[House Report 109-455]
[From the U.S. Government Publishing Office]
109th Congress Report
HOUSE OF REPRESENTATIVES
2d Session 109-455
_______________________________________________________________________
TAX INCREASE PREVENTION
AND RECONCILIATION ACT
OF 2005
__________
CONFERENCE REPORT
to accompany
H.R. 4297
May 9, 2006.--Ordered to be printed
109th Congress Report
HOUSE OF REPRESENTATIVES
2d Session 109-455
======================================================================
TAX INCREASE PREVENTION AND RECONCILIATION ACT OF 2005
_______
May 9, 2006.--Ordered to be printed
_______
Mr. Thomas, from the Committee of Conference, submitted the following
CONFERENCE REPORT
[To accompany H.R. 4297]
The committee of conference on the disagreeing votes of
the two Houses on the amendment of the Senate to the bill (H.R.
4297), to provide for reconciliation pursuant to section 201(b)
of the concurrent resolution on the budget for fiscal year
2006, having met, after full and free conference, have agreed
to recommend and do recommend to their respective Houses as
follows:
That the House recede from its disagreement to the
amendment of the Senate and agree to the same with an amendment
as follows:
In lieu of the matter proposed to be inserted by the
Senate amendment, insert the following:
SECTION 1. SHORT TITLE, ETC.
(a) Short Title.--This Act may be cited as the ``Tax
Increase Prevention and Reconciliation Act of 2005''.
(b) Amendment of 1986 Code.--Except as otherwise expressly
provided, whenever in this Act an amendment or repeal is
expressed in terms of an amendment to, or repeal of, a section
or other provision, the reference shall be considered to be
made to a section or other provision of the Internal Revenue
Code of 1986.
(c) Table of Contents.--The table of contents for this Act
is as follows:
Sec. 1. Short title, etc.
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
Sec. 101. Increased expensing for small business.
Sec. 102. Capital gains and dividends rates.
Sec. 103. Controlled foreign corporations.
TITLE II--OTHER PROVISIONS
Sec. 201. Clarification of taxation of certain settlement funds.
Sec. 202. Modification of active business definition under section 355.
Sec. 203. Veterans' mortgage bonds.
Sec. 204. Capital gains treatment for certain self-created musical
works.
Sec. 205. Vessel tonnage limit.
Sec. 206. Modification of special arbitrage rule for certain funds.
Sec. 207. Amortization of expenses incurred in creating or acquiring
music or music copyrights.
Sec. 208. Modification of effective date of disregard of certain capital
expenditures for purposes of qualified small issue bonds.
Sec. 209. Modification of treatment of loans to qualified continuing
care facilities.
TITLE III--ALTERNATIVE MINIMUM TAX RELIEF
Sec. 301. Increase in alternative minimum tax exemption amount for 2006.
Sec. 302. Allowance of nonrefundable personal credits against regular
and alternative minimum tax liability.
TITLE IV--CORPORATE ESTIMATED TAX PROVISIONS
Sec. 401. Time for payment of corporate estimated taxes.
TITLE V--REVENUE OFFSET PROVISIONS
Sec. 501. Application of earnings stripping rules to partners which are
corporations.
Sec. 502. Reporting of interest on tax-exempt bonds.
Sec. 503. 5-year amortization of geological and geophysical expenditures
for certain major integrated oil companies.
Sec. 504. Application of FIRPTA to regulated investment companies.
Sec. 505. Treatment of distributions attributable to FIRPTA gains.
Sec. 506. Prevention of avoidance of tax on investments of foreign
persons in United States real property through wash sale
transactions.
Sec. 507. Section 355 not to apply to distributions involving
disqualified investment companies.
Sec. 508. Loan and redemption requirements on pooled financing
requirements.
Sec. 509. Partial payments required with submission of offers-in-
compromise.
Sec. 510. Increase in age of minor children whose unearned income is
taxed as if parent's income.
Sec. 511. Imposition of withholding on certain payments made by
government entities.
Sec. 512. Conversions to Roth IRAs.
Sec. 513. Repeal of FSC/ETI binding contract relief.
Sec. 514. Only wages attributable to domestic production taken into
account in determining deduction for domestic production.
Sec. 515. Modification of exclusion for citizens living abroad.
Sec. 516. Tax involvement of accommodation parties in tax shelter
transactions.
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
SEC. 101. INCREASED EXPENSING FOR SMALL BUSINESS.
Subsections (b)(1), (b)(2), (b)(5), (c)(2), and
(d)(1)(A)(ii) of section 179 (relating to election to expense
certain depreciable business assets) are each amended by
striking ``2008'' and inserting ``2010''.
SEC. 102. CAPITAL GAINS AND DIVIDENDS RATES.
Section 303 of the Jobs and Growth Tax Relief
Reconciliation Act of 2003 is amended by striking ``December
31, 2008'' and inserting ``December 31, 2010''.
SEC. 103. CONTROLLED FOREIGN CORPORATIONS.
(a) Subpart F Exception for Active Financing.--
(1) Exempt insurance income.--Paragraph (10) of
section 953(e) (relating to application) is amended--
(A) by striking ``January 1, 2007'' and
inserting ``January 1, 2009'', and
(B) by striking ``December 31, 2006'' and
inserting ``December 31, 2008''.
(2) Exception to treatment as foreign personal
holding company income.--Paragraph (9) of section
954(h) (relating to application) is amended by striking
``January 1, 2007'' and inserting ``January 1, 2009''.
(b) Look-Through Treatment of Payments Between Related
Controlled Foreign Corporations Under the Foreign Personal
Holding Company Rules.--
(1) In general.--Subsection (c) of section 954
(relating to foreign personal holding company income)
is amended by adding at the end the following new
paragraph:
``(6) Look-thru rule for related controlled foreign
corporations.--
``(A) In general.--For purposes of this
subsection, dividends, interest, rents, and
royalties received or accrued from a controlled
foreign corporation which is a related person
shall not be treated as foreign personal
holding company income to the extent
attributable or properly allocable (determined
under rules similar to the rules of
subparagraphs (C) and (D) of section 904(d)(3))
to income of the related person which is not
subpart F income. For purposes of this
subparagraph, interest shall include factoring
income which is treated as income equivalent to
interest for purposes of paragraph (1)(E). The
Secretary shall prescribe such regulations as
may be appropriate to prevent the abuse of the
purposes of this paragraph.
``(B) Application.--Subparagraph (A) shall
apply to taxable years of foreign corporations
beginning after December 31, 2005, and before
January 1, 2009, and to taxable years of United
States shareholders with or within which such
taxable years of foreign corporations end.''.
(2) Effective date.--The amendment made by this
subsection shall apply to taxable years of foreign
corporations beginning after December 31, 2005, and to
taxable years of United States shareholders with or
within which such taxable years of foreign corporations
end.
TITLE II--OTHER PROVISIONS
SEC. 201. CLARIFICATION OF TAXATION OF CERTAIN SETTLEMENT FUNDS.
(a) In General.--Subsection (g) of section 468B (relating
to clarification of taxation of certain funds) is amended to
read as follows:
``(g) Clarification of Taxation of Certain Funds.--
``(1) In general.--Except as provided in paragraph
(2), nothing in any provision of law shall be construed
as providing that an escrow account, settlement fund,
or similar fund is not subject to current income tax.
The Secretary shall prescribe regulations providing for
the taxation of any such account or fund whether as a
grantor trust or otherwise.
``(2) Exemption from tax for certain settlement
funds.--An escrow account, settlement fund, or similar
fund shall be treated as beneficially owned by the
United States and shall be exempt from taxation under
this subtitle if--
``(A) it is established pursuant to a
consent decree entered by a judge of a United
States District Court,
``(B) it is created for the receipt of
settlement payments as directed by a government
entity for the sole purpose of resolving or
satisfying one or more claims asserting
liability under the Comprehensive Environmental
Response, Compensation, and Liability Act of
1980,
``(C) the authority and control over the
expenditure of funds therein (including the
expenditure of contributions thereto and any
net earnings thereon) is with such government
entity, and
``(D) upon termination, any remaining funds
will be disbursed to such government entity for
use in accordance with applicable law.
For purposes of this paragraph, the term `government
entity' means the United States, any State or political
subdivision thereof, the District of Columbia, any
possession of the United States, and any agency or
instrumentality of any of the foregoing.
``(3) Termination.--Paragraph (2) shall not apply
to accounts and funds established after December 31,
2010.''.
(b) Effective Date.--The amendment made by subsection (a)
shall apply to accounts and funds established after the date of
the enactment of this Act.
SEC. 202. MODIFICATION OF ACTIVE BUSINESS DEFINITION UNDER SECTION 355.
Subsection (b) of section 355 (defining active conduct of a
trade or business) is amended by adding at the end the
following new paragraph:
``(3) Special rule relating to active business
requirement.--
``(A) In general.--In the case of any
distribution made after the date of the
enactment of this paragraph and on or before
December 31, 2010, a corporation shall be
treated as meeting the requirement of paragraph
(2)(A) if and only if such corporation is
engaged in the active conduct of a trade or
business.
``(B) Affiliated group rule.--For purposes
of subparagraph (A), all members of such
corporation's separate affiliated group shall
be treated as one corporation. For purposes of
the preceding sentence, a corporation's
separate affiliated group is the affiliated
group which would be determined under section
1504(a) if such corporation were the common
parent and section 1504(b) did not apply.
``(C) Transition rule.--Subparagraph (A)
shall not apply to any distribution pursuant to
a transaction which is--
``(i) made pursuant to an agreement
which was binding on the date of the
enactment of this paragraph and at all
times thereafter,
``(ii) described in a ruling
request submitted to the Internal
Revenue Service on or before such date,
or
``(iii) described on or before such
date in a public announcement or in a
filing with the Securities and Exchange
Commission.
The preceding sentence shall not apply if the
distributing corporation elects not to have
such sentence apply to distributions of such
corporation. Any such election, once made,
shall be irrevocable.
``(D) Special rule for certain pre-
enactment distributions.--For purposes of
determining the continued qualification under
paragraph (2)(A) of distributions made on or
before the date of the enactment of this
paragraph as a result of an acquisition,
disposition, or other restructuring after such
date and on or before December 31, 2010, such
distribution shall be treated as made on the
date of such acquisition, disposition, or
restructuring for purposes of applying
subparagraphs (A) through (C) of this
paragraph.''.
SEC. 203. VETERANS' MORTGAGE BONDS.
(a) Expansion of Definition of Veterans Eligible for State
Home Loan Programs Funded by Qualified Veterans' Mortgage
Bonds.--
(1) In general.--Paragraph (4) of section 143(l)
(defining qualified veteran) is amended to read as
follows:
``(4) Qualified veteran.--For purposes of this
subsection, the term `qualified veteran' means--
``(A) in the case of the States of Alaska,
Oregon, and Wisconsin, any veteran--
``(i) who served on active duty,
and
``(ii) who applied for the
financing before the date 25 years
after the last date on which such
veteran left active service, and
``(B) in the case of any other State, any
veteran--
``(i) who served on active duty at
some time before January 1, 1977, and
``(ii) who applied for the
financing before the later of--
``(I) the date 30 years
after the last date on which
such veteran left active
service, or
``(II) January 31, 1985.''.
(2) Effective date.--The amendments made by this
subsection shall apply to bonds issued on or after the
date of the enactment of this Act.
(b) Revision of State Veterans Limit.--
(1) In general.--Subparagraph (B) of section
143(l)(3) (relating to volume limitation) is amended--
(A) by redesignating clauses (i) and (ii)
as subclauses (I) and (II), respectively, and
moving such clauses 2 ems to the right,
(B) by amending the matter preceding
subclause (I), as designated by subparagraph
(A), to read as follows:
``(B) State veterans limit.--
``(i) In general.--In the case of
any State to which clause (ii) does not
apply, the State veterans limit for any
calendar year is the amount equal to--
'', and
(C) by adding at the end the following new
clauses:
``(ii) Alaska, oregon, and
wisconsin.--In the case of the
following States, the State veterans
limit for any calendar year is the
amount equal to--
``(I) $25,000,000 for the
State of Alaska,
``(II) $25,000,000 for the
State of Oregon, and
``(III) $25,000,000 for the
State of Wisconsin.
``(iii) Phasein.--In the case of
calendar years beginning before 2010,
clause (ii) shall be applied by
substituting for each of the dollar
amounts therein an amount equal to the
applicable percentage of such dollar
amount. For purposes of the preceding
sentence, the applicable percentage
shall be determined in accordance with
the following table:
``For Calendar Year: Applicable percentage is:
2006.................................................... 20 percent
2007.................................................... 40 percent
2008.................................................... 60 percent
2009.................................................... 80 percent.
``(iv) Termination.--The State
veterans limit for the States specified
in clause (ii) for any calendar year
after 2010 is zero.''.
(2) Effective date.--The amendments made by this
subsection shall apply to allocations of State volume
limit after April 5, 2006.
SEC. 204. CAPITAL GAINS TREATMENT FOR CERTAIN SELF-CREATED MUSICAL
WORKS.
(a) In General.--Subsection (b) of section 1221 (relating
to capital asset defined) is amended by redesignating paragraph
(3) as paragraph (4) and by inserting after paragraph (2) the
following new paragraph:
``(3) Sale or exchange of self-created musical
works.--At the election of the taxpayer, paragraphs (1)
and (3) of subsection (a) shall not apply to musical
compositions or copyrights in musical works sold or
exchanged before January 1, 2011, by a taxpayer
described in subsection (a)(3).''.
(b) Limitation on Charitable Contributions.--Subparagraph
(A) of section 170(e)(1) is amended by inserting ``(determined
without regard to section 1221(b)(3))'' after ``long-term
capital gain''.
(c) Effective Date.--The amendments made by this section
shall apply to sales and exchanges in taxable years beginning
after the date of the enactment of this Act.
SEC. 205. VESSEL TONNAGE LIMIT.
(a) In General.--Paragraph (4) of section 1355(a) (relating
to qualifying vessel) is amended by inserting ``(6,000, in the
case of taxable years beginning after December 31, 2005, and
ending before January 1, 2011)'' after ``10,000''.
(b) Effective Date.--The amendment made by subsection (a)
shall apply to taxable years beginning after December 31, 2005.
SEC. 206. MODIFICATION OF SPECIAL ARBITRAGE RULE FOR CERTAIN FUNDS.
In the case of bonds issued after the date of the enactment
of this Act and before August 31, 2009--
(1) the requirement of paragraph (1) of section 648
of the Deficit Reduction Act of 1984 (98 Stat. 941)
shall be treated as met with respect to the securities
or obligations referred to in such section if such
securities or obligations are held in a fund the annual
distributions from which cannot exceed 7 percent of the
average fair market value of the assets held in such
fund except to the extent distributions are necessary
to pay debt service on the bond issue, and
(2) paragraph (3) of such section shall be applied
by substituting ``distributions from'' for ``the
investment earnings of'' both places it appears.
SEC. 207. AMORTIZATION OF EXPENSES INCURRED IN CREATING OR ACQUIRING
MUSIC OR MUSIC COPYRIGHTS.
(a) In General.--Section 167(g) (relating to depreciation
under income forecast method) is amended by adding at the end
the following new paragraph:
``(8) Special rules for certain musical works and
copyrights.--
``(A) In general.--If an election is in
effect under this paragraph for any taxable
year, then, notwithstanding paragraph (1), any
expense which--
``(i) is paid or incurred by the
taxpayer in creating or acquiring any
applicable musical property placed in
service during the taxable year, and
``(ii) is otherwise properly
chargeable to capital account,
shall be amortized ratably over the 5-year
period beginning with the month in which the
property was placed in service. The preceding
sentence shall not apply to any expense which,
without regard to this paragraph, would not be
allowable as a deduction.
``(B) Exclusive method.--Except as provided
in this paragraph, no depreciation or
amortization deduction shall be allowed with
respect to any expense to which subparagraph
(A) applies.
``(C) Applicable musical property.--For
purposes of this paragraph--
``(i) In general.--The term
`applicable musical property' means any
musical composition (including any
accompanying words), or any copyright
with respect to a musical composition,
which is property to which this
subsection applies without regard to
this paragraph.
``(ii) Exceptions.--Such term shall
not include any property--
``(I) with respect to which
expenses are treated as
qualified creative expenses to
which section 263A(h) applies,
``(II) to which a
simplified procedure
established under section
263A(j)(2) applies, or
``(III) which is an
amortizable section 197
intangible (as defined in
section 197(c)).
``(D) Election.--An election under this
paragraph shall be made at such time and in
such form as the Secretary may prescribe and
shall apply to all applicable musical property
placed in service during the taxable year for
which the election applies.
``(E) Termination.--An election may not be
made under this paragraph for any taxable year
beginning after December 31, 2010.''.
(b) Effective Date.--The amendments made by this section
shall apply to expenses paid or incurred with respect to
property placed in service in taxable years beginning after
December 31, 2005.
SEC. 208. MODIFICATION OF EFFECTIVE DATE OF DISREGARD OF CERTAIN
CAPITAL EXPENDITURES FOR PURPOSES OF QUALIFIED
SMALL ISSUE BONDS.
(a) In General.--Section 144(a)(4)(G) is amended by
striking ``September 30, 2009'' and inserting ``December 31,
2006''.
(b) Conforming Amendment.--Section 144(a)(4)(F) is amended
by striking ``September 30, 2009'' and inserting ``December 31,
2006''.
SEC. 209. MODIFICATION OF TREATMENT OF LOANS TO QUALIFIED CONTINUING
CARE FACILITIES.
(a) In General.--Section 7872 is amended by redesignating
subsection (h) as subsection (i) and inserting after subsection
(g) the following new subsection:
``(h) Exception for Loans to Qualified Continuing Care
Facilities.--
``(1) In general.--This section shall not apply for
any calendar year to any below-market loan owed by a
facility which on the last day of such year is a
qualified continuing care facility, if such loan was
made pursuant to a continuing care contract and if the
lender (or the lender's spouse) attains age 62 before
the close of such year.
``(2) Continuing care contract.--For purposes of
this section, the term `continuing care contract' means
a written contract between an individual and a
qualified continuing care facility under which--
``(A) the individual or individual's spouse
may use a qualified continuing care facility
for their life or lives,
``(B) the individual or individual's spouse
will be provided with housing, as appropriate
for the health of such individual or
individual's spouse--
``(i) in an independent living unit
(which has additional available
facilities outside such unit for the
provision of meals and other personal
care), and
``(ii) in an assisted living
facility or a nursing facility, as is
available in the continuing care
facility, and
``(C) the individual or individual's spouse
will be provided assisted living or nursing
care as the health of such individual or
individual's spouse requires, and as is
available in the continuing care facility.
The Secretary shall issue guidance which limits such
term to contracts which provide only facilities, care,
and services described in this paragraph.
``(3) Qualified continuing care facility.--
``(A) In general.--For purposes of this
section, the term `qualified continuing care
facility' means 1 or more facilities--
``(i) which are designed to provide
services under continuing care
contracts,
``(ii) which include an independent
living unit, plus an assisted living or
nursing facility, or both, and
``(iii) substantially all of the
independent living unit residents of
which are covered by continuing care
contracts.
``(B) Nursing homes excluded.--The term
`qualified continuing care facility' shall not
include any facility which is of a type which
is traditionally considered a nursing home.
``(4) Termination.--This subsection shall not apply
to any calendar year after 2010.''.
(b) Conforming Amendments.--
(1) Section 7872(g) is amended by adding at the end
the following new paragraph:
``(6) Suspension of application.--Paragraph (1)
shall not apply for any calendar year to which
subsection (h) applies.''.
(2) Section 142(d)(2)(B) is amended by striking
``Section 7872(g)'' and inserting ``Subsections (g) and
(h) of section 7872''.
(c) Effective Date.--The amendment made by this section
shall apply to calendar years beginning after December 31,
2005, with respect to loans made before, on, or after such
date.
TITLE III--ALTERNATIVE MINIMUM TAX RELIEF
SEC. 301. INCREASE IN ALTERNATIVE MINIMUM TAX EXEMPTION AMOUNT FOR
2006.
(a) In General.--Section 55(d)(1) (relating to exemption
amount for taxpayers other than corporations) is amended--
(1) by striking ``$58,000'' and all that follows
through ``2005'' in subparagraph (A) and inserting
``$62,550 in the case of taxable years beginning in
2006'', and
(2) by striking ``$40,250'' and all that follows
through ``2005'' in subparagraph (B) and inserting
``$42,500 in the case of taxable years beginning in
2006''.
(b) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2005.
SEC. 302. ALLOWANCE OF NONREFUNDABLE PERSONAL CREDITS AGAINST REGULAR
AND ALTERNATIVE MINIMUM TAX LIABILITY.
(a) In General.--Paragraph (2) of section 26(a) is
amended--
(1) by striking ``2005'' in the heading thereof and
inserting ``2006'', and
(2) by striking ``or 2005'' and inserting ``2005,
or 2006''.
(b) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2005.
TITLE IV--CORPORATE ESTIMATED TAX PROVISIONS
SEC. 401. TIME FOR PAYMENT OF CORPORATE ESTIMATED TAXES.
Notwithstanding section 6655 of the Internal Revenue Code
of 1986--
(1) in the case of a corporation with assets of not
less than $1,000,000,000 (determined as of the end of
the preceding taxable year)--
(A) the amount of any required installment
of corporate estimated tax which is otherwise
due in July, August, or September of 2006 shall
be 105 percent of such amount,
(B) the amount of any required installment
of corporate estimated tax which is otherwise
due in July, August, or September of 2012 shall
be 106.25 percent of such amount,
(C) the amount of any required installment
of corporate estimated tax which is otherwise
due in July, August, or September of 2013 shall
be 100.75 percent of such amount, and
(D) the amount of the next required
installment after an installment referred to in
subparagraph (A), (B), or (C) shall be
appropriately reduced to reflect the amount of
the increase by reason of such subparagraph,
(2) 20.5 percent of the amount of any required
installment of corporate estimated tax which is
otherwise due in September 2010 shall not be due until
October 1, 2010, and
(3) 27.5 percent of the amount of any required
installment of corporate estimated tax which is
otherwise due in September 2011 shall not be due until
October 1, 2011.
TITLE V--REVENUE OFFSET PROVISIONS
SEC. 501. APPLICATION OF EARNINGS STRIPPING RULES TO PARTNERS WHICH ARE
CORPORATIONS.
(a) In General.--Section 163(j) (relating to limitation on
deduction for interest on certain indebtedness) is amended by
redesignating paragraph (8) as paragraph (9) and by inserting
after paragraph (7) the following new paragraph:
``(8) Treatment of corporate partners.--Except to
the extent provided by regulations, in applying this
subsection to a corporation which owns (directly or
indirectly) an interest in a partnership--
``(A) such corporation's distributive share
of interest income paid or accrued to such
partnership shall be treated as interest income
paid or accrued to such corporation,
``(B) such corporation's distributive share
of interest paid or accrued by such partnership
shall be treated as interest paid or accrued by
such corporation, and
``(C) such corporation's share of the
liabilities of such partnership shall be
treated as liabilities of such corporation.''.
(b) Additional Regulatory Authority.--Section 163(j)(9)
(relating to regulations), as redesignated by subsection (a),
is amended by striking ``and'' at the end of subparagraph (B),
by striking the period at the end of subparagraph (C) and
inserting ``, and'', and by adding at the end the following new
subparagraph:
``(D) regulations providing for the
reallocation of shares of partnership
indebtedness, or distributive shares of the
partnership's interest income or interest
expense.''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning on or after the date of
the enactment of this Act.
SEC. 502. REPORTING OF INTEREST ON TAX-EXEMPT BONDS.
(a) In General.--Section 6049(b)(2) (relating to
exceptions) is amended by striking subparagraph (B) and by
redesignating subparagraphs (C) and (D) as subparagraphs (B)
and (C), respectively.
(b) Conforming Amendment.--Section 6049(b)(2)(C), as
redesignated by subsection (a), is amended by striking
``subparagraph (C)'' and inserting ``subparagraph (B)''.
(c) Effective Date.--The amendments made by this section
shall apply to interest paid after December 31, 2005.
SEC. 503. 5-YEAR AMORTIZATION OF GEOLOGICAL AND GEOPHYSICAL
EXPENDITURES FOR CERTAIN MAJOR INTEGRATED OIL
COMPANIES.
(a) In General.--Section 167(h) (relating to amortization
of geological and geophysical expenditures) is amended by
adding at the end the following new paragraph:
``(5) Special rule for major integrated oil
companies.--
``(A) In general.--In the case of a major
integrated oil company, paragraphs (1) and (4)
shall be applied by substituting `5-year' for
`24 month'.
``(B) Major integrated oil company.--For
purposes of this paragraph, the term `major
integrated oil company' means, with respect to
any taxable year, a producer of crude oil--
``(i) which has an average daily
worldwide production of crude oil of at
least 500,000 barrels for the taxable
year,
``(ii) which had gross receipts in
excess of $1,000,000,000 for its last
taxable year ending during calendar
year 2005, and
``(iii) to which subsection (c) of
section 613A does not apply by reason
of paragraph (4) of section 613A(d),
determined--
``(I) by substituting `15
percent' for `5 percent' each
place it occurs in paragraph
(3) of section 613A(d), and
``(II) without regard to
whether subsection (c) of
section 613A does not apply by
reason of paragraph (2) of
section 613A(d).
For purposes of clauses (i) and (ii), all
persons treated as a single employer under
subsections (a) and (b) of section 52 shall be
treated as 1 person and, in case of a short
taxable year, the rule under section
448(c)(3)(B) shall apply.''.
(b) Effective Date.--The amendment made by this section
shall apply to amounts paid or incurred after the date of the
enactment of this Act.
SEC. 504. APPLICATION OF FIRPTA TO REGULATED INVESTMENT COMPANIES.
(a) In General.--Subclause (II) of section 897(h)(4)(A)(i)
(defining qualified investment entity) is amended by inserting
``which is a United States real property holding corporation or
which would be a United States real property holding
corporation if the exceptions provided in subsections (c)(3)
and (h)(2) did not apply to interests in any real estate
investment trust or regulated investment company'' after
``regulated investment company''.
(b) Effective Date.--The amendment made by this section
shall take effect as if included in the provisions of section
411 of the American Jobs Creation Act of 2004 to which it
relates.
SEC. 505. TREATMENT OF DISTRIBUTIONS ATTRIBUTABLE TO FIRPTA GAINS.
(a) Qualified Investment Entity.--
(1) In general.--Section 897(h)(1) is amended--
(A) by striking ``a nonresident alien
individual or a foreign corporation'' in the
first sentence and inserting ``a nonresident
alien individual, a foreign corporation, or
other qualified investment entity'',
(B) by striking ``such nonresident alien
individual or foreign corporation'' in the
first sentence and inserting ``such nonresident
alien individual, foreign corporation, or other
qualified investment entity'', and
(C) by striking the second sentence and
inserting the following new sentence:
``Notwithstanding the preceding sentence, any
distribution by a qualified investment entity
to a nonresident alien individual or a foreign
corporation with respect to any class of stock
which is regularly traded on an established
securities market located in the United States
shall not be treated as gain recognized from
the sale or exchange of a United States real
property interest if such individual or
corporation did not own more than 5 percent of
such class of stock at any time during the 1-
year period ending on the date of such
distribution.''.
(2) Exception to termination of application of
section 897 rules to regulated investment companies.--
Clause (ii) of section 897(h)(4)(A) is amended by
adding at the end the following new sentence:
``Notwithstanding the preceding sentence, an entity
described in clause (i)(II) shall be treated as a
qualified investment entity for purposes of applying
paragraphs (1) and (5) and section 1445 with respect to
any distribution by the entity to a nonresident alien
individual or a foreign corporation which is
attributable directly or indirectly to a distribution
to the entity from a real estate investment trust.''.
(b) Withholding on Distributions Treated as Gain From
United States Real Property Interests.--Section 1445(e)
(relating to special rules for distributions, etc. by
corporations, partnerships, trusts, or estates) is amended by
redesignating paragraph (6) as paragraph (7) and by inserting
after paragraph (5) the following new paragraph:
``(6) Distributions by regulated investment
companies and real estate investment trusts.--If any
portion of a distribution from a qualified investment
entity (as defined in section 897(h)(4)) to a
nonresident alien individual or a foreign corporation
is treated under section 897(h)(1) as gain realized by
such individual or corporation from the sale or
exchange of a United States real property interest, the
qualified investment entity shall deduct and withhold
under subsection (a) a tax equal to 35 percent (or, to
the extent provided in regulations, 15 percent (20
percent in the case of taxable years beginning after
December 31, 2010)) of the amount so treated.''.
(c) Treatment of Certain Distributions as Dividends.--
(1) In general.--Section 852(b)(3) (relating to
capital gains) is amended by adding at the end the
following new subparagraph:
``(E) Certain distributions.--In the case
of a distribution to which section 897 does not
apply by reason of the second sentence of
section 897(h)(1), the amount of such
distribution which would be included in
computing long-term capital gains for the
shareholder under subparagraph (B) or (D)
(without regard to this subparagraph)--
``(i) shall not be included in
computing such shareholder's long-term
capital gains, and
``(ii) shall be included in such
shareholder's gross income as a
dividend from the regulated investment
company.''.
(2) Conforming amendment.--Section 871(k)(2)
(relating to short-term capital gain dividends) is
amended by adding at the end the following new
subparagraph:
``(E) Certain distributions.--In the case
of a distribution to which section 897 does not
apply by reason of the second sentence of
section 897(h)(1), the amount which would be
treated as a short-term capital gain dividend
to the shareholder (without regard to this
subparagraph)--
``(i) shall not be treated as a
short-term capital gain dividend, and
``(ii) shall be included in such
shareholder's gross income as a
dividend from the regulated investment
company.''.
(d) Effective Dates.--The amendments made by this section
shall apply to taxable years of qualified investment entities
beginning after December 31, 2005, except that no amount shall
be required to be withheld under section 1441, 1442, or 1445 of
the Internal Revenue Code of 1986 with respect to any
distribution before the date of the enactment of this Act if
such amount was not otherwise required to be withheld under any
such section as in effect before such amendments.
SEC. 506. PREVENTION OF AVOIDANCE OF TAX ON INVESTMENTS OF FOREIGN
PERSONS IN UNITED STATES REAL PROPERTY THROUGH WASH
SALE TRANSACTIONS.
(a) In General.--Section 897(h) (relating to special rules
for certain investment entities) is amended by adding at the
end the following new paragraph:
``(5) Treatment of certain wash sale
transactions.--
``(A) In general.--If an interest in a
domestically controlled qualified investment
entity is disposed of in an applicable wash
sale transaction, the taxpayer shall, for
purposes of this section, be treated as having
gain from the sale or exchange of a United
States real property interest in an amount
equal to the portion of the distribution
described in subparagraph (B) with respect to
such interest which, but for the disposition,
would have been treated by the taxpayer as gain
from the sale or exchange of a United States
real property interest under paragraph (1).
``(B) Applicable wash sales transaction.--
For purposes of this paragraph--
``(i) In general.--The term
`applicable wash sales transaction'
means any transaction (or series of
transactions) under which a nonresident
alien individual, foreign corporation,
or qualified investment entity--
``(I) disposes of an
interest in a domestically
controlled qualified investment
entity during the 30-day period
preceding the ex-dividend date
of a distribution which is to
be made with respect to the
interest and any portion of
which, but for the disposition,
would have been treated by the
taxpayer as gain from the sale
or exchange of a United States
real property interest under
paragraph (1), and
``(II) acquires, or enters
into a contract or option to
acquire, a substantially
identical interest in such
entity during the 61-day period
beginning with the 1st day of
the 30-day period described in
subclause (I).
For purposes of subclause (II), a
nonresident alien individual, foreign
corporation, or qualified investment
entity shall be treated as having
acquired any interest acquired by a
person related (within the meaning of
section 267(b) or 707(b)(1)) to the
individual, corporation, or entity, and
any interest which such person has
entered into any contract or option to
acquire.
``(ii) Application to substitute
dividend and similar payments.--
Subparagraph (A) shall apply to--
``(I) any substitute
dividend payment (within the
meaning of section 861), or
``(II) any other similar
payment specified in
regulations which the Secretary
determines necessary to prevent
avoidance of the purposes of
this paragraph.
The portion of any such payment treated
by the taxpayer as gain from the sale
or exchange of a United States real
property interest under subparagraph
(A) by reason of this clause shall be
equal to the portion of the
distribution such payment is in lieu of
which would have been so treated but
for the transaction giving rise to such
payment.
``(iii) Exception where
distribution actually received.--A
transaction shall not be treated as an
applicable wash sales transaction if
the nonresident alien individual,
foreign corporation, or qualified
investment entity receives the
distribution described in clause (i)(I)
with respect to either the interest
which was disposed of, or acquired, in
the transaction.
``(iv) Exception for certain
publicly traded stock.--A transaction
shall not be treated as an applicable
wash sales transaction if it involves
the disposition of any class of stock
in a qualified investment entity which
is regularly traded on an established
securities market within the United
States but only if the nonresident
alien individual, foreign corporation,
or qualified investment entity did not
own more than 5 percent of such class
of stock at any time during the 1-year
period ending on the date of the
distribution described in clause
(i)(I).''.
(b) No Withholding Required.--Section 1445(b) (relating to
exemptions) is amended by adding at the end the following new
paragraph:
``(8) Applicable wash sales transactions.--No
person shall be required to deduct and withhold any
amount under subsection (a) with respect to a
disposition which is treated as a disposition of a
United States real property interest solely by reason
of section 897(h)(5).''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2005,
except that such amendments shall not apply to any
distribution, or substitute dividend payment, occurring before
the date that is 30 days after the date of the enactment of
this Act.
SEC. 507. SECTION 355 NOT TO APPLY TO DISTRIBUTIONS INVOLVING
DISQUALIFIED INVESTMENT COMPANIES.
(a) In General.--Section 355 (relating to distributions of
stock and securities of a controlled corporation) is amended by
adding at the end the following new subsection:
``(g) Section Not to Apply to Distributions Involving
Disqualified Investment Corporations.--
``(1) In general.--This section (and so much of
section 356 as relates to this section) shall not apply
to any distribution which is part of a transaction if--
``(A) either the distributing corporation
or controlled corporation is, immediately after
the transaction, a disqualified investment
corporation, and
``(B) any person holds, immediately after
the transaction, a 50-percent or greater
interest in any disqualified investment
corporation, but only if such person did not
hold such an interest in such corporation
immediately before the transaction.
``(2) Disqualified investment corporation.--For
purposes of this subsection--
``(A) In general.--The term `disqualified
investment corporation' means any distributing
or controlled corporation if the fair market
value of the investment assets of the
corporation is--
``(i) in the case of distributions
after the end of the 1-year period
beginning on the date of the enactment
of this subsection, \2/3\ or more of
the fair market value of all assets of
the corporation, and
``(ii) in the case of distributions
during such 1-year period, \3/4\ or
more of the fair market value of all
assets of the corporation.
``(B) Investment assets.--
``(i) In general.--Except as
otherwise provided in this
subparagraph, the term `investment
assets' means--
``(I) cash,
``(II) any stock or
securities in a corporation,
``(III) any interest in a
partnership,
``(IV) any debt instrument
or other evidence of
indebtedness,
``(V) any option, forward
or futures contract, notional
principal contract, or
derivative,
``(VI) foreign currency, or
``(VII) any similar asset.
``(ii) Exception for assets used in
active conduct of certain financial
trades or businesses.--Such term shall
not include any asset which is held for
use in the active and regular conduct
of--
``(I) a lending or finance
business (within the meaning of
section 954(h)(4)),
``(II) a banking business
through a bank (as defined in
section 581), a domestic
building and loan association
(within the meaning of section
7701(a)(19)), or any similar
institution specified by the
Secretary, or
``(III) an insurance
business if the conduct of the
business is licensed,
authorized, or regulated by an
applicable insurance regulatory
body.
This clause shall only apply with
respect to any business if
substantially all of the income of the
business is derived from persons who
are not related (within the meaning of
section 267(b) or 707(b)(1)) to the
person conducting the business.
``(iii) Exception for securities
marked to market.--Such term shall not
include any security (as defined in
section 475(c)(2)) which is held by a
dealer in securities and to which
section 475(a) applies.
``(iv) Stock or securities in a 20-
percent controlled entity.--
``(I) In general.--Such
term shall not include any
stock and securities in, or any
asset described in subclause
(IV) or (V) of clause (i)
issued by, a corporation which
is a 20-percent controlled
entity with respect to the
distributing or controlled
corporation.
``(II) Look-thru rule.--The
distributing or controlled
corporation shall, for purposes
of applying this subsection, be
treated as owning its ratable
share of the assets of any 20-
percent controlled entity.
``(III) 20-percent
controlled entity.--For
purposes of this clause, the
term `20-percent controlled
entity' means, with respect to
any distributing or controlled
corporation, any corporation
with respect to which the
distributing or controlled
corporation owns directly or
indirectly stock meeting the
requirements of section
1504(a)(2), except that such
section shall be applied by
substituting `20 percent' for
`80 percent' and without regard
to stock described in section
1504(a)(4).
``(v) Interests in certain
partnerships.--
``(I) In general.--Such
term shall not include any
interest in a partnership, or
any debt instrument or other
evidence of indebtedness,
issued by the partnership, if 1
or more of the trades or
businesses of the partnership
are (or, without regard to the
5-year requirement under
subsection (b)(2)(B), would be)
taken into account by the
distributing or controlled
corporation, as the case may
be, in determining whether the
requirements of subsection (b)
are met with respect to the
distribution.
``(II) Look-thru rule.--The
distributing or controlled
corporation shall, for purposes
of applying this subsection, be
treated as owning its ratable
share of the assets of any
partnership described in
subclause (I).
``(3) 50-percent or greater interest.--For purposes
of this subsection--
``(A) In general.--The term `50-percent or
greater interest' has the meaning given such
term by subsection (d)(4).
``(B) Attribution rules.--The rules of
section 318 shall apply for purposes of
determining ownership of stock for purposes of
this paragraph.
``(4) Transaction.--For purposes of this
subsection, the term `transaction' includes a series of
transactions.
``(5) Regulations.--The Secretary shall prescribe
such regulations as may be necessary to carry out, or
prevent the avoidance of, the purposes of this
subsection, including regulations--
``(A) to carry out, or prevent the
avoidance of, the purposes of this subsection
in cases involving--
``(i) the use of related persons,
intermediaries, pass-thru entities,
options, or other arrangements, and
``(ii) the treatment of assets
unrelated to the trade or business of a
corporation as investment assets if,
prior to the distribution, investment
assets were used to acquire such
unrelated assets,
``(B) which in appropriate cases exclude
from the application of this subsection a
distribution which does not have the character
of a redemption which would be treated as a
sale or exchange under section 302, and
``(C) which modify the application of the
attribution rules applied for purposes of this
subsection.''.
(b) Effective Dates.--
(1) In general.--The amendments made by this
section shall apply to distributions after the date of
the enactment of this Act.
(2) Transition rule.--The amendments made by this
section shall not apply to any distribution pursuant to
a transaction which is--
(A) made pursuant to an agreement which was
binding on such date of enactment and at all
times thereafter,
(B) described in a ruling request submitted
to the Internal Revenue Service on or before
such date, or
(C) described on or before such date in a
public announcement or in a filing with the
Securities and Exchange Commission.
SEC. 508. LOAN AND REDEMPTION REQUIREMENTS ON POOLED FINANCING
REQUIREMENTS.
(a) Strengthened Reasonable Expectation Requirement.--
Subparagraph (A) of section 149(f)(2) (relating to reasonable
expectation requirement) is amended to read as follows:
``(A) In general.--The requirements of this
paragraph are met with respect to an issue if
the issuer reasonably expects that--
``(i) as of the close of the 1-year
period beginning on the date of
issuance of the issue, at least 30
percent of the net proceeds of the
issue (as of the close of such period)
will have been used directly or
indirectly to make or finance loans to
ultimate borrowers, and
``(ii) as of the close of the 3-
year period beginning on such date of
issuance, at least 95 percent of the
net proceeds of the issue (as of the
close of such period) will have been so
used.''.
(b) Written Loan Commitment and Redemption Requirements.--
Section 149(f) (relating to treatment of certain pooled
financing bonds) is amended by redesignating paragraphs (4) and
(5) as paragraphs (6) and (7), respectively, and by inserting
after paragraph (3) the following new paragraphs:
``(4) Written loan commitment requirement.--
``(A) In general.--The requirement of this
paragraph is met with respect to an issue if
the issuer receives prior to issuance written
loan commitments identifying the ultimate
potential borrowers of at least 30 percent of
the net proceeds of such issue.
``(B) Exception.--Subparagraph (A) shall
not apply with respect to any issuer which--
``(i) is a State (or an integral
part of a State) issuing pooled
financing bonds to make or finance
loans to subordinate governmental units
of such State, or
``(ii) is a State-created entity
providing financing for water-
infrastructure projects through the
federally-sponsored State revolving
fund program.
``(5) Redemption requirement.--The requirement of
this paragraph is met if to the extent that less than
the percentage of the proceeds of an issue required to
be used under clause (i) or (ii) of paragraph (2)(A) is
used by the close of the period identified in such
clause, the issuer uses an amount of proceeds equal to
the excess of--
``(A) the amount required to be used under
such clause, over
``(B) the amount actually used by the close
of such period,
to redeem outstanding bonds within 90 days after the
end of such period.''.
(c) Elimination of Disregard of Pooled Bonds in Determining
Eligibility for Small Issuer Exception to Arbitrage Rebate.--
Section 148(f)(4)(D)(ii) (relating to aggregation of issuers)
is amended by striking subclause (II) and by redesignating
subclauses (III) and (IV) as subclauses (II) and (III),
respectively.
(d) Conforming Amendments.--
(1) Section 149(f)(1) is amended by striking
``paragraphs (2) and (3)'' and inserting ``paragraphs
(2), (3), (4), and (5)''.
(2) Section 149(f)(7)(B), as redesignated by
subsection (b), is amended by striking ``paragraph
(4)(A)'' and inserting ``paragraph (6)(A)''.
(3) Section 54(l)(2) is amended by striking
``section 149(f)(4)(A)'' and inserting ``section
149(f)(6)(A)''.
(e) Effective Date.--The amendments made by this section
shall apply to bonds issued after the date of the enactment of
this Act.
SEC. 509. PARTIAL PAYMENTS REQUIRED WITH SUBMISSION OF OFFERS-IN-
COMPROMISE.
(a) In General.--Section 7122 (relating to compromises) is
amended by redesignating subsections (c) and (d) as subsections
(d) and (e), respectively, and by inserting after subsection
(b) the following new subsection:
``(c) Rules for Submission of Offers-in-Compromise.--
``(1) Partial payment required with submission.--
``(A) Lump-sum offers.--
``(i) In general.--The submission
of any lump-sum offer-in-compromise
shall be accompanied by the payment of
20 percent of the amount of such offer.
``(ii) Lump-sum offer-in-
compromise.--For purposes of this
section, the term `lump-sum offer-in-
compromise' means any offer of payments
made in 5 or fewer installments.
``(B) Periodic payment offers.--
``(i) In general.--The submission
of any periodic payment offer-in-
compromise shall be accompanied by the
payment of the amount of the first
proposed installment.
``(ii) Failure to make installment
during pendency of offer.--Any failure
to make an installment (other than the
first installment) due under such
offer-in-compromise during the period
such offer is being evaluated by the
Secretary may be treated by the
Secretary as a withdrawal of such
offer-in-compromise.
``(2) Rules of application.--
``(A) Use of payment.--The application of
any payment made under this subsection to the
assessed tax or other amounts imposed under
this title with respect to such tax may be
specified by the taxpayer.
``(B) Application of user fee.--In the case
of any assessed tax or other amounts imposed
under this title with respect to such tax which
is the subject of an offer-in-compromise to
which this subsection applies, such tax or
other amounts shall be reduced by any user fee
imposed under this title with respect to such
offer-in-compromise.
``(C) Waiver authority.--The Secretary may
issue regulations waiving any payment required
under paragraph (1) in a manner consistent with
the practices established in accordance with
the requirements under subsection (d)(3).''.
(b) Additional Rules Relating to Treatment of Offers.--
(1) Unprocessable offer if payment requirements are
not met.--Paragraph (3) of section 7122(d) (relating to
standards for evaluation of offers), as redesignated by
subsection (a), is amended by striking ``; and'' at the
end of subparagraph (A) and inserting a comma, by
striking the period at the end of subparagraph (B) and
inserting ``, and'', and by adding at the end the
following new subparagraph:
``(C) any offer-in-compromise which does
not meet the requirements of subparagraph
(A)(i) or (B)(i), as the case may be, of
subsection (c)(1) may be returned to the
taxpayer as unprocessable.''.
(2) Deemed acceptance of offer not rejected within
certain period.--Section 7122, as amended by subsection
(a), is amended by adding at the end the following new
subsection:
``(f) Deemed Acceptance of Offer Not Rejected Within
Certain Period.--Any offer-in-compromise submitted under this
section shall be deemed to be accepted by the Secretary if such
offer is not rejected by the Secretary before the date which is
24 months after the date of the submission of such offer. For
purposes of the preceding sentence, any period during which any
tax liability which is the subject of such offer-in-compromise
is in dispute in any judicial proceeding shall not be taken
into account in determining the expiration of the 24-month
period.''.
(c) Conforming Amendment.--Section 6159(f) is amended by
striking ``section 7122(d)'' and inserting ``section 7122(e)''.
(d) Effective Date.--The amendments made by this section
shall apply to offers-in-compromise submitted on and after the
date which is 60 days after the date of the enactment of this
Act.
SEC. 510. INCREASE IN AGE OF MINOR CHILDREN WHOSE UNEARNED INCOME IS
TAXED AS IF PARENT'S INCOME.
(a) In General.--Section 1(g)(2)(A) (relating to child to
whom subsection applies) is amended by striking ``age 14'' and
inserting ``age 18''.
(b) Treatment of Distributions From Qualified Disability
Trusts.--Section 1(g)(4) (relating to net unearned income) is
amended by adding at the end the following new subparagraph:
``(C) Treatment of distributions from
qualified disability trusts.--For purposes of
this subsection, in the case of any child who
is a beneficiary of a qualified disability
trust (as defined in section 642(b)(2)(C)(ii)),
any amount included in the income of such child
under sections 652 and 662 during a taxable
year shall be considered earned income of such
child for such taxable year.''.
(c) Conforming Amendment.--Section 1(g)(2) is amended by
striking ``and'' at the end of subparagraph (A), by striking
the period at the end of subparagraph (B) and inserting ``,
and'', and by inserting after subparagraph (B) the following
new subparagraph:
``(C) such child does not file a joint
return for the taxable year.''.
(d) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2005.
SEC. 511. IMPOSITION OF WITHHOLDING ON CERTAIN PAYMENTS MADE BY
GOVERNMENT ENTITIES.
(a) In General.--Section 3402 is amended by adding at the
end the following new subsection:
``(t) Extension of Withholding to Certain Payments Made by
Government Entities.--
``(1) General rule.--The Government of the United
States, every State, every political subdivision
thereof, and every instrumentality of the foregoing
(including multi-State agencies) making any payment to
any person providing any property or services
(including any payment made in connection with a
government voucher or certificate program which
functions as a payment for property or services) shall
deduct and withhold from such payment a tax in an
amount equal to 3 percent of such payment.
``(2) Property and services subject to
withholding.--Paragraph (1) shall not apply to any
payment--
``(A) except as provided in subparagraph
(B), which is subject to withholding under any
other provision of this chapter or chapter 3,
``(B) which is subject to withholding under
section 3406 and from which amounts are being
withheld under such section,
``(C) of interest,
``(D) for real property,
``(E) to any governmental entity subject to
the requirements of paragraph (1), any tax-
exempt entity, or any foreign government,
``(F) made pursuant to a classified or
confidential contract described in section
6050M(e)(3),
``(G) made by a political subdivision of a
State (or any instrumentality thereof) which
makes less than $100,000,000 of such payments
annually,
``(H) which is in connection with a public
assistance or public welfare program for which
eligibility is determined by a needs or income
test, and
``(I) to any government employee not
otherwise excludable with respect to their
services as an employee.
``(3) Coordination with other sections.--For
purposes of sections 3403 and 3404 and for purposes of
so much of subtitle F (except section 7205) as relates
to this chapter, payments to any person for property or
services which are subject to withholding shall be
treated as if such payments were wages paid by an
employer to an employee.''.
(b) Effective Date.--The amendment made by this section
shall apply to payments made after December 31, 2010.
SEC. 512. CONVERSIONS TO ROTH IRAS.
(a) Repeal of Income Limitations.--
(1) In general.--Paragraph (3) of section 408A(c)
(relating to limits based on modified adjusted gross
income) is amended by striking subparagraph (B) and
redesignating subparagraphs (C) and (D) as
subparagraphs (B) and (C), respectively.
(2) Conforming amendment.--Clause (i) of section
408A(c)(3)(B) (as redesignated by paragraph (1)) is
amended by striking ``except that--'' and all that
follows and inserting ``except that any amount included
in gross income under subsection (d)(3) shall not be
taken into account, and''.
(b) Rollovers to a Roth IRA From an IRA Other Than a Roth
IRA.--
(1) In general.--Clause (iii) of section
408A(d)(3)(A) (relating to rollovers from an IRA other
than a Roth IRA) is amended to read as follows:
``(iii) unless the taxpayer elects
not to have this clause apply, any
amount required to be included in gross
income for any taxable year beginning
in 2010 by reason of this paragraph
shall be so included ratably over the
2-taxable-year period beginning with
the first taxable year beginning in
2011.''.
(2) Conforming amendments.--
(A) Clause (i) of section 408A(d)(3)(E) is
amended to read as follows:
``(i) Acceleration of inclusion.--
``(I) In general.--The
amount otherwise required to be
included in gross income for
any taxable year beginning in
2010 or the first taxable year
in the 2-year period under
subparagraph (A)(iii) shall be
increased by the aggregate
distributions from Roth IRAs
for such taxable year which are
allocable under paragraph (4)
to the portion of such
qualified rollover contribution
required to be included in
gross income under subparagraph
(A)(i).
``(II) Limitation on
aggregate amount included.--The
amount required to be included
in gross income for any taxable
year under subparagraph
(A)(iii) shall not exceed the
aggregate amount required to be
included in gross income under
subparagraph (A)(iii) for all
taxable years in the 2-year
period (without regard to
subclause (I)) reduced by
amounts included for all
preceding taxable years.''.
(B) The heading for section 408A(d)(3)(E)
is amended by striking ``4-year'' and inserting
``2-year''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2009.
SEC. 513. REPEAL OF FSC/ETI BINDING CONTRACT RELIEF.
(a) FSC Provisions.--Paragraph (1) of section 5(c) of the
FSC Repeal and Extraterritorial Income Exclusion Act of 2000 is
amended by striking ``which occurs--'' and all that follows and
inserting ``which occurs before January 1, 2002.''.
(b) ETI Provisions.--Section 101 of the American Jobs
Creation Act of 2004 is amended by striking subsection (f).
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after the date of the
enactment of this Act.
SEC. 514. ONLY WAGES ATTRIBUTABLE TO DOMESTIC PRODUCTION TAKEN INTO
ACCOUNT IN DETERMINING DEDUCTION FOR DOMESTIC
PRODUCTION.
(a) In General.--Paragraph (2) of section 199(b) (relating
to W-2 wages) is amended to read as follows:
``(2) W-2 wages.--For purposes of this section--
``(A) In general.--The term `W-2 wages'
means, with respect to any person for any
taxable year of such person, the sum of the
amounts described in paragraphs (3) and (8) of
section 6051(a) paid by such person with
respect to employment of employees by such
person during the calendar year ending during
such taxable year.
``(B) Limitation to wages attributable to
domestic production.--Such term shall not
include any amount which is not properly
allocable to domestic production gross receipts
for purposes of subsection (c)(1).
``(C) Return requirement.--Such term shall
not include any amount which is not properly
included in a return filed with the Social
Security Administration on or before the 60th
day after the due date (including extensions)
for such return.''.
(b) Simplification of Rules for Determining W-2 Wages of
Partners and S Corporation Shareholders.--
(1) In general.--Clause (iii) of section
199(d)(1)(A) is amended to read as follows:
``(iii) each partner or shareholder
shall be treated for purposes of
subsection (b) as having W-2 wages for
the taxable year in an amount equal to
such person's allocable share of the W-
2 wages of the partnership or S
corporation for the taxable year (as
determined under regulations prescribed
by the Secretary).''.
(2) Conforming amendment.--Paragraph (2) of section
199(a) is amended by striking ``and subsection
(d)(1)''.
(c) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after the date of the
enactment of this Act.
SEC. 515. MODIFICATION OF EXCLUSION FOR CITIZENS LIVING ABROAD.
(a) Inflation Adjustment of Foreign Earned Income
Limitation.--Clause (ii) of section 911(b)(2)(D) (relating to
inflation adjustment) is amended--
(1) by striking ``2007'' and inserting ``2005'',
and
(2) by striking ``2006'' in subclause (II) and
inserting ``2004''.
(b) Modification of Housing Cost Amount.--
(1) Modification of housing cost floor.--Clause (i)
of section 911(c)(1)(B) is amended to read as follows:
``(i) 16 percent of the amount
(computed on a daily basis) in effect
under subsection (b)(2)(D) for the
calendar year in which such taxable
year begins, multiplied by''.
(2) Maximum amount of exclusion.--
(A) In general.--Subparagraph (A) of
section 911(c)(1) is amended by inserting ``to
the extent such expenses do not exceed the
amount determined under paragraph (2)'' after
``the taxable year''.
(B) Limitation.--Subsection (c) of section
911 is amended by redesignating paragraphs (2)
and (3) as paragraphs (3) and (4),
respectively, and by inserting after paragraph
(1) the following new paragraph:
``(2) Limitation.--
``(A) In general.--The amount determined
under this paragraph is an amount equal to the
product of--
``(i) 30 percent (adjusted as may
be provided under subparagraph (B)) of
the amount (computed on a daily basis)
in effect under subsection (b)(2)(D)
for the calendar year in which the
taxable year of the individual begins,
multiplied by
``(ii) the number of days of such
taxable year within the applicable
period described in subparagraph (A) or
(B) of subsection (d)(1).
``(B) Regulations.--The Secretary may issue
regulations or other guidance providing for the
adjustment of the percentage under subparagraph
(A)(i) on the basis of geographic differences
in housing costs relative to housing costs in
the United States.''.
(C) Conforming amendments.--
(i) Section 911(d)(4) is amended by
striking ``and (c)(1)(B)(ii)'' and
inserting ``, (c)(1)(B)(ii), and
(c)(2)(A)(ii)''.
(ii) Section 911(d)(7) is amended
by striking ``subsection (c)(3)'' and
inserting ``subsection (c)(4)''.
(c) Rates of Tax Applicable to Nonexcluded Income.--Section
911 (relating to exclusion of certain income of citizens and
residents of the United States living abroad) is amended by
redesignating subsection (f) as subsection (g) and by inserting
after subsection (e) the following new subsection:
``(f) Determination of Tax Liability on Nonexcluded
Amounts.--For purposes of this chapter, if any amount is
excluded from the gross income of a taxpayer under subsection
(a) for any taxable year, then, notwithstanding section 1 or
55--
``(1) the tax imposed by section 1 on the taxpayer
for such taxable year shall be equal to the excess (if
any) of--
``(A) the tax which would be imposed by
section 1 for the taxable year if the
taxpayer's taxable income were increased by the
amount excluded under subsection (a) for the
taxable year, over
``(B) the tax which would be imposed by
section 1 for the taxable year if the
taxpayer's taxable income were equal to the
amount excluded under subsection (a) for the
taxable year, and
``(2) the tentative minimum tax under section 55
for such taxable year shall be equal to the excess (if
any) of--
``(A) the amount which would be such
tentative minimum tax for the taxable year if
the taxpayer's taxable excess were increased by
the amount excluded under subsection (a) for
the taxable year, over
``(B) the amount which would be such
tentative minimum tax for the taxable year if
the taxpayer's taxable excess were equal to the
amount excluded under subsection (a) for the
taxable year.
For purposes of this subsection, the amount excluded under
subsection (a) shall be reduced by the aggregate amount of any
deductions or exclusions disallowed under subsection (d)(6)
with respect to such excluded amount.''.
(d) Effective Date.--The amendments made by this section
shall apply to taxable years beginning after December 31, 2005.
SEC. 516. TAX INVOLVEMENT OF ACCOMMODATION PARTIES IN TAX SHELTER
TRANSACTIONS.
(a) Imposition of Excise Tax.--
(1) In general.--Chapter 42 (relating to private
foundations and certain other tax-exempt organizations)
is amended by adding at the end the following new
subchapter:
``Subchapter F--Tax Shelter Transactions
``Sec. 4965. Excise tax on certain tax-exempt entities entering into
prohibited tax shelter transactions.
``SEC. 4965. EXCISE TAX ON CERTAIN TAX-EXEMPT ENTITIES ENTERING INTO
PROHIBITED TAX SHELTER TRANSACTIONS.
``(a) Being a Party to and Approval of Prohibited
Transactions.--
``(1) Tax-exempt entity.--
``(A) In general.--If a transaction is a
prohibited tax shelter transaction at the time
any tax-exempt entity described in paragraph
(1), (2), or (3) of subsection (c) becomes a
party to the transaction, such entity shall pay
a tax for the taxable year in which the entity
becomes such a party and any subsequent taxable
year in the amount determined under subsection
(b)(1).
``(B) Post-transaction determination.--If
any tax-exempt entity described in paragraph
(1), (2), or (3) of subsection (c) is a party
to a subsequently listed transaction at any
time during a taxable year, such entity shall
pay a tax for such taxable year in the amount
determined under subsection (b)(1).
``(2) Entity manager.--If any entity manager of a
tax-exempt entity approves such entity as (or otherwise
causes such entity to be) a party to a prohibited tax
shelter transaction at any time during the taxable year
and knows or has reason to know that the transaction is
a prohibited tax shelter transaction, such manager
shall pay a tax for such taxable year in the amount
determined under subsection (b)(2).
``(b) Amount of Tax.--
``(1) Entity.--In the case of a tax-exempt entity--
``(A) In general.--Except as provided in
subparagraph (B), the amount of the tax imposed
under subsection (a)(1) with respect to any
transaction for a taxable year shall be an
amount equal to the product of the highest rate
of tax under section 11, and the greater of--
``(i) the entity's net income
(after taking into account any tax
imposed by this subtitle (other than by
this section) with respect to such
transaction) for such taxable year
which--
``(I) in the case of a
prohibited tax shelter
transaction (other than a
subsequently listed
transaction), is attributable
to such transaction, or
``(II) in the case of a
subsequently listed
transaction, is attributable to
such transaction and which is
properly allocable to the
period beginning on the later
of the date such transaction is
identified by guidance as a
listed transaction by the
Secretary or the first day of
the taxable year, or
``(ii) 75 percent of the proceeds
received by the entity for the taxable
year which--
``(I) in the case of a
prohibited tax shelter
transaction (other than a
subsequently listed
transaction), are attributable
to such transaction, or
``(II) in the case of a
subsequently listed
transaction, are attributable
to such transaction and which
are properly allocable to the
period beginning on the later
of the date such transaction is
identified by guidance as a
listed transaction by the
Secretary or the first day of
the taxable year.
``(B) Increase in tax for certain knowing
transactions.--In the case of a tax-exempt
entity which knew, or had reason to know, a
transaction was a prohibited tax shelter
transaction at the time the entity became a
party to the transaction, the amount of the tax
imposed under subsection (a)(1)(A) with respect
to any transaction for a taxable year shall be
the greater of--
``(i) 100 percent of the entity's
net income (after taking into account
any tax imposed by this subtitle (other
than by this section) with respect to
the prohibited tax shelter transaction)
for such taxable year which is
attributable to the prohibited tax
shelter transaction, or
``(ii) 75 percent of the proceeds
received by the entity for the taxable
year which are attributable to the
prohibited tax shelter transaction.
This subparagraph shall not apply to any
prohibited tax shelter transaction to which a
tax-exempt entity became a party on or before
the date of the enactment of this section.
``(2) Entity manager.--In the case of each entity
manager, the amount of the tax imposed under subsection
(a)(2) shall be $20,000 for each approval (or other act
causing participation) described in subsection (a)(2).
``(c) Tax-Exempt Entity.--For purposes of this section, the
term `tax-exempt entity' means an entity which is--
``(1) described in section 501(c) or 501(d),
``(2) described in section 170(c) (other than the
United States),
``(3) an Indian tribal government (within the
meaning of section 7701(a)(40)),
``(4) described in paragraph (1), (2), or (3) of
section 4979(e),
``(5) a program described in section 529,
``(6) an eligible deferred compensation plan
described in section 457(b) which is maintained by an
employer described in section 4457(e)(1)(A), or
``(7) an arrangement described in section 4973(a).
``(d) Entity Manager.--For purposes of this section, the
term `entity manager' means--
``(1) in the case of an entity described in
paragraph (1), (2), or (3) of subsection (c)--
``(A) the person with authority or
responsibility similar to that exercised by an
officer, director, or trustee of an
organization, and
``(B) with respect to any act, the person
having authority or responsibility with respect
to such act, and
``(2) in the case of an entity described in
paragraph (4), (5), (6), or (7) of subsection (c), the
person who approves or otherwise causes the entity to
be a party to the prohibited tax shelter transaction.
``(e) Prohibited Tax Shelter Transaction; Subsequently
Listed Transaction.--For purposes of this section--
``(1) Prohibited tax shelter transaction.--
``(A) In general.--The term `prohibited tax
shelter transaction' means--
``(i) any listed transaction, and
``(ii) any prohibited reportable
transaction.
``(B) Listed transaction.--The term `listed
transaction' has the meaning given such term by
section 6707A(c)(2).
``(C) Prohibited reportable transaction.--
The term `prohibited reportable transaction'
means any confidential transaction or any
transaction with contractual protection (as
defined under regulations prescribed by the
Secretary) which is a reportable transaction
(as defined in section 6707A(c)(1)).
``(2) Subsequently listed transaction.--The term
`subsequently listed transaction' means any transaction
to which a tax-exempt entity is a party and which is
determined by the Secretary to be a listed transaction
at any time after the entity has become a party to the
transaction. Such term shall not include a transaction
which is a prohibited reportable transaction at the
time the entity became a party to the transaction.
``(f) Regulatory Authority.--The Secretary is authorized to
promulgate regulations which provide guidance regarding the
determination of the allocation of net income or proceeds of a
tax-exempt entity attributable to a transaction to various
periods, including before and after the listing of the
transaction or the date which is 90 days after the date of the
enactment of this section.
``(g) Coordination With Other Taxes and Penalties.--The tax
imposed by this section is in addition to any other tax,
addition to tax, or penalty imposed under this title.''.
(2) Conforming amendment.--The table of subchapters
for chapter 42 is amended by adding at the end the
following new item:
``Subchapter F. Tax Shelter Transactions.''.
(b) Disclosure Requirements.--
(1) Disclosure by entity to the internal revenue
service.--
(A) In general.--Section 6033(a) (relating
to organizations required to file) is amended
by redesignating paragraph (2) as paragraph (3)
and by inserting after paragraph (1) the
following new paragraph:
``(2) Being a party to certain reportable
transactions.--Every tax-exempt entity described in
section 4965(c) shall file (in such form and manner and
at such time as determined by the Secretary) a
disclosure of--
``(A) such entity's being a party to any
prohibited tax shelter transaction (as defined
in section 4965(e)), and
``(B) the identity of any other party to
such transaction which is known by such tax-
exempt entity.''.
(B) Conforming amendment.--Section
6033(a)(1) is amended by striking ``paragraph
(2)'' and inserting ``paragraph (3)''.
(2) Disclosure by other taxpayers to the tax-exempt
entity.--Section 6011 (relating to general requirement
of return, statement, or list) is amended by
redesignating subsection (g) as subsection (h) and by
inserting after subsection (f) the following new
subsection:
``(g) Disclosure of Reportable Transaction to Tax-Exempt
Entity.--Any taxable party to a prohibited tax shelter
transaction (as defined in section 4965(e)(1)) shall by
statement disclose to any tax-exempt entity (as defined in
section 4965(c)) which is a party to such transaction that such
transaction is such a prohibited tax shelter transaction.''.
(c) Penalty for Nondisclosure.--
(1) In general.--Section 6652(c) (relating to
returns by exempt organizations and by certain trusts)
is amended by redesignating paragraphs (3) and (4) as
paragraphs (4) and (5), respectively, and by inserting
after paragraph (2) the following new paragraph:
``(3) Disclosure under section 6033(a)(2).--
``(A) Penalty on entities.--In the case of
a failure to file a disclosure required under
section 6033(a)(2), there shall be paid by the
tax-exempt entity (the entity manager in the
case of a tax-exempt entity described in
paragraph (4), (5), (6), or (7) of section
4965(c)) $100 for each day during which such
failure continues. The maximum penalty under
this subparagraph on failures with respect to
any 1 disclosure shall not exceed $50,000.
``(B) Written demand.--
``(i) In general.--The Secretary
may make a written demand on any entity
or manager subject to penalty under
subparagraph (A) specifying therein a
reasonable future date by which the
disclosure shall be filed for purposes
of this subparagraph.
``(ii) Failure to comply with
demand.--If any entity or manager fails
to comply with any demand under clause
(i) on or before the date specified in
such demand, there shall be paid by
such entity or manager failing to so
comply $100 for each day after the
expiration of the time specified in
such demand during which such failure
continues. The maximum penalty imposed
under this subparagraph on all entities
and managers for failures with respect
to any 1 disclosure shall not exceed
$10,000.
``(C) Definitions.--Any term used in this
section which is also used in section 4965
shall have the meaning given such term under
section 4965.''.
(2) Conforming amendment.--Paragraph (1) of section
6652(c) is amended by striking ``6033'' each place it
appears in the text and heading thereof and inserting
``6033(a)(1)''.
(d) Effective Dates.--
(1) In general.--Except as provided in paragraph
(2), the amendments made by this section shall apply to
taxable years ending after the date of the enactment of
this Act, with respect to transactions before, on, or
after such date, except that no tax under section
4965(a) of the Internal Revenue Code of 1986 (as added
by this section) shall apply with respect to income or
proceeds that are properly allocable to any period
ending on or before the date which is 90 days after
such date of enactment.
(2) Disclosure.--The amendments made by subsections
(b) and (c) shall apply to disclosures the due date for
which are after the date of the enactment of this Act.
And the Senate agree to the same.
William Thomas,
Jim McCrery,
Dave Camp,
Managers on the Part of the House.
Chuck Grassley,
Jon Kyl,
Managers on the Part of the Senate.
JOINT EXPLANATORY STATEMENT OF THE COMMITTEE OF CONFERENCE
The managers on the part of the House and the Senate at
the conference on the disagreeing votes of the two Houses on
the amendment of the Senate to the bill (H.R. 4297), to provide
for reconciliation pursuant to section 201(b) of the concurrent
resolution on the budget for fiscal year 2006, submit the
following joint statement to the House and the Senate in
explanation of the effect of the action agreed upon by the
managers and recommended in the accompanying conference report:
The Senate amendment struck all of the House bill after
the enacting clause and inserted a substitute text.
The House recedes from its disagreement to the amendment
of the Senate with an amendment that is a substitute for the
House bill and the Senate amendment. The differences between
the House bill, the Senate amendment, and the substitute agreed
to in conference are noted below, except for clerical
corrections, conforming changes made necessary by agreements
reached by the conferees, and minor drafting and clarifying
changes.
CONTENTS
Page
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS........ 36
A. Allowance of Nonrefundable Personal Credits Against
Regular and Alternative Minimum Tax Liability (sec. 101 of
the House bill, sec. 107 of the Senate amendment, and sec.
26 of the Code)............................................ 36
B. Tax Incentives for Business Activities on Indian
Reservations............................................... 37
1. Indian employment tax credit (sec. 102(a) of the House
bill, sec. 115 of the Senate amendment, and sec. 45A of
the Code).............................................. 37
2. Accelerated depreciation for business property on
Indian reservations (sec. 102(b) of the House bill,
sec. 116 of the Senate amendment, and sec. 168(j) of
the Code).............................................. 39
C. Work Opportunity Tax Credit and Welfare-To-Work Tax Credit
(secs. 103 and 104 of the House bill, sec. 109 of the
Senate amendment and secs. 51 and 51A of the Code)......... 40
D. Deduction for Corporate Donations of Computer Technology
and Equipment (sec. 105 of the House bill, sec. 111 of the
Senate amendment and sec. 170 of the Code)................. 45
E. Availability of Archer Medical Savings Accounts (sec. 106
of the House bill and sec. 220 of the Code)................ 46
F. Fifteen-Year Straight-Line Cost Recovery for Qualified
Leasehold Improvements and Qualified Restaurant
Improvements (sec. 107 and sec. 108 of the House bill, sec.
117 of the Senate amendment, and sec. 168 of the Code)..... 48
G. Taxable Income Limit on Percentage Depletion for Oil and
Natural Gas Produced from Marginal Properties (sec. 109 of
the House bill and sec. 613A(c)(6)(H) of the Code)......... 50
H. Tax Incentives for Investment in the District of Columbia
(sec. 110 of the House bill, sec. 114 of the Senate
amendment and secs. 1400, 1400A, 1400B, and 1400C of the
Code)...................................................... 51
I. Possession Tax Credit with Respect to American Samoa (sec.
111 of the House bill and sec. 936 of the Code)............ 54
J. Parity in the Application of Certain Limits to Mental
Health Benefits (sec. 112 of the House bill and sec. 9812
of the Code)............................................... 56
K. Research Credit (sec. 113 of the House bill, sec. 108 of
the Senate amendment, and sec. 41 of the Code)............. 57
L. Qualified Zone Academy Bonds (sec. 114 of the House bill,
sec. 110 of the Senate amendment and sec. 1397E of the
Code)...................................................... 62
M. Above-the-Line Deduction for Certain Expenses of
Elementary and Secondary School Teachers (sec. 115 of the
House bill, sec. 112 of the Senate amendment and sec. 62 of
the Code).................................................. 64
N. Above-the-Line Deduction for Higher Education Expenses
(sec. 116 of the House bill, sec. 103 of the Senate
amendment and sec. 222 of the Code)........................ 65
O. Deduction of State and Local General Sales Taxes (sec. 117
of the House bill, sec. 105 of the Senate amendment, and
sec. 164 of the Code)...................................... 66
P. Extension and Expansion to Petroleum Products of Expensing
for Environmental Remediation Costs (sec. 201 of the House
bill, sec. 113 of the Senate amendment, and sec. 198 of the
Code)...................................................... 68
Q. Controlled Foreign Corporations........................... 70
1. Subpart F exception for active financing (sec. 202(a)
of the House bill and secs. 953 and 954 of the Code)... 70
2. Look-through treatment of payments between related
controlled foreign corporations under foreign personal
holding company income rules (sec. 202(b) of the House
bill and sec. 954(c) of the Code)...................... 73
R. Reduced Rates for Capital Gains and Dividends of
Individuals (sec. 203 of the House bill and sec. 1(h) of
the Code).................................................. 74
S. Credit for Elective Deferrals and IRA Contributions (the
``Saver's Credit'') (sec. 204 of the House bill, sec. 102
of the Senate amendment, and sec. 25B of the Code)......... 77
T. Extension of Increased Expensing for Small Business (sec.
205 of the House bill, sec. 101 of the Senate amendment,
and sec. 179 of the Code).................................. 79
U. Extend and Increase Alternative Minimum Tax Exemption
Amount for Individuals (sec. 106 of the Senate amendment
and sec. 55 of the Code)................................... 80
V. Extension and Modification of the New Markets Tax Credit
(sec. 204 of the Senate amendment and sec. 45D of the Code) 81
W. Phasedown of Credit for Electric Vehicles (sec. 118 of the
Senate amendment and sec. 30 of the Code).................. 83
X. Application of EGTRRA Sunset to Title II of the Senate
Amendment (sec. 231 of the Senate amendment)............... 84
TITLE II--OTHER PROVISIONS....................................... 85
A. Taxation of Certain Settlement Funds (sec. 301 of the
House bill and sec. 468B of the Code)...................... 85
B. Modifications to Rules Relating to Taxation of
Distributions of Stock and Securities of a Controlled
Corporation (sec. 302 of the House bill, sec. 467 of the
Senate amendment and sec. 355 of the Code)................. 86
C. Qualified Veteran's Mortgage Bonds (sec. 303 of the House
bill and sec. 143 of the Code)............................. 91
D. Capital Gains Treatment for Certain Self-Created Musical
Works (sec. 304 of the House bill and sec. 1221 of the
Code)...................................................... 93
E. Decrease Minimum Vessel Tonnage Limit to 6,000 Deadweight
Tons (sec. 305 of the House bill and sec. 1355 of the Code) 94
F. Modification of Special Arbitrage Rule for Certain Funds
(sec. 306 of the House bill and sec. 307 of the Senate
amendment)................................................. 96
G. Amortization of Expenses Incurred in Creating or Acquiring
Music or Music Copyrights (sec. 468 of the Senate amendment
and secs. 167(g) and 263A of the Code)..................... 97
TITLE III--CHARITABLE PROVISIONS................................. 99
A. Charitable Giving Incentives.............................. 99
1. Charitable deduction for nonitemizers; floor on
deductions for itemizers (sec. 201 of the Senate
amendment and secs. 63 and 170 of the Code)............ 99
2. Tax-free distributions from individual retirement
plans for charitable purposes (sec. 202 of the Senate
amendment and secs. 408, 6034, 6104, and 6652 of the
Code).................................................. 101
3. Charitable deduction for contributions of food
inventory (sec. 203 of the Senate amendment and sec.
170 of the Code)....................................... 109
4. Basis adjustment to stock of S corporation
contributing property (sec. 204 of the Senate amendment
and sec. 1367 of the Code)............................. 111
5. Charitable deduction for contributions of book
inventory (sec. 205 of the Senate amendment and sec.
170 of the Code)....................................... 112
6. Modify tax treatment of certain payments to
controlling exempt organizations and public disclosure
of information relating to UBIT (sec. 206 of the Senate
amendment and secs. 512, 6011, 6104, and new sec. 6720C
of the Code)........................................... 114
7. Encourage contributions of real property made for
conservation purposes (sec. 207 of the Senate amendment
and sec. 170 of the Code).............................. 117
8. Enhanced deduction for charitable contributions of
literary, musical, artistic, and scholarly compositions
(sec. 208 of the Senate amendment and sec. 170 of the
Code).................................................. 120
9. Mileage reimbursements to charitable volunteers
excluded from gross income (sec. 209 of the Senate
amendment and new sec. 139B of the Code)............... 122
10. Alternative percentage limitation for corporate
charitable contributions to the mathematics and science
partnership program (sec. 210 of the Senate amendment
and sec. 170 of the Code).............................. 124
B. Reforming Charitable Organizations........................ 125
1. Tax involvement of accommodation parties in tax-
shelter transactions (sec. 211 of the Senate amendment
and secs. 6011, 6033, 6652, and new sec. 4965 of the
Code).................................................. 125
2. Apply an excise tax to acquisitions of interests in
insurance contracts in which certain exempt
organizations hold interests (sec. 212 of the Senate
amendment and new secs. 4966 and 6050V of the Code).... 132
3. Increase the amounts of excise taxes imposed on public
charities, social welfare organizations, and private
foundations (sec. 213 of the Senate amendment and secs.
4941, 4942, 4943, 4944, 4945, and 4958 of the Code).... 138
4. Reform rules for charitable contributions of easements
on buildings in registered historic districts (sec. 214
of the Senate amendment and sec. 170 of the Code)...... 142
5. Reform rules relating to charitable contributions of
taxidermy and recapture tax benefit on property not
used for an exempt use (secs. 215 and 216 of the Senate
amendment and secs. 170, 6050L, and new sec. 6720B of
the Code).............................................. 146
6. Limit charitable deduction for contributions of
clothing and household items and modify recordkeeping
and substantiation requirements for certain charitable
contributions (secs. 217 and 218 of the Senate
amendment and sec. 170 of the Code).................... 150
7. Contributions of fractional interests in tangible
personal property (sec. 219 of the Senate amendment and
sec. 170 of the Code).................................. 154
8. Provisions relating to substantial and gross
overstatement of valuations of property (sec. 220 of
the Senate amendment and secs. 6662 and 6664 of the
Code).................................................. 156
9. Establish additional exemption standards for credit
counseling organizations (sec. 221 of the Senate
amendment and secs. 501 and 513 of the Code)........... 159
10. Expand the base of the tax on private foundation net
investment income (sec. 222 of the Senate amendment and
sec. 4940 of the Code)................................. 165
11. Definition of convention or association of churches
(sec. 223 of the Senate amendment and sec. 7701 of the
Code).................................................. 169
12. Notification requirement for exempt entities not
currently required to file an annual information return
(sec. 224 of the Senate amendment and secs. 6033, 6104,
6652, and 7428 of the Code)............................ 170
13. Disclosure to state officials of proposed actions
related to section 501(c) organizations (sec. 225 of
the Senate amendment and secs. 6103, 6104, 7213, 7213A,
and 7431 of the Code).................................. 172
14. Improve accountability of donor advised funds (secs.
231 through 234 of the Senate amendment and secs. 170
and 4958 and new secs. 4967, 4968, and 4969 of the
Code).................................................. 174
15. Improve accountability of supporting organizations
(secs. 241-246 of the Senate amendment and secs. 509,
4942, 4943, 4945, 4958, and 6033 and new sec. 4959 of
the Code).............................................. 187
TITLE IV--MISCELLANEOUS PROVISIONS............................... 197
A. Restructure New York Liberty Zone Tax Incentives (sec. 301
of the Senate amendment)................................... 197
B. Modification of S Corporation Passive Investment Income
Rules (sec. 302 of the Senate amendment and secs. 1362 and
1375 of the Code).......................................... 202
C. Capital Expenditure Limitation For Qualified Small Issue
Bonds (sec. 303 of the Senate amendment and sec. 144 of the
Code)...................................................... 203
D. Premiums for Mortgage Insurance (sec. 304 of the Senate
amendment and secs. 163(h) and 6050H of the Code).......... 204
E. Sense of the Senate on Use of No-Bid Contracting by
Federal Emergency Management Agency (sec. 305 of the Senate
amendment)................................................. 205
F. Sense of Congress Regarding Doha Round (sec. 306 of the
Senate amendment).......................................... 205
G. Treatment of Certain Stock Option Plans Under Nonqualified
Deferred Compensation Rules (sec. 308 of the Senate
amendment)................................................. 206
H. Sense of the Senate Regarding the Dedication of Excess
Funds (sec. 309 of the Senate amendment)................... 207
I. Modification of Treatment of Loans to Qualified Continuing
Care Facilities (sec. 310 of the Senate amendment and sec.
7872(g) of the Code)....................................... 208
J. Exclusion of Gain on Sale of a Principal Residence by a
Member of the Intelligence Community (sec. 311 of the
Senate amendment and sec. 121 of the Code)................. 210
K. Sense of the Senate Regarding the Permanent Extension of
EGTRRA and JGTRRA Provisions Relating to the Child Tax
Credit (sec. 312 of the Senate amendment).................. 212
L. Partial Expensing for Advanced Mine Safety Equipment (sec.
313 of the Senate amendment)............................... 212
M. Mine Rescue Team Training Credit (sec. 314 of the Senate
amendment and new sec. 45N of the Code).................... 214
N. Funding for Veterans Health Care and Disability
Compensation and Hospital Infrastructure for Veterans (sec.
315 of the Senate Amendment)............................... 215
O. Sense of the Senate Regarding Protecting Middle-Class
Families From the Alternative Minimum Tax (sec. 316 of the
Senate amendment).......................................... 215
TITLE V--REVENUE OFFSET PROVISIONS............................... 216
A. Provisions Designed to Curtail Tax Shelters............... 216
1. Understatement of taxpayer's liability by income tax
return preparer (sec. 401 of the Senate amendment and
sec. 6694 of the Code)................................. 216
2. Frivolous tax submissions (sec. 402 of the Senate
amendment and sec. 6702 of the Code)................... 217
3. Penalty for promoting abusive tax shelters (sec. 403
of the Senate amendment and sec. 6700 of the Code)..... 218
4. Penalty for aiding and abetting the understatement of
tax liability (sec. 404 of the Senate amendment and
sec. 6701 of the Code)................................. 219
B. Economic Substance Doctrine............................... 220
1. Clarification of the economic substance doctrine (sec.
411 of the Senate amendment)........................... 220
2. Penalty for understatements attributable to
transactions lacking economic substance, etc. (sec. 412
of the Senate amendment)............................... 225
3. Denial of deduction for interest on underpayments
attributable to noneconomic substance transactions
(sec. 413 of the Senate amendment and sec. 163(m) of
the Code).............................................. 231
C. Improvements in Efficiency and Safeguards in Internal
Revenue Service Collections................................ 232
1. Waiver of user fee for installment agreements using
automated withdrawals (sec. 421 of the Senate amendment
and sec. 6159 of the Code)............................. 232
2. Termination of installment agreements (sec. 422 of the
Senate amendment and sec. 6159 of the Code)............ 233
3. Partial payments required with submissions of offers-
in-compromise (sec. 423 of the Senate amendment and
sec. 7122 of the Code)................................. 234
D. Penalties and Fines....................................... 235
1. Increase in criminal monetary penalty limitation for
the underpayment or overpayment of tax due to fraud
(sec. 431 of the Senate amendment and secs. 7201, 7203,
and 7206 of the Code).................................. 235
2. Doubling of certain penalties, fines, and interest on
underpayments related to certain offshore financial
arrangements (sec. 432 of the Senate amendment)........ 237
3. Denial of deduction for certain fines, penalties, and
other amounts (sec. 433 of the Senate Amendment and
sec. 162 of the Code).................................. 241
4. Denial of deduction for punitive damages (sec. 434 of
the Senate amendment and sec. 162 of the Code)......... 244
5. Increase in penalty for bad checks and money orders
(sec. 435 of the Senate amendment and sec. 6657 of the
Code).................................................. 245
E. Provisions to Discourage Expatriation..................... 245
1. Tax treatment of inverted corporate entities (sec. 441
of the Senate amendment and sec. 7874 of the Code)..... 245
2. Revision of tax rules on expatriation of individuals
(sec. 442 of the Senate amendment and secs. 102, 877,
2107, 2501, 7701, and 6039G of the Code)............... 250
F. Miscellaneous Provisions.................................. 261
1. Treatment of contingent payment convertible debt
instruments (sec. 451 of the Senate amendment and sec.
1275 of the Code)...................................... 261
2. Grant Treasury regulatory authority to address foreign
tax credit transactions involving inappropriate
separation of foreign taxes from related foreign income
(sec. 452 of the Senate amendment and sec. 901 of the
Code).................................................. 263
3. Modifications of effective dates of leasing provisions
of the American Jobs Creation Act of 2004 (sec. 453 of
the Senate amendment and sec. 470 of the Code)......... 264
4. Application of earnings stripping rules to partners
which are corporations (sec. 454 of the Senate
amendment and sec. 163 of the Code).................... 265
5. Limitation on employer deduction for certain
entertainment expenses (sec. 455 of the Senate
amendment and sec. 274(e) of the Code)................. 266
6. Increase in age of minor children whose unearned
income is taxed as if parent's income (sec. 456 of the
Senate amendment and sec. 1(g) of the Code)............ 268
7. Impose loan and redemption requirements on pooled
financing bonds (sec. 457 of the Senate amendment and
sec. 149 of the Code).................................. 272
8. Amend information reporting requirements to include
interest on tax-exempt bonds (sec. 458 of the Senate
amendment and sec. 6049 of the Code)................... 275
9. Modification of credit for fuel from a non-
conventional source (sec. 459 of the Senate amendment
and sec. 45K of the Code).............................. 276
10. Modification of individual estimated tax safe harbor
(sec. 460 of the Senate Amendment and sec. 6654 of the
Code).................................................. 278
11. Revaluation of LIFO inventories of large integrated
oil companies (sec. 461 of the Senate amendment)....... 279
12. Amortization of geological and geophysical
expenditures (sec. 462 of the Senate amendment and sec.
167(h) of the Code).................................... 280
13. Valuation of employee personal use of noncommercial
aircraft (sec. 463 of the Senate amendment)............ 281
14. Application of Foreign Investment in Real Property
Tax Act (``FIRPTA'') to Regulated Investment Companies
(``RICs'') (sec. 464 of the Senate amendment and sec.
897(h)(4) of the Code)................................. 282
15. Treatment of REIT and RIC distributions attributable
to FIRPTA gains (secs. 465 and 466 of the Senate
amendment and secs. 897, 852, and 871 of the Code)..... 285
16. Credit to holders of rural renaissance bonds (sec.
469 of the Senate amendment)........................... 291
17. Modify foreign tax credit rules for large integrated
oil companies which are dual capacity taxpayers (sec.
470 of the Senate amendment and sec. 901 of the Code).. 294
18. Disability preference program for tax collection
contracts (sec. 471 of the Senate amendment)........... 296
TITLE VI--SUNSET OF CERTAIN PROVISIONS AND AMENDMENT (sec. 501 of
the Senate amendment).......................................... 297
TITLE VII--FUNDING FOR MILITARY OPERATION (secs. 601 and 602 of
the Senate amendment).......................................... 298
TITLE VIII--OTHER REVENUE OFFSET PROVISIONS...................... 299
A. Imposition of Withholding on Certain Payments Made by
Government Entities (sec. 3402 of the Code)................ 299
B. Eliminate Income Limitations on Roth IRA Conversions (sec.
408A of the Code).......................................... 301
C. Repeal of FSC/ETI Binding Contract Relief................. 304
D. Modification of Wage Limit for Purposes of Domestic
Production Activities Deduction (sec. 199 of the Code)..... 306
E. Modification of Exclusion for Citizens Living Abroad (sec.
911 of the Code)........................................... 307
TITLE IX--CORPORATE ESTIMATED TAX PROVISIONS..................... 310
TITLE X--COMPLEXITY ANALYSIS..................................... 310
TITLE XI--UNFUNDED MANDATES...................................... 312
TITLE I--EXTENSION AND MODIFICATION OF CERTAIN PROVISIONS
A. Allowance of Nonrefundable Personal Credits Against Regular and
Alternative Minimum Tax Liability
(Sec. 101 of the House bill, sec. 107 of the Senate amendment, and sec.
26 of the Code)
PRESENT LAW
Present law provides for certain nonrefundable personal
tax credits (i.e., the dependent care credit, the credit for
the elderly and disabled, the adoption credit, the child tax
credit, the credit for interest on certain home mortgages, the
HOPE Scholarship and Lifetime Learning credits, the credit for
savers, the credit for certain nonbusiness energy property, the
credit for residential energy efficient property, and the D.C.
first-time homebuyer credit). The Energy Tax Incentives Act of
2005 enacted, effective for 2006, nonrefundable tax credits for
alternative motor vehicles, and alternative motor vehicle
refueling property.\1\
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\1\ The portion of these credits relating to personal use property
is subject to the same tax liability limitation as the nonrefundable
personal tax credits (other than the adoption credit, child credit, and
saver's credit).
---------------------------------------------------------------------------
For taxable years beginning in 2005, the nonrefundable
personal credits are allowed to the extent of the full amount
of the individual's regular tax and alternative minimum tax.
For taxable years beginning after 2005, the nonrefundable
personal credits (other than the adoption credit, child credit
and saver's credit) are allowed only to the extent that the
individual's regular income tax liability exceeds the
individual's tentative minimum tax, determined without regard
to the minimum tax foreign tax credit. The adoption credit,
child credit, and saver's credit are allowed to the full extent
of the individual's regular tax and alternative minimum tax.
The alternative minimum tax is the amount by which the
tentative minimum tax exceeds the regular income tax. An
individual's tentative minimum tax is the sum of (1) 26 percent
of so much of the taxable excess as does not exceed $175,000
($87,500 in the case of a married individual filing a separate
return) and (2) 28 percent of the remaining taxable excess. The
taxable excess is so much of the alternative minimum taxable
income (``AMTI'') as exceeds the exemption amount. The maximum
tax rates on net capital gain and dividends used in computing
the regular tax are used in computing the tentative minimum
tax. AMTI is the individual's taxable income adjusted to take
account of specified preferences and adjustments.
The exemption amount is: (1) $45,000 ($58,000 for taxable
years beginning before 2006) in the case of married individuals
filing a joint return and surviving spouses; (2) $33,750
($40,250 for taxable years beginning before 2006) in the case
of other unmarried individuals; (3) $22,500 ($29,000 for
taxable years beginning before 2006) in the case of married
individuals filing a separate return; and (4) $22,500 in the
case of an estate or trust. The exemption amount is phased out
by an amount equal to 25 percent of the amount by which the
individual's AMTI exceeds (1) $150,000 in the case of married
individuals filing a joint return and surviving spouses, (2)
$112,500 in the case of other unmarried individuals, and (3)
$75,000 in the case of married individuals filing separate
returns, an estate, or a trust. These amounts are not indexed
for inflation.
HOUSE BILL
The House bill extends for one year the present-law
provision allowing nonrefundable personal credits to the full
extent of the individual's regular tax and alternative minimum
tax (through taxable years beginning on or before December 31,
2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
SENATE AMENDMENT
The Senate amendment extends for two years the present-
law provision allowing nonrefundable personal credits to the
full extent of the individual's regular tax and alternative
minimum tax (through taxable years beginning on or before
December 31, 2007).
The provision also applies to the personal credits for
alternative motor vehicles, and alternative motor vehicle
refueling property.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
B. Tax Incentives for Business Activities on Indian Reservations
1. Indian employment tax credit (Sec. 102(a) of the House bill, sec.
115 of the Senate amendment, and sec. 45A of the Code)
PRESENT LAW
In general, a credit against income tax liability is
allowed to employers for the first $20,000 of qualified wages
and qualified employee health insurance costs paid or incurred
by the employer with respect to certain employees (sec.
45A).\2\ The credit is equal to 20 percent of the excess of
eligible employee qualified wages and health insurance costs
during the current year over the amount of such wages and costs
incurred by the employer during 1993. The credit is an
incremental credit, such that an employer's current-year
qualified wages and qualified employee health insurance costs
(up to $20,000 per employee) are eligible for the credit only
to the extent that the sum of such costs exceeds the sum of
comparable costs paid during 1993. No deduction is allowed for
the portion of the wages equal to the amount of the credit.
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\2\ All section references are to the Internal Revenue Code of
1986, unless otherwise indicated.
---------------------------------------------------------------------------
Qualified wages means wages paid or incurred by an
employer for services performed by a qualified employee. A
qualified employee means any employee who is an enrolled member
of an Indian tribe or the spouse of an enrolled member of an
Indian tribe, who performs substantially all of the services
within an Indian reservation, and whose principal place of
abode while performing such services is on or near the
reservation in which the services are performed. An ``Indian
reservation'' is a reservation as defined in section 3(d) of
the Indian Financing Act of 1974 or section 4(1) of the Indian
Child Welfare Act of 1978. For purposes of the preceding
sentence, section 3(d) is applied by treating ``former Indian
reservations in Oklahoma'' as including only lands that are (1)
within the jurisdictional area of an Oklahoma Indian tribe as
determined by the Secretary of the Interior, and (2) recognized
by such Secretary as an area eligible for trust land status
under 25 C.F.R. Part 151 (as in effect on August 5, 1997).
An employee is not treated as a qualified employee for
any taxable year of the employer if the total amount of wages
paid or incurred by the employer with respect to such employee
during the taxable year exceeds an amount determined at an
annual rate of $30,000 (which after adjusted for inflation
after 1993 is currently $35,000). In addition, an employee will
not be treated as a qualified employee under certain specific
circumstances, such as where the employee is related to the
employer (in the case of an individual employer) or to one of
the employer's shareholders, partners, or grantors. Similarly,
an employee will not be treated as a qualified employee where
the employee has more than a 5 percent ownership interest in
the employer. Finally, an employee will not be considered a
qualified employee to the extent the employee's services relate
to gaming activities or are performed in a building housing
such activities.
The wage credit is available for wages paid or incurred
on or after January 1, 1994, in taxable years that begin before
January 1, 2006.
HOUSE BILL
The provision extends for one year the present-law
employment credit provision (through taxable years beginning on
or before December 31, 2006).
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
SENATE AMENDMENT
The Senate amendment extends for two years the present-
law employment credit provision (through taxable years
beginning on or before December 31, 2007).
Effective date.--Same as the House bill provision.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
2. Accelerated depreciation for business property on Indian
reservations (Sec. 102(b) of the House bill, sec. 116 of the
Senate amendment, and sec. 168(j) of the Code)
PRESENT LAW
With respect to certain property used in connection with
the conduct of a trade or business within an Indian
reservation, depreciation deductions under section 168(j) are
determined using the following recovery periods:
Years
3-year property................................................... 2
5-year property................................................... 3
7-year property................................................... 4
10-year property.................................................. 6
15-year property.................................................. 9
20-year property.................................................. 12
Nonresidential real property...................................... 22
``Qualified Indian reservation property'' eligible for
accelerated depreciation includes property which is (1) used by
the taxpayer predominantly in the active conduct of a trade or
business within an Indian reservation, (2) not used or located
outside the reservation on a regular basis, (3) not acquired
(directly or indirectly) by the taxpayer from a person who is
related to the taxpayer (within the meaning of section
465(b)(3)(C)), and (4) described in the recovery-period table
above. In addition, property is not ``qualified Indian
reservation property'' if it is placed in service for purposes
of conducting gaming activities. Certain ``qualified
infrastructure property'' may be eligible for the accelerated
depreciation even if located outside an Indian reservation,
provided that the purpose of such property is to connect with
qualified infrastructure property located within the
reservation (e.g., roads, power lines, water systems, railroad
spurs, and communications facilities).
An ``Indian reservation'' means a reservation as defined
in section 3(d) of the Indian Financing Act of 1974 or section
4(1) of the Indian Child Welfare Act of 1978. For purposes of
the preceding sentence, section 3(d) is applied by treating
``former Indian reservations in Oklahoma'' as including only
lands that are (1) within the jurisdictional area of an
Oklahoma Indian tribe as determined by the Secretary of the
Interior, and (2) recognized by such Secretary as an area
eligible for trust land status under 25 CFR. Part 151 (as in
effect on August 5, 1997).
The depreciation deduction allowed for regular tax
purposes is also allowed for purposes of the alternative
minimum tax. The accelerated depreciation for Indian
reservations is available with respect to property placed in
service on or after January 1, 1994, and before January 1,
2006.
HOUSE BILL
The provision extends for one year the present-law
incentive relating to depreciation of qualified Indian
reservation property (to apply to property placed in service
through December 31, 2006).
Effective date.--The provision applies to property placed
in service after December 31, 2005.
SENATE AMENDMENT
The Senate amendment extends for two years the present-
law incentive relating to depreciation of qualified Indian
reservation property (to apply to property placed in service
through December 31, 2007).
Effective date.--The Senate amendment is the same as the
House bill.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
C. Work Opportunity Tax Credit and Welfare-To-Work Tax Credit
(Secs. 103 and 104 of the House bill, sec. 109 of the Senate amendment
and secs. 51 and 51A of the Code)
PRESENT LAW
Work opportunity tax credit
Targeted groups eligible for the credit
The work opportunity tax credit is available on an
elective basis for employers hiring individuals from one or
more of eight targeted groups. The eight targeted groups are:
(1) certain families eligible to receive benefits under the
Temporary Assistance for Needy Families Program; (2) high-risk
youth; (3) qualified ex-felons; (4) vocational rehabilitation
referrals; (5) qualified summer youth employees; (6) qualified
veterans; (7) families receiving food stamps; and (8) persons
receiving certain Supplemental Security Income (SSI) benefits.
A high-risk youth is an individual aged 18 but not aged
25 on the hiring date who is certified by a designated local
agency as having a principal place of abode within an
empowerment zone, enterprise community, or renewal community.
The credit is not available if such youth's principal place of
abode ceases to be within an empowerment zone, enterprise
community, or renewal community.
A qualified ex-felon is an individual certified by a
designated local agency as: (1) having been convicted of a
felony under State or Federal law; (2) being a member of an
economically disadvantaged family; and (3) having a hiring date
within one year of release from prison or conviction.
A food stamp recipient is an individual aged 18 but not
aged 25 on the hiring date certified by a designated local
agency as being a member of a family either currently or
recently receiving assistance under an eligible food stamp
program.
Qualified wages
Generally, qualified wages are defined as cash wages paid
by the employer to a member of a targeted group. The employer's
deduction for wages is reduced by the amount of the credit.
Calculation of the credit
The credit equals 40 percent (25 percent for employment
of 400 hours or less) of qualified first-year wages. Generally,
qualified first-year wages are qualified wages (not in excess
of $6,000) attributable to service rendered by a member of a
targeted group during the one-year period beginning with the
day the individual began work for the employer. Therefore, the
maximum credit per employee is $2,400 (40 percent of the first
$6,000 of qualified first-year wages). With respect to
qualified summer youth employees, the maximum credit is $1,200
(40 percent of the first $3,000 of qualified first-year wages).
Minimum employment period
No credit is allowed for qualified wages paid to
employees who work less than 120 hours in the first year of
employment.
Coordination of the work opportunity tax credit and the
welfare-to-work tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The work opportunity tax credit is not allowed for wages
paid to a relative or dependent of the taxpayer. Similarity
wages paid to replacement workers during a strike or lockout
are not eligible for the work opportunity tax credit. Wages
paid to any employee during any period for which the employer
received on-the-job training program payments with respect to
that employee are not eligible for the work opportunity tax
credit. The work opportunity tax credit generally is not
allowed for wages paid to individuals who had previously been
employed by the employer. In addition, many other technical
rules apply.
Expiration
The work opportunity tax credit is not available for
individuals who begin work for an employer after December 31,
2005.
Welfare-to-work tax credit
Targeted group eligible for the credit
The welfare-to-work tax credit is available on an
elective basis to employers of qualified long-term family
assistance recipients. Qualified long-term family assistance
recipients are: (1) members of a family that has received
family assistance for at least 18 consecutive months ending on
the hiring date; (2) members of a family that has received such
family assistance for a total of at least 18 months (whether or
not consecutive) after August 5, 1997 (the date of enactment of
the welfare-to-work tax credit) if they are hired within 2
years after the date that the 18-month total is reached; and
(3) members of a family who are no longer eligible for family
assistance because of either Federal or State time limits, if
they are hired within 2 years after the Federal or State time
limits made the family ineligible for family assistance.
Qualified wages
Qualified wages for purposes of the welfare-to-work tax
credit are defined more broadly than the work opportunity tax
credit. Unlike the definition of wages for the work opportunity
tax credit which includes simply cash wages, the definition of
wages for the welfare-to-work tax credit includes cash wages
paid to an employee plus amounts paid by the employer for: (1)
educational assistance excludable under a section 127 program
(or that would be excludable but for the expiration of sec.
127); (2) health plan coverage for the employee, but not more
than the applicable premium defined under section 4980B(f)(4);
and (3) dependent care assistance excludable under section 129.
The employer's deduction for wages is reduced by the amount of
the credit.
Calculation of the credit
The welfare-to-work tax credit is available on an
elective basis to employers of qualified long-term family
assistance recipients during the first two years of employment.
The maximum credit is 35 percent of the first $10,000 of
qualified first-year wages and 50 percent of the first $10,000
of qualified second-year wages. Qualified first-year wages are
defined as qualified wages (not in excess of $10,000)
attributable to service rendered by a member of the targeted
group during the one-year period beginning with the day the
individual began work for the employer. Qualified second-year
wages are defined as qualified wages (not in excess of $10,000)
attributable to service rendered by a member of the targeted
group during the one-year period beginning immediately after
the first year of that individual's employment for the
employer. The maximum credit is $8,500 per qualified employee.
Minimum employment period
No credit is allowed for qualified wages paid to a member
of the targeted group unless they work at least 400 hours or
180 days in the first year of employment.
Coordination of the work opportunity tax credit and the
welfare-to-work tax credit
An employer cannot claim the work opportunity tax credit
with respect to wages of any employee on which the employer
claims the welfare-to-work tax credit.
Other rules
The welfare-to-work tax credit incorporates directly or
by reference many of these other rules contained on the work
opportunity tax credit.
Expiration
The welfare-to-work credit is not available for
individuals who begin work for an employer after December 31,
2005.
HOUSE BILL
Work opportunity tax credit
The House bill extends the work opportunity credit for
one year (through December 31, 2006). Also, the House bill
raises the maximum age limit for the food stamp recipient
category to include individuals who are at least age 18 but
under age 35 on the hiring date.
Effective date
The provision is effective for wages paid or incurred to
a qualified individual who begins work for an employer after
December 31, 2005, and before January 1, 2007.
Welfare-to-work tax credit
The House bill extends the welfare-to-work tax credit for
one year (through December 31, 2006).
Effective date.--The provision is effective for wages
paid or incurred to a qualified individual who begins work for
an employer after December 31, 2005, and before January 1,
2007.
SENATE AMENDMENT
In general
The Senate amendment combines the work opportunity and
welfare-to-work tax credits and extends the combined credit for
one year. The welfare-to-work credit is repealed.
Targeted groups eligible for the combined credit
The combined credit is available on an elective basis for
employers hiring individuals from one or more of all nine
targeted groups. The nine targeted groups are the present-law
eight groups with the addition of the welfare-to-work credit/
long-term family assistance recipient as the ninth targeted
group.
The Senate amendment raises the age limit for the high-
risk youth category to include individuals aged 18 but not aged
40 on the hiring date. The Senate amendment also renames the
high-risk youth category to be the designated community
resident category.
The Senate amendment repeals the requirement that a
qualified ex-felon be an individual certified as a member of an
economically disadvantaged family.
The Senate amendment raises the age limit for the food
stamp recipient category to include individuals aged 18 but not
aged 40 on the hiring date.
Qualified wages
Qualified first-year wages for the eight work opportunity
tax credit categories remain capped at $6,000 ($3,000 for
qualified summer youth employees). No credit is allowed for
second-year wages. In the case of long-term family assistance
recipients, the cap is $10,000 for both qualified first-year
wages and qualified second-year wages. The combined credit
follows the work opportunity tax credit definition of wages
which does not include amounts paid by the employer for: (1)
educational assistance excludable under a section 127 program
(or that would be excludable but for the expiration of sec.
127); (2) health plan coverage for the employee, but not more
than the applicable premium defined under section 4980B(f)(4);
and (3) dependent care assistance excludable under section 129.
For all targeted groups, the employer's deduction for wages is
reduced by the amount of the credit.
Calculation of the credit
First-year wages.--For the eight work opportunity tax
credit categories, the credit equals 40 percent (25 percent for
employment of 400 hours or less) of qualified first-year wages.
Generally, qualified first-year wages are qualified wages (not
in excess of $6,000) attributable to service rendered by a
member of a targeted group during the one-year period beginning
with the day the individual began work for the employer.
Therefore, the maximum credit per employee for members of any
of the eight work opportunity tax credit targeted groups
generally is $2,400 (40 percent of the first $6,000 of
qualified first-year wages). With respect to qualified summer
youth employees, the maximum credit remains $1,200 (40 percent
of the first $3,000 of qualified first-year wages). For the
welfare-to-work/long-term family assistance recipients, the
maximum credit equals $4,000 per employee (40 percent of
$10,000 of wages).
Second-year wages.--In the case of long-term family
assistance recipients the maximum credit is $5,000 (50 percent
of the first $10,000 of qualified second-year wages).
Minimum employment period
No credit is allowed for qualified wages paid to
employees who work less than 120 hours in the first year of
employment.
Coordination of the work opportunity tax credit and the welfare-to-work
tax credit
Coordination is no longer necessary once the two credits
are combined.
Effective date.--The provision is effective for wages
paid or incurred to a qualified individual who begins work for
an employer after December 31, 2005, and before January 1,
2007.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
D. Deduction for Corporate Donations of Computer Technology and
Equipment
(Sec. 105 of the House bill, sec. 111 of the Senate amendment and sec.
170 of the Code)
PRESENT LAW
In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property, the
amount of the charitable deduction generally is limited to the
taxpayer's basis in the property. In the case of a charitable
contribution of tangible personal property, the deduction is
limited to the taxpayer's basis in such property if the use by
the recipient charitable organization is unrelated to the
organization's tax-exempt purpose. In cases involving
contributions to a private foundation (other than certain
private operating foundations), the amount of the deduction is
limited to the taxpayer's basis in the property.
Under present law, a taxpayer's deduction for charitable
contributions of computer technology and equipment generally is
limited to the taxpayer's basis (typically, cost) in the
property. However, certain corporations may claim a deduction
in excess of basis for a ``qualified computer contribution.''
This enhanced deduction is equal to the lesser of (1) basis
plus one-half of the item's appreciation (i.e., basis plus one
half of fair market value minus basis) or (2) two times basis.
The enhanced deduction for qualified computer contributions
expires for any contribution made during any taxable year
beginning after December 31, 2005.
A qualified computer contribution means a charitable
contribution of any computer technology or equipment, which
meets standards of functionality and suitability as established
by the Secretary of the Treasury. The contribution must be to
certain educational organizations or public libraries and made
not later than three years after the taxpayer acquired the
property or, if the taxpayer constructed the property, not
later than the date construction of the property is
substantially completed. The original use of the property must
be by the donor or the donee, and in the case of the donee,
must be used substantially for educational purposes related to
the function or purpose of the donee. The property must fit
productively into the donee's education plan. The donee may not
transfer the property in exchange for money, other property, or
services, except for shipping, installation, and transfer
costs. To determine whether property is constructed by the
taxpayer, the rules applicable to qualified research
contributions apply. That is, property is considered
constructed by the taxpayer only if the cost of the parts used
in the construction of the property (other than parts
manufactured by the taxpayer or a related person) does not
exceed 50 percent of the taxpayer's basis in the property.
Contributions may be made to private foundations under certain
conditions.
HOUSE BILL
The present-law provision is extended for one year to
apply to contributions made during any taxable year beginning
after December 31, 2005, and before January 1, 2007.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005.
SENATE AMENDMENT
Same as House bill.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
E. Availability of Archer Medical Savings Accounts
(Sec. 106 of the House bill and sec. 220 of the Code)
PRESENT LAW
Archer medical savings accounts
In general
Within limits, contributions to an Archer medical savings
account (``Archer MSA'') are deductible in determining adjusted
gross income if made by an eligible individual and are
excludable from gross income and wages for employment tax
purposes if made by the employer of an eligible individual.
Earnings on amounts in an Archer MSA are not currently taxable.
Distributions from an Archer MSA for medical expenses are not
includible in gross income. Distributions not used for medical
expenses are includible in gross income. In addition,
distributions not used for medical expenses are subject to an
additional 15-percent tax unless the distribution is made after
age 65, death, or disability.
Eligible individuals
Archer MSAs are available to employees covered under an
employer-sponsored high deductible plan of a small employer and
self-employed individuals covered under a high deductible
health plan. An employer is a small employer if it employed, on
average, no more than 50 employees on business days during
either the preceding or the second preceding year. An
individual is not eligible for an Archer MSA if he or she is
covered under any other health plan in addition to the high
deductible plan.
Tax treatment of and limits on contributions
Individual contributions to an Archer MSA are deductible
(within limits) in determining adjusted gross income (i.e.,
``above-the-line''). In addition, employer contributions are
excludable from gross income and wages for employment tax
purposes (within the same limits), except that this exclusion
does not apply to contributions made through a cafeteria plan.
In the case of an employee, contributions can be made to an
Archer MSA either by the individual or by the individual's
employer.
The maximum annual contribution that can be made to an
Archer MSA for a year is 65 percent of the deductible under the
high deductible plan in the case of individual coverage and 75
percent of the deductible in the case of family coverage.
Definition of high deductible plan
A high deductible plan is a health plan with an annual
deductible of at least $1,800 and no more than $2,700 in the
case of individual coverage and at least $3,650 and no more
than $5,450 in the case of family coverage (for 2006). In
addition, the maximum out-of-pocket expenses with respect to
allowed costs (including the deductible) must be no more than
$3,650 in the case of individual coverage and no more than
$6,650 in the case of family coverage (for 2006). A plan does
not fail to qualify as a high deductible plan merely because it
does not have a deductible for preventive care as required by
State law. A plan does not qualify as a high deductible health
plan if substantially all of the coverage under the plan is for
certain permitted coverage. In the case of a self-insured plan,
the plan must in fact be insurance (e.g., there must be
appropriate risk shifting) and not merely a reimbursement
arrangement.
Cap on taxpayers utilizing Archer MSAs and expiration of
pilot program
The number of taxpayers benefiting annually from an
Archer MSA contribution is limited to a threshold level
(generally 750,000 taxpayers). The number of Archer MSAs
established has not exceeded the threshold level.
After 2005, no new contributions may be made to Archer
MSAs except by or on behalf of individuals who previously made
(or had made on their behalf) Archer MSA contributions and
employees who are employed by a participating employer.
Trustees of Archer MSAs are generally required to make
reports to the Treasury by August 1 regarding Archer MSAs
established by July 1 of that year. If the threshold level is
reached in a year, the Secretary is required to make and
publish such determination by October 1 of such year.
Health savings accounts
Health savings accounts (``HSAs'') were enacted by the
Medicare Prescription Drug, Improvement, and Modernization Act
of 2003. Like Archer MSAs, an HSA is a tax-exempt trust or
custodial account to which tax-deductible contributions may be
made by individuals with a high deductible health plan. HSAs
provide tax benefits similar to, but more favorable than, those
provided by Archer MSAs. HSAs were established on a permanent
basis.
HOUSE BILL
The House bill extends for one year the present-law
Archer MSA provisions (through December 31, 2006).
The report required by Archer MSA trustees is treated as
timely filed if made before the close of the 90-day period
beginning on the date of enactment. The determination and
publication whether the threshold level has been exceeded is
treated as timely if made before the close of the 120-day
period beginning on the date of enactment.
Effective date.--The provision is effective on the date
of enactment.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision.
F. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold
Improvements and Qualified Restaurant Improvements
(Sec. 107 and sec. 108 of the House bill, sec. 117 of the Senate
amendment, and sec. 168 of the Code)
PRESENT LAW
In general
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the modified
accelerated cost recovery system (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property (sec. 168). The cost of
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years.
Nonresidential real property is subject to the mid-month
placed-in-service convention. Under the mid-month convention,
the depreciation allowance for the first year property is
placed in service is based on the number of months the property
was in service, and property placed in service at any time
during a month is treated as having been placed in service in
the middle of the month.
Depreciation of leasehold improvements
Generally, depreciation allowances for improvements made
on leased property are determined under MACRS, even if the
MACRS recovery period assigned to the property is longer than
the term of the lease. This rule applies regardless of whether
the lessor or the lessee places the leasehold improvements in
service. If a leasehold improvement constitutes an addition or
improvement to nonresidential real property already placed in
service, the improvement generally is depreciated using the
straight-line method over a 39-year recovery period, beginning
in the month the addition or improvement was placed in service.
However, exceptions exist for certain qualified leasehold
improvements and certain qualified restaurant property.
Qualified leasehold improvement property
Section 168(e)(3)(E)(iv) provides a statutory 15-year
recovery period for qualified leasehold improvement property
placed in service before January 1, 2006. Qualified leasehold
improvement property is recovered using the straight-line
method. Leasehold improvements placed in service in 2006 and
later will be subject to the general rules described above.
Qualified leasehold improvement property is any
improvement to an interior portion of a building that is
nonresidential real property, provided certain requirements are
met. The improvement must be made under or pursuant to a lease
either by the lessee (or sublessee), or by the lessor, of that
portion of the building to be occupied exclusively by the
lessee (or sublessee). The improvement must be placed in
service more than three years after the date the building was
first placed in service. Qualified leasehold improvement
property does not include any improvement for which the
expenditure is attributable to the enlargement of the building,
any elevator or escalator, any structural component benefiting
a common area, or the internal structural framework of the
building. However, if a lessor makes an improvement that
qualifies as qualified leasehold improvement property, such
improvement does not qualify as qualified leasehold improvement
property to any subsequent owner of such improvement. An
exception to the rule applies in the case of death and certain
transfers of property that qualify for non-recognition
treatment.
Qualified restaurant property
Section 168(e)(3)(E)(v) provides a statutory 15-year
recovery period for qualified restaurant property placed in
service before January 1, 2006. For purposes of the provision,
qualified restaurant property means any improvement to a
building if such improvement is placed in service more than
three years after the date such building was first placed in
service and more than 50 percent of the building's square
footage is devoted to the preparation of, and seating for on-
premises consumption of, prepared meals. Qualified restaurant
property is recovered using the straight-line method.
HOUSE BILL
Under the House bill, the present-law provisions relating
to qualified leasehold improvement property and qualified
restaurant improvement property are extended for one year
(through December 31, 2006).
Effective date.--The House bill applies to property
placed in service after December 31, 2005.
SENATE AMENDMENT
Under the Senate amendment, the present-law provisions
are extended for two years (through December 31, 2007).
Effective date.--The Senate amendment applies to property
placed in service after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
G. Taxable Income Limit on Percentage Depletion for Oil and Natural Gas
Produced From Marginal Properties
(Sec. 109 of the House bill and sec. 613A(c)(6)(H) of the Code)
PRESENT LAW
The Code permits taxpayers to recover their investments
in oil and gas wells through depletion deductions. Two methods
of depletion are currently allowable under the Code: (1) the
cost depletion method, and (2) the percentage depletion method.
Under the cost depletion method, the taxpayer deducts that
portion of the adjusted basis of the depletable property which
is equal to the ratio of units sold from that property during
the taxable year to the number of units remaining as of the end
of taxable year plus the number of units sold during the
taxable year. Thus, the amount recovered under cost depletion
may never exceed the taxpayer's basis in the property.
The Code generally limits the percentage depletion method
for oil and gas properties to independent producers and royalty
owners. Generally, under the percentage depletion method, 15
percent of the taxpayer's gross income from an oil- or gas-
producing property is allowed as a deduction in each taxable
year. The amount deducted generally may not exceed 100 percent
of the taxable income from that property in any year. For
marginal production, the 100-percent taxable income limitation
has been suspended for taxable years beginning after December
31, 1997, and before January 1, 2006.
Marginal production is defined as domestic crude oil and
natural gas production from stripper well property or from
property substantially all of the production from which during
the calendar year is heavy oil. Stripper well property is
property from which the average daily production is 15 barrel
equivalents or less, determined by dividing the average daily
production of domestic crude oil and domestic natural gas from
producing wells on the property for the calendar year by the
number of wells. Heavy oil is domestic crude oil with a
weighted average gravity of 20 degrees API or less (corrected
to 60 degrees Fahrenheit).
HOUSE BILL
The provision extends for one year the present-law
taxable income limitation suspension provision for marginal
production (through taxable years beginning on or before
December 31, 2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision.
H. Tax Incentives for Investment in the District of Columbia
(Sec. 110 of the House bill, sec. 114 of the Senate amendment and secs.
1400, 1400A, 1400B, and 1400C of the Code)
PRESENT LAW
In general
The Taxpayer Relief Act of 1997 designated certain
economically depressed census tracts within the District of
Columbia as the District of Columbia Enterprise Zone (the
``D.C. Zone''), within which businesses and individual
residents are eligible for special tax incentives. The census
tracts that compose the D.C. Zone are (1) all census tracts
that presently are part of the D.C. enterprise community
designated under section 1391 (i.e., portions of Anacostia, Mt.
Pleasant, Chinatown, and the easternmost part of the District),
and (2) all additional census tracts within the District of
Columbia where the poverty rate is not less than 20 percent.
The D.C. Zone designation remains in effect for the period from
January 1, 1998, through December 31, 2005. In general, the tax
incentives available in connection with the D.C. Zone are a 20-
percent wage credit, an additional $35,000 of section 179
expensing for qualified zone property, expanded tax-exempt
financing for certain zone facilities, and a zero-percent
capital gains rate from the sale of certain qualified D.C. zone
assets.
Wage credit
A 20-percent wage credit is available to employers for
the first $15,000 of qualified wages paid to each employee
(i.e., a maximum credit of $3,000 with respect to each
qualified employee) who (1) is a resident of the D.C. Zone, and
(2) performs substantially all employment services within the
D.C. Zone in a trade or business of the employer.
Wages paid to a qualified employee who earns more than
$15,000 are eligible for the wage credit (although only the
first $15,000 of wages is eligible for the credit). The wage
credit is available with respect to a qualified full-time or
part-time employee (employed for at least 90 days), regardless
of the number of other employees who work for the employer. In
general, any taxable business carrying out activities in the
D.C. Zone may claim the wage credit, regardless of whether the
employer meets the definition of a ``D.C. Zone business.'' \3\
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\3\ However, the wage credit is not available for wages paid in
connection with certain business activities described in section
144(c)(6)(B) or certain farming activities. In addition, wages are not
eligible for the wage credit if paid to (1) a person who owns more than
five percent of the stock (or capital or profits interests) of the
employer, (2) certain relatives of the employer, or (3) if the employer
is a corporation or partnership, certain relatives of a person who owns
more than 50 percent of the business.
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An employer's deduction otherwise allowed for wages paid
is reduced by the amount of wage credit claimed for that
taxable year.\4\ Wages are not to be taken into account for
purposes of the wage credit if taken into account in
determining the employer's work opportunity tax credit under
section 51 or the welfare-to-work credit under section 51A.\5\
In addition, the $15,000 cap is reduced by any wages taken into
account in computing the work opportunity tax credit or the
welfare-to-work credit.\6\ The wage credit may be used to
offset up to 25 percent of alternative minimum tax
liability.\7\
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\4\ Sec. 280C(a).
\5\ Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2).
\6\ Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2).
\7\ Sec. 38(c)(2).
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Section 179 expensing
In general, a D.C. Zone business is allowed an additional
$35,000 of section 179 expensing for qualifying property placed
in service by a D.C. Zone business.\8\ The section 179
expensing allowed to a taxpayer is phased out by the amount by
which 50 percent of the cost of qualified zone property placed
in service during the year by the taxpayer exceeds $200,000
($400,000 for taxable years beginning after 2002 and before
2008). The term ``qualified zone property'' is defined as
depreciable tangible property (including buildings), provided
that (1) the property is acquired by the taxpayer (from an
unrelated party) after the designation took effect, (2) the
original use of the property in the D.C. Zone commences with
the taxpayer, and (3) substantially all of the use of the
property is in the D.C. Zone in the active conduct of a trade
or business by the taxpayer.\9\ Special rules are provided in
the case of property that is substantially renovated by the
taxpayer.
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\8\ Sec. 1397A.
\9\ Sec. 1397D.
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Tax-exempt financing
A qualified D.C. Zone business is permitted to borrow
proceeds from tax-exempt qualified enterprise zone facility
bonds (as defined in section 1394) issued by the District of
Columbia.\10\ Such bonds are subject to the District of
Columbia's annual private activity bond volume limitation.
Generally, qualified enterprise zone facility bonds for the
District of Columbia are bonds 95 percent or more of the net
proceeds of which are used to finance certain facilities within
the D.C. Zone. The aggregate face amount of all outstanding
qualified enterprise zone facility bonds per qualified D.C.
Zone business may not exceed $15 million and may be issued only
while the D.C. Zone designation is in effect.
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\10\ Sec. 1400A.
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Zero-percent capital gains
A zero-percent capital gains rate applies to capital
gains from the sale of certain qualified D.C. Zone assets held
for more than five years.\11\ In general, a qualified ``D.C.
Zone asset'' means stock or partnership interests held in, or
tangible property held by, a D.C. Zone business. For purposes
of the zero-percent capital gains rate, the D.C. Enterprise
Zone is defined to include all census tracts within the
District of Columbia where the poverty rate is not less than 10
percent.
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\11\ Sec. 1400B.
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In general, gain eligible for the zero-percent tax rate
means gain from the sale or exchange of a qualified D.C. Zone
asset that is (1) a capital asset or property used in the trade
or business as defined in section 1231(b), and (2) acquired
before January 1, 2006. Gain that is attributable to real
property, or to intangible assets, qualifies for the zero-
percent rate, provided that such real property or intangible
asset is an integral part of a qualified D.C. Zone
business.\12\ However, no gain attributable to periods before
January 1, 1998, and after December 31, 2010, is qualified
capital gain.
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\12\ However, sole proprietorships and other taxpayers selling
assets directly cannot claim the zero-percent rate on capital gain from
the sale of any intangible property (i.e., the integrally related test
does not apply).
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District of Columbia homebuyer tax credit
First-time homebuyers of a principal residence in the
District of Columbia are eligible for a nonrefundable tax
credit of up to $5,000 of the amount of the purchase price. The
$5,000 maximum credit applies both to individuals and married
couples. Married individuals filing separately can claim a
maximum credit of $2,500 each. The credit phases out for
individual taxpayers with adjusted gross income between $70,000
and $90,000 ($110,000-$130,000 for joint filers). For purposes
of eligibility, ``first-time homebuyer'' means any individual
if such individual did not have a present ownership interest in
a principal residence in the District of Columbia in the one-
year period ending on the date of the purchase of the residence
to which the credit applies. The credit is scheduled to expire
for residences purchased after December 31, 2005.\13\
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\13\ Sec. 1400C(i).
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HOUSE BILL
The provision extends the designation of the D.C. Zone
for one year (through December 31, 2006), thus extending the
wage credit and section 179 expensing for one year.
The provision extends the tax-exempt financing authority
for one year, applying to bonds issued during the period
beginning on January 1, 1998, and ending on December 31, 2006.
The provision extends the zero-percent capital gains rate
applicable to capital gains from the sale of certain qualified
D.C. Zone assets for one year.
The provision extends the first-time homebuyer credit for
one year, through December 31, 2006.
Effective date.--The amendment generally is effective on
January 1, 2006, except the provision relating to bonds is
effective for obligations issued after the date of enactment.
SENATE AMENDMENT
The Senate amendment is the same as the House bill.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
I. Possession Tax Credit With Respect to American Samoa
(Sec. 111 of the House bill and sec. 936 of the Code)
PRESENT LAW
In general
Certain domestic corporations with business operations in
the U.S. possessions are eligible for the possession tax
credit.\14\ This credit offsets the U.S. tax imposed on certain
income related to operations in the U.S. possessions.\15\ For
purposes of the section 936 credit, possessions include, among
other places, American Samoa. Income eligible for the section
936 credit includes non-U.S. source income from (1) the active
conduct of a trade or business within a U.S. possession, (2)
the sale or exchange of substantially all of the assets that
were used in such a trade or business, or (3) certain
possessions investments. The section 936 credit expires for
taxable years beginning after December 31, 2005.
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\14\ Secs. 27(b), 936.
\15\ Domestic corporations with activities in Puerto Rico are
eligible for the section 30A economic activity credit. That credit is
calculated under the rules set forth in section 936.
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To qualify for the possession tax credit for a taxable
year, a domestic corporation must satisfy two conditions.
First, the corporation must derive at least 80 percent of its
gross income for the three-year period immediately preceding
the close of the taxable year from sources within a possession.
Second, the corporation must derive at least 75 percent of its
gross income for that same period from the active conduct of a
possession business. A domestic corporation that has elected
the possession tax credit and that satisfies these two
conditions for a taxable year generally is entitled to a credit
against the U.S. tax attributable to the taxpayer's income that
is eligible for the section 936 credit.
The possession tax credit applies only to a corporation
that qualifies as an existing credit claimant. The
determination of whether a corporation is an existing credit
claimant is made separately for each possession. The possession
tax credit is computed separately for each possession with
respect to which the corporation is an existing credit
claimant, and the credit is subject to either an economic
activity-based limitation or an income-based limit.
Qualification as existing credit claimant
A corporation is an existing credit claimant with respect
to a possession if (1) the corporation was engaged in the
active conduct of a trade or business within the possession on
October 13, 1995, and (2) the corporation elected the benefits
of the possession tax credit in an election in effect for its
taxable year that included October 13, 1995.\16\ A corporation
that adds a substantial new line of business (other than in a
qualifying acquisition of all the assets of a trade or business
of an existing credit claimant) ceases to be an existing credit
claimant as of the close of the taxable year ending before the
date on which that new line of business is added.
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\16\ A corporation will qualify as an existing credit claimant if
it acquired all the assets of a trade or business of a corporation that
(1) actively conducted that trade or business in a possession on
October 13, 1995, and (2) had elected the benefits of the possession
tax credit in an election in effect for the taxable year that included
October 13, 1995.
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Economic activity-based limit
Under the economic activity-based limit, the amount of
the credit determined under the rules described above may not
exceed an amount equal to the sum of (1) 60 percent of the
taxpayer's qualifying possession wage and fringe benefit
expenses, (2) 15 percent of depreciation allowances with
respect to short-life qualifying tangible property, plus 40
percent of depreciation allowances with respect to medium-life
qualifying tangible property, plus 65 percent of depreciation
allowances with respect to long-life tangible property, and (3)
in certain cases, a portion of the taxpayer's possession income
taxes.
Income-based limit
As an alternative to the economic activity-based limit, a
taxpayer may elect to apply a limit equal to the applicable
percentage of the credit that would otherwise be allowable with
respect to possession business income; the applicable
percentage currently is 40 percent.
Repeal and phase out
In 1996, the section 936 credit was repealed for new
claimants for taxable years beginning after 1995 and was phased
out for existing credit claimants over a period including
taxable years beginning before 2006. The amount of the
available credit during the phaseout period generally is
reduced by special limitation rules. These phaseout period
limitation rules do not apply to the credit available to
existing credit claimants for income from activities in Guam,
American Samoa, and the Northern Mariana Islands. The section
936 credit is repealed for all possessions, including Guam,
American Samoa, and the Northern Mariana Islands, for all
taxable years beginning after 2005.
HOUSE BILL
The House bill extends for one year the present-law
section 936 credit as applied to American Samoa; it thus allows
existing credit claimants to claim the credit for income from
activities in American Samoa in taxable years beginning on or
before December 31, 2006.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision.
J. Parity in the Application of Certain Limits to Mental Health
Benefits
(Sec. 112 of the House bill and sec. 9812 of the Code)
PRESENT LAW \17\
The Code, the Employee Retirement Income Security Act of
1974 (``ERISA'') and the Public Health Service Act (``PHSA'')
contain provisions under which group health plans that provide
both medical and surgical benefits and mental health benefits
cannot impose aggregate lifetime or annual dollar limits on
mental health benefits that are not imposed on substantially
all medical and surgical benefits (``mental health parity
requirements''). In the case of a group health plan which
provides benefits for mental health, the mental health parity
requirements do not affect the terms and conditions (including
cost sharing, limits on numbers of visits or days of coverage,
and requirements relating to medical necessity) relating to the
amount, duration, or scope of mental health benefits under the
plan, except as specifically provided in regard to parity in
the imposition of aggregate lifetime limits and annual limits.
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\17\ This description of present law refers to the law in effect at
the time the bill passed the House of Representatives, which was before
the enactment of Pub. L. No. 109-151, which extended the mental health
parity requirements of the Code, ERISA, and the PHSA through December
31, 2006.
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The Code imposes an excise tax on group health plans
which fail to meet the mental health parity requirements. The
excise tax is equal to $100 per day during the period of
noncompliance and is generally imposed on the employer
sponsoring the plan if the plan fails to meet the requirements.
The maximum tax that can be imposed during a taxable year
cannot exceed the lesser of 10 percent of the employer's group
health plan expenses for the prior year or $500,000. No tax is
imposed if the Secretary determines that the employer did not
know, and in exercising reasonable diligence would not have
known, that the failure existed.
The mental health parity requirements do not apply to
group health plans of small employers nor do they apply if
their application results in an increase in the cost under a
group health plan of at least one percent. Further, the mental
health parity requirements do not require group health plans to
provide mental health benefits.
The Code, ERISA and PHSA mental health parity
requirements are scheduled to expire with respect to benefits
for services furnished after December 31, 2005.
HOUSE BILL
The House bill extends for one year the present-law Code
excise tax for failure to comply with the mental health parity
requirements (through December 31, 2006).
Effective date.--The provision is effective on the date
of enactment.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision.
K. Research Credit
(Sec. 113 of the House bill, sec. 108 of the Senate amendment, and sec.
41 of the Code)
PRESENT LAW
General rule
Prior to January 1, 2006, a taxpayer could claim a
research credit equal to 20 percent of the amount by which the
taxpayer's qualified research expenses for a taxable year
exceeded its base amount for that year.\18\ Thus, the research
credit was generally available with respect to incremental
increases in qualified research.
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\18\ Sec. 41.
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A 20-percent research tax credit was also available with
respect to the excess of (1) 100 percent of corporate cash
expenses (including grants or contributions) paid for basic
research conducted by universities (and certain nonprofit
scientific research organizations) over (2) the sum of (a) the
greater of two minimum basic research floors plus (b) an amount
reflecting any decrease in nonresearch giving to universities
by the corporation as compared to such giving during a fixed-
base period, as adjusted for inflation. This separate credit
computation was commonly referred to as the university basic
research credit (see sec. 41(e)).
Finally, a research credit was available for a taxpayer's
expenditures on research undertaken by an energy research
consortium. This separate credit computation was commonly
referred to as the energy research credit. Unlike the other
research credits, the energy research credit applied to all
qualified expenditures, not just those in excess of a base
amount.
The research credit, including the university basic
research credit and the energy research credit, expired on
December 31, 2005.\19\
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\19\ The research tax credit initially was enacted in the Economic
Recovery Tax Act of 1981 as a credit equal to 25 percent of the excess
of qualified research expenses incurred in the current taxable year
over the average of qualified research expenses incurred in the prior
three taxable years. The research tax credit was modified in the Tax
Reform Act of 1986, which (1) extended the credit through December 31,
1988, (2) reduced the credit rate to 20 percent, (3) tightened the
definition of qualified research expenses eligible for the credit, and
(4) enacted the separate university basic credit.
The Technical and Miscellaneous Revenue Act of 1988 (``1988 Act'')
extended the research tax credit for one additional year, through
December 31, 1989. The 1988 Act also reduced the deduction allowed
under section 174 (or any other section) for qualified research
expenses by an amount equal to 50 percent of the research tax credit
determined for the year.
The Omnibus Budget Reconciliation Act of 1989 (``1989 Act'')
effectively extended the research credit for nine months (by prorating
qualified expenses incurred before January 1, 1991). The 1989 Act also
modified the method for calculating a taxpayer's base amount (i.e., by
substituting the present-law method which uses a fixed-base percentage
for the prior-law moving base which was calculated by reference to the
taxpayer's average research expenses incurred in the preceding three
taxable years). The 1989 Act further reduced the deduction allowed
under section 174 (or any other section) for qualified research
expenses by an amount equal to 100 percent of the research tax credit
determined for the year.
The Omnibus Budget Reconciliation Act of 1990 extended the research
tax credit through December 31, 1991 (and repealed the special rule to
prorate qualified expenses incurred before January 1, 1991).
The Tax Extension Act of 1991 extended the research tax credit for
six months (i.e., for qualified expenses incurred through June 30,
1992).
The Omnibus Budget Reconciliation Act of 1993 (``1993 Act'')
extended the research tax credit for three years--i.e., retroactively
from July 1, 1992 through June 30, 1995. The 1993 Act also provided a
special rule for start-up firms, so that the fixed-base ratio of such
firms eventually will be computed by reference to their actual research
experience.
Although the research tax credit expired during the period July 1,
1995, through June 30, 1996, the Small Business Job Protection Act of
1996 (``1996 Act'') extended the credit for the period July 1, 1996,
through May 31, 1997 (with a special 11-month extension for taxpayers
that elect to be subject to the alternative incremental research credit
regime). In addition, the 1996 Act expanded the definition of start-up
firms under section 41(c)(3)(B)(i), enacted a special rule for certain
research consortia payments under section 41(b)(3)(C), and provided
that taxpayers may elect an alternative research credit regime (under
which the taxpayer is assigned a three-tiered fixed-base percentage
that is lower than the fixed-base percentage otherwise applicable and
the credit rate likewise is reduced) for the taxpayer's first taxable
year beginning after June 30, 1996, and before July 1, 1997.
The Taxpayer Relief Act of 1997 (``1997 Act'') extended the
research credit for 13 months--i.e, generally for the period June 1,
1997, through June 30, 1998. The 1997 Act also provided that taxpayers
are permitted to elect the alternative incremental research credit
regime for any taxable year beginning after June 30, 1996 (and such
election will apply to that taxable year and all subsequent taxable
years unless revoked with the consent of the Secretary of the
Treasury). The Tax and Trade Relief Extension Act of 1998 extended the
research credit for 12 months, i.e., through June 30, 1999.
The Ticket to Work and Work Incentive Improvement Act of 1999
extended the research credit for five years, through June 30, 2004,
increased the rates of credit under the alternative incremental
research credit regime, and expanded the definition of research to
include research undertaken in Puerto Rico and possessions of the
United States.
The Working Families Tax Relief Act of 224 extended the research
credit through December 31, 2005.
The Energy Tax Incentives Act of 2005 added the energy research
credit.
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Computation of allowable credit
Except for energy research payments and certain
university basic research payments made by corporations, the
research tax credit applied only to the extent that the
taxpayer's qualified research expenses for the current taxable
year exceeded its base amount. The base amount for the current
year generally was computed by multiplying the taxpayer's
fixed-base percentage by the average amount of the taxpayer's
gross receipts for the four preceding years. If a taxpayer both
incurred qualified research expenses and had gross receipts
during each of at least three years from 1984 through 1988,
then its fixed-base percentage was the ratio that its total
qualified research expenses for the 1984-1988 period bore to
its total gross receipts for that period (subject to a maximum
fixed-base percentage of 16 percent). All other taxpayers (so-
called start-up firms) were assigned a fixed-base percentage of
three percent.\20\
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\20\ The Small Business Job Protection Act of 1996 expanded the
definition of start-up firms under section 41(c)(3)(B)(i) to include
any firm if the first taxable year in which such firm had both gross
receipts and qualified research expenses began after 1983. A special
rule (enacted in 1993) was designed to gradually recompute a start-up
firm's fixed-base percentage based on its actual research experience.
Under this special rule, a start-up firm would be assigned a fixed-base
percentage of three percent for each of its first five taxable years
after 1993 in which it incurs qualified research expenses. In the event
that the research credit is extended beyond its expiration date, a
start-up date, a start-up firm's fixed-base percentage for its sixth
through tenth taxable years after 1993 in which it incurs qualified
research expenses will be a phased-in ratio based on its actual
research experience. For all subsequent taxable years, the taxpayer's
fixed-base percentage will be its actual ratio of qualified research
expenses to gross receipts for any five years selected by the taxpayer
from its fifth through tenth taxable years after 1993 (sec.
41(c)(3)(B)).
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In computing the credit, a taxpayer's base amount could
not be less than 50 percent of its current-year qualified
research expenses.
To prevent artificial increases in research expenditures
by shifting expenditures among commonly controlled or otherwise
related entities, a special aggregation rule provided that all
members of the same controlled group of corporations were
treated as a single taxpayer (sec. 41(f)(1)). Under regulations
prescribed by the Secretary, special rules applied for
computing the credit when a major portion of a trade or
business (or unit thereof) changed hands, under which qualified
research expenses and gross receipts for periods prior to the
change of ownership of a trade or business were treated as
transferred with the trade or business that gave rise to those
expenses and receipts for purposes of recomputing a taxpayer's
fixed-base percentage (sec. 41(f)(3)).
Alternative incremental research credit regime
Taxpayers were allowed to elect an alternative
incremental research credit regime.\21\ If a taxpayer elected
to be subject to this alternative regime, the taxpayer was
assigned a three-tiered fixed-base percentage (that was lower
than the fixed-base percentage otherwise applicable) and the
credit rate likewise was reduced. Under the alternative
incremental credit regime, a credit rate of 2.65 percent
applied to the extent that a taxpayer's current-year research
expenses exceeded a base amount computed by using a fixed-base
percentage of one percent (i.e., the base amount equaled one
percent of the taxpayer's average gross receipts for the four
preceding years) but did not exceed a base amount computed by
using a fixed-base percentage of 1.5 percent. A credit rate of
3.2 percent applied to the extent that a taxpayer's current-
year research expenses exceeded a base amount computed by using
a fixed-base percentage of 1.5 percent but did not exceed a
base amount computed by using a fixed-base percentage of two
percent. A credit rate of 3.75 percent applied to the extent
that a taxpayer's current-year research expenses exceeded a
base amount computed by using a fixed-base percentage of two
percent. An election to be subject to this alternative
incremental credit regime could be made for any taxable year
beginning after June 30, 1996, and such an election applied to
that taxable year and all subsequent years unless revoked with
the consent of the Secretary of the Treasury.
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\21\ Sec. 41(c)(4).
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Eligible expenses
Qualified research expenses eligible for the research tax
credit consisted of: (1) in-house expenses of the taxpayer for
wages and supplies attributable to qualified research; (2)
certain time-sharing costs for computer use in qualified
research; and (3) 65 percent of amounts paid or incurred by the
taxpayer to certain other persons for qualified research
conducted on the taxpayer's behalf (so-called contract research
expenses).\22\ Notwithstanding the limitation for contract
research expenses, qualified research expenses included 100
percent of amounts paid or incurred by the taxpayer to an
eligible small business, university, or Federal laboratory for
qualified energy research.
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\22\ Under a special rule enacted as part of the Small Business Job
Protection Act of 1996, 75 percent of amounts paid to a research
consortium for qualified research were treated as qualified research
expenses eligible for the research credit (rather than 65 percent under
the general rule under section 41(b)(3) governing contract research
expenses) if (1) such research consortium was a tax-exempt organization
that is described in section 501(c)(3) (other than a private
foundation) or section 501(c)(6) and was organized and operated
primarily to conduct scientific research, and (2) such qualified
research was conducted by the consortium on behalf of the taxpayer and
one or more persons not related to the taxpayer. Sec. 41(b)(3)(C).
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To be eligible for the credit, the research did not only
have to satisfy the requirements of present-law section 174
(described below) but also had to be undertaken for the purpose
of discovering information that is technological in nature, the
application of which was intended to be useful in the
development of a new or improved business component of the
taxpayer, and substantially all of the activities of which had
to constitute elements of a process of experimentation for
functional aspects, performance, reliability, or quality of a
business component. Research did not qualify for the credit if
substantially all of the activities related to style, taste,
cosmetic, or seasonal design factors (sec. 41(d)(3)). In
addition, research did not qualify for the credit: (1) if
conducted after the beginning of commercial production of the
business component; (2) if related to the adaptation of an
existing business component to a particular customer's
requirements; (3) if related to the duplication of an existing
business component from a physical examination of the component
itself or certain other information; or (4) if related to
certain efficiency surveys, management function or technique,
market research, market testing, or market development, routine
data collection or routine quality control (sec. 41(d)(4)).
Research did not qualify for the credit if it was conducted
outside the United States, Puerto Rico, or any U.S. possession.
Relation to deduction
Under section 174, taxpayers may elect to deduct
currently the amount of certain research or experimental
expenditures paid or incurred in connection with a trade or
business, notwithstanding the general rule that business
expenses to develop or create an asset that has a useful life
extending beyond the current year must be capitalized.\23\
While the research credit was in effect, however, deductions
allowed to a taxpayer under section 174 (or any other section)
were reduced by an amount equal to 100 percent of the
taxpayer's research tax credit determined for the taxable year
(sec. 280C(c)). Taxpayers could alternatively elect to claim a
reduced research tax credit amount (13 percent) under section
41 in lieu of reducing deductions otherwise allowed (sec.
280C(c)(3)).
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\23\ Taxpayers may elect 10-year amortization of certain research
expenditures allowable as a deduction under section 174(a). Secs.
174(f)(2) and 59(e).
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HOUSE BILL
The provision extends for one year and modifies the
present-law research credit provision (for amounts paid or
incurred through December 31, 2006).
The provision increases the rates of the alternative
incremental credit: (1) a credit rate of three percent (rather
than 2.65 percent) applies to the extent that a taxpayer's
current-year research expenses exceed a base amount computed by
using a fixed-base percentage of one percent (i.e., the base
amount equals one percent of the taxpayer's average gross
receipts for the four preceding years) but do not exceed a base
amount computed by using a fixed-base percentage of 1.5
percent; (2) a credit rate of four percent (rather than 3.2
percent) applies to the extent that a taxpayer's current-year
research expenses exceed a base amount computed by using a
fixed-base percentage of 1.5 percent but do not exceed a base
amount computed by using a fixed-base percentage of two
percent; and (3) a credit rate of 5 percent (rather than 3.75
percent) applies to the extent that a taxpayer's current-year
research expenses exceed a base amount computed by using a
fixed-base percentage of two percent.
The provision also creates, at the election of the
taxpayer, an alternative simplified credit for qualified
research expenses. The alternative simplified research is equal
to 12 percent of qualified research expenses that exceed 50
percent of the average qualified research expenses for the
three preceding taxable years. The rate is reduced to 6 percent
if a taxpayer has no qualified research expenses in any one of
the three preceding taxable years.
An election to use the alternative simplified credit
applies to all succeeding taxable years unless revoked with the
consent of the Secretary. An election to use the alternative
simplified credit may not be made for any taxable year for
which an election to use the alternative incremental credit is
in effect. A special transition rule applies which permits a
taxpayer to elect to use the alternative simplified credit in
lieu of the alternative incremental credit if such election is
made during the taxable year which includes the date of
enactment of the provision. The transition rule only applies to
the taxable year which includes the date of enactment.
Effective date.--The extension of the research credit
applies to amounts paid or incurred after December 31, 2005.
The modification of the alternative incremental credit and the
creation of the alternative simplified credit are effective for
taxable years ending after date of enactment.
SENATE AMENDMENT
The Senate amendment generally follows the House bill but
provides for a two-year extension of the modified research
credit. It also adds a provision that broadens the research
credit as it applies to research consortia. Under the Senate
amendment, a 20 percent credit would be available for a
taxpayer's expenditures on research carried out by any research
consortium, rather than being limited to research carried out
by an energy research consortium.
Effective date.--The Senate amendment applies to amounts
paid or incurred after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
L. Qualified Zone Academy Bonds
(Sec. 114 of the House bill, sec. 110 of the Senate amendment and sec.
1397E of the Code)
PRESENT LAW
Tax-exempt bonds
Interest on State and local governmental bonds generally
is excluded from gross income for Federal income tax purposes
if the proceeds of the bonds are used to finance direct
activities of these governmental units or if the bonds are
repaid with revenues of these governmental units. Activities
that can be financed with these tax-exempt bonds include the
financing of public schools (sec. 103).
Qualified zone academy bonds
As an alternative to interest-bearing tax-exempt bonds,
States and local governments are given the authority to issue
``qualified zone academy bonds'' (sec. 1397E). A total of $400
million of qualified zone academy bonds may be issued annually
in calendar years 1998 through 2005. The $400 million aggregate
bond cap is allocated each year to the States according to
their respective populations of individuals below the poverty
line. Each State, in turn, allocates the credit authority to
qualified zone academies within such State.
Financial institutions that hold qualified zone academy
bonds are entitled to a nonrefundable tax credit in an amount
equal to a credit rate multiplied by the face amount of the
bond. A taxpayer holding a qualified zone academy bond on the
credit allowance date is entitled to a credit. The credit is
includable in gross income (as if it were a taxable interest
payment on the bond), and may be claimed against regular income
tax and AMT liability.
The Treasury Department sets the credit rate at a rate
estimated to allow issuance of qualified zone academy bonds
without discount and without interest cost to the issuer. The
maximum term of the bond is determined by the Treasury
Department, so that the present value of the obligation to
repay the bond is 50 percent of the face value of the bond.
``Qualified zone academy bonds'' are defined as any bond
issued by a State or local government, provided that: (1) at
least 95 percent of the proceeds are used for the purpose of
renovating, providing equipment to, developing course materials
for use at, or training teachers and other school personnel in
a ``qualified zone academy'' (``qualified zone academy
property'') and (2) private entities have promised to
contribute to the qualified zone academy certain equipment,
technical assistance or training, employee services, or other
property or services with a value equal to at least 10 percent
of the bond proceeds.
A school is a ``qualified zone academy'' if: (1) the
school is a public school that provides education and training
below the college level, (2) the school operates a special
academic program in cooperation with businesses to enhance the
academic curriculum and increase graduation and employment
rates, and (3) either (a) the school is located in an
empowerment zone or enterprise community designated under the
Code or (b) it is reasonably expected that at least 35 percent
of the students at the school will be eligible for free or
reduced-cost lunches under the school lunch program established
under the National School Lunch Act.
Arbitrage restrictions on tax-exempt bonds
To prevent States and local governments from issuing more
tax-exempt bonds than is necessary for the activity being
financed or from issuing such bonds earlier than needed for the
purpose of the borrowing, the Code includes arbitrage
restrictions limiting the ability to profit from investment of
tax-exempt bond proceeds. In general, arbitrage profits may be
earned only during specified periods (e.g., defined ``temporary
periods'' before funds are needed for the purpose of the
borrowing) or on specified types of investments (e.g.,
``reasonably required reserve or replacement funds''). Subject
to limited exceptions, profits that are earned during these
periods or on such investments must be rebated to the Federal
Government. Governmental bonds are subject to less restrictive
arbitrage rules than most private activity bonds. The arbitrage
rules do not apply to qualified zone academy bonds.
HOUSE BILL
The House bill extends for one year the present-law
provision relating to qualified zone academy bonds (through
December 31, 2006).
Effective date.--The provision is effective for bonds
issued after December 31, 2005.
SENATE AMENDMENT
The Senate amendment extends for two years the present-
law provision relating to qualified zone academy bonds (through
December 31, 2007).
In addition, the Senate amendment imposes the arbitrage
requirements of section 148 that apply to tax-exempt bonds to
qualified zone academy bonds. Principles under section 148 and
the regulations thereunder shall apply for purposes of
determining the yield restriction and arbitrage rebate
requirements applicable to qualified zone academy bonds. For
example, for arbitrage purposes, the yield on an issue of
qualified zone academy bonds is computed by taking into account
all payments of interest, if any, on such bonds, i.e., whether
the bonds are issued at par, premium, or discount. However, for
purposes of determining yield, the amount of the credit allowed
to a taxpayer holding qualified zone academy bonds is not
treated as interest, although such credit amount is treated as
interest income to the taxpayer.
The provision imposes new spending requirements for
qualified zone academy bonds. An issuer of qualified zone
academy bonds must reasonably expect to and actually spend 95
percent or more of the proceeds of such bonds on qualified zone
academy property within the five-year period that begins on the
date of issuance. To the extent less than 95 percent of the
proceeds are used to finance qualified zone academy property
during the five-year spending period, bonds will continue to
qualify as qualified zone academy bonds if unspent proceeds are
used within 90 days from the end of such five-year period to
redeem any ``nonqualified bonds.'' For these purposes, the
amount of nonqualified bonds is to be determined in the same
manner as Treasury regulations under section 142. In addition,
the provision provides that the five-year spending period may
be extended by the Secretary upon the issuer's request if
reasonable cause for such extension is established.
Under the provision, qualified private business
contributions must be in the form of cash or cash equivalents,
rather than property or services as permitted under present
law. The provision also requires an equal amount of principal
is to be paid by the issuer during each calendar year that the
issue is outstanding.
Under the provision, issuers of qualified zone academy
bonds are required to report issuance to the IRS in a manner
similar to that required for tax-exempt bonds.
Effective date.--The provision is effective for bonds
issued after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
M. Above-the-Line Deduction for Certain Expenses of Elementary and
Secondary School Teachers
(Sec. 115 of the House bill, sec. 112 of the Senate amendment and sec.
62 of the Code)
PRESENT LAW
In general, ordinary and necessary business expenses are
deductible (sec. 162). However, in general, unreimbursed
employee business expenses are deductible only as an itemized
deduction and only to the extent that the individual's total
miscellaneous deductions (including employee business expenses)
exceed two percent of adjusted gross income. An individual's
otherwise allowable itemized deductions may be further limited
by the overall limitation on itemized deductions, which reduces
itemized deductions for taxpayers with adjusted gross income in
excess of $145,950 (for 2005). In addition, miscellaneous
itemized deductions are not allowable under the alternative
minimum tax.
Certain expenses of eligible educators are allowed an
above-the-line deduction. Specifically, for taxable years
beginning prior to January 1, 2006, an above-the-line deduction
is allowed for up to $250 annually of expenses paid or incurred
by an eligible educator for books, supplies (other than
nonathletic supplies for courses of instruction in health or
physical education), computer equipment (including related
software and services) and other equipment, and supplementary
materials used by the eligible educator in the classroom. To be
eligible for this deduction, the expenses must be otherwise
deductible under 162 as a trade or business expense. A
deduction is allowed only to the extent the amount of expenses
exceeds the amount excludable from income under section 135
(relating to education savings bonds), 529(c)(1) (relating to
qualified tuition programs), and section 530(d)(2) (relating to
Coverdell education savings accounts).
An eligible educator is a kindergarten through grade 12
teacher, instructor, counselor, principal, or aide in a school
for at least 900 hours during a school year. A school means any
school which provides elementary education or secondary
education, as determined under State law.
The above-the-line deduction for eligible educators is
not allowed for taxable years beginning after December 31,
2005.
HOUSE BILL
The present-law provision is extended for one year,
through December 31, 2006.
Effective date.--The provision is effective for expenses
paid or incurred in taxable years beginning after December 31,
2005.
SENATE AMENDMENT
The present-law provision is extended for two years,
through December 31, 2007.
Effective date.--The provision is effective for expenses
paid or incurred in taxable years beginning after December 31,
2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
N. Above-the-Line Deduction for Higher Education Expenses
(Sec. 116 of the House bill, sec. 103 of the Senate amendment and sec.
222 of the Code)
PRESENT LAW
An individual is allowed an above-the-line deduction for
qualified tuition and related expenses for higher education
paid by the individual during the taxable year. Qualified
tuition and related expenses include tuition and fees required
for the enrollment or attendance of the taxpayer, the
taxpayer's spouse, or any dependent of the taxpayer with
respect to whom the taxpayer may claim a personal exemption, at
an eligible institution of higher education for courses of
instruction of such individual at such institution. Charges and
fees associated with meals, lodging, insurance, transportation,
and similar personal, living, or family expenses are not
eligible for the deduction. The expenses of education involving
sports, games, or hobbies are not qualified tuition and related
expenses unless this education is part of the student's degree
program.
The amount of qualified tuition and related expenses must
be reduced by certain scholarships, educational assistance
allowances, and other amounts paid for the benefit of such
individual, and by the amount of such expenses taken into
account for purposes of determining any exclusion from gross
income of: (1) income from certain United States Savings Bonds
used to pay higher education tuition and fees; and (2) income
from a Coverdell education savings account. Additionally, such
expenses must be reduced by the earnings portion (but not the
return of principal) of distributions from a qualified tuition
program if an exclusion under section 529 is claimed with
respect to expenses eligible for exclusion under section 222.
No deduction is allowed for any expense for which a deduction
is otherwise allowed or with respect to an individual for whom
a Hope credit or Lifetime Learning credit is elected for such
taxable year.
The expenses must be in connection with enrollment at an
institution of higher education during the taxable year, or
with an academic term beginning during the taxable year or
during the first three months of the next taxable year. The
deduction is not available for tuition and related expenses
paid for elementary or secondary education.
For taxable years beginning in 2004 and 2005, the maximum
deduction is $4,000 for an individual whose adjusted gross
income for the taxable year does not exceed $65,000 ($130,000
in the case of a joint return), or $2,000 for other individuals
whose adjusted gross income does not exceed $80,000 ($160,000
in the case of a joint return). No deduction is allowed for an
individual whose adjusted gross income exceeds the relevant
adjusted gross income limitations, for a married individual who
does not file a joint return, or for an individual with respect
to whom a personal exemption deduction may be claimed by
another taxpayer for the taxable year. The deduction is not
available for taxable years beginning after December 31, 2005.
HOUSE BILL
The provision extends the tuition deduction for one year,
through December 31, 2006.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
SENATE AMENDMENT
The provision extends the tuition deduction for four
years, through December 31, 2009.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House
provision or the Senate amendment provision.
O. Deduction of State and Local General Sales Taxes
(Sec. 117 of the House bill, sec. 105 of the Senate amendment, and sec.
164 of the Code)
PRESENT LAW
For purposes of determining regular tax liability, an
itemized deduction is permitted for certain State and local
taxes paid, including individual income taxes, real property
taxes, and personal property taxes. The itemized deduction is
not permitted for purposes of determining a taxpayer's
alternative minimum taxable income. For taxable years beginning
in 2004 and 2005, at the election of the taxpayer, an itemized
deduction may be taken for State and local general sales taxes
in lieu of the itemized deduction provided under present law
for State and local income taxes. As is the case for State and
local income taxes, the itemized deduction for State and local
general sales taxes is not permitted for purposes of
determining a taxpayer's alternative minimum taxable income.
Taxpayers have two options with respect to the determination of
the sales tax deduction amount. Taxpayers may deduct the total
amount of general State and local sales taxes paid by
accumulating receipts showing general sales taxes paid.
Alternatively, taxpayers may use tables created by the
Secretary of the Treasury that show the allowable deduction.
The tables are based on average consumption by taxpayers on a
State-by-State basis taking into account filing status, number
of dependents, adjusted gross income and rates of State and
local general sales taxation. Taxpayers who use the tables
created by the Secretary may, in addition to the table amounts,
deduct eligible general sales taxes paid with respect to the
purchase of motor vehicles, boats and other items specified by
the Secretary. Sales taxes for items that may be added to the
tables are not reflected in the tables themselves.
The term ``general sales tax'' means a tax imposed at one
rate with respect to the sale at retail of a broad range of
classes of items. However, in the case of items of food,
clothing, medical supplies, and motor vehicles, the fact that
the tax does not apply with respect to some or all of such
items is not taken into account in determining whether the tax
applies with respect to a broad range of classes of items, and
the fact that the rate of tax applicable with respect to some
or all of such items is lower than the general rate of tax is
not taken into account in determining whether the tax is
imposed at one rate. Except in the case of a lower rate of tax
applicable with respect to food, clothing, medical supplies, or
motor vehicles, no deduction is allowed for any general sales
tax imposed with respect to an item at a rate other than the
general rate of tax. However, in the case of motor vehicles, if
the rate of tax exceeds the general rate, such excess shall be
disregarded and the general rate is treated as the rate of tax.
A compensating use tax with respect to an item is treated
as a general sales tax, provided such tax is complimentary to a
general sales tax and a deduction for sales taxes is allowable
with respect to items sold at retail in the taxing jurisdiction
that are similar to such item.
HOUSE BILL
The present-law provision allowing taxpayers to elect to
deduct State and local sales taxes in lieu of State and local
income taxes is extended for one year (through December 31,
2006).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
SENATE AMENDMENT
The present-law provision allowing taxpayers to elect to
deduct State and local sales taxes in lieu of State and local
income taxes is extended for two years (through December 31,
2007).
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
P. Extension and Expansion to Petroleum Products of Expensing for
Environmental Remediation Costs
(Sec. 201 of the House bill, sec. 113 of the Senate amendment, and sec.
198 of the Code)
PRESENT LAW
Present law allows a deduction for ordinary and necessary
expenses paid or incurred in carrying on any trade or
business.\24\ Treasury regulations provide that the cost of
incidental repairs that neither materially add to the value of
property nor appreciably prolong its life, but keep it in an
ordinarily efficient operating condition, may be deducted
currently as a business expense. Section 263(a)(1) limits the
scope of section 162 by prohibiting a current deduction for
certain capital expenditures. Treasury regulations define
``capital expenditures'' as amounts paid or incurred to
materially add to the value, or substantially prolong the
useful life, of property owned by the taxpayer, or to adapt
property to a new or different use. Amounts paid for repairs
and maintenance do not constitute capital expenditures. The
determination of whether an expense is deductible or
capitalizable is based on the facts and circumstances of each
case.
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\24\ Sec. 162.
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Taxpayers may elect to treat certain environmental
remediation expenditures that would otherwise be chargeable to
capital account as deductible in the year paid or incurred.\25\
The deduction applies for both regular and alternative minimum
tax purposes. The expenditure must be incurred in connection
with the abatement or control of hazardous substances at a
qualified contaminated site. In general, any expenditure for
the acquisition of depreciable property used in connection with
the abatement or control of hazardous substances at a qualified
contaminated site does not constitute a qualified environmental
remediation expenditure. However, depreciation deductions
allowable for such property, which would otherwise be allocated
to the site under the principles set forth in Commissioner v.
Idaho Power Co.\26\ and section 263A, are treated as qualified
environmental remediation expenditures.
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\25\ Sec. 198.
\26\ 418 U.S. 1 (1974).
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A ``qualified contaminated site'' (a so-called
``brownfield'') generally is any property that is held for use
in a trade or business, for the production of income, or as
inventory and is certified by the appropriate State
environmental agency to be an area at or on which there has
been a release (or threat of release) or disposal of a
hazardous substance. Both urban and rural property may qualify.
However, sites that are identified on the national priorities
list under the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980 (``CERCLA'') \27\
cannot qualify as targeted areas. Hazardous substances
generally are defined by reference to sections 101(14) and 102
of CERCLA, subject to additional limitations applicable to
asbestos and similar substances within buildings, certain
naturally occurring substances such as radon, and certain other
substances released into drinking water supplies due to
deterioration through ordinary use. Petroleum products
generally are not regarded as hazardous substances for purposes
of section 198 (except for purposes of determining qualified
environmental remediation expenditures in the ``Gulf
Opportunity Zone'' under section 1400N(g), as described
below).\28\
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\27\ Pub. L. No. 96-510 (1980).
\28\ Section 101(14) of CERCLA specifically excludes ``petroleum,
including crude oil or any fraction thereof which is not otherwise
specifically listed or designated as a hazardous substance under
subparagraphs (A) through (F) of this paragraph,'' from the definition
of ``hazardous substance.''
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In the case of property to which a qualified
environmental remediation expenditure otherwise would have been
capitalized, any deduction allowed under section 198 is treated
as a depreciation deduction and the property is treated as
section 1245 property. Thus, deductions for qualified
environmental remediation expenditures are subject to recapture
as ordinary income upon a sale or other disposition of the
property. In addition, sections 280B (demolition of structures)
and 468 (special rules for mining and solid waste reclamation
and closing costs) do not apply to amounts that are treated as
expenses under this provision.
Eligible expenditures are those paid or incurred before
January 1, 2006.
Under section 1400N(g), the above provisions apply to
expenditures paid or incurred to abate contamination at
qualified contaminated sites in the Gulf Opportunity Zone
(defined as that portion of the Hurricane Katrina Disaster Area
determined by the President to warrant individual or individual
and public assistance from the Federal Government under the
Robert T. Stafford Disaster Relief and Emergency Assistance Act
by reason of Hurricane Katrina) before January 1, 2008; in
addition, within the Gulf Opportunity Zone section 1400N(g)
broadens the definition of hazardous substance to include
petroleum products (defined by reference to section
4612(a)(3)).
HOUSE BILL
The House bill extends for two years the present-law
provisions relating to environmental remediation expenditures
(through December 31, 2007).
In addition, the provision expands the definition of
hazardous substance to include petroleum products. Under the
provision, petroleum products are defined by reference to
section 4612(a)(3), and thus include crude oil, crude oil
condensates and natural gasoline.\29\
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\29\ The present law exceptions for sites on the national
priorities list under CERCLA, and for substances with respect to which
a removal or remediation is not permitted under section 104 of CERCLA
by reason of subsection (a)(3) thereof, would continue to apply to all
hazardous substances (including petroleum products).
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Effective date.--The provision applies to expenditures
paid or incurred after December 31, 2005.
SENATE AMENDMENT
The Senate amendment modifies the House bill to provide
for only a one-year extension of the present-law provisions
relating to environmental remediation expenditures (through
December 31, 2006). The Senate amendment follows the House bill
in expanding the definition of hazardous substances to include
petroleum products.
Effective date.--The provision applies to expenditures
paid or incurred after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
Q. Controlled Foreign Corporations
1. Subpart F exception for active financing (Sec. 202(a) of the House
bill and secs. 953 and 954 of the Code)
PRESENT LAW
Under the subpart F rules, 10-percent U.S. shareholders
of a controlled foreign corporation (``CFC'') are subject to
U.S. tax currently on certain income earned by the CFC, whether
or not such income is distributed to the shareholders. The
income subject to current inclusion under the subpart F rules
includes, among other things, insurance income and foreign base
company income. Foreign base company income includes, among
other things, foreign personal holding company income and
foreign base company services income (i.e., income derived from
services performed for or on behalf of a related person outside
the country in which the CFC is organized).
Foreign personal holding company income generally
consists of the following: (1) dividends, interest, royalties,
rents, and annuities; (2) net gains from the sale or exchange
of (a) property that gives rise to the preceding types of
income, (b) property that does not give rise to income, and (c)
interests in trusts, partnerships, and REMICs; (3) net gains
from commodities transactions; (4) net gains from certain
foreign currency transactions; (5) income that is equivalent to
interest; (6) income from notional principal contracts; (7)
payments in lieu of dividends; and (8) amounts received under
personal service contracts.
Insurance income subject to current inclusion under the
subpart F rules includes any income of a CFC attributable to
the issuing or reinsuring of any insurance or annuity contract
in connection with risks located in a country other than the
CFC's country of organization. Subpart F insurance income also
includes income attributable to an insurance contract in
connection with risks located within the CFC's country of
organization, as the result of an arrangement under which
another corporation receives a substantially equal amount of
consideration for insurance of other country risks. Investment
income of a CFC that is allocable to any insurance or annuity
contract related to risks located outside the CFC's country of
organization is taxable as subpart F insurance income.\30\
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\30\ Prop. Treas. Reg. sec. 1.953-1(a).
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Temporary exceptions from foreign personal holding
company income, foreign base company services income, and
insurance income apply for subpart F purposes for certain
income that is derived in the active conduct of a banking,
financing, or similar business, or in the conduct of an
insurance business (so-called ``active financing income'').\31\
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\31\ Temporary exceptions from the subpart F provisions for certain
active financing income applied only for taxable years beginning in
1998. Those exceptions were modified and extended for one year,
applicable only for taxable years beginning in 1999. The Tax Relief
Extension Act of 1999 (Pub. L. No. 106-170) clarified and extended the
temporary exceptions for two years, applicable only for taxable years
beginning after 1999 and before 2002. The Job Creation and Worker
Assistance Act of 2002 (Pub. L. No. 107-147) modified and extended the
temporary exceptions for five years, for taxable years beginning after
2001 and before 2007.
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With respect to income derived in the active conduct of a
banking, financing, or similar business, a CFC is required to
be predominantly engaged in such business and to conduct
substantial activity with respect to such business in order to
qualify for the exceptions. In addition, certain nexus
requirements apply, which provide that income derived by a CFC
or a qualified business unit (``QBU'') of a CFC from
transactions with customers is eligible for the exceptions if,
among other things, substantially all of the activities in
connection with such transactions are conducted directly by the
CFC or QBU in its home country, and such income is treated as
earned by the CFC or QBU in its home country for purposes of
such country's tax laws. Moreover, the exceptions apply to
income derived from certain cross border transactions, provided
that certain requirements are met. Additional exceptions from
foreign personal holding company income apply for certain
income derived by a securities dealer within the meaning of
section 475 and for gain from the sale of active financing
assets.
In the case of insurance, in addition to a temporary
exception from foreign personal holding company income for
certain income of a qualifying insurance company with respect
to risks located within the CFC's country of creation or
organization, certain temporary exceptions from insurance
income and from foreign personal holding company income apply
for certain income of a qualifying branch of a qualifying
insurance company with respect to risks located within the home
country of the branch, provided certain requirements are met
under each of the exceptions. Further, additional temporary
exceptions from insurance income and from foreign personal
holding company income apply for certain income of certain CFCs
or branches with respect to risks located in a country other
than the United States, provided that the requirements for
these exceptions are met.
In the case of a life insurance or annuity contract,
reserves for such contracts are determined as follows for
purposes of these provisions. The reserves equal the greater
of: (1) the net surrender value of the contract (as defined in
section 807(e)(1)(A)), including in the case of pension plan
contracts; or (2) the amount determined by applying the tax
reserve method that would apply if the qualifying life
insurance company were subject to tax under Subchapter L of the
Code, with the following modifications. First, there is
substituted for the applicable Federal interest rate an
interest rate determined for the functional currency of the
qualifying insurance company's home country, calculated (except
as provided by the Treasury Secretary in order to address
insufficient data and similar problems) in the same manner as
the mid-term applicable Federal interest rate (within the
meaning of section 1274(d)). Second, there is substituted for
the prevailing State assumed rate the highest assumed interest
rate permitted to be used for purposes of determining statement
reserves in the foreign country for the contract. Third, in
lieu of U.S. mortality and morbidity tables, mortality and
morbidity tables are applied that reasonably reflect the
current mortality and morbidity risks in the foreign country.
Fourth, the Treasury Secretary may provide that the interest
rate and mortality and morbidity tables of a qualifying
insurance company may be used for one or more of its branches
when appropriate. In no event may the reserve for any contract
at any time exceed the foreign statement reserve for the
contract, reduced by any catastrophe, equalization, or
deficiency reserve or any similar reserve.
Present law permits a taxpayer in certain circumstances,
subject to approval by the IRS through the ruling process or in
published guidance, to establish that the reserve of a life
insurance company for life insurance and annuity contracts is
the amount taken into account in determining the foreign
statement reserve for the contract (reduced by catastrophe,
equalization, or deficiency reserve or any similar reserve).
IRS approval is to be based on whether the method, the interest
rate, the mortality and morbidity assumptions, and any other
factors taken into account in determining foreign statement
reserves (taken together or separately) provide an appropriate
means of measuring income for Federal income tax purposes. In
seeking a ruling, the taxpayer is required to provide the IRS
with necessary and appropriate information as to the method,
interest rate, mortality and morbidity assumptions and other
assumptions under the foreign reserve rules so that a
comparison can be made to the reserve amount determined by
applying the tax reserve method that would apply if the
qualifying insurance company were subject to tax under
Subchapter L of the Code (with the modifications provided under
present law for purposes of these exceptions). The IRS also may
issue published guidance indicating its approval. Present law
continues to apply with respect to reserves for any life
insurance or annuity contract for which the IRS has not
approved the use of the foreign statement reserve. An IRS
ruling request under this provision is subject to the present-
law provisions relating to IRS user fees.
HOUSE BILL
The House bill extends for two years (for taxable years
beginning before 2009) the present-law temporary exceptions
from subpart F foreign personal holding company income, foreign
base company services income, and insurance income for certain
income that is derived in the active conduct of a banking,
financing, or similar business, or in the conduct of an
insurance business.
Effective date.--The provision is effective for taxable
years of foreign corporations beginning after December 31,
2006, and before January 1, 2009, and for taxable years of U.S.
shareholders with or within which such taxable years of such
foreign corporations end.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
2. Look-through treatment of payments between related controlled
foreign corporations under foreign personal holding company
income rules (sec. 202(b) of the House bill and sec. 954(c) of
the Code)
PRESENT LAW
In general, the rules of subpart F (secs. 951-964)
require U.S. shareholders with a 10-percent or greater interest
in a controlled foreign corporation (``CFC'') to include
certain income of the CFC (referred to as ``subpart F income'')
on a current basis for U.S. tax purposes, regardless of whether
the income is distributed to the shareholders.
Subpart F income includes foreign base company income.
One category of foreign base company income is foreign personal
holding company income. For subpart F purposes, foreign
personal holding company income generally includes dividends,
interest, rents, and royalties, among other types of income.
However, foreign personal holding company income does not
include dividends and interest received by a CFC from a related
corporation organized and operating in the same foreign country
in which the CFC is organized, or rents and royalties received
by a CFC from a related corporation for the use of property
within the country in which the CFC is organized. Interest,
rent, and royalty payments do not qualify for this exclusion to
the extent that such payments reduce the subpart F income of
the payor.
HOUSE BILL
Under the House bill, for taxable years beginning after
2005 and before 2009, dividends, interest,\32\ rents, and
royalties received by one CFC from a related CFC are not
treated as foreign personal holding company income to the
extent attributable or properly allocable to non-subpart-F
income of the payor. For this purpose, a related CFC is a CFC
that controls or is controlled by the other CFC, or a CFC that
is controlled by the same person or persons that control the
other CFC. Ownership of more than 50 percent of the CFC's stock
(by vote or value) constitutes control for these purposes. The
bill provides that the Secretary shall prescribe such
regulations as are appropriate to prevent the abuse of the
purposes of this provision.
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\32\ Interest for this purpose includes factoring income which is
treated as equivalent to interest under sec. 954(c)(1)(E).
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The provision in the House bill is effective for taxable
years of foreign corporations beginning after December 31,
2005, but before January 1, 2009, and for taxable years of U.S.
shareholders with or within which such taxable years of such
foreign corporations end.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
R. Reduced Rates for Capital Gains and Dividends of Individuals
(Sec. 203 of the House bill and sec. 1(h) of the Code)
PRESENT LAW
Capital gains
In general
In general, gain or loss reflected in the value of an
asset is not recognized for income tax purposes until a
taxpayer disposes of the asset. On the sale or exchange of a
capital asset, any gain generally is included in income. Any
net capital gain of an individual is generally taxed at maximum
rates lower than the rates applicable to ordinary income. Net
capital gain is the excess of the net long-term capital gain
for the taxable year over the net short-term capital loss for
the year. Gain or loss is treated as long-term if the asset is
held for more than one year.
Capital losses generally are deductible in full against
capital gains. In addition, individual taxpayers may deduct
capital losses against up to $3,000 of ordinary income in each
year. Any remaining unused capital losses may be carried
forward indefinitely to another taxable year.
A capital asset generally means any property except (1)
inventory, stock in trade, or property held primarily for sale
to customers in the ordinary course of the taxpayer's trade or
business, (2) depreciable or real property used in the
taxpayer's trade or business, (3) specified literary or
artistic property, (4) business accounts or notes receivable,
(5) certain U.S. publications, (6) certain commodity derivative
financial instruments, (7) hedging transactions, and (8)
business supplies. In addition, the net gain from the
disposition of certain property used in the taxpayer's trade or
business is treated as long-term capital gain. Gain from the
disposition of depreciable personal property is not treated as
capital gain to the extent of all previous depreciation
allowances. Gain from the disposition of depreciable real
property is generally not treated as capital gain to the extent
of the depreciation allowances in excess of the allowances that
would have been available under the straight-line method of
depreciation.
Tax rates before 2009
Under present law, for taxable years beginning before
January 1, 2009, the maximum rate of tax on the adjusted net
capital gain of an individual is 15 percent. Any adjusted net
capital gain which otherwise would be taxed at a 10- or 15-
percent rate is taxed at a 5-percent rate (zero for taxable
years beginning after 2007). These rates apply for purposes of
both the regular tax and the alternative minimum tax.
Under present law, the ``adjusted net capital gain'' of
an individual is the net capital gain reduced (but not below
zero) by the sum of the 28-percent rate gain and the
unrecaptured section 1250 gain. The net capital gain is reduced
by the amount of gain that the individual treats as investment
income for purposes of determining the investment interest
limitation under section 163(d).
The term ``28-percent rate gain'' means the amount of net
gain attributable to long-term capital gains and losses from
the sale or exchange of collectibles (as defined in section
408(m) without regard to paragraph (3) thereof), an amount of
gain equal to the amount of gain excluded from gross income
under section 1202 (relating to certain small business stock),
the net short-term capital loss for the taxable year, and any
long-term capital loss carryover to the taxable year.
``Unrecaptured section 1250 gain'' means any long-term
capital gain from the sale or exchange of section 1250 property
(i.e., depreciable real estate) held more than one year to the
extent of the gain that would have been treated as ordinary
income if section 1250 applied to all depreciation, reduced by
the net loss (if any) attributable to the items taken into
account in computing 28-percent rate gain. The amount of
unrecaptured section 1250 gain (before the reduction for the
net loss) attributable to the disposition of property to which
section 1231 (relating to certain property used in a trade or
business) applies may not exceed the net section 1231 gain for
the year.
An individual's unrecaptured section 1250 gain is taxed
at a maximum rate of 25 percent, and the 28-percent rate gain
is taxed at a maximum rate of 28 percent. Any amount of
unrecaptured section 1250 gain or 28-percent rate gain
otherwise taxed at a 10- or 15-percent rate is taxed at the
otherwise applicable rate.
Tax rates after 2008
For taxable years beginning after December 31, 2008, the
maximum rate of tax on the adjusted net capital gain of an
individual is 20 percent. Any adjusted net capital gain which
otherwise would be taxed at a 10- or 15-percent rate is taxed
at a 10-percent rate.
In addition, any gain from the sale or exchange of
property held more than five years that would otherwise have
been taxed at the 10-percent rate is taxed at an 8-percent
rate. Any gain from the sale or exchange of property held more
than five years and the holding period for which began after
December 31, 2000, that would otherwise have been taxed at a
20-percent rate is taxed at an 18-percent rate.
The tax rates on 28-percent gain and unrecaptured section
1250 gain are the same as for taxable years beginning before
2009.
Dividends
In general
A dividend is the distribution of property made by a
corporation to its shareholders out of its after-tax earnings
and profits.
Tax rates before 2009
Under present law, dividends received by an individual
from domestic corporations and qualified foreign corporations
are taxed at the same rates that apply to capital gains. This
treatment applies for purposes of both the regular tax and the
alternative minimum tax. Thus, for taxable years beginning
before 2009, dividends received by an individual are taxed at
rates of five (zero for taxable years beginning after 2007) and
15 percent.
If a shareholder does not hold a share of stock for more
than 60 days during the 121-day period beginning 60 days before
the ex-dividend date (as measured under section 246(c)),
dividends received on the stock are not eligible for the
reduced rates. Also, the reduced rates are not available for
dividends to the extent that the taxpayer is obligated to make
related payments with respect to positions in substantially
similar or related property.
Qualified dividend income includes otherwise qualified
dividends received from qualified foreign corporations. The
term ``qualified foreign corporation'' includes a foreign
corporation that is eligible for the benefits of a
comprehensive income tax treaty with the United States which
the Treasury Department determines to be satisfactory and which
includes an exchange of information program. In addition, a
foreign corporation is treated as a qualified foreign
corporation with respect to any dividend paid by the
corporation with respect to stock that is readily tradable on
an established securities market in the United States.
Dividends received from a corporation that is a passive
foreign investment company (as defined in section 1297) in
either the taxable year of the distribution, or the preceding
taxable year, are not qualified dividends.
Special rules apply in determining a taxpayer's foreign
tax credit limitation under section 904 in the case of
qualified dividend income. For these purposes, rules similar to
the rules of section 904(b)(2)(B) concerning adjustments to the
foreign tax credit limitation to reflect any capital gain rate
differential will apply to any qualified dividend income.
If a taxpayer receives an extraordinary dividend (within
the meaning of section 1059(c)) eligible for the reduced rates
with respect to any share of stock, any loss on the sale of the
stock is treated as a long-term capital loss to the extent of
the dividend.
A dividend is treated as investment income for purposes
of determining the amount of deductible investment interest
only if the taxpayer elects to treat the dividend as not
eligible for the reduced rates.
The amount of dividends qualifying for reduced rates that
may be paid by a regulated investment company (``RIC'') for any
taxable year in which the qualified dividend income received by
the RIC is less than 95 percent of its gross income (as
specially computed) may not exceed the sum of (i) the qualified
dividend income of the RIC for the taxable year and (ii) the
amount of earnings and profits accumulated in a non-RIC taxable
year that were distributed by the RIC during the taxable year.
The amount of dividends qualifying for reduced rates that
may be paid by a real estate investment trust (``REIT'') for
any taxable year may not exceed the sum of (i) the qualified
dividend income of the REIT for the taxable year, (ii) an
amount equal to the excess of the income subject to the taxes
imposed by section 857(b)(1) and the regulations prescribed
under section 337(d) for the preceding taxable year over the
amount of these taxes for the preceding taxable year, and (iii)
the amount of earnings and profits accumulated in a non-REIT
taxable year that were distributed by the REIT during the
taxable year.
The reduced rates do not apply to dividends received from
an organization that was exempt from tax under section 501 or
was a tax-exempt farmers' cooperative in either the taxable
year of the distribution or the preceding taxable year;
dividends received from a mutual savings bank that received a
deduction under section 591; or deductible dividends paid on
employer securities.\33\
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\33\ In addition, for taxable years beginning before 2009, amounts
treated as ordinary income on the disposition of certain preferred
stock (sec. 306) are treated as dividends for purposes of applying the
reduced rates; the tax rate for the accumulated earnings tax (sec. 531)
and the personal holding company tax (sec. 541) is reduced to 15
percent; and the collapsible corporation rules (sec. 341) are repealed.
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Tax rates after 2008
For taxable years beginning after 2008, dividends
received by an individual are taxed at ordinary income tax
rates.
HOUSE BILL
The House bill extends for two years the present-law
provisions relating to lower capital gain and dividend tax
rates (through taxable years beginning on or before December
31, 2010).
Effective date.--The provision applies to taxable years
beginning after December 31, 2008.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
S. Credit for Elective Deferrals and IRA Contributions (the ``Saver's
Credit'')
(Sec. 204 of the House bill, sec. 102 of the Senate amendment, and sec.
25B of the Code)
PRESENT LAW
Present law provides a temporary nonrefundable tax credit
for eligible taxpayers for qualified retirement savings
contributions, referred to as the ``saver's credit.'' The
maximum annual contribution eligible for the credit is $2,000.
The credit rate depends on the adjusted gross income (``AGI'')
of the taxpayer. Taxpayers filing joint returns with AGI of
$50,000 or less, head of household returns of $37,500 or less,
and single returns of $25,000 or less are eligible for the
credit. The AGI limits applicable to single taxpayers apply to
married taxpayers filing separate returns. The credit is in
addition to any deduction or exclusion that would otherwise
apply with respect to the contribution. The credit offsets
minimum tax liability as well as regular tax liability. The
credit is available to individuals who are 18 or over, other
than individuals who are full-time students or claimed as a
dependent on another taxpayer's return.
The credit is available with respect to: (1) elective
deferrals to a qualified cash or deferred arrangement (a
``section 401(k) plan''), a tax-sheltered annuity (a ``section
403(b)'' annuity), an eligible deferred compensation
arrangement of a State or local government (a ``governmental
section 457 plan''), a SIMPLE plan, or a simplified employee
pension (``SEP''); (2) contributions to a traditional or Roth
IRA; and (3) voluntary after-tax employee contributions to a
tax-sheltered annuity or qualified retirement plan.
The amount of any contribution eligible for the credit is
generally reduced by distributions received by the taxpayer (or
by the taxpayer's spouse if the taxpayer filed a joint return
with the spouse) from any plan or IRA to which eligible
contributions can be made during the taxable year for which the
credit is claimed, the two taxable years prior to the year the
credit is claimed, and during the period after the end of the
taxable year for which the credit is claimed and prior to the
due date for filing the taxpayer's return for the year.
Distributions that are rolled over to another retirement plan
do not affect the credit.
The credit rates based on AGI are provided below.
TABLE 1.--CREDIT RATES FOR SAVER'S CREDIT
----------------------------------------------------------------------------------------------------------------
Heads of Credit rate
Joint filers households All other filers (percent)
----------------------------------------------------------------------------------------------------------------
$0-$30,000..................................................... $0-$22,500 $0-$15,000 50
30,001-32,500.................................................. 22,501-24,375 15,001-16,250 20
32,501-50,000.................................................. 24,376-37,500 16,251-25,000 10
Over $50,000................................................... Over $37,500 Over $25,000 0
----------------------------------------------------------------------------------------------------------------
The credit does not apply to taxable years beginning
after December 31, 2006.\34\
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\34\ The saver's credit was enacted as part of the Economic Growth
and Tax Relief Reconciliation Act of 2001 (``EGTRRA''), Pub. L. No.
107-16. The provisions of EGTRRA generally do not apply for years
beginning after December 31, 2010.
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HOUSE BILL
The House bill extends the saver's credit for two years,
through December 31, 2008.
Effective date.--The provision is effective on the date
of enactment.
SENATE AMENDMENT
The Senate amendment extends the saver's credit for three
years, through December 31, 2009.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the House bill
provision or the Senate amendment provision.
T. Extension of Increased Expensing for Small Business
(Sec. 205 of the House bill, sec. 101 of the Senate amendment, and sec.
179 of the Code)
PRESENT LAW
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs. Present law provides that the maximum
amount a taxpayer may expense, for taxable years beginning in
2003 through 2007, is $100,000 of the cost of qualifying
property placed in service for the taxable year.\35\ In
general, qualifying property is defined as depreciable tangible
personal property that is purchased for use in the active
conduct of a trade or business. Off-the-shelf computer software
placed in service in taxable years beginning before 2008 is
treated as qualifying property. The $100,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $400,000. The $100,000 and $400,000 amounts are indexed
for inflation for taxable years beginning after 2003 and before
2008.
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\35\ Additional section 179 incentives are provided with respect to
a qualified property used by a business in the New York Liberty Zone
(sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal
community (sec. 1400J).
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The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations). No general business credit
under section 38 is allowed with respect to any amount for
which a deduction is allowed under section 179. An expensing
election is made under rules prescribed by the Secretary.\36\
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\36\ Sec. 179(c)(1). Under Treas. Reg. sec. 179-5, applicable to
property placed in service in taxable years beginning after 2002 and
before 2008, a taxpayer is permitted to make or revoke an election
under section 179 without the consent of the Commissioner on an amended
Federal tax return for that taxable year. This amended return must be
filed within the time prescribed by law for filing an amended return
for the taxable year. T.D. 9209, July 12, 2005.
---------------------------------------------------------------------------
For taxable years beginning in 2008 and thereafter (or
before 2003), the following rules apply. A taxpayer with a
sufficiently small amount of annual investment may elect to
deduct up to $25,000 of the cost of qualifying property placed
in service for the taxable year. The $25,000 amount is reduced
(but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year
exceeds $200,000. The $25,000 and $200,000 amounts are not
indexed. In general, qualifying property is defined as
depreciable tangible personal property that is purchased for
use in the active conduct of a trade or business (not including
off-the-shelf computer software). An expensing election may be
revoked only with consent of the Commissioner.\37\
---------------------------------------------------------------------------
\37\ Sec. 179(c)(2).
---------------------------------------------------------------------------
HOUSE BILL
The provision extends for two years the increased amount
that a taxpayer may deduct and the other section 179 rules
applicable in taxable years beginning before 2008. Thus, under
the provision, these present-law rules continue in effect for
taxable years beginning after 2007 and before 2010.
Effective date.--The provision is effective for taxable
years beginning after 2007 and before 2010.
SENATE AMENDMENT
The Senate amendment provision is the same as the House
bill.
CONFERENCE AGREEMENT
The conference agreement includes the provision in the
House bill and the Senate amendment.
U. Extend and Increase Alternative Minimum Tax Exemption Amount for
Individuals
(Sec. 106 of the Senate amendment and sec. 55 of the Code)
PRESENT LAW
Present law imposes an alternative minimum tax. The
alternative minimum tax is the amount by which the tentative
minimum tax exceeds the regular income tax. An individual's
tentative minimum tax is the sum of (1) 26 percent of so much
of the taxable excess as does not exceed $175,000 ($87,500 in
the case of a married individual filing a separate return) and
(2) 28 percent of the remaining taxable excess. The taxable
excess is so much of the alternative minimum taxable income
(``AMTI'') as exceeds the exemption amount. The maximum tax
rates on net capital gain and dividends used in computing the
regular tax are used in computing the tentative minimum tax.
AMTI is the individual's taxable income adjusted to take
account of specified preferences and adjustments.
The exemption amount is: (1) $45,000 ($58,000 for taxable
years beginning before 2006) in the case of married individuals
filing a joint return and surviving spouses; (2) $33,750
($40,250 for taxable years beginning before 2006) in the case
of unmarried individuals other than surviving spouses; (3)
$22,500 ($29,000 for taxable years beginning before 2006) in
the case of married individuals filing a separate return; and
(4) $22,500 in the case of estates and trusts. The exemption
amount is phased out by an amount equal to 25 percent of the
amount by which the individual's AMTI exceeds (1) $150,000 in
the case of married individuals filing a joint return and
surviving spouses, (2) $112,500 in the case of unmarried
individuals other than surviving spouses, and (3) $75,000 in
the case of married individuals filing separate returns,
estates, and trusts. These amounts are not indexed for
inflation.
HOUSE BILL
No provision.
SENATE AMENDMENT
Under the Senate amendment, for taxable years beginning
in 2006, the exemption amounts are increased to: (1) $62,550 in
the case of married individuals filing a joint return and
surviving spouses; (2) $42,500 in the case of unmarried
individuals other than surviving spouses; and (3) $31,275 in
the case of married individuals filing a separate return.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement includes the provision in the
Senate amendment.
V. Extension and Modification of the New Markets Tax Credit
(Sec. 204 of the Senate amendment and sec. 45D of the Code)
PRESENT LAW
Section 45D provides a new markets tax credit for
qualified equity investments made to acquire stock in a
corporation, or a capital interest in a partnership, that is a
qualified community development entity (``CDE'').\38\ The
amount of the credit allowable to the investor (either the
original purchaser or a subsequent holder) is (1) a five-
percent credit for the year in which the equity interest is
purchased from the CDE and for each of the following two years,
and (2) a six-percent credit for each of the following four
years. The credit is determined by applying the applicable
percentage (five or six percent) to the amount paid to the CDE
for the investment at its original issue, and is available for
a taxable year to the taxpayer who holds the qualified equity
investment on the date of the initial investment or on the
respective anniversary date that occurs during the taxable
year. The credit is recaptured if at any time during the seven-
year period that begins on the date of the original issue of
the investment the entity ceases to be a qualified CDE, the
proceeds of the investment cease to be used as required, or the
equity investment is redeemed.
---------------------------------------------------------------------------
\38\ Section 45D was added by section 121(a) of the Community
Renewal Tax Relief Act of 2000, P.L. No. 106-554 (December 21, 2000).
---------------------------------------------------------------------------
A qualified CDE is any domestic corporation or
partnership: (1) whose primary mission is serving or providing
investment capital for low-income communities or low-income
persons; (2) that maintains accountability to residents of low-
income communities by their representation on any governing
board of or any advisory board to the CDE; and (3) that is
certified by the Secretary as being a qualified CDE. A
qualified equity investment means stock (other than
nonqualified preferred stock) in a corporation or a capital
interest in a partnership that is acquired directly from a CDE
for cash, and includes an investment of a subsequent purchaser
if such investment was a qualified equity investment in the
hands of the prior holder. Substantially all of the investment
proceeds must be used by the CDE to make qualified low-income
community investments. For this purpose, qualified low-income
community investments include: (1) capital or equity
investments in, or loans to, qualified active low-income
community businesses; (2) certain financial counseling and
other services to businesses and residents in low-income
communities; (3) the purchase from another CDE of any loan made
by such entity that is a qualified low-income community
investment; or (4) an equity investment in, or loan to, another
CDE.
A ``low-income community'' is a population census tract
with either (1) a poverty rate of at least 20 percent or (2)
median family income which does not exceed 80 percent of the
greater of metropolitan area median family income or statewide
median family income (for a non-metropolitan census tract, does
not exceed 80 percent of statewide median family income). In
the case of a population census tract located within a high
migration rural county, low-income is defined by reference to
85 percent (rather than 80 percent) of statewide median family
income. For this purpose, a high migration rural county is any
county that, during the 20-year period ending with the year in
which the most recent census was conducted, has a net out-
migration of inhabitants from the county of at least 10 percent
of the population of the county at the beginning of such
period.
The Secretary has the authority to designate ``targeted
populations'' as low-income communities for purposes of the new
markets tax credit. For this purpose, a ``targeted population''
is defined by reference to section 103(20) of the Riegle
Community Development and Regulatory Improvement Act of 1994
(12 U.S.C. 4702(20)) to mean individuals, or an identifiable
group of individuals, including an Indian tribe, who (A) are
low-income persons; or (B) otherwise lack adequate access to
loans or equity investments. Under such Act, ``low-income''
means (1) for a targeted population within a metropolitan area,
less than 80 percent of the area median family income; and (2)
for a targeted population within a non-metropolitan area, less
than the greater of 80 percent of the area median family income
or 80 percent of the statewide non-metropolitan area median
family income.\39\ Under such Act, a targeted population is not
required to be within any census tract. In addition, a
population census tract with a population of less than 2,000 is
treated as a low-income community for purposes of the credit if
such tract is within an empowerment zone, the designation of
which is in effect under section 1391, and is contiguous to one
or more low-income communities.
---------------------------------------------------------------------------
\39\ 12 U.S.C. 4702(17) (defines ``low-income'' for purposes of 12
U.S.C. 4702(20)).
---------------------------------------------------------------------------
A qualified active low-income community business is
defined as a business that satisfies, with respect to a taxable
year, the following requirements: (1) at least 50 percent of
the total gross income of the business is derived from the
active conduct of trade or business activities in any low-
income community; (2) a substantial portion of the tangible
property of such business is used in a low-income community;
(3) a substantial portion of the services performed for such
business by its employees is performed in a low-income
community; and (4) less than five percent of the average of the
aggregate unadjusted bases of the property of such business is
attributable to certain financial property or to certain
collectibles.
The maximum annual amount of qualified equity investments
is capped at $2.0 billion per year for calendar years 2004 and
2005, and at $3.5 billion per year for calendar years 2006 and
2007.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision extends through 2008 the $3.5 billion
maximum annual amount of qualified equity investments. The
provision also requires that the Secretary prescribe
regulations to ensure that non-metropolitan counties receive a
proportional allocation of qualified equity investments.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
W. Phasedown of Credit for Electric Vehicles
(Sec. 118 of the Senate amendment and sec. 30 of the Code)
PRESENT LAW
A 10-percent tax credit is provided for the cost of a
qualified electric vehicle, up to a maximum credit of $4,000. A
qualified electric vehicle generally is a motor vehicle that is
powered primarily by an electric motor drawing current from
rechargeable batteries, fuel cells, or other portable sources
of electrical current. The full amount of the credit is
available for purchases prior to 2006. The credit is reduced to
25 percent of the otherwise allowable amount for purchases in
2006, and is unavailable for purchases after December 31, 2006.
HOUSE BILL
No provision.
SENATE AMENDMENT
Under the Senate amendment, the full amount of the credit
for qualified electric vehicles is available for purchases
prior to 2006. As under present law, the credit is unavailable
for purchases after December 31, 2006.
Effective date.--The provision is effective for property
placed in service after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
X. Application of EGTRRA Sunset to Title II of the Senate Amendment
(Sec. 231 of the Senate amendment)
PRESENT LAW
Reconciliation is a procedure under the Congressional
Budget Act of 1974 (the ``Budget Act'') by which Congress
implements spending and tax policies contained in a budget
resolution. The Budget Act contains numerous rules enforcing
the scope of items permitted to be considered under the budget
reconciliation process. One such rule, the so-called ``Byrd
rule,'' was incorporated into the Budget Act in 1990. The Byrd
rule, named after its principal sponsor, Senator Robert C.
Byrd, is contained in section 313 of the Budget Act. The Byrd
rule generally permits members to raise a point of order
against extraneous provisions (those which are unrelated to the
goals of the reconciliation process) from either a
reconciliation bill or a conference report on such bill.
Under the Byrd rule, a provision is considered to be
extraneous if it falls under one or more of the following six
definitions:
1. It does not produce a change in outlays or revenues;
2. It produces an outlay increase or revenue decrease
when the instructed committee is not in compliance with its
instructions;
3. It is outside of the jurisdiction of the committee
that submitted the title or provision for inclusion in the
reconciliation measure;
4. It produces a change in outlays or revenues which is
merely incidental to the nonbudgetary components of the
provision;
5. It would increase the deficit for a fiscal year beyond
those covered by the reconciliation measure; and
6. It recommends changes in Social Security.
The Economic Growth and Tax Relief Reconciliation Act of
2001 (EGTRRA) contains sunset provisions to ensure compliance
with the Budget Act. Under title IX of EGTRRA, the provisions
of, and amendments made by that Act that are in effect on
September 30, 2011, shall cease to apply as of the close of
September 30, 2011, except that all provisions of, and
amendments made by, the Act generally do not apply for taxable,
plan or limitation years beginning after December 31, 2010.
With respect to the estate, gift, and generation-skipping
provisions of the Act, the provisions do not apply to estates
of decedents dying, gifts made, or generation-skipping
transfers, after December 31, 2010. The Code and the Employee
Retirement Income Security Act of 1974 are applied to such
years, estates, gifts and transfers after December 31, 2010, as
if the provisions of and amendments made by the Act had never
been enacted.
HOUSE BILL
No provision.
SENATE AMENDMENT
Sunset of provisions
To ensure compliance with the Budget Act, the Senate
amendment provides that all provisions of, and amendments made
by title II of the Senate amendment shall be subject to the
sunset provisions of EGTRRA to the same extent and in the same
manner as the provision of such Act to which the Senate
amendment provision relates.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE II--OTHER PROVISONS
A. Taxation of Certain Settlement Funds
(Sec. 301 of the House bill and sec. 468B of the Code)
PRESENT LAW
Present law provides that if a taxpayer makes a payment
to a designated settlement fund pursuant to a court order, the
deduction timing rules that require economic performance
generally are deemed to be met as the payments are made by the
taxpayer to the fund. A designated settlement fund means a fund
which: is established pursuant to a court order; extinguishes
completely the taxpayer's tort liability arising out of
personal injury, death or property damage; is administered by
persons a majority of whom are independent of the taxpayer; and
under the terms of the fund the taxpayer (or any related
person) may not hold any beneficial interest in the income or
corpus of the fund.
Generally, a designated or qualified settlement fund is
taxed as a separate entity at the maximum trust rate on its
modified income. Modified income is generally gross income less
deductions for administrative costs and other incidental
expenses incurred in connection with the operation of the
settlement fund.
The cleanup of hazardous waste sites is sometimes funded
by environmental ``settlement funds'' or escrow accounts. These
escrow accounts are established in consent decrees between the
Environmental Protection Agency (``EPA'') and the settling
parties under the jurisdiction of a Federal district court. The
EPA uses these accounts to resolve claims against private
parties under Comprehensive Environmental Response,
Compensation and Liability Act of 1980 (``CERCLA'').
Present law provides that nothing in any provision of law
is to be construed as providing that an escrow account,
settlement fund, or similar fund is not subject to current
income tax.
HOUSE BILL
The provision provides that certain settlement funds
established in consent decrees for the sole purpose of
resolving claims under CERCLA are to be treated as beneficially
owned by the United States government and therefore not subject
to Federal income tax.
To qualify the settlement fund must be: (1) established
pursuant to a consent decree entered by a judge of a United
States District Court; (2) created for the receipt of
settlement payments for the sole purpose of resolving claims
under CERCLA; (3) controlled (in terms of expenditures of
contributions and earnings thereon) by the government or an
agency or instrumentality thereof; and (4) upon termination,
any remaining funds will be disbursed to such government entity
and used in accordance with applicable law. For purposes of the
provision, a government entity means the United States, any
State of political subdivision thereof, the District of
Columbia, any possession of the United States, and any agency
or instrumentality of the foregoing.
The provision does not apply to accounts or funds
established after December 31, 2010.
Effective date.--The provision is effective for accounts
and funds established after the date of enactment.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
B. Modifications to Rules Relating to Taxation of Distributions of
Stock and Securities of a Controlled Corporation
(Sec. 302 of the House bill, sec. 467 of the Senate amendment and sec.
355 of the Code)
PRESENT LAW
A corporation generally is required to recognize gain on
the distribution of property (including stock of a subsidiary)
to its shareholders as if the corporation had sold such
property for its fair market value. In addition, the
shareholders receiving the distributed property are ordinarily
treated as receiving a dividend of the value of the
distribution (to the extent of the distributing corporation's
earnings and profits), or capital gain in the case of a stock
buyback that significantly reduces the shareholder's interest
in the parent corporation.
An exception to these rules applies if the distribution
of the stock of a controlled corporation satisfies the
requirements of section 355 of the Code. If all the
requirements are satisfied, there is no tax to the distributing
corporation or to the shareholders on the distribution.
One requirement to qualify for tax-free treatment under
section 355 is that both the distributing corporation and the
controlled corporation must be engaged immediately after the
distribution in the active conduct of a trade or business that
has been conducted for at least five years and was not acquired
in a taxable transaction during that period (the ``active
business test'').\40\ For this purpose, a corporation is
engaged in the active conduct of a trade or business only if
(1) the corporation is directly engaged in the active conduct
of a trade or business, or (2) the corporation is not directly
engaged in an active business, but substantially all its assets
consist of stock and securities of one or more corporations
that it controls that are engaged in the active conduct of a
trade or business.\41\
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\40\ Section 355(b).
\41\ Section 355(b)(2)(A). The IRS takes the position that the
statutory test requires that at least 90 percent of the fair market
value of the corporation's gross assets consist of stock and securities
of a controlled corporation that is engaged in the active conduct of a
trade or business. Rev. Proc. 96-30, sec. 4.03(5), 1996-1 C.B. 696;
Rev. Proc. 77-37, sec. 3.04, 1977-2 C.B. 568.
---------------------------------------------------------------------------
In determining whether a corporation is directly engaged
in an active trade or business that satisfies the requirement,
old IRS guidelines for advance ruling purposes required that
the value of the gross assets of the trade or business being
relied on must ordinarily constitute at least five percent of
the total fair market value of the gross assets of the
corporation directly conducting the trade or business.\42\ More
recently, the IRS has suspended this specific rule in
connection with its general administrative practice of moving
IRS resources away from advance rulings on factual aspects of
section 355 transactions in general.\43\
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\42\ Rev. Proc. 2003-3, sec. 4.01(30), 2003-1 I.R.B. 113.
\43\ Rev. Proc. 2003-48, 2003-29 I.R.B. 86.
---------------------------------------------------------------------------
If the distributing or controlled corporation is not
directly engaged in an active trade or business, then the IRS
takes the position that the ``substantially all'' test as
applied to that corporation requires that at least 90 percent
of the fair market value of the corporation's gross assets
consist of stock and securities of a controlled corporation
that is engaged in the active conduct of a trade or
business.\44\
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\44\ Rev. Proc. 96-30, sec. 4.03(5), 1996-1 C.B. 696; Rev. Proc.
77-37, sec. 3.04, 1977-2 C.B. 568.
---------------------------------------------------------------------------
In determining whether assets are part of a five-year
qualifying active business, assets acquired more recently than
five years prior to the distribution, in a taxable transaction,
are permitted to qualify as five-year ``active business''
assets if they are considered to have been acquired as part of
an expansion of an existing business that does so qualify.\45\
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\45\ Treas. Reg. sec. 1.355-3(b)(ii).
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When a corporation holds an interest in a partnership,
IRS revenue rulings have allowed an active business of the
partnership to count as an active business of a corporate
partner in certain circumstances. One such case involved a
situation in which the corporation owned at least 20 percent of
the partnership, was actively engaged in management of the
partnership, and the partnership itself had an active
business.\46\
---------------------------------------------------------------------------
\46\ Rev. Rul. 92-17, 1002-1 C.B. 142; see also, Rev. Rul. 2002-49,
2002-2 C.B. 50.
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In addition to its active business requirements, section
355 does not apply to any transaction that is a ``device'' for
the distribution of earnings and profits to a shareholder
without the payment of tax on a dividend. A transaction is
ordinarily not considered a ``device'' to avoid dividend tax if
the distribution would have been treated by the shareholder as
a redemption that was a sale or exchange of its stock, rather
than as a dividend, if section 355 had not applied.\47\
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\47\ Treas. Reg. sec. 1.355-2(d)(5)(iv).
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HOUSE BILL
Under the House bill provision, the active business test
is determined by reference to the relevant affiliated group.
For the distributing corporation, the relevant affiliated group
consists of the distributing corporation as the common parent
and all corporations affiliated with the distributing
corporation through stock ownership described in section
1504(a)(1)(B) (regardless of whether the corporations are
includible corporations under section 1504(b)), immediately
after the distribution. The relevant affiliated group for a
controlled corporation is determined in a similar manner (with
the controlled corporation as the common parent).
Effective date.--The provision applies to distributions
after the date of enactment and before December 31, 2010, with
three exceptions. The provision does not apply to distributions
(1) made pursuant to an agreement which is binding on the date
of enactment and at all times thereafter, (2) described in a
ruling request submitted to the IRS on or before the date of
enactment, or (3) described on or before the date of enactment
in a public announcement or in a filing with the Securities and
Exchange Commission. The distributing corporation may
irrevocably elect not to have the exceptions described above
apply.
The provision also applies, solely for the purpose of
determining whether, after the date of enactment, there is
continuing qualification under the requirements of section
355(b)(2)(A) of distributions made before such date, as a
result of an acquisition, disposition, or other restructuring
after such date and before December 31, 2010.\48\
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\48\ For example, a holding company taxpayer that had distributed a
controlled corporation in a spin-off prior to the date of enactment, in
which spin-off the taxpayer satisfied the ``substantially all'' active
business stock test of present law section 355(b)(2)(A) immediately
after the distribution, would not be deemed to have failed to satisfy
any requirement that it continue that same qualified structure for any
period of time after the distribution, solely because of a
restructuring that occurs after the date of enactment and before
January 1, 2010, and that would satisfy the requirements of new section
355(b)(2)(A).
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SENATE AMENDMENT
The Senate amendment provision is the same as the House
bill with respect to the House bill provision described above,
except for the date on which that provision sunsets.\49\
---------------------------------------------------------------------------
\49\ See ``Effective date'' for the Senate Amendment, infra.
---------------------------------------------------------------------------
In addition, the Senate amendment contains another
provision that denies section 355 treatment if either the
distributing or distributed corporation is a disqualified
investment corporation immediately after the transaction
(including any series of related transactions) and any person
that did not hold 50 percent or more of the voting power or
value of stock of such distributing or controlled corporation
immediately before the transaction does hold such a 50 percent
or greater interest immediately after such transaction. The
attribution rules of section 318 apply for purposes of this
determination.
A disqualified investment corporation is any distributing
or controlled corporation if the fair market value of the
investment assets of the corporation is 75 percent or more of
the fair market value of all assets of the corporation. Except
as otherwise provided, the term ``investment assets'' for this
purpose means (i) cash, (ii) any stock or securities in a
corporation, (iii) any interest in a partnership, (iv) any debt
instrument or other evidence of indebtedness; (v) any option,
forward or futures contract, notional principal contract, or
derivative; (vi) foreign currency, or (vii) any similar asset.
The term ``investment assets'' does not include any asset
which is held for use in the active and regular conduct of (i)
a lending or finance business (as defined in section
954(h)(4)); (ii) a banking business through a bank (as defined
in section 581), a domestic building and loan association
(within the meaning of section 7701(a)(19), or any similar
institution specified by the Secretary; or (iii) an insurance
business if the conduct of the business is licensed,
authorized, or regulated by an applicable insurance regulatory
body. These exceptions only apply with respect to any business
if substantially all the income of the business is derived from
persons who are not related (within the meaning of section
267(b) or 707(b)(1) to the person conducting the business.
The term ``investment assets'' also does not include any
security (as defined in section 475(c)(2)) which is held by a
dealer in securities and to which section 475(a) applies.
The term ``investment assets'' also does not include any
stock or securities in, or any debt instrument, evidence of
indebtedness, option, forward or futures contract, notional
principal contract, or derivative issued by, a corporation
which is a 25-percent controlled entity with respect to the
distributing or controlled corporation. Instead, the
distributing or controlled corporation is treated as owning its
ratable share of the assets of any 25-percent controlled
entity.
The term 25-percent controlled entity means any
corporation with respect to which the corporation in question
(distributing or controlled) owns directly or indirectly stock
possessing at least 25 percent of voting power and value,
excluding stock that is not entitled to vote, is limited and
preferred as to dividends and does not participate in corporate
growth to any significant extent, has redemption and
liquidation rights which do not exceed the issue price of such
stock (except for a reasonable redemption or liquidation
premium), and is not convertible into another class of stock.
The term ``investment assets'' also does not include any
interest in a partnership, or any debt instrument or other
evidence of indebtedness issued by the partnership, if one or
more trades or businesses of the partnership are, (or without
regard to the 5-year requirement of section 355(b)(2)(B), would
be) taken into account by the distributing or controlled
corporation, as the case may be, in determining whether the
active business test of section 355 is met by such corporation.
The Treasury department shall provide regulations as may
be necessary to carry out, or prevent the avoidance of, the
purposes of the provision, including regulations in cases
involving related persons, intermediaries, pass-through
entities, or other arrangements; and the treatment of assets
unrelated to the trade or business of a corporation as
investment assets if, prior to the distribution, investment
assets were used to acquire such assets. Regulations may also
in appropriate cases exclude from the application of the
provision a distribution which does not have the character of a
redemption and which would be treated as a sale or exchange
under section 302, and may modify the application of the
attribution rules.
Effective date.--The effective date of the first
provision of the Senate amendment generally is the same as the
effective date of the identical provision of the House bill,
except that the Senate amendment provision sunsets for
distributions (and for acquisitions, dispositions, or other
restructurings as relating to continuing qualification of pre-
effective date distributions) after December 31, 2009, rather
than for distributions (and for acquisitions, dispositions, or
other restructurings as relating to continuing qualification of
pre-effective date distributions) on or after December 31,
2010.
The second provision of the Senate amendment is effective
for distributions after the date of enactment, except in
transactions which are (i) made pursuant to an agreement which
was binding on such date of enactment and at all times
thereafter; (ii) described in a ruling request submitted to the
Internal Revenue Service on or before such date, or (iii)
described on or before such date in a public announcement or in
a filing with the Securities and Exchange Commission.
CONFERENCE AGREEMENT
The conference agreement includes the House bill and the
Senate amendment with modifications.
With respect to the provision that applies the active
business test by reference to the relevant affiliated group,
the conference agreement provision is the same as the House
bill and the Senate amendment except for the date on which the
conference agreement provision sunsets.\50\
---------------------------------------------------------------------------
\50\ See ``Effective date'' of the conference agreement provision,
infra.
---------------------------------------------------------------------------
With respect to the provision that affects transactions
involving disqualified investment corporations, the conference
agreement reduces the percentage of investment assets of a
corporation that will cause such corporation to be a
disqualified investment corporation, from 75 percent (three-
quarters) to two-thirds of the fair market value of the
corporation's assets, for distributions occurring after one
year after the date of enactment.
The conference agreement also reduces from 25 percent to
20 percent the percentage stock ownership in a corporation that
will cause such ownership to be disregarded as an investment
asset itself, instead requiring ``look-through'' to the ratable
share of the underlying assets of such corporation attributable
to such stock ownership.
The conferees wish to clarify that the disqualified
investment corporation provision applies when a person directly
or indirectly holds 50 percent of either the vote or the value
of a company immediately following a distribution, and such
person did not hold such 50 percent interest directly or
indirectly prior to the distribution. As one example, the
provision applies if a person that held 50 percent or more of
the vote, but not of the value, of a distributing corporation
immediately prior to a transaction in which a controlled
corporation that was 100 percent owned by that distributing
corporation is distributed, directly or indirectly holds 50
percent of the value of either the distributing or controlled
corporation immediately following such transaction.
The conferees further wish to clarify that the
enumeration in subsection 355(g)(5)(A) through (C) of specific
situations that Treasury regulations may address is not
intended to restrict or limit any other situations that
Treasury may address under the general authority of new section
355(g)(5) to carry out, or prevent the avoidance of, the
purposes of the disqualified investment corporation provision.
Effective date.--The starting effective date of the
provision that applies the active business test by reference to
the relevant affiliated group is the same as that of the House
bill and the Senate amendment provisions. The conference
agreement changes the date on which the provision sunsets so
that the provision does not apply for distributions (or for
acquisitions, dispositions, or other restructurings as relating
to continuing qualification of pre-effective date
distributions) occurring after December 31, 2010.
The effective date of the provision that affects
transactions involving disqualified investment corporations is
the same as that of the Senate amendment provision, except for
the conference agreement reduction in the amount of investment
assets of a corporation that will cause it to be a disqualified
investment corporation, from three-quarters to two-thirds of
the fair market value of all assets of the corporation. The
two-thirds test applies for distributions occurring after one
year after the date of enactment.
C. Qualified Veteran's Mortgage Bonds
(Sec. 303 of the House bill and sec. 143 of the Code)
PRESENT LAW
Private activity bonds are bonds that nominally are
issued by States or local governments, but the proceeds of
which are used (directly or indirectly) by a private person and
payment of which is derived from funds of such private person.
The exclusion from income for State and local bonds does not
apply to private activity bonds, unless the bonds are issued
for certain permitted purposes (``qualified private activity
bonds''). The definition of a qualified private activity bond
includes both qualified mortgage bonds and qualified veterans'
mortgage bonds.
Qualified veterans' mortgage bonds are private activity
bonds the proceeds of which are used to make mortgage loans to
certain veterans. Authority to issue qualified veterans'
mortgage bonds is limited to States that had issued such bonds
before June 22, 1984. Qualified veterans' mortgage bonds are
not subject to the State volume limitations generally
applicable to private activity bonds. Instead, annual issuance
in each State is subject to a State volume limitation based on
the volume of such bonds issued by the State before June 22,
1984. The five States eligible to issue these bonds are Alaska,
California, Oregon, Texas, and Wisconsin. Loans financed with
qualified veterans' mortgage bonds can be made only with
respect to principal residences and can not be made to acquire
or replace existing mortgages. Mortgage loans made with the
proceeds of these bonds can be made only to veterans who served
on active duty before 1977 and who applied for the financing
before the date 30 years after the last date on which such
veteran left active service (the ``eligibility period'').
Qualified mortgage bonds are issued to make mortgage
loans to qualified mortgagors for owner-occupied residences.
The Code imposes several limitations on qualified mortgage
bonds, including income limitations for homebuyers and purchase
price limitations for the home financed with bond proceeds. In
addition, qualified mortgage bonds generally cannot be used to
finance a mortgage for a homebuyer who had an ownership
interest in a principal residence in the three years preceding
the execution of the mortgage (the ``first-time homebuyer''
requirement).
HOUSE BILL
The House bill repeals the requirement that veterans
receiving loans financed with qualified veterans' mortgage
bonds must have served before 1977. It also reduces the
eligibility period to 25 years (rather than 30 years) following
release from the military service. The bill provides new State
volume limits for these bonds for the five eligible States. In
2010, the new annual limit on the total volume of veterans'
bonds is $25 million for Alaska, $66.25 million for California,
$25 million for Oregon, $53.75 million for Texas, and $25
million for Wisconsin. These volume limits are phased-in over
the four-year period immediately preceding 2010 by allowing the
applicable percentage of the 2010 volume limits. The following
table provides those percentages.
Calendar Year: Applicable Percentage is:
2006.............................................................. 20
2007.............................................................. 40
2008.............................................................. 60
2009.............................................................. 80
The volume limits are zero for 2011 and each year
thereafter. Unused allocation cannot be carried forward to
subsequent years.
Effective date.--The provision generally applies to bonds
issued after December 31, 2005. The provision expanding the
definition of eligible veterans applies to financing provided
after date of enactment.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill with the
following modifications. The conference agreement does not
amend present law as it relates to qualified veterans' mortgage
bonds issued by the States of California and Texas. In the case
of qualified veterans' mortgage bonds issued by the States of
Alaska, Oregon, and Wisconsin, (1) the requirement that
veterans must have served before 1977 is repealed and (2) the
eligibility period for applying for a loan following release
from the military service is reduced from 30 years to 25 years.
In addition, the annual issuance of qualified veterans'
mortgage bonds in the States of Alaska, Oregon and Wisconsin is
subject to new State volume limitations which are phased in
between the years 2006 and 2010. The State volume limit in
these States for any calendar year after 2010 is zero.
Effective date.--The provision expanding the definition
of eligible veterans applies to bonds issued on or after date
of enactment. The provision amending State volume limitations
applies to allocations of volume limitation made after April 5,
2006.
D. Capital Gains Treatment for Certain Self-Created Musical Works
(Sec. 304 of the House bill and sec. 1221 of the Code)
PRESENT LAW
Capital gains
The maximum tax rate on the net capital gain income of an
individual is 15 percent for taxable years beginning in 2006.
By contrast, the maximum tax rate on an individual's ordinary
income is 35 percent. The reduced 15-percent rate generally is
available for gain from the sale or exchange of a capital asset
for which the taxpayer has satisfied a holding-period
requirement. Capital assets generally include all property held
by a taxpayer with certain specified exclusions.
An exclusion from the definition of a capital asset
applies to inventory property or property held by a taxpayer
primarily for sale to customers in the ordinary course of the
taxpayer's trade or business. Another exclusion from capital
asset status applies to copyrights, literary, musical, or
artistic compositions, letters or memoranda, or similar
property held by a taxpayer whose personal efforts created the
property (or held by a taxpayer whose basis in the property is
determined by reference to the basis of the taxpayer whose
personal efforts created the property). Consequently, when a
taxpayer that owns copyrights in, for example, books, songs, or
paintings that the taxpayer created (or when a taxpayer to
which the copyrights have been transferred by the works'
creator in a substituted basis transaction) sells the
copyrights, gain from the sale is treated as ordinary income,
not capital gain.
Charitable contributions
A taxpayer generally is allowed a deduction for the fair
market value of property contributed to a charity. If a
taxpayer makes a contribution of property that would have
generated ordinary income (or short-term capital gain), the
taxpayer's charitable contribution deduction generally is
limited to the property's adjusted basis.
HOUSE BILL
The House bill provides that at the election of a
taxpayer, the sale or exchange before January 1, 2011 of
musical compositions or copyrights in musical works created by
the taxpayer's personal efforts (or having a basis determined
by reference to the basis in the hands of the taxpayer whose
personal efforts created the compositions or copyrights) is
treated as the sale or exchange of a capital asset. The House
bill provision does not change the present law limitation on a
taxpayer's charitable deduction for the contribution of those
compositions or copyrights.
Effective date.--The provision is effective for sales or
exchanges in taxable years beginning after the date of
enactment.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
E. Decrease Minimum Vessel Tonnage Limit to 6,000 Deadweight Tons
(Sec. 305 of the House bill and sec. 1355 of the Code)
PRESENT LAW
The United States employs a ``worldwide'' tax system,
under which domestic corporations generally are taxed on all
income, including income from shipping operations, whether
derived in the United States or abroad. In order to mitigate
double taxation, a foreign tax credit for income taxes paid to
foreign countries is provided to reduce or eliminate the U.S.
tax owed on such income, subject to certain limitations.
Generally, the United States taxes foreign corporations
only on income that has a sufficient nexus to the United
States. Thus, a foreign corporation is generally subject to
U.S. tax only on income, including income from shipping
operations, which is ``effectively connected'' with the conduct
of a trade or business in the United States (sec. 882). Such
``effectively connected income'' generally is taxed in the same
manner and at the same rates as the income of a U.S.
corporation.
The United States imposes a four percent tax on the
amount of a foreign corporation's U.S. source gross
transportation income (sec. 887). Transportation income
includes income from the use (or hiring or leasing for use) of
a vessel and income from services directly related to the use
of a vessel. Fifty percent of the transportation income
attributable to transportation that either begins or ends (but
not both) in the United States is treated as U.S. source gross
transportation income. The tax does not apply, however, to U.S.
source gross transportation income that is treated as income
effectively connected with the conduct of a U.S. trade or
business. U.S. source gross transportation income is not
treated as effectively connected income unless (1) the taxpayer
has a fixed place of business in the United States involved in
earning the income, and (2) substantially all the income is
attributable to regularly scheduled transportation.
The tax imposed by section 882 or 887 on income from
shipping operations may be limited by an applicable U.S. income
tax treaty or by an exemption of a foreign corporation's
international shipping operations income in instances where a
foreign country grants an equivalent exemption (sec. 883).
Notwithstanding the general rules described above, the
American Jobs Creation Act of 2004 (``AJCA'') \51\ generally
allows corporations that are qualifying vessel operators \52\
to elect a ``tonnage tax'' in lieu of the corporate income tax
on taxable income from certain shipping activities.
Accordingly, an electing corporation's gross income does not
include its income from qualifying shipping activities (and
items of loss, deduction, or credit are disallowed with respect
to such excluded income), and electing corporations are only
subject to tax on these activities at the maximum corporate
income tax rate on their notional shipping income, which is
based on the net tonnage of the corporation's qualifying
vessels.\53\ No deductions are allowed against the notional
shipping income of an electing corporation, and no credit is
allowed against the notional tax imposed under the tonnage tax
regime. In addition, special deferral rules apply to the gain
on the sale of a qualifying vessel, if such vessel is replaced
during a limited replacement period.
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\51\ Pub. L. No. 108-357, sec. 248. The tonnage tax regime is
effective for taxable years beginning after the date of enactment of
AJCA (October 22, 2004).
\52\ Generally, a qualifying vessel operator is a corporation that
(1) operates one or more qualifying vessels and (2) meets certain
requirements with respect to its shipping activities.
\53\ An electing corporation's notional shipping income for the
taxable year is the product of the following amounts for each of the
qualifying vessels it operates: (1) the daily notional shipping income
from the operation of the qualifying vessel, and (2) the number of days
during the taxable year that the electing corporation operated such
vessel as a qualifying vessel in the United States foreign trade. The
daily notional shipping income from the operation of a qualifying
vessel is (1) 40 cents for each 100 tons of so much of the net tonnage
of the vessel as does not exceed 25,000 net tons, and (2) 20 cents for
each 100 tons of so much of the net tonnage of the vessel as exceeds
25,000 net tons. ``United States foreign trade'' means the
transportation of goods or passengers between a place in the United
States and a foreign place or between foreign places. The temporary use
in the United States domestic trade (i.e., the transportation of goods
or passengers between places in the United States) of any qualifying
vessel or the temporary ceasing to use a qualifying vessel may be
disregarded, under special rules.
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Generally, a ``qualifying vessel'' is defined as a self-
propelled (or a combination of self-propelled and non-self-
propelled) U.S.-flag vessel of not less than 10,000 deadweight
tons \54\ that is used exclusively in the U.S. foreign trade.
---------------------------------------------------------------------------
\54\ Deadweight measures the lifting capacity of a ship expressed
in long tons (2,240 lbs.), including cargo, crew, and consumables such
as fuel, lube oil, drinking water, and stores. It is the difference
between the number of tons of water a vessel displaces without such
items on board and the number of tons it displaces when fully loaded.
---------------------------------------------------------------------------
HOUSE BILL
The House bill expands the definition of ``qualifying
vessel'' to include self-propelled (or a combination of self-
propelled and non-self-propelled) U.S. flag vessels of not less
than 6,000 deadweight tons used exclusively in the United
States foreign trade. The modified definition applies for
taxable years beginning after December 31, 2005 and ending
before January 1, 2011.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005 and ending before January 1,
2011.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement includes the provision in the
House bill.
F. Modification of Special Arbitrage Rule for Certain Funds
(Sec. 306 of the House bill and sec. 307 of the Senate amendment)
PRESENT LAW
In general, present-law tax-exempt bond arbitrage
restrictions provide that interest on a State or local
government bond is not eligible for tax-exemption if the
proceeds are invested, directly or indirectly, in materially
higher yielding investments or if the debt service on the bond
is secured by or paid from (directly or indirectly) such
investments. An exception to the arbitrage restrictions,
enacted in 1984, provides that the pledge of income from
investments in the Texas Permanent University Fund (the
``Fund'') as security for a limited amount of tax-exempt bonds
will not cause interest on those bonds to be taxable. The terms
of this exception are limited to State constitutional or
statutory restrictions continuously in effect since October 9,
1969. In addition, the exception only applies to an amount of
tax-exempt bonds that does not exceed 20 percent of the value
of the Fund.
The Fund consists of certain State lands that were set
aside for the benefit of higher education, the income from
mineral rights to these lands, and certain other earnings on
Fund assets. The Texas constitution directs that monies held in
the Fund are to be invested in interest-bearing obligations and
other securities. Income from the Fund is apportioned between
two university systems operated by the State. Tax-exempt bonds
issued by the university systems to finance buildings and other
permanent improvements were secured by and payable from the
income of the Fund.
Prior to 1999, the constitution did not permit the
expenditure or mortgage of the Fund for any purpose. In 1999,
the State constitutional rules governing the Fund were modified
with regard to the manner in which amounts in the Fund are
distributed for the benefit of the two university systems. The
State constitutional amendments allow for the possibility that
in the event investment earnings are less than annual debt
service on the bonds some of the debt service could be
considered as having been paid with the Fund corpus. The 1984
exception refers only to bonds secured by investment earnings
on securities or obligations held by the Fund. Despite the
constitutional amendments, the IRS has agreed to continue to
apply the 1984 exception to the Fund through August 31, 2007,
if clarifying legislation is introduced in the 109th Congress
prior to August 31, 2005. Clarifying legislation was introduced
in the 109th Congress on May 26, 2005.\55\
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\55\ H.R. 2661.
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HOUSE BILL
The provision codifies and extends the IRS agreement
until August 31, 2009. The 1984 exception is conformed to the
State constitutional amendments to permit its continued
applicability to bonds of the two university systems. The
limitation on the aggregate amount of bonds which may benefit
from the exception is not modified, and remains at 20 percent
of the value of the Fund. The provision sunsets August 31,
2009.
Effective date.--The provision is effective for bonds
issued after the date of enactment and before August 31, 2009.
SENATE AMENDMENT
The Senate amendment follows the House bill provision,
and also increases the amount of bonds that may benefit from
the exception to 30 percent of the value of the Fund.
Effective date.--The Senate amendment is the same as the
House bill.
CONFERENCE AGREEMENT
The conference agreement includes the House bill
provision.
G. Amortization of Expenses Incurred in Creating or Acquiring Music or
Music Copyrights
(Sec. 468 of the Senate amendment and secs. 167(g) and 263A of the
Code)
PRESENT LAW
A taxpayer is allowed to recover, through annual
depreciation deductions, the cost of certain property used in a
trade or business or for the production of income. Section
167(g) provides that the cost of motion picture films, sound
recordings, copyrights, books, patents, and other property
specified in regulations is eligible to be recovered using the
income forecast method of depreciation.
Under the income forecast method, the depreciation
deduction with respect to eligible property for a taxable year
is determined by multiplying the adjusted basis of the property
by a fraction, the numerator of which is the income generated
by the property during the year, and the denominator of which
is the total forecasted or estimated income expected to be
generated prior to the close of the tenth taxable year after
the year the property was placed in service. Any costs that are
not recovered by the end of the tenth taxable year after the
property was placed in service may be taken into account as
depreciation in such year.
The adjusted basis of property that may be taken into
account under the income forecast method includes only amounts
that satisfy the economic performance standard of section
461(h) (except in the case of certain participations and
residuals). In addition, taxpayers that claim depreciation
deductions under the income forecast method are required to pay
(or receive) interest based on a recalculation of depreciation
under a ``look-back'' method.
The ``look-back'' method is applied in any
``recomputation year'' by (1) comparing depreciation deductions
that had been claimed in prior periods to depreciation
deductions that would have been claimed had the taxpayer used
actual, rather than estimated, total income from the property;
(2) determining the hypothetical overpayment or underpayment of
tax based on this recalculated depreciation; and (3) applying
the overpayment rate of section 6621 of the Code. Except as
provided in Treasury regulations, a ``recomputation year'' is
the third and tenth taxable year after the taxable year the
property was placed in service, unless the actual income from
the property for each taxable year ending with or before the
close of such years was within 10 percent of the estimated
income from the property for such years.
A special rule is provided under Treasury guidance in the
case of certain authors and other taxpayers, with respect to
their capitalization of costs under section 263A and with
respect to the recovery or amortization of such costs.
Specifically, IRS Notice 88-62 (1988-1 C.B. 548) provides an
elective safe harbor under which eligible taxpayers capitalize
qualified created costs incurred during the taxable year and
amortize 50 percent of the costs in the taxable year incurred,
and 25 percent in each of the two successive taxable years.
Under the Notice, qualified creative costs generally are those
incurred by a self-employed individual in the production of
creative properties (such as films, sound recordings, musical
and dance compositions including accompanying words, and other
similar properties), provided the personal efforts of the
individual predominantly create the properties. An eligible
taxpayer is an individual, and also a corporation or
partnership, substantially all of which is owned by one
qualified employee owner (an individual and family members).
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that if any expense is paid
or incurred by the taxpayer in creating or acquiring any
musical composition (including accompanying words) or any
copyright with respect to a musical composition that is
required to be capitalized, then the income forecast method
does not apply to such expenses, but rather, the expenses are
amortized over a five-year period. The five-year period is the
period beginning with the month in which the composition or
copyright was acquired (or if created, the five-taxable-year
period beginning with the taxable year in which the expenses
were paid or incurred).
The provision does not apply to certain expenses. The
expenses to which it does not apply are expenses: (1) that are
qualified creative expenses under section 263A(h); (2) to which
a simplified procedure established under section 263A(j)(2)
applies; (3) that are an amortizable section 197 intangible; or
(4) that, without regard to this provision, would not be
allowable as a deduction.
Effective date.--The provision is effective for expenses
paid or incurred after December 31, 2005, in taxable years
ending after that date.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision with the following modifications. Under the
conference agreement, the five-year amortization period is
elective for the taxable year. Thus, a taxpayer that places in
service any musical composition or copyright with respect to a
musical composition in a taxable year may elect to apply the
provision with respect to all musical compositions and musical
composition copyrights placed in service in that taxable year.
An eligible taxpayer that does not make the election may
recover the costs under any method allowable under present law,
including the income forecast method.
Under the conference agreement, the election may be made
for any taxable year which begins before January 1, 2011.
In addition, the conference agreement provides that the
five-year amortization period begins in the month the property
is placed in service.
Effective date.--The conference agreement is effective
for expenses paid or incurred with respect to property placed
in service in taxable years beginning after December 31, 2005
and before January 1, 2011.
TITLE III--CHARITABLE PROVISIONS
A. Charitable Giving Incentives
1. Charitable deduction for nonitemizers; floor on deductions for
itemizers (sec. 201 of the Senate amendment and secs. 63 and
170 of the Code)
PRESENT LAW
In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property contributed
to a charity described in section 501(c)(3), to certain
veterans' organizations, fraternal societies, and cemetery
companies,\56\ or to a Federal, State, or local governmental
entity for exclusively public purposes.\57\ The deduction also
is allowed for purposes of calculating alternative minimum
taxable income.
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\56\ Secs. 170(c)(3)-(5).
\57\ Sec. 170(c)(1).
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The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the type
of charitable organization to which the property is
contributed, and the income of the taxpayer.\58\
---------------------------------------------------------------------------
\58\ 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.\59\
---------------------------------------------------------------------------
\59\ Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a
temporary provision that permitted individual taxpayers who did not
itemize income tax deductions to claim a deduction from gross income
for a specified percentage of their charitable contributions. The
maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent
of the amount of the contribution for 1985, and 100 percent of the
amount of the contribution for 1986. The nonitemizer deduction
terminated for contributions made after 1986.
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A payment to a charity (regardless of whether it is
termed a ``contribution'') in exchange for which the donor
receives an economic benefit is not deductible, except to the
extent that the donor can demonstrate that the payment exceeds
the fair market value of the benefit received from the charity.
To facilitate distinguishing charitable contributions from
purchases of goods or services from charities, present law
provides that no charitable contribution deduction is allowed
for a separate contribution of $250 or more unless the donor
obtains a contemporaneous written acknowledgement of the
contribution from the charity indicating whether the charity
provided any good or service (and an estimate of the value of
any such good or service) to the taxpayer in consideration for
the contribution.\60\ In addition, present law requires that
any charity that receives a contribution exceeding $75 made
partly as a gift and partly as consideration for goods or
services furnished by the charity (a ``quid pro quo''
contribution) is required to inform the contributor in writing
of an estimate of the value of the goods or services furnished
by the charity and that only the portion exceeding the value of
the goods or services is deductible as a charitable
contribution.\61\
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\60\ Sec. 170(f)(8).
\61\ Sec. 6115.
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Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating loss
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property
to public charities generally may be deducted up to 30 percent
of the taxpayer's contribution base, (2) contributions of cash
to private foundations and certain other charitable
organizations generally may be deducted up to 30 percent of the
taxpayer's contribution base, and (3) contributions of capital
gain property to private foundations and certain other
charitable organizations generally may be deducted up to 20
percent of the taxpayer's contribution base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limit may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes a
reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2006 is
$150,500 ($77,250 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount, but
not by more than 80 percent of itemized deductions subject to
the limit. Beginning in 2006, the overall limitation on
itemized deductions phases-out for all taxpayers. The overall
limitation on itemized deductions is reduced by one-third in
taxable years beginning in 2006 and 2007, and by two-thirds in
taxable years beginning in 2008 and 2009. The overall
limitation on itemized deductions is eliminated for taxable
years beginning after December 31, 2009; however, this
elimination of the limitation sunsets on December 31, 2010.
HOUSE BILL
No provision.
SENATE AMENDMENT
Deduction for nonitemizers
In the case of an individual taxpayer who does not
itemize deductions, the provision allows a ``direct charitable
deduction'' from adjusted gross income for charitable
contributions paid in cash during the taxable year. This
deduction is allowed in addition to the standard deduction. The
direct charitable deduction is the amount of the deduction
allowable under section 170(a) for the taxable year for cash
contributions (determined without regard to any carryover). The
amount deductible under the provision is subject to the rules
normally governing charitable contribution deductions, such as
the substantiation requirements. In addition, the amount of the
deduction is available only to the extent that the otherwise
allowable direct charitable deduction exceeds the floor on
charitable contributions, described below (i.e., $210 ($420 in
the case of a joint return)). The deduction is allowed in
computing alternative minimum taxable income.
The provision does not change the present-law rules
regarding the carryover of charitable contributions to or from
a taxable year, including a taxable year in which the taxpayer
is allowed the direct contribution deduction.
Floor on itemized deductions
Under the provision, the amount of an individual's
charitable contribution deduction (cash and noncash) is subject
to a floor. The floor is $210 ($420 in the case of a joint
return). In the case of an individual who elects to itemize
deductions, the floor applies to the deduction otherwise
allowed under section 170 for all contributions. In the case of
an individual who does not elect to itemize deductions, the
floor applies in determining the amount of the direct
charitable deduction. The provision does not otherwise change
the present-law rules pertaining to charitable contributions.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005, and before January 1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Tax-free distributions from individual retirement plans for
charitable purposes (sec. 202 of the Senate amendment and secs.
408, 6034, 6104, and 6652 of the Code)
PRESENT LAW
In general
If an amount withdrawn from a traditional individual
retirement arrangement (``IRA'') or a Roth IRA is donated to a
charitable organization, the rules relating to the tax
treatment of withdrawals from IRAs apply to the amount
withdrawn and the charitable contribution is subject to the
normally applicable limitations on deductibility of such
contributions.
Charitable contributions
In computing taxable income, an individual taxpayer who
itemizes deductions generally is allowed to deduct the amount
of cash and up to the fair market value of property contributed
to a charity described in section 501(c)(3), to certain
veterans' organizations, fraternal societies, and cemetery
companies,\62\ or to a Federal, State, or local governmental
entity for exclusively public purposes.\63\ The deduction also
is allowed for purposes of calculating alternative minimum
taxable income.
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\62\ Secs. 170(c)(3)-(5).
\63\ Sec. 170(c)(1).
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The amount of the deduction allowable for a taxable year
with respect to a charitable contribution of property may be
reduced depending on the type of property contributed, the type
of charitable organization to which the property is
contributed, and the income of the taxpayer.\64\
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\64\ Secs. 170(b) and (e).
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A taxpayer who takes the standard deduction (i.e., who
does not itemize deductions) may not take a separate deduction
for charitable contributions.\65\
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\65\ Sec. 170(a).
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A payment to a charity (regardless of whether it is
termed a ``contribution'') in exchange for which the donor
receives an economic benefit is not deductible, except to the
extent that the donor can demonstrate, among other things, that
the payment exceeds the fair market value of the benefit
received from the charity. To facilitate distinguishing
charitable contributions from purchases of goods or services
from charities, present law provides that no charitable
contribution deduction is allowed for a separate contribution
of $250 or more unless the donor obtains a contemporaneous
written acknowledgement of the contribution from the charity
indicating whether the charity provided any good or service
(and an estimate of the value of any such good or service) to
the taxpayer in consideration for the contribution.\66\ In
addition, present law requires that any charity that receives a
contribution exceeding $75 made partly as a gift and partly as
consideration for goods or services furnished by the charity (a
``quid pro quo'' contribution) is required to inform the
contributor in writing of an estimate of the value of the goods
or services furnished by the charity and that only the portion
exceeding the value of the goods or services may be deductible
as a charitable contribution.\67\
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\66\ Sec. 170(f)(8).
\67\ Sec. 6115.
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Under present law, total deductible contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base, which is the taxpayer's adjusted gross
income for a taxable year (disregarding any net operating loss
carryback). To the extent a taxpayer has not exceeded the 50-
percent limitation, (1) contributions of capital gain property
to public charities generally may be deducted up to 30 percent
of the taxpayer's contribution base, (2) contributions of cash
to private foundations and certain other charitable
organizations generally may be deducted up to 30 percent of the
taxpayer's contribution base, and (3) contributions of capital
gain property to private foundations and certain other
charitable organizations generally may be deducted up to 20
percent of the taxpayer's contribution base.
Contributions by individuals in excess of the 50-percent,
30-percent, and 20-percent limits may be carried over and
deducted over the next five taxable years, subject to the
relevant percentage limitations on the deduction in each of
those years.
In addition to the percentage limitations imposed
specifically on charitable contributions, present law imposes a
reduction on most itemized deductions, including charitable
contribution deductions, for taxpayers with adjusted gross
income in excess of a threshold amount, which is indexed
annually for inflation. The threshold amount for 2006 is
$150,500 ($75,250 for married individuals filing separate
returns). For those deductions that are subject to the limit,
the total amount of itemized deductions is reduced by three
percent of adjusted gross income over the threshold amount, but
not by more than 80 percent of itemized deductions subject to
the limit. Beginning in 2006, the overall limitation on
itemized deductions phases-out for all taxpayers. The overall
limitation on itemized deductions is reduced by one-third in
taxable years beginning in 2006 and 2007, and by two-thirds in
taxable years beginning in 2008 and 2009. The overall
limitation on itemized deductions is eliminated for taxable
years beginning after December 31, 2009; however, this
elimination of the limitation sunsets on December 31, 2010.
In general, a charitable deduction is not allowed for
income, estate, or gift tax purposes if the donor transfers an
interest in property to a charity (e.g., a remainder) while
also either retaining an interest in that property (e.g., an
income interest) or transferring an interest in that property
to a noncharity for less than full and adequate
consideration.\68\ Exceptions to this general rule are provided
for, among other interests, remainder interests in charitable
remainder annuity trusts, charitable remainder unitrusts, and
pooled income funds, and present interests in the form of a
guaranteed annuity or a fixed percentage of the annual value of
the property.\69\ For such interests, a charitable deduction is
allowed to the extent of the present value of the interest
designated for a charitable organization.
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\68\ Secs. 170(f), 2055(e)(2), and 2522(c)(2).
\69\ Sec. 170(f)(2).
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IRA rules
Within limits, individuals may make deductible and
nondeductible contributions to a traditional IRA. Amounts in a
traditional IRA are includible in income when withdrawn (except
to the extent the withdrawal represents a return of
nondeductible contributions). Individuals also may make
nondeductible contributions to a Roth IRA. Qualified
withdrawals from a Roth IRA are excludable from gross income.
Withdrawals from a Roth IRA that are not qualified withdrawals
are includible in gross income to the extent attributable to
earnings. Includible amounts withdrawn from a traditional IRA
or a Roth IRA before attainment of age 59\1/2\ are subject to
an additional 10-percent early withdrawal tax, unless an
exception applies. Under present law, minimum distributions are
required to be made from tax-favored retirement arrangements,
including IRAs. Minimum required distributions from a
traditional IRA must generally begin by the April 1 of the
calendar year following the year in which the IRA owner attains
age 70\1/2\.\70\
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\70\ Minimum distribution rules also apply in the case of
distributions after the death of a traditional or Roth IRA owner.
---------------------------------------------------------------------------
If an individual has made nondeductible contributions to
a traditional IRA, a portion of each distribution from an IRA
is nontaxable until the total amount of nondeductible
contributions has been received. In general, the amount of a
distribution that is nontaxable is determined by multiplying
the amount of the distribution by the ratio of the remaining
nondeductible contributions to the account balance. In making
the calculation, all traditional IRAs of an individual are
treated as a single IRA, all distributions during any taxable
year are treated as a single distribution, and the value of the
contract, income on the contract, and investment in the
contract are computed as of the close of the calendar year.
In the case of a distribution from a Roth IRA that is not
a qualified distribution, in determining the portion of the
distribution attributable to earnings, contributions and
distributions are deemed to be distributed in the following
order: (1) regular Roth IRA contributions; (2) taxable
conversion contributions;\71\ (3) nontaxable conversion
contributions; and (4) earnings. In determining the amount of
taxable distributions from a Roth IRA, all Roth IRA
distributions in the same taxable year are treated as a single
distribution, all regular Roth IRA contributions for a year are
treated as a single contribution, and all conversion
contributions during the year are treated as a single
contribution.
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\71\ Conversion contributions refer to conversions of amounts in a
traditional IRA to a Roth IRA.
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Distributions from an IRA (other than a Roth IRA) are
generally subject to withholding unless the individual elects
not to have withholding apply.\72\ Elections not to have
withholding apply are to be made in the time and manner
prescribed by the Secretary.
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\72\ Sec. 3405.
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Split-interest trust filing requirements
Split-interest trusts, including charitable remainder
annuity trusts, charitable remainder unitrusts, and pooled
income funds, are required to file an annual information return
(Form 1041A).\73\ Trusts that are not split-interest trusts but
that claim a charitable deduction for amounts permanently set
aside for a charitable purpose\74\ also are required to file
Form 1041A. The returns are required to be made publicly
available.\75\ A trust that is required to distribute all trust
net income currently to trust beneficiaries in a taxable year
is exempt from this return requirement for such taxable year. A
failure to file the required return may result in a penalty on
the trust of $10 a day for as long as the failure continues, up
to a maximum of $5,000 per return.
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\73\ Sec. 6034. This requirement applies to all split-interest
trusts described in section 4947(a)(2).
\74\ Sec. 642(c).
\75\ Sec. 6104(b).
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In addition, split-interest trusts are required to file
annually Form 5227.\76\ Form 5227 requires disclosure of
information regarding a trust's noncharitable beneficiaries.
The penalty for failure to file this return is calculated based
on the amount of tax owed. A split-interest trust generally is
not subject to tax and therefore, in general, a penalty may not
be imposed for the failure to file Form 5227. Form 5227 is not
required to be made publicly available.
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\76\ Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
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HOUSE BILL
No provision.
SENATE AMENDMENT
Qualified charitable distributions from IRAs
The provision provides an exclusion from gross income for
otherwise taxable IRA distributions from a traditional or a
Roth IRA in the case of qualified charitable distributions.\77\
Special rules apply in determining the amount of an IRA
distribution that is otherwise taxable. The present-law rules
regarding taxation of IRA distributions and the deduction of
charitable contributions continue to apply to distributions
from an IRA that are not qualified charitable distributions.
Qualified charitable distributions are taken into account for
purposes of the minimum distribution rules applicable to
traditional IRAs to the same extent the distribution would have
been taken into account under such rules had the distribution
not been directly distributed under the provision. An IRA does
not fail to qualify as an IRA merely because qualified
charitable distributions have been made from the IRA. It is
intended that the Secretary will prescribe rules under which
IRA owners are deemed to elect out of withholding if they
designate that a distribution is intended to be a qualified
charitable distribution.
---------------------------------------------------------------------------
\77\ The provision does not apply to distributions from employer-
sponsored retirements plans, including SIMPLE IRAs and simplified
employee pensions (``SEPs'').
---------------------------------------------------------------------------
A qualified charitable distribution is any distribution
from an IRA that is made after December 31, 2005, and before
January 1, 2008, directly by the IRA trustee either to (1) an
organization to which deductible contributions can be made (a
``direct distribution'') or (2) a ``split-interest entity.'' A
split-interest entity means a charitable remainder annuity
trust or charitable remainder unitrust (together referred to as
a ``charitable remainder trust''), a pooled income fund, or a
charitable gift annuity. Direct distributions are eligible for
the exclusion only if made on or after the date the IRA owner
attains age 70\1/2\. Distributions to a split interest entity
are eligible for the exclusion only if made on or after the
date the IRA owner attains age 59\1/2\. In the case of
distributions to split-interest distributions, no person may
hold an income interest in the amounts in the split-interest
entity attributable to the charitable distribution other than
the IRA owner, the IRA owner's spouse, or a charitable
organization.
The exclusion applies to direct distributions only if a
charitable contribution deduction for the entire distribution
otherwise would be allowable (under present law), determined
without regard to the generally applicable percentage
limitations. Thus, for example, if the deductible amount is
reduced because of a benefit received in exchange, or if a
deduction is not allowable because the donor did not obtain
sufficient substantiation, the exclusion is not available with
respect to any part of the IRA distribution. Similarly, the
exclusion applies in the case of a distribution directly to a
split-interest entity only if a charitable contribution
deduction for the entire present value of the charitable
interest (for example, a remainder interest) otherwise would be
allowable, determined without regard to the generally
applicable percentage limitations.
If the IRA owner has any IRA that includes nondeductible
contributions, a special rule applies in determining the
portion of a distribution that is includible in gross income
(but for the provision) and thus is eligible for qualified
charitable distribution treatment. Under the special rule, the
distribution is treated as consisting of income first, up to
the aggregate amount that would be includible in gross income
(but for the provision) if the aggregate balance of all IRAs
having the same owner were distributed during the same year. In
determining the amount of subsequent IRA distributions
includible in income, proper adjustments are to be made to
reflect the amount treated as a qualified charitable
distribution under the special rule.
Special rules apply for distributions to split-interest
entities. For distributions to charitable remainder trusts, the
provision provides that subsequent distributions from the
charitable remainder trust are treated as ordinary income in
the hands of the beneficiary, notwithstanding how such amounts
normally are treated under section 664(b). In addition, for a
charitable remainder trust to be eligible to receive qualified
charitable distributions, the charitable remainder trust has to
be funded exclusively by such distributions. For example, an
IRA owner may not make qualified charitable distributions to an
existing charitable remainder trust any part of which was
funded with assets that were not qualified charitable
distributions.
Under the provision, a pooled income fund is eligible to
receive qualified charitable distributions only if the fund
accounts separately for amounts attributable to such
distributions. In addition, all distributions from the pooled
income fund that are attributable to qualified charitable
distributions are treated as ordinary income to the
beneficiary. Qualified charitable distributions to a pooled
income fund are not includible in the fund's gross income.
In determining the amount includible in gross income by
reason of a payment from a charitable gift annuity purchased
with a qualified charitable distribution from an IRA, the
portion of the distribution from the IRA used to purchase the
annuity is not an investment in the annuity contract.
Any amount excluded from gross income by reason of the
provision is not taken into account in determining the
deduction for charitable contributions under section 170.
Qualified charitable distribution examples
The following examples illustrate the determination of
the portion of an IRA distribution that is a qualified
charitable distribution and the application of the special
rules for a qualified charitable distribution to a split-
interest entity. In each example, it is assumed that the
requirements for qualified charitable distribution treatment
are otherwise met (e.g., the applicable age requirement and the
requirement that contributions are otherwise deductible) and
that no other IRA distributions occur during the year.
Example 1.--Individual A has a traditional IRA with a
balance of $100,000, consisting solely of deductible
contributions and earnings. Individual A has no other IRA. The
entire IRA balance is distributed in a direct distribution to a
charitable organization. Under present law, the entire
distribution of $100,000 would be includible in Individual A's
income. Accordingly, under the provision, the entire
distribution of $100,000 is a qualified charitable
distribution. As a result, no amount is included in Individual
A's income as a result of the distribution and the distribution
is not taken into account in determining the amount of
Individual A's charitable deduction for the year.
Example 2.--The facts are the same as in Example 1,
except that the entire IRA balance of $100,000 is distributed
to a charitable remainder unitrust, which contains no other
assets and which must be funded exclusively by qualified
charitable distributions. Under the terms of the trust,
Individual A is entitled to receive five percent of the net
fair market value of the trust assets each year. As explained
in Example 1, the entire $100,000 distribution is a qualified
charitable distribution, no amount is included in Individual
A's income as a result of the distribution, and the
distribution is not taken into account in determining the
amount of Individual A's charitable deduction for the year. In
addition, under a special rule in the provision for charitable
remainder trusts, any distribution from the charitable
remainder unitrust to Individual A is includible in gross
income as ordinary income, regardless of the character of the
distribution under the usual rules for the taxation of
distributions from such a trust.
Example 3.--Individual B has a traditional IRA with a
balance of $100,000, consisting of $20,000 of nondeductible
contributions and $80,000 of deductible contributions and
earnings. Individual B has no other IRA. In a direct
distribution to a charitable organization, $80,000 is
distributed from the IRA. Under present law, a portion of the
distribution from the IRA would be treated as a nontaxable
return of nondeductible contributions. The nontaxable portion
of the distribution would be $16,000, determined by multiplying
the amount of the distribution ($80,000) by the ratio of the
nondeductible contributions to the account balance ($20,000/
$100,000). Accordingly, under present law, $64,000 of the
distribution ($80,000 minus $16,000) would be includible in
Individual B's income.
Under the provision, notwithstanding the present-law tax
treatment of IRA distributions, the distribution is treated as
consisting of income first, up to the total amount that would
be includible in gross income (but for the provision) if all
amounts were distributed from all IRAs otherwise taken into
account in determining the amount of IRA distributions. The
total amount that would be includible in income if all amounts
were distributed from the IRA is $80,000. Accordingly, under
the provision, the entire $80,000 distributed to the charitable
organization is treated as includible in income (before
application of the provision) and is a qualified charitable
distribution. As a result, no amount is included in Individual
B's income as a result of the distribution and the distribution
is not taken into account in determining the amount of
Individual B's charitable deduction for the year. In addition,
for purposes of determining the tax treatment of other
distributions from the IRA, $20,000 of the amount remaining in
the IRA is treated as Individual B's nondeductible
contributions (i.e., not subject to tax upon distribution).
Split-interest trust filing requirements
The provision increases the penalty on split-interest
trusts for failure to file a return and for failure to include
any of the information required to be shown on such return and
to show the correct information. The penalty is $20 for each
day the failure continues up to $10,000 for any one return. In
the case of a split-interest trust with gross income in excess
of $250,000, the penalty is $100 for each day the failure
continues up to a maximum of $50,000. In addition, if a person
(meaning any officer, director, trustee, employee, or other
individual who is under a duty to file the return or include
required information) \78\ knowingly failed to file the return
or include required information, then that person is personally
liable for such a penalty, which would be imposed in addition
to the penalty that is paid by the organization. Information
regarding beneficiaries that are not charitable organizations
as described in section 170(c) is exempt from the requirement
to make information publicly available. In addition, the
provision repeals the present-law exception to the filing
requirement for split-interest trusts that are required in a
taxable year to distribute all net income currently to
beneficiaries. Such exception remains available to trusts other
than split-interest trusts that are otherwise subject to the
filing requirement.
---------------------------------------------------------------------------
\78\ Sec. 6652(c)(4)(C).
---------------------------------------------------------------------------
Effective date
The provision relating to qualified charitable
distributions is effective for distributions made in taxable
years beginning after December 31, 2005, and before January 1,
2008. The provision relating to information returns of split-
interest trusts is effective for returns for taxable years
beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
3. Charitable deduction for contributions of food inventory (sec. 203
of the Senate amendment and sec. 170 of the Code)
PRESENT LAW
Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory, or if less
the fair market value of the inventory.
For certain contributions of inventory, C corporations
may claim an enhanced deduction equal to the lesser of (1)
basis plus one-half of the item's appreciation (i.e., basis
plus one half of fair market value in excess of basis) or (2)
two times basis (sec. 170(e)(3)). In general, a C corporation's
charitable contribution deductions for a year may not exceed 10
percent of the corporation's taxable income (sec. 170(b)(2)).
To be eligible for the enhanced deduction, the contributed
property generally must be inventory of the taxpayer,
contributed to a charitable organization described in section
501(c)(3) (except for private nonoperating foundations), and
the donee must (1) use the property consistent with the donee's
exempt purpose solely for the care of the ill, the needy, or
infants, (2) not transfer the property in exchange for money,
other property, or services, and (3) provide the taxpayer a
written statement that the donee's use of the property will be
consistent with such requirements. In the case of contributed
property subject to the Federal Food, Drug, and Cosmetic Act,
the property must satisfy the applicable requirements of such
Act on the date of transfer and for 180 days prior to the
transfer.
A donor making a charitable contribution of inventory
must make a corresponding adjustment to the cost of goods sold
by decreasing the cost of goods sold by the lesser of the fair
market value of the property or the donor's basis with respect
to the inventory (Treas. Reg. sec. 1.170A-4A(c)(3)).
Accordingly, if the allowable charitable deduction for
inventory is the fair market value of the inventory, the donor
reduces its cost of goods sold by such value, with the result
that the difference between the fair market value and the
donor's basis may still be recovered by the donor other than as
a charitable contribution.
To use the enhanced deduction, the taxpayer must
establish that the fair market value of the donated item
exceeds basis. The valuation of food inventory has been the
subject of disputes between taxpayers and the IRS.\79\
---------------------------------------------------------------------------
\79\ Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995)
(holding that the value of surplus bread inventory donated to charity
was the full retail price of the bread rather than half the retail
price, as the IRS asserted).
---------------------------------------------------------------------------
Under the Katrina Emergency Tax Relief Act of 2005, any
taxpayer, whether or not a C corporation, engaged in a trade or
business is eligible to claim the enhanced deduction for
certain donations made after August 28, 2005, and before
January 1, 2006, of food inventory. For taxpayers other than C
corporations, the total deduction for donations of food
inventory in a taxable year generally may not exceed 10 percent
of the taxpayer's net income for such taxable year from all
sole proprietorships, S corporations, or partnerships (or other
entity that is not a C corporation) from which contributions of
``apparently wholesome food'' are made. ``Apparently wholesome
food'' is defined as food intended for human consumption that
meets all quality and labeling standards imposed by Federal,
State, and local laws and regulations even though the food may
not be readily marketable due to appearance, age, freshness,
grade, size, surplus, or other conditions.
HOUSE BILL
No provision.
SENATE AMENDMENT
Extension of Katrina Emergency Tax Relief Act of 2005
The provision extends the provision enacted as part of
the Katrina Emergency Tax Relief Act of 2005. As under such
Act, under the provision, any taxpayer, whether or not a C
corporation, engaged in a trade or business is eligible to
claim the enhanced deduction for donations of food inventory.
For taxpayers other than C corporations, the total deduction
for donations of food inventory in a taxable year generally may
not exceed 10 percent of the taxpayer's net income for such
taxable year from all sole proprietorships, S corporations, or
partnerships (or other non C corporation) from which
contributions of apparently wholesome food are made. For
example, as under the Katrina Emergency Tax Relief Act of 2005,
if a taxpayer is a sole proprietor, a shareholder in an S
corporation, and a partner in a partnership, and each business
makes charitable contributions of food inventory, the
taxpayer's deduction for donations of food inventory is limited
to 10 percent of the taxpayer's net income from the sole
proprietorship and the taxpayer's interests in the S
corporation and partnership. However, if only the sole
proprietorship and the S corporation made charitable
contributions of food inventory, the taxpayer's deduction would
be limited to 10 percent of the net income from the trade or
business of the sole proprietorship and the taxpayer's interest
in the S corporation, but not the taxpayer's interest in the
partnership.\80\
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\80\ The 10 percent limitation does not affect the application of
the generally applicable percentage limitations. For example, if 10
percent of a sole proprietor's net income from the proprietor's trade
or business was greater than 50 percent of the proprietor's
contribution base, the available deduction for the taxable year (with
respect to contributions to public charities) would be 50 percent of
the proprietor's contribution base. Consistent with present law, such
contributions may be carried forward because they exceed the 50 percent
limitation. Contributions of food inventory by a taxpayer that is not a
C corporation that exceed the 10 percent limitation but not the 50
percent limitation could not be carried forward.
---------------------------------------------------------------------------
Under the provision, the enhanced deduction for food is
available only for food that qualifies as ``apparently
wholesome food.'' ``Apparently wholesome food'' is defined as
it is defined under the Katrina Emergency Tax Relief Act of
2005.
Modifications to enhanced deduction for food inventory
Under the provision, for purposes of calculating the
enhanced deduction, taxpayers that do not account for
inventories under section 471 and that are not required to
capitalize indirect costs under section 263A are able to elect
to treat the basis of the contributed food as being equal to 25
percent of the food's fair market value.\81\
---------------------------------------------------------------------------
\81\ This includes, for example, taxpayers who are eligible for
administrative relief under Revenue Procedures 2002-28 and 2001-10.
---------------------------------------------------------------------------
The provision changes the amount of the enhanced
deduction for eligible contributions of food inventory to the
lesser of fair market value or twice the taxpayer's basis in
the inventory. For example, a taxpayer who makes an eligible
donation of food that has a fair market value of $10 and a
basis of $4 could take a deduction of $8 (twice basis). If the
taxpayer's basis is $6 instead of $4, then the deduction would
be $10 (fair market value). By contrast, under present law, a C
corporation's deduction in the first example would be $7 (fair
market value less half the appreciation) and in the second
example would be $8. (Except for contributions made after
August 28, 2005, and before January 1, 2006, taxpayers other
than C corporations generally could take a deduction for a
contribution of food inventory only for the $4 basis in either
example.)
The provision provides that the fair market value of
donated apparently wholesome food that cannot or will not be
sold solely due to internal standards of the taxpayer or lack
of market is determined without regard to such internal
standards or lack of market and by taking into account the
price at which the same or substantially the same food items
(as to both type and quality) are sold by the taxpayer at the
time of the contribution or, if not so sold at such time, in
the recent past.
Effective date
The provision is effective for contributions made in
taxable years beginning after December 31, 2005, and before
January 1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
4. Basis adjustment to stock of S corporation contributing property
(sec. 204 of the Senate amendment and sec. 1367 of the Code)
PRESENT LAW
Under present law, if an S corporation contributes money
or other property to a charity, each shareholder takes into
account the shareholder's pro rata share of the contribution in
determining its own income tax liability.\82\ A shareholder of
an S corporation reduces the basis in the stock of the S
corporation by the amount of the charitable contribution that
flows through to the shareholder.\83\
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\82\ Sec. 1366(a)(1)(A).
\83\ Sec. 1367(a)(2)(B).
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HOUSE BILL
No provision.
SENATE AMENDMENT
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.\84\
---------------------------------------------------------------------------
\84\ See Rev. Rul. 96-11 (1996-1 C.B. 140) for a rule reaching a
similar result in the case of charitable contributions made by a
partnership.
---------------------------------------------------------------------------
Thus, for example, assume an S corporation with one
individual shareholder makes a charitable contribution of stock
with a basis of $200 and a fair market value of $500. The
shareholder will be treated as having made a $500 charitable
contribution (or a lesser amount if the special rules of
section 170(e) apply), and will reduce the basis of the S
corporation stock by $200.\85\
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\85\ This example assumes that basis of the S corporation stock
(before reduction) is at least $200.
---------------------------------------------------------------------------
Effective date.--The provision applies to contributions
made in taxable years beginning after December 31, 2005, and
before January 1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
5. Charitable deduction for contributions of book inventory (sec. 205
of the Senate amendment and sec. 170 of the Code)
PRESENT LAW
Under present law, a taxpayer's deduction for charitable
contributions of inventory generally is limited to the
taxpayer's basis (typically, cost) in the inventory, or if less
the fair market value of the inventory.
For certain contributions of inventory, C corporations
may claim an enhanced deduction equal to the lesser of (1)
basis plus one-half of the item's appreciation (i.e., basis
plus one half of fair market value in excess of basis) or (2)
two times basis (sec. 170(e)(3)). In general, a C corporation's
charitable contribution deductions for a year may not exceed 10
percent of the corporation's taxable income (sec. 170(b)(2)).
To be eligible for the enhanced deduction, the contributed
property generally must be inventory of the taxpayer,
contributed to a charitable organization described in section
501(c)(3) (except for private nonoperating foundations), and
the donee must (1) use the property consistent with the donee's
exempt purpose solely for the care of the ill, the needy, or
infants, (2) not transfer the property in exchange for money,
other property, or services, and (3) provide the taxpayer a
written statement that the donee's use of the property will be
consistent with such requirements. In the case of contributed
property subject to the Federal Food, Drug, and Cosmetic Act,
the property must satisfy the applicable requirements of such
Act on the date of transfer and for 180 days prior to the
transfer.
A donor making a charitable contribution of inventory
must make a corresponding adjustment to the cost of goods sold
by decreasing the cost of goods sold by the lesser of the fair
market value of the property or the donor's basis with respect
to the inventory (Treas. Reg. sec. 1.170A-4A(c)(3)).
Accordingly, if the allowable charitable deduction for
inventory is the fair market value of the inventory, the donor
reduces its cost of goods sold by such value, with the result
that the difference between the fair market value and the
donor's basis may still be recovered by the donor other than as
a charitable contribution.
To use the enhanced deduction, the taxpayer must
establish that the fair market value of the donated item
exceeds basis.
The Katrina Emergency Tax Relief Act of 2005 extended the
present-law enhanced deduction for C corporations to certain
qualified book contributions made after August 28, 2005, and
before January 1, 2006. For such purposes, a qualified book
contribution means a charitable contribution of books to a
public school that provides elementary education or secondary
education (kindergarten through grade 12) and that is an
educational organization that normally maintains a regular
faculty and curriculum and normally has a regularly enrolled
body of pupils or students in attendance at the place where its
educational activities are regularly carried on. The enhanced
deduction under the Katrina Emergency Tax Relief Act of 2005 is
not allowed unless the donee organization certifies in writing
that the contributed books are suitable, in terms of currency,
content, and quantity, for use in the donee's educational
programs and that the donee will use the books in such
educational programs.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision modifies the present-law enhanced deduction
for C corporations so that it is equal to the lesser of fair
market value or twice the taxpayer's basis in the case of
qualified book contributions. The provision provides that the
fair market value for this purpose is determined by reference
to a bona fide published market price for the book. Under the
provision, a bona fide published market price of a book is a
price of a book, determined using the same printing and same
edition, published within seven years preceding the
contribution, determined as a result of an arm's length
transaction, and for which the book was customarily sold. For
example, a publisher's listed retail price for a book would not
meet the standard if the publisher could not demonstrate to the
satisfaction of the Secretary that the price was one at which
the book was customarily sold and was the result of an arm's
length transaction. If a publisher entered into a contract with
a local school district to sell newly published textbooks six
years prior to making a qualified book contribution of such
textbooks, the publisher could use as a bona fide published
market price, the price at which such books regularly were sold
to the school district under the contract. By contrast, if a
publisher listed in a catalogue or elsewhere a ``suggested
retail price,'' but books were not in fact customarily sold at
such price, the publisher could not use the ``suggested retail
price'' to determine the fair market value of the book for
purposes of the enhanced deduction. Thus, in general, a bona
fide published market price must be independently verifiable by
reference to actual sales within the seven-year period
preceding the contribution, and not to a publisher's own price
list.
As an illustration of the mechanics of calculating the
enhanced deduction under the provision, a C corporation that
made a qualified book contribution with a bona fide published
market price of $10 and a basis of $4 could take a deduction of
$8 (twice basis). If the taxpayer's basis is $6 instead of $4,
then the deduction is $10. Also, in such latter case, if the
book's bona fide published market price was $5 at the time of
the contribution but was $10 five years before the
contribution, then the deduction is $10.
A qualified book contribution means a charitable
contribution of books to: (1) an educational organization that
normally maintains a regular faculty and curriculum and
normally has a regularly enrolled body of pupils or students in
attendance at the place where its educational activities are
regularly carried on; (2) a public library; or (3) an
organization described in section 501(c)(3) (except for private
nonoperating foundations), that is organized primarily to make
books available to the general public at no cost or to operate
a literacy program. The donee must: (1) use the property
consistent with the donee's exempt purpose; (2) not transfer
the property in exchange for money, other property, or
services; and (3) provide the taxpayer a written statement that
the donee's use of the property will be consistent with such
requirements and also that the books are suitable, in terms of
currency, content, and quantity, for use in the donee's
educational programs and that the donee will use the books in
such educational programs.
Effective date.--The provision is effective for
contributions made in taxable years beginning after December
31, 2005, and before January 1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
6. Modify tax treatment of certain payments to controlling exempt
organizations and public disclosure of information relating to
UBIT (sec. 206 of the Senate amendment and secs. 512, 6011,
6104, and new sec. 6720C of the Code)
PRESENT LAW
Payments to controlling exempt organizations
In general, interest, rents, royalties, and annuities are
excluded from the unrelated business income of tax-exempt
organizations. However, section 512(b)(13) generally treats
otherwise excluded rent, royalty, annuity, and interest income
as unrelated business income if such income is received from a
taxable or tax-exempt subsidiary that is 50 percent controlled
by the parent tax-exempt organization. In the case of a stock
subsidiary, ``control'' means ownership by vote or value of
more than 50 percent of the stock. In the case of a partnership
or other entity, control means ownership of more than 50
percent of the profits, capital or beneficial interests. In
addition, present law applies the constructive ownership rules
of section 318 for purposes of section 512(b)(13). Thus, a
parent exempt organization is deemed to control any subsidiary
in which it holds more than 50 percent of the voting power or
value, directly (as in the case of a first-tier subsidiary) or
indirectly (as in the case of a second-tier subsidiary).
Under present law, interest, rent, annuity, or royalty
payments made by a controlled entity to a tax-exempt
organization are includable in the latter organization's
unrelated business income and are subject to the unrelated
business income tax to the extent the payment reduces the net
unrelated income (or increases any net unrelated loss) of the
controlled entity (determined as if the entity were tax
exempt).
The Taxpayer Relief Act of 1997 (the ``1997 Act'') made
several modifications to the control requirement of section
512(b)(13). In order to provide transitional relief, the
changes made by the 1997 Act do not apply to any payment
received or accrued during the first two taxable years
beginning on or after the date of enactment of the 1997 Act
(August 5, 1997) if such payment is received or accrued
pursuant to a binding written contract in effect on June 8,
1997, and at all times thereafter before such payment (but not
pursuant to any contract provision that permits optional
accelerated payments).
Public disclosure of returns
In general, an organization described in section 501(c)
or (d) is required to make available for public inspection a
copy of its annual information return (Form 990) and exemption
application materials.\86\ A penalty may be imposed on any
person who does not make an organization's annual returns or
exemption application materials available for public
inspection. The penalty amount is $20 for each day during which
a failure occurs. If more than one person fails to comply, each
person is jointly and severally liable for the full amount of
the penalty. The maximum penalty that may be imposed on all
persons for any one annual return is $10,000. There is no
maximum penalty amount for failing to make exemption
application materials available for public inspection. Any
person who willfully fails to comply with the public inspection
requirements is subject to an additional penalty of $5,000.\87\
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\86\ Sec. 6104(d).
\87\ Sec. 6685.
---------------------------------------------------------------------------
These requirements do not apply to an organization's
annual return for unrelated business income tax (generally Form
990-T).\88\
---------------------------------------------------------------------------
\88\ Treas. Reg. sec. 301.6104(d)-1(b)(4)(ii).
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HOUSE BILL
No provision.
SENATE AMENDMENT
Payments to controlling exempt organizations
The provision provides that the general rule of section
512(b)(13), which includes interest, rent, annuity, or royalty
payments made by a controlled entity to a tax-exempt
organization in the latter organization's unrelated business
income to the extent the payment reduces the net unrelated
income (or increases any net unrelated loss) of the controlled
entity, applies only to the portion of payments received or
accrued in a taxable year that exceed the amount of the
specified payment that would have been paid or accrued if such
payment had been determined under the principles of section
482. Thus, if a payment of rent by a controlled subsidiary to
its tax-exempt parent organization exceeds fair market value,
the excess amount of such payment over fair market value (as
determined in accordance with section 482) is included in the
parent organization's unrelated business income, to the extent
that such excess reduced the net unrelated income (or increased
any net unrelated loss) of the controlled entity (determined as
if the entity were tax exempt). In addition, the provision
imposes a 20-percent penalty on the larger of such excess
determined without regard to any amendment or supplement to a
return of tax, or such excess determined with regard to all
such amendments and supplements.
The provision provides that if modifications to section
512(b)(13) made by the 1997 Act did not apply to a contract
because of the transitional relief provided by the 1997 Act,
then such modifications also do not apply to amounts received
or accrued under such contract before January 1, 2001.
Require public availability of unrelated business income tax returns
The provision extends the present-law public inspection
and disclosure requirements and penalties applicable to the
Form 990 to the unrelated business income tax return (Form 990-
T) of organizations described in section 501(c)(3). The
provision provides that certain information may be withheld by
the organization from public disclosure and inspection if
public availability would adversely affect the organization,
similar to the information that may be withheld under present
law with respect to applications for tax exemption and the Form
990 (e.g., information relating to a trade secret, patent,
process, style of work, or apparatus of the organization, if
the Secretary determines that public disclosure of such
information would adversely affect the organization).
Require a UBIT certification for certain large charitable organizations
Under the provision, a charitable organization that has
annual total gross income and receipts (including, e.g.,
contributions and grants, program service revenue, investment
income, and revenues from an unrelated trade or business or
other sources) or gross assets of at least $10 million on the
last day of the taxable year must include with its Form 990 and
Form 990-T filings (if any) a statement by an independent
auditor or an independent counsel that (1) contains a
certification that the information contained in the return has
been reviewed by the auditor or counsel and, to the best of his
or her knowledge, is accurate; (2) to the best of the auditor's
or counsel's knowledge, the allocation of expenses between the
exempt and the unrelated business income activities of the
organization comply with the requirements set forth by the
Secretary under section 512; and (3) indicates whether the
auditor or counsel has provided a tax opinion to the
organization regarding the classification of any trade or
business of the organization as an unrelated trade or business
or the treatment of any income as unrelated business taxable
income and a description of any material facts with respect to
any such opinion.
Failure to file the required statement results in a
penalty, imposed on the organization, of one half of one
percent (0.5 percent) of the organization's total gross
revenues for the taxable year, excluding revenues from
contributions and grants. No penalty is imposed with respect to
any failure that is due to reasonable cause.
Effective date.--The provision related to payments to
controlling organizations applies to payments received or
accrued after December 31, 2000. The public availability
requirements of the provision apply to returns filed after the
date of enactment. The certification requirement applies to
returns for taxable years beginning after the date of
enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
7. Encourage contributions of real property made for conservation
purposes (sec. 207 of the Senate amendment and sec. 170 of the
Code)
PRESENT LAW
Charitable contributions generally
In general, a deduction is permitted for charitable
contributions, subject to certain limitations that depend on
the type of taxpayer, the property contributed, and the donee
organization. The amount of deduction generally equals the fair
market value of the contributed property on the date of the
contribution. Charitable deductions are provided for income,
estate, and gift tax purposes.\89\
---------------------------------------------------------------------------
\89\ Secs. 170, 2055, and 2522, respectively.
---------------------------------------------------------------------------
In general, in any taxable year, charitable contributions
by a corporation are not deductible to the extent the aggregate
contributions exceed 10 percent of the corporation's taxable
income computed without regard to net operating or capital loss
carrybacks. For individuals, the amount deductible is a
percentage of the taxpayer's contribution base, which is the
taxpayer's adjusted gross income computed without regard to any
net operating loss carryback. The applicable percentage of the
contribution base varies depending on the type of donee
organization and property contributed. Cash contributions of an
individual taxpayer to public charities, private operating
foundations, and certain types of private nonoperating
foundations may not exceed 50 percent of the taxpayer's
contribution base. Cash contributions to private foundations
and certain other organizations generally may be deducted up to
30 percent of the taxpayer's contribution base.
In general, a charitable deduction is not allowed for
income, estate, or gift tax purposes if the donor transfers an
interest in property to a charity while also either retaining
an interest in that property or transferring an interest in
that property to a noncharity for less than full and adequate
consideration. Exceptions to this general rule are provided
for, among other interests, remainder interests in charitable
remainder annuity trusts, charitable remainder unitrusts, and
pooled income funds, present interests in the form of a
guaranteed annuity or a fixed percentage of the annual value of
the property, and qualified conservation contributions.
Capital gain property
Capital gain property means any capital asset or property
used in the taxpayer's trade or business the sale of which at
its fair market value, at the time of contribution, would have
resulted in gain that would have been long-term capital gain.
Contributions of capital gain property to a qualified charity
are deductible at fair market value within certain limitations.
Contributions of capital gain property to charitable
organizations described in section 170(b)(1)(A) (e.g., public
charities, private foundations other than private non-operating
foundations, and certain governmental units) generally are
deductible up to 30 percent of the taxpayer's contribution
base. An individual may elect, however, to bring all these
contributions of capital gain property for a taxable year
within the 50-percent limitation category by reducing the
amount of the contribution deduction by the amount of the
appreciation in the capital gain property. Contributions of
capital gain property to charitable organizations described in
section 170(b)(1)(B) (e.g., private non-operating foundations)
are deductible up to 20 percent of the taxpayer's contribution
base.
For purposes of determining whether a taxpayer's
aggregate charitable contributions in a taxable year exceed the
applicable percentage limitation, contributions of capital gain
property are taken into account after other charitable
contributions. Contributions of capital gain property that
exceed the percentage limitation may be carried forward for
five years.
Qualified conservation contributions
Qualified conservation contributions are not subject to
the ``partial interest'' rule, which generally bars deductions
for charitable contributions of partial interests in property.
A qualified conservation contribution is a contribution of a
qualified real property interest to a qualified organization
exclusively for conservation purposes. A qualified real
property interest is defined as: (1) the entire interest of the
donor other than a qualified mineral interest; (2) a remainder
interest; or (3) a restriction (granted in perpetuity) on the
use that may be made of the real property. Qualified
organizations include certain governmental units, public
charities that meet certain public support tests, and certain
supporting organizations. Conservation purposes include: (1)
the preservation of land areas for outdoor recreation by, or
for the education of, the general public; (2) the protection of
a relatively natural habitat of fish, wildlife, or plants, or
similar ecosystem; (3) the preservation of open space
(including farmland and forest land) where such preservation
will yield a significant public benefit and is either for the
scenic enjoyment of the general public or pursuant to a clearly
delineated Federal, State, or local governmental conservation
policy; and (4) the preservation of an historically important
land area or a certified historic structure.
Qualified conservation contributions of capital gain
property are subject to the same limitations and carryover
rules of other charitable contributions of capital gain
property.
HOUSE BILL
No provision.
SENATE AMENDMENT
In general
Under the provision, the 30-percent contribution base
limitation on contributions of capital gain property by
individuals does not apply to qualified conservation
contributions (as defined under present law). Instead,
individuals may deduct the fair market value of any qualified
conservation contribution to an organization described in
section 170(b)(1)(A) to the extent of the excess of 50-percent
of the contribution base over the amount of all other allowable
charitable contributions. These contributions are not taken
into account in determining the amount of other allowable
charitable contributions.
Individuals are allowed to carryover any qualified
conservation contributions that exceed the 50-percent
limitation for up to 15 years.
For example, assume an individual with a contribution
base of $100 makes a qualified conservation contribution of
property with a fair market value of $80 and makes other
charitable contributions subject to the 50-percent limitation
of $60. The individual is allowed a deduction of $50 in the
current taxable year for the non-conservation contributions (50
percent of the $100 contribution base) and is allowed to
carryover the excess $10 for up to 5 years. No current
deduction is allowed for the qualified conservation
contribution, but the entire $80 qualified conservation
contribution may be carried forward for up to 15 years.
Farmers and ranchers
Individuals
In the case of an individual who is a qualified farmer or
rancher for the taxable year in which the contribution is made,
a qualified conservation contribution is allowable up to 100
percent of the excess of the taxpayer's contribution base over
the amount of all other allowable charitable contributions.
In the above example, if the individual is a qualified
farmer or rancher, in addition to the $50 deduction for non-
conservation contributions, an additional $50 for the qualified
conservation contribution is allowed and $30 may be carried
forward for up to 15 years as a contribution subject to the
100-percent limitation.
Corporations
In the case of a corporation (other than a publicly
traded corporation) that is a qualified farmer or rancher for
the taxable year in which the contribution is made, any
qualified conservation contribution is allowable up to 100
percent of the excess of the corporation's taxable income (as
computed under section 170(b)(2)) over the amount of all other
allowable charitable contributions. Any excess may be carried
forward for up to 15 years as a contribution subject to the
100-percent limitation.
Definition
A qualified farmer or rancher means a taxpayer whose
gross income from the trade of business of farming (within the
meaning of section 2032A(e)(5)) is greater than 50 percent of
the taxpayer's gross income for the taxable year.
Effective date.
The provision applies to contributions made in taxable
years beginning after December 31, 2005, and before January 1,
2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
8. Enhanced deduction for charitable contributions of literary,
musical, artistic, and scholarly compositions (sec. 208 of the
Senate amendment and sec. 170 of the Code)
PRESENT LAW
In the case of a charitable contribution of inventory or
other ordinary-income or short-term capital gain property, the
amount of the deduction generally is limited to the taxpayer's
basis in the property.\90\ In the case of a charitable
contribution of tangible personal property, the deduction is
limited to the taxpayer's basis in such property if the use by
the recipient charitable organization is unrelated to the
organization's tax-exempt purpose. In cases involving
contributions of tangible personal property to a private
foundation (other than certain private foundations),\91\ the
amount of the deduction is limited to the taxpayer's basis in
the property.
---------------------------------------------------------------------------
\90\ Sec. 170(e)(1).
\91\ Sec. 170(e)(1)(B)(ii).
---------------------------------------------------------------------------
Under present law, charitable contributions of literary,
musical, and artistic compositions created or prepared by the
donor are considered ordinary income property and a taxpayer's
deduction of such property is limited to the taxpayer's basis
(typically, cost) in the property. A charitable contribution of
a literary, musical, or artistic composition by a person other
than the person who created or prepared the work generally is
eligible for a fair market value deduction if the donee
organization's use of the property is related to such
organization's exempt purposes.
To be eligible for the deduction, the contribution must
be of an undivided portion of the donor's entire interest in
the property.\92\ For purposes of the charitable income tax
deduction, the copyright and the work in which the copyright is
embodied are not treated as separate property interests.
Accordingly, if a donor owns a work of art and the copyright to
the work of art, a gift of the artwork without the copyright or
the copyright without the artwork will constitute a gift of a
``partial interest'' and will not qualify for the income tax
charitable deduction.
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\92\ Sec. 170(f)(3).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision provides that a deduction for ``qualified
artistic charitable contributions'' generally is increased from
the value under present law (generally, basis) to the fair
market value of the property contributed, measured at the time
of the contribution. However, the amount of the increase of the
deduction provided by the provision may not exceed the amount
of the donor's adjusted gross income for the taxable year
attributable to: (1) income from the sale or use of property
created by the personal efforts of the donor that is of the
same type as the donated property; and (2) income from
teaching, lecturing, performing, or similar activities with
respect to such property. In addition, the increase to the
present-law deduction provided by the provision may not be
carried over and deducted in other taxable years.
The provision defines a qualified artistic charitable
contribution to mean a charitable contribution of any literary,
musical, artistic, or scholarly composition, or similar
property, or the copyright thereon (or both) that meets certain
requirements. First, the contributed property must have been
created by the personal efforts of the donor at least 18 months
prior to the date of contribution. Second, the donor must
obtain a qualified appraisal of the contributed property, a
copy of which is required to be attached to the donor's income
tax return for the taxable year in which such contribution is
made. The appraisal must include evidence of the extent (if
any) to which property created by the personal efforts of the
taxpayer and of the same type as the donated property is or has
been owned, maintained, and displayed by certain charitable
organizations and sold to or exchanged by persons other than
the taxpayer, donee, or any related person. Third, the
contribution must be made to a public charity or to certain
limited types of private foundations (i.e., an organization
described in section 170(b)(1)(A)). Finally, the use of donated
property by the recipient organization must be related to the
organization's charitable purpose or function, and the donor
must receive a written statement from the organization
verifying such use.
Under the provision, the tangible property and the
copyright on such property are treated as separate properties
for purposes of the ``partial interest'' rule; thus, a gift of
artwork without the copyright or a copyright without the
artwork does not constitute a gift of a partial interest and is
deductible. Contributions of letters, memoranda, or similar
property that are written, prepared, or produced by or for an
individual while the individual is an officer or employee of
any person (including a government agency or instrumentality)
do not qualify for a fair market value deduction unless the
contributed property is entirely personal.
Effective date.--The deduction for qualified artistic
charitable contributions applies to contributions made after
December 31, 2005, and before January 1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
9. Mileage reimbursements to charitable volunteers excluded from gross
income (sec. 209 of the Senate amendment and new sec. 139B of
the Code)
PRESENT LAW
In general, an itemized deduction is permitted for
charitable contributions, subject to certain limitations that
depend on the type of taxpayer, the property contributed, and
the donee organization. Unreimbursed out-of-pocket expenditures
made incident to providing donated services to a qualified
charitable organization--such as out-of-pocket transportation
expenses necessarily incurred in performing donated services--
may qualify as a charitable contribution.\93\ No charitable
contribution deduction is allowed for traveling expenses
(including expenses for meals and lodging) while away from
home, whether paid directly or by reimbursement, unless there
is no significant element of personal pleasure, recreation, or
vacation in such travel.\94\
---------------------------------------------------------------------------
\93\ Treas. Reg. sec. 1.170A-1(g).
\94\ Sec. 170(j).
---------------------------------------------------------------------------
In determining the amount treated as a charitable
contribution where a taxpayer operates a vehicle to provide
donated services to a charity, the taxpayer either may deduct
actual out-of-pocket expenditures or, in the case of a
passenger automobile, may use the charitable standard mileage
rate. The charitable standard mileage rate is set by statute at
14 cents per mile.\95\ The taxpayer may also deduct (under
either computation method), any parking fees and tolls incurred
in rendering the services, but may not deduct any amount
(regardless of the computation method used) for general repair
or maintenance expenses, depreciation, insurance, registration
fees, etc. Regardless of the computation method used, the
taxpayer must keep reliable written records of expenses
incurred. For example, where a taxpayer uses the charitable
standard mileage rate to determine a deduction, the IRS has
stated that the taxpayer generally must maintain records of
miles driven, time, place (or use), and purpose of the mileage.
If the charitable standard mileage rate is not used to
determine the deduction, the taxpayer generally must maintain
reliable written records of actual expenses incurred.
---------------------------------------------------------------------------
\95\ Sec. 170(i).
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In lieu of actual operating expenses, an optional
standard mileage rate may be used in computing the deductible
costs of business use of an automobile. The business standard
mileage rate is determined by the IRS and updated periodically.
For business use occurring on or after January 1, 2006, the
business standard mileage rate specified by the IRS is 44.5
cents per mile.
The standard mileage rate for charitable purposes is
lower than the standard business rate because the charitable
rate covers only the out-of-pocket operating expenses
(including gasoline and oil) directly related to the use of the
automobile in performing the donated services that a taxpayer
may deduct as a charitable contribution. The charitable rate
does not include costs that are not deductible as a charitable
contribution such as general repair or maintenance expenses,
depreciation, insurance, and registration fees. Such costs are,
however, included in computing the business standard mileage
rate.
Volunteer drivers who are reimbursed for mileage expenses
have taxable income to the extent the reimbursement exceeds
deductible travel expenses. Employees who are reimbursed for
mileage expenses under a qualified arrangement that pays a
mileage allowance in lieu of reimbursing actual expenses
generally have taxable income to the extent the reimbursement
exceeds the amount of the business standard mileage rate
multiplied by the actual business miles.
Under section 6041, information reporting generally is
required with respect to payments of $600 or more in any
taxable year.
Under the Katrina Emergency Tax Relief Act of 2005,
reimbursement by an organization described in section 170(c)
(including public charities and private foundations) to a
volunteer for the costs of using a passenger automobile in
providing donated services to charity solely for the provision
of relief related to Hurricane Katrina is excludable from the
gross income of the volunteer up to an amount that does not
exceed the business standard mileage rate prescribed for
business use (as periodically adjusted), provided that
recordkeeping requirements applicable to deductible business
expenses are satisfied. The Katrina Emergency Tax Relief Act of
2005 does not permit a volunteer to claim a deduction or credit
with respect to such amounts excluded. The provision applies
for purposes of use of a passenger automobile during the period
beginning on August 25, 2005, and ending on December 31, 2006.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision extends the provision enacted as part of
the Katrina Emergency Tax Relief Act of 2005. Under the
provision, reimbursement by an organization described in
section 170(c) (including public charities and private
foundations) to a volunteer for the costs of using a passenger
automobile in providing donated services to charity is
excludable from the gross income of the volunteer up to an
amount that does not exceed the business standard mileage rate
prescribed for business use (as periodically adjusted),
provided that recordkeeping requirements applicable to
deductible business expenses are satisfied. Unlike the
provision enacted as part of the Katrina Emergency Tax Relief
Act of 2005, the provision is not limited to use solely for the
provision of relief related to Hurricane Katrina. The provision
does not permit a volunteer to claim a deduction or credit with
respect to amounts excluded under the provision. Information
reporting required by section 6041 is not required with respect
to reimbursements excluded under the provision.
Effective date.--The provision applies for taxable years
beginning after December 31, 2005, and beginning before January
1, 2008.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
10. Alternative percentage limitation for corporate charitable
contributions to the mathematics and science partnership
program (sec. 210 of the Senate amendment and sec. 170 of the
Code)
PRESENT LAW
Under present law, a corporation is allowed to deduct
charitable contributions up to 10 percent of the corporation's
modified taxable income for the year. For this purpose, taxable
income is determined without regard to (1) the charitable
contributions deduction, (2) any net operating loss carryback,
(3) deductions for dividends received, and (4) any capital loss
carryback for the taxable year.\96\ Any charitable contribution
by a corporation that is not currently deductible because of
the percentage limitation may be carried forward for up to five
taxable years.
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\96\ Sec. 170(b)(2).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
Under the provision, the corporate percentage limitation
is applied separately to eligible mathematics and science
contributions and to all other charitable contributions. In
addition, the applicable percentage limitation for purposes of
eligible mathematics and science contributions is 15 percent;
the applicable percentage limitation for all other corporate
charitable contributions remains 10 percent.
In general, an eligible mathematics and science
contribution is a charitable contribution (other than a
contribution of used equipment) to a qualified partnership for
the purpose of an activity described in section 2202(c) of the
Elementary and Secondary Education Act of 1965. Such activities
include, for example, creating opportunities for enhanced and
ongoing professional development of mathematics and science
teachers and promoting strong teaching skills for mathematics
and science teachers and teacher educators. A qualified
partnership is an eligible partnership within the meaning of
section 2201(b)(1) of the Elementary and Secondary Education
Act of 1965, but only to the extent that such partnership does
not include a person other than a person described in section
170(b)(1)(A) (describing organizations to which individuals may
make charitable contributions deductible up to 50 percent of
such individual's contribution base).
Effective date.--The provision applies for contributions
made in taxable years beginning after December 31, 2005, and
beginning before January 1, 2007.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
B. Reforming Charitable Organizations
1. Tax involvement of accommodation parties in tax-shelter transactions
(sec. 211 of the Senate amendment and secs. 6011, 6033, 6652,
and new sec. 4965 of the Code)
PRESENT LAW
Disclosure of listed and other reportable transactions by taxpayers
Present law provides that a taxpayer that participates in
a reportable transaction (including a listed transaction) and
that is required to file a tax return must attach to its return
a disclosure statement in the form prescribed by the
Secretary.\97\ For this purpose, the term taxpayer includes any
person, including an individual, trust, estate, partnership,
association, company, or corporation.\98\
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\97\ Treas. Reg. sec. 1.6011-4(a).
\98\ Sec. 7701(a)(1); Treas. Reg. sec. 1.6011-4(c)(1).
---------------------------------------------------------------------------
Under present Treasury regulations, a reportable
transaction includes a listed transaction and five other
categories of transactions: (1) confidential transactions,
which are transactions offered to a taxpayer under conditions
of confidentiality and for which the taxpayer has paid an
advisor a minimum fee; (2) transactions with contractual
protection, which include transactions for which the taxpayer
or a related party has the right to a full or partial refund of
fees if all or part of the intended tax consequences from the
transaction are not sustained, or for which fees are contingent
on the taxpayer's realization of tax benefits from the
transaction; (3) loss transactions, which are transactions
resulting in the taxpayer claiming a loss under section 165
that exceeds certain thresholds, depending upon the type of
taxpayer; (4) transactions with a significant book-tax
difference; and (5) transactions involving a brief asset
holding period.\99\ A listed transaction means a reportable
transaction which is the same as, or substantially similar to,
a transaction specifically identified by the Secretary as a tax
avoidance transaction for purposes of section 6011 (relating to
the filing of returns and statements), and identified by
notice, regulation, or other form of published guidance as a
listed transaction.\100\ The fact that a transaction is a
reportable transaction does not affect the legal determination
of whether the taxpayer's treatment of the transaction is
proper.\101\ Present law authorizes the Secretary to define a
reportable transaction on the basis of such transaction being
of a type which the Secretary determines as having a potential
for tax avoidance or evasion.\102\
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\99\ Treas. Reg. sec. 1.6011-4(b). In Notice 2006-6 (January 6,
2006), the Service indicated that it was removing transactions with a
significant book-tax difference from the categories of reportable
transactions.
\100\ Sec. 6707A(c)(2); Treas. Reg. sec. 1.6011-4(b)(2).
\101\ Treas. Reg. sec. 1.6011-4(a).
\102\ Sec. 6707A(c)(1).
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Treasury regulations provide guidance regarding the
determination of when a taxpayer participates in a transaction
for these purposes.\103\ A taxpayer has participated in a
listed transaction if the taxpayer's tax return reflects tax
consequences or a tax strategy described in the published
guidance that lists the transaction, or if the taxpayer knows
or has reason to know that the taxpayer's tax benefits are
derived directly or indirectly from tax consequences of a tax
strategy described in published guidance that lists a
transaction. A taxpayer has participated in a confidential
transaction if the taxpayer's tax return reflects a tax benefit
from the transaction and the taxpayer's disclosure of the tax
treatment or tax structure of the transaction is limited under
conditions of confidentiality. A taxpayer has participated in a
transaction with contractual protection if the taxpayer's tax
return reflects a tax benefit from the transaction, and the
taxpayer has the right to the full or partial refund of fees or
the fees are contingent.
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\103\ Treas. Reg. sec. 1.6011-4(c)(3).
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Present law provides a penalty for any person who fails
to include on any return or statement any required information
with respect to a reportable transaction.\104\ The penalty
applies without regard to whether the transaction ultimately
results in an understatement of tax, and applies in addition to
any other penalty that may be imposed.
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\104\ Sec. 6707A.
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The penalty for failing to disclose a reportable
transaction is $10,000 in the case of a natural person and
$50,000 in any other case. The amount is increased to $100,000
and $200,000, respectively, if the failure is with respect to a
listed transaction. The penalty cannot be waived with respect
to a listed transaction. As to reportable transactions, the IRS
Commissioner may rescind all or a portion of the penalty if
rescission would promote compliance with the tax laws and
effective tax administration.
Disclosure of listed and other reportable transactions by material
advisors
Present law requires each material advisor with respect
to any reportable transaction (including any listed
transaction) to timely file an information return with the
Secretary (in such form and manner as the Secretary may
prescribe).\105\ The information return must include (1)
information identifying and describing the transaction, (2)
information describing any potential tax benefits expected to
result from the transaction, and (3) such other information as
the Secretary may prescribe. The return must be filed by the
date specified by the Secretary.
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\105\ Sec. 6707(a), as added by the American Jobs Creation Act of
2004, Pub. L. No. 108-357, sec. 816(a).
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A ``material advisor'' means any person (1) who provides
material aid, assistance, or advice with respect to organizing,
managing, promoting, selling, implementing, insuring, or
carrying out any reportable transaction, and (2) who directly
or indirectly derives gross income in excess of $250,000
($50,000 in the case of a reportable transaction substantially
all of the tax benefits from which are provided to natural
persons) or such other amount as may be prescribed by the
Secretary for such advice or assistance.\106\
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\106\ Sec. 6707(b)(1).
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The Secretary may prescribe regulations which provide (1)
that only one material advisor is required to file an
information return in cases in which two or more material
advisors would otherwise be required to file information
returns with respect to a particular reportable transaction,
(2) exemptions from the requirements of this section, and (3)
other rules as may be necessary or appropriate to carry out the
purposes of this section.\107\
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\107\ Sec. 6707(c).
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Present law imposes a penalty on any material advisor who
fails to timely file an information return, or who files a
false or incomplete information return, with respect to a
reportable transaction (including a listed transaction).\108\
The amount of the penalty is $50,000. If the penalty is with
respect to a listed transaction, the amount of the penalty is
increased to the greater of (1) $200,000, or (2) 50 percent of
the gross income derived by such person with respect to aid,
assistance, or advice which is provided with respect to the
transaction before the date the information return that
includes the transaction is filed. An intentional failure or
act by a material advisor with respect to the requirement to
disclose a listed transaction increases the penalty to 75
percent of the gross income derived from the transaction.
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\108\ Sec. 6707(b).
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The penalty cannot be waived with respect to a listed
transaction. As to reportable transactions, the IRS
Commissioner can rescind all or a portion of the penalty if
rescission would promote compliance with the tax laws and
effective tax administration.
HOUSE BILL
No provision.
SENATE AMENDMENT
In general
In general, under the provision, certain tax-exempt
entities are subject to penalties for being a party to a
prohibited tax shelter transaction. A prohibited tax shelter
transaction is a transaction that the Secretary determines is a
listed transaction (as defined in section 6707A(c)(2)) or a
prohibited transaction. A prohibited reportable transaction is
a confidential transaction or a transaction with contractual
protection (as defined by the Secretary in regulations) which
is a reportable transaction as defined in sec. 6707A(c)(1).
Under the provision, a tax-exempt entity is an entity that is
described in section 501(c), 501(d), or 170(c) (not including
the United States), Indian tribal governments, and tax
qualified pension plans, individual retirement arrangements
(``IRAs''), and similar tax-favored savings arrangements (such
as Coverdell education savings accounts, health savings
accounts, and qualified tuition plans).
Entity level tax
Under the provision, if a tax-exempt entity is a party at
any time to a transaction during a taxable year and knows or
has reason to know that the transaction is a prohibited tax
shelter transaction, the entity is subject to a tax for such
year equal to the greater of (1) 100 percent of the entity's
net income (after taking into account any tax imposed with
respect to the transaction) for such year that is attributable
to the transaction or (2) 75 percent of the proceeds received
by the entity that are attributable to the transaction.
In addition, if a transaction is not a listed transaction
at the time a tax-exempt entity enters into the transaction
(and is not otherwise a prohibited tax shelter transaction),
but the transaction subsequently is determined by the Secretary
to be a listed transaction (a ``subsequently listed
transaction''), the entity must pay each taxable year an excise
tax at the highest unrelated business taxable income rate times
the greater of (1) the entity's net income (after taking into
account any tax imposed) that is attributable to the
subsequently listed transaction and that is properly allocable
to the period beginning on the later of the date such
transaction is listed by the Secretary or the first day of the
taxable year or (2) 75 percent of the proceeds received by the
entity that are attributable to the subsequently listed
transaction and that are properly allocable to the period
beginning on the later of the date such transaction is listed
by the Secretary or the first day of the taxable year. The
Secretary has the authority to promulgate regulations that
provide guidance regarding the determination of the allocation
of net income of a tax-exempt entity that is attributable to a
transaction to various periods, including before and after the
listing of the transaction or the date which is 90 days after
the date of enactment of the provision.
The entity level tax does not apply if the entity's
participation is not willful and is due to reasonable cause,
except that the willful and reasonable cause exception does not
apply to the tax imposed for subsequently listed transactions.
The entity level taxes do not apply to tax qualified pension
plans, IRAs, and similar tax-favored savings arrangements (such
as Coverdell education savings accounts, health savings
accounts, and qualified tuition plans).
Disclosure of participation in prohibited tax shelter transactions
The provision requires that a taxable party to a
prohibited tax shelter transaction disclose to the tax-exempt
entity that the transaction is a prohibited tax shelter
transaction. Failure to make such disclosure is subject to the
present-law penalty for failure to include reportable
transaction information under section 6707A. Thus, the penalty
is $10,000 in the case of a natural person or $50,000 in any
other case, except that if the transaction is a listed
transaction, the penalty is $100,000 in the case of a natural
person and $200,000 in any other case.\109\
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\109\ The IRS Commissioner may rescind all or any portion of any
such penalty if the violation is with respect to a prohibited tax
shelter transaction other than a listed transaction and doing so would
promote compliance with the requirements of the Code and effective tax
administration. See sec. 6707A(d).
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The provision requires disclosure by a tax-exempt entity
to the IRS of each participation in a prohibited tax shelter
transaction and disclosure of other known parties to the
transaction. The penalty for failure to disclose is imposed on
the entity (or entity manager, in the case of qualified pension
plans and similar tax favored retirement arrangements) at $100
per day the failure continues, not to exceed $50,000. If any
person fails to comply with a demand on the tax-exempt entity
by the Secretary for disclosure, such person or persons shall
pay a penalty of $100 per day (beginning on the date of the
failure to comply) not to exceed $10,000 per prohibited tax
shelter transaction. As under present-law section 6652, no
penalty is imposed with respect to any failure if it is shown
that the failure is due to reasonable cause.
Penalty on entity managers
A tax of $20,000 is imposed on an entity manager that
approves or otherwise causes a tax-exempt entity to be a party
to a prohibited tax shelter transaction at any time during the
taxable year, knowing or with reason to know that the
transaction is a prohibited tax shelter transaction. An entity
manager is defined as a person with authority or responsibility
similar to that exercised by an officer, director, or trustee
of an organization, except: (1) in the case of an entity
described in section 501(c)(3) or (c)(4) (other than a private
foundation), an entity manager is an organization manager as
defined in section 4958(f)(2); and (2) in the case of a private
foundation, an entity manager is a foundation manager as
defined in section 4946(b). The reasonable cause (or no willful
participation) exception applies to this tax.
Effective date.
The provision generally is effective for transactions
after the date of enactment, except that no tax applies with
respect to income that is properly allocable to any period on
or before the date that is 90 days after the date of enactment.
The disclosure provisions apply to disclosures the due date for
which are after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision, with modifications.
The conference agreement does not include the provision
that the entity level or entity manager tax does not apply if
the entity's participation is not willful and is due to
reasonable cause.
In addition, the conference agreement adds a tax in the
event that a tax-exempt entity becomes a party to a prohibited
tax shelter transaction without knowing or having reason to
know that the transaction is a prohibited tax shelter
transaction. In that case, the tax-exempt entity is subject to
a tax in the taxable year the entity becomes a party and any
subsequent taxable year of the highest unrelated business
taxable income rate times the greater of (1) the entity's net
income (after taking into account any tax imposed with respect
to the transaction) for such year that is attributable to the
transaction or (2) 75 percent of the proceeds received by the
entity that are attributable to the transaction for such
year.\110\
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\110\ The conference agreement clarifies that in all cases the 75
percent of proceeds received by the entity that are attributable to the
transaction are with respect to the taxable year.
---------------------------------------------------------------------------
The conference agreement clarifies that the entity level
tax rate that applies if the entity knows or has reason to know
that a transaction is a prohibited tax shelter transaction does
not apply to subsequently listed transactions.
The conference agreement modifies the definition of an
entity manager to provide that: (1) in the case of tax
qualified pension plans, IRAs, and similar tax-favored savings
arrangements (such as Coverdell education savings accounts,
health savings accounts, and qualified tuition plans) an entity
manager is the person that approves or otherwise causes the
entity to be a party to a prohibited tax shelter transaction,
and (2) in all other cases the entity manager is the person
with authority or responsibility similar to that exercised by
an officer, director, or trustee of an organization, and with
respect to any act, the person having authority or
responsibility with respect to such act.
In the case of a qualified pension plan, IRA, or similar
tax-favored savings arrangement (such as a Coverdell education
savings account, health savings account, or qualified tuition
plan), the conferees intend that, in general, a person who
decides that assets of the plan, IRA, or other savings
arrangement are to be invested in a prohibited tax shelter
transaction is the entity manager under the provision. Except
in the case of a fully self-directed plan or other savings
arrangement with respect to which a participant or beneficiary
decides to invest in the prohibited tax shelter transaction, a
participant or beneficiary generally is not an entity manager
under the provision. Thus, for example, a participant or
beneficiary is not an entity manager merely by reason of
choosing among pre-selected investment options (as is typically
the case if a qualified retirement plan provides for
participant-directed investments).\111\ Similarly, if an
individual has an IRA and may choose among various mutual funds
offered by the IRA trustee, but has no control over the
investments held in the mutual funds, the individual is not an
entity manager under the provision.
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\111\ Depending on the circumstances, the person who is responsible
for determining the pre-selected investment options may be an entity
manager under the provision.
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Under the provision, certain taxes are imposed if the
entity or entity manager knows or has reason to know that a
transaction is a prohibited tax shelter transaction. In
general, the conferees intend that in order for an entity or
entity manager to have reason to know that a transaction is a
prohibited tax shelter transaction, the entity or entity
manager must have knowledge of sufficient facts that would lead
a reasonable person to conclude that the transaction is a
prohibited tax shelter transaction. If there is justifiable
reliance on a reasoned written opinion of legal counsel
(including in-house counsel) or of an independent accountant
with expertise in tax matters, after making full disclosure of
relevant facts about a transaction to such counsel or
accountant, that a transaction is not a prohibited tax shelter
transaction, then absent knowledge of facts not considered in
the reasoned written opinion that would lead a reasonable
person to conclude that the transaction is a prohibited tax
shelter transaction, the reason to know standard is not met.
Not obtaining a reasoned written opinion of legal counsel
does not alone indicate whether a person has reason to know.
However, if a transaction is extraordinary for the entity,
promises a return for the organization that is exceptional
considering the amount invested by, the participation of, or
the absence of risk to the organization, or the transaction is
of significant size, either in an absolute sense or relative to
the receipts of the entity, then, in general, the presence of
such factors may indicate that the entity or entity manager has
a responsibility to inquire further about whether a transaction
is a prohibited tax shelter transaction, or, absent such
inquiry, that the reason to know standard is satisfied. For
example, if a tax-exempt entity's investment in a transaction
is $1,000, and the entity is promised or expects to receive
$10,000 in the near term, in general, the rate of return would
be considered exceptional and the entity should make inquiries
with respect to the transaction. As another example, if a tax-
exempt entity's expected income from a transaction is greater
than five percent of the entity's annual receipts, or is in
excess of $1,000,000, and the entity fails to make appropriate
inquiries with respect to its participation in such
transaction, such failure is a factor tending to show that the
reason to know standard is met. Appropriate inquiries need not
involve obtaining a reasoned written opinion. In general, if a
transaction does not present the factors described above and
the organization is small (measured by receipts and assets) and
described in section 501(c)(3), it is expected that the reason
to know standard will not be met.
In general, the conferees intend that in determining
whether a tax-exempt entity is a ``party'' to a prohibited tax
shelter transaction all the facts and circumstances should be
taken into account. Absence of a written agreement is not
determinative. Certain indirect involvement in a prohibited tax
shelter transaction would not result in an entity being
considered a party to the transaction. For example, investment
by a tax-exempt entity in a mutual fund that in turn invests in
or participates in a prohibited tax shelter transaction does
not, in general, make the tax-exempt entity a party to such
transaction, absent facts or circumstances that indicate that
the purpose of the tax exempt entity's investment in the mutual
fund was specifically to participate in such a transaction.
However, whether a tax-exempt entity is a party to such a
transaction will be informed by whether the entity or entity
manager knew or had reason to know that an investment of the
entity would be used in a prohibited tax shelter transaction.
Presence of such knowledge or reason to know may indicate that
the purpose of the investment was to participate in the
prohibited tax shelter transaction and that the tax-exempt
entity is a party to such transaction.
The conference agreement clarifies that a subsequently
listed transaction means any transaction to which a tax-exempt
entity is a party and which is determined by the Secretary to
be a listed transaction at any time after the entity has
``become a party to'' the transaction, and not, as under the
Senate amendment, when the entity ``entered into'' the
transaction. The conference agreement provides that a
subsequently listed transaction does not include a transaction
that is a prohibited reportable transaction. The conference
agreement provides that the Secretary has the authority to
allocate proceeds as well as income of a tax-exempt entity to
various periods. The conference agreement also provides that
the disclosure by tax-exempt entities to the Internal Revenue
Service required under the provision is based on an entity's
being a party to a prohibited tax shelter transaction and not,
as under the Senate amendment, on an entity's ``participation''
in a prohibited tax shelter transaction. The conference
agreement further provides that the Secretary may make a demand
for disclosure on any entity manager subject to the tax, as
well as on any tax exempt entity, and also provides that such
managers and entities and not, as under the Senate amendment,
``persons'' are subject to the penalty for failure to comply
with the demand.
Effective date.--In general, the provision is effective
for taxable years ending after the date of enactment, with
respect to transactions before, on, or after such date, except
that no tax shall apply with respect to income or proceeds that
are properly allocable to any period ending on or before the
date that is 90 days after the date of enactment. The tax on
certain knowing transactions does not apply to any prohibited
tax shelter transaction to which a tax-exempt entity became a
party on or before the date of enactment. The disclosure
provisions apply to disclosures the due date for which are
after the date of enactment.
2. Apply an excise tax to acquisitions of interests in insurance
contracts in which certain exempt organizations hold interests
(sec. 212 of the Senate amendment and new secs. 4966 and 6050V
of the Code)
PRESENT LAW
Amounts received under a life insurance contract
Amounts received under a life insurance contract paid by
reason of the death of the insured are not includible in gross
income for Federal tax purposes.\112\ No Federal income tax
generally is imposed on a policyholder with respect to the
earnings under a life insurance contract (inside buildup).\113\
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\112\ Sec. 101(a).
\113\ This favorable tax treatment is available only if a life
insurance contract meets certain requirements designed to limit the
investment character of the contract. Sec. 7702.
---------------------------------------------------------------------------
Distributions from a life insurance contract (other than
a modified endowment contract) that are made prior to the death
of the insured generally are includible in income to the extent
that the amounts distributed exceed the taxpayer's investment
in the contract (i.e., basis). Such distributions generally are
treated first as a tax-free recovery of basis, and then as
income.\114\
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\114\ Sec. 72(e). In the case of a modified endowment contract,
however, in general, distributions are treated as income first, loans
are treated as distributions (i.e., income rather than basis recovery
first), and an additional 10-percent tax is imposed on the income
portion of distributions made before age 59\1/2\ and in certain other
circumstances. Secs. 72(e) and (v). A modified endowment contract is a
life insurance contract that does not meet a statutory ``7-pay'' test,
i.e., generally is funded more rapidly than seven annual level
premiums. Sec. 7702A.
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Transfers for value
A limitation on the exclusion for amounts received under
a life insurance contract is provided in the case of transfers
for value. If a life insurance contract (or an interest in the
contract) is transferred for valuable consideration, the amount
excluded from income by reason of the death of the insured is
limited to the actual value of the consideration plus the
premiums and other amounts subsequently paid by the acquiror of
the contract.\115\
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\115\ Section 101(a)(2). The transfer-for-value rule does not
apply, however, in the case of a transfer in which the life insurance
contract (or interest in the contract) transferred has a basis in the
hands of the transferee that is determined by reference to the
transferor's basis. Similarly, the transfer-for-value rule generally
does not apply if the transfer is between certain parties
(specifically, if the transfer is to the insured, a partner of the
insured, a partnership in which the insured is a partner, or a
corporation in which the insured is a shareholder or officer).
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Tax treatment of charitable organizations and donors
Present law generally provides tax-exempt status for
charitable, educational and certain other organizations, no
part of the net earnings of which inures to the benefit of any
private shareholder or individual, and which meet certain other
requirements.\116\ Governmental entities, including some
educational organizations, are exempt from tax on income under
other tax rules providing that gross income does not include
income derived from the exercise of any essential governmental
function and accruing to a State or any political subdivision
thereof.\117\
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\116\ Section 501(c)(3).
\117\ Section 115.
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In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity for exclusively public
purposes.\118\
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\118\ Section 170.
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State-law insurable interest rules
State laws generally provide that the owner of a life
insurance contract must have an insurable interest in the
insured person when the life insurance contract is issued.
State laws vary as to the insurable interest of a charitable
organization in the life of any individual. Some State laws
provide that a charitable organization meeting the requirements
of section 501(c)(3) of the Code is treated as having an
insurable interest in the life of any donor,\119\ or, in other
States, in the life of any individual who consents (whether or
not the individual is a donor).\120\ Other States' insurable
interest rules permit the purchase of a life insurance contract
even though the person paying the consideration has no
insurable interest in the life of the person insured if a
charitable, benevolent, educational or religious institution is
designated irrevocably as the beneficiary.\121\
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\119\ See, e.g., Mass. Gen. Laws Ann. ch. 175, sec. 123A(2) (West
2005); Iowa Code Ann. sec. 511.39 (West 2004) (``a person who, when
purchasing a life insurance policy, makes a donation to the charitable
organization or makes the charitable organization the beneficiary of
all or a part of the proceeds of the policy . . . ).
\120\ See, e.g., Cal. Ins. Code sec. 10110.1(f) (West 2005); 40 Pa.
Cons. Stat. Ann. sec. 40-512 (2004); Fla. Stat. Ann. sec. 27.404 (2)
(2004); Mich. Comp. Laws Ann. sec. 500.2212 (West 2004).
\121\ Or. Rev. Stat. sec. 743.030 (2003); Del. Code Ann. Tit. 18,
sec. 2705(a) (2004).
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Transactions involving charities and non-charities acquiring life
insurance
Recently, there has been an increase in transactions
involving the acquisition of life insurance contracts using
arrangements in which both exempt organizations, primarily
charities, and private investors have an interest in the
contract.\122\ The exempt organization has an insurable
interest in the insured individuals, either because they are
donors, because they consent, or otherwise under applicable
State insurable interest rules. Private investors provide
capital used to fund the purchase of the life insurance
contracts, sometimes together with annuity contracts. Both the
private investors and the charity have an interest in the
contracts, directly or indirectly, through the use of trusts,
partnerships, or other arrangements for sharing the rights to
the contracts. Both the charity and the private investors
receive cash amounts in connection with the investment in the
contracts while the life insurance is in force or as the
insured individuals die.
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\122\ Davis, Wendy, ``Death-Pool Donations,'' Trusts and Estates,
May 2004, 55; Francis, Theo, ``Tax May Thwart Investment Plans
Enlisting Charities,'' Wall St. J., Feb. 8, 2005, A-10.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision imposes an excise tax, equal to 100 percent
of the acquisition costs, on the taxable acquisition of any
interest in an applicable insurance contract. An applicable
insurance contract is any life insurance, annuity or endowment
contract in which both an applicable exempt organization and
any person that is not an applicable exempt organization have,
directly or indirectly, held an interest in the contract
(whether or not the interests are held at the same time).
An applicable exempt organization is any organization
described in section 170(c), 168(h)(2)(A)(iv), 2055(a), or
2522(a). Thus, for example, an applicable exempt organization
generally includes an organization that is exempt from Federal
income tax by reason of being described in section 501(c)(3)
(including one organized outside the United States), a
government or political subdivision of a government, and an
Indian tribal government.
A taxable acquisition is the acquisition of any direct or
indirect interest in an applicable insurance contract by an
applicable exempt organization, or by any other person if the
interest in the contract in that person's hands is not
described in the specific exceptions to ``applicable insurance
contract.''
Under the provision, acquisition costs mean the direct or
indirect costs (including premiums, commissions, fees, charges,
or other amounts) of acquiring or maintaining an interest in an
applicable insurance contract. Except as provided in
regulations, if acquisition costs of any taxable acquisition
are paid or incurred in more than one calendar year, the excise
tax under the provision is imposed each time such costs are
paid or incurred. In the case of an acquisition of an interest
in an entity that directly or indirectly holds an interest in
an applicable insurance contract, acquisition costs are
intended to include the amount of money or value of property
(including an applicable insurance contract) contributed to an
entity or otherwise transferred or paid to acquire or increase
an interest in the entity, that directly or indirectly holds an
interest in an applicable insurance contract.
For example, acquisition costs include (1) each premium,
commission, or fee with respect to the contract, (2) each
amount paid or incurred to acquire or increase an interest in
the contract, (3) each amount paid or incurred to acquire or
increase an interest in an entity (such as a partnership,
trust, corporation, or other type of entity or arrangement)
that has a direct or indirect interest in the contract, and (4)
if the contract is contributed to an entity, the greater of the
value of the contract or the total amount of premiums,
commissions, and fees paid or incurred to acquire and maintain
the insurance contract. It is intended that, under regulatory
authority provided as necessary to carry out the purposes of
the provision, any other similar or economically equivalent
amount paid or incurred is to be treated as acquisition costs.
Under the provision, an interest in an applicable
insurance contract includes any right with respect to the
contract, whether as an owner, beneficiary, or otherwise. An
indirect interest in a contract includes an interest in an
entity that, directly or indirectly, holds an interest in the
contract. In the case of a section 1035 exchange of an
applicable insurance contract, any interest in any of the
contracts involved in the exchange is treated as an interest in
all such contracts. An increase in an interest in an applicable
insurance contract is treated as a separate acquisition, for
purposes of application of the excise tax under the provision.
If an interest of an applicable exempt organization
exists solely because the organization holds, as part of a
diversified investment strategy, a de minimis interest in an
entity which directly or indirectly holds an interest in the
contract, such interest is not taken into account for purposes
of the provision. For example, if an applicable exempt
organization owns a de minimis amount of stock in a corporation
which in turn owns life insurance contracts covering key
employees, the excise tax under the provision does not apply
because the stock ownership is not treated as an indirect
interest in this circumstance. It is intended that Treasury
regulations provide guidance as to the application of this rule
so that it does not permit circumvention of the provision.
Except as provided in regulations, if a person acquires
an interest in a contract before the contract is treated as an
applicable insurance contract, the acquisition is treated as a
taxable acquisition of an interest in applicable insurance
contract as of the date the contract becomes an applicable
insurance contract.
It is intended that an interest in an applicable
insurance contract includes, for example, (1) a right with
respect to the applicable insurance contract pursuant to a side
contract or other similar arrangement, (2) an interest as a
trust beneficiary in distributions from or income of a trust
holding an interest in a contract, and (3) a right to
distributions, guaranteed payments, or income of a partnership
that holds an interest in a contract. It is not intended that a
right with respect to the contract include typical rights of
issuers of applicable insurance contracts.
Exceptions to the term ``applicable insurance contract''
apply under the provision. First, the term does not apply if
each person (other than an applicable exempt organization) with
a direct or indirect interest in the contract has an insurable
interest in the insured independent of any interest of the
exempt organization in the contract. Second, the term does not
apply if the sole interest in the contract of each person other
than the applicable exempt organization is as a named
beneficiary. Third, the term does not apply if the sole
interest in the contract of each person other than the
applicable exempt organization is either (1) as a beneficiary
of a trust holding an interest in the contract, but only if the
person's designation as such a beneficiary was made without
consideration and solely on a purely gratuitous basis, or (2)
as a trustee who holds an interest in the contract in a
fiduciary capacity solely for the benefit of applicable exempt
organizations or of persons otherwise meeting one of the first
two exceptions.
An exception to the term ``applicable insurance
contract'' also is provided under the provision in certain
cases in which a person other than an applicable exempt
organization has an interest solely as a lender \123\ with
respect to the contract, and the contract covers only one
individual who is an officer, director, or employee of the
applicable exempt organization with an interest in the
contract, provided other requirements are met. This exception
applies only if the number of insured persons under loans by
such lenders with respect to such contracts does not exceed the
greater of: (1) the lesser of five percent of the total
officers, directors, and employees of the organization or 20,
or (2) five. Under this exception, the aggregate amount of
indebtedness with respect to 1 or more contracts covering a
single individual may not exceed $50,000.
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\123\ For this purpose, an interest as a lender includes a security
interest in the insurance contract to which the loan relates.
---------------------------------------------------------------------------
In addition, Treasury regulatory authority is provided to
except certain contracts from treatment as applicable insurance
contracts. Contracts may be excepted based on specific factors
including (1) whether the transaction is at arms' length, (2)
whether the economic benefits to the applicable exempt
organization substantially exceed the economic benefits to all
other persons with an interest in the contract (determined
without regard to whether, or the extent to which, such
organization has paid or contributed with respect to the
contract), and (3) the likelihood of abuse.
The application of the exceptions can be illustrated as
follows. Assume that an individual acquires a life insurance
contract in which the individual is the insured person, and the
named beneficiaries are the individual's son and a university
that is an organization described in section 170(c). The
contract is not an applicable insurance contract because the
first exception applies. That is, because both the individual
and his son have an insurable interest in the individual, all
persons holding any interest in the contract (other than
applicable exempt organizations) have an insurable interest in
the insured independent of any interest of an applicable exempt
organization in the contract. The second exception also applies
in this situation.
As another example, assume that the three named
beneficiaries are the insured's son, an unrelated friend, and a
charity. The contract is not an applicable insurance contract
because the second exception applies. That is, each
beneficiary's sole interest is as a named beneficiary. In
addition, the first exception also applies in this situation.
As a further example, assume that the insured individual
creates an irrevocable trust for the benefit of the insured's
descendants, and that the trustee of the trust uses trust funds
to purchase a life insurance policy on the insured's life, and
the trust is both the owner and beneficiary of the insurance
policy. The insured individual's naming of his or her
descendants as trust beneficiaries is a gratuitous act, done
without consideration. As a result, the contract is not an
applicable insurance contract under the third exception.
No Federal income tax deduction is permitted for the
excise tax payable under the provision, as provided under the
rule of Code section 275(a)(6). The amount of the excise tax
payable under the provision is not included in the investment
in the contract for purposes of section 72.
Treasury regulatory authority is provided to carry out
the purposes of the provision. This includes authority to
provide appropriate rules in the case in which a person
acquires an interest before a contract is treated as an
applicable insurance contract. This also includes authority to
prevent, in cases the Treasury Secretary determines
appropriate, the imposition of more than one tax if the same
interest is acquired more than once (otherwise, the tax under
the provision applies to each acquisition). Treasury regulatory
authority is also provided to prevent avoidance of the
provision, including through the use of intermediaries.
The provision provides reporting rules requiring an
applicable exempt organization or other person that makes a
taxable acquisition of an applicable insurance contract to file
a return containing required information and such other
information as is prescribed by the Treasury Secretary. Under
these rules, a statement is required to be furnished to each
person whose taxpayer identification information is required to
be reported on the return. Penalties apply for failure to file
the return or furnish the statement, including, in the case of
intentional disregard of the return filing requirement, a
penalty equal to the amount of the excise tax that has not been
paid with respect to the items required to be included on the
return.
Effective date.--The provision is effective for contracts
issued after May 3, 2005.
The application of the effective date with respect to
prior acquisitions of interests may be illustrated as follows.
Assume that an exempt organization and a person that is not an
exempt organization described in section 170(c) form a
partnership before May 3, 2005. After May 3, 2005, the
partnership acquires an interest in a life insurance contract
that is issued after May 3, 2005. The acquisition by the
partnership of the interest in the contract is treated as a
taxable acquisition under the provision by each of the partners
(i.e., the exempt organization and the other person).
The provision also requires reporting of existing life
insurance, endowment and annuity contracts issued on or before
that date, in which an applicable exempt organization holds an
interest on that date and which would be treated as an
applicable insurance contract under the provision. This
reporting is required within one year after the date of
enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
3. Increase the amounts of excise taxes imposed on public charities,
social welfare organizations, and private foundations (sec. 213
of the Senate amendment and secs. 4941, 4942, 4943, 4944, 4945,
and 4958 of the Code)
PRESENT LAW
Public charities and social welfare organizations
The Code imposes excise taxes on excess benefit
transactions between disqualified persons (as defined in
section 4958(f)) and charitable organizations (other than
private foundations) or social welfare organizations (as
described in section 501(c)(4)).\124\ An excess benefit
transaction generally is a transaction in which an economic
benefit is provided by a charitable or social welfare
organization directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including the
performance of services) received for providing such benefit.
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\124\ Sec. 4958. The excess benefit transaction tax is commonly
referred to as ``intermediate sanctions,'' because it imposes penalties
generally considered to be less punitive than revocation of the
organization's exempt status.
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The excess benefit tax is imposed on the disqualified
person and, in certain cases, on the organization manager, but
is not imposed on the exempt organization. An initial tax of 25
percent of the excess benefit amount is imposed on the
disqualified person that receives the excess benefit. An
additional tax on the disqualified person of 200 percent of the
excess benefit applies if the violation is not corrected. A tax
of 10 percent of the excess benefit (not to exceed $10,000 with
respect to any excess benefit transaction) is imposed on an
organization manager that knowingly participated in the excess
benefit transaction, if the manager's participation was willful
and not due to reasonable cause, and if the initial tax was
imposed on the disqualified person.\125\ If more than one
person is liable for the tax on disqualified persons or on
management, all such persons are jointly and severally liable
for the tax.\126\
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\125\ Sec. 4958(d)(2). Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\126\ Sec. 4958(d)(1).
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Private foundations
Self-dealing by private foundations
Excise taxes are imposed on acts of self-dealing between
a disqualified person (as defined in section 4946) and a
private foundation.\127\ In general, self-dealing transactions
are any direct or indirect: (1) sale or exchange, or leasing,
of property between a private foundation and a disqualified
person; (2) lending of money or other extension of credit
between a private foundation and a disqualified person; (3) the
furnishing of goods, services, or facilities between a private
foundation and a disqualified person; (4) the payment of
compensation (or payment or reimbursement of expenses) by a
private foundation to a disqualified person; (5) the transfer
to, or use by or for the benefit of, a disqualified person of
the income or assets of the private foundation; and (6) certain
payments of money or property to a government official.\128\
Certain exceptions apply.\129\
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\127\ Sec. 4941.
\128\ Sec. 4941(d)(1).
\129\ See sec. 4941(d)(2).
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An initial tax of five percent of the amount involved
with respect to an act of self-dealing is imposed on any
disqualified person (other than a foundation manager acting
only as such) who participates in the act of self-dealing. If
such a tax is imposed, a 2.5-percent tax of the amount involved
is imposed on a foundation manager who participated in the act
of self-dealing knowing it was such an act (and such
participation was not willful and was due to reasonable cause)
up to $10,000 per act. Such initial taxes may not be
abated.\130\ Such initial taxes are imposed for each year in
the taxable period, which begins on the date the act of self-
dealing occurs and ends on the earliest of the date of mailing
of a notice of deficiency for the tax, the date on which the
tax is assessed, or the date on which correction of the act of
self-dealing is completed. A government official (as defined in
section 4946(c)) is subject to such initial tax only if the
official participates in the act of self-dealing knowing it is
such an act. If the act of self-dealing is not corrected, a tax
of 200 percent of the amount involved is imposed on the
disqualified person and a tax of 50 percent of the amount
involved (up to $10,000 per act) is imposed on a foundation
manager who refused to agree to correcting the act of self-
dealing. Such additional taxes are subject to abatement.\131\
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\130\ Sec. 4962(b).
\131\ Sec. 4961.
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Tax on failure to distribute income
Private nonoperating foundations are required to pay out
a minimum amount each year as qualifying distributions. In
general, a qualifying distribution is an amount paid to
accomplish one or more of the organization's exempt purposes,
including reasonable and necessary administrative
expenses.\132\ Failure to pay out the minimum results in an
initial excise tax on the foundation of 15 percent of the
undistributed amount. An additional tax of 100 percent of the
undistributed amount applies if an initial tax is imposed and
the required distributions have not been made by the end of the
applicable taxable period.\133\ A foundation may include as a
qualifying distribution the salaries, occupancy expenses,
travel costs, and other reasonable and necessary administrative
expenses that the foundation incurs in operating a grant
program. A qualifying distribution also includes any amount
paid to acquire an asset used (or held for use) directly in
carrying out one or more of the organization's exempt purposes
and certain amounts set-aside for exempt purposes.\134\ Private
operating foundations are not subject to the payout
requirements.
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\132\ Sec. 4942(g)(1)(A).
\133\ Sec. 4942(a) and (b). Taxes imposed may be abated if certain
conditions are met. Secs. 4961 and 4962.
\134\ Sec. 4942(g)(1)(B) and 4942(g)(2). In general, an
organization is permitted to adjust the distributable amount in those
cases where distributions during the five preceding years have exceeded
the payout requirements. Sec. 4942(i).
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Tax on excess business holdings
Private foundations are subject to tax on excess business
holdings.\135\ In general, a private foundation is permitted to
hold 20 percent of the voting stock in a corporation, reduced
by the amount of voting stock held by all disqualified persons
(as defined in section 4946). If it is established that no
disqualified person has effective control of the corporation, a
private foundation and disqualified persons together may own up
to 35 percent of the voting stock of a corporation. A private
foundation shall not be treated as having excess business
holdings in any corporation if it owns (together with certain
other related private foundations) not more than two percent of
the voting stock and not more than two percent in value of all
outstanding shares of all classes of stock in that corporation.
Similar rules apply with respect to holdings in a partnership
(``profits interest'' is substituted for ``voting stock'' and
``capital interest'' for ``nonvoting stock'') and to other
unincorporated enterprises (by substituting ``beneficial
interest'' for ``voting stock''). Private foundations are not
permitted to have holdings in a proprietorship. Foundations
generally have a five-year period to dispose of excess business
holdings (acquired other than by purchase) without being
subject to tax.\136\ This five-year period may be extended an
additional five years in limited circumstances.\137\
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\135\ Sec. 4943. Taxes imposed may be abated if certain conditions
are met. Secs. 4961 and 4962.
\136\ Sec. 4943(c)(6).
\137\ Sec. 4943(c)(7).
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The initial tax is equal to five percent of the value of
the excess business holdings held during the foundation's
applicable taxable year. An additional tax is imposed if an
initial tax is imposed and at the close of the applicable
taxable period, the foundation continues to hold excess
business holdings. The amount of the additional tax is equal to
200 percent of such holdings.
Tax on jeopardizing investments
Private foundations and foundation managers are subject
to tax on investments that jeopardize the foundation's
charitable purpose.\138\ In general, an initial tax of five
percent of the amount of the investment applies to the
foundation and to foundation managers who participated in the
making of the investment knowing that it jeopardized the
carrying out of the foundation's exempt purposes. The initial
tax on foundation managers may not exceed $5,000 per
investment. If the investment is not removed from jeopardy
(e.g., sold or otherwise disposed of), an additional tax of 25
percent of the amount of the investment is imposed on the
foundation and five percent of the amount of the investment on
a foundation manager who refused to agree to removing the
investment from jeopardy. The additional tax on foundation
managers may not exceed $10,000 per investment. An investment,
the primary purpose of which is to accomplish a charitable
purpose and no significant purpose of which is the production
of income or the appreciation of property, is not considered a
jeopardizing investment.\139\
---------------------------------------------------------------------------
\138\ Sec. 4944. Taxes imposed may be abated if certain conditions
are met. Secs. 4961 and 4962.
\139\ Sec. 4944(c).
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Tax on taxable expenditures
Certain expenditures of private foundations are subject
to tax.\140\ In general, taxable expenditures are expenses: (1)
for lobbying; (2) to influence the outcome of a public election
or carry on a voter registration drive (unless certain
requirements are met); (3) as a grant to an individual for
travel, study, or similar purposes unless made pursuant to
procedures approved by the Secretary; (4) as a grant to an
organization that is not a public charity or exempt operating
foundation unless the foundation exercises expenditure
responsibility \141\ with respect to the grant; or (5) for any
non-charitable purpose. For each taxable expenditure, a tax is
imposed on the foundation of 10 percent of the amount of the
expenditure, and an additional tax of 100 percent is imposed on
the foundation if the expenditure is not corrected. A tax of
2.5 percent of the expenditure (up to $5,000) also is imposed
on a foundation manager who agrees to making a taxable
expenditure knowing that it is a taxable expenditure. An
additional tax of 50 percent of the amount of the expenditure
(up to $10,000) is imposed on a foundation manager who refuses
to agree to correction of such expenditure.
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\140\ Sec. 4945. Taxes imposed may be abated if certain conditions
are met. Secs. 4961 and 4962.
\141\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish reasonable
procedures to ensure that the grant is spent solely for the purpose for
which it was made, to obtain reports from the grantee on the
expenditure of the grant, and to make reports to the Secretary
regarding such expenditures. Sec. 4945(h).
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HOUSE BILL
No provision.
SENATE AMENDMENT
Self-dealing and excess benefit transaction initial taxes and dollar
limitations
For acts of self-dealing other than the payment of
compensation by a private foundation to a disqualified person,
the provision increases the initial tax on the self-dealer from
five percent of the amount involved to 10 percent of the amount
involved. For acts of self-dealing regarding the payment of
compensation by a private foundation to a disqualified person,
the provision increases the initial tax on the self-dealer from
five percent of the amount involved (none of which is subject
to abatement) to 25 percent of the amount involved (15 percent
of which is subject to abatement). The provision increases the
initial tax on foundation managers from 2.5 percent of the
amount involved to five percent of the amount involved and
increases the dollar limitation on the amount of the initial
and additional taxes on foundation managers per act of self-
dealing from $10,000 per act to $20,000 per act. Similarly, the
provision doubles the dollar limitation on organization
managers of public charities and social welfare organizations
for participation in excess benefit transactions from $10,000
per transaction to $20,000 per transaction.
Failure to distribute income, excess business holdings, jeopardizing
investments, and taxable expenditures
The provision doubles the amounts of the initial taxes
and the dollar limitations on foundation managers with respect
to the private foundation excise taxes on the failure to
distribute income, excess business holdings, jeopardizing
investments, and taxable expenditures.
Specifically, for the failure to distribute income, the
initial tax on the foundation is increased from 15 percent of
the undistributed amount to 30 percent of the undistributed
amount.
For excess business holdings, the initial tax on excess
business holdings is increased from five percent of the value
of such holdings to 10 percent of such value.
For jeopardizing investments, the initial tax of five
percent of the amount of the investment that is imposed on the
foundation and on foundation managers is increased to 10
percent of the amount of the investment. The dollar limitation
on the initial tax on foundation managers of $5,000 per
investment is increased to $10,000 and the dollar limitation on
the additional tax on foundation managers of $10,000 per
investment is increased to $20,000.
For taxable expenditures, the initial tax on the
foundation is increased from 10 percent of the amount of the
expenditure to 20 percent, the initial tax on the foundation
manager is increased from 2.5 percent of the amount of the
expenditure to five percent, the dollar limitation on the
initial tax on foundation managers is increased from $5,000 to
$10,000, and the dollar limitation on the additional tax on
foundation managers is increased from $10,000 to $20,000.
Effective date
The provision is effective for taxable years beginning
after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
4. Reform rules for charitable contributions of easements on buildings
in registered historic districts (sec. 214 of the Senate
amendment and sec. 170 of the Code)
PRESENT LAW
In general
Present law provides special rules that apply to
charitable deductions of qualified conservation contributions,
which include conservation easements and facade easements.\142\
Qualified conservation contributions are not subject to the
``partial interest'' rule, which generally bars deductions for
charitable contributions of partial interests in property.\143\
Accordingly, qualified conservation contributions are
contributions of partial interests that are eligible for a fair
market value charitable deduction.
---------------------------------------------------------------------------
\142\ Sec. 170(h).
\143\ Sec. 170(f)(3).
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A qualified conservation contribution is a contribution
of a qualified real property interest to a qualified
organization exclusively for conservation purposes. A qualified
real property interest is defined as: (1) the entire interest
of the donor other than a qualified mineral interest; (2) a
remainder interest; or (3) a restriction (granted in
perpetuity) on the use that may be made of the real
property.\144\ Qualified organizations include certain
governmental units, public charities that meet certain public
support tests, and certain supporting organizations.
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\144\ Charitable contributions of interests that constitute the
taxpayer's entire interest in the property are not regarded as
qualified real property interests within the meaning of section 170(h),
but instead are subject to the general rules applicable to charitable
contributions of entire interests of the taxpayer (i.e., generally are
deductible at fair market value, without regard to satisfaction of the
requirements of section 170(h)).
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Conservation purposes include: (1) the preservation of
land areas for outdoor recreation by, or for the education of,
the general public; (2) the protection of a relatively natural
habitat of fish, wildlife, or plants, or similar ecosystem; (3)
the preservation of open space (including farmland and forest
land) where such preservation will yield a significant public
benefit and is either for the scenic enjoyment of the general
public or pursuant to a clearly delineated Federal, State, or
local governmental conservation policy; and (4) the
preservation of an historically important land area or a
certified historic structure.\145\
---------------------------------------------------------------------------
\145\ Sec. 170(h)(4)(A).
---------------------------------------------------------------------------
In general, no deduction is available if the property may
be put to a use that is inconsistent with the conservation
purpose of the gift.\146\ A contribution is not deductible if
it accomplishes a permitted conservation purpose while also
destroying other significant conservation interests.\147\
---------------------------------------------------------------------------
\146\ Treas. Reg. sec. 1.170A-14(e)(2).
\147\ Treas. Reg. sec. 1.170A-14(e)(2).
---------------------------------------------------------------------------
Taxpayers are required to obtain a qualified appraisal
for donated property with a value of $5,000 or more, and to
attach an appraisal summary to the tax return.\148\ Under
Treasury regulations, a qualified appraisal means an appraisal
document that, among other things: (1) relates to an appraisal
that is made not earlier than 60 days prior to the date of
contribution of the appraised property and not later than the
due date (including extensions) of the return on which a
deduction is first claimed under section 170; \149\ (2) is
prepared, signed, and dated by a qualified appraiser; (3)
includes (a) a description of the property appraised; (b) the
fair market value of such property on the date of contribution
and the specific basis for the valuation; (c) a statement that
such appraisal was prepared for income tax purposes; (d) the
qualifications of the qualified appraiser; and (e) the
signature and taxpayer identification number of such appraiser;
and (4) does not involve an appraisal fee that violates certain
prescribed rules.\150\
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\148\ Sec. 170(f)(11)(C).
\149\ In the case of a deduction first claimed or reported on an
amended return, the deadline is the date on which the amended return is
filed.
\150\ Treas. Reg. sec. 1.170A-13(c)(3).
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Valuation
The value of a conservation restriction granted in
perpetuity generally is determined under the ``before and after
approach.'' Such approach provides that the fair market value
of the restriction is equal to the difference (if any) between
the fair market value of the property the restriction encumbers
before the restriction is granted and the fair market value of
the encumbered property after the restriction is granted.\151\
---------------------------------------------------------------------------
\151\ Treas. Reg. sec. 1.170A-14(h)(3).
---------------------------------------------------------------------------
If the granting of a perpetual restriction has the effect
of increasing the value of any other property owned by the
donor or a related person, the amount of the charitable
deduction for the conservation contribution is to be reduced by
the amount of the increase in the value of the other
property.\152\ In addition, the donor is to reduce the amount
of the charitable deduction by the amount of financial or
economic benefits that the donor or a related person receives
or can reasonably be expected to receive as a result of the
contribution.\153\ If such benefits are greater than those that
will inure to the general public from the transfer, no
deduction is allowed.\154\ In those instances where the grant
of a conservation restriction has no material effect on the
value of the property, or serves to enhance, rather than
reduce, the value of the property, no deduction is
allowed.\155\
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\152\ Treas. Reg. sec. 1.170A-14(h)(3)(i).
\153\ Id.
\154\ Id.
\155\ Treas. Reg. sec. 1.170A-14(h)(3)(ii).
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Preservation of a certified historic structure
A certified historic structure means any building,
structure, or land which is (i) listed in the National
Register, or (ii) located in a registered historic district (as
defined in section 47(c)(3)(B)) and is certified by the
Secretary of the Interior to the Secretary of the Treasury as
being of historic significance to the district.\156\ For this
purpose, a structure means any structure, whether or not it is
depreciable, and, accordingly, easements on private residences
may qualify.\157\ If restrictions to preserve a building or
land area within a registered historic district permit future
development on the site, a deduction will be allowed only if
the terms of the restrictions require that such development
conform with appropriate local, State, or Federal standards for
construction or rehabilitation within the district.\158\
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\156\ Sec. 170(h)(4)(B).
\157\ Treas. Reg. sec. 1.170A-14(d)(5)(iii).
\158\ Treas. Reg. sec. 1.170A-14(d)(5)(i).
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The IRS and the courts have held that a facade easement
may constitute a qualifying conservation contribution.\159\ In
general, a facade easement is a restriction the purpose of
which is to preserve certain architectural, historic, and
cultural features of the facade, or front, of a building. The
terms of a facade easement might permit the property owner to
make alterations to the facade of the structure if the owner
obtains consent from the qualified organization that holds the
easement.
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\159\ Hillborn v. Commissioner, 85 T.C. 677 (1985) (holding the
fair market value of a facade donation generally is determined by
applying the ``before and after'' valuation approach); Richmond v.
U.S., 699 F. Supp. 578 (E.D. La. 1988); Priv. Ltr. Rul. 199933029 (May
24, 1999) (ruling that a preservation and conservation easement
relating to the facade and certain interior portions of a fraternity
house was a qualified conservation contribution).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision revises the rules for qualified
conservation contributions with respect to property for which a
charitable deduction is allowable under section
170(h)(4)(B)(ii) by reason of a property's location in a
registered historic district. Under the provision, a charitable
deduction is not allowable with respect to a structure or land
area located in such a district (by reason of the structure or
land area's location in such a district). A charitable
deduction is allowable with respect to buildings (as is the
case under present law) but the qualified real property
interest that relates to the exterior of the building must
preserve the entire exterior of the building, including the
space above the building, the sides, the rear, and the front of
the building. In addition, such qualified real property
interest must provide that no portion of the exterior of the
building may be changed in a manner inconsistent with the
historical character of such exterior.
For any contribution relating to a registered historic
district made after the date of enactment of the provision,
taxpayers must include with the return for the taxable year of
the contribution a qualified appraisal of the qualified real
property interest (irrespective of the claimed value of such
interest) and attach the appraisal with the taxpayer's return,
photographs of the entire exterior of the building, and
descriptions of all current restrictions on development of the
building, including, for example, zoning laws, ordinances,
neighborhood association rules, restrictive covenants, and
other similar restrictions. Failure to obtain and attach an
appraisal or to include the required information results in
disallowance of the deduction. In addition, the donor and the
donee must enter into a written agreement certifying, under
penalty of perjury, that the donee is a qualified organization,
with a purpose of environmental protection, land conservation,
open space preservation, or historic preservation, and that the
donee has the resources to manage and enforce the restriction
and a commitment to do so.
Taxpayers claiming a deduction for a qualified
conservation contribution with respect to the exterior of a
building located in a registered historic district in excess of
the greater of three percent of the fair market value of the
underlying property or $10,000 must pay a $500 fee to the
Internal Revenue Service or the deduction is not allowed.
Amounts paid are required to be dedicated to Internal Revenue
Service enforcement of qualified conservation contributions.
Effective date.--The provision relating to deductions for
contributions relating to structures and land areas is
effective for contributions made after the date of enactment.
The limitation on the amount that may be deducted and the
filing fee is effective for contributions made 180 days after
the date of enactment. The rest of the provision is effective
for contributions made after November 15, 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
5. Reform rules relating to charitable contributions of taxidermy and
recapture tax benefit on property not used for an exempt use
(secs. 215 and 216 of the Senate amendment and secs. 170,
6050L, and new sec. 6720B of the Code)
PRESENT LAW
Deductibility of charitable contributions
In general
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity.\160\ The amount of the
deduction allowable for a taxable year with respect to a
charitable contribution of property may be reduced or limited
depending on the type of property contributed, the type of
charitable organization to which the property is contributed,
and the income of the taxpayer.\161\ In general, more generous
charitable contribution deduction rules apply to gifts made to
public charities than to gifts made to private foundations.
Within certain limitations, donors also are entitled to deduct
their contributions to section 501(c)(3) organizations for
Federal estate and gift tax purposes. By contrast,
contributions to nongovernmental, non-charitable tax-exempt
organizations generally are not deductible by the donor,\162\
though such organizations are eligible for the exemption from
Federal income tax with respect to such donations.
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\160\ The deduction also is allowed for purposes of calculating
alternative minimum taxable income.
\161\ Secs. 170(b) and (e).
\162\ Exceptions to the general rule of non-deductibility include
certain gifts made to a veterans' organization or to a domestic
fraternal society. In addition, contributions to certain nonprofit
cemetery companies are deductible for Federal income tax purposes, but
generally are not deductible for Federal estate and gift tax purposes.
Secs. 170(c)(3), 170(c)(4), 170(c)(5), 2055(a)(3), 2055(a)(4),
2106(a)(2)(A)(iii), 2522(a)(3), and 2522(a)(4).
---------------------------------------------------------------------------
Contributions of property
The amount of the deduction for charitable contributions
of capital gain property generally equals the fair market value
of the contributed property on the date of the contribution.
Capital gain property means any capital asset, or property used
in the taxpayer's trade or business, the sale of which at its
fair market value, at the time of contribution, would have
resulted in gain that would have been long-term capital gain.
Contributions of capital gain property are subject to different
percentage limitations (i.e., limitations based on the donor's
income) than other contributions of property.
For certain contributions of property, the deductible
amount is reduced from the fair market value of the contributed
property by the amount of any gain, generally resulting in a
deduction equal to the taxpayer's basis. This rule applies to
contributions of: (1) ordinary income property, e.g., property
that, at the time of contribution, would not have resulted in
long-term capital gain if the property was sold by the taxpayer
on the contribution date; \163\ (2) tangible personal property
that is used by the donee in a manner unrelated to the donee's
exempt (or governmental) purpose; and (3) property to or for
the use of a private foundation (other than a foundation
defined in section 170(b)(1)(E)).
---------------------------------------------------------------------------
\163\ For certain contributions of inventory, C corporations may
claim an enhanced deduction equal to the lesser of (1) basis plus one-
half of the item's appreciation (i.e., basis plus one half of fair
market value in excess of basis) or (2) two times basis. Sec.
170(e)(3), 170(e)(4), 170(e)(6).
---------------------------------------------------------------------------
Charitable contributions of taxidermy are subject to the
tangible personal property rule (number (2) above). For
example, for appreciated taxidermy, if the property is used to
further the donee's exempt purpose, the deduction is fair
market value. But if the property is not used to further the
donee's exempt purpose, the deduction is the donor's basis. If
the taxidermy is depreciated, i.e., the value is less than the
taxpayer's basis in such property, taxpayers generally deduct
the fair market value of such contributions, regardless of
whether the property is used for exempt or unrelated purposes
by the donee.
Substantiation
No charitable deduction is allowed for any contribution
of $250 or more unless the taxpayer substantiates the
contribution by a contemporaneous written acknowledgement of
the contribution by the donee organization.\164\ Such
acknowledgement must include the amount of cash and a
description (but not value) of any property other than cash
contributed, whether the donee provided any goods or services
in consideration for the contribution (and a good faith
estimate of the value of any such goods or services).
---------------------------------------------------------------------------
\164\ Sec. 170(f)(8).
---------------------------------------------------------------------------
In general, if the total charitable deduction claimed for
non-cash property is more than $500, the taxpayer must attach a
completed Form 8283 (Noncash Charitable Contributions) to the
taxpayer's return or the deduction is not allowed.\165\ C
corporations (other than personal service corporations and
closely-held corporations) are required to file Form 8283 only
if the deduction claimed is more than $5,000. Information
required on the Form 8283 includes, among other things, a
description of the property, the appraised fair market value
(if an appraisal is required), the donor's basis in the
property, how the donor acquired the property, a declaration by
the appraiser regarding the appraiser's general qualifications,
an acknowledgement by the donee that it is eligible to receive
deductible contributions, and an indication by the donee
whether the property is intended for an unrelated use.
---------------------------------------------------------------------------
\165\ Sec. 170(f)(11).
---------------------------------------------------------------------------
Taxpayers are required to obtain a qualified appraisal
for donated property with a value of more than $5,000, and to
attach an appraisal summary to the tax return.\166\ Under
Treasury regulations, a qualified appraisal means an appraisal
document that, among other things: (1) relates to an appraisal
that is made not earlier than 60 days prior to the date of
contribution of the appraised property and not later than the
due date (including extensions) of the return on which a
deduction is first claimed under section 170;\167\ (2) is
prepared, signed, and dated by a qualified appraiser; (3)
includes (a) a description of the property appraised; (b) the
fair market value of such property on the date of contribution
and the specific basis for the valuation; (c) a statement that
such appraisal was prepared for income tax purposes; (d) the
qualifications of the qualified appraiser; and (e) the
signature and taxpayer identification number of such appraiser;
and (4) does not involve an appraisal fee that violates certain
prescribed rules.\168\ In the case of contributions of art
valued at more than $20,000 and other contributions of more
than $500,000, taxpayers are required to attach the appraisal
to the tax return. Taxpayers may request a Statement of Value
from the Internal Revenue Service in order to substantiate the
value of art with an appraised value of $50,000 or more for
income, estate, or gift tax purposes.\169\ The fee for such a
Statement is $2,500 for one, two, or three items or art plus
$250 for each additional item.
---------------------------------------------------------------------------
\166\ Id.
\167\ In the case of a deduction first claimed or reported on an
amended return, the deadline is the date on which the amended return is
filed.
\168\ Treas. Reg. sec. 1.170A-13(c)(3). Sec. 170(f)(11)(E).
\169\ Rev. Proc. 96-15, 1996-1 C.B. 627.
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If a donee organization sells, exchanges, or otherwise
disposes of contributed property with a claimed value of more
than $5,000 (other than publicly traded securities) within two
years of the property's receipt, the donee is required to file
a return (Form 8282) with the Secretary, and to furnish a copy
of the return to the donor, showing the name, address, and
taxpayer identification number of the donor, a description of
the property, the date of the contribution, the amount received
on the disposition, and the date of the disposition.\170\
---------------------------------------------------------------------------
\170\ Sec. 6050L(a)(1).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
Contributions of taxidermy
For contributions of taxidermy property with a claimed
value of more than $500, the individual must include with the
individual's return a photograph of the taxidermy and
comparable sales data for similar items. It is intended that
valuation must be based on comparable sales and that a
deduction is not allowable if sufficient comparable sales are
not provided.
For claims of more than $5,000, the taxpayer must notify
the IRS of the deduction and include with the taxpayer's return
a statement of value from the IRS, similar to that available
under present law for items of art, or a request for such a
statement and a fee of $500. The provision defines taxidermy
property as a mounted work of art which contains any part of a
dead animal.
It is intended that for purposes of the charitable
contribution deduction, a taxpayer may not include in the
taxpayer's basis of the contributed taxidermy any costs
attributable to travel.
Recapture of tax benefit upon subsequent disposition of tangible
personal property intended for an exempt use
In general, the provision recovers the tax benefit for
charitable contributions of tangible personal property with
respect to which a fair market value deduction is claimed and
which is not used for exempt purposes. The provision applies to
appreciated tangible personal property that is identified by
the donee organization as for a use related to the purpose or
function constituting the donee's basis for tax exemption, and
for which a deduction of more than $5,000 is claimed
(``applicable property'').\171\
---------------------------------------------------------------------------
\171\ Present law rules continue to apply to any contribution of
exempt use property for which a deduction of $5,000 or less is claimed.
---------------------------------------------------------------------------
Under the provision, if a donee organization disposes of
applicable property within three years of the contribution of
the property, the donor is subject to an adjustment of the tax
benefit. If the disposition occurs in the tax year of the donor
in which the contribution is made, the donor's deduction
generally is basis and not fair market value.\172\ If the
disposition occurs in a subsequent year, the donor must include
as ordinary income for its taxable year in which the
disposition occurs an amount equal to the excess (if any) of
(i) the amount of the deduction previously claimed by the donor
as a charitable contribution with respect to such property,
over (ii) the donor's basis in such property at the time of the
contribution.
---------------------------------------------------------------------------
\172\ The disposition proceeds are regarded as relevant to a
determination of fair market value.
---------------------------------------------------------------------------
There is no adjustment of the tax benefit if the donee
organization makes a certification to the Secretary, by written
statement signed under penalties of perjury by an officer of
the organization. The statement must either (1) certify that
the use of the property by the donee was related to the purpose
or function constituting the basis for the donee's exemption,
and describe how the property was used and how such use
furthered such purpose or function; or (2) state the intended
use of the property by the donee at the time of the
contribution and certify that such use became impossible or
infeasible to implement. The organization must furnish a copy
of the certification to the donor.
A penalty of $10,000 applies to a person that identifies
applicable property as having a use that is related to a
purpose or function constituting the basis for the donee's
exemption knowing that it is not intended for such a use.\173\
---------------------------------------------------------------------------
\173\ Other present-law penalties also may apply, such as the
penalty for aiding and abetting the understatement of tax liability
under section 6701.
---------------------------------------------------------------------------
Reporting of exempt use property contributions
The provision modifies the present-law information return
requirements that apply upon the disposition of contributed
property by a charitable organization (Form 8282, sec. 6050L).
The return requirement is extended to dispositions made within
three years after receipt (from two years). The donee
organization also must provide, in addition to the information
already required to be provided on the return, a description of
the donee's use of the property, a statement of whether use of
the property was related to the purpose or function
constituting the basis for the donee's exemption, and, if
applicable, a certification of any such use (described above).
Effective date
With respect to contributions of taxidermy property, the
provision is effective for contributions made after November
15, 2005. With respect to exempt use property generally, the
provision is effective for contributions made and returns filed
after June 1, 2006.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
6. Limit charitable deduction for contributions of clothing and
household items and modify recordkeeping and substantiation
requirements for certain charitable contributions (secs. 217
and 218 of the Senate amendment and sec. 170 of the Code)
PRESENT LAW
Deductibility of charitable contributions
In general
In computing taxable income, a taxpayer who itemizes
deductions generally is allowed to deduct the amount of cash
and the fair market value of property contributed to an
organization described in section 501(c)(3) or to a Federal,
State, or local governmental entity.\174\ The amount of the
deduction allowable for a taxable year with respect to a
charitable contribution of property may be reduced or limited
depending on the type of property contributed, the type of
charitable organization to which the property is contributed,
and the income of the taxpayer.\175\ In general, more generous
charitable contribution deduction rules apply to gifts made to
public charities than to gifts made to private foundations.
Within certain limitations, donors also are entitled to deduct
their contributions to section 501(c)(3) organizations for
Federal estate and gift tax purposes. By contrast,
contributions to nongovernmental, non-charitable tax-exempt
organizations generally are not deductible by the donor,\176\
though such organizations are eligible for the exemption from
Federal income tax with respect to such donations.
---------------------------------------------------------------------------
\174\ The deduction also is allowed for purposes of calculating
alternative minimum taxable income.
\175\ Secs. 170(b) and (e).
\176\ Exceptions to the general rule of non-deductibility include
certain gifts made to a veterans' organization or to a domestic
fraternal society. In addition, contributions to certain nonprofit
cemetery companies are deductible for Federal income tax purposes, but
generally are not deductible for Federal estate and gift tax purposes.
Secs. 170(c)(3), 170(c)(4), 170(c)(5), 2055(a)(3), 2055(a)(4),
2106(a)(2)(A)(iii), 2522(a)(3), and 2522(a)(4).
---------------------------------------------------------------------------
Contributions of property
The amount of the deduction for charitable contributions
of capital gain property generally equals the fair market value
of the contributed property on the date of the contribution.
Capital gain property means any capital asset or property used
in the taxpayer's trade or business the sale of which at its
fair market value, at the time of contribution, would have
resulted in gain that would have been long-term capital gain.
Contributions of capital gain property are subject to different
percentage limitations than other contributions of property.
For certain contributions of property, the deductible
amount is reduced from the fair market value of the contributed
property by the amount of any gain, generally resulting in a
deduction equal to the taxpayer's basis. This rule applies to
contributions of: (1) ordinary income property, e.g., property
that, at the time of contribution, would not have resulted in
long-term capital gain if the property was sold by the taxpayer
on the contribution date; \177\ (2) tangible personal property
that is used by the donee in a manner unrelated to the donee's
exempt (or governmental) purpose; and (3) property to or for
the use of a private foundation (other than a foundation
defined in section 170(b)(1)(E)).
---------------------------------------------------------------------------
\177\ For certain contributions of inventory and other property, C
corporations may claim an enhanced deduction equal to the lesser of (1)
basis plus one-half of the item's appreciation (i.e., basis plus one
half of fair market value in excess of basis) or (2) two times basis.
Sec. 170(e)(3), 170(e)(4), 170(e)(6).
---------------------------------------------------------------------------
Charitable contributions of clothing and household items
are subject to the tangible personal property rule (number (2)
above). If such contributed property is appreciated property in
the hands of the taxpayer, and is not used to further the
donee's exempt purpose, the deduction is basis. In general,
however, the value of clothing and household items is less than
the taxpayer's basis in such property, with the result that
taxpayers generally deduct the fair market value of such
contributions, regardless of whether the property is used for
exempt or unrelated purposes by the donee.
Substantiation
A donor who claims a deduction for a charitable
contribution must maintain reliable written records regarding
the contribution, regardless of the value or amount of such
contribution. For a contribution of money, the donor generally
must maintain one of the following: (1) a cancelled check; (2)
a receipt (or a letter or other written communication) from the
donee showing the name of the donee organization, the date of
the contribution, and the amount of the contribution; or (3) in
the absence of a cancelled check or a receipt, other reliable
written records showing the name of the donee, the date of the
contribution, and the amount of the contribution. For a
contribution of property other than money, the donor generally
must maintain a receipt from the donee organization showing the
name of the donee, the date and location of the contribution,
and a detailed description (but not the value) of the
property.\178\ A donor of property other than money need not
obtain a receipt, however, if circumstances make obtaining a
receipt impracticable. Under such circumstances, the donor must
maintain reliable written records regarding the contribution.
The required content of such a record varies depending upon
factors such as the type and value of property
contributed.\179\
---------------------------------------------------------------------------
\178\ Treas. Reg. sec. 1.170A-13(a).
\179\ Treas. Reg. sec. 1.170A-13(b).
---------------------------------------------------------------------------
In addition to the foregoing recordkeeping requirements,
substantiation requirements apply in the case of charitable
contributions with a value of $250 or more. No charitable
deduction is allowed for any contribution of $250 or more
unless the taxpayer substantiates the contribution by a
contemporaneous written acknowledgement of the contribution by
the donee organization. Such acknowledgement must include the
amount of cash and a description (but not value) of any
property other than cash contributed, whether the donee
provided any goods or services in consideration for the
contribution, and a good faith estimate of the value of any
such goods or services.\180\ In general, if the total
charitable deduction claimed for non-cash property is more than
$500, the taxpayer must attach a completed Form 8283 (Noncash
Charitable Contributions) to the taxpayer's return or the
deduction is not allowed.\181\ In general, taxpayers are
required to obtain a qualified appraisal for donated property
with a value of more than $5,000, and to attach an appraisal
summary to the tax return.
---------------------------------------------------------------------------
\180\ Sec. 170(f)(8).
\181\ Sec. 170(f)(11).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
General rule relating to clothing and household items
The provision requires the Secretary to prepare and
publish an itemized list of clothing and household items and to
assign an amount to each item on the list. The assigned amount
is treated as the fair market value of the item for purposes of
the charitable contribution deduction and is based on an
assumption that the item is in good used condition or better.
Any deduction for a charitable contribution of each such item
may not exceed the item's assigned amount. Any deduction for an
item not in good used condition or better may not exceed 20
percent of the item's assigned amount. Any deduction for an
item that is not functional with respect to the use for which
it was designed is not allowed. The list must be published by
the Secretary at least once each calendar year and is
applicable to contributions of clothing and household items
made while the list is effective. The Secretary has discretion
to determine the effective dates for each published list. The
list should be prepared in consultation with donee
organizations that accept charitable contributions of clothing
and household items. In assigning amounts to particular items,
the Secretary should take into account the sales price of such
contributed item when sold by the donee organizations, whether
through an exempt program of such organizations or otherwise.
If an item of clothing or household item is not included on the
list published by the Secretary, present law rules apply to the
contribution of the item.
The provision does not apply to contributions for which
the donor has obtained a qualified appraisal. The provision
also does not apply to contributions for which a deduction of
more than $500 is claimed if (1) the donee sells the
contributed item before the earlier of the due date (including
extensions) for filing the return of tax for the taxable year
of the donor in which the contribution was made or the date
such return was filed; (2) the donee reports the sales price of
the contributed item to the donor; and (3) the amount claimed
as a deduction with respect to the contributed item does not
exceed the amount of the sales price reported to the donor.
The provision does not apply to contributions by C
corporations. The provision applies to new and used items.
Household items include furniture, furnishings, electronics,
appliances, linens, and other similar items. Food, paintings,
antiques, and other objects of art, jewelry and gems, and
collections are excluded from the provision.
Substantiation
Clothing and household items
As under present law, for contributions with a claimed
value of $250 or more, the taxpayer must obtain contemporaneous
substantiation from the donee organization, which must include
a description of the property contributed. The provision
provides that, as part of such substantiation, the taxpayer
obtain an indication of the condition of the item(s), a
description of the type of item, and either a copy of the
published list or instructions as to how to find such list.
Under present law, if a taxpayer claims that the total
value of charitable contributions of noncash property is more
than $500, the taxpayer must include with the taxpayer's return
a description of the property contributed and such other
information as the Secretary may require in order to claim a
charitable deduction (sec. 170(f)(11)(B)). This requirement
presently is satisfied through completion by the taxpayer of
the Form 8283 and attachment of the form to the taxpayer's
return. The provision requires that the donor include the
information about the contribution that is contained in the
contemporaneous substantiation obtained from the donee
organization (for gifts of $250 or more) as part of such
requirement.
Contributions of cash
In addition, in the case of a charitable contribution of
money, regardless of the amount, applicable recordkeeping
requirements are satisfied under the provision only if the
donor maintains a cancelled check or a receipt (or a letter or
other written communication) from the donee showing the name of
the donee organization, the date of the contribution, and the
amount of the contribution. The recordkeeping requirements may
not be satisfied by maintaining other written records.
Effective date
The provision relating to clothing and household items is
effective for contributions made after December 31, 2006. The
provision relating to substantiation more generally is
effective for contributions made in taxable years beginning
after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
7. Contributions of fractional interests in tangible personal property
(sec. 219 of the Senate amendment and sec. 170 of the Code)
PRESENT LAW
In general, a charitable deduction is not allowable for a
contribution of a partial interest in property, such as an
income interest, a remainder interest, or a right to use
property.\182\ A gift of an undivided portion of a donor's
entire interest in property generally is not treated as a
nondeductible gift of a partial interest in property.\183\ For
this purpose, an undivided portion of a donor's entire interest
in property must consist of a fraction or percentage of each
and every substantial interest or right owned by the donor in
such property and must extend over the entire term of the
donor's interest in such property.\184\ A gift generally is
treated as a gift of an undivided portion of a donor's entire
interest in property if the donee is given the right, as a
tenant in common with the donor, to possession, dominion, and
control of the property for a portion of each year appropriate
to its interest in such property.\185\
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\182\ Secs. 170(f)(3)(A) (income tax), 2055(e)(2) (estate tax), and
2522(c)(2) (gift tax).
\183\ Sec. 170(f)(3)(B)(ii).
\184\ Treas. Reg. sec. 1.170A-7(b)(1).
\185\ Treas. Reg. sec. 1.170A-7(b)(1).
---------------------------------------------------------------------------
Consistent with these requirements, a charitable
contribution deduction generally is not allowable for a
contribution of a future interest in tangible personal
property.\186\ For this purpose, a future interest is one ``in
which a donor purports to give tangible personal property to a
charitable organization, but has an understanding, arrangement,
agreement, etc., whether written or oral, with the charitable
organization which has the effect of reserving to, or retaining
in, such donor a right to the use, possession, or enjoyment of
the property.'' \187\ Treasury regulations provide that section
170(a)(3), which generally denies a deduction for a
contribution of a future interest in tangible personal
property, ``[has] no application in respect of a transfer of an
undivided present interest in property. For example, a
contribution of an undivided one-quarter interest in a painting
with respect to which the donee is entitled to possession
during three months of each year shall be treated as made upon
the receipt by the donee of a formally executed and
acknowledged deed of gift. However, the period of initial
possession by the donee may not be deferred in time for more
than one year.'' \188\
---------------------------------------------------------------------------
\186\ Sec. 170(a)(3).
\187\ Treas. Reg. sec. 1.170A-5(a)(4).
\188\ Treas. Reg. sec. 1.170A-5(a)(2).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
Require consistent valuation of fractional interests in the same item
of property
In general, under present law and the provision a donor
may take a deduction for a charitable contribution of a
fractional interest in tangible personal property (such as an
artwork), provided the donor satisfies the requirements for
deductibility (including the requirements concerning
contributions of partial interests and future interests in
property), and in subsequent years make additional charitable
contributions of interests in the same property.\189\ Under the
provision, a donor's charitable deduction for the initial
contribution of a fractional interest in an item of tangible
personal property (or collection of such items) shall be
determined as under current law (e.g., based upon the fair
market value of the artwork at the time of the contribution of
the fractional interest and considering whether the use of the
artwork will be related to the donee's exempt purposes). For
purposes of determining the deductible amount of each
additional contribution of an interest (whether or not a
fractional interest) in the same item of property, under the
provision, the fair market value of the item shall be the
lesser of: (1) the value used for purposes of determining the
charitable deduction for the initial fractional contribution;
or (2) the fair market value of the item at the time of the
subsequent contribution. This portion of the provision applies
for income, gift, and estate tax purposes.
---------------------------------------------------------------------------
\189\ See, e.g., Winokur v. Commissioner, 90 T.C. 733 (1988).
---------------------------------------------------------------------------
Require actual possession by the donee
The provision provides for recapture of the income tax
charitable deduction or gift tax charitable deduction under
certain circumstances. Specifically, if, during any one-year
period following a contribution of a fractional interest in an
item of tangible personal property, the donee fails to take
actual possession of the item for a period of time
corresponding substantially to the donee's then-existing
percentage interest in the item, then the donee's charitable
deduction for all previous contributions of interests in the
item shall be recaptured (plus interest).
Under the provision, the Secretary of the Treasury is
authorized to promulgate rules to prevent the circumvention of
the provision by, for example, engaging in a transaction in
which a donor first transfers one or more items of tangible
personal property to a separate entity in exchange for
ownership interests in the entity, and subsequently makes
charitable contributions of such ownership interests.
Effective date
The provision is applicable for contributions, bequests,
and gifts made after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
8. Provisions relating to substantial and gross overstatement of
valuations of property (sec. 220 of the Senate amendment and
secs. 6662 and 6664 of the Code)
PRESENT LAW
Taxpayer penalties
Present law imposes accuracy-related penalties on a
taxpayer in cases involving a substantial valuation
misstatement or gross valuation misstatement relating to an
underpayment of income tax.\190\ For this purpose, a
substantial valuation misstatement generally means a value
claimed that is at least twice (200 percent or more) the amount
determined to be the correct value, and a gross valuation
misstatement generally means a value claimed that is at least
four times (400 percent or more) the amount determined to be
the correct value.
---------------------------------------------------------------------------
\190\ Sec. 6662(b)(3) and (h).
---------------------------------------------------------------------------
The penalty is 20 percent of the underpayment of tax
resulting from a substantial valuation misstatement and rises
to 40 percent for a gross valuation misstatement. No penalty is
imposed unless the portion of the underpayment attributable to
the valuation misstatement exceeds $5,000 ($10,000 in the case
of a corporation other than an S corporation or a personal
holding company). Under present law, no penalty is imposed with
respect to any portion of the understatement attributable to
any item if (1) the treatment of the item on the return is or
was supported by substantial authority, or (2) facts relevant
to the tax treatment of the item were adequately disclosed on
the return or on a statement attached to the return and there
is a reasonable basis for the tax treatment. Special rules
apply to tax shelters.
In addition, the accuracy-related penalty does not apply
if a taxpayer shows there was reasonable cause for an
underpayment and the taxpayer acted in good faith.\191\
---------------------------------------------------------------------------
\191\ Sec. 6664(c).
---------------------------------------------------------------------------
Penalty for aiding and abetting understatement of tax
A penalty is imposed on a person who: (1) aids or assists
in or advises with respect to a tax return or other document;
(2) knows (or has reason to believe) that such document will be
used in connection with a material tax matter; and (3) knows
that this would result in an understatement of tax of another
person. In general, the amount of the penalty is $1,000. If the
document relates to the tax return of a corporation, the amount
of the penalty is $10,000.
Qualified appraisals
Present law requires a taxpayer to obtain a qualified
appraisal for donated property with a value of more than
$5,000, and to attach an appraisal summary to the tax
return.\192\ Treasury Regulations state that a qualified
appraisal means an appraisal document that, among other things:
(1) relates to an appraisal that is made not earlier than 60
days prior to the date of contribution of the appraised
property and not later than the due date (including extensions)
of the return on which a deduction is first claimed under
section 170; (2) is prepared, signed, and dated by a qualified
appraiser; (3) includes (a) a description of the property
appraised; (b) the fair market value of such property on the
date of contribution and the specific basis for the valuation;
(c) a statement that such appraisal was prepared for income tax
purposes; (d) the qualifications of the qualified appraiser;
and (e) the signature and taxpayer identification number of
such appraiser; and (4) does not involve an appraisal fee that
violates certain prescribed rules.\193\
---------------------------------------------------------------------------
\192\ Sec. 170(f)(11).
\193\ Treas. Reg. sec. 1.170A-13(c)(3).
---------------------------------------------------------------------------
Qualified appraisers
Treasury Regulations define a qualified appraiser as a
person who holds himself or herself out to the public as an
appraiser or performs appraisals on a regular basis, is
qualified to make appraisals of the type of property being
valued (as determined by the appraiser's background,
experience, education and membership, if any, in professional
appraisal associations), is independent, and understands that
an intentionally false or fraudulent overstatement of the value
of the appraised property may subject the appraiser to civil
penalties.\194\
---------------------------------------------------------------------------
\194\ Treas. Reg. sec. 1.170A-13(c)(5)(i).
---------------------------------------------------------------------------
Appraiser oversight
The Secretary is authorized to regulate the practice of
representatives of persons before the Department of the
Treasury (``Department'').\195\ After notice and hearing, the
Secretary is authorized to suspend or disbar from practice
before the Department or the Internal Revenue Service (``IRS'')
a representative who is incompetent, who is disreputable, who
violates the rules regulating practice before the Department or
the IRS, or who (with intent to defraud) willfully and
knowingly misleads or threatens the person being represented
(or a person who may be represented).
---------------------------------------------------------------------------
\195\ 31 U.S.C. sec. 330.
---------------------------------------------------------------------------
The Secretary also is authorized to bar from appearing
before the Department or the IRS, for the purpose of offering
opinion evidence on the value of property or other assets, any
individual against whom a civil penalty for aiding and abetting
the understatement of tax has been assessed. Thus, an appraiser
who aids or assists in the preparation or presentation of an
appraisal will be subject to disciplinary action if the
appraiser knows that the appraisal will be used in connection
with the tax laws and will result in an understatement of the
tax liability of another person. The Secretary has authority to
provide that the appraisals of an appraiser who has been
disciplined have no probative effect in any administrative
proceeding before the Department or the IRS.
HOUSE BILL
No provision.
SENATE AMENDMENT
Taxpayer penalties
The provision lowers the thresholds for imposing
accuracy-related penalties on a taxpayer who claims a deduction
for donated property for which a qualified appraisal is
required. Under the provision, a substantial valuation
misstatement exists when the claimed value of donated property
is 150 percent or more of the amount determined to be the
correct value. A gross valuation misstatement occurs when the
claimed value of donated property is 200 percent or more the
amount determined to be the correct value. Under the provision,
the reasonable cause exception to the accuracy-related penalty
does not apply in the case of gross valuation misstatements.
Appraiser oversight
Appraiser penalties
The provision establishes a civil penalty on any person
who prepares an appraisal that is to be used to support a tax
position if such appraisal results in a substantial or gross
valuation misstatement. The penalty is equal to the greater of
$1,000 or 10 percent of the understatement of tax resulting
from a substantial or gross valuation misstatement, up to a
maximum of 125 percent of the gross income derived from the
appraisal. Under the provision, the penalty does not apply if
the appraiser establishes that it was ``more likely than not''
that the appraisal was correct.
Disciplinary proceeding
The provision eliminates the requirement that the
Secretary assess against an appraiser the civil penalty for
aiding and abetting the understatement of tax before such
appraiser may be subject to disciplinary action. Thus, the
Secretary is authorized to discipline appraisers after notice
and hearing. Disciplinary action may include, but is not
limited to, suspending or barring an appraiser from: preparing
or presenting appraisals on the value of property or other
assets to the Department or the IRS; appearing before the
Department or the IRS for the purpose of offering opinion
evidence on the value of property or other assets; and
providing that the appraisals of an appraiser who have been
disciplined have no probative effect in any administrative
proceeding before the Department or the IRS.
Qualified appraisers
The provision defines a qualified appraiser as an
individual who (1) has earned an appraisal designation from a
recognized professional appraiser organization or has otherwise
met minimum education and experience requirements to be
determined by the IRS in regulations; (2) regularly performs
appraisals for which he or she receives compensation; (3) can
demonstrate verifiable education and experience in valuing the
type of property for which the appraisal is being performed;
(4) has not been prohibited from practicing before the IRS by
the Secretary at any time during the three years preceding the
conduct of the appraisal; and (5) is not excluded from being a
qualified appraiser under applicable Treasury regulations.
Qualified appraisals
The provision defines a qualified appraisal as an
appraisal of property prepared by a qualified appraiser (as
defined by the provision) in accordance with generally accepted
appraisal standards and any regulations or other guidance
prescribed by the Secretary.
Effective date
The provision amending the accuracy-related penalty
applies to returns filed after the date of enactment. The
provision establishing a civil penalty that may be imposed on
any person who prepares an appraisal that is to be used to
support a tax position if such appraisal results in a
substantial or gross valuation misstatement applies to
appraisals prepared with respect to returns or submissions
filed after the date of enactment. The provisions relating to
appraiser oversight apply to appraisals prepared with respect
to returns or submissions filed after the date of enactment.
With respect to any contribution of a qualified real property
interest which is a restriction with respect to the exterior of
a building described in section 170(h)(4)(C)(ii) (currently
designated section 170(h)(4)(B)(ii), relating to certain
property located in a registered historic district and
certified as being of historic significance to the district),
and any appraisal with respect to such contribution, the
provision generally applies to returns filed after December 16,
2004.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
9. Establish additional exemption standards for credit counseling
organizations (sec. 221 of the Senate amendment and secs. 501
and 513 of the Code)
PRESENT LAW
Under present law, a credit counseling organization may
be exempt as a charitable or educational organization described
in section 501(c)(3), or as a social welfare organization
described in section 501(c)(4). The IRS has issued two revenue
rulings holding that certain credit counseling organizations
are exempt as charitable or educational organizations or as
social welfare organizations.
In Revenue Ruling 65-299,\196\ an organization whose
purpose was to assist families and individuals with financial
problems, and help reduce the incidence of personal bankruptcy,
was determined to be a social welfare organization described in
section 501(c)(4). The organization counseled people in
financial difficulties, advised applicants on payment of debts,
and negotiated with creditors and set up debt repayment plans.
The organization did not restrict its services to the poor,
made no charge for counseling services, and made a nominal
charge for certain services to cover postage and supplies. For
financial support, the organization relied on voluntary
contributions from local businesses, lending agencies, and
labor unions.
---------------------------------------------------------------------------
\196\ Rev. Rul. 65-299, 1965-2 C.B. 165.
---------------------------------------------------------------------------
In Revenue Ruling 69-441,\197\ the IRS ruled an
organization was a charitable or educational organization
exempt under section 501(c)(3) by virtue of aiding low-income
people who had financial problems and providing education to
the public. The organization in that ruling had two functions:
(1) educating the public on personal money management, such as
budgeting, buying practices, and the sound use of consumer
credit through the use of films, speakers, and publications;
and (2) providing individual counseling to low-income
individuals and families without charge. As part of its
counseling activities, the organization established debt
management plans for clients who required such services, at no
charge to the clients.\198\ The organization was supported by
contributions primarily from creditors, and its board of
directors was comprised of representatives from religious
organizations, civic groups, labor unions, business groups, and
educational institutions.
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\197\ Rev. Rul. 65-441, 1969-2 C.B. 115.
\198\ Debt management plans are debt payment arrangements,
including debt consolidation arrangements, entered into by a debtor and
one or more of the debtor's creditors, generally structured to reduce
the amount of a debtor's regular ongoing payment by modifying the
interest rate, minimum payment, maturity or other terms of the debt.
Such plans frequently are promoted as a means for a debtor to
restructure debt without filing for bankruptcy.
---------------------------------------------------------------------------
In 1976, the IRS denied exempt status to an organization,
Consumer Credit Counseling Service of Alabama, whose activities
were distinguishable from those in Revenue Ruling 69-441 in
that (1) it did not restrict its services to the poor, and (2)
it charged a nominal fee for its debt management plans.\199\
The organization provided free information to the general
public through the use of speakers, films, and publications on
the subjects of budgeting, buying practices, and the use of
consumer credit. It also provided counseling to debt-distressed
individuals, not necessarily poor or low-income, and provided
debt management plans at the cost of $10 per month, which was
waived in cases of financial hardship. Its debt management
activities were a relatively small part of its overall
activities. The district court determined the organization
qualified as charitable and educational within section
501(c)(3), finding the debt management plans to be an integral
part of the agency's counseling function, and that its debt
management activities were incidental to its principal
functions, as only approximately 12 percent of the counselors'
time was applied to such programs and the charge for the
service was nominal. The court also considered the facts that
the agency was publicly supported, and that it had a board
dominated by members of the general public, as factors
indicating a charitable operation.\200\
---------------------------------------------------------------------------
\199\ Consumer Credit Counseling Services of Alabama, Inc. v. U.S.,
44 A.F.T.R. 2d (RIA) 5122 (D.D.C. 1978). The case involved 24 agencies
throughout the United States.
\200\ See also, Credit Counseling Centers of Oklahoma, Inc. v.
U.S., 45 A.F.T.R. 2d (RIA) 1401 (D.D.C. 1979) (holding the same on
virtually identical facts).
---------------------------------------------------------------------------
A recent estimate shows the number of credit counseling
organizations increased from approximately 200 in 1990 to over
1,000 in 2002.\201\ During the period from 1994 to late 2003,
1,215 credit counseling organizations applied to the IRS for
tax exempt status under section 501(c)(3), including 810 during
2000 to 2003.\202\ The IRS has recognized more than 850 credit
counseling organizations as tax exempt under section
501c)((3).\203\ Few credit counseling organizations have sought
section 501(c)(4) status, and the IRS reports it has not seen
any significant increase in the number or activity of such
organizations operating as social welfare organizations.\204\
As of late 2003, there were 872 active tax-exempt credit
counseling agencies operating in the United States.\205\
---------------------------------------------------------------------------
\201\ Opening Statement of The Honorable Max Sandlin, Hearing on
Non-Profit Credit Counseling Organizations, House Ways and Means
Committee, Subcommittee on Oversight (November 20, 2003).
\202\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs, Profiteering in a
Non-Profit Industry: Abusive Practices in Credit Counseling, Report
Prepared by the Majority & Minority Staffs of the Permanent
Subcommittee on Investigations and Released in Conjunction with the
Permanent Subcommittee Investigations' Hearing on March 24, 2004, p. 3
(citing letter dated December 18, 2003, to the Subcommittee from IRS
Commissioner Everson).
\203\ Testimony of Commissioner Mark Everson before the House Ways
and Means Committee, Subcommittee on Oversight (November 20, 2003).
\204\ Testimony of Commissioner Mark Everson before the House Ways
and Means Committee, Subcommittee on Oversight (November 20, 2003).
\205\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs, Profiteering in a
Non-Profit Industry: Abusive Practices in Credit Counseling, Report
Prepared by the Majority & Minority Staffs of the Permanent
Subcommittee on Investigations and Released in Conjunction with the
Permanent Subcommittee Investigations' Hearing on March 24, 2004, p. 3
(citing letter dated December 18, 2003 to the Subcommittee from IRS
Commissioner Everson).
---------------------------------------------------------------------------
A credit counseling organization described in section
501(c)(3) is exempt from certain Federal and State consumer
protection laws that provide exemptions for organizations
described therein.\206\ Some believe that these exclusions from
Federal and State regulation may be a primary motivation for
the recent increase in the number of organizations seeking and
obtaining exempt status under section 501(c)(3).\207\ Such
regulatory exemptions generally are not available for social
welfare organizations described in section 501(c)(4).
---------------------------------------------------------------------------
\206\ E.g., The Credit Repair Organizations Act, 15 U.S.C. section
1679 et seq., effective April 1, 1997 (imposing restrictions on credit
repair organizations that are enforced by the Federal Trade Commission,
including forbidding the making of untrue or misleading statements and
forbidding advance payments; section 501(c)(3) organizations are
explicitly exempt from such regulation). Testimony of Commissioner Mark
Everson before the House Ways and Means Committee, Subcommittee on
Oversight (November 20, 2003) (California's consumer protections laws
that impose strict standards on credit service organizations and the
credit repair industry do not apply to nonprofit organizations that
have received a final determination from the IRS that they are exempt
from tax under section 501(c)(3) and are not private foundations).
\207\ Testimony of Commissioner Mark Everson before the House Ways
and Means Committee, Subcommittee on Oversight (November 20, 2003).
---------------------------------------------------------------------------
Congress recently conducted hearings investigating the
activities of credit counseling organizations under various
consumer protection laws,\208\ such as the Federal Trade
Commission Act.\209\ In addition, the IRS has commenced a broad
examination and compliance program with respect to the credit
counseling industry, pursuant to which the IRS has initiated
audits of 50 credit counseling organizations, including nine of
the 15 largest in terms of gross receipts.\210\
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\208\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs, Profiteering in a
Non-Profit Industry: Abusive Practices in Credit Counseling, Report
Prepared by the Majority & Minority Staffs of the Permanent
Subcommittee on Investigations and Released in Conjunction with the
Permanent Subcommittee Investigations' Hearing on March 24, 2004.
\209\ 15 U.S.C. sec. 45(a) (prohibiting unfair and deceptive acts
or practices in or affecting commerce; although the Federal Trade
Commission generally lacks jurisdiction to enforce consumer protection
laws against bona fide nonprofit organizations, it may assert
jurisdiction over a nonprofit, including a credit counseling
organization, if it demonstrates the organization is organized to carry
on business for profit, is a mere instrumentality of a for-profit
entity, or operates through a common enterprise with one or more for-
profit entities).
\210\ United States Senate Permanent Subcommittee on
Investigations, Committee on Governmental Affairs, Profiteering in a
Non-Profit Industry: Abusive Practices in Credit Counseling, Report
Prepared by the Majority & Minority Staffs of the Permanent
Subcommittee on Investigations and Released in Conjunction with the
Permanent Subcommittee Investigations' Hearing on March 24, 2004, p.
31.
---------------------------------------------------------------------------
Under the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, an individual generally may not be a
debtor in bankruptcy unless such individual has, within 180
days of filing a petition for bankruptcy, received from an
approved nonprofit budget and credit counseling agency an
individual or group briefing that outlines the opportunities
for available credit counseling and assists the individual in
performing a related budget analysis.\211\ The clerk of the
court must maintain a publicly available list of nonprofit
budget and credit counseling agencies approved by the U.S.
Trustee (or bankruptcy administrator). In general, the U.S.
Trustee (or bankruptcy administrator) shall only approve an
agency that demonstrates that it will provide qualified
counselors, maintain adequate provision for safekeeping and
payment of client funds, provide adequate counseling with
respect to client credit problems, and deal responsibly and
effectively with other matters relating to the quality,
effectiveness, and financial security of the services it
provides. The minimum qualifications for approval of such an
agency include: (1) in general, having an independent board of
directors; (2) charging no more than a reasonable fee, and
providing services without regard to ability to pay; (3)
adequate provision for safekeeping and payment of client funds;
(4) provision of full disclosures to clients; (5) provision of
adequate counseling with respect to a client's credit problems;
(6) trained counselors who receive no commissions or bonuses
based on the outcome of the counseling services; (7) experience
and background in providing credit counseling; and (8) adequate
financial resources to provide continuing support services for
budgeting plans over the life of any repayment plan. An
individual debtor must file with the court a certificate from
the approved nonprofit budget and credit counseling agency that
provided the required services describing the services
provided, and a copy of the debt management plan, if any,
developed through the agency.\212\
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\211\ This requirement does not apply in certain circumstances,
such as: (1) in general, where a debtor resides in a district for which
the U.S. Trustee has determined that the approved counseling agencies
for such district are not reasonably able to provide adequate services
to additional individuals; (2) where exigent circumstances merit a
waiver, the individual seeking bankruptcy protection files an
appropriate certification with the court, and the certification is
acceptable to the court; and (3) in general, where a court determines,
after notice and hearing, that the individual is unable to complete the
requirement because of incapacity, disability, or active military duty
in a military combat zone.
\212\ The Act also requires that, prior to discharge of
indebtedness under chapter 7 or chapter 13, a debtor complete an
approved instructional course concerning personal financial management,
which course need not be conducted by a nonprofit agency.
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HOUSE BILL
No provision.
SENATE AMENDMENT
Requirements for exempt status of credit counseling organizations
Under the provision, an organization that provides credit
counseling services as a substantial purpose of the
organization (``credit counseling organization'') is eligible
for exemption from Federal income tax only as a charitable or
educational organization under section 501(c)(3) or as a social
welfare organization under section 501(c)(4), and only if (in
addition to present-law requirements) the credit counseling
organization is organized and operated in accordance with the
following:
1. The organization provides credit counseling services
tailored to the specific needs and circumstances of the
consumer;
2. The organization makes no loans to debtors and does
not negotiate the making of loans on behalf of debtors;
3. The organization generally does not promote, or charge
any separate fee for any service for the purpose of improving
any consumer's credit record, credit history, or credit rating;
4. The organization does not refuse to provide credit
counseling services to a consumer due to inability of the
consumer to pay, the ineligibility of the consumer for debt
management plan enrollment, or the unwillingness of a consumer
to enroll in a debt management plan;
5. The organization establishes and implements a fee
policy to require that any fees charged to a consumer for its
services are reasonable, and prohibits charging any fee based
in whole or in part on a percentage of the consumer's debt, the
consumer's payments to be made pursuant to a debt management
plan, or on the projected or actual savings to the consumer
resulting from enrolling in a debt management plan;
6. The organization at all times has a board of directors
or other governing body (a) that is controlled by persons who
represent the broad interests of the public, such as public
officials acting in their capacities as such, persons having
special knowledge or expertise in credit or financial
education, and community leaders; (b) not more than 20 percent
of the voting power of which is vested in persons who are
employed by the organization or who will benefit financially,
directly or indirectly, from the organization's activities
(other than through the receipt of reasonable directors' fees
or the repayment of consumer debt to creditors other than the
credit counseling organization or its affiliates) and (c) not
more than 49 percent of the voting power of which is vested in
persons who are employed by the organization or who will
benefit financially, directly or indirectly, from the
organization's activities (other than through the receipt of
reasonable directors' fees);
7. The organization receives no amount for providing
referrals to others for financial services (including debt
management services) or credit counseling services to be
provided to consumers, and pays no amount to others for
obtaining referrals of consumers; and
8. The organization does not own more than 35 percent of
the total combined voting power of a corporation (or profits or
beneficial interest in the case of a partnership or trust or
estate) that is in the business of lending money, repairing
credit, or providing debt management plan services, payment
processing, and similar services.
The Secretary may require any credit counseling
organization to submit such information as the Secretary
requires to verify that such organization meets the
requirements of the provision.
Additional requirements for charitable and educational organizations
Under the provision, a credit counseling organization is
described in section 501(c)(3) only if, in addition to
satisfying the above requirements, the organization is
organized and operated such that the organization (1) charges
no fees (other than nominal fees) for debt management plan
services and waives any fees if the consumer is unable to pay
such fees; (2) does not solicit contributions from consumers
during the initial counseling process or while the consumer is
receiving services from the organization; (3) normally limits
debt management plan services (in the aggregate) to 25 percent
of the organization's total activities (determined by taking
into account time, resources, source of revenues or effort
expended by the organization, and any other measures prescribed
by the Secretary).\213\
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\213\ If, under any such measure, the organization's debt
management plan services exceed 25 percent of the organization's total
activities, the organization is treated as exceeding the 25-percent
limit. For example, an organization that devotes 30 percent of its
total staff time to debt management plan services is regarded as
exceeding the 25-percent limit, even if the organization devotes less
than 15 percent of its total financial resources to debt management
plan services.
---------------------------------------------------------------------------
Additional requirements for social welfare organizations
Under the provision, a credit counseling organization is
described in section 501(c)(4) only if, in addition to
satisfying the above requirements applicable to such
organizations, it is organized and operated such that the
organization charges no fees (other than nominal fees) for its
credit counseling services, and waives any fees if the consumer
is unable to pay such fees. In addition, a credit counseling
organization shall not be treated as an organization described
in section 501(c)(4) unless such organization notifies the
Secretary, in such manner as the Secretary may by regulations
prescribe, that it is applying for recognition as a credit
counseling organization.
Debt management plan services treated as an unrelated trade or business
Under the provision, debt management plan services are
treated as an unrelated trade or business for purposes of the
tax on income from an unrelated trade or business to the extent
such services are not substantially related to the provision of
credit counseling services to a consumer or are provided by an
organization that is not a credit counseling organization.
Definitions
Credit counseling services
Credit counseling services are (a) the provision of
educational information to the general public on budgeting,
personal finance, financial literacy, saving and spending
practices, and the sound use of consumer credit; (b) the
assisting of individuals and families with financial problems
by providing them with counseling; or (c) any combination of
such activities.
Debt management plan services
Debt management plan services are services related to the
repayment, consolidation, or restructuring of a consumer's
debt, and includes the negotiation with creditors of lower
interest rates, the waiver or reduction of fees, and the
marketing and processing of debt management plans.
Effective date
In general the provision applies to taxable years
beginning after the date of enactment. For a credit counseling
organization that is described in section 501(c)(3) or
501(c)(4) on the date of enactment, the provision is effective
for taxable years beginning after the date that is one year
after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
10. Expand the base of the tax on private foundation net investment
income (sec. 222 of the Senate amendment and sec. 4940 of the
Code)
PRESENT LAW
In general
Under section 4940(a) of the Code, private foundations
that are recognized as exempt from Federal income tax under
section 501(a) of the Code are subject to a two-percent excise
tax on their net investment income. Private foundations that
are not exempt from tax, such as certain charitable
trusts,\214\ also are subject to an excise tax under section
4940(b) based on net investment income and unrelated business
income. The two-percent rate of tax is reduced to one-percent
if certain requirements are met in a taxable year.\215\ Unlike
certain other excise taxes imposed on private foundations, the
tax based on investment income does not result from a violation
of substantive law by the private foundation; it is solely an
excise tax.
---------------------------------------------------------------------------
\214\ See sec. 4947(a)(1).
\215\ Sec. 4940(e).
---------------------------------------------------------------------------
The tax on taxable private foundations under section
4940(b) is equal to the excess of the sum of the excise tax
that would have been imposed under section 4940(a) if the
foundation were tax exempt and the amount of the unrelated
business income tax that would have been imposed if the
foundation were tax exempt, over the income tax imposed on the
foundation under subtitle A of the Code.
Net investment income
Internal Revenue Code
In general, net investment income is defined as the
amount by which the sum of gross investment income and capital
gain net income exceeds the deductions relating to the
production of gross investment income.\216\
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\216\ Sec. 4940(c)(1). Net investment income also is determined by
applying section 103 (generally providing an exclusion for interest on
certain State and local bonds) and section 265 (generally disallowing
the deduction for interest and certain other expenses with respect to
tax-exempt income). Sec. 4940(c)(5).
---------------------------------------------------------------------------
Gross investment income is the gross amount of income
from interest, dividends, rents, payments with respect to
securities loans, and royalties. Gross investment income does
not include any income that is included in computing a
foundation's unrelated business taxable income.\217\
---------------------------------------------------------------------------
\217\ Sec. 4940(c)(2).
---------------------------------------------------------------------------
Capital gain net income takes into account only gains and
losses from the sale or other disposition of property used for
the production of interest, dividends, rents, and royalties,
and property used for the production of income included in
computing the unrelated business income tax (except to the
extent the gain or loss is taken into account for purposes of
such tax). Losses from sales or other dispositions of property
are allowed only to the extent of gains from such sales or
other dispositions, and no capital loss carryovers are
allowed.\218\
---------------------------------------------------------------------------
\218\ Sec. 4940(c)(4).
---------------------------------------------------------------------------
Treasury Regulations and case law
The Treasury regulations elaborate on the Code definition
of net investment income. The regulations cite items of
investment income listed in the Code, and in addition clarify
that net investment income includes interest, dividends, rents,
and royalties derived from all sources, including from assets
devoted to charitable activities. For example, interest
received on a student loan is includible in the gross
investment income of a foundation making the loan.\219\
---------------------------------------------------------------------------
\219\ Treas. Reg. sec. 53.4940-1(d)(1).
---------------------------------------------------------------------------
The regulations further provide that gross investment
income includes certain items of investment income that are
described in the unrelated business income tax
regulations.\220\ Such additional items include payments with
respect to securities loans (an item added to the Code in
1978), annuities, income from notional principal contracts, and
other substantially similar income from ordinary and routine
investments to the extent determined by the Commissioner.\221\
These latter three categories of income are not enumerated as
net investment income in the Code.
---------------------------------------------------------------------------
\220\ Id.
\221\ Treas. Reg. sec. 1.512(b)-1(a)(1).
---------------------------------------------------------------------------
The Treasury regulations also elaborate on the Code
definition of capital gain net income. The regulations provide
that the only capital gains and losses that are taken into
account are (1) gains and losses from the sale or other
disposition of property held by a private foundation for
investment purposes (other than program related investments),
and (2) property used for the production of income included in
computing the unrelated business income tax (except to the
extent the gain or loss is taken into account for purposes of
such tax).
This definition of capital gain net income builds on the
definition provided in the Code by providing an exception for
gain and loss from program related investments and by stating,
in addition, that ``gains and losses from the sale or other
disposition of property used for the exempt purposes of the
private foundation are excluded.'' \222\ As an example, the
regulations provide that gain or loss on the sale of buildings
used for the foundation's exempt activities are not taken into
account for purposes of the section 4940 tax. If a foundation
uses exempt income for exempt purposes and (other than
incidentally) for investment purposes, then the portion of the
gain or loss received upon sale or other disposition that is
allocable to the investment use is taken into account for
purposes of the tax.
---------------------------------------------------------------------------
\222\ Treas. Reg. sec. 53.4940-1(f)(1).
---------------------------------------------------------------------------
The regulations further provide that ``property shall be
treated as held for investment purposes even though such
property is disposed of by the foundation immediately upon its
receipt, if it is property of a type which generally produces
interest, dividends, rents, royalties, or capital gains through
appreciation (for example, rental real estate, stock, bonds,
mineral interest, mortgages, and securities).'' \223\
---------------------------------------------------------------------------
\223\ Id.
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This regulation has been challenged in the courts. The
regulation says that property is treated as held for investment
purposes if it is of a type that ``generally produces'' certain
types of income. By contrast, the Code provides that the
property be ``used'' to produce such income. In Zemurray
Foundation v. United States, 687 F.2d 97 (5th Cir. 1982), the
taxpayer foundation challenged the Treasury's attempt to tax
under section 4940 capital gain on the sale of timber property.
The taxpayer asserted that the property was not actually used
to produce investment income, and that the Treasury Regulation
was invalid because the regulation would subject to tax
property that is of a type that could generally be used to
produce investment income. On this issue, the court upheld the
Treasury regulation, reasoning that the regulation's use of the
phrase ``generally used,'' though permitting taxation ``so long
as the property sold is usable to produce the applicable types
of income, regardless of whether the property is actually used
to produce income or not'' was not unreasonable or plainly
inconsistent with the statute.\224\ However, on remand to the
district court, the district court concluded that the timber
property at issue, though a type of property generally used to
produce investment income, was not susceptible for such
use.\225\ Thus, the district court concluded that the Treasury
could not tax the gain under this portion of the regulation.
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\224\ Zemurray Foundation v. United States, 687 F.2d 97, 100 (5th
Cir. 1982).
\225\ Zemurray Foundation v. United States, 53 A.F.T.R. 2d (RIA)
842 (E. D. La. 1983).
---------------------------------------------------------------------------
The question then turned to the taxpayer's second
challenge to the regulation. At issue was the meaning of the
regulatory phrase ``capital gains through appreciation.'' The
regulation provides that if property is of a type that
generally produces capital gains through appreciation, then the
gain is subject to tax. The Treasury argued that the timber
property at issue, although held by the court not to be
property (in this case) susceptible for use to produce
interest, dividends, rents, or royalties, still was held by the
taxpayer to produce capital gain through appreciation and
therefore the gain should be subject to tax under the
regulation.
On this issue, the court held for the taxpayer, reasoning
that the language of the Code clearly is limited to certain
gains and losses, e.g., the court cited the Code language
providing that ``there shall be taken into account only gains
and losses from the sale or other disposition of property used
for the production of interest, dividends, rents, and
royalties. . . .'' \226\ The court noted that ``capital gains
through appreciation'' is not enumerated in the statute. The
court used as an example a jade figurine held by a foundation.
Jade figurines do not generally produce interest, dividends,
rents, or royalties, but gain on the sale of such a figurine
would be taxable under the ``capital gains through
appreciation'' standard, yet such standard does not appear in
the statute. After Zemurray, the Treasury generally conceded
this issue.\227\
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\226\ Zemurray Foundation v. United States, 755 F.2d 404 (5th Cir.
1985), 413 (citing Code sec. 4940(c)(4)(A).
\227\ G.C.M. 39538 (July 23, 1986).
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With respect to capital losses, the Code provides that
carryovers are not permitted, whereas the regulations state
that neither carryovers nor carrybacks are permitted.\228\
---------------------------------------------------------------------------
\228\ Treas. Reg. sec. 53.4940-1(f)(3).
---------------------------------------------------------------------------
Application of Zemurray to the Code and the regulations
Applying the Zemurray case to the Code and regulations
results in a general principle for purposes of present law:
private foundations are subject to tax under section 4940 only
on the items of income and only on gains and losses
specifically enumerated therein. Under this principle, private
foundations generally are not subject to the section 4940 tax
on other substantially similar types of income from ordinary
and routine investments, notwithstanding Treasury regulations
to the contrary. In addition, the regulations provide that gain
or loss from the sale or other disposition of assets used for
exempt purposes, with specific reference to program-related
investments, is excluded. The Code provides for no such blanket
exclusion; thus, under the language of the Code and the
reasoning of Zemurray, if a foundation provided office space at
below market rent to a charitable organization for use in the
organization's exempt purposes, gain on the sale of the
building by the foundation should be subject to the section
4940 tax despite the Treasury regulations.\229\
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\229\ See also the example in Treas. Reg. sec. 53.4940-1(f)(1).
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In addition, under the logic of Zemurray, capital loss
carrybacks arguably are permitted, notwithstanding Treasury
regulations to the contrary, because the Code mentions only a
bar on use of carryovers and says nothing about carrybacks.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision amends the definition of gross investment
income (including for purposes of capital gain net income) to
include items of income that are similar to the items presently
enumerated in the Code. Such similar items include income from
notional principal contracts, annuities, and other
substantially similar income from ordinary and routine
investments, and, with respect to capital gain net income,
capital gains from appreciation, including capital gains and
losses from the sale or other disposition of assets used to
further an exempt purpose.
The provision provides that there are no carrybacks of
losses from sales or other dispositions of property.
Effective date.--The provision is effective for taxable
years beginning after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
11. Definition of convention or association of churches (sec. 223 of
the Senate amendment and sec. 7701 of the Code)
PRESENT LAW
Under present law, an organization that qualifies as a
``convention or association of churches'' (within the meaning
of sec. 170(b)(1)(A)(i)) is not required to file an annual
return,\230\ is subject to the church tax inquiry and church
tax examination provisions applicable to organizations claiming
to be a church,\231\ and is subject to certain other provisions
generally applicable to churches.\232\ The Internal Revenue
Code does not define the term ``convention or association of
churches.''
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\230\ Sec. 6033(a)(2)(A)(i).
\231\ Sec. 7611(h)(1)(B).
\232\ See, e.g., Sec. 402(g)(8)(B) (limitation on elective
deferrals); sec. 403(b)(9)(B) (definition of retirement income
account); sec. 410(d) (election to have participation, vesting,
funding, and certain other provisions apply to church plans); sec.
414(e) (definition of church plan); sec. 415(c)(7) (certain
contributions by church plans); sec. 501(h)(5) (disqualification of
certain organizations from making the sec. 501(h) election regarding
lobbying expenditure limits); sec. 501(m)(3) (definition of commercial-
type insurance); sec. 508(c)(1)(A) (exception from requirement to file
application seeking recognition of exempt status); sec. 512(b)(12)
(allowance of up to $1,000 deduction for purposes of determining
unrelated business taxable income); sec. 514(b)(3)(E) (definition of
debt-financed property); sec. 3121(w)(3)(A) (election regarding
exemption from social security taxes); sec. 3309(b)(1) (application of
federal unemployment tax provisions to services performed in the employ
of certain organizations); sec. 6043(b)(1) (requirement to file a
return upon liquidation or dissolution of the organization); and sec.
7702(j)(3)(A) (treatment of certain death benefit plans as life
insurance).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision provides that an organization that
otherwise is a convention or association of churches does not
fail to so qualify merely because the membership of the
organization includes individuals as well as churches, or
because individuals have voting rights in the organization.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
12. Notification requirement for exempt entities not currently required
to file an annual information return (sec. 224 of the Senate
amendment and secs. 6033, 6104, 6652, and 7428 of the Code)
PRESENT LAW
Under present law, the requirement that an exempt
organization file an annual information return does not apply
to several categories of exempt organizations. Organizations
excepted from the filing requirement include organizations
(other than private foundations), the gross receipts of which
in each taxable year normally are not more than $25,000.\233\
Also exempt from the requirement are churches, their integrated
auxiliaries, and conventions or associations of churches; the
exclusively religious activities of any religious order;
section 501(c)(1) instrumentalities of the United States;
section 501(c)(21) trusts; an interchurch organization of local
units of a church; certain mission societies; certain church-
affiliated elementary and high schools; certain state
institutions whose income is excluded from gross income under
section 115; certain governmental units and affiliates of
governmental units; and other organizations that the IRS has
relieved from the filing requirement pursuant to its statutory
discretionary authority.
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\233\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i); Treas.
Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii) provides a $5,000
annual gross receipts exception from the annual reporting requirements
for certain exempt organizations. In Announcement 82-88, 1982-25 I.R.B.
23, the IRS exercised its discretionary authority under section 6033 to
increase the gross receipts exception to $25,000, and enlarge the
category of exempt organizations that are not required to file Form
990.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision provides that organizations that are
excused from filing an information return by reason of normally
having gross receipts below a certain specified amount
(generally, under $25,000) shall furnish to the Secretary
annually the legal name of the organization, any name under
which the organization operates or does business, the
organization's mailing address and Internet web site address
(if any), the organization's taxpayer identification number,
the name and address of a principal officer, and evidence of
the organization's continuing basis for its exemption from the
generally applicable information return filing requirements.
Upon such organization's termination of existence, the
organization is required to furnish notice of such termination.
The provision provides that if an organization fails to
provide the required notice for three consecutive years, the
organization's tax-exempt status is revoked. In addition, if an
organization that is required to file an annual information
return under section 6033(a) (Form 990) fails to file such an
information return for three consecutive years, the
organization's tax-exempt status is revoked. If an organization
fails to meet its filing obligation to the IRS for three
consecutive years in cases where the organization is subject to
the information return filing requirement in one or more years
during a three-year period and also is subject to the notice
requirement for one or more years during the same three-year
period, the organization's tax-exempt status is revoked.
A revocation under the provision is effective from the
date that the Secretary determines was the last day the
organization could have timely filed the third required
information return or notice. To again be recognized as tax-
exempt, the organization must apply to the Secretary for
recognition of tax-exemption, irrespective of whether the
organization was required to make an application for
recognition of tax-exemption in order to gain tax-exemption
originally.
If upon application for tax-exempt status after a
revocation under the provision, the organization shows to the
satisfaction of the Secretary reasonable cause for failing to
file the required annual notices or returns, the organization's
tax-exempt status may, in the discretion of the Secretary, be
reinstated retroactive to the date of revocation. An
organization may not challenge under the Code's declaratory
judgment procedures (section 7428) a revocation of tax-
exemption made pursuant to the provision.
There is no monetary penalty for failure to file the
notice. The provision does not require that the notices be made
available to the public under the public disclosure and
inspection rules generally applicable to exempt organizations.
The provision does not affect an organization's obligation
under present law to file required information returns or
existing penalties for failure to file such returns.
The Secretary is required to notify in a timely manner
every organization that is subject to the notice filing
requirement of the new filing obligation. Notification by the
Secretary shall be by mail, in the case of any organization the
identity and address of which is included in the list of exempt
organizations maintained by the Secretary, and by Internet or
other means of outreach, in the case of any other organization.
In addition, the Secretary is required to publicize in a timely
manner in appropriate forms and instructions and other means of
outreach the new penalty imposed for consecutive failures to
file the information return.
The Secretary is authorized to publish a list of
organizations whose exempt status is revoked under the
provision.
Effective date.--The provision is effective for notices
and returns with respect to annual periods beginning after
2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
13. Disclosure to state officials of proposed actions related to
section 501(c) organizations (sec. 225 of the Senate amendment
and secs. 6103, 6104, 7213, 7213A, and 7431 of the Code)
PRESENT LAW
In the case of organizations that are described in
section 501(c)(3) and exempt from tax under section 501(a) or
that have applied for exemption as an organization so
described, present law (sec. 6104(c)) requires the Secretary to
notify the appropriate State officer of (1) a refusal to
recognize such organization as an organization described in
section 501(c)(3), (2) a revocation of a section 501(c)(3)
organization's tax-exempt status, and (3) the mailing of a
notice of deficiency for any tax imposed under section 507,
chapter 41, or chapter 42.\234\ In addition, at the request of
such appropriate State officer, the Secretary is required to
make available for inspection and copying, such returns, filed
statements, records, reports, and other information relating to
the above-described disclosures, as are relevant to any State
law determination. An appropriate State officer is the State
attorney general, State tax officer, or any State official
charged with overseeing organizations of the type described in
section 501(c)(3).
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\234\ The applicable taxes include the termination tax on private
foundations; taxes on public charities for certain excess lobbying
expenses; taxes on a private foundation's net investment income, self-
dealing activities, undistributed income, excess business holdings,
investments that jeopardize charitable purposes, and taxable
expenditures (some of these taxes also apply to certain non-exempt
trusts); taxes on the political expenditures and excess benefit
transactions of section 501(c)(3) organizations; and certain taxes on
black lung benefit trusts and foreign organizations.
---------------------------------------------------------------------------
In general, returns and return information (as such terms
are defined in section 6103(b)) are confidential and may not be
disclosed or inspected unless expressly provided by law.\235\
Present law requires the Secretary to keep records of
disclosures and requests for inspection \236\ and requires that
persons authorized to receive returns and return information
maintain various safeguards to protect such information against
unauthorized disclosure.\237\ Willful unauthorized disclosure
or inspection of returns or return information is subject to a
fine and/or imprisonment.\238\ The knowing or negligent
unauthorized inspection or disclosure of returns or return
information gives the taxpayer a right to bring a civil
suit.\239\ Such present-law protections against unauthorized
disclosure or inspection of returns and return information do
not apply to the disclosures or inspections, described above,
that are authorized by section 6104(c).
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\235\ Sec. 6103(a).
\236\ Sec. 6103(p)(3).
\237\ Sec. 6103(p)(4).
\238\ Secs. 7213 and 7213A.
\239\ Sec. 7431.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision provides that upon written request by an
appropriate State officer, the Secretary may disclose: (1) a
notice of proposed refusal to recognize an organization as a
section 501(c)(3) organization; (2) a notice of proposed
revocation of tax-exemption of a section 501(c)(3)
organization; (3) the issuance of a proposed deficiency of tax
imposed under section 507, chapter 41, or chapter 42; (4) the
names, addresses, and taxpayer identification numbers of
organizations that have applied for recognition as section
501(c)(3) organizations; and (5) returns and return information
of organizations with respect to which information has been
disclosed under (1) through (4) above.\240\ Disclosure or
inspection is permitted for the purpose of, and only to the
extent necessary in, the administration of State laws
regulating section 501(c)(3) organizations, such as laws
regulating tax-exempt status, charitable trusts, charitable
solicitation, and fraud. Such disclosure or inspection may be
made only to or by an appropriate State officer or to an
officer or employee of the State who is designated by the
appropriate State officer, and may not be made by or to a
contractor or agent. The Secretary also is permitted to
disclose or open to inspection the returns and return
information of an organization that is recognized as tax-exempt
under section 501(c)(3), or that has applied for such
recognition, to an appropriate State officer if the Secretary
determines that disclosure or inspection may facilitate the
resolution of Federal or State issues relating to the tax-
exempt status of the organization. For this purpose,
appropriate State officer means the State attorney general, the
State tax official, or any other State official charged with
overseeing organizations of the type described in section
501(c)(3).
---------------------------------------------------------------------------
\240\ Such returns and return information also may be open to
inspection by an appropriate State officer.
---------------------------------------------------------------------------
In addition, the provision provides that upon the written
request by an appropriate State officer, the Secretary may make
available for inspection or disclosure returns and return
information of an organization described in section 501(c)(2)
(certain title holding companies), 501(c)(4) (certain social
welfare organizations), 501(c)(6) (certain business leagues and
similar organizations), 501(c)(7) (certain recreational clubs),
501(c)(8) (certain fraternal organizations), 501(c)(10)
(certain domestic fraternal organizations operating under the
lodge system), and 501(c)(13) (certain cemetery companies).
Such returns and return information are available for
inspection or disclosure only for the purpose of, and to the
extent necessary in, the administration of State laws
regulating the solicitation or administration of the charitable
funds or charitable assets of such organizations. Such
disclosure or inspection may be made only to or by an
appropriate State officer or to an officer or employee of the
State who is designated by the appropriate State officer, and
may not be made by or to a contractor or agent. For this
purpose, appropriate State officer means the State attorney
general, the State tax officer, and the head of an agency
designated by the State attorney general as having primary
responsibility for overseeing the solicitation of funds for
charitable purposes of such organizations.
In addition, the provision provides that any returns and
return information disclosed under section 6104(c) may be
disclosed in civil administrative and civil judicial
proceedings pertaining to the enforcement of State laws
regulating the applicable tax-exempt organization in a manner
prescribed by the Secretary. Returns and return information are
not to be disclosed under section 6104(c), or in such an
administrative or judicial proceeding, to the extent that the
Secretary determines that such disclosure would seriously
impair Federal tax administration. The provision makes
disclosures of returns and return information under section
6104(c) subject to the disclosure, recordkeeping, and safeguard
provisions of section 6103, including the requirements that the
Secretary maintain a permanent system of records of requests
for disclosure (sec. 6103(p)(3)), and that the appropriate
State officer maintain various safeguards that protect against
unauthorized disclosure (sec. 6103(p)(4)). The provision
provides that the willful unauthorized disclosure of returns or
return information described in section 6104(c) is a felony
subject to a fine of up to $5,000 and/or imprisonment of up to
five years (sec. 7213(a)(2)), the willful unauthorized
inspection of returns or return information described in
section 6104(c) is subject to a fine of up to $1,000 and/or
imprisonment of up to one year (sec. 7213A), and provides the
taxpayer the right to bring a civil action for damages in the
case of knowing or negligent unauthorized disclosure or
inspection of such information (sec. 7431(a)(2)).
Effective date.--The provision is effective on the date
of enactment but does not apply to requests made before such
date.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
14. Improve accountability of donor advised funds (secs. 231 through
234 of the Senate amendment and secs. 170 and 4958 and new
secs. 4967, 4968, and 4969 of the Code)
PRESENT LAW
Requirements for section 501(c)(3) tax-exempt status
Charitable organizations, i.e., organizations described
in section 501(c)(3), generally are exempt from Federal income
tax and are eligible to receive tax deductible contributions. A
charitable organization must operate primarily in pursuance of
one or more tax-exempt purposes constituting the basis of its
tax exemption.\241\ In order to qualify as operating primarily
for a purpose described in section 501(c)(3), an organization
must satisfy the following operational requirements: (1) the
net earnings of the organization may not inure to the benefit
of any person in a position to influence the activities of the
organization; (2) the organization must operate to provide a
public benefit, not a private benefit; \242\ (3) the
organization may not be operated primarily to conduct an
unrelated trade or business; \243\ (4) the organization may not
engage in substantial legislative lobbying; and (5) the
organization may not participate or intervene in any political
campaign.
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\241\ Treas. Reg. sec. 1.501(c)(3)-1(c)(1). The Code specifies such
purposes as religious, charitable, scientific, testing for public
safety, literary, or educational purposes, or to foster international
amateur sports competition, or for the prevention of cruelty to
children or animals. In general, an organization is organized and
operated for charitable purposes if it provides relief for the poor and
distressed or the underprivileged. Treas. Reg. sec. 1.501(c)(3)-
1(d)(2).
\242\ Treas. Reg. sec. 1.501(c)(3)-1(d)(1)(ii).
\243\ Treas. Reg. sec. 1.501(c)(3)-1(e)(1). Conducting a certain
level of unrelated trade or business activity will not jeopardize tax-
exempt status.
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Classification of section 501(c)(3) organizations
Section 501(c)(3) organizations are classified either as
``public charities'' or ``private foundations.'' \244\ Private
foundations generally are defined under section 509(a) as all
organizations described in section 501(c)(3) other than an
organization granted public charity status by reason of: (1)
being a specified type of organization (i.e., churches,
educational institutions, hospitals and certain other medical
organizations, certain organizations providing assistance to
colleges and universities, or a governmental unit); (2)
receiving a substantial part of its support from governmental
units or direct or indirect contributions from the general
public; or (3) providing support to another section 501(c)(3)
entity that is not a private foundation. In contrast to public
charities, private foundations generally are funded from a
limited number of sources (e.g., an individual, family, or
corporation). Donors to private foundations and persons related
to such donors together often control the operations of private
foundations.
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\244\ Sec. 509(a). Private foundations are either private operating
foundations or private non-operating foundations. In general, private
operating foundations operate their own charitable programs in contrast
to private non-operating foundations, which generally are grant-making
organizations. Most private foundations are non-operating foundations.
---------------------------------------------------------------------------
Because private foundations receive support from, and
typically are controlled by, a small number of supporters,
private foundations are subject to a number of anti-abuse rules
and excise taxes not applicable to public charities.\245\ For
example, the Code imposes excise taxes on acts of ``self-
dealing'' between disqualified persons (generally, an
enumerated class of foundation insiders \246\) and a private
foundation. Acts of self-dealing include, for example, sales or
exchanges, or leasing, of property; lending of money; or the
furnishing of goods, services, or facilities between a
disqualified person and a private foundation.\247\ In addition,
private non-operating foundations are required to pay out a
minimum amount each year as qualifying distributions. In
general, a qualifying distribution is an amount paid to
accomplish one or more of the organization's exempt purposes,
including reasonable and necessary administrative
expenses.\248\ Certain expenditures of private foundations are
also subject to tax.\249\ In general, taxable expenditures are
expenditures: (1) for lobbying; (2) to influence the outcome of
a public election or carry on a voter registration drive
(unless certain requirements are met); (3) as a grant to an
individual for travel, study, or similar purposes unless made
pursuant to procedures approved by the Secretary; (4) as a
grant to an organization that is not a public charity or exempt
operating foundation unless the foundation exercises
expenditure responsibility \250\ with respect to the grant; or
(5) for any non-charitable purpose. Additional excise taxes may
also apply in the event a private foundation holds certain
business interests (``excess business holdings'') \251\ or
makes an investment that jeopardizes the foundation's exempt
purposes.\252\
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\245\ Secs. 4940-4945.
\246\ See sec. 4946(a).
\247\ Sec. 4941.
\248\ Sec. 4942(g)(1)(A). A qualifying distribution also includes
any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more of the organization's exempt purposes and
certain amounts set-aside for exempt purposes. Sec. 4942(g)(1)(B) and
4942(g)(2).
\249\ Sec. 4945. Taxes imposed may be abated if certain conditions
are met. Secs. 4961 and 4962.
\250\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish reasonable
procedures to ensure that the grant is spent solely for the purpose for
which it was made, to obtain reports from the grantee on the
expenditure of the grant, and to make reports to the Secretary
regarding such expenditures. Sec. 4945(h).
\251\ Sec. 4943.
\252\ Sec. 4944.
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Supporting organizations
The Code provides that certain ``supporting
organizations'' (in general, organizations that provide support
to another section 501(c)(3) organization that is not a private
foundation) are classified as public charities rather than
private foundations.\253\ To qualify as a supporting
organization, an organization must meet all three of the
following tests: (1) it must be organized and at all times
operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of one or more
``publicly supported organizations'' \254\ (the
``organizational and operational tests''); \255\ (2) it must be
operated, supervised, or controlled by or in connection with
one or more publicly supported organizations (the
``relationship test''); \256\ and (3) it must not be controlled
directly or indirectly by one or more disqualified persons (as
defined in section 4946) other than foundation managers and
other than one or more publicly supported organizations (the
``lack of outside control test'').\257\
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\253\ Sec. 509(a)(3).
\254\ In general, supported organizations of a supporting
organization must be publicly supported charities described in sections
509(a)(1) or (a)(2).
\255\ Sec. 509(a)(3)(A).
\256\ Sec. 509(a)(3)(B).
\257\ Sec. 509(a)(3)(C).
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To satisfy the relationship test, a supporting
organization must hold one of three statutorily described close
relationships with the supported organization. The organization
must be: (1) operated, supervised, or controlled by a publicly
supported organization (commonly referred to as ``Type I''
supporting organizations); (2) supervised or controlled in
connection with a publicly supported organization (``Type II''
supporting organizations); or (3) operated in connection with a
publicly supported organization (``Type III'' supporting
organizations).\258\
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\258\ Treas. Reg. sec. 1.509(a)-4(f)(2).
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Type I supporting organizations
In the case of supporting organizations that are
operated, supervised, or controlled by one or more publicly
supported organizations (Type I supporting organizations), one
or more supported organizations must exercise a substantial
degree of direction over the policies, programs, and activities
of the supporting organization.\259\ The relationship between
the Type I supporting organization and the supported
organization generally is comparable to that of a parent and
subsidiary. The requisite relationship may be established by
the fact that a majority of the officers, directors, or
trustees of the supporting organization are appointed or
elected by the governing body, members of the governing body,
officers acting in their official capacity, or the membership
of one or more publicly supported organizations.\260\
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\259\ Treas. Reg. sec. 1.509(a)-4(g)(1)(i).
\260\ Id.
---------------------------------------------------------------------------
Type II supporting organizations
Type II supporting organizations are supervised or
controlled in connection with one or more publicly supported
organizations. Rather than the parent-subsidiary relationship
characteristic of Type I organizations, the relationship
between a Type II organization and its supported organizations
is more analogous to a brother-sister relationship. In order to
satisfy the Type II relationship requirement, generally there
must be common supervision or control by the persons
supervising or controlling both the supporting organization and
the publicly supported organizations.\261\ An organization
generally is not considered to be ``supervised or controlled in
connection with'' a publicly supported organization merely
because the supporting organization makes payments to the
publicly supported organization, even if the obligation to make
payments is enforceable under state law.\262\
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\261\ Treas. Reg. sec. 1.509(a)-4(h)(1).
\262\ Treas. Reg. sec. 1.509(a)-4(h)(2).
---------------------------------------------------------------------------
Type III supporting organizations
Type III supporting organizations are ``operated in
connection with'' one or more publicly supported organizations.
To satisfy the ``operated in connection with'' relationship,
Treasury regulations require that the supporting organization
be responsive to, and significantly involved in the operations
of, the publicly supported organization. This relationship is
deemed to exist where the supporting organization meets both a
``responsiveness test'' and an ``integral part test.'' \263\ In
general, the responsiveness test requires that the Type III
supporting organization be responsive to the needs or demands
of the publicly supported organizations. In general, the
integral part test requires that the Type III supporting
organization maintain significant involvement in the operations
of one or more publicly supported organizations, and that such
publicly supported organizations are in turn dependent upon the
supporting organization for the type of support which it
provides.
---------------------------------------------------------------------------
\263\ Treas. Reg. sec. 1.509(a)-4(i)(1).
---------------------------------------------------------------------------
Charitable contributions
Contributions to organizations described in section
501(c)(3) are deductible, subject to certain limitations, as an
itemized deduction from Federal income taxes.\264\ Such
contributions also generally are deductible for estate and gift
tax purposes.\265\ However, if the taxpayer retains control
over the assets transferred to charity, the transfer may not
qualify as a completed gift for purposes of claiming an income,
estate, or gift tax deduction.
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\264\ Sec. 170.
\265\ Secs. 2055 and 2522.
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Public charities enjoy certain advantages over private
foundations regarding the deductibility of contributions. For
example, contributions of appreciated capital gain property to
a private foundation generally are deductible only to the
extent of the donor's cost basis.\266\ In contrast,
contributions to public charities generally are deductible in
an amount equal to the property's fair market value, except for
gifts of inventory and other ordinary income property, short-
term capital gain property, and tangible personal property the
use of which is unrelated to the donee organization's exempt
purpose. In addition, under present law, a taxpayer's
deductible contributions generally are limited to specified
percentages of the taxpayer's contribution base, which
generally is the taxpayer's adjusted gross income for a taxable
year. The applicable percentage limitations vary depending upon
the type of property contributed and the classification of the
donee organization. In general, contributions to non-operating
private foundations are limited to a smaller percentage of the
donor's contribution base (up to 30 percent) than contributions
to public charities (up to 50 percent).\267\
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\266\ A special rule in section 170(e)(5) provides that taxpayers
are allowed a deduction equal to the fair market value of certain
contributions of appreciated, publicly traded stock contributed to a
private foundation.
\267\ Sec. 170(b).
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In general, taxpayers who make contributions and claim a
charitable deduction must satisfy recordkeeping and
substantiation requirements.\268\ The requirements vary
depending on the type and value of property contributed. A
deduction generally may be denied if the donor fails to satisfy
applicable recordkeeping or substantiation requirements.
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\268\ Sec. 170(f)(8).
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Intermediate sanctions (excess benefit transaction tax)
The Code imposes excise taxes on excess benefit
transactions between disqualified persons and public
charities.\269\ An excess benefit transaction generally is a
transaction in which an economic benefit is provided by a
public charity directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including the
performance of services) received for providing such benefit.
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\269\ Sec. 4958. The excess benefit transaction tax is commonly
referred to as ``intermediate sanctions,'' because it imposes penalties
generally considered to be less punitive than revocation of the
organization's exempt status. The tax also applies to transactions
between disqualified persons and social welfare organizations (as
described in section 501(c)(4)).
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For purposes of the excess benefit transaction rules, a
disqualified person is any person in a position to exercise
substantial influence over the affairs of the public charity at
any time in the five-year period ending on the date of the
transaction at issue.\270\ Persons holding certain powers,
responsibilities, or interests (e.g., officers, directors, or
trustees) are considered to be in a position to exercise
substantial influence over the affairs of the public charity.
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\270\ Sec. 4958(f)(1). A disqualified person also includes certain
family members of such a person, and certain entities that satisfy a
control test with respect to such persons.
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An excess benefit transaction tax is imposed on the
disqualified person and, in certain cases, on the organization
managers, but is not imposed on the public charity. An initial
tax of 25 percent of the excess benefit amount is imposed on
the disqualified person that receives the excess benefit. An
additional tax on the disqualified person of 200 percent of the
excess benefit applies if the violation is not corrected within
a specified period. A tax of 10 percent of the excess benefit
(not to exceed $10,000 with respect to any excess benefit
transaction) is imposed on an organization manager that
knowingly participated in the excess benefit transaction, if
the manager's participation was willful and not due to
reasonable cause, and if the initial tax was imposed on the
disqualified person.
Community foundations
Community foundations generally are broadly supported
section 501(c)(3) public charities that make grants to other
charitable organizations located within a community
foundation's particular geographic area. Donors sometimes make
contributions to a community foundation through transfers to a
separate trust or fund, the assets of which are held and
managed by a bank or investment company.
Certain community foundations are subject to special
rules that permit them to treat the separate funds or trusts
maintained by the community foundation as a single entity for
tax purposes. This ``single entity'' status allows the
community foundation to be classified as a public charity. One
of the requirements that community foundations must meet is
that funds maintained by the community foundation may not be
subject by the donor to any material restrictions or
conditions. The prohibition against material restrictions or
conditions is designed to prevent a donor from encumbering a
fund in a manner that prevents the community foundation from
freely distributing the assets and income from it in
furtherance of the community foundation's charitable purposes.
Under Treasury regulations, whether a particular restriction or
condition placed by the donor on the transfer of assets is
material must be determined from all of the facts and
circumstances of the transfer. The regulations set out some of
the more significant facts and circumstances to be considered
in making a determination, including: (1) whether the
transferee public charity is the fee owner of the assets
received; (2) whether the assets are held and administered by
the public charity in a manner consistent with its own exempt
purposes; (3) whether the governing body of the public charity
has the ultimate authority and control over the assets and the
income derived from them; and (4) whether the governing body of
the public charity is independent from the donor. The
regulations provide several non-adverse factors for determining
whether a particular restriction or condition placed by the
donor on the transfer of assets is material. In addition, the
regulations list numerous factors and subfactors that indicate
that the community foundation is prevented from freely and
effectively employing the donated assets and the income
thereon.
Donor advised funds
Some charitable organizations (including community
foundations) establish accounts to which donors may contribute
and thereafter provide nonbinding advice or recommendations
with regard to distributions from the fund or the investment of
assets in the fund. Such accounts are commonly referred to as
``donor advised funds.'' Donors who make contributions to
charities for maintenance in a donor advised fund generally
claim a charitable contribution deduction at the time of the
contribution. Although sponsoring charities frequently permit
donors (or other persons appointed by donors) to provide
nonbinding recommendations concerning the distribution or
investment of assets in a donor advised fund, sponsoring
charities generally must have legal ownership and control of
such assets following the contribution. If the sponsoring
charity does not have such control (or permits a donor to
exercise control over amounts contributed), the donor's
contributions may not qualify for a charitable deduction, and,
in the case of a community foundation, the contribution may be
treated as being subject to a material restriction or condition
by the donor.
In recent years, a number of financial institutions have
formed charitable corporations for the principal purpose of
offering donor advised funds, sometimes referred to as
``commercial'' donor advised funds. In addition, some
established charities have begun operating donor advised funds
in addition to their primary activities. The IRS has recognized
several organizations that sponsor donor advised funds,
including ``commercial'' donor advised funds, as section
501(c)(3) public charities. The term ``donor advised fund'' is
not defined in statute or regulations.
Under the Katrina Emergency Tax Relief Act of 2005,
certain of the above-described percent limitations on
contributions to public charities are temporarily suspended for
purposes of certain ``qualified contributions'' to public
charities. Under the Act, qualified contributions do not
include a contribution if the contribution is for establishment
of a new, or maintenance in an existing, segregated fund or
account with respect to which the donor (or any person
appointed or designated by such donor) has, or reasonably
expects to have, advisory privileges with respect to
distributions or investments by reason of the donor's status as
a donor.
HOUSE BILL
No provision.
SENATE AMENDMENT
Definitions
Donor advised fund
The provision defines a ``donor advised fund'' as a fund
or account that is: (1) separately identified by reference to
contributions of a donor or donors \271\ (2) owned and
controlled by a sponsoring organization and (3) with respect to
which a donor (or any person appointed or designated by such
donor (a ``donor advisor'')) has, or reasonably expects to
have, advisory privileges with respect to the distribution or
investment of amounts held in the separately identified fund or
account by reason of the donor's status as a donor.
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\271\ The requirement that a donor advised fund be separately
identified by reference to contributions of a donor or donors is
intended to exclude from the definition of ``donor advised fund''
certain types of funds or accounts maintained by community foundations
and other charities, such as field-of-interest funds and scholarship
funds, provided such funds or accounts are not separately identified by
reference to contributions of a donor or donors.
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Notwithstanding the foregoing, the term ``donor advised
fund'' does not include a fund or account from which are made
grants to individuals for travel, study, or other similar
purposes by such individual, provided that (1) a donor's or
donor advisor's advisory privileges are performed exclusively
by such donor or donor advisor in such person's capacity as a
member of a committee appointed by the sponsoring organization,
(2) no combination of a donor and persons related to or
appointed by such donor, control, directly or indirectly, such
committee, and (3) all grants from such fund or account satisfy
requirements similar to those described in section 4945(g)
(concerning grants to individuals by private foundations). In
addition, the Secretary may exempt a fund or account from
treatment as a donor advised fund if such fund or account (1)
is advised by a committee not directly or indirectly controlled
by a donor, donor advisor, or persons related to a donor or
donor advisor or (2) will benefit a single identified
organization or governmental entity or a single identified
charitable purpose.
Sponsoring organization
The provision defines a ``sponsoring organization'' as an
organization that: (1) is described in section 170(c) \272\
(other than a governmental entity described in section
170(c)(1), and without regard to any requirement that the
organization be organized in the United States \273\); and (2)
maintains one or more donor advised funds.
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\272\ Section 170(c) describes organizations to which charitable
contributions that are deductible for income tax purposes can be made.
\273\ See sec. 170(c)(2)(A).
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Investment advisor
Under the provision, the term ``investment advisor''
means, with respect to any sponsoring organization, any person
(other than an employee of the sponsoring organization)
compensated by the sponsoring organization for managing the
investment of, or providing investment advice with respect to,
assets maintained in donor advised funds owned by the
sponsoring organization.
Deductibility of contributions to a sponsoring organization for
maintenance in a donor advised fund
Contributions to certain sponsoring organizations for
maintenance in a donor advised fund not eligible
for a charitable deduction
Under the provision, contributions to a sponsoring
organization for maintenance in a donor advised fund are not
eligible for a charitable deduction for income tax purposes if
the sponsoring organization is a veterans' organization
described in section 170(c)(3), a fraternal society described
in section 170(c)(4), or a cemetery company described in
section 170(c)(5); for gift tax purposes if the sponsoring
organization is a fraternal society described in section
2522(a)(3) or a veterans' organization described in section
2522(a)(4); or for estate tax purposes if the sponsoring
organization is a fraternal society described in section
2055(a)(3) or a veterans' organization described in section
2055(a)(4). In addition, contributions to a sponsoring
organization for maintenance in a donor advised fund are not
eligible for a charitable deduction if the sponsoring
organization is a Type III supporting organization; a deduction
is allowed for such a contribution to a Type I or Type II
supporting organization to the extent not prohibited by
regulations. Regulations generally shall prohibit such a
deduction where the donor of the contribution directly or
indirectly controls a supported organization of the Type I or
Type II supporting organization.
Additional substantiation requirements
In addition to satisfying present-law substantiation
requirements under section 170(f), a donor must obtain, with
respect to each charitable contribution to a sponsoring
organization to be maintained in a donor advised fund, a
contemporaneous written acknowledgment from the sponsoring
organization providing that the sponsoring organization has
exclusive legal control over the assets contributed.
Minimum distributions
Aggregate distribution requirement
Under the provision, a sponsoring organization is
required, for each taxable year of the organization, to make
qualifying distributions, from the assets of donor advised
funds maintained by the organization, equivalent to the
applicable percentage of the aggregate asset value of donor
advised funds maintained by the sponsoring organization as
determined on the last day of the immediately preceding taxable
year. Such qualifying distributions generally must be made by
the first day of the second taxable year following the taxable
year. The provision excludes from the computation of the
required distributable amount for a taxable year the assets of
donor advised funds that have been in existence for less than
one full year as of the end of the immediately preceding
taxable year.\274\ The aggregate payout rule does not apply in
the case of a donor advised fund maintained by a private
foundation that is subject to the requirements of section 4942.
The applicable percentage is three percent for the first
taxable year beginning after the date of enactment, four
percent for the second such taxable year, and five percent for
any such taxable year thereafter.
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\274\ Assume, for example, that a sponsoring organization initially
maintained 10 donor advised funds, each established in Year 1. In Year
3, a new donor advised fund is established. For purposes of determining
the sponsoring organization's aggregate payout requirement for Year 4,
the donor advised fund established in Year 3 is excluded, because it
was in existence for less than a year as of the end of Year 3. For
these purposes, a donor advised fund is considered created when the
account is first established (rather than, for example, when a donor
achieves the minimum account balance required under the sponsoring
organization's rules to begin grantmaking).
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Generally applicable account-level activity requirement
Under the provision, a sponsoring organization must
distribute from each of its donor advised funds at least a
certain amount in qualifying distributions during any
applicable three-year period by the 181st day of the first
taxable year following such period. The required distributable
amount is the greater of (1) $250 or (2) two and one-half
percent of the sponsoring organization's average required
minimum initial contribution amount for such period \275\ (or
average required minimum balance, if greater) for the type of
donor \276\ at issue. An applicable three-year period must
correspond with three consecutive taxable years of the
sponsoring organization. The first applicable three-year period
for a donor advised fund begins only after the fund has been in
existence for one full year.\277\
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\275\ For purposes of the provision, the required minimum initial
contribution amount is the minimum contribution amount required by the
sponsoring organization in order to open a donor advised fund.
\276\ Under some circumstances, for example, a sponsoring
organization may establish higher minimum initial contribution amounts
for corporate donors than for individual donors.
\277\ Applicable three-year periods for any donor advised fund run
consecutively, such that the second three-year period begins
immediately after the first three-year period ends. For example, assume
donor advised fund X is established on March 30 of Year 1, and the
sponsoring organization's taxable year corresponds to the calendar
year. As of the end of Year 1, X has not been in existence for one full
year; therefore, X's first applicable three-year period does not begin
in Year 2. Instead, the first such period begins on January 1 of Year 3
and runs through December 31 of Year 5. X's second applicable three-
year period begins on January 1 of Year 6 and ends on December 31 of
Year 8.
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Account-level distribution requirement for accounts that
hold illiquid assets
If, as of the end of any taxable year of the sponsoring
organization, a donor advised fund holds assets other than cash
and marketable securities (i.e., ``illiquid assets'') that
equal more than 10 percent of the total value of assets in the
fund (determined using the valuation procedures described
below), the donor advised fund is considered to be an
``illiquid asset donor advised fund'' for the subsequent
taxable year of the sponsoring organization. A sponsoring
organization must distribute from each illiquid asset donor
advised fund as qualifying distributions by the 181st day of
the second taxable year following such subsequent taxable year
an amount equal to the applicable percentage of the value of
the assets in the donor advised fund as of the end of such year
(the ``illiquid asset payout requirement''). The applicable
percentage is three percent for the first taxable year
beginning after the date of enactment, four percent for the
second such taxable year, and five percent for any such taxable
year thereafter.
If, as of the end of a taxable year of the sponsoring
organization, an illiquid asset in a donor advised fund has not
been held for a period of 12 months, such asset is not
considered an illiquid asset for such year. However, if an
illiquid asset has been exchanged for another illiquid asset,
then the holding period for any such other illiquid asset
includes the period during which the illiquid asset that was
exchanged was held. The Secretary is authorized to promulgate
anti-abuse rules to prevent the circumvention of the provision
through transactions designed to avoid application of illiquid
asset payout requirement, such as through exchanges of illiquid
assets for other assets.
Qualifying distributions
For purposes of all of the distribution requirements
described in the provision, qualifying distributions are
amounts paid to organizations described in section 170(b)(1)(A)
(other than Type III supporting organizations or a sponsoring
organization if the amount is for maintenance in a donor
advised fund). Distributions to Type I or Type II supporting
organizations may be qualifying distributions if not prohibited
by regulations.\278\ Distributions to the sponsoring
organization generally are qualifying distributions; however, a
distribution to the sponsoring organization in satisfaction of
the aggregate distribution requirement is a qualifying
distribution only if the distribution is designated for use in
connection with a charitable program of the sponsoring
organization (e.g., if funds are transferred to a scholarship
fund (that does not meet the definition of donor advised fund
because, for example, the scholarship fund is not separately
identified by reference to donors) for the awarding of
scholarships consistent with the sponsoring organization's
exempt purposes). Amounts permanently set aside for purposes,
and under procedures similar to those, described in section
4942(g) are treated as qualifying distributions. Qualifying
distributions also include amounts paid during a taxable year
for reasonable and necessary administrative expenses charged to
a donor advised fund by a sponsoring organization.
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\278\ Regulations generally shall prohibit such a distribution
where the donor or donor advisor of the amounts distributed directly or
indirectly controls a supported organization of the Type I or Type II
supporting organization.
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Valuation
Special valuation rules apply for purposes of determining
the required distributable amount for a taxable year under the
aggregate payout requirement and the account-level payout
requirement applicable to accounts that hold illiquid assets.
For such purposes, the fair market values of cash and of
securities for which market quotations are readily available
are determined on a monthly basis. All other assets (``illiquid
assets'') transferred by a donor to a sponsoring organization
for maintenance in a donor advised fund are valued at the sum
of (1) the value claimed by the donor for purposes of
determining the donor's charitable deduction for the
contribution of such assets to the sponsoring
organization,\279\ and (2) an assumed annual rate of return of
five percent. If a donor advised fund purchases an illiquid
asset, such asset is valued at the sum of (1) the purchase
price paid for the assets, and (2) an assumed annual rate of
return of five percent. The Secretary of the Treasury is
authorized to specify the requirements for making such
computations. Under the provision, the Secretary of the
Treasury is also authorized to promulgate rules permitting
adjustments in the value of an illiquid asset in situations
where the asset declines significantly in value following a
contribution or purchase of the asset.
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\279\ The donor is required to report to the sponsoring
organization the value of the asset claimed by the donor for charitable
deduction purposes either by supplying to the sponsoring organization a
copy of the donor's completed Form 8283 related to the deduction (if
applicable) or by following any alternative procedures specified by the
Secretary.
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Treatment of qualifying distributions
Distributions made in satisfaction of any of the above-
described distribution requirements are counted for purposes of
all payout requirements described in the provision. For
purposes of any distribution requirement described in this
provision, the taxpayer may designate a qualifying distribution
as being made out of the undistributed amount remaining from
any prior taxable year or as being made in satisfaction of the
distribution requirement for the current taxable year. Amounts
distributed in excess of the undistributed amount for the
current year and all previous taxable years may be carried
forward for up to five taxable years following the taxable year
in which the excess payment is made.
Excise tax for failure to distribute
In the event of a failure to distribute the required
amount in connection with any of the above-described
distribution requirements within the prescribed time period,
the provision imposes excise taxes similar to the private
foundation excise taxes under section 4942. Specifically, a
first-tier excise tax equal to 30 percent of the undistributed
amount is imposed. If the failure is not corrected within the
taxable period (as defined in existing section 4942(j)(1)), a
second-tier tax equal to 100 percent of the undistributed
amount is imposed. The first and second tier taxes are subject
to abatement under generally applicable present law rules.
Taxable period means, with respect to any undistributed amount
for any taxable year or applicable 3-year period, the period
beginning with the first day of the taxable year or applicable
period and ending on the earlier of the date of mailing of a
notice of deficiency with respect to the imposition of the
initial tax or the date on which such tax is assessed.
Disqualified persons, excess benefit transactions, and other sanctions
Disqualified persons
The provision provides that donors, donor advisors, and
investment advisors to donor advised funds (as well as persons
related to the foregoing persons \280\) are treated as
disqualified persons with respect to the sponsoring
organization under section 4958 or under section 4946(a).
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\280\ For purposes of the provision, a person is treated as related
to another person if (1) such person bears a relationship to such other
person similar to the relationships described in sections 4958(f)(1)(B)
and 4958(f)(1)(C).
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Excess benefit transactions
The provision also provides that distributions from a
donor advised fund to a person that with respect to such fund
is a donor, donor adviser, or a person related to a donor or
donor adviser (though not an investment advisor) is treated as
an excess benefit transaction under section 4958, with the
entire amount paid to any such person treated as the amount of
the excess benefit. This rule applies regardless of whether the
sponsoring organization is a public charity or a private
foundation and regardless of whether, but for this rule, the
transaction would have been subject to the section 4941 self-
dealing rules.\281\
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\281\ This rule includes any distribution to a donor, donor
advisor, or a related person, whether in the form of a grant, loan,
compensation arrangement, expense reimbursement, or other payment. If
the excess benefit results from the payment of compensation, the entire
amount paid as compensation will be deemed the amount of the excess
benefit, whether the sponsoring organization is a private foundation or
a public charity.
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Any amount repaid as a result of correcting such an
excess benefit transaction shall not be held in or credited to
any donor advised fund.
Other sanctions
Under the provision, distributions from a donor advised
fund (as opposed to a sponsoring organization's non donor
advised funds or accounts) to any person other than the
sponsoring organization's non donor advised funds or accounts
or organizations described in section 170(b)(1)(A) \282\ (other
than Type III supporting organizations \283\ or sponsoring
organizations for maintenance in a donor advised fund) are
prohibited.\284\ The provision provides for a penalty in the
event a distribution is made from a donor advised fund to an
ineligible person, such as a private non-operating foundation
or a Type III supporting organization. In the event of such a
distribution, an excise tax equal to 20 percent of the amount
of the distribution is imposed against any donor or donor
advisor who advised that such distribution be made. In
addition, an excise tax equal to five percent of the amount of
the distribution is imposed against any manager of the
sponsoring organization (defined in a manner similar to the
term ``foundation manager'' under section 4945) who knowingly
approved the distribution. The taxes described in this
paragraph are subject to abatement under generally applicable
present law rules.
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\282\ By requiring that distributions from a donor advised fund be
made only to certain entities, the provision prohibits distributions
from a donor advised fund to a donor or donor advisor (or person
related to a donor or donor advisor), whether as compensation, loans,
or reimbursement of expenses.
\283\ Distributions to Type I and Type II supporting organizations
generally are not prohibited unless prohibited under regulations.
Regulations generally shall prohibit such distributions where the donor
or donor advisor of the amounts distributed directly or indirectly
controls a supported organization of the Type I or Type II supporting
organization.
\284\ Under the provision, distributions from donor advised funds
to individuals are prohibited. However, sponsoring organizations may
make grants to individuals from amounts not held in donor advised funds
and may establish scholarship funds that are not donor advised funds. A
donor may choose to make a contribution directly to such a scholarship
fund (or advise that a donor advised fund make a distribution to such a
scholarship fund).
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Under the provision, if a donor, a donor advisor, or a
person related to a donor or donor advisor of a donor advised
fund advises as to a distribution that results in any such
person receiving, directly or indirectly, a more than
incidental benefit, excise taxes are imposed against any donor
or donor advisor who advised as to the distribution, and
against the recipient of the benefit. The amount of the tax is
determined by multiplying the rate of the initial tax imposed
against a disqualified person under section 4958 by the amount
of the distribution that gave rise to the more-than-incidental
benefit. Persons subject to the tax are jointly and severally
liable for the entire amount of the tax. In addition, if a
manager of the sponsoring organization (defined in a manner
similar to the term ``foundation manager'' under section 4945)
who agreed to the making of the distribution knowing that the
distribution would confer a more than incidental benefit on a
donor, a donor advisor, or a person related to a donor or donor
advisor of a donor advised fund, the manager also is subject to
an excise tax, calculated by multiplying the rate of the
initial tax specified under section 4958 with respect to
organization managers by the amount of the distribution that
gave rise to the more than incidental benefit. The taxes on
more than incidental benefit are subject to abatement under
generally applicable present law rules.
Reporting and disclosure
The provision requires each sponsoring organization to
disclose on its information return: (1) the total number of
donor advised funds it owns; (2) the aggregate value of assets
held in those funds at the end of the organization's taxable
year; and (3) the aggregate contributions to and grants made
from those funds during the year. The statute of limitations
for assessing any tax arising under the provision in any year
with respect to which the required information has not been
provided shall not expire before three years after the date on
which the required information is disclosed to the IRS.
In addition, when seeking recognition of its tax-exempt
status, a sponsoring organization must disclose whether it
intends to maintain donor advised funds.
Effective date
The provision generally is effective for taxable years
beginning after the date of enactment. Distribution
requirements are effective for taxable years beginning after
the date of enactment. Information return requirements are
effective for taxable years ending after the date of enactment.
The requirements concerning disclosures on an organization's
application for tax exemption are effective for organizations
applying for recognition of exempt status after the date of
enactment. Requirements relating to charitable contributions to
donor advised funds are effective for contributions made after
180 days from the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
15. Improve accountability of supporting organizations (secs. 241-246
of the Senate amendment and secs. 509, 4942, 4943, 4945, 4958,
and 6033 and new sec. 4959 of the Code)
PRESENT LAW
Requirements for section 501(c)(3) tax-exempt status
Charitable organizations, i.e., organizations described
in section 501(c)(3), generally are exempt from Federal income
tax and are eligible to receive tax deductible contributions. A
charitable organization must operate primarily in pursuance of
one or more tax-exempt purposes constituting the basis of its
tax exemption.\285\ In order to qualify as operating primarily
for a purpose described in section 501(c)(3), an organization
must satisfy the following operational requirements: (1) the
net earnings of the organization may not inure to the benefit
of any person in a position to influence the activities of the
organization; (2) the organization must operate to provide a
public benefit, not a private benefit; \286\ (3) the
organization may not be operated primarily to conduct an
unrelated trade or business; \287\ (4) the organization may not
engage in substantial legislative lobbying; and (5) the
organization may not participate or intervene in any political
campaign.
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\285\ Treas. Reg. sec. 1.501(c)(3)-1(c)(1). The Code specifies such
purposes as religious, charitable, scientific, testing for public
safety, literary, or educational purposes, or to foster international
amateur sports competition, or for the prevention of cruelty to
children or animals. In general, an organization is organized and
operated for charitable purposes if it provides relief for the poor and
distressed or the underprivileged. Treas. Reg. sec. 1.501(c)(3)-
1(d)(2).
\286\ Treas. Reg. sec. 1.501(c)(3)-1(d)(1)(ii).
\287\ Treas. Reg. sec. 1.501(c)(3)-1(e)(1). Conducting a certain
level of unrelated trade or business activity will not jeopardize tax-
exempt status.
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Section 501(c)(3) organizations (with certain exceptions)
are required to seek formal recognition of tax-exempt status by
filing an application with the IRS (Form 1023). In response to
the application, the IRS issues a determination letter or
ruling either recognizing the applicant as tax-exempt or not.
In general, organizations exempt from Federal income tax
under section 501(a) are required to file an annual information
return with the IRS.\288\ Under present law, the information
return requirement does not apply to several categories of
exempt organizations. Organizations exempt from the filing
requirement include organizations (other than private
foundations), the gross receipts of which in each taxable year
normally are not more than $25,000.\289\
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\288\ Sec. 6033(a)(1).
\289\ Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i); Treas.
Reg. sec. 1.6033-2(g)(1). Sec. 6033(a)(2)(A)(ii) provides a $5,000
annual gross receipts exception from the annual reporting requirements
for certain exempt organizations. In Announcement 82-88, 1982-25 I.R.B.
23, the IRS exercised its discretionary authority under section 6033 to
increase the gross receipts exception to $25,000, and enlarge the
category of exempt organizations that are not required to file Form
990.
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Classification of section 501(c)(3) organizations
In general
Section 501(c)(3) organizations are classified either as
``public charities'' or ``private foundations.'' \290\ Private
foundations generally are defined under section 509(a) as all
organizations described in section 501(c)(3) other than an
organization granted public charity status by reason of: (1)
being a specified type of organization (i.e., churches,
educational institutions, hospitals and certain other medical
organizations, certain organizations providing assistance to
colleges and universities, or a governmental unit); (2)
receiving a substantial part of its support from governmental
units or direct or indirect contributions from the general
public; or (3) providing support to another section 501(c)(3)
entity that is not a private foundation. In contrast to public
charities, private foundations generally are funded from a
limited number of sources (e.g., an individual, family, or
corporation). Donors to private foundations and persons related
to such donors together often control the operations of private
foundations.
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\290\ Sec. 509(a). Private foundations are either private operating
foundations or private non-operating foundations. In general, private
operating foundations operate their own charitable programs in contrast
to private non-operating foundations, which generally are grant-making
organizations. Most private foundations are non-operating foundations.
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Because private foundations receive support from, and
typically are controlled by, a small number of supporters,
private foundations are subject to a number of anti-abuse rules
and excise taxes not applicable to public charities.\291\ For
example, the Code imposes excise taxes on acts of ``self-
dealing'' between disqualified persons (generally, an
enumerated class of foundation insiders \292\) and a private
foundation. Acts of self-dealing include, for example, sales or
exchanges, or leasing, of property; lending of money; or the
furnishing of goods, services, or facilities between a
disqualified person and a private foundation.\293\ In addition,
private non-operating foundations are required to pay out a
minimum amount each year as qualifying distributions. In
general, a qualifying distribution is an amount paid to
accomplish one or more of the organization's exempt purposes,
including reasonable and necessary administrative
expenses.\294\ Certain expenditures of private foundations are
also subject to tax.\295\ In general, taxable expenditures are
expenditures: (1) for lobbying; (2) to influence the outcome of
a public election or carry on a voter registration drive
(unless certain requirements are met); (3) as a grant to an
individual for travel, study, or similar purposes unless made
pursuant to procedures approved by the Secretary; (4) as a
grant to an organization that is not a public charity or exempt
operating foundation unless the foundation exercises
expenditure responsibility \296\ with respect to the grant; or
(5) for any non-charitable purpose. Additional excise taxes may
apply in the event a private foundation holds certain business
interests (``excess business holdings'') \297\ or makes an
investment that jeopardizes the foundation's exempt
purposes.\298\
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\291\ Secs. 4940-4945.
\292\ See sec. 4946(a).
\293\ Sec. 4941.
\294\ Sec. 4942(g)(1)(A). A qualifying distribution also includes
any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more of the organization's exempt purposes and
certain amounts set-aside for exempt purposes. Sec. 4942(g)(1)(B) and
4942(g)(2).
\295\ Sec. 4945. Taxes imposed may be abated if certain conditions
are met. Secs. 4961 and 4962.
\296\ In general, expenditure responsibility requires that a
foundation make all reasonable efforts and establish reasonable
procedures to ensure that the grant is spent solely for the purpose for
which it was made, to obtain reports from the grantee on the
expenditure of the grant, and to make reports to the Secretary
regarding such expenditures. Sec. 4945(h).
\297\ Sec. 4943.
\298\ Sec. 4944.
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Public charities also enjoy certain advantages over
private foundations regarding the deductibility of
contributions. For example, contributions of appreciated
capital gain property to a private foundation generally are
deductible only to the extent of the donor's cost basis.\299\
In contrast, contributions to public charities generally are
deductible in an amount equal to the property's fair market
value, except for gifts of inventory and other ordinary income
property, short-term capital gain property, and tangible
personal property the use of which is unrelated to the donee
organization's exempt purpose. In addition, under present law,
a taxpayer's deductible contributions generally are limited to
specified percentages of the taxpayer's contribution base,
which generally is the taxpayer's adjusted gross income for a
taxable year. The applicable percentage limitations vary
depending upon the type of property contributed and the
classification of the donee organization. In general,
contributions to non-operating private foundations are limited
to a smaller percentage of the donor's contribution base (up to
30 percent) than contributions to public charities (up to 50
percent).\300\
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\299\ A special rule in section 170(e)(5) provides that taxpayers
are allowed a deduction equal to the fair market value of certain
contributions of appreciated, publicly traded stock contributed to a
private foundation.
\300\ Sec. 170(b).
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Supporting organizations (section 509(a)(3))
The Code provides that certain ``supporting
organizations'' (in general, organizations that provide support
to another section 501(c)(3) organization that is not a private
foundation) are classified as public charities rather than
private foundations.\301\ To qualify as a supporting
organization, an organization must meet all three of the
following tests: (1) it must be organized and at all times
operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of one or more
``publicly supported organizations'' \302\ (the
``organizational and operational tests''); \303\ (2) it must be
operated, supervised, or controlled by or in connection with
one or more publicly supported organizations (the
``relationship test''); \304\ and (3) it must not be controlled
directly or indirectly by one or more disqualified persons (as
defined in section 4946) other than foundation managers and
other than one or more publicly supported organizations (the
``lack of outside control test'').\305\
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\301\ Sec. 509(a)(3).
\302\ In general, supported organizations of a supporting
organization must be publicly supported charities described in sections
509(a)(1) or (a)(2).
\303\ Sec. 509(a)(3)(A).
\304\ Sec. 509(a)(3)(B).
\305\ Sec. 509(a)(3)(C).
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To satisfy the relationship test, a supporting
organization must hold one of three statutorily described close
relationships with the supported organization. The organization
must be: (1) operated, supervised, or controlled by a publicly
supported organization (commonly referred to as ``Type I''
supporting organizations); (2) supervised or controlled in
connection with a publicly supported organization (``Type II''
supporting organizations); or (3) operated in connection with a
publicly supported organization (``Type III'' supporting
organizations).\306\
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\306\ Treas. Reg. sec. 1.509(a)-4(f)(2).
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Type I supporting organizations
In the case of supporting organizations that are
operated, supervised, or controlled by one or more publicly
supported organizations (Type I supporting organizations), one
or more supported organizations must exercise a substantial
degree of direction over the policies, programs, and activities
of the supporting organization.\307\ The relationship between
the Type I supporting organization and the supported
organization generally is comparable to that of a parent and
subsidiary. The requisite relationship may be established by
the fact that a majority of the officers, directors, or
trustees of the supporting organization are appointed or
elected by the governing body, members of the governing body,
officers acting in their official capacity, or the membership
of one or more publicly supported organizations.\308\
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\307\ Treas. Reg. sec. 1.509(a)-4(g)(1)(i).
\308\ Id.
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Type II supporting organizations
Type II supporting organizations are supervised or
controlled in connection with one or more publicly supported
organizations. Rather than the parent-subsidiary relationship
characteristic of Type I organizations, the relationship
between a Type II organization and its supported organizations
is more analogous to a brother-sister relationship. In order to
satisfy the Type II relationship requirement, generally there
must be common supervision or control by the persons
supervising or controlling both the supporting organization and
the publicly supported organizations.\309\ An organization
generally is not considered to be ``supervised or controlled in
connection with'' a publicly supported organization merely
because the supporting organization makes payments to the
publicly supported organization, even if the obligation to make
payments is enforceable under state law.\310\
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\309\ Treas. Reg. sec. 1.509(a)-4(h)(1).
\310\ Treas. Reg. sec. 1.509(a)-4(h)(2).
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Type III supporting organizations
Type III supporting organizations are ``operated in
connection with'' one or more publicly supported organizations.
To satisfy the ``operated in connection with'' relationship,
Treasury regulations require that the supporting organization
be responsive to, and significantly involved in the operations
of, the publicly supported organization. This relationship is
deemed to exist where the supporting organization meets both a
``responsiveness test'' and an ``integral part test.'' \311\
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\311\ Treas. Reg. sec. 1.509(a)-4(i)(1).
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In general, the responsiveness test requires that the
Type III supporting organization be responsive to the needs or
demands of the publicly supported organizations. The
responsiveness test may be satisfied in one of two ways.\312\
First, the supporting organization may demonstrate that: (1)(a)
one or more of its officers, directors, or trustees are elected
or appointed by the officers, directors, trustees, or
membership of the supported organization; (b) one or more
members of the governing bodies of the publicly supported
organizations are also officers, directors, or trustees of the
supporting organization; or (c) the officers, directors, or
trustees of the supporting organization maintain a close
continuous working relationship with the officers, directors,
or trustees of the publicly supported organizations; and (2) by
reason of such arrangement, the officers, directors, or
trustees of the supported organization have a significant voice
in the investment policies of the supporting organization, the
timing and manner of making grants, the selection of grant
recipients by the supporting organization, and otherwise
directing the use of the income or assets of the supporting
organization.\313\ Alternatively, the responsiveness test may
be satisfied if the supporting organization is a charitable
trust under state law, each specified supported organization is
a named beneficiary under the trust's governing instrument, and
the beneficiary organization has the power to enforce the trust
and compel an accounting under state law.\314\
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\312\ For an organization that was supporting or benefiting one or
more publicly supported organizations before November 20, 1970,
additional facts and circumstances, such as an historic and continuing
relationship between organizations, also may be taken into
consideration to establish compliance with either of the responsiveness
tests. Treas. Reg. sec. 1.509(a)-4(i)(1)(ii).
\313\ Treas. Reg. sec. 1.509(a)-4(i)(2)(ii).
\314\ Treas. Reg. sec. 1.509(a)-4(i)(2)(iii).
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In general, the integral part test requires that the Type
III supporting organization maintain significant involvement in
the operations of one or more publicly supported organizations,
and that such publicly supported organizations are in turn
dependent upon the supporting organization for the type of
support which it provides. There are two alternative methods
for satisfying the integral part test. The first alternative is
to establish that (1) the activities engaged in for or on
behalf of the publicly supported organization are activities to
perform the functions of, or carry out the purposes of, such
organizations; and (2) these activities, but for the
involvement of the supporting organization, normally would be
engaged in by the publicly supported organizations
themselves.\315\ The second method for satisfying the integral
part test is to establish that: (1) the supporting organization
pays substantially all of its income to or for the use of one
or more publicly supported organizations; \316\ (2) the amount
of support received by one or more of the publicly supported
organizations is sufficient to insure the attentiveness of the
organization or organizations to the operations of the
supporting organization (this is known as the ``attentiveness
requirement''); \317\ and (3) a significant amount of the total
support of the supporting organization goes to those publicly
supported organizations that meet the attentiveness
requirement.\318\
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\315\ Treas. Reg. sec. 1.509(a)-4(i)(3)(ii).
\316\ For this purpose, the IRS has defined the term
``substantially all'' of an organization's income to mean 85 percent or
more. Rev. Rul. 76-208, 1976-1 C.B. 161.
\317\ Although the regulations do not specify the requisite level
of support in numerical or percentage terms, the IRS has suggested that
grants that represent less than 10 percent of the beneficiary's support
likely would be viewed as insufficient to ensure attentiveness. Gen.
Couns. Mem. 36379 (August 15, 1975). As an alternative to satisfying
the attentiveness standard by the foregoing method, a supporting
organization may demonstrate attentiveness by showing that, in order to
avoid the interruption of the carrying on of a particular function or
activity, the beneficiary organization will be sufficiently attentive
to the operations of the supporting organization. Treas. Reg. sec.
1.509(a)-4(i)(3)(iii)(b).
\318\ Treas. Reg. sec. 1.509(a)-4(i)(3)(iii).
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Intermediate sanctions (excess benefit transaction tax)
The Code imposes excise taxes on excess benefit
transactions between disqualified persons and public
charities.\319\ An excess benefit transaction generally is a
transaction in which an economic benefit is provided by a
public charity directly or indirectly to or for the use of a
disqualified person, if the value of the economic benefit
provided exceeds the value of the consideration (including the
performance of services) received for providing such benefit.
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\319\ Sec. 4958. The excess benefit transaction tax is commonly
referred to as ``intermediate sanctions,'' because it imposes penalties
generally considered to be less punitive than revocation of the
organization's exempt status. The tax also applies to transactions
between disqualified persons and social welfare organizations (as
described in section 501(c)(4)).
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For purposes of the excess benefit transaction rules, a
disqualified person is any person in a position to exercise
substantial influence over the affairs of the public charity at
any time in the five-year period ending on the date of the
transaction at issue.\320\ Persons holding certain powers,
responsibilities, or interests (e.g., officers, directors, or
trustees) are considered to be in a position to exercise
substantial influence over the affairs of the public charity.
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\320\ Sec. 4958(f)(1). A disqualified person also includes certain
family members of such a person, and certain entities that satisfy a
control test with respect to such persons.
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An excess benefit transaction tax is imposed on the
disqualified person and, in certain cases, on the organization
managers, but is not imposed on the public charity. An initial
tax of 25 percent of the excess benefit amount is imposed on
the disqualified person that receives the excess benefit. An
additional tax on the disqualified person of 200 percent of the
excess benefit applies if the violation is not corrected within
a specified period. A tax of 10 percent of the excess benefit
(not to exceed $10,000 with respect to any excess benefit
transaction) is imposed on an organization manager that
knowingly participated in the excess benefit transaction, if
the manager's participation was willful and not due to
reasonable cause, and if the initial tax was imposed on the
disqualified person.
HOUSE BILL
No provision.
SENATE AMENDMENT
Provisions relating to all (Type I, Type II, and Type III) supporting
organizations
Excess benefit transactions
Under the provision, if a supporting organization (Type
I, Type II, or Type III) makes a grant, loan, payment of
compensation, or other similar payment to a substantial
contributor (or person related to the substantial contributor)
of the supporting organization, for purposes of the excess
benefit transaction rules (sec. 4958), the substantial
contributor is treated as a disqualified person and the payment
is treated as an excess benefit transaction with the entire
amount of the payment treated as the excess benefit.
A substantial contributor means any person who
contributed or bequeathed an aggregate amount of more than
$5,000 to the organization, if such amount is more than two
percent of the total contributions and bequests received by the
organization before the close of the taxable year of the
organization in which the contribution or bequest is received
by the organization from such person. In the case of a trust, a
substantial contributor also includes the creator of the trust.
A substantial contributor does not include a public charity
(other than a supporting organization).
A person is a related person (``related person'') if a
person is a member of the family (determined under section
4958(f)(4)) of a substantial contributor, or a 35 percent
entity, defined as a corporation, partnership, trust, or estate
in which a substantial contributor or family member thereof own
more than 35 percent of the total combined voting power,
profits interest, or beneficial interest, as the case may be.
In addition, under the provision, loans by any supporting
organization (Type I, Type II, or Type III) to a disqualified
person (as defined in section 4958) of the supporting
organization are treated as an excess benefit transaction under
section 4958 and the entire amount of the loan is treated as an
excess benefit. For this purpose, a disqualified person does
not include a public charity (other than a supporting
organization).
Disclosure requirements
All supporting organizations are required to file an
annual information return (Form 990 series) with the Secretary,
regardless of the organization's gross receipts. A supporting
organization must indicate on such annual information return
whether it is a Type I, Type II, or Type III supporting
organization and must identify its supported organizations.
Supporting organizations must demonstrate annually that
the organization is not controlled directly or indirectly by
one or more disqualified persons (other than foundation
managers and other than one or more publicly supported
organizations) through a certification on the annual
information return.
Disqualified person
For purposes of the excess benefit transaction rules
(sec. 4958), a disqualified person of a supporting organization
is treated as a disqualified person of the supported
organization.
Provisions that apply to Type III supporting organizations
Modify payout requirement of Type III supporting
organizations
A Type III supporting organization must pay each taxable
year, to or for the use of one or more public charities
described in section 509(a)(1) or 509(a)(2) (``qualifying
distributions''), the sum of (1) the greater of (i) 85 percent
of its adjusted net income (as defined in section 4942(f)) for
the preceding taxable year or (ii) the applicable percentage
\321\ of the aggregate fair market value of all of the assets
of the organization other than assets that are used (or held
for use) directly in supporting the charitable programs of the
supporting organization or one or more supported organizations,
determined as of the last day of the preceding taxable year,
and (2) any amount received or accrued in such year as
repayments of amounts that were taken into account as support
provided by the supporting organization in prior years.
Qualifying distributions are treated as made first to satisfy
the pay out requirement of the immediately preceding taxable
year, and then of the taxable year, unless the taxpayer elects
to have an amount as satisfying the payout of any prior taxable
year. Amounts distributed in excess of the required payout for
the current year and all previous taxable years may be carried
forward for up to five taxable years following the taxable year
in which the excess payment is made.
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\321\ The percentage is three percent for the first taxable year
beginning after the date of enactment, four percent for the second such
taxable year, and five percent for any such taxable year thereafter.
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A supporting organization's administrative expenses count
as expenses to or for the use of a supported organization. The
holding of assets for investment purposes, or to operate an
unrelated trade or business, is not considered a use or holding
for use directly to support a supported organization's
charitable programs. The Secretary may provide guidance as to
types of uses of assets that are considered to be directly in
support of a supported organization's charitable programs
similar to guidance provided under Treasury Regulation section
53.4942(a)-2(c)(3)(i).
An organization that fails to meet the payout requirement
is subject to an initial tax of 30 percent of the unpaid
amount, increased to 100 percent of the unpaid amount if the
payout requirement is not met by the earlier of the date of
mailing of a notice of deficiency with respect to the initial
tax or the date on which the initial tax is assessed.
Excess business holdings
The excess business holdings rules of section 4943 are
applied to Type III supporting organizations. In applying such
rules, the term disqualified person has the meaning provided in
section 4958, and also includes substantial contributors and
related persons and any organization that is effectively
controlled by the same person or persons who control the
supporting organization or any organization substantially all
of the contributions to which were made by the same person or
persons who made substantially all of the contributions to the
supporting organization. The excess business holdings rules do
not apply if the holdings are held for the benefit of the
community pursuant to the direction of a State attorney general
or a State official with jurisdiction over the Type III
supporting organization. The Secretary has the authority not to
impose the excess business holding rules if the organization
establishes to the satisfaction of the Secretary that the
excess holdings are consistent with the exempt purposes of the
organization. Transition rules apply to the present holdings of
an organization similar to those of section 4943(c)(4)-(6).
The excess business holdings rules also apply to Type II
supporting organizations but only if such organization accepts
any gift or contribution from a person (other than a public
charity, not including a supporting organization) who (1)
controls, directly or indirectly, either alone or together
(with persons described below) the governing body of a
supported organization of the supporting organization; (2) is a
member of the family of such a person; or (3) is a 35 percent
controlled entity.
Organizational and operational requirements
In general, after the date of enactment of the provision,
a Type III supporting organization may not support more than
five organizations. A transition rule applies to Type III
supporting organizations that support more than five
organizations on such date. Such organizations are not required
to reduce the number of supported organizations, but may not
increase the number of organizations supported above the number
of organizations supported on the date of enactment, and may
not add new supported organizations as beneficiaries unless no
more than five organizations are supported by the supporting
organization following such addition.
A Type III supporting organization may not support an
organization that is not organized in the United States on any
date after the date which is 180 days after the date of
enactment,\322\ and may not be a donor with respect to a donor
advised fund.
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\322\ U.S. charities established principally to provide financial
and other assistance to a foreign charity, sometimes referred to as
``friends of'' organizations, may not be established as supporting
organizations under the provision. Such organizations may continue to
obtain public charity status, however, by virtue of demonstrating broad
public support (as described in sections 509(a)(1) and 509(a)(2)).
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Relationship to supported organization(s)
A Type III supporting organization must, as part of its
exemption application (Form 1023) attach a letter from each
supported organization acknowledging that the supported
organization has been designated by such organization as a
supported organization.
On the annual information return filed by a Type III
supporting organization, the organization must indicate that it
has obtained letters from organizations that received its
support. It is intended that all such letters must be signed by
a senior officer or a member of the Board of the supported
organization. The letters must show (1) that the supported
organization agrees to be supported by the supporting
organization, (2) the type of support provided or to be
provided, and (3) how such support furthers the supported
organization's charitable purposes.
A Type III supporting organization must apprise each
organization it supports of information regarding the
supporting organization in order to help ensure the supporting
organization's responsiveness. Such a showing could be
satisfied, for example, through provision of documentation such
as a copy of the supporting organization's governing documents,
any changes made to the governing documents, the organization's
annual information return filed with the Secretary (Form 990
series), any tax return (Form 990-T) filed with the Secretary,
and an annual report (including a description of all of the
support provided by the supporting organization, how such
support was calculated, and a projection of the next year's
support). Failure to make a sufficient showing is a factor in
determining whether the responsiveness test of present law is
met.
A Type III supporting organization that is organized as a
trust must, in addition to present law requirements, establish
to the satisfaction of the Secretary, that it has a close and
continuous relationship with the supported organization such
that the trust is responsive to the needs or demands of the
supported organization.
Other provisions
Under the provision, if a Type I or Type III supporting
organization accepts any gift or contribution from a person
(other than a public charity, not including a supporting
organization) who (1) controls, directly or indirectly, either
alone or together (with persons described below) the governing
body of a supported organization of the supporting
organization; (2) is a member of the family of such a person;
or (3) is a 35 percent controlled entity, then the supporting
organization is treated as a private foundation for all
purposes until such time as the organization can demonstrate to
the satisfaction of the Secretary that it qualifies as a public
charity other than as a supporting organization.
Under the provision, a non-operating private foundation
may not count as a qualifying distribution under section 4942
any amount paid to a supporting organization. In addition, any
such amount is treated as a taxable expenditure under section
4945.
Effective date
The provision generally is effective on the date of
enactment. The distribution requirements are effective for
taxable years beginning after the date of enactment. The
prohibited transaction rules are effective for transactions
occurring after the date of enactment. The excess business
holdings requirements are effective for taxable years beginning
after the date of enactment. The provision relating to
distributions by nonoperating private foundations is effective
for distributions and expenditures made after the date of
enactment. The return requirements are effective for returns
filed for taxable years ending after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE IV--MISCELLANEOUS PROVISIONS
A. Restructure New York Liberty Zone Tax Incentives
(Sec. 301 of the Senate amendment)
PRESENT LAW
In general
Present law includes a number of incentives to invest in
property located in the New York Liberty Zone (``NYLZ''), which
is the area located on or south of Canal Street, East Broadway
(east of its intersection with Canal Street), or Grand Street
(east of its intersection with East Broadway) in the Borough of
Manhattan in the City of New York, New York. These incentives
were enacted following the terrorist attack in New York City on
September 11, 2001.\323\
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\323\ In addition to the NYLZ provisions described above, other
NYLZ incentives are provided: (1) $8 billion of tax-exempt private
activity bond financing for certain nonresidential real property,
residential rental property and public utility property is authorized
to be issued after March 9, 2002, and before January 1, 2010; and (2)
$9 billion of additional tax-exempt advance refunding bonds is
available after March 9, 2002, and before January 1, 2006, with respect
to certain State or local bonds outstanding on September 11, 2001.
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Special depreciation allowance for qualified New York Liberty Zone
property
Section 1400L(b) allows an additional first-year
depreciation deduction equal to 30 percent of the adjusted
basis of qualified NYLZ property.\324\ In order to qualify,
property generally must be placed in service on or before
December 31, 2006 (December 31, 2009 in the case of
nonresidential real property and residential rental property).
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\324\ The amount of the additional first-year depreciation
deduction is not affected by a short taxable year.
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The additional first-year depreciation deduction is
allowed for both regular tax and alternative minimum tax
purposes for the taxable year in which the property is placed
in service. A taxpayer is allowed to elect out of the
additional first-year depreciation for any class of property
for any taxable year.
In order for property to qualify for the additional
first-year depreciation deduction, it must meet all of the
following requirements. First, the property must be property to
which the general rules of the Modified Accelerated Cost
Recovery System (``MACRS'') \325\ apply with (1) an applicable
recovery period of 20 years or less, (2) water utility property
(as defined in section 168(e)(5)), (3) certain nonresidential
real property and residential rental property, or (4) computer
software other than computer software covered by section 197. A
special rule precludes the additional first-year depreciation
under this provision for (1) qualified NYLZ leasehold
improvement property \326\ and (2) property eligible for the
additional first-year depreciation deduction under section
168(k) (i.e., property is eligible for only one 30 percent
additional first-year depreciation). Second, substantially all
of the use of such property must be in the NYLZ. Third, the
original use of the property in the NYLZ must commence with the
taxpayer on or after September 11, 2001. Finally, the property
must be acquired by purchase\327\ by the taxpayer after
September 10, 2001 and placed in service on or before December
31, 2006. For qualifying nonresidential real property and
residential rental property the property must be placed in
service on or before December 31, 2009 in lieu of December 31,
2006. Property will not qualify if a binding written contract
for the acquisition of such property was in effect before
September 11, 2001.\328\
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\325\ A special rule precludes the additional first-year
depreciation deduction for property that is required to be depreciated
under the alternative depreciation system of MACRS.
\326\ Qualified NYLZ leasehold improvement property is defined in
another provision. Leasehold improvements that do not satisfy the
requirements to be treated as ``qualified NYLZ leasehold improvement
property'' maybe eligible for the 30 percent additional first-year
depreciation deduction (assuming all other conditions are met).
\327\ For purposes of this provision, purchase is defined as under
section 179(d).
\328\ Property is not precluded from qualifying for the additional
first-year depreciation merely because a binding written contract to
acquire a component of the property is in effect prior to September 11,
2001.
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Nonresidential real property and residential rental
property is eligible for the additional first-year depreciation
only to the extent such property rehabilitates real property
damaged, or replaces real property destroyed or condemned as a
result of the terrorist attacks of September 11, 2001.
Property that is manufactured, constructed, or produced
by the taxpayer for use by the taxpayer qualifies for the
additional first-year depreciation deduction if the taxpayer
begins the manufacture, construction, or production of the
property after September 10, 2001, and the property is placed
in service on or before December 31, 2006 \329\ (and all other
requirements are met). Property that is manufactured,
constructed, or produced for the taxpayer by another person
under a contract that is entered into prior to the manufacture,
construction, or production of the property is considered to be
manufactured, constructed, or produced by the taxpayer.
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\329\ December 31, 2009 with respect to qualified nonresidential
real property and residential rental property.
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Depreciation of New York Liberty Zone leasehold improvements
Generally, depreciation allowances for improvements made
on leased property are determined under MACRS, even if the
MACRS recovery period assigned to the property is longer than
the term of the lease.\330\ This rule applies regardless of
whether the lessor or the lessee places the leasehold
improvements in service.\331\ If a leasehold improvement
constitutes an addition or improvement to nonresidential real
property already placed in service, the improvement generally
is depreciated using the straight-line method over a 39-year
recovery period, beginning in the month the addition or
improvement is placed in service.\332\
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\330\ Sec. 168(i)(8). The Tax Reform Act of 1986 modified the
Accelerated Cost Recovery System (``ACRS'') to institute MACRS. Prior
to the adoption of ACRS by the Economic Recovery Tax Act of 1981,
taxpayers were allowed to depreciate the various components of a
building as separate assets with separate useful lives. The use of
component depreciation was repealed upon the adoption of ACRS. The Tax
Reform Act of 1986 also denied the use of component depreciation under
MACRS.
\331\ Former sections 168(f)(6) and 178 provided that, in certain
circumstances, a lessee could recover the cost of leasehold
improvements made over the remaining term of the lease. The Tax Reform
Act of 1986 repealed these provisions.
\332\ Secs. 168(b)(3), (c), (d)(2), and (i)(6). If the improvement
is characterized as tangible personal property, ACRS or MACRS
depreciation is calculated using the shorter recovery periods,
accelerated methods, and conventions applicable to such property. The
determination of whether improvements are characterized as tangible
personal property or as nonresidential real property often depends on
whether or not the improvements constitute a ``structural component''
of a building (as defined by Treas. Reg. sec. 1.48-1(e)(1)). See, e.g.,
Metro National Corp v. Commissioner, 52 TCM (CCH) 1440 (1987); King
Radio Corp Inc. v. U.S., 486 F.2d 1091 (10th Cir. 1973); Mallinckrodt,
Inc. v. Commissioner, 778 F.2d 402 (8th Cir. 1985) (with respect to
various leasehold improvements).
---------------------------------------------------------------------------
A special rule exists for qualified NYLZ leasehold
improvement property, which is recovered over five years using
the straight-line method. The term qualified NYLZ leasehold
improvement property means property defined in section
168(e)(6) that is acquired and placed in service after
September 10, 2001, and before January 1, 2007 (and not subject
to a binding contract on September 10, 2001), in the NYLZ. For
purposes of the alternative depreciation system, the property
is assigned a nine-year recovery period. A taxpayer may elect
out of the 5-year (and 9-year) recovery period for qualified
NYLZ leasehold improvement property.
Increased section 179 expensing for qualified New York Liberty Zone
property
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct the cost
of qualifying property. For taxable years beginning in 2003
through 2007, a taxpayer may deduct up to $100,000 of the cost
of qualifying property placed in service for the taxable year.
In general, qualifying property for this purpose is defined as
depreciable tangible personal property (and certain computer
software) that is purchased for use in the active conduct of a
trade or business. The $100,000 amount is reduced (but not
below zero) by the amount by which the cost of qualifying
property placed in service during the taxable year exceeds
$400,000. The $100,000 and $400,000 amounts are indexed for
inflation.
For taxable years beginning in 2008 and thereafter, a
taxpayer with a sufficiently small amount of annual investment
may elect to deduct up to $25,000 of the cost of qualifying
property placed in service for the taxable year. The $25,000
amount is reduced (but not below zero) by the amount by which
the cost of qualifying property placed in service during the
taxable year exceeds $200,000. In general, qualifying property
for this purpose is defined as depreciable tangible personal
property that is purchased for use in the active conduct of a
trade or business.
The amount eligible to be expensed for a taxable year may
not exceed the taxable income for a taxable year that is
derived from the active conduct of a trade or business
(determined without regard to this provision). Any amount that
is not allowed as a deduction because of the taxable income
limitation may be carried forward to succeeding taxable years
(subject to similar limitations). No general business credit
under section 38 is allowed with respect to any amount for
which a deduction is allowed under section 179.
The amount a taxpayer can deduct under section 179 is
increased for qualifying property used in the NYLZ.
Specifically, the maximum dollar amount that may be deducted
under section 179 is increased by the lesser of (1) $35,000 or
(2) the cost of qualifying property placed in service during
the taxable year. This amount is in addition to the amount
otherwise deductible under section 179.
Qualifying property for purposes of the NYLZ provision
means section 179 property \333\ purchased and placed in
service by the taxpayer after September 10, 2001 and before
January 1, 2007, where (1) substantially all of the use of such
property is in the NYLZ in the active conduct of a trade or
business by the taxpayer in the NYLZ, and (2) the original use
of which in the NYLZ commences with the taxpayer after
September 10, 2001.\334\
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\333\ As defined in sec. 179(d)(1).
\334\ See Rev. Proc. 2002-33, 2002-20 I.R.B. 963 (May 20, 2002),
for procedures on claiming the increased section 179 expensing
deduction by taxpayers who filed their tax returns before June 1, 2002.
---------------------------------------------------------------------------
The phase-out range for the section 179 deduction
attributable to NYLZ property is applied by taking into account
only 50 percent of the cost of NYLZ property that is section
179 property. Also, no general business credit under section 38
is allowed with respect to any amount for which a deduction is
allowed under section 179.
The provision is effective for property placed in service
after September 10, 2001 and before January 1, 2007.
Extended replacement period for New York Liberty Zone involuntary
conversions
A taxpayer may elect not to recognize gain with respect
to property that is involuntarily converted if the taxpayer
acquires within an applicable period (the ``replacement
period'') property similar or related in service or use
(section 1033). If the taxpayer does not replace the converted
property with property similar or related in service or use,
then gain generally is recognized. If the taxpayer elects to
apply the rules of section 1033, gain on the converted property
is recognized only to the extent that the amount realized on
the conversion exceeds the cost of the replacement property. In
general, the replacement period begins with the date of the
disposition of the converted property and ends two years after
the close of the first taxable year in which any part of the
gain upon conversion is realized.\335\ The replacement period
is extended to three years if the converted property is real
property held for the productive use in a trade or business or
for investment.\336\
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\335\ Section 1033(a)(2)(B).
\336\ Section 1033(g)(4).
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The replacement period is extended to five years with
respect to property that was involuntarily converted within the
NYLZ as a result of the terrorist attacks that occurred on
September 11, 2001. However, the five-year period is available
only if substantially all of the use of the replacement
property is in New York City. In all other cases, the present-
law replacement period rules continue to apply.
HOUSE BILL
No provision.
SENATE AMENDMENT
Repeal of certain NYLZ incentives
The provision repeals the four NYLZ incentives relating
to the additional first-year depreciation allowance of 30
percent, the five-year depreciation of leasehold improvements,
the additional section 179 expensing, and the extended
replacement period for involuntary conversions.\337\
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\337\ The provision does not change the present-law rules relating
to certain NYLZ private activity bond financing and additional advance
refunding bonds.
---------------------------------------------------------------------------
Creation of New York Liberty Zone tax credits
The provision provides a credit against tax imposed
(other than taxes of section 3111(a), 3403, or subtitle D) paid
or incurred by any governmental unit of the State of New York
and the City of New York equal to the lesser of (1) the total
expenditures during such year by such governmental unit for
qualifying projects, or (2) the amount allocated to such
governmental unit for such calendar year.
Qualifying projects means any transportation
infrastructure project, including highways, mass transit
systems, railroads, airports, ports, and waterways, in or
connecting with the New York Liberty Zone, which is designated
as a qualifying project jointly by the Governor of the State of
New York and the Mayor of the City of New York.
The Governor of the State of New York and the Mayor of
the City of New York shall jointly allocate to a governmental
unit the amount of expenditures which may be taken into account
for purposes of the credit for any calendar year in the credit
period with respect to a qualifying project. The aggregate
limit that may be allocated for all calendar years in the
credit period is two billion dollars. The annual limit for any
calendar year in the credit period shall not exceed the sum of
200 million dollars plus the aggregate amount authorized to be
allocated for all preceding calendar years in the credit period
which was not allocated. The credit period is the ten-year
period beginning on January 1, 2006.
If, at the close of the credit period, the aggregate
amounts allocated are less than the 2 billion dollar aggregate
limit, the Governor of the State of New York and the Mayor of
the City of New York may jointly allocate, for any calendar
year following the credit period, for expenditures with respect
to qualifying projects, amounts that in sum for all years
following the credit period would equal such shortfall.
Under the provision, any expenditure for a qualifying
project taken into account for purposes of the credit shall be
considered State and local funds for the purpose of any Federal
program.
Effective date
The provision is effective on the date of enactment, with
an exception for property subject to a written binding contract
in effect on the date of enactment which is placed in service
prior to the original sunset dates under present law. The
extended replacement period for involuntarily converted
property ends on the earlier of (1) the date of enactment or
(2) the last day of the five-year period specified in the Jobs
Creation and Worker Assistance Act of 2002 (``JCWAA'').\338\
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\338\ Pub. L. No. 107-147, sec. 301 (2002).
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CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
B. Modification of S Corporation Passive Investment Income Rules
(Sec. 302 of the Senate amendment and secs. 1362 and 1375 of the Code)
PRESENT LAW
An S corporation is subject to corporate-level tax, at
the highest corporate tax rate, on its excess net passive
income if the corporation has (1) accumulated earnings and
profits at the close of the taxable year and (2) gross receipts
more than 25 percent of which are passive investment income.
Excess net passive income is the net passive income for a
taxable year multiplied by a fraction, the numerator of which
is the amount of passive investment income in excess of 25
percent of gross receipts and the denominator of which is the
passive investment income for the year. Net passive income is
defined as passive investment income reduced by the allowable
deductions that are directly connected with the production of
that income. Passive investment income generally means gross
receipts derived from royalties, rents, dividends, interest,
annuities, and sales or exchanges of stock or securities (to
the extent of gains). Passive investment income generally does
not include interest on accounts receivable, gross receipts
that are derived directly from the active and regular conduct
of a lending or finance business, gross receipts from certain
liquidations, or gain or loss from any section 1256 contract
(or related property) of an options or commodities dealer.
In addition, an S corporation election is terminated
whenever the S corporation has accumulated earnings and profits
at the close of each of three consecutive taxable years and has
gross receipts for each of those years more than 25 percent of
which are passive investment income.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment increases the 25-percent threshold
to 60 percent; eliminates gains from the sale or exchange of
stock or securities from the definition of passive investment
income; and eliminates the rule terminating an S election by
reason of having excess passive investment income for three
consecutive taxable years.
Effective date.--The provision applies to taxable years
beginning after December 31, 2006, and before October 1, 2009.
CONFERENCE AGREEMENT
The conference agreement does not contain the Senate
amendment provision.
C. Capital Expenditure Limitation for Qualified Small Issue Bonds
(Sec. 303 of the Senate amendment and sec. 144 of the Code)
PRESENT LAW
Qualified small-issue bonds are tax-exempt State and
local government bonds used to finance private business
manufacturing facilities (including certain directly related
and ancillary facilities) or the acquisition of land and
equipment by certain farmers. In both instances, these bonds
are subject to limits on the amount of financing that may be
provided, both for a single borrowing and in the aggregate. In
general, no more than $1 million of small-issue bond financing
may be outstanding at any time for property of a business
(including related parties) located in the same municipality or
county. Generally, this $1 million limit may be increased to
$10 million if all other capital expenditures of the business
in the same municipality or county are counted toward the limit
over a six-year period that begins three years before the issue
date of the bonds and ends three years after such date.
Outstanding aggregate borrowing is limited to $40 million per
borrower (including related parties) regardless of where the
property is located.
For bonds issued after September 30, 2009, the Code
permits up to $10 million of capital expenditures to be
disregarded, in effect increasing from $10 million to $20
million the maximum allowable amount of total capital
expenditures by an eligible business in the same municipality
or county.\339\ However, no more than $10 million of bond
financing may be outstanding at any time for property of an
eligible business (including related parties) located in the
same municipality or county. Other limits (e.g., the $40
million per borrower limit) also continue to apply.
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\339\ Sec. 144(a)(4)(G) as added by sec. 340(a) of the American
Jobs Creation Act of 2004, Pub. L. No. 108-357 (2004).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision accelerates the application of the $20
million capital expenditure limitation from bonds issued after
September 30, 2009, to bonds issued after December 31, 2006.
Effective date.--The provision is effective on the date
of enactment for bonds issued after December 31, 2006.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision.
D. Premiums for Mortgage Insurance
(Sec. 304 of the Senate amendment and secs. 163(h) and 6050H of the
Code)
PRESENT LAW
Present law provides that qualified residence interest is
deductible notwithstanding the general rule that personal
interest is nondeductible (sec. 163(h)).
Qualified residence interest is interest on acquisition
indebtedness and home equity indebtedness with respect to a
principal and a second residence of the taxpayer. The maximum
amount of home equity indebtedness is $100,000. The maximum
amount of acquisition indebtedness is $1 million. Acquisition
indebtedness means debt that is incurred in acquiring
constructing, or substantially improving a qualified residence
of the taxpayer, and that is secured by the residence. Home
equity indebtedness is debt (other than acquisition
indebtedness) that is secured by the taxpayer's principal or
second residence, to the extent the aggregate amount of such
debt does not exceed the difference between the total
acquisition indebtedness with respect to the residence, and the
fair market value of the residence.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision provides that premiums
paid or accrued for qualified mortgage insurance by a taxpayer
during the taxable year in connection with acquisition
indebtedness on a qualified residence of the taxpayer are
treated as interest that is qualified residence interest and
thus deductible. The amount allowable as a deduction under the
provision is phased out ratably by 10 percent for each $1,000
by which the taxpayer's adjusted gross income exceeds $100,000
($500 and $50,000, respectively, in the case of a married
individual filing a separate return). Thus, the deduction is
not allowed if the taxpayer's adjusted gross income exceeds
$110,000 ($55,000 in the case of married individual filing a
separate return).
For this purpose, qualified mortgage insurance means
mortgage insurance provided by the Veterans Administration, the
Federal Housing Administration, or the Rural Housing
Administration, and private mortgage insurance (defined in
section 2 of the Homeowners Protection Act of 1998 as in effect
on the date of enactment of the Senate amendment provision).
Amounts paid for qualified mortgage insurance that are
properly allocable to periods after the close of the taxable
year are treated as paid in the period to which they are
allocated. No deduction is allowed for the unamortized balance
if the mortgage is paid before its term (except in the case of
qualified mortgage insurance provided by the Department of
Veterans Affairs or Rural Housing Administration).
Reporting rules apply under the provision.
Effective date.--The Senate amendment provision is
effective for amounts paid or accrued in taxable years
beginning after December 31, 2006, and ending before January 1,
2008, and properly allocable to that period, with respect to
mortgage insurance contracts issued after December 31, 2006.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
E. Sense of the Senate on Use of No-Bid Contracting by Federal
Emergency Management Agency
(Sec. 305 of the Senate amendment)
PRESENT LAW
Present law does not provide for the special rules
contemplated in the Sense of the Senate provision described
below.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate Amendment provision provides that it is the
sense of the Senate that the Federal Emergency Management
Agency should (1) rebid certain contracts entered into
following Hurricane Katrina for which competing bids were not
solicited; (2) implement its planned competitive contracting
strategy and, in carrying out that strategy, prioritize local
and small disadvantaged businesses in contracting and
subcontracting; and (3) immediately after awarding any
contract, make public the dollar amount of the contract and
whether competing bids were solicited.
Effective date.--The Senate amendment provision is
effective upon enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
F. Sense of Congress Regarding Doha Round
(Sec. 306 of the Senate amendment)
PRESENT LAW
Present law does not provide a sense of Congress
regarding the Doha Round of trade negotiations.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision provides that it is the
sense of Congress that the United States should not be a
signatory to an agreement or protocol with respect to the Doha
Development Round of the World Trade Organization (WTO)
negotiations or any other bilateral or multilateral trade
negotiations if the agreement or protocol (1) adopts any
provision to lessen the effectiveness of domestic and
international disciplines on unfair trade or safeguard
provisions or (2) would lessen in any manner the ability of the
United States to enforce rigorously its trade laws, including
the antidumping, countervailing duty, and safeguard laws. The
provision also provides that it is the sense of Congress that
(1) the United States trade laws and international rules
appropriately serve the public interest by offsetting injurious
unfair trade, and that further balancing modifications or other
similar provisions are unnecessary and would add to the
complexity and difficulty of achieving relief against injurious
unfair trade practices, and (2) the United States should ensure
that any new agreement relating to international disciplines on
unfair trade or safeguard provisions fully rectifies and
corrects decisions by WTO dispute settlement panels or the
Appellate Body that have unjustifiably and negatively impacted,
or threaten to negatively impact, United States law or
practice, including a law or practice with respect to foreign
dumping or subsidization.
Effective date.--The Senate amendment provision is
effective upon enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
G. Treatment of Certain Stock Option Plans Under Nonqualified Deferred
Compensation Rules
(Sec. 308 of the Senate amendment)
PRESENT LAW
Amounts deferred under a nonqualified deferred
compensation plan for all taxable years are currently
includible in gross income to the extent not subject to a
substantial risk of forfeiture and not previously included in
gross income, unless certain requirements are satisfied.\340\
For example, distributions from a nonqualified deferred
compensation plan may be allowed only upon certain times and
events. Rules also apply for the timing of elections. If the
requirements are not satisfied, in addition to current income
inclusion, interest at the underpayment rate plus one
percentage point is imposed on the underpayments that would
have occurred had the compensation been includible in income
when first deferred, or if later, when not subject to a
substantial risk of forfeiture. The amount required to be
included in income is also subject to a 20-percent additional
tax.
---------------------------------------------------------------------------
\340\ Section 409A.
---------------------------------------------------------------------------
The rules governing the tax treatment of nonqualified
deferred compensation generally apply to stock options granted
to employees. However, exceptions apply to incentive stock
options and options granted under employee stock purchase
plans.\341\
---------------------------------------------------------------------------
\341\ Sections 422 and 423, respectively.
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
Under the Senate amendment, the Secretary of the Treasury
is directed to modify the regulations relating to nonqualified
deferred compensation to extend to applicable foreign option
plans the exceptions for incentive stock options and options
granted under employee stock purchase plans. The exception for
applicable foreign option plans is subject to such terms and
conditions as may be prescribed in the regulations.
An applicable foreign option plan means a plan that (1)
provides for the issuance of employee stock options; (2) is
established under the laws of a foreign jurisdiction; and (3)
under such laws or the terms of the plan (or both), is subject
to requirements substantially similar to the requirements
applicable to incentive stock options and options granted under
employee stock purchase plans.
For this purpose, a foreign option plan is not treated as
subject to requirements substantially similar to the
requirements applicable to incentive stock options and options
granted under employee stock purchase plans unless the foreign
option plan: (1) is required to cover substantially all
employees; (2) in the case of an option under an employee stock
purchase plan, is required to provide an option price of not
less than the lesser of not less than 80 percent of the fair
market value of the stock at the time the option is granted or
an amount which, under the terms of the option, cannot be less
than 80 percent of the fair market value of the stock at the
time the option is exercised; (3) is required to provide
coverage of individuals who, but for the exception under the
provision, would be subject to tax under the nonqualified
deferred compensation rules with respect to the plan; and (4)
meets such other requirements as prescribed in regulations
issued under the provision.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
H. Sense of the Senate Regarding the Dedication of Excess Funds
(Sec. 309 of the Senate amendment)
PRESENT LAW
Present law does not provide a sense of the Senate
regarding the dedication of Treasury revenues that exceed
amounts specified in the reconciliation instructions for this
bill.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that it is the sense of the
Senate that any Federal revenue increases resulting from the
Senate amendment and exceeding the amounts specified in
applicable reconciliation instructions are to be dedicated to
the Low-Income Home Energy Assistance Program. The amount so
dedicated is not to exceed by more than $2.9 billion the
funding level established for the program for fiscal year 2005.
Effective date.--The Senate amendment provision is
effective upon enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
I. Modification of Treatment of Loans to Qualified Continuing Care
Facilities
(Sec. 310 of the Senate amendment and sec. 7872(g) of the Code)
PRESENT LAW
Present law provides generally that certain loans that
bear interest at a below-market rate are treated as loans
bearing interest at the market rate, accompanied by imputed
payments characterized in accordance with the substance of the
transaction (for example, as a gift, compensation, a dividend,
or interest).\342\
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\342\ Sec. 7872.
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An exception to this imputation rule is provided for any
calendar year for a below-market loan made by a lender to a
qualified continuing care facility pursuant to a continuing
care contract, if the lender or the lender's spouse attains age
65 before the close of the calendar year.\343\
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\343\ Sec. 7872(g).
---------------------------------------------------------------------------
The exception applies only to the extent the aggregate
outstanding loans by the lender (and spouse) to any qualified
continuing care facility do not exceed $163,300 (for
2006).\344\
---------------------------------------------------------------------------
\344\ Rev. Rul. 2005-75, 2005-49 I.R.B. 1073.
---------------------------------------------------------------------------
For this purpose, a continuing care contract means a
written contract between an individual and a qualified
continuing care facility under which: (1) the individual or the
individual's spouse may use a qualified continuing care
facility for their life or lives; (2) the individual or the
individual's spouse will first reside in a separate,
independent living unit with additional facilities outside such
unit for the providing of meals and other personal care and
will not require long-term nursing care, and then will be
provided long-term and skilled nursing care as the health of
the individual or the individual's spouse requires; and (3) no
additional substantial payment is required if the individual or
the individual's spouse requires increased personal care
services or long-term and skilled nursing care.
For this purpose, a qualified continuing care facility
means one or more facilities that are designed to provide
services under continuing care contracts, and substantially all
of the residents of which are covered by continuing care
contracts. A facility is not treated as a qualified continuing
care facility unless substantially all facilities that are used
to provide services required to be provided under a continuing
care contract are owned or operated by the borrower. For these
purposes, a nursing home is not a qualified continuing care
facility.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision modifies the present-law
exception under section 7872(g) relating to loans to continuing
care facilities by eliminating the dollar cap on aggregate
outstanding loans and making other modifications.
The Senate amendment provision provides an exception to
the imputation rule of section 7872 for any calendar year for
any below-market loan owed by a facility which on the last day
of the year is a qualified continuing care facility, if the
loan was made pursuant to a continuing care contract and if the
lender or the lender's spouse attains age 62 before the close
of the year.
For this purpose, a continuing care contract means a
written contract between an individual and a qualified
continuing care facility under which: (1) the individual or the
individual's spouse may use a qualified continuing care
facility for their life or lives; (2) the individual or the
individual's spouse will be provided with housing in an
independent living unit (which has additional available
facilities outside such unit for the provision of meals and
other personal care), an assisted living facility or nursing
facility, as is available in the continuing care facility, as
appropriate for the health of the individual or the
individual's spouse; and (3) the individual or the individual's
spouse will be provided assisted living or nursing care as the
health of the individual or the individual's spouse requires,
and as is available in the continuing care facility.
For this purpose, a qualified continuing care facility
means one or more facilities: (1) that are designed to provide
services under continuing care contracts; (2) that include an
independent living unit, plus an assisted living or nursing
facility, or both; and (3) substantially all of the independent
living unit residents of which are covered by continuing care
contracts. For these purposes, a nursing home is not a
qualified continuing care facility.
Effective date.--The provision is effective for loans
made after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision, with modifications. The conference agreement
provision provides that a continuing care contract is a written
contract between an individual and a qualified continuing care
facility under which: (1) the individual or the individual's
spouse may use a qualified continuing care facility for their
life or lives; (2) the individual or the individual's spouse
will be provided with housing, as appropriate for the health of
such individual or individual's spouse, (i) in an independent
living unit (which has additional available facilities outside
such unit for the provision of meals and other personal care),
and (ii) in an assisted living facility or a nursing facility,
as is available in the continuing care facility; and (3) the
individual or the individual's spouse will be provided assisted
living or nursing care as the health of the individual or the
individual's spouse requires, and as is available in the
continuing care facility. The Secretary is required to issue
guidance that limits the term ``continuing care contract'' to
contracts that provide only facilities, care, and services
described in the preceding sentence.
For purposes of defining the terms ``continuing care
contract'' and ``qualified continuing care facility'' under the
conference agreement provision, the term ``assisted living
facility'' is intended to mean a facility at which assistance
is provided (1) with activities of daily living (such as
eating, toileting, transferring, bathing, dressing, and
continence) or (2) in cases of cognitive impairment, to protect
the health or safety of an individual. The term ``nursing
facility'' is intended to mean a facility that offers care
requiring the utilization of licensed nursing staff.
Effective date.--The conference agreement provision is
generally effective for calendar years beginning after December
31, 2005, with respect to loans made before, on, or after such
date. The conference agreement provision does not apply to any
calendar year after 2010. Thus, the conference agreement
provision does not apply with respect to interest imputed after
December 31, 2010. After such date, the law as in effect prior
to enactment applies.
J. Exclusion of Gain on Sale of a Principal Residence by a Member of
the Intelligence Community
(Sec. 311 of the Senate amendment and sec. 121 of the Code)
PRESENT LAW
Under present law, an individual taxpayer may exclude up
to $250,000 ($500,000 if married filing a joint return) of gain
realized on the sale or exchange of a principal residence. To
be eligible for the exclusion, the taxpayer must have owned and
used the residence as a principal residence for at least two of
the five years ending on the sale or exchange. A taxpayer who
fails to meet these requirements by reason of a change of place
of employment, health, or, to the extent provided under
regulations, unforeseen circumstances is able to exclude an
amount equal to the fraction of the $250,000 ($500,000 if
married filing a joint return) that is equal to the fraction of
the two years that the ownership and use requirements are met.
Present law also contains special rules relating to
members of the uniformed services or the Foreign Service of the
United States. An individual may elect to suspend for a maximum
of 10 years the five-year test period for ownership and use
during certain absences due to service in the uniformed
services or the Foreign Service of the United States. The
uniformed services include: (1) the Armed Forces (the Army,
Navy, Air Force, Marine Corps, and Coast Guard); (2) the
commissioned corps of the National Oceanic and Atmospheric
Administration; and (3) the commissioned corps of the Public
Health Service. If the election is made, the five-year period
ending on the date of the sale or exchange of a principal
residence does not include any period up to five years during
which the taxpayer or the taxpayer's spouse is on qualified
official extended duty as a member of the uniformed services or
in the Foreign Service of the United States. For these
purposes, qualified official extended duty is any period of
extended duty while serving at a place of duty at least 50
miles away from the taxpayer's principal residence or under
orders compelling residence in Government furnished quarters.
Extended duty is defined as any period of duty pursuant to a
call or order to such duty for a period in excess of 90 days or
for an indefinite period. The election may be made with respect
to only one property for a suspension period.
HOUSE BILL
No provision.
SENATE AMENDMENT
Under the provision, specified employees of the
intelligence community may elect to suspend the running of the
five-year test period during any period in which they are
serving on extended duty. The term ``employee of the
intelligence community'' means an employee of the Office of the
Director of National Intelligence, the Central Intelligence
Agency, the National Security Agency, the Defense Intelligence
Agency, the National Geospatial-Intelligence Agency, or the
National Reconnaissance Office. The term also includes
employment with: (1) any other office within the Department of
Defense for the collection of specialized national intelligence
through reconnaissance programs; (2) any of the intelligence
elements of the Army, the Navy, the Air Force, the Marine
Corps, the Federal Bureau of Investigation, the Department of
the Treasury, the Department of Energy, and the Coast Guard;
(3) the Bureau of Intelligence and Research of the Department
of State; and (4) the elements of the Department of Homeland
Security concerned with the analyses of foreign intelligence
information. To qualify, a specified employee must move from
one duty station to another and at least one of such duty
stations must be located outside of the Washington, D.C. and
Baltimore metropolitan statistical areas, as defined by the
Secretary of Commerce. As under present law, the five-year
period may not be extended more than 10 years.
Effective date.--The provision is effective for sales and
exchanges after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
K. Sense of the Senate Regarding the Permanent Extension of EGTRRA and
JGTRRA Provisions Relating to the Child Tax Credit
(Sec. 312 of the Senate amendment)
PRESENT LAW
Present law provides for the sunset of the child tax
credit provisions under Economic Growth and Tax Relief
Reconciliation Act of 2001 (``EGTRRA'') and Jobs and Growth Tax
Relief Reconciliation Act of 2003 (``JGTRRA'').
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment includes a provision stating that it
is the sense of the Senate that the conferees for the Tax
Relief Act of 2006 should strive to permanently extend the
amendments to the child tax credit made by EGTRRA and JGTRRA.
Effective date.--The Senate amendment provision is
effective on the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
L. Partial Expensing for Advanced Mine Safety Equipment
(Sec. 313 of the Senate amendment)
PRESENT LAW
A taxpayer generally must capitalize the cost of property
used in a trade or business and recover such cost over time
through annual deductions for depreciation or amortization.
Tangible property generally is depreciated under the Modified
Accelerated Cost Recovery System (``MACRS''), which determines
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of
various types of depreciable property (sec. 168).
Personal property is classified under MACRS based on the
property's class life unless a different classification is
specifically provided in section 168. The class life applicable
for personal property is the asset guideline period (midpoint
class life as of January 1, 1986). Based on the property's
classification, a recovery period is prescribed under MACRS. In
general, there are six classes of recovery periods to which
personal property can be assigned. For example, personal
property that has a class life of four years or less has a
recovery period of three years, whereas personal property with
a class life greater than four years but less than 10 years has
a recovery period of five years. The class lives and recovery
periods for most property are contained in Revenue Procedure
87-56.\345\
---------------------------------------------------------------------------
\345\ 1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-
22, 1988-1 C.B. 785).
---------------------------------------------------------------------------
In lieu of depreciation, a taxpayer with a sufficiently
small amount of annual investment may elect to deduct (or
``expense'') such costs. Present law provides that the maximum
amount a taxpayer may expense, for taxable years beginning in
2003 through 2007, is $100,000 of the cost of qualifying
property placed in service for the taxable year. In general,
qualifying property is defined as depreciable tangible personal
property that is purchased for use in the active conduct of a
trade or business. The $100,000 amount is reduced (but not
below zero) by the amount by which the cost of qualifying
property placed in service during the taxable year exceeds
$400,000.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that the taxpayer may elect
to treat 50 percent of the cost of any qualified advanced mine
safety equipment property as a deduction in the taxable year in
which the equipment is placed in service.
Advanced mine safety equipment property means any of the
following: (1) emergency communication technology or devices
used to allow a miner to maintain constant communication with
an individual who is not in the mine; (2) electronic
identification and location devices that allow individuals not
in the mine to track at all times the movements and location of
miners working in or at the mine; (3) emergency oxygen-
generating, self-rescue devices that provide oxygen for at
least 90 minutes; (4) pre-positioned supplies of oxygen
providing each miner on a shift the ability to survive for at
least 48 hours; and (5) comprehensive atmospheric monitoring
systems that monitor the levels of carbon monoxide, methane and
oxygen that are present in all areas of the mine and that can
detect smoke in the case of a fire in a mine.
To be treated as qualified advanced mine safety equipment
property under the provision, the original use of the property
must have commenced with the taxpayer, and the taxpayer must
have placed the property in service after the date of
enactment.
The portion of the cost of any property with respect to
which an expensing election under section 179 is made may not
be taken into account for purposes of the 50-percent deduction
allowed under this provision. For Federal tax purposes, the
basis of property is reduced by the portion of its cost that is
taken into account for purposes of the 50-percent deduction
allowed under the provision.
The provision requires the taxpayer to report information
required by the Treasury Secretary with respect to the
operation of mines of the taxpayer, in order for the deduction
to be allowed for the taxable year.
The provision includes a termination rule providing that
it does not apply to property placed in service after the date
that is three years after the date of enactment.
Effective date.--The provision applies to costs paid or
incurred after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
M. Mine Rescue Team Training Credit
(Sec. 314 of the Senate amendment and new sec. 45N of the Code)
PRESENT LAW
There is no present law credit for expenditures incurred
by a taxpayer to train mine rescue workers. In general, a
deduction is allowed for all ordinary and necessary expenses
that are paid or incurred by the taxpayer during the taxable
year in carrying on any trade or business.\346\ A taxpayer that
employs individuals as miners in underground mines will
generally be permitted to deduct as ordinary and necessary
expenses the educational expenditures such taxpayer incurs to
train its employees in the principles, procedures, and
techniques of mine rescue, as well as the wages paid by the
taxpayer for the time its employees were engaged in such
training.
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\346\ Sec. 162(a).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that a taxpayer which is an
eligible employer may claim a credit equal to the lesser of (1)
20 percent of the amount paid or incurred by the taxpayer
during the taxable year with respect to the training program
costs of each qualified mine rescue team employee (including
wages of the employee), or (2) $10,000.\347\ An eligible
employer is any taxpayer which employs individuals as miners in
underground mines in the United States. No deduction is allowed
for the amount of the expenses otherwise deductible which is
equal to the amount of the credit.
---------------------------------------------------------------------------
\347\ The credit is part of the general business credit (sec. 38).
---------------------------------------------------------------------------
A qualified mine rescue team employee is any full-time
employee of the taxpayer who is a miner eligible for more than
six months of a taxable year to serve as a mine rescue team
member by virtue of either having completed the initial 20-hour
course of instruction prescribed by the Mine Safety and Health
Administration's Office of Educational Policy and Development,
or receiving at least 40 hours of refresher training in such
instruction.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2005, and before January 1,
2009.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
N. Funding for Veterans Health Care and Disability Compensation and
Hospital Infrastructure for Veterans
(Sec. 315 of the Senate amendment)
PRESENT LAW
Within the U.S. Department of Veterans Affairs, the
Veterans Health Administration provides a broad spectrum of
medical, surgical, and rehabilitative care to veterans. The
Veteran Benefits Administration provides services to veterans,
including services related to compensation and pensions.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment authorizes the appropriation of
funds for the Department of Veterans Affairs for the Veterans
Health Administration for Medical Care as well as the Veterans
Benefits Administration for Compensation and Pensions for
fiscal years 2006 through 2010 in the amounts listed below. The
amounts authorized are in addition to any other amounts
authorized for these Administrations under any other provision
of law.
------------------------------------------------------------------------
Veterans health Veterans benefits
Fiscal year administration administration
------------------------------------------------------------------------
2006.............................. $900,000,000 $2,300,000,000
2007.............................. 1,300,000,000 2,700,000,000
2008.............................. 1,500,000,000 3,000,000,000
2009.............................. 1,600,000,000 3,000,000,000
2010.............................. 1,600,000,000 3,000,000,000
------------------------------------------------------------------------
The Senate amendment also establishes the Veterans
Hospital Improvement Fund, with an initial balance of
$1,000,000,000, to be administered by the Secretary of Veterans
Affairs. The funds are to be used for improvements of health
facilities treating veterans.
Effective date.--The Senate amendment is effective upon
the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
O. Sense of the Senate Regarding Protecting Middle-Class Families From
the Alternative Minimum Tax
(Sec. 316 of the Senate amendment)
PRESENT LAW
Present law imposes an alternative minimum tax. The
alternative minimum tax is the amount by which the tentative
minimum tax exceeds the regular income tax. An individual's
tentative minimum tax is the sum of (1) 26 percent of so much
of the taxable excess as does not exceed $175,000 ($87,500 in
the case of a married individual filing a separate return) and
(2) 28 percent of the remaining taxable excess. The taxable
excess is so much of the alternative minimum taxable income
(``AMTI'') as exceeds an exemption amount. AMTI is the
individual's taxable income adjusted to take account of
specified preferences and adjustments.
Under present law, for taxable years beginning before
January 1, 2009, the maximum rate of tax on the adjusted net
capital gain of an individual is 15 percent, and dividends
received by an individual from domestic corporations and
qualified foreign corporations are taxed at the same rates that
apply to capital gains. For taxable years beginning after
December 31, 2008, the maximum rate of tax on the adjusted net
capital gain of an individual is 20 percent, and dividends
received by an individual are taxed as ordinary income at rates
of up to 35 percent.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that it is the sense of the
Senate that protecting middle-class families from the
alternative minimum tax should be a higher priority for
Congress in 2006 than extending a tax cut that does not expire
until the end of 2008.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE V--REVENUE OFFSET PROVISIONS
A. Provisions Designed to Curtail Tax Shelters
1. Understatement of taxpayer's liability by income tax return preparer
(Sec. 401 of the Senate amendment and sec. 6694 of the Code)
PRESENT LAW
An income tax return preparer who prepares a return with
respect to which there is an understatement of tax that is due
to an undisclosed position for which there was not a realistic
possibility of being sustained on its merits, or a frivolous
position, is liable for a penalty of $250, provided the
preparer knew or reasonably should have known of the position.
An income tax return preparer who prepares a return and engages
in specified willful or reckless conduct with respect to
preparing such a return is liable for a penalty of $1,000.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision alters the standards of conduct that must
be met to avoid imposition of the first penalty described above
by replacing the realistic possibility standard with a
requirement that there be a reasonable belief that the tax
treatment of the position was more likely than not the proper
treatment. The provision also replaces the not-frivolous
standard with the requirement that there be a reasonable basis
for the tax treatment of the position, increases the present-
law $250 penalty to $1,000, and increases the present-law
$1,000 penalty to $5,000.
Effective date.--The provision is effective for documents
prepared after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Frivolous tax submissions (Sec. 402 of the Senate amendment and sec.
6702 of the Code)
PRESENT LAW
The Code provides that an individual who files a
frivolous income tax return is subject to a penalty of $500
imposed by the IRS (sec. 6702). The Code also permits the Tax
Court \348\ to impose a penalty of up to $25,000 if a taxpayer
has instituted or maintained proceedings primarily for delay or
if the taxpayer's position in the proceeding is frivolous or
groundless (sec. 6673(a)).
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\348\ Because in general the Tax Court is the only pre-payment
forum available to taxpayers, it deals with most of the frivolous,
groundless, or dilatory arguments raised in tax cases.
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment modifies the IRS-imposed penalty by
increasing the amount of the penalty to up to $5,000 and by
applying it to all taxpayers and to all types of Federal taxes.
The Senate amendment also modifies present law with
respect to certain submissions that raise frivolous arguments
or that are intended to delay or impede tax administration. The
submissions to which the Senate amendment applies are requests
for a collection due process hearing, installment agreements,
offers-in-compromise, and taxpayer assistance orders. First,
the Senate amendment permits the IRS to disregard such
requests. Second, the Senate amendment permits the IRS to
impose a penalty of up to $5,000 for such requests, unless the
taxpayer withdraws the request after being given an opportunity
to do so.
The Senate amendment requires the IRS to publish a list
of positions, arguments, requests, and submissions determined
to be frivolous for purposes of these provisions.
Effective date.--The Senate amendment applies to
submissions made and issues raised after the date on which the
Secretary first prescribes the required list of frivolous
positions.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
3. Penalty for promoting abusive tax shelters (sec. 403 of the Senate
amendment and sec. 6700 of the Code)
PRESENT LAW
A penalty is imposed on any person who organizes, assists
in the organization of, or participates in the sale of any
interest in, a partnership or other entity, any investment plan
or arrangement, or any other plan or arrangement, if in
connection with such activity the person makes or furnishes a
qualifying false or fraudulent statement or a gross valuation
overstatement.\349\ A qualified false or fraudulent statement
is any statement with respect to the allowability of any
deduction or credit, the excludability of any income, or the
securing of any other tax benefit by reason of holding an
interest in the entity or participating in the plan or
arrangement which the person knows or has reason to know is
false or fraudulent as to any material matter. A ``gross
valuation overstatement'' means any statement as to the value
of any property or services if the stated value exceeds 200
percent of the correct valuation, and the value is directly
related to the amount of any allowable income tax deduction or
credit.
---------------------------------------------------------------------------
\349\ Sec. 6700.
---------------------------------------------------------------------------
In the case of a gross valuation overstatement, the
amount of the penalty is $1,000 (or, if the person establishes
that it is less, 100 percent of the gross income derived or to
be derived by the person from such activity). A penalty
attributable to a gross valuation misstatement can be waived on
a showing that there was a reasonable basis for the valuation
and it was made in good faith. In the case of any activity that
involves a qualified false or fraudulent statement, the penalty
amount is equal to 50 percent of the gross income derived by
the person from the activity.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment modifies the penalty rate imposed on
any person who organizes, assists in the organization of, or
participates in the sale of any interest in, a partnership or
other entity, any investment plan or arrangement, or any other
plan or arrangement, if in connection with such activity the
person makes or furnishes a qualifying false or fraudulent
statement or a gross valuation overstatement. The penalty is
equal to 100 percent of the gross income derived (or to be
derived) from the activity. The penalty amount is calculated
with respect to each instance of an activity subject to the
penalty, each instance in which income was derived by the
person or persons subject to the penalty, and each person who
participated in an activity subject to the penalty.
Under the Senate amendment, if more than one person is
liable for the penalty, all such persons are jointly and
severally liable for the penalty. In addition, the Senate
amendment provides that the penalty, as well as amounts paid to
settle or avoid the imposition of the penalty, is not
deductible for tax purposes.
Effective date.--The provision is effective for
activities occurring after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
4. Penalty for aiding and abetting the understatement of tax liability
(sec. 404 of the Senate amendment and sec. 6701 of the Code)
PRESENT LAW
A penalty is imposed on a person who: (1) aids or assists
in, procures, or advises with respect to a tax return or other
document; (2) knows (or has reason to believe) that such
document will be used in connection with a material tax matter;
and (3) knows that this would result in an understatement of
tax of another person. In general, the amount of the penalty is
$1,000. If the document relates to the tax return of a
corporation, the amount of the penalty is $10,000.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment expands the scope of the penalty in
several ways. First, it applies the penalty to aiding or
assisting with respect to tax liability reflected in a tax
return. Second, it applies the penalty to each instance of
aiding or abetting. Third, it increases the amount of the
penalty to a maximum of 100 percent of the gross income derived
(or to be derived) from the aiding or abetting. Fourth, if more
than one person is liable for the penalty, all such persons are
jointly and severally liable for the penalty. Fifth, the
penalty, as well as amounts paid to settle or avoid the
imposition of the penalty, is not deductible for tax purposes.
Effective date.--The provision is effective for
activities occurring after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
B. Economic Substance Doctrine
1. Clarification of the economic substance doctrine (sec. 411 of the
Senate amendment)
PRESENT LAW
In general
The Code provides specific rules regarding the
computation of taxable income, including the amount, timing,
source, and character of items of income, gain, loss and
deduction. These rules are designed to provide for the
computation of taxable income in a manner that provides for a
degree of specificity to both taxpayers and the government.
Taxpayers generally may plan their transactions in reliance on
these rules to determine the federal income tax consequences
arising from the transactions.
In addition to the statutory provisions, courts have
developed several doctrines that can be applied to deny the tax
benefits of tax motivated transactions, notwithstanding that
the transaction may satisfy the literal requirements of a
specific tax provision. The common-law doctrines are not
entirely distinguishable, and their application to a given set
of facts is often blurred by the courts and the IRS. Although
these doctrines serve an important role in the administration
of the tax system, invocation of these doctrines can be seen as
at odds with an objective, ``rule-based'' system of taxation.
Nonetheless, courts have applied the doctrines to deny tax
benefits arising from certain transactions.\350\
---------------------------------------------------------------------------
\350\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d
Cir. 1998), aff'g 73 T.C.M. (CCH) 2189 (1997), cert. denied 526 U.S.
1017 (1999).
---------------------------------------------------------------------------
A common-law doctrine applied with increasing frequency
is the ``economic substance'' doctrine. In general, this
doctrine denies tax benefits arising from transactions that do
not result in a meaningful change to the taxpayer's economic
position other than a purported reduction in federal income
tax.\351\
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\351\ Closely related doctrines also applied by the courts
(sometimes interchangeable with the economic substance doctrine)
include the ``sham transaction doctrine'' and the ``business purpose
doctrine''. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960)
(denying interest deductions on a ``sham transaction'' whose only
purpose was to create the deductions).
---------------------------------------------------------------------------
Economic substance doctrine
Courts generally deny claimed tax benefits if the
transaction that gives rise to those benefits lacks economic
substance independent of tax considerations--notwithstanding
that the purported activity actually occurred. The tax court
has described the doctrine as follows:
The tax law . . . requires that the intended
transactions have economic substance separate and
distinct from economic benefit achieved solely by tax
reduction. The doctrine of economic substance becomes
applicable, and a judicial remedy is warranted, where a
taxpayer seeks to claim tax benefits, unintended by
Congress, by means of transactions that serve no
economic purpose other than tax savings.\352\
---------------------------------------------------------------------------
\352\ ACM Partnership v. Commissioner, 73 T.C.M. at 2215.
---------------------------------------------------------------------------
Business purpose doctrine
Another common law doctrine that overlays and is often
considered together with (if not part and parcel of) the
economic substance doctrine is the business purpose doctrine.
The business purpose test is a subjective inquiry into the
motives of the taxpayer--that is, whether the taxpayer intended
the transaction to serve some useful non-tax purpose. In making
this determination, some courts have bifurcated a transaction
in which independent activities with non-tax objectives have
been combined with an unrelated item having only tax-avoidance
objectives in order to disallow the tax benefits of the overall
transaction.\353\
---------------------------------------------------------------------------
\353\ ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
---------------------------------------------------------------------------
Application by the courts
Elements of the doctrine
There is a lack of uniformity regarding the proper
application of the economic substance doctrine.\354\ Some
courts apply a conjunctive test that requires a taxpayer to
establish the presence of both economic substance (i.e., the
objective component) and business purpose (i.e., the subjective
component) in order for the transaction to survive judicial
scrutiny.\355\ A narrower approach used by some courts is to
conclude that either a business purpose or economic substance
is sufficient to respect the transaction).\356\ A third
approach regards economic substance and business purpose as
``simply more precise factors to consider'' in determining
whether a transaction has any practical economic effects other
than the creation of tax benefits.\357\
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\354\ ``The casebooks are glutted with [economic substance] tests.
Many such tests proliferate because they give the comforting illusion
of consistency and precision. They often obscure rather than clarify.''
Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988).
\355\ See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th
Cir. 1993) (``The threshold question is whether the transaction has
economic substance. If the answer is yes, the question becomes whether
the taxpayer was motivated by profit to participate in the
transaction.'').
\356\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d 89,
91-92 (4th Cir. 1985) (``To treat a transaction as a sham, the court
must find that the taxpayer was motivated by no business purposes other
than obtaining tax benefits in entering the transaction, and, second,
that the transaction has no economic substance because no reasonable
possibility of a profit exists.''); IES Industries v. United States,
253 F.3d 350, 358 (8th Cir. 2001) (``In determining whether a
transaction is a sham for tax purposes [under the Eighth Circuit test],
a transaction will be characterized as a sham if it is not motivated by
any economic purpose out of tax considerations (the business purpose
test), and if it is without economic substance because no real
potential for profit exists (the economic substance test).''). As noted
earlier, the economic substance doctrine and the sham transaction
doctrine are similar and sometimes are applied interchangeably. For a
more detailed discussion of the sham transaction doctrine, see, e.g.,
Joint Committee on Taxation, Study of Present-Law Penalty and Interest
Provisions as Required by Section 3801 of the Internal Revenue Service
Restructuring and Reform Act of 1998 (including Provisions Relating to
Corporate Tax Shelters) (JCS-3-99) at 182.
\357\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247;
James v. Commissioner, 899 F.2d 905, 908 (10th Cir. 1995); Sacks v.
Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (``Instead, the
consideration of business purpose and economic substance are simply
more precise factors to consider . . . We have repeatedly and carefully
noted that this formulation cannot be used as a `rigid two-step
analysis'.'').
---------------------------------------------------------------------------
Recently, the Court of Federal Claims questioned the
continuing viability of the doctrine.\358\ The court also
stated that ``the use of the `economic substance' doctrine to
trump `mere compliance with the Code' would violate the
separation of powers.'' \359\
---------------------------------------------------------------------------
\358\ Coltec Industries, Inc. v. United States, 62 Fed. Cl. 716
(2004) (slip opinion at 123-124). The court also found, however, that
the doctrine was satisfied in that case. Id. at 128.
\359\ Id. at 128.
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Nontax economic benefits
There also is a lack of uniformity regarding the type of
non-tax economic benefit a taxpayer must establish in order to
satisfy economic substance. Several courts have denied tax
benefits on the grounds that the subject transactions lacked
profit potential.\360\ In addition, some courts have applied
the economic substance doctrine to disallow tax benefits in
transactions in which a taxpayer was exposed to risk and the
transaction had a profit potential, but the court concluded
that the economic risks and profit potential were insignificant
when compared to the tax benefits.\361\ Under this analysis,
the taxpayer's profit potential must be more than nominal.
Conversely, other courts view the application of the economic
substance doctrine as requiring an objective determination of
whether a ``reasonable possibility of profit'' from the
transaction existed apart from the tax benefits.\362\ In these
cases, in assessing whether a reasonable possibility of profit
exists, it is sufficient if there is a nominal amount of pre-
tax profit as measured against expected net tax benefits.
---------------------------------------------------------------------------
\360\ See, e.g., Knetsch, 364 U.S. at 361; Goldstein v.
Commissioner, 364 F.2d 734 (2d Cir. 1966) (holding that an
unprofitable, leveraged acquisition of Treasury bills, and accompanying
prepaid interest deduction, lacked economic substance).
\361\ See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-40
(disallowing deduction even though taxpayer had a possibility of small
gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94
T.C. 738, 768 (1990) (stating that ``potential for gain . . . is
infinitesimally nominal and vastly insignificant when considered in
comparison with the claimed deductions'').
\362\ See, e.g., Rice's Toyota World v. Commissioner, 752 F.2d at
94 (the economic substance inquiry requires an objective determination
of whether a reasonable possibility of profit from the transaction
existed apart from tax benefits); Compaq Computer Corp. v.
Commissioner, 277 F.3d at 781 (applied the same test, citing Rice's
Toyota World); IES Industries v. United States, 253 F.3d 350, 354 (8th
Cir. 2001). s
---------------------------------------------------------------------------
Financial accounting benefits
In determining whether a taxpayer had a valid business
purpose for entering into a transaction, at least one court has
concluded that financial accounting benefits arising from tax
savings do not qualify as a non-tax business purpose.\363\
However, based on court decisions that recognize the importance
of financial accounting treatment, taxpayers have asserted that
financial accounting benefits arising from tax savings can
satisfy the business purpose test.\364\
---------------------------------------------------------------------------
\363\ See, American Electric Power, Inc. v. U.S., 136 F. Supp. 2d
762, 791-92 (S.D. Ohio 2001); aff'd 326 F.3d.737 (6th Cir. 2003).
\364\ See, e.g., Joint Committee on Taxation, Report of
Investigation of Enron Corporation and Related Entities Regarding
Federal Tax and Compensation Issues, and Policy Recommendations (JSC-3-
03) February, 2003 (``Enron Report''), Volume III at C-93, 289. Enron
Corporation relied on Frank Lyon Co. v. United States, 435 U.S. 561,
577-78 (1978), and Newman v. Commissioner, 902 F.2d 159, 163 (2d Cir.
1990) to argue that financial accounting benefits arising from tax
savings constitutes a good business purpose.
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision clarifies and enhances the
application of the economic substance doctrine. Under the
provision, in a case in which a court determines that the
economic substance doctrine is relevant to a transaction (or a
series of transactions), such transaction (or series of
transactions) has economic substance (and thus satisfies the
economic substance doctrine) only if the taxpayer establishes
that (1) the transaction changes in a meaningful way (apart
from Federal income tax consequences) the taxpayer's economic
position, and (2) the taxpayer has a substantial non-tax
purpose for entering into such transaction and the transaction
is a reasonable means of accomplishing such purpose.\365\
---------------------------------------------------------------------------
\365\ If the tax benefits are clearly contemplated and expected by
the language and purpose of the relevant authority, it is not intended
that such tax benefits be disallowed if the only reason for such
disallowance is that the transaction fails the economic substance
doctrine as defined in this provision.
---------------------------------------------------------------------------
The provision does not change current law standards used
by courts in determining when to utilize an economic substance
analysis.\366\ Also, the provision does not alter the court's
ability to aggregate, disaggregate or otherwise recharacterize
a transaction when applying the doctrine.\367\ The provision
provides a uniform definition of economic substance, but does
not alter the flexibility of the courts in other respects.
---------------------------------------------------------------------------
\366\ See, e.g., Treas. Reg. sec. 1.269-2, stating that
characteristic of circumstances in which a deduction otherwise allowed
will be disallowed are those in which the effect of the deduction,
credit, or other allowance would be to distort the liability of the
particular taxpayer when the essential nature of the transaction or
situation is examined in the light of the basic purpose or plan which
the deduction, credit, or other allowance was designed by the Congress
to effectuate.
\367\ See, e.g., Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613
(1938) (``A given result at the end of a straight path is not made a
different result because reached by following a devious path.'').
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Conjunctive analysis
The provision clarifies that the economic substance
doctrine involves a conjunctive analysis--there must be an
objective inquiry regarding the effects of the transaction on
the taxpayer's economic position, as well as a subjective
inquiry regarding the taxpayer's motives for engaging in the
transaction. Under the provision, a transaction must satisfy
both tests--i.e., it must change in a meaningful way (apart
from Federal income tax consequences) the taxpayer's economic
position, and the taxpayer must have a substantial non-tax
purpose for entering into such transaction (and the transaction
is a reasonable means of accomplishing such purpose)--in order
to satisfy the economic substance doctrine. This clarification
eliminates the disparity that exists among the circuits
regarding the application of the doctrine, and modifies its
application in those circuits in which either a change in
economic position or a non-tax business purpose (without having
both) is sufficient to satisfy the economic substance doctrine.
Non-tax business purpose
Under the provision, a taxpayer's non-tax purpose for
entering into a transaction (the second prong in the analysis)
must be ``substantial,'' and the transaction must be ``a
reasonable means'' of accomplishing such purpose. Under this
formulation, the non-tax purpose for the transaction must bear
a reasonable relationship to the taxpayer's normal business
operations or investment activities.\368\
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\368\ See, e.g., Treas. Reg. sec. 1.269-2(b) (stating that a
distortion of tax liability indicating the principal purpose of tax
evasion or avoidance might be evidenced by the fact that ``the
transaction was not undertaken for reasons germane to the conduct of
the business of the taxpayer''). Similarly, in ACM Partnership v.
Commissioner, 73 T.C.M. (CCH) 2189 (1997), the court stated:
``Key to [the determination of whether a transaction has economic
substance] is that the transaction must be rationally related to a
useful nontax purpose that is plausible in light of the taxpayer's
conduct and useful in light of the taxpayer's economic situation and
intentions. Both the utility of the stated purpose and the rationality
of the means chosen to effectuate it must be evaluated in accordance
with commercial practices in the relevant industry. A rational
relationship between purpose and means ordinarily will not be found
unless there was a reasonable expectation that the nontax benefits
would be at least commensurate with the transaction costs.'' [citations
omitted]
See also 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.'').
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In determining whether a taxpayer has a substantial non-
tax business purpose, an objective of achieving a favorable
accounting treatment for financial reporting purposes will not
be treated as having a substantial non-tax purpose.\369\
Furthermore, a transaction that is expected to increase
financial accounting income as a result of generating tax
deductions or losses without a corresponding financial
accounting charge (i.e., a permanent book-tax difference) \370\
should not be considered to have a substantial non-tax purpose
unless a substantial non-tax purpose exists apart from the
financial accounting benefits.\371\
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\369\ However, if the tax benefits are clearly contemplated and
expected by the language and purpose of the relevant authority, such
tax benefits should not be disallowed solely because the transaction
results in a favorable accounting treatment. An example is the repealed
foreign sales corporation rules.
\370\ This includes tax deductions or losses that are anticipated
to be recognized in a period subsequent to the period the financial
accounting benefit is recognized. For example, FAS 109 in some cases
permits the recognition of financial accounting benefits prior to the
period in which the tax benefits are recognized for income tax
purposes.
\371\ Claiming that a financial accounting benefit constitutes a
substantial non-tax purpose fails to consider the origin of the
accounting benefit (i.e., reduction of taxes) and significantly
diminishes the purpose for having a substantial non-tax purpose
requirement. See, e.g., American Electric Power, Inc. v. U.S., 136 F.
Supp. 2d 762, 791-92 (S.D. Ohio, 2001) (``AEP's intended use of the
cash flows generated by the [corporate-owned life insurance] plan is
irrelevant to the subjective prong of the economic substance analysis.
If a legitimate business purpose for the use of the tax savings `were
sufficient to breathe substance into a transaction whose only purpose
was to reduce taxes, [then] every sham tax-shelter device might
succeed,' '') (citing Winn-Dixie v. Commissioner, 113 T.C. 254, 287
(1999)); aff'd 326 F3d 737 (6th Cir. 2003).
---------------------------------------------------------------------------
By requiring that a transaction be a ``reasonable means''
of accomplishing its non-tax purpose, the provision reiterates
the present-law ability of the courts to bifurcate a
transaction in which independent activities with non-tax
objectives are combined with an unrelated item having only tax-
avoidance objectives in order to disallow the tax benefits of
the overall transaction.\372\
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\372\ See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 256
n.48.
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Profit potential
Under the provision, a taxpayer may rely on factors other
than profit potential to demonstrate that a transaction results
in a meaningful change in the taxpayer's economic position; the
provision merely sets forth a minimum threshold of profit
potential if that test is relied on to demonstrate a meaningful
change in economic position. If a taxpayer relies on a profit
potential, however, the present value of the reasonably
expected pre-tax profit must be substantial in relation to the
present value of the expected net tax benefits that would be
allowed if the transaction were respected.\373\ Moreover, the
profit potential must exceed a risk-free rate of return. In
addition, in determining pre-tax profit, fees and other
transaction expenses and foreign taxes are treated as expenses.
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\373\ 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 potential test to a lessor of
tangible property, depreciation, applicable tax credits (such
as the rehabilitation tax credit and the low income housing tax
credit), and any other deduction as provided in guidance by the
Secretary are not taken into account in measuring tax benefits.
Transactions with tax-indifferent parties
The provision also provides special rules for
transactions with tax-indifferent parties. For this purpose, a
tax-indifferent party means any person or entity not subject to
Federal income tax, or any person to whom an item would have no
substantial impact on its income tax liability. Under these
rules, the form of a financing transaction will not be
respected if the present value of the tax deductions to be
claimed is substantially in excess of the present value of the
anticipated economic returns to the lender. Also, the form of a
transaction with a tax-indifferent party will not be respected
if it results in an allocation of income or gain to the tax-
indifferent party in excess of the tax-indifferent party's
economic gain or income or if the transaction results in the
shifting of basis on account of overstating the income or gain
of the tax-indifferent party.
Other rules
The Secretary may prescribe regulations which provide (1)
exemptions from the application of the provision, and (2) other
rules as may be necessary or appropriate to carry out the
purposes of the provision.
No inference is intended as to the proper application of
the economic substance doctrine under present law. In addition,
except with respect to the economic substance doctrine, the
provision shall not be construed as altering or supplanting any
other common law doctrine (including the sham transaction
doctrine), and the provision shall be construed as being
additive to any such other doctrine.
Effective date.--The provision applies to transactions
entered into after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Penalty for understatements attributable to transactions lacking
economic substance, etc. (sec. 412 of the Senate amendment)
PRESENT LAW
General accuracy-related penalty
An accuracy-related penalty under section 6662 applies to
the portion of any underpayment that is attributable to (1)
negligence, (2) any substantial understatement of income tax,
(3) any substantial valuation misstatement, (4) any substantial
overstatement of pension liabilities, or (5) any substantial
estate or gift tax valuation understatement. If the correct
income tax liability exceeds that reported by the taxpayer by
the greater of 10 percent of the correct tax or $5,000 (or, in
the case of corporations, by the lesser of (a) 10 percent of
the correct tax (or $10,000 if greater) or (b) $10 million),
then a substantial understatement exists and a penalty may be
imposed equal to 20 percent of the underpayment of tax
attributable to the understatement.\374\ Except in the case of
tax shelters,\375\ the amount of any understatement is reduced
by any portion attributable to an item if (1) the treatment of
the item is supported by substantial authority, or (2) facts
relevant to the tax treatment of the item were adequately
disclosed and there was a reasonable basis for its tax
treatment. The Treasury Secretary may prescribe a list of
positions which the Secretary believes do not meet the
requirements for substantial authority under this provision.
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\374\ Sec. 6662.
\375\ A tax shelter is defined for this purpose as a partnership or
other entity, an investment plan or arrangement, or any other plan or
arrangement if a significant purpose of such partnership, other entity,
plan, or arrangement is the avoidance or evasion of Federal income tax.
Sec. 6662(d)(2)(C).
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The section 6662 penalty generally is abated (even with
respect to tax shelters) in cases in which the taxpayer can
demonstrate that there was ``reasonable cause'' for the
underpayment and that the taxpayer acted in good faith.\376\
The relevant regulations provide that reasonable cause exists
where the taxpayer ``reasonably relies in good faith on an
opinion based on a professional tax advisor's analysis of the
pertinent facts and authorities [that] . . . unambiguously
concludes that there is a greater than 50-percent likelihood
that the tax treatment of the item will be upheld if
challenged'' by the IRS.\377\
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\376\ Sec. 6664(c).
\377\ Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec.
1.6664-4(c).
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Listed transactions and reportable avoidance transactions
In general
A separate accuracy-related penalty under section 6662A
applies to ``listed transactions'' and to other ``reportable
transactions'' with a significant tax avoidance purpose
(hereinafter referred to as a ``reportable avoidance
transaction''). The penalty rate and defenses available to
avoid the penalty vary depending on whether the transaction was
adequately disclosed.
Both listed transactions and reportable transactions are
allowed to be described by the Treasury Department under
section 6707A(c), which imposes a penalty for failure
adequately to report such transactions under section 6011. A
reportable transaction is defined as one that the Treasury
Secretary determines is required to be disclosed because it is
determined to have a potential for tax avoidance or
evasion.\378\ A listed transaction is defined as a reportable
transaction which is the same as, or substantially similar to,
a transaction specifically identified by the Secretary as a tax
avoidance transaction for purposes of the reporting disclosure
requirements.\379\
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\378\ Sec. 6707A(c)(1).
\379\ Sec. 6707A(c)(2).
---------------------------------------------------------------------------
Disclosed transactions
In general, a 20-percent accuracy-related penalty is
imposed on any understatement attributable to an adequately
disclosed listed transaction or reportable avoidance
transaction.\380\ The only exception to the penalty is if the
taxpayer satisfies a more stringent reasonable cause and good
faith exception (hereinafter referred to as the ``strengthened
reasonable cause exception''), which is described below. The
strengthened reasonable cause exception is available only if
the relevant facts affecting the tax treatment are adequately
disclosed, there is or was substantial authority for the
claimed tax treatment, and the taxpayer reasonably believed
that the claimed tax treatment was more likely than not the
proper treatment.
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\380\ Sec. 6662A(a).
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Undisclosed transactions
If the taxpayer does not adequately disclose the
transaction, the strengthened reasonable cause exception is not
available (i.e., a strict-liability penalty generally applies),
and the taxpayer is subject to an increased penalty equal to 30
percent of the understatement.\381\ However, a taxpayer will be
treated as having adequately disclosed a transaction for this
purpose if the IRS Commissioner has separately rescinded the
separate penalty under section 6707A for failure to disclose a
reportable transaction.\382\ The IRS Commissioner is authorized
to do this only if the failure does not relate to a listed
transaction and only if rescinding the penalty would promote
compliance and effective tax administration.\383\
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\381\ Sec. 6662A(c).
\382\ Sec. 6664(d).
\383\ Sec. 6707A(d).
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A public entity that is required to pay a penalty for an
undisclosed listed or reportable transaction must disclose the
imposition of the penalty in reports to the SEC for such
periods as the Secretary shall specify. The disclosure to the
SEC applies without regard to whether the taxpayer determines
the amount of the penalty to be material to the reports in
which the penalty must appear; and any failure to disclose such
penalty in the reports is treated as a failure to disclose a
listed transaction. A taxpayer must disclose a penalty in
reports to the SEC once the taxpayer has exhausted its
administrative and judicial remedies with respect to the
penalty (or if earlier, when paid).\384\
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\384\ Sec. 6707A(e).
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Determination of the understatement amount
The penalty is applied to the amount of any
understatement attributable to the listed or reportable
avoidance transaction without regard to other items on the tax
return. For purposes of this provision, the amount of the
understatement is determined as the sum of: (1) the product of
the highest corporate or individual tax rate (as appropriate)
and the increase in taxable income resulting from the
difference between the taxpayer's treatment of the item and the
proper treatment of the item (without regard to other items on
the tax return); \385\ and (2) the amount of any decrease in
the aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item.
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\385\ For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses which would (without regard
to section 1211) be allowed for such year, shall be treated as an
increase in taxable income. Sec. 6662A(b).
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Except as provided in regulations, a taxpayer's treatment
of an item shall not take into account any amendment or
supplement to a return if the amendment or supplement is filed
after the earlier of when the taxpayer is first contacted
regarding an examination of the return or such other date as
specified by the Secretary.\386\
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\386\ Sec. 6662A(e)(3).
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Strengthened reasonable cause exception
A penalty is not imposed under the provision with respect
to any portion of an understatement if it is shown that there
was reasonable cause for such portion and the taxpayer acted in
good faith. Such a showing requires: (1) adequate disclosure of
the facts affecting the transaction in accordance with the
regulations under section 6011; \387\ (2) that there is or was
substantial authority for such treatment; and (3) that the
taxpayer reasonably believed that such treatment was more
likely than not the proper treatment. For this purpose, a
taxpayer will be treated as having a reasonable belief with
respect to the tax treatment of an item only if such belief:
(1) is based on the facts and law that exist at the time the
tax return (that includes the item) is filed; and (2) relates
solely to the taxpayer's chances of success on the merits and
does not take into account the possibility that (a) a return
will not be audited, (b) the treatment will not be raised on
audit, or (c) the treatment will be resolved through settlement
if raised.\388\
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\387\ See the previous discussion regarding the penalty for failing
to disclose a reportable transaction.
\388\ Sec. 6664(d).
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A taxpayer may (but is not required to) rely on an
opinion of a tax advisor in establishing its reasonable belief
with respect to the tax treatment of the item. However, a
taxpayer may not rely on an opinion of a tax advisor for this
purpose if the opinion (1) is provided by a ``disqualified tax
advisor'' or (2) is a ``disqualified opinion.''
Disqualified tax advisor
A disqualified tax advisor is any advisor who: (1) is a
material advisor \389\ and who participates in the
organization, management, promotion or sale of the transaction
or is related (within the meaning of section 267(b) or
707(b)(1)) to any person who so participates; (2) is
compensated directly or indirectly \390\ by a material advisor
with respect to the transaction; (3) has a fee arrangement with
respect to the transaction that is contingent on all or part of
the intended tax benefits from the transaction being sustained;
or (4) as determined under regulations prescribed by the
Secretary, has a disqualifying financial interest with respect
to the transaction.
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\389\ The term ``material advisor'' means any person who provides
any material aid, assistance, or advice with respect to organizing,
managing, promoting, selling, implementing, or carrying out any
reportable transaction, and who derives gross income in excess of
$50,000 in the case of a reportable transaction substantially all of
the tax benefits from which are provided to natural persons ($250,000
in any other case). Sec. 6111(b)(1).
\390\ This situation could arise, for example, when an advisor has
an arrangement or understanding (oral or written) with an organizer,
manager, or promoter of a reportable transaction that such party will
recommend or refer potential participants to the advisor for an opinion
regarding the tax treatment of the transaction.
---------------------------------------------------------------------------
A material advisor is considered as participating in the
``organization'' of a transaction if the advisor performs acts
relating to the development of the transaction. This may
include, for example, preparing documents: (1) establishing a
structure used in connection with the transaction (such as a
partnership agreement); (2) describing the transaction (such as
an offering memorandum or other statement describing the
transaction); or (3) relating to the registration of the
transaction with any federal, state or local government
body.\391\ Participation in the ``management'' of a transaction
means involvement in the decision-making process regarding any
business activity with respect to the transaction.
Participation in the ``promotion or sale'' of a transaction
means involvement in the marketing or solicitation of the
transaction to others. Thus, an advisor who provides
information about the transaction to a potential participant is
involved in the promotion or sale of a transaction, as is any
advisor who recommends the transaction to a potential
participant.
---------------------------------------------------------------------------
\391\ An advisor should not be treated as participating in the
organization of a transaction if the advisor's only involvement with
respect to the organization of the transaction is the rendering of an
opinion regarding the tax consequences of such transaction. However,
such an advisor may be a ``disqualified tax advisor'' with respect to
the transaction if the advisor participates in the management,
promotion or sale of the transaction (or if the advisor is compensated
by a material advisor, has a fee arrangement that is contingent on the
tax benefits of the transaction, or as determined by the Secretary, has
a continuing financial interest with respect to the transaction).
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Disqualified opinion
An opinion may not be relied upon if the opinion: (1) is
based on unreasonable factual or legal assumptions (including
assumptions as to future events); (2) unreasonably relies upon
representations, statements, findings or agreements of the
taxpayer or any other person; (3) does not identify and
consider all relevant facts; or (4) fails to meet any other
requirement prescribed by the Secretary.
Coordination with other penalties
To the extent a penalty on an understatement is imposed
under section 6662A, that same amount of understatement is not
also subject to the accuracy-related penalty under section
6662(a) or to the valuation misstatement penalties under
section 6662(e) or 6662(h). However, such amount of
understatement is included for purposes of determining whether
any understatement (as defined in sec. 6662(d)(2)) is a
substantial understatement as defined under section 6662(d)(1)
and for purposes of identifying an underpayment under the
section 6663 fraud penalty.
The penalty imposed under section 6662A does not apply to
any portion of an understatement to which a fraud penalty is
applied under section 6663.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision imposes a new, stronger
penalty for an understatement attributable to any transaction
that lacks economic substance (referred to in the statute as a
``non-economic substance transaction understatement'').\392\
The penalty rate is 40 percent (reduced to 20 percent if the
taxpayer adequately discloses the relevant facts in accordance
with regulations prescribed under section 6011). No exceptions
(including the reasonable cause or rescission rules) to the
penalty are available (i.e., the penalty is a strict-liability
penalty).
---------------------------------------------------------------------------
\392\ Thus, unlike the present-law accuracy-related penalty under
section 6662A (which applies only to listed and reportable avoidance
transactions), the new penalty under the provision applies to any
transaction that lacks economic substance.
---------------------------------------------------------------------------
A ``non-economic substance transaction'' means any
transaction if (1) the transaction lacks economic substance (as
defined in the Senate amendment provision regarding the
clarification of the economic substance doctrine),\393\ (2) the
transaction was not respected under the rules relating to
transactions with tax-indifferent parties (as described in the
Senate amendment provision regarding the clarification of the
economic substance doctrine),\394\ or (3) any similar rule of
law. For this purpose, a similar rule of law would include, for
example, an understatement attributable to a transaction that
is determined to be a sham transaction.
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\393\ That Senate amendment provision generally provides that in
any case in which a court determines that the economic substance
doctrine is relevant, a transaction has economic substance only if: (1)
the transaction changes in a meaningful way (apart from Federal income
tax effects) the taxpayer's economic position, and (2) the taxpayer has
a substantial non-tax purpose for entering into such transaction and
the transaction is a reasonable means of accomplishing such purpose.
Specific other rules also apply. See ``Explanation of Provision'' for
the immediately preceding Senate amendment provision, ``Clarification
of the economic substance doctrine.''
\394\ That Senate amendment provision provides that the form of a
transaction that involves a tax-indifferent party will not be respected
in certain circumstances. See ``Explanation of Provision'' for the
immediately preceding Senate amendment provision, ``Clarification of
the economic substance doctrine.''
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For purposes of the bill, the calculation of an
``understatement'' is made in the same manner as in the present
law provision relating to accuracy-related penalties for listed
and reportable avoidance transactions (sec. 6662A). Thus, the
amount of the understatement under the provision would be
determined as the sum of (1) the product of the highest
corporate or individual tax rate (as appropriate) and the
increase in taxable income resulting from the difference
between the taxpayer's treatment of the item and the proper
treatment of the item (without regard to other items on the tax
return),\395\ and (2) the amount of any decrease in the
aggregate amount of credits which results from a difference
between the taxpayer's treatment of an item and the proper tax
treatment of such item. In essence, the penalty will apply to
the amount of any understatement attributable solely to a non-
economic substance transaction.
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\395\ For this purpose, any reduction in the excess of deductions
allowed for the taxable year over gross income for such year, and any
reduction in the amount of capital losses that would (without regard to
section 1211) be allowed for such year, would be treated as an increase
in taxable income.
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As in the case of the understatement penalty for
reportable and listed transactions under present law section
6662A(e)(3), except as provided in regulations, the taxpayer's
treatment of an item will not take into account any amendment
or supplement to a return if the amendment or supplement is
filed after the earlier of the date the taxpayer is first
contacted regarding an examination of such return or such other
date as specified by the Secretary.
As in the case of the understatement penalty for
undisclosed reportable transactions under present law section
6707A, a public entity that is required to pay a penalty under
the provision (but in this case, regardless of whether the
transaction was disclosed) must disclose the imposition of the
penalty in reports to the SEC for such periods as the Secretary
shall specify. The disclosure to the SEC applies without regard
to whether the taxpayer determines the amount of the penalty to
be material to the reports in which the penalty must appear,
and any failure to disclose such penalty in the reports is
treated as a failure to disclose a listed transaction. A
taxpayer must disclose a penalty in reports to the SEC once the
taxpayer has exhausted its administrative and judicial remedies
with respect to the penalty (or if earlier, when paid).
Regardless of whether the transaction was disclosed, once
a penalty under the provision has been included in the first
letter of proposed deficiency which allows the taxpayer an
opportunity for administrative review in the IRS Office of
Appeals, the penalty cannot be compromised for purposes of a
settlement without approval of the Commissioner personally.
Furthermore, the IRS is required to keep records summarizing
the application of this penalty and providing a description of
each penalty compromised under the provision and the reasons
for the compromise.
Any understatement on which a penalty is imposed under
the provision will not be subject to the accuracy-related
penalty under section 6662 or under 6662A (accuracy-related
penalties for listed and reportable avoidance transactions).
However, an understatement under the provision is taken into
account for purposes of determining whether any understatement
(as defined in sec. 6662(d)(2)) is a substantial understatement
as defined under section 6662(d)(1). The penalty imposed under
the provision will not apply to any portion of an
understatement to which a fraud penalty is applied under
section 6663.
Effective date.--The provision applies to transactions
entered into after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not contain the Senate
amendment provision.
3. Denial of deduction for interest on underpayments attributable to
noneconomic substance transactions (sec. 413 of the Senate
amendment and sec. 163(m) of the Code)
PRESENT LAW
No deduction for interest is allowed for interest paid or
accrued on any underpayment of tax which is attributable to the
portion of any reportable transaction understatement with
respect to which the relevant facts were not adequately
disclosed.\396\ The Secretary of the Treasury is authorized to
define reportable transactions for this purpose.\397\
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\396\ Sec. 163(m). Under section 6664(d)(2)(A), in such a case of
nondisclosure, the taxpayer also is not entitled to the ``reasonable
cause and good faith'' exception to the section 6662A penalty for a
reportable transaction understatement.
\397\ See the description of present law with respect to the
immediately preceding Senate amendment provision, ``Penalty for
understatements attributable to transactions lacking economic
substance, etc.''
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision extends the disallowance
of interest deductions to interest paid or accrued on any
underpayment of tax which is attributable to any noneconomic
substance underpayment (whether or not disclosed).
Effective date.--The provision applies to transactions
after the date of enactment in taxable years ending after such
date.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
C. Improvements in Efficiency and Safeguards in Internal Revenue
Service Collections
1. Waiver of user fee for installment agreements using automated
withdrawals (sec. 421 of the Senate amendment and sec. 6159 of
the Code)
PRESENT LAW
The Code authorizes the IRS to enter into written
agreements with any taxpayer under which the taxpayer is
allowed to pay taxes owed, as well as interest and penalties,
in installment payments if the IRS determines that doing so
will facilitate collection of the amounts owed.\398\ An
installment agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the period
installment payments are being made, other IRS enforcement
actions (such as levies or seizures) with respect to the taxes
included in that agreement are held in abeyance.
---------------------------------------------------------------------------
\398\ Sec. 6159.
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The IRS charges a user fee if a request for an
installment agreement is approved.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment waives the user fee for installment
agreements in which the parties agree to the use of automated
installment payments (such as automated debits from a bank
account).
Effective date.--The provision is effective with respect
to agreements entered into on or after the date which is 180
days after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Termination of installment agreements (sec. 422 of the Senate
amendment and sec. 6159 of the Code)
PRESENT LAW
The Code authorizes the IRS to enter into written
agreements with any taxpayer under which the taxpayer is
allowed to pay taxes owed, as well as interest and penalties,
in installment payments, if the IRS determines that doing so
will facilitate collection of the amounts owed.\399\ An
installment agreement does not reduce the amount of taxes,
interest, or penalties owed. Generally, during the period
installment payments are being made, other IRS enforcement
actions (such as levies or seizures) with respect to the taxes
included in that agreement are held in abeyance.
---------------------------------------------------------------------------
\399\ Sec. 6159.
---------------------------------------------------------------------------
Under present law, the IRS is permitted to terminate an
installment agreement only if: (1) the taxpayer fails to pay an
installment at the time the payment is due; (2) the taxpayer
fails to pay any other tax liability at the time when such
liability is due; (3) the taxpayer fails to provide a financial
condition update as required by the IRS; (4) the taxpayer
provides inadequate or incomplete information when applying for
an installment agreement; (5) there has been a significant
change in the financial condition of the taxpayer; or (6) the
collection of the tax is in jeopardy.\400\
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\400\ Sec. 6159(b)(2), (3), and (4).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment grants the IRS authority to
terminate installment agreement when a taxpayer fails to timely
make a required Federal tax deposit or fails to timely file a
tax return (including extensions). Under the provision, the IRS
may terminate an installment agreement even if the taxpayer
remained current with payments under the installment agreement.
Effective date.--The provision is effective for failures
occurring on or after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
3. Partial payments required with submissions of offers-in-compromise
(sec. 423 of the Senate amendment and sec. 7122 of the Code)
PRESENT LAW
The IRS has the authority to compromise any civil or
criminal case arising under the internal revenue laws.\401\ In
general, taxpayers initiate this process by making an offer-in-
compromise, which is an offer by the taxpayer to settle an
outstanding tax liability for less than the total amount due.
The IRS currently imposes a user fee of $150 on most offers,
payable upon submission of the offer to the IRS. Taxpayers may
justify their offers on the basis of doubt as to collectibility
or liability or on the basis of effective tax administration.
In general, enforcement action is suspended during the period
that the IRS evaluates an offer. In some instances, it may take
the IRS 12 to 18 months to evaluate an offer.\402\ Taxpayers
are permitted (but not required) to make a deposit with their
offer; if the offer is rejected, the deposit is generally
returned to the taxpayer. There are two general categories
\403\ of offers-in-compromise, lump-sum offers and periodic
payment offers. Taxpayers making lump-sum offers propose to
make one lump-sum payment of a specified dollar amount in
settlement of their outstanding liability. Taxpayers making
periodic payment offers propose to make a series of payments
over time (either short-term or long-term) in settlement of
their outstanding liability.
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\401\ Sec. 7122.
\402\ Olsen v. United States, 326 F. Supp. 2d 184 (D. Mass. 2004).
\403\ The IRS categorizes payment plans with more specificity,
which is generally not significant for purposes of the provision. See
Form 656, Offer in Compromise, page 6 of instruction booklet (revised
July 2004).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision requires a taxpayer to make partial
payments to the IRS while the taxpayer's offer is being
considered by the IRS. For lump-sum offers, taxpayers must make
a down payment of 20 percent of the amount of the offer with
any application. For purposes of this provision, a lump-sum
offer includes single payments as well as payments made in five
or fewer installments. For periodic payment offers, the
provision requires the taxpayer to comply with the taxpayer's
own proposed payment schedule while the offer is being
considered. Offers submitted to the IRS that do not comport
with these payment requirements are returned to the taxpayer as
unprocessable and immediate enforcement action is permitted.
The provision eliminates the user fee requirement for offers
submitted with the appropriate partial payment.
The provision also provides that an offer is deemed
accepted if the IRS does not make a decision with respect to
the offer within two years from the date the offer was
submitted.
The Senate amendment authorizes the Secretary to issue
regulations providing exceptions to the partial payment
requirements in the case of offers from certain low-income
taxpayers and offers based on doubt as to liability.
Effective date.--The provision is effective for offers-
in-compromise submitted on and after the date which is 60 days
after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision, with the following modifications. Under the
conference agreement, any user fee imposed by the IRS for
participation in the offer-in-compromise program must be
submitted with the appropriate partial payment. The user fee is
applied to the taxpayer's outstanding tax liability. In
addition, under the conference agreement, offers submitted to
the IRS that do not comport with the payment requirements may
be returned to the taxpayer as unprocessable.
D. Penalties and Fines
1. Increase in criminal monetary penalty limitation for the
underpayment or overpayment of tax due to fraud (sec. 431 of
the Senate amendment and secs. 7201, 7203, and 7206 of the
Code)
PRESENT LAW
Attempt to evade or defeat tax
In general, section 7201 imposes a criminal penalty on
persons who willfully attempt to evade or defeat any tax
imposed by the Code. Upon conviction, the Code provides that
the penalty is up to $100,000 or imprisonment of not more than
five years (or both). In the case of a corporation, the Code
increases the monetary penalty to a maximum of $500,000.
Willful failure to file return, supply information, or pay tax
In general, section 7203 imposes a criminal penalty on
persons required to make estimated tax payments, pay taxes,
keep records, or supply information under the Code who
willfully fails to do so. Upon conviction, the Code provides
that the penalty is up to $25,000 or imprisonment of not more
than one year (or both). In the case of a corporation, the Code
increases the monetary penalty to a maximum of $100,000.
Fraud and false statements
In general, section 7206 imposes a criminal penalty on
persons who make fraudulent or false statements under the Code.
Upon conviction, the Code provides that the penalty is up to
$100,000 or imprisonment of not more than three years (or
both). In the case of a corporation, the Code increases the
monetary penalty to a maximum of $500,000.
Uniform sentencing guidelines
Under the uniform sentencing guidelines established by 18
U.S.C. 3571, a defendant found guilty of a criminal offense is
subject to a maximum fine that is the greatest of: (a) the
amount specified in the underlying provision, (b) for a felony
\404\ $250,000 for an individual or $500,000 for an
organization, or (c) twice the gross gain if a person derives
pecuniary gain from the offense. This Title 18 provision
applies to all criminal provisions in the United States Code,
including those in the Internal Revenue Code. For example, for
an individual, the maximum fine under present law upon
conviction of violating section 7206 is $250,000 or, if
greater, twice the amount of gross gain from the offense.
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\404\ Section 7206 states that making fraudulent or false
statements under the Code is a felony. In addition, this offense is a
felony pursuant to the classification guidelines of 18 U.S.C.
3559(a)(5).
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HOUSE BILL
No provision.
SENATE AMENDMENT
Attempt to evade or defeat tax
The provision increases the criminal penalty under
section 7201 of the Code for individuals to $500,000 and for
corporations to $1,000,000. The provision increases the maximum
prison sentence to ten years.
Willful failure to file return, supply information, or pay tax
The provision increases the criminal penalty under
section 7203 of the Code for individuals from $25,000 to
$50,000 and, in the case of an ``aggravated failure to file''
(defined as a failure to file a return for a period of three or
more consecutive taxable years if the aggregated tax liability
for such period is at least $100,000), changes the crime from a
misdemeanor to a felony and increases the maximum prison
sentence to ten years.
Fraud and false statements
The provision increases the criminal penalty for making
fraudulent or false statements to $500,000 for individuals and
$1,000,000 for corporations. The provision increases the
maximum prison sentence for making fraudulent or false
statements to five years. The provision provides that in no
event shall the amount of the monetary penalty under the
provision be less than the amount of the underpayment or
overpayment attributable to fraud.
Effective date
The provision is effective for actions and failures to
act occurring after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Doubling of certain penalties, fines, and interest on underpayments
related to certain offshore financial arrangements (sec. 432 of
the Senate amendment)
PRESENT LAW
In general
The Code contains numerous civil penalties, such as the
delinquency, accuracy-related, fraud, and assessable penalties.
These civil penalties are in addition to any interest that may
be due as a result of an underpayment of tax. If all or any
part of a tax is not paid when due, the Code imposes interest
on the underpayment, which is assessed and collected in the
same manner as the underlying tax and is subject to the
respective statutes of limitations for assessment and
collection.
Delinquency penalties
Failure to file.--Under present law, a taxpayer who fails
to file a tax return on a timely basis is generally subject to
a penalty equal to 5 percent of the net amount of tax due for
each month that the return is not filed, up to a maximum of
five months or 25 percent. An exception from the penalty
applies if the failure is due to reasonable cause. In the case
of fraudulent failure to file, the penalty is increased to 15
percent of the net amount of tax due for each month that the
return is not filed, up to a maximum of five months or 75
percent. The net amount of tax due is the excess of the amount
of the tax required to be shown on the return over the amount
of any tax paid on or before the due date prescribed for the
payment of tax.
Failure to pay.--Taxpayers who fail to pay their taxes
are subject to a penalty of 0.5 percent per month on the unpaid
amount, up to a maximum of 25 percent. If a penalty for failure
to file and a penalty for failure to pay tax shown on a return
both apply for the same month, the amount of the penalty for
failure to file for such month is reduced by the amount of the
penalty for failure to pay tax shown on a return. If an income
tax return is filed more than 60 days after its due date, then
the penalty for failure to pay tax shown on a return may not
reduce the penalty for failure to file below the lesser of $100
or 100 percent of the amount required to be shown on the
return. For any month in which an installment payment agreement
with the IRS is in effect, the rate of the penalty is half the
usual rate (0.25 percent instead of 0.5 percent), provided that
the taxpayer filed the tax return in a timely manner (including
extensions).
Failure to make timely deposits of tax.--The penalty for
the failure to make timely deposits of tax consists of a four-
tiered structure in which the amount of the penalty varies with
the length of time within which the taxpayer corrects the
failure. A depositor is subject to a penalty equal to 2 percent
of the amount of the underpayment if the failure is corrected
on or before the date that is five days after the prescribed
due date. A depositor is subject to a penalty equal to 5
percent of the amount of the underpayment if the failure is
corrected after the date that is five days after the prescribed
due date but on or before the date that is 15 days after the
prescribed due date. A depositor is subject to a penalty equal
to 10 percent of the amount of the underpayment if the failure
is corrected after the date that is 15 days after the due date
but on or before the date that is 10 days after the date of the
first delinquency notice to the taxpayer (under sec. 6303).
Finally, a depositor is subject to a penalty equal to 15
percent of the amount of the underpayment if the failure is not
corrected on or before earlier of 10 days after the date of the
first delinquency notice to the taxpayer and 10 days after the
date on which notice and demand for immediate payment of tax is
given in cases of jeopardy.
An exception from the penalty applies if the failure is
due to reasonable cause. In addition, the Secretary may waive
the penalty for an inadvertent failure to deposit any tax by
specified first-time depositors.
Accuracy-related penalties
In general.--The accuracy-related penalties are imposed
at a rate of 20 percent of the portion of any underpayment that
is attributable, in relevant part, to (1) negligence, (2) any
substantial understatement of income tax, (3) any substantial
valuation misstatement, and (4) any reportable transaction
understatement. The penalty for a substantial valuation
misstatement is doubled for certain gross valuation
misstatements. In the case of a reportable transaction
understatement for which the transaction is not disclosed, the
penalty rate is 30 percent. These penalties are coordinated
with the fraud penalty. This statutory structure operates to
eliminate any stacking of the penalties.
No penalty is to be imposed if it is shown that there was
reasonable cause for an underpayment and the taxpayer acted in
good faith, and in the case of a reportable transaction
understatement the relevant facts of the transaction have been
disclosed, there is or was substantial authority for the
taxpayer's treatment of such transaction, and the taxpayer
reasonably believed that such treatment was more likely than
not the proper treatment.
Negligence or disregard for the rules or regulations.--If
an underpayment of tax is attributable to negligence, the
negligence penalty applies only to the portion of the
underpayment that is attributable to negligence. Negligence
means any failure to make a reasonable attempt to comply with
the provisions of the Code. Disregard includes any careless,
reckless, or intentional disregard of the rules or regulations.
Substantial understatement of income tax.--Generally, an
understatement is substantial if the understatement exceeds the
greater of (1) 10 percent of the tax required to be shown on
the return for the tax year, or (2) $5,000. In determining
whether a substantial understatement exists, the amount of the
understatement is reduced by any portion attributable to an
item if (1) the treatment of the item on the return is or was
supported by substantial authority, or (2) facts relevant to
the tax treatment of the item were adequately disclosed on the
return or on a statement attached to the return.
Substantial valuation misstatement.--A penalty applies to
the portion of an underpayment that is attributable to a
substantial valuation misstatement. Generally, a substantial
valuation misstatement exists if the value or adjusted basis of
any property claimed on a return is 200 percent or more of the
correct value or adjusted basis. The amount of the penalty for
a substantial valuation misstatement is 20 percent of the
amount of the underpayment if the value or adjusted basis
claimed is 200 percent or more but less than 400 percent of the
correct value or adjusted basis. If the value or adjusted basis
claimed is 400 percent or more of the correct value or adjusted
basis, then the overvaluation is a gross valuation
misstatement.
Reportable transaction understatement.--A penalty applies
to any item that is attributable to any listed transaction, or
to any reportable transaction (other than a listed transaction)
if a significant purpose of such reportable transaction is tax
avoidance or evasion.
Fraud penalty
The fraud penalty is imposed at a rate of 75 percent of
the portion of any underpayment that is attributable to fraud.
The accuracy-related penalty does not apply to any portion of
an underpayment on which the fraud penalty is imposed.
Assessable penalties
In addition to the penalties described above, the Code
imposes a number of additional penalties, including, for
example, penalties for failure to file (or untimely filing of)
information returns with respect to foreign trusts, and
penalties for failure to disclose any required information with
respect to a reportable transaction.
Interest provisions
Taxpayers are required to pay interest to the IRS
whenever there is an underpayment of tax. An underpayment of
tax exists whenever the correct amount of tax is not paid by
the last date prescribed for the payment of the tax. The last
date prescribed for the payment of the income tax is the
original due date of the return.
Different interest rates are provided for the payment of
interest depending upon the type of taxpayer, whether the
interest relates to an underpayment or overpayment, and the
size of the underpayment or overpayment. Interest on
underpayments is compounded daily.
Offshore Voluntary Compliance Initiative
In January 2003, Treasury announced the Offshore
Voluntary Compliance Initiative (``OVCI'') to encourage the
voluntary disclosure of previously unreported income placed by
taxpayers in offshore accounts and accessed through credit card
or other financial arrangements. A taxpayer had to comply with
various requirements in order to participate in the OVCI,
including sending a written request to participate in the
program by April 15, 2003. This request had to include
information about the taxpayer, the taxpayer's introduction to
the credit card or other financial arrangements and the names
of parties that promoted the transaction. A taxpayer entering
into a closing agreement under the OVCI is not liable for the
civil fraud penalty, the fraudulent failure to file penalty, or
the civil information return penalties. Such a taxpayer is
responsible for back taxes, interest, and certain accuracy-
related and delinquency penalties.\405\
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\405\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
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Voluntary disclosure policy
A taxpayer's timely, voluntary disclosure of a
substantial unreported tax liability has long been an important
factor in deciding whether the taxpayer's case should
ultimately be referred for criminal prosecution. The voluntary
disclosure must be truthful, timely, and complete. The taxpayer
must show a willingness to cooperate (as well as actual
cooperation) with the IRS in determining the correct tax
liability. The taxpayer must make good-faith arrangements with
the IRS to pay in full the tax, interest, and any penalties
determined by the IRS to be applicable. A voluntary disclosure
does not guarantee immunity from prosecution. It creates no
substantive or procedural rights for taxpayers.\406\ The IRS
treats participation in the OVCI as a voluntary
disclosure.\407\
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\406\ Internal Revenue News Release 2002-135, IR-2002-135 (December
11, 2002).
\407\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment doubles the amounts of civil
penalties, interest, and fines related to taxpayers'
underpayments of U.S. income tax liability through the direct
or indirect use of certain offshore financial arrangements. The
provision applies to taxpayers who did not (or do not)
voluntarily disclose such arrangements through the OVCI or
otherwise. Under the Senate amendment, the determination of
whether any civil penalty is to be applied to such underpayment
is made without regard to whether a return has been filed,
whether there was reasonable cause for such underpayment, and
whether the taxpayer acted in good faith.
The proscribed financial arrangements include, but are
not limited to, the use of certain foreign leasing corporations
for providing domestic employee services,\408\ certain
arrangements whereby the taxpayer may hold securities trading
accounts through offshore banks or other financial
intermediaries, certain arrangements whereby the taxpayer may
access funds through the use of offshore credit, debit, or
charge cards, and offshore annuities or trusts.
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\408\ These arrangements were described and classified as listed
transactions in Notice 2003-22, 2003-1 C.B. 851.
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The Secretary of the Treasury is granted the authority to
waive the application of the provision if the use of the
offshore financial arrangements is incidental to the
transaction and, in the case of a trade or business, such use
is conducted in the ordinary course of the type of trade or
business in which the taxpayer is engaged.
Effective date.--The provision generally is effective
with respect to a taxpayer's open tax years on or after the
date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
3. Denial of deduction for certain fines, penalties, and other amounts
(sec. 433 of the Senate Amendment and sec. 162 of the Code)
PRESENT LAW
Under present law, no deduction is allowed as a trade or
business expense under section 162(a) for the payment of a fine
or similar penalty to a government for the violation of any law
(sec. 162(f)). The enactment of section 162(f) in 1969 codified
existing case law that denied the deductibility of fines as
ordinary and necessary business expenses on the grounds that
``allowance of the deduction would frustrate sharply defined
national or State policies proscribing the particular types of
conduct evidenced by some governmental declaration thereof.''
\409\
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\409\ S. Rep. No. 91-552, 91st Cong, 1st Sess., 273-74 (1969),
referring to Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30
(1958).
---------------------------------------------------------------------------
Treasury regulation section 1.162-21(b)(1) provides that
a fine or similar penalty includes an amount: (1) paid pursuant
to conviction or a plea of guilty or nolo contendere for a
crime (felony or misdemeanor) in a criminal proceeding; (2)
paid as a civil penalty imposed by Federal, State, or local
law, including additions to tax and additional amounts and
assessable penalties imposed by chapter 68 of the Code; (3)
paid in settlement of the taxpayer's actual or potential
liability for a fine or penalty (civil or criminal); or (4)
forfeited as collateral posted in connection with a proceeding
which could result in imposition of such a fine or penalty.
Treasury regulation section 1.162-21(b)(2) provides, among
other things, that compensatory damages (including damages
under section 4A of the Clayton Act (15 U.S.C. 15a), as
amended) paid to a government do not constitute a fine or
penalty.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision modifies the rules
regarding the determination whether payments are nondeductible
payments of fines or penalties under section 162(f). In
particular, the provision generally provides that amounts paid
or incurred (whether by suit, agreement, or otherwise) to, or
at the direction of, a government in relation to the violation
of any law or the investigation or inquiry into the potential
violation of any law \410\ are nondeductible under any
provision of the income tax provisions.\411\ The provision
applies to deny a deduction for any such payments, including
those where there is no admission of guilt or liability and
those made for the purpose of avoiding further investigation or
litigation. An exception applies to payments that the taxpayer
establishes are either restitution (including remediation of
property), or amounts required to come into compliance with any
law that was violated or involved in the investigation or
inquiry, and that are identified in the court order or
settlement as restitution, remediation, or required to come
into compliance.\412\ The IRS remains free to challenge the
characterization of an amount so identified; however, no
deduction is allowed unless the identification is made.\413\
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\410\ The provision does not affect amounts paid or incurred in
performing routine audits or reviews such as annual audits that are
required of all organizations or individuals in a similar business
sector, or profession, as a requirement for being allowed to conduct
business. However, if the government or regulator raised an issue of
compliance and a payment is required in settlement of such issue, the
provision would affect that payment.
\411\ The provision provides that such amounts are nondeductible
under chapter 1 of the Internal Revenue Code.
\412\ The provision does not affect the treatment of antitrust
payments made under section 4 of the Clayton Act, which continue to be
governed by the provisions of section 162(g).
\413\ If a settlement agreement does not specify a specific amount
to be paid for the purpose of coming into compliance but instead simply
requires the taxpayer to come into compliance, it is sufficient
identification to so state. Amounts expended by the taxpayer for that
purpose would then be considered identified. However, if an agreement
specifies a specific dollar amount that must be paid or incurred, the
amount would not be eligible to be deducted without a specification
that it is for restitution (including remediation of property), or
coming into compliance.
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An exception also applies to any amount paid or incurred
as taxes due.\414\
---------------------------------------------------------------------------
\414\ Thus, amounts paid or incurred as taxes due are not affected
by the provision (e.g., State taxes that are otherwise deductible). The
reference to taxes due is also intended to include interest with
respect to such taxes (but not interest, if any, with respect to any
penalties imposed with respect to such taxes).
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The provision is intended to apply only where a
government (or other entity treated in a manner similar to a
government under the amendment) is a complainant or
investigator with respect to the violation or potential
violation of any law.\415\
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\415\ Thus, for example, the provision would not apply to payments
made by one private party to another in a lawsuit between private
parties, merely because a judge or jury acting in the capacity as a
court directs the payment to be made. The mere fact that a court enters
a judgment or directs a result in a private dispute does not cause a
payment to be made ``at the direction of a government'' for purposes of
the provision.
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It is intended that a payment will be treated as
restitution (including remediation of property) only if
substantially all of the payment is required to be paid to the
specific persons, or in relation to the specific property,
actually harmed by the conduct of the taxpayer that resulted in
the payment. Thus, a payment to or with respect to a class
substantially broader than the specific persons or property
that were actually harmed (e.g., to a class including similarly
situated persons or property) does not qualify as restitution
or included remediation of property.\416\ Restitution and
included remediation of property is limited to the amount that
bears a substantial quantitative relationship to the harm
caused by the past conduct or actions of the taxpayer that
resulted in the payment in question. If the party harmed is a
government or other entity, then restitution and included
remediation of property includes payment to such harmed
government or entity, provided the payment bears a substantial
quantitative relationship to the harm. However, restitution or
included remediation of property does not include reimbursement
of government investigative or litigation costs, or payments to
whistleblowers.
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\416\ Similarly, a payment to a charitable organization benefiting
a broader class than the persons or property actually harmed, or to be
paid out without a substantial quantitative relationship to the harm
caused, would not qualify as restitution. Under the provision, such a
payment not deductible under section 162 would also not be deductible
under section 170.
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It is intended that a payment will be treated as an
amount required to come into compliance only if it directly
corrects a violation with respect to a particular requirement
of law that was under investigation. For example, if the law
requires a particular emission standard to be met or particular
machinery to be used, amounts required to be paid under a
settlement agreement to meet the required standard or install
the machinery are deductible to the extent otherwise allowed.
Similarly, if the law requires certain practices and procedures
to be followed and a settlement agreement requires the taxpayer
to pay to establish such practices or procedures, such amounts
would be deductible. However, amounts paid for other purposes
not directly correcting a violation of law are not deductible.
For example, amounts paid to bring other machinery that is
already in compliance up to a standard higher than required by
the law, or to create other benefits (such as a park or other
action not previously required by law), are not deductible if
required under a settlement agreement. Similarly, amounts paid
to educate consumers or customers about the risks of doing
business with the taxpayer or about the field in which the
taxpayer does business generally, which education efforts are
not specifically required under the law, are not deductible if
required under a settlement agreement.
The provision requires government agencies to report to
the IRS and to the taxpayer the amount of each settlement
agreement or order entered where the aggregate amount required
to be paid or incurred to or at the direction of the government
under such settlement agreements and orders with respect to the
violation, investigation, or inquiry is least $600 (or such
other amount as may be specified by the Secretary of the
Treasury as necessary to ensure the efficient administration of
the Internal Revenue laws). The reports must be made within 30
days of the date the court order is issued or the settlement
agreement is entered into, or such other time as may be
required by Secretary. The report must separately identify any
amounts that are restitution or remediation of property, or
correction of noncompliance.\417\
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\417\ As in the case of the identification requirement, if the
agreement does not specify a specific amount to be expended to come
into compliance but simply requires that to occur, it is expected that
the report may state simply that the taxpayer is required to come into
compliance but no specific dollar amount has been specified for that
purpose in the settlement agreement.
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The IRS is encouraged to require taxpayers to identify
separately on their tax returns the amounts of any such
settlements with respect to which reporting is required under
the provision, including separate identification of the
nondeductible amount and of any amount deductible as
restitution, remediation, or required to correct
noncompliance.\418\
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\418\ For example, the IRS might require such reporting as part of
the schedule M-3, whether or not the particular amounts create a book-
tax difference.
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Amounts paid or incurred (whether by suit, agreement, or
otherwise) to, or at the direction of, any self-regulatory
entity that regulates a financial market or other market that
is a qualified board or exchange under section 1256(g)(7), and
that is authorized to impose sanctions (e.g., the National
Association of Securities Dealers) are likewise subject to the
provision if paid in relation to a violation, or investigation
or inquiry into a potential violation, of any law (or any rule
or other requirement of such entity). To the extent provided in
regulations, amounts paid or incurred to, or at the direction
of, any other nongovernmental entity that exercises self-
regulatory powers as part of performing an essential
governmental function are similarly subject to the provision.
The exception for payments that the taxpayer establishes are
paid or incurred for restitution, remediation of property, or
coming into compliance and that are identified as such in the
order or settlement agreement likewise applies in these cases.
The requirement of reporting to the IRS and the taxpayer also
applies in these cases.
No inference is intended as to the treatment of payments
as nondeductible fines or penalties under present law. In
particular, the provision is not intended to limit the scope of
present-law section 162(f) or the regulations thereunder.
Effective date.--The provision is effective for amounts
paid or incurred on or after the date of enactment; however the
provision does not apply to amounts paid or incurred under any
binding order or agreement entered into before such date. Any
order or agreement requiring court approval is not a binding
order or agreement for this purpose unless such approval was
obtained before the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not contain the Senate
amendment provision.
4. Denial of deduction for punitive damages (sec. 434 of the Senate
amendment and sec. 162 of the Code)
PRESENT LAW
In general, a deduction is allowed for all ordinary and
necessary expenses that are paid or incurred by the taxpayer
during the taxable year in carrying on any trade or
business.\419\ However, no deduction is allowed for any payment
that is made to an official of any governmental agency if the
payment constitutes an illegal bribe or kickback or if the
payment is to an official or employee of a foreign government
and is illegal under Federal law.\420\ In addition, no
deduction is allowed under present law for any fine or similar
payment made to a government for violation of any law.\421\
Furthermore, no deduction is permitted for two-thirds of any
damage payments made by a taxpayer who is convicted of a
violation of the Clayton antitrust law or any related antitrust
law.\422\
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\419\ Sec. 162(a).
\420\ Sec. 162(c).
\421\ Sec. 162(f).
\422\ Sec. 162(g).
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In general, gross income does not include amounts
received on account of personal physical injuries and physical
sickness.\423\ However, this exclusion does not apply to
punitive damages.\424\
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\423\ Sec. 104(a).
\424\ Sec. 104(a)(2).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision denies any deduction for punitive damages
that are paid or incurred by the taxpayer as a result of a
judgment or in settlement of a claim. If the liability for
punitive damages is covered by insurance, any such punitive
damages paid by the insurer are included in gross income of the
insured person and the insurer is required to report such
amounts to both the insured person and the IRS.
Effective date.--The provision is effective for punitive
damages that are paid or incurred on or after the date of
enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
5. Increase in penalty for bad checks and money orders (sec. 435 of the
Senate amendment and sec. 6657 of the Code)
PRESENT LAW
The Code \425\ imposes a penalty for bad checks and money
orders on the person who tendered it. The penalty is two
percent of the amount of the bad check or money order. For
checks that are less than $750, the minimum penalty is $15 (or,
if less, the amount of the check).
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\425\ Sec. 6657.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision increases the minimum penalty to $25 (or,
if less, the amount of the check), applicable to checks that
are less than $1,250.
Effective date.--The provision is effective with respect
to checks or money orders received after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
E. Provisions to Discourage Expatriation
1. Tax treatment of inverted corporate entities (sec. 441 of the Senate
amendment and sec. 7874 of the Code)
PRESENT LAW
Determination of corporate residence
The U.S. tax treatment of a multinational corporate group
depends significantly on whether the parent corporation of the
group is domestic or foreign. For purposes of U.S. tax law, a
corporation is treated as domestic if it is incorporated under
the law of the United States or of any State. Other
corporations (i.e., those incorporated under the laws of
foreign countries or U.S. possessions) generally are treated as
foreign.
U.S. taxation of domestic corporations
The United States employs a ``worldwide'' tax system,
under which domestic corporations generally are taxed on all
income, whether derived in the United States or abroad. In
order to mitigate the double taxation that may arise from
taxing the foreign-source income of a domestic corporation, a
foreign tax credit for income taxes paid to foreign countries
is provided to reduce or eliminate the U.S. tax owed on such
income, subject to certain limitations.
Income earned by a domestic parent corporation from
foreign operations conducted by foreign corporate subsidiaries
generally is subject to U.S. tax when the income is distributed
as a dividend to the domestic corporation. Until such
repatriation, the U.S. tax on such income generally is
deferred, and U.S. tax is imposed on such income when
repatriated. However, certain anti-deferral regimes may cause
the domestic parent corporation to be taxed on a current basis
in the United States with respect to certain categories of
passive or highly mobile income earned by its foreign
subsidiaries, regardless of whether the income has been
distributed as a dividend to the domestic parent corporation.
The main anti-deferral regimes in this context are the
controlled foreign corporation rules of subpart F (secs. 951-
964) and the passive foreign investment company rules (secs.
1291-1298). A foreign tax credit is generally available to
offset, in whole or in part, the U.S. tax owed on this foreign-
source income, whether such income is repatriated as an actual
dividend or included under one of the anti-deferral regimes.
U.S. taxation of foreign corporations
The United States taxes foreign corporations only on
income that has a sufficient nexus to the United States. Thus,
a foreign corporation is generally subject to U.S. tax only on
income that is ``effectively connected'' with the conduct of a
trade or business in the United States. Such ``effectively
connected income'' generally is taxed in the same manner and at
the same rates as the income of a U.S. corporation. An
applicable tax treaty may limit the imposition of U.S. tax on
business operations of a foreign corporation to cases in which
the business is conducted through a ``permanent establishment''
in the United States.
In addition, foreign corporations generally are subject
to a gross-basis U.S. tax at a flat 30-percent rate on the
receipt of interest, dividends, rents, royalties, and certain
similar types of income derived from U.S. sources, subject to
certain exceptions. The tax generally is collected by means of
withholding by the person making the payment. This tax may be
reduced or eliminated under an applicable tax treaty.
U.S. tax treatment of inversion transactions prior to the American Jobs
Creation Act of 2004
Prior to the American Jobs Creation Act of 2004
(``AJCA''), a U.S. corporation could reincorporate in a foreign
jurisdiction and thereby replace the U.S. parent corporation of
a multinational corporate group with a foreign parent
corporation. These transactions were commonly referred to as
inversion transactions. Inversion transactions could take many
different forms, including stock inversions, asset inversions,
and various combinations of and variations on the two. Most of
the known transactions were stock inversions. In one example of
a stock inversion, a U.S. corporation forms a foreign
corporation, which in turn forms a domestic merger subsidiary.
The domestic merger subsidiary then merges into the U.S.
corporation, with the U.S. corporation surviving, now as a
subsidiary of the new foreign corporation. The U.S.
corporation's shareholders receive shares of the foreign
corporation and are treated as having exchanged their U.S.
corporation shares for the foreign corporation shares. An asset
inversion could be used to reach a similar result, but through
a direct merger of the top-tier U.S. corporation into a new
foreign corporation, among other possible forms. An inversion
transaction could be accompanied or followed by further
restructuring of the corporate group. For example, in the case
of a stock inversion, in order to remove income from foreign
operations from the U.S. taxing jurisdiction, the U.S.
corporation could transfer some or all of its foreign
subsidiaries directly to the new foreign parent corporation or
other related foreign corporations.
In addition to removing foreign operations from U.S.
taxing jurisdiction, the corporate group could seek to derive
further advantage from the inverted structure by reducing U.S.
tax on U.S.-source income through various earnings stripping or
other transactions. This could include earnings stripping
through payment by a U.S. corporation of deductible amounts
such as interest, royalties, rents, or management service fees
to the new foreign parent or other foreign affiliates. In this
respect, the post-inversion structure could enable the group to
employ the same tax-reduction strategies that are available to
other multinational corporate groups with foreign parents and
U.S. subsidiaries, subject to the same limitations (e.g., secs.
163(j) and 482).
Inversion transactions could give rise to immediate U.S.
tax consequences at the shareholder and/or the corporate level,
depending on the type of inversion. In stock inversions, the
U.S. shareholders generally recognized gain (but not loss)
under section 367(a), based on the difference between the fair
market value of the foreign corporation shares received and the
adjusted basis of the domestic corporation stock exchanged. To
the extent that a corporation's share value had declined, and/
or it had many foreign or tax-exempt shareholders, the impact
of this section 367(a) ``toll charge'' was reduced. The
transfer of foreign subsidiaries or other assets to the foreign
parent corporation also could give rise to U.S. tax
consequences at the corporate level (e.g., gain recognition and
earnings and profits inclusions under secs. 1001, 311(b), 304,
367, 1248 or other provisions). The tax on any income
recognized as a result of these restructurings could be reduced
or eliminated through the use of net operating losses, foreign
tax credits, and other tax attributes.
In asset inversions, the U.S. corporation generally
recognized gain (but not loss) under section 367(a) as though
it had sold all of its assets, but the shareholders generally
did not recognize gain or loss, assuming the transaction met
the requirements of a reorganization under section 368.
U.S. tax treatment of inversion transactions under AJCA
In general
AJCA added new section 7874 to the Code, which defines
two different types of corporate inversion transactions and
establishes a different set of consequences for each type.
Certain partnership transactions also are covered.
Transactions involving at least 80 percent identity of
stock ownership
The first type of inversion is a transaction in which,
pursuant to a plan \426\ or a series of related transactions:
(1) a U.S. corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all of
its properties to such an entity in a transaction completed
after March 4, 2003; (2) the former shareholders of the U.S.
corporation hold (by reason of holding stock in the U.S.
corporation) 80 percent or more (by vote or value) of the stock
of the foreign-incorporated entity after the transaction; and
(3) the foreign-incorporated entity, considered together with
all companies connected to it by a chain of greater than 50
percent ownership (i.e., the ``expanded affiliated group''),
does not have substantial business activities in the entity's
country of incorporation, compared to the total worldwide
business activities of the expanded affiliated group. The
provision denies the intended tax benefits of this type of
inversion by deeming the top-tier foreign corporation to be a
domestic corporation for all purposes of the Code.\427\
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\426\ Acquisitions with respect to a domestic corporation or
partnership are deemed to be ``pursuant to a plan'' if they occur
within the four-year period beginning on the date which is two years
before the ownership threshold under the provision is met with respect
to such corporation or partnership.
\427\ Since the top-tier foreign corporation is treated for all
purposes of the Code as domestic, the shareholder-level ``toll charge''
of sec. 367(a) does not apply to these inversion transactions.
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In determining whether a transaction meets the definition
of an inversion under the provision, stock held by members of
the expanded affiliated group that includes the foreign
incorporated entity is disregarded. For example, if the former
top-tier U.S. corporation receives stock of the foreign
incorporated entity (e.g., so-called ``hook'' stock), the stock
would not be considered in determining whether the transaction
meets the definition. Similarly, if a U.S. parent corporation
converts an existing wholly owned U.S. subsidiary into a new
wholly owned controlled foreign corporation, the stock of the
new foreign corporation would be disregarded, with the result
that the transaction would not meet the definition of an
inversion under the provision. Stock sold in a public offering
related to the transaction also is disregarded for these
purposes.
Transfers of properties or liabilities as part of a plan
a principal purpose of which is to avoid the purposes of the
provision are disregarded. In addition, the Treasury Secretary
is to provide regulations to carry out the provision, including
regulations to prevent the avoidance of the purposes of the
provision, including avoidance through the use of related
persons, pass-through or other noncorporate entities, or other
intermediaries, and through transactions designed to qualify or
disqualify a person as a related person or a member of an
expanded affiliated group. Similarly, the Treasury Secretary
has the authority to treat certain non-stock instruments as
stock, and certain stock as not stock, where necessary to carry
out the purposes of the provision.
Transactions involving at least 60 percent but less than 80
percent identity of stock ownership
The second type of inversion is a transaction that would
meet the definition of an inversion transaction described
above, except that the 80-percent ownership threshold is not
met. In such a case, if at least a 60-percent ownership
threshold is met, then a second set of rules applies to the
inversion. Under these rules, the inversion transaction is
respected (i.e., the foreign corporation is treated as
foreign), but any applicable corporate-level ``toll charges''
for establishing the inverted structure are not offset by tax
attributes such as net operating losses or foreign tax credits.
Specifically, any applicable corporate-level income or gain
required to be recognized under sections 304, 311(b), 367,
1001, 1248, or any other provision with respect to the transfer
of controlled foreign corporation stock or the transfer or
license of other assets by a U.S. corporation as part of the
inversion transaction or after such transaction to a related
foreign person is taxable, without offset by any tax attributes
(e.g., net operating losses or foreign tax credits). This rule
does not apply to certain transfers of inventory and similar
property. These measures generally apply for a 10-year period
following the inversion transaction.
Other rules
Under section 7874, inversion transactions include
certain partnership transactions. Specifically, the provision
applies to transactions in which a foreign-incorporated entity
acquires substantially all of the properties constituting a
trade or business of a domestic partnership, if after the
acquisition at least 60 percent (or 80 percent, as the case may
be) of the stock of the entity is held by former partners of
the partnership (by reason of holding their partnership
interests), provided that the other terms of the basic
definition are met. For purposes of applying this test, all
partnerships that are under common control within the meaning
of section 482 are treated as one partnership, except as
provided otherwise in regulations. In addition, the modified
``toll charge'' rules apply at the partner level.
A transaction otherwise meeting the definition of an
inversion transaction is not treated as an inversion
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more
than half of the properties held directly or indirectly by the
domestic corporation, or more than half of the properties
constituting the partnership trade or business, as the case may
be.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment makes several changes to the
inversions regime of section 7874. First, the provision applies
the rules of section 7874 to transactions completed after March
20, 2002 (as opposed to March 4, 2003 under present law). A
transaction otherwise meeting the definition of an inversion
transaction under the provision is not treated as an inversion
transaction if, on or before March 20, 2002, the foreign-
incorporated entity had acquired directly or indirectly more
than half the properties held directly or indirectly by the
domestic corporation, or more than half the properties
constituting the partnership trade or business, as the case may
be.
The Senate amendment also lowers the present-law 60-
percent ownership threshold for the second category of
inversion transactions to greater-than-50-percent, and
increases the accuracy-related penalties and tightens the
earnings stripping rules of section 163(j) with respect to
companies involved in this type of transaction. Specifically,
the 20-percent penalty for negligence or disregard of rules or
regulations, substantial understatement of income tax, and
substantial valuation misstatement is increased to 30 percent
with respect to the inverting entity and taxpayers related to
the inverting entity, and the 40-percent penalty for gross
valuation misstatement is increased to 50 percent with respect
to such taxpayers. In applying section 163(j) to taxpayers
related to the inverted entity, the generally applicable debt-
equity threshold is eliminated, and the 50-percent thresholds
for ``excess interest expense'' and ``excess limitation'' are
lowered to 25 percent.
The Senate amendment also excludes from the inversions
regime the acquisition of a U.S. corporation in cases in which
none of the stock of the U.S. corporation was readily tradable
on an established securities market at any time during the
four-year period ending on the date of the acquisition, except
as provided in regulations.
Effective date.--The provision in the Senate amendment is
effective for taxable years ending after March 20, 2002.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Revision of tax rules on expatriation of individuals (sec. 442 of
the Senate amendment and secs. 102, 877, 2107, 2501, 7701, and
6039G of the Code)
PRESENT LAW
In general
U.S. citizens and residents generally are subject to U.S.
income taxation on their worldwide income. The U.S. tax may be
reduced or offset by a credit allowed for foreign income taxes
paid with respect to foreign source income. Nonresident aliens
are taxed at a flat rate of 30 percent (or a lower treaty rate)
on certain types of passive income derived from U.S. sources,
and at regular graduated rates on net profits derived from a
U.S. trade or business. The estates of nonresident aliens
generally are subject to estate tax on U.S.-situated property
(e.g., real estate and tangible property located within the
United States and stock in a U.S. corporation). Nonresident
aliens generally are subject to gift tax on transfers by gift
of U.S.-situated property (e.g., real estate and tangible
property located within the United States), but excluding
intangibles, such as stock, regardless of where they are
located.
Income tax rules with respect to expatriates
For the 10 taxable years after an individual relinquishes
his or her U.S. citizenship or terminates his or her U.S. long-
term residency, unless certain conditions are met, the
individual is subject to an alternative method of income
taxation than that generally applicable to nonresident aliens
(the ``alternative tax regime''). Generally, the individual is
subject to income tax for the 10-year period at the rates
applicable to U.S. citizens, but only on U.S.-source
income.\428\
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\428\ For this purpose, however, U.S.-source income has a broader
scope than it does typically in the Code.
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A ``long-term resident'' is a noncitizen who is a lawful
permanent resident of the United States for at least eight
taxable years during the period of 15 taxable years ending with
the taxable year during which the individual either ceases to
be a lawful permanent resident of the United States or
commences to be treated as a resident of a foreign country
under a tax treaty between such foreign country and the United
States (and does not waive such benefits).
A former citizen or former long-term resident is subject
to the alternative tax regime for a 10-year period following
citizenship relinquishment or residency termination, unless the
former citizen or former long-term resident: (1) establishes
that his or her average annual net income tax liability for the
five preceding years does not exceed $124,000 (adjusted for
inflation after 2004) and his or her net worth is less than $2
million, or alternatively satisfies limited, objective
exceptions for certain dual citizens and minors who have had no
substantial contacts with the United States; and (2) certifies
under penalties of perjury that he or she has complied with all
U.S. Federal tax obligations for the preceding five years and
provides such evidence of compliance as the Secretary of the
Treasury may require.
Anti-abuse rules are provided to prevent the
circumvention of the alternative tax regime.
Estate tax rules with respect to expatriates
Special estate tax rules apply to individuals who die
during a taxable year in which he or she is subject to the
alternative tax regime. Under these special rules, certain
closely-held foreign stock owned by the former citizen or
former long-term resident is includible in his or her gross
estate to the extent that the foreign corporation owns U.S.-
situated assets. The special rules apply if, at the time of
death: (1) the former citizen or former long-term resident
directly or indirectly owns 10 percent or more of the total
combined voting power of all classes of stock entitled to vote
of the foreign corporation; and (2) directly or indirectly, is
considered to own more than 50 percent of (a) the total
combined voting power of all classes of stock entitled to vote
in the foreign corporation, or (b) the total value of the stock
of such corporation. If this stock ownership test is met, then
the gross estate of the former citizen or former long-term
resident includes that proportion of the fair market value of
the foreign stock owned by the individual at the time of death,
which the fair market value of any assets owned by such foreign
corporation and situated in the United States (at the time of
death) bears to the total fair market value of all assets owned
by such foreign corporation (at the time of death).
Gift tax rules with respect to expatriates
Special gift tax rules apply to individuals who make
gifts during a taxable year in which he or she is subject to
the alternative tax regime. The individual is subject to gift
tax on gifts of U.S.-situated intangibles made during the 10
years following citizenship relinquishment or residency
termination. In addition, gifts of stock of certain closely-
held foreign corporations by a former citizen or former long-
term resident are subject to gift tax, if the gift is made
during the time that such person is subject to the alternative
tax regime. The operative rules with respect to these gifts of
closely-held foreign stock are the same as described above
relating to the estate tax, except that the relevant testing
and valuation date is the date of gift rather than the date of
death.
Termination of U.S. citizenship or long-term resident status for U.S.
Federal income tax purposes
An individual continues to be treated as a U.S. citizen
or long-term resident for U.S. Federal tax purposes, including
for purposes of section 7701(b)(10), until the individual: (1)
gives notice of an expatriating act or termination of residency
(with the requisite intent to relinquish citizenship or
terminate residency) to the Secretary of State or the Secretary
of Homeland Security, respectively; and (2) provides a
statement to the Secretary of the Treasury in accordance with
section 6039G.
Sanction for individuals subject to the individual tax regime who
return to the United States for extended periods
The alternative tax regime does not apply to any
individual for any taxable year during the 10-year period
following citizenship relinquishment or residency termination
if such individual is present in the United States for more
than 30 days in the calendar year ending in such taxable year.
Such individual is treated as a U.S. citizen or resident for
such taxable year and, therefore, is taxed on his or her
worldwide income.
Similarly, if an individual subject to the alternative
tax regime is present in the United States for more than 30
days in any calendar year ending during the 10-year period
following citizenship relinquishment or residency termination,
and the individual dies during that year, he or she is treated
as a U.S. resident, and the individual's worldwide estate is
subject to U.S. estate tax. Likewise, if an individual subject
to the alternative tax regime is present in the United States
for more than 30 days in any year during the 10-year period
following citizenship relinquishment or residency termination,
the individual is subject to U.S. gift tax on any transfer of
his or her worldwide assets by gift during that taxable year.
For purposes of these rules, an individual is treated as
present in the United States on any day if such individual is
physically present in the United States at any time during that
day. The present-law exceptions from being treated as present
in the United States for residency purposes \429\ generally do
not apply for this purpose. However, for individuals with
certain ties to countries other than the United States \430\
and individuals with minimal prior physical presence in the
United States,\431\ a day of physical presence in the United
States is disregarded if the individual is performing services
in the United States on such day for an unrelated employer
(within the meaning of sections 267 and 707(b)), who meets the
requirements the Secretary of the Treasury may prescribe in
regulations. No more than 30 days may be disregarded during any
calendar year under this rule.
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\429\ Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
\430\ An individual has such a relationship to a foreign country if
(1) the individual becomes a citizen or resident of the country in
which the individual was born, such individual's spouse was born, or
either of the individual's parents was born, and (2) the individual
becomes fully liable for income tax in such country.
\431\ An individual has a minimal prior physical presence in the
United States if the individual was physically present for no more than
30 days during each year in the ten-year period ending on the date of
loss of United States citizenship or termination of residency. However,
for purposes of this test, an individual is not treated as being
present in the United States on a day if the individual remained in the
United States because of a medical condition that arose while the
individual was in the United States. Sec. 7701(b)(3)(D)(ii).
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Annual return
Former citizens and former long-term residents are
required to file an annual return for each year following
citizenship relinquishment or residency termination in which
they are subject to the alternative tax regime. The annual
return is required even if no U.S. Federal income tax is due.
The annual return requires certain information, including
information on the permanent home of the individual, the
individual's country of residence, the number of days the
individual was present in the United States for the year, and
detailed information about the individual's income and assets
that are subject to the alternative tax regime. This
requirement includes information relating to foreign stock
potentially subject to the special estate and gift tax rules.
If the individual fails to file the statement in a timely
manner or fails correctly to include all the required
information, the individual is required to pay a penalty of
$10,000. The $10,000 penalty does not apply if it is shown that
the failure is due to reasonable cause and not to willful
neglect.
HOUSE BILL
No provision.
SENATE AMENDMENT
In general
The Senate amendment creates new section 877A, that
generally subjects certain U.S. citizens who relinquish their
U.S. citizenship and certain long-term U.S. residents who
terminate their U.S. residence to tax on the net unrealized
gain in their property as if such property were sold for fair
market value on the day before the expatriation or residency
termination (``mark-to-market tax''). Gain from the deemed sale
is taken into account at that time without regard to other Code
provisions. Any loss from the deemed sale generally is taken
into account to the extent otherwise provided in the Code,
except that the wash sale rules of section 1091 do not apply.
Any net gain on the deemed sale, is recognized to the extent it
exceeds $600,000 ($1.2 million in the case of married
individuals filing a joint return, both of whom relinquish
citizenship or terminate residency). The $600,000 amount is
increased by a cost of living adjustment factor for calendar
years after 2005.
Individuals covered
Under the Senate amendment, the mark-to-market tax
applies to U.S. citizens who relinquish citizenship and long-
term residents who terminate U.S. residency (collectively,
``covered expatriates''). The definition of ``long-term
resident'' under the provision is the same as that under
present law. As under present law, an individual is considered
to terminate long-term residency when the individual either
ceases to be a lawful permanent resident (i.e., loses his or
her green card status), or is treated as a resident of another
country under a tax treaty and does not waive the benefits of
the treaty.
Exceptions to an individual's classification as a covered
expatriate are provided in two situations. The first exception
applies to an individual who was born with citizenship both in
the United States and in another country; provided that (1) as
of the expatriation date the individual continues to be a
citizen of, and is taxed as a resident of, such other country,
and (2) the individual was not a resident of the United States
for the five taxable years ending with the year of
expatriation. The second exception applies to a U.S. citizen
who relinquishes U.S. citizenship before reaching age 18\1/2\,
provided that the individual was a resident of the United
States for no more than five taxable years before such
relinquishment.
For purposes of the mark-to-market tax, an individual is
treated as having relinquished U.S. citizenship on the earliest
of four possible dates: (1) the date that the individual
renounces U.S. nationality before a diplomatic or consular
officer of the United States (provided that the voluntary
relinquishment is later confirmed by the issuance of a
certificate of loss of nationality); (2) the date that the
individual furnishes to the State Department a signed statement
of voluntary relinquishment of U.S. nationality confirming the
performance of an expatriating act (again, provided that the
voluntary relinquishment is later confirmed by the issuance of
a certificate of loss of nationality); (3) the date that the
State Department issues a certificate of loss of nationality;
or (4) the date that a U.S. court cancels a naturalized
citizen's certificate of naturalization.
In addition, the provision provides that, for all tax
purposes (i.e., not limited to the mark-to-market tax), a U.S.
citizen continues to be treated as a U.S. citizen for tax
purposes until that individual's citizenship is treated as
relinquished under the rules of the immediately preceding
paragraph. However, under Treasury regulations, relinquishment
may occur earlier with respect to an individual who became at
birth a citizen of the United Sates and of another country.
Election to be treated as a U.S. citizen
Under the provision, a covered expatriate is permitted to
make an irrevocable election to continue to be taxed as a U.S.
citizen with respect to all property that otherwise is covered
by the expatriation tax. This election is an ``all or nothing''
election; an individual is not permitted to elect this
treatment for some property but not for other property. The
election, if made, applies to all property that would be
subject to the expatriation tax and to any property the basis
of which is determined by reference to such property. Under
this election, following expatriation the individual continues
to pay U.S. income taxes at the rates applicable to U.S.
citizens on any income generated by the property and on any
gain realized on the disposition of the property. In addition,
the property continues to be subject to U.S. gift, estate, and
generation-skipping transfer taxes. In order to make this
election, the taxpayer is required to waive any treaty rights
that would preclude the collection of the tax.
The individual is also required to provide security to
ensure payment of the tax under this election in such form,
manner, and amount as the Secretary of the Treasury requires.
The amount of mark-to-market tax that would have been owed but
for this election (including any interest, penalties, and
certain other items) becomes a lien in favor of the United
States on all U.S.-situated property owned by the individual.
This lien arises on the expatriation date and continues until
the tax liability is satisfied, the tax liability has become
unenforceable by reason of lapse of time, or the Secretary of
the Treasury is satisfied that no further tax liability may
arise by reason of this provision. The rules of section
6324A(d)(1), (3), and (4) (relating to liens arising in
connection with the deferral of estate tax under section 6166)
apply to liens arising under this provision.
Deemed sale of property upon expatriation or residency termination and
tentative tax
The deemed sale rule of the provision generally applies
to all property interests held by the individual on the date of
relinquishment of citizenship or termination of residency.
Special rules apply in the case of trust interests, as
described below. U.S. real property interests (which remain
subject to U.S. tax in the hands of nonresident noncitizens),
with the exception of stock of certain former U.S. real
property holding corporations, are exempted from the provision.
Regulatory authority is granted to the Treasury to exempt other
types of property from the provision.
Under the provision, an individual who is subject to the
mark-to-market tax is required to pay a tentative tax equal to
the amount of tax that would be due for a hypothetical short
tax year ending on the date the individual relinquishes
citizenship or terminates residency. Thus, the tentative tax is
based on all income, gains, deductions, losses, and credits of
the individual for the year through such date, including
amounts realized from the deemed sale of property. Moreover,
notwithstanding any other provision of the Code, any period
during which recognition of income or gain had been deferred
terminates on the day before relinquishment of citizenship or
termination of residency (and, therefore, such income or gain
recognition becomes part of the tax base of the tentative tax).
The tentative tax is due on the 90th day after the date of
relinquishment of citizenship or termination of residency,
subject to the election, described below, to defer payments of
the mark-to-market tax. In addition, notwithstanding any other
provision of the Code, any extension of time for payment of tax
ceases to apply on the day before relinquishment of citizenship
or termination of residency, and the unpaid portion of such tax
becomes due and payable at the time and in the manner
prescribed by the Secretary of the Treasury.
Deferral of payment of mark-to-market tax
Under the provision, an individual is permitted to elect
to defer payment of the mark-to-market tax imposed on the
deemed sale of property. Interest is charged for the period the
tax is deferred at a rate two percentage points higher than the
rate normally applicable to individual underpayments. The
election is irrevocable and is made on a property-by-property
basis. Under the election, the deferred tax attributable to a
particular property is due when the property is disposed of
(or, if the property is disposed of in a transaction in which
gain is not recognized in whole or in part, at such other time
as the Secretary of the Treasury may prescribe). The deferred
tax attributable to a particular property is an amount that
bears the same ratio to the total mark-to-market tax as the
gain taken into account with respect to such property bears to
the total gain taken into account under these rules. The
deferral of the mark-to-market tax may not be extended beyond
the due date of the return for the taxable year which includes
the individual's death.
In order to elect deferral of the mark-to-market tax, the
individual is required to provide a bond in the amount of the
deferred tax to the Secretary of the Treasury. Other security
mechanisms are permitted provided that the individual
establishes to the satisfaction of the Secretary of the
Treasury that the security is adequate. In the event that the
security provided with respect to a particular property
subsequently becomes inadequate and the individual fails to
correct the situation, the deferred tax and the interest with
respect to such property will become due. As a further
condition to making the election, the individual is required to
consent to the waiver of any treaty rights that would preclude
the collection of the tax.
The deferred tax amount (including any interest,
penalties, and certain other items) becomes a lien in favor of
the United States on all U.S.-situated property owned by the
individual. This lien arises on the expatriation date and
continues until the tax liability is satisfied, the tax
liability has become unenforceable by reason of lapse of time,
or the Secretary is satisfied that no further tax liability may
arise by reason of this provision. The rules of section
6324A(d)(1), (3), and (4) (relating to liens arising in
connection with the deferral of estate tax under section 6166)
apply to such liens.
Retirement plans and similar arrangements
Subject to certain exceptions, the provision applies to
all property interests held by covered expatriates at the time
of relinquishment of citizenship or termination of residency.
Accordingly, such property includes an interest in an employer-
sponsored qualified plan or deferred compensation arrangement
as well as an interest in an individual retirement account or
annuity (i.e., an IRA).\432\ However, the provision contains a
special rule for an interest in a ``retirement plan.'' For
purposes of the provision, a ``retirement plan'' includes an
employer-sponsored qualified plan (sec. 401(a)), a qualified
annuity (sec. 403(a)), a tax-sheltered annuity (sec. 403(b)),
an eligible deferred compensation plan of a governmental
employer (sec. 457(b)), an individual retirement account (sec.
408(a)), and an individual retirement annuity (sec. 408(b)).
The special retirement plan rule also applies, to the extent
provided in regulations, to any foreign plan or similar
retirement arrangement or program. An interest in a trust that
is part of a retirement plan is subject to the special
retirement plan rules and not to the rules for interests in
trusts (discussed below).
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\432\ Application of the provision is not limited to an interest
that meets the definition of property under section 83 (relating to
property transferred in connection with the performance of services).
---------------------------------------------------------------------------
Under the special retirement plan rules, in lieu of the
deemed sale rule, an amount equal to the present value of the
individual's vested, accrued benefit under a retirement plan is
treated as having been received by the individual as a
distribution under the retirement plan on the day before the
individual's relinquishment of citizenship or termination of
residency. In the case of any later distribution to the
individual from the retirement plan, the amount otherwise
includible in the individual's income as a result of the
distribution is reduced to reflect the amount previously
included in income under the special retirement plan rule. The
amount of the reduction applied to a distribution is the excess
of: (1) the amount included in income under the special
retirement plan rule, over (2) the total reductions applied to
any prior distributions. It is not intended that the retirement
plan would be deemed to have made a distribution at the time of
expatriation for purposes of the tax-favored status of the
retirement plan, such as whether a plan may permit
distributions before a participant has severed employment.
However, the retirement plan, and any person acting on the
plan's behalf, will treat any later distribution in the same
manner as the distribution would be treated without regard to
the special retirement plan rule.
It is expected that the Treasury Department will provide
guidance for determining the present value of an individual's
vested, accrued benefit under a retirement plan, such as the
individual's account balance in the case of a defined
contribution plan or an IRA, or present value determined under
the qualified joint and survivor annuity rules applicable to a
defined benefit plan (sec. 417(e)).
Interests in trusts
Detailed rules apply under the provision to trust
interests held by an individual at the time of relinquishment
of citizenship or termination of residency. The treatment of
trust interests depends on whether the trust is a ``qualified
trust.'' A trust is a qualified trust if a court within the
United States is able to exercise primary supervision over the
administration of the trust and one or more U.S. persons have
the authority to control all substantial decisions of the
trust.
Constructive ownership rules apply to a trust beneficiary
that is a corporation, partnership, trust, or estate. In such
cases, the shareholders, partners, or beneficiaries of the
entity are deemed to be the direct beneficiaries of the trust.
In addition, an individual who holds (or who is treated as
holding) a trust instrument at the time of relinquishment of
citizenship or termination of residency is required to disclose
on his or her tax return the methodology used to determine his
or her interest in the trust, and whether such individual knows
(or has reason to know) that any other beneficiary of the trust
uses a different method.
Nonqualified trusts.--If an individual holds an interest
in a trust that is not a qualified trust, a special rule
applies for purposes of determining the amount of the mark-to-
market tax due with respect to such trust interest. The
individual's interest in the trust is treated as a separate
trust consisting of the trust assets allocable to such
interest. Such separate trust is treated as having sold its net
assets for their fair market value on the day before the date
of relinquishment of citizenship or termination of residency
and having distributed the assets to the individual, who then
is treated as having recontributed the assets to the trust. Any
income, gain, or loss of the individual arising from the deemed
distribution from the trust is taken into account as if it had
arisen under the deemed sale rules.
The election to defer payment is available for the mark-
to-market tax attributable to a nonqualified trust interest. A
beneficiary's interest in a nonqualified trust is determined
under all the facts and circumstances, including the trust
instrument, letters of wishes, historical patterns of trust
distributions, and the existence of, and function performed by,
a trust protector or any similar advisor.
Qualified trusts.--If an individual has an interest in a
qualified trust, the amount of mark-to-market tax on unrealized
gain allocable to the individual's trust interest (``allocable
expatriation gain'') is calculated at the time of expatriation
or residency termination, but is collected as the individual
receives distributions from the qualified trust. The allocable
expatriation gain is the amount of gain which would be
allocable to the individual's trust interest if the individual
directly held all the assets allocable to such interest.\433\
If any individual's interest in a trust is vested as of the day
before the expatriation date (e.g., if the individual's
interest in the trust is non-contingent and non-discretionary),
the gain allocable to the individual's trust interest is
determined based on the trust assets allocable to his or her
trust interest. If the individual's interest in the trust is
not vested as of the expatriation date (e.g., if the
individual's trust interest is a contingent or discretionary
interest), the gain allocable to his or her trust interest is
determined based on all of the trust assets that could be
allocable to his or her trust interest, determined by resolving
all contingencies and discretionary powers in the individual's
favor (i.e., the individual is allocated the maximum amount
that he or she could receive).
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\433\ Allocable expatriation gain is subject to the $600,000
exemption (adjusted for cost of living increases).
---------------------------------------------------------------------------
Taxes are imposed on each distribution from a qualified
trust. These distributions also may be subject to other U.S.
income taxes. If a distribution from a qualified trust is made
after the individual relinquishes citizenship or terminates
residency, the mark-to-market tax is imposed in an amount equal
to the amount of the distribution multiplied by the highest tax
rate generally applicable to trusts and estates for the taxable
year which includes the date of expatriation, but in no event
will the tax imposed exceed the balance in the ``deferred tax
account'' with respect to the trust interest. For this purpose,
the balance in the deferred tax account is equal to (1) the
hypothetical tax calculated under the ``regular'' deemed sale
rules with respect to the allocable expatriation gain, (2)
increased by interest charged on the balance in the deferred
tax account at a rate two percentage points higher than the
rate normally applicable to individual underpayments, for
periods beginning after the 90th day after the expatriation
date and calculated up to 30 days prior to the date of the
distribution, (3) reduced by any mark-to-market tax imposed on
prior trust distributions to the individual, and (4) to the
extent provided in Treasury regulations, in the case of a
covered expatriate holding a nonvested interest, reduced by
mark-to-market taxes imposed on trust distributions to other
persons holding nonvested interests.
The tax that is imposed on distributions from a qualified
trust generally is to be deducted and withheld by the trustees.
If the individual does not agree to waive treaty rights that
would preclude collection of the tax, the tax with respect to
such distributions is imposed on the trust, the trustee is
personally liable for the tax, and any other beneficiary has a
right of contribution against such individual with respect to
the tax.
Mark-to-market taxes become due immediately if the trust
ceases to be a qualified trust, the individual disposes of his
or her qualified trust interest, or the individual dies. In
such cases, the amount of mark-to-market tax equals the lesser
of (1) the tax calculated under the rules for nonqualified
trust interests as of the date of the triggering event, or (2)
the balance in the deferred tax account with respect to the
trust interest immediately before that date. Such tax is
imposed on the trust, the trustee is personally liable for the
tax, and any other beneficiary has a right of contribution
against such individual (or his or her estate) with respect to
such tax.
Regulatory authority
The provision authorizes the Secretary of the Treasury to
prescribe such regulations as may be necessary or appropriate
to carry out the purposes of section 877A. In addition, the
Secretary of the Treasury may provide for adjustments to the
bases of assets in a trust or a deferred tax account, and the
timing of such adjustments, to ensure that gain is taxed only
once.
Income tax treatment of gifts and inheritances from a former citizen or
former long-term resident
Under the provision, the exclusion from income provided
in section 102 (relating to exclusions from income for the
value of property acquired by gift or inheritance) does not
apply to the value of any property received by gift or
inheritance from a covered expatriate. Accordingly, a U.S.
taxpayer who receives a gift or inheritance from such an
individual is required to include the value of such gift or
inheritance in gross income and is subject to U.S. tax on such
amount. Having included the value of the property in income,
the recipient takes a basis in the property equal to that
value. The tax does not apply to property that is shown on a
timely filed gift tax return and that is a taxable gift by the
former citizen or former long-term resident, or property that
is shown on a timely filed estate tax return and included in
the gross U.S. estate of the former citizen or former long-term
resident (regardless of whether the tax liability shown on such
a return is reduced by credits, deductions, or exclusions
available under the estate and gift tax rules). In addition,
the tax does not apply to property in cases in which no estate
or gift tax return was filed, but no such return would have
been required to be filed if the former citizen or former long-
term resident had not relinquished citizenship or terminated
residency, as the case may be.
Coordination with present-law alternative tax regime
The provision provides a coordination rule with the
present-law alternative tax regime. Under the provision, the
expatriation income tax rules under section 877, and the
special present-law expatriation estate and gift tax rules
under sections 2107 and 2501(a)(3) (generally described above),
do not apply to a covered expatriate whose expatriation or
residency termination occurs on or after the date of enactment.
Information reporting
Certain information reporting requirements under the law
presently applicable to former citizens and former long-term
residents (sec. 6039G) also apply for purposes of the
provision.
Immigration rules
The provision denies former citizens reentry into the
United States if the individual is determined not to be in
compliance with his or her tax obligations under the
provision's expatriation tax rules (regardless of the
subjective motive for expatriating). For this purpose, the
provision permits the IRS to disclose certain items of return
information of an individual, upon written request of the
Attorney General or his delegate, as is necessary for making a
determination under section 212(a)(10)(E) of the Immigration
and Nationality Act. Specifically, the provision permits the
IRS to disclose to the agency administering section
212(a)(10)(E) whether such taxpayer is in compliance with
section 877A, and to identify the items of any noncompliance.
Recordkeeping requirements, safeguards, and civil and criminal
penalties for unauthorized disclosure or inspection apply to
return information disclosed under this provision.
Effective date
The provision generally is effective for U.S. citizens
who relinquish citizenship or long-term residents who terminate
their residency on or after the date of enactment. The due date
for tentative tax, however, may not occur before the 90th day
after the date of enactment. The provision relating to income
taxes on gifts and inheritances is effective for gifts and
inheritances received from former citizens or former long-term
residents (or their estates) on or after the date of enactment,
whose relinquishment of citizenship or residency termination
occurs after such date. The immigration and disclosure
provisions relating to former citizens are effective with
respect to individuals who relinquish citizenship on or after
the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
F. Miscellaneous Provisions
1. Treatment of contingent payment convertible debt instruments (sec.
451 of the Senate amendment and sec. 1275 of the Code)
PRESENT LAW
Under present law, a taxpayer generally deducts the
amount of interest paid or accrued within the taxable year on
indebtedness issued by the taxpayer. In the case of original
issue discount (``OID''), the issuer of a debt instrument
generally accrues and deducts, as interest, the OID over the
life of the obligation, even though the amount of the OID may
not be paid until the maturity of the instrument.
The amount of OID with respect to a debt instrument is
equal to the excess of the stated redemption price at maturity
over the issue price of the debt instrument. The stated
redemption price at maturity includes all amounts that are
payable on the debt instrument by maturity. The amount of OID
with respect to a debt instrument is allocated over the life of
the instrument through a series of adjustments to the issue
price for each accrual period. The adjustment to the issue
price is determined by multiplying the adjusted issue price
(i.e., the issue price increased or decreased by adjustments
prior to the accrual period) by the instrument's yield to
maturity, and then subtracting any payments on the debt
instrument (other than non-OID stated interest) during the
accrual period. Thus, in order to compute the amount of OID and
the portion of OID allocable to a particular period, the stated
redemption price at maturity and the time of maturity must be
known. Issuers of debt instruments with OID accrue and deduct
the amount of OID as interest expense in the same manner as the
holders of such instruments accrue and include in gross income
the amount of OID as interest income.
Treasury regulations provide special rules for
determining the amount of OID allocated to a period with
respect to certain debt instruments that provide for one or
more contingent payments of principal or interest.\434\ The
regulations provide that a debt instrument does not provide for
contingent payments merely because it provides for an option to
convert the debt instrument into the stock of the issuer, into
the stock or debt of a related party, or into cash or other
property in an amount equal to the approximate value of such
stock or debt.\435\ The regulations also provide that a payment
is not a contingent payment merely because of a contingency
that, as of the issue date of the debt instrument, is either
remote or incidental.\436\
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\434\ Treas. Reg. sec. 1.1275-4.
\435\ Treas. Reg. sec. 1.1275-4(a)(4).
\436\ Treas. Reg. sec. 1.1275-4(a)(5).
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In the case of contingent payment debt instruments that
are issued for money or publicly traded property,\437\ the
regulations provide that interest on a debt instrument must be
taken into account (as OID) whether or not the amount of any
payment is fixed or determinable in the taxable year. The
amount of OID that is taken into account for each accrual
period is determined by constructing a comparable yield and a
projected payment schedule for the debt instrument, and then
accruing the OID on the basis of the comparable yield and
projected payment schedule by applying rules similar to those
for accruing OID on a noncontingent debt instrument (the
``noncontingent bond method''). If the actual amount of a
contingent payment is not equal to the projected amount,
appropriate adjustments are made to reflect the difference. The
comparable yield for a debt instrument is the yield at which
the issuer would be able to issue a fixed-rate noncontingent
debt instrument with terms and conditions similar to those of
the contingent payment debt instrument (i.e., the comparable
fixed-rate debt instrument), including the level of
subordination, term, timing of payments, and general market
conditions.\438\
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\437\ Treas. Reg. sec. 1.1275-4(b).
\438\ Treas. Reg. sec. 1.1275-4(b)(4)(i)(A).
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With respect to certain debt instruments that are
convertible into the common stock of the issuer and that also
provide for contingent payments (other than the conversion
feature)--often referred to as ``contingent convertible'' debt
instruments--the IRS has stated that the noncontingent bond
method applies in computing the accrual of OID on the debt
instrument.\439\ In applying the noncontingent bond method, the
IRS has stated that the comparable yield for a contingent
convertible debt instrument is determined by reference to a
comparable fixed-rate nonconvertible debt instrument, and the
projected payment schedule is determined by treating the issuer
stock received upon a conversion of the debt instrument as a
contingent payment.
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\439\ Rev. Rul. 2002-31, 2002-1 C.B. 1023.
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that, in the case of a
contingent convertible debt instrument,\440\ any Treasury
regulations which require OID to be determined by reference to
the comparable yield of a noncontingent fixed-rate debt
instrument shall be applied as requiring that such comparable
yield be determined by reference to a noncontingent fixed-rate
debt instrument which is convertible into stock. For purposes
of applying the provision, the comparable yield shall be
determined without taking into account the yield resulting from
the conversion of a debt instrument into stock. Thus, the
noncontingent bond method in the Treasury regulations shall be
applied in a manner such that the comparable yield for
contingent convertible debt instruments shall be determined by
reference to comparable noncontingent fixed-rate convertible
(rather than nonconvertible) debt instruments.
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\440\ Under the provision, a contingent convertible debt instrument
is defined as a debt instrument that: (1) is convertible into stock of
the issuing corporation, or a corporation in control of, or controlled
by, the issuing corporation; and (2) provides for contingent payments.
---------------------------------------------------------------------------
Effective date.--The provision is effective for debt
instruments issued on or after date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
2. Grant Treasury regulatory authority to address foreign tax credit
transactions involving inappropriate separation of foreign
taxes from related foreign income (sec. 452 of the Senate
amendment and sec. 901 of the Code)
PRESENT LAW
The United States employs a ``worldwide'' tax system,
under which residents generally are taxed on all income,
whether derived in the United States or abroad. In order to
mitigate the possibility of double taxation arising from
overlapping claims of the United States and a source country to
tax the same item of income, the United States provides a
credit for foreign income taxes paid or accrued, subject to
several conditions and limitations.
For purposes of the foreign tax credit, regulations
provide that a foreign tax is treated as being paid by ``the
person on whom foreign law imposes legal liability for such
tax.'' \441\ Thus, for example, if a U.S. corporation owns an
interest in a foreign partnership, the U.S. corporation can
claim foreign tax credits for the tax that is imposed on it as
a partner in the foreign entity. This would be true under the
regulations even if the U.S. corporation elected to treat the
foreign entity as a corporation for U.S. tax purposes. In such
a case, if the foreign entity does not meet the definition of a
controlled foreign corporation or does not generate income that
is subject to current inclusion under the rules of subpart F,
the income generated by the foreign entity might never be
reported on a U.S. return, and yet the U.S. corporation might
take the position that it can claim credits for taxes imposed
on that income. This is one example of how a taxpayer might
attempt to separate foreign taxes from the related foreign
income, and thereby attempt to claim a foreign tax credit under
circumstances in which there is no threat of double taxation.
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\441\ Treas. Reg. sec. 1.901-2(f)(1).
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The Treasury Department currently has the authority to
promulgate regulations under section 901 and other provisions
of the Code to address transactions and structures that produce
inappropriate foreign tax credit results.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment enhances the regulatory authority of
the Treasury Department to address transactions that involve
the inappropriate separation of foreign taxes from the related
foreign income or in which foreign taxes are imposed on any
person in respect of income of another person. This grant of
regulatory authority supplements existing Treasury Department
authority and thereby provide greater flexibility in addressing
a wide range of transactions and structures. Regulations issued
pursuant to this authority could, for example, provide for the
disallowance of a credit for all or a portion of the foreign
taxes, or for the allocation of the foreign taxes among the
participants in the transaction in a manner more consistent
with the economics of the transaction.
Effective date.--The provision generally is effective for
transactions entered into after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision. No inference is intended as to the scope
of the Treasury Department's existing regulatory authority to
address transactions that involve the inappropriate separation
of foreign taxes from the related foreign income.
3. Modifications of effective dates of leasing provisions of the
American Jobs Creation Act of 2004 (sec. 453 of the Senate
amendment and sec. 470 of the Code)
PRESENT LAW
Present law provides for the deferral of losses
attributable to certain tax exempt use property, generally
effective for leases entered into after March 12, 2004.
However, the deferral provision does not apply to property
located in the United States that is subject to a lease with
respect to which a formal application: (1) was submitted for
approval to the Federal Transit Administration (an agency of
the Department of Transportation) after June 30, 2003, and
before March 13, 2004; (2) is approved by the Federal Transit
Administration before January 1, 2006; and (3) includes a
description and the fair market value of such property (the
``qualified transportation property exception'').
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment makes two changes to the effective
date of the loss deferral rules. First, the Senate amendment
repeals the qualified transportation property exception.
Second, the Senate amendment applies the loss deferral rules to
leases entered into on or before March 12, 2004, if the lessee
is a foreign person or entity. With respect to such leases,
losses are deferred starting in taxable years beginning after
December 31, 2005.
Effective date.--The Senate amendment is effective as if
included in the provisions of the American Jobs Creation Act of
2004, Pub. L. No. 108-357 (2004), to which it relates.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
4. Application of earnings stripping rules to partners which are
corporations (sec. 454 of the Senate amendment and sec. 163 of
the Code)
PRESENT LAW
Present law provides rules to limit the ability of U.S.
corporations to reduce the U.S. tax on their U.S.-source income
through earnings stripping transactions. Section 163(j)
specifically addresses earnings stripping involving interest
payments, by limiting the deductibility of interest paid to
certain related parties (``disqualified interest''),\442\ if
the payor's debt-equity ratio exceeds 1.5 to 1 and the payor's
net interest expense exceeds 50 percent of its ``adjusted
taxable income'' (generally taxable income computed without
regard to deductions for net interest expense, net operating
losses, and depreciation, amortization, and depletion).
Disallowed interest amounts can be carried forward
indefinitely. In addition, excess limitation (i.e., any excess
of the 50-percent limit over a company's net interest expense
for a given year) can be carried forward three years.
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\442\ This interest also may include interest paid to unrelated
parties in certain cases in which a related party guarantees the debt.
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Proposed Treasury regulations provide that a partner's
proportionate share of partnership liabilities is treated as
liabilities incurred directly by the partner, for purposes of
applying the earnings stripping limitation to interest payments
by a corporate partner of a partnership.\443\ The proposed
Treasury regulations provide that interest paid or accrued to a
partnership is treated as paid or accrued to the partners of
the partnership in proportion to each partner's distributive
share of the partnership's interest income for the taxable
year.\444\ In addition, the proposed Treasury regulations
provide that interest expense paid or accrued by a partnership
is treated as paid or accrued by the partners of the
partnership in proportion to each partner's distributive share
of the partnership's interest expense.\445\
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\443\ Prop. Treas. Reg. sec. 1.163(j)-3(b)(3).
\444\ Prop. Treas. Reg. sec. 1.163(j)-2(e)(4).
\445\ Prop. Treas. reg. sec. 1.163(j)-2(e)(5).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision codifies the approach of
the proposed Treasury regulations by providing that, except to
the extent provided by regulations, in the case of a
corporation that owns, directly or indirectly, an interest in a
partnership, the corporation's share of partnership liabilities
is treated as liabilities of the corporation for purposes of
applying the earnings stripping rules to the corporation. The
provision provides that the corporation's distributive share of
interest income of the partnership, and of interest expense of
the partnership, is treated as interest income or interest
expense of the corporation.
The provision provides Treasury regulatory authority to
reallocate shares of partnership debt, or distributive shares
of the partnership's interest income or interest expense, as
may be appropriate to carry out the purposes of the provision.
For example, it is not intended that the application of the
earnings stripping rules to corporations with direct or
indirect interests in partnerships be circumvented through the
use of allocations of partnership interest income or expense
(or partnership liabilities) to or away from partners.
Effective date.--The provision is effective for taxable
years beginning on or after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision.
5. Limitation on employer deduction for certain entertainment expenses
(sec. 455 of the Senate amendment and sec. 274(e) of the Code)
PRESENT LAW
In general
Under present law, no deduction is allowed with respect
to (1) an activity generally considered to be entertainment,
amusement or recreation, unless the taxpayer establishes that
the item was directly related to (or, in certain cases,
associated with) the active conduct of the taxpayer's trade or
business, or (2) a facility (e.g., an airplane) used in
connection with such activity.\446\ The Code includes a number
of exceptions to the general rule disallowing deductions of
entertainment expenses. Under one exception, the deduction
disallowance rule does not apply to expenses for goods,
services, and facilities to the extent that the expenses are
reported by the taxpayer as compensation and wages to an
employee.\447\ The deduction disallowance rule also does not
apply to expenses paid or incurred by the taxpayer for goods,
services, and facilities to the extent that the expenses are
includible in the gross income of a recipient who is not an
employee (e.g., a nonemployee director) as compensation for
services rendered or as a prize or award.\448\ The exceptions
apply only to the extent that amounts are properly reported by
the company as compensation and wages or otherwise includible
in income. In no event can the amount of the deduction exceed
the amount of the actual cost, even if a greater amount is
includible in income.
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\446\ Sec. 274(a).
\447\ Sec. 274(e)(2). As discussed below, a special rule applies in
the case of specified individuals.
\448\ Sec. 274(e)(9).
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Except as otherwise provided, gross income includes
compensation for services, including fees, commissions, fringe
benefits, and similar items. In general, an employee or other
service provider must include in gross income the amount by
which the fair value of a fringe benefit exceeds the amount
paid by the individual. Treasury regulations provide rules
regarding the valuation of fringe benefits, including flights
on an employer-provided aircraft.\449\ In general, the value of
a non-commercial flight is determined under the base aircraft
valuation formula, also known as the Standard Industry Fare
Level formula or ``SIFL''.\450\ If the SIFL valuation rules do
not apply, the value of a flight on a company-provided aircraft
is generally equal to the amount that an individual would have
to pay in an arm's-length transaction to charter the same or a
comparable aircraft for that period for the same or a
comparable flight.\451\
---------------------------------------------------------------------------
\449\ Treas. Reg. sec. 1.61-21.
\450\ Treas. Reg. sec. 1.61-21(g).
\451\ Treas. Reg. sec. 1.61-21(b)(6).
---------------------------------------------------------------------------
In the context of an employer providing an aircraft to
employees for nonbusiness (e.g., vacation) flights, the
exception for expenses treated as compensation was interpreted
in Sutherland Lumber-Southwest, Inc. v. Commissioner
(``Sutherland Lumber'') as not limiting the company's deduction
for operation of the aircraft to the amount of compensation
reportable to its employees,\452\ which can result in a
deduction many times larger than the amount required to be
included in income. In many cases, the individual including
amounts attributable to personal travel in income directly
benefits from the enhanced deduction, resulting in a net
deduction for the personal use of the company aircraft.
---------------------------------------------------------------------------
\452\ Sutherland Lumber-Southwest, Inc. v. Comm., 114 T.C. 197
(2000), aff'd, 255 F.3d 495 (8th Cir. 2001), acq., AOD 2002-02 (Feb.
11, 2002).
---------------------------------------------------------------------------
Specified individuals
In the case of specified individuals, the exceptions to
the general entertainment expense disallowance rule for
expenses treated as compensation or includible in income apply
only to the extent of the amount of expenses treated as
compensation or includible in income of the specified
individual. For example, a company's deduction attributable to
aircraft operating costs and other expenses for a specified
individual's vacation use of a company aircraft is limited to
the amount reported as compensation to the specified
individual. Sutherland Lumber is thus overturned with respect
to specified individuals.
Specified individuals are individuals who, with respect
to an employer or other service recipient (or a related party),
are subject to the requirements of section 16(a) of the
Securities and Exchange Act of 1934, or would be subject to
such requirements if the employer or service recipient (or the
related party) were an issuer of equity securities referred to
in section 16(a).\453\ Such individuals generally include
officers (as defined by section 16(a)),\454\ directors, and 10-
percent-or-greater owners of private and publicly-held
companies.
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\453\ For purposes of this definition, a person is a related party
with respect to another person if such person bears a relationship to
such other person described in section 267(b) or 707(b).
\454\ An officer is defined as the president, principal financial
officer, principal accounting officer (or, if there is no such
accounting officer, the controller), any vice-president in charge of a
principal business unit, division or function (such as sales,
administration or finance), any other officer who performs a policy-
making function, or any other person who performs similar policy-making
functions.
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HOUSE BILL
No provision.
SENATE AMENDMENT
Under the Senate amendment, in the case of all
individuals, the exceptions to the general entertainment
expense disallowance rule for expenses treated as compensation
or includible in income apply only to the extent of the amount
of expenses treated as compensation or includible in income.
Thus, under those exceptions, no deduction is allowed with
respect to expenses for (1) a nonbusiness activity generally
considered to be entertainment, amusement or recreation, or (2)
a facility (e.g., an airplane) used in connection with such
activity to the extent that such expenses exceed the amount
treated as compensation or includible in income. The provision
is intended to overturn Sutherland Lumber for all individuals.
As under present law, the exceptions apply only if amounts are
properly reported by the company as compensation and wages or
otherwise includible in income.
Effective date.--The provision is effective for expenses
incurred after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
6. Increase in age of minor children whose unearned income is taxed as
if parent's income (sec. 456 of the Senate amendment and sec.
1(g) of the Code)
PRESENT LAW
Filing requirements for children
A single unmarried individual eligible to be claimed as a
dependent on another taxpayer's return generally must file an
individual income tax return if he or she has: (1) earned
income only over $5,150 (for 2006); (2) unearned income only
over the minimum standard deduction amount for dependents ($850
in 2006); or (3) both earned income and unearned income
totaling more than the smaller of (a) $5,150 (for 2006) or (b)
the larger of (i) $850 (for 2006), or (ii) earned income plus
$300.\455\ Thus, if a dependent child has less than $850 in
gross income, the child does not have to file an individual
income tax return for 2006.\456\
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\455\ Sec. 6012(a)(1)(C). Other filing requirements apply to
dependents who are married, elderly, or blind. See, Internal Revenue
Service, Publication 929, Tax Rules for Children and Dependents, at 2,
Table 1 (2005).
\456\ A taxpayer generally need not file a return if he or she has
gross income in an amount less than the standard deduction (and, if
allowable to the taxpayer, the personal exemption amount). An
individual who may be claimed as a dependent of another taxpayer is not
eligible to claim the dependency exemption relating to that individual.
Sec. 151(d)(2). For taxable years beginning in 2006, the standard
deduction amount for an individual who may be claimed as a dependent by
another taxpayer may not exceed the greater of $850 or the sum of $300
and the individual's earned income.
---------------------------------------------------------------------------
A child who cannot be claimed as a dependent on another
person's tax return is subject to the generally applicable
filing requirements. Such a child generally must file a return
if the individual's gross income exceeds the sum of the
standard deduction and the personal exemption amount ($3,300
for 2006).
Taxation of unearned income under section 1(g)
Special rules (generally referred to as the ``kiddie
tax'') apply to the unearned income of a child who is under age
14.\457\ The kiddie tax applies if: (1) the child has not
reached the age of 14 by the close of the taxable year; (2) the
child's unearned income was more than $1,700 (for 2006); and
(3) the child is required to file a return for the year. The
kiddie tax applies regardless of whether the child may be
claimed as a dependent on the parent's return.
---------------------------------------------------------------------------
\457\ Sec. 1(g).
---------------------------------------------------------------------------
For these purposes, unearned income is income other than
wages, salaries, professional fees, or other amounts received
as compensation for personal services actually rendered.\458\
For children under age 14, net unearned income (for 2006,
generally unearned income over $1,700) is taxed at the parent's
rate if the parent's rate is higher than the child's rate. The
remainder of a child's taxable income (i.e., earned income,
plus unearned income up to $1,700 (for 2006), less the child's
standard deduction) is taxed at the child's rates, regardless
of whether the kiddie tax applies to the child. In general, a
child is eligible to use the preferential tax rates for
qualified dividends and capital gains.\459\
---------------------------------------------------------------------------
\458\ Sec. 1(g)(4) and sec. 911(d)(2).
\459\ Sec. 1(h).
---------------------------------------------------------------------------
The kiddie tax is calculated by computing the ``allocable
parental tax.'' This involves adding the net unearned income of
the child to the parent's income and then applying the parent's
tax rate. A child's ``net unearned income'' is the child's
unearned income less the sum of (1) the minimum standard
deduction allowed to dependents ($850 for 2006), and (2) the
greater of (a) such minimum standard deduction amount or (b)
the amount of allowable itemized deductions that are directly
connected with the production of the unearned income.\460\ A
child's net unearned income cannot exceed the child's taxable
income.
---------------------------------------------------------------------------
\460\ Sec. 1(g)(4).
---------------------------------------------------------------------------
The allocable parental tax equals the hypothetical
increase in tax to the parent that results from adding the
child's net unearned income to the parent's taxable income. If
the child has net capital gains or qualified dividends, these
items are allocated to the parent's hypothetical taxable income
according to the ratio of net unearned income to the child's
total unearned income. If a parent has more than one child
subject to the kiddie tax, the net unearned income of all
children is combined, and a single kiddie tax is calculated.
Each child is then allocated a proportionate share of the
hypothetical increase, based upon the child's net unearned
income relative to the aggregate net unearned income of all of
the parent's children subject to the tax.
Special rules apply to determine which parent's tax
return and rate is used to calculate the kiddie tax. If the
parents file a joint return, the allocable parental tax is
calculated using the income reported on the joint return. In
the case of parents who are married but file separate returns,
the allocable parental tax is calculated using the income of
the parent with the greater amount of taxable income. In the
case of unmarried parents, the child's custodial parent is the
parent whose taxable income is taken into account in
determining the child's liability. If the custodial parent has
remarried, the stepparent is treated as the child's other
parent. Thus, if the custodial parent and stepparent file a
joint return, the kiddie tax is calculated using that joint
return. If the custodial parent and stepparent file separate
returns, the return of the one with the greater taxable income
is used. If the parents are unmarried but lived together all
year, the return of the parent with the greater taxable income
is used.\461\
---------------------------------------------------------------------------
\461\ Sec. 1(g)(5); Internal Revenue Service, Publication 929, Tax
Rules for Children and Dependents, at 6 (2005).
---------------------------------------------------------------------------
Unless the parent elects to include the child's income on
the parent's return (as described below) the child files a
separate return to report the child's income.\462\ In this
case, items on the parent's return are not affected by the
child's income. The total tax due from a child is the greater
of:
---------------------------------------------------------------------------
\462\ The child must attach to the return Form 8615, Tax for
Children Under Age 14 With Investment Income of More Than $1,700
(2006).
---------------------------------------------------------------------------
1. the sum of (a) the tax payable by the child on the
child's earned income and unearned income up to $1,700 (for
2006), plus (b) the allocable parental tax on the child's
unearned income, or
2. the tax on the child's income without regard to the
kiddie tax provisions.
Parental election to include child's dividends and interest on parent's
return
Under certain circumstances, a parent may elect to report
a child's dividends and interest on the parent's return. If the
election is made, the child is treated as having no income for
the year and the child does not have to file a return. The
parent makes the election on Form 8814, Parents' Election to
Report Child's Interest and Dividends. The requirements for the
parent's election are that:
1. the child has gross income only from interest and
dividends (including capital gains distributions and Alaska
Permanent Fund Dividends); \463\
---------------------------------------------------------------------------
\463\ Internal Revenue Service, Publication 929, Tax Rules for
Children and Dependents, at 6 (2005).
---------------------------------------------------------------------------
2. such income is more than the minimum standard
deduction amount for dependents ($850 in 2006) and less than 10
times that amount ($8500 in 2006);
3. no estimated tax payments for the year were made in
the child's name and taxpayer identification number;
4. no backup withholding occurred; and
5. the child is required to file a return if the parent
does not make the election.
Only the parent whose return must be used when
calculating the kiddie tax may make the election. The parent
includes in income the child's gross income in excess of twice
the minimum standard deduction amount for dependents (i.e., the
child's gross income in excess of $1,700 for 2007). This amount
is taxed at the parent's rate. The parent also must report an
additional tax liability equal to the lesser of: (1) $85 (in
2006), or (2) 10 percent of the child's gross income exceeding
the child's standard deduction ($850 in 2006).
Including the child's income on the parent's return can
affect the parent's deductions and credits that are based on
adjusted gross income, as well as income-based phaseouts,
limitations, and floors.\464\ In addition, certain deductions
that the child would have been entitled to take on his or her
own return are lost.\465\ Further, if the child received tax-
exempt interest from a private activity bond, that item is
considered a tax preference of the parent for alternative
minimum tax purposes.\466\
---------------------------------------------------------------------------
\464\ Internal Revenue Service, Publication 929, Tax Rules for
Children and Dependents, at 7 (2005).
\465\ Internal Revenue Service, Publication 929, Tax Rules for
Children and Dependents, at 7 (2005).
\466\ Sec. 1(g)(7)(B).
---------------------------------------------------------------------------
Taxation of compensation for services under section 1(g)
Compensation for a child's services is considered the
gross income of the child, not the parent, even if the
compensation is not received or retained by the child (e.g. is
the parent's income under local law).\467\ If the child's
income tax is not paid, however, an assessment against the
child will be considered as also made against the parent to the
extent the assessment is attributable to amounts received for
the child's services.\468\
---------------------------------------------------------------------------
\467\ Sec. 73(a).
\468\ Sec. 6201(c).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The provision increases the age to which the kiddie tax
provisions apply from under 14 to under 18 years of age. The
provision also creates an exception to the kiddie tax for
distributions from certain qualified disability trusts, defined
by cross-reference to sections 1917 and 1614(a)(3) of the
Social Security Act.
Effective date.--The provision applies to taxable years
beginning after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision with one modification. This modification provides
that the kiddie tax does not apply to a child who is married
and files a joint return for the taxable year.
7. Impose loan and redemption requirements on pooled financing bonds
(sec. 457 of the Senate amendment and sec. 149 of the Code)
PRESENT LAW
In general
Interest on bonds issued by State and local governments
generally is excluded from gross income for Federal income tax
purposes if the proceeds of such bonds are used to finance
direct activities of governmental units or if such bonds are
repaid with revenues of governmental units. These bonds are
called ``governmental bonds.'' Interest on State or local
government bonds issued to finance activities of private
persons is taxable unless a specific exception applies. These
bonds are called ``private activity bonds.'' The exclusion from
income for State and local bonds does not apply to private
activity bonds, unless the bonds are issued for certain
permitted purposes. In addition, the Code imposes qualification
requirements that apply to all State and local bonds. Arbitrage
restrictions, for example, limit the ability of issuers to
profit from investment of tax-exempt bond proceeds. The Code
also imposes requirements that only apply to specific types of
bond issues. For instance, pooled financing bonds (defined
below) are not tax-exempt unless the issuer meets certain
requirements regarding the expected use of proceeds.
Pooled financing bond restrictions
State or local governments also issue bonds to provide
financing for the benefit of a third party (a ``conduit
borrower''). Pooled financing bonds are bond issues that are
used to make or finance loans to two or more conduit borrowers,
unless the conduit loans are to be used to finance a single
project.\469\ The Code imposes several requirements on pooled
financing bonds if more than $5 million of proceeds are
expected to be used to make loans to conduit borrowers. For
purposes of these rules, a pooled financing bond does not
include certain private activity bonds.\470\
---------------------------------------------------------------------------
\469\ Treas. Reg. sec. 1.150-1(b).
\470\ Sec. 149(f)(4)(B).
---------------------------------------------------------------------------
A pooled financing bond is not tax-exempt unless the
issuer reasonably expects that at least 95 percent of the net
proceeds will be lent to ultimate borrowers by the end of the
third year after the date of issue. The term ``net proceeds''
is defined to mean the proceeds of the issue less the following
amounts: 1) proceeds used to finance issuance costs; 2)
proceeds necessary to pay interest on the bonds during a three-
year period; and 3) amounts in reasonably required
reserves.\471\
---------------------------------------------------------------------------
\471\ Sec. 149(f)(2)(C).
---------------------------------------------------------------------------
An issuer's past experience regarding loan origination is
a criterion upon which the reasonableness of the issuer's
expectations can be based. As an additional requirement for tax
exemption, all legal and underwriting costs associated with the
issuance of pooled financing bonds may not be contingent and
must be substantially paid within 180 days of the date of
issuance.
Arbitrage restrictions on tax-exempt bonds
To prevent the issuance of more Federally subsidized tax-
exempt bonds than necessary; the tax exemption for State and
local bonds does not apply to any arbitrage bond.\472\ An
arbitrage bond is defined as any bond that is part of an issue
if any proceeds of the issue are reasonably expected to be used
(or intentionally are used) to acquire higher yielding
investments or to replace funds that are used to acquire higher
yielding investments. In general, arbitrage profits may be
earned only during specified periods (e.g., defined ``temporary
periods'') before funds are needed for the purpose of the
borrowing or on specified types of investments (e.g.,
``reasonably required reserve or replacement funds''). Subject
to limited exceptions, investment profits that are earned
during these periods or on such investments must be rebated to
the Federal Government (``arbitrage rebate'').
---------------------------------------------------------------------------
\472\ Secs. 103(a) and (b)(2).
---------------------------------------------------------------------------
The Code contains several exceptions to the arbitrage
rebate requirement, including an exception for bonds issued by
small governments (the ``small issuer exception''). For this
purpose, small governments are defined as general purpose
governmental units that issue no more than $5 million of tax-
exempt governmental bonds in a calendar year.\473\
---------------------------------------------------------------------------
\473\ The $5 million limit is increased to $15 million if at least
$10 million of the bonds are used to finance public schools.
---------------------------------------------------------------------------
Pooled financing bonds are subject to the arbitrage
restrictions that apply to all tax-exempt bonds, including
arbitrage rebate. Under certain circumstances, however, small
governments may issue pooled financing bonds without those
bonds counting towards the determination of whether the issuer
qualifies for the small issuer exception to arbitrage rebate.
In the case of a pooled financing bond where the ultimate
borrowers are governmental units with general taxing powers not
subordinate to the issuer of the pooled bond, the pooled bond
does not count against the issuer's $5 million limitation,
provided the issuer is not a borrower from the pooled
bond.\474\ However, the issuer of the pooled financing bond
remains subject to the arbitrage rebate requirement for
unloaned proceeds.\475\
---------------------------------------------------------------------------
\474\ Sec. 148(f)(4)(D)(ii)(II).
\475\ Treas. Reg. sec. 1.148-8(d)(1).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
In general
The provision imposes new requirements on pooled
financing bonds as a condition of tax-exemption. First, the
provision imposes a written loan commitment requirement to
restrict the issuance of pooled bonds where potential borrowers
have not been identified (``blind pools''). Second, in addition
to the current three-year expectations requirement, the issuer
must reasonably expect that at least 50 percent of the net
proceeds of the pooled bond will be lent to borrowers one year
after the date of issue. Third, the provision requires the
redemption of outstanding bonds with proceeds that are not
loaned to borrowers within the expected loan origination
periods. Finally, the provision eliminates the rule allowing an
issuer of pooled financing bonds to disregard the pooled bonds
for purposes of determining whether the issuer qualifies for
the small issuer exception to rebate.
Borrower identification
Under the provision, interest on a pooled financing bond
is tax exempt only if the issuer obtains written commitments
with ultimate borrowers for loans equal to at least 50 percent
of the net proceeds of the pooled bond prior to issuance. The
loan commitment requirement does not apply to bonds issued by
States (or an integral part of a State) to provide loans to
subordinate governmental units or State entities created to
provide financing for water-infrastructure projects through the
federally-sponsored State revolving fund program.
Loan origination expectations
The provision imposes new reasonable expectations
requirements for loan originations. The issuer must expect that
at least 50 percent of the net proceeds of a pooled financing
bond will be lent to ultimate borrowers one year after the date
of issue. This is in addition to the present-law requirement
that at least 95 percent of the net proceeds will be lent to
ultimate borrowers by the end of the third year after the date
of issue.
Redemption requirement
Under the provision, if bond proceeds are not loaned to
borrowers within prescribed periods, outstanding bonds equal to
the amount of proceeds that were not loaned within the required
period must be redeemed with 90 days. The bond redemption
requirement applies with respect to proceeds that are unloaned
as of expiration of the one-year and three-year loan
origination periods. For example, if an amount equal to 45
percent of the net proceeds of an issue are used to make loans
to ultimate borrowers as of one year after the bonds are
issued, an amount equal to five percent of the net proceeds of
the issue is no longer available for lending and must be used
to redeem bonds within the following six-month period.
Similarly, if only 85 percent of the net proceeds of the issue
are used to make qualifying loans (or to redeem bonds) as of
three years after the bonds are issued, 10 percent of the
remaining net proceeds is no longer available for lending and
must be used to redeem bonds within the following six months.
Small issuer exception
The provision eliminates the rule disregarding pooled
financing bonds from the issuer's $5,000,000 annual limitation
for purposes of the small issuer exception to arbitrage rebate.
Effective date.--The provision is effective for bonds
issued after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision, with the following modifications.
Under the conference agreement, issuers of pooled
financing bonds must reasonably expect that at least 30 percent
of the net proceeds of such bonds will be loaned to ultimate
borrowers one year after the date of issue. The present-law
requirement that issuers must reasonably expect to loan at
least 95 percent of the net proceeds of a pooled financing bond
to ultimate borrowers three years after the date of issue is
unchanged. Bond proceeds that are not loaned to borrowers as
required under the one- and three-year rules must be used to
redeem outstanding bonds within 90 days of the expiration of
such one- and three-year periods.
The conference agreement requires issuers of pooled
financing bonds to obtain, prior to issuance, written
commitments from borrowers equal to at least 30 percent of the
net proceeds of the pooled financing bond. The conference
agreement includes the Senate amendment's exception to the
written loan commitment requirement. Thus, the loan commitment
requirement does not apply to pooled financing bonds issued by
States (or an integral part of a State) to provide loans to
subordinate governmental units or State entities created to
provide financing for water-infrastructure projects through the
federally-sponsored State revolving fund program.
8. Amend information reporting requirements to include interest on tax-
exempt bonds (sec. 458 of the Senate amendment and sec. 6049 of
the Code)
PRESENT LAW
Tax-exempt bonds
Generally, gross income does not include interest on
State or local bonds.\476\ State and local bonds are classified
generally as either governmental bonds or private activity
bonds. Governmental bonds are bonds the proceeds of which are
primarily used to finance governmental facilities or the debt
is repaid with governmental funds. Private activity bonds are
bonds in which the State or local government serves as a
conduit providing financing to nongovernmental persons (e.g.,
private businesses or individuals). The exclusion from income
for State and local bonds does not apply to private activity
bonds, unless the bonds are issued for certain purposes
(``qualified private activity bonds'') permitted by the
Code.\477\
---------------------------------------------------------------------------
\476\ Sec. 103.
\477\ Secs. 103(b)(1) and 141.
---------------------------------------------------------------------------
Tax-exempt interest reporting by taxpayers
The Code provides that every person required to file a
return must report the amount of tax-exempt interest received
or accrued during any taxable year.\478\ There are a number of
reasons why the amount of tax-exempt interest received is
relevant to determining tax liability despite the general
exclusion from income. For example, the interest income from
qualified private activity bonds (other than qualified
501(c)(3) bonds) issued after August 7, 1986, is a preference
item for purposes of calculating the alternative minimum tax
(``AMT'').\479\ Tax-exempt interest also is relevant for
determining eligibility for the earned income credit (the
``EIC'') \480\ and the amount of Social Security benefits
includable in gross income.\481\ Moreover, determining
includable Social Security benefits is necessary for
calculating either adjusted or modified adjusted gross income
under several Code sections.\482\
---------------------------------------------------------------------------
\478\ Sec. 6012(d).
\479\ Sec. 57(a)(5). Special rules apply to exclude refundings of
bonds issued before August 8, 1986, and certain bonds issued before
September 1, 1986.
\480\ Sec. 32(i).
\481\ Sec. 86.
\482\ See Secs. 135, 219, and 221.
---------------------------------------------------------------------------
Information reporting by payors
The Code generally requires every person who makes
payments of interest aggregating $10 or more or receives
payments of interest as a nominee and who makes payments
aggregating $10 or more to file an information return setting
forth the amount of interest payments for the calendar year and
the name, address, and TIN \483\ of the person to whom interest
is paid.\484\ Treasury regulations prescribe the form and
manner for filing interest payment information returns.
Penalties are imposed for failures to file interest payment
information returns or payee statements.\485\ Treasury
Regulations also impose recordkeeping requirements on any
person required to file information returns.\486\ The Code
excludes interest paid on tax-exempt bonds from interest
reporting requirements.\487\
---------------------------------------------------------------------------
\483\ The taxpayer's identification number, generally, for
individuals is the taxpayer's social security number. Sec. 7701(a)(41).
\484\ Sec. 6049.
\485\ Secs. 6721 and 6722.
\486\ Treas. Reg. sec. 1.6001-1(a).
\487\ Sec. 6049.
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision eliminates the exception from information
reporting requirements for interest paid on tax-exempt bonds.
Effective date.--The provision is effective for interest
paid on tax-exempt bonds after December 31, 2005.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision.
9. Modification of credit for fuel from a non-conventional source (sec.
459 of the Senate amendment and sec. 45K of the Code)
PRESENT LAW
Certain fuels produced from ``non-conventional sources''
and sold to unrelated parties are eligible for an income tax
credit equal to $3 (generally adjusted for inflation) \488\ per
barrel or Btu oil barrel equivalent (``non- conventional source
fuel credit'').\489\ Qualified fuels must be produced within
the United States.
---------------------------------------------------------------------------
\488\ The inflation adjustment is generally calculated using 1979
as the base year. Generally, the value of the credit for fuel produced
in 2005 was $6.79 per barrel-of-oil equivalent produced, which is
approximately $1.20 per thousand cubic feet of natural gas. The credit
for coke or coke gas is indexed for inflation using 2004 as the base
year instead of 1979.
\489\ Sec. 29 (for tax years ending before 2006); sec. 45K (for tax
years ending after 2005).
---------------------------------------------------------------------------
Qualified fuels include:
--oil produced from shale and tar sands;
--gas produced from geopressured brine, Devonian
shale, coal seams, tight formations, or biomass; and
--liquid, gaseous, or solid synthetic fuels
produced from coal (including lignite).
Generally, the non-conventional source fuel credit has
expired, except for certain biomass gas and synthetic fuels
sold before January 1, 2008, and produced at facilities placed
in service after December 31, 1992, and before July 1, 1998.
The non-conventional source fuel credit provision also includes
a credit for producing coke or coke gas at qualified facilities
placed in service before 1993 or after June 30, 1998, and
before 2010. The coke production credit is available for coke
or coke gas produced over the four-year period beginning on
January 1, 2006, or the date the facility was placed in
service, if later. The amount of credit-eligible coke produced
at any one facility may not exceed an average barrel-of-oil
equivalent of 4,000 barrels per day.
The non-conventional source fuel credit is reduced (but
not below zero) over a $6 (inflation-adjusted) phase-out period
as the reference price for oil exceeds $23.50 per barrel (also
adjusted for inflation). The reference price is the Secretary's
estimate of the annual average wellhead price per barrel for
all domestic crude oil. The credit did not phase-out for 2004
because the reference price for that year of $50.26 did not
exceed the inflation adjusted threshold of $51.35.
Beginning with taxable years ending after December 31,
2005, the non-conventional source fuel credit is part of the
general business credit (sec. 38).
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision modifies the manner in which the phase-out
of the non-conventional source fuel credit is calculated.
Specifically, in calculating the phase-out of the credit rather
than relying upon the reference price for the calendar year in
which the sale of qualified non-conventional fuel occurs, the
provision uses the reference price for the calendar year
preceding the calendar year in which the sale occurs. Thus,
under the provision, whether the credit is phased out in 2005
is determined by reference to 2004 wellhead prices, whether the
credit is phased out in 2006 is determined by reference to 2005
wellhead prices, and so on. In addition, the provision repeals
the phase-out limitation entirely for coke and coke gas
produced under section 45K(g).
The provision eliminates the inflation adjustment for all
fuels other than coke and coke gas for 2005, 2006, and 2007.
Thus, the current credit amount of $6.79 per barrel of oil
equivalent would be retroactively reduced to $6.56 per barrel
of oil equivalent, and that reduced amount would remain in
effect through the December 31, 2007. Under the provision, the
credit amount of $3 per barrel of oil equivalent for coke and
coke gas produced under section 45K(g) would continue to be
adjusted for inflation using 2004 as the base year.
Finally, the provision clarifies that qualifying
facilities producing coke and coke gas under section 45K(g) do
not include facilities that produce petroleum-based coke or
coke gas.
Effective date.--The provision applies to fuel sold after
December 31, 2004.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
10. Modification of individual estimated tax safe harbor (sec. 460 of
the Senate Amendment and sec. 6654 of the Code)
PRESENT LAW
An individual taxpayer generally is subject to an
addition to tax for any underpayment of estimated tax. An
individual generally does not have an underpayment of estimated
tax if he or she makes timely estimated tax payments equal to
the lesser of: (1) 90 percent of the tax shown on the current
year's return or (2) 100 percent of the prior year's tax. For
individuals with a prior year's AGI above $150,000, however,
the rule that allows payment of 100 percent of prior year's tax
is modified. Individuals with prior-year AGI above $150,000
generally must make estimated payments equal to the lesser of
(1) 90 percent of the tax shown on the current year's return or
(2) 110 percent of the tax shown on the prior year's return.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that individuals with prior
year's AGI above $150,000 who make estimated tax payments based
on prior year's tax must do so based on 120 percent of the tax
shown on the prior year's return, for estimated tax payments
for taxable years beginning in 2006. That percentage will
revert back to 110 percent for taxable years beginning after
2006.
Effective date.--The provision is effective for estimated
tax payments for taxable years beginning after December 31,
2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
11. Revaluation of LIFO inventories of large integrated oil companies
(sec. 461 of the Senate amendment)
PRESENT LAW
A taxpayer is generally permitted to use a last-in,
first-out (LIFO) method to inventory goods, on the condition
that the taxpayer also uses the LIFO method in reporting to
shareholders, partners, other proprietors, and beneficiaries,
and for credit purposes.\490\ Under the LIFO method, a taxpayer
(i) treats goods on hand at the close of the taxable year as
being: first, those goods included in the opening inventory of
the taxable year (in the order of acquisition) to the extent
thereof; and second, those acquired in the taxable year; (ii)
inventories the goods at cost; and (iii) treats those goods
included in the opening inventory of the taxable year in which
the LIFO method was first used as having been acquired at the
same time, and determines their cost by the average cost
method.\491\
---------------------------------------------------------------------------
\490\ Sec. 472(c).
\491\ Sec. 472.
---------------------------------------------------------------------------
In periods during which a taxpayer produces or purchases
more goods than the taxpayer sells (such excess, an ``inventory
increment''), a LIFO method taxpayer generally records the
inventory cost of such excess (and separately tracks such
amount as the ``LIFO layer'' for such period), adds it to the
cost of inventory at the start of the period, and carries such
total inventory cost forward to the beginning inventory of the
following year.
In periods during which the taxpayer sells more goods
than the taxpayer produces or purchases (such decrease, an
``inventory decrement''), a LIFO method taxpayer generally
determines the cost of goods sold of the amount of the
decrement by treating such sales as occurring out of the most
recent LIFO layer (or the most recent LIFO layers, if the
amount of the decrement exceeds the amount of inventory in the
most recent LIFO layer) in reverse chronological order.
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision disallows a portion of the benefit of the
LIFO method to integrated oil companies \492\ which have an
average daily production of crude oil of at least 500,000
barrels of oil and which have in excess of $1 billion for the
last taxable year ending during 2005.
---------------------------------------------------------------------------
\492\ The provision defines an ``integrated oil company'' by cross-
reference to section 291(b)(4), which generally includes retailers and
large refiners of oil or natural gas or any product derived from oil or
natural gas.
---------------------------------------------------------------------------
Specifically, the provision requires such taxpayers to
revalue each historic LIFO layer of crude oil inventories by
adding to each layer an amount equal to $18.75 multiplied by
the number of barrels of crude oil represented by such LIFO
layer; the taxpayer must reduce its cost of sales for such
taxable year by a like amount.
For example, suppose a taxpayer, which is an integrated
oil company with average daily production of at least 500,000
barrels of oil and revenues in excess of $1 billion, has a 2005
starting inventory of 200x barrels, comprised of a 1955 LIFO
layer with 50x barrels valued at $5 per barrel (with a total
cost of $250x); a 1985 LIFO layer with 100x barrels valued at
$18 per barrel (with a total cost $1800x); a 2000 LIFO layer
with 30x barrels valued at $25 per barrel (with a total cost of
$750x), and a 2004 LIFO layer with 20x barrels valued at $35
per barrel (with a total cost $700x), for a total inventory
value of $3500x. Suppose further that the taxpayer's ending
inventory is 200x barrels, i.e., the same as the starting
inventory, so the taxpayer has neither an inventory increment
nor an inventory decrement for the taxable year.
Under the provision, the taxpayer will revalue each layer
upwards by $18.75/barrel. Thus, the taxpayer will increase its
1955 LIFO layer by $937.50x; its 1985 LIFO layer by $1875x; its
2000 LIFO layer by $562.50x; and its 2004 LIFO layer by $375x.
The taxpayer will offset this $3750x increase in inventory by
reducing by $3750x the taxpayer's cost of goods sold for the
last taxable year ending in 2005. In the event the taxpayer's
cost of goods sold for such taxable year prior to such
reduction is less than $3750x, the taxpayer will reduce its
cost of goods sold to zero and increase its gross income for
such taxable year by such difference.
Effective date.--The provision is effective for the last
taxable year of a taxpayer ending in 2005.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
12. Amortization of geological and geophysical expenditures (sec. 462
of the Senate amendment and sec. 167(h) of the Code)
PRESENT LAW
Geological and geophysical expenditures (``G&G costs'')
are costs incurred by a taxpayer for the purpose of obtaining
and accumulating data that will serve as the basis for the
acquisition and retention of mineral properties by taxpayers
exploring for minerals. G&G costs incurred in connection with
oil and gas exploration in the United States may be amortized
over two years.\493\ In the case of abandoned property,
remaining basis may not be recovered in the year of abandonment
of a property as all basis is recovered over the two-year
amortization period.
---------------------------------------------------------------------------
\493\ Sec. 167(h).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The provision repeals the two-year amortization period
with respect to G&G costs paid or incurred by certain large
integrated oil companies, defined to include integrated oil
companies (as defined in section 291(b)(4) of the Code) that
have an average daily worldwide production of crude oil of at
least 500,000 barrels. Thus, affected oil companies are
required to capitalize their G&G costs associated with
successful exploration projects that result in the acquisition
of property. Such companies can recover any G&G costs
associated with abandoned property in the year of abandonment.
Effective date.--The provision is effective for G&G costs
paid or incurred in taxable years beginning after August 8,
2005.
CONFERENCE AGREEMENT
The conference agreement extends the two-year
amortization period for G&G costs to five years for certain
major integrated oil companies. Under the conference agreement,
the five-year amortization rule for G&G costs applies only to
integrated oil companies that have an average daily worldwide
production of crude oil of at least 500,000 barrels for the
taxable year, gross receipts in excess of $1 billion in the
last taxable year ending during calendar year 2005, and an
ownership interest in a crude oil refiner of 15 percent or
more.
Effective date.--The provision applies to amounts paid or
incurred after the date of enactment.
13. Valuation of employee personal use of noncommercial aircraft (sec.
463 of the Senate amendment)
PRESENT LAW
Unless an exception applies, gross income includes
compensation for services, including fees, commissions, fringe
benefits, and similar items. In general, an employee or other
service provider must include in gross income the amount by
which the fair value of a fringe benefit exceeds the amount
paid by the individual. Treasury regulations provide rules
regarding the valuation of fringe benefits, including flights
on an employer-provided aircraft.\494\ In general, the value of
a non-commercial flight is determined under the base aircraft
valuation formula, also known as the Standard Industry Fare
Level formula or ``SIFL''.\495\ If the SIFL valuation rules do
not apply, the value of a flight on a company-provided aircraft
is generally equal to the amount that an individual would have
to pay in an arm's-length transaction to charter the same or a
comparable aircraft for that period for the same or a
comparable flight.\496\
---------------------------------------------------------------------------
\494\ Treas. Reg. sec. 1.61-21.
\495\ Treas. Reg. sec. 1.61-21(g).
\496\ Treas. Reg. sec. 1.61-21(b)(6).
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HOUSE BILL
No provision.
SENATE AMENDMENT
Under the Senate amendment, for purposes of income
inclusion, the value of any employee personal use of
noncommercial aircraft is equal to the excess of (1) the
greater of the fair market value of such use or actual cost of
such use (including all fixed and variable costs), over (2) the
amount paid by or on behalf of the employee for such use. Thus,
the SIFL valuation rules may no longer be used to determine the
value of such use.
Effective date.--The provision applies to use after the
date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
14. Application of Foreign Investment in Real Property Tax Act
(``FIRPTA'') to Regulated Investment Companies (``RICs'') (sec.
464 of the Senate amendment and sec. 897(h)(4) of the Code)
In general
A nonresident alien individual or foreign corporation is
taxable on its taxable income which is effectively connected
with the conduct of a trade or business within the United
States, at the income tax rates applicable to U.S. persons. A
nonresident alien individual is taxed (at a 30-percent rate) on
gains, derived from sources within the United States, from the
sale or exchange of capital assets if the individual is present
in the United States for 183 days or more during the taxable
year.
In addition, the Foreign Investment in Real Property Tax
Act (FIRPTA) \497\ generally treats a nonresident alien
individual or foreign corporation's gain or loss from the
disposition of a U.S. real property interest (USRPI) as income
that is effectively connected with a U.S. trade or business,
and thus taxable at the income tax rates applicable to U.S.
persons, including the rates for net capital gain. A foreign
investor subject to tax on this income is required to file a
U.S. income tax return under the normal rules relating to
receipt of income effectively connected with a U.S. trade or
business.
---------------------------------------------------------------------------
\497\ FIRPTA is codified in section 897 of the Code.
---------------------------------------------------------------------------
The payor of FIRPTA effectively connected income to a
foreign person is generally required to withhold U.S. tax from
the payment. Withholding is generally 10 percent of the sales
price in the case of a direct sale by the foreign person of a
USRPI, and 35 percent of the amount of a distribution to a
foreign person of proceeds attributable to such sales from an
entity such as a partnership.\498\ The foreign person can
request a refund with its U.S. tax return, if appropriate based
on that person's total U.S. effectively connected income and
deductions (if any) for the taxable year.
---------------------------------------------------------------------------
\498\ Sec. 1445 and Treasury regulations thereunder. The Treasury
department is authorized to issue regulations that would reduce the 35
percent withholding on distributions to 15 percent during the time that
the maximum income tax rate on dividends and capital gains of U.S.
persons is 15 percent.
Section 1445 statutorily requires the 10 percent withholding by the
purchaser of a USRPI and the 35 percent withholding (or less if
directed by Treasury) on certain distributions by partnerships, trusts,
and estates, among other situations. Treasury regulations prescribe the
35 percent withholding requirement for distributions by REITs to
foreign shareholders. Treas. Reg. sec. 1.1445-8. No regulations have
been issued relating specifically to RIC distributions, which first
became subject to FIRPTA in 2005.
---------------------------------------------------------------------------
USRPIs include interests in real property located in the
United States or the U.S. Virgin Islands, and stock of a
domestic U.S. real property holding company (USRPHC), generally
defined as any corporation, unless the taxpayer established
that the fair market value of its U.S. real property interests
is less than 50 percent of the combined fair market value of
all its real property interests (U.S. and worldwide) and of all
its assets used or held for use in a trade or business.\499\
However, any class of stock that is regularly traded on an
established securities market located in the U.S. is treated as
a U.S. real property interest only if the seller held more than
5 percent of the stock at any time during the 5-year period
ending on the date of disposition of the stock.\500\
---------------------------------------------------------------------------
\499\ Sec. 897(c)(2).
\500\ Sec. 897(c)(3).
---------------------------------------------------------------------------
Special rules for certain investment entities
Real estate investment trusts and regulated investment
companies are generally passive investment entities. They are
organized as U.S. domestic entities and are taxed as U.S.
domestic corporations. However, because of their special
status, they are entitled to deduct amounts distributed to
shareholders and, in some cases, to allow the shareholders to
characterize these amounts based on the type of income the REIT
or RIC received. Among numerous other requirements for
qualification as a REIT or RIC, the entity is required to
distribute to shareholders at least 90 percent of its income
(excluding net capital gain) annually.\501\ A REIT or RIC may
designate a capital gain dividend to its shareholders, who then
treat the amount designated as capital gain.\502\ A REIT or RIC
is taxed at regular corporate rates on undistributed income;
but the combination of the requirement to distribute income
other than net capital gain, plus the ability to declare a
capital gain dividend and avoid corporate level tax on such
income, can result in little, if any, corporate level tax paid
by a REIT or RIC. Instead, the shareholder-level tax on
distributions is the principal tax paid with respect to income
of these entities. The requirements for REIT eligibility
include primary investment in real estate assets (which assets
can include mortgages). The requirements for RIC eligibility
include primary investment in stocks and securities (which can
include stock of REITs or of other RICs).
---------------------------------------------------------------------------
\501\ Secs. 852(a)(1) and 852(b)(2)(A); 857(a)(1).
\502\ Secs. 852(b)(3); 857(b)(3).
---------------------------------------------------------------------------
FIRPTA contains special rules for real estate investment
trusts (REITs) and regulated investment companies (RICs).\503\
---------------------------------------------------------------------------
\503\ Sec. 897(h).
---------------------------------------------------------------------------
Stock of a ``domestically controlled'' REIT is not a
USRPI. The term ``domestically controlled'' is defined to mean
that less than 50 percent in value of the REIT has been owned
by non-U.S. shareholders during the 5-year period ending on the
date of disposition.\504\ For 2005, 2006, and 2007, a similar
exception applies to RIC stock. Thus, stock of a domestically
controlled REIT or RIC can be sold without FIRPTA consequences.
This exception applies regardless of whether the sale of stock
is made directly by a foreign person, or by a REIT or RIC whose
distributions to foreign persons of gain attributable to the
sale of USRPI's would be subject to FIRPTA as described below.
---------------------------------------------------------------------------
\504\ Sec. 897(h)(2) and (h)(4)(B).
---------------------------------------------------------------------------
A distribution by a REIT to a foreign shareholder, to the
extent attributable to gain from the REIT's sale or exchange of
USRPIs, is generally treated as FIRPTA gain to the shareholder.
An exception enacted in 2004 applies if the distribution is
made on a class of REIT stock that is regularly traded on an
established securities market located in the United States and
the foreign shareholder has not held more than 5 percent of the
class of stock at any time during the one-year period ending on
the date of the distribution.\505\ Where the exception applies,
the distribution to the foreign shareholder is treated as the
distribution of an ordinary dividend (rather than as a capital
gain dividend), subject to 30-percent (or lower treaty rate)
withholding.\506\
---------------------------------------------------------------------------
\505\ This exception, effective beginning in 2005, was added by
section 418 of the American Jobs Creation Act of 2004 (``AJCA''), Pub.
L. No. 108-357, and modified by section 403(p) of the Tax Technical
Corrections Act of 2005.
\506\ Sec. 857(b)(3)(F).
---------------------------------------------------------------------------
Prior to 2005, distributions by RICs to foreign
shareholders, to the extent attributable to the RIC's sale or
exchange of USRPIs, were not treated as FIRPTA gain. If
distributions were attributable to long-term capital gains, the
RIC could designate the distributions as long-term capital gain
dividends that would not be subject to any tax to the foreign
shareholder, rather than as a regular dividends subject to 30-
percent (or lower treaty rate) withholding.\507\ For 2005,
2006, and 2007, RICs are subject to the rule that had applied
to REITs prior to 2005, i.e., any distribution to a foreign
shareholder attributable to gain from the RIC's sale of a USRPI
is characterized as FIRPTA gain, without any exceptions.\508\
---------------------------------------------------------------------------
\507\ Sec. 852(b)(3)(C); Treas. Reg. sec. 1.1441-3(c)(2)(D).
\508\ This requirement for RICs was added by section 411 of the
American Jobs Creation Act of 2004 (``AJCA''), in connection with the
enactment of other rules that allow RICs to identify certain types of
distributions to foreign shareholders, attributable to the RIC's
receipt of short-term capital gains or interest income, as
distributions to such shareholders of such short-term gains or interest
income and thus not taxed to the foreign shareholders, rather than as
regular dividends that would be subject to withholding. See Secs.
871(k), 881(e), 1441(c)(12) and 1442(a). All these rules are scheduled
to expire at the end of 2007, as is the rule subjecting to FIRPTA all
distributions of RIC gain attributable to sales of U.S. real property
interests and the rule excepting from FIRPTA a foreign person's sale of
stock of a ``domestically controlled'' RIC.
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provision provides that
distributions by a RIC to foreign shareholders of amounts
attributable to the sale of USRPIs are not treated as FIRPTA
income unless the RIC itself is a U.S. real property holding
corporation (i.e. 50 percent or more of its value is
represented by its U.S. real property interests, including
investments in U.S. real property holding corporations). In
determining whether a RIC is a real property holding company
for this purpose, a special rule applies that requires the RIC
to include as U.S. real property interests its holdings of RIC
or REIT stock if such RIC or REIT is a U.S. real property
holding corporation, even if such stock is regularly traded on
an established securities market and even if the RIC owns less
than 5 percent of such stock. Another special rule requires the
RIC to include as U.S. real property interests its interests in
any domestically controlled RIC or REIT that is a U.S. real
property holding corporation.
Effective date.--The provision applies to distributions
with respect to taxable years beginning after December 31,
2004.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision with a clarification to the effective date. Under the
clarification, the provision takes effect as if included in the
provisions of section 411 of the American Jobs Creation Act of
2004 to which it relates.
15. Treatment of REIT and RIC distributions attributable to FIRPTA
gains (secs. 465 and 466 of the Senate amendment and secs. 897,
852, and 871 of the Code)
PRESENT LAW
General treatment of U.S.-source income of foreign investors
Fixed and determinable annual and periodical income
The United States generally imposes a flat 30-percent
tax, collected by withholding, on the gross amount of U.S.-
source investment income payments, such as interest, dividends,
rents, royalties and similar types of fixed and determinable
annual and periodical income, to nonresident alien individuals
and foreign corporations (``foreign persons'').\509\ Under
treaties, the United States may reduce or eliminate such taxes.
---------------------------------------------------------------------------
\509\ Secs. 871(a), 881, 1441, and 1442.
---------------------------------------------------------------------------
Dividends
Even taking into account U.S. treaties, the tax on a
dividend generally is not entirely eliminated. Instead, U.S.-
source portfolio investment dividends received by foreign
persons generally are subject to U.S. withholding tax at a rate
of at least 15 percent.
Interest
Although payments of U.S.-source interest that is not
effectively connected with a U.S. trade or business generally
are subject to the 30-percent withholding tax, there are
exceptions to that rule. For example, interest from certain
deposits with banks and other financial institutions is exempt
from tax.\510\ Original issue discount on obligations maturing
in 183 days or less from the date of original issue (without
regard to the period held by the taxpayer) is also exempt from
tax.\511\ An additional exception is provided for certain
interest paid on portfolio obligations.\512\ Such ``portfolio
interest'' generally is defined as any U.S.-source interest
(including original issue discount), not effectively connected
with the conduct of a U.S. trade or business, (i) on an
obligation that satisfies certain registration requirements or
specified exceptions thereto (i.e., the obligation is ``foreign
targeted''), and (ii) that is not received by a 10-percent
shareholder.\513\ With respect to a registered obligation, a
statement that the beneficial owner is not a U.S. person is
required.\514\ This exception is not available for any interest
received either by a bank on a loan extended in the ordinary
course of its business (except in the case of interest paid on
an obligation of the United States), or by a controlled foreign
corporation from a related person.\515\ Moreover, this
exception is not available for certain contingent interest
payments.\516\ For 2005, 2006 and 2007, a regulated investment
company (``RIC'') may designate certain distributions to
foreign shareholders that are attributable to the RIC's
qualified interest income as non-taxable interest distributions
to such foreign persons.\517\
---------------------------------------------------------------------------
\510\ Secs. 871(i)(2)(A) and 881(d).
\511\ Sec. 871(g).
\512\ Secs. 871(h) and 881(c).
\513\ Secs. 871(h)(3) and 881(c)(3).
\514\ Secs. 871(h)(2), (5) and 881(c)(2).
\515\ Sec. 881(c)(3).
\516\ Secs. 871(h)(4) and 881(c)(4).
\517\ This interest distribution rule was added by section 411 of
the American Jobs Creation Act of 2004 (``AJCA''), Pub. L. No. 108-357.
---------------------------------------------------------------------------
Capital gains
A foreign person generally is not subject to U.S. tax on
capital gain, including gain realized on the disposition of
stock or securities issued by a U.S. person, unless the gain is
effectively connected with the conduct of a trade or business
in the United States or such person is an individual present in
the United States for a period or periods aggregating 183 days
or more during the taxable year.\518\ A regulated investment
company (RIC) can generally designate dividends to foreign
persons that are attributable to the RIC's long term capital
gain as a long-term gain dividends that are not subject to
withholding.\519\ For 2005, 2006 and 2007, RICs may also
designate short-term capital gain dividends.\520\
---------------------------------------------------------------------------
\518\ Secs. 871(a)(2) and 881.
\519\ Treas. Reg. sec. 1.1441-3(c)(2)(D).
\520\ This short-term gain distribution rule was added by section
411 of AJCA.
---------------------------------------------------------------------------
For the years 2005, 2006 and 2007, RIC capital gain
dividends that are attributable to the sale of U.S. real
property interests (which can include stock of companies that
are U.S. real property holding companies) are subject to
special rules described below.
Real estate investment trusts (REITs) can also designate
long-term capital gain dividends to shareholders; but when made
to a foreign person such distributions attributable to the sale
of U.S. real property interests are also subject to the special
rules described below.
Foreign Investment in Real Property Tax Act (``FIRPTA'')
Unlike most other U.S. source capital gains, which are
generally not taxed to a foreign investor, the Foreign
Investment in Real Property Tax Act of 1980 (FIRPTA) subjects
gain or loss of a foreign person from the disposition of a U.S.
real property interest (USRPI) to tax as if the taxpayer were
engaged in a trade or business within the United States and the
gain or loss were effectively connected with such trade or
business.\521\ In addition to an interest in real property
located in the United States or the Virgin Islands, USRPIs
include (among other things) any interest in a domestic
corporation unless the taxpayer establishes that the
corporation was not, during a five-year period ending on the
date of the disposition of the interest, a U.S. real property
holding corporation (which is defined generally to mean any
corporation the fair market value of whose U.S. real property
interests equals or exceeds 50 percent of the sum of the fair
market values of its real property interests and any other of
its assets used or held for use in a trade or business).
---------------------------------------------------------------------------
\521\ Sec. 897.
---------------------------------------------------------------------------
Distributions by a REIT to its foreign shareholders
attributable to the sale of USRPI's are generally treated as
income from the sale of USRPIs.\522\ Treasury regulations
require the REIT to withhold at 35 percent on such a
distribution.\523\ However, there is an exception for
distributions by a REIT with respect to stock of the REIT that
is regularly traded on an established securities market located
in the U.S., to a foreign shareholder that has not held more
than 5 percent of the stock of the REIT for the one year period
ending with the date of the distribution.\524\ In such cases,
the REIT and the shareholder treat the distribution to a
foreign shareholder as the distribution of an ordinary
dividend,\525\ subject to the 30-percent (or lower treaty rate)
withholding applicable to dividends.
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\522\ Sec. 897(h)(1).
\523\ Treas. Reg. sec. 1.1445-8.
\524\ Sec. 897(h)(1)(second sentence).
\525\ Sec. 857(b)(3)(F).
---------------------------------------------------------------------------
For 2005, 2006, and 2007, any RIC distribution to a
foreign shareholder attributable to the sale of USRPIs is
treated as FIRPTA income, without any exceptions.\526\ However,
no Treasury regulations have been issued addressing withholding
obligations with respect to such distributions.
---------------------------------------------------------------------------
\526\ Sec. 897(h)(1)
---------------------------------------------------------------------------
A more complete description of the provisions of FIRPTA
and the special rules under FIRPTA that apply to RICs and REITs
is contained under ``Present Law'' for the provision
``Application of Foreign Investors in Real Property Tax Act
(FIRPTA) to Regulated Investment Companies (RICS).
Although the law thus provides rules for taxing foreign
persons under FIRPTA on distributions of gain from the sale of
USRPIs by RICs or REITs, some taxpayers may be taking the
position that if a foreign person invests in a RIC or REIT
that, in turn, invests in a lower-tier RIC or REIT that is the
entity that disposes of USRPIs and distributes the proceeds,
then the proceeds from such disposition by the lower-tier RIC
or REIT cease to be FIRPTA income when distributed to the
upper-tier RIC or REIT (which is not itself a foreign person),
and can thereafter be distributed by that latter entity to its
foreign shareholders as non- FIRPTA income of such RIC or REIT,
rather than continuing to be categorized as FIRPTA income.
Furthermore, RICs may take the position that in the absence of
regulations or a specific statutory rule addressing the
withholding rules for FIRPTA capital gain that is treated as
effectively connected with a U.S. trade or business, such gain
should be considered capital gain for which no withholding is
required.
In addition, some foreign persons may be attempting to
avoid FIRPTA tax on a distribution from a RIC or a REIT, by
selling the RIC or REIT stock shortly before the distribution
and buying back the stock shortly after the distribution. If
the stock is not a U.S. real property interest in the hands of
the foreign seller, that person would take the position that
the gain on the sale of the stock is capital gain not subject
to U.S. tax. Stock of a RIC or REIT that is ``domestically
controlled'' is not a U.S. real property interest.\527\
---------------------------------------------------------------------------
\527\ Sec. 897(g)(3). A RIC or REIT is ``domestically controlled''
if less than 50 percent in value of the entity's stock is held by
foreign persons. RIC stock ceases to be eligible for this exception as
of the end of 2007. Distributions by a domestically controlled RIC or
REIT, if attributable to the sale of U.S. real property interests, are
not exempt from FIRPTA by reason of such domestic control. A foreign
person that would be subject to FIRPTA on receipt of a distribution
from such an entity might sell its stock before the distribution and
repurchase stock after the distribution in an attempt to avoid FIRPTA
consequences.
Under a different exception from FIRPTA, applicable to stock of all
entities, neither RIC nor REIT stock is a U.S. real property interest
if the RIC or REIT stock is regularly traded on an established
securities market located in the United States and if the stock sale is
made by a foreign shareholder that has not owned more than five percent
of the stock during the five years ending with the date of the sale.
Sec. 897(c)(3). Distributions by a REIT to a foreign person,
attributable to the sale of U.S. real property interests, are also not
subject to FIRPTA if made with respect to stock that is regularly
traded on an established securities market located in the United States
and made to a foreign person that has not held more than five percent
of the REIT stock for the one-year period ending on the date of
distribution. (Sec. 897(h)(1), second sentence.) Thus, any foreign
shareholder of such a regularly traded REIT that would be exempt from
FIRPTA on a sale of the REIT stock immediately before a distribution
would also generally be exempt from FIRPTA on a distribution from the
REIT if such shareholder held the stock through the date of the
distribution, due to the holding period requirements. Distributions
that are not subject to FIRPTA under this five percent exception are
recharacterized as ordinary dividends and thus would normally be
subject to ordinary dividend withholding rules. Secs. 857(b)(3)(F) and
1441.
---------------------------------------------------------------------------
If the stock is a USRPI in the hands of the foreign
person, the transferee generally is required to withhold 10
percent of the gross sales price under general FIRPTA
withholding rules.\528\
---------------------------------------------------------------------------
\528\ Secs. 1445(a) and 1445(e).
---------------------------------------------------------------------------
HOUSE BILL
No provision.
SENATE AMENDMENT
The first part of the Senate amendment provision requires
any distribution that is made by a RIC or a REIT that would
otherwise be subject to FIRPTA because the distribution is
attributable to the disposition of a U.S. real property
interest (USRPI) to retain its character as FIRPTA income when
distributed to any other RIC or REIT, and to be treated as if
it were from the disposition of a USRPI by that other RIC or
REIT. Under the provision, a RIC continues to be subject to
FIRPTA, even after December 31, 2007, in any case in which a
REIT makes a distribution to the RIC that is attributable to
gain from the sale of U.S. real property interests.
The second part of the Senate amendment provision
provides that a distribution by a RIC to a foreign shareholder,
or to a RIC or REIT shareholder, attributable to sales of
USRPIs is not treated as gain from the sale of a USRPI by that
shareholder if the distribution is made with respect to a class
of RIC stock that is regularly traded on an established
securities market \529\ located in the U.S. and if such
shareholder did not hold more than 5 percent of such stock
within the one year period ending on the date of the
distribution. Such distributions instead are treated as
dividend distributions.\530\
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\529\ It is intended that the rules generally applicable for this
purpose under section 897 also apply under the provision in determining
whether a class of interests is regularly traded on an established
securities market located in the United States. For example, at the
present time the rules currently in force for this purpose include
Temp. Reg. sec. 1.897-9T(d)(2).
\530\ The provision treats such distributions as ordinary dividend
distributions rather than as distributions of long term capital gain.
This rule is the same as the present law rule for publicly traded REITs
making a distribution to a foreign shareholder. In addition, under the
immediately preceding provision (sec. 464) of the Senate amendment, for
the years 2005, 2006 and 2007 that RICs are subject to FIRPTA, a RIC
can make distributions from sales of USRPIs to shareholders who do not
meet this rule, and such distributions will be treated not as dividends
but as non-taxable long- or short-term capital gain, if so designated
by the RIC, as long as the RIC itself is not a USRPHC after applying
the special rules for counting the RIC's ownership of REIT or other RIC
stock.
---------------------------------------------------------------------------
The third part of the Senate amendment provision requires
a foreign person that disposes of stock of a RIC or REIT during
the 30-day period preceding a distribution on that stock that
would have been treated as a distribution from the disposition
of a USRPI, that acquires an identical stock interest during
the 60 day period beginning the first day of such 30-day period
preceding the distribution, and that does not in fact receive
the distribution in a manner that subjects the person to tax
under FIRPTA, to pay FIRPTA tax on an amount equal to the
amount of the distribution that was not taxed under FIRPTA as a
result of the disposition. A foreign person is treated as
having acquired any interest acquired by any person treated as
related to that foreign first person under section
465(b)(3)(C).\531\
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\531\ These relationships generally include persons that are
engaged in trades or businesses under common control (generally, a more
than 50 percent relationship) and also include persons that have a more
than 10 percent relationship, such as (for example) a corporation and
an individual owning more than 10 percent of the corporation; or a
corporation and a partnership if the same persons own more than 10
percent of the interests in each.
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This third part of the Senate amendment provision applies
only in the case of a shareholder that would have been treated
as receiving FIRPTA income on the distribution if that
shareholder had in fact received the distribution, but that
would not have been treated as receiving FIRPTA income if the
form of the disposition transaction were respected. This
category of persons consists of persons that are shareholders
in a domestically controlled RIC or REIT (since sales of shares
of such an entity are not subject to FIRPTA tax), but does not
include a person who sells stock that is regularly traded on an
established securities market located in the U.S. and who did
not own more than five percent of such stock during the one
year period ending on the date of the distribution (since such
a person would not have been subject to FIRPTA tax under
present law for REITs and under the second part of the Senate
amendment provision for RICs, supra., if that person had
received the dividend instead of disposing of the stock).
Notwithstanding the recharacterization of the disposition
as involving a FIRPTA distribution to the foreign person, no
withholding on disposition proceeds to the foreign person on
the disposition of such stock would be required. No inference
is intended as to what situations under present law would or
would not be respected as dispositions.
Effective dates.--The first part of the Senate amendment
provision is effective for distributions with respect to
taxable years of a RIC or REIT beginning after the date of
enactment.
The second part of the Senate amendment provision applies
to dividends with respect to taxable years of regulated
investment companies beginning after December 31, 2004.
The third part of the Senate amendment provision is
effective for dispositions after December 31, 2005, in taxable
years ending after that date.
CONFERENCE AGREEMENT
The conference agreement includes the Senate amendment
provision with modifications and clarifications.
The conference agreement provides that the second part of
the Senate amendment provision, treating certain distributions
attributable to sales of U.S. real property interests as
dividends subject to dividend withholding, applies when the
distribution is made to a foreign shareholder of a RIC or REIT,
but does not apply when the distribution is made to another RIC
or a REIT. In such cases, the character of the distribution as
FIRPTA gain is retained and must be tracked by the recipient
RIC or REIT, but the distribution itself does not become
dividend income in the hands of such RIC or REIT. Therefore,
such recipient RIC or REIT can in turn distribute amounts
attributable to that distribution (attributable to the sale of
USRPIs) to its U.S shareholders as capital gain. However, if
any recipient RIC or REIT in turn distributes to a foreign
shareholder amounts that are attributable to a sale by a lower
tier RIC or REIT of USRPIs, such amounts distributed to a
foreign shareholder shall be treated as FIRPTA gain or as
dividend income, according to whether or not such distribution
to such foreign shareholder qualifies for dividend treatment.
The conference agreement amends section 1445 so that it
explicitly requires withholding on RIC and REIT distributions
to foreign persons, attributable to the sale of USRPIs, at 35
percent, or, to the extent provided by regulations, at 15
percent.\532\
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\532\ This provision is similar to present law section 1445(c)(1).
The regulatory authority to reduce the withholding to 15 percent
sunsets in accordance with the same sunset that applies to section
1445(c)(1), at the time that the present law maximum 15 percent rate on
dividends is scheduled to sunset.
Treasury regulations under section 1445 already impose FIRPTA
withholding on REITs under present law. Treasury has not yet written
regulations applicable to RICs. No inference is intended regarding the
existing Treasury regulations in force under section 1445 with respect
to REITs.
---------------------------------------------------------------------------
The conference agreement clarifies that the treatment of
a RIC as a qualified investment entity continues after December
2007 with respect to a RIC that receives a distribution from a
REIT, not only for purposes of the distribution rules,
including withholding on distributions to foreign shareholders,
but also for purposes of the new ``wash sale'' rules of the
provision.
The conference agreement modifies the new ``wash sale''
rule. The period within which the basic ``wash-sale'' rule
applies is changed from 60 days to 61 days.\533\ The definition
of ``applicable wash sales transaction'' is expanded to cover
not only situations in which the taxpayer acquires a
substantially identical interest, but also situations in which
the taxpayer enters into a contract or option to acquire such
an interest. The related party rule is also modified to apply
the 50-percent relationship test under section 267(b) and
707(b)(1) rather than a 10-percent test.
---------------------------------------------------------------------------
\533\ Thus the period includes the 30 days before and the 30 days
after the ex-dividend date, in addition to the ex-dividend date itself.
---------------------------------------------------------------------------
In addition, treatment of a foreign shareholder of a RIC
or REIT as if it had received a FIRPTA distribution that is
treated as U.S. effectively connected income is extended to
transactions that meet the definition of ``substitute dividend
payments'' provided for purposes of section 861 and that would
be properly treated by the foreign taxpayer as receipt of a
distribution of FIRPTA gain if the distribution from the RIC or
REIT had itself been received by the taxpayer, but that, by
virtue of the substitute dividend payment, is not so treated
but for the provision,\534\ as well as to other similar
arrangements to which Treasury may extend the rules.
---------------------------------------------------------------------------
\534\ The conference agreement adopts the definition of
``substitute dividend payment'' used for purposes of section 861, which
definition applies to determine substitute dividend payments under the
conference agreement provision, even though the recipient may not be an
individual and even though the underlying payment would not have been
treated as a dividend to the recipient but as a distribution of FIRPTA
gain. Treasury regulations section 1.861-3(a)(6) defines a ``substitute
dividend payment'' as a payment, made to the transferor of a security
in a securities lending transaction or a sale-repurchase transaction,
of an amount equivalent to a dividend distribution which the owner of
the transferred security is entitled to receive during the term of the
transaction. The regulation applies to amounts received or accrued by
the taxpayer. The regulation defines a securities lending transaction
as a transfer of one or more securities that is described in section
1058(a) or a substantially similar transaction. The regulation defines
a sale-repurchase transaction as an agreement under which a person
transfers a security in exchange for cash and simultaneously agrees to
receive substantially identical securities from the transferee in the
future in exchange for cash. Under the regulation, a ``substitute
dividend payment'' is generally sourced and in many instances
characterized in the same manner as the underlying distribution with
respect to the transferred security.
---------------------------------------------------------------------------
Effective date.--The first part of the conference
agreement provision, relating to distributions generally,
applies to distributions with respect to taxable years of RICs
and REITs beginning after December 31, 2005, except that no
withholding is required under sections 1441, 1442, or 1445 with
respect to any distribution before the date of enactment if
such amount was not otherwise required to be withheld under any
such section as in affect before the amendments made by the
conference agreement.
The second part of the conference agreement, relating to
the ``wash sale'' and substitute dividend payment transactions,
is applicable to distributions and substitute dividend payments
occurring on or after the 30th day following the date of
enactment.
No inference is intended regarding the treatment under
present law of any transactions addressed by the conference
agreement.
16. Credit to holders of rural renaissance bonds (sec. 469 of the
Senate amendment)
PRESENT LAW
In general
Interest on bonds issued by State and local governments
generally is excluded from gross income for Federal income tax
purposes if the proceeds of such bonds are used to finance
direct activities of governmental units or if such bonds are
repaid with revenues of governmental units. These bonds are
called ``governmental bonds.'' Interest on State or local
government bonds issued to finance activities of private
persons is taxable unless a specific exception applies. These
bonds are called ``private activity bonds.'' The term ``private
person'' generally includes the Federal Government and all
other individuals and entities other than States or local
governments.
Private activity bonds are eligible for tax-exemption if
issued for certain purposes permitted by the Code (``qualified
private activity bonds''). Generally, qualified private
activity bonds are subject to restrictions on the use of
proceeds for the acquisition of land and existing property, use
of proceeds to finance certain specified facilities (e.g.,
airplanes, skyboxes, other luxury boxes, health club
facilities, gambling facilities, and liquor stores), and use of
proceeds to pay costs of issuance (e.g., bond counsel and
underwriter fees). Small issue and redevelopment also are
subject to additional restrictions on the use of proceeds for
certain facilities (e.g., golf courses and massage parlors).
Moreover, the term of qualified private activity bonds
generally may not exceed 120 percent of the economic life of
the property being financed and certain public approval
requirements (similar to requirements that typically apply
under State law to issuance of governmental debt) apply under
Federal law to issuance of private activity bonds.
Tax-credit bonds
As an alternative to traditional tax-exempt bonds, States
and local governments may issue tax-credit bonds for certain
purposes. Rather than receiving interest payments, a taxpayer
holding a tax-credit bond on an allowance date is entitled to a
credit. Generally, the credit amount is includible in gross
income (as if it were a taxable interest payment on the bond),
and the credit may be claimed against regular income tax and
alternative minimum tax liability. The following types of tax-
credit bonds may be issued under present law: ``qualified zone
academy bonds,'' which are bonds issued for the purpose of
renovating, providing equipment to, developing course materials
for use at, or training teachers and other personnel at certain
school facilities; ``clean renewable energy bonds,'' which are
bonds issued to finance for facilities that would qualify for
the tax credit under section 45 without regard to the placed in
service date requirements of that section; and ``gulf tax
credit bonds,'' which are bonds issued by the States of
Louisiana, Mississippi, and Alabama to pay principal, interest,
or premium on certain prior bonds.
Arbitrage restrictions on tax-exempt bonds
To prevent States and local governments from issuing more
tax-exempt bonds than is necessary for the activity being
financed or from issuing such bonds earlier than needed for the
purpose of the borrowing, the Code includes arbitrage
restrictions limiting the ability to profit from investment of
tax-exempt bond proceeds. In general, arbitrage profits may be
earned only during specified periods (e.g., defined ``temporary
periods'' before funds are needed for the purpose of the
borrowing) or on specified types of investments (e.g.,
``reasonably required reserve or replacement funds''). Subject
to limited exceptions, profits that are earned during these
periods or on such investments must be rebated to the Federal
Government. Governmental bonds are subject to less restrictive
arbitrage rules than most private activity bonds.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment creates a new category of tax-credit
bonds to finance certain projects located in rural areas
(``Rural Renaissance Bonds''). As with present law tax-credit
bonds, the taxpayer holding Rural Renaissance Bonds on the
allowance date would be entitled to a tax credit. The amount of
the credit would be determined by multiplying the bond's credit
rate by the face amount on the holder's bond. The credit would
be includible in gross income (as if it were an interest
payment on the bond) and could be claimed against regular
income tax liability and alternative minimum tax liability.
Under the Senate amendment, Rural Renaissance Bonds are
defined as any bonds issued by a qualified issuer if, in
addition to the requirements discussed below, 95 percent or
more of the proceeds of such bonds are used to finance capital
expenditures incurred for one or more qualified projects.
``Qualified projects'' include any of the following projects
located in a rural area: (i) a water or waste treatment
project, (ii) an affordable housing project, (iii) a community
facility project, including hospitals, fire and police
stations, and nursing and assisted-living facilities, (iv) a
value-added agriculture or renewable energy facility project
for agricultural producers or farmer-owned entities, including
any project to promote the production, processing, or retail
sale of ethanol (including fuel at least 85 percent of the
volume of which consists of ethanol), bio-diesel, animal waste,
biomass, raw commodities, or wind as a fuel, (v) a distance
learning or telemedicine project, (vi) a rural utility
infrastructure project, including any electric or telephone
system, (vii) a project to expand broadband technology, (viii)
a rural teleworks project, and (ix) any of the previously
described projects if carried out by the Delta Regional
Authority. A ``rural area'' means any area other than a city or
town which has a population of greater than 50,000 inhabitants
or the urbanized area contiguous and adjacent to such a city or
town.
For purposes of the provision, the term ``qualified
issuer'' means any not-for-profit cooperative lender which, as
of the date of enactment of this provision, has received a
guarantee under the Rural Electrification Act. A qualified
issuer must also meet a user fee requirement during the period
any Rural Renaissance Bond issued by such qualified issuer is
outstanding. The user fee requirement is met if the qualified
issuer makes semi-annual grants for qualified projects equal to
the outstanding principal of Rural Renaissance Bond issued by
such issuer multiplied by one-half the rate on United States
Treasury securities of the same maturity.
The Senate amendment imposes a maximum maturity
limitation on Rural Renaissance Bonds. The maximum maturity is
the term which the Secretary estimates will result in the
present value of the obligation to repay the principal on any
bonds being equal to 50 percent of the face amount of such
bond. The provision also requires level amortization of Rural
Renaissance Bonds during the period such bonds are outstanding.
To qualify as Rural Renaissance Bonds, the qualified
issuer of such bonds must reasonably expect to and actually
spend 95 percent or more of the proceeds of such bonds on
qualified projects within the five-year period that begins on
the date of issuance. To the extent less than 95 percent of the
proceeds are used to finance qualified projects during the
five-year spending period, bonds will continue to qualify as
Rural Renaissance Bonds if unspent proceeds are used within 90
days from the end of such five-year period to redeem any
``nonqualified bonds.'' For these purposes, the amount of
nonqualified bonds is to be determined in the same manner as
Treasury regulations under section 142. In addition, the
provision provides that the five-year spending period may be
extended by the Secretary upon the qualified issuer's request.
Under the provision, Rural Renaissance Bonds are subject
to the arbitrage requirements of section 148 that apply to
traditional tax-exempt bonds. Principles under section 148 and
the regulations thereunder shall apply for purposes of
determining the yield restriction and arbitrage rebate
requirements applicable to Rural Renaissance Bonds. For
example, for arbitrage purposes, the yield on an issue of Rural
Renaissance Bonds is computed by taking into account all
payments of interest, if any, on such bonds, i.e., whether the
bonds are issued at par, premium, or discount. However, for
purposes of determining yield, the amount of the credit allowed
to a taxpayer holding Rural Renaissance Bonds is not treated as
interest, although such credit amount is treated as interest
income to the taxpayer.
Rural Renaissance Bonds must be designated as such by the
qualified issuer and must be issued in registered form. The
provision also requires issuers of Rural Renaissance Bonds to
report issuance to the IRS in a manner similar to that required
for tax-exempt bonds. There is a national limitation of $200
million of Rural Renaissance Bonds that the Secretary may
allocate, in the aggregate, to qualified projects. The
authority to issue Rural Renaissance Bonds expires December 31,
2009.
Effective date.--The provision is effective for bonds
issued after the date of enactment and before January 1, 2010.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
17. Modify foreign tax credit rules for large integrated oil companies
which are dual capacity taxpayers (sec. 470 of the Senate
amendment and sec. 901 of the Code)
PRESENT LAW
U.S. persons are subject to U.S. income tax on their
worldwide income. A credit against U.S. tax on foreign source
income is allowed for foreign taxes that are paid or
accrued.\535\ In addition, a domestic corporation which owns 10
percent or more of the voting stock of a foreign corporation
from which it receives dividends or with respect to which it is
taxed under the rules of subpart F is deemed to have paid a
portion of the foreign taxes of such foreign corporation.\536\
The foreign tax credit is available only for foreign income,
war profits, and excess profits taxes, and for certain taxes
that qualify under section 903 as imposed ``in lieu'' of such
taxes. Other foreign levies generally are treated as deductible
expenses only.
---------------------------------------------------------------------------
\535\ Sec. 901. Foreign taxes include taxes imposed by possessions.
\536\ Secs. 902 and 960. Foreign corporations include corporations
created or organized in possessions.
---------------------------------------------------------------------------
The amount of foreign tax credits that a taxpayer may
claim in a year is subject to a limitation that prevents
taxpayers from using foreign tax credits to offset U.S. tax on
U.S. source income. The foreign tax credit limitation is
calculated separately for specific categories of income. The
amount of creditable taxes paid or accrued (or deemed paid) in
any taxable year which exceeds the foreign tax credit
limitation is permitted to be carried back one year and carried
forward 10 years.
Treasury regulations provide detailed rules for
determining whether a foreign levy is a creditable income tax.
A levy generally is a tax if it is a compulsory payment under
the authority of a foreign country to levy taxes and is not
compensation for a specific economic benefit provided by a
foreign country. A taxpayer that is subject to a foreign levy
and also receives a specific economic benefit from such country
is considered a ``dual capacity taxpayer.'' \537\ Treasury
regulations provide that the portion of a foreign levy paid by
a dual capacity taxpayer that is considered a tax is determined
based on all the facts and circumstances.\538\ Alternatively,
under a safe harbor provided in the regulations, the portion of
a foreign levy paid by a dual capacity taxpayer that is
creditable is determined based on the foreign country's
generally imposed income tax or, if the foreign country has no
generally imposed income tax, the U.S. tax.\539\
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\537\ Treas. Reg. sec. 1.901-2(a)(2)(ii)(A).
\538\ Treas. Reg. sec. 1.901-2A(c)(2)(i).
\539\ Treas. Reg. sec. 1.901-2A(e).
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HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment denies the foreign tax credit with
respect to all amounts paid or accrued (or deemed paid) to any
foreign country or possession by a large integrated oil company
which is a dual capacity taxpayer if the country or possession
does not impose a generally applicable income tax. The
provision modifies the safe harbor rule currently provided by
Treasury Regulations. Under the provision, as under present
law, a dual capacity taxpayer is a person who is subject to a
levy in a foreign country or possession and also directly or
indirectly receives (or will receive) a specific economic
benefit (as determined in accordance with regulations) from
such foreign country or possession. A generally applicable
income tax is an income tax that is generally imposed on income
derived from a trade or business conducted within that foreign
country or possession (which may include taxes qualifying under
section 903 as imposed in lieu of income taxes), provided that
the tax has substantial application (by its terms and in
practice) to persons who are not dual capacity taxpayers and to
persons who are citizens or residents of the foreign country or
possession.
If the country does impose a generally applicable income
tax, the foreign tax credit is denied to the extent that such
amounts exceed the amount (as determined under regulations)
which is paid by the dual capacity taxpayer pursuant to such
generally applicable income tax, or which would have been paid
if such generally applicable income tax were applicable to the
dual capacity taxpayer. Amounts not in excess of the amount
calculated under the generally applicable income tax are
subject to all other rules pertaining to foreign tax credits.
Amounts for which the foreign tax credit is denied under the
provision are not subject to carryback or carryforward, but
could constitute deductible expenses if such amounts qualify
under the relevant deduction provisions. The provision does not
apply to the extent contrary to any treaty obligation of the
United States.
The provision applies only to ``large integrated oil
companies.'' These are persons that meet all of the following
requirements for a particular taxable year: (1) the person is a
producer of crude oil; (2) the person has gross receipts in
excess of one billion dollars; (3) the person or persons
related to such person has an average daily worldwide
production of crude oil of at least 500,000 barrels; and (4)
either (a) the person or persons related to such person sells
at retail oil or natural gas (excluding bulk sales of such
items to commercial or industrial users), or any product
derived from oil or natural gas (excluding bulk sales of
aviation fuels to the Department of Defense), in an aggregate
amount of five million dollars or greater, or (b) the person or
persons related to such person engage in the refining of crude
oil, if the aggregate average daily refinery runs for that
taxable year exceeds 75,000 barrels. For purposes of
requirement (4), a person is a related person with respect to
another person if either one owns a five percent or greater
interest in the other, or if a third person owns such an
interest in both.
Effective date.--The provision applies to taxes paid or
accrued in taxable years beginning after the date of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
18. Disability preference program for tax collection contracts (sec.
471 of the Senate amendment)
PRESENT LAW
Under present law, the IRS may use private debt
collection companies to locate and contact taxpayers owing
outstanding tax liabilities of any type and to arrange payment
of those taxes by the taxpayers.
There are several procedural conditions applicable to the
use of private debt collection contracts. First, provisions of
the Fair Debt Collection Practices Act apply to the private
debt collection company. Second, taxpayer protections that are
statutorily applicable to the IRS are also made statutorily
applicable to the private sector debt collection companies. In
addition, taxpayer protections that are statutorily applicable
to IRS employees also are made statutorily applicable to
employees of private sector debt collection companies. Third,
subcontractors are prohibited from having contact with
taxpayers, providing quality assurance services, and composing
debt collection notices; any other service provided by a
subcontractor must receive prior approval from the IRS.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that the IRS may not enter
a contract with a private debt collection company after April
1, 2006, until the Secretary implements a qualified disability
preference program. A qualified disability preference program
is a program that requires qualified employers to receive not
less than 10 percent of taxpayer accounts (based on dollar
value) awarded to private debt collection companies. A
qualified employer is an employer who, as of the date the
private debt collection contract is awarded, employs not less
than 50 severely disabled individuals or not less than 30
percent of such employer's employees are severely disabled. In
addition, a qualified employer must agree that not more than 90
days after being awarded a private debt collection contract not
less than 35 percent of the employees providing services under
the private debt collection contract shall be severely disabled
individuals and hired after the date the contract is awarded.
For purposes of the provision, a severely disabled
individual means (i) a veteran of the United States armed
forces with a disability of 50 percent or greater determined by
law or the Secretary of Veterans Affairs to be service-
connected or (ii) any individual who is a disabled beneficiary
as defined by the Social Security Act or would be considered to
such a disabled beneficiary but for having income or resources
in excess of limits established by the Social Security Act.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE VI--SUNSET OF CERTAIN PROVISIONS AND AMENDMENTS
(Sec. 501 of the Senate amendment)
PRESENT LAW
Reconciliation is a procedure under the Congressional
Budget Act of 1974 (the ``Budget Act'') by which Congress
implements spending and tax policies contained in a budget
resolution. The Budget Act contains numerous rules enforcing
the scope of items permitted to be considered under the budget
reconciliation process. One such rule, the so-called ``Byrd
rule,'' was incorporated into the Budget Act in 1990. The Byrd
rule, named after its principal sponsor, Senator Robert C.
Byrd, is contained in section 313 of the Budget Act. The Byrd
rule generally permits members to raise a point of order
against extraneous provisions (those which are unrelated to the
goals of the reconciliation process) from either a
reconciliation bill or a conference report on such bill.
Under the Byrd rule, a provision is considered to be
extraneous if it falls under one or more of the following six
definitions:
1. It does not produce a change in outlays or revenues;
2. It produces an outlay increase or revenue decrease
when the instructed committee is not in compliance with its
instructions;
3. It is outside of the jurisdiction of the committee
that submitted the title or provision for inclusion in the
reconciliation measure;
4. It produces a change in outlays or revenues which is
merely incidental to the nonbudgetary components of the
provision;
5. It would increase the deficit for a fiscal year beyond
those covered by the reconciliation measure; and
6. It recommends changes in Social Security.
HOUSE BILL
No provision.
SENATE AMENDMENT
To ensure compliance with the Budget Act, the Senate
amendment provides that the provisions of, and amendments made
by, title I, subtitle A of title II, and title III of the
Senate amendment shall not apply to taxable years beginning
after September 30, 2010, and that the Code shall be applied
and administered to such years as if those provisions and
amendments had never been enacted.
Effective date.--The provision is effective on the date
of enactment.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE VII--FUNDING FOR MILITARY OPERATIONS
(Secs. 601 and 602 of the Senate amendment)
PRESENT LAW
Present law does not include the Senate amendment
provision.
HOUSE BILL
No provision.
SENATE AMENDMENT
The Senate amendment provides that there is to be
appropriated, out of any money in the Treasury that is not
otherwise appropriated, for the fiscal years 2006 through 2010,
the following amounts, to be used for resetting and
recapitalizing equipment being used in theaters of operations:
(1) $16,900,000,000 for operations and maintenance of the Army;
(2) $1,800,000,000 for aircraft for the Army; (3)
$6,300,000,000 for other Army procurement; (4) $10,000,000,000
for wheeled and tracked combat vehicles for the Army; (5)
$467,000,000 for the Army working capital fund; (6) $6,000,000
for missiles for the Department of Defense; (7) $100,000,000
for defense wide procurement for the Department of Defense; (8)
$4,500,000,000 for Marine Corps procurement; (9) $4,500,000,000
for operations and maintenance of the Marine Corps; and (10)
$2,700,000,000 for Navy aircraft procurement.
CONFERENCE AGREEMENT
The conference agreement does not include the Senate
amendment provision.
TITLE VIII--OTHER REVENUE OFFSET PROVISIONS
A. Imposition of Withholding on Certain Payments Made by Government
Entities
(Sec. 3402 of the Code)
PRESENT LAW
Withholding requirements
Employers are required to withhold income tax on wages
paid to employees, including wages and salaries of employees or
elected officials of Federal, State, and local government
units. Withholding rates vary depending on the amount of wages
paid, the length of the payroll period, and the number of
withholding allowances claimed by the employee.
Certain non-wage payments also are subject to mandatory
or voluntary withholding. For example:
Employers are required to withhold FICA and
Railroad Retirement taxes from wages paid to their employees.
Withholding rates are generally uniform.
Payors of pensions are required to withhold from
payments made to payees, unless the payee elects no
withholding.\540\ Withholding from periodic payments is at
variable rates, parallel to income tax withholding from wages,
whereas withholding from nonperiodic payments is at a flat 10-
percent rate.
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\540\ Withholding at a rate of 20 percent is required in the case
of an eligible rollover distribution that is not directly rolled over.
---------------------------------------------------------------------------
A variety of payments (such as interest and
dividends) are subject to backup withholding if the payee has
not provided a valid taxpayer identification number (TIN).
Withholding is at a flat rate based on the fourth lowest rate
of tax applicable to single taxpayers.
Certain gambling proceeds are subject to
withholding. Withholding is at a flat rate based on the third
lowest rate of tax applicable to single taxpayers.
Voluntary withholding applies to certain Federal
payments, such as Social Security payments. Withholding is at
rates specified by Treasury regulations.
Voluntary withholding applies to unemployment
compensation benefits. Withholding is at a flat 10-percent
rate.
Foreign taxpayers are generally subject to
withholding on certain U.S.-source income which is not
effectively connected with the conduct of a U.S. trade or
business. Withholding is at a flat 30-percent rate (14-percent
for certain items of income).
Many payments, including payments made by government
entities, are not subject to withholding under present law. For
example, no tax is generally withheld from payments made to
workers who are not classified as employees (i.e., independent
contractors).
Information reporting
Present law imposes numerous information reporting
requirements that enable the Internal Revenue Service (``IRS'')
to verify the correctness of taxpayers' returns. For example,
every person engaged in a trade or business generally is
required to file information returns for each calendar year for
payments of $600 or more made in the course of the payor's
trade or business. Special information reporting requirements
exist for employers required to deduct and withhold tax from
employees' income. In addition, any service recipient engaged
in a trade or business and paying for services is required to
make a return according to regulations when the aggregate of
payments is $600 or more. Government entities are specifically
required to make an information return, reporting certain
payments to corporations as well as individuals. Moreover, the
head of every Federal executive agency that enters into certain
contracts must file an information return reporting the
contractor's name, address, TIN, date of contract action,
amount to be paid to the contractor, and any other information
required by Forms 8596 (Information Return for Federal
Contracts) and 8596A (Quarterly Transmittal of Information
Returns for Federal Contracts).
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement requires withholding on certain
payments to persons providing property or services made by the
Government of the United States, every State, every political
subdivision thereof, and every instrumentality of the foregoing
(including multi-State agencies). The withholding requirement
applies regardless of whether the government entity making such
payment is the recipient of the property or services. Political
subdivisions of States (or any instrumentality thereof) with
less than $100 million of annual expenditures for property or
services that would otherwise be subject to withholding under
this provision are exempt from the withholding requirement.
The rate of withholding is three percent on all payments
regardless of whether the payments are for property or
services. Payments subject to withholding under the provision
include any payment made in connection with a government
voucher or certificate program which functions as a payment for
property or services. For example, payments to a commodity
producer under a government commodity support program are
subject to the withholding requirement. The provision imposes
information reporting requirements on the payments that are
subject to withholding under the provision.
The provision does not apply to any payments made through
a Federal, State, or local government public assistance or
public welfare program for which eligibility is determined by a
needs or income test. For example, payments under government
programs providing food vouchers or medical assistance to low-
income individuals are not subject to withholding under the
provision. However, payments under government programs to
provide health care or other services that are not based on the
needs or income of the recipients are subject to withholding,
including programs where eligibility is based on the age of the
beneficiary.
The provision does not apply to payments of wages or to
any other payment with respect to which mandatory (e.g., U.S.-
source income of foreign taxpayers) or voluntary (e.g.,
unemployment benefits) withholding applies under present law.
The provision does not exclude payments that are potentially
subject to backup withholding under section 3406. If, however,
payments are actually being withheld under backup withholding,
withholding under the provision does not apply.
The provision also does not apply to the following:
payments of interest; payments for real property; payments to
tax-exempt entities or foreign governments; intra-governmental
payments; payments made pursuant to a classified or
confidential contract (as defined in section 6050M(e)(3)); and
payments to government employees that are not otherwise
excludable from the new withholding provision with respect to
the employees' services as an employees.
Effective date.--The provision applies to payments made
after December 31, 2010.
B. Eliminate Income Limitations on Roth IRA Conversions
(Sec. 408A of the Code)
PRESENT LAW
There are two general types of individual retirement
arrangements (``IRAs''): traditional IRAs and Roth IRAs. The
total amount that an individual may contribute to one or more
IRAs for a year is generally limited to the lesser of: (1) a
dollar amount ($4,000 for 2006); and (2) the amount of the
individual's compensation that is includible in gross income
for the year. In the case of an individual who has attained age
50 before the end of the year, the dollar amount is increased
by an additional amount ($1,000 for 2006). In the case of a
married couple, contributions can be made up to the dollar
limit for each spouse if the combined compensation of the
spouses that is includible in gross income is at least equal to
the contributed amount. IRA contributions in excess of the
applicable limit are generally subject to an excise tax of six
percent per year until withdrawn.
Contributions to a traditional IRA may or may not be
deductible. The extent to which contributions to a traditional
IRA are deductible depends on whether or not the individual (or
the individual's spouse) is an active participant in an
employer-sponsored retirement plan and the taxpayer's AGI. An
individual may deduct his or her contributions to a traditional
IRA if neither the individual nor the individual's spouse is an
active participant in an employer-sponsored retirement plan. If
an individual or the individual's spouse is an active
participant in an employer-sponsored retirement plan, the
deduction is phased out for taxpayers with AGI over certain
levels. To the extent an individual does not or cannot make
deductible contributions, the individual may make nondeductible
contributions to a traditional IRA, subject to the maximum
contribution limit. Distributions from a traditional IRA are
includible in gross income to the extent not attributable to a
return of nondeductible contributions.
Individuals with adjusted gross income (``AGI'') below
certain levels may make contributions to a Roth IRA (up to the
maximum IRA contribution limit). The maximum Roth IRA
contribution is phased out between $150,000 to $160,000 of AGI
in the case of married taxpayers filing a joint return and
between $95,000 to $105,000 in the case of all other returns
(except a separate return of a married individual).\541\
Contributions to a Roth IRA are not deductible. Qualified
distributions from a Roth IRA are excludable from gross income.
Distributions from a Roth IRA that are not qualified
distributions are includible in gross income to the extent
attributable to earnings. In general, a qualified distribution
is a distribution that is made on or after the individual
attains age 59\1/2\, death, or disability or which is a
qualified special purpose distribution. A distribution is not a
qualified distribution if it is made within the five-taxable
year period beginning with the taxable year for which an
individual first made a contribution to a Roth IRA.
---------------------------------------------------------------------------
\541\ In the case of a married taxpayer filing a separate return,
the phaseout range is $0 to $10,000 of AGI.
---------------------------------------------------------------------------
A taxpayer with AGI of $100,000 or less may convert all
or a portion of a traditional IRA to a Roth IRA.\542\ The
amount converted is treated as a distribution from the
traditional IRA for income tax purposes, except that the 10-
percent additional tax on early withdrawals does not apply.
---------------------------------------------------------------------------
\542\ Married taxpayers filing a separate return may not convert
amounts in a traditional IRA into a Roth IRA.
---------------------------------------------------------------------------
In the case of a distribution from a Roth IRA that is not
a qualified distribution, certain ordering rules apply in
determining the amount of the distribution that is includible
in income. For this purpose, a distribution that is not a
qualified distribution is treated as made in the following
order: (1) regular Roth IRA contributions; (2) conversion
contributions (on a first in, first out basis); and (3)
earnings. To the extent a distribution is treated as made from
a conversion contribution, it is treated as made first from the
portion, if any, of the conversion contribution that was
required to be included in income as a result of the
conversion.
Includible amounts withdrawn from a traditional IRA or a
Roth IRA before attainment of age 59\1/2\, death, or disability
are subject to an additional 10-percent early withdrawal tax,
unless an exception applies.
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement eliminates the income limits on
conversions of traditional IRAs to Roth IRAs.\543\ Thus,
taxpayers may make such conversions without regard to their
AGI.
---------------------------------------------------------------------------
\543\ Under the conference agreement, married taxpayers filing a
separate return may convert amounts in a traditional IRA into a Roth
IRA.
---------------------------------------------------------------------------
For conversions occurring in 2010, unless a taxpayer
elects otherwise, the amount includible in gross income as a
result of the conversion is included ratably in 2011 and 2012.
That is, unless a taxpayer elects otherwise, none of the amount
includible in gross income as a result of a conversion
occurring in 2010 is included in income in 2010, and half of
the income resulting from the conversion is includible in gross
income in 2011 and half in 2012. However, income inclusion is
accelerated if converted amounts are distributed before
2012.\544\ In that case, the amount included in income in the
year of the distribution is increased by the amount
distributed, and the amount included in income in 2012 (or 2011
and 2012 in the case of a distribution in 2010) is the lesser
of: (1) half of the amount includible in income as a result of
the conversion; and (2) the remaining portion of such amount
not already included in income. The following example
illustrates the application of the accelerated inclusion rule.
---------------------------------------------------------------------------
\544\ Whether a distribution consists of converted amounts is
determined under the present-law ordering rules.
---------------------------------------------------------------------------
Example.--Taxpayer A has a traditional IRA with a value
of $100, consisting of deductible contributions and earnings. A
does not have a Roth IRA. A converts the traditional IRA to a
Roth IRA in 2010, and, as a result of the conversion, $100 is
includible in gross income. Unless A elects otherwise, $50 of
the income resulting from the conversion is included in income
in 2011 and $50 in 2012. Later in 2010, A takes a $20
distribution, which is not a qualified distribution and all of
which, under the ordering rules, is attributable to amounts
includible in gross income as a result of the conversion. Under
the accelerated inclusion rule, $20 is included in income in
2010. The amount included in income in 2011 is the lesser of
(1) $50 (half of the income resulting from the conversion) or
(2) $70 (the remaining income from the conversion), or $50. The
amount included in income in 2012 is the lesser of (1) $50
(half of the income resulting from the conversion) or (2) $30
(the remaining income from the conversion, i.e., $100--$70 ($20
included in income in 2010 and $50 included in income in
2011)), or $30.
Effective date.--The provision is effective for taxable
years beginning after December 31, 2009.
C. Repeal of FSC/ETI Binding Contract Relief
PRIOR AND PRESENT LAW
For most of the last two decades, the United States
provided export-related tax benefits under the foreign sales
corporation (``FSC'') regime. In 2000, the World Trade
Organization (``WTO'') held that the FSC regime constituted a
prohibited export subsidy under the relevant trade agreements.
In response to this WTO finding, the United States repealed the
FSC rules and enacted a new regime, under the FSC Repeal and
Extraterritorial Income (``ETI'') Exclusion Act of 2000.
Transition rules delayed the repeal of the FSC rules and the
effective date of ETI for transactions in the ordinary course
of a trade or business occurring before January 1, 2002, or
after December 31, 2001 pursuant to a binding contract between
the taxpayer and an unrelated person which was in effect on
September 30, 2000 and at all times thereafter (the ``FSC
binding contract relief'').\545\ In 2002, the WTO held that the
ETI regime also constituted a prohibited export subsidy.
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\545\ An election was provided, however, under which taxpayers
could adopt ETI at an earlier date for transactions after September 30,
2000. This election allowed the ETI rules to apply to transactions
after September 30, 2000, including transactions occurring pursuant to
pre-existing binding contracts.
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In general, under the ETI regime, an exclusion from gross
income applied with respect to ``extraterritorial income,''
which was a taxpayer's gross income attributable to ``foreign
trading gross receipts.'' This income was eligible for the
exclusion to the extent that it was ``qualifying foreign trade
income.'' Qualifying foreign trade income was the amount of
gross income that, if excluded, would result in a reduction of
taxable income by the greatest of: (1) 1.2 percent of the
foreign trading gross receipts derived by the taxpayer from the
transaction; (2) 15 percent of the ``foreign trade income''
derived by the taxpayer from the transaction; \546\ or (3) 30
percent of the ``foreign sale and leasing income'' derived by
the taxpayer from the transaction.\547\
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\546\ ``Foreign trade income'' was the taxable income of the
taxpayer (determined without regard to the exclusion of qualifying
foreign trade income) attributable to foreign trading gross receipts.
\547\ ``Foreign sale and leasing income'' was the amount of the
taxpayer's foreign trade income (with respect to a transaction) that
was properly allocable to activities constituting foreign economic
processes. Foreign sale and leasing income also included foreign trade
income derived by the taxpayer in connection with the lease or rental
of qualifying foreign trade property for use by the lessee outside the
United States.
---------------------------------------------------------------------------
Foreign trading gross receipts were gross receipts
derived from certain activities in connection with ``qualifying
foreign trade property'' with respect to which certain economic
processes had taken place outside of the United States.
Specifically, the gross receipts must have been: (1) from the
sale, exchange, or other disposition of qualifying foreign
trade property; (2) from the lease or rental of qualifying
foreign trade property for use by the lessee outside the United
States; (3) for services which were related and subsidiary to
the sale, exchange, disposition, lease, or rental of qualifying
foreign trade property (as described above); (4) for
engineering or architectural services for construction projects
located outside the United States; or (5) for the performance
of certain managerial services for unrelated persons. A
taxpayer could elect to treat gross receipts from a transaction
as not being foreign trading gross receipts. As a result of
such an election, a taxpayer could use any related foreign tax
credits in lieu of the exclusion.
Qualifying foreign trade property generally was property
manufactured, produced, grown, or extracted within or outside
the United States that was held primarily for sale, lease, or
rental in the ordinary course of a trade or business for direct
use, consumption, or disposition outside the United States. No
more than 50 percent of the fair market value of such property
could be attributable to the sum of: (1) the fair market value
of articles manufactured outside the United States; and (2) the
direct costs of labor performed outside the United States. With
respect to property that was manufactured outside the United
States, certain rules were provided to ensure consistent U.S.
tax treatment with respect to manufacturers.
The American Jobs Creation Act of 2004 (``AJCA'')
repealed the ETI exclusion,\548\ generally effective for
transactions after December 31, 2004. AJCA provides a general
transition rule under which taxpayers retain 100 percent of
their ETI benefits for transactions prior to 2005, 80 percent
of their otherwise-applicable ETI benefits for transactions
during 2005, and 60 percent of their otherwise-applicable ETI
benefits for transactions during 2006.
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\548\ Pub. L. No. 108-357, sec. 101. In addition, foreign
corporations that elected to be treated for all Federal tax purposes as
domestic corporations in order to facilitate the claiming of ETI
benefits were allowed to revoke such elections within one year of the
date of enactment of the repeal without recognition of gain or loss,
subject to anti-abuse rules.
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In addition to the general transition rule, AJCA provides
that the ETI exclusion provisions remain in effect for
transactions in the ordinary course of a trade or business if
such transactions are pursuant to a binding contract \549\
between the taxpayer and an unrelated person and such contract
is in effect on September 17, 2003, and at all times thereafter
(the ``ETI binding contract relief'').
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\549\ This rule also applies to a purchase option, renewal option,
or replacement option that is included in such contract. For this
purpose, a replacement option is considered enforceable against a
lessor notwithstanding the fact that a lessor retained approval of the
replacement lessee.
---------------------------------------------------------------------------
In early 2006, the WTO Appellate Body held that the ETI
general transition rule and the FSC and ETI binding contract
relief measures are prohibited export subsidies.
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
The conference agreement repeals both the FSC binding
contract relief and the ETI binding contract relief. The
general transition rule remains in effect.
Effective date.--The provision is effective for taxable
years beginning after date of enactment.
D. Modification of Wage Limit for Purposes of Domestic Production
Activities Deduction
(Sec. 199 of the Code)
PRESENT LAW
In general
Present law provides a deduction from taxable income (or,
in the case of an individual, adjusted gross income) that is
equal to a portion of the taxpayer's qualified production
activities income. For taxable years beginning after 2009, the
deduction is nine percent of such income. For taxable years
beginning in 2005 and 2006, the deduction is three percent of
income and, for taxable years beginning in 2007, 2008 and 2009,
the deduction is six percent of income. However, the deduction
for a taxable year is limited to 50 percent of the wages paid
by the taxpayer during the calendar year that ends in such
taxable year.\550\
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\550\ For purposes of the provision, ``wages'' include the sum of
the amounts of wages as defined in section 3401(a) and elective
deferrals that the taxpayer properly reports to the Social Security
Administration with respect to the employment of employees of the
taxpayer during the calendar year ending during the taxpayer's taxable
year. Elective deferrals include elective deferrals as defined in
section 402(g)(3), amounts deferred under section 457, and, for taxable
years beginning after December 31, 2005, designated Roth contributions
(as defined in section 402A).
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Qualified production activities income
In general, ``qualified production activities income'' is
equal to domestic production gross receipts (defined by section
199(c)(4)), reduced by the sum of: (1) the costs of goods sold
that are allocable to such receipts; and (2) other expenses,
losses, or deductions which are properly allocable to such
receipts.
Application of wage limitation to passthrough entities
For purposes of applying the wage limitation, a
shareholder, partner, or similar person who is allocated
components of qualified production activities income from a
passthrough entity also is treated as having been allocated
wages from such entity in an amount that is equal to the lesser
of: (1) such person's allocable share of wages, as determined
under regulations prescribed by the Secretary; or (2) twice the
qualified production activities income that actually is
allocated to such person for the taxable year.
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
Under the conference agreement, the wage limitation is
modified such that taxpayers may only include amounts which are
properly allocable to domestic production gross receipts.\551\
Thus, the wage limitation is 50 percent of those wages which
are deducted in arriving at qualified production activities
income.
---------------------------------------------------------------------------
\551\ As under present law, the Secretary shall provide rules for
the proper allocation of items (including wages) in determining
qualified production activities income. Section 199(c)(2).
---------------------------------------------------------------------------
In addition, the conference agreement repeals the special
limitation on wages treated as allocated to partners or
shareholders of passthrough entities. Accordingly, for purposes
of the wage limitation, a shareholder, partner, or similar
person who is allocated components of qualified production
activities income from a passthrough entity is treated as
having been allocated wages from such entity in an amount that
is equal to such person's allocable share of wages as
determined under regulations prescribed by the Secretary, even
if such amount is more than twice the qualified production
activities income that actually is allocated to such person for
the taxable year. The shareholder, partner, or similar person
will then include in its wage limitation only those wages which
are deducted in arriving at qualified production activities
income.
Effective date.--The conference agreement is effective
with respect to taxable years beginning after the date of
enactment.
E. Modification of Exclusion for Citizens Living Abroad
(Sec. 911 of the Code)
PRESENT LAW
In general
U.S. citizens generally are subject to U.S. income tax on
all their income, whether derived in the United States or
elsewhere. A U.S. citizen who earns income in a foreign country
also may be taxed on that income by the foreign country. The
United States generally cedes the primary right to tax a U.S.
citizen's non-U.S. source income to the foreign country in
which the income is derived. This concession is effected by the
allowance of a credit against the U.S. income tax imposed on
foreign-source income for foreign taxes paid on that income.
The amount of the credit for foreign income tax paid on
foreign-source income generally is limited to the amount of
U.S. tax otherwise owed on that income. Accordingly, if the
amount of foreign tax paid on foreign-source income is less
than the amount of U.S. tax owed on that income, a foreign tax
credit generally is allowed in an amount not exceeding the
amount of the foreign tax, and a residual U.S. tax liability
remains.
A U.S. citizen or resident living abroad may be eligible
to exclude from U.S. taxable income certain foreign earned
income and foreign housing costs.\552\ This exclusion applies
regardless of whether any foreign tax is paid on the foreign
earned income or housing costs. To qualify for these
exclusions, an individual (a ``qualified individual'') must
have his or her tax home in a foreign country and must be
either (1) a U.S. citizen \553\ who is a bona fide resident of
a foreign country or countries for an uninterrupted period that
includes an entire taxable year, or (2) a U.S. citizen or
resident present in a foreign country or countries for at least
330 full days in any 12-consecutive-month period.
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\552\ Sec. 911.
\553\ Generally, only U.S. citizens may qualify under the bona fide
residence test. A U.S. resident alien who is a citizen of a country
with which the United States has a tax treaty may, however, qualify for
the section 911 exclusions under the bona fide residence test by
application of a nondiscrimination provision of the treaty.
---------------------------------------------------------------------------
Exclusion for compensation
The foreign earned income exclusion generally is
available for a qualified individual's non-U.S. source earned
income attributable to personal services performed by that
individual during the period of foreign residence or presence
described above. The maximum exclusion amount for any calendar
year is $80,000 in 2002 through 2007 and is indexed for
inflation after 2007.
Exclusion for housing costs
A qualified individual is allowed an exclusion from gross
income (or, as described below, a deduction) for certain
foreign housing costs paid or incurred by or on behalf of the
individual. The amount of this housing cost exclusion is equal
to the excess of a taxpayer's ``housing expenses'' over a base
housing amount. The term ``housing expenses'' means the
reasonable expenses paid or incurred during the taxable year
for a taxpayer's housing (and, if they live with the taxpayer,
for the housing of the taxpayer's spouse and dependents) in a
foreign country. The term includes expenses attributable to
housing such as utilities and insurance, but it does not
include separately deductible interest and taxes. If the
taxpayer maintains a second household outside the United States
for a spouse or dependents who do not reside with the taxpayer
because of dangerous, unhealthful, or otherwise adverse living
conditions, the housing expenses of the second household also
are eligible for exclusion. The base housing amount above which
costs are eligible for exclusion in a taxable year is 16
percent of the annual salary (computed on a daily basis) of a
grade GS-14, step 1, U.S. government employee, multiplied by
the number of days of foreign residence or presence (as
described above) in the taxable year. For 2006 this salary is
$77,793; the current base housing amount therefore is $12,447
(assuming the taxpayer is a bona fide resident of or is present
in a foreign country every day during the year).
To the extent otherwise excludable housing costs are not
paid or reimbursed by a taxpayer's employer, these costs
generally are allowed as a deduction in computing adjusted
gross income.
Exclusion limitation amounts
The combined foreign earned income exclusion and housing
cost exclusion (including the amount of any deductible housing
costs) may not exceed the taxpayer's total foreign earned
income for the taxable year. The taxpayer's foreign tax credit
is reduced by the amount of the credit that is attributable to
excluded income.
Tax brackets
A taxpayer with excludable income under section 911 is
subject to tax on the taxpayer's other income, after
deductions, starting in the lowest tax rate bracket.
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
Exclusion for compensation
The conference agreement provision adjusts for inflation
the maximum amount of the foreign earned income exclusion in
taxable years beginning in calendar years after 2005 (rather
than, as under present law, after 2007). The limitation in 2006
therefore is $82,400.\554\
---------------------------------------------------------------------------
\554\ This $82,400 amount is calculated under section
911(b)(2)(D)(ii), as amended by the conference agreement provision,
using current U.S. Bureau of Labor Statistics (``BLS'') Consumer Price
Index data.
---------------------------------------------------------------------------
Exclusion for housing costs
Under the conference agreement, the base housing amount
used in calculating the foreign housing cost exclusion in a
taxable year is 16 percent of the amount (computed on a daily
basis) of the foreign earned income exclusion limitation
(instead of the present law 16 percent of the grade GS-14, step
1 amount), multiplied by the number of days of foreign
residence or presence (as previously described) in that year.
Reasonable foreign housing expenses in excess of the base
housing amount remain excluded from gross income (or, if paid
by the taxpayer, are deductible) under the conference
agreement, but the amount of the exclusion is limited to 30
percent of the maximum amount of a taxpayer's foreign earned
income exclusion.\555\ The Secretary is given authority to
issue regulations or other guidance providing for the
adjustment of this 30-percent housing cost limitation based on
geographic differences in housing costs relative to housing
costs in the United States. The conferees intend that the
Secretary be permitted to use publicly available data, such as
the Quarterly Report Indexes published by the U.S. Department
of State or any other information deemed reliable by the
Secretary, in making adjustments. The conferees also intend
that the Secretary may adjust the 30-percent amount upward or
downward. The conferees intend that the Secretary make
adjustments annually.
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\555\ In certain programs including grant-making to subsidize
rents, the U.S. Department of Housing and Urban Development considers
maximum affordable housing costs to be 30 percent of a household's
income. See, e.g., United States Housing Act of 1937, 42 U.S.C. sec.
1437a (a)(1)(A), as amended.
---------------------------------------------------------------------------
Under the 30-percent rule described above, the maximum
amount of the foreign housing cost exclusion in 2006 is
(assuming foreign residence or presence on all days in the
year) $11,536 (= ($82,400 30 percent)-($82,400
16 percent)).\556\
---------------------------------------------------------------------------
\556\ The $11,536 amount is based on a calculation under section
911(b)(2)(D)(ii), as amended by the conference agreement, using the BLS
data described above.
---------------------------------------------------------------------------
Tax brackets
Under the conference agreement, if an individual excludes
an amount from income under section 911, any income in excess
of the exclusion amount determined under section 911 is taxed
(under the regular tax and alternative minimum tax) by applying
to that income the tax rates that would have been applicable
had the individual not elected the section 911 exclusion. For
example, an individual with $80,000 of foreign earned income
that is excluded under section 911 and with $20,000 in other
taxable income (after deductions) would be subject to tax on
that $20,000 at the rate or rates applicable to taxable income
in the range of $80,000 to $100,000.
Effective date
The conference agreement provision is effective for
taxable years beginning after December 31, 2005.
TITLE IX--CORPORATE ESTIMATED TAX PROVISIONS
PRESENT LAW
In general, corporations are required to make quarterly
estimated tax payments of their income tax liability. For a
corporation whose taxable year is a calendar year, these
estimated tax payments must be made by April 15, June 15,
September 15, and December 15.
HOUSE BILL
No provision.
SENATE AMENDMENT
No provision.
CONFERENCE AGREEMENT
In case of a corporation with assets of at least $1
billion, payments due in July, August, and September, 2006,
shall be increased to 105 percent of the payment otherwise due
and the next required payment shall be reduced accordingly.
In case of a corporation with assets of at least $1
billion, the payments due in July, August, and September, 2012,
shall be increased to 106.25 percent of the payment otherwise
due and the next required payment shall be reduced accordingly.
In case of a corporation with assets of at least $1
billion, the payments due in July, August, and September, 2013,
shall be increased to 100.75 percent of the payment otherwise
due and the next required payment shall be reduced accordingly.
With respect to corporate estimated tax payments due on
September 15, 2010, 20.5 percent shall not be due until October
1, 2010.
With respect to corporate estimated tax payments due on
September 15, 2011, 27.5 percent shall not be due until October
1, 2011.
Effective date.--The provision is effective on the date
of enactment.
TITLE X--COMPLEXITY ANALYSIS
Section 4022(b) of the Internal Revenue Service Reform
and Restructuring Act of 1998 (the ``IRS Reform Act'') requires
the Joint Committee on Taxation (in consultation with the
Internal Revenue Service (``IRS'') and the Department of the
Treasury) to provide a tax complexity analysis. The complexity
analysis is required for all legislation reported by the Senate
Committee on Finance, the House Committee on Ways and Means, or
any committee of conference if the legislation includes a
provision that directly or indirectly amends the Internal
Revenue Code (the ``Code'') and has widespread applicability to
individuals or small businesses. For each such provision
identified by the staff of the Joint Committee on Taxation, a
summary description of the provision is provided along with an
estimate of the number and type of affected taxpayers, and a
discussion regarding the relevant complexity and administrative
issues.
Following the analysis of the staff of the Joint
Committee on Taxation are the comments of the IRS and Treasury
regarding each of the provisions included in the complexity
analysis.
Capital gain and dividend rate reduction (sec. 102 of the conference
agreement)
Summary description of provision
The conference agreement extends the zero- and 15-percent
capital gain and dividend rates to taxable years beginning in
2009 and 2010.
Number of affected taxpayers
It is estimated that the provision will affect 33 million
individual tax returns.
Discussion
The extension of the provision means that for 2009 and
2010 individual taxpayers and the IRS will continue to use the
same forms for capital gains and dividends.
The extension of the lower rates for net capital gain
will achieve simplification because the extension prevents the
separate five-year holding periods from going into effect in
2009 and 2010. On the other hand, the extension of the lower
rates for dividends will continue requiring dividends to be
classified as qualified dividends and nonqualified dividends in
2009 and 2010 and will continue to require the tax to be
computed using the capital gains forms.
Increase in the AMT exemption amount (sec. 301 of the conference
agreement)
Summary description of the provision
The alternative minimum tax exemption amounts for 2006
are increased.
Number of affected taxpayers
It is estimated that the provisions will affect
approximately 19 million individual tax returns.
Discussion
Many individuals will not have to compute their
alternative minimum tax and file the IRS forms relating to that
tax.
TITLE XI--UNFUNDED MANDATES
The staff of the Joint Committee on Taxation has reviewed
the tax provisions in the conference agreement for H.R. 4297,
the ``Tax Relief Extension Reconciliation Act of 2005'' as
agreed to by the conferees. This information is provided in
accordance with the requirements of Public Law 104-04, the
Unfunded Mandates Reform Act of 1995, which provides that if a
conference agreement contains (1) a mandate that was not
previously considered by either the House or the Senate, or (2)
an increase in the direct cost of a previously considered
mandate, then the committee of conference is to ensure, to the
greatest extent practicable, that a mandates statement is
prepared.
We have determined that the tax provisions of the
conference agreement contain two unfunded private sector
mandates that were not previously considered by either the
House or the Senate: (1) repeal of FSC-ETI grandfather rule,
and (2) amend section 911 housing exclusion. In addition, the
provision relating to withholding on certain government
payments imposes an intergovernmental mandate not previously
considered by either the House or the Senate.
The costs required to comply with each Federal private
sector mandate and Federal intergovernmental mandate generally
are no greater than the aggregate estimated budget effects of
the provision as indicated on the enclosed revenue table.
Benefits from the provisions include improved administration of
the tax laws and a more accurate measurement of income for
Federal income tax purposes.
Wm. Thomas,
Jim McCrery,
Dave Camp,
Managers on the Part of the House.
Chuck Grassley,
Jon Kyl,
Managers on the Part of the Senate.