Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) (Title XIII--Revenue Reconciliation Act of 1993)

(sec. 14101 of the House bill, sec. 8101 of the Senate amendment, sec. 13101 of the Conference agreement, and sec. 127 of the Code)

In the absence of the exclusion, for purposes of income and employment taxes, an employee generally is required to include in income and wages the value of educational assistance provided by the employer unless the cost of such assistance qualifies as a deductible job-related expense of the employee.

The House bill includes a number of transition rules to deal with cases in which employers provided educational assistance to employees between July 1, 1992, and December 31, 1992. First, no interest, penalty, or addition to tax is imposed on employers or employees who continued to exclude from income educational assistance payments made after June 30, 1992. Second, if an employer included educational assistance payments made after June 30, 1992, in its employees' income and wages (for purposes of income or employment taxes) the amount included is deducted from income and wages paid in 1993 rather than requiring the taxpayers to file a request for refund for 1992.

The House bill also clarifies the rule under which educational assistance that does not satisfy section 127 may be excluded from income if and only if it meets the requirements of a working condition fringe benefit.

The conferees intend that the Secretary will use his existing authority to the fullest extent possible to alleviate any administrative problems that may result from the expiration and retroactive extension of the exclusion and to facilitate in the simplest way possible the recoupment of excess taxes paid with respect to educational assistance provided in the last half of 1992.

2. Extension of Targeted Jobs Tax Credit

(sec. 14102 of the House bill, sec. 8102 of the Senate amendment, sec. 13102 of the Conference agreement, and sec. 51 of the Code)

Prior to July 1, 1992, the targeted jobs tax credit was available to employers on an elective basis for hiring individuals from several targeted groups. The targeted groups consist of individuals who are either recipients of payments under means-tested transfer programs, economically disadvantaged, or disabled.

The credit generally is equal to 40 percent of up to $6,000 of qualified first-year wages paid to a member of a targeted group. Thus, the maximum credit generally is $2,400 per individual. With respect to economically disadvantaged summer youth employees, however, the credit is equal to 40 percent of up to $3,000 of wages, for a maximum credit of $1,200.

The credit expired for individuals who began work for an employer after June 30, 1992.

Certification of members of targeted groups

Generally, an individual is not treated as a member of a targeted group unless certain certification conditions are satisfied. On or before the day on which the individual begins work for the employer, the employer has to have received or have requested in writing from the designated local agency certification that the individual is a member of a targeted group. In the case of a certification of an economically disadvantaged youth participating in a cooperative education program, this requirement is satisfied if necessary certification is requested or received from the participating school on or before the day on which the individual begins work for the employer.

The deadline for requesting certification of targeted group membership is extended until five days after the day the individual begins work for the employer, provided that, on or before the day the individual begins work, the individual has received a written preliminary determination of targeted group eligibility (a "voucher") from the designated local agency (or other agency or organization designated pursuant to a written agreement with the designated local agency). The "designated local agency" is the State employment security agency.

Authorization of Appropriations

Appropriations for administrative and publicity expenses relating to the targeted jobs credit was authorized through June 30, 1992. These monies were to be used by the Internal Revenue Service and the Department of Labor to inform employers of the credit program.

The House bill permanently and retroactively extends the targeted jobs tax credit for individuals who begin work for the employer after June 30, 1992. The House bill also extends the authorization of appropriations for administrative and publicity expenses relating to the credit.

Approved school-to-work program

In addition, the targeted jobs tax credit is expanded to include qualified participants in an approved school-to-work program, for participation beginning after December 31, 1993.

The Senate amendment extends for 24 months the targeted jobs tax credit for individuals who begin work for the employer after June 30, 1992 and before July 1, 1994. Under the Senate amendment, the targeted jobs tax credit does not apply with respect to individuals who begin work for the employer after June 30, 1994. The Senate amendment also extends the authorization of appropriations for administrative and publicity expenses relating to the credit.

Approved school-to-work program

No provision.

The conference agreement extends for 30 months the targeted jobs tax credit for individuals who begin work for the employer after June 30, 1992 and on or before December 31, 1994.

Approved school-to-work program

The conference agreement does not include the House bill provision.

(secs. 14111 and 14112 of the House bill, secs. 8111 and 8112 of the Senate amendment, secs. 13111(a) and (c), and 13112 of the Conference agreement, and sec. 41 of the Code)

The base amount for the current year generally is computed by multiplying the taxpayer's "fixed-base percentage" by the average amount of the taxpayer's gross receipts for the four preceding years. If a taxpayer both incurred qualified research expenditures and had gross receipts during each of at least three years from 1984 through 1988, then its "fixed-base percentage" is the ratio that its total qualified research expenditures for the 1984-1988 period bears to its total gross receipts for that period (subject to a maximum ratio of .16). All other taxpayers (such as "start-up" firms) are assigned a fixed-base percentage of .03.

In computing the credit, a taxpayer's base amount may not be less than 50 percent of its current-year qualified research expenditures.

Qualified research expenditures eligible for the credit consist of: (1) "in-house" expenses of the taxpayer for research wages and supplies used in research; (2) certain time-sharing costs for computer use in research; and (3) 65 percent of amounts paid by the taxpayer for contract research conducted on the taxpayer's behalf. The credit is not available for expenditures attributable to research that is conducted outside the United States. In addition, the credit is not available for research in the social sciences, arts, or humanities, nor is it available for research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity).

The 20-percent research tax credit also applies to the excess of (1) 100 percent of corporate cash expenditures (including grants or contributions) paid for basic research conducted by universities (and certain scientific research organizations) over (2) the sum of (a) the greater of two fixed research floors plus (b) an amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixed-base period, as adjusted for inflation.

Deductions for expenditures allowed to a taxpayer under section 174 (or any other section) are reduced by an amount equal to 100 percent of the taxpayer's research tax credit determined for the taxable year.¹

The House bill also adds a new rule regarding the determination of the fixed-base percentage of start-up firms. Under the provision, a taxpayer that did not have gross receipts in at least three years during the 1984-1988 period will be assigned a fixed base percentage of .03 for each of its first five taxable years after 1993 in which it incurs qualified research expenditures. The taxpayer's fixed-base percentage for its sixth through tenth taxable years after 1993 in which it incurred qualified research expenditures will be as follows: (1) for the taxpayer's sixth year, its fixed-base percentage will be one-sixth of its ratio of qualified research expenditures to gross receipts for its fourth and fifth years; (2) for its seventh year, its fixed-base percentage will be one-third of its ratio for its fifth and sixth years; (3) for its eighth year, its fixed-base percentage will be one-half of its ratio for its fifth through seventh years; (4) for its ninth year, its fixed-base percentage will be two-thirds of its ratio for its fifth through eighth years; and (5) for its tenth year, its fixed-base percentage will be five-sixths of its ratio for its fifth through ninth years. For subsequent taxable years, the taxpayer's fixed-base percentage will be its actual ratio of qualified research expenditures to gross receipts for five years selected by the taxpayer from its fifth through tenth taxable years.

The committee report to the House bill states that, in extending the research tax credit, the committee wishes to reaffirm congressional intent that neither the enactment of the credit in 1981 nor the "targeting" modifications to the credit in 1986 affect the definition of "research or experimental expenditures" for purposes of section 174. Thus, the various new credit limitations enacted in the Tax Reform Act of 1986 apply in determining eligibility for the credit (in taxable years beginning after December 31, 1985), and do not determine eligibility of product development costs under section 174.

The Senate amendment also adds the same rule contained in the House bill regarding the determination of the fixed-base percentage of start-up firms in taxable years after the firm's start-up period. In addition, the committee report to the Senate amendment contains the same language as included in the House bill committee report regarding the effect on section 174 of the enactment of the research credit in 1981 and the targeting modifications to the credit in 1986.

The conference agreement also adds the rule contained in the House bill and the Senate amendment regarding the determination of the fixed-base of start-up firms in taxable years after the firm's start-up period. In addition, the conferees reiterate the intent expressed in the House bill committee report and the Senate amendment committee report that neither the enactment of the credit in 1981 nor the "targeting" modifications to the credit in 1986 affect the definition of "research or experimental expenditures" for purposes of section 174. Thus, the various new credit limitations enacted in the Tax Reform Act of 1986 apply in determining eligibility for the credit (in taxable years beginning after December 31, 1985), and do not determine eligibility of product development costs under section 174.

2. Capital Gains Exclusion for Certain Small Business Stock

(sec. 14113 of the House bill, sec. 13113 of the Conference agreement, and new sec. 1202 of the Code)

Net capital gain (i.e., long-term capital gain less short-term capital loss) of an individual is taxed at the same rates that apply to ordinary income, subject to a maximum rate of 28 percent.

The House bill generally permits a noncorporate taxpayer who holds qualified small business stock for more than 5 years to exclude 50 percent of any gain on the sale or exchange of the stock. The amount of gain eligible for the 50 percent exclusion is limited to the greater of (1) 10 times the taxpayer's basis in the stock or (2) $10 million gain from stock in that corporation.

Qualified small business stock

In order for stock held by a taxpayer to qualify as small business stock, the following requirements must be met.

In order to prevent evasion of the requirement that the stock be newly issued, the exclusion does not apply if the issuing corporation (1) purchases any stock from the stockholder (or a related person) within 2 years of the issuance of the stock or (2) redeems more than 5 percent (by value) of its own stock within 1 year of the issuance. For purposes of this anti-evasion rule, purchases by persons related to the issuing corporation are treated as purchases by the issuing corporation.

A qualified small business is a subchapter C corporation other than: a DISC or former DISC, a corporation with respect to which an election under section 936 is in effect, a regulated investment company, a real estate investment trust, a real estate mortgage investment conduit, or a cooperative. The corporation also generally cannot own (i) real property the value of which exceeds 10 percent of its total assets or (ii) portfolio stock or securities the value of which exceeds 10 percent of its total assets in excess of liabilities.

Assets that are held to meet reasonable working capital needs of the corporation, or are held for investment and are reasonably expected to be used within 2 years to finance future research and experimentation, are treated as used in the active conduct of a trade or business. In addition, certain rights to computer software are treated as assets used in the active conduct of a trade or business.

A qualified trade or business is any trade or business other than one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of the trade or business is the reputation or skill of 1 or more of its employees. The term also excludes any banking, insurance, leasing, financing, investing, or similar business, any farming business (including the business of raising or harvesting trees), any business involving the production or extraction of products of a character for which percentage depletion is allowable, or any business of operating a hotel, motel, restaurant or similar business.

A corporation that is a specialized small business investment company ("SSBIC") is treated as meeting the active business test. An SSBIC is defined as any corporation (other than certain non-qualified corporations) that is licensed by the Small Business Administration under section 301(d) of the Small Business Act of 1958, as in effect on May 13, 1993.

If a corporation satisfies the gross assets test as of the date of issuance but subsequently exceeds the $50 million threshold, stock that otherwise constitutes qualified small business stock would not lose that characterization solely as a result of that subsequent event. If a corporation (or a predecessor corporation) exceeds the $50 million threshold at any time after December 31, 1992, the corporation cannot issue stock that would qualify for the exclusion.

Subsidiaries of issuing corporation

In the case of a corporation that owns at least 50 percent of the vote or value of a subsidiary, the parent corporation is deemed to own its ratable share of the subsidiary's assets for purposes of the "qualified corporation," "active business," and "gross assets" tests described above.

Pass-through entities

Gain from the disposition of qualified small business stock by a partnership, S corporation, regulated investment company or common trust fund that is taken into account by a partner, shareholder or participant (other than a C corporation) is eligible for the exclusion, provided that (1) all eligibility requirements with respect to qualified small business stock are met, (2) the stock was held by the entity for more than 5 years, and (3) the partner, shareholder or participant held its interest in the entity on the date the entity acquired the stock and at all times thereafter and before the disposition of the stock. In addition, a partner, shareholder, or participant cannot exclude gain received from an entity to the extent that the partner's, shareholder's, or participant's share in the entity's gain exceeded the partner's, shareholder's or participant's interest in the entity at the time the entity acquired the stock.

Certain tax-free and other transfers

If qualified small business stock is transferred by gift or at death, the transferee is treated as having acquired the stock in the same manner as the transferor, and as having held the stock during any continuous period immediately preceding the transfer during which it was held by the transferor. A partner can treat stock distributed by a partnership as qualified small business stock as long as (1) all eligibility requirements with respect to qualified small business stock are met by the partnership with respect to its investment in the stock, and (2) the partner held its interest in the partnership on the date the partnership acquired the stock and at all times thereafter and before the disposition of the stock. In addition, a partner cannot treat stock distributed by a partnership as qualified small business stock to the extent that the partner's share of the stock distributed by the partnership exceeded the partner's interest in the partnership at the time the partnership acquired the stock.

Transferees in other cases are not eligible for the exclusion. Thus, for example, if qualified small business stock is transferred to a partnership and the partnership disposes of the stock, any gain from the disposition will not be eligible for the exclusion.

In the case of certain incorporations and reorganizations where qualified small business stock is transferred for other stock, the transferor treats the stock received as qualified small business stock. The holding period of the original stock is added to that of the stock received. However, the amount of gain eligible for the exclusion is limited to the gain accrued as of the date of the incorporation or reorganization.

Special basis rules

If property (other than money or stock) is transferred to a corporation in exchange for its stock, the basis of the stock received is treated as not less than the fair market value of the property exchanged. Thus, only gains that accrue after the transfer are eligible for the exclusion.

Options, nonvested stock, and convertible instruments

Stock acquired by the taxpayer through the exercise of options or warrants, or through the conversion of convertible debt, is treated as acquired at original issue. The determination whether the gross assets test is met is made at the time of exercise or conversion, and the holding period of such stock is treated as beginning at that time.

In the case of convertible preferred stock, the gross assets determination is made at the time the convertible stock is issued, and the holding period of the convertible stock is added to that of the common stock acquired upon conversion.

Stock received in connection with the performance of services is treated as issued by the corporation and acquired by the taxpayer when included in the taxpayer's gross income in accordance with the rules of section 83.

Offsetting short positions

A taxpayer cannot exclude gain from the sale of qualified small business stock if the taxpayer (or a related person) held an offsetting short position with respect to that stock anytime before the 5-year holding period is satisfied. If the taxpayer (or a related person) acquires an offsetting short position with respect to qualified small business stock after the 5-year holding period is satisfied, the taxpayer must elect to treat the acquisition of the offsetting short position as a sale of the qualified small business stock in order to exclude any gain from that stock.

An offsetting short position is defined to be (1) a short sale of property substantially identical to the qualified small business stock (including writing a call option that the holder is more likely than not to exercise or selling the stock for future delivery) or (2) an option to sell substantially identical property at a fixed price.

Capital gains and investment interest

Any gain that is excluded from gross income under the bill is not taken into account in computing long-term capital gain or in applying the capital loss rules of sections 1211 and 1212. In addition, the taxable portion of the gain is taxed under section 1(h), which provides for a maximum rate of 28 percent.

The amount treated as investment income for purposes of the investment interest limitation does not include any gain that is excluded from gross income under the bill.

Minimum tax

One-half of any excluded gain is treated as a preference for purposes of the alternative minimum tax.

In general

The agreement clarifies that the $10 million limitation on eligible gain is applied on a shareholder-by-shareholder basis. The conferees also wish to clarify that for purposes of the 10-times-basis limitation, basis is determined by valuing any contributed property at fair market value (at the date of contribution).

Qualified small business stock

Subsidiaries of issuing corporation

The agreement provides that corporations that are part of a parent-subsidiary controlled group (using a more than 50% ownership test) are treated as a single corporation for purposes of the gross assets test. The conferees also wish to clarify that, for purposes of the active business requirement, a parent's ratable share of a subsidiary's assets (and activities) is based on the percentage of outstanding stock owned (by value).

Certain tax-free and other transfers

The conference agreement follows the House bill by limiting the gain that is eligible for exclusion on the sale of stock that was acquired through incorporation or reorganization where the stock acquired would not have been stock of a qualified small business (at the time acquired). The agreement, however, also provides that the limit will not apply to gain from stock that was acquired through incorporation or reorganization that would have been stock of a qualified small business.

Alternative minimum tax study

The conferees understand that the individual alternative minimum tax (AMT) may operate to disallow deductions that may be associated with the production of income, including section 212 expenses associated with income derived through partnerships. A provision was included in H.R. 11 last year to allow a certain amount of the distributive share of section 212 expenses of a partner in a partnership to be deductible for AMT purposes. Concern has been expressed that the present-law AMT treatment of section 212 expenses might create a disincentive for the long-term investments that Congress has intended to foster through the capital gains exclusion. Accordingly, the conferees urge that the Treasury Department study the question whether the present-law AMT treatment of section 212 expenses creates such a disincentive, and provide the House Committee on Ways and Means and the Senate Finance Committee with a report of such study by March 1, 1994. The study should include the Treasury Department's views and recommendations as to whether a statutory amendment is appropriate insofar as the AMT treatment of section 212 uses is concerned, along with a discussion of the merits and consequences of any such amendment.

3. Rollover of Gain From Sale of Publicly-Traded Securities into Specialized Small Business Investment Companies

(sec. 14114 of the House bill, sec. 13114 of the Conference agreement and new sec. 1044 of the Code)

^{Estates, trusts, S-corporations, and partnerships are not eligible to make this election to roll over gains. In addition, "publicly-traded securities" are defined as stock or debt traded on an established securities market. An SSBIC is defined as any partnership or corporation that is licensed by the Small Business Administration under section 301(d) of the Small Business Investment Act of 1958, as in effect on May 13, 1993.}

^{The amount of gain that an individual may elect to roll over under this provision for a taxable year is limited to the lesser of (l) $50,000 or (2) $500,000 reduced by the gain previously excluded under this provision. For corporations, these limits are $250,000 and $1,000,000.}

4. Modification to Minimum Tax Depreciation Rules

(sec. 14115 of the House bill, sec. 8115 of the Senate amendment, sec. 13115 of the Conference agreement, and sec. 56 of the Code)

One of the adjustments which is made to taxable income to arrive at AMTI relates to depreciation. For AMT purposes, depreciation on most personal property to which the modified Accelerated Cost Recovery System (MACRS) adopted in 1986 applies is calculated using the 150-percent declining balance method (switching to straight line in the year necessary to maximize the deduction) over the property's class life. The class lives of MACRS property generally are longer than the recovery periods allowed for regular tax purposes.

For taxable years beginning after 1989, the AMTI of a corporation is increased by an amount equal to 75 percent of the amount by which adjusted current earnings (ACE) of the corporation exceed AMTI (as determined before this adjustment). In general, ACE means AMTI with additional adjustments that generally follow the rules presently applicable to corporations in computing their earnings and profits. For purposes of ACE, depreciation is computed using the straight-line method over the class life of the property. Thus, a corporation generally must make two depreciation calculations for purposes of the AMT -- once using the 150-percent declining balance method over the class life and again using the straight-line method over the class life. Taxpayers may elect to use either method for regular tax purposes. If a taxpayer uses the straight-line method for regular tax purposes, it must also use the straight-line method for AMT purposes.

5. Increase Expensing Deduction for Small Business

(sec. 14116 of the House bill, sec. 8119 of the Senate amendment, sec. 13116 of the Conference agreement, and sec. 179 of the Code)

6. Bonds for High-Speed Intercity Rail Facilities

(sec. 14121 of the House bill, sec. 13121 of the Conference agreement, and sec. 146 of the Code)

Twenty-five percent of each bond issue for high-speed intercity rail facilities must receive an allocation from a State private activity bond volume limitation. If facilities are located in two or more States, this requirement must be met on a State-by-State basis for the financing of facilities located in each State.

7. Extension of Qualified Small-Issue Bonds

(sec. 14122 of the House bill, sec. 8121 of the Senate amendment, sec. 13122 of the Conference agreement, and sec. 144 of the Code)

Authority to issue qualified small-issue bonds expired after June 30, 1992.

8. Extension of Tax Credit for Orphan Drug Clinical Testing Expenses

(sec. 13111(b) of the Conference agreement and sec. 28 of the Code)

^{The orphan drug tax credit expired after June 30, 1992.}

This maximum credit is reduced by 13.21 percent of earned income (or adjusted gross income, if greater) in excess of $12,200 (13.93 percent for taxpayers with more than one qualifying child). In 1993, the EITC is totally phased out for workers with earned income (or adjusted gross income, if greater) over $23,050. The maximum amount of earned income on which the EITC may be claimed, and the income threshold for the phaseout of the EITC, are indexed for inflation. Earned income consists of wages, salaries, other employee compensation,1 and net self-employment income.

Present law provides that the credit rates for the EITC increase in 1994, as shown in the following table.

                     One qualifying                Two or more

A supplemental young child credit is available to taxpayers with qualifying children under the age of one year. This young child credit rate is 5 percent and the phase-out rate is 3.57 percent. It is computed on the same income base as the ordinary EITC. The maximum supplemental young child credit for 1993 is $388.

A supplemental health insurance credit is available to taxpayers who provide health insurance coverage for their qualifying children. This health insurance credit rate is 6 percent and the phase-out rate is 4.285 percent. It is computed on the same income base as the ordinary EITC, but the credit claimed cannot exceed the out-of-pocket cost of the health insurance coverage. In addition, the taxpayer is denied an itemized deduction for medical expenses of qualifying insurance coverage up to the amount of credit claimed. The maximum supplemental health insurance credit for 1993 is $465.

For taxpayers with two or more qualifying children, the EITC is increased to 31.59 percent of the first $8,500 of earned income in 1994. The maximum credit is $2,685 which is reduced by 15.79 percent of earned income (or adjusted gross income, if greater) in excess of $11,000. Thus, in 1994, the credit is completely phased out for taxpayers with earned income (or adjusted gross income, if greater) over $28,000. For 1995 and thereafter, the credit rate increases to 39.66 percent. The maximum amount of earned income on which the credit could be claimed is projected to be $8,730 in 1995 (which equals the 1994 level, adjusted for projected inflation). Thus, the maximum credit in 1995 is projected to be $3,460. The phase-out rate for 1995 and thereafter is 19.83 percent.

Under the House bill, the EITC is extended to low-income workers who (1) do not have any qualifying children (including workers with children who are not qualifying children with respect to that worker); (2) are age 22 or older; and (3) who may not be claimed as a dependent on another taxpayer's return. For these taxpayers, the EITC is 7.65 percent of the first $4,000 of earned income (for a maximum credit of $306 in 1994). The maximum credit is reduced by 7.65 percent of earned income (or adjusted gross income, if greater) above $5,000. In 1994 the credit is completely phased out for taxpayers with earned income (or adjusted gross income, if greater) over $9,000. This credit is not available on an advance payment basis.

As under present law, all dollar thresholds for years after 1994 are indexed for inflation.

The supplemental young child credit and the supplemental health insurance credit are repealed.

For taxpayers with one qualifying child, the EITC is 26.0 percent of the first $7,750 of earned income in 1994. The maximum credit in 1994 is $2,015 and is reduced by 16.16 percent of earned income (or adjusted gross income, if greater) in excess of $11,000. For 1995 and thereafter, the credit rate increases to 34.0 percent. The maximum amount of earned income on which the credit could be claimed is (an estimated) $6,170 (this is a $6,000 base in 1994, adjusted for projected inflation).

For taxpayers with two or more qualifying children, the EITC is 30.0 percent of the first $8,500 of earned income in 1994. The maximum credit for 1994 is $2,550 and is reduced by 15.94 percent of earned income (or adjusted gross income, if greater) in excess of $11,000. The credit rate increases over time and equals 34.0 percent for 1995 and 39.0 percent for 1996 and thereafter. The phase-out rate is 18.06 percent for 1995 and 20.72 percent for 1996 and thereafter.

There is no credit available for workers without qualifying children.

For taxpayers with one qualifying child, the EITC is 26.3 percent of the first $7,750 of earned income in 1994. The maximum credit in 1994 is $2,038 and is reduced by 15.98 percent of earned income (or adjusted gross income, if greater) in excess of $11,000. For 1995 and thereafter, the credit rate increases to 34.0 percent. The maximum amount of earned income on which the credit could be claimed is (an estimated) $6,170 (this is a $6,000 base in 1994, adjusted for projected inflation). The phaseout rate for 1995 and thereafter is 15.98 percent.

For taxpayers with two or more qualifying children, the EITC is 30.0 percent of the first $8,425 of earned income in 1994. The maximum credit for 1994 is $2,527 and is reduced by 17.68 percent of earned income (or adjusted gross income, if greater) in excess of $11,000. The credit rate increases over time and equals 36.0 percent for 1995 and 40.0 percent for 1996 and thereafter. The phase-out rate is 20.22 percent for 1995 and 21.06 percent for 1996 and thereafter.

The EITC is extended to taxpayers with no qualifying children, as in the House bill, with a modification to the age requirement. Under the conference agreement, this credit for taxpayers with no qualifying children would only be available to taxpayers over age 25 and below age 65.

The Internal Revenue Service (IRS) is required to provide notice to taxpayers with qualifying children who receive a refund on account of the EITC that the credit may be available on an advance payment basis. To prevent taxpayers from incurring an unexpectedly large tax liability due to receipt of the EITC on an advance payment basis, the amount of advance payment allowable in a taxable year is limited to 60 percent of the maximum credit available to a taxpayer with one qualifying child. After providing these notices to taxpayers for two taxable years, the Secretary of Treasury is directed to study the effect of the notice program on utilization of the advance payment mechanism. Based on the results of this study, the Secretary may recommend modifications to the notice program to the Committee on Ways and Means and the Committee on Finance.

Finally, the conferees are concerned that working homeless individuals may not claim the full amount of EITC to which they are entitled. The conferees urge the IRS to explore the use of outreach programs that target homeless individuals and that aim to educate these individuals of the availability of the EITC.

(sec. 14141 of the House bill, sec. 8141 and 8141A of the Senate amendment, sec. 13141 of the Conference agreement, and secs. 25 and 143 of the Code)

Qualified mortgage bonds ("QMBs") are bonds the proceeds of which are used to finance the purchase, or qualifying rehabilitation or improvement, of single-family, owner-occupied residences located within the jurisdiction of the issuer of the bonds (sec. 143). Persons receiving QMB loans must satisfy a home purchase price, borrower income, first-time homebuyer, and other requirements. Part or all of the interest subsidy provided by QMBs is recaptured if the borrower experiences substantial increases in income and disposes of the subsidized residence within nine years after purchase.

Mortgage credit certificates

Qualified governmental units may elect to exchange QMB authority for authority to issue mortgage credit certificates ("MCCs") (sec. 25). MCCs entitle homebuyers to nonrefundable income tax credits for a specified percentage of interest paid on mortgage loans on their principal residences. Once issued, an MCC remains in effect as long as the loan remains outstanding and the residence being financed continues to be the certificate-recipient's principal residence. MCCs are subject to the same targeting requirements as QMBs.

Expiration

Authority to issue QMBs and to elect to trade in bond volume authority to issue MCCs expired after June 30, 1992.

Treatment of certain housing affordability programs

The conference agreement provides that, in high housing cost areas, the fact that an issuer of QMBs or MCCs also provides certain mortgage loans or grants other than first mortgage loans or grants to homebuyers in conjunction with QMB or MCC financing will not preclude availability of the QMB- or MCC-assistance on the purchase of a residence. Qualifying subordinate mortgage loans or grants may not be financed directly or indirectly with tax-exempt private activity bonds. Also qualifying subordinate mortgage loans or grants either must be accompanied by a "resale price control restriction", (or in the case of loans must be, "shared appreciation loans"). Finally, the local government must retain its interest in the home's appreciation for a period at least as long as the Federal QMB and MCC recapture period.

A resale price control restriction is defined as a deed restriction, right of repurchase, or similar mechanism which (1) requires the owner to sell the unit to a purchaser qualifying for QMB or MCC financing and (2) limits the resale price to an amount not exceeding the initial purchase price plus an indexed amount that is less than the full appreciation on the residence. A shared appreciation loan is defined as a below-market rate or deferred interest loan which entitles the governmental lender to a share of any appreciation in value (attributable to the portion of the residence financed with the shared appreciation loan) realized upon disposition of the residence as repayment for the subsidy provided by the loan.

Any interest of a governmental unit in a QMB- or MCC-financed residence attributable to a qualifying subordinated mortgage loan will be disregarded for purposes of (1) the first-time homebuyer and owner-occupied residence requirements of the QMB and MCC programs; (2) the maximum purchase price limit for QMB- and MCC-financed residences; (3) the rules for determining who is the owner of a QMB- or MCC-financed residence; and (4) the rules for determining the effective rate of interest on QMB-financed loans. The terms of the subordinated mortgage loan or grant will be taken into account, however, for measuring the amount of the homeowner's gain, if any, under the QMB- and MCC-recapture restrictions. The conferees intend that the special rules for these housing affordability programs will not apply to any subordination loans or grant if the governmental unit's interest under the loan or grant is structured so as to realize an amount in excess of the pro rata portion of the appreciation on the residence financed with the subordinated mortgage loan or grant (e.g., by allocating to the governmental unit an amount of gain on disposition greater than the proportionate amount of the total subsidy to the homebuyer that is provided by the subordinated mortgage loan).

Treatment of certain contracts for deeds

The conference agreement also provides that, in the case of certain homebuyers whose family incomes do not exceed fifty percent of applicable median family income, ownership of land subject to certain contracts for deed does not violate the requirement that QMB- and MCC-financed homebuyers be first-time homebuyers and that the financing provided be for new mortgages. Thus, QMB-financed loans may be made (and MCCs to be granted) to individuals who own and maintain their principal residence on land subject to these contracts for deed provided that the homebuyers satisfy (a) all otherwise applicable requirements of the QMB and MCC programs but for the contract for deed and (b) the special income limit. These loans may be used to repay the contract for deed and to finance a new residence on the land. Also, as under present law, these homebuyers will remain eligible for qualified home improvement loans to rehabilitate existing principal residences on the land held subject to the contracts for deed.

Treatment of certain two-family housing

The conference agreement expands a present-law exception to the requirement that all residences receiving qualified mortgage bond financing or MCCs be single family, owner-occupied housing to allow certain newly constructed two-family housing to qualify. Under the expanded exception, newly constructed two-family housing will be eligible for these subsidies if (a) the housing is located in a targeted area of economic distress (sec. 143(j)), (b) at least one of the two units is occupied as the principal residence of the mortgagor, and (c) the family income of the mortgagor is 140 percent or less of the applicable area median family income.⁴

2. Extension and Modification of the Tax Credit for Low-Income Rental Housing

(sec. 14142 of the House bill, sec. 8142 of the Senate amendment, sec. 13142 of the Conference agreement, and sec. 42 of the Code)

A tax credit is allowed in annual installments over 10 years for qualifying newly constructed or substantially rehabilitated low-income residential rental housing. For most qualifying housing, the credit has a present value of 70 percent of the qualified basis of the low-income housing units. For housing also receiving other Federal subsidies (e.g., tax-exempt bond financing) and for the acquisition cost (e.g., costs other than rehabilitation expenditures) of existing housing that is substantially rehabilitated, the credit has a present value of 30 percent of qualified costs.

HOME funds

Housing which receives assistance under the National Affordable Housing Act of 1990 generally is treated as Federally subsidized and therefore not eligible for the 70 percent present value credit.

Full-time students

A housing unit generally is not eligible for the low-income housing tax credit if the tenants are full-time students who are not married individuals filing joint returns. Exceptions to this rule allow the credit to be claimed on housing units occupied by persons who are enrolled in certain job training programs or by students who are receiving Aid to Families with Dependent Children (AFDC) payments.

Deep-rent skewing

Generally, the credit amount is based on the qualified basis of the housing units serving low-income tenants. A residential rental project will qualify for the credit only if (1) 20 percent or more of the aggregate residential rental units in the project are occupied by individuals whose incomes do not exceed 50 percent of area median income, or (2) 40 percent or more of the aggregate residential rental units in the project are occupied by individuals whose incomes do not exceed 60 percent of area median income. A different income targeting rule applies to entities described in sec. 142(d)(6) of the Code. These income figures are adjusted for family size. The low income set-aside is elected when the project is placed in service.

To qualify under the deep rent skewing exception from the general targeting requirements, at least 15 percent of the low-income units must be occupied by tenants whose incomes do not exceed 40 percent of area median income, the rents on such units must be restricted to 30 percent of the qualifying income limitation, and rents on the market rate units must be at least 200 percent of rents charged on comparable rent restricted units. For projects receiving allocations prior to 1990, rents on market rate units must be at least 300 percent of rents charged on comparable rent restricted units.

Maximum rent

The maximum rent that may be charged a family in a low-income housing tax credit unit depends on the number of bedrooms in that unit. Prior to 1990, maximum allowable rent was determined on the basis of the actual family size of the occupants.

Tenant occupancy

Under the general low-income tenant occupancy requirement, a residential rental project qualifies for the low-income housing tax credit only if at least: (1) 20 percent or more of the aggregate residential rental units in the project are occupied by individuals whose incomes do not exceed 50 percent of area median income or, (2) 40 percent or more of the aggregate residential rental units in the project are occupied by individuals whose incomes do not exceed 60 percent of area median income.

Income recertification

Generally, the owner of a low-income housing project must annually recertify tenant incomes to meet the low-income tenant occupancy requirements, regardless of whether the building is entirely occupied by low-income tenants.

Tenant protection

The low-income housing tax credit provisions in the Code do not include any specific provisions concerning the grounds for denial of admission to low-income housing projects, for termination of a tenancy, or for refusal to renew the lease of a tenant.

Developmental and operational costs

In general, housing credit agencies cannot allocate more low-income housing tax credits to a project than are necessary for the financial feasibility of the project and its viability as a qualified low-income housing project throughout the 10-year credit period. In making this determination, a housing credit agency must consider (1) the sources and uses of funds and the total financing of the project, (2) any proceeds expected to be generated by reason of tax benefits and (3) the percentage of the housing credit dollar amount to be used for project costs other than the costs of intermediaries.

Allocation between buyer and seller in month of disposition

The Code requires that the low-income housing tax credit be divided between a buyer and seller of a low-income housing tax credit project based upon the number of days during the year of disposition that the project was held by each. The Internal Revenue Service has issued guidance that requires a mid-month averaging convention.

Expiration

The low-income housing tax credit expired after June 30, 1992.

The House bill permanently extends the low-income housing tax credit.

HOME funds

The House bill provides that a building shall not be treated as Federally subsidized solely by reason of assistance with respect to that building received under the National Affordable Housing Act of 1990 (as in effect on the date of enactment of this provision) if 40 percent or more of the aggregate residential rental units in the residential rental project receiving the assistance are occupied by individuals with 50 percent or less of area median income. These projects are eligible for the 70 percent and 30 percent credits but not for the 91-percent or 39 percent credits otherwise available in qualified census tracts and difficult development areas.

Full-time students

No provision.

Deep-rent skewing

No provision.

Maximum rent

No provision.

Tenant occupancy

No provision.

Income recertification

No provision.

Tenant protection

No provision.

Developmental and operational costs

No provision.

Allocation between buyer and seller in month of disposition

No provision.

The Senate amendment is the same as the House bill.

HOME funds

No provision.

Full-time students

The Senate amendment provides that a housing unit occupied entirely by full-time students may qualify for the credit if the full-time students are a single parent and his or her minor children and none of the tenants is a dependent of a third party. The Senate amendment also codifies the present-law exception regarding married students filing joint returns (which continues to apply to all buildings placed in service since original enactment of the low-income housing tax credit by the Tax Reform Act of 1986).

Deep-rent skewing

The Senate amendment allows an irrevocable election by the owner of a low-income building receiving a credit allocation before 1990 to satisfy the 200-percent rent restriction rather than the 300-percent rent restriction. The election is available only to taxpayers who enter into a compliance monitoring agreement with a housing credit agency. Further, the election applies only with respect to tenants first occupying any unit in the building after the date of the election, and must be made within 180 days after the date of enactment.

Maximum rent

The Senate amendment allows an irrevocable election by the owner of a low-income building placed in-service before l990 to use either apartment size or family size in determining maximum allowable rent. The election is available only to taxpayers who enter into a compliance monitoring agreement with a housing credit agency. Further, the election applies only with respect to tenants first occupying any unit in the building after the date of the election, and must be made within 180 days after the date of enactment.

Tenant Occupancy

The Senate amendment authorizes the Treasury Department to provide a waiver of penalties for de minimis errors in the application of the low-income tenant occupancy requirement.

Income recertification

The Senate amendment authorizes the Treasury Department to grant a waiver from the annual recertification of tenant income for tenants in buildings that are occupied entirely by low-income tenants.

Tenant protection

The Senate amendment provides that an applicant may not be denied admission to a low-income housing tax credit project because the applicant holds a voucher or certificate of eligibility under section 8 of the Housing Act of 1937.

Developmental and operational costs

The Senate amendment requires a housing credit agency to consider the reasonableness of the developmental and operational costs of a project as an additional factor in making its determination as to the proper amount of low-income housing tax credits to allocate to a project.

Allocation between buyer and seller in month of disposition

The bill provides that the buyer and seller may agree to use either the exact number of days or the mid-month convention to determine the division of the credit in the month of disposition.

The conference agreement follows the House bill and the Senate amendment.

HOME funds

The conference agreement follows the House bill with a modification to the House bill requirement that 40 percent or more of the aggregate residential rental units in the residential rental project receiving the assistance are occupied by individuals with 50 percent or less of area median income. Specifically 40 percent would be reduced to 25 percent for entities described in Code section 142(d)(6), consistent with the income targeting rules currently applicable to such entities. The House bill requirement limiting this provision to the 70 percent and 30 percent credits but not for the 91 percent or 39 percent credits otherwise available in qualified census tracts and difficult development areas is retained.

Full-time students

The conference agreement follows the Senate amendment.

Deep-rent skewing

The conference agreement follows the Senate amendment with a modification. The modification provides that the irrevocable election would apply to both current and future tenants but would not allow rent increases on existing low-income tenants.

Maximum rent

The conference agreement follows the Senate amendment.

Income recertification

The conference agreement follows the Senate amendment.

Income recertification

The conference agreement follows the Senate amendment with a modification. The conference agreement provides that third-party verification of a tenant's or prospect tenant's income from his combined assets is not necessary if (l) the combined assets do not exceed $5,000 and (2) the tenant or prospective tenant provides a signed, sworn statement to this effect to the building owner. Further the conferees do not intend to modify the treatment of individuals receiving section 8 assistance.

Tenant protection

The conference agreement follows the Senate amendment.

Development and operational costs

The conference agreement follows the Senate amendment with a clarification that the provision is not intended to create a national standard of reasonableness. The conferees intend for allocating agencies to set standards of reasonableness reflecting the applicable facts and circumstances including the location of the projects and the uses for which the projects are built.

Allocation between buyer and seller in month of dispositions

The conference agreement follows the Senate amendment.

3. Modification of Passive Loss Rules for Certain Real Estate Persons

(sec. 14143 of the House bill, sec. 8143 of the Senate amendment, sec. 13143 of the Conference agreement, and sec. 469 of the Code)

The passive loss rules apply to individuals, estates and trusts, closely held C corporations, and personal service corporations. A special rule permits closely held C corporations to apply passive activity losses and credits against active business income (or tax liability allocable thereto) but not against portfolio income.

Passive activities are defined to include trade or business activities in which the taxpayer does not materially participate. Rental activities (including rental real estate activities) are also treated as passive activities, regardless of the level of taxpayer's participation. A special rule permits the deduction of up to $25,000 of losses from rental real estate activities (even though they are considered passive), if the taxpayer actively participates in them. This $25,000 amount is allowed for taxpayers with adjusted gross incomes of $100,000 or less, and is phased out for taxpayers with adjusted gross incomes between $100,000 and $150,000.

Real property trade or business means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

An individual taxpayer meets the eligibility requirements if more than half of the personal services the taxpayer performs in trades or businesses during the taxable year are in real properly trades or businesses in which he materially participates. Personal services performed as an employee are not treated as performed in a real property trade or business unless the person performing services has more than a 5 percent ownership interest in the employer.

In the case of a joint return, each spouse's personal services are taken into account separately. In determining material participation, however, the provision does not change the present-law rule that the participation of the spouse of the taxpayer is taken into account. Thus, for example, a husband and wife filing a joint return meet the eligibility requirements of the provision if during the taxable year one spouse performs at least half of his or her business services in a real property trade or business in which either spouse materially participates.

A closely held C corporation meets the eligibility requirements if more than 50 percent of its gross receipts for the taxable year are derived from real property trades or businesses in which the corporation materially participates.

4. Changes Relating to Real Estate Investments by Pension Funds and Others

(secs. 14144-14149 of the House bill, secs. 8144-8149 of the Senate amendment, and secs. 13144-13149 of the Conference agreement)

An exception to the rule treating income from debt-financed property as UBTI is available to pension trusts, educational institutions, and certain other exempt organizations (collectively referred to as "qualified organizations") that make debt-financed investments in real property (sec. 514(c)(9)(A)). Under this exception, income from investments in real property is not treated as income from debt-financed property. Mortgages are not considered real property for purposes of the exception.

The real property exception to the debt-financed property rules is available for investments in debt-financed property, only if the following six restrictions are satisfied: (1) the purchase price of the real property is a fixed amount determined as of the date of the acquisition (the "fixed price restriction"); (2) the amount of the indebtedness or any amount payable with respect to the indebtedness, or the time for making any payment of any such amount, is not dependent (in whole or in part) upon revenues, income, or profits derived from the property (the "participating loan restriction"); (3) the property is not leased by the qualified organization to the seller or to a person related to the seller (the "leaseback restriction"); (4) in the case of a pension trust, the seller or lessee of the property is not a disqualified person (the "disqualified person restriction"); (5) the seller or a person related to the seller (or a person related to the plan with respect to which a pension trust was formed) is not providing financing in connection with the acquisition of the property (the "seller-financing restriction"); and (6) if the investment in the property is held through a partnership, certain additional requirements are satisfied by the partnership (the "partnership restrictions") (sec. 514(c)(9)(B)(i) through (vi)).

The House bill relaxes the leaseback and disqualified person restrictions to permit limited leaseback of debt-financed real property to the seller (or a person related to the seller) or to a disqualified person.⁵ The exception applies only where (1) no more than 25 percent of the leasable floor space in a building (or complex of buildings) is leased back to the seller (or related party) or to the disqualified person, and (2) the lease is on commercially reasonable terms, independent of the sale and other transactions.

Relaxation of the seller-financing restriction

The House bill relaxes the seller-financing restriction to permit seller financing on terms that are commercially reasonable independent of the sale and other transactions. The House bill grants authority to the Treasury Department to issue regulations for the purpose of determining commercially reasonable financing terms.

The House bill does not modify the present-law fixed price and participating loan restrictions. Thus, for example, income from real property acquired with seller-financing where the timing or amount of payment is based on revenue, income, or profits from the property generally will continue to be treated as income from debt-financed property, unless some other exception applies.

Relaxation of the fixed price and participating loan restriction for property acquired from financial institutions

The House bill relaxes the fixed price and participating loan restrictions for certain sales of real property foreclosed upon by financial institutions.⁶ The relaxation of these rules is limited to cases where: (1) a qualified organization acquires the property from a financial institution that acquired the real property by foreclosure (or after an actual or imminent default), or was held by the selling financial institution at the time that it entered into conservatorship or receivership; (2) any gain recognized by the financial institution with respect to the property is ordinary income; (3) the stated principal amount of the seller financing does not exceed the financial institution's outstanding indebtedness (including accrued but unpaid interest) with respect to the property at the time of foreclosure or default; and (4) the present value of the maximum amount payable pursuant to any participation feature cannot exceed 30 percent of the total purchase price of the property (including contingent payments).

By contrast, a tax-exempt organization's distributive share of gross income from a publicly-traded partnership (that is not otherwise treated as a corporation) automatically is treated as gross income derived from an unrelated trade or business (sec. 512(c)(2)(A)). The organization's share of the partnership deductions is allowed in computing the organization's UBTI (sec. 512(c)(2)(B)).

In addition, the House bill provides that a section 501(c)(2) or 501(c)(25) title-holding company will not lose its tax-exempt status if UBTI that is incidentally derived from the holding of real property exceeds the 10-percent limitation, provided that the title-holding company establishes to the satisfaction of the Secretary of the Treasury that the receipt of UBTI in excess of the 10-percent limitation was inadvertent and reasonable steps are being taken to correct the circumstances giving rise to such excess UBTI.

The exclusion is limited to properties designated as disposal property within nine months of acquisition, and disposed of within two-and-a-half years of acquisition. The two-and-a-half year disposition period may be extended by the Secretary if an extension is necessary for the orderly liquidation of the property. No more than one-half by value of properties acquired in a single transaction may be designated as disposal property.

The exclusion is not available for properties that are improved or developed to the extent that the aggregate expenditures on development do not exceed 20 percent of the net selling price of the property.

Present law is unclear on whether premiums from unexercised options on real estate and loan commitment fees are UBTI.

In addition, the House bill excludes loan commitment fees from UBTI. For purposes of this provision, loan commitment fees are non-refundable charges made by a lender to reserve a sum of money with fixed terms for a specified period of time. These charges are to compensate the lender for the risk inherent in committing to make the loan (e.g., for the lender's exposure to interest rate changes and for potential lost opportunities).

Dividends paid by a REIT are not UBTI,⁸ unless the stock in the REIT is debt-financed. Depending on its character, income earned by a partnership may be UBTI (sec. 512(c)). Special rules treat debt-financed income earned by a partnership as UBTI (sec. 514(c)(9)(B)(vi)).

The House bill provides that a pension trust generally is not treated as a single individual for purposes of the five-or-fewer rule. Rather, the bill treats beneficiaries of the pension trust as holding stock in the REIT in proportion to their actuarial interests in the trust. This rule does not apply if disqualified persons, within the meaning of section 4975(e)(2) (other than by reason of subparagraphs (B) and (I)), together own five percent or more of the value of the REIT stock and the REIT has earnings and profits attributable to a period during which it did not qualify as a REIT.⁹

^{In addition, the bill provides that a REIT cannot be a personal holding company and, therefore, is not subject to the personal holding company tax on its undistributed income.}

^{Unrelated business taxable income}

^{Under the bill, certain pension trusts owning more than 10 percent of a REIT must treat a percentage of dividends from the REIT as UBTI. This percentage is the gross income derived from an unrelated trade or business (determined as if the REIT were a pension trust) divided by the gross income of the REIT for the year in which the dividends are paid. Dividends are not treated as UBTI, however, unless this percentage is at least five percent.}

^{The UBTI rule applies only if the REIT qualifies as a REIT by reason of the above modification of the five or fewer rule. Moreover, the UBTI rule applies only if (1) one pension trust owns more than 25 percent of the value of the REIT, or (2) a group of pension trusts individually holding more than 10 percent of the value of the REIT collectively own more than 50 percent of the value of the REIT.}

5. Treatment of Certain Real Property Business Debt of Individuals

(sec. 14150 of the House bill, sec. 13150 of the Conference agreement, and secs. 108 and 1017 of the Code)

Qualified real property business indebtedness is indebtedness that (1) is incurred or assumed in connection with real property used in a trade or business, (2) is secured by that real property, and (3) with respect to which the taxpayer has made an election under this provision. Indebtedness incurred or assumed on or after January 1, 1993 is not qualified real property business indebtedness unless it is either (1) debt incurred to refinance qualified real property business debt incurred or assumed before that date (but only to the extent the amount of such debt does not exceed the amount of debt being refinanced) or (2) qualified acquisition indebtedness. Qualified real property business indebtedness does not include qualified farm indebtedness.

Qualified acquisition indebtedness is debt incurred to acquire, construct or substantially improve real property that is secured by such debt, and debt resulting from the refinancing of qualified acquisition debt, to the extent the amount of such debt does not exceed the amount of debt being refinanced.

The amount excluded under the provision with respect to the discharge of any qualified real property business indebtedness may not exceed the excess of (1) the outstanding principal amount of such debt (immediately before the discharge), over (2) the fair market value (immediately before the discharge) of the business real property which is security for the debt. For this purpose, the fair market value of the property is reduced by the outstanding principal amount of any other qualified real property indebtedness secured by the property immediately before the discharge.

The amount excluded under the provision also may not exceed the aggregate adjusted bases (determined as of the first day of the next taxable year or, if earlier, the date of disposition) of depreciable real property held by the taxpayer immediately before the discharge, determined after any reductions under subsections (b) and (g) of section 108. The amount of debt discharge excluded under the provision is applied, using the rules of section 1017 (as modified by the provision), to reduce the basis of business real property held by the taxpayer at the beginning of the taxable year following the taxable year in which the discharge occurs.

The amount that is recaptured as ordinary income (under applicable recapture rules) is reduced over the time the taxpayer continues to hold the property, as the taxpayer forgoes depreciation deductions due to the basis reduction.

6. Increase Recovery Period for Depreciation of Nonresidential Real Property

(sec. 14151 of the House bill, sec. 8151 of the Senate amendment, sec. 13151 of the Conference agreement, and sec. 168 of the Code)

The conferees wish to clarify that the provision does not change the recovery period of any property to which the ACRS amendments made by section 201 of the Tax Reform Act of 1986 do not apply.

(secs. 14161 and 14162 of the House bill, secs. 8161 and 8162 of the Senate amendment, secs. 13161 and 13162 of the Conference agreement, and secs. 4001-4012 of the Code)

The tax applies to sales before January 1, 2000.

The House bill repeals the luxury excise tax imposed on boats, aircraft, jewelry, and furs.

Indexing of tax on automobiles

The House bill modifies the luxury excise tax on automobiles to provide that the $30,000 threshold is indexed annually for inflation occurring after 1990.

Exemption for certain equipment installed on passenger vehicles for use by disabled individuals

The House bill provides that the luxury excise tax does not apply to a part or accessory installed on a passenger vehicle to enable or assist an individual with a disability to operate the vehicle, or to enter or exit the vehicle, in order to compensate for the effect of the disability.

Exemption for demonstrator vehicles

The House bill exempts passenger vehicle dealers from paying the luxury tax on vehicles used as demonstrators for potential customers. Under the provision, the tax, if any, is to be assessed and paid on the sales price of the vehicle when the vehicle is sold.

2. Impose Excise Tax on Diesel Fuel Used in Noncommercial Motorboats

(sec. 14163 of the House bill, sec. 8163 of the Senate amendment, sec. 13163 of the Conference agreement, and secs. 4092, 4041, 6421, 9503, and 9508 of the Code).

The revenues from these taxes, minus the 2.5-cents-per-gallon General Fund rate are deposited in various trust funds. Revenues from the remaining 2.5 cents per gallon are retained in the General Fund through September 30, 1995, after which time the 2.5-cents-per-gallon portion of the taxes (including the tax on diesel fuel used in trains) is scheduled to expire.¹⁰

^{An additional 0.1-cent-per-gallon tax applies to these fuels to finance the Leaking Underground Storage Trust Fund, generally through December 31, 1995.}

^{Diesel fuel used in motorboats is not currently taxed.}

A separate provision of the House bill imposes a Btu tax beginning July 1, 1994. Diesel fuel used by noncommercial motorboats also is subject to the Btu tax beginning at that time.¹¹

^{The tax is collected at the same point in the distribution chain as the highway diesel fuel tax. A separate provision modifies the point of collection for highway diesel fuel.12}

^{The revenues from the 20.1-cents-per-gallon tax on diesel fuel used by motorboats are to be retained in the General Fund.}

In addition, a separate provision of the Senate amendment imposes a 4.3-cents-per-gallon transportation fuels tax effective October 1, 1993. Diesel fuel used by noncommercial motorboats also is to be subject to the transportation fuels tax beginning at that time.¹³

^{Also, a separate provision of the Senate amendment modifies the point of collection for the highway diesel fuel tax.14}

(sec. 14171 of the House bill, sec. 8171 of the Senate amendment, sec. 13171 of the Conference agreement, and secs. 56 and 57 of the Code)

In computing taxable income, a taxpayer who itemizes deductions generally is allowed to deduct the fair market value of property contributed to a charitable organization.¹⁶ However, in the case of a charitable contribution of inventory or other ordinary-income property, short-term capital gain property. or certain gifts to private foundations, the amount of the deduction is limited to the taxpayer's basis in the property.¹⁷ In the case of a charitable contribution of tangible personal property, a taxpayer's deduction is limited to the adjusted basis in such property if the use by the recipient charitable organization is unrelated to the organization's tax-exempt purpose (sec. 170(e)(1)(B)(i)).

For purposes of computing alternative minimum taxable income (AMTI), the deduction for charitable contributions of capital gain property (real, personal, or intangible) is disallowed to the extent that the fair market value of the property exceeds its adjusted basis (sec. 57(a)(6)). However, in the case of a contribution made in a taxable year beginning in 1991 or made before July 1, 1992, in a taxable year beginning in 1992, this rule does not apply to contributions of tangible personal property.

For taxable years beginning after 1989, the AMTI of a corporation is increased by 75 percent of the amount by which adjusted current earnings (ACE) exceeds AMTI (calculated before this adjustment). ACE generally is computed pursuant to the rules that a corporation uses to determine its earnings and profits (sec. 56(g)).

Valuation procedures

Present law and current IRS practice do not provide for a procedure by which a taxpayer may seek determination of the IRS' position with respect to the value of property before the taxpayer donates the property to a charitable organization. However, if a taxpayer claims a charitable contribution deduction for a noncash gift in excess of $5,000 per item or group of similar items (other than certain publicly traded securities), the taxpayer must attach to his of her income tax return a separate form (Form 8283), which provides specific information about the donated property and which is signed by a qualified appraiser.¹⁸

The House bill eliminates the treatment of contributions of appreciated property (real, personal, and intangible) as a tax preference for AMT purposes. In addition, the House bill provides that no adjustment related to the earnings and profits effects of any charitable contribution shall be made in computing the ACE component of the corporate AMT.

Thus, the difference between the fair market value of donated appreciated property and the adjusted basis of such property is not treated as a tax preference item for alternative minimum tax (AMT) purposes. If a taxpayer makes a gift to charity of property (other than inventory or other ordinary income property, short-term capital gain property, or certain gifts to private foundations) that is real property, intangible property, or tangible personal property the use of which is related to the donee's tax-exempt purpose, the taxpayer is allowed to claim a deduction for both regular tax and AMT purposes in the amount of the property's fair market value (subject to present-law percentage limitations).¹⁹

^{Treasury report on advance valuation procedure}

^{Under the House bill, not later than one year after the date of enactment of the bill, the Secretary of the Treasury is required to submit a report to the House Committee on Ways and Means and the Senate Committee on Finance, reporting on the development of an advance valuation procedure under which a taxpayer could elect to enter into an agreement with the Secretary regarding the value of tangible personal property prior to the donation of such property to a qualifying charitable organization (provided that time limits for donation and any other conditions contained in the agreement are satisfied). The report should address the advisability of establishing threshold amounts for claimed value and imposing user fees as prerequisites for seeking an agreement under the procedure, possible limitations on applying the procedure only to items with significant artistic or cultural value, and recommendations for legislative action needed to implement the procedure.}

The Treasury Department must report to Congress not later than one year after the date of enactment on the development of an advance valuation procedure.

The Senate amendment is the same as the House bill.

Treasury report of advance valuation procedure

No provision.

The conference agreement follows the House bill and the Senate amendment.²⁰

^{Treasury report on advance valuation procedure}

^{The conference agreement follows the Senate amendment, but the conferees intend that the Secretary of the Treasury will report to Congress on the development of an advance valuation procedure as contemplated under the House bill statutory provision.}

^{2. Substantiation and Disclosure Requirements for Charitable Contributions}

^{(secs. 14271 and 14272 of the House bill, secs. 8172 and 8173 of the Senate amendment, secs. 13172 and 13173 of the Conference agreement, and sec. 170 and new secs. 6115 and 6714 of the Code)}

A taxpayer is not required to provide specific information on his or her return regarding a claimed charitable contribution made by cash or check; nor in such a case is a donee organization required to file an information return with the IRS, regardless of the amount of cash or check involved. However, taxpayers must provide certain information (on Form 8283) if the amount of the claimed deduction for all noncash contributions exceeds $500.²¹

^{A payment to a charity (regardless of whether it is termed a "contribution") in exchange for which the payor receives an economic benefit is not deductible under section 170, except to the extent that the taxpayer can demonstrate that the payment exceeds the fair market value of the benefit received from the charity.22}

^{The Code does not require a tax-exempt organization that is eligible to receive tax-deductible contributions to state explicitly, in its solicitations for support from members or the general public, whether an amount paid to the organization is deductible as a charitable contribution or whether all or part of the payment constitutes consideration for goods or services furnished to the payor.23} In contrast, tax-exempt organizations that are not eligible to receive tax-deductible contributions are required to state expressly in certain fund-raising solicitations that contributions or gifts to the organization are not deductible as charitable contributions for Federal income tax purposes (sec. 6113).²⁴ A penalty is imposed on such organizations for failure to comply with the section 6113 disclosure requirement, unless reasonable cause is shown (sec. 6710).

Tax-exempt organizations generally are required to file an annual information return (Form 990) with the IRS. However, churches (and their affiliated organizations), as well as tax-exempt organizations (other than private foundations) that normally have gross receipts in each taxable year of not more than $25,000, are not required to file the Form 990.²⁵ If a charity is required to file a Form 990, then it must report, among other items, the names and addresses of all persons who contributed, bequeathed, or devised $5,000 or more (in cash or other property) during the taxable year.²⁶

Substantiation requirement

Section 170 is amended to provide that no deduction is allowed under that section for a separate contribution of $750 or more²⁷ unless the taxpayer has written substantiation from the donee organization of the contribution (including a good faith estimate of the value of any good or service that has been provided to the donor in exchange for making the gift to the donee).

This provision does not impose an information reporting requirement upon charities; rather, it places the responsibility upon taxpayers who claim an itemized deduction for a separate contribution of $750 or more to request (and maintain in their records) substantiation from the charity of their contribution (and any good or service received in exchange). Taxpayers may not rely solely on a canceled check as substantiation for a donation of $750 or more.

Under the provision, a taxpayer must obtain substantiation prior to filing his or her return for the taxable year in which the contribution was made (or if earlier, the due date, including extensions, for filing such return). Substantiation is not required if the donee organization files a return with the IRS (in accordance with Treasury regulations) reporting information sufficient to substantiate the amount of the deductible contribution.²⁸

^{Information disclosure for quid pro quo contributions}

^{A charitable organization that receives aquid pro quo contribution (meaning "a payment made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization") will be required, in connection with the solicitation or receipt of such a contribution, to (1) inform the donor that the amount of the contribution deductible for Federal income tax purposes is limited to the excess of the amount of any money (and the value of any property other than money) contributed by the donor over the value of the goods or services provided by the organization, and (2) provide the donor with a good faith estimate of the value of goods or services furnished to the donor by the organization.}

^{The disclosure requirement applies to allquid pro quo contributions regardless of the dollar amount of the contribution involved (e.g., even in cases with payments of less than $750), and the disclosure must be made by the charity in connection with either the solicitation or receipt of the contribution. Thus, for example, if a charity receives a $75 contribution from a donor, in exchange for which the donor receives a dinner valued at $40, then the charity must inform the donor that only $35 is deductible as a charitable contribution. However, the provision will not apply if onlyde minimis, token goods or services are given to a donor (seeRev. Procs. 90-12 and 92-49, discussed above). Also, the provision will not apply to transactions that have no donative element (e.g., sales of goods by a museum gift shop that are not, in part, donations).}

^{The provision also provides that penalties ($10 per contribution, but capped at $5,000 per particular fundraising event or mailing) may be imposed upon charities that fail to make the required disclosure, unless the failure was due to reasonable cause. The penalties will apply if an organization either fails to make any disclosure in connection with aquid pro quo contribution or makes a disclosure that is incomplete or inaccurate (e.g., an estimate not determined in good faith of the value of goods or services furnished to the donor).}

Substantiation requirement

Section 170 is amended to provide that no deduction is allowed under that section far a separate contribution of $250 or more²⁹ unless the taxpayer has written substantiation from the donee organization of the contribution (including a good faith estimate of the value of any good or service that has been provided to the donor in exchange for making the gift to the donee).³⁰

^{This provision does not impose an information reporting requirement upon charities; rather, it places the responsibility upon taxpayers who claim an itemized deduction for a contribution of $250 or more to request (and maintain in their records) substantiation from the charity of their contribution (and any good or service received in exchange).31} Taxpayers may not rely solely on a canceled check as substantiation for a donation of $250 or more.

Under the provision, a taxpayer must obtain substantiation prior to filing his or her return for the taxable year in which the contribution was made (or if earlier, the due date, including extensions, for filing such return).³² Substantiation is not required if the donee organization files a return with the IRS (in accordance with Treasury regulations) reporting information sufficient to substantiate the amount of the deductible contribution.³³

^{The provision explicitly provides that, if in return for making a contribution of $250 or more to a religious organization, a donor receives in return solely an intangible religious benefit that generally is not sold in commercial transactions outside the donative context (e.g., admission to a religious ceremony34}), then such a religious benefit may be disregarded for purposes of the substantiation requirement.

Information disclosure for quid pro quo contributions

A charitable organization that receives a quid pro quo contribution in excess of $75 (meaning a payment exceeding $75 "made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization") is required, in connection with the solicitation or receipt of such a contribution, to provide a written statement to the donor that (1) informs the donor that the amount of the contribution that is deductible for Federal income tax purposes is limited to the excess of the amount of any money (and the value of any property other than money) contributed by the donor over the value of the goods or services provided by the organization, and (2) provides the donor with a good faith estimate of the value of goods or services furnished to the donor by the organization.³⁵

^{The disclosure requirement applies to allquid pro quo contributions where the donor makes a payment of more than $75.36} Thus, for example, if a charity receives a $100 contribution from a donor, in exchange for which the donor receives a dinner valued at $40, then the charity must inform the donor in writing that only $60 is deductible as a charitable contribution. However, the provision does not apply if only de minimis, token goods or services are given to a donor (see Rev. Procs. 90-12 and 92-49, discussed above). In addition, as with the substantiation provision (described above), the provision does not apply to a contribution in return for which the contributor receives solely an intangible religious benefit that generally is not sold in a commercial transaction outside the donative context.³⁷ Furthermore, the provision does not apply to transactions that have no donative element (e.g., sales of goods by a museum gift shop that are not, in part, donations).

The provision also provides that penalties ($10 per contribution, but capped at $5,000 per particular fundraising event or mailing) may be imposed upon charities that fail to make the required disclosure, unless the failure was due to reasonable cause. The penalties will apply if an organization either fails to make any disclosure in connection with a quid pro quo contribution or makes a disclosure that is incomplete or inaccurate (e.g., an estimate not determined in good faith of the value of goods or services furnished to the donor).

However, with respect to the substantiation provision, the conference agreement clarifies that in cases where, in consideration (in whole or in part) for a contribution of $250 or more, a religious organization furnishes to the contributor solely an intangible religious benefit generally not sold in a commercial transaction outside the donative context, the written substantiation must contain a statement to the effect that an intangible religious benefit was so furnished, but the substantiation need not further describe, nor provide a valuation for, such benefit.³⁹

^{In addition, the conferees intend that the authority granted to the Secretary of the Treasury to issue regulations providing that some or all of the requirements of the substantiation provision do not apply in appropriate cases shall be exercised to clarify the treatment of contributions made through payroll deductions.}

^{3. Extension of General Fund Transfer to Railroad Retirement Tier 2 Fund}

^{(sec. 14172 of the House bill and sec. 8174 of the Senate amendment)}

4. Extension of Health Insurance Deduction for Self-Employed Individuals

(sec. 14173 of the House bill, sec. 8175 of the Senate amendment, sec. 13174 of the Conference agreement, and sec. 162(1) of the Code)

For coverage prior to July 1, 1992, a self-employed individual was allowed to deduct as a business expense up to 25 percent of the amount paid for health insurance coverage for the taxpayer, the taxpayer's spouse, and the taxpayer's dependents. Only amounts paid prior to July 1, 1992, for coverage before that date were eligible for the deduction. The deduction was not allowed if the self-employed individual or his or her spouse were eligible for employer-paid health benefits.

(secs. 14201-14205 of the House bill, secs. 8201-8205 of the Senate amendment, secs. 13201-13205 of the Conference agreement, and secs. 1, 55, 68, and 151 of the Code)

For 1993, the individual income tax rates are as follows--

 If taxable income is:                        Then income tax equals:

The individual income tax brackets are indexed each year for inflation.

Alternative minimum tax

An individual taxpayer is subject to an alternative minimum tax (AMT) to the extent that the taxpayer's tentative minimum tax exceeds the taxpayer's regular tax liability. A taxpayer's tentative minimum tax generally equals 24 percent of alternative minimum taxable income (AMTI) in excess of an exemption amount. The exemption amount is $40,000 for married taxpayers filing joint returns, $30,000 for unmarried taxpayers filing as single or head of household, and $20,000 for married taxpayers filing separate returns, estates, and trusts. The exemption amount is phased out for taxpayers with AMTI above specified thresholds. These thresholds are: $150,000 for married taxpayers filing joint returns, $112,500 for unmarried taxpayers filing as single or head of household, and $75,000 for married taxpayers filing separate returns, estates, and trusts. The exemption is completely phased out for individuals with AMTI above $310,000 (married taxpayers filing joint returns) or $232,500 (unmarried taxpayers filing as single or head of household). The exemption amount and the thresholds are not indexed for inflation.

Surtax on higher-income taxpayers

Under present law, there is no surtax imposed on higher-income individuals.

Itemized deduction limitation

Under present law, individuals who do not elect the standard deduction may claim itemized deductions (subject to certain limitations) for certain expenses incurred during the taxable year. Among these deductible expenses are unreimbursed medical expenses, unreimbursed casualty and theft losses, charitable contributions, qualified residence interest, State and local income and property taxes, unreimbursed employee business expenses, and certain other miscellaneous expenses.

Certain itemized deductions are allowed only to the extent that the amount exceeds a specified percentage of the taxpayer's adjusted gross income (AGI). Unreimbursed medical expenses for care of the taxpayer and the taxpayer's spouse and dependents are deductible only to the extent that the total of these expenses exceeds 7.5 percent of the taxpayer's AGI. Nonbusiness, unreimbursed casualty or theft losses are deductible only to the extent that the amount of loss arising from each casualty or theft exceeds $100 and only to the extent that the net amount of casualty and theft losses exceeds 10 percent of the taxpayer's AGI. Unreimbursed employee business expenses and certain other miscellaneous expenses are deductible only to the extent that the total of these expenses exceeds 2 percent of the taxpayer's AGI.

The total amount of otherwise allowable itemized deductions (other than medical expenses, casualty and theft losses, and investment interest) is reduced by 3 percent of the amount of the taxpayer's AGI in excess of $108,450 in 1993 (indexed for inflation). Under this provision, otherwise allowable itemized deductions may not be reduced by more than 80 percent. In computing the reduction of total itemized deductions, all present-law limitations applicable to such deductions are first applied and then the otherwise allowable total amount of deductions is reduced in accordance with this provision.

The reduction of otherwise allowable itemized deductions does not apply to taxable years beginning after December 31, 1995.

Personal exemption phaseout

Present law permits a personal exemption deduction from gross income for an individual, the individual's spouse1 and each dependent. For 1993, the amount of this deduction is $2,350 for each exemption claimed. This exemption amount is adjusted for inflation. The deduction for personal exemptions is phased out for taxpayers with AGI above a threshold amount (indexed for inflation) which is based on filing status. For 1993, the threshold amounts are $162,700 for married taxpayers filing joint returns, $81,350 for married taxpayers filing separate returns, $135,600 for unmarried taxpayers filing as head of household, and $108,450 for unmarried taxpayers filing as single.

The total amount of exemptions that may be claimed by a taxpayer is reduced by 2 percent for each $2,500 (or portion thereof) by which the taxpayer's AGI exceeds the applicable threshold. (The phaseout rate is 2 percent for each $1,250 for married taxpayers filing separate returns.) Thus, the personal exemptions claimed are phased out over a $122,500 range (which is not indexed for inflation), beginning at the applicable threshold.

This provision does not apply to taxable years beginning after December 31, 1996.

The House bill imposes a new 36-percent marginal tax rate on taxable income in excess of the following thresholds:

           Filing status                      Applicable threshold

As under present law, the tax rate bracket thresholds are indexed for inflation. However, indexing of thresholds for the 36-percent rate applies to taxable years beginning after December 31, 1994.

Alternative minimum tax

The House bill provides a two-tiered graduated rate schedule for the AMT for taxpayers other than corporations. A 26-percent rate applies to the first $175,000 of a taxpayer's AMTI in excess of the exemption amount, and a 28-percent rate applies to AMTI more than $175,000 above the exemption amount. For married individuals filing separate returns, the 28-percent rate applies to AMTI more than $87,500 above the exemption amount. The bill increases the exemption amount to $45,000 for married individuals filing joint returns, to $33,750 for unmarried individuals, and to $22,500 for married individuals filing separate returns, estates, and trusts.

Surtax on higher-income taxpayers

The House bill provides a 10-percent surtax on individuals with taxable income in excess of $250,000 and on estates and trusts with taxable income in excess of $7,500. For married taxpayers filing separate returns, the threshold amount for the surtax is $125,000. The surtax is computed by applying a 39.6-percent rate to taxable income in excess of the applicable threshold. Under this method of computation, unlike a simple 10-percent increase in tax liability, net capital gain income is not subject to tax at a rate in excess of the current 28-percent maximum rate. The thresholds for the surtax are indexed for inflation in the same manner as other individual income tax rate thresholds for taxable years beginning after December 31, 1994.

Itemized deduction limitation and phaseout of personal exemptions

The House bill makes permanent the provisions that limit itemized deductions and phase out personal exemptions.

The Senate amendment generally follows the House bill with respect to the new 36-percent marginal tax rate. However, for taxable years beginning in 1993, a blended rate (described below) is used.

Alternative minimum tax

The Senate amendment generally follows the House bill. However, for taxable years beginning in 1993, a blended rate (described below) is used.

Surtax on higher-income taxpayers; surtax on net capital gain

The Senate amendment generally follows the House bill and imposes a 10-percent surtax on individuals with taxable income in excess of $250,000 and on estates and trusts with taxable income in excess of $7,500. For married taxpayers filing separate returns, the threshold amount for the surtax is $125,000. The surtax is computed by applying a 39.6-percent rate to taxable income in excess of the applicable threshold. However, the Senate amendment also imposes the surtax on net capital gain income. An individual's net capital gain is subject to the surtax by applying a maximum rate of 30.8 percent (instead of the present-law maximum rate of 28 percent) to capital gain income to the extent an individual's taxable income exceeds $250,000. For taxable years beginning in 1993, a blended rate (described below) is used.

Itemized deduction limitation and phaseout of personal exemptions

The Senate amendment is the same as the House bill.

In addition, the conference agreement contains a provision permitting individual taxpayers to elect to pay their additional 1993 taxes that are attributable to the rate increases contained in the conference agreement in three annual installments. The first installment must be paid on or before the due date for the individual's taxable year that begins in calendar year 1993; the second installment must be paid on or before the date one year after that date; and the third installment must be paid on or before the date two years after that date. The election must be made on the tax return for the individual's taxable year that begins in 1993 (which, in general, is due on April l5, 1994).

The amount eligible for this installment payment election is the excess of the individual's net liability under chapter 1 of the Code as shown on the individual's tax return over the amount that would have been the individual's net liability but for the amendments made by the conference report that alter the individual tax rates (i.e., the 36 percent and 39.6 percent marginal tax rates). These amounts are computed after the application of any credit (except the credit for wage withholding and the credit for special fuel uses) and before crediting any payment of estimated tax. Amounts required to be shown on the return but not actually shown on the return are ineligible for this installment payment election.

The Secretary shall immediately terminate this installment payment election, and the whole amount of the unpaid tax shall be paid immediately upon notice and demand from the Secretary, if either (1) the taxpayer does not pay any installment on or before the required date, or (2) the Secretary believes that the collection of any amount under this installment payment election is in jeopardy.

Because this installment payment election applies only to amounts actually shown on the individual's tax return, those amounts are considered to be assessed. Consequently, the 10-year statute of limitations applicable to collection after assessment (sec. 6502) is applicable to these installment payments.

2. Provisions to Prevent Conversion of Ordinary Income to Capital Gain

(sec. 14206 of the House bill, sec. 8206 of the Senate amendment, and sec. 13206 of the Conference agreement)

Gain or loss from the sale or exchange of a capital asset generally is treated as capital gain or loss. Net capital gain (i.e., net long-term capital gain less net short-term capital loss) of an individual is subject to a maximum tax rate of 28 percent. Generally, capital losses are not deductible against ordinary income.

A conversion transaction is a transaction, generally consisting of two or more positions taken with regard to the same or similar property, where substantially all of the taxpayer's return is attributable to the time value of the taxpayer's net investment in the transaction. In a conversion transaction, the taxpayer is in the economic position of a lender -- he has an expectation of a return from the transaction which in substance is in the nature of interest and he undertakes no significant risks other than those typical of a lender. However, a transaction is not a conversion transaction subject to the provision unless it also satisfies one of the following four criteria: (1) the transaction consists of the acquisition of property by the taxpayer and a substantially contemporaneous agreement to sell the same or substantially identical property in the future; (2) the transaction is a straddle, within the meaning of section 1092⁴⁰; (3) the transaction is one that was marketed or sold to the taxpayer on the basis that it would have the economic characteristics of a loan but the interest-like return would be taxed as capital gain; or (4) the transaction is described as a conversion transaction in regulations promulgated by the Secretary of the Treasury.

Under the provision, gain realized by a taxpayer from a conversion transaction that would otherwise be treated as capital gain will be treated as ordinary income (but not as interest) for all purposes of the Internal Revenue Code. The amount of gain so recharacterized will not exceed the amount of interest that would have accrued on the taxpayer's net investment for the relevant period at a yield equal to 120% of the "applicable rate". This limit is subject to appropriate reduction to reflect prior inclusion of ordinary income items from the conversion transaction or the capitalization of interest on acquisition indebtedness under section 263(g). The "applicable rate" is the applicable Federal rate under section 1274(d) at the time the taxpayer enters into the conversion transaction (if the conversion transaction has a definite term) or the Federal short term rate determined under section 6621(b) (if the conversion transaction has an indefinite term).

First, the conferees clarify that the Secretary has the authority (under sec. 1274(d)(1)(D)) to provide for the use of an applicable rate lower than the applicable Federal rate in appropriate cases. Second, the conferees clarify that transactions (including transactions involving positions other than options or section 1256 contracts) of options dealers and commodities traders in the normal course of their trade or business of dealing in options or trading section 1256 contracts, respectively, will not be considered conversion transactions, except as provided in the special rules noted below.

Third, under the agreement, the term "commodities trader" includes any person who is a member of a domestic board of trade (including a member having member trading privileges only with respect to a portion of the contracts available for trading on the board of trade) which is designated as a contract market by the Commodity Futures Trading Commission. "Commodities trader" also, except as otherwise provided by Treasury regulations, includes a person entitled to trade as a member, such as a lessee of a membership or an entity that is (or is affiliated with) a beneficial owner of a membership if such entity is eligible for any preferential rates available to members with respect to transaction fees or margins imposed by the board of trade or for the clearing of trades on the board of trade. Other persons eligible for such member rates also will be treated as "commodities traders" for purposes of the exception; however, the Secretary may promulgate regulations that prevent unwarranted expansion of the exception, by excluding from the definition of "commodities trader" a person who acquires some attributes of board of trade membership for the principal purpose of qualifying for the "commodities trader" exception or whose margins or fees are substantially more than the margins or fees associated with owned or leased memberships.

Special rules limit the availability of the options dealer and commodities trader exception for limited partners or limited entrepreneurs in an entity that is an options dealer or a commodities trader.

Gain on the disposition of a market discount bond generally must be recognized as ordinary income to the extent of the market discount that has accrued. This ordinary income rule, however, does not apply to tax-exempt obligations or to market discount bonds issued on or before July 18, 1984. Under current law, income attributable to accrued market discount on tax-exempt bonds is not tax-exempt but is taxable as capital gain if the bond is held as a capital asset.

A stripped bond (i.e., a bond issued with interest coupons some of which are subsequently "stripped" so that the ownership of the bond is separated from the ownership of the interest coupons) generally is treated as a bond issued with OID equal to (1) the stated redemption price of the bond at maturity minus (2) the amount paid for the stripped bond.

If preferred stock is stripped of some of its dividend rights, however, the stripped stock is not subject to the rules that apply to stripped bonds or to the rules that apply to bonds and certain preferred stock issued at a discount.

Stripped preferred stock is defined as any preferred stock where the ownership of the stock has been separated from the right to receive any dividend that has not yet become payable. The provision applies to stock that is limited and preferred as to dividends, does not participate in corporate growth to any significant extent, and has a fixed redemption price.

No inference is intended as to as to the treatment of stripped preferred stock for tax purposes with respect to any issues not directly addressed by this legislation, including the availability of the dividends received deduction to a holder of dividends stripped from preferred stock, the allocation of basis by the creator of stripped preferred stock, or the proper characterization of a purported sale of stripped dividend rights.

Investment interest that is allowable is deductible against income taxable at ordinary income rates. The net capital gain (i.e., net long-term capital gain less net short-term capital loss) of a noncorporate taxpayer is taxed at a maximum rate of 28 percent.

Prior to 1986, when a significant rate differential existed between long-term capital gains and ordinary income, long-term capital gains were not included in investment income for purposes of computing the investment interest limitation.

For these purposes, inventory is treated as substantially appreciated if the value of the partnership's inventory exceeds both 120 percent of its adjusted basis and 10 percent of the value of all partnership property (other than money).

3. Repeal Health Insurance Wage Base Cap

(sec. 14207 of the House bill, sec. 8207 of the Senate amendment, sec. 13207 of the Conference agreement, and sec. 3121(x) of the Code)

Under the Self-Employment Contributions Act of 1954 (SECA), a tax is imposed on an individual's self-employment income. The self-employment tax rate is the same as the total rate for employers and employees (i.e., 2.9 percent for HI and 12.40 percent for OASDI). For 1993, the HI tax is applied to the first $135,000 of self-employment income and the OASDI tax is applied to the first $57,600 self-employment income. In general, the tax is reduced to the extent that the individual had wages for which employment taxes were withheld during the year.

The cap on wages and self-employment income subject to FICA and SECA taxes is indexed to changes in the average wages in the economy.

4. Reinstate Top Estate and Gift Tax Rates

(sec. 14208 of the House bill, sec. 8208 of the Senate amendment, sec. 13208 of the Conference agreement, and sec. 2001 of the Code)

In order to phase out the benefit of the graduated brackets and unified credit, the estate and gift tax is increased by five percent on cumulative taxable transfers between $10 million and $18,340,000, for decedents dying and gifts made after 1992.⁴² (Prior to 1993, this phase out of the graduated rates and unified credit applied to cumulative taxable transfers between $10 million and $21,040,000.)

5. Reduce Deductible Portion of Business Meals and Entertainment Expenses

(sec. 14209 of the House bill, secs. 8209 and 8209A of the Senate amendment, sec. 13209 of the Conference agreement, and sec. 274(n) of the Code)

Meal and entertainment expenses incurred for business or investment reasons are deductible if certain legal and substantiation requirements are met. The amount of the deduction generally is limited to 80 percent of the expense that meets these requirements. No deduction is allowed, however, for meal or beverage expenses that are lavish or extravagant under the circumstances.

No deduction is allowed with respect to business meal and entertainment expenses (as well as other specified items) unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement (1) the amount of the expense, (2) the time and place of the expense, (3) the business purpose of the expense, and (4) the business relationship to the taxpayer of the persons entertained. Under Treasury regulations, such documentary evidence is required for expenditures of $25 or more (Treas. Reg. sec. 1.274-5T(c)(2)(iii)(B)).

Section 8209A of the Senate amendment includes a sense of the Senate resolution that the conferees should reduce or eliminate the proposed reduction in the deductible portion of otherwise allowable business meals and entertainment expenses.

6. Deny Deduction for Club Dues

(sec. 14210 of the House bill, sec. 8210 of the Senate amendment, sec. 13210 of the Conference agreement, and sec. 274(a) of the Code)

Dues for airline and hotel clubs are not subject to the deduction disallowance.

7. Deny Deduction for Executive Pay Over $1 Million

(sec. 14211 of the House bill, sec. 8211 of the Senate amendment, sec. 13211 of the Conference agreement, and sec. 162 of the Code)

Under the House bill, for purposes of the regular income tax and the alternative minimum tax, the otherwise allowable deduction for compensation paid or accrued with respect to a covered employee of a publicly held corporation is limited to no more than $1 million per year.

Certain types of compensation are not subject to the deduction limit and are not taken into account in determining whether other compensation exceeds $1 million. The following types of compensation are not taken into account: (1) remuneration payable on a commission basis: (2) remuneration payable solely on account of the attainment of one or more performance goals if certain independent director and shareholder approval requirements are met: (3) payments to a tax-qualified retirement plan (including salary reduction contributions); (4) amounts that are excludable from the executive's gross income (such as employer provided health benefits and miscellaneous fringe benefits (sec. 132)); and (5) any remuneration payable under a written binding contract which was in effect on February 17, 1993, and all times thereafter before such remuneration was paid and which was not modified thereafter in any material respect before such remuneration was paid.

The conference agreement follows the Senate amendment, with certain modifications and clarifications.

Under the conference agreement, for purposes of the regular income tax and the alternative minimum tax, the otherwise allowable deduction for compensation paid or accrued with respect to a covered employee of a publicly held corporation is limited to no more than $1 million per year.⁴⁴

Definition of publicly held corporation

For purposes of this provision, a corporation is treated as publicly held if the corporation has a class of common equity securities that is required to be registered under section 12 of the Securities Exchange Act of 1934. In general, the Securities Exchange Act requires a corporation to register its common equity securities under section 12 if (1) the securities are listed on a national securities exchange or (2) the corporation has $5 million or more of assets and 500 or more holders of such securities. A corporation is not considered publicly held under the provision if registration of its equity securities is voluntary. Such a voluntary registration might occur, for example, if a corporation that otherwise is not required to register its equity securities does so in order to take advantage of other procedures with regard to public offerings of debt securities.

Covered employees

Covered employees are defined by reference to the Securities and Exchange Commission (SEC) rules governing disclosure of executive compensation. Thus, with respect to a taxable year, a person is a covered employee if (1) the employee is the chief executive officer of the corporation (or an individual acting in such capacity) as of the close of the taxable year or (2) the employee's total compensation is required to be reported for the taxable year under the Securities Exchange Act of 1934 because the employee is one of the four highest compensated officers for the taxable year (other than the chief executive officer). If disclosure is required with respect to fewer than four executives (other than the chief executive officer) under the SEC rules, then only those for whom disclosure is required are covered employees.

Compensation subject to the deduction limitation

The deduction limitation applies when the deduction would otherwise be taken. Thus, for example, in the case of a nonqualified stock option, the deduction is normally taken in the year the option is exercised, even though the option was granted with respect to services performed in a prior year.⁴⁵

Certain types of compensation are not subject to the deduction limit and are not taken into account in determining whether other compensation exceeds $1 million. The following types of compensation are not taken into account: (1) remuneration payable on a commission basis; (2) remuneration payable solely on account of the attainment of one or more performance goals if certain outside director and shareholder approval requirements are met; (3) payments to a tax-qualified retirement plan (including salary reduction contributions); (4) amounts that are excludable from the executive's gross income (such as employer provided health benefits and miscellaneous fringe benefits (sec. 132)); and (5) any remuneration payable under a written binding contract which was in effect on February 17, 1993, and all times thereafter before such remuneration was paid and which was not modified thereafter in any material respect before such remuneration was paid.

Other performance-based compensation

Stock options or other stock appreciation rights generally are treated as meeting the exception for performance-based compensation, provided that the requirements for outside director and shareholder approval are met (without the need for certification that the performance standards have been met), because the amount of compensation attributable to the options or other rights received by the executive would be based solely on an increase in the corporation's stock price. In the case of stock options, it is intended that the directors may retain discretion as to the exact number of options that are granted to an executive, provided that the maximum number of options that the individual executive may receive during a specified period is predetermined.

Stock-based compensation is not treated as performance-based if it is dependent on factors other than corporate performance. For example, if a stock option is granted to an executive with an exercise price that is less than the current fair market value of the stock at the time of grant, then the executive would have the right to receive compensation on the exercise of the option even if the stock price decreases or stays the same. Thus, stock options that are granted with an exercise price that is less than the fair market value of the stock at the time of grant do not meet the requirements for performance-based compensation. Similarly, if the executive is otherwise protected from decreases in the value of the stock (such as through automatic repricing), the compensation is not performance-based.

In contrast to options or other stock appreciation rights, grants of restricted stock are not inherently performance-based because the executive may receive compensation even if the stock price decreases or stays the same. Thus, a grant of restricted stock is treated like cash compensation and does not satisfy the definition of performance-based compensation unless the grant or vesting of the restricted stock is based upon the attainment of a performance goal and otherwise satisfies the standards for performance-based compensation under the bill.

Compensation does not qualify for the performance-based exception if the executive has a right to receive the compensation notwithstanding the failure of (1) the compensation committee to certify attainment of the performance goal (or goals) or (2) the shareholders to approve the compensation.

In the case of performance-based compensation paid pursuant to a plan (other than a stock option plan), the shareholder approval requirement generally is satisfied if the shareholders approve the specific terms of the plan, including the class of executives to which it applies. In the case of a stock option plan, the shareholders generally must approve the specific terms of the plan, the class of executives to which it applies, the option price (or formula under which the price is determined), and the maximum number of shares subject to option that can be awarded under the plan to any executive. Further shareholder approval of payments under a plan or grants of options is not required after the plan has been approved. Of course, if there are material changes to the plan, shareholder approval would have to be obtained again in order for the exception to apply to payments under the modified plan.

It is intended that not all the details of a plan (or agreement) need be disclosed in all cases. In developing standards as to whether disclosure of the terms of a plan or agreement is adequate, the Secretary should take into account the SEC rules regarding disclosure. To the extent consistent with those rules, however, disclosure should be as specific as possible. It is expected that shareholders will, at a minimum, be made aware of the general performance goals on which the executive's compensation is based and the maximum amount that could be paid to the executive if such performance goals were met. For example, it would not be adequate if the shareholders were merely informed that an executive would be awarded $x "if the executive meets certain performance goals established by the compensation committee."

Under present law, in the case of a privately held company that becomes publicly held, the prospectus is subject to the rules similar to those applicable to publicly held companies. Thus, if there has been disclosure that would satisfy the rules described above, persons who buy stock in the publicly held company will be aware of existing compensation arrangements. No further shareholder approval is required of compensation arrangements existing prior to the time the company became public unless there is a material modification of such arrangements. It is intended that similar rules apply in the case of other business transactions.

Compensation payable under a written binding contract

Remuneration payable under a written binding contract which was in effect on February 17, 1993, and at all times thereafter before such remuneration was paid is not subject to the deduction limitation.

Compensation paid pursuant to a plan qualifies for this exception provided that the right to participate in the plan is part of a written binding contract with the covered employee in effect on February 17, 1993. For example, suppose a covered employee was hired by XYZ Corporation on January 17, 1993, and one of the terms of the written employment contract is that the executive is eligible to participate in the "XYZ Corporation Executive Deferred Compensation Plan" in accordance with the terms of the plan. Assume further that the terms of the plan provide for participation after 6 months of employment, amounts payable under the plan are not subject to discretion, and the corporation does not have the right to amend materially the plan or terminate the plan (except on a prospective basis before any services are performed with respect to the applicable period for which such compensation is to be paid). Provided that the other conditions of the binding contract exception are met (e.g., the plan itself is in writing), payments under the plan are grandfathered, even though the employee was not actually a participant in the plan on February 17, 1993.⁴⁷

^{The fact that a plan was in existence on February 17, 1993, is not by itself sufficient to qualify the plan for the exception for binding written contracts.}

^{The exception for remuneration paid pursuant to a binding written contract ceases to apply to amounts paid after there has been a material modification to the terms of the contract. The exception does not apply to new contracts entered into or renewed after February 17, 1993. For purposes of this rule, any contract that is entered into on or before February 17, 1993, and that is renewed after such date is treated as a new contract entered into on the day the renewal takes effect. A contract that is terminable or cancelable unconditionally at will by either party to the contract without the consent of the other, or by both parties to the contract, is treated as a new contract entered into on the date any such termination or cancellation, if made, would be effective. However, a contract is not treated as so terminable or cancelable if it can be terminated or cancelled only by terminating the employment relationship of the covered employee.}

8. Reduce Compensation Taken Into Account for Qualified Retirement Plan Purposes

(sec. 14212 of the House bill, sec. 8212 of the Senate amendment, sec. 13212 of the Conference agreement, and sec. 401(a)(17) of the Code)

In the case of an eligible participant in a plan maintained by a State or local government, the limit on compensation taken into account is the greater of the limit under the Senate amendment and the compensation allowed to be taken into account under the plan as in effect on July 1, 1993. For purposes of this rule, an eligible participant is an individual who first became a participant in the plan during a plan year beginning before the first plan year beginning after the earlier of: (1) the plan year in which the plan is amended to reflect the proposal, or (2) December 31, 1995. This special rule does not apply unless the plan is amended to incorporate the dollar limit in effect under section 401(a)(17) by reference, effective with respect to persons other than eligible participants for benefits accruing in plan years beginning after December 31, 1995 (or earlier if the plan amendment so provides).

In the case of a plan maintained pursuant to one or more collective bargaining agreements ratified before the date of enactment, the provision does not apply to contributions or benefits accruing under such agreements in plan years beginning before the earlier of (1) the latest of (a) January 1, 1994, (b) the date on which the last of such collective bargaining agreements terminates (without regard to any extension or modification on or after the date of enactment), or (c) in the case of a plan maintained pursuant to collective bargaining under the Railway Labor Act, the date of execution of an extension or replacement of the last of such collective bargaining agreements in effect on the date of enactment, or (2) January 1, 1997.

9. Modify Deduction for Moving Expenses

(sec. 14213 of the House bill, sec. 8213 of the Senate amendment, sec. 13213 of the Conference agreement, and secs. 62, 132, and 217 of the Code)

Deductible moving expenses are the expenses of transporting the taxpayer and members of the taxpayer's household, as well as household goods and personal effects, from the old residence to the new residence; the cost of meals and lodging en route; the expenses for pre-move house-hunting trips; temporary living expenses for up to 30 days in the general location of the new job; and certain expenses related to either the sale of (or settlement of an unexpired lease) on the old residence, or the purchase of (or acquisition of a lease on) a new residence in the general location of the new job.

The moving expense deduction is subject to a number of limitations. A maximum of $1,500 can be deducted for pre-move house-hunting and temporary living expenses in the general location of the new job. A maximum of $3,000 (reduced by any deduction claimed for house-hunting or temporary living expenses) can be deducted for certain qualified expenses for the sale or purchase of a residence or settlement or acquisition of a lease. If both a husband and wife begin new jobs in the same general location, the move is treated as a single commencement of work. If a husband and wife file separate returns, the maximum deductible amounts available to each are one-half the amounts otherwise allowed.

Also, in order for a taxpayer to claim a moving expense deduction, the taxpayer's new principal place of work must be at least 35 miles farther from the taxpayer's former residence than was the taxpayer's former principal place of work (or at least 35 miles from the taxpayer's former residence, if the taxpayer has no former place of work).

The conference agreement follows the House bill with the following modifications: (1) the cost of pre-move house-hunting trips is excluded from the definition of moving expenses; (2) the cost of temporary living expenses for up to 30 days in the general location of the new job is excluded from the definition of moving expenses; (3) the mileage limit is increased from 35 miles to 50 miles; (4) moving expenses not paid or reimbursed by the taxpayer's employer are allowable as a deduction in calculating adjusted gross income; and (5) moving expenses paid or reimbursed by the taxpayer's employer are excludable from gross income.

Definition of moving expenses

Under the conference agreement, moving expenses are defined as the reasonable costs of (1) moving household goods and personal effects from the former residence to the new residence and (2) traveling (including lodging during the period of travel) from the former residence to the new place of residence. Moving expenses do not include any expenses for meals.

Employer-paid moving expenses

Moving expenses are excludable from gross income and wages for income and employment tax purposes to the extent paid for by the taxpayer's employer (whether directly or through reimbursement). Moving expenses are not excludable if the taxpayer actually deducted the expenses in a prior taxable year. The conferees intend that the employer treat moving expenses as excludable unless it has actual knowledge that the employee deducted the expenses in a prior year. The employer has no obligation to determine whether the individual deducted the expenses.

The conferees intend that rules similar to the rules relating to accountable plans under section 62(c) will apply to reimbursed expenses.

Moving expenses not paid for by the employer

Moving expenses are deductible in computing adjusted gross income to the extent not paid for by the taxpayer's employer (whether directly or through reimbursement). Allowing such a deduction will treat taxpayers whose expenses are not paid for by their employer in a comparable manner to taxpayers whose moving expenses are paid for by their employer.

10. Modify Estimated Tax Requirements for Individuals

(sec. 14214 of the House bill, sec. 8214 of the Senate amendment, sec. 13214 of the Conference agreement, and sec. 6654 of the Code)

In addition, for taxable years beginning after 1991 and before 1997, a special rule provides that the 100 percent of last year's liability safe harbor generally is not available to a taxpayer that (1) has a modified adjusted gross income (AGI) in the current year that exceeds the taxpayer's AGI in the preceding year by more than $40,000 ($20,000 in the case of a separate return by a married individual) and (2) has a modified AGI in excess of $75,000 in the current year ($37,500 in the case of a separate return by a married individual).

For taxable years beginning after 1993, the House bill does not change the availability of (1) the 100 percent of last year's liability safe harbor for an individual with a preceding year AGI of $150,000 or less, or (2) the present-law rule that allows any individual to base estimated tax payments on 90 percent of the tax shown on the return for the current year.

11. Increase Taxable Portion of Social Security and Railroad Retirement Tier 1 Benefits

(sec. 14215 of the House bill, sec. 8215 of the Senate amendment, sec. 13215 of the Conference agreement, and sec. 86 of the Code)

A taxpayer may receive a lump-sum payment of benefits which includes benefits for one or more earlier years. In general, such payments are includible in total benefits in the year received. However, a taxpayer receiving these lump-sum benefits may elect to calculate their tax liability as if the benefits had been received in the year to which they are attributable (using the other elements of provisional income related to that year) and then include the appropriate amount in gross income for the current taxable year (in addition to the amount of benefits attributable to the current taxable year that are includible in gross income).

Proceeds from the income taxation of these benefits are credited quarterly to the Old-Age and Survivors Insurance Trust Fund, the Disability Insurance Trust Fund, or the Social Security Equivalent Benefit Account (of the Railroad Retirement system), as appropriate.

Proceeds from the income taxation of Social Security and Railroad Retirement Tier 1 benefits attributable to the increased portion of benefits included in gross income will be retained in the General Fund.

For taxpayers with provisional incomes above these higher thresholds, gross income includes the lesser of:

For purposes of this computation, a taxpayer's provisional income (modified adjusted gross income plus one-half of the taxpayer's Social Security or Railroad Retirement Tier 1 benefit) is calculated in the same manner as under present law.

Revenues from the income taxation of Social Security and Railroad Retirement Tier 1 benefits attributable to the increased portion of benefits included in gross income will be transferred to the Medicare Hospital Insurance (HI) Trust Fund.

(sec. 14221 of the House bill, sec. 8221 of the Senate amendment, sec. 13221 of the Conference agreement, and sec. 11 of the Code)

A corporation with taxable income in excess of $15 million is required to increase its tax liability by the lesser of 3 percent of the excess or $100,000. This increase in tax recaptures the benefits of the 34-percent rate in a manner analogous to the recapture of the benefits of the 15- and 25-percent rates.

Some taxpayers may be subject to the increased corporate tax rates with respect to a taxable year that has already ended. Those taxpayers may have filed an application for an extension of the time for filing their corporate income tax returns pursuant to section 6081. For such a filing to be valid, the taxpayer must remit "the amount of the properly estimated unpaid tax liability" (Treas. Reg. sec. 1.6081-3). The conferees intend that the IRS apply this provision by computing that amount by reference to the law in effect on the date the application for the extension was filed.

2. Disallowance of Deduction for Lobbying Expenses

(sec. 14222 of the House bill, sec. 8222 of the Senate amendment, sec. 13222 of the Conference agreement, and secs. 162, 170, and 6033 of the Code)

Taxpayers engaged in a trade or business generally are allowed a deduction for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on such trade or business (sec. 162). Present-law section 162(e)(1) specifically provides a deduction for certain so-called "direct lobbying" expenses (including travel expenses, costs of preparing testimony, and a portion of dues) paid in carrying on a trade or business if such expenses are (1) in direct connection with appearances before, submissions of statements to, or sending communications to, the committees, or individual members, of Congress or of any legislative body of a State, a possession of the United States, or a political subdivision of any of the foregoing with respect to legislation or proposed legislation of direct interest to the taxpayer, or (2) in direct connection with communication of information between the taxpayer and an organization of which the taxpayer is a member with respect to legislation or proposed legislation of direct interest to the taxpayer and to such organization.⁴⁹

^{Section 162(e)(2) provides, however, that no deduction is allowed for any amount paid (whether by contribution, gift, or otherwise) for participation or intervention in any political campaign (i.e., "political campaign" expenses) or in connection with any attempt to influence the general public, or segments thereof, with respect to legislative matters, elections or referendums (i.e., "grass roots lobbying").}

^{Treasury regulations further provide that if expenditures for lobbying purposes do not meet the requirements of section 162(e)(1), such expenditures are not deductible as ordinary and necessary business expenses (Treas. Reg. sec. 1.162-20(c)(1)). Thus, for example, lobbying of foreign government officials is not a deductible business expense under section 162. Under the regulations, however, expenditures for institutional or "good will" advertising which keeps the taxpayer's name before the public are generally deductible, provided such expenditures are related to patronage the taxpayer might reasonably expect in the future (Treas. Reg. sec. 1.162-20(a)(2)).}

^{Rules governing lobbying by tax-exempt organizations}

^{An organization will not fail to meet the requirements of section 501(c)(3) merely because it advocates, as an insubstantial part of its activities, the adoption or rejection of legislation (Treas. Reg. sec. 1.501(c)(3)-1(c)(3)). Similarly, a public charity making the section 501(h) election can incur lobbying expenditures in an amount determined in accordance with a numeric formula set forth in section 501(h) without jeopardizing its exempt status. However, if a public charity's lobbying expenditures (for either all lobbying or grass roots lobbying in particular) made during a taxable year exceed the amount allowable under the formula, an excise tax equal to 25 percent of the excess lobbying expenditures is imposed on the organization (sec. 4911(a)). If the sum of the electing organization's lobbying expenditures during a four-year period exceeds 150 percent of the sum of the allowable amounts during that period, the organization loses its tax-exempt status under section 501(c)(3) (Treas. Reg. sec. 1.501(h)-3(b)).}

^{Section 501(h) defines "lobbying expenditures" as "expenditures for the purpose of influencing legislation (as defined in section 4911(d))." Section 4911(d) defines the term "influencing legislation" as--}

The House bill disallows a deduction for amounts paid or incurred in connection with any attempt to influence legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of legislation.

The present-law disallowance of business deductions for expenses of grass roots lobbying and participation in political campaigns remains in effect under the House bill, as does the present-law rule disallowing a deduction for lobbying of foreign governments.

Scope of general rule

The general disallowance rule contained in the House bill applies to attempts to influence legislation (as defined in present-law section 4911(e)(2)) through communications with the legislative branch, as well as the executive branch, of the Federal government, or any State or local government.⁵⁴

^Exception

^{Taxpayers are permitted to deduct expenditures for providing technical advice or assistance to a governmental body or to a committee or other subdivision thereof in response to a specific written request by such governmental entity.}

^{Association dues}

^{The House bill provides a flow-through rule to disallow a deduction for a portion of membership dues (or similar payments) paid to a tax-exempt organization which engages in political or lobbying activities. Trade associations and similar organizations are required to report annually to their members (and the IRS) the portion of membership dues (or similar payments) that is attributable to lobbying activities of the organization (unless this reporting requirement is waived by Treasury regulation).}

^Charities

^{Contributions to charities are not affected by the House bill. However, present-law rules which prevent charities from engaging in a substantial amount of lobbying remain in effect.}

^Penalties

^{Organizations will be subject to penalties for failing to meet the reporting requirements of the provision. In addition to the normal reporting penalties (generally, $50 for each failure to report to the IRS or organization member), a special penalty applies if an organization materially underreports its lobbying expenses to its members (meaning the aggregate amount of nondeductible dues reported to members is less than 75 percent of the correct amount).}

The Senate amendment disallows the costs of any "lobbying contact," meaning (1) in the case of a "lobbyist" (as defined below), any oral or written communication with a legislative branch official or employee or certain high-ranking Federal executive branch officials⁵⁵, and (2) in the case of any other person (i.e., a non-lobbyist), any oral or written communication with a legislative branch official or employee in an attempt to influence the formulation of legislation or with certain high-ranking Federal executive branch officials in an attempt to influence legislation or the formulation or administration of Federal rules, regulations, programs or policies (with certain exceptions described below).

Under the Senate amendment, the present-law rules disallowing business deductions for expenses of grass roots lobbying, participation in political campaigns, and lobbying of foreign governments remain in effect.

Scope of general rule

The general disallowance rule contained in the Senate amendment applies to attempts to influence legislation (as defined in present-law section 4911(e)(2)) through communications with the legislative branch, as well as the executive branch, of the Federal government, or any State or local government. In addition, the Senate amendment disallows expenses incurred in connection with lobbying with respect to certain Federal executive branch actions, and the costs of certain communications by "lobbyists" are disallowed under a per se rule.

Activities in support of lobbying

The Senate amendment disallows the costs of activities in support of a "lobbying contact" (as defined above), including (1) any preparation or planning activity relating to a lobbying contact (including, in the case of a lobbyist, the formulation, review, and management of the lobbying contacts on behalf of a client), (2) any research or other background work relating to a lobbying contact, and (3) any activity coordinating the lobbying activity of two or more persons.

Exceptions

Definition of "lobbyist"

As described above, the Senate amendment provides a presumption that communications made by "lobbyists" to certain government officials are nondeductible lobbying. In contrast, communications made by other persons (i.e., non-lobbyists) to certain government officials are nondeductible lobbying only if such communications are made in an attempt to influence legislation or certain Federal executive branch actions. For purposes of the Senate amendment, the term "lobbyist" has a meaning similar to the definition under the Lobbying Disclosure Act of 1993 (S. 349), as passed by the Senate on 6, 1993, and includes any person who is employed or retained by another for financial or other compensation to perform services that include any attempt to influence the formulation of legislation or the formulation or administration of Federal rules, regulations, programs, or policies (with the exceptions described above). However, the term "lobbyist" does not include a person whose lobbying activities are only incidental to, and are not a significant part of, the services provided by such person to the client. The determination of whether an individual is a "lobbyist" is made on a client-by-client basis.

Association dues

The Senate amendment provides a flow-through rule to disallow a deduction for a portion of membership dues (or other similar amounts) paid by a person to a tax-exempt organization (other than a charity eligible to receive tax-deductible contributions) if such dues are allocable to lobbying activities conducted by the organization. Trade associations and similar organizations are required to report annually to their members (and the IRS) the portion of membership dues (or similar payments) that is attributable to lobbying activities of the organization (unless this reporting requirement is waived by Treasury regulation).

However, the Senate amendment also provides a de minimis exception, so that flow-through reporting to members or the IRS is not required if the lobbying expenditures of the organization for the calendar year are less than $2,000. For purposes of applying the $2,000 de minimis exception, an organization is required to take into account direct expenses incurred for lobbying activities (i.e., labor and materials costs and fees paid to third parties for lobbying), but need not take into account indirect expenses (i.e., a portion of general overhead) otherwise allocable to lobbying.

Charities

The Senate amendment provides for a flow-through of the lobbying disallowance rule in the case of contributions, dues, or similar amounts paid to a charity (other than a church) eligible to receive tax-deductible contributions under section 170 to the extent that the contribution (or other amount) is attributable to amounts incurred for lobbying activities by the charity, provided that (1) the lobbying activities of the charity are of direct interest to the payor's (or a related person's) trade or business and (2) the payor makes total payments to the charity during the year exceeding $2,000. In such cases, a portion of a contribution that otherwise may be deductible under section 170 is disallowed.

Penalties

Under the Senate amendment, penalties may be imposed under present-law section 6721 on organizations for failing to make the required flow-through information reporting.

Meals, entertainment or travel

The Senate amendment provides a per se rule disallowing any amount paid or incurred by a taxpayer in connection with providing meals, entertainment, or travel to legislative officials or employees or certain high-ranking Federal executive branch officials (or to an individual accompanying such official or employee).

General rule

Under the conference agreement, no deduction is allowed under section 162 for any amount paid or incurred in connection with (1) influencing Federal or State legislation or (2) any communication with certain covered Federal executive branch officials in an attempt to influence the official actions or positions of such officials.

The present-law rules disallowing business deductions for expenses of grass roots lobbying and participation in political campaigns will remain in effect. Similarly, the conferees intend that the present-law rule disallowing a deduction for lobbying of foreign governments will remain in effect.

Scope of general rule

The conference agreement applies to attempts to influence Federal or State legislation (as defined in present-law section 4911(e)(2)) through communication with a member or employee of Congress or a State legislative body, or with any other government official or employee who may participate in the formulation of legislation.⁵⁶ In addition, the conference agreement disallows a deduction for costs incurred in connection with any direct communication with a "covered executive branch official" in an attempt to influence the official actions or positions of such official.⁵⁷ For this purpose, the term "covered executive branch official" means the following Federal officials: (1) the president; (2) the Vice President; (3) an individual serving in a position in level I of the Executive Schedule (e.g., a Cabinet member)⁵⁸ or any other individual designated by the President as having Cabinet-level status; (4) any immediate deputy of an individual listed in (3) above; (5) the two most senior-level officers of each agency within the Executive Office of the President;⁵⁹ and (6) any other officer or employee of the White House Office of the Executive Office of the President.

The conference agreement does not apply to attempts to influence legislative actions of a "local council or similar governing body."⁶⁰ The conferees intend that any legislative body of a political subdivision of a State (e.g., a county or city council) be considered to be a "local council or similar governing body." Thus, attempts to influence the actions of such local bodies are not affected by the conference agreement and remain subject to present-law rules.⁶¹

^{De minimis rule}

^{The conference agreement provides ade minimis rule that exempts certain in-house lobbying expenditures from the general disallowance rule if a taxpayer's total amount of such expenditures for a taxable year does not exceed $2,000 (computed without taking into account general overhead costs otherwise allocable to lobbying). For purposes of this rule, "in-house expenditures" means expenditures for lobbying (e.g., labor and materials costs) other than (1) payments to a person engaged in the trade or business of lobbying to conduct lobbying for the taxpayer (e.g., a payment to hire a professional lobbyist), and (2) dues or other similar payments that are allocable to lobbying (e.g., association dues).}

^{Thus, so long as a taxpayer's in-house lobbying expenditures do not exceed $2,000, such expenditures (including allocable overhead) may be disregarded and are not subject to the disallowance rule. However, payments made by a taxpayer to third-party lobbyists and dues payments allocable to lobbying are subject to the disallowance rules of the conference agreement, regardless of whether or not the taxpayer's in-house expenses are exempted under thede minimis rule.62} In addition, the de minimis rule contained in the conference agreement does not apply to expenses incurred for political activity, grass-roots lobbying, or foreign lobbying, which continue to be disallowed in their entirety under present-law ruled.

Activities in support of lobbying

The conference agreement provides that any amount paid or incurred for research for, or preparation, planning, or coordination of, any lobbying activity subject to the general disallowance rule described above will be treated as paid or incurred in connection with such lobbying activity.

The conferees intend that the Secretary of the Treasury will provide guidance for distinguishing costs incurred in connection with (1) attempts to influence legislation from (2) mere monitoring of legislative activities where there is no attempt to influence the formulation or enactment of legislation. In cases where a taxpayer (or tax-exempt organization) monitors legislation and subsequently attempts to influence the formulation or enactment of the same (or similar) legislation, the conferees intend the costs of the monitoring activities generally will be treated as incurred "in connection with" nondeductible lobbying activity.⁶³

^{In determining the expenses incurred in connection with any direct communication with a covered executive branch official in an attempt to influence the official actions or positions of such official, only the costs attributable to the direct communication itself are nondeductible under the conference agreement. Thus, for example, if a taxpayer works for an extended period to influence the actions of non-covered executive branch officials and, at the end of the project, a covered executive branch official approves the final decision through a separate communication with the taxpayer (e.g., a briefing or review of the matter), only the direct costs of the communication with the covered official would be disallowed (and not the costs of the work product from the earlier period). In contrast, if a taxpayer conducts research and analysis with a view toward directly communicating with a covered executive branch official, the costs of such research and analysis would be disallowed as attributable to the direct communication with the covered official.}

^Exceptions

^{The conference agreement does not include any of the statutory exceptions to the general disallowance rule that are contained in the House bill or Senate amendment. However, the conferees wish to clarify that (consistent with pre-1962 interpretations) any communication compelled by subpoena, or otherwise compelled by Federal or State law, does not constitute an "attempt to influence" legislation or an official's actions and, therefore, is not subject to the general disallowance rule.}

^{Association dues}

^{The conference agreement provides a flow-through rule to disallow a deduction for a portion of the membership dues (or similar payments64}) paid to a tax-exempt organization (other than a charitable organization) which engages in political or lobbying activities. Trade associations and similar organizations generally are required under the conference agreement to provide annual information disclosure (but not Form 1099 information reporting) to members estimating the portion of their dues allocable to lobbying. However, such disclosure is not required for an organization that (1) incurs only de minimis amounts of in-house lobbying expenditures; (2) elects to pay a proxy tax on its lobbying expenditures incurred during the taxable year; or (3) establishes pursuant to Treasury regulation (or other procedure) that substantially all of its dues monies are paid by members not entitled to deduct such dues in computing their taxable income.

An organization also is required to provide notice to each person paying dues (or similar payments) at the time of assessment or payment of such dues (or similar payments) of the portion of dues that the organization reasonably estimates will be allocable to the organization' s lobbying expenditures during the year and that is, therefore, not deductible by the member. This estimate must be provided at the time of assessment or payment of such dues and be reasonably calculated to provide organization members with adequate notice of the nondeductible amount.⁶⁵ If an organization's actual lobbying and political expenditures for a taxable year exceed the estimated allocable amount of such expenditures (either because of higher-than-anticipated lobbying expenses or lower-than-projected dues receipts), then the organization is required to pay a proxy tax on the excess amount or may seek permission to adjust the following year's notice of estimated expenditures, as described below.

^{If the amount of lobbying expenditures exceeds the amount of dues and other similar payments for the taxable year, the proxy tax is imposed on an amount equal to the dues and similar payments; any excess lobbying expenditures are carried forward to the next taxable year.67} The proxy tax rate is equal to the highest corporate rate in effect for the taxable year. If an organization elects to pay the proxy tax rather than to provide any information disclosure to members, no portion of any dues or other payments made by members of the organization will be deemed non-deductible as the result of the organization's lobbying activities.

^Charities

^{Under the conference agreement, charitable organizations described in section 501(c)(3) are not subject to the disclosure requirements (or proxy tax option) imposed on other tax-exempt organizations. However, the conference agreement does contain an anti-avoidance rule designed to prevent donors from using charities as a conduit to conduct lobbying activities, the costs of which would be nondeductible if conducted directly by the donor.}

^{Therefore, the conference agreement provides that no deduction will be allowed under sections 170 or 162 for amounts contributed to a charity that conducts lobbying activities, if (1) the charity's lobbying activities regard matters of direct financial interest to the donor's trade or business and (2) a principal purpose of the contribution is to avoid the general disallowance rule that would apply if the contributor directly had conducted such lobbying activities.70}

^{The conferees intend that the determination regarding a principal purpose of the contribution for purposes of this rule be based on the facts and circumstances surrounding the contribution, including the existence of any formal or informal instructions relating to the charity's use of the contribution for lobbying efforts (including nonpartisan analysis), the temporal nexus between the making of the contribution and conduct of the lobbying activities, and any historical pattern of contributions by the donor to the charity.}

^{Anti-cascading rule}

^{The conference agreement contains a special provision to prevent a "cascading" of the lobbying disallowance rule. The purpose of the provision is to ensure that, when multiple parties are involved, the general lobbying disallowance rule results in the denial of a deduction at only one level. Thus, the conference agreement provides that, in the case of a taxpayer engaged in the trade or business of lobbying activities or a taxpayer who is an employee and receives employer reimbursements for lobbying expenses, the disallowance rule does not apply to expenditures of the taxpayer in conducting such activities directly on behalf of a client or employer. Instead, the lobbying payments made by the client (or employer) to the lobbyist (or employee) are nondeductible under the general disallowance rule.}

^{The anti-cascading rule applies where there is a direct, one-on-one relationship between the taxpayer and the entity conducting the lobbying activity, such as a client or employee relationship. Thus, the conferees intend that the anti-cascading rule will not apply to dues or other payments to taxable membership organizations which act to further the interests of their members rather than the interests of any one particular member. Such organizations are themselves subject to the general disallowance rule based on the amount of their lobbying expenditures, and dues payments to such organizations are not affected by the conference agreement.}

3. Mark-to-Market Accounting Method for Dealers in Securities

(sec. 14223 of the House bill, sec. 8223 of the Senate amendment, sec. 13223 of the Conference agreement, and new sec. 475 of the Code)

If the inventory of securities is determined based on cost, unrealized gains and losses with respect to the securities are not taken into account for Federal income tax purposes. If the inventory of securities is determined based on the LCM value, unrealized losses (but not unrealized gains) with respect to the securities are taken into account for Federal income tax purposes. If the inventory of securities is determined based on market value, both unrealized gains and losses with respect to the securities are taken into account for Federal income tax purposes.

The House bill provides two general rules (the "mark-to-market rules") that apply to certain securities that are held by a dealer in securities. First, any such security that is inventory in the hands of the dealer is required to be included in inventory at its fair market value. Second, any such security that is not inventory in the hands of the dealer and that is held as of the close of any taxable year is treated as sold by the dealer for its fair market value on the last business day of the taxable year and any gain or loss is required to be taken into account by the dealer in determining gross income for that taxable year.

If gain or loss is taken into account with respect to a security by reason of the second mark-to-market rule, then the amount of gain or loss subsequently realized as a result of a sale, exchange, or other disposition of the security, or as a result of the application of the mark-to-market rules, is to be appropriately adjusted to reflect such gain or loss.

Character of gain or loss

Any gain or loss taken into account under the provision (or any gain or loss recognized with respect to a security that would be subject to the provision if held at the end of the year) generally is treated as ordinary gain or loss. This character rule does not apply to any gain or loss allocable to any period during which the security (1) is a hedge of a position, right to income, or a liability that is not subject to a mark-to-market rule under the provision, or (2) is held by the taxpayer other than in its capacity as a dealer in securities. In addition, the character rule does not apply to any security that is improperly identified by the taxpayer.

No inference is intended as to the character of any gain or loss recognized in taxable years prior to the enactment of this provision or any gain or loss recognized with respect to any property to which this character rule does not apply.

Definitions

A dealer in securities is defined as any taxpayer that either (1) regularly purchases securities from, or sells securities to, customers in the ordinary course of a trade or business, or (2) regularly offers to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business.

A security is defined as: (1) any share of stock in a corporation; (2) any partnership or beneficial ownership interest in a widely-held or publicly-traded partnership or trust; (3) any note, bond, debenture, or other evidence of indebtedness; (4) any interest rate, currency, or equity notional principal contract (but not any other notional principal contract such as a notional principal contract that is based on the price of oil, wheat, or other commodity); and (5) any evidence of an interest in, or any derivative financial instrument in, any currency or in a security described in (1) through (4) above, including any option, forward contract, short position, or any similar financial instrument in such a security or currency.

In addition, a security is defined to include any position if: (1) the position is not a security described in the preceding paragraph; (2) the position is a hedge with respect to a security described in the preceding paragraph; and (3) before the close of the day on which the position was acquired or entered into (or such other time as the Treasury Department may specify in regulations), the position is clearly identified in the dealer's records as a hedge with respect to a security described in the preceding paragraph.

Exceptions to the mark-to-market rules

Under the House bill, the mark-to-market rules generally do not apply to: (1) any security that is held for investment; (2) any evidence of indebtedness that is acquired (including originated) by a dealer in the ordinary course of its trade or business, but only if the evidence of indebtedness is not held for sale; (3) any security which is a hedge with respect to a security that is not subject to the mark-to-market rules (i.e., any security that is a hedge with respect to (a) a security held for investment, or (b) an evidence of indebtedness described in (2); and (4) any security which is a hedge with respect to a position, right to income, or a liability that is not a security in the hands of the taxpayer.

In addition, the exceptions to the mark-to-market rules do not apply unless, before the close of the day on which the security (including any evidence of indebtedness) is acquired, originated, or entered into (or such other time as the Treasury Department may specify in regulations), the security is clearly identified in the dealer's records as being described in one of the exceptions listed above.

Improper identification

The House bill provides that if (1) a dealer identifies a security as qualifying for an exception to the mark-to-market rules but the security does not qualify for that exception, or (2) a dealer fails to identify a position that is not a security as a hedge of a security but the position is a hedge of a security, then the mark-to-market rules are to apply to any such security or position, except that loss is to be recognized under the mark-to-market rules prior to the disposition of the security or position only to the extent of gain previously recognized under the mark-to-market rules (and not previously taken into account under this provision) with respect to the security or position.

Other rules

The House bill provides that the uniform cost capitalization rules of section 263A of the Code and the rules of section 263(g) of the Code that require the capitalization of certain interest and carrying charges in the case of straddles do not apply to any security to which the mark-to-market rules apply because the fair market value of a security should include the costs that the dealer would otherwise capitalize.

In addition, a security subject to the provision is not to be treated as sold and reacquired for purposes of section 1091 of the Code. Section 1092 of the Code will apply to any loss recognized under the mark-to-market rules (but will have no effect if all the offsetting positions that make up the straddle are subject to the mark-to-market rules).

Furthermore, the House bill provides that (1) the mark-to-market rules do not apply to any section 988 transaction (generally, a foreign currency transaction) that is part of a section 988 hedging transaction, and (2) the determination of whether a transaction is a section 988 transaction is to be made without regard to whether the transaction would otherwise be marked-to-market under the bill.

For purposes of the House bill, fair market value generally is determined by valuing each security on an individual security basis. Thus, if a taxpayer holds a large block of securities of the same type, the securities should be valued without taking any blockage discount into account. It is expected that the Treasury Department will authorize the use of appropriate valuation methods that will alleviate unnecessary compliance burdens of taxpayers under the bill.

Finally, the House bill authorizes the Treasury Department to promulgate such regulations as may be necessary or appropriate to carry out the provisions of the bill, including rules to prevent the use of year-end transfers, related persons, or other arrangements to avoid the provisions of the House bill.

The provision applies to taxable years ending on or after December 31, 1993. A taxpayer that is required to change its method of accounting to comply with the requirements of the provision is treated as having initiated the change in method of accounting and as having received the consent of the Treasury Department to make such change. The net amount of the section 481(a) adjustment is to be taken into account ratably over a 5-taxable year period beginning with the first taxable year ending on or after December 31, 1993.

Special rule for certain floor specialists and market

To the extent that a portion of the section 481(a) adjustment of a floor specialist or a market maker is attributable to the use of the LIFO inventory method of accounting for any qualified security, such portion of the adjustment generally is taken into account ratably over the shorter of (1) a 20-taxable year period or (2) the number of years the taxpayer (or any predecessor) had utilized the LIFO inventory method for that security, beginning with the first taxable year ending on or after December 31, 1993. In no event may the period be less than 5 years.

Except as provided below, the Senate amendment generally is the same as the House bill.

Exceptions to the mark-to-market rules

Under the Senate amendment, the mark-to-market rules generally do not apply to: (1) any security that is held for investment; (2) any security that is a hedge with respect to a security that is not subject to the mark-to-market rules (i.e., any security that is a hedge with respect to a security held for investment); or (3) any security which is a hedge with respect to a position, right to income, or a liability that is not a security in the hands of the taxpayer. Under the Senate amendment, securities held for investment include debt instruments acquired (including originated) by the taxpayer in the ordinary course of a trade or business of the taxpayer and not held for sale.

However, under the Senate amendment, to the extent that a portion of the section 481 (a) adjustment of a floor specialist or a market maker is attributable to the use of the LIFO inventory method of accounting for any qualified security, such portion of the adjustment generally is taken into account ratably over a 15-taxable year period if the taxpayer (or any predecessor) had utilized the LIFO inventory method for that security for at least 5 years.

Exceptions to the mark-to-market rules

The exceptions to the mark-to-market rules do not apply unless, before the close of the day on which the security (including any evidence of indebtedness) is acquired, originated, or entered into (or such other time as the Treasury Department may specify in regulations), the security is clearly identified in the dealer's records as being described in one of the exceptions listed above. The conferees anticipate that the Treasury regulations will permit a financial institution that is treated as a dealer under the provision and that originates evidences of indebtedness in the ordinary course of a trade or business to identify such evidences of indebtedness as held for investment based on the accounting practices of the institution, but in no event later than the date that is 30 days after the date that any such evidence of indebtedness is originated. Where appropriate, Treasury regulations may provide similar identification rules for similar debt that is acquired, rather than originated, by a financial institution. Further, it is anticipated that the Treasury regulations will permit a dealer that enters into commitments to acquire mortgages to identify such commitments as being held for investment if the dealer acquires the mortgages and holds the mortgages as investments. It is anticipated that this identification of commitments to acquire mortgages will occur within an appropriate period after the acquisition of the mortgages, but in no event later than the date that is 30 days after the date that the mortgages are acquired.

Further, the conferees anticipate that the identification rules with respect to hedges will be applied in such a manner as to minimize the imposition of additional accounting burdens on dealers in securities. For example, it is understood that certain taxpayers engage in risk management strategies known as "global hedging." Under global hedging, the positions of one business unit of the taxpayer may be counter-balanced by positions of another separate business unit; any remaining net risk of the enterprise may then be hedged by entering into positions with unrelated third parties. The conferees understand that taxpayers engaging in global hedging often use accounting systems that clearly identify and treat the transactions entered into between the separate business units as if such transactions were entered into with unrelated third parties. The conferees anticipate that, subject to Treasury regulations, such an accounting system generally will provide adequate evidence for purposes of determining whether, and to what extent, a hedge with a third party is (1) a hedge of a security that is subject to the mark-to-market rules or (2) a hedge of a position, right to income, or a liability that is not subject to a mark-to-market rule, for purposes of applying the mark-to-market rules and the special character rule to a hedge with a third party.

Regulatory authority

The provision grants authority to the Treasury Department to promulgate regulations as may be necessary or appropriate to carry out the provisions of the bill. Such authority includes the authority to promulgate such regulations to prevent the use of year-end transfers, related persons, or other arrangements to take unintended advantage of the provisions of the bill. For instance, assume that an individual who is not subject to the mark-to-market rules contributes a security that has a built-in loss in the hands of the individual to a partnership that is subject to the mark-to-market rules. Consistent with rules that govern the treatment of a security that ceases to qualify for one of the exceptions to the mark-to-market rules in the hands of a single taxpayer, the Treasury regulations may provide that any loss that arose prior to the contribution to the partnership may not be taken into account by the partnership under the mark-to-market rules and that the suspended loss may be taken into account when the security is sold. Conversely, assume that prior to year end, a partnership that is subject to the mark-to-market rules distributes a security with a built-in gain to a partner that is not subject to such rules. Consistent with the authority to apply the mark-to-market rules at times other than at the end of a taxable year, the Treasury regulations may provide that the mark-to-market rules are to apply to the partnership with respect to such security as of the date of distribution.

Valuation of securities

The conference agreement does not provide any explicit rules mandating valuation methods that are required to be used for purposes of applying the mark-to-market rules. However, the conferees expect that the Treasury Department will authorize the use of valuation methods that will alleviate unnecessary compliance burdens for taxpayers and clearly reflect income for Federal income tax purposes.

Other hedging transactions

The conference agreement generally provides that any gain or loss with respect to hedges that are subject to the mark-to-market rules of the bill will be treated as ordinary gain or loss. The conferees understand that hedging transactions are also important to the management of risks by businesses that are not subject to these mark-to-market rules. Hedging transactions are part of a sound business strategy in fields as diverse as farming, banking, manufacturing and energy production. However, the conferees understand that there may be a level of uncertainty regarding the tax treatment of such hedging transactions following a decision by the United States Supreme Court in 1988, Arkansas Best Corp. v. Commissioner, 485 U.S. 212 (1988). Despite subsequent litigation, (e.g., Federal National Mortgage Association v. Commissioner, 100 T.C. No. 36 (June 17, 1993)), the scope of the United States Supreme Court decision, and its effect on hedging transactions, may be unclear in some instances. The conferees believe that this is a significant issue. To the extent a solution to this issue may require coordination between the executive and legislative branches, the conferees urge the Administration, in the strongest terms, to advise the House Ways and Means and the Senate Finance Committees, within 90 days of the enactment of this Act, how best to proceed.

4. Tax Treatment of Certain FSLIC Financial Assistance

(sec. 14224 of the House bill, sec. 8224 of the Senate amendment, sec. 13224 of the Conference agreement, and secs. 165, 166, 585, and 593 of the Code)

A special statutory tax rule, enacted in 1981, excluded from a thrift institution's income financial assistance received from the Federal Savings and Loan Insurance Corporation (FSLIC), and prohibited a reduction in the tax basis of the thrift institution's assets on account of the receipt of the assistance. Under the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), taxpayers generally were required to reduce certain tax attributed by one-half the amount of financial assistance received from the FSLIC pursuant to certain acquisitions of financially troubled thrift institutions occurring after December 31, 1988. These special rules were repealed by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), but still apply to transactions that occurred before May 10, 1989.

In September 1990, the Resolution Trust Corporation (RTC), in accordance with the requirements of FIRREA, issued a report to Congress and the Oversight Board of the RTC on certain FSLIC-assisted transactions (the "1988/89 FSLIC transactions"). The report recommended further study of the covered loss and other tax issues relating to these transactions. A March 4, 1991 Treasury Department report on tax issues relating to the 1988/89 FSLIC transactions concluded that deductions should not be allowed for losses that are reimbursed with exempt FSLIC assistance.

The House bill does not apply to any financial assistance to which the amendments made by section 1401(a)(3) of FIRREA apply.

No inference is intended as to prior law or as to the treatment of any item to which the bill does not apply.

In accordance with the general estimated tax penalty provisions of the bill, no addition to tax is to be made under section 6654 or 6655 of the Code for any period before March 16, 1994 in the case of a corporation (April 16, 1994 in the case of an individual). However, in providing this relief, no inference is intended as to prior law, the effect of the bill on prior law, or the treatment of any item to which the bill does not apply.

As stated in both the House and Senate committee reports, It is expected that for purposes of the adjusted current earnings adjustment of the corporate alternative minimum tax, there will not be any net positive adjustment to the extent that FSLIC assistance is taken into account as compensation for a loss or in determining worthlessness and there is, therefore, no deductible loss or bad debt charge off. The conferees wish to clarify that this result is expected to apply to all taxpayers, including those who received IRS determinations regarding the treatment of FSLIC assistance for earnings and profits purposes in the form of a ruling or closing agreement. The conferees also wish to clarify that, for all taxpayers, Treasury is expected to treat such FSLIC assistance for other earnings and profits purposes in a manner that is consistent with the purposes of this provision.

5. Modify Corporate Estimated Tax Rules

(sec. 14225 of the House bill, sec. 8225 of the Senate amendment, sec. 13225 of the Conference agreement, and sec. 6655 of the Code)

A corporation that is not a "large corporation" generally may avoid the addition to tax if it makes four timely estimated tax payments each equal to at least 25 percent of the tax liability shown on its return for the preceding taxable year. A large corporation may also use this rule with respect to its estimated tax payment for the first quarter of its current taxable year. A large corporation is one that had taxable income of $1 million or more for any of the three preceding taxable years.

In addition, the bill modifies the rules relating to income annualization for corporate estimated tax purposes. In general, the bill (1) adds a new, third set of periods over which corporations may elect to annualize income and (2) requires corporations to annually elect which of the three periods they will use to annualize income for the year.

6. Repeal Stock-for-Debt Exception to Cancellation of Indebtedness Income

(sec. 8226(a) of the Senate amendment, sec. 13226(a) of the Conference agreement, and sec. 108 of the Code)

The amount of COD income generally is the difference between the adjusted issue price of the debt being canceled and the amount of cash and the value of any property used to satisfy the debt. Thus, for purposes of determining the amount of COD income of a debtor corporation that transfers stock to a creditor in satisfaction of its indebtedness, the corporation generally is treated as realizing COD income equal to the excess of the adjusted issue price of the debt over the fair market value of the stock. However, if the debtor corporation is in a title 11 case or is insolvent, the excess of the debt discharged over the fair market value of the transferred stock generally does not constitute COD income (the "stock-for-debt exception"). Thus, a corporate debtor that qualifies for the stock-for-debt exception is not required to reduce its tax attributes as a result of the debt discharge. The stock-for-debt exception does not apply to the issuance of certain preferred stock, nominal or token shares of stock, or stock issued to unsecured creditors on a relatively disproportionate basis. In the case of an insolvent debtor not in a title 11 case, the exception applies only to the extent the debtor is insolvent.

The conference agreement provides authority to the Treasury Department to promulgate such regulations as are necessary to coordinate the present-law rules regarding the acquisition by a corporation of its debt from a shareholder as a contribution to capital (sec. 108 (e)(6)) with the repeal of the stock-for-debt exception.

In addition, the conferees clarify that no inference is intended with the enactment of this provision as to the treatment of any cancellation of the indebtedness of any entity that is not a corporation in exchange for an ownership or equity interest in such entity.

7. Treatment of Passive Activity Losses and Credits and Alternative Minimum Tax Credits in Certain Discharges of Indebtedness

(sec. 8226(b) of the Senate amendment, sec. 13226(b) of the Conference agreement, and sec. 108(b) of the Code)

Under present law, the passive loss rules limit deductions and credits from passive trade or business activities (sec. 469). Deductions and credits suspended under these rules are carried forward to the next taxable year, and suspended losses are allowed in full when the taxpayer disposes of his entire interest in the passive activity to an unrelated person. Passive losses and credits are not tax attributes that are reduced under the rule relating to exclusion of discharge of indebtedness income.

Present law generally allows a minimum tax credit against a taxpayer's regular tax for the taxable year, for taxpayers who paid alternative minimum tax in a prior year (sec. 53). The minimum tax credit generally is the excess of (1) the sum of the minimum tax imposed for all prior taxable years following 1986, over (2) the amount allowed as a minimum tax credit for those prior taxable years. Minimum tax credits are not tax attributes that are reduced under the rule relating to exclusion of discharge of indebtedness income.

8. Limitation on Section 936 Credit

(sec. 34226 [14226] of the House bill, sec. 8227 of the Senate amendment, sec. 33227 of the Conference agreement, and secs. 56, 936 and 7652 of the Code)

Certain domestic corporations with business operations in the U.S. possessions⁷¹ may elect the use of the section 936 credit which generally eliminates the U.S. tax on certain income related to their operations in the possessions.⁷² Income exempt from U.S. tax under this provision falls into two broad categories: business income, which in order to be exempt must be income treated as foreign source income derived from the active conduct of a trade or business within a U.S. possession or from the sale or exchange of substantially all of the assets that were used in such a trade or business; and investment income, which in order to be exempt must be derived from certain investments in the possessions or in certain Caribbean Basin countries. The investment income exempted under the provision is known as "qualified possession source investment income" (QPSII). For these and other purposes, income derived within a possession is encompassed within the term " foreign source income."

In order to qualify for the section 936 credit, a domestic corporation must satisfy two requirements. Under one requirement, the corporation must be treated as deriving at least 75 percent of its gross income from the' active conduct of a trade or business within a possession over a three-year period. Under the other requirement, the corporation must be treated as deriving at least 80 percent of its gross income from sources within a possession during that same three-year period.

Three alternative rules are provided that relate to allocating income from intangible property between a domestic corporation that elects the section 936 credit (a "possession corporation") and its U.S. shareholders. The general rule is to prohibit the possession corporation from earning any return on intangible property. A possession corporation can instead elect to subject itself to one of two alternative rules, if it satisfies certain conditions.

One such rule is referred to as the "cost sharing method." Use of this method requires the possession corporation to pay to the appropriate members of its affiliated group of corporations (including foreign affiliates) an amount which represents its current share of the costs of the research and development expenses of the group. The Code determines that share to be the greater of (1) the total amount of the group's research and development expenses concerning the possession corporation's product area, multiplied by 110 percent of the proportion of its sales as compared to total product area sales of the group; or (2) the amount of the royalty payment or inclusion that would be required under sections 367(d) and 482 with respect to intangible assets which the possession corporation is treated as owning under the cost sharing method, were the possession corporation a foreign corporation (whether or not the intangible assets actually are transferred to the possession corporation). By making this cost sharing payment, the possession corporation becomes entitled to treat its income as including a return from certain intangibles, primarily manufacturing intangibles, associated with the products it manufactures in the possessions.

The alternative elective rule for allocating income from intangible property between a possession corporation and its U.S. affiliates is a "profit split" approach. This method generally permits allocation to the possession corporation of 50 percent of the affiliated group of U.S. corporations' combined taxable income derived from sales of products which are manufactured in a possession.⁷³

^{Dividends paid by a possession corporation to a U.S. shareholder may qualify for the deduction for dividends received from a domestic corporation (sec. 243). In cases where at least 80 percent of the stock of the possession corporation is owned by a single domestic corporation, the possession corporation's possession source income generally may be distributed without the parent corporation incurring any regular U.S. income tax.}

^{Taxes paid or accrued by possession corporations to foreign countries or possessions on income which is taken into account in determining the section 936 credit are neither deductible nor allowable for purposes of determining the foreign tax credit.}

^{A possession corporation's income, the tax on which may be offset by the section 936 credit, is not included in the alternative minimum taxable income (AMTI) of the possession corporation. Thus, possession corporations generally are exempt not only from the regular income tax but also from the alternative minimum tax (AMT). Moreover, dividends received by a U.S. corporation from a possession corporation generally do not constitute AMTI of the recipient corporation since, as described above, they may be offset by the dividends received deduction.}

^{For purposes of determining a U.S. corporation's adjustment to AMTI based on adjusted current earnings (ACE), a deduction is allowed for certain dividends received. Specifically, a deduction is available (to the extent allowed under section 243 or 245) for any dividend that qualifies for the 100-percent dividends received deduction for regular tax purposes, or that is received from a 20-percent owned corporation (as defined in section 243 (c)(2)), but only to the extent that the dividend is attributable to income of the paying corporation which is subject to U.S. income tax determined after the application of section 936. A dividend received by a U.S. corporation from its wholly owned possession corporation subsidiary generally does not qualify for the dividends received deduction, and thus increases the ACE of the recipient, because the income of the possession corporation typically is not taxed by the United States due to the section 936 credit.}

^{For purposes of computing the foreign tax credit, the Code provides that dividends paid by a possession corporation to an affiliated U.S. corporation are characterized as foreign source income. Unless an exception applies, dividends are subject to the separate foreign tax credit limitation for passive income. In computing the AMT foreign tax credit, 75 percent of any withholding or income tax paid to a possession with respect to dividends received from a possession corporation generally is treated as a creditable tax.74} Moreover for such computation, taxes paid to a possession by a possession corporation are deemed to be such a withholding tax for this purpose to the extent they would be treated as taxes paid by the recipient of the dividend under rules similar to the rules of the indirect foreign tax credit (secs. 78 and 902) if the possession corporation were a foreign corporation.

Cover over of excise taxes

U.S. excise taxes generally do not apply within the possessions, including Puerto Rico and the U.S. Virgin Islands. Articles that are manufactured in the possessions and brought into the United States for use or consumption are taxed on entry into the United States in the same manner as if the articles were imported from a foreign country. Thus, under general excise tax principles, these articles are taxed at the same rate that applies to domestically produced like articles.

In the case of excise taxes on certain articles brought into the United States from Puerto Rico and the Virgin Islands, and in the case of the distilled spirits excise tax on rum, a portion of the revenues is transferred ("covered over") to the treasuries of Puerto Rico and the Virgin Islands. This revenue cover over is significantly limited, both as to the taxes included and as to activities (e.g., manufacturing value added) that must occur in the possession from which the article comes as a condition of payment.

For example, revenues equal to $10.50 (less an administrative fee) per proof gallon of the $13.50 per proof gallon excise tax on rum imported from any foreign country is covered over to Puerto Rico and the Virgin Islands. On the other hand, cover over of tobacco excise tax revenues to Puerto Rico is limited to products where significant manufacturing value is added in the possession from which the product enters the United States, and no cover over is allowed for taxes on distilled spirits other than rum. Further, no cover over is permitted for many other excise taxes, e.g., the fuels excise taxes currently included in the Internal Revenue Code.

In general, the House bill provides that the section 936 credit is determined as under present law, but is subject to two limitations. Under the first limitation, the credit allowed to a possession corporation for a taxable year against U.S. tax on its business income (i.e., income derived from the active conduct of a possession-based business, or from the sale of assets used in such a business) is limited to 60 percent of the qualified possession wages the possession corporation pays to its employees.

For purposes of this limitation, qualified possession wages generally are wages paid or incurred by the possession corporation during the taxable year to any employee for services performed in a U.S. possession, but only if the services are performed while the principal place of employment of the employee is within the possession. In computing the wage-based credit limitation, only certain wages paid to employees in the possessions are taken into account. For this purpose, wages are defined by reference to the Federal Unemployment Tax Act (FUTA) definition of wages, and the amount of wages taken into account for each employee is limited to the maximum earnings subject to tax under the OASDI portion of Social Security (currently $57,600).

The House bill provides that qualified possession wages do not include amounts paid to employees who are assigned by the employer to perform services for another person, unless the principal trade or business of the employer (and any related possession corporations) is to make employees available for temporary periods to other persons in return for compensation.

The second limitation placed on the section 936 credit under the House bill deals with QPSII. Under this provision, the credit allowed against U.S. tax on QPSII is limited in cases where the possession corporation's assets that generate QPSII exceed 60 percent of its qualified tangible business investment in the possessions. In such a case, no section 936 credit is allowed against U.S. tax on the portion (determined on a pro-rata basis) of its QPSII attributable to QPSII assets which exceed that 80-percent threshold.

For purposes of the QPSII limitation, the amount of a possession corporation's QPSII assets for a taxable year is determined by computing the average of the aggregate adjusted bases (for purposes of computing earnings and profits) of its assets which generate QPSII as of the close of each quarter of that year. Similarly, a possession corporation's qualified tangible business investment for a taxable year is determined by computing the average of the aggregate adjusted bases (for purposes of computing earnings and profits) of tangible property used in a possession by the corporation in the conduct of an active trade or business.

The House bill allows an affiliated group of corporations (generally as defined in sec. 1504, but treating possession corporations as includible corporations) to elect to consolidate related possession corporations for purposes of determining the application of the bill's two limitations on the section 936 credit. For a group so electing, the available consolidated credit amount is to be allocated among the possession corporations under rules prescribed by the Treasury Secretary.

If the section 936 credit of a possession corporation is reduced by either of the limitations for a taxable year, the House bill permits the corporation to claim a deduction for a portion of its income taxes paid or accrued to a possession for that year. The portion of the taxes so deductible would be the portion that is allocable on a pro-rata basis to the corporation's taxable income (computed before taking into account any possession tax), the U.S. tax on which is not offset by the section 936 credit as a result of the bill's limitations.

The House bill requires possession corporations to certify that the establishment of new operations in a possession after May 13, 1993 (or the addition, after that date, to an existing possession-based business) will not result in a decrease in employment at an existing business operation of the corporation or a related person in the United States. If the corporation fails to provide the certification with respect to such an establishment or addition, or if there is reason to believe that the establishment or addition was done with the intention of closing down a related U.S.-based operation, then for purposes of computing the House bill's limitations on the section 936 credit, the wages paid and the tangible business property used by the possession corporation with respect to the new operation will be disregarded.

Foreign tax credit limitation for dividends from possession corporations

The House bill also creates a new separate foreign tax credit limitation category for purposes of computing the AMT foreign tax credit. The new category would include the portion of dividends received from a possession corporation for which the dividends received deduction is disallowed, and thus is included in alternative minimum taxable income.

In general, the Senate amendment provides that the section 936 credit allowed to a possession corporation for a taxable year against U.S. tax on its active business income (i.e., income derived from the active conduct of a possession-based business, or from the sale of assets used in such a business) is determined as under present law (as modified by the 2.5 percent reduction), but is subject to either of two alternative limitations. One alternative limitation is based on factors that reflect the corporation's economic activity in the possessions (the "economic-activity limitation"), and the other limitation is based on a statutorily defined percentage of the section 936 credit that would be allowable under present-law rules (the "percentage limitation").

The option of which alternative limitation to apply is left to the taxpayer. In order to utilize the percentage limitation, however, a corporation must elect use of that limitation for its first taxable year beginning after 1993 for which it claims a section 936 credit. Once a possession corporation elects to use the percentage limitation, it must continue to compute its section 936 credit under that limitation for all subsequent taxable years unless the election is revoked.

The Senate amendment includes a consistency rule that requires all affiliated possession corporations to utilize the same alternative limitation. If, for example, a possession corporation that uses the percentage limitation becomes a member of an affiliated group that contains a second possession corporation that uses the economic-activity limitation, then the first corporation will be deemed to have revoked its election to use the percentage limitation. The determination whether a possession corporation is part of an affiliated group generally is made by reference to the consolidated return rules, except that stock owned by attribution under the rules of section 1563 is treated as owned directly, and the exclusions from the definition of "includible corporation" listed in section 1504(b) are disregarded. The Senate amendment also grants authority to the Treasury Secretary to develop rules that would treat 2 or more possession corporations as members of the same affiliated group to prevent avoidance of the consistency rule through deconsolidation or other means.

Other than the 2.5 percent reduction described above, the Senate amendment does not reduce the present-law section 936 credit against U.S. tax on QPSII.

Economic-activity limitation

For this purpose, the term wages refers to the Federal Unemployment Tax Act (FUTA) definition of wages, and the cumulative amount of wages for each employee that are taken into account for a taxable year in computing the credit limitation may not exceed 85 percent of the maximum earnings subject to tax under the OASDI portion of Social Security (currently $57,600). The Senate amendment specifies that the Treasury Secretary will provide rules for making appropriate adjustments to this limit in the cases of part-time employees and of employees whose principal place of employment is not within a possession for the entire year. In addition, the Senate amendment does not include in qualified possession wages amounts paid to employees who are assigned by the employer to perform services for another person, unless the principal trade or business of the employer (and any related possession corporations) is to make employees available for temporary periods to other persons in return for compensation.

Allocable employee fringe benefit expenses are equal to the aggregate amount allowable to the possession corporation as a deduction for the taxable year of the fringe benefits listed below, multiplied by a fraction the numerator of which is the aggregate amount of the corporation's qualified possession wages (as defined above) for the year and the denominator of which is the aggregate amount of the wages it pays or incurs during that year. In no event, however, may the corporation's allocable employee fringe benefit expenses for a taxable year exceed 15 percent of the aggregate amount of its qualified possession wages for that year.

Fringe benefit expenses that are taken into account for purposes of determining the credit limitation are (1) employer contributions under a stock bonus, pension, profit-sharing, or annuity plan, (2) employer-provided coverage under any accident or health plan for employees, and (3) the cost of life or disability insurance provided to employees. Fringe benefit expenses do not include any amount that is treated as wages.

Possession income tax

As a general rule, for possession corporations that do not elect the profit-split method, taxes paid or accrued to a possession with respect to taxable income which is taken into account in computing the section 936 credit are factored into the credit-limitation base. However, possession income taxes paid in excess of a 9-percent effective rate of tax are not included for purposes of determining the limitation. Moreover, only the portion of taxes satisfying the effective-rate requirement that are allocable (on a pro-rata basis taking all possession income taxes into account) to nonsheltered income are so included. The fraction of possession income taxes allocated to nonsheltered income is determined by computing the ratio of two hypothetical U.S. tax amounts that are computed under the assumption that no credit or deduction is allowed for possession income taxes.

The numerator of the ratio described above is the U.S. tax liability of the possession corporation that would arise under the bill by virtue of the economic-activity limitation determined without regard to any credit or deduction for possession income taxes. The denominator of the ratio is the pre-section 936 credit U.S. tax liability of the possession corporation that would be imposed on the income of the corporation (such income being computed under the rules that apply under current section 936) without regard to any credit or deduction for possession income taxes.

A possession corporation that utilizes the profit-split method for allocating any income from intangible property for the taxable year is not permitted to include any taxes in its credit-limitation base. Such a corporation, however, is allowed a deduction for a portion of its possession income taxes paid or accrued during that taxable year. The deductible portion of possession income taxes is the portion that is allocable (on a pro-rata basis) to the corporation's taxable income (computed before taking into account any deduction for such taxes), the U.S. tax on which is not offset by the section 936 credit as a result of the Senate amendment's limitation.

Denial of double benefit

For purposes of computing the pre-section 936 credit U.S. income tax liability of a possession corporation that utilizes the economic-activity limitation, the Senate amendment requires the corporation to compute taxable income by reducing its otherwise deductible amounts of compensation and depreciation by the amounts that are included in its credit-limitation base.

Election to treat affiliated corporations as one corporation

For purposes of computing the economic-activity limitation, the Senate amendment allows an affiliated group of corporations (generally as defined in sec. 1504, but treating possession corporations and foreign corporations as includible corporations) to elect to treat all affiliated possession corporations as one corporation. For a group so electing, the available consolidated credit amount is to be allocated among the possession corporations of the group under rules prescribed by the Treasury Secretary. Any election to consolidate applies to the taxable year for which made and to all succeeding taxable years unless revoked with the consent of the Treasury Secretary.

Percentage limitation

Under the percentage limitation, the section 936 credit allowed to a possession corporation against U.S. tax on business income for a taxable year is limited to an applicable percentage (40 percent once fully phased in) of the credit that would be allowable under present-law rules (as modified by the 2.5 percent reduction). Under a transition rule that provides a 5-year phase in, the applicable percentage is as follows:

 Taxable years            Applicable

Foreign tax credit limitation for dividends from possession corporations

The Senate amendment also creates a new separate foreign tax credit limitation category for purposes of computing the AMT foreign tax credit. The new category includes the portion of dividends received from a possession corporation for which the dividends received deduction is disallowed, and thus is included in alternative minimum taxable income.

Excise tax cover over

The Senate amendment also temporarily increases the cover over of rum excise taxes to Puerto Rico and the Virgin Islands from $10.50 per proof gallon to $11.30 per proof gallon. This increased cover over rate applies in the case of distilled spirits brought into the United States during the five year period beginning on July 1, 1995.

First, the conference agreement does not include the provision requiring a reduction of 2.5 percent of a taxpayer's otherwise allowable section 936 credit.

Second, the conference agreement provides that the economic-activity limitation base includes 60 percent of qualified compensation, 15 percent of depreciation deductions for short-life qualified tangible property, 40 percent of depreciation deductions for medium-life qualified tangible property, and 65 percent of depreciation deductions for long-life qualified tangible property. The conference agreement further provides that there is no disallowance of deductions for compensation or deprecation amounts which are included in the credit-limitation base.

Third, the conference agreement provides that the temporary increase in the cover over of rum excise taxes to Puerto Rico and the Virgin Islands applies in the case of distilled spirits brought into the United States during the five-year period beginning on October 1, 1993.

In addition, the conferees intend that the Secretary take into account the significant nature of the modifications made by the conference agreement to the operation of the section 936 credit in cases where a possession corporation either seeks to change its method of allocating income from intangible property or to revoke its election to use the section 936 credit.

9. Enhance Earnings Stripping Rules

(sec. 14227 of the House bill, sec. 8228 of the Senate amendment, sec. 13228 of the Conference agreement, and sec. 163(j) of the Code)

The Treasury is authorized to provide such regulations as may be appropriate to prevent the avoidance of the purposes of this provision, including regulations that would disallow deductions for interest paid to unrelated creditors in certain cases: for example, certain cases that involve guarantees of the debt by parties related to the debtor. The legislative history accompanying the bill enacting the provision, however, indicates an intent that such regulations not generally subject third-party interest to disallowance whenever a guarantee is given in the ordinary course. The legislative history further indicates an expectation that any such regulations would not apply to debt outstanding prior to notice of the rule if and to the extent that the regulations depart from positions the Service and Treasury might properly take under analogous principles of law that would recharacterize guaranteed debt as equity.

To date, Treasury has promulgated no proposed or final regulations that interpret the application of the earnings stripping rules to third-party debt that is guaranteed by a person related to the debtor.

(secs. 14231-14233 of the House bill, secs. 8231-8233 of the Senate amendment, secs. 13231-13233 of the Conference agreement, and secs. 951(a), 954(c), 956, 959, 960(b), 1296, 1297, and new sec. 956A of the Code)

Under the controlled foreign corporation rules of subpart F, a controlled foreign corporation is defined generally as any foreign corporation if U.S. persons own more than 50 percent of the corporation's stock, taking into account only so-called "U.S. shareholders": namely, those U.S. persons that own (directly, indirectly or by attribution) at least 10 percent of its voting stock. A "U.S. shareholder" may be taxed by the United States on certain earnings of the controlled foreign corporation that have not been distributed by the foreign corporation to the U.S. shareholder. Such "inclusions" of undistributed controlled foreign corporation earnings are triggered by two different provisions of the controlled foreign corporation rules.

Under one such provision, a U.S. shareholder is taxed currently on its proportionate share of the controlled foreign corporation's "subpart F income" earned during the taxable year. Subpart F income typically is foreign income that is relatively movable from one taxing jurisdiction to another and that is subject to low rates of foreign tax relative to the U.S. rate. Excluded from the definition of subpart F income, among other things, are certain dividends and interest received from a related corporation organized and operated in the same foreign country as the recipient.

The other provision taxing U.S. shareholders on undistributed controlled foreign corporation earnings applies to the controlled foreign corporation's total current or accumulated earnings (other than subpart F income), to the extent of an increase in the amount of those earnings invested by the controlled foreign corporation in certain U.S. property (as defined in Code section 956).

Earnings and profits of a controlled foreign corporation that have been included in the income of U.S. shareholders before actual repatriation are not taxed again when such earnings are in fact distributed to the U.S. shareholders.

If any foreign corporation (including a controlled foreign corporation) is a "passive foreign investment company" (PFIC), U.S. persons (including 10-percent "U.S. shareholders") that own any stock in the PFIC may be subject to one of two other sets of operating rules that eliminate or reduce the benefits of deferral. A PFIC generally is defined as any foreign corporation if (1) 75 percent or more of its gross income for the taxable year consists of passive income, or (2) 50 percent or more of its assets consist of passive assets, defined as assets that produce, or are held for the production of, passive income.

A U.S. person owning PFIC stock may elect to include currently in gross income its share of the PFIC's total earnings. A nonelecting U.S. person owning PFIC stock pays no current tax on the PFIC's undistributed income. However, when realizing income earned through ownership of PFIC stock (such as certain dividends distributed by the PFIC or capital gains from selling PFIC stock), the nonelecting U.S. person may pay an additional interest charge.

The House bill limits the availability of deferral of U.S. tax on certain earnings of controlled foreign corporations. As explained further below, the bill generally requires current inclusions in the income of U.S. shareholders of a controlled foreign corporation to the extent of the corporation's accumulated earnings invested in excess passive assets. The bill also conforms the treatment of earnings of controlled foreign corporations invested in U.S. property to the new rules for earnings invested in excess passive assets, and makes related modifications to other rules applicable to controlled foreign corporations and PFICs.

Inclusions based on excess passive assets

The first amount is the excess (if any) of the U.S. shareholder's pro rata share of the controlled foreign corporation's "excess passive assets," over that portion of the retained earnings of the foreign corporation that is treated as having been previously included in the income of the U.S. shareholder on account of excess passive assets. The second amount, defined as the "applicable earnings" of the controlled foreign corporation, is the U.S. shareholder's pro rata share of the controlled foreign corporation's current and accumulated earnings and profits (but not reduced by a deficit in accumulated earnings and profits), reduced by the portion of the retained earnings of the foreign corporation that was previously included in the income of the U.S. shareholder on account of either investments in U.S. property or investments in excess passive assets.

The income inclusion for a U.S. shareholder of the controlled foreign corporation is the amount determined as above under new section 956A, less retained earnings of the controlled foreign corporation that are treated as having been previously taxed to the U.S. shareholder as subpart F income of the controlled foreign corporation under section 951(a)(1)(A).

^{Modification of section 956}

^{The House bill treats earnings invested by a controlled foreign corporation in U.S. property under revised rules that parallel those that govern the treatment of excess passive assets, as described above. Under the revised rules, the amount determined under section 956 with respect to a U.S. shareholder of a controlled foreign corporation is the lesser of two amounts.}

^{The first amount is the excess (if any) of the U.S. shareholder's pro rata share of the U.S. property of the controlled foreign corporation, over that portion of the retained earnings of the foreign corporation that is treated as having been previously included in the income of the U.S. shareholder on account of earnings invested in U.S. property. The second amount is the U.S. shareholder's pro rata share of the controlled foreign corporation's current and accumulated earnings and profits (but not reduced by a deficit in accumulated earnings and profits), reduced by the portion of the retained earnings of the foreign corporation that was previously included in the income of the U.S. shareholder on account of either investments in U.S. property or investments in excess passive assets.}

^{The income inclusion for a U.S. shareholder of the controlled foreign corporation is the amount determined as above under section 956, less retained earnings of the controlled foreign corporation that are treated as having been previously taxed to the U.S. shareholder as subpart F income of the controlled foreign corporation under section 951(a)(1)(A).}

^{Study on investments in U.S. property}

^{The House bill requires that the Treasury Department study the tax treatment of investments by controlled foreign corporations in obligations of U.S. persons other than corporations, and provide the Committee on Ways and Means with a report of such study by December 31, 1993. The study is to include the Treasury's views as to whether those rules should be amended insofar as they relate to the treatment of investments by controlled foreign corporations in the obligations of U.S. persons other than corporations, along with a discussion of the merits and consequences of any such amendment.}

^{Other modifications to the subpart F rules}

^{The House bill limits the application of the same-country exception to the determination of subpart F income in the case of certain dividends received by controlled foreign corporations. Under the bill, amounts distributed with respect to stock owned by the controlled foreign corporation do not qualify for the same-country exception to the extent that the distributed earnings and profits were accumulated by the distributing corporation during periods when the controlled foreign corporation did not hold the stock. In addition, the House bill modifies the effect on the foreign tax credit limitation of distributions of previously taxed income. Under the bill, receipt of a distribution of previously taxed income by a U.S. shareholder of one or more controlled foreign corporations increases the U.S. shareholder's foreign tax credit limitation to the extent of the aggregate amount in a single "excess limitation account" maintained by that U.S. shareholder for each of its separate foreign tax credit limitation categories.}

^{Modification of certain PFIC rules}

^{The House bill makes several modifications to the PFIC rules:}

^{The House bill modifies the present-law rules for applying the PFIC asset test in the case of U.S. shareholders of controlled foreign corporations. In testing a controlled foreign corporation for PFIC status with respect to its "U.S. shareholders," under the bill, assets are measured by adjusted basis as determined for purposes of calculating earnings and profits, with no option to use fair market value.}

^{The House bill excludes from the definition of passive income under the PFIC rules income derived in the active conduct of a securities business by certain corporations registered in the United States as brokers or dealers in securities, and, to the extent provided in Treasury regulations, income so derived by any other corporation engaged in the active conduct of a trade or business as a broker or dealer in securities. As with the asset-valuation rule above, this exclusion applies only to a controlled foreign corporation, and only for purposes of the treatment of its U.S. shareholders. The bill provides that similar rules apply in determining whether the income of a related person is passive (whether or not the related person is a corporation), solely for purposes of classifying amounts paid by that related person to a controlled foreign corporation pursuant to the PFIC related-person rule (sec. 1296(b)(2)(C)).}

^{Under the House bill, inclusions of income on account of investments of earnings of a controlled foreign corporation in U.S. property, or ownership of excess passive assets, are treated as distributions for purposes of computing the interest charge on excess distributions to the U.S. shareholders of PFICs that are controlled foreign corporations.}

^{The House bill treats certain leased property as assets held by the foreign corporation for purposes of the PFIC asset test. This rule applies to tangible personal property with respect to which the foreign corporation is the lessee under a lease with a term of at least 12 months. Under the bill, the measure of leased property for purposes of applying the asset test is the unamortized portion of the present value of the payments under the lease.}

Under the House bill, the excess passive assets provision is phased in during taxable years beginning after September 30, 1993, and before October 1, 1997. The amount of income included under the provision is 20 percent of the amount otherwise determined in the case of taxable years beginning after September 30, 1993, and before October 1, 1994; 25 percent of the amount otherwise determined in the case of taxable years beginning after September 30, 1994, and before October 1, 1995; 35 percent of the amount otherwise determined in the case of taxable years beginning after September 30, 1995, and before October 1, 1996; and 50 percent of the amount otherwise determined in the case of taxable years beginning after September 30, 1996, and before October 1, 1997. The provision is fully effective for taxable years beginning after September 30, 1997.

Inclusions based on excess passive assets

The Senate amendment applies only to earnings and profits of the controlled foreign corporation that are attributable to taxable years beginning after September 30, 1993, and includes certain aggregation and anti-abuse rules.

Under the Senate amendment, the applicable earnings" of the controlled foreign corporation include only that portion of the controlled foreign corporation's total current earnings and profits (but not reduced by a deficit in accumulated earnings and profits) and earnings and profits to the extent accumulated in taxable years beginning after September 30, 1993. In computing the potential amount of earnings invested in excess passive assets that might be includible in the income of the U.S. shareholders of the controlled foreign corporation, applicable earnings under the Senate amendment are reduced by the portion of such post-1993 retained earnings of the foreign corporation that was previously included in the income of the U.S. shareholder on account of either investments in U.S. property or investments in excess passive assets.

The Senate amendment provides an aggregation rule applicable to any chain of controlled foreign corporations that are connected through stock ownership, where more than 50 percent, by vote or value, of the stock of each member of the chain (other than the top-tier controlled foreign corporation) is owned, directly or indirectly, by one or more other controlled foreign corporations that are members of the chain ("CFC chain"). Under this rule, the amount of excess passive assets of the CFC chain would be determined on the basis of the sum of the assets of each controlled foreign corporation in the CFC chain and the sum of the passive assets of each controlled foreign corporation in the CFC chain. The total applicable earnings of the CFC chain would be determined as the sum of the applicable earnings of each controlled foreign corporation in the CFC chain. Each controlled foreign corporation in the CFC chain would be treated as holding its pro rata share of the excess passive assets of the CFC chain, on the basis of that controlled foreign corporation's percentage share of the total applicable earnings of the CFC chain.

Modification of certain PFIC rules

The Senate amendment includes special rules to increase the basis of assets (for purposes of this provision) to reflect certain research and experimental expenditures and certain payments with respect to licensed intangible property.

Under the Senate amendment, as under the House bill, in testing a controlled foreign corporation for PFIC status with respect to its "U.S. shareholders," assets generally are measured by adjusted basis as determined for purposes of calculating earnings and profits, with no option to use fair market value.

Under the Senate amendment, however, adjusted basis for this purpose is modified to take into account certain research and experimental expenditures and certain payments for the use of intangible property that is licensed to the controlled foreign corporation. First, the aggregate adjusted basis of the total assets of the controlled foreign corporation is increased by the total amount of research and experimental expenditures made by the controlled foreign corporation for qualified research or experimental expenditures (as defined for purposes of Code section 174 and the Treasury regulations thereunder), taking into account payments and expenditures (including cost-sharing payments) made in the current taxable year and the two most recent preceding taxable years. In addition, the aggregate adjusted basis of the total assets of the controlled foreign corporation is increased by the amount of three times the total payments made during the taxable year to unrelated persons and related U.S. persons for the use of intangible property with respect to which the controlled foreign corporation is a licensee, and which the controlled foreign corporation uses in the active conduct of its trade or business. Payments made to related foreign persons are not taken into account.

Study on investments in U.S. property

The Senate amendment does not include the House bill provision requiring a Treasury department study on the tax treatment of certain investments in U.S. property.

Inclusions based on excess passive assets

The conferees wish to clarify that under the conference agreement, as is typically the case where a group of corporations is treated as a single corporation for tax purposes, intercompany stock and obligations generally are disregarded in the determination of excess passive assets. For example, stock owned by one member of the group in another member of the group is disregarded, as are intercompany loans, other intercompany receivables, and intercompany licenses. As another example, assume that one member of the group provides goods or services to an unrelated customer, thereby acquiring a trade or service receivable. Assume further that the group member then factors the receivable to another member of the group, and the second member later receives the payment from the customer, which gives rise to income for the second member which is treated as passive interest income. During the period when the receivable is held by the second group member, the basis of the receivable in the hands of group, for purposes of applying the conference agreement to the group, would reflect the cost incurred by the second member to acquire the receivable in the factoring transaction with the first member. The conferees intend that the characterization of the receivable as a passive or nonpassive asset for purposes of determining excess passive assets depend on the activities by which the group as a whole derived the receivable. If the receivable properly would be viewed as a nonpassive asset based on those activities (without regard to which member of the group carried out the activities), the conferees anticipate that interest incidentally received by the second group member generally would not cause the receivable to be characterized as a passive asset (see, e.g., Notice 88-22, 1988-1 C.B. 489).

Inasmuch as stock owned by one member of the group in another member of the group would be disregarded, the look-through rule of section 1296(c) does not apply within a CFC group. However, the look-through rule of section 3296(c) does apply in the case of stock owned by one or more members of the CFC group in a foreign corporation that is not a member of the CFC group. For example, if one member of the CFC group owns 20 percent of the stock of another controlled foreign corporation that is not a member of the CFC group, and a second member of the CFC group owns 10 percent of the stock of such non-member controlled foreign corporation, the CFC group would be treated as owning 30 percent of the assets of the non-member controlled foreign corporation under the look-through rule of section 3296(c).

For purposes of the conference agreement's aggregation rule and look-through rule, all amounts of assets and earnings must be converted into units of a single currency, ordinarily the U.S. dollar. The conferees anticipate that Treasury will provide guidance as to the translation method appropriate to such conversion. The conferees anticipate that Treasury will authorize the use of the spot rate on the date of measurement for such purpose. In addition, the conferees anticipate that Treasury may authorize an alternative method, under which the U.S. shareholders of a controlled foreign corporation would be permitted to determine the adjusted basis of the assets of the controlled foreign corporation using the historical cost in U.S. dollars of the foreign currency-denominated assets, in cases where the Secretary is satisfied that such historical costs can be established in a reasonably administrable fashion consistent with the purposes of the provision. Until guidance is issued by the Secretary, the conferees intend that taxpayers be permitted to convert asset costs to a single currency using any reasonable method (which may be, for example, a spot-rate conversion method or a historical dollar-cost method), so long as the method is consistently applied to all controlled foreign corporations (whether or not members of a CFC group) in all taxable years.

Modification of certain PFIC rules

Modifications to section 956

The conference agreement also provides regulatory authority under which the Treasury is instructed to prescribe such regulations as may be necessary to carry out the purposes of section 956, and to prevent their avoidance. Within this authority, the conferees anticipate that the Treasury may prescribe regulations that, for example, would prevent taxpayers from taking advantage of the differences between the excess passive assets rules and the rules of section 956.

Other modifications to the subpart F rules

The House bill and the Senate amendment limit the availability of the same-country exception applicable to the determination of subpart F income in the case of certain dividends received by controlled foreign corporations. Under the conference agreement, amounts distributed with respect to stock owned by the controlled foreign corporation do not qualify for the same-country exception to the extent that the distributed earnings and profits were accumulated by the distributing corporation during periods when the controlled foreign corporation did not hold the stock either directly or indirectly through a chain of one or more subsidiaries, each of which qualifies as a same-country corporation. For example, the same-country exception is available under the conference agreement in the case of a chain of three wholly owned same-country subsidiaries, where the middle-tier subsidiary is liquidated prior to the payment of a dividend from the lowest tier subsidiary to the highest tier subsidiary, and the dividend comprises earnings of the lowest tier subsidiary that were accumulated solely during periods when it was (indirectly) owned by the highest tier subsidiary.

2. Allocation of Research Expenditures

(sec. 14234 of the House bill, sec. 8234 of the Senate amendment, sec. 13234 of the Conference agreement, and sec. 864(f) of the Code)

Foreign source taxable income in any limitation category equals foreign source gross income in that category less the expenses, losses and other deductions properly apportioned or allocated to that income. A Treasury regulation issued in 1977 describes methods for allocating expenses between U.S. and foreign source income, including rules for the allocation of research expenses. Since 1981, however, the research expense allocation regulation has been subject to a series of statutory temporary suspensions and modifications. The most recent temporary statutory provision (set forth in Code section 864(f)) was applicable generally for the first six months of the first taxable year beginning after August 1, 1991. For this purpose, total research expenses for the year were deemed to be incurred evenly throughout the year.

For expenses deemed paid or incurred during the first six months of the year referred to above (other than amounts incurred to meet certain legal requirements, and thus allocable to one geographical source), 64 percent of U.S.-incurred research expenses were allocated to U.S. source income, and 64 percent of foreign-incurred research expenses were allocated to foreign source income. The remainder of research expenses were allocated and apportioned either on the basis of sales or gross income, but subject to the condition that if income-based apportionment was used, the amount apportioned to foreign source income could have been no less than 30 percent of the amount that would have been apportioned to foreign source income had the sales method been used.

The Treasury has announced that during what would ordinarily be an 18-month period following the six-month period referred to above -- that is, the last six months of the taxpayer's first taxable year beginning after August 1, 1991 and the immediately succeeding taxable year -- taxpayers may continue to allocate research expenses in accordance with the method set forth in Code section 864(f). In granting the transitional period, Treasury stated that the transitional method was not intended to suggest any particular views about the proper allocation and apportionment of research expenses. Rather, Treasury stated, the transition method was intended solely to provide taxpayers with transitional relief and to minimize audit controversy and facilitate business planning during the conduct of the regulatory review.

The House bill provides regulatory authority for the implementation of certain adjustments regarding section 936 companies. In addition, the bill authorizes the Treasury to prescribe such regulations as may be appropriate to carry out the purposes of this provision, including regulations relating to the determination of whether research activities are conducted inside or outside the United States and making such adjustments as may be appropriate in the case of cost sharing arrangements and contract research.

3. Eliminate Working Capital Exception for Foreign Oil and Gas and Shipping Income

(sec. 14235 of the House bill, sec. 8235 of the Senate amendment, sec. 13235 of the Conference agreement, and secs. 904(d), 907, and 954 of the Code)

Foreign tax credit limitations are computed separately for certain categories of foreign source income, including passive income, high withholding tax interest, financial services income, shipping income, dividends from each noncontrolled section 902 corporation, certain distributions from DISCs and FSCs, certain types of income earned by a FSC, and all other (i.e., "overall basket" or "general basket") income. Passive income generally includes income which is of a kind which would be foreign personal holding company income as defined under Code section 954(c) (e.g., interest and dividends) and typically is not subject to high levels of foreign tax. The separate limitation for passive income generally prevents the cross-crediting of high foreign taxes on income which falls in the general basket against the residual U.S. tax on passive income.

The separate foreign tax credit limitation for passive income was enacted in 1986 and replaced the prior law separate foreign tax credit limitation for passive interest income.⁷⁷ Prior law excluded from the passive interest separate limitation category interest derived from any transaction which is directly related to the active conduct by the taxpayer of a trade or business in a foreign country. Regulations under prior law expressly treated certain types of interest on working capital as interest derived from a transaction which is directly related to the active conduct of a trade or business.⁷⁸ No such general working capital exception exists under the passive income definition as established in 1986. As a result of the interaction of the Code and Treasury regulations originally developed prior to 1987, however, the working capital exception has been retained for the oil and gas and shipping industries.

Special limitations on credits for foreign extraction taxes and taxes on foreign oil related income

In addition to the foreign tax credit limitations that apply to all creditable foreign taxes, a special limitation is placed on foreign income taxes on foreign oil and gas extraction income (FOGEI). Under this special limitation, amounts claimed as taxes paid on FOGEI of a U.S. corporation qualify as creditable taxes (if they otherwise so qualify) only to the extent they do not exceed the product of the highest marginal U.S. tax rate on corporations (presently 34 percent) multiplied by such extraction income. Foreign taxes paid in excess of that amount on such income are, in general, neither creditable nor deductible (unless a credit carryover provision applies).

A similar special limitation may apply to foreign taxes paid on foreign oil related income (FORI) in certain cases where that type of income is subjected to a materially greater level of tax by a foreign jurisdiction than non oil and gas income generally would be. Under this limitation, a portion of the foreign taxes on FORI may be deductible, but not creditable.

As previously described, regulations issued prior to 1986 and still effective define FOGEI and FORI to include interest on working capital related to extraction or oil related activities, as the case may be. Thus, under current regulations, FOGEI and FORI include what generally would be considered as passive income for foreign tax credit limitation purposes.

The House bill prevents the cross-crediting of foreign taxes on FOGEI, FORI, and shipping income by placing certain passive income related to oil and gas and shipping operations in the passive category for foreign tax credit limitation purposes. In addition, the House bill excludes certain passive income related to foreign oil and gas extraction or other foreign oil related activities from the computation of the FOGEI and FORI foreign tax credit limitations.

Foreign tax credit separate limitations

With respect to the separate foreign tax credit limitation for passive income, the House bill eliminates the present-law exclusion of FOGEI from the definition of passive income. Thus, if a taxpayer has gross income that falls within the definition of passive income under section 904, and also satisfies the definition of FOGEI under section 907, the income would be treated as passive income in determining the taxpayer's foreign tax credit.

In addition, the House bill amends the present-law rule applicable to income which by definition qualifies both as foreign personal holding company income under section 954 (c) and as foreign base company oil related income under section 954 (g). The House bill provides that such income is to be treated as foreign personal holding company income. As such, the income generally would be passive income for foreign tax credit purposes.

Likewise, the House bill specifies that dividend or interest income that by definition qualifies as both foreign personal holding company income and foreign base company shipping income is to be treated as foreign personal holding company income. Thus, for foreign tax credit purposes, the income would fall in the passive basket rather than in the separate basket for shipping income.

Special FOGEI and FORI limitations

The House bill provides that the term "foreign oil and gas extraction income" does not include any dividend or interest income which is passive income as defined for foreign tax credit limitation purposes. Since, as discussed above, the House bill treats gross interest income on working capital related to foreign oil and gas extraction activities, for example, as passive income, such income is not considered FOGEI for purposes of computing the special limitation for foreign taxes paid on FOGEI.

In addition, the House bill specifies that the term "foreign oil related income" does not include any dividend or interest income which is passive income as defined under the foreign tax credit provisions. As a result, for example, gross interest income on working capital related to activities which generate foreign oil related income would not be treated as FORI for purposes of computing the special limitation for foreign taxes paid on FORI.

The conference agreement clarifies that for purposes of applying section 954(f), dividends and interest received from a foreign corporation in respect of which taxes are deemed paid under section 902 are classified as foreign base company shipping income (as under present law) to the extent attributable to foreign base company shipping income. Similarly, the conferees intend that dividends and interest received from a foreign corporation in respect of which taxes are deemed paid under section 902 are classified as FOGEI or TORI, respectively, to the extent attributable to FOGEI or FORI.

The conferees also wish to clarify the treatment (under sec. 954(b)(6)(B)) of a post-effective date corporate distribution of income earned by the payor in a pre-effective date year. The determination whether such pre-effective date income was shipping income for this purpose will be made under the laws defining shipping income in effect for the year in which the income was earned.

4. Transfer Pricing Initiative

(sec. 14236 of the House bill, sec. 8236 of the Senate amendment, sec. 13236 of the Conference agreement, and sec. 6662 of the Code)

There is a substantial valuation misstatement if, among other things, the net section 482 transfer price adjustment for the taxable year exceeds $10 million. The analogous "gross valuation misstatement" involves a net section 482 transfer price adjustment of $20 million. The net section 482 transfer price adjustment is the net increase in taxable income for a taxable year resulting from adjustments under section 482 in the price for any property or services (or use of property). However, a net increase in taxable income attributable to a price redetermination is disregarded, for this purpose, if it is shown that there was a reasonable cause for the taxpayer's determination of the price, and that the taxpayer acted in good faith with respect to the price.

In measuring the amount of a taxpayer's net section 482 transfer price adjustment, a net increase in taxable income attributable to a price redetermination is disregarded under the House bill only if the taxpayer satisfies certain statutory requirements.

The taxpayer would meet the requirements if it established that each of three criteria were met. First, the taxpayer would have to establish that the price it used was determined under a pricing method specified in the section 482 regulations. Second, the taxpayer would have to establish that it applied the method reasonably. (In order for the application of the method to have been reasonable, it is intended that any procedural or other requirements imposed under the regulations must have been observed. For example, if certain adjustments required under a particular method were not made, the application of that method would not be reasonable.) Third, the taxpayer would have to establish that it had documentation, in existence as of the time of filing its original return, setting forth the reasonable determination of the price as described above, which documentation the taxpayer provides to the IRS within 30 days of a request for it.

Alternatively, the taxpayer would meet the requirements if it established that none of the methods specified in the section 482 regulations was likely to result in a price that would clearly reflect income, that it used another method which was likely to result in such a price, and that it had documentation, in existence as of the time of filing its original return, setting forth the determination of the price and establishing the foregoing requirements, which documentation the taxpayer provides to the IRS within 30 days of a request for it.

Under the House bill, it is intended that the application of any method would not be considered reasonable if the taxpayer became aware prior to filing its tax return that such application more likely than not did not lead to an arm's length result.

In the case of a valuation misstatement due to a net section 482 transfer price adjustment, no penalty would be excused for reasonable cause and good faith unless the above requirements were met.

5. Deny Portfolio Interest Exemption for Contingent Interest

(sec. 14237 of the House bill, sec. 8237 of the Senate amendment, sec. 13237 of the Conference agreement, and secs. 871(h), 881(c), and 2105(b) of the Code)

As a general rule, a deduction is allowed for all interest paid or accrued on indebtedness. Whether a financial instrument is treated as debt for Federal income tax purposes depends on the facts of the particular case. Under existing law, an instrument may qualify as debt even if it provides the holder with significant equity participation rights. For example, the IRS has ruled that in certain cases, contingent interest paid on a shared appreciation mortgage loan used to finance the purchase of a personal residence may be deductible by a cash basis payor.⁷⁹ As another example, contingent interest based on a share of the borrower's profits has been determined to be deductible in certain cases.⁸⁰

^{Interest received by foreign persons}

^{The Internal Revenue Code provides that U.S. source interest income earned by a nonresident alien individual or a foreign corporation that is not effectively connected with the conduct of a U.S. trade or business generally is subject to a gross-basis 30-percent withholding tax. A significant statutory exemption from that tax applies to so-called "portfolio interest" received by foreign persons.}

^{Portfolio interest generally is defined as any U.S. source interest (including original issue discount) that is not effectively connected with the conduct of a trade or business and (1) is paid on an obligation that satisfies certain registration requirements or specified exceptions thereto, and (2) is not received by a 10-percent owner of the issuer of the obligation, taking into account shares owned by attribution.81}

^{Foreign-investment in U.S. real property--shared appreciation debt}

^{A foreign person's gain on the disposition of a U.S. real property interest (USRPI) is treated as income that is effectively connected with the conduct of a U.S. trade or business, and thus is subject to net-basis tax at ordinary U.S. income tax rates pursuant to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA). USRPIs include interests (other than solely as a creditor) in (1) real property, and (2) domestic corporations that are U.S. real property holding corporations (USRPHCs).}

^{Whether a financial instrument is considered debt under any provisions of the Code is not determinative of whether it constitutes an "interest solely as a creditor" for purposes of FIRPTA. Regulations provide that an interest in real property other than an interest solely as a creditor includes any right to share in the appreciation in the value of, or in the gross or net proceeds or profits generated by, the real property. Similarly, an interest in an entity (such as a USRPHC) other than an interest solely as a creditor includes any right to share in the appreciation in the value of an interest in, or the assets of, the entity, or a right to share in the gross or net proceeds or profits derived by, the entity.}

^{Regulations further provide that amounts otherwise treated for tax purposes as principal and interest payments on debt obligations of all kinds (including obligations that are interests other than solely as a creditor) do not give, rise to gain or loss that is subject to U.S. tax under FIRPTA.82} Thus, a foreign owner of a note that pays interest contingent on appreciation in U.S. real property incurs U.S. income tax if he disposes of the note, but may not incur U.S. income tax if he holds the note and receives interest payments under its terms.

Estate tax treatment of portfolio obligations

As a general rule, estate tax is imposed on the transfer of the taxable estate of every decedent nonresident who was not a citizen of the United States. For this purpose, the value of the gross estate of such a decedent that is subject to tax is that part of his or her gross estate which at the time of death (or as provided in section 2104(b)) is situated in the United States. Certain types of property are specifically excluded by statute from a nonresident decedent's gross estate. One type of property granted such an exclusion is a debt obligation if any interest thereon would he eligible for the exemption from income tax for portfolio interest were such interest received by the decedent at the time of his or her death, determined without regard to whether a statement has been received that the beneficial owner of the obligation is not a United States person.

Under the House bill, contingent interest includes interest determined by reference to any of the following attributes of the debtor or any related person: receipts, sales, or other cash flow; income or profits; or changes in the value of property.⁸³ In addition, contingent interest includes interest determined by reference to any dividend, partnership distribution, or similar payment made by the debtor or a related person.

The House bill provides a number of exceptions to the general definition of contingent interest as detailed above. Under one such exception, interest is not considered contingent solely because the timing of the interest or any related principal payment is subject to a contingency. In addition, portfolio interest treatment is not denied under the House bill solely because the interest is paid with respect to nonrecourse or limited recourse indebtedness. Interest also is not denied portfolio treatment under the House bill if all or substantially all of it is determined by reference to certain other amounts of interest that is not described as contingent above (or by reference to the principal amount of indebtedness on which such other interest is paid). In determining whether all or substantially all of an amount of interest payable on a debt obligation is computed by reference to another amount of interest that is not contingent interest, other factors that affect the amount of interest payable on the debt obligation, but which are not contingencies as contemplated by the House bill, are not taken into account.

Another of the House bill's exceptions provides that interest is not denied portfolio treatment solely because the debtor or a related person enters into a hedging transaction to reduce the risk of interest rate or currency fluctuations with respect to such interest. Interest also is not denied portfolio treatment under the House bill if it is determined by reference to changes in the value of (or any index of the value of) actively traded property other than a USRPI. For this purpose, the term "property" includes stock, and the term "actively traded" has the meaning given to that term under section 1052(d) of the Code. In general, portfolio treatment also is not denied if the interest is determined by reference to the yield (or any index of the yield) on such actively traded property. However, this exception for interest contingent on the yield of actively traded property does not apply if the property is a debt instrument that itself pays contingent interest as described above, or the actively traded property is stock or other property that represents a beneficial interest in the debtor or a related person.

The House bill provides that application of the provision may be extended to any type of contingent interest not specifically described in the bill, if identified by the Treasury Secretary in regulations. The Secretary is granted authority under the House bill to issue such regulations to supplement the statutory description of contingent interest in order to address cases where a denial of the portfolio interest exemption is necessary or appropriate to prevent avoidance of U.S. income tax. The House bill additionally provides that the Secretary may by regulation exempt any type of interest from denial, under the bill, of portfolio treatment.

The provision is not intended to override existing treaties that reduce or eliminate U.S. withholding tax on interest paid to foreign persons.

The conferees wish to clarify the treatment under the provision of a debt instrument with a minimum non-contingent interest rate. For example, assume that the interest rate on a debt instrument is stated as the greater of either of two amounts -- 6% of the principal amount or 10% of gross profits. In such a case, only the gross-profits-based interest is contingent interest. The conferees wish to clarify that with respect to such an instrument, only the excess of the contingent amount, if any, over the minimum fixed interest amount is disqualified from portfolio interest treatment.

The conference agreement provides that, for purposes of determining the gross estate of a nonresident noncitizen decedent subject to the estate tax, a special rule applies to debt instruments that provide for both contingent and noncontingent interest. Under the conference agreement, an appropriate portion of the value of such an instrument, as determined in a manner prescribed by the Secretary of the Treasury, is treated as property within the United States and, thus, is included in the decedent's gross estate. Until rules are issued that provide guidance as to the proper method for determining the appropriate portion of such an instrument that is treated as situated in the United States, the conferees intend that taxpayers be permitted to use any reasonable method for making such determination.

The estate tax provision is effective for decedents dying after December 31, 1993. The provision does not apply to any obligation with a fixed term that was issued on or before April 7, 1993, or was issued after such date pursuant to a written binding contract in effect on such date and at all times thereafter before it was issued.

6. Regulatory Authority to Address Multiple-Party Financing Arrangements

(sec. 14238 of the House bill, sec. 8238 of the Senate amendment, sec. 13238 of the Conference agreement, and new sec. 7701(1) of the Code)

Under the Code, payments of interest by U.S. persons to related foreign persons may be subject to 30-percent gross-basis withholding tax. On the other hand, no such tax applies to payments by U.S. persons to unrelated foreign persons of so-called portfolio interest. Under treaties, payments of interest by U.S. persons to related foreign persons who are resident in the treaty country may be subject to little or no U.S. gross-basis tax. By contrast, if the related recipient of interest is resident in a country with respect to which no U.S. income tax treaty is in force, the 30-percent gross-basis tax would be imposed.

Courts have stated that the incidence of taxation depends upon the substance of a transaction as a whole.⁸⁴ In certain cases, courts have recharacterized transactions in order to impose tax consistent with this principle. For example, where three parties have engaged in a chain of transactions, the courts have at times ignored the "middle" party as a mere "conduit," and imposed tax as if a single transaction had been carried out between the parties at the ends of the chain.

In Aiken Industries, Inc. v. Commissioner,⁸⁵ the Tax Court recharacterized an interest payment by a U.S. person on its note held by a related treaty-country resident, which in turn had a precisely matching obligation to a related non-treaty-country resident, as a payment directly by the U.S. person to the non-treaty-country resident. The transaction in its recharacterized form resulted in a loss of the treaty protection that would otherwise have applied on the payment of interest by the U.S. person to the treaty-country resident, and thus caused the interest payment to give rise to 30-percent U.S. tax.

The IRS has taken the position that it will apply a similar result in cases where the back-to-back related party debt obligations are less closely matched than those in Aiken Industries, so long as the intermediary entity does not obtain complete dominion and control over the interest payments.⁸⁶ The IRS has taken an analogous position where an unrelated financial intermediary is interposed between the two related parties as lender to one and borrower from the other, as long as the intermediary would not have made or maintained the loan on the same terms without the corresponding borrowing.⁸⁷ In a recent technical advice memorandum, the IRS has taken the position that interest payments by a U.S. company to a related, treaty-protected financial intermediary may be treated as payments by the U.S. company directly to the foreign parent of the financial intermediary even though the matching payments from the intermediary to the parent are not interest payments, but rather are dividends.⁸⁸

It is intended that the provision apply not solely to back-to-back loan transactions, but also to other financing transactions. For example, it would be within the proper scope of the provision for the Secretary to issue regulations dealing with multiple-party transactions involving debt guarantees or equity investments.

7. Exports of Certain Unprocessed Softwood Timber

(sec. 8239 of the Senate amendment, sec. 13239 of the Conference agreement, and secs. 861-865, 921-927, 951-964, and 991-996 of the Code)

Subject to significant exceptions, income from the sale of personal property generally is sourced on the basis of the residence of the seller. One set of exceptions apply to sales of inventory property. Income derived from the purchase of inventory property within the United States and its sale outside the United States constitutes foreign source income. Similarly, income derived from the purchase of inventory property outside the United States and its sale within the United States constitutes domestic source income. Income attributable to the marketing of inventory property by U.S. residents in other cases may also have its source determined to be the place of sale. For this purpose, the place of sale generally is the place where title to the property passes to the purchaser (the "title passage" rule).

Income derived from the manufacture of products in the United States and their sale elsewhere is treated as having a divided source. Under Treasury regulations, 50 percent of such income generally is attributed to the place of production (in this case, the United States), and 50 percent of the income is attributed to marketing activities and is sourced on the basis of the place of sale (determined under the title passage rule). Under certain circumstances, the division of the income between production and marketing activities must be made on the basis of an independent factory or production price, rather than on a 50-50 basis, where a taxpayer sells part of its output to wholly independent distributors or other selling concerns in such a way as to establish fairly the independent factory or production price unaffected by considerations of tax liability (Treas. Reg. sec. 1.863-3(b)(2), Example (1); Notice 89-10, 1989-4 I.R.B. 10).

Income earned by foreign corporations

The United States exerts jurisdiction to tax all income, whether derived in the United States or elsewhere, of U.S. citizens, residents, and corporations. By contrast, the United States taxes nonresident aliens and foreign corporations only on income with a sufficient nexus to the United States. In the case of income earned by a U.S.-owned foreign corporation, generally no U.S. tax is imposed until that income is distributed to the U.S. shareholders as a dividend.

When a U.S.-controlled foreign corporation earns so-called subpart F income," the United States generally taxes the corporation's 10-percent U.S. shareholders currently on their pro-rata share of that income regardless of whether the income is actually distributed currently to the shareholders. Included among the types of income deemed distributed (generally referred to as "subpart F income") is foreign base company sales income.

Certain subpart F income derived by a controlled foreign corporation that is an export trade corporation (ETC) from certain export activities is exempt from current taxation. Under this exemption, the subpart F income of an ETC is reduced by certain amounts that constitute export trade income (as defined in section 971). No foreign corporation may qualify as an ETC unless it has so qualified generally since 1971.

Foreign sales corporations

A portion of the income of an eligible foreign sales corporation (FSC) that is generated from export property is exempt from Federal income tax. If the income earned by the FSC is determined under special administrative pricing rules, then the exempt foreign trade income generally is 15/23 of the foreign trade income the FSC derives from the transaction. In addition, a domestic corporation is allowed a 100-percent dividends-received deduction for dividends distributed from the FSC out of earnings attributable to certain foreign trade income. Thus, there generally is no corporate level tax imposed on a portion of the income from exports of a FSC.

Foreign trade income is defined as the gross income of a FSC attributable to foreign trading gross receipts. Foreign trade income includes both the profits earned by the FSC itself from exports and commissions earned by the FSC from products exported by others and services related thereto. In general, the term foreign trading gross receipts means the gross receipts of a FSC which are attributable to the export of certain goods and services. Foreign trading gross receipts are the gross receipts of the FSC that are attributable to the following types of transactions: the sale of export property, the lease or rental of export property, services related and subsidiary to the sale or lease of export property, engineering and architectural services, and export management services.

Export property, for purposes of the FSC rules, is defined as property that is (1) manufactured, produced, grown, or extracted in the United States by a person other than a PSC, (2) held primarily for sale, lease, or rental, in the ordinary conduct of a trade or business by, or to, a FSC, for direct use, consumption, or disposition outside the United States, and (3) not more than 50 percent of the fair market value of which is attributable to articles imported into the United States.

Domestic International Sales Corporations

Prior law provided for a system of tax deferral for corporations known as Domestic International Sales Corporations, or "DISCs," and their shareholders. Under this system, the profits of a DISC were not taxed to the DISC but were taxed to the shareholders of the DISC when distributed or deemed distributed to them. Each year, a DISC was deemed to have distributed a portion of its income, thereby subjecting that income to current taxation in its shareholders' hands. Federal income tax could generally be deferred on the remaining portion of the DISC's taxable income until the income was actually distributed to the shareholders.

Under current law, a DISC is permitted to continue to defer income attributable to $10 million or less of qualified export receipts. However, unlike the prior-law DISC rules, an interest charge is imposed on the shareholders of the DISC. The amount of the interest is based on the tax otherwise due on the deferred income computed as if the income were distributed. Taxable income of the DISC attributable to qualified export receipts that exceed $10 million is deemed distributed to the DISC's shareholders.

To qualify for DISC treatment, at least 95 percent of a domestic corporation's gross receipts must consist of qualified export receipts. In general, qualified export receipts are receipts, including commission receipts, derived from the sale or lease for use outside the United States of export property, or from the furnishing of services related or subsidiary to the sale or lease of export property. Export property must be manufactured, produced, grown, or extracted in the United States.

The Senate amendment excludes from the definition of "export property" for purposes of the FSC rules any unprocessed timber which is a softwood. Similarly, the Senate amendment excludes from the definition of "export property" for purposes of the DISC rules any unprocessed timber which is a softwood.

The Senate amendment also amends the sales source rules as they apply to inventory property. In this case, the Senate amendment provides that any income from the sale of any unprocessed timber which is a softwood and which was cut from an area located in the United States would be domestic source income.

Finally, the Senate amendment treats as subpart F foreign base company sales income any income derived by a controlled foreign corporation in connection with the sale of any unprocessed timber which is a softwood and was cut from an area located in the United States. In addition, the Senate amendment treats as subpart F foreign base company sales income any income derived by a controlled foreign corporation from the milling of any such timber outside the United States. Any income treated as subpart F income under the Senate amendment that is earned by an export trade corporation is not subject to reduction by the export trade income of the corporation.

(sec. 14241 of the House bill)

The House bill imposes excise taxes on petroleum products, natural gas, coal, alcohol fuels, and electricity. The taxes are imposed at a base rate of 26.8 cents per million Btus on all fuels; an additional (supplemental) rate of 34.2 cents per million Btus is imposed on most petroleum products and on alcohol fuels. The electricity tax rate is calculated separately by each seller based on the Btu content of the fuels used in generating its electricity, and on statutorily assumed Btu contents for hydro- and nuclear-generated electricity.

The bill imposes an imputed Btu tax on imported products that the Treasury Department designates as "energy intensive." The tax applies only to products of industries classified, or individual products classified, as having direct energy inputs, measured as a percentage of the value of the finished product, in excess of two percent.

Points of collection

The petroleum and alcohol fuels taxes are collected on removal of those fuels from registered terminal facilities. The natural gas, coal, and electricity taxes are collected at the retail level. Use of these products is taxable if the use occurs before the point at which tax normally is imposed.

Exemptions

Number 2 distillate fuel oil used for the heating of any building and gasoline and diesel fuel used on farms are exempt from the supplemental petroleum rate. Full exemptions are provided for: electricity generated from renewable sources or biomass; direct energy exports; feedstocks (including electricity used in electrolytic production processes); certain fuels used to produce taxable energy products; fuels used in international commercial transportation; a portion of coal used in certain coke production; and methane recovered from biomass or certain coal mining operations.

2. Transportation Fuels Tax Increase

(sec. 8241 of the Senate amendment, sec. 13241 of the Conference agreement, and secs. 4041, 4042, 4081, 4091, 6416, 6421, 6427, 9502, 9503 of the Code)

In general, gasoline and special motor fuels used in highway vehicles and motorboats are taxed at a total rate of 14.1 cents per gallon; highway diesel fuel is taxed at a total rate of 20.1 cents per gallon (except certain intercity bus diesel fuel is taxed at a reduced rate of 3.1 cents per gallon); noncommercial aviation gasoline is taxed at a total rate of 15.1 cents per gallon; noncommercial aviation jet fuel is taxed at a total rate of 17.6 cents per gallon; commercial aviation fuels are taxed at a total rate of 0.1 cent per gallon; railroad diesel fuel is taxed at a total rate of 2.6 cents per gallon; and inland waterways fuels are taxed at a total rate of 17.1 cents per gallon in 1993 (increasing to 19.1 cents per gallon in 1994 and 20.1 cents per gallon in 1995 and thereafter).

Revenues from most of these excise taxes are deposited in various trust funds to finance specific Federal public works and environmental programs. The set of fuels subject to each tax generally reflects the purposes of the trust fund to which the revenues are dedicated. The above rates also include a 2.5-cents-per-gallon general deficit reduction tax (in effect through September 30, 1995⁹⁰) imposed on highway motor fuels, motorboat gasoline and special motor fuels, and train diesel fuel. Revenues from this deficit reduction tax are retained in the General Fund of the Treasury.

One of the dedicated excise taxes is a 0.1 cent per gallon tax (0.05 cent per gallon for qualified ethanol and methanol fuels) imposed on all of the fuels listed above, except liquefied petroleum gas. This tax, in effect through 1995, is deposited into the Leaking Underground Storage Tank ("LUST") Trust Fund, which is used to fund cleanup costs associated with leaking underground storage tanks containing petroleum products.

Certain fuel uses are exempt from the LUST excise tax. Exempt uses include No. 2 distillate fuel oil⁹¹ used as heating oil; gasoline and diesel fuel used on farms for farming purposes; off-highway business uses of fuel (for example, fuel used to operate pumps, generators, compressors, forklift trucks, or bulldozers, or fuel used in vessels used by fisheries or whaling businesses); fuels used by State and local governments; fuels used by nonprofit educational organizations; exported fuels, including fuels used in international aviation and international shipping; and fuel for military ships and aircraft.

The gasoline excise tax (including the LUST rate on gasoline) is imposed when the fuel leaves terminal storage facilities (i.e., at the terminal rack). The diesel fuel excise tax is imposed on the wholesale sale of that fuel.

The Senate amendment imposes a permanent excise tax of 4.3 cents per gallon on: (1) all transportation fuels currently subject to the Leaking Underground Storage Tank Trust Fund ("LUST") excise tax, except jet fuels used in aviation; (2) liquefied petroleum gases currently taxable as special motor fuels; and (3) diesel fuel used in noncommercial motorboats. Taxable fuels include motor fuels (gasoline, diesel fuel and special motor fuels) used for highway transportation or in motorboats; gasoline used in aviation; gasoline used in off-highway non-business uses (e.g., small engines and recreational trail uses); diesel fuel used in trains; and fuels used in inland waterways transportation.

Point of collection

The new 4.3-cents-per-gallon excise tax generally is collected in the same manner as the existing excise taxes on these fuels (i.e., the tax on gasoline and diesel fuel (see item II.D.3., below) is collected on removal of these fuels from registered terminal facilities, the tax on special motor fuels is collected upon the retail sale of these fuels, and the tax on fuels used in inland waterways is collected on the use of these fuels).

Exemptions

Most fuel uses that are exempt from the LUST tax are exempt from the new tax. These uses include, for example, number 2 distillate (diesel) fuel used as heating oil; gasoline and diesel fuel used on farms for farming purposes; off-highway business uses (such as to operate stationary pumps or compressors or in construction vehicles or vessels operated by fisheries); fuels used by State and local governments and nonprofit schools including fuel used in privately operated school and intracity buses; exported fuels; fuels used in international aviation; and, international and domestic shipping (other than shipping on the inland waterways system).

Disposition of revenues

The 4.3-cents-per-gallon highway and rail fuel revenues are to be transferred to the Highway Trust Fund; aviation gasoline revenues are to be transferred to the Airport and Airway Trust Fund; inland waterways transportation fuel revenues are to be transferred to the Inland Waterways Trust Fund; motorboat fuels and small-engine gasoline revenues are to be transferred to the Aquatic Resources Trust Fund; and non-highway recreational vehicle fuels revenues are to be transferred to the National Recreational Trails Trust Fund.

The tax base is expanded to include compressed natural gas (CNG) used in highway motor vehicles or motorboats, and jet fuel used in noncommercial aviation. In addition, gasoline and jet fuel used in commercial aviation is subject to the 4.3 cent-per-gallon rate beginning on October 1, 1995 (with appropriate floor stocks taxes being imposed on that date).

CNG used in highway vehicles or motorboats is taxed at a rate of 48.54 cents per mcf (thousand cubic feet) at standard temperature and pressure. The tax is collected on the retail sale or use of CNG under the same provisions as the special motor fuels tax currently is collected.

Revenues from the new 4.3-cents-per-gallon tax (48.54 cents per mcf on compressed natural gas) are retained in the General Fund of the Treasury.

3. Modification of the collection of the Diesel Fuel Excise Tax

(secs. 14242-14243 of the House bill, secs. 8242-8243 of the Senate amendment, secs. 13242-13243 of the Conference agreement, and secs. 4041, 4081 and 4091 of the Code)

Taxes totaling 20.1 cents per gallon generally are imposed on the sale of diesel fuel by a producer or importer. A reduced rate of 3.1 cents per gallon applies to sales of diesel fuel for use in certain intercity buses. A reduced rate of 2.6 cents per gallon applies to sales of diesel fuel for use in trains.

Diesel fuel for heating and for certain other non-taxable uses (including use on a farm for farming purposes) is exempt from tax. Diesel fuel may be sold without the payment of tax only if certain prescribed conditions are satisfied, which may include registration by the buyer and seller and certification of exempt use by the buyer to the seller.

The producer making a taxable sale generally is liable for the tax. The term producer generally includes refiners, compounders, blenders, wholesale distributors of diesel fuel and dealers selling any diesel fuel exclusively to producers of diesel fuel. Producers must be registered with the Internal Revenue Service ("IRS") and, as a condition of registration, may be required to post a bond. Producers who are registered may sell diesel fuel to other registered producers without the payment of tax. Thus, in general, most diesel fuel tax is collected at the wholesale distributor level.

Reduced-rate and exempt users who buy diesel fuel after tax has been paid on the fuel may file a claim for credit or refund. These users must, however, keep business records that will enable the IRS to verify the amount claimed.

Gasoline tax collection

Taxes totaling 14.1 cents a gallon generally are imposed on (1) the removal of gasoline from any refinery, (2) the removal of gasoline from any terminal, (3) the entry of gasoline into the United States, and (4) the sale to any unregistered person unless there was a prior taxable removal or entry of the gasoline under (1), (2), or (3) above. The tax, however, does not apply to any entry or removal of gasoline transferred in bulk to a terminal if all the persons involved (including the terminal operator) are registered. Thus, tax generally is imposed when gasoline is removed by truck from a terminal (this is called removal at the "terminal rack").

As under the diesel fuel tax, exemptions from the gasoline tax are provided for certain uses, such as for farming or for off-highway business use. Taxpayers who use gasoline for an exempt use are eligible to claim a credit or refund of the excise tax included in the price of the gasoline.

Under Treasury Department regulations, the person liable for the tax imposed on gasoline removed from a terminal rack is the "position holder," which, in general, is the person that holds the inventory position to gasoline as reflected on the records of the terminal operator (i.e., has a contract with the terminal operator for the use of storage facilities and terminaling services at a terminal). In addition, the terminal operator may be jointly and severally liable for the tax if the position holder is not registered with Treasury. Terminal operators are required to be registered and, as a condition of registration, may be required to post a bond in such sum as the Treasury determines.

The House bill provides that the full 20.1 cents per gallon diesel fuel excise tax rate will be collected on removal from a terminal (i.e., at the terminal rack) under generally the same rules as the gasoline tax currently is collected. However, unlike the gasoline tax, removal of diesel fuel that is destined for an exempt use will not be taxed as the fuel is removed from the terminal if certain dyeing (and marking) requirements are met.

As under present law, a reduced-rate or exempt user that uses tax-paid undyed diesel fuel is permitted a refund if the user establishes that a prior tax was paid with respect to the fuel and that the fuel has been used for an exempt or reduced-rate use.

Administrative provisions

As under present law, the Treasury Department is permitted to require appropriate registration, record-keeping and reporting by persons necessary to implement the collection of the diesel fuel tax.

In addition, the Treasury Department is authorized to impose a new penalty on any person who sold dyed fuel to a person whom the seller knew or had reason to know would use the fuel for a taxable use, or any person who knew or had reason to know that it used dyed fuel for a taxable use. This new penalty is the greater of $1,000 or twice the otherwise applicable tax on the diesel fuel so used.

In addition, vendors to farmers and State and local governments are required to apply for refunds for these exempt users, if the vendors sell tax-paid fuel to these persons for use in an exempt use. For other cases of exempt use of tax-paid fuel (e.g., construction, mining, mineral extraction, timber, home heating fuel, nonprofit educational organizations), the exempt user must apply for the refund if tax-paid fuel is used.

The agreement also modifies the penalty for persons who improperly sell or use dyed fuel to be the greater of $1,000 or $10 for each gallon of dyed fuel involved in the violation. For repeated violations, the penalty is multiplied by the number of prior penalties that had been imposed under this provision. Any officer, employee, or agent who willfully participated in any act giving rise to the above penalties will be jointly and severally liable with any business entity that is liable for the penalty. Dyed fuel means any fuel that is dyed, regardless of whether or not the fuel was dyed to administer compliance with the diesel fuel tax provisions.

4. Extend the Current 2.5-Cents-Per-Gallon Motor Fuels Excise Tax Rate; Transfer of Revenues

(sec. 14244 of the House bill, sec. 8244 of the Senate amendment, sec. 13244 of the Conference agreement, and secs. 4041, 4081, and 4091of the Code)

The rate of tax on motor fuels is 14.1 cents per gallon on gasoline and special motor fuels and 20.1 cents per gallon on diesel fuel; this rate includes a deficit reduction rate" (General Fund rate) of 2.5 cents per gallon and a Leaking Underground Storage Tank (LUST) Trust Fund rate of 0.1 cents per gallon. Diesel used in trains is subject only to the 2.5-cents deficit reduction rate and to the 0.1-cents LUST rate (not to the full 20.1 cents per gallon rate). The deficit reduction rate does not apply after September 30, 1995. Revenues from the deficit reduction rate are retained in the General Fund, while the balance of the highway motor fuels tax revenues are transferred to the Highway Trust Fund through September 30, 1999. Revenues from the 0.1-cent-per-gallon LUST tax rate are transferred to the LUST Trust Fund through December 31, 1995.

5. Increase Inland Waterways Fuel Excise Tax

(secs. 14413 and 8002 of the House bill and sec. 4042 of the Code)

The tax rate on these fuels is 17 cents per gallon for 1993, 19 cents per gallon for 1994, and 20 cents per gallon for 1995 and thereafter. In addition, there is a 0.1-cent-per-gallon tax on such fuels for the Leaking Underground Storage Tank Trust Fund through December 31, 1995 (sec. 9508).

The House bill (sec. 14413) increases the Federal inland waterway fuel tax by 50 cents per gallon in a series of steps. Under the House bill, inland waterways fuel is to be taxed at a rate of 24 cents per gallon in 1994, 40 cents per gallon in 1995, 55 cents per gallon in 1996, and 70 cents per gallon in 1997 and thereafter. The House bill does not change the additional 0.1-cent-per-gallon fuel tax imposed for the Leaking Underground Storage Tank Trust Fund.

Title VIII

The House bill (sec. 8002) also includes a Sense of Congress resolution that the inland waterways fuel tax should not be further increased beyond those increases already scheduled under present law.

(sec. 14251 of the House bill, and secs. 6041 and 6041A of the Code)

The conferees intend that the Office of Management and Budget (OMB) provide a report to the chairmen of the House Ways and Means Committee and the Senate Finance Committee within six months from the date of enactment recommending ways to improve information reporting compliance by Federal executive agencies. Such recommendations could include, for example, requiring Federal executive agencies to disclose their level of compliance in their published annual reports and requiring OMB to report annually to the chairmen of the two tax-writing committees regarding Federal executive agencies' compliance with information reporting obligations. The OMB report should also address appropriate sanctions for Federal executive agency noncompliance with all information reporting requirements and any changes to the law that may be needed to impose such sanctions. For example, IRS could be permitted to assess penalties on an agency for failure to comply with information reporting requirements and to collect the penalties assessed out of the agency's appropriated funds.

The conferees understand that the effectiveness of information reporting generally will be enhanced, and the burden on reporting businesses will be reduced, by a comprehensive taxpayer identification number (TIN) matching system. Accordingly, the conferees encourage the IRS to establish a TIN matching pilot program as soon as practicable and to include governmental agencies in such pilot program.

2. Raise Standard for Accuracy-Related and Preparer Penalties

(sec. 14252(a) of the House bill, sec. 8252(a) of the Senate amendment, sec. 13251 of the Conference agreement, and secs. 6662 and 6694 of the Code)

For this purpose, an understatement⁹³ is considered substantial if it exceeds the greater of 10 percent of the tax required to be shown on the year's return or $5,000 ($10,000 for corporations other than S corporations and personal holding companies). In determining whether an understatement is substantial, the amount of the understatement is reduced by any portion attributable to an item if (l) the treatment of the item on the return is or was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed on the tax return (or a statement attached to the return), provided that the treatment of the disclosed item was not "frivolous" (Treas. Reg. sec. 1.6662-4). Special rules apply to tax shelters.

The term "negligence" includes any failure to make a reasonable attempt to comply with the internal revenue laws, a failure to exercise ordinary and reasonable care in the preparation of a tax return, and a failure to keep adequate books and records or to substantiate items properly (Treas. Reg. sec. 1.6662-3(b)(1)). The term "disregard" includes any careless, reckless, or intentional disregard of rules or regulations (sec. 6662(c)). The penalty for negligence or disregard of rules or regulations does not apply where the position taken is adequately disclosed, the position is not "frivolous", and the taxpayer has adequate books and records and has substantiated items properly (Treas. Reg. sec. 1.6662-3(c)).⁹⁴

^{A $250 penalty with respect to a return or claim for refund of income tax may be imposed on the preparer if any understatement of tax liability on the return or claim for refund resulted from a position that did not have a realistic possibility of being sustained on its merits and the preparer knew or reasonably should have known of the position (sec. 6694(a)). The penalty is $1,000 per return or claim for refund if the understatement is due to any reckless or intentional disregard of rules or regulations (sec. 6694(b)). These penalties may be avoided where the position taken on the return or claim for refund is adequately disclosed and is not "frivolous" (Treas. Reg. secs. 1.6694-2(c), 1.6694-3(c)(2)).95}

^{A "frivolous" position with respect to an item for purposes of all of these penalty provisions is one that is "patently improper" (Treas. Reg. sec. 1.6662-3(b)(3), 1.6662-4(e)(2)(i), 1.6694-2(c)(2), 1.6694-3(c)(2)).}

The House bill also eliminates the reasonable cause and good faith exception for fraud, because fraud is inconsistent with reasonable cause and good faith.

3. Modify Tax Shelter Rules for Purposes of the Substantial Understatement Penalty

(sec. 14252(b) of the House bill and sec. 6662(d) of the Code)

In determining whether an understatement is substantial, the understatement generally is reduced by the portion of the understatement that is attributable to an item for which there was substantial authority or adequate disclosure (sec. 6662(d)(2)). However, in the case of tax shelter items, the understatement is reduced only by the portion of the understatement that is attributable to an item both for which there was substantial authority and with respect to which the taxpayer reasonably believed that the claimed treatment of the item was more likely than not the proper treatment (sec. 6662(d)(2)(C)(i)). Disclosure made with respect to a tax shelter item does not affect the amount of an understatement.

A "tax shelter" is any partnership or other entity, any investment plan or arrangement, or any other plan or arrangement if the principal purpose of such partnership, entity, plan or arrangement is to avoid or to evade Federal income tax (sec. 6662(d)(2)(C)(ii)). An item of income, gain, loss, deduction or credit is a "tax shelter item" if the item is directly or indirectly attributable to the principal purpose of the tax shelter (Treas. Reg. sec. 1.6662-4(g)(3)).

4. Information Returns Relating to the Discharge of Indebtedness by Certain Financial Entities

(sec. 14253 of the House bill, sec. 8253 [8252] of the Senate amendment, sec. 13252 of the Conference agreement, and sec. 6050P of the Code)

^{The determination of when a discharge of indebtedness occurs under section 61(a)(12) is a question of fact.See, e.g.,Carl T. Miller Trust v. Commissioner, 76 T.C. 191 (1981) In general, a debtor has discharge of indebtedness income where a debt is repurchased or otherwise deemed satisfied for less than its outstanding balance. For example, discharge of indebtedness income may be triggered by a debt modification under Code section 1001 or where a court adjudicates favorably a defense for the borrower. Discharge of indebtedness income is generally not deemed to result merely because the lender (1) has not actively pursued its claim against the debtor, provided a legal claim still exists, (2) claims a deduction for financial or regulatory reporting purposes, or (3) claims a partial or full bad debt deduction for tax purposes. However, the existence of several factors such as these may, when considered collectively, indicate that a discharge of indebtedness has occurred.}

^{Pursuant to a 1984 Office of Management and Budget memorandum, Treasury Department guidelines currently require Federal agencies to report forgiven debt amounts exceeding $600 to the Internal Revenue Service (IRS) on a Form 1099-G, except where prohibited by law. The Federal Deposit Insurance Corporation (FDIC) and Resolution Trust Corporation (RTC) do not issue such reports because of concerns that information reporting may violate the Right to Financial Privacy Act of 1978 (RFPA). The RFPA permits such information reporting if the Code specifically requires it.}

The information return must set forth the name, address and taxpayer identification number of the person whose debt was discharged, the amount of debt discharged, and the date on which the debt was discharged.⁹⁷ The information return must be filed in the manner and at the time specified by the IRS. The same information also must be provided to the person whose debt is discharged by January 31 of the year following the discharge.

For purposes of the House bill, "applicable financial entities" include: (1) the FDIC, the RTC, the National Credit Union Administration, and any successor or subunit of any of them;⁹⁸ (2) any financial institution (as described in secs. 581 or 591(a)); (3) any credit union; and (4) any subsidiary of an entity described in (2) or (3) which, by virtue of being affiliated with such entity, is subject to supervision and examination by a Federal or State agency regulating such entities.

Under the House bill, the penalties for failure to file correct information reports with the IRS and to furnish statements to taxpayers are similar to those imposed with respect to a failure to provide other information returns. For example, the penalty for failure to furnish statements to taxpayers is generally $50 per failure, subject to a maximum of $100,000 for any calendar year.⁹⁹ These penalties are not applicable if the failure is due to reasonable cause and not to willful neglect.

(sec. 14261 of the House bill, sec. 8261 of the Senate amendment, sec. 13261 of the Conference agreement, and new sec. 197 of the Code)

The U.S. Supreme Court recently held that a taxpayer able to prove that a particular asset can be valued, and that the asset has a limited useful life which can be ascertained with reasonable accuracy, may depreciate the value over the useful life regardless of how much the asset appears to reflect the expectancy of continued patronage. However, the Supreme Court also characterized the taxpayer's burden of proof as "substantial" and stated that it "often will prove too great to bear." Newark Morning Ledger Co. v. United States, ___ U.S. ___, 61 U.S.L.W. 4313 at 4320, 4319 (April 20, 1993).

The bill allows an amortization deduction with respect to the capitalized costs of certain intangible property (defined as a "section 197 intangible") that is acquired by a taxpayer and that is held by the taxpayer in connection with the conduct of a trade or business or an activity engaged in for the production of income. The amount of the deduction is determined by amortizing the adjusted basis (for purposes of determining gain) of the intangible ratably over a 14-year period that begins with the month that the intangible is acquired.¹⁰⁰ No other depreciation or amortization deduction is allowed with respect to a section 197 intangible that is acquired by a taxpayer.

In general, the bill applies to a section 197 intangible acquired by a taxpayer regardless of whether it is acquired as part of a trade or business. In addition, the bill generally applies to a section 197 intangible that is treated as acquired under section 338 of the Code. The bill generally does not apply to a section 197 intangible that is created by the taxpayer if the intangible is not created in connection with a transaction (or series of related transactions) that involves the acquisition of a trade or business or a substantial portion thereof.

Except in the case of amounts paid or incurred under certain covenants not to compete (or under certain other arrangements have substantially the same effect as covenants not to compete) and certain amounts paid or incurred on account of the transfer of a franchise, trademark, or trade name, the bill generally does not apply to any amount that is otherwise currently deductible (i.e., not capitalized) under present law.

No inference is intended as to whether a depreciation or amortization deduction is allowed under present law with respect to any intangible property that is either included in, or excluded from, the definition of a section 197 intangible. In addition, no inference is intended as to whether an asset is to be considered tangible or intangible property for any other purpose of the Internal Revenue Code.

Definition of section 197 intangible

Certain types of property, however, are specifically excluded from the definition of the term "section 197 intangible." The term "section 197 intangible" does not include: (1) any interest in a corporation, partnership, trust, or estate; (2) any interest under an existing futures contract, foreign currency contract, notional principal contract, interest rate swap, or other similar financial contract; (3) any interest in land; (4) certain computer software; (5) certain interests in films, sound recordings, video tapes, books, or other similar property; (6) certain rights to receive tangible property or services; (7) certain interests in patents or copyrights; (8) any interest under an existing lease of tangible property; (9) any interest under an existing indebtedness (except for the deposit base and similar items of a financial institution); (10) a franchise to engage in any professional sport, and any item acquired in connection with such a franchise; and (11) certain transaction costs.

In addition, the Treasury Department is authorized to issue regulations that exclude certain rights of fixed duration or amount from the definition of a section 197 intangible.

In addition, for purposes of the bill, going concern value is the additional element of value of a trade or business that attaches to property by reason of its existence as an integral part of a going concern. Going concern value includes the value that is attributable to the ability of a trade or business to continue to function and generate income without interruption notwithstanding a change in ownership. Going concern value also includes the value that is attributable to the use or availability of an acquired trade or business (for example, the net earnings that otherwise would not be received during any period were the acquired trade or business not available or operational).

The term "section 197 intangible" includes workforce in place (which is sometimes referred to as agency force or assembled workforce), the composition of a workforce (for example, the experience, education, or training of a workforce), the terms and conditions of employment whether contractual or otherwise, and any other value placed on employees or any of their attributes. Thus, for example, the portion (if any) of the purchase price of an acquired trade or business that is attributable to the existence of a highly-skilled workforce is to be amortized over the 14-year period specified in the bill. As a further example, the cost of acquiring an existing employment contract (or contracts) or a relationship with employees or consultants (including but not limited to any "key employee" contract or relationship) as part of the acquisition of a trade or business is to be amortized over the 14-year period specified in the bill.

Information base

The term "section 197 intangible" includes business books and records, operating systems, and any other information base including lists or other information with respect to current or prospective customers (regardless of the method of recording such information). Thus, for example, the portion (if any) of the purchase price of an acquired trade or business that is attributable to the intangible value of technical manuals, training manuals or programs, data files, and accounting or inventory control systems is to be amortized over the 14-year period specified in the bill. As a further example, the cost of acquiring customer lists, subscription lists, insurance expirations,¹⁰¹ patient or client files, or lists of newspaper, magazine, radio or television advertisers is to be amortized over the 14-year period specified in the bill.

Know-how

The term "section 197 intangible" includes any patent, copyright, formula, process, design, pattern, know-how, format, or other similar item. For this purpose, the term "section 197 intangible" is to include package designs, computer software, and any interest in a film, sound recording, video tape, book, or other similar property, except as specifically provided otherwise in the bill.¹⁰²

^{Customer-based intangibles}

^{The term "section 197 intangible" includes any customer-based intangible, which is defined as the composition of market, market share, and any other value resulting from the future provision of goods or services pursuant to relationships with customers (contractual or otherwise) in the ordinary course of business. Thus, for example, the portion (if any) of the purchase price of an acquired trade or business that is attributable to the existence of customer base, circulation base, undeveloped market or market growth, insurance in force, mortgage servicing contracts, investment management contracts, or other relationships with customers that involve the future provision of goods or services, is to be amortized over the 14-year period specified in the bill. On the other hand, the portion (if any) of the purchase price of an acquired trade or business that is attributable to accounts receivable or other similar rights to income for those goods or services that have been provided to customers prior to the acquisition of a trade or business is not to be taken into account under the bill.103}

^{In addition, the bill specifically provides harm "customer-based intangible" includes the deposit base and any similar asset of a financial institution. Thus, for example, the portion (if any) of the purchase price of an acquired financial institution that is attributable to the checking accounts, savings accounts, escrow accounts and other similar items of the financial institution is to be amortized over the 14-year period specified in the bill.}

^{Supplier-based intangibles}

^{The term "section l97 intangible" includes any supplier-based intangible, which is defined as the value resulting from the future acquisition of goods or services pursuant to relationships (contractual or otherwise) in the ordinary course of business with suppliers of goods or services to be used or sold by the taxpayer. Thus, for example, the portion (if any) of the purchase price of an acquired trade or business that is attributable to the existence of a favorable relationship with persons that provide distribution services (for example, favorable shelf or display space at a retail outlet), the existence of a favorable credit rating, or the existence of favorable supply contracts, is to be amortized over the 14-year period specified in the bill.104}

^{Other similar items}

^{The term "section 197 intangible" also includes any other intangible property that is similar to workforce, information base, know-how, customer-based intangibles, or supplier-based intangibles.}

Any amount that is paid or incurred under a covenant not to compete (or other similar arrangement) entered into in connection with the direct or indirect acquisition of an interest in a trade or business (or a substantial portion thereof) is chargeable to capital account and is to be amortized ratably over the 14-year period specified in the bill. In addition, any amount that is paid or incurred under a covenant not to compete (or other similar arrangement) after the taxable year in which the covenant (or other similar arrangement) was entered into is to be amortized ratably over the remaining months in the 14-year amortization period that applies to the covenant (or other similar arrangement) as of the beginning of the month that the amount is paid or incurred.

For purposes of this provision, an arrangement that requires the former owner of an interest in a trade or business to continue to perform services (or to provide property or the use of property) that benefit the trade or business is considered to have substantially the same effect as a covenant not to compete to the extent that the amount paid to the former owner under the arrangement exceeds the amount that represents reasonable compensation for the services actually rendered (or for the property or use of property actually provided) by the former owner. As under present law, to the extent that the amount paid or incurred under a covenant not to compete (or other similar arrangement) represents additional consideration for the acquisition of stock in a corporation, such amount is not to be taken into account under this provision but, instead, is to be included as part of the acquirer's basis in the stock.

^{The bill continues the present-law treatment of certain contingent amounts that are paid or incurred on account of the transfer of a franchise, trademark, or trade name. Under these rules, a deduction is allowed for amounts that are contingent on the productivity, use, or disposition of a franchise, trademark, or trade name only if (1) the contingent amounts are paid as part of a series of payments that are payable at least annually throughout the term of the transfer agreement, and (2) the payments are substantially equal in amount or payable under a fixed formula.108} Any other amount, whether fixed or contingent, that is paid or incurred on account of the transfer of a franchise, trademark, or trade name is chargeable to capital account and is to be amortized ratably over the 14-year period specified in the bill.

The bill contains several exceptions to the definition of the term "section 197 intangible." Several of the exceptions contained in the bill apply only if the intangible property is not acquired in a transaction (or series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion of a trade or business. It is anticipated that the Treasury Department will exercise its regulatory authority to require any intangible property that could otherwise be excluded from the definition of the term "section 197 intangible" to be taken into account under the bill under circumstances where the acquisition of the intangible property is, in and of itself, the acquisition of an asset which constitutes a trade or business or a substantial portion of a trade or business.

The determination of whether acquired assets constitute a substantial portion of a trade or business is to be based on all of the facts and circumstances, including the nature and the amount of the assets acquired as well as the nature and amount of the assets retained by the transferor. It is not intended, however, that the value of the assets acquired relative to the value of the assets retained by the transferor is determinative of whether the acquired assets constitute a substantial portion of a trade or business.

For purposes of the bill, a group of assets is to constitute a trade or business if the use of such assets would constitute a trade or business for purposes of section 1060 of the Code (i.e., if the assets are of such a character that goodwill or going concern value could under any circumstances attach to the assets). In addition, the acquisition of a franchise, trademark or trade name is to constitute the acquisition of a trade or business or a substantial portion of a trade or business.

In determining whether a taxpayer has acquired an intangible asset in a transaction (or series of related transactions) that involves the acquisition of assets that constitute a trade or business or a substantial portion of a trade or business, only those assets acquired in a transaction (or a series of related transactions) by a taxpayer (and persons related to the taxpayer) from the same person (and any related person) are to be taken into account. In addition, any employee relationships that continue (or covenants not to compete that are entered into) as part of the transfer or assets are to be taken into account in determining whether the transferred assets constitute a trade or business or a substantial portion of a trade or business.

Interests in a corporation, partnership, trust, or estate

The term "section 197 intangible" does not include any interest in a corporation, partnership, trust, or estate. Thus, for example, the bill does not apply to the cost of acquiring stock, partnership interests, or interests in a trust or estate, whether or not such interests are regularly traded on an established market.¹⁰⁹

^{Interests under certain financial contracts}

^{The term "section 197 intangible" does not include any interest under an existing futures contract, foreign currency contract, notional principal contract, interest rate swap, or other similar financial contract, whether or not such interest is regularly traded on an established market. Any interest under a mortgage servicing contract, credit card servicing contract or other contract to service indebtedness issued by another person, and any interest under an assumption reinsurance contract110} is not excluded from the definition of the term "section 197 intangible" by reason of the exception for interests under certain financial contracts.

Interests in land

The term "section 197 intangible" does not include any interest in land. Thus, the cost of acquiring an interest in land is to be taken into account under present law rather than under the bill. For this purpose, an interest in land includes a fee interest, life estate, remainder, easement, mineral rights, timber rights, grazing rights, riparian rights, air rights, zoning variances, and any other similar rights with respect to land. An interest in land is not to include an airport landing or takeoff right, a regulated airline route, or a franchise to provide cable television services.

The costs of acquiring licenses, permits, and other rights relating to improvements to land, such as building construction or use permits, are to be taken into account in the same manner as the underlying improvement in accordance with present law.

Certain computer software

The term "section 197 intangible" does not include computer software (whether acquired as part of a trade or business or otherwise) that (1) is readily available for purchase by the general public; (2) is subject to a non-exclusive license; and (3) has not been substantially modified. In addition, the term "section 197 intangible" does not include computer software which is not acquired in a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion of a trade or business.

For purposes of the bill, the term "computer software" is defined as any program (i.e., any sequence of machine-readable code) that is designed to cause a computer to perform a desired function. The term "computer software" includes any incidental and ancillary rights with respect to computer software that (1) are necessary to effect the legal acquisition of the title to, and the ownership of, the computer software, and (2) are used only in connection with the computer software. The term "computer software" does not include any data base or similar item (other than a data base or item that is in the public domain and that is incidental to the software¹¹¹) regardless of the form in which it is maintained or stored.

If a depreciation deduction is allowed with respect to any computer software that is not a section 197 intangible, the amount of the deduction is to be determined by amortizing the adjusted basis of the computer software ratably over a 36-month period that begins with the month that the computer software is placed in service. For this purpose, the cost of any computer software that is taken into account as part of the cost of computer hardware or other tangible property under present law is to continue to be taken into account in such manner under the bill. In addition, the cost of any computer software that is currently deductible (i.e., not capitalized) under present law is to continue to be taken into account in such manner under the bill.

Certain interests in films, sound recordings, video tapes, books, or other similar property

The term "section 197 intangible" does not include any interest (including an interest as a licensee) in a film, sound recording, video tape, book, or other similar property (including the right to broadcast or transmit a live event) if the interest is not acquired in a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion of a trade or business.

Certain rights to receive tangible property or services

The term "section 197 intangible" does not include any right to receive tangible property or services under a contract (or any right to receive tangible property or services granted by a governmental unit or an agency or instrumentality thereof) if the right is not acquired in a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion of a trade or business.

If a depreciation deduction is allowed with respect to a right to receive tangible property or services that is not a section 197 intangible, the amount of the deduction is to be determined in accordance with regulations to be promulgated by the Treasury Department. It is anticipated that the regulations may provide that in the case of an amortizable right to receive tangible property or services in substantially equal amounts over a fixed period that is not renewable, the cost of acquiring the right will be taken into account ratably over such fixed period. It is also anticipated that the regulations may provide that in the case of a right to receive a fixed amount of tangible property or services over an unspecified period, the cost of acquiring such right will be taken into account under a method that allows a deduction based on the amount of tangible property or services received during a taxable year compared to the total amount of tangible property or services to be received.

Certain interests in patents or copyrights

The term "section 197 intangible" does not include any interest in a patent or copyright which is not acquired in a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion of a trade or business.

If a depreciation deduction is allowed with respect to an interest in a patent or copyright and the interest is not a section 197 intangible, then the amount of the deduction is to be determined in accordance with regulations to be promulgated by the Treasury Department. It is expected that the regulations may provide that if the purchase price of a patent is payable on an annual basis as a fixed percentage of the revenue derived from the use of the patent, then the amount of the depreciation deduction allowed for any taxable year with respect to the patent equals the amount of the royalty paid or incurred during such year.¹¹²

^{Interests under leases of tangible property}

^{The term "section 197 intangible" does not include any interest as a lessor or lessee under an existing lease of tangible property (whether real or personal).113} The cost of acquiring an interest as a lessor under a lease of tangible property where the interest as lessor is acquired in connection with the acquisition of the property is to be taken into account as part of the cost of the tangible property. For example, if a taxpayer acquires a shopping center that is leased to tenants operating retail stores, the portion (if any) of the purchase price of the shopping center that is attributable to the favorable attributes of the leases is to be taken into account as a part of the basis of the shopping center and is to be taken into account in determining the depreciation deduction allowed with respect to the shopping center.

The cost of acquiring an interest as a lessee under an existing lease of tangible property is to be taken into account under present law (see section 178 of the Code and Treas. Reg. sec. 1.162-11(a)) rather than under the provisions of the bill.¹¹⁴ In the case of any interest as a lessee under a lease of tangible property that is acquired with any other intangible property (either in the same transaction or series of related transactions), however, the portion of the total purchase price that is allocable to the interest as a lessee is not to exceed the excess of (1) the present value of the fair market value rent for the use of the tangible property for the term of the lease,¹¹⁵ over (2) the present value of the rent reasonably expected to be paid for the use of the tangible property for the term of the lease.

Interests under indebtedness

The term "section 197 intangible" does not include any interest (whether as a creditor or debtor) under any indebtedness that was in existence on the date that the interest was acquired.¹¹⁶ Thus, for example, the value of assuming an existing indebtedness with a below-market interest rate is to be taken into account under present law rather than under the bill. In addition, the premium paid for acquiring the right to receive an above-market rate of interest under a debt instrument may be taken into account under section 171 of the Code, which generally allows the amount of the premium to be amortized on a yield-to-maturity basis over the remaining term of the debt instrument. This exception for interests under existing indebtedness does not apply to the deposit base and other similar items of a financial institution.

Professional sports franchises

The term "section 197 intangible" does not include a franchise to engage in professional baseball, basketball, football, or other professional sport, and any item acquired in connection with such a franchise. Consequently, the cost of acquiring a professional sports franchise and related assets (including any goodwill, going concern value, or other section 197 intangibles) is to be allocated among the assets acquired as provided under present law (see, for example, section 1056 of the Code) and is to be taken into account under the provisions of present law.

Certain transaction costs

The term section 197 intangible does not include the amount of any fees for professional services, and any transaction costs, incurred by parties to a transaction with respect to which any portion of the gain or loss is not recognized under part III of subchapter C. This provision addresses a concern that some taxpayers might attempt to contend that the 14-year amortization provided by the provision applies to any such amounts that may be required to be capitalized under present law but that do not relate to any asset with a readily identifiable useful life.¹¹⁷ The exception is provided solely to clarify that section 197 is not to be construed to provide 14-year amortization for any such amounts. No inference is intended that such amounts would (but for this provision) be properly characterized as amounts eligible for such 14-year amortization, nor is any inference intended that any amounts not specified in this provision should be so characterized. In addition, no inference is intended regarding the proper treatment of professional fees or transaction costs in other circumstances under present law.

Regulatory authority regarding rights of fixed term or duration

The bill authorizes the Treasury Department to issue regulation, that exclude a right received under a contract, or granted by a governmental unit or an agency or instrumentality thereof, from the definition of a section 197 intangible if (1) the right is not acquired in a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business (or a substantial portion thereof) and (2) the right either (A) has a fixed duration of less than 14 years or (B) is fixed as to amount¹¹⁸ and the cost is properly recoverable (without regard to this provision) under a method similar to the unit of production method.

Generally, it is anticipated that the mere fact that a taxpayer will have the opportunity to renew a contract or other right on the same terms as are available to others, in a competitive auction or similar process that is designed to reflect fair market value and in which the taxpayer is not contractually advantaged, will not be taken into account in determining the duration of such right or whether it is for a fixed amount. However, the fact that competitive bidding occurs at the time of renewal and that there are or may be modifications in price (or in terms or requirements relating to the right that increase the cost to the bidder) shall not be within the scope of the preceding sentence unless the bidding also actually produces a fair market value price comparable to the price that would obtain if the rights were purchased immediately after renewal from a person (other than the person granting the renewal) in an arm's length transaction. Furthermore, it is expected that, as under present law, the Treasury Department will take into account all the facts and circumstances, including any facts indicating an actual practice of renewals or expectancy of renewals.

Exception for certain self-created intangibles

The bill generally does not apply to any section 197 intangible that is created by the taxpayer if the section 197 intangible is not created in connection with a transaction (or a series of related transactions) that involves the acquisition of assets which constitute a trade or business or a substantial portion thereof.

For purposes of this exception, a section 197 intangible that is owned by a taxpayer is to be considered created by the taxpayer if the intangible is produced for the taxpayer by another person under a contract with the taxpayer that is entered into prior to the production of the intangible. For example, a technological process or other know-how that is developed specifically for a taxpayer under an arrangement with another person pursuant to which the taxpayer retains all rights to the process or know-how is to be considered created by the taxpayer.

The exception for "self-created" intangibles does not apply to the entering into (or renewal of) a contract for the use of a section 197 intangible. Thus, for example, the exception does not apply to the capitalized costs incurred by a licensee in connection with the entering into (or renewal of) a contract for the use of know-how or other section 197 intangible. These capitalized costs are to be amortized over the 14-year period specified in the bill.

In addition, the exception for "self-created" intangibles does not apply to: (1) any license, permit, or other right that is granted by a governmental unit or an agency or instrumentality thereof; (2) any covenant not to compete (or other similar arrangement) entered into in connection with the direct or indirect acquisition of an interest in a trade or business (or a substantial portion thereof); and (3) any franchise, trademark, or trade name. Thus, for example, the capitalized costs incurred in connection with the development or registration of a trademark or trade name are to be amortized over the 14-year period specified in the bill.

Special rules

For purposes of these rules, all persons treated as a single taxpayer under section 41(f)(1) of the Code are treated as a single taxpayer. Thus, for example, a loss is not to be recognized by a corporation upon the disposition of a section 197 intangible if after the disposition a member of the same controlled group as the corporation retains other section 197 intangibles that were acquired in the same transaction (or a series of related transactions) as the section 197 intangible that was disposed of. It is anticipated that the Treasury Department will provide rules for taking into account the amount of any loss that is not recognized due to this rule (for example, by allowing the corporation that disposed of the section 197 intangible to amortize the loss over the remaining portion of the 14-year amortization period).

Under the residual method specified in the Treasury regulations, all assets of an acquired trade or business are divided into the following four classes: (1) Class I assets, which generally include cash and cash equivalents; (2) Class II assets, which generally include certificates of deposit, U.S. government securities, readily marketable stock or securities, and foreign currency; (3) Class III assets, which generally include all assets other than those included in Class I, II, or IV (generally all furniture, fixtures, land, buildings, equipment, other tangible property, accounts receivable, covenants not to compete, and other amortizable intangible assets); and (4) Class IV assets, which include intangible assets in the nature of goodwill or going concern value. The purchase price of an acquired trade or business (as first reduced by the amount of the assets included in Class I) is allocated to the assets included in Class II and Class III based on the value of the assets included in each class. To the extent that the purchase price (as reduced by the amount of the assets in Class I) exceeds the value of the assets included in Class II and Class III, the excess is allocable to assets included in Class IV.

It is expected that the present Treasury regulations which provide for the allocation of purchase price in the case of certain asset acquisitions will be amended to reflect the fact that the bill allows an amortization deduction with respect to intangible assets in the nature of goodwill and going concern value. It is anticipated that the residual method specified in the regulations will be modified to treat all amortizable section 197 intangibles as Class IV assets and that this modification will apply to any acquisition of property to which the bill applies.

Section 1060 also authorizes the Treasury Department to require the transferor and transferee in certain asset acquisitions to furnish information to the Treasury Department concerning the amount of any purchase price that is allocable to goodwill or going concern value. The bill provides that the information furnished to the Treasury Department with respect to certain asset acquisitions is to specify the amount of purchase price that is allocable to amortizable section 197 intangibles rather than the amount of purchase price that is allocable to goodwill or going concern value. In addition, it is anticipated that the Treasury Department will exercise its existing regulatory authority to require taxpayers to furnish such additional information as may be necessary or appropriate to carry out the provisions of the bill, including the amount of purchase price that is allocable to intangible assets that are not amortizable section 197 intangibles.¹²⁶

Study

The Treasury Department is directed to conduct a continuing study of the implementation and effects of the bill, including effects on merger and acquisition activities (including hostile takeovers and leveraged buyouts). It is expected that the study will address effects of the legislation on the pricing of acquisitions and on the reported values of different types of intangibles (including goodwill). The Treasury Department is to report the initial results of such study as expeditiously as possible and no later than December 31, 1994. The Treasury Department is to provide additional reports annually thereafter.

Report regarding backlog of pending cases

The purpose of the provision is to simplify the law regarding the amortization of intangibles. The severe backlog of cases in audit and litigation is a matter of great concern, and any principles established in such cases will no longer have precedential value due to the provision. Therefore, the Internal Revenue Service is urged in the strongest possible terms to expedite the settlement of cases under present law. In considering settlements and establishing procedures for handling existing controversies in an expedient and balanced manner, the Internal Revenue Service is strongly encouraged to take into account the principles of the bill so as to produce consistent results for similarly situated taxpayers. However, no inference is intended that any deduction should be allowed in these cases for assets that are not amortizable under present law.

The Treasury Department is required to report annually to the House Ways and Means Committee and the Senate Finance Committee, regarding the volume of pending disputes in audit and litigation involving the amortization of intangibles and the progress made in resolving such disputes. It is expected that the report will also address the effects of the provision on the volume and nature of disputes regarding the amortization of intangibles. The first such report is to be made no later than December 31, 1994.

The provision generally applies to property acquired after the date of enactment of the bill. As more fully described below, however, a taxpayer may elect to apply the bill to all property acquired after July 25, 1991. In addition, a taxpayer that does not make this election may elect to apply present law (rather than the provisions of the bill) to property that is acquired after the date of enactment of the bill pursuant to a binding written contract in effect on the date of enactment of the bill and at all times thereafter until the property is acquired. Finally, special "anti-churning" rules may apply to prevent taxpayers from converting existing goodwill, going concern value, or any other section 197 intangible for which a depreciation or amortization deduction would not have been allowable under present law into amortizable property to which the bill applies.

Election to apply bill to property acquired after July 25, 1991

A taxpayer may elect to apply the bill to all property acquired by the taxpayer after July 25, 1991. If a taxpayer makes this election, the bill also applies to all property acquired after July 25, 1991, by any taxpayer that is under common control with the electing taxpayer (within the meaning of subparagraphs (A) and (B) of section 41(f)(1)) of the Code) at any time during the period that began on November 22, 1991, and that ends on the date that the election is made.¹²⁷

^{The election is to be made at such time and in such manner as may be specified by the Treasury Department,128} and the election may be revoked only with the consent of the Treasury Department.

The election is to be made at such time and in such manner as may be specified by the Treasury Department,¹²⁹ and the election may be revoked only with the consent of the Treasury Department.

Under these "anti-churning" rules, goodwill, going concern value, or any other section 197 intangible for which a depreciation or amortization deduction would not be allowable but for the provisions of the bill¹³⁰ may not be amortized as an amortizable section 197 intangible if: (1) the section 197 intangible is acquired by a taxpayer after the date of enactment of the bill; and (2) either (a) the taxpayer or a related person held or used the intangible at any time during the period that begins on July 25, 1991, and that ends on the date of enactment of the bill; (b) the taxpayer acquired the intangible from a person that held such intangible at any time during the period that begins on July 25, 1991, and that ends on the date of enactment of the bill and, as part of the transaction, the user of the intangible does not change; or (c) the taxpayer grants the right to use the intangible to a person (or a person related to such person) that held or used the intangible at any time during the period that begins on July 25, 1991, and that ends on the date of enactment of the bill. The anti-churning rules, however, do not apply to the acquisition of any intangible by a taxpayer if the basis of the intangible in the hands of the taxpayer is determined under section 1014(a) (relating to property acquired from a decedent).

For purposes of the anti-churning rules, a person is related to another person if: (1) the person bears a relationship to that person which would be specified in section 267(b)(1) or 707(b)(1) of the Code if those sections were amended by substituting 20 percent for 50 percent; or (2) the persons are engaged in trades or businesses under common control (within the meaning of subparagraphs (A) and (B) of section 41(f)(1) of the Code). A person is treated as related to another person if such relationship exists immediately before or immediately after the acquisition of the intangible involved.

In addition, in determining whether the anti-churning rules apply with respect to any increase in the basis of partnership property under section 732, 734, or 743 of the Code, the determinations are to be made at the partner level and each partner is to be treated as having owned or used the partner's proportionate share of the partnership property. Thus, for example, the anti-churning rules do not apply to any increase in the basis of partnership property that occurs upon the acquisition of an interest in a partnership that has made a section 754 election if the person acquiring the partnership interest is not related to the person selling the partnership interest.¹³¹

^{These "anti-churning" rules are not to apply to any section 197 intangible that is acquired from a person with less than a 50-percent relationship to the acquirer to the extent that: (1) the seller recognizes gain on the transaction with respect to such intangible; and (2) the seller agrees, notwithstanding any other provision of the Code, to pay a tax on such gain which, when added to any other Federal income tax imposed on such gain, equals the product of such gain and the highest rate of tax imposed by section 1 or 11 of the Code, whichever is applicable. The seller is treated as satisfying the second requirement if the excess of (1) the total tax liability for the year of the transaction over (2) what its tax liability for such year would have been had the sale of the intangible (but not the remainder of the transaction) been excluded from the computation equals or exceeds the product of the gain on that asset times the relevant maximum rate.}

^{The bill also contains a general anti-abuse rule that applies to any section 197 intangible that is acquired by a taxpayer from another person. Under this rule, a section 197 intangible may not be amortized under the provisions of the bill if the taxpayer acquired the intangible in a transaction one of the principal purposes of which is to (1) avoid the requirement that the intangible be acquired after the date of enactment of the bill or (2) avoid any of the anti-churning rules described above that are applicable to goodwill, going concern value, or any other section 197 intangible for which a depreciation or amortization deduction would not be allowable but for the provisions of the bill.}

^{Finally, the special rules described above that apply in the case of a transaction described in section 332, 351, 361, 721, 731, 1031, or 1033 of the Code also apply for purposes of the effective date. Consequently, if the transferor of any section 197 property is not allowed an amortization deduction with respect to such property under this provision, then the transferee is not allowed an amortization deduction under this provision to the extent of the adjusted basis of the transferee that does not exceed the adjusted basis of the transferor. In addition, this provision is to apply to any subsequent transfers of any such property in a transaction described in section 332, 351, 361, 721, 731, 1031, or 1033.}

The amount of deduction with respect to any amortizable section 197 intangible is determined by amortizing 75 percent of the adjusted basis of the intangible over 14 years. The remaining 25 percent of adjusted basis is not amortizable.

Purchased mortgage servicing rights not acquired with a trade or business or substantial portion thereof are excluded from the definition of a section 197 intangible. Any depreciation deduction allowable with respect to such excluded rights must be taken over 9 years (108 months) on a straight-line basis.

In addition to the provisions of the House bill regarding computer software, special allocation and amortization rules apply to acquisitions of certain businesses that have made certain computer software expenditures. Fifty percent of the amortizable portion of "amortizable section 197 intangibles" (i.e., 50 percent of 75 percent of the basis of such assets) is amortized on a straight-line basis over 5 years. The remaining 50 percent of 75 percent is amortized over 14 years under the general rule of the provision.

The Senate amendment does not contain any requirement of reports from the Treasury department.

Period of amortization

The straight line amortization period for an amortizable section l97 intangible is 15 years rather than 14 years.

Treasury regulatory authority regarding rights of fixed duration or amount

As a conforming amendment to the change in amortization period, under the conference agreement the Treasury regulatory authority regarding rights of fixed duration or amount applies to rights that have a fixed duration of less than 15 years (rather than 14 years).

Purchased mortgage servicing rights

The conference agreement follows the Senate bill in excluding purchased mortgage servicing rights (not acquired in connection with the acquisition of a trade or business or substantial portion thereof) from the definition of a section 197 intangible. Any depreciation deduction allowable with respect to such excluded rights must be computed on a straight line basis over a period of 9 years (108 months).¹³²

^{Technical correction regarding losses on covenants not to compete}

^{The conference agreement contains a technical correction conforming the statute to both the House and Senate committee reports regarding the amortization of covenants not to compete. The correction provides that a covenant not to compete (or other arrangement to the extent such arrangement has substantially the same effect as a covenant not to compete) shall not be considered to have been disposed of or to have become worthless until the disposition or worthlessness of all interests in the trade or business or substantial portion thereof that was directly or indirectly acquired in connection with such covenant (or other arrangement).}

^{Thus, for example, in the case of an indirect acquisition of a trade or business (e.g., through the acquisition of stock that is not treated as an asset acquisition), it is clarified that a covenant not to compete (or other arrangement) entered into in connection with the indirect acquisition cannot be written off faster than on a straight-line basis over 15 years (even if the covenant or other arrangement expires or otherwise becomes worthless) unless all the trades or businesses indirectly acquired (e.g., acquired through such stock interest) are also disposed of or become worthless.}

^{Modification of related party rule for purposes of the July 25, 1991 election}

^{The conference agreement modifies the rules regarding the effect of an election on certain related parties, in order to reflect the passage of time since the election was originally proposed (H. Res. 292, introduced November 22, 1991).}

^{The conference agreement provides that an election by a taxpayer affects all property acquired by that taxpayer since July 25, 1991, and also affects all property acquired since that date by parties that are related to the taxpayer at any time between August 2, 1993 (rather than November 22, 1991) and the date of the election.}

^{Consistent with the operation of the consolidated return rules, for this purpose it is intended that any property acquired after July 25, 1991 by an entity that is a member of an affiliated group filing a consolidated return at the time of such acquisition is treated as property acquired by the taxpayer group filing such return for purposes of any election by that taxpayer group.}

^{An election by an affiliated group filing a consolidated return would not force an election to be made by an acquirer of a former group member, even if such acquirer would normally continue the treatment of such former group member's assets (e.g., an acquirer in a transaction that does not affect the inside basis of the assets of the former group member). Similarly, a failure by the former group to make an election would not affect the ability of the former group member, or a new acquirer that is related to such member on the date of the election, to make an election that would affect the post-July 25, 1991 intangible asset acquisitions of that former group member (including such intangible asset acquisitions made while it was a member of the former group).133}

^{The conferees expect that the Treasury Department will provide rules regarding appropriate adjustments, if any, to be made where property acquired after July 25, 1991 has been transferred from one related party group to another in a transaction that would not involve a change in asset basis and one or both groups independently make a July 25, 1991 election that would affect the amortization of such property.134}

^{Reports regarding backlog of pending cases and implementation and effects of the bill}

^{The conferees reiterate the intended purpose of the provision, as stated in both the House and Senate reports, to simplify the law regarding the amortization of intangibles. The severe backlog of cases in audit and litigation is a matter of great concern to the conferees; and any principles established in such cases will no longer have precedential value due to the provision contained in the conference agreement. Therefore, the conferees urge the Internal Revenue Service in the strongest possible terms to expedite the settlement of cases under present law. In considering settlements and establishing procedures for handling existing controversies in an expedited and balanced manner, the conferees strongly encourage the Internal Revenue Service to take into account the principles of the bill so as to produce consistent results for similarly situated taxpayers. However, no inference is intended that any deduction should be allowed in these cases for assets that are not amortizable under present law.}

^{The conferees intend that the Treasury Department report annually to the House Ways and Means Committee and the Senate Finance Committee regarding the volume of pending disputes in audit and litigation involving the amortization of intangibles and the progress made in resolving disputes. It is intended that the report also address the effects of the provision on the volume and nature of disputes regarding the amortization of intangibles. It is intended that the first such report shall be made no later than December 3l, 1994.}

^{The conferees also intend that the Treasury Department conduct a continuing study of the implementation and effects of the bill, including effects on merger and acquisition activities including hostile takeovers and leveraged buyouts). It is expected that the study will address effects of the legislation on the pricing of acquisitions and on the reported values of different types of intangibles (including goodwill). It is intended that the Treasury Department will report the initial results of such study as expeditiously as possible and no later than December 31, l994. The Treasury Department is expected to provide additional reports annually thereafter.}

^{2. Modify Special Treatment of Certain Liquidation Payments}

^{(sec. 14262 of the House bill, sec. 8262 of the Senate amendment, sec. 13262 of the Conference agreement and sec. 736 of the Code)}

A current deduction generally is not allowed for a capital expenditure (i.e., an expenditure that yields benefits beyond the current taxable year). The cost of goodwill acquired in connection with the assets of a going concern normally is a capital expenditure, as is the cost of acquiring accounts receivable. The cost of acquiring goodwill is recovered only when the goodwill is disposed of, while the cost of acquiring accounts receivable is taken into account only when the receivable is disposed of or becomes worthless.

Payments made in liquidation of partnership interest

The tax treatment of a payment made in liquidation of the interest of a retiring or deceased partner depends upon whether the payment is made in exchange for the partner's interest in partnership property. A liquidating payment made in exchange for such property is treated as a distribution by the partnership (sec. 736(b)). Such distribution generally results in gain to the retiring partner only to the extent that the cash distributed exceeds such partner's adjusted basis in the partnership interest.

A liquidating payment not made in exchange for the partner's interest in partnership property receives either of two possible treatments. If the amount of the payment is determined without reference to partnership income, it is treated as a guaranteed payment and is generally deductible (sec. 736(a)(2)). If the amount of payment is determined by reference to partnership income, the payment is treated as a distributive share of partnership income, thereby reducing the distributive shares of other partners (which is equivalent to a deduction) (sec. 736(a)(2)).

A special rule treats amounts paid for goodwill of the partnership (except to the extent provided in the partnership agreement) and unrealized receivables as not made in exchange for an interest in partnership property (sec. 736(b)(2)(B)). Thus, such amounts may be deductible. Unrealized receivables include unbilled amounts, accounts receivable, depreciation recapture, market discount, and certain other items (sec. 751(c)).

Sale or exchange of a partnership interest

The sale or exchange of a partnership interest results in capital gain or loss to the transferor partner, except to the extent that ordinary income or loss is recognized with respect to the partner's share of the partnership's unrealized receivables and substantially appreciated inventory items (sec. 741). It is often unclear whether a payment by a partnership to a retiring partner is made in sale or exchange of, or in liquidation of, a partnership interest.

The bill generally repeals the special treatment of liquidation payments made for goodwill and unrealized receivables. Thus, such payments would be treated as made in exchange for the partner's interest in partnership property, and not as a distributive share or guaranteed payment that could give rise to a deduction or its equivalent. The bill does not change present law with respect to payments made to a general partner in a partnership in which capital is not a material income-producing factor. The determination of whether capital is a material income-producing factor would be made under principles of present and prior law.¹³⁵ For purposes of this provision, capital is not a material income-producing factor where substantially all the gross income of the business consists of fees, commissions, or other compensation for personal services performed by an individual. The practice of his or her profession by a doctor, dentist, lawyer, architect, or accountant will not, as such, be treated as a trade or business in which capital is a material income-producing factor even though the practitioner may have a substantial capital investment in professional equipment or in the physical plant constituting the office from which such individual conducts his or her practice so long as such capital investment is merely incidental to such professional practice. In addition, the bill does not affect the deductibility of compensation paid to a retiring partner for past services.

Unrealized receivables

The bill also repeals the special treatment of payments made for unrealized receivables (other than unbilled amounts and accounts receivable) for all partners. Such amounts would be treated as made in exchange for the partner's interest in partnership property. Thus, for example, a payment for depreciation recapture would be treated as made in exchange for an interest in partnership property, and not as a distributive share or guaranteed payment that could give rise to a deduction or its equivalent.

(sec. 14273 of the House bill, sec. 7950 of the Senate amendment, sec. 13271 of the Conference agreement and sec. 6611(e) of the Code)

There is no parallel rule for refunds of taxes other than income taxes (i.e., employment, excise, and estate and gift taxes), for refunds of any type of tax arising from amended returns, or for claims for refunds of any type of tax.

If a taxpayer files a timely original return with respect to any type of tax and later files an amended return claiming a refund, and if the IRS determines that the taxpayer is due a refund on the basis of the amended return, the IRS will pay the refund with interest computed from the due date of the original return.

A parallel rule applies to amended returns and claims for refunds: if the refund is issued by the 45th day after the date the amended return or claim for refund is filed, no interest is to be paid by the Government for that period of up to 45 days (interest would continue to be paid for the period from the due date of the return to the date the amended return or claim for refund is filed). If the IRS does not issue the refund by the 45th day after the date the amended return or claim for refund is filed, interest would be paid (as under present law) for the period from the due date of the original return to the date the IRS pays the refund.

A parallel rule also applies to IRS-initiated adjustments (whether due to computational adjustments or audit adjustments). With respect to these adjustments, the IRS is to pay interest for 45 fewer days than it otherwise would.

2. Deny Deductions Relating to Travel Expenses Paid or Incurred in Connection With Travel of Taxpayer's Spouse or Dependents

(sec. 14274 of the House bill, sec. 8271 of the Senate amendment, sec. 13272 of the Conference agreement, and sec. 274(m) of the Code)

In the case of ordinary and necessary business expenses, if a taxpayer travels to a destination and while at that destination engages in both business and personal activities, travel expenses to and from such destination are deductible only if the trip is related primarily to the taxpayer's trade or business. If the trip is primarily personal in nature, expenses while at the destination that are properly allocable to the taxpayer's trade or business are deductible even though the traveling expenses to and from the destination are not deductible (Treas. Reg. sec. 1.162-2(b)(1)).

Under Treasury regulations, if the taxpayer's spouse accompanies the taxpayer on a business trip, expenses attributable to the spouse's travel are not deductible unless it is adequately shown that the spouse's presence on the trip has a bona fide business purpose (Treas. reg. sec. 1.162-2(c)). The performance of some incidental service by the spouse does not cause the expenses to qualify as deductible business expenses. Under the Treasury regulations, the same rules apply to any other members of the taxpayer's family who accompany the taxpayer on such a trip.

3. Increase Withholding Rate on Supplemental Wage Payments

(sec. 14275 of the House bill, sec. 8272 of the Senate amendment, sec. 13273 of the Conference agreement, and sec. 3402(g) of the Code)

(secs. 14301-14304 of the House bill, sec. 15001 of the Senate amendment, secs. 13301-13304 [13303] of the Conference agreement, and new secs. 1391-1397D of the Code)

The Secretary of Housing and Urban Development (HUD) will designate in eligible urban areas six empowerment zones and 65 enterprise communities. (The six empowerment zones located in urban areas will include at least one zone in an urban area most populous city of which has a population of 500,000 or less.) The Secretary of Agriculture will designate in eligible rural areas¹³⁸ three empowerment zones and 30 enterprise communities. In addition, the Secretary of the Interior will designate in eligible Indian reservation areas one empowerment zone and five enterprise communities.¹³⁹ Nominated areas located in Indian reservations also will be eligible for designation (provided the bill's criteria are met) as rural areas. All designations will be made in consultation with an Enterprise Board (to be established in the future), which will include officials from various Federal agencies. The designations will be made prior to January 1, 1996.

Designations of areas as empowerment zones or enterprise communities generally will remain in effect for 10 years. An area's designation can be revoked if the local government(s) or State(s) modify the boundaries of the designated area or do not comply with the agreed-upon strategic plan for the area (described below).¹⁴⁰

Resident population

An eligible urban area is subject to a maximum population of the lesser of (1) 200,000, or (2) the greater of 50,000 or 10 percent of the population of the most populous city within the nominated area. (In addition, the Secretary of HUD is required to designate empowerment zones located in urban areas in such a manner that the aggregate population of such zones does not exceed 750,000.) Rural areas are subject to a maximum population of 30,000. Indian reservations are not subject to a population limit.

General condition

An eligible area must have a condition of pervasive poverty, unemployment, and general economic distress (which may include distress from a high incidence of crime and narcotics use).

Area

The nominated area must either (1) have a continuous boundary, or (2) except in the case of a rural area located in more than one State, consist of not more than three noncontiguous parcels. Urban areas must be located entirely within no more than two contiguous States, and rural areas must be located entirely within no more than three contiguous States.

Size

The nominated area must not exceed (1) 20 square miles for urban areas, or (2) 1,000 square miles for rural areas and Indian reservations.

Poverty

Each of the census tracts within a nominated area must have a poverty rate of at least 20 percent;¹⁴¹ at least 90 percent of the area's census tracts must each have a poverty rate of at least 25 percent; and at least 50 percent of the area's census tracts must each have a poverty rate of at least 35 percent.¹⁴² For purposes of these measurements, unpopulated census tracts and census tracts with limited populations and 75 percent or more zoned for commercial or industrial use will be treated as satisfying the bill's 20-percent and 25-percent poverty rate criteria. With respect to empowerment zones, each census tract located in a central business district (as such term is used for purposes of the most recent Census of Retail Trade) must have a poverty rate of at least 35 percent. With respect to enterprise communities, each census tract located in a central business district must have a poverty rate of at least 30 percent.¹⁴³ If the nominated area consists of noncontiguous parcels, each parcel must separately satisfy the above poverty criteria.

Strategic plan

A strategic plan must be submitted by the nominating body for purposes of accomplishing the goals of this legislation.

Tax incentives for empowerment zones

The maximum credit per qualified employee is $5,000 per year. Wages paid to a qualified employee continue to be eligible for the credit if the employee earns more than $20,000, although only the first $20,000 of wages will be eligible for the credit.¹⁴⁷ The wage credit is available with respect to a qualified employee, regardless of the number of other employees who work for the employer or whether the employer meets the definition of an "enterprise zone business" (which applies for the investment tax incentives described below).¹⁴⁸

^{The credit will be phased out beginning in 2001. The credit rate will be reduced to 20 percent in 2001, 15 percent in 2002, 10 percent in 2003, and five percent in 2004. The credit will not be available after December 31, 2004.}

^{Qualified wages include the first $20,000 of "wages," defined to include (1) salary and wages as generally defined for FUTA purposes, and (2) certain training and educational expenses paid on behalf of a qualified employee, provided that (a) the expenses are paid to an unrelated third party and are excludable from gross income of the employee under section 127 (which is retroactively and permanently extended under another provision of the bill), or (b) in the case of an employee under age 19, the expenses are incurred by the employer in operating a youth training program in conjunction with local education officials.}

^{The credit is allowed with respect to full-time and part-time employees. However, the employee must be employed by the employer for a minimum period of at least 90 days. Wages are not eligible for the credit if paid to certain relatives of the employer or, if the employer is a corporation or partnership, certain relatives of a person who owns more than 50 percent of the business. In addition, wages are not eligible for the credit if paid to a person who owns more than five percent of the stock (or capital or profits interests) of the employer.149}

^{An employer's deduction otherwise allowed for wages paid is reduced by the amount of credit claimed for that taxable year. Wages are not be taken into account for purposes of the empowerment zone employment credit if taken into account in determining the employer's targeted jobs tax credit (TJTC).}

^{The credit is allowable to offset up to 25 percent of alternative minimum tax liability.}

As under present law, an employer's deduction otherwise allowed for wages paid is reduced by the amount of TJTC claimed for that taxable year.

The credit is available for contributions to any tax-qualified defined contribution plan other than an employee stock ownership plan, stock bonus plan, or a plan subject to the minimum funding requirements (sec. 412). Contributions may also be made to a simplified employee pension (as defined in sec. 408(k) (SEP)). Except as specifically provided, the rules applicable to qualified plans and SEPs (as the case may be) apply to contributions for which the credit is available.

To be eligible for the credit, the employer contribution must be 100 percent vested, and must be either a matching or nonelective contribution; salary reduction contributions are not eligible for the credit. The plan is required to permit an employee with respect to whom the credit can be claimed to withdraw contributions from the plan (and earnings thereon) for higher education or health expenses, first-time home purchase, or to invest in a qualified enterprise zone business. A plan that permits such withdrawals will not fail to be a tax-qualified plan merely because it does so. The 10-percent early withdrawal tax (sec. 72(t)) will not apply to such withdrawals. The special withdrawal provisions apply only while the employee meets the qualifications for the credit.

The credit is available in lieu of the otherwise available deduction for the contributions and may be claimed in addition to the employment and training credit. The credit is elective.

A "qualified business" is defined as any trade or business other than a trade or business that consists predominantly of the development or holding of intangibles for sale or license.¹⁵⁵ In addition, the leasing of real property that is located within the empowerment zone to others is treated as a qualified business only if (1) the leased property is not residential property, and (2) at least 50 percent of the gross rental income from the real property is from enterprise zone businesses. The rental of tangible personal property to others is not a qualified business unless substantially all of the rental of such property is by enterprise zone businesses or by residents of an empowerment zone.

Activities of legally separate (even if related) parties would not be aggregated for purposes of determining whether an entity qualifies as an enterprise zone business.

"Qualified zone property" is defined as depreciable tangible property (including buildings), provided that: (1) such property was acquired by the taxpayer (but not from a related party) after the zone designation took effect; (2) the original use of the property in the zone commences with the taxpayer¹⁵⁶; and (3) substantially all of the use of the property is in the zone in the active conduct of a trade or business by the taxpayer in the zone. In the case of property which is substantially renovated by the taxpayer, however, such property need not be acquired by the taxpayer after zone designation or originally used by the taxpayer within the zone if during any 24-month period after zone designation the additions to the taxpayer's basis in such property exceed 100 percent of the taxpayer's basis in such property at the beginning of the period or $5,000 (whichever is greater).¹⁵⁷

^{As under present law, the section 179 expensing allowance is phased out for certain taxpayers with investment in qualified property during the taxable year above a specified threshold. However, under the bill, the present-law phase-out range is applied by decreasing the amount of the cost of qualified zone property that is deductible under section 179 by one-half of the amount by which the cost of qualified zone property (other than real estate) and other section 179 property exceeds $200,000. Thus, the section 179 deduction applicable to qualified zone property is completely phased-out when the cost of qualified zone property (other than real estate) and other section 179 property placed in service during the taxable year reaches $350,000. For example, assume that a taxpayer places $270,000 of qualified zone property (none of which is real estate) in service during the taxable year and that the taxpayer does not place any property in service outside the zone. Under the bill, the taxpayer will be allowed to claim a section 179 deduction of $40,000 ($75,000 section 179 amount less $35,000 (one-half of the difference between $270,000 and $200,000)).}

^{As under present-law section 179, all component members of a controlled group are treated as one taxpayer for purposes of the expensing allowance and application of the phaseout range (sec. 179(d)(6)). Also, as under present law, the $75,000 expensing allowance is to apply at both the partnership (and S corporation) and partner (and shareholder) levels.}

^{The increased expensing allowance would apply for purposes of the alternative minimum tax (i.e., it is not treated as an adjustment for purposes of the alternative minimum tax). The section 179 expensing deduction will be recaptured if the property is not used predominantly in a enterprise zone business (under rules similar to present-law section 179(d)(10)).}

      3-year property                              2 years

The House bill creates a new category of exempt facility private activity bonds, qualified enterprise zone facility bonds for use in empowerment zones. Generally qualified enterprise zone facility bonds are bonds 95 percent or more of the net proceeds of which is used to finance qualified zone property (as generally defined under the bill) for a qualified enterprise zone business (as generally defined under the bill) and land located in the empowerment zone which is functionally related and subordinate to the qualified zone property. These bonds may be issued only while a zone designation is in effect.

Special rules on issue size and use to finance certain facilities

The aggregate face amount of all outstanding qualified enterprise zone bonds per qualified enterprise zone business may not exceed $3 million for each zone. In addition total outstanding qualified enterprise zone bond financing for each qualified enterprise zone business may not exceed $20 million for all zones. For purposes of these determinations, the aggregate amount of outstanding enterprise zone facility bonds allocable to any business shall be determined under rules similar to rules contained in section 144(a)(10).

As with other exempt facility bonds, these bonds may be issued only to finance identified facilities. However the House committee report indicates that it is not intended that the $3 million per enterprise zone business requirement will limit issuance of a single issue of bonds (in excess of $3 million) for more than one identified facility, provided that the $3 million limit is satisfied with respect to each zone business. The House committee report contemplates that ease of marketing these exempt facility bonds, like other exempt facility bonds, may require common marketing of separate issues of bonds for discrete facilities if such issues are simultaneous or proximate in time.

The House bill exempts qualified enterprise zone facility bonds from the general restrictions on financing the acquisition of existing property (sec. 147(d)). Additionally, these bonds are exempted from the general restriction on financing land (or an interest therein) with 25 percent or more of the net proceeds of a bond issue (sec. 147(c)(1)(A)). Unless otherwise noted, all tax-exempt bond rules relating to exempt facility bonds shall apply to qualified enterprise zone facility bonds.

Penalty for failure to continue as zone business or to use bond-financed property in the zone business

The House bill extends change-in-use rules to qualified enterprise zone facility bonds. Accordingly, interest on all bond-financed loans to a business that no longer qualifies as an enterprise zone business, or on loans to finance property that ceases to be used by the business in the enterprise zone, becomes nondeductible, effective from the first day of the taxable year in which the disqualification or cessation of use occurs. This penalty is waived if: (1) the issuer and principal user in good faith attempted to meet these requirements and (2) any failure to meet such requirements is corrected within a reasonable period after such failure is first discovered. This penalty does no; apply solely by reason of the termination or revocation of a designation as an empowerment zone. The good faith rule described above also applies to certain other requirements of qualified enterprise zone facility bonds.

Partial exemption from State volume limitations

Under the House bill, only 25 percent of the amount of qualified enterprise zone facility bonds is subject to the State private activity volume cap, provided that enterprise zone residents possess more than a 50-percent ownership interest in the principal user of the bond-proceeds. If the resident ownership requirement is not satisfied, then 50 percent of the qualified enterprise zone facility bonds (rather than 25 percent) is subject to the State private activity volume cap.

Exception from bank pro rata interest deduction disallowance

The House bill exempts financial institutions from the general rule denying them a ratable portion of their otherwise allowable interest expense deductions to the extent that they have invested in qualified enterprise zone facility bonds (sec. 265(b)).

Tax incentives available in both empowerment zones and enterprise communities

The House bill also provides an additional housing credit dollar amount of $818,000 to each empowerment zone and enterprise community. Allocation of this amount may be made over a three-year period. This amount is available for allocation only during calendar years 1994, 1995, and 1996. The House committee report indicates that it is intended that these amounts be allocated in a way that will not displace, but will supplement, allocations to low-income housing credit buildings located within empowerment zones and enterprise communities.

^{Designation of eligible areas}

^{"General distress" may be indicated by factors such as high crime rates, high vacancy rates, or designation of an area as a disaster area or high intensity drug trafficking area ("HIDTA") under the Anti-Drug Abuse Act of 1988; job loss (including manufacturing job loss); and economic distress due to closures of military bases or restrictions on timber harvesting. In addition, consideration should be given to communities along the U.S. border in which population has increased significantly, without a corresponding expansion of basic infrastructure, and in which a significant portion of the area's population reside in substandard housing.}

^{Tax incentives for empowerment zones}

^{The conference agreement provides the following tax incentives for areas designated as empowerment zones:}

The maximum credit per qualified employee is $3,000 per year. Wages paid to a qualified employee continue to be eligible for the credit if the employee earns more than $15,000, although only the first $15,000 of wages will be eligible for the credit.¹⁶⁵ The wage credit is available with respect to a qualified employee, regardless of the number of other employees who work for the employer or whether the employer meets the definition of an "enterprise zone business" (which applied for the increased section 179 expensing and the tax-exempt financing provisions described below).¹⁶⁶

^{The credit will be phased out beginning in 2002. The credit rate will be reduced to 15 percent in 2002, 10 percent in 2003, and five percent in 2004. The credit will not be available after December 31, 2004.}

^{Qualified wages include the first $15,000 of "wages," defined to include (1) salary and wages as generally defined for FUTA purposes, and (2) certain training and educational expenses paid on behalf of a qualified employee, provided that (a) the expenses are paid to an unrelated third party and are excludable from gross income of the employee under section 127 (which is retroactively and permanently extended under another provision of the bill), or (b) in the case of an employee under age 19, the expenses are incurred by the employer in operating a youth training program in conjunction with local education officials.}

^{The credit is allowed with respect to full-time and part-time employees. However, the employee must be employed by the employer for a minimum period of at least 90 days. Wages are not eligible for the credit if paid to certain relatives of the employer or, if the employer is a corporation or partnership, certain relatives of a person who owns more than 50 percent of the business. In addition, wages are not eligible for the credit if paid to a person who owns more than five percent of the stock (or capital or profits interests) of the employer.167}

^{An employer's deduction otherwise allowed for wages paid is reduced by the amount of credit claimed for that taxable year. Wages are not be taken into account for purposes of the empowerment zone employment credit if taken into account in determining the employer's targeted jobs tax credit (TJTC).}

^{The credit is allowable to offset up to 25 percent of alternative minimum tax liability.}

As under present law, the section 179 expensing allowance is phased out for certain taxpayers with investment in qualified property during the taxable year above a specified threshold. However, under the conference agreement, the present-law phase-out range is applied by taking into account only one-half of the cost of qualified zone property that is section 179 property. In applying the section 179 phaseout, the cost of section 179 property that is not qualified zone property is not reduced.

In general, all other provisions of present-law section 179 apply to the increased expensing for enterprise zone businesses. Thus, all component members of a controlled group are treated as one taxpayer for purposes of the expensing allowance and the application of the phaseout range (sec. 179(d)(6)). The limitations apply at both the partnership (and S corporation) and partner (and shareholder) levels. The increased expensing allowance is allowed for purposes of the alternative minimum tax (i.e., it is not treated as an adjustment for purposes of the alternative minimum tax). The section 179 expensing deduction will be recaptured if the property is not used predominantly in a enterprise zone business (under rules similar to present-law section 179(d)(10)).

Tax-exempt facility bonds available for both empowerment zones and enterprise communities

Generally, qualified enterprise zone facility bonds are bonds 95 percent or more of the net proceeds of which are used to finance: (1) qualified zone property the principal user of which is a qualified enterprise zone business, and (2) functionally related and subordinate land located in the empowerment zone or enterprise community. Qualified zone property for these purposes is generally defined as under the House bill, except that it also includes property which would qualify as qualified zone property but for the fact that it is located in an enterprise community rather than in an empowerment zone. For these purposes, the term "enterprise zone business" has the same meaning generally given to it under the House bill, but also includes a business located in a zone or community which would qualify as an enterprise zone business if it were separately incorporated.¹⁶⁸ These bonds may only be issued while an empowerment zone or enterprise community designation is in effect.

As with other exempt facility bonds, these bonds may be issued only to finance identified facilities. However, the $3 million-per-enterprise zone business requirement should not limit issuance of a single issue of bonds (in excess of $3 million) for more than one identified facility, provided that the $3 million limit is satisfied with respect to each zone business. The conferees recognize that it may be necessary to permit common marketing of separate issues of bonds for discrete facilities (if such issues are simultaneous or proximate in time) to enable qualified enterprise zone facility bonds to be marketed in a manner comparable to other exempt facility bonds.

The conference agreement exempts qualified enterprise zone facility bonds from the general restrictions on financing the acquisition of existing property (sec. 147(d)). Additionally, these bonds are exempted from the general restriction on financing land (or an interest therein) with 25 percent or more of the net proceeds of a bond issue (sec. 147(c)(1)(A)). Unless otherwise noted, all other tax-exempt bond rules relating to exempt facility bonds (including the restrictions on bank deductibility of interest allocable to tax-exempt bonds) apply to qualified enterprise zone facility bonds.

2. Tax Credit for Contributions to Certain Community Development Corporations

(sec. 14311 of the House bill, sec. 13311 of the Conference agreement, and sec. 38 of the Code)

For purposes of this provision, a qualified contribution is defined as any transfer of cash that meets the following requirements: (1) it is made to one of up to 10 CDCs selected by the Secretary of HUD, provided that the contribution is made during the five-year period after the CDC is so selected by the Secretary of HUD; (2) the amount is available for use by the CDC for at least 10 years;¹⁶⁹ (3) the contribution is to be used by the CDC to provide qualified low-income assistance¹⁷⁰ within its operational area; and (4) the CDC designates the contribution as eligible for the credit. The aggregate amount of contributions which may be designated by a selected CDC as eligible for the credit may not exceed $4 million.

Prior to July 1, 1994, the Secretary of HUD may select up to 10 CDCs as eligible to participate in the program (subject to the availability of eligible CDCs), at least four of which must operate in rural areas. To be selected, a CDC must have the following characteristics: (1) it must be a tax-exempt charity described in section 501(c)(3) of the Code; (2) its principal purposes must include promoting employment and business opportunities for individuals who are residents of its operational area; and (3) its operational area must (a) meet the geographic limitations that would apply if the area were designated as an empowerment zone or enterprise community, (b) have an unemployment rate that is not less than the national average, and (c) have a median family income which does not exceed 80 percent of the median family income of residents within the jurisdiction of the local government.

The credit is subject to the general business credit limitations of section 38 and, therefore, may not be used to reduce tentative minimum tax.

3. Tax Incentives for Businesses on Indian Reservations

(secs. 8181-8182 of the Senate amendment, sec. 13321-13322 of the Conference agreement, secs. 280C(a), 196(c), 39(d), and 38(b), and new secs. 168(j) and 45A of the Code)

Under the Senate amendment, businesses located on Indian reservations¹⁷² generally are allowed a credit against income tax liability for certain investments (the "Indian reservation credit") and a credit against income tax liability for certain wages and health insurance costs (the "Indian employment credit").

Indian reservation credit

A credit against income tax liability is allowed for investments in certain property located or used within an Indian reservation which has a level of unemployment that greatly exceeds the national average. In general, the amount of the credit allowed a taxpayer for any taxable year equals the sum of: (1) 10 percent of the qualified investment in "reservation personal property" placed in service by the taxpayer during the taxable year; and (2) 15 percent of the qualified investment in "new reservation construction property" and "reservation infrastructure investment" placed in service by the taxpayer during the taxable year.

The full amount of the credit is allowed only if the Indian unemployment rate¹⁷³ on the applicable Indian reservation exceeds 300 percent of the national average unemployment rate at any time during the calendar year in which the property is placed in service or during either of the immediately preceding two calendar years.¹⁷⁴ If the Indian unemployment rate on the applicable Indian reservation exceeds 150 percent but does not exceed 300 percent of the national average unemployment rate at any time during the relevant calendar years, then only one-half of the otherwise allowable credit may be claimed (i.e., the credit rates are 7.5 percent and 5 percent). If the Indian unemployment rate on the applicable Indian reservation does not exceed 150 percent of the national average unemployment rate at any time during the relevant calendar years, then no credit is allowed.

For purposes of the credit, "reservation personal property" is defined as property: (1) for which a depreciation deduction is allowable under section 168 of the Code; (2) which is not nonresidential real property, residential rental property, or any other real property with a class life of more than 12.5 years; (3) which is used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation; and (4) which is not used or located outside the Indian reservation on any regular basis.

In addition, "new reservation construction property" is defined as property: (1) which is nonresidential real property, residential rental property, or any other real property with a class life of more than 12.5 years for which a depreciation deduction is allowable under section 168 of the Code; (2) which is located in an Indian reservation; (3) which is used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation;¹⁷⁵ and (4) which is originally placed in service by the taxpayer.

Further, "reservation infrastructure investment" is defined as property: (1) for which a depreciation deduction is allowable under section 168 of the Code (whether real or personal property); (2) which benefits the tribal infrastructure; (3) which is available to the general public; and (4) which is placed in service in connection with the taxpayer's active conduct of a trade or business within an Indian reservation. The term "reservation infrastructure investment" is to include otherwise qualifying property that is used or located outside an Indian reservation only if the purpose of the property is to connect to existing tribal infrastructure in the reservation (including, but not limited to, roads, power lines, water systems, railroad spurs, and communications facilities).

Notwithstanding the above definitions, property will not qualify for the Indian reservation credit if the property is acquired (directly or indirectly) by the taxpayer from a person who is related to the taxpayer (within the meaning of section 465(b)(3)(C) of the Code). In addition, property will not qualify for the credit if the property (or any portion thereof) is placed in service for purposes of conducting or housing certain gaming activities.¹⁷⁶ Finally, property will not qualify for the Indian reservation credit if the energy credit or the rehabilitation credit is allowed with respect to the property.

In the case of reservation personal property and new reservation construction property, the qualified investment for purposes of determining the amount of the credit is the taxpayer's basis in the property. In the case of reservation infrastructure investment, the qualified investment for purposes of determining the amount of the credit is the amount expended by the taxpayer for the acquisition or construction of the property. The at-risk rules of section 49 of the Code also apply in determining the amount of the qualified investment for purposes of the Indian reservation credit.

The basis of new reservation construction property is reduced by the full amount of the credit allowed with respect to the property. The basis of reservation personal property and reservation infrastructure investment is reduced by only 50 percent of the credit allowed with respect to the property. The Indian reservation credit is recaptured (i.e., the amount of tax due is increased) if, before the end of the applicable recovery period with respect to the property, the property is disposed of by the taxpayer, or, in the case of reservation personal property, is removed from the Indian reservation, converted, or otherwise ceases to be reservation personal property with respect to the taxpayer.

Indian employment credit

A credit against income tax liability is also allowed to employers for certain wages and health insurance costs paid or incurred by the employer with respect to certain employees. In general, the amount of the credit allowed an employer for any taxable year equals 10 percent¹⁷⁷ of the sum of (1) the wages paid or incurred by the employer for services performed by an employee while the employee is a qualified employee ("qualified wages");¹⁷⁸ and (2) the amount paid or incurred by the employer for health insurance (other than health insurance provided pursuant to a salary reduction arrangement) to the extent that such amount is attributable to coverage provided to an employee while the employee is a qualified employee ("qualified employee health insurance costs").

The credit is available to an employer, however, only to the extent its qualified wages and health insurance costs during the current year exceed such wages and costs incurred by the employer during 1993. Specifically, the amount of the credit allowed an employer for any taxable year is limited to an amount equal to the credit rate multiplied by the excess (if any) of (1) the sum of the qualified wages and qualified health insurance costs paid or incurred by the employer during the taxable year with respect to employees whose wages (which are paid or incurred by the employer) for such taxable year do not exceed the amount determined at an annual rate of $30,000 (as adjusted for inflation for years beginning after 1993), over (2) the sum of the qualified wages and qualified health insurance costs paid or incurred by the employer (or any predecessor) during the 1993 calendar year with respect to employees whose wages (which are paid or incurred by the employer or any predecessor) for such taxable year do not exceed the amount determined at an annual rate of $30,000.¹⁷⁹ For purposes of this limitation, all employees of a controlled group of corporations (or partnerships or proprietorships under common control) are treated as employed by a single employer.

In general, an individual is a qualified employee of an employer for any period only if: (1) the individual is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe;¹⁸⁰ (2) substantially all of the services performed during such period by the employee for such employer are performed within an Indian reservation; (3) the principal place of abode of the employee while performing such services is on or near the Indian reservation within which the services are performed; and (4) the employee began work for such employer on or after January 1, 1994.

An employee may be treated as a qualified employee for a maximum period of seven years after the day on which the employee first begins work for the employer. In addition, an employee will not be treated as a qualified employee for any taxable year of the employer if the total amount of wages paid or incurred by the employer with respect to such employee during such taxable year (whether or not for services rendered within the Indian reservation) exceeds an amount determined at an annual rate of $30,000 (as adjusted for inflation for years beginning after 1993). Further, an employee will be treated as a qualified employee for a taxable year of the employer only if more than 50 percent of the wages paid or incurred by the employer to such employee during such taxable year are for services performed in a trade or business of the employer.

Qualified employees do not include certain relatives or dependents of the employer (described under present-law section 51(i)(1)) or, if the employer is a corporation, certain relatives of a person who owns more than 50 percent of the corporation. In addition, any person who owns more than five percent of the stock of the employer (or if the employer is not a corporation, more than five percent of the capital or profits interests in the employer) cannot be a qualified employee. Finally, a qualified employee does not include any individual if the services performed by the individual for the employer involve certain gaming activities or are performed in a building housing such gaming activities.¹⁸¹

^{The Indian employment credit is allowed with respect to full-time and part-time employees. However, if an employee is terminated less than one year after the date of initial employment, the amount of credits previously claimed by the employer with respect to that employee generally is recaptured (unless the employee voluntarily leaves, becomes disabled, or is fired due to misconduct).}

^{An employer's deduction otherwise allowed for wages is reduced by the amount of the credit claimed for the taxable year. The Senate amendment also provides that the employment credit is not refundable. Finally, the Indian employment credit is subject to the general business credit limitations of section 38,182} and, therefore, the credit may not be used to reduce tentative minimum tax.

^{Accelerated Depreciation}

^{With respect to certain property used in connection with the conduct of a trade or business within an Indian reservation, depreciation deductions for purposes of section 168 will be determined using the following recovery periods:}

  ^{3-year property                        2 years}

^{The conference agreement includes a special rule for "qualified infrastructure property" which may be eligible for the accelerated depreciation even if locatedoutside an Indian reservation, provided that the purpose of such property is to connect with qualified infrastructure property locatedwithin the reservation (e.g., roads, power lines, water systems, railroad spurs, and communications facilities). For this purpose, "qualified infrastructure property" must be property that is (1) allowed a depreciation deduction under section 168, (2) benefits the tribal infrastructure, (3) available to the general public, and (4) placed in service in connection with the taxpayer's active conduct of a trade or business within a reservation.}

^{The depreciation deduction allowed for regular tax purposes is also allowed for purposes of the alternative minimum tax.}

^{Indian employment credit}

^{The conference agreement follows the Senate amendment, except that (1) a single-rate 20-percent credit applies (rather than the two-tiered 10-percent and 30-percent credit rates of the Senate amendment); and (2) the credit is available only for the first $20,000 of qualified wages and qualified employee health insurance costs paid to each qualified employee.}

^{As under the Senate amendment, a tribal member or spouse is a qualified employee only if he or she works on a reservation (and lives on or near that reservation) and is paid wages that do not exceed $30,000 annually.187} The credit is an incremental credit, such that an employer's current-year qualified wages and qualified employee health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent that the sum of such costs exceeds the sum of comparable costs paid during 1993 to employees whose wages did not exceed $30,000.

(sec. 14401 of the House bill, secs. 7901 and 13008 of the Senate amendment, sec. 13401 of the Conference Agreement, and sec. 6103 of the Code)

Among the disclosures permitted under the Code is disclosure to the Department of Veterans Affairs ("DVA") of self-employment tax information and certain tax information supplied to the Internal Revenue Service and Social Security Administration by third parties. Disclosure is permitted to assist DVA in determining eligibility for, and establishing correct benefit amounts under, certain of its needs-based pension and other programs (sec. 6103(1)(7)(D)(viii)). The income tax returns filed by the veterans themselves are not disclosed to DVA.

The DVA is required to comply with the safeguards currently contained in the Code and in section 1137(c) of the Social Security Act (governing the use of disclosed tax information). These safeguards include independent verification of tax data, notification to the individual concerned, and the opportunity to contest agency findings based on such information.

The DVA disclosure provision is scheduled to expire after September 30, 1997.

2. Access to Tax Information by the Department of Education

(secs. 4032, 4033, and 14402 of the House bill, secs. 7902, 12011, and 12055 of the Senate amendment, sec. 13402 of the Conference agreement and sec. 6103 of the Code)

The IRS may disclose to the Department of Education the mailing address of taxpayers who have defaulted on certain student loans. The Department of Education may in turn make this information available to its agents and to the holders of such loans (and their agents) for the purpose of locating the taxpayers and collecting the loan.

Section 14402 of the House bill gives the Department of Education access to certain tax return information in order to implement a direct student loan program. The only information the Department of Education is permitted to obtain is the name, address, taxpayer identification number, filing status, and adjusted gross income of the former student. Disclosure of this information may be made only to Department of Education employees and may only be used by these employees in establishing the appropriate income-contingent repayment amount for an applicable student loan. Applicable student loans are loans under the new direct student loan program and other student loans that are in default and have been assigned to the Department of Education. The Department of Education and its employees would be subject to the restrictions on unauthorized disclosure in present law.

The authority to disclose tax information to the Department of Education for purposes of implementing the direct student loan program expires on September 30, 1998.

Access to mailing addresses of taxpayers owing overpayments of Pell Grants

Section 14402 of the House bill also permits the Department of Education to obtain the mailing address of any taxpayer who owes an overpayment (i.e., has received more than the proper amount) on a Federal Pell Grant or who has defaulted on certain additional student loans administered by the Department of Education. This authority is permanent.

Evaluation of student loan repayment through wage withholding

Section 14402 of the House bill requires the Treasury Department, in consultation with the Department of Education, to conduct a study of the feasibility of student loan repayment through wage withholding or other means involving the IRS. The study is to include an examination of (1) whether the IRS could conduct such a system of student loan repayment within its current resources and without impairing its ability to collect tax revenues, (2) the impact of increased disclosure of tax information on voluntary compliance with the tax laws, (3) the effect of such a system of student loan repayment on collections and repayment of such loans, and (4) the ability of the IRS to service student loans. The study must be submitted to the Congress within six months of the date of enactment. If the Treasury Department finds that the IRS's current resources are inadequate to permit the IRS to increase its involvement in student loan collection, then it should identify the amount of additional resources or appropriations needed.

Section 4032 of the House bill contains the same provision for a feasibility study, except that the requirement is imposed on the Department of Education, in consultation with the Treasury Department.

Preference for IRS collection of student loan repayments

Section 4033 of the House bill expresses the sense of the Committee on Education and Labor supporting IRS collection of student loan repayments.

With respect to this provision, Section 7902 of the Senate amendment is the same as section 14402 of the House bill.

With respect to this provision, Section 12055 of the Senate amendment is the same as both section 7902 of the Senate amendment and section 14402 of the House bill, except that disclosure of the tax return information is permitted to agents of the Department of Education.

Access to mailing addresses of taxpayers owing overpayments of Pell Grants

With respect to this provision, Section 7902 of the Senate amendment is the same as section 14402 of the House bill.

With respect to this provision, Section 12055 of the Senate amendment is the same as both section 7902 of the Senate amendment and section 14402 of the House bill, except that the authority expires after September 30, 1998.

Evaluation of student loan repayment through wage withholding

Section 12011 of the Senate amendment requires the Secretaries of Education and Treasury to present to the President a plan that provides for repayment of student loans through wage withholding and evaluates the feasibility of other wage withholding repayment options for such loans. The study must be submitted to the President within six months of the date of enactment.

With respect to this provision, Section 12055 of the Senate amendment is similar to section 14402 of the House bill, except that (1) no study is required; (2) upon a determination by the President (pursuant to the study described in section 12011 of the Senate amendment) that repayment of student loans should be done through wage withholding or other means involving the IRS, the Secretary of the Treasury may enter into an agreement with the Secretary of Education to allow the IRS to collect student loan repayments as if they were taxes (without the need for additional legislative authorization); and (3) the agreement described in (2) is authorized to include an alternate system of fees and penalties for nonpayment of amounts due.

With respect to this provision, the conference agreement follows section 14402 of the House bill and section 7902 of the Senate amendment.

Access to mailing addresses of taxpayers owing overpayments of Pell Grants

With respect to this provision, the conference agreement follows section 14402 of the House bill and section 7902 of the Senate amendment.

Evaluation of student loan repayment through wage withholding

With respect to this provision, the conference agreement does not include the provisions in sections 4032, 4033, or 14402 of the House bill or sections 12011 or 12055 of the Senate amendment.

The conferees direct the Treasury Department, in consultation with the Department of Education, to conduct a study of the feasibility of implementing a system for the repayment of Federal student loans through wage withholding or other means involving the IRS. Such study should include an examination of: (1) whether the IRS could implement such a system of student loan repayment with its current resources and without adversely affecting its ability to collect tax revenues, (2) the cumulative impact of increased disclosure of tax information and increased IRS involvement in nontax collection activities on voluntary compliance with the tax laws, (3) the ability of the IRS to enforce collection of student loans using an alternate system of dispute resolution, penalties, and collection devices, (4) the effect of separating loan collection from other loan servicing functions, and (5) the anticipated effect on the management of Federal student loan collections and on borrower repayment of such loans. If the study concludes that IRS collection is feasible, the Treasury Department and the Department of Education should develop a plan to implement such a collection system. The feasibility study and any plan that is developed, together with any legislative recommendations that the Secretaries may deem advisable, should be submitted to the Congress within six months of the date of enactment.

3. Access to Tax Information by the Department of Housing and Urban Development

(sec. 14403 of the House bill, secs. 7903 and 3003 of the Senate amendment, sec. 13403 of the Conference agreement, and sec. 6103 of the Code)

The House bill requires the Treasury Department, in consultation with HUD, to conduct a study to determine (1) whether the tax return information disclosed to HUD is being used effectively, (2) whether HUD is complying with the Code's safeguards against unauthorized disclosure of the information, and (3) the impact on the privacy rights of applicants and participants in HUD housing programs. The study must be submitted to the tax-writing committees before January 1, 1998.

Under the Program, all persons who were immunized with a covered vaccine after the effective date of the Program, October 1, 1988, are prohibited from commencing a civil action in State court for vaccine-related damages unless they first file a petition with the United States Claims Court, where such petitions are assigned to a special master and governed by streamlined procedural rules designed to expedite the proceedings.¹⁸⁸ In these cases, the Federal Government is the respondent party in the proceedings, and the claimant generally must show only that certain medical conditions (or death) followed the administration of a covered vaccine and that the first onset of symptoms occurred within a prescribed time period.¹⁸⁹ Compensation under the Program generally is limited to actual and projected unreimbursed medical, rehabilitative, and custodial expenses, lost earnings, pain and suffering (or, in the event of death, a recovery for the estate) up to $250,000, and reasonable attorney's fees.¹⁹⁰ Only if the final settlement under the Program is rejected may the claimant proceed with a civil tort action in the appropriate State court, where recovery generally will be governed by State tort law principles¹⁹¹, subject to certain limitations and specifications imposed by the National Childhood Vaccine Injury Act of 1986.¹⁹²

^{Present law authorizes up to $6 million per year from the Vaccine Trust Fund for administrative expenses incurred in administering the Vaccine Injury Compensation Program.}

^{The Vaccine Trust Fund is funded by net revenues from a manufacturer's excise tax on DPT, DT, MMR, and polio vaccines (and any other vaccines used to prevent these diseases).}

^{Prior to the expiration of the vaccine excise tax, the excise tax per dose was $4.56 for DPT, $0.06 for DT, $4.44 for MMR, and $0.29 for polio vaccines.}

^{The vaccine excise tax expired after December 31, 1992. Amounts in the Vaccine Trust Fund are available for the payment of compensation under the Program with respect to vaccines administered after September 30, 1988, and before October 1, 1992.}

The House bill permanently extends the excise taxes imposed on certain vaccines. Authorization for compensation to be paid from the Vaccine Trust Fund under the National Vaccine Injury Compensation Program for certain damages resulting from vaccines administered after September 30, 1988, also is permanently extended.¹⁹³

^Study

^{The Secretary of the Treasury, in consultation with the Secretary of Health and Human Services, is directed to conduct a study of: (1) the estimated amount that will be paid from the Vaccine Trust Fund with respect to vaccines administered after September 30, 1988; (2) the rates of vaccine-related injury or death with respect to various types of vaccines; (3) new vaccines and immunization practices being developed or used for which amounts may be paid from the Vaccine Trust Fund; (4) whether additional vaccines should be included in the National Vaccine Injury Compensation Program; and (5) the appropriate treatment of vaccines produced by State governmental entities. Not later than one year after the date of enactment, the Secretary of the Treasury must submit a report detailing his findings to the House Committee on Ways and Means and the Senate Committee on Finance.}

^{Childhood immunization program trust fund}

^{The House bill establishes a new Childhood Immunization Trust Fund ("Childhood Trust Fund") in the Internal Revenue Code. Monies in the Childhood Trust Fund are to be available, subject to appropriations Acts, for the childhood immunization entitlement program (under part A of subtitle 3 of title XXI of the Public Health Service Act), adopted by the Committee on Energy and Commerce as part of its reconciliation recommendations.}

^{Maintenance-of-effort requirement for pediatric vaccine health care coverage}

^{The House bill makes the failure of health plans that provide coverage for the cost of pediatric vaccines as of May 1, 1993, to continue to provide that level of coverage subject to the excise tax penalty (under sec. 4980B(f)) applicable to plans that fail to provide COBRA health plan continuation coverage.}

The maintenance-of-effort requirement for pediatric vaccine health care coverage applies to plan years beginning after the date of enactment.

The Senate amendment is the same as the House bill.

Study

No provision.

Childhood immunization program trust fund

No provision for a childhood immunization program trust fund.

Maintenance-of-effort requirement for pediatric vaccine health care coverage

No tax provision.

The conference agreement follows the House bill and the Senate amendment.

Study

The conference agreement follows the Senate amendment, but the conferees intend that the Secretary of the Treasury will conduct a study of the Vaccine Trust Fund and related matters as contemplated by the statutory provision contained in the House bill, including a report to the House Committee on Ways and Means and the Senate Committee on Finance within one year after the date of enactment.

Childhood immunization program trust fund

The conference agreement does not include the House bill provision for a childhood immunization program trust fund.

Maintenance-of-effort requirement for pediatric vaccine health care coverage

The conference agreement follows the House bill.

(sec. 13431 of the Conference agreement and sec. 1033 of the Code)

In addition, the conference agreement extends the ending of the applicable period for the replacement of property involuntarily converted as a result of a Presidentially declared disaster to four years after the close of the first taxable year in which any part of the gain upon conversion is realized.

The conference agreement applies to residences located in areas subject to a disaster that resulted in a subsequent determination by the President that assistance by the Federal Government was warranted under the Disaster Relief and Emergency Assistance Act.

2. Increase Amount of Presidential Election Campaign Fund Checkoff

(sec. 7953 of the Senate amendment, sec. 13441 of the Conference agreement, and sec. 6096(a) of the Code)

3. Disallowance of Deduction for Amounts Paid or Incurred in Connection With Certain Noncomplying Group Health Plans

(sec. 13442 of the Conference agreement and new sec. 162(n) of the Code)

If a group health plan provides inpatient hospital services through a health maintenance organization (HMO), the conference agreement disallows employer deductions in connection with the plan if the plan fails to reimburse hospitals for inpatient services at the same rate (without regard to exempt individuals) that HMOs are required to reimburse hospitals for individuals not covered by a group health plan.

If a group health plan provides coverage for inpatient hospital services through a Blue Cross and Blue Shield corporation, the conference agreement disallows employer deductions in connection with the plan if the plan fails to reimburse hospitals for inpatient services at the same rate that such corporations are required to reimburse hospitals for individuals not covered by a group health plan.

The deduction disallowance does not apply to any group health plan which is not required under the laws of the state of New York (determined without regard to this provision or other provisions of Federal law) to reimburse for hospital services at the rates described above. Thus, self-insured plans are not subject to the deduction disallowance with respect to the 11 percent surcharge imposed on commercial insurers through March 31, 1993. Similarly, the deduction disallowance does not apply to self-insured plans that do not provide for reimbursement directly to hospitals on an expense incurred basis. The deduction denial also does not apply to payments by self-insured plans exempt from New York's all-payer reimbursement system because of agreements in effect on May 1, 1985.

No inference is intended as to whether any provision of the New York all-payer hospital reimbursement system is preempted by ERISA.

4. Employer Tax Credit for FICA Taxes Paid on Tip Income

(sec. 13443 of the Conference agreement and sec. 45B of the Code)

To prevent double dipping, no deduction is allowed for any amount taken into account in determining the credit. The conference agreement prohibits carryback of unused FICA credits to a taxable year ending before the date of enactment.

5. Availability and Use of Death Information

(sec. 13020 [13010] of the House bill, sec. 13444 of the Conference agreement, and sec. 6103 of the Code)

In addition, the House bill requires the Secretary of Health and Human Services to conduct a study of possible improvements in the current methods of gathering and reporting death information by Federal, State, and local governments that would result in more efficient and expeditious handling of such information. The House bill also requires the Secretary to submit a written report by June 1, 1994, to the Committee on Ways and Means and the Committee on Finance setting forth the results of this study, together with such administrative and legislative recommendations as the Secretary considers appropriate.

6. BATF User Fees for Processing Applications for Alcohol Certificates of Label Approval

(sec. 14411 of the House bill and sec. 7951 of the Senate amendment)

Under the Internal Revenue Code, annual alcohol occupational excise taxes are imposed as follows:

      Producers of distilled spirits,

The Secretary of the Treasury is authorized to implement the user fee program and to establish fee rates: not less than $50 for each application and not less than $250 for each formula (and statement of process) review or test and analysis. The fees charged under this program are to be determined so that the Secretary estimates that the aggregate of such fees received during any fiscal year will be $5 million. A maximum of $5 million of these fees are to be offsetting receipts deposited in the Treasury and ascribed to BATF's Compliance Alcohol Program.

7. Use of Harbor Maintenance Trust Fund for Administrative Expenses

(sec. 14412 of the House bill, sec. 7952 of the Senate amendment, and sec. 9505(c) of the Code)

8. Federal and State Income Tax Refund Offset for Medical Assistance

(sec. 7433 of the Senate amendment)

Before a refund can be offset under this program, the agency owed the debt is required to certify to the IRS that the debtor has been notified about the proposed offset and has been given at least 60 days to present evidence that all or part of the debt is not past due or not legally enforceable. The agency also is required to enter into agreement with the IRS prior to transmitting proposed offsets. If a refund otherwise due an individual is subject to offset both under this provision and because of past-due support under the Aid to Families with Dependent Children (AFDC) program, the offset for AFDC past-due support is implemented first.

9. Annual Report to Taxpayers on Federal Finances

(sec. 15002 of the Senate amendment)

² Basis in common stock of a corporate SSBIC is not reduced for purposes of calculating the gain eligible for the 50 percent exclusion for qualified small business stock under new section 1202 as provided in the House bill.

³ A taxpayer's otherwise allowable deduction for clinical testing expenses is reduced by the amount of any orphan drug tax credit allowed for the taxable year (sec. 280C(b)).

⁴ The conferees intend, however, that the interest of a governmental unit will be disregarded under the recapture restriction if the governmental unit's interest is structured so as to capture any amount otherwise subject to Federal recapture e.g. by allocating to the governmental unit an amount of gain on disposition greater than the proportionate amount of the total subsidy to the homebuyer that is provided by the subordinated mortgage loan.

⁵ As under present law, a leaseback to a disqualified person is subject to the prohibited transaction rules set forth in section 4975.

⁶ For this purpose, financial institutions include financial institutions in conservatorship or receivership, certain affiliates of financial institutions, and government corporations that succeed to the rights and interests of a receiver or conservator.

⁷ IRS Notice 88-121, 1988-2 C.B. 457. See also Treas. Reg. sec. 1.501(c)(2)-1(a).

⁸See Rev. Rul. 66-151, 1966-1 C.B. 151.

⁹ Moreover, as under present law, any investment by a pension trust must be in accordance with the fiduciary rules of the Employee Retirement Security Act ("ERISA") and the prohibited transaction rules of the Code and ERISA.

¹⁰ A separate provision of the conference agreement extends the 2.5-cents-per-gallon rate through September 30, 1999, and transfers applicable highway-related revenues to the Highway Trust Fund for the extended period. (See section 13244 of the conference agreement, Item II.D.4., below.)

¹¹See section 14241 of the House bill, Item II.D.1., below.

¹²See sections 14242-14243 of the House bill, Item II.D.3., below.

¹³See section 8241 of the Senate amendment, Item II.D.2., below.

¹⁴See section 8242 of the Senate amendment, Item II.D.3., below.

¹⁵See section 13241 and sections 13242 and 13243 of the conference agreement, Items II.D.2. and II.D.3. below.

¹⁶ The amount of the deduction allowable for a taxable year with respect to a charitable contribution may be reduced depending on the type of property contributed, the type of charitable organization to which the property is contributed, and the income of the taxpayer (secs. 170(b) and 170(e)).

¹⁷ Section 170(e)(3) provides an augmented deduction for certain corporate contributions of inventory property for the care of the ill, the needy, or infants.

¹⁸ Form 8283 must be attached to an income tax return (Form 1040) in all cases where total noncash contributions exceed $500, but the Form 8283 need not be signed by a qualified appraiser unless the $5,000 threshold per item or group of similar items is exceeded. In the case of donated art for which a deduction of $20,000 or more is claimed, a complete copy of the signed appraisal must be attached to the Form 8283.

¹⁹ Contributions of inventory or other ordinary income property, short-term capital gain property, and certain gifts to private foundations continue to be governed by present-law rules.

²⁰ The provision is effective for contributions of tangible personal property made after June 30, 1992, and of other property made after December 31, 1992. Thus, the conferees wish to clarify that the relief provided by the provision does not apply to any carryover from a contribution made prior to the applicable effective date (see Rev. Rul. 90-111, 1990-2 C.B. 30).

²¹ If the claimed deduction for a noncash gift exceeds $5,000 per item or group of similar items (other than certain publicly traded securities), a qualified appraiser must sign the Form 8283. In addition, an authorized representative of the donee charity must sign the Form 8283, acknowledging receipt of the gift and providing certain other information. In certain situations, information reporting by the donee charity is required if it subsequently disposes of donated property (sec. 6050L).

²²See, e.g., Rev. Rul. 67-246, 1967-2 C.B. 104.

Under current IRS practice1 certain small items and token benefits (e.g., key chains and bumper stickers) that have insubstantial value are disregarded, such that the full amount of the contribution is deductible. Rev. Proc. 90-12, 1990-1 C.B. 471, provides that tokens or benefits given to the donor in connection with a contribution will be considered to have insubstantial value if (1) the payment occurs in the context of a fundraising campaign in which the charity informs patrons how much of their payment is a deductible contribution, and (2) either (a) the fair market value of all the benefits received in connection with the payment is not more than two percent of the payment, or $50, whichever is less, or (b) the payment made by the patron is $25 or more (adjusted for inflation) and the only benefits received in connection with the payment are token items (e.g., key chains or mugs) that bear the organization's name or logo and that (in the aggregate) are within the limits for "low-cost items" under section 513(h)(2). See also Rev. Proc. 92-49, 1992-26 I.R.B. 18 (amplifying Rev. Proc. 90-12, by allowing charities to distribute certain low-cost items to contributors without affecting the deductibility of the contribution).

²³ However, Schedule A to the Form 1040 and the accompanying instructions inform taxpayers that if they made a contribution to a charity and received a benefit in return, the value of the benefit must be subtracted in calculating the charitable contribution deduction.

²⁴ However, the disclosure requirement of section 6113 does not apply to an organization the gross receipts of which in each taxable year are normally not more than $100,000, nor does the disclosure requirement apply to any solicitation made by letter or telephone call if such letter or call is not part of a coordinated fundraising campaign soliciting more than 10 persons during the calendar year (sec. 6113(b)(2)(A) and (c)(2)).

²⁵See section 6033(a)(2) and Rev. Proc. 83-23, 1983-1 C.B. 687.

²⁶See section 6033(b)(5) and Treas. Reg. sec. 1.6033-2(a)(2)(ii)(f). The names and addresses of substantial contributors to a public charity must be reported to the IRS but are not subject to public inspection (sec. 6104(e)(1)(C)).

²⁷ Separate payments generally will be treated as separate contributions and will not be aggregated for the purposes of applying the $750 threshold. In cases of contributions paid by withholding from wages, the deduction from each paycheck will be treated as separate payments.

²⁸ In addition, the House bill provides that the Secretary of the Treasury shall issue regulations as may be necessary to carry out the purposes of the substantiation provision, including regulations that may provide that some or all of the requirements of the provision do not apply in appropriate cases.

²⁹ Separate payments generally will be treated as separate contributions and will not be aggregated for the purposes of applying the $250 threshold. In cases of contributions paid by withholding from wages, the deduction from each paycheck will be treated as a separate payment. However, the Senate committee explanation states that it is expected that the Secretary of the Treasury will issue anti-abuse rules to prevent avoidance of the substantiation requirement by writing multiple checks on the same date.

³⁰ If the donee organization provided no goods or services to the taxpayer in consideration of the taxpayer's contribution, the written substantiation is required to include a statement to that effect. The substantiation need not contain the taxpayer's social security number or taxpayer identification number (TIN).

³¹ In the case where a taxpayer makes a noncash contribution claimed by the taxpayer to be worth $250 or more, the taxpayer is required to obtain from the charity a receipt that describes the donated property (and indicates whether any good or service was given to the taxpayer in exchange), but the provision specifically provides that the charity is not required to value the property it receives from the taxpayer.

³² The provision requires that the written acknowledgment provide information sufficient to substantiate the amount of the deductible contribution, but the acknowledgment need not take any particular form. Thus, for example, acknowledgments may be made by letter, postcard, or computer-generated forms. Further, a donee organization may prepare a separate acknowledgment for each contribution, or may provide donors with periodic (e.g., annual) acknowledgments that set forth the required information for each contribution of $250 or more made by the donor during the period. The Senate committee explanation states that is intended that a charitable organization that knowingly provides a false written substantiation to a donor may be subject to the penalties provided for by section 6701 for aiding and abetting an understatement of tax liability.

³³ In addition, the Senate amendment provides that the Secretary of the Treasury shall issue regulations as may be necessary to carry out the purposes of the substantiation provision, including regulations that may provide that some or all of the requirements of the provision do not apply in appropriate cases.

³⁴ This exception does not apply, for example, to tuition for education leading to a recognized degree, travel services, or consumer goods. However, the Senate committee explanation states that it is intended that de minimis tangible benefits furnished to contributors that are incidental to a religious ceremony (such as wine) generally may be disregarded.

³⁵ The Senate committee explanation states that it is intended that the disclosure be made in a manner that is reasonably likely to come to the attention of the donor. For example, a disclosure of the required information in small print set forth within a larger document might not meet the requirement.

³⁶ For purposes of the $75 threshold, separate payments made at different times of the year with respect to separate fundraising events generally will not be aggregated. However, the conferees intend that the Secretary will issue anti-abuse rules to prevent avoidance of the quid pro quo disclosure requirement by writing multiple checks for the same transaction.

³⁷ The Senate committee explanation states that no inference is intended, however, regarding the full or partial deductibility of any payment outside the scope of the quid pro quo disclosure provision or substantiation provision under the present-law requirements of section 170.

³⁸ The Senate committee explanation states that it is intended that, following enactment of the bill, the Secretary of the Treasury will expeditiously issue a notice or other announcement providing guidance with respect to the substantiation and disclosure provisions. In this regard, it is expected that such Treasury guidance will urge charities to assist taxpayers in meeting the substantiation requirement.

³⁹ As under the Senate amendment, charities are not required to make any disclosure under the quid pro quo disclosure provision when no benefit other than an intangible religious benefit is furnished to the donor.

⁴⁰ Except that stock also is treated as personal property in defining a straddle for purposes of the conversion transaction provision.

⁴¹ Or in the case of a bond issued with original issue discount (OID), a price that is less than the amount of the issue price plus accrued OID.

⁴² The additional five percent rate applies to the taxable transfers of a nonresident noncitizen in excess of $10 million only to the extent necessary to phase out the graduated rates and unified credit actually allowed, either by statute or by treaty (where applicable).

⁴³Kenneth D. Smith, 24 TCM 899 (1965).

⁴⁴ The provision does not modify the present-law requirement that, in order to be deductible, compensation must be reasonable. Thus, as under present law, in certain circumstances compensation less than $1 million may not be deductible.

⁴⁵ Of course, if the executive is no longer a covered employee at the time the options are exercised, then the deduction limitation would not apply.

⁴⁶ Discretion does not exist merely because the outside directors have the authority to interpret a compensation plan, agreement, or contract in accordance with its terms.

⁴⁷ Of course, as discussed below in the text, the grandfather ceases to apply if the plan is materially amended.

⁴⁸ These figures equal 50 percent of the difference between the present law thresholds for 50-percent Social Security benefit inclusion and the proposed second-tier thresholds for 85-percent Social Security benefit inclusion.

⁴⁹ Prior to 1963, Treasury Department regulations (originally dating back to 1915) provided that ALL expenditures for lobbying purposes, for the promotion or defeat of legislation, for political campaign purposes, or for propaganda (including advertising) related to any such purposes, were not deductible as "ordinary and necessary" business expenses. See Cammarano v. United States, 358 U.S. 498 (1959) (upholding validity of regulation denying deduction for lobbying expenses, even if expenses related to proposed legislation that affected the very survival of the taxpayer's business). In response to the Cammarano decision, Congress enacted, as part of the Revenue Act of 1962, the statutory rule contained in section 162(e)(1) specifically allowing a deduction for certain "direct lobbying" expenses.

⁵⁰See Regan v. Taxation With Representation, 461 U.S. 540 (1983) (upholding constitutionality of section 501(c)(3) lobbying restriction on grounds that legislature is not required to subsidize lobbying through a tax exemption or deduction).

⁵¹See Rev. Rul. 70-79, 1970-1 C.B. 127; Rev. Rul. 70-449, 1970-2 C.B. 111; Slee v. Commr, 42 F.2d 184 (2d Cir. 1930).

⁵² Under the section 4911 regulations, "nonpartisan analysis, study, or research" means an independent and objective exposition of a particular subject matter, including any activity that is "educational" within the meaning of Treasury Regulation section 1.501(c)(3)-1(d)(3). Thus, "nonpartisan analysis, study, or research" may advocate a particular position or viewpoint so long as there is a sufficiently full and fair exposition of the pertinent facts to enable the public or an individual to form an independent opinion or conclusion. The mere presentation of unsupported opinion does not qualify as "nonpartisan analysis, study, or research." Nonpartisan analysis may be made available to the general public, a segment thereof, or governmental bodies. Communications may not be limited to, or be directed toward, persons who are interested solely in one side of a particular issue (Treas. Reg. sec. 56.4911-2(c)(1)).

Furthermore, a Treasury regulation under section 4911 provides that "[e]xaminations and discussions of broad social, economic, and similar problems are neither direct lobbying communications . . . nor grass roots lobbying communications . . . even if the problems are of the type with which government would be expected to deal ultimately. Thus, . . . lobbying communications do not include public discussion, or communications with members of legislative bodies or governmental employees, the general subject of which is also the subject of legislation before a legislative body, so long as such discussion does not address itself to the merits of a specific legislative proposal and so long as such discussion does not directly encourage recipients to take action with respect to legislation" (Treas. Reg. sec. 56.4911-2(c)(2)).

⁵³ Under this exception, the request for assistance or advice must be made in the name of the requesting governmental body, committee, or subdivision rather than an individual member thereof; and the response to such request must be made available to every member of the requesting body, committee, or subdivision. Treasury regulations further provide that because such assistance or advice may be given only at the express request of a governmental body, the oral or written presentation of such assistance or advice need not qualify as nonpartisan analysis, study or research. The offering of opinions or recommendations will ordinarily qualify under this exception only if such opinions or recommendations are specifically requested by the governmental body or are directly related to the materials so requested (Treas. Reg. secs. 56.4911-2(c)(3) and 53.4945-2(d)(2)).

⁵⁴ For purposes of the provision, the term "legislation" has the same meaning as under section 4911(e)(2), which, in turn, defines "legislation" as including "action with respect to Acts, bills, resolutions, or similar items by the Congress, any State legislature, any local council, or similar governing body, or by the public in a referendum, initiative, constitutional amendment, or similar procedure."

Treasury regulations provide that "legislation" for purposes of section 4911(e)(2) includes action by legislative bodies but does not include action by "executive, judicial, or administrative bodies" (Treas. Reg. sec. 56.4911-2(d)(3)). Treasury regulations further provide that "administrative bodies" includes school boards, housing authorities, sewer and water districts, zoning boards, and other similar Federal, State, or local special purpose bodies, whether elective or appointive (Treas. Reg. sec. 56.4911-2(d)(4)). Thus, communications with, and attempts to influence, members of a local zoning board (acting in their capacity as members of that board, regardless of whether or not such members are elected to their position) will not be affected by the provision.

⁵⁵ The Senate amendment applies to the costs of communications with the following Federal executive branch officials: (1) the President; (2) the Vice President; (3) any officer or employee of the Executive Office of the President other than a clerical or secretarial employee; (4) any officer or employee serving in an Executive level I, II, III, IV, or V position, as designated in statute or Executive order (such as Secretaries, Deputy Secretaries and Assistant Secretaries, Directors, and Commissioners); (5) any officer or employee serving in a Senior Executive Service position as defined under 5 U.S.C. section 3232(a)(2); (6) any member of the uniformed services whose pay grade is at or in excess of 0-7 under 37 U.S.C. section 201; and (7) any officer or employee serving in a position of confidential or policy-determining character under Schedule C of the excepted service pursuant to 5 U.S.C. section 7511. Under the Lobbying Disclosure Act of 1993 (S. 349), as passed by the Senate on May 6, 1993, such Federal executive branch officials are referred to as "covered executive branch officials," communications to whom are subject to the Act's reporting requirements.

⁵⁶ Thus, if a taxpayer communicates with any executive branch official or employee (regardless of rank) in an attempt to influence the official's or employee's participation in the Federal or State legislative process, then costs incurred in connection with the communication are nondeductible. Under present-law section 4911 regulations, "legislation" does not include actions of Federal or State administrative or special purpose bodies, whether elective or appointive (Treas. Reg. sec. 56.4911-2(d)(4)).

⁵⁷ The conferees intend that direct communications include all written and oral communications with covered executive branch officials. A communication will be considered to be a direct communication with a covered executive branch official if such official is the intended primary recipient of the communication, regardless of whether the communication is formally addressed to the official.

⁵⁸See 5 U.S. Code sec. 5312.

⁵⁹ In the case of councils or other agencies within the Executive Office of the president with respect to which the president, Vice president or one or more Cabinet members serve as ranking members, the covered officers include the two most senior administrative officers (other than the ranking members) of the council or agency.

⁶⁰ The conference agreement provides that, for purposes of the section 162 lobbying rules, a tribal government of an Indian reservation will be treated as a "local council or similar governing body." Thus, lobbying with respect to such tribal governments continues to be governed by present-law rules.

⁶¹ Under present law, at the local government level, lobbying expenses are deductible only if incurred in direct connection with communications to government officials (or an organization of which the taxpayer is a member) with respect to local legislation of direct interest to the taxpayer (and to the organization). Expenditures for grass roots lobbying with respect to local legislation or for participation in local elections are not deductible.

⁶² The conference agreement includes a de minimis rule primarily to provide administrative convenience to taxpayers. Therefore, if, during a taxable year, a taxpayer incurs in-house expenditures in excess of $2,000, then the full amount of its lobbying expenses must be determined and such amount (including the first $2,000 of in-house expenditures) is subject to the disallowance rule.

⁶³ In addition, the conferees intend that the Secretary of the Treasury will permit taxpayers to adopt reasonable methods for allocating expenses to lobbying (and related research and other background) activities in order to reduce taxpayer recordkeeping responsibilities.

⁶⁴ Payments that are similar to dues include voluntary payments made by members and special assessments imposed by the recipient organization to conduct lobbying activities. This is comparable to the treatment of special assessments for grass roots lobbying or campaign expenses under present-law Treasury Regulation section 1.162-20(c)(3).

⁶⁵ The conferees intend that such notice be provided in a conspicuous and easily recognizable format. See section 6113 and the regulations issued thereunder for guidance regarding the appropriate format of the disclosure statement.

⁶⁶ In this case, the conference agreement grants the Secretary of the Treasury authority to waive the proxy tax otherwise imposed if an organization agrees to adjust its notice of estimated lobbying expenditures provided to members in the following year. Further, the conferees intend that the Secretary will prescribe regulations governing the treatment of organizations that incur actual lobbying expenditures below the estimated amount.

⁶⁷ For example, if during a taxable year, an organization receives $100,000 in dues, spends $150,000 on lobbying and elects to pay the proxy tax (rather than provide flow-through disclosure to members), the proxy tax for that year would be imposed on $100,000 of lobbying expenditures. The remaining $50,000 of lobbying expenditures would be carried forward to the subsequent year, during which the organization could comply with the disclosure requirements outlined above or elect to pay the proxy tax with respect to such amount, as well as any additional lobbying expenditures incurred during that subsequent year.

⁶⁸ Examples of such organizations include organizations that receive 90 percent or more of their dues monies from members that are tax-exempt charities or who are individuals not entitled to deduct the dues payments in determining taxable income because the payments are not ordinary and necessary business expenses. Another example would be a union that establishes to the satisfaction of the Secretary that 90 percent or more of its dues monies are paid by individuals who do not deduct such dues because of the operation of the two-percent floor on miscellaneous itemized deductions (sec. 67).

⁶⁹See, e.g., section 6652(c)(1)(A)(ii).

⁷⁰ The conference agreement does not alter present-law rules under sections 501(c)(3) and 4911 regarding the impact of lobbying on a charity's tax-exempt status. Thus, even if a contributor is subject to the anti-avoidance rule in a particular case because its payment to a charity is made with a principal purpose of funding "lobbying" as defined under section 162, the charity's tax-exempt status will not be jeopardized if its activity qualifies as non-partisan analysis or does not constitute "substantial lobbying" under the present-law section 501(c)(3) or section 4911 standards.

⁷¹ Possessions to which special tax rules presently apply include Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, and the U.S. Virgin Islands.

⁷² In contrast to the foreign tax credit, the section 936 credit is a "tax sparing" credit. That is, the credit is granted whether or not the electing corporation pays income tax to the possession.

⁷³ A special allocation of research and development expenses as required by section 936(h)(5)(C)(ii)(II) can cause the proportion of the combined taxable which is allocable to the possession corporation to be less than 50 percent.

⁷⁴ The amount of tax allowable for purposes of the credit is limited to 75 percent of possessions tax paid in order to correspond to the portion of a dividend from a possession corporation that would be included in the recipient shareholder's AMTI as a result of the ACE adjustment.

⁷⁵ Unlike the PFIC rules of present law, the House bill offers no option to measure assets by fair market value.

⁷⁶ Under the present-law ordering rules for the attribution of actual distributions or income inclusions to years of earnings, earnings from more recent years are treated as distributed or included before earnings from earlier years. Thus, the pre-acquisition earnings, which operate as a limit to the exclusion of certain U.S. property acquired before the foreign corporation became a controlled foreign corporation, will not be treated as distributed or included until actual distributions or income inclusions from the controlled foreign corporation carry out all more recent earnings.

⁷⁷ P.L. 99-514, sec. 1201(a) (1986).

⁷⁸ Former Treas. Reg. sec. 1.904-4(b).

⁷⁹ Rev. Rul. 83-51, 1983-1 C.B. 48.

⁸⁰See, e.g., Dorzback v. Collison, 195 F.2d 69 (3d Cir. 1952).

⁸¹ Certain additional exceptions to this general rule apply only in the case of a corporate recipient of interest. In such a case, the term portfolio interest generally excludes (1) interest received by a bank on a loan extended in the ordinary course of its business (except in the case of interest paid on an obligation of the United States), and (2) interest received by a controlled foreign corporation from a related person.

⁸² Treas. Reg. sec. 1.897-1(h). FIRPTA applies in the case of a "disposition" of a USRPI. Treasury Reg. sec. 1.897-1(h) generally defines a disposition as a transaction that gives rise to gain under section 1001 of the Code. Section 1001 does not apply to interest received on indebtedness.

⁸³ For purposes of determining whether interest is contingent interest under the House bill, the term related person means any person who is related to the borrower under Code section 267(b) or 707(b)(1). In addition, a related person, for this purpose, includes a party to an arrangement undertaken for a purpose of avoiding the application of this provision of the House bill.

⁸⁴See, e.g., Commissioner v. Court Holding Co., 324 U.S. 331 (1945)

⁸⁵ 56 T.C. 925 (1971), acq. on another issue, 1972-2 C.B. 1.

⁸⁶ Rev. Rul. 84-152, 1984-2 C.B. 381; Rev. Rul. 84-153, 1984-2 C.B. 383.

⁸⁷ Rev. Rul. 87-89, 1987-2 C.B. 195.

⁸⁸ Tech. Adv. Mem. 9133004 (May 3, 1991).

⁸⁹ Special motor fuels include benzol, benzene, naphtha, liquefied petroleum gas, casing head and natural gasoline, and any other liquid (other than kerosene, gas oil, fuel oil, or gasoline) sold for use in motor vehicles or motorboats.

⁹⁰See Item II.D.4., below, for the extension and transfer of the deficit reduction tax rate.

⁹¹ No. 2 residual fuel oil can be used either as diesel fuel or as home heating oil.

⁹² In general, information returns are required regarding payments to a corporation engaged in providing medical and health care services or engaged in billing and collecting payments with respect to medical and health care services.

⁹³ An "understatement" of income tax is the excess of the tax required to be shown on the return over the tax imposed which is shown on the return (reduced by any rebates of tax)

⁹⁴ In the case of a position contrary to a regulation, the position taken must also represent a good faith challenge to the validity of the regulation.

⁹⁵ In the case of a position contrary to a regulation, the position taken must also represent a good faith challenge to the validity of the regulation.

⁹⁶ Lenders are generally required to report any foreclosure or other acquisition of property in satisfaction of a debt secured by that property (sec. 6050J). Such events may effect a discharge of indebtedness. The conferees intend that the Treasury Department issue guidance to coordinate reporting under this section with reporting on foreclosures and abandonments under section 6050J.

⁹⁷ The date of discharge is required to facilitate the use of such information returns with respect to fiscal year taxpayers.

⁹⁸ With respect to these entities, any return required by the provision shall be made by the officer or employee appropriately designated to make these returns.

⁹⁹ In the case of intentional disregard of the filing requirements, the penalty is not less than $100 per failure and the $100,000 annual limitation does not apply.

¹⁰⁰ In the case of a short taxable year, the amortization deduction is to be based on the number of months in such taxable year.

¹⁰¹ Insurance expirations are records that are maintained by insurance agents with respect to insurance customers. These records generally include information relating to the type of insurance, the amount of insurance, and the expiration date of the insurance.

¹⁰²See below for a description of the exceptions for certain patents, certain computer software, and certain interests in films, sound recordings, video tapes, books, or other similar property.

¹⁰³ As under present law, the portion of the purchase price of an acquired trade or business that is attributable to accounts receivable is to be allocated among such receivables and is to be taken into account as payment is received under each receivable or at the time that a receivable becomes worthless.

¹⁰⁴See below, however, for a description of the exception for certain rights to receive tangible property or services from another person.

¹⁰⁵ A right granted by a governmental unit or an agency or instrumentality thereof that constitutes an interest in land or an interest under a lease of tangible property is excluded from the definition of a section 197 intangible. See below for a description of the exceptions for interests in land and for interests under leases of tangible property.

¹⁰⁶ Section 1253(b)(1) of the Code.

¹⁰⁷ Only the costs incurred in connection with the renewal, however, are to be amortized over the 14-year period that begins with the month that the franchise, trademark, or trade name is renewed. Any costs incurred in connection with the issuance (or an earlier renewal) of a franchise, trademark, or trade name are to continue to be taken into account over the remaining portion of the amortization period that began at the time of such issuance (or earlier renewal).

¹⁰⁸ Section 1253(d)(1) of the Code.

¹⁰⁹ A temporal interest in property, outright or in trust, may not be used to convert a section 197 intangible into property that is amortizable more rapidly than ratably over the 14-year period specified in the bill.

¹¹⁰See below for a description of the treatment of assumption reinsurance contracts.

¹¹¹ For example, a data base would not include a dictionary feature used to spell-check a word processing program.

¹¹²See Associated Patentees, Inc., 4 T.C. 979 (1945); and Rev. Rul. 67-136, 1967-1 C.B. 58.

¹¹³ The bill provides that a sublease is to be treated in the same manner as a lease of the underlying property. Thus, the term "section 197 intangible" does not include any interest as a sublessor or sublessee of tangible property.

¹¹⁴ The lease of a gate at an airport for the purpose of loading and unloading passengers and cargo is a lease of tangible property for this purpose. It is anticipated that such treatment will serve as guidance to the Internal Revenue Service and taxpayers in resolving existing disputes.

¹¹⁵ In no event is the present value of the fair market value rent for the use of the tangible property for the term of the lease to exceed the fair market value of the tangible property as of the date of acquisition. The present value of such rent is presumed to be less than the value of the tangible property if the duration of the lease is less than the economic useful life of the property.

¹¹⁶ For purposes of this exceptions the term "interest under any existing indebtedness" is to include mortgage servicing rights to the extent that the rights are stripped coupons under section 1286 of the Code. See Rev. Rule. 91-46, 1991-34 I.R.B. 5 (August 26, 1991).

¹¹⁷See, e.g., INDOPCO, Inc. v. Commissioner, 112 S. Ct. 1039 (1992).

¹¹⁸ For example, an emission allowance granted a public utility under Title IV of the Clean Air Act Amendments of 1990 is a right that is limited in amount within the meaning of this provision, because each allowance grants a right to a fixed amount of emissions. It is expected that the Treasury Department will provide guidance regarding the interaction of section 461 with these provisions. No inference is intended that would require the Treasury Department to disturb the result in Rev. Proc. 92-91, 1992-46 I.R.B. 32.

¹¹⁹ For this purpose, the abandonment of a section 197 intangible or any other event that renders a section 197 intangible worthless is to be considered a disposition of a section 197 intangible.

¹²⁰ These special rules do not apply to a section 197 intangible that is separately acquired (i.e., a section 197 intangible that is acquired other than in a transaction or a series of related transactions that involve the acquisition of other section 197 intangibles). Consequently, a loss may be recognized upon the disposition of a separately acquired section 197 intangible. In no event, however, is the termination or worthlessness of a portion of a section 197 intangible to be considered the disposition of a separately acquired section 197 intangible. For example, the termination of one or more customers from an acquired customer list or the worthlessness of some information from an acquired data base is not to be considered the disposition of a separately acquired section 197 intangible.

¹²¹ The termination of a partnership wider section 708(b)(1)(B) of the Code is a transaction to which this rule applies. In such a case, the bill applies only to the extent that the adjusted basis of the section 197 intangibles before the termination exceeds the adjusted basis of the section 197 intangibles after the termination. (See the example below in the discussion of "Treatment of certain partnership transactions.")

¹²² No inference is intended whether any asset treated as a section 197 intangible under the bill is eligible for like kind exchange treatment.

¹²³ This discussion is subject to the application of the anti-churning rules which are discussed below.

¹²⁴ An assumption reinsurance transaction is an arrangement whereby one insurance company (the reinsurer) becomes solely liable to policyholders on contracts transferred by another insurance company (the ceding company). In addition, for purposes of the bill, an assumption reinsurance transaction is to include any acquisition of an insurance contract that is treated as occurring by reason of an election under section 338 of the Code.

¹²⁵ The amount paid or incurred by the acquirer/reinsurer under an assumption reinsurance transaction is to be determined under the principles of present law. (See Treas. Reg. sec. 1.817-4(d)(2).)

¹²⁶ There is no intention to codify any aspect of the existing regulations under section 1060 or other provisions. Furthermore, it is expected that the Treasury Department will review the operation of the regulations under sections 1060 and 338 in light of new section 197.

¹²⁷ However, with certain exceptions, an amortization deduction is not to be allowed under the bill for goodwill, going concern value, or any other section 197 intangible for which a depreciation or amortization deduction would not be allowable but for the provisions of the bill if: (1) the section 197 intangible is acquired after July 25, 1991; and (2) either (a) the taxpayer or a related person held or used the intangible on July 25, 1991; (b) the taxpayer acquired the intangible from a person that held such intangible on July 25, 1991, and, as part of the transaction, the user of the intangible does not change; or (c) the taxpayer grants the right to use the intangible to a person (or a person related to such person) that held or used the intangible on July 25, 1991. See below for a more detailed description of these "anti-churning" rules.

¹²⁸ It is anticipated that the Treasury Department will require the election to be made on the timely filed Federal income tax return of the taxpayer for the taxable year that includes the date of enactment of the bill.

¹²⁹ It is anticipated that the Treasury Department will require the election to be made on the timely filed Federal income tax return of the taxpayer for the taxable year that includes the date of enactment of the bill.

¹³⁰ Amounts that are properly deductible pursuant to section 1253 under present law are to be treated for purposes of the anti-churning provision as amounts for which depreciation or amortization is allowable under present law.

¹³¹ In addition to these rules, it is anticipated that rules similar to the anti-churning rules under section 168 of the Code will apply in determining whether persons are related. (See Prop. Treas. Reg. 1.168-4 (February 16, 1984).) For example, it Is anticipated that a corporation, partnership, or trust that owned or used property at any time during the period that begins on July 25, 1991, and that ends on the date of enactment of the bill and that is no longer in existence will be considered to be in existence for purposes of determining whether the taxpayer that acquired the property is related to such corporation, partnership, or trust.

As a further example, it is anticipated that in the case of a transaction to which section 338 of the Code applies, the corporation that is treated as selling its assets will not be considered related to the corporation that is treated as purchasing the assets if at least 80 percent of the stock of the corporation that is treated as selling its assets is acquired by purchase after July 25, 1991.

¹³² Consistent with both the House and Senate bills, purchased mortgage servicing rights are not depreciable to the extent that the rights are stripped coupons under section 1286 of the Code. To the extent that the rights are stripped coupons under section 1286 of the Code, they will not be amortized on a straight line basis over 108 months. See Rev. Rul. 91-46, 1991-2 C.B. 358.

¹³³ For example, assume the following facts. Corporation P is the parent of an affiliated group filing a consolidated return that includes subsidiary S. The P group files its consolidated return on the basis of the calendar year. S acquires certain intangible assets on August 1, 1991. The stock of S is sold to corporation X on December 31, 1992, in a transaction in which S's adjusted basis in its assets is not changed. Corporation X is also the parent of an affiliated group filing a consolidated return that now includes S. S remains in the X group. Under the conference agreement, if the X group makes the July 25, 1991 election, such election does not require the P group also to make the election. If the P group makes the July 25, 1991 election, the election will affect the amortization deductions allowed on the P group's 1991 and 1992 consolidated returns with respect to the assets acquired by S on August 1, 1991. Such election does not require the X group also to make the election.

¹³⁴ For example, such rules would apply if a corporation that is a member of an affiliated group filing a consolidated return acquires property after July 25, 1991 and then, before August 2, 1993 becomes a member of another group in a transaction that does not affect the basis of that corporation's assets. In such a case, the first group could make the election for periods when the corporation was included in that group's consolidated return. In addition, the second group could make the election because the corporation was related to the second group on August 2, 1993.

¹³⁵ E.g., sections 401(c)(2) and 911(d) of the Code and old section 1348(b)(1)(A) of the Code.

¹³⁶ If the employer chooses not to use the 20-percent method, withholding may be computed by aggregating the supplemental payments with regular wages paid within the same calendar year for the last preceding payroll period or the current payroll period. The employer would then use withholding tables to determine the total tax on this aggregate amount. The amount to be withheld for the supplemental wages is the total tax less any amount already withheld for regular wages included in the aggregate amount.

¹³⁷ An area will be treated as nominated by a State or local government if it is nominated by such other entity as may be specified by an Enterprise Board (to be established in the future).

¹³⁸ For purposes of the House bill, a "rural area" means any area which is (1) outside a metropolitan statistical area as defined by the Secretary of Commerce, or (2) determined by the Secretary of Agriculture to be a rural area. The term "urban area" means any area which is not a rural area.

¹³⁹ Under the House bill, the term "Indian reservation" means a reservation as defined in (1) section 3(d) of the Indian Financing Act of 1974 (25 U.S.C. 1452(d)), or (2) section 4(10) of the Indian Child Welfare Act of 1978 (25 U.S.C. 1903(10)).

¹⁴⁰ An area's designation may be revoked only after a hearing on the record at which officials of the State and local governments are given an opportunity to participate.

¹⁴¹ The poverty rate is to be determined by the 1990 census or subsequent census data. If areas are not tracted as population census tracts, the equivalent county divisions as defined by the Bureau of the Census for purposes of defining poverty areas would be treated as population census tracts.

¹⁴² With respect to an area nominated to be an empowerment zone, the appropriate Secretary may reduce one of these poverty criteria by five percentage points for not more than 10 percent of the population census tracts (up to a maximum of five population census tracts) in the nominated area. With respect to an area nominated to be an enterprise community, the appropriate Secretary may reduce one of the poverty criteria as described in the preceding sentence or, as an alternative, may reduce the 35-percent poverty threshold by ten percentage points (i.e., to 25 percent) for up to three population census tracts.

¹⁴³ The appropriate Secretary has no discretion to reduce the 35-percent poverty rate threshold for tracts located in a central business district that is part of an empowerment zone or to reduce the 30-percent poverty rate threshold for tracts located in a central business district that is part of an enterprise community.

¹⁴⁴ In the case of an Indian reservation, the reservation governing body is deemed to be both the State and local governments with respect to such area.

¹⁴⁵ The House bill provides that the required strategic plan may not include any action to assist any business in relocating from one area outside the nominated area to the nominated area, except that assistance for the expansion of an existing business entity through establishment of a new branch, affiliate, or subsidiary is permitted if (1) the establishment of the new branch, affiliate, or subsidiary will not result in a decrease in employment in the area of original location or in any other area where the existing business entity conducts business operations, and (2) there is no reason to believe that the new branch, affiliate, or subsidiary is being established with the intention of closing down the operations of the existing business entity in the area of its original location or in any other area where the existing business entity conducts business operations.

¹⁴⁶ The House committee report indicates that it is intended that employers will undertake reasonable measures to verify an employee's residence within the zone, so that the employer will be able to substantiate a wage credit claimed under the House bill.

¹⁴⁷ To prevent avoidance of the $20,000 limit, all employers of a controlled group of corporations (or partnerships or proprietorships under common control) would be treated as a single employer.

¹⁴⁸ Employers would be required to take reasonable steps to notify all qualified zone employees of the availability to eligible individuals of receiving advance payments of the earned income tax credit (EITC).

¹⁴⁹ The wage credit is not available with respect to any individual employed at any facility described in present-law section 144(c)(6)(B) (i.e., a 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 business of which is the sale of alcoholic beverages for consumption off premises). In addition, the wage credit is not available with respect to any individual employed by a trade or business the principal activity of which is farming (within the meaning of subparagraphs (A) and (B) of section 2032A(e)(5)), but only if, as of the close of the preceding taxable year, the sum of the aggregate unadjusted bases (or, if greater, the fair market value) of assets of the farm exceed $500,000.

¹⁵⁰ For this purpose, an individual is economically disadvantaged if he or she is a member of an economically disadvantaged family under present-law section 51(d)(11).

¹⁵¹ The TJTC expired on June 30, 1992, but it is to be extended until December 31, 1994 by section 13102 of the conference agreement.

¹⁵² The restrictions regarding employees with respect to whom the wage credit can be claimed also apply here. Thus, for example, the credit for savings contributions is not available with respect to any individual employed at certain facilities. See the discussion under the wage credit for further explanation.

¹⁵³ This requirement does not apply to a business carried on by an individual as a proprietorship.

¹⁵⁴ For this purpose, the term "employee" includes a self-employed individual (within the meaning of section 401(c)(1)).

The House committee report indicates that it is intended that the Secretary of the Treasury will prescribe regulations to determine the appropriate treatment of part-time employees for purposes of calculating whether 35 percent of the employees are residents of the empowerment zone.

¹⁵⁵ However, the House bill specifically provides that a "qualified business" does not include (1) any trade or business consisting of the operation of any facility described in present-law section 144(c)(6)(B) (i.e., a 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 business of which is the sale of alcoholic beverages for consumption off premises, or (2) any trade or business the principal activity of which is farming (within the meaning of subparagraphs (A) or (B) of section 2032A(e)(5)), but only if, as of the close of the preceding taxable year, the sum of the aggregate unadjusted bases (or, if greater, the fair market value) of assets of the farm exceed $500,000.

¹⁵⁶ Thus, used property may constitute qualified zone property so long as it has not previously been used within the empowerment zone.

¹⁵⁷ Qualified zone property does not include any property to which the alternative depreciation system under section 168(g) applies, determined (1) without regard to section 168(g)(7), and (2) after application of section 280F(b).

¹⁵⁸ The low-income housing credit expired on June 30, 1992, but is permanently extended by section 13142 of the Conference agreement.

¹⁵⁹ The conference agreement does not include section 15001 of the Senate amendment (the sense of the Senate resolution).

¹⁶⁰ The conference agreement provides that, if six urban empowerment zones are designated, not less than one urban empowerment zone must be designated in an area the most populous city of which has a population of 500,000 or less, and not less than one urban empowerment zone shall be a nominated area (1) with a population of 50,000 or less, and (2) which includes areas located in two States.

¹⁶¹ The conference agreement does not provide for the creation of an Enterprise Board which, under the House bill, was to participate in the designation of eligible areas as empowerment zones and enterprise communities. In addition, the conference agreement does not provide a procedure for the revocation of an area's designation as an eligible zone or community. However, the conferees intend that (i) the Secretary will promulgate rules regarding both the selection and revocation processes and (ii) a designation will be revoked only after a hearing on the record involving officials of the State and local governments. The conferees further intend that, if an area's zone or community designation is revoked, the relevant Secretary shall not designate another area as a zone or community in lieu thereof.

¹⁶² With respect to an area nominated to be an enterprise community, the appropriate Secretary may reduce one of the poverty criteria by five percentage points for not more than 10 percent of the population census tracts (up to a maximum of five alternative, may reduce the 35-percent poverty threshold by 10 percentage points (i.e., to 25 percent) for up to three population census tracts.

¹⁶³ The conferees intend that, in the case of an urban empowerment zone located in two States, the nominating States and local governments shall provide written assurances satisfactory to the Secretary of HUD that the incentives afforded the zone on the account of the designation will be distributed equitably between the two States.

¹⁶⁴ The conferees intend that employers will undertake reasonable measures to verify an employee's residence within the zone, so that the employer will be able to substantiate a wage credit claimed under the conference agreement.

¹⁶⁵ To prevent avoidance of the $15,000 limit, all employers of a controlled group of corporations (or partnerships or proprietorships under common control) will be treated as a single employer.

¹⁶⁶ The conferees intend that employers take reasonable steps to notify all qualified zone employees of the availability to eligible individuals of advance payments of the earned income tax credit (EITC).

¹⁶⁷ The wage credit is not available with respect to any individual employed at any facility described in present-law section 144(c)(6)(B) (i.e., a 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 business of which is the sale of alcoholic beverages for consumption off premises). In addition, the wage credit is not available with respect to any individual employed by a trade or business the principal activity of which is farming (within the meaning of subparagraphs (A) and (B) of section 2032A(e)(5)), but only if, as of the close of the preceding taxable year, the sum of the aggregate unadjusted bases (or, if greater, the fair market value) of assets of the farm exceed $500,000.

¹⁶⁸ For example, an establishment which is part of a national chain could qualify as an enterprise zone business for purposes of the tax-exempt financing incentive, provided that such establishment would satisfy the definition of an enterprise zone business if it were separately incorporated.

¹⁶⁹ The contribution of the CDC must be available for use by the CDC for up to a 10-year period, but need not meet the requirements of a "contribution or gift" for purposes of section 170. In other words, a contribution eligible for the credit under the bill may be made in the form of a 10-year loan (or other long-term investment), the principal of which is to be returned to the taxpayer after the 10-year period. However, in the case of a donation of cash made by a taxpayer to an eligible CDC, the taxpayer would be allowed to claim a charitable contribution deduction (subject to the present-law rules under section 170) and, in addition, could claim the credit under the bill's provisions.

¹⁷⁰ The House bill defines "qualified low-income assistance" as assistance (1) which is designed to provide employment and business opportunities to individuals who are residents of the operational area of the CDC, and (2) which is approved by the Secretary of HUD.

¹⁷¹ Under the conference agreement, at least eight of the selected CDCs must operate in rural areas.

¹⁷² For purposes of the Indian employment and investment incentives, the term "Indian reservation" means a reservation as defined in (1) section 3(d) of the Indian Financing Act of 1974 (25 U.S.C. 1452(d)), as in effect on the date of enactment of the provision, or (2) section 4(10) of the Indian Child Welfare Act of 1978 (25 U.S.C. 1903(10)), as in effect on the date of enactment of the provision.

¹⁷³ The Indian unemployment rate is to be based on the number of Indians unemployed and able to work and is to be certified by the Secretary of the Interior.

¹⁷⁴ A special rule applies to qualifying property that has (or is a component of a project that has) an estimated construction period of more than two years or a cost of more than $1 million. With respect to such property, the relevant unemployment rate is the rate during the calendar year in which the taxpayer enters into a binding agreement to make a qualified investment (or, if earlier, the first calendar year in which the taxpayer has expended at least 10 percent of the qualified investment) or during the immediately preceding calendar year.

¹⁷⁵ The active conduct of a trade or business for purposes of the Indian reservation credit includes the rental to others of real property located in an Indian reservation. In addition, the credit for new reservation construction property is allowed with respect to otherwise qualifying property that is used to furnish lodging.

¹⁷⁶ The limitation applies to class I, II, or III gaming as defined in section 4 of the Indian Regulatory Act (25 U.S.C. 2703), as in effect on the date of enactment of the provision.

¹⁷⁷ If, for the entire taxable year of the employer, at least 85 percent of the employees of the employer are enrolled members of an Indian tribe or spouses of enrolled members of an Indian tribe, then the amount of the credit for such taxable year is to be determined by using a 30-percent rate rather than the 10-percent rate.

¹⁷⁸ Wages are not eligible for the credit if attributable to services rendered by an employee during the first year he or she begins work for the employer if any portion of such wages is taken into account in determining the targeted jobs tax credit (TJTC) under present-law section 51.

¹⁷⁹ In the case of a short taxable year, the qualified wages and the qualified health insurance costs paid or incurred by the employer are to be annualized and the limitation for such taxable year is to equal the otherwise applicable limitation determined using such annualized amounts multiplied by a fraction, the numerator of which is the number of days in the taxable year and the denominator of which is 365.

¹⁸⁰ For this purpose, an Indian tribe is defined as any Indian tribe, band, nation, pueblo, or other organized group or community, including any Alaska Native village, or regional or village corporation, as defined in, or established pursuant to, the Alaska Native Claims Settlement Act (43 U.S.C. 1601 et. seq.), as in effect on the date of enactment of the provision, which is recognized as eligible for the special programs and services provided by the United States to Indians because of their status as Indians.

¹⁸¹ The limitation applies to class I, II, or III gaming as defined in section 4 of the Indian Regulatory Act (25 U.S.C. 2703), as in effect on the date of enactment of the provision.

¹⁸² No portion of the unused business credit for any taxable year that is attributable to the Indian employment credit may be carried back to a taxable year ending before the date of enactment of the provision.

¹⁸³ As under the Senate amendment, the term "Indian reservation" means a reservation as defined in (1) section 3(d) of the Indian Financing Act of 1974 (25 U.S.C. 1452(d)), as in effect on the date of enactment of this provision, or (2) section 4(10) of the Indian Child Welfare Act of 1978 (25 U.S.C. 1903(10)), as in effect on the date of enactment of this provision.

¹⁸⁴ The conference agreement treats the rental of real property located within a reservation as an active trade or business.

¹⁸⁵ In addition, the conference agreement provides that accelerated depreciation is not available for any property to which the alternative depreciation system under section 168(g) applies (determined without regard to subsection 168(g)(7) and after application of section 280F(b)).

¹⁸⁶ For this purpose, gaming activities include class I, II, or III gaming, as defined in section 4 of the Indian Regulatory Act (25 U.S.C. sec. 2703), as in effect on the date of enactment of this provision.

¹⁸⁷ The $30,000 amount for determining qualified employees is adjusted for inflation beginning after 1994.

¹⁸⁸ Persons who received vaccines before the Program's effective date of October 1, 1988 ("retrospective cases") also may be eligible for compensation under the Program if they had not yet received compensation and elected to file a petition with the United States Claims Court on or before January 31, 1991. Under the Program, awards in retrospective cases are somewhat limited compared to "prospective cases" (i.e., those where the vaccine was administered on or after October 1, 1988). Awards in retrospective cases are not paid out of the Vaccine Trust Fund but are paid out of funds specially authorized by Congress. See 42 U.S.C. sec. 300aa-15(i), (j) (appropriating $80 million for fiscal year 1989 and for each subsequent year).

¹⁸⁹ Compensation may not be awarded, however, if there is a preponderance of the evidence that the claimant's condition or death resulted from factors unrelated to the vaccine in question.

¹⁹⁰ 42 U.S.C. sec. 300aa-15.

¹⁹¹ In most State proceedings, significant issues arise whether injuries suffered by an individual after immunization were, in fact, caused by the vaccine administered and whether the manufacturer was at fault in either the manufacture or marketing of the vaccine.

¹⁹² Title III, P.L. 99-660. This Act preempts State tort law to a limited extent by imposing limits on recovery from vaccine manufacturers. Among the limitations are a prohibition on compensation if the injury or death resulted from side effects that were unavoidable; a presumption that manufacturers are not negligent in manufacturing or marketing vaccines if they complied, in all material respects, with Federal Food and Drug Administration requirements; and limits on punitive damage awards.

¹⁹³ The House committee report states that it is intended that the Secretary of the Treasury expeditiously (within 60 days of enactment) adopt rules for purposes of Code section 4221 for determining the conditions under which exported vaccines to be administered to individuals not eligible for compensation under the program are not subject to tax.

¹⁹⁴ Principle residence is defined as under section 1034, except that renters receiving insurance proceeds as a result of the involuntary conversion of their property in a rented residence also qualify for relief under this provision to the extent the rented residence would constitute their principal residence if they owned it.

¹⁹⁵ Section 6053(c)(4) is to be applied without regard to the number of employees.

¹⁹⁶ Tax is $500 per year per premise for businesses with gross receipts of less than $500,000 in the preceding taxable year.

¹⁹⁷ A separate trade provision (sec. 13602 of the House bill and sec. 7701 of the Senate amendment) would extend the current Customs processing fee for three years, through September 30, 1998.