Joint Committee Report JCS-71-81: General Explanation of the Economic Recovery Tax Act of 1981
DEC. 29, 1981
JCS-71-81
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Citations: JCS-71-81
The following is a brief summary of the principal provisions of P.L. 97-34, the Economic Recovery Tax Act of 1981 (the "Act").
Individual Income Tax Provisions
Individual Tax Rates
The Act provides cumulative across-the-board reductions in individual income tax rates of 1-1/4 percent in 1981, 10 percent in 1982, 19 percent in 1983, and 23 percent in 1984 and subsequent years. These tax reductions will be reflected in reductions in withholding on October 1, 1981, July 1, 1982, and July 1, 1983.
The top marginal tax rate is reduced from 70 percent to 50 percent beginning January 1, 1982. The maximum tax rate on long-term capital gains is reduced to 20 percent for sales or exchanges after June 9, 1981.
Indexing
The Act adjusts the income tax brackets, zero bracket amount, and personal exemption for increases in the consumer price index, starting in 1985. The first adjustment, for 1985 tax returns, will be based on price increases between fiscal year 1983 and fiscal year 1984.
Deduction for Two-Earner Married Couples
The Act allows a two-earner married couple filing a joint return a new deduction in computing adjusted gross income. This deduction equals a percentage of the first $30,000 of qualified income earned by whichever spouse has the lower amount of earnings. In 1982, the percentage will be five percent ($1,500 maximum deduction). In 1983 and subsequent years, the percentage will be ten percent ($3,000 maximum deduction).
Child Care Credit, Exclusion
The Act increases the maximum amount of employment-related expenditures eligible for the child care tax credit from $2,000 to $2,400 for taxpayers with one dependent and from $4,000 to $4,800 for taxpayers with two or more dependents. In addition, the Act increases the rate of the child care credit from 20 percent to 30 percent for taxpayers with incomes of $10,000 or less. The rate of the credit is reduced by one percentage point for each $2,000 of income, or fraction thereof, above $10,000 until the lowest rate (20 percent) is reached for taxpayers with incomes above $28,000.
Also, the Act generally excludes from an employee's gross income amounts paid by an employer for dependent care assistance provided pursuant to a qualified program.
Charitable Contributions Deduction for Nonitemizers
The Act provides a deduction for charitable contributions for individual taxpayers who do not itemize personal deductions.
For 1982 and 1983, the deduction is limited to 25 percent of the first $100 of contributions, or a maximum deduction of $25. For first $100 of contributions, or a maximum deduction of $25. For 1984, the contribution cap is raised to $300, or a maximum deduction of $75. (In the case of a married individual filing a separate return, the deduction limitation is one-half of the amounts just stated.) For 1985, the deduction is allowed for 50 percent of contributions, with no cap, and for 1986 the deduction is allowed for 100 percent of contributions. This provision expires after 1986.
Deduction for Adoption Expenses
The Act provides a new itemized deduction, beginning in 1981, for up to $1,500 of expenses incurred in connection with the adoption of a child who has special needs which make him or her hard to place for adoption.
Gain on Sale of Residence
The Act extends from 18 months to two years the replacement period during which taxpayers must reinvest the proceeds from the sale of their principal residence in a new principal residence in order to be eligible for rollover nonrecognition treatment on gain from that sale. Also, the Act increases from $100,000 to $125,000 the maximum amount of capital gain on the sale of a principal residence which is excludable from gross income by a taxpayer age 55 or over.
Foreign Earned Income
The Act replaces the present system of deductions and exclusions for excess costs of living abroad with an exclusion of income earned abroad. The maximum amount excludable from income will be $75,000 in 1982, increasing in $5,000 increments to the permanent level of $95,000 in 1986 and thereafter. In addition, there is an exclusion for excess housing costs.
Capital Cost Recovery Provisions
The Act replaces the prior law depreciation system with the Accelerated Cost Recovery System for most tangible property placed in service after December 31, 1980.
Machinery and Equipment
For tangible personal property (principally, machinery and equipment), assets are grouped into four classes with recovery periods of 3, 5, 10, and 15 years. The 3-year class consists of autos, light duty trucks, equipment used in research and experimentation, other short-lived property, certain racehorses over two years old, and certain other horses over 12 years old. The 5-year class includes most other equipment, except long-lived public utility property. The 10-year class includes public utility property with a midpoint life under the prior asset depreciation range system ("ADR") between 18 and 25 years, railroad tank cars, certain theme park structures, certain mobile homes, and utility coal-burning equipment used to replace or convert oil-fired and gas-fired combustors and boilers. The 15-year class includes public utility property with an ADR midpoint life above 25 years.
Under the Act, statutory schedules of capital cost recovery deductions are provided for each class of recovery property. For each class, one schedule is provided for property placed in service in the years 1981 through 1984. A more accelerated schedule is provided for each class for property placed in service in 1985. For property placed in service after 1985, the schedule for each class is accelerated to a greater extent.
The investment tax credit will be six percent for property in the 3-year class and ten percent for all other eligible property.
Real Property
Real property will be written off over a 15-year period using a prescribed schedule of capital cost recovery deductions. A schedule is provided for low-income housing that is more accelerated than the schedule for other real property. If a taxpayer sells nonresidential real property for which the accelerated method has been used, gain will be treated as ordinary income to the extent of all recovery deductions previously taken. If a taxpayer sells residential real property for which the accelerated method has been used, ordinary income recapture will be limited to the excess of the accelerated over straight-line cost recovery. If a taxpayer uses straight-line recovery, all gain will be treated as capital gain.
Other Provisions
Businesses may elect to expense up to $5,000 of personal property for taxable years beginning in 1982 and 1983, $7,500 in 1984 and 1985, and $10,000 thereafter. The Act repeals the provision of prior law for additional first-year depreciation, effective for property placed in service after 1980.
The Act raises the amount of used property eligible for the investment credit from $100,000 to $125,000 for taxable years beginning in 1981 through 1984, and to $150,000 for 1985 and subsequent years.
The Act provides a safe harbor rule under which a nominal lessor will be treated as the owner of the property for Federal income tax purposes and thus entitled to the associated cost recovery allowances and investment credits, even if the lessee is the State-law owner of the property.
The Act limits the amount of property eligible for the investment credit to the extent to which the taxpayer is "at risk," that is, has invested the taxpayer's own money or is personally liable for loans. There are, however, exceptions to these rules for nonrecourse loans from financial institutions and other business lenders and for certain energy property.
The Act extends the carryover period for unused net operating losses and investment tax credits from seven to 15 years.
Rehabilitation Expenditures
Three-Tier Investment Credit
The Act replaces the present ten-percent investment credit for expenditures to rehabilitate nonresidential structures, and the amortization and rapid depreciation provisions for certain rehabilitations of certified historic structures, with a three-tier system of investment credits. Under the Act, the credit is 15 percent for rehabilitation of nonresidential buildings 30 to 39 years old, 20 percent for rehabilitation of nonresidential buildings over 39 years old, and 25 percent for certified rehabilitation of certified historic structures. (No credit is allowed for a noncertified rehabilitation of a certified historic structure.) In the case of expenditures to which the 15-percent and 20-percent credits apply, the basis for determining cost recovery deductions is reduced by the amount of the credit. The rehabilitation provisions of the Act generally apply to expenditures incurred after December 31, 1981.
Demolition of Certified Historic Structures
The Act repeals the requirement that taxpayers who demolish or substantially alter certified historic structures must use the straight-line method of depreciation.
Incentives for Research
Tax Credit for Incremental Research Expenditures
The Act provides a 25-percent income tax credit for certain qualified research expenditures if incurred in carrying on a trade or business of the taxpayer, to the extent such expenditures exceed a base period amount. This new credit applies to expenditures made after June 30, 1981, and before 1986.
For the credit, the Act adopts the definition of research used for purposes of the special deduction rules under Code section 174, but subject to certain exclusions. A taxpayer's expenditures eligible for the new incremental credit consist of (1) the taxpayer's "in-house" expenditures for research wages and supplies used in research, plus certain expenditures for research use of computers, laboratory equipment, and other personal property; (2) 65 percent of amounts paid for contract research conducted on behalf of the taxpayer; and (3) if the taxpayer is a corporation, 65 percent of grants for basic research to be performed by universities or certain scientific research organizations.
Contributions of Research Equipment to Universities
The Act allows corporations a charitable deduction for contributions of newly manufactured scientific equipment to universities for research use equal to the taxpayer's basis plus 50 percent of the appreciation, but not to exceed twice the basis.
Allocation of Research Expenditures to U.S.-Source Income
For two years, taxpayers are required to allocate expenditures for research and experimentation conducted in the United States entirely to U.S.-source income.
Other Business Provisions
Corporate Rate Reduction
The Act reduces the tax rate on the first $25,000 of corporate taxable income from 17 percent to 16 percent in 1982 and 15 percent in subsequent years. The Act also reduces the rate on the next $25,000 of taxable income from 20 percent to 19 percent in 1982 and 18 percent in subsequent years.
Incentive Stock Options
The Act reinstates certain nonrecognition rules and capital gains characterization with respect to employee stock options which meet certain conditions ("incentive stock options"). Under these rules, no gain or loss is recognized by the employee, and no deduction is allowed to the corporate employer, when the option is granted or when the option is exercised. Also, the employee is allowed capital gains treatment on any gain on the sale of the stock.
The aggregate value of stock subject to incentive stock options for an employee in a calendar year is limited to $100,000. However, employees are allowed a three-year carryover of up to $50,000 if they do not use the full $100,000 in any one year. In the case of options granted before 1981, the aggregate value of stock which an employee may treat as subject to incentive stock options cannot exceed $50,000 per year and $200,000 in the aggregate.
Targeted Jobs Credit
The Act extends the targeted jobs tax credit through 1982. It adds AFDC recipients and WIN registrants as additional targeted groups, as well as Vietnam veterans age 35 or over and employees laid off from CETA programs. It limits the credit for cooperative education students to the economically disadvantaged. Also, the Act requires the employer to request or obtain certification of employee eligibility before the employee begins work and makes a number of other modifications to the rules for administration of the credit.
Accumulated Earnings Credit
The Act increases from $150,000 to $250,000 the amount which a corporation may accumulate, without showing a business purpose, that is exempt from the accumulated earnings tax, effective for post-1981 taxable years.
Subchapter S Corporations
The Act increases the maximum number of shareholders for a subchapter S corporation from 15 to 25 and allows certain trusts to be qualified shareholders, effective for post-1981 taxable years.
Inventory Accounting
The Act simplifies LIFO inventory accounting for small businesses. Businesses with annual average gross receipts of less than $2 million for the prior three years are allowed to use a single dollar-value LIFO pool, and taxpayers switching to LIFO are given three years to take into income the inventory write-downs from prior years. Also, the Treasury Department is directed to issue rules to simplify the use of dollar-value LIFO inventory accounting through the use of published government indices.
Savings Incentives
Interest and Dividend Exclusion
The Act limits to 1981 the applicability of the $200 interest and dividend exclusion ($400 for a joint return). Effective for 1982 and later years, the Act provides a $100 exclusion for dividends only (with $200 excludable on a joint return regardless of which spouse earns the dividends). Starting in 1985, individuals also will be able to exclude 15 percent of interest income to the extent such income exceeds nonbusiness and nonmortgage interest deductions, up to a maximum interest exclusion of $450 ($900 for joint returns).
Qualified Savings Certificates
The Act excludes from income interest on qualified savings certificates, not to exceed an aggregate amount of $1,000 ($2,000 for a joint return).
These one-year certificates must be issued after September 30, 1981, and before January 1, 1983, and must have a yield exactly equal to 70 percent of the yield on 52-week Treasury bills. The certificates must be issued by credit unions or by certain financial institutions which must use the proceeds to provide residential-related financing or agricultural loans.
Individual Retirement Accounts
The Act increases the limit on deductions for contributions to individual retirement accounts from the lesser of 15 percent of compensation or $1,500 ($1,750 for a spousal IRA) to the lesser of 100 percent of compensation or $2,000 ($2,250 for a spousal IRA). Also, the Act allows an active participant in an employer-sponsored plan to deduct up to $2,000 of voluntary employee contributions to the plan or to an IRA These IRA changes are effective for taxable years beginning after 1981.
Under the Act, an amount in an IRA (or in an individually directed account in a qualified plan) which is used to acquire coins, antiques, art, stamp collections, or other collectibles after December 31, 1981, is taxed to the individual.
Self-Employed Retirement Savings
The Act increases from $7,500 to $15,000 the maximum annual deduction for a contribution to a self-employed retirement plan (Keogh or H.R. 10 plan), and for employer contributions to a simplified employee pension, and makes other changes in tax rules applicable to such plans, generally effective for taxable years beginning after 1981.
Employee Stock Ownership Plans
The Act terminates after 1982 the additional investment tax credit for contributions to an employee stock ownership plan (ESOP), and substitutes an income tax credit for contributions to an ESOP which is based on employee payroll. For 1983 and 1984, the credit is limited to one-half of one percent of compensation paid to employees under the plan; the limitation increases to three-fourths of one percent after 1984. The payroll-based ESOP credit expires at the end of 1987.
Dividend Reinvestment Plans
The Act excludes from income up to $750 ($1,500 for a joint return) of stock distributions from public utilities which are reinvested in the stock of the utility under a qualified dividend reinvestment plan. When the taxpayer sells the stock, gain generally will be treated as capital gain. The exclusion applies for the years 1982 through 1985.
Estate and Gift Tax Provisions
Unified Credit
The Act increases the unified credit against the estate and gift taxes. As a result, the amount of cumulative transfers exempt from these taxes increases from $175,625 under prior law to $225,000 for gifts made and estates of decedents dying in 1982, $275,000 in 1983, $325,000 in 1984, $400,000 in 1985, $500,000 in 1986, and $600,000 in 1987 and subsequent years.
Rate Reduction
The Act reduces the top estate and gift tax rate from 70 percent to 65 percent for gifts made and estates of decedents dying in 1982, 60 percent in 1983, 55 percent in 1984, and 50 percent in 1985 and subsequent years.
Marital Deduction
The Act removes the quantitative limits on the marital deduction under both the estate and gift taxes so that no transfer tax is imposed on transfers between spouses. Also, the Act makes certain terminable interests eligible for the marital deduction and makes such interests includible in the surviving spouse's gross estate.
Current Use Valuation
The Act increases the maximum amount by which the gross estate may be reduced under the current use valuation rules from $500,000 to $600,000 for decedents dying in 1981, $700,000 in 1982, and $750,000 in 1983 and subsequent years. It also makes a number of technical changes intended to liberalize the current use valuation rules.
Gift Tax Exclusion
The Act increases from $3,000 to $10,000 the annual exclusion from the gift tax for gifts to a single donee. It also provides an unlimited exclusion for certain gifts made to pay for qualifying medical expenses and school tuition.
Other Provisions
The Act makes a number of other modifications to the estate and gift tax rules, including repeal (for most purposes) of the rule that gifts made by a decedent within three years of death must be included in the decedent's gross estate; liberalization of the rules allowing deferral of the estate tax attributable to closely held businesses; elimination of a step-up in basis if appreciated property is acquired by gift by the decedent within one year of the decedent's death and then is returned to the donor or the donor's spouse; repeal of the orphan's exclusion; annual filing of gift tax returns; one-year extension of the transition rule for certain wills or revocable trusts under the tax on generation-skipping transfers; and allowance of a charitable deduction for estate and gift tax purposes for certain bequests or gifts of copyrightable works of art, etc., when the donor retains the copyright.
Tax Straddles
Gain or Loss on Straddles
The Act requires that commodity futures contracts must be marked to market at the end of each year (or immediately prior to disposition) and treated as if 60 percent of the capital gains and losses on the contracts were long-term and 40 percent were short-term. It provides a three-year carryback for losses on mark-to-market assets. Under a transition rule, tax due on gains rolled forward from prior years into 1981 may be paid in five annual installments with interest.
For straddles involving property other than futures contracts, losses are generally allowed only to the extent that the amount of the loss exceeds the unrealized gains on offsetting positions. Other losses are deferred, and the wash sale and short sale principles of present law are extended to straddles.
Interest and Carrying Charges
The Act requires that interest and carrying charges for investments in commodities and other personal property be capitalized if the investments are part of a straddle.
Hedging
The Act exempts certain hedging transactions from the mark-to-market, loss deferral, and capitalization rules.
Treasury Bills
The Act treats Treasury bills (and other short-term government obligations) as capital assets. Under the Act, gain from the sale or exchange of a Treasury bill, to the extent of the earned ratable share of the market discount to the taxpayer, is ordinary income.
Dealer Identification of Securities
The Act requires dealers in securities to identify securities as held for investment on the date of acquisition. A seven-day look-back applies to floor specialists with respect to the stocks for which they are registered specialists.
Sale or Exchange of Capital Assets
The Act provides that taxable dispositions of capital assets are treated as sales or exchanges.
Windfall Profit Tax Provisions
Royalty Owner Credit and Exemption
For 1981, royalty owners are allowed a credit against the first $2,500 of windfall profit tax liability. For 1982 through 1984, the Act provides an exemption from the windfall profit tax for up to two barrels a day of royalty production. After 1984, there is an exclusion for up to three barrels a day.
Stripper Oil Exemption
The Act exempts from the windfall profit tax stripper oil produced by independent producers, starting in 1983.
Newly Discovered Oil Tax Rate
The Act reduces the windfall profit tax rate on newly discovered oil from 30 percent to 27.5 percent in 1982, 25 percent in 1983, 22.5 percent in 1984, 20 percent in 1985, and 15 percent in subsequent years.
Exemption for Certain Charities
The Act exempts from the windfall profit tax qualified production owned by orphanages and similar charitable organizations.
Administrative Provisions
Interest on Deficiencies and Overpayments
The Act provides that the interest rate applicable to tax deficiencies and overpayments is to be set annually at the average prime interest rate for September.
Penalty for Valuation Overstatements
The Act provides an additional penalty, applicable with respect to returns filed after 1981, in the case of underpayments of income tax which result from an overstatement of valuation of property made by an individual or certain other taxpayers, subject to certain exceptions and waiver provisions.
Other Administrative Provisions
The Act makes certain increases in penalties for negligence, filing false withholding certificates, failure to file information returns (or furnish copies to payees), and overstated tax deposits. Also, the Act provides for confidentiality of Internal Revenue Service information used to develop standards for auditing tax returns. The Act authorizes an increased fee for filing petitions with the U.S. Tax Court.
Corporate Estimated Tax Payments
The Act increases the minimum amount of the current year's tax liability which large corporations must pay currently through estimated tax payments, regardless of their prior year's tax liability, from 60 percent to 65 percent in 1982, 75 percent in 1983, and 80 percent in subsequent years.
Individual Estimated Tax Payments
The Act increases the threshold for payment of estimated taxes for individuals from $100 to $500, over a four-year period.
Railroad Retirement Tax
The Act increases the railroad retirement tax on employers from 9.5 percent to 11.75 percent and provides for a new tax of two percent on the compensation of employees. A number of other technical changes are made to the railroad retirement program.
Miscellaneous Provisions
Installment Sales of Land
The Act places an upper limit on the interest rate the Internal Revenue Service may impute on certain installment sales of land between related parties.
Business Travel Expenses of State Legislators
The Act allows State legislators to treat their district residence as their tax home and to treat as business expenses an amount equal to the greater of the Federal per diem or the State per diem, with certain limitations, and without regard to the "away-from-home" rule. The changes apply to taxable years beginning after December 31, 1975.
Tax Rate on Principal Campaign Committees
The Act allows the principal campaign committee of a Congressional candidate to pay corporate income tax at graduated rates on its taxable income for taxable years beginning after 1981.
Reorganizations of Thrift Institutions
The Act provides special rules relating to tax-free reorganizations of financially troubled thrift institutions.
Bad Debt Deduction of Commercial Banks
For 1982, the Act increases from 0.6 percent to 1.0 percent the percentage of eligible loans which limits the bad debt deduction of commercial banks under the percentage of outstanding loans method.
Tax Treatment of Mutual Savings Banks Converting to Stock Associations.
The Act contains rules to facilitate conversions of mutual savings banks into stock associations.
Restricted Property
The Act postpones recognition of income and deductibility as compensation, absent an employee election, when property subject to certain restrictions on transferability imposed by the Securities Exchange Act of 1934 (or SEC accounting rules) is transferred to an employee as compensation, effective for taxable years ending after 1981.
Amortization of Construction Period Interest and Taxes
The Act permanently exempts low-income housing from the requirement that interest and taxes paid during the construction period of a building be capitalized.
Amortization of Low-Income Housing Rehabilitation Expenditures
Under certain limited circumstances, the Act raises from $20,000 to $40,000 the maximum amount of expenditures (made after 1980) eligible for five-year amortization in connection with the rehabilitation of low-income housing.
Corporate Charitable Contributions
The Act increases, from five percent to ten percent of taxable income (computed with certain modifications), the limit on the deduction for charitable contributions by corporations, effective for taxable years beginning after 1981.
Deductibility of Certain Business Gifts to Employees
The Act increases the ceiling on deductibility by an employer of business gifts of tangible personal property to its employees, and expands the purposes for which such awards may be given, effective for taxable years ending on or after the date of enactment of the Act.
Motor Carrier Operating Rights
The Act allows taxpayers who held motor carrier operating rights on July 1, 1980 to amortize the basis of those rights over a 60-month period. This provision applies to taxable years ending after June 30, 1980.
Production Credit for Natural Gas
The Act amends the production credit for certain kinds of natural gas to coordinate the credit with elections provided under the pricing provisions of the Natural Gas Policy Act of 1978.
Moratorium on Fringe Benefit Regulations
The Act extends through December 31, 1983 the moratorium on issuance of Treasury regulations relating to the income tax treatment of fringe benefits.
Group Legal Services Plans
The Act extends through 1984 the present exclusion from an employee's income for employer contributions to, and benefits provided under, qualified group legal services plans and the tax exemption of trusts under such plans.
Tax-Exempt Bond Provisions
The Act provides tax exemption for interest on certain bonds issued by volunteer fire departments and for interest on bonds used to purchase leased mass transit facilities.
Telephone Excise Tax
The Act extends the telephone excise tax at a one-percent rate for 1983 and 1984.
FUTA Tax on Certain Fishing Boat Wages
The Act provides that, during 1981, wages paid to fishing boat crew members who are self-employed for purposes of FICA and income tax withholding are not subject to FUTA taxes.
Payout Rule for Private Foundations
The Act modifies the distribution requirements for private foundations. For taxable years beginning after 1981, a private foundation must annually distribute for charitable purposes an amount equal to five percent of the value of net investment assets (but is not required to distribute any excess of the amount of its net income over this investment return amount).
Foreign Investment in U.S. Real Property
The Act makes a series of technical changes to the tax on capital gains recognized by foreign investors on dispositions of U.S. real estate.
Foreign Investment Company Rules
The Act modifies the rules relating to taxation of gain from disposition of stock in a foreign investment company by excluding from those rules gain attributable to earnings and profits derived before the foreign corporation became a foreign investment company.
DOCUMENT ATTRIBUTES
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