TECHNICAL EXPLANATION OF THE 

“SMALL BUSINESS AND WORK OPPORTUNITY TAX ACT OF 2007” 

CONTAINED IN H.R. 1591 

AS REPORTED BY THE CONFERENCE COMMITTEE 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

 

 

April 24, 2007 

JCX-24-07
i 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. SMALL BUSINESS TAX RELIEF PROVISIONS........................................................... 2 

A. General Provisions........................................................................................................ 2 

1. Extension and modification of work opportunity tax credit (sec. 7511 of the 

bill and sec. 51 of the Code) ................................................................................... 2 

2. Increase and extension of expensing for small business (sec. 7512 of the bill 

and sec. 179 of the Code)........................................................................................ 7 

3. Determination of credit for certain taxes paid with respect to employee 

cash tips (sec. 7513 of the bill and sec. 45B of the Code) ...................................... 8 

4. Waiver of individual and corporate alternative minimum tax limits on work 

opportunity credit and credit for taxes paid with respect to employee cash tips 

(sec. 7514 of the bill and sec. 38 of the Code)........................................................ 9 

5. Family business tax simplification (sec. 7515 of the bill and sec. 761 of the 

Code)..................................................................................................................... 10 

B. Gulf Opportunity Zone Tax Incentives....................................................................... 12 

1. Extension of increased expensing for qualified section 179 Gulf Opportunity 

Zone property (sec. 7521 of the bill and sec. 1400N(e) of the Code)................... 12 

2. Extension and expansion of low-income housing credit rules for buildings 

in the GO Zones (sec. 7522 of the bill and 1400N(c) of the Code)...................... 14 

3. Special tax-exempt bond financing rule for repairs and reconstructions of 

residences in the GO Zones (sec. 7523 of the bill and secs. 143 and 1400N(a) 

of the Code)........................................................................................................... 18 

4. GAO study of practices employed by state and local governments in allocating 

and utilizing tax incentives provided pursuant to the Gulf Opportunity Zone 

Tax Act of 2005 (sec. 7524 of the bill)................................................................. 20 

C. Subchapter S Provisions (secs. 7531-7536 of the bill and secs. 641, 1361 and 

1362 of the Code)........................................................................................................ 21 

1. Capital gain not treated as passive investment income......................................... 21 

2. Treatment of bank director shares......................................................................... 22 

3. Treatment of banks changing from reserve method of accounting....................... 23 

4. Treatment of sale of an interest in a qualified subchapter S subsidiary................ 24 

5. Elimination of earnings and profits attributable to pre-1983 years ...................... 25 

6. Deductibility of interest expense of an ESBT on indebtedness incurred to 

acquire S corporation stock................................................................................... 25 

II. REVENUE PROVISIONS ............................................................................................... 27 

1. Increase in age of minor children whose unearned income is taxed as if 

parents’ income (sec. 7541 of the bill and sec. 1(g) of the Code) ........................ 27 

2. Suspension of penalties and interest (sec. 7542 of the bill and sec. 6404(g) 

of the Code)........................................................................................................... 28 
ii 

3. Modification of collection due process procedures for employment tax 

liabilities (sec. 7543 of the bill and sec. 6330 of the Code).................................. 29 

4. Permanent extension of IRS user fees (sec. 7544 of the bill and sec. 7528 

of the Code)........................................................................................................... 30 

5. Increase in penalty for bad checks and money orders (sec. 7545 of the bill 

and sec. 6657 of the Code).................................................................................... 31 

6. Understatement of taxpayer’s liability by tax return preparers 

(sec. 7546 of the bill and secs. 6694 and 7701 of the Code) ................................ 31 

7. Penalty for filing erroneous refund claims (sec. 7547 of the bill and sec. 6662 

of the Code)........................................................................................................... 32 

8. Time for payment of corporate estimated tax (sec. 7548 of the bill).................... 33 
1 

INTRODUCTION 

This document,1

 prepared by the staff of the Joint Committee on Taxation, provides a 

technical explanation of the “Small Business and Work Opportunity Tax Act of 2007” contained 

in H.R. 1591 as reported by the conference committee. 

 1

 This document may be cited as follows: Joint Committee on Taxation, Technical Explanation 

of the “Small Business and Work Opportunity Tax Act of 2007” Contained in H.R. 1591 as Reported by 

the Conference Committee, (JCX-24-07), April 24, 2007. This publication is also available on the web at 

www.house.gov/jct. 
2

I. SMALL BUSINESS TAX RELIEF PROVISIONS 

A. General Provisions 

1. Extension and modification of work opportunity tax credit (sec. 7511 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 
3

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 (the (“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 
4

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 has received family assistance 

for at least 18 consecutive months ending on the hiring date; (2) a member of a family that has 

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)2

 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 is 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. 

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 

 2

 The welfare-to-work tax credit was consolidated into the work opportunity tax credit in the Tax 

Relief and Health Care Act of 2006, for qualified individuals who begin to work for an employer after 

December 31, 2006. 
5

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 prescreening 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 fiftypercent 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. 
6

Explanation of Provision

Extension

The provision extends the work opportunity tax credit for 44 months (for qualified 

individuals who begin work for an employer after December 31, 2007, and before September 1, 

2011). 

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 and: (1) having a 

hiring date which is not more than one year after having been discharged or released from active 

duty in the Armed Forces of the United States, or (2) having been unemployed for six months or 

more (whether or not consecutive) during the one-year period ending on the date of hiring. 

Being entitled to compensation for a service-connected disability is defined with reference to 

section 101 of Title 38, U.S.C., which 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 who qualify under either of the new expansions of the qualified veteran 

group, above. The expanded definition of qualified first-year wages does not apply to the 

veterans qualified with reference to a food stamp program, as defined under present law. 

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. Also, the provision expands the 

definition of eligible individuals under this category to include otherwise qualifying individuals 

from rural renewal counties. For these purposes, a rural renewal county is a county outside a 

metropolitan statistical area (as defined the Office of Management and Budget) which had a net 

population loss during the five-year periods 1990-1994 and 1995-1999. Finally, the provision 

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. 
7

Certification

Under present law, designated local employment agencies may enter into information 

sharing agreements to facilitate certification for purposes of WOTC eligibility. Such agreements 

are subject to confidentiality requirements. The Congress expects that the Department of 

Defense, the Department of Veterans Affairs, and the Social Security Administration will work 

with the designated local agencies to facilitate certification of the expansions of the qualified 

veteran category and the SSI recipient category. Finally, the Congress expects that the Internal 

Revenue Service will develop procedures to allow (in addition to original documents) paper 

versions of electronically completed pre-screening notices and photographic copies of hand 

signed original pre-screening notices for purposes of the credit. This allowance of pre-screening 

notices which are not original documents should be allowed only to the extent it does not foster 

incorrect or fraudulent filings. 

Effective Date

The provisions are effective for individuals who begin work for an employer after the 

date of enactment. 

2. Increase and extension of expensing for small business (sec. 7512 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.3

 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.4

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 

 3

 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)). 

4

 Rev. Proc. 2006-53, sec. 2.19, 2006-48 I.R.B. 996 (Nov. 27, 2006). 
8

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.5

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 offthe-shelf computer software). An expensing election may be revoked only with consent of the 

Commissioner.6

Explanation of Provision7

The provision increases the $100,000 and $400,000 amounts to $125,000 and $500,000, 

respectively, for taxable years beginning in 2007 through 2010. These amounts are indexed for 

inflation in taxable years beginning after 2007 and before 2011. 

In addition, 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 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, 2006. 

3. Determination of credit for certain taxes paid with respect to employee cash tips 

(sec. 7513 of the bill and sec. 45B of the Code) 

Present Law

The Federal minimum wage under the Fair Labor Standards Act (the “FLSA”) is $5.15 

per hour. In the case of tipped employees, the FLSA provides that the minimum wage may be 

 5

 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. 

6

 Sec. 179(c)(2). 

7

 Separate provision of H.R. 1591 increases the Federal minimum wage. 
9

reduced to $2.13 per hour (that is, the employer is only required to pay cash equal to $2.13 per 

hour) if the combination of tips and cash income equals the Federal minimum wage.8 

Under present law, employee tip income is treated as employer-provided wages for 

purposes of the Federal Insurance Contributions Act (“FICA”). Employees are required to report 

the amount of tips received. 

A business tax credit is provided equal to an employer’s FICA taxes paid on tips in 

excess of those treated as wages for purposes of meeting the minimum wage requirements of the 

FLSA. The credit applies only with respect to FICA taxes paid on tips received from customers 

in connection with the providing, delivering, or serving of food or beverages for consumption if 

the tipping of employees delivering or serving food or beverages by customers is customary. 

The credit is available whether or not the employee reports the tips on which the employer FICA 

taxes were paid. No deduction is allowed for any amount taken into account in determining the 

tip credit. A taxpayer may elect not to have the credit apply for a taxable year. 

Explanation of Provision

The provision provides that the amount of the tip credit is based on the amount of tips in 

excess of those treated as wages for purposes of the FLSA as in effect on January 1, 2007. That 

is, under the provision, the tip credit is determined based on a minimum wage of $5.15 per hour. 

Therefore, if the amount of the minimum wage increases, the amount of the FICA tip credit will 

not be reduced. 

Effective Date

The provision applies with respect to tips received for services performed after December 

31, 2006. 

4. Waiver of individual and corporate alternative minimum tax limits on work opportunity 

credit and credit for taxes paid with respect to employee cash tips (sec. 7514 of the bill and 

sec. 38 of the Code) 

Present Law

Under present law, business tax credits generally may not exceed the excess of the 

taxpayer’s income tax liability over the tentative minimum tax (or, if greater, 25 percent of the 

regular tax liability in excess of $25,000). Credits in excess of the limitation may be carried 

back one year and carried over for up to 20 years. 

 8

 Some States require the payment of cash wages to tipped employees in excess of the Federal 

minimum of $2.13 per hour. For a history of the tip provisions under the FLSA and a description of 

relevant State laws, see William G. Whittaker, Congressional Research Service, The Tip Credit 

Provisions of the Fair Labor Standards Act (Order Code RL33348), March 24, 2006. 
10

The tentative minimum tax is an amount equal to specified rates of tax imposed on the 

excess of the alternative minimum taxable income over an exemption amount. To the extent the 

tentative minimum tax exceeds the regular tax, a taxpayer is subject to the alternative minimum 

tax. 

Thus, business tax credits generally cannot offset the alternative minimum tax liability. 

Explanation of Provision

The provision treats the tentative minimum tax as being zero for purposes of determining 

the tax liability limitation with respect to the work opportunity credit and the credit for taxes paid 

with respect to employee cash tips. 

Thus, the work opportunity tax credit and the credit for taxes paid with respect to cash 

tips may offset the alternative minimum tax liability. 

Effective Date

The provision applies to credits determined in taxable years beginning after December 

31, 2006. 

5. Family business tax simplification (sec. 7515 of the bill and sec. 761 of the Code) 

Present Law

Under present law, a partnership is defined to include a syndicate, group, pool, joint 

venture, or other unincorporated organization through or by means of which any business, 

financial operation or venture is carried on, and which is not a trust or estate or a corporation 

(sec. 7701(a)(2)). A partnership is treated as a pass-through entity, and income earned by the 

partnership, whether distributed or not, is taxed to the partners. The income of a partnership and 

its partners is determined under subchapter K of the Code. An election not to be subject to the 

rules of subchapter K is provided for certain partnerships that meet specified criteria (e.g., the 

partnership is for investment purposes only, is for the joint production, extraction or use of 

property but not for selling services or property produced or extracted, or is used by securities 

dealers for short periods to underwrite, sell or distribute securities). Otherwise, the rules of 

subchapter K apply to a venture that is treated as a partnership for Federal tax purposes. 

In the case of an individual with self-employment income, the income subject to selfemployment tax is the net earnings from self-employment (sec. 1402(a)). Net earnings from 

self-employment is the gross income derived by an individual from any trade or business carried 

on by the individual, less the deductions attributable to the trade or business that are allowed 

under the self-employment tax rules. If the individual is a partner in a partnership, the net 

earnings from self-employment generally include his or her distributive share (whether or not 

distributed) of income or loss from any trade or business carried on by the partnership. 
11

Explanation of Provision

The provision generally permits a qualified joint venture whose only members are a 

husband and wife filing a joint return not to be treated as a partnership for Federal tax purposes. 

A qualified joint venture is a joint venture involving the conduct of a trade or business, if (1) the 

only members of the joint venture are a husband and wife, (2) both spouses materially participate 

in the trade or business, and (3) both spouses elect to have the provision apply. 

Under the provision, a qualified joint venture conducted by a husband and wife who file a 

joint return is not treated as a partnership for Federal tax purposes. All items of income, gain, 

loss, deduction and credit are divided between the spouses in accordance with their respective 

interests in the venture. Each spouse takes into account his or her respective share of these items 

as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her 

respective share on the appropriate form, such as Schedule C. The provision is not intended to 

change the determination under present law of whether an entity is a partnership for Federal tax 

purposes (without regard to the election provided by the provision). 

For purposes of determining net earnings from self-employment, each spouse’s share of 

income or loss from a qualified joint venture is taken into account just as it is for Federal income 

tax purposes under the provision (i.e., in accordance with their respective interests in the 

venture). A corresponding change is made to the definition of net earnings from selfemployment under the Social Security Act. The provision is not intended to prevent allocations 

or reallocations, to the extent permitted under present law, by courts or by the Social Security 

Administration of net earnings from self-employment for purposes of determining Social 

Security benefits of an individual. 

Effective Date

The provision is effective for taxable years beginning after December 31, 2006. 
12

B. Gulf Opportunity Zone Tax Incentives 

1. Extension of increased expensing for qualified section 179 Gulf Opportunity Zone 

property (sec. 7521 of the bill and sec. 1400N(e) of the Code) 

Present Law

In General

Present law provides that, 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. 

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.9

 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.10

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.11

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 

 9

 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), or a renewal 

community (sec. 1400J). 

10 Rev. Proc. 2006-53, sec. 2.19, 2006-48 I.R.B. 996 (Nov. 27, 2006). 

11 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. 
13

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 offthe-shelf computer software). An expensing election may be revoked only with consent of the 

Commissioner.12

Increase for Gulf Opportunity Zone Property

Under section 1400N(e), the $100,000 maximum amount that a taxpayer may elect to 

deduct under section 179 is increased by the lesser of $100,000 or the cost of qualified section 

179 Gulf Opportunity Zone property for the taxable year. The provision applies with respect to 

qualified section 179 Gulf Opportunity Zone property acquired on or after August 28, 2005, and 

placed in service on or before December 31, 2007. Thus, in addition to the $100,000 maximum 

cost of any section 179 property (including property that also meets the definition of qualified 

section 179 Gulf Opportunity Zone property) that may be deducted under present law, a taxpayer 

may elect to deduct a maximum $100,000 additional amount of the taxpayer's cost of qualified 

section 179 Gulf Opportunity Zone property, resulting in a maximum deductible amount of 

$200,000 of qualified section 179 Gulf Opportunity Zone property. (The $100,000 present-law 

portion of this amount is indexed for taxable years beginning after 2003 and before 2010, so the 

total may be higher than $200,000 after taking indexation of this portion into account.) The 

$100,000 additional amount for the cost of qualified section 179 Gulf Opportunity Zone property 

is not indexed. 

There is a special rule for the reduction in the $200,000 maximum deduction for the cost 

of qualified section 179 Gulf Opportunity Zone property. Under this rule, the $200,000 amount 

is reduced (but not below zero) by the amount by which the cost of qualified section 179 Gulf 

Opportunity Zone property placed in service during the taxable year exceeds a dollar cap of up to 

$1 million. (The $400,000 present-law portion of this amount is indexed for taxable years 

beginning after 2003 and before 2010, so the total may be higher than $1 million after taking 

indexation of this portion into account.) The dollar cap is computed by increasing the $400,000 

present-law amount by the lesser of (1) $600,000, or (2) the cost of qualified section 179 Gulf 

Opportunity Zone property placed in service during the taxable year. The $600,000 amount is 

not indexed. 

Qualified section 179 Gulf Opportunity Zone property means section 179 property (as 

defined in section 179(d)) that also meets the requirements to qualify for Gulf Opportunity Zone 

bonus depreciation. Specifically, for section 179 purposes, qualified Gulf Opportunity Zone 

property is property (1) described in section 168(k)(2)(A)(i), (2) substantially all of the use of 

which is in the Gulf Opportunity Zone and is in the active conduct of a trade or business by the 

taxpayer in that Zone, (3) the original use of which commences with the taxpayer on or after 

August 28, 2005, (4) which is acquired by the taxpayer by purchase on or after August 28, 2005, 

but only if no written binding contract for the acquisition was in effect before August 28, 2005, 

and (5) which is placed in service by the taxpayer on or before December 31, 2007. Such 

 12 Sec. 179(c)(2). 
14

property does not include alternative depreciation property, tax-exempt bond-financed property, 

or qualified revitalization buildings. 

These rules are coordinated with expensing rules with respect to enterprise zone 

businesses in empowerment zones and with respect to renewal communities. For purposes of 

those rules, qualified section 179 Gulf Opportunity Zone property is not treated as qualified zone 

property or qualified renewal property, unless the taxpayer elects not to take such property into 

account for purposes of the increased section 179 expensing. Thus, a taxpayer acquiring 

property that could qualify as either qualified section 179 Gulf Opportunity Zone property, or 

qualified zone property or qualified renewal property, may elect the additional expensing 

provided either under this provision, or under the empowerment zone or renewal community 

rules, but not both, with respect to the property. 

Recapture rules apply to this property if recapture applies under section 179(d)(10) or if 

the property ceases to be qualified section 179 Gulf Opportunity Zone property. 

Explanation of Provision

The provision extends the increased expensing amount for property substantially all of 

the use of which is in one or more specified portions of the GO Zone to property placed in 

service by the taxpayer on or before December 31, 2008. The specified portions of the Go Zone 

include the Louisiana parishes of Calcasieu, Cameron, Orleans, Plaquemines, St. Bernard, St. 

Tammany, and Washington, and the Mississippi counties of Hancock, Harrison, Jackson, Pearl 

River, and Stone.13

Effective Date

The provision is effective for taxable years beginning after the date of enactment. 

2. Extension and expansion of low-income housing credit rules for buildings in the GO 

Zones (sec. 7522 of the bill and 1400N(c) of the Code) 

Present Law

In general

The low-income housing credit may be claimed over a 10-year period for the cost of 

building rental housing occupied by tenants having incomes below specified levels. The amount 

of the credit for any taxable year in the credit period is the applicable percentage of the qualified 

basis of each qualified low-income building. The qualified basis of any qualified low-income 

building for any taxable year equals the applicable fraction of the eligible basis of the building. 

 13 The “specified portions of the Go Zone” as defined by section 1400N(d)(6) are identified by 

the Secretary in Notice 2007-36, 2007-17 I.R.B. 
15

The credit percentage for newly constructed or substantially rehabilitated housing that is 

not Federally subsidized is adjusted monthly by the Internal Revenue Service so that the 10 

annual installments of the credit have a present value of 70 percent of the total qualified basis. 

The credit percentage for newly constructed or substantially rehabilitated housing that is 

Federally subsidized and for existing housing that is substantially rehabilitated is calculated to 

have a present value of 30 percent of qualified basis. These are referred to as the 70-percent 

credit and 30-percent credit, respectively. 

Credit cap

A low-income housing credit is allowable only if the owner of a qualified building 

receives a housing credit allocation from the State or local housing credit agency. Credit cap is 

provided to the States annually. For 2006, the amount is $1.90 per resident with a minimum 

annual cap of $2,180,000 for certain small population States. These amounts are indexed for 

inflation. These limits do not apply in the case of projects that also receive financing with 

proceeds of tax-exempt bonds issued subject to the private activity bond volume limit. 

Under the Gulf Opportunity Zone Act of 2005, the otherwise applicable housing credit 

ceiling amount is increased for each of the States within the Gulf Opportunity Zone (Alabama, 

Louisiana, and Mississippi). The additional credit cap for each of the affected States equals 

$18.00 times the number of such State’s residents within the Gulf Opportunity Zone. This 

increase applies to calendar years 2006, 2007, and 2008. This amount is not adjusted for 

inflation. For purposes of the additional credit cap amount, the determination of population for 

any calendar year is made on the basis of the most recent census estimate of the resident 

population of the State in the Gulf Opportunity Zone released by the Bureau of the Census before 

August 28, 2005. In addition, under the Gulf Opportunity Zone Act of 2005, the otherwise 

applicable housing credit ceiling amount is increased for Florida and Texas by $3,500,000 per 

State. This increase applies only to calendar year 2006. 

Carryover allocation rule

A low-income housing credit is allowable only if the owner of a qualified building 

receives a housing credit allocation from the State or local housing credit agency. In general, the 

allocation must be made not later than the close of the calendar year in which the building is 

placed in service. One exception to this rule is a carryover allocation. In the case of a carryover 

allocation, an allocation may be made to a building that has not yet been placed in service, 

provided that: (1) more than ten percent of the taxpayer's reasonably expected basis in the project 

(as of the close of the second calendar year following the calendar year of the allocation) is 

incurred as of the later of six months after the allocation is made or the end of the calendar year 

in which the allocation is made; and (2) the building is placed in service not later than the close 

of the second calendar year following the calendar year of the allocation. 

Enhanced credit

Generally, buildings located in high cost areas (i.e., qualified census tracts and difficult 

development areas) are eligible for an enhanced credit. Under the enhanced credit, the 70-

percent and 30-percent credit is increased to a 91-percent and 39-percent credit, respectively. 
16

The mechanism for this increase is an increase from 100 to 130 percent of the otherwise 

applicable eligible basis of a new building or the rehabilitation expenditures of an existing 

building. A further requirement for the enhanced credit is that no area having more than 20 

percent of the population of each metropolitan statistical area or nonmetropolitan statistical area 

can be a difficult to develop area and therefore a high cost area eligible for this treatment. 

Under the Gulf Opportunity Zone Act of 2005, the Gulf Opportunity Zone, the Rita GO 

Zone, and the Wilma GO Zone (the, “Go Zones”) are treated as high-cost areas for purposes of 

the low income housing credit for property placed-in-service in calendar years 2006, 2007, and 

2008. Therefore, buildings located in the GO Zones are eligible for the enhanced credit. Under 

the enhanced credit, the 70-percent and 30-percent credits are increased to 91-percent and 39-

percent credits, respectively. The 20-percent of population restriction is waived for this purpose. 

This enhanced credit applies regardless of whether the building receives its credit allocation 

under the otherwise applicable low-income housing credit cap or the additional credit cap 

provided under the Gulf Opportunity Zone Act of 2005 The provision to treat the GO Zones as a 

high-cost area is generally effective for calendar years beginning after 2005 and before 2009, and 

for buildings placed-in-service during such period in the case of projects that also receive 

financing with the proceeds of tax-exempt bonds subject to the private activity bond volume 

limit which are issued after December 31, 2005. 

Definition of Federally subsidized

In general, any newly constructed or substantially rehabilitated building is treated as 

Federally subsidized for any taxable year if, at any time during such taxable year or prior taxable 

year, there is or was outstanding any obligation the interest on which is exempt under section 

103, or any below market Federal loan, the proceeds of which are or were used (directly or 

indirectly) with respect to such building or the operation thereof. Exceptions are provided from 

this general rule: (1) if the taxpayer elects to reduce eligible basis; and (2) for certain subsidized 

construction financing. For purposes of this rule, a below market Federal loan generally is 

defined as a loan funded, in whole or in part, with Federal funds if the interest payable on such 

loan is less than the applicable Federal rate in effect under section 1274(d)(1) (as of the date the 

loan was made). A loan is not treated as a below market Federal loan for these purposes, if it is 

below market solely by reason of assistance provided under section 106, 107, or 108 of the 

Housing and Community Development Act of 1974, as in effect on December 19, 1989 (the date 

of enactment of the Omnibus Budget Reconciliation Act of 1989). 

Rehabilitation expenditures

Rehabilitation expenditures paid or incurred by the taxpayer with respect to any building 

shall be treated as a separate new building for purposes of the credit. In general, rehabilitation 

expenditures are amounts chargeable to a capital account and incurred for property (or additions 

or improvements to property) of a character subject to depreciation in connection with the 

rehabilitation of a building. Such term does not include the cost of acquiring a building (or 

interest therein). Other rules, including a minimum expenditure requirement, apply. 
17

Explanation of Provision

Carryover allocation rule

The provision makes two modifications to the carryover allocation rule for otherwise 

qualifying buildings located in the GO Zones placed in service before January 1, 2011. First, it 

repeals the requirement that 10 percent of the taxpayer's reasonably expected basis in the project 

(as of the close of the second calendar year following the calendar year of the allocation) must be 

incurred as of the later of six months after the allocation is made or the end of the calendar year 

in which the allocation is made (the “10-percent rule”). Second, it repeals the requirement that 

such building be placed in service not later than the close of the second calendar year following 

the calendar year of the allocation (the “second-year placed in service rule”). These changes 

apply only to allocations made in 2006, 2007, or 2008 whether made out of the regular credit cap 

or the additional Gulf Opportunity Zone credit cap. Therefore, an otherwise qualifying building 

is treated as a qualifying for the credit regardless of whether the 10-percent rule or the secondyear placed in service rule are satisfied if such building in one of the GO Zones: (1) receives an 

allocation in 2006, 2007, or 2008; and (2) is placed in service before January 1, 2011. 

Enhanced credit

The provision extends the placed in service dates for buildings eligible for the enhanced 

credit available under the Gulf Opportunity Zone Act of 2005 for two additional years (2009 and 

2010) for allocations made in 2006, 2007, or 2008. The provision to treat the GO Zones as a 

high-cost area is generally effective for calendar years beginning after December 31, 2008 and 

before January 1, 2011, and for buildings placed-in-service during such period in the case of 

projects that also receive financing with the proceeds of tax-exempt bonds subject to the private 

activity bond volume limit which are issued during that period. Therefore, otherwise qualifying 

buildings located in the GO Zones generally are eligible for the enhanced credit for allocations 

made in 2006, 2007, or 2008, if placed in service after December 31, 2005 and before January 1, 

2011. 

Definition of Federally subsidized

The provision modifies the definition of below market Federal loan for otherwise 

qualifying buildings located in the GO Zones that are placed in service during the period 

beginning on January 1, 2006 and ending on December 31, 2010. Under the provision, a loan is 

not treated as a below market Federal loan solely by reason of assistance provided under section 

106, 107, or 108 of the Housing and Community Development Act of 1974 by reason of: (1) 

section 122 of that Act; (2) any provision of the Department of Defense Appropriations Act, 

2006 (Pub. L. No. 109-141); or (3) the Emergency Supplemental Appropriations Act for 

Defense, the Global War on Terror, and Hurricane Recovery, 2006 (Pub. L. No. 109-234). 

Therefore, such assistance will not cause an otherwise qualifying building receiving such 

assistance to be treated as Federally subsidized for purposes of the low income housing credit. 

Rehabilitation expenditures

The Congress expects that the present law rules treating rehabilitation expenses as a 

separate new building for purposes of the low-income housing credit will apply in the case of 
18

buildings in the GO Zones which have been destroyed and, therefore, must be rehabilitated. For 

example, if a building receiving the low-income housing credit (with an eligible basis of $100 for 

credit purposes) was destroyed and the cost of replacing the building is $150, then the Congress 

expects that present law rules may allow the expenditures that exceed $100 but do not exceed 

$150 to be treated as a separate building with separate credit and compliance periods, assuming 

the rehabilitation expenditure receives a credit allocation and meets the otherwise applicable low 

income housing tax credit requirements. 

Effective Date

The provisions are effective upon enactment. 

3. Special tax-exempt bond financing rule for repairs and reconstructions of residences in 

the GO Zones (sec. 7523 of the bill and secs. 143 and 1400N(a) of the Code) 

Present Law

In general

Under present law, gross income does not include interest on State or local bonds. State 

and local bonds are classified generally as either governmental bonds or private activity bonds. 

Governmental bonds are bonds which are primarily used to finance governmental functions or 

which are repaid with governmental funds. Private activity bonds are bonds with respect to 

which the State or local government serves as a conduit providing financing to nongovernmental 

persons (e.g., private businesses or individuals). The exclusion from income for State and local 

bonds does not apply to private activity bonds, unless the bonds are issued for certain permitted 

purposes (“qualified private activity bonds”). The definition of a qualified private activity bond 

includes a qualified mortgage bond. 

Qualified mortgage bonds

Qualified mortgage bonds are tax-exempt bonds issued to make mortgage loans to 

eligible mortgagors for the purchase, improvement, or rehabilitation of owner-occupied 

residences. The Code imposes several limitations on qualified mortgage bonds, including 

income limitations for eligible mortgagors, purchase price limitations on the home financed with 

bond proceeds, and a “first-time homebuyer” requirement. In addition, bond proceeds generally 

only can be used for new mortgages, i.e., proceeds cannot be used to acquire or replace existing 

mortgages. 

Exceptions to the new mortgage requirement are provided for the replacement of 

construction period loans, bridge loans, and other similar temporary initial financing. In 

addition, qualified rehabilitation loans may be used, in part, to replace existing mortgages. A 

qualified rehabilitation loan means certain loans for the rehabilitation of a building if there is a 

period of at least 20 years between the date on which the building was first used (the “20 year 

rule”) and the date on which the physical work on such rehabilitation begins and the existing 

walls and basis requirements are met. The existing walls requirement for a rehabilitated building 

is met if 50 percent or more of the existing external walls are retained in place as external walls, 

75 percent or more of the existing external walls are retained in place as internal or external 
19

walls, and 75 percent or more of the existing internal structural framework is retained in place. 

The basis requirement is met if expenditures for rehabilitation are 25 percent or more of the 

mortgagor’s adjusted basis in the residence, determined as of the later of the completion of the 

rehabilitation or the date on which the mortgagor acquires the residence. 

Qualified mortgage bonds also may be used to finance qualified home-improvement 

loans. Qualified home-improvement loans are defined as loans to finance alterations, repairs, 

and improvements on an existing residence, but only if such alterations, repairs, and 

improvements substantially protect or improve the basic livability or energy efficiency of the 

property. Qualified home-improvement loans may not exceed $15,000, and may not be used to 

refinance existing mortgages. 

As with most qualified private activity bonds, issuance of qualified mortgage bonds is 

subject to annual State volume limitations (the “State volume cap”). For calendar year 2007, the 

State volume cap, which is indexed for inflation, equals the greater of $85 per resident of the 

State, or $256.24 million. Exceptions from the State volume cap are provided for bonds issued 

for certain governmentally owned facilities (airports, ports, high-speed intercity rail, and solid 

waste disposal) and bonds which are subject to separate local, State, or national volume limits 

(public/private educational facilities, enterprise zone facility bonds, qualified green 

building/sustainable design projects, and qualified highway or surface freight transfer facility 

bonds). 

Gulf Opportunity Zone Bonds

The Gulf Opportunity Zone Act of 2005 (the “Act”) authorizes Alabama, Louisiana, and 

Mississippi (or any political subdivision of those States) to issue qualified private activity bonds 

to finance the construction and rehabilitation of residential and nonresidential property located in 

the Gulf Opportunity Zone (“Gulf Opportunity Zone Bonds”). Gulf Opportunity Zone Bonds are 

not subject to the State volume cap. Rather, the maximum aggregate amount of Gulf 

Opportunity Zone Bonds that may be issued in any eligible State is limited to $2,500 multiplied 

by the population of the respective State within the Gulf Opportunity Zone. 

Gulf Opportunity Zone Bonds issued to finance residences located in the Gulf 

Opportunity Zone are treated as qualified mortgage bonds if the general requirements for 

qualified mortgage bonds are met. The Code also provides special rules for Gulf Opportunity 

Zone Bonds issued to finance residences located in the Gulf Opportunity Zone. For example, the 

first-time homebuyer rule is waived and the income and purchase price rules are relaxed for 

residences financed in the GO Zone, the Rita GO Zone, or the Wilma GO Zone. In addition, the 

Code increases from $15,000 to $150,000 the amount of a qualified home-improvement loan 

with respect to residences located in the specified disaster areas. Gulf Opportunity Zone Bonds 

must be issued before January 1, 2011. 

Explanation of Provision

Under the provision, a qualified GO Zone repair or reconstruction loan is treated as a 

qualified rehabilitation loan for purposes of the qualified mortgage bond rules. Thus, such loans 

financed with the proceeds of qualified mortgage bonds and Gulf Opportunity Zone Bonds may 
20

be used to acquire or replace existing mortgages, without regard to the existing walls or 20 year 

rule under present law. The provision defines a qualified GO Zone repair or reconstruction loan 

as any loan used to repair damage caused by Hurricane Katrina, Hurricane Rita, or Hurricane 

Wilma to a building located in the GO Zones (or reconstruction of such building in the case of 

damage constituting destruction) if the expenditures for such repair or reconstruction are 25 

percent or more of the mortgagor’s adjusted basis in the residence. For purposes of the 

provision, the mortgagor’s adjusted basis is determined as of the later of (1) the completion of 

the repair or reconstruction or (2) the date on which the mortgagor acquires the residence. 

Effective Date

The provision applies to owner-financing provided after the date of enactment and before 

January 1, 2011. 

4. GAO study of practices employed by state and local governments in allocating and 

utilizing tax incentives provided pursuant to the Gulf Opportunity Zone Tax Act of 2005 

(sec. 7524 of the bill) 

Present Law

There is no requirement under present law that the Government Accountability Office 

(“GAO”) study and report on the utilization of tax incentives in the GO Zones. 

Explanation of Provision

The provision requires the GAO to conduct a study of the practices employed by State 

and local governments, and subdivisions thereof, in allocating and utilizing tax incentives 

provided pursuant to the Gulf Opportunity Act of 2005 (Pub. L. No.109-135) and this bill. 

Not more than one year after the date of enactment of this bill, the GAO must submit a 

report to the House Committee on Ways and Means and the Senate Committee on Finance on the 

findings of its study and recommendations, if any, relating to such findings. If the GAO report 

includes findings of significant fraud, waste or abuse, then each of the two committees should 

hold public hearings to review such findings within 60 days of the submission of the report. 

Effective Date

The provision is effective on the date of enactment. 
21

C. Subchapter S Provisions 

(secs. 7531-7536 of the bill and secs. 641, 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. 

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. 
22

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.14

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.15 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.16

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.17 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 

 14 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). 

15 12 U.S.C. secs. 71-72. 

16 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. 

17 No inference is intended as to the proper income tax treatment of restricted bank director stock 

or other similar stock under present law. 
23

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. 

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.18 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.19

Positive adjustments (i.e., additions to taxable income) are generally spread over four 

taxable years beginning in the year of change.20 Negative adjustments (i.e., reductions to taxable 

income) are generally taken into account entirely in the year of change.21

 18 Sec. 1361(b)(2)(A). 

19 Sec. 481. 

20 Rev. Proc. 2002-19, 2002-1 C.B. 696. 

21 Id. 
24

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,22 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 example23 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. 

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 

 22 Treas. Reg. sec. 1.1361-5(b). 

23 Example 1 of Treas. Reg. sec. 1.1361-5(b)(3). 
25

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 percentinterest 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. Deductibility of interest expense of an ESBT on indebtedness incurred to acquire S 

corporation stock 

Present Law

Under present law, an electing small business trust (“ESBT”) is subject to a tax at the 

highest individual income tax rate (currently 35 percent) on the portion of the trust which 
26

consists of stock in one or more S corporations (“S portion”).24 The income from the S portion 

of an ESBT is not included in the beneficiaries' income. 

The only items of income, loss, or deduction taken into account in computing the taxable 

income of the S portion of an ESBT are: (1) the items of income, loss or deduction allocated to it 

as an S corporation shareholder under the rules of subchapter S, (2) gain or loss from the sale of 

the S corporation stock, and (3) to the extent provided in regulations, any state or local income 

taxes and administrative expenses of the ESBT properly allocable to the S corporation stock. 

Under Treasury regulations,25 interest paid by an ESBT to purchase stock in an S corporation is 

allocated to the S portion of the ESBT but is not a deductible administrative expense for 

purposes determining the taxable income of the S portion. 

In determining the tax liability with regard to the remaining portion of the trust, the items 

taken into account by the subchapter S portion of the trust are disregarded. 

Explanation of Provision

The provision provides that a deduction for interest paid or accrued on indebtedness to 

acquire stock in an S corporation may be taken into account in computing the taxable income of 

the S portion of an ESBT. 

Effective Date

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

 24 Sec. 641(c). 

25 Treas. Reg. sec. 1.641(c)-1(d)(4)(ii). 
27

II. REVENUE PROVISIONS 

1. Increase in age of minor children whose unearned income is taxed as if parents’ income 

(sec. 7541 of the bill and sec. 1(g) of the Code) 

Present Law

Special rules (generally referred to as the “kiddie tax”) apply to the net unearned income 

of certain children.26 Generally, the kiddie tax applies to a child if: (1) the child has not reached 

the age of 18 by the close of the taxable year and either of the child's parents is alive at such 

time; (2) the child’s unearned income exceeds $1,700 (for 2007); and (3) the child does not file a 

joint return. The kiddie tax applies regardless of whether the child may be claimed as a 

dependent by either or both parents. 

Under these rules, the net unearned income of a child (for 2007, generally unearned 

income over $1,700) is taxed at the parents’ tax rates if the parents’ tax rates are higher than the 

tax rates of the child.27 The remainder of a child’s taxable income (i.e., earned income, plus 

unearned income up to $1,700 (for 2007), less the child’s standard deduction) is taxed at the 

child’s rates, regardless of whether the kiddie tax applies to the child. For these purposes, 

unearned income is income other than wages, salaries, professional fees, other amounts received 

as compensation for personal services actually rendered, and distributions from qualified 

disability trusts.28 In general, a child is eligible to use the preferential tax rates for qualified 

dividends and capital gains.29 

The kiddie tax is calculated by computing the “allocable parental tax.” This involves 

adding the net unearned income of the child to the parent’s income and then applying the 

parent’s tax rate. A child’s “net unearned income” is the child’s unearned income less the sum 

of (1) the minimum standard deduction allowed to dependents ($850 for 2007), and (2) the 

greater of (a) such minimum standard deduction amount or (b) the amount of allowable itemized 

deductions that are directly connected with the production of the unearned income.30 A child’s 

net unearned income cannot exceed the child’s taxable income. 

 The allocable parental tax equals the hypothetical increase in tax to the parent that results 

from adding the child’s net unearned income to the parent’s taxable income. If the child has net 

capital gains or qualified dividends, these items are allocated to the parent’s hypothetical taxable 

income according to the ratio of net unearned income to the child’s total unearned income. If a 

 26 Sec. 1(g). 

27 Special rules apply for determining which parent’s rates apply where a joint return is not filed. 

28 Sec. 1(g)(4) and sec. 911(d)(2). 

29 Sec. 1(h). 

30 Sec. 1(g)(4). 
28

parent has more than one child subject to the kiddie tax, the net unearned income of all children 

is combined, and a single kiddie tax is calculated. Each child is then allocated a proportionate 

share of the hypothetical increase, based upon the child’s net unearned income relative to the 

aggregate net unearned income of all of the parent’s children subject to the tax. 

Generally, a child must file a separate return to report his or her income.31 In such case, 

items on the parents’ return are not affected by the child’s income, and the total tax due from the 

child is the greater of: 

1. the sum of (a) the tax payable by the child on the child’s earned income and unearned 

income up to $1,700 (for 2007), plus (b) the allocable parental tax on the child’s 

unearned income, or 

2. the tax on the child’s income without regard to the kiddie tax provisions. 

Under certain circumstances, a parent may elect to report a child’s unearned income on the 

parent’s return. 

Explanation of Provision

The provision expands the kiddie tax to apply to children who are 18 years old or who are 

full-time students over age 18 but under age 24. The expanded provision applies only to children 

whose earned income does not exceed one-half of the amount of their support. 

Effective Date

The provision is effective for taxable years beginning after the date of enactment. 

2. Suspension of penalties and interest (sec. 7542 of the bill and sec. 6404(g) of the Code) 

Present Law

In general, interest and penalties accrue during periods for which taxes were unpaid 

without regard to whether the taxpayer was aware that there was tax due. The Code suspends the 

accrual of certain penalties and interest starting 18 months after the filing of the tax return if the 

IRS has not sent the taxpayer a notice specifically stating the taxpayer's liability and the basis for 

the liability within the specified period. If the return is filed before the due date, for this purpose 

it is considered to have been filed on the due date. Interest and penalties resume 21 days after 

the IRS sends the required notice to the taxpayer. The provision is applied separately with 

respect to each item or adjustment. The provision does not apply where a taxpayer has 

self-assessed the tax. The suspension applies only to taxpayers who are individuals and who file 

a timely tax return. In addition, the provision does not apply to the failure-to-pay penalty, in the 

case of fraud, or with respect to criminal penalties. Generally, the provision also does not apply 

 31 In cases where the kiddie tax applies, the child must attach to the return Form 8615, Tax for 

Children Under Age 18 With Investment Income of More Than $1,700 (2006). 
29

to interest accruing with respect to underpayments resulting from listed transactions or 

undisclosed reportable transactions. 

Explanation of Provision

The provision extends the period before which accrual of interest and certain penalties 

are suspended. Under the provision, the accrual of certain penalties and interest is suspended 

starting 36 months after the filing of the tax return if the IRS has not sent the taxpayer a notice 

specifically stating the taxpayer's liability and the basis for the liability. 

Effective Date

The provision is effective for IRS notices issued after the date that is six months after the 

date of enactment. 

3. Modification of collection due process procedures for employment tax liabilities 

(sec. 7543 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.32 Similar rules apply with respect to notices of tax liens, although the right to a 

hearing arises only on the filing of a notice.33 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. 

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 

 32 Sec. 6330(a). 

33 Sec. 6320. 
30

tax withholding”).34 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. 

Explanation of Provision

Under the provision, a levy issued to collect Federal employment taxes is excepted from 

the pre-levy CDP hearing requirement if the taxpayer subject to the levy requested a CDP 

hearing with respect to unpaid employment taxes arising in the two-year period before the 

beginning of the taxable period with respect to which the employment tax levy is served. 

However, the taxpayer is provided an opportunity for a hearing within a reasonable period of 

time after the levy. As the Code provides for State tax refunds or jeopardy determinations, 

collection by levy of employment tax liabilities 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. 

4. Permanent extension of IRS user fees (sec. 7544 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.35 These user fees are authorized by 

statute through September 30, 2014. 

Explanation of Provision

The provision permanently extends the statutory authorization for IRS user fees. 

Effective Date

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

 34 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. 

35 Section 7528. 
31

5. Increase in penalty for bad checks and money orders (sec. 7545 of the bill and sec. 6657 

of the Code) 

Present Law

The Code36 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). 

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. 

6. Understatement of taxpayer’s liability by tax return preparers (sec. 7546 of the bill and 

secs. 6694 and 7701 of the Code) 

Present Law

An income tax return preparer is defined as any person who prepares for compensation, 

or who employs other people to prepare for compensation, all or a substantial portion of an 

income tax return or claim for refund.37 Under present law, the definition of an income tax 

return preparer does not include a person preparing non-income tax returns, such as estate and 

gift, excise, or employment tax returns. 

An income tax return preparer who prepares a return with respect to which there is an 

understatement of tax that is due to an undisclosed position for which there was not a realistic 

possibility of being sustained on its merits, or a frivolous position, is liable for a first-tier penalty 

of $250, provided the preparer knew or reasonably should have known of the position.38 For 

purposes of the penalty, an understatement is generally defined as any understatement with 

respect to any tax imposed by subtitle A (i.e., income taxes). An income tax return preparer who 

prepares a return and engages in specified willful or reckless conduct with respect to preparing 

an income tax return is liable for a second-tier penalty of $1,000. 

 36 Sec. 6657. 

37 Sec. 7701(a)(36)(A). 

38 Sec. 6694. 
32

Explanation of Provision

The provision broadens the scope of the present-law tax return preparer penalties to 

include preparers of estate and gift tax, employment tax, and excise tax returns, and returns of 

exempt organizations. 

The provision also alters the standards of conduct that must be met to avoid imposition of 

the penalties for preparing a return with respect to which there is an understatement of tax. First, 

the provision replaces the realistic possibility standard for undisclosed positions with a 

requirement that there be a reasonable belief that the tax treatment of the position was more 

likely than not the proper treatment. The provision replaces the not-frivolous standard 

accompanied by disclosure with the requirement that there be a reasonable basis for the tax 

treatment of the position accompanied by disclosure. 

The provision also increases the first-tier penalty from $250 to the greater of $1,000 or 50 

percent of the income derived (or to be derived) by the tax return preparer from the preparation 

of a return or claim with respect to which the penalty is imposed. The provision increases the 

second-tier penalty from $1,000 to the greater of $5,000 or 50 percent of the income derived (or 

to be derived) by the tax return preparer. 

Effective Date

The provision is effective for tax returns prepared after the date of enactment. 

7. Penalty for filing erroneous refund claims (sec. 7547 of the bill and sec. 6662 of the 

Code) 

Present Law

Present law imposes accuracy-related penalties on a taxpayer in cases involving a 

substantial valuation misstatement or gross valuation misstatement relating to an underpayment 

of income tax.39 For this purpose, a substantial valuation misstatement generally means a value 

claimed that is at least twice (200 percent or more) the amount determined to be the correct 

value, and a gross valuation misstatement generally means a value claimed that is at least four 

times (400 percent or more) the amount determined to be the correct value. 

The penalty is 20 percent of the underpayment of tax resulting from a substantial 

valuation misstatement and rises to 40 percent for a gross valuation misstatement. No penalty is 

imposed unless the portion of the underpayment attributable to the valuation misstatement 

exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal 

holding company). Under present law, no penalty is imposed with respect to any portion of the 

understatement attributable to any 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 

 39 Sec. 6662(b)(3) and (h). 
33

adequately disclosed on the return or on a statement attached to the return and there is a 

reasonable basis for the tax treatment. Special rules apply to tax shelters. 

Explanation of Provision

The provision imposes a penalty on any taxpayer filing an erroneous claim for refund or 

credit. The penalty is equal to 20 percent of the disallowed portion of the claim for refund or 

credit for which there is no reasonable basis for the claimed tax treatment. The penalty does not 

apply to any portion of the disallowed portion of the claim for refund or credit relating to the 

earned income credit or any portion of the disallowed portion of the claim for refund or credit 

that is subject to accuracy-related or fraud penalties. 

Effective Date

The provision is effective for claims for refund or credit filed after the date of enactment. 

8. Time for payment of corporate estimated tax (sec. 7548 of the bill) 

Present Law

In general, corporations are required to make quarterly estimated tax payments of their 

income tax liability. For a corporation whose taxable year is a calendar year, these estimated tax 

payments must be made by April 15, June 15, September 15, and December 15. Fiscal year 

taxpayers make quarterly payments on corresponding dates. 

The Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”) provided that in 

the case of a corporation with assets of at least $1 billion, the payments due in July, August, and 

September, 2012 (for fiscal and calendar year taxpayers, respectively) are increased to 106.25 

percent of the payment otherwise due and the next required payment is reduced accordingly. 

Explanation of Provision

The provision increases the corporate estimated tax payments due in July, August, and 

September, 2012, from 106.25 percent to 114.25 percent of the payment otherwise due. As 

under present law, the next payment is reduced accordingly. 

Effective Date

The provision is effective on the date of enactment.