DESCRIPTION OF PROPOSED MODIFICATIONS

TO THE CHAIRMAN’S MARK OF 

“THE COMMUNITY RENEWAL AND NEW

MARKETS ACT OF 2000"

Scheduled for Markup

before the

Senate Committee on Finance

on September 27, 2000

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

September 27, 2000

JCX-103-00
-iCONTENTS

Page

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

I. MODIFICATIONS TO PROVISIONS IN THE CHAIRMAN'S MARK ...... 2

A. Tax Incentives for Distressed Areas .................................. 2

B. Amtrak Bonds: Protection of Highway Trust Fund ....................... 2

C. Broadband Tax Credit ............................................ 3

D. Treatment of Indian Tribes as Non-Profit Organizations and State or Local

Governments for Purposes of the Federal Unemployment Tax (FUTA) ....... 3

II. ADDITIONAL PROVISIONS ........................................ 4

A. Tax Relief for Farmers ............................................ 4

1. Farm, Fish, and Ranch Risk Management accounts (“FFARRM

Accounts”) .................................................. 4

2. Exclusion of rental income from SECA tax ......................... 5

3. Exclusion of conservation reserve program payments from SECA tax ..... 5

4. Exemption of agricultural bonds from private activity bond volume cap ... 6

5. Modifications to section 512(b)(13) ............................... 6

6. Charitable deduction for contributions of food inventory ............... 7

7. Coordinate farmer and fisherman income averaging and the alternative

minimum tax ................................................. 8

8. Cooperative marketing to include value added processing through animals . 9

9. Declaratory judgment relief for section 521 cooperatives .............. 10

10. Small ethanol producer credit .................................... 11

11. Payment of dividends on stock of cooperatives without reducing

patronage dividends ........................................... 11

B. Energy Proposals ................................................ 13

1. Allow geological and geophysical costs to be deducted currently ........ 13

2. Allow certain oil and gas “delay rental payments” to be deducted

currently .................................................... 15

3. Allow net operating losses from oil and gas properties to be carried back

for up to five years ............................................ 16

4. Temporary suspension of percentage of depletion deduction limitation
Page

-iibased on 65 percent of taxable income ............................. 16

5. Tax credit for oil and gas production from marginal wells .............. 17

6. Establish a seven-year recovery period for natural gas gathering lines .... 18

7. Subpart F treatment of pipeline transportation income ................. 19

C. Conservation Proposals ........................................... 21

1. Capital gains exclusion on sales of conservation property .............. 21

2. Expand the estate tax rule for conservation easements ................. 21

3. Cost-sharing payments under the Partners for Wildlife Program ......... 22

4. Deduction for energy efficient commercial business .................. 23

5. Expand tax credit for electricity produced by wind, closed-loop biomass,

and poultry waste ............................................. 24

6. Credit for hybrid vehicles ....................................... 26

D. Additional Provisions Relating to Tax Incentives for Distressed Areas ....... 27

1. Expand the zero-percent capital gains rate treatment for the District of

Columbia ................................................... 27

2. Conform the gross income test for D.C. zone business ................. 27

3. First-time D.C. homebuyer tax credit .............................. 28

4. Mortgage financing for certain residences located in Presidentially declared

disaster areas ................................................ 28

5. Exclusion from gross income for certain forgiven mortgage obligations ... 29

6. Extend and modify Puerto Rico economic activity tax credit ............ 30

7. Provide tax exemption for organizations created by a State to provide

property and casualty insurance coverage for property for which such

coverage is otherwise unavailable ................................ 31

E. Miscellaneous Provisions .......................................... 33

1. Creation of Individual Development Accounts ....................... 33

2. Enhanced deduction for corporate contributions of computers ........... 33

3. Limitation on use of non-accrual experience method of accounting ....... 35

4. Charitable contribution deduction for certain expenses in support of native

Alaskan subsistence whaling .................................... 36

5. Extension of the adoption tax credit ............................... 37

6. Repeal of section 1706 of the Tax Reform Act of 1986 ................ 38

7. Treatment of purchase of structured settlements ...................... 38

8. Modify personal holding company “lending or finance business” exception 40

9. Additional funding for empowerment zones and enterprise communities ... 42

10. Funding for Social Services Block Grant ........................... 42
1

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

Proposed Modifications to the Chairman’s Mark of “The Community Renewal And New

Markets Act of 2000" (JCX-103-00), September 27, 2000.

2

 A description of the Chairman’s Mark is contained in: Joint Committee on Taxation,

Description of Community Renewal and New Markets Act of 2000 (JCX-99-00), September 18,

2000.

1

INTRODUCTION

This document,1 prepared by the staff of the Joint Committee on Taxation, provides a

description of proposed modifications to the Chairman’s Mark of the “Community Renewal and

New Markets Act of 2000,"2 which is scheduled for markup before the Senate Committee on

Finance on September 27, 2000.
2

I. MODIFICATIONS TO PROVISIONS IN THE CHAIRMAN'S MARK

A. Tax Incentives for Distressed Areas

The proposal in the Chairman’s Mark relating to renewal zones would be modified to require

that the General Accounting Office audit and report to Congress on an annual basis on the renewal

zone program and its effect on poverty, unemployment, and economic growth within the designated

renewal zones. In addition, in lieu of the poverty, income, and unemployment criteria, out

migration may be taken into account in designating one rural renewal zone.

The proposal in the Chairman’s Mark relating to the new markets tax credit would be modified

to require that the General Accounting Office audit and report to Congress on an annual basis on

the new markets program, including on all qualified community development entities that receive

an allocation under the new markets tax credit. The modification also would clarify that a

qualified low-income community investment may include an investment in a qualifying business in

which the community development entity (or a related party) holds a significant interest. 

However, in allocating the credits among eligible community development entities, the Treasury

Department will give priority to entities other than those where the entity (or a related party) will

hold a significant interest in a qualifying business.

The proposal in the Chairman’s Mark relating to the designation of the D.C. Enterprise Zone

would be modified by extending the designation to December 31, 2006 (instead of December 31,

2009). The proposal would be effective for taxable years beginning after date of enactment.

B. Amtrak Tax Credit Bonds

Modification to Amtrak tax credit bonds.--The proposal in the Chairman’s Mark relating to

Amtrak tax credit bonds would be modified to define the third category of projects eligible for

bond financing as other intercity passenger rail corridors, including station rehabilitation, track or

signal improvements, or grade crossing elimination. This purpose would be limited to a maximum

of 10 percent of the proceeds of any bond issue.

The proposal would be modified to provide that no more than $3 billion of the bonds may

be designated for any one high-speed rail corridor.

The proposal would be modified to provide that a preference will be given for projects

with State matching contributions greater than 20 percent.

Protection of Highway Trust Fund.--Issuance of tax-credit bonds by Amtrak (or the Alaska

Railroad) would be conditioned on a certification by the Secretary of the Treasury (after

consultation with the Secretary of Transportation) that the issuing railroad had not received any

unauthorized funds from the Highway Trust Fund. Unauthorized funds would be defined as any

funds received (directly or indirectly) beyond amounts permitted under law or administrative

action in effect on the date of the proposal’s enactment. Such funds would include only amounts
3

received during the period beginning on the date of the proposal’s enactment and ending on the last

day of the year before the year in which the bonds were to be issued. The Treasury would be

required to respond to a request for such a certification within 30 days.

In the event that Amtrak or the Alaska Railroad received any unauthorized Highway Trust

Fund funds, no future tax-credit bonds could be issued until the Secretary of the Treasury certified

that the issuing railroad had repaid to the Highway Trust Fund an amount equal to the funds

received. Following certification of such a repayment, the railroad’s tax-credit bond authority

again would be available under the rules generally applicable to issuance of such bonds. These

provisions would not affect tax credits on outstanding bonds.

Conforming amendments would be made to the Highway Trust Fund expenditure purposes

to clarify that the limit on expenditures for the for the benefit of Amtrak or the Alaska Railroad

applies without regard to subsequently enacted legislation and to provide for reimbursement of the

Trust Fund in the even a repayment is required.

C. Broadband Tax Credit

The proposal in the Chairman’s mark relating to a broadband internet access credit would

be modified such that in the case of current generation broadband services, qualified expenditures

would be those that are incurred by the taxpayer after December 31, 2000, and before January 1,

2004. In the case of next generation broadband services, qualified expenditures would be those

that are incurred by the taxpayer after December 31, 2001, and before January 1, 2005.

D. Treatment of Indian Tribes as Non-Profit Organizations

and State or Local Governments for Purposes

of the Federal Unemployment Tax (FUTA)

The proposal generally would be effective with respect to service performed beginning on

or after the date of enactment. Under a transition rule, service performed in the employ of an

Indian tribe would not be treated as employment for FUTA purposes if: (1) it is service which is

performed before the date of enactment and with respect to which FUTA tax has not been paid; and

(2) such Indian tribe reimburses a State unemployment fund for unemployment benefits paid for

service attributable to such tribe for such period.
4

II. ADDITIONAL PROVISIONS

The following provisions would be added to the Chairman's Mark.

A. Tax Relief For Farmers

1. Farm, Fish, and Ranch Risk Management accounts (“FFARRM Accounts”)

Present Law

There is no provision in present law allowing the elective deferral of farm or fishing

income.

Description of Proposal

The proposal would allow taxpayers engaged in an eligible business to establish FFARRM

accounts. An eligible business would be any trade or business of farming in which the taxpayer

actively participates, including the operation of a nursery or sod farm or the raising or harvesting

of crop-bearing or ornamental trees. An eligible business also would be the trade or business of

commercial fishing as that term is defined under section (3) of the Magnuson-Stevens Fishery

Conservation and Management Act (16 U.S.C. 1802) and would include the trade or business of

catching, taking or harvesting fish that are intended to enter commerce through sale, barter or trade.

Contributions to a FFARRM account would be deductible and would be limited to 20

percent of the taxable income that is attributable to the eligible business. The deduction would be

taken into account in determining adjusted gross income and would reduce income attributable to

the eligible business for all income tax purposes other than the determination of the 20 percent of

eligible income limitation on contributions to a FFARRM account. Contributions to a FFARRM

account would not reduce earnings from self-employment. Accordingly, distributions would not

be included in self-employment income.

A FFARRM account would be taxed as a grantor trust and any earnings would be required

to be distributed currently. Thus, any income earned in the FFARRM account would be taxed

currently to the farmer or fisherman who established the account. Amounts could remain on

deposit in a FFARRM account for up to five years. Any amount that has not been distributed by

the close of the fourth year following the year of deposit would be deemed to be distributed and

includible in the gross income of the account owner.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
5

2. Exclusion of rental income from SECA tax

Present Law

Generally, SECA taxes are imposed on an individual’s net earnings from self employment. 

Net earnings from self-employment generally means gross income (including the individual’s net

distributive share of partnership income) derived by an individual from any trade or business

carried on by the individual less applicable deductions. One exclusion from net earnings from self

employment involves certain real estate rentals. Under this rule, net earnings from self

employment do not include income from the rental of real estate and from personal property leased

with the real estate unless the rental income is received under an arrangement between an owner or

tenant of land and another individual that provides: (1) such other individual shall produce

agricultural or horticultural commodities on such land; and (2) there shall be material participation

by the owner or tenant with respect to any such agricultural or horticultural commodities. Other

rules apply to rental payments received by an individual in the course of the individual’s trade or

business as a real estate dealer.

Description of Proposal

The proposal would provide that net earnings from self employment would not include

income from the rental of real estate under a lease agreement (rather than an arrangement) between

an owner or tenant of land and another individual which provides that: (1) such other individual

shall produce agricultural or horticultural commodities on such land; and (2) there shall be

material participation by the owner or tenant in the production or management of the production of

such agricultural or horticultural commodities.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.

3. Exclusion of conservation reserve program payments from SECA tax

Present Law

Generally, SECA tax is imposed on an individual’s self-employment income within the

Social Security wage base. Net earnings from self-employment generally means gross income

(including the individual’s net distributive share of partnership income) derived by an individual

from any trade or business carried on by the individual less applicable deductions. A recent court

decision found that payments made under the conservation reserve program are includible in an

individual’s self-employment income for purposes of SECA tax.
6

Description of Proposal

The proposal would provide that net earnings from self-employment would not include

conservation reserve program payments for SECA.

Effective Date

The proposal would be effective for payments made after December 31, 2000.

4. Exemption of agricultural bonds from private activity bond volume cap

Present Law

Interest on bonds issued by States and local governments is excluded from income if the

proceeds of the bonds are used to finance activities conducted and paid for by the governmental

units (sec. 103). Interest on bonds issued by these governmental units to finance activities carried

out and paid for by private persons (“private activity bonds”) is taxable unless the activities are

specified in the Internal Revenue Code. Private activity bonds on which interest may be taxexempt include bonds issued to finance loans to first-time farmers for the acquisition of land and

certain equipment (“aggie bonds”).

The volume of tax-exempt private activity bonds that States and local governments may

issue in each calendar year (including aggie bonds) is limited by State-wide volume limits. The

current annual volume limits are $50 per resident of the State or $150 million if greater. The

volume limits do not apply to private activity bonds to finance airports, docks and wharves,

certain governmentally owned, but privately operated solid waste disposal facilities, certain high

speed rail facilities, and to certain types of private activity tax-exempt bonds that are subject to

other limits on their volume (qualified veterans’ mortgage bonds and certain “new” empowerment

zone and enterprise community bonds).

Description of Proposal

The proposal would exempt “aggie bonds” from the State volume limits.

Effective Date

The proposal would apply to bonds issued after December 31, 2000.

5. Modifications to section 512(b)(13)

Present Law

In general, interest, rents, royalties and annuities are excluded from the unrelated business

income (“UBI”) of tax-exempt organizations. However, section 512(b)(13) treats otherwise
7

excluded rent, royalty, annuity, and interest income as UBI if such income is received from a

taxable or tax-exempt subsidiary that is 50 percent controlled by the parent tax-exempt

organization. In the case of a stock subsidiary, “control” means ownership by vote or value of

more than 50 percent of the stock. In the case of a partnership or other entity, control means

ownership of more than 50 percent of the profits, capital or beneficial interests. In addition,

present law applies the constructive ownership rules of section 318 for purposes of section

512(b)(13). Thus, a parent exempt organization is deemed to control any subsidiary in which it

holds more than 50 percent of the voting power or value, directly (as in the case of a first-tier

subsidiary) or indirectly (as in the case of a second-tier subsidiary).

Under present law, interest, rent, annuity, or royalty payments made by a controlled entity

to a tax-exempt organization are includible in the latter organization's UBI and are subject to the

unrelated business income tax to the extent the payment reduces the net unrelated income (or

increases any net unrelated loss) of the controlled entity.

The Taxpayer Relief Act of 1997 (the “1997 Act”) made several modifications, as

described above, to the control requirement of section 512(b)(13). In order to provide transitional

relief, the changes made by the 1997 Act do not apply to any payment received or accrued during

the first two taxable years beginning on or after the date of enactment of the 1997 Act (August 5,

1997) if such payment is received or accrued pursuant to a binding written contract in effect on

June 8, 1997, and at all times thereafter before such payment (but not pursuant to any contract

provision that permits optional accelerated payments).

Description of Proposal

The proposal would provide that interest, rent, annuity, or royalty payments made by a

controlled subsidiary to a tax-exempt parent is not Unrelated Business Income except to the extent

that such payments exceed arm’s length values, as determined under sec. 482 principles.

Effective Date

The proposal would generally be effective for payments received or accrued after

December 31, 2000.

6. Charitable deduction for contributions of food inventory

Present Law

The maximum charitable contribution deduction that may be claimed by a corporation for

any one taxable year is limited to 10 percent of the corporation's taxable income for that year

(disregarding charitable contributions and with certain other modifications) (sec. 170(b)(2)). 

Corporations also are subject to certain limitations based on the type of property contributed. In

the case of a charitable contribution of short-term gain property, inventory, or other ordinary

income property, the amount of the deduction generally is limited to the taxpayer's basis (generally,
3

 See, e.g., Lucky Stores Inc. v. Commissioner, 105 TC 420 (1995), holding that the value

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

the retail price, as the IRS asserted. 

8

cost) in the property. However, special rules in the Code provide an augmented deduction for

certain corporate contributions. Under these special rules, the amount of the augmented deduction

is equal to the lesser of (1) the basis of the donated property plus one-half of the amount of

ordinary income that would have been realized if the property had been sold, or (2) twice the basis

of the donated property. To be eligible for the enhanced deduction, the taxpayer must establish that

the fair market value of the donated item exceeds basis. The valuation of food inventory has been

the subject of ongoing disputes between taxpayers and the IRS.3

The special treatment applies only to donations made by C corporations. S corporations,

personal holding companies, and service organizations are not eligible donors.

Description of Proposal

The proposal would amend Code section 170 to expand the augmented deduction such that

any taxpayer engaged in the trade or business of farming would be eligible to claim an enhanced

deduction for donations of food inventory under section 170(e)(3).

The value of the enhanced deduction could be no greater than twice the taxpayer’s basis in

the donated property. The proposal would provide that in the case of a cash method taxpayer, the

taxpayer’s basis in the donated food would equal half of the fair market value of the donated food.

The proposal would modify and clarify the determination of fair market value. Under the

proposal, the fair market value of donated food which cannot or will not be sold solely due to

internal standards of the taxpayer, lack of market, or similar circumstances would be determined

without regard to such factors and, if applicable, by taking into account the price at which the same

or similar food items are sold by the taxpayer at the time of the contribution or in the recent past.

The proposal would not apply for taxable years beginning after December 31, 2003.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.

7. Coordinate farmers and fisherman income averaging and the alternative minimum tax

Present Law

An individual taxpayer engaged in a farming business as defined by section 263A(e)(4)

may elect to compute his or her current year tax liability by averaging, over the prior three-year

period, all or portion of his or her taxable income from the trade or business of farming. The
9

averaging election is not coordinated with the alternative minimum tax. Thus, some farmers may

become subject to the alternative minimum tax solely as a result of the averaging election.

Description of Proposal

The proposal would extend to individuals engaged in the trade or business of fishing the

election that is available to individual farmers to use income averaging.

The proposal also would coordinate farmers and fishermen income averaging with the

alternative minimum tax. Under the proposed coordination, a farmer would owe alternative

minimum tax only to the extent he or she would have owed alternative minimum tax had averaging

not been elected. This result would be achieved by excluding the impact of the election to average

farm income from the calculation of both regular tax and tentative minimum tax, solely for the

purpose of determining alternative minimum tax.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.

8. Cooperative marketing to include value added processing through animals

Present Law

Under present law, taxable cooperatives in essence are treated as pass-through entities in

that the cooperative is not subject to corporate income tax to the extent the cooperative timely pays

patronage dividends. Tax-exempt cooperatives (sec. 521) are cooperatives of farmers, fruit

growers, and like organizations organized and operated on a cooperative basis for the purpose of

marketing the products of members or other producers and turning back the proceeds of sales, less

necessary marketing expenses on the basis of either the quantity or the value of products furnished

by them.

The Internal Revenue Service takes the position that a cooperative is not marketing the

products of members or other producers where the cooperative adds value through the use of

animals (e.g., farmers sell corn to cooperative which is feed to chickens which produce eggs).

Description of Proposal

The proposal would provide that marketing products of members or other producers

includes feeding products of members or other producers to cattle, hogs, fish, chickens, or other

animals and selling the resulting animals or animal products.

Effective Date

The proposal would be effective for taxable years beginning after the date of enactment.
10

9. Extend declaratory judgment procedures to farmers’ cooperative organizations

Present Law

Cooperatives may deduct from their taxable income amounts distributed to patrons in the

form of patronage dividends, and certain other amounts paid or allocated to patrons, to the extent

the net earnings of the cooperative from business done with or for patrons, provided that there is a

pre-existing obligation to distribute such amounts (sec. 1382). Cooperatives that qualify as

farmers’ cooperatives under section 521 also may deduct such amounts from income to the extent

of all net income, and also may deduct to a limited extend dividends paid on common stock.

Under present law, there is limited access to judicial review of disputes regarding the

initial or continuing qualification of a farmer’s cooperative described in section 521. The only

remedies available to such an organization are to file a petition in the U.S. Tax Court for relief

following the issuance of a notice of deficiency or to pay tax and sue for a refund in a U.S. district

court or the U.S. Court of Federal Claims.

In limited circumstances, declaratory judgment procedures are available, which generally

permit a taxpayer to seek judicial review of an IRS determination prior to the issuance of a notice

of deficiency and prior to payment of tax. Examples of declaratory judgment procedures which are

available include disputes involving the status of a tax-exempt organization under section

501(c)(3), the qualification of retirement plans, the value of gifts, the status of certain

governmental obligations, or eligibility of an estate to pay tax in installments under section 6166. 

In such cases, taxpayers may challenge adverse determinations by commencing a declaratory

judgment action. For example, where the IRS denies an organization’s application for recognition

of exemption under section 501(c)(3) or fails to act on such application, or where the IRS informs

a section 501(c)(3) organization that it is considering revoking or adversely modifying its taxexempt status, present law authorizes the organization to seek a declaratory judgment regarding its

tax exempt status.

Declaratory judgment procedures are not available under present law to a cooperative with

respect to an IRS determination regarding its status as a farmers’ cooperative under section 521.

Description of Proposal

The amendment would extend the declaratory judgment procedures to cooperatives. 

Jurisdiction over such cases would be in the U.S. Tax Court, a U.S. district court, or the U.S. Court

of Federal Claims, and would include determination of initial or continuing qualification of a

farmers’ cooperative described in sec. 521.
11

Effective Date

The amendment would be effective with respect to pleadings filed after the date of

enactment, but only with respect to determinations (or requests for determinations) made after

January 1, 2000.

10. Small ethanol producer credit

Present Law

“Small ethanol producers” are allowed a 10-cents-per-gallon production income tax credit

on up to 15 million gallons of production annually. This credit is in addition to the 54-cents-pergallon benefit available for ethanol generally.

Description of Proposal

The proposal would: (1) allow cooperatives to flow the credit through to patrons; (2)

provide that the small producer credit is not a “passive credit”; (3) allow the credit to be claimed

against the alternative minimum tax; and (4) repeal the present rule that the amount of the credit is

included in income.

Effective Date

The proposal would be effective for taxable years beginning after date of enactment.

11. Payment of dividends on stock of cooperatives without reducing patronage

dividends

Present Law

Cooperatives, including tax-exempt farmers' cooperatives, are treated like a conduit for

Federal income tax purposes since a cooperative may deduct patronage dividends paid from its

taxable income. In general, patronage dividends are amounts paid to patrons (1) on the basis of the

quantity or value of business done with or for its patrons, (2) under a valid enforceable written

obligation to the patron to pay such amount, which obligation existed before the cooperative

received such amounts, and (3) which is determined by reference to the net earnings of the

cooperative from business done with or for its patrons.

Treasury Regulations provide that net earnings are reduced by dividends paid on capital

stock or other proprietary capital interests. The effect of this rule is to reduce the amount of

earnings that the cooperative can treat as patronage earnings which reduces the amount that

cooperative can deduct as patronage dividends.
12

Description of Proposal

The proposal would allow cooperatives to pay dividends on capital stock without those

dividends reducing excludable patronage-sourced income to the extent that the cooperative’s

organizational documents provide that the dividends do not reduce amounts owed to patrons.

Effective Date

The proposal would apply to distributions in taxable years beginning after the date of

enactment.
4

 Treas. Reg. sec. 1.263(a)-(1)(b).

5

 See, e.g., Schermerhorn Oil Corporation, 46 B.T.A. 151 (1942).

6

 By contrast, section 617 of the Code permits a taxpayer to elect to deduct certain

expenditures incurred for the purpose of ascertaining the existence, location, extent, or quality of

any deposit of ore or other mineral (but not oil and gas). These deductions are subject to recapture

if the mine with respect to which the expenditures were incurred reaches the producing stage.

7

 1977-1 C.B. 76.

13

B. Energy Proposals

1. Allow geological and geophysical costs to be deducted currently

Present Law

In general

Under present law, current deductions are not allowed for any amount paid for new

buildings or for permanent improvements or betterments made to increase the value of any

property or estate (sec. 263(a)). Treasury Department regulations define capital amounts to

include amounts paid or incurred (1) to add to the value, or substantially prolong the useful life, of

property owned by the taxpayer or (2) to adapt property to a new or different use.4

The proper income tax treatment of geological and geophysical costs ("G&G costs")

associated with oil and gas production has been the subject of a number of court decisions and

administrative rulings. G&G costs are incurred by the taxpayer for the purpose of obtaining and

accumulating data that will serve as a basis for the acquisition and retention of oil or gas 

properties by taxpayers exploring for the minerals. Courts have ruled that such costs are capital in

nature and are not deductible as ordinary and necessary business expenses.5 Accordingly, the

costs attributable to such exploration are allocable to the cost of the property acquired or

retained.6 The term "property" includes an economic interest in a tract or parcel of land

notwithstanding that a mineral deposit has not been established or proven at the time the costs are

incurred.

Revenue Ruling 77-188

In Revenue Ruling 77-1887 (hereinafter referred to as the "1977 ruling"), the Internal

Revenue Service ("IRS") provided guidance regarding the proper tax treatment of G&G costs. The

ruling describes a typical geological and geophysical exploration program as containing the

following elements:
14

• It is customary in the search for mineral producing properties for a taxpayer to conduct an

exploration program in one or more identifiable project areas. Each project area

encompasses a territory that the taxpayer determines can be explored advantageously in a

single integrated operation. This determination is made after analyzing certain variables

such as the size and topography of the project area to be explored, the existing information

available with respect to the project area and nearby areas, and the quantity of equipment,

the number of personnel, and the amount of money available to conduct a reasonable

exploration program over the project area.

• The taxpayer selects a specific project area from which geological and geophysical data

are desired and conducts a reconnaissance-type survey utilizing various geological and

geophysical exploration techniques that are designed to yield data that will afford a basis

for identifying specific geological features with sufficient mineral potential to merit further

exploration.

• Each separable, noncontiguous portion of the original project area in which such a specific

geological feature is identified is a separate "area of interest." The original project area is

subdivided into as many small projects as there are areas of interest located and identified

within the original project area. If the circumstances permit a detailed exploratory survey

to be conducted without an initial reconnaissance-type survey, the project area and the area

of interest will be coextensive.

• The taxpayer seeks to further define the geological features identified by the prior

reconnaissance-type surveys by additional, more detailed, exploratory surveys conducted

with respect to each area of interest. For this purpose, the taxpayer engages in more

intensive geological and geophysical exploration employing methods that are designed to

yield sufficiently accurate sub-surface data to afford a basis for a decision to acquire or

retain properties within or adjacent to a particular area of interest or to abandon the entire

area of interest as unworthy of development by mine or well.

The 1977 ruling provides that if, on the basis of data obtained from the preliminary

geological and geophysical exploration operations, only one area of interest is located and

identified within the original project area, then the entire expenditure for those exploratory

operations is to be allocated to that one area of interest and thus capitalized into the depletable

basis of that area of interest. On the other hand, if two or more areas of interest are located and

identified within the original project area, the entire expenditure for the exploratory operations is

to be allocated equally among the various areas of interest.

The 1977 ruling further provides that if, on the basis of data obtained from a detailed

survey that does not relate exclusively to any particular property within a particular area of

interest, an oil or gas property is acquired or retained within or adjacent to that area of interest, the

entire G&G exploration expenditures, including those incurred prior to the identification of the

particular area of interest but allocated thereto, are to be allocated to the property as a capital cost

under section 263(a).
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If, however, from the data obtained by the exploratory operations no areas of interest are

located and identified by the taxpayer within the original project area, then the 1977 ruling states

that the entire amount of the G&G costs related to the exploration is deductible as a loss under

section 165 for the taxable year in which that particular project area is abandoned as a potential

source of mineral production.

Description of Proposal

The proposal would allow geological and geophysical costs incurred in connection with

oil and gas exploration in the United States to be deducted currently.

Effective Date

The proposal would be effective for G&G costs incurred or paid in taxable years

beginning after December 31, 2001.

2. Allow certain oil and gas “delay rental payments” to be deducted currently

Present Law

Present law generally requires costs associated with inventory and property held for resale

to be capitalized rather than currently deducted as they are incurred. (sec. 263A). Oil and gas

producers typically contract for mineral production in exchange for royalty payments. If mineral

production is delayed, these contracts provide for “delay rental payments” as a condition of their

extension. The Treasury Department has taken the position that the uniform capitalization rules of

section 263A require delay rental payments to be capitalized.

Description of Proposal

The proposal would allow delay rental payments to be deducted currently.

Effective Date

The proposal would apply to delay rental payments incurred in taxable years beginning

after December 31, 2001.

The legislative history accompanying the provision would state that no inference is

intended from the proposal as to the proper treatment of pre-effective date delay rental payments.
8

 A taxpayer could elect to forgo the carryback of an NOL.

16

3. Allow net operating losses from oil and gas properties to be carried back for up to five

years

Present Law

A net operating loss (“NOL”) generally is the amount by which business deductions of a

taxpayer exceed business gross income. In general, an NOL may be carried back two years and

carried forward 20 years to offset taxable income in such years.8 A carryback of an NOL results

in the refund of Federal income tax for the carryback year. A carryforward of an NOL reduces

Federal income tax for the carryforward year. Special NOL carryback rules apply to (1) casualty

and theft losses of individual taxpayers, (2) Presidentially declared disasters for taxpayers

engaged in a farming business or a small business, (3) real estate investment trusts, (4) specified

liability losses, (5) excess interest losses, and (6) farm losses.

Description of Proposal

The proposal would provide a special five-year carryback for certain eligible oil and gas

losses of independent producers. The carryforward period would remain 20 years. An “eligible

oil and gas loss” would be defined as the lesser of (1) the amount which would be the taxpayer=s

NOL for the taxable year if only income and deductions attributable to operating mineral interests

in oil and gas wells were taken into account, or (2) the amount of such net operating loss for such

taxable year. In calculating the amount of a taxpayer’s NOL carrybacks, the portion of the NOL

that would be attributable to an eligible oil and gas loss would be treated as a separate NOL and

taken into account after the remaining portion of the NOL for the taxable year.

Effective Date

The proposal would apply to NOLs arising in taxable years beginning after December 31,

2001.

4. Temporary suspension of percentage of depletion deduction limitation based on 65 percent

of taxable income

Present Law

Depletion, like depreciation, is a form of capital cost recovery. In both cases, the taxpayer

is allowed a deduction in recognition of the fact that an asset–in the case of depletion for oil or gas

interests, the mineral reserve itself–is being expended in order to produce income. Certain costs

incurred prior to drilling an oil or gas property are recovered through the depletion deduction. 

These include costs of acquiring the lease or other interest in the property and geological and

geophysical costs (in advance of actual drilling). Depletion is available to any person having an

economic interest in a producing property.
9

 Amounts disallowed as a result of this rule may be carried forward and deducted in

subsequent taxable years, subject to the 65-percent taxable income limitation for those years.

17

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

method, and (2) the percentage depletion method (secs. 611-613). 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.

Under the percentage depletion method, generally, 15 percent of the taxpayer’s gross

income from an oil-or gas-producing property is allowed as a deduction in each taxable year (sec.

613A(c)). The amount deducted generally may not exceed 100 percent of the net income from that

property in any year (the “net-income limitation”) (sec. 613(a)). Additionally, the percentage

depletion deduction for all oil and gas properties may not exceed 65 percent of the taxpayer’s

overall taxable income (determined before such deduction and adjusted for certain loss carrybacks

and trust distributions) (sec. 613A(d)(1)).9

Description of Proposal

The proposal would suspend the 65-percent-of-taxable-income limit for taxable years

beginning after December 31, 2000, and before January 1, 2004.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.

5. Tax credit for oil and gas production from marginal wells

Present Law

There is no income tax credit for oil or gas production from marginal wells generally. 

Present law does, however, provide a tax credit for production requiring the use of certain tertiary

recovery methods (the "enhanced oil recovery credit") (sec. 43).

Description of Proposal

The proposal would provide an income tax credit equal to $3 per barrel of qualified crude

oil produced from a marginal well and 50 cents per 1,000 cubic feet of qualified natural gas

production. Qualified production would be defined as production from wells having production of

1,095 barrels per year (3 barrels per day) or less.
10 1987-2 C.B. 674. Rev Proc 87-56 subsequently was clarified and modified by Rev.

Proc. 88-22, 1988-1, CB 785.

11 Duke Energy v. Commissioner, 172 F.3d 1255 (10th Cir. 1999), rev’g 109 TC 416

(1997). See also True v. United States, 97-2 U.S. Tax Cas. (CCH) par. 50,946 (D. Wyo. 1997).

18

The credit would apply fully only when oil prices were below $14. The credit would

phase-out ratably when the price of oil was between $14 and $17 per barrel for oil (and

equivalent amounts for natural gas).

The credit could be claimed against both the regular income tax and the alternative

minimum tax.

Effective Date

The proposal would apply to production in taxable years beginning after December 31,

2000.

6. Establish a seven-year recovery period for natural gas gathering lines 

Present Law

The applicable recovery period for assets placed in service under the Modified

Accelerated Cost Recovery System is based on the “class life of the property.” The class lives of

assets placed in service after 1986 are set forth in Revenue Procedure 87-56.10 Revenue

Procedure 87-56 includes two asset classes that could describe natural gas gathering lines owned

by non-producers of natural gas. Asset class 13.2, describing assets used in the exploration for

and production of petroleum and natural gas deposits, provides a class life of 14 years and a

depreciation recovery period of seven years. Asset class 46.0, describing pipeline transportation,

provides a class life of 22 years and a recovery period of 15 years. The uncertainty regarding the

appropriate recovery period has resulted in litigation between taxpayers and the IRS. Recently,

the 10th Circuit Court of Appeals held that natural gas gathering lines owned by non-producers fall

within the scope of Asset class 13.2 (i.e., seven-year recovery period).11

Description of Proposal

The proposal would establish a statutory seven-year recovery period for all natural gas

gathering lines. A natural gas gathering line would be defined to include pipe, equipment, and

appurtenances that is (1) determined to be a gathering line by the Federal Energy Regulatory

Commission, or (2) used to deliver natural gas from the wellhead or a common point to the point at

which such gas first reaches (a) a gas processing plant, (b) an interconnection with an interstate

transmission line, (c) an interconnection with an intrastate transmission line, or (d) a direct

interconnection with a local distribution company, a gas storage facility, or an industrial consumer.
19

Effective Date

The proposal would be effective for property placed in service on or after the date of

enactment. No inference would be intended as to the proper treatment of such property placed in

service before the date of enactment.

7. Subpart F treatment of pipeline transportation income

Present Law

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

(“CFC”) are subject to U.S. tax currently on their shares of certain income earned by the foreign

corporation, whether or not such income is distributed to the shareholders (referred to as “subpart

F income”). Subpart F income includes foreign base company income, which in turn includes five

categories of income: foreign personal holding company income, foreign base company sales

income, foreign base company services income, foreign base company shipping income, and

foreign base company oil related income (sec. 954(a)).

Foreign base company oil related income is income derived outside the United States from

the processing of minerals extracted from oil or gas wells into their primary products; the

transportation, distribution, or sale of such minerals or primary products; the disposition of assets

used by the taxpayer in a trade or business involving the foregoing; or the performance of any

related services. However, foreign base company oil related income does not include income

derived from a source within a foreign country in connection with: (1) oil or gas which was

extracted from a well located in such foreign country or, (2), oil, gas, or a primary product of oil

or gas which is sold by the CFC or a related person for use or consumption within such foreign

country or is loaded in such country as fuel on a vessel or aircraft. An exclusion also is provided

for income of a CFC that is a small producer (i.e., a corporation whose average daily oil and

natural gas production, including production by related corporations, is less than 1,000 barrels).

Description of Proposal

The proposal would provide an exception to the definition of foreign base company oil

related income. Under the proposal, foreign base company oil related income would not include

income derived from a source within a foreign country in connection with the pipeline

transportation of oil or gas within such foreign country. Thus, the proposed exception would apply

whether or not the CFC that owns the pipeline also owns any interest in the oil or gas transported. 

In addition, the proposed exception would apply to income earned from the transportation of oil or

gas by pipeline in a country in which the oil or gas was neither extracted nor consumed within such

foreign country.
20

Effective Date

The proposal would be effective for taxable years of CFCs beginning after December 31,

2001, and taxable years of U.S. shareholders with or within which such taxable years of CFCs

end.
21

C. Conservation Proposals

1. Capital gains exclusion on sales of conservation property

Present Law

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

long-term capital gain.

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

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

Description of Proposal

The proposal would provide a 50-percent exclusion from a taxpayer’s gross income for

gain realized on the qualifying sale of land, or an interest in land or water, provided the land, or

interest in land or water, has been held by the taxpayer or the taxpayer’s family for at least three

years prior to the date of sale. A qualifying sale would be a sale (including condemnation) to any

agency of the Federal Government, a State government, or a local government, or a sale to

501(c)(3) organization that is organized and operated primarily to meet a qualified conservation

purpose. In addition, to be a qualifying sale, the person acquiring the land, or interest in land or

water, must provide the taxpayer with a letter detailing that the intent of the purchase is to further a

qualified conservation purpose. A qualified conservation purpose is (1) the preservation of land

areas for outdoor recreation by, or the education of, the general public, (2) the protection of a

relatively natural habitat of fish, wildlife, or plants, or similar ecosystem, or (3) the preservation

of open space (including farmland and forest land) where the preservation is for the scenic

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

governmental conservation policy that will yield a significant public benefit.

Effective Date

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

2. Expand the estate tax rule for conservation easements

Present Law

An executor may elect to exclude from the taxable estate 40 percent of the value of any land

subject to a qualified conservation easement, up to a maximum exclusion of $100,000 in 1998,

$200,000 in 1999, $300,000 in 2000, $400,000 in 2001, and $500,000 in 2002 and thereafter (sec.

2031(c)). The exclusion percentage is reduced by 2 percentage points for each percentage point

(or fraction thereof) by which the value of the qualified conservation easement is less than 30

percent of the value of the land (determined without regard to the value of such easement and

reduced by the value of any retained development right).
22

A qualified conservation easement is one that meets the following requirements: (1) the

land is located within 25 miles of a metropolitan area (as defined by the Office of Management

and Budget) or a national park or wilderness area, or within 10 miles of an Urban National Forest

(as designated by the Forest Service of the U.S. Department of Agriculture); (2) the land has been

owned by the decedent or a member of the decedent’s family at all times during the three-year

period ending on the date of the decedent’s death; and (3) a qualified conservation contribution

(within the meaning of sec. 170(h)) of a qualified real property interest (as generally defined in

sec. 170(h)(2)(C)) was granted by the decedent or a member of his or her family. For purposes of

the provision, preservation of a historically important land area or a certified historic structure

does not qualify as a conservation purpose.

In order to qualify for the exclusion, a qualifying easement must have been granted by the

decedent, a member of the decedent’s family, the executor of the decedent’s estate, or the trustee of

a trust holding the land, no later than the date of the election. To the extent that the value of such

land is excluded from the taxable estate, the basis of such land acquired at death is a carryover

basis (i.e., the basis is not stepped-up to its fair market value at death). Property financed with

acquisition indebtedness is eligible for this provision only to the extent of the net equity in the

property. The exclusion from estate taxes does not extend to the value of any development rights

retained by the decedent or donor.

Description of Proposal

The proposal would expand the availability of qualified conservation easements by

eliminating the distance requirements. Under the proposal, the land would qualify without regard

to the distance from which the land is situated from a metropolitan area, national park, wilderness

area, or Urban National Forest.

Effective Date

The proposal would be effective for estates of decedents dying after December 31, 2001.

3. Cost-sharing payments under the Partners for Wildlife Program

Present Law

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

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

under certain conservation programs. These programs include payments received under (1) the

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

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

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

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

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

and Domestic Allotment Act, (6) the great plains conservation program authorized by section 16 of
23

the Soil Conservation and Domestic Policy Act, (7) the resource conservation and development

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

Domestic Allotment Act, (8) the forestry incentives program authorized by section 4 of the

Cooperative Forestry Assistance Act of 1978, (9) any small watershed program administered by

the Secretary of Agriculture which is determined by the Secretary of the Treasury or his delegate

to be substantially similar to the type of programs described in items (1) through (8), and (10) any

program of a State, possession of the United States, a political subdivision of any of the foregoing,

or the District of Columbia under which payments are made to individuals primarily for the

purpose of conserving soil, protecting or restoring the environment, improving forests, or

providing a habitat for wildlife.

Description of Proposal

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

payments under the Partners for Wildlife Program.

Effective Date

The amendment would apply to payments received after the date of enactment.

4. Deduction for energy-efficient commercial business property

Present Law

No special deduction is currently provided for expenses incurred for energy efficient

building property.

Description of Proposal

The proposal would allow a deduction from income for expenses incurred for energy

efficient commercial building property. Energy-efficient commercial building property would be

defined as property which reduces annual energy and power costs with respect to lighting, cooling,

heating, ventilation, and hot water supply by 50 percent or more in comparison to a reference

building. A reference building is defined as one which meets the requirements of Standard 90.1-

1999 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the

Illuminating Engineering Society of North America. The maximum deduction would be $2.25 per

square foot. For all property eligible for the deduction, the depreciable basis of the property

would be reduced by the amount of the deduction. For public property, such as schools, the

Secretary shall issue regulations to allow the deduction to be allocated to the person primarily

responsible for designing the property in lieu of the public entity owner.
24

Effective Date

The deduction would be effective for taxable years beginning after December 31, 2000,

and before January 1, 2004.

5. Expand tax credit for electricity produced by wind, closed-loop biomass, and poultry waste

Present Law

Section 45

An income tax credit is allowed for the production of electricity from either qualified wind

energy facilities, qualified “closed-loop” biomass facilities, or qualified poultry waste facilities

(sec. 45). The current value of the credit is 1.7 cents/kilowatt hour of electricity produced and the

value of the credit is indexed for inflation. The credit applies to electricity produced by a

qualified wind energy facility placed in service after December 31, 1993, and before January 1,

2002, to electricity produced by a qualified closed-loop biomass facility placed in service after

December 31, 1992, and before January 1, 2002, and to a qualified poultry waste facility placed in

service after December 31, 1999, and before January 1, 2002. The credit is allowable for

production during the 10-year period after a facility is originally placed in service.

Closed-loop biomass is the use of plant matter, where the plants are grown for the sole

purpose of being used to generate electricity. It does not include the use of waste materials

(including, but not limited to, scrap wood, manure, and municipal or agricultural waste). The

credit also is not available to taxpayers who use standing timber to produce electricity. In order to

claim the credit, a taxpayer must own the facility and sell the electricity produced by the facility to

an unrelated party.

Section 29

Certain fuels produced from "nonconventional sources" and sold to unrelated parties are

eligible for an income tax credit equal to $3 (generally adjusted for inflation) per barrel or BTU

oil barrel equivalent (sec. 29) (referred to as the "section 29 credit"). Qualified fuels must be

produced within the United States. Qualified fuels include:

(1) oil produced from shale and tar sands;

(2) gas produced from geopressured brine, Devonian shale, coal seams, tight formations

("tight sands"), or biomass; and

(3) liquid, gaseous, or solid synthetic fuels produced from coal (including lignite).

In general, the credit is available only with respect to fuels produced from wells drilled or

facilities placed in service after December 31, 1979, and before January 1, 1993. An exception

extends the January 1, 1993 expiration date for facilities producing gas from biomass and synthetic
25

fuel from coal if the facility producing the fuel is placed in service before July 1, 1998, pursuant to

a binding contract entered into before January 1, 1997.

The credit may be claimed for qualified fuels produced and sold before January 1, 2003

(in the case of nonconventional sources subject to the January 1, 1993 expiration date) or January

1, 2008 (in the case of biomass gas and synthetic fuel facilities eligible for the extension period).

Description of Proposal

The present-law tax credit for electricity produced by wind, closed-loop biomass, and

poultry waste facilities would be expanded to include electricity produced from certain other

biomass (in addition to closed-loop biomass and poultry waste) and electricity produced from

landfill gas. Taxpayers producing electricity from other biomass or landfill gas could claim credit

for production of electricity for three years commencing on the date the facility is placed in service

(or in the case of other facilities producing electricity from other biomass three years commencing

on the later of January 1, 2001, or the date the facility is placed in service).

"Other biomass" would be defined as solid nonhazardous, cellulose waste material which

is segregated from other waste materials and which is derived from forest resources, but not

including old growth timber. The term would include urban sources such as waste pallets, crates,

manufacturing and construction wood waste, and tree trimmings, or agricultural sources (including

orchard tree crops, grain, vineyard, legumes, sugar, and other crop by-products or residues). 

However, the term would not include unsegregated municipal solid waste, paper that is commonly

recycled, or certain chemically treated wood wastes. Qualifying other biomass and landfill gas

facilities would include facilities owned by the taxpayer.

A special rule would modify present-law qualified closed-loop biomass facilities to

include facilities in which electricity is produced from closed-loop biomass fuels co-fired with

coal.

In the case of other biomass facilities, the credit would apply to electricity produced after

December 31, 2000, from facilities that are placed in service before January 1, 2002 (including

facilities placed in service before the date of enactment of this provision). In the case of landfill

gas facilities, the credit would apply to electricity produced from facilities placed in service after

December 31, 1999, and before January 1, 2002. In the case of closed-loop biomass facilities in

which closed-loop biomass fuel is co-fired with coal, the credit would apply to electricity

produced after December 31, 2000 from facilities that are placed in service before January 1,

2002 (including facilities placed in service before the date of enactment of this provision).

Effective Date

The proposal would be effective on the date of enactment.
26

6. Credit for hybrid vehicles

Present Law

Present law does not provide a credit for the purchase of hybrid vehicles. However,

taxpayers may claim a credit of 10 percent of the cost of an electric vehicle up to a maximum

credit of $4,000 (sec. 30). A qualified electric vehicle is a vehicle powered primarily by an

electric motor drawing current from rechargeable batteries, fuel cells, or other portable sources of

electrical current. The credit does not apply to property placed in service after December 31,

2004 and is reduced ratably between 2002 and 2004.

Taxpayers may claim an immediate deduction (expensing) for up to $2,000 of the cost of a

qualified clean-fuel vehicle which is a car and up to $50,000 in the case of certain trucks or vans

(sec. 179A). For the purpose of the deduction, gasoline and diesel fuel are not clean-burning

fuels. The deduction expires after December 31, 2004, and is phased out ratably between 2002

and 2004.

Description of Proposal

The proposal would provide a temporary tax credit for qualified hybrid vehicles, with a

rechargeable energy system used in business and for personal use. For vehicles with a

rechargeable energy system that provides five percent to less than 10 percent of the maximum

available power, the credit amount is $500; for a system that provides 10 percent to less than 20

percent of maximum available power the credit is $1,000; for a system that provides 20 percent to

less than 30 percent of maximum available power, the credit is $1,500; and for a system that

provides 30 percent or greater of maximum available power, the credit is $2,000. The credit

amount would be increased for qualified hybrid vehicles that also actively employ a regenerative

braking system that supplies energy to the rechargeable energy storage system. For a hybrid

vehicle with a regenerative braking system that provides 20 percent to less than 40 percent of the

energy available from braking in a typical 60 miles per hour to zero miles per hour breaking event,

the additional credit amount is $250, for 40 percent to less than 60 percent, the additional credit

would be $500, and for 60 percent or greater, the additional credit would be $1,000.

Effective Date

The credit would be available for a hybrid vehicle placed in service after December 31,

2003, and before January 1, 2005.
27

D. Additional Provisions Relating to Tax Incentives for Distressed Areas

1. Expand the zero-percent capital gains rate treatment for the District of Columbia

Present Law

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

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

percent as determined on the basis of the 1990 Census (sec. 1400B(d)).

Description of Proposal

The proposal would eliminate the 10-percent poverty rate limitation for purposes of the

zero-percent capital gains rate. Thus, the zero-percent capital gains rate would apply to capital

gains from the sale of qualifying business stock, partnership interests, and business property held

for more than five years attributable to qualifying businesses located in the District of Columbia.

Effective Date

The proposal would be effective for DC Zone business stock and partnership interests

originally issued after, and DC Zone business property originally acquired by the taxpayer after

December 31, 2000.

2. Conform the gross income test for D.C. zone business

Present Law

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

assets. In general, a “DC Zone asset” means stock or partnership interests held in, or tangible

property held by, a DC Zone business. A DC zone business generally refers to certain enterprise

zone businesses within the DC Zone, except that 80 percent of the total gross income of the entity

must be derived from the active conduct of the business (sec. 1400B(c)(2)).

Description of Proposal

The proposal would reduce the level of gross income needed to qualify as a D.C. zone

business to 50 percent.

Effective Date

The proposal would be effective for DC Zone business stock and partnership interests

originally issued after, and DC Zone business property originally acquired by the taxpayer after

December 31, 2000.
28

3. First-time D.C. homebuyer tax credit

Present Law

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, 2001.

Description of Proposal

The proposal would extend the first-time homebuyer credit for two years, through

December 31, 2003. The proposal also would extend the phase-out range for married individuals

filing a joint return so that it is twice that of individuals. Thus, under the proposal, the D.C.

homebuyer credit would be phased out for joint filers with adjusted gross income between

$140,000 and $180,000.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.

4. Mortgage financing for certain residences located in Presidentially declared disaster

areas

Present Law

Qualified mortgage bonds are private activity tax-exempt bonds issued by States and local

governments acting as conduits to provide mortgage loans to first-time home buyers who satisfy

specified income limits and who purchase homes that cost less than statutory maximums. The

income and purchase price limits are increased for homes purchased in economically distressed

areas, and a portion of loans made in such areas is exempt from some requirements.

Present law waives the three buyer targeting requirements for a portion of the loans made

with proceeds of a qualified mortgage bond issue if the loans are made to finance homes in

statutorily prescribed economically distressed areas. 

For bonds issued during 1997 and 1998, a special exception exempted loans made in

Presidentially declared disaster areas within two years of the declaration from the first-time

homebuyer limit. In addition, the more liberal income and purchase price rules applicable to
29

economically distressed areas applied to such loans. There was no requirement that the specially

treated loans be made to repair or replace housing damaged or destroyed by the disaster.

Description of Proposal

The proposal would reinstate, with modifications, the prior-law exception for certain

qualified mortgage bond financed loans in Presidentially declared disaster areas. First, the

proposal would: (1) allow loans for replacement housing without regard to the first-time

homebuyer requirement; and (2) increase the borrower income and house purchase price

requirements to those that apply in targeted areas of economic distress. Second, the proposal

would increase the per-borrower “home improvement loan” maximum from $15,000 to $100,000

and extend the more liberal borrower income limits for targeted areas to these loans. In both

cases, the exception would apply only to loans made during the two-year period after the area was

declared a qualified disaster area. A qualified disaster area would be defined as an area

determined by the President (1) to warrant assistance under the Robert T. Stafford Disaster Relief

and Emergency Assistance Act and (2) with respect to which the Federal share of disaster

payments exceeds 75 percent.

Effective Date

The proposal would be effective for bonds issued after December 31, 2000.

5. Exclusion from gross income for certain forgiven mortgage obligations

Present Law

Generally, gross income means all income from whatever source derived, including

income from the discharge of indebtedness. However, gross income does not include discharge of

indebtedness income if: (1) the discharge occurs in a Title 11case; (2) the discharge occurs when

the taxpayer is insolvent; (3) the indebtedness discharged is qualified farm indebtedness; or (4)

except in the case of a C corporation, the indebtedness discharged is qualified real property

business indebtedness. No exclusion provided for qualified residential indebtedness.

Description of Proposal

In the case of an individual taxpayer, the proposal would provide an exclusion from

discharge of indebtedness income to the extent such income is attributable to the sale of real

property securing qualified residential indebtedness. Qualified residential indebtedness would be

defined as indebtedness incurred or assumed by the taxpayer for the acquisition, construction,

reconstruction, or substantial improvement of the taxpayer’s residence and which is secured by

such residence. The taxpayer would elect to have this exclusion apply. The exclusion would not

apply to qualified farm indebtedness or qualified real property business indebtedness.
30

Effective Date

The proposal would be effective for discharges of indebtedness after the date of enactment.

6. Extend and modify Puerto Rico economic-activity tax credit

Present Law

The Small Business Job Protection Act of 1996 generally repealed the Puerto Rico and

possession tax credit. However, certain domestic corporations that had active business operations

in Puerto Rico or another U.S. possession on October 13, 1995, may continue to claim credits

under section 936 or section 30A for a 10-year transition period. Such credits apply to possession

business income, which is derived from the active conduct of a trade or business within a U.S.

possession or from the sale or exchange of substantially all of the assets that were used in such a

trade or business. In contrast to the foreign tax credit, the Puerto Rico and possession tax credit is

granted whether or not the corporation pays income tax to the possession.

One of two alternative limitations is applicable to the amount of the credit attributable to

possession business income. Under the economic activity limit, the amount of the credit with

respect to such income cannot exceed the sum of a portion of the taxpayer's wage and fringe benefit

expenses and depreciation allowances (plus, in certain cases, possession income taxes); beginning

in 2002, the income eligible for the credit computed under this limit generally is subject to a cap

based on the corporation's pre-1996 possession business income adjusted for inflation. Under the

alternative limit, the amount of the credit is limited to the applicable percentage (40 percent for

1998 and thereafter) of the credit that would otherwise be allowable with respect to possession

business income; beginning in 1998, the income eligible for the credit computed under this limit

generally is subject to a cap based on the corporation's pre-1996 possession business income.

Special rules apply in computing the credit with respect to operations in Guam, American Samoa,

and the Commonwealth of the Northern Mariana Islands. The credit expires for taxable years

beginning after December 31, 2005.

Description of Proposal

The proposal would modify the credit computed under the economic activity limit with

respect to operations in Puerto Rico only. First, the proposal would expand the lines of business

eligible under the credit to include existing credit claimants that establish new lines of business in

Puerto Rico after December 31, 2000, and before January 1, 2005. These “new opportunity

credit” claimants would be eligible to claim credits in taxable years beginning before January 1,

2006. In addition, income eligible for the credit computed under the economic activity limitation

would not be subject to the present-law income limitation. Also, these “new opportunity credit”

claimants would be required to calculate their credit in each taxable year, but claim that amount of

credit over a five-year period (on a pro-rata basis) beginning the year in which the credit is

earned.
31

In addition, for taxpayers eligible to claim the credit under present law (“existing credit

claimants”), the present-law limitation on income eligible for the credit for any taxable year would

be increased by the ratio of the average number of full-time employees of taxpayer during the

taxable year to the average number of full-time employees of the taxpayer in 1995 and 1996.

Effective Date

The proposal would apply to taxable years beginning after December 31, 2000.

7. Provide tax exemption for organizations created by a State to provide property and

casualty insurance coverage for property for which such coverage is otherwise unavailable

Present Law

In general

A life insurance company is subject to tax on its life insurance company taxable income,

which is its life insurance income reduced by life insurance deductions (sec. 801). Similarly, a

property and casualty insurance company is subject to tax on its taxable income, which is

determined as the sum of its underwriting income and investment income (as well as gains and

other income items) (sec. 831). Present law provides that the term “corporation” includes an

insurance company (sec. 7701(a)(3)).

In general, the Internal Revenue Service (“IRS”) takes the position that organizations that

provide insurance for their members or other individuals are not considered to be engaged in a

tax-exempt activity. The IRS maintains that such insurance activity is either (1) a regular business

of a kind ordinarily carried on for profit, or (2) an economy or convenience in the conduct of

members' businesses because it relieves the members from obtaining insurance on an individual

basis.

Certain insurance risk pools have qualified for tax exemption under Code section

501(c)(6). In general, these organizations (1) assign any insurance policies and administrative

functions to their member organizations (although they may reimburse their members for amounts

paid and expenses); (2) serve an important common business interest of their members; and (3)

must be membership organizations financed, at least in part, by membership dues.

State insurance risk pools may also qualify for tax exempt status under section 501(c)(4) as

a social welfare organization or under section 115 as serving an essential governmental function of

a State. In seeking qualification under section 501(c)(4), insurance organizations generally are

constrained by the restrictions on the provision of “commercial-type insurance” contained in

section 501(m). Section 115 generally provides that gross income does not include income derived

from the exercise of any essential governmental function or accruing to a State or any political

subdivision thereof.
32

Certain specific provisions provide tax-exempt status to organizations meeting statutory

requirements.

Health coverage for high-risk individuals

Section 501(c)(26) provides tax-exempt status to any membership organization that is

established by a State exclusively to provide coverage for medical care on a nonprofit basis to

certain high-risk individuals, provided certain criteria are satisfied.

Workers' compensation reinsurance organizations

Section 501(c)(27)(A) provides tax-exempt status to any membership organization that is

established by a State before June 1, 1996, exclusively to reimburse its members for workers'

compensation insurance losses, and that satisfies certain other conditions.

State workmen’s compensation act companies

Section 501(c)(27)(B) provides tax-exempt status for any organization that is created by

State law, and organized and operated exclusively to provide workmen's compensation insurance

and related coverage that is incidental to workmen's compensation insurance, and that meets

certain requirements.

Description of Proposal

The proposal would provide tax-exempt status for any association created before January

1, 1999, by State law and organized and operated exclusively to provide property and casualty

insurance coverage for property located within the State for which the State has determined that

coverage in the authorized insurance market is limited or unavailable at reasonable rates, provided

certain requirements are met.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
12 The financial institution would be required to adjust tax deposits to take into account

forfeitures of matching contributions.

33

E. Miscellaneous Provisions

1. Creation of Individual Development Accounts

Present Law

There are no tax benefits to encourage financial institutions to match savings of lowincome individuals.

Description of Proposal

The proposal would create individual development accounts (“IDA”s) to which eligible

individuals could contribute up to $2,000 annually. Contributions to IDAs by eligible individuals

would not be deductible, and earnings on such contributions would be currently includible in

income. An eligible individual would be an individual who is: (1) at least 18 years of age; (2) a

citizen or legal resident of the United States; and (3) a member of a household with family gross

income of 60 percent or less of national median gross income and a net worth not to exceed

$10,000. In addition, the proposal would provide a maximum annual tax credit of $270 (90

percent of $300) for certain matching contributions made to an IDA by the financial institution

maintaining the IDA. An additional $100 tax credit would be allowed for each account opened. 

The credits could be claimed by the financial institution or its legal affiliate. Matching

contributions (and earnings thereon) would not be includible in the gross income of the eligible

individual. If an individual withdraws his or her own IDA contributions (or earnings thereon) for

a purpose other than a qualified purpose, the matching contribution attributable to such individual

contribution would be forfeited.12 Matching contributions could be withdrawn only for the

following qualified purposes: (1) certain educational expenses, (2) first-time homebuyer expenses, 

(3) business start-up or expansion expenses, and (4) qualified rollovers. Any amounts in the IDA

would not be taken into account for certain Federal means-tested programs.

Effective Date

The proposal would be effective for contributions to IDAs and matching contributions

made with respect to such IDAs after December 31, 2001, and before January 1, 2006.

2. Enhanced deduction for corporate contributions of computers

Present Law

The maximum charitable contribution deduction that may be claimed by a corporation for

any one taxable year is limited to 10 percent of the corporation's taxable income for that year

(disregarding charitable contributions and with certain other modifications) (sec. 170(b)(2)). 
34

Corporations also are subject to certain limitations based on the type of property contributed. In

the case of a charitable contribution of short-term gain property, inventory, or other ordinary

income property, the amount of the deduction generally is limited to the taxpayer's basis (generally,

cost) in the property. However, special rules in the Code provide an augmented deduction for

certain corporate contributions. Under these special rules, the amount of the augmented deduction

is equal to the lesser of (1) the basis of the donated property plus one-half of the amount of

ordinary income that would have been realized if the property had been sold, or (2) twice the basis

of the donated property.

Section 170(e)(6) allows corporate taxpayers an augmented deduction for qualified

contributions of computer technology and equipment (i.e., computer software, computer or

peripheral equipment, and fiber optic cable related to computer use) to be used within the United

States for educational purposes in grades K-12. Eligible donees are: (1) any educational

organization that normally maintains a regular faculty and curriculum and has a regularly enrolled

body of pupils in attendance at the place where its educational activities are regularly carried on;

and (2) tax-exempt charitable organizations that are organized primarily for purposes of supporting

elementary and secondary education. A private foundation also is an eligible donee, provided

that, within 30 days after receipt of the contribution, the private foundation contributes the property

to an eligible donee described above.

Qualified contributions are limited to gifts made no later than two years after the date the

taxpayer acquired or substantially completed the construction of the donated property. In addition,

the original use of the donated property must commence with the donor or the donee. Accordingly,

qualified contributions generally are limited to property that is no more than two years old. Such

donated property could be computer technology or equipment that is inventory or depreciable trade

or business property in the hands of the donor.

Donee organizations are not permitted to transfer the donated property for money or

services (e.g., a donee organization cannot sell the computers). However, a donee organization

may transfer the donated property in furtherance of its exempt purposes and be reimbursed for

shipping, installation, and transfer costs. For example, if a corporation contributes computers to a

charity that subsequently distributes the computers to several elementary schools in a given area,

the charity could be reimbursed by the elementary schools for shipping, transfer, and installation

costs.

The special treatment applies only to donations made by C corporations. S corporations,

personal holding companies, and service organizations are not eligible donors.

The provision is scheduled to expire for contributions made in taxable years beginning

after December 31, 2000.
35

Description of Proposal

The proposal would extend the current enhanced deduction for donations of computer

technology and equipment through December 31, 2003. In addition, the enhanced deduction would

be expanded to include donations to public libraries.

Effective date

The proposal would be effective for contributions made upon the date of enactment.

3. Limitation on use of non-accrual experience method of accounting

Present Law

An accrual method taxpayer generally must recognize income when all the events have

occurred that fix the right to receive the income and the amount of the income can be determined

with reasonable accuracy. An accrual method taxpayer may deduct the amount of any receivable

that was previously included in income that becomes worthless during the year.

Accrual method taxpayers are not required to include in income amounts to be received for

the performance of services which, on the basis of experience, will not be collected (the “nonaccrual experience method”). The availability of this method is conditioned on the taxpayer not

charging interest or a penalty for failure to timely pay the amount charged.

A cash method taxpayer is not required to include an amount in income until it is received. 

A taxpayer generally may not use the cash method if purchase, production, or sale of merchandise

is an income producing factor. Such taxpayers generally are required to keep inventories and use

an accrual method of accounting. In addition, corporations (and partnerships with corporate

partners) generally may not use the cash method of accounting if their average annual gross

receipts exceed $5 million. An exception to this $5 million rule is provided for qualified

personal service corporations. A qualified personal service corporation is a corporation (1)

substantially all of whose activities involve the performance of services in the fields of health,

law, engineering, architecture, accounting, actuarial science, performing arts or consulting and (2)

substantially all of the stock of which is owned by current or former employees performing such

services, their estates or heirs. Qualified personal service corporations are allowed to use the

cash method without regard to whether their average annual gross receipts exceed $5 million.

Description of Proposal

The proposal would provide that the non-accrual experience method of accounting will be

available only for amounts received for the performance of qualified personal services. Amounts

to be received for all other services will be subject to the general rule regarding inclusion of

income. Qualified personal services are personal services in the fields of health, law,

engineering, architecture, accounting, actuarial science, performing arts or consulting.
36

As under present law, the availability of this method is conditioned on the taxpayer not

charging interest or a penalty for failure to timely pay the amount charged.

Effective Date

The proposal would be effective for taxable years ending after date of enactment. Any

change in the taxpayer’s method of accounting necessitated as a result of the proposal would be

treated as a voluntary change initiated by the taxpayer with the consent of the Secretary of the

Treasury. Any required section 481(a) adjustment is to be taken into account over a period not to

exceed four years under principles consistent with those in Rev. Proc. 98-60.

4. Charitable contribution deduction for certain expenses in support of native Alaskan

subsistence whaling

Present Law

In computing taxable income, individuals who do not elect the standard deduction may

claim itemized deductions, including a deduction (subject to certain limitations) for charitable

contributions or gifts made during the taxable year to a qualified charitable organization or

governmental entity (sec. 170). Individuals who elect the standard deduction may not claim a

deduction for charitable contributions made during the taxable year.

No charitable contribution deduction is allowed for a contribution of services. However,

unreimbursed expenditures made incident to the rendition of services to an organization,

contributions to which are deductible, may constitute a deductible contribution (Treas. Reg. sec.

1.170A-1(g)). Specifically, section 170(j) provides that no charitable contribution deduction is

allowed for traveling expenses (including amounts expended for meals and lodging) while away

from home, whether paid directly or by reimbursement, unless there is no significant element of

personal pleasure, recreation, or vacation in such travel.

Description of Proposal

The proposal would allow individuals to claim a deduction under section 170 not

exceeding $7,500 per taxable year for certain expenses incurred in carrying out sanctioned

whaling activities. The deduction would be available only to an individual who is recognized by

the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of

maintaining and carrying out sanctioned whaling activities. The deduction would be available for

reasonable and necessary expenses paid by the taxpayer during the taxable year for (1) the

acquisition and maintenance of whaling boats, weapons, and gear used in sanctioned whaling

activities, (2) the supplying of food for the crew and other provisions for carrying out such

activities, and (3) storage and distribution of the catch from such activities.
37

For purposes of the provision, the term "sanctioned whaling activities" would mean

subsistence bowhead whale hunting activities conducted pursuant to the management plan of the

Alaska Eskimo Whaling Commission.

Effective Date

The proposal would be effective for taxable years ending after December 31, 2000.

5. Extension of the adoption tax credit

Present Law

Taxpayers are entitled to a maximum nonrefundable credit against income tax liability of

$5,000 per child for qualified adoption expenses paid or incurred by the taxpayer (sec. 23). In the

case of a special needs adoption, the maximum credit amount is $6,000 ($5,000 in the case of a

foreign special needs adoption). A special needs child is a child who the State has determined: (1)

cannot or should not be returned to the home of the birth parents, and (2) has a specific factor or

condition because of which the child cannot be placed with adoptive parents without adoption

assistance. The adoption of a child who is not a citizen or a resident of the United States is a

foreign adoption.

Qualified adoption expenses are reasonable and necessary adoption fees, court costs,

attorneys' fees, and other expenses that are directly related to the legal adoption of an eligible

child. All reasonable and necessary expenses required by a State as a condition of adoption are

qualified adoption expenses. Otherwise qualified adoption expenses paid or incurred in one

taxable year are not taken into account for purposes of the credit until the next taxable year unless

the expenses are paid or incurred in the year the adoption becomes final.

An eligible child is an individual (1) who has not attained age 18 or (2) who is physically

or mentally incapable of caring for himself or herself. After December 31, 2001, the credit will

be available only for domestic special needs adoptions.

No credit is allowed for expenses incurred (1) in violation of State or Federal law, (2) in

carrying out any surrogate parenting arrangement, (3) in connection with the adoption of a child of

the taxpayer's spouse, (4) that are reimbursed under an employer adoption assistance program or

otherwise, or (5) for a foreign adoption that is not finalized.

The credit is phased out ratably for taxpayers with modified AGI above $75,000, and is

fully phased out at $115,000 of modified AGI. For these purposes modified AGI is computed by

increasing the taxpayer's AGI by the amount otherwise excluded from gross income under Code

sections 911, 931, or 933.
38

Description of Proposal

The proposal would extend the adoption credit for the adoption of non-special needs

children through December 31, 2003.

Effective Date

The proposal would be effective on the date of enactment.

6. Repeal of section 1706 of the Tax Reform Act of 1986

Present Law

Under present law, determination of whether a worker is an employee or independent

contractor is generally made under a common-law test. Section 530 of the Revenue Act of 1978

provides safe harbors under which a service recipient may treat a worker as an independent

contractor for employment tax purposes (regardless of their status under the common-law test) if

certain requirements are satisfied. One of the requirements of safe-harbor relief under section 530

is that the taxpayer (or a predecessor) must not have treated any worker holding a substantially

similar position as an employee for purposes of employment taxes for any period after 1977. In

determining whether workers hold substantially similar positions, one of the factors that is to be

taken into account is the relationship of the parties, including the degree of supervision and control

of the worker by the taxpayer.

Under section 1706 of the Tax Reform Act of 1986, section 530 safe-harbor relief does not

apply to certain technical services personnel.

Description of Proposal

The proposal would repeal section 1706 of the Tax Reform Act of 1986. Thus, section

530 safe-harbor relief would be available with respect to workers covered by section 1706, if the

requirements of the safe harbor are otherwise satisfied. The proposal would not repeal the

consistency requirement with respect to workers covered by section 1706.

Effective Date

The proposal would be effective for periods beginning after the date of enactment.

7. Treatment of purchase of structured settlements

Present Law

Present law provides tax-favored treatment for structured settlement arrangements for the

payment of damages on account of personal injury or sickness.
39

Under present law, an exclusion from gross income is provided for amounts received for

agreeing to a qualified assignment to the extent that the amount received does not exceed the

aggregate cost of any qualified funding asset (sec. 130). A qualified assignment means any

assignment of a liability to make periodic payments as damages (whether by suit or agreement) on

account of a personal injury or sickness (in a case involving physical injury or physical sickness),

provided the liability is assumed from a person who is a party to the suit or agreement, and the

terms of the assignment satisfy certain requirements. Generally, these requirements are that (1) the

periodic payments are fixed as to amount and time; (2) the payments cannot be accelerated,

deferred, increased, or decreased by the recipient; (3) the assignee's obligation is no greater than

that of the assignor; and (4) the payments are excludable by the recipient under section 104(a)(2)

as damages on account of personal injuries or sickness.

A qualified funding asset means an annuity contract issued by an insurance company

licensed in the U.S., or any obligation of the United States, provided the annuity contract or

obligation meets statutory requirements. An annuity that is a qualified funding asset is not subject

to the rule requiring current inclusion of the income on the contract which generally applies to

annuity contract holders that are not natural persons (e.g., corporations) (sec. 72(u)(3)(C)). In

addition, when the payments on the annuity are received by the structured settlement company and

included in income, the company generally may deduct the corresponding payments to the injured

person, who, in turn, excludes the payments from his or her income (sec. 104). Thus, neither the

amount received for agreeing to the qualified assignment of the liability to pay damages, nor the

income on the annuity that funds the liability to pay damages, generally is subject to tax.

The exclusion for recipients of the periodic payments received under a structured

settlement arrangement as damages for personal physical injuries or physical sickness can be

contrasted with the treatment of investment earnings that are not paid as damages. If a recipient of

damages chooses to receive a lump sum payment (excludable from income under sec. 104), and

then to invest it himself, generally the earnings on the investment are includible in income. For

example, if the recipient uses the lump sum to purchase an annuity contract providing for periodic

payments, then a portion of each payment under the annuity contract is includible in income, and

the balance is excludable under present-law rules based on the ratio of the individual’s investment

in the contract to the expected return on the contract (sec. 72(b)).

Present law provides that the payments to the injured person under the qualified assignment

cannot be accelerated, deferred, increased, or decreased by the recipient. Consistent with these

requirements, it is understood that contracts under structured settlement arrangements generally

contain anti-assignment clauses. It is understood, however, that injured persons may nonetheless be

willing to accept discounted lump sum payments from certain “factoring” companies in exchange

for their payment streams. The tax effect on the parties of these transactions may not be completely

clear under present law.

Description of Proposal

The proposal generally would impose an excise tax on any person acquiring a payment

stream under a structured settlement arrangement. The amount of the excise tax would be 40
40

percent of the excess of (1) the undiscounted amount of the payment stream acquired, over (2) the

total amount actually paid.

The 40 percent excise tax would not apply, however, if the transfer is approved in advance

in a final court order (or order of the responsible administrative authority) that finds: (1) that the

transaction does not contravene any Federal or State statute or the order of any court or

responsible administrative authority; and (2) is in the best interest of the payee, taking into account

the welfare and support of the payee’s dependents. Rules would be provided for determining the

applicable State statute.

The proposal would also provide that the acquisition transaction does not affect the

application of certain present-law rules, if those rules were satisfied at the time the structured

settlement was entered into. The rules are section 130 (relating to an exclusion from gross income

for personal injury liability assignments), section 72 (relating to annuities), sections 104(a)(1) and

(2) (relating to an exclusion for amounts received under workers’ compensation acts and for

damages on account of personal physical injuries or physical sickness), and section 461(h)

(relating to the time of economic performance in determining the taxable year of a deduction).

Effective Date

The proposal would generally be effective for acquisition transactions entered into on or

after 30 days following enactment. A transition rule would apply during the period from that date

to July 1, 2002. If no applicable State law (relating to the best interest of the payee) applies to a

transfer during that period, then the exception from the 40 percent excise tax is available without

the otherwise required court (or administrative) order, provided certain disclosure requirements

are met. The person acquiring the structured settlement payments would be required to disclose in

advance to the payee: (1) the amounts and due dates of the payments to be transferred; (2) the

aggregate amount to be transferred; (3) the consideration to be received by the payee; (4) dis

discounted present value of the transferred payments; and (5) the expenses to be paid by the payee

or deducted from the payee’s proceeds.

The provision providing that the acquisition transaction does not affect the application of

certain present-law rules would be effective for transactions entered into before, on, or after the

30th day following enactment.

8. Modify personal holding company “lending or finance business” exception

Present Law

Personal holding companies (PHC’s) are subject to a 39.6 percent tax on undistributed

PHC income. This tax can be avoided by distributing the income to shareholders, who then pay

shareholder level tax. PHC’s are closely held companies with at least 60 percent “personal

holding company income” (PHCI). This is generally passive income, including interest,

dividends, and rents. Certain rent is excluded from the definition, if rent is at least 50 percent of
41

the adjusted ordinary gross income of the company and other undistributed PHCI does not exceed

10 percent of the adjusted ordinary gross income.

In the case of a group of corporations filing a consolidated return, with certain exceptions,

the application of the PHC tax to the group and any member thereof is generally determined on the

basis of consolidated income and consolidated PHCI. If any member of the group is excluded

from the definition of a PHC under certain provisions (including one for certain lending or finance

businesses), then each other member of the group is tested separately for PHC status.

A special rule of present law excludes a lending or finance business from the definition of

a PHC if certain requirements are met. At least 60 percent of its income must come from the active

conduct of a lending or finance business, and no more than 20 percent of its adjusted gross income

may be from certain other PHCI. A lending or finance business does not include a business of

making loans longer than 144 months (12 years). Also, the deductions attributable to this active

lending or finance business (but not including interest expense) must be at least 5 percent of

income over $500,000 (plus 15 percent of income under that amount). 

Description of Proposal

The proposal would modify the personal holding company exclusion for lending or finance

companies to provide that, in determining whether a member of an affiliated group (as defined in

section 1504(a)(1)) filing a consolidated return is a lending or finance company, only corporations

engaged in a lending or finance business would be taken into account, and all such companies

would be aggregated for purposes of this determination. The effect of this rule would be to treat a

corporation as a lending or finance company if all companies engaged in a lending or finance

business in the affiliated group, in the aggregate, satisfy the requirements of the exclusion.

The proposal would also repeal the business expense requirement and the limitation on the

maturity of loans made by a lending or finance business.

The proposal would also broaden the definition of a lending or finance business to include

providing financial or investment advisory services, as well as engaging in leasing, including

entering into leases and/or purchasing, servicing, and/or disposing of leases and leased assets.

Rents that are not derived from the active and regular conduct of a lending or finance

business would continue to be treated under the present law personal holding company income

rules.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
42

9. Additional funding for empowerment zones and enterprise communities

The proposal would provide a one-time grant in fiscal year 2001 of $5,000,000 for each of

the 15 urban empowerment zones designated pursuant to the Taxpayer Relief Act of 1997, and

$2,000,000 for each of the 5 rural empowerment zones designated pursuant to the Taxpayer Relief

Act of 1997.

The proposal also would provide a one-time grant $250,000 for each of the remaining

Round I enterprise communities (i.e., those that have not become empowerment zones).

10. Funding for Social Service Block Grant

The proposal would amend Section 203(c) of Title XX of the Social Security Act and

provide an additional one-time amount of $700,000,000 for fiscal year 2001.