69–010 

Calendar No. 446 

110TH CONGRESS REPORT " ! SENATE 1st Session 110–206 

HEARTLAND, HABITAT, HARVEST, AND HORTICULTURE 

ACT OF 2007 

OCTOBER 25, 2007.—Ordered to be printed 

Mr. BAUCUS, from the Committee on Finance, 

submitted the following 

R E P O R T 

[To accompany S. 2242] 

The Committee on Finance, having considered an original bill (S. 

2242) to amend the Trade Act of 1974 to establish supplemental 

agricultural disaster assistance and to amend the Internal Revenue 

Code of 1986 to provide tax incentives for conservation and alternative energy sources and to provide tax relief for farmers, and for 

other purposes, reports favorably thereon and recommends that the 

bill do pass. 

CONTENTS 

Page 

I. LEGISLATIVE BACKGROUND ..................................................................... 3 

II. EXPLANATION OF THE BILL ...................................................................... 3 

TITLE I—SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE AGRICULTURE DISASTER RELIEF TRUST 

FUND ............................................................................................................. 3 

A. Crop Disaster Assistance Program and Other Disaster Assistance 3 

TITLE II—CONSERVATION PROVISIONS ................................................. 8 

A. Provide Tax Credit for Eligible Farmland Enrolled in the Conservation Reserve Program (sec. 201 of the bill and sec. 30D 

of the Code) ......................................................................................... 8 

B. Exclusion of Conservation Reserve Program Payments From 

SECA Tax for Individuals Receiving Social Security Retirement 

or Disability Payments (sec. 202 of the bill and sec. 1402(a) 

of the Code) ......................................................................................... 9 

C. Make Permanent the Special Rule Encouraging Contributions of 

Capital Gain Real Property for Conservation Purposes (sec. 203 

of the bill and sec. 170 of the Code) ................................................. 9 

D. Provide Tax Credit for Recovery and Restoration of Endangered 

Species (sec. 204 of the bill and new sec. 30D of the Code) ............ 13 

E. Deduction for Endangered Species Recovery Expenditures (sec. 

205 of the bill and sec. 175 of the Code) .......................................... 17 


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F. Provide Exclusion for Certain Payments and Programs Relating 

to Fish and Wildlife (sec. 206 of the bill and sec. 126 of the 

Code) ................................................................................................... 19 

G. Provide Tax Credit for Easements Made Pursuant to Certain 

U.S.D.A. Conservation Programs (sec. 207 of the bill and sec. 

30F of the Code) ................................................................................. 21 

H. Provide for Exempt Facility Bonds for Forest Conservation Activities (sec. 208 of the bill and sec. 142 of the Code) ........................... 23 

I. Deduction for Qualified Timber Gain and Timber REIT Provisions 

(secs. 209–214 of the bill and new sec. 1203, and secs. 856, 

857 and 4981 of the Code) ................................................................. 28 

TITLE III—ENERGY PROVISIONS .............................................................. 33 

A. Credit for Residential and Business Wind Property (sec. 301 of 

the bill and secs. 25D and 48 of the Code) ....................................... 33 

B. Landowner Incentive to Encourage Electric Transmission BuildOut (sec. 302 of the bill and new sec. 139B of the Code) ................ 36 

C. Exception to Reduction of Renewable Electricity Credit (sec. 303 

of the bill and sec. 45 of the Code) ................................................... 37 

D. Expansion of Special Depreciation Allowance to Cellulosic Biomass Alcohol Fuel Plant (sec. 311 of the bill and sec. 168(l) 

of the Code) ......................................................................................... 43 

E. Credit for Production of Cellulosic Biomass Alcohol (sec. 312 of 

the bill and sec. 40 of the Code) ........................................................ 44 

F. Extension of Small Ethanol Producer Credit (sec. 313 of the bill 

and sec. 40 of the Code) ..................................................................... 46 

G. Credit for Producers of Fossil-Free Alcohol (sec. 314 of the bill 

and sec. 40 of the Code) ..................................................................... 47 

H. Modification of Alcohol Credit (sec. 315 of the bill and secs. 40, 

6426 and 6427 of the Code) ............................................................... 48 

I. Calculation of Volume of Alcohol for Fuels Credits (sec. 316 of 

the bill, and sec. 40 of the Code) ....................................................... 50 

J. Ethanol Tariff Extension (sec. 317 of the bill) ................................... 50 

K. Elimination and Reductions of Duty Drawback on Certain Imported Ethanol (sec. 318 of the bill) .................................................. 51 

L. Extension of Credits for Biodiesel (sec. 321 of the bill and secs. 

40A, 6426 and 6427 of the Code) ...................................................... 52 

M. Extension and Modification of Renewable Diesel Incentives (sec. 

321 of the bill and sec. 40A(f), 6426 and 6427 of the Code) ........... 54 

N. Treatment of Qualified Alcohol Mixtures and Qualified Biodiesel 

Fuel Mixtures as Taxable Fuels (sec. 322 of the bill and sec. 

4083 of the Code) ................................................................................ 55 

O. Extension and Modification of the Alternative Fuel Credits (sec. 

331 of the bill and sec. 6426 and 6427 of the Code) ........................ 57 

P. Extension of Alternative Fuel Vehicle Refueling Property Credit 

(sec. 332 of the bill and sec. 30C of the Code) ................................. 59 

TITLE IV—AGRICULTURAL PROVISIONS ................................................ 60 

A. Qualified Small Issue Bonds for Farming (sec. 401 of the bill 

and sec. 147 of the Code) ................................................................... 60 

B. Modification of Installment Sale Rules for Certain Farm Property 

(sec. 402 of the bill and sec. 453 of the Code) .................................. 61 

C. Allowance of Section 1031 Treatment for Exchanges Involving 

Certain Mutual Ditch, Reservoir, or Irrigation Company Stock 

(sec. 403 of the bill and sec. 1031 of the Code) ................................ 62 

D. Rural Renaissance Bonds (sec. 404 of the bill and new sec. 54A 

of the Code) ......................................................................................... 63 

E. Agricultural Business Security Tax Credit (sec. 405 of the bill 

and sec. 45 of the Code) ..................................................................... 68 

F. Credit for Drug Safety and Effectiveness Testing for Minor Species (sec. 406 of the bill and new sec. 45P of the Code) .................. 69 

G. Farm Equipment Treated as Five-Year Property (sec. 407 of the 

bill and sec. 168 of the Code) ............................................................ 71 

H. Expensing of Broadband Internet Access Expenditures (sec. 408 

of the bill and new sec. 191 of the Code) ......................................... 72 

I. Credit for Energy Efficient Electric Motors (sec. 409 of the bill 

and new sec. 45Q of the Code) .......................................................... 75 

TITLE V—REVENUE RAISING PROVISIONS ............................................ 75 

A. Limitation on Farming Losses of Certain Taxpayers (sec. 501 

of the bill and sec. 461 of the Code) ................................................. 75 


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1The description of this provision was supplied by the Majority Staff of the Senate Finance 

Committee. 2For more information see the USDA FSA Ongoing Disaster Assistance Programs for Agricultural Producers Fact Sheet, January 2007 available at http://www.fsa.usda.gov/Internet/ 

FSA—File/ongdisasst07.pdf. 

B. Increase and Index Dollar Thresholds for Farm Optional Method 

and Nonfarm Optional Method for Computing Net Earnings from 

Self-Employment (sec. 502 of the bill and sec. 1402(a) of the 

Code) ................................................................................................... 76 

C. Information Reporting for Commodity Credit Corporation Transactions (sec. 503 of the bill and new sec. 6039J of the Code) ......... 79 

D. Modification of Section 1031 Treatment for Certain Real Estate 

(sec. 504 of the bill and sec. 1031 of the Code) ................................ 80 

E. Modification of Effective Date of Leasing Provisions of the American Jobs Creation Act of 2004 (sec. 505 of the bill and sec. 

470 of the Code) .................................................................................. 81 

F. Modifications to Corporate Estimated Tax Payments (sec. 506 of 

the bill) ................................................................................................ 82 

G. Ineligibility of Collectibles for Nontaxable Like Kind Exchange 

Treatment (sec. 507 of the bill and sec. 1031 of the Code) ............. 82 

H. Denial of Deduction for Certain Fines, Penalties, and Other 

Amounts (sec. 508 of the bill and sec. 162(f) and new sec. 6050W 

of the Code) ......................................................................................... 83 

I. Increase in Information Return Penalties (sec. 509 of the bill and 

secs. 6721, 6722, and 6723 of the Code) ........................................... 87 

J. Economic Substance Doctrine (secs. 511–513 of the bill and sec. 

7701, new sec. 6662B, and sec. 163 of the Code) ............................. 88 

1. Clarification of the economic substance doctrine ....................... 88 

2. Penalty for understatements attributable to transactions lacking economic substance, etc. ...................................................... 95 

3. Denial of deduction for interest on underpayments attributable 

to noneconomic substance transactions .................................... 101 

III. BUDGET EFFECTS OF THE BILL ............................................................... 102 

IV. VOTES OF THE COMMITTEE ...................................................................... 109 

V. REGULATORY IMPACT AND OTHER MATTERS ..................................... 109 

VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS REPORTED 110 

I. LEGISLATIVE BACKGROUND 

The Finance Committee has exclusive jurisdiction over tax matters and has previously held hearing and reported legislation that 

included some of the provisions in this legislation. The Committee 

anticipates that the Senate may consider adding the substance of 

this bill to H.R. 2419, the ‘‘Farm, Nutrition, and Bioenergy Act of 

2007,’’ or similar legislation. 

II. EXPLANATION OF THE BILL 

TITLE I—SUPPLEMENTAL AGRICULTURAL DISASTER ASSISTANCE FROM THE AGRICULTURE DISASTER RELIEF 

TRUST FUND 1

A. CROP DISASTER ASSISTANCE PROGRAM AND OTHER DISASTER

ASSISTANCE

PRESENT LAW

The Farm Service Agency (‘‘FSA’’) of the United States Department of Agriculture (‘‘USDA’’) offers various ongoing programs for 

agricultural producers to facilitate recovery from losses caused by 

natural events.2 Ongoing programs include the Emergency Conservation Program (‘‘ECP’’), the Noninsured Crop Disaster AssistVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00003 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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ance Program (‘‘NAP’’), the Disaster Debt Set-Aside Program 

(‘‘DSA’’), and the Emergency Loan Program (‘‘EM’’). 

ECP is a discretionary program funded through annual appropriations that provides funding for farmers and ranchers to rehabilitate farmland damaged by natural disaster and for carrying out 

emergency water conservation measures during severe drought. 

The natural disaster must create new conservation problems that 

if untreated would (1) impair or endanger the land; (2) materially 

affect the productive capacity of the land; (3) represent unusual 

damage which, except for wind erosion, is not the type likely to 

recur frequently in the same area; and (4) be so costly to repair 

that federal assistance is, or will be required, to return the land 

to productive agricultural use. 

NAP provides a low level of insurance to producers who grow 

otherwise noninsurable crops. NAP provides coverage for crop 

losses and planting prevented by disasters. Landowners, tenants, 

or sharecroppers who share in the risk of producing an eligible crop 

may qualify for this program. Before payments can be issued, applications must first be received and approved, generally before the 

crop is planted, and the crop must have suffered a minimum of 50 

percent loss in yield. Payments are 55 percent of the commodities’

average market price on crop losses beyond 50 percent. Eligible 

crops include commercial crops and other agricultural commodities 

produced for food, including livestock feed or fiber for which the 

catastrophic level of crop insurance is unavailable. Also eligible for 

NAP coverage are controlled-environment crops (mushroom and floriculture), specialty crops (honey and maple sap), and value loss 

crops (aquaculture, Christmas trees, ginseng, ornamental nursery, 

and turfgrass sod). 

DSA is available to those producers who are borrowers from the 

Farm Service Agency in primary or contiguous counties that have 

been declared by the President or designated by the Secretary of 

Agriculture (‘‘Secretary’’) as a disaster area. When borrowers affected by natural disasters are unable to make their scheduled payments on any debt, FSA is authorized to consider the set-aside of 

some payments to allow the farming operation to continue. After a 

disaster designation is made, FSA will notify borrowers of the 

availability of the DSA. Borrowers who are notified have eight 

months from the date of designation to apply. FSA borrowers may 

also request a release of income proceeds to meet current operating 

and family living expenses or may request special servicing provisions from their local FSA county offices to explore other options. 

EM provides emergency loans to help producers recover from production and physical losses due to drought, flooding, other natural 

disasters, or quarantine. Emergency loans may be made to farmers 

and ranchers who own or operate land located in a county declared 

by the President as a disaster area or designated by the Secretary 

as a disaster area or quarantine area (for physical losses only, the 

FSA administrator may authorize emergency loan assistance). EM 

funds may be used to: (1) restore or replace essential property; (2) 

pay all or part of production costs associated with the disaster 

year; (3) pay essential family expenses; (4) reorganize the farming 

operation; and (5) refinance certain debts. 


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REASONS FOR CHANGE

Farmers and ranchers can wait years to receive assistance from 

Congress when faced with a weather-related disaster such as 

drought, floods or severe storms. The Committee believes that a 

supplemental agricultural disaster assistance program is appropriate to ensure that farmers have a dependable and timely safety 

net when disasters strike. The Supplemental Agriculture Disaster 

Assistance program creates a trust fund that will cover losses not 

covered by crop insurance. To receive benefits from the trust fund, 

farmers and ranchers must: (1) carry crop insurance; and (2) be located in a Secretarially declared disaster county or a contiguous 

county, or show proof of an individual loss of at least 50%. Farmers 

carrying higher levels of insurance will be eligible for higher payments. Each farmer or rancher applying for supplemental disaster 

assistance must show that whole farm income from crop production 

declined due to the loss of a particular crop due to natural disasters. The Committee believes that these additional accountability 

measures will encourage farmers to participate in crop insurance 

programs, and will target assistance to those farmers and ranchers 

with the greatest need. The Committee believes that Supplemental 

Disaster Assistance program will be particularly useful to beginning farmers and ranchers who cannot afford to wait years for disaster assistance and do not have the equity to handle large scale 

crop losses due to natural disasters. 

The Committee believes that the creation of a trust fund, funded 

through an allocation of tariff revenues, is the appropriate mechanism to support this program. An amount equal to 3.34% of revenues from all tariffs will be transferred to the trust fund through 

December 31, 2012. Payments from the trust fund could begin in 

crop year 2008. The creation of the trust fund was modeled after 

Section 32 of the Act of August 24, 1935 (7 U.S.C. 612c), which sets 

aside a percentage of tariff revenues for nutrition and other programs that broadly benefit all sectors of U.S. agriculture. 

EXPLANATION OF PROVISION

In general 

The provision amends the Trade Act of 1974 to create an Agriculture Disaster Relief Trust Fund (‘‘ADTF’’) that would provide 

payments to farmers and ranchers who suffer losses in areas that 

are declared disaster areas by the USDA. The trust fund will be 

funded by an amount equal to 3.34 percent of the amounts received 

in the general fund of the Treasury that are attributable to the duties collected on articles entered, or withdrawn from warehouse, for 

consumption under the Harmonized Tariff Schedule. The ADTF 

could make payments under four new disaster assistance programs: the crop disaster assistance program, the livestock indemnity program, the tree assistance program, and the emergency assistance program for livestock, honey bees, and farm raised fish. In 

addition, the ADTF will also fund a new pest and disease management and disaster prevention program. Amounts not required to 

meet current withdrawals may be invested in U.S. Treasury obligations with interest credited to the ADTF. The ADTF may also borrow, with interest, as repayable advances sums necessary to carry 

out the purposes of the fund. 


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Crop Disaster Assistance Program (‘‘CDAP’’) 

Generally, CDAP payments will be paid to producers located in 

disaster counties on 52 percent of the difference between the disaster program guarantee and the sum of total farm revenue. Disaster counties include counties receiving disaster declarations by 

the Secretary due to production losses resulting directly or indirectly from adverse weather, counties contiguous to such counties, 

and any farm whose production due to weather was less than 50 

percent of normal production. To be eligible for CDAP payments, 

the producer must have purchased or enrolled in both crop insurance for insurable crops at a minimum of 50 percent of yield at 55 

percent of price and NAP for uninsurable crops. The Secretary may 

waive this requirement under certain conditions. 

The disaster program guarantee for insurable crops is equal to 

the product of a measure of crop yield, the percentage of crop insurance yield guarantee, the percentage of crop insurance price elected 

by the producer, the crop insurance price, and 115 percent. The disaster program guarantee for noninsured crops is equal to the product of the yield as determined by NAP for each crop, 100 percent 

of the NAP established price, and 115 percent. The disaster program guarantee is the sum of the disaster program guarantee for 

insurable and noninsured crops. 

Total farm revenue includes the sum of the estimated value of 

crops and grazing, crop insurance and NAP indemnities accruing to 

the farm, the value of prevented planting payments, the amount of 

other natural disaster assistance payments provided by the federal 

government to a farm for the same loss, and an amount equal to 

20 percent of any direct payments made to the producer under section 1103 of the Farm Security and Rural Investment Act of 2002. 

The estimated value of crops is generally the product of actual crop 

acreage grazed or harvested, estimated actual yields of grazing 

land or crop production, and the average market price during the 

first five months of the marketing year in which a farm or portion 

of a farm is located. 

Livestock Indemnity Program 

The ADTF may also make payments under the livestock indemnity program to eligible producers on farms that have incurred livestock death losses in excess of normal mortality rates during the 

calendar year due to adverse weather, as determined by the Secretary. Indemnity payments are made at a rate of 75 percent of the 

fair market value of the livestock on the day before the date of 

death of the livestock as determined by the Secretary. 

Tree Assistance Program 

The Secretary shall make payments to eligible orchardists as follows. Assistance is in the form of (1) 75 percent reimbursement for 

the cost of replanting trees lost due to a natural disaster if tree 

mortality is in excess of 15 percent, adjusted for normal mortality, 

or sufficient seedlings to reestablish a stand; and (2) 50 percent reimbursement of the cost of pruning, removal, and other costs incurred to salvage existing trees or to prepare land to replant trees 

lost due to a natural disaster in excess of 15 percent damage or 

mortality adjusted for normal tree damage and mortality. 


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3 7 U.S.C. sec. 1308–3a(a). 

Buy-up NAP Coverage 

Under NAP, FSA compensates eligible producers for losses of 

noninsurable crops exceeding 50 percent of the expected yield 

based on 55 percent of the average market price of the commodity. 

This provision permits producers to buy additional NAP coverage. 

Producers could purchase additional coverage guarantee up to 60 

or 65 percent, as elected by the producers, of expected yield, and 

up to 100 percent of the average market price of the commodity. 

Fees would be established and collected by the Secretary to fully 

offset the cost of supplemental NAP coverage. 

Emergency Assistance for livestock, honey bees, and farm-raised fish 

The Secretary shall use up to $35,000,000 annually from the 

trust fund to provide emergency relief to producers of livestock (including horses), honey bees, and farm-raised fish due to losses from 

adverse weather or other environmental conditions, such as blizzards and wildfires, as determined by the Secretary, that are not 

covered under the authority of the Secretary to make qualifying 

natural disaster declarations. For purposes of the provision, farmraised fish includes the propagation and rearing of aquatic species 

(including any species of finfish, mollusk, crustacean, or other 

aquatic invertebrate, amphibian, reptile, or aquatic plant) in controlled or semi-controlled environments. 

Limitations 

No eligible producer may receive more than $100,000 annually in 

total disaster assistance under this Act. A producer is not eligible 

for benefits under the provision if, as determined by the Secretary, 

such producer’s adjusted gross income (as defined in section 

1001D(a) of the Food Security Act of 1985 3 or any successor provision) exceeds $2.5 million, unless not less than 75 percent of the 

average adjusted gross income of such producer is derived from 

farming, ranching or forestry operations. 

Pest and Disease Management and Disaster Prevention 

The provision also establishes a new program under which USDA 

will conduct early pest detection and surveillance activities in coordination with State departments of agriculture, will prioritize 

and create action plans to address pest and disease threats to specialty crops, and will create an audit-based certification approach 

to protect against the spread of plant pests. 

Sunset of provision 

The authority provided by the provision shall be effective only for 

losses that are incurred as a result of a disaster, adverse weather, 

or another environmental condition that occurs on or before September 30, 2012, as determined by the Secretary. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 


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4The term ‘‘conservation reserve program’’ means the conservation reserve program established under subchapter B of chapter 1 of subtitle D of title XII of the Food Security Act of 1985. 

TITLE II—CONSERVATION PROVISIONS 

A. PROVIDE TAX CREDIT FOR ELIGIBLE FARMLAND ENROLLED IN THE

CONSERVATION RESERVE PROGRAM

(Sec. 201 of the bill and sec. 30D of the Code) 

PRESENT LAW

The Department of Agriculture administers various programs designed to encourage conservation. Under the conservation reserve 

program,4 eligible producers generally enter into contracts under 

which they agree to establish long-term, resource conserving covers 

on eligible farmland in exchange for annual contract payments. 

Present law does not provide an income tax credit for eligible 

farmland enrolled in the conservation reserve program. 

REASONS FOR CHANGE

The Committee believes additional incentives should be provided 

to encourage eligible producers to establish long-term, resource conserving covers on eligible farmland. 

DESCRIPTION OF PROVISION

In general, the provision establishes as a credit against income 

taxes the conservation reserve credit. The credit is elective, but a 

taxpayer may not claim the credit for a particular year if the taxpayer receives a contract payment from the Department of Agriculture pursuant to the conservation reserve program for such 

year. 

The conservation reserve credit requires the taxpayer to be an eligible producer on eligible farmland enrolled in the conservation reserve program. The credit is equal to the rental value of any such 

property enrolled in the program, as determined by the Secretary 

in consultation with the Secretary of Agriculture. The Secretary 

may not allocate more than $50,000 of conservation reserve credit 

to any one taxpayer for any fiscal year. The credit is not includable 

in the taxpayer’s gross income and is not subject to Self-Employment Contributions Act (SECA) tax. 

The credit allowed under the provision is taken into account after 

other credits (sections 21–27, 30, 30B, and 30C) and may not offset 

the alternative minimum tax. A taxpayer is not entitled to a deduction for any amount with respect to which a credit is allowed under 

the proposal. In the event a taxpayer terminates a conservation reserve program contract, the Secretary may recapture a portion of 

the credit corresponding to the portion of the taxable year during 

which the contract was not in effect. 

The provision establishes an annual conservation reserve credit 

limitation of $750 million for each of fiscal years 2009 through 

2012, which represents the total amount of credits that may be allocated under the program for all taxpayers for such years. 

Unallocated amounts with respect to any calendar year are carried 

forward to the allowable allocation for the next calendar year, except that no amount of conservation reserve credit may be allocated 


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5Sec. 1402. 

to any taxpayer after fiscal year 2012. The credit allowed under the 

provision may not exceed the excess of the amount allocated to the 

taxpayer by the Secretary of the Treasury, in consultation with the 

Secretary of Agriculture, for the taxable year and all prior taxable 

years over the credit allowed for all prior taxable years. 

EFFECTIVE DATE

The provision is effective on the date of enactment and applies 

with respect to conservation reserve program contracts entered into 

before, on, or after such date. 

B. EXCLUSION OF CONSERVATION RESERVE PROGRAM PAYMENTS

FROM SECA TAX FOR INDIVIDUALS RECEIVING SOCIAL SECURITY

RETIREMENT OR DISABILITY PAYMENTS

(Sec. 202 of the bill and sec. 1402(a) of the Code) 

PRESENT LAW

Generally, the Self-Employment Contributions Act (‘‘SECA’’) tax 

is imposed on an individual’s net earnings from self-employment 

income within the social security wage base. Net earnings from 

self-employment generally mean 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.5

REASONS FOR CHANGE

The Committee believes that the correct measurement of income 

for SECA purposes in the cases of retired or disabled individuals 

does not include conservation reserve program payments. 

EXPLANATION OF PROVISION

The provision excludes conservation reserve program payments 

from self-employment income for purpose of SECA tax in the case 

of individuals who are receiving social security retirement or disability benefits. The treatment of conservation reserve program 

payments received by other entities is not changed. 

EFFECTIVE DATE

The provision is effective for payments made after December 31, 

2007. 

C. MAKE PERMANENT THE SPECIAL RULE ENCOURAGING CONTRIBU- TIONS OF CAPITAL GAIN REAL PROPERTY FOR CONSERVATION PURPOSES

(Sec. 203 of the bill and sec. 170 of the Code) 

PRESENT LAW

Charitable contributions generally 

In general, a deduction is permitted for charitable contributions, 

subject to certain limitations that depend on the type of taxpayer, 

the property contributed, and the donee organization. The amount 


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6Secs. 170, 2055, and 2522, respectively. Unless otherwise provided, all section references are 

to the Internal Revenue Code of 1986, as amended (the ‘‘Code’’). 

of deduction generally equals the fair market value of the contributed property on the date of the contribution. Charitable deductions are provided for income, estate, and gift tax purposes.6

In general, in any taxable year, charitable contributions by a corporation are not deductible to the extent the aggregate contributions exceed 10 percent of the corporation’s taxable income computed without regard to net operating or capital loss carrybacks. 

For individuals, the amount deductible is a percentage of the taxpayer’s contribution base, which is the taxpayer’s adjusted gross income computed without regard to any net operating loss carryback. 

The applicable percentage of the contribution base varies depending on the type of donee organization and property contributed. 

Cash contributions of an individual taxpayer to public charities, 

private operating foundations, and certain types of private nonoperating foundations may not exceed 50 percent of the taxpayer’s 

contribution base. Cash contributions to private foundations and 

certain other organizations generally may be deducted up to 30 

percent of the taxpayer’s contribution base. 

In general, a charitable deduction is not allowed for income, estate, or gift tax purposes if the donor transfers an interest in property to a charity while also either retaining an interest in that 

property or transferring an interest in that property to a noncharity for less than full and adequate consideration. Exceptions to 

this general rule are provided for, among other interests, remainder interests in charitable remainder annuity trusts, charitable remainder unitrusts, and pooled income funds, present interests in 

the form of a guaranteed annuity or a fixed percentage of the annual value of the property, and qualified conservation contributions. 

Capital gain property 

Capital gain property means any capital asset or property used 

in the taxpayer’s trade or business the sale of which at its fair market value, at the time of contribution, would have resulted in gain 

that would have been long-term capital gain. Contributions of capital gain property to a qualified charity are deductible at fair market value within certain limitations. Contributions of capital gain 

property to charitable organizations described in section 

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

private non-operating foundations, and certain governmental units) 

generally are deductible up to 30 percent of the taxpayer’s contribution base. An individual may elect, however, to bring all these 

contributions of capital gain property for a taxable year within the 

50-percent limitation category by reducing the amount of the contribution deduction by the amount of the appreciation in the capital 

gain property. Contributions of capital gain property to charitable 

organizations described in section 170(b)(1)(B) (e.g., private non-operating foundations) are deductible up to 20 percent of the taxpayer’s contribution base. 

For purposes of determining whether a taxpayer’s aggregate 

charitable contributions in a taxable year exceed the applicable 

percentage limitation, contributions of capital gain property are 


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7Sec. 170(b)(1)(E). 

taken into account after other charitable contributions. Contributions of capital gain property that exceed the percentage limitation 

may be carried forward for five years. 

Qualified conservation contributions 

Qualified conservation contributions are not subject to the ‘‘partial interest’’ rule, which generally bars deductions for charitable 

contributions of partial interests in property. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. A qualified real property interest is defined as: (1) the entire 

interest of the donor other than a qualified mineral interest; (2) a 

remainder interest; or (3) a restriction (granted in perpetuity) on 

the use that may be made of the real property. Qualified organizations include certain governmental units, public charities that meet 

certain public support tests, and certain supporting organizations. 

Conservation purposes include: (1) the preservation of land areas 

for outdoor recreation by, or for the education of, the general public; (2) the protection of a relatively natural habitat of fish, wildlife, 

or plants, or similar ecosystem; (3) the preservation of open space 

(including farmland and forest land) where such preservation will 

yield a significant public benefit and is either for the scenic enjoyment of the general public or pursuant to a clearly delineated Federal, State, or local governmental conservation policy; and (4) the 

preservation of an historically important land area or a certified 

historic structure. 

Qualified conservation contributions of capital gain property are 

subject to the same limitations and carryover rules of other charitable contributions of capital gain property. 

Special rule regarding contributions of capital gain real property for 

conservation purposes 

In general 

Under a temporary provision that is effective for contributions 

made in taxable years beginning after December 31, 2005,7 the 30- 

percent contribution base limitation on contributions of capital gain 

property by individuals does not apply to qualified conservation 

contributions (as defined under present law). Instead, individuals 

may deduct the fair market value of any qualified conservation contribution to an organization described in section 170(b)(1)(A) to the 

extent of the excess of 50 percent of the contribution base over the 

amount of all other allowable charitable contributions. These contributions are not taken into account in determining the amount of 

other allowable charitable contributions. 

Individuals are allowed to carry over any qualified conservation 

contributions that exceed the 50-percent limitation for up to 15 

years. 

For example, assume an individual with a contribution base of $100 makes a qualified conservation contribution of property with 

a fair market value of $80 and makes other charitable contributions subject to the 50-percent limitation of $60. The individual is 

allowed a deduction of $50 in the current taxable year for the nonconservation contributions (50 percent of the $100 contribution 


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8Sec. 170(b)(2)(B). 

base) and is allowed to carry over the excess $10 for up to 5 years. 

No current deduction is allowed for the qualified conservation contribution, but the entire $80 qualified conservation contribution 

may be carried forward for up to 15 years. 

Farmers and ranchers 

In the case of an individual who is a qualified farmer or rancher 

for the taxable year in which the contribution is made, a qualified 

conservation contribution is allowable up to 100 percent of the excess of the taxpayer’s contribution base over the amount of all 

other allowable charitable contributions. 

In the above example, if the individual is a qualified farmer or 

rancher, in addition to the $50 deduction for non-conservation contributions, an additional $50 for the qualified conservation contribution is allowed and $30 may be carried forward for up to 15 

years as a contribution subject to the 100-percent limitation. 

In the case of a corporation (other than a publicly traded corporation) that is a qualified farmer or rancher for the taxable year in 

which the contribution is made, any qualified conservation contribution is allowable up to 100 percent of the excess of the corporation’s taxable income (as computed under section 170(b)(2)) 

over the amount of all other allowable charitable contributions. 

Any excess may be carried forward for up to 15 years as a contribution subject to the 100-percent limitation.8

As an additional condition of eligibility for the 100 percent limitation, with respect to any contribution of property in agriculture 

or livestock production, or that is available for such production, by 

a qualified farmer or rancher, the qualified real property interest 

must include a restriction that the property remain generally available for such production. (There is no requirement as to any specific use in agriculture or farming, or necessarily that the property 

be used for such purposes, merely that the property remain available for such purposes.) Such additional condition does not apply 

to contributions made on or before August 17, 2006. 

A qualified farmer or rancher means a taxpayer whose gross income from the trade or business of farming (within the meaning of 

section 2032A(e)(5)) is greater than 50 percent of the taxpayer’s 

gross income for the taxable year. 

Termination 

The special rule regarding contributions of capital gain real property for conservation purposes does not apply to contributions made 

in taxable years beginning after December 31, 2007. 

REASONS FOR CHANGE

Gifts of conservation easements to organizations that are dedicated to maintaining natural habitats, open spaces, or traditional 

agriculture help protect our nation’s heritage. The charitable tax 

deduction for such conservation easements has proven to be a valuable incentive for making such gifts. The Committee believes that 

the special rule that provides an increased incentive to make charitable contributions of partial interests in real property for conVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00012 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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servation purposes is an important way of encouraging conservation and preservation, and should be made permanent. 

EXPLANATION OF PROVISION

The provision makes permanent the special rule regarding contributions of capital gain real property for conservation purposes. 

EFFECTIVE DATE

The provision is effective for contributions made in taxable years 

beginning after December 31, 2007. 

D. PROVIDE TAX CREDIT FOR RECOVERY AND RESTORATION OF

ENDANGERED SPECIES

(Sec. 204 of the bill and new sec. 30D of the Code) 

PRESENT LAW

Present law does not provide an income tax credit for endangered 

species recovery expenditures. 

REASONS FOR CHANGE

The Endangered Species Act (‘‘ESA’’) of 1973 is a comprehensive 

attempt to protect species at risk of extinction and to consider habitat protection as an integral part of that effort. The purpose of the 

ESA is to conserve the ecosystems upon which endangered and 

threatened species depend and to conserve and recover listed species. Under the ESA, species of plants and animals (both vertebrate 

and invertebrate) may be listed as either endangered or threatened 

according to assessments of the risk of their extinction. 

As of September 20, 2007, according to the U.S. Fish and Wildlife 

Service (‘‘USFWS’’), a total of 607 species of animals and 744 species of plants had been listed as either endangered or threatened 

in the United States and its territories. According to the USFWS, 

over 70 percent of the nation’s landscape is in private ownership 

and nearly two-thirds of Federally listed endangered and threatened species are found on private lands. With such a large number 

of the country’s listed species dependent upon private lands for 

their survival, and many exclusively so, the goals of the ESA cannot be accomplished without the Federal government becoming involved to provide incentives for species protection on private lands. 

For both plants and animals, the ESA has very few provisions for 

restoration and managing habitats on private lands. Many important habitats require restoration and management because, among 

other things, they have been overrun by invasive species or have 

been deprived of fire and other natural processes. 

Although the ESA prohibits landowners from harming endangered or threatened species, the Act itself contains only a small 

number of incentives for landowners to undertake the beneficial 

management actions that most species require for recovery. In addition, while most private landowners care about their land and 

want to practice good stewardship, they often lack the time and resources to deal with complex regulations and necessary management activities. 

The Committee believes that tax credits for private landowners 

who undertake habitat protection and restoration for endangered 


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9See, e.g., Treas. Reg. sec. 1.170A–14(h)(3)(iii). 

species will provide some needed incentives to help recover threatened and endangered species. 

EXPLANATION OF PROVISION

In general 

For eligible taxpayers, the provision establishes a credit against 

income taxes for: (1) costs paid or incurred by an eligible taxpayer 

for the taxable year (reduced by the amount of government financing for conservation of a qualified species, and not including costs 

required by a Federal, State, or local government) pursuant to a 

habitat management plan entered into under certain qualified 

habitat protection agreements (‘‘habitat restoration credit’’) and (2) 

a percentage of the loss in value to real property attributable to an 

easement placed on the property pursuant to such agreements (less 

any amount received in connection with the easement) (‘‘habitat 

protection easement credit’’). The allowable credit amount is 100 

percent of costs paid or incurred and the loss in value to property 

pursuant to qualified perpetual habitat protection agreements; 75 

percent of costs paid or incurred and the loss in value to property 

pursuant to qualified 30-year habitat protection agreements; and 

50 percent of costs paid or incurred pursuant to a qualified habitat 

protection agreement. 

For purposes of the habitat protection easement credit, the loss 

in value is the difference between the fair market value of the real 

property subject to the agreement determined on the day before the 

agreement is entered into less the fair market value of such property determined one day after the agreement is entered into. To 

claim such credit, the eligible taxpayer must own the real property 

with respect to which the easement is placed, and include on the 

tax return for the taxable year a qualified appraisal (within the 

meaning of section 170(f)(11)(E)) of the real property. The taxpayer’s basis in such property is reduced by the amount of basis 

allocated to the easement under regulations prescribed by the Secretary.9

The habitat restoration credit is taken into account after other 

credits (sections 21–27, 30, 30B, 30C, and the habitat protection 

easement credit) and may not offset the alternative minimum tax. 

If such credit is allowed for any expenditure with respect to any 

property, the increase in the basis of such property that would otherwise result from such expenditure is reduced by the amount of 

the credit allowed. The habitat protection easement credit is taken 

into account after other credits (sections 21–27, 30, 30B, and 30C) 

and such credit may offset the alternative minimum tax. Amounts 

allowed but in excess of either limitation may be carried forward 

to the succeeding taxable year. No deduction is allowed for any 

amount with respect to which a credit is allowed. The Secretary of 

the Treasury shall by regulations provide for the recapture of the 

credit if such Secretary determines that the eligible taxpayer has 

failed to carry out the duties required by the qualified agreement 

and there are no other available means to remediate such failure. 

The sum of the two credits may not exceed the amount allocated 

to the eligible taxpayer for the calendar year in which the taxpayer’s taxable year ends by the Secretary of the Treasury, in conVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00014 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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sultation with the Secretary of the Interior and the Secretary of 

Commerce, or by the Secretary of the Treasury in consultation with 

the Secretary of Agriculture. If the amount allowed as a credit exceeds the amount allocated for such year, the excess may be carried 

forward to the next taxable year for which the taxpayer has received an allocation. If the amount allocated to a taxpayer for a calendar year exceeds the amount allowed as a credit for such year, 

the difference may be carried forward to the next taxable year and 

treated as allocated to the taxpayer for use in such year. No credit 

is allowed unless the appropriate Secretary certifies that a qualified agreement will contribute to the recovery of a qualified species. 

The aggregate amount allocated by the Secretary of the Treasury, in consultation with the Secretary of the Interior and the Secretary of Commerce may not exceed in each year 2008 through 

2012: $290,000,000 with respect to qualified perpetual habitat protection agreements, $55,000,000 with respect to qualified 30-year 

habitat protection agreements, and $35,000,000 with respect to 

qualified habitat protection agreements. The aggregate amount allocated by the Secretary of the Treasury, in consultation with the 

Secretary of Agriculture may not exceed in each year 2008 through 

2012: $5,000,000 with respect to qualified perpetual habitat protection agreements, $2,000,000 with respect to qualified 30-year habitat protection agreements, and $1,000,000 with respect to qualified 

habitat protection agreements. No allocation is allowed after 2012, 

except that unallocated amounts with respect to any calendar year 

are carried forward to the allowable allocation for the next calendar 

year. 

Not later than 180 days after the date of enactment, the Secretary of the Treasury, in consultation with the Secretary of the Interior and the Secretary of Commerce, shall by regulation establish 

a program to process applications from eligible taxpayers and to determine how best to allocate the credit. In allocating the credit, priority shall be given to taxpayers with agreements (1) relating to 

habitats that will significantly increase the likelihood of recovering 

and delisting a species as an endangered species or a threatened 

species (as defined under section 2 of the Endangered Species Act 

of 1973), (2) that are cost-effective and maximize the benefits to a 

qualified species per dollar expended, (3) relating to habitats of 

species that have a Federally approved recovery plan pursuant to 

section 4 of the Endangered Species Act of 1973, (4) relating to 

habitats with the potential to contribute significantly to the improvement of the status of a qualified species, (5) relating to habitats with the potential to contribute significantly to the eradication 

or control of invasive species that are imperiling a qualified species, 

(6) with habitat management plans that will manage multiple 

qualified species, (7) with habitat management plans that will create adjacent or proximate habitat for the recovery of a qualified 

species, (8) relating to habitats for qualified species with an urgent 

need for protection, (9) with habitat management plans that assist 

in preventing the listing of a species as endangered or threatened 

under the Endangered Species Act of 1973 or a similar State law, 

(10) with habitat management plans that may resolve conflicts between the protection of qualified species and otherwise lawful 

human activities, and (11) with habitat management plans that 


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may resolve conflicts between the protection of a qualified species 

and military training or other military operation. 

The Secretary of the Treasury shall request that the appropriate 

Secretary consider whether to authorize under the Endangered 

Species Act of 1973 takings by an eligible taxpayer of a qualified 

species to which a qualified agreement relates if the takings are incidental to (1) the restoration, enhancement, or management of the 

habitat pursuant to the habitat management plan under the agreement or (2) the use of the property to which the agreement pertains at any time after the expiration of the easement (or specified 

period of time pursuant to a qualified habitat protection agreement), but only if such use will leave the qualified species at least 

as well off on the property as it was before the agreement was 

made. Both types of incidental takings currently are authorized 

under section 10(a)(1) of the Endangered Species Act of 1973 (enhancement of survival permits) and 50 C.F.R. part 17 (safe harbor 

permits). 

The Comptroller General of the United States shall undertake a 

study on the effectiveness of the credits. Such study shall evaluate 

the effectiveness of the credits in encouraging landowners to enter 

into agreements for the protection of the habitats of endangered 

and threatened species, and the degree to which such agreements 

are effective in preserving the habitats of such species and assisting in the recovery of such species, and shall include recommendations for improving the effectiveness of the credits. The Comptroller 

General shall issue an interim report based on such study within 

three years of the date of enactment and a final report within five 

years of such date. 

Definitions 

Eligible taxpayer 

An eligible taxpayer is (1) a taxpayer who owns real property 

that contains habitat of a qualified species and enters into a qualified perpetual habitat protection agreement, a qualified 30-year 

habitat protection agreement, or a qualified habitat protection 

agreement with the appropriate Secretary with respect to such real 

property, and (2) a taxpayer who is a party to a qualified perpetual 

habitat protection agreement, a qualified 30-year habitat protection 

agreement, or a qualified habitat protection agreement and, as part 

of any such agreement, agrees to assume responsibility for costs 

paid or incurred as a result of implementing such agreement. 

Qualified agreements 

A qualified perpetual habitat protection agreement is an agreement under which an easement is granted to the appropriate Secretary, the Secretary of Agriculture, the Secretary of Defense, or a 

State to protect the habitat of a qualified species in perpetuity. A 

qualified 30-year habitat protection agreement is an agreement 

under which an easement is granted to the appropriate Secretary, 

the Secretary of Agriculture, the Secretary of Defense, or a State 

to protect the habitat of a qualified species for a period of not less 

than 30 years and less than perpetuity. A qualified habitat protection agreement requires agreement with the appropriate Secretary, 

the Secretary of Agriculture, the Secretary of Defense, or a State 


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to protect the habitat of a qualified species for a specified period 

of time. 

In addition, each of the three types of qualified agreement must 

meet the following requirements: (1) the agreement must be consistent with any recovery plan that is applicable and that has been 

approved for a qualified species under section 4 of the Endangered 

Species Act of 1973; (2) the agreement must include a habitat management plan agreed to by the appropriate Secretary and the eligible taxpayer; and (3) the agreement must require that technical assistance with respect to the duties under the habitat management 

plan be provided to the taxpayer by the appropriate Secretary or 

an entity approved by the appropriate Secretary. 

Habitat management plan 

A habitat management plan means, with respect to any habitat, 

a plan that (1) identifies one or more qualified species to which the 

plan applies; (2) is designed to restore or enhance the habitat of a 

qualified species or reduce threats to a qualified species through 

the management of the habitat; (3) describes the threats to the 

qualified species that are intended to be reduced through the plan; 

(4) describes the management practices to be undertaken by the 

taxpayer; (5) provides a schedule of deadlines for undertaking such 

management practices; (6) requires monitoring of the management 

practices and the status of the qualified species; and (7) describes 

the technical assistance to be provided to the taxpayer and identifies the entity that will provide such assistance. 

Qualified species 

A qualified species is any species listed as an endangered species 

or threatened species under the Endangered Species Act of 1973 or 

any species for which a finding has been made under section 4(b)(3) 

of the Endangered Species Act of 1973 that listing under such Act 

may be warranted. 

Taking 

A taking has the meaning given to such term under the Endangered Species Act of 1973. 

Appropriate Secretary 

Appropriate Secretary has the meaning given to the term ‘‘Secretary’’ under section 3(15) of the Endangered Species Act of 1973. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2007. 

E. DEDUCTION FOR ENDANGERED SPECIES RECOVERY EXPENDITURES

(Sec. 205 of the bill and sec. 175 of the Code) 

PRESENT LAW

Under present law, a taxpayer engaged in the business of farming may treat expenditures that are paid or incurred by him during 

the taxable year for the purpose of soil or water conservation in respect of land used in farming, or for the prevention or erosion of 


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10Sec. 175. 11 16 U.S.C. 1533(f)(B). 

land used in farming, as expenses that are not chargeable to capital account. Such expenditures are allowed as a deduction, not to 

exceed 25 percent of the gross income derived from farming during 

the taxable year.10 Any excess above such percentage is deductible 

for succeeding taxable years, not to exceed 25 percent of the gross 

income derived from farming during such succeeding taxable year. 

REASONS FOR CHANGE

The goal of the Endangered Species Act of 1973 is to recover listed species and the ecosystems on which they depend to levels 

where protection under such Act is no longer necessary. Recovery 

is the process by which the decline of an endangered species is arrested or reversed, and threats removed or reduced so that the species’ long-term survival in the wild can be ensured. Section 4(f)(1) 

of such Act directs the appropriate Secretary to develop and implement recovery plans for the conservation and survival of endangered and threatened species, unless the appropriate Secretary 

finds that such a plan will not promote the conservation of the species. To the maximum extent practicable, the recovery plan must 

incorporate a description of management actions to achieve the 

plan’s goals, objective and measurable criteria for determining the 

removal of species from the endangered species list, and estimate 

the time required and cost to carry out the recovery plan. The appropriate Secretary may procure the services of appropriate private 

and public agencies in developing and implementing a recovery 

plan. 

According to an April 6, 2006, General Accountability Office report entitled ‘‘Endangered Species: Time and Costs to Recover Species Are Largely Unknown’’, as of January 2006, the Fish and 

Wildlife Service and the National Marine Fisheries Service had finalized and approved 558 recovery plans covering 1,049 species, or 

about 82 percent of the 1,272 endangered or threatened species 

protected in the United States at that time. Recovery plans contain 

management measures that landowners can adopt on their land 

that will aid in the recovery of endangered or threatened species, 

resulting in a public benefit. Such are similar to measures undertaken for soil and water conservation, which are entitled to a tax 

deduction. The Committee believes that certain expenses of farmers made pursuant to a recovery plan under the Endangered Species Act should be treated similarly to expenditures by farmers 

made for soil and water conservation. 

EXPLANATION OF PROVISION

The provision provides that expenditures paid or incurred by a 

taxpayer engaged in the business of farming for the purpose of 

achieving site-specific management actions pursuant to the Endangered Species Act of 1973 11 to be treated the same as expenditures 

for the purpose of soil or water conservation in respect of land used 

in farming, or for the prevention or erosion of land used in farming, 

i.e., such expenditures are treated as not chargeable to capital account and are deductible subject to the limitation that the deducVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00018 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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12Sec. 126. 

tion may not exceed 25 percent of the farmer’s gross income derived from farming during the taxable year. 

EFFECTIVE DATE

The provision is effective for expenditures paid or incurred after 

the date of enactment. 

F. PROVIDE EXCLUSION FOR CERTAIN PAYMENTS AND PROGRAMS

RELATING TO FISH AND WILDLIFE

(Sec. 206 of the bill and sec. 126 of the Code) 

PRESENT LAW

Under present law, gross income does not include the excludable 

portion of payments made to taxpayers by the Federal and State 

governments for a share of the cost of improvements to property 

under certain conservation programs.12

The excludable portion is the portion (or all) of a payment made 

under such programs that is determined by the Secretary of Agriculture to be made primarily for the purpose of conserving soil and 

water resources, protecting or restoring the environment, improving forests, or providing a habitat for wildlife, and is determined 

by the Secretary of the Treasury as not increasing substantially the 

annual income derived from the property. The excludable portion 

does not include that portion of any payment that is properly associated with an amount that is allowable as a deduction for the taxable year in which such amount is paid or incurred. 

Applicable conservation programs include (1) the rural clean 

water program authorized by section 208(j) of the Federal Water 

Pollution Control Act, (2) the rural abandoned mine program authorized by section 406 of the Surface Mining Control and Reclamation Act of 1977, (3) the water bank program authorized by 

the Water Bank Act, (4) the emergency conservation measures program authorized by title IV of the Agricultural Credit Act of 1978, 

(5) the agriculture conservation program authorized by the Soil 

Conservation and Domestic Allotment Act, (6) the great plains conservation program authorized by section 16 of the Soil Conservation and Domestic Policy Act, (7) the resource conservation and development program authorized by the Bankhead-Jones Farm Tenant Act and by the Soil Conservation and Domestic Allotment Act, 

(8) the forestry incentives program authorized by section 4 of the 

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

is determined by the Secretary of the Treasury or his delegate to 

be substantially similar to the type of programs described in items 

(1) through (8), and (10) any program of a State, possession of the 

United States, a political subdivision of any of the foregoing, or the 

District of Columbia under which payments are made to individuals primarily for the purpose of conserving soil, protecting or restoring the environment, improving forests, or providing a habitat 

for wildlife. 


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REASONS FOR CHANGE

Currently, there are a few Federal programs aimed at encouraging landowners to protect and aid in the recovery of endangered 

or threatened species. Partners for Fish and Wildlife is a national 

voluntary cost-share program implemented by the U.S. Fish and 

Wildlife Service to protect, enhance, and restore important fish and 

wildlife habitats on private lands through partnerships with landowners. The Landowner’s Incentive Program provides funding for 

states to staff their programs and to fund conservation work with 

private landowners to restore and maintain habitat for endangered, 

threatened, and other imperiled species. State Wildlife Grant funds 

are used to address species and their habitats that are identified 

in State Comprehensive Wildlife Conservation Plans/Strategies 

(also known as Wildlife Action Plans). Priority for use of these 

funds is on those species of greatest conservation need. The Private 

Stewardship Grant Program provides Federal grants on a competitive basis to individuals and groups engaged in voluntary conservation efforts on private lands that benefit Federally listed endangered or threatened species, candidate species or other at-risk species. Private landowners and groups working with private landowners are able to submit proposals directly to the U.S. Fish and 

Wildlife Service for funding to support these efforts. Each grant 

must be matched by at least 10 percent of the total project cost in 

either non Federal dollars or in-kind contributions. The Healthy 

Forests Reserve Program is a voluntary program to restore and enhance forest ecosystems to promote the recovery of threatened and 

endangered species, improve biodiversity and enhance carbon sequestration. 

The Committee believes that payments received by taxpayers 

under the Partners for Fish and Wildlife Program, the Landowner 

Incentive Program, the State Wildlife Grants Program, the Private 

Stewardship Grants Program, the Forest Health Protection Program, and the program related to integrated pest management are 

similar to payments made under other government programs that 

are excludable from gross income under present law. Accordingly, 

the Committee believes it is appropriate to extend the present-law 

exclusion to payments under these programs. 

EXPLANATION OF PROVISION

The provision expands the exclusion for the excludable portion of 

certain payments to include the excludable portion of payments 

made under the Partners for Fish and Wildlife Program authorized 

by the Partners for Fish and Wildlife Act, the Landowner Incentive 

Program, the State Wildlife Grants Program, the Private Stewardship Grants Program authorized by the Fish and Wildlife Act of 

1956, the Forest Health Protection Program authorized by the Cooperative Forestry Assistance Act of 1978, and the program related 

to integrated pest management authorized by section 8(i)(1)(A) of 

the Cooperative Forestry Act of 1978. 

EFFECTIVE DATE

The provision is effective for payments received after the date of 

enactment. 


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13The term ‘‘wetlands reserve program’’ means the wetlands reserve program established 

under subchapter C of chapter 1 of subtitle D of title XII of the Food Security Act of 1985. 14The term ‘‘working grassland protection program’’ means the working grassland protection 

program established under subchapter C of chapter 2 of subtitle D of Title XII of the Food Security Act of 1985. 

G. PROVIDE TAX CREDIT FOR EASEMENTS MADE PURSUANT TO

CERTAIN U.S.D.A. CONSERVATION PROGRAMS

(Sec. 207 of the bill and sec. 30F of the Code) 

PRESENT LAW

The Department of Agriculture administers various programs designed to encourage conservation. Under the wetlands reserve program 13 and the grassland reserve program (referred to herein as 

the working grassland protection program),14 land owners generally place conservation easements on real property in exchange 

for payments from the Department of Agriculture. 

Present law does not provide an income tax credit for easements 

placed on real property pursuant to the wetlands reserve program 

or the working grassland protection program. 

REASONS FOR CHANGE

The Committee believes that additional incentives should be provided to encourage landowners to grant conservation easements on 

real property pursuant to the wetlands reserve program and the 

working grassland protection program. 

EXPLANATION OF PROVISION

In general, the provision establishes two income tax credits: (1) 

the wetlands reserve conservation credit; and (2) the working 

grassland protection credit. The credits are elective, but a taxpayer 

may not claim the credits if the taxpayer receives a payment for 

an easement made pursuant to the wetlands reserve program or 

the working grassland protection program. 

The wetlands reserve conservation credit requires the taxpayer 

to grant to the Secretary of Agriculture an easement pursuant to 

the wetlands reserve program. The credit is equal to the applicable 

percentage of the wetlands reserve easement value. The applicable 

percentage is the excess of 1 over the applicable marginal tax rate 

assuming that the taxpayer sold the easement on the date the 

easement is granted to the Secretary of Agriculture. The wetlands 

reserve easement value is the lesser of: (1) the wetlands reserve geographic area rate for the area in which the real property is located 

multiplied by the number of acres placed under easement and (2) 

the amount of the payment the taxpayer otherwise would have received from the Department of Agriculture in exchange for the 

easement pursuant to the wetlands reserve program. The wetlands 

reserve geographic area rate is a per-acre rate appropriate for easements made under the wetlands reserve program in the particular 

geographic area as determined by the Secretary of Treasury in consultation with the Secretary of Agriculture. 

The working grassland protection credit requires the taxpayer to 

grant an easement in perpetuity or for a period not less than 30 

years to the Secretary of Agriculture or to a State pursuant to the 

working grassland protection program. In the case of an easement 


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in perpetuity, the working grassland protection credit for any taxable year is an amount equal to the applicable percentage of the 

working grassland easement value. The applicable percentage is 

the excess of 1 over the applicable marginal tax rate assuming that 

the taxpayer sold the easement on the date the easement is granted to the Department of Agriculture or a State. The working grassland easement value is the lesser of: (1) the working grassland geographic area rate for the area in which the property is located multiplied by the number of acres placed under easement and (2) the 

amount of the payment the taxpayer otherwise would have received from the Department of Agriculture pursuant to the working 

grassland protection program. The working grassland geographic 

area rate is a per-acre rate appropriate for easements granted 

under the working grassland protection program in the particular 

geographic area as determined by the Secretary of Treasury in consultation with the Secretary of Agriculture. In the case of a taxpayer who has entered into an easement of at least 30 years, the 

amount of the working grassland conservation credit is the lesser 

of: (1) 30 percent of the amount determined under (1) above; and 

(2) the amount of the payment the taxpayer otherwise would have 

received from the Department of Agriculture pursuant to the working grassland protection program. 

The credits allowed under the provision are taken into account 

after other credits (sections 21–27, 30, 30B, and 30C) and may not 

offset the alternative minimum tax. A taxpayer is not entitled to 

a deduction for any amount with respect to which a credit is allowed under the provision. The Secretary of Treasury shall by regulations provide for the recapture of the wetlands reserve credit or 

the working grassland protection credit if the Secretary, in consultation with the Secretary of Agriculture, determines that the 

taxpayer has failed to carry out the duties of the taxpayer under 

the terms of the easement and there are no other available means 

to remediate such failure. 

The credit allowed under the provision may not exceed the excess 

of the amount allocated to the taxpayer by the Secretary of the 

Treasury, in consultation with the Secretary of Agriculture, for the 

taxable year and all prior taxable years over the credit allowed for 

all prior taxable years. The taxpayer’s basis in property subject to 

an easement under the provision is reduced. 

The provision establishes a national conservation credit limitation of $1 billion, which represents the aggregate amount of credits 

that may be allocated under the provision for all taxpayers. The 

Secretary of Treasury, in consultation with the Secretary of Agriculture, shall allocate the national conservation credit limitation to 

taxpayers who grant easements under the wetlands reserve program or the working grassland protection program. No amount of 

national conservation credit limitation may be allocated to any taxpayer after fiscal year 2012. 

EFFECTIVE DATE

The provision is effective for easements granted after September 

30, 2007, in taxable years ending after such date. 


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H. PROVIDE FOR EXEMPT FACILITY BONDS FOR FOREST

CONSERVATION ACTIVITIES

(Sec. 208 of the bill and Sec. 142 of the Code) 

PRESENT LAW

Tax-exempt bonds 

In general 

Subject to certain Code restrictions, interest on bonds issued by 

State and local government generally is excluded from gross income 

for Federal income tax purposes. Bonds issued by State and local 

governments may be classified as either governmental bonds or private activity bonds. Governmental bonds are bonds the proceeds of 

which are primarily used to finance governmental functions or 

which are repaid with governmental funds. Private activity bonds 

are bonds in which the State or local government serves as a conduit providing financing to nongovernmental persons. For this purpose, the term ‘‘nongovernmental person’’ generally includes the 

Federal Government and all other individuals and entities other 

than States or local governments. The exclusion from income for interest on State and local bonds does not apply to private activity 

bonds, unless the bonds are issued for certain permitted purposes 

(‘‘qualified private activity bonds’’) and other Code requirements 

are met. 

Qualified private activity bonds 

As stated, interest on private activity bonds is taxable unless the 

bonds meet the requirements for qualified private activity bonds. 

Qualified private activity bonds permit States or local governments 

to act as conduits providing tax-exempt financing for certain private activities. The definition of qualified private activity bonds includes an exempt facility bond, or qualified mortgage, veterans’ mortgage, small issue, redevelopment, 501(c)(3), or student loan 

bond (sec. 141(e)). 

The definition of an exempt facility bond includes bonds issued 

to finance certain transportation facilities (airports, ports, mass 

commuting, and high-speed intercity rail facilities); qualified residential rental projects; privately owned and/or operated utility facilities (sewage, water, solid waste disposal, and local district heating and cooling facilities, certain private electric and gas facilities, 

and hydroelectric dam enhancements); public/private educational 

facilities; qualified green building and sustainable design projects; 

and qualified highway or surface freight transfer facilities (sec. 

142(a)). 

In most cases, the aggregate volume of qualified private activity 

bonds is restricted by annual aggregate volume limits imposed on 

bonds issued by issuers within each State (‘‘State volume cap’’). For 

calendar year 2007, the State volume cap, which is indexed for inflation, equals $85 per resident of the State, or $256.24 million, if 

greater. Exceptions to the State volume cap are provided for bonds 

for certain governmentally owned facilities (e.g., airports, ports, 

high-speed intercity rail, and solid waste disposal) and bonds which 

are subject to separate local, State, or national volume limits (e.g., 

public/private educational facility bonds, enterprise zone facility 


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bonds, qualified green building bonds, and qualified highway or 

surface freight transfer facility bonds). 

Qualified private activity bonds generally are subject to restrictions on the use of proceeds for the acquisition of land and existing 

property. For example, generally no more than 25 percent of the 

net proceeds of a qualified private activity bond may be used for 

the acquisition of land. In addition, the term of qualified private activity bonds generally may not exceed 120 percent of the economic 

life of the property being financed. 

Taxation of income from timber harvesting 

In general, gross income for Federal income tax purposes means 

all income from whatever source derived, including gross income 

derived from a trade or business. An organization exempt from taxation generally is subject to tax on its unrelated business taxable 

income, generally defined to mean gross income (less deductions) 

derived from a trade or business, the conduct of which is not substantially related to the exercise or performance of the organization’s exempt purposes or functions, that is regularly carried on by 

the organization. Special unrelated trade or business income rules 

applicable to the cutting of timber are contained in sections 

512(b)(5) and 631. Under these rules, the determination of whether 

income derived from the cutting of timber constitutes unrelated 

trade or business income depends upon a variety of factors. 

REASONS FOR CHANGE

The Committee believes it is appropriate to provide certain tax 

incentives to further the goal of permanently setting aside working 

forests for conservation purposes. The Committee believes that providing tax-exempt financing to nonprofit organizations for the purpose of acquiring forests and forest lands to be dedicated to certain 

conservation purposes will increase their ability to purchase such 

properties from commercial owners and operators, and that providing limited exclusions from income tax to such nonprofit organizations will enable them to conduct charitable and conservation activities as they make debt service payments on the bonds. 

EXPLANATION OF PROVISION

Overview 

In general 

The provision establishes a pilot project for forest conservation 

activities by providing two types of tax benefits available to qualified organizations that acquire forest and forest lands for conservation management. First, the provision provides for the treatment of 

qualified forest conservation bonds as exempt facility bonds. Second, the provision provides for the exclusion from gross income of 

income from certain timber harvesting activities conducted by a 

qualified organization on lands acquired with proceeds from qualified forest conservation bonds. 

Qualified organizations 

Under the provision, an organization must be a qualified organization to be eligible for the tax-exempt financing benefit, and must 

be a qualified organization for whom qualified forest conservation 


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15The provision requires that at least 20 percent of the board members be comprised of representatives of the conservation community, and that at least 20 percent of the board members 

be public officials. Not more than one-third of the board members may be comprised of individuals who have or had (during a prescribed five year period) certain types of financial or contractual relationships with a commercial forest products enterprise. A representative of the conservation community is a person well-known in the community located near the acquired forest 

land for dedication to the causes of conservation and preservation, and may include a member 

of the board of an established section 501(c)(3) organization with the primary purpose of conservation or preservation. Such term does not include a public official or a person described 

above who has or had certain types of financial or contractual relationships with a commercial 

forest products enterprise. 

bonds have been issued (and remain outstanding as tax-exempt 

bonds) to be eligible for the income exclusion. In general, under the 

provision, a qualified organization means a nonprofit organization: 

(1) substantially all the activities of which are charitable, scientific, 

or educational, including acquiring, protecting, restoring, managing, and developing forest lands and other renewable resources 

for the long-term charitable, educational, scientific, and public benefit; (2) that periodically conducts educational programs designed to 

inform the public of environmentally sensitive forestry management and conservation techniques; (3) whose board satisfies certain 

board composition requirements designed to ensure that it represents public conservation interests; 15 (4) with governance provisions contained in its bylaws that provide a supermajority vote of 

at least two-thirds of the members of the board of directors is required to approve and amend the qualified organization’s qualified 

conservation plan; and (5) that upon dissolution, its assets are required to be dedicated to an organization exempt from tax under 

section 501(c)(3) that is organized and operated for conservation 

purposes, or to a governmental unit. 

Qualified forest conservation bonds 

In general 

The provision creates a new category of tax-exempt bonds, ‘‘qualified forest conservation bonds.’’ For purposes of the Code, qualified 

forest conservation bonds are treated as exempt facility bonds, and 

therefore, unless otherwise provided, are governed by the same 

rules as exempt facility bonds. A qualified forest conservation bond 

means any bond issued as part of an issue if: (1) 95 percent or 

more of the net proceeds of such issue are to be used for qualified 

project costs; (2) such bond is issued for a qualified organization; 

and (3) such bond is issued within 36 months of the date of enactment of the provision. The maximum aggregate face amount of 

bonds that may be issued is $1.5 billion. 

The bonds are allocated by the Secretary generally as follows: (i) 

35 percent for qualified project costs with respect to the cost of acquisition by any qualified organization in the Pacific Northwest region; (ii) 30 percent for qualified project costs with respect to the 

cost of acquisition by any qualified organization in the Western region; (iii) 17.5 percent for qualified project costs with respect to the 

cost of acquisition by any qualified organization in the Southeast 

region; (iv) 17.5 percent for qualified project costs with respect to 

the cost of acquisition by any qualified organization in the Northeast region. 

The term ‘‘Pacific Northwest region’’ means Region 6 as defined 

by the United States Forest Service of the Department of Agriculture under section 200.2 of title 36, Code of Federal Regulations. 


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16For this purpose, a person is related to another person if such person bears a relationship 

to such other person described in section 267(b) (determined without regard to paragraph (9) 

thereof), or section 707(b)(1), determined by substituting 25 percent for 50 percent for purposes 

of those determinations. If such other person is a nonprofit organization, a person is related to 

such nonprofit organization if such person controls directly or indirectly more than 25 percent 

of the governing body of such nonprofit organization. 

The term ‘‘Western region’’ means Regions 1, 2, 3, 4, 5, and 10 (as 

so defined). The term ‘‘Southeast region’’ means Region 8 (as so defined). The term ‘‘Northeast region’’ means Region 9 (as so defined). 

If any region has not received a full allocation of its bond limitation amount by the end of the period that is 24 months after the 

date of enactment, the Secretary may allocate excess amounts to 

other regions in such manner as the Secretary determines appropriate. 

Qualified project costs 

Qualified project costs include the cost of acquisition by the 

qualified organization, from an unrelated person, of forests and forest land that at the time of acquisition or immediately thereafter 

are subject to a conservation restriction that meets certain requirements.16 The conservation restriction must: (1) be granted in perpetuity to an unrelated charitable organization (other than a private foundation) that is organized and operated for conservation 

purposes, or to a governmental unit; (2) protect a relatively natural 

habitat of fish, wildlife, or plants, or similar ecosystem, or preserve 

open space (including farmland and forest land) pursuant to a 

clearly delineated Federal, State, or local governmental conservation policy and yield a significant public benefit; (3) obligate the 

qualified organization to pay the costs incurred by the holder of the 

conservation restriction in monitoring compliance with such restriction; and (4) require that an increasing level of conservation benefits be provided whenever circumstances allow it. 

The issuance of qualified forest conservation bonds generally is 

subject to the rules applicable to issuance of exempt-facility private 

activity bonds. However, the issuance of such bonds is not subject 

to the State volume cap. In addition, the restrictions on acquisition 

of land and existing property do not apply to such bonds. For purposes of determining the maximum maturity on such bonds, the 

land and standing timber acquired with the proceeds of the bonds 

is treated as having an economic life of 35 years. 

Exclusion of certain qualified harvesting activity income from tax 

Income from qualified harvesting activities 

Under the provision, income, gains, deductions, losses, or credits 

from a qualified harvesting activity conducted by a qualified organization generally are not subject to tax or taken into account for 

Federal income tax purposes. A qualified harvesting activity means 

the sale, lease, or harvesting of standing timber: (1) on land owned 

by a qualified organization that it acquired with proceeds of qualified forest conservation bonds; and (2) pursuant to a qualified conservation plan adopted by the organization. Qualified harvesting 

activity does not include any sale, lease, or harvesting for any period during which the organization ceases to qualify as a qualified 

organization. 


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17This debt service limitation does not apply to income that otherwise is not subject to tax 

under other provisions of the Code (e.g., income from harvesting if such harvesting activity is 

not an unrelated trade or business within the meaning of section 513 with respect to the qualified organization). 

Timber cutting and the sale or lease of timber is not a qualified 

harvesting activity to the extent the timber harvesting or removal 

exceeds prescribed limits. For this purpose, the average annual 

area of timber harvested cannot exceed 2.5 percent of the total area 

of the land acquired with the proceeds of qualified forest conservation bonds; or the quantity of timber removed from such land cannot exceed the quantity that can be removed from such land annually in perpetuity on a sustained-yield basis determined only with 

respect to such land. Certain deviations from these restrictions are 

permitted to protect the forest from catastrophic danger, such as by 

fire or windthrow, or from imminent danger from insect or disease 

attack. 

The amount of income from a qualified harvesting activity that 

may be excluded from gross income for a taxable year may not exceed the amount used by the qualified organization to make debt 

service payments during such taxable year for qualified forest conservation bonds.17 The exclusion of income from a qualified harvesting activity does not apply during any period the organization 

fails to qualify as a qualified organization, or after the bonds are 

no longer outstanding or fail to qualify as tax-exempt bonds. 

Qualified conservation plan 

A qualified conservation plan means a multiple land use plan (a) 

designed and administered primarily for the purposes of protecting 

and enhancing wildlife, fish, timber, scenic attributes, recreation, 

and soil and water quality of the forest and forest land, (b) mandates that conservation of the forest and forest land is the singlemost significant use of the forest and land, and (c) requires that 

timber harvesting be consistent with (1) restoring and maintaining 

reference conditions for the region’s ecotype (such as with respect 

to types of trees), (2) restoring and maintaining a representative 

sample of young, mid, and late successional forest age classes, (3) 

maintaining or restoring the resources’ ecological health for purposes of preventing damage from fire, insect, or disease, (4) maintaining or enhancing wildlife or fish habitat, or (5) enhancing research opportunities in sustainable renewable resource uses. 

Recapture taxes 

Once the qualified forest conservation bonds issued for a qualified organization are no longer outstanding or cease to qualify as 

qualified private activity bonds, the qualified organization becomes 

liable for a recapture of tax benefits (plus interest) for its excess 

harvesting activities. Under the provision, if the average annual 

area of timber harvested from the land exceeds the applicable 2.5 

percent average annual area limitation, the organization’s income 

tax liability is increased by the amount of the tax benefits (plus interest) attributable to such excess harvesting. 

EFFECTIVE DATE

The provision is effective for obligations issued on or after the 

date that is 180 days after the date of enactment. 


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18 Net capital gain is defined as the excess of net long-term capital gain over net short-term 

capital gain for the taxable year. Sec. 1222(11). 19 Because the entire amount of the capital gain is included in alternative minimum taxable 

income (‘‘AMTI’’), for taxpayers subject to the alternative minimum tax with AMTI in excess of $112,500 ($150,000 in the case of a joint return), the gain may cause a reduction in the minimum tax exemption amount and thus effectively tax the gain at rates of 21.5 or 22 percent. 

Also the gain may cause the phase-out of certain benefits in computing the regular tax. 20 A distribution to a corporate shareholder out of current or accumulated earnings and profits 

of the corporation is a dividend, unless the distribution is a redemption that terminates the 

shareholder’s stock interest or reduces the shareholder’s interest in the distributing corporation 

to an extent considered to result in treatment as a sale or exchange of the shareholder’s stock. 

Secs. 301 and 302. A distribution in excess of corporate earnings and profits is treated by shareholders as first a recovery of their stock basis and then, to the extent the distribution exceeds 

a shareholder’s stock basis, as a sale or exchange of the stock. Sec. 301. These rules generally 

apply to REITs. 

I. DEDUCTION FOR QUALIFIED TIMBER GAIN AND TIMBER REIT 

PROVISIONS

(Secs. 209–214 of the bill and new sec. 1203, and secs. 856, 857 and 

4981 of the Code) 

PRESENT LAW

Treatment of certain timber gain 

Under present law, if a taxpayer cuts standing timber, the taxpayer may elect to treat the cutting as a sale or exchange eligible 

for capital gains treatment (sec. 631(a)). For purposes of determining the gain attributable to such cutting, and the cost of the cut 

timber for purposes of the taxpayer’s income from later sales of the 

timber or timber products, the fair market value of the timber on 

the first day of the taxable year in which the timber is used. Also, 

if a taxpayer disposes of the timber with a retained economic interest or makes an outright sale of the timber, the gain is eligible for 

capital gain treatment (sec. 631(b)). This treatment under either 

section 631(a) or (b) requires that the taxpayer has owned the timber or held the contract right for a period of more than one year. 

Under present law, for taxable years beginning before January 1, 

2011, the maximum rate of tax on long term capital gain (‘‘net capital gain’’) 18 of an individual, estate, or trust is 15 percent. Any net 

capital gain that otherwise would be taxed at a 10- or 15-percent 

rate is taxed at a 5-percent rate (zero for taxable years beginning 

after 2007). These rates apply for purposes of both the regular tax 

and the alternative minimum tax.19

For taxable years beginning after December 31, 2010, the maximum rate of tax on the net capital gain of an individual is 20 percent. Any net capital gain that otherwise would be taxed at a 10- 

or 15-percent rate is taxed at a 10-percent rate. In addition, any 

gain from the sale or exchange of property held more than five 

years that would otherwise have been taxed at the 10-percent rate 

is taxed at an 8-percent rate. Any gain from the sale or exchange 

of property held more than five years and the holding period for 

which began after December 31, 2000, which would otherwise have 

been taxed at a 20-percent rate, is taxed at an 18-percent rate. The 

net capital gain of a corporation is taxed at the same rates as ordinary income, up to a maximum rate of 35 percent. 

Real estate investment trusts (‘‘REITs’’) are subject to a special 

taxation regime. Under this regime, a REIT is allowed a deduction 

for dividends paid to its shareholders.20 As a result, REITs generally do not pay tax on distributed income, but the income is taxed 


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21Sec. 857(b)(3)(D). The shareholders also obtain a basis increase in their REIT stock for the 

gross amount of the deemed distribution that is included in their income less the amount of 

corporate tax deemed paid by them that was paid by the REIT on the retained gain. Sec. 

857(b)(3)(D)(iii). 22Section 4981. The definition is the excess of gains from sales or exchanges of capital assets 

over losses from such sales or exchanges for the calendar year, reduced by any net ordinary loss. 23Section 856(c) and section 1221(a). Income from sales that are not prohibited transactions 

solely by virtue of section 857(b)(6) is also qualified REIT income. 24Section 856(c)(5)(C). 

to the REIT shareholders. A REIT that has long term capital gain 

can declare a dividend that shareholders are entitled to treat as 

long term capital gain. 

REITs generally are required to distribute 90 percent of their 

taxable income (other than net capital gain). A REIT generally 

must pay tax at regular corporate rates on any undistributed income. However, a REIT that has net capital gain can retain that 

gain without distributing it, and the shareholders can report the 

net capital gain as if it were distributed to them. In that case the 

REIT pays a C corporation tax on the retained gain, but the shareholders who report the income are entitled to a credit or refund for 

the difference between the tax that would be due if the income had 

been distributed and the 35-percent rate paid by the REIT.21 In effect, net capital gain of a REIT (including but not limited to timber 

gain) can be taxed as net capital gain of the shareholders, whether 

or not the gain is distributed. 

Other REIT provisions 

A REIT is also subject to a 4-percent excise tax to the extent it 

does not distribute specified percentages of its income within any 

calendar year. The required distributed percentage is 85 percent in 

the case of the REIT ordinary income, and 95 percent in the case 

of the REIT capital gain net income (as defined).22 The amount of 

the excess of the required distribution over the actual distribution 

is subject to the 4-percent tax. 

A REIT generally is restricted to earning certain types of passive 

income. Among other requirements, at least 75 percent of the gross 

income of a REIT in a taxable year must consist of certain types 

of real estate related income, including rents from real property, income from the sale or exchange of real property (including interests 

in real property) that is not stock in trade, inventory, or held by 

the taxpayer primarily for sale to customers in the ordinary course 

of its trade or business, and interest on mortgages secured by real 

property or interests in real property.23 Interests in real property 

are specifically defined to exclude mineral, oil, or gas royalty interests.24 A REIT will not qualify as a REIT, and will be taxable as 

a C corporation, for any taxable year if it does not meet this income 

test. 

Some REITs have been formed to hold land on which trees are 

grown. Upon maturity of the trees, the standing trees are sold by 

the REIT. The Internal Revenue Service has issued private letter 

rulings in particular instances stating that the income from the 

sale of the trees under section 631(b) can qualify as REIT real 

property income because the uncut timber and the timberland on 

which the timber grew is considered real property and the sale of 


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25Timber income under section 631(b) has also been held to be qualified real estate income 

even if the one year holding period is not met. See, e.g., PLR 200052021, see also PLR 

199945055, PLR 199927021, PLR 8838016. A private letter ruling may be relied upon only by 

the taxpayer to which the ruling is issued. However, such rulings provide an indication of administrative practice. 26Sections 857(b)(6) and 1221(a)(1). There is an exception for certain foreclosure property. 27 Aggregate expenditures (other than timberland acquisition expenditures) during such period 

made by the REIT or a partner of the REIT, which are includible in basis, may not exceed 30 

percent of the net selling price in the case of expenditures that are directly related to operation 

of the property for the production of timber or the preservation of the property for use as 

timberland, and may not exceed 5 percent of the net selling price in the case of expenditures 

that are not directly related to those purposes. 28Section 857(b)(6)(D). 29Section 857(b)(6)(C). 30Section 856(c)(4)(B)(ii) and (iii). Certain interests are not treated as ‘‘securities’’ for purposes 

of the rule forbidding the REIT to hold securities representing more than 10 percent of the value 

of securities of any one issuer. Sec. 856(m). 

uncut trees can qualify as capital gain derived from the sale of real 

property.25

A REIT is subject to a 100-percent excise tax on gain from any 

sale that is a ‘‘prohibited transaction,’’ defined as a sale of property 

that is stock in trade, inventory, or property held by the taxpayer 

primarily for sale to customers in the ordinary course of its trade 

or business.26 This determination is based on facts and circumstances. However, a safe-harbor provides that no excise tax is 

imposed if certain requirements are met. In the case of timber 

property, the safe harbor is met, regardless of the number of sales 

that occur during the taxable year, if (i) the REIT has held the 

property for not less than 4 years in connection with the trade or 

business of producing timber; (ii) the aggregate adjusted bases of 

the property sold (other than foreclosure property) during the taxable year does not exceed 10 percent of the aggregate bases of all 

the assets of the REIT as of the beginning of the taxable year, and 

if certain other requirements are met. These include requirements 

that limit the amount of expenditures the REIT can make during 

the 4-year period prior to the sale that are includible in the adjusted basis of the property,27 that require marketing to be done 

by an independent contractor, and that forbid a sales price that is 

based on the income or profits of any person.28 There is a similar 

but separate safe harbor for sales of non-timber property, with 

similar rules, including a 4-year holding period requirement and a 

limit on the percentage of the aggregate adjusted basis of property 

that can be sold in one taxable year.29

A REIT is not generally permitted to hold securities representing 

more than 10 percent of the voting power or value of the securities 

of any one issuer; nor may more than 5 percent of the fair market 

value of REIT assets be securities of any one issuer.30 However, 

under an exception, a REIT may hold any amount of securities of 

one or more ‘‘taxable REIT subsidiary’’ (TRS) corporations, provided that such TRS securities do not represent more than 20 percent of the fair market value of REIT assets at the end of any quarter. A TRS is a C corporation that is subject to regular corporate 

tax on its income and that meets certain other requirements. A 

taxable REIT subsidiary may conduct activities that would produce 

disqualified non-passive or non-real estate income that could disqualify the REIT if conducted by a REIT itself. Such business could 

include business relating to processing timber, or holding timber 

products or other assets for sale to customers in the ordinary 


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31 A 100-percent excise tax is imposed on the amount of certain transactions involving a TRS 

and a REIT, to the extent such amount would exceed an arm’s length amount under section 

482. Sec. 857(b)(7). 32 Under the provision, because only 40 percent of the gain is included in adjusted gross income and AMTI, only that amount of gain would result in the phase-out of tax benefits. 33For purposes of the section 4981 excise tax on undistributed REIT income, the amount 

treated as subject to the 95 percent distribution requirement is the 40 percent of timber gain 

income that remains after allowing the deduction. 

course of business. Such income would be subject to regular corporate rates of tax as income of the TRS.31

REASONS FOR CHANGE

The committee believes it is desirable to provide greater equivalence to the capital gain tax treatment of timber gain, regardless 

of whether the gain is recognized by a C corporation or a REIT, or 

by an individual. The committee also believes it is desirable to provide changes to the statutory rules governing REITs, in order to 

clarify and facilitate timber REIT operations. 

EXPLANATION OF PROVISION

Elective deduction for 60 percent of qualified timber gain 

The provision allows a taxpayer to elect to deduct an amount 

equal to 60 percent of the taxpayer’s qualified timber gain (or, if 

less, the net capital gain) for a taxable year. In the case of an individual, the deduction reduces adjusted gross income. Qualified timber gain means the net gain described in section 631(a) and (b) for 

the taxable year. 

The deduction is allowed in computing the regular tax and the 

alternative minimum tax (including the adjusted current earnings 

of a corporation). 

If a taxpayer elects the deduction, the 40 percent of the gain subject to tax is taxed at ordinary income tax rates.32

In the case of a pass-thru entity other than a REIT, the election 

may be made separately by each taxpayer subject to tax on the 

gain. The Treasury Department may prescribe rules appropriate to 

apply this provision to gain taken into account by a pass-thru entity. 

In the case of a REIT, the election to take the 60-percent deduction is made by the REIT. If a REIT makes the election, then the 

timber gain is excluded from the computation of capital gain or loss 

of the REIT and can no longer be designated as a capital gain dividend to shareholders. Instead, the gain is treated as ordinary income for purposes of applying the REIT income distribution requirements, but for this purpose 60-percent of the amount of the 

gain is deductible by the REIT in computing its income. REIT earnings and profits also exclude the portion of the timber gain that is 

deductible. Thus, 40 percent of the gain is subject to the REIT distribution requirements,33 and 40 percent of the gain increases 

REIT earnings and profits. Accordingly, because REIT earnings 

and profits have been increased by the 40-percent amount, there is 

sufficient earnings and profits that a distribution of that 40-percent 

amount that otherwise qualifies as a dividend would be treated as 

an ordinary dividend distribution to shareholders. Since this dividend is from a REIT and is not derived from an entity that was 

taxed as a C corporation, it would not qualify for the current 15 


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percent qualified dividend rates and would be taxed at the ordinary 

income rates of the shareholders. 

REIT shareholders obtain an upward basis adjustment in their 

REIT interests, equal to the 60 percent of the timber gain that is 

deductible by the electing REIT. Because the 60 percent of timber 

gain that was deductible by the REIT does not increase REIT earnings and profits, a distribution of such 60 percent to the shareholder generally will not be treated as a dividend (in the absence 

of other retained earnings) but as a return of basis under the general rules of section 301(c). Because the shareholders’ basis has 

been increased by this 60 percent, this distribution would not exceed the shareholders’ basis and thus would be nontaxable return 

of basis, rather than capital gain in excess of basis. However, if a 

REIT shareholder has obtained such an upward basis adjustment 

for a REIT interest and disposes of the interest before having held 

the interest for at least 6 months, then any loss on disposition of 

the interest is disallowed to the extent of such upward basis adjustment. 

Additional REIT provisions 

Timber gain qualified REIT income without regard to 1 year 

holding period 

The provision specifically includes timber gain under section 

631(a) as a category of statutorily recognized qualified real estate 

income of a REIT if the cutting is provided by a taxable REIT subsidiary, and also includes gain recognized under section 631(b). For 

purposes of such qualified income treatment under those provisions, the requirement of a one-year holding period is removed. 

Thus, for a example, a REIT can acquire timber property and harvest the timber on the property within one year of the acquisition, 

with the resulting income being qualified real estate income for 

REIT qualification purposes, even though such income is not eligible for long term capital gain treatment under sections 631(a) or 

(b). The provision specifically provides, however, that for all purposes of the Code, such income shall not be considered to be gain 

described in section 1221(a)(1), that is, it shall not be treated as income from the sale of stock in trade, inventory, or property held by 

the REIT primarily for sale to customers in the ordinary course of 

the REITs trade or business. 

For purposes of determining REIT income, if the cutting is done 

by a taxable REIT subsidiary, the cut timber is deemed sold on the 

first day of the taxable year to the taxable REIT subsidiary (with 

subsequent gain, if any, attributable to the taxable REIT subsidiary). 

REIT prohibited transaction safe harbor for timber property 

For sales to a qualified organization for conservation purposes, as 

defined in section 170(h), the provision reduces to 2 years the 

present law 4-year holding period requirement under section 

857(b)(6)(D), which provides a safe harbor from ‘‘prohibited transaction’’ treatment for certain timber property sales. Also, in the 

case of such sales, the safe-harbor limitations on how much may 

be added, within the 4-year period prior to the date of sale, to the 


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34Sec. 25D. 

aggregate adjusted basis of the property, are changed to refer to 

the 2-year period prior to the date of sale. 

The provision also removes the safe-harbor requirement that 

marketing of the property must be done by an independent contractor, and permits a taxable REIT subsidiary of the REIT to perform the marketing. 

The provision states that any gain that is eligible for the timber 

property safe harbor is considered for all purposes of the Code not 

to be described in section 1221(a)(1), that is, it shall not be treated 

as income from the sale of stock in trade, inventory, or property 

held by the REIT primarily for sale to customers in the ordinary 

course of the REITs trade or business. 

Special rules for Timber REITs 

The provision contains several provisions applicable only to a ‘‘timber REIT,’’ defined as a REIT in which more than 50 percent 

of the value of its total assets consists of real property held in connection with the trade or business of producing timber. 

First, mineral royalty income from real property owned by a timber REIT and held, or once held, in connection with the trade or 

business of producing timber by such REIT, is included as qualifying real estate income for purposes of the REIT income tests. 

Second, a timber REIT is permitted to hold TRS securities with 

a value up to 25 percent, (rather than 20 percent) of the value of 

the total assets of the REIT. 

EFFECTIVE DATE

The provision applies to taxable years beginning after the date 

of enactment, but does not apply after the last day of the first taxable year beginning after the date of enactment. 

TITLE III—ENERGY PROVISIONS 

A. CREDIT FOR RESIDENTIAL AND BUSINESS WIND PROPERTY

(Sec. 301 of the bill and secs. 25D and 48 of the Code) 

PRESENT LAW

Credit for residential energy efficient property 

A personal tax credit is allowed for the purchase of qualified 

solar electric property and qualified solar water heating property 

that is used exclusively for purposes other than heating swimming 

pools and hot tubs.34 The credit is equal to 30 percent of qualifying 

expenditures, with a maximum credit for each of these systems of 

property of $2,000 per taxable year. A 30 percent credit is also allowed for the purchase of qualified fuel cell power plants. The credit for any fuel cell power plant may not exceed $500 for each 0.5 

kilowatt of capacity. 

Qualifying solar water heating property means expenditure for 

property to heat water for use in a dwelling unit located in the 

United States and used as a residence if at least half of the energy 

used by such property for such purpose is derived from the sun. 

Qualified solar electric property is property that uses solar energy 


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35Sec. 48. 36Sec. 38(b)(1). 37Sec. 39. 38Sec. 50(c)(3). 

to generate electricity for use in a dwelling unit. A qualified fuel 

cell power plant is an integrated system comprised of a fuel cell 

stack assembly and associated balance of plant components that (1) 

converts a fuel into electricity using electrochemical means, (2) has 

an electricity-only generation efficiency of greater than 30 percent. 

The qualified fuel cell power plant must be installed on or in connection with a dwelling unit located in the United States and used 

by the taxpayer as a principal residence. 

The credit is nonrefundable, and the depreciable basis of the 

property is reduced by the amount of the credit. Expenditures for 

labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit are eligible expenditures. 

Certain equipment safety requirements must be met to qualify 

for the credit. Special proration rules apply in the case of jointly 

owned property, condominiums, and tenant-stockholders in cooperative housing corporations. If less than 80 percent of the property 

is used for nonbusiness purposes, only that portion of expenditures 

that is used for nonbusiness purposes is taken into account. 

The credit applies to expenditures after December 31, 2005, for 

property placed in service prior to January 1, 2009. 

Energy credit for businesses 

In general 

A nonrefundable, 10-percent business energy credit 35 is allowed 

for the cost of new property that is equipment that either (1) uses 

solar energy to generate electricity, to heat or cool a structure, or 

to provide solar process heat, or (2) is used to produce, distribute, 

or use energy derived from a geothermal deposit, but only, in the 

case of electricity generated by geothermal power, up to the electric 

transmission stage. Property used to generate energy for the purposes of heating a swimming pool is not eligible solar energy property. 

The energy credit is a component of the general business credit 36

and as such is subject to the alternative minimum tax. An unused 

general business credit generally may be carried back one year and 

carried forward 20 years.37 The taxpayer’s basis in the property is 

reduced by one-half of the amount of the credit claimed.38 For 

projects whose construction time is expected to equal or exceed two 

years, the credit may be claimed as progress expenditures are 

made on the project, rather than during the year the property is 

placed in service. Similarly, the credit only applies to expenditures 

made after the effective date of the provision. 

In general, property that is public utility property is not eligible 

for the credit. Public utility property is property that is used predominantly in the trade or business of the furnishing or sale of (1) 

electrical energy, water, or sewage disposal services, (2) gas 

through a local distribution system, or (3) telephone service, domestic telegraph services, or other communication services (other than 

international telegraph services), if the rates for such furnishing or 


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sale have been established or approved by a State or political subdivision thereof, by an agency or instrumentality of the United 

States, or by a public service or public utility commission. This rule 

is waived in the case of telecommunication companies’ purchases of 

fuel cell and microturbine property. 

Special rules for solar energy property 

The credit for solar energy property is increased to 30 percent in 

the case of periods after December 31, 2005 and prior to January 

1, 2009. Additionally, equipment that uses fiber-optic distributed 

sunlight to illuminate the inside of a structure is solar energy property eligible for the 30-percent credit. 

Fuel cells and microturbines 

The business energy credit also applies for the purchase of qualified fuel cell power plants, but only for periods after December 31, 

2005 and prior to January 1, 2009. The credit rate is 30 percent. 

A qualified fuel cell power plant is an integrated system composed of a fuel cell stack assembly and associated balance of plant 

components that (1) converts a fuel into electricity using electrochemical means, and (2) has an electricity-only generation efficiency of greater than 30 percent and a capacity of at least 0.5 kilowatt. The credit may not exceed $500 for each 0.5 kilowatt of capacity. 

The business energy credit also applies for the purchase of qualifying stationary microturbine power plants, but only for periods 

after December 31, 2005 and prior to January 1, 2009. The credit 

is limited to the lesser of 10 percent of the basis of the property 

or $200 for each kilowatt of capacity. 

A qualified stationary microturbine power plant is an integrated 

system comprised of a gas turbine engine, a combustor, a 

recuperator or regenerator, a generator or alternator, and associated balance of plant components that converts a fuel into electricity and thermal energy. Such system also includes all secondary 

components located between the existing infrastructure for fuel delivery and the existing infrastructure for power distribution, including equipment and controls for meeting relevant power standards, 

such as voltage, frequency and power factors. Such system must 

have an electricity-only generation efficiency of not less that 26 

percent at International Standard Organization conditions and a 

capacity of less than 2,000 kilowatts. 

Additionally, for purposes of the fuel cell and microturbine credits, and only in the case of telecommunications companies, the general present-law section 48 restriction that would otherwise prohibit telecommunication companies from claiming the new credit 

due to their status as public utilities is waived. 

REASONS FOR CHANGE

The Committee believes that the promotion of viable alternative 

energy sources is essential to reduce dependence of foreign oil and 

to reduce the harmful impacts of fossil fuel consumption. As wind 

energy is a proven and effective alternative means of electricity 

generation, the Committee believes a credit for wind energy property should be made available on similar terms to that provided for 

solar electric generation under present law. 


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39Sec. 61. 

EXPLANATION OF PROVISION

Residential wind credit 

The provision provides a 30 percent credit for qualified small 

wind energy property expenditures made by the taxpayer during 

the taxable year. The credit is limited to $4,000 per taxable year. 

Qualified small wind energy property expenditures are expenditures for property that uses a qualified wind turbine to generate 

electricity for use in a dwelling unit located in the U.S. and used 

as a residence by the taxpayer. A qualifying wind turbine means 

a wind turbine of 100 kilowatts of rated capacity or less that meets 

the latest performance rating standards published by the American 

Wind Energy Association. 

Business wind credit 

The provision provides a credit of 30 percent of the basis of qualified small wind energy property placed in service during the taxable year. The credit is limited to $4,000 per taxable year. Qualified small wind energy property is property that uses a qualified 

wind turbine to generate electricity for use in the U.S. A qualifying 

wind turbine means a wind turbine of 100 kilowatts of rated capacity or less that meets the latest performance rating standards published by the American Wind Energy Association. As part of the 

section 48 energy credit, a basis reduction of 50 percent of the 

amount of the credit applies. 

EFFECTIVE DATE

The provision is effective for expenditures after December 31, 

2007, for property placed in service prior to January 1, 2009. 

B. LANDOWNER INCENTIVE TO ENCOURAGE ELECTRIC TRANSMISSION

BUILD-OUT

(Sec. 302 of the bill and new sec. 139B of the Code) 

PRESENT LAW

Gross income includes all income from whatever source derived 

unless a specific exclusion applies.39

REASON FOR CHANGE

The Committee believes that an incentive should be provided for 

the build-out of electricity generated from certain alternative energy sources. 

EXPLANATION OF PROVISION

The proposal provides an exclusion from gross income for any 

qualified electric transmission easement payment. For purposes of 

the proposal, a qualified electric transmission easement payment is 

any payment by an electric utility or electric transmission entity 

pursuant to an easement or other agreement granted by the payee 

for the right to locate on the payee’s property transmission lines 

and equipment used to transmit electricity at 230 or more kilovolts 


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40Sec. 45. 41 Collectively, the electricity production credit, the refined coal production credit, and the Indian coal production credit are referred to herein as the section 45 credit. 

primarily from qualified facilities described in section 45(d) (without regard to any placed in service date). 

EFFECTIVE DATE

The proposal is effective for payments received after the date of 

enactment. 

C. EXCEPTION TO REDUCTION OF RENEWABLE ELECTRICITY CREDIT

(Sec. 303 of the bill and sec. 45 of the Code) 

PRESENT LAW

In general 

An income tax credit is allowed for the production of electricity 

at qualified facilities using qualified energy resources.40 Qualified 

energy resources comprise wind, closed-loop biomass, open-loop biomass, geothermal energy, solar energy, small irrigation power, municipal solid waste, and qualified hydropower production. Qualified 

facilities are, generally, facilities that generate electricity using 

qualified energy resources. To be eligible for the credit, electricity 

produced from qualified energy resources at qualified facilities 

must be sold by the taxpayer to an unrelated person. In addition 

to the electricity production credit, an income tax credit is allowed 

for the production of refined coal and Indian coal at qualified facilities.41

Credit amounts and credit period 

In general 

The base amount of the electricity production credit is 1.5 cents 

per kilowatt-hour (indexed annually for inflation) of electricity produced. The amount of the credit is 2 cents per kilowatt-hour for 

2007. A taxpayer may generally claim a credit during the 10-year 

period commencing with the date the qualified facility is placed in 

service. The credit is reduced for grants, tax-exempt bonds, subsidized energy financing, and other credits. 

The amount of credit a taxpayer may claim is phased out as the 

market price of electricity (or refined coal in the case of the refined 

coal production credit) exceeds certain threshold levels. The electricity production credit is reduced over a 3 cent phase-out range 

to the extent the annual average contract price per kilowatt hour 

of electricity sold in the prior year from the same qualified energy 

resource exceeds 8 cents (adjusted for inflation). The refined coal 

credit is reduced over an $8.75 phase-out range as the reference 

price of the fuel used as feedstock for the refined coal exceeds the 

reference price for such fuel in 2002 (adjusted for inflation). 

Reduced credit amounts and credit periods 

Generally, in the case of open-loop biomass facilities (including 

agricultural livestock waste nutrient facilities), geothermal energy 

facilities, solar energy facilities, small irrigation power facilities, 

landfill gas facilities, and trash combustion facilities, the 10-year 


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credit period is reduced to five years commencing on the date the 

facility was originally placed in service, for qualified facilities 

placed in service before August 8, 2005. However, for qualified 

open-loop biomass facilities (other than a facility described in sec. 

45(d)(3)(A)(i) that uses agricultural livestock waste nutrients) 

placed in service before October 22, 2004, the five-year period commences on January 1, 2005. In the case of a closed-loop biomass facility modified to co-fire with coal, to co-fire with other biomass, or 

to co-fire with coal and other biomass, the credit period begins no 

earlier than October 22, 2004. 

In the case of open-loop biomass facilities (including agricultural 

livestock waste nutrient facilities), small irrigation power facilities, 

landfill gas facilities, trash combustion facilities, and qualified hydropower facilities the otherwise allowable credit amount is 0.75 

cent per kilowatt-hour, indexed for inflation measured after 1992 

(currently 1 cent per kilowatt-hour for 2007). 

Credit applicable to refined coal 

The amount of the credit for refined coal is $4.375 per ton (also 

indexed for inflation after 1992 and equaling $5.877 per ton for 

2007). 

Credit applicable to Indian coal 

A credit is available for the sale of Indian coal to an unrelated 

third part from a qualified facility for a seven-year period beginning on January 1, 2006, and before January 1, 2013. The amount 

of the credit for Indian coal is $1.50 per ton for the first four years 

of the seven-year period and $2.00 per ton for the last three years 

of the seven-year period. Beginning in calendar years after 2006, 

the credit amounts are indexed annually for inflation using 2005 

as the base year; for 2007 the Indian coal credit is $1.544 per ton. 

Special rules and other limitations on credit claimants and 

credit amounts 

In general, in order to claim the credit, a taxpayer must own the 

qualified facility and sell the electricity produced by the facility (or 

refined coal or Indian coal, with respect to those credits) to an unrelated party. A lessee or operator may claim the credit in lieu of 

the owner of the qualifying facility in the case of qualifying openloop biomass facilities and in the case of closed-loop biomass facilities modified to co-fire with coal, to co-fire with other biomass, or 

to co-fire with coal and other biomass. In the case of a poultry 

waste facility, the taxpayer may claim the credit as a lessee or operator of a facility owned by a governmental unit. 

For all qualifying facilities, other than closed-loop biomass facilities modified to co-fire with coal, to co-fire with other biomass, or 

to co-fire with coal and other biomass, the amount of credit a taxpayer may claim is reduced by reason of grants, tax-exempt bonds, 

subsidized energy financing, and other credits, but the reduction 

cannot exceed 50 percent of the otherwise allowable credit. In the 

case of closed-loop biomass facilities modified to co-fire with coal, 

to co-fire with other biomass, or to co-fire with coal and other biomass, there is no reduction in credit by reason of grants, tax-exempt bonds, subsidized energy financing, and other credits. 


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42Sec. 38(b)(8). 

The credit for electricity produced from renewable sources is a 

component of the general business credit.42 For alternative minimum tax purposes, a taxpayer’s tentative minimum tax is treated 

as being zero when determining the tax liability limitation for the 

section 45 credit for electricity produced from a facility (placed in 

service after October 22, 2004) during the first four years of production beginning on the date the facility is placed in service. 

Special rules apply for eligible cooperatives claiming the section 

45 credit. For taxable years ending after August 8, 2005, eligible 

cooperatives may elect to pass any portion of the credit through to 

their patrons. An eligible cooperative is defined as a cooperative organization that is owned more than 50 percent by agricultural producers or entities owned by agricultural producers. The credit may 

be apportioned among patrons eligible to share in patronage dividends on the basis of the quantity or value of business done with 

or for such patrons for the taxable year. 

Qualified facilities 

Wind energy facility 

A wind energy facility is a facility that uses wind to produce electricity. To be a qualified facility, a wind energy facility must be 

placed in service after December 31, 1993, and before January 1, 

2009. 

Closed-loop biomass facility 

A closed-loop biomass facility is a facility that uses any organic 

material from a plant which is planted exclusively for the purpose 

of being used at a qualifying facility to produce electricity. In addition, a facility can be a closed-loop biomass facility if it is a facility 

that is modified to use closed-loop biomass to co-fire with coal, with 

other biomass, or with both coal and other biomass, but only if the 

modification is approved under the Biomass Power for Rural Development Programs or is part of a pilot project of the Commodity 

Credit Corporation. 

To be a qualified facility, a closed-loop biomass facility must be 

placed in service after December 31, 1992, and before January 1, 

2009. In the case of a facility using closed-loop biomass but also cofiring the closed-loop biomass with coal, other biomass, or coal and 

other biomass, a qualified facility must be originally placed in service and modified to co-fire the closed-loop biomass at any time before January 1, 2009. 

Open-loop biomass (including agricultural livestock waste nutrients) facility 

An open-loop biomass facility is a facility that uses open-loop biomass to produce electricity. For purposes of the credit, open-loop 

biomass is defined as (1) any agricultural livestock waste nutrients 

or (2) any solid, nonhazardous, cellulosic waste material or any 

lignin material that is segregated from other waste materials and 

which is derived from: 

• forest-related resources, including mill and harvesting residues, precommercial thinnings, slash, and brush; 


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• solid wood waste materials, including waste pallets, crates, 

dunnage, manufacturing and construction wood wastes, and 

landscape or right-of-way tree trimming; or 

• agricultural sources, including orchard tree crops, vineyard, grain, legumes, sugar, and other crop by-products or residues. 

Agricultural livestock waste nutrients are defined as agricultural 

livestock manure and litter, including bedding material for the disposition of manure. Wood waste materials do not qualify as openloop biomass to the extent they are pressure treated, chemically 

treated, or painted. In addition, municipal solid waste, gas derived 

from the biodegradation of solid waste, and paper which is commonly recycled do not qualify as open-loop biomass. Open-loop biomass does not include closed-loop biomass or any biomass burned 

in conjunction with fossil fuel (co-firing) beyond such fossil fuel required for start up and flame stabilization. 

In the case of an open-loop biomass facility that uses agricultural 

livestock waste nutrients, a qualified facility is one that was originally placed in service after October 22, 2004, and before January 

1, 2009, and has a nameplate capacity rating which is not less than 

150 kilowatts. In the case of any other open-loop biomass facility, 

a qualified facility is one that was originally placed in service before January 1, 2009. 

Geothermal facility 

A geothermal facility is a facility that uses geothermal energy to 

produce electricity. Geothermal energy is energy derived from a 

geothermal deposit that is a geothermal reservoir consisting of natural heat that is stored in rocks or in an aqueous liquid or vapor 

(whether or not under pressure). To be a qualified facility, a geothermal facility must be placed in service after October 22, 2004 

and before January 1, 2009. 

Solar facility 

A solar facility is a facility that uses solar energy to produce electricity. To be a qualified facility, a solar facility must be placed in 

service after October 22, 2004, and before January 1, 2006. 

Small irrigation facility 

A small irrigation power facility is a facility that generates electric power through an irrigation system canal or ditch without any 

dam or impoundment of water. The installed capacity of a qualified 

facility must be at least 150 kilowatts but less than five 

megawatts. To be a qualified facility, a small irrigation facility 

must be originally placed in service after October 22, 2004, and before January 1, 2009. 

Landfill gas facility 

A landfill gas facility is a facility that uses landfill gas to produce 

electricity. Landfill gas is defined as methane gas derived from the 

biodegradation of municipal solid waste. To be a qualified facility, 

a landfill gas facility must be placed in service after October 22, 

2004, and before January 1, 2009. 


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Trash combustion facility 

Trash combustion facilities are facilities that burn municipal 

solid waste (garbage) to produce steam to drive a turbine for the 

production of electricity. To be a qualified facility, a trash combustion facility must be placed in service after October 22, 2004 and 

before January 1, 2009. A qualified trash combustion facility includes a new unit, placed in service after October 22, 2004, that increases electricity production capacity at an existing trash combustion facility. A new unit generally would include a new burner/boiler and turbine. The new unit may share certain common equipment, such as trash handling equipment, with other pre-existing 

units at the same facility. Electricity produced at a new unit of an 

existing facility qualifies for the production credit only to the extent of the increased amount of electricity produced at the entire 

facility. 

Hydropower facility 

A qualifying hydropower facility is (1) a facility that produced hydroelectric power (a hydroelectric dam) prior to August 8, 2005, at 

which efficiency improvements or additions to capacity have been 

made after such date and before January 1, 2009, that enable the 

taxpayer to produce incremental hydropower or (2) a facility placed 

in service before August 8, 2005, that did not produce hydroelectric 

power (a nonhydroelectric dam) on such date, and to which turbines or other electricity generating equipment have been added 

after such date and before January 1, 2009. 

At an existing hydroelectric facility, the taxpayer may claim credit only for the production of incremental hydroelectric power. Incremental hydroelectric power for any taxable year is equal to the percentage of average annual hydroelectric power produced at the facility attributable to the efficiency improvement or additions of capacity determined by using the same water flow information used 

to determine a historic average annual hydroelectric power production baseline for that facility. The Federal Energy Regulatory Commission will certify the baseline power production of the facility 

and the percentage increase due to the efficiency and capacity improvements. 

At a nonhydroelectric dam, the facility must be licensed by the 

Federal Energy Regulatory Commission and meet all other applicable environmental, licensing, and regulatory requirements and the 

turbines or other generating devices must be added to the facility 

after August 8, 2005 and before January 1, 2009. In addition there 

must not be any enlargement of the diversion structure, or construction or enlargement of a bypass channel, or the impoundment 

or any withholding of additional water from the natural stream 

channel. 

Refined coal facility 

A qualifying refined coal facility is a facility producing refined 

coal that is placed in service after October 22, 2004 and before January 1, 2009. Refined coal is a qualifying liquid, gaseous, or solid 

fuel produced from coal (including lignite) or high-carbon fly ash, 

including such fuel used as a feedstock. A qualifying fuel is a fuel 

that when burned emits 20 percent less nitrogen oxides and either 

SO2 or mercury than the burning of feedstock coal or comparable 


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coal predominantly available in the marketplace as of January 1, 

2003, and if the fuel sells at prices at least 50 percent greater than 

the prices of the feedstock coal or comparable coal. In addition, to 

be qualified refined coal the fuel must be sold by the taxpayer with 

the reasonable expectation that it will be used for the primary purpose of producing steam. 

Indian coal facility 

A qualified Indian coal facility is a facility which is placed in 

service before January 1, 2009, that produces coal from reserves 

that on June 14, 2005, were owned by a Federally recognized tribe 

of Indians or were held in trust by the United States for a tribe 

or its members. 

Summary of credit rate and credit period by facility type 

TABLE 1.—SUMMARY OF SECTION 45 CREDIT 

Eligible electricity production or coal production 

activity 

Credit amount for 2007 

(cents per kilowatt-hour; 

dollars per ton) 

Credit period for facilities 

placed in service on or before August 8, 2005 (years 

from placed-in-service date) 

Credit period facilities 

placed in service after August 8, 2005 (years from 

placed-in-service date) 

Wind ............................................................ 2 10 10 

Closed-loop biomass ................................... 2 1 10 10 

Open-loop biomass (including agricultural 

livestock waste nutrient facilities) ........ 1 2 5 10 

Geothermal .................................................. 2 5 10 

Solar (pre-2006 facilities only) .................. 2 5 10 

Small irrigation power ................................ 1 5 10 

Municipal solid waste (including landfill 

gas facilities and trash combustion facilities) .................................................... 1 5 10 

Qualified hydropower .................................. 1 N/A 10 

Refined Coal ............................................... 5.877 10 10 

Indian Coal ................................................. 1.544 3 7 3 7 

1 In the case of certain co-firing closed-loop facilities, the credit period begins no earlier than October 22, 2004. 

2 For certain facilities placed in service before October 22, 2004, the 5-year credit period commences on January 1, 2005. 

3 For Indian coal, the credit period begins for coal sold after January 1, 2006. 

REASONS FOR CHANGE

The Committee believes that building additional renewable energy infrastructure advances America’s environmental and energy 

independence goals. The Committee believes that additional renewable energy infrastructure will be built if the tax incentives for renewable energy are better coordinated with certain federal spending programs. 

EXPLANATION OF PROVISION

The provision provides an exception to the reduction in the section 45 credit by reason of grants, tax-exempt bonds, subsidized energy financing, and other credits. Under the provision, the section 

45 credit is not reduced by any loans, loan guarantees, or grants 

to farmers, ranchers, or rural small businesses issued by the Secretary of Agriculture under authority granted by section 9006 of 

the Farm Security and Rural Investment Act of 2002 (Pub. L. No. 

107–171). 


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EFFECTIVE DATE

The provision is effective for facilities placed in service after the 

date of enactment. 

D. EXPANSION OF SPECIAL DEPRECIATION ALLOWANCE TO

CELLULOSIC BIOMASS ALCOHOL FUEL PLANT

(Sec. 311 of the bill and sec. 168(l) of the Code) 

PRESENT LAW

Section 168(l) allows an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified cellulosic 

biomass ethanol plant property. In order to qualify, the property 

generally must be placed in service before January 1, 2013. 

Qualified cellulosic biomass ethanol plant property means property used in the U.S. solely to produce cellulosic biomass ethanol. 

For this purpose, cellulosic biomass ethanol means ethanol derived 

from any lignocellulosic or hemicellulosic matter that is available 

on a renewable or recurring basis. For example, lignocellulosic or 

hemicellulosic matter that is available on a renewable or recurring 

basis includes bagasse (from sugar cane), corn stalks, and 

switchgrass. 

The additional first-year depreciation deduction is allowed for 

both regular tax and alternative minimum tax purposes for the 

taxable year in which the property is placed in service. The additional first-year depreciation deduction is subject to the general 

rules regarding whether an item is deductible under section 162 or 

subject to capitalization under section 263 or section 263A. The 

basis of the property and the depreciation allowances in the year 

of purchase and later years are appropriately adjusted to reflect 

the additional first-year depreciation deduction. In addition, there 

is no adjustment to the allowable amount of depreciation for purposes of computing a taxpayer’s alternative minimum taxable income with respect to property to which the provision applies. A taxpayer is allowed to elect out of the additional first-year depreciation for any class of property for any taxable year. 

In order for property to qualify for the additional first-year depreciation deduction, it must meet the following requirements. The 

original use of the property must commence with the taxpayer on 

or after December 20, 2006. The property must be acquired by purchase (as defined under section 179(d)) by the taxpayer after December 20, 2006, and placed in service before January 1, 2013. 

Property does not qualify if a binding written contract for the acquisition of such property was in effect on or before December 20, 

2006. 

Property that is manufactured, constructed, or produced by the 

taxpayer for use by the taxpayer qualifies if the taxpayer begins 

the manufacture, construction, or production of the property after 

December 20, 2006, and the property is placed in service before 

January 1, 2013 (and all other requirements are met). Property 

that is manufactured, constructed, or produced for the taxpayer by 

another person under a contract that is entered into prior to the 

manufacture, construction, or production of the property is considered to be manufactured, constructed, or produced by the taxpayer. 


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Property any portion of which is financed with the proceeds of a 

tax-exempt obligation under section 103 is not eligible for the additional first-year depreciation deduction. Recapture rules apply if 

the property ceases to be qualified cellulosic biomass ethanol plant 

property. 

Property with respect to which the taxpayer has elected 50 percent expensing under section 179C is not eligible for the additional 

first-year depreciation deduction. 

REASONS FOR CHANGE

The Committee believes that the expensing provision should include any cellulosic biomass alcohol and not be limited to ethanol. 

Additionally, the Committee believes that the provision should not 

be limited to certain processes. 

EXPLANATION OF PROVISION

The provision changes the definition of qualified property. Under 

the provision, qualified property includes property used solely to 

produce cellulosic biomass alcohol. Cellulosic biomass alcohol is defined as any alcohol produced by any process from any 

lignocellulosic or hemicellulosic matter that is available on a renewable or recurring basis. 

EFFECTIVE DATE

The provision is effective for property placed in service in taxable 

years ending after the date of enactment. 

E. CREDIT FOR PRODUCTION OF CELLULOSIC BIOMASS ALCOHOL

(Sec. 312 of the bill and sec. 40 of the Code) 

PRESENT LAW

In the case of ethanol, the Code provides a separate 10-cents-pergallon credit for up to 15 million gallons per year for small producers, defined generally as persons whose production capacity 

does not exceed 60 million gallons per year. The ethanol must (1) 

be sold by such producer to another person (a) for use by such 

other person in the production of a qualified alcohol fuel mixture 

in such person’s trade or business (other than casual off-farm production), (b) for use by such other person as a fuel in a trade or 

business, or, (c) who sells such ethanol at retail to another person 

and places such ethanol in the fuel tank of such other person; or 

(2) used by the producer for any purpose described in (a), (b), or 

(c). A cooperative may pass through the small ethanol producer 

credit to its patrons. The credit is includible in income and is treated as a general business credit, subject to the ordering rules and 

carryforward/carryback rules that apply to business credits generally. The alcohol fuels tax credit, of which the small producer 

credit is a part, is scheduled to expire after December 31, 2010. 

Under the Renewable Fuels Standard Program all renewable fuel 

produced or imported on or after September 1, 2007 must have a 

renewable identification number (RIN) associated with it. Producers and importers must generate RINs to represent all the renewable fuel they produce or import and provide those RINs to the 


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EPA. For cellulosic ethanol, 2.5 RINs are generated for every gallon produced. 

REASONS FOR CHANGE

The Committee believes that the development of fuels from cellulosic materials, such as corn stover, switchgrass, and other organic materials that can be grown anywhere, is a significant component in establishing the nation’s energy independence. Tax incentives are an important part of taking this industry from the 

level of demonstration projects into a practical and competitive fuel 

source. To encourage new production capacity for this fuel, the provision provides a new per-gallon incentive for cellulosic alcohol fuel 

producers. 

EXPLANATION OF PROVISION

The provision provides an income tax credit for up to 60 million 

gallons of qualified cellulosic fuel production of the producer for the 

taxable year. The amount of the credit per gallon is $1.28 less the 

credit amount for alcohol fuel and the credit amount for small ethanol producers as of the date the cellulosic alcohol fuel is produced. 

This credit is in addition to any credit that may be available under 

section 40 of the Code. A small cellulosic alcohol fuel producer is 

not precluded from also claiming the alcohol or alcohol fuel mixture 

credit, or the small ethanol producer credit, if the requirements for 

those credits are also met. For example, in the case of a gallon of 

ethanol, a small producer may be able to claim 50 cents as a cellulosic alcohol producer, plus 51 cents under the alcohol fuel mixture credit, and an additional 10 cents as a small ethanol producer. 

Qualified cellulosic fuel production is any cellulosic alcohol which 

is produced by a small cellulosic alcohol fuel producer during the 

taxable year which is sold by such producer to another person (a) 

for use by such other person in the production of a qualified alcohol 

fuel mixture in such person’s trade or business (other than casual 

off-farm production), (b) for use by such other person as a fuel in 

a trade or business, or, (c) who sells such alcohol at retail to another person and places such alcohol in the fuel tank of such other 

person; or (2) used by the producer for any purpose described in (a), 

(b), or (c). 

Cellulosic alcohol is alcohol that is produced in the United States 

and is derived from any lignocellulosic or hemicellulosic matter 

that is available on a renewable or recurring basis. Examples of 

lignocellulosic or hemicellulosic matter that is available of a renewable or recurring basis includes dedicated energy crops and trees, 

wood and wood residues, plants, grasses, agricultural residues, fibers, animal wastes and other waste materials, and municipal solid 

waste. 

Generally, a small cellulosic alcohol fuel producer is a cellulosic 

alcohol producer whose production capacity does not exceed 60 million gallons. 

The small cellulosic alcohol producer credit is limited to domestic 

production. Only domestically produced cellulosic alcohol sold for 

use, or used, in the United States qualifies for the credit. 

The small cellulosic alcohol producer credit terminates on April 

1, 2015. 


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43The alcohol fuels credit is unavailable when, for any period before January 1, 2011, the tax 

rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 44 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less 

than 190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with 

a proof that is at least 150 but less than 190, the low-proof blender amount is 37.78 cents. 

EFFECTIVE DATE

The provision is effective for alcohol produced after December 31, 

2007. 

F. EXTENSION OF SMALL ETHANOL PRODUCER CREDIT

(Sec. 313 of the bill and sec. 40 of the Code) 

PRESENT LAW

The alcohol fuels credit is the sum of three credits: the alcohol 

mixture credit, the alcohol credit, and the small ethanol producer 

credit. Generally, the alcohol fuels credit expires after December 

31, 2010.43

Taxpayers are eligible for an income tax credit of 51 cents per 

gallon of ethanol (60 cents in the case of alcohol other than ethanol) used in the production of a qualified mixture (the ‘‘alcohol 

mixture credit’’). A ‘‘qualified mixture’’ means a mixture of alcohol 

and gasoline, (or of alcohol and a special fuel) sold by the taxpayer 

as fuel, or used as fuel by the taxpayer producing such mixture. 

The term ‘‘alcohol’’ includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a proof of less than 150. 

Taxpayers may reduce their income taxes by 51 cents for each 

gallon of ethanol, which is not in a mixture with gasoline or other 

special fuel, that they sell at the retail level as vehicle fuel or use 

themselves as a fuel in their trade or business (‘‘the alcohol credit’’). For alcohol other than ethanol, the rate is 60 cents per gallon.44

In the case of ethanol, the Code provides an additional 10-centsper-gallon credit for up to 15 million gallons per year for small producers. Small producers are defined generally as persons whose 

production capacity does not exceed 60 million gallons per year. 

The ethanol must (1) be sold by such producer to another person 

(a) for use by such other person in the production of a qualified alcohol fuel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a 

fuel in a trade or business, or, (c) who sells such ethanol at retail 

to another person and places such ethanol in the fuel tank of such 

other person; or (2) be used by the producer for any purpose described in (a), (b), or (c). A cooperative may pass through the small 

ethanol producer credit to its patrons. 

The alcohol fuels credit is includible in income and is treated as 

a general business credit, subject to the ordering rules and 

carryforward/carryback rules that apply to business credits generally. The credit is allowable against the alternative minimum 

tax. 

REASONS FOR CHANGE

The Committee believes that as the ethanol industry continues 

to mature, it is appropriate to encourage small producers to conVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00046 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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45The alcohol fuels credit is unavailable when, for any period before January 1, 2011, the tax 

rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 46 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less 

than 190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with 

a proof that is at least 150 but less than 190, the low-proof blender amount is 37.78 cents. 

tinue to participate in such industry. Therefore, the bill extends the 

small ethanol producer credit for an additional two years. 

EXPLANATION OF PROVISION

The provision extends the small ethanol producer component of 

the alcohol fuels credit for an additional two years (through December 31, 2012). 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

G. CREDIT FOR PRODUCERS OF FOSSIL-FREE ALCOHOL

(Sec. 314 of the bill and sec. 40 of the Code) 

PRESENT LAW

The alcohol fuels credit is the sum of three credits: the alcohol 

mixture credit, the alcohol credit, and the small ethanol producer 

credit. Generally, the alcohol fuels credit expires after December 

31, 2010.45

Taxpayers are eligible for an income tax credit of 51 cents per 

gallon of ethanol (60 cents in the case of alcohol other than ethanol) used in the production of a qualified mixture (the ‘‘alcohol 

mixture credit’’). A ‘‘qualified mixture’’ means a mixture of alcohol 

and gasoline, (or of alcohol and a special fuel) sold by the taxpayer 

as fuel, or used as fuel by the taxpayer producing such mixture. 

The term ‘‘alcohol’’ includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a proof of less than 150. 

Taxpayers may reduce their income taxes by 51 cents for each 

gallon of ethanol, which is not in a mixture with gasoline or other 

special fuel, that they sell at the retail level as vehicle fuel or use 

themselves as a fuel in their trade or business (‘‘the alcohol credit’’). For alcohol other than ethanol, the rate is 60 cents per gallon.46

In the case of ethanol, the Code provides an additional 10-centsper-gallon credit for up to 15 million gallons per year for small producers. Small producer is defined generally as a producer whose 

production capacity does not exceed 60 million gallons per year. 

The ethanol must (1) be sold by such producer to another person 

(a) for use by such other person in the production of a qualified alcohol fuel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a 

fuel in a trade or business, or, (c) who sells such ethanol at retail 

to another person and places such ethanol in the fuel tank of such 

other person; or (2) be used by the producer for any purpose described in (a), (b), or (c). A cooperative may pass through the small 

ethanol producer credit to its patrons. 

The alcohol fuels credit is includible in income and is treated as 

a general business credit, subject to the ordering rules and 


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47The alcohol fuels credit is unavailable when, for any period before January 1, 2011, the tax 

rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 

carryforward/carryback rules that apply to business credits generally. The credit is allowable against the alternative minimum 

tax. 

REASONS FOR CHANGE

The production of ethanol consumes a significant amount of fossil 

fuel. To encourage the use of alternative fuels in that production 

process, the Committee believes it is appropriate to provide an additional credit to small producers of ethanol that displace 90 percent of the fossil-fuel use with bio-based fuels. 

EXPLANATION OF PROVISION

The provision adds a new component to the alcohol fuels credit, 

the small fossil-free alcohol producer credit. The credit provides an 

additional 25-cents-per-gallon credit for up to 60 million gallons of 

alcohol produced at a fossil-free facility during the calendar year 

for small producers. Small producer is defined generally as a producer whose fossil-free alcohol production capacity does not exceed 

60 million gallons per year. A fossil-free facility is one at which 90 

percent of the fuel used in the production of alcohol at such facility 

is from biomass as defined in sec. 45K(c)(3). 

The alcohol must (1) be sold by such producer to another person 

(a) for use by such other person in the production of a qualified alcohol fuel mixture in such person’s trade or business (other than 

casual off-farm production), (b) for use by such other person as a 

fuel in a trade or business, or, (c) who sells such ethanol at retail 

to another person and places such ethanol in the fuel tank of such 

other person; or (2) used by the producer for any purpose described 

in (1)(a), (b), or (c). Only domestically produced alcohol, sold for use 

or used in the United States qualifies for the credit. A cooperative 

may pass through the small producer credit to its patrons. 

The credit terminates after December 31, 2012. 

EFFECTIVE DATE

The provision is effective after December 31, 2007. 

H. MODIFICATION OF ALCOHOL CREDIT

(Sec. 315 of the bill and secs. 40, 6426 and 6427 of the Code) 

Income tax credit 

The alcohol fuels credit is the sum of three credits: the alcohol 

mixture credit, the alcohol credit, and the small ethanol producer 

credit. Generally, the alcohol fuels credit expires after December 

31, 2010.47

Taxpayers are eligible for an income tax credit of 51 cents per 

gallon of ethanol (60 cents in the case of alcohol other than ethanol) used in the production of a qualified mixture (the ‘‘alcohol 

mixture credit’’). A ‘‘qualified mixture’’ means a mixture of alcohol 

and gasoline, (or of alcohol and a special fuel) sold by the taxpayer 

as fuel, or used as fuel by the taxpayer producing such mixture. 

The term ‘‘alcohol’’ includes methanol and ethanol but does not inVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00048 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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48 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less 

than 190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with 

a proof that is at least 150 but less than 190, the low-proof blender amount is 37.78 cents. 

clude (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a proof of less than 150. 

Taxpayers may reduce their income taxes by 51 cents for each 

gallon of ethanol, which is not in a mixture with gasoline or other 

special fuel, that they sell at the retail level as vehicle fuel or use 

themselves as a fuel in their trade or business (‘‘the alcohol credit’’). For alcohol other than ethanol, the rate is 60 cents per gallon.48

In the case of ethanol, the Code provides an additional 10-centsper-gallon credit for up to 15 million gallons per year for small producers. Small producer is defined generally as persons whose production capacity does not exceed 60 million gallons per year. The 

ethanol must (1) be sold by such producer to another person (a) for 

use by such other person in the production of a qualified alcohol 

fuel mixture in such person’s trade or business (other than casual 

off-farm production), (b) for use by such other person as a fuel in 

a trade or business, or, (c) who sells such ethanol at retail to another person and places such ethanol in the fuel tank of such other 

person; or (2) used by the producer for any purpose described in (a), 

(b), or (c). A cooperative may pass through the small ethanol producer credit to its patrons. 

The alcohol fuels credit is includible in income and is treated as 

a general business credit, subject to the ordering rules and 

carryforward/carryback rules that apply to business credits generally. The credit is allowable against the alternative minimum 

tax. 

Excise tax credit and payment provision for alcohol fuel mixtures 

The Code also provides an excise tax credit and payment provision for alcohol fuel mixtures. Like the income tax credit, the 

amount of the credit is 60 cents per gallon of alcohol used as part 

of a qualified mixture (51 cents in the case of ethanol). For purposes of the excise tax credit and payment provisions, alcohol includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) 

alcohol with a proof of less than 190. Such term also includes an 

alcohol gallon equivalent of ethyl tertiary butyl either or other 

ethers produced from alcohol. In lieu of a tax credit, a person making a qualified mixture eligible for the credit may seek a payment 

from the Secretary in the amount of the credit. The payment provisions and credits are coordinated such that the incentive is not 

claimed more than once for each gallon of alcohol used as part of 

qualified mixture. 

Renewable Fuels Standard Program 

Under the Renewable Fuels Standard Program all renewable fuel 

produced or imported on or after September 1, 2007 must have a 

renewable identification number (RIN) associated with it. Producers and importers must generate RINs to represent all the renewable fuel they produce or import and provide those RINs to the 

Environmental Protection Agency. For cellulosic ethanol, 2.5 RINs 

are generated for every gallon produced. 


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49Sec. 40(d)(4). 

REASONS FOR CHANGE

As the ethanol industry further matures, the Committee believes 

it is appropriate to reduce the amount of the tax incentive. 

EXPLANATION OF PROVISION

Under the provision, the 51-cent-per-gallon incentive for ethanol 

is adjusted to 46 cents per gallon beginning with the first calendar 

year after the year in which the Environmental Protection Agency 

receives RINs in an amount equivalent to 7.5 billion gallons of ethanol (including cellulosic ethanol). 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

I. CALCULATION OF VOLUME OF ALCOHOL FOR FUELS CREDITS

(Sec. 316 of the bill, and sec. 40 of the Code) 

PRESENT LAW

The Code provides a per-gallon credit for the volume of alcohol 

used as a fuel or in a qualified mixture. For purposes of determining the number of gallons of alcohol with respect to which the 

credit is allowable, the volume of alcohol includes any denaturant, 

including gasoline.49 The denaturant must be added under a formula approved by the Secretary and the denaturant cannot exceed 

five percent of the volume of such alcohol (including denaturants). 

REASONS FOR CHANGE

Gasoline can be used as a denaturant of alcohol. The Committee 

believes it is inappropriate to allow a credit that is intended to be 

for alcohol to be claimed on liquids that do not constitute alcohol. 

EXPLANATION OF PROVISION

The provision provides that the volume of alcohol eligible for the 

credit does not include the volume of any denaturant. 

EFFECTIVE DATE

The provision is effective January 1, 2008. 

J. ETHANOL TARIFF EXTENSION

(Sec. 317 of the bill) 

PRESENT LAW

Heading 9901.00.50 of the Harmonized Tariff Schedule of the 

United States imposes a cumulative general duty of 14.27 cents per 

liter (approximately 54 cents per gallon) to imports of ethyl alcohol, 

and any mixture containing ethyl alcohol, if used as a fuel or in 

producing a mixture to be used as a fuel, that are entered into the 

United States prior to January 1, 2009. The temporary duty under 

heading 9901.00.50 offsets the alcohol fuels credit of 51 cents per 

gallon that is available to taxpayers that blend ethanol with gasoVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00050 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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line; both domestic and imported ethanol is eligible for the alcohol 

fuels credit. 

Heading 9901.00.52 of the Harmonized Tariff Schedule of the 

United States imposes a general duty of 5.99 cents per liter to imports of ethyl tertiary-butyl ether, and any mixture containing 

ethyl tertiary-butyl ether, that are entered into the United States 

prior to January 1, 2009. 

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the tariff 

through the end of calendar year 2010. 

EXPLANATION OF PROVISION

The provision modifies the existing effective period for ethyl alcohol as classified under heading 9901.00.50 and 9901.00.52 of the 

Harmonized Tariff Schedule of the United States from before January 1, 2009 to before January 1, 2011. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

K. ELIMINATION AND REDUCTIONS OF DUTY DRAWBACK ON CERTAIN

IMPORTED ETHANOL

(Sec. 318 of the bill) 

PRESENT LAW

Subheading 9901.00.50, Harmonized Tariff Schedule of the 

United States (‘‘HTSUS’’), imposes an additional duty on ethanol 

that is used as fuel or use to make fuel. Subsection (b) of Section 

1313 of the Tariff Act of 1930, as amended, permits the refund of 

duty if the duty-paid good, or a substitute good, is used to make 

an article that is exported. Subsection (j)(2) of Section 1313 permits 

the refund of duty if the duty-paid good, or a substitute good, is exported. Subsection (p) of section 1313 permits the substitution on 

exportation for drawback eligibility of one motor fuel for another 

motor fuel. A person who manufactures or acquires gasoline with 

ethanol subject to the duty imposed by subheading 9901.00.50, 

HTSUS, can export jet fuel (which does not involve the use of ethanol) and obtain a refund of the duty paid under subheading 

9901.00.50, HTSUS. 

REASONS FOR CHANGE

The Committee believes it is appropriate to eliminate the ability 

to claim duty drawback on the substitution of jet fuel for ethyl alcohol (ethanol), or an ethyl alcohol mixture, used as a fuel. In addition, the Committee believes that it is appropriate to eliminate the 

ability to claim duty drawback on the substitution of a low-value 

ethyl alcohol for ethyl alcohol (ethanol) subject to the duty under 

HTSUS subheading 9901.00.50. 

EXPLANATION OF PROVISION

The provision eliminates the ability to obtain a refund of the 

duty imposed by subheading 9901.00.50, HTSUS by substitution of 


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50Sec. 40A. 51Treasury Notice 2005–62. 

ethanol not subject to the duty under subheading 9901.00.50, 

HTSUS for ethanol subject to the duty imposed under subheading 

9901.00.50, HTSUS, for drawback purposes. The provision also prevents a petroleum product which contains ethanol from being substituted for any other petroleum product that is exported to obtain 

drawback. 

EFFECTIVE DATE

The provision is effective for any good exported on and after the 

fifteenth day after enactment. 

L. EXTENSION OF CREDITS FOR BIODIESEL

(Sec. 321 of the bill and secs. 40A, 6426 and 6427 of the Code) 

PRESENT LAW

Income tax credit 

Overview 

The Code provides an income tax credit for biodiesel fuels (the ‘‘biodiesel fuels credit’’).50 The biodiesel fuels credit is the sum of 

the biodiesel mixture credit, the biodiesel credit, and the small 

agri-biodiesel producer credit. The biodiesel fuels credit is treated 

as a general business credit. The amount of the biodiesel fuels 

credit is includable in gross income. The biodiesel fuels credit is coordinated to take into account benefits from the biodiesel excise tax 

credit and payment provisions discussed below. The credit does not 

apply to fuel sold or used after December 31, 2008. 

Biodiesel is monoalkyl esters of long chain fatty acids derived 

from plant or animal matter that meet (1) the registration requirements established by the Environmental Protection Agency under 

section 211 of the Clean Air Act and (2) the requirements of the 

American Society of Testing and Materials D6751. Agri-biodiesel is 

biodiesel derived solely from virgin oils including oils from corn, 

soybeans, sunflower seeds, cottonseeds, canola, crambe, rapeseeds, 

safflowers, flaxseeds, rice bran, mustard seeds, or animal fats. The 

language ‘‘including’’ indicates that this list is not exclusive.51

Camelina is a plant from which oil can be extracted. 

Biodiesel may be taken into account for purposes of the credit 

only if the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer or importer 

of the biodiesel which identifies the product produced and the percentage of the biodiesel and agri-biodiesel in the product. 

Biodiesel mixture credit 

The biodiesel mixture credit is 50 cents for each gallon of biodiesel (other than agri-biodiesel) used by the taxpayer in the production of a qualified biodiesel mixture. For agri-biodiesel, the credit is $1.00 per gallon. A qualified biodiesel mixture is a mixture of 

biodiesel and diesel fuel that (1) is sold by the taxpayer producing 

such mixture to any person for use as a fuel, or (2) is used as a 

fuel by the taxpayer producing such mixture. The sale or use must 

be in the trade or business of the taxpayer and is to be taken into 


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52Sec. 6426(c). 53Sec. 6426(c)(4). 54Sec. 6427(e). 

account for the taxable year in which such sale or use occurs. No 

credit is allowed with respect to any casual off-farm production of 

a qualified biodiesel mixture. 

Biodiesel credit 

The biodiesel credit is 50 cents for each gallon of biodiesel which 

is not in a mixture with diesel fuel (100 percent biodiesel or B–100) 

and which during the taxable year is (1) used by the taxpayer as 

a fuel in a trade or business or (2) sold by the taxpayer at retail 

to a person and placed in the fuel tank of such person’s vehicle. For 

agri-biodiesel, the credit is $1.00 per gallon. 

Small agri-biodiesel producer credit 

The Code provides a small agri-biodiesel producer income tax 

credit, in addition to the biodiesel and biodiesel fuel mixture credits. The credit is a 10-cents-per-gallon credit for up to 15 million 

gallons of agri-biodiesel produced by small producers, defined generally as persons whose agri-biodiesel production capacity does not 

exceed 60 million gallons per year. The agri-biodiesel must (1) be 

sold by such producer to another person (a) for use by such other 

person in the production of a qualified biodiesel mixture in such 

person’s trade or business (other than casual off-farm production), 

(b) for use by such other person as a fuel in a trade or business, 

or, (c) who sells such agri-biodiesel at retail to another person and 

places such ethanol in the fuel tank of such other person; or (2) 

used by the producer for any purpose described in (a), (b), or (c). 

Biodiesel mixture excise tax credit 

The Code also provides an excise tax credit for biodiesel mixtures.52 The credit is 50 cents for each gallon of biodiesel used by 

the taxpayer in producing a biodiesel mixture for sale or use in a 

trade or business of the taxpayer. In the case of agri-biodiesel, the 

credit is $1.00 per gallon. A biodiesel mixture is a mixture of biodiesel and diesel fuel that (1) is sold by the taxpayer producing 

such mixture to any person for use as a fuel, or (2) is used as a 

fuel by the taxpayer producing such mixture. No credit is allowed 

unless the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer of the biodiesel that identifies the product produced and the percentage of 

biodiesel and agri-biodiesel in the product.53

The credit is not available for any sale or use for any period after 

December 31, 2008. This excise tax credit is coordinated with the 

income tax credit for biodiesel such that credit for the same biodiesel cannot be claimed for both income and excise tax purposes. 

Payments with respect to biodiesel fuel mixtures 

If any person produces a biodiesel fuel mixture in such person’s 

trade or business, the Secretary is to pay such person an amount 

equal to the biodiesel mixture credit.54 To the extent the biodiesel 

fuel mixture credit exceeds the section 4081 liability of a person, 

the Secretary is to pay such person an amount equal to the bioVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00053 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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55Sec. 6427(e)(1) and 6427(e)(3). 56Secs. 40A, 6426(c), and 6427(e). For purposes of the Code, renewable diesel is generally 

treated as biodiesel. The Code also provides an income tax credit for renewable diesel that is 

not in a mixture which is sold at retail to a person and placed in the fuel tank of such person’s vehicle or used by the taxpayer producing the renewable diesel as a fuel in a trade or business. 

See sec. 40A(b)(2) in conjunction with sec. 40A(f)(1). 57 ‘‘Biomass’’ means any organic material other than (1) oil and natural gas (or any product 

thereof) and (2) coal (including lignite) or any product thereof (sec. 45K(c)(3)). 

diesel fuel mixture credit with respect to such mixture.55 Thus, if 

the person has no section 4081 liability, the credit is refundable. 

The Secretary is not required to make payments with respect to 

biodiesel fuel mixtures sold or used after December 31, 2008. 

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the biodiesel 

incentives to further encourage the development and use of this 

fuel. In particular, to encourage the participation of small producers into the market, the Committee believes it is appropriate to 

extend the small agri-biodiesel producer credit an additional four 

years. 

EXPLANATION OF PROVISION

The provision generally extends an additional two years (through 

December 31, 2010) the income tax credit, excise tax credit, and 

payment provisions for biodiesel (including agri-biodiesel). The 

small agri-biodiesel producer credit is extended an additional four 

years (through December 31, 2012). The provision adds camelina to 

the illustrative and nonexclusive list of sources of virgin oils for 

agri-biodiesel. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

M. EXTENSION AND MODIFICATION OF RENEWABLE DIESEL

INCENTIVES

(Sec. 321 of the bill and sec. 40A(f), 6426 and 6427 of the Code) 

PRESENT LAW

The Code provides a tax incentive of $1.00 per gallon relating to 

renewable diesel that is part of a qualified mixture with diesel fuel. 

This incentive may be taken as an income tax credit, an excise tax 

credit, or as a payment from the Secretary.56 The incentive is available only to the person who produced and sold or used the mixture 

in their trade or business and is based on the gallons of renewable 

diesel in the mixture. The provisions relating to renewable diesel 

do not apply after December 31, 2008. 

‘‘Renewable diesel’’ is diesel fuel that (1) is derived from biomass 

(as defined in section 45K(c)(3) 57) using a thermal 

depolymerization process; (2) meets the registration requirements 

for fuels and fuel additives established by the Environmental Protection Agency under section 211 of the Clean Air Act (42 U.S.C. 

sec. 7545); and (3) meets the requirements of the American Society 

of Testing and Materials (ASTM) D975 or D396. ASTM D975 provides standards for diesel fuel suitable for use in diesel engines. 


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58Sec. 4081(a)(1). 

ASTM D396 provides standards for fuel oil intended for use in fueloil burning equipment, such as furnaces. 

Pursuant to IRS Notice 2007–37, the Secretary provided that fuel 

produced as a result of co-processing biomass and petroleum feedstock (‘‘co-produced fuel’’) qualifies for the renewable diesel incentives to the extent of the fuel attributable to the biomass in the 

mixture. In co-produced fuel, the fuel attributable to the biomass 

does not exist as a distinct separate quantity prior to mixing. 

REASONS FOR CHANGE

To encourage the further development of renewable diesel, the 

Committee believes it is appropriate to extend the tax incentives 

for this fuel. However, the Committee also believes that less incentives are needed for renewable diesel produced as part of the refining process of crude oil. Utilizing existing refinery processes does 

not require significant investment in new equipment to produce the 

renewable diesel. Therefore, the Committee limits the incentive as 

it relates to co-produced fuel. 

EXPLANATION OF PROVISION

The provision provides that, on a per year basis, producers of co- produced fuel may claim $1.00 per gallon for up to 60 million gallons of renewable diesel contained in a qualified mixture. The 60 

million gallons is determined on a per facility basis. No credit is 

allowable for gallons in excess of 60 million gallons produced at a 

facility. As under present law, the credit and payments are only for 

that volume of renewable diesel contained in the qualified mixture 

and not the total volume of co-produced fuel. 

The provision extends the tax incentives for renewable diesel (income tax credit, excise tax credit, and payment provisions) an additional two years (through December 31, 2010). 

EFFECTIVE DATE

The provision restricting the amount of credit allowable for coproduced fuels is effective for fuels sold or used after the date of 

enactment. The extension of the renewable diesel incentives is effective on the date of enactment. 

N. TREATMENT OF QUALIFIED ALCOHOL MIXTURES AND QUALIFIED

BIODIESEL FUEL MIXTURES AS TAXABLE FUELS

(Sec. 322 of the bill and sec. 4083 of the Code) 

PRESENT LAW

An excise tax is imposed upon (1) the removal of any taxable fuel 

from a refinery or terminal, (2) the entry of any taxable fuel into 

the United States, or (3) the sale of any taxable fuel to any person 

who is not registered with the IRS to receive untaxed fuel, unless 

there was a prior taxable removal or entry.58 The tax does not 

apply to any removal or entry of taxable fuel transferred in bulk 

by pipeline or vessel to a terminal or refinery if the person removing or entering the taxable fuel, the operator of such pipeline or 

vessel (excluding deep draft vessels) and the operator of such terVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00055 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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59Sec. 4081(a)(1)(B). 60Sec. 4083(a). 61Sec. 4083(a)(3). 62Treas. Reg. sec. 48.4081–1(c)(2)(ii). 63 Under Treas. Reg. sec. 48.4081–1(c), blended taxable fuel generally means any taxable fuel 

that (1) is produced outside the bulk transfer/terminal system and (2) by mixing taxable fuel 

with respect to which tax has been imposed under sec. 4081(a)(gasoline, diesel fuel, or kerosene) 

with any other liquid on which tax has not been imposed under sec. 4081. 

minal or refinery are registered with the Secretary.59 The term ‘‘taxable fuel’’ means gasoline, diesel fuel, and kerosene.60

Diesel fuel is (1) any liquid suitable for use in a diesel powered 

highway vehicle or diesel powered train, (2) transmix, and (3) diesel fuel blendstocks identified by the Secretary.61 By regulation, 

diesel fuel does not include kerosene, gasoline, No. 5 and No. 6 fuel 

oils (as described in ASTM Specification D 396), or F–76 (Fuel 

Naval Distillates MIL–F–16884) any liquid that contains less than 

four percent normal parafins, or any liquid that has a distillation 

range of 125 degrees Fahrenheit or less, sulfur content of 10 ppm 

or less and minimum color of +27 Saybolt.62

Biodiesel is monoalkyl esters of long chain fatty acids derived 

from plant or animal matter which meet (1) the registration requirements for fuels and fuel additives established by the Environmental Protection Agency under section 211 of the Clean Air Act, 

and (2) the requirements of the American Society of Testing Materials D6751 (‘‘ASTM D6751’’). 

Biodiesel is not a taxable fuel because it has less than four percent paraffin content. Ethanol and other fuel alcohols also are not 

treated as taxable fuel. However, such fuels are subject to the 

backup tax under section 4041 if sold for use or used as a fuel in 

a diesel powered highway vehicle or diesel powered train and not 

for a nontaxable use. In addition, such fuels are taxable if used in 

the production of a blended taxable fuel.63

The Code provides per-gallon tax incentives relating to biodiesel 

fuel used in a qualified mixture. The taxpayer has the option of 

taking the credit amount as an income tax credit, excise tax credit 

against the tax imposed on taxable fuels (‘‘section 4081 liability’’) 

or as a payment from the Secretary in the amount of the credit. 

The credit is 50 cents for each gallon of biodiesel used by the taxpayer in producing a biodiesel mixture for sale or use in a trade 

or business of the taxpayer. In the case of agri-biodiesel, the credit 

is $1.00 per gallon. No credit is allowed unless the taxpayer obtains 

a certification from the producer or importer of the biodiesel that 

identifies the product produced and the percentage of biodiesel and 

agri-biodiesel in the product. 

A qualified biodiesel mixture is a mixture of biodiesel and diesel 

fuel that (1) is sold by the taxpayer producing such mixture to any 

person for use as a fuel, or (2) is used as a fuel by the taxpayer 

producing such mixture. Pursuant to Treasury Notice, a mixture of 

99.9 percent biodiesel and diesel fuel is considered a mixture but 

such mixture is not a blended taxable fuel because it contains less 

than four percent paraffin content. Thus, while eligible for the biodiesel fuel mixture tax credit and payment provisions, such fuel 

would not be subject to tax until put in a motor vehicle for a taxable use. 

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ture of alcohol and gasoline, (or of alcohol and a special fuel) sold 

by the taxpayer as fuel, or used as fuel by the taxpayer producing 

such mixture. The credit is 51 cents if the alcohol is ethanol (60 

cents in the case of other alcohols). 

REASONS FOR CHANGE

The Committee notes that when it enacted the credit for qualified biodiesel fuel mixtures, it intended that the resulting mixture 

of biodiesel and diesel fuel would be a taxable fuel and that the 

credit would be taken against the tax imposed on that fuel if not 

used for a nontaxable purpose. For biodiesel not in a mixture, it 

was intended that tax be imposed on the fuel when it was sold at 

retail into the fuel tank of a motor vehicle. It has come to the Committee’s attention that persons are exploiting the Treasury Notice 

by adding minute amounts of diesel fuel to biodiesel in order to 

claim the full amount of credit for biodiesel fuel mixtures, while not 

paying any tax on the fuel because it does not meet the regulatory 

definition of diesel fuel. The Committee believes that such exploitation occurs to avoid both the imposition of tax and the more restrictive rules governing biodiesel that is not in a mixture, which 

require that the fuel be sold as motor fuel. The Committee believes 

it is consistent with Committee intent and appropriate to subject 

such fuel mixtures eligible for the fuel mixture credits to the taxes 

applicable to diesel fuel (taxes applicable to gasoline in the case of 

a mixture of alcohol and special fuel). 

EXPLANATION OF PROVISION

The provision adds qualified alcohol fuel mixtures and qualified 

biodiesel fuel mixtures to the definition of taxable fuel. The proposal also requires the Secretary to require producers of these mixtures to file information reports with the Secretary. 

The provision modifies the certification requirements for biodiesel. In addition to certifying that the product meets the statutory definition of biodiesel and identifying the percentage of biodiesel and agri-biodiesel in the product, the provision also requires 

the importer or producer to provide documentation that the biodiesel was tested by an independent laboratory and found to meet 

the requirements of ASTM D6751. 

EFFECTIVE DATE

The provision is effective for fuels removed, entered, or sold after 

December 31, 2007. 

O. EXTENSION AND MODIFICATION OF THE ALTERNATIVE FUEL

CREDITS

(Sec. 331 of the bill and sec. 6426 and 6427 of the Code) 

PRESENT LAW

The Code provides two per-gallon excise tax credits with respect 

to alternative fuel, the alternative fuel credit, and the alternative 

fuel mixture credit. For this purpose, the term ‘‘alternative fuel’’

means liquefied petroleum gas, P Series fuels (as defined by the 

Secretary of Energy under 42 U.S.C. sec. 13211(2)), compressed or 

liquefied natural gas, liquefied hydrogen, liquid fuel derived from 


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64 ‘‘Gasoline gallon equivalent’’ means, with respect to any nonliquid alternative fuel, the 

amount of such fuel having a Btu content of 124,800 (higher heating value). 

coal through the Fischer-Tropsch process, or liquid hydrocarbons 

derived from biomass. Such term does not include ethanol, methanol, or biodiesel. 

The alternative fuel credit is allowed against section 4041 liability and the alternative fuel mixture credit is allowed against section 4081 liability. Neither credit is allowed unless the taxpayer is 

registered with the Secretary. The alternative fuel credit is 50 

cents per gallon of alternative fuel or gasoline gallon equivalents 64

of nonliquid alternative fuel sold by the taxpayer for use as a motor 

fuel in a motor vehicle or motorboat, or so used by the taxpayer. 

The alternative fuel mixture credit is 50 cents per gallon of alternative fuel used in producing an alternative fuel mixture for sale 

or use in a trade or business of the taxpayer. The mixture must 

be sold by the taxpayer producing such mixture to any person for 

use as a fuel or used by the taxpayer for use as a fuel. The credits 

generally expire after September 30, 2009. 

A person may file a claim for payment equal to the amount of 

the alternative fuel credit and alternative fuel mixture credits. 

These payment provisions generally also expire after September 30, 

2009. 

With respect to liquefied hydrogen, the credit and payment provisions expire after September 30, 2014. Under coordination rules, a 

claim for payment or credit may only be taken once with respect 

to any particular gallon or gasoline-gallon equivalent of alternative 

fuel. 

REASONS FOR CHANGE

The Committee believes it is appropriate to extend the alternative fuel excise tax credits to encourage the production and use 

of these fuels. However, the Committee is concerned with the carbon emissions from coal facilities and the impact of such emissions 

on the environment. Therefore, the provision imposes a carbon sequestration requirement for facilities producing liquid fuel from 

coal as a condition of credit eligibility. 

EXPLANATION OF PROVISION

The provision extends the alternative fuel excise tax credit, alternative fuel mixture excise tax credit and related payment provisions through December 31, 2010, for all fuels other hydrogen. The 

incentives for hydrogen are unchanged by the proposal and will expire as provided under present law. The provision provides that 

biomass gas qualifies for the credit. The provision also provides 

that alternative fuel that is not in a mixture may be used, or sold 

for use, as a fuel in aviation for purposes of the credit. 

Beginning on the date of enactment, to qualify as an alternative 

fuel, liquid fuel from coal derived through the Fischer-Tropsch 

process must be certified as having been derived from coal produced at a gasification facility that separates and sequesters at 

least 50 percent of such facilities total carbon dioxide emissions. 

The sequestration requirement increases to 75 percent on the earlier of (1) December 31, 2010, or (2) the date the Secretary determines that, taking into account the recommendations of the Carbon 


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65Sec. 30C. 

Sequestration Capability Panel, the sequestration rate should be 75 

percent. 

The Carbon Sequestration Capability Panel is composed of one 

individual appointed by the National Academy of Sciences, one individual appointed by the Chairman of the Committee on Finance 

in consultation with the Ranking member of the Committee, and 

one individual jointly appointed by the other two members. The 

panel is to submit to the Secretary, the Senate Committee on Finance, and the House Committee on Ways and Means a report regarding the appropriate percentage of carbon dioxide sequestration 

for purposes of liquid fuel derived from coal through the Fischer 

Tropsch process. In preparing its report, the panel shall consider 

whether it is feasible to separate and sequester 75 percent of the 

carbon dioxide emissions of a facility and the costs and other factors associated with separating and sequestering such percentage 

of carbon dioxide emissions. The report is to be submitted on the 

date that is six months after the date of enactment. The Secretary 

is to make his determination within 30 days of receiving the report. 

EFFECTIVE DATE

The provision is effective for fuel sold or used after date of enactment. 

P. EXTENSION OF ALTERNATIVE FUEL VEHICLE REFUELING

PROPERTY CREDIT

(Sec. 332 of the bill and sec. 30C of the Code) 

PRESENT LAW

Taxpayers may claim a 30-percent credit for the cost of installing 

qualified clean-fuel vehicle refueling property to be used in a trade 

or business of the taxpayer or installed at the principal residence 

of the taxpayer.65 The credit may not exceed $30,000 per taxable 

year per location in the case of qualified refueling property used in 

a trade or business and $1,000 per taxable year in the case of 

qualified refueling property installed on property which is used as 

a principal residence. 

Qualified refueling property is property (not including a building 

or its structural components) for the storage or dispensing of a 

clean-burning fuel into the fuel tank of a motor vehicle propelled 

by such fuel, but only if the storage or dispensing of the fuel is at 

the point where such fuel is delivered into the fuel tank of the 

motor vehicle. The use of such property must begin with the taxpayer. 

Clean-burning fuels are any fuel at least 85 percent of the volume of which consists of ethanol, natural gas, compressed natural 

gas, liquefied natural gas, liquefied petroleum gas, or hydrogen. In 

addition, any mixture of biodiesel and diesel fuel, determined without regard to any use of kerosene and containing at least 20 percent biodiesel, qualifies as a clean fuel. 

Credits for qualified refueling property used in a trade or business are part of the general business credit and may be carried 

back for 1 year and forward for 20 years. Credits for residential 


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qualified refueling property cannot exceed for any taxable year the 

difference between the taxpayer’s regular tax (reduced by certain 

other credits) and the taxpayer’s tentative minimum tax. Generally, in the case of qualified refueling property sold to a tax-exempt entity, the taxpayer selling the property may claim the credit. 

A taxpayer’s basis in qualified refueling property is reduced by 

the amount of the credit. In addition, no credit is available for 

property used outside the United States or for which an election to 

expense has been made under section 179. 

The credit is available for property placed in service after December 31, 2005, and (except in the case of hydrogen refueling property) before January 1, 2010. In the case of hydrogen refueling 

property, the property must be placed in service before January 1, 

2015. 

REASONS FOR CHANGE

The Committee believes that building additional renewable fuel 

infrastructure advances America’s environmental and energy independence goals and for this reason want to extend the tax incentive 

for alternative fuel refueling property. 

EXPLANATION OF PROVISION

The provision extends for one year (through 2010) the credit for 

installing non-hydrogen alternative fuel refueling property. 

EFFECTIVE DATE

The provision is effective for property placed in service after the 

date of enactment, in taxable years ending after such date. 

TITLE IV—AGRICULTURAL PROVISIONS 

A. QUALIFIED SMALL ISSUE BONDS FOR FARMING

(Sec. 401 of the bill and sec. 147 of the Code) 

PRESENT LAW

Qualified small issue bonds are tax-exempt bonds issued by State 

and local governments to finance private business manufacturing 

facilities (including certain directly related and ancillary facilities) 

or the acquisition of land and equipment by certain first-time farmers. A first-time farmer means any individual who has not at any 

time had any direct ownership interest in substantial farmland in 

the operation of which such individual materially participated. In 

addition, an individual does not qualify as a first-time farmer if 

such individual has received more than $250,000 in qualified small 

issue bond financing. Substantial farmland means any parcel of 

land unless (1) such parcel is smaller than 30 percent of the median size of a farm in the county in which such parcel is located 

and (2) the fair market value of the land does not at any time while 

held by the individual exceed $125,000. 

REASONS FOR CHANGE

The Committee notes that the loan limits for first-time farmers 

have not been increased in more than two decades. Similarly, the 

rules relating to the definition of substantial farmland have not 


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66Sec. 453. 67Sec. 453(i). 68This property is 10-year property described in section 168(e)(3)(D). 

been increased in many years and, as a result, have not kept pace 

with increases in land prices. Thus, the Committee believes the 

tax-exempt bond rules for first-time farmers should be updated. 

EXPLANATION OF PROVISION

The provision increases the maximum amount of qualified small 

issue bond proceeds available to first-time farmers to $450,000 and 

indexes this amount for inflation. The provision also eliminates the 

fair market value test from the definition of substantial farmland. 

EFFECTIVE DATE

The provision is effective for bonds issued after the date of enactment. 

B. MODIFICATION OF INSTALLMENT SALE RULES FOR CERTAIN FARM

PROPERTY

(Sec. 402 of the bill and sec. 453 of the Code) 

PRESENT LAW

Taxpayers are permitted to recognize as gain on a disposition of 

property only that proportion of payments received in a taxable 

year that is the same as the proportion that the gross profit bears 

to the total contract price (the ‘‘installment method’’).66 Notwithstanding this general rule, with respect to any installment sale, the 

aggregate amount that would be treated as ordinary income under 

section 1245 or section 1250 for the taxable year of the disposition 

if all payments to be received were received in the taxable year of 

disposition (‘‘recapture income’’) is recognized in the year of the disposition.67

REASONS FOR CHANGE

The Committee believes that the provision will encourage the 

sale of farms to younger farmers that may not otherwise qualify for 

traditional financing. While this proposal changes the rules for the 

seller, it is expected to help buyers by making the installment rules 

more favorable to sellers. 

EXPLANATION OF PROVISION

The provision repeals the immediate recognition of recapture income for sales of any single purpose agricultural or horticultural 

structure (as defined in section 168(i)(13)) or any tree or vine bearing fruit or nuts.68

EFFECTIVE DATE

The provision is effective for installment sales after the date of 

enactment. 


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69Sec. 1031(a)(1). 70Sec. 1031(a)(2). 

C. ALLOWANCE OF SECTION 1031 TREATMENT FOR EXCHANGES INVOLVING CERTAIN MUTUAL DITCH, RESERVOIR, OR IRRIGATION

COMPANY STOCK

(Sec. 403 of the bill and sec. 1031 of the Code) 

PRESENT LAW

An exchange of property, like a sale, generally is a taxable event. 

However, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for 

property of a ‘‘like-kind’’ which is to be held for productive use in 

a trade or business or for investment.69 If section 1031 applies to 

an exchange of properties, the basis of the property received in the 

exchange is equal to the basis of the property transferred, decreased by any money received by the taxpayer, and further adjusted for any gain or loss recognized on the exchange. In general, 

section 1031 does not apply to any exchange of stock in trade or 

other property held primarily for sale; stocks, bonds or notes; other 

securities or evidences of indebtedness or interest; interests in a 

partnership; certificates of trust or beneficial interests; or choses in 

action.70

REASONS FOR CHANGE

The Committee believes that section 1031 should be clarified to 

remove any doubt that an exchange of shares in mutual ditch, reservoir, and irrigation company stock qualifies for tax deferral treatment under section 1031. The Committee intends this clarification 

would be for cases in which the highest court or statute of the 

State in which the company is organized recognize such shares as 

constituting or representing real property or an interest in real 

property. 

EXPLANATION OF PROVISION

The provision provides that the general exclusion from section 

1031 treatment for stocks shall not apply to shares in a mutual 

ditch, reservoir, or irrigation company, if at the time of the exchange: (1) the company is an organization described in section 

501(c)(12)(A) (determined without regard to the percentage of its 

income that is collected from its members for the purpose of meeting losses and expenses); and (2) the shares in the company have 

been recognized by the highest court of the State in which such 

company was organized or by applicable State statute as constituting or representing real property or an interest in real property. 

EFFECTIVE DATE

The provision is effective for transfers after the date of enactment. 


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71Secs. 103(a) and (b)(2). 72Sec. 148. 73Sec. 149(e). 74Sec. 103(a) and (b)(2). 75Sec. 148. 

D. RURAL RENAISSANCE BONDS

(Sec. 404 of the bill and new sec. 54A of the Code) 

PRESENT LAW

Tax-exempt bonds 

1. Subject to certain Code restrictions, interest on bonds issued 

by State and local government generally is excluded from gross income for Federal income tax purposes. Bonds issued by State and 

local governments may be classified as either governmental bonds 

or private activity bonds. Governmental bonds are bonds the proceeds of which are primarily used to finance governmental functions or which are repaid with governmental funds. Private activity 

bonds are bonds in which the State or local government serves as 

a conduit providing financing to nongovernmental persons. For this 

purpose, the term ‘‘nongovernmental person’’ generally includes the 

Federal Government and all other individuals and entities other 

than States or local governments. The exclusion from income for interest on State and local bonds does not apply to private activity 

bonds, unless the bonds are issued for certain permitted purposes 

(‘‘qualified private activity bonds’’) and other Code requirements 

are met. 

The tax exemption for State and local bonds also does not apply 

to any arbitrage bond.71 An arbitrage bond is defined as any bond 

that is part of an issue if any proceeds of the issue are reasonably 

expected to be used (or intentionally are used) to acquire higher 

yielding investments or to replace funds that are used to acquire 

higher yielding investments.72 In general, arbitrage profits may be 

earned only during specified periods (e.g., defined ‘‘temporary periods’’) before funds are needed for the purpose of the borrowing or 

on specified types of investments (e.g., ‘‘reasonably required reserve 

or replacement funds’’). Subject to limited exceptions, investment 

profits that are earned during these periods or on such investments 

must be rebated to the Federal government. 

An issuer of tax-exempt bonds must file with the IRS a return 

that provides certain information regarding the bond issuance.73

Generally, this information return is required to be filed no later 

the 15th day of the second month after the close of the calendar 

quarter in which the bonds were issued. 

The tax exemption for State and local bonds also does not apply 

to any arbitrage bond.74 An arbitrage bond is defined as any bond 

that is part of an issue if any proceeds of the issue are reasonably 

expected to be used (or intentionally are used) to acquire higher 

yielding investments or to replace funds that are used to acquire 

higher yielding investments.75 In general, arbitrage profits may be 

earned only during specified periods (e.g., defined ‘‘temporary periods’’) before funds are needed for the purpose of the borrowing or 

on specified types of investments (e.g., ‘‘reasonably required reserve 

or replacement funds’’). Subject to limited exceptions, investment 


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76Secs. 1397E, 54, and 1400N(l), respectively. 77 In addition, Notice 2006–7 provides that qualified projects include any facility owned by a 

qualified borrower that is functionally related and subordinate to any facility described in section 45(d)(1) through (d)(9) and owned by such qualified borrower. 

profits that are earned during these periods or on such investments 

must be rebated to the Federal government. 

Tax credit bonds 

In general 

As an alternative to traditional tax-exempt bonds, the Code permits three types of tax-credit bonds. States and local governments 

have the authority to issue qualified zone academy bonds 

(‘‘QZABS’’), clean renewable energy bonds (‘‘CREBS’’), and ‘‘Gulf 

tax credit bonds.’’76

A common feature of the present law tax-credit bonds is that the 

taxpayer holding such a bond receives a tax credit, rather than an 

interest payment. The amount of the credit is determined by multiplying the bond’s credit rate by the face amount on the taxpayer’s 

bond. The credit rate on the bonds is determined by the Secretary 

and is to be a rate that permits issuance of such bonds without discount and interest cost to the qualified issuer. The credit is includible in gross income (as if it were an interest payment on the bond), 

and can be claimed against regular income tax liability and alternative minimum tax liability. 

Clean renewable energy bonds 

CREBs are defined as any bond issued by a qualified issuer if, 

in addition to the requirements discussed below, 95 percent or 

more of the proceeds of such bonds are used to finance capital expenditures incurred by qualified borrowers for qualified projects. 

‘‘Qualified projects’’ are facilities that qualify for the tax credit 

under section 45 (other than Indian coal production facilities), 

without regard to the placed-in-service date requirements of that 

section.77 The term ‘‘qualified issuers’’ includes (1) governmental 

bodies (including Indian tribal governments); (2) mutual or cooperative electric companies (described in section 501(c)(12) or section 

1381(a)(2)(C), or a not-for-profit electric utility which has received 

a loan or guarantee under the Rural Electrification Act); and (3) 

clean renewable energy bond lenders. The term ‘‘qualified borrower’’ includes a governmental body (including an Indian tribal 

government) and a mutual or cooperative electric company. A clean 

renewable energy bond lender means a cooperative which is owned 

by, or has outstanding loans to, 100 or more cooperative electric 

companies and is in existence on February 1, 2002. 

In addition to the above requirements, at least 95 percent of the 

proceeds of CREBs must be spent on qualified projects within the 

five-year period that begins on the date of issuance. To the extent 

less than 95 percent of the proceeds are used to finance qualified 

projects during the five-year spending period, bonds will continue 

to qualify as CREBs if unspent proceeds are used within 90 days 

from the end of such five-year period to redeem any ‘‘nonqualified 

bonds.’’ The five-year spending period may be extended by the Secretary upon the qualified issuer’s request demonstrating that the 


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failure to satisfy the five-year requirement is due to reasonable 

cause and the projects will continue to proceed with due diligence. 

CREBs also are subject to the arbitrage requirements of section 

148 that apply to tax-exempt bonds. Principles under section 148 

and the regulations thereunder apply for purposes of determining 

the yield restriction and arbitrage rebate requirements applicable 

to CREBs. 

Issuers of CREBs are required to report issuance to the IRS in 

a manner similar to the information returns required for tax-exempt bonds. There is a national CREB limitation of $1.2 billion. 

The maximum amount of CREBs that may be allocated to qualified 

projects of governmental bodies is $750 million. CREBs must be 

issued before January 1, 2009. 

Qualified zone academy bonds 

‘‘QZABs’’ are defined as any bond issued by a State or local government, provided that (1) at least 95 percent of the proceeds are 

used for the purpose of renovating, providing equipment to, developing course materials for use at, or training teachers and other 

school personnel in a ‘‘qualified zone academy,’’ and (2) private entities have promised to contribute to the qualified zone academy 

certain equipment, technical assistance or training, employee services, or other property or services with a value equal to at least 10 

percent of the bond proceeds. Eligible holders of QZABs are limited 

to financial institutions. 

An issuer of QZABs must reasonably expect to and actually 

spend 95 percent or more of the proceeds of such bonds on qualified 

zone academy property within the five-year period that begins on 

the date of issuance. To the extent less than 95 percent of the proceeds are used to finance qualified zone academy property during 

the five-year spending period, bonds will continue to qualify as 

QZABs if unspent proceeds are used within 90 days from the end 

of such five-year period to redeem any nonqualified bonds. For 

these purposes, the amount of nonqualified bonds is to be determined in the same manner as Treasury regulations under section 

142. The provision provides that the five-year spending period may 

be extended by the Secretary if the issuer establishes that the failure to meet the spending requirement is due to reasonable cause 

and the related purposes for issuing the bonds will continue to proceed with due diligence. 

A total of $400 million of qualified zone academy bonds is authorized to be issued annually in calendar years 1998 through 2007. 

The $400 million aggregate bond cap is allocated to the States according to their respective populations of individuals below the poverty line. Each State, in turn, allocates the credit authority to 

qualified zone academies within such State. 

Issuers of QZABs are required to report issuance to the IRS in 

a manner similar to the information returns required for tax-exempt bonds. In addition, QZABs are subject to the arbitrage requirements of section 148 that apply to tax-exempt bonds. Principles under section 148 and the regulations thereunder apply for 

purposes of determining the yield restriction and arbitrage rebate 

requirements applicable to QZABs. 


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Gulf tax credit bonds 

Gulf tax credit bonds may be issued by the States of Louisiana, 

Mississippi, and Alabama. To qualify as Gulf tax credit bonds, 95 

percent or more of the proceeds of such bonds must be used to (i) 

pay principal, interest, or premium on a bond (other than a private 

activity bond) that was outstanding on August 28, 2005, and was 

issued by the State issuing the Gulf tax credit bonds, or any political subdivision thereof, or (ii) make a loan to any political subdivision of such State to pay principal, interest, or premium on a bond 

issued by such political subdivision. In addition, the issuer of Gulf 

tax credit bonds must provide additional funds to pay principal, interest, or premium on outstanding bonds equal to the amount of 

Gulf tax credit bonds issued to repay such outstanding bonds. Gulf 

tax credit bonds must be a general obligation of the issuing State 

and must be designated by the Governor of such State. The maximum maturity on Gulf tax credit bonds is two years. In addition, 

present-law arbitrage rules that restrict the ability of State and 

local governments to invest bond proceeds apply to Gulf tax credit 

bonds. 

Gulf tax credit bonds must have been issued in calendar year 

2006. The maximum amount of Gulf tax credit bonds authorized to 

be issued was $200 million in the case of Louisiana, $100 million 

in the case of Mississippi, and $50 million in the case of Alabama. 

Gulf tax credit bonds may not be used to pay principal, interest, 

or premium on any bond with respect to which there is any outstanding refunded or refunding bond. Moreover, Gulf tax credit 

bonds may not be used to pay principal, interest, or premium on 

any prior bond if the proceeds of such prior bond were used to provide any property described in section 144(c)(6)(B) (i.e., any private 

or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, 

or any store the principal purpose of which is the sale of alcoholic 

beverages for consumption off premises). 

Issuers of Gulf tax credit bonds are required to report issuance 

to the IRS in a manner similar to the information returns required 

for tax-exempt bonds. 

REASONS FOR CHANGE

The Committee believes that existing programs are not meeting 

the financing needs of rural communities. The Committee believes 

that additional incentives are needed to encourage economic development in rural areas. Thus, the Committee believes it is appropriate to provide rural communities with additional financing tools 

in order to promote investment in these underserved communities. 

EXPLANATION OF PROVISION

The provision provides for a new category of tax-credit bonds, 

‘‘Rural Renaissance Bonds.’’ A Rural Renaissance Bond means any 

bond if: (1) the bond is issued by a qualified issuer pursuant to an 

allocation of the national limitation on such bonds; (2) 95 percent 

or more of the proceeds of the bond are to be used for capital expenditures incurred by qualified borrowers for one or more qualified projects; (3) the qualified issuer designates the bond as a Rural 

Renaissance Bond and such bond is issued in registered form; (4) 


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the bond meets the five-year spending requirement (described 

below); and (5) the bond is not Federally guaranteed (i.e., no portion of the bond is guaranteed in whole or in part by the United 

States). 

Under the provision, the term ‘‘qualified issuer’’ means: (1) a 

rural renaissance bond lender; (2) a cooperative electric company; 

and (3) a governmental body. A ‘‘rural renaissance bond lender’’ means a cooperative which is owned by, or has outstanding loans 

to, 100 or more cooperative electric companies and is in existence 

on February 1, 2002, including any affiliated lender which is controlled by such lender. The term ‘‘cooperative electric company’’ means a mutual or cooperative electric company (described in section 501(c)(12) or section 1381(a)(2)(C), or a not-for-profit electric 

utility which has received a loan or guarantee under the Rural 

Electrification Act. The term ‘‘governmental body’’ means a State, 

territory, possession of the United States, the District of Columbia, 

Indian tribal government, and any political subdivision thereof. 

Under the provision, a ‘‘qualified borrower’’ means a cooperative 

electric company or a governmental body. 

The term ‘‘qualified projects’’ means: (1) a utilities program described in section 381E(d)(2) of the Consolidated Farm and Rural 

Development Act; (2) a distance learning or telemedicine program 

authorized pursuant to chapter 1 of subtitle D of title XXIII of the 

Food, Agriculture, Conservation, and Trade Act of 1990; (3) the 

rural electric programs authorized pursuant to the Rural Electrification Act of 1936; (4) the rural telephone programs authorized 

pursuant to the Rural Electrification Act of 1936; (5) the broadband 

access programs authorized pursuant to title VI of the Rural Electrification Act of 1936; and (6) the rural community facility programs as described in section 381E(d)(1) of the Consolidated Farm 

and Rural Development Act. 

As with present-law tax credit bonds, the taxpayer holding Rural 

Renaissance Bonds on a credit allowance date is entitled to a tax 

credit. The amount of the credit is determined by multiplying the 

bond’s credit rate by the face amount on the taxpayer’s bond. The 

credit rate on the bonds is determined by the Secretary and is to 

be a rate that permits issuance of such bonds without discount and 

interest cost to the qualified issuer. The credit is includible in gross 

income (as if it were an interest payment on the bond), and can be 

claimed against regular income tax liability and alternative minimum tax liability. 

Under the provision, at least 95 percent or more of the proceeds 

of Rural Renaissance Bonds must be spent on qualified projects 

within the five-year period that begins on the date of issuance of 

such bonds. To the extent less than 95 percent of the proceeds are 

spent as required during the five-year spending period, bonds will 

continue to qualify as Rural Renaissance Bonds only if unspent 

proceeds are used within 90 days from the end of such five-year period to redeem outstanding bonds. The five-year spending period 

may be extended by the Secretary upon the qualified issuer’s request demonstrating that the failure to satisfy the five-year requirement is due to reasonable cause and the projects will continue 

to proceed with due diligence. 

The provision requires level amortization of Rural Renaissance 

Bonds during the period such bonds are outstanding. In addition, 


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78Sec. 38(b)(1). 79The term taxpayer includes controlled groups under rules similar to the rules set out in 

section 41(f)(1) and (2). 

Rural Renaissance Bonds are subject to the arbitrage requirements 

of section 148 that apply to tax-exempt bonds. Principles under section 148 and the regulations thereunder apply for purposes of determining the yield restriction and arbitrage rebate requirements 

applicable to Rural Renaissance Bonds. 

The provision establishes a national limitation of $400,000,000 

on the amount of bonds that may be designated as Rural Renaissance Bonds. The Secretary, in consultation with the Secretary of 

Agriculture, shall make allocations of the national limitation to at 

least 20 qualified projects, or such lesser number of qualified 

projects based on the number of applications filed 12 months after 

applications for allocations have been solicited by the Secretary. In 

addition, no more than 15 percent of the national limitation may 

be allocated to qualified projects located in any one State. Under 

the provision, Rural Renaissance Bonds may not be issued after 

December 31, 2008. 

EFFECTIVE DATE

The provision is effective for bonds issued after the date of enactment. 

E. AGRICULTURAL BUSINESS SECURITY TAX CREDIT

(Sec. 405 of the bill and sec. 45 of the Code) 

PRESENT LAW

Present law does not provide a credit for agricultural business 

security. 

REASONS FOR CHANGE

The Committee believes that a security tax credit would help the 

agricultural industry to properly safeguard agricultural pesticides 

and fertilizers from the threat of terrorists, drug dealers and other 

criminals. These safeguards are necessary to help alleviate a 

heightened concern as to the vulnerability of chemical storage facilities. This credit will help ease the substantial increase in production costs faced by agriculture related to installing improved security measures that will better protect the American public from 

the potential threat of terrorism or other illegal activities. 

EXPLANATION OF PROVISION

The provision establishes a 30 percent credit for qualified chemical security expenditures for the taxable year with respect to eligible agricultural businesses. The credit is a component of the general business credit.78

The credit is limited to $100,000 per facility, this amount is reduced by the aggregate amount of the credits allowed for the facility in the prior five years. In addition, each taxpayer’s annual credit is limited to $2,000,000.79 The credit only applies to expenditures 

paid or incurred before December 31, 2012. The taxpayer’s deductible expense is reduced by the amount of the credit claimed. 


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Qualified chemical security expenditures are amounts paid by 

for: 1) employee security training and background checks; (2) limitation and prevention of access to controls of specific agricultural 

chemicals stored at a facility; (3) tagging, locking tank valves, and 

chemical additives to prevent the theft of specific agricultural 

chemicals or to render such chemicals unfit for illegal use; (4) protection of the perimeter of specified agricultural chemicals; (5) installation of security lighting, cameras, recording equipment and 

intrusion detection sensors (6) implementation of measures to increase computer or computer network security; (7) conducting security vulnerability assessments; (8) implementing a site security 

plan; and (9) other measures provided for by regulation. Amounts 

described in the preceding sentences are only eligible to the extent 

they are incurred by an eligible agricultural business for protecting 

specified agricultural chemicals. 

Eligible agricultural businesses are businesses that: (1) sell agricultural products, including specified agricultural chemicals, at retail predominantly to farmers and ranchers; or (2) manufacture, 

formulate, distribute, or aerially apply specified agricultural chemicals. 

Specified agricultural chemicals means: (1) are fertilizer commonly used in agricultural operations which is listed under section 

302(a)(2) of the Emergency Planning and Community Right-toknow Act of 1986, section 101 or part 172 of title 49, Code of Federal Regulations, or part 126, 127 or 154 of title 33, Code of Federal Regulations; and (2) any pesticide (as defined in section 2(u) 

of the Federal Insecticide, Fungicide, and Rodenticide Act) including all active and inert ingredients which are used on crops grown 

for food, feed or fiber. 

EFFECTIVE DATE

The provision is effective for expenses paid or incurred after date 

of enactment. 

F. CREDIT FOR DRUG SAFETY AND EFFECTIVENESS TESTING FOR

MINOR SPECIES

(Sec. 406 of the bill and new sec. 45P of the Code) 

PRESENT LAW

Present law does not provide a credit for drug safety and effectiveness testing for use in a minor animal species. 

REASONS FOR CHANGE

The Committee believes that insufficient resources are devoted to 

developing drugs for minor animal species such as sheep and goats. 

The Committee believes that a tax incentive for drug safety and effectiveness testing for use in minor animal species will encourage 

more investment in this area. 

EXPLANATION OF PROVISION

The provision establishes, at the election of the taxpayer, a 50 

percent credit for qualified safety and effectiveness testing expenses incurred during the taxable year for certain designated new 

animal drugs intended for use in a minor species. The taxpayer’s 


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80These definitions are intended to correspond with the definitions provided in section 201 

of the FFDC Act. 81 Under the provision, the term taxpayer includes controlled groups under rules similar to 

the rules set out in section 41(f)(1) and (2). 

otherwise deductible expenses are reduced by the amount of the 

credit claimed. 

Safety and effectiveness testing is testing carried out under an 

exemption for a new animal drug for use on a minor species under 

section 512(j) of the Federal Food, Drug, and Cosmetic Act (or regulations issued under such section) (the ‘‘FFDC Act’’). The testing 

must occur after a new animal drug request is filed for designation 

under section 573 of the FFDC Act but before the application with 

respect to such drug is approved under section 512(c) of such Act. 

Moreover, the testing must be conducted by or on behalf of the taxpayer who applied for the designation or by the owner of the animals that are the subject of the testing. Safety and effectiveness 

testing may be taken into account under the provision only to the 

extent such testing is related to the use of a new animal drug for 

the minor species for which it was designated under section 573 of 

FFDC Act. 

A ‘‘minor species’’ means animals other than humans that are 

not major species. A ‘‘major species’’ means cattle, horses, swine, 

chickens, turkeys, dogs, and cats, as well as any species the Secretary, in consultation with the Secretary of Agriculture, adds by 

regulation.80

Qualified safety and effectiveness testing expenses comprise both 

in-house and contract expenses incurred by a taxpayer 81 in carrying on a trade or business or by a taxpayer that owns animals 

that are the subject of safety and effectiveness testing. For purposes of the provision, in-house expenses are (1) wages paid or incurred to an employee for safety and effectiveness testing or the direct supervision or support thereof; (2) any amount paid or incurred for supplies used in the conduct of safety and effectiveness 

testing; and (3) under regulations prescribed by the Secretary, any 

amount paid or incurred to another person for the right to use computers in the conduct of safety and effectiveness testing. Contract 

expenses are any amounts paid or incurred by the taxpayer to any 

person (other than an employee of the taxpayer) for safety and effectiveness testing. 

Qualified safety and effectiveness testing expenses do not include 

amounts funded by any grant, contract, or otherwise by another 

person or government entity. In addition, qualified expenses will 

not be taken into account when determining the section 41 credit 

for research and experimentation except for purposes of calculating 

base period research expenses. 

EFFECTIVE DATE

The provision is effective for expenses incurred after the date of 

enactment. 


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82Sec. 168. 83 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 84Treas. Reg. sec. 1.263A–4(a)(4)(i). 85Treas. Reg. sec. 1.263A–4(a)(4)(ii). 

G. FARM EQUIPMENT TREATED AS FIVE-YEAR PROPERTY

(Sec. 407 of the bill and sec. 168 of the Code) 

PRESENT LAW

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’).82 The class lives of assets placed in service after 1986 

are generally set forth in Revenue Procedure 87–56.83 Asset class 

01.1 includes machinery and equipment, grain bins, and fences (but 

no other land improvements), that are used in the production of 

crops or plants, vines, and trees; livestock; the operation of farm 

dairies, nurseries, greenhouses, sod farms, mushrooms cellars, 

cranberry bogs, apiaries, and fur farms; and the performance of agricultural, animal husbandry, and horticultural services. These assets are assigned a class life of 10 years and a recovery period of 

seven years. 

REASONS FOR CHANGE

The Committee believes that the depreciation incentive will provide important economic benefits to encourage development within 

the agricultural sector. The provision lowers the cost of capital for 

property used in agricultural trades or businesses which will lead 

to additional investment in more equipment and employment of 

more workers. 

EXPLANATION OF PROVISION

The provision provides a five year recovery period for any machinery or equipment (other than any grain bin, cotton ginning 

asset, fence, or other land improvement) which is used in a farming 

business and placed in service before January 1, 2010, the original 

use of which begins with the taxpayer. For these purposes, the 

term ‘‘farming business’’ means a trade or business involving the 

cultivation of land or the raising or harvesting of any agricultural 

or horticultural commodity.84 A farming business includes processing activities that are normally incident to the growing, raising, 

or harvesting of agricultural or horticultural products.85

EFFECTIVE DATE

The provision is effective for original use property placed in service after the date of enactment. 


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86Sec. 168. 87Pub. L. No. 110–28, sec. 8212 (2007). 88 Additional section 179 incentives are provided with respect to qualified property meeting 

applicable requirements that is used by a business in an empowerment zone (sec. 1397A), a renewal community (sec. 1400J), or the Gulf Opportunity Zone (sec. 1400N(e)). 

H. EXPENSING OF BROADBAND INTERNET ACCESS EXPENDITURES

(Sec. 408 of the bill and new sec. 191 of the Code) 

PRESENT LAW

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’).86 Under MACRS, different types of property generally 

are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property 

(generally tangible property other than residential rental property 

and nonresidential real property) range from 3 to 25 years. The depreciation methods generally applicable to tangible personal property are the 200-percent and 150-percent declining balance methods, switching to the straight-line method for the taxable year in 

which the depreciation deduction would be maximized. 

In lieu of depreciation, a taxpayer with a sufficiently small 

amount of annual investment may elect to deduct (or ‘‘expense’’) 

such costs under section 179. The Small Business and Work Opportunity Tax Act of 2007 87 increased the amount a taxpayer may deduct, for taxable years beginning in 2007 through 2010, to $125,000 

of the cost of qualifying property placed in service for the taxable 

year.88 In general, qualifying property is defined as depreciable 

tangible personal property that is purchased for use in the active 

conduct of a trade or business. Off-the-shelf computer software 

placed in service in taxable years beginning before 2010 is treated 

as qualifying property. The $125,000 amount is reduced (but not 

below zero) by the amount by which the cost of qualifying property 

placed in service during the taxable year exceeds $500,000. The 

$125,000 and $500,000 amounts are indexed for inflation in taxable 

years beginning after 2007 and before 2011. For taxable years beginning in 2011 and thereafter (or before 2003), the following rules 

apply. A taxpayer with a sufficiently small amount of annual investment may elect to deduct up to $25,000 of the cost of qualifying 

property placed in service for the taxable year. The $25,000 amount 

is reduced (but not below zero) by the amount by which the cost 

of qualifying property placed in service during the taxable year exceeds $200,000. The $25,000 and $200,000 amounts are not indexed. 

REASONS FOR CHANGE

The Committee believes that it is appropriate to provide the tax 

incentive of expensing to encourage the provision of broadband 

services through new or upgraded equipment. In particular, the 

Committee believes that the provision of such services should be 

encouraged in rural areas and areas in which residents tend to 

have incomes significantly lower than the median. Because some 


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such areas may be served by current-generation broadband services, the tax incentive is provided with respect to current generation broadband services for residential subscribers if the area is not 

a saturated market. The expensing incentive is provided without 

regard to whether the local market is saturated, in the case of next 

generation broadband service, because of the Committee’s desire to 

encourage wider availability of faster broadband service. 

EXPLANATION OF PROVISION

The provision provides an election to treat any qualified 

broadband expenditure paid or incurred by the taxpayer as not 

chargeable to capital account, but rather, as a deduction. The deduction is allowed in the first taxable year in which either current 

generation or next generation broadband services are provided 

through qualified equipment to qualified subscribers. Expenditures 

are eligible for this election only for qualified equipment, the original use of which commences with the taxpayer. The provision applies for qualified broadband expenditures incurred after the date 

of enactment and on or before the first December 31 that is three 

years after such date. ‘‘Current generation broadband services’’ are defined as the 

transmission of signals at a rate of at least 5 million bits per second to the subscriber and at a rate of at least 1 million bits per 

second from the subscriber. ‘‘Next generation broadband services’’

are defined as the transmission of signals at a rate of at least 100 

million bits per second to the subscriber and at a rate of at least 

20 million bits per second from the subscriber. 

‘‘Qualified broadband expenditures’’ means the direct or indirect 

costs properly taken into account for the taxable year for the purchase or installation of qualified equipment (including upgrades) 

and the connection of the equipment to a qualified subscriber. The 

term does not include costs of launching satellite equipment. For 

current generation broadband services, only 50 percent of the otherwise allowable amount of deduction is treated as qualified 

broadband expenditures. 

Qualified broadband expenditures include only the portion of the 

purchase price paid by the lessor, in the case of leased equipment, 

that is attributable to otherwise qualified broadband expenditures 

by the lessee. In the case of property that is originally placed in 

service by a person and that is sold to the taxpayer and leased 

back to such person by the taxpayer within three months after the 

date that the property was originally placed in service, the property 

is treated as originally placed in service by the taxpayer not earlier 

than the date that the property is used under the leaseback. 

A qualified subscriber, with respect to current generation 

broadband services, means any nonresidential subscriber maintaining a permanent place of business in a rural area or underserved 

area, or any residential subscriber residing in a rural area or underserved area that is not a saturated market. A qualified subscriber, with respect to next generation broadband services, means 

any nonresidential subscriber maintaining a permanent place of 

business in a rural area or underserved area, or any residential 

subscriber. 

For this purpose, a rural area means any census tract not within 

10 miles of an incorporated or census-designated place with more 


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than 25,000 people and not within a county or county equivalent 

with overall population density of more than 500 people per square 

mile. An underserved area means a census tract located in an empowerment zone or enterprise community designated under section 

1391 or the District of Columbia Enterprise Zone established under 

section 1400, or any census tract the poverty level of which is at 

least 30 percent and the median family income of which does not 

exceed (1) for a tract in a metropolitan statistical area, 70 percent 

of the greater of the metropolitan area median family income or the 

statewide median family income, and (2) for a tract that is not in 

a metropolitan statistical area, 70 percent of the nonmetropolitan 

statewide median family income. 

A saturated market, for this purpose, means any census tract in 

which, as of the date of enactment, current generation broadband 

services have been provided by a single provider to 85 percent or 

more of the total potential residential subscribers. The services 

must be usable at least a majority of the time during periods of 

maximum demand, and usable in a manner substantially the same 

as services provided through equipment not eligible for the deduction under this provision. 

If current, or next, generation broadband services can be provided through qualified equipment to both qualified subscribers 

and to other subscribers, the provision provides that the expenditures with respect to the equipment are allocated among subscribers to determine the amount of qualified broad broadband expenditures that may be deducted under the provision. 

Qualified equipment means equipment that provides current, or 

next, generation broadband services at least a majority of the time 

during periods of maximum demand to each subscriber, and in a 

manner substantially the same as such services are provided by 

the provider to subscribers through equipment with respect to 

which no deduction is allowed under the provision. Limitations are 

imposed under the provision on equipment depending on where it 

extends, and on certain packet switching equipment, and on certain 

multiplexing and demultiplexing equipment. 

Expenditures generally are not taken into account for purposes 

of the deduction under the provision with respect to property used 

predominantly outside the United States, used predominantly to 

furnish lodging, used by a tax-exempt organization (other than in 

a business whose income is subject to unrelated business income 

tax), or used by the United States or a political subdivision or by 

a possession, agency or instrumentality thereof or by a foreign person or entity. The basis of property is reduced by the cost of the 

property that is taken into account as a deduction under the provision. Recapture rules are provided. No business credit under section 38 is allowed with respect to any amount allowed as a deduction under the provision. 

EFFECTIVE DATE

The provision is effective on the date of enactment and applies 

to expenditures incurred after the date of enactment and on or before the first December 31 that is three years after such date. 


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I. CREDIT FOR ENERGY EFFICIENT ELECTRIC MOTORS

(Sec. 409 of the bill and new sec. 45Q of the Code) 

PRESENT LAW

There is no present law credit for energy efficient electric motors. 

REASONS FOR CHANGE

The Committee recognizes the need to reduce the consumption of 

electricity, both to mitigate the harmful effects of electricity generation from fossil fuels and to reduce demands on the electrical grid. 

The Committee has long recognized the potential to save energy 

from the promotion of more energy efficient products, and believes 

that the provision of a tax credit for energy efficient motors will increase the use of such motors and result in less electricity consumption 

EXPLANATION OF PROVISION

The provision provides a business tax credit for the purchase of 

qualified energy efficient electric motors that meet or exceed certain energy efficiency standards. The credit equals $15 per horsepower and the aggregate amount of credit that a taxpayer may 

claim for any taxable year cannot exceed $1,250,000. A ‘‘qualifying 

energy efficient motor’’ is: (a) a general- or definite-purpose electric 

motor of 500 horsepower or less that meets or exceeds the efficiency levels specified in Tables 12–12 or 12–13 of the National 

Electrical Manufacturers Association MG–1 (2006); (b) the original 

use begins with the taxpayer; and (c) is placed in service in the 

United States. The provision applies to energy efficient motors 

placed in service after the date of enactment and prior to 36 

months from the date of enactment. 

The basis of any property for which a credit is allowable is reduced by the amount of the credit. The Secretary of the Treasury, 

by regulations, is to provide rules for recapturing the credit in the 

case of any property which ceases to be property eligible for the 

credit. No credit is allowed with respect to the portion of the cost 

of any property taken into account for expensing under section 179. 

EFFECTIVE DATE

The provision is effective for property placed in service after the 

date of enactment and prior to 36 months from the date of enactment. 

TITLE V—REVENUE RAISING PROVISIONS 

A. LIMITATION ON FARMING LOSSES OF CERTAIN TAXPAYERS

(Sec. 501 of the bill and sec. 461 of the Code) 

PRESENT LAW

Farming income and expenses are reported by individuals, estates, trusts, and partnerships on IRS Schedule F, Profit and Loss 

from Farming. For taxpayers who materially participate (as defined 

in section 469(h)), net farming losses are reported in full as a reduction to income from both passive and nonpassive sources. To the 


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extent taxpayers do not materially participate in the farming activity, the passive activity rules in section 469 may limit the ability 

to use such losses to reduce income from nonpassive sources. 

Farming income generally includes sales of livestock, produce, 

grains, and other products; cooperative distributions; Agricultural 

Program Payments; certain Commodity Credit Corporation (‘‘CCC’’) 

loans (if an election is made to include loan proceeds in income in 

the year received); certain crop insurance proceeds and federal crop 

disaster payments; and other income. Farm expenses generally include feed, fertilizers, gasoline, fuel, and oil; insurance; interest; 

hired labor; rent and lease payments; repairs and maintenance; 

taxes; utilities; depreciation; and other business-related expenses. 

Living expenses and other personal expenses are not deductible 

farming expenses. 

REASONS FOR CHANGE

The Committee believes that taxpayers receiving government assistance through payment programs and loan programs should not 

be allowed to claim unlimited amounts of losses from farming activities. 

EXPLANATION OF PROVISION

The provision limits the amount of losses that can be claimed by 

an individual, estate, trust, or partnership on Schedule F to 

$200,000 in cases where the taxpayer has received Agriculture Program Payments or CCC loans. Losses that are limited in a particular year may be carried forward to subsequent years. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2007. 

B. INCREASE AND INDEX DOLLAR THRESHOLDS FOR FARM OPTIONAL

METHOD AND NONFARM OPTIONAL METHOD FOR COMPUTING NET

EARNINGS FROM SELF-EMPLOYMENT

(Sec. 502 of the bill and sec. 1402(a) of the Code) 

PRESENT LAW

In general 

Generally, tax under the Self-Employment Contributions Act 

(SECA) is imposed on the self-employment income of an individual. 

SECA tax has two components. Under the old-age, survivors, and 

disability insurance component, the rate of tax is 12.40 percent on 

self-employment income up to the Social Security wage base 

($97,500 for 2007). Under the hospital insurance component, the 

rate is 2.90 percent of all self-employment income (without regard 

to the Social Security wage base). 

Self-employment income subject to the SECA tax is determined 

as the net earnings from self-employment. An individual may use 

one of three methods to calculate net earnings from self-employment. Under the generally applicable rule, net earnings from selfemployment means gross income (including the individual’s net distributive share of partnership income) derived by an individual 


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from any trade or business carried on by the individual, less the 

deductions attributable to the trade or business that are allowed 

under the SECA tax rules. Alternatively, an individual may elect 

to use one of two optional methods for calculating net earnings 

from self-employment. These methods are: (1) the farm optional 

method; and (2) the nonfarm optional method. The farm optional 

method allows individuals to pay SECA taxes (and secure Social 

Security benefit coverage) when they have low net income or losses 

from farming. The nonfarm optional method is similar to the farm 

optional method. 

Farm optional method 

If an individual is engaged in a farming trade or business, either 

as a sole proprietor or as a partner, the individual may elect to use 

the farm optional method in one of two instances. The first instance is an individual engaged in a farming business who has 

gross farm income of $2,400 or less for the taxable year. In this instance, the individual may elect to report two-thirds of gross farm 

income as net earnings from self-employment. In the second instance, an individual engaged in a farming business may elect the 

farm optional method even though gross farm income exceeds 

$2,400 for the taxable year but only if the net farm income is less 

than $1,733 for the taxable year. In this second instance, the individual may elect to report $1,600 as net earnings from self-employment for the taxable year. In all other instances (i.e., more than 

$2,400 of gross farm income and net farm income of at least 

$1,733) a person engaged in a farming business must compute net 

earnings from self-employment under the generally applicable rule. 

There is no limit on the number of years that an individual may 

elect the farm optional method during such individual’s lifetime. 

The dollar limits in the farm optional method are not indexed for 

inflation. 

Nonfarm optional method 

The nonfarm optional method is available only to individuals 

who have been self-employed for at least two of the three years before the year in which they seek to elect the nonfarm optional 

method and who meet certain other requirements. Specifically, an 

individual may elect the nonfarm optional method if the individual’s: (1) net nonfarm income for the taxable year is less than 

$1,733; and (2) net nonfarm income for the taxable year is less 

than 72.189 percent of gross nonfarm income. If a qualified individual engaged in a nonfarming business who elects the nonfarm 

optional method has gross nonfarm income of $2,400 or less for the 

taxable year, then the individual may elect to report two-thirds of 

gross nonfarm income as net earnings from self-employment. If the 

electing individual engaged in a nonfarming business has gross 

nonfarm income of at least $2,400 for the taxable year, then the 

individual may elect to report $1,600 as net earnings from self-employment for the taxable year. In all other instances, a person engaged in a nonfarming business must compute net earnings from 

self-employment under the generally applicable rule. An individual 

may elect to use the nonfarm optional method for no more than five 

years in the course of the individual’s lifetime. 


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The dollar limits in the nonfarm optional method are not indexed 

for inflation. 

Other rules applicable to farm optional and nonfarm optional methods 

In the case of a cash method trade or business, gross income is 

defined as the gross receipts from such trade or business less the 

cost or other basis of property sold in carrying out such trade or 

business with certain adjustments. In the case of an accrual method trade or business, gross income is defined as the gross income 

from the trade or business with certain adjustments. If an individual (including a member of a partnership) derives gross income 

from more than one trade or business then such gross income (including the individual’s distributive share of the gross income of 

any partnership) is treated as derived from a single trade or business. 

Social Security benefit eligibility 

Generally, Social Security benefits can be paid to an individual 

(and dependents or survivors) only if that individual has worked 

long enough in covered employment to be insured. Insured status 

is measured in terms of ‘‘credits,’’ previously called ‘‘quarters of coverage.’’ For this purpose, Social Security uses the lifetime record of 

earnings reported for that individual. In the case of a self-employed 

individual, net earnings from self-employment is used to calculate 

Social Security benefit eligibility. 

Up to four quarters of coverage can be earned for a year, depending on covered wages for the year and the amount needed to earn 

each quarter of coverage. For 2007, credit for a quarter of coverage 

is provided for each $1,000 of wages. 

REASONS FOR CHANGE

The Committee believes that taxpayers should have the ability to 

earn four quarters of coverage for Social Security benefits annually 

under either the farm optional method or nonfarm optional method. 

Because the present-law dollar amounts are not updated or indexed 

for inflation otherwise eligible taxpayers have lost that ability. The 

bill makes needed changes to those methods and ensures that they 

are indexed so the problem will not reoccur in the future. 

DESCRIPTION OF PROPOSAL

The provision modifies the farm optional method so that electing 

taxpayers may be eligible to secure four credits of Social Security 

benefit coverage each taxable year by increasing an indexing the 

thresholds. The provision makes a similar modification to the nonfarm optional method. 

EFFECTIVE DATE

The provision is effective for taxable years beginning after December 31, 2007. 


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89Pub. L. No. 107–171. 90 2007–33 IRB. 91The tax gap is the amount of tax that is imposed by law for a given tax year but is not 

paid voluntarily and timely. 

C. INFORMATION REPORTING FOR COMMODITY CREDIT CORPORATION

TRANSACTIONS

(Sec. 503 of the bill and new sec. 6039J of the Code) 

PRESENT LAW

The Farm Security and Rural Investment Act of 2002 89 authorizes a marketing assistance loan program through the Commodity 

Credit Corporation (‘‘CCC’’). Under such program, the CCC may 

make loans for eligible commodities at a specified rate per unit of 

commodity (the original loan rate). The repayment amount for such 

a loan secured by an eligible commodity generally is based on the 

lower of the original loan rate or the alternative repayment rate, 

as determined by the CCC, as of the date of repayment. The alternative repayment rate may be adjusted to reflect quality and location for each type of commodity. A taxpayer receiving a CCC loan 

can use cash to repay such a loan, purchase CCC certificates for 

use in repayment of the loan, or deliver the pledged collateral as 

full payment for the loan at maturity. 

If a taxpayer uses cash or CCC certificates to repay a CCC loan, 

and the loan is repaid at a time when the repayment rate is less 

than the original loan rate, the difference between the original loan 

amount and the lesser repayment amount is market gain. Regardless of whether a taxpayer repays a CCC loan in cash or uses CCC 

certificates in repayment of the loan, the market gain is taken into 

account either as income or as an adjustment to the basis of the 

commodity (if the taxpayer has made an election under section 77). 

If a farmer uses cash instead of certificates, the farmer will receive a Form CCC–1099–G Information Return showing the market 

gain realized. For transactions prior to January 1, 2001, however, 

if a farmer uses CCC certificates to facilitate repayment of a CCC 

loan, the farmer will not receive an information return. For transactions after January 1, 2001, IRS Notice 2007–63 provides that 

the CCC reports market gain associated with the repayment of a 

CCC loan whether the taxpayer repays the loan with cash or uses 

CCC certificates in repayment of the loan.90 The CCC reports the 

market gain on Form 1099–G, Certain Government Payments. 

REASONS FOR CHANGE

Income that is subject to information reporting is less likely to 

be underreported. In contrast, the absence of information reporting 

on many types of payments results in underreporting and contributes to the tax gap.91 Thus, the Committee believes it is important 

to ensure that information reporting rules are applied consistently 

to payments that may differ in form, but are economically equivalent. For this reason, the Committee believes it is appropriate to 

codify the IRS’s administrative determination regarding information reporting for the repayment of CCC loans. 


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92Sec. 1031(a)(1). 93Treas. Reg. sec. 1.1031(a)–1(b). 94Treas. Reg. sec. 1.1031(a)–1(c). 

EXPLANATION OF PROVISION

The provision codifies the requirements of IRS Notice 2007–63 

providing that the CCC reports market gain associated with the repayment of a CCC loan, regardless of whether the taxpayer repays 

the loan with cash or uses CCC certificates in repayment of the 

loan. 

EFFECTIVE DATE

The provision is effective for loans repaid on or after January 1, 

2007. 

D. MODIFICATION OF SECTION 1031 TREATMENT FOR CERTAIN REAL

ESTATE

(Sec. 504 of the bill and sec. 1031 of the Code) 

PRESENT LAW

An exchange of property, like a sale, generally is a taxable event. 

However, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for 

property of a ‘‘like kind’’ that is to be held for productive use in a 

trade or business or for investment.92 If section 1031 applies to an 

exchange of properties, the basis of the property received in the exchange is equal to the basis of the property transferred, decreased 

by any money received by the taxpayer, and further adjusted for 

any gain or loss recognized on the exchange. For purposes of section 1031, the determination of ‘‘like kind’’ relates to the nature or 

character of the property and not its grade or quality.93 Therefore, 

improved real estate and unimproved real estate are generally considered to be property of a ‘‘like kind’’ as this distinction relates to 

the grade or quality of the real estate.94

REASONS FOR CHANGE

The Committee believes that sellers are currently using section 

1031 to defer gains on improved real estate exchanged for farm 

property and also receiving the benefit of the farm property’s historical agricultural base involved in calculating Agriculture Program Payments to include direct payments and counter cyclical 

payments. The Committee believes that those exchanges should not 

be like kind. 

EXPLANATION OF PROVISION

The provision modifies section 1031 to disallow nonrecognition 

treatment for exchanges of unimproved real estate for which the 

owner is receiving Agriculture Program Payments or Commodity 

Credit Corporation (‘‘CCC’’) loans for improved real estate, unless 

the undeveloped land is permanently retired from farm program 

payments. 


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EFFECTIVE DATE

The provision is effective for exchanges completed after the date 

of enactment. 

E. MODIFICATION OF EFFECTIVE DATE OF LEASING PROVISIONS OF

THE AMERICAN JOBS CREATION ACT OF 2004 

(Sec. 505 of the bill and sec. 470 of the Code) 

PRESENT LAW

Present law provides for the deferral of losses attributable to certain tax exempt use property, generally effective for leases entered 

into after March 12, 2004. The deferral provision does not apply to 

property located in the United States that is subject to a lease with 

respect to which a formal application: (1) was submitted for approval to the Federal Transit Administration (an agency of the Department of Transportation) after June 30, 2003, and before March 

13, 2004; (2) was approved by the Federal Transit Administration 

before January 1, 2006; and (3) includes a description and the fair 

market value of such property (the ‘‘qualified transportation property exception’’). 

REASONS FOR CHANGE

The Committee is aware that certain leasing transactions entered into with foreign lessees prior to March 12, 2004, are continuing to provide a tax benefit to the taxpayers who participated 

in such transactions. The Committee finds these transactions and 

their continuing tax benefit to be inappropriate. 

EXPLANATION OF PROVISION

The provision changes the effective date of the loss deferral rules 

with respect to certain leases. Under the provision, the loss deferral rules also apply to leases entered into on or before March 12, 

2004, if the lessee is a foreign person or entity. With respect to 

such leases, losses are deferred starting in taxable years beginning 

after December 31, 2006. 

No inference is intended regarding the appropriate present-law 

tax treatment of transactions entered into prior to March 12, 2004, 

if the lessee is not a foreign person or entity. In addition, it is intended that the provision shall not be construed as altering or supplanting the present-law tax rules providing that a taxpayer is 

treated as the owner of leased property only if the taxpayer acquires and retains significant and genuine attributes of an owner 

of the property, including the benefits and burdens of ownership. 

The provision also is not intended to affect the scope of any other 

present-law tax rules or doctrines applicable to purported leasing 

transactions. 

EFFECTIVE DATE

The provision is effective as if included in the provisions of the 

American Jobs Creation Act of 2004 to which it relates. 


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95Sec. 1031(a)(1). 96Treas. Reg. sec. 1.1031(a)–1(b). 

F. MODIFICATIONS TO CORPORATE ESTIMATED TAX PAYMENTS

(Sec. 506 of the bill) 

PRESENT LAW

In general, corporations are required to make quarterly estimated tax payments of their income tax liability. For a corporation 

whose taxable year is a calendar year, these estimated tax payments must be made by April 15, June 15, September 15, and December 15. 

Under present law, in the case of a corporation with assets of at 

least $1 billion, the payments due in July, August, and September, 

2012, shall be increased to 115.00 percent of the payment otherwise due and the next required payment shall be reduced accordingly. 

REASONS FOR CHANGE

The Committee believes it is appropriate to adjust the corporate 

estimated tax payments. 

EXPLANATION OF PROVISION

The bill increases the otherwise applicable percentage (115.00 

percent) by 7.00 percent. 

EFFECTIVE DATE

The provision is effective on the date of enactment. 

G. INELIGIBILITY OF COLLECTIBLES FOR NONTAXABLE LIKE KIND

EXCHANGE TREATMENT

(Sec. 507 of the bill and sec. 1031 of the Code) 

PRESENT LAW

An exchange of property, like a sale, generally is a taxable event. 

However, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for 

property of a ‘‘like kind’’ that is to be held for productive use in a 

trade or business or for investment.95 If section 1031 applies to an 

exchange of properties, the basis of the property received in the exchange is equal to the basis of the property transferred, decreased 

by any money received by the taxpayer, and further adjusted for 

any gain or loss recognized on the exchange. For purposes of section 1031, the determination of ‘‘like kind’’ relates to the nature or 

character of the property and not its grade or quality. ‘‘One kind 

or class of property may not, under that section, be exchanged for 

property of a different kind or class.’’ 96

REASONS FOR CHANGE

The Committee believes that section 1031 was designed to encourage capital reinvestment for assets used in a trade or business 

or held for investment. Because collectibles have elements of both 


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97S. Rep. No. 91–552, 91st Cong, 1st Sess., 273–74 (1969), referring to Tank Truck Rentals, 

Inc. v. Commissioner, 356 U.S. 30 (1958). 

investment and personal use, the Committee wishes to exclude collectibles from property qualifying for nonrecognition treatment. 

EXPLANATION OF PROVISION

The provision denies nonrecognition treatment for exchanges of 

collectibles, as defined by section 408(m)(2). 

EFFECTIVE DATE

The provision is effective for exchanges completed after the date 

of enactment. 

H. DENIAL OF DEDUCTION FOR CERTAIN FINES, PENALTIES, AND

OTHER AMOUNTS

(Sec. 508 of the bill and sec. 162(f) and new sec. 6050W of the 

Code) 

PRESENT LAW

Under present law, no deduction is allowed as a trade or business expense under section 162(a) for the payment to a government 

of a fine or similar penalty for the violation of any law (sec. 162(f)). 

The enactment of section 162(f) in 1969 codified existing case law 

that denied the deductibility of fines as ordinary and necessary 

business expenses on the grounds that ‘‘allowance of the deduction 

would frustrate sharply defined national or State policies proscribing the particular types of conduct evidenced by some governmental declaration thereof.’’ 97

Treasury regulation section 1.162–21(b)(1) provides that a fine or 

similar penalty includes an amount: (1) paid pursuant to conviction 

or a plea of guilty or nolo contendere for a crime (felony or misdemeanor) in a criminal proceeding; (2) paid as a civil penalty imposed by Federal, State, or local law, including additions to tax and 

additional amounts and assessable penalties imposed by chapter 68 

of the Code; (3) paid in settlement of the taxpayer’s actual or potential liability for a fine or penalty (civil or criminal); or (4) forfeited 

as collateral posted in connection with a proceeding which could result in imposition of such a fine or penalty. Treasury regulation 

section 1.162–21(b)(2) provides, among other things, that compensatory damages (including damages under section 4A of the Clayton Act (15 U.S.C. sec. 15a), as amended) paid to a government do 

not constitute a fine or penalty. 

REASONS FOR CHANGE

The Committee is concerned that there is a lack of clarity and 

consistency under present law regarding when taxpayers may deduct payments made in settlement of government investigations of 

potential wrongdoing, as well as in situations where there has been 

a final determination of wrongdoing. If a taxpayer deducts payments made in settlement of an investigation of potential wrongdoing or as a result of a finding of wrongdoing, the publicly announced amount of the settlement payment does not reflect the 

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98The provision does not affect amounts paid or incurred in performing routine audits or reviews such as annual audits that are required of all organizations or individuals in a similar 

business sector, or profession, as a requirement for being allowed to conduct business. However, 

if the government or regulator raised an issue of compliance and a payment is required in settlement of such issue, the provision would affect that payment. 99The provision provides that such amounts are nondeductible under chapter 1 of the Internal 

Revenue Code. 100This exception from deductibility for reimbursements is intended to include payments to 

reimburse a government for payments to whistleblowers. 101The provision does not affect such costs or fees that are a regular charge for a routine audit 

or customary review, nor does it affect amounts paid or incurred in performing routine audits 

or reviews that are required of all organizations or individuals in a similar business sector, or 

profession, as a requirement for being allowed to conduct business. However, if the government 

or regulator raised an issue of compliance and a payment is required in settlement of such issue, 

the provision would affect that payment. 102The provision does not affect the treatment of antitrust payments made under section 4 

of the Clayton Act, which continue to be governed by the provisions of section 162(g). 103 If a settlement agreement does not specify a specific amount to be paid for the purpose 

of coming into compliance but instead simply requires the taxpayer to come into compliance, 

it is sufficient identification to so state. Amounts expended by the taxpayer for that purpose 

would then be considered identified. However, if an agreement specifies a specific dollar amount 

that must be paid or incurred, the amount would not be eligible to be deducted without a specification that it is for restitution (including remediation of property) or coming into compliance. 104Thus, for example, the provision would not apply to payments made by one private party 

to another in a lawsuit between private parties merely because a judge or jury acting in the 

capacity as a court ddirects the payment to be made. The mere fact that a court enters a judgcerned that allowing a deduction for such payments in effect shifts 

a portion of the penalty to the Federal government and to the public. 

EXPLANATION OF PROVISION

The provision modifies the rules regarding the determination 

whether payments are nondeductible payments of fines or penalties 

under section 162(f). In particular, the provision generally provides 

that amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government in relation to the 

violation of any law, or the investigation or inquiry into the potential violation of any law which is initiated by such government,98

are nondeductible under any provision of the income tax provisions.99 The provision applies to deny a deduction for any such payments, including those where there is no admission of guilt or liability and those made for the purpose of avoiding further investigation or litigation. An exception applies to payments that the 

taxpayer establishes are either restitution (including remediation 

of property) for damage or harm caused by, or which may be 

caused by, the violation or potential violation, or amounts paid to 

come into compliance with any law that was violated or involved 

in the investigation or inquiry. The exception for restitution does 

not apply to any amount paid or incurred as reimbursement to the 

government for the costs of any investigation or litigation 100 unless 

such amount is paid or incurred for a cost or fee regularly charged 

for any routine audit or other customary review performed by the 

government.101

In the case of any court order or binding written settlement agreement, if the amounts required to be paid exceed $1 million, 

then the deduction is not allowed unless such court order or written settlement agreement specifies that the amount is for restitution, for remediation of property, or to come into compliance with 

the law.102 The IRS remains free to challenge the characterization 

of an amount so identified.103

The provision does not apply to any amount paid or incurred by 

order of a court in a suit in which no government is a party.104


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ment or directs a result in a private dispute does not cause a payment to be made ‘‘at the direction of a government’’ for purposes of the provision. 105Thus, amounts paid or incurred as taxes due are not affected by the provision (e.g., State 

taxes that are otherwise deductible). The reference to taxes due is also intended to include interest with respect to such taxes (but not interest, if any, with respect to any penalties imposed 

with respect to such taxes). 106Similarly, a payment to a charitable organization benefiting a broader class than the persons or property actually harmed, or to be paid out without a substantial quantitative relationship to the harm caused, would not qualify as restitution. Under the provision, such a payment 

not deductible under section 162 would also not be deductible under section 170. 

The provision does not apply to any amount paid or incurred as 

taxes due.105

It is intended that a payment will be treated as restitution (including remediation of property) only if substantially all of the payment is required to be paid to the specific persons, or in relation 

to the specific property, actually harmed by the conduct of the taxpayer that resulted in the payment. Thus, a payment to or with respect to a class substantially broader than the specific persons or 

property that were actually harmed (e.g., to a class including similarly situated persons or property) does not qualify as restitution 

or included remediation of property.106 Restitution and included remediation of property is limited to the amount that bears a substantial quantitative relationship to the harm caused by the past 

conduct or actions of the taxpayer that resulted in the payment in 

question. If the party harmed is a government or other entity, then 

restitution and included remediation of property includes payment 

to such harmed government or entity, provided the payment bears 

a substantial quantitative relationship to the harm. 

It is intended that a payment will be treated as an amount paid 

to come into compliance only if it directly corrects a violation with 

respect to a particular requirement of law that was under investigation. For example, if the law requires a particular emission 

standard to be met or particular machinery to be used, amounts required to be paid under a settlement agreement to meet the required standard or install the machinery are deductible to the extent otherwise allowed. Similarly, if the law requires certain practices and procedures to be followed and a settlement agreement requires the taxpayer to pay to establish such practices or procedures, such amounts would be deductible. However, amounts paid 

for other purposes not directly correcting a violation of law are not 

deductible. For example, amounts paid to bring other machinery 

that is already in compliance up to a standard higher than required by the law, or to create other benefits (such as a park or 

other action not previously required by law), are not deductible if 

required under a settlement agreement. Similarly, amounts paid to 

educate consumers or customers about the risks of doing business 

with the taxpayer or about the field in which the taxpayer does 

business generally, which education efforts are not specifically required under the law, are not deductible if required under a settlement agreement. 

The provision requires government agencies to report to the IRS 

and to the taxpayer the amount of each settlement agreement or 

order entered where the aggregate amount required to be paid or 

incurred to or at the direction of the government under such settlement agreements and orders with respect to the violation, investigation, or inquiry is least $600 (or such other amount as may be 

specified by the Secretary of the Treasury as necessary to ensure 


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107 As in the case of the identification requirement, if the agreement does not specify a specific 

amount to be expended to come into compliance but simply requires that to occur, it is expected 

that the report may state simply that the taxpayer is required to come into compliance but no 

specific dollar amount has been specified for that purpose in the settlement agreement. 108For example, the IRS might require such separate reporting as part of, or in addition to, 

reporting of amouts that are not deducted and that thus create a book tax difference on the 

schedule M–3. 

the efficient administration of the Internal Revenue laws). The reports must be made within 30 days of the date the court order is 

issued or the settlement agreement is entered into, or such other 

time as may be required by Secretary. The report must separately 

identify any amounts that are restitution or remediation of property, or correction of noncompliance.107

The IRS is encouraged to require taxpayers to identify separately 

on their tax returns the amounts of any such settlements with respect to which reporting is required under the provision, including 

separate identification of the nondeductible amount and of any 

amount deductible as restitution, remediation, or required to correct noncompliance.108

Amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, any self-regulatory entity that regulates a financial market or other market that is a qualified board 

or exchange under section 1256(g)(7), and that is authorized to impose sanctions (e.g., the National Association of Securities Dealers) 

are likewise subject to the provision if paid in relation to a violation, or investigation or inquiry into a potential violation, of any 

law (or any rule or other requirement of such entity). To the extent 

provided in regulations, amounts paid or incurred to, or at the direction of, any other nongovernmental entity that exercises selfregulatory powers as part of performing an essential governmental 

function are similarly subject to the provision. The exception for 

payments that the taxpayer establishes are paid or incurred for 

restitution, remediation of property, or coming into compliance; the 

rules requiring identification of those amounts in a court order or 

written settlement agreement of $1 million or greater; and all the 

other requirements of the provision including the requirement of 

reporting to the IRS and the taxpayer, likewise apply in such cases. 

No inference is intended as to the treatment of payments as nondeductible fines or penalties under present law. In particular, the 

provision is not intended to limit the scope of present-law section 

162(f) or the regulations thereunder. 

EFFECTIVE DATE

The provision is effective for amounts paid or incurred on or after 

the date of enactment; however the provision does not apply to 

amounts paid or incurred under any binding order or agreement 

entered into before such date. Any order or agreement requiring 

court approval is not a binding order or agreement for this purpose 

unless such approval was obtained before the date of enactment. 


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I. INCREASE IN INFORMATION RETURN PENALTIES

(Sec. 509 of the bill and secs. 6721, 6722, and 6723 of the Code) 

PRESENT LAW

Present law imposes information reporting requirements on participants in certain transactions. Under section 6721 of the Code, 

any person required to file a correct information return who fails 

to do so on or before the prescribed filing date is subject to a penalty that varies based on when, if at all, the correct information return is filed. If a person files a correct information return after the 

prescribed filing date, but on or before the date that is 30 days 

after the prescribed filing date, the amount of the penalty is $15 

per return (the ‘‘first-tier penalty’’), with a maximum penalty of $75,000 per calendar year. If a person files a correct information 

return more than 30 days after the prescribed filing date, but on 

or before August 1, the amount of the penalty is $30 per return 

(the ‘‘second-tier penalty’’), with a maximum penalty of $150,000 

per calendar year. If a correct information return is not filed on or 

before August 1, the amount of the penalty is $50 per return (the 

‘‘third-tier penalty’’), with a maximum penalty of $250,000 per calendar year. 

Special lower maximum levels for this penalty apply to small 

businesses. Small businesses are defined as firms having average 

annual gross receipts for the most recent three taxable years that 

do not exceed $5 million. The maximum penalties for small businesses are: $25,000 (instead of $75,000) if the failures are corrected 

on or before 30 days after the prescribed filing date; $50,000 (instead of $150,000) if the failures are corrected on or before August 

1; and $100,000 (instead of $250,000) if the failures are not corrected on or before August 1. 

Section 6722 of the Code also imposes penalties for failing to furnish correct payee statements to taxpayers. In addition, section 

6723 imposes a penalty for failing to comply with other information 

reporting requirements. Under both section 6722 and section 6723, 

the penalty amount is $50 for each failure, up to a maximum of 

$100,000. 

REASONS FOR CHANGE

The Committee believes the present law penalties for failing to 

file accurate information returns are too low to discourage noncompliance. The Committee believes that increasing the information return penalties will encourage the filing of timely and accurate information returns and generally will improve tax administration and tax compliance. 

EXPLANATION OF PROVISION

The provision increases the penalties for failing to file correct information returns, failing to furnish correct payee statements, and 

failing to comply with other information reporting requirements. 

Specifically, the provision increases the failure to file correct information returns as follows: the first-tier penalty would be increased 

from $15 to $50, with a maximum penalty of $500,000 per calendar 

year; the second-tier penalty would be increased from $30 to $100, 

with a maximum penalty of $1,500,000 per calendar year; and the 


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109See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. 

(CCH) 2189 (1997), cert. denied 526 U.S. 1017 (1999). Closely related doctrines also applied by 

the courts (sometimes interchangeable with the economic substance doctrine) include the ‘‘sham 

transaction doctrine’’ and the ‘‘business purpose doctrine.’’ See, e.g., Knetsch v. United States, 

364 U.S. 361 (1960) (denying interest deductions on a ‘‘sham transaction’’ whose only purpose 

was to create the deductions). Certain ‘‘substance over form’’ cases involving tax-indifferent parties, in which courts have found that the substance of the transaction did not comport with the 

form asserted by the taxpayer, have also involved examination of whether the change in economic position that occurred, if any, was consistent with the form asserted, and whether the 

claimed business purpose supported the particular tax benefits that were claimed. See, e.g., 

Klamath Strategic Investment Fund, LLC v. United States, 472 F. Supp. 2d 885 (E.D. Texas 

third-tier penalty would be increased from $50 to $250, with a 

maximum penalty of $3,000,000 per calendar year. The maximum 

penalties for small businesses would be: $175,000 if the failures are 

corrected on or before 30 days after the prescribed filing date; 

$500,000 if the failures are corrected on or before August 1; and 

$1,000,000 if the failures are not corrected on or before August 1. 

The provision increases both the penalty for failing to furnish 

correct payee statements to taxpayers and the penalty for failing 

to comply with other information reporting requirements penalties 

to $250 for each such failure, up to a maximum of $1,000,000 in 

a calendar year. 

EFFECTIVE DATE

The provision is effective with respect to information returns required to be filed on or after January 1, 2008. 

J. ECONOMIC SUBSTANCE DOCTRINE

(Secs. 511–513 of the bill and sec. 7701, new sec. 6662B, and sec. 

163 of the Code) 

1. Clarification of the economic substance doctrine 

PRESENT LAW

In general 

The Code provides detailed rules specifying the computation of 

taxable income, including the amount, timing, source, and character of items of income, gain, loss, and deduction. These rules permit both taxpayers and the government to compute taxable income 

with reasonable accuracy and predictability. Taxpayers generally 

may plan their transactions in reliance on these rules to determine 

the federal income tax consequences arising from the transactions. 

In addition to the statutory provisions, courts have developed 

several doctrines that can be applied to deny the tax benefits of tax 

motivated transactions, notwithstanding that the transaction may 

satisfy the literal requirements of a specific tax provision. The common-law doctrines are not entirely distinguishable, and their application to a given set of facts is often blurred by the courts and the 

IRS. Although these doctrines serve an important role in the administration of the tax system, they can be seen as at odds with 

an objective, ‘‘rule-based’’ system of taxation. 

A common-law doctrine applied with increasing frequency is the 

‘‘economic substance’’ doctrine. In general, this doctrine denies tax 

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2007); TIFD–III–E, Inc. v. United States, 459 F. 3d 220 (2d Cir. 2006); BB&T Corporation v. 

United States, ——F. Supp. 2d ——, 2007–1 USTC P 50,130 (M.D.N.C. 2007). 110 AACM Partnership v. Commissioner, 73 T.C.M. at 2215. 111See, ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 112 ‘‘The casebooks are glutted with [economic substance] tests. Many such tests proliferate because they give the comforting illusion of consistency and precision. They often obscure rather 

than clarify.’’ Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988). 113See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993) (‘‘The threshold 

question is whether the transaction has economic substance. If the answer is yes, the question 

becomes whether the taxpayer was motivated by profit to participate in the transaction.’’). 114See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d 89, 91–92 (4th Cir. 1985) (‘‘To 

treat a transaction as a sham, the court must find that the taxpayer was motivated by no business purposes other than obtaining tax benefits in entering the transaction, and, second, that 

the transaction has no economic substance because no reasonable possibility of a profit exists.’’); 

IES Industries v. United States, 253 F.3d 350, 358 (8th Cir. 2001) (‘‘In determining whether 

a transaction is a sham for tax purposes [under the Eighth Circuit test], a transaction will be 

characterized as a sham if it is not motivated by any economic purpose out of tax considerations 

(the business purpose test), and if it is without economic substance because no real potential 

for profit exists (the economic substance test).’’). As noted earlier, the economic substance doctrine and the sham transaction doctrine are similar and sometimes are applied interchangeably. 

For a more detailed discussion of the sham transaction doctrine, see, e.g., Joint Committee on 

Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 

Continued 

Economic substance doctrine 

Courts generally deny claimed tax benefits if the transaction that 

gives rise to those benefits lacks economic substance independent 

of tax considerations—notwithstanding that the purported activity 

actually occurred. The Tax Court has described the doctrine as follows: 

The tax law . . . requires that the intended transactions 

have economic substance separate and distinct from economic benefit achieved solely by tax reduction. The doctrine of economic substance becomes applicable, and a judicial remedy is warranted, where a taxpayer seeks to claim 

tax benefits, unintended by Congress, by means of transactions that serve no economic purpose other than tax savings.110

Business purpose doctrine 

A common law doctrine that often is considered together with the 

economic substance doctrine is the business purpose doctrine. The 

business purpose doctrine involves a subjective inquiry into the motives of the taxpayer—that is, whether the taxpayer intended the 

transaction to serve some useful non-tax purpose. In making this 

determination, some courts have bifurcated a transaction in which 

independent activities with non-tax objectives have been combined 

with an unrelated item having only tax-avoidance objectives in 

order to disallow the tax benefits of the overall transaction.111

Application by the courts 

Elements of the doctrine 

There is a lack of uniformity regarding the proper application of 

the economic substance doctrine.112 Some courts apply a conjunctive test that requires a taxpayer to establish the presence of both 

economic substance (i.e., the objective component) and business 

purpose (i.e., the subjective component) in order for the transaction 

to survive judicial scrutiny.113 A narrower approach used by some 

courts is to conclude that either a business purpose or economic 

substance is sufficient to respect the transaction.114 A third apVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00089 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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of the Internal Revenue Service Restructuring and Reform Act of 1998 (including Provisions Relating to Corporate Tax Shelters) (JCS–3–99) at 182. 115 1ASee, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247; James v. Commissioner, 

899 F.2d 905, 908 (10th Cir. 1995); Sacks v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) 

(‘‘Instead, the consideration of business purpose and economic substance are simply more precise 

factors to consider . . . We have repeatedly and carefully noted that this formulation cannot be 

used as a ‘rigid two-step analysis’.’’). 116 Coltec Industries, Inc. v. United States, 62 Fed. Cl. 716 (2004) (slip opinion at 123–124, 

128); vacated and remanded, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied, 127 S. Ct. 1261 

(Mem.) (2007). 117The Federal Circuit Court stated that ‘‘when the taxpayer claims a deduction, it is the taxpayer who bears the burden of proving that the transaction has economic substance.’’ The Federal Circuit Court quoted a decision of its predecessor court, stating that ‘‘Gregory v. Helvering 

requires that a taxpayer carry an unusually heavy burden when he attempts to demonstrate 

that Congress intended to give favorable tax treatment to the kind of transaction that would 

never occur absent the motive of tax avoidance.’’ The Court also stated that ‘‘while the taxpayer’s subjective motivation may be pertinent to the existence of a tax avoidance purpose, all 

courts have looked to the objective reality of a transaction in assessing its economic substance.’’ Coltec Industries, Inc. v. United States, 454 F.3d at 1355, 1356. 118See, e.g., Coltec Industries v. United States, 454 F.3d 1340 (Fed. Cir. 2006). The court analyzed the transfer to a subsidiary of a note purporting to provide high stock basis in exchange 

for a purported assumption of liabilities, and held these transactions unnecessary to accomplish 

any business purpose of using a subsidiary to manage asbestos liabilities. The court also held 

that the purported business purpose of adding a barrier to veil-piercing claims by third parties 

was not accomplished by the transaction. 454 F.3d at 1358–1360 (Fed. Cir. 2006). 119See, e.g., Knetsch, 364 U.S. at 361; Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966) 

(holding that an unprofitable, leveraged acquisition of Treasury bills, and accompanying prepaid 

interest deduction, lacked economic substance). 120See, e.g., Goldstein v. Commissioner, 364 F.2d at 739–40 (disallowing deduction even 

though taxpayer had a possibility of small gain or loss by owning Treasury bills); Sheldon v. 

proach regards economic substance and business purpose as ‘‘simply more precise factors to consider’’ in determining whether a 

transaction has any practical economic effects other than the creation of tax benefits.115

Recently, the Court of Federal Claims questioned the continuing 

viability of the doctrine. That court also stated that ‘‘the use of the ‘economic substance’ doctrine to trump ‘mere compliance with the 

Code’ would violate the separation of powers’’ though that court 

also found that the particular case did not lack economic substance. 

The Court of Appeals for the Federal Circuit (‘‘Federal Circuit 

Court’’) overruled the Court of Federal Claims decision, reiterating 

the viability of the economic substance doctrine and concluding 

that the transaction in question violated that doctrine.116 The Federal Circuit Court stated that ‘‘[w]hile the doctrine may well also 

apply if the taxpayer’s sole subjective motivation is tax avoidance 

even if the transaction has economic substance, [footnote omitted], 

a lack of economic substance is sufficient to disqualify the transaction without proof that the taxpayer’s sole motive is tax avoidance.’’ 117

Nontax economic benefits 

There also is a lack of uniformity regarding the type of non-tax 

economic benefit a taxpayer must establish in order to satisfy economic substance. Some courts have denied tax benefits on the 

grounds that a stated business benefit of a particular structure was 

not in fact obtained by that structure.118 Several courts have denied tax benefits on the grounds that the subject transactions 

lacked profit potential.119 In addition, some courts have applied the 

economic substance doctrine to disallow tax benefits in transactions 

in which a taxpayer was exposed to risk and the transaction had 

a profit potential, but the court concluded that the economic risks 

and profit potential were insignificant when compared to the tax 

benefits.120 Under this analysis, the taxpayer’s profit potential 


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Commissioner, 94 T.C. 738, 768 (1990) (stating that ‘‘potential for gain . . . is infinitesimally 

nominal and vastly insignificant when considered in comparison with the claimed deductions’’). 121See, e.g., Rice’s Toyota World v. Commissioner, 752 F. 2d 89, 94 (4th Cir. 1985) (the economic substance inquiry requires an objective determination of whether a reasonable possibility 

of profit from the transaction existed apart from tax benefits); Compaq Computer Corp. v. Commissioner, 277 F.3d 778, 781 (5th Cir. 2001) (applied the same test, citing Rice’s Toyota World); 

IES Industries v. United States, 253 F.3d 350, 354 (8th Cir. 2001). 122See American Electric Power, Inc. v. United States, 136 F. Supp. 2d 762, 791–92 (S.D. Ohio 

2001); aff’d 326 F.3d.737 (6th Cir. 2003). 123See, e.g., Joint Committee on Taxation, Report of Investigation of Enron Corporation and 

Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations 

(JSC–3–03) February, 2003 (‘‘Enron Report’’), Volume III at C–93, 289. Enron Corporation relied 

on Frank Lyon Co. v. United States, 435 U.S. 561, 577–78 (1978), and Newman v. Commissioner, 902 F.2d 159, 163 (2d Cir. 1990), to argue that financial accounting benefits arising from 

tax savings constitute a good business purpose. 124See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. 

(CCH) 2189 (1997), cert. denied 526 U.S. 1017 (1999). 125See, e.g., TIFD–III–E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006). 

must be more than nominal. Conversely, other courts view the application of the economic substance doctrine as requiring an objective determination of whether a ‘‘reasonable possibility of profit’’ from the transaction existed apart from the tax benefits.121 In 

these cases, in assessing whether a reasonable possibility of profit 

exists, it may be sufficient if there is a nominal amount of pre-tax 

profit as measured against expected net tax benefits. 

Financial accounting benefits 

In determining whether a taxpayer had a valid business purpose 

for entering into a transaction, at least one court has concluded 

that financial accounting benefits arising from tax savings do not 

qualify as a non-tax business purpose.122 However, based on court 

decisions that recognize the importance of financial accounting 

treatment, taxpayers have asserted that financial accounting benefits arising from tax savings can satisfy the business purpose 

test.123

Tax-indifferent parties 

A number of cases have involved transactions structured to allocate income for Federal tax purposes to a tax-indifferent party, 

with a corresponding deduction, or favorable basis result, to a taxable person. The income allocated to the tax-indifferent party for 

tax purposes was structured to exceed any actual economic income 

to be received by the tax indifferent party from the transaction. 

Courts have sometimes concluded that a particular type of transaction did not satisfy the economic substance doctrine.124 In other 

cases, courts have indicated that the substance of the transaction 

did not support the form of income allocations asserted by the taxpayer, and have questioned whether asserted business purpose or 

other standards were met.125

REASONS FOR CHANGE

Recent tax avoidance transactions have relied upon the interaction of highly technical tax law provisions to produce tax consequences not contemplated by the Congress. When successful, taxpayers who engage in these transactions enlarge the tax gap by 

gaining unintended tax relief and by undermining overall respect 

for the tax system. 

A strictly rule-based tax system cannot efficiently prescribe the 

appropriate outcome of every conceivable transaction that might be 


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126See, e.g., Treas. Reg. sec. 1.269–2, stating that characteristic of circumstances in which a 

deduction otherwise allowed will be disallowed are those in which the effect of the deduction, 

credit, or other allowance would be to distort the liability of the particular taxpayer when the 

essential nature of the transaction or situation is examined in the light of the basic purpose 

or plan which the deduction, credit, or other allowance was designed by the Congress to effectuate. 127The examples are illustrative and not exclusive. 128See, e.g., John Kelley Co. v. Commissioner, 326 U.S. 521 (1946) (respecting debt characterization in one case and not in the other, based on all the facts and circumstances). 

devised and is, as a result, incapable of preventing all unintended 

consequences. Thus, many courts have long recognized the need to 

supplement tax rules with anti-tax avoidance standards, such as 

the economic substance doctrine, in order to assure the Congressional purpose is achieved. The Committee recognizes that IRS has 

achieved a number of recent successes in litigation. The Committee 

believes it is still desirable to provide greater clarity and uniformity in the application of the economic substance doctrine in 

order to assure such continued application of the doctrine and to 

improve its effectiveness at deterring unintended consequences. 

The Committee believes that a stronger penalty imposed on understatements attributable to non-economic substance transactions is 

desirable in this connection, to deter taxpayers from entering such 

transactions and thus improve compliance. 

The Committee believes the same result with respect to interest 

on underpayments that occurs with respect to nondisclosed reportable transactions should also apply to noneconomic substance 

transactions. 

EXPLANATION OF PROVISION

The provision clarifies and enhances the application of the economic substance doctrine. Under the provision, in a case in which 

a court determines that the economic substance doctrine is relevant 

to a transaction (or a series of transactions), such transaction (or 

series of transactions) has economic substance (and thus satisfies 

the economic substance doctrine) only if the taxpayer establishes 

that (1) the transaction changes in a meaningful way (apart from 

Federal income tax consequences) the taxpayer’s economic position, 

and (2) the taxpayer has a substantial non-Federal-tax purpose for 

entering into such transaction. The provision provides a uniform 

definition of economic substance, but does not alter the flexibility 

of the courts in other respects. 

If the tax benefits are clearly consistent with all applicable provisions of the Code and the purposes of such provisions, it is not intended that such tax benefits be disallowed if the only reason for 

such disallowance is that the transaction fails the economic substance doctrine as defined in this provision. Thus, the provision 

does not change current law standards used by courts in determining when to utilize an economic substance analysis.126

The provision is not intended to alter the tax treatment of certain basic business transactions that, under longstanding judicial 

and administrative practice are respected, merely because the 

choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages. Among127 these basic 

transactions are (1) the choice between capitalizing a business enterprise with debt or equity;128 (2) a U.S. person’s choice between 

utilizing a foreign corporation or a domestic corporation to make a 


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129See, e.g., Sam Siegel v. Commissioner, 45. T.C. 566 (1966), acq. 1966–2 C.B. 3; but see 

Commissioner v. Bollinger, 485 U.S. 340 (1988) (agency principles applied to title-holding corporation under all the facts and circumstance). 130See, e.g. Rev. Proc. 2007–3 2007–1 I.R.B. 108, secs 3.01(33), (34), and (36) (IRS will not 

rule on certain matters relating to incorporations or reorganizations unless there is a ‘‘significant issue’’); compare Gregory v. Helvering. 293 U.S. 465 (1935). 131See, e.g., National Carbide v. Commissioner, 336 U.S. 422 (1949), Moline Properties v. 

Commissioner, 319 U.S. 435 (1943); compare, e.g. Aiken Industries, Inc. v. Commissioner, 56 

T.C. 925 (1971), acq., 1972–2 C.B. 1; Commissioner v. Bollinger, 485 U.S. 340 (1988), see also 

sec. 7701(l). 132See, e.g., Frank Lyon v. Commissioner, 435 U.S. 561 (1978); Hilton v. Commissioner, 74 

T.C. 305, aff’d 671 F. 2d 316 (9th Cir. 1982), cert. denied 459 U.S. 907 (1982); Coltec Industries 

v. United States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 (Mem) (2007). 133 As examples of cases in which courts have found that a transaction does not meet the requirements for the treatment claimed by the taxpayer under the Code, or does not have economic substance, see e.g., TIFD–III–E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006); BB&T 

Corporation v. United States, ——F. Supp.——, 2007–1 USTC P 50,130 (M.D.N,C, 2007); Tribune Company and Subsidiaries v. Commissioner, 125 T.C. 110 (2005) ; H.J. Heinz Company and 

Subsidiaries v. United States, 76 Fed. Cl. 570 (2007); Coltec Industries, Inc. v. United States, 

454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 (Mem.) (2007); Long Term Capital 

Holdings LP v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004), aff’d 150 Fed. Appx. 40 

(2d Cir. 2005); Klamath Strategic Investment Fund, LLC v. United States, 472 F. Supp. 2d 885 

(E.D. Texas 2007); Santa Monica Pictures LLC v. Commissioner, 89 T.C.M. 1157 (2005). 134See, e.g., Coltec Industries, Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006), cert. denied 127 S. Ct. 1261 (Mem.) (2007) (‘‘the first asserted business purpose focuses on the wrong 

transaction—the creation of Garrison as a separate subsidiary to manage asbestos liabilities.. . . [W]e must focus on the transaction that gave the taxpayer a high basis in the stock 

and thus gave rise to the alleged benefit upon sale...’’) 454 F.3d 1340, 1358 (Fed. Cir. 2006). 

See also ACM Partnership v. Commissioner, 157 F.3d at 256 n.48; Minnesota Tea Co. v. 

Helvering, 302 U.S. 609, 613 (1938) (‘‘A given result at the end of a straight path is not made 

a different result because reached by following a devious path.’’). 

foreign investment;129 (3) the choice to enter a transaction or series 

of transactions that constitute a corporate organization or reorganization under subchapter C;130 and (4) the choice to utilize a related-party entity in a transaction, provided that the arm’s length 

standard of section 482 and other applicable concepts are satisfied.131 Leasing transactions, like all other types of transactions, 

will continue to be analyzed in light of all the facts and circumstances.132 As under present law, whether a particular transaction meets the requirements for specific treatment under any of 

these provisions can be a question of facts and circumstances. Also, 

the fact that a transaction does meet the requirements for specific 

treatment under any provision of the Code is not determinative of 

whether a transaction or series of transactions of which it is a part 

has economic substance.133

The provision does not alter the court’s ability to aggregate, 

disaggregate, or otherwise recharacterize a transaction when applying the doctrine. For example, the provision reiterates the presentlaw ability of the courts to bifurcate a transaction in which independent activities with non-tax objectives are combined with an unrelated item having only tax-avoidance objectives in order to disallow those tax motivated benefits.134

Conjunctive analysis 

The provision clarifies that the economic substance doctrine involves a conjunctive analysis—there must be a judicial inquiry regarding the objective effects of the transaction on the taxpayer’s 

economic position as well as an inquiry regarding the taxpayer’s 

subjective motives for engaging in the transaction. Under the provision, a transaction must satisfy both tests, i.e., the transaction 

must change in a meaningful way (apart from Federal income tax 

effects) the taxpayer’s economic position, and the taxpayer must 


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135 A purpose of reducing non-Federal taxes is not a non-Federal-tax business purpose if (i) 

the transaction will effect a reduction in both Federal and non-Federal taxes because of similarities between Federal tax law and the law of the other jurisdiction and (ii) the reduction of Federal taxes is greater than or substantially coextensive with the reduction of non-Federal taxes. 136See, e.g., Treas. Reg. sec. 1.269–2(b) (stating that a distortion of tax liability indicating the 

principal purpose of tax evasion or avoidance might be evidenced by the fact that ‘‘the transaction was not undertaken for reasons germane to the conduct of the business of the taxpayer’’). 

Similarly, in ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189 (1997), the court stated: 

‘‘Key to [the determination of whether a transaction has economic substance] is that the transaction must be rationally related to a useful nontax purpose that is plausible in light of the 

taxpayer’s conduct and useful in light of the taxpayer’s economic situation and intentions. Both 

the utility of the stated purpose and the rationality of the means chosen to effectuate it must 

be evaluated in accordance with commercial practices in the relevant industry. A rational relationship between purpose and means ordinarily will not be found unless there was a reasonable 

expectation that the nontax benefits would be at least commensurate with the transaction 

costs.’’ [citations omitted] 137 However, if the tax benefits are clearly contemplated and expected by the language and 

purpose of the relevant authority, such tax benefits should not be disallowed solely because the 

transaction results in a favorable accounting treatment. An example is the repealed foreign 

sales corporation rules. 138This includes tax deductions or losses that are anticipated to be recognized in a period subsequent to the period the financial accounting benefit is recognized. For example, FAS 109 in 

some cases permits the recognition of financial accounting benefits prior to the period in which 

the tax benefits are recognized for income tax purposes. 139 Claiming that a financial accounting benefit constitutes a substantial non-tax purpose fails 

to consider the origin of the accounting benefit (i.e., reduction of taxes) and significantly diminishes the purpose for having a substantial non-tax purpose requirement. See, e.g., American 

Electric Power, Inc. v. United States, 136 F. Supp. 2d 762, 791–92 (S.D. Ohio 2001) (‘‘AEP’s intended use of the cash flows generated by the [corporate-owned life insurance] plan is irrelevant 

to the subjective prong of the economic substance analysis. If a legitimate business purpose for 

the use of the tax savings ‘were sufficient to breathe substance into a transaction whose only 

purpose was to reduce taxes, [then] every sham tax-shelter device might succeed,’ ’’) (citing 

Winn-Dixie v. Commissioner, 113 T.C. 254, 287 (1999)); aff’d, 326 F3d 737 (6th Cir. 2003). 

have a substantial non-Federal-tax purpose135 for entering into 

such transaction, in order to satisfy the economic substance doctrine. This clarification eliminates the disparity that exists among 

the circuits regarding the application of the doctrine, and modifies 

its application in those circuits in which either a change in economic position or a non-tax business purpose (without having both) 

is sufficient to satisfy the economic substance doctrine. 

Non-Federal-tax business purpose 

Under the provision, a taxpayer’s non-Federal-tax purpose for entering into a transaction (the second prong in the analysis) must 

be ‘‘substantial.’’136

An objective of achieving a favorable accounting treatment for financial reporting purposes will not itself be treated as a substantial non-Federal-tax purpose if the origin of such financial accounting benefit is a reduction of Federal income tax.137 For example, a 

transaction that is expected to increase financial accounting income 

as a result of generating tax deductions or losses without a corresponding financial accounting charge (i.e., a permanent book-tax 

difference)138 should not be considered to have a substantial nonFederal-tax purpose unless a substantial non-Federal-tax purpose 

exists apart from the financial accounting benefits.139

Profit potential 

Under the provision, a taxpayer may rely on factors other than 

profit potential to demonstrate that a transaction results in a 

meaningful change in the taxpayer’s economic position or that the 

taxpayer has a substantial non-Federal-tax purpose for entering 

into such transaction. The provision does not require or establish 

a specified minimum return that will satisfy the profit potential 

test. However, if a taxpayer relies on a profit potential, the present 


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140Thus, a ‘‘reasonable possibility of profit’’ alone will not be sufficient to establish that a 

transacgtion has economic substance. 141There is no intention to restrict the ability of the courts to consider the appropriate treatment of foreign taxes in particular cases, as under present law. However, the Treasury Department may, in addition, choose to require treatment of foreign taxes as expenses as provided in 

regulations. 142Sec. 6662. 143 A tax shelter is defined for this purpose as a partnership or other entity, an investment 

plan or arrangement, or any other plan or arrangement if a significant purpose of such partnership, other entity, plan, or arrangement is the avoidance or evasion of Federal income tax. Sec. 

6662(d)(2)(C). 

value of the reasonably expected pre-Federal-tax profit must be 

substantial in relation to the present value of the expected net Federal tax benefits that would be allowed if the transaction were respected.140 In addition, in determining pre-Federal-tax profit, foreign taxes are treated as expenses to the extent provided in regulations.141

Other rules 

The Secretary may prescribe regulations that provide (1) exemptions from the application of the provision, and (2) other rules as 

may be necessary or appropriate to carry out the purposes of the 

provision. 

No inference is intended as to the proper application of the economic substance doctrine under present law. In addition, the provision shall not be construed as altering or supplanting any other 

common law doctrine or provision of the Code or regulations or 

other guidance thereunder; and the provision shall be construed as 

being additive to any such other doctrine, Code provision, or regulations or guidance thereunder. 

EFFECTIVE DATE

The provision applies to transactions entered into after the date 

of enactment. 

2. Penalty for understatements attributable to transactions lacking 

economic substance, etc. 

PRESENT LAW

General accuracy-related penalty 

An accuracy-related penalty under section 6662 applies to the 

portion of any underpayment that is attributable to (1) negligence, 

(2) any substantial understatement of income tax, (3) any substantial valuation misstatement, (4) any substantial overstatement of 

pension liabilities, or (5) any substantial estate or gift tax valuation 

understatement. If the correct income tax liability exceeds that reported by the taxpayer by the greater of 10 percent of the correct 

tax or $5,000 (or, in the case of corporations, by the lesser of (a) 

10 percent of the correct tax (or $10,000 if greater) or (b) $10 million), then a substantial understatement exists and a penalty may 

be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.142 Except in the case of tax shelters,143 the amount of any understatement is reduced by any portion attributable to an item if (1) the treatment of the item is supported by substantial authority, or (2) facts relevant to the tax 

treatment of the item were adequately disclosed and there was a 

reasonable basis for its tax treatment. The Treasury Secretary may 


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144Sec. 6664(c). 145Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 146Sec. 6707A(c)(1). 147Sec. 6707A(c)(2). 148Sec. 6662A(a). 

prescribe a list of positions which the Secretary believes do not 

meet the requirements for substantial authority under this provision. 

The section 6662 penalty generally is abated (even with respect 

to tax shelters) in cases in which the taxpayer can demonstrate 

that there was ‘‘reasonable cause’’ for the underpayment and that 

the taxpayer acted in good faith.144 The relevant regulations provide that reasonable cause exists where the taxpayer ‘‘reasonably 

relies in good faith on an opinion based on a professional tax advisor’s analysis of the pertinent facts and authorities [that] . . . unambiguously concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged’’ by the IRS.145

LISTED TRANSACTIONS AND REPORTABLE AVOIDANCE TRANSACTIONS

In general 

A separate accuracy-related penalty under section 6662A applies 

to ‘‘listed transactions’’ and to other ‘‘reportable transactions’’ with 

a significant tax avoidance purpose (hereinafter referred to as a 

‘‘reportable avoidance transaction’’). The penalty rate and defenses 

available to avoid the penalty vary depending on whether the 

transaction was adequately disclosed. 

Both listed transactions and reportable transactions are allowed 

to be described by the Treasury Department under section 

6707A(c), which imposes a penalty for failure adequately to report 

such transactions under section 6011. A reportable transaction is 

defined as one that the Treasury Secretary determines is required 

to be disclosed because it is determined to have a potential for tax 

avoidance or evasion.146 A listed transaction is defined as a reportable transaction, which is the same as, or substantially similar to, 

a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of the reporting disclosure requirements.147

Disclosed transactions 

In general, a 20-percent accuracy-related penalty is imposed on 

any understatement attributable to an adequately disclosed listed 

transaction or reportable avoidance transaction.148 The only exception to the penalty is if the taxpayer satisfies a more stringent reasonable cause and good faith exception (hereinafter referred to as 

the ‘‘strengthened reasonable cause exception’’), which is described 

below. The strengthened reasonable cause exception is available 

only if the relevant facts affecting the tax treatment are adequately 

disclosed, there is or was substantial authority for the claimed tax 

treatment, and the taxpayer reasonably believed that the claimed 

tax treatment was more likely than not the proper treatment. 

Undisclosed transactions 

If the taxpayer does not adequately disclose the transaction, the 

strengthened reasonable cause exception is not available (i.e., a 


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149Sec. 6662A(c). 150Sec. 6664(d). 151Sec. 6707A(d). 152Sec. 6707A(e). 153For this purpose, any reduction in the excess of deductions allowed for the taxable year 

over gross income for such year, and any reduction in the amount of capital losses which would 

(without regard to section 1211) be allowed for such year, shall be treated as an increase in 

taxable income. Sec. 6662A(b). 154Sec. 6662A(e)(3). 

strict-liability penalty generally applies), and the taxpayer is subject to an increased penalty equal to 30 percent of the understatement.149 However, a taxpayer will be treated as having adequately 

disclosed a transaction for this purpose if the IRS Commissioner 

has separately rescinded the separate penalty under section 6707A 

for failure to disclose a reportable transaction.150 The IRS Commissioner is authorized to do this only if the failure does not relate to 

a listed transaction and only if rescinding the penalty would promote compliance and effective tax administration.151

A public entity that is required to pay a penalty for an undisclosed listed or reportable transaction must disclose the imposition 

of the penalty in reports to the SEC for such periods as the Secretary shall specify. The disclosure to the SEC applies without regard to whether the taxpayer determines the amount of the penalty 

to be material to the reports in which the penalty must appear, 

and any failure to disclose such penalty in the reports is treated 

as a failure to disclose a listed transaction. A taxpayer must disclose a penalty in reports to the SEC once the taxpayer has exhausted its administrative and judicial remedies with respect to 

the penalty (or if earlier, when paid).152

Determination of the understatement amount 

The penalty is applied to the amount of any understatement attributable to the listed or reportable avoidance transaction without 

regard to other items on the tax return. For purposes of this provision, the amount of the understatement is determined as the sum 

of: (1) the product of the highest corporate or individual tax rate 

(as appropriate) and the increase in taxable income resulting from 

the difference between the taxpayer’s treatment of the item and the 

proper treatment of the item (without regard to other items on the 

tax return);153 and (2) the amount of any decrease in the aggregate 

amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such 

item. 

Except as provided in regulations, a taxpayer’s treatment of an 

item shall not take into account any amendment or supplement to 

a return if the amendment or supplement is filed after the earlier 

of when the taxpayer is first contacted regarding an examination 

of the return or such other date as specified by the Secretary.154

Strengthened reasonable cause exception 

A penalty is not imposed with respect to any portion of an understatement if it is shown that there was reasonable cause for such 

portion and the taxpayer acted in good faith. Such a showing requires: (1) adequate disclosure of the facts affecting the transaction 


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155See the previous discussion regarding the penalty for failing to disclose a reportable transaction. 156Sec. 6664(d). 157The term ‘‘material advisor’’ means any person who provides any material aid, asistance, 

or advice with respect to organizing, managing, promoting, selling, implementing, or carrying 

out any reportable transaction, and who derives gross income in excess of $50,000 in the case 

of a reportable transaction substantially all of the tax benefits from which are provided to natural persons ($250,000 in any other case). Sec. 6111(b)(1). 158This situation could arise, for example, when an advisor has an arrangement or understanding (oral or written) with an organizer, manager, or promoter of a reportable transaction 

that such party will recommend or refer potential participants to the advisor for an opinion regarding the tax treatment of the transaction. 159 An advisor shoud not be treated as participating in the organization of a transaction if the 

advisor’s only involvement with respect to the organization of the transaction is the rendering 

of an opinion regarding the tax consequences of such transaction. However, such an advisor may 

be a ‘‘disqualified tax advisor’’ with respect to the transaction if the advisor participates in the 

management, promotion, or sale of the transaction (or if the advisor is compensated by a material advisor, has a fee arrangement that is contingent on the tax benefits of the transaction, 

or as determined by the Secretary, has a continuing financial interest with respect to the transaction). 

in accordance with the regulations under section 6011;155 (2) that 

there is or was substantial authority for such treatment; and (3) 

that the taxpayer reasonably believed that such treatment was 

more likely than not the proper treatment. For this purpose, a taxpayer will be treated as having a reasonable belief with respect to 

the tax treatment of an item only if such belief: (1) is based on the 

facts and law that exist at the time the tax return (that includes 

the item) is filed; and (2) relates solely to the taxpayer’s chances 

of success on the merits and does not take into account the possibility that (a) a return will not be audited, (b) the treatment will 

not be raised on audit, or (c) the treatment will be resolved through 

settlement if raised.156

A taxpayer may (but is not required to) rely on an opinion of a 

tax advisor in establishing its reasonable belief with respect to the 

tax treatment of the item. However, a taxpayer may not rely on an 

opinion of a tax advisor for this purpose if the opinion (1) is provided by a ‘‘disqualified tax advisor’’ or (2) is a ‘‘disqualified opinion.’’

Disqualified tax advisor 

A disqualified tax advisor is any advisor who: (1) is a material 

advisor157 and who participates in the organization, management, 

promotion, or sale of the transaction or is related (within the meaning of section 267(b) or 707(b)(1)) to any person who so participates; 

(2) is compensated directly or indirectly158 by a material advisor 

with respect to the transaction; (3) has a fee arrangement with respect to the transaction that is contingent on all or part of the intended tax benefits from the transaction being sustained; or (4) as 

determined under regulations prescribed by the Secretary, has a 

disqualifying financial interest with respect to the transaction. 

A material advisor is considered as participating in the ‘‘organization’’ of a transaction if the advisor performs acts relating to the 

development of the transaction. This may include, for example, preparing documents: (1) establishing a structure used in connection 

with the transaction (such as a partnership agreement); (2) describing the transaction (such as an offering memorandum or other 

statement describing the transaction); or (3) relating to the registration of the transaction with any federal, state, or local government body.159 Participation in the ‘‘management’’ of a transaction 

means involvement in the decision-making process regarding any 


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160Thus, unlike the present-law accuracy-related penalty under section 6662A (which applies 

only to listed and reportable avoidance transactions), the new penalty under the provision applies to any transaction that lacks economic substance. 161That provision generally provides that in any case in which a court determines that the 

economic substance doctrine is relevant, a transaction has economic substance only if: (1) the 

transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s 

economic position, and (2) the taxpayer has a substantial non-Federal-tax purpose for entering 

Continued 

business activity with respect to the transaction. Participation in 

the ‘‘promotion or sale’’ of a transaction means involvement in the 

marketing or solicitation of the transaction to others. Thus, an advisor who provides information about the transaction to a potential 

participant is involved in the promotion or sale of a transaction, as 

is any advisor who recommends the transaction to a potential participant. 

Disqualified opinion 

An opinion may not be relied upon if the opinion: (1) is based on 

unreasonable factual or legal assumptions (including assumptions 

as to future events); (2) unreasonably relies upon representations, 

statements, findings or agreements of the taxpayer or any other 

person; (3) does not identify and consider all relevant facts; or (4) 

fails to meet any other requirement prescribed by the Secretary. 

Coordination with other penalties 

To the extent a penalty on an understatement is imposed under 

section 6662A, that same amount of understatement is not also 

subject to the accuracy-related penalty under section 6662(a) or to 

the valuation misstatement penalties under section 6662(e) or 

6662(h). However, such amount of understatement is included for 

purposes of determining whether any understatement (as defined 

in sec. 6662(d)(2)) is a substantial understatement as defined under 

section 6662(d)(1) and for purposes of identifying an underpayment 

under the section 6663 fraud penalty. 

The penalty imposed under section 6662A does not apply to any 

portion of an understatement to which a fraud penalty is applied 

under section 6663. 

EXPLANATION OF PROVISION

The provision imposes a new, stronger penalty for an understatement attributable to any transaction that lacks economic substance 

(referred to in the statute as a ‘‘noneconomic substance transaction 

understatement’’).160 The penalty rate is 30 percent (reduced to 20 

percent if the taxpayer adequately discloses the relevant facts in 

accordance with regulations prescribed under section 6011). No exceptions (including the reasonable cause or rescission rules) to the 

penalty are available (i.e., the penalty is a strict-liability penalty). 

Under the provision, outside opinions or in-house analysis would 

not protect a taxpayer from imposition of a penalty if it is determined that the transaction lacks economic substance or is not respected as described below. 

A ‘‘noneconomic substance transaction’’ means any transaction if 

the transaction lacks economic substance (as defined in the provision regarding the clarification of the economic substance doctrine).161 For this purpose, a transaction is one that lacks economic 


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into such transaction. Specific other rules also apply. See ‘‘Explanation of Provision’’ for the immediately preceding provision, ‘‘Clarification of the economic substance doctrine.’’ 162For this purpose, any reduction in the excess of deductions allowed for the taxable year 

over gross income for such year, and any reduction in the amount of capital losses that would 

(without regard to section 1211) be allowed for such year, would be treated as an increase in 

taxable income. 

substance if it is disregarded as a result of the application of the 

same factors and analysis that is required under the provision for 

an economic substance analysis, even if a court uses a different 

term to describe the doctrine. 

For purposes of the bill, the calculation of an ‘‘understatement’’ is made in the same manner as in the present law provision relating to accuracy-related penalties for listed and reportable avoidance 

transactions (sec. 6662A). Thus, the amount of the understatement 

under the provision would be determined as the sum of (1) the 

product of the highest corporate or individual tax rate (as appropriate) and the increase in taxable income resulting from the difference between the taxpayer’s treatment of the item and the proper treatment of the item (without regard to other items on the tax 

return),162 and (2) the amount of any decrease in the aggregate 

amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such 

item. In essence, the penalty will apply to the amount of any understatement attributable solely to a non-economic substance 

transaction. 

As in the case of the understatement penalty for reportable and 

listed transactions under present law section 6662A(e)(3), except as 

provided in regulations, the taxpayer’s treatment of an item will 

not take into account any amendment or supplement to a return 

if the amendment or supplement is filed after the earlier of the 

date the taxpayer is first contacted regarding an examination of 

such return or such other date as specified by the Secretary. 

As in the case of the understatement penalty for undisclosed reportable transactions under present law section 6707A, a public entity that is required to pay a penalty under the provision (but in 

this case, regardless of whether the transaction was disclosed) 

must disclose the imposition of the penalty in reports to the SEC 

for such periods as the Secretary shall specify. The disclosure to 

the SEC applies without regard to whether the taxpayer determines the amount of the penalty to be material to the reports in 

which the penalty must appear, and any failure to disclose such 

penalty in the reports is treated as a failure to disclose a listed 

transaction. A taxpayer must disclose a penalty in reports to the 

SEC once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when paid). 

Regardless of whether the transaction was disclosed, a penalty 

under the provision cannot be asserted until there has been a review and approval by the Chief Counsel of the Internal Revenue 

Service (or, if so delegated, a branch chief within the office of Chief 

Counsel) and the taxpayer has had the opportunity to submit a 

written statement in connection with that review. Once the penalty 

has been asserted following such National Office review, the penalty cannot be compromised for purposes of a settlement without 

approval of the Chief Counsel (or, if so delegated, a branch chief 

within the office of Chief Counsel). The penalty can be compromised in such event only to the extent the underlying underVerDate Aug 31 2005 02:15 Oct 30, 2007 Jkt 069010 PO 00000 Frm 00100 Fmt 6659 Sfmt 6602 E:\HR\OC\SR206.XXX SR206

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163 Nothing in the provision precludes the IRS from asserting alternative grounds in a case 

in addition to a lack of economic substance or from asserting other penalties; however, at the 

conclusion of the case if there is a penalty under this provision then the interaction with any 

other penalties would be as described in the text. 164Sec. 162(m). Under section 6664(d)(2)(A), in such a case of nondisclosure, the taxpayer also 

is not entitled to the ‘‘reasonable cause and good faith’’ exception to the section 6662A penalty 

for a reportable transaction understatement. 165See the description of present law under the immediately preceding proposal, ‘‘Penalty for 

understatements attributable to transactions lacking economic substance, etc.’’

statement with respect to which it was asserted is also compromised. Furthermore, the IRS is required to keep records summarizing the application of this penalty and providing a description 

of each penalty compromised under the provision and the reasons 

for the compromise. If a final adjudication of a court determines 

that the economic substance doctrine does not apply, then a noneconomic substance penalty asserted by the IRS in that case would 

not apply. 

Any understatement on which a penalty is imposed under the 

provision will not be subject to the accuracy-related penalty under 

section 6662 or under 6662A (accuracy-related penalties for listed 

and reportable avoidance transactions). However, an understatement under the provision is taken into account for purposes of determining whether any understatement (as defined in sec. 

6662(d)(2)) is a substantial understatement as defined under section 6662(d)(1). The penalty imposed under the provision will not 

apply to any portion of an understatement to which a fraud penalty 

is applied under section 6663.163

EFFECTIVE DATE

The provision applies to transactions entered into after the date 

of enactment. 

3. Denial of deduction for interest on underpayments attributable to 

noneconomic substance transactions 

PRESENT LAW

No deduction for interest is allowed for interest paid or accrued 

on any underpayment of tax which is attributable to the portion of 

any reportable transaction understatement with respect to which 

the relevant facts were not adequately disclosed.164 The Secretary 

of the Treasury is authorized to define reportable transactions for 

this purpose.165

DESCRIPTION OF PROPOSAL

The provision extends the disallowance of interest deductions to 

interest paid or accrued on any underpayment of tax which is attributable to any noneconomic substance underpayment (whether 

or not disclosed). 

EFFECTIVE DATE

The provision applies to transactions entered into after the date 

of enactment 


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III. BUDGET EFFECTS OF THE BILL 

A. COMMITTEE ESTIMATES

In compliance with paragraph 11(a) of rule XXVI of the Standing 

Rules of the Senate, the following statement is made concerning 

the estimated budget effects of the revenue provisions of the 

‘‘Heartland, Habitat, Harvest, and Work Horticulture Act of 2007’’

as reported. 


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cnoel on PRODPC60 with HEARINGInsert offset folio 131 here SR206.001
104 


cnoel on PRODPC60 with HEARINGInsert offset folio 132 here SR206.002
105 


cnoel on PRODPC60 with HEARINGInsert offset folio 133 here SR206.003
106 


cnoel on PRODPC60 with HEARINGInsert offset folio 134 here SR206.004
107 


cnoel on PRODPC60 with HEARINGInsert offset folio 135 here SR206.005
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cnoel on PRODPC60 with HEARINGInsert offset folio 136 here SR206.006
109 

B. BUDGET AUTHORITY AND TAX EXPENDITURES

Budget authority 

In compliance with section 308(a)(1) of the Budget Act, the Committee states that the supplemental agricultural disaster assistance 

provisions of the bill as reported involve new or increased budget 

authority. 

Tax expenditures 

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

above). The revenue-increasing provisions of the bill involve reduced tax expenditures (see revenue table in part A, above). 

C. CONSULTATION WITH CONGRESSIONAL BUDGET OFFICE

In accordance with section 403 of the Budget Act, the Committee 

advises that the Congressional Budget Office has not submitted a 

statement on the bill. The letter from the Congressional Budget Office has not been received, and therefore will be provided separately. 

IV. VOTES OF THE COMMITTEE 

In compliance with paragraph 7(b) of rule XXVI of the Standing 

Rules of the Senate, the Committee states that, with a majority 

and quorum present, the ‘‘Heartland, Habitat, Harvest and Work 

Horticulture Act of 2007,’’ as amended, was ordered favorably reported by a voice vote on October 4, 2007. 

V. REGULATORY IMPACT AND OTHER MATTERS 

A. REGULATORY IMPACT

Pursuant to paragraph 11(b) of rule XXVI of the Standing Rules 

of the Senate, the Committee makes the following statement concerning the regulatory impact that might be incurred in carrying 

out the provisions of the bill as amended. 

Impact on individuals and businesses, personal privacy and paperwork 

The bill includes provisions to extend present-law tax benefits, 

expand eligibility for other benefits, and create new tax incentives. 

The bill also includes provisions limiting farming losses of certain 

taxpayers, codifying information reporting on Commodity Credit 

Corporation transactions and limiting section 1031 treatment for 

certain real estate and collectibles. The effective date of AJCA relating to loss limitations on SILOs is also modified under the bill. 

The bill also denies a deduction for certain fines, penalties and 

other amounts and increases information return penalties. Finally, 

the bill includes provisions to clarify and codify the economic substance doctrine and related penalties and to deny the deduction for 

interest paid on certain tax motivated transactions. 

The bill includes various other provisions that are not expected 

to impose additional administrative requirements or regulatory 

burdens on individuals or businesses. 


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The provisions of the bill do not impact personal privacy. 

B. UNFUNDED MANDATES STATEMENT

This information is provided in accordance with section 423 of 

the Unfunded Mandates Reform Act of 1995 (Pub. L. 104–4). 

The Committee has determined that the following two tax provisions of the reported bill contain Federal private sector mandates 

within the meaning of Public Law 104–4, the Unfunded Mandates 

Reform Act of 1995: (1) modifying the effective date for the application of the AJCA 2004 leasing (‘‘SILO’’) provision—apply loss limitation to leases with foreign entities regardless of when the lease 

was entered into; and (2) clarification of the economic substance 

doctrine and related penalties. The tax provisions of the reported 

bill do not impose a Federal intergovernmental mandate on State, 

local, or tribal governments within the meaning of Public Law 104–

4, the Unfunded Mandates Reform Act of 1995. 

The costs required to comply with each Federal private sector 

mandate generally are no greater than the aggregate estimated 

budget effects of the provision. Benefits from the provisions include 

improved administration of the tax laws and a more accurate measurement of income for Federal income tax purposes. 

C. TAX COMPLEXITY ANALYSIS

Section 4022(b) of the Internal Revenue Service Restructuring 

and Reform Act of 1998 (the ‘‘IRS Reform Act’’) requires the Joint 

Committee on Taxation (in consultation with the Internal Revenue 

Service and the Department of the Treasury) to provide a tax complexity analysis. The complexity analysis is required for all legislation reported by the Senate Committee on Finance, the House 

Committee on Ways and Means, or any committee of conference if 

the legislation includes a provision that directly or indirectly 

amends the Internal Revenue Code (the ‘‘Code’’) and has widespread applicability to individuals or small businesses. 

The staff of the Joint Committee on Taxation has determined 

that a complexity analysis is not required under section 4022(b) of 

the IRS Reform Act because the bill contains no provisions that 

have ‘‘widespread applicability’’ to individuals or small businesses. 

VI. CHANGES IN EXISTING LAW MADE BY THE BILL, AS 

REPORTED 

In the opinion of the Committee, it is necessary in order to expedite the business of the Senate, to dispense with the requirements 

of paragraph 12 of rule XXVI of the Standing Rules of the Senate 

(relating to the showing of changes in existing law made by the bill 

as reported by the Committee). 

Æ 


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