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[Senate Report 110-1]
[From the U.S. Government Publishing Office]

110th Congress                                                   Report
                                 SENATE
 1st Session                                                      110-1

======================================================================

 
            SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007

                                _______
                                

                January 22, 2007.--Ordered to be printed

                                _______
                                

   Mr. Baucus, from the Committee on Finance, submitted the following

                              R E P O R T

                             together with

                            ADDITIONAL VIEWS

                         [To accompany S. 349]

    The Committee on Finance, having considered an original 
bill, S. 349, to amend the Internal Revenue Code of 1986 to 
provide additional tax incentives to employers and employees of 
small businesses, and for other purposes, reports favorably 
thereon and recommends that the bill do pass.

                                CONTENTS

                                                                   Page
 I.  LEGISLATIVE BACKGROUND...........................................2
    TITLE I--SMALL BUSINESS TAX RELIEF PROVISIONS.....................3
        A. Extension of Increased Expensing for Small Business 
            (sec. 101 of the bill and sec. 179 of the Code)......     3
        B. Fifteen-Year Straight-Line Cost Recovery for Qualified 
            Leasehold Improvements, Qualified Restaurant 
            Improvements and New Restaurant Buildings (Sec. 102 
            of the bill and sec. 168 of the Code)................     5
        C. Fifteen-Year Straight-Line Cost Recovery for Qualified 
            Retail Improvement Property (sec. 102 of the bill and 
            sec. 168 of the Code)................................     7
        D. Expand Eligibility for Cash Method of Accounting (sec. 
            103 of the bill and secs. 446 and 448 of the Code)...     8
        E. Work Opportunity Tax Credit (sec. 104 of the bill and 
            sec. 51 of the Code).................................    10
        F. Treatment of Professional Employer Organizations as 
            Employers for Employment Tax Purposes (sec. 105 of 
            the bill and new secs. 3511 and 7705 of the Code)....    15
        G. Subchapter S Provisions (secs. 111-116 of the bill and 
            secs. 1361 and 1362 of the Code).....................    24
          1. Capital gain not treated as passive investment 
              income.............................................    24
          2. Treatment of bank director shares...................    25
          3. Treatment of banks changing from reserve method of 
              accounting.........................................    26
          4. Treatment of sale of an interest in a qualified 
              subchapter S subsidiary............................    27
          5. Elimination of earnings and profits attributable to 
              pre-1983 years.....................................    28
          6. Expansion of qualifying beneficiaries of an electing 
              small business trust...............................    28
    TITLE II--REVENUE PROVISIONS.....................................29
        A. Modification of Effective Date of Leasing Provisions 
            of the American Jobs Creation Act of 2004 (sec. 201 
            of the bill and sec. 470 of the Code)................    29
        B. Tax Treatment of Certain Inverted Corporate Entities 
            (sec. 202 of the bill and sec. 7874 of the Code).....    30
        C. Denial of Deduction for Punitive Damages (sec. 203 of 
            the bill and sec. 162(g) of the Code)................    35
        D. Denial of Deduction for Certain Fines, Penalties, and 
            Other Amounts (sec. 204 of the bill and sec. 162 of 
            the Code)............................................    36
        E. Revision of Tax Rules on Expatriation of Individuals 
            (sec. 205 of the bill and secs. 102, 877, 2107, 2501, 
            7701 and 6039G of the Code)..........................    39
        F. Limit Amounts of Annual Deferrals Under Nonqualified 
            Deferred Compensation Plans (sec. 206 of the bill and 
            sec. 409A of the Code)...............................    51
        G. Increase in Criminal Monetary Penalty Limitation for 
            the Underpayment or Overpayment of Tax Due to Fraud 
            (sec. 207 of the bill and secs. 7201, 7203, and 7206 
            of the Code).........................................    54
        H. Doubling of Certain Penalties, Fines, and Interest on 
            Underpayments Related to Certain Offshore Financial 
            Arrangements (sec. 208 of the bill)..................    56
        I. Increase in Penalty for Bad Checks and Money Orders 
            (sec. 209 of the bill and sec. 6657 of the Code).....    60
        J. Treatment of Contingent Payment Convertible Debt 
            Instruments (sec. 210 of the bill and sec. 1275 of 
            the Code)............................................    61
        K. Extension of IRS User Fees (sec. 211 of the bill and 
            sec. 7528 of the Code)...............................    64
        L. Modification of Collection Due Process Procedures for 
            Employment Tax Liabilities (sec. 212 of the bill and 
            sec. 6330 of the Code)...............................    64
        M. Whistleblower Reforms (sec. 213 of the bill and sec. 
            7623 of the Code)....................................    66
        N. Expand Denial of Deduction for Certain Excessive 
            Employee Remuneration (sec. 214 of the bill and sec. 
            162(m) of the Code)..................................    68
II. BUDGET EFFECTS OF THE BILL.......................................69
III.VOTES OF THE COMMITTEE...........................................73

IV. REGULATORY IMPACT AND OTHER MATTERS..............................73
 V. ADDITIONAL VIEWS.................................................75
VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED............76

                       I. LEGISLATIVE BACKGROUND

    Since the Fair Labor Standards Act of 1938, Congress has 
required employers to pay a minimum wage to workers, with some 
exceptions. Congress enacted the current general minimum wage 
of $5.15 an hour in 1996. The decade that has passed since then 
marks the longest period in history without an adjustment to 
the minimum wage. A majority of states have enacted minimum 
wages in excess of the current Federal level.
    A full-time minimum wage worker earns about $10,712 a year. 
Roughly two million workers are paid at or below the federal 
minimum wage. Millions more would be affected by any increase, 
because many workers earn slightly more than the minimum wage 
and may also see an increase. According to some research, 
smaller businesses employ a disproportionate share of workers 
earning the minimum wage. Small business owners have therefore 
argued that any increase in the minimum wage should be 
accompanied by tax incentives targeted for small businesses in 
order to lower their costs.
    The Finance Committee has exclusive jurisdiction over tax 
matters and held a hearing on January 10, 2007, entitled, ``Tax 
Incentives for Businesses in Response to a Minimum Wage 
Increase.'' The Committee heard from a variety of witnesses, 
including labor economists, small business owners, and tax 
experts.\1\ Following this hearing, the Committee held a mark-
up on January 17, 2007, to consider an original bill, S. 349 
(the ``Small Business and Work Opportunity Act of 2007''), a 
revenue-neutral bill containing a number of tax incentives for 
small businesses and businesses that hire minimum wage workers. 
With a majority and quorum present, the Committee favorably 
reported the bill by unanimous voice vote on that date and this 
report describes the provisions of the bill. The Committee 
anticipates that the Senate may consider adding the substance 
of this bill to H.R. 2, the ``Fair Minimum Wage Act of 2007,'' 
or similar legislation.
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    \1\ The Committee heard testimony that while increasing the minimum 
wage would benefit workers through increased wages, a minimum wage 
increase may also have consequences of employers hiring fewer workers 
or reducing workers' hours. Others testified that research has shown 
moderate increases to the minimum wage have little or no adverse 
employment impact with significant benefits to affected workers.
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             TITLE I--SMALL BUSINESS TAX RELIEF PROVISIONS

         A. Extension of Increased Expensing for Small Business

(Sec. 101 of the bill and sec. 179 of the Code)

                              PRESENT LAW

    In lieu of depreciation, a taxpayer with a sufficiently 
small amount of annual investment may elect to deduct (or 
``expense'') such costs under section 179. Present law provides 
that the maximum amount a taxpayer may expense, for taxable 
years beginning in 2003 through 2009, is $100,000 of the cost 
of qualifying property placed in service for the taxable 
year.\2\ In general, qualifying property is defined as 
depreciable tangible personal property that is purchased for 
use in the active conduct of a trade or business. Off-the-shelf 
computer software placed in service in taxable years beginning 
before 2010 is treated as qualifying property. The $100,000 
amount is reduced (but not below zero) by the amount by which 
the cost of qualifying property placed in service during the 
taxable year exceeds $400,000. The $100,000 and $400,000 
amounts are indexed for inflation for taxable years beginning 
after 2003 and before 2010. For taxable years beginning in 
2007, the inflation-adjusted amounts are $112,000 and $450,000, 
respectively.\3\
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    \2\ Additional section 179 incentives are provided with respect to 
qualified property meeting applicable requirements that is used by a 
business in an empowerment zone (sec. 1397A), a renewal community (sec. 
1400J), or the Gulf Opportunity Zone (sec. 1400N(e)).
    \3\ Rev. Proc. 2006-53, sec. 2.19, 2006-48 I.R.B. 996 (Nov. 27, 
2006).
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    The amount eligible to be expensed for a taxable year may 
not exceed the taxable income for a taxable year that is 
derived from the active conduct of a trade or business 
(determined without regard to this provision). Any amount that 
is not allowed as a deduction because of the taxable income 
limitation may be carried forward to succeeding taxable years 
(subject to similar limitations). No general business credit 
under section 38 is allowed with respect to any amount for 
which a deduction is allowed under section 179. An expensing 
election is made under rules prescribed by the Secretary.\4\
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    \4\ Sec. 179(c)(1). Under Treas. Reg. sec. 1.179-5, applicable to 
property placed in service in taxable years beginning after 2002 and 
before 2008, a taxpayer is permitted to make or revoke an election 
under section 179 without the consent of the Commissioner on an amended 
Federal tax return for that taxable year. This amended return must be 
filed within the time prescribed by law for filing an amended return 
for the taxable year. T.D. 9209, July 12, 2005.
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    For taxable years beginning in 2010 and thereafter (or 
before 2003), the following rules apply. A taxpayer with a 
sufficiently small amount of annual investment may elect to 
deduct up to $25,000 of the cost of qualifying property placed 
in service for the taxable year. The $25,000 amount is reduced 
(but not below zero) by the amount by which the cost of 
qualifying property placed in service during the taxable year 
exceeds $200,000. The $25,000 and $200,000 amounts are not 
indexed. In general, qualifying property is defined as 
depreciable tangible personal property that is purchased for 
use in the active conduct of a trade or business (not including 
off-the-shelf computer software). An expensing election may be 
revoked only with consent of the Commissioner.\5\
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    \5\ Sec. 179(c)(2).
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                           REASONS FOR CHANGE

    The Committee believes that section 179 expensing provides 
two important benefits for small businesses. First, it lowers 
the cost of capital for property used in a trade or business. 
With a lower cost of capital, the Committee believes small 
businesses will invest in more equipment and employ more 
workers. Second, it eliminates depreciation recordkeeping 
requirements with respect to expensed property. In 2006, 
Congress acted to extend the increased value of these benefits 
and the increased number of taxpayers eligible for these 
benefits for taxable years through 2009. The Committee believes 
that the changes to section 179 expensing will continue to 
provide important benefits if extended, and the bill therefore 
extends these changes for an additional year.

                        EXPLANATION OF PROVISION

    The provision extends for one year the increased amount 
that a taxpayer may deduct and the other section 179 rules 
applicable in taxable years beginning before 2010. Thus, under 
the provision, these present-law rules continue in effect for 
taxable years beginning after 2009 and before 2011.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2009.

  B. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold 
  Improvements, Qualified Restaurant Improvements and New Restaurant 
                               Buildings

(Sec. 102 of the bill and sec. 168 of the Code)

                              PRESENT LAW

In general

    A taxpayer generally must capitalize the cost of property 
used in a trade or business and recover such cost over time 
through annual deductions for depreciation or amortization. 
Tangible property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of 
various types of depreciable property.\6\ The cost of 
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years. 
Nonresidential real property is subject to the mid-month 
placed-in-service convention. Under the mid-month convention, 
the depreciation allowance for the first year property is 
placed in service is based on the number of months the property 
was in service, and property placed in service at any time 
during a month is treated as having been placed in service in 
the middle of the month.
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    \6\ Sec. 168.
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Depreciation of leasehold improvements

    Generally, depreciation allowances for improvements made on 
leased property are determined under MACRS, even if the MACRS 
recovery period assigned to the property is longer than the 
term of the lease. This rule applies regardless of whether the 
lessor or the lessee places the leasehold improvements in 
service. If a leasehold improvement constitutes an addition or 
improvement to nonresidential real property already placed in 
service, the improvement generally is depreciated using the 
straight-line method over a 39-year recovery period, beginning 
in the month the addition or improvement was placed in service. 
However, exceptions exist for certain qualified leasehold 
improvements and certain qualified restaurant property.

Qualified leasehold improvement property

    Section 168(e)(3)(E)(iv) provides a statutory 15-year 
recovery period for qualified leasehold improvement property 
placed in service before January 1, 2008. Qualified leasehold 
improvement property is recovered using the straight-line 
method. Leasehold improvements placed in service in 2008 and 
later will be subject to the general rules described above.
    Qualified leasehold improvement property is any improvement 
to an interior portion of a building that is nonresidential 
real property, provided certain requirements are met. The 
improvement must be made under or pursuant to a lease either by 
the lessee (or sublessee), or by the lessor, of that portion of 
the building to be occupied exclusively by the lessee (or 
sublessee). The improvement must be placed in service more than 
three years after the date the building was first placed in 
service. Qualified leasehold improvement property does not 
include any improvement for which the expenditure is 
attributable to the enlargement of the building, any elevator 
or escalator, any structural component benefiting a common 
area, or the internal structural framework of the building. 
However, if a lessor makes an improvement that qualifies as 
qualified leasehold improvement property, such improvement does 
not qualify as qualified leasehold improvement property to any 
subsequent owner of such improvement. An exception to the rule 
applies in the case of death and certain transfers of property 
that qualify for non-recognition treatment.

Qualified restaurant property

    Section 168(e)(3)(E)(v) provides a statutory 15-year 
recovery period for qualified restaurant property placed in 
service before January 1, 2008. For purposes of the provision, 
qualified restaurant property means any improvement to a 
building if such improvement is placed in service more than 
three years after the date such building was first placed in 
service and more than 50 percent of the building's square 
footage is devoted to the preparation of, and seating for on-
premises consumption of, prepared meals. Qualified restaurant 
property is recovered using the straight-line method.

                           REASONS FOR CHANGE

    The Committee believes that taxpayers should not be 
required to recover the costs of certain leasehold improvements 
beyond the useful life of the investment. The 39-year recovery 
period for leasehold improvements for property placed in 
service after December 31, 2007 extends beyond the useful life 
of many such investments. Although lease terms differ, the 
Committee believes that lease terms for commercial real estate 
are also typically shorter than the 39-year recovery period. In 
the interests of simplicity and administrability, a uniform 
period for recovery of leasehold improvements is desirable. 
Therefore, the provision extends the 15-year recovery period 
for leasehold improvements.
    The Committee also believes that unlike other commercial 
buildings, restaurant buildings generally are more specialized 
structures. Restaurants also experience considerably more 
traffic, and remain open longer than most commercial 
properties. This daily use causes rapid deterioration of 
restaurant properties and forces restaurateurs to constantly 
repair and upgrade their facilities. As such, restaurant 
facilities generally have a shorter life span than other 
commercial establishments. The Committee bill extends the 15-
year recovery period for improvements made to restaurant 
buildings, and applies the 15-year recovery period to new 
restaurants, to more accurately reflect the true economic life 
of such properties.

                        EXPLANATION OF PROVISION

    The present-law provisions for qualified leasehold 
improvement property and restaurant improvements are extended 
for three months (through March 31, 2008). In addition, the 
three-year rule for restaurant property is repealed. Thus, 
newly constructed restaurant buildings and restaurant 
improvements within the first three years also qualify for the 
15-year recovery period.

                             EFFECTIVE DATE

    The provision generally applies to property placed in 
service after December 31, 2007. Repeal of the three-year rule 
for restaurant property is effective for property placed in 
service after the date of enactment, the original use of which 
begins with the taxpayer after the date of enactment.

   C. Fifteen-Year Straight-Line Cost Recovery for Qualified Retail 
                          Improvement Property

(Sec. 102 of the bill and sec. 168 of the Code)

                              PRESENT LAW

    A taxpayer generally must capitalize the cost of property 
used in a trade or business and recover such cost over time 
through annual deductions for depreciation or amortization. 
Tangible property generally is depreciated under the modified 
accelerated cost recovery system (``MACRS''), which determines 
depreciation by applying specific recovery periods, placed-in-
service conventions, and depreciation methods to the cost of 
various types of depreciable property.\7\ The cost of 
nonresidential real property is recovered using the straight-
line method of depreciation and a recovery period of 39 years. 
Nonresidential real property is subject to the mid-month 
placed-in-service convention. Under the mid-month convention, 
the depreciation allowance for the first year property is 
placed in service is based on the number of months the property 
was in service, and property placed in service at any time 
during a month is treated as having been placed in service in 
the middle of the month.
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    \7\ Sec. 168.
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    Generally, depreciation allowances for improvements made on 
retail property are determined under MACRS. If a retail 
property improvement constitutes an addition or improvement to 
nonresidential real property already placed in service, the 
improvement generally is depreciated using the straight-line 
method over a 39-year recovery period, beginning in the month 
the addition or improvement was placed in service. A special 
provision provides a 15-year recovery period for qualified 
leasehold improvement property.\8\
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    \8\ Sec. 168(e)(3)(E)(iv).
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                           REASONS FOR CHANGE

    The Committee believes that taxpayers should not be 
required to recover the costs of certain improvements beyond 
the useful life of the investment. The present law 39-year 
recovery period for improvements to owner occupied (i.e., not 
leased) retail property extends beyond the useful life of many 
such investments. Therefore, the provision includes a 15-year 
recovery period for qualified retail improvements.
    Additionally, the Committee believes that retailers should 
not be treated differently based on whether the building in 
which they operate is owned or leased. The shorter 15-year 
recovery period for leasehold improvements under present law 
provides an unfair competitive advantage for those retailers 
who lease space. As many small business retailers own the 
building in which they operate their business, the Committee 
believes this provision will provide relief to small 
businesses.

                        EXPLANATION OF PROVISION

    The provision provides a statutory 15-year recovery period 
for qualified retail improvement property placed in service 
before March 31, 2008. For purposes of the provision, qualified 
retail improvement property means any improvement to an 
interior portion of a building which is nonresidential real 
property if such portion is open to the general public \9\ and 
is used in the retail trade or business of selling tangible 
personal property to the general public, and such improvement 
is placed in service more than three years after the date the 
building was first placed in service. Qualified retail 
improvement property does not include any improvement for which 
the expenditure is attributable to the enlargement of the 
building, any elevator or escalator, or the internal structural 
framework of the building.
---------------------------------------------------------------------------
    \9\ Improvements to portions of a building not open to the general 
public (e.g., stock room in back of retail space) do not qualify under 
the provision.
---------------------------------------------------------------------------
    For the purposes of this provision, retail establishments 
that qualify for the 15-year recovery period include those 
primarily engaged in the sale of goods. Examples of these 
retail establishments include, but are not limited to, grocery 
stores, clothing stores, hardware stores and convenience 
stores. However, establishments primarily engaged in providing 
services, such as professional services, financial services, 
personal services, health services, and entertainment, do not 
qualify. It is generally intended that businesses defined as a 
store retailer under the current North American Industry 
Classification System (industry sub-sectors 441 through 453) 
qualify for the provision, while those in other industry 
classes do not qualify under the provision.

                             EFFECTIVE DATE

    The provision applies to property placed in service after 
the date of enactment.

          D. Expand Eligibility for Cash Method of Accounting

(Sec. 103 of the bill and secs. 446 and 448 of the Code)

                              PRESENT LAW

    Section 446(c) of the Code generally allows a taxpayer to 
select the method of accounting it will use to compute its 
taxable income provided that such method clearly reflects the 
income of the taxpayer. A taxpayer is entitled to adopt any one 
of the permissible methods for each separate trade or business, 
subject to certain restrictions. Permissible methods include 
the cash receipts and disbursements method (``cash method''), 
an accrual method, or any other method (including a hybrid 
method) permitted under regulations prescribed by the Secretary 
of the Treasury.
    Section 448 generally provides that the cash method of 
accounting may not be used by any C corporation,\10\ by any 
partnership that has a C corporation as a partner, or by any 
tax shelter. Exceptions are made for farming businesses and 
qualified personal service corporations. Additionally, an 
exception is provided for C corporations and partnerships that 
have a C corporation as a partner if the average annual gross 
receipts of the taxpayer is $5 million or less for all prior 
taxable years (including the prior taxable years of any 
predecessor of the entity). For this purpose, average annual 
gross receipts is calculated for each tax year by averaging the 
annual gross receipts for the three-year period ending in such 
year. The test must be met for all prior tax years beginning 
after December 31, 1985 in order for a taxpayer to be eligible 
for the exception.
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    \10\ For this purpose, a tax-exempt trust with unrelated business 
income is treated as a C corporation with respect to the portion of its 
activities that constitute an unrelated trade or business. Treas. Reg. 
sec. 1.448-1T(a)(3).
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    Section 471 provides that, regardless of a taxpayer's 
overall method of accounting, the Secretary may require 
taxpayers to maintain inventories on the accrual method if 
necessary to clearly reflect income. This requirement is 
generally applied to taxpayers for whom the production, 
purchase, or sale of merchandise is an income-producing 
factor.\11\ However, an exception is provided for taxpayers 
whose average annual gross receipts does not exceed $1 
million.\12\ Such taxpayers account for inventory as materials 
and supplies that are not incidental pursuant to Regulations 
section 1.162-3.\13\
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    \11\ Treas. Reg. sec. 1.471-1.
    \12\ Rev. Proc. 2001-10, 2001-02 I.R.B. 272 (January 8, 2001).
    \13\ Under Treas. Reg. sec. 1.162-3, a deduction is permitted for 
the cost of materials and supplies only in the amount that they are 
actually consumed and used in operations during the tax year.
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    When a taxpayer changes its method of accounting, there is 
taken into account for the taxable year of the change 
adjustments to taxable income necessary to prevent amounts from 
being duplicated or omitted by reason of the change.\14\ 
Positive adjustments (i.e., additions to taxable income), if 
initiated by the taxpayer and made with the consent of the 
Secretary, are generally spread over four taxable years 
beginning in the year of change.\15\ Negative adjustments 
(i.e., reductions to taxable income) are generally taken into 
account entirely in the year of change.\16\
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    \14\ Sec. 481.
    \15\ Rev. Proc. 2002-19, 2002-1 C.B. 696.
    \16\ Ibid.
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                           REASONS FOR CHANGE

    The Committee is sensitive to the trade-off between 
competing priorities of simplification and accurate income 
measurement in the tax system. Many taxpayers find the cash 
method of accounting to be simpler to use than the accrual 
method, which generally is considered to provide a more 
accurate measurement of income for each taxable year. The 
effect of the differences in income measurement is not 
permanent, as the different methods produce the same total 
amount of taxable income over time.
    The present-law exception for small businesses with gross 
receipts under $5 million \17\ reflects the view that, in the 
case of small businesses, the benefits of simplification under 
the cash method outweigh any impact on accuracy. The Committee 
believes that the threshold has become outdated over time and 
understates the maximum size of business which should be 
eligible for use of the cash method. Accordingly, the Committee 
provision increases the threshold and indexes it for inflation 
to prevent it from becoming outdated in the future.
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    \17\ The threshold is $1 million with respect to inventory 
accounting.
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                        EXPLANATION OF PROVISION

    Under the provision, eligibility to use the cash method 
under the annual gross receipts exception is expanded to all 
non-farm taxpayers other than tax shelters regardless of the 
presence of inventories, and the threshold for the exception is 
increased from $5 million to $10 million.
    The provision also resets the December 31, 1985 testing 
start date. Under the provision, the gross receipts test must 
be met for all tax years ending on or after the date of 
enactment. Thus, a taxpayer who did not meet the $5 million 
gross receipts test in one or more years ending prior to the 
date of enactment but meets the new $10 million test for all 
tax years ending on or after the date of enactment is eligible 
to use the cash method under the provision.
    The $10 million threshold is indexed for tax years 
beginning in calendar years after 2008. The indexed amount 
applies in each year for the purposes of testing the average 
annual gross receipts, calculated based on the prior three tax 
years. Once a taxpayer has either met or not met the gross 
receipts test with respect to a particular tax year, that 
result cannot subsequently be changed by the effect of the 
indexing. Thus, a tax year that ends on or after the date of 
enactment for which the gross receipts test is not met causes 
the taxpayer to be ineligible to use the cash method under the 
gross receipts test exception in all tax years subsequent to 
the year in which the test is not met, regardless of whether 
the threshold is subsequently increased by indexing above the 
amount of average annual gross receipts for the year in which 
the test was not met.
    Accounting method changes under the provision are deemed to 
be initiated by the taxpayer and made with the consent of the 
Secretary. Thus, the adjustments under section 481 are spread 
over four years (in the case of a positive change) or taken 
into account entirely in one year (in the case of a negative 
change).
    Taxpayers who are eligible to use the cash method under the 
provision also are exempt from maintaining inventories on the 
accrual method. Thus, the $1 million gross receipts threshold 
of Rev. Proc. 2001-10 is effectively increased to $10 million 
for taxpayers qualifying for the provision.

                             EFFECTIVE DATE

    The provision is applicable to taxable years beginning 
after the date of enactment.

                     E. Work Opportunity Tax Credit

(Sec. 104 of the bill and sec. 51 of the Code)

                              PRESENT LAW

In general

    The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of nine 
targeted groups. The amount of the credit available to an 
employer is determined by the amount of qualified wages paid by 
the employer. Generally, qualified wages consist of wages 
attributable to service rendered by a member of a targeted 
group during the one-year period beginning with the day the 
individual begins work for the employer (two years in the case 
of an individual in the long-term family assistance recipient 
category).

Targeted groups eligible for the credit

    Generally an employer is eligible for the credit only for 
qualified wages paid to members of a targeted group.
            (1) Families receiving TANF
    An eligible recipient is an individual certified by a 
designated local employment agency (e.g., a State employment 
agency) as being a member of a family eligible to receive 
benefits under the Temporary Assistance for Needy Families 
Program (``TANF'') for a period of at least nine months part of 
which is during the 18-month period ending on the hiring date. 
For these purposes, members of the family are defined to 
include only those individuals taken into account for purposes 
of determining eligibility for the TANF.
            (2) Qualified veteran
    A qualified veteran is a veteran who is certified by the 
designated local agency as a member of a family certified as 
receiving assistance under a food stamp program under the Food 
Stamp Act of 1977 for a period of at least three months part of 
which is during the 12-month period ending on the hiring date. 
For these purposes, members of a family are defined to include 
only those individuals taken into account for purposes of 
determining eligibility for a food stamp program under the Food 
Stamp Act of 1977.
    For these purposes, a veteran is an individual who has 
served on active duty (other than for training) in the Armed 
Forces for more than 180 days or who has been discharged or 
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served 
for a period of more than 90 days during which the individual 
was on active duty (other than for training) is not a qualified 
veteran if any of this active duty occurred during the 60-day 
period ending on the date the individual was hired by the 
employer. This latter rule is intended to prevent employers who 
hire current members of the armed services (or those departed 
from service within the last 60 days) from receiving the 
credit.
            (3) Qualified ex-felon
    A qualified ex-felon is an individual certified as: (1) 
having been convicted of a felony under any State or Federal 
law, and (2) having a hiring date within one year of release 
from prison or date of conviction.
            (4) High risk youth
    A high-risk youth is an individual certified as being at 
least age 18 but not yet age 25 on the hiring date and as 
having a principal place of abode within an empowerment zone, 
enterprise community, or renewal community (as defined under 
Subchapter U of Subtitle A, Chapter 1 of the Internal Revenue 
Code). Qualified wages do not include wages paid or incurred 
for services performed after the individual moves outside an 
empowerment zone, enterprise community, or renewal community.
            (5) Vocational rehabilitation referral
    A vocational rehabilitation referral is an individual who 
is certified by a designated local agency as an individual who 
has a physical or mental disability that constitutes a 
substantial handicap to employment and who has been referred to 
the employer while receiving, or after completing: (a) 
vocational rehabilitation services under an individualized, 
written plan for employment under a State plan approved under 
the Rehabilitation Act of 1973; or (b) under a rehabilitation 
plan for veterans carried out under Chapter 31 of Title 38, 
U.S. Code. Certification will be provided by the designated 
local employment agency upon assurances from the vocational 
rehabilitation agency that the employee has met the above 
conditions.
            (6) Qualified summer youth employee
    A qualified summer youth employee is an individual: (1) who 
performs services during any 90-day period between May 1 and 
September 15, (2) who is certified by the designated local 
agency as being 16 or 17 years of age on the hiring date, (3) 
who has not been an employee of that employer before, and (4) 
who is certified by the designated local agency as having a 
principal place of abode within an empowerment zone, enterprise 
community, or renewal community (as defined under Subchapter U 
of Subtitle A, Chapter 1 of the Internal Revenue Code). As with 
high risk youths, no credit is available on wages paid or 
incurred for service performed after the qualified summer youth 
moves outside of an empowerment zone, enterprise community, or 
renewal community. If, after the end of the 90-day period, the 
employer continues to employ a youth who was certified during 
the 90-day period as a member of another targeted group, the 
limit on qualified first year wages will take into account 
wages paid to the youth while a qualified summer youth 
employee.
            (7) Qualified food stamp recipient
    A qualified food stamp recipient is an individual aged 18 
but not yet 40 certified by a designated local employment 
agency as being a member of a family receiving assistance under 
a food stamp program under the Food Stamp Act of 1977 for a 
period of at least six months ending on the hiring date. In the 
case of families that cease to be eligible for food stamps 
under section 6(o) of the Food Stamp Act of 1977, the six-month 
requirement is replaced with a requirement that the family has 
been receiving food stamps for at least three of the five 
months ending on the date of hire. For these purposes, members 
of the family are defined to include only those individuals 
taken into account for purposes of determining eligibility for 
a food stamp program under the Food Stamp Act of 1977.
            (8) Qualified SSI recipient
    A qualified SSI recipient is an individual designated by a 
local agency as receiving supplemental security income 
(``SSI'') benefits under Title XVI of the Social Security Act 
for any month ending within the 60-day period ending on the 
hiring date.
            (9) Long-term family assistance recipients
    A qualified long-term family assistance recipient is an 
individual certified by a designated local agency as being: (1) 
a member of a family that have received family assistance for 
at least 18 consecutive months ending on the hiring date; (2) a 
member of a family that have received such family assistance 
for a total of at least 18 months (whether or not consecutive) 
after August 5, 1997 (the date of enactment of the welfare-to-
work tax credit) \18\ if the individual is hired within two 
years after the date that the 18-month total is reached; or (3) 
a member of a family who are no longer eligible for family 
assistance because of either Federal or State time limits, if 
the individual is hired within two years after the Federal or 
State time limits made the family ineligible for family 
assistance.
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    \18\ The welfare-to-work tax credit was consolidated into the work 
opportunity tax credit in the Tax Relief and Health Care Act of 2006.
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Qualified wages

    Generally, qualified wages are defined as cash wages paid 
by the employer to a member of a targeted group. The employer's 
deduction for wages is reduced by the amount of the credit.
    For purposes of the credit, generally wages are defined by 
reference to the FUTA definition of wages contained in sec. 
3306(b) (without regard to the dollar limitation therein 
contained). Special rules apply in the case of certain 
agricultural labor and certain railroad labor.

Calculation of the credit

    The credit available to an employer for qualified wages 
paid to members of all targeted groups except for long-term 
family assistance recipients equals 40 percent (25 percent for 
employment of 400 hours or less) of qualified first-year wages. 
Generally, qualified first-year wages are qualified wages (not 
in excess of $6,000) attributable to service rendered by a 
member of a targeted group during the one-year period beginning 
with the day the individual began work for the employer. 
Therefore, the maximum credit per employee is $2,400 (40 
percent of the first $6,000 of qualified first-year wages). 
With respect to qualified summer youth employees, the maximum 
credit is $1,200 (40 percent of the first $3,000 of qualified 
first-year wages). Except for long-term family assistance 
recipients, no credit is allowed for second-year wages.
    In the case of long-term family assistance recipients, the 
credit equals 40 percent (25 percent for employment of 400 
hours or less) of $10,000 for qualified first-year wages and 50 
percent of the first $10,000 of qualified second-year wages. 
Generally, qualified second-year wages are qualified wages (not 
in excess of $10,000) attributable to service rendered by a 
member of the long-term family assistance category during the 
one-year period beginning on the day after the one-year period 
beginning with the day the individual began work for the 
employer. Therefore, the maximum credit per employee is $9,000 
(40 percent of the first $10,000 of qualified first-year wages 
plus 50 percent of the first $10,000 of qualified second-year 
wages).

Certification rules

    An individual is not treated as a member of a targeted 
group unless: (1) on or before the day on which an individual 
begins work for an employer, the employer has received a 
certification from a designated local agency that such 
individual is a member of a targeted group; or (2) on or before 
the day an individual is offered employment with the employer, 
a pre-screening notice is completed by the employer with 
respect to such individual, and not later than the 28th day 
after the individual begins work for the employer, the employer 
submits such notice, signed by the employer and the individual 
under penalties of perjury, to the designated local agency as 
part of a written request for certification. For these 
purposes, a pre-screening notice is a document (in such form as 
the Secretary may prescribe) which contains information 
provided by the individual on the basis of which the employer 
believes that the individual is a member of a targeted group.

Minimum employment period

    No credit is allowed for qualified wages paid to employees 
who work less than 120 hours in the first year of employment.

Other rules

    The work opportunity tax credit is not allowed for wages 
paid to a relative or dependent of the taxpayer. No credit is 
allowed for wages paid to an individual who is a more than 
fifty-percent owner of the entity. Similarly, wages paid to 
replacement workers during a strike or lockout are not eligible 
for the work opportunity tax credit. Wages paid to any employee 
during any period for which the employer received on-the-job 
training program payments with respect to that employee are not 
eligible for the work opportunity tax credit. The work 
opportunity tax credit generally is not allowed for wages paid 
to individuals who had previously been employed by the 
employer. In addition, many other technical rules apply.

Expiration

    The work opportunity tax credit is not available for 
individuals who begin work for an employer after December 31, 
2007.

                           REASONS FOR CHANGE

    The Committee believes that the experience with the credit 
has been positive and wishes to extend and expand the credit. 
In particular, the Committee believes that the credit can be 
used to improve employment opportunities for broader classes of 
qualified veterans and designated community residents. Also, 
the Committee believes that the expansion of the vocational 
rehabilitation referral group appropriately conforms 
availability of the credit to a previous expansion of the 
vocational rehabilitation referral program. Finally, the 
Committee believes that a longer-term expansion will encourage 
greater employer participation in the credit.

                        EXPLANATION OF PROVISION

Extension

    The provision extends the work opportunity tax credit for 
five years (for qualified individuals who begin work for an 
employer after December 31, 2007 and before January 1, 2013).

Qualified veterans targeted group

    The provision expands the qualified veterans' targeted 
group to include an individual who is certified as entitled to 
compensation for a service-connected disability incurred after 
September 10, 2001. Being entitled to such compensation means 
having a disability rating of 10-percent or higher for service 
connected injuries.

Qualified first-year wages

    The provision expands the definition of qualified first-
year wages from $6,000 to $12,000 in the case of individuals 
certified as being entitled to compensation for a service-
connected disability incurred after September 10, 2001 (i.e., 
having a disability rating of 10-percent or higher).

High risk youth targeted group

    The provision expands the definition of high risk youths to 
include otherwise qualifying individuals age 18 but not yet age 
40 on the hiring date. The provision also changes the name of 
the category to the ``designated community residents'' targeted 
group.

Vocational rehabilitation referral targeted group

    The provision expands the definition of vocational 
rehabilitation referral to include any individual who is 
certified by a designated local agency as an individual who has 
a physical or mental disability that constitutes a substantial 
handicap to employment and who has been referred to the 
employer while receiving, or after completing, an individual 
work plan developed and implemented by an employment network 
pursuant to subsection (g) of section 1148 of the Social 
Security Act.

                             EFFECTIVE DATE

    Generally, the extension of the credit is effective for 
wages paid or incurred to a qualified individual who begins 
work for an employer after December 31, 2007. The other 
provisions are effective for individuals who begin work for an 
employer after the date of enactment in taxable years ending 
after such date.

 F. Treatment of Professional Employer Organizations as Employers for 
                        Employment Tax Purposes

(Sec. 105 of the bill and new secs. 3511 and 7705 of the Code)

                              PRESENT LAW

In general

    Employment taxes generally consist of the taxes under the 
Federal Insurance Contributions Act (``FICA''), the taxes under 
the Railroad Retirement Tax Act (``RRTA''), the tax under the 
Federal Unemployment Tax Act (``FUTA''), and income taxes 
required to be withheld by employers from wages paid to 
employees (``income tax withholding'').\19\
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    \19\ Secs. 3101-3128 (FICA), 3201-3241 (RRTA), 3301-3311 (FUTA), 
and 3401-3404 (income tax withholding). Sections 3501-3510 provide 
additional rules.
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    FICA tax consists of two parts: (1) old age, survivor, and 
disability insurance (``OASDI''), which correlates to the 
Social Security program that provides monthly benefits after 
retirement, disability, or death; and (2) Medicare hospital 
insurance (``HI''). The OASDI tax rate is 6.2 percent on both 
the employee and employer (for a total rate of 12.4 percent). 
The OASDI tax rate applies to wages up to the OASDI wage base 
for the calendar year ($97,500 for 2007). The HI tax rate is 
1.45 percent on both the employee and the employer (for a total 
rate of 2.9 percent). Unlike the OASDI tax, the HI tax is not 
limited to a specific amount of wages, but applies to all 
wages.
    RRTA taxes consist of tier 1 taxes and tier 2 taxes. Tier 1 
taxes parallel the OASDI and HI taxes applicable to employers 
and employees. Tier 2 taxes consist of employer and employee 
taxes on railroad compensation up to the tier 2 wage base for 
the calendar year. For 2007, the tier 2 employer rate is 12.1 
percent, the employee rate is 3.9 percent, and the tier 2 wage 
base is $72,600.
    Under FUTA, employers must pay a tax of 6.2 percent of 
wages up to the FUTA wage base of $7,000. An employer may take 
a credit against its FUTA tax liability for its contributions 
to a State unemployment fund and, in certain cases, an 
additional credit for contributions that would have been 
required if the employer had been subject to a higher 
contribution rate under State law. For purposes of the credit, 
contributions means payments required by State law to be made 
by an employer into an unemployment fund, to the extent the 
payments are made by the employer without being deducted or 
deductible from employees' remuneration.\20\
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    \20\ The ``SUTA Dumping Prevention Act of 2004'' (Pub. L. No. 108-
295), set standards for State law to prevent the practice of ``SUTA 
dumping,'' a tax evasion scheme where shell companies are formed to 
obtain low State unemployment insurance tax rates.
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    Employers are required to withhold income taxes from wages 
paid to employees. Withholding rates vary depending on the 
amount of wages paid, the length of the payroll period, and the 
number of withholding allowances claimed by the employee.
    Wages paid to employees, and FICA, RRTA, and income taxes 
withheld from the wages, are required to be reported on 
employment tax returns and on Forms W-2.\21\
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    \21\ Secs. 6011 and 6051.
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    Employment taxes generally apply to all remuneration paid 
by an employer to an employee. However, various exclusions 
apply to certain types of remuneration or certain types of 
services, which may depend on the type of employer for whom an 
employee performs services.\22\ For example, remuneration 
(subject to a dollar limit) paid to an employee by a tax-exempt 
organization is excluded from wages for FICA purposes, and 
services performed in the employ of certain tax-exempt 
organizations are excluded from employment for FUTA 
purposes.\23\ In addition, various definitions and special 
rules apply to certain types of employers.\24\
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    \22\ See, e.g., secs. 3121(a) and (b), 3231(e), 3306(b) and (c), 
and 3401(a).
    \23\ Secs. 3121(a)(16) and 3306(c)(8).
    \24\ See, e.g., secs. 3121, 3122, 3125, 3126, 3127, 3231, 3306, 
3308, 3309, 3401(a), 3404, 3506, and 3510.
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    As discussed above, certain employment taxes apply only on 
amounts up to a specified wage base. If an employee works for 
multiple employers during a year, separate wage bases generally 
apply to each employer. However, a single OASDI, RRTA tier 1 or 
tier 2, or FUTA wage base applies in certain cases in which an 
employer (a ``successor'' employer) takes over the business of 
another employer (the ``predecessor'' employer) and employs the 
employees of the predecessor employer.

Responsibility for employment tax compliance

    Employment tax responsibility generally rests with the 
person who is the employer of an employee under a common-law 
test that has been incorporated into Treasury regulations.\25\ 
Under the regulations, an employer-employee relationship 
generally exists if the person for whom services are performed 
has the right to control and direct the individual who performs 
the services, not only as to the result to be accomplished by 
the work, but also as to the details and means by which that 
result is accomplished. That is, an employee is subject to the 
will and control of the employer, not only as to what is to be 
done, but also as to how it is to be done. It is not necessary 
that the employer actually control the manner in which the 
services are performed, rather it is sufficient that the 
employer have a right to control. Whether the requisite control 
exists is determined on the basis of all the relevant facts and 
circumstances. The test of whether an employer-employee 
relationship exists often arises in determining whether a 
worker is an employee or an independent contractor. However, 
the same test applies in determining whether a worker is an 
employee of one person or another.\26\
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    \25\ Treas. Reg. secs. 31.3121(d)-1(c)(1), 31.3306(i)-1(a), and 
31.3401(c)-1.
    \26\ Issues relating to the classification of workers as employees 
or independent contractors are discussed in Joint Committee on 
Taxation, Study of the Overall State of the Federal Tax System and 
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of 
the Internal Revenue Code of 1986 (JCS-3-01), April 2001, at Vol. II, 
Part XV.A, at 539-550.
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    In some cases, a person other than the common-law employer 
(a ``third party'') may be liable for employment taxes. For 
example, if wages are paid to an employee by a third party and 
the third party, rather than the employer, has control of the 
payment of the wages, the third party is the statutory employer 
responsible for complying with applicable employment tax 
requirements.\27\ In addition, certain designated agents are 
jointly and severally liable with the employer for employment 
taxes with respect to wages paid to the employer's employees. 
These designated agents prepare and file employment tax returns 
using their own name and employer identification number. In 
contrast, reporting agents (often referred to as payroll 
service providers) are generally not liable for the employment 
taxes reported on their clients' returns. Reporting agents 
prepare and file employment tax returns for their clients using 
the client's name and employer identification number.
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    \27\ Sec. 3401(d)(1) (for purposes of income tax withholding, if 
the employer does not have control of the payment of wages, the person 
having control of the payment of such wages is treated as the 
employer); Otte v. United States, 419 U.S. 43 (1974) (the person who 
has the control of the payment of wages is treated as the employer for 
purposes of withholding the employee's share of FICA from wages); In re 
Armadillo Corporation, 561 F.2d 1382 (10th Cir. 1977), and In re The 
Laub Baking Company v. United States, 642 F.2d 196 (6th Cir. 1981) (the 
person who has control of the payment of wages is the employer for 
purposes of the employer's share of FICA and FUTA). The mere fact that 
wages are paid by a person other than the employer does not necessarily 
mean that the payor has control of the payment of the wages. Rather, 
control depends on the facts and circumstances. See, e.g., Consolidated 
Flooring Services v. United States, 38 Fed. Cl. 450 (1997), and 
Winstead v. United States, 109 F. 2d 989 (4th Cir. 1997).
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Professional employer organizations

    A professional employer organization (sometimes called an 
employee leasing company) provides employees to perform 
services in the businesses of the professional employer 
organization's customers, generally small and medium-sized 
businesses. In many cases, before the professional employer 
organization arrangement is entered into, the employees already 
work in the customer's business as employees of the customer. 
The terms of a typical professional employer organization 
agreement provide that the professional employer organization 
is responsible for paying the employees and for the related 
employment tax compliance. Legally, the employees may be the 
employees of the customer, rather than the professional 
employer organization; nonetheless, customers typically rely on 
the professional employer organization to satisfy employment 
tax obligations.\28\
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    \28\ As discussed in the text above, the issue of whether a worker 
is an employee of a particular entity for employment tax purposes is 
generally determined by reference to section 3121(d), which 
incorporates the common law definition of employee. This common law 
definition also generally applies for purposes of who is an employee 
for retirement plan purposes. In some cases, a professional employer 
organization may provide benefits to workers who are legally the 
employees of the customer. The IRS has issued guidance with respect to 
how the retirement plan rules apply in such cases. For example, Revenue 
Procedure 2002-11, 2002-1 C.B. 911, provides that employees of a 
customer may be covered under a multiple employer defined contribution 
plan of the professional employer organization if the customer adopts 
the plan and certain other requirements are satisfied. See also Rev. 
Proc. 2003-86, 2003-2 C.B. 1211.
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Income tax credits based on wages for employment tax purposes

    The Code provides various income tax credits to employers 
under which the amount of the credit is determined by reference 
to the amount of wages for employment tax purposes.\29\ For 
example, the amount of an employer's work opportunity credit is 
based on a portion of FUTA wages paid by the employer to 
employees who are members of certain targeted groups.\30\ In 
addition, the credit for employer FICA tax paid on tips is 
based on the employer share of FICA tax paid by the employer 
with respect to certain tips treated as wages for FICA 
purposes.\31\
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    \29\ See, e.g., secs. 41 (credit for research expenses), 45A 
(Indian employment credit), 45B (credit for employer FICA tax paid on 
tips), 45C (credit for clinical drug testing expenses), 51 (work 
opportunity credit), 51A (welfare-to-work credit), 1396 (empowerment 
zone employment credit), 1400(d) (DC Zone employment credit), and 1400H 
(renewal community employment credit).
    \30\ Sec. 51(c)(1).
    \31\ Sec. 45B(b)(1).
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Reporting by large food and beverage establishments

    Certain reporting requirements relating to tips apply to 
large food or beverage establishments.\32\ In the case of such 
an establishment, an employer is generally required to report 
the following information to the IRS each calendar year: (1) 
the gross receipts of the establishment from the provision of 
food and beverages (other than certain receipts); (2) the 
aggregate amount of charge receipts (other than certain 
receipts); (3) the aggregate amount of charged tips on the 
charge receipts; (4) the sum of the aggregate amount of tips 
reported to the employer by employees and certain amounts 
required to be reported by the employer on employees' Form W-
2s; and (5) with respect to each employee, the amount of tips 
allocated to the employee based on the receipts of the 
establishment. The employer must also provide employees with 
written statements showing certain information each calendar 
year, including the amount of tips allocated to the employee 
for the year.
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    \32\ Sec. 6053(c).
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User fees

    User fees apply to requests to the IRS for ruling letters, 
opinion letters, determination letters, and similar 
requests.\33\ The user fees that apply are determined by the 
IRS and are generally required to be determined after taking 
into account the average time and difficulty involved in a 
request.
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    \33\ Sec. 7528.
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                           REASONS FOR CHANGE

    The IRS estimates that the portion of tax gap attributable 
to FICA and FUTA taxes is $15 billion.\34\ An additional 
portion of the tax gap is attributable to income taxes due on 
unreported wages.
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    \34\ Internal Revenue Service, IRS Updates Tax Gap Estimates, IR-
2006-28, and attachment (Feb. 14, 2006). The tax gap is the amount of 
tax that is imposed by law for a given tax year but is not paid 
voluntarily and timely.
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    Professional employer organizations specialize in providing 
employees and employment-related services, including employment 
tax compliance, to their customers, which are generally small 
and medium-sized businesses. In addition, a professional 
employer organization can obtain economies of scale not 
available to its individual customers. As a result, 
professional employer organizations may improve employment tax 
compliance.
    Under present law, responsibility for employment tax 
compliance generally rests with the employer. Uncertainty may 
exist as to whether a professional employer organization or its 
customer is the employer of the employees provided to the 
customer, making it unclear which party bears employment tax 
responsibility. In the case of noncompliance, the IRS may have 
difficulty establishing either party's liability for unpaid 
employment taxes. The Committee believes that improved 
employment tax compliance can be achieved by providing rules 
under which a professional employer organization that meets 
certain standards and follows certain procedures is treated for 
employment tax purposes as the employer of employees provided 
to customers, and thus is responsible for employment tax 
compliance, rather than the customers.

                        EXPLANATION OF PROVISION

Treatment of certified professional employer organization as employer 
        for employment tax purposes

    Under the provision, if certain requirements are met, 
solely for purposes of employment taxes and other obligations 
under the employment tax rules, a certified professional 
employer organization is treated as the employer of any work 
site employee performing services for any customer of the 
certified professional employer organization, but only with 
respect to remuneration remitted to the work site employee by 
the certified professional employer organization. In addition, 
no other person is treated as the employer for employment tax 
purposes with respect to remuneration remitted by the certified 
professional employer organization to a work site employee.
    Under the provision, if an individual (other than a self-
employed individual) who is not a work site employee, but who 
performs services under a contract that meets the contract 
requirements applicable to work site employees, then, solely 
for purposes of a certified professional employer 
organization's liability for employment taxes and other 
obligations under the employment tax rules, a certified 
professional employer organization is treated as the employer 
of the individual, but only with respect to remuneration 
remitted to the individual by the certified professional 
employer organization.
    Under the provision, exclusions, definitions, and special 
rules that are based on the type of employer and that would 
apply if the certified professional employer organization were 
not treated as the employer under the provision continue to 
apply. Thus, for example, if services performed in the employ 
of a customer that is a tax-exempt organization would be 
excluded from employment for FUTA purposes, the fact that a 
certified professional employer organization is treated as the 
employer for employment tax purposes does not affect the 
application of the exclusion. Similarly, if remuneration for 
agricultural labor \35\ or for catching fish \36\ would not be 
subject to FICA taxes, the application of the exclusion is not 
affected by the fact that a certified professional employer 
organization is treated as the employer for employment tax 
purposes under the provision.
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    \35\ See sec. 3121(a)(8).
    \36\ See sec. 3121(b)(20).
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    The provision provides rules under which, on entering into 
a service contract with a customer with respect to a work site 
employee, a certified professional employer organization is 
treated as a successor employer and the customer is treated as 
the predecessor employer. Similarly, on termination of a 
service contract with respect to a work site employee, the 
customer is treated as a successor employer and the certified 
professional employer organization is treated as a predecessor 
employer. Thus, wages paid by the customer and the certified 
professional employer organization to a work site employee 
during a calendar year are subject to a single OASDI, RRTA tier 
1 or tier 2, or FUTA wage base.
    The provision does not apply in the case of a customer who 
is related to the certified professional employer 
organization.\37\ In addition, an individual with net earnings 
from self-employment derived from a customer's trade or 
business (i.e., a self-employed individual), including a 
customer who is a sole proprietor or a partner of a customer 
that is a partnership, is not a work site employee for 
employment tax purposes with respect to remuneration paid by a 
certified professional employer organization.
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    \37\ Whether a customer and a certified professional employer 
organization are related is determined under the rules of section 
267(b) (relating to transactions between related taxpayers) or 707(b) 
(relating to transactions between a partner and partnership). However, 
rules based on more than 50 percent ownership are applied by 
substituting 10 percent for 50 percent.
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    A certified professional employer organization is eligible 
for the FUTA credit with respect to contributions made to a 
State unemployment fund with respect to a work site employee by 
the certified professional employer organization or a customer. 
An additional FUTA credit may be claimed by a certified 
professional employer organization if, under State law, a 
certified professional employer organization is permitted to 
collect and remit contributions with respect to a work site 
employee to the State unemployment fund.

Certified professional employer organization

    A certified professional employer organization is a person 
who has been certified by the Secretary, for purposes of being 
treated as the employer for employment tax purposes under the 
provision, as meeting certain requirements. These requirements 
are met if the person--
           demonstrates that the person (and any owner, 
        officer, and such other persons as may be specified in 
        regulations) meets requirements established by the 
        Secretary with respect to tax status, background, 
        experience, business location, and annual financial 
        audits;
           computes its taxable income using an accrual 
        method of accounting unless the Secretary approves 
        another method;
           agrees to satisfy the bond and independent 
        financial review requirements (described below) on an 
        ongoing basis;
           agrees to satisfy any reporting obligations 
        imposed by the Secretary;
           agrees to verify on such periodic basis as 
        prescribed by the Secretary that it continues to meet 
        the requirements for certification; and
           agrees to notify the Secretary in writing 
        within such time as prescribed by the Secretary of any 
        change that materially affects whether it continues to 
        meet the requirements for certification.
    Under the bond requirement, a certified professional 
employer organization must post a bond for the payment of 
employment taxes in a minimum amount and in a form acceptable 
to the Secretary. The minimum amount is determined for the 
period April 1 of any calendar year through March 31 of the 
following calendar year and is the greater of (1) five percent 
of the employment taxes for which the certified professional 
employer organization is liable under the provision during the 
preceding calendar year (but not to exceed $1,000,000), or (2) 
$50,000.
    Under the independent financial review requirements, a 
certified professional employer organization must: (1) have, as 
of the most recent review date (i.e., six months after the 
completion of the certified professional employer 
organization's fiscal year), caused to be prepared and provided 
to the Secretary an opinion of an independent certified public 
accountant that the certified professional employer 
organization's financial statements are presented fairly in 
accordance with generally accepted accounting principles; and 
(2) provide to the Secretary, not later than the last day of 
the second month beginning after the end of each calendar 
quarter, from an independent certified public accountant an 
assertion regarding Federal employment tax payments and an 
examination level attestation on the assertion. The assertion 
must state that the certified professional employer 
organization has withheld and made deposits of all required 
FICA, RRTA, and withheld income taxes for the calendar quarter, 
and the attestation must state that the assertion is fairly 
stated in all material respects. If a certified professional 
employer organization fails to file the required assertion and 
attestation with respect to any calendar quarter, the 
independent financial review requirements are treated as not 
satisfied for the period beginning on the due date for the 
attestation.
    For purposes of the bond and independent financial review 
requirements, all professional employer organizations that are 
members of a controlled group of corporations or under common 
control are treated as a single organization.\38\ The Secretary 
may suspend or revoke the certification of a person's certified 
professional employer organization status if the Secretary 
determines that the person does not satisfy the representations 
or other requirements for certification or fails to satisfy the 
applicable accounting, reporting, payment, or deposit 
requirements.
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    \38\ Whether entities are members of a controlled group of 
corporations or under common control is determined under the rules of 
section 414(b) and (c).
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Work site employee

    A work site employee is an individual who: (1) performs 
services for a customer of a certified professional employer 
organization pursuant to a contract between the customer and 
the certified professional employer organization that meets 
certain requirements (described below); and (2) performs 
services at a work site meeting certain requirements (described 
below).\39\ Thus, if the contract or work site fails to meet 
applicable requirements, the individual is not a work site 
employee.
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    \39\ As discussed above, a self-employed individual is not a work 
site employee.
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    The contract between the customer and the certified 
professional employer organization must be in writing and, with 
respect to an individual performing services for the customer, 
must provide that the certified professional employer 
organization will--
           assume responsibility for payment of wages 
        to the individual, without regard to the receipt or 
        adequacy of payment from the customer;
           assume responsibility for reporting, 
        withholding, and paying any employment taxes with 
        respect to the individual's wages, without regard to 
        the receipt or adequacy of payment from the customer;
           assume responsibility for any employee 
        benefits that the contract may require the certified 
        professional employer organization to provide, without 
        regard to the receipt or adequacy of payment from the 
        customer;
           assume responsibility for hiring, firing, 
        and recruiting workers in addition to the customer's 
        responsibility for hiring, firing and recruiting 
        workers;
           maintain employee records relating to the 
        individual; and
           agree to be treated as a certified 
        professional employer organization for employment tax 
        purposes with respect to such individual.
    For purposes of whether an individual is a work site 
employee, the work site where the individual performs services 
meets the applicable requirements if at least 85 percent of the 
individuals performing services for the customer at the work 
site are subject to one or more contracts with the certified 
professional employer organization that meet the above 
requirements.\40\
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    \40\ For this purpose, excluded employees under section 414(q)(5), 
such as employees who are under age 21 or have not completed six months 
of service, are not taken into account.
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Regulations

    The Secretary of Treasury (``Secretary'') is directed to 
prescribe such regulations as may be necessary or appropriate 
to carry out the purposes of the provision. The Secretary is 
also directed to develop reporting and recordkeeping rules, 
regulations, and procedures to ensure compliance with the 
provision with respect to entities applying for and receiving 
certification as certified professional employer organizations. 
These are to be designed in a manner to streamline, to the 
extent possible, the application of the requirements of the 
provision, the exchange of information between a certified 
professional employer organization and its customers, and the 
reporting and recordkeeping obligations of a certified 
professional employer organization.

No inference with respect to other provisions

    Nothing contained in the provision or the amendments made 
by the provision is to be construed to create any inference 
with respect to the determination of who is an employee or 
employer (1) for Federal tax purposes (other than the purposes 
set forth in the provision), or (2) for purposes of any other 
provision of law.

Other rules

            Income tax credits based on wages for employment tax 
                    purposes
    Under the provision, for purposes of various income tax 
credits \41\ under which the amount of the credit is determined 
by reference to the amount of employment tax wages or 
employment taxes: (1) the credit with respect to a work site 
employee performing services for a customer applies to the 
customer (not to the certified professional employer 
organization); (2) the customer (and not the certified 
professional employer organization) is to take into account 
wages and employment taxes paid by the certified professional 
employer organization with respect to the work site employee 
and for which the certified professional employer organization 
receives payment from the customer; and (3) the certified 
professional employer organization is required to furnish the 
customer with any information necessary for the customer to 
claim the credit.\42\
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    \41\ Secs. 41 (credit for research expenses), 45A (Indian 
employment credit), 45B (credit for employer FICA tax paid on tips), 
45C (credit for clinical drug testing expenses), 51 (work opportunity 
credit), 51A (welfare-to-work credit), 1396 (empowerment zone 
employment credit), 1400(d) (DC Zone employment credit), 1400H (renewal 
community employment credit), and any other provision as provided by 
the Secretary.
    \42\ Present law provides a deduction from taxable income (or, in 
the case of an individual, adjusted gross income) that is equal to a 
portion of the taxpayer's qualified production activities income (sec. 
199). The deduction for a taxable year is limited to 50 percent of the 
wages deducted in arriving at qualified production activities income. 
To be taken into account, wages must be paid by the taxpayer to its 
employees and reported on Form W-2. For this purpose, wages means wages 
subject to income tax withholding, as well as elective deferrals and 
certain other amounts. Under regulations dealing with wages paid by an 
entity other than the common-law employer, a taxpayer may take into 
account wages paid by another entity and reported by the other entity 
on Form W-2 (with the other entity listed as the employer on the Form 
W-2), provided that the wages were paid to employees of the taxpayer 
for employment by the taxpayer. Treas. Reg. sec. 1.199-2(a)(2). The 
provision does not affect the application of these rules.
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            Reporting by large food and beverage establishments
    Under the provision, if a certified professional employer 
organization is treated for employment tax purposes as the 
employer of a work site employee, the customer for whom the 
work site employee performs services is the employer for 
purposes of the reporting required with respect to a large food 
or beverage establishment. The certified professional employer 
organization is required to furnish the customer with any 
information necessary to complete the required reporting.
            User fees
    Under the provision, the user fee charged under the program 
for certifying a professional employer organization may not 
exceed $500.

                             EFFECTIVE DATE

    The provision is effective with respect to wages paid for 
services performed on or after January 1 of the first calendar 
year beginning more than 12 months after the date of enactment 
of the provision. The Secretary is directed to establish the 
certification program for professional employer organizations 
not later than six months before the provision becomes 
effective.

                       G. Subchapter S Provisions

(Secs. 111-116 of the bill and secs. 1361 and 1362 of the Code)

                                OVERVIEW

    In general, an S corporation is not subject to corporate-
level income tax on its items of income and loss. Instead, an S 
corporation passes through its items of income and loss to its 
shareholders. The shareholders take into account separately 
their shares of these items on their individual income tax 
returns. To prevent double taxation of these items when the 
stock is later disposed of, each shareholder's basis in the 
stock of the S corporation is increased by the amount included 
in income (including tax-exempt income) and is decreased by the 
amount of any losses (including nondeductible losses) taken 
into account. A shareholder's loss may be deducted only to the 
extent of his or her basis in the stock or debt of the S 
corporation. To the extent a loss is not allowed due to this 
limitation, the loss generally is carried forward with respect 
to the shareholder.

                           REASONS FOR CHANGE

    Many small businesses are organized as S corporations. The 
bill contains a number of provisions relating to these 
corporations. These provisions modernize the S corporation 
rules and eliminate undue restrictions on S corporations. The 
Committee believes that these changes will improve the 
operation of Subchapter S and therefore will benefit small 
businesses.

1. Capital gain not treated as passive investment income

                              PRESENT LAW

Passive investment income

    An S corporation is subject to corporate-level tax, at the 
highest corporate tax rate, on its excess net passive income if 
the corporation has (1) accumulated earnings and profits at the 
close of the taxable year and (2) gross receipts more than 25 
percent of which are passive investment income.
    Excess net passive income is the net passive income for a 
taxable year multiplied by a fraction, the numerator of which 
is the amount of passive investment income in excess of 25 
percent of gross receipts and the denominator of which is the 
passive investment income for the year. Net passive income is 
defined as passive investment income reduced by the allowable 
deductions that are directly connected with the production of 
that income. Passive investment income generally means gross 
receipts derived from royalties, rents, dividends, interest, 
annuities, and sales or exchanges of stock or securities (to 
the extent of gains). Passive investment income generally does 
not include interest on accounts receivable, gross receipts 
that are derived directly from the active and regular conduct 
of a lending or finance business, gross receipts from certain 
liquidations, gain or loss from any section 1256 contract (or 
related property) of an options or commodities dealer, or 
certain interest and dividend income of banks and depository 
institution of holding companies.
    In addition, an S corporation election is terminated 
whenever the S corporation has accumulated earnings and profits 
at the close of each of three consecutive taxable years and has 
gross receipts for each of those years more than 25 percent of 
which are passive investment income.

                        EXPLANATION OF PROVISION

    The provision eliminates gains from sales or exchanges of 
stock or securities as an item of passive investment income.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after the 
date of enactment.

2. Treatment of bank director shares

                              PRESENT LAW

    An S corporation may have no more than 100 shareholders and 
may have only one outstanding class of stock.
    An S corporation has one class of stock if all outstanding 
shares of stock confer identical rights to distribution and 
liquidation proceeds. Differences in voting rights are 
disregarded.\43\
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    \43\ Sec. 1361(c)(4). Treasury regulations provide that buy-sell 
and redemption agreements are disregarded in determining whether a 
corporation's outstanding shares confer identical distribution and 
liquidation rights unless (1) a principal purpose of the agreement is 
to circumvent the one class of stock requirement and (2) the agreement 
establishes a purchase price that, at the time the agreement is entered 
into, is significantly in excess of, or below, the fair market value of 
the stock. Treas. Reg. sec. 1.1361-1(l).
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    National banking law requires that a director of a national 
bank own stock in the bank and that a bank have at least five 
directors.\44\ A number of States have similar requirements for 
State-chartered banks. In some cases, a bank director enters 
into an agreement under which the bank (or a holding company) 
will reacquire the stock upon the director's ceasing to hold 
the office of director, at the price paid by the director for 
the stock.\45\
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    \44\ 12 U.S.C. secs. 71-72.
    \45\ See Private Letter Ruling 200217048 (January 24, 2002) 
describing such an agreement and holding that it creates a second class 
of stock. Nonetheless, the ruling concluded that the election to be an 
S corporation was inadvertently invalid and that an amended agreement 
did not create a second class of stock so that the corporation's 
election was validated.
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                        EXPLANATION OF PROVISION

    Under the provision, restricted bank director stock is not 
taken into account as outstanding stock in applying the 
provisions of subchapter S.\46\ Thus, the stock is not treated 
as a second class of stock; a director is not treated as a 
shareholder of the S corporation by reason of the stock; the 
stock is disregarded in allocating items of income, loss, etc. 
among the shareholders; and the stock is not treated as 
outstanding for purposes of determining whether an S 
corporation holds 100 percent of the stock of a qualified 
subchapter S subsidiary.
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    \46\ No inference is intended as to the proper income tax treatment 
of restricted bank director stock or other similar stock under present 
law.
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    Restricted bank director stock is stock in a bank (as 
defined in sec. 581), or a depository institution holding 
company (within the meaning of sec. 3(w)(1) of the Federal 
Deposit Insurance Act), if the stock is required to be held by 
an individual under applicable Federal or State law in order to 
permit the individual to serve as a director of the bank or 
holding company and which is subject to an agreement with the 
bank or holding company (or corporation in control of the bank 
or company) pursuant to which the holder is required to sell 
the stock back upon ceasing to be a director at the same price 
the individual acquired the stock.
    A distribution (other than a payment in exchange for the 
stock) with respect to the restricted stock is includible in 
the gross income of the director and is deductible by the S 
corporation for the taxable year that includes the last day of 
the director's taxable year in which the distribution is 
included in income.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2006.
    The provision also provides that restricted bank director 
stock is not treated as a second class of stock for taxable 
years beginning after December 31, 1996.

3. Treatment of banks changing from reserve method of accounting

                              PRESENT LAW

    A financial institution which uses the reserve method of 
accounting for bad debts may not elect to be an S 
corporation.\47\ If a financial institution changes from the 
reserve method of accounting, there is taken into account for 
the taxable year of the change adjustments to taxable income 
necessary to prevent amounts from being duplicated or omitted 
by reason of the change.\48\
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    \47\ Sec. 1361(b)(2)(A).
    \48\ Sec. 481.
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    Positive adjustments (i.e., additions to taxable income) 
are generally spread over four taxable years beginning in the 
year of change.\49\ Negative adjustments (i.e., reductions to 
taxable income) are generally taken into account entirely in 
the year of change.\50\
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    \49\ Rev. Proc. 2002-19, 2002-1 C.B. 696.
    \50\ Id.
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    In the case of a financial institution that changes from 
the reserve method and elects to be an S corporation for the 
year of change, the adjustments are both included in the income 
of the shareholders and are taken into account in computing the 
tax on built-in gain under section 1374. If the change in 
accounting method is made for the last taxable year prior to 
becoming an S corporation, any adjustments for that year are 
taken into account in computing the corporation's taxable 
income, but not taken into account by the shareholders.

                        EXPLANATION OF PROVISION

    The provision allows a bank which changes from the reserve 
method of accounting for bad debts for its first taxable year 
for which it is an S corporation to elect to take into account 
all adjustments under section 481 by reason of the change in 
the last taxable year it was a C corporation.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2006.

4. Treatment of sale of an interest in a qualified subchapter S 
        subsidiary

                              PRESENT LAW

    Under present law, an S corporation that owns all the stock 
of a corporation may elect to treat the subsidiary corporation 
as a qualified subchapter S subsidiary (``QSub''). A qualified 
subchapter S subsidiary is disregarded as a separate entity for 
Federal tax purposes and its items of income, deduction, loss, 
and credit are treated as items of the S corporation.
    If the subsidiary corporation ceases to be a QSub (e.g., 
fails to meet the wholly-owned requirement) the subsidiary is 
treated as a new corporation acquiring all its assets (and 
assuming all of its liabilities) immediately before such 
cessation from the parent S corporation in exchange for its 
stock. Under Treasury regulations,\51\ the tax treatment of the 
termination of the QSub election is determined under general 
principals of tax law, including the step transaction doctrine. 
The regulations set forth an example \52\ in which an S 
corporation sells 21 percent of the stock of a QSub to an 
unrelated party. In the example, the deemed transfer of all the 
assets to the QSub is treated as a taxable sale because the S 
corporation was not in control of the QSub immediately after 
the transfer by reason of the sale, and thus the transfer did 
not qualify for nonrecognition treatment under section 351.
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    \51\ Treas. Reg. sec. 1.1361-5(b).
    \52\ Example 1 of Treas. Reg. sec. 1.1361-5(b)(3).
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                        EXPLANATION OF PROVISION

    The provision provides that where the sale of stock of a 
QSub results in the termination of the QSub election, the sale 
is treated as a sale of an undivided interest in the assets of 
the QSub (based on the percentage of the stock sold) followed 
by a deemed transfer to the QSub in a transaction to which 
section 351 applies.
    Thus, in the above example, the S corporation will be 
treated as selling a 21 percent-interest in all the assets of 
the QSub to the unrelated party, followed by a transfer of all 
the assets to a new corporation in a transaction to which 
section 351 applies. Thus, the S corporation will recognize 21 
percent of the gain or loss in the assets of the QSub.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31. 2006.

5. Elimination of earnings and profits attributable to pre-1983 years

                              PRESENT LAW

    The Small Business Jobs Protection Act of 1996 provided 
that if a corporation was an S corporation for its first 
taxable year beginning after December 31, 1996, the accumulated 
earnings and profits of the corporation as of the beginning of 
that year were reduced by the accumulated earnings and profits 
(if any) accumulated in a taxable year beginning before January 
1, 1983, for which the corporation was an electing small 
business corporation under subchapter S.

                        EXPLANATION OF PROVISION

    The provision provides in the case of any corporation which 
was not an S corporation for its first taxable year beginning 
after December 31, 1996, the accumulated earnings and profits 
of the corporation as of the beginning of the first taxable 
year beginning after the date of the enactment of this 
provision is reduced by the accumulated earnings and profits 
(if any) accumulated in a taxable year beginning before January 
1, 1983, for which the corporation was an electing small 
business corporation under subchapter S.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after the 
date of enactment.

6. Expansion of qualifying beneficiaries of an electing small business 
        trust

                              PRESENT LAW

    Under present law, an electing small business trust 
(``ESBT'') may be a shareholder of an S corporation. Generally, 
the eligible beneficiaries of an ESBT include individuals, 
estates, and certain charitable organizations eligible to hold 
S corporation stock directly. A nonresident alien individual 
may not be a potential current beneficiary of an ESBT.
    The portion of an ESBT which consists of the stock of an S 
corporation is treated as a separate trust and is generally 
taxed on its share of the S corporation's income at the highest 
rate of tax imposed on individual taxpayers (currently 35 
percent). This income (whether or not distributed by the ESBT) 
is not taxed to the beneficiaries of the ESBT.

                        EXPLANATION OF PROVISION

    The provision allows a nonresident alien individual to be a 
potential current beneficiary of an ESBT.

                             EFFECTIVE DATE

    The provision is effective on the date of enactment.

                      TITLE II--REVENUE PROVISIONS

A. Modification of Effective Date of Leasing Provisions of the American 
                       Jobs Creation Act of 2004

(Sec. 201 of the bill and sec. 470 of the Code)

                              PRESENT LAW

    Present law provides for the deferral of losses 
attributable to certain tax exempt use property, generally 
effective for leases entered into after March 12, 2004. The 
deferral provision does not apply to property located in the 
United States that is subject to a lease with respect to which 
a formal application: (1) was submitted for approval to the 
Federal Transit Administration (an agency of the Department of 
Transportation) after June 30, 2003, and before March 13, 2004; 
(2) is approved by the Federal Transit Administration before 
January 1, 2006; and (3) includes a description and the fair 
market value of such property (the ``qualified transportation 
property exception'').

                           REASONS FOR CHANGE

    The Committee is aware that certain leasing transactions 
entered into with foreign lessees prior to March 12, 2004 are 
continuing to provide a benefit to the taxpayers who 
participated in such transactions. The Committee finds these 
transactions and their continuing benefit to be inappropriate. 
Thus, the provision denies any future tax benefit with respect 
to the transactions.

                        EXPLANATION OF PROVISION

    The provision changes the effective date of the loss 
deferral rules with respect to certain leases. Under the 
provision, the loss deferral rules also apply to leases entered 
into on or before March 12, 2004, if the lessee is a foreign 
person or entity. With respect to such leases, losses are 
deferred starting in taxable years beginning after December 31, 
2006.
    No inference is intended with respect to the tax treatment 
of leases entered into on or before March 12, 2004, if the 
lessee is not a foreign person or entity.

                             EFFECTIVE DATE

    The provision is effective as if included in the provisions 
of the American Jobs Creation Act of 2004 to which it relates.

        B. Tax Treatment of Certain Inverted Corporate Entities

(Sec. 202 of the bill and sec. 7874 of the Code)

                              PRESENT LAW

Determination of corporate residence

    The U.S. tax treatment of a multinational corporate group 
depends significantly on whether the parent corporation of the 
group is domestic or foreign. For purposes of U.S. tax law, a 
corporation is treated as domestic if it is incorporated under 
the law of the United States or of any State. Other 
corporations (i.e., those incorporated under the laws of 
foreign countries or U.S. possessions) generally are treated as 
foreign.

U.S. taxation of domestic corporations

    The United States employs a ``worldwide'' tax system, under 
which domestic corporations generally are taxed on all income, 
whether derived in the United States or abroad. In order to 
mitigate the double taxation that may arise from taxing the 
foreign-source income of a domestic corporation, a foreign tax 
credit for income taxes paid to foreign countries is provided 
to reduce or eliminate the U.S. tax owed on such income, 
subject to certain limitations.
    Income earned by a domestic parent corporation from foreign 
operations conducted by foreign corporate subsidiaries 
generally is subject to U.S. tax when the income is distributed 
as a dividend to the domestic corporation. Until such 
repatriation, the U.S. tax on such income generally is 
deferred, and U.S. tax is imposed on such income when 
repatriated. However, certain anti-deferral regimes may cause 
the domestic parent corporation to be taxed on a current basis 
in the United States with respect to certain categories of 
passive or highly mobile income earned by its foreign 
subsidiaries, regardless of whether the income has been 
distributed as a dividend to the domestic parent corporation. 
The main anti-deferral regimes in this context are the 
controlled foreign corporation rules of subpart F (secs. 951-
964) and the passive foreign investment company rules (secs. 
1291-1298). A foreign tax credit is generally available to 
offset, in whole or in part, the U.S. tax owed on this foreign-
source income, whether such income is repatriated as an actual 
dividend or included under one of the anti-deferral regimes.

U.S. taxation of foreign corporations

    The United States taxes foreign corporations only on income 
that has a sufficient nexus to the United States. Thus, a 
foreign corporation is generally subject to U.S. tax only on 
income that is ``effectively connected'' with the conduct of a 
trade or business in the United States. Such ``effectively 
connected income'' generally is taxed in the same manner and at 
the same rates as the income of a U.S. corporation. An 
applicable tax treaty may limit the imposition of U.S. tax on 
business operations of a foreign corporation to cases in which 
the business is conducted through a ``permanent establishment'' 
in the United States.
    In addition, foreign corporations generally are subject to 
a gross-basis U.S. tax at a flat 30-percent rate on the receipt 
of interest, dividends, rents, royalties, and certain similar 
types of income derived from U.S. sources, subject to certain 
exceptions. The tax generally is collectedby means of 
withholding by the person making the payment. This tax may be reduced 
or eliminated under an applicable tax treaty.

U.S. tax treatment of inversion transactions prior to the American Jobs 
        Creation Act of 2004

    Prior to the American Jobs Creation Act of 2004 (``AJCA''), 
a U.S. corporation could reincorporate in a foreign 
jurisdiction and thereby replace the U.S. parent corporation of 
a multinational corporate group with a foreign parent 
corporation. These transactions were commonly referred to as 
inversion transactions. Inversion transactions could take many 
different forms, including stock inversions, asset inversions, 
and various combinations of and variations on the two. Most of 
the known transactions were stock inversions. In one example of 
a stock inversion, a U.S. corporation forms a foreign 
corporation, which in turn forms a domestic merger subsidiary. 
The domestic merger subsidiary then merges into the U.S. 
corporation, with the U.S. corporation surviving, now as a 
subsidiary of the new foreign corporation. The U.S. 
corporation's shareholders receive shares of the foreign 
corporation and are treated as having exchanged their U.S. 
corporation shares for the foreign corporation shares. An asset 
inversion could be used to reach a similar result, but through 
a direct merger of the top-tier U.S. corporation into a new 
foreign corporation, among other possible forms. An inversion 
transaction could be accompanied or followed by further 
restructuring of the corporate group. For example, in the case 
of a stock inversion, in order to remove income from foreign 
operations from the U.S. taxing jurisdiction, the U.S. 
corporation could transfer some or all of its foreign 
subsidiaries directly to the new foreign parent corporation or 
other related foreign corporations.
    In addition to removing foreign operations from U.S. taxing 
jurisdiction, the corporate group could seek to derive further 
advantage from the inverted structure by reducing U.S. tax on 
U.S.-source income through various earnings stripping or other 
transactions. This could include earnings stripping through 
payment by a U.S. corporation of deductible amounts such as 
interest, royalties, rents, or management service fees to the 
new foreign parent or other foreign affiliates. In this 
respect, the post-inversion structure could enable the group to 
employ the same tax-reduction strategies that are available to 
other multinational corporate groups with foreign parents and 
U.S. subsidiaries, subject to the same limitations (e.g., secs. 
163(j) and 482).
    Inversion transactions could give rise to immediate U.S. 
tax consequences at the shareholder and/or the corporate level, 
depending on the type of inversion. In stock inversions, the 
U.S. shareholders generally recognized gain (but not loss) 
under section 367(a), based on the difference between the fair 
market value of the foreign corporation shares received and the 
adjusted basis of the domestic corporation stock exchanged. To 
the extent that a corporation's share value had declined, and/
or it had many foreign or tax-exempt shareholders, the impact 
of this section 367(a) ``toll charge'' was reduced. The 
transfer of foreign subsidiaries or other assets to the foreign 
parent corporation also could give rise to U.S. tax 
consequences at the corporate level (e.g., gain recognition and 
earnings and profits inclusions under secs. 1001, 311(b), 304, 
367, 1248 or other provisions). The tax on any income 
recognized as a result of these restructurings could be reduced 
or eliminated through the use of net operating losses, foreign 
tax credits, and other tax attributes.
    In asset inversions, the U.S. corporation generally 
recognized gain (but not loss) under section 367(a) as though 
it had sold all of its assets, but the shareholders generally 
did not recognize gain or loss, assuming the transaction met 
the requirements of a reorganization under section 368.

U.S. tax treatment of inversion transactions under AJCA

            In general
    AJCA added new section 7874 to the Code, which defines two 
different types of corporate inversion transactions and 
establishes a different set of consequences for each type. 
Certain partnership transactions also are covered.
            Transactions involving at least 80 percent identity of 
                    stock ownership
    The first type of inversion is a transaction in which, 
pursuant to a plan \53\ or a series of related transactions: 
(1) a U.S. corporation becomes a subsidiary of a foreign-
incorporated entity or otherwise transfers substantially all of 
its properties to such an entity in a transaction completed 
after March 4, 2003; (2) the former shareholders of the U.S. 
corporation hold (by reason of holding stock in the U.S. 
corporation) 80 percent or more (by vote or value) of the stock 
of the foreign-incorporated entity after the transaction; and 
(3) the foreign-incorporated entity, considered together with 
all companies connected to it by a chain of greater than 50 
percent ownership (i.e., the ``expanded affiliated group''), 
does not have substantial business activities in the entity's 
country of incorporation, compared to the total worldwide 
business activities of the expanded affiliated group. The 
provision denies the intended tax benefits of this type of 
inversion (``80-percent inversion'') by deeming the top-tier 
foreign corporation to be a domestic corporation for all 
purposes of the Code.\54\
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    \53\ Acquisitions with respect to a domestic corporation or 
partnership are deemed to be ``pursuant to a plan'' if they occur 
within the four-year period beginning on the date which is two years 
before the ownership threshold under the provision is met with respect 
to such corporation or partnership.
    \54\ Since the top-tier foreign corporation is treated for all 
purposes of the Code as domestic, the shareholder-level ``toll charge'' 
of sec. 367(a) does not apply to these inversion transactions.
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    In determining whether a transaction meets the definition 
of an inversion under the provision, stock held by members of 
the expanded affiliated group that includes the foreign 
incorporated entity is disregarded. For example, if the former 
top-tier U.S. corporation receives stock of the foreign 
incorporated entity (e.g., so-called ``hook'' stock), the stock 
would not be considered in determining whether the transaction 
meets the definition. Similarly, if a U.S. parent corporation 
converts an existing wholly owned U.S. subsidiary into a new 
wholly owned controlled foreign corporation, the stock of the 
new foreign corporation would be disregarded, with the result 
that the transaction would not meet the definition of an 
inversion under the provision. Stock sold in a public offering 
related to the transaction also is disregarded for these 
purposes.
    Transfers of properties or liabilities as part of a plan a 
principal purpose of which is to avoid the purposes of the 
provision are disregarded. In addition, the Treasury Secretary 
is to provide regulations to carry out the provision, including 
regulations to prevent the avoidance of the purposes of the 
provision, including avoidance through the use of related 
persons, pass-through or other noncorporate entities, or other 
intermediaries, and through transactions designed to qualify or 
disqualify a person as a related person or a member of an 
expanded affiliated group. Similarly, the Treasury Secretary 
has the authority to treat certain non-stock instruments as 
stock, and certain stock as not stock, where necessary to carry 
out the purposes of the provision.
            Transactions involving at least 60 percent but less than 80 
                    percent identity of stock ownership
    The second type of inversion is a transaction that would 
meet the definition of an inversion transaction described 
above, except that the 80-percent ownership threshold is not 
met. In such a case, if at least a 60-percent ownership 
threshold is met, then a second set of rules applies to the 
inversion. Under these rules, the inversion transaction is 
respected (i.e., the foreign corporation is treated as 
foreign), but any applicable corporate-level ``toll charges'' 
for establishing the inverted structure are not offset by tax 
attributes such as net operating losses or foreign tax credits. 
Specifically, any applicable corporate-level income or gain 
required to be recognized under sections 304, 311(b), 367, 
1001, 1248, or any other provision with respect to the transfer 
of controlled foreign corporation stock or the transfer or 
license of other assets by a U.S. corporation as part of the 
inversion transaction or after such transaction to a related 
foreign person is taxable, without offset by any tax attributes 
(e.g., net operating losses or foreign tax credits). This rule 
does not apply to certain transfers of inventory and similar 
property. These measures generally apply for a 10-year period 
following the inversion transaction.
            Other rules
    Under section 7874, inversion transactions include certain 
partnership transactions. Specifically, the provision applies 
to transactions in which a foreign-incorporated entity acquires 
substantially all of the properties constituting a trade or 
business of a domestic partnership, if after the acquisition at 
least 60 percent (or 80 percent, as the case may be) of the 
stock of the entity is held by former partners of the 
partnership (by reason of holding their partnership interests), 
provided that the other terms of the basic definition are met. 
For purposes of applying this test, all partnerships that are 
under common control within the meaning of section 482 are 
treated as one partnership, except as provided otherwise in 
regulations. In addition, the modified ``toll charge'' rules 
apply at the partner level.
    A transaction otherwise meeting the definition of an 
inversion transaction is not treated as an inversion 
transaction if, on or before March 4, 2003, the foreign-
incorporated entity had acquired directly or indirectly more 
than half of the properties held directly or indirectly by the 
domestic corporation, or more than half of the properties 
constituting the partnership trade or business, as the case may 
be.

                           REASONS FOR CHANGE

    The Committee believes that the inversions regime should 
generally apply to companies that completed 80-percent 
inversion transactions after public notice was given that 
eventual legislation on this issue could be effective after 
March 20, 2002.

                        EXPLANATION OF PROVISION

    The provision generally extends the 80-percent inversion 
regime of section 7874 to 80-percent inversions completed after 
March 20, 2002 but on or before March 4, 2003, with certain 
modifications as described below. A transaction otherwise 
meeting the definition of an 80-percent inversion under the 
provision (i.e., one completed after March 20, 2002 but on or 
before March 4, 2003) is not treated as an 80-percent inversion 
if, on or before March 20, 2002, the foreign-incorporated 
entity had acquired directly or indirectly more than half the 
properties held directly or indirectly by the domestic 
corporation, or more than half the properties constituting the 
partnership trade or business, as the case may be.
    Under the provision, an 80-percent inversion that is 
completed after March 20, 2002 but on or before March 4, 2003 
is respected until the end of the last day of the foreign-
incorporated entity's taxable year that began in 2006. At the 
end of that day, the inverted foreign-incorporated entity that 
completed the 80-percent inversion (or if relevant, any 
successor entity) is deemed to have transferred all of its 
assets and liabilities to a domestic corporation in a 
transaction that is generally treated as a nontaxable inbound 
reorganization (``repatriation''). The basis of the assets of 
the foreign-incorporated entity generally remains the same in 
the hands of the domestic corporation, subject to any special 
adjustments for importing built-in losses (e.g., sec. 362(e)). 
Shareholders of the domestic corporation inherit the respective 
bases of their shares of the foreign-incorporated entity.
    On the day of the repatriation, the earnings and profits of 
the inverted foreign-incorporated entity transfer over to the 
domestic corporation. The transfer of such earnings and profits 
is not a deemed dividend and does not result in a tax upon the 
domestic corporation or its shareholders. In addition, any 
foreign taxes attributable to such earnings and profits are not 
creditable. However, shareholders may be subject to tax on 
distributions of such earnings and profits.
    Beginning on the day after the repatriation, the inverted 
foreign-incorporated entity is treated for all tax purposes as 
a domestic corporation. Thus, any income earned by the inverted 
foreign-incorporated entity after the date of repatriation is 
deemed to be earned by a domestic corporation, and therefore, 
is fully taxable at U.S. corporate income tax rates. As a 
further consequence of the repatriation of the inverted 
foreign-incorporated entity, foreign subsidiaries become 
controlled foreign corporations, subject to the rules of 
subpart F.
    It is intended that the Secretary will prescribe 
regulations that are necessary or appropriate to carry out the 
provision, including, but not limited to, regulations to 
prevent the avoidance of the purposes of the provision.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2006.

              C. Denial of Deduction for Punitive Damages

(Sec. 203 of the bill and sec. 162(g) of the Code)

                              PRESENT LAW

    In general, a deduction is allowed for all ordinary and 
necessary expenses that are paid or incurred by the taxpayer 
during the taxable year in carrying on any trade or 
business.\55\ However, no deduction is allowed for any payment 
that is made to an official of any governmental agency if the 
payment constitutes an illegal bribe or kickback or if the 
payment is to an official or employee of a foreign government 
and is illegal under Federal law.\56\ In addition, no deduction 
is allowed under present law for any fine or similar payment 
made to a government for violation of any law.\57\ Furthermore, 
no deduction is permitted for two-thirds of any damage payments 
made by a taxpayer who is convicted of a violation of the 
Clayton antitrust law or any related antitrust law.\58\
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    \55\ Sec. 162(a).
    \56\ Sec. 162(c).
    \57\ Sec. 162(f).
    \58\ Sec. 162(g).
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    In general, gross income does not include amounts received 
on account of personal physical injuries and physical 
sickness.\59\ However, this exclusion does not apply to 
punitive damages.\60\
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    \59\ Sec. 104(a).
    \60\ Sec. 104(a)(2).
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                           REASONS FOR CHANGE

    The Committee believes that allowing a tax deduction for 
punitive damages undermines the societal role of punitive 
damages in discouraging and penalizing the activities or 
actions for which punitive damages are imposed. If a taxpayer 
deducts a payment for punitive damages, the amount of the 
payment does not reflect the true after-tax punitive effect on 
the taxpayer. The Committee is concerned that allowing a 
deduction for such payments in effect shifts a portion of the 
penalty to the Federal Government and to the public. 
Furthermore, the Committee believes that determining the amount 
of punitive damages to be disallowed as a tax deduction is not 
administratively burdensome because taxpayers generally can 
make such a determination readily by reference to pleadings 
filed with a court, and plaintiffs already make such a 
determination in determining the taxable portion of any 
payment. The Committee also believes that reporting the amount 
of any insurance payment for punitive damages to the IRS and 
the taxpayer will promote effective tax administration and 
foster compliance with the tax laws.

                        EXPLANATION OF PROVISION

    The provision denies any deduction for punitive damages 
that are paid or incurred by the taxpayer as a result of a 
judgment or in settlement of a claim. If the liability for 
punitive damages is covered by insurance, any such punitive 
damages paid by the insurer are included in gross income of the 
insured person and the insurer is required to report such 
amounts to both the insured person and the IRS.

                             EFFECTIVE DATE

    The provision is effective for punitive damages that are 
paid or incurred on or after the date of enactment.

 D. Denial of Deduction for Certain Fines, Penalties, and Other Amounts

(Sec. 204 of the bill and sec. 162 of the Code)

                              PRESENT LAW

    Under present law, no deduction is allowed as a trade or 
business expense under section 162(a) for the payment of a fine 
or similar penalty to a government for the violation of any law 
(sec. 162(f)). The enactment of section 162(f) in 1969 codified 
existing case law that denied the deductibility of fines as 
ordinary and necessary business expenses on the grounds that 
``allowance of the deduction would frustrate sharply defined 
national or State policies proscribing the particular types of 
conduct evidenced by some governmental declaration thereof.'' 
\61\
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    \61\ S. Rep. No. 91-552, 91st Cong, 1 Sess., 273-74 (1969), 
referring to Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30 
(1958).
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    Treasury regulation section 1.162-21(b)(1) provides that a 
fine or similar penalty includes an amount: (1) paid pursuant 
to conviction or a plea of guilty or nolo contendere for a 
crime (felony or misdemeanor) in a criminal proceeding; (2) 
paid as a civil penalty imposed by Federal, State, or local 
law, including additions to tax and additional amounts and 
assessable penalties imposed by chapter 68 of the Code; (3) 
paid in settlement of the taxpayer's actual or potential 
liability for a fine or penalty (civil or criminal); or (4) 
forfeited as collateral posted in connection with a proceeding 
which could result in imposition of such a fine or penalty. 
Treasury regulation section 1.162-21(b)(2) provides, among 
other things, that compensatory damages (including damages 
under section 4A of the Clayton Act (15 U.S.C. 15a), as 
amended) paid to a government do not constitute a fine or 
penalty.

                           REASONS FOR CHANGE

    The Committee is concerned that there is a lack of clarity 
and consistency under present law regarding when taxpayers may 
deduct payments made in settlement of government investigations 
of potential wrongdoing, as well as in situations where there 
has been a final determination of wrongdoing. If a taxpayer 
deducts payments made in settlement of an investigation of 
potential wrongdoing or as a result of a finding of wrongdoing, 
the publicly announced amount of the settlement payment does 
not reflect the true after-tax penalty on the taxpayer.\62\ The 
Committee also is concerned that allowing a deduction for such 
payments in effect shifts a portion of the penalty to the 
Federal government and to the public. The Committee believes 
that reporting the payments to the IRS and the taxpayer 
promotes effective tax administration and fosters compliance 
with the tax law.
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    \62\ The Government Acountability Office (``GAO'') reported that 
the majority of companies responding to a GAO survey deducted civil 
settlement payments when their settlement agreements did not label the 
payments as penalties. See, Government Accountability Office, TAX 
ADMINISTRATION: Systematic Information Sharing Would Help IRS Determine 
the Deductibility of Civil Settlement Payments (GAO-05-747).
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                        EXPLANATION OF PROVISION

    The provision modifies the rules regarding the 
determination whether payments are nondeductible payments of 
fines or penalties under section 162(f). In particular, the 
provision generally provides that amounts paid or incurred 
(whether by suit, agreement, or otherwise) to, or at the 
direction of, a government in relation to the violation of any 
law or the investigation or inquiry into the potential 
violation of any law \63\ are nondeductible under any provision 
of the income tax provisions.\64\ The provision applies to deny 
a deduction for any such payments, including those where there 
is no admission of guilt or liability and those made for the 
purpose of avoiding further investigation or litigation. An 
exception applies to payments that the taxpayer establishes are 
either restitution (including remediation of property), or 
amounts required to come into compliance with any law that was 
violated or involved in the investigation or inquiry, and that 
are identified in the court order or settlement as restitution, 
remediation, or required to come into compliance.\65\ The IRS 
remains free to challenge the characterization of an amount so 
identified; however, no deduction is allowed unless the 
identification is made.\66\
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    \63\ The provision does not affect amounts paid or incurred in 
performing routine audits or reviews such as annual audits that are 
required of all organizations or individuals in a similar business 
sector, or profession, as a requirement for being allowed to conduct 
business. However, if the government or regulator raised an issue of 
compliance and a payment is required in settlement of such issue, the 
provision would affect that payment.
    \64\ The provision provides that such amounts are nondeductible 
under chapter 1 of the Internal Revenue Code.
    \65\ The provision does not affect the treatment of antitrust 
payments made under section 4 of the Clayton Act, which continue to be 
governed by the provisions of section 162(g).
    \66\ If a settlement agreement does not specify a specific amount 
to be paid for the purpose of coming into compliance but instead simply 
requires the taxpayer to come into compliance, it is sufficient 
identification to so state. Amounts expended by the taxpayer for that 
purpose would then be considered identified. However, if an agreement 
specifies a specific dollar amount that must be paid or incurred, the 
amount would not be eligible to be deducted without a specification 
that it is for restitution (including remediation of property), or 
coming into compliance.
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    An exception also applies to any amount paid or incurred as 
taxes due.\67\
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    \67\ Thus, amounts paid or incurred as taxes due are not affected 
by the provision (e.g., State taxes that are otherwise deductible). The 
reference to taxes due is also intended to include interest with 
respect to such taxes (but not interest, if any, with respect to any 
penalties imposed with respect to such taxes).
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    The provision is intended to apply only where a government 
(or other entity treated in a manner similar to a government 
under the provision) is a complainant or investigator with 
respect to the violation or potential violation of any law.\68\
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    \68\ Thus, for example, the provision would not apply to payments 
made by one private party to another in a lawsuit between private 
parties, merely because a judge or jury acting in the capacity as a 
court directs the payment to be made. The mere fact that a court enters 
a judgment or directs a result in a private dispute does not cause a 
payment to be made ``at the direction of government" for purposes of 
the provision.
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    It is intended that a payment will be treated as 
restitution (including remediation of property) only if 
substantially all of the payment is required to be paid to the 
specific persons, or in relation to the specific property, 
actually harmed by the conduct of the taxpayer that resulted in 
the payment. Thus, a payment to or with respect to a class 
substantially broader than the specific persons or property 
that were actually harmed (e.g., to a class including similarly 
situated persons or property) does not qualify as restitution 
or included remediation of property.\69\ Restitution and 
included remediation of property is limited to the amount that 
bears a substantial quantitative relationship to the harm 
caused by the past conduct or actions of the taxpayer that 
resulted in the payment in question. If the party harmed is a 
government or other entity, then restitution and included 
remediation of property includes payment to such harmed 
government or entity, provided the payment bears a substantial 
quantitative relationship to the harm. However, restitution or 
included remediation of property does not include reimbursement 
of government investigative or litigation costs, or payments to 
whistleblowers.
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    \69\ Similarly, a payment to a charitable organization benefiting a 
broader class than the persons or property actually harmed, or to be 
paid out without a substantial quantitative relationship to the harm 
caused, would not qualify as restitution. Under the provision, such a 
payment not deductible under section 162 would also not be deductible 
under section 170.
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    It is intended that a payment will be treated as an amount 
required to come into compliance only if it directly corrects a 
violation with respect to a particular requirement of law that 
was under investigation. For example, if the law requires a 
particular emission standard to be met or particular machinery 
to be used, amounts required to be paid under a settlement 
agreement to meet the required standard or install the 
machinery are deductible to the extent otherwise allowed. 
Similarly, if the law requires certain practices and procedures 
to be followed and a settlement agreement requires the taxpayer 
to pay to establish such practices or procedures, such amounts 
would be deductible. However, amounts paid for other purposes 
not directly correcting a violation of law are not deductible. 
For example, amounts paid to bring other machinery that is 
already in compliance up to a standard higher than required by 
the law, or to create other benefits (such as a park or other 
action not previously required by law), are not deductible if 
required under a settlement agreement. Similarly, amounts paid 
to educate consumers or customers about the risks of doing 
business with the taxpayer or about the field in which the 
taxpayer does business generally, which education efforts are 
not specifically required under the law, are not deductible if 
required under a settlement agreement.
    The provision requires government agencies to report to the 
IRS and to the taxpayer the amount of each settlement agreement 
or order entered where the aggregate amount required to be paid 
or incurred to or at the direction of the government under such 
settlement agreements and orders with respect to the violation, 
investigation, or inquiry is least $600 (or such other amount 
as may be specified by the Secretary of the Treasury as 
necessary to ensure the efficient administration of the 
Internal Revenue laws). The reports must be made within 30 days 
of the date the court order is issued or the settlement 
agreement is entered into, or such other time as may be 
required by Secretary. The report must separately identify any 
amounts that are restitution or remediation of property, or 
correction of noncompliance.\70\
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    \70\ As in the case of the identification requirement, if the 
agreement does not specify a specific amount to be expended to come 
into compliance but simply requires that to occur, it is expected that 
the report may state simply that the taxpayer is required to come into 
compliance but no specific dollar amount has been specified for that 
purpose in the settlement agreement.
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    The IRS is encouraged to require taxpayers to identify 
separately on their tax returns the amounts of any such 
settlements with respect to which reporting is required under 
the provision, including separate identification of the 
nondeductible amount and of any amount deductible as 
restitution, remediation, or required to correct 
noncompliance.\71\
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    \71\ For example, the IRS might require such separate reporting as 
part of, or in addition to, reporting of amounts that are not deducted 
and that thus create a book tax difference on the schedule M-3.
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    Amounts paid or incurred (whether by suit, agreement, or 
otherwise) to, or at the direction of, any self-regulatory 
entity that regulates a financial market or other market that 
is a qualified board or exchange under section 1256(g)(7), and 
that is authorized to impose sanctions (e.g., the National 
Association of Securities Dealers) are likewise subject to the 
provision if paid in relation to a violation, or investigation 
or inquiry into a potential violation, of any law (or any rule 
or other requirement of such entity). To the extent provided in 
regulations, amounts paid or incurred to, or at the direction 
of, any other nongovernmental entity that exercises self-
regulatory powers as part of performing an essential 
governmental function are similarly subject to the provision. 
The exception for payments that the taxpayer establishes are 
paid or incurred for restitution, remediation of property, or 
coming into compliance and that are identified as such in the 
order or settlement agreement likewise applies in these cases. 
The requirement of reporting to the IRS and the taxpayer also 
applies in these cases.
    No inference is intended as to the treatment of payments as 
nondeductible fines or penalties under present law. In 
particular, the provision is not intended to limit the scope of 
present-law section 162(f) or the regulations thereunder.

                             EFFECTIVE DATE

    The provision is effective for amounts paid or incurred on 
or after the date of enactment; however the provision does not 
apply to amounts paid or incurred under any binding order or 
agreement entered into before such date. Any order or agreement 
requiring court approval is not a binding order or agreement 
for this purpose unless such approval was obtained before the 
date of enactment.

        E. Revision of Tax Rules on Expatriation of Individuals

(Sec. 205 of the bill and secs. 102, 877, 2107, 2501, 7701 and 6039G of 
        the Code)

                              PRESENT LAW

In general

    U.S. citizens and residents generally are subject to U.S 
income taxation on their worldwide income. The U.S. tax may be 
reduced or offset by a credit allowed for foreign income taxes 
paid with respect to foreign source income. Nonresident aliens 
are taxed at a flat rate of 30 percent (or a lower treaty rate) 
on certain types of passive income derived from U.S. sources, 
and at regular graduated rates on net profits derived from a 
U.S. trade or business. The estates of nonresident aliens 
generally are subject to estate tax on U.S.-situated property 
(e.g., real estate and tangible property located within the 
United States and stock in a U.S. corporation). Nonresident 
aliens generally are subject to gift tax on transfers by gift 
of U.S.-situated property (e.g., real estate and tangible 
property located within the United States), but excluding 
intangibles, such as stock, regardless of where they are 
located.

Income tax rules with respect to expatriates

    For the 10 taxable years after an individual relinquishes 
his or her U.S. citizenship or terminates his or her U.S. long-
term residency, unless certain conditions are met, the 
individual is subject to an alternative method of income 
taxation than that generally applicable to nonresident aliens 
(the ``alternative tax regime''). Generally, the individual is 
subject to income tax for the 10-year period at the rates 
applicable to U.S. citizens, but only on U.S.-source 
income.\72\
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    \72\ For this purpose, however, U.S.-source income has a broader 
scope than it does typically in the Code.
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    A ``long-term resident'' is a noncitizen who is a lawful 
permanent resident of the United States for at least eight 
taxable years during the period of 15 taxable years ending with 
the taxable year during which the individual either ceases to 
be a lawful permanent resident of the United States or 
commences to be treated as a resident of a foreign country 
under a tax treaty between such foreign country and the United 
States (and does not waive such benefits).
    A former citizen or former long-term resident is subject to 
the alternative tax regime for a 10-year period following 
citizenship relinquishment or residency termination, unless the 
former citizen or former long-term resident: (1) establishes 
that his or her average annual net income tax liability for the 
five preceding years does not exceed $124,000 (adjusted for 
inflation after 2004) and his or her net worth is less than $2 
million, or alternatively satisfies limited, objective 
exceptions for certain dual citizens and minors who have had no 
substantial contacts with the United States; and (2) certifies 
under penalties of perjury that he or she has complied with all 
U.S. Federal tax obligations for the preceding five years and 
provides such evidence of compliance as the Secretary of the 
Treasury may require.
    Anti-abuse rules are provided to prevent the circumvention 
of the alternative tax regime.

Estate tax rules with respect to expatriates

    Special estate tax rules apply to individuals who die 
during a taxable year in which he or she is subject to the 
alternative tax regime. Under these special rules, certain 
closely-held foreign stock owned by the former citizen or 
former long-term resident is includible in his or her gross 
estate to the extent that the foreign corporation owns U.S.-
situated assets. The special rules apply if, at the time of 
death: (1) the former citizen or former long-term resident 
directly or indirectly owns 10 percent or more of the total 
combined voting power of all classes of stock entitled to vote 
of the foreign corporation; and (2) directly or indirectly, is 
considered to own more than 50 percent of (a) the total 
combined voting power of all classes of stock entitled to vote 
in the foreign corporation, or (b) the total value of the stock 
of such corporation. If this stock ownership test is met, then 
the gross estate of the former citizen or former long-term 
resident includes that proportion of the fair market value of 
the foreign stock owned by the individual at the time of death, 
which the fair market value of any assets owned by such foreign 
corporation and situated in the United States (at the time of 
death) bears to the total fair market value of all assets owned 
by such foreign corporation (at the time of death).

Gift tax rules with respect to expatriates

    Special gift tax rules apply to individuals who make gifts 
during a taxable year in which he or she is subject to the 
alternative tax regime. The individual is subject to gift tax 
on gifts of U.S.-situated intangibles made during the 10 years 
following citizenship relinquishment or residency termination. 
In addition, gifts of stock of certain closely-held foreign 
corporations by a former citizen or former long-term resident 
are subject to gift tax, if the gift is made during the time 
that such person is subject to the alternative tax regime. The 
operative rules with respect to these gifts of closely-held 
foreign stock are the same as described above relating to the 
estate tax, except that the relevant testing and valuation date 
is the date of gift rather than the date of death.

Termination of U.S. citizenship or long-term resident status for U.S. 
        Federal income tax purposes

    An individual continues to be treated as a U.S. citizen or 
long-term resident for U.S. Federal tax purposes, including for 
purposes of section 7701(b)(10), until the individual: (1) 
gives notice of an expatriating act or termination of residency 
(with the requisite intent to relinquish citizenship or 
terminate residency) to the Secretary of State or the Secretary 
of Homeland Security, respectively; and (2) provides a 
statement to the Secretary of the Treasury in accordance with 
section 6039G.

Sanction for individuals subject to the individual tax regime who 
        return to the United States for extended periods

    The alternative tax regime does not apply to any individual 
for any taxable year during the 10-year period following 
citizenship relinquishment or residency termination if such 
individual is present in the United States for more than 30 
days in the calendar year ending in such taxable year. Such 
individual is treated as a U.S. citizen or resident for such 
taxable year and, therefore, is taxed on his or her worldwide 
income.
    Similarly, if an individual subject to the alternative tax 
regime is present in the United States for more than 30 days in 
any calendar year ending during the 10-year period following 
citizenship relinquishment or residency termination, and the 
individual dies during that year, he or she is treated as a 
U.S. resident, and the individual's worldwide estate is subject 
to U.S. estate tax. Likewise, if an individual subject to the 
alternative tax regime is present in the United States for more 
than 30 days in any year during the 10-year period following 
citizenship relinquishment or residency termination, the 
individual is subject to U.S. gift tax on any transfer of his 
or her worldwide assets by gift during that taxable year.
    For purposes of these rules, an individual is treated as 
present in the United States on any day if such individual is 
physically present in the United States at any time during that 
day. The present-law exceptions from being treated as present 
in the United States for residency purposes \73\ generally do 
not apply for this purpose. However, for individuals with 
certain ties to countries other than the United States \74\ and 
individuals with minimal prior physical presence in the United 
States,\75\ a day of physical presence in the United States is 
disregarded if the individual is performing services in the 
United States on such day for an unrelated employer (within the 
meaning of sections 267 and 707(b)), who meets the requirements 
the Secretary of the Treasury may prescribe in regulations. No 
more than 30 days may be disregarded during any calendar year 
under this rule.
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    \73\ Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)-(D).
    \74\ An individual has such a relationship to a foreign country if 
(1) the individual becomes a citizen or resident of the country in 
which the individual was born, such individual's spouse was born, or 
either of the individual's parents was born, and (2) the individual 
becomes fully liable for income tax in such country.
    \75\ An individual has a minimal prior physical presence in the 
United States if the individual was physically present for no more than 
30 days during each year in the ten-year period ending on the date of 
loss of United States citizenship or termination of residency. However, 
for purposes of this test, an individual is not treated as being 
present in the United States on a day if the individual remained in the 
United States because of a medical condition that arose while the 
individual was in the United States. Sec. 7701(b)(3)(D)(ii).
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Annual return

    Former citizens and former long-term residents are required 
to file an annual return for each year following citizenship 
relinquishment or residency termination in which they are 
subject to the alternative tax regime. The annual return is 
required even if no U.S. Federal income tax is due. The annual 
return requires certain information, including information on 
the permanent home of the individual, the individual's country 
of residence, the number of days the individual was present in 
the United States for the year, and detailed information about 
the individual's income and assets that are subject to the 
alternative tax regime. This requirement includes information 
relating to foreign stock potentially subject to the special 
estate and gift tax rules.
    If the individual fails to file the statement in a timely 
manner or fails correctly to include all the required 
information, the individual is required to pay a penalty of 
$10,000. The $10,000 penalty does not apply if it is shown that 
the failure is due to reasonable cause and not to willful 
neglect.

Immigration rules with respect to expatriates

    Under U.S. immigration laws, any former U.S. citizen who 
officially renounces his or her U.S. citizenship and who is 
determined by the Attorney General to have renounced for the 
purpose of U.S. tax avoidance is ineligible to receive a U.S. 
visa and will be denied entry into the United States. This 
provision was included as an amendment (the ``Reed amendment'') 
to immigration legislation that was enacted in 1996.

                           REASONS FOR CHANGE

    The Committee is aware that some individuals each year 
relinquish their U.S. citizenship or terminate their U.S. 
residency for the purpose of avoiding U.S. income, estate, and 
gift taxes. By so doing, such individuals reduce their annual 
U.S. income tax liability and reduce or eliminate their U.S. 
estate and gift tax liability.
    The Committee recognizes that citizens and residents of the 
United States have a right not only physically to leave the 
United States to live elsewhere, but also to relinquish their 
citizenship or terminate their residency. The Committee does 
not believe that the Internal Revenue Code should be used to 
stop U.S. citizens and residents from relinquishing citizenship 
or terminating residency; however, the Committee also does not 
believe that the Code should provide a tax incentive for doing 
so. In other words, to the extent possible, an individual's 
decision to relinquish citizenship or terminate residency 
should be tax-neutral.
    The Committee recognizes that the American Jobs Creation 
Act of 2004 altered prior law regarding expatriation in a 
number of respects, including the replacement of the subjective 
``principal purpose of tax avoidance test'' with objective 
rules. Notwithstanding these changes, the Committee remains 
concerned that the present-law expatriation tax rules (as 
modified in 2004) are difficult to administer and could be made 
more effective. In addition, the Committee is concerned that 
the alternative method of taxation under section 877 can be 
avoided by postponing the realization of U.S.-source income for 
10 years.
    Consequently, the Committee believes that the present-law 
expatriation tax rules should be replaced with a new tax regime 
applicable to former citizens and residents. Because U.S. 
citizens and residents who retain their citizenship or 
residency generally are subject to income tax on accrued 
appreciation when they dispose of their assets, as well as 
estate tax on the full value of assets that are held until 
death, the Committee believes it fair to tax individuals on the 
appreciation in their assets when they relinquish their 
citizenship or terminate their residency. The Committee 
believes that an exception from such a tax should be provided 
for individuals with a relatively modest amount of appreciated 
assets. The Committee also believes that, where U.S. estate or 
gift taxes are avoided with respect to a transfer of property 
to a U.S. person by reason of the expatriation of the donor, it 
is appropriate for the recipient to be subject to an income tax 
based on the value of the property.
    The Committee also believes that the present-law 
immigration rules applicable to former citizens are 
ineffective. The Committee believes that the rules should be 
modified to eliminate the requirement of proof of a tax 
avoidance purpose, and to coordinate the application of those 
rules with the tax rules provided under the new regime.

                        EXPLANATION OF PROVISION

In general

    The provision generally subjects certain U.S. citizens who 
relinquish their U.S. citizenship and certain long-term U.S. 
residents who terminate their U.S. residence to tax on the net 
unrealized gain in their property as if such property were sold 
for fair market value on the day before the expatriation or 
residency termination (``mark-to-market tax''). Gain from the 
deemed sale is taken into account at that time without regard 
to other Code provisions. Any loss from the deemed sale 
generally is taken into account to the extent otherwise 
provided in the Code, except that the wash sale rules of 
section 1091 do not apply. Any net gain on the deemed sale is 
recognized to the extent it exceeds $600,000 per covered 
expatriate. The $600,000 amount is increased by a cost of 
living adjustment factor for calendar years after 2007.

Individuals covered

    The mark-to-market tax applies to U.S. citizens who 
relinquish citizenship and long-term residents who terminate 
U.S. residency (collectively, ``covered expatriates''). The 
definition of ``long-term resident'' under the provision is the 
same as that under present law. As under present law, an 
individual is considered to terminate long-term residency when 
the individual either ceases to be a lawful permanent resident 
(i.e., loses his or her green card status), or is treated as a 
resident of another country under a tax treaty and does not 
waive the benefits of the treaty.
    Exceptions to an individual's classification as a covered 
expatriate are provided in two situations. The first exception 
applies to an individual who was born with citizenship both in 
the United States and in another country; provided that (1) as 
of the expatriation date the individual continues to be a 
citizen of, and is taxed as a resident of, such other country, 
and (2) the individual was not a resident of the United States 
for the five taxable years ending with the year of 
expatriation. The second exception applies to a U.S. citizen 
who relinquishes U.S. citizenship before reaching age 18\1/2\, 
provided that the individual was a resident of the United 
States for no more than five taxable years before such 
relinquishment.
    For purposes of the mark-to-market tax, an individual is 
treated as having relinquished U.S. citizenship on the earliest 
of four possible dates: (1) the date that the individual 
renounces U.S. nationality before a diplomatic or consular 
officer of the United States (provided that the voluntary 
relinquishment is later confirmed by the issuance of a 
certificate of loss of nationality); (2) the date that the 
individual furnishes to the State Department a signed statement 
of voluntary relinquishment of U.S. nationality confirming the 
performance of an expatriating act (again, provided that the 
voluntary relinquishment is later confirmed by the issuance of 
a certificate of loss of nationality); (3) the date that the 
State Department issues a certificate of loss of nationality; 
or (4) the date that a U.S. court cancels a naturalized 
citizen's certificate of naturalization.
    In addition, the provision provides that, for all tax 
purposes (i.e., not limited to the mark-to-market tax), a U.S. 
citizen continues to be treated as a U.S. citizen for tax 
purposes until that individual's citizenship is treated as 
relinquished under the rules of the immediately preceding 
paragraph. However, under Treasury regulations, relinquishment 
may occur earlier with respect to an individual who became at 
birth a citizen of the United Sates and of another country.

Election to be treated as a U.S. citizen

    Under the provision, a covered expatriate is permitted to 
make an irrevocable election to continue to be taxed as a U.S. 
citizen with respect to all property that otherwise is covered 
by the expatriation tax. This election is an ``all or nothing'' 
election; an individual is not permitted to elect this 
treatment for some property but not for other property. The 
election, if made, applies to all property that would be 
subject to the expatriation tax and to any property the basis 
of which is determined by reference to such property. Under 
this election, following expatriation the individual continues 
to pay U.S. income taxes at the rates applicable to U.S. 
citizens on any income generated by the property and on any 
gain realized on the disposition of the property. In addition, 
the property continues to be subject to U.S. gift, estate, and 
generation-skipping transfer taxes. In order to make this 
election, the taxpayer is required to waive any treaty rights 
that would preclude the collection of the tax.
    The individual is also required to provide security to 
ensure payment of the tax under this election in such form, 
manner, and amount as the Secretary of the Treasury requires. 
The amount of mark-to-market tax that would have been owed but 
for this election (including any interest, penalties, and 
certain other items) becomes a lien in favor of the United 
States on all U.S.-situated property owned by the individual. 
This lien arises on the expatriation date and continues until 
the tax liability is satisfied, the tax liability has become 
unenforceable by reason of lapse of time, or the Secretary of 
the Treasury is satisfied that no further tax liability may 
arise by reason of this provision. The rules of section 
6324A(d)(1), (3), and (4) (relating to liens arising in 
connection with the deferral of estate tax under section 6166) 
apply to liens arising under this provision.

Deemed sale of property upon expatriation or residency termination and 
        tentative tax

    The deemed sale rule of the provision generally applies to 
all property interests held by the individual on the date of 
relinquishment of citizenship or termination of residency. 
Special rules apply in the case of trust interests, as 
described below. U.S. real property interests (which remain 
subject to U.S. tax in the hands of nonresident noncitizens), 
with the exception of stock of certain former U.S. real 
property holding corporations, are exempted from the provision. 
Regulatory authority is granted to the Treasury to exempt other 
types of property from the provision.
    Under the provision, an individual who is subject to the 
mark-to-market tax is required to pay a tentative tax equal to 
the amount of tax that would be due for a hypothetical short 
tax year ending on the date the individual relinquishes 
citizenship or terminates residency. Thus, the tentative tax is 
based on all income, gains, deductions, losses, and credits of 
the individual for the year through such date, including 
amounts realized from the deemed sale of property. Moreover, 
notwithstanding any other provision of the Code, any period 
during which recognition of incomeor gain had been deferred 
terminates on the day before relinquishment of citizenship or 
termination of residency (and, therefore, such income or gain 
recognition becomes part of the tax base of the tentative tax). The 
tentative tax is due on the 90th day after the date of relinquishment 
of citizenship or termination of residency, subject to the election, 
described below, to defer payments of the mark-to-market tax. In 
addition, notwithstanding any other provision of the Code, any 
extension of time for payment of tax ceases to apply on the day before 
relinquishment of citizenship or termination of residency, and the 
unpaid portion of such tax becomes due and payable at the time and in 
the manner prescribed by the Secretary of the Treasury.

Deferral of payment of mark-to-market tax

    Under the provision, an individual is permitted to elect to 
defer payment of the mark-to-market tax imposed on the deemed 
sale of property. Interest is charged for the period the tax is 
deferred at a rate two percentage points higher than the rate 
normally applicable to individual underpayments. The election 
is irrevocable and is made on a property-by-property basis. 
Under the election, the deferred tax attributable to a 
particular property is due when the property is disposed of 
(or, if the property is disposed of in a transaction in which 
gain is not recognized in whole or in part, at such other time 
as the Secretary of the Treasury may prescribe). The deferred 
tax attributable to a particular property is an amount that 
bears the same ratio to the total mark-to-market tax as the 
gain taken into account with respect to such property bears to 
the total gain taken into account under these rules. The 
deferral of the mark-to-market tax may not be extended beyond 
the due date of the return for the taxable year which includes 
the individual's death.
    In order to elect deferral of the mark-to-market tax, the 
individual is required to provide a bond in the amount of the 
deferred tax to the Secretary of the Treasury. Other security 
mechanisms are permitted provided that the individual 
establishes to the satisfaction of the Secretary of the 
Treasury that the security is adequate. In the event that the 
security provided with respect to a particular property 
subsequently becomes inadequate and the individual fails to 
correct the situation, the deferred tax and the interest with 
respect to such property will become due. As a further 
condition to making the election, the individual is required to 
consent to the waiver of any treaty rights that would preclude 
the collection of the tax.
    The deferred tax amount (including any interest, penalties, 
and certain other items) becomes a lien in favor of the United 
States on all U.S.-situated property owned by the individual. 
This lien arises on the expatriation date and continues until 
the tax liability is satisfied, the tax liability has become 
unenforceable by reason of lapse of time, or the Secretary is 
satisfied that no further tax liability may arise by reason of 
this provision. The rules of section 6324A(d)(1), (3), and (4) 
(relating to liens arising in connection with the deferral of 
estate tax under section 6166) apply to such liens.

Retirement plans and similar arrangements

    Subject to certain exceptions, the provision applies to all 
property interests held by covered expatriates at the time of 
relinquishment of citizenship or termination of residency. 
Accordingly, such property includes an interest in an employer-
sponsored qualified plan or deferred compensation arrangement 
as well as an interest in an individual retirement account or 
annuity (i.e., an IRA).\76\ However, the provision contains a 
special rule for an interest in a ``retirement plan.'' For 
purposes of the provision, a ``retirement plan'' includes an 
employer-sponsored qualified plan (sec. 401(a)), a qualified 
annuity (sec. 403(a)), a tax-sheltered annuity (sec. 403(b)), 
an eligible deferred compensation plan of a governmental 
employer (sec. 457(b)), an individual retirement account (sec. 
408(a)), and an individual retirement annuity (sec. 408(b)). 
The special retirement plan rule also applies, to the extent 
provided in regulations, to any foreign plan or similar 
retirement arrangement or program. An interest in a trust that 
is part of a retirement plan is subject to the special 
retirement plan rules and not to the rules for interests in 
trusts (discussed below).
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    \76\ Application of the provision is not limited to an interest 
that meets the definition of property under section 83 (relating to 
property transferred in connection with the performance of services).
---------------------------------------------------------------------------
    Under the special retirement plan rules, in lieu of the 
deemed sale rule, an amount equal to the present value of the 
individual's vested, accrued benefit under a retirement plan is 
treated as having been received by the individual as a 
distribution under the retirement plan on the day before the 
individual's relinquishment of citizenship or termination of 
residency. In the case of any later distribution to the 
individual from the retirement plan, the amount otherwise 
includible in the individual's income as a result of the 
distribution is reduced to reflect the amount previously 
included in income under the special retirement plan rule. The 
amount of the reduction applied to a distribution is the excess 
of: (1) the amount included in income under the special 
retirement plan rule, over (2) the total reductions applied to 
any prior distributions. It is not intended that the retirement 
plan would be deemed to have made a distribution at the time of 
expatriation for purposes of the tax-favored status of the 
retirement plan, such as whether a plan may permit 
distributions before a participant has severed employment. 
However, the retirement plan, and any person acting on the 
plan's behalf, will treat any later distribution in the same 
manner as the distribution would be treated without regard to 
the special retirement plan rule.
    It is expected that the Treasury Department will provide 
guidance for determining the present value of an individual's 
vested, accrued benefit under a retirement plan, such as the 
individual's account balance in the case of a defined 
contribution plan or an IRA, or present value determined under 
the qualified joint and survivor annuity rules applicable to a 
defined benefit plan (sec. 417(e)).

Interests in trusts

            In general
    Detailed rules apply under the provision to trust interests 
held by an individual at the time of relinquishment of 
citizenship or termination of residency. The treatment of trust 
interests depends on whether the trust is a ``qualified 
trust.'' A trust is a qualified trust if a court within the 
United States is able to exercise primary supervision over the 
administration of the trust and one or more U.S. persons have 
the authority to control all substantial decisions of the 
trust.
    Constructive ownership rules apply to a trust beneficiary 
that is a corporation, partnership, trust, or estate. In such 
cases, the shareholders, partners, or beneficiaries of the 
entity are deemed to be the direct beneficiaries of the trust. 
In addition, an individual who holds (or who is treated as 
holding) a trust instrument at the time of relinquishment of 
citizenship or termination of residency is required to disclose 
on his or her tax return the methodology used to determine his 
or her interest in the trust, and whether such individual knows 
(or has reason to know) that any other beneficiary of the trust 
uses a different method.
            Nonqualified trusts
    If an individual holds an interest in a trust that is not a 
qualified trust, a special rule applies for purposes of 
determining the amount of the mark-to-market tax due with 
respect to such trust interest. The individual's interest in 
the trust is treated as a separate trust consisting of the 
trust assets allocable to such interest. Such separate trust is 
treated as having sold its net assets for their fair market 
value on the day before the date of relinquishment of 
citizenship or termination of residency and having distributed 
the assets to the individual, who then is treated as having 
recontributed the assets to the trust. Any income, gain, or 
loss of the individual arising from the deemed distribution 
from the trust is taken into account as if it had arisen under 
the deemed sale rules.
    The election to defer payment is available for the mark-to-
market tax attributable to a nonqualified trust interest. A 
beneficiary's interest in a nonqualified trust is determined 
under all the facts and circumstances, including the trust 
instrument, letters of wishes, historical patterns of trust 
distributions, and the existence of, and function performed by, 
a trust protector or any similar advisor.
            Qualified trusts
    If an individual has an interest in a qualified trust, the 
amount of mark-to-market tax on unrealized gain allocable to 
the individual's trust interest (``allocable expatriation 
gain'') is calculated at the time of expatriation or residency 
termination, but is collected as the individual receives 
distributions from the qualified trust. The allocable 
expatriation gain is the amount of gain which would be 
allocable to the individual's trust interest if the individual 
directly held all the assets allocable to such interest.\77\ If 
any individual's interest in a trust is vested as of the day 
before the expatriation date (e.g., if the individual's 
interest in the trust is non-contingent and non-discretionary), 
the gain allocable to the individual's trust interest is 
determined based on the trust assets allocable to his or her 
trust interest. If the individual's interest in the trust is 
not vested as of the expatriation date (e.g., if the 
individual's trust interest is a contingent or discretionary 
interest), the gain allocable to his or her trust interest is 
determined based on all of the trust assets that could be 
allocable to his or her trust interest, determined by resolving 
all contingencies and discretionary powers in the individual's 
favor (i.e., the individual is allocated the maximum amount 
that he or she could receive).
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    \77\ Allocable expatriation gain is subject to the $600,000 
exemption (adjusted for cost of living increases).
---------------------------------------------------------------------------
    Taxes are imposed on each distribution from a qualified 
trust. These distributions also may be subject to other U.S. 
income taxes. If a distribution from a qualified trust is made 
after the individual relinquishes citizenship or terminates 
residency, the mark-to-market tax is imposed in an amount equal 
to the amount of the distribution multiplied by the highest tax 
rate generally applicable to trusts and estates for the taxable 
year which includes the date of expatriation, but in no event 
will the tax imposed exceed the balance in the ``deferred tax 
account'' with respect to the trust interest. For this purpose, 
the balance in the deferred tax account is equal to (1) the 
hypothetical tax calculated under the ``regular'' deemed sale 
rules with respect to the allocable expatriation gain, (2) 
increased by interest charged on the balance in the deferred 
tax account at a rate two percentage points higher than the 
rate normally applicable to individual underpayments, for 
periods beginning after the 90th day after the expatriation 
date and calculated up to 30 days prior to the date of the 
distribution, (3) reduced by any mark-to-market tax imposed on 
prior trust distributions to the individual, and (4) to the 
extent provided in Treasury regulations, in the case of a 
covered expatriate holding a nonvested interest, reduced by 
mark-to-market taxes imposed on trust distributions to other 
persons holding nonvested interests.
    The tax that is imposed on distributions from a qualified 
trust generally is to be deducted and withheld by the trustees. 
If the individual does not agree to waive treaty rights that 
would preclude collection of the tax, the tax with respect to 
such distributions is imposed on the trust, the trustee is 
personally liable for the tax, and any other beneficiary has a 
right of contribution against such individual with respect to 
the tax.
    Mark-to-market taxes become due immediately if the trust 
ceases to be a qualified trust, the individual disposes of his 
or her qualified trust interest, or the individual dies. In 
such cases, the amount of mark-to-market tax equals the lesser 
of (1) the tax calculated under the rules for nonqualified 
trust interests as of the date of the triggering event, or (2) 
the balance in the deferred tax account with respect to the 
trust interest immediately before that date. Such tax is 
imposed on the trust, the trustee is personally liable for the 
tax, and any other beneficiary has a right of contribution 
against such individual (or his or her estate) with respect to 
such tax.

Regulatory authority

    The provision authorizes the Secretary of the Treasury to 
prescribe such regulations as may be necessary or appropriate 
to carry out the purposes of the provision. In addition, the 
Secretary of the Treasury may provide for adjustments to the 
bases of assets in a trust or a deferred tax account, and the 
timing of such adjustments, to ensure that gain is taxed only 
once.

Income tax treatment of gifts and inheritances from a former citizen or 
        former long-term resident

    Under the provision, the exclusion from income provided in 
section 102 (relating to exclusions from income for the value 
of property acquired by gift or inheritance) does not apply to 
the value of any property received by gift or inheritance from 
a covered expatriate. Accordingly, a U.S. taxpayer who receives 
a gift or inheritance from such an individual is required to 
include the value of such gift or inheritance in gross income 
and is subject to U.S. tax on such amount. Having included the 
value of the property in income, the recipient takes a basis in 
the property equal to that value. The tax does not apply to 
property that is shown on a timelyfiled gift tax return and 
that is a taxable gift by the former citizen or former long-term 
resident, or property that is shown on a timely filed estate tax return 
and included in the gross U.S. estate of the former citizen or former 
long-term resident (regardless of whether the tax liability shown on 
such a return is reduced by credits, deductions, or exclusions 
available under the estate and gift tax rules). In addition, the tax 
does not apply to property in cases in which no estate or gift tax 
return was filed, but no such return would have been required to be 
filed if the former citizen or former long-term resident had not 
relinquished citizenship or terminated residency, as the case may be.

Coordination with present-law alternative tax regime

    The provision provides a coordination rule with the 
present-law alternative tax regime. Under the provision, the 
present-law expatriation income tax rules under section 877, 
and the special present-law expatriation estate and gift tax 
rules under sections 2107 and 2501(a)(3) (generally described 
above), do not apply to a covered expatriate whose expatriation 
or residency termination occurs on or after the date of 
enactment.

Information reporting

    Certain information reporting requirements under the law 
presently applicable to former citizens and former long-term 
residents (sec. 6039G) also apply for purposes of the 
provision.

Immigration rules

    The provision amends the immigration rules that deny tax-
motivated expatriates reentry into the United States by 
removing the requirement that the expatriation be tax-
motivated, and instead denies former citizens reentry into the 
United States if the individual is determined not to be in 
compliance with his or her tax obligations under the 
provision's expatriation tax provisions (regardless of the 
subjective motive for expatriating). For this purpose, the 
provision permits the IRS to disclose certain items of return 
information of an individual, upon written request of the 
Attorney General or his delegate, as is necessary for making a 
determination under section 212(a)(10)(E) of the Immigration 
and Nationality Act. Specifically, the provision permits the 
IRS to disclose to the agency administering section 
212(a)(10)(E) whether such taxpayer is in compliance with the 
new tax rules, and to identify the items of any noncompliance. 
Recordkeeping requirements, safeguards, and civil and criminal 
penalties for unauthorized disclosure or inspection apply to 
return information disclosed under this provision.

                             EFFECTIVE DATE

    The provision generally is effective for U.S. citizens who 
relinquish citizenship or long-term residents who terminate 
their residency on or after the date of enactment. The due date 
for tentative tax, however, may not occur before the 90th day 
after the date of enactment. The portion of the provision 
relating to income taxes on gifts and inheritances is effective 
for gifts and inheritances received from former citizens or 
former long-term residents (or their estates) on or after the 
date of enactment, whose relinquishment of citizenship or 
residency termination occurs after such date. The portion of 
the provision relating to immigration and disclosure with 
respect to former citizens is effective with respect to 
individuals who relinquish citizenship on or after the date of 
enactment.

   F. Limit Amounts of Annual Deferrals Under Nonqualified Deferred 
                           Compensation Plans

(Sec. 206 of the bill and sec. 409A of the Code)

                              PRESENT LAW

    Amounts deferred under a nonqualified deferred compensation 
plan for all taxable years are currently includible in gross 
income to the extent not subject to a substantial risk of 
forfeiture and not previously included in gross income, unless 
certain requirements are satisfied.\78\ The requirements 
include rules relating to distributions, acceleration of 
benefits and funding. For example, distributions from a 
nonqualified deferred compensation plan may be allowed only 
upon certain times and events. Rules also apply for the timing 
of elections. In general, elections to defer compensation for a 
taxable year must be made not later than the close of the 
preceding taxable year. Section 409A does not include rules 
limiting the amount that may be deferred under a nonqualified 
deferred compensation plan.
---------------------------------------------------------------------------
    \78\ Code sec. 409A.
---------------------------------------------------------------------------
    A nonqualified deferred compensation plan generally 
includes any plan that provides for the deferral of 
compensation other than a qualified employer plan or any bona 
fide vacation leave, sick leave, compensatory time, disability 
pay, or death benefit plan. A qualified employer plan means a 
qualified retirement plan, tax-deferred annuity, simplified 
employee pension, and SIMPLE. A qualified governmental excess 
benefit arrangement (sec. 415(m)) and an eligible deferred 
compensation plan (sec. 457(b)) is a qualified employer plan.
    If the requirements of section 409A are not satisfied, in 
addition to current income inclusion, interest at the 
underpayment rate plus one percentage point is imposed on the 
underpayments that would have occurred had the compensation 
been includible in income when first deferred, or if later, 
when not subject to a substantial risk of forfeiture. The 
amount required to be included in income is also subject to a 
20-percent additional tax.
    Under present law, Treasury is authorized to prescribe 
regulations as are necessary or appropriate to carry out the 
purposes of the provision.

                           REASONS FOR CHANGE

    The Committee is concerned with the large amount of 
executive compensation that is deferred in order to avoid the 
payment of income taxes. Rank and file employees generally do 
not have the opportunity to defer taxation on otherwise 
includible income in excess of the qualified plan limits. 
However, it is common for nonqualified deferred compensation 
arrangements to allow executives to choose the amount of income 
inclusion they wish to defer.\79\ The Committee is concerned 
that the ability to defer unlimited amounts of compensation 
gives executives more control over the timing of income 
inclusion than rank and file employees. The Committee believes 
that the amount of compensation that can be deferred to avoid 
the payment of tax should be limited.
---------------------------------------------------------------------------
    \79\ See, e.g., Ellen E. Schultz and Theo Francis, As Workers' 
Pensions Wither, Those for Executives Flourish, Wall St. J., June 23, 
2006, at A1, and Deferring Compensation Also Creates A Company Debt to 
Executives, June 23, 2006, at A8. Theo Francis, `Phantom' Accounts for 
CEOs Draw Scrutiny, Wall St. J., June 13, 2005, at B1.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision adds an additional requirement to the rules 
governing the income inclusion of amounts deferred under a 
nonqualified deferred compensation plan. Under the provision, 
the annual aggregate amounts deferred under a nonqualified 
deferred compensation plan by an individual may not exceed the 
applicable dollar amount for the taxable year. The applicable 
dollar amount is the lesser of (1) $1 million or (2) the 
average annual compensation payable during the base period to 
the participant by the employer maintaining the nonqualified 
deferred compensation plan (or a predecessor or related entity) 
and which was includible in the participant's gross income for 
taxable years in the base period. Earnings (whether actual or 
notional) attributable to nonqualified deferred compensation 
are treated as additional deferred compensation and are subject 
to the provision. Thus, such amounts are taken into account in 
determining whether the limit on the amount deferred is 
exceeded.
    If the requirement is not satisfied, the present-law 
sanctions for failure to satisfy section 409A apply. Thus, if 
the requirement is not satisfied, all amounts deferred under 
the nonqualified deferred compensation plan for all taxable 
years are currently includible in gross income to the extent 
not subject to a substantial risk of forfeiture and not 
previously included in gross income. If the requirements of the 
provision are not satisfied, as under present law, in addition 
to current income inclusion, interest at the underpayment rate 
plus one percentage point is imposed on the underpayments that 
would have occurred had the compensation been includible in 
income when first deferred, or if later, when not subject to a 
substantial risk of forfeiture. The amount required to be 
included in income is also subject to a 20-percent additional 
tax.\80\
---------------------------------------------------------------------------
    \80\ These consequences apply under the provision to amounts 
deferred after the effective date of the provision.
---------------------------------------------------------------------------
    Earnings (whether actual or notional) in a subsequent 
taxable year on amounts included in income under the provision 
are includible in income in such subsequent taxable year to the 
extent such earnings are not subject to a substantial risk of 
forfeiture and not previously included in gross income. The 
present-law sanctions under 409A (interest at the underpayment 
rate plus one percentage point and a 20-percent additional tax) 
also apply.
    The base period is the five-taxable-year period ending with 
the taxable year preceding the taxable year for which the 
limitation is being determined (the ``computation year''). If, 
before the beginning of the computation year, an election is 
made to defer compensation for services performed in the 
computation year, the base period is the five-taxable-year 
period ending with the taxable year preceding the taxable year 
in which the election is made. For example, suppose an 
executive elects in 2008 to defer a portion of compensation to 
be earned in 2009. The baseperiod for the 2009 computation year 
would be 2003 to 2007. In the case that the individual does not perform 
services for the employer for the entire five-year period, the base 
period is the portion of such period during which the individual 
performs services for the employer (or a predecessor employer). It is 
intended that the Secretary of the Treasury issue guidance similar to 
that under section 280G regarding the base period determination in 
cases in which the individual does not perform services for the 
employer for the entire five-year period.
    As under section 409A generally, except as provided by the 
Secretary, aggregation rules similar to the rules under section 
414(b) and (c) apply. In addition, all nonqualified deferred 
compensation plans maintained by all employers treated as a 
single employer under these aggregation rules are treated as 
one plan.
    The provision applies to all amounts deferred under 
nonqualified deferred compensation plans (as defined under 
section 409A), including plans of both private and publicly-
held corporations.
    As under section 409A generally, this limitation is not 
intended to prevent the inclusion of amounts in gross income 
under any provision or rule of law earlier than the time 
provided in the provision. The provision does not affect the 
rules regarding the timing of an employer's deduction for 
nonqualified deferred compensation.
    The regulatory authority of the Secretary of the Treasury 
to prescribe regulations as are necessary to carry out the 
purposes of section 409A generally applies to the provision. 
Under such existing regulatory authority, it is expected that 
the Secretary of the Treasury will issue guidance relating to 
defined benefit arrangements, including the application of the 
annual limitation and determination of the amounts deferred.

                             EFFECTIVE DATE

    The provision applies to taxable years beginning after 
December 31, 2006, with respect to amounts deferred after such 
date (and earnings on such amounts). Amounts deferred (and 
earnings on amounts deferred) in taxable years beginning before 
January 1, 2007, are not subject to the provision. Taxable 
years beginning on or before December 31, 2006, are taken into 
account in determining the average annual compensation of a 
participant during any base period.
    The provision directs the Secretary of the Treasury, within 
60 days after enactment, to issue guidance providing a limited 
time period during which a nonqualified deferred compensation 
plan adopted before December 31, 2006, may, without violating 
the requirements of section 409A, be amended to provide that a 
participant may, no later than December 31, 2007, cancel or 
modify an outstanding deferral election with regard to all or a 
portion of amounts deferred after December 31, 2006, to the 
extent necessary to meet the requirements of the provision. 
Amounts subject to the cancellation or modification are 
currently includible in income to the participant to the extent 
not subject to a substantial risk of forfeiture and not 
previously included in income. Such guidance must also allow 
nonqualified deferred compensation plans adopted before 
December 31, 2006, to be amended to conform to the requirements 
of the provision with regard to amounts deferred after December 
31, 2006.

      G. Increase in Criminal Monetary Penalty Limitation for the 
            Underpayment or Overpayment of Tax Due to Fraud

(Sec. 207 of the bill and secs. 7201, 7203, and 7206 of the Code)

                              PRESENT LAW

Attempt to evade or defeat tax

    In general, section 7201 imposes a criminal penalty on 
persons who willfully attempt to evade or defeat any tax 
imposed by the Code. Upon conviction, the Code provides that 
the penalty is up to $100,000 or imprisonment of not more than 
five years (or both). In the case of a corporation, the Code 
increases the monetary penalty to a maximum of $500,000.

Willful failure to file return, supply information, or pay tax

    In general, section 7203 imposes a criminal penalty on 
persons required to make estimated tax payments, pay taxes, 
keep records, or supply information under the Code and who 
willfully fail to do so. Upon conviction, the Code provides 
that the penalty is up to $25,000 or imprisonment of not more 
than one year (or both). In the case of a corporation, the Code 
increases the monetary penalty to a maximum of $100,000.

Fraud and false statements

    In general, section 7206 imposes a criminal penalty on 
persons who make fraudulent or false statements under the Code. 
Upon conviction, the Code provides that the penalty is up to 
$100,000 or imprisonment of not more than three years (or 
both). In the case of a corporation, the Code increases the 
monetary penalty to a maximum of $500,000.

Uniform sentencing guidelines

    Under the uniform sentencing guidelines established by 18 
U.S.C. 3571, a defendant found guilty of a criminal offense is 
subject to a maximum fine that is the greatest of: (a) the 
amount specified in the underlying provision; (b) for a 
felony,\81\ $250,000 for an individual or $500,000 for an 
organization; or (c) twice the gross gain if a person derives 
pecuniary gain from the offense. This Title 18 provision 
applies to all criminal provisions in the United States Code, 
including those in the Internal Revenue Code.\82\ For example, 
for an individual, the maximum fine under present law upon 
conviction of violating section 7206 is $250,000 or, if 
greater, twice the amount of gross gain from the offense.
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    \81\ Section 7206 states that making fraudulent or false statements 
under the Code is a felony. In addition, this offense is a felony 
pursuant to the classification guidelines of 18 U.S.C. 3559(a)(5).
    \82\ In United States v. Booker, 543 U.S. 220 (2005), the Supreme 
Court held that mandatory application of the Federal Sentencing 
Guidelines is incompatible with the Sixth Amendment jury trial 
requirement. As a result of this decision, the Federal Sentencing 
Guidelines are effectively advisory, i.e., requiring a sentencing court 
to consider the sentencing ranges under the Guidelines, but permitting 
it to tailor a sentence in light of other statutory concerns.
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                           REASONS FOR CHANGE

    The Committee believes that existing criminal tax penalties 
do not adequately deter criminal behavior, which results in 
increased noncompliance and an increase in the tax gap. 
Increasing monetary penalties will raise the economic risk of 
failing to comply with tax laws. In addition, classifying 
certain willful failure to file cases as felonies should 
discourage criminal tax violations by substantially increasing 
the monetary and sentencing consequences of the offense 
together with the long term repercussions associated with a 
felony record.

                        EXPLANATION OF PROVISION

Attempt to evade or defeat tax

    The provision increases the criminal penalty under section 
7201 of the Code for individuals to $500,000 and for 
corporations to $1,000,000. The provision increases the maximum 
prison sentence to ten years.

Willful failure to file return, supply information, or pay tax

    The provision increases the criminal penalty under section 
7203 of the Code for individuals from $25,000 to $50,000 and, 
in the case of an ``aggravated failure to file'' (defined as a 
failure to file a return for a period of three or more 
consecutive taxable years if the aggregated tax liability for 
such period is at least $100,000), changes the crime from a 
misdemeanor to a felony and increases the maximum prison 
sentence to ten years.

Fraud and false statements

    The provision increases the criminal penalty for making 
fraudulent or false statements to $500,000 for individuals and 
$1,000,000 for corporations. The provision increases the 
maximum prison sentence for making fraudulent or false 
statements to five years. The provision provides that in no 
event shall the amount of the monetary penalty under the 
provision be less than the amount of the underpayment or 
overpayment attributable to fraud.

                             EFFECTIVE DATE

    The provision is effective for actions and failures to act 
occurring after the date of enactment.

H. Doubling of Certain Penalties, Fines, and Interest on Underpayments 
           Related to Certain Offshore Financial Arrangements

(Sec. 208 of the bill)

                              PRESENT LAW

In general

    The Code contains numerous civil penalties, such as the 
delinquency, accuracy-related, fraud, and assessable penalties. 
These civil penalties are in addition to any interest that may 
be due as a result of an underpayment of tax. If all or any 
part of a tax is not paid when due, the Code imposes interest 
on the underpayment, which is assessed and collected in the 
same manner as the underlying tax and is subject to the 
respective statutes of limitations for assessment and 
collection.

Delinquency penalties

            Failure to file
    Under present law, a taxpayer who fails to file a tax 
return on a timely basis is generally subject to a penalty 
equal to 5 percent of the net amount of tax due for each month 
that the return is not filed, up to a maximum of five months or 
25 percent. An exception from the penalty applies if the 
failure is due to reasonable cause. In the case of fraudulent 
failure to file, the penalty is increased to 15 percent of the 
net amount of tax due for each month that the return is not 
filed, up to a maximum of five months or 75 percent. The net 
amount of tax due is the excess of the amount of the tax 
required to be shown on the return over the amount of any tax 
paid on or before the due date prescribed for the payment of 
tax.
            Failure to pay
    Taxpayers who fail to pay their taxes are subject to a 
penalty of 0.5 percent per month on the unpaid amount, up to a 
maximum of 25 percent. If a penalty for failure to file and a 
penalty for failure to pay tax shown on a return both apply for 
the same month, the amount of the penalty for failure to file 
for such month is reduced by the amount of the penalty for 
failure to pay tax shown on a return. If an income tax return 
is filed more than 60 days after its due date, then the penalty 
for failure to pay tax shown on a return may not reduce the 
penalty for failure to file below the lesser of $100 or 100 
percent of the amount required to be shown on the return. For 
any month in which an installment payment agreement with the 
IRS is in effect, the rate of the penalty is half the usual 
rate (0.25 percent instead of 0.5 percent), provided that the 
taxpayer filed the tax return in a timely manner (including 
extensions).
            Failure to make timely deposits of tax
    The penalty for the failure to make timely deposits of tax 
consists of a four-tiered structure in which the amount of the 
penalty varies with the length of time within which the 
taxpayer corrects the failure. A depositor is subject to a 
penalty equal to 2 percent of the amount of the underpayment if 
the failure is corrected on or before the date that is five 
days after the prescribed due date. A depositor is subject to a 
penalty equal to 5 percent of the amount of the underpayment if 
the failure is corrected after the date that is five days after 
the prescribed due date but on or before the date that is 15 
days after the prescribed due date. A depositor is subject to a 
penalty equal to 10 percent of the amount of the underpayment 
if the failure is corrected after the date that is 15 days 
after the due date but on or before the date that is 10 days 
after the date of the first delinquency notice to the taxpayer 
(under sec. 6303). Finally, a depositor is subject to a penalty 
equal to 15 percent of the amount of the underpayment if the 
failure is not corrected on or before earlier of 10 days after 
the date of the first delinquency notice to the taxpayer and 10 
days after the date on which notice and demand for immediate 
payment of tax is given in cases of jeopardy.
    An exception from the penalty applies if the failure is due 
to reasonable cause. In addition, the Secretary may waive the 
penalty for an inadvertent failure to deposit any tax by 
specified first-time depositors.

Accuracy-related penalties

            In general
    The accuracy-related penalties are imposed at a rate of 20 
percent of the portion of any underpayment that is 
attributable, in relevant part, to (1) negligence, (2) any 
substantial understatement of income tax, (3) any substantial 
valuation misstatement, and (4) any reportable transaction 
understatement. The penalty for a substantial valuation 
misstatement is doubled for certain gross valuation 
misstatements. In the case of a reportable transaction 
understatement for which the transaction is not disclosed, the 
penalty rate is 30 percent. These penalties are coordinated 
with the fraud penalty. This statutory structure operates to 
eliminate any stacking of the penalties.
    No penalty is to be imposed if it is shown that there was 
reasonable cause for an underpayment and the taxpayer acted in 
good faith, and in the case of a reportable transaction 
understatement, the relevant facts of the transaction have been 
disclosed, there is or was substantial authority for the 
taxpayer's treatment of such transaction, and the taxpayer 
reasonably believed that such treatment was more likely than 
not the proper treatment.
            Negligence or disregard for the rules or regulations
    If an underpayment of tax is attributable to negligence, 
the negligence penalty applies only to the portion of the 
underpayment that is attributable to negligence. Negligence 
means any failure to make a reasonable attempt to comply with 
the provisions of the Code. Disregard includes any careless, 
reckless, or intentional disregard of the rules or regulations.
            Substantial understatement of income tax
    Generally, an understatement is substantial if the 
understatement exceeds the greater of (1) 10 percent of the tax 
required to be shown on the return for the tax year, or (2) 
$5,000. In determining whether a substantial understatement 
exists, the amount of the understatement is reduced by any 
portion attributable to an item if (1) the treatment of the 
item on the return is or was supported by substantial 
authority, or (2) facts relevant to the tax treatment of the 
item were adequately disclosed on the return or on a statement 
attached to the return.
            Substantial valuation misstatement
    A penalty applies to the portion of an underpayment that is 
attributable to a substantial valuation misstatement. 
Generally, a substantial valuation misstatement exists if the 
value or adjusted basis of any property claimed on a return is 
200 percent or more of the correct value or adjusted basis. The 
amount of the penalty for a substantial valuation misstatement 
is 20 percent of the amount of the underpayment if the value or 
adjusted basis claimed is 200 percent or more but less than 400 
percent of the correct value or adjusted basis. If the value or 
adjusted basis claimed is 400 percent or more of the correct 
value or adjusted basis, then the overvaluation is a gross 
valuation misstatement.
            Reportable transaction understatement
    A penalty applies to any item that is attributable to any 
listed transaction, or to any reportable transaction (other 
than a listed transaction) if a significant purpose of such 
reportable transaction is tax avoidance or evasion.

Fraud penalty

    The fraud penalty is imposed at a rate of 75 percent of the 
portion of any underpayment that is attributable to fraud. The 
accuracy-related penalty does not apply to any portion of an 
underpayment on which the fraud penalty is imposed.

Assessable penalties

    In addition to the penalties described above, the Code 
imposes a number of additional penalties, including, for 
example, penalties for failure to file (or untimely filing of) 
information returns with respect to foreign trusts, and 
penalties for failure to disclose any required information with 
respect to a reportable transaction.

Interest provisions

    Taxpayers are required to pay interest to the IRS whenever 
there is an underpayment of tax. An underpayment of tax exists 
whenever the correct amount of tax is not paid by the last date 
prescribed for the payment of the tax. The last date prescribed 
for the payment of the income tax is the original due date of 
the return.
    Different interest rates are provided for the payment of 
interest depending upon the type of taxpayer, whether the 
interest relates to an underpayment or overpayment, and the 
size of the underpayment or overpayment. Interest on 
underpayments is compounded daily.

Offshore Voluntary Compliance Initiative

    In January 2003, Treasury announced the Offshore Voluntary 
Compliance Initiative (``OVCI'') to encourage the voluntary 
disclosure of previously unreported income placed by taxpayers 
in offshore accounts and accessed through credit card or other 
financial arrangements. A taxpayer had to comply with various 
requirements in order to participate in the OVCI, including 
sending a written request to participate in the program by 
April 15, 2003. This request had to include information about 
the taxpayer, the taxpayer's introduction to the credit card or 
other financial arrangements and the names of parties that 
promoted the transaction. A taxpayer entering into a closing 
agreement under the OVCI is not liable for the civil fraud 
penalty, the fraudulent failure to file penalty, or the civil 
information return penalties. Such a taxpayer is responsible 
for back taxes, interest, and certain accuracy-related and 
delinquency penalties.\83\
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    \83\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------

Voluntary disclosure policy

    A taxpayer's timely, voluntary disclosure of a substantial 
unreported tax liability has long been an important factor in 
deciding whether the taxpayer's case should ultimately be 
referred for criminal prosecution. The voluntary disclosure 
must be truthful, timely, and complete. The taxpayer must show 
a willingness to cooperate (as well as actual cooperation) with 
the IRS in determining the correct tax liability. The taxpayer 
must make good-faith arrangements with the IRS to pay in full 
the tax, interest, and any penalties determined by the IRS to 
be applicable. A voluntary disclosure does not guarantee 
immunity from prosecution. It creates no substantive or 
procedural rights for taxpayers.\84\ The IRS treats 
participation in the OVCI as a voluntary disclosure.\85\
---------------------------------------------------------------------------
    \84\ Internal Revenue News Release 2002-135, IR-2002-135 (December 
11, 2002).
    \85\ Rev. Proc. 2003-11, 2003-4 C.B. 311.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is aware that individuals and corporations, 
through sophisticated transactions, are placing unreported 
income in offshore financial accounts accessed through credit 
or debit cards or other financial arrangements in order to 
avoid or evade Federal income tax. Such a phenomenon poses a 
serious threat to the efficacy of the tax system because of 
both the potential loss of revenue and the potential threat to 
the integrity of the self-assessment system. The IRS estimates 
there may be several hundred thousand taxpayers using offshore 
financial arrangements to conceal taxable income from the IRS, 
potentially costing the government billions of dollars in lost 
revenue. On February 10, 2004, the IRS announced that over 
1,300 applications to participate in the OVCI initiative were 
received, and that it had received over $175 million in taxes, 
interest, and penalties from these cases.\86\ At the start of 
the program, the clear message to taxpayers was that those who 
failed to come forward would be pursued by the IRS and would be 
subject to more significant penalties and possible criminal 
sanctions. The Committee believes that doubling the civil 
penalties, fines, and interest applicable to taxpayers who 
participate in these types of arrangements and who do not 
voluntarily disclose such arrangements (through the OVCI or 
otherwise) will provide the IRS with the significant sanctions 
needed to stem the promotion of, and participation in, these 
abusive schemes.
---------------------------------------------------------------------------
    \86\ Internal Revenue News Release 2004-19, IR-2002-19 (February 
10, 2004).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision doubles the amounts of civil penalties, 
interest, and fines related to taxpayers' underpayments of U.S. 
income tax liability through the direct or indirect use of 
certain offshore financial arrangements. The provision applies 
to taxpayers who did not (or do not) voluntarily disclose such 
arrangements through the OVCI or otherwise. Under the 
provision, the determination of whether any civil penalty is to 
be applied to such underpayment is made without regard to 
whether a return has been filed, whether there was reasonable 
cause for such underpayment, and whether the taxpayer acted in 
good faith.
    The proscribed financial arrangements include, but are not 
limited to, the use of certain foreign leasing corporations for 
providing domestic employee services,\87\ certain arrangements 
whereby the taxpayer may hold securities trading accounts 
through offshore banks or other financial intermediaries, 
certain arrangements whereby the taxpayer may access funds 
through the use of offshore credit, debit, or charge cards, and 
offshore annuities or trusts.
---------------------------------------------------------------------------
    \87\ These arrangements were described and classified as listed 
transactions in Notice 2003-22, 2003-1 C.B. 851.
---------------------------------------------------------------------------
    The Secretary of the Treasury is granted the authority to 
waive the application of the provision if the use of the 
offshore financial arrangements is incidental to the 
transaction and, in the case of a trade or business, such use 
is conducted in the ordinary course of the type of trade or 
business in which the taxpayer is engaged.

                             EFFECTIVE DATE

    The provision generally is effective with respect to a 
taxpayer's open tax years on or after the date of enactment.

         I. Increase in Penalty for Bad Checks and Money Orders

(Sec. 209 of the bill and sec. 6657 of the Code)

                              PRESENT LAW

    The Code \88\ imposes a penalty on a person who tenders a 
bad check or money orders. The penalty is two percent of the 
amount of the bad check or money order. For checks or money 
orders that are less than $750, the minimum penalty is $15 (or, 
if less, the amount of the check or money order).
---------------------------------------------------------------------------
    \88\ Sec. 6657.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to increase 
the minimum amount of this penalty so that it is more 
consistent with amounts charged by the private sector for bad 
checks.

                        EXPLANATION OF PROVISION

    The provision increases the minimum penalty to $25 (or, if 
less, the amount of the check or money order), applicable to 
checks or money orders that are less than $1,250.

                             EFFECTIVE DATE

    The provision is effective with respect to checks or money 
orders received after the date of enactment.

    J. Treatment of Contingent Payment Convertible Debt Instruments

(Sec. 210 of the bill and sec. 1275 of the Code)

                              PRESENT LAW

    Under present law, a taxpayer generally deducts the amount 
of interest paid or accrued within the taxable year on 
indebtedness issued by the taxpayer. In the case of original 
issue discount (``OID''), the issuer of a debt instrument 
generally accrues and deducts, as interest, the OID over the 
life of the obligation, even though the amount of the OID may 
not be paid until the maturity of the instrument. The holder of 
the instrument includes the OID in income over the term of the 
instrument.
    The amount of OID with respect to a debt instrument is 
equal to the excess of the stated redemption price at maturity 
over the issue price of the debt instrument. The stated 
redemption price at maturity includes all amounts that are 
payable on the debt instrument by maturity. The amount of OID 
with respect to a debt instrument is allocated over the life of 
the instrument through a series of adjustments to the issue 
price for each accrual period. The adjustment to the issue 
price is determined by multiplying the adjusted issue price 
(i.e., the issue price increased or decreased by adjustments 
prior to the accrual period) by the instrument's yield to 
maturity, and then subtracting any payments on the debt 
instrument (other than non-OID stated interest) during the 
accrual period. Thus, in order to compute the amount of OID and 
the portion of OID allocable to a particular period, the stated 
redemption price at maturity and the time of maturity must be 
known. Issuers of debt instruments with OID accrue and deduct 
the amount of OID as interest expense in the same manner as the 
holders of such instruments accrue and include in gross income 
the amount of OID as interest income.
    Treasury regulations provide special rules for determining 
the amount of OID allocated to a period with respect to certain 
debt instruments that provide for one or more contingent 
payments of principal or interest.\89\ The regulations provide 
that a debt instrument does not provide for contingent payments 
merely because it provides for an option to convert the debt 
instrument into the stock of the issuer, into the stock or debt 
of a related party, or into cash or other property in an amount 
equal to the approximate value of such stock or debt.\90\ The 
regulations also provide that a payment is not a contingent 
payment merely because of a contingency that, as of the issue 
date of the debt instrument, is either remote or 
incidental.\91\
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    \89\ Treas. Reg. sec. 1.1275-4.
    \90\ Treas. Reg. sec. 1.1275-4(a)(4).
    \91\ Treas. Reg. sec. 1.1275-4(a)(5).
---------------------------------------------------------------------------
    In the case of contingent payment debt instruments that are 
issued for money or publicly traded property,\92\ the 
regulations provide that interest on a debt instrument must be 
taken into account (as OID) whether or not the amount of any 
payment is fixed or determinable in the taxable year. The 
amount of OID that is taken into account for each accrual 
period is determined by constructing a comparable yield and a 
projected payment schedule for the debt instrument, and then 
accruing the OID on the basis of the comparable yield and 
projected payment schedule by applying rules similar to those 
for accruing OID on a noncontingent debt instrument (the 
``noncontingent bond method''). If the actual amount of a 
contingent payment is not equal to the projected amount, 
appropriate adjustments are made to reflect the difference. The 
comparable yield for a debt instrument is the yield at which 
the issuer would be able to issue a fixed-rate noncontingent 
debt instrument with terms and conditions similar to those of 
the contingent payment debt instrument (i.e., the comparable 
fixed-rate debt instrument), including the level of 
subordination, term, timing of payments, and general market 
conditions.\93\
---------------------------------------------------------------------------
    \92\ Treas. Reg. sec. 1.1275-4(b).
    \93\ Treas. Reg. sec. 1.1275-4(b)(4)(i)(A).
---------------------------------------------------------------------------
    With respect to certain debt instruments that are 
convertible into the common stock of the issuer and that also 
provide for contingent payments (other than the conversion 
feature)--often referred to as ``contingent convertible'' debt 
instruments--the IRS has stated that the noncontingent bond 
method applies in computing the accrual of OID on the debt 
instrument.\94\ In applying the noncontingent bond method, the 
IRS has stated that the comparable yield for a contingent 
convertible debt instrument is determined by reference to a 
comparable fixed-rate nonconvertible debt instrument, and the 
projected payment schedule is determined by treating the issuer 
stock received upon a conversion of the debt instrument as a 
contingent payment.
---------------------------------------------------------------------------
    \94\ Rev. Rul. 2002-31, 2002-1 C.B. 1023.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee is aware that, in recent years, several 
corporate taxpayers have issued convertible debt instruments 
that also include a separate contingent feature, usually 
consisting of an interest rate reset provision. The Committee 
understands that the primary intent of these corporations is 
simply to issue straight convertible debt instruments, and that 
the contingency is unlikely to have any meaningful impact on 
either the stated interest rate or overall economic yield of 
the debt instrument. Rather, the contingency is incorporated 
into the financing for the purpose of subjecting the debt 
instrument to the contingent payment OID regulations, which 
would not otherwise apply solely on the basis of the conversion 
feature. As with straight convertible debt instruments, the 
stated interest rate on contingent payment convertible debt 
instruments typically is substantially less than the stated 
interest rate would be on a nonconvertible debt instrument, 
usually less than 400 basis points.
    The Committee is aware that, in determining the comparable 
yield on contingent payment convertible debt instruments under 
the contingent payment OID regulations, borrowers and their 
advisors take the position that the regulations call for using 
a comparable noncontingent debt instrument that is also 
nonconvertible. The net effect of applying the contingent 
payment OID regulations in this manner (i.e., determining the 
comparable yield on the basis of a noncontingent, 
nonconvertible--rather than noncontingent, convertible--debt 
instrument), is tosignificantly and artificially enhance the 
interest deductions generated by what is essentially a straight 
convertible debt instrument. Because the corresponding interest income 
inclusions to holders of these debt instruments likewise is 
significantly and artificially enhanced, the Committee understands that 
the debt instruments almost exclusively are sold to and purchased by 
tax indifferent holders.
    Notwithstanding the endorsement of the taxpayer position by 
the IRS in Rev. Rul. 2002-31, the Committee believes that 
applying the contingent payment OID regulations in this manner 
is inappropriate, from an economic standpoint and based upon a 
reasonable interpretation of the plain meaning of the 
regulations. Furthermore, applying the regulations in this 
manner creates disparate tax treatment between contingent 
payment convertible debt instruments and straight convertible 
debt instruments that differ only on the basis of an 
economically meaningless contingency.
    The Committee believes that the methodology mandated by 
this provision would require the comparable yield on a 
contingent payment convertible debt instrument to be based upon 
a truly comparable noncontingent debt instrument (i.e., one 
that is convertible, like the actual debt instrument issued by 
the taxpayer). This methodology would provide parity between 
straight convertible debt instruments and contingent payment 
convertible debt instruments, and eliminate the unwarranted tax 
benefits that are currently attained merely by incorporating an 
essentially meaningless contingency into an otherwise ordinary 
convertible debt instrument.
    In its ruling, the IRS indicated that determining the 
comparable yield on contingent payment convertible debt 
instruments based upon a contingent nonconvertible debt 
instrument is more consistent with the overall economic 
rationale of the contingent payment OID regulations. However, 
the Committee believes that this view incorrectly assumes that 
the economic rationale of these regulations deviates from the 
rest of the OID rules--and, for that matter, general tax 
principles--in giving tax significance to a conversion feature 
in a debt instrument. The Committee recognizes that contingent 
payment convertible debt instruments highlight a potential flaw 
in the current tax system whereby both the Code and general tax 
principles typically disregard the economic yield provided by 
convertibility features in debt instruments. However, the 
Committee believes that this issue should be addressed 
legislatively through comprehensive reform of the tax treatment 
of financial products, rather than through administrative 
acquiescence in taxpayer self-help that is achieved using a 
particular financial product designed specifically to obtain a 
favorable tax result, particularly if that result is in 
conflict with the current operation of the Code and general tax 
principles.

                        EXPLANATION OF PROVISION

    The provision provides that, in the case of a contingent 
convertible debt instrument,\95\ any Treasury regulations which 
require OID to be determined by reference to the comparable 
yield of a noncontingent fixed-rate debt instrument shall be 
applied as requiring that such comparable yield be determined 
by reference to a noncontingent fixed-rate debt instrument 
which is convertible into stock. For purposes of applying the 
provision, the comparable yield shall be determined without 
taking into account the yield resulting from the conversion of 
a debt instrument into stock. Thus, the noncontingent bond 
method in the Treasury regulations shall be applied in a manner 
such that the comparable yield for contingent convertible debt 
instruments shall be determined by reference to comparable 
noncontingent fixed-rate convertible (rather than 
nonconvertible) debt instruments.
---------------------------------------------------------------------------
    \95\ Under the provision, a contingent convertible debt instrument 
is defined as a debt instrument that: (1) is convertible into stock of 
the issuing corporation, or a corporation in control of, or controlled 
by, the issuing corporation; and (2) provides for contingent payments.
---------------------------------------------------------------------------

                             EFFECTIVE DATE

    The provision is effective for debt instruments issued on 
or after date of enactment.

                     K. Extension of IRS User Fees

(Sec. 211 of the bill and sec. 7528 of the Code)

                              PRESENT LAW

    The IRS generally charges a fee for requests for a letter 
ruling, determination letter, opinion letter, or other similar 
ruling or determination.\96\ These user fees are authorized by 
statute through September 30, 2014.
---------------------------------------------------------------------------
    \96\ Sec. 7528.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Committee believes that it is appropriate to provide an 
extension of these user fees.

                        EXPLANATION OF PROVISION

    The provision extends the statutory authorization for IRS 
user fees for two years, through September 30, 2016.

                             EFFECTIVE DATE

    The provision is effective for requests made after the date 
of enactment.

L. Modification of Collection Due Process Procedures for Employment Tax 
                              Liabilities

(Sec. 212 of the bill and sec. 6330 of the Code)

                              PRESENT LAW

    Levy is the IRS's administrative authority to seize a 
taxpayer's property to pay the taxpayer's tax liability. The 
IRS is entitled to seize a taxpayer's property by levy if a 
Federal tax lien has attached to such property. A Federal tax 
lien arises automatically when (1) a tax assessment has been 
made, (2) the taxpayer has been given notice of the assessment 
stating the amount and demanding payment, and (3) the taxpayer 
has failed to pay the amount assessed within 10 days after the 
notice and demand.
    In general, the IRS is required to notify taxpayers that 
they have a right to a fair and impartial collection due 
process (``CDP'') hearing before levy may be made on any 
property or right to property.\97\ Similar rules apply with 
respect to notices of tax liens, although the right to a 
hearing arises only on the filing of a notice.\98\ The CDP 
hearing is held by an impartial officer from the IRS Office of 
Appeals, who is required to issue a determination with respect 
to the issues raised by the taxpayer at the hearing. The 
taxpayer is entitled to appeal that determination to a court. 
Under present law, taxpayers are not entitled to a pre-levy CDP 
hearing if a levy is issued to collect a Federal tax liability 
from a State tax refund or if collection of the Federal tax is 
in jeopardy. However, levies related to State tax refunds or 
jeopardy determinations are subject to post-levy review through 
the CDP hearing process.
---------------------------------------------------------------------------
    \97\ Sec. 6330(a).
    \98\ Sec. 6320.
---------------------------------------------------------------------------
    Employment taxes generally consist of the taxes under the 
Federal Insurance Contributions Act (``FICA''), the tax under 
the Federal Unemployment Tax Act (``FUTA''), and the 
requirement that employers withhold income taxes from wages 
paid to employees (``income tax withholding'').\99\ Income tax 
withholding rates vary depending on the amount of wages paid, 
the length of the payroll period, and the number of withholding 
allowances claimed by the employee.
---------------------------------------------------------------------------
    \99\ Secs. 3101-3128 (FICA), 3301-3311 (FUTA), and 3401-3404 
(income tax withholding). FICA taxes consist of an employer share and 
an employee share, which the employer withholds from employees' wages.
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    Congress enacted the CDP hearing procedures to afford 
taxpayers adequate notice of collection activity and a 
meaningful hearing before the IRS deprives them of their 
property. However, the Committee understands that some 
taxpayers abuse the CDP procedures by raising frivolous 
arguments simply for the purpose of delaying or evading 
collection of tax. The opportunity to delay collection of 
employment tax liabilities presents a greater risk to the 
government than delay may present in other contexts because 
employment tax liabilities continue to increase as ongoing wage 
payments are made to employees. A Governmental Accountability 
Office study found that businesses with employment tax 
liabilities were delinquent on more than twice as many periods 
than individuals. On average, businesses requesting a CDP 
appeal for delinquent employment taxes had not paid for nearly 
1\1/2\ years and had a median employment tax liability of 
$30,000.\100\ Thus, the Committee believes it is appropriate to 
revise the CDP procedures in cases where taxpayers are liable 
for unpaid employment taxes.
---------------------------------------------------------------------------
    \100\ Government Accountability Office, Tax Administration: Little 
Evidence of Procedural Errors in Collection Due Process Appeals Cases, 
but Opportunities Exist to Improve the Program, GAO-07-112, October 
2006.
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    Under the provision, levies issued to collect Federal 
employment taxes are excepted from the pre-levy CDP hearing 
requirement. Thus, under the provision, taxpayers have no right 
to a CDP hearing before a levy is issued to collect employment 
taxes. However, the taxpayer is provided an opportunity for a 
hearing within a reasonable period of time after the levy. 
Collection by levy is permitted to continue during the CDP 
proceedings.

                             EFFECTIVE DATE

    The provision is effective for levies issued on or after 
the date that is 120 days after the date of enactment.

                        M. Whistleblower Reforms

(Sec. 213 of the bill and sec. 7623 of the Code)

                              PRESENT LAW

    The Code authorizes the IRS to pay such sums as deemed 
necessary for: ``(1) detecting underpayments of tax; and (2) 
detecting and bringing to trial and punishment persons guilty 
of violating the internal revenue laws or conniving at the 
same.'' \101\ Generally, amounts are paid based on a percentage 
of tax, fines, and penalties (but not interest) actually 
collected based on the information provided.
---------------------------------------------------------------------------
    \101\ Sec. 7623.
---------------------------------------------------------------------------
    The Tax Relief and Health Care Act of 2006 (the ``Act'') 
\102\ established an enhanced reward program for actions in 
which the tax, penalties, interest, additions to tax, and 
additional amounts in dispute exceed $2,000,000 and, if the 
taxpayer is an individual, the individual's gross income 
exceeds $200,000 for any taxable year. The reward floor in such 
cases is 15 percent of the collected proceeds (including 
penalties, interest, additions to tax and additional amounts) 
if the IRS moves forward with an administrative or judicial 
action based on information brought to the IRS's attention by 
an individual. The available reward in such cases is limited to 
30 percent of the collected proceeds.
---------------------------------------------------------------------------
    \102\ Pub. L. No. 109-432.
---------------------------------------------------------------------------
    Under present law, the Secretary is required to issue 
guidance within one year of the date of enactment of the Act 
for the establishment of the Whistleblower Office within the 
IRS to administer the reward program. The Whistleblower Office 
may seek assistance from the individual providing information 
or from his or her legal representative, and may reimburse the 
costs incurred by any legal representative out of the amount of 
the reward. To the extent the disclosure of returns or return 
information is required to render such assistance, the 
disclosure must be pursuant to an IRS tax administration 
contract.
    The Act permits an individual to appeal the amount or a 
denial of an award determination to the United States Tax Court 
(the ``Tax Court'') within 30 days of such determination. Tax 
Court review of an award determination may be assigned to a 
special trial judge.
    The Act also required the Secretary to conduct a study and 
report to Congress on the effectiveness of the whistleblower 
reward program and any legislative or administrative 
recommendations regarding the administration of the program.

                           REASONS FOR CHANGE

    A recent report by the Treasury Inspector General for Tax 
Administration concluded that the IRS's informant reward 
program has been an effective method of identifying and 
collecting unpaid taxes.\103\ The report made several 
recommendations for enhancing the effectiveness of the program, 
including centralizing management of the reward program and 
reducing the processing time for claims. The Act enhanced the 
reward program by establishing a minimum reward for certain 
cases and requiring the Secretary to establish a centralized 
office. The Committee believes that further enhancements to the 
reward program would make the program more attractive to future 
informants wishing to report violations of the tax laws. The 
Committee also believes that enhancements to the program will 
provide assurance that informants' claims are not lost, 
overlooked or forgotten, and that award amounts are determined 
in a consistent and equitable manner.
---------------------------------------------------------------------------
    \103\ Treasury Inspector General for Tax Administration, The 
Informants' Rewards Program Needs More Centralized Management 
Oversight, 2006-30-092 (June 2006).
---------------------------------------------------------------------------

                        EXPLANATION OF PROVISION

    The provision modifies the reward program established under 
the Act. Under the provision, this reward program applies to 
any actions in which the tax, penalties, interest, additions to 
tax, and additional amounts in dispute exceed $20,000 and, if 
the taxpayer is an individual, the individual's gross income 
exceeds $200,000 for any taxable year.
    The provision also establishes the Whistleblower Office 
under the Code, rather than pursuant to regulation as provided 
in the Act. Although recognizing that many functions of the IRS 
may be involved in evaluating or otherwise addressing an 
informant's claim, the Congress intends that one office within 
the IRS ultimately is responsible and accountable for 
monitoring informant claims for reward and determining the 
amounts to be rewarded. This will ensure that all claims are 
considered and that awards are issued in a consistent, timely 
and equitable manner.
    In addition, the provision requires the Secretary to report 
to Congress within six months of the date of enactment on the 
implementation of this provision, including the operation of 
the Whistleblower Office and the implementation of the 
recommendations of the Treasury Inspector General for Tax 
Administration.\104\
---------------------------------------------------------------------------
    \104\ Treasury Inspector General for Tax Administration, The 
Informants' Rewards Program Needs More Centralized Management 
Oversight, 2006-30-092 (June 2006).
---------------------------------------------------------------------------
    Finally, the provision authorizes the Tax Court to adopt 
rules to preserve the anonymity, privacy, or confidentiality of 
any person that may be identified during the appeal of an award 
determination appeal.

                             EFFECTIVE DATE

    The provision generally is effective for information 
provided on or after the date of enactment. The provision 
authorizing the Tax Court to adopt rules to preserve the 
anonymity, privacy, or confidentiality of any person that may 
be identified in the appeal of an award determination is 
effective as if included in section 406 of the Act.

     N. Expand Denial of Deduction for Certain Excessive Employee 
                              Remuneration

(Sec. 214 of the bill and sec. 162(m) of the Code)

                              PRESENT LAW

    Under present law, compensation in excess of $1 million 
paid by a publicly-held corporation to the corporation's 
``covered employees'' generally is not deductible.\105\ Covered 
employees are the chief executive officer as of the close of 
the taxable year and the four other most highly compensated 
officers of the company as reported in the company's proxy 
statement.
---------------------------------------------------------------------------
    \105\ Sec. 162(m).
---------------------------------------------------------------------------
    Subject to certain exceptions, the deduction limitation 
applies to all otherwise deductible compensation of a covered 
employee for a taxable year, regardless of the form in which 
the compensation is paid, whether the compensation is for 
services as a covered employee, and regardless of when the 
compensation was earned. The deduction limitation applies when 
the deduction would otherwise be taken.
    Performance-based compensation is not subject to the 
deduction limitation and is not taken into account in 
determining whether other compensation exceeds $1 million. In 
general, performance-based compensation is compensation payable 
solely on account of the attainment of one or more performance 
goals and with respect to which certain requirements are 
satisfied, including a shareholder approval requirement.\106\
---------------------------------------------------------------------------
    \106\ In addition, the following types of compensation are not 
subject to the deduction limitation and are not taken into account in 
determining whether other compensation exceeds $1 million: (1) 
compensation payable on a commission basis; (2) payments to a tax-
qualified retirement plan (including salary reduction contributions); 
and (3) amounts that are excludable from the individual's gross income 
(such as employer-provided health benefits). Sec. 162(m)(4).
---------------------------------------------------------------------------

                           REASONS FOR CHANGE

    The Securities and Exchange Commission recently modified 
the group of executives for whom compensation is required to be 
disclosed under the Securities Exchange Act of 1934. Given 
these modifications, the Committee believes that it is 
appropriate to delink the definition of covered employee from 
the Securities laws. The Committee also believes that the 
denial of the deduction for certain excess employee 
remuneration should apply to any individual who serves as the 
Chief Executive Officer during the year, regardless of whether 
that position is retained on the last day of the taxable year. 
Under present law, the deduction limitations for certain excess 
employee remuneration can be avoided by delaying payment of 
compensation to a year in the future in which the individual is 
no longer a covered employee. The Committee believes that it is 
appropriate to continue to treat individuals as covered 
employees if they had been covered employees in a preceding 
taxable year.

                        EXPLANATION OF PROVISION

    The provision modifies the definition of covered employee. 
Under the provision, covered employees include any individual 
who was the Chief Executive Officer of the company (or 
individual acting in such a capacity) at any time during the 
taxable year. In addition, covered employees include the four 
officers with the highest compensation for the year (other than 
the Chief Executive Officer). Under the provision, covered 
employees also include individuals who previously were covered 
employees for any preceding taxable year beginning after 
December 31, 2006, with respect to the corporation or any 
predecessor. In the case of an individual who is a covered 
employee after December 31, 2006, covered employees also 
include beneficiaries of such employees with respect to any 
remuneration for services performed by such employee as a 
covered employee (whether or not such services are performed 
during the taxable year in which the remuneration is paid). For 
example, under the provision, if the Chief Executive Officer 
retires in November, compensation received in the year of 
retirement, or paid under a deferral agreement in a succeeding 
year, is subject to the deduction limitations for a covered 
employee.

                             EFFECTIVE DATE

    The provision is effective for taxable years beginning 
after December 31, 2006.

                     II. BUDGET EFFECTS OF THE BILL

                         A. Committee Estimates

    In compliance with paragraph 11(a) of rule XXVI of the 
Standing Rules of the Senate, the following statement is made 
concerning the estimated budget effects of the revenue 
provisions of the ``Small Business and Work Opportunity Act of 
2007'' as reported.

                  ESTIMATED REVENUE EFFECTS OF S. 349, THE ``SMALL BUSINESS AND WORK OPPORTUNITY ACT OF 2007,'' AS REPORTED BY THE COMMITTEE ON FINANCE--FISCAL YEARS 2007-2016
                                                                                      [Millions of Dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                 Provision                            Effective             2007      2008      2009      2010      2011      2012      2013      2014      2015      2016     2007-11   2007-16
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
I. Small Business Provisions
    A. General Provisions
        1. Extension of increased           tyba 12/31/09...............        --        --        --    -2,964    -1,897     1,732     1,092       792       613       375    -4,861      -257
         expensing for small business--
         increase section 179 expensing
         from $25,000 to $100,000 and
         increase the phaseout threshold
         amount from $200,000 to $400,000;
         include software in section 179
         property; and extend indexing of
         both the deduction limit and the
         phaseout threshold (sunset 12/31/
         10).
        2. Extension of the 15-year         ppisa 12/31/07..............        --       -30       -88      -114      -112      -109      -100       -95      -100       -98      -345      -847
         straight-line cost recovery
         period for qualified leasehold
         and restaurant improvements
         (sunset 3/31/08).
        3. 15-year recovery period for new  ppisa DOE...................       -22       -66       -94       -99       -99       -98       -97       -95       -93       -86      -379      -847
         restaurant buildings (sunset 3/31/
         08).
        4. 15-year recovery period for      ppisa DOE...................       -22       -76      -119      -127      -123      -114      -106      -108      -109      -108      -467    -1,012
         retail improvements (sunset 3/31/
         08).
        5. Increase gross receipts          tyba DOE....................        -9      -278      -151       -52       -57       -63       -69       -76       -84       -92      -547      -931
         threshold for cash accounting to
         $10M regardless of inventories,
         index for inflation, and reset
         testing period.
        6. Extension and modification of    wpoifibwa 12/31/07..........        --      -150      -411      -569      -657      -726      -591      -302      -143       -75    -1,788    -3,624
         combined Work Opportunity Tax
         Credit and Welfare-to-work credit-
         expansions on post 9/11 disabled
         veterans, high-risk youth, and
         vocational rehabilitation
         referrals (sunset 12/31/12).
        7. Treatment of certified           (\1\).......................        --        --        -2        -3        -4        -4        -4        -5        -5        -6        -8       -32
         professional employer
         organizations as employers.
    B. Subchapter S Provisions
        1. Exclude capital gains from       tyba DOE....................        --       -15       -30       -32       -34       -35       -37       -40       -43       -46      -111      -312
         passive investment income.
        2. Treatment of qualifying          tyba 12/31/06...............        -4       -10       -14       -18       -20       -21       -22       -23       -23       -23       -66      -178
         director shares.
        3. Recapture of bad debt reserves.  tyba 12/31/06...............        11        27       -22       -40       -36       -23       -21       -22       -23       -24       -60      -173
        4. Treatment of sale of interest    tyba 12/31/06...............        -1        -3        -3        -4        -4        -4        -5        -5        -5        -6       -15       -40
         in a qualified subchapter S
         subsidiary.
        5. Elimination of all earnings and  tyba DOE....................        -3        -2        -2        -2        -2        -2        -2        -2        -2        -2       -11       -21
         profits attributable to pre-1983
         years.
        6. Expansion of qualifying          DOE.........................        --        -1        -2        -3        -4        -4        -4        -5        -5        -5       -10       -33
         beneficiaries of an electing
         small business trust.
            Total of Small Business         ............................       -50      -604      -938    -4,027    -3,049       529        34        14       -22      -196    -8,668    -8,307
             Provisions.
II. Provisions That Raise Revenue
    1. Modify the effective date for the    tyba 12/31/06...............     1,018     1,662       896       407       290       288       260       135      -239      -629     4,273     4,088
     application of the AJCA 2004 leasing
     (SILO) provision--apply loss
     limitation to leases with foreign
     entities regardless of when the lease
     was entered into.
    2. Tax treatment of inversion           tyba 2006...................        42        86        99       107       115       123       123       143       153       162       449     1,153
     transactions.
    3. Deny deduction for punitive damages  dpoio/a DOE.................         3        37        29        30        31        32        33        34        35        36       130       299
    4. Denial of deduction for certain      generally apoio/a DOE.......        25        87        31        15        15        15        15        15        15        15       172       244
     fines, penalties, and other amounts.
    5. Impose mark-to-market on             (\2\).......................        13        57        54        50        46        43        41        39        38        36       220       417
     individuals who expatriate.
    6. Limitation on annual amounts which   tyba 12/31/06...............        43        59        60        63        83        94        97       100       103       106       307       806
     may be deferred under nonqualified
     deferred compensation arrangements.
    7. Increase in certain criminal         aaftaoa DOE.................     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)     (\3\)         1         5
     penalties.
    8. Double certain penalties, fines,     oyo/a DOE...................         1         1         1         1         1         1         1         1         1         1         5        10
     and interest on underpayments related
     to certain offshore financial
     arrangements.
    9. Increase in penalty for bad checks   comora DOE..................         2         2         2         2         2         2         2         2         2         2        10        20
     and money orders.
    10. Change the tax treatment of         diio/a DOE..................         8        37        52        62        63        58        49        45        39        35       222       448
     contingent convertible debt
     instruments.
    11. Extension of IRS user fees (sunset  ra 9/30/14..................        --        --        --        --        --        --        --        --        30        30        --        60
     9/30/16) (\4\).
    12. Modification of collection due      lio/a 120da DOE.............        --        58        50        28        20        17        20        23        26        29       156       271
     process procedures for employment tax
     liabilities.
    13. Modifications to Whistleblower      ipo/a DOE...................         1         6        15        23        32        42        51        63        79        90        77       402
     reforms (\5\).
    14. Modify definition of covered        tyba 12/31/06...............         1         3         4         5         7        10        14        18        20        23        20       105
     employee for denial of deduction for
     excessive employee remuneration.
            Total of Provisions That Raise  ............................     1,157     2,095     1,293       793       705       725       706       618       302       -64     6,042     8,328
             Revenue.
                                           -----------------------------------------------------------------------------------------------------------------------------------------------------
              NET TOTAL...................  ............................     1,107     1,491       355    -3,234    -2,344     1,254       740       632       280      -260    -2,626        21
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Effective with respect to wages paid for services performed on or after January 1 of the first calendar year beginning more than 12 months after the date of enactment.
\2\ Generally effective for U.S. citizens who expatriate or long-term residents who terminate their residency on or after the date of enactment.
\3\ Gain of less than $500,000.
\4\ Estimate provided by the Congressional Budget Office.
\5\ Net of outlays.
Note.--Details may not add to totals due to rounding. Date of enactment is assumed to be April 1, 2007.
Legend for ``Effective'' column: aaftaoa = actions and failure to act occurring after, apoio/a = amounts paid or incurred on or after, comora=checks for money orders received after, diio/a =
  debt intrument issued on or after, DOE=date of enactment, dpoio/a = damages paid or incurred on or after, oyo/a = open years on or after, ppisa = property placed in service after, ipo/a =
  information provided on or after, lio/a = levies issued on or after, tyba = taxable years beginning after, ra = requests after, wpoifibwa = wages paid or incurred for individuals beginning
  work after, 120da = 120 days after.
Source: Joint Committee on Taxation.

                B. Budget Authority and Tax Expenditures

Budget authority

    In compliance with section 308(a)(1) of the Budget Act, the 
Committee states that no provisions of the bill as reported 
involve new or increased budget authority.

Tax expenditures

    In compliance with section 308(a)(2) of the Budget Act, the 
Committee states that the revenue-reducing provisions of the 
bill involve increased tax expenditures (see revenue table in 
Part A, above). The revenue-increasing provisions of the bill 
involve reduced tax expenditures (see revenue table in part A, 
above).

            C. Consultation With Congressional Budget Office

    In accordance with section 403 of the Budget Act, the 
Committee advises that the Congressional Budget Office has not 
submitted a statement on the bill. The letter from the 
Congressional Budget Office has not been received, and 
therefore will be provided separately.

                      III. VOTES OF THE COMMITTEE

    In compliance with paragraph 7(b) of rule XXVI of the 
standing rules of the Senate, the Committee states that, with a 
majority and quorum present, the ``Small Business and Work 
Opportunity Act of 2007,'' as amended, was ordered favorably 
reported by a voice vote on January 17, 2007.
    The Committee accepted the following resolution: It is the 
sense of the Committee on Finance that the small business 
provisions should be extended beyond the dates contained in the 
Mark.

                IV. REGULATORY IMPACT AND OTHER MATTERS

                          A. Regulatory Impact

    Pursuant to paragraph 11(b) of rule XXVI of the Standing 
Rules of the Senate, the Committee makes the following 
statement concerning the regulatory impact that might be 
incurred in carrying out the provisions of the bill as amended.

Impact on individuals and businesses, personal privacy and paperwork

    The bill includes provisions to extend present-law tax 
benefits, expand eligibility for other benefits, and update 
Subchapter S of the Code. The bill also includes provisions 
increasing certain penalties and extending IRS user fees. The 
bill modifies the treatment of corporate inversion transactions 
and individuals who expatriate, and imposes limitations on the 
amount of compensation which may be deducted by employers or 
deferred by employees under the Code. The bill includes a 
provision to improve employment tax compliance by providing 
rules under which certain professional employer organizations 
is treated as the employer of employees provided to customers.
    The bill includes various other provisions that are not 
expected to impose additional administrative requirements or 
regulatory burdens on individuals or businesses.
    The provisions of the bill do not impact personal privacy.

                     B. Unfunded Mandates Statement

    This information is provided in accordance with section 423 
of the Unfunded Mandates Reform Act of 1995 (Pub. L. 104-4).
    The Committee has determined that the following two tax 
provisions of the reported bill contain Federal private sector 
mandates within the meaning of Public Law 104-4, the Unfunded 
Mandates Reform Act of 1995: (1) modifying the effective date 
for the application of the AJCA 2004 leasing (``SILO'') 
provision--apply loss limitation to leases with foreign 
entities regardless of when the lease was entered into; and (2) 
tax treatment of inversion transactions. The tax provisions of 
the reported bill do not impose a Federal intergovernmental 
mandate on State, local, or tribal governments within the 
meaning of Public Law 104-4, the Unfunded Mandates Reform Act 
of 1995.
    The costs required to comply with each Federal private 
sector mandate generally are no greater than the aggregate 
estimated budget effects of the provision. Benefits from the 
provisions include improved administration of the tax laws and 
a more accurate measurement of income for Federal income tax 
purposes.

                       C. Tax Complexity Analysis

    Section 4022(b) of the Internal Revenue Service 
Restructuring and Reform Act of 1998 (the ``IRS Reform Act'') 
requires the Joint Committee on Taxation (in consultation with 
the Internal Revenue Service and the Department of the 
Treasury) to provide a tax complexity analysis. The complexity 
analysis is required for all legislation reported by the Senate 
Committee on Finance, the House Committee on Ways and Means, or 
any committee of conference if the legislation includes a 
provision that directly or indirectly amends the Internal 
Revenue Code (the ``Code'') and has widespread applicability to 
individuals or small businesses.
    The staff of the Joint Committee on Taxation has determined 
that a complexity analysis is not required under section 
4022(b) of the IRS Reform Act because the bill contains no 
provisions that have ``widespread applicability'' to 
individuals or small businesses.

              V. ADDITIONAL VIEWS OF SENATOR JOHN F. KERRY

    I support the majority of the provisions in the Small 
Business and Work Opportunity Act of 2007. I would have 
preferred that this package move separately rather than in 
tandem with a minimum wage bill. However, the reality is that 
we need a tax package in order to advance minimum wage 
legislation.
    Most of the provisions are targeted and will help small 
businesses. For example, the provision to provide fifteen-year 
straight line cost recovery for qualified retail improvement 
will help small businesses that own their stores. However, 
there is one provision that I find troubling. This provision 
would treat professional employer organizations as employers 
for employment tax purposes.
    The reason for including this provision is to improve 
compliance. I am concerned that the provision which that makes 
certified professional employer organizations liable for 
payroll taxes may not actually result in improved compliance. 
The Joint Committee on Taxation has estimated that this 
provision has a ten-year cost of $33 million. If this provision 
truly improved compliance, I would expect it to raise revenue.
    This proposal lets the workers' real employer off the hook 
for payroll taxes, and creates confusion about who is an 
employer under labor laws. I know the language says it will not 
affect other laws, but as a practical matter it will. It 
confuses workers, who will not be able to tell who their real 
employer is, and it sets a bad precedent that could make it 
harder for workers to protect their rights under important 
labor laws.
    I realize the Committee has reported out this provision in 
the past, but I believe this provision will result in 
unintended consequences. The Committee should review this 
proposal in order to address concerns that have been raised.
       VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED

    In the opinion of the Committee, it is necessary in order 
to expedite the business of the Senate, to dispense with the 
requirements of paragraph 12 of rule XXVI of the Standing Rules 
of the Senate (relating to the showing of changes in existing 
law made by the bill as reported by the Committee).

                                  
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