DESCRIPTION OF THE

"CARE ACT OF 2002"

Scheduled for a Markup

By the

SENATE COMMITTEE ON FINANCE

on June 13, 2002

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

June 11, 2002

JCX-57-02
i

CONTENTS

Page

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

I. CHARITABLE GIVING INCENTIVES.................................................................................... 2

A. Charitable Deduction for Nonitemizers.............................................................................. 2

B. Tax-Free Distributions From Individual Retirement Arrangements for Charitable 

Purposes.............................................................................................................................. 5

C. Charitable Deduction for Contributions of Food Inventory ............................................. 11

D. Charitable Deduction for Contributions of Book Inventory............................................. 13

E. Charitable Deduction for Contributions of Bonds............................................................ 14

F. Expand Charitable Contribution Allowed for Scientific Property Used for Research

and for Computer Technology and Equipment................................................................. 15

G. Encourage Contributions of Capital Gain Real Property Made for Conservation

Purposes............................................................................................................................ 17

H. 25 Percent Exclusion for Sales Made for Qualifying Conservation Purposes.................. 20

I. Cost Sharing Payments under the Partners for Fish and Wildlife Program...................... 21

J. Adjust Basis of S Corporation Stock for Certain Charitable Contributions..................... 22

II. DISCLOSURE OF INFORMATION RELATING TO TAX-EXEMPT

 ORGANIZATIONS................................................................................................................. 24

A. Disclosure of Written Determinations .............................................................................. 24

B. Disclosure of Internet Web Site and Name Under Which Organization Does Business.. 29

C. Modification to Reporting of Capital Transactions .......................................................... 30

D. Disclosure that Form 990 is Publicly Available ............................................................... 31

E. Disclosure to State Officials of Proposed Actions Related to Section 501(c)(3) 

Organizations.................................................................................................................... 32

III. OTHER CHARITABLE AND EXEMPT ORGANIZATION PROVISIONS...................... 35

A. Modify Tax on Unrelated Business Taxable Income of Charitable Remainder Trusts.... 35

B. Modify Section 512(b)(13) ............................................................................................... 37

C. Simplification of Lobbying Expenditure Limitation ........................................................ 39

D. Expedited Review Process for Certain Tax-Exemption Applications.............................. 43

E. Clarification of Definition of Church Tax Inquiry ........................................................... 45

F. Extension of Declaratory Judgment Procedures to Non-501(c)(3) Tax-Exempt 

Organizations.................................................................................................................... 46

G. Definition of Convention or Association of Churches ..................................................... 48

H. Charitable Contribution Deduction for Certain Expenses in Support of Native

Alaskan Subsistence Whaling........................................................................................... 49

I. Payments by Charitable Organizations to Victims of War on Terrorism......................... 50

IV. RESTORATION OF SOCIAL SERVICES BLOCK GRANT FUNDING........................... 52
ii

V. REVENUE RAISING PROPOSALS...................................................................................... 53

A. Tax Shelter Transparency Act .......................................................................................... 53

1. Penalty for failure to disclose reportable transactions.................................................. 53

2. Modifications to the accuracy-related penalties for listed transactions and reportable

 transactions having a significant tax avoidance purpose .............................................. 55

3. Modifications to the substantial understatement penalty.............................................. 57

4. Tax shelter exception to confidentiality privileges relating to taxpayer

 communications........................................................................................................... 58

5. Disclosure of reportable transactions by material advisors .......................................... 59

6. Investor lists and applicable penalties........................................................................... 61

7. Actions to enjoin conduct with respect to tax shelters.................................................. 63

8. Understatement of taxpayer’s liability by income tax return preparer......................... 63

9. Penalty on failure to report interests in foreign financial accounts............................... 64

10. Frivolous tax returns and submissions........................................................................ 65

11. Regulation of individuals practicing before the Department of the Treasury............. 66

12. Penalties on promoters of tax shelters ........................................................................ 67

B. Tax Treatment of Inversion Transactions......................................................................... 68

C. Reinsurance Agreements .................................................................................................. 73

D. Extension of IRS User Fees.............................................................................................. 74

E. Imposition of Custom User Fees....................................................................................... 75
1

INTRODUCTION

The Senate Committee on Finance has scheduled a markup on June 13, 2002, of the 

“CARE Act of 2002”. This document1, prepared by the staff of the Joint Committee on 

Taxation, provides a description of the “CARE Act of 2002.”

 

1

 This document may be cited as follows: Joint Committee on Taxation, Description of 

the “CARE Act of 2002” (JCX-57-02), June 11, 2002.
2

I. CHARITABLE GIVING INCENTIVES 

A. Charitable Deduction for Nonitemizers

Present Law

In computing taxable income, an individual taxpayer who itemizes deductions generally 

is allowed to deduct the amount of cash and up to the fair market value of property contributed to 

a charity described in section 501(c)(3)2 or a Federal, State, or local governmental entity. The 

deduction also is allowed for purposes of calculating alternative minimum taxable income. 

The amount of the deduction allowable for a taxable year with respect to a charitable 

contribution of property may be reduced depending on the type of property contributed, the type 

of charitable organization to which the property is contributed, and the income of the taxpayer.3

A taxpayer who takes the standard deduction (i.e., who does not itemize deductions) may 

not take a separate deduction for charitable contributions.4

A payment to a charity (regardless of whether it is termed a “contribution”) in exchange 

for which the donor receives an economic benefit is not deductible, except to the extent that the 

donor can demonstrate that the payment exceeds the fair market value of the benefit received 

from the charity. To facilitate distinguishing charitable contributions from purchases of goods or 

services from charities, present law provides that no charitable contribution deduction is allowed 

for a separate contribution of $250 or more unless the donor obtains a contemporaneous written 

acknowledgement of the contribution from the charity indicating whether the charity provided 

any good or service (and an estimate of the value of any such good or service) to the taxpayer in 

consideration for the contribution.5 In addition, present law requires that any charity that 

receives a contribution exceeding $75 made partly as a gift and partly as consideration for goods 

or services furnished by the charity (a “quid pro quo” contribution) is required to inform the 

contributor in writing of an estimate of the value of the goods or services furnished by the charity 

 

2

 All section references are to the Internal Revenue Code of 1986, unless otherwise 

indicated.

3

 Secs. 170(b) and (e).

4

 Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a temporary provision 

that permitted individual taxpayers who did not itemize income tax deductions to claim a 

deduction from gross income for a specified percentage of their charitable contributions. The 

maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent of the amount of the 

contribution for 1985, and 100 percent of the amount of the contribution for 1986. The 

nonitemizer deduction terminated after 1986.

5

 Sec. 170(f)(8).
3

and that only the portion exceeding the value of the goods or services is deductible as a 

charitable contribution.6

Under present law, total deductible contributions of an individual taxpayer to public 

charities, private operating foundations, and certain types of private nonoperating foundations 

may not exceed 50 percent of the taxpayer’s contribution base, which is the taxpayer’s adjusted 

gross income for a taxable year (disregarding any net operating loss carryback). To the extent a 

taxpayer has not exceeded the 50-percent limitation, (1) contributions of capital gain property to 

public charities generally may be deducted up to 30 percent of the taxpayer’s contribution base, 

(2) contributions of cash to private foundations and certain other charitable organizations 

generally may be deducted up to 30 percent of the taxpayer’s contribution base, and (3) 

contributions of capital gain property to private foundations and certain other charitable 

organizations generally may be deducted up to 20 percent of the taxpayer’s contribution base.

Contributions by individuals in excess of the 50-percent, 30-percent, and 20-percent limit 

may be carried over and deducted over the next five taxable years, subject to the relevant 

percentage limitations on the deduction in each of those years.

In addition to the percentage limitations imposed specifically on charitable contributions, 

present law imposes a reduction on most itemized deductions, including charitable contribution 

deductions, for taxpayers with adjusted gross income in excess of a threshold amount, which is 

indexed annually for inflation. The threshold amount for 2002 is $137,300 ($68,650 for married 

individuals filing separate returns). For those deductions that are subject to the limit, the total 

amount of itemized deductions is reduced by three percent of adjusted gross income over the 

threshold amount, but not by more than 80 percent of itemized deductions subject to the limit. 

Beginning in 2006, the overall limitation on itemized deductions phases-out for all taxpayers. 

The overall limitation on itemized deductions is reduced by one-third in taxable years beginning 

in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall 

limitation on itemized deductions is eliminated for taxable years beginning after December 31, 

2009; however, this elimination of the limitation sunsets on December 31, 2010.

Description of Proposal

In the case of an individual taxpayer who does not itemize deductions, the proposal 

would allow a direct charitable deduction from adjusted gross income for charitable 

contributions paid in cash. This deduction would be allowed in addition to the standard 

deduction. The deduction would be available only for that portion of contributions that in the 

aggregate exceed $250 ($500 in the case of a joint return). The maximum deduction would be 

$250 ($500 in the case of a joint return). For example, an individual would not be entitled to a 

charitable deduction for the first $250 of cash contributions made during the tax year, would be 

entitled to a deduction on a dollar-for-dollar basis for contributions of $251 to $500 (e.g., a $1 

contribution deduction in the case of $251 of contributions, and a $250 deduction in the case of 

$500 of contributions), and would not be entitled to a deduction for any contributions exceeding 

$500. The direct charitable deduction generally would be subject to the tax rules normally 

 

6

 Sec. 6115.
4

governing charitable contribution deductions, such as the substantiation requirements. The 

deduction would be allowed in computing alternative minimum taxable income.

The Secretary of the Treasury would be required to complete a study by December 31, 

2003, of the effect of the proposal on increased charitable giving, and of taxpayer compliance, 

for example, by comparing compliance by taxpayers who itemize their charitable contributions 

with compliance by those who claim the direct charitable deduction. 

Effective Date

The direct charitable deduction would be effective for taxable years beginning after 

December 31, 2001, and before January 1, 2004. The Treasury study would be required by 

December 31, 2003.
5

B. Tax-Free Distributions From Individual Retirement Arrangements 

for Charitable Purposes

Present Law

In general

If an amount withdrawn from a traditional individual retirement arrangement (“IRA”) or 

a Roth IRA is donated to a charitable organization, the rules relating to the tax treatment of 

withdrawals from IRAs apply to the amount withdrawn and the charitable contribution is subject 

to the normally applicable limitations on deductibility of such contributions.

Charitable contributions

In computing taxable income, an individual taxpayer who itemizes deductions generally 

is allowed to deduct the amount of cash and up to the fair market value of property contributed to 

a charity described in section 501(c)(3) or a Federal, State, or local governmental entity. The 

deduction also is allowed for purposes of calculating alternative minimum taxable income. 

The amount of the deduction allowable for a taxable year with respect to a charitable 

contribution of property may be reduced depending on the type of property contributed, the type 

of charitable organization to which the property is contributed, and the income of the taxpayer.7

A taxpayer who takes the standard deduction (i.e., who does not itemize deductions) may 

not take a separate deduction for charitable contributions.8

A payment to a charity (regardless of whether it is termed a “contribution”) in exchange 

for which the donor receives an economic benefit is not deductible, except to the extent that the 

donor can demonstrate that the payment exceeds the fair market value of the benefit received 

from the charity. To facilitate distinguishing charitable contributions from purchases of goods or 

services from charities, present law provides that no charitable contribution deduction is allowed 

for a separate contribution of $250 or more unless the donor obtains a contemporaneous written 

acknowledgement of the contribution from the charity indicating whether the charity provided 

any good or service (and an estimate of the value of any such good or service) to the taxpayer in 

consideration for the contribution.9 In addition, present law requires that any charity that 

receives a contribution exceeding $75 made partly as a gift and partly as consideration for goods 

 

7

 Secs. 170(b) and (e).

8

 Sec. 170(a). The Economic Recovery Tax Act of 1981 adopted a temporary provision 

that permitted individual taxpayers who did not itemize income tax deductions to claim a 

deduction from gross income for a specified percentage of their charitable contributions. The 

maximum deduction was $25 for 1982 and 1983, $75 for 1984, 50 percent of the amount of the 

contribution for 1985, and 100 percent of the amount of the contribution for 1986. The 

nonitemizer deduction terminated after 1986.

9

 Sec. 170(f)(8).
6

or services furnished by the charity (a “quid pro quo” contribution) is required to inform the 

contributor in writing of an estimate of the value of the goods or services furnished by the charity 

and that only the portion exceeding the value of the goods or services is deductible as a 

charitable contribution.10

Under present law, total deductible contributions of an individual taxpayer to public 

charities, private operating foundations, and certain types of private nonoperating foundations 

may not exceed 50 percent of the taxpayer’s contribution base, which is the taxpayer’s adjusted 

gross income for a taxable year (disregarding any net operating loss carryback). To the extent a 

taxpayer has not exceeded the 50-percent limitation, (1) contributions of capital gain property to 

public charities generally may be deducted up to 30 percent of the taxpayer’s contribution base, 

(2) contributions of cash to private foundations and certain other charitable organizations 

generally may be deducted up to 30 percent of the taxpayer’s contribution base, and (3) 

contributions of capital gain property to private foundations and certain other charitable 

organizations generally may be deducted up to 20 percent of the taxpayer’s contribution base.

Contributions by individuals in excess of the 50-percent, 30-percent, and 20-percent limit 

may be carried over and deducted over the next five taxable years, subject to the relevant 

percentage limitations on the deduction in each of those years.

In addition to the percentage limitations imposed specifically on charitable contributions, 

present law imposes a reduction on most itemized deductions, including charitable contribution 

deductions, for taxpayers with adjusted gross income in excess of a threshold amount, which is 

indexed annually for inflation. The threshold amount for 2002 is $137,300 ($68,650 for married 

individuals filing separate returns). For those deductions that are subject to the limit, the total 

amount of itemized deductions is reduced by three percent of adjusted gross income over the 

threshold amount, but not by more than 80 percent of itemized deductions subject to the limit. 

Beginning in 2006, the overall limitation on itemized deductions phases-out for all taxpayers. 

The overall limitation on itemized deductions is reduced by one-third in taxable years beginning 

in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall 

limitation on itemized deductions is eliminated for taxable years beginning after December 31, 

2009; however, this elimination of the limitation sunsets on December 31, 2010.

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if 

the donor transfers an interest in property to a charity (e.g., a remainder) while also either 

retaining an interest in that property (e.g., an income interest) or transferring an interest in that 

property to a noncharity for less than full and adequate consideration.11 Exceptions to this 

general rule are provided for, among other interests, remainder interests in charitable remainder 

annuity trusts, charitable remainder unitrusts, and pooled income funds, and present interests in 

the form of a guaranteed annuity or a fixed percentage of the annual value of the property.12 For 

 

10 Sec. 6115.

11 Secs. 170(f), 2055(e)(2), and 2522(c)(2).

12 Sec. 170(f)(2).
7

such interests, a charitable deduction is allowed to the extent of the present value of the interest 

designated for a charitable organization.

IRA rules

Within limits, individuals may make deductible and nondeductible contributions to a 

traditional IRA. Amounts in a traditional IRA are includible in income when withdrawn (except 

to the extent the withdrawal represents a return of nondeductible contributions). Individuals also 

may make nondeductible contributions to a Roth IRA. Qualified withdrawals from a Roth IRA 

are excludable from gross income. Withdrawals from a Roth IRA that are not qualified 

withdrawals are includible in gross income to the extent attributable to earnings. Includible 

amounts withdrawn from a traditional IRA or a Roth IRA before attainment of age 59-1/2 are 

subject to an additional 10-percent early withdrawal tax, unless an exception applies.

If an individual has made nondeductible contributions to a traditional IRA, a portion of 

each distribution from an IRA is nontaxable, until the total amount of nondeductible 

contributions has been received. In general, the amount of a distribution that is nontaxable is 

determined by multiplying the amount of the distribution by the ratio of the remaining 

nondeductible contributions to the account balance. In making the calculation, all traditional 

IRAs of an individual are treated as a single IRA, all distributions during any taxable year are 

treated as a single distribution, and the value of the contract, income on the contract, and 

investment in the contract are computed as of the close of the calendar year.

In the case of a distribution from a Roth IRA that is not a qualified distribution, in 

determining the portion of the distribution attributable to earnings, contributions and 

distributions are deemed to be distributed in the following order: (1) regular Roth IRA 

contributions; (2) taxable conversion contributions;13 (3) nontaxable conversion contributions; 

and (4) earnings. In determining the amount of taxable distributions from a Roth IRA, all Roth 

IRA distributions in the same taxable year are treated as a single distribution, all regular Roth 

IRA contributions for a year are treated as a single contribution, and all conversion contributions 

during the year are treated as a single contribution.

Split-interest trust filing requirements

Split-interest trusts, including charitable remainder annuity trusts, charitable remainder 

unitrusts, and pooled income funds, are required to file an annual information return14 (Form 

1041A). Trusts that are not split-interest trusts but that claim a charitable deduction for amounts 

permanently set aside for a charitable purpose15 also are required to file Form 1041A. The 

 

13 Conversion contributions refer to conversions of amounts in a traditional IRA to a 

Roth IRA.

14 Sec. 6034. This requirement applies to all split-interest trusts described in section 

4947(a)(2). 

15 Sec. 642(c).
8

returns are required to be made publicly available.16 A trust that is required to distribute all trust 

net income currently to trust beneficiaries in a taxable year is exempt from this return 

requirement for such taxable year. A failure to file the required return may result in a penalty on 

the trust of $10 a day for as long as the failure continues, up to a maximum of $5,000 per return.

In addition, split-interest trusts are required to file annually Form 5227.17 Form 5227 

requires disclosure of information regarding a trust’s noncharitable beneficiaries. The penalty 

for failure to file this return is calculated based on the amount of tax owed. A split-interest trust 

generally is not subject to tax and therefore, in general, a penalty may not be imposed for the 

failure to file Form 5227. Form 5227 is not required to be made publicly available.

Description of Proposal

Qualified charitable distributions from IRAs

The proposal would provide an exclusion from gross income for otherwise taxable IRA 

distributions from a traditional or a Roth IRA in the case of qualified charitable distributions. 

Special rules would apply in determining the amount of an IRA distribution that would be 

otherwise taxable. The present-law rules regarding taxation of IRA distributions and the 

deduction of charitable contributions would continue to apply to distributions from an IRA that 

are not qualified charitable distributions. 

A qualified charitable distribution would be defined as any distribution from an IRA that 

is made directly by the IRA trustee either to (1) an organization to which deductible 

contributions can be made (a “direct distribution”) or (2) a “split-interest entity.” A split-interest 

entity would mean a charitable remainder annuity trust or charitable remainder unitrust (together 

referred to as a “charitable remainder trust”), a pooled income fund, or a charitable gift annuity. 

Direct distributions would be eligible for the exclusion only if made on or after the date the IRA 

owner attains age 70-1/2. Distributions to a split interest entity would be eligible for the 

exclusion only if made on or after the date the IRA owner attains age 59-1/2. In the case of splitinterest distributions, no person may hold an income interest in the amounts in the split-interest 

entity attributable to the charitable distribution other than the IRA owner, his or her spouse, or a 

charitable organization. 

The exclusion would apply to direct distributions only if a charitable contribution 

deduction for the entire distribution would otherwise be allowable, determined without regard to 

the generally applicable percentage limitations. Thus, for example, if the deductible amount 

would be reduced because of a benefit received in exchange, or if a deduction would not be 

allowable because the donor did not obtain sufficient substantiation, the exclusion would not be 

available with respect to any part of the distribution. Similarly, the exclusion would apply in the 

case of a distribution directly to a split-interest entity only if a charitable contribution deduction 

for the entire present value of the charitable interest (for example, a remainder interest) would be 

allowable, determined without regard to the generally applicable percentage limitations.

 

16 Sec. 6104(b).

17 Sec. 6011; Treas. Reg. sec. 53.6011-1(d).
9

If the IRA owner has any IRA that includes nondeductible contributions, a special rule 

would apply in determining the portion of a distribution that would be includible in gross income 

(but for the proposal) and thus is eligible for qualified charitable distribution treatment. In such 

case, the IRA owner would aggregate all IRAs to determine eligibility for the exclusion. Under 

the special rule, the distribution would be treated as consisting of income first, up to the 

aggregate amount that would be includible in gross income (but for the proposal) if all amounts 

were distributed from all IRAs otherwise taken into account in determining the amount of IRA 

distributions during the year that is includible in income. In determining the amount of 

subsequent IRA distributions includible in income, proper adjustments would be made to reflect 

the amount treated as a qualified charitable distribution under the special rule.

Special rules would apply for distributions to split-interest entities. For distributions to 

charitable remainder trusts, the proposal would provide that subsequent distributions from the 

charitable remainder trust would be treated as ordinary income in the hands of the beneficiary, 

notwithstanding how such amounts normally would be treated under section 664(b). In addition, 

for a charitable remainder trust to be eligible to receive qualified charitable distributions, the 

charitable remainder trust would have to be funded exclusively by such distributions. For 

example, an IRA owner would not be able to make qualified charitable distributions to an 

existing charitable remainder trust any part of which was funded with assets that were not 

qualified charitable distributions. 

Under the proposal, a pooled income fund would be eligible to receive qualified 

charitable distributions only if the fund accounts separately for amounts attributable to such 

distributions. In addition, all distributions from the pooled income fund that are attributable to 

qualified charitable distributions would be treated as ordinary income to the beneficiary. 

Qualified charitable distributions to a pooled income fund would not be includible in the fund’s 

gross income.

In determining the amount includible in gross income by reason of a payment from a 

charitable gift annuity purchased with a qualified charitable distribution from an IRA, the portion 

of the distribution from the IRA used to purchase the annuity would not be an investment in the 

annuity contract.

Any amount excluded from gross income by reason of the proposal would not be taken 

into account in determining the deduction for charitable contributions under section 170.

Split-interest trust filing requirements

The proposal would increase the penalty on split-interest trusts for failure to file a return 

and for failure to include any of the information required to be shown on such return and to show 

the correct information, and would impose personal liability for such penalty on certain persons 

in certain circumstances. The penalty would be $20 for each day the failure continues up to 

$10,000 for any one return. In the case of a split-interest trust with gross income in excess of 

$250,000, the penalty would be $100 for each day the failure continues up to a maximum of 

$50,000. If a person (meaning any officer, director, trustee, employee, or other individual who is 
10

under a duty to file the return or include required information)18 knowingly failed to file the 

return or include required information, then that person would personally be liable for such 

penalty. Information regarding beneficiaries that are not charitable organizations as described in 

section 170(c) would be exempt from the requirement to make information publicly available. In 

addition, the proposal would repeal the present-law exception to the filing requirement for splitinterest trusts that are required in a taxable year to distribute all net income currently to 

beneficiaries. Such exception would remain available to trusts other than split-interest trusts that 

are otherwise subject to the filing requirement. 

Effective Date

The proposal generally would be effective for taxable years beginning after December 

31, 2002. The provision relating to information returns of split-interest trusts would be effective 

for returns for taxable years beginning after December 31, 2002.

 

18 Sec. 6652(c)(4)(C).
11

C. Charitable Deduction for Contributions of Food Inventory

Present Law

Under present law, a taxpayer’s deduction for charitable contributions of inventory 

generally is limited to the taxpayer’s basis (typically, cost) in the inventory. 

However, for certain contributions of inventory, C corporations may claim an enhanced 

deduction equal to the lesser of (1) basis plus one-half of the item’s appreciated value (i.e., basis 

plus one half of fair market value in excess of basis) or (2) two times basis.19 To be eligible for 

the enhanced deduction, the contributed property generally must be inventory of the taxpayer, 

contributed to a charitable organization described in section 501(c)(3) (except for private 

nonoperating foundations), and the donee must (1) use the property consistent with the donee’s 

exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in 

exchange for money, other property, or services, and (3) provide the taxpayer a written statement 

that the donee’s use of the property will be consistent with such requirements. In the case of 

contributed property subject to the Federal Food, Drug, and Cosmetic Act, the property must 

satisfy the applicable requirements of such Act on the date of transfer and for 180 days prior to 

the transfer. 

To use the enhanced deduction, the taxpayer must establish that the fair market value of 

the donated item exceeds basis. The valuation of food inventory has been the subject of ongoing 

disputes between taxpayers and the IRS. In one case, the Tax Court held that the value of 

surplus bread inventory donated to charity was the full retail price of the bread rather than half 

the retail price, as the IRS asserted.20

Description of Proposal

Under the proposal, any taxpayer, whether or not a C corporation, engaged in a trade or 

business would be eligible to claim an enhanced deduction for donations of food inventory. For 

taxpayers other than C corporations, the total deduction for donations of food inventory in a 

taxable year could not exceed 10 percent of the taxpayer’s net income for such year from its 

trade or business. In addition, a non-C corporate taxpayer would be required to apply separately 

carryforwards of contributions of food inventory and other charitable contributions.

The proposal would change the amount of the present-law enhanced deduction for 

eligible contributions of food inventory to the lesser of fair market value or twice the taxpayer’s 

basis in the inventory. For example, a taxpayer who makes an eligible donation of food that has 

a fair market value of $10 and a basis of $4 could take a deduction of $8 (twice basis). If the 

taxpayer’s basis was $6 instead of $4, then the deduction would be $10 (fair market value). 

Under present law, a C corporation’s deduction in the first example would be $7 (fair market 

value less half the appreciation) and in the second example would be $8. (Under present law, 

 

19 Sec. 170(e)(3). In general, a C corporation’s charitable contribution deductions for a 

year may not exceed 10 percent of the corporation’s taxable income. Sec. 170(b)(2).

20

 Lucky Stores Inc. v. Commissioner, 105 T.C. 420 (1995).
12

taxpayers other than C corporations generally could take a deduction for a contribution of food 

inventory only for the $4 basis in either example.) Taxpayers that do not account for inventories 

under section 471 and who are not required to capitalize indirect costs under section 263A would 

be able to elect to treat the basis of the contributed food as being equal to 25 percent of the 

food’s fair market value.21

The enhanced deduction would be available only for food that qualifies as “apparently 

wholesome food.” “Apparently wholesome food” would be defined as food intended for human 

consumption that meets all quality and labeling standards imposed by Federal, State, and local 

laws and regulations even though the food may not be readily marketable due to appearance, age, 

freshness, grade, size, surplus, or other conditions.

In addition, the proposal would provide that the fair market value of donated apparently 

wholesome food that cannot or will not be sold solely due to internal standards of the taxpayer or 

lack of market would be determined without regard to such internal standards or lack of market 

and by taking into account the price at which the same or substantially the same food items are 

sold by the taxpayer at the time of the contribution or, if not so sold at such time, in the recent 

past.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2002.

 

21 This would include, for example, taxpayers who are eligible for administrative relief 

under Revenue Procedures 2002-28 and 2001-10.
13

D. Charitable Deduction for Contributions of Book Inventory

Present Law

Under present law, a taxpayer’s deduction for charitable contributions of inventory 

generally is limited to the taxpayer’s basis (typically, cost) in the inventory. 

However, for certain contributions of inventory, C corporations may claim an enhanced 

deduction equal to the lesser of (1) basis plus one-half of the item’s appreciated value (i.e., basis 

plus one half of fair market value in excess of basis) or (2) two times basis.22 To be eligible for 

the enhanced deduction, the contributed property generally must be inventory of the taxpayer, 

contributed to a charitable organization described in section 501(c)(3) (except for private 

nonoperating foundations), and the donee must: (1) use the property consistent with the donee’s 

exempt purpose solely for the care of the ill, the needy, or infants, (2) not transfer the property in 

exchange for money, other property, or services, and (3) provide the taxpayer a written statement 

that the donee’s use of the property will be consistent with such requirements.

Description of Proposal

The proposal would modify the present-law enhanced deduction for C corporations so 

that it would be equal to the lesser of fair market value or twice the taxpayer’s basis in the case 

of qualified book contributions. For example, a C corporation that made a qualified book 

contribution with a fair market value of $10 and a basis of $4 could take a deduction of $8 (twice 

basis). If the taxpayer’s basis was $6 instead of $4, then the deduction would be $10 (fair market 

value). 

A qualified book contribution would mean a charitable contribution of books to: (1) an 

educational organization which normally maintains a regular faculty and curriculum and 

normally has a regularly enrolled body of pupils or students in attendance at the place where its 

educational activities are regularly carried on; (2) a public library; or (3) an organization 

described in section 501(c)(3) (except for private nonoperating foundations), which is organized 

primarily to make books available to the general public at no cost or to operate a literacy 

program. The donee must: (1) use the property consistent with the donee’s exempt purpose; (2) 

not transfer the property in exchange for money, other property, or services; (3) provide the 

taxpayer a written statement that the donee’s use of the property will be consistent with such 

requirements and also that the books are suitable, in terms of currency, content, and quantity, for 

use in the donee’s educational programs and that the donee will use the books in such 

educational programs.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2002.

 

22 Sec. 170(e)(3).
14

E. Charitable Deduction for Contributions of Bonds

Present Law

Under present law, a taxpayer’s deduction for charitable contributions of property, 

including a contribution of bonds, to or for the use of a private foundation (other than a private 

foundation described in section 170(b)(1)(E)) generally is limited to the taxpayer’s basis in the 

property. As an exception to the general rule, a taxpayer’s deduction for charitable contributions 

of qualified appreciated stock for the use of such a private foundation generally is the fair market 

value of the stock.23

Description of Proposal

The proposal would provide for a fair market value deduction for charitable contributions 

of qualified appreciated bonds to or for the use of a private foundation (other than a private 

foundation described in section 170(b)(1)(E)). The proposal would define qualified appreciated 

bonds as United States Treasury securities and such other debt instruments as may be prescribed 

by the Secretary in regulations.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2002.

 

23 Sec. 170(e)(5)(A).
15

F. Expand Charitable Contribution Allowed for Scientific Property Used

for Research and for Computer Technology and Equipment

Present Law

In the case of a charitable contribution of inventory or other ordinary-income or shortterm capital gain property, the amount of the charitable deduction generally is limited to the 

taxpayer’s basis in the property. In the case of a charitable contribution of tangible personal 

property, the deduction is limited to the taxpayer’s basis in such property if the use by the 

recipient charitable organization is unrelated to the organization’s tax-exempt purpose. In cases 

involving contributions to a private foundation (other than certain private operating foundations), 

the amount of the deduction is limited to the taxpayer’s basis in the property.24

Under present law, a taxpayer’s deduction for charitable contributions of scientific 

property used for research and for contributions of computer technology and equipment 

generally is limited to the taxpayer’s basis (typically, cost) in the property. However, certain 

corporations may claim a deduction in excess of basis for a “qualified research contribution” or a 

“qualified computer contribution.”25 This enhanced deduction is equal to the lesser of (1) basis 

plus one-half of the item’s appreciated value (i.e., basis plus one half of fair market value minus 

basis) or (2) two times basis. 

A qualified research contribution means a charitable contribution of inventory that is 

tangible personal property. The contribution must be to a qualified educational or scientific 

organization and be made not later than two years after construction of the property is 

substantially completed. The original use of the property must be by the donee, and be used 

substantially for research or experimentation, or for research training, in the U.S. in the physical 

or biological sciences. The property must be scientific equipment or apparatus, constructed by 

the taxpayer, and may not be transferred by the donee in exchange for money, other property, or 

services. The donee must provide the taxpayer with a written statement representing that it will 

use the property in accordance with the conditions for the deduction. For purposes of the 

enhanced deduction, property is considered constructed by the taxpayer only if the cost of the 

parts used in the construction of the property (other than parts manufactured by the taxpayer or a 

related person) do not exceed 50 percent of the taxpayer’s basis in the property.

A qualified computer contribution means a charitable contribution of any computer 

technology or equipment, which meets standards of functionality and suitability as established by 

the Secretary of the Treasury. The contribution must be to certain educational organizations or 

public libraries and made not later than three years after the taxpayer acquired the property or, if 

the taxpayer constructed the property, not later than the date construction of the property is 

 

24 Sec. 170(e)(1).

25 Secs. 170(e)(4) and 170(e)(6).
16

substantially completed.

26 The original use of the property must be by the donor or the donee,27

and in the case of the donee, must be used substantially for educational purposes related to the 

function or purpose of the donee. The property must fit productively into the donee’s education 

plan. The donee may not transfer the property in exchange for money, other property, or 

services, except for shipping, installation, and transfer costs. To determine whether property is 

constructed by the taxpayer, the rules applicable to qualified research contributions apply. 

Contributions may be made to private foundations under certain conditions.28

Description of Proposal

Under the proposal, property assembled by the taxpayer, in addition to property 

constructed by the taxpayer, would be eligible for either enhanced deduction.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2001.

 

26 If the taxpayer constructed the property and reacquired such property, the contribution 

must be within three years of the date the original construction was substantially completed. 

Sec. 170(e)(6)(D)(i).

27 This requirement does not apply if the property was reacquired by the manufacturer 

and contributed. Sec. 170(e)(6)(D)(ii).

28 Sec. 170(e)(6)(C).
17

G. Encourage Contributions of Capital Gain

Real Property Made for Conservation Purposes

Present Law

Charitable contributions generally

In general, a deduction is permitted for charitable contributions, subject to certain 

limitations that depend on the type of taxpayer, the property contributed, and the donee 

organization. The amount of deduction generally equals the fair market value of the contributed 

property on the date of the contribution. Charitable deductions are provided for income, estate, 

and gift tax purposes.29

In general, in any taxable year, charitable contributions by a corporation are not 

deductible to the extent the aggregate contributions exceed 10 percent of the corporation’s 

taxable income computed without regard to net operating or capital loss carrybacks. For 

individuals, the amount deductible is a percentage of the taxpayer’s contribution base, which is 

the taxpayer’s adjusted gross income computed without regard to any net operating loss 

carryback. The applicable percentage of the contribution base varies depending on the type of 

donee organization and property contributed. Cash contributions of an individual taxpayer to 

public charities, private operating foundations, and certain types of private nonoperating 

foundations may not exceed 50 percent of the taxpayer’s contribution base. Cash contributions 

to private foundations and certain other charitable organizations generally may be deducted up to 

30 percent of the taxpayer’s contribution base. 

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if 

the donor transfers an interest in property to a charity while also either retaining an interest in 

that property or transferring an interest in that property to a noncharity for less than full and 

adequate consideration. Exceptions to this general rule are provided for, among other interests, 

remainder interests in charitable remainder annuity trusts, charitable remainder unitrusts, and 

pooled income funds, present interests in the form of a guaranteed annuity or a fixed percentage 

of the annual value of the property, and qualified conservation contributions. 

Capital gain property

Capital gain property means any capital asset or property used in the taxpayer’s trade or 

business the sale of which at its fair market value, at the time of contribution, would have 

resulted in gain that would have been long-term capital gain. Contributions of capital gain 

property to a qualified charity are deductible at fair market value within certain limitations. 

Contributions of capital gain property to charitable organizations described in section 

170(b)(1)(A) (e.g., public charities, private foundations other than private non-operating 

foundations, and certain governmental units) generally are deductible up to 30 percent of the 

taxpayer’s contribution base. An individual may elect, however, to bring all these contributions 

of capital gain property for a taxable year within the 50-percent limitation category by reducing 

the amount of the contribution deduction by the amount of the appreciation in the capital gain 

 

29 Secs. 170, 2055, and 2522, respectively.
18

property. Contributions of capital gain property to charitable organizations described in section 

170(b)(1)(B) (e.g., private non-operating foundations) are deductible up to 20 percent of the 

taxpayer’s contribution base.

For purposes of determining whether a taxpayer’s aggregate charitable contributions in a 

taxable year exceed the applicable percentage limitation, contributions of capital gain property 

are taken into account after other charitable contributions. Contributions of capital gain property 

that exceed the percentage limitation may be carried forward for five years.

Qualified conservation contributions

Qualified conservation contributions are not subject to the “partial interest” rule, which 

generally bars deductions for charitable contributions of partial interests in property. A qualified 

conservation contribution is a contribution of a qualified real property interest to a qualified 

organization exclusively for conservation purposes. A qualified real property interest is defined 

as: (1) the entire interest of the donor other than a qualified mineral interest; (2) a remainder 

interest; or (3) a restriction (granted in perpetuity) on the use that may be made of the real 

property. Qualified organizations include certain governmental units, public charities that meet 

certain public support tests, and certain supporting organizations. Conservation purposes 

include: (1) the preservation of land areas for outdoor recreation by, or for the education of, the 

general public; (2) the protection of a relatively natural habitat of fish, wildlife, or plants, or 

similar ecosystem; (3) the preservation of open space (including farmland and forest land) where 

such preservation will yield a significant public benefit and is either for the scenic enjoyment of 

the general public or pursuant to a clearly delineated Federal, State, or local governmental 

conservation policy; and (4) the preservation of an historically important land area or a certified 

historic structure.

Qualified conservation contributions of capital gain property are subject to the same 

limitations and carryforward rules of other charitable contributions of capital gain property.

Description of Proposal

In general

Under the proposal, the 30-percent contribution base limitation on contributions of capital 

gain property by individuals would not apply to qualified conservation contributions (as defined 

under present law). Thus, individuals could include the fair market value of any qualified 

conservation contribution of capital gain property in determining the amount of the charitable 

contributions subject to the 50-percent contribution base limitation. In addition, individuals 

would be allowed to carryforward any qualified conservation contribution that exceeds the 50-

percent limitation for 15 years. 

The 50-percent contribution base limitation would apply first to contributions other than 

qualified conservation contributions and then to qualified conservation contributions. For 

example, an individual with a contribution base of $100 who made a qualified conservation 

contribution of $80 and other charitable contributions of $60 would be eligible to deduct $50 of 

the other contributions (50 percent of the $100 contribution base) and carryforward the excess 

$10 for 5 years, and would be required to carryforward the entire $80 qualified conservation 
19

contribution for 15 years. (By way of illustration, a reverse ordering rule would have limited the 

deduction to $50 for the qualified conservation contribution, leaving a $30 qualified conservation 

contribution carryforward for 15 years and $60 of other charitable contributions that could be 

carried forward for 5 years.)

Farmers and ranchers

In the case of an eligible farmer or rancher, a qualified conservation contribution would 

be allowable up to 100 percent of the taxpayer’s contribution base (after taking into account

other charitable contributions). This rule would apply both to individuals and corporations. In 

addition, corporate (and non-corporate) eligible farmers and ranchers would be allowed to 

carryforward any excess qualified conservation contributions for 15 years. The 100-percent 

contribution base limitation would apply first to contributions other than qualified conservation 

contributions (to the extent allowable under other percentage limitations) and then to qualified 

conservation contributions. For example, an individual with a contribution base of $100 who 

made a qualified conservation contribution of $80 and other charitable contributions of $60 

would be eligible to deduct $50 of other contributions (50 percent of the $100 contribution base) 

and carryforward the excess $10 for 5 years, and would be able to deduct $50 of the qualified 

charitable contribution and carryforward the remaining $30 qualified conservation contribution 

for 15 years. 

For this purpose, an eligible farmer or rancher would mean a taxpayer (other than a 

publicly traded C corporation) whose gross income from the trade of business of farming is at 

least 51 percent of the taxpayer’s gross income for the taxable year.

Effective Date

The proposal would be effective for contributions made in taxable years beginning after 

December 31, 2002.
20

H. 25 Percent Exclusion for Sales Made for Qualifying Conservation Purposes

Present Law

Gain from the sale or exchange of land held more than one year generally is treated as 

long-term capital gain. 

Generally the net capital gain of an individual (i.e., long-term capital gain less short-term 

capital loss) is subject to a maximum rate of 20 percent.

Description of Proposal

The proposal would provide a 25-percent exclusion from gross income of capital gain

from the qualifying sale of land, or an interest in land or water, provided the land, or interest in 

land or water, has been held by the taxpayer or the taxpayer’s family at all times during the five 

year period preceding the date of sale. The exclusion would not be available for sales or 

exchanges of ordinary income property or improvements. Only sales or exchanges of: (1) the 

entire interest of the taxpayer other than a qualified mineral interest; (2) a remainder interest; or 

(3) a restriction (granted in perpetuity) on the use which may be made of the land or interest in 

land or water, would qualify for the exclusion. A qualifying sale would be a sale or exchange 

(excluding a transfer made by order of condemnation or eminent domain or under imminence 

thereof) to an agency or department of the Federal Government, a State government, or a local 

government or a section 501(c)(3) organization that is organized and operated primarily to meet 

a qualified conservation purpose. In addition, to be a qualifying sale, the person acquiring the 

land, or interest in land or water, must provide the taxpayer with a letter stating that the intent of 

the purchase is to further a qualified conservation purpose and that any subsequent transfer of the 

acquired interest will protect the conservation purpose in perpetuity. A qualified conservation 

purpose is: (1) the preservation of land areas for outdoor recreation by, or the education of, the 

general public; (2) the protection of a relatively natural habitat of fish, wildlife, or plants, or 

similar ecosystem; or (3) the preservation of open space (including farmland and forest land) 

where the preservation is for the scenic enjoyment of the general public or pursuant to a clearly 

delineated Federal, State or local governmental conservation policy and will yield a significant 

public benefit.

Under the proposal, the exclusion would be available for capital gain from certain sales 

or exchanges of a controlling stock interest (generally a stock interest of at least 90 percent of the 

total voting power and total value of the corporation’s stock) in a corporation if at least 90 

percent of the fair market value of the corporation’s assets at all times during the three year 

period preceding the sale consisted of land or interests in land. Only controlling stock interests 

held by the taxpayer or the taxpayer’s family at all times during the five years preceding the sale 

would qualify for the 25-percent exclusion. 

Effective Date

The proposal would be effective for sales made after December 31, 2003.
21

I. Cost Sharing Payments under the Partners for Fish and Wildlife Program

Present Law

Under present law, gross income does not include the excludable portion of payments 

made to taxpayers by federal and state governments for a share of the cost of improvements to 

property under certain conservation programs. These programs include payments received under 

(1) the rural clean water program authorized by section 208(j) of the Federal Water Pollution 

Control Act, (2) the rural abandoned mine program authorized by section 406 of the Surface 

Mining Control and Reclamation Act of 1977, (3) the water bank program authorized by the 

Water Bank Act, (4) the emergency conservation measures program authorized by title IV of the 

Agricultural Credit Act of 1978, (5) the agriculture conservation program authorized by the Soil 

Conservation and Domestic Allotment Act, (6) the great plains conservation program authorized 

by section 16 of the Soil Conservation and Domestic Policy Act, (7) the resource conservation 

and development program authorized by the Bankhead-Jones Farm Tenant Act and by the Soil 

Conservation and Domestic Allotment Act, (8) the forestry incentives program authorized by 

section 4 of the Cooperative Forestry Assistance Act of 1978, (9) any small watershed program 

administered by the Secretary of Agriculture which is determined by the Secretary of the 

Treasury or his delegate to be substantially similar to the type of programs described in items (1) 

through (8), and (10) any program of a State, possession of the United States, a political 

subdivision of any of the foregoing, or the District of Columbia under which payments are made 

to individuals primarily for the purpose of conserving soil, protecting or restoring the 

environment, improving forests, or providing a habitat for wildlife.

Description of Proposal

The proposal would expand the types of qualified cost-sharing payments to include 

payments under the Partners for Fish and Wildlife Program.

Effective Date

The proposal would apply to taxable years beginning after December 31, 2002.
22

J. Adjust Basis of S Corporation Stock for Certain Charitable Contributions

Present Law

Under present law, if an S corporation contributes money or other property to a charity, each 

shareholder takes into account the shareholder’s pro rata share of the contribution in determining 

the shareholder’s own income tax liability.30 A shareholder of an S corporation reduces the basis 

in the stock of the S corporation by the amount of the charitable contribution that flows through 

to the shareholder.31

Description of Proposal

The proposal would provide that the amount of a shareholder’s basis reduction in the 

stock of an S corporation by reason of a charitable contribution made by the corporation would 

be an amount equal to the shareholder’s pro rata share of the adjusted basis of the contributed 

property.32 

Under present law, if an S corporation makes a charitable contribution of appreciated 

property, the shareholder is taxed on an amount equal to the appreciation in the contributed 

property when the stock in the S corporation is sold. Under the proposal, the basis in the S 

corporation stock would be adjusted so that on the sale of the S corporation stock, there would be 

no tax on the appreciation in the contributed property. The tax consequences under the proposal 

would be the same as if the individual taxpayer contributed the property directly to the charity 

without using an S corporation.

Thus, if an S corporation with one shareholder contributes stock with a cost basis of $200 

and a fair market value of $500 to a charitable organization, the shareholder would be treated as 

having made the contribution for purposes of computing the shareholder’s charitable 

contribution deduction (which generally would be $500, assuming section 170(e)(1) does not 

apply), and the shareholder would reduce the adjusted basis in the S corporation stock by $200.

When the shareholder sells the S corporation stock, the shareholder would not recognize gain as 

a result of the charitable contribution because the basis reduction in the S corporation stock 

would have been equal to the basis in the contributed property. This is the same result as if a 

taxpayer contributed such stock directly to a charitable organization -- the taxpayer would 

receive the same deduction ($500) and would not recognize gain. By contrast, under present 

law, the shareholder reduces the adjusted basis in the S corporation stock by $500, not $200 as 

under the proposal, and therefore is taxed on the $300 appreciation as a result of the charitable 

contribution when the shareholder sells the S corporation stock. 

 

30 Sec. 1366(a)(1)(A).

31 Sec. 1367(a)(2)(B).

32 Rev. Rul. 96-11 (1996-1 C.B. 140) reaches a similar result in the case of charitable 

contributions made by a partnership. 
23

Effective Date

The proposal would apply to contributions made in taxable years beginning after 

December 31, 2002.
24

II. DISCLOSURE OF INFORMATION RELATING

TO TAX-EXEMPT ORGANIZATIONS

A. Disclosure of Written Determinations

Present Law

In general

Three provisions of present law govern the disclosure of information relating to taxexempt organizations. First, section 6103 provides a general rule that tax returns and return 

information generally are not subject to public disclosure.33 Second, in order to allow the public 

to scrutinize the activities of tax-exempt organizations, section 6104 grants an exception to the 

confidentiality rule of section 6103 for certain categories of tax-exempt organization documents 

and information. Section 6104 permits the release in unredacted form of approved applications 

for tax-exempt status, certain related documents, and annual information returns filed by taxexempt organizations. As a general rule, to the extent section 6104 specifically provides for the 

disclosure of tax-exempt organization information, other disclosure provisions do not apply. If 

tax-exempt organization information does not come within the scope of section 6104, other 

disclosure provisions will govern whether the information may be disclosed. Third, section 6110 

provides that written determinations by the IRS and related background file documents generally 

are open to public inspection in redacted form. Section 6110 does not apply to any matter to 

which section 6104 applies.34

Disclosure of applications for recognition of tax exemption and annual information returns 

Under present law, tax-exempt organizations are required to make a copy of their 

application for recognition of tax-exempt status (and certain related documents)35 and their 

annual information return (Form 990 or Form 990-PF) available for public inspection. 

 

33 Sec. 6103(a). A “return” includes any tax or information return, declaration of 

estimated tax, or claim for refund required by, or provided for, or permitted under the provisions 

of the Code, which is filed with the IRS. Sec. 6103(b)(1). “Return” also includes any 

amendment or supplement to the filed return. Sec. 6103(b)(1). “Return information” is defined 

broadly to include any data received by, recorded by, prepared by, furnished to, or collected by 

the Secretary with respect to a return or with respect to the determination of the existence, or 

possible existence, of liability (or the amount thereof) of any person for any tax, penalty, interest, 

fine, forfeiture, or other imposition, or offense under the Code. The term “return information” 

does not include data in a form that cannot be associated with, or otherwise identify, directly or 

indirectly, a particular taxpayer. Sec. 6103(b)(2).

34 Sec. 6110(l)(1).

35 Section 6104(a)(1)(A) provides that “any papers submitted in support of” an 

application for tax-exempt status must be available for inspection. Treasury regulations limit the 

definition of supporting documents to papers submitted by the organization. Treas. Reg. sec. 

301.6104(a)-1(e). 
25

Organizations are not required to disclose an application for tax exemption filed by the 

organization unless the IRS responded favorably to the application.36 Charitable organizations 

that are not classified as private foundations are not required to disclose the names of donors to 

the organization.

The Secretary may withhold disclosure of certain information described in an 

organization’s application for tax-exempt status if disclosure would: (1) divulge a trade secret, 

patent, process, style of work, or apparatus of the organization, and the Secretary determines that 

such disclosure would harm the organization; or (2) that the Secretary determines would harm 

the national defense.37 The organization must apply to the Commissioner for a determination 

that the disclosure would violate one of these criteria. The organization will be given 15 days to 

contest an adverse determination before the information is made available for public 

inspection.38

Disclosure of written determinations

Section 6110 provides that the text of any written determination by the IRS and related 

background file document is open to public inspection.39 The term “written determination” 

means a ruling,40 determination letter,41 technical advice memorandum,42 or Chief Counsel 

advice.43 Closing agreements, which are final and conclusive written agreements entered into by 

 

36 Treas. Reg. sec. 301.6104(d)-1(b)(3)(iii)(A).

37 Sec. 6104(a)(1)(D). In the case of a pension plan, information may be withheld if it 

would identify any particular individual covered under the plan. Id.

38 Treas. Reg. sec. 301.6104(a)-5(a)(1).

39 Sec. 6110(a).

40 A ruling is a written statement issued by the National Office to a taxpayer or his or her 

authorized representative. Treas. Reg. sec. 301.6110-2(d). It generally recites the relevant facts, 

sets forth the applicable provisions of law, and shows the application of the law to the facts. 

Treas. Reg. sec. 301.6110-2(d).

41 A district director issues a “determination letter” in response to a written inquiry from 

an individual or organization that applies principles and precedents previously announced by the 

IRS National Office to the particular facts involved. Treas. Reg. sec. 301.6110-2(e).

42 A “technical advice memorandum” is a written statement issued by the IRS National 

Office to a district director in connection with the examination of a taxpayer’s return or 

consideration of a taxpayer’s claim for refund or credit. Treas. Reg. sec. 301.6110-2(f). 

Generally, a technical advice memorandum states the relevant facts, sets forth the applicable law, 

and states a legal conclusion. Treas. Reg. sec. 301.6110-2(f).

43 Sec. 6110(b)(1). Any IRS National Office component of the Office of Chief Counsel 

can issue Chief Counsel advice. The IRS National Office component issues the advice to IRS 

field or service center employees, or to regional or district employees of Chief Counsel. Sec. 
26

the IRS and a taxpayer in order to settle the taxpayer’s tax liability with respect to a taxable year, 

do not constitute written determinations.44 A background file document includes the request for 

a written determination, any written material submitted by the taxpayer in support of the request, 

and any communications between the IRS and other persons in connection with the written 

determination received before issuance of the written determination.45

A background file document is available upon written request to any person requesting a 

copy of the related written determination.46 Before releasing any written determination or 

background file document, the IRS must delete identifying details of the person about whom the 

written determination pertains and certain other information.47 With respect to tax-exempt 

organizations, disclosure under section 6110 is limited to letters and rulings unrelated to an 

organization’s tax-exempt status.48

The application of section 6110 to guidance relating to tax-exempt organizations is 

limited. Section 6110(l)(1) provides, “this section shall not apply to any matter to which section 

 

6110(i)(A)(i). The definition of Chief Counsel advice does not encompass advice issued from 

one IRS National Office component of the Office of Chief Counsel to another. The advice by 

definition conveys: (1) a legal interpretation of a revenue provision; (2) the IRS or Chief 

Counsel position or policy concerning a revenue provision; or (3) a legal interpretation of any 

law (Federal, State, or foreign) relating to the assessment or collection of liability under a 

revenue provision. Sec. 6110(i)(A)(ii).

44 Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B). 

45 Sec. 6110(b)(2). Communications between the IRS and the Department of Justice 

relating to a pending civil or criminal case are not considered background file documents.

46 Sec. 6110(e).

47 Sec. 6110(c) provides the following exemptions from disclosure: (1) the names, 

addresses, and other identifying details of the person to whom the written determination pertains 

and of any other person, other than a person with respect to whom a notation is made under 

subsection (d)(1) (relating to third party contacts), identified in the written determination or any 

background file document; (2) information specifically authorized under criteria established by 

an Executive order to be kept secret in the interest of national defense or foreign policy, and 

which is in fact properly classified pursuant to such Executive order; (3) information specifically 

exempted from disclosure by any statute (other than this title) which is applicable to the Internal 

Revenue Service; (4) trade secrets and commercial or financial information obtained from a 

person and privileged or confidential; (5) information the disclosure of which would constitute a 

clearly unwarranted invasion of personal privacy; (6) information contained in or related to 

examination, operating, or condition reports prepared by, or on behalf of, or for use of an agency 

responsible for the regulation or supervision of financial institutions; and (7) geological and 

geophysical information and data, including maps, concerning wells. 

48 Sec. 6110(l)(1); Treas. Reg. sec. 301.6110-1(a).
27

6104 applies.” The regulations under section 6110 clarify which matters are within the ambit of 

section 6104 and, therefore, are not subject to disclosure under section 6110:

“[a]ny application filed with the Internal Revenue Service with respect to the 

qualification or exempt status of an organization . . .; any document issued by the Internal 

Revenue Service in which the qualification or exempt status of an organization is . . . granted, 

denied or revoked or the portion of any document in which technical advice with respect thereto 

is given to a district director; . . . the portion of any document issued by the Internal Revenue 

Service in which is discussed the effect on the qualification or exempt status of an organization . 

. . of proposed transactions by such organization . . . ; and any document issued by the Internal 

Revenue Service in which is discussed the qualification or status of a [private foundation or 

private operating foundation].”49

In addition, the regulations under section 6104 provide that some determination letters 

and other documents relating to tax exemption that are not open to public inspection under 

section 6104(a)(1)(A) are nevertheless “within the ambit” of section 6104 for purposes of the 

disclosure provisions of section 6110.50 The regulation explains that the following documents 

are, therefore, not available for public inspection under either section 6104 or 6110:

(1) unfavorable rulings or determination letters issued in response to applications for 

tax exemption;

(2) rulings or determination letters revoking or modifying a favorable determination 

letter;

(3) technical advice memoranda relating to a disapproved application for tax 

exemption or the revocation or modification of a favorable determination letter;

(4) any letter or document filed with or issued by the IRS relating to whether a 

proposed or accomplished transaction is a prohibited transaction under section 

503;

(5) any letter or document filed with or issued by the IRS relating to an organization’s 

status as a private foundation or private operating foundation, unless the letter or 

document relates to the organization’s application for tax exemption; and

(6) any other letter or document filed with or issued by the IRS which, although it 

relates to an organization’s tax exempt status as an organization described in 

section 501(c), does not relate to that organization’s application for tax 

exemption.51

 

49 Treas. Reg. sec. 301.6110-1(a).

50 Treas. Reg. sec. 301.6104(a)-1(i).

51 Id.
28

The effect of these limitations is that written determinations relating to exempt status 

issues are not released, even in redacted form. The IRS does, however, release written 

determinations issued to tax-exempt organizations that include issues that clearly are not within 

the ambit of section 6104, such as the application of the unrelated business income tax to a 

particular proposed transaction.

Description of Proposal

The proposal would require disclosure in redacted form of written determinations relating 

to the tax-exempt status of an organization described in section 501(c) or (d) that are not required 

to be disclosed by section 6104(a)(1)(A) but that are within the scope of section 6104. Such 

written determinations (and related background file documents) would be disclosed under the 

provisions of section 6110 and would include: (1) unfavorable rulings or determination letters 

issued in response to applications for tax exemption; (2) rulings or determination letters revoking 

or modifying a favorable determination letter; (3) technical advice memoranda relating to a 

disapproved application for tax exemption or the revocation or modification of a favorable 

determination letter; (4) any letter or document filed with or issued by the IRS relating to 

whether a proposed or accomplished transaction is a prohibited transaction under section 503; (5) 

any letter or document filed with or issued by the IRS relating to an organization’s status as a 

private foundation or private operating foundation, unless the letter or document relates to the 

organization’s application for tax exemption; and (6) any other letter or document filed with or 

issued by the IRS which, although it relates to an organization’s tax exempt status as an 

organization described in section 501(c) or (d), does not relate to that organization’s application 

for tax exemption. 

Effective Date

The proposal would be effective for written determinations issued after December 31, 

2002.
29

B. Disclosure of Internet Web Site and Name

Under Which Organization Does Business

Present Law

Most types of tax-exempt organizations are required to file annually an information 

return.52 The Internal Revenue Code does not require an exempt organization to furnish on the 

applicable information return any name under which the organization operates or does business, 

if such name differs from the legal name of the organization, or the organization’s Internet web 

site address, if any.53

Description of Proposal

The proposal would require a tax-exempt organization subject to reporting requirements 

under section 6033(a) to include on its annual return any name under which such organization 

operates or does business, and the Internet web site address (if any) of such organization.

Effective Date

The proposal would be effective for returns filed after December 31, 2002.

 

52 Sec. 6033(a). See, e.g., Form 990 -- Return of Organization Exempt From Income 

Tax. An organization that is required to file Form 990, but that has gross receipts of less than 

$100,000 during its taxable year, and total assets of less than $250,000 at the end of its taxable 

year, may file Form 990-EZ instead of Form 990. Private foundations are required to file Form 

990-PF rather than Form 990. 

53 The IRS requires disclosure of an organization’s Internet web site address on Forms 

990 and 990-EZ.
30

C. Modification to Reporting of Capital Transactions

Present Law

Private foundations are required to file an annual information return (Form 990-PF).54 

Part IV of the Form 990-PF requires that private foundations report detailed information 

regarding the gain or loss from the sale or other disposition of property, including a description 

of the property sold, how it was acquired (purchase or donation), the date acquired, the date sold, 

the gross sales price, the amount of depreciation allowed or allowable, and the cost or other basis 

plus expenses of the sale. Such information generally is required for the IRS to calculate the tax 

on the private foundation’s net investment income. The Form 990-PF is required to be made 

available to the public. 

Description of Proposal

The proposal would require that any information regarding capital gains and losses that is 

required to be furnished by private foundations in order to calculate the tax on net investment 

income would be furnished also in summary form. Any such information regarding capital gains 

and losses that is required to be filed with the IRS but that is not in summary form would not be 

required to be made available to the public except by the explicit request of a member of the 

public to the organization or to the IRS. Private foundations would be required to state on the 

furnished summary that the more detailed description is available upon such request.

Effective Date

The proposal would be effective for returns filed after December 31, 2002.

 

54 Sec. 6033(a).
31

D. Disclosure that Form 990 is Publicly Available

Present Law

Under present law, there is no requirement that the IRS notify the public that the Form 

990 is publicly available.

Publication 17 (Your Federal Income Tax), Publication 526 (Charitable Contributions), 

and the Instructions to Schedule A (Itemized Deductions) of Form 1040 do not advise that an 

exempt organization’s Form 990 is publicly available.

Description of Proposal

The proposal would require the IRS to notify the public in Publication 17, Publication 

526, and the Instructions to Schedule A of Form 1040 that an exempt organization’s Form 990, 

Form 990-EZ, and Form 990-PF are publicly available.

Effective Date

The proposal would be effective for instructions or publications issued or revised after 

the date of enactment.
32

E. Disclosure to State Officials of Proposed Actions

Related to Section 501(c)(3) Organizations 

Present Law

In the case of organizations that are described in section 501(c)(3) and exempt from tax 

under section 501(a) or that have applied for exemption as an organization so described, present 

law (sec. 6104(c)) requires the Secretary to notify the appropriate State officer of (1) a refusal to 

recognize such organization as an organization described in section 501(c)(3), (2) a revocation of 

a section 501(c)(3) organization’s tax-exempt status, and (3) the mailing of a notice of deficiency 

for any tax imposed under section 507, chapter 41, or chapter 42.55 In addition, at the request of 

such appropriate State officer, the Secretary is required to make available for inspection and 

copying, such returns, filed statements, records, reports, and other information relating to the 

above-described disclosures, as are relevant to any State law determination. An appropriate 

State officer is the State attorney general, State tax officer, or any State official charged with 

overseeing organizations of the type described in section 501(c)(3). 

In general, return and return information (as such terms are defined in sec. 6103(b)) is 

confidential and may not be disclosed or inspected unless expressly provided by law.56 Present 

law requires the Secretary to keep records of disclosures and requests for inspection57 and 

requires that persons authorized to receive return and return information maintain various 

safeguards to protect such information against unauthorized disclosure.58 Willful unauthorized 

disclosure or inspection of return or return information is subject to a fine and/or imprisonment.59 

The knowing or negligent unauthorized inspection or disclosure of returns or return information 

gives the taxpayer a right to bring a civil suit.60 Such present-law protections against 

unauthorized disclosure or inspection of return and return information do not apply to the 

disclosures or inspections, described above, that are authorized by section 6104(c).

 

55 The applicable taxes include the termination tax on private foundations; taxes on 

public charities for certain excess lobbying expenses; taxes on a private foundation’s net 

investment income, self-dealing activities, undistributed income, excess business holdings, 

investments that jeopardize charitable purposes, and taxable expenditures (some of these taxes 

also apply to certain non-exempt trusts); taxes on the political expenditures and excess benefit 

transactions of section 501(c)(3) organizations; and certain taxes on black lung benefit trusts and 

foreign organizations.

56 Sec. 6103(a).

57 Sec. 6103(p)(3).

58 Sec. 6103(p)(4).

59 Secs. 7213 and 7213A.

60 Sec. 7431.
33

Description of Proposal

The proposal provides that upon written request by an appropriate State officer, the 

Secretary may disclose, with respect to a section 501(c)(2) (certain title holding companies), 

501(c)(3) (charitable and similar organizations), 501(c)(4) (certain social welfare organizations), 

501(c)(6) (certain business leagues and similar organizations), 501(c)(7) (certain recreational 

clubs), 501(c)(8) (certain fraternal organizations), 501(c)(10) (certain domestic fraternal 

organizations operating under the lodge system), and 501(c)(13) (certain cemetery companies) 

organization: (1) a notice of proposed refusal to recognize an organization as an organization 

exempt from tax; (2) a notice of proposed revocation of tax-exemption; (3) with respect to 

private foundations, the issuance of a proposed deficiency of tax imposed under section 507, 

chapter 41, or chapter 42; (4) the names and taxpayer identification numbers of organizations 

that have applied for recognition as tax-exempt organizations; and (5) return and return 

information of organizations61 with respect to which information has been disclosed under (1) 

through (4) above. Disclosure or inspection would be permitted for the purpose of, and only to 

the extent necessary in, the administration of State laws regulating the applicable tax-exempt 

organization, such as laws regulating tax-exempt status, charitable trusts, charitable solicitation, 

and fraud. Disclosure or inspection could be made only to or by designated representatives of 

the appropriate State officer, which includes officers, employees, agents, and contractors of the 

appropriate State officer. The Secretary also would be permitted to disclose or open to 

inspection the return and return information of an organization that is recognized as tax-exempt 

under sections 501(c)(2), 501(c)(3), 501(c)(4), 501(c)(6), 501(c)(7), 501(c)(8), 501(c)(10), and 

501(c)(13), or that has applied for such recognition, to an appropriate State officer if the 

Secretary determines that disclosure or inspection may facilitate the resolution of Federal and 

State issues relating to the organization. Appropriate State officer would mean the State attorney 

general or the head of any State agency, body, or commission that is charged under the laws of 

such State with responsibility for overseeing organizations of the type described in the applicable 

section.

In addition, the proposal would provide that return and return information disclosed 

under section 6104(c) may be disclosed in civil administrative and judicial proceedings 

pertaining to the enforcement of State laws regulating the applicable tax-exempt organization in 

a manner prescribed by the Secretary. Returns and return information would not be disclosed 

under section 6104(c), or in such an administrative or judicial proceeding, to the extent that the 

Secretary determines that such disclosure would seriously impair Federal tax administration. 

The proposal would make disclosures of returns and return information under section 6104(c) 

subject to many of the provisions of section 6103, including that such information remain 

confidential (sec. 6103(a)(2)), that the Secretary maintain a permanent system of records of 

requests for disclosure (sec. 6103(p)(3)), and that the appropriate State officer maintain various 

safeguards that protect against unauthorized disclosure (sec. 6103(p)(4)). The proposal would 

provide that the willful unauthorized disclosure of return or return information described in 

section 6104(c) is a felony subject to a fine of up to $5,000 and/or imprisonment of up to five 

years (sec. 7213(a)(2)), the willful unauthorized inspection of return or return information 

described in section 6104(c) is subject to a fine of up to $1,000 and/or imprisonment of up to one 

 

61 Such information also may be open to inspection by an appropriate State officer.
34

year (sec. 7213A), and would provide the taxpayer the right to bring a civil action for damages in 

the case of knowing or negligent unauthorized disclosure or inspection of such information (sec. 

7431(a)(2)).

Effective Date

The provision would be effective on the date of enactment but would not apply to 

requests made before such date.
35

III. OTHER CHARITABLE AND EXEMPT ORGANIZATION PROVISIONS

A. Modify Tax on Unrelated Business Taxable

Income of Charitable Remainder Trusts

Present Law

Charitable remainder annuity trusts and charitable remainder unitrusts are exempt from 

Federal income tax for a tax year unless the trust has any unrelated business taxable income for 

the year. Unrelated business taxable income includes certain debt financed income. A charitable 

remainder trust that loses exemption from income tax for a taxable year is taxed as a regular 

complex trust. As such, the trust is allowed a deduction in computing taxable income for 

amounts required to be distributed in a taxable year, not to exceed the amount of the trust’s 

distributable net income for the year. Taxes imposed on the trust are required to be allocated to 

corpus.62

Distributions from a charitable remainder annuity trust or charitable remainder unitrust 

are treated in the following order as: (1) ordinary income to the extent of the trust’s current and 

previously undistributed ordinary income for the trust’s year in which the distribution occurred, 

(2) capital gains to the extent of the trust’s current capital gain and previously undistributed 

capital gain for the trust’s year in which the distribution occurred, (3) other income (e.g., taxexempt income) to the extent of the trust’s current and previously undistributed other income for 

the trust’s year in which the distribution occurred, and (4) corpus.63

In general, distributions to the extent they are characterized as income are includible in 

the income of the beneficiary for the year that the annuity or unitrust amount is required to be 

distributed even though the annuity or unitrust amount is not distributed until after the close of 

the trust’s taxable year.64

A charitable remainder annuity trust is a trust that is required to pay, at least annually, a 

fixed dollar amount of at least five percent of the initial value of the trust to a noncharity for the 

life of an individual or for a period of 20 years or less, with the remainder passing to charity. A 

charitable remainder unitrust is a trust that generally is required to pay, at least annually, a fixed 

percentage of at least five percent of the fair market value of the trust’s assets determined at least 

annually to a noncharity for the life of an individual or for a period 20 years or less, with the 

remainder passing to charity.65

A trust does not qualify as a charitable remainder annuity trust if the annuity for a year is 

greater than 50 percent of the initial fair market value of the trust’s assets. A trust does not 

 

62 Treas. Reg. sec. 1.664-1(d)(2).

63 Sec. 664(b).

64 Treas. Reg. sec. 1.664-1(d)(4).

65 Sec. 664(d).
36

qualify as a charitable remainder unitrust if the percentage of assets that are required to be 

distributed at least annually is greater than 50 percent. A trust does not qualify as a charitable 

remainder annuity trust or a charitable remainder unitrust unless the value of the remainder 

interest in the trust is at least 10 percent of the value of the assets contributed to the trust. 

Description of Proposal

The proposal would impose a 100-percent excise tax on the unrelated business taxable 

income of a charitable remainder trust. This would replace the present-law rule that takes away 

the income tax exemption of a charitable remainder trust for any year in which the trust has any 

unrelated business taxable income. Consistent with present law, the tax would be treated as paid 

from corpus. The unrelated business taxable income would be considered income of the trust for 

purposes of determining the character of the distribution made to the beneficiary.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2001.
37

B. Modify Section 512(b)(13)

Present Law

In general, interest, rents, royalties and annuities are excluded from the unrelated 

business income (“UBI”) of tax-exempt organizations. However, section 512(b)(13) treats 

otherwise excluded rent, royalty, annuity, and interest income as UBI if such income is received 

from a taxable or tax-exempt subsidiary that is 50 percent controlled by the parent tax-exempt 

organization. In the case of a stock subsidiary, “control” means ownership by vote or value of 

more than 50 percent of the stock. In the case of a partnership or other entity, control means 

ownership of more than 50 percent of the profits, capital or beneficial interests. In addition, 

present law applies the constructive ownership rules of section 318 for purposes of section 

512(b)(13). Thus, a parent exempt organization is deemed to control any subsidiary in which it 

holds more than 50 percent of the voting power or value, directly (as in the case of a first-tier 

subsidiary) or indirectly (as in the case of a second-tier subsidiary).

Under present law, interest, rent, annuity, or royalty payments made by a controlled 

entity to a tax-exempt organization are includable in the latter organization’s UBI and are subject 

to the unrelated business income tax to the extent the payment reduces the net unrelated income 

(or increases any net unrelated loss) of the controlled entity. 

The Taxpayer Relief Act of 1997 (the “1997 Act”) made several modifications to the 

control requirement of section 512(b)(13). In order to provide transitional relief, the changes 

made by the 1997 Act do not apply to any payment received or accrued during the first two 

taxable years beginning on or after the date of enactment of the 1997 Act (August 5, 1997) if 

such payment is received or accrued pursuant to a binding written contract in effect on June 8, 

1997, and at all times thereafter before such payment (but not pursuant to any contract provision 

that permits optional accelerated payments).

Description of Proposal

The proposal would provide that the general rule of section 512(b)(13), which includes 

interest, rent, annuity, or royalty payments made by a controlled entity to a tax-exempt 

organization in the latter organization’s UBI, applies only to the portion of payments received in 

a taxable year that exceed the amount of the specified payment that would have been paid if such 

payment had been determined under the principles of section 482. Thus, if a payment of rent by 

a controlled subsidiary to its tax-exempt parent organization exceeds fair market value, the 

excess amount of such payment over fair market value (as determined in accordance with section 

482) is included in the parent organization’s UBI. In addition, the proposal would impose a 20 

percent penalty on the excess amount of any such payment. 

The proposal would provide that if modifications to section 512(b)(13) made by the 1997 

Act did not apply to a contract because of the transitional relief provided by the 1997 Act, then 

such modifications also would not apply to amounts received or accrued under such contract 

before January 1, 2001.
38

Effective Date

The proposal would apply to payments received or accrued after December 31, 2000.
39

C. Simplification of Lobbying Expenditure Limitation

Present Law

In general

An organization does not qualify for tax-exempt status under section 501(c)(3) unless “no 

substantial part” of the activities of the organization is “carrying on propaganda, or otherwise 

attempting, to influence legislation,” except as provided by section 501(h).66 Carrying on 

propaganda and attempting to influence legislation commonly are referred to as “lobbying” 

activities. Thus, section 501(c)(3) permits a limited amount of lobbying activity without loss of 

tax-exempt status. 

For purposes of determining whether lobbying activities are a substantial part of an 

organization’s overall functions, an organization may choose between two standards, the “no 

substantial part” test of section 501(c)(3) or the “expenditure” test of section 501(h). 

Whether an organization meets the “no substantial part” test is based on all the facts and 

circumstances. There is no statutory or regulatory guidance, and it is not clear whether the 

determination is based on the organization’s activities, its expenditures, or both. Alternatively, 

under section 501(h), certain organizations described in section 501(c)(3) can elect to be subject 

to the expenditure test,67 which consists of bright-line rules that specify the dollar amount of 

permitted expenses on lobbying activities. 

Consequences of excess lobbying under section 501(h)

Organizations that make a section 501(h) election (“electing charities”) are subject to tax 

if the electing charity makes either “lobbying expenditures” or “grass roots expenditures” in 

excess of a certain amount established for each type of expenditure for each taxable year. 

Lobbying expenditures are the sum of grass-roots expenditures and “direct lobbying” 

expenditures.68 

The expenditure limits are based on a “lobbying nontaxable amount” for the taxable year 

and a “grass roots nontaxable amount” for the taxable year. The lobbying nontaxable amount is 

the lesser of $1 million or an amount determined as a percentage of an organization’s exempt 

purpose expenditures.69 The grass-roots nontaxable amount is 25 percent of the organization’s 

 

66 Sec. 501(c)(3).

67 Organizations that do not make a section 501(h) election are subject to the “no 

substantial part” test. 

68 Secs. 501(h)(2)(A), 4911(c)(1), 4911(d).

69 Exempt purpose expenditures generally are expenses incurred for exempt purposes, 

such as amounts paid to accomplish exempt purposes, administrative expenses such as overhead, 

lobbying expenses, and certain fundraising expenses. Exempt purpose expenditures do not 

include, for example, expenses not for exempt purposes, payments of unrelated business income 
40

lobbying nontaxable amount. An electing charity that exceeds either of the spending limitations 

is subject to a 25 percent tax on the excess. An electing charity that exceeds both of the spending 

limitations is subject to a 25 percent tax on the greater of the excess of the lobbying expenditures 

or the grass-roots expenditures.

An electing charity that normally exceeds either of two “ceiling amounts,” which are 

based on the expenditure limits, will lose its tax exemption.70 The “lobbying ceiling amount” is 

150 percent of the electing charity’s lobbying nontaxable amount for the taxable year and the 

“grass roots ceiling amount” is 150 percent of the grass-roots nontaxable amount for the taxable 

year. For this purpose, “normal” expenditures are calculated based on a four-year averaging 

mechanism.71

Definitions

Grass-roots expenditures are defined as “any attempt to influence any legislation through 

an attempt to affect the opinions of the general public or any segment thereof.”72 For a 

communication to constitute grass-roots lobbying, it must refer to “specific legislation,” reflect a 

view on such legislation, and encourage the recipient of the communication to take action with 

respect to such legislation (a “call to action”).73 A communication includes a call to action if it 

incorporates one of four elements: (1) it urges the recipient to contact a legislator, employee of a 

government body, or any other government official or employee who may participate in the 

formulation of legislation with the principal purpose of influencing legislation; (2) it states the 

address, telephone number, or similar information of a legislator or an employee of a legislative 

body; (3) it provides a petition, tear-off postcard, or similar device for the recipient to 

communicate with government officials or employees who participate in the formulation of 

legislation with the principal purpose of influencing legislation; or (4) it states the position of one 

or more legislators on the legislation, except that a communication may name the main sponsors 

of legislation for purposes of identifying the legislation without constituting a call to action.74 In 

 

tax, or capital expenses in connection with an unrelated business. See Treas. Reg. sec. 56.4911-

4.

70 Sec. 501(h)(1).

71 Treas. Reg. sec. 1.501(h)-3.

72 Secs. 501(h)(2)(C) & 4911(d)(1)(A).

73 Treas. Reg. sec. 56.4911-2(b)(2)(i).

74 Treas. Reg. sec. 56.4911-2(b)(2)(iii). The regulations provide that the first three 

elements constitute “direct” encouragement, whereas the fourth element is “indirect” 

encouragement. This distinction becomes relevant in determining whether a communication 

meets one of the prescribed exceptions to lobbying, i.e., an indirect call to action in a grass-roots 

communication may qualify as “nonpartisan analysis, study or research” (Treas. Reg. sec. 

56.4911-2(b)(2)(iv)), and in determining the proper allocation of expenses between grass-roots 

and direct lobbying. Treas. Reg. sec. 56.4911-5(e).
41

addition, a communication is presumed to be grass-roots lobbying if the communication is a paid 

advertisement that: (1) appears in the mass media within two weeks before a vote by a legislative 

body or committee (but not a subcommittee) on a highly publicized piece of legislation; (2) 

reflects a view on the general subject of the legislation; and (3) either refers to the legislation or 

encourages the public to communicate with legislators on the general subject of such 

legislation.75 The presumption is rebuttable if the electing charity demonstrates that the timing 

of the communication was not related to the legislation or that the advertisement was of a type 

regularly made by the electing charity without regard to the timing of the legislation (a 

customary course of business exception).76

Direct lobbying expenditures are “any attempt to influence any legislation through 

communication with any member or employee of a legislative body, or with any government 

official or employee who may participate in the formulation of the legislation” if the principal 

purpose of the communication is to influence legislation.77 A communication would constitute 

direct lobbying only if the communication “refers to specific legislation” and reflects a view on 

such legislation.

Certain specified activities do not constitute attempts to influence legislation and 

therefore expenditures for such activities are not subject to the expenditure limits for lobbying 

expenditures or grass-roots expenditures. In general, such activities include: (1) making 

available the results of nonpartisan analysis, study, or research; (2) providing technical advice or 

assistance to a governmental body or to a committee in response to a written request; (3) 

appearances before, or communications to, any legislative body with respect to a possible 

decision of such body that might affect the existence of the organization, its powers and duties, 

tax-exempt status, or the deduction of contributions to the organization (so-called “self-defense” 

expenditures); (4) certain communications to members of the electing charity; and (5) 

communications with governmental officials or employees that are not intended to influence 

legislation.78

Special rules for mixed lobbying expenditures

Expenses that serve both direct and grass-roots lobbying purposes, e.g., communications 

that are sent to members and nonmembers, or “mixed lobbying” expenditures, are subject to 

special rules. The regulations specify how an electing charity is to allocate mixed lobbying 

expenditures between direct and grass-roots lobbying purposes.79 For example, for a mixed 

lobbying communication that is designed primarily for members (i.e., more than half the 

recipients are members) and that directly encourages grass-roots lobbying (even if it also 

 

75 Treas. Reg. sec. 56.4911-2(b)(5)(ii).

76

 Id.

77 Secs. 501(h)(2)(A) and 4911(d)(1)(B) and Treas. Reg. sec. 56.4911-2(b)(1).

78 Sec. 4911(d)(2).

79 Treas. Reg. sec. 56.4911-5(e).
42

encourages direct lobbying), the grass-roots expenditure amount includes all the costs of 

preparing the material used for purposes of grass-roots lobbying plus the mechanical and 

distributional costs associated with the communication. If a mixed lobbying communication 

encourages direct lobbying, but only indirectly encourages grass-roots lobbying, then the entire 

costs of the communication are allocated based on the proportion of members and nonmembers 

receiving the communication.

Disclosure of lobbying expenditures

An electing charity must disclose lobbying expenditures annually on Schedule A of Form 

990. In order to meet disclosure requirements, electing charities are required to keep detailed 

records of direct and grass-roots lobbying expenditures. Required records of grass-roots 

expenditures include: (1) all amounts directly paid or incurred for grass-roots lobbying; (2) 

payments to other organizations earmarked for grass-roots lobbying; (3) fees and expenses paid 

for grass-roots lobbying; (4) the printing, mailing, and other costs of reproducing and distributing 

materials used in grass-roots lobbying; (5) the portion of amounts paid or incurred as current or 

deferred compensation for an employee’s grass-roots lobbying services; (6) any amount paid for 

out-of-pocket expenditures incurred on behalf of the electing charity for grass-roots lobbying; (7) 

the allocable portion of administrative, overhead and other general expenditures attributable to 

grass-roots lobbying; and (8) expenditures for grass-roots lobbying of a controlled 

organization.80

Description of Proposal

The proposal would eliminate the separate limitation for grass-roots lobbying 

expenditures applicable to electing charities. Electing charities would remain subject to the 

overall limitation on lobbying expenditures, which would not change in amount, but electing 

charities would not be required to limit grass roots expenditures as a percentage of overall 

lobbying. Thus, an electing charity would be able to make tax-free any combination of grassroots and direct lobbying expenditures up to the lobbying non-taxable amount and would not risk 

loss of tax-exemption until total lobbying expenditures normally exceeded the lobbying ceiling 

amount. For purposes of the section 501(h) election, electing charities would no longer be 

required to distinguish between grass-roots lobbying and direct lobbying, whether for mixed 

lobbying expenditures or otherwise.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2001. 

 

80

 See Treas. Reg. sec. 56.4911-6.
43

D. Expedited Review Process for Certain Tax-Exemption Applications

Present Law

Most organizations that seek tax-exempt status as a charitable organization are required 

to file an Application for Recognition of Exemption (Form 1023) with the IRS.81 Organizations 

that are not required to file Form 1023 include churches, their integrated auxiliaries, and 

conventions or associations of churches, and any organization (other than a private foundation) 

that normally has gross receipts of $5,000 or less in a taxable year. Organizations that file Form 

1023 within 15 months of the end of the month of the organization’s formation will, if the 

application is approved, be recognized as tax-exempt from the date of formation. The IRS will 

automatically grant an organization’s request for an additional 12-month extension of the 15-

month period. Otherwise, exemption normally will be recognized as of the date the application 

was received by the IRS. In appropriate circumstances, upon written request, the IRS will 

expedite consideration of applications for tax-exemption. For example, organizations formed to 

provide relief to victims of disasters or other emergencies often receive expedited consideration.

Description of Proposal

The proposal would allow expedited consideration of applications for exempt status by 

organizations that are organized and operated for the primary purpose of providing social 

services. To be eligible, the organization must: (1) be seeking a contract or grant under a 

Federal, State, or local program that provides funding for social service programs; (2) establish 

that tax-exempt status is a condition of applying for such contract or grant; (3) include a 

completed copy of the contract or grant application with the application for exemption; and (4) 

meet such other criteria as the Secretary may provide. Organizations that meet the eligibility 

requirements described above (except for the requirement that tax-exempt status is a condition of 

the contract or grant application), and that certify that the organization’s average annual gross 

receipts over the four year period preceding the application (or during the organization’s first 

four years) was not more than $50,000 would be entitled to a waiver of any fee for application of 

tax-exempt status.

For this purpose, social services would be defined as services directed at helping people 

in need, reducing poverty, improving outcomes of low-income children, revitalizing low-income 

communities, and empowering low-income families and low-income individuals to become selfsufficient, including: (1) child care services, protective services for children and adults, services 

for children and adults in foster care, adoption services, services related to the management and 

maintenance of the home, day care services for adults, and services to meet the special needs of 

children, older individuals, and individuals with disabilities (including physical, mental, or 

emotional disabilities); (2) transportation services; (3) job training and related services, and 

employment services; (4) information, referral, and counseling services; (5) the preparation and 

delivery of meals, and services related to soup kitchens or food banks; (6) health support 

services; (7) literacy and mentoring programs; (8) services for the prevention and treatment of 

juvenile delinquency and substance abuse, services for the prevention of crime and the provision 

 

81 Sec. 508(a).
44

of assistance to the victims and the families of criminal offenders, and services related to the 

intervention in, and prevention of, domestic violence; and (9) services related to the provision of 

assistance for housing under Federal law. Social services does not include a program having the 

purpose of delivering educational assistance under the Elementary and Secondary Education Act

of 1965 or under the Higher Education Act of 1965.

Effective Date

The proposal would be effective for applications for tax-exempt status filed after 

December 31, 2002.
45

E. Clarification of Definition of Church Tax Inquiry

Present Law

Under present law, the IRS may begin a church tax inquiry only if an appropriate highlevel Treasury official reasonably believes, on the basis of the facts and circumstances recorded 

in writing, that an organization (1) may not qualify for tax exemption as a church, (2) may be 

carrying on an unrelated trade or business, or (3) otherwise may be engaged in taxable 

activities.82 A church tax inquiry is defined as any inquiry to a church (other than an 

examination) that serves as a basis for determining whether the organization qualified for tax 

exemption as a church or whether it is carrying on an unrelated trade or business or otherwise is 

engaged in taxable activities. An inquiry is considered to commence when the IRS requests 

information or materials from a church of a type contained in church records, other than routine 

requests for information or inquiries regarding matters that do not primarily concern the tax 

status or liability of the church itself.

Description of Proposal

The proposal would clarify that the present-law church tax inquiry procedures do not 

apply to contacts made by the IRS for the purpose of educating churches with respect to the law 

governing tax-exempt organizations. For example, the proposal would clarify that the IRS does 

not violate the church tax inquiry procedures when written materials are provided to a church or 

churches for the purpose of educating such church or churches with respect to the types of 

activities that are not permissible under section 501(c)(3).

Effective Date

The proposal would be effective on the date of enactment.

 

82 Sec. 7611. Prior to the year 2000 IRS restructuring, the lowest level official who 

could initiate a church tax inquiry was an IRS Regional Commissioner.
46

F. Extension of Declaratory Judgment Procedures to

Non-501(c)(3) Tax-Exempt Organizations

Present Law

In order for an organization to be granted tax exemption as a charitable entity described 

in section 501(c)(3), it generally must file an application for recognition of exemption with the 

IRS and receive a favorable determination of its status. Similarly, for most organizations, a 

charitable organization’s eligibility to receive tax-deductible contributions is dependent upon its 

receipt of a favorable determination from the IRS. In general, a section 501(c)(3) organization 

can rely on a determination letter or ruling from the IRS regarding its tax-exempt status, unless 

there is a material change in its character, purposes, or methods of operation. In cases in which 

an organization violates one or more of the requirements for tax exemption under section 

501(c)(3), the IRS is authorized to revoke an organization’s tax exemption, notwithstanding an 

earlier favorable determination.

In situations in which the IRS denies an organization’s application for recognition of 

exemption under section 501(c)(3) or fails to act on such application, or in which the IRS 

informs a section 501(c)(3) organization that it is considering revoking or adversely modifying 

its tax-exempt status, present law authorizes the organization to seek a declaratory judgment 

regarding its tax status (sec. 7428). Section 7428 provides a remedy in the case of a dispute 

involving a determination by the IRS with respect to: (1) the initial qualification or continuing 

qualification of an organization as a charitable organization for tax exemption purposes or for 

charitable contribution deduction purposes; (2) the initial classification or continuing 

classification of an organization as a private foundation; (3) the initial classification or 

continuing classification of an organization as a private operating foundation; or (4) the failure of 

the IRS to make a determination with respect to (1), (2), or (3). A “determination” in this 

context generally means a final decision by the IRS affecting the tax qualification of a charitable 

organization, although it also can include a proposed revocation of an organization’s tax-exempt 

status or public charity classification. Section 7428 vests jurisdiction over controversies 

involving such a determination in the U.S. District Court for the District of Columbia, the U.S. 

Court of Federal Claims, and the U.S. Tax Court.

Prior to utilizing the declaratory judgment procedure, an organization must have 

exhausted all administrative remedies available to it within the IRS. An organization is deemed 

to have exhausted its administrative remedies at the expiration of 270 days after the date on 

which the request for a determination was made if the organization has taken, in a timely 

manner, all reasonable steps to secure such determination.

If an organization (other than a section 501(c)(3) organization) files an application for 

recognition of exemption and receives a favorable determination from the IRS, the determination 

of tax-exempt status is usually effective as of the date of formation of the organization if its 

purposes and activities during the period prior to the date of the determination letter were 

consistent with the requirements for exemption. However, if the organization files an application 

for recognition of exemption and later receives an adverse determination from the IRS, the IRS 

may assert that the organization is subject to tax on some or all of its income for open taxable 
47

years. In addition, as with charitable organizations, the IRS may revoke or modify an earlier 

favorable determination regarding an organization’s tax-exempt status.

Under present law, a non-charity (i.e., an organization not described in section 501(c)(3)) 

may not seek a declaratory judgment with respect to an IRS determination regarding its taxexempt status. The only remedies available to such an organization are to petition the U.S. Tax 

Court for relief following the issuance of a notice of deficiency or to pay any tax owed and sue 

for refund in federal district court or the U.S. Court of Federal Claims. 

Description of Proposal

The proposal would extend declaratory judgment procedures similar to those currently 

available only to charities under section 7428 to other section 501(c) determinations. The 

provision would limit jurisdiction over controversies involving such determinations to the United 

States Tax Court.83

Effective Date

The extension of the declaratory judgment procedures to organizations other than section 

501(c)(3) organizations would be effective for pleadings with respect to determinations made 

after December 31, 2001.

 

83 This limitation currently applies to declaratory judgments relating to tax qualification 

for certain employee retirement plans (sec. 7476).
48

G. Definition of Convention or Association of Churches

Present Law

Under present law, an organization that qualifies as a “convention or association of 

churches” (within the meaning of sec. 170(b)(1)(A)(i)) is not required to file an annual return,84

is subject to the church tax inquiry and church tax examination provisions applicable to 

organizations claiming to be a church,85 and is subject to certain other provisions generally 

applicable to churches.86 The Internal Revenue Code does not define the term “convention or 

association of churches.”

Description of Proposal

The proposal would provide that an organization that otherwise is a convention or 

association of churches would not fail to so qualify merely because the membership of the 

organization includes individuals as well as churches, or because individuals have voting rights 

in the organization.

Effective Date

The proposal would be effective on the date of enactment.

 

84 Sec. 6033(a)(2)(A)(i).

85 Sec. 7611(h)(1)(B).

86

 See, e.g., Sec. 402(g)(8)(B) (limitation on elective deferrals); sec. 403(b)(9)(B) 

(definition of retirement income account); sec. 410(d) (election to have participation, vesting, 

funding, and certain other provisions apply to church plans); sec. 414(e) (definition of church 

plan); sec. 415(c)(7) (certain contributions by church plans); sec. 501(h)(5) (disqualification of 

certain organizations from making the sec. 501(h) election regarding lobbying expenditure 

limits); sec. 501(m)(3) (definition of commercial-type insurance); sec. 508(c)(1)(A) (exception 

from requirement to file application seeking recognition of exempt status); sec. 512(b)(12) 

(allowance of up to $1,000 deduction for purposes of determining unrelated business taxable 

income); sec. 514(b)(3)(E) (definition of debt-financed property); sec. 3121(w)(3)(A) (election 

regarding exemption from social security taxes); sec. 3309(b)(1) (application of federal 

unemployment tax provisions to services performed in the employ of certain organizations); sec. 

6043(b)(1) (requirement to file a return upon liquidation or dissolution of the organization); and 

sec. 7702(j)(3)(A) (treatment of certain death benefit plans as life insurance).
49

H. Charitable Contribution Deduction for Certain Expenses in Support

of Native Alaskan Subsistence Whaling

Present Law

In computing taxable income, individuals who do not elect the standard deduction may 

claim itemized deductions, including a deduction (subject to certain limitations) for charitable 

contributions or gifts made during the taxable year to a qualified charitable organization or 

governmental entity (sec. 170). Individuals who elect the standard deduction may not claim a 

deduction for charitable contributions made during the taxable year.

No charitable contribution deduction is allowed for a contribution of services. However, 

unreimbursed expenditures made incident to the rendition of services to an organization, 

contributions to which are deductible, may constitute a deductible contribution (Treas. Reg. sec. 

1.170A-1(g)). Specifically, section 170(j) provides that no charitable contribution deduction is 

allowed for traveling expenses (including amounts expended for meals and lodging) while away 

from home, whether paid directly or by reimbursement, unless there is no significant element of 

personal pleasure, recreation, or vacation in such travel.

Description of Proposal

The proposal would allow individuals to claim a deduction under section 170 not 

exceeding $7,500 per taxable year for certain expenses incurred in carrying out sanctioned 

whaling activities. The deduction would be available only to an individual who is recognized by 

the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of 

maintaining and carrying out sanctioned whaling activities. The deduction would be available 

for reasonable and necessary expenses paid by the taxpayer during the taxable year for: (1) the 

acquisition and maintenance of whaling boats, weapons, and gear used in sanctioned whaling 

activities, (2) the supplying of food for the crew and other provisions for carrying out such 

activities, and (3) storage and distribution of the catch from such activities.

For purposes of the provision, the term “sanctioned whaling activities” would mean 

subsistence bowhead whale hunting activities conducted pursuant to the management plan of the 

Alaska Eskimo Whaling Commission. 

Effective Date

The proposal would be effective for contributions made after December 31, 2002.
50

I. Payments by Charitable Organizations to Victims of War on Terrorism

Present Law

In general, organizations described in section 501(c)(3) of the Code are exempt from 

taxation. Contributions to such organizations generally are tax deductible.87 Section 501(c)(3) 

organizations must be organized and operated exclusively for exempt purposes and no part of the 

net earnings of such organizations may inure to the benefit of any private shareholder or 

individual. An organization is not organized or operated exclusively for one or more exempt 

purposes unless the organization serves a public rather than a private interest. Thus, an 

organization described in section 501(c)(3) generally must serve a charitable class of persons that 

is indefinite or of sufficient size. 

Tax-exempt private foundations are a type of organization described in section 501(c)(3) 

and are subject to special rules. Private foundations are subject to excise taxes on acts of selfdealing between the private foundation and a disqualified person with respect to the foundation.88

 

For example, it is self-dealing if assets of a private foundation are used for the benefit of a 

disqualified person, such as a substantial contributor to the foundation or a person in control of 

the foundation, and the benefit is not incidental or tenuous. 

Description of Proposal

The proposal would provide that organizations described in section 501(c)(3) that make 

certain payments are not required to make a specific assessment of need for the payments to be 

related to the purpose or function constituting the basis for the organization’s exemption, 

provided that the organization makes the payments in good faith and uses an objective formula 

that is consistently applied in making the payments. 

The proposal would apply to payments to a member of the Armed Forces of the United 

States (as defined in section 7701(a)(15)), or to a member of such person’s immediate family, by 

reason of the death, injury, wounding, or illness of a member of the Armed Forces of the United 

States that was incurred as a result of the military response of the United States to the terrorist 

attacks against the United States on September 11, 2001. As under present law, such payments

must be for public and not private benefit and therefore must serve a charitable class. For 

example, under the proposal, a charitable organization that assists the families of members of the 

Armed Forces killed in the line of duty would be able to make a pro-rata distribution to the 

families of those killed, even though the specific financial needs of each family were not directly 

considered. Similarly, if the amount of a distribution was based on the number of dependents of 

a charitable class of persons killed in the military response to the attacks and this standard was 

applied consistently among distributions, the specific needs of each recipient would not have to 

be taken into account. However, it would not be appropriate for a charity to make pro-rata 

payments based on the recipients’ living expenses before the harm occurred if the result 

generally would be to provide significantly greater assistance to persons in a better position to 

 

87 Sec. 170.

88 Sec. 4941.
51

provide for themselves than to persons with fewer financial resources. Although such a 

distribution might be based on objective criteria, it would not, under the proposal, be a 

reasonable formula for distributing assistance in an equitable manner. Similarly, although 

specific assessments of need would not be required, payments that would not further public 

purposes would not be permitted. The proposal would not change the substantive standards for 

exemption under section 501(c)(3), including the prohibition on private inurement. The proposal 

also would provide that if a private foundation makes payments under the conditions described 

above, the payment would not be treated as made to a disqualified person for purposes of section 

4941.

Effective Date

The provision applies to payments made after the date of enactment and before 

September 11, 2003.
52

IV. RESTORATION OF SOCIAL SERVICES BLOCK GRANT FUNDING

Present Law

Social Services Block Grant Funding (“SSBG”), also known as “Title XX” (because it is 

Title XX of the Social Security Act), is a flexible funding stream, providing states with resources 

to support a variety of social services. SSBG funds can be used to assist the elderly and disabled 

so that they do not need to enter institutions, to prevent child and elder abuse, to provide child 

care, to promote and support adoption, and for several other services. There are certain specified 

limitations so that SSBG cannot fund most medical care, for example, or cash welfare payments. 

It is a mandatory capped entitlement, distributed by a population-based formula among the 

states.

States use SSBG in differing ways. Much of the funding supports local social service 

providers, including faith-related organizations, through contracts with state and local 

governments. Overall, in fiscal year 1999, SSBG spending was as follows: 13.4 percent for 

“prevention” and case management; 13 percent for day care; 12.4 percent for child and adult 

protective services; 10.9 percent for foster care; 7.4 percent for home-based services. There are 

several other categories in the expenditure data as well.

Prior to the 1996 welfare reform law, SSBG was funded at $2.8 billion. That legislation 

reduced SSBG to $2.38 billion, as part of achieving budgetary savings, and permitted states to 

transfer up to 10 percent of their new Temporary Assistance for Needy Families (TANF) welfare 

block grant allocations to SSBG. (Any transferred funds are required to be spent on behalf of 

families below 200 percent of poverty.) In 1998, as part of the TEA-21 highway legislation, 

SSBG funding as further reduced, declining to $1.7 billion for fiscal year 2001 and fiscal year 

2002. The TANF transfer was further limited to 4.25 percent. 

Description of Proposal

The proposal would increase SSBG funding to $1.975 billion for fiscal year 2003 and 

$2.8 billion for fiscal year 2004. In addition, the TANF transfer limit would be restored to 10 

percent. These two measures provide additional resources to faith-related social service 

organizations. Finally, the Secretary of HHS would be required to submit annual reports on 

SSBG expenditures to the Congress.

Effective Date

The proposal would be effective for amounts made available for fiscal year 2003 and for 

amounts made available each fiscal year thereafter. The proposal requiring annual reports would 

be with respect to fiscal year 2002 and each fiscal year thereafter. 
53

V. REVENUE RAISING PROPOSALS

A. Tax Shelter Transparency Act

1. Penalty for failure to disclose reportable transactions

Present Law

Regulations under section 6011 require corporate taxpayers to disclose with their tax 

return certain information with respect to each “reportable transaction” in which the corporate 

taxpayer participates.89 

There are two categories of reportable transactions. The first category is any transaction 

that is the same as (or substantially similar to) a transaction that is specified by the Treasury as a 

tax avoidance transaction whose tax benefits are subject to disallowance under present law 

(referred to as a “listed transaction”). A corporation must disclose any listed transaction that is 

expected to reduce the taxpayer’s Federal income tax liability by more than $1 million in any 

single taxable year or more than $2 million in any combination of years.90

The second category of reportable transactions is transactions that are expected to reduce 

a taxpayer’s Federal income tax liability by more than $5 million in any single year or $10 

million in any combination of years and that have at least two of the following characteristics: 

(1) the taxpayer has participated in the transaction under conditions of confidentiality; (2) the 

taxpayer has obtained or been provided with contractual protection against the possibility that 

part or all of the intended tax benefits from the transaction will not be sustained; (3) the 

promoters of the transaction have received or are expected to receive fees or other consideration 

with an aggregate value in excess of $100,000, and such fees are contingent on the taxpayer’s 

participation; (4) the transaction results in a reported book/tax difference in excess of $5 million 

in any taxable year; or (5) the transaction involves a person that the taxpayer knows or has 

reason to know is in a Federal income tax position that differs from that of the taxpayer (such as 

a tax-exempt entity or foreign person), and the taxpayer knows or has reason to know that such 

difference has permitted the transaction to be structured to provide the taxpayer with a more 

favorable Federal income tax treatment.91 

Under present law, there is no specific penalty for failing to disclose a reportable 

transaction; however, such a failure may jeopardize the taxpayer’s ability to claim that any 

 

89 Temp. Treas. Reg. sec. 1.6011-4T; Prop. Treas. Reg. sec. 1.6011-4.

90 Temp. Treas. Reg. sec. 1.6011-4T(b)(2) and -(b)(4)(i).

91 Temp. Treas. Reg. sec. 1.6011-4T(b)(3)(i)(A)-(E). In certain circumstances, a 

taxpayer can avoid disclosure with respect to the second category of reportable transactions. See

Temp. Treas. Reg. sec. 1.6011-4T(b)(3)(ii)(A)-(E).
54

income tax understatement attributable to such undisclosed transaction is due to reasonable 

cause, and that the taxpayer acted in good faith.92

Description of Proposal

The proposal would create a new penalty for any person who fails to include with any 

return or statement any required information with respect to a reportable transaction. The new 

penalty would apply without regard to whether the transaction ultimately results in an 

understatement of tax and is in addition to any accuracy-related penalty that may be imposed.

The penalty for failing to disclose a reportable transaction is $50,000. The amount is 

increased to $100,000 if the failure is with respect to a listed transaction. For large entities and 

high net worth individuals, the penalty amount is doubled (i.e., $100,000 for a reportable 

transaction and $200,000 for a listed transaction). The penalty cannot be waived with respect to 

a listed transaction. As to reportable transactions, the penalty could be rescinded only in 

exceptional circumstances. The authority to rescind the penalty could only be exercised by the 

Commissioner or a high-level designee within the Office of Tax Shelter Analysis -- the penalty 

could not be rescinded by a revenue agent, an appeals officer, or other IRS personnel. The 

decision to rescind a penalty would have to be accompanied by a record describing the facts and 

reasons for the action. There would be no taxpayer right to appeal a refusal to rescind a penalty. 

The IRS also would be required to prepare an annual report to Congress summarizing the 

application of the disclosure penalties.

A public entity that is subject to a penalty for failing to disclose a listed transaction (or is

subject to an accuracy-related penalty for a nondisclosed listed transaction or a nondisclosed 

reportable transaction with a significant tax avoidance purpose93) must disclose the imposition of 

the penalty in reports to the Securities and Exchange Commission (“SEC”) (for such period as 

the Secretary shall specify). The proposal would treat any failure to disclose a transaction in 

reports to the SEC as a failure to disclose a listed transaction.

The proposal would define a “listed transaction” and a “reportable transaction” by 

reference to the definition given to these terms in Treasury regulations under section 6011. A 

“large entity” would be defined as any entity with gross receipts in excess of $10 million in the 

year of the transaction or in the preceding year. A “high net worth individual” would be defined 

as any individual whose net worth exceeds $2 million, based on the fair market value of the 

individual’s assets and liabilities immediately before entering into the transaction.

 

92 Section 6664(c) provides that a taxpayer can avoid the imposition of a section 6662 

accuracy-related penalty in cases where the taxpayer can demonstrate that there was reasonable 

cause for the underpayment and that the taxpayer acted in good faith.

93 This category of transactions is described in greater detail below in connection with 

the proposal to modify the accuracy-related penalty to tax shelters.
55

Effective Date

The proposal would be effective for returns and statements the due date for which is after 

the date of enactment. 

2. Modifications to the accuracy-related penalties for listed transactions and reportable 

transactions having a significant tax avoidance purpose 

Present Law

The accuracy-related penalty applies to the portion of any underpayment that is 

attributable to (1) negligence, (2) any substantial understatement of income tax, (3) any 

substantial valuation misstatement, (4) any substantial overstatement of pension liabilities, or (5) 

any substantial estate or gift tax valuation understatement. If the correct income tax liability 

exceeds that reported by the taxpayer by the greater of 10 percent of the correct tax or $5,000 

($10,000 in the case of corporations), then a substantial understatement exists and a penalty may 

be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.94 

The amount of any understatement generally is reduced by any portion attributable to an item if 

(1) the treatment of the item is supported by substantial authority, or (2) facts relevant to the tax 

treatment of the item were adequately disclosed and there was a reasonable basis for its tax 

treatment.95 

Special rules apply with respect to tax shelters.96 For understatements by non-corporate 

taxpayers attributable to tax shelters, the penalty may be avoided only if the taxpayer establishes 

that, in addition to having substantial authority for the position, the taxpayer reasonably believed 

that the treatment claimed was more likely than not the proper treatment of the item. This 

reduction in the penalty is unavailable to corporate tax shelters. 

The understatement penalty generally is abated (even with respect to tax shelters) in cases 

in which the taxpayer can demonstrate that there was “reasonable cause” for the underpayment 

and that the taxpayer acted in good faith.97 The relevant regulations provide that reasonable 

cause exists where the taxpayer “reasonably relies in good faith on an opinion based on a 

professional tax advisor’s analysis of the pertinent facts and authorities [that] . . . unambiguously 

concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will 

be upheld if challenged” by the IRS.98

 

94 Sec. 6662.

95 Sec. 6662(d)(2)(B).

96 Sec. 6662(d)(2)(C).

97 Sec. 6664(c).

98 Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 1.6664-4(c).
56

Description of Proposal

The proposal would modify the present-law accuracy related penalty by replacing the 

rules applicable to tax shelters with a new set of rules that would apply to listed transactions and 

reportable transactions with a significant tax avoidance purpose.99 The rate of the penalty and 

the defenses that would be available to avoid the penalty would vary depending on the type of 

transaction and on whether the transaction was adequately disclosed. 

Under the proposal, a 20-percent penalty would apply to any understatement attributable 

to a listed transaction or a reportable transaction with a significant purpose of tax avoidance. 

The only exception to the penalty would be the reasonable cause and good faith exception of 

section 6664(c). Under the proposal, the reasonable cause exception would apply only if the 

relevant facts affecting the tax treatment are adequately disclosed, there is or was substantial 

authority for the claimed treatment, and the taxpayer reasonably believed that the claimed 

treatment was more likely than not the proper treatment.

If the taxpayer does not adequately disclose the transaction, the reasonable cause and 

good faith exception would not be available, and a higher penalty rate would apply. If the 

understatement is attributable to an undisclosed listed transaction, the penalty rate would be 

increased to 30 percent. For understatements attributable to an undisclosed reportable 

transaction with a significant tax avoidance purpose, the penalty rate would be increased to 25 

percent. 

Rules are provided that would coordinate the interaction of this penalty with the 

understatement penalty and the fraud penalty.

Reportable transactions that are not listed transactions and do not have a significant 

purpose of tax avoidance would be subject to the general rules regarding substantial 

understatements.

The calculation of any penalty arising from a listed or reportable transaction with a tax 

avoidance purpose would be based on the amount of the understatement attributable to the 

transaction (without regard to other items on the tax return). Thus, the amount of the 

understatement would be determined as the product of the highest corporate or individual tax rate 

(as appropriate) and the increase in taxable income resulting from the difference between the 

taxpayer’s treatment of the item and the proper treatment of the item. 

The proposal would clarify what constitutes “reasonable belief,” and would provide that a 

reasonable belief will exist with respect to the tax treatment of an item only if such belief (1) is 

based on the facts and law that exist at the time the tax return (that includes the item) is filed, and 

(2) relates solely to the taxpayer’s chances of success on the merits and does not take into 

account the possibility that (a) a return will not be audited, (b) the treatment will not be raised on 

audit, or (c) the treatment will be resolved through settlement if raised. The proposal also sets 

forth certain criteria regarding the quality of the legal opinion being relied upon, as well as the 

 

99 The terms “reportable transaction” and “listed transaction” have the same meanings as 

previously described in connection with the disclosure provision.
57

independence of the advisor who is providing the legal opinion, in establishing whether a 

taxpayer had a reasonable belief that the tax treatment was more likely than not the correct 

treatment.

Effective Date

The proposal would be effective for taxable years ending after the date of enactment.

3. Modifications to the substantial understatement penalty

Present Law

Definition of substantial understatement

An accuracy-related penalty equal to 20 percent applies to any substantial understatement 

of tax. A “substantial understatement” exists if the correct income tax liability for a taxable year 

exceeds that reported by the taxpayer by the greater of 10 percent of the correct tax or $5,000 

($10,000 in the case of most corporations).100 

Reduction of understatement for certain positions

For purposes of a penalty that is attributable to a substantial understatement of tax, the 

amount of any understatement generally is reduced by any portion attributable to an item if (1) 

the treatment of the item is supported by substantial authority, or (2) facts relevant to the tax 

treatment of the item were adequately disclosed and there was a reasonable basis for its tax 

treatment.101 

The Secretary is required to publish annually in the Federal Register a list of positions for 

which the Secretary believes there is not substantial authority and which affect a significant 

number of taxpayers.102

Description of Proposal

Definition of substantial understatement

The proposal would modify the definition of “substantial” for corporate taxpayers. 

Under the proposal, a corporate taxpayer would have a substantial understatement if the amount 

of the understatement for the taxable year exceeds the lesser of (1) 10 percent of the tax required 

to be shown on the return for the taxable year (or, if greater, $10,000), or (2) $10 million.

 

100 Sec. 6662(a) and -(d)(1)(A).

101 Sec. 6662(d)(2)(B).

102 Sec. 6662(d)(2)(D).
58

Reduction of understatement for certain positions

The proposal would elevate the standard that a taxpayer must satisfy in order to reduce 

the amount of an understatement for undisclosed items. With respect to the treatment of an item 

whose facts are not adequately disclosed, the understatement would be reduced only if the 

taxpayer had a reasonable belief that the tax treatment was more likely than not the proper 

treatment. The proposal also would authorize (but not require) the Secretary to publish a list of 

positions for which it believes there is not substantial authority or there is no reasonable belief 

that the tax treatment is more likely than not the proper treatment (without regard to whether 

such positions affect a significant number of taxpayers).

Effective Date

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

4. Tax shelter exception to confidentiality privileges relating to taxpayer communications

Present Law

In general, a common law privilege of confidentiality exists for communications between 

an attorney and client with respect to the legal advice the attorney gives the client. The Code 

provides that, with respect to tax advice, the same common law protections of confidentiality that 

apply to a communication between a taxpayer and an attorney also apply to a communication 

between a taxpayer and a federally authorized tax practitioner to the extent the communication 

would be considered a privileged communication if it were between a taxpayer and an attorney. 

This rule is inapplicable to communications regarding corporate tax shelters.

Description of Proposal

The proposal would modify the rule relating to corporate tax shelters by making it 

applicable to all tax shelters, whether entered into by corporations, individuals, partnerships, taxexempt entities, or any other entity. Accordingly, communications with respect to tax shelters 

would not be subject to the confidentiality provision of the Code that otherwise applies to a

communication between a taxpayer and a federally authorized tax practitioner.

Effective Date

The proposal would be effective with respect to communications made on or after the 

date of enactment.
59

5. Disclosure of reportable transactions by material advisors

Present Law

Registration of tax shelter arrangements

An organizer of a tax shelter is required to register the shelter with the Secretary not later 

than the day on which the shelter is first offered for sale.103 A “tax shelter” means any 

investment with respect to which the tax shelter ratio104 for any investor as of the close of any of 

the first five years ending after the investment is offered for sale may be greater than two to one 

and which is: (1) required to be registered under Federal or State securities laws, (2) sold 

pursuant to an exemption from registration requiring the filing of a notice with a Federal or State 

securities agency, or (3) a substantial investment (greater than $250,000 and at least five 

investors).105

Other promoted arrangements are treated as tax shelters for purposes of the registration 

requirement if: (1) a significant purpose of the arrangement is the avoidance or evasion of 

Federal income tax by a corporate participant; (2) the arrangement is offered under conditions of 

confidentiality; and (3) the promoter may receive fees in excess of $100,000 in the aggregate.106 

A transaction has a “significant purpose of avoiding or evading Federal income tax” if the 

transaction: (1) is the same as or substantially similar to a “listed transaction,”107 or (2) is 

structured to produce tax benefits that constitute an important part of the intended results of the 

arrangement and the promoter reasonably expects to present the arrangement to more than one 

taxpayer.108 Certain exceptions are provided with respect to the second category of 

transactions.109

An arrangement is offered under conditions of confidentiality if: (1) an offeree has an 

understanding or agreement to limit the disclosure of the transaction or any significant tax 

features of the transaction; or (2) the promoter claims, knows, or has reason to know that a party 

 

103 Sec. 6111(a).

104 The tax shelter ratio is, with respect to any year, the ratio that the aggregate amount of 

the deductions and 350 percent of the credits, which are represented to be potentially allowable 

to any investor, bears to the investment base (money plus basis of assets contributed) as of the 

close of the tax year.

105 Sec. 6111(c).

106 Sec. 6111(d).

107 Temp. Treas. Reg. sec. 301.6111-2T(b)(2).

108 Temp. Treas. Reg. sec. 301.6111-2T(b)(3).

109 Temp. Treas. Reg. sec. 301.6111-2T(b)(4).
60

other than the potential participant claims that the transaction (or any aspect of it) is proprietary 

to the promoter or any party other than the offeree, or is otherwise protected from disclosure or 

use.110 

Failure to register tax shelter

The penalty for failing to timely register a tax shelter (or for filing false or incomplete 

information with respect to the tax shelter registration) generally is the greater of one percent of

the aggregate amount invested in the shelter or $500.111 However, if the tax shelter involves an 

arrangement offered to a corporation under conditions of confidentiality, the penalty is the 

greater of $10,000 or 50 percent of the fees payable to any promoter with respect to offerings 

prior to the date of late registration. Intentional disregard of the requirement to register increases 

the penalty to 75 percent of the applicable fees.

Section 6707 also imposes (1) a $100 penalty on the promoter for each failure to furnish 

the investor with the required tax shelter identification number, and (2) a $250 penalty on the 

investor for each failure to include the tax shelter identification number on a return.

Description of Proposals

Disclosure of reportable transactions by material advisors

The proposal would repeal the present law rules with respect to registration of tax 

shelters. Instead, the proposal would require each material advisor with respect to any reportable 

transaction112 to timely file an information return with the Secretary (in such form and manner as 

the Secretary may prescribe). The return must be filed on such date as prescribed by the 

Secretary. 

The information return would include (1) information identifying and describing the 

transaction, (2) information describing any potential tax benefits expected to result from the 

transaction, and (3) such other information as the Secretary may prescribe.

A “material advisor” means any person (1) who provides material aid, assistance, or 

advice with respect to promoting, selling, or carrying out any reportable transaction, and (2) who 

directly or indirectly derives gross income in excess of $250,000 ($50,000 in the case of a 

 

110 The regulations provide that the determination of whether an arrangement is offered 

under conditions of confidentiality is based on all the facts and circumstances surrounding the 

offer. If an offeree’s disclosure of the structure or tax aspects of the transaction are limited in 

any way by an express or implied understanding or agreement with or for the benefit of a tax 

shelter promoter, an offer is considered made under conditions of confidentiality, whether or not 

such understanding or agreement is legally binding. Treas. Reg. sec. 301.6111-2T(c)(1).

111 Sec. 6707.

112 A reportable transaction (which would include a listed transaction) has the same 

meaning as previously described in connection with the taxpayer-related provisions.
61

reportable transaction substantially all of the tax benefits from which are provided to natural 

persons) for such advice or assistance. 

Penalty for failing to furnish information regarding reportable transactions

The proposal would repeal the present law penalty for failure to register tax shelters. 

Instead, the proposal would impose a penalty on any material advisor who fails to file an 

information return with respect to any reportable transaction, or who files a false or incomplete 

information return with the Secretary with respect to a reportable transaction. The amount of the 

penalty would be $50,000. If the penalty is with respect to a listed transaction, the amount of the 

penalty is increased to the greater of (1) $200,000, or (2) 50 percent of the gross income of such 

person with respect to aid, assistance, or advice which is provided with respect to the reportable 

transaction before the date the return that includes the transaction is filed. Intentional disregard 

of the requirement to register a listed transaction increases the penalty to 75 percent of the gross 

income. 

The penalty cannot be waived with respect to a listed transaction. As to reportable 

transactions, the penalty could be rescinded only in exceptional circumstances. The authority to 

rescind the penalty could only be exercised by the Commissioner or a high-level designee within 

the Office of Tax Shelter Analysis -- the penalty could not be rescinded by a revenue agent, an 

appeals officer, or other IRS personnel. The decision to rescind a penalty would have to be 

accompanied by a record describing the facts and reasons for the action. There would be no right 

to appeal a refusal to rescind a penalty. The IRS also would be required to prepare an annual 

report to Congress summarizing the application of the information penalty.

The terms “reportable transaction” and “listed transaction” would have the same meaning 

as previously described in connection with the taxpayer-related provisions.

Effective Date

The proposal requiring disclosure of reportable transactions by material advisors would 

apply to transactions with respect to which material aid, assistance or advice is provided after the 

date of enactment.

The proposal imposing a penalty for failing to disclose reportable transactions would 

apply to returns the due date for which is after the date of enactment.

6. Investor lists and applicable penalties

Present Law

Investor lists

A promoter must maintain (for a period of seven years) a list identifying each person who 

was sold an interest in any tax shelter with respect to which registration was required under 

section 6111 (even though the particular party may not have been subject to confidentiality 
62

restrictions).113 Regulations under section 6112 provide that, in addition to the name, tax shelter 

identification number and other identifying information the promoter must include detailed 

information about the tax shelter (including details of the shelter and the expected tax benefits, as 

well as copies of any additional written material given to any participant or advisor).114 A 

limited exception is provided for certain shelters if the total fees are less than $25,000 or if the 

expected reduction in tax liabilities for any single year is less than $1 million for corporations or 

$250,000 for non-corporate taxpayers.115

The Secretary is required to prescribe regulations which provide that, in cases in which 2 

or more persons are required to maintain the same list, only one person would be required to 

maintain the list.116

Penalties for failing to maintain investor lists

Under section 6708, the penalty for failing to maintain the list required under section 

6112 is $50 for each name omitted from the list (with a maximum penalty of $100,000 per year).

Description of Proposals

Investor lists

Under the proposal, each material advisor117 that is required to file an information return 

with respect to a reportable transaction118 would be required to maintain a list that (1) identifies 

each person with respect to whom the advisor acted as a material advisor with respect to the 

reportable transaction, and (2) contains other information as may be required by the Secretary. 

In addition, the proposal would authorize the Secretary (but not require) to prescribe regulations 

which provide that, in cases in which 2 or more persons are required to maintain the same list, 

only one person would be required to maintain the list.

Penalty for failing to maintain investor lists

The proposal would modify the penalty for failing to maintain the required list by making 

it a time-sensitive penalty. Thus, a person who is required to maintain an investor list and who 

 

113 Sec. 6112.

114

 See Temp. Treas. Reg. sec. 301.6112-1T Q&A 17.

115

 See Temp. Treas. Reg. sec. 301-6112-1T Q&A 8.

116 Sec. 6112(c)(2).

117 The term “material advisor” has the same meaning as when used in connection with 

the requirement to file an information return under section 6111.

118 The term “reportable transaction” has the same meaning as previously described in 

connection with the taxpayer-related provisions.
63

fails to make the list available upon request by the Secretary within 20 business days after the 

request would be subject to a $10,000 per day penalty. Thus, this penalty could apply when a 

person has failed to maintain a list, has maintained an incomplete list, or has in fact maintained a 

list but does not make the list available to the Secretary. The penalty could be waived if the 

failure to make the list available is due to reasonable cause.

Effective Date

The proposal requiring disclosure of reportable transactions by material advisors would 

apply to transactions with respect to which material aid, assistance or advice is provided after the 

date of enactment.

The proposal imposing a penalty for failing to maintain investor lists would apply to 

requests made after the date of enactment.

7. Actions to enjoin conduct with respect to tax shelters 

Present Law

The Code authorizes civil action to enjoin any person from promoting abusive tax 

shelters or aiding or abetting the understatement of tax liability.

119

Description of Proposal

The proposal would expand this rule so that injunctions may also be sought with respect 

to the requirements of the reporting of tax shelters120 and of the keeping of lists of investors by 

the organizers and sellers of potentially abusive tax shelters.121

Effective Date

The proposal would be effective on the day after the date of enactment.

8. Understatement of taxpayer’s liability by income tax return preparer 

Present Law

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

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

being sustained on its merits and the position was not disclosed (or was frivolous) is liable for a 

penalty of $250, provided that the preparer knew or reasonably should have known of the 

position. An income tax return preparer who prepares a return and engages in specified willful 

or reckless conduct with respect to preparing that return is liable for a penalty of $1,000.

 

119 Code sec. 7408.

120 Code sec. 6707, as amended by other provisions of this proposal.

121 Code sec. 6708, as amended by other provisions of this proposal.
64

Description of Proposal

The proposal would alter the standards of conduct that must be met to avoid imposition 

of the first penalty. The proposal would replace the realistic possibility standard with a 

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

likely than not the proper treatment. The proposal also would replace the not frivolous standard 

with the requirement that there be a reasonable basis for the tax treatment of the position. 

In addition, the proposal would increase the amount of these penalties. The penalty 

relating to not having a reasonable belief that the tax treatment was more likely than not the 

proper tax treatment would be increased from $250 to $1,000. The penalty relating to willful or 

reckless conduct would be increased from $1,000 to $5,000.

Effective Date

The proposal would be effective for documents prepared after the date of enactment.

9. Penalty on failure to report interests in foreign financial accounts

Present Law

The Secretary of the Treasury must require citizens, residents, or persons doing business 

in the United States to keep records and file reports when that person makes a transaction or 

maintains an account with a foreign financial entity.122 In general, individuals must fulfill this 

requirement by answering questions regarding foreign accounts or foreign trusts that are 

contained in Part III of Schedule B of the IRS Form 1040. Taxpayers who answer “yes” in 

response to the question regarding foreign accounts must then file Treasury Department Form 

TD F 90-22.1. This form must be filed with the Department of the Treasury, and not as part of 

the tax return with the IRS.

The Secretary of the Treasury may impose a civil penalty on any person who willfully 

violates this reporting requirement. The civil penalty is the amount of the transaction or the 

value of the account, up to a maximum of $100,000; the minimum amount of the penalty is 

$25,000.123 In addition, any person who willfully violates this reporting requirement is subject to 

a criminal penalty. The criminal penalty is a fine of not more than $250,000 or imprisonment for 

not more than five years (or both); if the violation is part of a pattern of illegal activity, the 

maximum amount of the fine is increased to $500,000 and the maximum length of imprisonment 

is increased to 10 years.124

 

122 31 U.S.C. 5314.

123 31 U.S.C. 5321(a)(5).

124 31 U.S.C. 5322.
65

On April 26, 2002, the Secretary of the Treasury submitted to the Congress a report on 

these reporting requirements.125 This report, which was statutorily required,126 studies methods 

for improving compliance with these reporting requirements. It makes several administrative 

recommendations, but no legislative recommendations. A further report is required to be 

submitted by the Secretary of the Treasury to the Congress by October 26, 2002.

Description of Proposal

The proposal would add an additional civil penalty that may be imposed on any person 

who violates this reporting requirement (without regard to willfulness). This new civil penalty 

would be $5,000. The penalty could be waived if any income from the account was properly 

reported on the income tax return and there was reasonable cause for the failure to report.

Effective Date

The proposal would be effective with respect to failures to report occurring on or after the 

date of enactment.

10. Frivolous tax returns and submissions 

Present Law

The Code provides that an individual who files a frivolous income tax return is subject to 

a penalty of $500 imposed by the IRS (sec. 6702). The Code also permits the Tax Court127 to 

impose a penalty of up to $25,000 if a taxpayer has instituted or maintained proceedings 

primarily for delay or if the taxpayer’s position in the proceeding is frivolous or groundless (sec. 

6673(a)).

Description of Proposal

The proposal would modify the IRS-imposed penalty by increasing the amount of the 

penalty to up to $5,000 and by applying it to all taxpayers and to all types of Federal taxes.

The proposal would also modify present law with respect to certain submissions that raise 

frivolous arguments or that are intended to delay or impede tax administration. The submissions 

to which this provision would apply are requests for a collection due process hearing, installment 

agreements, offers-in-compromise, and taxpayer assistance orders. First, the provision would 

 

125

 A Report to Congress in Accordance with Sec. 361(b) of the Uniting and 

Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct 

Terrorism Act of 2001, April 26, 2002.

126 Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107-56).

127 Because in general the Tax Court is the only pre-payment forum available to 

taxpayers, it deals with most of the frivolous, groundless, or dilatory arguments raised in tax 

cases.
66

permit the IRS to dismiss such requests. Second, the provision would permit the IRS to impose a 

penalty of up to $5,000 for such requests, unless the taxpayer withdraws the request after being 

given an opportunity to do so.

The proposal would require the IRS to publish a list of positions, arguments, requests, 

and proposals determined to be frivolous for purposes of these provisions.

Effective Date

The proposal would be effective for submissions made and issues raised after the date on 

which the Secretary first prescribes the required list.

11. Regulation of individuals practicing before the Department of the Treasury

Present Law

The Secretary of the Treasury is authorized to regulate the practice of representatives of 

persons before the Department of the Treasury.128 The Secretary is also authorized to suspend or 

disbar from practice before the Department a representative who is incompetent, who is 

disreputable, who violates the rules regulating practice before the Department, or who (with 

intent to defraud) willfully and knowingly misleads or threatens the person being represented (or 

a person who may be represented). The rules promulgated by the Secretary pursuant to this 

provision are contained in Circular 230.

Description of Proposal

The proposal would make two modifications to expand the sanctions that the Secretary 

may impose pursuant to these statutory provisions. First, the proposal would expressly permit 

censure as a sanction. Second, the proposal would permit the imposition of a monetary penalty 

as a sanction. If the representative is acting on behalf of an employer or other entity, the 

Secretary may impose a monetary penalty on the employer or other entity if it knew, or 

reasonably should have known, of the conduct. This monetary penalty on the employer or other 

entity may be imposed in addition to any monetary penalty imposed directly on the 

representative. These monetary penalties are not to exceed the gross income derived (or to be 

derived) from the conduct giving rise to the penalty. These monetary penalties may be in 

addition to, or in lieu of, any suspension, disbarment, or censure.

The proposal would also confirm the present-law authority of the Secretary to impose 

standards applicable to written advice with respect to an entity, plan, or arrangement that is of a 

type that the Secretary determines as having a potential for tax avoidance or evasion.

Effective Date

The modifications to expand the sanctions that the Secretary may impose would be 

effective for actions taken after the date of enactment.

 

128 31 U.S.C. 330.
67

12. Penalties on promoters of tax shelters 

Present Law

A penalty is imposed on any person who organizes, assists in the organization of, or 

participates in the sale of any interest in, a partnership or other entity, any investment plan or 

arrangement, or any other plan or arrangement, if in connection with such activity the person 

makes or furnishes a qualifying false or fraudulent statement or a gross valuation 

overstatement.129 A qualified false or fraudulent statement is any statement with respect to the 

allowability of any deduction or credit, the excludability of any income, or the securing of any 

other tax benefit by reason of holding an interest in the entity or participating in the plan or 

arrangement which the person knows or has reason to know is false or fraudulent as to any 

material matter. A “gross valuation overstatement” means any statement as to the value of any 

property or services if the stated value exceeds 200 percent of the correct valuation, and the 

value is directly related to the amount of any allowable income tax deduction or credit.

The amount of the penalty is $1,000 (or, if the person establishes that it is less, 100 

percent of the gross income derived or to be derived by the person from such activity). A 

penalty attributable to a gross valuation misstatement can be waived on a showing that there was 

a reasonable basis for the valuation and it was made in good faith.

Description of Proposal

The proposal would modify the penalty amount to equal 50 percent of the gross income 

derived by the person from the activity for which the penalty is imposed. The new penalty 

would apply to any activity that involves a statement regarding the tax benefits of participating in 

a plan or arrangement if the person knows or has reason to know that such statement is false or 

fraudulent as to any material matter. The enhanced penalty would not apply to a gross valuation 

overstatement.

Effective Date

The proposal would be effective for activities after the date of enactment.

 

129 Sec. 6700.
68

B. Tax Treatment of Inversion Transactions

Present Law

Background

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. 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 is generally deferred. 

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. The main anti-deferral regimes in this context are the 

controlled foreign corporation rules of subpart F130 and the passive foreign investment company 

rules.131 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 earned directly by the domestic corporation, 

repatriated as an actual dividend, or included under one of the anti-deferral regimes, subject to 

certain limitations.

In contrast, the United States taxes foreign corporations only on income that has a 

sufficient nexus to the United States. Place of incorporation determines whether a corporation is 

treated as domestic or foreign for purposes of U.S. tax law.

Inversion transactions

Some U.S. corporations have reincorporated as foreign corporations in low-tax 

jurisdictions, thereby replacing the U.S. parent corporation of a multinational corporate group 

with a foreign parent corporation. These transactions, commonly referred to as “inversions,” 

place the corporate group in a position to derive two main U.S. tax benefits: (1) removing some 

or all of the group’s foreign operations and income from the U.S. taxing jurisdiction; and (2) 

reducing the U.S. taxes that otherwise would be incurred on income from U.S. operations, 

through the use of various “earnings stripping” strategies (e.g., making excessive payments of 

deductible interest or royalties to a new foreign parent). Inversion transactions may take many 

different forms, including stock inversions and asset inversions. 

An inversion may be accompanied or followed by further restructuring of the corporate 

group. For example, in order to remove income from foreign operations from the U.S. taxing 

jurisdiction, the U.S. corporation may 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 the U.S. taxing jurisdiction, the 

corporate group may derive further advantage from the post-inversion structure by reducing U.S. 

 

130 Secs. 951-964.

131 Secs. 1291-1298.
69

tax on U.S.-source income through various “earnings stripping” or other transactions. This may 

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, subject to certain limitations under present law. These limitations include section 

163(j), which limits the deductibility of interest paid to related parties, if the payor’s debt-equity 

ratio exceeds 1.5 to 1 and the payor’s net interest expense exceeds 50 percent of its “adjusted 

taxable income.” More generally, section 482 and the regulations thereunder require that all 

transactions between related parties be conducted on terms consistent with an “arm’s length” 

standard, and permit the Treasury Secretary to reallocate income and deductions among such 

parties if that standard is not met.

Inversion transactions themselves may give rise to 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 recognize gain (but not loss), 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 has 

declined, and/or it has many foreign or tax-exempt shareholders, the impact of this “toll charge” 

is reduced. 

The transfer by the U.S. corporation of foreign subsidiaries or other assets to the foreign 

parent corporation also may give rise to U.S. tax consequences at the corporate level (e.g., gain 

recognition and earnings and profits inclusions). The tax on any income recognized as a result of 

these restructurings may 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 recognizes gain (but not loss) as 

though it had sold all of its assets, but the shareholders generally do not recognize gain or loss, 

assuming the transaction meets the requirements of a tax-free reorganization under the Code.

Description of Proposal

In general

The proposal would define two different types of corporate inversion transactions and 

would establish a different set of consequences for each type. Certain partnership transactions 

also would be covered. 

Transactions involving at least 80 percent ownership

The first type of inversion would be a transaction in which, pursuant to a plan 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; (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 50 percent or greater ownership (i.e., the “expanded affiliated 

group”), does not have substantial business activities in the entity’s country of incorporation, 

compared to the total business activities of the group. The proposal would deny the intended tax 
70

benefits of this type of inversion by deeming the top-tier foreign corporation to be a domestic 

corporation for all purposes of the Code. 

In determining whether a transaction would meet the definition of an inversion under the 

proposal, stock held by members of the expanded affiliated group that includes the foreign 

incorporated entity would be disregarded. For example, if the former top-tier U.S. corporation 

receives stock of the foreign incorporated entity (e.g., “hook” stock), this 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, 

and the definition would not be met. Stock sold in a public offering related to the transaction at 

issue also would be 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 proposal would be disregarded. In addition, the Treasury Secretary 

would be granted authority to issue regulations to prevent the avoidance of the purposes of the 

proposal, 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 would be granted authority to issue regulations treating certain non-stock 

instruments as stock, and certain stock as not stock, where necessary to carry out the purposes of 

the proposal. 

Transactions involving greater than 50 percent but less than 80 percent ownership

The second type of inversion covered by the proposal would be 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 a greater-than-50-percent ownership threshold 

is met, then a second set of rules would apply to the inversion. Under these rules, the inversion 

transaction would be respected (i.e., the foreign corporation would be treated as foreign), but: (1) 

any applicable corporate-level “toll charges” for establishing the inverted structure would be 

strengthened; (2) the IRS would be given expanded power to monitor related-party transactions 

that may be used to reduce U.S. tax on U.S.-source income going forward; and (3) section 163(j), 

relating to “earnings stripping” through related-party debt, would be strengthened. These 

measures generally would apply for a 10-year period following the inversion transaction. 

Specifically, any applicable corporate-level “toll charge” imposed under sections 304, 

311(b), 367, 1001, 1248, or any other provision with respect to the transfer of controlled foreign 

corporation stock or other assets by a U.S. corporation as part of the inversion transaction or after 

such transaction to a related foreign person would be taxable, without offset by any tax attributes 

(e.g., net operating losses or foreign tax credits).

With respect to monitoring, the proposal would establish a new pre-filing procedure. 

Under this procedure, the taxpayer would be required annually to submit an application to the 

IRS for an agreement that all return positions to be taken by the taxpayer with respect to relatedparty transactions comply with all relevant provisions of the Code, including sections 482, 845, 

163(j), and 267(a)(3). The Treasury Secretary would be given the authority to specify the form, 
71

content, and supporting information required for this application, as well as the timing for its 

submission.

The IRS would be required to take one of the following three actions within 90 days of 

receiving a complete application from a taxpayer: (1) conclude an agreement with the taxpayer 

that the return positions to be taken with respect to related-party transactions comply with all 

relevant provisions of the Code; (2) advise the taxpayer that the IRS is satisfied that the 

application was made in good faith and substantially complies with the requirements set forth by 

the Treasury Secretary for such an application, but that the IRS reserves substantive judgment as 

to the tax treatment of the relevant transactions pending the normal audit process; or (3) advise 

the taxpayer that the IRS has concluded that the application was not made in good faith or does 

not substantially comply with the requirements set forth by the Treasury Secretary.

In the case of a compliance failure described in (3) above (and in cases in which the 

taxpayer fails to submit an application), the following sanctions would apply: (1) no deductions 

or additions to basis or cost of goods sold for payments to foreign related parties would be 

permitted; (2) any transfers or licenses of intangible property to related foreign parties would be 

disregarded; and (3) any cost-sharing arrangements would not be respected for the taxable year 

for which the application was required.

If the IRS fails to act on the taxpayer’s application within 90 days of receiving it, then the 

taxpayer would be treated as having submitted an application that substantially complies with the 

above-referenced requirements. Thus, the deduction-disallowance and other sanctions described

above would not apply, but the IRS could examine the transactions at issue under the normal 

audit process. The IRS would be authorized to request that the taxpayer extend this 90-day 

deadline in cases in which the IRS believes that such an extension might help the parties to reach 

an agreement. 

The “earnings stripping” rules of section 163(j), which deny or defer deductions for 

certain interest paid to foreign related parties, would be strengthened as to inverted corporations. 

With respect to such corporations, the proposal would eliminate the debt-equity threshold 

generally applicable under that provision and reduce the 50 percent thresholds for “excess 

interest expense” and “excess limitation” to 25 percent.

Partnership transactions

Under the proposal, both types of inversion transactions are defined to include certain 

partnership transactions. Specifically, both prongs of the proposal would apply 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 80 percent (or more 

than 50 percent but less than 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), and the 

“substantial business activities” test is not met. For purposes of determining whether these 

definitions are met, all partnerships that are under common control within the meaning of section 

482 would be treated as one partnership, except as provided otherwise in regulations. In 

addition, in situations in which the strengthened “toll charge” provisions would apply, those 

provisions would apply at the partner level.
72

Effective Date

The first prong of the proposal would apply to inversion transactions meeting the 80-

percent test that are completed after March 20, 2002. The second prong of the proposal, limiting 

the benefits of other inversions, would apply to inversion transactions meeting the 50-percent test 

that are completed after 1996. The measures set forth in the second prong also would apply to 

inversion transactions completed after 1996 that would have met the 80-percent test but for the 

March 20, 2002, effective date of the first prong. 
73

C. Reinsurance Agreements

Present Law

In the case of a reinsurance agreement between two or more related persons, present law 

provides the Treasury Secretary with authority to allocate among the parties or recharacterize 

income (whether investment income, premium or otherwise), deductions, assets, reserves, credits 

and any other items related to the reinsurance agreement, or make any other adjustment, in order 

to reflect the proper source and character of the items for each party.132 For this purpose, related 

persons are defined as in section 482. Thus, persons are related if they are organizations, trades 

or businesses (whether or not incorporated, whether or not organized in the United States, and 

whether or not affiliated) that are owned or controlled directly or indirectly by the same interests. 

The provision may apply to a contract even if one of the related parties is not a domestic 

company.133 In addition, the provision also permits such allocation, recharacterization, or other 

adjustments in a case in which one of the parties to a reinsurance agreement is, with respect to 

any contract covered by the agreement, in effect an agent of another party to the agreement, or a 

conduit between related persons. 

Description of Proposal

The proposal would modify the rules of section 845, relating to authority for the Treasury 

Secretary to allocate among the parties to a reinsurance agreement, recharacterize items, or make 

any other adjustment, in order to reflect the proper source and character of the items for each 

party. The proposal would authorize such allocation, recharacterization, or other adjustment, in 

order to reflect the proper source, character or amount of the item. It is intended that this 

authority134 be exercised in a manner similar to the authority under section 482 for the Treasury 

Secretary to make adjustments between related parties, including in situations in which the 

related persons (or agents or conduits) are engaged in cross-border transactions that require 

allocation, recharacterization, or other adjustments in order to reflect the proper source, character 

or amount of the item or items.

Effective Date

The provision would be effective for any risk reinsured after April 11, 2002.

 

132 Sec. 845(a).

133 See S. Rep. No. 97-494, "Tax Equity and Fiscal Responsibility Act of 1982," July 12, 

1982, 337 (describing provisions relating to the repeal of modified coinsurance provisions).

134 The authority to allocate, recharacterize or make other adjustments was granted in 

connection with the repeal of provisions relating to modified coinsurance transactions.
74

D. Extension of IRS User Fees

Present Law

The IRS provides written responses to questions of individuals, corporations, and 

organizations relating to their tax status or the effects of particular transactions for tax purposes. 

The IRS generally charges a fee for requests for a letter ruling, determination letter, opinion 

letter, or other similar ruling or determination. Public Law 104-117135 extended the statutory 

authorization for these user fees136 through September 30, 2003.

Description of Proposal

The proposal would extend the statutory authorization for these user fees. The proposal 

would also move the statutory authorization for these fees into the Internal Revenue Code.

Effective Date

The provision, including moving the statutory authorization for these fees into the Code 

and repealing the off-Code statutory authorization for these fees, would be effective for requests 

made after the date of enactment.

 

135 An Act to provide that members of the Armed Forces performing services for the 

peacekeeping efforts in Bosnia and Herzegovina, Croatia, and Macedonia shall be entitled to tax 

benefits in the same manner as if such services were performed in a combat zone, and for other 

purposes (March 20, 1996).

136 These user fees were originally enacted in section 10511 of the Revenue Act of 1987 

(Public Law 100-203, December 22, 1987).
75

E. Imposition of Custom User Fees

Present Law

Section 13031(j)(3) of the Consolidated Omnibus Budget Reconciliation Act of 1985 (19 

U.S.C. 58c(j)(3)) authorizes the temporary imposition and collection of custom user fees in 

connection with services provided by the United States Customs Service. The authorization is 

scheduled to expire on September 30, 2003.

Description of Proposal

The proposal would extend the authority to impose and collect custom user fees, 

provided, however, that any revenue generated from such custom user fees may be used only to 

fund the operations of the United States Customs Service.

Effective Date

The proposal would be effective on the date of enactment.