CRS Reports on Temporary Tax Provisions That Expired in 2003

Several temporary tax provisions expired in 2003. Often referred to as "extenders," these provisions were originally enacted with an expiration date that has subsequently been temporarily extended, in some cases numerous times. The extenders that expired included seven tax credits, which were the extension of personal tax credits allowed against the alternative minimum tax (AMT), the credit for electricity production from renewable sources, the Work Opportunity Tax Credit (WOTC), the Welfare-to-Work Tax Credit (WWTC), the New York WOTC, the credit for holders of qualified zone academy bonds, and the credit for first-time homebuyers in the District of Columbia. The expired tax provisions also included six deductions which were for the expenses of elementary and secondary school teachers, corporate contributions of computer technology, costs of remediation of "brownfields," contributions to Archer Medical Savings Accounts, capital investment in oil and gas produced from marginal wells, and policyholder dividends paid by mutual life insurance companies (Section 809). Other temporary tax provisions that expired included tax incentives for investment in the District of Columbia Enterprise Zone, an increased "cover over" of tax on distilled spirits from Puerto Rico and the U.S. Virgin Islands, and an excise tax to induce parity in the application of certain mental health benefits.

Several proposals were made to extend temporary tax provisions and were included in H.R. 6, H.R. 3521, H.R. 4520, S. 1637, and S. 1896. In late 2004, proposals to extend certain expiring provisions were included in the conference report, H.Rept. 108-696, to H.R. 1308, which was filed on September 23, 2004, and passed both the House and the Senate that same day. The provisions were retroactively extended when H.R. 1308 became law, P.L. 108-311, on October 4, 2004.

The temporary nature of extenders can be considered useful as it allows policymakers to evaluate the effectiveness of the provisions on a regular basis. If an extender is found to be ineffective, its scheduled expiration allows several policymaking options, including allowing the provision to expire or redesigning the provision to improve its use as a policy tool. However, policymakers have, for the most part, considered the extenders as a group during the enactment process, and have not reviewed the unique strengths and weaknesses of specific provisions. Treating permanent provisions as temporary masks their long-run budgetary cost and leads to uncertainty for taxpayers' planning.

This report discusses the nature of extenders, as temporary provisions and as tax benefits. Descriptions of the extenders that expired in 2003 are included. This report also includes summaries of the current proposals for extending the temporary tax provisions along with cost estimates for extension. It will be updated in the event of significant legislative developments. Descriptions of extenders that were scheduled to expire in 2004 are included in CRS Report RL32439 Temporary Tax Provisions ("Extenders") Expiring in 2004, by Pamela J. Jackson.

                            Contents

The extenders that expired included seven tax credits, two for individuals and five for businesses. They were extension of personal tax credits to the alternative minimum tax (AMT), the credit for electricity production from renewable sources, the Work Opportunity Tax Credit (WOTC), the Welfare-to-Work Tax Credit (WWTC), the New York WOTC, the credit for holders of qualified zone academy bonds, and the credit for first-time homebuyers in the District of Columbia.

The expired tax provisions also included six deductions, two for individuals and four for businesses. They were deductions for: expenses of elementary and secondary school teachers, corporate contributions of computer technology, costs of remediation of "brownfields," contributions to Archer Medical Savings Accounts, capital investment in oil and gas produced from marginal wells, and policyholder dividends paid by mutual life insurance companies (Section 809).

Other temporary tax provisions that expired in 2003 included tax incentives for investment in the District of Columbia Enterprise Zone, an increased "cover over" of tax on distilled spirits from Puerto Rico and the U.S. Virgin Islands, an excise tax to induce parity in the application of certain mental health benefits, and the interest rate used to determine additional required contributions to defined benefit pension plans.

This report does not include several well-known extenders that were scheduled to expire in 2004, such as the research and experimentation tax credit, increases in the personal exemption amount for the individual alternative minimum tax (AMT), and the allowance of net operating losses to offset 100% of alternative minimum taxable income. This report also does not include temporary provisions that began phasing out in 2003, such as the credit for electric vehicles and the deduction for clean fuel vehicles, which are often discussed as expiring extenders though they do not expire until 2006.

President Bush included many of the 2003 extenders in his FY2005 budget request, which was presented in February 2004. Of the 15 temporary provisions in S. 1896, 11 were also proposed in the Administration's FY2005 budget request. Of the 14 extenders in H.R. 3521, 11 were also proposed in the Administration's FY2005 budget request (these are not all the same 11 provisions as in the Senate bill).

The measures proposed in the Administration's FY2005 budget included extending alternative minimum tax (AMT) relief for individuals by allowing personal credits to offset the AMT, District of Columbia investment incentives, the research and experimentation tax credit, the Work Opportunity Tax Credit, and the Welfare-to-Work Tax Credit. While the President proposed that the research and experimentation tax credit be permanently extended, most of the other temporary provisions were proposed to be extended for two years. Also proposed was the combining the Welfare-to-Work Tax Credit with the Work Opportunity Tax Credit. Also, instead of extending the temporary suspension of Section 809 of the Internal Revenue Code, the President has proposed a repeal of this provision. Section 809 generally restricts the deduction of "policy holder dividends" paid by mutual life insurance companies (As described below, Section 809's restriction was permanently repealed by P.L. 108-218).

Late in the 108th Congress, proposals to extend certain expiring tax provisions were attached to major tax legislation proposed to replace the foreign sales corporation/extraterritorial income benefit (FSC/ETI). S. 1637, the Jumpstart Our Business Strength (JOBS) Act, was amended in March 2004 (an amendment, S.Amdt. 2687, to S.Amdt. 2686) to provide for the extension of certain expiring provisions. Originally introduced in September 2003, S. 1637 passed the Senate in May 2004. H.R. 4520, the American Jobs Creation Act of 2004, includes proposals to extend five temporary provisions expiring in 2004. Proposed on June 4, H.R. 4520 passed the House on June 17, 2004. In July 2004, S. 1637 was included as an amendment to H.R. 4520, which was then passed in the Senate.

Proposals similar to those made in S. 1637 to extend certain expiring provisions were included in the conference report, H.Rept. 108-696, to H.R. 1308, which was filed on September 23, 2004, and passed both the House and the Senate that same day. Certain expiring provisions became retroactively extended when H.R. 1308 was passed into law, P.L. 108-311, on October 4, 2004.

Tables 4, 5, and 6 at the end of this report provide details, generally, of the extension proposals made in the House and the Senate, and specifically, the details of the provisions extended when the conference report to H.R. 1308 became law.

The analysis of temporary tax provisions is complex, involving the examination of issues of policymaking and economics. Tax incentives are designed to alter the behavior of those who are the intended beneficiaries. Economic analysis provides a framework to examine the success of temporary tax provisions in achieving their intended outcomes.

It might also be argued that the temporary nature of the provisions is useful, quite apart from revenue considerations. The temporary nature of expiring provisions allows policymakers to evaluate their effectiveness and allow for reassessment of their value on a regular basis. In theory, extenders that fail to accomplish their purpose could be allowed to expire. Yet, only one extender, a corporate deduction for group legal services provided to employees, has been allowed to expire in the past 25 years. That provision expired in 1993. If a provision is thought to be ineffective, a policy alternative to allowing temporary provisions to expire is to redesign them. As an example, Congress replaced the Targeted Jobs Tax Credit, which was enacted in 1978, with the Work Opportunity Tax Credit in the Small Business Job Protection Act of 1996, P.L. 104-188. The temporary credit was initially effective for one year and then reauthorized by the Taxpayer Relief Act of 1997, P.L. 105-34, which also modified the credit by shortening the eligibility time, changing the subsidy rate, and adding a new group to the eligible population.

The extenders were not originally enacted at the same time. Many originated in one of the tax bills enacted during the late 1990s, and some in the mid 1980s. While their origins differ, the provisions have increasingly been considered as a group. Seven of the 17 extenders that expired in 2003 were most recently extended by the Job Creation and Worker Assistance Act of 2002 (P.L. 107-147). They were the credit for electricity production from renewable sources, the Work Opportunity Tax Credit (WOTC), the Welfare-to-Work Tax Credit (WWTC), the credit for holders of qualified zone academy bonds, the deduction for capital investment in oil and gas produced from marginal wells, the deduction for policyholder dividends paid by mutual life insurance companies (Section 809), and the "cover over" of tax on distilled spirits from Puerto Rico and the U.S. Virgin Islands. Of those seven provisions, six had been extended by the Tax Relief Extension Act of 1999 (TREA; P.L. 106-170).² Three of the six temporary provisions had been originally enacted by the Taxpayer Relief Act of 1997 (TRA; P.L. 105-34). The three provisions were the Welfare-to-Work Tax Credit (WWTC), the credit for holders of qualified zone academy bonds, and the deduction for capital investment in oil and gas produced from marginal wells.

Each extender is unique and addresses a separate topic in the tax code. Consideration of them as a group may ignore some of the strengths and weaknesses specific to individual provisions. Ideally, the purpose of each expiring provision should be clear, as well as the appropriateness of using the tax code to subsidize the targeted objective as opposed to a direct subsidy. Additionally, the benefits of the provisions should be examined to determine if they outweigh the costs of the provisions and to ensure that forgoing the tax revenue from the activity is justified relative to other policy goals.

Extenders, like all tax benefits, affect revenue estimating as well. Budget estimates are required to be made assuming current law proceeds uninterrupted. As a result, revenue projections are made assuming temporary tax provisions expire according to current law. Thus, if temporary provisions are frequently extended automatically, revenue projections may be inaccurate. An example that illustrates this point is when tax writers are looking for revenue offsets to balance tax cuts. Energy legislation, H.R. 6, has proposed several incentives for energy production. Some of the cost of those incentives is intended to be offset by a $10 billion increase in expected tax revenue for 2009 through 2014 from an ethanol tax credit set to expire in 2008. If this credit is then extended rather than allowed to expire, the revenue projections for those years is overstated.³

Treating permanent provisions as temporary also leads to uncertainty for government and taxpayer planning and causes, in some cases, significant impacts. When taxpayers are uncertain whether temporary provisions will be extended, they may have difficulty making reliable and effective business plans. An example of government uncertainty involves state employment agencies that certify the workers who qualify for the Work Opportunity Tax Credit and the Welfare-to-Work Tax Credit. If those credits are not extended, the state certification workers would need to be reassigned to other tasks. When the credits are reinstated, the states would have to reassign the workers a second time. Those workers would also face a backlog of pending certifications created during the lapse of the temporary provision.

Certain negative impacts from the expiration of the tax credit for electricity produced from renewable sources arose before the credit expired. In anticipation of the scheduled December 31, 2003 expiration date, worker layoffs began in early December. More than 100 employees in a West Fargo, North Dakota based manufacturer of wind turbines were laid off, with another 60 workers scheduled within the month.⁴ The impact of the lapse in the temporary provision extends beyond wind energy producers to their suppliers and vendors. One company that transports wind turbine blades, towers, and other wind energy generating equipment reported $1.5 million in revenue losses per month as a result of the lapse in the tax credit for wind energy production.⁵

Extenders as Tax Benefits

Temporary tax benefits are a form of federal subsidy that treats eligible activities favorably compared to others, and channels economic resources into qualified uses. Extenders influence how economic actors behave and how the economy's resources are employed. Like all tax benefits, economic theory suggests every extender can be evaluated by looking at the impact on economic efficiency, equity and simplicity. Temporary tax provisions may be efficient and effective in accomplishing their intended purpose, though not equitable. Alternatively, an extender may be equitable but not efficient. Policymakers may have to choose the economic objectives that matter most. Doing so on a case-by-case basis for extenders may prove to be the best option to achieve the desired results.

Efficiency. Extenders often provide subsidies to encourage more activity than would otherwise be undertaken. According to economic theory, in most cases an economy best satisfies the wants and needs of its participants if markets operate free from distortions by taxes and other factors. Market failures, however, may occur in some instances, and economic efficiency may actually be improved by tax distortions.⁶ Thus, the ability of extenders to improve economic welfare depends on whether or not the extender is remedying a market failure. But according to theory, an extender lowers efficiency if it distorts behavior in the absence of a market failure.

If an extender addresses a market failure and thus improves economic efficiency, the effectiveness of extenders can also be determined by examining their success in causing the intended response, or degree of response, by recipients of the tax incentive. Tax provisions can be an effective way to achieve program goals when they provide benefits to the intended entities or induce desirable activities. An extender may not be effective if it subsidizes activities that would have been undertaken in the absence of the tax incentive or if the activities undertaken are not the intended activities targeted by the tax incentive.

An extender is also considered effective to the degree that it stimulates the desired activity better than a direct subsidy. Direct spending programs are often more successful at targeting resources than indirect subsidies made through the tax system.

Fairness. A tax is considered to be fair when it contributes to a socially desirable distribution of the tax burden. Tax benefits such as the extenders can result in individuals with similar incomes and expenses paying differing amounts of tax, depending on whether they engage in tax subsidized activities. This differential treatment is a deviation from the standard of horizontal equity, which requires that people in equal positions should be treated equally.

Another component of fairness in taxation is vertical equity, which requires that tax burdens be distributed fairly among people with different abilities to pay. Most extenders benefit those who have sufficient income to pay tax. Those individuals without sufficient income to pay tax do not have the opportunity to benefit from extenders. The disproportionate benefit of tax expenditures to individuals with higher incomes reduces the progressivity of the tax system, which is often viewed as a reduction in equity.

An example of the effect a tax benefit can have on vertical equity violation can be seen by identifying two individual teachers who have both incurred $250 in classroom-related expenses and are eligible to take an above-the-line deduction. Yet the tax benefit to the two differs if they are in different tax brackets. A teacher with lower income, who may be in the 15% income tax bracket, receives a deduction with a value of $37.50, while another teacher, in the 31% bracket, receives a deduction value of $77.50. Thus, the higher income taxpayer, with presumably greater ability to pay taxes, receives a greater benefit than the lower income taxpayer.

Simplicity. Extenders contribute to the complexity of the tax code and raise the cost of administering the tax system. Those costs, which can be difficult to isolate and measure, are rarely included in the cost-benefit analysis of temporary tax provisions. The complexity of the tax code adds to the time cost of taxpayers in either learning how to claim various incentives and doing so, or an increased direct cost of paying tax professionals to perform the service for the taxpayer.

In October 2004, six of the seven tax credits were retroactively extended through December 31, 2005 by the Working Families Tax Relief Act of 2004, P.L. 108-311. The New York WOTC was not extended.

                  Table 1. Expired Tax Credits

Generally, individuals may claim certain nonrefundable personal tax credits only to the extent that their regular income tax liability, without reduction for credits, exceeds their tentative alternative minimum tax (AMT) liability. The Tax Relief Extension Act of 1999 (P.L. 106-170) amended the Internal Revenue Code by adding Section 26(a)(2) which allowed individuals to offset their entire regular tax liability and alternative minimum tax liability by personal nonrefundable credits for tax years beginning in 2000 and 2001. This change was accomplished by limiting the amount of nonrefundable credits to the sum of the taxpayer's regular tax liability, less any allowable foreign tax credit, plus the amount of AMT liability. Personal nonrefundable credits include the: dependent care credit, credit for the elderly and disabled, adoption credit, child tax credit, credit for interest on certain home mortgages, Hope Scholarship and Lifetime Learning credits, IRA credit, and District of Columbia Homebuyers credit.

Section 26 of the Internal Revenue Code was later amended by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) which allowed the use of the adoption, child and IRA credits to the full extent of the taxpayer's regular tax and AMT through December 31, 2010. EGTRRA did not address the other personal credits.

The Job Creation and Worker Assistance Act of 2002 (JCWAA; P.L. 107-147), allowed individuals, for 2002 and 2003, to offset their entire regular tax liability and AMT liability by the personal nonrefundable credits not included in the EGTRRA enactment. In addition to the dependent care credit, credit for the elderly and disabled, credit for interest on certain home mortgages, Hope Scholarship and Lifetime Learning credits, and District of Columbia Homebuyers credit, the JCWAA added the savers' credit for retirement account contributions.

Credit for Electricity Production from Renewable Sources

An income tax credit is temporarily allowed for the production of electricity from either qualified wind energy, qualified "closed- loop" biomass, or qualified poultry waste facilities as described in section 45(c)(3) of the Internal Revenue Code. The credit applies to electricity produced from wind energy facilities placed in service between December 31, 1993 and December 31, 2005; biomass facilities placed in service between January 1, 1993 and December 31, 2005; and poultry waste facilities placed in service between December 31, 1999 and January 1, 2006. The credit was allowable for production during the 10-year period after a facility was originally placed in service. The taxpayer must own the facility and sell the electricity produced by the facility to an unrelated third party in order to qualify for the credit. The tax credit was a 1.5-cent per kilowatt credit in 1992 dollars (adjusted for inflation) and was phased out as the average annual contract price of electricity rose over a 3-cent range, from 8-cents to 11-cents per kilowatt.⁷

Closed-loop biomass is plant matter, where plants are grown for the sole purpose of being used to generate electricity. Poultry waste includes poultry manure and litter, including wood shavings, straw, rice hulls and other bedding material for the disposition of manure.

The energy credits were first established in the Energy Policy Act of 1992 (P.L. 102-486), extended by the Tax Relief Extension Act of 1999 (P.L. 106-170), the JCWAA in 2002, and the Working Families Tax Relief Act (P.L. 108-311) in 2004. Their purpose was to encourage the development and utilization of electric-generating technologies using specified renewable energy resources as opposed to conventional fossil fuels.

For more detailed information see CRS Report RL32265, Expired and Expiring Energy Tax Incentives, by Salvatore Lazzari.

Employment Tax Credits

Several temporary tax credits were enacted to lower the relative cost of hiring targeted group members by subsidizing their wages, increasing employers' willingness to hire them despite their presumed lower productivity. Current law provides several separate credits, but they are the statutory descendent of a single provision -- the Targeted Jobs Tax Credit -- that was first enacted in 1978. While the credits targeted similarly situated populations, their benefits to employers differed slightly.

Work Opportunity Tax Credit (WOTC). This credit is available for wages paid by employers who hired individuals from certain targeted groups. The WOTC was taken for first-year wages paid to eligible individuals who begin work after September 30, 1996, and before January 1, 2006. The credit amounts to 40% of the first $6,000 of wages (or the first $3,000 of wages for qualified summer youth employees) paid to each targeted group member during the first year of employment, and 25% in the case of wages attributable to individuals meeting only minimum employment levels. An employee must have completed a minimum of 120 hours of service for the wages to be taken into account for calculation of the credit. Individuals who fit into one of the following target groups qualify for the WOTC: qualified IV-A or Temporary Assistance to Needy Families (TANF) recipients, qualified veterans, qualified ex-felons, high risk youth residing in an empowerment zone, enterprise community, or renewal community, vocational rehabilitation referral, qualified summer youth employees, qualified food stamp recipients, or qualified Supplemental Security Income recipients.

Welfare-to-Work Tax Credit (WWTC). This nonrefundable credit is available to private sector, for-profit employers who hire long-term recipients of TANF benefits. During the first year in which WWTC-eligible persons were hired, employers can claim an income tax credit of 35% of the first $10,000 earned by the employee. The employer can claim an income tax credit of 50% of the first $10,000 in earnings during the second year of their employment. In addition to gross wages, certain tax-exempt amounts received under accident and health plans, as well as under educational or dependent assistance programs, qualify for this subsidy rate. The maximum amount of the credit an employer can claim is $3,500 per worker in the first year of employment and $5,000 per worker in the second year of employment. An employer's usual deduction for wages has to be reduced by the amount of the credit and the credit could not exceed 90% of an employer's annual tax liability. Employers cannot claim the WOTC and WWTC for the same individuals.

The eligible group is defined as members of a family that received benefits for at least 18 consecutive months ending on the hiring date, members of a family that received benefits for a total of 18 (not necessarily consecutive) months beginning after August 5, 1997 (the date of the credit's enactment), members of a family that was no longer eligible for assistance after August 5, 1997, because of any federal- or state-imposed time limit (if they were hired within two years after the date the benefit ceases).

For more detailed information on both the Work Opportunity Tax Credit and the Welfare-to-Work Credit, see CRS Report RL30089, Employment Tax Credits Expiring During the 108th Congress, by Linda Levine.

The New York Liberty Zone Work Opportunity Tax Credit. The Job Creation and Worker Assistance Act of 2002 (P.L. 107-147) created a new group of targeted individuals whose wages will qualify for the WOTC. These individuals are employees, both new hires and existing employees, of businesses either located in the newly created New York Liberty Zone or forced to relocate due to destruction or damage of their place of business because of the terrorist attacks of September 11, 2001. The New York Work Opportunity Tax Credit was 40% of first $6,000 of wages earned.⁸

Tax Credit for Holders of Qualified Zone Academy Bonds

Qualified Zone Academy Bonds (QZAB), which were first introduced as part of the Taxpayer Relief Act of 1997 (P.L. 105-34), are a type of bond that offers the holder a nonrefundable federal tax credit instead of interest. Qualified zone academies are public schools and programs that provide education and training below the post-secondary level. Issuers of QZABs are required to use the proceeds to finance public school partnership programs in economically distressed areas. QZAB holders are limited to banks, insurance companies, and corporations actively engaged in the business of lending money.

Initially, state and local governments could issue QZABs only in 1998 and 1999, subject to a national limitation of $400 million each year. The Ticket to Work and Work Incentives Improvement Act of 1999, P.L. 106-170, extended this provision, authorizing up to $400 million of QZABs to be issued in each of 2000 and 2001, with any unused authority carried over for several years. The Job Creation and Worker Assistance Act of 2002, (P.L. 107-47), extended the QZAB program with an additional $400 million of bond capacity available for 2002 and 2003. The Working Families Tax Relief Act of 2004 (P.L. 108-311) authorized an additional extension through December 31, 2005.

For more detailed information, see CRS Report RS20606, Qualified Zone Academy Bonds: A Brief Explanation, by Steven Maguire.

Tax Credit for First-Time Homebuyers in the District of Columbia

This credit allows a nonrefundable credit against federal taxes of up to $5,000 for the first-time purchase of a principal residence in the District of Columbia. The credit is available only once for homebuyers who acquire title to a qualifying principal residence after August 1997 and before December 31, 2005. The tax credit was created by the Taxpayer Relief Act of 1997 (P.L. 105-34) to provide an incentive to purchase a home in DC, thus increasing the rate of owner-occupied home ownership. Compared to neighboring Maryland (70.7%) and Virginia (75.1%), the District of Columbia's home ownership rate is significantly lower (42.7%).⁹

Expired Temporary Tax Deductions

The 2003 expired tax provisions also included six deductions, two for individuals and four for corporations. They were deductions for: expenses of elementary and secondary school teachers, corporate contributions of computer technology, costs of remediation of "brownfields," contributions to Archer Medical Savings Accounts, capital investment in oil and gas produced from marginal wells, and policyholder dividends paid by mutual life insurance companies (Section 809).

In October 2004, five of the six tax deductions were retroactively extended through December 31, 2005 by the Working Families Tax Relief Act of 2004, P.L. 108-311. The Section 809 provision was not included because it had already been repealed by the Pension Funding Equity Act of 2004, P.L. 108-218, which was enacted April 10, 2004.

An above-the-line deduction (i.e., a deduction for non- itemizers) for certain classroom expenses paid or incurred during the school year by eligible elementary and secondary school (K-12) teachers, among other educators, was authorized in the Job Creation and Worker Assistance Act of 2002. The provision, effective for taxable years beginning after December 31, 2001, and before January 1, 2006, allows for up to $250 annually of expenses paid or incurred for books, supplies, computer equipment, and supplementary materials to be deducted. Under previously expired law, teachers were allowed to deduct these expenses only when itemizing on the tax return and (as with other deductions) only if the total of all itemized deductions exceeded 2% of adjusted gross income.¹⁰

Enhanced Deduction for Corporate Charitable Contributions of Computer Technology

Section 170(e)(6) of the Internal Revenue Code allows for an enhanced deduction for corporate contributions of computer equipment to public libraries and elementary and secondary schools. Generally, tax law allows for certain contributions of inventory or other ordinary-income property, and short-term capital gain property to be made by C (ordinary) corporations (S corporations, which are taxed as partnerships, are not eligible). In the case of charitable contributions, the amount of the deduction is limited to the taxpayer's basis (original investment) in the property. Special rules provide enhanced deductions for certain corporate contributions of inventory property for the care of the ill, the needy or infants and certain contributions of scientific equipment. Under these special rules, the amount of the enhanced deduction is equal to the donor's basis in the donated property plus one-half of the amount of ordinary income that would have been realized if the property had been sold.

Congress extended this special rule to provide an incentive for businesses to donate their computer equipment for the benefit of primary and secondary school students. Computer equipment includes computer software, computer or peripheral equipment, and fiber optic cable related to computer use. In addition to the augmented deduction benefit, the donor, by not selling the property, avoids realizing any capital gains and the subsequent income tax on those gains.

Originally authorized by the Taxpayer Relief Act of 1997 (P.L. 105-34), the provision was then extended for three years by the Community Renewal Tax Relief Act of 2000 (CRTRA; P.L. 106-554). CRTRA also expanded the deduction to include property donated to public libraries, property donated no later than three years (instead of two) after the date of taxpayer acquisition, and property donated after reacquisition by computer manufacturers. The most recent extension, through December 31, 2005, was authorized by the Working Families Tax Relief Act of 2004 (P.L. 108-311).

Expensing of "Brownfields" Environmental Remediation Costs

Section 198 of the Internal Revenue Code was created by the Taxpayer Relief Act of 1997, P.L. 104-34, to allow firms that undertake certain expenditures to deduct those costs against income in the year incurred. The allowable expenditures were those made to control or abate hazardous substances in a qualified contaminated business property. These expenditures would have otherwise been allocated to a capital account and could have been deducted only at some later point -- for example, when the land was sold.

Expensing, or deducting against income, provides a tax subsidy for capital invested by business. By expensing hazardous control and abatement costs rather than capitalizing those costs, taxes on the income generated by the expenditures were effectively zero. This provision provides a financial incentive to businesses and encouraged them to invest in the clean up and redevelopment of "brownfields," which are abandoned industrial sites and dumps that would be cleaned up and redeveloped except for the prohibitive costs and complexities of environmental contamination.¹¹

The provision, which has been extended three times, by the Tax Relief Extension Act of 1999, P.L. 106-170; the Community Renewal Tax Relief Act of 2000, P.L. 106-554; and the Working Families Tax Relief Act of 2004, P.L. 108-311; require eligible expenditures be incurred before January 1, 2006.

Contributions to Archer Medical Savings Accounts

Archer Medical Savings Accounts (MSAs) are tax-advantaged personal savings accounts used for unreimbursed medical expenses. MSAs were first authorized by the Health Insurance Portability and Accountability Act of 1996 (HIPPA; P.L. 104-91). Individuals' contributions are deductible from gross income up to an annual limit of 65% of the insurance deductible or earned income, whichever is less. Earnings on account balances are not taxed. These accounts are designed to encourage individuals to purchase high-deductible health insurance and to maintain a reserve for routine and other unreimbursed health care expenses. Contributions are allowed only if individuals are covered by a high-deductible health plan and no other insurance.

Archer MSAs were initially introduced as Medical Savings Accounts (MSAs) and later renamed by the Community Renewal Tax Relief Act of 2000, P.L. 106-554. MSAs were intended to slow the growth of health care costs, which had, at that time, exceeded the general rate of inflation for many years. By creating these accounts and giving consumers a larger financial stake in purchasing health care, policy makers were attempting to reduce third-party payments which were perceived to lower the effective price of health care to individuals and lead to excessive use. Highdeductible insurance, by requiring consumers to assume more of the initial costs incurred each year, might have encouraged more prudent choices.

Archer MSAs have not attracted many participants. The number of existing Archer MSAs has never come close to the limit of 750,000 accounts. In October 2002, the IRS estimated that there would be 78,913 Archer MSA returns filed for tax year 2001; it also determined that 20,592 taxpayers newly established Archer MSA accounts in 2002. This low participation rate may have been influenced by several factors. Archer MSAs may not have appealed to certain categories of individuals. Those with chronic illnesses were more likely to desire low-deductible health plans that would have been ineligible for the program. Low-income individuals, being unwilling to incur high out-of-pocket costs, may have chosen low-deductible health plans. Additionally, individuals with other health plan options through their employer or community would not be eligible to participate.

After 2002, no new contributions were to be made to Archer MSAs, except by or on behalf of individuals who previously made Archer MSA contributions, by employees of small employers, and by self-employed individuals with prior Archer MSA participation. Thus, taxpayers who participated in the programs could continue, but no new accounts could be opened. The Job Creation and Worker Assistance Act of 2002, P.L. 107-147, extended this provision for an additional year through December 31, 2003. The most recent extension, through December 31, 2005, was authorized by the Working Families Tax Relief Act of 2004 (P.L. 108- 311).

For more detailed information, see CRS Report RS21573, Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison by Bob Lyke and Chris Peterson.

Special Rules for Deduction for Oil and Gas from Marginal Wells

Firms that extract oil and gas were permitted an income tax deduction to recover their capital investment. That income tax deduction was determined using a method of percentage depletion, which was based on a fixed percentage of gross income. Among the limitations that apply in calculating percentage depletion deductions is a restriction that the amount deducted may not exceed 100% of the net income from oil and gas properties in any one year. Special percentage depletion rules applied to oil and gas production from marginal properties. One special rule, section 613A(c)(6) of the Internal Revenue Code, suspended the 100% of net income limitation as applied to domestic oil and gas production from marginal properties.

This tax incentive, designed to be a production subsidy, was criticized by some observers as inefficient. As a subsidy, the incentive was intended to increase investment exploration and output. In the short-run, it may have some impact on reducing dependence on imported oil. In the long-run, critics maintain that the provision may have contributed to a faster depletion of resources by encouraging swift development of existing properties.

Initially enacted by the Taxpayer Relief Act of 1997, P.L. 104-34, the 100% taxable income limitation suspension has been extended three times, by the Ticket to Work and Work Incentives Improvement Act of 1999, P.L. 106-170; by the Job Creation and Worker Assistance Act of 2002. The most recent extension, through December 31, 2005, was authorized by the Working Families Tax Relief Act of 2004 (P.L. 108-311).

For more detailed information see CRS Report RL32265, Expired and Expiring Energy Tax Incentives, by Salvatore Lazzari.

Special Rules for the Taxation of Mutual Life Insurance Companies

Ordinarily, a mutual life insurance company can deduct policyholder dividends distributed to policyholders. Stock insurance companies are not permitted to deduct dividends. In the case of mutual life insurance companies, the deduction for policyholder dividends must be reduced according to rules provided in Section 809 of the tax code. That reduction is made by using a so-called differential earnings amount, which is computed by multiplying a life insurance company's average equity base for the tax year by its differential earnings rate for that tax year. The purpose of the rule was to provide more even treatment of mutual and stock life insurance companies. Section 809(j) of the Internal Revenue Code enacted a zero differential earnings rate for tax years beginning in 2001, 2002, or 2003, thus effectively permitting a full deduction. Enacted by the Job Creation and Worker Assistance Act of 2002, P.L. 107-147, the zero differential earnings rate essentially eliminated the reduction in the deduction of policyholder dividends for mutual life insurance companies.

Permanent repeal of Section 809 was included in H.R. 3108, The Pension Funding Equity Act of 2004, which became law, P.L. 108-218 on April 10, 2004. The permanent repeal would be effective after December 31, 2004.

For more detailed information about the repeal of Section 809 and broader insurance company taxation issues, see CRS Report RL32180, Taxation of Life Insurance Companies, by Andrew D. Pike.

Other Expired Temporary Tax Provisions

Other temporary tax provisions that expired in 2003 included tax incentives for investment in the District of Columbia Enterprise Zone, an increased "cover over" of tax on distilled spirits from Puerto Rico and the U.S. Virgin Islands, an excise tax to induce parity in the application of certain mental health benefits, and interest rate provisions used to determine additional required contributions to defined benefit pension plans.

In April 2004, one of the temporary provisions was extended through December 31, 2005 by the Pension Funding Equity Act of 2004, P.L. 108-218; and in October 2004, the three remaining provisions were retroactively extended through December 31, 2005 by the Working Families Tax Relief Act of 2004, P.L. 108-311.

The Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code impose minimum and maximum funding requirements for any defined benefit pension plans that are not multi-employer plans. Plans are considered underfunded if the value of the plan assets is less than 90% of the plan's current liability. A plan's current liability includes all liabilities to employees and their beneficiaries under the plan.

The interest rate used to determine a plan's current liability must be within a permissible range (90% - 105%) of the weighted average of the interest rates on 30-year Treasury securities for the four year period ending on the last day before the plan year begins. As a result of the Job Creation and Worker Assistance Act of 2002 (P.L. 107-147), section 412(l)(7)(C)(i)(III) of the Internal Revenue Code expanded the permissible range of that statutory interest rate to 90%-120% for plan years beginning after December 31, 2001 and before January 1, 2004.

H.R. 3108, the Pension Funding Equity Act, was introduced to amend the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code to temporarily replace, for plan years 2004 and 2005, the 30-year Treasury rate with a rate of 5.5% based on long-term corporate bonds to be used in calculating defined benefit pension plan funding requirements. Additionally, H.R. 3108 sets the maximum permissible interest rate at 100% (down from 120%) of the weighted average of conservatively invested long-term corporate bond rates during the four-year period ending on the last day before the beginning of the plan year.¹²

Introduced in September 2003, H.R. 3108 passed the House in October and the Senate in January 2004. Conferees for H.R. 3108 were appointed the week of March 1; their report, H.Rept. 108-457, was filed on April 1, 2004, and approved by the House on April 2. After approval in the Senate on April 8, the measure was signed into law, P.L. 108-218, on April 10.

The declining value of the 30-year Treasury bond interest rate caused a significant increase in the amount corporations were required to contribute to their employee pension funds. The pension relief enacted by H.R. 3108 replaces the 30-year rate with a composite corporate bond rate for calculating pension funding requirements for 2004 and 2005. The Joint Committee on Taxation released cost estimates of the conference agreement, estimating that the interest rate replacement would postpone about $96 billion in corporate contributions to pension plans in 2004 and 2005. This reduction in pension contributions, which corporations can deduct from their income taxes, would add $9 billion in revenue for the federal government.

Tax Incentives for the District of Columbia Enterprise Zone

The District of Columbia (DC) Enterprise Zone includes the DC Enterprise Community and the census tracts in the District of Columbia with a poverty rate of at least 20%. Businesses in the DC Zone are eligible for the following tax benefits: 1) a wage credit equal to 20% of the first $15,000 in annual wages paid to qualified employees who resided within the District of Columbia; 2) $35,000 in increased section 179 expensing; and 3) in certain circumstances, tax-exempt bond financing. Additionally, a capital gains exclusion is allowed for certain investments in small business stock held more than five years and made within the DC Zone, or within any District of Columbia census tract with a poverty rate of at least 10%.¹³ The DC Zone incentives, created in the Taxpayer Relief Act of 1997 (P.L. 105-34), were applicable from January 1, 1998 through December 31, 2003 and then extended through December 31, 2005.

"Cover Over" of Tax on Distilled Spirits to Puerto Rico and the U.S. Virgin Islands

In general, federal excise taxes do not apply to items produced and consumed in Puerto Rico, the U.S. Virgin Islands (USVI), and other U.S. possessions. However, so that goods produced in the possessions do not have a tax-induced price advantage in U.S. markets over goods produced in the mainland, an "equalization tax" is levied on goods imported into the United States from Puerto Rico or the USVI. The tax is equal to the excise tax that applies to like items of domestic manufacture. That tax is then rebated or "covered over" to the Puerto Rico and USVI. The amounts covered over to Puerto Rico and the USVI are deposited into the treasuries of the two possessions for use as those possessions determine. The provision was granted because Congress believed that rebating the increased rate of tax would contribute to the economic stability of Puerto Rico and the USVI.¹⁴

In 1984, the Deficit Reduction Act, P.L. 98-369, increased excise taxes on U.S. distilled spirits to $12.50 from $10.50 per proof gallon; subsequent legislation increased the rate to $13.50. However, the 1984 Act also amended the Internal Revenue Code, section 7652, by adding subsection (f) which initially imposed a $10.50 limitation on "cover over" of the tax on distilled spirits. In 1993, the Omnibus Reconciliation Act, P.L. 103-66, extended the limitation such that the cover over amount was increased to $11.30 per gallon effective for the five-year period beginning October 1, 1993. The Tax Relief Extension Act of 1999, P.L. 106-170, extended the amendment for an additional two years, increasing the rate to $13.25 and the Job Creation and Worker Assistance Act of 2002, P.L. 107-147, provided a second extension effective through December 31, 2003. A third extension was authorized by the Working Families Tax Relief Act of 2004, P.L. 108-311, which makes the provision effective through December 31, 2005.

Parity in the Application of Certain Mental Health Benefits

The Taxpayer Relief Act of 1997 (P.L. 105-34) imposed an excise tax on group health plans that fail to meet the requirements of the Mental Health Parity Act of 1996 (Title VII of P.L. 104-204). The Mental Health Parity Act requires group health plans that provide both medical and surgical benefits and mental health benefits cannot impose aggregate lifetime or annual dollar limits on mental health benefits that are not also imposed on substantially all medical and surgical benefits.

The excise tax is equal to $100 per day during the period of noncompliance and is imposed on the employer sponsoring the plan if the plan fails to meet the requirements. The maximum tax that can be imposed during a taxable year cannot exceed the lesser of 10% of the employer's group health plan expenses for the prior year or $500,000.

The excise tax was applicable to plan years beginning on or after January 1, 1998 and expired with respect to those benefits for services provided on or after September 30, 2001. The FY2002 appropriation for the Departments of Labor, Health and Human Services, and Education (P.L. 107-116, section 701), enacted on January 10, 2002, retroactively restored the excise tax to September 30, 2001 and effective through December 31, 2002. The excise tax was extended by the Job Creation and Worker Assistance Act of 2002 through December 31, 2003 and by the Working Families Tax Relief Act of 2004 through December 31, 2005.

The Mental Health Parity Reauthorization of 2003, P.L. 108-197, was introduced (S. 1929) and passed in the Senate in November 2003. After being passed in the House on December 8, 2003 the bill was signed into law on December 19, 2003. The legislation extends the mental health parity provisions through 2004 but does not address the extension of the Internal Revenue Code containing the excise tax penalty provision.

² The Section 809 provision was the seventh extender not included in the TREA.

³ Martin Vaughan, "GOP Support Unclear for Thomas Tax Bill," Congress Daily, AM Edition, [http://nationaljournal.com/pubs/congressdaily/], visited March 4, 2004.

⁴ Katherine Stimmel, "Anticipated Lapse of Tax Measures Could Have Large Impact on Some," Daily Tax Report, [http://www.bnasoftware.com/knowledgecenter/dtr/article.aspx?id=84], visited Dec. 8, 2003.

⁵ Ibid.

⁶ Market failure occurs when the marginal benefit of an action does not equal the marginal cost. For example, polluting forms of energy production cause social costs that are not taken into account by the producer; hence, there is an argument for taxing this type of energy or, alternatively, subsidizing less polluting firms.

⁷ For more details about the credit and past legislation, see U.S. Congress, Senate Committee on the Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, committee print prepared by the Congressional Research Service, Library of Congress, 107th Cong., 2nd sess., S. Prt. 107-80 (Washington: GPO, 2002), pp. 101-103.

⁸ For more details about the credit, see U.S. Congress, Senate Committee on the Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, committee print prepared by the Congressional Research Service, Library of Congress, 107th Cong., 2nd sess., S. Prt. 107-80 (Washington: GPO, 2002), pp. 313-315.

⁹ U.S. Congress, Senate Committee on the Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, committee print prepared by the Congressional Research Service, Library of Congress, 107th Cong., 2nd sess., S. Prt. 107-80 (Washington: GPO, 2002), pp. 213-215.

¹⁰ For more detailed information see CRS Report RS21682, The Tax Deduction for Classroom Expenses of Elementary and Secondary School Teachers by Linda Levine.

¹¹ For more details, see U.S. Congress, Senate Committee on the Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, committee print prepared by the Congressional Research Service, Library of Congress, 107th Cong., 2nd sess., S. Prt. 107-80 (Washington: GPO, 2002), pp. 325-327.

¹² See CRS Report RS21717, H.R. 3108: The Pension Stability Act, by Patrick Purcell for more detailed information.

¹³ For more details, see U.S. Congress, Senate Committee on the Budget, Tax Expenditures: Compendium of Background Material on Individual Provisions, committee print prepared by the Congressional Research Service, Library of Congress, 107th Cong., 2nd sess., S. Prt. 107-80 (Washington: GPO, 2002), pp. 317-320.

¹⁴ U.S. House Committee Report to H.R. 3090, H.Rept. 107-251, Oct. 17, 2001.