Bipartisan Working Group Releases Business Tax Reform Framework

What follows is the report of the Business Income Tax Working Group. This report is the result of meetings amongst the members and staff of the group over the past few months. It reflects member and staff discussions over how to fairly and responsibly improve our nation's taxation of business income in an effort to boost our economy, create good-paying jobs, and raise incomes for American workers. While the report does not suggest a specific business tax reform plan, given the limited time available, we have attempted to explore those areas we consider to be the "threshold issues" of business tax reform. Our analysis largely comes in the form of principles, considerations and options, in addition to specific recommendations. Additionally, an addendum to the report prepared with the assistance of the Joint Committee on Taxation ("JCT") provides the technical details of a number of the proposals discussed in the report.

We approach tax reform from different political parties and different sides of the ideological spectrum. And yet we agree that tax reform is essential because our current tax system is too complex, unnecessarily distorts economic decision-making and is inadequate to the task of collecting revenue in a manner that puts American businesses, of all sizes, in a position to succeed in a competitive global economy. We are hopeful that this report will foster a discussion around the difficult trade-offs inherent in business tax reform, as well as a conversation about the type of business tax system we ought to have. We appreciate that real and meaningful tax reform is likely to be a once-in-a-lifetime legislative accomplishment, and one that we need to ensure we get right. Simply put, Americans deserve a business tax system designed for the 21^st century economy and one that is up to the task of addressing the challenges that will face American business owners and entrepreneurs in the decades to come.

We want to thank the members of the Business Income Tax Working Group: Senator Pat Roberts (R-KS), Senator Debbie Stabenow (D-MI), Senator Richard Burr (R-NC), Senator Tom Carper (D-DE), Senator Johnny Isakson (R-GA), Senator Bob Casey (D-PA), Senator Rob Portman (R-OH), Senator Mark Warner (D-VA), Senator Pat Toomey (R-PA), Senator Bob Menendez (D-NJ), Senator Dan Coats (R-IN) and Senator Bill Nelson (D-FL). Their participation in our sessions with the JCT staff informs the views expressed in the report. The same can be said of the tax staffers for these senators, who no doubt spent countless hours preparing their bosses to discuss a wide variety of business tax issues. We especially want to thank Tom Barthold and the staff of the JCT, without whom this report would not have been possible. Their tireless efforts to cover nearly every aspect of business taxation in the education sessions with members and staff were essential to this endeavor. Finally, we want to thank the more than 300 stakeholders who submitted formal comments to the working group. The continued participation of stakeholders will be vital as Congress takes up the challenge of tax reform.

Our tax system also promotes inefficiency by incentivizing businesses to make decisions based on tax considerations, rather than for business reasons. This has manifested itself in the area of business entity choice. Consider that over the past few decades, since enactment of the Tax Reform Act of 1986, there has been movement en masse away from C-corporation status to status as an LLC, S corporation, partnership, or other pass-through business.

 

Figure 1: Number of C Corporation Returns Compared to Sum of

 

S Corporation and Partnership Returns, 1978-2012

 

 

 

These pass-through businesses are a vital part of our economy, but the tax code should not so heavily tilt business owners towards one type of business structure over another. A better business tax system would have as little impact on business decision-making as possible. Or, as one recent study put it, "An ideal tax system would create the fewest distortions to business decisions about capital and labor, except to promote the types of activities that generate positive spillovers (e.g. research and development)."²

Our system for taxing business income is also woefully out of date and out of sync with our global competitors. America today retains the dubious distinction of having the highest statutory corporate tax rate among advanced economies at roughly 39 percent (including state taxes). The Organisation of Economic Development ("OECD") average corporate tax rate (excluding the U.S.) is 24.6 percent, a more than 14 percentage point differential with the U.S. average combined federal and state rate. Some of America's major competitors, such as Canada and the United Kingdom, have been particularly aggressive in lowering their corporate tax rates.

A high tax rate can put American companies at a disadvantage when competing for business opportunities in the markets beyond our borders, where more than 95 percent of global consumers reside. In addition, while international tax issues are within the purview of the International Tax Working Group, it is worth noting that many commentators have cited the fact that the U.S. is one of only a handful of OECD nations that maintain a worldwide tax system as an additional factor adversely impacting the competitiveness of American businesses.

Additionally, our business tax system too often fosters uncertainty, making it more difficult than necessary for business owners to plan for the future. Consider that more than 30 business tax provisions, often known as "tax extenders," expire periodically, adding complexity and uncertainty to many business decisions. Small business owners, for example, face cost recovery rules under section 179 of the tax code that can vary wildly from year to year based on congressional action, or lack thereof. In 2014, the section 179 expensing limit was $25,000 for more than 11 months of the year, until Congress enacted a $500,000 limit in December retroactive to the beginning of the year. Similarly, manufacturers and other capital-intensive industries face cost-recovery rules that have fluctuated due to the expiration of "bonus depreciation," which stood at 100 percent in 2011 and 50 percent from 2012 to 2014 -- but which was not extended retroactively until the provision had been expired for an entire year (2012) and nearly an entire year (2014). Because of this complexity and uncertainty, our business tax system can result in unfair treatment for different businesses, business owners, and workers. A better business tax system would allow businesses to plan future investments by providing them consistent tax treatment year after year, while also providing the government with a stable source of revenue.

In short, while it will entail many difficult decisions, the need for business tax reform only grows more urgent with each passing year. Recent history has demonstrated that every year that America waits to address reform will result in more business activity in those nations that have implemented more competitive tax systems, it will mean more and more U.S.-based companies acquired by their foreign-based competitors, and it will mean U.S. economic growth that continues to be hampered by our burdensome and antiquated tax system.

A well-designed reform of America's system of taxing business income has the potential to promote economic growth. For example, a recent study commissioned by the National Association of Manufacturers estimated that a pro-growth tax reform plan (including lower taxes on pass-through businesses as well as international reforms) would add almost 1 percentage point (about 0.9 percent) to GDP growth on an annual basis. This would result in more than $12 trillion in increased U.S. GDP growth between 2015 and 2024, and more than 6.5 million additional jobs over the period.³ Estimates will, of course, vary by the details of reform proposals, the methodologies used to evaluate growth effects, and the assumptions underlying those different methodologies, which can make predictions on growth, especially in the long term, somewhat uncertain. Nonetheless, reforming our outdated tax system provides a unique opportunity to better encourage economic growth and job creation.

Higher GDP growth from pro-growth tax reform would also mean higher government revenue. According to the Congressional Budget Office ("CBO"), a sustained increase in the growth rate of U.S. GDP of 1 percent over 10 years would result in deficit reduction of $3.3 trillion over that period.⁴

As important, business tax reform can result in not just higher economic growth and more jobs, but also higher wages. This is because workers bear some of the cost of the corporate income tax in the form of lower wages, although economists disagree to what extent. One CBO analysis estimated that U.S. domestic labor bears 70 percent of the U.S. corporate tax,⁵ while other economists find that, depending on assumptions, U.S. domestic labor bears a lower proportion (e.g., one-third).⁶ Whatever the exact percentage, it stands to reason that as capital becomes more mobile across borders, it is American workers who will increasingly bear a larger share of the burden of the high U.S. corporate tax rate.

Given the promise of business tax reform -- better economic growth, more jobs, higher wages, predictability for taxpayers, and stable revenues -- it should be no surprise that Democrats and Republicans alike are calling for an update of the U.S. business tax system. Like numerous economists and business leaders, they recognize that our more than 100-year-old tax code is due for more than a tune-up nearly 30 years after the last successful comprehensive tax reform effort (the Tax Reform Act of 1986) -- it is in need of a complete overhaul.

Business tax reform should:

Because of this overlap, the committee's consideration of the issues discussed in this report should depend on the reports submitted by the four other tax reform working groups. If the committee's goal is to use these reports to tackle comprehensive tax reform, it should also depend on the broader trade-offs between the issues considered by each working group.

As mentioned above, this report does contain more discrete provisions and issues that could warrant standalone committee consideration (for instance, provisions related to tax administration). However, the members of the working group urge the committee not to selectively focus on any given item without considering the tax reform principles outlined in this report and principles previously submitted by members of the Finance Committee.

In producing this report, the intent of the working group was not to provide the committee a comprehensive, "approved" list of tax reform options that could be selected or disregarded unilaterally. Instead, the report is aimed at providing a non-exhaustive compilation of issues and provisions that the working group believes warrant further committee review as tax reform efforts continue.

Finally, the working group would like to express appreciation for the comments submitted by stakeholders throughout the tax reform working group process, including the formal submissions to the committee in April. These comments were helpful in guiding the deliberations on the issues discussed in this report.

Overarching challenges include:

Table 1: Top Corporate Income Tax Rates in the OECD

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 16.]

 

 

 

Table 2: Tax Revenue Collected as a Share of GDP in OECD

 

Countries, by Revenue Source, 2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 17.]

 

 

 

Figure 2: Taxes by Source, All Levels of Government, 2012

 

 

 

Table 3: Joint Committee Staff Estimate of Revenue Effect of One

 

Percentage Point Increase in Statutory Corporate Income Tax Rates

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 19.]

 

 

 

Table 4: Select Corporate Tax Expenditures, 2014-2018

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 19.]

 

 

 

Table 5: Top Domestic Base Broadeners, Select Tax Reform Plans

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 20.]

 

 

 

Table 6: Distribution of C and S Corporations and

 

Partnerships by Receipts, 2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 24.]

 

 

 

Table 7: All Individual Returns: Partnership and S Corporation Net

 

Income Loss by Size of Adjusted Gross Income, Tax Year 2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 25.]

 

 

 

Table 8: Selected Tax Expenditures with Corporate Estimates of at

 

least $10 Billion, FY 2014-2018

 

[Billions of Dollars]

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 26.]

 

 

 

Economists also generally view private research activities as generating positive externalities, meaning that the benefits of the research are spread well beyond the business undertaking the research activities. In other words, the spill-over benefits to society outweigh the benefits to a single business engaged in research activity. Some studies have found that the benefit to the economy of private-sector research is at least twice the estimated return to the company performing the research.⁴⁴ However, because firms are not able to capture all of the benefits of the research themselves, they tend to under-invest in these activities. In this sense, the external benefits of private innovation create a market failure and government intervention in the form of a tax benefit is justifiable.

The tax code currently attempts to foster innovation through generous treatment of research expenses. Specifically, the tax code allows qualified research expenses by businesses to be expensed, as well as provides a credit for research expenditures in the form of the R&E tax credit. The combined effect of these policies is to greatly lower the after-tax cost of research for profitable firms, thus encouraging these firms to conduct more research and development ("R&D") than they might otherwise. According to the Office of Management and Budget, in FY2012 the combined budgetary cost of these policies totaled $11.1 billion, which was about 8 percent of the $140.9 billion spent by federal agencies on defense and non-defense R&D that year.⁴⁵ Additionally, many states also offer research-related tax incentives.

While there are questions, discussed below, regarding the design of the R&E credit and the need for improvements, there is considerable evidence that the credit has the intended effect of incentivizing research and creating higher-wage jobs tied to this research. A 2011 study by Ernst & Young, prepared for the R&D Credit Coalition, found that the credit has increased annual private research spending by $10 billion in the short term and by $22 billion in the long term.⁴⁶ A study of the R&E credit from 1981 to 1991 found that roughly $2 in research were generated for every one dollar in tax expenditure.⁴⁷

However, as other nations have increased the generosity of their research incentives, some have expressed the concern that existing incentives in the tax code are inadequate to the task of promoting cutting-edge R&D and the associated high-wage jobs. These observers have suggested two major initiatives that could be adopted as part of business tax reform: a strengthened and permanent R&E credit and a patent/innovation box.

Table 9: Percentage Distribution of Corporations (C and S)

 

Claiming R&E Tax Credit and of Credit Claimed by Corporation Size,

 

2012

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 48.]

 

 

 

Table 10: "Patent Box" Regimes in Select Countries

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 51.]

 

 

 

Administrative reforms, simplification measures, and other smaller changes may reduce noncompliance, improve taxpayer interactions with the IRS, and increase the time and money that businesses and organizations can spend on more productive purposes.⁷⁰ In addition, these small changes usually do not engender the controversy and questions that more comprehensive changes tend to inspire.

While the working group did not undertake an exhaustive overview of the many simplification and small improvement opportunities in business income tax law, these opportunities are, in general, worthy of the committee's attention. Provisions that may warrant further committee review include the following:

Rationalizing filing deadlines. Under current law, tax returns for calendar year corporations, including S corporations, are due on March 15 (September 15 if an extension is filed). Calendar year partnership and individual returns are due on April 15 (October 15 if an extension is filed). Individuals and corporations often rely on tax return information provided by partnerships to complete their returns. In addition, earlier receipt of forms such as W-2s could prove critical in detecting and preventing taxpayer identity theft.⁷¹ Modifying certain filing deadlines so that taxpayers will receive the information they need on a timely basis is a relatively straightforward, bipartisan administrative change that has been proposed multiple times, including in S. 420, the Tax Return Due Date Simplification and Modernization Act of 2013, sponsored by Senator Enzi; the Camp proposal; the President's FY 2016 budget; and former Senate Finance Committee Chairman Baucus's Tax Administration Discussion Draft.

A technical explanation of the Enzi proposal is included on pages A-63 to A-67 of the addendum to this report.

Electronic filing of Form 990s. Current law requires very large charitable organizations (those that file at least 250 returns during the calendar year) and very small organizations (those with gross receipts of less than $50,000 annually) to file a Form 990 electronically. The majority of non-profits still file paper returns. As a result, the IRS makes many Form 990s available to the public by providing scanned images of them in Tagged Image File format via DVDs. This manual conversion process is inefficient, expensive, and delays access to information. In order to increase transparency and accuracy, and reduce fraud, the committee should examine proposals that require all non-profits to file their Form 990s electronically. This proposal appears in the Camp proposal, the Baucus Tax Administration proposal, and in the Obama Admnistration's FY 2016 budget. According to JCT estimates of the Camp proposal, mandatory electronic filing of Form 990s for exempt organizations would have no revenue effect.

Pages A-68 to A-70 of the addendum to this report include a technical explanation of this proposal.

Expanded declaratory relief for 501(c) entities. Under current law, organizations applying for 501(c)(3) status may seek declaratory relief if their application is denied or if IRS fails to act on the application. If the IRS fails to act, the organization must first exhaust its administrative remedies and may not seek declaratory relief prior to 270 days after the date on which the request for a determination was made if the organization has taken, in a timely manner, all reasonable steps to secure such determination. The Taxpayer Bill of Rights Enhancement Act (S. 1578), introduced recently by Senators Grassley and Thune and supported by Senator Isakson, would extend these procedures to other 501(c) and 501(d) organizations, including 501(c)(4) social welfare organizations. This provision was also introduced as a separate bill, the ACCESS Act of 2014 (S. 2708), by Senator Coats in the 113^th Congress.

Pages A-71 to A-73 of the addendum to this report include a technical explanation of this proposal.

Private foundation excise tax simplification. Under current law, private foundations are required to pay a two percent excise tax on investment income. The excise tax rate is reduced to one percent in any year in which the foundation's distributions for charitable purposes exceeds the average level of the foundation's charitable distributions over the preceding five tax years. Private foundations devote considerable resources each year to determining whether they should calculate a one or two percent excise tax. Further, any increase in the foundation's payout in a given year (e.g., a response to increased needs or crises) makes it more difficult for the foundation to qualify for the reduced one percent excise tax rate in subsequent years. Simplification of the excise tax -- for example, by utilizing a flat percentage -- would provide administrative relief to foundations without undermining the original intent of the excise tax. A simplification proposal passed the House in February 2015 as part of the America Gives Mores Act (H.R. 644).

Pages A-74 to A-75 of the addendum to this report include a technical explanation of this proposal.

Enhanced deduction for food inventory donations. The enhanced deduction for donations of food allows individuals and organizations to reduce their taxable income by providing qualifying food inventory to certain charitable organizations. The provision is part of a package of 55 temporary tax extenders that were reinstated retroactively for the 2014 tax year, but expired again on January 1, 2015. The uncertainty caused by a need for an annual extension diminishes the incentive effect of this provision and reduces charitable giving. A version of this proposal passed the House in February 2015 as part of the America Gives More Act (H.R. 644) and Senator Patrick Leahy (D-VT) introduced a standalone bill in the Senate (S. 930) in April 2015. In addition to making the enhanced deduction for food inventory donations permanent, H.R. 644 expanded the provision, including increasing the maximum percentage deductible from 10 percent of total business income to 15 percent.

Disaster relief proposals. When natural disasters occur, lawmakers often enact emergency tax provisions to encourage charitable contributions, provide relief for individual taxpayers, and aid businesses in affected areas. Unfortunately, the type of relief and the response time by Congress often vary, resulting in taxpayers receiving different treatment for similar losses, and creating uncertainty until legislation is passed. Permanent disaster relief tax provisions that take effect when a disaster occurs would encourage certainty, fairness, and the prompt delivery of help to taxpayers in dire need. Among other proposals, the committee could consider providing permanent tax relief to businesses and households that is triggered for taxpayers residing in or with a principal place of business located in a federal disaster area.⁷²

² DONALD BRUCE, TAMI GURLEY-CALVEZ & MATTHEW MURRAY, NAT'L ASS'N OF MFRS., A MISSED OPPORTUNITY: THE ECONOMIC COST OF PRO-GROWTH TAX REFORM (2015), http://www.nam.org/Data-and-Reports/Reports/A-Missed-Opportunity/A-Missed-Opportunity--The-Economic-Cost-of-Delaying-Pro-Growth-Tax-Reform-Full-Study.pdf.

³Id. at 12-14.

⁴ CONG. BUDGET OFFICE, THE BUDGET AND ECONOMIC OUTLOOK: 2015 TO 2025 133 (2015), http://www.cbo.gov/publication/49892.

⁵ William C. Randolph, International Burdens of the Corporate Income Tax (Cong. Budget Office, Working Paper No. 2006-09, 2006), available at https://www.cbo.gov/sites/default/files/2006-09.pdf ("Given those values, domestic [U.S.] labor bears slightly more than 70 percent of the burden of the corporate income tax.").

⁶See Jennifer Gravelle, Corporate Tax Incidence: Review of General Equilibrium Estimate and Analysis, 66 NAT'L TAX J. 185 (Mar. 2013) (comparing estimates from four major studies, including Randolph, supra note 5).

⁷ KPMG Corporate Tax Rates Table, http://www.kpmg.com/global/en/services/tax/tax-tools-and-resources/pages/corporate-tax-rates-table.aspx (last visited June 26, 2015).

⁸ This report focuses on the top statutory corporate tax rate and average unweighted statutory rates. Estimates regarding the average effective corporate tax rate can vary over time, industries, and according to other factors like country size. See, e.g., Martin A. Sullivan, Untangling Corporate Effective Tax Rates, 146 TAX NOTES 1299 (2015).

⁹ The RATE Coalition is one example of a group that has agreed to make these trade-offs.

¹⁰ Note, however, the U.S. delivers a larger amount of government-provided goods and services via tax expenditures in the tax code than most OECD countries. With tax expenditures so accounted, the size of the tax pie in the United States is closer to its OECD competitors.

¹¹ Payroll taxes, which are paid by both the employer and the employee, represent a compelling one-third of total federal revenues today and 5.7% of GDP according to the most recent CBO 2015 Long-Term Outlook (June). Currently 80% of total federal revenues come from individuals, including owners of pass-through entities, and payroll taxes.

¹² Note that the Joint Committee staff estimate in Table 3 relates to a one percentage point increase, rather than a decrease, the statutory corporate income tax rates. This report uses this estimate as a proxy for a one percent decrease. The working group confirmed with JCT that the use of the estimate for this purpose is appropriate.

¹³ Potential base-broadening provisions that affect individuals were out of the jurisdiction of the working group and thus were not considered in the working group's discussions and are not considered in this report.

¹⁴ This estimate includes bonus depreciation and general acceleration under MACRS. Bonus depreciation provides a larger deduction in the year in which equipment is placed in service. Depreciation deductions are smaller than they otherwise would be in subsequent years. The negative estimate reflects the fact that the effects of this reversal due to bonus depreciation in prior years are larger than the effects of general acceleration under MACRS for fiscal years 2014 to 2018.

¹⁵ The revenue estimates presented in Table 5 and throughout this report are not necessarily comparable across proposals. The estimates use different baselines and in some cases involve different interactions with other provisions unique to a given proposal.

¹⁶ A table on how select tax expenditures impact corporations and individuals is included on page 25 of this report.

¹⁷ Unlike partnerships, entities like REITs are formed as corporations and are subject to special distribution rules. For instance, a REIT is required to distribute 90 percent of its income in the form of shareholder dividends. Thus, although the mechanism for getting to a single layer of taxation is different than partnerships, the result -- taxation only at the ownership level -- is the same.

¹⁸ KYLE POMERLEAU, TAX FOUND., AN OVERVIEW OF PASS-THROUGH BUSINESSES IN THE UNITED STATES (2015), available at http://taxfoundation.org/article/overview-pass-through-businesses-united-states.

¹⁹ Edward D. Kleinbard, Take the Odds on Corporate Tax Reform, BLOOMBERG VIEW (Mar. 3, 2015), http://www.bloombergview.com/articles/2015-03-03/corporate-tax-reform-looks-like-it-has-a-chance-in-2015.

²⁰ PUB. POLICY & GOV'T AFFAIRS, GRANT THORNTON, BUSINESS EQUIVALENCY RATE: FAIRNESS FOR PASS-THROUGH BUSINESSES (2013).

²¹Id.

²² PRESIDENT'S FRAMEWORK, supra note 1.

²³ STAFF OF JOINT COMM. ON TAXATION, 112TH CONG., DESCRIPTION OF H.R. 9, THE "SMALL BUSINESS TAX CUT ACT" 14 (JCX-30-14, Mar. 26, 2012).

²⁴ Though this report focuses on the economic case against the corporate income tax, it is important to note that tax neutrality and the reduction of economic distortions are not the only considerations involved in this issue. For example, commentators have argued that the corporate tax is an important vehicle to regulate corporate behavior -- a view that may not be inconsistent with the original intent behind the tax's adoption. See Reuven S. Avi-Yonah, Corporations, Society, and the State: A Defense of the Corporate Tax, 90 VA. L. REV. 1193 (2004) (reviewing the traditional defenses of the corporate income tax and detailing the regulation argument).

²⁵ For a concise overview of these issues, see MARTIN A. SULLIVAN, CORPORATE TAX REFORM: TAXING PROFITS IN THE 21ST CENTURY ch. 3 (2011).

²⁶ REPUBLICAN STAFF OF S. COMM. ON FINANCE, 113TH CONG., COMPREHENSIVE TAX REFORM FOR 2015 AND BEYOND (2014) [hereinafter COMPREHENSIVE TAX REFORM].

²⁷Id. at 153 (citing Jason Furman, Business Tax Reform and Economic Growth, 145 TAX NOTES 121, 126 (2014)).

²⁸ In the view of the Finance Committee Republican staff draft pamphlet on tax reform, "[i]t makes no sense today to have two levels of taxation of corporate earnings. The difficult decision is not whether business income should be subject to more than one level of tax -- it should not -- but whether the business income should be taxed at the entity level or at the owner level." Id. at 128.

²⁹ Michael J. Graetz & Alvin C. Warren, Jr., Unlocking Business Tax Reform, 145 TAX NOTES 707 (2014).

³⁰Id. at 710.

³¹ COMPREHENSIVE TAX REFORM, supra note 26.

³² Part of the attractiveness of the DPD coupled with a withholding tax from the standpoint of corporations is that such an approach could have the effect of increasing the corporation's earnings per share by reducing its tax expense for financial accounting purposes, depending on how the Financial Accounting Standards Board (FASB) treats the withholding tax.

³³ COMPREHENSIVE TAX REFORM, supra note 26.

³⁴ MARTIN A. SULLIVAN, CORPORATE TAX REFORM: TAXING PROFITS IN THE 21ST CENTURY ch. 4 (2011) (noting that dividend relief to shareholders may be less beneficial than a corporate rate reduction and that recently countries who have adopted integration proposals have begun questioning that approach). Note that while a dividends-paid deduction proposal does provide an effective corporate rate reduction via that deduction, the magnitude of that effective rate cut would depend on a company's dividend payout choices.

³⁵ Graetz & Warren, supra note 29.

³⁶ Certain areas of the U.S. tax code already contain consumption tax elements. For example, tax-preferred retirement plans defer tax on new savings, but require tax to be paid upon withdrawal for consumption.

³⁷See Jens Arnold et al., Tax Policy For Economic Recovery and Growth, 121 ECON. J. F59(2011); Åsa Johansson et al., Tax and Economic Growth (Org. for Econ. Cooperation & Dev. [OECD], Econ. Dep't Working Paper No. 620, 2008), available at http://www.oecd.org/tax/tax-policy/41000592.pdf.

³⁸ For a brief overview, see David R. Burton, Four Conservative Tax Plans with Equivalent Economic Results (Heritage Found., Backgrounder No. 2978, 2014), available at http://www.heritage.org/research/reports/2014/12/four-conservative-tax-plans-with-equivalent-economic-results.

³⁹ STAFF OF JOINT COMM. ON TAXATION, 112TH CONG., BACKGROUND AND PRESENT LAW RELATING TO MANUFACTURING ACTIVITIES WITHIN THE UNITED STATES 85 (JCX-61-12, Jul. 17, 2012).

⁴⁰Id. at 75.

⁴¹ STAFF OF JOINT COMM. ON TAXATION, 113TH CONG., MACROECONOMIC ANALYSIS OF THE "TAX REFORM ACT OF 2014" 15 (JCX-22-14, Feb. 26, 2014).

⁴²See, e.g., S. COMM. ON FINANCE, 113TH CONG., SUMMARY OF STAFF DISCUSSION DRAFT: COST RECOVERY AND ACCOUNTING (2013), available at http://www.finance.senate.gov/imo/media/doc/Chairman's%20Staff%20Discussion%20Draft%20on%20Cost%20Recovery%20and%20Accounting%20Summary.pdf (providing a short legislative history on cost recovery provisions).

⁴³ CONG. RESEARCH SERV., RL31181, RESEARCH TAX CREDIT: CURRENT LAW AND POLICY ISSUES FOR THE 114TH CONGRESS (2015).

⁴⁴ LUKE A. STEWART ET AL., INFO. TECH. & INNOVATION FOUND. [ITIF], WE'RE #27!: THE UNITED STATES LAGS FAR BEHIND IN R&D TAX INCENTIVE GENEROSITY (2012).

⁴⁵ OFFICE OF MGMT. & BUDGET, EXEC. OFFICE OF THE PRESIDENT, ANALYTICAL PERSPECTIVES, FISCAL YEAR 2014 374 (2013).

⁴⁶ DR. ROBERT CARROLL ET AL., ERNST & YOUNG, THE R&D CREDIT: AN EFFECTIVE POLICY FOR PROMOTING RESEARCH SPENDING (2011), available at http://investinamericasfuture.org/PDFs/EY_R&D_Credit_Report_2011_09_16.pdf.

⁴⁷ Bronwyn Hall & John Van Reenan, How Effective Are Fiscal Incentives for R&D? A Review of the Evidence, 29 RES. POL'Y 449 (2000).

⁴⁸ OECD, OECD SCIENCE, TECHNOLOGY AND INDUSTRY 2013 SCOREBOARD (2013), http://dx.doi.org/10.1787/sti_scoreboard-2013-en.

⁴⁹ STEWART ET AL., supra note 44.

⁵⁰Id.

⁵¹ Under the R&E credit, firms contracting out their research are able to claim 65 percent of any amount paid or incurred to a third party for qualified research..

⁵² The R&E credit allows companies to choose to calculate the credit either under the "traditional" credit, which is a 20 percent credit based on a firm's ratio of qualified research expenses (QREs) to gross receipts from 1984 to 1998, or under the Alternative Simplified Credit method based on 14 percent of a taxpayer's QREs in the current tax year above 50 percent of its average QREs during the previous three tax years.

⁵³ STAFF OF JOINT COMM. ON TAXATION, 114TH CONG., ESTIMATED REVENUE EFFECTS OF H.R. 880, THE "AMERICAN RESEARCH AND COMPETITIVENESS ACT OF 2015," SCHEDULED FOR CONSIDERATION BY THE HOUSE OF REPRESENTATIVES ON MAY 20, 2015 (JCX 86-15, May 20, 2015).

⁵⁴ STAFF OF JOINT COMM. ON TAXATION, 113TH CONG., MACROECONOMIC ANALYSIS FOR AMERICAN RESEARCH AND COMPETITIVENESS ACT OF 2014 11 (May 2, 2014) (in the Committee Report to accompany H.R. 4438, available at https://www.congress.gov/113/crpt/hrpt431/CRPT-113hrpt431.pdf).

⁵⁵ CARROLL ET AL., supra note 46.

⁵⁶ ROBERT D. ATKINSON, ITIF, CREATE JOBS BY EXPANDING THE R&D TAX CREDIT (2010).

⁵⁷ See Table 5 for this revenue estimate.

⁵⁸ BEN MILLER ET AL., ITIF, WHY THE TAX REFORM ACT OF 2014 SHOULD EXPAND, NOT CUT, THE R&D TAX CREDIT (2014).

⁵⁹Id. at 3.

⁶⁰ Among other anti-abuse provisions, the bill would restrict passive investors to active losses only to the extent related to contributions to fund R&D.

⁶¹ STEWART ET AL., supra note 44.

⁶² For a recent discussion of these and other issues related to adopting a U.S. innovation box regime, see Peter R. Merrill et al., Is It Time for the United States to Consider the Patent Box?, 134 TAX NOTES 1665 (2012).

⁶³ Former Ways & Means Chairman Chairman Dave Camp's 2011 international discussion draft proposal represents another example of an innovation box type of structure. One of the base erosion options in that proposal, Option C, would tax all CFC income attributable to the exploitation of intangibles related to sales and services for customers outside the United States immediately, but at a reduced rate of 15 percent. However, any such income earned in a jurisdiction at a rate below 13.5 percent would be taxed at the full corporate income tax rate (25 percent).

⁶⁴ For an overview of the economic rationales behind innovation box regimes and a brief review of these studies, see STAFF OF JOINT COMM. ON TAXATION, 114TH CONG., PRESENT LAW AND SELECTED POLICY ISSUES IN U.S. TAXATION OF CROSS-BORDER INCOME (JCX-51-15, Mar. 16, 2015).

⁶⁵See, e.g., ROBERT D. ATKINSON & SCOTT ANDES, ITIF, PATENT BOXES: INNOVATION IN TAX POLICY AND TAX POLICY FOR INNOVATION (2011).

⁶⁶ The committee has several significant examples of goals and phase-outs it may consider should energy tax reform be taken up. These include, among others, Senator Carper's Incentivizing Offshore Wind Power Act, which ties its tax incentive to power generation, combined with a limited time period for installing facilities and the disallowances of additional, potentially duplicative incentives and Former Chairman Baucus's Energy Tax Reform Draft, which phases out technology-neutral credits based on certain clean electricity and clean fuel market measures. An additional approach is represented by the five-year wind production tax credit phase-out offered to the EXPIRE Act by Senator Thune.

⁶⁷ While the term "master limited partnership" and "publicly traded partnership" are often used interchangeably, "master limited partnership" is generally used to refer to publicly traded partnerships and limited liability corporations that operate active businesses that are primarily energy related. See NAT'L ASS'N OF PUBLICLY TRADED P'SHIPS, MASTER LIMITED PARTNERSHIPS 101: UNDERSTANDING MLPS (2013).

⁶⁸See MCKINSEY & CO., ENERGY EFFICIENCY: A COMPELLING GLOBAL RESOURCE (2010).

⁶⁹See, e.g., 1 TAXPAYER ADVOCATE SERV., 2012 ANNUAL REPORT TO CONGRESS (2012).

⁷⁰ Some commentators have noted that focusing on efficiency and simplification would be a beneficial and bipartisan way to reframe the tax reform debate. See GENE STEUERLE, ONE AVENUE TO BIPARTISAN TAX REFORM: SIMPLIFICATION AND IMPROVED TAX ADMINISTRATION (Apr. 8, 2014), http://taxvox.taxpolicycenter.org/2015/04/08/one-avenue-to-bipartisan-tax-reform-simplification-and-improved-tax-administration/.

⁷¹ U.S. GOV'T ACCOUNTABILITY OFFICE, GAO-14-633, IDENTITY THEFT: ADDITIONAL ACTIONS COULD HELP IRS COMBAT THE LARGE, EVOLVING THREAT OF REFUND FRAUD (2014), http://www.gao.gov/products/GAO-14-633.

⁷² For a thoughtful example of such reforms, see AM. INST. OF CPAS, NATURAL DISASTERS: THE CASE FOR PERMANENT TAX RELIEF (2015), available at http://www.aicpa.org/advocacy/tax/downloadabledocuments/automatic-tax-relief-for-natural-disaster-victims-brochure.pdf (detailing the need for and specific proposals regarding permanent disaster tax relief provisions).

For taxable years beginning in 2015 and thereafter, a taxpayer may elect to deduct up to $25,000 of the cost of qualifying property placed in service for the taxable year, subject to limitation. The $25,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $200,000. The $25,000 and $200,000 amounts are not indexed for inflation. In general, qualifying property is defined as depreciable tangible personal property (not including off-the-shelf computer software, qualified real property, or air conditioning and heating units) that is purchased for use in the active conduct of a trade or business.

The amount eligible to be expensed for a taxable year may not exceed the taxable income for such taxable year that is derived from the active conduct of a trade or business (determined without regard to this provision).⁷ Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding taxable years (subject to limitations). However, amounts attributable to qualified real property that are disallowed under the trade or business income limitation may only be carried over to taxable years in which the definition of eligible section 179 property includes qualified real property.⁸ Thus, if a taxpayer's section 179 deduction for 2013 with respect to qualified real property is limited by the taxpayer's active trade or business income, such disallowed amount may be carried over to 2014. Any such carryover amounts that are not used in 2014 are treated as property placed in service in 2014 for purposes of computing depreciation. That is, the unused carryover amount from 2013 is considered placed in service on the first day of the 2014 taxable year.⁹

No general business credit under section 38 is allowed with respect to any amount for which a deduction is allowed under section 179.¹⁰ If a corporation makes an election under section 179 to deduct expenditures, the full amount of the deduction does not reduce earnings and profits. Rather, the expenditures that are deducted reduce corporate earnings and profits ratably over a five-year period.¹¹

An expensing election is made under rules prescribed by the Secretary.¹² In general, any election or specification made with respect to any property may not be revoked except with the consent of the Commissioner. However, an election or specification under section 179 may be revoked by the taxpayer without consent of the Commissioner for taxable years beginning after 2002 and before 2015.¹³

This option provides that the maximum amount a taxpayer may expense, for taxable years beginning after 2014, is $1,000,000 of the cost of qualifying property placed in service for the taxable year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,500,000.

In addition, the option makes permanent the treatment of off-the-shelf computer software as qualifying property. The option also makes permanent the treatment of qualified real property as eligible section 179 property and removes the limitation related to the amount of section 179 property that may be attributable to qualified real property for taxable years beginning after 2014.

The option also makes permanent the permission granted to a taxpayer to revoke without the consent of the Commissioner any election, and any specification contained therein, made under section 179.

The option applies to taxable years beginning after December 31, 2014.

America's Small Business Tax Relief Act of 2014¹⁵

This option provides that the maximum amount a taxpayer may expense, for taxable years beginning after 2014, is $500,000 of the cost of qualifying property placed in service for the taxable year. The $500,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,000,000. The $500,000 and $2,000,000 amounts are indexed for inflation for taxable years beginning after 2015.

In addition, the option makes permanent the treatment of off-the-shelf computer software as qualifying property. The option also makes permanent the treatment of qualified real property as eligible section 179 property and removes the limitation related to the amount of section 179 property that may be attributable to qualified real property for taxable years beginning after 2014. Further, the option strikes the flush language in section 179(d)(1) that excludes air conditioning and heating units from the definition of qualifying property.

The option also makes permanent the permission granted to a taxpayer to revoke without the consent of the Commissioner any election, and any specification contained therein, made under section 179.

The option exempts any budgetary effects from the PAYGO scorecards under the Statutory Pay-As-You-Go Act of 2010.

The option applies to taxable years beginning after December 31, 2014.

President's fiscal year 2016 budget proposal¹⁶

This option extends the 2014 section 179 limitations for qualifying property placed in service in taxable years beginning after 2014, and provides that the maximum amount a taxpayer may expense is $1,000,000 for qualifying property placed in service in taxable years beginning after 2015. The $1,000,000 is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the year exceeds $2,000,000. The amounts are indexed for inflation for all taxable years beginning after 2016, as is the dollar limitation on the expensing of sport utility vehicles.

In addition, the option makes permanent the treatment of off-the-shelf computer software as qualifying property.

The option also makes permanent the permission granted to a taxpayer to revoke without the consent of the Commissioner any election, and any specification contained therein, made under section 179.

The option applies to qualifying property placed in service in taxable years beginning after December 31, 2014.

A C corporation, a partnership that has a C corporation as a partner, or a tax-exempt trust or corporation with unrelated business income generally may not use the cash method of accounting. Exceptions are made for farming businesses, qualified personal service corporations, and the aforementioned entities to the extent their average annual gross receipts do not exceed $5 million for all prior years (including the prior taxable years of any predecessor of the entity) (the "gross receipts test"). The cash method of accounting may not be used by any tax shelter. In addition, the cash method generally may not be used if the purchase, production, or sale of merchandise is an income producing factor.²⁰ Such taxpayers generally are required to keep inventories and use an accrual method of accounting with respect to inventory items.²¹

A farming business is defined as a trade or business of farming, including operating a nursery or sod farm, or the raising or harvesting of trees bearing fruit, nuts, or other crops, timber, or ornamental trees.²² Such farming businesses are not precluded from using the cash method regardless of whether they meet the gross receipts test.²³

A qualified personal service corporation is a corporation: (1) substantially all of whose activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting and (2) substantially all of the stock of which is owned by current or former employees performing such services, their estates, or heirs. Qualified personal service corporations are allowed to use the cash method without regard to whether they meet the gross receipts test.

Accrual method taxpayers are not required to include in income that portion of any amounts to be received for the performance of services in the fields of health, law, engineering, architecture, accounting actuarial science, performing arts, or consulting, that, on the basis of experience, will not be collected (the "nonaccrual experience method").²⁴ The availability of this method is conditioned on the taxpayer not charging interest or a penalty for failure to timely pay the amount charged.

This option both expands and restricts the universe of taxpayers that may use the cash method of accounting.

Under the option, the cash method of accounting may only be used by taxpayers that satisfy the gross receipts test, other than tax shelters. In the case of a partnership, S corporation, trust, estate, or other passthrough entity, the gross receipts test applies at the entity level as well as the partner, shareholder, beneficiary, or similar level. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed the applicable dollar amount of $10 million for the three prior taxable-year period to use the cash receipts and disbursements method. This applicable dollar amount is adjusted for inflation in taxable years beginning after 2015.

The option eliminates the exceptions for farming businesses²⁶ and qualified personal service corporations. Thus, farming businesses and personal service corporations generally are precluded from using the cash method unless such farming business or personal service corporation satisfies the gross receipts test.

In the case of any taxpayer required by the option to change its method of accounting for any taxable year, such change is treated as initiated by the taxpayer and made with the consent of the Secretary. If a taxpayer is required to change its method of accounting for any taxable year from the cash method because the taxpayer did not meet the gross receipts test, the taxpayer may not elect to change its method back to the cash method for any of the four taxable years immediately following the taxable year for which such change was first required.

The option exempts certain taxpayers from the requirement to keep inventories. Specifically, taxpayers that meet the gross receipts test and that properly elect to use the cash method are not required to keep inventories.²⁷

Under the option, the rules for the nonaccrual experience method are retained and are moved from section 448 to new subsection (j) of section 451.

The option applies to taxable years beginning after December 31, 2014. Application of these rules is a change in the taxpayer's method of accounting for purposes of section 481.

Tax Reform Act of 2014 -- Limitation on Use of Cash Method of Accounting²⁸

This option both expands and restricts the universe of taxpayers that may use the cash method of accounting.

Under the option, the cash method of accounting may only be used by natural persons (i.e., sole proprietors) and taxpayers other than tax shelters that satisfy the gross receipts test. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $10 million for the three prior taxable-year period to use the cash receipts and disbursements method, so long as use of such method clearly reflects income.²⁹

The option eliminates the exceptions for qualified personal service corporations. Thus, personal service corporations generally are precluded from using the cash method unless such personal service corporation satisfies the gross receipts test. However, the option retains the exception for farming business such that farming businesses are not precluded from using the cash method regardless of whether they meet the gross receipts test.

Under the option, the rules for the nonaccrual experience method are retained and are moved from section 448 to new subsection (j) under section 451.

In the case of any taxpayer required by this section to change its method of accounting for any taxable year, such change is treated as initiated by the taxpayer and made with the consent of the Secretary.

The option applies to taxable years beginning after December 31, 2014. Application of these rules is a change in the taxpayer's method of accounting for purposes of section 481. Any resulting increase in income is taken into account over four taxable years beginning with the earlier of the taxpayer's elected taxable year³⁰ or the taxpayer's first taxable year beginning after December 31, 2018, using the following schedule: (1) first taxable year in such period, 10 percent; (2) second such taxable year, 15 percent; (3) third such taxable year, 25 percent; and (4) fourth such taxable year, 50 percent. For taxpayers with a final taxable year beginning before December 31, 2018, the present-law operative rules of section 481 apply (e.g., the full amount of the section 481 adjustment required to be included under this option is included with the final return).

President's fiscal year 2016 budget proposal³¹

The President's fiscal year 2016 budget proposal to expand simplified accounting for small business and establish a uniform definition of small business for accounting methods includes an option that expands the universe of taxpayers that may use the cash method of accounting. Under this option, the cash method of accounting may be used by taxpayers other than tax shelters that satisfy the gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior taxable-year period to use the cash receipts and disbursements method. The amount is indexed for inflation for taxable years beginning after 2016.

The option retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the gross receipts test, so long as the use of such method clearly reflects income.³² However, the option eliminates the exceptions from the required use of the accrual method for farming corporations such that farming corporations will be precluded from using the cash method unless they meet the $25 million gross receipts test.

Under the option, a taxpayer who fails the $25 million gross receipts test would not be eligible for the exception from the accrual method for the current taxable year and subsequent four taxable years.

The option is effective for taxable years beginning after December 31, 2015.

A C corporation³³ is subject to Federal income tax as an entity separate from its shareholders. A C corporation's income generally is taxed when earned at the corporate level and is taxed again at the individual level when distributed as dividends³⁴ to its shareholders. Corporate deductions and credits reduce only corporate income (and corporate income taxes) and are not passed directly through to shareholders.

Tax rates for C corporations

C corporations are taxed at statutory rates ranging from 15 percent (for taxable income up to $50,000) to 35 percent (for taxable income over $10,000,000); the intermediate rates are 25 percent (for taxable income above $50,000 but not exceeding $75,000) and 34 percent (for taxable income above $75,000 but not exceeding $10,000,000).³⁵ The benefit of graduated rates below 34 percent is phased out for C corporations with taxable income between $100,000 and $335,000, and the benefit of the 34 percent rate is phased out for C corporations with taxable income in excess of $15,000,000. C corporation long-term capital gains are taxed at the same rates as C corporation ordinary income. Thus, the maximum tax rate for C corporation net long-term capital gains is 35 percent.

A C corporation is subject to an alternative minimum tax that is payable, in addition to all other tax liabilities, to the extent that it exceeds the C corporation's regular income tax liability. The tax is imposed at a flat rate of 20 percent on alternative minimum taxable income ("AMTI") in excess of a $40,000 exemption amount.³⁶ Certain credits that are allowed to offset a C corporation's regular tax liability generally are not allowed to offset its minimum tax liability. If a C corporation pays the alternative minimum tax, the amount of the tax paid is allowed as a credit against the regular tax in future years to the extent the regular tax exceeds the tentative minimum tax. Small C corporations meeting a gross receipts test are exempt from the corporate alternative minimum tax. Generally, a C corporation meets the gross receipts test if its average annual gross receipts for the prior three taxable years do not exceed $7.5 million.

Passthrough entities

Tax rates for individuals

U.S. individuals (citizens and residents) are taxed at graduated statutory rates ranging from 10 percent (for taxable income of up to $9,225 for single filers and up to $18,450 for married taxpayers filing joint returns or surviving spouses) to 39.6 percent (for taxable income over $413,200 for single filers and $464,850 for married taxpayers filing joint returns) for taxable year 2015; the intermediate rates are 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent⁴⁵ for 2015 (other than collectibles or unrecaptured section 1250 property). The maximum tax rate on net long-term capital gains generally is 20 percent.⁴⁶ Dividends received by an individual from domestic corporations and qualified foreign corporations are taxed at the same rates that apply to capital gains.⁴⁷

An alternative minimum tax is imposed on an individual in an amount by which the tentative minimum tax exceeds the regular income tax for the taxable year. The tentative minimum tax is the sum of (1) 26 percent of so much of the taxable excess as does not exceed $175,000 ($87,500 in the case of a married individual filing a separate return) and (2) 28 percent of the remaining taxable excess. The taxable excess is so much of the AMTI as exceeds the exemption amount. The maximum tax rates on net capital gain and dividends used in computing the regular tax are used in computing the tentative minimum tax. AMTI is the taxpayer's taxable income increased by the taxpayer's tax preferences and adjusted by determining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items.

The exemption amounts for 2015 are: (1) $83,400 in the case of married individuals filing a joint return and surviving spouses; (2) $53,600 in the case of other unmarried individuals; and (3) $41,700 in the case of married individuals filing separate returns. The exemption amounts are phased out by an amount equal to 25 percent of the amount by which the individual's AMTI exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving spouses, (2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of married individuals filing separate returns. These amounts are not indexed for inflation.

Section 199 deduction

However, a taxpayer's deduction under section 199 for a taxable year may not exceed 50 percent of the wages properly allocable to domestic production gross receipts paid by the taxpayer during the calendar year that ends in such taxable year.⁵¹

However, domestic production gross receipts do not include any gross receipts of the taxpayer derived from property that is leased, licensed, or rented by the taxpayer for use by any related person.⁵⁷ Further, domestic production gross receipts do not include any gross receipts of the taxpayer that are derived from the sale of food or beverages prepared by the taxpayer at a retail establishment, that are derived from the transmission or distribution of electricity, gas, and potable water, or that are derived from the lease, rental, license, sale, exchange, or other disposition of land.⁵⁸

Trusts and estates. -- In the case of a trust or estate, the components of the calculation are apportioned between (and among) the beneficiaries and the fiduciary under regulations prescribed by the Secretary.⁶⁶

Agricultural and horticultural cooperatives. -- With regard to member-owned agricultural and horticultural cooperatives formed under Subchapter T of the Code, section 199 provides the same treatment of qualified production activities income derived from agricultural or horticultural products that are manufactured, produced, grown, or extracted by cooperatives,⁶⁷ or that are marketed through cooperatives, as it provides for qualified production activities income of other taxpayers, that is, the cooperative may claim a deduction from qualified production activities income.

Alternatively, section 199 provides that the amount of any patronage dividends or per-unit retain allocations paid to a member of an agricultural or horticultural cooperative (to which Part I of Subchapter T applies), which is allocable to the portion of qualified production activities income of the cooperative that is deductible under the provision, is deductible from the gross income of the member. To qualify, such amount must be designated by the organization as allocable to the deductible portion of qualified production activities income in a written notice mailed to its patrons not later than the payment period described in section 1382(d). The cooperative cannot reduce its income under section 1382 (e.g., cannot claim a dividends-paid deduction) for such amounts.

Alternative minimum tax. -- The deduction for domestic production activities is allowed for purposes of computing alternative minimum taxable income (including adjusted current earnings). The deduction in computing alternative minimum taxable income is determined by reference to the lesser of the qualified production activities income (as determined for the regular tax) or the alternative minimum taxable income (in the case of an individual, adjusted gross income as determined for the regular tax) without regard to this deduction.

In the case of a qualified small business, the option allows a deduction for 20 percent of qualified domestic business income of the taxpayer for the taxable year, or taxable income for the taxable year, whichever is less. However, a taxpayer's deduction for any taxable year may not exceed 50 percent of certain W-2 wages of the qualified small business.

W-2 wages

W-2 wages do not, however, include any amount not properly allocable to domestic business gross receipts under the option, nor does the term include any amount not allowed as a deduction under section 162 (relating to ordinary and necessary business expenses).⁶⁹

Certain partners' distributive shares of partnership items may be treated as W-2 wages solely for purposes of the option. In the case of a qualified small business that is a partnership and that so elects, the portion of the qualified domestic business taxable income of the partnership for the taxable year that is allocable to each qualified service-providing partner is treated as W-2 wages paid during that taxable year to an employee who is a 10-percent-or-less direct owner. The domestic business gross receipts of the partnership for the taxable year must be reduced by any amount treated as W-2 wages under this rule.

Qualified domestic business income

Qualified small business

For purposes of the option, a qualified small business means an employer engaged in a trade or business if the employer had fewer than 500 full-time equivalent employees ("FTEs")⁷² for either calendar year 2010 or 2011. For example, a C corporation, S corporation, partnership, or sole proprietorship with fewer than 500 FTEs in either calendar year 2010 or 2011 may be a qualified small business. In the case of an employer not in existence on January 1, 2012, the determination is made with respect to calendar year 2012 rather than 2010 or 2011.

In general, an employer's FTEs are calculated by dividing the total hours of service for which wages were paid by the employer to employees during the taxable year by 2,080 hours.⁷³ This number is rounded down to the nearest whole number if not otherwise a whole number. Employers in existence for a partial calendar year annualize the number of FTEs calculated based on the number of calendar days the taxpayer was in existence during 2012.

Any employer that is treated as a single employer for purposes of section 52(a) or (b) (without regard to section 1563(b)), relating to employees of entities under common control, or section 414(m) or (o), relating to employees of an affiliated service group, is treated as a single employer for purposes of determining whether an employer is a qualified small business.

Other rules

A taxpayer may elect not to take into account under this option any item of domestic business gross receipts. Under this election, for example, the taxpayer may treat an item of domestic business gross receipts as not taken into account under the option so that the item may be taken into account for purposes of section 199.

Under present law, corporations receiving dividends from domestic corporations generally are allowed a deduction of 70 percent or more of the amount of the dividends received. Certain anti-abuse rules prevent corporations from receiving low-taxed dividends and creating a capital loss.⁷⁹ The dividends-received deduction on certain debt-financed portfolio stock is reduced.⁸⁰

The proposal was not enacted. Instead, Congress in 2003 enacted the present law rule that provides a reduced rate of shareholder tax for dividends that is the same as the reduced rate for capital gains.⁸² The description of the President's budget proposal for fiscal year 2004 that was prepared by the staff of the Joint Committee on Taxation⁸³ is reproduced below.

In general

Under the proposal, the excludable portion of any dividend received by a shareholder is not included in gross income. The excludable portion of any dividend is the portion of the dividend which bears the same ratio to the dividend as the amount of the corporation's excludable dividend amount ("EDA") for a calendar year bears to all dividends paid by the corporation during the calendar year. The EDA, as discussed below, generally measures the corporation's fully taxed income reduced by taxes paid. In addition, shareholders may be allowed to increase the basis in their corporate stock to the extent the EDA exceeds the dividends paid by the corporation during the calendar year. These rules apply to both individual and corporate shareholders. ⁸⁴

Excludable dividend amount

A corporation calculates an EDA that measures the amount of the corporation's income that was fully taxed reduced by taxes paid. The EDA, for any calendar year, includes an amount the numerator of which is the amount of Federal income tax⁸⁵ in excess of all nonrefundable credits (other than the foreign tax credit and the minimum tax credit attributable to any minimum tax imposed in a taxable year ending before April 1, 2001) shown on a corporation's income tax return filed during the preceding calendar year ("applicable income tax") and the denominator of which is the highest corporate tax rate (35 percent under present law).⁸⁶ An assessment of tax not shown on a return is treated as if it were an amount of tax shown on a return for the calendar year in which the tax is assessed. If a tax is paid after the close of the year that it is shown on a return or otherwise assessed, the tax is taken into account in the year paid. The EDA is decreased by the amount of the Federal income tax taken into account in computing the increase in the EDA. No tax imposed for a taxable year ending before April 1, 2001, is treated as an applicable income tax.⁸⁷

The EDA also includes the amount of dividends received from another corporation in the preceding calendar year that are excluded under this provision or amounts added to the basis of stock in the other corporation in the preceding calendar year (as described below).

To the extent that the EDA for a calendar year exceeds the maximum amount of dividends that can be paid by the corporation in the calendar year (determined by reference to the corporation's earnings and profits), the excess is added to the EDA for the succeeding year. No other carryover of an amount in the EDA is allowed except to the extent provided by regulations.

Retained earnings basis adjustments

If the amount of the EDA for a calendar year exceeds the amount of dividends paid by a corporation during that year, a shareholder is allowed to increase the shareholder's basis in the corporation's stock by the portion (if any) of the excess allocated by the corporation to the stock. Basis increases are allocated by a corporation in the same manner as if the corporation actually had made dividend distributions, except that no amount may be allocated to stock described in section 1504(a)(4) (whether or not voting stock) that is limited and preferred as to dividends. The Secretary of the Treasury may prescribe regulations regarding allocations where a corporation has multiple classes of stock. Earnings and profits are adjusted in the same manner as if the allocation were a dividend (i.e., the distributing corporation's earnings and profits are reduced and, if the taxpayer receiving a basis adjustment is a corporation, that corporation's earnings and profits are increased). The allocated basis is added to the shares of stock the taxpayer holds and does not affect the holding periods of the shares.

Cumulative retained earnings basis adjustments account

Each corporation allocating basis adjustments is required to maintain a cumulative retained earnings basis adjustment account ("CREBAA"). The amount in the CREBAA is the cumulative amount of basis allocations for prior calendar years reduced by the amount of distributions in prior calendar years that were treated as described below.

To the extent of the amount in the CREBAA, distributions made by a corporation in a calendar year in excess of the amount in the EDA are not treated as dividends. Instead, the distributions reduce the basis of the shareholder's stock (or result in gain to the extent the distributions exceed the shareholder's basis).⁸⁸ These distributions reduce the amount in the CREBAA. The portion of any distribution to which this treatment applies is a fraction (not in excess of one) the numerator of which is the amount in the CREBAA account at the beginning of the calendar year and the denominator of which is the amount of all distributions (other than excluded dividends) paid by the corporation during the calendar year. This treatment is provided separately with respect to each class of stock for which a basis allocation was previously made.

For example, corporation X, a calendar year corporation, has a sole shareholder A. For its first taxable year, X has taxable income of $100, and files a return and pays a tax of $35 in its second taxable year. For all other taxable years in this example, X has no income or loss. On January 1 of its third taxable year, X has an EDA of $65 ($35/.35 less $35). X pays no dividends in the third year but allocates $65 of basis to A, and A increases its basis in the X stock by $65. X has a CREBAA of $65 at the beginning of the fourth year. The value of the X stock declines, and A sells the stock to B for $50 at the beginning of the fourth year. A's gain or loss is computed by taking the $65 into account in determining the basis in the X stock. X then distributes $65 to B later in the fourth year. B treats the $65 as a $50 reduction of the basis in the X stock to zero and a $15 capital gain from the sale of the X stock. X will have no balance in its CREBAA at the beginning of the fifth year.

Credits and refunds of overpayments of tax

The overpayment of a corporate income tax (including an overpayment resulting by reason of a carryback) is allowed as a credit or refund only to the extent of the applicable income taxes taken into account in computing EDA for the calendar year following the calendar year in which the refund or credit is otherwise allowable plus, to the extent the corporation elects, an amount equal to the amount of tax that would produce the amount equal to the EDA for the calendar year in which the refund or credit is otherwise allowable. Thus, for example, assume a corporation has paid no tax in the current calendar year and has an EDA of $65 for the current calendar year. The refund of any overpayment in the year is limited to $35 (the amount of applicable income tax which results in an EDA of $65).

To the extent a credit or refund is made, for purposes of computing EDA, the tax for the calendar year the refund or credit is made is reduced (but not below zero) by the amount of the credit or refund, and the excess (if any) reduces the amount in the EDA for the current calendar year, using the formula which converts applicable income tax to an EDA. Thus, in the above example, the EDA for the current calendar year is reduced to zero.

Any overpayment not allowed as a credit or refund by reason of this limitation continues to be an overpayment that will be taken into account in succeeding calendar years, subject to this limitation, until a credit or refund is allowed or made. Interest on an overpayment is not allowed during the period the overpayment is not allowed as a credit or refund by reason of this limitation.

This limitation does not apply to the extent any overpayment is attributable to the foreign tax credit.

Foreign taxes and foreign persons

No foreign tax credit is allowed with respect to the excludable portion of any dividend or from a distribution from a CREBAA.

Regulated investment companies (RICs) and Real Estate Investment Trusts (REITs)

Except as provided in regulations, a regulated investment company ("RIC") or real estate investment trust ("REIT") does not have an EDA. Instead special rules allow the treatment of distributions received by, or basis adjustments allocated to, a RIC or REIT to pass through to its shareholders and holders of beneficial interests.

A RIC or REIT that receives excludable dividend income is allowed to designate dividends it makes to its shareholders as excludable dividends to the extent of the amount of excludable dividends it receives. In addition, a RIC or REIT may cause its shareholders to increase their bases in RIC or REIT stock to the extent of any basis increases allocated to stock held by the REIC or REIT. To the extent a RIC or REIT receives distributions from a CREBAA that reduce the basis of stock held by the RIC or REIT, distributions from the RIC or REIT may be treated as distributions from a CREBAA.

A RIC or REIT takes into account excludable dividends received, and distributions from a CREBAA that reduce the basis in stock it holds, in determining its distribution requirements. Excludable dividends and distributions from a CREBAA received by a RIC or REIT are taken into account in applying the gross income tests applicable to RICs and REITs.

If a shareholder or holder of a beneficial interest of a RIC or REIT receives an excludable dividend or is allocated a basis adjustment, any loss on the sale of the RIC or REIT stock held six months or less is disallowed to the extent of the amount of the exclusion or adjustment.

Insurance companies

Under the proposal, all excludable dividends received by a life insurance company are subject to proration. Thus, the excluded dividends are allocated on a pro rata basis between the insurance company's general earnings and those amounts required to pay benefits. The basis increase allocated to an insurance company is treated as an excludable dividend received in the year the adjustment is made, and, as such, is subject to proration. All excludable dividends and basis increases attributable to assets held in a separate account funding variable life insurance and annuity contracts are allocated to the separate account. The policyholder's share of excludable dividends and basis adjustments is includable in the company's income. The company's share of excludable dividends and basis adjustments is added to the shareholder's surplus account of a stock life insurance company.

Excludable dividends and retained earnings basis adjustments of a non-life insurance company are treated in the same manner as taxable dividends in computing the reduction of the deduction for losses.

Partnerships and S corporations

Rules similar to the partnership rules apply to S corporations and their shareholders. In the case of S corporations, these amounts also increase the accumulated adjustments account of the corporation.

The items taken into account in determining the tax imposed on built-in gains under section 1374 no longer will pass through to the shareholders, so that S corporation shareholders generally will not pay a tax on the items which are taxed at the corporate level.⁹⁰ The amount of these items (determined without regard to any net operating loss from a C corporation year ⁹¹ and reduced by the amount of the tax) increases the corporation's accumulated earnings and profits.

Under regulations, distributions of excludable dividends and amounts from a CREBAA will be treated as made before distributions from the accumulated adjustments account. Thus, under the proposal, distributions by an S corporation with accumulated earnings and profits are made in the following order:

1. An excludable dividend to the extent of the EDA.

2. Reduction of basis (or recognition of gain) to the extent of the CREBAA.

3. Reduction of basis (or recognition of gain) to the extent of the accumulated adjustments account.

4. Taxable dividend to the extent of accumulated earnings and profits.

5. Reduction of basis.

6. Recognition of gain.

Trusts and estates

The distributable net income of a trust or estate includes the excludable dividends received by the trust or estate and the distributions from a CREBAA received by the trust or estate.

Cooperatives

The EDA of a cooperative shall be allocated between shares of the corporation held by patrons and shares held by other persons as prescribed by regulations, and no deduction shall be allowed to the cooperative for any excludable dividend or distribution from a CREBAA paid to a patron.

Employee stock ownership plans (ESOPs)

Deductible dividends paid to an employee stock ownership plan ("ESOP") are not treated as dividends for purposes of applying the rules under dividend exclusion rules added by the proposal. Thus, for example, they are disregarded in determining the excludable portion of dividends paid with respect to all dividends made by the corporation. Also, stock on which a deductible dividend may be made is disregarded for purposes of allocating basis adjustments and making distributions from a CREBAA.

Private foundations

Excludable dividends and distributions from a CREBAA will not be included in the calculation of net investment income of a private foundation for purposes of the tax imposed by section 4940.

Anti-abuse rules

If a shareholder does not hold stock for more than 45 days during the 90-day period beginning 45 days before the ex-dividend date (as measured under section 246(c)) ⁹², the basis of the stock is reduced by the amount of any excludable dividends and allocated basis adjustments. Also, no deduction is allowable with respect to payments related to an excludable dividend or basis increase.

The rules of section 1059 requiring a basis reduction with respect to certain extraordinary dividends are made applicable to the excludable dividends received by, and basis adjustments allocated to, both corporate and noncorporate shareholders. Except as provided by regulations, if an excludable dividend is received, or a basis adjustment is allocated, with respect to a share of stock, the basis reduction applies to that share of stock, without regard to whether the excludable dividend or basis adjustment otherwise would be extraordinary, if received during the first year (or such other period provided by regulations) the taxpayer holds the stock.⁹³

In the case of a corporate shareholder, the EDA and the earnings and profits are not increased by any amounts that result in a basis decrease under these rules.

Shareholder indebtedness

In the case of debt-financed portfolio stock held by a corporation, the excludable portion of a dividend is reduced by the average indebtedness percentage (as defined in section 246A) applicable to the stock. Also, there is included in gross income an amount equal to the basis adjustment to any stock held by the taxpayer multiplied by the average indebtedness percentage. The EDA of a corporate shareholder is not increased by any amount included in gross income by reason of this rule.

The investment interest limitations of section 163(d) for individuals apply. In addition, any excludable dividend is not investment income.

Redemptions

The present law rules relating to the treatment of redemptions of stock (either directly by a corporation or through the use of a related corporation) as a dividend or as an exchange remain the same as under present law. Redemptions treated as exchanges reduce the EDA and CREBAA by the ratable share of the amount attributable to the shares redeemed.

Tax-free reorganizations and liquidations

In the case of a tax-free reorganization or liquidation, the current rules providing for the carryover of tax attributes are amended to provide for the carryover of the acquired corporation's EDA and CREBAA. In the case of a tax-free spin-off, the CREBAA is divided between the distributing and controlled corporations in accordance with regulations provided by the Secretary of the Treasury.

Rights to acquire stock

The Secretary of the Treasury may promulgate regulations treating the holder of a right to acquire stock as the holder of stock and regulations amending the option attribution rules.

Alternative minimum tax

Excluded dividends and reduced gain (or increased loss) resulting from the allocated basis adjustments are not an item of tax preference or adjustment for purposes of determining alternative minimum taxable income (including the determination of adjusted current earnings for corporations).

Accumulated earnings tax and personal holding company tax

The accumulated earnings tax and the personal holding company tax are repealed, for taxable years beginning after December 31, 2002, except that any deficiency dividend or dividend paid on or before the 15th day of the third month after the close of the taxable year which is taken into account in computing the tax for a taxable year beginning before that date may be made. Such a dividend is not treated as a dividend for purposes of applying the dividend exclusion rules of the proposal.

Compliance

Form 1099 will be revised to provide information to shareholders to indicate the amount of excludable dividends and the amount of basis adjustments and the date they are allocated.

A corporation will calculate the EDA and CREBAA and report those amounts to the IRS annually on its income tax return.

Regulations

The Secretary of the Treasury is provided authority to prescribe appropriate regulations to carry out these provisions.

The Secretary of the Treasury may amend the consolidated return regulations (effective as of the effective date of the proposal) to properly account for an EDA of a member of the group, for basis adjustments allocated to a member of the group, and for CREBAA distributions received by a member of the group. These regulations may accelerate the inclusion in the excludable dividend amount with respect to activities of lower-tier members of the group, excludable dividends received from lower-tier members, and increases in basis allocated to stock in lower tier members.

For Federal income tax purposes, a taxpayer is allowed to recover through annual depreciation deductions the cost of certain property used in a trade or business or for the production of income.⁹⁵ Under the modified accelerated cost recovery system ("MACRS"), adopted in 1986, the amount of the depreciation deduction allowed with respect to tangible property for a taxable year is determined for different types of property based on an assigned applicable depreciation method, recovery period, and convention.⁹⁶

Recovery periods and depreciation methods

The applicable recovery period for an asset is determined in part by statute and in part by historic Treasury guidance.⁹⁷ The "type of property" of an asset is used to determine the "class life" of the asset, which in turn dictates the applicable recovery period for the asset.

The MACRS recovery periods applicable to most tangible personal property range from three to 20 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods,⁹⁸ switching to the straight-line method for the first taxable year where using the straight-line method with respect to the adjusted basis as of the beginning of that year will yield a larger depreciation allowance. The recovery periods for most real property are 39 years for nonresidential real property and 27.5 years for residential rental property. Table 1 provides general rules for class lives and recovery periods as provided in sections 168(c) and (e).

 

Table 1. -- General Rules for Class Lives and Recovery Periods

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 95.]

 

 

 

Depreciation of an asset begins when the asset is deemed to be placed in service under the applicable convention.⁹⁹ Under MACRS, nonresidential real property, residential rental property, and any railroad grading or tunnel bore generally are subject to the mid-month convention, which treats all property placed in service during any month (or disposed of during any month) as placed in service (or disposed of) on the mid-point of such month.¹⁰⁰ All other property generally is subject to the half-year convention, which treats all property placed in service during any taxable year (or disposed of during any taxable year) as placed in service (or disposed of) on the mid-point of such taxable year.¹⁰¹ However, if substantial property is placed in service during the last three months of a taxable year, a special rule requires use of the mid-quarter convention,¹⁰² designed to prevent the recognition of disproportionately large amounts of first-year depreciation under the half-year convention.

Alternative depreciation system

The alternative depreciation system ("ADS") is required to be used for property used predominantly outside the United States, tax-exempt bond financed property, and certain tax-exempt use property.¹⁰³ An election to use ADS is available to taxpayers for any class of property for any taxable year.¹⁰⁴ Under ADS, all property is depreciated using the straight-line method, over recovery periods which generally are equal to the class life of the property, with certain exceptions.¹⁰⁵

Like-kind exchanges

An exchange of property, like a sale, generally is a taxable event. However, no gain or loss is recognized if property held for productive use in a trade or business or for investment if exchanged for property of a "like-kind" which is to be held for productive use in a trade or business or for investment.¹⁰⁶ If section 1031 applies to an exchange of properties, the basis of the property received in the exchange is equal to the basis of the property transferred, decreased by any money received by the taxpayer, and further adjusted for any gain or loss recognized on the exchange. In general, section 1031 does not apply to any exchange of stock in trade or other property held primarily for sale; stocks, bonds or notes; other securities or evidences of indebtedness or interest; interests in a partnership; certificates of trust or beneficial interests; or choses in action.¹⁰⁷

Involuntary conversions

Although gain or loss realized from the sale or other disposition of property must generally be recognized, section 1033 provides an exception to this rule in the case of certain involuntary conversions of property. Section 1033 applies if property is involuntarily or compulsorily converted into similar property or money. Such a conversion may occur as a result of the property's destruction (in whole or in part), theft, seizure, requisition or condemnation, or a sale made under the threat of requisition or condemnation.¹⁰⁸

For purposes of section 1033, condemnation refers to the process by which private property is taken for public use without the consent of the property owner but upon the award and payment of just compensation.¹⁰⁹ Thus, for example, an order by a Federal court to a corporation to divest itself of ownership of certain stock because of anti-trust rules is not a condemnation (or a threat of imminence thereof), and the divestiture is not eligible for deferral under this provision.¹¹⁰

If property is involuntarily converted into property that is similar or related in service or use to the property so converted, no gain is recognized. This treatment is not elective. The replacement property may be acquired directly or by acquiring control of a corporation (generally, 80 percent of the stock of the corporation) that owns replacement property. If the taxpayer receives money (for instance, insurance payments or condemnation awards), or other dissimilar property for the involuntarily converted property, and acquires qualified replacement property within the prescribed time period, nonrecognition of the gain is optional.¹¹¹ As a general matter, the prescribed time period begins on the date of the disposition of the converted property (or threat or imminence of a threat of condemnation begins) and ends two years after the close of the first taxable year in which any part of the gain upon the conversion is realized.¹¹²

The taxpayer's basis in the replacement property is the same as the taxpayer's basis in the converted property, decreased by the amount of any money received or loss recognized on the conversion, and increased by the amount of any gain recognized on the conversion.¹¹³

In the case of pooled property, costs are recovered by multiplying the applicable recovery rate for each pool by the associated pool balance at year-end. "Pooled property" is defined as any tangible property (other than any personal-use passenger automobile) and any computer software (as defined in section 197(e)(3)(B) that is not an amortizable section 197 intangible) assigned to any one of the four pools (detailed in Table 2 below).

 

Table 2. -- Pooled Property by Pool

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 98.]

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

• Pool 1: 38 percent;

• Pool 2: 18 percent;

• Pool 3: 12 percent; and

• Pool 4: five percent.

• Foreign assets

First taxable year. -- For the first taxable year beginning after December 31, 2014, each asset pool balance is determined by:

(1) adding the adjusted basis of (A) any pooled property held by the taxpayer on the first day of such taxable year assigned to such asset pool;¹²⁴ (B) any pooled property placed in service by the taxpayer during the taxable year assigned to such asset pool; and (C) to the extent not already included by reason of (B), any capitalizable addition or improvement made to pooled property placed in service by the taxpayer during the taxable year assigned to such asset pool; and

(2) subtracting (A) the amount of any reduction pursuant to a discharge of indebtedness;¹²⁵ (B) except as provided in (C), the gross proceeds from the disposition or transfer during the taxable year of any asset assigned to such pool; and (C) in the case of any pooled property disposed of or transferred to a related person or tax shelter or any other pooled property which the taxpayer continues to use after its disposition, the recomputed basis (discussed below).

Subsequent taxable years. -- For each subsequent taxable year, a taxpayer must first compute each asset pool's adjusted balance. The adjusted balance of an asset pool is the prior year's ending pool balance decreased by the amount of any depreciation deduction claimed with respect to such pool and increased by the amount of any gain recognized with respect to a negative pool balance for such pool. To determine the pool balance as of the close of the taxable year, a taxpayer begins with the adjusted balance then:

(1) adds the adjusted basis of: (A) any pooled property placed in service by the taxpayer during the taxable year assigned to such asset pool; and (B) to the extent not already included by reason of (A), any capitalizable addition or improvement made to pooled property placed in service by the taxpayer during the taxable year assigned to such asset pool; and

(2) subtracts: (A) the amount of any reduction pursuant to a discharge of indebtedness;¹²⁶ (B) except as provided in (C), the gross proceeds from the disposition or transfer during the taxable year of any asset assigned to such pool; and (C) in the case of any pooled property disposed of or transferred to a related person or tax shelter or any other pooled property which the taxpayer continues to use after its disposition, the recomputed basis (discussed below).

On February 1, 2015, the taxpayer acquires a new computer for $2,000. On March 1, 2015, the taxpayer sells the violin to an unrelated party for $1,500. On March 2, 2015, the taxpayer acquires a viola for $1,700. On April 1, 2015, the taxpayer sells the light truck for $500 and acquires a new light truck for $1,500. The taxpayer makes no improvements to the land around the studio or to the building in 2015. The following describes the depreciation deductions allowable to the taxpayer.

Pool 1: The beginning balance of pool 1 is $1,000. The taxpayer acquired a new computer for $2,000 and added it to the pool for a balance of $3,000. The applicable rate of depreciation for assets in pool 1 is 38 percent. For 2015, the taxpayer is allowed a deduction for depreciation with respect to pool 1 of $1,140 (0.38 multiplied by $3,000). The $1,140 of depreciation for 2015 is deducted from the balance of pool 1, resulting in a balance of $1,860 for the beginning of 2016.

Pool 2: The beginning balance of pool 2 is $1000. During 2015, the taxpayer sells the light truck for $500 and acquires another for $1500, to be used 100 percent for business use. The balance of pool 2 is reduced by the proceeds of the sale of the old truck and is increased by the basis of the new truck. The pool balance before depreciation is $2000 ($1000 - $500 + $1500). The applicable rate of depreciation for assets in pool 2 is 18 percent. For 2015, the taxpayer is allowed a deduction for depreciation with respect to pool 2 of $360 (0.18 multiplied by $2000). The taxpayer recognizes no loss on the sale of the old truck. However, the taxpayer is permitted to continue to recover the remaining basis in the old truck, thus recognizing the loss over time. The $360 of depreciation is deducted from the balance of pool 2, resulting in a balance of $1,640 for the beginning of 2016.

Pool 3: The beginning balance of pool 3 is $1,000. In 2015, the taxpayer sold a violin to an unrelated party for $1,500 and acquired a viola for $1,700. The balance of pool 3 is reduced by the proceeds of the sale of the violin but is increased by the basis of the viola. The pool balance before depreciation is $1,200 ($1,000 - $1,500 + $1,700). The applicable rate of depreciation for assets in pool 3 is 12 percent. For 2015, the taxpayer is allowed a deduction for depreciation with respect to pool 3 of $144 (0.12 multiplied by $1,200). The taxpayer recognizes no gain on the sale of the violin. However, the taxpayer is only permitted to depreciate $1,200 of the cost of the viola, rather than $1,700. The $144 of depreciation for 2015 is deducted from the balance of pool 3, resulting in a balance of $1,056 for the beginning of 2016.

Pool 4: The beginning balance of pool 4 is $1,000. The taxpayer has no additions to the pool for 2015. The applicable rate of depreciation for assets in pool 4 is five percent. For 2015, the taxpayer is allowed a deduction for depreciation with respect to pool 4 of $50 (0.05 multiplied by $1,000). The $50 of depreciation for 2015 is deducted from the balance of pool 4, resulting in a balance of $950 for 2016.

The taxpayer is allowed a total deduction for depreciation in 2015 with respect to his trade or business of $1,694 ($1,140 + $360 + $144 + $50).

Similarly, if there are no assets remaining in a pool at year-end, any positive year-end balance in the pool may be deducted as a terminal loss with respect to that pool. Additionally, a taxpayer may deduct any pool balance at year-end of $1,000 or less ("de minimis balance"). Any amount deducted as a terminal loss or de minimis balance with respect to a pool is an ordinary loss and is subtracted from the pool balance to restore the taxpayer's pool balance to zero for the subsequent year's calculation.

If a taxpayer continues to use pooled property after its disposition (e.g., sale-lease-back transaction), the pool balance is reduced by the lesser of the recomputed basis (as defined above) or gross proceeds from the sale.

The excess of the fair market value of the property disposed of or transferred over the recomputed basis is treated as section 1245 gain.¹²⁸ The purchaser (or transferee) adds the asset to the appropriate pool at its purchase price.

 

Table 3. -- Real Property

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 109.]

 

 

 

A transition rule applicable to all straight-line property (including real property) placed in service in a taxable year beginning before January 1, 2015, provides that the adjusted basis of such real property is depreciated over a term of 43 years reduced by the number of taxable years for which the property has already been depreciated.¹³⁴ For example, assume a taxpayer purchased residential rental property for $907,500 and placed such property in service on June 15, 2005. Under the transition rule, for taxable years beginning on or after January 1, 2015, the taxpayer recovers the remaining basis of $594,000¹³⁵ over 33 years (43 years minus the 10 years the property has already been depreciated). Thus, the taxpayer is allowed depreciation deductions of $18,000 per year for 33 years (instead of $33,000 for the remaining 17.5 years) for the remaining basis.¹³⁶

The transition rule applicable to all straight-line property (including any personal-use passenger automobile) placed in service in a taxable year beginning before January 1, 2015, provides that the adjusted basis of the personal-use passenger automobile¹³⁹ is depreciated over a term of five years reduced by the number of taxable years for which the automobile had already been depreciated.¹⁴⁰

Additionally, at least every 10 years, the Secretary in consultation with the Secretary of Commerce (i.e., the Bureau of Economic Analysis),¹⁴² must submit a report to Congress analyzing the classification and assignment of all section 168 property, including the classification of assets as pooled property or real property, assignments of assets to pools, the number of asset pools, the applicable rates for such pools, and the recovery periods for straight-line property.

The option applies to taxable years beginning after December 31, 2014.

Tax Reform Act of 2014 -- Reform of Accelerated Cost Recovery System¹⁴⁶

• Property with no class life (12 years);

• Any race horse, and any horse other than a race horse that is more than 12 years old at the time it is placed in service (3 years);

• Semi-conductor manufacturing equipment (5 years);

• Qualified technological equipment (5 years);

• Automobile or light general purpose truck (5 years);

• Qualified rent-to-own property (9 years);

• Certain telephone switching equipment (9.5 years);

• Railroad track (10 years);

• Smart electric distribution property (10 years);

• Airplanes (12 years);¹⁴⁸

• Natural gas gathering line (14 years);

• Tree or vine bearing fruit or nuts (20 years);

• Telephone distribution plant (24 years);

• Real property, including nonresidential real property and residential rental property (40 years);

• Water treatment and utility property (50 years);

• Clearing and grading improvements, and tunnel bore (50 years); and

• Tax-exempt use property subject to lease (recovery period shall be no less than 125 percent of the lease term).

The below table illustrates depreciation for an asset with a cost of $1,000 and a seven-year recovery period under the straight-line method using the half-year convention with and without the election to apply the inflation adjustment. For purposes of the inflation adjustment, an inflation rate of three percent is assumed in the below table.

 

Table 4. -- Example

 

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 114.]

 

 

 

If an excess deferred tax reserve is reduced more rapidly or to a greater extent than such reserve would be reduced under the average rate assumption method, the taxpayer will not be treated as using a normalization method of accounting with respect to any of its assets. Thus, if the excess deferred tax reserve is not normalized, the taxpayer must compute its depreciation allowances using the depreciation method, useful life determination, averaging convention, and salvage value limitation used for purposes of setting rates and reflecting operating results in regulated books of account.

The excess deferred tax reserve is the reserve for deferred taxes computed under prior law over what the reserve for deferred taxes would be if the tax rate in effect under the option had been in effect for all prior periods. The average rate assumption method is the method that reduces the excess deferred tax reserve over the remaining regulatory lives of the property that gave rise to the reserve for deferred taxes. Under this method, the excess deferred tax reserve is reduced as the timing differences (i.e., differences between tax depreciation and regulatory depreciation with respect to each asset or group of assets in the case of vintage accounts) reverse over the life of the asset. The reversal of timing differences generally occurs when the amount of the tax depreciation taken with respect to an asset is less than the amount of the regulatory depreciation taken with respect to the asset. The excess deferred tax reserve is multiplied by a formula that is designed to insure that the excess is reduced to zero at the end of the regulatory life of the asset that generated the reserve.

The amendments made by this option apply to property placed in service after December 31, 2016.

For general research expenditures, a taxpayer may claim a research credit equal to 20 percent of the amount by which the taxpayer's qualified research expenses for a taxable year exceed its base amount for that year.¹⁵² Thus, the research credit is generally available with respect to incremental increases in qualified research. An alternative simplified research credit (with a 14-percent rate and a different base amount) may be claimed in lieu of this credit.¹⁵³

A 20-percent research tax credit also is available with respect to the excess of (1) 100 percent of corporate cash expenses (including grants or contributions) paid for basic research conducted by universities (and certain nonprofit scientific research organizations) over (2) the sum of (a) the greater of two minimum basic research floors plus (b) an amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixed-base period, as adjusted for inflation.¹⁵⁴ This separate credit computation commonly is referred to as the basic research credit.

Finally, a research credit is available for a taxpayer's expenditures on research undertaken by an energy research consortium.¹⁵⁵ This separate credit computation commonly is referred to as the energy research credit. Unlike the other research credits, the energy research credit applies to all qualified expenditures, not just those in excess of a base amount.

The research credit, including the basic research credit and the energy research credit, expires for amounts paid or incurred after December 31, 2014.¹⁵⁶

Computation of general research credit

The general research tax credit applies only to the extent that the taxpayer's qualified research expenses for the current taxable year exceed its base amount. 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 expenses 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 expenses for the 1984-1988 period bears to its total gross receipts for that period (subject to a maximum fixed-base percentage of 16 percent). Special rules apply to all other taxpayers (so called start-up firms).¹⁵⁷ In computing the research credit, a taxpayer's base amount cannot be less than 50 percent of its current-year qualified research expenses.

Alternative simplified credit

The alternative simplified research credit is equal to 14 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding taxable years.¹⁵⁸ The rate is reduced to 6 percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years.¹⁵⁹ An election to use the alternative simplified credit applies to all succeeding taxable years unless revoked with the consent of the Secretary.¹⁶⁰

Eligible expenses

Qualified research expenses eligible for the research tax credit consist of: (1) in-house expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts paid or incurred by the taxpayer to certain other persons for qualified research conducted on the taxpayer's behalf (so-called contract research expenses).¹⁶¹ Notwithstanding the limitation for contract research expenses, qualified research expenses include 100 percent of amounts paid or incurred by the taxpayer to an eligible small business, university, or Federal laboratory for qualified energy research.

To be eligible for the credit, the research not only has to satisfy the requirements of section 174, but also must be undertaken for the purpose of discovering information that is technological in nature, the application of which is intended to be useful in the development of a new or improved business component of the taxpayer, and substantially all of the activities of which constitute elements of a process of experimentation for functional aspects, performance, reliability, or quality of a business component. Research does not qualify for the credit if substantially all of the activities relate to style, taste, cosmetic, or seasonal design factors.¹⁶² In addition, research does not qualify for the credit if: (1) conducted after the beginning of commercial production of the business component; (2) related to the adaptation of an existing business component to a particular customer's requirements; (3) related to the duplication of an existing business component from a physical examination of the component itself or certain other information; (4) related to certain efficiency surveys, management function or technique, market research, market testing, or market development, routine data collection or routine quality control; (5) related to software developed primarily for internal use by the taxpayer; (6) conducted outside the United States, Puerto Rico, or any U.S. possession; (7) in the social sciences, arts, or humanities; or (8) funded by any grant, contract, or otherwise by another person (or government entity).¹⁶³

Relation to deduction

Deductions 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.¹⁶⁴ Taxpayers may alternatively elect to claim a reduced research tax credit amount under section 41 in lieu of reducing deductions otherwise allowed.¹⁶⁵

Specified credits allowed against alternative minimum tax

For any taxable year, the general business credit (which is the sum of the various business credits) generally may not exceed the excess of the taxpayer's net income tax¹⁶⁶ over the greater of (1) the taxpayer's tentative minimum tax or (2) 25 percent of so much of the taxpayer's net regular tax liability¹⁶⁷ as exceeds $25,000.¹⁶⁸ Any general business credit in excess of this limitation may be carried back one year and forward up to 20 years.¹⁶⁹ The tentative minimum tax is an amount equal to specified rates of tax imposed on the excess of the alternative minimum taxable income over an exemption amount.¹⁷⁰ Generally, the tentative minimum tax of a C corporation with average annual gross receipts of less than $7.5 million for prior 3-year periods is zero.¹⁷¹

In applying the tax liability limitation to a list of "specified credits" that are part of the general business credit, the tentative minimum tax is treated as being zero.¹⁷² Thus, the specified credits generally may offset both regular and alternative minimum tax liability ("AMT").

For taxable years beginning in 2010, an eligible small business was allowed to offset both the regular and AMT liability with the general business credits determined for the taxable year ("eligible small business credits").¹⁷³ For this purpose, an eligible small business was, with respect to any taxable year, a corporation, the stock of which was not publicly traded, a partnership, or a sole proprietor, if the average annual gross receipts did not exceed $50 million.¹⁷⁴ Credits determined with respect to a partnership or S corporation were not treated as eligible small business credits by a partner or shareholder unless the partner or shareholder met the gross receipts test for the taxable year in which the credits were treated as current year business credits.¹⁷⁵

This option makes permanent the alternative simplified method for calculating the research credit and increases the rate to 20 percent. That is, the research credit is equal to 20 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding taxable years. The rate is reduced to 10 percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years. The option repeals the traditional 20-percent research credit calculation method.¹⁷⁷

The option is generally effective for taxable years beginning after December 31, 2011. The option to make the research credit permanent applies to amounts paid or incurred after December 31, 2011.

American Research and Competiveness Act of 2015¹⁷⁸

This option makes permanent the alternative simplified method for calculating the research credit and increases the rate to 20 percent. That is, the research credit is equal to 20 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding taxable years. The rate is reduced to 10 percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years. The option repeals the traditional 20-percent research credit calculation method.

The option also makes permanent the basic research credit and the energy research credit (both with credit rates of 20 percent), and changes the base period for the basic research credit from a fixed period to a three-year rolling average.

The option also provides that, in the case of an eligible small business (as defined in section 38(c)(5)(C)), the research credit is a specified credit. Thus, the research credits of an eligible small business may offset both regular and AMT liability.¹⁷⁹

The option is generally effective for taxable years beginning after December 31, 2014. The option to make the research credit permanent applies to amounts paid or incurred after December 31, 2014.

President's fiscal year 2016 budget proposal¹⁸⁰

This option makes the research credit a permanent feature of the Code. However, for expenditures paid or incurred after 2015, the option repeals the traditional 20 percent research credit calculation method. In addition, the option increases the rate of the alternative simplified credit to 18 percent (i.e., the research credit is equal to 18 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding taxable years), but does not reduce such rate if a taxpayer has no qualified research expenses in any one of the three preceding taxable years.

The option also allows the research credit to offset alternative minimum tax liability.

The option also changes the special rules in the research credit to allow, in certain cases, for contract research expenses to include 75 (instead of 65) percent of payments to qualified non-profit organizations (e.g., educational institutions).

In addition, the option repeals the special rule for pass-through entities which limits the pass-through of the research credit to each owner's tax on income allocable to its ownership interest.

Finally, the option repeals the requirement that an individual owner of a pass-through entity who does not materially participate in such business must capitalize and amortize section 174(a) research and experimental expenditures over 10 years when calculating alternative minimum tax liability.

The option is effective for expenditures paid or incurred after December 31, 2015.

A partnership generally is not treated as a taxable entity (except for certain publicly traded partnerships), but rather, is treated as a passthrough entity. Income earned by a partnership, whether distributed or not, is taxed to the partners.¹⁸¹ The character of partnership items passes through to the partners, as if the items were realized directly by the partners.¹⁸²

Publicly traded partnerships

Under present law, a publicly traded partnership generally is treated as a corporation for Federal tax purposes.¹⁸³ A corporation is subject to tax at the corporate level on its taxable income.¹⁸⁴ For this purpose, a publicly traded partnership means any partnership if interests in the partnership are traded on an established securities market, or interests in the partnership are readily tradable on a secondary market (or the substantial equivalent thereof).¹⁸⁵ As of the first day that a partnership is treated as a corporation, the partnership is treated for Federal tax purposes as transferring all its assets (subject to liabilities) to a newly formed corporation in exchange for the stock of the corporation, and distributing the stock to its partners in liquidation of their partnership interests.¹⁸⁶

An exception from corporate treatment is provided for certain publicly traded partnerships, 90 percent or more of whose gross income is qualifying income.¹⁸⁷ Qualifying income includes interest, dividends, and gains from the disposition of a capital asset (or of property described in section 1231(b)) that is held for the production of income that is qualifying income. Qualifying income also includes rents from real property, gains from the sale or other disposition of real property, and income and gains from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber). It also includes income and gains from commodities (not described in section 1221(a)(1)) or futures, options, or forward contracts with respect to such commodities (including foreign currency transactions of a commodity pool) in the case of partnership, a principal activity of which is the buying and selling of such commodities, futures, options or forward contracts.

The option proposed in the Master Limited Partnership Parity Act expands the types of income that publicly traded partnerships may earn without being taxed as a corporation under section 7704. In particular, the option expands the definition of qualifying income to include income generated from certain: (1) renewable power facilities (that produce electricity using resources such as wind, solar, or biomass), (2) electricity storage devices (i.e. utility-scale batteries), (3) combined heat and power facilities, (4) renewable thermal energy projects (similar to renewable power, but where the income is derived from selling heat rather than electricity), (5) waste-heat-to-power projects, (6) renewable fuel infrastructure projects, (7) renewable fuels, (8) renewable chemicals, (9) energy efficient commercial buildings, (10) gasification projects (as defined in section 48B(c)(1)(A) and (B)) that sequester at least 75 percent of their qualified carbon dioxide, and (11) carbon dioxide capture and sequestration (using definitions set forth in section 45Q).

A partnership generally is required to file a Federal income tax return on or before the 15th day of the fourth month after the end of the partnership taxable year.¹⁹⁰ For a partnership with a taxable year that is a calendar year, for example, the partnership return due date (and the date by which Schedules K-1 must be furnished to partners) is April 15. However, a partnership is allowed an automatic five-month extension of time to file the partnership return and the Schedule K-1s (to September 15 in the foregoing example) by submitting an application on Form 7004 in accordance with the rules prescribed by the Treasury regulations.¹⁹¹

A C corporation or an S corporation generally is required to file a Federal income tax return on or before the 15th day of the third month following the close of the corporation's taxable year. For a corporation with a taxable year that is a calendar year, for example, the corporate return due date is March 15.¹⁹² However, a corporation is allowed an automatic six-month extension of time to file the corporate return (to September 15 in the foregoing example) by submitting an application on Form 7004 in accordance with the rules prescribed by the Treasury regulations.¹⁹³

To assist taxpayers in preparing their income tax returns and to help the Internal Revenue Service ("IRS") determine whether such income tax returns are correct and complete, present law imposes a variety of information reporting requirements on participants in certain transactions.¹⁹⁴ The primary provision governing information reporting by payors requires an information return by every person engaged in a trade or business who makes payments aggregating $600 or more in any taxable year to a single payee in the course of the payor's trade or business.¹⁹⁵ Payments subject to reporting include fixed or determinable income or compensation, but do not include payments for goods or certain enumerated types of payments that are subject to other specific reporting requirements.¹⁹⁶ Detailed rules are provided for the reporting of various types of investment income, including interest, dividends, and gross proceeds from brokered transactions (such as a sale of stock) paid to U.S. persons.¹⁹⁷

The payor of amounts described above is required to provide the recipient of the payment with an annual statement showing the aggregate payments made and contact information for the payor.¹⁹⁸ The statement must be supplied to taxpayers by the payors by January 31 of the year following the calendar year for which the return must be filed. Payors generally must file the information return with the IRS on or before the last day of February of the year following the calendar year for which the return must be filed,¹⁹⁹ unless they file electronically, in which event the information returns are due March 31.²⁰⁰

Payors also must report wage amounts paid to employees on information returns. For wages paid to, and taxes withheld from, employees, the payors must file an information return with the Social Security Administration ("SSA") by February 28 of the year following the calendar year for which the return must be filed.²⁰¹ However, the due date for information returns that are filed electronically is March 31.

Under the combined annual wage reporting ("CAWR") system, the SSA and the IRS have an agreement, in the form of a Memorandum of Understanding, to share wage data and to resolve, or reconcile, the differences in the wages reported to them. Employers submit Forms W-2, Wage and Tax Statement (listing Social Security wages earned by individual employees), and W-3, Transmittal of Wage and Tax Statements (providing an aggregate summary of wages paid and taxes withheld) directly to SSA.²⁰² After it records the Forms W-2 and W-3 wage information in its individual Social Security wage account records, SSA forwards the Forms W-2 and W-3 information to IRS.²⁰³

U.S. persons who transfer assets to, and hold interests in, foreign bank accounts or foreign entities may be subject to self-reporting requirements under both Title 26 (the Internal Revenue Code) and Title 31 (the Bank Secrecy Act) of the United States Code. With respect to account holders, a U.S. citizen, resident, or person doing business in the United States is required to keep records and file reports, as specified by the Secretary, when that person enters into a transaction or maintains an account with a foreign financial agency.²⁰⁴ Regulations promulgated pursuant to broad regulatory authority granted to the Secretary in the Bank Secrecy Act²⁰⁵ provide additional guidance regarding the disclosure obligation with respect to foreign accounts. Treasury Department Form TD F 90-22.1, "Report of Foreign Bank and Financial Accounts," (the "FBAR") must be filed by June 30 of the year following the year in which the $10,000 filing threshold is met.²⁰⁶

This option includes the following features: (i) filing deadline for partnerships and S corporations precede the due dates of their individual and corporate investors and (ii) due date for filing returns by C corporations to be determined under general rule, with effect that it is a later return than under present law. It also includes statutory confirmation that six-month extension for time to file corporate income tax return is automatic, conforms the FBAR filing due date with income tax filing dates, and requires regulatory updates to the rules regarding extension of time to file a return.

The option requires that the C corporation return be filed on or before the 15th day of the fourth month after the close of a taxable year, or April 15 in the case of a calendar year taxpayer.

The option requires that the Treasury Department modify its regulations that establish extensions of due dates by conforming the extension periods to the following terms. The maximum extension for the returns of partnerships using a calendar year is a six-month period ending on September 15. The maximum extension for the returns of trusts using a calendar year is a 5-1/2 month period ending on September 30. The maximum extension for the returns of employee benefit plans using a calendar year is an automatic 3-1/2 month period ending on November 15. The maximum extension for the returns of tax-exempt organizations using a calendar year is an automatic six-month period ending on November 15. The due date for forms relating to the Annual Information Return of Foreign Trust with a United States Owner for calendar year filers is April 15 with a maximum extension for a six-month period ending on October 15.

The Internal Revenue Service Restructuring and Reform Act of 1998 ("RRA 1998")²⁰⁸ states a Congressional policy to promote the paperless filing of Federal tax returns. Section 2001(a) of RRA 1998 set a goal for the IRS to have at least 80 percent of all Federal tax and information returns filed electronically by 2007.²⁰⁹ Section 2001(b) of RRA 1998 requires the IRS to establish a 10-year strategic plan to eliminate barriers to electronic filing.

Present law requires the Secretary to issue regulations regarding electronic filing and specifies certain limitations on the rules that may be included in such regulations.²¹⁰ The statute requires that Federal income tax returns prepared by specified tax return preparers be filed electronically,²¹¹ and that all partnerships with more than 100 partners be required to file electronically. For taxpayers other than partnerships, the statute prohibits any requirement that persons who file fewer than 250 returns during a calendar year file electronically. With respect to individuals, estates, and trusts, the Secretary may permit, but generally cannot require, electronic filing of income tax returns. In crafting any of these required regulations, the Secretary must take into account the ability of taxpayers to comply at reasonable cost.

The regulations require corporations that have assets of $10 million or more and file at least 250 returns during a calendar year to file electronically their Form 1120/1120S income tax returns and Form 990 information returns for tax years ending on or after December 31, 2006. In determining whether the 250 return threshold is met, income tax, information, excise tax, and employment tax returns filed within one calendar year are counted.

Tax-exempt organizations

Most tax-exempt organizations are required to file annual information returns in the Form 990 series. Since 2007, the smallest organizations -- generally, those with gross receipts of less than $50,000 -- may provide an abbreviated notice on Form 990-N, sometimes referred to as an "e-postcard." Which form to file depends on the annual receipts, value of assets, and types of activities of the exempt entity. The Forms 990, 990-EZ, and 990-PF are released to the public on DVDs.

In general, only the largest and smallest tax-exempt organizations are required to electronically file their annual information returns. First, as indicated above, tax-exempt corporations that have assets of $10 million or more and that file at least 250 returns during a calendar year must electronically file their Form 990 information returns. Private foundations and charitable trusts, regardless of asset size, that file at least 250 returns during a calendar year are required to file electronically their Form 990-PF information returns.²¹² Finally, organizations that file Form 990-N (the e-postcard) also must electronically file.²¹³

Section 501(a) exempts certain organizations from Federal income tax. Such organizations include: (1) tax-exempt organizations described in section 501(c) (including among others section 501(c)(3) charitable organizations and section 501(c)(4) social welfare organizations); (2) religious and apostolic organizations described in section 501(d); and (3) trusts forming part of a pension, profit-sharing, or stock bonus plan of an employer described in section 401(a).

Recognition of exempt status

In order for an organization to be granted tax exemption as a charitable entity described in section 501(c)(3), it must file an application for recognition of exemption with the IRS and receive a favorable determination of its status.²¹⁵ For most section 501(c)(3) organizations, eligibility to receive tax-deductible contributions similarly is dependent upon its receipt of a favorable determination from the IRS. In general, a section 501(c)(3) organization can rely on a determination letter or ruling from the IRS regarding its tax-exempt status, unless there is a material change in its character, purposes, or methods of operation. In cases where an organization violates one or more of the requirements for tax exemption under section 501(c)(3), the IRS generally may revoke an organization's tax exemption, notwithstanding an earlier favorable determination.

Many other types of organizations exempt from tax under section 501(c) may, but are not required to, file an application for recognition of exempt status. This includes organizations described in sections of 501(c)(4) (social welfare and certain other organizations), 501(c)(5) (labor and horticultural organizations), and 501(c)(6) (business leagues, trade associations, etc.).

Declaratory judgment procedure

Present law authorizes an organization to seek a declaratory judgment regarding its tax-exempt status as a remedy if the IRS denies its application for recognition of exemption under section 501(c)(3), fails to act on such an application, or informs a section 501(c)(3) organization that it is considering revoking or adversely modifying its tax-exempt status.²¹⁶ The right to seek a declaratory judgment arises in the case of a dispute involving a determination by the IRS with respect to: (1) the initial qualification or continuing qualification of an organization as a charitable organization for tax exemption purposes or for charitable contribution deduction purposes; (2) the initial classification or continuing classification of an organization as a private foundation; (3) the initial classification or continuing classification of an organization as a private operating foundation; or (4) the failure of the IRS to make a determination with respect to (1), (2), or (3).²¹⁷ A "determination" in this context generally means a final decision by the IRS affecting the tax qualification of a charitable organization. Section 7428 vests jurisdiction over controversies involving such a determination in the U.S. District Court for the District of Columbia, the U.S. Court of Federal Claims, and the U.S. Tax Court.²¹⁸

Prior to utilizing the declaratory judgment procedure, an organization must have exhausted all administrative remedies available to it within the IRS.²¹⁹ For the first 270 days after a request for a determination is made and before the IRS informs the organization of its decision, an organization is deemed not to have exhausted its administrative remedies. If no determination is made during the 270-day period, the organization may initiate an action for declaratory judgment after the period has elapsed. If, however, the IRS makes an adverse determination during the 270-day period, an organization may immediately seek declaratory relief. The 270-day period does not begin with respect to applications for recognition of tax-exempt status until the date a substantially completed application is submitted.

Under present law, a non-charity (i.e., an organization not described in section 501(c)(3)) may not seek a declaratory judgment with respect to an IRS determination regarding its tax-exempt status. In general, such an organization must petition the U.S. Tax Court for relief following the issuance of a notice of deficiency or pay any tax owed and file a refund action in Federal district court or the U.S. Court of Federal Claims.

The option also modifies section 7428 with regard to the court or courts from which an organization may seek a declaratory judgment. Under the option, an organization may seek a declaratory judgment from the U.S. Tax Court in the case of any type of determination or failure to which the declaratory judgment rules apply. An organization may seek a declaratory judgment from the U.S. Court of Federal Claims or the U.S. District Court for the District of Columbia, however, only in the case of determinations or failures relating to: (1) the initial qualification or continuing of an organization as an organization described in section 501(c)(3) or 170(c)(2); (2) the initial qualification or continuing classification of an organization as a private foundation (as defined in section 509(a)) or a private operating foundation (as defined in section 4942(j)(3)); or (3) the initial classification or continuing classification of a cooperative as an organization described in section 521(b).

Under section 4940(a), private foundations that are recognized as exempt from Federal income tax under section 501(a) (other than exempt operating foundations) are subject to a two-percent excise tax on their net investment income. Net investment income generally includes interest, dividends, rents, royalties (and income from similar sources), and capital gain net income, and is reduced by expenses incurred to earn this income. The two-percent rate of tax is reduced to one percent in any year in which a foundation exceeds the average historical level of its charitable distributions. Specifically, the excise tax rate is reduced if the foundation's qualifying distributions (generally, amounts paid to accomplish exempt purposes)²²¹ equal or exceed the sum of (1) the amount of the foundation's assets for the taxable year multiplied by the average percentage of the foundation's qualifying distributions over the five taxable years immediately preceding the taxable year in question, and (2) one percent of the net investment income of the foundation for the taxable year.²²² In addition, the foundation cannot have been subject to tax in any of the five preceding years for failure to meet minimum qualifying distribution requirements in section 4942.

Private foundations that are not exempt from tax under section 501(a), such as certain charitable trusts, are subject to an excise tax under section 4940(b). The tax is equal to the excess of the sum of the excise tax that would have been imposed under section 4940(a) if the foundation were tax exempt and the amount of the tax on unrelated business income that would have been imposed if the foundation were tax exempt, over the income tax imposed on the foundation under subtitle A of the Code.

Private foundations are required to make a minimum amount of qualifying distributions each year to avoid tax under section 4942. The minimum amount of qualifying distributions a foundation has to make to avoid tax under section 4942 is reduced by the amount of section 4940 excise taxes paid.²²³

Exempt operating foundations

Exempt operating foundations are exempt from the tax on the net investment income of private foundations.²²⁴ Exempt operating foundations generally include organizations such as museums or libraries that devote their assets to operating charitable programs but have difficulty meeting the "public support" tests necessary not to be classified as a private foundation. To be an exempt operating foundation, an organization must: (1) be an operating foundation (as defined in section 4942(j)(3)); (2) be publicly supported for at least 10 taxable years; (3) have a governing body no more than 25 percent of whom are disqualified persons and that is broadly representative of the general public; and (4) have no officers who are disqualified persons.²²⁵

² For the years 2003 through 2006, the relevant dollar amount is $400,000 (indexed for inflation); in 2007, the dollar limitation is $500,000; for the 2008 and 2009 years, the relevant dollar amount is $800,000; and for the years 2010 through 2013, the relevant dollar limitation is $2,000,000. Sec. 179(b)(2).

³ Passenger automobiles subject to the section 280F limitation are eligible for section 179 expensing only to the extent of the dollar limitations in section 280F. For sport utility vehicles above the 6,000 pound weight rating, which are not subject to the limitation under section 280F, the maximum cost that may be expensed for any taxable year under section 179 is $25,000. Sec. 179(b)(5).

⁴ Sec. 179(d)(1) flush language.

⁵ Sec. 179(d)(1)(A)(ii) and (f).

⁶ Sec. 179(f)(3).

⁷ Sec. 179(b)(3).

⁸ Section 179(f)(4) details the special rules that apply to disallowed amounts with respect to qualified real property.

⁹ For example, assume that during 2013, a company's only asset purchases are section 179-eligible equipment costing $100,000 and qualifying leasehold improvements costing $200,000. Assume the company has no other asset purchases during 2013, and has a taxable income limitation of $150,000. The maximum section 179 deduction the company can claim for 2013 is $150,000, which is allocated pro rata between the properties, such that the carryover to 2014 is allocated $100,000 to the qualified leasehold improvements and $50,000 to the equipment.

Assume further that in 2014, the company had no asset purchases and had no taxable income. The $100,000 carryover from 2013 attributable to qualified leasehold improvements is treated as placed in service as of the first day of the company's 2014 taxable year under section 179(f)(4)(C). The $50,000 carryover allocated to equipment is carried over to 2014 under section 179(b)(3)(B).

¹⁰ Sec. 179(d)(9).

¹¹ Sec. 312(k)(3)(B).

¹² Sec. 179(c)(1).

¹³ Sec. 179(c)(2).

¹⁴ S. 1399 (114^th Cong.), introduced May 20, 2015, by Sen. Michael Bennet.

¹⁵ H.R. 636 (114^th Cong.), introduced February 2, 2015, by Rep. Patrick Tiberi; passed House February 13, 2015. See also, H.R. Rep. No. 114-21.

¹⁶ As submitted to the Congress on February 2, 2015. See Office of Management and Budget, Budget of the U.S. Government, Fiscal Year 2016: Analytical Perspectives (H. Doc. 114-3, Vol. III), February 2, 2015, pp. 149-204.

¹⁷ See, e.g., sec. 451.

¹⁸ See, e.g., sec. 461.

¹⁹ See, e.g., sec.166.

²⁰ Treas. Reg. secs. 1.446-1(c)(2) and 1.471-1.

²¹ Sec. 471; Ibid.

²² Sec. 448(d)(1).

²³ However, section 447 generally requires a farming C corporation (and any farming partnership if a corporation is a partner in such partnership) to use an accrual method of accounting. Section 447 does not apply to nursery or sod farms, to the raising or harvesting of trees (other than fruit and nut trees), nor to farming C corporations meeting a gross receipts test with a $1 million threshold. For family farm C corporations, the threshold under the gross receipts test is $25 million. For farmers, nurserymen, and florists not required by section 447 to capitalize preproductive period expenses, section 352 of the Revenue Act of 1978 (Pub. L. No. 95-600) provides that such taxpayers are not required to inventory growing crops.

²⁴ Sec. 448(d)(5).

²⁵ MCG13833, available at http://www.finance.senate.gov/newsroom/chairman/release/index.cfm: "Baucus Works to Overhaul Outdated Tax Code," November 21, 2013. See also, Joint Committee on Taxation, Technical Explanation of the Senate Committee on Finance Chairman's Staff Discussion Draft to Reform Certain Business Options (JCX-19-13), November 21, 2013.

²⁶ As a conforming amendment, the option also repeals the exception from the requirement to inventory growing crops provided in section 352 of the Revenue Act of 1978 (Pub. L. No. 95-600).

²⁷ Thus, such taxpayers will not be required to use an accrual method by reason of Treas. Reg. sec. 1.446-1(c)(2).

²⁸ H.R. 1 (113^th Cong.), introduced December 10, 2014, by then-Chairman of the Ways and Means Committee Dave Camp.

²⁹ Consistent with present law, the cash method generally may not be used if the purchase, production, or sale of merchandise is an income producing factor.

³⁰ "Elected taxable year" means such taxable year as the taxpayer may elect (as prescribed by the Secretary) which begins after December 31, 2014, and is before the taxpayer's second taxable year beginning after December 31, 2018.

³¹ As submitted to the Congress on February 2, 2015. See Office of Management and Budget, Budget of the U.S. Government, Fiscal Year 2016: Analytical Perspectives (H. Doc. 114-3, Vol. III), February 2, 2015, pp. 149-204.

³² Consistent with present law, the cash method generally may not be used by taxpayers who do not meet the gross receipts test if the purchase, production, or sale of merchandise is an income-producing factor.

³³ A C corporation is so named because its Federal tax treatment is governed by subchapter C of the Internal Revenue Code of 1986, as amended (the "Code").

³⁴ Distributions with respect to stock that exceed corporate earnings and profits are not taxed as dividend income to shareholders but are treated as a tax-free return of capital that reduces the shareholder's basis in the stock. Distributions in excess of corporate earnings and profits that exceed a shareholder's basis in the stock are treated as amounts received in exchange for the stock which, in general, are taxed to the shareholder at capital gains rates. Sec. 301(c).

³⁵ Sec. 11.

³⁶ Sec. 56(d)(2). The exemption amount is phased out for corporations with income above certain thresholds.

³⁷ An S corporation is so named because its Federal tax treatment is governed by subchapter S of the Code.

³⁸ Sec. 1363.

³⁹ Sec. 1366.

⁴⁰ Sec. 1361. For this purpose, a husband and wife and all members of a family are treated as one shareholder. Sec. 1361(c)(1).

⁴¹ Sec. 1362.

⁴² Sec. 701.

⁴³ Sec. 702(a).

⁴⁴ Sec. 704(d).

⁴⁵ Secs. 1(a), (c) and (i).

⁴⁶ Sec. 1(h).

⁴⁷ Sec. 1(h)(11).

⁴⁸ Sec. 199.

⁴⁹ However, for taxpayers that have qualified income related to the production, refining, processing, transportation, or distribution of oil, gas, or any primary product thereof (collectively, "oil related production activities income"), the deduction is limited to six percent of its oil related production activities income. Sec. 199(d)(9).

⁵⁰ In the case of corporate taxpayers that are members of certain affiliated groups, the deduction is determined by treating all members of such groups as a single taxpayer and the deduction is allocated among such members in proportion to each member's respective amount (if any) of qualified production activities income. Members of an expanded affiliated group for purposes of the provision generally include those corporations which would be members of an affiliated group if such membership were determined based on an ownership threshold of "more than 50 percent" rather than "at least 80 percent."

⁵¹ For purposes of the provision, wages include the sum of the amounts of wages as defined in section 3401(a) (i.e., wages subject to income tax withholding) and elective deferrals that the taxpayer properly reports to the Social Security Administration with respect to the employment of employees of the taxpayer during the calendar year ending during the taxpayer's taxable year. Elective deferrals include elective deferrals as defined in section 402(g)(3), amounts deferred under section 457, and, for taxable years beginning after December 31, 2005, designated Roth contributions (as defined in section 402A).

⁵² For purposes of determining such costs, any item or service that is imported into the United States without an arm's length transfer price is treated as acquired by purchase, and its cost shall be treated as not less than its value when it entered the United States. A similar rule applies in determining the adjusted basis of leased or rented property where the lease or rental gives rise to domestic production gross receipts. With regard to property previously exported by the taxpayer for further manufacture, the increase in cost or adjusted basis may not exceed the difference between the value of the property when exported and the value of the property when re-imported into the United States after further manufacture. Except as provided by the Secretary, the value of property for this purpose is its customs value (as defined in section 1059A(b)(1)).

⁵³ See Treas. Reg. secs. 1.199-1 through 1.199-9 prescribing rules for the proper allocation of items of income, deduction, expense, and loss for purposes of determining qualified production activities income. Where appropriate, such rules are similar to and consistent with relevant present-law rules (e.g., sec. 263A, in determining the cost of goods sold, and sec. 861, in determining the source of such items). Other deductions, expenses or losses that are directly allocable to such receipts include, for example, selling and marketing expenses. A proper share of other deductions, expenses, and losses that are not directly allocable to such receipts or another class of income include, for example, general and administrative expenses allocable to selling and marketing expenses. In computing qualified production activities income, the domestic production activities deduction itself is not an allocable deduction.

⁵⁴ Domestic production gross receipts include gross receipts of a taxpayer derived from any sale, exchange, or other disposition of agricultural products with respect to which the taxpayer performs storage, handling, or other processing activities (other than transportation activities) within the United States, provided such products are consumed in connection with, or incorporated into, the manufacturing, production, growth, or extraction of qualifying production property (whether or not by the taxpayer).

⁵⁵ For this purpose, construction activities include activities that are directly related to the erection or substantial renovation of residential and commercial buildings and infrastructure. Substantial renovation would include structural improvements, but not mere cosmetic changes, such as painting that is not performed in connection with activities that otherwise constitute substantial renovation.

⁵⁶ With regard to the definition of "domestic production gross receipts" as it relates to construction performed in the United States and engineering or architectural services performed in the United States for construction projects in the United States, the term refers only to gross receipts derived from the construction of real property by a taxpayer engaged in the active conduct of a construction trade or business, or from engineering or architectural services performed with respect to real property by a taxpayer engaged in the active conduct of an engineering or architectural services trade or business.

⁵⁷ Sec. 199(c)(7). In general, principles similar to those under the extraterritorial income regime apply for this purpose. See Temp. Treas. Reg. sec. 1.927(a)-1T(f)(2)(i). For example, this exclusion generally does not apply to property leased by the taxpayer to a related person if the property is held for sublease, or is subleased, by the related person to an unrelated person for the ultimate use of such unrelated person. Similarly, the license of computer software to a related person for reproduction and sale, exchange, lease, rental or sublicense to an unrelated person for the ultimate use of such unrelated person is not treated as excluded property by reason of the license to the related person.

⁵⁸ Sec. 199(c)(4)(B).

⁵⁹ See Treas. Reg. sec. 1.199-3(k).

⁶⁰ To the extent that a taxpayer has included an estimate of participations and/or residuals in its income forecast calculation under section 167(g), the taxpayer must use the same estimate of participations and/or residuals for purposes of determining total compensation.

⁶¹ Treas. Reg. sec. 1.199-2.

⁶² Sec. 199(b)(2)(D). Effective for tax years beginning after December 31, 2007.

⁶³ Sec. 199(d)(1)(A)(i).

⁶⁴ Sec. 199(d)(1)(A)(ii).

⁶⁵ Sec. 199(d)(1)(A)(iii).

⁶⁶ See Treas. Reg. secs. 1.199-5(d) and (e).

⁶⁷ For this purpose, agricultural or horticultural products also include fertilizer, diesel fuel and other supplies used in agricultural or horticultural production that are manufactured, produced, grown, or extracted by the cooperative.

⁶⁸ H.R. 9, the "Small Business Tax Cut Act" (112th Congress), was introduced March 21, 2012, by Mr. Cantor with additional cosponsors and was referred to the Committee on Ways and Means. It was reported (as amended) by the Committee on Ways and Means on April 10, 2012 (H. Rep. 112-425, the Small Business Tax Cut Act, 112^th Cong., 2d Sess., April 10, 2012)), and was passed by the House of Representatives on April 19, 2012. The bill was received in the Senate April 23, 2012, and referred to the Committee on Finance.

⁶⁹ For example, any amount paid to a household employee unrelated to the employer's trade or business is not allowed as a deduction under section 162 since the amount is not an ordinary and necessary business expense. However, amounts paid to employees engaged in the trade or business (regardless of whether such amounts are capitalized into the inventory or under any other provision requiring capitalization) would be qualifying wages for this provision, to the extent such wages are allocable to domestic business gross receipts.

⁷⁰ For this purpose, family includes only brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendents.

⁷¹ Sections 267(c) and (e)(3) provide constructive ownership rules for stock and passthrough entities. Section 267(c)(2) treats an individual as owning interests owned by the individual's family.

⁷² The term full-time equivalent employees for this purpose has the meaning given under section 45R(d)(2), without regard to section 45R(d)(5) and (e)(1) and by applying that subsection on a calendar year rather than a taxable year basis. Thus, for this purpose, seasonal employees and self-employed individuals, including partners and sole proprietors, two percent shareholders of an S corporation and five percent owners of the employer are included in the calculation of an employer's FTEs.

⁷³ For employees who work in excess of 2,080 hours during any taxable year, the excess is not taken into account. See sec. 45R(d)(2)(B).

⁷⁴ See sec. 199(d)(1) and (3).

⁷⁵ See sec. 199(d)(2).

⁷⁶ Members of an expanded affiliated group for purposes of this provision generally include those corporations which would be members of an affiliated group if such membership were determined based on an ownership threshold of "more than 50 percent" rather than "at least 80 percent."

⁷⁷ See sec. 199(d)(4).

⁷⁸ Lower rates apply to the first $75,000 of taxable income. The benefits of the lower rates are phased-out.

⁷⁹ Secs. 246(c) and 1059.

⁸⁰ Sec. 246A.

⁸¹ The description reflects the proposal as set forth in H.R. 2 (introduced by Chairman Thomas) and S. 2 (introduced by Senators Nickles and Miller) on February 27, 2003.

⁸² Jobs and Growth Tax Relief Reconciliation Act of 2003, Pub. L. No. 108-27. See H. Rep. 108-126, Conference Report to accompany H.R. 2 (May 22, 2003). See also, Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 108th Congress (JCS-5-05), May 2005.

⁸³ Joint Committee on Taxation, Description of Revenue Provisions Contained in the President's Fiscal Year 2004 Budget Proposal (JCS-7-03), March 2003.

⁸⁴ Certain taxable dividends received by a parent corporation from a subsidiary and taxable dividends received by a small business investment company will continue to receive a 100-percent dividends-received deduction to the extent not excludable.

⁸⁵ For this purpose, the income tax includes the taxes imposed on a corporation by sections 11 (corporate income tax), 55 (alternative minimum tax), 511 (unrelated business income tax), 801 (life insurance company income tax), 831 (nonlife insurance company income tax), 882 (income tax on foreign corporations connected with U.S. business), 1201 (alternative capital gain tax), and 1291 (without regard to section 1291(c)(1)(B)) (tax on distributions from a passive foreign investment companies) and 1374 (tax on built-in gains of S corporations). It also includes the accumulated earnings tax and the personal holding company tax prior to their repeal by the proposal.

⁸⁶ For this purpose, a timely filed return is treated as filed in the calendar year which includes the date that is the 15^th day of the 9^th month following the close of the corporation's taxable year.

⁸⁷ A corporation whose taxable year ends April 30, 2001, and that files a timely income tax return and pays the tax is treated for purposes of computing an EDA as having filed the return on January 15, 2002 (the date that is the 15^th day of the 9^th month following the close of the taxable year).

⁸⁸ For purposes of this description, these distributions are referred to as distributions from a CREBAA.

⁸⁹ For example, the applicable income taxes imposed shown on a return filed in the final year the corporation was a C corporation or the first year the corporation is an S corporation are taken into account in computing the EDA for years the corporation is an S corporation. Any tax imposed by reason of the LIFO recapture rules of section 1363(d) will be taken into account in computing the corporation's EDA under the usual rules relating to the filing of returns and the payment of tax.

⁹⁰ The tax imposed by section 1374 will no longer pass through to shareholders as a loss sustained by the S corporation.

⁹¹ A C corporation loss reduced the earnings and profits (or increased a deficit in earnings and profits) for the taxable year that the loss arose.

⁹² In the case of preferred stock, the periods are doubled.

⁹³ For this purpose, the holding period of stock acquired from a decedent is determined without regard to the rule otherwise providing for long-term capital gain treatment for the stock (sec. 1223(11)).

⁹⁴ This effective date prevents a change in the taxation of S corporation shareholders for taxable years beginning before January 1, 2003.

⁹⁵ Sec. 167(a).

⁹⁶ The Tax Reform Act of 1986, Pub. L. No. 99-514, sec. 201 (1986).

⁹⁷ Exercising authority granted by Congress, the Secretary issued Revenue Procedure 87-56 (1987-2 C.B. 674), laying out the framework of recovery periods for enumerated classes of assets. The Secretary clarified and modified the list of asset classes in Revenue Procedure 88-22 (1988-1 C.B. 785). In November 1988, Congress revoked the Secretary's authority to modify the class lives of depreciable property. Revenue Procedure 87-56, as modified, remains in effect except to the extent that the Congress has, since 1988, statutorily modified the recovery period for certain depreciable assets, effectively superseding any administrative guidance with regard to such property.

⁹⁸ Under the declining balance method the depreciation rate is determined by dividing the appropriate percentage (here 150 or 200) by the appropriate recovery period. This leads to accelerated depreciation when the declining balance percentage is greater than 100. The table below illustrates depreciation for an asset with a cost of $1,000 and a seven-year recovery period under the 200-percent declining balance method, the 150-percent declining balance method, and the straight-line method.

 

[ Editor's Note: For a searchable version of the table,

 

see , p. 94.]

 

 

 

¹⁰⁰ Secs. 168(d)(2) and (d)(4)(B).

¹⁰¹ Secs. 168(d)(1) and (d)(4)(A).

¹⁰² The mid-quarter convention treats all property placed in service (or disposed of) during any quarter as placed in service (or disposed of) on the mid-point of such quarter. Secs. 168(d)(3) and (d)(4)(C).

¹⁰³ Sec. 168(g).

¹⁰⁴ Sec. 168(g)(7).

¹⁰⁵ Sec. 168(g)(2).

¹⁰⁶ Sec. 1031(a)(1).

¹⁰⁷ Sec. 1031(a)(2).

¹⁰⁸ Sec. 1033(a).

¹⁰⁹ Rev. Rul. 58-11, 1958-1 C.B. 273.

¹¹⁰Ibid. If the replacement property is stock of a corporation and if the stock basis is decreased under this rule, the aggregate basis of the corporation's assets is likewise decreased by the same amount (but not below that stock basis as so decreased). Sec. 1033(b)(3).

¹¹¹ Sec. 1033(a)(2)(A).

¹¹² Sec. 1033(a)(2)(B).

¹¹³ Sec. 1033(b).

¹¹⁴ MCG13833, available at http://www.finance.senate.gov/newsroom/chairman/release/index.cfm: "Baucus Works to Overhaul Outdated Tax Code," November 21, 2013. See also, Joint Committee on Taxation, Technical Explanation of the Senate Committee on Finance Chairman's Staff Discussion Draft to Reform Certain Business Options (JCX-19-13), November 21, 2013.

¹¹⁵ "Sound recordings" are any works resulting from the fixation of a series of musical, spoken, or other sounds, regardless of the nature of the material (e.g., discs, tapes, or other phonorecordings) in which such sounds are embodied.

¹¹⁶ Except where noted, the classification is based on the asset class categorization provided in Rev. Proc. 87-56, 1987-2 C.B. 674. Any reference to Rev. Proc. 87-56 shall include any amendment to such revenue procedure (e.g., Rev. Proc. 88-22, 1988-1 C.B. 785). The assignment of asset classes based on the categorization provider in Rev. Proc. 87-56 is not intended to disrupt IRS guidance (e.g., Rev. Proc. 2011-22, 2011 I.R.B. 737).

¹¹⁷ The section number refers to computer software described in such section of the discussion draft.

¹¹⁸ "TOCSC" stands for telegraph, ocean cable, and satellite communications.

¹¹⁹ The section number refers to an asset defined in such section as in effect for taxable years beginning in 2014.

¹²⁰ The section number refers to an asset defined in such section as in effect for taxable years beginning in 2014.

¹²¹ "CATV" stands for cable television.

¹²² "Section 1245 property" refers to an asset defined under such section as in effect for taxable years beginning in 2014.

¹²³ The section number refers to an asset described in such section as in effect for taxable years beginning in 2014.

¹²⁴ The term "any pooled property held by the taxpayer" includes pooled property with zero adjusted basis.

¹²⁵ For this purpose, the relevant subsections are (b)(2)(E), (b)(5), and (c)(1) of section 108, as amended by the discussion draft.

¹²⁶ For this purpose, the relevant subsections are (b)(2)(E), (b)(5), and (c)(1) of section 108, as amended by the discussion draft.

¹²⁷ A person is treated as related to another person if such relationship exists immediately before or immediately after the acquisition of the property involved.

¹²⁸ For a discussion of section 1245 gain, see Section 12, Rules related to treatment of gains from depreciable property.

¹²⁹ Rev. Proc. 87-56, 1987-2 C.B. 674. Any reference to Rev. Proc. 87-56 shall include any amendment to such revenue procedure (e.g., Rev. Proc. 88-22, 1988-1 C.B. 785).

¹³⁰ Except where noted, the classification is based on the asset class categorization provided in Rev. Proc. 87-56, 1987-2 C.B. 674. Any reference to Rev. Proc. 87-56 shall include any amendment to such revenue procedure (e.g., Rev. Proc. 88-22, 1988-1 C.B. 785).

¹³¹ The section number refers to an asset defined in such section as in effect for taxable years beginning in 2014.

¹³² The section number refers to an asset defined in such section as in effect for taxable years beginning in 2014.

¹³³ The section number refers to an asset defined in such section as in effect for taxable years beginning in 2014.

¹³⁴ The first year the real property is placed in service is considered an entire year for purposes of the transition rule. For example, assume a calendar-year taxpayer places real property in service in June of 2012 and begins depreciating such amount. For purposes of the transition, the taxpayer is deemed to have amortized the intangible for four years as of January 1, 2015. Therefore, the remaining basis of the real property as of January 1, 2015 is depreciated over 39 years (43 years minus four years for which the real property had already been depreciated).

¹³⁵ Prior to enactment of this option, the taxpayer would have taken $16,500 (half of $907,500 divided by 27.5 years) of depreciation for the first year and $33,000 of depreciation ($907,500 divided by 27.5 years) for the subsequent nine years (January 1, 2006 to December 31, 2014).

¹³⁶ For purposes of this transition rule only, the computation is made as if the remaining basis of the property was placed in service on the first day of the taxable year for which the option is effective and disposed of on the last day of the final taxable year in question. If the property is disposed of prior to being fully depreciated, the mid-month convention for determining the depreciation for the year of disposition applies.

¹³⁷ In the case of a truck or van, "gross vehicle weight" is replaced with "unloaded gross vehicle weight."

¹³⁸ The $45,000 limitation is provided in section 13 of the discussion draft, Limitation on depreciation of personal use passenger automobiles, modifying section 280F.

¹³⁹ See section 13 of the discussion draft, Limitation on depreciation of personal use passenger automobiles, for a further discussion of personal-use automobiles.

¹⁴⁰ The first year the personal-use passenger automobile is placed in service is considered an entire year for purposes of the transition rule.

¹⁴¹ Unless otherwise noted, any reference to the "Secretary" means the Secretary of the Treasury.

¹⁴² It is expected that the Secretary of the Treasury will consult with the Bureau of Economic Analysis within the Commerce Department, which estimates economic depreciation for purposes of the National Income and Product Accounts. The purpose of these estimates is to measure the consumption of fixed capital for purposes of accurately measuring the components of gross domestic product.

¹⁴³ See section _14 of the discussion draft, Limitation on depreciation to property predominantly used in a trade or business, for new section 167(i).

¹⁴⁴Ibid.

¹⁴⁵ For pooled property, it is intended that the related party rules requiring the computation of a recomputed basis for the converted personal-use property apply. Authority is granted to the Secretary to provide rules for changes in the business use percentage between 50 percent and 100 percent.

¹⁴⁶ H.R. 1 (113^th Cong.), introduced December 10, 2014, by then Chairman Dave Camp.

¹⁴⁷ See, e.g., Rev. Proc. 87-56 (1987-2 C.B. 674) for class lives of certain property.

¹⁴⁸ While the option increases the recovery period for fixed wing aircraft from six years to 12 years, the recovery period for helicopters remains unchanged from present law (i.e., remains the six-year class life).

¹⁴⁹ Once elected, the taxpayer is required to apply the inflation adjustment percentage to such property for all subsequent taxable years.

¹⁵⁰ The increase for the first taxable year is reduced to take into account the placed in service convention applicable to the property (i.e., reduced by one-eighth for property subject to the mid-quarter convention, and reduced by one-half for all other property).

¹⁵¹ For a discussion of the indexing tax provisions for inflation, see the description of section 1001 of the discussion draft, "Simplification of individual income tax rates."

¹⁵² Sec. 41(a)(1). Except where otherwise specified, all section references are to the Internal Revenue Code of 1986, as amended (the "Code").

¹⁵³ Sec. 41(c)(5).

¹⁵⁴ Sec. 41(a)(2) and (e). The base period for the basic research credit generally extends from 1981 through 1983.

¹⁵⁵ Sec. 41(a)(3).

¹⁵⁶ Sec. 41(h).

¹⁵⁷ The Small Business Job Protection Act of 1996 expanded the definition of start-up firms under section 41(c)(3)(B)(i) to include any firm if the first taxable year in which such firm had both gross receipts and qualified research expenses began after 1983. A special rule (enacted in 1993) is designed to gradually recompute a start-up firm's fixed-base percentage based on its actual research experience. Under this special rule, a start-up firm is assigned a fixed-base percentage of three percent for each of its first five taxable years after 1993 in which it incurs qualified research expenses. A start-up firm's fixed-base percentage for its sixth through tenth taxable years after 1993 in which it incurs qualified research expenses is a phased-in ratio based on the firm's actual research experience. For all subsequent taxable years, the taxpayer's fixed-base percentage is its actual ratio of qualified research expenses to gross receipts for any five years selected by the taxpayer from its fifth through tenth taxable years after 1993. Sec. 41(c)(3)(B).

¹⁵⁸ Sec. 41(c)(5)(A).

¹⁵⁹ Sec. 41(c)(5)(B).

¹⁶⁰ Sec. 41(c)(5)(C).

¹⁶¹ Under a special rule, 75 percent of amounts paid to a research consortium for qualified research are treated as qualified research expenses eligible for the research credit (rather than 65 percent under the general rule under section 41(b)(3) governing contract research expenses) if (1) such research consortium is a tax-exempt organization that is described in section 501(c)(3) (other than a private foundation) or section 501(c)(6) and is organized and operated primarily to conduct scientific research, and (2) such qualified research is conducted by the consortium on behalf of the taxpayer and one or more persons not related to the taxpayer. Sec. 41(b)(3)(C).

¹⁶² Sec. 41(d)(3).

¹⁶³ Sec. 41(d)(4).

¹⁶⁴ Sec. 280C(c).

¹⁶⁵ Sec. 280C(c)(3).

¹⁶⁶ The term "net income tax" means the sum of the regular tax liability and the alternative minimum tax, reduced by the credits allowable under sections 21 through 30D. Sec. 38(c)(1).

¹⁶⁷ The term "net regular tax liability" means the regular tax liability reduced by the sum of certain nonrefundable personal and other credits. Sec. 38(c)(1).

¹⁶⁸ Sec. 38(c)(1).

¹⁶⁹ Sec. 39(a)(1).

¹⁷⁰ See sec. 55(b). For example, assume a taxpayer has a regular tax of $80,000, a tentative minimum tax of $100,000, and a research credit determined under section 41 of $90,000 for a taxable year (and no other credits). Under present law, the taxpayer's research credit is limited to the excess of $100,000 over the greater of (1) $100,000 or (2) $13,750 (25% of the excess of $80,000 over $25,000). Accordingly, no research credit may be claimed ($100,000 - $100,000 = $0) for the taxable year and the taxpayer's net tax liability is $100,000. The $90,000 research credit may be carried back or forward under the rules applicable to the general business credit.

¹⁷¹ Sec. 55(e).

¹⁷² See section 38(c)(4)(B) for the list of specified credits, which does not presently include the research credit determined under section 41.

¹⁷³ Sec. 38(c)(5)(B).

¹⁷⁴ Sec. 38(c)(5)(C).

¹⁷⁵ Sec. 38(c)(5)(D).

¹⁷⁶ S. 1577 (112^th Cong.), introduced September 19, 2011, by then Chairman Max Baucus.

¹⁷⁷ The GROWTH Act also proposed certain technical amendments to section 41(f) regarding special rules for taxpayers under common control and the special rules for computing the research credit when a major portion of a trade or business (or unit thereof) changes hands. Such rules were subsequently modified by the American Taxpayer Relief Act of 2012 (Pub. L. No. 112-240).

¹⁷⁸ H.R. 880 (114^th Cong.), introduced February 11, 2015, by Rep. Kevin Brady; passed House May 20, 2015. See also, H.R. Rep. No. 114-113.

¹⁷⁹ Using the above example, under this provision, the limitation would be the excess of $80,000 over the greater of (1) $0 or (2) $13,750. Since $13,750 is greater than $0, the $80,000 would be reduced by $13,750 such that the research credit limitation would be $66,250. Hence, the taxpayer would be able to claim a research credit of $66,250 against its net income tax liability, as well as its AMT liability, which would result in $33,250 of total tax owed ($100,000 - $66,250). The remaining $23,750 of its research credit ($90,000 - $66,250) may be carried back or forward, as applicable.

¹⁸⁰ As submitted to the Congress on February 2, 2015. See Office of Management and Budget, Budget of the U.S. Government, Fiscal Year 2016: Analytical Perspectives (H. Doc. 114-3, Vol. III), February 2, 2015, pp. 149-204.

¹⁸¹ Sec. 701.

¹⁸² Sec. 702.

¹⁸³ Sec. 7704(a).

¹⁸⁴ Sec. 11(a).

¹⁸⁵ Sec. 7704(b).

¹⁸⁶ Sec. 7704(f).

¹⁸⁷ Sec. 7704(c)(2).

¹⁸⁸ S. 1656 (114^th Cong.), introduced June 24, 2015, by Senator Coons and cosponsored by Senators Moran, Murkowski, Stabenow, Collins, Bennet, Gardner, and King.

¹⁸⁹ Section 6012 provides general rules identifying who must file an income tax return, while other Code provisions referenced herein specifically address filing requirements of partnerships, corporations, and other entities.

¹⁹⁰ Secs. 6031, 6072.

¹⁹¹ Sec. 6081. Treas. Reg. sec. 1.6081-2. See Department of the Treasury, Internal Revenue Service, 2011 Instructions for Form 1065, U.S. Return of Partnership Income, p. 3. Unlike other partnerships, an electing large partnership is required to furnish a Schedule K-1 to each partner by the first March 15 following the close of the partnership's taxable year (sec. 6031(b)). For calendar year 2012 partnerships, for example, the due date is March 15, 2013 even though the partnership return due date is April 15, 2013. However, an electing large partnership is allowed an automatic six-month extension of time to file the partnership return and the Schedule K-1s by submitting an application on form 7004 in accordance with the rules prescribed by the Treasury Regulations. Treas. Reg. sec. 1.6081-2(a)(2).

¹⁹² Secs. 6012, 6037, 6072. Section 6012(a)(2) provides that every corporation subject to taxation under subtitle A shall be required to file an income tax return. Section 6037, which governs the returns of S corporations, provides that any return filed pursuant to section 6037 shall, for purposes of chapter 66 (relating to limitations) be treated as a return filed by the corporation under section 6012. Section 6072, which sets forth the due dates for filing various income tax returns, provides that returns of corporations with a taxable year that is a calendar year under section 6012 (and section 6037 based on the language in that section) are due March 15.

¹⁹³ Section 6081(b) provides that a corporation is allowed an automatic extension of three months to file its income tax return if the corporation files the form prescribed by the Secretary and pays on or before the due date prescribed for payment, the amount properly estimated as its tax. However, section 6081(a) provides that the Secretary may grant an automatic extension of up to six months to file and the Treasury regulations do so provide. Treas. Reg. sec. 1.6081-3.

¹⁹⁴ Secs. 6031 through 6060.

¹⁹⁵ Sec. 6041(a). The information return generally is submitted electronically as a Form-1099 or Form-1096, although certain payments to beneficiaries or employees may require use of Forms W-3 or W-2, respectively. Treas. Reg. sec. 1.6041-1(a)(2).

¹⁹⁶ Sec. 6041(a) requires reporting as to fixed or determinable gains, profits, and income (other than payments to which section 6042(a)(1), 6044(a)(1), 6047(c), 6049(a), or 6050N(a) applies and other than payments with respect to which a statement is required under authority of section 6042(a), 6044(a)(2) or 6045). These payments excepted from section 6041(a) include most interest, royalties, and dividends.

¹⁹⁷ Secs. 6042 (dividends), 6045 (broker reporting) and 6049 (interest) and the Treasury regulations thereunder.

¹⁹⁸ Sec. 6041(d).

¹⁹⁹ Treas. Reg. sec. 31.6071(a)-1(a)(3)(i).

²⁰⁰ Secs. 6011(e) and 6071(b) apply to "returns made under subparts B and C of part III of this subchapter"; Treas. Reg. sec. 301.6011-2(b), mandates use of magnetic media by persons filing information returns identified in the regulation or subsequent or contemporaneous revenue procedures and permits use of magnetic media for all others.

²⁰¹ Treas. Reg. sec. 31.6051-2; IRS, "Filing Information Returns Electronically," Pub. 3609 (Rev. 12-2011); Treas. Reg. sec. 31.6071(a)-1(a)(3)(i).

²⁰² Pub. L. No. 94-202, sec. 232, 89 Stat. 1135 (1976) (effective with respect to statements reporting income received after 1977).

²⁰³ Employers submit quarterly reports to IRS on Form 941 regarding aggregate quarterly totals of wages paid and taxes due. IRS then compares the W-3 wage totals to the Form 941 wage totals.

²⁰⁴ 31 U.S.C. sec. 5314. The term "agency" in the Bank Secrecy Act includes financial institutions.

²⁰⁵ 31 U.S.C. sec. 5314(a) provides: "Considering the need to avoid impeding or controlling the export or import of monetary instruments and the need to avoid burdening unreasonably a person making a transaction with a foreign financial agency, the Secretary of the Treasury shall require a resident or citizen of the United States or a person in, and doing business in, the United States, to keep records, file reports, or keep records and file reports, when the resident, citizen, or person makes a transaction or maintains a relation for any person with a foreign financial agency."

²⁰⁶ 31 C.F.R. sec. 103.27(c). The $10,000 threshold is the aggregate value of all foreign financial accounts in which a U.S. person has a financial interest or over which the U.S. person has signature or other authority.

²⁰⁷ The "Tax Return Due Date Simplification and Modernization Act of 2013," (S. 420, 113th Cong.), introduced by Senator Enzi.

²⁰⁸ Pub. L. No. 105-206.

²⁰⁹ The Electronic Tax Administration Advisory Committee, the body charged with oversight of IRS progress in reaching that goal reported that e-filing by individuals exceeded 80 percent in the 2013 filing season, but projected an overall rate of 72.8 percent based on all Federal returns. See Electronic Tax Administration Advisory Committee, Annual Report to Congress, June 2013, IRS Pub. 3415, page 6.

²¹⁰ Sec. 6011(e).

²¹¹ Section 6011(e)(3)(B) defines a "specified tax return preparer" as any return preparer who reasonably expects to file more than 10 individual income tax returns during a calendar year.

²¹² Taxpayers can request waivers of the electronic filing requirement if they cannot meet that requirement due to technological constraints, or if compliance with the requirement would result in undue financial burden on the taxpayer.

²¹³ See Form 990-N, "Electronic Notice for Tax-exempt Organizations not Required to File a Form 990 or 990-EZ."

²¹⁴ See the Taxpayer Bill of Rights Enhancement Act of 2015 (S. 1578, 114th Cong.), sec. 504. An identical proposal is included in the Tax Reform Act of 2014 (H.R. 1, 113th Cong), sec. 6004, introduced by then-Ways and Means Committee Chairman Camp. A similar proposal is included in the Administration's budget proposals for each of fiscal years 2014 through 2016. See, e.g., Department of the Treasury, General Explanation of the Administration's Fiscal Year 2015 Revenue Proposals (March 2014), p. 231. For fiscal year 2016, the Administration's proposal is combined with proposed e-filing requirements for other types of taxpayers. See Department of the Treasury, General Explanation of the Administration's Fiscal Year 2016 Revenue Proposals (March 2014), pp. 247-249.

²¹⁵ Sec. 508(a).

²¹⁶ Sec. 7428.

²¹⁷ Sec. 7428(a)(1).

²¹⁸ Sec. 7428(a)(2).

²¹⁹ Sec. 7428(b)(2).

²²⁰ See the Taxpayer Bill of Rights Enhancement Act of 2015 (S. 1578, 114th Cong.), sec. 303. A more limited proposal that extends the section 501(c)(3) declaratory judgment procedure only to section 501(c)(4) organizations and which does not modify the rules regarding courts of jurisdiction is included in the Tax Reform Act of 2014 (H.R. 1, 113th Cong), sec. 6002, introduced by then-Ways and Means Committee Chairman Camp.

²²¹ Sec. 4942(g).

²²² Sec. 4940(e).

²²³ Sec. 4942(d)(2).

²²⁴ Sec. 4940(d)(1).

²²⁵ Sec. 4940(d)(2).

²²⁶ See the America Gives More Act of 2015 (S. 644, 114th Cong.), sec. 5, as passed by the U.S. House of Representatives on February 12, 2015. A similar proposal (effective for taxable years beginning after December 31, 2014) is included in the Tax Reform Act of 2014 (H.R. 1, 113th Cong), sec. 5204, although that proposal also repeals the exception for exempt operating foundations from the tax on net investment income of private foundations. A similar proposal also is included in the Administration's budget proposals for fiscal years 2016, although the Administration's proposal sets the excise tax rate at 1.35 percent. Department of the Treasury, General Explanation of the Administration's Fiscal Year 2016 Revenue Proposals (March 2014), p. 267.