 
that the purported activity actually occurred. The tax court 
has described the doctrine as follows:

          The tax law . . . requires that the intended 
        transactions have economic substance separate and 
        distinct from economic benefit achieved solely by tax 
        reduction. The doctrine of economic substance becomes 
        applicable, and a judicial remedy is warranted, where a 
        taxpayer seeks to claim tax benefits, unintended by 
        Congress, by means of transactions that serve no 
        economic purpose other than tax savings.\127\
---------------------------------------------------------------------------
    \127\ ACM Partnership v. Commissioner, 73 T.C.M. at 2215.
---------------------------------------------------------------------------
            Business purpose doctrine
    Another common law doctrine that overlays and is often 
considered together with (if not part and parcel of) the 
economic substance doctrine is the business purpose doctrine. 
The business purpose test is a subjective inquiry into the 
motives of the taxpayer--that is, whether the taxpayer intended 
the transaction to serve some useful non-tax purpose. In making 
this determination, some courts have bifurcated a transaction 
in which independent activities with non-tax objectives have 
been combined with an unrelated item having only tax-avoidance 
objectives in order to disallow the tax benefits of the overall 
transaction.\128\
---------------------------------------------------------------------------
    \128\ ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
---------------------------------------------------------------------------

Application by the courts

            Elements of the doctrine
    There is a lack of uniformity regarding the proper 
application of the economic substance doctrine. Some courts 
apply a conjunctive test that requires a taxpayer to establish 
the presence of both economic substance (i.e., the objective 
component) and business purpose (i.e., the subjective 
component) in order for the transaction to sustain court 
scrutiny.\129\ A narrower approach used by some courts is to 
invoke the economic substance doctrine only after a 
determination that the transaction lacks both a business 
purpose and economic substance (i.e., the existence of either a 
business purpose or economic substance would be sufficient to 
respect the transaction).\130\ A third approach regards 
economic substance and business purpose as ``simply more 
precise factors to consider'' in determining whether a 
transaction has any practical economic effects other than the 
creation of tax benefits.\131\
---------------------------------------------------------------------------
    \129\ See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th 
Cir. 1993) (``The threshold question is whether the transaction has 
economic substance. If the answer is yes, the question becomes whether 
the taxpayer was motivated by profit to participate in the 
transaction.'')
    \130\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d 89, 
91-92 (4th Cir. 1985) (``To treat a transaction as a sham, the court 
must find that the taxpayer was motivated by no business purposes other 
than obtaining tax benefits in entering the transaction, and, second, 
that the transaction has no economic substance because no reasonable 
possibility of a profit exists.''); IES Industries v. United States, 
253 F.3d 350, 358 (8th Cir. 2001) (``In determining whether a 
transaction is a sham for tax purposes [under the Eighth Circuit test], 
a transaction will be characterized as a sham if it is not motivated by 
any economic purpose out of tax considerations (the business purpose 
test), and if it is without economic substance because no real 
potential for profit exists'' (the economic substance test).'') As 
noted earlier, the economic substance doctrine and the sham transaction 
doctrine are similar and sometimes are applied interchangeably. For a 
more detailed discussion of the sham transaction doctrine, see, e.g., 
Joint Committee on Taxation, Study of Present-Law Penalty and Interest 
Provisions as Required by Section 3801 of the Internal Revenue Service 
Restructuring and Reform Act of 1998 (including Provisions Relating to 
Corporate Tax Shelters) (JCS-3-99) at 182.
    \131\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247; 
James v. Commissioner, 899 F.2d 905, 908 (10th Cir. 1995); Sacks v. 
Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (``Instead, the 
consideration of business purpose and economic substance are simply 
more precise factors to consider * * *. We have repeatedly and 
carefully noted that this formulation cannot be used as a 'rigid two-
step analysis'.'').
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            Profit potential
    There also is a lack of uniformity regarding the necessity 
and level of profit potential necessary to establish economic 
substance. Since the time of Gregory, several courts have 
denied tax benefits on the grounds that the subject 
transactions lacked profit potential.\132\ In addition, some 
courts have applied the economic substance doctrine to disallow 
tax benefits in transactions in which a taxpayer was exposed to 
risk and the transaction had a profit potential, but the court 
concluded that the economic risks and profit potential were 
insignificant when compared to the tax benefits.\133\ Under 
this analysis, the taxpayer's profit potential must be more 
than nominal. Conversely, other courts view the application of 
the economic substance doctrine as requiring an objective 
determination of whether a ``reasonable possibility of profit'' 
from the transaction existed apart from the tax benefits.\134\ 
In these cases, in assessing whether a reasonable possibility 
of profit exists, it is sufficient if there is a nominal amount 
of pre-tax profit as measured against expected net tax 
benefits.
---------------------------------------------------------------------------
    \132\ See, e.g., Knetsch, 364 U.S. at 361; Goldstein v. 
Commissioner, 364 F.2d 734 (2d Cir. 1966) (holding that an 
unprofitable, leveraged acquisition of Treasury bills, and accompanying 
prepaid interest deduction, lacked economic substance); Ginsburg v. 
Commissioner, 35 T.C.M. (CCH) 860 (1976) (holding that a leveraged 
cattle-breeding program lacked economic substance).
    \133\ See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-40 
(disallowing deduction even though taxpayer had a possibility of small 
gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94 
T.C. 738, 768 (1990) (stating, ``potential for gain * * * is 
infinitesimally nominal and vastly insignificant when considered in 
comparison with the claimed deductions'').
    \134\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d at 
94 (the economic substance inquiry requires an objective determination 
of whether a reasonable possibility of profit from the transaction 
existed apart from tax benefits); Compaq Computer Corp. v. 
Commissioner, 277 F.3d at 781 (applied the same test, citing Rice's 
Toyota World); IES Industries v. United States, 253 F.3d at 354 (the 
application of the objective economic substance test involves 
determining whether there was a ``reasonable possibility of profit * * 
* apart from tax benefits.'').
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                           REASONS FOR CHANGE

    The Committee is concerned that many taxpayers are engaging 
in tax avoidance transactions that rely on the interaction of 
highly technical tax law provisions. These transactions usually 
produce surprising results that were not contemplated by 
Congress. Whether these transactions are respected usually 
hinges on whether the transaction had sufficient economic 
substance. The Committee is concerned that in addressing these 
transactions the courts, in some cases, are reaching 
conclusions inconsistent with Congressional intent. In 
addition, the Committee is concerned that in determining 
whether a transaction has economic substance, taxpayers are 
subject to different legal standards based on the circuit that 
the taxpayer is located. Thus, the Committee believes it is 
appropriate to clarify for the courts the appropriate standards 
to use in determining whether a transaction has economic 
substance.

                        EXPLANATION OF PROVISION

In general

    The bill clarifies and enhances the application of the 
economic substance doctrine. The bill provides that a 
transaction has economic substance (and thus satisfies the 
economic substance doctrine) only if the taxpayer establishes 
that (1) the transaction changes in a meaningful way (apart 
from Federal income tax consequences) the taxpayer's economic 
position, and (2) the taxpayer has a substantial non-tax 
purpose for entering into such transaction and the transaction 
is a reasonable means of accomplishing such purpose.\135\
---------------------------------------------------------------------------
    \135\ If the tax benefits are clearly contemplated and expected by 
the language and purpose of the relevant authority, it is not intended 
that such tax benefits be disallowed if the only reason for such 
disallowance is that the transaction fails the economic substance 
doctrine as defined in this provision.
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    The bill does not change current law standards used by 
courts in determining when to utilize an economic substance 
analysis. Also, the bill does not alter the court's ability to 
aggregate or disaggregate a transaction when applying the 
doctrine. The bill provides a uniform definition of economic 
substance, but does not alter court flexibility in other 
respects.

Conjunctive analysis

    The bill clarifies that the economic substance doctrine 
involves a conjunctive analysis--there must be an objective 
inquiry regarding the effects of the transaction on the 
taxpayer's economic position, as well as a subjective inquiry 
regarding the taxpayer's motives for engaging in the 
transaction. Under the bill, a transaction must satisfy both 
tests--i.e., it must change in a meaningful way (apart from 
Federal income tax consequences) the taxpayer's economic 
position, and the taxpayer must have a substantial non-tax 
purpose for entering into such transaction (and the transaction 
is a reasonable means of accomplishing such purpose)--in order 
to satisfy the economic substance doctrine. This clarification 
eliminates the disparity that exists among the circuits 
regarding the application of the doctrine, and modifies its 
application in those circuits in which either a change in 
economic position or a non-tax business purpose (without having 
both) is sufficient to satisfy the economic substance doctrine.

Non-tax business purpose

    The bill provides that a taxpayer's non-tax purpose for 
entering into a transaction (the second prong in the analysis) 
must be ``substantial,'' and that the transaction must be ``a 
reasonable means'' of accomplishing such purpose. Under this 
formulation, the non-tax purpose for the transaction must bear 
a reasonable relationship to the taxpayer's normal business 
operations or investment activities.\136\
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    \136\ See, Martin McMahon Jr., Economic Substance, Purposive 
Activity, and Corporate Tax Shelters, 94 Tax Notes 1017, 1023 (Feb. 25, 
2002) (advocates ``confining the most rigorous application of business 
purpose, economic substance, and purposive activity tests to 
transactions outside the ordinary course of the taxpayer's business--
those transactions that do not appear to contribute to any business 
activity or objective that the taxpayer may have had apart from tax 
planning but are merely loss generators.''); Mark P. Gergen, The Common 
Knowledge of Tax Abuse, 54 SMU L. Rev. 131, 140 (Winter 2001) (``The 
message is that you can pick up tax gold if you find it in the street 
while going about your business, but you cannot go hunting for it.'').
---------------------------------------------------------------------------
    In determining whether a taxpayer has a substantial non-tax 
business purpose, it is intended that an objective of achieving 
a favorable accounting treatment for financial reporting 
purposes will not be treated as having a substantial non-tax 
purpose.\137\ Furthermore, a transaction that is expected to 
increase financial accounting income as a result of generating 
tax deductions or losses without a corresponding financial 
accounting charge (i.e., a permanent book-tax difference) \138\ 
should not be considered to have a substantial non-tax purpose 
unless a substantial non-tax purpose exists apart from the 
financial accounting benefits.\139\
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    \137\ However, if the tax benefits are clearly contemplated and 
expected by the language and purpose of the relevant authority, such 
tax benefits should not be disallowed solely because the transaction 
results in a favorable accounting treatment. An example is the repealed 
foreign sales corporation rules.
    \138\ This includes tax deductions or losses that are anticipated 
to be recognized in a period subsequent to the period the financial 
accounting benefit is recognized. For example, FAS 109 in some cases 
permits the recognition of financial accounting benefits prior to the 
period in which the tax benefits are recognized for income tax 
purposes.
    \139\ Claiming that a financial accounting benefit constitutes a 
substantial non-tax purpose fails to consider the origin of the 
accounting benefit (i.e., reduction of taxes) and significantly 
diminishes the purpose for having a substantial non-tax purpose 
requirement. See, e.g., American Electric Power, Inc. v. U.S., 136 F. 
Supp. 2d 762, 791-92 (S.D. Ohio, 2001) (``AEP's intended use of the 
cash flows generated by the [corporate-owned life insurance] plan is 
irrelevant to the subjective prong of the economic substance analysis. 
If a legitimate business purpose for the use of the tax savings 'were 
sufficient to breathe substance into a transaction whose only purpose 
was to reduce taxes, [then] every sham tax-shelter device might 
succeed,''' citing Winn-Dixie v. Commissioner, 113 T.C. 254, 287 
(1999)).
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    By requiring that a transaction be a ``reasonable means'' 
of accomplishing its non-tax purpose, the bill broadens the 
ability of the courts to bifurcate a transaction in which 
independent activities with non-tax objectives are combined 
with an unrelated item having only tax-avoidance objectives in 
order to disallow the tax benefits of the overall transaction.

Profit potential

    Under the bill, a taxpayer may rely on factors other than 
profit potential to demonstrate that a transaction results in a 
meaningful change in the taxpayer's economic position; the bill 
merely sets forth a minimum threshold of profit potential if 
that test is relied on to demonstrate a meaningful change in 
economic position. If a taxpayer relies on a profit potential, 
however, the present value of the reasonably expected pre-tax 
profit must be substantial in relation to the present value of 
the expected net tax benefits that would be allowed if the 
transaction were respected.\140\ Moreover, the profit potential 
must exceed a risk-free rate of return. In addition, in 
determining pre-tax profit, fees and other transaction expenses 
and foreign taxes are treated as expenses.
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    \140\ Thus, a ``reasonable possibility of profit'' will not be 
sufficient to establish that a transaction has economic substance.
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    In applying the profit test to the lessor of tangible 
property, certain deductions and other applicable tax credits 
(such as the rehabilitation tax credit and the low income 
housing tax credit) are not taken into account in measuring tax 
benefits. Thus, a traditional leveraged lease is not affected 
by the bill to the extent it meets the present law standards.

Transactions with tax-indifferent parties

    The bill also provides special rules for transactions with 
tax-indifferent parties. For this purpose, a tax-indifferent 
party means any person or entity not subject to Federal income 
tax, or any person to whom an item would have no substantial 
impact on its income tax liability. Under these rules, the form 
of a financing transaction will not be respected if the present 
value of the tax deductions to be claimed is substantially in 
excess of the present value of the anticipated economic returns 
to the lender. Also, the form of a transaction with a tax-
indifferent party will not be respected if it results in an 
allocation of income or gain to the tax-indifferent party in 
excess of the tax-indifferent party's economic gain or income 
or if the transaction results in the shifting of basis on 
account of overstating the income or gain of the tax-
indifferent party.

Other rules

    The Secretary may prescribe regulations which provide (1) 
exemptions from the application of this bill, and (2) other 
rules as may be necessary or appropriate to carry out the 
purposes of the bill.
    No inference is intended as to the proper application of 
the economic substance doctrine under present law. In addition, 
except with respect to the economic substance doctrine, the 
provision shall not be construed as altering or supplanting any 
other common law doctrine (including the sham transaction 
doctrine), and this provision shall be construed as being 
additive to any such other doctrine.

                             EFFECTIVE DATE

    The bill applies to transactions entered into after the 
date of enactment.

       2. Penalty for Failure To Disclose Reportable Transactions


(Sec. 702 of the bill and new sec. 6707A of the Code)

                              PRESENT LAW

    Regulations under section 6011 require a taxpayer to 
disclose with its tax return certain information with respect 
to each ``reportable transaction'' in which the taxpayer 
participates.\141\
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    \141\ On October 17, 2002, Treasury Department and the IRS released 
new temporary and proposed regulations regarding the disclosure of 
reportable transactions. The regulations are effective for transactions 
entered into on or after January 1, 2003. Subsequent to the issuance of 
the new regulations, the IRS announced that, in light of the numerous 
comments received regarding the new regulations, the revised 
regulations under section 6011 will permit taxpayers who entered into 
transactions on or after January 1, 2003 (and before the filing date of 
the revised regulations) to elect to apply the revised regulations. 
Notice 2003-11, 2003-6 I.R.B. 1 (January 17, 2003).
    The discussion of present law refers to the new regulations. The 
rules that apply with respect to transactions entered into on or before 
December 31, 2002, are contained in Treas. Reg. sec. 1.6011-4T in 
effect prior to January 1, 2003.
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    There are six categories of reportable transactions. The 
first category is any transaction that is the same as (or 
substantially similar to) \142\ a transaction that is specified 
by the Treasury Department as a tax avoidance transaction whose 
tax benefits are subject to disallowance under present law 
(referred to as a ``listed transaction'').\143\
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    \142\ The regulations clarify that the term ``substantially 
similar'' includes any transaction that is expected to obtain the same 
or similar types of tax benefits and that is either factually similar 
or based on the same or similar tax strategy. Also, the term must be 
broadly construed in favor of disclosureTemp. Treas. Reg. sec. 1-6011-
4T(c)(4).
    \143\ Temp. Treas. Reg. sec. 1.6011-4T(b)(2).
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    The second category is any transaction that is offered 
under conditions of confidentiality. If a taxpayer's disclosure 
of the structure or tax aspects of the transaction is limited 
in any way by an express or implied understanding or agreement 
with or for the benefit of any person who makes or provides a 
statement, oral or written, as to the potential tax 
consequences that may result from the transaction, it is 
considered offered under conditions of confidentiality (whether 
or not the understanding is legally binding).\144\
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    \144\ Temp. Treas. Reg. sec. 1.6011-4T(b)(3).
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    The third category of reportable transaction is any 
transaction for which the taxpayer has obtained or been 
provided with contractual protection against the possibility 
that part or all of the intended tax consequences from the 
transaction will not be sustained. Such protection can include 
recission rights, the right to a refund of fees, contingent 
fees, insurance protection with respect to the tax treatment, 
or a tax indemnity or similar agreement.\145\
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    \145\ Temp. Treas. Reg. sec. 1.6011-4T(b)(4).
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    The fourth category of reportable transactions relates to 
any transaction resulting in, or that is reasonably expected to 
result in, a taxpayer claiming a loss (under section 165) of at 
least (1) $10 million in any single year or $20 million in any 
combination of years by a corporate taxpayer; (2) $5 million in 
any single year or $10 million in any combination of years by a 
partnership or S corporation; (3) $2 million in any single year 
or $4 million in any combination of years by an individual or 
trust; or (4) $50,000 in any single year for individuals or 
trusts if the loss arises with respect to foreign currency 
translation losses.\146\
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    \146\ Temp. Treas. Reg. sec. 1.6011-4T(b)(5).
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    The fifth category of reportable transactions refers to any 
transaction done by certain taxpayers \147\ in which the tax 
treatment of the transaction differs (or is expected to differ) 
by more than $10 million from its treatment for book purposes 
(using generally accepted accounting principles) in any 
year.\148\
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    \147\ The significant book-tax category applies only to taxpayers 
that are reporting companies under the Securities Exchange Act of 1934 
or business entities that have $100 million or more in gross assets.
    \148\ Temp. Treas. Reg. sec. 1.6011-4T(b)(6). The regulations 
exempt 13 types of transactions from the book-tax reportable 
transaction category. See Temp. Treas. Reg. sec. 1.6011-
4T(b)(6)(iii)(A)-(M).
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    The final category of reportable transactions is any 
transaction that results in a tax credit exceeding $250,000 
(including a foreign tax credit) if the taxpayer holds the 
underlying asset for less than 45 days.\149\
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    \149\ Temp. Treas. Reg. sec. 1.6011-4T(b)(7).
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    Under present law, there is no specific penalty for failing 
to disclose a reportable transaction; however, such a failure 
may jeopardize a taxpayer's ability to claim that any income 
tax understatement attributable to such undisclosed transaction 
is due to reasonable cause, and that the taxpayer acted in good 
faith.\150\
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    \150\Section 6664(c) provides that a taxpayer can avoid the 
imposition of a section 6662 accuracy-related penalty in cases where 
the taxpayer can demonstrate that there was reasonable cause for the 
underpayment and that the taxpayer acted in good faith. On December 31, 
2002, the Treasury Department and IRS issued proposed regulations under 
sections 6662 and 6664 (REG-126016-01) that limit the defenses 
available to the imposition of an accuracy-related penalty in 
connection with a reportable transaction when the transaction is not 
disclosed.
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                           reasons for change

    The Committee is aware that individuals and corporations 
are increasingly using sophisticated transactions to avoid or 
evade Federal income tax.\151\ Such a phenomenon could pose a 
serious threat to the efficacy of the tax system because of 
both the potential loss of revenue and the potential threat to 
the integrity of the self-assessment system.
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    \151\ In this regard, the Committee has concerns with the outcomes 
and rationales used by courts in some recent decisions involving tax-
motivated transactions. For a more detailed discussion of recent court 
decisions and other developments regarding tax shelters, see Joint 
Committee on Taxation, Background and Present Law Relating to Tax 
Shelters (JCX 19-02), March 19, 2002.
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    The Committee over two years ago began working on 
legislation to address this significant compliance problem. In 
addition, the Treasury Department, using the tools available, 
issued regulations requiring disclosure of certain transactions 
and requiring organizers and promoters of tax-engineered 
transactions to maintain customer lists and make these lists 
available to the IRS. Nevertheless, the Committee believed that 
additional legislation was needed to provide the Treasury 
Department with additional tools to assist its efforts to 
curtail abusive transactions. Moreover, the Committee believes 
that a penalty for failing to make the required disclosures, 
when the imposition of such penalty is not dependent on the tax 
treatment of the underlying transaction ultimately being 
sustained, will provide an additional incentive for taxpayers 
to satisfy their reporting obligations under the new disclosure 
provisions.

                        EXPLANATION OF PROVISION

In general

    The bill creates a new penalty for any person who fails to 
include with any return or statement any required information 
with respect to a reportable transaction. The new penalty 
applies without regard to whether the transaction ultimately 
results in an understatement of tax, and applies in addition to 
any accuracy-related penalty that may be imposed.

Transactions to be disclosed

    The bill does not define the terms ``listed transaction'' 
\152\ or ``reportable transaction,'' nor does the bill explain 
the type of information that must be disclosed in order to 
avoid the imposition of a penalty. Rather, the bill authorizes 
the Treasury Department to define a ``listed transaction'' and 
a ``reportable transaction'' under section 6011.
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    \152\ The provision states that, except as provided in regulations, 
a listed transaction means a reportable transaction, which is the same 
as, or substantially similar to, a transaction specifically identified 
by the Secretary as a tax avoidance transaction for purposes of section 
6011. For this purpose, it is expected that the definition of 
``substantially similar'' will be the definition used in Temp. Treas. 
Reg. sec. 1.6011-4T(b)(2). However, the Secretary may modify this 
definition (as well as the definitions of ``listed transaction'' and 
``reportable transactions'') as appropriate.
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Penalty rate

    The penalty for failing to disclose a reportable 
transaction is $50,000. The amount is increased to $100,000 if 
the failure is with respect to a listed transaction. For large 
entities and high net worth individuals, the penalty amount is 
doubled (i.e., $100,000 for a reportable transaction and 
$200,000 for a listed transaction). The penalty cannot be 
waived with respect to a listed transaction. As to reportable 
transactions, the penalty can be rescinded or abated only if: 
(1) the taxpayer on whom the penalty is imposed has a history 
of complying with the Federal tax laws, (2) it is shown that 
the violation is due to an unintentional mistake of fact, (3) 
imposing the penalty would be against equity and good 
conscience, and (4) rescinding the penalty would promote 
compliance with the tax laws and effective tax administration. 
The authority to rescind the penalty can only be exercised by 
the IRS Commissioner personally or the head of the Office of 
Tax Shelter Analysis. Thus, the penalty cannot be rescinded by 
a revenue agent, an appeals officer, or any other IRS 
personnel. The decision to rescind a penalty must be 
accompanied by a record describing the facts and reasons for 
the action and the amount rescinded. There will be no taxpayer 
right to appeal a refusal to rescind a penalty. The IRS also is 
required to submit an annual report to Congress summarizing the 
application of the disclosure penalties and providing a 
description of each penalty rescinded under this provision and 
the reasons for the rescission.
    A ``large entity'' is defined as any entity with gross 
receipts in excess of $10 million in the year of the 
transaction or in the preceding year. A ``high net worth 
individual'' is defined as any individual whose net worth 
exceeds $2 million, based on the fair market value of the 
individual's assets and liabilities immediately before entering 
into the transaction.
    A public entity that is required to pay a penalty for 
failing to disclose a listed transaction (or is subject to an 
understatement penalty attributable to a non-disclosed listed 
transaction, a non-disclosed reportable avoidance transaction, 
or a transaction that lacks economic substance \153\) must 
disclose the imposition of the penalty in reports to the 
Securities and Exchange Commission for such period as the 
Secretary shall specify. The bill applies without regard to 
whether the taxpayer determines the amount of the penalty to be 
material to the reports in which the penalty must appear, and 
treats any failure to disclose a transaction in such reports as 
a failure to disclose a listed transaction. A taxpayer must 
disclose a penalty in reports to the Securities and Exchange 
Commission once the taxpayer has exhausted its administrative 
and judicial remedies with respect to the penalty (or if 
earlier, when paid).
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    \153\ These categories of transactions are described in greater 
detail below in connection with the provisions modifying the accuracy-
related penalty for listed and certain reportable transactions and a 
penalty for understatements attributable to transactions that lack 
economic substance.
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                             EFFECTIVE DATE

    The bill is effective for returns and statements the due 
date for which is after the date of enactment.

     3. Modifications to the Accuracy-Related Penalties for Listed 
   Transactions and Reportable Transactions Having a Significant Tax 
                           Avoidance Purpose


(Sec. 703 of the bill and new sec. 6662A of the Code)

                              PRESENT LAW

    The accuracy-related penalty applies to the portion of any 
underpayment that is attributable to (1) negligence, (2) any 
substantial understatement of income tax, (3) any substantial 
valuation misstatement, (4) any substantial overstatement of 
pension liabilities, or (5) any substantial estate or gift tax 
valuation understatement. If the correct income tax liability 
exceeds that reported by the taxpayer by the greater of 10 
percent of the correct tax or $5,000 ($10,000 in the case of 
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.\154\ The amount of 
any understatement generally is reduced by any portion 
attributable to an item if (1) the treatment of the item is 
supported by substantial authority, or (2) facts relevant to 
the tax treatment of the item were adequately disclosed and 
there was a reasonable basis for its tax treatment.\155\
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    \154\ Sec. 6662.
    \155\ Sec. 6662(d)(2)(B).
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    Special rules apply with respect to tax shelters.\156\ For 
understatements by non-corporate taxpayers attributable to tax 
shelters, the penalty may be avoided only if the taxpayer 
establishes that, in addition to having substantial authority 
for the position, the taxpayer 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.
---------------------------------------------------------------------------
    \156\ Sec. 6662(d)(2)(C).
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    The understatement penalty generally is abated (even with 
respect to tax shelters) in cases in which the taxpayer can 
demonstrate that there was ``reasonable cause'' for the 
underpayment and that the taxpayer acted in good faith.\157\ 
The relevant regulations provide that reasonable cause exists 
where the taxpayer ``reasonably relies in good faith on an 
opinion based on a professional tax advisor's analysis of the 
pertinent facts and authorities [that] . . . unambiguously 
concludes that there is a greater than 50-percent likelihood 
that the tax treatment of the item will be upheld if 
challenged'' by the IRS.\158\
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    \157\ Sec. 6664(c).
    \158\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 
1.6664-4(c).
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                           REASONS FOR CHANGE

    Because the Treasury shelter initiative emphasizes 
combating abusive tax avoidance transactions by requiring 
increased disclosure of such transactions by all parties 
involved, the Committee believes that taxpayers should be 
subject to a strict liability penalty on an understatement of 
tax that is attributable to non-disclosed listed transactions 
or non-disclosed reportable transactions that have a 
significant purpose of tax avoidance. Furthermore, in order to 
deter taxpayers from entering into tax avoidance transactions, 
the Committee believes that a more meaningful (but less 
stringent) accuracy-related penalty should apply to such 
transactions even when disclosed.

                        EXPLANATION OF PROVISION

In general

    The bill modifies the present-law accuracy related penalty 
by replacing the rules applicable to tax shelters with a new 
accuracy-related penalty that applies to listed transactions 
and reportable transactions with a significant tax avoidance 
purpose (hereinafter referred to as a ``reportable avoidance 
transaction'').\159\ The penalty rate and defenses available to 
avoid the penalty vary depending on the category of the 
transaction (i.e., listed or reportable avoidance transaction) 
and whether the transaction was adequately disclosed.
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    \159\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meanings as previously described in 
connection with the penalty for failing to disclose reportable 
transactions.
---------------------------------------------------------------------------
            Disclosed transactions
    In general, a 20-percent accuracy-related penalty is 
imposed on any understatement attributable to an adequately 
disclosed listed transaction or reportable avoidance 
transaction. The only exception to the penalty is if the 
taxpayer satisfies a more stringent reasonable cause and good 
faith exception (hereinafter referred to as the ``strengthened 
reasonable cause exception''), which is described below. The 
strengthened reasonable cause exception is available only if 
the relevant facts affecting the tax treatment are adequately 
disclosed, there is or was substantial authority for the 
claimed tax treatment, and the taxpayer reasonably believed 
that the claimed tax treatment was more likely than not the 
proper treatment.
            Undisclosed transactions
    If the taxpayer does not adequately disclose the 
transaction, the strengthened reasonable cause exception is not 
available (i.e., a strict-liability penalty applies), and the 
taxpayer is subject to an increased penalty rate equal to 30 
percent of the understatement.
    In addition, a public entity that is required to pay the 30 
percent penalty must disclose the imposition of the penalty in 
reports to the SEC for such periods as the Secretary shall 
specify. The disclosure to the SEC applies without regard to 
whether the taxpayer determines the amount of the penalty to be 
material to the reports in which the penalty must appear, and 
any failure to disclose such penalty in the reports is treated 
as a failure to disclose a listed transaction. A taxpayer must 
disclose a penalty in reports to the SEC once the taxpayer has 
exhausted its administrative and judicial remedies with respect 
to the penalty (or if earlier, when paid).
    Once the 30 percent penalty has been included in the 
Revenue Agent Report, the penalty cannot be compromised for 
purposes of a settlement without approval of the Commissioner 
personally or the head of the Office of Tax Shelter Analysis. 
Furthermore, the IRS is required to submit an annual report to 
Congress summarizing the application of this penalty and 
providing a description of each penalty compromised under this 
provision and the reasons for the compromise.

Determination of the understatement amount

    The penalty is applied to the amount of any understatement 
attributable to the listed or reportable avoidance transaction 
without regard to other items on the tax return. For purposes 
of this bill, the amount of the understatement is determined as 
the sum of (1) the product of the highest corporate or 
individual tax rate (as appropriate) and the increase in 
taxable income resulting from the difference between the 
taxpayer's treatment of the item and the proper treatment of 
the item (without regard to other items on the tax return) 
\160\, and (2) the amount of any decrease in the aggregate 
amount of credits which results from a difference between the 
taxpayer's treatment of an item and the proper tax treatment of 
such item.
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    \160\ For this purpose, any reduction in the excess of deductions 
allowed for the taxable year over gross income for such year, and any 
reduction in the amount of capital losses which would (without regard 
to section 1211) be allowed for such year, shall be treated as an 
increase in taxable income.
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    Except as provided in regulations, a taxpayer's treatment 
of an item shall not take into account any amendment or 
supplement to a return if the amendment or supplement is filed 
after the earlier of when the taxpayer is first contacted 
regarding an examination of the return or such other date as 
specified by the Secretary.

Strengthened reasonable cause exception

    A penalty is not imposed under the bill with respect to any 
portion of an understatement if it shown that there was 
reasonable cause for such portion and the taxpayer acted in 
good faith. Such a showing requires (1) adequate disclosure of 
the facts affecting the transaction in accordance with the 
regulations under section 6011,\161\ (2) there is or was 
substantial authority for such treatment, and (3) the taxpayer 
reasonably believed that such treatment was more likely than 
not the proper treatment. For this purpose, a taxpayer will be 
treated as having a reasonable belief with respect to the tax 
treatment of an item only if such belief (1) is based on the 
facts and law that exist at the time the tax return (that 
includes the item) is filed, and (2) relates solely to the 
taxpayer's chances of success on the merits and does not take 
into account the possibility that (a) a return will not be 
audited, (b) the treatment will not be raised on audit, or (c) 
the treatment will be resolved through settlement if raised.
---------------------------------------------------------------------------
    \161\ See the previous discussion regarding the penalty for failing 
to disclose a reportable transaction.
---------------------------------------------------------------------------
    A taxpayer may (but is not required to) rely on an opinion 
of a tax advisor in establishing its reasonable belief with 
respect to the tax treatment of the item. However, a taxpayer 
may not rely on an opinion of a tax advisor for this purpose if 
the opinion (1) is provided by a ``disqualified tax advisor,'' 
or (2) is a ``disqualified opinion.''
            Disqualified tax advisor
    A disqualified tax advisor is any advisor who (1) is a 
material advisor \162\ and who participates in the 
organization, management, promotion or sale of the transaction 
or is related (within the meaning of section 267 or 707) to any 
person who so participates, (2) is compensated directly or 
indirectly \163\ by a material advisor with respect to the 
transaction, (3) has a fee arrangement with respect to the 
transaction that is contingent on all or part of the intended 
tax benefits from the transaction being sustained, or (4) as 
determined under regulations prescribed by the Secretary, has a 
continuing financial interest with respect to the transaction.
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    \162\ The term ``material advisor'' (defined below in connection 
with the new information filing requirements for material advisors) 
means any person who provides any material aid, assistance, or advice 
with respect to organizing, promoting, selling, implementing, or 
carrying out any reportable transaction, and who derives gross income 
in excess of $50,000 in the case of a reportable transaction 
substantially all of the tax benefits from which are provided to 
natural persons ($250,000 in any other case).
    \163\ This situation could arise, for example, when an advisor has 
an arrangement or understanding (oral or written) with an organizer, 
manager, or promoter of a reportable transaction that such party will 
recommend or refer potential participants to the advisor for an opinion 
regarding the tax treatment of the transaction.
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            Organization, management, promotion or sale of a 
                    transaction
    A material advisor is considered as participating in the 
``organization'' of a transaction if the advisor performs acts 
relating to the development of the transaction. This may 
include, for example, preparing documents (1) establishing a 
structure used in connection with the transaction (such as a 
partnership agreement), (2) describing the transaction (such as 
an offering memorandum or other statement describing the 
transaction), or (3) relating to the registration of the 
transaction with any federal, state or local government 
body.\164\ Participation in the ``management'' of a transaction 
means involvement in the decision-making process regarding any 
business activity with respect to the transaction. 
Participation in the ``promotion or sale'' of a transaction 
means involvement in the marketing or solicitation of the 
transaction to others. Thus, an advisor who provides 
information about the transaction to a potential participant is 
involved in the promotion or sale of a transaction, as is any 
advisor who recommends the transaction to a potential 
participant.
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    \164\ An advisor should not be treated as participating in the 
organization of a transaction if the advisor's only involvement with 
respect to the organization of the transaction is the rendering of an 
opinion regarding the tax consequences of such transaction. However, 
such an advisor may be a ``disqualified tax advisor'' with respect to 
the transaction if the advisor participates in the management, 
promotion or sale of the transaction (or if the advisor is compensated 
by a material advisor, has a fee arrangement that is contingent on the 
tax benefits of the transaction, or as determined by the Secretary, has 
a continuing financial interest with respect to the transaction).
---------------------------------------------------------------------------
            Disqualified opinion
    An opinion may not be relied upon if the opinion (1) is 
based on unreasonable factual or legal assumptions (including 
assumptions as to future events), (2) unreasonably relies upon 
representations, statements, finding or agreements of the 
taxpayer or any other person, (3) does not identify and 
consider all relevant facts, or (4) fails to meet any other 
requirement prescribed by the Secretary.

Coordination with other penalties

    Any understatement to which a penalty is imposed under this 
bill is not subject to the accuracy-related penalty under 
section 6662. However, such understatement is included for 
purposes of determining whether any understatement (as defined 
in sec. 6662(d)(2)) is a substantial understatement as defined 
under section 6662(d)(1).
    The penalty imposed under this provision shall not apply to 
any portion of an understatement to which a fraud penalty is 
applied under section 6663.

                             EFFECTIVE DATE

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

   4. Penalty for Understatements From Transactions Lacking Economic 
                               Substance


(Sec. 704 of the bill and new sec. 6662B of the Code)

                              PRESENT LAW

    An accuracy-related penalty applies to the portion of any 
underpayment that is attributable to (1) negligence, (2) any 
substantial understatement of income tax, (3) any substantial 
valuation misstatement, (4) any substantial overstatement of 
pension liabilities, or (5) any substantial estate or gift tax 
valuation understatement. If the correct income tax liability 
exceeds that reported by the taxpayer by the greater of 10 
percent of the correct tax or $5,000 ($10,000 in the case of 
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.\165\ The amount of 
any understatement is reduced by any portion attributable to an 
item if (1) the treatment of the item is supported by 
substantial authority, or (2) facts relevant to the tax 
treatment of the item were adequately disclosed and there was a 
reasonable basis for its tax treatment.
---------------------------------------------------------------------------
    \165\ Sec. 6662.
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    Special rules apply with respect to tax shelters.\166\ For 
understatements by non-corporate taxpayers attributable to tax 
shelters, the penalty may be avoided only if the taxpayer 
establishes that, in addition to having substantial authority 
for the position, the taxpayer 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.
---------------------------------------------------------------------------
    \166\ Sec. 6662(d)(2)(C).
---------------------------------------------------------------------------
    The penalty generally is abated (even with respect to tax 
shelters) in cases in which the taxpayer can demonstrate that 
there was ``reasonable cause'' for the underpayment and that 
the taxpayer acted in good faith.\167\ The relevant regulations 
provide that reasonable cause exists where the taxpayer 
``reasonably relies in good faith on an opinion based on a 
professional tax advisor's analysis of the pertinent facts and 
authorities [that] . . . unambiguously concludes that there is 
a greater than 50-percent likelihood that the tax treatment of 
the item will be upheld if challenged'' by the IRS.\168\
---------------------------------------------------------------------------
    \167\ Sec. 6664(c).
    \168\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 
1.6664-4(c).
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                           REASONS FOR CHANGE

    The Committee is concerned that many taxpayers are engaging 
in tax avoidance transactions that rely on the interaction of 
highly technical tax law provisions. These transactions usually 
produce surprising results that were not contemplated by 
Congress. Whether these transactions are respected usually 
hinges on whether the transaction had sufficient economic 
substance. The Committee believes that the benefits that 
taxpayers potentially obtain from these transactions 
significantly outweigh the potential costs of engaging in such 
transactions. In addition, the Committee believes taxpayers 
will continue to engage in tax avoidance transactions until the 
risk and cost to the taxpayer of engaging in the transactions 
is increased. Thus, the Committee believes that taxpayers 
should be subject to the imposition of a substantial strict 
liability penalty for transactions that are determined not have 
economic substance.

                        EXPLANATION OF PROVISION

    The bill imposes a penalty for an understatement 
attributable to any transaction that lacks economic substance 
(referred to in the statute as a ``non-economic substance 
transaction understatement'').\169\ The penalty rate is 40 
percent (reduced to 20 percent if the taxpayer adequately 
discloses the relevant facts in accordance with regulations 
prescribed under section 6011). No exceptions (including the 
reasonable cause or rescission rules) to the penalty would be 
available under the bill (i.e., the penalty is a strict-
liability penalty).
---------------------------------------------------------------------------
    \169\ Thus, unlike the new accuracy-related penalty under section 
6662A (which applies only to listed and reportable avoidance 
transactions), the new penalty under this provision applies to any 
transaction that lacks economic substance.
---------------------------------------------------------------------------
    A ``non-economic substance transaction'' means any 
transaction if (1) the transaction lacks economic substance (as 
defined in the earlier provision regarding the economic 
substance doctrine),\170\ (2) the transaction was not respected 
under the rules relating to transactions with tax-indifferent 
parties (as described in the earlier provision regarding the 
economic substance doctrine),\171\ or (3) any similar rule of 
law. For this purpose, a similar rule of law would include, for 
example, an understatement attributable to a transaction that 
is determined to be a sham transaction.
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    \170\ The provision provides that a transaction has economic 
substance only if: (1) the transaction changes in a meaningful way 
(apart from Federal income tax effects) the taxpayer's economic 
position, and (2) the transaction has a substantial non-tax purpose for 
entering into such transaction and is a reasonable means of 
accomplishing such purpose.
    \171\ The provision provides that the form of a transaction that 
involves a tax-indifferent party will not be respected in certain 
circumstances.
---------------------------------------------------------------------------
    For purposes of this provision, the calculation of an 
``understatement'' is made in the same manner as in the 
separate provision relating to accuracy-related penalties for 
listed and reportable avoidance transactions (new sec. 6662A). 
Thus, the amount of the understatement under this provision 
would be determined as the sum of (1) the product of the 
highest corporate or individual tax rate (as appropriate) and 
the increase in taxable income resulting from the difference 
between the taxpayer's treatment of the item and the proper 
treatment of the item (without regard to other items on the tax 
return),\172\ and (2) the amount of any decrease in the 
aggregate amount of credits which results from a difference 
between the taxpayer's treatment of an item and the proper tax 
treatment of such item. In essence, the penalty will apply to 
the amount of any understatement attributable solely to a non-
economic substance transaction.
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    \172\ For this purpose, any reduction in the excess of deductions 
allowed for the taxable year over gross income for such year, and any 
reduction in the amount of capital losses that would (without regard to 
section 1211) be allowed for such year, would be treated as an increase 
in taxable income.
---------------------------------------------------------------------------
    Except as provided in regulations, the taxpayer's treatment 
of an item will not take into account any amendment or 
supplement to a return if the amendment or supplement is filed 
after the earlier of the date the taxpayer is first contacted 
regarding an examination of the return or such other date as 
specified by the Secretary.
    A public entity that is required to pay a penalty under 
this provision (regardless of whether the transaction was 
disclosed) must disclose the imposition of the penalty in 
reports to the SEC for such periods as the Secretary shall 
specify. The disclosure to the SEC applies without regard to 
whether the taxpayer determines the amount of the penalty to be 
material to the reports in which the penalty must appear, and 
any failure to disclose such penalty in the reports is treated 
as a failure to disclose a listed transaction. A taxpayer must 
disclose a penalty in reports to the SEC once the taxpayer has 
exhausted its administrative and judicial remedies with respect 
to the penalty (or if earlier, when paid).
    Once a penalty (regardless of whether the transaction was 
disclosed) has been included in the Revenue Agent Report, the 
penalty cannot be compromised for purposes of a settlement 
without approval of the Commissioner personally or the head of 
the Office of Tax Shelter Analysis. Furthermore, the IRS is 
required to submit an annual report to Congress summarizing the 
application of this penalty and providing a description of each 
penalty compromised under this provision and the reasons for 
the compromise.
    Any understatement to which a penalty is imposed under this 
provision will not be subject to the accuracy-related penalty 
under section 6662 or under new 6662A (accuracy-related 
penalties for listed and reportable avoidance transactions). 
However, an understatement under this provision would be taken 
into account for purposes of determining whether any 
understatement (as defined in sec. 6662(d)(2)) is a substantial 
understatement as defined under section 6662(d)(1). The penalty 
imposed under this provision will not apply to any portion of 
an understatement to which a fraud penalty is applied under 
section 6663.

                             EFFECTIVE DATE

    The bill applies to transactions after the date of 
enactment.

       5. Modifications to the Substantial Understatement Penalty


(Sec. 705 of the bill and sec. 6662 of the Code)

                              PRESENT LAW

Definition of substantial understatement

    An accuracy-related penalty equal to 20 percent applies to 
any substantial understatement of tax. A ``substantial 
understatement'' exists if the correct income tax liability 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).\173\
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    \173\ Sec. 6662(a) and (d)(1)(A).
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Reduction of understatement for certain positions

    For purposes of determining whether a substantial 
understatement penalty applies, the amount of any 
understatement generally is reduced by any portion attributable 
to an item if (1) the treatment of the item is supported by 
substantial authority, or (2) facts relevant to the tax 
treatment of the item were adequately disclosed and there was a 
reasonable basis for its tax treatment.\174\
---------------------------------------------------------------------------
    \174\ Sec. 6662(d)(2)(B).
---------------------------------------------------------------------------
    The Secretary is required to publish annually in the 
Federal Register a list of positions for which the Secretary 
believes there is not substantial authority and which affect a 
significant number of taxpayers.\175\
---------------------------------------------------------------------------
    \175\ Sec. 6662(d)(2)(D).
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                           REASONS FOR CHANGE

    The Committee believes that the present-law definition of 
substantial understatement allows large corporate taxpayers to 
avoid the accuracy-related penalty on questionable transactions 
of a significant size. The Committee believes that an 
understatement of more than $10 million is substantial in and 
of itself, regardless of the proportion it represents of the 
taxpayer's total tax liability.
    The Committee believes that a higher compliance standard 
should be imposed on any taxpayer in order to reduce the amount 
of an understatement resulting from a transaction that the 
taxpayer did not adequately disclose. The Committee further 
believes that a taxpayer should not take a position on a tax 
return that could give rise to a substantial understatement 
penalty that the taxpayer does not believe is more likely than 
not the correct tax treatment unless this information is 
disclosed to the IRS.

                        EXPLANATION OF PROVISION

Definition of substantial understatement

    The bill modifies the definition of ``substantial'' for 
corporate taxpayers. Under the bill, a corporate taxpayer has a 
substantial understatement if the amount of the understatement 
for the taxable year exceeds the lesser of (1) 10 percent of 
the tax required to be shown on the return for the taxable year 
(or, if greater, $10,000), or (2) $10 million.

Reduction of understatement for certain positions

    The bill elevates the standard that a taxpayer must satisfy 
in order to reduce the amount of an understatement for 
undisclosed items. With respect to the treatment of an item 
whose facts are not adequately disclosed, a resulting 
understatement is reduced only if the taxpayer had a reasonable 
belief that the tax treatment was more likely than not the 
proper treatment. The bill also authorizes (but does not 
require) the Secretary to publish a list of positions for which 
it believes there is not substantial authority or there is no 
reasonable belief that the tax treatment is more likely than 
not the proper treatment (without regard to whether such 
positions affect a significant number of taxpayers). The list 
shall be published in the Federal Register or the Internal 
Revenue Bulletin.

                             EFFECTIVE DATE

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

  6. Tax Shelter Exception to Confidentiality Privileges Relating to 
                        Taxpayer Communications


(Sec. 706 of the bill and sec. 7525 of the Code)

                              PRESENT LAW

    In general, a common law privilege of confidentiality 
exists for communications between an attorney and client with 
respect to the legal advice the attorney gives the client. The 
Code provides that, with respect to tax advice, the same common 
law protections of confidentiality that apply to a 
communication between a taxpayer and an attorney also apply to 
a communication between a taxpayer and a federally authorized 
tax practitioner to the extent the communication would be 
considered a privileged communication if it were between a 
taxpayer and an attorney. This rule is inapplicable to 
communications regarding corporate tax shelters.

                           REASONS FOR CHANGE

    The Committee believes that the rule currently applicable 
to corporate tax shelters should be applied to all tax 
shelters, regardless of whether or not the participant is a 
corporation.

                        EXPLANATION OF PROVISION

    The bill modifies the rule relating to corporate tax 
shelters by making it applicable to all tax shelters, whether 
entered into by corporations, individuals, partnerships, tax-
exempt entities, or any other entity. Accordingly, 
communications with respect to tax shelters are not subject to 
the confidentiality provision of the Code that otherwise 
applies to a communication between a taxpayer and a federally 
authorized tax practitioner.

                             EFFECTIVE DATE

    The bill is effective with respect to communications made 
on or after the date of enactment.

     7. Disclosure of Reportable Transactions by Material Advisors


(Secs. 707 and 708 of the bill and secs. 6111 and 6707 of the Code)

                              PRESENT LAW

Registration of tax shelter arrangements

    An organizer of a tax shelter is required to register the 
shelter with the Secretary not later than the day on which the 
shelter is first offered for sale.\176\ A ``tax shelter'' means 
any investment with respect to which the tax shelter ratio 
\177\ for any investor as of the close of any of the first five 
years ending after the investment is offered for sale may be 
greater than two to one and which is: (1) required to be 
registered under Federal or State securities laws, (2) sold 
pursuant to an exemption from registration requiring the filing 
of a notice with a Federal or State securities agency, or (3) a 
substantial investment (greater than $250,000 and at least five 
investors).\178\
---------------------------------------------------------------------------
    \176\ Sec. 6111(a).
    \177\ The tax shelter ratio is, with respect to any year, the ratio 
that the aggregate amount of the deductions and 350 percent of the 
credits, which are represented to be potentially allowable to any 
investor, bears to the investment base (money plus basis of assets 
contributed) as of the close of the tax year.
    \178\ Sec. 6111(c).
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    Other promoted arrangements are treated as tax shelters for 
purposes of the registration requirement if: (1) a significant 
purpose of the arrangement is the avoidance or evasion of 
Federal income tax by a corporate participant; (2) the 
arrangement is offered under conditions of confidentiality; and 
(3) the promoter may receive fees in excess of $100,000 in the 
aggregate.\179\
---------------------------------------------------------------------------
    \179\ Sec. 6111(d).
---------------------------------------------------------------------------
    A transaction has a ``significant purpose of avoiding or 
evading Federal income tax'' if the transaction: (1) is the 
same as or substantially similar to a ``listed transaction,'' 
\180\ or (2) is structured to produce tax benefits that 
constitute an important part of the intended results of the 
arrangement and the promoter reasonably expects to present the 
arrangement to more than one taxpayer.\181\ Certain exceptions 
are provided with respect to the second category of 
transactions.\182\
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    \180\ Temp. Treas. Reg. sec. 301.6111-2T(b)(2).
    \181\ Temp. Treas. Reg. sec. 301.6111-2T(b)(3).
    \182\ Temp. Treas. Reg. sec. 301.6111-2T(b)(4).
---------------------------------------------------------------------------
    An arrangement is offered under conditions of 
confidentiality if: (1) an offeree has an understanding or 
agreement to limit the disclosure of the transaction or any 
significant tax features of the transaction; or (2) the 
promoter claims, knows, or has reason to know that a party 
other than the potential participant claims that the 
transaction (or any aspect of it) is proprietary to the 
promoter or any party other than the offeree, or is otherwise 
protected from disclosure or use.\183\
---------------------------------------------------------------------------
    \183\ The regulations provide that the determination of whether an 
arrangement is offered under conditions of confidentiality is based on 
all the facts and circumstances surrounding the offer. If an offeree's 
disclosure of the structure or tax aspects of the transaction are 
limited in any way by an express or implied understanding or agreement 
with or for the benefit of a tax shelter promoter, an offer is 
considered made under conditions of confidentiality, whether or not 
such understanding or agreement is legally binding. Treas. Reg. sec. 
301.6111-2T(c)(1).
---------------------------------------------------------------------------

Failure to register tax shelter

    The penalty for failing to timely register a tax shelter 
(or for filing false or incomplete information with respect to 
the tax shelter registration) generally is the greater of one 
percent of the aggregate amount invested in the shelter or 
$500.\184\ However, if the tax shelter involves an arrangement 
offered to a corporation under conditions of confidentiality, 
the penalty 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. Intentional disregard of the 
requirement to register increases the penalty to 75 percent of 
the applicable fees.
---------------------------------------------------------------------------
    \184\ Sec. 6707.
---------------------------------------------------------------------------
    Section 6707 also imposes (1) a $100 penalty on the 
promoter for each failure to furnish the investor with the 
required tax shelter identification number, and (2) a $250 
penalty on the investor for each failure to include the tax 
shelter identification number on a return.

                           REASONS FOR CHANGE

    The Committee has been advised that the current promoter 
registration rules have not proven particularly helpful, 
because the rules are not appropriate for the kinds of abusive 
transactions now prevalent, and because the limitations 
regarding confidential corporate arrangements have proven easy 
to circumvent.
    The Committee believes that providing a single, clear 
definition regarding the types of transactions that must be 
disclosed by taxpayers and material advisors, coupled with more 
meaningful penalties for failing to disclose such transactions, 
are necessary tools if the effort to curb the use of abusive 
tax avoidance transactions is to be effective.

                        EXPLANATION OF PROVISION

Disclosure of reportable transactions by material advisors

    The bill repeals the present law rules with respect to 
registration of tax shelters. Instead, the bill requires each 
material advisor with respect to any reportable transaction 
(including listed transaction) \185\ to timely file an 
information return with the Secretary (in such form and manner 
as the Secretary may prescribe). The return must be filed on 
such date as specified by the Secretary.
---------------------------------------------------------------------------
    \185\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The information return will include (1) information 
identifying and describing the transaction, (2) information 
describing any potential tax benefits expected to result from 
the transaction, and (3) such other information as the 
Secretary may prescribe. It is expected that the Secretary may 
seek from the material advisor the same type of information 
that the Secretary may request from a taxpayer in connection 
with a reportable transaction.\186\
---------------------------------------------------------------------------
    \186\ See the previous discussion regarding the disclosure 
requirements under new section 6707A.
---------------------------------------------------------------------------
    A ``material advisor'' means any person (1) who provides 
material aid, assistance, or advice with respect to organizing, 
promoting, selling, implementing, or carrying out any 
reportable transaction, and (2) who directly or indirectly 
derives gross income in excess of $250,000 ($50,000 in the case 
of a reportable transaction substantially all of the tax 
benefits from which are provided to natural persons) for such 
advice or assistance.
    The Secretary may prescribe regulations which provide (1) 
that only one material advisor has to file an information 
return in cases in which two or more material advisors would 
otherwise be required to file information returns with respect 
to a particular reportable transaction, (2) exemptions from the 
requirements of this section, and (3) other rules as may be 
necessary or appropriate to carry out the purposes of this 
section (including, for example, rules regarding the 
aggregation of fees in appropriate circumstances).

Penalty for failing to furnish information regarding reportable 
        transactions

    The bill repeals the present law penalty for failure to 
register tax shelters. Instead, the bill imposes a penalty on 
any material advisor who fails to file an information return, 
or who files a false or incomplete information return, with 
respect to a reportable transaction (including a listed 
transaction).\187\ The amount of the penalty is $50,000. If the 
penalty is with respect to a listed transaction, the amount of 
the penalty is increased to the greater of (1) $200,000, or (2) 
50 percent of the gross income of such person with respect to 
aid, assistance, or advice which is provided with respect to 
the reportable transaction before the date the information 
return that includes the transaction is filed. Intentional 
disregard by a material advisor of the requirement to disclose 
a reportable transaction increases the penalty to 75 percent of 
the gross income.
---------------------------------------------------------------------------
    \187\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------
    The penalty cannot be waived with respect to a listed 
transaction. As to reportable transactions, the penalty can be 
rescinded or abated only in exceptional circumstances.\188\ All 
or part of the penalty may be rescinded only if: (1) the 
material advisor on whom the penalty is imposed has a history 
of complying with the Federal tax laws, (2) it is shown that 
the violation is due to an unintentional mistake of fact, (3) 
imposing the penalty would be against equity and good 
conscience, and (4) rescinding the penalty would promote 
compliance with the tax laws and effective tax administration. 
The authority to rescind the penalty can only be exercised by 
the Commissioner personally or the head of the Office of Tax 
Shelter Analysis; this authority to rescind cannot otherwise be 
delegated by the Commissioner. Thus, the penalty cannot be 
rescinded by a revenue agent, an appeals officer, or other IRS 
personnel. The decision to rescind a penalty must be 
accompanied by a record describing the facts and reasons for 
the action and the amount rescinded. There will be no right to 
appeal a refusal to rescind a penalty. The IRS also is required 
to submit an annual report to Congress summarizing the 
application of the disclosure penalties and providing a 
description of each penalty rescinded under this provision and 
the reasons for the rescission.
---------------------------------------------------------------------------
    \188\ The Secretary's present-law authority to postpone certain 
tax-related deadlines because of Presidentially-declared disasters 
(sec. 7508A) will also encompass the authority to postpone the 
reporting deadlines established by the provision.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision requiring disclosure of reportable 
transactions by material advisors applies to transactions with 
respect to which material aid, assistance or advice is provided 
after the date of enactment.
    The provision imposing a penalty for failing to disclose 
reportable transactions applies to returns the due date for 
which is after the date of enactment.

 8. Investor Lists and Modification of Penalty for Failure To Maintain 
                             Investor Lists


(Secs. 707 and 709 of the bill and secs. 6112 and 6708 of the Code)

                              PRESENT LAW

Investor lists

    Any organizer or seller of a potentially abusive tax 
shelter must maintain a list identifying each person who was 
sold an interest in any such tax shelter with respect to which 
registration was required under section 6111 (even though the 
particular party may not have been subject to confidentiality 
restrictions).\189\ Recently-issued temporary regulations under 
section 6112 contain elaborate rules regarding the list 
maintenance requirements.\190\ The regulations apply to 
transactions that are potentially abusive tax shelters entered 
into, or acquired after, January 1, 2003.\191\
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    \189\ Sec. 6112.
    \190\ Temp. Treas. Reg. sec. 301-6112-1T.
    \191\ Subsequent to the issuance of the new regulations, the IRS 
announced that, in order to provide necessary clarification of the list 
maintenance regulations, the effective date will be changed to the date 
that revised regulations under section 6112 are filed. The delayed 
effective date, however, will not apply to listed transactions or 
transactions that are section 6111 shelters (as defined in Treas. Reg. 
sec. 301.6112-1T(b)(1)). Notice 2003-11, 2003-6 I.R.B. 1 (January 17, 
2003).
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    The temporary regulations, issued in October 2002, provide 
that a person is an organizer or seller of a potentially 
abusive tax shelter if the person is a material advisor with 
respect to that transaction.\192\ A potentially abusive tax 
shelter is any transaction that (1) is required to be 
registered under section 6111, (2) is a listed transaction (as 
defined under the new temporary regulations under section 
6011), or (3) any transaction that a potential material advisor 
knows or has reason to know, at the time the transaction is 
entered into, is a reportable transaction (as defined under the 
new temporary regulations under section 6011).\193\
---------------------------------------------------------------------------
    \192\ Temp. Treas. Reg. sec. 301.6112-1T(c)(1).
    \193\ Temp. Treas. Reg. sec. 301.6112-1T(b).
---------------------------------------------------------------------------
    The temporary regulations define an organizer or a seller 
of an interest with respect to a potentially abusive tax 
shelter if that person is a ``material advisor.'' A material 
advisor is defined any person who (directly or indirectly) 
receives, or is expected to receive, a minimum fee of (1) 
$250,000 for a transaction that is a potentially abusive tax 
shelter if all participants are corporations, or (2) $50,000 
for any other transaction that is a potentially abusive tax 
shelter.\194\
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    \194\ Temp. Treas. Reg. sec. 301.6112-1T(c)(1) and (2).
---------------------------------------------------------------------------
    The Secretary is required to prescribe regulations which 
provide that, in cases in which 2 or more persons are required 
to maintain the same list, only one person would be required to 
maintain the list.\195\
---------------------------------------------------------------------------
    \195\ Sec. 6112(c)(2).
---------------------------------------------------------------------------

Penalties for failing to maintain investor lists

    Under section 6708, the penalty for failing to maintain the 
list required under section 6112 is $50 for each name omitted 
from the list (with a maximum penalty of $100,000 per year).

                           REASONS FOR CHANGE

    The Committee has been advised that the present-law 
penalties for failure to maintain customer lists are not 
meaningful and that promoters often have refused to provide 
requested information to the IRS. The Committee believes that 
requiring material advisors to maintain a list of advisees with 
respect to each reportable transaction, coupled with more 
meaningful penalties for failing to maintain an investor list, 
are important tools in the ongoing efforts to curb the use of 
abusive tax avoidance transactions.

                        EXPLANATION OF PROVISION

Investor lists

    Each material advisor \196\ that is required to file an 
information return with respect to a reportable transaction 
(including a listed transaction) \197\ is required to maintain 
a list that (1) identifies each person with respect to whom the 
advisor acted as a material advisor with respect to the 
reportable transaction, and (2) contains other information as 
may be required by the Secretary. In addition, the bill 
authorizes (but does not require) the Secretary to prescribe 
regulations which provide that, in cases in which 2 or more 
persons are required to maintain the same list, only one person 
would be required to maintain the list.
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    \196\ The term ``material advisor'' has the same meaning as when 
used in connection with the requirement to file an information return 
under section 6111.
    \197\ The terms ``reportable transaction'' and ``listed 
transaction'' have the same meaning as previously described in 
connection with the taxpayer-related provisions.
---------------------------------------------------------------------------

Penalty for failing to maintain investor lists

    The bill modifies the penalty for failing to maintain the 
required list by making it a time-sensitive penalty. Thus, a 
material advisor who is required to maintain an investor list 
and who fails to make the list available upon request by the 
Secretary within 20 business days after the request will be 
subject to a $10,000 per day penalty. The penalty applies to a 
person who fails to maintain a list, maintains an incomplete 
list, or has in fact maintained a list but does not make the 
list available to the Secretary. The penalty can be waived if 
the failure to make the list available is due to reasonable 
cause.\198\
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    \198\ In no event will failure to maintain a list be considered 
reasonable cause for failing to make a list available to the Secretary.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision requiring a material advisor to maintain an 
investor list applies to transactions with respect to which 
material aid, assistance or advice is provided after the date 
of enactment.
    The provision imposing a penalty for failing to maintain 
investor lists applies to requests made after the date of 
enactment.

     9. Actions To Enjoin Conduct With Respect to Tax Shelters and 
                        Reportable Transactions


(Sec. 710 of the bill and sec. 7408 of the Code)

                              PRESENT LAW

    The Code authorizes civil action to enjoin any person from 
promoting abusive tax shelters or aiding or abetting the 
understatement of tax liability.\199\
---------------------------------------------------------------------------
    \199\ Sec. 7408.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that some promoters are blatantly 
ignoring the rules regarding registration and list maintenance 
regardless of the penalties. An injunction would place these 
promoters in a public proceeding under court order. Thus, the 
Committee believes that the types of tax shelter activities 
with respect to which an injunction may be sought should be 
expanded.

                        EXPLANATION OF PROVISION

    The bill expands this rule so that injunctions may also be 
sought with respect to the requirements relating to the 
reporting of reportable transactions \200\ and the keeping of 
lists of investors by material advisors.\201\ Thus, under the 
bill, an injunction may be sought against a material advisor to 
enjoin the advisor from (1) failing to file an information 
return with respect to a reportable transaction, or (2) failing 
to maintain, or to timely furnish upon written request by the 
Secretary, a list of investors with respect to each reportable 
transaction.
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    \200\ Sec. 6707, as amended by other provisions of this bill.
    \201\ Sec. 6708, as amended by other provisions of this bill.
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                             EFFECTIVE DATE

    The bill is effective on the day after the date of 
enactment.

    10. Understatement of Taxpayer's Liability by Income Tax Return 
                                Preparer


(Sec. 711 of the bill and sec. 6694 of the Code)

                              PRESENT LAW

    An income tax return preparer who prepares a return with 
respect to which there is an understatement of tax that is due 
to a position for which there was not a realistic possibility 
of being sustained on its merits and the position was not 
disclosed (or was frivolous) is liable for a penalty of $250, 
provided that the preparer knew or reasonably should have known 
of the position. An income tax return preparer who prepares a 
return and engages in specified willful or reckless conduct 
with respect to preparing such a return is liable for a penalty 
of $1,000.

                           REASONS FOR CHANGE

    The Committee believes that the standards of conduct 
applicable to income tax return preparers should be the same as 
the standards applicable to taxpayers. Accordingly, the minimum 
standard for each undisclosed position on a tax return would be 
that the preparer must reasonably believe that the tax 
treatment is more likely than not the proper tax treatment. The 
Committee believes that this standard is appropriate because 
the tax return is signed under penalties of perjury, which 
implies a high standard of diligence in determining the facts 
and substantial accuracy in determining and applying the rules 
that govern those facts. The Committee believes that it is both 
appropriate and vital to the tax system that both taxpayers and 
their return preparers file tax returns that they reasonably 
believe are more likely than not correct. In addition, 
conforming the standards of conduct applicable to income tax 
return preparers to the standards applicable to taxpayers will 
simplify the law by reducing confusion inherent in different 
standards applying to the same behavior.

                        EXPLANATION OF PROVISION

    The bill alters the standards of conduct that must be met 
to avoid imposition of the first penalty. The bill replaces the 
realistic possibility standard with a requirement that there be 
a reasonable belief that the tax treatment of the position was 
more likely than not the proper treatment. The bill also 
replaces the not frivolous standard with the requirement that 
there be a reasonable basis for the tax treatment of the 
position.
    In addition, the bill increases the amount of these 
penalties. The penalty relating to not having a reasonable 
belief that the tax treatment was more likely than not the 
proper tax treatment is increased from $250 to $1,000. The 
penalty relating to willful or reckless conduct is increased 
from $1,000 to $5,000.

                             EFFECTIVE DATE

    The bill is effective for documents prepared after the date 
of enactment.

   11. Penalty for Failure To Report Interests in Foreign Financial 
                                Accounts


(Sec. 712 of the bill and sec. 5321 of Title 31, United States Code)

                              PRESENT LAW

    The Secretary of the Treasury must require citizens, 
residents, or persons doing business in the United States to 
keep records and file reports when that person makes a 
transaction or maintains an account with a foreign financial 
entity.\202\ In general, individuals must fulfill this 
requirement by answering questions regarding foreign accounts 
or foreign trusts that are contained in Part III of Schedule B 
of the IRS Form 1040. Taxpayers who answer ``yes'' in response 
to the question regarding foreign accounts must then file 
Treasury Department Form TD F 90-22.1. This form must be filed 
with the Department of the Treasury, and not as part of the tax 
return that is filed with the IRS.
---------------------------------------------------------------------------
    \202\ 31 U.S.C. 5314.
---------------------------------------------------------------------------
    The Secretary of the Treasury may impose a civil penalty on 
any person who willfully violates this reporting requirement. 
The civil penalty is the amount of the transaction or the value 
of the account, up to a maximum of $100,000; the minimum amount 
of the penalty is $25,000.\203\ In addition, any person who 
willfully violates this reporting requirement is subject to a 
criminal penalty. The criminal penalty is a fine of not more 
than $250,000 or imprisonment for not more than five years (or 
both); if the violation is part of a pattern of illegal 
activity, the maximum amount of the fine is increased to 
$500,000 and the maximum length of imprisonment is increased to 
10 years.\204\
---------------------------------------------------------------------------
    \203\ 31 U.S.C. 5321(a)(5).
    \204\ 31 U.S.C. 5322.
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    On April 26, 2002, the Secretary of the Treasury submitted 
to the Congress a report on these reporting requirements.\205\ 
This report, which was statutorily required,\206\ studies 
methods for improving compliance with these reporting 
requirements. It makes several administrative recommendations, 
but no legislative recommendations. A further report was 
required to be submitted by the Secretary of the Treasury to 
the Congress by October 26, 2002.
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    \205\ A Report to Congress in Accordance with Sec. 361(b) of the 
Uniting and Strengthening America by Providing Appropriate Tools 
Required to Intercept and Obstruct Terrorism Act of 2001, April 26, 
2002.
    \206\ Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee understands that the number of individuals 
involved in using offshore bank accounts to engage in abusive 
tax scams has grown significantly in recent years. For one 
scheme alone, the IRS estimates that there may be one to two 
million taxpayers with offshore bank accounts attempting to 
conceal income from the IRS. The Committee is concerned about 
this activity and believes that improving compliance with this 
reporting requirement is vitally important to sound tax 
administration, to combating terrorism, and to preventing the 
use of abusive tax schemes and scams. Adding a new civil 
penalty that applies without regard to willfulness will improve 
compliance with this reporting requirement.

                        EXPLANATION OF PROVISION

    The bill adds an additional civil penalty that may be 
imposed on any person who violates this reporting requirement 
(without regard to willfulness). This new civil penalty is up 
to $5,000. The penalty may be waived if any income from the 
account was properly reported on the income tax return and 
there was reasonable cause for the failure to report.

                             EFFECTIVE DATE

    The bill is effective with respect to failures to report 
occurring on or after the date of enactment.

               12. Frivolous Tax Returns and Submissions


(Sec. 713 of the bill and sec. 6702 of the Code)

                              PRESENT LAW

    The Code provides that an individual who files a frivolous 
income tax return is subject to a penalty of $500 imposed by 
the IRS (sec. 6702). The Code also permits the Tax Court \207\ 
to impose a penalty of up to $25,000 if a taxpayer has 
instituted or maintained proceedings primarily for delay or if 
the taxpayer's position in the proceeding is frivolous or 
groundless (sec. 6673(a)).
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    \207\ Because in general the Tax Court is the only pre-payment 
forum available to taxpayers, it deals with most of the frivolous, 
groundless, or dilatory arguments raised in tax cases.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The IRS has been faced with a significant number of tax 
filers who are filing returns based on frivolous arguments or 
who are seeking to hinder tax administration by filing returns 
that are patently incorrect. In addition, taxpayers are using 
existing procedures for collection due process hearings, 
offers-in-compromise, installment agreements, and taxpayer 
assistance orders to impede or delay tax administration by 
raising frivolous arguments. These procedures were intended to 
provide assistance to taxpayers genuinely seeking to resolve 
legitimate disputes with the IRS, and the use of these 
procedures for impeding or delaying tax administration diverts 
scarce IRS resources away from resolving genuine disputes. 
Allowing the IRS to assert more substantial penalties for 
frivolous submissions and to dismiss frivolous requests without 
the need to follow otherwise mandated procedures will deter 
frivolous taxpayer behavior and enable the IRS to use its 
resources to better assist taxpayers in resolving genuine 
disputes.

                        EXPLANATION OF PROVISION

    The bill modifies the IRS-imposed penalty by increasing the 
amount of the penalty to up to $5,000 and by applying it to all 
taxpayers and to all types of Federal taxes.
    The bill also modifies present law with respect to certain 
submissions that raise frivolous arguments or that are intended 
to delay or impede tax administration. The submissions to which 
this provision applies are requests for a collection due 
process hearing, installment agreements, offers-in-compromise, 
and taxpayer assistance orders. First, the bill permits the IRS 
to dismiss such requests. Second, the bill permits the IRS to 
impose a penalty of up to $5,000 for such requests, unless the 
taxpayer withdraws the request after being given an opportunity 
to do so.
    The bill requires the IRS to publish a list of positions, 
arguments, requests, and submissions determined to be frivolous 
for purposes of these provisions.

                             EFFECTIVE DATE

    The bill is effective for submissions made and issues 
raised after the date on which the Secretary first prescribes 
the required list.

 13. Regulation of Individuals Practicing Before the Department of the 
                                Treasury


(Sec. 714 of the bill and sec. 330 of Title 31, United States Code)

                              PRESENT LAW

    The Secretary of the Treasury is authorized to regulate the 
practice of representatives of persons before the Department of 
the Treasury.\208\ The Secretary is also authorized to suspend 
or disbar from practice before the Department a representative 
who is incompetent, who is disreputable, who violates the rules 
regulating practice before the Department, or who (with intent 
to defraud) willfully and knowingly misleads or threatens the 
person being represented (or a person who may be represented). 
The rules promulgated by the Secretary pursuant to this 
provision are contained in Circular 230.
---------------------------------------------------------------------------
    \208\ 31 U.S.C. 330.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is critical that the 
Secretary have the authority to censure tax advisors as well as 
to impose monetary sanctions against tax advisors because of 
the important role of tax advisors in our tax system. Use of 
these sanctions is expected to curb the participation of tax 
advisors in both tax shelter activity and any other activity 
that is contrary to Circular 230 standards.

                        EXPLANATION OF PROVISION

    The bill makes two modifications to expand the sanctions 
that the Secretary may impose pursuant to these statutory 
provisions. First, the bill expressly permits censure as a 
sanction. Second, the bill permits the imposition of a monetary 
penalty as a sanction. If the representative is acting on 
behalf of an employer or other entity, the Secretary may impose 
a monetary penalty on the employer or other entity if it knew, 
or reasonably should have known, of the conduct. This monetary 
penalty on the employer or other entity may be imposed in 
addition to any monetary penalty imposed directly on the 
representative. These monetary penalties are not to exceed the 
gross income derived (or to be derived) from the conduct giving 
rise to the penalty. These monetary penalties may be in 
addition to, or in lieu of, any suspension, disbarment, or 
censure.
    The bill also confirms the present-law authority of the 
Secretary to impose standards applicable to written advice with 
respect to an entity, plan, or arrangement that is of a type 
that the Secretary determines as having a potential for tax 
avoidance or evasion.

                             EFFECTIVE DATE

    The modifications to expand the sanctions that the 
Secretary may impose are effective for actions taken after the 
date of enactment.

               14. Penalties on Promoters of Tax Shelters


(Sec. 715 of the bill and sec. 6700 of the Code)

                              PRESENT LAW

    A penalty is imposed on any person who organizes, assists 
in the organization of, or participates in the sale of any 
interest in, a partnership or other entity, any investment plan 
or arrangement, or any other plan or arrangement, if in 
connection with such activity the person makes or furnishes a 
qualifying false or fraudulent statement or a gross valuation 
overstatement.\209\ A qualified false or fraudulent statement 
is any statement with respect to the allowability of any 
deduction or credit, the excludability of any income, or the 
securing of any other tax benefit by reason of holding an 
interest in the entity or participating in the plan or 
arrangement which the person knows or has reason to know is 
false or fraudulent as to any material matter. A ``gross 
valuation overstatement'' means any statement as to the value 
of any property or services if the stated value exceeds 200 
percent of the correct valuation, and the value is directly 
related to the amount of any allowable income tax deduction or 
credit.
---------------------------------------------------------------------------
    \209\ Sec. 6700.
---------------------------------------------------------------------------
    The amount of the penalty is $1,000 (or, if the person 
establishes that it is less, 100 percent of the gross income 
derived or to be derived by the person from such activity). A 
penalty attributable to a gross valuation misstatement can be 
waived on a showing that there was a reasonable basis for the 
valuation and it was made in good faith.

                           REASONS FOR CHANGE

    The Committee believes that the present-law penalty rate is 
insufficient to deter the type of conduct that gives rise to 
the penalty.

                        EXPLANATION OF PROVISION

    The bill modifies the penalty amount to equal 50 percent of 
the gross income derived by the person from the activity for 
which the penalty is imposed. The new penalty rate applies to 
any activity that involves a statement regarding the tax 
benefits of participating in a plan or arrangement if the 
person knows or has reason to know that such statement is false 
or fraudulent as to any material matter. The enhanced penalty 
does not apply to a gross valuation overstatement.

                             EFFECTIVE DATE

    The bill is effective for activities after the date of 
enactment.

 15. Extend Statute of Limitations for Certain Undisclosed Transactions


(Sec. 716 of the bill and sec. 6501 of the Code)

                              PRESENT LAW

    In general, the Code requires that taxes be assessed within 
three years \210\ after the date a return is filed.\211\ If 
there has been a substantial omission of items of gross income 
that total more than 25 percent of the amount of gross income 
shown on the return, the period during which an assessment must 
be made is extended to six years.\212\ If an assessment is not 
made within the required time periods, the tax generally cannot 
be assessed or collected at any future time. Tax may be 
assessed at any time if the taxpayer files a false or 
fraudulent return with the intent to evade tax or if the 
taxpayer does not file a tax return at all.\213\
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    \210\ Sec. 6501(a).
    \211\ For this purpose, a return that is filed before the date on 
which it is due is considered to be filed on the required due date 
(sec. 6501(b)(1)).
    \212\ Sec. 6501(e).
    \213\ Sec. 6501(c).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that extending the statute of 
limitations if a taxpayer required to disclose a listed 
transaction fails to do so will encourage taxpayers to provide 
the required disclosure and will afford the IRS additional time 
to discover the transaction if the taxpayer does not disclose 
it.

                        EXPLANATION OF PROVISION

    The bill extends the statute of limitations to six years 
with respect to the entire tax return \214\ if a taxpayer 
required to disclose a listed transaction \215\ fails to do so 
in the manner required. For example, if a taxpayer entered into 
a transaction in 2005 that becomes a listed transaction in 2006 
and the taxpayer fails to disclose such transaction in the 
manner required by Treasury regulations, the 2005 tax return 
will be subject to a six-year statute of limitations.\216\
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    \214\ The tax year extended is the tax year the transaction is 
entered into.
    \215\ The term ``listed transaction'' has the same meaning as 
described in a previous provision regarding the penalty for failure to 
disclose reportable transactions.
    \216\ However, if the Treasury Department lists a transaction in a 
year subsequent to the year a taxpayer entered into such transaction, 
and the taxpayer's tax return for the year the transaction was entered 
into is closed by the statute of limitations prior to the transaction 
becoming a listed transaction, this provision does not re-open the 
statute of limitations for such year.
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                             EFFECTIVE DATE

    The bill is effective for transactions entered into in 
taxable years beginning after the date of enactment.

16. Deny Deduction for Interest Paid to IRS on Underpayments Involving 
                   Certain Tax-Motivated Transactions


(Sec. 717 of the bill and sec. 163 of the Code)

                              PRESENT LAW

    In general, corporations may deduct interest paid or 
accrued within a taxable year on indebtedness.\217\ Interest on 
indebtedness to the Federal government attributable to an 
underpayment of tax generally may be deducted pursuant to this 
provision.
---------------------------------------------------------------------------
    \217\ Sec. 163(a).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is inappropriate for 
corporations to deduct interest paid to the Government with 
respect to certain tax shelter transactions.

                        EXPLANATION OF PROVISION

    The bill disallows any deduction for interest paid or 
accrued within a taxable year on any portion of an underpayment 
of tax that is attributable to an understatement arising from 
(1) an undisclosed reportable avoidance transaction, (2) an 
undisclosed listed transaction, or (3) a transaction that lacks 
economic substance.\218\
---------------------------------------------------------------------------
    \218\ The definitions of these transactions are the same as those 
previously described in connection with the provision to modify the 
accuracy-related penalty for listed and certain reportable transactions 
and the provision to impose a penalty on understatements attributable 
to transactions that lack economic substance.
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                             EFFECTIVE DATE

    The bill is effective for underpayments attributable to 
transactions entered into in taxable years beginning after the 
date of enactment.

  17. Authorize Additional $300 Million Per Year to the IRS To Combat 
                   Abusive Tax Avoidance Transactions


(Sec. 718 of the bill)

                              PRESENT LAW

    There is no explicit authorization of appropriations to the 
Internal Revenue Service to be used to combat abusive tax 
avoidance transactions.

                           REASONS FOR CHANGE

    The Committee believes that authorizing an additional $300 
million to the Internal Revenue Service to be used to combat 
abusive tax avoidance transactions will aid in the 
implementation of the tax shelter measures the Committee is 
simultaneously approving.

                        EXPLANATION OF PROVISION

    The bill includes an authorization of an additional $300 
million to the Internal Revenue Service to be used to combat 
abusive tax avoidance transactions.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

                          B. Other Provisions


       1. Affirmation of Consolidated Return Regulation Authority


(Sec. 721 of the bill and sec. 1502 of the Code)

                              PRESENT LAW

    An affiliated group of corporations may elect to file a 
consolidated return in lieu of separate returns. A condition of 
electing to file a consolidated return is that all corporations 
that are members of the consolidated group must consent to all 
the consolidated return regulations prescribed under section 
1502 prior to the last day prescribed by law for filing such 
return.\219\
---------------------------------------------------------------------------
    \219\ Sec. 1501.
---------------------------------------------------------------------------
    Section 1502 states:

          The Secretary shall prescribe such regulations as he 
        may deem necessary in order that the tax liability of 
        any affiliated group of corporations making a 
        consolidated return and of each corporation in the 
        group, both during and after the period of affiliation, 
        may be returned, determined, computed, assessed, 
        collected, and adjusted, in such manner as clearly to 
        reflect the income-tax liability and the various 
        factors necessary for the determination of such 
        liability, and in order to prevent the avoidance of 
        such tax liability.\220\
---------------------------------------------------------------------------
    \220\ Sec. 1502.
---------------------------------------------------------------------------
    Under this authority, the Treasury Department has issued 
extensive consolidated return regulations.\221\
---------------------------------------------------------------------------
    \221\ Regulations issued under the authority of section 1502 are 
considered to be ``legislative'' regulations rather than 
``interpretative'' regulations, and as such are usually given greater 
deference by courts in case of a taxpayer challenge to such a 
regulation. See, S. Rep. No. 960, 70th Cong., 1st Sess. at 15, 
describing the consolidated return regulations as ``legislative in 
character''. The Supreme Court has stated that ``* * * legislative 
regulations are given controlling weight unless they are arbitrary, 
capricious, or manifestly contrary to the statute.'' Chevron, U.S.A., 
Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 
(1984) (involving an environmental protection regulation). For examples 
involving consolidated return regulations, see, e.g., Wolter 
Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); 
Garvey, Inc. v. United States, 1 Ct. Cl. 108 (1983), aff'd 726 F.2d 
1569 (Fed. Cir. 1984), cert. denied 469 U.S. 823 (1984). Compare, e.g., 
Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing 
different standards of review. The case did not involve a consolidated 
return regulation.
---------------------------------------------------------------------------
    In the recent case of Rite Aid Corp. v. United States,\222\ 
the Federal Circuit Court of Appeals addressed the application 
of a particular provision of certain consolidated return loss 
disallowance regulations, and concluded that the provision was 
invalid.\223\ The particular provision, known as the 
``duplicated loss'' provision,\224\ would have denied a loss on 
the sale of stock of a subsidiary by a parent corporation that 
had filed a consolidated return with the subsidiary, to the 
extent the subsidiary corporation had assets that had a built-
in loss, or had a net operating loss, that could be recognized 
or used later.\225\
---------------------------------------------------------------------------
    \222\ 255 F.3d 1357 (Fed. Cir. 2001), reh'g denied, 2001 U.S. App. 
LEXIS 23207 (Fed. Cir. Oct. 3, 2001).
    \223\ Prior to this decision, there had been a few instances 
involving prior laws in which certain consolidated return regulations 
were held to be invalid. See, e.g., American Standard, Inc. v. United 
States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. see 
also Union Carbide Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), 
and Allied Corporation v. United States, 685 F. 2d 396 (Ct. Cl. 1982), 
all three cases involving the allocation of income and loss within a 
consolidated group for purposes of computation of a deduction allowed 
under prior law by the Code for Western Hemisphere Trading 
Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222, 
1242-1244 (1959), involving the application of certain regulations to 
the excess profits tax credit allowed under prior law, and concluding 
that the Commissioner had applied a particular regulation in an 
arbitrary manner inconsistent with the wording of the regulation and 
inconsistent with even a consolidated group computation. Cf. Kanawha 
Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding 
that the substance of a transaction was an acquisition of assets rather 
than stock. Thus, a regulation governing basis of the assets of 
consolidated subsidiaries did not apply to the case. See also General 
Machinery Corporation v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt 
Realty Corporation, 31 B.T.A. 978 (1935); Helvering v. Morgans, Inc., 
293 U.S. 121 (1934), interpreting the term ``taxable year.''
    \224\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \225\ Treasury Regulation section 1.1502-20, generally imposing 
certain ``loss disallowance'' rules on the disposition of subsidiary 
stock, contained other limitations besides the ``duplicated loss'' rule 
that could limit the loss available to the group on a disposition of a 
subsidiary's stock. Treasury Regulation section 1.1502-20 as a whole 
was promulgated in connection with regulations issued under section 
337(d), principally in connection with the so-called General Utilities 
repeal of 1986 (referring to the case of General Utilities & Operating 
Company v. Helvering, 296 U.S. 200 (1935)). Such repeal generally 
required a liquidating corporation, or a corporation acquired in a 
stock acquisition treated as a sale of assets, to pay corporate level 
tax on the excess of the value of its assets over the basis. Treasury 
regulation section 1.1502-20 principally reflected an attempt to 
prevent corporations filing consolidated returns from offsetting income 
with a loss on the sale of subsidiary stock. Such a loss could result 
from the unique upward adjustment of a subsidiary's stock basis 
required under the consolidated return regulations for subsidiary 
income earned in consolidation, an adjustment intended to prevent 
taxation of both the subsidiary and the parent on the same income or 
gain. As one example, absent a denial of certain losses on a sale of 
subsidiary stock, a consolidated group could obtain a loss deduction 
with respect to subsidiary stock, the basis of which originally 
reflected the subsidiary's value at the time of the purchase of the 
stock, and that had then been adjusted upward on recognition of any 
built-in income or gain of the subsidiary reflected in that value. The 
regulations also contained the duplicated loss factor addressed by the 
court in Rite Aid. The preamble to the regulations stated: ``it is not 
administratively feasible to differentiate between loss attributable to 
built-in gain and duplicated loss.'' T.D. 8364, 1991-2 C.B. 43, 46 
(Sept. 13, 1991). The government also argued in the Rite Aid case that 
duplicated loss was a separate concern of the regulations. 255 F.3d at 
1360.
---------------------------------------------------------------------------
    The Federal Circuit Court opinion contained language 
discussing the fact that the regulation produced a result 
different than the result that would have obtained if the 
corporations had filed separate returns rather than 
consolidated returns.\226\
---------------------------------------------------------------------------
    \226\ For example, the court stated: ``The duplicated loss factor * 
* * addresses a situation that arises from the sale of stock regardless 
of whether corporations file separate or consolidated returns. With 
I.R.C. secs. 382 and 383, Congress has addressed this situation by 
limiting the subsidiary's potential future deduction, not the parent's 
loss on the sale of stock under I.R.C. sec. 165.'' 255 F.3d 1357, 1360 
(Fed. Cir. 2001).
---------------------------------------------------------------------------
    The Federal Circuit Court opinion cited a 1928 Senate 
Finance Committee Report to legislation that authorized 
consolidated return regulations, which stated that ``many 
difficult and complicated problems, * * * have arisen in the 
administration of the provisions permitting the filing of 
consolidated returns'' and that the committee ``found it 
necessary to delegate power to the commissioner to prescribe 
regulations legislative in character covering them.'' \227\ The 
Court's opinion also cited a previous decision of the Court of 
Claims for the proposition, interpreting this legislative 
history, that section 1502 grants the Secretary ``the power to 
conform the applicable income tax law of the Code to the 
special, myriad problems resulting from the filing of 
consolidated income tax returns;'' but that section 1502 ``does 
not authorize the Secretary to choose a method that imposes a 
tax on income that would not otherwise be taxed.'' \228\
---------------------------------------------------------------------------
    \227\ S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not 
quoted by the court in Rite Aid, the same Senate report also indicated 
that one purpose of the consolidated return authority was to permit 
treatment of the separate corporations as if they were a single unit, 
stating ``The mere fact that by legal fiction several corporations 
owned by the same shareholders are separate entities should not obscure 
the fact that they are in reality one and the same business owned by 
the same individuals and operated as a unit.'' S. Rep. No. 960, 70th 
Cong., 1st Sess. 29 (1928).
    \228\ American Standard, Inc. v. United States, 602 F.2d 256, 261 
(Ct. Cl. 1979). That case did not involve the question of separate 
returns as compared to a single return approach. It involved the 
computation of a Western Hemisphere Trade Corporation (``WHTC'') 
deduction under prior law (which deduction would have been computed as 
a percentage of each WHTC's taxable income if the corporations had 
filed separate returns), in a case where a consolidated group included 
several WHTCs as well as other corporations. The question was how to 
apportion income and losses of the admittedly consolidated WHTCs and 
how to combine that computation with the rest of the group's 
consolidated income or losses. The court noted that the new, changed 
regulations approach varied from the approach taken to a similar 
problem involving public utilities within a group and previously 
allowed for WHTCs. The court objected that the allocation method 
adopted by the regulation allowed non-WHTC losses to reduce WHTC 
income. However, the court did not disallow a method that would net 
WHTC income of one WHTC with losses of another WHTC, a result that 
would not have occurred under separate returns. Nor did the court 
expressly disallow a different fractional method that would net both 
income and losses of the WHTCs with those of other corporations in the 
consolidated group. The court also found that the regulation had been 
adopted without proper notice.
---------------------------------------------------------------------------
    The Federal Circuit Court construed these authorities and 
applied them to invalidate Treas. Reg. Sec. 1.1502-
20(c)(1)(iii), stating that:

          The loss realized on the sale of a former 
        subsidiary's assets after the consolidated group sells 
        the subsidiary's stock is not a problem resulting from 
        the filing of consolidated income tax returns. The 
        scenario also arises where a corporate shareholder 
        sells the stock of a non-consolidated subsidiary. The 
        corporate shareholder could realize a loss under I.R.C. 
        sec. 1001, and deduct the loss under I.R.C. sec. 165. 
        The subsidiary could then deduct any losses from a 
        later sale of assets. The duplicated loss factor, 
        therefore, addresses a situation that arises from the 
        sale of stock regardless of whether corporations file 
        separate or consolidated returns. With I.R.C. secs. 382 
        and 383, Congress has addressed this situation by 
        limiting the subsidiary's potential future deduction, 
        not the parent's loss on the sale of stock under I.R.C. 
        sec. 165.\229\
---------------------------------------------------------------------------
    \229\ Rite Aid, 255 F.3d at 1360.

    The Treasury Department has announced that it will not 
continue to litigate the validity of the duplicated loss 
provision of the regulations, and has issued interim 
regulations that permit taxpayers for all years to elect a 
different treatment, though they may apply the provision for 
the past if they wish.\230\
---------------------------------------------------------------------------
    \230\ See Temp. Reg. 1.1502-20T(i)(2). The Treasury Department has 
also indicated its intention to continue to study all the issues that 
the original loss disallowance regulations addressed (including issues 
of furthering single entity principles) and possibly issue different 
regulations (not including the particular approach of Treas. Reg. Sec. 
1.1502-20(c)(1)(iii)) on the issues in the future. See Notice 2002-11, 
2002-7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12, 
2002); REG-102740-02, 67 F.R. 11070 (March 12, 2002); see also Notice 
2002-18, 2002-12 I.R.B. 644 (March 25, 2002).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is concerned that the language and analysis 
in the Rite Aid decision might lead taxpayers to attempt to 
challenge other Treasury consolidated return regulations that 
prescribe a tax result different from the result that would 
occur if separate returns were filed.
    The Committee is concerned that any such challenges may 
lead to protracted litigation and commitment of Internal 
Revenue Service resources to defending the consolidated return 
provisions.
    The Committee wishes to clarify that the fact that a result 
under the consolidated return regulations differs from the 
result under separate returns does not provide a basis to 
challenge a Treasury consolidated return regulation.
    The Committee believes that the result of the case with 
respect to the type of factual situation in Rite Aid, involving 
the ``duplicated loss factor'' portion of Treasury Regulation 
section 1.1502-20, which Treasury has announced that taxpayers 
need not follow, should not be overturned. Therefore, the 
committee legislatively allows the specific result of the case 
to stand for the taxpayer in Rite Aid or any similarly situated 
taxpayers.
    Apart from that specific result, the Committee disagrees 
with the reasoning of the case and believes it should not be 
applied to support any challenge to other consolidated return 
regulations. The Committee also wishes to reaffirm the broad 
authority of the Treasury Department to issue consolidated 
return regulations.

                        EXPLANATION OF PROVISION

    The bill confirms that, in exercising its authority under 
section 1502 to issue consolidated return regulations, the 
Treasury Department may provide rules treating corporations 
filing consolidated returns differently from corporations 
filing separate returns.
    Thus, under the statutory authority of section 1502, the 
Treasury Department is authorized to issue consolidated return 
regulations utilizing either a single taxpayer or separate 
taxpayer approach or a combination of the two approaches, as 
Treasury deems necessary in order that the tax liability of any 
affiliated group of corporations making a consolidated return, 
and of each corporation in the group, both during and after the 
period of affiliation, may be determined and adjusted in such 
manner as clearly to reflect the income-tax liability and the 
various factors necessary for the determination of such 
liability, and in order to prevent avoidance of such liability.
    Rite Aid is thus overruled to the extent it suggests that 
there is not a problem that can be addressed in consolidated 
return regulations if application of a particular Code 
provision on a separate taxpayer basis would produce a result 
different from single taxpayer principles that may be used for 
consolidation.
    The bill nevertheless allows the result of the Rite Aid 
case to stand with respect to the type of factual situation 
presented in the case. That is, the legislation provides for 
the override of the regulatory provision that took the approach 
of denying a loss on a deconsolidating disposition of stock of 
a consolidated subsidiary \231\ to the extent the subsidiary 
had net operating losses or built in losses that could be used 
later outside the group.\232\
---------------------------------------------------------------------------
    \231\ Treas. Reg. Sec. 1.1502-20(c)(1)(iii).
    \232\ The provision is not intended to overrule the current 
Treasury Department regulations, which allow taxpayers for the past to 
follow Treasury Regulations Section 1.1502-20(c)(1)(iii), if they 
choose to do so. Temp. Reg. Sec. 1.1502-20T(i)(2).
---------------------------------------------------------------------------
    Retaining the result in the Rite Aid case with respect to 
the particular regulation section 1.1502-20(c)(1)(iii) as 
applied to the factual situation of the case does not in any 
way prevent or invalidate the various approaches Treasury has 
announced it will apply or that it intends to consider in lieu 
of the approach of that regulation, including, for example, the 
denial of a loss on a stock sale if inside losses of a 
subsidiary may also be used by the consolidated group, and the 
possible requirement that inside attributes be adjusted when a 
subsidiary leaves a group.\233\
---------------------------------------------------------------------------
    \233\ See, e.g., Notice 2002-11, 2002-7 I.R.B. 526 (Feb. 19, 2002); 
T.D. 8984, 67 F.R. 11034 (Mar. 12, 2002); REG-102740-02, 67 F.R. 11070 
(Mar. 12, 2002); see also Notice 2002-18, 2002-12 I.R.B. 644 (Mar. 25, 
2002). In exercising its authority under section 1502, the Secretary is 
also authorized to prescribe rules that protect the purpose of General 
Utilities repeal using presumptions and other simplifying conventions.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The bill is effective for all years, whether beginning 
before, on, or after the date of enactment of the bill.
    No inference is intended that the results following from 
this provision are not the same as the results under present 
law.

   2. Chief Executive Officer Required To Sign Corporate Income Tax 
                                Returns


(Sec. 722 of the bill and sec. 6062 of the Code)

                              PRESENT LAW

    The Code requires \234\ that the income tax return of a 
corporation must be signed by either the president, the vice-
president, the treasurer, the assistant treasurer, the chief 
accounting officer, or any other officer of the corporation 
authorized by the corporation to sign the return.
---------------------------------------------------------------------------
    \234\ Sec. 6062.
---------------------------------------------------------------------------
    The Code also imposes \235\ a criminal penalty on any 
person who willfully signs any tax return under penalties of 
perjury that that person does not believe to be true and 
correct with respect to every material matter at the time of 
filing. If convicted, the person is guilty of a felony; the 
Code imposes a fine of not more than $100,000 \236\ ($500,000 
in the case of a corporation) or imprisonment of not more than 
three years, or both, together with the costs of prosecution.
---------------------------------------------------------------------------
    \235\ Sec. 7206.
    \236\ Pursuant to 18 U.S.C. 3571, the maximum fine for an 
individual convicted of a felony is $250,000.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the filing of accurate tax 
returns is essential to the proper functioning of the tax 
system. The Committee believes that requiring that the chief 
executive officer of a corporation sign its corporate income 
tax returns will elevate the level of care given to the 
preparation of those returns.

                        EXPLANATION OF PROVISION

    The bill requires that the chief executive officer of a 
corporation sign that corporation's income tax returns. If the 
corporation does not have a chief executive officer, the IRS 
may designate another officer of the corporation; otherwise, no 
other person is permitted to sign the income tax return of a 
corporation. The Committee intends that the IRS issue general 
guidance, such as a revenue procedure, to (1) address 
situations when a corporation does not have a chief executive 
officer, and (2) define who the chief executive officer is, in 
situations (for example) when the primary official bears a 
different title or when a corporation has multiple chief 
executive officers. The Committee intends that, in every 
instance, the highest ranking corporate officer (regardless of 
title) sign the tax return.
    The provision does not apply to the income tax returns of 
mutual funds; \237\ they are required to be signed as under 
present law.
---------------------------------------------------------------------------
    \237\ The provision does, however, apply to the income tax returns 
of mutual fund management companies and advisors.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

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

                    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 provisions of 
the bill as reported.

                                                  ESTIMATED BUDGET EFFECTS OF THE ``CARE ACT OF 2003,'' AS REPORTED BY THE COMMITTEE ON FINANCE
                                                                          [Fiscal years 2003-2013, millions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
          Provision                Effective        2003       2004       2005       2006       2007       2008       2009       2010       2011       2012       2013      2003-08     2003-13
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
     I. Charitable Giving
     Incentive Provisions


1. Provide charitable          tyba 12/31/02 &.       -204     -1,368     -1,218  .........  .........  .........  .........  .........  .........  .........  .........      -2,790      -2,790
 contribution deduction for    tybb 1/1/05.....
 non-itemizers with cash
 contributions in excess of
 $250 for individuals and
 $500 for joint returns; cap
 on deduction of $250 for
 individuals and $500 for
 joint returns.
2. Tax-free distributions      DOE &...........        -48       -156       -248       -270       -258       -244       -231       -247       -352       -450       -471      -1,223      -2,974
 from IRAs for charitable      tyba 12/31/03...
 purposes--taxpayer must have
 attained age 70\1/2\ for
 contributions made directly
 to a charitable organization
 and age 59\1/2\ for
 contributions to a split-
 interest entity.
3. Extend present-law section  cma DOE.........        -59       -154       -173       -185       -193       -201       -209       -217       -225       -234       -246        -965      -2,094
 170(e)(3) deduction for food
 inventory to all businesses
 and provide special basis
 rule for certain taxpayers;
 modify the enhanced
 deduction for charitable
 contributions of donations
 of food inventory to equal
 the lesser of the item's
 fair market value or twice
 basis.
4. Enhanced charitable         cma DOE.........         -8        -17        -19        -21        -23        -25        -28        -31        -33        -37        -41        -113        -283
 deduction for contributions
 of book inventories, with
 special fair market value
 rule.
5. Expand charitable           generally.......         -1        -67       -133        -63         -1         -1         -1         -1         -1         -1         -1        -266        -271
 contribution allowed for      tyba 12/31/02...
 scientific property used for
 research and for computer
 technology and equipment;
 and temporary extension of
 enhanced deduction for
 qualified computer
 contributions (through 12/31/
 05).
6. Encourage contributions of  cma DOE.........         -3         -5         -9        -13        -16        -23        -32        -41        -51        -62        -75         -70        -332
 capital gain real property
 made for conservation
 purposes.
7. 25% capital gain exclusion  soeoa DOE.......         -4        -21        -40        -59        -62        -65        -69        -72        -76        -80        -84        -251        -632
 for sales or exchanges of
 land or interest in land or
 water to eligible entities
 for conservation purposes.
8. Exclusion for government    pra DOE.........         -1         -2         -2         -3         -3         -3         -3         -3         -3         -3         -3         -12         -26
 payments under Partners for
 Fish and Wildlife Program.
9. Adjustment to basis of S    cma DOE.........         -8        -22        -30        -33        -37        -41        -45        -50        -55        -62        -68        -172        -453
 corporation stock for
 certain charitable
 contributions.
10. Enhanced deduction for     cma DOE.........         -2         -4         -4         -5         -5         -6         -6         -6         -7         -7         -7         -26         -59
 certain charitable
 contributions of literary,
 musical, artistic, and
 scholarly compositions.
11. Certain mileage            tyba DOE........      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)          -1          -3
 reimbursements to charitable
 volunteers excluded from
 gross income.
12. Provide an equal enhanced  cma 12/31/03....  .........        -17        -28        -31        -34        -38        -41        -46        -50        -55        -59        -148        -399
 deduction for qualified
 corporate contributions of
 inventory to public schools
 as currently allowed for
 contributions to private
 schools; computer technology
 and equipment are not
 eligible property.
                                                ------------------------------------------------------------------------------------------------------------------------------------------------
      Total of Charitable      ................       -338     -1,833     -1,904       -683       -632       -647       -665       -714       -853       -991     -1,055      -6,037     -10,316
       Giving Incentive
       Provisions.
                                                ================================================================================================================================================
  II. Provisions to Improve
   Oversight of Tax-Exempt
        Organizations


1. Disclosure of written       wdia DOE........                                                             Negligible Revenue Effect
 determinations.
2. Disclosure of name under    rfa 12/31/03....                                                             Negligible Revenue Effect
 which an organization does
 business and its Internet
 Web site.
3. Modification to private     rfa 12/31/03....                                                             Negligible Revenue Effect
 foundation reporting of
 capital transactions.
4. Disclosure that Form 990    pomiora DOE.....                                                             Negligible Revenue Effect
 is publicly available.
5. Disclosure to State         DOE.............                                                             Negligible Revenue Effect
 officials of certain tax
 information related to
 certain section 501(c)
 organizations.
6. Expansion of penalties to   dpa DOE.........                                                             Negligible Revenue Effect
 preparers of Form 990.
7. Notification requirement    fapba 12/31/03..                                                             Negligible Revenue Effect
 for exempt entities not
 currently required to file.
8. Suspension of tax-exempt    (\2\)...........                                                        Negligible Revenue Effect Total Rule
 status of terrorist
 organizations.
                                                ------------------------------------------------------------------------------------------------------------------------------------------------
      Total of Provisions to   ................                                                             Negligible Revenue Effect
       Improve Oversight of
       Tax-Exempt
       Organizations.
  III. Other Charitable and
     Exempt Organization
          Provisions

1. Modify tax on unrelated     tyba 12/31/02...          -         -4         -4         -5         -5         -5         -5         -6         -6         -6         -7         -23         -53
 business taxable income of
 charitable remainder trusts.
2. Modify tax treatment of     proaa 12/31/00..        -32        -12        -13        -13        -14        -15        -16        -17        -18        -20        -21         -99        -191
 certain payments to
 controlling exempt
 organizations.
3. Simplification of lobbying  tyba 12/31/02...         -1         -1         -1         -1         -1         -1         -2         -2         -2         -2         -3          -7         -15
 expenditure limitation.
4. Expedited review process    afa 12/31/03....                                                             Negligible Revenue Effect
 for certain tax-exemption
 applications.
5. Clarification of            DOE.............                                                                 No Revenue Effect
 definition of church tax
 inquiry.
6. Extension of declaratory    dma 12/31/03....                                                             Negligible Revenue Effect
 judgment procedures to non-
 501(c)(3) tax-exempt
 organizations.
7. Definition of convention    DOE.............                                                             Negligible Revenue Effect
 or association of churches.
8. Provide that certain        pma DOE & pmb...                                                             Negligible Revenue Effect
 payments by charitable        9/11/04; \3\....
 organizations made by reason
 of the death, injury,
 wounding, or illness of
 military personnel incurred
 as a result of the war on
 terrorism and astronauts
 killed in the line of duty
 (no sunset) are deemed
 consistent with exempt
 purposes.
9. Increase percentage limits  gma DOE.........  .........         -6         -9        -11        -12        -14        -15        -17        -19        -22        -25         -52        -150
 for certain employer-related
 scholarship programs under
 Revenue Procedure 76-47 to
 35% of eligible applicants
 or 20% of eligible students.
10. Treatment of certain       iia 12/31/03....  .........         -8        -16        -18        -19        -20        -20        -21        -22        -23        -23         -80        -189
 hospital organizations as
 qualified organizations for
 purposes of determining
 acquisition indebtedness.
11. Charitable contribution    cma 12/31/03....  .........      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)      (\1\)          -1          -4
 deduction for certain
 expenses in support of
 Native Alaska subsistence
 whaling.
12. Matching grants to low-    DOE.............                                                                 No Revenue Effect
 income taxpayer clinics for
 return preparation.
                                                ------------------------------------------------------------------------------------------------------------------------------------------------
      Total of Other           ................        -33        -31        -43        -48        -51        -55        -58        -63        -67        -73        -79        -262        -602
       Charitable and Exempt
       Organization
       Provisions.
                                                ================================================================================================================================================
IV. Restoration of Social      (\5\)...........       -238       -946       -278         23         16         27         20  .........  .........  .........  .........      -1,395      -1,375
 Services Block Grant Funding
 (outlays) \4\.
V. Individual Development      tyea 12/31/04 &.  .........  .........        -24        -44        -39        -61        -76        -90       -104        -48      (\1\)        -169        -487
 Accounts--provide a tax       tybb 1/1/12.....
 credit to eligible entities
 with respect to the first
 300,000 individual
 development accounts
 established for low-income
 workers.
VI. Management of Exempt       DOE.............                                                                 No Revenue Effect
 Organizations.
   VII. Revenue Provisions

    A. Provisions to Curtail
     Tax Shelters:
        1. Clarification of    ta 2/15/04......       -258        552      1,119      1,042        927        965      1,079      1,213      1,395      1,607      1,848       4,347      11,490
         the economic
         substance doctrine
         and related penalty
         provisions.
        2. Provisions          various dates...         35         92        115        119        120        124        131        139        150        164        179         604       1,366
         relating to           after DOE \6\...
         reportable
         transactions and tax
         shelters.
        3. Modification to     ta DOE..........  .........  .........          4         11         19         23         26         30         34         38         38          57         223
         the substantial
         understatement
         penalty \7\.
        4. Actions to enjoin   DOE.............                                                             Negligible Revenue Effect
         conduct with respect
         to tax shelters.
        5. Understatement of   dpa DOE.........                                                             Negligible Revenue Effect
         taxpayer's liability
         by income tax return
         preparer.
        6. Impose a civil      DOE.............      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)      (\8\)           1           3
         penalty (of up to
         $5,000) on failure
         to report interest
         in foreign financial
         accounts.
        7. Frivolous tax       (\9\)...........          1          3          3          3          3          3          3          3          3          3          3          16          31
         submissions.
        8. Regulation of       ata DOE.........                                                                 No Revenue Effect
         individuals
         practicing before
         the Department of
         Treasury.
        9. Amend Code section  tyba DOE........  .........  .........  .........          1          1          1          1          1          1          1          1           3           8
         6501 to provide for
         6-year statute of
         limitations for
         undisclosed listed
         transactions.
        10. Amend Code         tyba DOE........  .........  .........  .........          1          1          3          4          4          4          4          4           5          25
         section 163 to
         disallow a deduction
         for deficiency
         interest paid to the
         IRS on underpayments
         involving tax
         motivated
         transactions.
        11. Additional $300    DOE.............                                                                 No Revenue Effect
         million tax law
         enforcement
         authorization for
         the IRS \4\.
    B. Other Provisions:
        1. Affirmation of      (\10\)..........                                                             Negligible Revenue Effect
         consolidated return
         regulation authority.
        2. Require CEO         rfa DOE.........                                                             Negligible Revenue Effect
         signatures on income
         tax returns.
                                                ------------------------------------------------------------------------------------------------------------------------------------------------
          Total of Revenue     ................       -222        647      1,241      1,177      1,071      1,119      1,244      1,390      1,587      1,817      2,073       5,033      13,146
           Provisions.
                                                ================================================================================================================================================
      Net Total..............  ................       -831     -2,163     -1,008        425        365        383        465        523        563        705        939      -2,830        366
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Loss of less than $500,000.
\2\ Effective for organizations that are designated or identified as a terrorist organization prior to, on, or after the date of enactment.
\3\ Effective for payments made after December 31, 2002, with respect to astronauts killed in the line of duty after December 31, 2002.
\4\ Estimate provided by the Congressional Budget Office.
\5\ Effective for amounts made available for fiscal year 2003 and for amounts made available each fiscal year thereafter. The proposal requiring annual reports would be with respect to fiscal
  year 2002 and each fiscal year thereafter.
\6\ Effective dates for provisions relating to reportable transactions and tax shelters: the penalty for failure to disclose reportable transactions is effective for returns and statements the
  due date of which is after the date of enactment; the modification to the accuracy-related penalty for listed or reportable transactions is effective for taxable years ending after the date
  of enactment; the tax shelter exception to confidentiality privileges is effective for communications made on or after the date of enactment; the material advisor disclosure provisions
  applies to transactions with respect to which material aid, assistance or advice is provided after the date of enactment; the investor list provision applies to transactions with respect to
  which material aid, assistance or advice is provided after the date of enactment, and the penalty on promoters of tax shelters is effective for activities after the date of enactment.
\7\ Failure or substantial delay of forthcoming regulations for section 6011 of the Internal Revenue Code and other administrative actions to be taken by the Treasury Department or the
  Internal Revenue Service would reduce the estimated revenue effects of these provisions.
\8\ Gain of less than $1 million.
\9\ Effective for submissions made and issues raised after the first list is prescribed under section 6702(c).
\10\ Effective for all taxable years, whether beginning before, with, or after the date of enactment.

Legend for ``Effective'' column: afa = applications filed after; ata = actions taken after; bia = bonds issued after; cma = contributions made after; dma = determinations made after; DOE =
  date of enactment; dpa = documents prepared after; fapba = for annual periods beginning after; gma = grants made after; iia = indebtedness incurred after; pma = payments made after; pmb =
  payments made before; pra = payments received after; pomiora = publications or materials issued or revised after; proaa = payments received or accrued after; rfa = returns filed after; soeoa
  = sales or exchanges occurring after; ta = transactions after; tyba = taxable years beginning after; tybb = taxable years beginning before; tyea = taxable years ending after; and wdia =
  written determinations issued after.

Note.--Details may not add to totals due to rounding.

Source: Joint Committee on Taxation.

                B. Budget Authority and Tax Expenditures


Budget authority

    In compliance with section 308(a)(1) of the Budget Act, the 
Committee states that the revenue provisions of the bill as 
reported involve new or increased budget authority.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that the revenue-reducing provisions of the 
bill involve increased tax expenditures (see revenue table in 
Part III.A., above). The revenue increasing provisions of the 
bill involve reduced expenditures (see revenue table in Part 
III.A., above).

            C. Consultation with Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office 
submitted the following statement on this bill.

                                     U.S. Congress,
                               Congressional Budget Office,
                                 Washington, DC, February 20, 2003.
Hon. Charles E. Grassley,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for S. 256, the CARE Act of 
2003.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Annabelle 
Bartsch (for federal revenues) and Sheila Dacey (for federal 
spending).
            Sincerely,
                                       Douglas Holtz-Eakin,
                                                          Director.
    Enclosure.
                                     U.S. Congress,
                               Congressional Budget Office,
                                 Washington, DC, February 25, 2003.
Hon. Charles E. Grassley,
Chairman, Committee on Finance,
U.S. Senate, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for the CARE Act of 2003 as 
ordered reported by the Senate Committee on Finance. This 
estimate supersedes the one CBO provided on February 20, 2003, 
which identified the bill as S. 256. Because the Committee is 
now planning to report an original bill, this estimate deletes 
any reference to S. 256. CBO's estimate of the budgetary impact 
of the Care Act is unchanged.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contacts are Annabelle 
Bartsch (for federal revenues) and Sheila Dacey (for federal 
spending.
            Sincerely,
                                       Douglas Holtz-Eakin,
                                                          Director.
    Enclosure.

CARE Act of 2003

    Summary: The Care Act would provide taxpayers with several 
incentives for charitable giving, restrict tax-shelter 
activity, increase funding for the Social Services Block Grant 
(SSBG), and increase the amount that could be transferred from 
the Temporary Assistance to Needy Families (TANF) program to 
SSBG.
    CBO and the Joint Committee on Taxation (JCT) estimate that 
enacting the bill would decrease governmental receipts by $596 
million in 2003 and by about $1.7 billion over the 2003-2008 
period. Over the 2003-2013 period, however, enacting the 
legislation would increase governmental receipts by about $1.5 
billion. The bill also would increase direct spending by $76 
million in 2003, and $1.4 billion over the 2003-2008 period 
(with a comparable total for the 2003-2013 period).
    The bill also would authorize the appropriation of $83 
million in 2003 and $491 million over the 2003-2008 period for 
administering an expanded Individual Development Account (IDA) 
program and handling filing of tax-exempt organizations. 
Assuming that those amounts are appropriated, CBO estimates 
that the resulting outlays would be $439 million over the 2003-
2008 period.
    CBO has reviewed title IV of the bill and has determined 
that it contains no intergovernmental mandates as defined in 
the Unfunded Mandates Reform Act (UMRA). That title would 
benefit states by increasing their ability to transfer TANF 
funds to SSBG and also by increasing funding for SSBG in 2003 
and 2004. JCT has determined that the remaining provisions of 
the bill contain no intergovernmental mandates as defined in 
UMRA and would not affect the budgets of state, local, or 
tribal governments.
    JCT has determined that the provisions relating to tax 
shelters contain private-sector mandates. The total cost of 
complying with those mandates would exceed the threshold 
established by UMRA ($117 million in 2003, adjusted annually 
for inflation). CBO has determined that title IV of the bill 
contains no private-sector mandates as defined in UMRA.
    Estimated cost to the Federal Government: The estimated 
budgetary impact of the Care Act is shown in Table 1. All 
revenue estimates were provided by JCT. The spending under the 
bill falls in budget functions 500 (education, training, 
employment, and social services), 600 (income security), and 
800 (general government).
    Basis of estimate: For this estimate, CBO assumes the CARE 
Act will be enacted in the spring of 2003 and that the 
authorized amounts will be appropriated for each year. These 
estimates would change if the bill were enacted later in the 
year. We estimated the bill's budgetary effect using CBO's 
January 2003 baseline assumptions, updated to reflect 
legislation that has cleared the Congress, particularly the 
Consolidated Appropriations Resolution, 2003 (Public Law 108-
10).

Revenues

    All estimates were provided by JCT. A number of provisions 
would reduce revenues, and several would increase revenues. All 
together, the bill's provisions would reduce governmental 
receipts by $596 million in 2003 and by about $1.7 billion over 
the 2003-2008 period. Over the 2003-2013 period, however, 
enacting the legislation would increase revenues by about $1.5 
billion.
    Most of the revenue reductions would occur from the 
provisions that allow tax-free distributions from individual 
retirement accounts (IRAs) for charitable purposes, a 25 
percent exclusion of capital gains for sales of land or water 
for conservation purposes, and the deduction of a certain 
amount of charitable contributions by taxpayers who do not 
itemize. Other provisions that would reduce revenues include 
enhancing deductions for contributions of food inventories, 
adjusting the tax basis of certain stock for charitable 
contributions, and providing a tax credit to eligible financial 
entities for matching contributions to Individual Development 
Accounts made by certain low-income workers. These provisions 
together would reduce revenues by $326 million in 2003, by 
about $5.7 billion over the 2003-2008 period, and by about $9.6 
billion over the 2003-2013 period. The remaining provisions to 
provide incentives to increase charitable giving would decrease 
receipts by $48 million in 2003, by about $1.0 billion over the 
2003-2008 period, and by about $2.1 billion over the 2003-2013 
period.

                          TABLE 1.--ESTIMATED BUDGETARY IMPACT OF THE CARE ACT OF 2003
----------------------------------------------------------------------------------------------------------------
                                                            By fiscal year, in millions of dollars--
                                               -----------------------------------------------------------------
                                                   2003       2004       2005       2006       2007       2008
----------------------------------------------------------------------------------------------------------------
                                               Changes in Revenue

Estimated Revenues............................       -596     -1,252       -750        310        277        347

                                           Changes in Direct Spending

Increased SSBG Funding:
    Budget Authority..........................        275      1,100          0          0          0          0
    Estimated Outlays.........................        110        990        231         44          0          0
TANF Effect of New SSBG Funding:
    Budget Authority..........................          0          0          0          0          0          0
    Estimated Outlays.........................        -34       -114         25         41         46         36
Increased Transfer Authority from TANF to
 SSBG:
    Budget Authority..........................          0          0          0          0          0          0
    Estimated Outlays.........................          0        114         84        -82        -49        -50
    Total Changes in Direct Spending:
        Budget Authority......................        275      1,100          0          0          0          0
        Estimated Outlays.....................         76        990        340          3         -3        -14

                                  Changes in Spending Subject to Appropriations

Individual Development Accounts:
    Authorization Level.......................          0          4          1          1          1          1
    Estimated Outlays.........................          0          1          1          1          1          2
Tax-Exempt Organizations:
    Authorization Level.......................         83         80         80         80         80         80
    Estimated Outlays.........................         23         90         80         80         80         80
    Total:
    Authorization Level.......................         83         84         81         81         81         81
    Estimated Outlays.........................         23         91         81         81         81         82
----------------------------------------------------------------------------------------------------------------
Notes.--SSBG=Social Services Block Grant. TANF=Temporary Assistance to Needy Families.

    Most of the revenue increases would result from provisions 
restricting tax-shelter activity. The provision clarifying the 
economic substance doctrine and the related penalty provisions 
would decrease revenues by $258 million in 2003, but would 
increase revenues by about $4.3 billion over the 2003-2008 
period and $11.5 billion over the 2003-2013 period. The 
remaining provisions, which relate to reportable transactions 
and tax shelters and modifications of the substantial 
understatement penalty and certain other penalties, would 
increase revenues by $36 million in 2003, by $686 million over 
the 2003-2008 period, and by about $1.7 billion over the 2003-
2013 period.

                           TABLE 2.--ESTIMATED REVENUE EFFECTS OF THE CARE ACT OF 2003
----------------------------------------------------------------------------------------------------------------
                                                            By fiscal year, in millions of dollars--
                                               -----------------------------------------------------------------
                                                   2003       2004       2005       2006       2007       2008
----------------------------------------------------------------------------------------------------------------
                                             Major Revenue Reducers

Charitable Contribution Deduction for                -204     -1,368     -1,218          0          0          0
 Nonitemizers.................................
Tax-Free Distributions from IRAs for                  -48       -156       -248       -270       -258       -244
 Charitable Purposes..........................
Enhanced Deductions for Contributions to Food         -59       -154       -173       -185       -193       -201
 Inventories..................................
25 percent Exclusion of Capital Gains Taxes            -7        -56        -60        -67        -70        -74
 for Sales of Land or Water for Conservation
 purposes.....................................
Adjustment to Basis of S Corporation Stock for         -8        -22        -30        -33        -37        -41
 Certain Charitable Contributions.............
Tax Credit for IDA Program Expansion..........          0          0        -24        -44        -39        -61
Other Provisions..............................        -48       -143       -238       -268       -197       -151
                                               -----------------------------------------------------------------
      Subtotal................................       -374     -1,899     -1,991       -867       -794       -772
                                               =================================================================
                                              Major Revenue Raisers

Clarification of the Economic Substance              -258        552      1,119      1,042        927        965
 Doctrine and Related Penalty Provisions......
Provisions Relating to Reportable Transactions         35         92        115        119        120        124
 and Tax Shelters.............................
Other Provisions..............................          1          3          7         16         24         30
                                               -----------------------------------------------------------------
      Subtotal................................       -222        647      1,241      1,177      1,071      1,119
                                               =================================================================
                                            Net Effect on Revenues

Estimated Revenues............................       -596     -1,252       -750       -310       -277       -347
----------------------------------------------------------------------------------------------------------------
Notes.--components may not sum to totals because of rounding. IRA = Individual Retirement Account. IDA =
  Individual Development Account.

Direct Spending

    Title IV would increase the funding level for the Social 
Services Block Grant in 2003 and 2004 and raise the percentage 
of the TANF grant that states could transfer to SSBG. SSBG is 
permanently authorized at $1.7 billion annually. Title IV would 
increase funding for 2003 to $1.975 billion and for 2004 to 
$2.8 billion. Funding would return to $1.7 billion in 2005 and 
later. CBO estimates that states would spend the new funds a 
little more slowly than regular SSBG funds, raising outlays by 
$76 million in 2003 and about $1.4 billion over the 2003-2008 
period. Title IV also would allow states to maintain the 
authority to transfer up to 10 percent of TANF funds to SSBG. 
That authority is scheduled to fall to 4.25 percent in 2004 and 
after. In recent years, states have transferred about $1 
billion annually.
    Those provisions would affect TANF spending in two ways. 
First, the additional SSBG spending would tend to reduce the 
incentives for TANF transfers to SSBG. CBO estimates that 
change would lower TANF spending by $148 million over the 2003-
2004 period, but raise it by a similar amount over the 2005-
2008 period. Second, maintaining the transfer authority at the 
higher level would make it easier for states to spend their 
TANF grants and would tend to accelerate spending relative to 
current law. (Based on recent state transfers, CBO expects that 
states would transfer an additional $400 million in 2004 under 
the provision, but because some of this money would have been 
spent within the TANF program anyway, only $114 million of 
additional spending would occur in 2004.) The combined effect 
of the provisions would be to increase net TANF spending over 
the 2003-2008 period by $17 million, but lower it by 417 
million over the 2009-2013 period. Thus, there would be no net 
impact on TANF spending over the 11-year period as a whole.

Spending Subject to Appropriation

    Title V would augment the existing Individual Development 
Account program by providing an IDA tax credit to qualified 
financial institutions for matching the IDA savings of low-
income individuals. The effect of those tax credits on reducing 
federal revenues is estimated to total $168 million over the 
2005-2008 period. (Those effects were included in the totals 
discussed in the earlier section on revenues.) The bill also 
would authorize the appropriation of $2.5 million for a report 
on cost and outcomes of IDAs and $1 million in each year 2004 
through 2011 for other administrative activities. Assuming 
appropriation of the authorized amounts, CBO estimates outlays 
of $1 million in 2004, $6 million over the 2004-2008 period, 
and $10 million over the eight-year period.
    The bill also would disregard any funds in IDA accounts for 
purposes of qualifying individuals for federal means-tested 
programs. It is possible that expanding the IDA program could 
allow certain people with assets to participate in means-tested 
programs who would otherwise be ineligible, but CBO estimates 
that would have an insignificant effect (less than $500,000 a 
year) on federal spending. While there are limited data on 
current IDA participants, the available information indicates 
most participants would not deposit enough into their accounts 
to disqualify themselves from any federal means-tested program.
    Title VI would authorize the annual appropriation of $80 
million for the Internal Revenue Service for its administrative 
costs related to filing of tax-exempt organizations. it would 
authorize $3 million in fiscal year 2003 for the Department of 
Treasury for its administrative costs related to filing of 
section 527 political organizations.
    Assuming the appropriation of the authorized amounts, CBO 
estimates that implementing those provisions would cost $23 
million in 2003 and $433 million over the 2003-2008 period.
    Estimated Impact on state, local, and tribal governments: 
CBO has reviewed title IV of the bill and has determined that 
it contains no intergovernmental mandates as defined in UMRA. 
That title would benefit states by increasing their ability to 
transfer TANF funds to SSBG and also by increasing funding for 
SSBG in 2003 and 2004.
    JCT has determined that the remaining provisions of the 
bill contain no intergovernmental mandates as defined in UMRA 
and would not affect the budgets of state, local, or tribal 
governments.
    Estimated impact on the private sector: JCT has determined 
that the provisions relating to tax shelters contain private-
sector mandates, and that the direct cost of complying with 
those mandates would exceed the threshold established by UMRA 
($117 million in 2003, adjusted annually for inflation), in 
2003 and thereafter. CBO has determined that title IV of the 
bill contains no private-sector mandates as defined in UMRA.
    Previous CBO estimate: On February 20, 2003, CBO 
transmitted a cost estimate for the CARE Act of 2003 as ordered 
reported by the Senate Committee on Finance on February 5, 
2003. CBO's estimate of the budgetary impact of the CARE Act of 
2003 is unchanged. This estimate deletes any reference to S. 
256 as the bill number of the CARE Act ordered reported by the 
Senate Finance Committee.
    Estimate prepared by: Federal Revenues: Annabelle Bartsch. 
Federal Spending: Social Services Block Grant: Sheila Dacy; 
Individual Development Accounts: Donna Wong; and Department of 
Treasury: Matthew Pickford. Impact on State, Local, and Tribal 
Governments: Leo Lex. Impact on the Private Sector: Kate 
Bloniarz.
    Estimate approved by: Peter H. Fontaine, Deputy Director 
for Budget Analysis; and G. Thomas Woodward, Assistant Director 
for Tax Analysis.

                       IV. VOTES OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the following statements are made 
concerning the votes taken on the Committee's consideration of 
the bill.

Motion to report the bill

    The bill was ordered favorably reported by a voice vote, a 
quorum being present, on February 5, 2003.

Votes on amendments

    An amendment by Senator Baucus to require the chief 
executive officer of a corporation to sign that corporation's 
income tax return was agreed to by a voice vote.

                 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 amended.

Impact on individuals and businesses

    With respect to the provisions that do not increase 
revenue, the committee amendment to the bill modifies the rules 
relating to (1) certain charitable giving incentives; (2) 
disclosure of information relating to tax-exempt organizations; 
(3) tax treatment and procedures relating to exempt 
organizations; (4) restoration of funds for the Social Services 
Block Grant; and (5) individual development accounts. Under 
these provisions, taxpayers may elect whether to avail 
themselves of the provisions. The Social Services Block Grant 
provisions provide increased funding to States to support a 
variety of social services, the low-income taxpayer clinic 
provision authorize grants by the Secretary of the Treasury, 
and the management of exempt organization provisions authorize 
certain appropriations. Thus, the provisions do not impose 
increased regulatory burdens on individuals or businesses.
    With respect to the revenue-increasing provisions, the 
committee amendment to the bill modifies the rules relating to 
(1) the disclosure of reportable transactions and tax shelters; 
(2) the substantial understatement penalty; (3) actions to 
enjoin conduct with respect to tax shelters; (4) an 
understatement of a taxpayer's liability by an income tax 
return preparer; (5) the imposition of a civil penalty (of up 
to $5,000) on a failure to report interest in foreign financial 
accounts; and (6) frivolous tax submissions. These provisions 
relate to taxpayers that engage in certain tax avoidance 
transactions. Taxpayers that have not undertaken or planned to 
undertake such transactions generally are not affected by the 
provisions of the bill. Thus, the revenue provisions generally 
do not impose increased regulatory burdens on individuals or 
businesses.

Impact on personal privacy and paperwork

    The provisions of the bill do not impact personal privacy. 
Individuals either elect whether to avail themselves of the 
provisions of the bill or are subject to the bill for engaging 
in certain tax avoidance transactions. The bill does not impose 
increased paperwork burdens on individuals. Individuals who 
elect to take advantage of provisions in the bill may in some 
cases need to keep records in order to demonstrate that they 
qualify for the treatment provided. Individuals who elect to 
engage in tax avoidance transactions, and certain advisors who 
provide material aid, assistance, or advice with respect to 
such transactions, may in some cases need to file certain 
disclosure statements with the IRS.

                     B. Unfunded Mandates Statement

    The 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: (1) 
provisions relating to reportable transactions and tax 
shelters; (2) modifications to the substantial understatement 
penalty; (3) actions to enjoin conduct with respect to tax 
shelters; (4) understatement of taxpayer's liability by an 
income tax return preparer; (5) the imposition of a civil 
penalty (of up to $5,000) on a failure to report interest in 
foreign financial accounts; and (6) frivolous tax submissions.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the estimated 
budget effect 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.

                       C. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service Reform and 
Restructuring Act of 1998 (the ``IRS Reform Act'') requires the 
Joint Committee on Taxation (in consultation with the Internal 
Revenue Service and the Department of the Treasury) to provide 
a tax complexity analysis. The complexity analysis is required 
for all legislation reported by the Senate Committee on 
Finance, the House Committee on Ways and Means, or any 
committee of conference if the legislation includes a provision 
that directly or indirectly amends the Internal Revenue Code 
(the ``Code'') and has widespread applicability to individuals 
or small businesses. For each such provision identified by the 
staff of the Joint Committee on Taxation, a summary description 
of the provision is provided, along with an estimate of the 
number and type of affected taxpayers, and a discussion 
regarding the relevant complexity and administrative issues. 
Following the analysis of the staff of the Joint Committee on 
Taxation are the comments of the IRS regarding each provision 
included in the complexity analysis, including a discussion of 
the likely effect on IRS forms and any expected impact on the 
IRS.

Direct charitable deduction for nonitemizers (sec. 101 of the bill)

            Summary description of provision
    In the case of an individual taxpayer who does not itemize 
deductions, the bill would allow a direct charitable deduction 
from adjusted gross income for charitable contributions paid in 
cash. This deduction would be allowed in addition to the 
standard deduction. The deduction would be available only for 
that portion of contributions that in the aggregate exceed $250 
($500 in the case of a joint return). The maximum deduction 
would be $250 ($500 in the case of a joint return). The direct 
charitable deduction generally would be subject to the tax 
rules normally governing charitable contribution deductions, 
such as the substantiation requirements. The deduction would be 
allowed in computing alternative minimum taxable income. The 
direct charitable deduction would be effective for taxable 
years beginning after December 31, 2002, and before January 1, 
2005.
            Number of affected taxpayers
    It is estimated that the provision will affect 
approximately 30 million individual income tax returns each 
year the deduction is in effect.
            Discussion
    Individuals who do not itemize their deductions will need 
to keep additional records (e.g., canceled checks, a receipt 
from the donee organization, or other reliable written records) 
in order to substantiate that a contribution was made to a 
qualified charitable organization. The information necessary to 
implement the provision should be readily available to 
taxpayers (in the form of new tax return forms and 
instructions). The direct charitable deduction is expected to 
require an additional line on the individual income tax return 
forms. The provision might result in an increase in disputes 
with the IRS for taxpayers who are unable to substantiate a 
claimed deduction. Additional regulatory guidance will not be 
necessary to implement this provision. Any increase in tax 
preparation costs is expected be negligible.

                        Department of the Treasury,
                                  Internal Revenue Service,
                                 Washington, DC, February 10, 2003.
Ms. Lindy L. Paull,
Chief of Staff, Joint Committee on Taxation,
Washington, DC.
    Dear Ms. Paul: Enclosed are the combined comments of the 
Internal Revenue Service and the Treasury Department on the 
provision for a charitable deduction for non-itemizers from the 
Senate Finance Committee's markup of the ``CARE Act of 2003,'' 
that you identified for complexity analysis in your letter of 
February 5, 2003. Our comments are based on the description of 
that provision in you letter and in JCX-04-03, Joint Committee 
on Taxation, Description of the CARE Act of 2003, February 3, 
2003.
    Due to the short turnaround time, our comments are 
provisional and subject to change upon a more complete and in-
depth analysis of the provision.
            Sincerely,
                                                Bob Wenzel,
                                               Acting Commissioner.
    Enclosure.

       Complexity Analysis of Provision From the Care Act of 2003


                 CHARITABLE DEDUCTION FOR NON-ITEMIZERS

    Provision: A taxpayer who does not itemize deductions would 
be allowed a direct charitable deduction from adjusted gross 
income for charitable contributions paid in cash. This 
deduction would be available only for that portion of 
contributions that in the aggregate exceed $250 ($500 in the 
case of a joint return). The maximum deduction would be $250 
($500 in the case of a joint return). The direct charitable 
deduction generally would be subject to the tax rules normally 
governing charitable contribution deductions, and would be 
allowed in computing alternative minimum taxable income. The 
provision would be effective for taxable years beginning after 
December 31, 2002, and before January 1, 2005.

IRS and Treasury Comments

     Two lines would have to be added to Forms 1040, 
1040A, 1040EZ, 1040NR, and 1040NR-EZ for 2003 and 2004; one for 
the allowable deduction and one to reflect the total of the 
standard deduction and the charitable contribution deduction. 
One line would be added to the TeleFile Tax Record for 2003 and 
2004 (taxpayers would enter their total contributions on the 
new line and TeleFile would calculate the allowable deduction). 
No new forms would be required.
     The new deduction would also have to be reflected 
on Form 1040-ES for 2004 and in the instructions for Forms 
1040X and 1045 for 2003 and 2004. Subsequent to enactment, the 
IRS may have to advise taxpayers who make estimated tax 
payments for 2003 how they can adjust their estimated tax 
payments for 2003 to reflect the new deduction.
     Information necessary for taxpayers to determine 
their eligibility for the deduction, including the AGI 
limitation applicable to cash contributions, and the 
substantiation requirements, would have to be reflected in the 
2003 and 2004 instructions for Forms 1040, 1040A, 1040EZ, 
1040NR, and 1040NR-EZ and for TeleFile.
     A worksheet (consisting of four lines) for 
taxpayers to calculate their allowable deduction would have to 
be reflected in the 2003 and 2004 instructions for Forms 1040, 
1040A, 1040EZ, 1040NR, and 1040NR-EZ.
     Changes to the TeleFile script for 2003 and 2004 
would be required to allow the deduction to taxpayers who use 
TeleFile.
     All of the above changes would have to be reversed 
for tax years beginning after December 31, 2004, to reflect the 
termination of the charitable deduction for non-itemizers 
(e.g., the lines would be removed from the Form 1040 series of 
returns, the worksheet would be removed from the instructions 
for these returns, and programming and script changes would be 
necessary to eliminate the deduction).
     Ensuring compliance with the new charitable 
deduction would be difficult. The only means of verifying 
amounts deducted would be through examination, and the normal 
examination rate for such returns is relatively low.
     Programming changes would be required to reflect 
the new deduction on the tax returns.

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

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

                                
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