White House Releases Fiscal 2007 Budget -- Federal Receipts, Effect of Tax Proposals

The Federal Government also collects income from the public from market-oriented activities. Collections from these activities, which are subtracted from gross outlays, rather than added to taxes and other governmental receipts, are discussed in the following Chapter.

Total receipts in 2007 are estimated to be $2,415.9 billion, an increase of $130.4 billion or 5.7 percent relative to 2006. Receipts are projected to grow at an average annual rate of 5.9 percent between 2007 and 2011, rising to $3,034.9 billion. This growth in receipts is largely due to assumed increases in incomes resulting from both real economic growth and inflation.

As a share of GDP, receipts are projected to increase from 17.5 percent in 2006 to 17.6 percent in 2007. The receipts share of GDP is projected to increase to 17.9 percent in 2011.

           Table 17-1. RECEIPTS BY SOURCE -- SUMMARY

This Act expanded the energy production credit to apply to electricity produced from hydropower at a facility: (1) that produced hydroelectric power before August 8, 2005 and to which efficiency improvements or additions to capacity are made after August 8, 2005 and before January 1, 2008; or (2) that did not produce hydroelectric power before August 8, 2005 and to which turbines or other electricity generating equipment is added after August 8, 2005 and before January 1, 2008. This Act also expanded the credit to apply to sales of coal produced from coal reserves that on June 14, 2005 were: (1) owned by a tribe of Indians recognized by the United States; or (2) were held in trust for a tribe of Indians or its members by the United States. The credit for Indian coal is $1.50 per ton for coal sold after December 31, 2005 and before January 1, 2010, and $2.00 per ton for coal sold after December 31, 2009 and before January 1, 2013 (both rates are adjusted for inflation).

Under prior law, cooperatives were not allowed to pass any portion of the energy production credit through to their patrons. Under this Act, eligible cooperatives may elect to pass any portion of the credit through to their patrons.

Provide tax credits for investment in clean coal facilities. -- Under this Act, a 20-percent tax credit was provided for qualified investments in electricity production facilities using integrated gasification combined cycle (IGCC) technologies and a 15-percent credit was provided to qualified investments in electricity production facilities using other advanced coal-based technologies. Qualified projects must be economically feasible and use the appropriate clean coal technologies. The Secretary of Treasury, in consultation with the Secretary of Energy, may allocate $800 million of credits to IGCC projects and $500 million of credits to projects using other advanced coal-based technologies. A 20-percent tax credit was also provided for investment in certified gasification projects. The total amount of gasification credits allocable by the Secretary of the Treasury is $350 million. These three credits are effective for qualified investments made after August 8, 2005.

Modify treatment of nuclear decommissioning funds. -- Under prior law, deductible contributions to nuclear decommissioning funds were limited to the amount included in the taxpayer's cost of service to ratepayers. In addition, deductible contributions were not permitted to exceed the amount the Internal Revenue Service (IRS) determined to be necessary to provide for level funding of an amount equal to the taxpayer's post-1983 decommissioning costs. Effective for taxable years beginning after December 31, 2005, this Act repealed the cost-of-service requirement for deductible contributions to a nuclear decommissioning fund and expanded the deduction to apply to pre-1984 decommissioning costs. As provided under prior law, deductible contributions may not be made more rapidly than required to provide for level funding of the taxpayer's decommissioning costs.

Reduce recovery period for certain assets used in the transmission of electricity. -- Under the Modified Accelerated Cost Recovery System (MACRS) of current law, assets used in the transmission and distribution of electricity for sale may be depreciated over 20 years. This Act reduced the recovery period for certain assets used in the transmission of electricity for sale to 15 years. To qualify for the reduced recovery period: (1) the original use of the property must commence with the taxpayer after April 11, 2005; (2) the property must be used in the transmission at 69 or more kilovolts of electricity for sale; and (3) the property must not be subject to a binding contract on or before April 11, 2005 or, if self-constructed, the taxpayer or a related party must not have started construction on or before such date.

Provide 84-month amortization for certain air pollution control facilities. -- A taxpayer may elect to recover a portion of the cost of a certified pollution control facility over a period of 60 months under current law. To be eligible, the pollution control facility must be new, used in connection with a plant in operation before January 1, 1976, certified as being in conformity with State and Federal environmental laws, and meet certain other requirements. The amortizable portion is 100 percent if the facility has a depreciation recovery period of 15 years or less; otherwise, the portion equals 15 divided by the recovery period. This Act provided 84-month amortization to a similar portion of the cost of certified air pollution control facilities used in connection with an electric generation plant that is primarily coal fired and that was not in operation before January 1, 1976. For an air pollution control facility to be eligible for cost recovery over a period of 84 months: (1) its construction, reconstruction, or erection must be completed after April 11, 2005; or (2) it must be acquired after April 11, 2005 and its original use must commence with the taxpayer after that date.

Reduce recovery period for certain natural gas distribution lines. -- Under MACRS, natural gas distribution lines are assigned a 20-year recovery period. This Act established a 15-year recovery period for natural gas distribution lines, the original use of which begins with the taxpayer after April 11, 2005 and before January 1, 2011. The shortened recovery period does not apply to property subject to a binding contract on or before April 11, 2005, or, if self-constructed, the taxpayer or a related party must not have started construction on or before such date.

Treat natural gas gathering lines as seven-year property. -- This Act clarified existing law by establishing a statutory seven-year recovery period for natural gas gathering lines, the original use of which commences with the taxpayer after April 11, 2005. In addition, no depreciation adjustment must be made with respect to this property in computing a taxpayer's alternative minimum taxable income.

Provide two-year amortization for certain geological and geophysical expenditures. -- Geological and geophysical expenditures (G&G costs) are costs incurred by a taxpayer for the purpose of obtaining and accumulating data that will serve as the basis for the acquisition and retention of mineral properties by taxpayers exploring for minerals. A key issue with regard to such costs has been whether or not they are capital in nature. Various courts have held that G&G costs are capital and allocable to the cost of the property acquired or retained; IRS administrative rulings have provided further guidance regarding the definition and proper tax treatment of such costs. Under this Act, G&G costs paid or incurred in taxable years beginning after August 8, 2005, in connection with oil and gas exploration in the United States, may be amortized over two years.

Provide tax credit for energy-efficient improvements to principal residences. -- This Act provided a nonrefundable 10-percent tax credit to homeowners for the cost of purchasing qualified energy efficient improvements installed in or on a dwelling unit in the United States that is used as their principal residence. Qualified energy efficient improvements include any energy efficiency building envelope component that meets or exceeds the prescriptive criteria for such a component established by the 2000 International Energy Conservation Code as supplemented and in effect on August 8, 2005. Building envelope components are: (1) insulation materials or systems that are specifically and primarily designed to reduce the heat loss or gain for a dwelling; (2) exterior windows (including skylights) and doors; and (3) metal roofs with appropriate pigmented coating specifically and primarily designed to reduce the heat gain for a dwelling. The credit, which applies to property placed in service after December 31, 2005 and before January 1, 2008, may not exceed $500 over all taxable years, and no more than $200 of such credit may be attributable to expenditures on windows.

This Act also provided a tax credit to homeowners for the cost of residential energy property installed in or on a dwelling unit in the United States that is used as their principal residence. Residential energy property includes: (1) advanced main air circulating fans; (2) qualified natural gas, propane, or oil furnaces and hot water boilers; and (3) energy-efficient building property (certain electric and geothermal heat pumps, air conditioners, and natural gas, propane, or oil water heaters). The credit, which applies to property placed in service after December 31, 2005 and before January 1, 2008, may not exceed $50 per fan, $150 for each furnace or boiler, and $300 for each item of energy-efficient building property.

Provide tax credit for the purchase of qualified hybrid, fuel cell and alternative fuel motor vehicles. -- A qualified fuel cell vehicle is propelled by power derived from one or more cells that convert chemical energy directly into electricity. This Act provided a credit for the purchase of fuel cell vehicles, effective for vehicles placed in service after December 31, 2005 and before January 1, 2015. The amount of the credit is equal to a base credit amount, determined by the weight class of the vehicle and, in the case of automobiles and light trucks, an additional credit amount, determined by the rated fuel economy of the vehicle compared to the 2002 model year city fuel economy rating for vehicles of various weight classes. The base credit amount ranges from $8,000 ($4,000 after December 31, 2009) for vehicles with a gross weight less than or equal to 8,500 pounds, to $40,000 for vehicles weighting over 26,000 pounds. The additional credit amount ranges from $1,000 for a fuel economy rating that is at least 150 percent, but less than 175 percent of the 2002 model year city fuel economy rating, to $4,000 for a fuel economy rating that is at least 300 percent of the 2002 model year city fuel economy rating.

A qualified alternative fuel motor vehicle operates only on qualifying alternative fuels (compressed natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen and any liquid fuel that is at least 85 percent methanol) and is incapable of operating on gasoline or diesel fuel (except to the extent that gasoline or diesel fuel is part of a qualified mixed fuel). This Act provided a credit for the purchase of alternative fuel vehicles, effective for vehicles placed in service after December 31, 2005 and before January 1, 2011. The credit is equal to 50 percent of the incremental cost of the vehicle (the excess of the manufacturer's suggested retail price over the manufacturer's suggested retail price for a comparable gasoline or diesel vehicle), plus an additional 30 percent if the vehicle meets certain emissions standards. Depending on the weight of the vehicle, a maximum allowable incremental cost is specified, ranging from $5,000 for a vehicle weighing less than or equal to 8,500 pounds, to $40,000 for a vehicle weighing more than 26,000 pounds. The total credit for the purchase of a new alternative fuel vehicle may not exceed $4,000 for a vehicle weighing less than or equal to 8,500 pounds and $32,000 for a vehicle weighing more than 26,000 pounds. Certain mixed fuel vehicles (vehicles that use a combination of an alternative fuel and a petroleum-based fuel) are eligible for a reduced credit. Specifically, if the vehicle operates on a mixed fuel that is at least 75 percent alternative fuel, the vehicle is eligible for 70 percent of the otherwise allowable alternative fuel vehicle credit and if the vehicle operates on a mixed fuel that is at least 90 percent alternative fuel, the vehicle is eligible for 90 percent of the otherwise allowable credit.

A qualified hybrid vehicle is a motor vehicle that draws propulsion energy from on-board sources of stored energy that include both an internal combustion engine or heat engine using combustible fuel and are chargeable energy storage system. This Act provided a credit for the purchase of qualified hybrid motor vehicles placed in service after December 31 2005 and before January 1, 2011 (January 1, 2010 in the case of a qualified hybrid vehicle weighing more than 8,500 pounds). For a qualified hybrid automobile or light truck weighing less than or equal to 8,500 pounds, or a lean-burn technology motor vehicle, the credit consists of two components: (1) a fuel economy credit of $400 to $2,400, depending upon the rated fuel economy of the vehicle compared to the 2002 model year standard; and (2) a conservation credit of $250 to $1,000, depending upon the estimated lifetime fuel savings of the vehicle compared to a comparable 2002 model year vehicle. For a qualified hybrid vehicle weighing more than 8,500 pounds (a medium or heavy truck), the amount of credit is determined by the estimated increase in fuel economy and the incremental cost of the hybrid vehicle compared to a vehicle comparable in weight, size and use that is powered solely by a gasoline or diesel internal combustion engine. Depending on the weight of the vehicle, a maximum incremental cost is specified, ranging from $7,500 for a vehicle weighing more than 8,500 pounds but less than or equal to 14,000 pounds, to $30,000 for a vehicle weighing more than 26,000 pounds. For a vehicle that achieves a fuel economy increase of at least 30 percent but less than 40 percent, the credit is equal to 20 percent of the incremental cost of the vehicle. The credit increases to 30 percent of the incremental cost for a vehicle that achieves a fuel economy increase of at least 40 percent but less than 50 percent, and to 40 percent of the incremental cost for a vehicle that achieves a fuel economy increase of 50 percent or more. In the case of passenger automobiles and light trucks, a limitation is imposed on the number of qualified hybrid motor vehicles and advanced lean-burn technology motor vehicles sold by each manufacturer. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter following the quarter in which the manufacturer from whom they purchased their vehicle records its 60,000th sale of a hybrid or advanced lean-burn technology passenger automobile or light truck. The credit declines to one half the otherwise allowable amount in the subsequent two quarters, to one quarter of the otherwise allowable amount in the next two quarters, and then expires.

Provide additional incentives to promote energy conservation and efficiency. -- This Act provided a number of additional incentives to promote energy conservation and efficiency, which included: (1) a tax deduction for energy-efficient property installed during the construction of a commercial building; (2) tax credits for the purchase of qualified fuel cell and stationary micro-turbine power plants; (3) a tax credit for the construction of qualified new energy-efficient homes; and (4) a tax credit for the production of certain energy-efficient dishwashers, clothes washers and refrigerators.

Extend excise taxes deposited in the Leaking Underground Storage Tank (LUST) Trust Fund. -- An excise tax is imposed, generally at a rate of 0.1 cents per gallon, on gasoline and other liquid motor fuels used on highways, in aviation, on inland waterways, and in diesel-powered trains. The tax, which is deposited in the LUST Trust Fund, was scheduled to expire on October 1, 2005 under prior law. This Act extended the tax through September 30, 2011. In addition, the tax was expanded to apply to dyed fuel, which was exempt from the tax under prior law and all other liquid fuel that is not exported.

Modify recapture of section 197 amortization. -- Gain on the sale of depreciable property must be recaptured as ordinary income to the extent of depreciation deductions previously claimed. The recapture amount is computed separately for each item of property that is sold. This Act modified the recapture rules of current law with respect to dispositions of section 197 intangibles. Section 197 intangibles include goodwill; a patent, copyright, formula, design or similar item; any license, permit, or other right granted by a governmental unit or agency; and any franchise, trademark, or trade name. Under this Act, multiple section 197 intangibles sold in a single transaction or in a series of transactions after August 8, 2005 are treated as a single asset for the purpose of calculating the amount of gain to be recaptured as ordinary income. This rule does not apply to any amortizable section 197 intangible for which adjusted basis exceeds fair market value.

Eliminate Aquatic Resources Trust Fund and create Sport Fish Restoration and Boating Trust Fund. -- Under prior law, 13.5 cents per gallon of the excise taxes imposed on motorboat gasoline and special motor fuels, and on gasoline used as a fuel in the nonbusiness use of small-engine outdoor power equipment, was transferred from the Highway Trust Fund to the Land and Water Conservation Fund and to the Boat Safety and Sport Fish Restoration Accounts of the Aquatic Resources Trust Fund. The remaining 4.8 cents per gallon of these taxes was retained in the General Fund of the Treasury. Amounts transferred from the Highway Trust Fund to the Land and Water Conservation Fund and the Aquatic Resources Trust Fund were allocated as follows: (1) Up to $70 million in annual collections was transferred to the Boat Safety Account, subject to an overall limit equal to the amount that would not cause the Boat Safety Account to have an unobligated balance in excess of $70 million. (2) The next $1 million in annual collections was transferred to the Land and Water Conservation Fund. (3) All remaining annual collections were transferred to the Sport Fish Restoration Account. As explained in the preceding discussion of the Highway Trust Fund, these excise taxes were scheduled to decline to 4.3 cents per gallon on September 30, 2005; in addition, the retention of 4.8 cents per gallon of these taxes in the General Fund of the Treasury was scheduled to expire on that date.

Effective October 1, 2005, this Act eliminated the Aquatic Resources Trust Fund and created the Sport Fish Restoration and Boating Trust Fund. This Act also extended the taxes on motorboat fuels and on gasoline used as a fuel in the nonbusiness use of small-engine outdoor power equipment at their prior law rates through September 30, 2011, but did not extend the retention of 4.8 cents per gallon of these taxes in the General Fund of the Treasury. Therefore, effective October 1, 2005, 18.3 cents per gallon of the taxes on these fuels is deposited in the Highway Trust Fund and then transferred to the Land and Water Conservation Fund and to the Sport Fish Restoration and Boating Trust Fund as follows: (1) The first $1 million in annual collections is transferred to the Land and Water Conservation Fund. (2) All remaining annual collections are transferred to the Sport Fish Restoration and Boating Trust Fund.

A tax equal to 12 percent of the sales price is imposed on the first retail sale of heavy highway vehicles. Under prior law, the tax was imposed on trucks with a gross weight greater than 33,000 pounds; trailers with a gross weight greater than 26,000 pounds; and highway tractors, regardless of weight. Effective for sales after September 30, 2005, this Act repealed the tax with respect to tractors weighing less than or equal to 19,500 pounds, provided that when combined with a towed vehicle, the total weight does not exceed 33,000 pounds.

Modify taxation of alternative fuels. -- In general, nonaviation gasoline is taxed at 18.3 cents per gallon, aviation gasoline is taxed at 19.3 cents per gallon, and diesel fuel and kerosene are taxed at 24.3 cents per gallon. Although most special motor fuels are subject to tax at 18.3 cents per gallon, certain special motor fuels and compressed natural gas are taxed at reduced rates. Effective for sales after September 30, 2006, this Act increased the tax on certain special motor fuels as follows: (1) Liquefied petroleum gas and P Series fuels (as defined by the Secretary of Energy) will be taxed at 18.3 cents per gallon. (2) Compressed natural gas will be taxed at 18.3 cents per energy equivalent of a gallon of gasoline. (3) Liquefied natural gas, any liquid fuel derived from coal (other than ethanol or methanol) and liquid hydrocarbons derived from biomass will be taxed at 24.3 cents per gallon. This Act also created two new excise tax credits -- the alternative fuel credit and the alternative fuel mixture credit -- for the sale or use of alternative fuels. For purposes of the credits, alternative fuels are defined as liquefied petroleum gas, P Series fuels (as defined by the Secretary of Energy), compressed or liquefied natural gas, liquefied hydrogen, liquid fuel derived from coal through the Fisher-Tropsch process, and liquid hydrocarbons derived from biomass. The alternative fuel credit is 50 cents for each gallon of alternative fuel or gasoline-gallon equivalent of nonliquid alternative fuel sold by the taxpayer for use as a motor fuel in a motor vehicle or motorboat. The alternative fuel mixture credit is 50 cents for each gallon of alternative fuel used in producing an alternative fuel mixture for sale or use in a trade or business of the taxpayer. These credits, which are effective for qualified fuels sold or used after October 1, 2006 and before October 1, 2009 (October 1, 2014 for liquefied hydrogen), are to be paid from the General Fund of the Treasury.

Cap excise tax on certain fishing equipment. -- Effective for sales after September 30, 2005, the 10-percent excise tax imposed on the sale of fishing rods and poles is capped at $10.00 on each rod and pole sold.

Modify aviation excise taxes. -- Fuel used on a farm for farming purposes is exempt from Federal excise taxes on fuel. Under prior law, crop-dusters, instead of farm owners and operators, were allowed to claim a refund for taxes on aviation fuel consumed while operating over a farm if they had written consent from the farm owner or operator. Fuel consumed traveling to and from the farm was not exempt from Federal excise taxes on fuel. This Act repealed the requirement that crop-dusters receive written consent to apply for a refund and clarified that travel to and from a farm is exempt use, effective for fuel used after September 30, 2005.

Domestic passenger tickets are subject to an air passenger ticket tax equal to 7.5 percent of the ticket price, plus $3.20 per domestic flight segment. Amounts paid to persons engaged in the business of transporting property by air for hire are subject to an air cargo tax of 6.25 percent. The air passenger ticket tax does not apply to: (1) transportation by helicopter if the helicopter does not use Federally funded airport and airway services and is used for certain timber operations or the exploration, development or removal of oil, gas, or hard minerals; and (2) helicopters and fixed-wing aircraft that provide emergency medical services. In addition, the $3.20 tax on flight segments does not apply to a domestic segment beginning or ending at a rural airport. Neither the air passenger ticket tax nor the air cargo tax apply to transportation by an aircraft having a maximum certificated takeoff weight of 6,000 pounds or less unless the aircraft is operated on an established line. Under prior law, a rural airport was defined as an airport that: (1) had fewer than 100,000 passengers departing by air during the second preceding calendar year and was located more than 75 miles from a larger airport; or (2) was receiving essential air service subsidy payments as of August 5, 1997. This Act expanded the definition of a rural airport, effective October 1, 2005, to include airports not connected by paved roads to another airport and having fewer than 100,000 passengers departing on flight segments of at least 100 miles during the second preceding calendar year. This Act also expanded the types of transportation exempt from the passenger ticket and/or air cargo tax, effective with respect to transportation beginning after September 30, 2005. The expansions included the following: (1) The exemption of transportation by a seaplane from the air passenger ticket tax and the air cargo tax, provided the take off is from, and the landing is on, water, and the places from which such landings and takeoffs occur have not received or are not receiving financial assistance from the Airport and Airway Trust Fund. (2) The exemption of fixed-wing aircraft engaged in timber operations from aviation excise taxes if they are not using Federally-funded airport and airway services. (3) The exemption of sightseeing flights from the passenger ticket tax.

Modify alcohol-related excise taxes. -- The 2004 job creation act suspended the special occupational taxes imposed on producers and others engaged in the marketing of distilled spirits, wine, and beer, for the period July 1, 2005 through June 30, 2008. This Act repealed these taxes effective July 1, 2008. This Act also: (1) provided an income tax credit to eligible wholesalers, distillers, and importers of distilled spirits for the cost of carrying tax-paid products in inventory, effective for taxable years beginning after September 30, 2005; and (2) allowed certain domestic producers and importers of distilled spirits, wine, and beer with annual excise tax liability of $50,000 or less attributable to these articles in the preceding calendar year to file returns and pay taxes quarterly (rather than semi-monthly) in most cases effective for quarterly periods beginning after December 31, 2005.

Provide custom gunsmiths an exemption from taxes on firearms and ammunition. -- Sales of firearms and ammunition by the manufacturer, producer or importer generally are subject to an excise tax of 10 or 11 percent of the retail price, depending upon the type of good sold. Sales of machine guns and short-barreled firearms are exempt from the tax. This Act expanded the exemption to apply to sales of firearms, pistols, and revolvers by a person who manufactures, produces, or imports less than 50 of such articles during the calendar year. The exemption is effective for sales after September 30, 2005.

Modify treatment of kerosene for use in aviation. -- In general, aviation-grade kerosene is taxed at a rate of 21.8 cents per gallon when it enters the United States, is removed from a refinery or terminal, or is sold to an unregistered person, unless there was a prior taxation upon entry or removal of the fuel. Aviation-grade kerosene may be taxed at a reduced rate, either 4.3 or zero cents per gallon, if it is removed directly into the fuel tank of an aircraft for use in commercial aviation or is for a use that is exempt from tax. Kerosene used for surface transportation is taxed at the diesel fuel rate of 24.3 cents per gallon. Under this Act, all kerosene is taxed at a rate of 24.3 cents per gallon unless it is removed directly into the fuel tank of an aircraft or is for a use that is exempt from tax. This change is effective for kerosene that enters the United States, is removed from a refinery or terminal, or is sold after September 30, 2005. If the kerosene taxed at 24.3 cents per gallon is used for aviation or tax exempt purposes, a credit or refund may be claimed.

Combat fuel fraud. -- This Act included a number of provisions designed to combat fuel fraud. Under this Act: (1) Farmers who purchase clear diesel fuel must pay the excise tax on that fuel and then claim a refund for taxes paid on fuel used for farming purposes. (2) Credit card companies that allow tax-exempt fuel purchases on their cards must register with the IRS and be the party responsible for claiming refunds of the tax. (3) Blenders, importers, pipeline operators, position holders, refiners, terminal operators, and vessel operators who are registered with the IRS must reregister in the event of a change in ownership. (4) Information regarding taxable fuels destined for the United States must be transmitted electronically from the Bureau of Customs and Border Control to the IRS. (5) Operators of deep-draft ocean-going vessels used in the bulk transfer of fuel must register with the IRS.

Extend replacement period for non-recognition of gain. -- Gain realized by a taxpayer on the involuntary conversion of property generally is deferred to the extent the taxpayer purchases property similar or related in service or use to the converted property within the replacement period. The replacement period generally begins with the date of the disposition of the converted property and ends two years after the close of the first taxable year in which any part of the gain upon conversion is realized. Under current law, special rules extend the replacement period for certain real property and principal residences damaged by a Presidentially declared disaster or the terrorist attacks on September 11, 2001, and for livestock sold as the result of drought, flood, or other weather-related conditions. This Act extended from two to five years the replacement period for property in the Hurricane Katrina disaster area compulsorily or involuntarily converted on or after August 25, 2005, as a result of the hurricane.

Provide exclusion for certain cancellations of indebtedness. -- Under current law, gross income generally includes any income realized by a debtor from the discharge of indebtedness, subject to certain exceptions for debtors in Title 11 bankruptcy cases, insolvent debtors, certain farm indebtedness, and certain real property business indebtedness. This Act excluded from gross income the discharge of nonbusiness debt on or after August 28, 2005 and before January 1, 2007, if the debtor's principal place of abode on August 25, 2005 was located in: (1) the core disaster area, or (2) the Hurricane Katrina disaster area and such person suffered economic loss as a result of the hurricane.

Provide special rule for purposes of computing the child tax credit and earned income tax credit. -- The earned income tax credit (EITC) is a refundable credit for low-income workers, the amount of which depends on the earned income of the taxpayer and whether the taxpayer has one, more than one, or no qualifying children. Taxpayers with income below certain thresholds also are eligible for a child credit for each qualifying child, which may be refundable. Under this Act, qualified individuals were permitted to elect to use their earned income from the prior taxable year to determine eligibility for these credits for the taxable year that includes August 25, 2005 if their earned income for the taxable year that includes August 25, 2005 was less than their earned income for the preceding taxable year. Qualified individuals are those whose principal place of abode on August 25, 2005 was located in: (1) the core disaster area, or (2) in the Hurricane Katrina disaster area and who were displaced by the hurricane.

Provide special rules for mortgage revenue bonds. -- Under current law State and local governments may issue mortgage revenue bonds (MRBs) to provide low-interest rate financing to qualified individuals for the purchase, improvement, or rehabilitation of owner-occupied residences. Several restrictions, including purchase price limitations, mortgagor income, and the first-time homebuyer requirement (except with regard to residences in certain targeted areas) apply to the financing of mortgages with MRBs. Effective for financing provided before January 1, 2008, this Act waived the first-time homebuyer requirement of current law with respect to financing for: (1) residences located in the core disaster area, and (2) any other residence if the mortgagor owned a principal residence in the Hurricane Katrina disaster area on August 28, 2005 that was rendered uninhabitable by the hurricane and the residence being financed is located in the same State as the prior principal residence. This Act also increased the current law limitation on home improvement loans financed with MRBs from $15,000 to $150,000 for residences located in the Hurricane Katrina disaster area, to the extent the loan is for the repair of damage caused by the hurricane.

Extend tax filing and payment deadlines. -- Deadlines for the filing of tax returns and the payment of taxes, including employment and excise taxes, otherwise required on or after August 25, 2005, were extended until February 28, 2006 for taxpayers affected by Hurricane Katrina.

Authorize the Secretary of the Treasury to make adjustment regarding taxpayer and dependency status. -- This Act authorized the Secretary of the Treasury to make adjustments in applying the Federal tax laws that may be necessary to ensure that taxpayers do not lose any deduction or credit or experience a change of filing status because of temporary relocations caused by Hurricane Katrina. This provision applies to taxable years beginning in 2005 and 2006.

Provide an employee retention credit to employers affected by Hurricane Katrina. -- Under this Act, a 40-percent tax credit was provided to eligible employers for the first $6,000 in qualified wages paid to an eligible employee. To be eligible, an employer must have employed an average of 200 or fewer employees in a business located in the core disaster area on August 28, 2005 that was inoperable on any day beginning on that date and ending on December 31, 2005, as a result of damage caused by the hurricane. An eligible employee, with respect to an eligible employer, is one whose principal place of employment with that employer was in the core disaster zone on August 28, 2005. Qualified wages are those paid by an eligible employer to an eligible employee on any day after August 28, 2005 and before January 1, 2006 during the period beginning on the date on which the trade or business first became inoperable at the principal place of employment of the employee and ending on the date on which such trade or business resumed significant operations at such principal place of employment. Qualified wages include those paid without regard to whether the employee performs a service, performs services at a different place of employment than such principal place of employment, or performs services at such principal place of employment before significant operations have resumed.

Provide an exemption to taxpayers who housed individuals displaced by Hurricane Katrina. --Taxpayers who provided housing to individuals displaced by Hurricane Katrina were provided a one-time $500 exemption for each individual whom they housed. Taxpayers may claim the exemption for up to four displaced individuals, for a maximum exemption amount of $2,000. An individual displaced by Hurricane Katrina is a person (other than a spouse or dependent of the taxpayer): (1) whose principal place of abode on August 28, 2005 was in the Hurricane Katrina disaster area, (2) who is displaced from such abode, and (3) who is provided housing free of charge in the taxpayer's principal residence for a period of 60 consecutive days, which ends in the taxable year in which the exemption is claimed. For individuals whose principal place of abode on August 28, 2005 was in the Hurricane Katrina disaster area but outside the core disaster area, in order to qualify as a displaced individual, their abode must have been damaged by the hurricane or they must have been evacuated as a result of the hurricane. This provision applies to taxable years beginning in 2005 and 2006.

Increase deduction for the costs associated with the charitable use of a motor vehicle. -- Taxpayers may claim a deduction for the costs associated with the use of a motor vehicle in providing donated services to charity. The deduction may be calculated by using a standard mileage rate of 14 cents per mile. This Act increased the charitable standard mileage rate to 34 cents per mile for the costs associated with the use of a vehicle in providing services to charity solely for the provision of relief related to Hurricane Katrina. In addition, this Act excluded from the gross income of a volunteer up to 48.5 cents per mile in reimbursements paid by a charitable organization to the volunteer for the costs associated with using a passenger automobile in performing such charitable work. A volunteer may not claim a deduction or credit with respect to reimbursed amounts. Certain recordkeeping requirements apply. These changes apply to such relief provided during the period beginning on August 25, 2005 and ending on December 31, 2006.

Expand enhanced deduction for contributions of food and books. -- A taxpayer's deduction for charitable contributions of inventory generally is limited to the taxpayer's basis in the inventory, or, if less, the fair market value of the inventory. However, an enhanced deduction is provided to C corporations for certain contributions of inventory. This Act expanded the enhanced deduction to apply to qualified contributions of: (1) food inventory by all taxpayers (not just C corporations) engaged in a trade or business, and to (2) books to public schools by C corporations. The donated food must meet certain quality and labeling standards, and the taxpayer's total deduction for donated food inventory may not exceed 10 percent of the taxpayer's net income from the related trade or business. The donated books must be suitable for use and used by the public school in its educational programs. The enhanced deduction applies to such qualified contributions of food and books made after August 27, 2005 and before January 1, 2006.

Provide tax-favored and penalty-free treatment for the recontribution of withdrawals for home purchase cancelled as a result of Hurricane Katrina. -- Under current law, certain amounts held in a 401(k) plan or a 403(b) annuity may not be distributed before severance from employment, age 591/2, death, disability, or financial hardship of the employee. For this purpose, subject to certain conditions, distributions for costs directly related to the purchase of a principal residence by an employee (excluding mortgage payments) are deemed to be distributions on account of financial hardship. Current law also allows distributions of up to $10,000 from IRAs for the purchase or construction of a principal residence of a first-time homebuyer. Under this Act, hardship distributions from a 401(k) plan or 403(b) annuity, and qualified first-time homebuyer distributions from an IRA received after February 28, 2005 and before August 29, 2005 for the purchase or construction of a principal residence in the Hurricane Katrina disaster area can be recontributed to such a plan, annuity or IRA if the residence was not purchased or constructed as a result of the hurricane. Any amount recontributed to such a plan is treated as a rollover and thereby excluded from the taxpayer's gross income and exempt from the 10-percent early withdrawal tax.

Modify treatment of loans from qualified retirement plans. -- A loan from a qualified retirement plan to a plan participant generally is treated as a taxable distribution under current law. An exception to this general rule is provided to the extent that the loan does not exceed the lesser of (1) $50,000, reduced by the excess of the highest outstanding balance of loans from such plans during the one-year period ending on the day before the date the loan is made over the outstanding balance of loans from the plan on the date the loan is made, or (2) the greater of $10,000 or one half of the participant's accrued benefit under the plan. This Act increased from $50,000 to $100,000 the limit on loans from a qualified retirement plan to an individual whose principal place of abode on August 28, 2005 was located in the Hurricane Katrina disaster area and who sustained an economic loss as a result of Hurricane Katrina. To qualify for the higher limit, the loan must be made after September 23, 2005 and before January 1, 2007.

Allow advance refunding of certain tax-exempt bonds. -- Refunding bonds are used to pay principal, interest or redemption price on previously issued bonds. Different rules apply to "current" and "advance" refunding bonds. A current refunding occurs when the refunded debt is retired within 90 days of issuance of the refunding bonds. Tax-exempt bonds may be currently refunded an indefinite number of times. An advance refunding occurs when the refunded debt is not retired within 90 days after the refunding bonds are issued; instead, the proceeds of the refunding bonds are invested in an escrow account and held until a future date when the refunded debt may be retired. In general, governmental bonds and tax-exempt private activity bonds for charitable organizations (qualified 501(c)(3) bonds) may be advance refunded one time.

This Act permitted an additional advance refunding of certain governmental and qualified 501(c)(3) bonds issued by Alabama, Louisiana, or Mississippi (or any political subdivision thereof). It also permitted one advance refunding of certain exempt facility bonds for airports, docks, or wharves issued by these States or any political subdivision thereof. Eligible bonds include only those bonds outstanding on August 28, 2005 that could not be advance refunded because of restrictions in effect on that date. The maximum amount of advance refunding bonds that may be issued under this provision by Louisiana, Mississippi and Alabama is $4.5 billion, $2.250 billion, and $1.125 billion, respectively. Eligible advance refunding bonds must be designated as 17. FEDERAL RECEIPTS 249 such by the governor of the respective State and must be issued before January 1, 2011.

Increase and modify the low-income housing tax credit. -- A low-income housing tax credit is provided to owners of qualified low-income rental units under current law. The credit may be claimed over a 10-year period for a portion of the cost of rental housing occupied by tenants having incomes below specified levels. The credit percentage for newly constructed or substantially rehabilitated housing that is not federally subsidized is adjusted monthly by the IRS so that the 10 annual credit amounts have a present value of 70 percent of the qualified basis of the structure. The credit percentage for newly constructed or substantially rehabilitated housing that is federally subsidized is calculated to have a present value of 30 percent of the qualified basis of the structure. Buildings located in high cost areas (qualified census tracts and difficult development areas) are eligible for an enhanced credit, provided no more than 20 percent of the population of each metropolitan statistical area or nonmetropolitan statistical area is a difficult development area. Under the enhanced credit, the 70 percent and 30 percent credits are increased to 91 percent and 39 percent, respectively. The aggregate credit authority allocated to each State for calendar year 2006 generally is the greater of $2.180 million or $1.90 per capita. These amounts are indexed annually for inflation. In general, to qualify for the credit, a low-income housing project must satisfy one of two tests: (1) 20 percent or more of the residential units in the project are both rent-restricted and occupied by individuals whose income is 50 percent or less of area median gross income; or (2) 40 percent or more of the residential units in the project are both rent-restricted and occupied by individuals whose income is 60 percent or less of area median gross income.

Under this Act, for calendar years 2006 through 2008, the otherwise applicable aggregate housing credit authority was increased for each State within the GO Zone. The additional credit amount for each State is equal to $18.00 multiplied by the number of such State's residents within the GO Zone. This amount is not indexed for inflation. For calendar year 2006, the otherwise applicable aggregate housing credit authority amount for both Florida and Texas was increased by $3.5 million. This Act also replaced the area median gross income standards of current law with a national nonmetropolitan median gross income standard, with respect to property placed in service in a nonmetropolitan area within the GO Zone during calendar years 2006, 2007, and 2008. The income targeting rules for property in metropolitan areas in the Go Zone are the same as under current law. In addition, property placed in service in calendar years 2006 through 2008 in the Go Zone, the Rita Go Zone, and the Wilma GO Zone are treated as high-cost areas and eligible for the enhanced credit; the 20 percent of population restriction of current law is waived. The enhanced credit and modified income targeting rules apply regardless of whether the property receives its credit allocation under the otherwise applicable low-income housing authority or the additional credit authority provided in this Act.

Provide special depreciation allowance for certain property. -- Taxpayers are allowed to recover the cost of certain property used in a trade or business or for the production of income through annual depreciation deductions. The amount of the allowable depreciation deduction for a taxable year generally is determined under MACRS, which assigns applicable recovery periods and depreciation methods to different types of property. Under this Act, qualifying GO Zone property is eligible for an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of the property. The additional first-year deprecation deduction is allowed for both regular and alternative minimum tax purposes in the year the property is placed in service. The basis of the property and the depreciation deductions allowable in other years are adjusted to reflect the additional first-year depreciation deduction. Qualifying property generally must be tangible property with a recovery period of 20 years or less, and also includes: (1) certain computer software; (2) water utility property; (3) leasehold improvement property; (4) nonresidential real property; and (5) residential rental property. In addition: (1) substantially all of the use of the property must be in the GO Zone and in the active conduct of a trade or business by the taxpayer in the GO Zone; (2) the original use of the property in the Go Zone must commence with the taxpayer on or after August 28, 2005; and (3) the property must be acquired by purchase by the taxpayer on or after August 28, 2005 and placed in service on or before December 31, 2007 (December 31, 2008 in the case of nonresidential real property and residential rental property). Property acquired under a binding written contract entered into before August 28, 2005 is not eligible for the additional first-year depreciation deduction provided under this provision. Current law allowed certain property an extended placed-in-service deadline (December 31, 2005) with respect to existing additional first-year depreciation provisions. This Act granted the Department of Treasury authority to extend that deadline for up to one year if such property is placed in service in the GO Zone, the Rita GO Zone or the Wilma GO Zone.

Increase expensing for small business. -- Business taxpayers are allowed to expense up to $100,000 in annual investment expenditures for eligible property placed in service in taxable years 2003 through 2007. The amount that may be expensed is reduced by the amount by which the taxpayer's annual cost of qualifying property exceeds $400,000. Both the deduction and annual investment limits are indexed annually for inflation, effective for taxable years beginning after 2003 and before 2008. Eligible property includes tangible personal property, certain real property, and, currently, off-the- shelf computer software. This Act increased the amount of annual investment expenditures 250 ANALYTICAL PERSPECTIVES that business taxpayers are allowed to expense by the lesser of $100,000 or the cost of eligible property that is also qualified GO Zone property placed in service during the taxable year. This Act also increased the phase-out threshold investment amount by the lesser of $600,000 or the cost of eligible property that is also qualified GO Zone property placed in service during the taxable year. Neither of these increased values is indexed for inflation. Qualified GO Zone property is property that meets the requirements needed to qualify for the special depreciation allowance (see discussion in the preceding paragraph).

Allow five-year carryback of certain net operating losses. -- A net operating loss (NOL) generally is the amount by which a taxpayer's allowable deductions exceed the taxpayer's gross income. A carryback of an NOL generally results in a refund of Federal income taxes paid for the carryback year. A carryforward of an NOL generally reduces Federal income tax payments for the carryforward year. Under current law, an NOL generally can be carried back two years and carried forward 20 years. This Act provided a special five-year carryback period for NOLs to the extent of certain specified amounts related to Hurricane Katrina or the GO Zone. The amount of the NOL eligible for the five-year carryback is limited to the aggregate amount of the following deductions: (1) qualified GO Zone casualty losses; (2) certain moving expenses; (3) certain temporary housing expenses; (4) depreciation deductions with respect to qualified GO Zone property for the taxable year the property is placed in service; and (5) deductions for certain repair expenses resulting form Hurricane Katrina. The five-year carryback applies to losses paid or incurred after August 27, 2005 and before January 1, 2008.

Increase amount of qualifying investment eligible for the new markets tax credit. -- Under current law, the new markets tax credit is provided for qualified equity investments made to acquire stock in a corporation or a capital interest in a partnership that is a qualified community development entity (CDE). A credit of five percent is provided to the investor for the first three years of investment. The credit increases to six percent for the next four years. The maximum amount of annual qualifying equity investment is capped at $2.0 billion for calendar years 2004 and 2005, and $3.5 billion for calendar years 2006 and 2007. This Act increased the annual qualifying equity investment cap by $300 million for 2005 and 2006, and $400 million for 2007. The additional amount is to be allocated among qualified CDEs to make qualified low-income community investments within the GO Zone. To qualify for the allocation, a qualified CDE must have as a significant mission the recovery and redevelopment of the GO Zone.

Provide tax relief for in-kind lodging provided by an employer. -- Under current law, employer-provided housing generally is includible in income as compensation and is wages for purposes of social security, Medicare, and unemployment insurance taxes. This Act provided an income tax exclusion for the value of in-kind lodging provided for a month to a qualified employee (and the employee's spouse or dependents) by or on behalf of a qualified employer. The amount of the exclusion for any month for which such lodging is furnished cannot exceed $600. For purposes of this exclusion, a qualified employee is any individual who: (1) on August 28, 2005, had a principal residence in the GO Zone; and (2) performed substantially all of his or her employment services in the Go Zone for the qualified employer furnishing the lodging. A qualified employer is any employer with a trade or business located in the GO Zone. The exclusion, which applies to lodging provided after December 31, 2005 and before July 1, 2006, does not apply for purposes of social security, Medicare or unemployment insurance taxes. This Act also provided a tax credit to qualified employers equal to 30 percent of the value of such lodging excluded from the income of a qualified employee. The amount taken as a credit is not deductible by the employer.

Provide other tax relief. -- Other tax relief provided to property and individuals located in the GO Zone included: (1) a deduction for 50 percent of certain cleanup costs; (2) a two- year extension of the current law provision allow expensing of certain environmental remediation costs; (3) an increase in the rehabilitation tax credit with respect to certain buildings; (4) an increase in the expensing limit for reforestation expenditures of certain small timber producers (also applicable to the Rita and Wilma GO Zones); (5) a five-year carryback for certain timber losses (also applicable to the Rita and Wilma GO Zones); (6) a ten-year carryback for certain public utility casualty losses; (7) a new category of tax-credit bonds to be issued by Louisiana, Mississippi and Alabama; (8) modification of the treatment of public utility disaster losses; and (9) expansion of the Hope and Lifetime Learning credits.

Exclude certain property from specific tax benefits. -- The provisions of this Act relating to additional first-year depreciation, increased expensing for small business, and the five-year carryback of NOLs do not apply with respect to the following property: (1) any private or commercial golf course, country club, massage parlor, hot tub facility, or suntan facility; (2) any store the principal business of which is the sale of alcoholic beverages for consumption off premises; and (3) any gambling or animal racing property.

Provide an employee retention credit to employers affected by Hurricanes Rita and Wilma. -- Under the Katrina Emergency Tax Relief Act of 2005, an employee retention credit was provided to employers who employed an average of 200 or fewer employees in a business located in the core Katrina disaster area on August 28, 2005, whose business was inoperable on any day during the period August 28, 2005 through December 31, 2005, as a result of Hurricane Katrina. This Act repealed the employer size limitation, effective for wages paid with respect to Hurricane Katrina on any day after August 28, 2005 and before January 1, 2006. This Act also expanded eligibility for the employee retention credit, as modified to repeal the employer size limitation, to apply to employers affected by Hurricanes Rita and Wilma and located in the Rita GO Zone on September 23, 2005 and in the Wilma GO Zone on October 23, 2005, respectively.

Suspend limitation on charitable contributions. -- Deductions for charitable contributions are subject to certain limitations under current law. The Katrina Emergency Tax Relief Act of 2005 temporarily suspended these limitations for corporations and individuals who itemize deductions with respect to cash contributions to certain public charities made after August 27, 2005 and before January 1, 2006. For corporations, the suspension applied only to contributions for relief efforts related to Hurricane Katrina. This Act expanded this temporary suspension to apply to corporate cash contributions for relief efforts related to Hurricanes Rita and Wilma.

Suspend limitation on personal casualty losses. -- The Katrina Emergency Tax Relief Act of 2005 suspended both the $100 and 10-percent-of-AGI limitations otherwise applicable to personal casualty losses, with respect to such loses occurring in the Hurricane Katrina disaster area on or after August 25, 2005 and attributable to the hurricane. This Act expanded this suspension to apply to such losses occurring in the Hurricane Rita disaster area on or after September 23, 2005 and the Hurricane Wilma disaster area on or after October 23, 2005.

Provide other tax relief for victims of Hurricane Rita and Hurricane Wilma. -- Other tax relief provided to victims of Hurricanes Rita and Wilma included: (1) a special rule for purposes of computing the refundable portion of the child tax credit and the EITC; (2) authority to make adjustments regarding taxpayer and dependency status; and (3) special rules for mortgage revenue bonds.

Modify the rules regarding the suspension of interest and penalties where the IRS fails to contact the taxpayer. -- In general, interest and penalties accrue during periods for which taxes are unpaid, without regard to whether the taxpayer was aware that taxes were due. Beginning 18 months after the filing of a timely return, the accrual of certain penalties and interest is suspended if the IRS failed to send the taxpayer a notice specifically stating the taxpayer's liability and the basis for the liability. Interest and penalties resume 21 days after the required notice is sent to the taxpayer by the IRS. The temporary suspension of certain penalties and interest does not apply to interest accruing after October 3, 2004 with respect to underpayments resulting from listed transactions or undisclosed reportable transactions. This Act expanded the exception for listed transactions and undisclosed reportable transactions to apply to interest accruing on or before October 3, 2004. However, taxpayers remain eligible for the present-law suspension of interest if: (1) the year in which the underpayment occurred is barred by the statute of limitations (or a closing agreement) as of December 14, 2005; (2) it is determined that the taxpayer acted reasonably and in good faith with respect to the transaction; or (3) as of January 23, 2006, the taxpayer participates in the IRS settlement initiative with respect to the transaction. In addition, if a taxpayer files an amended return or other signed written document after December 21, 2005 that shows that the taxpayer owes an additional amount of tax for a given taxable year, the 18- month period is measured from the latest date on which such documents were provided.

Make technical corrections to recently enacted legislation. -- This Act also included technical corrections and other corrections to recently enacted tax legislation.

The President has proposed several changes that move the tax code in this direction. The Budget includes proposals to make health care more affordable to a mobile labor force, to promote savings for all Americans, to encourage investment by entrepreneurs, and to enhance our competitiveness by lowering the cost of capital. The Budget also recognizes that tax policy analysis needs to account fully for the economic benefits of reform on our economy. In the coming months, the Treasury Department will continue to study reform and engage in a public dialogue on this important issue.

Extend permanently increased expensing for small business. -- Business taxpayers are allowed to expense up to $100,000 in annual investment expenditures for qualifying property (expanded to include off-the-shelf computer software) placed in service in taxable years 2003 through 2007. The amount that may be expensed is reduced by the amount by which the taxpayer's cost of qualifying property exceeds $400,000. Both the deduction and annual investment limits are indexed annually for inflation, effective for taxable years beginning after 2003 and before 2008. Also, with respect to a taxable year beginning after 2002 and before 2008, taxpayers are permitted to make or revoke expensing elections on amended returns without the consent of the IRS Commissioner. The Administration proposes to extend permanently each of these temporary provisions, applicable for qualifying property (including off-the-shelf computer software) placed in service in taxable years beginning after 2007.

Extend permanently provisions expiring in 2010. -- Most of the provisions of the 2001 tax cut sunset on December 31, 2010. The Administration proposes to extend those provisions permanently.

The Administration proposes to replace current law IRAs with two new savings accounts: a Lifetime Savings Account (LSA) and a Retirement Savings Account (RSA). Regardless of age or income, individuals could make annual nondeductible contributions of $5,000 to an LSA and $5,000 (or earnings if less) to an RSA. Distributions from an LSA would be excluded from income and could be made at anytime for any purpose without restriction. Distributions from an RSA would be excluded from income after attaining age 58 or in the event of death or disability. All other distributions would be included in income (to the extent they exceed basis) and subject to an additional tax. Distributions would be deemed to come from basis first. The proposal would be effective for contributions made after December 31, 2006 and future year contribution limits would be indexed for inflation.

Existing Roth IRAs would be renamed RSAs and would be subject to the new rules for RSAs. Existing traditional and nondeductible IRAs could be converted into an RSA by including the conversion amount (excluding basis) in gross income, similar to a current-law Roth conversion. However, no income limit would apply to the ability to convert. Taxpayers who convert IRAs to RSAs could spread the included conversion amount over several years. Existing traditional or nondeductible IRAs that are not converted to RSAs could not accept new contributions. New traditional IRAs could be created to accommodate rollovers from employer plans, but they could not accept new individual contributions. Individuals wishing to roll an amount directly from an employer plan to an RSA could do so by including the rollover amount (excluding basis) in gross income (i.e., "converting" the rollover, similar to a current law Roth conversion).

Saving will be further simplified and encouraged by administrative changes already planned for the 2007 filing season that will allow taxpayers to have their tax refunds directly deposited into more than one account. Consequently, taxpayers will be able, for example, to direct that a portion of their tax refunds be deposited into an LSA or RSA.

Consolidate employer-based savings accounts. -- Current law provides multiple types of tax-preferred employer-based savings accounts to encourage saving for retirement. The accounts have similar goals but are subject to different sets of rules regulating eligibility, contribution limits, tax treatment, and withdrawal restrictions. For example, 401(k) plans for private employers, SIMPLE 401(k) plans for small employers, 403(b) plans for 501(c)(3) organizations and public schools, and 457 plans for State and local governments are all subject to different rules. To qualify for tax benefits, plans must satisfy multiple requirements. Among the requirements, the plan generally may not discriminate in favor of highly compensated employees with regard either to coverage or to amount or availability of contributions or benefits. Rules covering employer-based savings accounts are among the lengthiest and most complicated sections of the tax code and associated regulations. This complexity imposes substantial costs on employers, participants, and the Government, and likely has inhibited the adoption of retirement plans by employers, especially small employers.

The Administration proposes to consolidate 401(k), SIMPLE 401(k), 403(b), and 457 plans, as well as SIMPLE IRAs and SARSEPs, into a single type of plan -- Employee Retirement Savings Accounts (ERSAs) that would be available to all employers. ERSA non-discrimination rules would be simpler and include a new ERSA non-discrimination safe-harbor. Under one of the safeharbor options, a plan would satisfy the nondiscrimination rules with respect to employee deferrals and employee contributions if it provided a 50-percent match on elective contributions up to six percent of compensation. By creating a simplified and uniform set of rules, the proposal would substantially reduce complexity. The proposal would be effective for taxable years beginning after December 31, 2006.

Establish Individual Development Accounts (IDAs). -- The Administration proposes to allow eligible individuals to make contributions to a new savings vehicle, the Individual Development Account, which would be set up and administered by qualified financial institutions, nonprofit organizations, or Indian tribes (qualified entities). Citizens or legal residents of the United States between the ages of 18 and 60 who cannot be claimed as a dependent on another taxpayer's return, are not students, and who meet certain income limitations would be eligible to establish and contribute to an IDA. A single taxpayer would be eligible to establish and contribute to an IDA if his or her modified AGI in the preceding taxable year did not exceed $20,000 ($30,000 for heads of household, and $40,000 for married taxpayers filing a joint return). These thresholds would be indexed annually for inflation beginning in 2008. Qualified entities that set up and administer IDAs would be required to match, dollar-for-dollar, the first $500 contributed by an eligible individual to an IDA in a taxable year. Qualified entities would be allowed a 100 percent tax credit for up to $500 in annual matching contributions to each IDA, and a $50 tax credit for each IDA maintained at the end of a taxable year with a balance of not less that $100 (excluding the taxable year in which the account was established). Matching contributions and the earnings on those contributions would be deposited in a separate "parallel account." Contributions to an IDA by an eligible individual would not be deductible, and earnings on those contributions would be included in income. Matching contributions by qualified entities and the earnings on those contributions would be tax-free.

Withdrawals from the parallel account may be made only for qualified purposes (higher education, the firsttime purchase of a home, business start-up, and qualified rollovers). Withdrawals from the IDA for other than qualified purposes may result in the forfeiture of some or all matching contributions and the earnings on those contributions. The credit could be claimed for taxable years ending after December 31, 2007 and beginning before January 1, 2015. The credit would apply with respect to the first 900,000 IDA accounts opened after December 31, 2007 and before January 1, 2013, and with respect to matching funds for participant contributions that are made after December 31, 2007 and before January 1, 2015.

The Administration proposes that individuals who make after-tax contributions to an HSA would be allowed a credit equal to a percentage of their after-tax contributions to the HSA to offset the employment taxes on their contributions. The credit generally would be 15.3 percent of their HSA contributions, but would be limited by the amount of wages in the payroll tax base. In order to recapture the credit relating to employment taxes for contributions that are not used for medical expenses, the additional tax on non-medical withdrawals would increase to 30 percent, with a 15 percent rate on non-medical distributions after death, disability, or attaining the age of 65.

The Administration proposes to increase the maximum HSA contribution for all eligible individuals. For any year, the maximum HSA contribution would be increased to the bona fide out-of-pocket limit of the high-deductible health plan.

Additional changes would be made to HSAs to encourage the use of HSAs and coverage under the HSA-eligible high-deductible health plans, including: (1) allowing HSA funds to be used tax-free for premiums for the purchase of non-group high-deductible health plans; (2) allowing qualified medical expenses to include any medical expense incurred on or after the first day of HDHP coverage if individuals have established an HSA by their return filing date for that year; (3) allowing employers to contribute existing health reimbursement arrangement (HRA) balances to the HSAs of employees who would be eligible individuals but for the HRA coverage; and (4) excluding from the comparability rules extra employer contributions to HSAs on behalf of employees who are chronically ill or employees who have spouses or dependents who are chronically ill. All of the HSA-related proposals would be effective for years beginning after December 31, 2006.

Provide an above-the-line deduction for high-deductible insurance premiums. -- Current law provides a tax preference for employer-provided group health insurance plans, but not for individually purchased health insurance coverage except to the extent that deductible medical expenses exceed 7.5 percent of AGI, the individual has self-employment income, or the individual is eligible under the Trade Act of 2002 to purchase certain types of qualified health insurance. Current law also allows individuals to accumulate funds in an HSA or MSA on a tax-preferred basis to pay for medical expenses, provided they are covered by an HDHP, and no other health plan.

The Administration proposes to allow individuals who are eligible for an HSA because they are covered under an HDHP in the individual insurance market to deduct the amount of the premium in determining AGI (whether or not the person itemizes deductions). These individuals would also be entitled to an income tax credit to account for employment taxes. Individuals claiming other credits or deductions or covered by public plans or otherwise not eligible to contribute to an HSA would not qualify for the above-the-line deduction or the credit. The credit generally would be 15.3 percent of their HDHP premium payment, but would be limited by the amount of wages in the payroll tax base. The above-the-line deduction and tax credit would be effective for taxable years beginning after December 31, 2006.

Provide refundable tax credit for the purchase of health insurance. -- Current law provides a tax preference for employer-provided group health insurance plans, but not for individually purchase health insurance coverage except to the extent that deductible medical expenses exceed 7.5 percent of AGI, the individual has self-employment income, or the individual is eligible under the Trade Act of 2002 to purchase certain types of qualified health insurance. In addition, individuals are allowed to accumulate funds in an HSA or MSA on a tax-preferred basis to pay for medical expenses, provided they are covered by an HDHP, and no other health plan.

The Administration proposes to make health insurance more affordable for individuals not covered by an employer plan or a public program. Effective for taxable years beginning after December 31, 2006, a new refundable tax credit would be provided for the cost of an HDHP purchased by an individual under age 65. The credit would provide a subsidy for a percentage of the health insurance premium, up to a maximum includable premium. The maximum subsidy percentage would be 90 percent for low-income taxpayers and would phase down with income. The maximum credit would be $1,000 for a plan covering one adult, $2,000 for a plan covering two adults, $3,000 for a plan covering two adults and one or more children, and $1,000 for a plan covering only children. The credit would be phased out at an income of $30,000 for single taxpayers and $60,000 for families purchasing a family policy. Individuals could claim the tax credit for health insurance premiums paid as part of the normal tax-filing process. Alternatively, beginning July 1, 2007, the tax credit would be available in advance at the time the individual purchases health insurance. The advance credit would reduce the premium paid by the individual to the health insurer, and the health insurer would be reimbursed directly by the Department of Treasury for the amount of the advance credit. Eligibility for an advance credit would be based on an individual's prior year tax return. Qualifying insurance could be purchased in the individual market. Qualifying health insurance could also be purchased through private purchasing groups, State- sponsored insurance purchasing pools, and high-risk pools.

Improve the Health Coverage Tax Credit. -- The Health Coverage Tax Credit (HCTC) was created under the Trade Act of 2002 for the purchase of qualified health insurance. Eligible persons include certain individuals who are receiving benefits under the TAA or the Alternative TAA (ATAA) program and certain individuals between the ages of 55 and 64 who are receiving pension benefits from the Pension Benefit Guaranty Corporation (PBGC). The tax credit is refundable and can be claimed through an advance payment mechanism at the time the insurance is purchased.

To make the requirements for qualified State-based coverage under the HCTC more consistent with the rules applicable under the Health Insurance Portability and Accountability Act (HIPAA) and thus encourage more plans to participate in the HCTC program, the Administration proposes to allow State-based coverage to impose a pre-existing condition restriction for a period of up to 12 months, provided the plan reduces the restriction period by the length of the eligible individual's creditable coverage (as of the date the individual applied for the State-based coverage). This provision would be effective for eligible individuals applying for coverage after December 31, 2006. Also, in order to prevent an individual from losing the benefit of the HCTC just because his or her spouse becomes eligible for Medicare, the Administration proposes to permit spouses of HCTC-eligible individuals to claim the HCTC when the HCTC-eligible individual becomes entitled to Medicare coverage. The spouse, however, would have to be at least 55 years old and meet the other HCTC eligibility requirements. This provision would be effective for taxable years beginning after December 31, 2006.

To improve the administration of the HCTC, the Administration proposes to: (1) modify the definition of "other specified coverage" for "eligible ATAA recipients," to be the same as the definition applied to "eligible TAA recipients;" (2) clarify that certain PBGC pension recipients are eligible for the tax credit; (3) allow State-based continuation coverage to qualify without meeting the requirements for State-based qualified coverage; and (4) for purposes of the State-based coverage rules, permit the Commonwealths of Puerto Rico and Northern Mariana Islands, as well as American Samoa, Guam, and the U.S. Virgin Islands to be deemed as States.

Allow the orphan drug tax credit for certain predesignation expenses. -- Current law provides a 50-percent credit for expenses related to human clinical testing of drugs for the treatment of certain rare diseases and conditions ("orphan drugs"). A taxpayer may claim the credit only for expenses incurred after the Food and Drug Administration (FDA) designates a drug as a potential treatment for a rare disease or condition. This creates an incentive to defer clinical testing for orphan drugs until the taxpayer receives the FDA's approval and increases complexity for taxpayers by treating pre-designation and post-designation clinical expenses differently. The Administration proposes to allow taxpayers to claim the orphan drug credit for expenses incurred prior to FDA designation if designation occurs before the due date (including extensions) for filing the tax return for the year in which the FDA application was filed. The proposal would be effective for qualified expenses incurred after December 31, 2005.

Expand and increase the enhanced charitable deduction for contributions of food inventory. -- A taxpayer's deduction for charitable contributions of inventory generally is limited to the taxpayer's basis (typically cost) in the inventory. However, for certain contributions of inventory, C corporations may claim an enhanced deduction equal to the lesser of: (1) basis plus one half of the fair market value in excess of basis, or (2) two times basis. To be eligible for the enhanced deduction, the contributed property generally must be inventory of the taxpayer contributed to a charitable organization and the donee must: (1) use the property consistent with the donee's exempt purpose solely for the care of the ill, the needy, or infants; (2) not transfer the property in exchange for money, other property, or services; and (3) provide the taxpayer a written statement that the donee's use of the property will be consistent with such requirements. To use the enhanced deduction, the taxpayer must establish that the fair market value of the donated item exceeds basis.

Under the Administration's proposal, which is designed to encourage contributions of food inventory to charitable organizations, any taxpayer engaged in a trade or business would be eligible to claim an enhanced deduction for donations of food inventory. The enhanced deduction for donations of food inventory would be increased to the lesser of: (1) fair market value or (2) two times basis. However, to ensure consistent treatment of all businesses claiming an enhanced deduction for donations of food inventory, the enhanced deduction for qualified food donations by S corporations and non-corporate taxpayers would be limited to 10 percent of net income from the trade or business. A special provision would allow taxpayers with a zero or low basis in the qualified food donation (e.g., taxpayers that use the cash method of accounting for purchases and sales, and taxpayers that are not required to capitalize indirect costs) to assume a basis equal to 25 percent of fair market value. The enhanced deduction would be available only for donations of "apparently wholesome food" (food intended for human consumption that meets all quality and labeling standards imposed by Federal, State, and local laws and regulations, even though the food may not be readily marketable due to appearance, age, freshness, grade, size, surplus, or other conditions). The fair market value of "apparently wholesome food" that cannot or will not be sold solely due to internal standards of the taxpayer or lack of market, would be determined by taking into account the price at which the same or substantially the same food items (as to both type and quality) are sold by the taxpayer at the time of the contribution or, if not sold at such time, in the recent past. These proposed changes in the enhanced deduction for donations of food inventory would be effective for taxable years beginning after December 31, 2005.

Reform excise tax based on investment income of private foundations. -- Under current law, private foundations that are exempt from Federal income tax are subject to a two-percent excise tax on their net investment income (one-percent if certain requirements are met). The excise tax on private foundations that are not exempt from Federal income tax, such as certain charitable trusts, is equal to the excess of the sum of the excise tax that would have been imposed if the foundation were tax exempt and the amount of the unrelated business income tax that would have been imposed if the foundation were tax exempt, over the income tax imposed on the foundation. To encourage increased charitable activity and simplify the tax laws, the Administration proposes to replace the two rates of tax on the net investment income of private foundations that are exempt from Federal income tax with a single tax rate of one percent. The excise tax on private foundations not exempt from Federal income tax would be equal to the excess of the sum of the one-percent excise tax that would have been imposed if the foundation were tax exempt and the amount of the unrelated business income tax what would have been imposed if the foundation were tax exempt, over the income tax imposed on the foundation. The proposed change would be effective for taxable years beginning after December 31, 2005.

Modify tax on unrelated business taxable income of charitable remainder trusts. -- A charitable remainder annuity trust is a trust that is required to pay, at least annually, a fixed dollar amount of at least five percent of the initial value of the trust to a noncharity for the life of an individual or for a period of 20 years or less, with the remainder passing to charity. A charitable remainder unitrust is a trust that generally is required to pay, at least annually, a fixed percentage of at least five percent of the fair market value of the trust's assets determined at least annually to a non-charity for the life of an individual or for a period of 20 years or less, with the remainder passing to charity. A trust does not qualify as a charitable remainder annuity trust if the annuity for a year is greater than 50 percent of the initial fair market value of the trust's assets. A trust does not qualify as a charitable remainder unitrust if the percentage of assets that are required to be distributed at least annually is greater than 50 percent. A trust does not qualify as a charitable remainder annuity trust or a charitable remainder unitrust unless the value of the remainder interest in the trust is at least 10 percent of the value of the assets contributed to the trust. Distributions from a charitable remainder annuity trust or charitable remainder unitrust, which are included in the income of the beneficiary for the year that the amount is required to be distributed, are treated in the following order as: (1) ordinary income to the extent of the trust's undistributed ordinary income for that year and all prior years; (2) capital gains to the extent of the trust's undistributed capital gain for that year and all prior years; (3) other income to the extent of the trust's undistributed other income for that year and all prior years; and (4) corpus (trust principal).

Charitable remainder annuity trusts and charitable remainder unitrusts are exempt from Federal income tax; however, such trusts lose their income tax exemption for any year in which they have unrelated business taxable income. Any taxes imposed on the trust are required to be allocated to trust corpus. The Administration proposes to levy a 100-percent excise tax on the unrelated business taxable income of charitable remainder trusts, in lieu of removing the Federal income tax exemption for any year in which unrelated business taxable income is incurred. This change, which is a more appropriate remedy than loss of tax exemption, is proposed to become effective for taxable years beginning after December 31, 2005, regardless of when the trust was created.

Modify basis adjustment to stock of S corporations contributing appreciated property. -- Under current law, each shareholder in an S corporation separately accounts for his or her pro rata share of the S corporation's charitable contributions in determining his or her income tax liability. A shareholder's basis in the stock of the S corporation must be reduced by the amount of his or her pro rata share of the S corporation's charitable contribution. In order to preserve the benefit of providing a charitable contribution deduction for contributions of appreciated property and to prevent the recognition of gain in the contributed property on the disposition of the S corporation stock, the Administration proposes to allow a shareholder in an S corporation to increase his or her basis in the stock of an S corporation by an amount equal to the excess of the shareholder's pro rata share of the S corporation's charitable contribution over the stockholder's pro rata share of the adjusted basis of the contributed property. The proposal would be effective for taxable years beginning after December 31, 2005.

Repeal the $150 million limitation on qualified 501(c)(3) bonds. -- Current law contains a $150 million limitation on the volume of outstanding, non-hospital, tax-exempt bonds for the benefit of any one 501(c)(3) organization. The limitation was repealed in 1997 for bonds issued after August 5, 1997, at least 95 percent of the net proceeds of which are used to finance capital expenditures incurred after that date. However, the limitation continues to apply to bonds more than five percent of the net proceeds of which finance or refinance working capital expenditures, or capital expenditures incurred on or before August 5, 1997. In order to simplify the tax laws and provide consistent treatment of bonds for 501(c)(3) organizations, the Administration proposes to repeal the $150 million limitation in its entirety.

Repeal certain restrictions on the use of qualified 501(c)(3) bonds for residential rental property. -- Tax-exempt, 501(c)(3) organizations generally may utilize tax-exempt financing for charitable purposes. However, existing law contains a special limitation under which 501(c)(3) organizations may not use tax-exempt financing to acquire existing residential rental property for charitable purposes unless the property is rented to low-income tenants or is substantially rehabilitated. In order to simplify the tax laws and provide consistent treatment of bonds for 501(c)(3) organizations, the Administration proposes to repeal the residential rental property limitation.

A number of tax incentives would be applicable to opportunity zones. First, a business would be allowed to exclude 25 percent of its taxable income if it qualified as an "opportunity zone business" and it satisfied a $5 million gross receipts test. The definition of an opportunity zone business would be based on the definition of a "qualified active low-income community business" for purposes of the new markets tax credit, treating opportunity zones as low-income communities. Second, an opportunity zone business would be allowed to expense the cost of section 179 property that is qualified zone property, up to an additional $100,000 above the amounts generally available under current law. Third, a commercial revitalization deduction would be available for opportunity zones in a manner similar to the deduction for renewal communities. A $12 million annual cap on these deductions would apply to each opportunity zone. Finally, individuals who live and work in an opportunity zone would constitute a new target group with respect to wages earned within the zone under the proposed combined work opportunity tax credit and welfare-to-work tax credit (see discussion later in this Chapter).

Repeal certain New York City Liberty Zone incentives. -- The Administration proposes to terminate the following tax incentives provided to qualified property within the New York Liberty Zone under the 2002 economic stimulus act: (1) the additional first-year depreciation deduction; (2) the five-year recovery period for leasehold improvement property; (3) increased expensing for small businesses; and (4) the extended replacement period for the nonrecognition of gain on involuntarily converted property. These terminations are proposed to be effective on the date of enactment. Property placed in service after the date of enactment would not be eligible for the first three incentives listed above unless a binding written contract was in effect on the date of enactment, in which case the property would need to be placed in service by the original termination dates provided in the 2002 economic stimulus act. Other related changes to the Internal Revenue Code would be made as appropriate.

To ensure that deserving taxpayers receive child-related tax benefits, the Administration proposes to clarify the uniform definition of a child. First, the definition of a qualifying child would be further simplified. A taxpayer would not be a qualifying child of another individual if the taxpayer is older than that individual. However, an individual could be a qualifying child of a younger sibling if the individual is permanently and totally disabled. Also, under the proposal, an individual who is married and filing jointly (for any reason other than to obtain a refund of over-withheld taxes) would not be considered a qualifying child for the child-related tax benefits, including the child tax credit. Second, the proposal clarifies when a taxpayer is eligible to claim child-related tax benefits. If a parent resides with his or her child for over half the year, the parent would be the only individual eligible to claim the child as a qualifying child. The parent could waive the child-related tax benefits to another member of the household who has higher adjusted gross income and is otherwise eligible for the tax benefits. In addition, dependent filers would not be allowed to claim qualifying children. The proposal is effective for taxable years beginning after December 31, 2006.

Simplify EITC eligibility requirement regarding filing status, presence of children, and work and immigrant status. -- To qualify for the EITC, taxpayers must satisfy requirements regarding filing status, the presence of children in their households, and their work and immigration status in the United States. These rules are confusing, require significant record-keeping, and are costly to administer. Under the proposal, married taxpayers who reside with children could claim the EITC without satisfying a complicated household maintenance test if they live apart from their spouse for the last six months of the year. In addition, certain taxpayers who live with children but do not qualify for the larger child-related EITC could claim the smaller EITC for very low-income childless workers. The proposal would also improve the administration of the EITC with respect to eligibility requirements for undocumented workers. The proposal is effective for taxable years beginning after December 31, 2006.

Reduce computational complexity of refundable child tax credit. -- Taxpayers with earned income in excess of $11,300 may qualify for a refundable (or "additional") child tax credit even if they do not have any income tax liability. About 70 percent of additional child tax credit claimants also claim the EITC. However, the two credits have a different definition of earned income and different U.S. residency requirements. In addition, some taxpayers have to perform multiple computations to determine the amount of the additional child tax credit they can claim. First, they must compute the additional child tax credit using a formula based on earned income. Then, if they have three or more children, they may recalculate the credit using a formula based on social security taxes and claim the higher of the two amounts.

Under the proposal, the additional child tax credit would use the same definition of earned income as is used for the EITC. Taxpayers (other than members of the Armed Forces stationed overseas) would be required to reside with a child in the United States to claim the additional child tax credit (as they are currently required to do for the EITC). Taxpayers with three or more children would do only one computation based on earned income to determine the credit amount. The proposal would be effective for taxable years beginning after December 31, 2006.

Strengthen funding for single-employer pension plans. -- Under current law, defined benefit pension plans are subject to minimum funding requirements imposed under both the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA). In the case of a qualified plan, the Internal Revenue Code excludes such contributions from gross income and allows a deduction for the contributions, subject to certain limits on the maximum deductible amount. The calculation of the minimum funding requirements and the limits on deductible contributions are determined under a series of complex rules and measures of assets and liability, many of which are manipulable and none of which entail the use of an accurate measure of the plan's assets and its true liabilities.

The Administration proposes rationalizing the multiple sets of funding rules applicable to single-employer defined benefit plans and replacing them with a single set of rules that provide for: (1) funding targets that are based on meaningful, accurate measures of liabilities that reflect the financial health of the employer; (2) the use of market value of assets; (3) a seven-year amortization period for funding shortfalls; (4) the opportunity for an employer to make additional deductible contributions in good years, even when the plan's assets are above the funding target; and (5) meaningful consequences for employers and plans whose funded status does not improve.

These funding rules changes and the addition of meaningful consequences for employers and plans whose funded status does not improve and improved disclosure to plan participants, investors and regulators are part of an overall package of reforms that will improve the health of defined benefit pensions and the PBGC guarantee system. As described in Chapter 7 of Analytical Perspectives and the Department of Labor Chapter of the Budget volume, this overall package includes reform of the premium structure for the PBGC, revision in the application of the PBGC guarantee rates and changes to the bankruptcy law.

Reflect market interest rates in lump sum payments. -- Current law generally requires that a lump sum paid from a pension plan be calculated using the rate of interest on 30-year Treasury securities (or a close proxy) for the month preceding the distribution. The Administration proposes that the value of the lump sum reflect market interest rates and the timing of the expected benefit payments for which the lump sum is calculated. This would ensure that the value of the lump sum is equivalent to the value of the annuity. Lump sums would be calculated using interest rates that are drawn from a zero-coupon corporate bond yield curve. The yield curve would be issued monthly by the Secretary of the Treasury and would be based on the interest rates (averaged over 90 business days) for high quality corporate bonds with varying maturities. In order to avoid disruptions, the proposal would be phased in for plan years beginning in 2008 and 2009 and would not be fully effective until the plan year beginning in 2010.

Modify the active trade or business test. -- Current law allows corporations to avoid recognizing gain in certain spin-off and split-off transactions provided that, among other things, the active trade or business test is satisfied. The active trade or business test requires that immediately after the distribution, the distributing corporation and the corporation the stock of which is distributed (the controlled corporation) be engaged in a trade or business that has been actively conducted throughout the five-year period ending on the date of the distribution. There is no statutory requirement that a certain percentage of the distributing corporation's or controlled corporation's assets be used in that active trade or business in order for the active trade or business test to be satisfied. Because certain non-pro rata distributions resemble redemptions for cash, the Administration proposes to require that in the case of a non-pro rata distribution, in order for a corporation to satisfy the active trade or business test, as of the date of the distribution, at least 50 percent of its assets, by value, must be used or held for use in a trade or business that satisfies the active trade or business test.

Impose penalties on charities that fail to enforce conservation easements. -- Although gifts of partial interests in property generally are not deductible as charitable contributions, current law allows a deduction for certain restrictions granted in perpetuity on the use that may be made of real property (such as an easement). A deduction is allowed only if the contribution is made to a qualified organization exclusively for conservation purposes. To qualify to receive such qualified conservation contributions, a charity must have a commitment to protect the conservation purposes of the donation and have the resources to enforce the restrictions. The Department of Treasury is concerned that in some cases charities are failing to monitor and enforce the conservation restrictions for which charitable contribution deductions were claimed. The proposal would impose significant penalties on any charity that removes or fails to enforce such a conservation restriction, or transfers the easement without ensuring that the conservation purposes will be protected in perpetuity. The amount of the penalty would be determined based on the value of the easement shown on the appraisal summary provided to the charity by the donor. The Secretary of the Treasury would be authorized to waive the penalty in certain circumstances. The Secretary of the Treasury also would be authorized to require such additional reporting as may be necessary or appropriate to ensure that the conservation purposes are protected in perpetuity.

Eliminate the special exclusion from unrelated business taxable income for gain or loss on the sale or exchange of certain brownfields. -- In general, an organization that is otherwise exempt from Federal income tax is taxed on income from any trade or business regularly carried on by the organization that is not substantially related to the organization's exempt purposes. In addition, income derived from property that is debt-financed generally is subject to unrelated business income tax. The 2004 job creation act created a special exclusion from unrelated business taxable income of gain or loss from the sale or exchange of certain qualifying brownfield properties. The exclusion applies regardless of whether the property is debt-financed. The new provision adds considerable complexity to the Internal Revenue Code and, because there is no limit on the amount of tax-free gain, could exempt from tax real estate development considerably beyond mere environmental remediation. The proposal would eliminate this special exclusion effective for taxable years beginning after December 31, 2006.

Limit related party interest deductions. -- Current law (section 163(j) of the Internal Revenue Code) denies U.S. tax deductions for certain interest expenses paid to a related party where: (1) the corporation's debt-to-equity ratio exceeds 1.5 to 1, and (2) net interest expenses exceed 50 percent of the corporation's adjusted taxable income (computed by adding back net interest expense, depreciation, amortization, depletion, and any net operating loss deduction). If these thresholds are exceeded, no deduction is allowed for interest in excess of the 50-percent limit that is paid to a related party or paid to an unrelated party but guaranteed by a related party, and that is not subject to U.S. tax. Any interest that is disallowed in a given year is carried forward indefinitely and may be deductible in a subsequent taxable year. A three-year carryforward for any excess limitation (the amount by which interest expense for a given year falls short of the 50-percent limit) is also allowed. Because of the opportunities available under current law to reduce inappropriately U.S. tax on income earned on U.S. operations through the use of foreign related-party debt, the Administration proposes to tighten the interest disallowance rules of section 163(j) as follows: (1) the current law 1.5 to 1 debt-to-equity safe harbor would be eliminated; (2) the adjusted taxable income threshold for the limitation would be reduced from 50 percent to 25 percent of adjusted taxable income with respect to disqualified interest other than interest paid to unrelated parties on debt that is subject to a related-party guarantee, which generally would remain subject to the current law 50 percent threshold; and (3) the indefinite carryforward for disallowed interest would be limited to ten years and the three- year carryforward of excess limitation would be eliminated. The Department of Treasury also is conducting a study of these rules and the potential for further modifications to ensure the prevention of inappropriate income-reduction opportunities.

Clarify and simplify qualified tuition programs. -- Current law provides special tax treatment for contributions to and distributions from qualified tuition programs under Section 529. The purpose of these programs is to encourage saving for the higher education expenses of designated beneficiaries. However, current law is unclear in certain situations with regard to the transfer tax consequences of changing the designated beneficiary of a qualified tuition program account. In addition, current law creates opportunities for inappropriate use of these accounts. The proposal would simplify the tax consequences under these programs and promote use of these accounts to save for higher education. The most significant change made by this proposal is the elimination of substantially all post-contribution transfer taxes, thus permitting tax-free changes of the designated beneficiary of an account, without limitation as to the relationship or number of generations between the current and former beneficiaries. Any distribution used to pay the beneficiary's qualified higher education expenses would continue to be tax-free. However, to eliminate the potential transfer tax benefit of using an account for purposes not intended by the statute, any distribution that is not used for higher education expenses generally would be subject to a new excise tax (payable from the account) once the cumulative amount of these distributions exceeds a stated amount per beneficiary. Distributions from an account would be permitted to be made only to or for the benefit of the designated beneficiary. However, a contributor who sets up an account would be permitted to withdraw funds from the account during the contributor's life, subject to income tax on the income portion of the withdrawal. The income portion of a withdrawal by the account's contributor generally also would be subject to an additional tax to discourage individuals from using these accounts to save for retirement. The proposal would be effective for Section 529 accounts established after the date of enactment, and no additional contributions would be permitted to preexisting Section 529 savings accounts unless those accounts elect to be governed by the new rules.

Initiate IRS cost saving measures. -- The Administration has two proposals to improve IRS efficiency and performance from current resources. The first proposal modifies the way that Financial Management Services (FMS) recovers its transaction fees for processing IRS levies by permitting FMS to retain a portion of the amount collected before transmitting the balance to the IRS, thereby reducing Government transaction costs. The offset amount would be included as part of the 15-percent limit on continuous levies against income and would also be credited against the taxpayer's liability. The second proposal would provide the IRS additional authority to require electronic filing. This proposal would allow the IRS to process more returns and payments efficiently.

Allow IRS to access information in the National Directory of New Hires for tax administration purposes. -- The National Directory of New Hires (NDNH), an electronic database maintained by the Department of Health and Human Services, contains timely, uniformly compiled employment data from State agencies across the country. Currently, the IRS may obtain data from the NDNH, but only for limited purposes. Access to NDNH data for tax administration purposes generally would make the IRS more productive by reducing the amount of resources it must dedicate to obtaining and processing data. The Administration proposes to amend the Social Security Act to allow the IRS access to NDNH data for general tax administration purposes, including data matching, verification of taxpayer claims during return processing, preparation of substitute returns for non-compliant taxpayers, and identification of levy sources. Data obtained by the IRS from the NDNH would be protected by existing taxpayer privacy law, including civil and criminal sanctions. The proposal would be effective on the date of enactment.

Extend IRS authority to fund undercover operations. -- Current law places the IRS on equal footing with other Federal law enforcement agencies by permitting the IRS to fund certain necessary and reasonable expenses of undercover operations. These undercover operations include international and domestic money laundering and narcotics operations. The Administration proposes to extend this funding authority, which expires on December 31, 2006, through December 31, 2010.

Reduce the tax gap. -- While the vast majority of American taxpayers pay their taxes timely and accurately, the nation still has a significant tax gap, which is the difference between what taxpayers should pay and what they actually pay on a timely basis. The IRS has taken a number of steps to bolster enforcement; however, it is unlikely that IRS will be able to narrow the tax gap to an acceptable level through enforcement alone. In an effort to reduce the tax gap with minimum taxpayer burden, the Administration proposes to: (1) Clarify the circumstances in which employee leasing companies and their clients can be held jointly liable for Federal employment taxes. (2) Require debit and credit card issuers to report to the IRS gross reimbursements paid to certain businesses. (3) Require increased information reporting for certain non-wage payments made by Federal, State and local governments to procure property and services. (4) Amend collections due process procedures applicable to Federal employment taxes. (5) Expand return preparer identification and penalty provisions. In addition, the Department of Treasury will study the standards used to distinguish between employees and independent contractors for purposes of withholding and paying Federal employment taxes.

Extend unemployment insurance surtax. -- The unemployment insurance surtax of 0.2 percent imposed on employers is scheduled to expire with respect to wages paid after December 31, 2007. This tax is proposed to be extended for five years, through December 31, 2012.

Modify amortization for certain geological and geophysical expenditures. -- Under the Energy Policy Act of 2005, geological and geophysical expenditures paid or incurred in taxable years beginning after August 8, 2005, in connection with oil and gas exploration in the United States, may be amortized over two years. The Administration proposes to increase the amortization period to five years for amounts paid or incurred in taxable years beginning after December 31, 2006.

Extend Generalized System of Preferences (GSP). -- Under GSP, duty-free access is provided to approximately 3,400 products from eligible beneficiary developing countries that meet certain worker rights, intellectual property protection, and other statutory criteria. The Administration proposes to extend this program, which is scheduled to expire after December 31, 2006, through December 31, 2011.

Extend permanently the research and experimentation (R&E) tax credit. -- The Administration proposes to extend permanently the 20-percent tax credit for qualified research and experimentation expenditures above a base amount and the alternative incremental credit, which expired on December 31, 2005.

In addition, the Administration is concerned that features of the R&E tax credit may limit its effectiveness in encouraging taxpayers to invest in R&E. The Administration will work closely with the Congress to develop and enact reforms to modernize the R&E tax credit and improve its incentive effect.

Extend and modify the work opportunity tax credit and the welfare-to-work tax credit. -- Under present law, the work opportunity tax credit provides incentives for hiring individuals from certain targeted groups. The credit generally applies to the first $6,000 of wages paid to several categories of economically disadvantaged or handicapped workers. The credit rate is 25 percent of qualified wages for employment of at least 120 hours but less than 400 hours and 40 percent for employment of 400 or more hours. The credit is available for a qualified individual who begins work before January 1, 2006.

Under present law, the welfare-to-work tax credit provides an incentive for hiring certain recipients of long-term family assistance. The credit is 35 percent of up to $10,000 of eligible wages in the first year of employment and 50 percent of wages up to $10,000 in the second year of employment. Eligible wages include cash wages plus the cash value of certain employer-paid health, dependent care, and educational fringe benefits. The minimum employment period that employees must work before employers can claim the credit is 400 hours. This credit is available for qualified individuals who begin work before January 1, 2006.

The Administration proposes to simplify employment incentives by combining the credits into one credit and making the rules for computing the combined credit simpler. The credits would be combined by creating a new welfare-to-work targeted group under the work opportunity tax credit. The minimum employment periods and credit rates for the first year of employment under the present work opportunity tax credit would apply to welfare-to-work employees. The maximum amount of eligible wages would continue to be $10,000 for welfare-to-work employees and $6,000 for other targeted groups. In addition, the second year 50-percent credit currently available under the welfare-to-work credit would continue to be available for welfare-to-work employees under the modified work opportunity tax credit. Qualified wages would be limited to cash wages. The work opportunity tax credit would also be simplified by eliminating the need to determine family income for qualifying ex-felons (one of the present targeted groups). The modified work opportunity tax credit would apply to individuals who begin work after December 31, 2005 and before January 1, 2007.

Extend the first-time homebuyer credit for the District of Columbia. -- A one-time nonrefundable $5,000 credit is available to purchasers of a principal residence in the District of Columbia who have not owned a residence in the District during the year preceding the purchase. The credit phases out for taxpayers with modified adjusted gross income between $70,000 and $90,000 ($110,000 and $130,000 for joint returns). The credit does not apply to purchases after December 31, 2005. The Administration proposes to extend the credit for one year, making the credit available with respect to purchases after December 31, 2005 and before January 1, 2007.

Extend authority to issue Qualified Zone Academy Bonds. -- Current law allows State and local governments to issue "qualified zone academy bonds," the interest on which is effectively paid by the Federal government in the form of an annual income tax credit. The proceeds of the bonds have to be used for teacher training, purchases of equipment, curriculum development, or rehabilitation and repairs at certain public school facilities. A nationwide total of $400 million of qualified zone academy bonds were authorized to be issued in each of calendar years 1998 through 2005. In addition, unused authority arising in 1998 and 1999 can be carried forward for up to three years and unused authority arising in 2000 through 2005 can be carried forward for up to two years. The Administration proposes to authorize the issuance of an additional $400 million of qualified zone academy bonds in calendar year 2006; unused authority could be carried forward for up to two years. Reporting of issuance would be required.

Extend provisions permitting disclosure of tax return information relating to terrorist activity. -- Current law permits disclosure of tax return information relating to terrorism in two situations. The first is when an executive of a Federal law enforcement or intelligence agency has reason to believe that the return information is relevant to a terrorist incident, threat or activity and submits a written request. The second is when the IRS wishes to apprise a Federal law enforcement agency of a terrorist incident, threat or activity. The Administration proposes to extend this disclosure authority, which expires on December 31, 2006, through December 31, 2007.

Extend excise tax on coal at current rates. -- Excise taxes levied on coal mined and sold for use in the United States are deposited in the Black Lung Disability Trust Fund. Amounts deposited in the Fund are used to cover the cost of program administration and compensation, medical, and survivor benefits to eligible miners and their survivors, when mine employment terminated prior to 1970 or when no mine operator can be assigned liability. Current tax rates on coal sold by a producer are $1.10 per ton of coal from underground mines and $0.55 per ton of coal from surface mines; however, these rates may not exceed 4.4 percent of the price at which the coal is sold. Effective for coal sold after December 31, 2013, the tax rates on coal from underground mines and surface mines will decline to $0.50 per ton and $0.25 per ton, respectively, and will be capped at 2 percent of the price at which the coal is sold. The Administration proposes to repeal the reduction in these tax rates effective for sales after December 31, 2013, and keep current rates in effect until the Black Lung Disability Trust Fund debt is repaid.

          Table 17-3. EFFECT OF PROPOSALS ON RECEIPTS