DESCRIPTION OF H.R. 4297, A BILL TO PROVIDE FOR 

RECONCILIATION PURSUANT TO SECTION 

201(b) OF THE CONCURRENT RESOLUTION 

ON THE BUDGET FOR FISCAL YEAR 2006 

Scheduled for Markup 

By the 

COMMITTEE ON WAYS AND MEANS 

on November 15, 2005 

Prepared by 

the Staff of the 

JOINT COMMITTEE ON TAXATION 

November 14, 2005 

JCX-75-05 
ii

CONTENTS 

Page

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

I. EXTENSIONS OF CERTAIN PROVISIONS THROUGH 2006 ..................................... 2 

A. Allowance of Nonrefundable Personal Credits Against Regular and Alternative 

Minimum Tax Liability.................................................................................................... 2 

B. Deduction of State and Local General Sales Taxes......................................................... 4 

C. Research Credit................................................................................................................ 5 

D. Above-the-Line Deduction for Higher Education Expenses ........................................... 8 

E. Above-the-Line Deduction for Certain Expenses of Elementary and Secondary 

School Teachers............................................................................................................. 10 

F. Qualified Zone Academy Bonds.................................................................................... 11 

G. Tax Incentives for Business Activities on Indian Reservations..................................... 13 

1. Indian employment credit ........................................................................................ 13 

2. Accelerated depreciation for business property on an Indian reservation ............... 14 

H. Deduction for Corporate Donations of Computer Technology and Equipment............ 16 

I. Availability of Archer Medical Savings Accounts ........................................................ 17 

J. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold Improvements 

and Qualified Restaurant Improvements ....................................................................... 19 

K. Taxable Income Limit on Percentage Depletion for Oil and Natural Gas 

Produced from Marginal Properties............................................................................... 21 

L. Tax Incentives for Investment in the District of Columbia ........................................... 22 

M. Possession Tax Credit with Respect to American Samoa ............................................. 26 

N. Parity in the Application of Certain Limits to Mental Health Benefits ......................... 28 

O. Authority for Undercover Operations............................................................................ 29 

II. OTHER EXTENSIONS AND MODIFICATIONS ......................................................... 30 

A. Work Opportunity Tax Credit and Welfare-To-Work Tax Credit................................. 30 

B. Extension and Expansion to Petroleum Products of Expensing for Environmental 

Remediation Costs ......................................................................................................... 34 

C. Controlled Foreign Corporations ................................................................................... 36 

1. Subpart F exception for active financing................................................................. 36 

2. Look-through treatment of payments between related controlled foreign 

corporations under foreign personal holding company income rules...................... 39 

III. EXTENSIONS OF CERTAIN PROVISIONS THROUGH 2010 ................................... 40 

A. Credit for Elective Deferrals and IRA Contributions (the “Saver’s Credit”) ................ 40 

B. Extension of Increased Expensing for Small Business.................................................. 42 

C. Reduced Rates for Capital Gains and Dividends of Individuals.................................... 44 
1

INTRODUCTION 

The Committee on Ways and Means has scheduled a markup on November 15, 2005, of 

H.R. 4297, a bill to provide for reconciliation pursuant to section 201(b) of the concurrent 

resolution on the budget for fiscal year 2006. This document,1

 prepared by the staff of the Joint 

Committee on Taxation, provides a description of the bill. 

 1

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

4297, a Bill to Provide for Reconciliation Pursuant to Section 201(b) of the Concurrent Resolution on the 

Budget for Fiscal Year 2006 (JCX-75-05), November 14, 2005. 
2 

I. EXTENSIONS OF CERTAIN PROVISIONS THROUGH 2006 

A. Allowance of Nonrefundable Personal Credits Against Regular 

and Alternative Minimum Tax Liability 

Present Law

Present law provides for certain nonrefundable personal tax credits (i.e., the dependent 

care credit, the credit for the elderly and disabled, the adoption credit, the child tax credit, the 

credit for interest on certain home mortgages, the HOPE Scholarship and Lifetime Learning 

credits, the credit for savers, the credit for certain nonbusiness energy property, the credit for 

residential energy efficient property, and the D.C. first-time homebuyer credit). 

For taxable years beginning in 2005, the nonrefundable personal credits are allowed to 

the extent of the full amount of the individual’s regular tax and alternative minimum tax. 

For taxable years beginning after 2005, the nonrefundable personal credits (other than the 

adoption credit, child credit and saver’s credit) are allowed only to the extent that the 

individual’s regular income tax liability exceeds the individual’s tentative minimum tax, 

determined without regard to the minimum tax foreign tax credit. The adoption credit, child 

credit, and saver’s credit are allowed to the full extent of the individual’s regular tax and 

alternative minimum tax. 

The alternative minimum tax is the amount by which the tentative minimum tax exceeds 

the regular income tax. An individual’s tentative minimum tax is the sum of (1) 26 percent of so 

much of the taxable excess as does not exceed $175,000 ($87,500 in the case of a married 

individual filing a separate return) and (2) 28 percent of the remaining taxable excess. The 

taxable excess is so much of the alternative minimum taxable income (“AMTI”) as exceeds the 

exemption amount. The maximum tax rates on net capital gain and dividends used in computing 

the regular tax are used in computing the tentative minimum tax. AMTI is the individual’s 

taxable income adjusted to take account of specified preferences and adjustments. 

The exemption amount is: (1) $45,000 ($58,000 for taxable years beginning before 

2006) in the case of married individuals filing a joint return and surviving spouses; (2) $33,750 

($40,250 for taxable years beginning before 2006) in the case of other unmarried individuals; (3) 

$22,500 ($29,000 for taxable years beginning before 2006) in the case of married individuals 

filing a separate return; and (4) $22,500 in the case of an estate or trust. The exemption amount 

is phased out by an amount equal to 25 percent of the amount by which the individual's AMTI 

exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving 

spouses, (2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of 

married individuals filing separate returns, an estate, or a trust. These amounts are not indexed 

for inflation. 

Description of Proposal

The proposal extends for one year the present-law provision allowing nonrefundable 

personal credits to the full extent of the individual’s regular tax and alternative minimum tax 

(through taxable years beginning on or before December 31, 2006). 
3 

Effective Date

The proposal applies to taxable years beginning after December 31, 2005.
4 

B. Deduction of State and Local General Sales Taxes 

Present Law

For purposes of determining regular tax liability, an itemized deduction is permitted for 

certain State and local taxes paid, including individual income taxes, real property taxes, and 

personal property taxes. The itemized deduction is not permitted for purposes of determining a 

taxpayer’s alternative minimum taxable income. For taxable years beginning in 2004 and 2005, 

at the election of the taxpayer, an itemized deduction may be taken for State and local general 

sales taxes in lieu of the itemized deduction provided under present law for State and local 

income taxes. As is the case for State and local income taxes, the itemized deduction for State 

and local general sales taxes is not permitted for purposes of determining a taxpayer’s alternative 

minimum taxable income. Taxpayers have two options with respect to the determination of the 

sales tax deduction amount. Taxpayers may deduct the total amount of general State and local 

sales taxes paid by accumulating receipts showing general sales taxes paid. Alternatively, 

taxpayers may use tables created by the Secretary of the Treasury that show the allowable 

deduction. The tables are based on average consumption by taxpayers on a State-by-State basis 

taking into account filing status, number of dependents, adjusted gross income and rates of State 

and local general sales taxation. Taxpayers who use the tables created by the Secretary may, in 

addition to the table amounts, deduct eligible general sales taxes paid with respect to the 

purchase of motor vehicles, boats and other items specified by the Secretary. Sales taxes for 

items that may be added to the tables are not reflected in the tables themselves. 

The term “general sales tax” means a tax imposed at one rate with respect to the sale at 

retail of a broad range of classes of items. However, in the case of items of food, clothing, 

medical supplies, and motor vehicles, the fact that the tax does not apply with respect to some or 

all of such items is not taken into account in determining whether the tax applies with respect to 

a broad range of classes of items, and the fact that the rate of tax applicable with respect to some 

or all of such items is lower than the general rate of tax is not taken into account in determining 

whether the tax is imposed at one rate. Except in the case of a lower rate of tax applicable with 

respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any 

general sales tax imposed with respect to an item at a rate other than the general rate of tax. 

However, in the case of motor vehicles, if the rate of tax exceeds the general rate, such excess 

shall be disregarded and the general rate is treated as the rate of tax. 

A compensating use tax with respect to an item is treated as a general sales tax, provided 

such tax is complimentary to a general sales tax and a deduction for sales taxes is allowable with 

respect to items sold at retail in the taxing jurisdiction that are similar to such item. 

Description of Proposal

The proposal extends for one year the present-law provision allowing taxpayers to elect 

to deduct State and local sales taxes in lieu of State and local income taxes (through taxable 

years beginning on or before December 31, 2006). 

Effective Date

The proposal applies to taxable years beginning after December 31, 2005.
5 

C. Research Credit 

Present Law

General rule

Generally, a taxpayer may claim a research credit equal to 20 percent of the amount by 

which the taxpayer’s qualified research expenses for a taxable year exceed its base amount for 

that year (sec. 41). Thus, the research credit is generally available with respect to incremental 

increases in qualified research. 

The research credit also applies to the excess of (1) 100 percent of corporate cash 

expenses (including grants or contributions) paid for basic research conducted by universities 

(and certain nonprofit scientific research organizations) over (2) the sum of (a) the greater of two 

minimum basic research floors plus (b) an amount reflecting any decrease in nonresearch giving 

to universities by the corporation as compared to such giving during a fixed-base period, as 

adjusted for inflation. This separate credit computation is commonly referred to as the university 

basic research credit (see sec. 41(e)). 

Finally, the research credit applies to a taxpayer’s expenditures on research undertaken 

by an energy research consortium. This separate credit computation is referred to here as the 

energy research credit. Unlike the general research credit, the energy research credit applies to 

all qualified expenditures, not just those in excess of a base amount. 

The research credit (including the university basic research credit and the energy research 

credit) is scheduled to expire and generally will not apply to amounts paid or incurred after 

December 31, 2005. 

Computation of allowable credit

Except for energy research payments and certain university basic research payments 

made by corporations, the research credit applies only to the extent that the taxpayer’s qualified 

research expenses for the current taxable year exceed its base amount. The base amount for the 

current year generally is computed by multiplying the taxpayer’s fixed-base percentage by the 

average amount of the taxpayer’s gross receipts for the four preceding years. If a taxpayer both 

incurred qualified research expenses and had gross receipts during each of at least three years 

from 1984 through 1988, then its fixed-base percentage is the ratio that its total qualified 

research expenses for the 1984-1988 period bears to its total gross receipts for that period 

(subject to a maximum fixed-base percentage of 16 percent). All other taxpayers (so-called 

“start-up firms”) are assigned a fixed-base percentage of three percent. 

In computing the credit, a taxpayer’s base amount may not be less than 50 percent of its 

current-year qualified research expenses. 

To prevent artificial increases in research expenditures by shifting expenditures among 

commonly controlled or otherwise related entities, a special aggregation rule provides that all 

members of the same controlled group of corporations are treated as a single taxpayer (sec. 

41(f)(1)). Under regulations prescribed by the Secretary, special rules apply for computing the 
6 

credit when a major portion of a trade or business (or unit thereof) changes hands, under which 

qualified research expenses and gross receipts for periods prior to the change of ownership of a 

trade or business are treated as transferred with the trade or business that gave rise to those 

expenses and receipts for purposes of recomputing a taxpayer’s fixed-base percentage (sec. 

41(f)(3)). 

Alternative incremental research credit regime

Taxpayers are allowed to elect an alternative incremental research credit regime. If a 

taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered 

fixed-base percentage (that is lower than the fixed-base percentage otherwise applicable under 

present law) and the credit rate likewise is reduced. Under the alternative incremental credit 

regime, a credit rate of 2.65 percent applies to the extent that a taxpayer’s current-year research 

expenses exceed a base amount computed by using a fixed-base percentage of one percent (i.e., 

the base amount equals one percent of the taxpayer’s average gross receipts for the four 

preceding years) but do not exceed a base amount computed by using a fixed-base percentage of 

1.5 percent. A credit rate of 3.2 percent applies to the extent that a taxpayer’s current-year 

research expenses exceed a base amount computed by using a fixed-base percentage of 1.5 

percent but do not exceed a base amount computed by using a fixed-base percentage of two 

percent. A credit rate of 3.75 percent applies to the extent that a taxpayer’s current-year research 

expenses exceed a base amount computed by using a fixed-base percentage of two percent. An 

election to be subject to this alternative incremental credit regime may be made for any taxable 

year beginning after June 30, 1996, and such an election applies to that taxable year and all 

subsequent years unless revoked with the consent of the Secretary of the Treasury. 

Eligible expenses

Generally, qualified research expenses eligible for the research credit consist of: (1) inhouse expenses of the taxpayer for wages and supplies attributable to qualified research; (2) 

certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts 

paid or incurred by the taxpayer to certain other persons for qualified research conducted on the 

taxpayer’s behalf (so-called contract research expenses). Notwithstanding the limitation for 

contract research expenses, qualified research expenses include 100 percent of amounts paid or 

incurred by the taxpayer to an eligible small business, university, or Federal laboratory for 

qualified energy research. 

To be eligible for the credit, the research must not only satisfy the requirements of 

present-law section 174 (described below) but must be undertaken for the purpose of discovering 

information that is technological in nature, the application of which is intended to be useful in 

the development of a new or improved business component of the taxpayer, and substantially all 

of the activities of which must constitute elements of a process of experimentation for functional 

aspects, performance, reliability, or quality of a business component. Research does not qualify 

for the credit if substantially all of the activities relate to style, taste, cosmetic, or seasonal design 

factors (sec. 41(d)(3)). In addition, research does not qualify for the credit: (1) if conducted 

after the beginning of commercial production of the business component; (2) if related to the 

adaptation of an existing business component to a particular customer’s requirements; (3) if 

related to the duplication of an existing business component from a physical examination of the 
7 

component itself or certain other information; or (4) if related to certain efficiency surveys, 

management function or technique, market research, market testing, or market development, 

routine data collection or routine quality control (sec. 41(d)(4)). Research does not qualify for 

the credit if it is conducted outside the United States, Puerto Rico, or any U.S. possession. 

Relation to deduction

Under section 174, taxpayers may elect to deduct currently the amount of certain research 

or experimental expenditures paid or incurred in connection with a trade or business, 

notwithstanding the general rule that business expenses to develop or create an asset that has a 

useful life extending beyond the current year must be capitalized. However, deductions allowed 

to a taxpayer under section 174 (or any other section) are reduced by an amount equal to 100 

percent of the taxpayer’s research credit determined for the taxable year (Sec. 280C(c)). 

Taxpayers may alternatively elect to claim a reduced research credit amount under section 41 in 

lieu of reducing deductions otherwise allowed (sec. 280C(c)(3)). 

Description of Proposal

The proposal extends for one year the present-law research credit provision (for amounts 

paid or incurred through December 31, 2006). 

Effective Date

The proposal applies to amounts paid or incurred after December 31, 2005. 
8 

D. Above-the-Line Deduction for Higher Education Expenses 

Present Law

An individual is allowed an above-the-line deduction for qualified tuition and related 

expenses for higher education paid by the individual during the taxable year. Qualified tuition 

and related expenses include tuition and fees required for the enrollment or attendance of the 

taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer with respect to whom the 

taxpayer may claim a personal exemption, at an eligible institution of higher education for 

courses of instruction of such individual at such institution. Charges and fees associated with 

meals, lodging, insurance, transportation, and similar personal, living, or family expenses are not 

eligible for the deduction. The expenses of education involving sports, games, or hobbies are not 

qualified tuition and related expenses unless this education is part of the student’s degree 

program. 

The amount of qualified tuition and related expenses must be reduced by certain 

scholarships, educational assistance allowances, and other amounts paid for the benefit of such 

individual, and by the amount of such expenses taken into account for purposes of determining 

any exclusion from gross income of: (1) income from certain United States Savings Bonds used 

to pay higher education tuition and fees; and (2) income from a Coverdell education savings 

account. Additionally, such expenses must be reduced by the earnings portion (but not the return 

of principal) of distributions from a qualified tuition program if an exclusion under section 529 is 

claimed with respect to expenses eligible for exclusion under section 222. No deduction is 

allowed for any expense for which a deduction is otherwise allowed or with respect to an 

individual for whom a Hope credit or Lifetime Learning credit is elected for such taxable year. 

The expenses must be in connection with enrollment at an institution of higher education 

during the taxable year, or with an academic term beginning during the taxable year or during the 

first three months of the next taxable year. The deduction is not available for tuition and related 

expenses paid for elementary or secondary education. 

For taxable years beginning in 2004 and 2005, the maximum deduction is $4,000 for an 

individual whose adjusted gross income for the taxable year does not exceed $65,000 ($130,000 

in the case of a joint return), or $2,000 for other individuals whose adjusted gross income does 

not exceed $80,000 ($160,000 in the case of a joint return). No deduction is allowed for an 

individual whose adjusted gross income exceeds the relevant adjusted gross income limitations, 

for a married individual who does not file a joint return, or for an individual with respect to 

whom a personal exemption deduction may be claimed by another taxpayer for the taxable year. 

The deduction is not available for taxable years beginning after December 31, 2005. 

Description of Proposal

The proposal extends the present-law tuition deduction for one year (through taxable 

years beginning on or before December 31, 2006). 
9 

Effective Date

The proposal is effective for payments made in taxable years beginning after 

December 31, 2005. 
10 

E. Above-the-Line Deduction for Certain Expenses of 

Elementary and Secondary School Teachers 

Present Law

In general, ordinary and necessary business expenses are deductible (sec. 162). However, 

in general, unreimbursed employee business expenses are deductible only as an itemized 

deduction and only to the extent that the individual’s total miscellaneous deductions (including 

employee business expenses) exceed two percent of adjusted gross income. An individual’s 

otherwise allowable itemized deductions may be further limited by the overall limitation on 

itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross 

income in excess of $145,950 (for 2005). In addition, miscellaneous itemized deductions are not 

allowable under the alternative minimum tax. 

Certain expenses of eligible educators are allowed an above-the-line deduction. 

Specifically, for taxable years beginning prior to January 1, 2006, an above-the-line deduction is 

allowed for up to $250 annually of expenses paid or incurred by an eligible educator for books, 

supplies (other than nonathletic supplies for courses of instruction in health or physical 

education), computer equipment (including related software and services) and other equipment, 

and supplementary materials used by the eligible educator in the classroom. To be eligible for 

this deduction, the expenses must be otherwise deductible under section 162 as a trade or 

business expense. A deduction is allowed only to the extent the amount of expenses exceeds the 

amount excludable from income under section 135 (relating to education savings bonds), section 

529(c)(1) (relating to qualified tuition programs), and section 530(d)(2) (relating to Coverdell 

education savings accounts). 

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, 

principal, or aide in a school for at least 900 hours during a school year. A school means any 

school which provides elementary education or secondary education, as determined under State 

law. 

The above-the-line deduction for eligible educators is not allowed for taxable years 

beginning after December 31, 2005. 

Description of Proposal

The proposal extends for one year the present-law deduction for expenses of eligible 

educators (through taxable years beginning on or before December 31, 2006). 

Effective Date

The proposal is effective for expenses paid or incurred in taxable years beginning after 

December 31, 2005.
11 

F. Qualified Zone Academy Bonds 

Present Law

Tax-exempt bonds

Interest on State and local governmental bonds generally is excluded from gross income 

for Federal income tax purposes if the proceeds of the bonds are used to finance direct activities 

of these governmental units or if the bonds are repaid with revenues of the governmental units. 

Activities that can be financed with these tax-exempt bonds include the financing of public 

schools (sec. 103). 

Qualified zone academy bonds

As an alternative to traditional tax-exempt bonds, States and local governments are given 

the authority to issue “qualified zone academy bonds” (sec. 1397E). A total of $400 million of 

qualified zone academy bonds may be issued annually in calendar years 1998 through 2005. The 

$400 million aggregate bond cap is allocated each year to the States according to their respective 

populations of individuals below the poverty line. Each State, in turn, allocates the credit 

authority to qualified zone academies within such State. 

Financial institutions that hold qualified zone academy bonds are entitled to a 

nonrefundable tax credit in an amount equal to a credit rate multiplied by the face amount of the 

bond. A taxpayer holding a qualified zone academy bond on the credit allowance date is entitled 

to a credit. The credit is includable in gross income (as if it were a taxable interest payment on 

the bond), and may be claimed against regular income tax and AMT liability. 

The Treasury Department sets the credit rate at a rate estimated to allow issuance of 

qualified zone academy bonds without discount and without interest cost to the issuer. The 

maximum term of the bond is determined by the Treasury Department, so that the present value 

of the obligation to repay the bond is 50 percent of the face value of the bond. 

“Qualified zone academy bonds” are defined as any bond issued by a State or local 

government, provided that: (1) at least 95 percent of the proceeds are used for the purpose of 

renovating, providing equipment to, developing course materials for use at, or training teachers 

and other school personnel in a “qualified zone academy”, and (2) private entities have promised 

to contribute to the qualified zone academy certain equipment, technical assistance or training, 

employee services, or other property or services with a value equal to at least 10 percent of the 

bond proceeds. 

A school is a “qualified zone academy” if: (1) the school is a public school that provides 

education and training below the college level, (2) the school operates a special academic 

program in cooperation with businesses to enhance the academic curriculum and increase 

graduation and employment rates, and (3) either (a) the school is located in an empowerment 

zone or enterprise community designated under the Code, or (b) it is reasonably expected that at 

least 35 percent of the students at the school will be eligible for free or reduced-cost lunches 

under the school lunch program established under the National School Lunch Act. 
12 

Description of Proposal

The proposal extends for one year the present-law provision relating to qualified zone 

academy bonds (through December 31, 2006). 

Effective Date

The proposal applies to bonds issued after December 31, 2005.
13 

G. Tax Incentives for Business Activities on Indian Reservations 

1. Indian employment credit 

Present Law

In general, a credit against income tax liability is allowed to employers for the first 

$20,000 of qualified wages and qualified employee health insurance costs paid or incurred by the 

employer with respect to certain employees. The credit is equal to 20 percent of the excess of 

eligible employee qualified wages and health insurance costs during the current year over the 

amount of such wages and costs incurred by the employer during 1993. The credit is an 

incremental credit, such that an employer’s current-year qualified wages and qualified employee 

health insurance costs (up to $20,000 per employee) are eligible for the credit only to the extent 

that the sum of such costs exceeds the sum of comparable costs paid during 1993. No deduction 

is allowed for the portion of the wages equal to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer for services performed by 

a qualified employee. A qualified employee means any employee who is an enrolled member of 

an Indian tribe or the spouse of an enrolled member of an Indian tribe, who performs 

substantially all of the services within an Indian reservation, and whose principal place of abode 

while performing such services is on or near the reservation in which the services are performed. 

An “Indian reservation” is a reservation as defined in section 3(d) of the Indian Financing Act of 

1974 or section 4(1) of the Indian Child Welfare Act of 1978. For purposes of the preceding 

sentence, section 3(d) is applied by treating “former Indian reservations in Oklahoma” as 

including only lands that are (1) within the jurisdictional area of an Oklahoma Indian tribe as 

determined by the Secretary of the Interior, and (2) recognized by such Secretary as an area 

eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997). 

An employee is not treated as a qualified employee for any taxable year of the employer 

if the total amount of wages paid or incurred by the employer with respect to such employee 

during the taxable year exceeds an amount determined at an annual rate of $30,000 (which after 

adjusted for inflation after 1993 is currently $35,000). In addition, an employee will not be 

treated as a qualified employee under certain specific circumstances, such as where the employee 

is related to the employer (in the case of an individual employer) or to one of the employer’s 

shareholders, partners, or grantors. Similarly, an employee will not be treated as a qualified 

employee where the employee has more than a 5 percent ownership interest in the employer. 

Finally, an employee will not be considered a qualified employee to the extent the employee’s 

services relate to gaming activities or are performed in a building housing such activities. 

The wage credit is available for wages paid or incurred on or after January 1, 1994, in 

taxable years that begin before January 1, 2006. 

Description of Proposal

The proposal extends for one year the present-law employment credit provision (through 

taxable years beginning on or before December 31, 2006). 
14 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005. 

2. Accelerated depreciation for business property on an Indian reservation 

Present Law

With respect to certain property used in connection with the conduct of a trade or 

business within an Indian reservation, depreciation deductions under section 168(j) are 

determined using the following recovery periods: 

3-year property 2 years 

5-year property 3 years 

7-year property 4 years 

10-year property 6 years 

15-year property 9 years 

20-year property 12 years 

Nonresidential real 

property 22 years 

“Qualified Indian reservation property” eligible for accelerated depreciation includes 

property which is (1) used by the taxpayer predominantly in the active conduct of a trade or 

business within an Indian reservation, (2) not used or located outside the reservation on a regular 

basis, (3) not acquired (directly or indirectly) by the taxpayer from a person who is related to the 

taxpayer (within the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period 

table above. In addition, property is not “qualified Indian reservation property” if it is placed in 

service for purposes of conducting gaming activities. Certain “qualified infrastructure property” 

may be eligible for the accelerated depreciation even if located outside an Indian reservation, 

provided that the purpose of such property is to connect with qualified infrastructure property 

located within the reservation (e.g., roads, power lines, water systems, railroad spurs, and 

communications facilities). 

An “Indian reservation” means a reservation as defined in section 3(d) of the Indian 

Financing Act of 1974 or section 4(1) of the Indian Child Welfare Act of 1978. For purposes of 

the preceding sentence, section 3(d) is applied by treating “former Indian reservations in 

Oklahoma” as including only lands that are (1) within the jurisdictional area of an Oklahoma 

Indian tribe as determined by the Secretary of the Interior, and (2) recognized by such Secretary 

as an area eligible for trust land status under 25 C.F.R. Part 151 (as in effect on August 5, 1997). 

The depreciation deduction allowed for regular tax purposes is also allowed for purposes 

of the alternative minimum tax. The accelerated depreciation for Indian reservations is available 
15 

with respect to property placed in service on or after January 1, 1994, and before January 1, 

2006. 

Description of Proposal

The proposal extends for one year the present-law provision relating to depreciation of 

qualified Indian reservation property (to apply to property placed in service through 

December 31, 2006). 

Effective Date

The proposal applies to property placed in service after December 31, 2005.
16 

H. Deduction for Corporate Donations of 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. 

Under present law, a taxpayer’s deduction for charitable 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 computer contribution.” This enhanced deduction is equal to the lesser of (1) basis 

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

or (2) two times basis. The enhanced deduction for qualified computer contributions expires for 

any contribution made during any taxable year beginning after December 31, 2005. 

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 

substantially completed. The original use of the property must be by the donor or the donee, 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. That 

is, 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) 

does not exceed 50 percent of the taxpayer’s basis in the property. Contributions may be made 

to private foundations under certain conditions. 

Description of Proposal

The proposal extends for one year the present-law provision relating to qualified 

computer contributions (to apply to contributions made in taxable years beginning on or before 

December 31, 2006). 

Effective Date

The proposal applies to contributions made in taxable years beginning after 

December 31, 2005. 
17 

I. Availability of Archer Medical Savings Accounts 

Present Law

Archer medical savings accounts

In general

Within limits, contributions to an Archer medical savings account (“Archer MSA”) are 

deductible in determining adjusted gross income if made by an eligible individual and are 

excludable from gross income and wages for employment tax purposes if made by the employer 

of an eligible individual. Earnings on amounts in an Archer MSA are not currently taxable. 

Distributions from an Archer MSA for medical expenses are not includible in gross income. 

Distributions not used for medical expenses are includible in gross income. In addition, 

distributions not used for medical expenses are subject to an additional 15-percent tax unless the 

distribution is made after age 65, death, or disability. 

Eligible individuals

Archer MSAs are available to employees covered under an employer-sponsored high 

deductible plan of a small employer and self-employed individuals covered under a high 

deductible health plan. An employer is a small employer if it employed, on average, no more 

than 50 employees on business days during either the preceding or the second preceding year. 

An individual is not eligible for an Archer MSA if he or she is covered under any other health 

plan in addition to the high deductible plan. 

Tax treatment of and limits on contributions

Individual contributions to an Archer MSA are deductible (within limits) in determining 

adjusted gross income (i.e., “above-the-line”). In addition, employer contributions are 

excludable from gross income and wages for employment tax purposes (within the same limits), 

except that this exclusion does not apply to contributions made through a cafeteria plan. In the 

case of an employee, contributions can be made to an Archer MSA either by the individual or by 

the individual’s employer. 

The maximum annual contribution that can be made to an Archer MSA for a year is 65 

percent of the deductible under the high deductible plan in the case of individual coverage and 75 

percent of the deductible in the case of family coverage. 

Definition of high deductible plan

A high deductible plan is a health plan with an annual deductible of at least $1,750 and 

no more than $2,650 in the case of individual coverage and at least $3,500 and no more than 

$5,250 in the case of family coverage (for 2005). In addition, the maximum out-of-pocket 

expenses with respect to allowed costs (including the deductible) must be no more than $3,500 in 

the case of individual coverage and no more than $6,450 in the case of family coverage (for 

2005). A plan does not fail to qualify as a high deductible plan merely because it does not have a 

deductible for preventive care as required by State law. A plan does not qualify as a high 
18 

deductible health plan if substantially all of the coverage under the plan is for certain permitted 

coverage. In the case of a self-insured plan, the plan must in fact be insurance (e.g., there must 

be appropriate risk shifting) and not merely a reimbursement arrangement. 

Cap on taxpayers utilizing Archer MSAs and expiration of pilot program

The number of taxpayers benefiting annually from an Archer MSA contribution is limited 

to a threshold level (generally 750,000 taxpayers). The number of Archer MSAs established has 

not exceeded the threshold level. 

After 2005, no new contributions may be made to Archer MSAs except by or on behalf 

of individuals who previously made (or had made on their behalf) Archer MSA contributions and 

employees who are employed by a participating employer. 

Trustees of Archer MSAs are generally required to make reports to the Treasury by 

August 1 regarding Archer MSAs established by July 1 of that year. If the threshold level is 

reached in a year, the Secretary is required to make and publish such determination by October 1 

of such year. 

Health savings accounts

Health savings accounts (“HSAs”) were enacted by the Medicare Prescription Drug, 

Improvement, and Modernization Act of 2003. Like Archer MSAs, an HSA is a tax-exempt trust 

or custodial account to which tax-deductible contributions may be made by individuals with a 

high deductible health plan. HSAs provide tax benefits similar to, but more favorable than, those 

provide by Archer MSAs. HSAs were established on a permanent basis. 

Description of Proposal

The proposal extends for one year the present-law Archer MSA provisions (through 

December 31, 2006). 

The report required by Archer MSA trustees is treated as timely filed if made before the 

close of the 90-day period beginning on the date of enactment. The determination and 

publication whether the threshold level has been exceeded is treated as timely if made before the 

close of the 120-day period beginning on the date of enactment. 

Effective Date

The proposal is effective on the date of enactment.
19 

J. Fifteen-Year Straight-Line Cost Recovery for Qualified Leasehold 

Improvements and Qualified Restaurant Improvements 

Present Law

In general

A taxpayer generally must capitalize the cost of property used in a trade or business and 

recover such cost over time through annual deductions for depreciation or amortization. Tangible 

property generally is depreciated under the modified accelerated cost recovery system 

(“MACRS”), which determines depreciation by applying specific recovery periods, placed-inservice conventions, and depreciation methods to the cost of various types of depreciable 

property (sec. 168). The cost of nonresidential real property is recovered using the straight-line 

method of depreciation and a recovery period of 39 years. Nonresidential real property is subject 

to the mid-month placed-in-service convention. Under the mid-month convention, the 

depreciation allowance for the first year property is placed in service is based on the number of 

months the property was in service, and property placed in service at any time during a month is 

treated as having been placed in service in the middle of the month. 

Depreciation of leasehold improvements

Generally, depreciation allowances for improvements made on leased property are 

determined under MACRS, even if the MACRS recovery period assigned to the property is 

longer than the term of the lease. This rule applies regardless of whether the lessor or the lessee 

places the leasehold improvements in service. If a leasehold improvement constitutes an 

addition or improvement to nonresidential real property already placed in service, the 

improvement generally is depreciated using the straight-line method over a 39-year recovery 

period, beginning in the month the addition or improvement was placed in service. However, 

exceptions exist for certain qualified leasehold improvements and certain qualified restaurant 

property. 

Qualified leasehold improvement property

Section 168(e)(3)(E)(iv) provides a statutory 15-year recovery period for qualified 

leasehold improvement property placed in service before January 1, 2006. Qualified leasehold 

improvement property is recovered using the straight-line method. Leasehold improvements 

placed in service in 2006 and later will be subject to the general rules described above. 

Qualified leasehold improvement property is any improvement to an interior portion of a 

building that is nonresidential real property, provided certain requirements are met. The 

improvement must be made under or pursuant to a lease either by the lessee (or sublessee), or by 

the lessor, of that portion of the building to be occupied exclusively by the lessee (or sublessee). 

The improvement must be placed in service more than three years after the date the building was 

first placed in service. Qualified leasehold improvement property does not include any 

improvement for which the expenditure is attributable to the enlargement of the building, any 

elevator or escalator, any structural component benefiting a common area, or the internal 

structural framework of the building. However, if a lessor makes an improvement that qualifies 

as qualified leasehold improvement property, such improvement does not qualify as qualified 
20 

leasehold improvement property to any subsequent owner of such improvement. An exception 

to the rule applies in the case of death and certain transfers of property that qualify for nonrecognition treatment. 

Qualified restaurant property

Section 168(e)(3)(E)(v) provides a statutory 15-year recovery period for qualified 

restaurant property placed in service before January 1, 2006. For purposes of the provision, 

qualified restaurant property means any improvement to a building if such improvement is 

placed in service more than three years after the date such building was first placed in service 

and more than 50 percent of the building’s square footage is devoted to the preparation of, and 

seating for on-premises consumption of, prepared meals. Qualified restaurant property is 

recovered using the straight-line method. 

Description of Proposal

The proposal extends for one year the present-law provisions providing a 15-year 

recovery period for qualified leasehold improvement property and for qualified restaurant 

property (to apply to property placed in service through December 31, 2006). 

Effective Date

The proposal applies to property placed in service after December 31, 2005.
21 

K. Taxable Income Limit on Percentage Depletion for Oil and Natural Gas 

 Produced from Marginal Properties 

Present Law

The Code permits taxpayers to recover their investments in oil and gas wells through 

depletion deductions. Two methods of depletion are currently allowable under the Code: (1) the 

cost depletion method, and (2) the percentage depletion method. Under the cost depletion 

method, the taxpayer deducts that portion of the adjusted basis of the depletable property which 

is equal to the ratio of units sold from that property during the taxable year to the number of units 

remaining as of the end of taxable year plus the number of units sold during the taxable year. 

Thus, the amount recovered under cost depletion may never exceed the taxpayer's basis in the 

property. 

The Code generally limits the percentage depletion method for oil and gas properties to 

independent producers and royalty owners. Generally, under the percentage depletion method, 

15 percent of the taxpayer's gross income from an oil- or gas-producing property is allowed as a 

deduction in each taxable year. The amount deducted generally may not exceed 100 percent of 

the taxable income from that property in any year. For marginal production, the 100-percent 

taxable income limitation has been suspended for taxable years beginning after December 31, 

1997, and before January 1, 2006. 

Marginal production is defined as domestic crude oil and natural gas production from 

stripper well property or from property substantially all of the production from which during the 

calendar year is heavy oil. Stripper well property is property from which the average daily 

production is 15 barrel equivalents or less, determined by dividing the average daily production 

of domestic crude oil and domestic natural gas from producing wells on the property for the 

calendar year by the number of wells. Heavy oil is domestic crude oil with a weighted average 

gravity of 20 degrees API or less (corrected to 60 degrees Fahrenheit). 

Description of Proposal

The proposal extends for one year the present-law taxable income limitation suspension 

provision for marginal production (through taxable years beginning on or before December 31, 

2006). 

Effective Date

The proposal applies to taxable years beginning after December 31, 2005.
22

L. Tax Incentives for Investment in the District of Columbia 

Present Law

In general

The Taxpayer Relief Act of 1997 designated certain economically depressed census tracts 

within the District of Columbia as the District of Columbia Enterprise Zone (the “D.C. Zone”), 

within which businesses and individual residents are eligible for special tax incentives. The 

census tracts that compose the D.C. Zone are (1) all census tracts that presently are part of the 

D.C. enterprise community designated under section 1391 (i.e., portions of Anacostia, Mt. 

Pleasant, Chinatown, and the easternmost part of the District), and (2) all additional census tracts 

within the District of Columbia where the poverty rate is not less than 20 percent. The D.C. 

Zone designation remains in effect for the period from January 1, 1998, through December 31, 

2005. In general, the tax incentives available in connection with the D.C. Zone are a 20-percent 

wage credit, an additional $35,000 of section 179 expensing for qualified zone property, 

expanded tax-exempt financing for certain zone facilities, and a zero-percent capital gains rate 

from the sale of certain qualified D.C. zone assets. 

Wage credit

A 20-percent wage credit is available to employers for the first $15,000 of qualified 

wages paid to each employee (i.e., a maximum credit of $3,000 with respect to each qualified 

employee) who (1) is a resident of the D.C. Zone, and (2) performs substantially all employment 

services within the D.C. Zone in a trade or business of the employer. 

Wages paid to a qualified employee who earns more than $15,000 are eligible for the 

wage credit (although only the first $15,000 of wages is eligible for the credit). The wage credit 

is available with respect to a qualified full-time or part-time employee (employed for at least 90 

days), regardless of the number of other employees who work for the employer. In general, any 

taxable business carrying out activities in the D.C. Zone may claim the wage credit, regardless of 

whether the employer meets the definition of a “D.C. Zone business.”2

An employer’s deduction otherwise allowed for wages paid is reduced by the amount of 

wage credit claimed for that taxable year.3

 Wages are not to be taken into account for purposes 

of the wage credit if taken into account in determining the employer’s work opportunity tax 

credit under section 51 or the welfare-to-work credit under section 51A.4

 In addition, the 

 2

 However, the wage credit is not available for wages paid in connection with certain business 

activities described in section 144(c)(6)(B) or certain farming activities. In addition, wages are not 

eligible for the wage credit if paid to (1) a person who owns more than five percent of the stock (or capital 

or profits interests) of the employer, (2) certain relatives of the employer, or (3) if the employer is a 

corporation or partnership, certain relatives of a person who owns more than 50 percent of the business. 

3

 Sec. 280C(a). 

4

 Secs. 1400H(a), 1396(c)(3)(A) and 51A(d)(2). 
23

$15,000 cap is reduced by any wages taken into account in computing the work opportunity tax 

credit or the welfare-to-work credit.5

 The wage credit may be used to offset up to 25 percent of 

alternative minimum tax liability.6

Section 179 expensing

In general, a D.C. Zone business is allowed an additional $35,000 of section 179 

expensing for qualifying property placed in service by a D.C. Zone business.7

 The section 179 

expensing allowed to a taxpayer is phased out by the amount by which 50 percent of the cost of 

qualified zone property placed in service during the year by the taxpayer exceeds $200,000 

($400,000 for taxable years beginning after 2002 and before 2008). The term “qualified zone 

property” is defined as depreciable tangible property (including buildings), provided that (1) the 

property is acquired by the taxpayer (from an unrelated party) after the designation took effect, 

(2) the original use of the property in the D.C. Zone commences with the taxpayer, and (3) 

substantially all of the use of the property is in the D.C. Zone in the active conduct of a trade or 

business by the taxpayer.8

 Special rules are provided in the case of property that is substantially 

renovated by the taxpayer. 

Tax-exempt financing

A qualified D.C. Zone business is permitted to borrow proceeds from tax-exempt 

qualified enterprise zone facility bonds (as defined in section 1394) issued by the District of 

Columbia.9 Such bonds are subject to the District of Columbia’s annual private activity bond 

volume limitation. Generally, qualified enterprise zone facility bonds for the District of 

Columbia are bonds 95 percent or more of the net proceeds of which are used to finance certain 

facilities within the D.C. Zone. The aggregate face amount of all outstanding qualified 

enterprise zone facility bonds per qualified D.C. Zone business may not exceed $15 million and 

may be issued only while the D.C. Zone designation is in effect. 

Zero-percent capital gains

A zero-percent capital gains rate applies to capital gains from the sale of certain qualified 

D.C. Zone assets held for more than five years.10 In general, a qualified “D.C. Zone asset” 

means stock or partnership interests held in, or tangible property held by, a D.C. Zone business. 

For purposes of the zero-percent capital gains rate, the D.C. Enterprise Zone is defined to include 

 5

 Secs. 1400H(a), 1396(c)(3)(B) and 51A(d)(2). 

6

 Sec. 38(c)(2). 

7

 Sec. 1397A. 

8

 Sec. 1397D. 

9

 Sec. 1400A. 

10 Sec. 1400B. 
24

all census tracts within the District of Columbia where the poverty rate is not less than 10 

percent. 

In general, gain eligible for the zero-percent tax rate means gain from the sale or 

exchange of a qualified D.C. Zone asset that is (1) a capital asset or property used in the trade or 

business as defined in section 1231(b), and (2) acquired before January 1, 2006. Gain that is 

attributable to real property, or to intangible assets, qualifies for the zero-percent rate, provided 

that such real property or intangible asset is an integral part of a qualified D.C. Zone business.11 

However, no gain attributable to periods before January 1, 1998, and after December 31, 2010, is 

qualified capital gain. 

District of Columbia homebuyer tax credit

First-time homebuyers of a principal residence in the District of Columbia are eligible for 

a nonrefundable tax credit of up to $5,000 of the amount of the purchase price. The $5,000 

maximum credit applies both to individuals and married couples. Married individuals filing 

separately can claim a maximum credit of $2,500 each. The credit phases out for individual 

taxpayers with adjusted gross income between $70,000 and $90,000 ($110,000-$130,000 for 

joint filers). For purposes of eligibility, “first-time homebuyer” means any individual if such 

individual did not have a present ownership interest in a principal residence in the District of 

Columbia in the one-year period ending on the date of the purchase of the residence to which the 

credit applies. The credit is scheduled to expire for residences purchased after December 31, 

2005.12

Description of Proposal

The proposal extends for one year the designation of the D.C. Zone for one year (through 

December 31, 2006), thus extending the wage credit and section 179 expensing. 

The proposal extends the tax-exempt financing for one year, applying to bonds issued 

during the period beginning on January 1, 1998, and ending on December 31, 2006. 

The proposal extends the zero-percent capital gains rate applicable to capital gains from 

the sale or exchange of certain qualified D.C. Zone assets to gain recognized before January 1, 

2011, from the sale of assets acquired before January 1, 2007. 

The proposal extends the first-time homebuyer credit for one year, through December 31, 

2006. 

 11 However, sole proprietorships and other taxpayers selling assets directly cannot claim the 

zero-percent rate on capital gain from the sale of any intangible property (i.e., the integrally related test 

does not apply). 

12 Sec. 1400C(i). 
25

Effective Date

The proposal generally is effective on January 1, 2006. The extension of tax-exempt 

financing is effective for obligations issued after the date of enactment. 
26 

M. Possession Tax Credit with Respect to American Samoa 

Present Law

In general

Certain domestic corporations with business operations in the U.S. possessions are 

eligible for the possession tax credit.13 This credit offsets the U.S. tax imposed on certain 

income related to operations in the U.S. possessions.14 For purposes of the section 936 credit, 

possessions include, among other places, American Samoa. Income eligible for the section 936 

credit includes non-U.S. source income from (1) the active conduct of a trade or business within 

a U.S. possession, (2) the sale or exchange of substantially all of the assets that were used in such 

a trade or business, or (3) certain possessions investments.15 The section 936 credit expires for 

taxable years beginning after December 31, 2005. 

To qualify for the possession tax credit for a taxable year, a domestic corporation must 

satisfy two conditions. First, the corporation must derive at least 80 percent of its gross income 

for the three-year period immediately preceding the close of the taxable year from sources within 

a possession. Second, the corporation must derive at least 75 percent of its gross income for that 

same period from the active conduct of a possession business. A domestic corporation that has 

elected the possession tax credit and that satisfies these two conditions for a taxable year 

generally is entitled to a credit against the U.S. tax attributable to the taxpayer's income that is 

eligible for the section 936 credit. 

The possession tax credit applies only to a corporation that qualifies as an existing credit 

claimant. The determination of whether a corporation is an existing credit claimant is made 

separately for each possession. The possession tax credit is computed separately for each 

possession with respect to which the corporation is an existing credit claimant, and the credit is 

subject to either an economic activity-based limitation or an income-based limit. 

Qualification as existing credit claimant

A corporation is an existing credit claimant with respect to a possession if (1) the 

corporation was engaged in the active conduct of a trade or business within the possession on 

October 13, 1995, and (2) the corporation elected the benefits of the possession tax credit in an 

 13 Secs. 27(b), 936. 

14 Domestic corporations with activities in Puerto Rico are eligible for the section 30A economic 

activity credit. That credit is calculated under the rules set forth in section 936. 

15 Under phaseout rules described below, investment only in Guam, American Samoa, and the 

Northern Mariana Islands (and not in other possessions) now may give rise to income eligible for the 

section 936 credit. 
27 

election in effect for its taxable year that included October 13, 1995.16 A corporation that adds a 

substantial new line of business (other than in a qualifying acquisition of all the assets of a trade 

or business of an existing credit claimant) ceases to be an existing credit claimant as of the close 

of the taxable year ending before the date on which that new line of business is added. 

Economic activity-based limit

Under the economic activity-based limit, the amount of the credit determined under the 

rules described above may not exceed an amount equal to the sum of (1) 60 percent of the 

taxpayer's qualifying possession wage and fringe benefit expenses, (2) 15 percent of depreciation 

allowances with respect to short-life qualifying tangible property, plus 40 percent of depreciation 

allowances with respect to medium-life qualifying tangible property, plus 65 percent of 

depreciation allowances with respect to long-life tangible property, and (3) in certain cases, a 

portion of the taxpayer's possession income taxes. 

Income-based limit

As an alternative to the economic activity-based limit, a taxpayer may elect to apply a 

limit equal to the applicable percentage of the credit that would otherwise be allowable with 

respect to possession business income; the applicable percentage currently is 40 percent. 

Repeal and phase out

In 1996, the section 936 credit was repealed for new claimants for taxable years 

beginning after 1995 and was phased out for existing credit claimants over a period including 

taxable years beginning before 2006. The amount of the available credit during the phaseout 

period generally is reduced by special limitation rules. These phaseout period limitation rules do 

not apply to the credit available to existing credit claimants for income from activities in Guam, 

American Samoa, and the Northern Mariana Islands. The section 936 credit is repealed for all 

possessions, including Guam, American Samoa, and the Northern Mariana Islands, for all 

taxable years beginning after 2005. 

Description of Proposal

The proposal extends for one year the present-law section 936 credit as applied to 

American Samoa; it thus allows existing credit claimants to claim the credit for income from 

activities in American Samoa in taxable years beginning on or before December 31, 2006. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005.

 16 A corporation will qualify as an existing credit claimant if it acquired all the assets of a trade 

or business of a corporation that actively conducted that trade or business in a possession on October 13, 

1995, and had elected the benefits of the possession tax credit in an election in effect for the taxable year 

that included October 13, 1995. 
28 

N. Parity in the Application of Certain Limits to Mental Health Benefits 

Present Law

The Code, the Employee Retirement Income Security Act of 1974 (“ERISA”) and the 

Public Health Service Act (“PHSA”) contain provisions under which group health plans that 

provide both medical and surgical benefits and mental health benefits cannot impose aggregate 

lifetime or annual dollar limits on mental health benefits that are not imposed on substantially all 

medical and surgical benefits (“mental health parity requirements”). In the case of a group 

health plan which provides benefits for mental health, the mental health parity requirements do 

not affect the terms and conditions (including cost sharing, limits on numbers of visits or days of 

coverage, and requirements relating to medical necessity) relating to the amount, duration, or 

scope of mental health benefits under the plan, except as specifically provided in regard to parity 

in the imposition of aggregate lifetime limits and annual limits. 

The Code imposes an excise tax on group health plans which fail to meet the mental 

health parity requirements. The excise tax is equal to $100 per day during the period of 

noncompliance and is generally imposed on the employer sponsoring the plan if the plan fails to 

meet the requirements. The maximum tax that can be imposed during a taxable year cannot 

exceed the lesser of 10 percent of the employer’s group health plan expenses for the prior year or 

$500,000. No tax is imposed if the Secretary determines that the employer did not know, and in 

exercising reasonable diligence would not have known, that the failure existed. 

The mental health parity requirements do not apply to group health plans of small 

employers nor do they apply if their application results in an increase in the cost under a group 

health plan of at least one percent. Further, the mental health parity requirements do not require 

group health plans to provide mental health benefits. 

The Code, ERISA and PHSA mental health parity requirements are scheduled to expire 

with respect to benefits for services furnished after December 31, 2005. 

Description of Proposal

The proposal extends for one year the present-law Code excise tax for failure to comply 

with the mental health parity requirements (through December 31, 2006). 

Effective Date

The provision is effective on the date of enactment. 
29 

O. Authority for Undercover Operations 

Present Law

IRS undercover operations are exempt from the otherwise applicable statutory restrictions 

controlling the use of Government funds (which generally provide that all receipts must be 

deposited in the general fund of the Treasury and all expenses be paid out of appropriated funds). 

In general, the exemption permits the IRS to use proceeds from an undercover operation to pay 

additional expenses incurred in the undercover operation. The IRS is required to conduct a 

detailed financial audit of large undercover operations in which the IRS is using proceeds from 

such operations and to provide an annual audit report to the Congress on all such large 

undercover operations. 

The provision was originally enacted in The Anti-Drug Abuse Act of 1988. The 

exemption originally expired on December 31, 1989, and was extended by the Comprehensive 

Crime Control Act of 1990 to December 31, 1991. There followed a gap of approximately four 

and a half years during which the provision had lapsed. In the Taxpayer Bill of Rights II, the 

authority to use proceeds from undercover operations was extended for five years, through 2000. 

The Community Renewal Tax Relief Act of 2000 extended the authority of the IRS to use 

proceeds from undercover operations for an additional five years, through 2005. 

Description of Proposal

The proposal extends for one year the present-law authority of the IRS to use proceeds 

from undercover operations to pay additional expenses incurred in conducting undercover 

operations (through December 31, 2006). 

Effective Date

The proposal is effective on the date of enactment.
30 

II. OTHER EXTENSIONS AND MODIFICATIONS 

A. Work Opportunity Tax Credit and Welfare-To-Work Tax Credit 

Present Law

Work opportunity tax credit

Targeted groups eligible for the credit

The work opportunity tax credit is available on an elective basis for employers hiring 

individuals from one or more of eight targeted groups. The eight targeted groups are: (1) certain 

families eligible to receive benefits under the Temporary Assistance for Needy Families 

Program; (2) high-risk youth; (3) qualified ex-felons; (4) vocational rehabilitation referrals; (5) 

qualified summer youth employees; (6) qualified veterans; (7) families receiving food stamps; 

and (8) persons receiving certain Supplemental Security Income (SSI) benefits. 

A high-risk youth is an individual aged at least 18 but aged under 25 on the hiring date 

who is certified by a designated local agency as having a principal place of abode within an 

empowerment zone, enterprise community, or renewal community. The credit is not available if 

the youth’s principal place of abode ceases to be within an empowerment zone, enterprise 

community, or renewal community. 

A qualified ex-felon is an individual certified by a designated local agency as: (1) having 

been convicted of a felony under State or Federal law; (2) being a member of an economically 

disadvantaged family; and (3) having a hiring date within one year of release from prison or 

conviction. 

A food stamp recipient is an individual aged at least 18 but aged under 25 on the hiring 

date certified by a designated local agency as being a member of a family either currently or 

recently receiving assistance under an eligible food stamp program. 

Qualified wages

Generally, qualified wages are defined as cash wages paid by the employer to a member 

of a targeted group. The employer’s deduction for wages is reduced by the amount of the credit. 

Calculation of the credit

The credit equals 40 percent (25 percent for employment of 400 hours or less) of 

qualified first-year wages. Generally, qualified first-year wages are qualified wages (not in 

excess of $6,000) attributable to service rendered by a member of a targeted group during the 

one-year period beginning with the day the individual began work for the employer. Therefore, 

the maximum credit per employee is $2,400 (40 percent of the first $6,000 of qualified first-year 

wages). With respect to qualified summer youth employees, the maximum credit is $1,200 (40 

percent of the first $3,000 of qualified first-year wages). 
31 

Minimum employment period

No credit is allowed for qualified wages paid to employees who work less than 120 hours 

in the first year of employment. 

Coordination of the work opportunity tax credit and the welfare-to-work tax credit

An employer cannot claim the work opportunity tax credit with respect to wages of any 

employee on which the employer claims the welfare-to-work tax credit. 

Other rules

The work opportunity tax credit is not allowed for wages paid to a relative or dependent 

of the taxpayer. Similarity wages paid to replacement workers during a strike or lockout are not 

eligible for the work opportunity tax credit. Wages paid to any employee during any period for 

which the employer received on-the-job training program payments with respect to that 

employee are not eligible for the work opportunity tax credit. The work opportunity tax credit 

generally is not allowed for wages paid to individuals who had previously been employed by the 

employer. In addition, many other technical rules apply. 

Expiration

The work opportunity tax credit is not available for individuals who begin work for an 

employer after December 31, 2005. 

Welfare-to-work tax credit

Targeted group eligible for the credit

The welfare-to-work tax credit is available on an elective basis to employers of qualified 

long-term family assistance recipients. Qualified long-term family assistance recipients are: (1) 

members of a family that has received family assistance for at least 18 consecutive months 

ending on the hiring date; (2) members of a family that has received such family assistance for a 

total of at least 18 months (whether or not consecutive) after August 5, 1997 (the date of 

enactment of the welfare-to-work tax credit) if they are hired within two years after the date that 

the 18-month total is reached; and (3) members of a family who are no longer eligible for family 

assistance because of either Federal or State time limits, if they are hired within two years after 

the Federal or State time limits made the family ineligible for family assistance. 

Qualified wages

Qualified wages for purposes of the welfare-to-work tax credit are defined more broadly 

than the work opportunity tax credit. Unlike the definition of wages for the work opportunity tax 

credit which includes simply cash wages, the definition of wages for the welfare-to-work tax 

credit includes cash wages paid to an employee plus amounts paid by the employer for: (1) 

educational assistance excludable under a section 127 program (or that would be excludable but 

for the expiration of sec. 127); (2) health plan coverage for the employee, but not more than the 

applicable premium defined under section 4980B(f)(4); and (3) dependent care assistance 
32 

excludable under section 129. The employer’s deduction for wages is reduced by the amount of 

the credit. 

Calculation of the credit

The welfare-to-work tax credit is available on an elective basis to employers of qualified 

long-term family assistance recipients during the first two years of employment. The maximum 

credit is 35 percent of the first $10,000 of qualified first-year wages and 50 percent of the first 

$10,000 of qualified second-year wages. Qualified first-year wages are defined as qualified 

wages (not in excess of $10,000) attributable to service rendered by a member of the targeted 

group during the one-year period beginning with the day the individual began work for the 

employer. Qualified second-year wages are defined as qualified wages (not in excess of 

$10,000) attributable to service rendered by a member of the targeted group during the one-year 

period beginning immediately after the first year of that individual’s employment for the 

employer. The maximum credit is $8,500 per qualified employee. 

Minimum employment period

No credit is allowed for qualified wages paid to a member of the targeted group unless 

they work at least 400 hours or 180 days in the first year of employment. 

Coordination of the work opportunity tax credit and the welfare-to-work tax credit

An employer cannot claim the work opportunity tax credit with respect to wages of any 

employee on which the employer claims the welfare-to-work tax credit. 

Other rules

The welfare-to-work tax credit incorporates directly or by reference many of these other 

rules contained on the work opportunity tax credit. 

Expiration

The welfare-to-work credit is not available for individuals who begin work for an 

employer after December 31, 2005. 

Description of Proposal

In general

The proposal combines the work opportunity and welfare-to-work tax credits and extends 

the combined credit for two years. The welfare-to-work credit is repealed. 

Targeted groups eligible for the combined credit

The combined credit is available on an elective basis for employers hiring individuals 

from one or more of all nine targeted groups. The nine targeted groups are the present-law eight 

groups with the addition of the long-term family assistance recipient as the ninth targeted group. 
33 

The proposal repeals the requirement that a qualified ex-felon be an individual certified 

as a member of an economically disadvantaged family. 

The proposal raises the age limit for the food stamp recipient category to include 

individuals aged at least 18 but aged under 35 on the hiring date. 

Qualified wages

The combined credit follows the work opportunity tax credit wage cap. Therefore 

qualified first-year wages for all nine targeted groups is capped at $6,000 ($3,000 for qualified 

summer youth employees). No credit is allowed for any targeted group for second-year wages. 

The combined credit follows the work opportunity tax credit definition of wages which 

does not include amounts paid by the employer for: (1) educational assistance excludable under a 

section 127 program (or that would be excludable but for the expiration of sec. 127); (2) health 

plan coverage for the employee, but not more than the applicable premium defined under section 

4980B(f)(4); and (3) dependent care assistance excludable under section 129. For all targeted 

groups, the employer’s deduction for wages is reduced by the amount of the credit. 

Calculation of the credit

First-year wages.–For all nine targeted groups, the credit equals 40 percent (25 percent 

for employment of 400 hours or less) of qualified first-year wages. Generally, qualified firstyear wages are qualified wages (not in excess of $6,000) attributable to service rendered by a 

member of a targeted group during the one-year period beginning with the day the individual 

began work for the employer. Therefore, the maximum credit per employee for members of any 

of the nine targeted groups generally is $2,400 (40 percent of the first $6,000 of qualified firstyear wages). With respect to qualified summer youth employees, the maximum credit remains 

$1,200 (40 percent of the first $3,000 of qualified first-year wages). 

Second-year wages.–There is no credit for second-year wages. 

Minimum employment period

The minimum employment period is the same as the present-law work opportunity tax 

credit. Therefore no credit is allowed for qualified wages paid to employees who work less than 

120 hours in the first year of employment. 

Coordination of the work opportunity tax credit and the welfare-to-work tax credit

Coordination is no longer necessary once the two credits are combined. 

Effective Date

The proposal is effective for wages paid or incurred to a qualified individual who begins 

work for an employer after December 31, 2005, and before January 1, 2008. 
34 

B. Extension and Expansion to Petroleum Products of Expensing 

for Environmental Remediation Costs 

Present Law

Present law allows a deduction for ordinary and necessary expenses paid or incurred in 

carrying on any trade or business (sec. 162). Treasury regulations provide that the cost of 

incidental repairs that neither materially add to the value of property nor appreciably prolong its 

life, but keep it in an ordinarily efficient operating condition, may be deducted currently as a 

business expense. Section 263(a)(1) limits the scope of section 162 by prohibiting a current 

deduction for certain capital expenditures. Treasury regulations define “capital expenditures” as 

amounts paid or incurred to materially add to the value, or substantially prolong the useful life, 

of property owned by the taxpayer, or to adapt property to a new or different use. Amounts paid 

for repairs and maintenance do not constitute capital expenditures. The determination of whether 

an expense is deductible or capitalizable is based on the facts and circumstances of each case. 

Taxpayers may elect to treat certain environmental remediation expenditures that would 

otherwise be chargeable to capital account as deductible in the year paid or incurred (sec. 198). 

The deduction applies for both regular and alternative minimum tax purposes. The expenditure 

must be incurred in connection with the abatement or control of hazardous substances at a 

qualified contaminated site. In general, any expenditure for the acquisition of depreciable 

property used in connection with the abatement or control of hazardous substances at a qualified 

contaminated site does not constitute a qualified environmental remediation expenditure. 

However, depreciation deductions allowable for such property, which would otherwise be 

allocated to the site under the principles set forth in Commissioner v. Idaho Power Co.17 and 

section 263A, are treated as qualified environmental remediation expenditures. 

A “qualified contaminated site” (a so-called “brownfield”) generally is any property that 

is held for use in a trade or business, for the production of income, or as inventory and is 

certified by the appropriate State environmental agency to be an area at or on which there has 

been a release (or threat of release) or disposal of a hazardous substance. Both urban and rural 

property may qualify. However, sites that are identified on the national priorities list under the 

Comprehensive Environmental Response, Compensation, and Liability Act of 1980 

(“CERCLA”) cannot qualify as targeted areas. Hazardous substances generally are defined by 

reference to sections 101(14) and 102 of CERCLA, subject to additional limitations applicable to 

asbestos and similar substances within buildings, certain naturally occurring substances such as 

radon, and certain other substances released into drinking water supplies due to deterioration 

through ordinary use. Petroleum products generally are not regarded as hazardous substances for 

purposes of section 198.18 

 17 418 U.S. 1 (1974). 

18 Section 101(14) of CERCLA specifically excludes “petroleum, including crude oil or any 

fraction thereof which is not otherwise specifically listed or designated as a hazardous substance under 

subparagraphs (A) through (F) of this paragraph,” from the definition of “hazardous substance.” 
35 

In the case of property to which a qualified environmental remediation expenditure 

otherwise would have been capitalized, any deduction allowed under section 198 is treated as a 

depreciation deduction and the property is treated as section 1245 property. Thus, deductions for 

qualified environmental remediation expenditures are subject to recapture as ordinary income 

upon a sale or other disposition of the property. In addition, sections 280B (demolition of 

structures) and 468 (special rules for mining and solid waste reclamation and closing costs) do 

not apply to amounts that are treated as expenses under this provision. 

Eligible expenditures are those paid or incurred before January 1, 2006. 

Description of Proposal

The proposal extends for two years the present-law provisions relating to environmental 

remediation expenditures (through December 31, 2007). 

In addition, the proposal expands the definition of hazardous substance to include 

petroleum products. Under the proposal, petroleum products are defined by reference to section 

4612(a)(3), and thus include crude oil, crude oil condensates and natural gasoline.19 

Effective Date

The proposal applies to expenditures paid or incurred after December 31, 2005.

 19 The present law exceptions for sites on the national priorities list under CERCLA, and for 

substances with respect to which a removal or remediation is not permitted under section 104 of 

CERCLA by reason of subsection (a)(3) thereof, would continue to apply to all hazardous substances 

(including petroleum products). 
36 

C. Controlled Foreign Corporations 

1. Subpart F exception for active financing 

Present and Prior Law

Under the subpart F rules, 10-percent U.S. shareholders of a controlled foreign 

corporation (“CFC”) are subject to U.S. tax currently on certain income earned by the CFC, 

whether or not such income is distributed to the shareholders. The income subject to current 

inclusion under the subpart F rules includes, among other things, insurance income and foreign 

base company income. Foreign base company income includes, among other things, foreign 

personal holding company income and foreign base company services income (i.e., income 

derived from services performed for or on behalf of a related person outside the country in which 

the CFC is organized). 

Foreign personal holding company income generally consists of the following: (1) 

dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) 

property that gives rise to the preceding types of income, (b) property that does not give rise to 

income, and (c) interests in trusts, partnerships, and REMICs; (3) net gains from commodities 

transactions; (4) net gains from certain foreign currency transactions; (5) income that is 

equivalent to interest; (6) income from notional principal contracts; (7) payments in lieu of 

dividends; and (8) amounts received under personal service contracts. 

Insurance income subject to current inclusion under the subpart F rules includes any 

income of a CFC attributable to the issuing or reinsuring of any insurance or annuity contract in 

connection with risks located in a country other than the CFC's country of organization. Subpart 

F insurance income also includes income attributable to an insurance contract in connection with 

risks located within the CFC's country of organization, as the result of an arrangement under 

which another corporation receives a substantially equal amount of consideration for insurance 

of other country risks. Investment income of a CFC that is allocable to any insurance or annuity 

contract related to risks located outside the CFC's country of organization is taxable as subpart F 

insurance income.20

Temporary exceptions from foreign personal holding company income, foreign base 

company services income, and insurance income apply for subpart F purposes for certain income 

that is derived in the active conduct of a banking, financing, or similar business, or in the conduct 

of an insurance business (so-called “active financing income”).21 

 20 Prop. Treas. Reg. sec. 1.953-1(a). 

21 Temporary exceptions from the subpart F provisions for certain active financing income 

applied only for taxable years beginning in 1998. Those exceptions were modified and extended for one 

year, applicable only for taxable years beginning in 1999. The Tax Relief Extension Act of 1999 (Pub. L. 

No. 106-170) clarified and extended the temporary exceptions for two years, applicable only for taxable 

years beginning after 1999 and before 2002. The Job Creation and Worker Assistance Act of 2002 (Pub. 
37 

With respect to income derived in the active conduct of a banking, financing, or similar 

business, a CFC is required to be predominantly engaged in such business and to conduct 

substantial activity with respect to such business in order to qualify for the exceptions. In 

addition, certain nexus requirements apply, which provide that income derived by a CFC or a 

qualified business unit (“QBU”) of a CFC from transactions with customers is eligible for the 

exceptions if, among other things, substantially all of the activities in connection with such 

transactions are conducted directly by the CFC or QBU in its home country, and such income is 

treated as earned by the CFC or QBU in its home country for purposes of such country's tax 

laws. Moreover, the exceptions apply to income derived from certain cross border transactions, 

provided that certain requirements are met. Additional exceptions from foreign personal holding 

company income apply for certain income derived by a securities dealer within the meaning of 

section 475 and for gain from the sale of active financing assets. 

In the case of insurance, in addition to a temporary exception from foreign personal 

holding company income for certain income of a qualifying insurance company with respect to 

risks located within the CFC's country of creation or organization, certain temporary exceptions 

from insurance income and from foreign personal holding company income apply for certain 

income of a qualifying branch of a qualifying insurance company with respect to risks located 

within the home country of the branch, provided certain requirements are met under each of the 

exceptions. Further, additional temporary exceptions from insurance income and from foreign 

personal holding company income apply for certain income of certain CFCs or branches with 

respect to risks located in a country other than the United States, provided that the requirements 

for these exceptions are met. 

In the case of a life insurance or annuity contract, reserves for such contracts are 

determined as follows for purposes of these provisions. The reserves equal the greater of: (1) 

the net surrender value of the contract (as defined in section 807(e)(1)(A)), including in the case 

of pension plan contracts; or (2) the amount determined by applying the tax reserve method that 

would apply if the qualifying life insurance company were subject to tax under Subchapter L of 

the Code, with the following modifications. First, there is substituted for the applicable Federal 

interest rate an interest rate determined for the functional currency of the qualifying insurance 

company's home country, calculated (except as provided by the Treasury Secretary in order to 

address insufficient data and similar problems) in the same manner as the mid-term applicable 

Federal interest rate (within the meaning of section 1274(d)). Second, there is substituted for the 

prevailing State assumed rate the highest assumed interest rate permitted to be used for purposes 

of determining statement reserves in the foreign country for the contract. Third, in lieu of U.S. 

mortality and morbidity tables, mortality and morbidity tables are applied that reasonably reflect 

the current mortality and morbidity risks in the foreign country. Fourth, the Treasury Secretary 

may provide that the interest rate and mortality and morbidity tables of a qualifying insurance 

company may be used for one or more of its branches when appropriate. In no event may the 

reserve for any contract at any time exceed the foreign statement reserve for the contract, 

reduced by any catastrophe, equalization, or deficiency reserve or any similar reserve. 

 

L. No. 107-147) modified and extended the temporary exceptions for five years, for taxable years 

beginning after 2001 and before 2007. 
38 

Present law permits a taxpayer in certain circumstances, subject to approval by the IRS 

through the ruling process or in published guidance, to establish that the reserve of a life 

insurance company for life insurance and annuity contracts is the amount taken into account in 

determining the foreign statement reserve for the contract (reduced by catastrophe, equalization, 

or deficiency reserve or any similar reserve). IRS approval is to be based on whether the 

method, the interest rate, the mortality and morbidity assumptions, and any other factors taken 

into account in determining foreign statement reserves (taken together or separately) provide an 

appropriate means of measuring income for Federal income tax purposes. In seeking a ruling, 

the taxpayer is required to provide the IRS with necessary and appropriate information as to the 

method, interest rate, mortality and morbidity assumptions and other assumptions under the 

foreign reserve rules so that a comparison can be made to the reserve amount determined by 

applying the tax reserve method that would apply if the qualifying insurance company were 

subject to tax under Subchapter L of the Code (with the modifications provided under present 

law for purposes of these exceptions). The IRS also may issue published guidance indicating its 

approval. Present and prior law continues to apply with respect to reserves for any life insurance 

or annuity contract for which the IRS has not approved the use of the foreign statement reserve. 

An IRS ruling request under this provision is subject to the present-law provisions relating to 

IRS user fees. 

Description of Proposal

The proposal extends for two years (for taxable years beginning before 2009) the presentlaw temporary exceptions from subpart F foreign personal holding company income, foreign 

base company services income, and insurance income for certain income that is derived in the 

active conduct of a banking, financing, or similar business, or in the conduct of an insurance 

business. 

Effective Date

The proposal is effective for taxable years of foreign corporations beginning after 

December 31, 2006, and before January 1, 2009, and for taxable years of U.S. shareholders with 

or within which such taxable years of such foreign corporations end. 
39

2. Look-through treatment of payments between related controlled foreign corporations 

under foreign personal holding company income rules 

Present Law

In general, the rules of subpart F (secs. 951-964) require U.S. shareholders with a 10-

percent or greater interest in a controlled foreign corporation (“CFC”) to include certain income 

of the CFC (referred to as “subpart F income”) on a current basis for U.S. tax purposes, 

regardless of whether the income is distributed to the shareholders. 

Subpart F income includes foreign base company income. One category of foreign base 

company income is foreign personal holding company income. For subpart F purposes, foreign 

personal holding company income generally includes dividends, interest, rents and royalties, 

among other types of income. However, foreign personal holding company income does not 

include dividends and interest received by a CFC from a related corporation organized and 

operating in the same foreign country in which the CFC is organized, or rents and royalties 

received by a CFC from a related corporation for the use of property within the country in which 

the CFC is organized. Interest, rent, and royalty payments do not qualify for this exclusion to the 

extent that such payments reduce the subpart F income of the payor. 

Description of Proposal

Under the proposal, for taxable years beginning after 2005 and before 2009, dividends, 

interest,22 rents, and royalties received by one CFC from a related CFC are not treated as foreign 

personal holding company income to the extent attributable or properly allocable to non-subpartF income of the payor. For this purpose, a related CFC is a CFC that controls or is controlled by 

the other CFC, or a CFC that is controlled by the same person or persons that control the other 

CFC. Ownership of more than 50 percent of the CFC's stock (by vote or value) constitutes 

control for these purposes. 

Effective Date

The proposal is effective for taxable years of foreign corporations beginning after 

December 31, 2005 but before January 1, 2009, and for taxable years of U.S. shareholders with 

or within which such taxable years of such foreign corporations end.

 22 Interest for this purpose includes factoring income which is treated as equivalent to interest 

under sec. 954(c)(1)(E). 
40 

III. EXTENSIONS OF CERTAIN PROVISIONS THROUGH 2010 

A. Credit for Elective Deferrals and IRA Contributions 

(the “Saver’s Credit”) 

Present Law

Eligible taxpayers may claim a nonrefundable credit for qualified retirement savings 

contributions, referred to as the “saver’s credit.” The maximum annual contribution eligible for 

the credit is $2,000. The credit rate depends on the adjusted gross income (“AGI”) of the 

taxpayer. Taxpayers filing joint returns with AGI of $50,000 or less, head of household returns 

of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The AGI 

limits applicable to single taxpayers apply to married taxpayers filing separate returns. The 

credit is in addition to any deduction or exclusion that would otherwise apply with respect to the 

contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit 

is available to individuals who are 18 or over, other than individuals who are full-time students 

or claimed as a dependent on another taxpayer’s return. 

The credit is available with respect to: (1) elective deferrals to a qualified cash or 

deferred arrangement (a “section 401(k) plan”), a tax-sheltered annuity (a “section 403(b)” 

annuity), an eligible deferred compensation arrangement of a State or local government (a 

“governmental section 457 plan”), a SIMPLE plan, or a simplified employee pension (“SEP”); 

(2) contributions to a traditional or Roth IRA; and (3) voluntary after-tax employee contributions 

to a tax-sheltered annuity or qualified retirement plan. 

The amount of any contribution eligible for the credit is generally reduced by 

distributions received by the taxpayer (or by the taxpayer’s spouse if the taxpayer filed a joint 

return with the spouse) from any plan or IRA to which eligible contributions can be made during 

the taxable year for which the credit is claimed, the two taxable years prior to the year the credit 

is claimed, and during the period after the end of the taxable year for which the credit is claimed 

and prior to the due date for filing the taxpayer’s return for the year. Distributions that are rolled 

over to another retirement plan do not affect the credit. 

The table below shows the credit rates based on AGI. 

Table.–Credit Rates Based on AGI 

Joint Filers Heads of Household All Other Filers Credit Rate 

$0-$30,000 

$30,001-$32,500 

$32,501-$50,000 

Over $50,000 

$0-$22,500 

$22,501-$24,375 

$24,376-$37,500 

Over $37,500 

$0-$15,000 

$15,001-$16,250

$16,251-$25,000

Over $25,000 

50 percent 

20 percent 

10 percent 

0 percent 
41 

The saver’s credit does not apply for taxable years beginning after December 31, 2006.23

Description of Proposal

The proposal extends the saver’s credit for four years, through December 31, 2010. 

Effective Date

The proposal is effective on the date of enactment. 

 23 The saver’s credit was enacted as part of the Economic Growth and Tax Relief Reconciliation 

Act of 2001 (“EGTRRA”), Pub. L. No. 107-16. The provisions of EGTRRA generally do not apply for 

years beginning after December 31, 2010. 
42

B. Extension of Increased Expensing for Small Business 

Present Law

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment 

may elect to deduct (or “expense”) such costs. Present law provides that the maximum amount a 

taxpayer may expense, for taxable years beginning in 2003 through 2007, is $100,000 of the cost 

of qualifying property placed in service for the taxable year.24 In general, qualifying property is 

defined as depreciable tangible personal property that is purchased for use in the active conduct 

of a trade or business. Off-the-shelf computer software placed in service in taxable years 

beginning before 2008 is treated as qualifying property. The $100,000 amount is reduced (but 

not below zero) by the amount by which the cost of qualifying property placed in service during 

the taxable year exceeds $400,000. The $100,000 and $400,000 amounts are indexed for 

inflation for taxable years beginning after 2003 and before 2008. 

The amount eligible to be expensed for a taxable year may not exceed the taxable income 

for a taxable year that is derived from the active conduct of a trade or business (determined 

without regard to this provision). Any amount that is not allowed as a deduction because of the 

taxable income limitation may be carried forward to succeeding taxable years (subject to similar 

limitations). No general business credit under section 38 is allowed with respect to any amount 

for which a deduction is allowed under section 179. An expensing election is made under rules 

prescribed by the Secretary.25

For taxable years beginning in 2008 and thereafter (or before 2003), the following rules 

apply. A taxpayer with a sufficiently small amount of annual investment may elect to deduct up 

to $25,000 of the cost of qualifying property placed in service for the taxable year. The $25,000 

amount is reduced (but not below zero) by the amount by which the cost of qualifying property 

placed in service during the taxable year exceeds $200,000. The $25,000 and $200,000 amounts 

are not indexed. In general, qualifying property is defined as depreciable tangible personal 

property that is purchased for use in the active conduct of a trade or business (not including offthe-shelf computer software). An expensing election may be revoked only with consent of the 

Commissioner.26

 24 Additional section 179 incentives are provided with respect to a qualified property used by a 

business in the New York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec. 1397A), or a renewal 

community (sec. 1400J). 

25 Sec. 179(c)(1). Under Treas. Reg. sec. 179-5, applicable to property placed in service in 

taxable years beginning after 2002 and before 2008, a taxpayer is permitted to make or revoke an election 

under section 179 without the consent of the Commissioner on an amended Federal tax return for that 

taxable year. This amended return must be filed within the time prescribed by law for filing an amended 

return for the taxable year. T.D. 9209, July 12, 2005. 

26 Sec. 179(c)(2). 
43

Description of Proposal

The proposal extends for three years the increased amount that a taxpayer may deduct 

and the other section 179 rules applicable in taxable years beginning before 2008. Thus, under 

the proposal, these present-law rules continue in effect for taxable years beginning after 2007 

and before 2011. 

Effective Date

The provision is effective for taxable years beginning after 2007 and before 2011.
44 

C. Reduced Rates for Capital Gains and Dividends of Individuals 

Present Law

Capital gains

In general

In general, gain or loss reflected in the value of an asset is not recognized for income tax 

purposes until a taxpayer disposes of the asset. On the sale or exchange of a capital asset, any 

gain generally is included in income. Any net capital gain of an individual is taxed at maximum 

rates lower than the rates applicable to ordinary income. Net capital gain is the excess of the net 

long-term capital gain for the taxable year over the net short-term capital loss for the year. Gain 

or loss is treated as long-term if the asset is held for more than one year. 

Capital losses generally are deductible in full against capital gains. In addition, 

individual taxpayers may deduct capital losses against up to $3,000 of ordinary income in each 

year. Any remaining unused capital losses may be carried forward indefinitely to another 

taxable year. 

A capital asset generally means any property except (1) inventory, stock in trade, or 

property held primarily for sale to customers in the ordinary course of the taxpayer’s trade or 

business, (2) depreciable or real property used in the taxpayer’s trade or business, (3) specified 

literary or artistic property, (4) business accounts or notes receivable, (5) certain U.S. 

publications, (6) certain commodity derivative financial instruments, (7) hedging transactions, 

and (8) business supplies. In addition, the net gain from the disposition of certain property used 

in the taxpayer’s trade or business is treated as long-term capital gain. Gain from the disposition 

of depreciable personal property is not treated as capital gain to the extent of all previous 

depreciation allowances. Gain from the disposition of depreciable real property is generally not 

treated as capital gain to the extent of the depreciation allowances in excess of the allowances 

that would have been available under the straight-line method of depreciation. 

Tax rates before 2009

Under present law, for taxable years beginning before January 1, 2009, the maximum rate 

of tax on the adjusted net capital gain of an individual is 15 percent. Any adjusted net capital 

gain which otherwise would be taxed at a 10- or 15-percent rate is taxed at a five-percent rate 

(zero for taxable years beginning after 2007). These rates apply for purposes of both the regular 

tax and the alternative minimum tax. 

Under present law, the “adjusted net capital gain” of an individual is the net capital gain 

reduced (but not below zero) by the sum of the 28-percent rate gain and the unrecaptured section 

1250 gain. The net capital gain is reduced by the amount of gain that the individual treats as 

investment income for purposes of determining the investment interest limitation under section 

163(d). 

The term “28-percent rate gain” means the amount of net gain attributable to long-term 

capital gains and losses from the sale or exchange of collectibles (as defined in section 408(m) 
45 

without regard to paragraph (3) thereof), an amount of gain equal to the amount of gain excluded 

from gross income under section 1202 (relating to certain small business stock), the net shortterm capital loss for the taxable year, and any long-term capital loss carryover to the taxable 

year. 

“Unrecaptured section 1250 gain” means any long-term capital gain from the sale or 

exchange of section 1250 property (i.e., depreciable real estate) held more than one year to the 

extent of the gain that would have been treated as ordinary income if section 1250 applied to all 

depreciation, reduced by the net loss (if any) attributable to the items taken into account in 

computing 28-percent rate gain. The amount of unrecaptured section 1250 gain (before the 

reduction for the net loss) attributable to the disposition of property to which section 1231 

(relating to certain property used in a trade or business) applies may not exceed the net section 

1231 gain for the year. 

An individual’s unrecaptured section 1250 gain is taxed at a maximum rate of 25 percent, 

and the 28-percent rate gain is taxed at a maximum rate of 28 percent. Any amount of 

unrecaptured section 1250 gain or 28-percent rate gain otherwise taxed at a 10- or 15-percent 

rate is taxed at the otherwise applicable rate. 

Tax rates after 2008

For taxable years beginning after December 31, 2008, the maximum rate of tax on the 

adjusted net capital gain of an individual is 20 percent. Any adjusted net capital gain which 

otherwise would be taxed at a 10- or 15-percent rate is taxed at a 10-percent rate. 

In addition, any gain from the sale or exchange of property held more than five years that 

would otherwise have been taxed at the 10-percent rate is taxed at an eight-percent rate. Any 

gain from the sale or exchange of property held more than five years and the holding period for 

which began after December 31, 2000, that would otherwise have been taxed at a 20-percent rate 

is taxed at an 18-percent rate. 

The tax rates on 28-percent gain and unrecaptured section 1250 gain are the same as for 

taxable years beginning before 2009. 

Dividends

In general

A dividend is the distribution of property made by a corporation to its shareholders out of 

its after-tax earnings and profits. 

Tax rates before 2009

Under present law, dividends received by an individual from domestic corporations and 

qualified foreign corporations are taxed at the same rates that apply to net capital gain. This 

treatment applies for purposes of both the regular tax and the alternative minimum tax. Thus, for 

taxable years beginning before 2009, dividends received by an individual are taxed at rates of 

five (zero for taxable years beginning after 2007) and 15 percent. 
46 

If a shareholder does not hold a share of stock for more than 60 days during the 121-day 

period beginning 60 days before the ex-dividend date (as measured under section 246(c)), 

dividends received on the stock are not eligible for the reduced rates. Also, the reduced rates are 

not available for dividends to the extent that the taxpayer is obligated to make related payments 

with respect to positions in substantially similar or related property. 

Qualified dividend income includes otherwise qualified dividends received from 

qualified foreign corporations. The term “qualified foreign corporation” includes a foreign 

corporation that is eligible for the benefits of a comprehensive income tax treaty with the United 

States which the Treasury Department determines to be satisfactory and which includes an 

exchange of information program. In addition, a foreign corporation is treated as a qualified 

foreign corporation with respect to any dividend paid by the corporation with respect to stock 

that is readily tradable on an established securities market in the United States. 

Dividends received from a corporation that is a passive foreign investment company (as 

defined in section 1297) in either the taxable year of the distribution, or the preceding taxable 

year, are not qualified dividends. 

Special rules apply in determining a taxpayer’s foreign tax credit limitation under section 

904 in the case of qualified dividend income. For these purposes, rules similar to the rules of 

section 904(b)(2)(B) concerning adjustments to the foreign tax credit limitation to reflect any 

capital gain rate differential will apply to any qualified dividend income. 

If a taxpayer receives an extraordinary dividend (within the meaning of section 1059(c)) 

eligible for the reduced rates with respect to any share of stock, any loss on the sale of the stock 

is treated as a long-term capital loss to the extent of the dividend. 

A dividend is treated as investment income for purposes of determining the amount of 

deductible investment interest only if the taxpayer elects to treat the dividend as not eligible for 

the reduced rates. 

The amount of dividends qualifying for reduced rates that may be paid by a regulated 

investment company (“RIC”) for any taxable year in which the qualified dividend income 

received by the company is less than 95 percent of its gross income (as specially computed) may 

not exceed the sum of (i) the qualified dividend income of the RIC for the taxable year and (ii) 

the amount of earnings and profits accumulated in a non-RIC taxable year that were distributed 

by the RIC during the taxable year. 

The amount of dividends qualifying for reduced rates that may be paid by a real estate 

investment trust (“REIT”) for any taxable year may not exceed the sum of (i) the qualified 

dividend income of the REIT for the taxable year, (ii) an amount equal to the excess of the 

income subject to the taxes imposed by section 857(b)(1) and the regulations prescribed under 

section 337(d) for the preceding taxable year over the amount of these taxes for the preceding 

taxable year, and (iii) the amount of earnings and profits accumulated in a non-REIT taxable year 

that were distributed by the REIT during the taxable year. 

The reduced rates do not apply to dividends received from an organization that was 

exempt from tax under section 501 or was a tax-exempt farmers’ cooperative in either the 
47 

taxable year of the distribution or the preceding taxable year; dividends received from a mutual 

savings bank that received a deduction under section 591; or deductible dividends paid on 

employer securities.27 

Tax rates after 2008

For taxable years beginning after 2008, dividends received by an individual are taxed as 

ordinary income at rates up to 35 percent. 

Description of Proposal

The proposal extends for two years the present-law provisions relating to lower capital 

gain and dividend tax rates (through taxable years beginning on or before December 31, 2010). 

Effective Date

The proposal applies to taxable years beginning after December 31, 2008. 

 27 In addition, for taxable years beginning before 2009, amounts treated as ordinary income on 

the disposition of certain preferred stock (sec. 306) are treated as dividends for purposes of applying the 

reduced rates; the tax rate for the accumulated earnings tax (sec. 531) and the personal holding company 

tax (sec. 541) is reduced to 15 percent; and the collapsible corporation rules (sec. 341) are repealed.