D. Amendments to Title II of the 1997 Act Relating to Capital Gains

1, Individual capital gain rate reductions (sec. 311 of the 1997 Act and sec. 1(h) of the
Code)

Present Law

The 1997 Act provided lower capital gains rates for individuals. Generally, the 1997 Act
reduced the maximum capital gains rate from 28 percent to 20 percent and provided a 10-percent
rate for capital gains otherwise taxed at a 15-percent rate. The 1997 Act generally retained a 28-
percent maximum rate for gain from collectibles, gain included in income from the sale of
certain small business stock, net gain properly taken into account before May 7, 1997, and net
gain properly taken into account after July 28, 1997, from property held more than one year but
not more than 18 months. In addition, a maximum rate of 25 percent is provided for the long-
term capital gain attributable to real estate depreciation. Lower rates are also provided in the
future for certain property held more than five years.

Under the provisions of the 1997 Act, net short-term capital losses and long-term capital
loss carryovers offset gain taxed at a 20-percent rate before offsetting gain taxed at the 25- or 28-
percent rates.

Description of Proposal

The proposal would make the following technical corrections to the individual capital
gain rate reduction provisions of the 1997 Act:

Collectibles gains and losses, certain small business stock gain included in income,
capital gains and losses properly taken into account after July 28, 1997, from the disposition of
property held more than one year but not more than 18 months, and long-term capital gains and
losses properly taken into account before May 7, 1997, would be placed in one basket (“28-
percent rate gain”) taxed a maximum rate of 28 percent. All the gains and losses in this basket
would be netted for purposes of determining the amount taxed at a maximum 28-percent rate.

Any net short-term capital loss for the taxable year and any long-term capital loss
carryover to the taxable year would be placed in the 28-percent rate gain basket. This would
allow these capital losses to offset gain taxed at the 28-percent rate before offsetting gain taxed
at lower rates. Any net loss in the 28-percent rate gain basket next would offset gain taxed at the
25-percent rate.

Several conforming amendments would be made to co-ordinate the multiple holding
periods with other provisions of the Code. Inherited property and certain patents would be
deemed to have a holding period of more than 18 months, thus, allowing the lower 10- and 20-
percent rates to apply. The proposal would clarify that long-term capital gain or loss on a section
1256 contract would be treated as gain or loss from property held more than 18 months. Also,

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employee of the trade or business.” The provision is silent as to the treatment of coverage of
such an individual under a master contract.

Reporting

The provision does not apply to any policy or contract held by a natural person; however,
if a trade or business is directly or indirectly the beneficiary under any policy or contract, the
policy or contract is treated as held by the trade or business and not by a natural person. In
addition, the provision includes a reporting requirement. Specifically, the provision provides
that the Treasury Secretary shall require such reporting from policyholders and issuers as is
necessary to carry out the rule applicable when the trade or business is directly or indirectly the
beneficiary under any policy or contract held by a natural person. Any report required under this
reporting requirement is treated as a statement referred to in Code section 6724(d)(1) (relating to
information returns). The provision does not specifically refer to Code section 6724(d)(2)
(relating to payee statements).

Description of Proposal

Master contracts

The proposal would clarify that if coverage for each insured individual under a master
contract is treated as a separate contract for purposes of sections 817(h), 7702, and 7702A of the
Code, then coverage for each such insured individual is treated as a separate contract, for
purposes of the exception to the pro rata interest disallowance rule in the case of a policy or
contract covering an individual who is an employee, officer or director of the trade or business at
the time first covered. For this purpose, a master contract does not include a group life insurance
contract within the meaning of Code section 848(e)(2). No inference would be intended that
coverage for each such insured individual, in the case of a master contract, is not treated as a
separate contract for other purposes under present law.

Reporting

The proposal would clarify that the required reporting to the Treasury Secretary is treated
as an information return (within meaning of sec. 6724(d)(1)), and the reporting required to be
made to any other person is treated as a payee statement (within the meaning of sec. 6724(d)(2)).
Thus, the $50-per-report penalty imposed under sections 6722 and 6723 of the Code for failure
to file or provide such an information return or payee statement applies. It would be further

” The exception also applies in the case of a joint-life policy or contract under which the
sole insureds are a 20-percent owner and the spouse of the 20-percent owner. A joint-life
contract under which the sole insureds are a 20-percent owner and his or her spouse is the only
type of policy or contract with more than one insured that comes within the exception.

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interest of each of the nine other former shareholder of D, is not counted. The remaining 81
percent ownership of the merged corporation, representing a decrease of nine percent in the
interests of each of the nine former shareholders other than A, is counted in determining the
extent of an acquisition. Therefore, a 50-percent or greater interest in D has been acquired.

Treasury regulatory authority

The proposal would also clarify that the regulatory authority of the Treasury Department
under section 358(c) applies to distributions after April 16, 1997, without regard to whether a
distribution involves a plan (or series of related transactions) which involves an acquisition.
As stated in the Conference Report to the Act, with respect to the Treasury Department
regulatory authority under section 358(c) as applied to intragroup spin-off transactions that are
not part of a plan or series of related transactions that involve an acquisition of a 50-percent of
greater interest under new section 355(f), it is expected that any Treasury regulations will be
applied prospectively, except in cases to prevent abuse.

Effective Date
The proposal generally would be effective for distributions after April 16, 1997.

6, Certain preferred stock treated as “boot”—statute of limitations (sec. 1014 of the 1997
Act and sec. 354(a) of the Code).

Present law

Under the 1997 Act, certain preferred stock received in otherwise tax-free transactions is
treated as “other property.” Exchanges of stock in certain recapitalizations of family-owned
corporations are excepted from this rule. A family-owned corporation is defined as any
corporation if at least 50 percent of the total voting power and value of the stock of such
corporation is owned by the same family for five years preceding the recapitalization. In
addition, a recapitalization does not qualify for the exception if the same family does not own 50
percent of the total voting power and value of the stock throughout the three-year period
following the recapitalization.

Description of Proposal

The proposal would provide that the statutory period for the assessment of any deficiency
attributable to a corporation failing to be a family-owned corporation shall not expire before the
expiration of three years after the date the Secretary of the Treasury is notified by the corporation
(in such manner as the Secretary may prescribe) of such failure, and such deficiency may be
assessed before the expiration of such three-year period notwithstanding the provisions of any
other law or rule of law which would otherwise prevent such assessment.

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K. Amendments to Title XVI of the 1997 Act Relating to Technical Corrections

1. Application of requirements for SIMPLE IRAs in the case of mergers and acquisitions
(sec. 1601 of the 1997 Act and sec. 408(p)(2) of the Code)

Present Law

If an employer maintains a qualified plan and a SIMPLE IRA in the same year due to an
acquisition, disposition or similar transaction the SIMPLE IRA is treated as a qualified salary
reduction arrangement for the year of the transaction and the following calendar year provided
tules similar to the special coverage rules of section 410(b)(6)(C) apply. There is a similar
provision with respect to an employer who, because of an acquisition, disposition or similar
transaction, fails to be an eligible employer because such employer employs more than 100
employees. In this situation, the employer is treated as an eligible employer for two years
following the transaction provided rules similar to the coverage rules of section 410(b)(6)(C)(i)

apply.
Description of Proposal

The proposal would conform the treatment applicable to SIMPLE IRAs upon acquisition,
disposition or similar transaction for purposes of (1) the 100 employee limit, (2) the exclusive
plan requirement, and (3) the coverage rules for participation. In the event of such a transaction,
the employer will be treated as an eligible employer and the arrangement will be treated as a
qualified salary reduction arrangement for the year of the transaction and the two following
years, provided mules similar to the rules of section 410(b)(6)(C)(i)(ID) are satisfied and the
arrangement would satisfy the requirements to be a qualified salary reduction arrangement after
the transaction if the trade or business that maintained the arrangement prior to the transaction
had remained a separate employer.

Effective Date

The proposal would be effective as if included in the Small Business Job Protection Act
of 1996.

2. Treatment of Indian tribal governments under section 403(b) (sec. 1601 of the 1997 Act
and sec. 403(b) of the Code)

Present Law

Any 403(b) annuity contract purchased in a plan year beginning before January 1, 1995,
by an Indian tribal government is treated as purchased by an entity permitted to maintain a tax-
sheltered annuity plan. Such contracts may be rolled over into a section 401(k) plan maintained
by the Indian tribal government in accordance with the rollover rules of section 403(b)(8). An
employee participating in a 403(b) annuity contract of the Indian tribal government may roll over

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C. Amendments to Title III of the 1997 Act Relating to Savings Incentives

1. Conversions of IRAs into Roth IRAs (sec. 302 of the 1997 Act and secs. 408A and 72(t)
of the Code)

Present Law

A taxpayer with adjusted gross income of less than $100,000 may convert a present-law
deductible or nondeductible IRA into a Roth IRA at any time. The amount converted is
includible in income in the year of the conversion, except that if the conversion occurs in 1998,
the amount converted is includible in income ratably over the 4-year period beginning with the
year in which the conversion occurs. The 10-percent tax on early withdrawals does not apply to
conversions of IRAs into Roth IRAs. The 5-year holding period for converted amounts begins
from the year of the conversion.

Present law does not contain a specific rule addressing what happens if an individual dies
during the 4-year spread period for 1998 conversions.

Description of Proposal
Distributions of converted amounts within 5 years

The proposal would modify the rules relating to conversions of IRAs into Roth IRAs in
order to prevent taxpayers from receiving premature distributions from a Roth conversion IRA
(.e., before the lapse of 5 years) while retaining the benefits of 4-year income averaging and the
nonpayment of the early withdrawal tax.

Under the proposal, if converted amounts are withdrawn within the 5-year period
beginning with the year of the conversion, then, to the extent attributable to amounts that were
includible in income due to the conversion the amount withdrawn would be subject to (1) the 10-
percent early withdrawal tax,’ and (2) in the case of conversions to which the 4-year income

° If the conversion is accomplished by means of a withdrawal and a rollover into a Roth
IRA, the 4-year rule applies if the withdrawal is made during 1998 and the rollover occurs within
60 days of the withdrawal. In such a case, the 4-year period begins with the year in which the
withdrawal was made. For purposes of this discussion, such conversions are treated as occurring
in 1998.

7 The otherwise available exceptions to the early withdrawal tax, e.g., for distributions
after age 59-1/2, would apply.

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Description of Proposal

The proposal would revise the rules correlating the increase in the unified credit with a
decrease in the lower family-owned business exclusion such that there will be neither an increase
or decrease in the total estate tax on estates holding family-owned businesses as increases in the
unified credit are phased in. The proposal would achieve this result by decreasing the amount of
tax benefit provided by the exclusion for family-owned business interests in a given year by an
amount exactly equal to the increase in the dollar amount of the unified credit (“the applicable
credit amount”) in that year over the amount of unified credit provided in 1998 (i.e., $202,050).
Thus, for example, in 2006, when the unified credit is $345,800, the tax benefit provided by the
exclusion for family-owned business interests would be reduced by $143,750 (i.e., $345,800
minus $202,050).

The computation would be made as follows. First, one would compute the decrease in
tentative estate tax liability (under Code section 2001(c)) that would result if the estate were
entitled to an exclusion of $675,000. (This amount will vary from taxpayer to taxpayer,
depending upon the size of the estate, because of different marginal estate tax rates.) This
amount then would be reduced by the amount of increase in the unified credit since 1998. The
resulting number would be the “maximum credit equivalent benefit.” The maximum qualified
family-owned business exclusion available to the estate (“the exclusion limitation”) would be
equal to the amount of exclusion that would reduce the estate’s tax liability by the maximum
credit equivalent benefit.

For example, assume that an individual dies in 2006 with an estate of $1.4 million, and
the executor elects the application of the qualified family-owned business exclusion. Under
Code section 2001(c), an estate of $1.4 million (after all deductions but before application of the
unified credit) would have a tentative estate tax liability of $512,800. If this estate were entitled
to an exclusion of $675,000, the tentative estate tax liability would be only $239,050 (a decrease
of $273,750). For decedents dying in 2006, the unified credit will be equal to $345,800 (an
increase of $143,750 over the 1998 unified credit amount of $202,050). Thus, this estate’s
maximum credit equivalent benefit would be equal to $273,750 minus $143,750, or $130,000.
To determine the amount of qualified family-owned business exclusion available to the estate in
2006, a calculation would be made to determine the amount of exclusion that would provide the
estate with $130,000 in tax savings. An estate of $1,090,244 would have a tentative tax liability
of $382,800, which is exactly $130,000 less than the $512,800 tentative estate tax liability on a
$1.4 million estate, as determined above. Thus, a maximum qualified family-owned business
exclusion of $309,756 (i.e., $1.4 million minus $1,090,244) would be available for a decedent
dying in 2006 with a $1.4 million estate.

If the estate in the above example includes qualified family-owned business interests of
at least $309,756, the estate may utilize the entire exclusion, and its Federal estate tax liability
. would be calculated as follows. The taxable estate would be equal to $1,090,244 (i.e.,
$1,400,000 minus $309,756), resulting in a tentative tax of $382,800 (based on the rate schedule
set forth in Code sec. 2001(c)). For decedents dying in 2006, a unified credit of $345,800 is

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clarified that the Treasury Secretary may require reporting of relevant information either by
regulations or by other appropriate guidance (including but not limited to publication of a form).

Effective Date

The proposal would be effective as if included in the 1997 Act.

12. Clarification to the definition of modified adjusted gross income for purposes of the
earned income credit phaseout (sec. 1085(d) of the 1997 Act and sec. 32(c) of the Code)

Present Law

The earned income credit (“EIC”) is phased out above certain income levels. For
individuals with eared income (or modified adjusted gross income (“modified AGT”), if greater)
in excess of the beginning of the phaseout range, the maximum credit amount is reduced by the
phaseout rate multiplied by the amount of earned income (or modified AGL, if greater) in excess
of the beginning of the phaseout range. For individuals with earned income (or modified AGI, if
greater) in excess of the end of the phaseout range, no credit is allowed. The definition of
modified AGI used for the phase out of the eared income credit is the sum of: (1) AGI with
certain losses disregarded, and (2) certain nontaxable amounts not generally included in AGI.
The losses disregarded are: (1) net capital losses (if greater than zero); (2) net losses from trusts
and estates; (3) net losses from nonbusiness rents and royalties; (4) 75 percent of the net losses
from business, computed separately with respect to sole proprietorships (other than in farming),
sole proprietorships in farming, and other businesses.'? The nontaxable amounts included in
modified AGI which are generally not included in AGI are: (1) tax-exempt interest; and (2)
nontaxable distributions from pensions, annuities, and individual retirement arrangements (but
only if not rolled over into similar vehicles during the applicable rollover period).

Description of Proposal

The proposal would clarify that the two nontaxable amounts that are added to adjusted
gross income to compute modified AGI for purposes of the EIC phaseout are additions to
adjusted gross income and not disregarded losses.

Effective Date

The proposal would be effective for taxable years beginning after December 3 1, 1997.

% The 1997 Act increased the amount of net losses from businesses, computed separately
with respect to sole proprietorships (other than farming), sole proprietorships in farming, and
other businesses disregarded from 50 percent to 75 percent.

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1. INTRODUCTION

The House Committee on Ways and Means has scheduled a markup of tax technical
corrections provisions, on October 9, 1997. This document,! prepared by the staff of the Joint
Committee on Taxation, provides a description of the Chairman’s mark for various technical
corrections to previously enacted tax legislation, primarily the Taxpayer Relief Act of 1997
(“1997 Act”). As noted in the descriptions, these technical corrections generally are proposed to
be effective as if included in the original provisions to which they relate. Proposed technical
corrections that are clerical in nature are not described in this document.

’ This document may be cited as follows: Joint Committee on Taxation, Description of
the “Tax Technical Corrections Act of 1997” (JCX-56-97), October 8, 1997.

-1-


remains open at any time during the three years prior to the decedent's death, and (4) the
transaction is not closed within the 30-day period beginning on the date of enactment of the 1997
Act. If the requirements of the special effective date provision are met, both the appreciated
financial position and the transaction resulting in the constructive sale are generally treated as
property constituting rights to receive income in respect of a decedent under section 691.
However, gain with respect to a position in a constructive sale transaction that accrues after the
transaction is closed is not included in income in respect of a decedent.

Description of Proposal

The proposed technical correction would clarify the special effective date rule to provide
that the rule does not apply if the constructive sale transaction is closed at any time prior to the
end of the 30th day after the date of enactment of the 1997 Act.

Effective Date
The proposal would be effective for decedents dying after June 8, 1997.

5. Treatment of certain corporate distributions (sec. 1012 of the 1997 Act and
secs. 355(e)(3)(A)(iv) and 358(c) of the Code)

Present Law

The 1997 Act (sec. 1012(a)) requires a distributing corporation (“distributing”) to
recognize corporate level gain on the distribution of stock of a controlled corporation
(“controlled”) under section 355 of the Code if, pursuant to a plan or series of related
transactions, one or more persons acquire a 50-percent or greater interest (defined as 50 percent
or more of the voting power or value of the stock) of either the distributing or controlled
corporation (Code sec. 355(e)). Certain transactions are excepted from the definition of
acquisition for this purpose, including, under section 355(e)(3)(A)(iv), the acquisition by a
person of stock in a corporation if shareholders owning directly or indirectly stock possessing
more than 50 percent of the voting power and more than 50 percent of the value of the stock in
distributing or any controlled corporation before such acquisition own directly or indirectly stock
possessing such vote and value in such distributing or controlled corporation after such
acquisition.””

The 1997 Act (sec. 1012(b)(1)) also provides that, except as provided in regulations,
section 355 shall not apply to the distribution of stock from one member of an affiliated group of

"| This exception (as certain other exceptions) does not apply if the stock held before the
acquisition was acquired pursuant to a plan (or series of related transactions) to acquire a 50-
percent or greater interest in the distributing or a controlled corporation.

31-



the short sale holding period rules of section 1233 and the holding period rules of section 1092(f)
would be amended to conform those rules with the new 12-18 month holding period. Amounts
treated as ordinary income by reason of section 1231(c) would be allocated among categories of
gain in accordance with IRS forms or regulations.

Finally, the proposal would reorder some of the provisions and make other minor
technical changes, including a provision to reduce the minimum tax preference on small business
stock to 28 percent, beginning in 2006.

Effective Date
The proposal would be effective for taxable years ending after May 6, 1997.

2. Rollover of gain from sale of qualified stock (sec. 313 of the 1997 Act and sec. 1045 of
the Code)

Present Law

The 1997 Act provided that gain from the sale of qualified small business stock held by
an individual for more than 6 months can be “rolled over” tax-free to other qualified small
business stock.

Description of Proposal

Under the proposal, a partnership or an S corporation can roll over gain from qualified
small business stock held more than 6 months if (and only if) all the interests in the partnership
or S corporation are held by individuals or estates at all times during the taxable year.

Effective Date

The proposal would be effective on August 5, 1997, the date of enactment of the 1997
Act.

3. Exclusion of gain on the sale of a principal residence owned and used less than two years
(sec. 312(a) of the 1997 Act and sec. 121 of the Code)

Present Law

Under present law, a taxpayer generally is able to exclude up to $250,000 ($500,000 if
married filing a joint return) of gain realized on the sale or exchange of a principal residence. To
be eligible for the exclusion, the taxpayer must have owned the residence and used it as a
principal residence for at least two of the five years prior to the sale or exchange. A taxpayer
who fails to meet these requirements by reason of a change of place of employment, health, or

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Effective Date

The proposal would be effective for decedents dying after the date of enactment of the
1997 Act

6. Clarification of rules governing revaluation of gifts (sec. 506 of the 1997 Act and sec.
2504(c) of the Code)

Present Law

The valuation of a gift becomes final for gift tax purposes after the statute of limitations
on any gift tax assessed or paid has expired. The 1997 Act extended that rule to apply for estate
tax purposes, provided for a lengthened statute of limitations for gift tax purposes if certain
information is not disclosed with the gift tax return, and provided jurisdiction to the U.S. Tax
Court to determine the value of any gift.

Description of Proposal

The proposal would clarify that in determining the amount of taxable gifts made in
preceding calendar periods, the value of prior gifts is the value of such gifts as finally
determined, even if no gift tax was assessed or paid on that gift. For this purpose, final
determinations would include, e.g., the value reported on the gift tax return (if not challenged by
the IRS prior to the expiration of the statute of limitations), the value determined by the IRS (if
not challenged through the declaratory judgment procedure by the taxpayer), the value
determined by the courts, or the value agreed to by the IRS and the taxpayer in a settlement
agreement.

Effective Date

The proposal would be effective with respect to gifts made after the date of enactment of
the 1997 Act.

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E. Amendments to Title V of the 1997 Act Relating to Estate and Gift Taxes

1. Clarification of effective date for indexing of generation-skipping exemption
(secs. 501(d) and (f) of the 1997 Act and sec. 2631(c) of the Code)

Present Law

The 1997 Act provided for the indexation of the $1 million exemption from generation-
skipping transfers effective for decedents dying after December 31, 1998

Description of Proposal

The proposal would clarify that the indexing of the exemption from generation-skipping
transfers would be effective with respect to all generation-skipping transfers (i.¢., direct skips,
taxable terminations, and taxable distributions) made after 1998.

Effective Date

The proposal would be effective for generation-skipping transfers made after December
31, 1998.

2. Coordination between unified credit and family-owned business exclusion (sec. 502 of
the 1997 Act and sec. 2033A(a) of the Code)

Present Law

The 1997 Act effectively increased the amount of lifetime gifts and transfers at death
that are exempt from unified estate and gift tax from $600,000 to $1,000,000 over the period
1997 to 2006, through increases in an individual's unified credit. In addition, the Act provided a
limited exclusion for certain family-owned business interests. The exclusion for family-owned
business interests may be taken only to the extent that the exclusion for family-owned business
interests, plus the amount effectively exempted by the unified credit, does not exceed $1.3
million. As a result, for years after 1998, the maximum amount of exclusion for family-owned
business interests is reduced by increases in the dollar amount of transfers effectively exempted
through the unified credit.

Because the structure of the Act increases the unified credit over time (until 2006) while
decreasing over the same period the benefit of the closely-held business exclusion, the estate tax
on estates with family-owned businesses increases over time until 2006. This increase in estate
tax results from the fact that increases in the unified credit provide a benefit at the decedent's
lowest estate tax brackets, while the exclusion for family-owned businesses provides a benefit at
the decedent’s highest estate tax brackets.

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corporations (as defined in section 1504(a)) to another member of such group (an intragroup
spin-off) if such distribution is part of a such a plan or series of related transactions pursuant to
which one or more persons acquire stock representing a 50-percent or greater interest in a
distributing or controlled corporation, determined after the application of the rules of section
355(e).

In addition, the 1997 Act (sec. 1012(c)) provides that in the case of any distribution of
stock of one member of an affiliated group of corporations to another member under section 355,
the Treasury Department has regulatory authority under section 358(c) to provide adjustments to
the basis of any stock in a corporation which is a member of such group, to reflect appropriately
the proper treatment of such distribution.

The effective date (Act section 1012(d)(1)) states that the forgoing provisions of the Act
apply to distributions after April 16, 1997, pursuant to a plan (or series of related transactions)
which involves an acquisition occurring after such date (unless certain transition provisions

apply).

Acquisition of a 50-percent or greater interest

The proposal would clarify that the acquisitions described in Code section 355(e)(3)(A)
are disregarded in determining whether there has been an acquisition of a 50-percent or greater
interest in a corporation. However, other transactions that are part of a plan or series of related
transactions could result in an acquisition of a 50-percent or greater interest.

In the case of acquisitions under section 355(e)(3)(A)(iv), the proposal clarifies that the
acquisition of stock in the distributing corporation or any controlled corporation is disregarded to
the extent that the percentage of stock owned directly or indirectly in such corporation by each
person owning stock in such corporation immediately before the acquisition does not decrease.

Example: Shareholder A owns 10 percent of the vote and value of the stock of
corporation D (which owns all of corporation C). There are nine other equal shareholders of D.
A also owns 100 percent of the vote and value of the stock of unrelated corporation P. D
distributes C to all the shareholders of D. Thereafter, pursuant to a plan or series of related
transactions, D (worth 100x) merges with corporation P (worth 900x). After the merger, each of
the former shareholders of corporation D owns stock of the merged entity reflecting the vote and
value attributable to that shareholder’s respective 10 percent former stock ownership of D. Each
of the former shareholders of D owns 1 percent of the stock of the merged corporation, except
that shareholder A (who owned 100 percent of corporation P and 10 percent of corporation D
before the merger) now owns 91 percent of the stock of the merged corporation. In determining
whether a 50-percent or greater interest in D has been acquired, the interest of each of the
continuing shareholders is disregarded only to the extent there has been no decrease in such
shareholder’s direct or indirect ownership. Thus, the 10 percent interest of A, and the 1 percent

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up to the limits described above if the AGI of the such individuals filing a joint return does not
exceed certain limits. The limit is phased for out for such individuals with AGI between
$150,000 and $160,000.

An individual may make nondeductible contributions up to the lesser of $2,000 or 100
percent of compensation to a Roth IRA if the individual’s AGI does not exceed certain limits, An
individual may make nondeductible contributions to an IRA to the extent the individual does not
or cannot make deductible contributions to an IRA or contributions to a Roth IRA. Contributions
to all an individual’s IRAs for a taxable year may not exceed $2,000.

Description of Proposal

The proposal would clarify the intent of the Act that an individual may contribute up to
$2,000 a year to all the individual’s IRAs. Thus, for example, suppose an individual is not
eligible to make deductible IRA contributions because of the phase-out limits, and is eligible to
make a $1,000 Roth IRA contribution. The individual could contribute $1,000 to the Roth IRA
and $1,000 to a nondeductible IRA.

Effective Date

The proposal would be effective as if included in the 1997 Act, i.e., for taxable years
beginning after December 31, 1997.

5. Contribution limitations for active participants in an IRA (sec. 301(b) of the 1997 Act
and sec. 219(g) of the Code)

Present Law
Under present law, if a married individual (filing a joint return) is an active participant in
an employer-sponsored retirement plan, the $2,000 IRA deduction limit is phased out over the
following levels of adjusted gross income (“AGT”):

Taxable years beginning in:

1997 $40,000 to $50,000
1998 $50,000 to $60,000
1999 $51,000 to $61,000
2000 $52,000 to $62,000
2001 $53,000 to $63,000
2002 . $54,000 to $64,000
2003 $60,000 to $70,000
2004 $65,000 to $75,000

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Description of Proposal

The proposal would clarify that the maximum HOPE credit amount will be indexed for
inflation occurring after the year 2000, by increasing the cap on qualified tuition and related
expenses subject to the 100-percent credit rate and the cap on such tuition and related expenses
subject to the 50-percent credit rate, and both caps will be rounded down to the closest multiple
of $100. The first taxable year for which the inflation adjustment could be made to increase the
caps on qualified tuition and related expenses will be 2002.

In addition, the proposal would clarify that, under section 6050S, information returns
containing information with respect to qualified tuition and fees must be filed by a person that is
not an eligible educational institution only if such person is engaged in a trade or business of
making payments to any individual under an insurance arrangement as reimbursements or
refunds (or similar payments) of qualified tuition and related expenses. As under present law,
section 6050S also will require the filing of information returns by persons engaged in a trade or
business if, in the course of such trade or business, the person receives from any individual
interest aggregating $600 or more for any calendar year on one or more qualified education
joans.

Effective Date

The proposal would be effective as if included in the 1997 Act--i.e., for expenses paid
after December 31, 1997, for education furnished in academic periods beginning after such date.

2. Education IRAs (sec. 213 of the 1997 Act and sec. 530 of the Code)
Present Law

Section 530 provides that taxpayers may establish “education IRAs,” meaning certain
trusts or custodial accounts created exclusively for the purpose of paying qualified higher
education expenses of a named beneficiary. Annual contributions to education IRAs may not
exceed $500 per designated beneficiary, and may not be made after the designated beneficiary
reaches age 18. Contributions to an education IRA may not be made by certain high-income
taxpayers--i.e., the contribution limit is phased out for taxpayers with modified adjusted gross
income between $95,000 and $110,000 ($150,000 and $160,000 for taxpayers filing joint
returns). No contribution may be made to an education IRA during any year in which any
contributions are made by anyone to a qualified State tuition program on behalf of the same
beneficiary.

6-


H. Amendments to Title X of the 1997 Act Relating to Revenue-Raising Provisions

1. Exception from constructive sales rules for certain debt positions (sec. 1001(a) of the
1997 Act and sec. 1259(b)(2) of the Code)

Present Law

A taxpayer is required to recognize gain (but not loss) upon entering into a constructive
sale of an “appreciated financial position,” which generally includes an appreciated position with
respect to any stock, debt instrument or partnership interest. An exception is provided for
positions with respect to debt instruments that have an unconditionally payable principal amount,
that are not convertible into the stock of the issuer or a related person, and the interest on which
is either fixed, payable at certain variable rates or based on certain interest payments on a pool of
mortgages.

Description of Proposal

The proposed technical correction would clarify that, to qualify for the exception for
positions with respect to debt instruments, the position would have to either itself meet the
requirements as to unconditional principal amount, non-convertibility and interest terms or,
alternatively, be a hedge of a position meeting these requirements. A hedge for this purpose
would include any position that reduces the taxpayer's risk of interest rate or price changes or
currency fluctuations with respect to another position.

Effective Date

The proposal would generally be effective for constructive sales entered into after June 8,
1997,

2. Definition of forward contract under constructive sales rules (sec. 1001(a) of the 1997
Act and sec. 1259(d)(1) of the Code)

Present Law

A constructive sale of an appreciated financial position generally results when the
taxpayer enters into a forward contact to deliver the same or substantially identical property. A
forward contract for this purpose is defined as a contract that provides for delivery of a
substantially fixed amount of property at a substantially fixed price.

- Description of Proposal
The proposed technical correction would clarify that the definition of a forward contract

includes a contract that provides for cash settlement with respect to a substantially fixed amount
of property at a substantially fixed price.

-29-



G. Amendments to Title IX of the 1997 Act Relating to Miscellaneous Provisions

1. Clarification of effect of certain transfers to Highway Trust Fund (sec. 901 of the 1997
Act and sec. 9503 of the Code)

Present Law

The 1997 Act provided for the transfer of an additional 4.3 cents per gallon of the
highway motor fuels tax revenues from the General Fund to the Highway Trust Fund, and
provided further that revenues transferred to the Trust Fund under this provision could not be
used in a manner resulting in changes in direct spending. The 1997 Act further changed the
dates by which certain taxes would be required to be deposited with the Treasury in fiscal year
1998.

Description of Proposal

The proposal would clarify that the tax deposit delays included in the provisions affecting
transfers to the Highway Trust Fund, like the revenue transfers themselves, do not affect direct
spending from the Trust Fund.

Effective Date
The proposal would be effective as if included in the 1997 Act.

2. Clarification of Mass Transit Account portions of highway motor fuels taxes (sec. 901 of
the 1997 Act and sec. 9503 of the Code)

Present Law

The 1997 Act provided for the transfer to the Highway Trust Fund of revenues
attributable to a General Fund fuels tax rate of 4.3 cents per gallon. That Act further enacted
reduced rates, based on energy content, for propane, liquefied natural tax, compressed natural
gas, and methanol produced from natural gas. When deposited in the Highway Trust Fund,
revenues from the taxes on each of these products are divided between the Trust Fund's Highway
Account and the Mass Transit Account.

Description of Proposal

The proposal would clarify that the Mass Transit Account portion of the highway motor
fuels taxes generally is 2.86 cents per gallon. Taxes on the four fuels eligible for reduced rates
are divided between the Highway Account and the Mass Transit Account in the same proportion
as is the tax on gasoline.

-26-



and the investment tax credit. Refundable credits, which are not limited by the minimum tax, are
not stacked until after the nonrefundable credits.

Description of Proposal

The proposal would clarify the application of the income tax liability limitation to the
refundable portion of the child credit by treating the refundable portion of the child credit in the
same way as the other refundable credits. Specifically, after all the other credits are applied
according to the stacking rules of the income tax limitation then the refundable credits would be
applied first to reduce the taxpayer’s tax liability for the year and then to provide a credit in
excess of income tax liability for the year.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.

2. Treatment of a portion of the child credit as a supplemental child credit (sec. 101 of the
1997 Act and sec. 32(m) of the Code)

Present Law

A portion of the child credit may be treated as a supplemental child credit. The amount
of the supplemental child credit, if any, equals the excess of (1) $500 times the number of
qualifying children up to the excess of the taxpayer's income tax liability (net of applicable
credits other than the earned income credit) over the taxpayer’s alternative minimum tax liability
(determined without regard to the alternative minimum foreign tax credit) over (2) the sum of the
taxpayer's regular income tax liability (net of applicable credits other than the earned income
credit) and the employee share of FICA taxes (and one-half of the taxpayer's SECA tax liability,
if applicable) reduced by any earned income credit amount. The supplemental child credit is
treated as provided under the earned income credit and the child credit amount is reduced by the
amount of the supplemental child credit.

Description of Proposal

The proposal would clarify that the treatment of a portion of the child credit as a
supplemental child credit under the earned income credit (sec. 32) and the offsetting reduction of
the child credit (sec. 24) does not effect any other credit available to the taxpayer. It would also

minimum foreign tax credit) then the nonrefundable personal credits which do not provide a
carryforward would be applied to reduce the income tax liability for that year first and any
excess credits which allow a carryforward would be available to reduce the taxpayer’s income
tax liability in future years.

3-


1. DESCRIPTION OF TECHNICAL CORRECTIONS
TO THE TAXPAYER RELIEF ACT OF 1997

A. Amendments to Title I of the 1997 Act Relating to the Child Credit

1, Stacking rules for the child credit under the limitations based on tax liability (sec. 101 of
the 1997 Act and sec. 24 of the Code)

Present Law

Present law provides a $500 ($400 for taxable year 1998) tax credit for each qualifying
child under the age of 17. A qualifying child is defined as an individual for whom the taxpayer
can claim a dependency exemption and who is a son or daughter of the taxpayer (or a descendent
of either), a stepson or stepdaughter of the taxpayer or an eligible foster child of the taxpayer.
For taxpayers with modified adjusted gross income in excess of certain thresholds, the allowable
child credit is phased out. The length of the phase-out range is affected by the number of the
taxpayer’s qualifying children.

Generally, the maximum amount of a taxpayer’s child credit for each taxable year is
limited to the excess of the taxpayer’s regular tax liability over the taxpayer’s tentative minimum
tax liability (determined without regard to the alternative minimum foreign tax credit). In the
case of a taxpayer with three or more qualifying children, the maximum amount of the
taxpayer’s child credit for each taxable year is limited to the greater of: (1) the amount computed
under the rule described above, or (2) an amount equal to the excess of the sum of the taxpayer’s
regular income tax liability and the employee share of FICA taxes (and one-half of the
taxpayer’s SECA tax liability, if applicable) reduced by the earned income credit. In the case of
a taxpayer with three or more qualifying children, the excess of the amount allowed in (2) over
the amount computed in (1) is a refundable credit.

Nonrefundable credits may not be used to reduce tax liability below a taxpayer’s
tentative minimum tax. Certain credits not used as result of this rule may be carried over to
other taxable years, while others may not. Special stacking rules apply in determining which
nonrefundable credits are used in the current year. Generally, the stacking rules require that
nonrefundable personal credits be considered first”, followed by other credits, business credits,

? Tt is understood that there is also a stacking rule under which the income tax liability
limitation applies between the nonrefundable personal credits including the nonrefundable
portion of the child credit. Generally, the nonrefundable portion of the child credit and the other
nonrefundable personal credits which do not provide a carryforward are grouped together and
stacked first followed by the nonrefundable personal credits which provide a carryforward for
purposes of applying the income tax liability limitation. Therefore, if the sum of the taxpayer’s
nonrefundable credits exceeds the difference between the taxpayer’s regular income tax liability
and the taxpayer’s alternative minimum tax liability (determined without regard to the alternative

2-


2005 $70,000 to $80,000
2006 $75,000 to $85,000
2007 $80,000 to $100,000

An individual is not considered an active participant in an employer-sponsored retirement
plan merely because the individual’s spouse is an active participant. The $2,000 maximum
deductible IRA contribution for an individual who is not an active participant, but whose spouse
is, is phased out for taxpayers with AGI between $150,000 and $160,000.

Description of Proposal

The proposal would clarify the intent of the Act relating to the AGI phase-out ranges for
married individuals who are active participants in employer-sponsored plans and the AGI phase-
out range for spouses of such active participants as described above.

Effective Date

The proposal would be effective as if included in the 1997 Act, i.e., for taxable years
beginning after December 31, 1997.

-15-


B. Amendments to Title II of the 1997 Act Relating to Education Incentives

1. Clarifications to HOPE and Lifetime Learning credits (sec. 201 of the 1997 Act and secs.
25A and 6050S of the Code)

Present Law

Individual taxpayers are allowed to claim a nonrefundable HOPE credit against Federal
income taxes up to $1,500 per student for qualified tuition and fees paid during the year on
behalf of a student (i.e., the taxpayer, the taxpayer’s spouse, or a dependent of the taxpayer) who
is enrolled in a post-secondary degree or certificate program at an eligible post-secondary
institution on at least a half-time basis. The HOPE credit is available only for the first two years
of a student’s post-secondary education. The credit rate is 100 percent of the first $1,000 of
qualified tuition and fees and 50 percent on the next $1,000 of qualified tuition and fees. The
HOPE credit amount that a taxpayer may otherwise claim is phased out for taxpayers with
modified adjusted gross income (AGI) between $40,000 and $50,000 ($80,000 and $100,000 for
joint returns). For taxable years beginning after 2001, the $1,500 maximum HOPE credit
amount and the AGI phase-out range will be indexed for inflation. The HOPE credit is available
for expenses paid after December 31, 1997, for education furnished in academic periods
beginning after such date.

Ifa student is not eligible for the HOPE credit (or in lieu of claiming a HOPE credit with
respect to a student), individual taxpayers are allowed to claim a nonrefundable Lifetime
Learning credit against Federal income taxes equal to 20 percent of qualified tuition and fees
paid during the taxable year on behalf of the taxpayer, the taxpayer’s spouse, or a dependent. In
contrast to the HOPE credit, the student need not be enrolled on at least a half-time basis in order
to be eligible for the Lifetime Learning credit, which is available for an unlimited number of
years of post-secondary training. For expenses paid before January 1, 2003, up to $5,000 of
qualified tuition and fees per taxpayer return will be eligible for the Lifetime Learning credit
(.e., the maximum credit per taxpayer return will be $1,000). For expenses paid after December
31, 2002, up to $10,000 of qualified tuition and fees per taxpayer return will be eligible for the
Lifetime Learning credit (i.e., the maximum credit per taxpayer return will be $2,000). The
Lifetime Learning credit amount that a taxpayer may otherwise claim is phased out over the
same modified AGI phase-out range as applies for purposes of the HOPE credit. The Lifetime
Learning credit is available for expenses paid after June 30, 1998, for education furnished in
academic periods beginning after such date.

Section 6050S provides that certain educational institutions and other taxpayers engaged
in a trade or business must file information returns with the IRS and certain individual taxpayers,
as required by regulations prescribed by the Secretary of the Treasury, containing information on
individuals who made payments for qualified tuition and related expenses or to whom
reimbursements or refunds were made of such expenses.

5.


allowed. Thus, the Federal estate tax liability for this estate would be equal to $37,000 (i.e.,
$382,800 minus $345,800), less any other applicable credits, such as the credit for State death
taxes."

Effective Date
The proposal would be effective for decedents dying after December 31, 1997.

3. Clarification of businesses eligible for family-owned business exclusion (sec. 502 of the
1997 Act and sec. 2033A(b)(3) of the Code)

Present Law

In order to be eligible to exclude from the gross estate a portion of the value of a family-
owned business, the sum of (1) the adjusted value of family-owned business interests includible
in the decedent's estate, and (2) the amount of gifts of family-owned business interests to family
members of the decedent that are not included in the decedent’s gross estate, must exceed 50
percent of the decedent's adjusted gross estate.

Description of Proposal
The proposal would clarify the formula for determining the amount of gifts of family-

owned business interests made to members of the decedent’s family that are not otherwise
includible in the decedent’s gross estate.

Effective Date

The proposal would be effective with respect to decedents dying after December 31,
1997.

"© Note that under this formula, the Federal estate tax liability (before application of
credits other than the unified credit) for any estate of $1.4 million that has at least $675,000 in
qualified family-owned business interests always will be $37,000, regardless of the year in
which the decedent dies. For examiple, if the decedent instead died in 2000, this formula would”
yield a maximum qualified family-owned business exclusion of $626,282, which would result in
a taxable estate of $773,718, and a tentative tax of $257,550. After applying the unified credit
amount that is allowed in 2000, i.e., $220,550, the Federal estate tax liability would be equal to
$37,000, less any other applicable credits.

-21-


DESCRIPTION OF CHAIRMAN’S MARK
OF THE
“TAX TECHNICAL CORRECTIONS ACT OF 1997”

Scheduled for Markup
By the
HOUSE COMMITTEE ON WAYS AND MEANS

on October 9, 1997

Prepared by the Staff
of the

JOINT COMMITTEE ON TAXATION

October 8, 1997

JCX-56-97



A. Allow Deduction for Unused Employer Social Security Credit (sec. 13443 of the
Omnibus Budget Reconcilement Act of 1993 and sec. 196 of the Code)

Present Law

The general business credit (“GBC”) consists of various individual tax credits (including
the employer social security credit of Code section 45B) allowed with respect to certain qualified
expenditures and activities. In general, the various individual tax credits contain provisions that
prohibit “double benefits,” either by denying deductions in the case of expenditure-related
credits or by requiring income inclusions in the case of activity-related credits. Unused credits
may be carried back one year and carried forward 20 years. Section 196 allows a deduction to
the extent that certain portions of the GBC expire unused after the end of the carry forward
period. Section 196 does not allow a deduction to the extent that the portion of the GBC that
expires unused after the end of the carry forward period relates to the employer social security
credit.

Description of Proposal

The proposal would allow a deduction to the extent that the portion of the GBC relating
to the employer social security credit expires unused after the end of the carry forward period.

Effective Date

The proposal would be effective as if included in the Omnibus Budget Reconciliation Act
of 1993.

-44-



In addition, because the 1997 Act allows taxpayers to redeem U.S. Savings Bonds and be
eligible for the exclusion under present-law section 135 (as if the proceeds were used to pay
qualified higher education expenses) provided the proceeds from the redemption are contributed
to an education IRA (or to a qualified State tuition program defined under section 529) on behalf
of the taxpayer, the taxpayer’s spouse, or a dependent, the proposal would conform the definition
of “eligible educational institution” under section 135 to the broader definition of that term under
present-law section 530 (and section 529). Thus, for purposes of section 135, as under present-
law sections 529 and 530, the term “eligible educational institution” would be defined as an
institution which (1) is described in section 481 of the Higher Education Act of 1965 (20 U.S.C.
1088) and (2) is eligible to participate in Department of Education student aid programs.

Effective Date

The proposal would be effective as if included in the 1997 Act--i.e., for taxable years
beginning after December 31, 1997.

3. Treatment of cancellation of certain student loans (sec. 225 of the 1997 Act and sec.
108(f) of the Code)

Present Law

Under present law, an individual's gross income does not include forgiveness of loans
made by tax-exempt educational organizations if the proceeds of such loans are used to pay costs
of attendance at an educational institution or to refinance outstanding student loans and the
student is not employed by the lender organization. The exclusion applies only if the forgiveness
is contingent on the student's working for a certain period of time in certain professions for any
of a broad class of employers. In addition, the student’s work must fulfill a public service
requirement.

education expenses of the beneficiary during the year of the distribution are at least equal to the
$2,000 total amount of the distribution (i.e., principal plus earnings), then the entire earnings
portion of the distribution will be excludible under section 530, provided that a Hope credit or
Lifetime Learning credit is not claimed for that same taxable year on behalf of the beneficiary.
If, however, the qualified higher education expenses of the beneficiary for the taxable year are
less than the total amount of the distribution, then only a portion of the earnings will be
excludable from gross income under section 530. Thus, in the example discussed above, if the
beneficiary incurs only $1,500 of qualified higher education expenses in the year that a $2,000
distribution is made, then only $900 of the earnings will be excludable from gross income under
section 530 (i.e., an exclusion will be provided for the pro-rata portion of the earnings, based on
the ratio that the $1,500 of qualified higher education expenses bears to the $2,000 distribution)
and the remaining $300 of earnings portion of the distribution will be includible in the
distributee’s gross income.

~8-


Until a distribution is made from an education IRA, earnings on contributions to the
account are generally not subject to tax.’ In addition, distributions from an education IRA are
excludable from gross income to the extent that the distribution does not exceed qualified higher
education expenses incurred by the beneficiary during the year the distribution is made (provided
that a HOPE credit or Lifetime Learning credit is not claimed with respect to the beneficiary for
the same taxable year). The earnings portion of an education IRA distribution not used to pay
qualified higher education expenses is includible in the gross income of the distributee and
generally is subject to an additional 10-percent tax.* However, the additional 10-percent tax
does not apply if a distribution is made of excess contributions above the $500 limit (and any
earnings attributable to such excess contributions) if the distribution is made on or before the
date that a return is required to be filed (including extensions of time) by the contributor for the
year in which the excess contribution was made. In addition, section 530 allows tax-free
rollovers of account balances from an education IRA benefiting one family member to an
education IRA benefiting another family member. Section 530 is effective for taxable years
beginning after December 31, 1997.

Description of Proposal

Consistent with the legislative history to the 1997 Act, any balance remaining in an
education IRA will be deemed to be distributed within 30 days after the date that the named
beneficiary reaches age 30 (or, if earlier, within 30 days of the date that the beneficiary dies).

The proposal further would provide that the additional 10-percent tax would not apply to
the distribution of any contribution to an education IRA made during a taxable year if such
distribution is made on or before the date that a return is required to be filed (including
extensions of time) by the beneficiary for the taxable year during which the contribution was
made (or, if the beneficiary is not required to file such a return, April 15th of the year following
the taxable year during which the contribution was made).

The proposal also would clarify that, under rules contained in present-law section 72,
distributions from education IRAs are treated as representing a pro-rata share of the principal
(..e., contributions) and accumulated earnings in the account.>

> However, education IRAs are subject to the unrelated business income tax (“UBIT”)
imposed by section 511.

* This 10-percent additional tax does not apply if a distribution from an education IRA is
made on account of the death, disability, or scholarship received by the designated beneficiary.

* For example, if an education IRA has a total balance of $1 0,000, of which $4,000
tepresents principal (i.e., contributions) and $6,000 represents earnings, and if a distribution of
$2,000 is made from such an account, then $800 of that distribution will be treated as a return of
principal (which under no event is includible in the gross income of the distributee) and $1,200
of the distribution will be treated as accumulated earnings. In such a case, if qualified higher

-7-


J. Amendments to Title XII of the 1997 Act Relating to Simplification Provisions

1. Travel expenses of Federal employees participating in a Federal criminal investigation
(sec. 1204 of the 1997 Act and sec. 162 of the Code)

Present Law

Unreimbursed ordinary and necessary travel expenses paid or incurred by an individual
in connection with temporary employment away from home (e.g., transportation costs and the
cost of meals and lodging) are generally deductible, subject to the two-percent floor on
miscellaneous itemized deductions. Travel expenses paid or incurred in connection with
indefinite employment away from home, however, are not deductible. A taxpayer's employment
away from home in a single location is indefinite rather than temporary if it lasts for one year or
more; thus, no deduction is permitted for travel expenses paid or incurred in connection with
such employment (sec. 162(a)). If a taxpayer's employment away from home in a single location
lasts for less than one year, whether such employment is temporary or indefinite is determined
on the basis of the facts and circumstances.

The 1997 Act provided that the one-year limitation with respect to deductibility of
expenses while temporarily away from home does not include any period during which a Federal
employee is certified by the Attorney General (or the Attorney General's designee) as traveling
on behalf of the Federal Government in a temporary duty status to investigate or provide support
services to the investigation of a Federal crime. Thus, expenses for these individuals during
these periods are fully deductible, regardless of the length of the period for which certification is
given (provided that the other requirements for deductibility are satisfied).

Description of Proposal

The proposal would clarify that prosecuting a Federal crime or providing support services
to the prosecution of a Federal crime is considered part of investigating a Federal crime.

Effective Date

The proposal would be effective for amounts paid or incurred with respect to taxable
years ending after the date of enactment of the 1997 Act.

2. Effective date for provisions relating to electing large partnerships, partnership returns
required on magnetic media, and treatment of partnership items of individual retirement
arrangements (sec. 1226 of the 1997 Act)

Present Law

Rules for simplified flowthrough and simplified audit procedures for electing large
partnerships, as well as a March 15 due date for furnishing information to partners of an electing

-40-



Effective Date

The proposal would be effective on the date of enactment of the 1997 Act (August 5,
1997), and will expire on the date five years after the date of enactment of the 1997 Act.

-28-



B. Treatment of Certain Stapled REITs (sec. 136(c) of the Tax Reform
Act of 1984 and sec. 269B of the Code)

Present Law

Only one level of tax generally applies to an entity that qualifies as a real estate
investment trust (a “REIT”). Section 269B(a)(3), as added by the Tax Reform Act of 1984,
provides that in order to determine whether an entity qualifies as a REIT, all stapled entities are
treated as one entity. Section 269B(a)(3) does not apply to entities that were stapled entities on
June 30, 1983.

Description of Proposal

The proposal would clarify that the grandfather rule provided by the Tax Reform Act of
1984 for entities stapled on June 30, 1983, applies to each period after June 30, 1983, during
which such entities are stapled entities, whether or not such entities were stapled entities for all
periods after June 30, 1983.

Effective Date

The proposal would be effective as if included in the Tax Reform Act of 1984.

-45-



Effective Date
The proposal would be effective as if included in the 1997 Act.

3. Combined employment tax reporting demonstration project (sec. 976 of the 1997 Act
and sec. 6103 of the Code)

Present Law

Traditionally, Federal tax forms are filed with the Federal Government and State tax
forms are filed with individual states. This necessitates duplication of items common to both
returns. Some States have recently been working with the IRS to implement combined State and
Federal reporting of certain types of items on one form as a way of reducing the burdens on
taxpayers. The State of Montana and the IRS have cooperatively developed a system to combine
State and Federal employment tax reporting on one form. The one form would contain
exclusively Federal data, exclusively State data, and information common to both: the taxpayer’s
name, address, TIN, and signature.

The Internal Revenue Code prohibits disclosure of tax returns and return information,
except to the extent specifically authorized by the Internal Revenue Code (sec. 6103).
Unauthorized disclosure is a felony punishable by a fine not exceeding $5,000 or imprisonment
of not more than five years, or both (sec. 7213). An action for civil damages also may be
brought for unauthorized disclosure (sec. 7431). No tax information may be furnished by the
Internal Revenue Service (“IRS”) to another agency unless the other agency establishes
procedures satisfactory to the IRS for safeguarding the tax information it receives (sec. 6103(p)).

Implementation of the combined Montana-Federal employment tax reporting project had
been hindered because the IRS interprets section 6103 to apply that provision’s restrictions on
disclosure to information common to both the State and Federal portions of the combined form,
although these restrictions would not apply to the State with respect to the State’s use of State-
requested information if that information were supplied separately to both the State and the IRS.

The 1997 Act permits implementation of a demonstration project to assess the feasibility
and desirability of expanding combined reporting in the future. There are several limitations on
the demonstration project. First, it is limited to the State of Montana and the IRS. Second, it is
limited to employment tax reporting. Third, it is limited to disclosure of the name, address, TIN,
and signature of the taxpayer, which is information common to both the Montana and Federal
portions of the combined form. Fourth, it is limited to a period of five years.

- Description of Proposal
The proposal would permit Montana to use this information as if it had collected it

separately by eliminating Federal penalties for disclosure of this information. The proposal
would also correct a cross-reference to the provision.

-27-



clarify that the earned income credit rules (e.g., the phaseout of the earned credit) generally do
not apply to the supplemental child credit.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997

4.


unforeseen circumstances is able to exclude a fraction of the taxpayer’s realized gain equal to the
fraction of the two years that the requirements are met.

Description of Proposal

The proposal would clarify that an otherwise qualifying taxpayer who fails to satisfy the
two-year ownership and use requirements is able to exclude an amount equal to the fraction of
the $250,000 ($500,000 if married filing a joint return), not the fraction of the realized gain
which is equal to the fraction of the two years that the ownership and use requirements are met.
For example, an unmarried taxpayer who owns and uses a principal residence for one year then
sells at realized gain of $500,000 may exclude $125,000 of gain (one-half of $250,000) not
$250,000 of gain (one-half of the realized gain). Similarly, an unmarried taxpayer who owns
and uses a principal residence for one year then sells at a realized gain of $50,000 may exclude
the entire $50,000 of gain since it is less than one half of $250,000. The exclusion is not limited
to $25,000 (one-half of the $50,000 realized gain).

Effective Date
The proposal would be effective as if included in section 312 of the 1997 Act.

4. Effective date of the exclusion of gain on the sale of a principal residence (sec. 312(d)(2)
of the 1997 Act and sec. 121 of the Code)

Present law

The exclusion for gain on sale of a principal residence under the 1997 Act generally
applies to sales or exchanges occurring after May 6, 1997. A taxpayer may elect, however, to
apply prior law to a sale or exchange (1) made before the date of enactment of the Act, (2) made
after the date of enactment pursuant to a binding contract in effect on such date, or (3) where a
replacement residence was acquired on or before the date of enactment (or pursuant to a binding
contract in effect on the date of enactment) and the prior-law rollover provision would apply.

Description of Proposal

The proposal would clarify that a taxpayer may elect to apply prior law with respect to a
sale or exchange on the date of enactment of section 312 of the 1997 Act.

Effective Date

The proposal would be effective as if included in section 312 of the 1997 Act.

-18-



and wages is continuous from the date it is first made until the date it is fully paid or becomes
unenforceable.

The 1997 Act provides that a continuous levy is also applicable to non-means tested
recurring Federal payments and specified wage replacement payments.

Description of Proposal

The proposal would clarify that the IRS must approve the use of a continuous levy before
it may take effect.

Effective Date

The proposal would be effective for levies issued after the date of enactment of the 1997
Act (August 5, 1997).

9. Clarification regarding aviation gasoline excise tax (sec. 1031 of the 1997 Act and sec.
6421(f) of the Code)

Present Law

Before enactment of the 1997 Act, aviation gasoline was subject to a 19.3-cents-per-
gallon tax rate, with 15 cents per gallon being deposited in the Airport and Airway Trust Fund
and 4.3 cents per gallon being retained in the General Fund. The 1997 Act extended the 15-
cents-per-gallon rate for 10 years, through September 30, 2007, and expanded deposits to the
Trust Fund to include revenues from the 4.3-cents-per-gallon rate. The tax does not apply to fuel
used in flight segments outside the United States or to flight segments from the United States to
foreign countries

Description of Proposal

The proposal would clarify the application of the gasoline tax refund provisions to
aviation gasoline used in flight segments outside the United States and to flight segments from
the United States to foreign countries.

Effective Date
The proposal would be effective as if included in the 1997 Act.

-35-



10. Clarification of requirement that registered fuel terminals offer dyed fuel (sec. 1032 of
the 1997 Act and sec. 4101 of the Code)

Present Law

The 1997 Act provides that fuel terminals are eligible to register to handle non-tax-paid
diesel fuel and kerosene only if the terminal operator offers both undyed (taxable) and dyed
(nontaxable) fuel.

Description of Proposal

The proposal would clarify that this provisions requires terminals eligible to handle non-
tax-paid diesel must offer dyed diesel fuel and terminals eligible to handle non-tax-paid kerosene
(including diesel fuel #1 and kerosene-type aviation fuel) to offer dyed kerosene. The provision
does not require that a terminal offer for sale kerosene as a condition of receiving diesel fuel on a
non-tax-paid basis.

Effective Date
The proposal would be effective as if included in the 1997 Act.

11. Corrections to provision expanding the limitations on deductibility of premiums and
interest with respect to life insurance, endowment and annuity contracts (sec. 1084 of the
1997 Act and sec. 264 of the Code)

Present Law

M aster contracts

The 1997 Act provided limitations on the deductibility of interest and premiums with
respect to life insurance, endowment and annuity contracts. Under the pro rata interest
disallowance provision added by the Act, an exception is provided for any policy or contract
owned by an entity engaged in a trade or business, covering an individual who is an employee,
officer or director of the trade or business at the time first covered. The exception applies to any
policy or contract owned by an entity engaged in a trade or business, which covers one
individual who (at the time first insured under the policy or contract) is (1) a 20-percent owner of
the entity, or (2) an individual (who is not a 20-percent owner) who is an officer, director or

-36-



F. Amendments to Title VII of the 1997 Act Relating to Incentives
for the District of Columbia (sec. 701 of the 1997 Act and
secs. 1400, 1400B and 1400C of the Code)

Present Law
Designation of D.C. Enterprise Zone

Certain economically depressed census tracts within the District of Columbia are
designated as the “D.C. Enterprise Zone,” within which businesses and individual residents are
eligible for special tax incentives. The census tracts that compose the D.C. Enterprise Zone for
purposes of the wage credit, expensing, and tax-exempt financing incentives include all census
tracts that presently are part of the D.C. enterprise community and census tracts within the
District of Columbia where the poverty rate is not less than 20 percent. The D.C. Enterprise
Zone designation generally will remain in effect for five years for the period from January 1,
1998, through December 31, 2002.

Empowerment zone wage credit, expensing. and tax-exempt financing

The following tax incentives generally are available in the D.C. Enterprise Zone: (Q)a
20-percent wage credit for the first $15,000 of wages paid to D.C. residents who work in the
D.C. Enterprise Zone; (2) an additional $20,000 of expensing under Code section 179 for
qualified zone property; and (3) special tax-exempt financing for certain zone facilities,

Zero-percent capital gains rate

A zero-percent capital gains rate applies to capital gains from the sale of certain qualified
D.C. Zone assets held for more than five years. For purposes of the zero-percent capital gains
rate, the D.C. Enterprise Zone is defined to include all census tracts within the District of
Columbia where the poverty rate is not less than 10 percent. Only capital gain that is attributable
to the 10-year period beginning December 31, 1997, and ending December 31, 2007, is eligible
for the zero-percent rate.

First-time homebuyer tax credit

First-time homebuyers of a principal residence in the District are eligible for a tax credit
of up to $5,000 of the amount of the purchase price, except that the credit phases out for
individual taxpayers with adjusted gross income between $70,000 and $90,000 ($110,000-
$130,000 for joint filers). The credit is available with respect to property purchased after the
date of enactment and before January 1, 2001.

-24-



11. Corrections to provision expanding the limitations on deductibility
of premiums and interest with respect to life insurance, endowment
and annuity contracts ©2222 00... cece eee ee
12. Clarification to the definition of modified adjusted gross income
for purposes of the earned income credit phaseout ...............
I. Amendments to Title XI of the 1997 Act Relating to Foreign
Provisions .. 20.2... cnn cece c eee cease
J. Amendments to Title XII of the 1997 Act Relating to Simplification
Provisions ©... 2... e cece e ence
1, Travel expenses of Federal employees participating in a Federal
criminal investigation ©... 2.0... 00. c cece eee e ee
2. Effective date for provisions relating to electing large partnerships,
partnership returns required on magnetic media, and treatment of
partnership items of individual retirement arrangements ...........
K. Amendments to Title XVI of the 1997 Act Relating to Technical
Corrections 2.0. ccc cece nee e eee
1. Application of requirements for SIMPLE IRAs in the case of mergers
and acquisitions 20.2... ee
2. Treatment of Indian tribal governments under section 403(b)

Il, TECHNICAL CORRECTIONS TO OTHER TAX LEGISLATION ....
A. Allow Deduction for Unused Employer Social Security Credit .........

B. Treatment of Certain Stapled REITs .............0 0.00. c cee eee

Gi)

38

39

40

40

40

42

42
42

44

45


amounts from such contract to a section 401(k) plan maintained by the Indian tribal government
whether or not the annuity contract is terminated.

Description of Proposal
The proposal would clarify that an employee participating in a 403(b)(7) custodial

account of the Indian tribal government may roll over amounts from such account to a section
401(k) plan maintained by the Indian tribal government.

Effective Date

The proposal would be effective as if included in the Small Business Job Protection Act
of 1996.

-43-



large partnership, were added to present law by the 1997 Act. The 1997 Act also added a rule
providing that partnership returns are required on magnetic media, and modified the treatment of
partnership items of individual retirement arrangements. The 1997 Act statement of managers
provided that these provisions apply to partnership taxable years beginning after December 31,
1997. The statute provided that the rules for simplified flowthrough for electing large
partnerships apply to partnership taxable years beginning after December 31, 1997 (Act sec.
1221(c)), although the statute also provided that all the provisions apply to partnership taxable
years ending on or after December 31, 1997 (Act sec. 1226)

Description of Proposal

The proposal would provide that these provisions apply to partnership taxable years
beginning after December 31, 1997.

Effective Date

The proposal would be effective as if enacted in the 1997 Act.

-41-



inclusion rule applies, an additional 10-percent tax.* Any withdrawal from a Roth IRA which
contains converted amounts (called a “Roth Conversion IRA”) within the 5-year period
beginning with the year of the conversion would be deemed to come first from the amounts that
were includible in income as a result of the conversion.

To assist in applying these rules, it is anticipated that appropriate forms will be developed
to clearly differentiate Roth Conversion IRAs from other Roth IRAs and, for taxpayers who
make conversions in more than one year, to differentiate Roth Conversion IRAs for different
years so that taxpayers will be able to easily maintain separate IRAs for conversion amounts for
each year in which a conversion is made and to facilitate reporting with respect to such IRAs by
trustees and custodians.

Special rules would apply in the event that separate Roth IRAs are not maintained. In
the case of a Roth IRA which contains conversion contributions and other contributions or
conversion contributions from more than one year, the 5-year period begins with the most recent
taxable year for which a conversion contribution was made.? For purposes of determining the
amount of a withdrawal attributable to amounts includible in income due to a conversion, all
Roth IRAs with the same 5-year holding period would be aggregated.

In order to assist individuals who erroneously convert IRAs into Roth IRAs or otherwise
wish to change the nature of an IRA contribution, contributions to an IRA (and earnings thereon)
may be transferred from any IRA to another IRA by the due date for the taxpayer's return for the
year of the contribution (including extensions). Any such transferred contributions will be
treated as if contributed to the transferee IRA (and not to the transferor IRA).

The following example illustrates the application of the proposed rules.

Example: Taxpayer A has a nondeductible IRA with a value of $100 (and no other
IRAs). The $100 consists of $75 of contributions and $25 of earnings. A converts the
IRA into a Roth IRA in 1998. As a result of the conversion, $25 is includible in income
ratably over 4 years ($6.25 per year). The 10-percent early withdrawal tax does not
apply to the conversion. (It is anticipated that when A opens the account, it will be
designated as a 1998 Roth Conversion IRA.) At the beginning of 1999, the value of the
account is $110, and A makes a withdrawal of $45. $25 of the withdrawal is treated as
attributable entirely to amounts that were includible in income due to the conversion.
Upon withdrawal, the $25 is not includible in income, nor is the 4-year income inclusion

* This additional tax is intended to recapture the benefit of deferring the income
inclusion of the converted amounts. The converted amounts would still be includible in income
under the 4-year rule; that is, there would be no acceleration of the income inclusion.

° This same rule would apply for purposes of determining whether a distribution from a
Roth IRA is a qualified distribution.

-I1-


distributions would not be subject to the 20-percent withholding applicable to eligible rollover
distributions.

Effective Date

The proposal would be effective as if included in the 1997 Act, i.e., for taxable years
beginning after December 31, 1997.

3. Limits based on modified adjusted gross income (sec. 302(a) of the 1997 Act
and sec. 72(t) of the Code)

Present Law

The $2,000 Roth IRA maximum contribution limit is phased out for individual taxpayers
with adjusted gross income (“AGI”) between $95,000 and $110,000 and for married taxpayers
filing a joint return with AGI between $150,000 and $160,000. The maximum deductible IRA.
contribution is phased out between $0 and $10,000 of AGI in the case of married couples filing a
separate return.

Description of Proposal

The proposal would clarify the phase-out range for the Roth IRA maximum contribution
limit for a married individual filing a separate return and conform it to the range for deductible
IRA contributions. Under the proposal, the phase-out range for married individuals filing a
separate return would be $0 to $10,000 of AGI.

Effective Date

The proposal would be effective as if included in the 1997 Act, i.e., for taxable years
beginning after December 31, 1997.

4. Contribution limit to Roth IRAs (sec. 302 of the 1997 Act and sec. 408A(c) of the Code)

Present Law

An individual who is an active participant in an employer-sponsored plan may deduct
annual IRA contributions up to the lesser of $2,000 or 100 percent of compensation if the
individual’s adjusted gross income (“AGI”) does not exceed certain limits. For 1998, the limit is
phased-out over the following ranges of AGI: $30,000 to $40,000 in the case of a single taxpayer
and $50,000 to $60,000 in the case of married taxpayers. An individual who is not an active
participant in an employer-sponsored retirement plan (and whose spouse is not an active
participant) may deduct IRA contributions up to the limits described above without limitation
based on income. An individual who is not an active participant in an employer-sponsored
retirement plan (and whose spouse is such an active participant) may deduct IRA contributions

-13-


E. Amendments to Title V of the 1997 Act Relating to Estate and
Gift Taxes .

1,

2.

5.

6.

Clarification of effective date for indexing of generation-skipping
exemption 00. eee eens
Coordination between unified credit and family-owned business

exclusion

Clarification of businesses eligible for family-owned business

exclusion

Clarification of interest on installment payment of estate tax

on holding companies

Clarification on declaratory judgment jurisdiction of U.S. Tax
Court regarding installment payment of estate tax................
Clarification of rules governing revaluation of gifts...............

F. Amendments to Title VII of the 1997 Act Relating to Incentives

for the District of Columbia

G. Amendments to Title IX of the 1997 Act Relating to Miscellaneous
Provisions .

1

Clarification of effect on certain transfers to Highway Trust Fund... .
2. Clarification of Mass Transit Account portions of highway

motor fuels taxes

H. Amendments to Title X of the 1997 Act Relating to Revenue-

Raising Provisions

1.

N

an

SO MNANERYW

Exemption from constructive sales rules for certain debt

positions

Definition of forward contract under constructive sales

tules .. .

Treatment of mark-to-market gains of electing traders
Special effective date for constructive sale rules
Treatment of certain corporate distributions

Certain preferred stock treated as “boot”~-statute of limitations .....
Certain preferred stock treated as “boot”--treatment of transferor... .
Establish IRS continuous levy and improve debt collection .........

Clarification regarding aviation gasoline excise tax

Clarification of requirement that registered fuel terminals offer

dyed fuel

19

19

21

22

22

23

24

26
26

26
27

29

29

29
30
30
31
33
34
34
35

36


Effective Date

The proposal would apply to transactions after June 8, 1997.

7. Certain preferred stock treated as “boot”--treatment of transferor (sec. 1014 of the 1997
Act and sec. 351(g) of the Code)

Present Law

The 1997 Act amended section 351 of the Code to provide that in the case of a person
who transfers property to a controlled corporation and receives nonqualified preferred stock,
section 351(b) will apply to such person. Section 351(b) provides that if section 351(a) of the
Code would apply to an exchange but for the fact that there is received, in addition to stock
permitted to be received under section 351(a), other property or money, then gain but no loss to
such recipient shall be recognized. The Statement of Managers to the 1997 Act states that if
nonqualified preferred stock is received, gain but not loss shall be recognized.

Description of Proposal

The proposal would clarify that section 351(b) applies to a transferor who transfers
property in a section 351 exchange and receives nonqualified preferred stock in addition to stock
that is not treated as “other property” under that section. Thus, if a transferor received only
nonqualified preferred stock but the transaction in the aggregate otherwise qualified as a section
351 exchange, such a transferor would recognize loss and the basis of the nonqualified preferred
stock and of the property in the hands of the transferee corporation would reflect the transaction
in the same manner as if that particular transferor had received solely “other property” of any
other type. As under the 1997 Act, the nonqualified preferred stock continues to be treated as
stock received by a transferor for purposes of qualification of a transaction under section 351(a),
unless and until regulations may provide otherwise.

Effective Date
The proposal would apply to transactions after June 8, 1997.

8. Establish IRS continuous levy and improve debt collection (secs. 1024, 1025, and 1026 of
the 1997 Act and secs. 6331 and 6334 of the Code)

Present Law

If any person is liable for any internal revenue tax and does not pay it within 10 days
after notice and demand by the IRS, the IRS may then collect the tax by levy upon all property
and rights to property belonging to the person, unless there is an explicit statutory restriction on
doing so. A levy is the seizure of the person's property or rights to property. A levy on salary

-34-



4. Clarification of interest on installment payment of estate tax on holding companies
(sec. 503 of the 1997 Act and secs. 6166(b)(7)(A) and 6166(b)(8)(A) of the Code)

Present Law

Where certain conditions are met, a decedent's estate may elect to pay the estate tax
attributable to certain closely-held businesses over a 14-year period. The 1997 Act provided for
a 2-percent interest rate on the estate tax on first $1 million in value of interests in qualified
closely-held businesses, and a rate equal to 45 percent of the regular deficiency rate on the
amount in excess of the portion eligible for the 2-percent rate, but also provided that none of
interest on the deferred payment of estate taxes would be deductible for income or estate tax
purposes. Interests in holding companies and non-readily-tradeable business interests are not
eligible for the 2-percent rate.

Description of Proposal

The proposal would clarify that deferred payments of estate tax on holding companies
and non-readily-tradable business interests do not qualify for the 2-percent interest rate, but
instead are subject to a rate of 45 percent of the regular deficiency rate. Such interest payments
are not deductible for income or estate tax purposes.

Effective Date

The proposal generally would be effective for decedents dying after December 31, 1997.

5. Clarification on declaratory judgment jurisdiction of U.S. Tax Court regarding
installment payment of estate tax (sec. 505 of the 1997 Act and sec. 7479(a) of the Code)

Present Law

Where certain conditions are met, a decedent's estate may elect to pay estate tax
attributable to certain closely-held business over a 14-year period. The 1997 Act provided that
the U.S. Tax Court would have jurisdiction to determine whether the estate of a decedent
qualifies for the 14-year installment payment of estate tax.

Description of Proposal
The proposal would clarify that the jurisdiction of the U.S. Tax Court to determine

whether an estate qualifies for installment payment of estate tax on closely-held businesses
extends to determining which businesses in an estate are eligible for the deferral.

-22-



CONTENTS

INTRODUCTION .. 000 eee

I. DESCRIPTION OF TECHNICAL CORRECTIONS
TO THE TAXPAYER RELIEF ACT OF 1997 ....0 20.0.0... 0.0...

A. Amendments to Title I of the 1997 Act Relating to the Child
Credit 2... ccc cece eee eeeees

1, Stacking rules for the child credit under the limitations based on
tax liability eee eee
2. Treatment of a portion of the child credit as a supplemental child
credit cece eee

B. Amendments to Title I of the 1997 Act Relating to Education
Incentives... cence cece ee eveenes

1. Clarifications to HOPE and Lifetime Learning credits ............

wn

2. EducationsIRAs 2.0.2... 0... cece cece cece eee

. Amendments to Title III of the 1997 Act Relating to Savings
Incentives... 0. cece ene

1. Conversions of IRAs into RothIRAs ..................0.
2. Penalty-free distributions from IRAs for education expenses and

purchase of first homes ...........2......00. 0000s ee aee
3. Limits based on modified adjusted gross income ............
4. Contribution limit to Roth IRAs .........0.0....0.0.0.004
5

D. Amendments to Title III of the 1997 Act Relating to Capital Gains

1, Individual capital gain rate reductions....................
2. Rollover of gain from sale of qualified stock ...............
3. Exclusion of gain on the sale of a principal residence owned and
used less that two years «2.0.2...
4. Effective date of the exclusion of gain on the sale of a principal
residence 6.6...

a

10
10
12
13
13
14
16

16
17

17

18


Effective Date

The proposal would generally be effective for constructive sales entered into after June 8,
1997.

3. Treatment of mark-to-market gains of electing traders (sec. 1001(b) of the 1997 Act and
sec. 475(f)(1)(D) of the Code)

Present Law

Securities and commodities traders may elect application of the mark-to-market
accounting rules. Gain or loss recognized by an electing taxpayer under these rules is treated as
ordinary gain or loss.

Under the Self-Employment Contributions Act (“SECA”), a tax is imposed on an
individual's net earnings from self-employment (“NESE”). Gain or loss from the sale or
exchange of a capital asset is excluded from NESE.

A publicly-traded partnership generally is treated as a corporation for Federal tax
purposes. An exception to this rule applies if 90 percent or more of the partnership's gross
income consists of passive-type income, which includes gain from the sale or disposition of a
capital asset.

Description of Proposal

The proposed technical correction would clarify that gain or loss of a securities or
commodities trader that is treated as ordinary solely by reason of election of mark-to-market
treatment would not be treated as other than gain or loss from a capital asset for purposes of
determining NESE for SECA tax purposes or determining whether the passive-type income
exception to the publicly-traded partnership rules is met.

Effective Date

The proposal would apply to taxable years of electing securities and commodities traders
ending after the date of enactment of the 1997 Act.

4. Special effective date for constructive sale rules (sec. 1001(d) of the 1997 Act and
sec. 1259 of the Code)

Present Law
The constructive sales rules contain a special effective date provision for decedents dying

after June 8, 1997, if (1) a constructive sale of an appreciated financial position occurred before
such date, (2) the transaction remains open for not less than two years, (3) the transaction

-30-



I. Amendments to Title XI of the 1997 Act Relating to Foreign Provisions
(sec. 1121 of the 1997 Act and sec. 1298 of the Code)

Present Law

Special attribution rules apply to the extent that the effect is to treat stock of a passive
foreign investment company (“PFIC”) as owned by a U.S. person. In general, if 50 percent or
more in value of the stock of a corporation is owned (directly or indirectly) by or for any person,
such person is considered as owning a proportionate part of the stock owned directly or
indirectly by or for such corporation, determined based on the person’s proportionate interest in
the value of such corporation’s stock. However, this 50-percent limitation does not apply in the
case of a corporation that is a PFIC. Accordingly, a person that is a shareholder of a PFIC is
considered as owning a proportionate part of the stock owned directly or indirectly by or for such
PFIC, without regard to whether such shareholder owns at least 50 percent of the PFIC’s stock
by value.

A corporation is not treated as a PFIC with respect to a shareholder during the qualified
portion of the shareholder’s holding period for the stock of such corporation. The qualified
portion of the shareholder’s holding period generally is the portion of such period which is after
the effective date of the 1997 Act and during which the shareholder is a United States
shareholder (as defined in sec. 951(b)) and the corporation is a controlled foreign corporation.

Ifa corporation is not treated as a PFIC with respect to a shareholder for the qualified
portion of such shareholder’s holding period, it is unclear whether the attribution rules that apply
with respect to stock owned by or for such corporation apply without regard to the requirement
that the shareholder own 50 percent or more of the corporation’s stock.

Description of Proposal

The proposal would clarify that the attribution rules apply without regard to the provision
that treats a corporation as a non-PFIC with respect to a shareholder for the qualified portion of
the shareholder’s holding period. Accordingly, stock owned directly or indirectly by or for a
corporation that is not treated as a PFIC for the qualified portion of the shareholder’s holding
period nevertheless will be attributed to such shareholder, regardless of the shareholder’s
ownership percentage of such corporation.

Effective Date
The proposal would be effective for taxable years of U.S. persons beginning after

December 31, 1997 and taxable years of foreign corporations ending with or within such taxable
years of U.S. persons.

-39-



Description of Proposal

Eligible census tracts

The proposal would clarify that the determination of whether a census tract in the District
of Columbia satisfies the applicable poverty criteria for inclusion in the D.C. Enterprise Zone for
purposes of the wage credit, expensing, and special tax-exempt financing incentives (poverty
rate of not less than 20 percent) or for purposes of the zero-percent capital gains rate (poverty
rate of not less than 10 percent), would be based on 1990 decennial census data. Thus, data from
the 2000 decennial census would not result in the expansion or other reconfiguration of the D.C.
Enterprise Zone.

First-time homebuyer credit

The proposal would clarify that, for purposes of the first-time homebuyer credit, a “first-
time homebuyer” means any individual if such individual (and, if married, such individual’s
spouse) did not have a present ownership interest in a principal residence in the District of
Columbia during the one-year period ending on the date of the purchase of the principal
residence to which the credit applies.

In addition, the proposal would clarify that the term “purchase price” means the adjusted
basis of the principal residence on the date the residence is purchased. Newly constructed
residences would be treated as purchased by the taxpayer on the date the taxpayer first occupies
such residence.

The proposal would clarify that the first-time homebuyer credit is a nonrefundable
personal credit and would provide that the first-time homebuyer credit is claimed after the credits
described in Code sections 25 (credit for interest on certain home mortgages) and 23 (adoption
credit).

Finally, the proposal would clarify that the first-time homebuyer credit would be
available only for property purchased after August 4, 1997, and before January 1, 2001. Thus,
the credit would be available to first-time home purchasers who acquire title to a qualifying
principal residence on or after August 5, 1997, and on or before December 31, 2000, irrespective
of the date the purchase contract was entered into.

Effective Date

The proposal would be effective as of August 5, 1997, the date of enactment of the 1997

Act.

-25-



Description of Proposal

The proposal would clarify that the forgiveness of loans made by tax-exempt educational
organizations and other tax-exempt organizations to refinance any existing student loan may be
excludable from gross income. However, the proposal would require that such refinancing loans
must be made pursuant to a program of the refinancing organization (e.g., school or private
foundation) that requires the student to fulfill a public service work requirement.

Effective Date

The proposal would be effective as of August 5, 1997, the date of enactment of the 1997
Act.

-9-


affected. However, the $25 is subject to the 10-percent tax on early withdrawals (unless
an exception applies) and an additional 10-percent tax to recapture the benefit of the 4-
year income inclusion. The remaining $20 of the distribution would not be includible in
income nor subject to the early withdrawal tax because it would be considered as a return
of contributions under the ordering rule generally applicable to Roth IRAs. Subsequent
withdrawals would be subject to the ordering rule generally applicable to Roth IRAs.

Effect of death on 4-year spread

Under the proposal, in general, any amounts remaining to be included in income as a
result of a 1998 conversion would be includible in income on the final return of the taxpayer. If
the surviving spouse is the beneficiary of the Roth IRA, the spouse could continue the deferral
by including the remaining amounts in his or her income over the remainder of the 4-year period.

Effective Date

The provision would be effective as if included in the 1997 Act, i.e., for taxable years
beginning after December 31, 1997.

2. Penalty-free distributions for education expenses and purchase of first homes (secs. 203
and 303 of the 1997 Act and sec. 402 of the Code)

Present Law

The 10-percent early withdrawal tax does not apply to distributions from an IRA if the
distribution is for first-time homebuyer expenses, subject to a $10,000 life-time cap, or for
higher education expenses. These exceptions do not apply to distributions from employer-
sponsored retirement plans. A distribution from an employer-sponsored retirement plan that is an
“eligible rollover distribution” may be rolled over to an IRA. The term “eligible rollover
distribution” means any distribution to an employee of all or a portion or the balance to the credit
of the employee in a qualified trust. Distributions from cash or deferred arrangements made on
account of hardship are eligible rollover distributions. An eligible rollover distribution which is
not transferred directly to another retirement plan or an IRA is subject to 20-percent withholding
on the distribution.

Description of Proposal

Under present law, participants in employer-sponsored retirement plans can avoid the
early withdrawal tax applicable to such plans by rolling over hardship distributions to an IRA
and withdrawing the funds from the IRA. The proposal would modify the rules relating to the
ability to roll over hardship distributions from employer-sponsored retirement plans to an IRA in
order to prevent such avoidance of the 10-percent early withdrawal tax. The proposal would
provide that distributions from cash or deferred arrangements made on account of hardship of the
employee are not eligible rollover distributions and may not be rolled over to any IRA. Such

-12-