[Senate Report 110-206]
[From the U.S. Government Publishing Office]



                                                       Calendar No. 446
110th Congress                                                   Report
                                 SENATE
 1st Session                                                    110-206

======================================================================



 
       HEARTLAND, HABITAT, HARVEST, AND HORTICULTURE ACT OF 2007

                                _______
                                

                October 25, 2007.--Ordered to be printed

                                _______
                                

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

                              R E P O R T

                         [To accompany S. 2242]

    The Committee on Finance, having considered an original 
bill (S. 2242) to amend the Trade Act of 1974 to establish 
supplemental agricultural disaster assistance and to amend the 
Internal Revenue Code of 1986 to provide tax incentives for 
conservation and alternative energy sources and to provide tax 
relief for farmers, and for other purposes, reports favorably 
thereon and recommends that the bill do pass.

                                CONTENTS

                                                                   Page
 I. LEGISLATIVE BACKGROUND............................................3
II. EXPLANATION OF THE BILL...........................................3
    TITLE I--SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE 
    AGRICULTURE DISASTER RELIEF TRUST FUND............................3
        A. Crop Disaster Assistance Program and Other Disaster 
            Assistance...........................................     3
    TITLE II--CONSERVATION PROVISIONS.................................8
        A. Provide Tax Credit for Eligible Farmland Enrolled in 
            the Conservation Reserve Program (sec. 201 of the 
            bill and sec. 30D of the Code).......................     8
        B. Exclusion of Conservation Reserve Program Payments 
            From SECA Tax for Individuals Receiving Social 
            Security Retirement or Disability Payments (sec. 202 
            of the bill and sec. 1402(a) of the Code)............     9
        C. Make Permanent the Special Rule Encouraging 
            Contributions of Capital Gain Real Property for 
            Conservation Purposes (sec. 203 of the bill and sec. 
            170 of the Code).....................................     9
        D. Provide Tax Credit for Recovery and Restoration of 
            Endangered Species (sec. 204 of the bill and new sec. 
            30D of the Code).....................................    13
        E. Deduction for Endangered Species Recovery Expenditures 
            (sec. 205 of the bill and sec. 175 of the Code)......    17
        F. Provide Exclusion for Certain Payments and Programs 
            Relating to Fish and Wildlife (sec. 206 of the bill 
            and sec. 126 of the Code)............................    19
        G. Provide Tax Credit for Easements Made Pursuant to 
            Certain U.S.D.A. Conservation Programs (sec. 207 of 
            the bill and sec. 30F of the Code)...................    21
        H. Provide for Exempt Facility Bonds for Forest 
            Conservation Activities (sec. 208 of the bill and 
            sec. 142 of the Code)................................    23
        I. Deduction for Qualified Timber Gain and Timber REIT 
            Provisions (secs. 209-214 of the bill and new sec. 
            1203, and secs. 856, 857 and 4981 of the Code).......    28
    TITLE III--ENERGY PROVISIONS.....................................33
        A. Credit for Residential and Business Wind Property 
            (sec. 301 of the bill and secs. 25D and 48 of the 
            Code)................................................    33
        B. Landowner Incentive to Encourage Electric Transmission 
            Build-Out (sec. 302 of the bill and new sec. 139B of 
            the Code)............................................    36
        C. Exception to Reduction of Renewable Electricity Credit 
            (sec. 303 of the bill and sec. 45 of the Code).......    37
        D. Expansion of Special Depreciation Allowance to 
            Cellulosic Biomass Alcohol Fuel Plant (sec. 311 of 
            the bill and sec. 168(l) of the Code)................    43
        E. Credit for Production of Cellulosic Biomass Alcohol 
            (sec. 312 of the bill and sec. 40 of the Code).......    44
        F. Extension of Small Ethanol Producer Credit (sec. 313 
            of the bill and sec. 40 of the Code).................    46
        G. Credit for Producers of Fossil-Free Alcohol (sec. 314 
            of the bill and sec. 40 of the Code).................    47
        H. Modification of Alcohol Credit (sec. 315 of the bill 
            and secs. 40, 6426 and 6427 of the Code).............    48
        I. Calculation of Volume of Alcohol for Fuels Credits 
            (sec. 316 of the bill, and sec. 40 of the Code)......    50
        J. Ethanol Tariff Extension (sec. 317 of the bill).......    50
        K. Elimination and Reductions of Duty Drawback on Certain 
            Imported Ethanol (sec. 318 of the bill)..............    51
        L. Extension of Credits for Biodiesel (sec. 321 of the 
            bill and secs. 40A, 6426 and 6427 of the Code).......    52
        M. Extension and Modification of Renewable Diesel 
            Incentives (sec. 321 of the bill and sec. 40A(f), 
            6426 and 6427 of the Code)...........................    54
        N. Treatment of Qualified Alcohol Mixtures and Qualified 
            Biodiesel Fuel Mixtures as Taxable Fuels (sec. 322 of 
            the bill and sec. 4083 of the Code)..................    55
        O. Extension and Modification of the Alternative Fuel 
            Credits (sec. 331 of the bill and sec. 6426 and 6427 
            of the Code).........................................    57
        P. Extension of Alternative Fuel Vehicle Refueling 
            Property Credit (sec. 332 of the bill and sec. 30C of 
            the Code)............................................    59
    TITLE IV--AGRICULTURAL PROVISIONS................................60
        A. Qualified Small Issue Bonds for Farming (sec. 401 of 
            the bill and sec. 147 of the Code)...................    60
        B. Modification of Installment Sale Rules for Certain 
            Farm Property (sec. 402 of the bill and sec. 453 of 
            the Code)............................................    61
        C. Allowance of Section 1031 Treatment for Exchanges 
            Involving Certain Mutual Ditch, Reservoir, or 
            Irrigation Company Stock (sec. 403 of the bill and 
            sec. 1031 of the Code)...............................    62
        D. Rural Renaissance Bonds (sec. 404 of the bill and new 
            sec. 54A of the Code)................................    63
        E. Agricultural Business Security Tax Credit (sec. 405 of 
            the bill and sec. 45 of the Code)....................    68
        F. Credit for Drug Safety and Effectiveness Testing for 
            Minor Species (sec. 406 of the bill and new sec. 45P 
            of the Code).........................................    69
        G. Farm Equipment Treated as Five-Year Property (sec. 407 
            of the bill and sec. 168 of the Code)................    71
        H. Expensing of Broadband Internet Access Expenditures 
            (sec. 408 of the bill and new sec. 191 of the Code)..    72
        I. Credit for Energy Efficient Electric Motors (sec. 409 
            of the bill and new sec. 45Q of the Code)............    75
    TITLE V--REVENUE RAISING PROVISIONS..............................75
        A. Limitation on Farming Losses of Certain Taxpayers 
            (sec. 501 of the bill and sec. 461 of the Code)......    75
        B. Increase and Index Dollar Thresholds for Farm Optional 
            Method and Nonfarm Optional Method for Computing Net 
            Earnings from Self-Employment (sec. 502 of the bill 
            and sec. 1402(a) of the Code)........................    76
        C. Information Reporting for Commodity Credit Corporation 
            Transactions (sec. 503 of the bill and new sec. 6039J 
            of the Code).........................................    79
        D. Modification of Section 1031 Treatment for Certain 
            Real Estate (sec. 504 of the bill and sec. 1031 of 
            the Code)............................................    80
        E. Modification of Effective Date of Leasing Provisions 
            of the American Jobs Creation Act of 2004 (sec. 505 
            of the bill and sec. 470 of the Code)................    81
        F. Modifications to Corporate Estimated Tax Payments 
            (sec. 506 of the bill)...............................    82
        G. Ineligibility of Collectibles for Nontaxable Like Kind 
            Exchange Treatment (sec. 507 of the bill and sec. 
            1031 of the Code)....................................    82
        H. Denial of Deduction for Certain Fines, Penalties, and 
            Other Amounts (sec. 508 of the bill and sec. 162(f) 
            and new sec. 6050W of the Code)......................    83
        I. Increase in Information Return Penalties (sec. 509 of 
            the bill and secs. 6721, 6722, and 6723 of the Code).    87
        J. Economic Substance Doctrine (secs. 511-513 of the bill 
            and sec. 7701, new sec. 6662B, and sec. 163 of the 
            Code)................................................    88
            1. Clarification of the economic substance doctrine..    88
            2. Penalty for understatements attributable to 
                transactions lacking economic substance, etc.....    95
            3. Denial of deduction for interest on underpayments 
                attributable to noneconomic substance 
                transactions.....................................   101
III.BUDGET EFFECTS OF THE BILL......................................102

IV. VOTES OF THE COMMITTEE..........................................109
 V. REGULATORY IMPACT AND OTHER MATTERS.............................109
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED...........110

                       I. LEGISLATIVE BACKGROUND

    The Finance Committee has exclusive jurisdiction over tax 
matters and has previously held hearing and reported 
legislation that included some of the provisions in this 
legislation. The Committee anticipates that the Senate may 
consider adding the substance of this bill to H.R. 2419, the 
``Farm, Nutrition, and Bioenergy Act of 2007,'' or similar 
legislation.

                      II. EXPLANATION OF THE BILL


    TITLE I--SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE 
               AGRICULTURE DISASTER RELIEF TRUST FUND\1\

---------------------------------------------------------------------------
    \1\The description of this provision was supplied by the Majority 
Staff of the Senate Finance Committee.
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   A. Crop Disaster Assistance Program and Other Disaster Assistance


                              PRESENT LAW

    The Farm Service Agency (``FSA'') of the United States 
Department of Agriculture (``USDA'') offers various ongoing 
programs for agricultural producers to facilitate recovery from 
losses caused by natural events.\2\ Ongoing programs include 
the Emergency Conservation Program (``ECP''), the Noninsured 
Crop Disaster Assistance Program (``NAP''), the Disaster Debt 
Set-Aside Program (``DSA''), and the Emergency Loan Program 
(``EM'').
---------------------------------------------------------------------------
    \2\For more information see the USDA FSA Ongoing Disaster 
Assistance Programs for Agricultural Producers Fact Sheet, January 2007 
available at http://www.fsa.usda.gov/Internet/FSA--File/
ongdisasst07.pdf.
---------------------------------------------------------------------------
    ECP is a discretionary program funded through annual 
appropriations that provides funding for farmers and ranchers 
to rehabilitate farmland damaged by natural disaster and for 
carrying out emergency water conservation measures during 
severe drought. The natural disaster must create new 
conservation problems that if untreated would (1) impair or 
endanger the land; (2) materially affect the productive 
capacity of the land; (3) represent unusual damage which, 
except for wind erosion, is not the type likely to recur 
frequently in the same area; and (4) be so costly to repair 
that federal assistance is, or will be required, to return the 
land to productive agricultural use.
    NAP provides a low level of insurance to producers who grow 
otherwise noninsurable crops. NAP provides coverage for crop 
losses and planting prevented by disasters. Landowners, 
tenants, or sharecroppers who share in the risk of producing an 
eligible crop may qualify for this program. Before payments can 
be issued, applications must first be received and approved, 
generally before the crop is planted, and the crop must have 
suffered a minimum of 50 percent loss in yield. Payments are 55 
percent of the commodities' average market price on crop losses 
beyond 50 percent. Eligible crops include commercial crops and 
other agricultural commodities produced for food, including 
livestock feed or fiber for which the catastrophic level of 
crop insurance is unavailable. Also eligible for NAP coverage 
are controlled-environment crops (mushroom and floriculture), 
specialty crops (honey and maple sap), and value loss crops 
(aquaculture, Christmas trees, ginseng, ornamental nursery, and 
turfgrass sod).
    DSA is available to those producers who are borrowers from 
the Farm Service Agency in primary or contiguous counties that 
have been declared by the President or designated by the 
Secretary of Agriculture (``Secretary'') as a disaster area. 
When borrowers affected by natural disasters are unable to make 
their scheduled payments on any debt, FSA is authorized to 
consider the set-aside of some payments to allow the farming 
operation to continue. After a disaster designation is made, 
FSA will notify borrowers of the availability of the DSA. 
Borrowers who are notified have eight months from the date of 
designation to apply. FSA borrowers may also request a release 
of income proceeds to meet current operating and family living 
expenses or may request special servicing provisions from their 
local FSA county offices to explore other options.
    EM provides emergency loans to help producers recover from 
production and physical losses due to drought, flooding, other 
natural disasters, or quarantine. Emergency loans may be made 
to farmers and ranchers who own or operate land located in a 
county declared by the President as a disaster area or 
designated by the Secretary as a disaster area or quarantine 
area (for physical losses only, the FSA administrator may 
authorize emergency loan assistance). EM funds may be used to: 
(1) restore or replace essential property; (2) pay all or part 
of production costs associated with the disaster year; (3) pay 
essential family expenses; (4) reorganize the farming 
operation; and (5) refinance certain debts.

                           REASONS FOR CHANGE

    Farmers and ranchers can wait years to receive assistance 
from Congress when faced with a weather-related disaster such 
as drought, floods or severe storms. The Committee believes 
that a supplemental agricultural disaster assistance program is 
appropriate to ensure that farmers have a dependable and timely 
safety net when disasters strike. The Supplemental Agriculture 
Disaster Assistance program creates a trust fund that will 
cover losses not covered by crop insurance. To receive benefits 
from the trust fund, farmers and ranchers must: (1) carry crop 
insurance; and (2) be located in a Secretarially declared 
disaster county or a contiguous county, or show proof of an 
individual loss of at least 50%. Farmers carrying higher levels 
of insurance will be eligible for higher payments. Each farmer 
or rancher applying for supplemental disaster assistance must 
show that whole farm income from crop production declined due 
to the loss of a particular crop due to natural disasters. The 
Committee believes that these additional accountability 
measures will encourage farmers to participate in crop 
insurance programs, and will target assistance to those farmers 
and ranchers with the greatest need. The Committee believes 
that Supplemental Disaster Assistance program will be 
particularly useful to beginning farmers and ranchers who 
cannot afford to wait years for disaster assistance and do not 
have the equity to handle large scale crop losses due to 
natural disasters.
    The Committee believes that the creation of a trust fund, 
funded through an allocation of tariff revenues, is the 
appropriate mechanism to support this program. An amount equal 
to 3.34% of revenues from all tariffs will be transferred to 
the trust fund through December 31, 2012. Payments from the 
trust fund could begin in crop year 2008. The creation of the 
trust fund was modeled after Section 32 of the Act of August 
24, 1935 (7 U.S.C. 612c), which sets aside a percentage of 
tariff revenues for nutrition and other programs that broadly 
benefit all sectors of U.S. agriculture.

                        EXPLANATION OF PROVISION

In general

    The provision amends the Trade Act of 1974 to create an 
Agriculture Disaster Relief Trust Fund (``ADTF'') that would 
provide payments to farmers and ranchers who suffer losses in 
areas that are declared disaster areas by the USDA. The trust 
fund will be funded by an amount equal to 3.34 percent of the 
amounts received in the general fund of the Treasury that are 
attributable to the duties collected on articles entered, or 
withdrawn from warehouse, for consumption under the Harmonized 
Tariff Schedule. The ADTF could make payments under four new 
disaster assistance programs: the crop disaster assistance 
program, the livestock indemnity program, the tree assistance 
program, and the emergency assistance program for livestock, 
honey bees, and farm raised fish. In addition, the ADTF will 
also fund a new pest and disease management and disaster 
prevention program. Amounts not required to meet current 
withdrawals may be invested in U.S. Treasury obligations with 
interest credited to the ADTF. The ADTF may also borrow, with 
interest, as repayable advances sums necessary to carry out the 
purposes of the fund.

Crop Disaster Assistance Program (``CDAP'')

    Generally, CDAP payments will be paid to producers located 
in disaster counties on 52 percent of the difference between 
the disaster program guarantee and the sum of total farm 
revenue. Disaster counties include counties receiving disaster 
declarations by the Secretary due to production losses 
resulting directly or indirectly from adverse weather, counties 
contiguous to such counties, and any farm whose production due 
to weather was less than 50 percent of normal production. To be 
eligible for CDAP payments, the producer must have purchased or 
enrolled in both crop insurance for insurable crops at a 
minimum of 50 percent of yield at 55 percent of price and NAP 
for uninsurable crops. The Secretary may waive this requirement 
under certain conditions.
    The disaster program guarantee for insurable crops is equal 
to the product of a measure of crop yield, the percentage of 
crop insurance yield guarantee, the percentage of crop 
insurance price elected by the producer, the crop insurance 
price, and 115 percent. The disaster program guarantee for 
noninsured crops is equal to the product of the yield as 
determined by NAP for each crop, 100 percent of the NAP 
established price, and 115 percent. The disaster program 
guarantee is the sum of the disaster program guarantee for 
insurable and noninsured crops.
    Total farm revenue includes the sum of the estimated value 
of crops and grazing, crop insurance and NAP indemnities 
accruing to the farm, the value of prevented planting payments, 
the amount of other natural disaster assistance payments 
provided by the federal government to a farm for the same loss, 
and an amount equal to 20 percent of any direct payments made 
to the producer under section 1103 of the Farm Security and 
Rural Investment Act of 2002. The estimated value of crops is 
generally the product of actual crop acreage grazed or 
harvested, estimated actual yields of grazing land or crop 
production, and the average market price during the first five 
months of the marketing year in which a farm or portion of a 
farm is located.

Livestock Indemnity Program

    The ADTF may also make payments under the livestock 
indemnity program to eligible producers on farms that have 
incurred livestock death losses in excess of normal mortality 
rates during the calendar year due to adverse weather, as 
determined by the Secretary. Indemnity payments are made at a 
rate of 75 percent of the fair market value of the livestock on 
the day before the date of death of the livestock as determined 
by the Secretary.

Tree Assistance Program

    The Secretary shall make payments to eligible orchardists 
as follows. Assistance is in the form of (1) 75 percent 
reimbursement for the cost of replanting trees lost due to a 
natural disaster if tree mortality is in excess of 15 percent, 
adjusted for normal mortality, or sufficient seedlings to 
reestablish a stand; and (2) 50 percent reimbursement of the 
cost of pruning, removal, and other costs incurred to salvage 
existing trees or to prepare land to replant trees lost due to 
a natural disaster in excess of 15 percent damage or mortality 
adjusted for normal tree damage and mortality.

Buy-up NAP Coverage

    Under NAP, FSA compensates eligible producers for losses of 
noninsurable crops exceeding 50 percent of the expected yield 
based on 55 percent of the average market price of the 
commodity. This provision permits producers to buy additional 
NAP coverage. Producers could purchase additional coverage 
guarantee up to 60 or 65 percent, as elected by the producers, 
of expected yield, and up to 100 percent of the average market 
price of the commodity. Fees would be established and collected 
by the Secretary to fully offset the cost of supplemental NAP 
coverage.

Emergency Assistance for livestock, honey bees, and farm-raised fish

    The Secretary shall use up to $35,000,000 annually from the 
trust fund to provide emergency relief to producers of 
livestock (including horses), honey bees, and farm-raised fish 
due to losses from adverse weather or other environmental 
conditions, such as blizzards and wildfires, as determined by 
the Secretary, that are not covered under the authority of the 
Secretary to make qualifying natural disaster declarations. For 
purposes of the provision, farm-raised fish includes the 
propagation and rearing of aquatic species (including any 
species of finfish, mollusk, crustacean, or other aquatic 
invertebrate, amphibian, reptile, or aquatic plant) in 
controlled or semi-controlled environments.

Limitations

    No eligible producer may receive more than $100,000 
annually in total disaster assistance under this Act. A 
producer is not eligible for benefits under the provision if, 
as determined by the Secretary, such producer's adjusted gross 
income (as defined in section 1001D(a) of the Food Security Act 
of 1985\3\ or any successor provision) exceeds $2.5 million, 
unless not less than 75 percent of the average adjusted gross 
income of such producer is derived from farming, ranching or 
forestry operations.
---------------------------------------------------------------------------
    \3\7 U.S.C. sec. 1308-3a(a).
---------------------------------------------------------------------------

Pest and Disease Management and Disaster Prevention

    The provision also establishes a new program under which 
USDA will conduct early pest detection and surveillance 
activities in coordination with State departments of 
agriculture, will prioritize and create action plans to address 
pest and disease threats to specialty crops, and will create an 
audit-based certification approach to protect against the 
spread of plant pests.

Sunset of provision

    The authority provided by the provision shall be effective 
only for losses that are incurred as a result of a disaster, 
adverse weather, or another environmental condition that occurs 
on or before September 30, 2012, as determined by the 
Secretary.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

                   TITLE II--CONSERVATION PROVISIONS


      A. Provide Tax Credit for Eligible Farmland Enrolled in the 
                      Conservation Reserve Program


(Sec. 201 of the bill and sec. 30D of the Code)

                              PRESENT LAW

    The Department of Agriculture administers various programs 
designed to encourage conservation. Under the conservation 
reserve program,\4\ eligible producers generally enter into 
contracts under which they agree to establish long-term, 
resource conserving covers on eligible farmland in exchange for 
annual contract payments.
---------------------------------------------------------------------------
    \4\The term ``conservation reserve program'' means the conservation 
reserve program established under subchapter B of chapter 1 of subtitle 
D of title XII of the Food Security Act of 1985.
---------------------------------------------------------------------------
    Present law does not provide an income tax credit for 
eligible farmland enrolled in the conservation reserve program.

                           REASONS FOR CHANGE

    The Committee believes additional incentives should be 
provided to encourage eligible producers to establish long-
term, resource conserving covers on eligible farmland.

                        DESCRIPTION OF PROVISION

    In general, the provision establishes as a credit against 
income taxes the conservation reserve credit. The credit is 
elective, but a taxpayer may not claim the credit for a 
particular year if the taxpayer receives a contract payment 
from the Department of Agriculture pursuant to the conservation 
reserve program for such year.
    The conservation reserve credit requires the taxpayer to be 
an eligible producer on eligible farmland enrolled in the 
conservation reserve program. The credit is equal to the rental 
value of any such property enrolled in the program, as 
determined by the Secretary in consultation with the Secretary 
of Agriculture. The Secretary may not allocate more than 
$50,000 of conservation reserve credit to any one taxpayer for 
any fiscal year. The credit is not includable in the taxpayer's 
gross income and is not subject to Self-Employment 
Contributions Act (SECA) tax.
    The credit allowed under the provision is taken into 
account after other credits (sections 21-27, 30, 30B, and 30C) 
and may not offset the alternative minimum tax. A taxpayer is 
not entitled to a deduction for any amount with respect to 
which a credit is allowed under the proposal. In the event a 
taxpayer terminates a conservation reserve program contract, 
the Secretary may recapture a portion of the credit 
corresponding to the portion of the taxable year during which 
the contract was not in effect.
    The provision establishes an annual conservation reserve 
credit limitation of $750 million for each of fiscal years 2009 
through 2012, which represents the total amount of credits that 
may be allocated under the program for all taxpayers for such 
years. Unallocated amounts with respect to any calendar year 
are carried forward to the allowable allocation for the next 
calendar year, except that no amount of conservation reserve 
credit may be allocated to any taxpayer after fiscal year 2012. 
The credit allowed under the provision may not exceed the 
excess of the amount allocated to the taxpayer by the Secretary 
of the Treasury, in consultation with the Secretary of 
Agriculture, for the taxable year and all prior taxable years 
over the credit allowed for all prior taxable years.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment and 
applies with respect to conservation reserve program contracts 
entered into before, on, or after such date.

B. Exclusion of Conservation Reserve Program Payments From SECA Tax for 
Individuals Receiving Social Security Retirement or Disability Payments


(Sec. 202 of the bill and sec. 1402(a) of the Code)

                              PRESENT LAW

    Generally, the Self-Employment Contributions Act (``SECA'') 
tax is imposed on an individual's net earnings from self-
employment income within the social security wage base. Net 
earnings from self-employment generally mean gross income 
(including the individual's net distributive share of 
partnership income) derived by an individual from any trade or 
business carried on by the individual less applicable 
deductions.\5\
---------------------------------------------------------------------------
    \5\Sec. 1402.
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                           REASONS FOR CHANGE

    The Committee believes that the correct measurement of 
income for SECA purposes in the cases of retired or disabled 
individuals does not include conservation reserve program 
payments.

                        EXPLANATION OF PROVISION

    The provision excludes conservation reserve program 
payments from self-employment income for purpose of SECA tax in 
the case of individuals who are receiving social security 
retirement or disability benefits. The treatment of 
conservation reserve program payments received by other 
entities is not changed.

                             EFFECTIVE DATE

    The provision is effective for payments made after December 
31, 2007.

C. Make Permanent the Special Rule Encouraging Contributions of Capital 
              Gain Real Property for Conservation Purposes


(Sec. 203 of the bill and sec. 170 of the Code)

                              PRESENT LAW

Charitable contributions generally

    In general, a deduction is permitted for charitable 
contributions, subject to certain limitations that depend on 
the type of taxpayer, the property contributed, and the donee 
organization. The amount of deduction generally equals the fair 
market value of the contributed property on the date of the 
contribution. Charitable deductions are provided for income, 
estate, and gift tax purposes.\6\
---------------------------------------------------------------------------
    \6\Secs. 170, 2055, and 2522, respectively. Unless otherwise 
provided, all section references are to the Internal Revenue Code of 
1986, as amended (the ``Code'').
---------------------------------------------------------------------------
    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.

Special rule regarding contributions of capital gain real property for 
        conservation purposes

            In general
    Under a temporary provision that is effective for 
contributions made in taxable years beginning after December 
31, 2005,\7\ 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.
---------------------------------------------------------------------------
    \7\Sec. 170(b)(1)(E).
---------------------------------------------------------------------------
    Individuals are allowed to carry over 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 carry over the excess 
$10 for up to 5 years. No current deduction is allowed for the 
qualified conservation contribution, but the entire $80 
qualified conservation contribution may be carried forward for 
up to 15 years.
            Farmers and ranchers
    In the case of an 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.
    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.\8\
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    \8\Sec. 170(b)(2)(B).
---------------------------------------------------------------------------
    As an additional condition of eligibility for the 100 
percent limitation, with respect to any contribution of 
property in agriculture or livestock production, or that is 
available for such production, by a qualified farmer or 
rancher, the qualified real property interest must include a 
restriction that the property remain generally available for 
such production. (There is no requirement as to any specific 
use in agriculture or farming, or necessarily that the property 
be used for such purposes, merely that the property remain 
available for such purposes.) Such additional condition does 
not apply to contributions made on or before August 17, 2006.
    A qualified farmer or rancher means a taxpayer whose gross 
income from the trade or 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.
            Termination
    The special rule regarding contributions of capital gain 
real property for conservation purposes does not apply to 
contributions made in taxable years beginning after December 
31, 2007.

                           REASONS FOR CHANGE

    Gifts of conservation easements to organizations that are 
dedicated to maintaining natural habitats, open spaces, or 
traditional agriculture help protect our nation's heritage. The 
charitable tax deduction for such conservation easements has 
proven to be a valuable incentive for making such gifts. The 
Committee believes that the special rule that provides an 
increased incentive to make charitable contributions of partial 
interests in real property for conservation purposes is an 
important way of encouraging conservation and preservation, and 
should be made permanent.

                        EXPLANATION OF PROVISION

    The provision makes permanent the special rule regarding 
contributions of capital gain real property for conservation 
purposes.

                             EFFECTIVE DATE

    The provision is effective for contributions made in 
taxable years beginning after December 31, 2007.

   D. Provide Tax Credit for Recovery and Restoration of Endangered 
                                Species


(Sec. 204 of the bill and new sec. 30D of the Code)

                              PRESENT LAW

    Present law does not provide an income tax credit for 
endangered species recovery expenditures.

                           REASONS FOR CHANGE

    The Endangered Species Act (``ESA'') of 1973 is a 
comprehensive attempt to protect species at risk of extinction 
and to consider habitat protection as an integral part of that 
effort. The purpose of the ESA is to conserve the ecosystems 
upon which endangered and threatened species depend and to 
conserve and recover listed species. Under the ESA, species of 
plants and animals (both vertebrate and invertebrate) may be 
listed as either endangered or threatened according to 
assessments of the risk of their extinction.
    As of September 20, 2007, according to the U.S. Fish and 
Wildlife Service (``USFWS''), a total of 607 species of animals 
and 744 species of plants had been listed as either endangered 
or threatened in the United States and its territories. 
According to the USFWS, over 70 percent of the nation's 
landscape is in private ownership and nearly two-thirds of 
Federally listed endangered and threatened species are found on 
private lands. With such a large number of the country's listed 
species dependent upon private lands for their survival, and 
many exclusively so, the goals of the ESA cannot be 
accomplished without the Federal government becoming involved 
to provide incentives for species protection on private lands. 
For both plants and animals, the ESA has very few provisions 
for restoration and managing habitats on private lands. Many 
important habitats require restoration and management because, 
among other things, they have been overrun by invasive species 
or have been deprived of fire and other natural processes.
    Although the ESA prohibits landowners from harming 
endangered or threatened species, the Act itself contains only 
a small number of incentives for landowners to undertake the 
beneficial management actions that most species require for 
recovery. In addition, while most private landowners care about 
their land and want to practice good stewardship, they often 
lack the time and resources to deal with complex regulations 
and necessary management activities.
    The Committee believes that tax credits for private 
landowners who undertake habitat protection and restoration for 
endangered species will provide some needed incentives to help 
recover threatened and endangered species.

                        EXPLANATION OF PROVISION

In general

    For eligible taxpayers, the provision establishes a credit 
against income taxes for: (1) costs paid or incurred by an 
eligible taxpayer for the taxable year (reduced by the amount 
of government financing for conservation of a qualified 
species, and not including costs required by a Federal, State, 
or local government) pursuant to a habitat management plan 
entered into under certain qualified habitat protection 
agreements (``habitat restoration credit'') and (2) a 
percentage of the loss in value to real property attributable 
to an easement placed on the property pursuant to such 
agreements (less any amount received in connection with the 
easement) (``habitat protection easement credit''). The 
allowable credit amount is 100 percent of costs paid or 
incurred and the loss in value to property pursuant to 
qualified perpetual habitat protection agreements; 75 percent 
of costs paid or incurred and the loss in value to property 
pursuant to qualified 30-year habitat protection agreements; 
and 50 percent of costs paid or incurred pursuant to a 
qualified habitat protection agreement.
    For purposes of the habitat protection easement credit, the 
loss in value is the difference between the fair market value 
of the real property subject to the agreement determined on the 
day before the agreement is entered into less the fair market 
value of such property determined one day after the agreement 
is entered into. To claim such credit, the eligible taxpayer 
must own the real property with respect to which the easement 
is placed, and include on the tax return for the taxable year a 
qualified appraisal (within the meaning of section 
170(f)(11)(E)) of the real property. The taxpayer's basis in 
such property is reduced by the amount of basis allocated to 
the easement under regulations prescribed by the Secretary.\9\
---------------------------------------------------------------------------
    \9\See, e.g., Treas. Reg. sec. 1.170A-14(h)(3)(iii).
---------------------------------------------------------------------------
    The habitat restoration credit is taken into account after 
other credits (sections 21-27, 30, 30B, 30C, and the habitat 
protection easement credit) and may not offset the alternative 
minimum tax. If such credit is allowed for any expenditure with 
respect to any property, the increase in the basis of such 
property that would otherwise result from such expenditure is 
reduced by the amount of the credit allowed. The habitat 
protection easement credit is taken into account after other 
credits (sections 21-27, 30, 30B, and 30C) and such credit may 
offset the alternative minimum tax. Amounts allowed but in 
excess of either limitation may be carried forward to the 
succeeding taxable year. No deduction is allowed for any amount 
with respect to which a credit is allowed. The Secretary of the 
Treasury shall by regulations provide for the recapture of the 
credit if such Secretary determines that the eligible taxpayer 
has failed to carry out the duties required by the qualified 
agreement and there are no other available means to remediate 
such failure.
    The sum of the two credits may not exceed the amount 
allocated to the eligible taxpayer for the calendar year in 
which the taxpayer's taxable year ends by the Secretary of the 
Treasury, in consultation with the Secretary of the Interior 
and the Secretary of Commerce, or by the Secretary of the 
Treasury in consultation with the Secretary of Agriculture. If 
the amount allowed as a credit exceeds the amount allocated for 
such year, the excess may be carried forward to the next 
taxable year for which the taxpayer has received an allocation. 
If the amount allocated to a taxpayer for a calendar year 
exceeds the amount allowed as a credit for such year, the 
difference may be carried forward to the next taxable year and 
treated as allocated to the taxpayer for use in such year. No 
credit is allowed unless the appropriate Secretary certifies 
that a qualified agreement will contribute to the recovery of a 
qualified species.
    The aggregate amount allocated by the Secretary of the 
Treasury, in consultation with the Secretary of the Interior 
and the Secretary of Commerce may not exceed in each year 2008 
through 2012: $290,000,000 with respect to qualified perpetual 
habitat protection agreements, $55,000,000 with respect to 
qualified 30-year habitat protection agreements, and 
$35,000,000 with respect to qualified habitat protection 
agreements. The aggregate amount allocated by the Secretary of 
the Treasury, in consultation with the Secretary of Agriculture 
may not exceed in each year 2008 through 2012: $5,000,000 with 
respect to qualified perpetual habitat protection agreements, 
$2,000,000 with respect to qualified 30-year habitat protection 
agreements, and $1,000,000 with respect to qualified habitat 
protection agreements. No allocation is allowed after 2012, 
except that unallocated amounts with respect to any calendar 
year are carried forward to the allowable allocation for the 
next calendar year.
    Not later than 180 days after the date of enactment, the 
Secretary of the Treasury, in consultation with the Secretary 
of the Interior and the Secretary of Commerce, shall by 
regulation establish a program to process applications from 
eligible taxpayers and to determine how best to allocate the 
credit. In allocating the credit, priority shall be given to 
taxpayers with agreements (1) relating to habitats that will 
significantly increase the likelihood of recovering and 
delisting a species as an endangered species or a threatened 
species (as defined under section 2 of the Endangered Species 
Act of 1973), (2) that are cost-effective and maximize the 
benefits to a qualified species per dollar expended, (3) 
relating to habitats of species that have a Federally approved 
recovery plan pursuant to section 4 of the Endangered Species 
Act of 1973, (4) relating to habitats with the potential to 
contribute significantly to the improvement of the status of a 
qualified species, (5) relating to habitats with the potential 
to contribute significantly to the eradication or control of 
invasive species that are imperiling a qualified species, (6) 
with habitat management plans that will manage multiple 
qualified species, (7) with habitat management plans that will 
create adjacent or proximate habitat for the recovery of a 
qualified species, (8) relating to habitats for qualified 
species with an urgent need for protection, (9) with habitat 
management plans that assist in preventing the listing of a 
species as endangered or threatened under the Endangered 
Species Act of 1973 or a similar State law, (10) with habitat 
management plans that may resolve conflicts between the 
protection of qualified species and otherwise lawful human 
activities, and (11) with habitat management plans that may 
resolve conflicts between the protection of a qualified species 
and military training or other military operation.
    The Secretary of the Treasury shall request that the 
appropriate Secretary consider whether to authorize under the 
Endangered Species Act of 1973 takings by an eligible taxpayer 
of a qualified species to which a qualified agreement relates 
if the takings are incidental to (1) the restoration, 
enhancement, or management of the habitat pursuant to the 
habitat management plan under the agreement or (2) the use of 
the property to which the agreement pertains at any time after 
the expiration of the easement (or specified period of time 
pursuant to a qualified habitat protection agreement), but only 
if such use will leave the qualified species at least as well 
off on the property as it was before the agreement was made. 
Both types of incidental takings currently are authorized under 
section 10(a)(1) of the Endangered Species Act of 1973 
(enhancement of survival permits) and 50 C.F.R. part 17 (safe 
harbor permits).
    The Comptroller General of the United States shall 
undertake a study on the effectiveness of the credits. Such 
study shall evaluate the effectiveness of the credits in 
encouraging landowners to enter into agreements for the 
protection of the habitats of endangered and threatened 
species, and the degree to which such agreements are effective 
in preserving the habitats of such species and assisting in the 
recovery of such species, and shall include recommendations for 
improving the effectiveness of the credits. The Comptroller 
General shall issue an interim report based on such study 
within three years of the date of enactment and a final report 
within five years of such date.

Definitions

            Eligible taxpayer
    An eligible taxpayer is (1) a taxpayer who owns real 
property that contains habitat of a qualified species and 
enters into a qualified perpetual habitat protection agreement, 
a qualified 30-year habitat protection agreement, or a 
qualified habitat protection agreement with the appropriate 
Secretary with respect to such real property, and (2) a 
taxpayer who is a party to a qualified perpetual habitat 
protection agreement, a qualified 30-year habitat protection 
agreement, or a qualified habitat protection agreement and, as 
part of any such agreement, agrees to assume responsibility for 
costs paid or incurred as a result of implementing such 
agreement.
            Qualified agreements
    A qualified perpetual habitat protection agreement is an 
agreement under which an easement is granted to the appropriate 
Secretary, the Secretary of Agriculture, the Secretary of 
Defense, or a State to protect the habitat of a qualified 
species in perpetuity. A qualified 30-year habitat protection 
agreement is an agreement under which an easement is granted to 
the appropriate Secretary, the Secretary of Agriculture, the 
Secretary of Defense, or a State to protect the habitat of a 
qualified species for a period of not less than 30 years and 
less than perpetuity. A qualified habitat protection agreement 
requires agreement with the appropriate Secretary, the 
Secretary of Agriculture, the Secretary of Defense, or a State 
to protect the habitat of a qualified species for a specified 
period of time.
    In addition, each of the three types of qualified agreement 
must meet the following requirements: (1) the agreement must be 
consistent with any recovery plan that is applicable and that 
has been approved for a qualified species under section 4 of 
the Endangered Species Act of 1973; (2) the agreement must 
include a habitat management plan agreed to by the appropriate 
Secretary and the eligible taxpayer; and (3) the agreement must 
require that technical assistance with respect to the duties 
under the habitat management plan be provided to the taxpayer 
by the appropriate Secretary or an entity approved by the 
appropriate Secretary.
            Habitat management plan
    A habitat management plan means, with respect to any 
habitat, a plan that (1) identifies one or more qualified 
species to which the plan applies; (2) is designed to restore 
or enhance the habitat of a qualified species or reduce threats 
to a qualified species through the management of the habitat; 
(3) describes the threats to the qualified species that are 
intended to be reduced through the plan; (4) describes the 
management practices to be undertaken by the taxpayer; (5) 
provides a schedule of deadlines for undertaking such 
management practices; (6) requires monitoring of the management 
practices and the status of the qualified species; and (7) 
describes the technical assistance to be provided to the 
taxpayer and identifies the entity that will provide such 
assistance.
            Qualified species
    A qualified species is any species listed as an endangered 
species or threatened species under the Endangered Species Act 
of 1973 or any species for which a finding has been made under 
section 4(b)(3) of the Endangered Species Act of 1973 that 
listing under such Act may be warranted.
            Taking
    A taking has the meaning given to such term under the 
Endangered Species Act of 1973.
            Appropriate Secretary
    Appropriate Secretary has the meaning given to the term 
``Secretary'' under section 3(15) of the Endangered Species Act 
of 1973.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2007.

       E. Deduction for Endangered Species Recovery Expenditures


(Sec. 205 of the bill and sec. 175 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer engaged in the business of 
farming may treat expenditures that are paid or incurred by him 
during the taxable year for the purpose of soil or water 
conservation in respect of land used in farming, or for the 
prevention or erosion of land used in farming, as expenses that 
are not chargeable to capital account. Such expenditures are 
allowed as a deduction, not to exceed 25 percent of the gross 
income derived from farming during the taxable year.\10\ Any 
excess above such percentage is deductible for succeeding 
taxable years, not to exceed 25 percent of the gross income 
derived from farming during such succeeding taxable year.
---------------------------------------------------------------------------
    \10\Sec. 175.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The goal of the Endangered Species Act of 1973 is to 
recover listed species and the ecosystems on which they depend 
to levels where protection under such Act is no longer 
necessary. Recovery is the process by which the decline of an 
endangered species is arrested or reversed, and threats removed 
or reduced so that the species' long-term survival in the wild 
can be ensured. Section 4(f)(1) of such Act directs the 
appropriate Secretary to develop and implement recovery plans 
for the conservation and survival of endangered and threatened 
species, unless the appropriate Secretary finds that such a 
plan will not promote the conservation of the species. To the 
maximum extent practicable, the recovery plan must incorporate 
a description of management actions to achieve the plan's 
goals, objective and measurable criteria for determining the 
removal of species from the endangered species list, and 
estimate the time required and cost to carry out the recovery 
plan. The appropriate Secretary may procure the services of 
appropriate private and public agencies in developing and 
implementing a recovery plan.
    According to an April 6, 2006, General Accountability 
Office report entitled ``Endangered Species: Time and Costs to 
Recover Species Are Largely Unknown'', as of January 2006, the 
Fish and Wildlife Service and the National Marine Fisheries 
Service had finalized and approved 558 recovery plans covering 
1,049 species, or about 82 percent of the 1,272 endangered or 
threatened species protected in the United States at that time. 
Recovery plans contain management measures that landowners can 
adopt on their land that will aid in the recovery of endangered 
or threatened species, resulting in a public benefit. Such are 
similar to measures undertaken for soil and water conservation, 
which are entitled to a tax deduction. The Committee believes 
that certain expenses of farmers made pursuant to a recovery 
plan under the Endangered Species Act should be treated 
similarly to expenditures by farmers made for soil and water 
conservation.

                        EXPLANATION OF PROVISION

    The provision provides that expenditures paid or incurred 
by a taxpayer engaged in the business of farming for the 
purpose of achieving site-specific management actions pursuant 
to the Endangered Species Act of 1973\11\ to be treated the 
same as expenditures for the purpose of soil or water 
conservation in respect of land used in farming, or for the 
prevention or erosion of land used in farming, i.e., such 
expenditures are treated as not chargeable to capital account 
and are deductible subject to the limitation that the deduction 
may not exceed 25 percent of the farmer's gross income derived 
from farming during the taxable year.
---------------------------------------------------------------------------
    \11\16 U.S.C. 1533(f)(B).
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for expenditures paid or 
incurred after the date of enactment.

F. Provide Exclusion for Certain Payments and Programs Relating to Fish 
                              and Wildlife


(Sec. 206 of the bill and sec. 126 of the Code)

                              PRESENT LAW

    Under present law, gross income does not include the 
excludable portion of payments made to taxpayers by the Federal 
and State governments for a share of the cost of improvements 
to property under certain conservation programs.\12\
---------------------------------------------------------------------------
    \12\Sec. 126.
---------------------------------------------------------------------------
    The excludable portion is the portion (or all) of a payment 
made under such programs that is determined by the Secretary of 
Agriculture to be made primarily for the purpose of conserving 
soil and water resources, protecting or restoring the 
environment, improving forests, or providing a habitat for 
wildlife, and is determined by the Secretary of the Treasury as 
not increasing substantially the annual income derived from the 
property. The excludable portion does not include that portion 
of any payment that is properly associated with an amount that 
is allowable as a deduction for the taxable year in which such 
amount is paid or incurred.
    Applicable conservation programs include (1) the rural 
clean water program authorized by section 208(j) of the Federal 
Water Pollution Control Act, (2) the rural abandoned mine 
program authorized by section 406 of the Surface Mining Control 
and Reclamation Act of 1977, (3) the water bank program 
authorized by the Water Bank Act, (4) the emergency 
conservation measures program authorized by title IV of the 
Agricultural Credit Act of 1978, (5) the agriculture 
conservation program authorized by the Soil Conservation and 
Domestic Allotment Act, (6) the great plains conservation 
program authorized by section 16 of the Soil Conservation and 
Domestic Policy Act, (7) the resource conservation and 
development program authorized by the Bankhead-Jones Farm 
Tenant Act and by the Soil Conservation and Domestic Allotment 
Act, (8) the forestry incentives program authorized by section 
4 of the Cooperative Forestry Assistance Act of 1978, (9) any 
small watershed program administered by the Secretary of 
Agriculture which is determined by the Secretary of the 
Treasury or his delegate to be substantially similar to the 
type of programs described in items (1) through (8), and (10) 
any program of a State, possession of the United States, a 
political subdivision of any of the foregoing, or the District 
of Columbia under which payments are made to individuals 
primarily for the purpose of conserving soil, protecting or 
restoring the environment, improving forests, or providing a 
habitat for wildlife.

                           REASONS FOR CHANGE

    Currently, there are a few Federal programs aimed at 
encouraging landowners to protect and aid in the recovery of 
endangered or threatened species. Partners for Fish and 
Wildlife is a national voluntary cost-share program implemented 
by the U.S. Fish and Wildlife Service to protect, enhance, and 
restore important fish and wildlife habitats on private lands 
through partnerships with landowners. The Landowner's Incentive 
Program provides funding for states to staff their programs and 
to fund conservation work with private landowners to restore 
and maintain habitat for endangered, threatened, and other 
imperiled species. State Wildlife Grant funds are used to 
address species and their habitats that are identified in State 
Comprehensive Wildlife Conservation Plans/Strategies (also 
known as Wildlife Action Plans). Priority for use of these 
funds is on those species of greatest conservation need. The 
Private Stewardship Grant Program provides Federal grants on a 
competitive basis to individuals and groups engaged in 
voluntary conservation efforts on private lands that benefit 
Federally listed endangered or threatened species, candidate 
species or other at-risk species. Private landowners and groups 
working with private landowners are able to submit proposals 
directly to the U.S. Fish and Wildlife Service for funding to 
support these efforts. Each grant must be matched by at least 
10 percent of the total project cost in either non Federal 
dollars or in-kind contributions. The Healthy Forests Reserve 
Program is a voluntary program to restore and enhance forest 
ecosystems to promote the recovery of threatened and endangered 
species, improve biodiversity and enhance carbon sequestration.
    The Committee believes that payments received by taxpayers 
under the Partners for Fish and Wildlife Program, the Landowner 
Incentive Program, the State Wildlife Grants Program, the 
Private Stewardship Grants Program, the Forest Health 
Protection Program, and the program related to integrated pest 
management are similar to payments made under other government 
programs that are excludable from gross income under present 
law. Accordingly, the Committee believes it is appropriate to 
extend the present-law exclusion to payments under these 
programs.

                        EXPLANATION OF PROVISION

    The provision expands the exclusion for the excludable 
portion of certain payments to include the excludable portion 
of payments made under the Partners for Fish and Wildlife 
Program authorized by the Partners for Fish and Wildlife Act, 
the Landowner Incentive Program, the State Wildlife Grants 
Program, the Private Stewardship Grants Program authorized by 
the Fish and Wildlife Act of 1956, the Forest Health Protection 
Program authorized by the Cooperative Forestry Assistance Act 
of 1978, and the program related to integrated pest management 
authorized by section 8(i)(1)(A) of the Cooperative Forestry 
Act of 1978.

                             EFFECTIVE DATE

    The provision is effective for payments received after the 
date of enactment.

 G. Provide Tax Credit for Easements Made Pursuant to Certain U.S.D.A. 
                         Conservation Programs


(Sec. 207 of the bill and sec. 30F of the Code)

                              PRESENT LAW

    The Department of Agriculture administers various programs 
designed to encourage conservation. Under the wetlands reserve 
program\13\ and the grassland reserve program (referred to 
herein as the working grassland protection program),\14\ land 
owners generally place conservation easements on real property 
in exchange for payments from the Department of Agriculture.
---------------------------------------------------------------------------
    \13\The term ``wetlands reserve program'' means the wetlands 
reserve program established under subchapter C of chapter 1 of subtitle 
D of title XII of the Food Security Act of 1985.
    \14\The term ``working grassland protection program'' means the 
working grassland protection program established under subchapter C of 
chapter 2 of subtitle D of Title XII of the Food Security Act of 1985.
---------------------------------------------------------------------------
    Present law does not provide an income tax credit for 
easements placed on real property pursuant to the wetlands 
reserve program or the working grassland protection program.

                           REASONS FOR CHANGE

    The Committee believes that additional incentives should be 
provided to encourage landowners to grant conservation 
easements on real property pursuant to the wetlands reserve 
program and the working grassland protection program.

                        EXPLANATION OF PROVISION

    In general, the provision establishes two income tax 
credits: (1) the wetlands reserve conservation credit; and (2) 
the working grassland protection credit. The credits are 
elective, but a taxpayer may not claim the credits if the 
taxpayer receives a payment for an easement made pursuant to 
the wetlands reserve program or the working grassland 
protection program.
    The wetlands reserve conservation credit requires the 
taxpayer to grant to the Secretary of Agriculture an easement 
pursuant to the wetlands reserve program. The credit is equal 
to the applicable percentage of the wetlands reserve easement 
value. The applicable percentage is the excess of 1 over the 
applicable marginal tax rate assuming that the taxpayer sold 
the easement on the date the easement is granted to the 
Secretary of Agriculture. The wetlands reserve easement value 
is the lesser of: (1) the wetlands reserve geographic area rate 
for the area in which the real property is located multiplied 
by the number of acres placed under easement and (2) the amount 
of the payment the taxpayer otherwise would have received from 
the Department of Agriculture in exchange for the easement 
pursuant to the wetlands reserve program. The wetlands reserve 
geographic area rate is a per-acre rate appropriate for 
easements made under the wetlands reserve program in the 
particular geographic area as determined by the Secretary of 
Treasury in consultation with the Secretary of Agriculture.
    The working grassland protection credit requires the 
taxpayer to grant an easement in perpetuity or for a period not 
less than 30 years to the Secretary of Agriculture or to a 
State pursuant to the working grassland protection program. In 
the case of an easement in perpetuity, the working grassland 
protection credit for any taxable year is an amount equal to 
the applicable percentage of the working grassland easement 
value. The applicable percentage is the excess of 1 over the 
applicable marginal tax rate assuming that the taxpayer sold 
the easement on the date the easement is granted to the 
Department of Agriculture or a State. The working grassland 
easement value is the lesser of: (1) the working grassland 
geographic area rate for the area in which the property is 
located multiplied by the number of acres placed under easement 
and (2) the amount of the payment the taxpayer otherwise would 
have received from the Department of Agriculture pursuant to 
the working grassland protection program. The working grassland 
geographic area rate is a per-acre rate appropriate for 
easements granted under the working grassland protection 
program in the particular geographic area as determined by the 
Secretary of Treasury in consultation with the Secretary of 
Agriculture. In the case of a taxpayer who has entered into an 
easement of at least 30 years, the amount of the working 
grassland conservation credit is the lesser of: (1) 30 percent 
of the amount determined under (1) above; and (2) the amount of 
the payment the taxpayer otherwise would have received from the 
Department of Agriculture pursuant to the working grassland 
protection program.
    The credits allowed under the provision are taken into 
account after other credits (sections 21-27, 30, 30B, and 30C) 
and may not offset the alternative minimum tax. A taxpayer is 
not entitled to a deduction for any amount with respect to 
which a credit is allowed under the provision. The Secretary of 
Treasury shall by regulations provide for the recapture of the 
wetlands reserve credit or the working grassland protection 
credit if the Secretary, in consultation with the Secretary of 
Agriculture, determines that the taxpayer has failed to carry 
out the duties of the taxpayer under the terms of the easement 
and there are no other available means to remediate such 
failure.
    The credit allowed under the provision may not exceed the 
excess of the amount allocated to the taxpayer by the Secretary 
of the Treasury, in consultation with the Secretary of 
Agriculture, for the taxable year and all prior taxable years 
over the credit allowed for all prior taxable years. The 
taxpayer's basis in property subject to an easement under the 
provision is reduced.
    The provision establishes a national conservation credit 
limitation of $1 billion, which represents the aggregate amount 
of credits that may be allocated under the provision for all 
taxpayers. The Secretary of Treasury, in consultation with the 
Secretary of Agriculture, shall allocate the national 
conservation credit limitation to taxpayers who grant easements 
under the wetlands reserve program or the working grassland 
protection program. No amount of national conservation credit 
limitation may be allocated to any taxpayer after fiscal year 
2012.

                             EFFECTIVE DATE

    The provision is effective for easements granted after 
September 30, 2007, in taxable years ending after such date.

H. Provide for Exempt Facility Bonds for Forest Conservation Activities


(Sec. 208 of the bill and Sec. 142 of the Code)

                              PRESENT LAW

Tax-exempt bonds

            In general
    Subject to certain Code restrictions, interest on bonds 
issued by State and local government generally is excluded from 
gross income for Federal income tax purposes. Bonds issued by 
State and local governments may be classified as either 
governmental bonds or private activity bonds. Governmental 
bonds are bonds the proceeds of which are primarily used to 
finance governmental functions or which are 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. For this purpose, the 
term ``nongovernmental person'' generally includes the Federal 
Government and all other individuals and entities other than 
States or local governments. The exclusion from income for 
interest on State and local bonds does not apply to private 
activity bonds, unless the bonds are issued for certain 
permitted purposes (``qualified private activity bonds'') and 
other Code requirements are met.
            Qualified private activity bonds
    As stated, interest on private activity bonds is taxable 
unless the bonds meet the requirements for qualified private 
activity bonds. Qualified private activity bonds permit States 
or local governments to act as conduits providing tax-exempt 
financing for certain private activities. The definition of 
qualified private activity bonds includes an exempt facility 
bond, or qualified mortgage, veterans' mortgage, small issue, 
redevelopment, 501(c)(3), or student loan bond (sec. 141(e)).
    The definition of an exempt facility bond includes bonds 
issued to finance certain transportation facilities (airports, 
ports, mass commuting, and high-speed intercity rail 
facilities); qualified residential rental projects; privately 
owned and/or operated utility facilities (sewage, water, solid 
waste disposal, and local district heating and cooling 
facilities, certain private electric and gas facilities, and 
hydroelectric dam enhancements); public/private educational 
facilities; qualified green building and sustainable design 
projects; and qualified highway or surface freight transfer 
facilities (sec. 142(a)).
    In most cases, the aggregate volume of qualified private 
activity bonds is restricted by annual aggregate volume limits 
imposed on bonds issued by issuers within each State (``State 
volume cap''). For calendar year 2007, the State volume cap, 
which is indexed for inflation, equals $85 per resident of the 
State, or $256.24 million, if greater. Exceptions to the State 
volume cap are provided for bonds for certain governmentally 
owned facilities (e.g., airports, ports, high-speed intercity 
rail, and solid waste disposal) and bonds which are subject to 
separate local, State, or national volume limits (e.g., public/
private educational facility bonds, enterprise zone facility 
bonds, qualified green building bonds, and qualified highway or 
surface freight transfer facility bonds).
    Qualified private activity bonds generally are subject to 
restrictions on the use of proceeds for the acquisition of land 
and existing property. For example, generally no more than 25 
percent of the net proceeds of a qualified private activity 
bond may be used for the acquisition of land. In addition, the 
term of qualified private activity bonds generally may not 
exceed 120 percent of the economic life of the property being 
financed.

Taxation of income from timber harvesting

    In general, gross income for Federal income tax purposes 
means all income from whatever source derived, including gross 
income derived from a trade or business. An organization exempt 
from taxation generally is subject to tax on its unrelated 
business taxable income, generally defined to mean gross income 
(less deductions) derived from a trade or business, the conduct 
of which is not substantially related to the exercise or 
performance of the organization's exempt purposes or functions, 
that is regularly carried on by the organization. Special 
unrelated trade or business income rules applicable to the 
cutting of timber are contained in sections 512(b)(5) and 631. 
Under these rules, the determination of whether income derived 
from the cutting of timber constitutes unrelated trade or 
business income depends upon a variety of factors.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to provide certain 
tax incentives to further the goal of permanently setting aside 
working forests for conservation purposes. The Committee 
believes that providing tax-exempt financing to nonprofit 
organizations for the purpose of acquiring forests and forest 
lands to be dedicated to certain conservation purposes will 
increase their ability to purchase such properties from 
commercial owners and operators, and that providing limited 
exclusions from income tax to such nonprofit organizations will 
enable them to conduct charitable and conservation activities 
as they make debt service payments on the bonds.

                        EXPLANATION OF PROVISION

Overview

            In general
    The provision establishes a pilot project for forest 
conservation activities by providing two types of tax benefits 
available to qualified organizations that acquire forest and 
forest lands for conservation management. First, the provision 
provides for the treatment of qualified forest conservation 
bonds as exempt facility bonds. Second, the provision provides 
for the exclusion from gross income of income from certain 
timber harvesting activities conducted by a qualified 
organization on lands acquired with proceeds from qualified 
forest conservation bonds.
            Qualified organizations
    Under the provision, an organization must be a qualified 
organization to be eligible for the tax-exempt financing 
benefit, and must be a qualified organization for whom 
qualified forest conservation bonds have been issued (and 
remain outstanding as tax-exempt bonds) to be eligible for the 
income exclusion. In general, under the provision, a qualified 
organization means a nonprofit organization: (1) substantially 
all the activities of which are charitable, scientific, or 
educational, including acquiring, protecting, restoring, 
managing, and developing forest lands and other renewable 
resources for the long-term charitable, educational, 
scientific, and public benefit; (2) that periodically conducts 
educational programs designed to inform the public of 
environmentally sensitive forestry management and conservation 
techniques; (3) whose board satisfies certain board composition 
requirements designed to ensure that it represents public 
conservation interests;\15\ (4) with governance provisions 
contained in its bylaws that provide a supermajority vote of at 
least two-thirds of the members of the board of directors is 
required to approve and amend the qualified organization's 
qualified conservation plan; and (5) that upon dissolution, its 
assets are required to be dedicated to an organization exempt 
from tax under section 501(c)(3) that is organized and operated 
for conservation purposes, or to a governmental unit.
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    \15\The provision requires that at least 20 percent of the board 
members be comprised of representatives of the conservation community, 
and that at least 20 percent of the board members be public officials. 
Not more than one-third of the board members may be comprised of 
individuals who have or had (during a prescribed five year period) 
certain types of financial or contractual relationships with a 
commercial forest products enterprise. A representative of the 
conservation community is a person well-known in the community located 
near the acquired forest land for dedication to the causes of 
conservation and preservation, and may include a member of the board of 
an established section 501(c)(3) organization with the primary purpose 
of conservation or preservation. Such term does not include a public 
official or a person described above who has or had certain types of 
financial or contractual relationships with a commercial forest 
products enterprise.
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Qualified forest conservation bonds

            In general
    The provision creates a new category of tax-exempt bonds, 
``qualified forest conservation bonds.'' For purposes of the 
Code, qualified forest conservation bonds are treated as exempt 
facility bonds, and therefore, unless otherwise provided, are 
governed by the same rules as exempt facility bonds. A 
qualified forest conservation bond means any bond issued as 
part of an issue if: (1) 95 percent or more of the net proceeds 
of such issue are to be used for qualified project costs; (2) 
such bond is issued for a qualified organization; and (3) such 
bond is issued within 36 months of the date of enactment of the 
provision. The maximum aggregate face amount of bonds that may 
be issued is $1.5 billion.
    The bonds are allocated by the Secretary generally as 
follows: (i) 35 percent for qualified project costs with 
respect to the cost of acquisition by any qualified 
organization in the Pacific Northwest region; (ii) 30 percent 
for qualified project costs with respect to the cost of 
acquisition by any qualified organization in the Western 
region; (iii) 17.5 percent for qualified project costs with 
respect to the cost of acquisition by any qualified 
organization in the Southeast region; (iv) 17.5 percent for 
qualified project costs with respect to the cost of acquisition 
by any qualified organization in the Northeast region.
    The term ``Pacific Northwest region'' means Region 6 as 
defined by the United States Forest Service of the Department 
of Agriculture under section 200.2 of title 36, Code of Federal 
Regulations. The term ``Western region'' means Regions 1, 2, 3, 
4, 5, and 10 (as so defined). The term ``Southeast region'' 
means Region 8 (as so defined). The term ``Northeast region'' 
means Region 9 (as so defined).
    If any region has not received a full allocation of its 
bond limitation amount by the end of the period that is 24 
months after the date of enactment, the Secretary may allocate 
excess amounts to other regions in such manner as the Secretary 
determines appropriate.
            Qualified project costs
    Qualified project costs include the cost of acquisition by 
the qualified organization, from an unrelated person, of 
forests and forest land that at the time of acquisition or 
immediately thereafter are subject to a conservation 
restriction that meets certain requirements.\16\ The 
conservation restriction must: (1) be granted in perpetuity to 
an unrelated charitable organization (other than a private 
foundation) that is organized and operated for conservation 
purposes, or to a governmental unit; (2) protect a relatively 
natural habitat of fish, wildlife, or plants, or similar 
ecosystem, or preserve open space (including farmland and 
forest land) pursuant to a clearly delineated Federal, State, 
or local governmental conservation policy and yield a 
significant public benefit; (3) obligate the qualified 
organization to pay the costs incurred by the holder of the 
conservation restriction in monitoring compliance with such 
restriction; and (4) require that an increasing level of 
conservation benefits be provided whenever circumstances allow 
it.
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    \16\For this purpose, a person is related to another person if such 
person bears a relationship to such other person described in section 
267(b) (determined without regard to paragraph (9) thereof), or section 
707(b)(1), determined by substituting 25 percent for 50 percent for 
purposes of those determinations. If such other person is a nonprofit 
organization, a person is related to such nonprofit organization if 
such person controls directly or indirectly more than 25 percent of the 
governing body of such nonprofit organization.
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    The issuance of qualified forest conservation bonds 
generally is subject to the rules applicable to issuance of 
exempt-facility private activity bonds. However, the issuance 
of such bonds is not subject to the State volume cap. In 
addition, the restrictions on acquisition of land and existing 
property do not apply to such bonds. For purposes of 
determining the maximum maturity on such bonds, the land and 
standing timber acquired with the proceeds of the bonds is 
treated as having an economic life of 35 years.

Exclusion of certain qualified harvesting activity income from tax

            Income from qualified harvesting activities
    Under the provision, income, gains, deductions, losses, or 
credits from a qualified harvesting activity conducted by a 
qualified organization generally are not subject to tax or 
taken into account for Federal income tax purposes. A qualified 
harvesting activity means the sale, lease, or harvesting of 
standing timber: (1) on land owned by a qualified organization 
that it acquired with proceeds of qualified forest conservation 
bonds; and (2) pursuant to a qualified conservation plan 
adopted by the organization. Qualified harvesting activity does 
not include any sale, lease, or harvesting for any period 
during which the organization ceases to qualify as a qualified 
organization.
    Timber cutting and the sale or lease of timber is not a 
qualified harvesting activity to the extent the timber 
harvesting or removal exceeds prescribed limits. For this 
purpose, the average annual area of timber harvested cannot 
exceed 2.5 percent of the total area of the land acquired with 
the proceeds of qualified forest conservation bonds; or the 
quantity of timber removed from such land cannot exceed the 
quantity that can be removed from such land annually in 
perpetuity on a sustained-yield basis determined only with 
respect to such land. Certain deviations from these 
restrictions are permitted to protect the forest from 
catastrophic danger, such as by fire or windthrow, or from 
imminent danger from insect or disease attack.
    The amount of income from a qualified harvesting activity 
that may be excluded from gross income for a taxable year may 
not exceed the amount used by the qualified organization to 
make debt service payments during such taxable year for 
qualified forest conservation bonds.\17\ The exclusion of 
income from a qualified harvesting activity does not apply 
during any period the organization fails to qualify as a 
qualified organization, or after the bonds are no longer 
outstanding or fail to qualify as tax-exempt bonds.
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    \17\This debt service limitation does not apply to income that 
otherwise is not subject to tax under other provisions of the Code 
(e.g., income from harvesting if such harvesting activity is not an 
unrelated trade or business within the meaning of section 513 with 
respect to the qualified organization).
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            Qualified conservation plan
    A qualified conservation plan means a multiple land use 
plan (a) designed and administered primarily for the purposes 
of protecting and enhancing wildlife, fish, timber, scenic 
attributes, recreation, and soil and water quality of the 
forest and forest land, (b) mandates that conservation of the 
forest and forest land is the single-most significant use of 
the forest and land, and (c) requires that timber harvesting be 
consistent with (1) restoring and maintaining reference 
conditions for the region's ecotype (such as with respect to 
types of trees), (2) restoring and maintaining a representative 
sample of young, mid, and late successional forest age classes, 
(3) maintaining or restoring the resources' ecological health 
for purposes of preventing damage from fire, insect, or 
disease, (4) maintaining or enhancing wildlife or fish habitat, 
or (5) enhancing research opportunities in sustainable 
renewable resource uses.

Recapture taxes

    Once the qualified forest conservation bonds issued for a 
qualified organization are no longer outstanding or cease to 
qualify as qualified private activity bonds, the qualified 
organization becomes liable for a recapture of tax benefits 
(plus interest) for its excess harvesting activities. Under the 
provision, if the average annual area of timber harvested from 
the land exceeds the applicable 2.5 percent average annual area 
limitation, the organization's income tax liability is 
increased by the amount of the tax benefits (plus interest) 
attributable to such excess harvesting.

                             EFFECTIVE DATE

    The provision is effective for obligations issued on or 
after the date that is 180 days after the date of enactment.

   I. Deduction for Qualified Timber Gain and Timber REIT Provisions


(Secs. 209-214 of the bill and new sec. 1203, and secs. 856, 857 and 
        4981 of the Code)

                              PRESENT LAW

Treatment of certain timber gain

    Under present law, if a taxpayer cuts standing timber, the 
taxpayer may elect to treat the cutting as a sale or exchange 
eligible for capital gains treatment (sec. 631(a)). For 
purposes of determining the gain attributable to such cutting, 
and the cost of the cut timber for purposes of the taxpayer's 
income from later sales of the timber or timber products, the 
fair market value of the timber on the first day of the taxable 
year in which the timber is used. Also, if a taxpayer disposes 
of the timber with a retained economic interest or makes an 
outright sale of the timber, the gain is eligible for capital 
gain treatment (sec. 631(b)). This treatment under either 
section 631(a) or (b) requires that the taxpayer has owned the 
timber or held the contract right for a period of more than one 
year.
    Under present law, for taxable years beginning before 
January 1, 2011, the maximum rate of tax on long term capital 
gain (``net capital gain'')\18\ of an individual, estate, or 
trust is 15 percent. Any net capital gain that 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.\19\
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    \18\Net capital gain is defined as the excess of net long-term 
capital gain over net short-term capital gain for the taxable year. 
Sec. 1222(11).
    \19\Because the entire amount of the capital gain is included in 
alternative minimum taxable income (``AMTI''), for taxpayers subject to 
the alternative minimum tax with AMTI in excess of $112,500 ($150,000 
in the case of a joint return), the gain may cause a reduction in the 
minimum tax exemption amount and thus effectively tax the gain at rates 
of 21.5 or 22 percent. Also the gain may cause the phase-out of certain 
benefits in computing the regular tax.
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    For taxable years beginning after December 31, 2010, the 
maximum rate of tax on the net capital gain of an individual is 
20 percent. Any net capital gain that 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, 
which would otherwise have been taxed at a 20-percent rate, is 
taxed at an 18-percent rate. The net capital gain of a 
corporation is taxed at the same rates as ordinary income, up 
to a maximum rate of 35 percent.
    Real estate investment trusts (``REITs'') are subject to a 
special taxation regime. Under this regime, a REIT is allowed a 
deduction for dividends paid to its shareholders.\20\ As a 
result, REITs generally do not pay tax on distributed income, 
but the income is taxed to the REIT shareholders. A REIT that 
has long term capital gain can declare a dividend that 
shareholders are entitled to treat as long term capital gain.
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    \20\A distribution to a corporate shareholder out of current or 
accumulated earnings and profits of the corporation is a dividend, 
unless the distribution is a redemption that terminates the 
shareholder's stock interest or reduces the shareholder's interest in 
the distributing corporation to an extent considered to result in 
treatment as a sale or exchange of the shareholder's stock. Secs. 301 
and 302. A distribution in excess of corporate earnings and profits is 
treated by shareholders as first a recovery of their stock basis and 
then, to the extent the distribution exceeds a shareholder's stock 
basis, as a sale or exchange of the stock. Sec. 301. These rules 
generally apply to REITs.
---------------------------------------------------------------------------
    REITs generally are required to distribute 90 percent of 
their taxable income (other than net capital gain). A REIT 
generally must pay tax at regular corporate rates on any 
undistributed income. However, a REIT that has net capital gain 
can retain that gain without distributing it, and the 
shareholders can report the net capital gain as if it were 
distributed to them. In that case the REIT pays a C corporation 
tax on the retained gain, but the shareholders who report the 
income are entitled to a credit or refund for the difference 
between the tax that would be due if the income had been 
distributed and the 35-percent rate paid by the REIT.\21\ In 
effect, net capital gain of a REIT (including but not limited 
to timber gain) can be taxed as net capital gain of the 
shareholders, whether or not the gain is distributed.
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    \21\Sec. 857(b)(3)(D). The shareholders also obtain a basis 
increase in their REIT stock for the gross amount of the deemed 
distribution that is included in their income less the amount of 
corporate tax deemed paid by them that was paid by the REIT on the 
retained gain. Sec. 857(b)(3)(D)(iii).
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Other REIT provisions

    A REIT is also subject to a 4-percent excise tax to the 
extent it does not distribute specified percentages of its 
income within any calendar year. The required distributed 
percentage is 85 percent in the case of the REIT ordinary 
income, and 95 percent in the case of the REIT capital gain net 
income (as defined).\22\ The amount of the excess of the 
required distribution over the actual distribution is subject 
to the 4-percent tax.
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    \22\Section 4981. The definition is the excess of gains from sales 
or exchanges of capital assets over losses from such sales or exchanges 
for the calendar year, reduced by any net ordinary loss.
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    A REIT generally is restricted to earning certain types of 
passive income. Among other requirements, at least 75 percent 
of the gross income of a REIT in a taxable year must consist of 
certain types of real estate related income, including rents 
from real property, income from the sale or exchange of real 
property (including interests in real property) that is not 
stock in trade, inventory, or held by the taxpayer primarily 
for sale to customers in the ordinary course of its trade or 
business, and interest on mortgages secured by real property or 
interests in real property.\23\ Interests in real property are 
specifically defined to exclude mineral, oil, or gas royalty 
interests.\24\ A REIT will not qualify as a REIT, and will be 
taxable as a C corporation, for any taxable year if it does not 
meet this income test.
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    \23\Section 856(c) and section 1221(a). Income from sales that are 
not prohibited transactions solely by virtue of section 857(b)(6) is 
also qualified REIT income.
    \24\Section 856(c)(5)(C).
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    Some REITs have been formed to hold land on which trees are 
grown. Upon maturity of the trees, the standing trees are sold 
by the REIT. The Internal Revenue Service has issued private 
letter rulings in particular instances stating that the income 
from the sale of the trees under section 631(b) can qualify as 
REIT real property income because the uncut timber and the 
timberland on which the timber grew is considered real property 
and the sale of uncut trees can qualify as capital gain derived 
from the sale of real property.\25\
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    \25\Timber income under section 631(b) has also been held to be 
qualified real estate income even if the one year holding period is not 
met. See, e.g., PLR 200052021, see also PLR 199945055, PLR 199927021, 
PLR 8838016. A private letter ruling may be relied upon only by the 
taxpayer to which the ruling is issued. However, such rulings provide 
an indication of administrative practice.
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    A REIT is subject to a 100-percent excise tax on gain from 
any sale that is a ``prohibited transaction,'' defined as a 
sale of property that is stock in trade, inventory, or property 
held by the taxpayer primarily for sale to customers in the 
ordinary course of its trade or business.\26\ This 
determination is based on facts and circumstances. However, a 
safe-harbor provides that no excise tax is imposed if certain 
requirements are met. In the case of timber property, the safe 
harbor is met, regardless of the number of sales that occur 
during the taxable year, if (i) the REIT has held the property 
for not less than 4 years in connection with the trade or 
business of producing timber; (ii) the aggregate adjusted bases 
of the property sold (other than foreclosure property) during 
the taxable year does not exceed 10 percent of the aggregate 
bases of all the assets of the REIT as of the beginning of the 
taxable year, and if certain other requirements are met. These 
include requirements that limit the amount of expenditures the 
REIT can make during the 4-year period prior to the sale that 
are includible in the adjusted basis of the property,\27\ that 
require marketing to be done by an independent contractor, and 
that forbid a sales price that is based on the income or 
profits of any person.\28\ There is a similar but separate safe 
harbor for sales of non-timber property, with similar rules, 
including a 4-year holding period requirement and a limit on 
the percentage of the aggregate adjusted basis of property that 
can be sold in one taxable year.\29\
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    \26\Sections 857(b)(6) and 1221(a)(1). There is an exception for 
certain foreclosure property.
    \27\Aggregate expenditures (other than timberland acquisition 
expenditures) during such period made by the REIT or a partner of the 
REIT, which are includible in basis, may not exceed 30 percent of the 
net selling price in the case of expenditures that are directly related 
to operation of the property for the production of timber or the 
preservation of the property for use as timberland, and may not exceed 
5 percent of the net selling price in the case of expenditures that are 
not directly related to those purposes.
    \28\Section 857(b)(6)(D).
    \29\Section 857(b)(6)(C).
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    A REIT is not generally permitted to hold securities 
representing more than 10 percent of the voting power or value 
of the securities of any one issuer; nor may more than 5 
percent of the fair market value of REIT assets be securities 
of any one issuer.\30\ However, under an exception, a REIT may 
hold any amount of securities of one or more ``taxable REIT 
subsidiary'' (TRS) corporations, provided that such TRS 
securities do not represent more than 20 percent of the fair 
market value of REIT assets at the end of any quarter. A TRS is 
a C corporation that is subject to regular corporate tax on its 
income and that meets certain other requirements. A taxable 
REIT subsidiary may conduct activities that would produce 
disqualified non-passive or non-real estate income that could 
disqualify the REIT if conducted by a REIT itself. Such 
business could include business relating to processing timber, 
or holding timber products or other assets for sale to 
customers in the ordinary course of business. Such income would 
be subject to regular corporate rates of tax as income of the 
TRS.\31\
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    \30\Section 856(c)(4)(B)(ii) and (iii). Certain interests are not 
treated as ``securities'' for purposes of the rule forbidding the REIT 
to hold securities representing more than 10 percent of the value of 
securities of any one issuer. Sec. 856(m).
    \31\A 100-percent excise tax is imposed on the amount of certain 
transactions involving a TRS and a REIT, to the extent such amount 
would exceed an arm's length amount under section 482. Sec. 857(b)(7).
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                           REASONS FOR CHANGE

    The committee believes it is desirable to provide greater 
equivalence to the capital gain tax treatment of timber gain, 
regardless of whether the gain is recognized by a C corporation 
or a REIT, or by an individual. The committee also believes it 
is desirable to provide changes to the statutory rules 
governing REITs, in order to clarify and facilitate timber REIT 
operations.

                        EXPLANATION OF PROVISION

Elective deduction for 60 percent of qualified timber gain

    The provision allows a taxpayer to elect to deduct an 
amount equal to 60 percent of the taxpayer's qualified timber 
gain (or, if less, the net capital gain) for a taxable year. In 
the case of an individual, the deduction reduces adjusted gross 
income. Qualified timber gain means the net gain described in 
section 631(a) and (b) for the taxable year.
    The deduction is allowed in computing the regular tax and 
the alternative minimum tax (including the adjusted current 
earnings of a corporation).
    If a taxpayer elects the deduction, the 40 percent of the 
gain subject to tax is taxed at ordinary income tax rates.\32\
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    \32\Under the provision, because only 40 percent of the gain is 
included in adjusted gross income and AMTI, only that amount of gain 
would result in the phase-out of tax benefits.
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    In the case of a pass-thru entity other than a REIT, the 
election may be made separately by each taxpayer subject to tax 
on the gain. The Treasury Department may prescribe rules 
appropriate to apply this provision to gain taken into account 
by a pass-thru entity.
    In the case of a REIT, the election to take the 60-percent 
deduction is made by the REIT. If a REIT makes the election, 
then the timber gain is excluded from the computation of 
capital gain or loss of the REIT and can no longer be 
designated as a capital gain dividend to shareholders. Instead, 
the gain is treated as ordinary income for purposes of applying 
the REIT income distribution requirements, but for this purpose 
60-percent of the amount of the gain is deductible by the REIT 
in computing its income. REIT earnings and profits also exclude 
the portion of the timber gain that is deductible. Thus, 40 
percent of the gain is subject to the REIT distribution 
requirements,\33\ and 40 percent of the gain increases REIT 
earnings and profits. Accordingly, because REIT earnings and 
profits have been increased by the 40-percent amount, there is 
sufficient earnings and profits that a distribution of that 40-
percent amount that otherwise qualifies as a dividend would be 
treated as an ordinary dividend distribution to shareholders. 
Since this dividend is from a REIT and is not derived from an 
entity that was taxed as a C corporation, it would not qualify 
for the current 15 percent qualified dividend rates and would 
be taxed at the ordinary income rates of the shareholders.
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    \33\For purposes of the section 4981 excise tax on undistributed 
REIT income, the amount treated as subject to the 95 percent 
distribution requirement is the 40 percent of timber gain income that 
remains after allowing the deduction.
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    REIT shareholders obtain an upward basis adjustment in 
their REIT interests, equal to the 60 percent of the timber 
gain that is deductible by the electing REIT. Because the 60 
percent of timber gain that was deductible by the REIT does not 
increase REIT earnings and profits, a distribution of such 60 
percent to the shareholder generally will not be treated as a 
dividend (in the absence of other retained earnings) but as a 
return of basis under the general rules of section 301(c). 
Because the shareholders' basis has been increased by this 60 
percent, this distribution would not exceed the shareholders' 
basis and thus would be nontaxable return of basis, rather than 
capital gain in excess of basis. However, if a REIT shareholder 
has obtained such an upward basis adjustment for a REIT 
interest and disposes of the interest before having held the 
interest for at least 6 months, then any loss on disposition of 
the interest is disallowed to the extent of such upward basis 
adjustment.

Additional REIT provisions

            Timber gain qualified REIT income without regard to 1 year 
                    holding period
    The provision specifically includes timber gain under 
section 631(a) as a category of statutorily recognized 
qualified real estate income of a REIT if the cutting is 
provided by a taxable REIT subsidiary, and also includes gain 
recognized under section 631(b). For purposes of such qualified 
income treatment under those provisions, the requirement of a 
one-year holding period is removed. Thus, for a example, a REIT 
can acquire timber property and harvest the timber on the 
property within one year of the acquisition, with the resulting 
income being qualified real estate income for REIT 
qualification purposes, even though such income is not eligible 
for long term capital gain treatment under sections 631(a) or 
(b). The provision specifically provides, however, that for all 
purposes of the Code, such income shall not be considered to be 
gain described in section 1221(a)(1), that is, it shall not be 
treated as income from the sale of stock in trade, inventory, 
or property held by the REIT primarily for sale to customers in 
the ordinary course of the REITs trade or business.
    For purposes of determining REIT income, if the cutting is 
done by a taxable REIT subsidiary, the cut timber is deemed 
sold on the first day of the taxable year to the taxable REIT 
subsidiary (with subsequent gain, if any, attributable to the 
taxable REIT subsidiary).
            REIT prohibited transaction safe harbor for timber property
    For sales to a qualified organization for conservation 
purposes, as defined in section 170(h), the provision reduces 
to 2 years the present law 4-year holding period requirement 
under section 857(b)(6)(D), which provides a safe harbor from 
``prohibited transaction'' treatment for certain timber 
property sales. Also, in the case of such sales, the safe-
harbor limitations on how much may be added, within the 4-year 
period prior to the date of sale, to the aggregate adjusted 
basis of the property, are changed to refer to the 2-year 
period prior to the date of sale.
    The provision also removes the safe-harbor requirement that 
marketing of the property must be done by an independent 
contractor, and permits a taxable REIT subsidiary of the REIT 
to perform the marketing.
    The provision states that any gain that is eligible for the 
timber property safe harbor is considered for all purposes of 
the Code not to be described in section 1221(a)(1), that is, it 
shall not be treated as income from the sale of stock in trade, 
inventory, or property held by the REIT primarily for sale to 
customers in the ordinary course of the REITs trade or 
business.
            Special rules for Timber REITs
    The provision contains several provisions applicable only 
to a ``timber REIT,'' defined as a REIT in which more than 50 
percent of the value of its total assets consists of real 
property held in connection with the trade or business of 
producing timber.
    First, mineral royalty income from real property owned by a 
timber REIT and held, or once held, in connection with the 
trade or business of producing timber by such REIT, is included 
as qualifying real estate income for purposes of the REIT 
income tests.
    Second, a timber REIT is permitted to hold TRS securities 
with a value up to 25 percent, (rather than 20 percent) of the 
value of the total assets of the REIT.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after the 
date of enactment, but does not apply after the last day of the 
first taxable year beginning after the date of enactment.

                      TITLE III--ENERGY PROVISIONS


          A. Credit for Residential and Business Wind Property


(Sec. 301 of the bill and secs. 25D and 48 of the Code)

                              PRESENT LAW

Credit for residential energy efficient property

    A personal tax credit is allowed for the purchase of 
qualified solar electric property and qualified solar water 
heating property that is used exclusively for purposes other 
than heating swimming pools and hot tubs.\34\ The credit is 
equal to 30 percent of qualifying expenditures, with a maximum 
credit for each of these systems of property of $2,000 per 
taxable year. A 30 percent credit is also allowed for the 
purchase of qualified fuel cell power plants. The credit for 
any fuel cell power plant may not exceed $500 for each 0.5 
kilowatt of capacity.
---------------------------------------------------------------------------
    \34\Sec. 25D.
---------------------------------------------------------------------------
    Qualifying solar water heating property means expenditure 
for property to heat water for use in a dwelling unit located 
in the United States and used as a residence if at least half 
of the energy used by such property for such purpose is derived 
from the sun. Qualified solar electric property is property 
that uses solar energy to generate electricity for use in a 
dwelling unit. A qualified fuel cell power plant is an 
integrated system comprised of a fuel cell stack assembly and 
associated balance of plant components that (1) converts a fuel 
into electricity using electrochemical means, (2) has an 
electricity-only generation efficiency of greater than 30 
percent. The qualified fuel cell power plant must be installed 
on or in connection with a dwelling unit located in the United 
States and used by the taxpayer as a principal residence.
    The credit is nonrefundable, and the depreciable basis of 
the property is reduced by the amount of the credit. 
Expenditures for labor costs allocable to onsite preparation, 
assembly, or original installation of property eligible for the 
credit are eligible expenditures.
    Certain equipment safety requirements must be met to 
qualify for the credit. Special proration rules apply in the 
case of jointly owned property, condominiums, and tenant-
stockholders in cooperative housing corporations. If less than 
80 percent of the property is used for nonbusiness purposes, 
only that portion of expenditures that is used for nonbusiness 
purposes is taken into account.
    The credit applies to expenditures after December 31, 2005, 
for property placed in service prior to January 1, 2009.

Energy credit for businesses

            In general
    A nonrefundable, 10-percent business energy credit\35\ is 
allowed for the cost of new property that is equipment that 
either (1) uses solar energy to generate electricity, to heat 
or cool a structure, or to provide solar process heat, or (2) 
is used to produce, distribute, or use energy derived from a 
geothermal deposit, but only, in the case of electricity 
generated by geothermal power, up to the electric transmission 
stage. Property used to generate energy for the purposes of 
heating a swimming pool is not eligible solar energy property.
---------------------------------------------------------------------------
    \35\Sec. 48.
---------------------------------------------------------------------------
    The energy credit is a component of the general business 
credit\36\ and as such is subject to the alternative minimum 
tax. An unused general business credit generally may be carried 
back one year and carried forward 20 years.\37\ The taxpayer's 
basis in the property is reduced by one-half of the amount of 
the credit claimed.\38\ For projects whose construction time is 
expected to equal or exceed two years, the credit may be 
claimed as progress expenditures are made on the project, 
rather than during the year the property is placed in service. 
Similarly, the credit only applies to expenditures made after 
the effective date of the provision.
---------------------------------------------------------------------------
    \36\Sec. 38(b)(1).
    \37\Sec. 39.
    \38\Sec. 50(c)(3).
---------------------------------------------------------------------------
    In general, property that is public utility property is not 
eligible for the credit. Public utility property is property 
that is used predominantly in the trade or business of the 
furnishing or sale of (1) electrical energy, water, or sewage 
disposal services, (2) gas through a local distribution system, 
or (3) telephone service, domestic telegraph services, or other 
communication services (other than international telegraph 
services), if the rates for such furnishing or sale have been 
established or approved by a State or political subdivision 
thereof, by an agency or instrumentality of the United States, 
or by a public service or public utility commission. This rule 
is waived in the case of telecommunication companies' purchases 
of fuel cell and microturbine property.
            Special rules for solar energy property
    The credit for solar energy property is increased to 30 
percent in the case of periods after December 31, 2005 and 
prior to January 1, 2009. Additionally, equipment that uses 
fiber-optic distributed sunlight to illuminate the inside of a 
structure is solar energy property eligible for the 30-percent 
credit.
            Fuel cells and microturbines
    The business energy credit also applies for the purchase of 
qualified fuel cell power plants, but only for periods after 
December 31, 2005 and prior to January 1, 2009. The credit rate 
is 30 percent.
    A qualified fuel cell power plant is an integrated system 
composed of a fuel cell stack assembly and associated balance 
of plant components that (1) converts a fuel into electricity 
using electrochemical means, and (2) has an electricity-only 
generation efficiency of greater than 30 percent and a capacity 
of at least 0.5 kilowatt. The credit may not exceed $500 for 
each 0.5 kilowatt of capacity.
    The business energy credit also applies for the purchase of 
qualifying stationary microturbine power plants, but only for 
periods after December 31, 2005 and prior to January 1, 2009. 
The credit is limited to the lesser of 10 percent of the basis 
of the property or $200 for each kilowatt of capacity.
    A qualified stationary microturbine power plant is an 
integrated system comprised of a gas turbine engine, a 
combustor, a recuperator or regenerator, a generator or 
alternator, and associated balance of plant components that 
converts a fuel into electricity and thermal energy. Such 
system also includes all secondary components located between 
the existing infrastructure for fuel delivery and the existing 
infrastructure for power distribution, including equipment and 
controls for meeting relevant power standards, such as voltage, 
frequency and power factors. Such system must have an 
electricity-only generation efficiency of not less that 26 
percent at International Standard Organization conditions and a 
capacity of less than 2,000 kilowatts.
    Additionally, for purposes of the fuel cell and 
microturbine credits, and only in the case of 
telecommunications companies, the general present-law section 
48 restriction that would otherwise prohibit telecommunication 
companies from claiming the new credit due to their status as 
public utilities is waived.

                           REASONS FOR CHANGE

    The Committee believes that the promotion of viable 
alternative energy sources is essential to reduce dependence of 
foreign oil and to reduce the harmful impacts of fossil fuel 
consumption. As wind energy is a proven and effective 
alternative means of electricity generation, the Committee 
believes a credit for wind energy property should be made 
available on similar terms to that provided for solar electric 
generation under present law.

                        EXPLANATION OF PROVISION

Residential wind credit

    The provision provides a 30 percent credit for qualified 
small wind energy property expenditures made by the taxpayer 
during the taxable year. The credit is limited to $4,000 per 
taxable year. Qualified small wind energy property expenditures 
are expenditures for property that uses a qualified wind 
turbine to generate electricity for use in a dwelling unit 
located in the U.S. and used as a residence by the taxpayer. A 
qualifying wind turbine means a wind turbine of 100 kilowatts 
of rated capacity or less that meets the latest performance 
rating standards published by the American Wind Energy 
Association.

Business wind credit

    The provision provides a credit of 30 percent of the basis 
of qualified small wind energy property placed in service 
during the taxable year. The credit is limited to $4,000 per 
taxable year. Qualified small wind energy property is property 
that uses a qualified wind turbine to generate electricity for 
use in the U.S. A qualifying wind turbine means a wind turbine 
of 100 kilowatts of rated capacity or less that meets the 
latest performance rating standards published by the American 
Wind Energy Association. As part of the section 48 energy 
credit, a basis reduction of 50 percent of the amount of the 
credit applies.

                             EFFECTIVE DATE

    The provision is effective for expenditures after December 
31, 2007, for property placed in service prior to January 1, 
2009.

  B. Landowner Incentive To Encourage Electric Transmission Build-Out


(Sec. 302 of the bill and new sec. 139B of the Code)

                              PRESENT LAW

    Gross income includes all income from whatever source 
derived unless a specific exclusion applies.\39\
---------------------------------------------------------------------------
    \39\Sec. 61.
---------------------------------------------------------------------------

                           REASON FOR CHANGE

    The Committee believes that an incentive should be provided 
for the build-out of electricity generated from certain 
alternative energy sources.

                        EXPLANATION OF PROVISION

    The proposal provides an exclusion from gross income for 
any qualified electric transmission easement payment. For 
purposes of the proposal, a qualified electric transmission 
easement payment is any payment by an electric utility or 
electric transmission entity pursuant to an easement or other 
agreement granted by the payee for the right to locate on the 
payee's property transmission lines and equipment used to 
transmit electricity at 230 or more kilovolts primarily from 
qualified facilities described in section 45(d) (without regard 
to any placed in service date).

                             EFFECTIVE DATE

    The proposal is effective for payments received after the 
date of enactment.

       C. Exception to Reduction of Renewable Electricity Credit


(Sec. 303 of the bill and sec. 45 of the Code)

                              PRESENT LAW

In general

    An income tax credit is allowed for the production of 
electricity at qualified facilities using qualified energy 
resources.\40\ Qualified energy resources comprise wind, 
closed-loop biomass, open-loop biomass, geothermal energy, 
solar energy, small irrigation power, municipal solid waste, 
and qualified hydropower production. Qualified facilities are, 
generally, facilities that generate electricity using qualified 
energy resources. To be eligible for the credit, electricity 
produced from qualified energy resources at qualified 
facilities must be sold by the taxpayer to an unrelated person. 
In addition to the electricity production credit, an income tax 
credit is allowed for the production of refined coal and Indian 
coal at qualified facilities.\41\
---------------------------------------------------------------------------
    \40\Sec. 45.
    \41\Collectively, the electricity production credit, the refined 
coal production credit, and the Indian coal production credit are 
referred to herein as the section 45 credit.
---------------------------------------------------------------------------

Credit amounts and credit period

            In general
    The base amount of the electricity production credit is 1.5 
cents per kilowatt-hour (indexed annually for inflation) of 
electricity produced. The amount of the credit is 2 cents per 
kilowatt-hour for 2007. A taxpayer may generally claim a credit 
during the 10-year period commencing with the date the 
qualified facility is placed in service. The credit is reduced 
for grants, tax-exempt bonds, subsidized energy financing, and 
other credits.
    The amount of credit a taxpayer may claim is phased out as 
the market price of electricity (or refined coal in the case of 
the refined coal production credit) exceeds certain threshold 
levels. The electricity production credit is reduced over a 3 
cent phase-out range to the extent the annual average contract 
price per kilowatt hour of electricity sold in the prior year 
from the same qualified energy resource exceeds 8 cents 
(adjusted for inflation). The refined coal credit is reduced 
over an $8.75 phase-out range as the reference price of the 
fuel used as feedstock for the refined coal exceeds the 
reference price for such fuel in 2002 (adjusted for inflation).
            Reduced credit amounts and credit periods
    Generally, in the case of open-loop biomass facilities 
(including agricultural livestock waste nutrient facilities), 
geothermal energy facilities, solar energy facilities, small 
irrigation power facilities, landfill gas facilities, and trash 
combustion facilities, the 10-year credit period is reduced to 
five years commencing on the date the facility was originally 
placed in service, for qualified facilities placed in service 
before August 8, 2005. However, for qualified open-loop biomass 
facilities (other than a facility described in sec. 
45(d)(3)(A)(i) that uses agricultural livestock waste 
nutrients) placed in service before October 22, 2004, the five-
year period commences on January 1, 2005. In the case of a 
closed-loop biomass facility modified to co-fire with coal, to 
co-fire with other biomass, or to co-fire with coal and other 
biomass, the credit period begins no earlier than October 22, 
2004.
    In the case of open-loop biomass facilities (including 
agricultural livestock waste nutrient facilities), small 
irrigation power facilities, landfill gas facilities, trash 
combustion facilities, and qualified hydropower facilities the 
otherwise allowable credit amount is 0.75 cent per kilowatt-
hour, indexed for inflation measured after 1992 (currently 1 
cent per kilowatt-hour for 2007).
            Credit applicable to refined coal
    The amount of the credit for refined coal is $4.375 per ton 
(also indexed for inflation after 1992 and equaling $5.877 per 
ton for 2007).
            Credit applicable to Indian coal
    A credit is available for the sale of Indian coal to an 
unrelated third part from a qualified facility for a seven-year 
period beginning on January 1, 2006, and before January 1, 
2013. The amount of the credit for Indian coal is $1.50 per ton 
for the first four years of the seven-year period and $2.00 per 
ton for the last three years of the seven-year period. 
Beginning in calendar years after 2006, the credit amounts are 
indexed annually for inflation using 2005 as the base year; for 
2007 the Indian coal credit is $1.544 per ton.
            Special rules and other limitations on credit claimants and 
                    credit amounts
    In general, in order to claim the credit, a taxpayer must 
own the qualified facility and sell the electricity produced by 
the facility (or refined coal or Indian coal, with respect to 
those credits) to an unrelated party. A lessee or operator may 
claim the credit in lieu of the owner of the qualifying 
facility in the case of qualifying open-loop biomass facilities 
and in the case of closed-loop biomass facilities modified to 
co-fire with coal, to co-fire with other biomass, or to co-fire 
with coal and other biomass. In the case of a poultry waste 
facility, the taxpayer may claim the credit as a lessee or 
operator of a facility owned by a governmental unit.
    For all qualifying facilities, other than closed-loop 
biomass facilities modified to co-fire with coal, to co-fire 
with other biomass, or to co-fire with coal and other biomass, 
the amount of credit a taxpayer may claim is reduced by reason 
of grants, tax-exempt bonds, subsidized energy financing, and 
other credits, but the reduction cannot exceed 50 percent of 
the otherwise allowable credit. In the case of closed-loop 
biomass facilities modified to co-fire with coal, to co-fire 
with other biomass, or to co-fire with coal and other biomass, 
there is no reduction in credit by reason of grants, tax-exempt 
bonds, subsidized energy financing, and other credits.
    The credit for electricity produced from renewable sources 
is a component of the general business credit.\42\ For 
alternative minimum tax purposes, a taxpayer's tentative 
minimum tax is treated as being zero when determining the tax 
liability limitation for the section 45 credit for electricity 
produced from a facility (placed in service after October 22, 
2004) during the first four years of production beginning on 
the date the facility is placed in service.
---------------------------------------------------------------------------
    \42\Sec. 38(b)(8).
---------------------------------------------------------------------------
    Special rules apply for eligible cooperatives claiming the 
section 45 credit. For taxable years ending after August 8, 
2005, eligible cooperatives may elect to pass any portion of 
the credit through to their patrons. An eligible cooperative is 
defined as a cooperative organization that is owned more than 
50 percent by agricultural producers or entities owned by 
agricultural producers. The credit may be apportioned among 
patrons eligible to share in patronage dividends on the basis 
of the quantity or value of business done with or for such 
patrons for the taxable year.

Qualified facilities

            Wind energy facility
    A wind energy facility is a facility that uses wind to 
produce electricity. To be a qualified facility, a wind energy 
facility must be placed in service after December 31, 1993, and 
before January 1, 2009.
            Closed-loop biomass facility
    A closed-loop biomass facility is a facility that uses any 
organic material from a plant which is planted exclusively for 
the purpose of being used at a qualifying facility to produce 
electricity. In addition, a facility can be a closed-loop 
biomass facility if it is a facility that is modified to use 
closed-loop biomass to co-fire with coal, with other biomass, 
or with both coal and other biomass, but only if the 
modification is approved under the Biomass Power for Rural 
Development Programs or is part of a pilot project of the 
Commodity Credit Corporation.
    To be a qualified facility, a closed-loop biomass facility 
must be placed in service after December 31, 1992, and before 
January 1, 2009. In the case of a facility using closed-loop 
biomass but also co-firing the closed-loop biomass with coal, 
other biomass, or coal and other biomass, a qualified facility 
must be originally placed in service and modified to co-fire 
the closed-loop biomass at any time before January 1, 2009.
            Open-loop biomass (including agricultural livestock waste 
                    nutrients) facility
    An open-loop biomass facility is a facility that uses open-
loop biomass to produce electricity. For purposes of the 
credit, open-loop biomass is defined as (1) any agricultural 
livestock waste nutrients or (2) any solid, nonhazardous, 
cellulosic waste material or any lignin material that is 
segregated from other waste materials and which is derived 
from:
           forest-related resources, including mill and 
        harvesting residues, precommercial thinnings, slash, 
        and brush;
           solid wood waste materials, including waste 
        pallets, crates, dunnage, manufacturing and 
        construction wood wastes, and landscape or right-of-way 
        tree trimming; or
           agricultural sources, including orchard tree 
        crops, vineyard, grain, legumes, sugar, and other crop 
        by-products or residues.
    Agricultural livestock waste nutrients are defined as 
agricultural livestock manure and litter, including bedding 
material for the disposition of manure. Wood waste materials do 
not qualify as open-loop biomass to the extent they are 
pressure treated, chemically treated, or painted. In addition, 
municipal solid waste, gas derived from the biodegradation of 
solid waste, and paper which is commonly recycled do not 
qualify as open-loop biomass. Open-loop biomass does not 
include closed-loop biomass or any biomass burned in 
conjunction with fossil fuel (co-firing) beyond such fossil 
fuel required for start up and flame stabilization.
    In the case of an open-loop biomass facility that uses 
agricultural livestock waste nutrients, a qualified facility is 
one that was originally placed in service after October 22, 
2004, and before January 1, 2009, and has a nameplate capacity 
rating which is not less than 150 kilowatts. In the case of any 
other open-loop biomass facility, a qualified facility is one 
that was originally placed in service before January 1, 2009.
            Geothermal facility
    A geothermal facility is a facility that uses geothermal 
energy to produce electricity. Geothermal energy is energy 
derived from a geothermal deposit that is a geothermal 
reservoir consisting of natural heat that is stored in rocks or 
in an aqueous liquid or vapor (whether or not under pressure). 
To be a qualified facility, a geothermal facility must be 
placed in service after October 22, 2004 and before January 1, 
2009.
            Solar facility
    A solar facility is a facility that uses solar energy to 
produce electricity. To be a qualified facility, a solar 
facility must be placed in service after October 22, 2004, and 
before January 1, 2006.
            Small irrigation facility
    A small irrigation power facility is a facility that 
generates electric power through an irrigation system canal or 
ditch without any dam or impoundment of water. The installed 
capacity of a qualified facility must be at least 150 kilowatts 
but less than five megawatts. To be a qualified facility, a 
small irrigation facility must be originally placed in service 
after October 22, 2004, and before January 1, 2009.
            Landfill gas facility
    A landfill gas facility is a facility that uses landfill 
gas to produce electricity. Landfill gas is defined as methane 
gas derived from the biodegradation of municipal solid waste. 
To be a qualified facility, a landfill gas facility must be 
placed in service after October 22, 2004, and before January 1, 
2009.
            Trash combustion facility
    Trash combustion facilities are facilities that burn 
municipal solid waste (garbage) to produce steam to drive a 
turbine for the production of electricity. To be a qualified 
facility, a trash combustion facility must be placed in service 
after October 22, 2004 and before January 1, 2009. A qualified 
trash combustion facility includes a new unit, placed in 
service after October 22, 2004, that increases electricity 
production capacity at an existing trash combustion facility. A 
new unit generally would include a new burner/boiler and 
turbine. The new unit may share certain common equipment, such 
as trash handling equipment, with other pre-existing units at 
the same facility. Electricity produced at a new unit of an 
existing facility qualifies for the production credit only to 
the extent of the increased amount of electricity produced at 
the entire facility.
            Hydropower facility
    A qualifying hydropower facility is (1) a facility that 
produced hydroelectric power (a hydroelectric dam) prior to 
August 8, 2005, at which efficiency improvements or additions 
to capacity have been made after such date and before January 
1, 2009, that enable the taxpayer to produce incremental 
hydropower or (2) a facility placed in service before August 8, 
2005, that did not produce hydroelectric power (a 
nonhydroelectric dam) on such date, and to which turbines or 
other electricity generating equipment have been added after 
such date and before January 1, 2009.
    At an existing hydroelectric facility, the taxpayer may 
claim credit only for the production of incremental 
hydroelectric power. Incremental hydroelectric power for any 
taxable year is equal to the percentage of average annual 
hydroelectric power produced at the facility attributable to 
the efficiency improvement or additions of capacity determined 
by using the same water flow information used to determine a 
historic average annual hydroelectric power production baseline 
for that facility. The Federal Energy Regulatory Commission 
will certify the baseline power production of the facility and 
the percentage increase due to the efficiency and capacity 
improvements.
    At a nonhydroelectric dam, the facility must be licensed by 
the Federal Energy Regulatory Commission and meet all other 
applicable environmental, licensing, and regulatory 
requirements and the turbines or other generating devices must 
be added to the facility after August 8, 2005 and before 
January 1, 2009. In addition there must not be any enlargement 
of the diversion structure, or construction or enlargement of a 
bypass channel, or the impoundment or any withholding of 
additional water from the natural stream channel.
            Refined coal facility
    A qualifying refined coal facility is a facility producing 
refined coal that is placed in service after October 22, 2004 
and before January 1, 2009. Refined coal is a qualifying 
liquid, gaseous, or solid fuel produced from coal (including 
lignite) or high-carbon fly ash, including such fuel used as a 
feedstock. A qualifying fuel is a fuel that when burned emits 
20 percent less nitrogen oxides and either SO2 or mercury than 
the burning of feedstock coal or comparable coal predominantly 
available in the marketplace as of January 1, 2003, and if the 
fuel sells at prices at least 50 percent greater than the 
prices of the feedstock coal or comparable coal. In addition, 
to be qualified refined coal the fuel must be sold by the 
taxpayer with the reasonable expectation that it will be used 
for the primary purpose of producing steam.
            Indian coal facility
    A qualified Indian coal facility is a facility which is 
placed in service before January 1, 2009, that produces coal 
from reserves that on June 14, 2005, were owned by a Federally 
recognized tribe of Indians or were held in trust by the United 
States for a tribe or its members.

Summary of credit rate and credit period by facility type

                                     TABLE 1.--SUMMARY OF SECTION 45 CREDIT
----------------------------------------------------------------------------------------------------------------
                                                                   Credit period for
                                                                  facilities placed in        Credit period
  Eligible electricity production or    Credit amount for 2007    service on or before     facilities placed in
       coal production activity          (cents per kilowatt-    August 8, 2005 (years   service after August 8,
                                        hour; dollars per ton)   from placed-in-service  2005 (years from placed-
                                                                         date)               in-service date)
----------------------------------------------------------------------------------------------------------------
Wind.................................                        2                       10                       10
Closed-loop biomass..................                        2                    \1\10                       10
Open-loop biomass (including                                 1                     \2\5                       10
 agricultural livestock waste
 nutrient facilities)................
Geothermal...........................                        2                        5                       10
Solar (pre-2006 facilities only).....                        2                        5                       10
Small irrigation power...............                        1                        5                       10
Municipal solid waste (including                             1                        5                       10
 landfill gas facilities and trash
 combustion facilities)..............
Qualified hydropower.................                        1                      N/A                       10
Refined Coal.........................                    5.877                       10                       10
Indian Coal..........................                    1.544                     \3\7                     \3\7
----------------------------------------------------------------------------------------------------------------
\1\In the case of certain co-firing closed-loop facilities, the credit period begins no earlier than October 22,
  2004.
\2\For certain facilities placed in service before October 22, 2004, the 5-year credit period commences on
  January 1, 2005.
\3\For Indian coal, the credit period begins for coal sold after January 1, 2006.

                           REASONS FOR CHANGE

    The Committee believes that building additional renewable 
energy infrastructure advances America's environmental and 
energy independence goals. The Committee believes that 
additional renewable energy infrastructure will be built if the 
tax incentives for renewable energy are better coordinated with 
certain federal spending programs.

                        EXPLANATION OF PROVISION

    The provision provides an exception to the reduction in the 
section 45 credit by reason of grants, tax-exempt bonds, 
subsidized energy financing, and other credits. Under the 
provision, the section 45 credit is not reduced by any loans, 
loan guarantees, or grants to farmers, ranchers, or rural small 
businesses issued by the Secretary of Agriculture under 
authority granted by section 9006 of the Farm Security and 
Rural Investment Act of 2002 (Pub. L. No. 107-171).

                             EFFECTIVE DATE

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

 D. Expansion of Special Depreciation Allowance to Cellulosic Biomass 
                           Alcohol Fuel Plant


(Sec. 311 of the bill and sec. 168(l) of the Code)

                              PRESENT LAW

    Section 168(l) allows an additional first-year depreciation 
deduction equal to 50 percent of the adjusted basis of 
qualified cellulosic biomass ethanol plant property. In order 
to qualify, the property generally must be placed in service 
before January 1, 2013.
    Qualified cellulosic biomass ethanol plant property means 
property used in the U.S. solely to produce cellulosic biomass 
ethanol. For this purpose, cellulosic biomass ethanol means 
ethanol derived from any lignocellulosic or hemicellulosic 
matter that is available on a renewable or recurring basis. For 
example, lignocellulosic or hemicellulosic matter that is 
available on a renewable or recurring basis includes bagasse 
(from sugar cane), corn stalks, and switchgrass.
    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. 
The additional first-year depreciation deduction is subject to 
the general rules regarding whether an item is deductible under 
section 162 or subject to capitalization under section 263 or 
section 263A. The basis of the property and the depreciation 
allowances in the year of purchase and later years are 
appropriately adjusted to reflect the additional first-year 
depreciation deduction. In addition, there is no adjustment to 
the allowable amount of depreciation for purposes of computing 
a taxpayer's alternative minimum taxable income with respect to 
property to which the provision applies. 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 the following 
requirements. The original use of the property must commence 
with the taxpayer on or after December 20, 2006. The property 
must be acquired by purchase (as defined under section 179(d)) 
by the taxpayer after December 20, 2006, and placed in service 
before January 1, 2013. Property does not qualify if a binding 
written contract for the acquisition of such property was in 
effect on or before December 20, 2006.
    Property that is manufactured, constructed, or produced by 
the taxpayer for use by the taxpayer qualifies if the taxpayer 
begins the manufacture, construction, or production of the 
property after December 20, 2006, and the property is placed in 
service before January 1, 2013 (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.
    Property any portion of which is financed with the proceeds 
of a tax-exempt obligation under section 103 is not eligible 
for the additional first-year depreciation deduction. Recapture 
rules apply if the property ceases to be qualified cellulosic 
biomass ethanol plant property.
    Property with respect to which the taxpayer has elected 50 
percent expensing under section 179C is not eligible for the 
additional first-year depreciation deduction.

                           REASONS FOR CHANGE

    The Committee believes that the expensing provision should 
include any cellulosic biomass alcohol and not be limited to 
ethanol. Additionally, the Committee believes that the 
provision should not be limited to certain processes.

                        EXPLANATION OF PROVISION

    The provision changes the definition of qualified property. 
Under the provision, qualified property includes property used 
solely to produce cellulosic biomass alcohol. Cellulosic 
biomass alcohol is defined as any alcohol produced by any 
process from any lignocellulosic or hemicellulosic matter that 
is available on a renewable or recurring basis.

                             EFFECTIVE DATE

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

         E. Credit for Production of Cellulosic Biomass Alcohol


(Sec. 312 of the bill and sec. 40 of the Code)

                              PRESENT LAW

    In the case of ethanol, the Code provides a separate 10-
cents-per-gallon credit for up to 15 million gallons per year 
for small producers, defined generally as persons whose 
production capacity does not exceed 60 million gallons per 
year. The ethanol must (1) be sold by such producer to another 
person (a) for use by such other person in the production of a 
qualified alcohol fuel mixture in such person's trade or 
business (other than casual off-farm production), (b) for use 
by such other person as a fuel in a trade or business, or, (c) 
who sells such ethanol at retail to another person and places 
such ethanol in the fuel tank of such other person; or (2) used 
by the producer for any purpose described in (a), (b), or (c). 
A cooperative may pass through the small ethanol producer 
credit to its patrons. The credit is includible in income and 
is treated as a general business credit, subject to the 
ordering rules and carryforward/carryback rules that apply to 
business credits generally. The alcohol fuels tax credit, of 
which the small producer credit is a part, is scheduled to 
expire after December 31, 2010.
    Under the Renewable Fuels Standard Program all renewable 
fuel produced or imported on or after September 1, 2007 must 
have a renewable identification number (RIN) associated with 
it. Producers and importers must generate RINs to represent all 
the renewable fuel they produce or import and provide those 
RINs to the EPA. For cellulosic ethanol, 2.5 RINs are generated 
for every gallon produced.

                           REASONS FOR CHANGE

    The Committee believes that the development of fuels from 
cellulosic materials, such as corn stover, switchgrass, and 
other organic materials that can be grown anywhere, is a 
significant component in establishing the nation's energy 
independence. Tax incentives are an important part of taking 
this industry from the level of demonstration projects into a 
practical and competitive fuel source. To encourage new 
production capacity for this fuel, the provision provides a new 
per-gallon incentive for cellulosic alcohol fuel producers.

                        EXPLANATION OF PROVISION

    The provision provides an income tax credit for up to 60 
million gallons of qualified cellulosic fuel production of the 
producer for the taxable year. The amount of the credit per 
gallon is $1.28 less the credit amount for alcohol fuel and the 
credit amount for small ethanol producers as of the date the 
cellulosic alcohol fuel is produced. This credit is in addition 
to any credit that may be available under section 40 of the 
Code. A small cellulosic alcohol fuel producer is not precluded 
from also claiming the alcohol or alcohol fuel mixture credit, 
or the small ethanol producer credit, if the requirements for 
those credits are also met. For example, in the case of a 
gallon of ethanol, a small producer may be able to claim 50 
cents as a cellulosic alcohol producer, plus 51 cents under the 
alcohol fuel mixture credit, and an additional 10 cents as a 
small ethanol producer.
    Qualified cellulosic fuel production is any cellulosic 
alcohol which is produced by a small cellulosic alcohol fuel 
producer during the taxable year which is sold by such producer 
to another person (a) for use by such other person in the 
production of a qualified alcohol fuel mixture in such person's 
trade or business (other than casual off-farm production), (b) 
for use by such other person as a fuel in a trade or business, 
or, (c) who sells such alcohol at retail to another person and 
places such alcohol in the fuel tank of such other person; or 
(2) used by the producer for any purpose described in (a), (b), 
or (c).
    Cellulosic alcohol is alcohol that is produced in the 
United States and is derived from any lignocellulosic or 
hemicellulosic matter that is available on a renewable or 
recurring basis. Examples of lignocellulosic or hemicellulosic 
matter that is available of a renewable or recurring basis 
includes dedicated energy crops and trees, wood and wood 
residues, plants, grasses, agricultural residues, fibers, 
animal wastes and other waste materials, and municipal solid 
waste.
    Generally, a small cellulosic alcohol fuel producer is a 
cellulosic alcohol producer whose production capacity does not 
exceed 60 million gallons.
    The small cellulosic alcohol producer credit is limited to 
domestic production. Only domestically produced cellulosic 
alcohol sold for use, or used, in the United States qualifies 
for the credit.
    The small cellulosic alcohol producer credit terminates on 
April 1, 2015.

                             EFFECTIVE DATE

    The provision is effective for alcohol produced after 
December 31, 2007.

             F. Extension of Small Ethanol Producer Credit


(Sec. 313 of the bill and sec. 40 of the Code)

                              PRESENT LAW

    The alcohol fuels credit is the sum of three credits: the 
alcohol mixture credit, the alcohol credit, and the small 
ethanol producer credit. Generally, the alcohol fuels credit 
expires after December 31, 2010.\43\
---------------------------------------------------------------------------
    \43\The alcohol fuels credit is unavailable when, for any period 
before January 1, 2011, the tax rates for gasoline and diesel fuels 
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
    Taxpayers are eligible for an income tax credit of 51 cents 
per gallon of ethanol (60 cents in the case of alcohol other 
than ethanol) used in the production of a qualified mixture 
(the ``alcohol mixture credit''). A ``qualified mixture'' means 
a mixture of alcohol and gasoline, (or of alcohol and a special 
fuel) sold by the taxpayer as fuel, or used as fuel by the 
taxpayer producing such mixture. The term ``alcohol'' includes 
methanol and ethanol but does not include (1) alcohol produced 
from petroleum, natural gas, or coal (including peat), or (2) 
alcohol with a proof of less than 150.
    Taxpayers may reduce their income taxes by 51 cents for 
each gallon of ethanol, which is not in a mixture with gasoline 
or other special fuel, that they sell at the retail level as 
vehicle fuel or use themselves as a fuel in their trade or 
business (``the alcohol credit''). For alcohol other than 
ethanol, the rate is 60 cents per gallon.\44\
---------------------------------------------------------------------------
    \44\In the case of any alcohol (other than ethanol) with a proof 
that is at least 150 but less than 190, the credit is 45 cents per 
gallon (the ``low-proof blender amount''). For ethanol with a proof 
that is at least 150 but less than 190, the low-proof blender amount is 
37.78 cents.
---------------------------------------------------------------------------
    In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year 
for small producers. Small producers are defined generally as 
persons whose production capacity does not exceed 60 million 
gallons per year. The ethanol must (1) be sold by such producer 
to another person (a) for use by such other person in the 
production of a qualified alcohol fuel mixture in such person's 
trade or business (other than casual off-farm production), (b) 
for use by such other person as a fuel in a trade or business, 
or, (c) who sells such ethanol at retail to another person and 
places such ethanol in the fuel tank of such other person; or 
(2) be used by the producer for any purpose described in (a), 
(b), or (c). A cooperative may pass through the small ethanol 
producer credit to its patrons.
    The alcohol fuels credit is includible in income and is 
treated as a general business credit, subject to the ordering 
rules and carryforward/carryback rules that apply to business 
credits generally. The credit is allowable against the 
alternative minimum tax.

                           REASONS FOR CHANGE

    The Committee believes that as the ethanol industry 
continues to mature, it is appropriate to encourage small 
producers to continue to participate in such industry. 
Therefore, the bill extends the small ethanol producer credit 
for an additional two years.

                        EXPLANATION OF PROVISION

    The provision extends the small ethanol producer component 
of the alcohol fuels credit for an additional two years 
(through December 31, 2012).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

             G. Credit for Producers of Fossil-Free Alcohol


(Sec. 314 of the bill and sec. 40 of the Code)

                              PRESENT LAW

    The alcohol fuels credit is the sum of three credits: the 
alcohol mixture credit, the alcohol credit, and the small 
ethanol producer credit. Generally, the alcohol fuels credit 
expires after December 31, 2010.\45\
---------------------------------------------------------------------------
    \45\The alcohol fuels credit is unavailable when, for any period 
before January 1, 2011, the tax rates for gasoline and diesel fuels 
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
    Taxpayers are eligible for an income tax credit of 51 cents 
per gallon of ethanol (60 cents in the case of alcohol other 
than ethanol) used in the production of a qualified mixture 
(the ``alcohol mixture credit''). A ``qualified mixture'' means 
a mixture of alcohol and gasoline, (or of alcohol and a special 
fuel) sold by the taxpayer as fuel, or used as fuel by the 
taxpayer producing such mixture. The term ``alcohol'' includes 
methanol and ethanol but does not include (1) alcohol produced 
from petroleum, natural gas, or coal (including peat), or (2) 
alcohol with a proof of less than 150.
    Taxpayers may reduce their income taxes by 51 cents for 
each gallon of ethanol, which is not in a mixture with gasoline 
or other special fuel, that they sell at the retail level as 
vehicle fuel or use themselves as a fuel in their trade or 
business (``the alcohol credit''). For alcohol other than 
ethanol, the rate is 60 cents per gallon.\46\
---------------------------------------------------------------------------
    \46\In the case of any alcohol (other than ethanol) with a proof 
that is at least 150 but less than 190, the credit is 45 cents per 
gallon (the ``low-proof blender amount''). For ethanol with a proof 
that is at least 150 but less than 190, the low-proof blender amount is 
37.78 cents.
---------------------------------------------------------------------------
    In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year 
for small producers. Small producer is defined generally as a 
producer whose production capacity does not exceed 60 million 
gallons per year. The ethanol must (1) be sold by such producer 
to another person (a) for use by such other person in the 
production of a qualified alcohol fuel mixture in such person's 
trade or business (other than casual off-farm production), (b) 
for use by such other person as a fuel in a trade or business, 
or, (c) who sells such ethanol at retail to another person and 
places such ethanol in the fuel tank of such other person; or 
(2) be used by the producer for any purpose described in (a), 
(b), or (c). A cooperative may pass through the small ethanol 
producer credit to its patrons.
    The alcohol fuels credit is includible in income and is 
treated as a general business credit, subject to the ordering 
rules and carryforward/carryback rules that apply to business 
credits generally. The credit is allowable against the 
alternative minimum tax.

                           REASONS FOR CHANGE

    The production of ethanol consumes a significant amount of 
fossil fuel. To encourage the use of alternative fuels in that 
production process, the Committee believes it is appropriate to 
provide an additional credit to small producers of ethanol that 
displace 90 percent of the fossil-fuel use with bio-based 
fuels.

                        EXPLANATION OF PROVISION

    The provision adds a new component to the alcohol fuels 
credit, the small fossil-free alcohol producer credit. The 
credit provides an additional 25-cents-per-gallon credit for up 
to 60 million gallons of alcohol produced at a fossil-free 
facility during the calendar year for small producers. Small 
producer is defined generally as a producer whose fossil-free 
alcohol production capacity does not exceed 60 million gallons 
per year. A fossil-free facility is one at which 90 percent of 
the fuel used in the production of alcohol at such facility is 
from biomass as defined in sec. 45K(c)(3).
    The alcohol must (1) be sold by such producer to another 
person (a) for use by such other person in the production of a 
qualified alcohol fuel mixture in such person's trade or 
business (other than casual off-farm production), (b) for use 
by such other person as a fuel in a trade or business, or, (c) 
who sells such ethanol at retail to another person and places 
such ethanol in the fuel tank of such other person; or (2) used 
by the producer for any purpose described in (1)(a), (b), or 
(c). Only domestically produced alcohol, sold for use or used 
in the United States qualifies for the credit. A cooperative 
may pass through the small producer credit to its patrons.
    The credit terminates after December 31, 2012.

                             EFFECTIVE DATE

    The provision is effective after December 31, 2007.

                   H. Modification of Alcohol Credit


(Sec. 315 of the bill and secs. 40, 6426 and 6427 of the Code)

Income tax credit

    The alcohol fuels credit is the sum of three credits: the 
alcohol mixture credit, the alcohol credit, and the small 
ethanol producer credit. Generally, the alcohol fuels credit 
expires after December 31, 2010.\47\
---------------------------------------------------------------------------
    \47\The alcohol fuels credit is unavailable when, for any period 
before January 1, 2011, the tax rates for gasoline and diesel fuels 
drop to 4.3 cents per gallon.
---------------------------------------------------------------------------
    Taxpayers are eligible for an income tax credit of 51 cents 
per gallon of ethanol (60 cents in the case of alcohol other 
than ethanol) used in the production of a qualified mixture 
(the ``alcohol mixture credit''). A ``qualified mixture'' means 
a mixture of alcohol and gasoline, (or of alcohol and a special 
fuel) sold by the taxpayer as fuel, or used as fuel by the 
taxpayer producing such mixture. The term ``alcohol'' includes 
methanol and ethanol but does not include (1) alcohol produced 
from petroleum, natural gas, or coal (including peat), or (2) 
alcohol with a proof of less than 150.
    Taxpayers may reduce their income taxes by 51 cents for 
each gallon of ethanol, which is not in a mixture with gasoline 
or other special fuel, that they sell at the retail level as 
vehicle fuel or use themselves as a fuel in their trade or 
business (``the alcohol credit''). For alcohol other than 
ethanol, the rate is 60 cents per gallon.\48\
---------------------------------------------------------------------------
    \48\In the case of any alcohol (other than ethanol) with a proof 
that is at least 150 but less than 190, the credit is 45 cents per 
gallon (the ``low-proof blender amount''). For ethanol with a proof 
that is at least 150 but less than 190, the low-proof blender amount is 
37.78 cents.
---------------------------------------------------------------------------
    In the case of ethanol, the Code provides an additional 10-
cents-per-gallon credit for up to 15 million gallons per year 
for small producers. Small producer is defined generally as 
persons whose production capacity does not exceed 60 million 
gallons per year. The ethanol must (1) be sold by such producer 
to another person (a) for use by such other person in the 
production of a qualified alcohol fuel mixture in such person's 
trade or business (other than casual off-farm production), (b) 
for use by such other person as a fuel in a trade or business, 
or, (c) who sells such ethanol at retail to another person and 
places such ethanol in the fuel tank of such other person; or 
(2) used by the producer for any purpose described in (a), (b), 
or (c). A cooperative may pass through the small ethanol 
producer credit to its patrons.
    The alcohol fuels credit is includible in income and is 
treated as a general business credit, subject to the ordering 
rules and carryforward/carryback rules that apply to business 
credits generally. The credit is allowable against the 
alternative minimum tax.

Excise tax credit and payment provision for alcohol fuel mixtures

    The Code also provides an excise tax credit and payment 
provision for alcohol fuel mixtures. Like the income tax 
credit, the amount of the credit is 60 cents per gallon of 
alcohol used as part of a qualified mixture (51 cents in the 
case of ethanol). For purposes of the excise tax credit and 
payment provisions, alcohol includes methanol and ethanol but 
does not include (1) alcohol produced from petroleum, natural 
gas, or coal (including peat), or (2) alcohol with a proof of 
less than 190. Such term also includes an alcohol gallon 
equivalent of ethyl tertiary butyl either or other ethers 
produced from alcohol. In lieu of a tax credit, a person making 
a qualified mixture eligible for the credit may seek a payment 
from the Secretary in the amount of the credit. The payment 
provisions and credits are coordinated such that the incentive 
is not claimed more than once for each gallon of alcohol used 
as part of qualified mixture.

Renewable Fuels Standard Program

    Under the Renewable Fuels Standard Program all renewable 
fuel produced or imported on or after September 1, 2007 must 
have a renewable identification number (RIN) associated with 
it. Producers and importers must generate RINs to represent all 
the renewable fuel they produce or import and provide those 
RINs to the Environmental Protection Agency. For cellulosic 
ethanol, 2.5 RINs are generated for every gallon produced.

                           REASONS FOR CHANGE

    As the ethanol industry further matures, the Committee 
believes it is appropriate to reduce the amount of the tax 
incentive.

                        EXPLANATION OF PROVISION

    Under the provision, the 51-cent-per-gallon incentive for 
ethanol is adjusted to 46 cents per gallon beginning with the 
first calendar year after the year in which the Environmental 
Protection Agency receives RINs in an amount equivalent to 7.5 
billion gallons of ethanol (including cellulosic ethanol).

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

         I. Calculation of Volume of Alcohol for Fuels Credits


(Sec. 316 of the bill, and sec. 40 of the Code)

                              PRESENT LAW

    The Code provides a per-gallon credit for the volume of 
alcohol used as a fuel or in a qualified mixture. For purposes 
of determining the number of gallons of alcohol with respect to 
which the credit is allowable, the volume of alcohol includes 
any denaturant, including gasoline.\49\ The denaturant must be 
added under a formula approved by the Secretary and the 
denaturant cannot exceed five percent of the volume of such 
alcohol (including denaturants).
---------------------------------------------------------------------------
    \49\Sec. 40(d)(4).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Gasoline can be used as a denaturant of alcohol. The 
Committee believes it is inappropriate to allow a credit that 
is intended to be for alcohol to be claimed on liquids that do 
not constitute alcohol.

                        EXPLANATION OF PROVISION

    The provision provides that the volume of alcohol eligible 
for the credit does not include the volume of any denaturant.

                             EFFECTIVE DATE

    The provision is effective January 1, 2008.

                      J. Ethanol Tariff Extension


(Sec. 317 of the bill)

                              PRESENT LAW

    Heading 9901.00.50 of the Harmonized Tariff Schedule of the 
United States imposes a cumulative general duty of 14.27 cents 
per liter (approximately 54 cents per gallon) to imports of 
ethyl alcohol, and any mixture containing ethyl alcohol, if 
used as a fuel or in producing a mixture to be used as a fuel, 
that are entered into the United States prior to January 1, 
2009. The temporary duty under heading 9901.00.50 offsets the 
alcohol fuels credit of 51 cents per gallon that is available 
to taxpayers that blend ethanol with gasoline; both domestic 
and imported ethanol is eligible for the alcohol fuels credit.
    Heading 9901.00.52 of the Harmonized Tariff Schedule of the 
United States imposes a general duty of 5.99 cents per liter to 
imports of ethyl tertiary-butyl ether, and any mixture 
containing ethyl tertiary-butyl ether, that are entered into 
the United States prior to January 1, 2009.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to extend the 
tariff through the end of calendar year 2010.

                        EXPLANATION OF PROVISION

    The provision modifies the existing effective period for 
ethyl alcohol as classified under heading 9901.00.50 and 
9901.00.52 of the Harmonized Tariff Schedule of the United 
States from before January 1, 2009 to before January 1, 2011.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

  K. Elimination and Reductions of Duty Drawback on Certain Imported 
                                Ethanol


(Sec. 318 of the bill)

                              PRESENT LAW

    Subheading 9901.00.50, Harmonized Tariff Schedule of the 
United States (``HTSUS''), imposes an additional duty on 
ethanol that is used as fuel or use to make fuel. Subsection 
(b) of Section 1313 of the Tariff Act of 1930, as amended, 
permits the refund of duty if the duty-paid good, or a 
substitute good, is used to make an article that is exported. 
Subsection (j)(2) of Section 1313 permits the refund of duty if 
the duty-paid good, or a substitute good, is exported. 
Subsection (p) of section 1313 permits the substitution on 
exportation for drawback eligibility of one motor fuel for 
another motor fuel. A person who manufactures or acquires 
gasoline with ethanol subject to the duty imposed by subheading 
9901.00.50, HTSUS, can export jet fuel (which does not involve 
the use of ethanol) and obtain a refund of the duty paid under 
subheading 9901.00.50, HTSUS.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to eliminate the 
ability to claim duty drawback on the substitution of jet fuel 
for ethyl alcohol (ethanol), or an ethyl alcohol mixture, used 
as a fuel. In addition, the Committee believes that it is 
appropriate to eliminate the ability to claim duty drawback on 
the substitution of a low-value ethyl alcohol for ethyl alcohol 
(ethanol) subject to the duty under HTSUS subheading 
9901.00.50.

                        EXPLANATION OF PROVISION

    The provision eliminates the ability to obtain a refund of 
the duty imposed by subheading 9901.00.50, HTSUS by 
substitution of ethanol not subject to the duty under 
subheading 9901.00.50, HTSUS for ethanol subject to the duty 
imposed under subheading 9901.00.50, HTSUS, for drawback 
purposes. The provision also prevents a petroleum product which 
contains ethanol from being substituted for any other petroleum 
product that is exported to obtain drawback.

                             EFFECTIVE DATE

    The provision is effective for any good exported on and 
after the fifteenth day after enactment.

                 L. Extension of Credits for Biodiesel


(Sec. 321 of the bill and secs. 40A, 6426 and 6427 of the Code)

                              PRESENT LAW

Income tax credit

            Overview
    The Code provides an income tax credit for biodiesel fuels 
(the ``biodiesel fuels credit'').\50\ The biodiesel fuels 
credit is the sum of the biodiesel mixture credit, the 
biodiesel credit, and the small agri-biodiesel producer credit. 
The biodiesel fuels credit is treated as a general business 
credit. The amount of the biodiesel fuels credit is includable 
in gross income. The biodiesel fuels credit is coordinated to 
take into account benefits from the biodiesel excise tax credit 
and payment provisions discussed below. The credit does not 
apply to fuel sold or used after December 31, 2008.
---------------------------------------------------------------------------
    \50\Sec. 40A.
---------------------------------------------------------------------------
    Biodiesel is monoalkyl esters of long chain fatty acids 
derived from plant or animal matter that meet (1) the 
registration requirements established by the Environmental 
Protection Agency under section 211 of the Clean Air Act and 
(2) the requirements of the American Society of Testing and 
Materials D6751. Agri-biodiesel is biodiesel derived solely 
from virgin oils including oils from corn, soybeans, sunflower 
seeds, cottonseeds, canola, crambe, rapeseeds, safflowers, 
flaxseeds, rice bran, mustard seeds, or animal fats. The 
language ``including'' indicates that this list is not 
exclusive.\51\ Camelina is a plant from which oil can be 
extracted.
---------------------------------------------------------------------------
    \51\Treasury Notice 2005-62.
---------------------------------------------------------------------------
    Biodiesel may be taken into account for purposes of the 
credit only if the taxpayer obtains a certification (in such 
form and manner as prescribed by the Secretary) from the 
producer or importer of the biodiesel which identifies the 
product produced and the percentage of the biodiesel and agri-
biodiesel in the product.
            Biodiesel mixture credit
    The biodiesel mixture credit is 50 cents for each gallon of 
biodiesel (other than agri-biodiesel) used by the taxpayer in 
the production of a qualified biodiesel mixture. For agri-
biodiesel, the credit is $1.00 per gallon. A qualified 
biodiesel mixture is a mixture of biodiesel and diesel fuel 
that (1) is sold by the taxpayer producing such mixture to any 
person for use as a fuel, or (2) is used as a fuel by the 
taxpayer producing such mixture. The sale or use must be in the 
trade or business of the taxpayer and is to be taken into 
account for the taxable year in which such sale or use occurs. 
No credit is allowed with respect to any casual off-farm 
production of a qualified biodiesel mixture.
            Biodiesel credit
    The biodiesel credit is 50 cents for each gallon of 
biodiesel which is not in a mixture with diesel fuel (100 
percent biodiesel or B-100) and which during the taxable year 
is (1) used by the taxpayer as a fuel in a trade or business or 
(2) sold by the taxpayer at retail to a person and placed in 
the fuel tank of such person's vehicle. For agri-biodiesel, the 
credit is $1.00 per gallon.
            Small agri-biodiesel producer credit
    The Code provides a small agri-biodiesel producer income 
tax credit, in addition to the biodiesel and biodiesel fuel 
mixture credits. The credit is a 10-cents-per-gallon credit for 
up to 15 million gallons of agri-biodiesel produced by small 
producers, defined generally as persons whose agri-biodiesel 
production capacity does not exceed 60 million gallons per 
year. The agri-biodiesel must (1) be sold by such producer to 
another person (a) for use by such other person in the 
production of a qualified biodiesel mixture in such person's 
trade or business (other than casual off-farm production), (b) 
for use by such other person as a fuel in a trade or business, 
or, (c) who sells such agri-biodiesel at retail to another 
person and places such ethanol in the fuel tank of such other 
person; or (2) used by the producer for any purpose described 
in (a), (b), or (c).

Biodiesel mixture excise tax credit

    The Code also provides an excise tax credit for biodiesel 
mixtures.\52\ The credit is 50 cents for each gallon of 
biodiesel used by the taxpayer in producing a biodiesel mixture 
for sale or use in a trade or business of the taxpayer. In the 
case of agri-biodiesel, the credit is $1.00 per gallon. A 
biodiesel mixture is a mixture of biodiesel and diesel fuel 
that (1) is sold by the taxpayer producing such mixture to any 
person for use as a fuel, or (2) is used as a fuel by the 
taxpayer producing such mixture. No credit is allowed unless 
the taxpayer obtains a certification (in such form and manner 
as prescribed by the Secretary) from the producer of the 
biodiesel that identifies the product produced and the 
percentage of biodiesel and agri-biodiesel in the product.\53\
---------------------------------------------------------------------------
    \52\Sec. 6426(c).
    \53\Sec. 6426(c)(4).
---------------------------------------------------------------------------
    The credit is not available for any sale or use for any 
period after December 31, 2008. This excise tax credit is 
coordinated with the income tax credit for biodiesel such that 
credit for the same biodiesel cannot be claimed for both income 
and excise tax purposes.

Payments with respect to biodiesel fuel mixtures

    If any person produces a biodiesel fuel mixture in such 
person's trade or business, the Secretary is to pay such person 
an amount equal to the biodiesel mixture credit.\54\ To the 
extent the biodiesel fuel mixture credit exceeds the section 
4081 liability of a person, the Secretary is to pay such person 
an amount equal to the biodiesel fuel mixture credit with 
respect to such mixture.\55\ Thus, if the person has no section 
4081 liability, the credit is refundable. The Secretary is not 
required to make payments with respect to biodiesel fuel 
mixtures sold or used after December 31, 2008.
---------------------------------------------------------------------------
    \54\Sec. 6427(e).
    \55\Sec. 6427(e)(1) and 6427(e)(3).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to extend the 
biodiesel incentives to further encourage the development and 
use of this fuel. In particular, to encourage the participation 
of small producers into the market, the Committee believes it 
is appropriate to extend the small agri-biodiesel producer 
credit an additional four years.

                        EXPLANATION OF PROVISION

    The provision generally extends an additional two years 
(through December 31, 2010) the income tax credit, excise tax 
credit, and payment provisions for biodiesel (including agri-
biodiesel). The small agri-biodiesel producer credit is 
extended an additional four years (through December 31, 2012). 
The provision adds camelina to the illustrative and 
nonexclusive list of sources of virgin oils for agri-biodiesel.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

      M. Extension and Modification of Renewable Diesel Incentives


(Sec. 321 of the bill and sec. 40A(f), 6426 and 6427 of the Code)

                              PRESENT LAW

    The Code provides a tax incentive of $1.00 per gallon 
relating to renewable diesel that is part of a qualified 
mixture with diesel fuel. This incentive may be taken as an 
income tax credit, an excise tax credit, or as a payment from 
the Secretary.\56\ The incentive is available only to the 
person who produced and sold or used the mixture in their trade 
or business and is based on the gallons of renewable diesel in 
the mixture. The provisions relating to renewable diesel do not 
apply after December 31, 2008.
---------------------------------------------------------------------------
    \56\Secs. 40A, 6426(c), and 6427(e). For purposes of the Code, 
renewable diesel is generally treated as biodiesel. The Code also 
provides an income tax credit for renewable diesel that is not in a 
mixture which is sold at retail to a person and placed in the fuel tank 
of such person's vehicle or used by the taxpayer producing the 
renewable diesel as a fuel in a trade or business. See sec. 40A(b)(2) 
in conjunction with sec. 40A(f)(1).
---------------------------------------------------------------------------
    ``Renewable diesel'' is diesel fuel that (1) is derived 
from biomass (as defined in section 45K(c)(3)\57\) using a 
thermal depolymerization process; (2) meets the registration 
requirements for fuels and fuel additives established by the 
Environmental Protection Agency under section 211 of the Clean 
Air Act (42 U.S.C. sec. 7545); and (3) meets the requirements 
of the American Society of Testing and Materials (ASTM) D975 or 
D396. ASTM D975 provides standards for diesel fuel suitable for 
use in diesel engines. ASTM D396 provides standards for fuel 
oil intended for use in fuel-oil burning equipment, such as 
furnaces.
---------------------------------------------------------------------------
    \57\``Biomass'' means any organic material other than (1) oil and 
natural gas (or any product thereof) and (2) coal (including lignite) 
or any product thereof (sec. 45K(c)(3)).
---------------------------------------------------------------------------
    Pursuant to IRS Notice 2007-37, the Secretary provided that 
fuel produced as a result of co-processing biomass and 
petroleum feedstock (``co-produced fuel'') qualifies for the 
renewable diesel incentives to the extent of the fuel 
attributable to the biomass in the mixture. In co-produced 
fuel, the fuel attributable to the biomass does not exist as a 
distinct separate quantity prior to mixing.

                           REASONS FOR CHANGE

    To encourage the further development of renewable diesel, 
the Committee believes it is appropriate to extend the tax 
incentives for this fuel. However, the Committee also believes 
that less incentives are needed for renewable diesel produced 
as part of the refining process of crude oil. Utilizing 
existing refinery processes does not require significant 
investment in new equipment to produce the renewable diesel. 
Therefore, the Committee limits the incentive as it relates to 
co-produced fuel.

                        EXPLANATION OF PROVISION

    The provision provides that, on a per year basis, producers 
of co-produced fuel may claim $1.00 per gallon for up to 60 
million gallons of renewable diesel contained in a qualified 
mixture. The 60 million gallons is determined on a per facility 
basis. No credit is allowable for gallons in excess of 60 
million gallons produced at a facility. As under present law, 
the credit and payments are only for that volume of renewable 
diesel contained in the qualified mixture and not the total 
volume of co-produced fuel.
    The provision extends the tax incentives for renewable 
diesel (income tax credit, excise tax credit, and payment 
provisions) an additional two years (through December 31, 
2010).

                             EFFECTIVE DATE

    The provision restricting the amount of credit allowable 
for co-produced fuels is effective for fuels sold or used after 
the date of enactment. The extension of the renewable diesel 
incentives is effective on the date of enactment.

N. Treatment of Qualified Alcohol Mixtures and Qualified Biodiesel Fuel 
                       Mixtures as Taxable Fuels


(Sec. 322 of the bill and sec. 4083 of the Code)

                              PRESENT LAW

    An excise tax is imposed upon (1) the removal of any 
taxable fuel from a refinery or terminal, (2) the entry of any 
taxable fuel into the United States, or (3) the sale of any 
taxable fuel to any person who is not registered with the IRS 
to receive untaxed fuel, unless there was a prior taxable 
removal or entry.\58\ The tax does not apply to any removal or 
entry of taxable fuel transferred in bulk by pipeline or vessel 
to a terminal or refinery if the person removing or entering 
the taxable fuel, the operator of such pipeline or vessel 
(excluding deep draft vessels) and the operator of such 
terminal or refinery are registered with the Secretary.\59\ The 
term ``taxable fuel'' means gasoline, diesel fuel, and 
kerosene.\60\
---------------------------------------------------------------------------
    \58\Sec. 4081(a)(1).
    \59\Sec. 4081(a)(1)(B).
    \60\Sec. 4083(a).
---------------------------------------------------------------------------
    Diesel fuel is (1) any liquid suitable for use in a diesel 
powered highway vehicle or diesel powered train, (2) transmix, 
and (3) diesel fuel blendstocks identified by the 
Secretary.\61\ By regulation, diesel fuel does not include 
kerosene, gasoline, No. 5 and No. 6 fuel oils (as described in 
ASTM Specification D 396), or F-76 (Fuel Naval Distillates MIL-
F-16884) any liquid that contains less than four percent normal 
parafins, or any liquid that has a distillation range of 125 
degrees Fahrenheit or less, sulfur content of 10 ppm or less 
and minimum color of +27 Saybolt.\62\
---------------------------------------------------------------------------
    \61\Sec. 4083(a)(3).
    \62\Treas. Reg. sec. 48.4081-1(c)(2)(ii).
---------------------------------------------------------------------------
    Biodiesel is monoalkyl esters of long chain fatty acids 
derived from plant or animal matter which meet (1) the 
registration requirements for fuels and fuel additives 
established by the Environmental Protection Agency under 
section 211 of the Clean Air Act, and (2) the requirements of 
the American Society of Testing Materials D6751 (``ASTM 
D6751'').
    Biodiesel is not a taxable fuel because it has less than 
four percent paraffin content. Ethanol and other fuel alcohols 
also are not treated as taxable fuel. However, such fuels are 
subject to the backup tax under section 4041 if sold for use or 
used as a fuel in a diesel powered highway vehicle or diesel 
powered train and not for a nontaxable use. In addition, such 
fuels are taxable if used in the production of a blended 
taxable fuel.\63\
---------------------------------------------------------------------------
    \63\Under Treas. Reg. sec. 48.4081-1(c), blended taxable fuel 
generally means any taxable fuel that (1) is produced outside the bulk 
transfer/terminal system and (2) by mixing taxable fuel with respect to 
which tax has been imposed under sec. 4081(a)(gasoline, diesel fuel, or 
kerosene) with any other liquid on which tax has not been imposed under 
sec. 4081.
---------------------------------------------------------------------------
    The Code provides per-gallon tax incentives relating to 
biodiesel fuel used in a qualified mixture. The taxpayer has 
the option of taking the credit amount as an income tax credit, 
excise tax credit against the tax imposed on taxable fuels 
(``section 4081 liability'') or as a payment from the Secretary 
in the amount of the credit. The credit is 50 cents for each 
gallon of biodiesel used by the taxpayer in producing a 
biodiesel mixture for sale or use in a trade or business of the 
taxpayer. In the case of agri-biodiesel, the credit is $1.00 
per gallon. No credit is allowed unless the taxpayer obtains a 
certification from the producer or importer of the biodiesel 
that identifies the product produced and the percentage of 
biodiesel and agri-biodiesel in the product.
    A qualified biodiesel mixture is a mixture of biodiesel and 
diesel fuel that (1) is sold by the taxpayer producing such 
mixture to any person for use as a fuel, or (2) is used as a 
fuel by the taxpayer producing such mixture. Pursuant to 
Treasury Notice, a mixture of 99.9 percent biodiesel and diesel 
fuel is considered a mixture but such mixture is not a blended 
taxable fuel because it contains less than four percent 
paraffin content. Thus, while eligible for the biodiesel fuel 
mixture tax credit and payment provisions, such fuel would not 
be subject to tax until put in a motor vehicle for a taxable 
use.
    The Code also provides per-gallon tax incentives relating 
to alcohol used in a qualified mixture. A qualified mixture 
means a mixture of alcohol and gasoline, (or of alcohol and a 
special fuel) sold by the taxpayer as fuel, or used as fuel by 
the taxpayer producing such mixture. The credit is 51 cents if 
the alcohol is ethanol (60 cents in the case of other 
alcohols).

                           REASONS FOR CHANGE

    The Committee notes that when it enacted the credit for 
qualified biodiesel fuel mixtures, it intended that the 
resulting mixture of biodiesel and diesel fuel would be a 
taxable fuel and that the credit would be taken against the tax 
imposed on that fuel if not used for a nontaxable purpose. For 
biodiesel not in a mixture, it was intended that tax be imposed 
on the fuel when it was sold at retail into the fuel tank of a 
motor vehicle. It has come to the Committee's attention that 
persons are exploiting the Treasury Notice by adding minute 
amounts of diesel fuel to biodiesel in order to claim the full 
amount of credit for biodiesel fuel mixtures, while not paying 
any tax on the fuel because it does not meet the regulatory 
definition of diesel fuel. The Committee believes that such 
exploitation occurs to avoid both the imposition of tax and the 
more restrictive rules governing biodiesel that is not in a 
mixture, which require that the fuel be sold as motor fuel. The 
Committee believes it is consistent with Committee intent and 
appropriate to subject such fuel mixtures eligible for the fuel 
mixture credits to the taxes applicable to diesel fuel (taxes 
applicable to gasoline in the case of a mixture of alcohol and 
special fuel).

                        EXPLANATION OF PROVISION

    The provision adds qualified alcohol fuel mixtures and 
qualified biodiesel fuel mixtures to the definition of taxable 
fuel. The proposal also requires the Secretary to require 
producers of these mixtures to file information reports with 
the Secretary.
    The provision modifies the certification requirements for 
biodiesel. In addition to certifying that the product meets the 
statutory definition of biodiesel and identifying the 
percentage of biodiesel and agri-biodiesel in the product, the 
provision also requires the importer or producer to provide 
documentation that the biodiesel was tested by an independent 
laboratory and found to meet the requirements of ASTM D6751.

                             EFFECTIVE DATE

    The provision is effective for fuels removed, entered, or 
sold after December 31, 2007.

     O. Extension and Modification of the Alternative Fuel Credits


(Sec. 331 of the bill and sec. 6426 and 6427 of the Code)

                              PRESENT LAW

    The Code provides two per-gallon excise tax credits with 
respect to alternative fuel, the alternative fuel credit, and 
the alternative fuel mixture credit. For this purpose, the term 
``alternative fuel'' means liquefied petroleum gas, P Series 
fuels (as defined by the Secretary of Energy under 42 U.S.C. 
sec. 13211(2)), compressed or liquefied natural gas, liquefied 
hydrogen, liquid fuel derived from coal through the Fischer-
Tropsch process, or liquid hydrocarbons derived from biomass. 
Such term does not include ethanol, methanol, or biodiesel.
    The alternative fuel credit is allowed against section 4041 
liability and the alternative fuel mixture credit is allowed 
against section 4081 liability. Neither credit is allowed 
unless the taxpayer is registered with the Secretary. The 
alternative fuel credit is 50 cents per gallon of alternative 
fuel or gasoline gallon equivalents\64\ of nonliquid 
alternative fuel sold by the taxpayer for use as a motor fuel 
in a motor vehicle or motorboat, or so used by the taxpayer.
---------------------------------------------------------------------------
    \64\``Gasoline gallon equivalent'' means, with respect to any 
nonliquid alternative fuel, the amount of such fuel having a Btu 
content of 124,800 (higher heating value).
---------------------------------------------------------------------------
    The alternative fuel mixture credit is 50 cents per gallon 
of alternative fuel used in producing an alternative fuel 
mixture for sale or use in a trade or business of the taxpayer. 
The mixture must be sold by the taxpayer producing such mixture 
to any person for use as a fuel or used by the taxpayer for use 
as a fuel. The credits generally expire after September 30, 
2009.
    A person may file a claim for payment equal to the amount 
of the alternative fuel credit and alternative fuel mixture 
credits. These payment provisions generally also expire after 
September 30, 2009.
    With respect to liquefied hydrogen, the credit and payment 
provisions expire after September 30, 2014. Under coordination 
rules, a claim for payment or credit may only be taken once 
with respect to any particular gallon or gasoline-gallon 
equivalent of alternative fuel.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to extend the 
alternative fuel excise tax credits to encourage the production 
and use of these fuels. However, the Committee is concerned 
with the carbon emissions from coal facilities and the impact 
of such emissions on the environment. Therefore, the provision 
imposes a carbon sequestration requirement for facilities 
producing liquid fuel from coal as a condition of credit 
eligibility.

                        EXPLANATION OF PROVISION

    The provision extends the alternative fuel excise tax 
credit, alternative fuel mixture excise tax credit and related 
payment provisions through December 31, 2010, for all fuels 
other hydrogen. The incentives for hydrogen are unchanged by 
the proposal and will expire as provided under present law. The 
provision provides that biomass gas qualifies for the credit. 
The provision also provides that alternative fuel that is not 
in a mixture may be used, or sold for use, as a fuel in 
aviation for purposes of the credit.
    Beginning on the date of enactment, to qualify as an 
alternative fuel, liquid fuel from coal derived through the 
Fischer-Tropsch process must be certified as having been 
derived from coal produced at a gasification facility that 
separates and sequesters at least 50 percent of such facilities 
total carbon dioxide emissions. The sequestration requirement 
increases to 75 percent on the earlier of (1) December 31, 
2010, or (2) the date the Secretary determines that, taking 
into account the recommendations of the Carbon Sequestration 
Capability Panel, the sequestration rate should be 75 percent.
    The Carbon Sequestration Capability Panel is composed of 
one individual appointed by the National Academy of Sciences, 
one individual appointed by the Chairman of the Committee on 
Finance in consultation with the Ranking member of the 
Committee, and one individual jointly appointed by the other 
two members. The panel is to submit to the Secretary, the 
Senate Committee on Finance, and the House Committee on Ways 
and Means a report regarding the appropriate percentage of 
carbon dioxide sequestration for purposes of liquid fuel 
derived from coal through the Fischer Tropsch process. In 
preparing its report, the panel shall consider whether it is 
feasible to separate and sequester 75 percent of the carbon 
dioxide emissions of a facility and the costs and other factors 
associated with separating and sequestering such percentage of 
carbon dioxide emissions. The report is to be submitted on the 
date that is six months after the date of enactment. The 
Secretary is to make his determination within 30 days of 
receiving the report.

                             EFFECTIVE DATE

    The provision is effective for fuel sold or used after date 
of enactment.

   P. Extension of Alternative Fuel Vehicle Refueling Property Credit


(Sec. 332 of the bill and sec. 30C of the Code)

                              PRESENT LAW

    Taxpayers may claim a 30-percent credit for the cost of 
installing qualified clean-fuel vehicle refueling property to 
be used in a trade or business of the taxpayer or installed at 
the principal residence of the taxpayer.\65\ The credit may not 
exceed $30,000 per taxable year per location in the case of 
qualified refueling property used in a trade or business and 
$1,000 per taxable year in the case of qualified refueling 
property installed on property which is used as a principal 
residence.
---------------------------------------------------------------------------
    \65\Sec. 30C.
---------------------------------------------------------------------------
    Qualified refueling property is property (not including a 
building or its structural components) for the storage or 
dispensing of a clean-burning fuel into the fuel tank of a 
motor vehicle propelled by such fuel, but only if the storage 
or dispensing of the fuel is at the point where such fuel is 
delivered into the fuel tank of the motor vehicle. The use of 
such property must begin with the taxpayer.
    Clean-burning fuels are any fuel at least 85 percent of the 
volume of which consists of ethanol, natural gas, compressed 
natural gas, liquefied natural gas, liquefied petroleum gas, or 
hydrogen. In addition, any mixture of biodiesel and diesel 
fuel, determined without regard to any use of kerosene and 
containing at least 20 percent biodiesel, qualifies as a clean 
fuel.
    Credits for qualified refueling property used in a trade or 
business are part of the general business credit and may be 
carried back for 1 year and forward for 20 years. Credits for 
residential qualified refueling property cannot exceed for any 
taxable year the difference between the taxpayer's regular tax 
(reduced by certain other credits) and the taxpayer's tentative 
minimum tax. Generally, in the case of qualified refueling 
property sold to a tax-exempt entity, the taxpayer selling the 
property may claim the credit.
    A taxpayer's basis in qualified refueling property is 
reduced by the amount of the credit. In addition, no credit is 
available for property used outside the United States or for 
which an election to expense has been made under section 179.
    The credit is available for property placed in service 
after December 31, 2005, and (except in the case of hydrogen 
refueling property) before January 1, 2010. In the case of 
hydrogen refueling property, the property must be placed in 
service before January 1, 2015.

                           REASONS FOR CHANGE

    The Committee believes that building additional renewable 
fuel infrastructure advances America's environmental and energy 
independence goals and for this reason want to extend the tax 
incentive for alternative fuel refueling property.

                        EXPLANATION OF PROVISION

    The provision extends for one year (through 2010) the 
credit for installing non-hydrogen alternative fuel refueling 
property.

                             EFFECTIVE DATE

    The provision is effective for property placed in service 
after the date of enactment, in taxable years ending after such 
date.

                   TITLE IV--AGRICULTURAL PROVISIONS


               A. Qualified Small Issue Bonds for Farming


(Sec. 401 of the bill and sec. 147 of the Code)

                              PRESENT LAW

    Qualified small issue bonds are tax-exempt bonds issued by 
State and local governments to finance private business 
manufacturing facilities (including certain directly related 
and ancillary facilities) or the acquisition of land and 
equipment by certain first-time farmers. A first-time farmer 
means any individual who has not at any time had any direct 
ownership interest in substantial farmland in the operation of 
which such individual materially participated. In addition, an 
individual does not qualify as a first-time farmer if such 
individual has received more than $250,000 in qualified small 
issue bond financing. Substantial farmland means any parcel of 
land unless (1) such parcel is smaller than 30 percent of the 
median size of a farm in the county in which such parcel is 
located and (2) the fair market value of the land does not at 
any time while held by the individual exceed $125,000.

                           REASONS FOR CHANGE

    The Committee notes that the loan limits for first-time 
farmers have not been increased in more than two decades. 
Similarly, the rules relating to the definition of substantial 
farmland have not been increased in many years and, as a 
result, have not kept pace with increases in land prices. Thus, 
the Committee believes the tax-exempt bond rules for first-time 
farmers should be updated.

                        EXPLANATION OF PROVISION

    The provision increases the maximum amount of qualified 
small issue bond proceeds available to first-time farmers to 
$450,000 and indexes this amount for inflation. The provision 
also eliminates the fair market value test from the definition 
of substantial farmland.

                             EFFECTIVE DATE

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

  B. Modification of Installment Sale Rules for Certain Farm Property


(Sec. 402 of the bill and sec. 453 of the Code)

                              PRESENT LAW

    Taxpayers are permitted to recognize as gain on a 
disposition of property only that proportion of payments 
received in a taxable year that is the same as the proportion 
that the gross profit bears to the total contract price (the 
``installment method'').\66\ Notwithstanding this general rule, 
with respect to any installment sale, the aggregate amount that 
would be treated as ordinary income under section 1245 or 
section 1250 for the taxable year of the disposition if all 
payments to be received were received in the taxable year of 
disposition (``recapture income'') is recognized in the year of 
the disposition.\67\
---------------------------------------------------------------------------
    \66\Sec. 453.
    \67\Sec. 453(i).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the provision will encourage 
the sale of farms to younger farmers that may not otherwise 
qualify for traditional financing. While this proposal changes 
the rules for the seller, it is expected to help buyers by 
making the installment rules more favorable to sellers.

                        EXPLANATION OF PROVISION

    The provision repeals the immediate recognition of 
recapture income for sales of any single purpose agricultural 
or horticultural structure (as defined in section 168(i)(13)) 
or any tree or vine bearing fruit or nuts.\68\
---------------------------------------------------------------------------
    \68\This property is 10-year property described in section 
168(e)(3)(D).
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for installment sales after the 
date of enactment.

C. Allowance of Section 1031 Treatment for Exchanges Involving Certain 
          Mutual Ditch, Reservoir, or Irrigation Company Stock


(Sec. 403 of the bill and sec. 1031 of the Code)

                              PRESENT LAW

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like-kind'' which 
is to be held for productive use in a trade or business or for 
investment.\69\ If section 1031 applies to an exchange of 
properties, the basis of the property received in the exchange 
is equal to the basis of the property transferred, decreased by 
any money received by the taxpayer, and further adjusted for 
any gain or loss recognized on the exchange. In general, 
section 1031 does not apply to any exchange of stock in trade 
or other property held primarily for sale; stocks, bonds or 
notes; other securities or evidences of indebtedness or 
interest; interests in a partnership; certificates of trust or 
beneficial interests; or choses in action.\70\
---------------------------------------------------------------------------
    \69\Sec. 1031(a)(1).
    \70\Sec. 1031(a)(2).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that section 1031 should be 
clarified to remove any doubt that an exchange of shares in 
mutual ditch, reservoir, and irrigation company stock qualifies 
for tax deferral treatment under section 1031. The Committee 
intends this clarification would be for cases in which the 
highest court or statute of the State in which the company is 
organized recognize such shares as constituting or representing 
real property or an interest in real property.

                        EXPLANATION OF PROVISION

    The provision provides that the general exclusion from 
section 1031 treatment for stocks shall not apply to shares in 
a mutual ditch, reservoir, or irrigation company, if at the 
time of the exchange: (1) the company is an organization 
described in section 501(c)(12)(A) (determined without regard 
to the percentage of its income that is collected from its 
members for the purpose of meeting losses and expenses); and 
(2) the shares in the company have been recognized by the 
highest court of the State in which such company was organized 
or by applicable State statute as constituting or representing 
real property or an interest in real property.

                             EFFECTIVE DATE

    The provision is effective for transfers after the date of 
enactment.

                       D. Rural Renaissance Bonds


(Sec. 404 of the bill and new sec. 54A of the Code)

                              PRESENT LAW

Tax-exempt bonds

    1. Subject to certain Code restrictions, interest on bonds 
issued by State and local government generally is excluded from 
gross income for Federal income tax purposes. Bonds issued by 
State and local governments may be classified as either 
governmental bonds or private activity bonds. Governmental 
bonds are bonds the proceeds of which are primarily used to 
finance governmental functions or which are 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. For this purpose, the 
term ``nongovernmental person'' generally includes the Federal 
Government and all other individuals and entities other than 
States or local governments. The exclusion from income for 
interest on State and local bonds does not apply to private 
activity bonds, unless the bonds are issued for certain 
permitted purposes (``qualified private activity bonds'') and 
other Code requirements are met.
    The tax exemption for State and local bonds also does not 
apply to any arbitrage bond.\71\ 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.\72\ 
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.
---------------------------------------------------------------------------
    \71\Secs. 103(a) and (b)(2).
    \72\Sec. 148.
---------------------------------------------------------------------------
    An issuer of tax-exempt bonds must file with the IRS a 
return that provides certain information regarding the bond 
issuance.\73\ Generally, this information return is required to 
be filed no later the 15th day of the second month after the 
close of the calendar quarter in which the bonds were issued.
---------------------------------------------------------------------------
    \73\Sec. 149(e).
---------------------------------------------------------------------------
    The tax exemption for State and local bonds also does not 
apply to any arbitrage bond.\74\ 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.\75\ 
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.
---------------------------------------------------------------------------
    \74\Sec. 103(a) and (b)(2).
    \75\Sec. 148.
---------------------------------------------------------------------------

Tax credit bonds

            In general
    As an alternative to traditional tax-exempt bonds, the Code 
permits three types of tax-credit bonds. States and local 
governments have the authority to issue qualified zone academy 
bonds (``QZABS''), clean renewable energy bonds (``CREBS''), 
and ``Gulf tax credit bonds.''\76\
---------------------------------------------------------------------------
    \76\Secs. 1397E, 54, and 1400N(l), respectively.
---------------------------------------------------------------------------
    A common feature of the present law tax-credit bonds is 
that the taxpayer holding such a bond receives a tax credit, 
rather than an interest payment. The amount of the credit is 
determined by multiplying the bond's credit rate by the face 
amount on the taxpayer's bond. The credit rate on the bonds is 
determined by the Secretary and is to be a rate that permits 
issuance of such bonds without discount and interest cost to 
the qualified issuer. The credit is includible in gross income 
(as if it were an interest payment on the bond), and can be 
claimed against regular income tax liability and alternative 
minimum tax liability.
            Clean renewable energy bonds
    CREBs are defined as any bond 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 by qualified borrowers for 
qualified projects. ``Qualified projects'' are facilities that 
qualify for the tax credit under section 45 (other than Indian 
coal production facilities), without regard to the placed-in-
service date requirements of that section.\77\ The term 
``qualified issuers'' includes (1) governmental bodies 
(including Indian tribal governments); (2) mutual or 
cooperative electric companies (described in section 501(c)(12) 
or section 1381(a)(2)(C), or a not-for-profit electric utility 
which has received a loan or guarantee under the Rural 
Electrification Act); and (3) clean renewable energy bond 
lenders. The term ``qualified borrower'' includes a 
governmental body (including an Indian tribal government) and a 
mutual or cooperative electric company. A clean renewable 
energy bond lender means a cooperative which is owned by, or 
has outstanding loans to, 100 or more cooperative electric 
companies and is in existence on February 1, 2002.
---------------------------------------------------------------------------
    \77\In addition, Notice 2006-7 provides that qualified projects 
include any facility owned by a qualified borrower that is functionally 
related and subordinate to any facility described in section 45(d)(1) 
through (d)(9) and owned by such qualified borrower.
---------------------------------------------------------------------------
    In addition to the above requirements, at least 95 percent 
of the proceeds of CREBs must be spent 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 CREBs if 
unspent proceeds are used within 90 days from the end of such 
five-year period to redeem any ``nonqualified bonds.'' The 
five-year spending period may be extended by the Secretary upon 
the qualified issuer's request demonstrating that the failure 
to satisfy the five-year requirement is due to reasonable cause 
and the projects will continue to proceed with due diligence.
    CREBs also are subject to the arbitrage requirements of 
section 148 that apply to tax-exempt bonds. Principles under 
section 148 and the regulations thereunder apply for purposes 
of determining the yield restriction and arbitrage rebate 
requirements applicable to CREBs.
    Issuers of CREBs are required to report issuance to the IRS 
in a manner similar to the information returns required for 
tax-exempt bonds. There is a national CREB limitation of $1.2 
billion. The maximum amount of CREBs that may be allocated to 
qualified projects of governmental bodies is $750 million. 
CREBs must be issued before January 1, 2009.
            Qualified zone academy bonds
    ``QZABs'' 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,'' 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. Eligible holders of QZABs are limited to 
financial institutions.
    An issuer of QZABs 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 QZABs 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. The provision provides 
that the five-year spending period may be extended by the 
Secretary if the issuer establishes that the failure to meet 
the spending requirement is due to reasonable cause and the 
related purposes for issuing the bonds will continue to proceed 
with due diligence.
    A total of $400 million of qualified zone academy bonds is 
authorized to be issued annually in calendar years 1998 through 
2007. The $400 million aggregate bond cap is allocated 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.
    Issuers of QZABs are required to report issuance to the IRS 
in a manner similar to the information returns required for 
tax-exempt bonds. In addition, QZABs are subject to the 
arbitrage requirements of section 148 that apply to tax-exempt 
bonds. Principles under section 148 and the regulations 
thereunder apply for purposes of determining the yield 
restriction and arbitrage rebate requirements applicable to 
QZABs.
            Gulf tax credit bonds
    Gulf tax credit bonds may be issued by the States of 
Louisiana, Mississippi, and Alabama. To qualify as Gulf tax 
credit bonds, 95 percent or more of the proceeds of such bonds 
must be used to (i) pay principal, interest, or premium on a 
bond (other than a private activity bond) that was outstanding 
on August 28, 2005, and was issued by the State issuing the 
Gulf tax credit bonds, or any political subdivision thereof, or 
(ii) make a loan to any political subdivision of such State to 
pay principal, interest, or premium on a bond issued by such 
political subdivision. In addition, the issuer of Gulf tax 
credit bonds must provide additional funds to pay principal, 
interest, or premium on outstanding bonds equal to the amount 
of Gulf tax credit bonds issued to repay such outstanding 
bonds. Gulf tax credit bonds must be a general obligation of 
the issuing State and must be designated by the Governor of 
such State. The maximum maturity on Gulf tax credit bonds is 
two years. In addition, present-law arbitrage rules that 
restrict the ability of State and local governments to invest 
bond proceeds apply to Gulf tax credit bonds.
    Gulf tax credit bonds must have been issued in calendar 
year 2006. The maximum amount of Gulf tax credit bonds 
authorized to be issued was $200 million in the case of 
Louisiana, $100 million in the case of Mississippi, and $50 
million in the case of Alabama. Gulf tax credit bonds may not 
be used to pay principal, interest, or premium on any bond with 
respect to which there is any outstanding refunded or refunding 
bond. Moreover, Gulf tax credit bonds may not be used to pay 
principal, interest, or premium on any prior bond if the 
proceeds of such prior bond were used to provide any property 
described in section 144(c)(6)(B) (i.e., any private or 
commercial golf course, country club, massage parlor, hot tub 
facility, suntan facility, racetrack or other facility used for 
gambling, or any store the principal purpose of which is the 
sale of alcoholic beverages for consumption off premises).
    Issuers of Gulf tax credit bonds are required to report 
issuance to the IRS in a manner similar to the information 
returns required for tax-exempt bonds.

                           REASONS FOR CHANGE

    The Committee believes that existing programs are not 
meeting the financing needs of rural communities. The Committee 
believes that additional incentives are needed to encourage 
economic development in rural areas. Thus, the Committee 
believes it is appropriate to provide rural communities with 
additional financing tools in order to promote investment in 
these underserved communities.

                        EXPLANATION OF PROVISION

    The provision provides for a new category of tax-credit 
bonds, ``Rural Renaissance Bonds.'' A Rural Renaissance Bond 
means any bond if: (1) the bond is issued by a qualified issuer 
pursuant to an allocation of the national limitation on such 
bonds; (2) 95 percent or more of the proceeds of the bond are 
to be used for capital expenditures incurred by qualified 
borrowers for one or more qualified projects; (3) the qualified 
issuer designates the bond as a Rural Renaissance Bond and such 
bond is issued in registered form; (4) the bond meets the five-
year spending requirement (described below); and (5) the bond 
is not Federally guaranteed (i.e., no portion of the bond is 
guaranteed in whole or in part by the United States).
    Under the provision, the term ``qualified issuer'' means: 
(1) a rural renaissance bond lender; (2) a cooperative electric 
company; and (3) a governmental body. A ``rural renaissance 
bond lender'' means a cooperative which is owned by, or has 
outstanding loans to, 100 or more cooperative electric 
companies and is in existence on February 1, 2002, including 
any affiliated lender which is controlled by such lender. The 
term ``cooperative electric company'' means a mutual or 
cooperative electric company (described in section 501(c)(12) 
or section 1381(a)(2)(C), or a not-for-profit electric utility 
which has received a loan or guarantee under the Rural 
Electrification Act. The term ``governmental body'' means a 
State, territory, possession of the United States, the District 
of Columbia, Indian tribal government, and any political 
subdivision thereof. Under the provision, a ``qualified 
borrower'' means a cooperative electric company or a 
governmental body.
    The term ``qualified projects'' means: (1) a utilities 
program described in section 381E(d)(2) of the Consolidated 
Farm and Rural Development Act; (2) a distance learning or 
telemedicine program authorized pursuant to chapter 1 of 
subtitle D of title XXIII of the Food, Agriculture, 
Conservation, and Trade Act of 1990; (3) the rural electric 
programs authorized pursuant to the Rural Electrification Act 
of 1936; (4) the rural telephone programs authorized pursuant 
to the Rural Electrification Act of 1936; (5) the broadband 
access programs authorized pursuant to title VI of the Rural 
Electrification Act of 1936; and (6) the rural community 
facility programs as described in section 381E(d)(1) of the 
Consolidated Farm and Rural Development Act.
    As with present-law tax credit bonds, the taxpayer holding 
Rural Renaissance Bonds on a credit allowance date is entitled 
to a tax credit. The amount of the credit is determined by 
multiplying the bond's credit rate by the face amount on the 
taxpayer's bond. The credit rate on the bonds is determined by 
the Secretary and is to be a rate that permits issuance of such 
bonds without discount and interest cost to the qualified 
issuer. The credit is includible in gross income (as if it were 
an interest payment on the bond), and can be claimed against 
regular income tax liability and alternative minimum tax 
liability.
    Under the provision, at least 95 percent or more of the 
proceeds of Rural Renaissance Bonds must be spent on qualified 
projects within the five-year period that begins on the date of 
issuance of such bonds. To the extent less than 95 percent of 
the proceeds are spent as required during the five-year 
spending period, bonds will continue to qualify as Rural 
Renaissance Bonds only if unspent proceeds are used within 90 
days from the end of such five-year period to redeem 
outstanding bonds. The five-year spending period may be 
extended by the Secretary upon the qualified issuer's request 
demonstrating that the failure to satisfy the five-year 
requirement is due to reasonable cause and the projects will 
continue to proceed with due diligence.
    The provision requires level amortization of Rural 
Renaissance Bonds during the period such bonds are outstanding. 
In addition, Rural Renaissance Bonds are subject to the 
arbitrage requirements of section 148 that apply to tax-exempt 
bonds. Principles under section 148 and the regulations 
thereunder apply for purposes of determining the yield 
restriction and arbitrage rebate requirements applicable to 
Rural Renaissance Bonds.
    The provision establishes a national limitation of 
$400,000,000 on the amount of bonds that may be designated as 
Rural Renaissance Bonds. The Secretary, in consultation with 
the Secretary of Agriculture, shall make allocations of the 
national limitation to at least 20 qualified projects, or such 
lesser number of qualified projects based on the number of 
applications filed 12 months after applications for allocations 
have been solicited by the Secretary. In addition, no more than 
15 percent of the national limitation may be allocated to 
qualified projects located in any one State. Under the 
provision, Rural Renaissance Bonds may not be issued after 
December 31, 2008.

                             EFFECTIVE DATE

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

              E. Agricultural Business Security Tax Credit


(Sec. 405 of the bill and sec. 45 of the Code)

                              PRESENT LAW

    Present law does not provide a credit for agricultural 
business security.

                           REASONS FOR CHANGE

    The Committee believes that a security tax credit would 
help the agricultural industry to properly safeguard 
agricultural pesticides and fertilizers from the threat of 
terrorists, drug dealers and other criminals. These safeguards 
are necessary to help alleviate a heightened concern as to the 
vulnerability of chemical storage facilities. This credit will 
help ease the substantial increase in production costs faced by 
agriculture related to installing improved security measures 
that will better protect the American public from the potential 
threat of terrorism or other illegal activities.

                        EXPLANATION OF PROVISION

    The provision establishes a 30 percent credit for qualified 
chemical security expenditures for the taxable year with 
respect to eligible agricultural businesses. The credit is a 
component of the general business credit.\78\
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    \78\Sec. 38(b)(1).
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    The credit is limited to $100,000 per facility, this amount 
is reduced by the aggregate amount of the credits allowed for 
the facility in the prior five years. In addition, each 
taxpayer's annual credit is limited to $2,000,000.\79\ The 
credit only applies to expenditures paid or incurred before 
December 31, 2012. The taxpayer's deductible expense is reduced 
by the amount of the credit claimed.
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    \79\The term taxpayer includes controlled groups under rules 
similar to the rules set out in section 41(f)(1) and (2).
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    Qualified chemical security expenditures are amounts paid 
by for: 1) employee security training and background checks; 
(2) limitation and prevention of access to controls of specific 
agricultural chemicals stored at a facility; (3) tagging, 
locking tank valves, and chemical additives to prevent the 
theft of specific agricultural chemicals or to render such 
chemicals unfit for illegal use; (4) protection of the 
perimeter of specified agricultural chemicals; (5) installation 
of security lighting, cameras, recording equipment and 
intrusion detection sensors (6) implementation of measures to 
increase computer or computer network security; (7) conducting 
security vulnerability assessments; (8) implementing a site 
security plan; and (9) other measures provided for by 
regulation. Amounts described in the preceding sentences are 
only eligible to the extent they are incurred by an eligible 
agricultural business for protecting specified agricultural 
chemicals.
    Eligible agricultural businesses are businesses that: (1) 
sell agricultural products, including specified agricultural 
chemicals, at retail predominantly to farmers and ranchers; or 
(2) manufacture, formulate, distribute, or aerially apply 
specified agricultural chemicals.
    Specified agricultural chemicals means: (1) are fertilizer 
commonly used in agricultural operations which is listed under 
section 302(a)(2) of the Emergency Planning and Community 
Right-to-know Act of 1986, section 101 or part 172 of title 49, 
Code of Federal Regulations, or part 126, 127 or 154 of title 
33, Code of Federal Regulations; and (2) any pesticide (as 
defined in section 2(u) of the Federal Insecticide, Fungicide, 
and Rodenticide Act) including all active and inert ingredients 
which are used on crops grown for food, feed or fiber.

                             EFFECTIVE DATE

    The provision is effective for expenses paid or incurred 
after date of enactment.

 F. Credit for Drug Safety and Effectiveness Testing for Minor Species


(Sec. 406 of the bill and new sec. 45P of the Code)

                              PRESENT LAW

    Present law does not provide a credit for drug safety and 
effectiveness testing for use in a minor animal species.

                           REASONS FOR CHANGE

    The Committee believes that insufficient resources are 
devoted to developing drugs for minor animal species such as 
sheep and goats. The Committee believes that a tax incentive 
for drug safety and effectiveness testing for use in minor 
animal species will encourage more investment in this area.

                        EXPLANATION OF PROVISION

    The provision establishes, at the election of the taxpayer, 
a 50 percent credit for qualified safety and effectiveness 
testing expenses incurred during the taxable year for certain 
designated new animal drugs intended for use in a minor 
species. The taxpayer's otherwise deductible expenses are 
reduced by the amount of the credit claimed.
    Safety and effectiveness testing is testing carried out 
under an exemption for a new animal drug for use on a minor 
species under section 512(j) of the Federal Food, Drug, and 
Cosmetic Act (or regulations issued under such section) (the 
``FFDC Act''). The testing must occur after a new animal drug 
request is filed for designation under section 573 of the FFDC 
Act but before the application with respect to such drug is 
approved under section 512(c) of such Act. Moreover, the 
testing must be conducted by or on behalf of the taxpayer who 
applied for the designation or by the owner of the animals that 
are the subject of the testing. Safety and effectiveness 
testing may be taken into account under the provision only to 
the extent such testing is related to the use of a new animal 
drug for the minor species for which it was designated under 
section 573 of FFDC Act.
    A ``minor species'' means animals other than humans that 
are not major species. A ``major species'' means cattle, 
horses, swine, chickens, turkeys, dogs, and cats, as well as 
any species the Secretary, in consultation with the Secretary 
of Agriculture, adds by regulation.\80\
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    \80\These definitions are intended to correspond with the 
definitions provided in section 201 of the FFDC Act.
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    Qualified safety and effectiveness testing expenses 
comprise both in-house and contract expenses incurred by a 
taxpayer\81\ in carrying on a trade or business or by a 
taxpayer that owns animals that are the subject of safety and 
effectiveness testing. For purposes of the provision, in-house 
expenses are (1) wages paid or incurred to an employee for 
safety and effectiveness testing or the direct supervision or 
support thereof; (2) any amount paid or incurred for supplies 
used in the conduct of safety and effectiveness testing; and 
(3) under regulations prescribed by the Secretary, any amount 
paid or incurred to another person for the right to use 
computers in the conduct of safety and effectiveness testing. 
Contract expenses are any amounts paid or incurred by the 
taxpayer to any person (other than an employee of the taxpayer) 
for safety and effectiveness testing.
---------------------------------------------------------------------------
    \81\Under the provision, the term taxpayer includes controlled 
groups under rules similar to the rules set out in section 41(f)(1) and 
(2).
---------------------------------------------------------------------------
    Qualified safety and effectiveness testing expenses do not 
include amounts funded by any grant, contract, or otherwise by 
another person or government entity. In addition, qualified 
expenses will not be taken into account when determining the 
section 41 credit for research and experimentation except for 
purposes of calculating base period research expenses.

                             EFFECTIVE DATE

    The provision is effective for expenses incurred after the 
date of enactment.

            G. Farm Equipment Treated as Five-Year Property


(Sec. 407 of the bill and sec. 168 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. The amount 
of the depreciation deduction allowed with respect to tangible 
property for a taxable year is determined under the modified 
accelerated cost recovery system (``MACRS'').\82\ The class 
lives of assets placed in service after 1986 are generally set 
forth in Revenue Procedure 87-56.\83\ Asset class 01.1 includes 
machinery and equipment, grain bins, and fences (but no other 
land improvements), that are used in the production of crops or 
plants, vines, and trees; livestock; the operation of farm 
dairies, nurseries, greenhouses, sod farms, mushrooms cellars, 
cranberry bogs, apiaries, and fur farms; and the performance of 
agricultural, animal husbandry, and horticultural services. 
These assets are assigned a class life of 10 years and a 
recovery period of seven years.
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    \82\Sec. 168.
    \83\1987-2 C.B. 674 (as clarified and modified by Rev. Proc. 88-22, 
1988-1 C.B. 785).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that the depreciation incentive will 
provide important economic benefits to encourage development 
within the agricultural sector. The provision lowers the cost 
of capital for property used in agricultural trades or 
businesses which will lead to additional investment in more 
equipment and employment of more workers.

                        EXPLANATION OF PROVISION

    The provision provides a five year recovery period for any 
machinery or equipment (other than any grain bin, cotton 
ginning asset, fence, or other land improvement) which is used 
in a farming business and placed in service before January 1, 
2010, the original use of which begins with the taxpayer. For 
these purposes, the term ``farming business'' means a trade or 
business involving the cultivation of land or the raising or 
harvesting of any agricultural or horticultural commodity.\84\ 
A farming business includes processing activities that are 
normally incident to the growing, raising, or harvesting of 
agricultural or horticultural products.\85\
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    \84\Treas. Reg. sec. 1.263A-4(a)(4)(i).
    \85\Treas. Reg. sec. 1.263A-4(a)(4)(ii).
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                             EFFECTIVE DATE

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

         H. Expensing of Broadband Internet Access Expenditures


(Sec. 408 of the bill and new sec. 191 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. The amount 
of the depreciation deduction allowed with respect to tangible 
property for a taxable year is determined under the modified 
accelerated cost recovery system (``MACRS'').\86\ Under MACRS, 
different types of property generally are assigned applicable 
recovery periods and depreciation methods. The recovery periods 
applicable to most tangible personal property (generally 
tangible property other than residential rental property and 
nonresidential real property) range from 3 to 25 years. The 
depreciation methods generally applicable to tangible personal 
property are the 200-percent and 150-percent declining balance 
methods, switching to the straight-line method for the taxable 
year in which the depreciation deduction would be maximized.
---------------------------------------------------------------------------
    \86\Sec. 168.
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    In lieu of depreciation, a taxpayer with a sufficiently 
small amount of annual investment may elect to deduct (or 
``expense'') such costs under section 179. The Small Business 
and Work Opportunity Tax Act of 2007\87\ increased the amount a 
taxpayer may deduct, for taxable years beginning in 2007 
through 2010, to $125,000 of the cost of qualifying property 
placed in service for the taxable year.\88\ 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 2010 is treated as 
qualifying property. The $125,000 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 
$500,000. The $125,000 and $500,000 amounts are indexed for 
inflation in taxable years beginning after 2007 and before 
2011. For taxable years beginning in 2011 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.
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    \87\Pub. L. No. 110-28, sec. 8212 (2007).
    \88\Additional section 179 incentives are provided with respect to 
qualified property meeting applicable requirements that is used by a 
business in an empowerment zone (sec. 1397A), a renewal community (sec. 
1400J), or the Gulf Opportunity Zone (sec. 1400N(e)).
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                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to provide 
the tax incentive of expensing to encourage the provision of 
broadband services through new or upgraded equipment. In 
particular, the Committee believes that the provision of such 
services should be encouraged in rural areas and areas in which 
residents tend to have incomes significantly lower than the 
median. Because some such areas may be served by current-
generation broadband services, the tax incentive is provided 
with respect to current generation broadband services for 
residential subscribers if the area is not a saturated market. 
The expensing incentive is provided without regard to whether 
the local market is saturated, in the case of next generation 
broadband service, because of the Committee's desire to 
encourage wider availability of faster broadband service.

                        EXPLANATION OF PROVISION

    The provision provides an election to treat any qualified 
broadband expenditure paid or incurred by the taxpayer as not 
chargeable to capital account, but rather, as a deduction. The 
deduction is allowed in the first taxable year in which either 
current generation or next generation broadband services are 
provided through qualified equipment to qualified subscribers. 
Expenditures are eligible for this election only for qualified 
equipment, the original use of which commences with the 
taxpayer. The provision applies for qualified broadband 
expenditures incurred after the date of enactment and on or 
before the first December 31 that is three years after such 
date.
    ``Current generation broadband services'' are defined as 
the transmission of signals at a rate of at least 5 million 
bits per second to the subscriber and at a rate of at least 1 
million bits per second from the subscriber. ``Next generation 
broadband services'' are defined as the transmission of signals 
at a rate of at least 100 million bits per second to the 
subscriber and at a rate of at least 20 million bits per second 
from the subscriber.
    ``Qualified broadband expenditures'' means the direct or 
indirect costs properly taken into account for the taxable year 
for the purchase or installation of qualified equipment 
(including upgrades) and the connection of the equipment to a 
qualified subscriber. The term does not include costs of 
launching satellite equipment. For current generation broadband 
services, only 50 percent of the otherwise allowable amount of 
deduction is treated as qualified broadband expenditures.
    Qualified broadband expenditures include only the portion 
of the purchase price paid by the lessor, in the case of leased 
equipment, that is attributable to otherwise qualified 
broadband expenditures by the lessee. In the case of property 
that is originally placed in service by a person and that is 
sold to the taxpayer and leased back to such person by the 
taxpayer within three months after the date that the property 
was originally placed in service, the property is treated as 
originally placed in service by the taxpayer not earlier than 
the date that the property is used under the leaseback.
    A qualified subscriber, with respect to current generation 
broadband services, means any nonresidential subscriber 
maintaining a permanent place of business in a rural area or 
underserved area, or any residential subscriber residing in a 
rural area or underserved area that is not a saturated market. 
A qualified subscriber, with respect to next generation 
broadband services, means any nonresidential subscriber 
maintaining a permanent place of business in a rural area or 
underserved area, or any residential subscriber.
    For this purpose, a rural area means any census tract not 
within 10 miles of an incorporated or census-designated place 
with more than 25,000 people and not within a county or county 
equivalent with overall population density of more than 500 
people per square mile. An underserved area means a census 
tract located in an empowerment zone or enterprise community 
designated under section 1391 or the District of Columbia 
Enterprise Zone established under section 1400, or any census 
tract the poverty level of which is at least 30 percent and the 
median family income of which does not exceed (1) for a tract 
in a metropolitan statistical area, 70 percent of the greater 
of the metropolitan area median family income or the statewide 
median family income, and (2) for a tract that is not in a 
metropolitan statistical area, 70 percent of the 
nonmetropolitan statewide median family income.
    A saturated market, for this purpose, means any census 
tract in which, as of the date of enactment, current generation 
broadband services have been provided by a single provider to 
85 percent or more of the total potential residential 
subscribers. The services must be usable at least a majority of 
the time during periods of maximum demand, and usable in a 
manner substantially the same as services provided through 
equipment not eligible for the deduction under this provision.
    If current, or next, generation broadband services can be 
provided through qualified equipment to both qualified 
subscribers and to other subscribers, the provision provides 
that the expenditures with respect to the equipment are 
allocated among subscribers to determine the amount of 
qualified broad broadband expenditures that may be deducted 
under the provision.
    Qualified equipment means equipment that provides current, 
or next, generation broadband services at least a majority of 
the time during periods of maximum demand to each subscriber, 
and in a manner substantially the same as such services are 
provided by the provider to subscribers through equipment with 
respect to which no deduction is allowed under the provision. 
Limitations are imposed under the provision on equipment 
depending on where it extends, and on certain packet switching 
equipment, and on certain multiplexing and demultiplexing 
equipment.
    Expenditures generally are not taken into account for 
purposes of the deduction under the provision with respect to 
property used predominantly outside the United States, used 
predominantly to furnish lodging, used by a tax-exempt 
organization (other than in a business whose income is subject 
to unrelated business income tax), or used by the United States 
or a political subdivision or by a possession, agency or 
instrumentality thereof or by a foreign person or entity. The 
basis of property is reduced by the cost of the property that 
is taken into account as a deduction under the provision. 
Recapture rules are provided. No business credit under section 
38 is allowed with respect to any amount allowed as a deduction 
under the provision.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment and 
applies to expenditures incurred after the date of enactment 
and on or before the first December 31 that is three years 
after such date.

             I. Credit for Energy Efficient Electric Motors


(Sec. 409 of the bill and new sec. 45Q of the Code)

                              PRESENT LAW

    There is no present law credit for energy efficient 
electric motors.

                           REASONS FOR CHANGE

    The Committee recognizes the need to reduce the consumption 
of electricity, both to mitigate the harmful effects of 
electricity generation from fossil fuels and to reduce demands 
on the electrical grid. The Committee has long recognized the 
potential to save energy from the promotion of more energy 
efficient products, and believes that the provision of a tax 
credit for energy efficient motors will increase the use of 
such motors and result in less electricity consumption

                        EXPLANATION OF PROVISION

    The provision provides a business tax credit for the 
purchase of qualified energy efficient electric motors that 
meet or exceed certain energy efficiency standards. The credit 
equals $15 per horsepower and the aggregate amount of credit 
that a taxpayer may claim for any taxable year cannot exceed 
$1,250,000. A ``qualifying energy efficient motor'' is: (a) a 
general- or definite-purpose electric motor of 500 horsepower 
or less that meets or exceeds the efficiency levels specified 
in Tables 12-12 or 12-13 of the National Electrical 
Manufacturers Association MG-1 (2006); (b) the original use 
begins with the taxpayer; and (c) is placed in service in the 
United States. The provision applies to energy efficient motors 
placed in service after the date of enactment and prior to 36 
months from the date of enactment.
    The basis of any property for which a credit is allowable 
is reduced by the amount of the credit. The Secretary of the 
Treasury, by regulations, is to provide rules for recapturing 
the credit in the case of any property which ceases to be 
property eligible for the credit. No credit is allowed with 
respect to the portion of the cost of any property taken into 
account for expensing under section 179.

                             EFFECTIVE DATE

    The provision is effective for property placed in service 
after the date of enactment and prior to 36 months from the 
date of enactment.

                  TITLE V--REVENUE RAISING PROVISIONS


          A. Limitation on Farming Losses of Certain Taxpayers


(Sec. 501 of the bill and sec. 461 of the Code)

                              PRESENT LAW

    Farming income and expenses are reported by individuals, 
estates, trusts, and partnerships on IRS Schedule F, Profit and 
Loss from Farming. For taxpayers who materially participate (as 
defined in section 469(h)), net farming losses are reported in 
full as a reduction to income from both passive and nonpassive 
sources. To the extent taxpayers do not materially participate 
in the farming activity, the passive activity rules in section 
469 may limit the ability to use such losses to reduce income 
from nonpassive sources.
    Farming income generally includes sales of livestock, 
produce, grains, and other products; cooperative distributions; 
Agricultural Program Payments; certain Commodity Credit 
Corporation (``CCC'') loans (if an election is made to include 
loan proceeds in income in the year received); certain crop 
insurance proceeds and federal crop disaster payments; and 
other income. Farm expenses generally include feed, 
fertilizers, gasoline, fuel, and oil; insurance; interest; 
hired labor; rent and lease payments; repairs and maintenance; 
taxes; utilities; depreciation; and other business-related 
expenses. Living expenses and other personal expenses are not 
deductible farming expenses.

                           REASONS FOR CHANGE

    The Committee believes that taxpayers receiving government 
assistance through payment programs and loan programs should 
not be allowed to claim unlimited amounts of losses from 
farming activities.

                        EXPLANATION OF PROVISION

    The provision limits the amount of losses that can be 
claimed by an individual, estate, trust, or partnership on 
Schedule F to $200,000 in cases where the taxpayer has received 
Agriculture Program Payments or CCC loans. Losses that are 
limited in a particular year may be carried forward to 
subsequent years.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2007.

 B. Increase and Index Dollar Thresholds for Farm Optional Method and 
Nonfarm Optional Method for Computing Net Earnings From Self-Employment


(Sec. 502 of the bill and sec. 1402(a) of the Code)

                              PRESENT LAW

In general

    Generally, tax under the Self-Employment Contributions Act 
(SECA) is imposed on the self-employment income of an 
individual. SECA tax has two components. Under the old-age, 
survivors, and disability insurance component, the rate of tax 
is 12.40 percent on self-employment income up to the Social 
Security wage base ($97,500 for 2007). Under the hospital 
insurance component, the rate is 2.90 percent of all self-
employment income (without regard to the Social Security wage 
base).
    Self-employment income subject to the SECA tax is 
determined as the net earnings from self-employment. An 
individual may use one of three methods to calculate net 
earnings from self-employment. Under the generally applicable 
rule, net earnings from self-employment means gross income 
(including the individual's net distributive share of 
partnership income) derived by an individual from any trade or 
business carried on by the individual, less the deductions 
attributable to the trade or business that are allowed under 
the SECA tax rules. Alternatively, an individual may elect to 
use one of two optional methods for calculating net earnings 
from self-employment. These methods are: (1) the farm optional 
method; and (2) the nonfarm optional method. The farm optional 
method allows individuals to pay SECA taxes (and secure Social 
Security benefit coverage) when they have low net income or 
losses from farming. The nonfarm optional method is similar to 
the farm optional method.

Farm optional method

    If an individual is engaged in a farming trade or business, 
either as a sole proprietor or as a partner, the individual may 
elect to use the farm optional method in one of two instances. 
The first instance is an individual engaged in a farming 
business who has gross farm income of $2,400 or less for the 
taxable year. In this instance, the individual may elect to 
report two-thirds of gross farm income as net earnings from 
self-employment. In the second instance, an individual engaged 
in a farming business may elect the farm optional method even 
though gross farm income exceeds $2,400 for the taxable year 
but only if the net farm income is less than $1,733 for the 
taxable year. In this second instance, the individual may elect 
to report $1,600 as net earnings from self-employment for the 
taxable year. In all other instances (i.e., more than $2,400 of 
gross farm income and net farm income of at least $1,733) a 
person engaged in a farming business must compute net earnings 
from self-employment under the generally applicable rule. There 
is no limit on the number of years that an individual may elect 
the farm optional method during such individual's lifetime.
    The dollar limits in the farm optional method are not 
indexed for inflation.

Nonfarm optional method

    The nonfarm optional method is available only to 
individuals who have been self-employed for at least two of the 
three years before the year in which they seek to elect the 
nonfarm optional method and who meet certain other 
requirements. Specifically, an individual may elect the nonfarm 
optional method if the individual's: (1) net nonfarm income for 
the taxable year is less than $1,733; and (2) net nonfarm 
income for the taxable year is less than 72.189 percent of 
gross nonfarm income. If a qualified individual engaged in a 
nonfarming business who elects the nonfarm optional method has 
gross nonfarm income of $2,400 or less for the taxable year, 
then the individual may elect to report two-thirds of gross 
nonfarm income as net earnings from self-employment. If the 
electing individual engaged in a nonfarming business has gross 
nonfarm income of at least $2,400 for the taxable year, then 
the individual may elect to report $1,600 as net earnings from 
self-employment for the taxable year. In all other instances, a 
person engaged in a nonfarming business must compute net 
earnings from self-employment under the generally applicable 
rule. An individual may elect to use the nonfarm optional 
method for no more than five years in the course of the 
individual's lifetime.
    The dollar limits in the nonfarm optional method are not 
indexed for inflation.

Other rules applicable to farm optional and nonfarm optional methods

    In the case of a cash method trade or business, gross 
income is defined as the gross receipts from such trade or 
business less the cost or other basis of property sold in 
carrying out such trade or business with certain adjustments. 
In the case of an accrual method trade or business, gross 
income is defined as the gross income from the trade or 
business with certain adjustments. If an individual (including 
a member of a partnership) derives gross income from more than 
one trade or business then such gross income (including the 
individual's distributive share of the gross income of any 
partnership) is treated as derived from a single trade or 
business.

Social Security benefit eligibility

    Generally, Social Security benefits can be paid to an 
individual (and dependents or survivors) only if that 
individual has worked long enough in covered employment to be 
insured. Insured status is measured in terms of ``credits,'' 
previously called ``quarters of coverage.'' For this purpose, 
Social Security uses the lifetime record of earnings reported 
for that individual. In the case of a self-employed individual, 
net earnings from self-employment is used to calculate Social 
Security benefit eligibility.
    Up to four quarters of coverage can be earned for a year, 
depending on covered wages for the year and the amount needed 
to earn each quarter of coverage. For 2007, credit for a 
quarter of coverage is provided for each $1,000 of wages.

                           REASONS FOR CHANGE

    The Committee believes that taxpayers should have the 
ability to earn four quarters of coverage for Social Security 
benefits annually under either the farm optional method or 
nonfarm optional method. Because the present-law dollar amounts 
are not updated or indexed for inflation otherwise eligible 
taxpayers have lost that ability. The bill makes needed changes 
to those methods and ensures that they are indexed so the 
problem will not reoccur in the future.

                        DESCRIPTION OF PROPOSAL

    The provision modifies the farm optional method so that 
electing taxpayers may be eligible to secure four credits of 
Social Security benefit coverage each taxable year by 
increasing an indexing the thresholds. The provision makes a 
similar modification to the nonfarm optional method.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2007.

 C. Information Reporting for Commodity Credit Corporation Transactions


(Sec. 503 of the bill and new sec. 6039J of the Code)

                              PRESENT LAW

    The Farm Security and Rural Investment Act of 2002\89\ 
authorizes a marketing assistance loan program through the 
Commodity Credit Corporation (``CCC''). Under such program, the 
CCC may make loans for eligible commodities at a specified rate 
per unit of commodity (the original loan rate). The repayment 
amount for such a loan secured by an eligible commodity 
generally is based on the lower of the original loan rate or 
the alternative repayment rate, as determined by the CCC, as of 
the date of repayment. The alternative repayment rate may be 
adjusted to reflect quality and location for each type of 
commodity. A taxpayer receiving a CCC loan can use cash to 
repay such a loan, purchase CCC certificates for use in 
repayment of the loan, or deliver the pledged collateral as 
full payment for the loan at maturity.
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    \89\Pub. L. No. 107-171.
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    If a taxpayer uses cash or CCC certificates to repay a CCC 
loan, and the loan is repaid at a time when the repayment rate 
is less than the original loan rate, the difference between the 
original loan amount and the lesser repayment amount is market 
gain. Regardless of whether a taxpayer repays a CCC loan in 
cash or uses CCC certificates in repayment of the loan, the 
market gain is taken into account either as income or as an 
adjustment to the basis of the commodity (if the taxpayer has 
made an election under section 77).
    If a farmer uses cash instead of certificates, the farmer 
will receive a Form CCC-1099-G Information Return showing the 
market gain realized. For transactions prior to January 1, 
2001, however, if a farmer uses CCC certificates to facilitate 
repayment of a CCC loan, the farmer will not receive an 
information return. For transactions after January 1, 2001, IRS 
Notice 2007-63 provides that the CCC reports market gain 
associated with the repayment of a CCC loan whether the 
taxpayer repays the loan with cash or uses CCC certificates in 
repayment of the loan.\90\ The CCC reports the market gain on 
Form 1099-G, Certain Government Payments.
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    \90\2007-33 IRB.
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                           REASONS FOR CHANGE

    Income that is subject to information reporting is less 
likely to be underreported. In contrast, the absence of 
information reporting on many types of payments results in 
underreporting and contributes to the tax gap.\91\ Thus, the 
Committee believes it is important to ensure that information 
reporting rules are applied consistently to payments that may 
differ in form, but are economically equivalent. For this 
reason, the Committee believes it is appropriate to codify the 
IRS's administrative determination regarding information 
reporting for the repayment of CCC loans.
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    \91\The tax gap is the amount of tax that is imposed by law for a 
given tax year but is not paid voluntarily and timely.
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                        EXPLANATION OF PROVISION

    The provision codifies the requirements of IRS Notice 2007-
63 providing that the CCC reports market gain associated with 
the repayment of a CCC loan, regardless of whether the taxpayer 
repays the loan with cash or uses CCC certificates in repayment 
of the loan.

                             EFFECTIVE DATE

    The provision is effective for loans repaid on or after 
January 1, 2007.

   D. Modification of Section 1031 Treatment for Certain Real Estate


(Sec. 504 of the bill and sec. 1031 of the Code)

                              PRESENT LAW

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like kind'' that is 
to be held for productive use in a trade or business or for 
investment.\92\ If section 1031 applies to an exchange of 
properties, the basis of the property received in the exchange 
is equal to the basis of the property transferred, decreased by 
any money received by the taxpayer, and further adjusted for 
any gain or loss recognized on the exchange. For purposes of 
section 1031, the determination of ``like kind'' relates to the 
nature or character of the property and not its grade or 
quality.\93\ Therefore, improved real estate and unimproved 
real estate are generally considered to be property of a ``like 
kind'' as this distinction relates to the grade or quality of 
the real estate.\94\
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    \92\Sec. 1031(a)(1).
    \93\Treas. Reg. sec. 1.1031(a)-1(b).
    \94\Treas. Reg. sec. 1.1031(a)-1(c).
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                           REASONS FOR CHANGE

    The Committee believes that sellers are currently using 
section 1031 to defer gains on improved real estate exchanged 
for farm property and also receiving the benefit of the farm 
property's historical agricultural base involved in calculating 
Agriculture Program Payments to include direct payments and 
counter cyclical payments. The Committee believes that those 
exchanges should not be like kind.

                        EXPLANATION OF PROVISION

    The provision modifies section 1031 to disallow 
nonrecognition treatment for exchanges of unimproved real 
estate for which the owner is receiving Agriculture Program 
Payments or Commodity Credit Corporation (``CCC'') loans for 
improved real estate, unless the undeveloped land is 
permanently retired from farm program payments.

                             EFFECTIVE DATE

    The provision is effective for exchanges completed after 
the date of enactment.

E. Modification of Effective Date of Leasing Provisions of the American 
                       Jobs Creation Act of 2004


(Sec. 505 of the bill 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. 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) was 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'').

                           REASONS FOR CHANGE

    The Committee is aware that certain leasing transactions 
entered into with foreign lessees prior to March 12, 2004, are 
continuing to provide a tax benefit to the taxpayers who 
participated in such transactions. The Committee finds these 
transactions and their continuing tax benefit to be 
inappropriate.

                        EXPLANATION OF PROVISION

    The provision changes the effective date of the loss 
deferral rules with respect to certain leases. Under the 
provision, the loss deferral rules also apply 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, 
2006.
    No inference is intended regarding the appropriate present-
law tax treatment of transactions entered into prior to March 
12, 2004, if the lessee is not a foreign person or entity. In 
addition, it is intended that the provision shall not be 
construed as altering or supplanting the present-law tax rules 
providing that a taxpayer is treated as the owner of leased 
property only if the taxpayer acquires and retains significant 
and genuine attributes of an owner of the property, including 
the benefits and burdens of ownership. The provision also is 
not intended to affect the scope of any other present-law tax 
rules or doctrines applicable to purported leasing 
transactions.

                             EFFECTIVE DATE

    The provision is effective as if included in the provisions 
of the American Jobs Creation Act of 2004 to which it relates.

          F. Modifications to Corporate Estimated Tax Payments


(Sec. 506 of the bill)

                              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.
    Under present law, in the case of a corporation with assets 
of at least $1 billion, the payments due in July, August, and 
September, 2012, shall be increased to 115.00 percent of the 
payment otherwise due and the next required payment shall be 
reduced accordingly.

                           REASONS FOR CHANGE

    The Committee believes it is appropriate to adjust the 
corporate estimated tax payments.

                        EXPLANATION OF PROVISION

    The bill increases the otherwise applicable percentage 
(115.00 percent) by 7.00 percent.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

  G. Ineligibility of Collectibles for Nontaxable Like Kind Exchange 
                               Treatment


(Sec. 507 of the bill and sec. 1031 of the Code)

                              PRESENT LAW

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like kind'' that is 
to be held for productive use in a trade or business or for 
investment.\95\ If section 1031 applies to an exchange of 
properties, the basis of the property received in the exchange 
is equal to the basis of the property transferred, decreased by 
any money received by the taxpayer, and further adjusted for 
any gain or loss recognized on the exchange. For purposes of 
section 1031, the determination of ``like kind'' relates to the 
nature or character of the property and not its grade or 
quality. ``One kind or class of property may not, under that 
section, be exchanged for property of a different kind or 
class.''\96\
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    \95\Sec. 1031(a)(1).
    \96\Treas. Reg. sec. 1.1031(a)-1(b).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that section 1031 was designed to 
encourage capital reinvestment for assets used in a trade or 
business or held for investment. Because collectibles have 
elements of both investment and personal use, the Committee 
wishes to exclude collectibles from property qualifying for 
nonrecognition treatment.

                        EXPLANATION OF PROVISION

    The provision denies nonrecognition treatment for exchanges 
of collectibles, as defined by section 408(m)(2).

                             EFFECTIVE DATE

    The provision is effective for exchanges completed after 
the date of enactment.

 H. Denial of Deduction for Certain Fines, Penalties, and Other Amounts


(Sec. 508 of the bill and sec. 162(f) and new sec. 6050W 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 to a 
government of a fine or similar penalty 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.''\97\
---------------------------------------------------------------------------
    \97\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. sec. 15a), as 
amended) paid to a government do not constitute a fine or 
penalty.

                           REASONS FOR CHANGE

    The Committee is concerned that there is a lack of clarity 
and consistency under present law regarding when taxpayers may 
deduct payments made in settlement of government investigations 
of potential wrongdoing, as well as in situations where there 
has been a final determination of wrongdoing. If a taxpayer 
deducts payments made in settlement of an investigation of 
potential wrongdoing or as a result of a finding of wrongdoing, 
the publicly announced amount of the settlement payment does 
not reflect the true after-tax penalty on the taxpayer. The 
Committee also is concerned that allowing a deduction for such 
payments in effect shifts a portion of the penalty to the 
Federal government and to the public.

                        EXPLANATION OF PROVISION

    The 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 which is initiated by such government,\98\ 
are nondeductible under any provision of the income tax 
provisions.\99\ 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) for damage or 
harm caused by, or which may be caused by, the violation or 
potential violation, or amounts paid to come into compliance 
with any law that was violated or involved in the investigation 
or inquiry. The exception for restitution does not apply to any 
amount paid or incurred as reimbursement to the government for 
the costs of any investigation or litigation\100\ unless such 
amount is paid or incurred for a cost or fee regularly charged 
for any routine audit or other customary review performed by 
the government.\101\
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    \98\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.
    \99\The provision provides that such amounts are nondeductible 
under chapter 1 of the Internal Revenue Code.
    \100\This exception from deductibility for reimbursements is 
intended to include payments to reimburse a government for payments to 
whistleblowers.
    \101\The provision does not affect such costs or fees that are a 
regular charge for a routine audit or customary review, nor does it 
affect amounts paid or incurred in performing routine audits or reviews 
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.
---------------------------------------------------------------------------
    In the case of any court order or binding written 
settlement agreement, if the amounts required to be paid exceed 
$1 million, then the deduction is not allowed unless such court 
order or written settlement agreement specifies that the amount 
is for restitution, for remediation of property, or to come 
into compliance with the law.\102\ The IRS remains free to 
challenge the characterization of an amount so identified.\103\
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    \102\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).
    \103\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.
---------------------------------------------------------------------------
    The provision does not apply to any amount paid or incurred 
by order of a court in a suit in which no government is a 
party.\104\
---------------------------------------------------------------------------
    \104\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 ddirects 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.
---------------------------------------------------------------------------
    The provision does not apply to any amount paid or incurred 
as taxes due.\105\
---------------------------------------------------------------------------
    \105\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).
---------------------------------------------------------------------------
    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.\106\ 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.
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    \106\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.
---------------------------------------------------------------------------
    It is intended that a payment will be treated as an amount 
paid 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.\107\
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    \107\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.\108\
---------------------------------------------------------------------------
    \108\For example, the IRS might require such separate reporting as 
part of, or in addition to, reporting of amouts that are not deducted 
and that thus create a book tax difference on the schedule M-3.
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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; the rules requiring identification of 
those amounts in a court order or written settlement agreement 
of $1 million or greater; and all the other requirements of the 
provision including the requirement of reporting to the IRS and 
the taxpayer, likewise apply in such 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.

              I. Increase In Information Return Penalties


(Sec. 509 of the bill and secs. 6721, 6722, and 6723 of the Code)

                              PRESENT LAW

    Present law imposes information reporting requirements on 
participants in certain transactions. Under section 6721 of the 
Code, any person required to file a correct information return 
who fails to do so on or before the prescribed filing date is 
subject to a penalty that varies based on when, if at all, the 
correct information return is filed. If a person files a 
correct information return after the prescribed filing date, 
but on or before the date that is 30 days after the prescribed 
filing date, the amount of the penalty is $15 per return (the 
``first-tier penalty''), with a maximum penalty of $75,000 per 
calendar year. If a person files a correct information return 
more than 30 days after the prescribed filing date, but on or 
before August 1, the amount of the penalty is $30 per return 
(the ``second-tier penalty''), with a maximum penalty of 
$150,000 per calendar year. If a correct information return is 
not filed on or before August 1, the amount of the penalty is 
$50 per return (the ``third-tier penalty''), with a maximum 
penalty of $250,000 per calendar year.
    Special lower maximum levels for this penalty apply to 
small businesses. Small businesses are defined as firms having 
average annual gross receipts for the most recent three taxable 
years that do not exceed $5 million. The maximum penalties for 
small businesses are: $25,000 (instead of $75,000) if the 
failures are corrected on or before 30 days after the 
prescribed filing date; $50,000 (instead of $150,000) if the 
failures are corrected on or before August 1; and $100,000 
(instead of $250,000) if the failures are not corrected on or 
before August 1.
    Section 6722 of the Code also imposes penalties for failing 
to furnish correct payee statements to taxpayers. In addition, 
section 6723 imposes a penalty for failing to comply with other 
information reporting requirements. Under both section 6722 and 
section 6723, the penalty amount is $50 for each failure, up to 
a maximum of $100,000.

                           REASONS FOR CHANGE

    The Committee believes the present law penalties for 
failing to file accurate information returns are too low to 
discourage noncompliance. The Committee believes that 
increasing the information return penalties will encourage the 
filing of timely and accurate information returns and generally 
will improve tax administration and tax compliance.

                        EXPLANATION OF PROVISION

    The provision increases the penalties for failing to file 
correct information returns, failing to furnish correct payee 
statements, and failing to comply with other information 
reporting requirements. Specifically, the provision increases 
the failure to file correct information returns as follows: the 
first-tier penalty would be increased from $15 to $50, with a 
maximum penalty of $500,000 per calendar year; the second-tier 
penalty would be increased from $30 to $100, with a maximum 
penalty of $1,500,000 per calendar year; and the third-tier 
penalty would be increased from $50 to $250, with a maximum 
penalty of $3,000,000 per calendar year. The maximum penalties 
for small businesses would be: $175,000 if the failures are 
corrected on or before 30 days after the prescribed filing 
date; $500,000 if the failures are corrected on or before 
August 1; and $1,000,000 if the failures are not corrected on 
or before August 1.
    The provision increases both the penalty for failing to 
furnish correct payee statements to taxpayers and the penalty 
for failing to comply with other information reporting 
requirements penalties to $250 for each such failure, up to a 
maximum of $1,000,000 in a calendar year.

                             EFFECTIVE DATE

    The provision is effective with respect to information 
returns required to be filed on or after January 1, 2008.

                     J. Economic Substance Doctrine


(Secs. 511-513 of the bill and sec. 7701, new sec. 6662B, and sec. 163 
        of the Code)

1. Clarification of the economic substance doctrine

                              PRESENT LAW

In general

    The Code provides detailed rules specifying the computation 
of taxable income, including the amount, timing, source, and 
character of items of income, gain, loss, and deduction. These 
rules permit both taxpayers and the government to compute 
taxable income with reasonable accuracy and predictability. 
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, they can be seen as at odds with an 
objective, ``rule-based'' system of taxation.
    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.\109\
---------------------------------------------------------------------------
    \109\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). 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). Certain ``substance over form'' 
cases involving tax-indifferent parties, in which courts have found 
that the substance of the transaction did not comport with the form 
asserted by the taxpayer, have also involved examination of whether the 
change in economic position that occurred, if any, was consistent with 
the form asserted, and whether the claimed business purpose supported 
the particular tax benefits that were claimed. See, e.g., Klamath 
Strategic Investment Fund, LLC v. United States, 472 F. Supp. 2d 885 
(E.D. Texas 2007); TIFD-III-E, Inc. v. United States, 459 F. 3d 220 (2d 
Cir. 2006); BB&T Corporation v. United States, ----F. Supp. 2d ----, 
2007-1 USTC P 50,130 (M.D.N.C. 2007).
---------------------------------------------------------------------------
            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.\110\
---------------------------------------------------------------------------
    \110\AACM Partnership v. Commissioner, 73 T.C.M. at 2215.
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            Business purpose doctrine
    A common law doctrine that often is considered together 
with the economic substance doctrine is the business purpose 
doctrine. The business purpose doctrine involves 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.\111\
---------------------------------------------------------------------------
    \111\See, ACM Partnership v. Commissioner, 157 F.3d at 256 n.48.
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Application by the courts

            Elements of the doctrine
    There is a lack of uniformity regarding the proper 
application of the economic substance doctrine.\112\ 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.\113\ A narrower approach used by some courts is to 
conclude that either a business purpose or economic substance 
is sufficient to respect the transaction.\114\ 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.\115\
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    \112\``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).
    \113\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.'').
    \114\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.
    \115\ 1ASee, e.g., ACM Partnership v. Commissioner, 157 F.3d at 
247; James v. Commissioner, 899 F.2d 905, 908 (10th Cir. 1995); Sacks 
v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (``Instead, the 
consideration of business purpose and economic substance are simply 
more precise factors to consider . . . We have repeatedly and carefully 
noted that this formulation cannot be used as a `rigid two-step 
analysis'.'').
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    Recently, the Court of Federal Claims questioned the 
continuing viability of the doctrine. That court also stated 
that ``the use of the `economic substance' doctrine to trump 
`mere compliance with the Code' would violate the separation of 
powers'' though that court also found that the particular case 
did not lack economic substance. The Court of Appeals for the 
Federal Circuit (``Federal Circuit Court'') overruled the Court 
of Federal Claims decision, reiterating the viability of the 
economic substance doctrine and concluding that the transaction 
in question violated that doctrine.\116\ The Federal Circuit 
Court stated that ``[w]hile the doctrine may well also apply if 
the taxpayer's sole subjective motivation is tax avoidance even 
if the transaction has economic substance, [footnote omitted], 
a lack of economic substance is sufficient to disqualify the 
transaction without proof that the taxpayer's sole motive is 
tax avoidance.''\117\
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    \116\Coltec Industries, Inc. v. United States, 62 Fed. Cl. 716 
(2004) (slip opinion at 123-124, 128); vacated and remanded, 454 F.3d 
1340 (Fed. Cir. 2006), cert. denied, 127 S. Ct. 1261 (Mem.) (2007).
    \117\The Federal Circuit Court stated that ``when the taxpayer 
claims a deduction, it is the taxpayer who bears the burden of proving 
that the transaction has economic substance.'' The Federal Circuit 
Court quoted a decision of its predecessor court, stating that 
``Gregory v. Helvering requires that a taxpayer carry an unusually 
heavy burden when he attempts to demonstrate that Congress intended to 
give favorable tax treatment to the kind of transaction that would 
never occur absent the motive of tax avoidance.'' The Court also stated 
that ``while the taxpayer's subjective motivation may be pertinent to 
the existence of a tax avoidance purpose, all courts have looked to the 
objective reality of a transaction in assessing its economic 
substance.'' Coltec Industries, Inc. v. United States, 454 F.3d at 
1355, 1356.
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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. Some courts have denied tax 
benefits on the grounds that a stated business benefit of a 
particular structure was not in fact obtained by that 
structure.\118\ Several courts have denied tax benefits on the 
grounds that the subject transactions lacked profit 
potential.\119\ 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.\120\ 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.\121\ In these 
cases, in assessing whether a reasonable possibility of profit 
exists, it may be sufficient if there is a nominal amount of 
pre-tax profit as measured against expected net tax benefits.
---------------------------------------------------------------------------
    \118\See, e.g., Coltec Industries v. United States, 454 F.3d 1340 
(Fed. Cir. 2006). The court analyzed the transfer to a subsidiary of a 
note purporting to provide high stock basis in exchange for a purported 
assumption of liabilities, and held these transactions unnecessary to 
accomplish any business purpose of using a subsidiary to manage 
asbestos liabilities. The court also held that the purported business 
purpose of adding a barrier to veil-piercing claims by third parties 
was not accomplished by the transaction. 454 F.3d at 1358-1360 (Fed. 
Cir. 2006).
    \119\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).
    \120\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'').
    \121\See, e.g., Rice's Toyota World v. Commissioner, 752 F. 2d 89, 
94 (4th Cir. 1985) (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 778, 781 (5th Cir. 2001) (applied the 
same test, citing Rice's Toyota World); IES Industries v. United 
States, 253 F.3d 350, 354 (8th Cir. 2001).
---------------------------------------------------------------------------
            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.\122\ 
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.\123\
---------------------------------------------------------------------------
    \122\See American Electric Power, Inc. v. United States, 136 F. 
Supp. 2d 762, 791-92 (S.D. Ohio 2001); aff'd 326 F.3d.737 (6th Cir. 
2003).
    \123\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 constitute a good business purpose.
---------------------------------------------------------------------------
            Tax-indifferent parties
    A number of cases have involved transactions structured to 
allocate income for Federal tax purposes to a tax-indifferent 
party, with a corresponding deduction, or favorable basis 
result, to a taxable person. The income allocated to the tax-
indifferent party for tax purposes was structured to exceed any 
actual economic income to be received by the tax indifferent 
party from the transaction. Courts have sometimes concluded 
that a particular type of transaction did not satisfy the 
economic substance doctrine.\124\ In other cases, courts have 
indicated that the substance of the transaction did not support 
the form of income allocations asserted by the taxpayer, and 
have questioned whether asserted business purpose or other 
standards were met.\125\
---------------------------------------------------------------------------
    \124\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).
    \125\See, e.g., TIFD-III-E, Inc. v. United States, 459 F.3d 220 (2d 
Cir. 2006).
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                           REASONS FOR CHANGE

    Recent tax avoidance transactions have relied upon the 
interaction of highly technical tax law provisions to produce 
tax consequences not contemplated by the Congress. When 
successful, taxpayers who engage in these transactions enlarge 
the tax gap by gaining unintended tax relief and by undermining 
overall respect for the tax system.
    A strictly rule-based tax system cannot efficiently 
prescribe the appropriate outcome of every conceivable 
transaction that might be devised and is, as a result, 
incapable of preventing all unintended consequences. Thus, many 
courts have long recognized the need to supplement tax rules 
with anti-tax avoidance standards, such as the economic 
substance doctrine, in order to assure the Congressional 
purpose is achieved. The Committee recognizes that IRS has 
achieved a number of recent successes in litigation. The 
Committee believes it is still desirable to provide greater 
clarity and uniformity in the application of the economic 
substance doctrine in order to assure such continued 
application of the doctrine and to improve its effectiveness at 
deterring unintended consequences. The Committee believes that 
a stronger penalty imposed on understatements attributable to 
non-economic substance transactions is desirable in this 
connection, to deter taxpayers from entering such transactions 
and thus improve compliance.
    The Committee believes the same result with respect to 
interest on underpayments that occurs with respect to 
nondisclosed reportable transactions should also apply to 
noneconomic substance transactions.

                        EXPLANATION OF PROVISION

    The 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-Federal-tax purpose for entering 
into such transaction. The provision provides a uniform 
definition of economic substance, but does not alter the 
flexibility of the courts in other respects.
    If the tax benefits are clearly consistent with all 
applicable provisions of the Code and the purposes of such 
provisions, 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. Thus, the provision does not change current law 
standards used by courts in determining when to utilize an 
economic substance analysis.\126\
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    \126\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.
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    The provision is not intended to alter the tax treatment of 
certain basic business transactions that, under longstanding 
judicial and administrative practice are respected, merely 
because the choice between meaningful economic alternatives is 
largely or entirely based on comparative tax advantages. 
Among\127\ these basic transactions are (1) the choice between 
capitalizing a business enterprise with debt or equity;\128\ 
(2) a U.S. person's choice between utilizing a foreign 
corporation or a domestic corporation to make a foreign 
investment;\129\ (3) the choice to enter a transaction or 
series of transactions that constitute a corporate organization 
or reorganization under subchapter C;\130\ and (4) the choice 
to utilize a related-party entity in a transaction, provided 
that the arm's length standard of section 482 and other 
applicable concepts are satisfied.\131\ Leasing transactions, 
like all other types of transactions, will continue to be 
analyzed in light of all the facts and circumstances.\132\ As 
under present law, whether a particular transaction meets the 
requirements for specific treatment under any of these 
provisions can be a question of facts and circumstances. Also, 
the fact that a transaction does meet the requirements for 
specific treatment under any provision of the Code is not 
determinative of whether a transaction or series of 
transactions of which it is a part has economic substance.\133\
---------------------------------------------------------------------------
    \127\The examples are illustrative and not exclusive.
    \128\See, e.g., John Kelley Co. v. Commissioner, 326 U.S. 521 
(1946) (respecting debt characterization in one case and not in the 
other, based on all the facts and circumstances).
    \129\See, e.g., Sam Siegel v. Commissioner, 45. T.C. 566 (1966), 
acq. 1966-2 C.B. 3; but see Commissioner v. Bollinger, 485 U.S. 340 
(1988) (agency principles applied to title-holding corporation under 
all the facts and circumstance).
    \130\See, e.g. Rev. Proc. 2007-3 2007-1 I.R.B. 108, secs 3.01(33), 
(34), and (36) (IRS will not rule on certain matters relating to 
incorporations or reorganizations unless there is a ``significant 
issue''); compare Gregory v. Helvering. 293 U.S. 465 (1935).
    \131\See, e.g., National Carbide v. Commissioner, 336 U.S. 422 
(1949), Moline Properties v. Commissioner, 319 U.S. 435 (1943); 
compare, e.g. Aiken Industries, Inc. v. Commissioner, 56 T.C. 925 
(1971), acq., 1972-2 C.B. 1; Commissioner v. Bollinger, 485 U.S. 340 
(1988), see also sec. 7701(l).
    \132\See, e.g., Frank Lyon v. Commissioner, 435 U.S. 561 (1978); 
Hilton v. Commissioner, 74 T.C. 305, aff'd 671 F. 2d 316 (9th Cir. 
1982), cert. denied 459 U.S. 907 (1982); Coltec Industries v. United 
States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 
(Mem) (2007).
    \133\As examples of cases in which courts have found that a 
transaction does not meet the requirements for the treatment claimed by 
the taxpayer under the Code, or does not have economic substance, see 
e.g., TIFD-III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006); 
BB&T Corporation v. United States, ----F. Supp.----, 2007-1 USTC P 
50,130 (M.D.N,C, 2007); Tribune Company and Subsidiaries v. 
Commissioner, 125 T.C. 110 (2005) ; H.J. Heinz Company and Subsidiaries 
v. United States, 76 Fed. Cl. 570 (2007); Coltec Industries, Inc. v. 
United States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 
1261 (Mem.) (2007); Long Term Capital Holdings LP v. United States, 330 
F. Supp. 2d 122 (D. Conn. 2004), aff'd 150 Fed. Appx. 40 (2d Cir. 
2005); Klamath Strategic Investment Fund, LLC v. United States, 472 F. 
Supp. 2d 885 (E.D. Texas 2007); Santa Monica Pictures LLC v. 
Commissioner, 89 T.C.M. 1157 (2005).
---------------------------------------------------------------------------
    The provision does not alter the court's ability to 
aggregate, disaggregate, or otherwise recharacterize a 
transaction when applying the doctrine. For example, 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 those tax 
motivated benefits.\134\
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    \134\See, e.g., Coltec Industries, Inc. v. United States, 454 F.3d 
1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 (Mem.) (2007) 
(``the first asserted business purpose focuses on the wrong 
transaction--the creation of Garrison as a separate subsidiary to 
manage asbestos liabilities.. . . [W]e must focus on the transaction 
that gave the taxpayer a high basis in the stock and thus gave rise to 
the alleged benefit upon sale...'') 454 F.3d 1340, 1358 (Fed. Cir. 
2006). See also ACM Partnership v. Commissioner, 157 F.3d at 256 n.48; 
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.'').
---------------------------------------------------------------------------

Conjunctive analysis

    The provision clarifies that the economic substance 
doctrine involves a conjunctive analysis--there must be a 
judicial inquiry regarding the objective effects of the 
transaction on the taxpayer's economic position as well as an 
inquiry regarding the taxpayer's subjective motives for 
engaging in the transaction. Under the provision, a transaction 
must satisfy both tests, i.e., the transaction must change in a 
meaningful way (apart from Federal income tax effects) the 
taxpayer's economic position, and the taxpayer must have a 
substantial non-Federal-tax purpose\135\ for entering into such 
transaction, 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.
---------------------------------------------------------------------------
    \135\A purpose of reducing non-Federal taxes is not a non-Federal-
tax business purpose if (i) the transaction will effect a reduction in 
both Federal and non-Federal taxes because of similarities between 
Federal tax law and the law of the other jurisdiction and (ii) the 
reduction of Federal taxes is greater than or substantially coextensive 
with the reduction of non-Federal taxes.
---------------------------------------------------------------------------

Non-Federal-tax business purpose

    Under the provision, a taxpayer's non-Federal-tax purpose 
for entering into a transaction (the second prong in the 
analysis) must be ``substantial.''\136\
---------------------------------------------------------------------------
    \136\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]
---------------------------------------------------------------------------
    An objective of achieving a favorable accounting treatment 
for financial reporting purposes will not itself be treated as 
a substantial non-Federal-tax purpose if the origin of such 
financial accounting benefit is a reduction of Federal income 
tax.\137\ For example, a transaction that is expected to 
increase financial accounting income as a result of generating 
tax deductions or losses without a corresponding financial 
accounting charge (i.e., a permanent book-tax difference)\138\ 
should not be considered to have a substantial non-Federal-tax 
purpose unless a substantial non-Federal-tax purpose exists 
apart from the financial accounting benefits.\139\
---------------------------------------------------------------------------
    \137\However, if the tax benefits are clearly contemplated and 
expected by the language and purpose of the relevant authority, such 
tax benefits should not be disallowed solely because the transaction 
results in a favorable accounting treatment. An example is the repealed 
foreign sales corporation rules.
    \138\This includes tax deductions or losses that are anticipated to 
be recognized in a period subsequent to the period the financial 
accounting benefit is recognized. For example, FAS 109 in some cases 
permits the recognition of financial accounting benefits prior to the 
period in which the tax benefits are recognized for income tax 
purposes.
    \139\Claiming that a financial accounting benefit constitutes a 
substantial non-tax purpose fails to consider the origin of the 
accounting benefit (i.e., reduction of taxes) and significantly 
diminishes the purpose for having a substantial non-tax purpose 
requirement. See, e.g., American Electric Power, Inc. v. United States, 
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).
---------------------------------------------------------------------------

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 or 
that the taxpayer has a substantial non-Federal-tax purpose for 
entering into such transaction. The provision does not require 
or establish a specified minimum return that will satisfy the 
profit potential test. However, if a taxpayer relies on a 
profit potential, the present value of the reasonably expected 
pre-Federal-tax profit must be substantial in relation to the 
present value of the expected net Federal tax benefits that 
would be allowed if the transaction were respected.\140\ In 
addition, in determining pre-Federal-tax profit, foreign taxes 
are treated as expenses to the extent provided in 
regulations.\141\
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    \140\Thus, a ``reasonable possibility of profit'' alone will not be 
sufficient to establish that a transacgtion has economic substance.
    \141\There is no intention to restrict the ability of the courts to 
consider the appropriate treatment of foreign taxes in particular 
cases, as under present law. However, the Treasury Department may, in 
addition, choose to require treatment of foreign taxes as expenses as 
provided in regulations.
---------------------------------------------------------------------------

Other rules

    The Secretary may prescribe regulations that 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, 
the provision shall not be construed as altering or supplanting 
any other common law doctrine or provision of the Code or 
regulations or other guidance thereunder; and the provision 
shall be construed as being additive to any such other 
doctrine, Code provision, or regulations or guidance 
thereunder.

                             EFFECTIVE DATE

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

2. Penalty for understatements attributable to transactions lacking 
        economic substance, etc.

                              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.\142\ Except in the case of 
tax shelters,\143\ 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.
---------------------------------------------------------------------------
    \142\Sec. 6662.
    \143\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).
---------------------------------------------------------------------------
    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.\144\ 
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.\145\
---------------------------------------------------------------------------
    \144\Sec. 6664(c).
    \145\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.\146\ 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.\147\
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    \146\Sec. 6707A(c)(1).
    \147\Sec. 6707A(c)(2).
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            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.\148\ 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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    \148\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.\149\ 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.\150\ 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.\151\
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    \149\Sec. 6662A(c).
    \150\Sec. 6664(d).
    \151\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).\152\
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    \152\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);\153\ 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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    \153\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.\154\
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    \154\Sec. 6662A(e)(3).
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            Strengthened reasonable cause exception
    A penalty is not imposed 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;\155\ (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.\156\
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    \155\See the previous discussion regarding the penalty for failing 
to disclose a reportable transaction.
    \156\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\157\ 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\158\ 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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    \157\The term ``material advisor'' means any person who provides 
any material aid, asistance, 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).
    \158\This situation could arise, for example, when an advisor has 
an arrangement or understanding (oral or written) with an organizer, 
manager, or promoter of a reportable transaction that such party will 
recommend or refer potential participants to the advisor for an opinion 
regarding the tax treatment of the transaction.
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    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.\159\ Participation in the ``management'' of a transaction 
means involvement in the decision-making process regarding any 
business activity with respect to the transaction. 
Participation in the ``promotion or sale'' of a transaction 
means involvement in the marketing or solicitation of the 
transaction to others. Thus, an advisor who provides 
information about the transaction to a potential participant is 
involved in the promotion or sale of a transaction, as is any 
advisor who recommends the transaction to a potential 
participant.
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    \159\An advisor shoud 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.

                        EXPLANATION OF PROVISION

    The provision imposes a new, stronger penalty for an 
understatement attributable to any transaction that lacks 
economic substance (referred to in the statute as a 
``noneconomic substance transaction understatement'').\160\ The 
penalty rate is 30 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). Under the provision, outside opinions or in-house 
analysis would not protect a taxpayer from imposition of a 
penalty if it is determined that the transaction lacks economic 
substance or is not respected as described below.
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    \160\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.
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    A ``noneconomic substance transaction'' means any 
transaction if the transaction lacks economic substance (as 
defined in the provision regarding the clarification of the 
economic substance doctrine).\161\ For this purpose, a 
transaction is one that lacks economic substance if it is 
disregarded as a result of the application of the same factors 
and analysis that is required under the provision for an 
economic substance analysis, even if a court uses a different 
term to describe the doctrine.
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    \161\That 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-Federal-tax purpose for entering into such transaction. Specific 
other rules also apply. See ``Explanation of Provision'' for the 
immediately preceding 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),\162\ 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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    \162\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, a 
penalty under the provision cannot be asserted until there has 
been a review and approval by the Chief Counsel of the Internal 
Revenue Service (or, if so delegated, a branch chief within the 
office of Chief Counsel) and the taxpayer has had the 
opportunity to submit a written statement in connection with 
that review. Once the penalty has been asserted following such 
National Office review, the penalty cannot be compromised for 
purposes of a settlement without approval of the Chief Counsel 
(or, if so delegated, a branch chief within the office of Chief 
Counsel). The penalty can be compromised in such event only to 
the extent the underlying understatement with respect to which 
it was asserted is also compromised. 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. If a 
final adjudication of a court determines that the economic 
substance doctrine does not apply, then a noneconomic substance 
penalty asserted by the IRS in that case would not apply.
    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.\163\
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    \163\Nothing in the provision precludes the IRS from asserting 
alternative grounds in a case in addition to a lack of economic 
substance or from asserting other penalties; however, at the conclusion 
of the case if there is a penalty under this provision then the 
interaction with any other penalties would be as described in the text.
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                             EFFECTIVE DATE

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

3. Denial of deduction for interest on underpayments attributable to 
        noneconomic substance transactions

                              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.\164\ The Secretary of the Treasury is authorized to 
define reportable transactions for this purpose.\165\
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    \164\Sec. 162(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.
    \165\See the description of present law under the immediately 
preceding proposal, ``Penalty for understatements attributable to 
transactions lacking economic substance, etc.''
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                        DESCRIPTION OF PROPOSAL

    The 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 entered into after 
the date of enactment

                    III. BUDGET EFFECTS OF THE BILL


                         A. Committee Estimates

    In compliance with paragraph 11(a) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the estimated budget effects of the revenue 
provisions of the ``Heartland, Habitat, Harvest, and Work 
Horticulture Act of 2007'' as reported.


                B. Budget Authority and Tax Expenditures


Budget authority

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

Tax expenditures

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

            C. Consultation With Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has not 
submitted a statement on the bill. The letter from the 
Congressional Budget Office has not been received, and 
therefore will be provided separately.

                       IV. VOTES OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
Standing Rules of the Senate, the Committee states that, with a 
majority and quorum present, the ``Heartland, Habitat, Harvest 
and Work Horticulture Act of 2007,'' as amended, was ordered 
favorably reported by a voice vote on October 4, 2007.

                 V. REGULATORY IMPACT AND OTHER MATTERS


                          A. Regulatory Impact

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

Impact on individuals and businesses, personal privacy and paperwork

    The bill includes provisions to extend present-law tax 
benefits, expand eligibility for other benefits, and create new 
tax incentives. The bill also includes provisions limiting 
farming losses of certain taxpayers, codifying information 
reporting on Commodity Credit Corporation transactions and 
limiting section 1031 treatment for certain real estate and 
collectibles. The effective date of AJCA relating to loss 
limitations on SILOs is also modified under the bill. The bill 
also denies a deduction for certain fines, penalties and other 
amounts and increases information return penalties. Finally, 
the bill includes provisions to clarify and codify the economic 
substance doctrine and related penalties and to deny the 
deduction for interest paid on certain tax motivated 
transactions.
    The bill includes various other provisions that are not 
expected to impose additional administrative requirements or 
regulatory burdens on individuals or businesses.
    The provisions of the bill do not impact personal privacy.

                     B. Unfunded Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4).
    The Committee has determined that the following two tax 
provisions of the reported bill contain Federal private sector 
mandates within the meaning of Public Law 104-4, the Unfunded 
Mandates Reform Act of 1995: (1) modifying the effective date 
for the application of the AJCA 2004 leasing (``SILO'') 
provision--apply loss limitation to leases with foreign 
entities regardless of when the lease was entered into; and (2) 
clarification of the economic substance doctrine and related 
penalties. The tax provisions of the reported bill do not 
impose a Federal intergovernmental mandate on State, local, or 
tribal governments within the meaning of Public Law 104-4, the 
Unfunded Mandates Reform Act of 1995.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the aggregate 
estimated budget effects of the provision. Benefits from the 
provisions include improved administration of the tax laws and 
a more accurate measurement of income for Federal income tax 
purposes.

                       C. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service 
Restructuring and Reform Act of 1998 (the ``IRS Reform Act'') 
requires the Joint Committee on Taxation (in consultation with 
the Internal Revenue Service and the Department of the 
Treasury) to provide a tax complexity analysis. The complexity 
analysis is required for all legislation reported by the Senate 
Committee on Finance, the House Committee on Ways and Means, or 
any committee of conference if the legislation includes a 
provision that directly or indirectly amends the Internal 
Revenue Code (the ``Code'') and has widespread applicability to 
individuals or small businesses.
    The staff of the Joint Committee on Taxation has determined 
that a complexity analysis is not required under section 
4022(b) of the IRS Reform Act because the bill contains no 
provisions that have ``widespread applicability'' to 
individuals or small businesses.

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

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

                                  
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