" HOUSE OF REPRESENTATIVES ! 108TH CONGRESS

2d Session 

REPORT

108–755

AMERICAN JOBS CREATION ACT OF 2004

CONFERENCE REPORT

TO ACCOMPANY

H.R. 4520

OCTOBER 7, 2004.—Ordered to be printed

★


E:\Seals\Congress.#13
AMERICAN JOBS CREATION ACT OF 2004

U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1

★ 96–542

" HOUSE OF REPRESENTATIVES ! 108TH CONGRESS

2d Session 

REPORT

2004

108–755

AMERICAN JOBS CREATION ACT OF 2004

CONFERENCE REPORT

TO ACCOMPANY

H.R. 4520

OCTOBER 7, 2004.—Ordered to be printed 


E:\Seals\Congress.#13
108TH CONGRESS REPORT " HOUSE OF REPRESENTATIVES ! 2d Session 108–755

AMERICAN JOBS CREATION ACT OF 2004

OCTOBER 7, 2004.—Ordered to be printed 

Mr. THOMAS, from the committee of conference, 

submitted the following 

CONFERENCE REPORT 

[To accompany H.R. 4520] 

The committee of conference on the disagreeing votes of the 

two Houses on the amendment of the Senate to the bill (H.R. 

4520), to amend the Internal Revenue Code of 1986 to remove impediments in such Code and make our manufacturing, service, and 

high-technology businesses and workers more competitive and productive both at home and abroad, having met, after full and free 

conference, have agreed to recommend and do recommend to their 

respective Houses as follows: 

That the House recede from its disagreement to the amendment of the Senate and agree to the same with an amendment as 

follows: 

In lieu of the matter proposed to be inserted by the Senate 

amendment, insert the following:

SECTION 1. SHORT TITLE; ETC. 

(a) SHORT TITLE.—This Act may be cited as the ‘‘American Jobs 

Creation Act of 2004’’. 

(b) AMENDMENT OF 1986 CODE.—Except as otherwise expressly 

provided, whenever in this Act an amendment or repeal is expressed 

in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or 

other provision of the Internal Revenue Code of 1986. 

(c) TABLE OF CONTENTS.—The table of contents of this Act is as 

follows:

TITLE I—PROVISIONS RELATING TO REPEAL OF EXCLUSION FOR 

EXTRATERRITORIAL INCOME 

Sec. 101. Repeal of exclusion for extraterritorial income. 

Sec. 102. Deduction relating to income attributable to domestic production activities. 

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TITLE II—BUSINESS TAX INCENTIVES 

Subtitle A—Small Business Expensing 

Sec. 201. 2-year extension of increased expensing for small business. 

Subtitle B—Depreciation 

Sec. 211. Recovery period for depreciation of certain leasehold improvements and 

restaurant property. 

Subtitle C—Community Revitalization 

Sec. 221. Modification of targeted areas and low-income communities for new markets tax credit. 

Sec. 222. Expansion of designated renewal community area based on 2000 census 

data. 

Sec. 223. Modification of income requirement for census tracts within high migration rural counties. 

Subtitle D—S Corporation Reform and Simplification 

Sec. 231. Members of family treated as 1 shareholder. 

Sec. 232. Increase in number of eligible shareholders to 100. 

Sec. 233. Expansion of bank S corporation eligible shareholders to include IRAs. 

Sec. 234. Disregard of unexercised powers of appointment in determining potential 

current beneficiaries of ESBT. 

Sec. 235. Transfer of suspended losses incident to divorce, etc. 

Sec. 236. Use of passive activity loss and at-risk amounts by qualified subchapter 

S trust income beneficiaries. 

Sec. 237. Exclusion of investment securities income from passive income test for 

bank S corporations. 

Sec. 238. Relief from inadvertently invalid qualified subchapter S subsidiary elections and terminations. 

Sec. 239. Information returns for qualified subchapter S subsidiaries. 

Sec. 240. Repayment of loans for qualifying employer securities. 

Subtitle E—Other Business Incentives 

Sec. 241. Phaseout of 4.3-cent motor fuel excise taxes on railroads and inland waterway transportation which remain in general fund. 

Sec. 242. Modification of application of income forecast method of depreciation. 

Sec. 243. Improvements related to real estate investment trusts. 

Sec. 244. Special rules for certain film and television productions. 

Sec. 245. Credit for maintenance of railroad track. 

Sec. 246. Suspension of occupational taxes relating to distilled spirits, wine, and 

beer. 

Sec. 247. Modification of unrelated business income limitation on investment in certain small business investment companies. 

Sec. 248. Election to determine corporate tax on certain international shipping activities using per ton rate. 

Subtitle F—Stock Options and Employee Stock Purchase Plan Stock Options 

Sec. 251. Exclusion of incentive stock options and employee stock purchase plan 

stock options from wages. 

TITLE III—TAX RELIEF FOR AGRICULTURE AND SMALL MANUFACTURERS 

Subtitle A—Volumetric Ethanol Excise Tax Credit 

Sec. 301. Alcohol and biodiesel excise tax credit and extension of alcohol fuels income tax credit. 

Sec. 302. Biodiesel income tax credit. 

Sec. 303. Information reporting for persons claiming certain tax benefits. 

Subtitle B—Agricultural Incentives 

Sec. 311. Special rules for livestock sold on account of weather-related conditions. 

Sec. 312. Payment of dividends on stock of cooperatives without reducing patronage 

dividends. 

Sec. 313. Apportionment of small ethanol producer credit. 

Sec. 314. Coordinate farmers and fishermen income averaging and the alternative 

minimum tax. 

Sec. 315. Capital gain treatment under section 631(b) to apply to outright sales by 

landowners. 

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Sec. 316. Modification to cooperative marketing rules to include value added processing involving animals. 

Sec. 317. Extension of declaratory judgment procedures to farmers’ cooperative organizations. 

Sec. 318. Certain expenses of rural letter carriers. 

Sec. 319. Treatment of certain income of cooperatives. 

Sec. 320. Exclusion for payments to individuals under National Health Service 

Corps loan repayment program and certain State loan repayment programs. 

Sec. 321. Modification of safe harbor rules for timber REITs. 

Sec. 322. Expensing of certain reforestation expenditures. 

Subtitle C—Incentives for Small Manufacturers 

Sec. 331. Net income from publicly traded partnerships treated as qualifying income 

of regulated investment companies. 

Sec. 332. Simplification of excise tax imposed on bows and arrows. 

Sec. 333. Reduction of excise tax on fishing tackle boxes. 

Sec. 334. Sonar devices suitable for finding fish. 

Sec. 335. Charitable contribution deduction for certain expenses incurred in support 

of Native Alaskan subsistence whaling. 

Sec. 336. Modification of depreciation allowance for aircraft. 

Sec. 337. Modification of placed in service rule for bonus depreciation property. 

Sec. 338. Expensing of capital costs incurred in complying with Environmental Protection Agency sulfur regulations. 

Sec. 339. Credit for production of low sulfur diesel fuel. 

Sec. 340. Expansion of qualified small-issue bond program. 

Sec. 341. Oil and gas from marginal wells. 

TITLE IV—TAX REFORM AND SIMPLIFICATION FOR UNITED STATES 

BUSINESSES 

Sec. 401. Interest expense allocation rules. 

Sec. 402. Recharacterization of overall domestic loss. 

Sec. 403. Look-thru rules to apply to dividends from noncontrolled section 902 corporations. 

Sec. 404. Reduction to 2 foreign tax credit baskets. 

Sec. 405. Attribution of stock ownership through partnerships to apply in determining section 902 and 960 credits. 

Sec. 406. Clarification of treatment of certain transfers of intangible property. 

Sec. 407. United States property not to include certain assets of controlled foreign 

corporation. 

Sec. 408. Translation of foreign taxes. 

Sec. 409. Repeal of withholding tax on dividends from certain foreign corporations. 

Sec. 410. Equal treatment of interest paid by foreign partnerships and foreign corporations. 

Sec. 411. Treatment of certain dividends of regulated investment companies. 

Sec. 412. Look-thru treatment for sales of partnership interests. 

Sec. 413. Repeal of foreign personal holding company rules and foreign investment 

company rules. 

Sec. 414. Determination of foreign personal holding company income with respect to 

transactions in commodities. 

Sec. 415. Modifications to treatment of aircraft leasing and shipping income. 

Sec. 416. Modification of exceptions under subpart F for active financing. 

Sec. 417. 10-year foreign tax credit carryover; 1-year foreign tax credit carryback. 

Sec. 418. Modification of the treatment of certain REIT distributions attributable to 

gain from sales or exchanges of United States real property interests.

Sec. 419. Exclusion of income derived from certain wagers on horse races and dog 

races from gross income of nonresident alien individuals. 

Sec. 420. Limitation of withholding tax for Puerto Rico corporations. 

Sec. 421. Foreign tax credit under alternative minimum tax. 

Sec. 422. Incentives to reinvest foreign earnings in United States. 

Sec. 423. Delay in effective date of final regulations governing exclusion of income 

from international operation of ships or aircraft. 

Sec. 424. Study of earnings stripping provisions. 

TITLE V—DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES 

Sec. 501. Deduction of State and local general sales taxes in lieu of State and local 

income taxes.

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TITLE VI—FAIR AND EQUITABLE TOBACCO REFORM 

Sec. 601. Short title. 

Subtitle A—Termination of Federal Tobacco Quota and Price Support Programs 

Sec. 611. Termination of tobacco quota program and related provisions. 

Sec. 612. Termination of tobacco price support program and related provisions. 

Sec. 613. Conforming amendments. 

Sec. 614. Continuation of liability for 2004 and earlier crop years. 

Subtitle B—Transitional Payments to Tobacco Quota Holders and Producers of 

Tobacco 

Sec. 621. Definitions. 

Sec. 622. Contract payments to tobacco quota holders. 

Sec. 623. Contract payments for producers of quota tobacco. 

Sec. 624. Administration. 

Sec. 625. Use of assessments as source of funds for payments. 

Sec. 626. Tobacco Trust Fund. 

Sec. 627. Limitation on total expenditures. 

Subtitle C—Implementation and Transition 

Sec. 641. Treatment of tobacco loan pool stocks and outstanding loan costs. 

Sec. 642. Regulations. 

Sec. 643. Effective date. 

TITLE VII—MISCELLANEOUS PROVISIONS 

Sec. 701. Brownfields demonstration program for qualified green building and sustainable design projects. 

Sec. 702. Exclusion of gain or loss on sale or exchange of certain brownfield sites 

from unrelated business taxable income. 

Sec. 703. Civil rights tax relief. 

Sec. 704. Modification of class life for certain track facilities. 

Sec. 705. Suspension of policyholders surplus account provisions. 

Sec. 706. Certain Alaska natural gas pipeline property treated as 7-year property. 

Sec. 707. Extension of enhanced oil recovery credit to certain Alaska facilities. 

Sec. 708. Method of accounting for naval shipbuilders. 

Sec. 709. Modification of minimum cost requirement for transfer of excess pension 

assets. 

Sec. 710. Expansion of credit for electricity produced from certain renewable resources. 

Sec. 711. Certain business credits allowed against regular and minimum tax. 

Sec. 712. Inclusion of primary and secondary medical strategies for children and 

adults with sickle cell disease as medical assistance under the Medicaid 

program. 

Sec. 713. Ceiling fans. 

Sec. 714. Certain steam generators, and certain reactor vessel heads and pressurizers, used in nuclear facilities. 

TITLE VIII—REVENUE PROVISIONS 

Subtitle A—Provisions to Reduce Tax Avoidance Through Individual and Corporate 

Expatriation 

Sec. 801. Tax treatment of expatriated entities and their foreign parents. 

Sec. 802. Excise tax on stock compensation of insiders in expatriated corporations. 

Sec. 803. Reinsurance of United States risks in foreign jurisdictions. 

Sec. 804. Revision of tax rules on expatriation of individuals. 

Sec. 805. Reporting of taxable mergers and acquisitions. 

Sec. 806. Studies. 

Subtitle B—Provisions Relating to Tax Shelters 

PART I—TAXPAYER-RELATED PROVISIONS

Sec. 811. Penalty for failing to disclose reportable transactions. 

Sec. 812. Accuracy-related penalty for listed transactions, other reportable transactions having a significant tax avoidance purpose, etc. 

Sec. 813. Tax shelter exception to confidentiality privileges relating to taxpayer communications. 

Sec. 814. Statute of limitations for taxable years for which required listed transactions not reported. 

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Sec. 815. Disclosure of reportable transactions. 

Sec. 816. Failure to furnish information regarding reportable transactions. 

Sec. 817. Modification of penalty for failure to maintain lists of investors. 

Sec. 818. Penalty on promoters of tax shelters. 

Sec. 819. Modifications of substantial understatement penalty for nonreportable 

transactions. 

Sec. 820. Modification of actions to enjoin certain conduct related to tax shelters and 

reportable transactions. 

Sec. 821. Penalty on failure to report interests in foreign financial accounts. 

Sec. 822. Regulation of individuals practicing before the Department of Treasury. 

PART II—OTHER PROVISIONS

Sec. 831. Treatment of stripped interests in bond and preferred stock funds, etc. 

Sec. 832. Minimum holding period for foreign tax credit on withholding taxes on income other than dividends. 

Sec. 833. Disallowance of certain partnership loss transfers. 

Sec. 834. No reduction of basis under section 734 in stock held by partnership in 

corporate partner. 

Sec. 835. Repeal of special rules for FASITS. 

Sec. 836. Limitation on transfer or importation of built-in losses. 

Sec. 837. Clarification of banking business for purposes of determining investment 

of earnings in United States property. 

Sec. 838. Denial of deduction for interest on underpayments attributable to nondisclosed reportable transactions. 

Sec. 839. Clarification of rules for payment of estimated tax for certain deemed asset 

sales. 

Sec. 840. Recognition of gain from the sale of a principal residence acquired in a 

like-kind exchange within 5 years of sale. 

Sec. 841. Prevention of mismatching of interest and original issue discount deductions and income inclusions in transactions with related foreign persons. 

Sec. 842. Deposits made to suspend running of interest on potential underpayments. 

Sec. 843. Partial payment of tax liability in installment agreements. 

Sec. 844. Affirmation of consolidated return regulation authority. 

Sec. 845. Expanded disallowance of deduction for interest on convertible debt. 

PART III—LEASING

Sec. 847. Reform of tax treatment of certain leasing arrangements. 

Sec. 848. Limitation on deductions allocable to property used by governments or 

other tax-exempt entities. 

Sec. 849. Effective date. 

Subtitle C—Reduction of Fuel Tax Evasion 

Sec. 851. Exemption from certain excise taxes for mobile machinery. 

Sec. 852. Modification of definition of off-highway vehicle. 

Sec. 853. Taxation of aviation-grade kerosene. 

Sec. 854. Dye injection equipment. 

Sec. 855. Elimination of administrative review for taxable use of dyed fuel.

Sec. 856. Penalty on untaxed chemically altered dyed fuel mixtures. 

Sec. 857. Termination of dyed diesel use by intercity buses. 

Sec. 858. Authority to inspect on-site records. 

Sec. 859. Assessable penalty for refusal of entry. 

Sec. 860. Registration of pipeline or vessel operators required for exemption of bulk 

transfers to registered terminals or refineries. 

Sec. 861. Display of registration. 

Sec. 862. Registration of persons within foreign trade zones, etc. 

Sec. 863. Penalties for failure to register and failure to report. 

Sec. 864. Electronic filing of required information reports. 

Sec. 865. Taxable fuel refunds for certain ultimate vendors. 

Sec. 866. Two-party exchanges. 

Sec. 867. Modifications of tax on use of certain vehicles. 

Sec. 868. Dedication of revenues from certain penalties to the Highway Trust Fund. 

Sec. 869. Simplification of tax on tires. 

Sec. 870. Transmix and diesel fuel blend stocks treated as taxable fuel. 

Sec. 871. Study regarding fuel tax compliance. 

Subtitle D—Other Revenue Provisions 

Sec. 881. Qualified tax collection contracts. 

Sec. 882. Treatment of charitable contributions of patents and similar property. 

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Sec. 883. Increased reporting for noncash charitable contributions. 

Sec. 884. Donations of motor vehicles, boats, and airplanes. 

Sec. 885. Treatment of nonqualified deferred compensation plans. 

Sec. 886. Extension of amortization of intangibles to sports franchises. 

Sec. 887. Modification of continuing levy on payments to Federal venders. 

Sec. 888. Modification of straddle rules. 

Sec. 889. Addition of vaccines against hepatitis A to list of taxable vaccines. 

Sec. 890. Addition of vaccines against influenza to list of taxable vaccines. 

Sec. 891. Extension of IRS user fees. 

Sec. 892. COBRA fees. 

Sec. 893. Prohibition on nonrecognition of gain through complete liquidation of 

holding company. 

Sec. 894. Effectively connected income to include certain foreign source income. 

Sec. 895. Recapture of overall foreign losses on sale of controlled foreign corporation. 

Sec. 896. Recognition of cancellation of indebtedness income realized on satisfaction 

of debt with partnership interest. 

Sec. 897. Denial of installment sale treatment for all readily tradable debt. 

Sec. 898. Modification of treatment of transfers to creditors in divisive reorganizations. 

Sec. 899. Clarification of definition of nonqualified preferred stock. 

Sec. 900. Modification of definition of controlled group of corporations. 

Sec. 901. Class lives for utility grading costs. 

Sec. 902. Consistent amortization of periods for intangibles. 

Sec. 903. Freeze of provisions regarding suspension of interest where Secretary fails 

to contact taxpayer. 

Sec. 904. Increase in withholding from supplemental wage payments in excess of 

$1,000,000. 

Sec. 905. Treatment of sale of stock acquired pursuant to exercise of stock options 

to comply with conflict-of-interest requirements. 

Sec. 906. Application of basis rules to nonresident aliens. 

Sec. 907. Limitation of employer deduction for certain entertainment expenses. 

Sec. 908. Residence and source rules relating to United States possessions. 

Sec. 909. Sales or dispositions to implement Federal Energy Regulatory Commission 

or State electric restructuring policy. 

Sec. 910. Expansion of limitation on depreciation of certain passenger automobiles.

TITLE I—PROVISIONS RELATING TO REPEAL OF EXCLUSION FOR 

EXTRATERRITORIAL INCOME 

SEC. 101. REPEAL OF EXCLUSION FOR EXTRATERRITORIAL INCOME. 

(a) IN GENERAL.—Section 114 is hereby repealed. 

(b) CONFORMING AMENDMENTS.— (1) Subpart E of part III of subchapter N of chapter 1 (relating to qualifying foreign trade income) is hereby repealed. 

(2) The table of subparts for such part III is amended by 

striking the item relating to subpart E. 

(3) The table of sections for part III of subchapter B of 

chapter 1 is amended by striking the item relating to section 

114. 

(4) The second sentence of section 56(g)(4)(B)(i) is amended 

by striking ‘‘114 or’’. 

(5) Section 275(a) is amended—

(A) by inserting ‘‘or’’ at the end of paragraph (4)(A), by 

striking ‘‘or’’ at the end of paragraph (4)(B) and inserting 

a period, and by striking subparagraph (C), and 

(B) by striking the last sentence. 

(6) Paragraph (3) of section 864(e) is amended—

(A) by striking: 

‘‘(3) TAX-EXEMPT ASSETS NOT TAKEN INTO ACCOUNT.—

‘‘(A) IN GENERAL.—For purposes of’’; and inserting: 

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‘‘(3) TAX-EXEMPT ASSETS NOT TAKEN INTO ACCOUNT.—For 

purposes of’’, and 

(B) by striking subparagraph (B). 

(7) Section 903 is amended by striking ‘‘114, 164(a),’’ and 

inserting ‘‘164(a)’’. 

(8) Section 999(c)(1) is amended by striking ‘‘941(a)(5),’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transactions after December 31, 2004. 

(d) TRANSITIONAL RULE FOR 2005 AND 2006.—

(1) IN GENERAL.—In the case of transactions during 2005 

or 2006, the amount includible in gross income by reason of the 

amendments made by this section shall not exceed the applicable percentage of the amount which would have been so included but for this subsection. 

(2) APPLICABLE PERCENTAGE.—For purposes of paragraph 

(1), the applicable percentage shall be as follows: 

(A) For 2005, the applicable percentage shall be 20 percent. 

(B) For 2006, the applicable percentage shall be 40 percent. 

(e) REVOCATION OF ELECTION TO BE TREATED AS DOMESTIC

CORPORATION.—If, during the 1-year period beginning on the date 

of the enactment of this Act, a corporation for which an election is 

in effect under section 943(e) of the Internal Revenue Code of 1986 

revokes such election, no gain or loss shall be recognized with respect to property treated as transferred under clause (ii) of section 

943(e)(4)(B) of such Code to the extent such property—

(1) was treated as transferred under clause (i) thereof, or 

(2) was acquired during a taxable year to which such election applies and before May 1, 2003, in the ordinary course of 

its trade or business. 

The Secretary of the Treasury (or such Secretary’s delegate) may 

prescribe such regulations as may be necessary to prevent the abuse 

of the purposes of this subsection. 

(f) BINDING CONTRACTS.—The amendments made by this section shall not apply to any transaction in the ordinary course of a 

trade or business which occurs pursuant to a binding contract—

(1) which is between the taxpayer and a person who is not 

a related person (as defined in section 943(b)(3) of such Code, 

as in effect on the day before the date of the enactment of this 

Act), and 

(2) which is in effect on September 17, 2003, and at all 

times thereafter. 

For purposes of this subsection, a binding contract shall include a 

purchase option, renewal option, or replacement option which is included in such contract and which is enforceable against the seller 

or lessor. 

SEC. 102. DEDUCTION RELATING TO INCOME ATTRIBUTABLE TO DOMESTIC PRODUCTION ACTIVITIES. 

(a) IN GENERAL.—Part VI of subchapter B of chapter 1 (relating 

to itemized deductions for individuals and corporations) is amended 

by adding at the end the following new section: 

‘‘SEC. 199. INCOME ATTRIBUTABLE TO DOMESTIC PRODUCTION ACTIVITIES. 

‘‘(a) ALLOWANCE OF DEDUCTION.—

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‘‘(1) IN GENERAL.—There shall be allowed as a deduction 

an amount equal to 9 percent of the lesser of—

‘‘(A) the qualified production activities income of the 

taxpayer for the taxable year, or 

‘‘(B) taxable income (determined without regard to this 

section) for the taxable year. 

‘‘(2) PHASEIN.—In the case of any taxable year beginning 

after 2004 and before 2010, paragraph (1) and subsections 

(d)(1) and (d)(6) shall be applied by substituting for the percentage contained therein the transition percentage determined 

under the following table:

‘‘For taxable years The transition 

beginning in: percentage is: 

2005 or 2006 ..................................................................................... 3

2007, 2008, or 2009 .......................................................................... 6.

‘‘(b) DEDUCTION LIMITED TO WAGES PAID.—

‘‘(1) IN GENERAL.—The amount of the deduction allowable 

under subsection (a) for any taxable year shall not exceed 50 

percent of the W–2 wages of the employer for the taxable year. 

‘‘(2) W–2 WAGES.—For purposes of paragraph (1), the term 

‘W–2 wages’ means the sum of the aggregate amounts the taxpayer is required to include on statements under paragraphs (3) 

and (8) of section 6051(a) with respect to employment of employees of the taxpayer during the calendar year ending during the 

taxpayer’s taxable year. 

‘‘(3) ACQUISITIONS AND DISPOSITIONS.—The Secretary shall 

provide for the application of this subsection in cases where the 

taxpayer acquires, or disposes of, the major portion of a trade 

or business or the major portion of a separate unit of a trade 

or business during the taxable year. 

‘‘(c) QUALIFIED PRODUCTION ACTIVITIES INCOME.—For purposes 

of this section—

‘‘(1) IN GENERAL.—The term ‘qualified production activities 

income’ for any taxable year means an amount equal to the excess (if any) of—

‘‘(A) the taxpayer’s domestic production gross receipts 

for such taxable year, over 

‘‘(B) the sum of— 

‘‘(i) the cost of goods sold that are allocable to such 

receipts, 

‘‘(ii) other deductions, expenses, or losses directly 

allocable to such receipts, and 

‘‘(iii) a ratable portion of other deductions, expenses, and losses that are not directly allocable to 

such receipts or another class of income. 

‘‘(2) ALLOCATION METHOD.—The Secretary shall prescribe 

rules for the proper allocation of items of income, deduction, expense, and loss for purposes of determining income attributable 

to domestic production activities. 

‘‘(3) SPECIAL RULES FOR DETERMINING COSTS.— ‘‘(A) IN GENERAL.—For purposes of determining costs 

under clause (i) of paragraph (1)(B), any item or service 

brought into the United States shall be treated as acquired 

by purchase, and its cost shall be treated as not less than 

its value immediately after it entered the United States. A 

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similar rule shall apply in determining the adjusted basis 

of leased or rented property where the lease or rental gives 

rise to domestic production gross receipts. 

‘‘(B) EXPORTS FOR FURTHER MANUFACTURE.—In the 

case of any property described in subparagraph (A) that 

had been exported by the taxpayer for further manufacture, 

the increase in cost or adjusted basis under subparagraph 

(A) shall not exceed the difference between the value of the 

property when exported and the value of the property when 

brought back into the United States after the further manufacture. 

‘‘(4) DOMESTIC PRODUCTION GROSS RECEIPTS.—

‘‘(A) IN GENERAL.—The term ‘domestic production gross 

receipts’ means the gross receipts of the taxpayer which are 

derived from—

‘‘(i) any lease, rental, license, sale, exchange, or 

other disposition of—

‘‘(I) qualifying production property which was 

manufactured, produced, grown, or extracted by 

the taxpayer in whole or in significant part within 

the United States, 

‘‘(II) any qualified film produced by the taxpayer, or 

‘‘(III) electricity, natural gas, or potable water 

produced by the taxpayer in the United States, 

‘‘(ii) construction performed in the United States, 

or 

‘‘(iii) engineering or architectural services performed in the United States for construction projects in 

the United States. 

‘‘(B) EXCEPTIONS.—Such term shall not include gross 

receipts of the taxpayer which are derived from—

‘‘(i) the sale of food and beverages prepared by the 

taxpayer at a retail establishment, and 

‘‘(ii) the transmission or distribution of electricity, 

natural gas, or potable water. 

‘‘(5) QUALIFYING PRODUCTION PROPERTY.—The term ‘qualifying production property’ means—

‘‘(A) tangible personal property, 

‘‘(B) any computer software, and 

‘‘(C) any property described in section 168(f)(4). 

‘‘(6) QUALIFIED FILM.—The term ‘qualified film’ means any 

property described in section 168(f)(3) if not less than 50 percent 

of the total compensation relating to the production of such 

property is compensation for services performed in the United 

States by actors, production personnel, directors, and producers. 

Such term does not include property with respect to which 

records are required to be maintained under section 2257 of 

title 18, United States Code. 

‘‘(7) RELATED PERSONS.—

‘‘(A) IN GENERAL.—The term ‘domestic production gross 

receipts’ shall not include any gross receipts of the taxpayer 

derived from property leased, licensed, or rented by the taxpayer for use by any related person. 

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‘‘(B) RELATED PERSON.—For purposes of subparagraph 

(A), a person shall be treated as related to another person 

if such persons are treated as a single employer under subsection (a) or (b) of section 52 or subsection (m) or (o) of section 414, except that determinations under subsections (a) 

and (b) of section 52 shall be made without regard to section 1563(b). 

‘‘(d) DEFINITIONS AND SPECIAL RULES.—

‘‘(1) APPLICATION OF SECTION TO PASS-THRU ENTITIES.—

‘‘(A) IN GENERAL.—In the case of an S corporation, 

partnership, estate or trust, or other pass-thru entity—

‘‘(i) subject to the provisions of paragraphs (2) and 

(3), this section shall be applied at the shareholder, 

partner, or similar level, and 

‘‘(ii) the Secretary shall prescribe rules for the application of this section, including rules relating to—

‘‘(I) restrictions on the allocation of the deduction to taxpayers at the partner or similar level, 

and 

‘‘(II) additional reporting requirements. 

‘‘(B) APPLICATION OF WAGE LIMITATION.—Notwithstanding subparagraph (A)(i), for purposes of applying subsection (b), a shareholder, partner, or similar person which 

is allocated qualified production activities income from an 

S corporation, partnership, estate, trust, or other pass-thru 

entity shall also be treated as having been allocated W–2 

wages from such entity in an amount equal to the lesser 

of—

‘‘(i) such person’s allocable share of such wages 

(without regard to this subparagraph), as determined 

under regulations prescribed by the Secretary, or 

‘‘(ii) 2 times 9 percent of the qualified production 

activities income allocated to such person for the taxable year. 

‘‘(2) APPLICATION TO INDIVIDUALS.—In the case of an individual, subsection (a)(1)(B) shall be applied by substituting ‘adjusted gross income’ for ‘taxable income’. For purposes of the 

preceding sentence, adjusted gross income shall be determined— 

‘‘(A) after application of sections 86, 135, 137, 219, 221, 

222, and 469, and 

‘‘(B) without regard to this section. 

‘‘(3) PATRONS OF AGRICULTURAL AND HORTICULTURAL COOPERATIVES.—

‘‘(A) IN GENERAL.—If any amount described in paragraph (1) or (3) of section 1385(a)—

‘‘(i) is received by a person from an organization to 

which part I of subchapter T applies which is engaged—

‘‘(I) in the manufacturing, production, growth, 

or extraction in whole or significant part of any 

agricultural or horticultural product, or 

‘‘(II) in the marketing of agricultural or horticultural products, and 

11

‘‘(ii) is allocable to the portion of the qualified production activities income of the organization which, but 

for this paragraph, would be deductible under subsection (a) by the organization and is designated as 

such by the organization in a written notice mailed to 

its patrons during the payment period described in section 1382(d), 

then such person shall be allowed a deduction under subsection (a) with respect to such amount. The taxable income 

of the organization shall not be reduced under section 1382 

by reason of any amount to which the preceding sentence 

applies. 

‘‘(B) SPECIAL RULES.—For purposes of applying subparagraph (A), in determining the qualified production activities income which would be deductible by the organization under subsection (a)—

‘‘(i) there shall not be taken into account in computing the organization’s taxable income any deduction 

allowable under subsection (b) or (c) of section 1382 

(relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions), and 

‘‘(ii) in the case of an organization described in 

subparagraph (A)(i)(II), the organization shall be treated as having manufactured, produced, grown, or extracted in whole or significant part any qualifying production property marketed by the organization which 

its patrons have so manufactured, produced, grown, or 

extracted. 

‘‘(4) SPECIAL RULE FOR AFFILIATED GROUPS.—

‘‘(A) IN GENERAL.—All members of an expanded affiliated group shall be treated as a single corporation for purposes of this section. 

‘‘(B) EXPANDED AFFILIATED GROUP.—For purposes of 

this section, the term ‘expanded affiliated group’ means an 

affiliated group as defined in section 1504(a), determined—

‘‘(i) by substituting ‘50 percent’ for ‘80 percent’ each 

place it appears, and 

‘‘(ii) without regard to paragraphs (2) and (4) of 

section 1504(b). 

‘‘(C) ALLOCATION OF DEDUCTION.—Except as provided 

in regulations, the deduction under subsection (a) shall be 

allocated among the members of the expanded affiliated 

group in proportion to each member’s respective amount (if 

any) of qualified production activities income. 

‘‘(5) TRADE OR BUSINESS REQUIREMENT.—This section shall 

be applied by only taking into account items which are attributable to the actual conduct of a trade or business. 

‘‘(6) COORDINATION WITH MINIMUM TAX.—The deduction 

under this section shall be allowed for purposes of the tax imposed by section 55; except that for purposes of section 55, the 

deduction under subsection (a) shall be 9 percent of the lesser 

of—

‘‘(A) qualified production activities income (determined 

without regard to part IV of subchapter A), or 

12

‘‘(B) alternative minimum taxable income (determined 

without regard to this section) for the taxable year. 

In the case of an individual, subparagraph (B) shall be applied 

by substituting ‘adjusted gross income’ for ‘alternative minimum taxable income’. For purposes of the preceding sentence, 

adjusted gross income shall be determined in the same manner 

as provided in paragraph (2). 

‘‘(7) REGULATIONS.—The Secretary shall prescribe such regulations as are necessary to carry out the purposes of this section.’’. 

(b) MINIMUM TAX.—Section 56(g)(4)(C) (relating to disallowance 

of items not deductible in computing earnings and profits) is 

amended by adding at the end the following new clause: 

‘‘(v) DEDUCTION FOR DOMESTIC PRODUCTION.—

Clause (i) shall not apply to any amount allowable as 

a deduction under section 199.’’. 

(c) SPECIAL RULE RELATING TO ELECTION TO TREAT CUTTING

OF TIMBER AS A SALE OR EXCHANGE.—Any election under section 

631(a) of the Internal Revenue Code of 1986 made for a taxable year 

ending on or before the date of the enactment of this Act may be revoked by the taxpayer for any taxable year ending after such date. 

For purposes of determining whether such taxpayer may make a 

further election under such section, such election (and any revocation under this section) shall not be taken into account. 

(d) TECHNICAL AMENDMENTS.—

(1) Sections 86(b)(2)(A), 135(c)(4)(A), 137(b)(3)(A), and 

219(g)(3)(A)(ii) are each amended by inserting ‘‘199,’’ before 

‘‘221’’. 

(2) Clause (i) of section 221(b)(2)(C) is amended by inserting ‘‘199,’’ before ‘‘222’’. 

(3) Clause (i) of section 222(b)(2)(C) is amended by inserting ‘‘199,’’ before ‘‘911’’. 

(4) Paragraph (1) of section 246(b) is amended by inserting 

‘‘199,’’ after ‘‘172,’’. 

(5) Clause (iii) of section 469(i)(3)(F) is amended by inserting ‘‘199,’’ before ‘‘219,’’. 

(6) Subsection (a) of section 613 is amended by inserting 

‘‘and without the deduction under section 199’’ after ‘‘without 

allowances for depletion’’. 

(7) Subsection (a) of section 1402 is amended by striking 

‘‘and’’ at the end of paragraph (14), by striking the period at the 

end of paragraph (15) and inserting ‘‘, and’’, and by inserting 

after paragraph (15) the following new paragraph: 

‘‘(16) the deduction provided by section 199 shall not be allowed.’’. 

(8) The table of sections for part VI of subchapter B of 

chapter 1 is amended by adding at the end the following new 

item:

‘‘Sec. 199. Income attributable to domestic production activities.’’.

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2004.

13

TITLE II—BUSINESS TAX INCENTIVES 

Subtitle A—Small Business Expensing 

SEC. 201. 2-YEAR EXTENSION OF INCREASED EXPENSING FOR SMALL 

BUSINESS. 

Subsections (b), (c), and (d) of section 179 are each amended by 

striking ‘‘2006’’ each place it appears and inserting ‘‘2008’’. 

Subtitle B—Depreciation 

SEC. 211. RECOVERY PERIOD FOR DEPRECIATION OF CERTAIN LEASEHOLD IMPROVEMENTS AND RESTAURANT PROPERTY. 

(a) 15-YEAR RECOVERY PERIOD.—Subparagraph (E) of section 

168(e)(3) (relating to classification of certain property) is amended 

by striking ‘‘and’’ at the end of clause (ii), by striking the period at 

the end of clause (iii) and inserting a comma, and by adding at the 

end the following new clauses: 

‘‘(iv) any qualified leasehold improvement property 

placed in service before January 1, 2006, and 

‘‘(v) any qualified restaurant property placed in 

service before January 1, 2006.’’. 

(b) QUALIFIED LEASEHOLD IMPROVEMENT PROPERTY.—Subsection (e) of section 168 is amended by adding at the end the following new paragraph: 

‘‘(6) QUALIFIED LEASEHOLD IMPROVEMENT PROPERTY.—The 

term ‘qualified leasehold improvement property’ has the meaning given such term in section 168(k)(3) except that the following special rules shall apply: 

‘‘(A) IMPROVEMENTS MADE BY LESSOR.—In the case of 

an improvement made by the person who was the lessor of 

such improvement when such improvement was placed in 

service, such improvement shall be qualified leasehold improvement property (if at all) only so long as such improvement is held by such person. 

‘‘(B) EXCEPTION FOR CHANGES IN FORM OF BUSINESS.— Property shall not cease to be qualified leasehold improvement property under subparagraph (A) by reason of—

‘‘(i) death, 

‘‘(ii) a transaction to which section 381(a) applies, 

‘‘(iii) a mere change in the form of conducting the 

trade or business so long as the property is retained in 

such trade or business as qualified leasehold improvement property and the taxpayer retains a substantial 

interest in such trade or business, 

‘‘(iv) the acquisition of such property in an exchange described in section 1031, 1033, or 1038 to the 

extent that the basis of such property includes an 

amount representing the adjusted basis of other property owned by the taxpayer or a related person, or 

‘‘(v) the acquisition of such property by the taxpayer in a transaction described in section 332, 351, 

361, 721, or 731 (or the acquisition of such property by 

the taxpayer from the transferee or acquiring corporaVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00017 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
14

tion in a transaction described in such section), to the 

extent that the basis of the property in the hands of the 

taxpayer is determined by reference to its basis in the 

hands of the transferor or distributor.’’. 

(c) QUALIFIED RESTAURANT PROPERTY.—Subsection (e) of section 168 (as amended by subsection (b)) is further amended by adding at the end the following new paragraph: 

‘‘(7) QUALIFIED RESTAURANT PROPERTY.—The term ‘qualified restaurant property’ means any section 1250 property 

which is an improvement to a building if—

‘‘(A) such improvement is placed in service more than 

3 years after the date such building was first placed in 

service, and 

‘‘(B) more than 50 percent of the building’s square footage is devoted to preparation of, and seating for on-premises consumption of, prepared meals.’’. 

(d) REQUIREMENT TO USE STRAIGHT LINE METHOD.—

(1) Paragraph (3) of section 168(b) is amended by adding 

at the end the following new subparagraphs: 

‘‘(G) Qualified leasehold improvement property described in subsection (e)(6). 

‘‘(H) Qualified restaurant property described in subsection (e)(7).’’. 

(2) Subparagraph (A) of section 168(b)(2) is amended by inserting before the comma ‘‘not referred to in paragraph (3)’’. 

(e) ALTERNATIVE SYSTEM.—The table contained in section 

168(g)(3)(B) is amended by adding at the end the following new 

items:

‘‘(E)(iv) .......................................................................................... 39

‘‘(E)(v) ........................................................................................... 39’’.

(f) EFFECTIVE DATE.—The amendments made by this section 

shall apply to property placed in service after the date of the enactment of this Act.

Subtitle C—Community Revitalization 

SEC. 221. MODIFICATION OF TARGETED AREAS AND LOW-INCOME COMMUNITIES FOR NEW MARKETS TAX CREDIT. 

(a) TARGETED AREAS.—Paragraph (2) of section 45D(e) (relating 

to targeted areas) is amended to read as follows: 

‘‘(2) TARGETED POPULATIONS.—The Secretary shall prescribe regulations under which 1 or more targeted populations 

(within the meaning of section 103(20) of the Riegle Community 

Development and Regulatory Improvement Act of 1994 (12 

U.S.C. 4702(20))) may be treated as low-income communities. 

Such regulations shall include procedures for determining 

which entities are qualified active low-income community businesses with respect to such populations.’’. 

(b) TRACTS WITH LOW POPULATION.—Subsection (e) of section 

45D (defining low-income community) is amended by adding at the 

end the following: 

‘‘(4) TRACTS WITH LOW POPULATION.—A population census 

tract with a population of less than 2,000 shall be treated as 

15

a low-income community for purposes of this section if such 

tract—

‘‘(A) is within an empowerment zone the designation of 

which is in effect under section 1391, and 

‘‘(B) is contiguous to 1 or more low-income communities 

(determined without regard to this paragraph).’’. 

(c) EFFECTIVE DATES.— (1) TARGETED AREAS.—The amendment made by subsection 

(a) shall apply to designations made by the Secretary of the 

Treasury after the date of the enactment of this Act. 

(2) TRACTS WITH LOW POPULATION.—The amendment made 

by subsection (b) shall apply to investments made after the date 

of the enactment of this Act.

SEC. 222. EXPANSION OF DESIGNATED RENEWAL COMMUNITY AREA 

BASED ON 2000 CENSUS DATA. 

(a) IN GENERAL.—Section 1400E (relating to designation of renewal communities) is amended by adding at the end the following 

new subsection: 

‘‘(g) EXPANSION OF DESIGNATED AREA BASED ON 2000 CEN- SUS.— ‘‘(1) IN GENERAL.—At the request of all governments which 

nominated an area as a renewal community, the Secretary of 

Housing and Urban Development may expand the area of such 

community to include any census tract if—

‘‘(A)(i) at the time such community was nominated, 

such community would have met the requirements of this 

section using 1990 census data even if such tract had been 

included in such community, and 

‘‘(ii) such tract has a poverty rate using 2000 census 

data which exceeds the poverty rate for such tract using 

1990 census data, or 

‘‘(B)(i) such community would be described in subparagraph (A)(i) but for the failure to meet one or more of the 

requirements of paragraphs (2)(C)(i), (3)(C), and (3)(D) of 

subsection (c) using 1990 census data, 

‘‘(ii) such community, including such tract, has a population of not more than 200,000 using either 1990 census 

data or 2000 census data, 

‘‘(iii) such tract meets the requirement of subsection 

(c)(3)(C) using 2000 census data, and 

‘‘(iv) such tract meets the requirement of subparagraph 

(A)(ii). 

‘‘(2) EXCEPTION FOR CERTAIN CENSUS TRACTS WITH LOW

POPULATION IN 1990.—In the case of any census tract which did 

not have a poverty rate determined by the Bureau of the Census 

using 1990 census data, paragraph (1)(B) shall be applied without regard to clause (iv) thereof. 

‘‘(3) SPECIAL RULE FOR CERTAIN CENSUS TRACTS WITH LOW

POPULATION IN 2000.—At the request of all governments which 

nominated an area as a renewal community, the Secretary of 

Housing and Urban Development may expand the area of such 

community to include any census tract if—

‘‘(A) either—

‘‘(i) such tract has no population using 2000 census 

data, or 

16

‘‘(ii) no poverty rate for such tract is determined by 

the Bureau of the Census using 2000 census data, 

‘‘(B) such tract is one of general distress, and 

‘‘(C) such community, including such tract, meets the 

requirements of subparagraphs (A) and (B) of subsection 

(c)(2). 

‘‘(4) PERIOD IN EFFECT.—Any expansion under this subsection shall take effect as provided in subsection (b).’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) 

shall take effect as if included in the amendments made by section 

101 of the Community Renewal Tax Relief Act of 2000. 

SEC. 223. MODIFICATION OF INCOME REQUIREMENT FOR CENSUS 

TRACTS WITHIN HIGH MIGRATION RURAL COUNTIES. 

(a) IN GENERAL.—Section 45D(e) (relating to low-income community), as amended by this Act, is amended by inserting after 

paragraph (4) the following new paragraph: 

‘‘(5) MODIFICATION OF INCOME REQUIREMENT FOR CENSUS

TRACTS WITHIN HIGH MIGRATION RURAL COUNTIES.—

‘‘(A) IN GENERAL.—In the case of a population census 

tract located within a high migration rural county, paragraph (1)(B)(i) shall be applied by substituting ‘85 percent’ 

for ‘80 percent’. 

‘‘(B) HIGH MIGRATION RURAL COUNTY.—For purposes of 

this paragraph, the term ‘high migration rural county’ 

means any county which, during the 20-year period ending 

with the year in which the most recent census was conducted, has a net out-migration of inhabitants from the 

county of at least 10 percent of the population of the county 

at the beginning of such period.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall take effect as if included in the amendment made by section 

121(a) of the Community Renewal Tax Relief Act of 2000. 

Subtitle D—S Corporation Reform and 

Simplification 

SEC. 231. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER. 

(a) IN GENERAL.—Paragraph (1) of section 1361(c) (relating to 

special rules for applying subsection (b)) is amended to read as follows: 

‘‘(1) MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.—

‘‘(A) IN GENERAL.—For purpose of subsection (b)(1)(A)—

‘‘(i) except as provided in clause (ii), a husband 

and wife (and their estates) shall be treated as 1 shareholder, and 

‘‘(ii) in the case of a family with respect to which 

an election is in effect under subparagraph (D), all 

members of the family shall be treated as 1 shareholder. 

‘‘(B) MEMBERS OF THE FAMILY.—For purpose of subparagraph (A)(ii)—

‘‘(i) IN GENERAL.—The term ‘members of the family’ 

means the common ancestor, lineal descendants of the 

17

common ancestor, and the spouses (or former spouses) 

of such lineal descendants or common ancestor. 

‘‘(ii) COMMON ANCESTOR—For purposes of this 

paragraph, an individual shall not be considered a 

common ancestor if, as of the later of the effective date 

of this paragraph or the time the election under section 

1362(a) is made, the individual is more than 6 generations removed from the youngest generation of shareholders who would (but for this clause) be members of 

the family. For purposes of the preceding sentence, a 

spouse (or former spouse) shall be treated as being of 

the same generation as the individual to which such 

spouse is (or was) married. 

‘‘(C) EFFECT OF ADOPTION, ETC.—In determining 

whether any relationship specified in subparagraph (B) exists, the rules of section 152(b)(2) shall apply. 

‘‘(D) ELECTION.—An election under subparagraph 

(A)(ii)—

‘‘(i) may, except as otherwise provided in regulations prescribed by the Secretary, be made by any 

member of the family, and 

‘‘(ii) shall remain in effect until terminated as provided in regulations prescribed by the Secretary.’’. 

(b) RELIEF FROM INADVERTENT INVALID ELECTION OR TERMINATION.—Section 1362(f) (relating to inadvertent invalid elections or 

terminations), as amended by this Act, is amended—

(1) by inserting ‘‘or section 1361(c)(1)(A)(ii)’’ after ‘‘section 

1361(b)(3)(B)(ii),’’ in paragraph (1), and 

(2) by inserting ‘‘or section 1361(c)(1)(D)(iii)’’ after ‘‘section 

1361(b)(3)(C),’’ in paragraph (1)(B). 

(c) EFFECTIVE DATES.—

(1) SUBSECTION (a).—The amendment made by subsection 

(a) shall apply to taxable years beginning after December 31, 

2004. 

(2) SUBSECTION (b).—The amendments made by subsection 

(b) shall apply to elections and terminations made after December 31, 2004. 

SEC. 232. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS TO 100. 

(a) IN GENERAL.—Section 1361(b)(1)(A) (defining small business corporation) is amended by striking ‘‘75’’ and inserting ‘‘100’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 233. EXPANSION OF BANK S CORPORATION ELIGIBLE SHAREHOLDERS TO INCLUDE IRAS. 

(a) IN GENERAL.—Section 1361(c)(2)(A) (relating to certain 

trusts permitted as shareholders) is amended by inserting after 

clause (v) the following new clause:

‘‘(vi) In the case of a corporation which is a bank 

(as defined in section 581), a trust which constitutes an 

individual retirement account under section 408(a), including one designated as a Roth IRA under section 

408A, but only to the extent of the stock held by such 

trust in such bank as of the date of the enactment of 

this clause.’’. 

18

(b) TREATMENT AS SHAREHOLDER.—Section 1361(c)(2)(B) (relating to treatment as shareholders) is amended by adding at the end 

the following new clause: 

‘‘(vi) In the case of a trust described in clause (vi) 

of subparagraph (A), the individual for whose benefit 

the trust was created shall be treated as a shareholder.’’. 

(c) SALE OF BANK STOCK IN IRA RELATING TO S CORPORATION

ELECTION EXEMPT FROM PROHIBITED TRANSACTION RULES.—Section 4975(d) (relating to exemptions) is amended by striking ‘‘or’’ at 

the end of paragraph (14), by striking the period at the end of paragraph (15) and inserting ‘‘; or’’, and by adding at the end the following new paragraph: 

‘‘(16) a sale of stock held by a trust which constitutes an individual retirement account under section 408(a) to the individual for whose benefit such account is established if—

‘‘(A) such stock is in a bank (as defined in section 581), 

‘‘(B) such stock is held by such trust as of the date of 

the enactment of this paragraph, 

‘‘(C) such sale is pursuant to an election under section 

1362(a) by such bank, 

‘‘(D) such sale is for fair market value at the time of 

sale (as established by an independent appraiser) and the 

terms of the sale are otherwise at least as favorable to such 

trust as the terms that would apply on a sale to an unrelated party, 

‘‘(E) such trust does not pay any commissions, costs, or 

other expenses in connection with the sale, and 

‘‘(F) the stock is sold in a single transaction for cash 

not later than 120 days after the S corporation election is 

made.’’. 

(d) CONFORMING AMENDMENT.—Section 512(e)(1) is amended 

by inserting ‘‘1361(c)(2)(A)(vi) or’’ before ‘‘1361(c)(6)’’. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on the date of the enactment of this Act. 

SEC. 234. DISREGARD OF UNEXERCISED POWERS OF APPOINTMENT IN 

DETERMINING POTENTIAL CURRENT BENEFICIARIES OF 

ESBT. 

(a) IN GENERAL.—Section 1361(e)(2) (defining potential current 

beneficiary) is amended—

(1) by inserting ‘‘(determined without regard to any power 

of appointment to the extent such power remains unexercised at 

the end of such period)’’ after ‘‘of the trust’’ in the first sentence, 

and 

(2) by striking ‘‘60-day’’ in the second sentence and inserting ‘‘1-year’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 235. TRANSFER OF SUSPENDED LOSSES INCIDENT TO DIVORCE, 

ETC. 

(a) IN GENERAL.—Section 1366(d)(2) (relating to indefinite carryover of disallowed losses and deductions) is amended to read as 

follows: 

‘‘(2) INDEFINITE CARRYOVER OF DISALLOWED LOSSES AND

DEDUCTIONS.—

19

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), any loss or deduction which is disallowed for any taxable year by reason of paragraph (1) shall be treated as incurred by the corporation in the succeeding taxable year 

with respect to that shareholder. 

‘‘(B) TRANSFERS OF STOCK BETWEEN SPOUSES OR INCIDENT TO DIVORCE.—In the case of any transfer described in 

section 1041(a) of stock of an S corporation, any loss or deduction described in subparagraph (A) with respect such 

stock shall be treated as incurred by the corporation in the 

succeeding taxable year with respect to the transferee.’’

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 236. USE OF PASSIVE ACTIVITY LOSS AND AT-RISK AMOUNTS BY 

QUALIFIED SUBCHAPTER S TRUST INCOME BENEFICIARIES. 

(a) IN GENERAL.—Section 1361(d)(1) (relating to special rule for 

qualified subchapter S trust) is amended—

(1) by striking ‘‘and’’ at the end of subparagraph (A), 

(2) by striking the period at the end of subparagraph (B) 

and inserting ‘‘, and’’, and 

(3) by adding at the end the following new subparagraph: 

‘‘(C) for purposes of applying sections 465 and 469 to 

the beneficiary of the trust, the disposition of the S corporation stock by the trust shall be treated as a disposition by 

such beneficiary.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transfers made after December 31, 2004. 

SEC. 237. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM 

PASSIVE INCOME TEST FOR BANK S CORPORATIONS. 

(a) IN GENERAL.—Section 1362(d)(3) (relating to where passive 

investment income exceeds 25 percent of gross receipts for 3 consecutive taxable years and corporation has accumulated earnings and 

profits) is amended by adding at the end the following new subparagraph: 

‘‘(F) EXCEPTION FOR BANKS; ETC.—In the case of a bank 

(as defined in section 581), a bank holding company (within the meaning of section 2(a) of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(a))), or a financial holding company (within the meaning of section 2(p) of such 

Act), the term ‘passive investment income’ shall not include—

‘‘(i) interest income earned by such bank or company, or 

‘‘(ii) dividends on assets required to be held by 

such bank or company, including stock in the Federal 

Reserve Bank, the Federal Home Loan Bank, or the 

Federal Agricultural Mortgage Bank or participation 

certificates issued by a Federal Intermediate Credit 

Bank.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after December 31, 2004. 

20

SEC. 238. RELIEF FROM INADVERTENTLY INVALID QUALIFIED SUBCHAPTER S SUBSIDIARY ELECTIONS AND TERMINATIONS. 

(a) IN GENERAL.—Section 1362(f) (relating to inadvertent invalid elections or terminations) is amended—

(1) by inserting ‘‘, section 1361(b)(3)(B)(ii),’’ after ‘‘subsection (a)’’ in paragraph (1), 

(2) by inserting ‘‘, section 1361(b)(3)(C),’’ after ‘‘subsection 

(d)’’ in paragraph (1)(B), 

(3) by amending paragraph (3)(A) to read as follows: 

‘‘(A) so that the corporation for which the election was 

made or the termination occurred is a small business corporation or a qualified subchapter S subsidiary, as the case 

may be, or’’, 

(4) by amending paragraph (4) to read as follows: 

‘‘(4) the corporation for which the election was made or the 

termination occurred, and each person who was a shareholder 

in such corporation at any time during the period specified pursuant to this subsection, agrees to make such adjustments (consistent with the treatment of such corporation as an S corporation or a qualified subchapter S subsidiary, as the case may be) 

as may be required by the Secretary with respect to such period,’’, and 

(5) by inserting ‘‘or a qualified subchapter S subsidiary, as 

the case may be’’ after ‘‘S corporation’’ in the matter following 

paragraph (4). 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to elections made and terminations made after December 31, 2004.

SEC. 239. INFORMATION RETURNS FOR QUALIFIED SUBCHAPTER S 

SUBSIDIARIES. 

(a) IN GENERAL.—Section 1361(b)(3)(A) (relating to treatment of 

certain wholly owned subsidiaries) is amended by inserting ‘‘and in 

the case of information returns required under part III of subchapter A of chapter 61’’ after ‘‘Secretary’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 240. REPAYMENT OF LOANS FOR QUALIFYING EMPLOYER SECURITIES. 

(a) IN GENERAL.—Subsection (f) of section 4975 (relating to 

other definitions and special rules) is amended by adding at the end 

the following new paragraph: 

‘‘(7) S CORPORATION REPAYMENT OF LOANS FOR QUALIFYING

EMPLOYER SECURITIES.—A plan shall not be treated as violating 

the requirements of section 401 or 409 or subsection (e)(7), or 

as engaging in a prohibited transaction for purposes of subsection (d)(3), merely by reason of any distribution (as described 

in section 1368(a)) with respect to S corporation stock that constitutes qualifying employer securities, which in accordance 

with the plan provisions is used to make payments on a loan 

described in subsection (d)(3) the proceeds of which were used 

to acquire such qualifying employer securities (whether or not 

allocated to participants). The preceding sentence shall not 

apply in the case of a distribution which is paid with respect 

to any employer security which is allocated to a participant unless the plan provides that employer securities with a fair marVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00024 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
21

ket value of not less than the amount of such distribution are 

allocated to such participant for the year which (but for the preceding sentence) such distribution would have been allocated to 

such participant.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to distributions with respect to S corporation stock made 

after December 31, 1997. 

Subtitle E—Other Business Incentives 

SEC. 241. PHASEOUT OF 4.3-CENT MOTOR FUEL EXCISE TAXES ON 

RAILROADS AND INLAND WATERWAY TRANSPORTATION 

WHICH REMAIN IN GENERAL FUND. 

(a) TAXES ON TRAINS.— (1) IN GENERAL.—Clause (ii) of section 4041(a)(1)(C) is 

amended by striking subclauses (I), (II), and (III) and inserting 

the following new subclauses: 

‘‘(I) 3.3 cents per gallon after December 31, 

2004, and before July 1, 2005, 

‘‘(II) 2.3 cents per gallon after June 30, 2005, 

and before January 1, 2007, and 

‘‘(III) 0 after December 31, 2006.’’. 

(2) CONFORMING AMENDMENTS.— (A) Subsection (d) of section 4041 is amended by redesignating paragraph (3) as paragraph (4) and by inserting 

after paragraph (2) the following new paragraph: 

‘‘(3) DIESEL FUEL USED IN TRAINS.—In the case of any sale 

for use or use after December 31, 2006, there is hereby imposed 

a tax of 0.1 cent per gallon on any liquid other than gasoline 

(as defined in section 4083)—

‘‘(A) sold by any person to an owner, lessee, or other operator of a diesel-powered train for use as a fuel in such 

train, or 

‘‘(B) used by any person as a fuel in a diesel-powered 

train unless there was a taxable sale of such fuel under 

subparagraph (A). 

No tax shall be imposed by this paragraph on the sale or use 

of any liquid if tax was imposed on such liquid under section 

4081.’’. 

(B) Subsection (f) of section 4082 is amended by striking ‘‘section 4041(a)(1)’’ and inserting ‘‘subsections (a)(1) 

and (d)(3) of section 4041’’. 

(C) Subparagraph (B) of section 6421(f)(3) is amended 

to read as follows: 

‘‘(B) so much of the rate specified in section 

4081(a)(2)(A) as does not exceed the rate applicable under 

section 4041(a)(1)(C)(ii).’’. 

(D) Subparagraph (B) of section 6427(l)(3) is amended 

to read as follows: 

‘‘(B) so much of the rate specified in section 

4081(a)(2)(A) as does not exceed the rate applicable under 

section 4041(a)(1)(C)(ii).’’. 

(b) FUEL USED ON INLAND WATERWAYS.—Subparagraph (C) of 

section 4042(b)(2) is amended to read as follows: 

‘‘(C) The deficit reduction rate is—

22

‘‘(i) 3.3 cents per gallon after December 31, 2004, 

and before July 1, 2005, 

‘‘(ii) 2.3 cents per gallon after June 30, 2005, and 

before January 1, 2007, and 

‘‘(iii) 0 after December 31, 2006.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on January 1, 2005. 

SEC. 242. MODIFICATION OF APPLICATION OF INCOME FORECAST 

METHOD OF DEPRECIATION. 

(a) IN GENERAL.—Section 167(g) (relating to depreciation under 

income forecast method) is amended by adding at the end the following new paragraph: 

‘‘(7) TREATMENT OF PARTICIPATIONS AND RESIDUALS.— ‘‘(A) IN GENERAL.—For purposes of determining the depreciation deduction allowable with respect to a property 

under this subsection, the taxpayer may include participations and residuals with respect to such property in the adjusted basis of such property for the taxable year in which 

the property is placed in service, but only to the extent that 

such participations and residuals relate to income estimated (for purposes of this subsection) to be earned in connection with the property before the close of the 10th taxable year referred to in paragraph (1)(A). 

‘‘(B) PARTICIPATIONS AND RESIDUALS.—For purposes of 

this paragraph, the term ‘participations and residuals’ 

means, with respect to any property, costs the amount of 

which by contract varies with the amount of income earned 

in connection with such property. 

‘‘(C) SPECIAL RULES RELATING TO RECOMPUTATION

YEARS.—If the adjusted basis of any property is determined 

under this paragraph, paragraph (4) shall be applied by 

substituting ‘for each taxable year in such period’ for ‘for 

such period’. 

‘‘(D) OTHER SPECIAL RULES.—

‘‘(i) PARTICIPATIONS AND RESIDUALS.—Notwithstanding subparagraph (A), the taxpayer may exclude 

participations and residuals from the adjusted basis of 

such property and deduct such participations and residuals in the taxable year that such participations 

and residuals are paid. 

‘‘(ii) COORDINATION WITH OTHER RULES.—Deductions computed in accordance with this paragraph 

shall be allowable notwithstanding paragraph (1)(B) or 

sections 263, 263A, 404, 419, or 461(h). 

‘‘(E) AUTHORITY TO MAKE ADJUSTMENTS.—The Secretary shall prescribe appropriate adjustments to the basis 

of property and to the look-back method for the additional 

amounts allowable as a deduction solely by reason of this 

paragraph.’’. 

(b) DETERMINATION OF INCOME.—Section 167(g)(5) (relating to 

special rules) is amended by redesignating subparagraphs (E) and 

(F) as subparagraphs (F) and (G), respectively, and inserting after 

subparagraph (D) the following new subparagraph: 

‘‘(E) TREATMENT OF DISTRIBUTION COSTS.—For purposes of this subsection, the income with respect to any 

23

property shall be the taxpayer’s gross income from such 

property.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to property placed in service after the date of the enactment of this Act. 

SEC. 243. IMPROVEMENTS RELATED TO REAL ESTATE INVESTMENT 

TRUSTS. 

(a) EXPANSION OF STRAIGHT DEBT SAFE HARBOR.—Section 856 

(defining real estate investment trust) is amended—

(1) in subsection (c) by striking paragraph (7), and 

(2) by adding at the end the following new subsection:

‘‘(m) SAFE HARBOR IN APPLYING SUBSECTION (c)(4).—

‘‘(1) IN GENERAL.—In applying subclause (III) of subsection 

(c)(4)(B)(iii), except as otherwise determined by the Secretary in 

regulations, the following shall not be considered securities held 

by the trust: 

‘‘(A) Straight debt securities of an issuer which meet 

the requirements of paragraph (2). 

‘‘(B) Any loan to an individual or an estate. 

‘‘(C) Any section 467 rental agreement (as defined in 

section 467(d)), other than with a person described in subsection (d)(2)(B). 

‘‘(D) Any obligation to pay rents from real property (as 

defined in subsection (d)(1)). 

‘‘(E) Any security issued by a State or any political subdivision thereof, the District of Columbia, a foreign government or any political subdivision thereof, or the Commonwealth of Puerto Rico, but only if the determination of any 

payment received or accrued under such security does not 

depend in whole or in part on the profits of any entity not 

described in this subparagraph or payments on any obligation issued by such an entity, 

‘‘(F) Any security issued by a real estate investment 

trust. 

‘‘(G) Any other arrangement as determined by the Secretary. 

‘‘(2) SPECIAL RULES RELATING TO STRAIGHT DEBT SECURITIES.—

‘‘(A) IN GENERAL.—For purposes of paragraph (1)(A), 

securities meet the requirements of this paragraph if such 

securities are straight debt, as defined in section 1361(c)(5) 

(without regard to subparagraph (B)(iii) thereof). 

‘‘(B) SPECIAL RULES RELATING TO CERTAIN CONTINGENCIES.—For purposes of subparagraph (A), any interest 

or principal shall not be treated as failing to satisfy section 

1361(c)(5)(B)(i) solely by reason of the fact that—

‘‘(i) the time of payment of such interest or principal is subject to a contingency, but only if—

‘‘(I) any such contingency does not have the effect of changing the effective yield to maturity, as 

determined under section 1272, other than a 

change in the annual yield to maturity which does 

not exceed the greater of 1⁄4 of 1 percent or 5 percent of the annual yield to maturity, or 

24

‘‘(II) neither the aggregate issue price nor the aggregate face amount of the issuer’s debt instruments 

held by the trust exceeds $1,000,000 and not more than 

12 months of unaccrued interest can be required to be 

prepaid thereunder, or 

‘‘(ii) the time or amount of payment is subject to a 

contingency upon a default or the exercise of a prepayment right by the issuer of the debt, but only if such 

contingency is consistent with customary commercial 

practice. 

‘‘(C) SPECIAL RULES RELATING TO CORPORATE OR PARTNERSHIP ISSUERS.—In the case of an issuer which is a corporation or a partnership, securities that otherwise would 

be described in paragraph (1)(A) shall be considered not to 

be so described if the trust holding such securities and any 

of its controlled taxable REIT subsidiaries (as defined in 

subsection (d)(8)(A)(iv)) hold any securities of the issuer 

which—

‘‘(i) are not described in paragraph (1) (prior to the 

application of this subparagraph), and 

‘‘(ii) have an aggregate value greater than 1 percent of the issuer’s outstanding securities determined 

without regard to paragraph (3)(A)(i). 

‘‘(3) LOOK-THROUGH RULE FOR PARTNERSHIP SECURITIES.— ‘‘(A) IN GENERAL.—For purposes of applying subclause 

(III) of subsection (c)(4)(B)(iii)—

‘‘(i) a trust’s interest as a partner in a partnership 

(as defined in section 7701(a)(2)) shall not be considered a security, and 

‘‘(ii) the trust shall be deemed to own its proportionate share of each of the assets of the partnership. 

‘‘(B) DETERMINATION OF TRUST’S INTEREST IN PARTNERSHIP ASSETS.—For purposes of subparagraph (A), with respect to any taxable year beginning after the date of the enactment of this subparagraph—

‘‘(i) the trust’s interest in the partnership assets 

shall be the trust’s proportionate interest in any securities issued by the partnership (determined without regard to subparagraph (A)(i) and paragraph (4), but not 

including securities described in paragraph (1)), and 

‘‘(ii) the value of any debt instrument shall be the 

adjusted issue price thereof, as defined in section 

1272(a)(4). 

‘‘(4) CERTAIN PARTNERSHIP DEBT INSTRUMENTS NOT TREATED AS A SECURITY.—For purposes of applying subclause (III) of 

subsection (c)(4)(B)(iii)—

‘‘(A) any debt instrument issued by a partnership and 

not described in paragraph (1) shall not be considered a security to the extent of the trust’s interest as a partner in the 

partnership, and 

‘‘(B) any debt instrument issued by a partnership and 

not described in paragraph (1) shall not be considered a security if at least 75 percent of the partnership’s gross income (excluding gross income from prohibited transactions) 

is derived from sources referred to in subsection (c)(3). 

25

‘‘(5) SECRETARIAL GUIDANCE.—The Secretary is authorized 

to provide guidance (including through the issuance of a written determination, as defined in section 6110(b)) that an arrangement shall not be considered a security held by the trust 

for purposes of applying subclause (III) of subsection 

(c)(4)(B)(iii) notwithstanding that such arrangement otherwise 

could be considered a security under subparagraph (F) of subsection (c)(5).’’. 

(b) CLARIFICATION OF APPLICATION OF LIMITED RENTAL EXCEP- TION.—Subparagraph (A) of section 856(d)(8) (relating to special 

rules for taxable REIT subsidiaries) is amended to read as follows: 

‘‘(A) LIMITED RENTAL EXCEPTION.—

‘‘(i) IN GENERAL.—The requirements of this subparagraph are met with respect to any property if at 

least 90 percent of the leased space of the property is 

rented to persons other than taxable REIT subsidiaries 

of such trust and other than persons described in paragraph (2)(B).

‘‘(ii) RENTS MUST BE SUBSTANTIALLY COMPARABLE.—Clause (i) shall apply only to the extent that 

the amounts paid to the trust as rents from real property (as defined in paragraph (1) without regard to 

paragraph (2)(B)) from such property are substantially 

comparable to such rents paid by the other tenants of 

the trust’s property for comparable space. 

‘‘(iii) TIMES FOR TESTING RENT COMPARABILITY.— The substantial comparability requirement of clause 

(ii) shall be treated as met with respect to a lease to a 

taxable REIT subsidiary of the trust if such requirement is met under the terms of the lease—

‘‘(I) at the time such lease is entered into, 

‘‘(II) at the time of each extension of the lease, 

including a failure to exercise a right to terminate, 

and 

‘‘(III) at the time of any modification of the 

lease between the trust and the taxable REIT subsidiary if the rent under such lease is effectively increased pursuant to such modification. 

With respect to subclause (III), if the taxable REIT subsidiary of the trust is a controlled taxable REIT subsidiary of the trust, the term ‘rents from real property’ 

shall not in any event include rent under such lease to 

the extent of the increase in such rent on account of 

such modification. 

‘‘(iv) CONTROLLED TAXABLE REIT SUBSIDIARY.—For 

purposes of clause (iii), the term ‘controlled taxable 

REIT subsidiary’ means, with respect to any real estate 

investment trust, any taxable REIT subsidiary of such 

trust if such trust owns directly or indirectly—

‘‘(I) stock possessing more than 50 percent of 

the total voting power of the outstanding stock of 

such subsidiary, or 

‘‘(II) stock having a value of more than 50 percent of the total value of the outstanding stock of 

such subsidiary. 

26

‘‘(v) CONTINUING QUALIFICATION BASED ON THIRD

PARTY ACTIONS.—If the requirements of clause (i) are 

met at a time referred to in clause (iii), such requirements shall continue to be treated as met so long as 

there is no increase in the space leased to any taxable 

REIT subsidiary of such trust or to any person described in paragraph (2)(B). 

‘‘(vi) CORRECTION PERIOD.—If there is an increase 

referred to in clause (v) during any calendar quarter 

with respect to any property, the requirements of clause 

(iii) shall be treated as met during the quarter and the 

succeeding quarter if such requirements are met at the 

close of such succeeding quarter.’’. 

(c) DELETION OF CUSTOMARY SERVICES EXCEPTION.—Subparagraph (B) of section 857(b)(7) (relating to redetermined rents) is 

amended by striking clause (ii) and by redesignating clauses (iii), 

(iv), (v), (vi), and (vii) as clauses (ii), (iii), (iv), (v), and (vi), respectively. 

(d) CONFORMITY WITH GENERAL HEDGING DEFINITION.—Subparagraph (G) of section 856(c)(5) (relating to treatment of certain 

hedging instruments) is amended to read as follows: 

‘‘(G) TREATMENT OF CERTAIN HEDGING INSTRUMENTS.— Except to the extent provided by regulations, any income of 

a real estate investment trust from a hedging transaction 

(as defined in clause (ii) or (iii) of section 1221(b)(2)(A)) 

which is clearly identified pursuant to section 1221(a)(7), 

including gain from the sale or disposition of such a transaction, shall not constitute gross income under paragraph 

(2) to the extent that the transaction hedges any indebtedness incurred or to be incurred by the trust to acquire or 

carry real estate assets.’’. 

(e) CONFORMITY WITH REGULATED INVESTMENT COMPANY

RULES.—Clause (i) of section 857(b)(5)(A) (relating to imposition of 

tax in case of failure to meet certain requirements) is amended by 

striking ‘‘90 percent’’ and inserting ‘‘95 percent’’. 

(f) SAVINGS PROVISIONS.— (1) RULES OF APPLICATION FOR FAILURE TO SATISFY SEC- TION 856(c)(4).—Section 856(c) (relating to definition of real estate investment trust) is amended by inserting after paragraph 

(6) the following new paragraph: 

‘‘(7) RULES OF APPLICATION FOR FAILURE TO SATISFY PARAGRAPH (4).—

‘‘(A) DE MINIMIS FAILURE.—A corporation, trust, or association that fails to meet the requirements of paragraph 

(4)(B)(iii) for a particular quarter shall nevertheless be considered to have satisfied the requirements of such paragraph for such quarter if—

‘‘(i) such failure is due to the ownership of assets 

the total value of which does not exceed the lesser of—

‘‘(I) 1 percent of the total value of the trust’s 

assets at the end of the quarter for which such 

measurement is done, and 

‘‘(II) $10,000,000, and 

‘‘(ii)(I) the corporation, trust, or association, following the identification of such failure, disposes of asVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00030 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
27

sets in order to meet the requirements of such paragraph within 6 months after the last day of the quarter 

in which the corporation, trust or association’s identification of the failure to satisfy the requirements of 

such paragraph occurred or such other time period prescribed by the Secretary and in the manner prescribed 

by the Secretary, or 

‘‘(II) the requirements of such paragraph are otherwise met within the time period specified in subclause 

(I). 

‘‘(B) FAILURES EXCEEDING DE MINIMIS AMOUNT.—A corporation, trust, or association that fails to meet the requirements of paragraph (4) for a particular quarter shall nevertheless be considered to have satisfied the requirements of 

such paragraph for such quarter if—

‘‘(i) such failure involves the ownership of assets 

the total value of which exceeds the de minimis standard described in subparagraph (A)(i) at the end of the 

quarter for which such measurement is done, 

‘‘(ii) following the corporation, trust, or association’s identification of the failure to satisfy the requirements of such paragraph for a particular quarter, a description of each asset that causes the corporation, 

trust, or association to fail to satisfy the requirements 

of such paragraph at the close of such quarter of any 

taxable year is set forth in a schedule for such quarter 

filed in accordance with regulations prescribed by the 

Secretary, 

‘‘(iii) the failure to meet the requirements of such 

paragraph for a particular quarter is due to reasonable 

cause and not due to willful neglect,

‘‘(iv) the corporation, trust, or association pays a 

tax computed under subparagraph (C), and 

‘‘(v)(I) the corporation, trust, or association disposes of the assets set forth on the schedule specified in 

clause (ii) within 6 months after the last day of the 

quarter in which the corporation, trust or association’s 

identification of the failure to satisfy the requirements 

of such paragraph occurred or such other time period 

prescribed by the Secretary and in the manner prescribed by the Secretary, or

‘‘(II) the requirements of such paragraph are otherwise met within the time period specified in subclause 

(I). 

‘‘(C) TAX.—For purposes of subparagraph (B)(iv)—

‘‘(i) TAX IMPOSED.—If a corporation, trust, or association elects the application of this subparagraph, 

there is hereby imposed a tax on the failure described 

in subparagraph (B) of such corporation, trust, or association. Such tax shall be paid by the corporation, 

trust, or association. 

‘‘(ii) TAX COMPUTED.—The amount of the tax imposed by clause (i) shall be the greater of—

‘‘(I) $50,000, or 

28

‘‘(II) the amount determined (pursuant to regulations promulgated by the Secretary) by multiplying the net income generated by the assets described in the schedule specified in subparagraph 

(B)(ii) for the period specified in clause (iii) by the 

highest rate of tax specified in section 11. 

‘‘(iii) PERIOD.—For purposes of clause (ii)(II), the 

period described in this clause is the period beginning 

on the first date that the failure to satisfy the requirements of such paragraph (4) occurs as a result of the 

ownership of such assets and ending on the earlier of 

the date on which the trust disposes of such assets or 

the end of the first quarter when there is no longer a 

failure to satisfy such paragraph (4). 

‘‘(iv) ADMINISTRATIVE PROVISIONS.—For purposes 

of subtitle F, the taxes imposed by this subparagraph 

shall be treated as excise taxes with respect to which 

the deficiency procedures of such subtitle apply.’’. 

(2) MODIFICATION OF RULES OF APPLICATION FOR FAILURE

TO SATISFY SECTIONS 856(c)(2) OR 856(c)(3).—Paragraph (6) of 

section 856(c) (relating to definition of real estate investment 

trust) is amended by striking subparagraphs (A) and (B), by redesignating subparagraph (C) as subparagraph (B), and by inserting before subparagraph (B) (as so redesignated) the following new subparagraph: 

‘‘(A) following the corporation, trust, or association’s 

identification of the failure to meet the requirements of 

paragraph (2) or (3), or of both such paragraphs, for any 

taxable year, a description of each item of its gross income 

described in such paragraphs is set forth in a schedule for 

such taxable year filed in accordance with regulations prescribed by the Secretary, and’’. 

(3) REASONABLE CAUSE EXCEPTION TO LOSS OF REIT STATUS

IF FAILURE TO SATISFY REQUIREMENTS.—Subsection (g) of section 856 (relating to termination of election) is amended—

(A) in paragraph (1) by inserting before the period at 

the end of the first sentence the following: ‘‘unless paragraph (5) applies’’, and 

(B) by adding at the end the following new paragraph: 

‘‘(5) ENTITIES TO WHICH PARAGRAPH APPLIES.—This paragraph applies to a corporation, trust, or association—

‘‘(A) which is not a real estate investment trust to 

which the provisions of this part apply for the taxable year 

due to one or more failures to comply with one or more of 

the provisions of this part (other than subsection (c)(6) or 

(c)(7) of section 856), 

‘‘(B) such failures are due to reasonable cause and not 

due to willful neglect, and 

‘‘(C) if such corporation, trust, or association pays (as 

prescribed by the Secretary in regulations and in the same 

manner as tax) a penalty of $50,000 for each failure to satisfy a provision of this part due to reasonable cause and 

not willful neglect.’’. 

(4) DEDUCTION OF TAX PAID FROM AMOUNT REQUIRED TO BE

DISTRIBUTED.—Subparagraph (E) of section 857(b)(2) is amendVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00032 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
29

ed by striking ‘‘(7)’’ and inserting ‘‘(7) of this subsection, section 

856(c)(7)(B)(iii), and section 856(g)(1).’’. 

(5) EXPANSION OF DEFICIENCY DIVIDEND PROCEDURE.—Subsection (e) of section 860 is amended by striking ‘‘or’’ at the end 

of paragraph (2), by striking the period at the end of paragraph 

(3) and inserting ‘‘; or’’, and by adding at the end the following 

new paragraph: 

‘‘(4) a statement by the taxpayer attached to its amendment 

or supplement to a return of tax for the relevant tax year.’’. 

(g) EFFECTIVE DATES.— (1) IN GENERAL.—Except as provided in paragraph (2), the 

amendments made by this section shall apply to taxable years 

beginning after December 31, 2000. 

(2) SUBSECTIONS (c) THROUGH (f).—The amendments made 

by subsections (c), (d), (e), and (f) shall apply to taxable years 

beginning after the date of the enactment of this Act. 

SEC. 244. SPECIAL RULES FOR CERTAIN FILM AND TELEVISION PRODUCTIONS. 

(a) IN GENERAL.—Part VI of subchapter B of chapter 1 is 

amended by inserting after section 180 the following new section: 

‘‘SEC. 181. TREATMENT OF CERTAIN QUALIFIED FILM AND TELEVISION 

PRODUCTIONS. 

‘‘(a) ELECTION TO TREAT COSTS AS EXPENSES.— ‘‘(1) IN GENERAL.—A taxpayer may elect to treat the cost of 

any qualified film or television production as an expense which 

is not chargeable to capital account. Any cost so treated shall 

be allowed as a deduction. 

‘‘(2) DOLLAR LIMITATION.— ‘‘(A) IN GENERAL.—Paragraph (1) shall not apply to 

any qualified film or television production the aggregate 

cost of which exceeds $15,000,000. 

‘‘(B) HIGHER DOLLAR LIMITATION FOR PRODUCTIONS IN

CERTAIN AREAS.—In the case of any qualified film or television production the aggregate cost of which is significantly incurred in an area eligible for designation as—

‘‘(i) a low-income community under section 45D, or 

‘‘(ii) a distressed county or isolated area of distress 

by the Delta Regional Authority established under section 2009aa–1 of title 7, United States Code, 

subparagraph (A) shall be applied by substituting 

‘$20,000,000’ for ‘$15,000,000’. 

‘‘(b) NO OTHER DEDUCTION OR AMORTIZATION DEDUCTION ALLOWABLE.—With respect to the basis of any qualified film or television production to which an election is made under subsection (a), 

no other depreciation or amortization deduction shall be allowable. 

‘‘(c) ELECTION.—

‘‘(1) IN GENERAL.—An election under this section with respect to any qualified film or television production shall be 

made in such manner as prescribed by the Secretary and by the 

due date (including extensions) for filing the taxpayer’s return 

of tax under this chapter for the taxable year in which costs of 

the production are first incurred. 

‘‘(2) REVOCATION OF ELECTION.—Any election made under 

this section may not be revoked without the consent of the Secretary. 

30

‘‘(d) QUALIFIED FILM OR TELEVISION PRODUCTION.—For purposes of this section—

‘‘(1) IN GENERAL.—The term ‘qualified film or television 

production’ means any production described in paragraph (2) if 

75 percent of the total compensation of the production is qualified compensation. 

‘‘(2) PRODUCTION.—

‘‘(A) IN GENERAL.—A production is described in this 

paragraph if such production is property described in section 168(f)(3). For purposes of a television series, only the 

first 44 episodes of such series may be taken into account. 

‘‘(B) EXCEPTION.—A production is not described in this 

paragraph if records are required under section 2257 of 

title 18, United States Code, to be maintained with respect 

to any performer in such production.

‘‘(3) QUALIFIED COMPENSATION.—For purposes of paragraph (1)—

‘‘(A) IN GENERAL.—The term ‘qualified compensation’ 

means compensation for services performed in the United 

States by actors, directors, producers, and other relevant 

production personnel. 

‘‘(B) PARTICIPATIONS AND RESIDUALS EXCLUDED.—The 

term ‘compensation’ does not include participations and residuals (as defined in section 167(g)(7)(B)). 

‘‘(e) APPLICATION OF CERTAIN OTHER RULES.—For purposes of 

this section, rules similar to the rules of subsections (b)(2) and (c)(4) 

of section 194 shall apply. 

‘‘(f) TERMINATION.—This section shall not apply to qualified 

film and television productions commencing after December 31, 

2008.’’. 

(b) CONFORMING AMENDMENT.—The table of sections for part 

VI of subchapter B of chapter 1 is amended by inserting after the 

item relating to section 180 the following new item:

‘‘Sec. 181. Treatment of certain qualified film and television productions.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to qualified film and television productions (as defined 

in section 181(d)(1) of the Internal Revenue Code of 1986, as added 

by this section) commencing after the date of the enactment of this 

Act. 

SEC. 245. CREDIT FOR MAINTENANCE OF RAILROAD TRACK. 

(a) IN GENERAL.—Subpart D of part IV of subchapter A of 

chapter 1 (relating to business-related credits) is amended by adding at the end the following new section: 

‘‘SEC. 45G. RAILROAD TRACK MAINTENANCE CREDIT. 

‘‘(a) GENERAL RULE.—For purposes of section 38, the railroad 

track maintenance credit determined under this section for the taxable year is an amount equal to 50 percent of the qualified railroad 

track maintenance expenditures paid or incurred by an eligible taxpayer during the taxable year. 

‘‘(b) LIMITATION.—The credit allowed under subsection (a) for 

any taxable year shall not exceed the product of—

‘‘(1) $3,500, and 

31

‘‘(2) the number of miles of railroad track owned or leased 

by the eligible taxpayer as of the close of the taxable year. 

A mile of railroad track may be taken into account by a person 

other than the owner only if such mile is assigned to such person 

by the owner for purposes of this subsection. Any mile which is so 

assigned may not be taken into account by the owner for purposes 

of this subsection. 

‘‘(c) ELIGIBLE TAXPAYER.—For purposes of this section, the term 

‘eligible taxpayer’ means—

‘‘(1) any Class II or Class III railroad, and 

‘‘(2) any person who transports property using the rail facilities of a person described in paragraph (1) or who furnishes 

railroad-related property or services to such a person. 

‘‘(d) QUALIFIED RAILROAD TRACK MAINTENANCE EXPENDITURES.—For purposes of this section, the term ‘qualified railroad 

track maintenance expenditures’ means expenditures (whether or not 

otherwise chargeable to capital account) for maintaining railroad 

track (including roadbed, bridges, and related track structures) 

owned or leased as of January 1, 2005, by a Class II or Class III 

railroad. 

‘‘(e) OTHER DEFINITIONS AND SPECIAL RULES.— ‘‘(1) CLASS II OR CLASS III RAILROAD.—For purposes of this 

section, the terms ‘Class II railroad’ and ‘Class III railroad’ 

have the respective meanings given such terms by the Surface 

Transportation Board. 

‘‘(2) CONTROLLED GROUPS.—Rules similar to the rules of 

paragraph (1) of section 41(f) shall apply for purposes of this 

section. 

‘‘(3) BASIS ADJUSTMENT.—For purposes of this subtitle, if a 

credit is allowed under this section with respect to any railroad 

track, the basis of such track shall be reduced by the amount 

of the credit so allowed. 

‘‘(f) APPLICATION OF SECTION.—This section shall apply to 

qualified railroad track maintenance expenditures paid or incurred 

during taxable years beginning after December 31, 2004, and before 

January 1, 2008.’’. 

(b) LIMITATION ON CARRYBACK.— (1) IN GENERAL.—Subsection (d) of section 39 is amended 

to read as follows: 

‘‘(d) TRANSITIONAL RULE.—No portion of the unused business 

credit for any taxable year which is attributable to a credit specified 

in section 38(b) or any portion thereof may be carried back to any 

taxable year before the first taxable year for which such specified 

credit or such portion is allowable (without regard to subsection 

(a)).’’. 

(2) EFFECTIVE DATE.—The amendment made by paragraph 

(1) shall apply with respect to taxable years ending after December 31, 2003. 

(c) CONFORMING AMENDMENTS.— (1) Section 38(b) (relating to general business credit) is 

amended by striking ‘‘plus’’ at the end of paragraph (14), by 

striking the period at the end of paragraph (15) and inserting 

‘‘, plus’’, and by adding at the end the following new paragraph: 

‘‘(16) the railroad track maintenance credit determined 

under section 45G(a).’’. 

32

(2) Subsection (a) of section 1016 is amended by striking 

‘‘and’’ at the end of paragraph (27), by striking the period at the 

end of paragraph (28) and inserting ‘‘, and’’, and by inserting 

after paragraph (28) the following new paragraph: 

‘‘(29) in the case of railroad track with respect to which a 

credit was allowed under section 45G, to the extent provided in 

section 45G(e)(3).’’. 

(d) CLERICAL AMENDMENT.—The table of sections for subpart D 

of part IV of subchapter A of chapter 1 is amended by inserting 

after the item relating to section 45F the following new item:

‘‘Sec. 45G. Railroad track maintenance credit.’’.

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2004.

SEC. 246. SUSPENSION OF OCCUPATIONAL TAXES RELATING TO DISTILLED SPIRITS, WINE, AND BEER. 

(a) IN GENERAL.—Subpart G of part II of subchapter A of chapter 51 is amended by redesignating section 5148 as section 5149 and 

by inserting after section 5147 the following new section: 

‘‘SEC. 5148. SUSPENSION OF OCCUPATIONAL TAX. 

‘‘(a) IN GENERAL.—Notwithstanding sections 5081, 5091, 5111, 

5121, and 5131, the rate of tax imposed under such sections for the 

suspension period shall be zero. During such period, persons engaged in or carrying on a trade or business covered by such sections 

shall register under section 5141 and shall comply with the recordkeeping requirements under this part. 

‘‘(b) SUSPENSION PERIOD.—For purposes of subsection (a), the 

suspension period is the period beginning on July 1, 2005, and ending on June 30, 2008.’’. 

(b) CONFORMING AMENDMENT.—Section 5117 is amended by 

adding at the end the following new subsection: 

‘‘(d) SPECIAL RULE DURING SUSPENSION PERIOD.—Except as 

provided in subsection (b) or by the Secretary, during the suspension period (as defined in section 5148) it shall be unlawful for any 

dealer to purchase distilled spirits for resale from any person other 

than a wholesale dealer in liquors who is required to keep records 

under section 5114.’’. 

(c) CLERICAL AMENDMENT.—The table of sections for subpart G 

of part II of subchapter A of chapter 51 is amended by striking the 

last item and inserting the following new items:

‘‘Sec. 5148. Suspension of occupational tax. 

‘‘Sec. 5149. Cross references.’’.

(d) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on the date of the enactment of this Act.

SEC. 247. MODIFICATION OF UNRELATED BUSINESS INCOME LIMITATION ON INVESTMENT IN CERTAIN SMALL BUSINESS INVESTMENT COMPANIES. 

(a) IN GENERAL.—Paragraph (6) of section 514(c) (relating to 

acquisition indebtedness) is amended to read as follows: 

‘‘(6) CERTAIN FEDERAL FINANCING.—

‘‘(A) IN GENERAL.—For purposes of this section, the 

term ‘acquisition indebtedness’ does not include—

‘‘(i) an obligation, to the extent that it is insured by 

the Federal Housing Administration, to finance the 

33

purchase, rehabilitation, or construction of housing for 

low and moderate income persons, or 

‘‘(ii) indebtedness incurred by a small business investment company licensed after the date of the enactment of the American Jobs Creation Act of 2004 under 

the Small Business Investment Act of 1958 if such indebtedness is evidenced by a debenture—

‘‘(I) issued by such company under section 

303(a) of such Act, and 

‘‘(II) held or guaranteed by the Small Business 

Administration. 

‘‘(B) LIMITATION.—Subparagraph (A)(ii) shall not 

apply with respect to any small business investment company during any period that—

‘‘(i) any organization which is exempt from tax 

under this title (other than a governmental unit) owns 

more than 25 percent of the capital or profits interest 

in such company, or 

‘‘(ii) organizations which are exempt from tax 

under this title (including governmental units other 

than any agency or instrumentality of the United 

States) own, in the aggregate, 50 percent or more of the 

capital or profits interest in such company.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to indebtedness incurred after the date of the enactment 

of this Act by a small business investment company licensed after 

the date of the enactment of this Act.

SEC. 248. ELECTION TO DETERMINE CORPORATE TAX ON CERTAIN 

INTERNATIONAL SHIPPING ACTIVITIES USING PER TON 

RATE. 

(a) IN GENERAL.—Chapter 1 is amended by inserting after subchapter Q the following new subchapter: 

‘‘Subchapter R—Election To Determine Corporate Tax on 

Certain International Shipping Activities Using Per Ton 

Rate

‘‘Sec. 1352. Alternative tax on qualifying shipping activities. 

‘‘Sec. 1353. Notional shipping income. 

‘‘Sec. 1354. Alternative tax election; revocation; termination. 

‘‘Sec. 1355. Definitions and special rules. 

‘‘Sec. 1356. Qualifying shipping activities. 

‘‘Sec. 1357. Items not subject to regular tax; depreciation; interest. 

‘‘Sec. 1358. Allocation of credits, income, and deductions. 

‘‘Sec. 1359. Disposition of qualifying vessels.

‘‘SEC. 1352. ALTERNATIVE TAX ON QUALIFYING SHIPPING ACTIVITIES. 

‘‘In the case of an electing corporation, the tax imposed by section 11 shall be the amount equal to the sum of—

‘‘(1) the tax imposed by section 11 determined after the application of this subchapter, and 

‘‘(2) a tax equal to—

‘‘(A) the highest rate of tax specified in section 11, multiplied by 

‘‘(B) the notional shipping income for the taxable year.

34

‘‘SEC. 1353. NOTIONAL SHIPPING INCOME. 

‘‘(a) IN GENERAL.—For purposes of this subchapter, the notional 

shipping income of an electing corporation shall be the sum of the 

amounts determined under subsection (b) for each qualifying vessel 

operated by such electing corporation. 

‘‘(b) AMOUNTS.— ‘‘(1) IN GENERAL.—For purposes of subsection (a), the 

amount of notional shipping income of an electing corporation 

for each qualifying vessel for the taxable year shall equal the 

product of—

‘‘(A) the daily notional shipping income, and 

‘‘(B) the number of days during the taxable year that 

the electing corporation operated such vessel as a qualifying vessel in United States foreign trade.

‘‘(2) TREATMENT OF VESSELS THE INCOME FROM WHICH IS

NOT OTHERWISE SUBJECT TO TAX.—In the case of a qualifying 

vessel any of the income from which is not included in gross income by reason of section 883 or otherwise, the amount of notional shipping income from such vessel for the taxable year 

shall be the amount which bears the same ratio to such shipping income (determined without regard to this paragraph) as 

the gross income from the operation of such vessel in the United 

States foreign trade bears to the sum of such gross income and 

the income so excluded. 

‘‘(c) DAILY NOTIONAL SHIPPING INCOME.—For purposes of subsection (b), the daily notional shipping income from the operation of 

a qualifying vessel is—

‘‘(1) 40 cents for each 100 tons of so much of the net tonnage of the vessel as does not exceed 25,000 net tons, and 

‘‘(2) 20 cents for each 100 tons of so much of the net tonnage of the vessel as exceeds 25,000 net tons. 

‘‘(d) MULTIPLE OPERATORS OF VESSEL.—If for any period 2 or 

more persons are operators of a qualifying vessel, the notional shipping income from the operation of such vessel for such period shall 

be allocated among such persons on the basis of their respective 

ownership and charter interests in such vessel or on such other 

basis as the Secretary may prescribe by regulations. 

‘‘SEC. 1354. ALTERNATIVE TAX ELECTION; REVOCATION; TERMINATION. 

‘‘(a) IN GENERAL.—A qualifying vessel operator may elect the 

application of this subchapter. 

‘‘(b) TIME AND MANNER; YEARS FOR WHICH EFFECTIVE.—An 

election under this subchapter—

‘‘(1) shall be made in such form as prescribed by the Secretary, and 

‘‘(2) shall be effective for the taxable year for which made 

and all succeeding taxable years until terminated under subsection (d). 

Such election may be effective for any taxable year only if made before the due date (including extensions) for filing the corporation’s 

return for such taxable year. 

‘‘(c) CONSISTENT ELECTIONS BY MEMBERS OF CONTROLLED

GROUPS.—An election under subsection (a) by a member of a controlled group shall apply to all qualifying vessel operators that are 

members of such group. 

35

‘‘(d) TERMINATION.— ‘‘(1) BY REVOCATION.— ‘‘(A) IN GENERAL.—An election under subsection (a) 

may be terminated by revocation. 

‘‘(B) WHEN EFFECTIVE.—Except as provided in subparagraph (C)—

‘‘(i) a revocation made during the taxable year and 

on or before the 15th day of the 3d month thereof shall 

be effective on the 1st day of such taxable year, and 

‘‘(ii) a revocation made during the taxable year but 

after such 15th day shall be effective on the 1st day of 

the following taxable year. 

‘‘(C) REVOCATION MAY SPECIFY PROSPECTIVE DATE.—If 

the revocation specifies a date for revocation which is on or 

after the day on which the revocation is made, the revocation shall be effective for taxable years beginning on and 

after the date so specified. 

‘‘(2) BY PERSON CEASING TO BE QUALIFYING VESSEL OPER- ATOR.— ‘‘(A) IN GENERAL.—An election under subsection (a) 

shall be terminated whenever (at any time on or after the 

1st day of the 1st taxable year for which the corporation is 

an electing corporation) such corporation ceases to be a 

qualifying vessel operator. 

‘‘(B) WHEN EFFECTIVE.—Any termination under this 

paragraph shall be effective on and after the date of cessation. 

‘‘(C) ANNUALIZATION.—The Secretary shall prescribe 

such annualization and other rules as are appropriate in 

the case of a termination under this paragraph. 

‘‘(e) ELECTION AFTER TERMINATION.—If a qualifying vessel operator has made an election under subsection (a) and if such election has been terminated under subsection (d), such operator (and 

any successor operator) shall not be eligible to make an election 

under subsection (a) for any taxable year before its 5th taxable year 

which begins after the 1st taxable year for which such termination 

is effective, unless the Secretary consents to such election. 

‘‘SEC. 1355. DEFINITIONS AND SPECIAL RULES. 

‘‘(a) DEFINITIONS.—For purposes of this subchapter—

‘‘(1) ELECTING CORPORATION.—The term ‘electing corporation’ means any corporation for which an election is in effect 

under this subchapter. 

‘‘(2) ELECTING GROUP; CONTROLLED GROUP.—

‘‘(A) ELECTING GROUP.—The term ‘electing group’ 

means a controlled group of which one or more members is 

an electing corporation. 

‘‘(B) CONTROLLED GROUP.—The term ‘controlled group’ 

means any group which would be treated as a single employer under subsection (a) or (b) of section 52 if paragraphs (1) and (2) of section 52(a) did not apply. 

‘‘(3) QUALIFYING VESSEL OPERATOR.—The term ‘qualifying 

vessel operator’ means any corporation—

‘‘(A) who operates one or more qualifying vessels, and 

‘‘(B) who meets the shipping activity requirement in 

subsection (c). 

36

‘‘(4) QUALIFYING VESSEL.—The term ‘qualifying vessel’ 

means a self-propelled (or a combination self-propelled and 

non-self-propelled) United States flag vessel of not less than 

10,000 deadweight tons used exclusively in the United States 

foreign trade during the period that the election under this subchapter is in effect. 

‘‘(5) UNITED STATES FLAG VESSEL.—The term ‘United States 

flag vessel’ means any vessel documented under the laws of the 

United States. 

‘‘(6) UNITED STATES DOMESTIC TRADE.—The term ‘United 

States domestic trade’ means the transportation of goods or passengers between places in the United States. 

‘‘(7) UNITED STATES FOREIGN TRADE.—The term ‘United 

States foreign trade’ means the transportation of goods or passengers between a place in the United States and a foreign 

place or between foreign places. 

‘‘(8) CHARTER.—The term ‘charter’ includes an operating 

agreement. 

‘‘(b) OPERATING A VESSEL.—For purposes of this subchapter—

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), a 

person is treated as operating any vessel during any period if 

such vessel is—

‘‘(A) owned by, or chartered (including a time charter) 

to, the person, and 

‘‘(B) is in use as a qualifying vessel during such period. 

‘‘(2) BAREBOAT CHARTERS.—A person is treated as operating 

and using a vessel that it has chartered out on bareboat charter 

terms only if—

‘‘(A)(i) the vessel is temporarily surplus to the person’s 

requirements and the term of the charter does not exceed 3 

years, or 

‘‘(ii) the vessel is bareboat chartered to a member of a 

controlled group which includes such person or to an unrelated person who sub-bareboats or time charters the vessel 

to such a member (including the owner of the vessel), and 

‘‘(B) the vessel is used as a qualifying vessel by the person to whom ultimately chartered. 

‘‘(c) SHIPPING ACTIVITY REQUIREMENT.—For purposes of this 

section—

‘‘(1) IN GENERAL.—Except as otherwise provided in this subsection, a corporation meets the shipping activity requirement of 

this subsection for any taxable year only if the requirement of 

paragraph (4) is met for each of the 2 preceding taxable years. 

‘‘(2) SPECIAL RULE FOR 1ST YEAR OF ELECTION.—A corporation meets the shipping activity requirement of this subsection 

for the first taxable year for which the election under section 

1354(a) is in effect only if the requirement of paragraph (4) is 

met for the preceding taxable year. 

‘‘(3) CONTROLLED GROUPS.—A corporation who is a member 

of a controlled group meets the shipping activity requirement of 

this subsection only if such requirement is met determined—

‘‘(A) by treating all members of such group as 1 person, 

and 

‘‘(B) by disregarding vessel charters between members 

of such group. 

37

‘‘(4) REQUIREMENT.—The requirement of this paragraph is 

met for any taxable year if, on average during such year, at 

least 25 percent of the aggregate tonnage of qualifying vessels 

used by the corporation were owned by such corporation or 

chartered to such corporation on bareboat charter terms. 

‘‘(d) ACTIVITIES CARRIED ON PARTNERSHIPS, ETC.—In applying 

this subchapter to a partner in a partnership—

‘‘(1) each partner shall be treated as operating vessels operated by the partnership, 

‘‘(2) each partner shall be treated as conducting the activities conducted by the partnership, and 

‘‘(3) the extent of a partner’s ownership or charter interest 

in any vessel owned by or chartered to the partnership shall be 

determined on the basis of the partner’s interest in the partnership. 

A similar rule shall apply with respect to other pass-thru entities. 

‘‘(e) EFFECT OF TEMPORARILY CEASING TO OPERATE A QUALI- FYING VESSEL.— ‘‘(1) IN GENERAL.—For purposes of subsections (b) and (c), 

an electing corporation shall be treated as continuing to use a 

qualifying vessel during any period of temporary cessation if 

the electing corporation gives timely notice to the Secretary stating—

‘‘(A) that it has temporarily ceased to operate the qualifying vessel, and 

‘‘(B) its intention to resume operating the qualifying 

vessel. 

‘‘(2) NOTICE.—Notice shall be deemed timely if given not 

later than the due date (including extensions) for the corporation’s tax return for the taxable year in which the temporary 

cessation begins. 

‘‘(3) PERIOD DISREGARD IN EFFECT.—The period of temporary cessation under paragraph (1) shall continue until the 

earlier of the date on which—

‘‘(A) the electing corporation abandons its intention to 

resume operation of the qualifying vessel, or 

‘‘(B) the electing corporation resumes operation of the 

qualifying vessel. 

‘‘(f) EFFECT OF TEMPORARILY OPERATING A QUALIFYING VESSEL

IN THE UNITED STATES DOMESTIC TRADE.—

‘‘(1) IN GENERAL.—For purposes of this subchapter, an 

electing corporation shall be treated as continuing to use a 

qualifying vessel in the United States foreign trade during any 

period of temporary use in the United States domestic trade if 

the electing corporation gives timely notice to the Secretary stating—

‘‘(A) that it temporarily operates or has operated in the 

United States domestic trade a qualifying vessel which had 

been used in the United States foreign trade, and 

‘‘(B) its intention to resume operation of the vessel in 

the United States foreign trade. 

‘‘(2) NOTICE.—Notice shall be deemed timely if given not 

later than the due date (including extensions) for the corporation’s tax return for the taxable year in which the temporary 

cessation begins. 

38

‘‘(3) PERIOD DISREGARD IN EFFECT.—The period of temporary use under paragraph (1) continues until the earlier of 

the date of which—

‘‘(A) the electing corporation abandons its intention to 

resume operations of the vessel in the United States foreign 

trade, or 

‘‘(B) the electing corporation resumes operation of the 

vessel in the United States foreign trade. 

‘‘(4) NO DISREGARD IF DOMESTIC TRADE USE EXCEEDS 30

DAYS.—Paragraph (1) shall not apply to any qualifying vessel 

which is operated in the United States domestic trade for more 

than 30 days during the taxable year. 

‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes 

of this section. 

‘‘SEC. 1356. QUALIFYING SHIPPING ACTIVITIES. 

‘‘(a) QUALIFYING SHIPPING ACTIVITIES.—For purposes of this 

subchapter, the term ‘qualifying shipping activities’ means—

‘‘(1) core qualifying activities, 

‘‘(2) qualifying secondary activities, and 

‘‘(3) qualifying incidental activities. 

‘‘(b) CORE QUALIFYING ACTIVITIES.—For purposes of this subchapter, the term ‘core qualifying activities’ means activities in operating qualifying vessels in United States foreign trade. 

‘‘(c) QUALIFYING SECONDARY ACTIVITIES.—For purposes of this 

section—

‘‘(1) IN GENERAL.—The term ‘qualifying secondary activities’ 

means secondary activities but only to the extent that, without 

regard to this subchapter, the gross income derived by such corporation from such activities does not exceed 20 percent of the 

gross income derived by the corporation from its core qualifying 

activities. 

‘‘(2) SECONDARY ACTIVITIES.—The term ‘secondary activities’ means—

‘‘(A) the active management or operation of vessels 

other than qualifying vessels in the United States foreign 

trade, 

‘‘(B) the provision of vessel, barge, container, or cargorelated facilities or services to any person, 

‘‘(C) other activities of the electing corporation and 

other members of its electing group that are an integral 

part of its business of operating qualifying vessels in 

United States foreign trade, including—

‘‘(i) ownership or operation of barges, containers, 

chassis, and other equipment that are the complement 

of, or used in connection with, a qualifying vessel in 

United States foreign trade, 

‘‘(ii) the inland haulage of cargo shipped, or to be 

shipped, on qualifying vessels in United States foreign 

trade, and 

‘‘(iii) the provision of terminal, maintenance, repair, logistical, or other vessel, barge, container, or 

cargo-related services that are an integral part of operating qualifying vessels in United States foreign trade, 

and 

39

‘‘(D) such other activities as may be prescribed by the 

Secretary pursuant to regulations. 

‘‘(3) COORDINATION WITH CORE ACTIVITIES.—

‘‘(A) IN GENERAL.—Such term shall not include any 

core qualifying activities. 

‘‘(B) NONELECTING CORPORATIONS.—In the case of a 

corporation (other than an electing corporation) which is a 

member of an electing group, any core qualifying activities 

of the corporation shall be treated as qualifying secondary 

activities (and not as core qualifying activities).

‘‘(d) QUALIFYING INCIDENTAL ACTIVITIES.—For purposes of this 

section, the term ‘qualified incidental activities’ means shipping-related activities if—

‘‘(1) they are incidental to the corporation’s core qualifying 

activities, 

‘‘(2) they are not qualifying secondary activities, and 

‘‘(3) without regard to this subchapter, the gross income derived by such corporation from such activities does not exceed 

0.1 percent of the corporation’s gross income from its core qualifying activities. 

‘‘(e) APPLICATION OF GROSS INCOME TESTS IN CASE OF ELECTING GROUP.—In the case of an electing group, subsections (c)(1) and 

(d)(3) shall be applied as if such group were 1 entity, and the limitations under such subsections shall be allocated among the corporations in such group. 

‘‘SEC. 1357. ITEMS NOT SUBJECT TO REGULAR TAX; DEPRECIATION; INTEREST. 

‘‘(a) EXCLUSION FROM GROSS INCOME.—Gross income of an 

electing corporation shall not include its income from qualifying 

shipping activities. 

‘‘(b) ELECTING GROUP MEMBER.—Gross income of a corporation 

(other than an electing corporation) which is a member of an electing group shall not include its income from qualifying shipping activities conducted by such member. 

‘‘(c) DENIAL OF LOSSES, DEDUCTIONS, AND CREDITS.—

‘‘(1) GENERAL RULE.—Subject to paragraph (2), each item of 

loss, deduction (other than for interest expense), or credit of any 

taxpayer with respect to any activity the income from which is 

excluded from gross income under this section shall be disallowed. 

‘‘(2) DEPRECIATION.—

‘‘(A) IN GENERAL.—Notwithstanding paragraph (1), the 

adjusted basis (for purposes of determining gain) of any 

qualifying vessel shall be determined as if the deduction for 

depreciation had been allowed. 

‘‘(B) METHOD.—

‘‘(i) IN GENERAL.—Except as provided in clause (ii), 

the straight-line method of depreciation shall apply to 

qualifying vessels the income from operation of which 

is excluded from gross income under this section. 

‘‘(ii) EXCEPTION.—Clause (i) shall not apply to any 

qualifying vessel which is subject to a charter entered 

into before the date of the enactment of this subchapter. 

‘‘(3) INTEREST.—

40

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), the interest expense of an electing corporation shall be 

disallowed in the ratio that the fair market value of such 

corporation’s qualifying vessels bears to the fair market 

value of such corporation’s total assets. 

‘‘(B) ELECTING GROUP.—In the case of a corporation 

which is a member of an electing group, the interest expense of such corporation shall be disallowed in the ratio 

that the fair market value of such corporation’s qualifying 

vessels bears to the fair market value of the electing group’s 

total assets. 

‘‘SEC. 1358. ALLOCATION OF CREDITS, INCOME, AND DEDUCTIONS. 

‘‘(a) QUALIFYING SHIPPING ACTIVITIES.—For purposes of this 

chapter, the qualifying shipping activities of an electing corporation 

shall be treated as a separate trade or business activity distinct 

from all other activities conducted by such corporation. 

‘‘(b) EXCLUSION OF CREDITS OR DEDUCTIONS.—

‘‘(1) No deduction shall be allowed against the notional 

shipping income of an electing corporation, and no credit shall 

be allowed against the tax imposed by section 1352(a)(2). 

‘‘(2) No deduction shall be allowed for any net operating 

loss attributable to the qualifying shipping activities of any person to the extent that such loss is carried forward by such person from a taxable year preceding the first taxable year for 

which such person was an electing corporation. 

‘‘(c) TRANSACTIONS NOT AT ARM’S LENGTH.—Section 482 applies in accordance with this subsection to a transaction or series 

of transactions— 

‘‘(1) as between an electing corporation and another person, 

or 

‘‘(2) as between a person’s qualifying shipping activities 

and other activities carried on by it. 

‘‘SEC. 1359. DISPOSITION OF QUALIFYING VESSELS. 

‘‘(a) IN GENERAL.—If any qualifying vessel operator sells or disposes of any qualifying vessel in an otherwise taxable transaction, 

at the election of such operator, no gain shall be recognized if any 

replacement qualifying vessel is acquired during the period specified 

in subsection (b), except to the extent that the amount realized upon 

such sale or disposition exceeds the cost of the replacement qualifying vessel. 

‘‘(b) PERIOD WITHIN WHICH PROPERTY MUST BE REPLACED.—

The period referred to in subsection (a) shall be the period beginning one year prior to the disposition of the qualifying vessel and 

ending—

‘‘(1) 3 years after the close of the first taxable year in which 

the gain is realized, or 

‘‘(2) subject to such terms and conditions as may be specified by the Secretary, on such later date as the Secretary may 

designate on application by the taxpayer. 

Such application shall be made at such time and in such manner 

as the Secretary may by regulations prescribe. 

‘‘(c) APPLICATION OF SECTION TO NONCORPORATE OPERATORS.—

For purposes of this section, the term ‘qualifying vessel operator’ inVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00044 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
41

cludes any person who would be a qualifying vessel operator were 

such person a corporation. 

‘‘(d) TIME FOR ASSESSMENT OF DEFICIENCY ATTRIBUTABLE TO

GAIN.—If a qualifying vessel operator has made the election provided in subsection (a), then— 

‘‘(1) the statutory period for the assessment of any deficiency, for any taxable year in which any part of the gain is realized, attributable to such gain shall not expire prior to the expiration of 3 years from the date the Secretary is notified by 

such operator (in such manner as the Secretary may by regulations prescribe) of the replacement qualifying vessel or of an intention not to replace, and 

‘‘(2) such deficiency may be assessed before the expiration of 

such 3-year period notwithstanding the provisions of section 

6212(c) or the provisions of any other law or rule of law which 

would otherwise prevent such assessment. 

‘‘(e) BASIS OF REPLACEMENT QUALIFYING VESSEL.—In the case 

of any replacement qualifying vessel purchased by the qualifying 

vessel operator which resulted in the nonrecognition of any part of 

the gain realized as the result of a sale or other disposition of a 

qualifying vessel, the basis shall be the cost of the replacement 

qualifying vessel decreased in the amount of the gain not so recognized; and if the property purchased consists of more than one piece 

of property, the basis determined under this sentence shall be allocated to the purchased properties in proportion to their respective 

costs.’’

(b) TECHNICAL AMENDMENTS.— (1) The second sentence of section 56(g)(4)(B)(i), as amended by this Act, is further amended by inserting ‘‘or 1357’’ after 

‘‘section 139A’’. 

(2) The table of subchapters for chapter 1 is amended by inserting after the item relating to subchapter S the following new 

item:

‘‘Subchapter R. Election to determine corporate tax on certain international shipping activities using per ton rate.’’

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act.

Subtitle F—Stock Options and Employee 

Stock Purchase Plan Stock Options 

SEC. 251. EXCLUSION OF INCENTIVE STOCK OPTIONS AND EMPLOYEE 

STOCK PURCHASE PLAN STOCK OPTIONS FROM WAGES. 

(a) EXCLUSION FROM EMPLOYMENT TAXES.— (1) SOCIAL SECURITY TAXES.— (A) Section 3121(a) (relating to definition of wages) is 

amended by striking ‘‘or’’ at the end of paragraph (20), by 

striking the period at the end of paragraph (21) and inserting ‘‘; or’’, and by inserting after paragraph (21) the following new paragraph: 

‘‘(22) remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual 

pursuant to an exercise of an incentive stock option (as deVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00045 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
42

fined in section 422(b)) or under an employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(B) Section 209(a) of the Social Security Act is amended by striking ‘‘or’’ at the end of paragraph (17), by striking 

the period at the end of paragraph (18) and inserting ‘‘; or’’, 

and by inserting after paragraph (18) the following new 

paragraph: 

‘‘(19) Remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual 

pursuant to an exercise of an incentive stock option (as defined in section 422(b) of the Internal Revenue Code of 

1986) or under an employee stock purchase plan (as defined 

in section 423(b) of such Code), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(2) RAILROAD RETIREMENT TAXES.—Subsection (e) of section 

3231 is amended by adding at the end the following new paragraph: 

‘‘(12) QUALIFIED STOCK OPTIONS.—The term ‘compensation’ 

shall not include any remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual 

pursuant to an exercise of an incentive stock option (as defined in section 422(b)) or under an employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(3) UNEMPLOYMENT TAXES.—Section 3306(b) (relating to 

definition of wages) is amended by striking ‘‘or’’ at the end of 

paragraph (17), by striking the period at the end of paragraph 

(18) and inserting ‘‘; or’’, and by inserting after paragraph (18) 

the following new paragraph: 

‘‘(19) remuneration on account of—

‘‘(A) a transfer of a share of stock to any individual 

pursuant to an exercise of an incentive stock option (as defined in section 422(b)) or under an employee stock purchase plan (as defined in section 423(b)), or 

‘‘(B) any disposition by the individual of such stock.’’. 

(b) WAGE WITHHOLDING NOT REQUIRED ON DISQUALIFYING DISPOSITIONS.—Section 421(b) (relating to effect of disqualifying dispositions) is amended by adding at the end the following new sentence: ‘‘No amount shall be required to be deducted and withheld 

under chapter 24 with respect to any increase in income attributable 

to a disposition described in the preceding sentence.’’. 

(c) WAGE WITHHOLDING NOT REQUIRED ON COMPENSATION

WHERE OPTION PRICE IS BETWEEN 85 PERCENT AND 100 PERCENT

OF VALUE OF STOCK.—Section 423(c) (relating to special rule where 

option price is between 85 percent and 100 percent of value of stock) 

is amended by adding at the end the following new sentence: ‘‘No 

amount shall be required to be deducted and withheld under chapter 24 with respect to any amount treated as compensation under 

this subsection.’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to stock acquired pursuant to options exercised after the 

date of the enactment of this Act.

43

TITLE III—TAX RELIEF FOR AGRICULTURE AND SMALL MANUFACTURERS 

Subtitle A—Volumetric Ethanol Excise Tax 

Credit 

SEC. 301. ALCOHOL AND BIODIESEL EXCISE TAX CREDIT AND EXTENSION OF ALCOHOL FUELS INCOME TAX CREDIT. 

(a) IN GENERAL.—Subchapter B of chapter 65 (relating to rules 

of special application) is amended by inserting after section 6425 

the following new section: 

‘‘SEC. 6426. CREDIT FOR ALCOHOL FUEL AND BIODIESEL MIXTURES. 

‘‘(a) ALLOWANCE OF CREDITS.—There shall be allowed as a 

credit against the tax imposed by section 4081 an amount equal to 

the sum of—

‘‘(1) the alcohol fuel mixture credit, plus 

‘‘(2) the biodiesel mixture credit. 

‘‘(b) ALCOHOL FUEL MIXTURE CREDIT.— ‘‘(1) IN GENERAL.—For purposes of this section, the alcohol 

fuel mixture credit is the product of the applicable amount and 

the number of gallons of alcohol used by the taxpayer in producing any alcohol fuel mixture for sale or use in a trade or 

business of the taxpayer. 

‘‘(2) APPLICABLE AMOUNT.—For purposes of this subsection—

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), the applicable amount is 51 cents. 

‘‘(B) MIXTURES NOT CONTAINING ETHANOL.—In the case 

of an alcohol fuel mixture in which none of the alcohol consists of ethanol, the applicable amount is 60 cents. 

‘‘(3) ALCOHOL FUEL MIXTURE.—For purposes of this subsection, the term ‘alcohol fuel mixture’ means a mixture of alcohol and a taxable fuel which—

‘‘(A) is sold by the taxpayer producing such mixture to 

any person for use as a fuel, or 

‘‘(B) is used as a fuel by the taxpayer producing such 

mixture. 

For purposes of subparagraph (A), a mixture produced by any 

person at a refinery prior to a taxable event which includes 

ethyl tertiary butyl ether or other ethers produced from alcohol 

shall be treated as sold at the time of its removal from the refinery (and only at such time) to another person for use as a fuel. 

‘‘(4) OTHER DEFINITIONS.—For purposes of this subsection—

‘‘(A) ALCOHOL.—The term ‘alcohol’ includes methanol 

and ethanol but does not include—

‘‘(i) alcohol produced from petroleum, natural gas, 

or coal (including peat), or 

‘‘(ii) alcohol with a proof of less than 190 (determined without regard to any added denaturants). 

Such term also includes an alcohol gallon equivalent of 

ethyl tertiary butyl ether or other ethers produced from 

such alcohol. 

44

‘‘(B) TAXABLE FUEL.—The term ‘taxable fuel’ has the 

meaning given such term by section 4083(a)(1). 

‘‘(5) TERMINATION.—This subsection shall not apply to any 

sale, use, or removal for any period after December 31, 2010. 

‘‘(c) BIODIESEL MIXTURE CREDIT.—

‘‘(1) IN GENERAL.—For purposes of this section, the biodiesel 

mixture credit is the product of the applicable amount and the 

number of gallons of biodiesel used by the taxpayer in producing any biodiesel mixture for sale or use in a trade or business of the taxpayer. 

‘‘(2) APPLICABLE AMOUNT.—For purposes of this subsection—

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), the applicable amount is 50 cents. 

‘‘(B) AMOUNT FOR AGRI-BIODIESEL.—In the case of any 

biodiesel which is agri-biodiesel, the applicable amount is 

$1.00. 

‘‘(3) BIODIESEL MIXTURE.—For purposes of this section, the 

term ‘biodiesel mixture’ means a mixture of biodiesel and diesel 

fuel (as defined in section 4083(a)(3)), determined without regard to any use of kerosene, which—

‘‘(A) is sold by the taxpayer producing such mixture to 

any person for use as a fuel, or 

‘‘(B) is used as a fuel by the taxpayer producing such 

mixture. 

‘‘(4) CERTIFICATION FOR BIODIESEL.—No credit shall be allowed under this subsection unless the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer of the biodiesel which identifies the 

product produced and the percentage of biodiesel and agri-biodiesel in the product. 

‘‘(5) OTHER DEFINITIONS.—Any term used in this subsection 

which is also used in section 40A shall have the meaning given 

such term by section 40A. 

‘‘(6) TERMINATION.—This subsection shall not apply to any 

sale, use, or removal for any period after December 31, 2006. 

‘‘(d) MIXTURE NOT USED AS A FUEL, ETC.—

‘‘(1) IMPOSITION OF TAX.—If—

‘‘(A) any credit was determined under this section with 

respect to alcohol or biodiesel used in the production of any 

alcohol fuel mixture or biodiesel mixture, respectively, and 

‘‘(B) any person— 

‘‘(i) separates the alcohol or biodiesel from the mixture, or 

‘‘(ii) without separation, uses the mixture other 

than as a fuel, 

then there is hereby imposed on such person a tax equal to 

the product of the applicable amount and the number of 

gallons of such alcohol or biodiesel.

‘‘(2) APPLICABLE LAWS.—All provisions of law, including 

penalties, shall, insofar as applicable and not inconsistent with 

this section, apply in respect of any tax imposed under paragraph (1) as if such tax were imposed by section 4081 and not 

by this section. 

45

‘‘(e) COORDINATION WITH EXEMPTION FROM EXCISE TAX.—Rules 

similar to the rules under section 40(c) shall apply for purposes of 

this section.’’. 

(b) REGISTRATION REQUIREMENT.—Section 4101(a)(1) (relating 

to registration), as amended by section 861, is amended by inserting 

‘‘and every person producing or importing biodiesel (as defined in 

section 40A(d)(1)) or alcohol (as defined in section 6426(b)(4)(A))’’ 

before ‘‘shall register with the Secretary’’. 

(c) ADDITIONAL AMENDMENTS.—

(1) Section 40(c) is amended by striking ‘‘subsection (b)(2), 

(k), or (m) of section 4041, section 4081(c), or section 4091(c)’’ 

and inserting ‘‘section 4041(b)(2), section 6426, or section 

6427(e)’’. 

(2) Paragraph (4) of section 40(d) is amended to read as 

follows: 

‘‘(4) VOLUME OF ALCOHOL.—For purposes of determining 

under subsection (a) the number of gallons of alcohol with respect to which a credit is allowable under subsection (a), the 

volume of alcohol shall include the volume of any denaturant 

(including gasoline) which is added under any formulas approved by the Secretary to the extent that such denaturants do 

not exceed 5 percent of the volume of such alcohol (including denaturants).’’. 

(3) Section 40(e)(1) is amended—

(A) by striking ‘‘2007’’ in subparagraph (A) and inserting ‘‘2010’’, and 

(B) by striking ‘‘2008’’ in subparagraph (B) and inserting ‘‘2011’’. 

(4) Section 40(h) is amended—

(A) by striking ‘‘2007’’ in paragraph (1) and inserting 

‘‘2010’’, and 

(B) by striking ‘‘, 2006, or 2007’’ in the table contained 

in paragraph (2) and inserting ‘‘through 2010’’. 

(5) Section 4041(b)(2)(B) is amended by striking ‘‘a substance other than petroleum or natural gas’’ and inserting ‘‘coal 

(including peat)’’. 

(6) Section 4041 is amended by striking subsection (k). 

(7) Section 4081 is amended by striking subsection (c). 

(8) Paragraph (2) of section 4083(a) is amended to read as 

follows: 

‘‘(2) GASOLINE.—The term ‘gasoline’—

‘‘(A) includes any gasoline blend, other than qualified 

methanol or ethanol fuel (as defined in section 

4041(b)(2)(B)), partially exempt methanol or ethanol fuel 

(as defined in section 4041(m)(2)), or a denatured alcohol, 

and 

‘‘(B) includes, to the extent prescribed in regulations—

‘‘(i) any gasoline blend stock, and 

‘‘(ii) any product commonly used as an additive in 

gasoline (other than alcohol). 

For purposes of subparagraph (B)(i), the term ‘gasoline blend 

stock’ means any petroleum product component of gasoline.’’. 

(9) Section 6427 is amended by inserting after subsection 

(d) the following new subsection: 

46

‘‘(e) ALCOHOL OR BIODIESEL USED TO PRODUCE ALCOHOL FUEL

AND BIODIESEL MIXTURES.—Except as provided in subsection (k)—

‘‘(1) USED TO PRODUCE A MIXTURE.—If any person produces 

a mixture described in section 6426 in such person’s trade or 

business, the Secretary shall pay (without interest) to such person an amount equal to the alcohol fuel mixture credit or the 

biodiesel mixture credit with respect to such mixture. 

‘‘(2) COORDINATION WITH OTHER REPAYMENT PROVISIONS.—

No amount shall be payable under paragraph (1) with respect 

to any mixture with respect to which an amount is allowed as 

a credit under section 6426. 

‘‘(3) TERMINATION.—This subsection shall not apply with 

respect to—

‘‘(A) any alcohol fuel mixture (as defined in section 

6426(b)(3)) sold or used after December 31, 2010, and 

‘‘(B) any biodiesel mixture (as defined in section 

6426(c)(3)) sold or used after December 31, 2006.’’. 

(10) Section 6427(i)(3) is amended—

(A) by striking ‘‘subsection (f)’’ both places it appears in 

subparagraph (A) and inserting ‘‘subsection (e)(1)’’, 

(B) by striking ‘‘gasoline, diesel fuel, or kerosene used 

to produce a qualified alcohol mixture (as defined in section 4081(c)(3))’’ in subparagraph (A) and inserting ‘‘a mixture described in section 6426’’, 

(C) by adding at the end of subparagraph (A) the following new flush sentence: 

‘‘In the case of an electronic claim, this subparagraph shall 

be applied without regard to clause (i).’’, 

(D) by striking ‘‘subsection (f)(1)’’ in subparagraph (B) 

and inserting ‘‘subsection (e)(1)’’, 

(E) by striking ‘‘20 days of the date of the filing of such 

claim’’ in subparagraph (B) and inserting ‘‘45 days of the 

date of the filing of such claim (20 days in the case of an 

electronic claim)’’, and 

(F) by striking ‘‘ALCOHOL MIXTURE’’ in the heading and 

inserting ‘‘ALCOHOL FUEL AND BIODIESEL MIXTURE’’. 

(11) Section 9503(b)(1) is amended by adding at the end the 

following new flush sentence: 

‘‘For purposes of this paragraph, taxes received under sections 

4041 and 4081 shall be determined without reduction for credits under section 6426.’’. 

(12) Section 9503(b)(4) is amended—

(A) by adding ‘‘or’’ at the end of subparagraph (C), 

(B) by striking the comma at the end of subparagraph 

(D)(iii) and inserting a period, and 

(C) by striking subparagraphs (E) and (F). 

(13) Section 9503(c)(2)(A) is amended by adding at the end 

the following: ‘‘Clauses (i)(III) and (ii) shall not apply to claims 

under section 6427(e).’’. 

(14) The table of sections for subchapter B of chapter 65 is 

amended by inserting after the item relating to section 6425 the 

following new item:

‘‘Sec. 6426. Credit for alcohol fuel and biodiesel mixtures.’’.

(d) EFFECTIVE DATES.—

47

(1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to 

fuel sold or used after December 31, 2004. 

(2) REGISTRATION REQUIREMENT.—The amendment made 

by subsection (b) shall take effect on April 1, 2005. 

(3) EXTENSION OF ALCOHOL FUELS CREDIT.—The amendments made by paragraphs (3), (4), and (14) of subsection (c) 

shall take effect on the date of the enactment of this Act. 

(4) REPEAL OF GENERAL FUND RETENTION OF CERTAIN ALCOHOL FUELS TAXES.—The amendments made by subsection 

(c)(12) shall apply to fuel sold or used after September 30, 2004. 

(e) FORMAT FOR FILING.—The Secretary of the Treasury shall 

describe the electronic format for filing claims described in section 

6427(i)(3)(B) of the Internal Revenue Code of 1986 (as amended by 

subsection (c)(10)(C)) not later than December 31, 2004. 

SEC. 302. BIODIESEL INCOME TAX CREDIT. 

(a) IN GENERAL.—Subpart D of part IV of subchapter A of 

chapter 1 (relating to business related credits) is amended by inserting after section 40 the following new section: 

‘‘SEC. 40A. BIODIESEL USED AS FUEL. 

‘‘(a) GENERAL RULE.—For purposes of section 38, the biodiesel 

fuels credit determined under this section for the taxable year is an 

amount equal to the sum of—

‘‘(1) the biodiesel mixture credit, plus 

‘‘(2) the biodiesel credit. 

‘‘(b) DEFINITION OF BIODIESEL MIXTURE CREDIT AND BIODIESEL

CREDIT.—For purposes of this section—

‘‘(1) BIODIESEL MIXTURE CREDIT.—

‘‘(A) IN GENERAL.—The biodiesel mixture credit of any 

taxpayer for any taxable year is 50 cents for each gallon of 

biodiesel used by the taxpayer in the production of a qualified biodiesel mixture. 

‘‘(B) QUALIFIED BIODIESEL MIXTURE.—The term ‘qualified biodiesel mixture’ means a mixture of biodiesel and 

diesel fuel (as defined in section 4083(a)(3)), determined 

without regard to any use of kerosene, which—

‘‘(i) is sold by the taxpayer producing such mixture 

to any person for use as a fuel, or 

‘‘(ii) is used as a fuel by the taxpayer producing 

such mixture. 

‘‘(C) SALE OR USE MUST BE IN TRADE OR BUSINESS, 

ETC.—Biodiesel used in the production of a qualified biodiesel mixture shall be taken into account—

‘‘(i) only if the sale or use described in subparagraph (B) is in a trade or business of the taxpayer, and 

‘‘(ii) for the taxable year in which such sale or use 

occurs. 

‘‘(D) CASUAL OFF-FARM PRODUCTION NOT ELIGIBLE.—No 

credit shall be allowed under this section with respect to 

any casual off-farm production of a qualified biodiesel mixture. 

‘‘(2) BIODIESEL CREDIT.— ‘‘(A) IN GENERAL.—The biodiesel credit of any taxpayer 

for any taxable year is 50 cents for each gallon of biodiesel 

48

which is not in a mixture with diesel fuel and which during the taxable year—

‘‘(i) is used by the taxpayer as a fuel in a trade or 

business, or 

‘‘(ii) is sold by the taxpayer at retail to a person 

and placed in the fuel tank of such person’s vehicle. 

‘‘(B) USER CREDIT NOT TO APPLY TO BIODIESEL SOLD AT

RETAIL.—No credit shall be allowed under subparagraph 

(A)(i) with respect to any biodiesel which was sold in a retail sale described in subparagraph (A)(ii). 

‘‘(3) CREDIT FOR AGRI-BIODIESEL.—In the case of any biodiesel which is agri-biodiesel, paragraphs (1)(A) and (2)(A) 

shall be applied by substituting ‘$1.00’ for ‘50 cents’. 

‘‘(4) CERTIFICATION FOR BIODIESEL.—No credit shall be allowed under this section unless the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer or importer of the biodiesel which 

identifies the product produced and the percentage of biodiesel 

and agri-biodiesel in the product. 

‘‘(c) COORDINATION WITH CREDIT AGAINST EXCISE TAX.—The 

amount of the credit determined under this section with respect to 

any biodiesel shall be properly reduced to take into account any benefit provided with respect to such biodiesel solely by reason of the 

application of section 6426 or 6427(e). 

‘‘(d) DEFINITIONS AND SPECIAL RULES.—For purposes of this 

section—

‘‘(1) BIODIESEL.—The term ‘biodiesel’ means the monoalkyl 

esters of long chain fatty acids derived from plant or animal 

matter which meet—

‘‘(A) the registration requirements for fuels and fuel additives established by the Environmental Protection Agency 

under section 211 of the Clean Air Act (42 U.S.C. 7545), 

and 

‘‘(B) the requirements of the American Society of Testing and Materials D6751. 

‘‘(2) AGRI-BIODIESEL.—The term ‘agri-biodiesel’ means biodiesel derived solely from virgin oils, including esters derived 

from virgin vegetable oils from corn, soybeans, sunflower seeds, 

cottonseeds, canola, crambe, rapeseeds, safflowers, flaxseeds, 

rice bran, and mustard seeds, and from animal fats. 

‘‘(3) MIXTURE OR BIODIESEL NOT USED AS A FUEL, ETC.—

‘‘(A) MIXTURES.—If—

‘‘(i) any credit was determined under this section 

with respect to biodiesel used in the production of any 

qualified biodiesel mixture, and 

‘‘(ii) any person— 

‘‘(I) separates the biodiesel from the mixture, 

or 

‘‘(II) without separation, uses the mixture 

other than as a fuel, 

then there is hereby imposed on such person a tax equal to 

the product of the rate applicable under subsection (b)(1)(A) 

and the number of gallons of such biodiesel in such mixture. 

‘‘(B) BIODIESEL.—If—

49

‘‘(i) any credit was determined under this section 

with respect to the retail sale of any biodiesel, and 

‘‘(ii) any person mixes such biodiesel or uses such 

biodiesel other than as a fuel, 

then there is hereby imposed on such person a tax equal to 

the product of the rate applicable under subsection (b)(2)(A) 

and the number of gallons of such biodiesel. 

‘‘(C) APPLICABLE LAWS.—All provisions of law, including penalties, shall, insofar as applicable and not inconsistent with this section, apply in respect of any tax imposed under subparagraph (A) or (B) as if such tax were 

imposed by section 4081 and not by this chapter. 

‘‘(4) PASS-THRU IN THE CASE OF ESTATES AND TRUSTS.—

Under regulations prescribed by the Secretary, rules similar to 

the rules of subsection (d) of section 52 shall apply. 

‘‘(e) TERMINATION.—This section shall not apply to any sale or 

use after December 31, 2006.’’. 

(b) CREDIT TREATED AS PART OF GENERAL BUSINESS CREDIT.—

Section 38(b) (relating to current year business credit), as amended 

by this Act, is amended by striking ‘‘plus’’ at the end of paragraph 

(15), by striking the period at the end of paragraph (16) and inserting ‘‘, plus’’, and by inserting after paragraph (16) the following new 

paragraph: 

‘‘(17) the biodiesel fuels credit determined under section 

40A(a).’’. 

(c) CONFORMING AMENDMENTS.—

(1)(A) Section 87 is amended to read as follows: 

‘‘SEC. 87. ALCOHOL AND BIODIESEL FUELS CREDITS. 

‘‘Gross income includes—

‘‘(1) the amount of the alcohol fuel credit determined with 

respect to the taxpayer for the taxable year under section 40(a), 

and 

‘‘(2) the biodiesel fuels credit determined with respect to the 

taxpayer for the taxable year under section 40A(a).’’. 

(B) The item relating to section 87 in the table of sections 

for part II of subchapter B of chapter 1 is amended by striking 

‘‘fuel credit’’ and inserting ‘‘and biodiesel fuels credits’’. 

(2) Section 196(c) is amended by striking ‘‘and’’ at the end 

of paragraph (9), by striking the period at the end of paragraph 

(10) and inserting ‘‘, and’’, and by adding at the end the following new paragraph:

‘‘(11) the biodiesel fuels credit determined under section 

40A(a).’’. 

(3) The table of sections for subpart D of part IV of subchapter A of chapter 1 is amended by adding after the item relating to section 40 the following new item:

‘‘Sec. 40A. Biodiesel used as fuel.’’.

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to fuel produced, and sold or used, after December 31, 

2004, in taxable years ending after such date. 

50

SEC. 303. INFORMATION REPORTING FOR PERSONS CLAIMING CERTAIN TAX BENEFITS. 

(a) IN GENERAL.—Subpart C of part III of subchapter A of 

chapter 32 is amended by adding at the end the following new section: 

‘‘SEC. 4104. INFORMATION REPORTING FOR PERSONS CLAIMING CERTAIN TAX BENEFITS. 

‘‘(a) IN GENERAL.—The Secretary shall require any person 

claiming tax benefits—

‘‘(1) under the provisions of section 34, 40, and 40A, to file 

a return at the time such person claims such benefits (in such 

manner as the Secretary may prescribe), and 

‘‘(2) under the provisions of section 4041(b)(2), 6426, or 

6427(e) to file a quarterly return (in such manner as the Secretary may prescribe). 

‘‘(b) CONTENTS OF RETURN.—Any return filed under this section 

shall provide such information relating to such benefits and the coordination of such benefits as the Secretary may require to ensure 

the proper administration and use of such benefits. 

‘‘(c) ENFORCEMENT.—With respect to any person described in 

subsection (a) and subject to registration requirements under this 

title, rules similar to rules of section 4222(c) shall apply with respect to any requirement under this section.’’. 

(b) CONFORMING AMENDMENT.—The table of sections for subpart C of part III of subchapter A of chapter 32 is amended by adding at the end the following new item:

‘‘Sec. 4104. Information reporting for persons claiming certain tax benefits.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on January 1, 2005.

Subtitle B—Agricultural Incentives 

SEC. 311. SPECIAL RULES FOR LIVESTOCK SOLD ON ACCOUNT OF 

WEATHER-RELATED CONDITIONS. 

(a) REPLACEMENT OF LIVESTOCK WITH OTHER FARM PROPERTY.—Subsection (f) of section 1033 (relating to involuntary conversions) is amended—

(1) by inserting ‘‘drought, flood, or other weather-related 

conditions, or’’ after ‘‘because of’’, 

(2) by inserting ‘‘in the case of soil contamination or other 

environmental contamination’’ after ‘‘including real property’’, 

and 

(3) by striking ‘‘WHERE THERE HAS BEEN ENVIRONMENTAL

CONTAMINATION’’ in the heading and inserting ‘‘IN CERTAIN

CASES’’. 

(b) EXTENSION OF REPLACEMENT PERIOD OF INVOLUNTARILY

CONVERTED LIVESTOCK.—Subsection (e) of section 1033 (relating to 

involuntary conversions) is amended—

(1) by striking ‘‘CONDITIONS.—For purposes’’ and inserting 

‘‘CONDITIONS.—

‘‘(1) IN GENERAL.—For purposes’’, and 

(2) by adding at the end the following new paragraph: 

‘‘(2) EXTENSION OF REPLACEMENT PERIOD.—

51

‘‘(A) IN GENERAL.—In the case of drought, flood, or 

other weather-related conditions described in paragraph (1) 

which result in the area being designated as eligible for assistance by the Federal Government, subsection (a)(2)(B) 

shall be applied with respect to any converted property by 

substituting ‘4 years’ for ‘2 years’. 

‘‘(B) FURTHER EXTENSION BY SECRETARY.—The Secretary may extend on a regional basis the period for replacement under this section (after the application of subparagraph (A)) for such additional time as the Secretary 

determines appropriate if the weather-related conditions 

which resulted in such application continue for more than 

3 years.’’. 

(c) INCOME INCLUSION RULES.—Section 451(e) (relating to special rule for proceeds from livestock sold on account of drought, 

flood, or other weather-related conditions) is amended by adding at 

the end the following new paragraph: 

‘‘(3) SPECIAL ELECTION RULES.—If section 1033(e)(2) applies 

to a sale or exchange of livestock described in paragraph (1), the 

election under paragraph (1) shall be deemed valid if made 

during the replacement period described in such section.’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to any taxable year with respect to which the due date 

(without regard to extensions) for the return is after December 31, 

2002. 

SEC. 312. PAYMENT OF DIVIDENDS ON STOCK OF COOPERATIVES 

WITHOUT REDUCING PATRONAGE DIVIDENDS. 

(a) IN GENERAL.—Subsection (a) of section 1388 (relating to patronage dividend defined) is amended by adding at the end the following: ‘‘For purposes of paragraph (3), net earnings shall not be reduced by amounts paid during the year as dividends on capital 

stock or other proprietary capital interests of the organization to the 

extent that the articles of incorporation or bylaws of such organization or other contract with patrons provide that such dividends are 

in addition to amounts otherwise payable to patrons which are derived from business done with or for patrons during the taxable 

year.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to distributions in taxable years beginning after the date 

of the enactment of this Act.

SEC. 313. APPORTIONMENT OF SMALL ETHANOL PRODUCER CREDIT. 

(a) ALLOCATION OF ALCOHOL FUELS CREDIT TO PATRONS OF A

COOPERATIVE.—Section 40(g) (relating to definitions and special 

rules for eligible small ethanol producer credit) is amended by adding at the end the following new paragraph: 

‘‘(6) ALLOCATION OF SMALL ETHANOL PRODUCER CREDIT TO

PATRONS OF COOPERATIVE.—

‘‘(A) ELECTION TO ALLOCATE.—

‘‘(i) IN GENERAL.—In the case of a cooperative organization described in section 1381(a), any portion of the 

credit determined under subsection (a)(3) for the taxable year may, at the election of the organization, be 

apportioned pro rata among patrons of the organizaVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00055 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
52

tion on the basis of the quantity or value of business 

done with or for such patrons for the taxable year. 

‘‘(ii) FORM AND EFFECT OF ELECTION.—An election 

under clause (i) for any taxable year shall be made on 

a timely filed return for such year. Such election, once 

made, shall be irrevocable for such taxable year. 

‘‘(B) TREATMENT OF ORGANIZATIONS AND PATRONS.— ‘‘(i) ORGANIZATIONS.—The amount of the credit not 

apportioned to patrons pursuant to subparagraph (A) 

shall be included in the amount determined under subsection (a)(3) for the taxable year of the organization. 

‘‘(ii) PATRONS.—The amount of the credit apportioned to patrons pursuant to subparagraph (A) shall 

be included in the amount determined under such subsection for the first taxable year of each patron ending 

on or after the last day of the payment period (as defined in section 1382(d)) for the taxable year of the organization or, if earlier, for the taxable year of each patron ending on or after the date on which the patron 

receives notice from the cooperative of the apportionment. 

‘‘(iii) SPECIAL RULES FOR DECREASE IN CREDITS

FOR TAXABLE YEAR.—If the amount of the credit of the 

organization determined under such subsection for a 

taxable year is less than the amount of such credit 

shown on the return of the organization for such year, 

an amount equal to the excess of—

‘‘(I) such reduction, over 

‘‘(ii) the amount not apportioned to such patrons under subparagraph (A) for the taxable year, 

shall be treated as an increase in tax imposed by this 

chapter on the organization. Such increase shall not be 

treated as tax imposed by this chapter for purposes of 

determining the amount of any credit under this chapter or for purposes of section 55.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years ending after the date of the enactment 

of this Act. 

SEC. 314. COORDINATE FARMERS AND FISHERMEN INCOME AVERAGING AND THE ALTERNATIVE MINIMUM TAX. 

(a) IN GENERAL.—Section 55(c) (defining regular tax) is amended by redesignating paragraph (2) as paragraph (3) and by inserting after paragraph (1) the following new paragraph: 

‘‘(2) COORDINATION WITH INCOME AVERAGING FOR FARMERS

AND FISHERMEN.—Solely for purposes of this section, section 

1301 (relating to averaging of farm and fishing income) shall 

not apply in computing the regular tax.’’. 

(b) ALLOWING INCOME AVERAGING FOR FISHERMEN.—

(1) IN GENERAL.—Section 1301(a) is amended by striking 

‘‘farming business’’ and inserting ‘‘farming business or fishing 

business’’. 

(2) DEFINITION OF ELECTED FARM INCOME.—

(A) IN GENERAL.—Clause (i) of section 1301(b)(1)(A) is 

amended by inserting ‘‘or fishing business’’ before the semicolon. 

53

(B) CONFORMING AMENDMENT.—Subparagraph (B) of 

section 1301(b)(1) is amended by inserting ‘‘or fishing business’’ after ‘‘farming business’’ both places it occurs. 

(3) DEFINITION OF FISHING BUSINESS.—Section 1301(b) is 

amended by adding at the end the following new paragraph: 

‘‘(4) FISHING BUSINESS.—The term ‘fishing business’ means 

the conduct of commercial fishing as defined in section 3 of the 

Magnuson-Stevens Fishery Conservation and Management Act 

(16 U.S.C. 1802).’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2003. 

SEC. 315. CAPITAL GAIN TREATMENT UNDER SECTION 631(b) TO APPLY 

TO OUTRIGHT SALES BY LANDOWNERS. 

(a) IN GENERAL.—The first sentence of section 631(b) (relating 

to disposal of timber with a retained economic interest) is amended 

by striking ‘‘retains an economic interest in such timber’’ and inserting ‘‘either retains an economic interest in such timber or makes an 

outright sale of such timber’’. 

(b) CONFORMING AMENDMENTS.—

(1) The third sentence of section 631(b) is amended by striking ‘‘The date of disposal’’ and inserting ‘‘In the case of disposal 

of timber with a retained economic interest, the date of disposal’’. 

(2) The heading for section 631(b) is amended by striking 

‘‘WITH A RETAINED ECONOMIC INTEREST’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to sales after December 31, 2004. 

SEC. 316. MODIFICATION TO COOPERATIVE MARKETING RULES TO INCLUDE VALUE ADDED PROCESSING INVOLVING ANIMALS. 

(a) IN GENERAL.—Section 1388 (relating to definitions and special rules) is amended by adding at the end the following new subsection: 

‘‘(k) COOPERATIVE MARKETING INCLUDES VALUE-ADDED PROCESSING INVOLVING ANIMALS.—For purposes of section 521 and this 

subchapter, the marketing of the products of members or other producers shall include the feeding of such products to cattle, hogs, 

fish, chickens, or other animals and the sale of the resulting animals or animal products.’’. 

(b) CONFORMING AMENDMENT.—Section 521(b) is amended by 

adding at the end the following new paragraph: 

‘‘(7) CROSS REFERENCE.—

‘‘For treatment of value-added processing involving animals, see 

section 1388(k).’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act.

SEC. 317. EXTENSION OF DECLARATORY JUDGMENT PROCEDURES TO 

FARMERS’ COOPERATIVE ORGANIZATIONS. 

(a) IN GENERAL.—Section 7428(a)(1) (relating to declaratory 

judgments of tax exempt organizations) is amended by striking ‘‘or’’ 

at the end of subparagraph (B) and by adding at the end the following new subparagraph: 

‘‘(D) with respect to the initial classification or continuing classification of a cooperative as an organization 

54

described in section 521(b) which is exempt from tax under 

section 521(a), or’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply with respect to pleadings filed after the date of the enactment of this Act. 

SEC. 318. CERTAIN EXPENSES OF RURAL LETTER CARRIERS. 

(a) IN GENERAL.—Section 162(o) (relating to treatment of certain reimbursed expenses of rural mail carriers) is amended by redesignating paragraph (2) as paragraph (3) and by inserting after 

paragraph (1) the following: 

‘‘(2) SPECIAL RULE WHERE EXPENSES EXCEED REIMBURSEMENTS.—Notwithstanding paragraph (1)(A), if the expenses incurred by an employee for the use of a vehicle in performing 

services described in paragraph (1) exceed the qualified reimbursements for such expenses, such excess shall be taken into 

account in computing the miscellaneous itemized deductions of 

the employee under section 67.’’. 

(b) CONFORMING AMENDMENT.—The heading for section 162(o) 

is amended by striking ‘‘REIMBURSED’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2003. 

SEC. 319. TREATMENT OF CERTAIN INCOME OF COOPERATIVES. 

(a) INCOME FROM OPEN ACCESS AND NUCLEAR DECOMMISSIONING TRANSACTIONS.—

(1) IN GENERAL.—Subparagraph (C) of section 501(c)(12) is 

amended by striking clause (ii) and adding at the end the following: 

‘‘(ii) from any provision or sale of electric energy 

transmission services or ancillary services if such services are provided on a nondiscriminatory open access 

basis under an open access transmission tariff approved or accepted by FERC or under an independent 

transmission provider agreement approved or accepted 

by FERC (other than income received or accrued directly or indirectly from a member), 

‘‘(iii) from the provision or sale of electric energy 

distribution services or ancillary services if such services are provided on a nondiscriminatory open access 

basis to distribute electric energy not owned by the mutual or electric cooperative company—

‘‘(I) to end-users who are served by distribution facilities not owned by such company or any 

of its members (other than income received or accrued directly or indirectly from a member), or 

‘‘(II) generated by a generation facility not 

owned or leased by such company or any of its 

members and which is directly connected to distribution facilities owned by such company or any 

of its members (other than income received or accrued directly or indirectly from a member), 

‘‘(iv) from any nuclear decommissioning transaction, or 

‘‘(v) from any asset exchange or conversion transaction. 

55

Clauses (ii) through (v) shall not apply to taxable years beginning after December 31, 2006.’’. 

(2) DEFINITIONS AND SPECIAL RULES.—Paragraph (12) of 

section 501(c) is amended by adding at the end the following 

new subparagraphs: 

‘‘(E) For purposes of subparagraph (C)(ii), the term 

‘FERC’ means the Federal Energy Regulatory Commission 

and references to such term shall be treated as including 

the Public Utility Commission of Texas with respect to any 

ERCOT utility (as defined in section 212(k)(2)(B) of the 

Federal Power Act (16 U.S.C. 824k(k)(2)(B))). 

‘‘(F) For purposes of subparagraph (C)(iii), the term 

‘nuclear decommissioning transaction’ means—

‘‘(i) any transfer into a trust, fund, or instrument 

established to pay any nuclear decommissioning costs 

if the transfer is in connection with the transfer of the 

mutual or cooperative electric company’s interest in a 

nuclear power plant or nuclear power plant unit, 

‘‘(ii) any distribution from any trust, fund, or instrument established to pay any nuclear decommissioning costs, or 

‘‘(iii) any earnings from any trust, fund, or instrument established to pay any nuclear decommissioning 

costs. 

‘‘(G) For purposes of subparagraph (C)(iv), the term 

‘asset exchange or conversion transaction’ means any voluntary exchange or involuntary conversion of any property 

related to generating, transmitting, distributing, or selling 

electric energy by a mutual or cooperative electric company, 

the gain from which qualifies for deferred recognition 

under section 1031 or 1033, but only if the replacement 

property acquired by such company pursuant to such section constitutes property which is used, or to be used, for—

‘‘(i) generating, transmitting, distributing, or selling electric energy, or 

‘‘(ii) producing, transmitting, distributing, or selling natural gas.’’. 

(b) TREATMENT OF INCOME FROM LOAD LOSS TRANSACTIONS, ETC.—Paragraph (12) of section 501(c), as amended by subsection 

(a)(2), is amended by adding after subparagraph (G) the following 

new subparagraph: 

‘‘(H)(i) In the case of a mutual or cooperative electric 

company described in this paragraph or an organization 

described in section 1381(a)(2)(C), income received or accrued from a load loss transaction shall be treated as an 

amount collected from members for the sole purpose of 

meeting losses and expenses. 

‘‘(ii) For purposes of clause (i), the term ‘load loss 

transaction’ means any wholesale or retail sale of electric 

energy (other than to members) to the extent that the aggregate sales during the recovery period do not exceed the load 

loss mitigation sales limit for such period. 

‘‘(iii) For purposes of clause (ii), the load loss mitigation sales limit for the recovery period is the sum of the annual load losses for each year of such period. 

56

‘‘(iv) For purposes of clause (iii), a mutual or cooperative electric company’s annual load loss for each year of the 

recovery period is the amount (if any) by which—

‘‘(I) the megawatt hours of electric energy sold during such year to members of such electric company are 

less than 

‘‘(II) the megawatt hours of electric energy sold 

during the base year to such members.

‘‘(v) For purposes of clause (iv)(II), the term ‘base year’ 

means—

‘‘(I) the calendar year preceding the start-up year, 

or 

‘‘(II) at the election of the mutual or cooperative 

electric company, the second or third calendar years 

preceding the start-up year. 

‘‘(vi) For purposes of this subparagraph, the recovery 

period is the 7-year period beginning with the start-up year. 

‘‘(vii) For purposes of this subparagraph, the start-up 

year is the first year that the mutual or cooperative electric 

company offers nondiscriminatory open access or the calendar year which includes the date of the enactment of this 

subparagraph, if later, at the election of such company.

‘‘(viii) A company shall not fail to be treated as a mutual or cooperative electric company for purposes of this 

paragraph or as a corporation operating on a cooperative 

basis for purposes of section 1381(a)(2)(C) by reason of the 

treatment under clause (i). 

‘‘(ix) For purposes of subparagraph (A), in the case of 

a mutual or cooperative electric company, income received, 

or accrued, indirectly from a member shall be treated as an 

amount collected from members for the sole purpose of 

meeting losses and expenses. 

‘‘(x) This subparagraph shall not apply to taxable years 

beginning after December 31, 2006.’’. 

(c) EXCEPTION FROM UNRELATED BUSINESS TAXABLE INCOME.—

Subsection (b) of section 512 (relating to modifications) is amended 

by adding at the end the following new paragraph: 

‘‘(18) TREATMENT OF MUTUAL OR COOPERATIVE ELECTRIC

COMPANIES.—In the case of a mutual or cooperative electric 

company described in section 501(c)(12), there shall be excluded 

income which is treated as member income under subparagraph 

(H) thereof.’’. 

(d) CROSS REFERENCE.—Section 1381 is amended by adding at 

the end the following new subsection:

‘‘(c) CROSS REFERENCE.—

‘‘For treatment of income from load loss transactions of organizations described in subsection (a)(2)(C), see section 501(c)(12)(H).’’.

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

57

SEC. 320. EXCLUSION FOR PAYMENTS TO INDIVIDUALS UNDER NATIONAL HEALTH SERVICE CORPS LOAN REPAYMENT PROGRAM AND CERTAIN STATE LOAN REPAYMENT PROGRAMS. 

(a) IN GENERAL.—Section 108(f) (relating to student loans) is 

amended by adding at the end the following new paragraph: 

‘‘(4) PAYMENTS UNDER NATIONAL HEALTH SERVICE CORPS

LOAN REPAYMENT PROGRAM AND CERTAIN STATE LOAN REPAYMENT PROGRAMS.—In the case of an individual, gross income 

shall not include any amount received under section 338B(g) of 

the Public Health Service Act or under a State program described in section 338I of such Act.’’. 

(b) TREATMENT FOR PURPOSES OF EMPLOYMENT TAXES.—Each 

of the following provisions is amended by inserting ‘‘108(f)(4),’’ after 

‘‘74(c),’’: 

(1) Section 3121(a)(20). 

(2) Section 3231(e)(5). 

(3) Section 3306(b)(16). 

(4) Section 3401(a)(19). 

(5) Section 209(a)(17) of the Social Security Act. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to amounts received by an individual in taxable years 

beginning after December 31, 2003. 

SEC. 321. MODIFICATION OF SAFE HARBOR RULES FOR TIMBER REITS. 

(a) EXPANSION OF PROHIBITED TRANSACTION SAFE HARBOR.—

Section 857(b)(6) (relating to income from prohibited transactions) 

is amended by redesignating subparagraphs (D) and (E) as subparagraphs (E) and (F), respectively, and by inserting after subparagraph (C) the following new subparagraph: 

‘‘(D) CERTAIN SALES NOT TO CONSTITUTE PROHIBITED

TRANSACTIONS.—For purposes of this part, the term ‘prohibited transaction’ does not include a sale of property 

which is a real estate asset (as defined in section 

856(c)(5)(B)) if—

‘‘(i) the trust held the property for not less than 4 

years in connection with the trade or business of producing timber, 

‘‘(ii) the aggregate expenditures made by the trust, 

or a partner of the trust, during the 4-year period preceding the date of sale which—

‘‘(I) are includible in the basis of the property 

(other than timberland acquisition expenditures), 

and 

‘‘(II) are directly related to operation of the 

property for the production of timber or for the 

preservation of the property for use as timberland, 

do not exceed 30 percent of the net selling price of the 

property, 

‘‘(iii) the aggregate expenditures made by the trust, 

or a partner of the trust, during the 4-year period preceding the date of sale which—

‘‘(I) are includible in the basis of the property 

(other than timberland acquisition expenditures), 

and 

58

‘‘(II) are not directly related to operation of the 

property for the production of timber, or for the 

preservation of the property for use as timberland, 

do not exceed 5 percent of the net selling price of the 

property, 

‘‘(iv)(I) during the taxable year the trust does not 

make more than 7 sales of property (other than sales 

of foreclosure property or sales to which section 1033 

applies), or 

‘‘(II) the aggregate adjusted bases (as determined 

for purposes of computing earnings and profits) of 

property (other than sales of foreclosure property or 

sales to which section 1033 applies) sold during the 

taxable year does not exceed 10 percent of the aggregate 

bases (as so determined) of all of the assets of the trust 

as of the beginning of the taxable year, 

‘‘(v) in the case that the requirement of clause 

(iv)(I) is not satisfied, substantially all of the marketing expenditures with respect to the property were 

made through an independent contractor (as defined in 

section 856(d)(3)) from whom the trust itself does not 

derive or receive any income, and 

‘‘(vi) the sales price of the property sold by the trust 

is not based in whole or in part on income or profits, 

including income or profits derived from the sale or operation of such property.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 322. EXPENSING OF CERTAIN REFORESTATION EXPENDITURES. 

(a) IN GENERAL.—So much of subsection (b) of section 194 (relating to amortization of reforestation expenditures) as precedes 

paragraph (2) is amended to read as follows: 

‘‘(b) TREATMENT AS EXPENSES.— ‘‘(1) ELECTION TO TREAT CERTAIN REFORESTATION EXPENDI- TURES AS EXPENSES.— ‘‘(A) IN GENERAL.—In the case of any qualified timber 

property with respect to which the taxpayer has made (in 

accordance with regulations prescribed by the Secretary) an 

election under this subsection, the taxpayer shall treat reforestation expenditures which are paid or incurred during 

the taxable year with respect to such property as an expense 

which is not chargeable to capital account. The reforestation expenditures so treated shall be allowed as a deduction. 

‘‘(B) DOLLAR LIMITATION.—The aggregate amount of reforestation expenditures which may be taken into account 

under subparagraph (A) with respect to each qualified timber property for any taxable year shall not exceed $10,000 

($5,000 in the case of a separate return by a married individual (as defined in section 7703)).’’. 

(b) NET AMORTIZABLE BASIS.—Section 194(c)(2) (defining amortizable basis) is amended by inserting ‘‘which have not been taken 

into account under subsection (b)’’ after ‘‘expenditures’’. 

(c) CONFORMING AMENDMENTS.—

59

(1) Section 194(b) is amended by striking paragraphs (3) 

and (4). 

(2) Section 194(b)(2) is amended by striking ‘‘paragraph 

(1)’’ both places it appears and inserting ‘‘paragraph (1)(B)’’.

(3) Section 194(c) is amended by striking paragraph (4) 

and inserting the following new paragraphs: 

‘‘(4) TREATMENT OF TRUSTS AND ESTATES.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), this section shall not apply to trusts and estates. 

‘‘(B) AMORTIZATION DEDUCTION ALLOWED TO ESTATES.—The benefit of the deduction for amortization provided by subsection (a) shall be allowed to estates in the 

same manner as in the case of an individual. The allowable deduction shall be apportioned between the income 

beneficiary and the fiduciary under regulations prescribed 

by the Secretary. Any amount so apportioned to a beneficiary shall be taken into account for purposes of determining the amount allowable as a deduction under subsection (a) to such beneficiary. 

‘‘(5) APPLICATION WITH OTHER DEDUCTIONS.—No deduction 

shall be allowed under any other provision of this chapter with 

respect to any expenditure with respect to which a deduction is 

allowed or allowable under this section to the taxpayer.’’. 

(4) The heading for section 194 is amended by striking 

‘‘AMORTIZATION’’ and inserting ‘‘TREATMENT’’. 

(5) The item relating to section 194 in the table of sections 

for part VI of subchapter B of chapter 1 is amended by striking 

‘‘Amortization’’ and inserting ‘‘Treatment’’. 

(d) REPEAL OF REFORESTATION CREDIT.—

(1) IN GENERAL.—Section 46 (relating to amount of credit) 

is amended—

(A) by adding ‘‘and’’ at the end of paragraph (1), 

(B) by striking ‘‘, and’’ at the end of paragraph (2) and 

inserting a period, and 

(C) by striking paragraph (3). 

(2) CONFORMING AMENDMENTS.—

(A) Section 48 is amended—

(i) by striking subsection (b), 

(ii) by striking ‘‘this subsection’’ in paragraph (5) 

of subsection (a) and inserting ‘‘subsection (a)’’, and 

(iii) by redesignating such paragraph (5) as subsection (b). 

(B) The heading for section 48 is amended by striking 

‘‘; REFORESTATION CREDIT’’. 

(C) The item relating to section 48 in the table of sections for subpart E of part IV of subchapter A of chapter 

1 is amended by striking ‘‘, reforestation credit’’. 

(D) Section 50(c)(3) is amended by striking ‘‘or reforestation credit’’. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply with respect to expenditures paid or incurred after the 

date of the enactment of this Act. 

60

Subtitle C—Incentives for Small 

Manufacturers 

SEC. 331. NET INCOME FROM PUBLICLY TRADED PARTNERSHIPS 

TREATED AS QUALIFYING INCOME OF REGULATED INVESTMENT COMPANIES. 

(a) IN GENERAL.—Paragraph (2) of section 851(b) (defining regulated investment company) is amended to read as follows: 

‘‘(2) at least 90 percent of its gross income is derived from—

‘‘(A) dividends, interest, payments with respect to securities loans (as defined in section 512(a)(5)), and gains from 

the sale or other disposition of stock or securities (as defined in section 2(a)(36) of the Investment Company Act of 

1940, as amended) or foreign currencies, or other income 

(including but not limited to gains from options, futures or 

forward contracts) derived with respect to its business of investing in such stock, securities, or currencies, and 

‘‘(B) net income derived from an interest in a qualified 

publicly traded partnership (as defined in subsection (h)); 

and’’. 

(b) SOURCE FLOW-THROUGH RULE NOT TO APPLY.—The last 

sentence of section 851(b) is amended by inserting ‘‘(other than a 

qualified publicly traded partnership as defined in subsection (h))’’ 

after ‘‘derived from a partnership’’. 

(c) LIMITATION ON OWNERSHIP.—Subsection (c) of section 851 is 

amended by redesignating paragraph (5) as paragraph (6) and inserting after paragraph (4) the following new paragraph: 

‘‘(5) The term ‘outstanding voting securities of such issuer’ 

shall include the equity securities of a qualified publicly traded 

partnership (as defined in subsection (h)).’’. 

(d) DEFINITION OF QUALIFIED PUBLICLY TRADED PARTNERSHIP.—Section 851 is amended by adding at the end the following 

new subsection: 

‘‘(h) QUALIFIED PUBLICLY TRADED PARTNERSHIP.—For purposes 

of this section, the term ‘qualified publicly traded partnership’ 

means a publicly traded partnership described in section 7704(b) 

other than a partnership which would satisfy the gross income requirements of section 7704(c)(2) if qualifying income included only 

income described in subsection (b)(2)(A).’’. 

(e) DEFINITION OF QUALIFYING INCOME.—Section 7704(d)(4) is 

amended by striking ‘‘section 851(b)(2)’’ and inserting ‘‘section 

851(b)(2)(A)’’. 

(f) LIMITATION ON COMPOSITION OF ASSETS.—Subparagraph 

(B) of section 851(b)(3) is amended to read as follows: 

‘‘(B) not more than 25 percent of the value of its total 

assets is invested in—

‘‘(i) the securities (other than Government securities 

or the securities of other regulated investment companies) of any one issuer, 

‘‘(ii) the securities (other than the securities of other 

regulated investment companies) of two or more issuers 

which the taxpayer controls and which are determined, 

under regulations prescribed by the Secretary, to be enVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00064 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
61

gaged in the same or similar trades or businesses or related trades or businesses, or 

‘‘(iii) the securities of one or more qualified publicly traded partnerships (as defined in subsection 

(h)).’’. 

(g) APPLICATION OF SPECIAL PASSIVE ACTIVITY RULE TO REGU- LATED INVESTMENT COMPANIES.—Subsection (k) of section 469 (relating to separate application of section in case of publicly traded 

partnerships) is amended by adding at the end the following new 

paragraph: 

‘‘(4) APPLICATION TO REGULATED INVESTMENT COMPA- NIES.—For purposes of this section, a regulated investment company (as defined in section 851) holding an interest in a qualified publicly traded partnership (as defined in section 851(h)) 

shall be treated as a taxpayer described in subsection (a)(2) 

with respect to items attributable to such interest.’’. 

(h) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act.

SEC. 332. SIMPLIFICATION OF EXCISE TAX IMPOSED ON BOWS AND ARROWS. 

(a) BOWS.—Paragraph (1) of section 4161(b) (relating to bows) 

is amended to read as follows: 

‘‘(1) BOWS.— ‘‘(A) IN GENERAL.—There is hereby imposed on the sale 

by the manufacturer, producer, or importer of any bow 

which has a peak draw weight of 30 pounds or more, a tax 

equal to 11 percent of the price for which so sold. 

‘‘(B) ARCHERY EQUIPMENT.—There is hereby imposed 

on the sale by the manufacturer, producer, or importer—

‘‘(i) of any part or accessory suitable for inclusion 

in or attachment to a bow described in subparagraph 

(A), and 

‘‘(ii) of any quiver or broadhead suitable for use 

with an arrow described in paragraph (2), 

a tax equal to 11 percent of the price for which so sold.’’. 

(b) ARROWS.—Subsection (b) of section 4161 (relating to bows 

and arrows, etc.) is amended by redesignating paragraph (3) as 

paragraph (4) and inserting after paragraph (2) the following: 

‘‘(3) ARROWS.— ‘‘(A) IN GENERAL.—There is hereby imposed on the sale 

by the manufacturer, producer, or importer of any arrow, 

a tax equal to 12 percent of the price for which so sold. 

‘‘(B) EXCEPTION.—In the case of any arrow of which the 

shaft or any other component has been previously taxed 

under paragraph (1) or (2)—

‘‘(i) section 6416(b)(3) shall not apply, and 

‘‘(ii) the tax imposed by subparagraph (A) shall be 

an amount equal to the excess (if any) of—

‘‘(I) the amount of tax imposed by this paragraph (determined without regard to this subparagraph), over 

‘‘(II) the amount of tax paid with respect to the 

tax imposed under paragraph (1) or (2) on such 

shaft or component. 

62

‘‘(C) ARROW.—For purposes of this paragraph, the term 

‘arrow’ means any shaft described in paragraph (2) to 

which additional components are attached.’’. 

(c) CONFORMING AMENDMENTS.—Section 4161(b)(2) is amended—

(1) by inserting ‘‘(other than broadheads)’’ after ‘‘point’’, and 

(2) by striking ‘‘ARROWS.—’’ in the heading and inserting 

‘‘ARROW COMPONENTS.—’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to articles sold by the manufacturer, producer, or importer after the date which is 30 days after the date of the enactment of this Act. 

SEC. 333. REDUCTION OF EXCISE TAX ON FISHING TACKLE BOXES. 

(a) IN GENERAL.—Subsection (a) of section 4161 (relating to 

sport fishing equipment) is amended by redesignating paragraph (3) 

as paragraph (4) and by inserting after paragraph (2) the following 

new paragraph: 

‘‘(3) 3 PERCENT RATE OF TAX FOR TACKLE BOXES.—In the 

case of fishing tackle boxes, paragraph (1) shall be applied by 

substituting ‘3 percent’ for ‘10 percent’.’’. 

(b) EFFECTIVE DATE.—The amendments made this section shall 

apply to articles sold by the manufacturer, producer, or importer 

after December 31, 2004. 

SEC. 334. SONAR DEVICES SUITABLE FOR FINDING FISH. 

(a) NOT TREATED AS SPORT FISHING EQUIPMENT.—Subsection 

(a) of section 4162 (relating to sport fishing equipment defined) is 

amended by inserting ‘‘and’’ at the end of paragraph (8), by striking 

‘‘, and’’ at the end of paragraph (9) and inserting a period, and by 

striking paragraph (10). 

(b) CONFORMING AMENDMENT.—Section 4162 is amended by 

striking subsection (b) and by redesignating subsection (c) as subsection (b). 

(c) EFFECTIVE DATE.—The amendments made this section shall 

apply to articles sold by the manufacturer, producer, or importer 

after December 31, 2004. 

SEC. 335. CHARITABLE CONTRIBUTION DEDUCTION FOR CERTAIN EXPENSES INCURRED IN SUPPORT OF NATIVE ALASKAN 

SUBSISTENCE WHALING. 

(a) IN GENERAL.—Section 170 (relating to charitable, etc., contributions and gifts), as amended by this Act, is amended by redesignating subsection (n) as subsection (o) and by inserting after subsection (m) the following new subsection: 

‘‘(n) EXPENSES PAID BY CERTAIN WHALING CAPTAINS IN SUPPORT OF NATIVE ALASKAN SUBSISTENCE WHALING.—

‘‘(1) IN GENERAL.—In the case of an individual who is recognized by the Alaska Eskimo Whaling Commission as a whaling captain charged with the responsibility of maintaining and 

carrying out sanctioned whaling activities and who engages in 

such activities during the taxable year, the amount described in 

paragraph (2) (to the extent such amount does not exceed 

$10,000 for the taxable year) shall be treated for purposes of 

this section as a charitable contribution. 

‘‘(2) AMOUNT DESCRIBED.—

63

‘‘(A) IN GENERAL.—The amount described in this paragraph is the aggregate of the reasonable and necessary 

whaling expenses paid by the taxpayer during the taxable 

year in carrying out sanctioned whaling activities. 

‘‘(B) WHALING EXPENSES.—For purposes of subparagraph (A), the term ‘whaling expenses’ includes expenses 

for—

‘‘(i) the acquisition and maintenance of whaling 

boats, weapons, and gear used in sanctioned whaling 

activities, 

‘‘(ii) the supplying of food for the crew and other 

provisions for carrying out such activities, and 

‘‘(iii) storage and distribution of the catch from 

such activities. 

‘‘(3) SANCTIONED WHALING ACTIVITIES.—For purposes of 

this subsection, the term ‘sanctioned whaling activities’ means 

subsistence bowhead whale hunting activities conducted pursuant to the management plan of the Alaska Eskimo Whaling 

Commission. 

‘‘(4) SUBSTANTIATION OF EXPENSES.—The Secretary shall 

issue guidance requiring that the taxpayer substantiate the 

whaling expenses for which a deduction is claimed under this 

subsection, including by maintaining appropriate written 

records with respect to the time, place, date, amount, and nature of the expense, as well as the taxpayer’s eligibility for such 

deduction, and that (to the extent provided by the Secretary) 

such substantiation be provided as part of the taxpayer’s return 

of tax.’’. 

(b) EFFECTIVE DATE.—The amendments made by subsection (a) 

shall apply to contributions made after December 31, 2004. 

SEC. 336. MODIFICATION OF DEPRECIATION ALLOWANCE FOR AIRCRAFT. 

(a) AIRCRAFT TREATED AS QUALIFIED PROPERTY.—

(1) IN GENERAL.—Paragraph (2) of section 168(k) is amended by redesignating subparagraphs (C) through (F) as subparagraphs (D) through (G), respectively, and by inserting after subparagraph (B) the following new subparagraph: 

‘‘(C) CERTAIN AIRCRAFT.—The term ‘qualified property’ 

includes property—

‘‘(i) which meets the requirements of clauses (ii) 

and (iii) of subparagraph (A), 

‘‘(ii) which is an aircraft which is not a transportation property (as defined in subparagraph (B)(iii)) 

other than for agricultural or firefighting purposes, 

‘‘(iii) which is purchased and on which such purchaser, at the time of the contract for purchase, has 

made a nonrefundable deposit of the lesser of—

‘‘(I) 10 percent of the cost, or 

‘‘(II) $100,000, and 

‘‘(iv) which has—

‘‘(I) an estimated production period exceeding 

4 months, and 

‘‘(II) a cost exceeding $200,000.’’.

64

(2) PLACED IN SERVICE DATE.—Clause (iv) of section 

168(k)(2)(A) is amended by striking ‘‘subparagraph (B)’’ and inserting ‘‘subparagraphs (B) and (C)’’. 

(b) CONFORMING AMENDMENTS.—

(1) Section 168(k)(2)(B) is amended by adding at the end 

the following new clause: 

‘‘(iv) APPLICATION OF SUBPARAGRAPH.—This subparagraph shall not apply to any property which is described in subparagraph (C).’’. 

(2) Section 168(k)(4)(A)(ii) is amended by striking ‘‘paragraph (2)(C)’’ and inserting ‘‘paragraph (2)(D)’’. 

(3) Section 168(k)(4)(B)(iii) is amended by inserting ‘‘and 

paragraph (2)(C)’’ after ‘‘of this paragraph)’’. 

(4) Section 168(k)(4)(C) is amended by striking ‘‘subparagraphs (B) and (D)’’ and inserting ‘‘subparagraphs (B), (C), and 

(E)’’. 

(5) Section 168(k)(4)(D) is amended by striking ‘‘Paragraph 

(2)(E)’’ and inserting ‘‘Paragraph (2)(F)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect as if included in the amendments made by section 

101 of the Job Creation and Worker Assistance Act of 2002. 

SEC. 337. MODIFICATION OF PLACED IN SERVICE RULE FOR BONUS 

DEPRECIATION PROPERTY. 

(a) IN GENERAL.—Subclause (II) of section 168(k)(2)(E)(iii) (relating to syndication), as amended by the Working Families Tax Relief Act of 2004 and as redesignated by this Act, is amended by inserting before the comma at the end the following: ‘‘(or, in the case 

of multiple units of property subject to the same lease, within 3 

months after the date the final unit is placed in service, so long as 

the period between the time the first unit is placed in service and 

the time the last unit is placed in service does not exceed 12 

months)’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to property sold after June 4, 2004. 

SEC. 338. EXPENSING OF CAPITAL COSTS INCURRED IN COMPLYING 

WITH ENVIRONMENTAL PROTECTION AGENCY SULFUR 

REGULATIONS. 

(a) IN GENERAL.—Part VI of subchapter B of chapter 1 (relating 

to itemized deductions for individuals and corporations) is amended 

by inserting after section 179A the following new section: 

‘‘SEC. 179B. DEDUCTION FOR CAPITAL COSTS INCURRED IN COMPLYING WITH ENVIRONMENTAL PROTECTION AGENCY 

SULFUR REGULATIONS. 

‘‘(a) ALLOWANCE OF DEDUCTION.—In the case of a small business refiner (as defined in section 45H(c)(1)) which elects the application of this section, there shall be allowed as a deduction an 

amount equal to 75 percent of qualified capital costs (as defined in 

section 45H(c)(2)) which are paid or incurred by the taxpayer during the taxable year. 

‘‘(b) REDUCED PERCENTAGE.—In the case of a small business refiner with average daily domestic refinery runs for the 1-year period 

ending on December 31, 2002, in excess of 155,000 barrels, the number of percentage points described in subsection (a) shall be reduced 

(not below zero) by the product of such number (before the applicaVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00068 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
65

tion of this subsection) and the ratio of such excess to 50,000 barrels. 

‘‘(c) BASIS REDUCTION.— ‘‘(1) IN GENERAL.—For purposes of this title, the basis of 

any property shall be reduced by the portion of the cost of such 

property taken into account under subsection (a). 

‘‘(2) ORDINARY INCOME RECAPTURE.—For purposes of section 1245, the amount of the deduction allowable under subsection (a) with respect to any property which is of a character 

subject to the allowance for depreciation shall be treated as a 

deduction allowed for depreciation under section 167.’’. 

‘‘(d) COORDINATION WITH OTHER PROVISIONS.—Section 280B 

shall not apply to amounts which are treated as expenses under this 

section.’’. 

(b) CONFORMING AMENDMENTS.—

(1) Section 263(a)(1), as amended by this Act, is amended 

by striking ‘‘or’’ at the end of subparagraph (G), by striking the 

period at the end of subparagraph (H) and inserting ‘‘, or’’, and 

by adding at the end the following new subparagraph: 

‘‘(I) expenditures for which a deduction is allowed 

under section 179B.’’. 

(2) Section 263A(c)(3) is amended by inserting ‘‘179B,’’ after 

‘‘section’’. 

(3) Section 312(k)(3)(B) is amended by striking ‘‘or 179A’’ 

each place it appears in the heading and text and inserting 

‘‘179A, or 179B’’. 

(4) Section 1016(a) is amended by striking ‘‘and’’ at the end 

of paragraph (28), by striking the period at the end of paragraph (29) and inserting ‘‘, and’’, and by inserting after paragraph (29) the following new paragraph: 

‘‘(30) to the extent provided in section 179B(c).’’

(5) Paragraphs (2)(C) and (3)(C) of section 1245(a) are each 

amended by inserting ‘‘179B,’’ after ‘‘179A,’’. 

(6) The table of sections for part VI of subchapter B of 

chapter 1, as amended by this Act, is amended by inserting 

after the item relating to section 179A the following new item:

‘‘Sec. 179B. Deduction for capital costs incurred in complying with 

Environmental Protection Agency sulfur regulations.’’.

(c) EFFECTIVE DATE.—The amendment made by this section 

shall apply to expenses paid or incurred after December 31, 2002, 

in taxable years ending after such date. 

SEC. 339. CREDIT FOR PRODUCTION OF LOW SULFUR DIESEL FUEL. 

(a) IN GENERAL.—Subpart D of part IV of subchapter A of 

chapter 1 (relating to business-related credits), as amended by this 

Act, is amended by inserting after section 45G the following new 

section: 

‘‘SEC. 45H. CREDIT FOR PRODUCTION OF LOW SULFUR DIESEL FUEL. 

‘‘(a) IN GENERAL.—For purposes of section 38, the amount of the 

low sulfur diesel fuel production credit determined under this section with respect to any facility of a small business refiner is an 

amount equal to 5 cents for each gallon of low sulfur diesel fuel produced during the taxable year by such small business refiner at 

such facility. 

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‘‘(b) MAXIMUM CREDIT.— ‘‘(1) IN GENERAL.—The aggregate credit determined under 

subsection (a) for any taxable year with respect to any facility 

shall not exceed—

‘‘(A) 25 percent of the qualified capital costs incurred 

by the small business refiner with respect to such facility, 

reduced by 

‘‘(B) the aggregate credits determined under this section 

for all prior taxable years with respect to such facility. 

‘‘(2) REDUCED PERCENTAGE.—In the case of a small business refiner with average daily domestic refinery runs for the 1-

year period ending on December 31, 2002, in excess of 155,000 

barrels, the number of percentage points described in paragraph (1) shall be reduced (not below zero) by the product of 

such number (before the application of this paragraph) and the 

ratio of such excess to 50,000 barrels. 

‘‘(c) DEFINITIONS AND SPECIAL RULE.—For purposes of this section—

‘‘(1) SMALL BUSINESS REFINER.—The term ‘small business 

refiner’ means, with respect to any taxable year, a refiner of 

crude oil—

‘‘(A) with respect to which not more than 1,500 individuals are engaged in the refinery operations of the business 

on any day during such taxable year, and 

‘‘(B) the average daily domestic refinery run or average 

retained production of which for all facilities of the taxpayer for the 1-year period ending on December 31, 2002, 

did not exceed 205,000 barrels. 

‘‘(2) QUALIFIED CAPITAL COSTS.—The term ‘qualified capital 

costs’ means, with respect to any facility, those costs paid or incurred during the applicable period for compliance with the applicable EPA regulations with respect to such facility, including 

expenditures for the construction of new process operation units 

or the dismantling and reconstruction of existing process units 

to be used in the production of low sulfur diesel fuel, associated 

adjacent or offsite equipment (including tankage, catalyst, and 

power supply), engineering, construction period interest, and 

sitework.

‘‘(3) APPLICABLE EPA REGULATIONS.—The term ‘applicable 

EPA regulations’ means the Highway Diesel Fuel Sulfur Control Requirements of the Environmental Protection Agency. 

‘‘(4) APPLICABLE PERIOD.—The term ‘applicable period’ 

means, with respect to any facility, the period beginning on 

January 1, 2003, and ending on the earlier of the date which 

is 1 year after the date on which the taxpayer must comply with 

the applicable EPA regulations with respect to such facility or 

December 31, 2009. 

‘‘(5) LOW SULFUR DIESEL FUEL.—The term ‘low sulfur diesel 

fuel’ means diesel fuel with a sulfur content of 15 parts per million or less. 

‘‘(d) REDUCTION IN BASIS.—For purposes of this subtitle, if a 

credit is determined under this section for any expenditure with respect to any property, the increase in basis of such property which 

would (but for this subsection) result from such expenditure shall be 

reduced by the amount of the credit so determined. 

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‘‘(e) SPECIAL RULE FOR DETERMINATION OF REFINERY RUNS.—

For purposes this section and section 179B(b), in the calculation of 

average daily domestic refinery run or retained production, only refineries which on April 1, 2003, were refineries of the refiner or a 

related person (within the meaning of section 613A(d)(3)), shall be 

taken into account. 

‘‘(f) CERTIFICATION.—

‘‘(1) REQUIRED.—No credit shall be allowed unless, not 

later than the date which is 30 months after the first day of the 

first taxable year in which the low sulfur diesel fuel production 

credit is determined with respect to a facility, the small business refiner obtains certification from the Secretary, after consultation with the Administrator of the Environmental Protection Agency, that the taxpayer’s qualified capital costs with respect to such facility will result in compliance with the applicable EPA regulations. 

‘‘(2) CONTENTS OF APPLICATION.—An application for certification shall include relevant information regarding unit capacities and operating characteristics sufficient for the Secretary, 

after consultation with the Administrator of the Environmental 

Protection Agency, to determine that such qualified capital costs 

are necessary for compliance with the applicable EPA regulations. 

‘‘(3) REVIEW PERIOD.—Any application shall be reviewed 

and notice of certification, if applicable, shall be made within 

60 days of receipt of such application. In the event the Secretary 

does not notify the taxpayer of the results of such certification 

within such period, the taxpayer may presume the certification 

to be issued until so notified. 

‘‘(4) STATUTE OF LIMITATIONS.—With respect to the credit 

allowed under this section—

‘‘(A) the statutory period for the assessment of any deficiency attributable to such credit shall not expire before the 

end of the 3-year period ending on the date that the review 

period described in paragraph (3) ends with respect to the 

taxpayer, and 

‘‘(B) such deficiency may be assessed before the expiration of such 3-year period notwithstanding the provisions of 

any other law or rule of law which would otherwise prevent 

such assessment. 

‘‘(g) COOPERATIVE ORGANIZATIONS.—

‘‘(1) APPORTIONMENT OF CREDIT.—

‘‘(A) IN GENERAL.—In the case of a cooperative organization described in section 1381(a), any portion of the credit determined under subsection (a) for the taxable year may, 

at the election of the organization, be apportioned among 

patrons eligible to share in patronage dividends on the 

basis of the quantity or value of business done with or for 

such patrons for the taxable year. 

‘‘(B) FORM AND EFFECT OF ELECTION.—An election 

under subparagraph (A) for any taxable year shall be made 

on a timely filed return for such year. Such election, once 

made, shall be irrevocable for such taxable year. 

‘‘(2) TREATMENT OF ORGANIZATIONS AND PATRONS.—

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‘‘(A) ORGANIZATIONS.—The amount of the credit not apportioned to patrons pursuant to paragraph (1) shall be included in the amount determined under subsection (a) for 

the taxable year of the organization. 

‘‘(B) PATRONS.—The amount of the credit apportioned 

to patrons pursuant to paragraph (1) shall be included in 

the amount determined under subsection (a) for the first 

taxable year of each patron ending on or after the last day 

of the payment period (as defined in section 1382(d)) for the 

taxable year of the organization or, if earlier, for the taxable year of each patron ending on or after the date on 

which the patron receives notice from the cooperative of the 

apportionment. 

‘‘(3) SPECIAL RULE.—If the amount of a credit which has 

been apportioned to any patron under this subsection is decreased for any reason—

‘‘(A) such amount shall not increase the tax imposed on 

such patron, and 

‘‘(B) the tax imposed by this chapter on such organization shall be increased by such amount. 

The increase under subparagraph (B) shall not be treated as 

tax imposed by this chapter for purposes of determining the 

amount of any credit under this chapter or for purposes of section 55.’’. 

(b) CREDIT MADE PART OF GENERAL BUSINESS CREDIT.—Subsection (b) of section 38 (relating to general business credit), as 

amended by this Act, is amended by striking ‘‘plus’’ at the end of 

paragraph (16), by striking the period at the end of paragraph (17) 

and inserting ‘‘, plus’’, and by inserting after paragraph (17) the following new paragraph: 

‘‘(18) the low sulfur diesel fuel production credit determined 

under section 45H(a).’’. 

(c) DENIAL OF DOUBLE BENEFIT.—Section 280C (relating to certain expenses for which credits are allowable) is amended by adding 

at the end the following new subsection: 

‘‘(d) LOW SULFUR DIESEL FUEL PRODUCTION CREDIT.—No deduction shall be allowed for that portion of the expenses otherwise 

allowable as a deduction for the taxable year which is equal to the 

amount of the credit determined for the taxable year under section 

45H(a).’’. 

(d) BASIS ADJUSTMENT.—Section 1016(a) (relating to adjustments to basis), as amended by this Act, is amended by striking 

‘‘and’’ at the end of paragraph (29), by striking the period at the end 

of paragraph (30) and inserting ‘‘, and’’, and by inserting after 

paragraph (30) the following new paragraph: 

‘‘(31) in the case of a facility with respect to which a credit 

was allowed under section 45H, to the extent provided in section 45H(d).’’. 

(e) DEDUCTION FOR CERTAIN UNUSED BUSINESS CREDITS.—Section 196(c) (defining qualified business credits), as amended by this 

Act, is amended by striking ‘‘and’’ at the end of paragraph (10), by 

striking the period at the end of paragraph (11) and inserting ‘‘, 

and’’, and by adding after paragraph (11) the following new paragraph: 

69

‘‘(12) the low sulfur diesel fuel production credit determined 

under section 45H(a).’’. 

(e) CLERICAL AMENDMENT.—The table of sections for subpart D 

of part IV of subchapter A of chapter 1, as amended by this Act, is 

amended by inserting after the item relating to section 45G the following new item:

‘‘Sec. 45H. Credit for production of low sulfur diesel fuel.’’.

(f) EFFECTIVE DATE.—The amendments made by this section 

shall apply to expenses paid or incurred after December 31, 2002, 

in taxable years ending after such date. 

SEC. 340. EXPANSION OF QUALIFIED SMALL-ISSUE BOND PROGRAM. 

(a) IN GENERAL.—Section 144(a)(4) (relating to $10,000,000 

limit in certain cases) is amended by adding at the end the following new subparagraph: 

‘‘(G) ADDITIONAL CAPITAL EXPENDITURES NOT TAKEN

INTO ACCOUNT.—With respect to bonds issued after September 30, 2009, in addition to any capital expenditure described in subparagraph (C), capital expenditures of not to 

exceed $10,000,000 shall not be taken into account for purposes of applying subparagraph (A)(ii).’’. 

(b) CONFORMING AMENDMENT.—Subparagraph (F) of section 

144(a)(4) is amended by adding at the end the following new sentence: ‘‘This subparagraph shall not apply to bonds issued after 

September 30, 2009.’’.

SEC. 341. OIL AND GAS FROM MARGINAL WELLS. 

(a) IN GENERAL.—Subpart D of part IV of subchapter A of 

chapter 1 (relating to business credits), as amended by this Act, is 

amended by inserting after section 45H the following: 

‘‘SEC. 45I. CREDIT FOR PRODUCING OIL AND GAS FROM MARGINAL 

WELLS. 

‘‘(a) GENERAL RULE.—For purposes of section 38, the marginal 

well production credit for any taxable year is an amount equal to 

the product of—

‘‘(1) the credit amount, and 

‘‘(2) the qualified credit oil production and the qualified 

natural gas production which is attributable to the taxpayer. 

‘‘(b) CREDIT AMOUNT.—For purposes of this section—

‘‘(1) IN GENERAL.—The credit amount is—

‘‘(A) $3 per barrel of qualified crude oil production, 

and 

‘‘(B) 50 cents per 1,000 cubic feet of qualified natural 

gas production. 

‘‘(2) REDUCTION AS OIL AND GAS PRICES INCREASE.—

‘‘(A) IN GENERAL.—The $3 and 50 cents amounts under 

paragraph (1) shall each be reduced (but not below zero) by 

an amount which bears the same ratio to such amount (determined without regard to this paragraph) as—

‘‘(i) the excess (if any) of the applicable reference 

price over $15 ($1.67 for qualified natural gas production), bears to 

‘‘(ii) $3 ($0.33 for qualified natural gas production). 

70

The applicable reference price for a taxable year is the reference price of the calendar year preceding the calendar 

year in which the taxable year begins. 

‘‘(B) INFLATION ADJUSTMENT.—In the case of any taxable year beginning in a calendar year after 2005, each of 

the dollar amounts contained in subparagraph (A) shall be 

increased to an amount equal to such dollar amount multiplied by the inflation adjustment factor for such calendar 

year (determined under section 43(b)(3)(B) by substituting 

‘2004’ for ‘1990’). 

‘‘(C) REFERENCE PRICE.—For purposes of this paragraph, the term ‘reference price’ means, with respect to any 

calendar year—

‘‘(i) in the case of qualified crude oil production, 

the reference price determined under section 

29(d)(2)(C), and 

‘‘(ii) in the case of qualified natural gas production, the Secretary’s estimate of the annual average 

wellhead price per 1,000 cubic feet for all domestic natural gas. 

‘‘(c) QUALIFIED CRUDE OIL AND NATURAL GAS PRODUCTION.—

For purposes of this section—

‘‘(1) IN GENERAL.—The terms ‘qualified crude oil production’ and ‘qualified natural gas production’ mean domestic 

crude oil or natural gas which is produced from a qualified 

marginal well. 

‘‘(2) LIMITATION ON AMOUNT OF PRODUCTION WHICH MAY

QUALIFY.—

‘‘(A) IN GENERAL.—Crude oil or natural gas produced 

during any taxable year from any well shall not be treated 

as qualified crude oil production or qualified natural gas 

production to the extent production from the well during 

the taxable year exceeds 1,095 barrels or barrel-of-oil 

equivalents (as defined in section 29(d)(5)). 

‘‘(B) PROPORTIONATE REDUCTIONS.—

‘‘(i) SHORT TAXABLE YEARS.—In the case of a short 

taxable year, the limitations under this paragraph 

shall be proportionately reduced to reflect the ratio 

which the number of days in such taxable year bears 

to 365. 

‘‘(ii) WELLS NOT IN PRODUCTION ENTIRE YEAR.—In 

the case of a well which is not capable of production 

during each day of a taxable year, the limitations 

under this paragraph applicable to the well shall be 

proportionately reduced to reflect the ratio which the 

number of days of production bears to the total number 

of days in the taxable year. 

‘‘(3) DEFINITIONS.—

‘‘(A) QUALIFIED MARGINAL WELL.—The term ‘qualified 

marginal well’ means a domestic well—

‘‘(i) the production from which during the taxable 

year is treated as marginal production under section 

613A(c)(6), or 

‘‘(ii) which, during the taxable year—

71

‘‘(I) has average daily production of not more 

than 25 barrel-of-oil equivalents (as so defined), 

and 

‘‘(II) produces water at a rate not less than 95 

percent of total well effluent. 

‘‘(B) CRUDE OIL, ETC.—The terms ‘crude oil’, ‘natural 

gas’, ‘domestic’, and ‘barrel’ have the meanings given such 

terms by section 613A(e). 

‘‘(d) OTHER RULES.— ‘‘(1) PRODUCTION ATTRIBUTABLE TO THE TAXPAYER.—In the 

case of a qualified marginal well in which there is more than 

one owner of operating interests in the well and the crude oil 

or natural gas production exceeds the limitation under subsection (c)(2), qualifying crude oil production or qualifying natural gas production attributable to the taxpayer shall be determined on the basis of the ratio which taxpayer’s revenue interest in the production bears to the aggregate of the revenue interests of all operating interest owners in the production. 

‘‘(2) OPERATING INTEREST REQUIRED.—Any credit under 

this section may be claimed only on production which is attributable to the holder of an operating interest. 

‘‘(3) PRODUCTION FROM NONCONVENTIONAL SOURCES EXCLUDED.—In the case of production from a qualified marginal 

well which is eligible for the credit allowed under section 29 for 

the taxable year, no credit shall be allowable under this section 

unless the taxpayer elects not to claim the credit under section 

29 with respect to the well.’’. 

(b) CREDIT TREATED AS BUSINESS CREDIT.—Section 38(b), as 

amended by this Act, is amended by striking ‘‘plus’’ at the end of 

paragraph (17), by striking the period at the end of paragraph (18) 

and inserting ‘‘, plus’’, and by inserting after paragraph (18) the following: 

‘‘(19) the marginal oil and gas well production credit determined under section 45I(a).’’. 

(c) CARRYBACK.—Subsection (a) of section 39 (relating to 

carryback and carryforward of unused credits generally) is amended by adding at the end the following: 

‘‘(3) 5-YEAR CARRYBACK FOR MARGINAL OIL AND GAS WELL

PRODUCTION CREDIT.—Notwithstanding subsection (d), in the 

case of the marginal oil and gas well production credit—

‘‘(A) this section shall be applied separately from the 

business credit (other than the marginal oil and gas well 

production credit), 

‘‘(B) paragraph (1) shall be applied by substituting ‘5 

taxable years’ for ‘1 taxable years’ in subparagraph (A) 

thereof, and 

‘‘(C) paragraph (2) shall be applied—

‘‘(i) by substituting ‘25 taxable years’ for ‘21 taxable years’ in subparagraph (A) thereof, and 

‘‘(ii) by substituting ‘24 taxable years’ for ‘20 taxable years’ in subparagraph (B) thereof.’’. 

(d) CLERICAL AMENDMENT.—The table of sections for subpart D 

of part IV of subchapter A of chapter 1, as amended by this Act, is 

amended by inserting after section 45H the following:

‘‘Sec. 45I. Credit for producing oil and gas from marginal wells.’’.

72

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to production in taxable years beginning after December 

31, 2004.

TITLE IV—TAX REFORM AND SIMPLIFICATION FOR UNITED STATES 

BUSINESSES 

SEC. 401. INTEREST EXPENSE ALLOCATION RULES. 

(a) ELECTION TO ALLOCATE ON WORLDWIDE BASIS.—Section 

864 is amended by redesignating subsection (f) as subsection (g) and 

by inserting after subsection (e) the following new subsection: 

‘‘(f) ELECTION TO ALLOCATE INTEREST, ETC. ON WORLDWIDE

BASIS.—For purposes of this subchapter, at the election of the 

worldwide affiliated group—

‘‘(1) ALLOCATION AND APPORTIONMENT OF INTEREST EX- PENSE.—‘‘(A) IN GENERAL.—The taxable income of each domestic 

corporation which is a member of a worldwide affiliated 

group shall be determined by allocating and apportioning 

interest expense of each member as if all members of such 

group were a single corporation. 

‘‘(B) TREATMENT OF WORLDWIDE AFFILIATED GROUP.— The taxable income of the domestic members of a worldwide affiliated group from sources outside the United 

States shall be determined by allocating and apportioning 

the interest expense of such domestic members to such income in an amount equal to the excess (if any) of—

‘‘(i) the total interest expense of the worldwide affiliated group multiplied by the ratio which the foreign 

assets of the worldwide affiliated group bears to all the 

assets of the worldwide affiliated group, over 

‘‘(ii) the interest expense of all foreign corporations 

which are members of the worldwide affiliated group to 

the extent such interest expense of such foreign corporations would have been allocated and apportioned to 

foreign source income if this subsection were applied to 

a group consisting of all the foreign corporations in 

such worldwide affiliated group. 

‘‘(C) WORLDWIDE AFFILIATED GROUP.—For purposes of 

this paragraph, the term ‘worldwide affiliated group’ 

means a group consisting of—

‘‘(i) the includible members of an affiliated group 

(as defined in section 1504(a), determined without regard to paragraphs (2) and (4) of section 1504(b)), and 

‘‘(ii) all controlled foreign corporations in which 

such members in the aggregate meet the ownership requirements of section 1504(a)(2) either directly or indirectly through applying paragraph (2) of section 958(a) 

or through applying rules similar to the rules of such 

paragraph to stock owned directly or indirectly by domestic partnerships, trusts, or estates. 

‘‘(2) ALLOCATION AND APPORTIONMENT OF OTHER EXPENSES.—Expenses other than interest which are not directly 

73

allocable or apportioned to any specific income producing activity shall be allocated and apportioned as if all members of the 

affiliated group were a single corporation. For purposes of the 

preceding sentence, the term ‘affiliated group’ has the meaning 

given such term by section 1504 (determined without regard to 

paragraph (4) of section 1504(b)). 

‘‘(3) TREATMENT OF TAX-EXEMPT ASSETS; BASIS OF STOCK IN

NONAFFILIATED 10-PERCENT OWNED CORPORATIONS.—The rules 

of paragraphs (3) and (4) of subsection (e) shall apply for purposes of this subsection, except that paragraph (4) shall be applied on a worldwide affiliated group basis. 

‘‘(4) TREATMENT OF CERTAIN FINANCIAL INSTITUTIONS.—

‘‘(A) IN GENERAL.—For purposes of paragraph (1), any 

corporation described in subparagraph (B) shall be treated 

as an includible corporation for purposes of section 1504 

only for purposes of applying this subsection separately to 

corporations so described. 

‘‘(B) DESCRIPTION.—A corporation is described in this 

subparagraph if—

‘‘(i) such corporation is a financial institution described in section 581 or 591, 

‘‘(ii) the business of such financial institution is 

predominantly with persons other than related persons 

(within the meaning of subsection (d)(4)) or their customers, and 

‘‘(iii) such financial institution is required by State 

or Federal law to be operated separately from any other 

entity which is not such an institution. 

‘‘(C) TREATMENT OF BANK AND FINANCIAL HOLDING

COMPANIES.—To the extent provided in regulations—

‘‘(i) a bank holding company (within the meaning 

of section 2(a) of the Bank Holding Company Act of 

1956 (12 U.S.C. 1841(a)), 

‘‘(ii) a financial holding company (within the 

meaning of section 2(p) of the Bank Holding Company 

Act of 1956 (12 U.S.C. 1841(p)), and 

‘‘(iii) any subsidiary of a financial institution described in section 581 or 591, or of any such bank or 

financial holding company, if such subsidiary is predominantly engaged (directly or indirectly) in the active conduct of a banking, financing, or similar business, 

shall be treated as a corporation described in subparagraph (B). 

‘‘(5) ELECTION TO EXPAND FINANCIAL INSTITUTION GROUP

OF WORLDWIDE GROUP.—

‘‘(A) IN GENERAL.—If a worldwide affiliated group 

elects the application of this subsection, all financial corporations which—

‘‘(i) are members of such worldwide affiliated 

group, but 

‘‘(ii) are not corporations described in paragraph 

(4)(B), 

shall be treated as described in paragraph (4)(B) for purposes of applying paragraph (4)(A). This subsection (other 

74

than this paragraph) shall apply to any such group in the 

same manner as this subsection (other than this paragraph) applies to the pre-election worldwide affiliated 

group of which such group is a part. 

‘‘(B) FINANCIAL CORPORATION.—For purposes of this 

paragraph, the term ‘financial corporation’ means any corporation if at least 80 percent of its gross income is income 

described in section 904(d)(2)(D)(ii) and the regulations 

thereunder which is derived from transactions with persons 

who are not related (within the meaning of section 267(b) 

or 707(b)(1)) to the corporation. For purposes of the preceding sentence, there shall be disregarded any item of income or gain from a transaction or series of transactions a 

principal purpose of which is the qualification of any corporation as a financial corporation.

‘‘(C) ANTI-ABUSE RULES.—In the case of a corporation 

which is a member of an electing financial institution 

group, to the extent that such corporation—

‘‘(i) distributes dividends or makes other distributions with respect to its stock after the date of the enactment of this paragraph to any member of the preelection worldwide affiliated group (other than to a 

member of the electing financial institution group) in 

excess of the greater of—

‘‘(I) its average annual dividend (expressed as 

a percentage of current earnings and profits) during the 5-taxable-year period ending with the taxable year preceding the taxable year, or 

‘‘(II) 25 percent of its average annual earnings 

and profits for such 5-taxable-year period, or 

‘‘(ii) deals with any person in any manner not 

clearly reflecting the income of the corporation (as determined under principles similar to the principles of 

section 482), 

an amount of indebtedness of the electing financial institution group equal to the excess distribution or the understatement or overstatement of income, as the case may be, 

shall be recharacterized (for the taxable year and subsequent taxable years) for purposes of this paragraph as indebtedness of the worldwide affiliated group (excluding the 

electing financial institution group). If a corporation has 

not been in existence for 5 taxable years, this subparagraph 

shall be applied with respect to the period it was in existence. 

‘‘(D) ELECTION.—An election under this paragraph 

with respect to any financial institution group may be 

made only by the common parent of the pre-election worldwide affiliated group and may be made only for the first 

taxable year beginning after December 31, 2008, in which 

such affiliated group includes 1 or more financial corporations. Such an election, once made, shall apply to all financial corporations which are members of the electing financial institution group for such taxable year and all subsequent years unless revoked with the consent of the Secretary. 

75

‘‘(E) DEFINITIONS RELATING TO GROUPS.—For purposes 

of this paragraph—

‘‘(i) PRE-ELECTION WORLDWIDE AFFILIATED

GROUP.—The term ‘pre-election worldwide affiliated 

group’ means, with respect to a corporation, the worldwide affiliated group of which such corporation would 

(but for an election under this paragraph) be a member 

for purposes of applying paragraph (1). 

‘‘(ii) ELECTING FINANCIAL INSTITUTION GROUP.— The term ‘electing financial institution group’ means 

the group of corporations to which this subsection applies separately by reason of the application of paragraph (4)(A) and which includes financial corporations 

by reason of an election under subparagraph (A). 

‘‘(F) REGULATIONS.—The Secretary shall prescribe such 

regulations as may be appropriate to carry out this subsection, including regulations—

‘‘(i) providing for the direct allocation of interest 

expense in other circumstances where such allocation 

would be appropriate to carry out the purposes of this 

subsection, 

‘‘(ii) preventing assets or interest expense from 

being taken into account more than once, and 

‘‘(iii) dealing with changes in members of any 

group (through acquisitions or otherwise) treated under 

this paragraph as an affiliated group for purposes of 

this subsection. 

‘‘(6) ELECTION.—An election to have this subsection apply 

with respect to any worldwide affiliated group may be made 

only by the common parent of the domestic affiliated group referred to in paragraph (1)(C) and may be made only for the first 

taxable year beginning after December 31, 2008, in which a 

worldwide affiliated group exists which includes such affiliated 

group and at least 1 foreign corporation. Such an election, once 

made, shall apply to such common parent and all other corporations which are members of such worldwide affiliated 

group for such taxable year and all subsequent years unless revoked with the consent of the Secretary.’’. 

(b) EXPANSION OF REGULATORY AUTHORITY.—Paragraph (7) of 

section 864(e) is amended—

(1) by inserting before the comma at the end of subparagraph (B) ‘‘and in other circumstances where such allocation 

would be appropriate to carry out the purposes of this subsection’’, and 

(2) by striking ‘‘and’’ at the end of subparagraph (E), by redesignating subparagraph (F) as subparagraph (G), and by inserting after subparagraph (E) the following new subparagraph: 

‘‘(F) preventing assets or interest expense from being 

taken into account more than once, and’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2008. 

SEC. 402. RECHARACTERIZATION OF OVERALL DOMESTIC LOSS. 

(a) GENERAL RULE.—Section 904 is amended by redesignating 

subsections (g), (h), (i), (j), and (k) as subsections (h), (i), (j), (k), and 

76

(l) respectively, and by inserting after subsection (f) the following 

new subsection: 

‘‘(g) RECHARACTERIZATION OF OVERALL DOMESTIC LOSS.—

‘‘(1) GENERAL RULE.—For purposes of this subpart and section 936, in the case of any taxpayer who sustains an overall 

domestic loss for any taxable year beginning after December 31, 

2006, that portion of the taxpayer’s taxable income from sources 

within the United States for each succeeding taxable year which 

is equal to the lesser of—

‘‘(A) the amount of such loss (to the extent not used 

under this paragraph in prior taxable years), or 

‘‘(B) 50 percent of the taxpayer’s taxable income from 

sources within the United States for such succeeding taxable year, 

shall be treated as income from sources without the United 

States (and not as income from sources within the United 

States). 

‘‘(2) OVERALL DOMESTIC LOSS DEFINED.—For purposes of 

this subsection—

‘‘(A) IN GENERAL.—The term ‘overall domestic loss’ 

means any domestic loss to the extent such loss offsets taxable income from sources without the United States for the 

taxable year or for any preceding taxable year by reason of 

a carryback. For purposes of the preceding sentence, the 

term ‘domestic loss’ means the amount by which the gross 

income for the taxable year from sources within the United 

States is exceeded by the sum of the deductions properly apportioned or allocated thereto (determined without regard 

to any carryback from a subsequent taxable year). 

‘‘(B) TAXPAYER MUST HAVE ELECTED FOREIGN TAX

CREDIT FOR YEAR OF LOSS.—The term ‘overall domestic loss’ 

shall not include any loss for any taxable year unless the 

taxpayer chose the benefits of this subpart for such taxable 

year. 

‘‘(3) CHARACTERIZATION OF SUBSEQUENT INCOME.—

‘‘(A) IN GENERAL.—Any income from sources within the 

United States that is treated as income from sources without the United States under paragraph (1) shall be allocated among and increase the income categories in proportion to the loss from sources within the United States previously allocated to those income categories. 

‘‘(B) INCOME CATEGORY.—For purposes of this paragraph, the term ‘income category’ has the meaning given 

such term by subsection (f)(5)(E)(i). 

‘‘(4) COORDINATION WITH SUBSECTION (f).—The Secretary 

shall prescribe such regulations as may be necessary to coordinate the provisions of this subsection with the provisions of subsection (f).’’. 

(b) CONFORMING AMENDMENTS.—

(1) Section 535(d)(2) is amended by striking ‘‘section 

904(g)(6)’’ and inserting ‘‘section 904(h)(6)’’. 

(2) Subparagraph (A) of section 936(a)(2) is amended by 

striking ‘‘section 904(f)’’ and inserting ‘‘subsections (f) and (g) of 

section 904’’. 

77

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to losses for taxable years beginning after December 31, 

2006. 

SEC. 403. LOOK-THRU RULES TO APPLY TO DIVIDENDS FROM NONCONTROLLED SECTION 902 CORPORATIONS. 

(a) IN GENERAL.—Section 904(d)(4) (relating to look-thru rules 

apply to dividends from noncontrolled section 902 corporations) is 

amended to read as follows: 

‘‘(4) LOOK-THRU APPLIES TO DIVIDENDS FROM NONCON- TROLLED SECTION 902 CORPORATIONS.— ‘‘(A) IN GENERAL.—For purposes of this subsection, any 

dividend from a noncontrolled section 902 corporation with 

respect to the taxpayer shall be treated as income described 

in a subparagraph of paragraph (1) in proportion to the 

ratio of—

‘‘(i) the portion of earnings and profits attributable 

to income described in such subparagraph, to 

‘‘(ii) the total amount of earnings and profits. 

‘‘(B) EARNINGS AND PROFITS OF CONTROLLED FOREIGN

CORPORATIONS.—In the case of any distribution from a controlled foreign corporation to a United States shareholder, 

rules similar to the rules of subparagraph (A) shall apply 

in determining the extent to which earnings and profits of 

the controlled foreign corporation which are attributable to 

dividends received from a noncontrolled section 902 corporation may be treated as income in a separate category. 

‘‘(C) SPECIAL RULES.—For purposes of this paragraph—

‘‘(i) EARNINGS AND PROFITS.— ‘‘(I) IN GENERAL.—The rules of section 316 

shall apply. 

‘‘(II) REGULATIONS.—The Secretary may prescribe regulations regarding the treatment of distributions out of earnings and profits for periods 

before the taxpayer’s acquisition of the stock to 

which the distributions relate. 

‘‘(ii) INADEQUATE SUBSTANTIATION.—If the Secretary determines that the proper subparagraph of 

paragraph (1) in which a dividend is described has not 

been substantiated, such dividend shall be treated as 

income described in paragraph (1)(A). 

‘‘(iii) COORDINATION WITH HIGH-TAXED INCOME

PROVISIONS.—Rules similar to the rules of paragraph 

(3)(F) shall apply for purposes of this paragraph. 

‘‘(iv) LOOK-THRU WITH RESPECT TO CARRYOVER OF

CREDIT.—Rules similar to subparagraph (A) also shall 

apply to any carryforward under subsection (c) from a 

taxable year beginning before January 1, 2003, of tax 

allocable to a dividend from a noncontrolled section 

902 corporation with respect to the taxpayer. The Secretary may by regulations provide for the allocation of 

any carryback of tax allocable to a dividend from a 

noncontrolled section 902 corporation from a taxable 

year beginning on or after January 1, 2003, to a taxable year beginning before such date for purposes of alVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00081 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
78

locating such dividend among the separate categories 

in effect for the taxable year to which carried.’’. 

(b) CONFORMING AMENDMENTS.—

(1) Subparagraph (E) of section 904(d)(1) is hereby repealed. 

(2) Section 904(d)(2)(C)(iii) is amended by adding ‘‘and’’ at 

the end of subclause (I), by striking subclause (II), and by redesignating subclause (III) as subclause (II). 

(3) The last sentence of section 904(d)(2)(D) is amended to 

read as follows: ‘‘Such term does not include any financial services income.’’. 

(4) Section 904(d)(2)(E) is amended—

(A) by inserting ‘‘or (4)’’ after ‘‘paragraph (3)’’ in clause 

(i), and 

(B) by striking clauses (ii) and (iv) and by redesignating clause (iii) as clause (ii). 

(5) Section 904(d)(3)(F) is amended by striking ‘‘(D), or (E)’’ 

and inserting ‘‘or (D)’’. 

(6) Section 864(d)(5)(A)(i) is amended by striking 

‘‘(C)(iii)(III)’’ and inserting ‘‘(C)(iii)(II)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2002. 

SEC. 404. REDUCTION TO 2 FOREIGN TAX CREDIT BASKETS. 

(a) IN GENERAL.—Paragraph (1) of section 904(d) (relating to 

separate application of section with respect to certain categories of 

income) is amended to read as follows: 

‘‘(1) IN GENERAL.—The provisions of subsections (a), (b), 

and (c) and sections 902, 907, and 960 shall be applied separately with respect to—

‘‘(A) passive category income, and 

‘‘(B) general category income.’’

(b) CATEGORIES.—Paragraph (2) of section 904(d) is amended 

by striking subparagraph (B), by redesignating subparagraph (A) as 

subparagraph (B), and by inserting before subparagraph (B) (as so 

redesignated) the following new subparagraph: 

‘‘(A) CATEGORIES.—

‘‘(i) PASSIVE CATEGORY INCOME.—The term ‘passive 

category income’ means passive income and specified 

passive category income.

‘‘(ii) GENERAL CATEGORY INCOME.—The term ‘general category income’ means income other than passive 

category income.’’. 

(c) SPECIFIED PASSIVE CATEGORY INCOME.—Subparagraph (B) 

of section 904(d)(2), as so redesignated, is amended by adding at the 

end the following new clause: 

‘‘(v) SPECIFIED PASSIVE CATEGORY INCOME.—The 

term ‘specified passive category income’ means—

‘‘(I) dividends from a DISC or former DISC 

(as defined in section 992(a)) to the extent such 

dividends are treated as income from sources without the United States, 

‘‘(II) taxable income attributable to foreign 

trade income (within the meaning of section 

923(b)), and 

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‘‘(III) distributions from a FSC (or a former 

FSC) out of earnings and profits attributable to 

foreign trade income (within the meaning of section 923(b)) or interest or carrying charges (as defined in section 927(d)(1)) derived from a transaction which results in foreign trade income (as 

defined in section 923(b)).’’. 

(d) TREATMENT OF FINANCIAL SERVICES.—Paragraph (2) of section 904(d), as amended by section 403(b)(3), is amended by striking 

subparagraph (D), by redesignating subparagraph (C) as subparagraph (D), and by inserting before subparagraph (D) (as so redesignated) the following new subparagraph: 

‘‘(C) TREATMENT OF FINANCIAL SERVICES INCOME AND

COMPANIES.—

‘‘(i) IN GENERAL.—Financial services income shall 

be treated as general category income in the case of—

‘‘(I) a member of a financial services group, 

and 

‘‘(II) any other person if such person is predominantly engaged in the active conduct of a 

banking, insurance, financing, or similar business. 

‘‘(ii) FINANCIAL SERVICES GROUP.—The term ‘financial services group’ means any affiliated group (as defined in section 1504(a) without regard to paragraphs 

(2) and (3) of section 1504(b)) which is predominantly 

engaged in the active conduct of a banking, insurance, 

financing, or similar business. In determining whether 

such a group is so engaged, there shall be taken into 

account only the income of members of the group that 

are—

‘‘(I) United States corporations, or 

‘‘(II) controlled foreign corporations in which 

such United States corporations own, directly or 

indirectly, at least 80 percent of the total voting 

power and value of the stock. 

‘‘(iii) PASS-THRU ENTITIES.—The Secretary shall by 

regulation specify for purposes of this subparagraph 

the treatment of financial services income received or 

accrued by partnerships and by other pass-thru entities 

which are not members of a financial services group.’’. 

(e) TREATMENT OF INCOME TAX BASE DIFFERENCES.—Paragraph (2) of section 904(d) is amended by redesignating subparagraphs (H) and (I) as subparagraphs (I) and (J), respectively, and 

by inserting after subparagraph (G) the following new subparagraph: 

‘‘(H) TREATMENT OF INCOME TAX BASE DIFFERENCES.—

‘‘(i) IN GENERAL.—In the case of taxable years beginning after December 31, 2006, tax imposed under 

the law of a foreign country or possession of the United 

States on an amount which does not constitute income 

under United States tax principles shall be treated as 

imposed on income described in paragraph (1)(B). 

‘‘(ii) SPECIAL RULE FOR YEARS BEFORE 2007.—

‘‘(I) IN GENERAL.—In the case of taxes paid or 

accrued in taxable years beginning after December 

80

31, 2004, and before January 1, 2007, a taxpayer 

may elect to treat tax imposed under the law of a 

foreign country or possession of the United States 

on an amount which does not constitute income 

under United States tax principles as tax imposed 

on income described in subparagraph (C) or (I) of 

paragraph (1). 

‘‘(II) ELECTION IRREVOCABLE.—Any such election shall apply to the taxable year for which made 

and all subsequent taxable years described in subclause (I) unless revoked with the consent of the 

Secretary.’’. 

(f) CONFORMING AMENDMENTS.—

(1) Clause (iii) of section 904(d)(2)(B) (relating to exceptions 

from passive income), as so redesignated, is amended by striking subclause (I) and by redesignating subclauses (II) and (III) 

as subclauses (I) and (II), respectively. 

(2) Clause (i) of section 904(d)(2)(D) (defining financial 

services income), as so redesignated, is amended by adding ‘‘or’’ 

at the end of subclause (I) and by striking subclauses (II) and 

(III) and inserting the following new subclause: 

‘‘(II) passive income (determined without regard to subparagraph (B)(iii)(II)).’’

(3) Section 904(d)(2)(D) (defining financial services income), as so redesignated and amended by section 404(b)(3), is 

amended by striking clause (iii). 

(4) Paragraph (3) of section 904(d) is amended to read as 

follows: 

‘‘(3) LOOK-THRU IN CASE OF CONTROLLED FOREIGN CORPORATIONS.—

‘‘(A) IN GENERAL.—Except as otherwise provided in this 

paragraph, dividends, interest, rents, and royalties received 

or accrued by the taxpayer from a controlled foreign corporation in which the taxpayer is a United States shareholder shall not be treated as passive category income. 

‘‘(B) SUBPART F INCLUSIONS.—Any amount included in 

gross income under section 951(a)(1)(A) shall be treated as 

passive category income to the extent the amount so included is attributable to passive category income. 

‘‘(C) INTEREST, RENTS, AND ROYALTIES.—Any interest, 

rent, or royalty which is received or accrued from a controlled foreign corporation in which the taxpayer is a 

United States shareholder shall be treated as passive category income to the extent it is properly allocable (under 

regulations prescribed by the Secretary) to passive category 

income of the controlled foreign corporation. 

‘‘(D) DIVIDENDS.—Any dividend paid out of the earnings and profits of any controlled foreign corporation in 

which the taxpayer is a United States shareholder shall be 

treated as passive category income in proportion to the ratio 

of—

‘‘(i) the portion of the earnings and profits attributable to passive category income, to 

‘‘(ii) the total amount of earnings and profits. 

81

‘‘(E) LOOK-THRU APPLIES ONLY WHERE SUBPART F APPLIES.—If a controlled foreign corporation meets the requirements of section 954(b)(3)(A) (relating to de minimis 

rule) for any taxable year, for purposes of this paragraph, 

none of its foreign base company income (as defined in section 954(a) without regard to section 954(b)(5)) and none of 

its gross insurance income (as defined in section 

954(b)(3)(C)) for such taxable year shall be treated as passive category income, except that this sentence shall not 

apply to any income which (without regard to this sentence) 

would be treated as financial services income. Solely for 

purposes of applying subparagraph (D), passive income of 

a controlled foreign corporation shall not be treated as passive category income if the requirements of section 954(b)(4) 

are met with respect to such income. 

‘‘(F) COORDINATION WITH HIGH-TAXED INCOME PROVISIONS.—

‘‘(i) In determining whether any income of a controlled foreign corporation is passive category income, 

subclause (II) of paragraph (2)(B)(iii) shall not apply. 

‘‘(ii) Any income of the taxpayer which is treated as 

passive category income under this paragraph shall be 

so treated notwithstanding any provision of paragraph 

(2); except that the determination of whether any 

amount is high-taxed income shall be made after the 

application of this paragraph. 

‘‘(G) DIVIDEND.—For purposes of this paragraph, the 

term ‘dividend’ includes any amount included in gross income in section 951(a)(1)(B). Any amount included in gross 

income under section 78 to the extent attributable to 

amounts included in gross income in section 951(a)(1)(A) 

shall not be treated as a dividend but shall be treated as 

included in gross income under section 951(a)(1)(A). 

‘‘(H) LOOK-THRU APPLIES TO PASSIVE FOREIGN INVESTMENT COMPANY INCLUSION.—If—

‘‘(i) a passive foreign investment company is a controlled foreign corporation, and 

‘‘(ii) the taxpayer is a United States shareholder in 

such controlled foreign corporation, 

any amount included in gross income under section 1293 

shall be treated as income in a separate category to the extent such amount is attributable to income in such category.’’. 

(5) Paragraph (2) of section 904(d) is amended by adding 

at the end the following new subparagraph: 

‘‘(K) TRANSITIONAL RULES FOR 2007 CHANGES.—For 

purposes of paragraph (1)—

‘‘(i) taxes carried from any taxable year beginning 

before January 1, 2007, to any taxable year beginning 

on or after such date, with respect to any item of income, shall be treated as described in the subparagraph of paragraph (1) in which such income would be 

described were such taxes paid or accrued in a taxable 

year beginning on or after such date, and 

82

‘‘(ii) the Secretary may by regulations provide for 

the allocation of any carryback of taxes with respect to 

income from a taxable year beginning on or after January 1, 2007, to a taxable year beginning before such 

date for purposes of allocating such income among the 

separate categories in effect for the taxable year to 

which carried.’’. 

(6) Section 904(j)(3)(A)(i) is amended by striking ‘‘subsection (d)(2)(A)’’ and inserting ‘‘subsection (d)(2)(B)’’. 

(g) EFFECTIVE DATES.—

(1) IN GENERAL.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2006. 

(2) TRANSITIONAL RULE RELATING TO INCOME TAX BASE DIFFERENCE.—Section 904(d)(2)(H)(ii) of the Internal Revenue Code 

of 1986, as added by subsection (e), shall apply to taxable years 

beginning after December 31, 2004. 

SEC. 405. ATTRIBUTION OF STOCK OWNERSHIP THROUGH PARTNERSHIPS TO APPLY IN DETERMINING SECTION 902 AND 960 

CREDITS. 

(a) IN GENERAL.—Subsection (c) of section 902 is amended by 

redesignating paragraph (7) as paragraph (8) and by inserting after 

paragraph (6) the following new paragraph: 

‘‘(7) CONSTRUCTIVE OWNERSHIP THROUGH PARTNERSHIPS.—

Stock owned, directly or indirectly, by or for a partnership shall 

be considered as being owned proportionately by its partners. 

Stock considered to be owned by a person by reason of the preceding sentence shall, for purposes of applying such sentence, be 

treated as actually owned by such person. The Secretary may 

prescribe such regulations as may be necessary to carry out the 

purposes of this paragraph, including rules to account for special partnership allocations of dividends, credits, and other incidents of ownership of stock in determining proportionate ownership.’’. 

(b) CLARIFICATION OF COMPARABLE ATTRIBUTION UNDER SECTION 901(b)(5).—Paragraph (5) of section 901(b) is amended by 

striking ‘‘any individual’’ and inserting ‘‘any person’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxes of foreign corporations for taxable years of such 

corporations beginning after the date of the enactment of this Act. 

SEC. 406. CLARIFICATION OF TREATMENT OF CERTAIN TRANSFERS OF 

INTANGIBLE PROPERTY. 

(a) IN GENERAL.—Subparagraph (C) of section 367(d)(2) is 

amended by adding at the end the following new sentence: ‘‘For purposes of applying section 904(d), any such amount shall be treated 

in the same manner as if such amount were a royalty.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to amounts treated as received pursuant to section 

367(d)(2) of the Internal Revenue Code of 1986 on or after August 

5, 1997. 

SEC. 407. UNITED STATES PROPERTY NOT TO INCLUDE CERTAIN ASSETS OF CONTROLLED FOREIGN CORPORATION. 

(a) IN GENERAL.—Section 956(c)(2) (relating to exceptions from 

property treated as United States property) is amended by striking 

‘‘and’’ at the end of subparagraph (J), by striking the period at the 

83

end of subparagraph (K) and inserting a semicolon, and by adding 

at the end the following new subparagraphs: 

‘‘(L) securities acquired and held by a controlled foreign corporation in the ordinary course of its business as a 

dealer in securities if—

‘‘(i) the dealer accounts for the securities as securities held primarily for sale to customers in the ordinary course of business, and 

‘‘(ii) the dealer disposes of the securities (or such 

securities mature while held by the dealer) within a period consistent with the holding of securities for sale to 

customers in the ordinary course of business; and 

‘‘(M) an obligation of a United States person which—

‘‘(i) is not a domestic corporation, and 

‘‘(ii) is not—

‘‘(I) a United States shareholder (as defined in 

section 951(b)) of the controlled foreign corporation, or 

‘‘(II) a partnership, estate, or trust in which 

the controlled foreign corporation, or any related 

person (as defined in section 954(d)(3)), is a partner, beneficiary, or trustee immediately after the 

acquisition of any obligation of such partnership, 

estate, or trust by the controlled foreign corporation.’’. 

(b) CONFORMING AMENDMENT.—Section 956(c)(2) is amended by 

striking ‘‘and (K)’’ in the last sentence and inserting ‘‘, (K), and (L)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years of foreign corporations beginning after 

December 31, 2004, and to taxable years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 408. TRANSLATION OF FOREIGN TAXES. 

(a) ELECTIVE EXCEPTION FOR TAXES PAID OTHER THAN IN

FUNCTIONAL CURRENCY.—Paragraph (1) of section 986(a) (relating 

to determination of foreign taxes and foreign corporation’s earnings 

and profits) is amended by redesignating subparagraph (D) as subparagraph (E) and by inserting after subparagraph (C) the following new subparagraph:

‘‘(D) ELECTIVE EXCEPTION FOR TAXES PAID OTHER THAN

IN FUNCTIONAL CURRENCY.—

‘‘(i) IN GENERAL.—At the election of the taxpayer, 

subparagraph (A) shall not apply to any foreign income 

taxes the liability for which is denominated in any currency other than in the taxpayer’s functional currency. 

‘‘(ii) APPLICATION TO QUALIFIED BUSINESS UNITS.—

An election under this subparagraph may apply to foreign income taxes attributable to a qualified business 

unit in accordance with regulations prescribed by the 

Secretary. 

‘‘(iii) ELECTION.—Any such election shall apply to 

the taxable year for which made and all subsequent 

taxable years unless revoked with the consent of the 

Secretary.’’. 

(b) SPECIAL RULE FOR REGULATED INVESTMENT COMPANIES.—

84

(1) IN GENERAL.—Section 986(a)(1), as amended by subsection (a), is amended by redesignating subparagraph (E) as 

subparagraph (F) and by inserting after subparagraph (D) the 

following: 

‘‘(E) SPECIAL RULE FOR REGULATED INVESTMENT COMPANIES.—In the case of a regulated investment company 

which takes into account income on an accrual basis, subparagraphs (A) through (D) shall not apply and foreign income taxes paid or accrued with respect to such income 

shall be translated into dollars using the exchange rate as 

of the date the income accrues.’’. 

(2) CONFORMING AMENDMENT.—Section 986(a)(2) is amended by inserting ‘‘or (E)’’ after ‘‘subparagraph (A)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 409. REPEAL OF WITHHOLDING TAX ON DIVIDENDS FROM CERTAIN FOREIGN CORPORATIONS. 

(a) IN GENERAL.—Paragraph (2) of section 871(i) (relating to 

tax not to apply to certain interest and dividends) is amended by 

adding at the end the following new subparagraph: 

‘‘(D) Dividends paid by a foreign corporation which are 

treated under section 861(a)(2)(B) as income from sources 

within the United States.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to payments made after December 31, 2004. 

SEC. 410. EQUAL TREATMENT OF INTEREST PAID BY FOREIGN PARTNERSHIPS AND FOREIGN CORPORATIONS. 

(a) IN GENERAL.—Paragraph (1) of section 861(a) is amended 

by striking ‘‘and’’ at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting ‘‘, and’’, and by 

adding at the end the following new subparagraph: 

‘‘(C) in the case of a foreign partnership, which is predominantly engaged in the active conduct of a trade or 

business outside the United States, any interest not paid by 

a trade or business engaged in by the partnership in the 

United States and not allocable to income which is effectively connected (or treated as effectively connected) with 

the conduct of a trade or business in the United States.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2003. 

SEC. 411. TREATMENT OF CERTAIN DIVIDENDS OF REGULATED INVESTMENT COMPANIES. 

(a) TREATMENT OF CERTAIN DIVIDENDS.— (1) NONRESIDENT ALIEN INDIVIDUALS.—Section 871 (relating to tax on nonresident alien individuals) is amended by redesignating subsection (k) as subsection (l) and by inserting 

after subsection (j) the following new subsection: 

‘‘(k) EXEMPTION FOR CERTAIN DIVIDENDS OF REGULATED INVESTMENT COMPANIES.—

‘‘(1) INTEREST-RELATED DIVIDENDS.— ‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), no tax shall be imposed under paragraph (1)(A) of subsection (a) on any interest-related dividend received from a 

regulated investment company. 

85

‘‘(B) EXCEPTIONS.—Subparagraph (A) shall not apply—

‘‘(i) to any interest-related dividend received from a 

regulated investment company by a person to the extent 

such dividend is attributable to interest (other than interest described in subparagraph (E) (i) or (iii)) received by such company on indebtedness issued by such 

person or by any corporation or partnership with respect to which such person is a 10-percent shareholder, 

‘‘(ii) to any interest-related dividend with respect to 

stock of a regulated investment company unless the 

person who would otherwise be required to deduct and 

withhold tax from such dividend under chapter 3 receives a statement (which meets requirements similar 

to the requirements of subsection (h)(5)) that the beneficial owner of such stock is not a United States person, 

and 

‘‘(iii) to any interest-related dividend paid to any 

person within a foreign country (or any interest-related 

dividend payment addressed to, or for the account of, 

persons within such foreign country) during any period 

described in subsection (h)(6) with respect to such 

country. 

Clause (iii) shall not apply to any dividend with respect to 

any stock which was acquired on or before the date of the 

publication of the Secretary’s determination under subsection (h)(6). 

‘‘(C) INTEREST-RELATED DIVIDEND.—For purposes of 

this paragraph, the term ‘interest-related dividend’ means 

any dividend (or part thereof) which is designated by the 

regulated investment company as an interest-related dividend in a written notice mailed to its shareholders not later 

than 60 days after the close of its taxable year. If the aggregate amount so designated with respect to a taxable year of 

the company (including amounts so designated with respect 

to dividends paid after the close of the taxable year described in section 855) is greater than the qualified net interest income of the company for such taxable year, the portion of each distribution which shall be an interest-related 

dividend shall be only that portion of the amounts so designated which such qualified net interest income bears to 

the aggregate amount so designated. Such term shall not 

include any dividend with respect to any taxable year of the 

company beginning after December 31, 2007. 

‘‘(D) QUALIFIED NET INTEREST INCOME.—For purposes 

of subparagraph (C), the term ‘qualified net interest income’ 

means the qualified interest income of the regulated investment company reduced by the deductions properly allocable 

to such income.

‘‘(E) QUALIFIED INTEREST INCOME.—For purposes of 

subparagraph (D), the term ‘qualified interest income’ 

means the sum of the following amounts derived by the regulated investment company from sources within the United 

States: 

‘‘(i) Any amount includible in gross income as 

original issue discount (within the meaning of section 

86

1273) on an obligation payable 183 days or less from 

the date of original issue (without regard to the period 

held by the company). 

‘‘(ii) Any interest includible in gross income (including amounts recognized as ordinary income in respect of original issue discount or market discount or 

acquisition discount under part V of subchapter P and 

such other amounts as regulations may provide) on an 

obligation which is in registered form; except that this 

clause shall not apply to—

‘‘(I) any interest on an obligation issued by a 

corporation or partnership if the regulated investment company is a 10-percent shareholder in such 

corporation or partnership, and 

‘‘(II) any interest which is treated as not being 

portfolio interest under the rules of subsection 

(h)(4). 

‘‘(iii) Any interest referred to in subsection (i)(2)(A) 

(without regard to the trade or business of the regulated investment company). 

‘‘(iv) Any interest-related dividend includable in 

gross income with respect to stock of another regulated 

investment company. 

‘‘(F) 10-PERCENT SHAREHOLDER.—For purposes of this 

paragraph, the term ‘10-percent shareholder’ has the meaning given such term by subsection (h)(3)(B). 

‘‘(2) SHORT-TERM CAPITAL GAIN DIVIDENDS.— ‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), no tax shall be imposed under paragraph (1)(A) of subsection (a) on any short-term capital gain dividend received 

from a regulated investment company. 

‘‘(B) EXCEPTION FOR ALIENS TAXABLE UNDER SUBSECTION (a)(2).—Subparagraph (A) shall not apply in the 

case of any nonresident alien individual subject to tax 

under subsection (a)(2). 

‘‘(C) SHORT-TERM CAPITAL GAIN DIVIDEND.—For purposes of this paragraph, the term ‘short-term capital gain 

dividend’ means any dividend (or part thereof) which is 

designated by the regulated investment company as a shortterm capital gain dividend in a written notice mailed to its 

shareholders not later than 60 days after the close of its 

taxable year. If the aggregate amount so designated with 

respect to a taxable year of the company (including 

amounts so designated with respect to dividends paid after 

the close of the taxable year described in section 855) is 

greater than the qualified short-term gain of the company 

for such taxable year, the portion of each distribution 

which shall be a short-term capital gain dividend shall be 

only that portion of the amounts so designated which such 

qualified short-term gain bears to the aggregate amount so 

designated. Such term shall not include any dividend with 

respect to any taxable year of the company beginning after 

December 31, 2007. 

‘‘(D) QUALIFIED SHORT-TERM GAIN.—For purposes of 

subparagraph (C), the term ‘qualified short-term gain’ 

87

means the excess of the net short-term capital gain of the 

regulated investment company for the taxable year over the 

net long-term capital loss (if any) of such company for such 

taxable year. For purposes of this subparagraph—

‘‘(i) the net short-term capital gain of the regulated 

investment company shall be computed by treating any 

short-term capital gain dividend includible in gross income with respect to stock of another regulated investment company as a short-term capital gain, and 

‘‘(ii) the excess of the net short-term capital gain 

for a taxable year over the net long-term capital loss for 

a taxable year (to which an election under section 

4982(e)(4) does not apply) shall be determined without 

regard to any net capital loss or net short-term capital 

loss attributable to transactions after October 31 of 

such year, and any such net capital loss or net shortterm capital loss shall be treated as arising on the 1st 

day of the next taxable year. 

To the extent provided in regulations, clause (ii) shall apply 

also for purposes of computing the taxable income of the 

regulated investment company.’’

(2) FOREIGN CORPORATIONS.—Section 881 (relating to tax 

on income of foreign corporations not connected with United 

States business) is amended by redesignating subsection (e) as 

subsection (f) and by inserting after subsection (d) the following 

new subsection: 

‘‘(e) TAX NOT TO APPLY TO CERTAIN DIVIDENDS OF REGULATED

INVESTMENT COMPANIES.— ‘‘(1) INTEREST-RELATED DIVIDENDS.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), no tax shall be imposed under paragraph (1) of subsection (a) on any interest-related dividend (as defined in 

section 871(k)(1)) received from a regulated investment 

company. 

‘‘(B) EXCEPTION.—Subparagraph (A) shall not apply—

‘‘(i) to any dividend referred to in section 

871(k)(1)(B), and 

‘‘(ii) to any interest-related dividend received by a 

controlled foreign corporation (within the meaning of 

section 957(a)) to the extent such dividend is attributable to interest received by the regulated investment 

company from a person who is a related person (within 

the meaning of section 864(d)(4)) with respect to such 

controlled foreign corporation. 

‘‘(C) TREATMENT OF DIVIDENDS RECEIVED BY CONTROLLED FOREIGN CORPORATIONS.—The rules of subsection 

(c)(5)(A) shall apply to any (within the meaning of section 

957(a)) to the extent such dividend is attributable to interest received by the regulated investment company which is 

described in clause (ii) of section 871(k)(1)(E) (and not described in clause (i) or (iii) of such section). 

‘‘(2) SHORT-TERM CAPITAL GAIN DIVIDENDS.—No tax shall 

be imposed under paragraph (1) of subsection (a) on any shortterm capital gain dividend (as defined in section 871(k)(2)) received from a regulated investment company.’’. 

88

(3) WITHHOLDING TAXES.—

(A) Section 1441(c) (relating to exceptions) is amended 

by adding at the end the following new paragraph: 

‘‘(12) CERTAIN DIVIDENDS RECEIVED FROM REGULATED INVESTMENT COMPANIES.—

‘‘(A) IN GENERAL.—No tax shall be required to be deducted and withheld under subsection (a) from any amount 

exempt from the tax imposed by section 871(a)(1)(A) by reason of section 871(k). 

‘‘(B) SPECIAL RULE.—For purposes of subparagraph 

(A), clause (i) of section 871(k)(1)(B) shall not apply to any 

dividend unless the regulated investment company knows 

that such dividend is a dividend referred to in such clause. 

A similar rule shall apply with respect to the exception contained in section 871(k)(2)(B).’’. 

(B) Section 1442(a) (relating to withholding of tax on 

foreign corporations) is amended—

(i) by striking ‘‘and the reference in section 

1441(c)(10)’’ and inserting ‘‘the reference in section 

1441(c)(10)’’, and

(ii) by inserting before the period at the end the following: ‘‘, and the references in section 1441(c)(12) to 

sections 871(a) and 871(k) shall be treated as referring 

to sections 881(a) and 881(e) (except that for purposes 

of applying subparagraph (A) of section 1441(c)(12), as 

so modified, clause (ii) of section 881(e)(1)(B) shall not 

apply to any dividend unless the regulated investment 

company knows that such dividend is a dividend referred to in such clause)’’. 

(b) ESTATE TAX TREATMENT OF INTEREST IN CERTAIN REGULATED INVESTMENT COMPANIES.—Section 2105 (relating to property 

without the United States for estate tax purposes) is amended by 

adding at the end the following new subsection: 

‘‘(d) STOCK IN A RIC.—

‘‘(1) IN GENERAL.—For purposes of this subchapter, stock in 

a regulated investment company (as defined in section 851) 

owned by a nonresident not a citizen of the United States shall 

not be deemed property within the United States in the proportion that, at the end of the quarter of such investment company’s taxable year immediately preceding a decedent’s date of 

death (or at such other time as the Secretary may designate in 

regulations), the assets of the investment company that were 

qualifying assets with respect to the decedent bore to the total 

assets of the investment company. 

‘‘(2) QUALIFYING ASSETS.—For purposes of this subsection, 

qualifying assets with respect to a decedent are assets that, if 

owned directly by the decedent, would have been—

‘‘(A) amounts, deposits, or debt obligations described in 

subsection (b) of this section, 

‘‘(B) debt obligations described in the last sentence of 

section 2104(c), or 

‘‘(C) other property not within the United States. 

‘‘(3) TERMINATION.—This subsection shall not apply to estates of decedents dying after December 31, 2007.’’

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(c) TREATMENT OF REGULATED INVESTMENT COMPANIES UNDER

SECTION 897.—

(1) Paragraph (1) of section 897(h) is amended by striking 

‘‘REIT’’ each place it appears and inserting ‘‘qualified investment entity’’. 

(2) Paragraphs (2) and (3) of section 897(h) are amended 

to read as follows: 

‘‘(2) SALE OF STOCK IN DOMESTICALLY CONTROLLED ENTITY

NOT TAXED.—The term ‘United States real property interest’ 

does not include any interest in a domestically controlled qualified investment entity. 

‘‘(3) DISTRIBUTIONS BY DOMESTICALLY CONTROLLED QUALI- FIED INVESTMENT ENTITIES.—In the case of a domestically controlled qualified investment entity, rules similar to the rules of 

subsection (d) shall apply to the foreign ownership percentage 

of any gain.’’

(3) Subparagraphs (A) and (B) of section 897(h)(4) are 

amended to read as follows: 

‘‘(A) QUALIFIED INVESTMENT ENTITY.— ‘‘(i) IN GENERAL.—The term ‘qualified investment 

entity’ means—

‘‘(I) any real estate investment trust, and 

‘‘(II) any regulated investment company. 

‘‘(ii) TERMINATION.—Clause (i)(II) shall not apply 

after December 31, 2007. 

‘‘(B) DOMESTICALLY CONTROLLED.—The term ‘domestically controlled qualified investment entity’ means any 

qualified investment entity in which at all times during the 

testing period less than 50 percent in value of the stock was 

held directly or indirectly by foreign persons.’’

(4) Subparagraphs (C) and (D) of section 897(h)(4) are each 

amended by striking ‘‘REIT’’ and inserting ‘‘qualified investment entity’’. 

(5) The subsection heading for subsection (h) of section 897 

is amended by striking ‘‘REITS’’ and inserting ‘‘CERTAIN IN- VESTMENT ENTITIES’’. 

(d) EFFECTIVE DATE.— (1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to 

dividends with respect to taxable years of regulated investment 

companies beginning after December 31, 2004. 

(2) ESTATE TAX TREATMENT.—The amendment made by 

subsection (b) shall apply to estates of decedents dying after December 31, 2004. 

(3) CERTAIN OTHER PROVISIONS.—The amendments made 

by subsection (c) (other than paragraph (1) thereof) shall take 

effect after December 31, 2004. 

SEC. 412. LOOK-THRU TREATMENT FOR SALES OF PARTNERSHIP INTERESTS. 

(a) IN GENERAL.—Section 954(c) (defining foreign personal 

holding company income) is amended by adding after paragraph (3) 

the following new paragraph: 

‘‘(4) LOOK-THRU RULE FOR CERTAIN PARTNERSHIP SALES.—

‘‘(A) IN GENERAL.—In the case of any sale by a controlled foreign corporation of an interest in a partnership 

90

with respect to which such corporation is a 25-percent 

owner, such corporation shall be treated for purposes of 

this subsection as selling the proportionate share of the assets of the partnership attributable to such interest. The 

Secretary shall prescribe such regulations as may be appropriate to prevent abuse of the purposes of this paragraph, 

including regulations providing for coordination of this 

paragraph with the provisions of subchapter K. 

‘‘(B) 25-PERCENT OWNER.—For purposes of this paragraph, the term ‘25-percent owner’ means a controlled foreign corporation which owns directly 25 percent or more of 

the capital or profits interest in a partnership. For purposes 

of the preceding sentence, if a controlled foreign corporation 

is a shareholder or partner of a corporation or partnership, 

the controlled foreign corporation shall be treated as owning directly its proportionate share of any such capital or 

profits interest held directly or indirectly by such corporation or partnership.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years of foreign corporations beginning after 

December 31, 2004, and to taxable years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 413. REPEAL OF FOREIGN PERSONAL HOLDING COMPANY RULES 

AND FOREIGN INVESTMENT COMPANY RULES. 

(a) GENERAL RULE.—The following provisions are hereby repealed: 

(1) Part III of subchapter G of chapter 1 (relating to foreign 

personal holding companies). 

(2) Section 1246 (relating to gain on foreign investment 

company stock). 

(3) Section 1247 (relating to election by foreign investment 

companies to distribute income currently). 

(b) EXEMPTION OF FOREIGN CORPORATIONS FROM PERSONAL

HOLDING COMPANY RULES.—

(1) IN GENERAL.—Subsection (c) of section 542 (relating to 

exceptions) is amended—

(A) by striking paragraph (5) and inserting the following: 

‘‘(5) a foreign corporation,’’, 

(B) by striking paragraphs (7) and (10) and by redesignating paragraphs (8) and (9) as paragraphs (7) and (8), 

respectively, 

(C) by inserting ‘‘and’’ at the end of paragraph (7) (as 

so redesignated), and 

(D) by striking ‘‘; and’’ at the end of paragraph (8) (as 

so redesignated) and inserting a period. 

(2) TREATMENT OF INCOME FROM PERSONAL SERVICE CONTRACTS.—Paragraph (1) of section 954(c) is amended by adding 

at the end the following new subparagraph: 

‘‘(I) PERSONAL SERVICE CONTRACTS.—

‘‘(i) Amounts received under a contract under 

which the corporation is to furnish personal services 

if—

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‘‘(I) some person other than the corporation 

has the right to designate (by name or by description) the individual who is to perform the services, 

or 

‘‘(II) the individual who is to perform the services is designated (by name or by description) in 

the contract, and 

‘‘(ii) amounts received from the sale or other disposition of such a contract. 

This subparagraph shall apply with respect to amounts received for services under a particular contract only if at 

some time during the taxable year 25 percent or more in 

value of the outstanding stock of the corporation is owned, 

directly or indirectly, by or for the individual who has performed, is to perform, or may be designated (by name or by 

description) as the one to perform, such services.’’. 

(c) CONFORMING AMENDMENTS.—

(1) Section 1(h) is amended—

(A) in paragraph (10), by inserting ‘‘and’’ at the end of 

subparagraph (F), by striking subparagraph (G), and by redesignating subparagraph (H) as subparagraph (G), and 

(B) by striking ‘‘a foreign personal holding company (as 

defined in section 552), a foreign investment company (as 

defined in section 1246(b)), or’’ in paragraph (11)(C)(iii). 

(2) Paragraph (2) of section 171(c) is amended—

(A) by striking ‘‘, or by a foreign personal holding company, as defined in section 552’’, and 

(B) by striking ‘‘, or foreign personal holding company’’. 

(3) Paragraph (2) of section 245(a) is amended by striking 

‘‘foreign personal holding company or’’. 

(4) Section 312 is amended by striking subsection (j). 

(5) Subsection (m) of section 312 is amended by striking ‘‘, 

a foreign investment company (within the meaning of section 

1246(b)), or a foreign personal holding company (within the 

meaning of section 552)’’. 

(6) Subsection (e) of section 443 is amended by striking 

paragraph (3) and by redesignating paragraphs (4) and (5) as 

paragraphs (3) and (4), respectively. 

(7) Subparagraph (B) of section 465(c)(7) is amended by 

adding ‘‘or’’ at the end of clause (i), by striking clause (ii), and 

by redesignating clause (iii) as clause (ii). 

(8) Paragraph (1) of section 543(b) is amended by inserting 

‘‘and’’ at the end of subparagraph (A), by striking ‘‘, and’’ at the 

end of subparagraph (B) and inserting a period, and by striking subparagraph (C). 

(9) Paragraph (1) of section 562(b) is amended by striking 

‘‘or a foreign personal holding company described in section 

552’’. 

(10) Section 563 is amended—

(A) by striking subsection (c), 

(B) by redesignating subsection (d) as subsection (c), 

and 

(C) by striking ‘‘subsection (a), (b), or (c)’’ in subsection 

(c) (as so redesignated) and inserting ‘‘subsection (a) or (b)’’. 

92

(11) Subsection (d) of section 751 is amended by adding 

‘‘and’’ at the end of paragraph (2), by striking paragraph (3), 

by redesignating paragraph (4) as paragraph (3), and by striking ‘‘paragraph (1), (2), or (3)’’ in paragraph (3) (as so redesignated) and inserting ‘‘paragraph (1) or (2)’’. 

(12) Paragraph (2) of section 864(d) is amended by striking 

subparagraph (A) and by redesignating subparagraphs (B) and 

(C) as subparagraphs (A) and (B), respectively. 

(13)(A) Subparagraph (A) of section 898(b)(1) is amended to 

read as follows: 

‘‘(A) which is treated as a controlled foreign corporation for any purpose under subpart F of part III of this subchapter, and’’. 

(B) Subparagraph (B) of section 898(b)(2) is amended by 

striking ‘‘and sections 551(f) and 554, whichever are applicable,’’. 

(C) Paragraph (3) of section 898(b) is amended to read as 

follows: 

‘‘(3) UNITED STATES SHAREHOLDER.—The term ‘United 

States shareholder’ has the meaning given to such term by section 951(b), except that, in the case of a foreign corporation having related person insurance income (as defined in section 

953(c)(2)), the Secretary may treat any person as a United 

States shareholder for purposes of this section if such person is 

treated as a United States shareholder under section 953(c)(1).’’. 

(D) Subsection (c) of section 898 is amended to read as follows: 

‘‘(c) DETERMINATION OF REQUIRED YEAR.—

‘‘(1) IN GENERAL.—The required year is—

‘‘(A) the majority U.S. shareholder year, or 

‘‘(B) if there is no majority U.S. shareholder year, the 

taxable year prescribed under regulations. 

‘‘(2) 1-MONTH DEFERRAL ALLOWED.—A specified foreign corporation may elect, in lieu of the taxable year under paragraph 

(1)(A), a taxable year beginning 1 month earlier than the majority U.S. shareholder year. 

‘‘(3) MAJORITY U.S. SHAREHOLDER YEAR.—

‘‘(A) IN GENERAL.—For purposes of this subsection, the 

term ‘majority U.S. shareholder year’ means the taxable 

year (if any) which, on each testing day, constituted the taxable year of—

‘‘(i) each United States shareholder described in 

subsection (b)(2)(A), and 

‘‘(ii) each United States shareholder not described 

in clause (i) whose stock was treated as owned under 

subsection (b)(2)(B) by any shareholder described in 

such clause. 

‘‘(B) TESTING DAY.—The testing days shall be—

‘‘(i) the first day of the corporation’s taxable year 

(determined without regard to this section), or 

‘‘(ii) the days during such representative period as 

the Secretary may prescribe.’’. 

(14) Clause (ii) of section 904(d)(2)(A) is amended to read 

as follows: 

93

‘‘(ii) CERTAIN AMOUNTS INCLUDED.—Except as provided in clause (iii), the term ‘passive income’ includes, 

except as provided in subparagraph (E)(iii) or paragraph (3)(I), any amount includible in gross income 

under section 1293 (relating to certain passive foreign 

investment companies).’’. 

(15)(A) Subparagraph (A) of section 904(h)(1), as redesignated by this Act, is amended by adding ‘‘or’’ at the end of 

clause (i), by striking clause (ii), and by redesignating clause 

(iii) as clause (ii). 

(B) The paragraph heading of paragraph (2) of section 

904(h), as so redesignated, is amended by striking ‘‘FOREIGN

PERSONAL HOLDING OR’’.

(16) Section 951 is amended by striking subsections (c) and 

(d) and by redesignating subsections (e) and (f) as subsections 

(c) and (d), respectively. 

(17) Paragraph (3) of section 989(b) is amended by striking 

‘‘, 551(a),’’. 

(18) Paragraph (5) of section 1014(b) is amended by inserting ‘‘and before January 1, 2005,’’ after ‘‘August 26, 1937,’’. 

(19) Subsection (a) of section 1016 is amended by striking 

paragraph (13). 

(20)(A) Paragraph (3) of section 1212(a) is amended to read 

as follows: 

‘‘(3) SPECIAL RULES ON CARRYBACKS.—A net capital loss of 

a corporation shall not be carried back under paragraph (1)(A) 

to a taxable year—

‘‘(A) for which it is a regulated investment company (as 

defined in section 851), or 

‘‘(B) for which it is a real estate investment trust (as 

defined in section 856).’’. 

(B) The amendment made by subparagraph (A) shall apply 

to taxable years beginning after December 31, 2004. 

(21) Section 1223 is amended by striking paragraph (10) 

and by redesignating the following paragraphs accordingly. 

(22) Subsection (d) of section 1248 is amended by striking 

paragraph (5) and by redesignating paragraphs (6) and (7) as 

paragraphs (5) and (6), respectively. 

(23) Paragraph (2) of section 1260(c) is amended by striking subparagraphs (H) and (I) and by redesignating subparagraph (J) as subparagraph (H). 

(24)(A) Subparagraph (F) of section 1291(b)(3) is amended 

by striking ‘‘551(d), 959(a),’’ and inserting ‘‘959(a)’’. 

(B) Subsection (e) of section 1291 is amended by inserting 

‘‘(as in effect on the day before the date of the enactment of the 

American Jobs Creation Act of 2004)’’ after ‘‘section 1246’’. 

(25) Paragraph (2) of section 1294(a) is amended to read as 

follows: 

‘‘(2) ELECTION NOT PERMITTED WHERE AMOUNTS OTHERWISE

INCLUDIBLE UNDER SECTION 951.—The taxpayer may not make 

an election under paragraph (1) with respect to the undistributed PFIC earnings tax liability attributable to a qualified 

electing fund for the taxable year if any amount is includible 

in the gross income of the taxpayer under section 951 with respect to such fund for such taxable year.’’. 

94

(26) Section 6035 is hereby repealed. 

(27) Subparagraph (D) of section 6103(e)(1) is amended by 

striking clause (iv) and redesignating clauses (v) and (vi) as 

clauses (iv) and (v), respectively. 

(28) Subparagraph (B) of section 6501(e)(1) is amended to 

read as follows: 

‘‘(B) CONSTRUCTIVE DIVIDENDS.—If the taxpayer omits 

from gross income an amount properly includible therein 

under section 951(a), the tax may be assessed, or a proceeding in court for the collection of such tax may be done 

without assessing, at any time within 6 years after the return was filed.’’. 

(29) Subsection (a) of section 6679 is amended—

(A) by striking ‘‘6035, 6046, and 6046A’’ in paragraph 

(1) and inserting ‘‘6046 and 6046A’’, and 

(B) by striking paragraph (3). 

(30) Sections 170(f)(10)(A), 508(d), 4947, and 4948(c)(4) are 

each amended by striking ‘‘556(b)(2),’’ each place it appears. 

(31) The table of parts for subchapter G of chapter 1 is 

amended by striking the item relating to part III. 

(32) The table of sections for part IV of subchapter P of 

chapter 1 is amended by striking the items relating to sections 

1246 and 1247. 

(33) The table of sections for subpart A of part III of subchapter A of chapter 61 is amended by striking the item relating to section 6035. 

(d) EFFECTIVE DATES.— (1) IN GENERAL.—Except as provided in paragraph (2), the 

amendments made by this section shall apply to taxable years 

of foreign corporations beginning after December 31, 2004, and 

to taxable years of United States shareholders with or within 

which such taxable years of foreign corporations end. 

(2) SUBSECTION (c)(27).—The amendments made by subsection (c)(27) shall apply to disclosures of return or return information with respect to taxable years beginning after December 31, 2004. 

SEC. 414. DETERMINATION OF FOREIGN PERSONAL HOLDING COMPANY INCOME WITH RESPECT TO TRANSACTIONS IN COMMODITIES. 

(a) IN GENERAL.—Clauses (i) and (ii) of section 954(c)(1)(C) (relating to commodity transactions) are amended to read as follows: 

‘‘(i) arise out of commodity hedging transactions 

(as defined in paragraph (4)(A)), 

‘‘(ii) are active business gains or losses from the 

sale of commodities, but only if substantially all of the 

controlled foreign corporation’s commodities are property described in paragraph (1), (2), or (8) of section 

1221(a), or’’. 

(b) DEFINITION AND SPECIAL RULES.—Subsection (c) of section 

954, as amended by this Act, is amended by adding after paragraph 

(4) the following new paragraph: 

‘‘(5) DEFINITION AND SPECIAL RULES RELATING TO COM- MODITY TRANSACTIONS.—

‘‘(A) COMMODITY HEDGING TRANSACTIONS.—For purposes of paragraph (1)(C)(i), the term ‘commodity hedging 

95

transaction’ means any transaction with respect to a commodity if such transaction—

‘‘(i) is a hedging transaction as defined in section 

1221(b)(2), determined—

‘‘(I) without regard to subparagraph (A)(ii) 

thereof, 

‘‘(II) by applying subparagraph (A)(i) thereof 

by substituting ‘ordinary property or property described in section 1231(b)’ for ‘ordinary property’, 

and 

‘‘(III) by substituting ‘controlled foreign corporation’ for ‘taxpayer’ each place it appears, and 

‘‘(ii) is clearly identified as such in accordance 

with section 1221(a)(7). 

‘‘(B) TREATMENT OF DEALER ACTIVITIES UNDER PARA- GRAPH (1)(C).—Commodities with respect to which gains 

and losses are not taken into account under paragraph 

(2)(C) in computing a controlled foreign corporation’s foreign personal holding company income shall not be taken 

into account in applying the substantially all test under 

paragraph (1)(C)(ii) to such corporation. 

‘‘(C) REGULATIONS.—The Secretary shall prescribe such 

regulations as are appropriate to carry out the purposes of 

paragraph (1)(C) in the case of transactions involving related parties.’’. 

(c) MODIFICATION OF EXCEPTION FOR DEALERS.—Clause (i) of 

section 954(c)(2)(C) is amended by inserting ‘‘and transactions involving physical settlement’’ after ‘‘(including hedging transactions’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transactions entered into after December 31, 2004. 

SEC. 415. MODIFICATIONS TO TREATMENT OF AIRCRAFT LEASING AND 

SHIPPING INCOME. 

(a) ELIMINATION OF FOREIGN BASE COMPANY SHIPPING IN- COME.—Section 954 (relating to foreign base company income) is 

amended—

(1) by striking paragraph (4) of subsection (a) (relating to 

foreign base company shipping income), and 

(2) by striking subsection (f) (relating to foreign base company shipping income). 

(b) SAFE HARBOR FOR CERTAIN LEASING ACTIVITIES.—Subparagraph (A) of section 954(c)(2) is amended by adding at the end the 

following new sentence: ‘‘For purposes of the preceding sentence, 

rents derived from leasing an aircraft or vessel in foreign commerce 

shall not fail to be treated as derived in the active conduct of a 

trade or business if, as determined under regulations prescribed by 

the Secretary, the active leasing expenses are not less than 10 percent of the profit on the lease.’’. 

(c) CONFORMING AMENDMENTS.—

(1) Section 952(c)(1)(B)(iii) is amended by striking subclause (I) and redesignating subclauses (II) through (VI) as subclauses (I) through (V), respectively. 

(2) Subsection (b) of section 954 is amended—

(A) by striking ‘‘the foreign base company shipping income,’’ in paragraph (5), 

(B) by striking paragraphs (6) and (7), and 

96

(C) by redesignating paragraph (8) as paragraph (6). 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years of foreign corporations beginning after 

December 31, 2004, and to taxable years of United States shareholders with or within which such taxable years of foreign corporations end. 

SEC. 416. MODIFICATION OF EXCEPTIONS UNDER SUBPART F FOR ACTIVE FINANCING. 

(a) IN GENERAL.—Section 954(h)(3) is amended by adding at 

the end the following: 

‘‘(E) DIRECT CONDUCT OF ACTIVITIES.—For purposes of 

subparagraph (A)(ii)(II), an activity shall be treated as conducted directly by an eligible controlled foreign corporation 

or qualified business unit in its home country if the activity 

is performed by employees of a related person and—

‘‘(i) the related person is an eligible controlled foreign corporation the home country of which is the same 

as the home country of the corporation or unit to which 

subparagraph (A)(ii)(II) is being applied, 

‘‘(ii) the activity is performed in the home country 

of the related person, and 

‘‘(iii) the related person is compensated on an 

arm’s-length basis for the performance of the activity 

by its employees and such compensation is treated as 

earned by such person in its home country for purposes 

of the home country’s tax laws.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years of such foreign corporations beginning 

after December 31, 2004, and to taxable years of United States 

shareholders with or within which such taxable years of such foreign corporations end. 

SEC. 417. 10-YEAR FOREIGN TAX CREDIT CARRYOVER; 1-YEAR FOREIGN 

TAX CREDIT CARRYBACK. 

(a) GENERAL RULE.—Section 904(c) (relating to carryback and 

carryover of excess tax paid) is amended—

(1) by striking ‘‘in the second preceding taxable year,’’, and 

(2) by striking ‘‘, and in the first, second, third, fourth, or 

fifth’’ and inserting ‘‘and in any of the first 10’’. 

(b) EXCESS EXTRACTION TAXES.—Paragraph (1) of section 907(f) 

is amended—

(1) by striking ‘‘in the second preceding taxable year,’’, 

(2) by striking ‘‘, and in the first, second, third, fourth, or 

fifth’’ and inserting ‘‘and in any of the first 10’’, and 

(3) by striking the last sentence. 

(c) EFFECTIVE DATE.—

(1) CARRYBACK.—The amendments made by subsections 

(a)(1) and (b)(1) shall apply to excess foreign taxes arising in 

taxable years beginning after the date of the enactment of this 

Act. 

(2) CARRYOVER.—The amendments made by subsections 

(a)(2) and (b)(2) shall apply to excess foreign taxes which (without regard to the amendments made by this section) may be 

carried to any taxable year ending after the date of the enactment of this Act. 

97

SEC. 418. MODIFICATION OF THE TREATMENT OF CERTAIN REIT DISTRIBUTIONS ATTRIBUTABLE TO GAIN FROM SALES OR EXCHANGES OF UNITED STATES REAL PROPERTY INTERESTS. 

(a) IN GENERAL.—Paragraph (1) of section 897(h) (relating to 

look-through of distributions) is amended by adding at the end the 

following new sentence: ‘‘Notwithstanding the preceding sentence, 

any distribution by a REIT with respect to any class of stock which 

is regularly traded on an established securities market located in 

the United States shall not be treated as gain recognized from the 

sale or exchange of a United States real property interest if the 

shareholder did not own more than 5 percent of such class of stock 

at any time during the taxable year.’’. 

(b) CONFORMING AMENDMENT.—Paragraph (3) of section 857(b) 

(relating to capital gains) is amended by adding at the end the following new subparagraph:

‘‘(F) CERTAIN DISTRIBUTIONS.—In the case of a shareholder of a real estate investment trust to whom section 897 

does not apply by reason of the second sentence of section 

897(h)(1), the amount which would be included in computing long-term capital gains for such shareholder under 

subparagraph (B) or (D) (without regard to this subparagraph)—

‘‘(i) shall not be included in computing such shareholder’s long-term capital gains, and 

‘‘(ii) shall be included in such shareholder’s gross 

income as a dividend from the real estate investment 

trust.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 419. EXCLUSION OF INCOME DERIVED FROM CERTAIN WAGERS 

ON HORSE RACES AND DOG RACES FROM GROSS INCOME 

OF NONRESIDENT ALIEN INDIVIDUALS. 

(a) IN GENERAL.—Subsection (b) of section 872 (relating to exclusions) is amended by redesignating paragraphs (5), (6), and (7) 

as paragraphs (6), (7), and (8), respectively, and inserting after 

paragraph (4) the following new paragraph: 

‘‘(5) INCOME DERIVED FROM WAGERING TRANSACTIONS IN

CERTAIN PARIMUTUEL POOLS.—Gross income derived by a nonresident alien individual from a legal wagering transaction initiated outside the United States in a parimutuel pool with respect to a live horse race or dog race in the United States.’’. 

(b) CONFORMING AMENDMENT.—Section 883(a)(4) is amended 

by striking ‘‘(5), (6), and (7)’’ and inserting ‘‘(6), (7), and (8)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to wagers made after the date of the enactment of this 

Act. 

SEC. 420. LIMITATION OF WITHHOLDING TAX FOR PUERTO RICO CORPORATIONS. 

(a) IN GENERAL.—Subsection (b) of section 881 is amended by 

redesignating paragraph (2) as paragraph (3) and by inserting after 

paragraph (1) the following new paragraph: 

‘‘(2) COMMONWEALTH OF PUERTO RICO.—

‘‘(A) IN GENERAL.—If dividends are received during a 

taxable year by a corporation—

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‘‘(i) created or organized in, or under the law of, 

the Commonwealth of Puerto Rico, and 

‘‘(ii) with respect to which the requirements of subparagraphs (A), (B), and (C) of paragraph (1) are met 

for the taxable year, 

subsection (a) shall be applied for such taxable year by substituting ‘10 percent’ for ‘30 percent’. 

‘‘(B) APPLICABILITY.—If, on or after the date of the enactment of this paragraph, an increase in the rate of the 

Commonwealth of Puerto Rico’s withholding tax which is 

generally applicable to dividends paid to United States corporations not engaged in a trade or business in the Commonwealth to a rate greater than 10 percent takes effect, 

this paragraph shall not apply to dividends received on or 

after the effective date of the increase.’’. 

(b) WITHHOLDING.—Subsection (c) of section 1442 (relating to 

withholding of tax on foreign corporations) is amended—

(1) by striking ‘‘For purposes’’ and inserting the following: 

‘‘(1) GUAM, AMERICAN SAMOA, THE NORTHERN MARIANA IS- LANDS, AND THE VIRGIN ISLANDS.—For purposes’’, and 

(2) by adding at the end the following new paragraph: 

‘‘(2) COMMONWEALTH OF PUERTO RICO.— ‘‘(A) IN GENERAL.—If dividends are received during a 

taxable year by a corporation—

‘‘(i) created or organized in, or under the law of, 

the Commonwealth of Puerto Rico, and 

‘‘(ii) with respect to which the requirements of subparagraphs (A), (B), and (C) of section 881(b)(1) are 

met for the taxable year, 

subsection (a) shall be applied for such taxable year by substituting ‘10 percent’ for ‘30 percent’. 

‘‘(B) APPLICABILITY.—If, on or after the date of the enactment of this paragraph, an increase in the rate of the 

Commonwealth of Puerto Rico’s withholding tax which is 

generally applicable to dividends paid to United States corporations not engaged in a trade or business in the Commonwealth to a rate greater than 10 percent takes effect, 

this paragraph shall not apply to dividends received on or 

after the effective date of the increase.’’. 

(c) CONFORMING AMENDMENTS.— (1) Subsection (b) of section 881 is amended by striking 

‘‘GUAM AND VIRGIN ISLANDS CORPORATIONS’’ in the heading 

and inserting ‘‘POSSESSIONS’’. 

(2) Paragraph (1) of section 881(b) is amended by striking 

‘‘IN GENERAL’’ in the heading and inserting ‘‘GUAM, AMERICAN

SAMOA, THE NORTHERN MARIANA ISLANDS, AND THE VIRGIN ISLANDS’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to dividends paid after the date of the enactment of this 

Act. 

SEC. 421. FOREIGN TAX CREDIT UNDER ALTERNATIVE MINIMUM TAX. 

(a) IN GENERAL.—

(1) Subsection (a) of section 59 is amended by striking 

paragraph (2) and by redesignating paragraphs (3) and (4) as 

paragraphs (2) and (3), respectively. 

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(2) Section 53(d)(1)(B)(i)(II) is amended by striking ‘‘and if 

section 59(a)(2) did not apply’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 422. INCENTIVES TO REINVEST FOREIGN EARNINGS IN UNITED 

STATES. 

(a) IN GENERAL.—Subpart F of part III of subchapter N of 

chapter 1 (relating to controlled foreign corporations) is amended by 

adding at the end the following new section: 

‘‘SEC. 965. TEMPORARY DIVIDENDS RECEIVED DEDUCTION. 

‘‘(a) DEDUCTION.—

‘‘(1) IN GENERAL.—In the case of a corporation which is a 

United States shareholder and for which the election under this 

section is in effect for the taxable year, there shall be allowed 

as a deduction an amount equal to 85 percent of the cash dividends which are received during such taxable year by such 

shareholder from controlled foreign corporations. 

‘‘(2) DIVIDENDS PAID INDIRECTLY FROM CONTROLLED FOREIGN CORPORATIONS.—If, within the taxable year for which the 

election under this section is in effect, a United States shareholder receives a cash distribution from a controlled foreign corporation which is excluded from gross income under section 

959(a), such distribution shall be treated for purposes of this 

section as a cash dividend to the extent of any amount included 

in income by such United States shareholder under section 

951(a)(1)(A) as a result of any cash dividend during such taxable year to—

‘‘(A) such controlled foreign corporation from another 

controlled foreign corporation that is in a chain of ownership described in section 958(a), or 

‘‘(B) any other controlled foreign corporation in such 

chain of ownership, but only to the extent of cash distributions described in section 959(b) which are made during 

such taxable year to the controlled foreign corporation from 

which such United States shareholder received such distribution. 

‘‘(b) LIMITATIONS.—

‘‘(1) IN GENERAL.—The amount of dividends taken into account under subsection (a) shall not exceed the greater of—

‘‘(A) $500,000,000, 

‘‘(B) the amount shown on the applicable financial 

statement as earnings permanently reinvested outside the 

United States, or

‘‘(C) in the case of an applicable financial statement 

which fails to show a specific amount of earnings permanently reinvested outside the United States and which 

shows a specific amount of tax liability attributable to such 

earnings, the amount equal to the amount of such liability 

divided by 0.35. 

The amounts described in subparagraphs (B) and (C) shall be 

treated as being zero if there is no such statement or such statement fails to show a specific amount of such earnings or liability, as the case may be. 

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‘‘(2) DIVIDENDS MUST BE EXTRAORDINARY.—The amount of 

dividends taken into account under subsection (a) shall not exceed the excess (if any) of—

‘‘(A) the dividends received during the taxable year by 

such shareholder from controlled foreign corporations, over 

‘‘(B) the annual average for the base period years of—

‘‘(i) the dividends received during each base period 

year by such shareholder from controlled foreign corporations, 

‘‘(ii) the amounts includible in such shareholder’s 

gross income for each base period year under section 

951(a)(1)(B) with respect to controlled foreign corporations, and 

‘‘(iii) the amounts that would have been included 

for each base period year but for section 959(a) with respect to controlled foreign corporations. 

The amount taken into account under clause (iii) for any 

base period year shall not include any amount which is not 

includible in gross income by reason of an amount described in clause (ii) with respect to a prior taxable year. 

Amounts described in subparagraph (B) for any base period year shall be such amounts as shown on the most recent return filed for such year; except that amended returns 

filed after June 30, 2003, shall not be taken into account. 

‘‘(3) REDUCTION OF BENEFIT IF INCREASE IN RELATED PARTY

INDEBTEDNESS.—The amount of dividends which would (but for 

this paragraph) be taken into account under subsection (a) 

shall be reduced by the excess (if any) of—

‘‘(A) the amount of indebtedness of the controlled foreign corporation to any related person (as defined in section 

954(d)(3)) as of the close of the taxable year for which the 

election under this section is in effect, over 

‘‘(B) the amount of indebtedness of the controlled foreign corporation to any related person (as so defined) as of 

the close of October 3, 2004. 

All controlled foreign corporations with respect to which the 

taxpayer is a United States shareholder shall be treated as 1 

controlled foreign corporation for purposes of this paragraph. 

‘‘(4) REQUIREMENT TO INVEST IN UNITED STATES.—Subsection (a) shall not apply to any dividend received by a United 

States shareholder unless the amount of the dividend is invested in the United States pursuant to a domestic reinvestment 

plan which—

‘‘(A) is approved by the taxpayer’s president, chief executive officer, or comparable official before the payment of 

such dividend and subsequently approved by the taxpayer’s 

board of directors, management committee, executive committee, or similar body, and 

‘‘(B) provides for the reinvestment of such dividend in 

the United States (other than as payment for executive compensation), including as a source for the funding of worker 

hiring and training, infrastructure, research and development, capital investments, or the financial stabilization of 

the corporation for the purposes of job retention or creation. 

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‘‘(c) DEFINITIONS AND SPECIAL RULES.—For purposes of this 

section—

‘‘(1) APPLICABLE FINANCIAL STATEMENT.—The term ‘applicable financial statement’ means, with respect to a United 

States shareholder, the most recently audited financial statement (including notes and other documents which accompany 

such statement) which includes such shareholder—

‘‘(A) which is certified on or before June 30, 2003, as 

being prepared in accordance with generally accepted accounting principles, and 

‘‘(B) which is used for the purposes of a statement or 

report—

‘‘(i) to creditors, 

‘‘(ii) to shareholders, or 

‘‘(iii) for any other substantial nontax purpose. 

In the case of a corporation required to file a financial statement with the Securities and Exchange Commission, such term 

means the most recent such statement filed on or before June 

30, 2003. 

‘‘(2) BASE PERIOD YEARS.—

‘‘(A) IN GENERAL.—The base period years are the 3 taxable years—

‘‘(i) which are among the 5 most recent taxable 

years ending on or before June 30, 2003, and 

‘‘(ii) which are determined by disregarding—

‘‘(I) 1 taxable year for which the sum of the 

amounts described in clauses (i), (ii), and (iii) of 

subsection (b)(2)(B) is the largest, and 

‘‘(II) 1 taxable year for which such sum is the 

smallest. 

‘‘(B) SHORTER PERIOD.—If the taxpayer has fewer than 

5 taxable years ending on or before June 30, 2003, then in 

lieu of applying subparagraph (A), the base period years 

shall include all the taxable years of the taxpayer ending 

on or before June 30, 2003. 

‘‘(C) MERGERS, ACQUISITIONS, ETC.— ‘‘(i) IN GENERAL.—Rules similar to the rules of subparagraphs (A) and (B) of section 41(f)(3) shall apply 

for purposes of this paragraph. 

‘‘(ii) SPIN-OFFS, ETC.—If there is a distribution to 

which section 355 (or so much of section 356 as relates 

to section 355) applies during the 5-year period referred to in subparagraph (A)(i) and the controlled corporation (within the meaning of section 355) is a 

United States shareholder—

‘‘(I) the controlled corporation shall be treated 

as being in existence during the period that the 

distributing corporation (within the meaning of 

section 355) is in existence, and 

‘‘(II) for purposes of applying subsection (b)(2) 

to the controlled corporation and the distributing 

corporation, amounts described in subsection 

(b)(2)(B) which are received or includible by the 

distributing corporation or controlled corporation 

(as the case may be) before the distribution reVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00105 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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ferred to in subclause (I) from a controlled foreign 

corporation shall be allocated between such corporations in proportion to their respective interests 

as United States shareholders of such controlled 

foreign corporation immediately after such distribution. 

Subclause (II) shall not apply if neither the controlled 

corporation nor the distributing corporation is a 

United States shareholder of such controlled foreign 

corporation immediately after such distribution. 

‘‘(3) DIVIDEND.—The term ‘dividend’ shall not include 

amounts includible in gross income as a dividend under section 

78, 367, or 1248. In the case of a liquidation under section 332 

to which section 367(b) applies, the preceding sentence shall not 

apply to the extent the United States shareholder actually receives cash as part of the liquidation. 

‘‘(4) COORDINATION WITH DIVIDENDS RECEIVED DEDUC- TION.—No deduction shall be allowed under section 243 or 245 

for any dividend for which a deduction is allowed under this 

section. 

‘‘(5) CONTROLLED GROUPS.— ‘‘(A) IN GENERAL.—All United States shareholders 

which are members of an affiliated group filing a consolidated return under section 1501 shall be treated as one 

United States shareholder. 

‘‘(B) APPLICATION OF $500,000,000 LIMIT.—All corporations which are treated as a single employer under section 

52(a) shall be limited to one $500,000,000 amount in subsection (b)(1)(A), and such amount shall be divided among 

such corporations under regulations prescribed by the Secretary. 

‘‘(C) PERMANENTLY REINVESTED EARNINGS.—If a financial statement is an applicable financial statement for more 

than 1 United States shareholder, the amount applicable 

under subparagraph (B) or (C) of subsection (b)(1) shall be 

divided among such shareholders under regulations prescribed by the Secretary. 

‘‘(d) DENIAL OF FOREIGN TAX CREDIT; DENIAL OF CERTAIN EX- PENSES.—

‘‘(1) FOREIGN TAX CREDIT.—No credit shall be allowed 

under section 901 for any taxes paid or accrued (or treated as 

paid or accrued) with respect to the deductible portion of—

‘‘(A) any dividend, or 

‘‘(B) any amount described in subsection (a)(2) which is 

included in income under section 951(a)(1)(A). 

No deduction shall be allowed under this chapter for any tax 

for which credit is not allowable by reason of the preceding sentence. 

‘‘(2) EXPENSES.—No deduction shall be allowed for expenses 

properly allocated and apportioned to the deductible portion described in paragraph (1). 

‘‘(3) DEDUCTIBLE PORTION.—For purposes of paragraph (1), 

unless the taxpayer otherwise specifies, the deductible portion of 

any dividend or other amount is the amount which bears the 

same ratio to the amount of such dividend or other amount as 

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the amount allowed as a deduction under subsection (a) for the 

taxable year bears to the amount described in subsection 

(b)(2)(A) for such year. 

‘‘(e) INCREASE IN TAX ON INCLUDED AMOUNTS NOT REDUCED BY

CREDITS, ETC.—

‘‘(1) IN GENERAL.—Any tax under this chapter by reason of 

nondeductible CFC dividends shall not be treated as tax imposed by this chapter for purposes of determining—

‘‘(A) the amount of any credit allowable under this 

chapter, or 

‘‘(B) the amount of the tax imposed by section 55. 

Subparagraph (A) shall not apply to the credit under section 53 

or to the credit under section 27(a) with respect to taxes attributable to such dividends. 

‘‘(2) LIMITATION ON REDUCTION IN TAXABLE INCOME, ETC.—

‘‘(A) IN GENERAL.—The taxable income of any United 

States shareholder for any taxable year shall in no event be 

less than the amount of nondeductible CFC dividends received during such year. 

‘‘(B) COORDINATION WITH SECTION 172.—The nondeductible CFC dividends for any taxable year shall not be 

taken into account—

‘‘(i) in determining under section 172 the amount 

of any net operating loss for such taxable year, and 

‘‘(ii) in determining taxable income for such taxable year for purposes of the 2nd sentence of section 

172(b)(2). 

‘‘(3) NONDEDUCTIBLE CFC DIVIDENDS.—For purposes of this 

subsection, the term ‘nondeductible CFC dividends’ means the 

excess of the amount of dividends taken into account under subsection (a) over the deduction allowed under subsection (a) for 

such dividends. 

‘‘(f) ELECTION.—The taxpayer may elect to apply this section 

to—

‘‘(1) the taxpayer’s last taxable year which begins before the 

date of the enactment of this section, or 

‘‘(2) the taxpayer’s first taxable year which begins during 

the 1-year period beginning on such date. 

Such election may be made for a taxable year only if made before 

the due date (including extensions) for filing the return of tax for 

such taxable year.’’

(b) ALTERNATIVE MINIMUM TAX.—Subparagraph (C) of section 

56(g)(4) is amended by inserting after clause (v) the following new 

clause: 

‘‘(vi) SPECIAL RULE FOR CERTAIN DISTRIBUTIONS

FROM CONTROLLED FOREIGN CORPORATIONS.—Clause 

(i) shall not apply to any deduction allowable under 

section 965.’’. 

(c) CLERICAL AMENDMENT.—The table of sections for subpart F 

of part III of subchapter N of chapter 1 is amended by adding at 

the end the following new item:

‘‘Sec. 965. Temporary dividends received deduction.’’.

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(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years ending on or after the date of the enactment of this Act. 

SEC. 423. DELAY IN EFFECTIVE DATE OF FINAL REGULATIONS GOVERNING EXCLUSION OF INCOME FROM INTERNATIONAL 

OPERATION OF SHIPS OR AIRCRAFT. 

Notwithstanding the provisions of Treasury regulation § 1.883–

5, the final regulations issued by the Secretary of the Treasury relating to income derived by foreign corporations from the international 

operation of ships or aircraft (Treasury regulations § 1.883–1 

through § 1.883–5) shall apply to taxable years of a foreign corporation seeking qualified foreign corporation status beginning after 

September 24, 2004. 

SEC. 424. STUDY OF EARNINGS STRIPPING PROVISIONS. 

(a) IN GENERAL.—The Secretary of the Treasury or the Secretary’s delegate shall conduct a study of the effectiveness of the provisions of the Internal Revenue Code of 1986 applicable to earnings 

stripping, including a study of—

(1) the effectiveness of section 163(j) of such Code in preventing the shifting of income outside the United States, 

(2) whether any deficiencies of such provisions place United 

States-based businesses at a competitive disadvantage relative 

to foreign-based businesses, 

(3) the impact of earnings stripping activities on the United 

States tax base, 

(4) whether laws of foreign countries facilitate stripping of 

earnings out of the United States, and 

(5) whether changes to the earning stripping rules would 

affect jobs in the United States. 

(b) REPORT.—Not later than June 30, 2005, the Secretary shall 

submit to the Congress a report of the study conducted under this 

section, including specific recommendations as to how to improve 

the provisions of such Code applicable to earnings stripping.

TITLE V—DEDUCTION OF STATE AND 

LOCAL GENERAL SALES TAXES 

SEC. 501. DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES 

IN LIEU OF STATE AND LOCAL INCOME TAXES. 

(a) IN GENERAL.—Subsection (b) of section 164 (relating to definitions and special rules) is amended by adding at the end the following: 

‘‘(5) GENERAL SALES TAXES.—For purposes of subsection 

(a)—

‘‘(A) ELECTION TO DEDUCT STATE AND LOCAL SALES

TAXES IN LIEU OF STATE AND LOCAL INCOME TAXES.—

‘‘(i) IN GENERAL.—At the election of the taxpayer 

for the taxable year, subsection (a) shall be applied—

‘‘(I) without regard to the reference to State 

and local income taxes, and 

‘‘(II) as if State and local general sales taxes 

were referred to in a paragraph thereof. 

‘‘(B) DEFINITION OF GENERAL SALES TAX.—The term 

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105

spect to the sale at retail of a broad range of classes of 

items. 

‘‘(C) SPECIAL RULES FOR FOOD, ETC.—In the case of 

items of food, clothing, medical supplies, and motor vehicles—

‘‘(i) the fact that the tax does not apply with respect 

to some or all of such items shall not be taken into account in determining whether the tax applies with respect to a broad range of classes of items, and 

‘‘(ii) the fact that the rate of tax applicable with respect to some or all of such items is lower than the general rate of tax shall not be taken into account in determining whether the tax is imposed at one rate. 

‘‘(D) ITEMS TAXED AT DIFFERENT RATES.—Except in the 

case of a lower rate of tax applicable with respect to an 

item described in subparagraph (C), no deduction shall be 

allowed under this paragraph for any general sales tax imposed with respect to an item at a rate other than the general rate of tax. 

‘‘(E) COMPENSATING USE TAXES.—A compensating use 

tax with respect to an item shall be treated as a general 

sales tax. For purposes of the preceding sentence, the term 

‘compensating use tax’ means, with respect to any item, a 

tax which—

‘‘(i) is imposed on the use, storage, or consumption 

of such item, and 

‘‘(ii) is complementary to a general sales tax, but 

only if a deduction is allowable under this paragraph 

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

‘‘(F) SPECIAL RULE FOR MOTOR VEHICLES.—In the case 

of motor vehicles, if the rate of tax exceeds the general rate, 

such excess shall be disregarded and the general rate shall 

be treated as the rate of tax. 

‘‘(G) SEPARATELY STATED GENERAL SALES TAXES.—If 

the amount of any general sales tax is separately stated, 

then, to the extent that the amount so stated is paid by the 

consumer (other than in connection with the consumer’s 

trade or business) to the seller, such amount shall be treated as a tax imposed on, and paid by, such consumer. 

‘‘(H) AMOUNT OF DEDUCTION MAY BE DETERMINED

UNDER TABLES.—

‘‘(i) IN GENERAL.—At the election of the taxpayer 

for the taxable year, the amount of the deduction allowed under this paragraph for such year shall be—

‘‘(I) the amount determined under this paragraph (without regard to this subparagraph) with 

respect to motor vehicles, boats, and other items 

specified by the Secretary, and 

‘‘(II) the amount determined under tables prescribed by the Secretary with respect to items to 

which subclause (I) does not apply. 

‘‘(ii) REQUIREMENTS FOR TABLES.—The tables prescribed under clause (i)—

106

‘‘(I) shall reflect the provisions of this paragraph, 

‘‘(II) shall be based on the average consumption by taxpayers on a State-by-State basis (as determined by the Secretary) of items to which clause 

(i)(I) does not apply, taking into account filing status, number of dependents, adjusted gross income, 

and rates of State and local general sales taxation, 

and 

‘‘(III) need only be determined with respect to 

adjusted gross incomes up to the applicable 

amount (as determined under section 68(b)). 

‘‘(I) APPLICATION OF PARAGRAPH.—This paragraph 

shall apply to taxable years beginning after December 31, 

2003, and before January 1, 2006.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after December 31, 2003. 

TITLE VI—FAIR AND EQUITABLE 

TOBACCO REFORM 

SEC. 601. SHORT TITLE. 

This title may be cited as the ‘‘Fair and Equitable Tobacco Reform Act of 2004’’.

Subtitle A—Termination of Federal Tobacco Quota and Price Support Programs 

SEC. 611. TERMINATION OF TOBACCO QUOTA PROGRAM AND RELATED 

PROVISIONS. 

(a) MARKETING QUOTAS.—Part I of subtitle B of title III of the 

Agricultural Adjustment Act of 1938 (7 U.S.C. 1311 et seq.) is repealed. 

(b) TOBACCO INSPECTIONS.—Section 213 of the Tobacco Adjustment Act of 1983 (7 U.S.C. 511r) is repealed. 

(c) TOBACCO CONTROL.—The Act of April 25, 1936 (commonly 

known as the Tobacco Control Act; 7 U.S.C. 515 et seq.), is repealed. 

(d) PROCESSING TAX.—Section 9(b) of the Agricultural Adjustment Act (7 U.S.C. 609(b)), reenacted with amendments by the Agricultural Marketing Agreement Act of 1937, is amended—

(1) in paragraph (2), by striking ‘‘tobacco,’’; and 

(2) in paragraph (6)(B)(i), by striking ‘‘, or, in the case of 

tobacco, is less than the fair exchange value by not more than 

10 per centum,’’. 

(e) DECLARATION OF POLICY.—Section 2 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1282) is amended by striking ‘‘tobacco,’’. 

(f) DEFINITIONS.—Section 301(b) of the Agricultural Adjustment 

Act of 1938 (7 U.S.C. 1301(b)) is amended—

(1) in paragraph (3)—

(A) by striking subparagraph (C); and 

(B) by redesignating subparagraph (D) as subparagraph (C); 

107

(2) in paragraph (6)(A), by striking ‘‘tobacco,’’; 

(3) in paragraph (10)—

(A) by striking subparagraph (B); and 

(B) by redesignating subparagraph (C) as subparagraph (B); 

(4) in paragraph (11)(B), by striking ‘‘and tobacco’’; 

(5) in paragraph (12), by striking ‘‘tobacco,’’; 

(6) in paragraph (14)—

(A) in subparagraph (A), by striking ‘‘(A)’’; and 

(B) by striking subparagraphs (B), (C), and (D); 

(7) by striking paragraph (15); 

(8) in paragraph (16)—

(A) by striking subparagraph (B); and 

(B) by redesignating subparagraph (C) as subparagraph (B); 

(9) by striking paragraph (17); and 

(10) by redesignating paragraph (16) as paragraph (15). 

(g) PARITY PAYMENTS.—Section 303 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1303) is amended in the first sentence 

by striking ‘‘rice, or tobacco,’’ and inserting ‘‘or rice,’’. 

(h) ADMINISTRATIVE PROVISIONS.—Section 361 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1361) is amended by striking ‘‘tobacco,’’. 

(i) ADJUSTMENT OF QUOTAS.—Section 371 of the Agricultural 

Adjustment Act of 1938 (7 U.S.C. 1371) is amended—

(1) in the first sentence of subsection (a), by striking ‘‘rice, 

or tobacco’’ and inserting ‘‘or rice’’; and 

(2) in the first sentence of subsection (b), by striking ‘‘rice, 

or tobacco’’ and inserting ‘‘or rice’’. 

(j) REPORTS AND RECORDS.—Section 373 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1373) is amended—

(1) by striking ‘‘rice, or tobacco’’ each place it appears in 

subsections (a) and (b) and inserting ‘‘or rice’’; and 

(2) in subsection (a)—

(A) in the first sentence, by striking ‘‘all persons engaged in the business of redrying, prizing, or stemming tobacco for producers,’’; and (B) in the last sentence, by striking ‘‘$500;’’ and all that 

follows through the period at the end of the sentence and 

inserting ‘‘$500.’’. 

(k) REGULATIONS.—Section 375 of the Agricultural Adjustment 

Act of 1938 (7 U.S.C. 1375) is amended—

(1) in subsection (a), by striking ‘‘peanuts, or tobacco’’ and 

inserting ‘‘or peanuts’’; and 

(2) by striking subsection (c). 

(l) EMINENT DOMAIN.—Section 378 of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1378) is amended—

(1) in the first sentence of subsection (c), by striking ‘‘cotton, 

and tobacco’’ and inserting ‘‘and cotton’’; and 

(2) by striking subsections (d), (e), and (f). 

(m) BURLEY TOBACCO FARM RECONSTITUTION.—Section 379 of 

the Agricultural Adjustment Act of 1938 (7 U.S.C. 1379) is amended—

(1) in subsection (a)—

(A) by striking ‘‘(a)’’; and 

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(B) in paragraph (6), by striking ‘‘, but this clause (6) 

shall not be applicable in the case of burley tobacco’’; and 

(2) by striking subsections (b) and (c). 

(n) ACREAGE-POUNDAGE QUOTAS.—Section 4 of the Act of April 

16, 1955 (Public Law 89–12; 7 U.S.C. 1314c note), is repealed. 

(o) BURLEY TOBACCO ACREAGE ALLOTMENTS.—The Act of July 

12, 1952 (7 U.S.C. 1315), is repealed. 

(p) TRANSFER OF ALLOTMENTS.—Section 703 of the Food and 

Agriculture Act of 1965 (7 U.S.C. 1316) is repealed. 

(q) ADVANCE RECOURSE LOANS.—Section 13(a)(2)(B) of the 

Food Security Improvements Act of 1986 (7 U.S.C. 1433c–1(a)(2)(B)) 

is amended by striking ‘‘tobacco and’’. 

(r) TOBACCO FIELD MEASUREMENT.—Section 1112 of the Omnibus Budget Reconciliation Act of 1987 (Public Law 100–203; 101 

Stat. 1330–8) is amended by striking subsection (c). 

(s) BURLEY TOBACCO IMPORT REVIEW.—Section 3 of Public Law 

98–59 (7 U.S.C. 625) is repealed.

SEC. 612. TERMINATION OF TOBACCO PRICE SUPPORT PROGRAM AND 

RELATED PROVISIONS. 

(a) TERMINATION OF TOBACCO PRICE SUPPORT AND NO NET

COST PROVISIONS.—Sections 106, 106A, and 106B of the Agricultural Act of 1949 (7 U.S.C. 1445, 1445–1, 1445–2) are repealed. 

(b) PARITY PRICE SUPPORT.—Section 101 of the Agricultural Act 

of 1949 (7 U.S.C. 1441) is amended—

(1) in the first sentence of subsection (a), by striking ‘‘tobacco (except as otherwise provided herein), corn,’’ and inserting 

‘‘corn’’; 

(2) by striking subsections (c), (g), (h), and (i); 

(3) in subsection (d)(3)—

(A) by striking ‘‘, except tobacco,’’; and 

(B) by striking ‘‘and no price support shall be made 

available for any crop of tobacco for which marketing 

quotas have been disapproved by producers;’’; and 

(4) by redesignating subsections (d) and (e) as subsections 

(c) and (d), respectively. 

(c) DEFINITION OF BASIC AGRICULTURAL COMMODITY.—Section 

408(c) of the Agricultural Act of 1949 (7 U.S.C. 1428(c)) is amended 

by striking ‘‘tobacco,’’. 

(d) POWERS OF COMMODITY CREDIT CORPORATION.—Section 5 of 

the Commodity Credit Corporation Charter Act (15 U.S.C. 714c) is 

amended by inserting ‘‘(other than tobacco)’’ after ‘‘agricultural commodities’’ each place it appears. 

SEC. 613. CONFORMING AMENDMENTS. 

Section 320B(c)(1) of the Agricultural Adjustment Act of 1938 

(7 U.S.C. 1314h(c)(1)) is amended—

(1) by inserting ‘‘(A)’’ after ‘‘(1)’’; 

(2) by striking ‘‘by’’ at the end and inserting ‘‘or’’; and 

(3) by adding at the end the following: 

‘‘(B) in the case of the 2004 marketing year, the price support rate for the kind of tobacco involved in effect under section 

106 of the Agricultural Act of 1949 (7 U.S.C. 1445) at the time 

of the violation; by’’. 

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SEC. 614. CONTINUATION OF LIABILITY FOR 2004 AND EARLIER CROP 

YEARS. 

The amendments made by this subtitle shall not affect the liability of any person under any provision of law so amended with 

respect to the 2004 or an earlier crop of each kind of tobacco. 

Subtitle B—Transitional Payments to Tobacco Quota Holders and Producers of 

Tobacco 

SEC. 621. DEFINITIONS. 

In this subtitle and subtitle C: 

(1) AGRICULTURAL ACT OF 1949.—The term ‘‘Agricultural 

Act of 1949’’ means the Agricultural Act of 1949 (7 U.S.C. 1421 

et seq.), as in effect on the day before the date of the enactment 

of this title. 

(2) AGRICULTURAL ADJUSTMENT ACT OF 1938.—The term 

‘‘Agricultural Adjustment Act of 1938’’ means the Agricultural 

Adjustment Act of 1938 (7 U.S.C. 1281 et seq.), as in effect on 

the day before the date of the enactment of this title. 

(3) CONSIDERED PLANTED.—The term ‘‘considered planted’’ 

means tobacco that was planted, but failed to be produced as 

a result of a natural disaster, as determined by the Secretary. 

(4) CONTRACT.—The term ‘‘contract’’ means a contract entered into under section 622 or 623. 

(5) CONTRACT PAYMENT.—The term ‘‘contract payment’’ 

means a payment made under section 622 or 623 pursuant to 

a contract. 

(6) PRODUCER OF QUOTA TOBACCO.—The term ‘‘producer of 

quota tobacco’’ means an owner, operator, landlord, tenant, or 

sharecropper that shared in the risk of producing tobacco on a 

farm where tobacco was produced or considered planted pursuant to a tobacco farm poundage quota or farm acreage allotment established under part I of subtitle B of title III of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1311 et seq.). 

(7) QUOTA TOBACCO.—The term ‘‘quota tobacco’’ means a 

kind of tobacco that is subject to a farm marketing quota or 

farm acreage allotment for the 2004 tobacco marketing year 

under a marketing quota or allotment program established 

under part I of subtitle B of title III of the Agricultural Adjustment Act of 1938 (7 U.S.C. 1311 et seq.). 

(8) TOBACCO.—The term ‘‘tobacco’’ means each of the following kinds of tobacco: 

(A) Flue-cured tobacco, comprising types 11, 12, 13, 

and 14. 

(B) Fire-cured tobacco, comprising types 22 and 23. 

(C) Dark air-cured tobacco, comprising types 35 and 

36. 

(D) Virginia sun-cured tobacco, comprising type 37. 

(E) Virginia fire-cured tobacco, comprising type 21. 

(F) Burley tobacco, comprising type 31. 

(G) Cigar-filler and cigar-binder tobacco, comprising 

types 42, 43, 44, 53, 54, and 55. 

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(9) TOBACCO QUOTA HOLDER.—The term ‘‘tobacco quota 

holder’’ means a person that was an owner of a farm, as of the 

date of enactment of this title, for which a basic tobacco farm 

marketing quota or farm acreage allotment for quota tobacco 

was established for the 2004 tobacco marketing year. 

(10) TOBACCO TRUST FUND.—The term ‘‘Tobacco Trust 

Fund’’ means the Tobacco Trust Fund established under section 

626. 

(11) SECRETARY.—The term ‘‘Secretary’’ means the Secretary of Agriculture. 

SEC. 622. CONTRACT PAYMENTS TO TOBACCO QUOTA HOLDERS. 

(a) CONTRACT OFFERED.—The Secretary shall offer to enter into 

a contract with each tobacco quota holder under which the tobacco 

quota holder shall be entitled to receive payments under this section 

in exchange for the termination of tobacco marketing quotas and related price support under the amendments made by sections 611 

and 612. The contract payments shall constitute full and fair consideration for the termination of such tobacco marketing quotas and 

related price support. 

(b) ELIGIBILITY.—To be eligible to enter into a contract to receive a contract payment under this section, a person shall submit 

to the Secretary an application containing such information as the 

Secretary may require to demonstrate to the satisfaction of the Secretary that the person is a tobacco quota holder. The application 

shall be submitted within such time, in such form, and in such 

manner as the Secretary may require. 

(c) BASE QUOTA LEVEL.— (1) ESTABLISHMENT.—The Secretary shall establish a base 

quota level applicable to each tobacco quota holder identified 

under subsection (b). 

(2) POUNDAGE QUOTAS.—Subject to adjustment under subsection (d), for each kind of tobacco for which the marketing 

quota is expressed in pounds, the base quota level for each tobacco quota holder shall be equal to the basic quota for quota 

tobacco established for the 2002 tobacco marketing year under 

a marketing quota program established under part I of subtitle 

B of title III of the Agriculture Adjustment Act of 1938 on the 

farm owned by the tobacco quota holder. 

(3) MARKETING QUOTAS OTHER THAN POUNDAGE QUOTAS.— Subject to adjustment under subsection (d), for each kind of tobacco for which there is marketing quota or allotment on an 

acreage basis, the base quota level for each tobacco quota holder 

shall be the quantity equal to the product obtained by multiplying—

(A) the basic tobacco farm marketing quota or allotment for the 2002 marketing year established by the Secretary for quota tobacco owned by the tobacco quota holder; 

by 

(B) the average production yield, per acre, for the period covering the 2001, 2002, and 2003 crop years for that 

kind of tobacco in the county in which the quota tobacco is 

located. 

(d) TREATMENT OF CERTAIN CONTRACTS AND AGREEMENTS.—

(1) EFFECT OF PURCHASE CONTRACT.—If there was an 

agreement for the purchase of all or part of a farm described 

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in subsection (c) as of the date of the enactment of this title, and 

the parties to the sale are unable to agree to the disposition of 

eligibility for contract payments, the Secretary, taking into account any transfer of quota that has been agreed to, shall provide for the equitable division of the contract payments among 

the parties by adjusting the determination of who is the tobacco 

quota holder with respect to particular pounds or allotment of 

the quota. 

(2) EFFECT OF AGREEMENT FOR PERMANENT QUOTA TRANSFER.—If the Secretary determines that there was in existence, as 

of the day before the date of the enactment of this title, an 

agreement for the permanent transfer of quota, but that the 

transfer was not completed by that date, the Secretary shall 

consider the tobacco quota holder to be the party to the agreement that, as of that date, was the owner of the farm to which 

the quota was to be transferred. 

(e) CONTRACT PAYMENTS.—

(1) CALCULATION OF TOTAL PAYMENT AMOUNT.—The total 

amount of contract payments to which an eligible tobacco quota 

holder is entitled under this section, with respect to a kind of 

tobacco, shall be equal to the product obtained by multiplying—

(A) $7.00 per pound; by 

(B) the base quota level of the tobacco quota holder determined under subsection (c) with respect to that kind of 

tobacco. 

(2) ANNUAL PAYMENT.—During each of fiscal years 2005 

through 2014, the Secretary shall make a contract payment 

under this section to each eligible tobacco quota holder, with respect to a kind of tobacco, in an amount equal to 1⁄10 of the 

amount determined under paragraph (1) for the tobacco quota 

holder for that kind of tobacco. 

(f) DEATH OF TOBACCO QUOTA HOLDER.—If a tobacco quota 

holder who is entitled to contract payments under this section dies 

and is survived by a spouse or one or more dependents, the right 

to receive the payments shall transfer to the surviving spouse or, if 

there is no surviving spouse, to the estate of the tobacco quota holder. 

SEC. 623. CONTRACT PAYMENTS FOR PRODUCERS OF QUOTA TOBACCO. 

(a) CONTRACT OFFERED.—The Secretary shall offer to enter into 

a contract with each producer of quota tobacco under which the producer of quota tobacco shall be entitled to receive payments under 

this section in exchange for the termination of tobacco marketing 

quotas and related price support under the amendments made by 

sections 611 and 612. The contract payments shall constitute full 

and fair consideration for the termination of such tobacco marketing quotas and related price support. 

(b) ELIGIBILITY.—

(1) APPLICATION AND DETERMINATION.—To be eligible to 

enter into a contract to receive a contract payment under this 

section, a person shall submit to the Secretary an application 

containing such information as the Secretary may require to 

demonstrate to the satisfaction of the Secretary that the person 

is a producer of quota tobacco. The application shall be subVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00115 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
112

mitted within such time, in such form, and in such manner as 

the Secretary may require. 

(2) EFFECT OF MULTIPLE PRODUCERS FOR SAME QUOTA TO- BACCO.—If, on the basis of the applications submitted under 

paragraph (1) or other information, the Secretary determines 

that two or more persons are a producer of the same quota tobacco, the Secretary shall provide for an equitable distribution 

among the persons of the contract payments made under this 

section with respect to that quota tobacco, based on relative 

share of such persons in the risk of producing the quota tobacco 

and such other factors as the Secretary considers appropriate. 

(c) BASE QUOTA LEVEL.—

(1) ESTABLISHMENT.—The Secretary shall establish a base 

quota level applicable to each producer of quota tobacco, as determined under this subsection. 

(2) FLUE-CURED AND BURLEY TOBACCO.—In the case of 

Flue-cured tobacco (types 11, 12, 13, and 14) and Burley tobacco (type 31), the base quota level for each producer of quota 

tobacco shall be equal to the effective tobacco marketing quota 

(irrespective of disaster lease and transfers) under part I of subtitle B of title III of the Agriculture Adjustment Act of 1938 for 

the 2002 marketing year for quota tobacco produced on the 

farm. 

(3) OTHER KINDS OF TOBACCO.—In the case of each kind of 

tobacco (other than tobacco covered by paragraph (2)), for the 

purpose of calculating a contract payment to a producer of 

quota tobacco, the base quota level for the producer of quota tobacco shall be the quantity obtained by multiplying—

(A) the basic tobacco farm acreage allotment for the 

2002 marketing year established by the Secretary for quota 

tobacco produced on the farm; by 

(B) the average annual yield, per acre, of quota tobacco 

produced on the farm for the period covering the 2001, 

2002, and 2003 crop years. 

(d) CONTRACT PAYMENTS.— (1) CALCULATION OF TOTAL PAYMENT AMOUNT.—Subject to 

subsection (b)(2), the total amount of contract payments to 

which an eligible producer of quota tobacco is entitled under 

this section, with respect to a kind of tobacco, shall be equal to 

the product obtained by multiplying— (A) subject to paragraph (2), $3.00 per pound; by 

(B) the base quota level of the producer of quota tobacco determined under subsection (c) with respect to that 

kind of tobacco. 

(2) ANNUAL PAYMENT.—During each of fiscal years 2005 

through 2014, the Secretary shall make a contract payment 

under this section to each eligible producer of tobacco, with respect to a kind of tobacco, in an amount equal to 1⁄10 of the 

amount determined under paragraph (1) for the producer for 

that kind of tobacco. 

(3) VARIABLE PAYMENT RATES.—The rate for payments to a 

producer of quota tobacco under paragraph (1)(A) shall be 

equal to—

(A) in the case of a producer of quota tobacco that produced quota tobacco marketed, or considered planted, 

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under a marketing quota in all three of the 2002, 2003, or 

2004 tobacco marketing years, the rate prescribed under 

paragraph (1)(A); 

(B) in the case of a producer of quota tobacco that produced quota tobacco marketed, or considered planted, 

under a marketing quota in only two of those tobacco marketing years, 2⁄3 of the rate prescribed under paragraph 

(1)(A); and 

(C) in the case of a producer of quota tobacco that produced quota tobacco marketed, or considered planted, 

under a marketing quota in only one of those tobacco marketing years, 1⁄3 of the rate prescribed under paragraph 

(1)(A). 

(e) DEATH OF TOBACCO PRODUCER.—If a producer of quota tobacco who is entitled to contract payments under this section dies 

and is survived by a spouse or one or more dependents, the right 

to receive the contract payments shall transfer to the surviving 

spouse or, if there is no surviving spouse, to the estate of the producer. 

SEC. 624. ADMINISTRATION. 

(a) TIME FOR PAYMENT OF CONTRACT PAYMENTS.—Contract 

payments required to be made for a fiscal year shall be made by the 

Secretary as soon as practicable. 

(b) USE OF COUNTY COMMITTEES TO RESOLVE DISPUTES.—Any 

dispute regarding the eligibility of a person to enter into a contract 

or to receive contract payments, and any dispute regarding the 

amount of a contract payment, may be appealed to the county committee established under section 8 of the Soil Conservation and Domestic Allotment Act (16 U.S.C. 590h) for the county or other area 

in which the farming operation of the person is located. 

(c) ROLE OF NATIONAL APPEALS DIVISION.—Any adverse determination of a county committee under subsection (b) may be appealed to the National Appeals Division established under subtitle 

H of the Department of Agriculture Reorganization Act of 1994 (7 

U.S.C. 6991 et seq.). 

(d) USE OF FINANCIAL INSTITUTIONS.—The Secretary may use 

a financial institution to manage assets, make contract payments, 

and otherwise carry out this title. 

(e) PAYMENT TO FINANCIAL INSTITUTIONS.—The Secretary shall 

permit a tobacco quota holder or producer of quota tobacco entitled 

to contract payments to assign to a financial institution the right to 

receive the contract payments. Upon receiving notification of the assignment, the Secretary shall make subsequent contract payments 

for the tobacco quota holder or producer of quota tobacco directly to 

the financial institution designated by the tobacco quota holder or 

producer of quota tobacco. The Secretary shall make information 

available to tobacco quota holders and producers of quota tobacco 

regarding their ability to elect to have the Secretary make payments 

directly to a financial institution under this subsection so that they 

may obtain a lump sum or other payment. 

SEC. 625. USE OF ASSESSMENTS AS SOURCE OF FUNDS FOR PAYMENTS. 

(a) DEFINITIONS.—In this section: 

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(1) BASE PERIOD.—The term ‘‘base period’’ means the oneyear period ending the June 30 before the beginning of a fiscal 

year. 

(2) GROSS DOMESTIC VOLUME.—The term ‘‘gross domestic 

volume’’ means the volume of tobacco products—

(A) removed (as defined by section 5702 of the Internal 

Revenue Code of 1986); and 

(B) not exempt from tax under chapter 52 of the Internal Revenue Code of 1986 at the time of their removal 

under that chapter or the Harmonized Tariff Schedule of 

the United States (19 U.S.C. 1202). 

(3) MARKET SHARE.—The term ‘‘market share’’ means the 

share of each manufacturer or importer of a class of tobacco 

product (expressed as a decimal to the fourth place) of the total 

volume of domestic sales of the class of tobacco product during 

the base period for a fiscal year for an assessment under this 

section. 

(b) QUARTERLY ASSESSMENTS.— (1) IMPOSITION OF ASSESSMENT.—The Secretary, acting 

through the Commodity Credit Corporation, shall impose quarterly assessments during each of fiscal years 2005 through 

2014, calculated in accordance with this section, on each tobacco product manufacturer and tobacco product importer that 

sells tobacco products in domestic commerce in the United 

States during that fiscal year. 

(2) AMOUNTS.—Beginning with the calendar quarter ending 

on December 31 of each of fiscal years 2005 through 2014, the 

assessment payments over each four-calendar quarter period 

shall be sufficient to cover—

(A) the contract payments made under sections 622 and 

623 during that period; and 

(B) other expenditures from the Tobacco Trust Fund 

made during the base quarter periods corresponding to the 

four calendar quarters of that period. 

(3) DEPOSIT.—Assessments collected under this section 

shall be deposited in the Tobacco Trust Fund. 

(c) ASSESSMENTS FOR CLASSES OF TOBACCO PRODUCTS.— (1) INITIAL ALLOCATION.—The percentage of the total 

amount required by subsection (b) to be assessed against, and 

paid by, the manufacturers and importers of each class of tobacco product in fiscal year 2005 shall be as follows: 

(A) For cigarette manufacturers and importers, 96.331 

percent. 

(B) For cigar manufacturers and importers, 2.783 percent. 

(C) For snuff manufacturers and importers, 0.539 percent. 

(D) For roll-your-own tobacco manufacturers and importers, 0.171 percent. 

(E) For chewing tobacco manufacturers and importers, 

0.111 percent. 

(F) For pipe tobacco manufacturers and importers, 

0.066 percent. 

(2) SUBSEQUENT ALLOCATIONS.—For subsequent fiscal 

years, the Secretary shall periodically adjust the percentage of 

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the total amount required under subsection (b) to be assessed 

against, and paid by, the manufacturers and importers of each 

class of tobacco product specified in paragraph (1) to reflect 

changes in the share of gross domestic volume held by that 

class of tobacco product. 

(3) EFFECT OF INSUFFICIENT AMOUNTS.—If the Secretary 

determines that the assessment imposed under subsection (b) 

will result in insufficient amounts to carry out this subtitle during a fiscal year, the Secretary shall assess such additional 

amounts as the Secretary determines to be necessary to carry 

out this subtitle during that fiscal year. The additional amount 

shall be allocated to manufacturers and importers of each class 

of tobacco product specified in paragraph (1) in the same manner and based on the same percentages applicable under paragraph (1) or (2) for that fiscal year. 

(d) NOTIFICATION AND TIMING OF ASSESSMENTS.—

(1) NOTIFICATION OF ASSESSMENTS.—The Secretary shall 

provide each manufacturer or importer subject to an assessment 

under subsection (b) with written notice setting forth the 

amount to be assessed against the manufacturer or importer for 

each quarterly payment period. The notice for a quarterly period shall be provided not later than 30 days before the date 

payment is due under paragraph (3). 

(2) CONTENT.—The notice shall include the following information with respect to the quarterly period used by the Secretary in calculating the amount: 

(A) The total combined assessment for all manufacturers and importers of tobacco products. 

(B) The total assessment with respect to the class of tobacco products manufactured or imported by the manufacturer or importer. 

(C) Any adjustments to the percentage allocations 

among the classes of tobacco products made pursuant to 

paragraph (2) or (3) of subsection (c). 

(D) The volume of gross sales of the applicable class of 

tobacco product treated as made by the manufacturer or 

importer for purposes of calculating the manufacturer’s or 

importer’s market share under subsection (f). 

(E) The total volume of gross sales of the applicable 

class of tobacco product that the Secretary treated as made 

by all manufacturers and importers for purposes of calculating the manufacturer’s or importer’s market share under 

subsection (f). 

(F) The manufacturer’s or importer’s market share of 

the applicable class of tobacco product, as determined by 

the Secretary under subsection (f). 

(G) The market share, as determined by the Secretary 

under subsection (f), of each other manufacturer and importer, for each applicable class of tobacco product. 

(3) TIMING OF ASSESSMENT PAYMENTS.—

(A) COLLECTION DATE.—Assessments shall be collected 

at the end of each calendar year quarter, except that the 

Secretary shall ensure that the final assessment due under 

this section is collected not later than September 30, 2014. 

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(B) BASE PERIOD QUARTER.—The assessment for a calendar year quarter shall correspond to the base period 

quarter that ended at the end of the preceding calendar 

year quarter. 

(e) ALLOCATION OF ASSESSMENT WITHIN EACH CLASS OF TOBACCO PRODUCT.—

(1) PRO RATA BASIS.—The assessment for each class of tobacco product specified in subsection (c)(1) shall be allocated on 

a pro rata basis among manufacturers and importers based on 

each manufacturer’s or importer’s share of gross domestic volume. 

(2) LIMITATION.—No manufacturer or importer shall be required to pay an assessment that is based on a share that is 

in excess of the manufacturer’s or importer’s share of domestic 

volume. 

(f) ALLOCATION OF TOTAL ASSESSMENTS BY MARKET SHARE.—

The amount of the assessment for each class of tobacco product specified in subsection (c)(1) to be paid by each manufacturer or importer of that class of tobacco product shall be determined for each 

quarterly payment period by multiplying—

(1) the market share of the manufacturer or importer, as 

calculated with respect to that payment period, of the class of 

tobacco product; by 

(2) the total amount of the assessment for that quarterly 

payment period under subsection (c), for the class of tobacco 

product. 

(g) DETERMINATION OF VOLUME OF DOMESTIC SALES.—

(1) IN GENERAL.—The calculation of the volume of domestic 

sales of a class of tobacco product by a manufacturer or importer, and by all manufacturers and importers as a group, 

shall be made by the Secretary based on information provided 

by the manufacturers and importers pursuant to subsection (h), 

as well as any other relevant information provided to or obtained by the Secretary. 

(2) GROSS DOMESTIC VOLUME.—The volume of domestic 

sales shall be calculated based on gross domestic volume. 

(3) MEASUREMENT.—For purposes of the calculations under 

this subsection and the certifications under subsection (h) by the 

Secretary, the volumes of domestic sales shall be measured by—

(A) in the case of cigarettes and cigars, the number of 

cigarettes and cigars; and 

(B) in the case of the other classes of tobacco products 

specified in subsection (c)(1), in terms of number of pounds, 

or fraction thereof, of those products. 

(h) MEASUREMENT OF VOLUME OF DOMESTIC SALES.—

(1) SUBMISSION OF INFORMATION.—Each manufacturer and 

importer of tobacco products shall submit to the Secretary a certified copy of each of the returns or forms described by paragraph (2) that are required to be filed with a Federal agency 

on the same date that those returns or forms are filed, or required to be filed, with the agency.

(2) RETURNS AND FORMS.—The returns and forms described by this paragraph are those returns and forms that relate to—

117

(A) the removal of tobacco products into domestic commerce (as defined by section 5702 of the Internal Revenue 

Code of 1986); and 

(B) the payment of the taxes imposed under charter 52 

of the Internal Revenue Code of 1986, including AFT Form 

5000.24 and United States Customs Form 7501 under currently applicable regulations. 

(3) EFFECT OF FAILURE TO PROVIDE REQUIRED INFORMATION.—Any person that knowingly fails to provide information 

required under this subsection or that provides false information under this subsection shall be subject to the penalties described in section 1003 of title 18, United States Code. The Secretary may also assess against the person a civil penalty in an 

amount not to exceed two percent of the value of the kind of tobacco products manufactured or imported by the person during 

the fiscal year in which the violation occurred, as determined 

by the Secretary. 

(i) CHALLENGE TO ASSESSMENT.—

(1) APPEAL TO SECRETARY.—A manufacturer or importer 

subject to this section may contest an assessment imposed on 

the manufacturer or importer under this section by notifying the 

Secretary, not later than 30 business days after receiving the assessment notification required by subsection (d), that the manufacturer or importer intends to contest the assessment. 

(2) INFORMATION.—Not later than 180 days after the date 

of the enactment of this title, the Secretary shall establish by 

regulation a procedure under which a manufacturer or importer 

contesting an assessment under this subsection may present information to the Secretary to demonstrate that the assessment 

applicable to the manufacturer or importer is incorrect. In challenging the assessment, the manufacturer or importer may use 

any information that is available, including third party data on 

industry or individual company sales volumes. 

(3) REVISION.—If a manufacturer or importer establishes 

that the initial determination of the amount of an assessment 

is incorrect, the Secretary shall revise the amount of the assessment so that the manufacturer or importer is required to pay 

only the amount correctly determined. 

(4) TIME FOR REVIEW.—Not later than 30 days after receiving notice from a manufacturer or importer under paragraph 

(1), the Secretary shall—

(A) decide whether the information provided to the Secretary under paragraph (2), and any other information that 

the Secretary determines is appropriate, is sufficient to establish that the original assessment was incorrect; and 

(B) make any revisions necessary to ensure that each 

manufacturer and importer pays only its correct pro rata 

share of total gross domestic volume from all sources. 

(5) IMMEDIATE PAYMENT OF UNDISPUTED AMOUNTS.—The 

regulations promulgated by the Secretary under paragraph (2) 

shall provide for the immediate payment by a manufacturer or 

importer challenging an assessment of that portion of the assessment that is not in dispute. The manufacturer and importer 

may place into escrow, in accordance with such regulations, 

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only the portion of the assessment being challenged in good 

faith pending final determination of the claim. 

(j) JUDICIAL REVIEW.—

(1) IN GENERAL.—Any manufacturer or importer aggrieved 

by a determination of the Secretary with respect to the amount 

of any assessment may seek review of the determination in the 

United States District Court for the District of Columbia or for 

the district in which the manufacturer or importer resides or 

has its principal place of business at any time following exhaustion of the administrative remedies available under subsection 

(i). 

(2) TIME LIMITS.—Administrative remedies shall be deemed 

exhausted if no decision by the Secretary is made within the 

time limits established under subsection (i)(4). 

(3) EXCESSIVE ASSESSMENTS.—The court shall restrain collection of the excessive portion of any assessment or order a refund of excessive assessments already paid, along with interest 

calculated at the rate prescribed in section 3717 of title 31, 

United States Code, if it finds that the Secretary’s determination is not supported by a preponderance of the information 

available to the Secretary. 

(k) TERMINATION DATE.—The authority provided by this section 

to impose assessments terminates on September 30, 2014. 

SEC. 626. TOBACCO TRUST FUND. 

(a) ESTABLISHMENT.—There is established in the Commodity 

Credit Corporation a revolving trust fund, to be known as the ‘‘Tobacco Trust Fund’’, which shall be used in carrying out this subtitle. 

The Tobacco Trust Fund shall consist of the following: 

(1) Assessments collected under section 625. 

(2) Such amounts as are necessary from the Commodity 

Credit Corporation. 

(3) Any interest earned on investment of amounts in the Tobacco Trust Fund under subsection (c). 

(b) EXPENDITURES.—

(1) AUTHORIZED EXPENDITURES.—Subject to paragraph (2), 

and notwithstanding any other provision of law, the Secretary 

shall use amounts in the Tobacco Trust Fund, in such amounts 

as the Secretary determines are necessary—

(A) to make payments under sections 622 and 623; 

(B) to provide reimbursement under section 641(c); 

(C) to reimburse the Commodity Credit Corporation for 

costs incurred by the Commodity Credit Corporation under 

paragraph (2); and 

(D) to make payments to financial institutions to satisfy contractual obligations under section 622 or 623. 

(2) EXPENDITURES BY COMMODITY CREDIT CORPORATION.—

Notwithstanding any other provision of law, the Secretary shall 

use the funds, facilities, and authorities of the Commodity 

Credit Corporation to make payments described in paragraph 

(1). Not later than January 1, 2015, the Secretary shall use 

amounts in the Tobacco Trust Fund to fully reimburse, with interest, the Commodity Credit Corporation for all funds of the 

Commodity Credit Corporation expended under the authority of 

this paragraph. Administrative costs incurred by the Secretary 

119

or the Commodity Credit Corporation to carry out this title may 

not be paid using amounts in the Tobacco Trust Fund. 

(c) INVESTMENT OF AMOUNTS.—

(1) IN GENERAL.—The Commodity Credit Corporation shall 

invest such portion of the amounts in the Tobacco Trust Fund 

as are not, in the judgment of the Commodity Credit Corporation, required to meet current expenditures. 

(2) INTEREST-BEARING OBLIGATIONS.—Investments may be 

made only in interest-bearing obligations of the United States. 

(3) ACQUISITION OF OBLIGATIONS.—For the purpose of investments under paragraph (1), obligations may be acquired—

(A) on original issue at the issue price; or 

(B) by purchase of outstanding obligations at the market price. 

(4) SALE OF OBLIGATIONS.—Any obligation acquired by the 

Tobacco Trust Fund may be sold by the Commodity Credit Corporation at the market price. 

(5) CREDITS TO FUND.—The interest on, and the proceeds 

from the sale or redemption of, any obligations held in the Tobacco Trust Fund shall be credited to and form a part of the 

Fund. 

SEC. 627. LIMITATION ON TOTAL EXPENDITURES. 

The total amount expended by the Secretary from the Tobacco 

Trust Fund to make payments under sections 622 and 623 and for 

the other authorized purposes of the Fund shall not exceed 

$10,140,000,000.

Subtitle C—Implementation and Transition 

SEC. 641. TREATMENT OF TOBACCO LOAN POOL STOCKS AND OUTSTANDING LOAN COSTS. 

(a) DISPOSAL OF STOCKS.—To provide for the orderly disposition of quota tobacco held by an association that has entered into 

a loan agreement with the Commodity Credit Corporation under 

section 106A or 106B of the Agricultural Act of 1949 (7 U.S.C. 

1445–1, 1445–2) (referred to in this section as an ‘‘association’’), 

loan pool stocks for each kind of tobacco held by the association 

shall be disposed of in accordance with this section. 

(b) DISPOSAL BY ASSOCIATIONS.—For each kind of tobacco held 

by an association, the association shall be responsible for the disposal of a specific quantity of the loan pool stocks for that kind of 

tobacco held by the association. The quantity transferred to the association for disposal shall be equal to the quantity determined by 

dividing—

(1) the amount of funds held by the association in the No 

Net Cost Tobacco Fund and the No Net Cost Tobacco Account 

established under sections 106A and 106B of the Agricultural 

Act of 1949 (7 U.S.C. 1445–1, 1445–2) for the kind of tobacco; 

by 

(2) the average list price per pound for the kind of tobacco, 

as determined by the Secretary. 

(c) DISPOSAL OF REMAINDER BY COMMODITY CREDIT CORPORATION.—

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(1) DISPOSAL.—Any loan pool stocks of a kind of tobacco of 

an association that are not transferred to the association under 

subsection (b) for disposal shall be disposed of by Commodity 

Credit Corporation in a manner determined by the Secretary. 

(2) REIMBURSEMENT.—As required by section 626(b)(1)(B), 

the Secretary shall transfer from the Tobacco Trust Fund to the 

No Net Cost Tobacco Fund or the No Net Cost Tobacco Account 

of an association established under section 106A or 106B of the 

Agricultural Act of 1949 (7 U.S.C. 1445–1, 1445–2) such 

amounts as the Secretary determines will be adequate to reimburse the Commodity Credit Corporation for any net losses that 

the Corporation may sustain under its loan agreements with the 

association. 

(d) TRANSFER OF REMAINING NO NET COST FUNDS.—Any funds 

in the No Net Cost Tobacco Fund or the No Net Cost Tobacco Account of an association established under sections 106A and 106B 

of the Agricultural Act of 1949 (7 U.S.C. 1445–1, 1445–2) that remain after the application of subsections (b) and (c) shall be transferred to the association for distribution to producers of quota tobacco in accordance with a plan approved by the Secretary. 

SEC. 642. REGULATIONS. 

(a) IN GENERAL.—The Secretary may promulgate such regulations as are necessary to implement this title and the amendments 

made by this title. 

(b) PROCEDURE.—The promulgation of the regulations and administration of this title and the amendments made by this title 

shall be made without regard to—

(1) the notice and comment provisions of section 553 of title 

5, United States Code; 

(2) the Statement of Policy of the Secretary of Agriculture 

effective July 24, 1971 (36 Fed. Reg. 13804), relating to notices 

of proposed rulemaking and public participation in rulemaking; 

and 

(3) chapter 35 of title 44, United States Code (commonly 

known as the ‘‘Paperwork Reduction Act’’). 

(c) CONGRESSIONAL REVIEW OF AGENCY RULEMAKING.—In carrying out this section, the Secretary shall use the authority provided 

under section 808 of title 5, United States Code. 

SEC. 643. EFFECTIVE DATE. 

This title and the amendments made by this title shall apply 

to the 2005 and subsequent crops of each kind of tobacco. 

TITLE VII—MISCELLANEOUS 

PROVISIONS 

SEC. 701. BROWNFIELDS DEMONSTRATION PROGRAM FOR QUALIFIED 

GREEN BUILDING AND SUSTAINABLE DESIGN PROJECTS. 

(a) TREATMENT AS EXEMPT FACILITY BOND.—Subsection (a) of 

section 142 (relating to the definition of exempt facility bond) is 

amended by striking ‘‘or’’ at the end of paragraph (12), by striking 

the period at the end of paragraph (13) and inserting ‘‘, or’’, and by 

inserting at the end the following new paragraph: 

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‘‘(14) qualified green building and sustainable design 

projects.’’. 

(b) QUALIFIED GREEN BUILDING AND SUSTAINABLE DESIGN

PROJECTS.—Section 142 (relating to exempt facility bonds) is 

amended by adding at the end thereof the following new subsection: 

‘‘(l) QUALIFIED GREEN BUILDING AND SUSTAINABLE DESIGN

PROJECTS.—

‘‘(1) IN GENERAL.—For purposes of subsection (a)(14), the 

term ‘qualified green building and sustainable design project’ 

means any project which is designated by the Secretary, after 

consultation with the Administrator of the Environmental Protection Agency, as a qualified green building and sustainable 

design project and which meets the requirements of clauses (i), 

(ii), (iii), and (iv) of paragraph (4)(A). 

‘‘(2) DESIGNATIONS.—

‘‘(A) IN GENERAL.—Within 60 days after the end of the 

application period described in paragraph (3)(A), the Secretary, after consultation with the Administrator of the Environmental Protection Agency, shall designate qualified 

green building and sustainable design projects. At least one 

of the projects designated shall be located in, or within a 

10-mile radius of, an empowerment zone as designated pursuant to section 1391, and at least one of the projects designated shall be located in a rural State. No more than one 

project shall be designated in a State. A project shall not 

be designated if such project includes a stadium or arena 

for professional sports exhibitions or games. 

‘‘(B) MINIMUM CONSERVATION AND TECHNOLOGY INNOVATION OBJECTIVES.—The Secretary, after consultation 

with the Administrator of the Environmental Protection 

Agency, shall ensure that, in the aggregate, the projects designated shall—

‘‘(i) reduce electric consumption by more than 150 

megawatts annually as compared to conventional generation, 

‘‘(ii) reduce daily sulfur dioxide emissions by at 

least 10 tons compared to coal generation power, 

‘‘(iii) expand by 75 percent the domestic solar photovoltaic market in the United States (measured in 

megawatts) as compared to the expansion of that market from 2001 to 2002, and 

‘‘(iv) use at least 25 megawatts of fuel cell energy 

generation. 

‘‘(3) LIMITED DESIGNATIONS.—A project may not be designated under this subsection unless—

‘‘(A) the project is nominated by a State or local government within 180 days of the enactment of this subsection, 

and 

‘‘(B) such State or local government provides written 

assurances that the project will satisfy the eligibility criteria described in paragraph (4). 

‘‘(4) APPLICATION.— ‘‘(A) IN GENERAL.—A project may not be designated 

under this subsection unless the application for such designation includes a project proposal which describes the enVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00125 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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ergy efficiency, renewable energy, and sustainable design 

features of the project and demonstrates that the project 

satisfies the following eligibility criteria: 

‘‘(i) GREEN BUILDING AND SUSTAINABLE DESIGN.— At least 75 percent of the square footage of commercial 

buildings which are part of the project is registered for 

United States Green Building Council’s LEED certification and is reasonably expected (at the time of the 

designation) to receive such certification. For purposes 

of determining LEED certification as required under 

this clause, points shall be credited by using the following: 

‘‘(I) For wood products, certification under the 

Sustainable Forestry Initiative Program and the 

American Tree Farm System.

‘‘(II) For renewable wood products, as credited 

for recycled content otherwise provided under 

LEED certification. 

‘‘(III) For composite wood products, certification under standards established by the American National Standards Institute, or such other 

voluntary standards as published in the Federal 

Register by the Administrator of the Environmental Protection Agency. 

‘‘(ii) BROWNFIELD REDEVELOPMENT.—The project 

includes a brownfield site as defined by section 101(39) 

of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (42 U.S.C. 9601), 

including a site described in subparagraph 

(D)(ii)(II)(aa) thereof. 

‘‘(iii) STATE AND LOCAL SUPPORT.—The project receives specific State or local government resources 

which will support the project in an amount equal to 

at least $5,000,000. For purposes of the preceding sentence, the term ‘resources’ includes tax abatement benefits and contributions in kind. 

‘‘(iv) SIZE.—The project includes at least one of the 

following: 

‘‘(I) At least 1,000,000 square feet of building. 

‘‘(II) At least 20 acres. 

‘‘(v) USE OF TAX BENEFIT.—The project proposal includes a description of the net benefit of the tax-exempt 

financing provided under this subsection which will be 

allocated for financing of one or more of the following: 

‘‘(I) The purchase, construction, integration, or 

other use of energy efficiency, renewable energy, 

and sustainable design features of the project. 

‘‘(II) Compliance with certification standards 

cited under clause (i). 

‘‘(III) The purchase, remediation, and foundation construction and preparation of the 

brownfields site. 

‘‘(vi) PROHIBITED FACILITIES.—An issue shall not 

be treated as an issue described in subsection (a)(14) if 

any proceeds of such issue are used to provide any faVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00126 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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cility the principal business of which is the sale of food 

or alcoholic beverages for consumption on the premises. 

‘‘(vii) EMPLOYMENT.—The project is projected to 

provide permanent employment of at least 1,500 full 

time equivalents (150 full time equivalents in rural 

States) when completed and construction employment 

of at least 1,000 full time equivalents (100 full time 

equivalents in rural States). 

The application shall include an independent analysis 

which describes the project’s economic impact, including 

the amount of projected employment. 

‘‘(B) PROJECT DESCRIPTION.—Each application described in subparagraph (A) shall contain for each project 

a description of—

‘‘(i) the amount of electric consumption reduced as 

compared to conventional construction, 

‘‘(ii) the amount of sulfur dioxide daily emissions 

reduced compared to coal generation, 

‘‘(iii) the amount of the gross installed capacity of 

the project’s solar photovoltaic capacity measured in 

megawatts, and 

‘‘(iv) the amount, in megawatts, of the project’s fuel 

cell energy generation. 

‘‘(5) CERTIFICATION OF USE OF TAX BENEFIT.—No later than 

30 days after the completion of the project, each project must 

certify to the Secretary that the net benefit of the tax-exempt financing was used for the purposes described in paragraph (4). 

‘‘(6) DEFINITIONS.—For purposes of this subsection—

‘‘(A) RURAL STATE.—The term ‘rural State’ means any 

State which has—

‘‘(i) a population of less than 4,500,000 according 

to the 2000 census, 

‘‘(ii) a population density of less than 150 people 

per square mile according to the 2000 census, and 

‘‘(iii) increased in population by less than half the 

rate of the national increase between the 1990 and 

2000 censuses. 

‘‘(B) LOCAL GOVERNMENT.—The term ‘local government’ 

has the meaning given such term by section 1393(a)(5). 

‘‘(C) NET BENEFIT OF TAX-EXEMPT FINANCING.—The 

term ‘net benefit of tax-exempt financing’ means the present 

value of the interest savings (determined by a calculation 

established by the Secretary) which result from the tax-exempt status of the bonds. 

‘‘(7) AGGREGATE FACE AMOUNT OF TAX-EXEMPT FINANCING.—

‘‘(A) IN GENERAL.—An issue shall not be treated as an 

issue described in subsection (a)(14) if the aggregate face 

amount of bonds issued by the State or local government 

pursuant thereto for a project (when added to the aggregate 

face amount of bonds previously so issued for such project) 

exceeds an amount designated by the Secretary as part of 

the designation. 

‘‘(B) LIMITATION ON AMOUNT OF BONDS.—The Secretary 

may not allocate authority to issue qualified green building 

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and sustainable design project bonds in an aggregate face 

amount exceeding $2,000,000,000. 

‘‘(8) TERMINATION.—Subsection (a)(14) shall not apply with 

respect to any bond issued after September 30, 2009. 

‘‘(9) TREATMENT OF CURRENT REFUNDING BONDS.—Paragraphs (7)(B) and (8) shall not apply to any bond (or series of 

bonds) issued to refund a bond issued under subsection (a)(14) 

before October 1, 2009, if—

‘‘(A) the average maturity date of the issue of which the 

refunding bond is a part is not later than the average maturity date of the bonds to be refunded by such issue, 

‘‘(B) the amount of the refunding bond does not exceed 

the outstanding amount of the refunded bond, and 

‘‘(C) the net proceeds of the refunding bond are used to 

redeem the refunded bond not later than 90 days after the 

date of the issuance of the refunding bond. 

For purposes of subparagraph (A), average maturity shall be 

determined in accordance with section 147(b)(2)(A).’’.

(c) EXEMPTION FROM GENERAL STATE VOLUME CAPS.—Paragraph (3) of section 146(g) (relating to exception for certain bonds) 

is amended—

(1) by striking ‘‘or (13)’’ and inserting ‘‘(13), or (14)’’, and 

(2) by striking ‘‘and qualified public educational facilities’’ 

and inserting ‘‘qualified public educational facilities, and qualified green building and sustainable design projects’’. 

(d) ACCOUNTABILITY.—Each issuer shall maintain, on behalf of 

each project, an interest bearing reserve account equal to 1 percent 

of the net proceeds of any bond issued under this section for such 

project. Not later than 5 years after the date of issuance, the Secretary of the Treasury, after consultation with the Administrator of 

the Environmental Protection Agency, shall determine whether the 

project financed with such bonds has substantially complied with 

the terms and conditions described in section 142(l)(4) of the Internal Revenue Code of 1986 (as added by this section). If the Secretary, after such consultation, certifies that the project has substantially complied with such terms and conditions and meets the commitments set forth in the application for such project described in 

section 142(l)(4) of such Code, amounts in the reserve account, including all interest, shall be released to the project. If the Secretary 

determines that the project has not substantially complied with such 

terms and conditions, amounts in the reserve account, including all 

interest, shall be paid to the United States Treasury. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to bonds issued after December 31, 2004. 

SEC. 702. EXCLUSION OF GAIN OR LOSS ON SALE OR EXCHANGE OF 

CERTAIN BROWNFIELD SITES FROM UNRELATED BUSINESS TAXABLE INCOME. 

(a) IN GENERAL.—Subsection (b) of section 512 (relating to unrelated business taxable income) is amended by adding at the end 

the following new paragraph: 

‘‘(18) TREATMENT OF GAIN OR LOSS ON SALE OR EXCHANGE

OF CERTAIN BROWNFIELD SITES.—

‘‘(A) IN GENERAL.—Notwithstanding paragraph (5)(B), 

there shall be excluded any gain or loss from the qualified 

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sale, exchange, or other disposition of any qualifying 

brownfield property by an eligible taxpayer. 

‘‘(B) ELIGIBLE TAXPAYER.—For purposes of this paragraph—

‘‘(i) IN GENERAL.—The term ‘eligible taxpayer’ 

means, with respect to a property, any organization exempt from tax under section 501(a) which—

‘‘(I) acquires from an unrelated person a qualifying brownfield property, and 

‘‘(II) pays or incurs eligible remediation expenditures with respect to such property in an 

amount which exceeds the greater of $550,000 or 

12 percent of the fair market value of the property 

at the time such property was acquired by the eligible taxpayer, determined as if there was not a 

presence of a hazardous substance, pollutant, or 

contaminant on the property which is complicating 

the expansion, redevelopment, or reuse of the property. 

‘‘(ii) EXCEPTION.—Such term shall not include any 

organization which is—

‘‘(I) potentially liable under section 107 of the 

Comprehensive Environmental Response, Compensation, and Liability Act of 1980 with respect to 

the qualifying brownfield property, 

‘‘(II) affiliated with any other person which is 

so potentially liable through any direct or indirect 

familial relationship or any contractual, corporate, 

or financial relationship (other than a contractual, 

corporate, or financial relationship which is created by the instruments by which title to any 

qualifying brownfield property is conveyed or financed or by a contract of sale of goods or services), or 

‘‘(III) the result of a reorganization of a business entity which was so potentially liable. 

‘‘(C) QUALIFYING BROWNFIELD PROPERTY.—For purposes of this paragraph—

‘‘(i) IN GENERAL.—The term ‘qualifying brownfield 

property’ means any real property which is certified, 

before the taxpayer incurs any eligible remediation expenditures (other than to obtain a Phase I environmental site assessment), by an appropriate State agency (within the meaning of section 198(c)(4)) in the State 

in which such property is located as a brownfield site 

within the meaning of section 101(39) of the Comprehensive Environmental Response, Compensation, 

and Liability Act of 1980 (as in effect on the date of the 

enactment of this paragraph). 

‘‘(ii) REQUEST FOR CERTIFICATION.—Any request by 

an eligible taxpayer for a certification described in 

clause (i) shall include a sworn statement by the eligible taxpayer and supporting documentation of the presence of a hazardous substance, pollutant, or contaminant on the property which is complicating the expanVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00129 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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sion, redevelopment, or reuse of the property given the 

property’s reasonably anticipated future land uses or 

capacity for uses of the property (including a Phase I 

environmental site assessment and, if applicable, evidence of the property’s presence on a local, State, or 

Federal list of brownfields or contaminated property) 

and other environmental assessments prepared or obtained by the taxpayer.

‘‘(D) QUALIFIED SALE, EXCHANGE, OR OTHER DISPOSI- TION.—For purposes of this paragraph—

‘‘(i) IN GENERAL.—A sale, exchange, or other disposition of property shall be considered as qualified 

if—

‘‘(I) such property is transferred by the eligible 

taxpayer to an unrelated person, and 

‘‘(II) within 1 year of such transfer the eligible 

taxpayer has received a certification from the Environmental Protection Agency or an appropriate 

State agency (within the meaning of section 

198(c)(4)) in the State in which such property is located that, as a result of the eligible taxpayer’s remediation actions, such property would not be 

treated as a qualifying brownfield property in the 

hands of the transferee. 

For purposes of subclause (II), before issuing such certification, the Environmental Protection Agency or appropriate State agency shall respond to comments received pursuant to clause (ii)(V) in the same form and 

manner as required under section 117(b) of the Comprehensive Environmental Response, Compensation, 

and Liability Act of 1980 (as in effect on the date of the 

enactment of this paragraph). 

‘‘(ii) REQUEST FOR CERTIFICATION.—Any request by 

an eligible taxpayer for a certification described in 

clause (i) shall be made not later than the date of the 

transfer and shall include a sworn statement by the eligible taxpayer certifying the following: 

‘‘(I) Remedial actions which comply with all 

applicable or relevant and appropriate requirements (consistent with section 121(d) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980) have been substantially completed, such that there are no hazardous 

substances, pollutants, or contaminants which 

complicate the expansion, redevelopment, or reuse 

of the property given the property’s reasonably anticipated future land uses or capacity for uses of 

the property. 

‘‘(II) The reasonably anticipated future land 

uses or capacity for uses of the property are more 

economically productive or environmentally beneficial than the uses of the property in existence on 

the date of the certification described in subparagraph (C)(i). For purposes of the preceding sentence, use of property as a landfill or other hazVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00130 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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ardous waste facility shall not be considered more 

economically productive or environmentally beneficial. 

‘‘(III) A remediation plan has been implemented to bring the property into compliance with 

all applicable local, State, and Federal environmental laws, regulations, and standards and to 

ensure that the remediation protects human health 

and the environment. 

‘‘(IV) The remediation plan described in subclause (III), including any physical improvements 

required to remediate the property, is either complete or substantially complete, and, if substantially complete, sufficient monitoring, funding, institutional controls, and financial assurances have 

been put in place to ensure the complete remediation of the property in accordance with the remediation plan as soon as is reasonably practicable 

after the sale, exchange, or other disposition of 

such property. 

‘‘(V) Public notice and the opportunity for comment on the request for certification was completed 

before the date of such request. Such notice and 

opportunity for comment shall be in the same form 

and manner as required for public participation 

required under section 117(a) of the Comprehensive Environmental Response, Compensation, and 

Liability Act of 1980 (as in effect on the date of the 

enactment of this paragraph). For purposes of this 

subclause, public notice shall include, at a minimum, publication in a major local newspaper of 

general circulation. 

‘‘(iii) ATTACHMENT TO TAX RETURNS.—A copy of 

each of the requests for certification described in clause 

(ii) of subparagraph (C) and this subparagraph shall 

be included in the tax return of the eligible taxpayer 

(and, where applicable, of the qualifying partnership) 

for the taxable year during which the transfer occurs. 

‘‘(iv) SUBSTANTIAL COMPLETION.—For purposes of 

this subparagraph, a remedial action is substantially 

complete when any necessary physical construction is 

complete, all immediate threats have been eliminated, 

and all long-term threats are under control. 

‘‘(E) ELIGIBLE REMEDIATION EXPENDITURES.—For purposes of this paragraph—

‘‘(i) IN GENERAL.—The term ‘eligible remediation 

expenditures’ means, with respect to any qualifying 

brownfield property, any amount paid or incurred by 

the eligible taxpayer to an unrelated third person to obtain a Phase I environmental site assessment of the 

property, and any amount so paid or incurred after the 

date of the certification described in subparagraph 

(C)(i) for goods and services necessary to obtain a certification described in subparagraph (D)(i) with respect 

to such property, including expenditures—

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‘‘(I) to manage, remove, control, contain, abate, 

or otherwise remediate a hazardous substance, pollutant, or contaminant on the property, 

‘‘(II) to obtain a Phase II environmental site 

assessment of the property, including any expenditure to monitor, sample, study, assess, or otherwise 

evaluate the release, threat of release, or presence 

of a hazardous substance, pollutant, or contaminant on the property, 

‘‘(III) to obtain environmental regulatory certifications and approvals required to manage the 

remediation and monitoring of the hazardous substance, pollutant, or contaminant on the property, 

and 

‘‘(IV) regardless of whether it is necessary to 

obtain a certification described in subparagraph 

(D)(i)(II), to obtain remediation cost-cap or stoploss coverage, re-opener or regulatory action coverage, or similar coverage under environmental insurance policies, or financial guarantees required 

to manage such remediation and monitoring. 

‘‘(ii) EXCEPTIONS.—Such term shall not include—

‘‘(I) any portion of the purchase price paid or 

incurred by the eligible taxpayer to acquire the 

qualifying brownfield property, 

‘‘(II) environmental insurance costs paid or incurred to obtain legal defense coverage, owner/operator liability coverage, lender liability coverage, 

professional liability coverage, or similar types of 

coverage,

‘‘(III) any amount paid or incurred to the extent such amount is reimbursed, funded, or otherwise subsidized by grants provided by the United 

States, a State, or a political subdivision of a State 

for use in connection with the property, proceeds of 

an issue of State or local government obligations 

used to provide financing for the property the interest of which is exempt from tax under section 

103, or subsidized financing provided (directly or 

indirectly) under a Federal, State, or local program provided in connection with the property, or 

‘‘(IV) any expenditure paid or incurred before 

the date of the enactment of this paragraph. 

For purposes of subclause (III), the Secretary may issue 

guidance regarding the treatment of government-provided funds for purposes of determining eligible remediation expenditures. 

‘‘(F) DETERMINATION OF GAIN OR LOSS.—For purposes 

of this paragraph, the determination of gain or loss shall 

not include an amount treated as gain which is ordinary 

income with respect to section 1245 or section 1250 property, including amounts deducted as section 198 expenses 

which are subject to the recapture rules of section 198(e), if 

the taxpayer had deducted such amounts in the computation of its unrelated business taxable income. 

129

‘‘(G) SPECIAL RULES FOR PARTNERSHIPS.—

‘‘(i) IN GENERAL.—In the case of an eligible taxpayer which is a partner of a qualifying partnership 

which acquires, remediates, and sells, exchanges, or 

otherwise disposes of a qualifying brownfield property, 

this paragraph shall apply to the eligible taxpayer’s 

distributive share of the qualifying partnership’s gain 

or loss from the sale, exchange, or other disposition of 

such property. 

‘‘(ii) QUALIFYING PARTNERSHIP.—The term ‘qualifying partnership’ means a partnership which—

‘‘(I) has a partnership agreement which satisfies the requirements of section 514(c)(9)(B)(vi) at 

all times beginning on the date of the first certification received by the partnership under subparagraph (C)(i), 

‘‘(II) satisfies the requirements of subparagraphs (B)(i), (C), (D), and (E), if ‘qualified partnership’ is substituted for ‘eligible taxpayer’ each 

place it appears therein (except subparagraph 

(D)(iii)), and 

‘‘(III) is not an organization which would be 

prevented from constituting an eligible taxpayer by 

reason of subparagraph (B)(ii). 

‘‘(iii) REQUIREMENT THAT TAX-EXEMPT PARTNER BE

A PARTNER SINCE FIRST CERTIFICATION.—This paragraph shall apply with respect to any eligible taxpayer 

which is a partner of a partnership which acquires, remediates, and sells, exchanges, or otherwise disposes of 

a qualifying brownfield property only if such eligible 

taxpayer was a partner of the qualifying partnership at 

all times beginning on the date of the first certification 

received by the partnership under subparagraph (C)(i) 

and ending on the date of the sale, exchange, or other 

disposition of the property by the partnership. 

‘‘(iv) REGULATIONS.—The Secretary shall prescribe 

such regulations as are necessary to prevent abuse of 

the requirements of this subparagraph, including 

abuse through—

‘‘(I) the use of special allocations of gains or 

losses, or 

‘‘(II) changes in ownership of partnership interests held by eligible taxpayers. 

‘‘(H) SPECIAL RULES FOR MULTIPLE PROPERTIES.—

‘‘(i) IN GENERAL.—An eligible taxpayer or a qualifying partnership of which the eligible taxpayer is a 

partner may make a 1-time election to apply this paragraph to more than 1 qualifying brownfield property by 

averaging the eligible remediation expenditures for all 

such properties acquired during the election period. If 

the eligible taxpayer or qualifying partnership makes 

such an election, the election shall apply to all qualified sales, exchanges, or other dispositions of qualifying 

brownfield properties the acquisition and transfer of 

130

which occur during the period for which the election remains in effect. 

‘‘(ii) ELECTION.—An election under clause (i) shall 

be made with the eligible taxpayer’s or qualifying partnership’s timely filed tax return (including extensions) 

for the first taxable year for which the taxpayer or 

qualifying partnership intends to have the election 

apply. An election under clause (i) is effective for the 

period—

‘‘(I) beginning on the date which is the first 

day of the taxable year of the return in which the 

election is included or a later day in such taxable 

year selected by the eligible taxpayer or qualifying 

partnership, and 

‘‘(II) ending on the date which is the earliest 

of a date of revocation selected by the eligible taxpayer or qualifying partnership, the date which is 

8 years after the date described in subclause (I), or, 

in the case of an election by a qualifying partnership of which the eligible taxpayer is a partner, the 

date of the termination of the qualifying partnership. 

‘‘(iii) REVOCATION.—An eligible taxpayer or qualifying partnership may revoke an election under clause 

(i)(II) by filing a statement of revocation with a timely 

filed tax return (including extensions). A revocation is 

effective as of the first day of the taxable year of the return in which the revocation is included or a later day 

in such taxable year selected by the eligible taxpayer or 

qualifying partnership. Once an eligible taxpayer or 

qualifying partnership revokes the election, the eligible 

taxpayer or qualifying partnership is ineligible to make 

another election under clause (i) with respect to any 

qualifying brownfield property subject to the revoked 

election. 

‘‘(I) RECAPTURE.—If an eligible taxpayer excludes gain 

or loss from a sale, exchange, or other disposition of property to which an election under subparagraph (H) applies, 

and such property fails to satisfy the requirements of this 

paragraph, the unrelated business taxable income of the eligible taxpayer for the taxable year in which such failure occurs shall be determined by including any previously excluded gain or loss from such sale, exchange, or other disposition allocable to such taxpayer, and interest shall be 

determined at the overpayment rate established under section 6621 on any resulting tax for the period beginning 

with the due date of the return for the taxable year during 

which such sale, exchange, or other disposition occurred, 

and ending on the date of payment of the tax. 

‘‘(J) RELATED PERSONS.—For purposes of this paragraph, a person shall be treated as related to another person if—

‘‘(i) such person bears a relationship to such other 

person described in section 267(b) (determined without 

regard to paragraph (9) thereof), or section 707(b)(1), 

131

determined by substituting ‘25 percent’ for ‘50 percent’ 

each place it appears therein, and 

‘‘(ii) in the case such other person is a nonprofit organization, if such person controls directly or indirectly 

more than 25 percent of the governing body of such organization. 

‘‘(K) TERMINATION.—Except for purposes of determining the average eligible remediation expenditures for 

properties acquired during the election period under subparagraph (H), this paragraph shall not apply to any property acquired by the eligible taxpayer or qualifying partnership after December 31, 2009.’’. 

(b) EXCLUSION FROM DEFINITION OF DEBT-FINANCED PROPERTY.—Section 514(b)(1) (defining debt-financed property) is amended by striking ‘‘or’’ at the end of subparagraph (C), by striking the 

period at the end of subparagraph (D) and inserting ‘‘; or’’, and by 

inserting after subparagraph (D) the following new subparagraph: 

‘‘(E) any property the gain or loss from the sale, exchange, or other disposition of which would be excluded by 

reason of the provisions of section 512(b)(18) in computing 

the gross income of any unrelated trade or business.’’.

(c) SAVINGS CLAUSE.—Nothing in the amendments made by 

this section shall affect any duty, liability, or other requirement imposed under any other Federal or State law. Notwithstanding section 128(b) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, a certification provided by the 

Environmental Protection Agency or an appropriate State agency 

(within the meaning of section 198(c)(4) of the Internal Revenue 

Code of 1986) shall not affect the liability of any person under section 107(a) of such Act. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to any gain or loss on the sale, exchange, or other disposition of any property acquired by the taxpayer after December 31, 

2004. 

SEC. 703. CIVIL RIGHTS TAX RELIEF. 

(a) DEDUCTION ALLOWED WHETHER OR NOT TAXPAYER

ITEMIZES OTHER DEDUCTIONS.—Subsection (a) of section 62 (defining adjusted gross income) is amended by inserting after paragraph 

(18) the following new item: 

‘‘(19) COSTS INVOLVING DISCRIMINATION SUITS, ETC.—Any 

deduction allowable under this chapter for attorney fees and 

court costs paid by, or on behalf of, the taxpayer in connection 

with any action involving a claim of unlawful discrimination 

(as defined in subsection (e)) or a claim of a violation of subchapter III of chapter 37 of title 31, United States Code or a 

claim made under section 1862(b)(3)(A) of the Social Security 

Act (42 U.S.C. 1395y(b)(3)(A)). The preceding sentence shall not 

apply to any deduction in excess of the amount includible in the 

taxpayer’s gross income for the taxable year on account of a 

judgment or settlement (whether by suit or agreement and 

whether as lump sum or periodic payments) resulting from such 

claim.’’. 

(b) UNLAWFUL DISCRIMINATION DEFINED.—Section 62 is 

amended by adding at the end the following new subsection: 

132

‘‘(e) UNLAWFUL DISCRIMINATION DEFINED.—For purposes of 

subsection (a)(19), the term ‘unlawful discrimination’ means an act 

that is unlawful under any of the following: 

‘‘(1) Section 302 of the Civil Rights Act of 1991 (2 U.S.C. 

1202). 

‘‘(2) Section 201, 202, 203, 204, 205, 206, or 207 of the Congressional Accountability Act of 1995 (2 U.S.C. 1311, 1312, 

1313, 1314, 1315, 1316, or 1317). 

‘‘(3) The National Labor Relations Act (29 U.S.C. 151 et 

seq.). 

‘‘(4) The Fair Labor Standards Act of 1938 (29 U.S.C. 201 

et seq.). 

‘‘(5) Section 4 or 15 of the Age Discrimination in Employment Act of 1967 (29 U.S.C. 623 or 633a). 

‘‘(6) Section 501 or 504 of the Rehabilitation Act of 1973 (29 

U.S.C. 791 or 794). 

‘‘(7) Section 510 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1140). 

‘‘(8) Title IX of the Education Amendments of 1972 (20 

U.S.C. 1681 et seq.). 

‘‘(9) The Employee Polygraph Protection Act of 1988 (29 

U.S.C. 2001 et seq.). 

‘‘(10) The Worker Adjustment and Retraining Notification 

Act (29 U.S.C. 2102 et seq.). 

‘‘(11) Section 105 of the Family and Medical Leave Act of 

1993 (29 U.S.C. 2615). 

‘‘(12) Chapter 43 of title 38, United States Code (relating to 

employment and reemployment rights of members of the uniformed services). 

‘‘(13) Section 1977, 1979, or 1980 of the Revised Statutes 

(42 U.S.C. 1981, 1983, or 1985). 

‘‘(14) Section 703, 704, or 717 of the Civil Rights Act of 

1964 (42 U.S.C. 2000e–2, 2000e–3, or 2000e–16). 

‘‘(15) Section 804, 805, 806, 808, or 818 of the Fair Housing 

Act (42 U.S.C. 3604, 3605, 3606, 3608, or 3617). 

‘‘(16) Section 102, 202, 302, or 503 of the Americans with 

Disabilities Act of 1990 (42 U.S.C. 12112, 12132, 12182, or 

12203). 

‘‘(17) Any provision of Federal law (popularly known as 

whistleblower protection provisions) prohibiting the discharge of 

an employee, the discrimination against an employee, or any 

other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted under Federal 

law. 

‘‘(18) Any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law—

‘‘(i) providing for the enforcement of civil rights, or 

‘‘(ii) regulating any aspect of the employment relationship, including claims for wages, compensation, or 

benefits, or prohibiting the discharge of an employee, 

the discrimination against an employee, or any other 

form of retaliation or reprisal against an employee for 

asserting rights or taking other actions permitted by 

law.’’. 

133

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to fees and costs paid after the date of the enactment 

of this Act with respect to any judgment or settlement occurring 

after such date. 

SEC. 704. MODIFICATION OF CLASS LIFE FOR CERTAIN TRACK FACILITIES. 

(a) 7-YEAR PROPERTY.—Subparagraph (C) of section 168(e)(3) 

(relating to classification of certain property) is amended by redesignating clause (ii) as clause (iii) and by inserting after clause (i) the 

following new clause: 

‘‘(ii) any motorsports entertainment complex, and’’. 

(b) DEFINITION.—Section 168(i) (relating to definitions and special rules) is amended by adding at the end the following new paragraph: 

‘‘(15) MOTORSPORTS ENTERTAINMENT COMPLEX.—

‘‘(A) IN GENERAL.—The term ‘motorsports entertainment complex’ means a racing track facility which—

‘‘(i) is permanently situated on land, and 

‘‘(ii) during the 36-month period following the first 

day of the month in which the asset is placed in service, hosts 1 or more racing events for automobiles (of 

any type), trucks, or motorcycles which are open to the 

public for the price of admission. 

‘‘(B) ANCILLARY AND SUPPORT FACILITIES.—Such term 

shall include, if owned by the taxpayer who owns the complex and provided for the benefit of patrons of the complex—

‘‘(i) ancillary facilities and land improvements in 

support of the complex’s activities (including parking 

lots, sidewalks, waterways, bridges, fences, and landscaping), 

‘‘(ii) support facilities (including food and beverage 

retailing, souvenir vending, and other nonlodging accommodations), and 

‘‘(iii) appurtenances associated with such facilities 

and related attractions and amusements (including 

ticket booths, race track surfaces, suites and hospitality 

facilities, grandstands and viewing structures, props, 

walls, facilities that support the delivery of entertainment services, other special purpose structures, facades, 

shop interiors, and buildings). 

‘‘(C) EXCEPTION.—Such term shall not include any 

transportation equipment, administrative services assets, 

warehouses, administrative buildings, hotels, or motels. 

‘‘(D) TERMINATION.—This paragraph shall not apply to 

any property placed in service after December 31, 2007.’’. 

(c) EFFECTIVE DATE.—

(1) IN GENERAL.—The amendments made by this section 

shall apply to any property placed in service after the date of 

the enactment of this Act. 

(2) SPECIAL RULE FOR ASSET CLASS 80.0.—In the case of 

race track facilities placed in service after the date of the enactment of this Act, such facilities shall not be treated as theme 

and amusement facilities classified under asset class 80.0. 

134

(3) NO INFERENCE.—Nothing in this section or the amendments made by this section shall be construed to affect the 

treatment of property placed in service on or before the date of 

the enactment of this Act.

SEC. 705. SUSPENSION OF POLICYHOLDERS SURPLUS ACCOUNT PROVISIONS. 

(a) DISTRIBUTIONS TO SHAREHOLDERS FROM PRE-1984 POLICYHOLDERS SURPLUS ACCOUNT.—Section 815 (relating to distributions 

to shareholders from pre-1984 policyholders surplus account) is 

amended by adding at the end the following: 

‘‘(g) SPECIAL RULES APPLICABLE DURING 2005 AND 2006.—In 

the case of any taxable year of a stock life insurance company beginning after December 31, 2004, and before January 1, 2007—

‘‘(1) the amount under subsection (a)(2) for such taxable 

year shall be treated as zero, and 

‘‘(2) notwithstanding subsection (b), in determining any 

subtractions from an account under subsections (c)(3) and 

(d)(3), any distribution to shareholders during such taxable 

year shall be treated as made first out of the policyholders surplus account, then out of the shareholders surplus account, and 

finally out of other accounts.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after December 31, 2004. 

SEC. 706. CERTAIN ALASKA NATURAL GAS PIPELINE PROPERTY TREATED AS 7-YEAR PROPERTY. 

(a) IN GENERAL.—Section 168(e)(3)(C) (defining 7-year property), as amended by this Act, is amended by striking ‘‘and’’ at the 

end of clause (ii), by redesignating clause (iii) as clause (iv), and by 

inserting after clause (ii) the following new clause: 

‘‘(iii) any Alaska natural gas pipeline, and’’. 

(b) ALASKA NATURAL GAS PIPELINE.—Section 168(i) (relating to 

definitions and special rules), as amended by this Act, is amended 

by inserting after paragraph (15) the following new paragraph: 

‘‘(16) ALASKA NATURAL GAS PIPELINE.—The term ‘Alaska 

natural gas pipeline’ means the natural gas pipeline system located in the State of Alaska which—

‘‘(A) has a capacity of more than 500,000,000,000 Btu 

of natural gas per day, and 

‘‘(B) is—

‘‘(i) placed in service after December 31, 2013, or 

‘‘(ii) treated as placed in service on January 1, 

2014, if the taxpayer who places such system in service 

before January 1, 2014, elects such treatment.

Such term includes the pipe, trunk lines, related equipment, 

and appurtenances used to carry natural gas, but does not include any gas processing plant.’’. 

(c) ALTERNATIVE SYSTEM.—The table contained in section 

168(g)(3)(B) (relating to special rule for certain property assigned to 

classes) is amended by inserting after the item relating to subparagraph (C)(ii) the following new item:

‘‘(C)(iii)......... 22’’.

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to property placed in service after December 31, 2004. 

135

SEC. 707. EXTENSION OF ENHANCED OIL RECOVERY CREDIT TO CERTAIN ALASKA FACILITIES. 

(a) IN GENERAL.—Section 43(c)(1) (defining qualified enhanced 

oil recovery costs) is amended by adding at the end the following 

new subparagraph: 

‘‘(D) Any amount which is paid or incurred during the 

taxable year to construct a gas treatment plant which—

‘‘(i) is located in the area of the United States 

(within the meaning of section 638(1)) lying north of 64 

degrees North latitude, 

‘‘(ii) prepares Alaska natural gas for transportation through a pipeline with a capacity of at least 

2,000,000,000,000 Btu of natural gas per day, and 

‘‘(iii) produces carbon dioxide which is injected 

into hydrocarbon-bearing geological formations.’’. 

(b) ALASKA NATURAL GAS.—Section 43(c) is amended by adding 

at the end the following new paragraph: 

‘‘(5) ALASKA NATURAL GAS.—For purposes of paragraph 

(1)(D)—

‘‘(1) IN GENERAL.—The term ‘Alaska natural gas’ means 

natural gas entering the Alaska natural gas pipeline (as defined in section 168(i)(16) (determined without regard to subparagraph (B) thereof)) which is produced from a well—

‘‘(A) located in the area of the State of Alaska lying 

north of 64 degrees North latitude, determined by excluding 

the area of the Alaska National Wildlife Refuge (including 

the continental shelf thereof within the meaning of section 

638(1)), and 

‘‘(B) pursuant to the applicable State and Federal pollution prevention, control, and permit requirements from 

such area (including the continental shelf thereof within 

the meaning of section 638(1)). 

‘‘(2) NATURAL GAS.—The term ‘natural gas’ has the meaning given such term by section 613A(e)(2).’’. 

(c) EFFECTIVE DATE.—The amendment made by this section 

shall apply to costs paid or incurred in taxable years beginning 

after December 31, 2004. 

SEC. 708. METHOD OF ACCOUNTING FOR NAVAL SHIPBUILDERS. 

(a) IN GENERAL.—In the case of a qualified naval ship contract, 

the taxable income of such contract during the 5-taxable year period 

beginning with the taxable year in which the contract commencement date occurs shall be determined under a method identical to 

the method used in the case of a qualified ship contract (as defined 

in section 10203(b)(2)(B) of the Revenue Act of 1987). 

(b) RECAPTURE OF TAX BENEFIT.—In the case of a qualified 

naval ship contract to which subsection (a) applies, the taxpayer’s 

tax imposed by chapter 1 of the Internal Revenue Code of 1986 for 

the first taxable year following the 5-taxable year period described 

in subsection (a) shall be increased by the excess (if any) of—

(1) the amount of tax which would have been imposed during such period if this section had not been enacted, over 

(2) the amount of tax so imposed during such period. 

(c) QUALIFIED NAVAL SHIP CONTRACT.—For purposes of this 

section—

136

(1) IN GENERAL.—The term ‘‘qualified naval ship contract’’ 

means any contract or portion thereof that is for the construction in the United States of 1 ship or submarine for the Federal 

Government if the taxpayer reasonably expects the acceptance 

date will occur no later than 9 years after the construction commencement date. 

(2) ACCEPTANCE DATE.—The term ‘‘acceptance date’’ means 

the date 1 year after the date on which the Federal Government 

issues a letter of acceptance or other similar document for the 

ship or submarine. 

(3) CONSTRUCTION COMMENCEMENT DATE.—The term ‘‘construction commencement date’’ means the date on which the 

physical fabrication of any section or component of the ship or 

submarine begins in the taxpayer’s shipyard. 

(d) EFFECTIVE DATE.—This section shall apply to contracts for 

ships or submarines with respect to which the construction commencement date occurs after the date of the enactment of this Act. 

SEC. 709. MODIFICATION OF MINIMUM COST REQUIREMENT FOR 

TRANSFER OF EXCESS PENSION ASSETS. 

(a) AMENDMENTS OF ERISA.—

(1) Section 101(e)(3) of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1021(e)(3)) is amended by striking 

‘‘Pension Funding Equity Act of 2004’’ and inserting ‘‘American 

Jobs Creation Act of 2004’’. 

(2) Section 403(c)(1) of such Act (29 U.S.C. 1103(c)(1)) is 

amended by striking ‘‘Pension Funding Equity Act of 2004’’ and 

inserting ‘‘American Jobs Creation Act of 2004’’. 

(3) Paragraph (13) of section 408(b) of such Act (29 U.S.C. 

1108(b)(3)) is amended by striking ‘‘Pension Funding Equity 

Act of 2004’’ and inserting ‘‘American Jobs Creation Act of 

2004’’. 

(b) MINIMUM COST REQUIREMENTS.— (1) IN GENERAL.—Section 420(c)(3)(E) is amended by adding at the end the following new clause: 

‘‘(ii) INSIGNIFICANT COST REDUCTIONS PERMITTED.—

‘‘(I) IN GENERAL.—An eligible employer shall 

not be treated as failing to meet the requirements 

of this paragraph for any taxable year if, in lieu of 

any reduction of retiree health coverage permitted 

under the regulations prescribed under clause (i), 

the employer reduces applicable employer cost by 

an amount not in excess of the reduction in costs 

which would have occurred if the employer had 

made the maximum permissible reduction in retiree health coverage under such regulations. In 

applying such regulations to any subsequent taxable year, any reduction in applicable employer 

cost under this clause shall be treated as if it were 

an equivalent reduction in retiree health coverage. 

‘‘(II) ELIGIBLE EMPLOYER.—For purposes of 

subclause (I), an employer shall be treated as an 

eligible employer for any taxable year if, for the 

preceding taxable year, the qualified current retiree 

health liabilities of the employer were at least 5 

137

percent of the gross receipts of the employer. For 

purposes of this subclause, the rules of paragraphs 

(2), (3)(B), and (3)(C) of section 448(c) shall apply 

in determining the amount of an employer’s gross 

receipts.’’. 

(2) CONFORMING AMENDMENT.—Section 420(c)(3)(E) is 

amended by striking ‘‘The Secretary’’ and inserting: 

‘‘(i) IN GENERAL.—The Secretary’’. 

(3) EFFECTIVE DATE.—The amendments made by this subsection shall apply to taxable years ending after the date of the 

enactment of this Act. 

SEC. 710. EXPANSION OF CREDIT FOR ELECTRICITY PRODUCED FROM 

CERTAIN RENEWABLE RESOURCES. 

(a) EXPANSION OF QUALIFIED ENERGY RESOURCES.—Subsection 

(c) of section 45 (relating to electricity produced from certain renewable resources) is amended to read as follows: 

‘‘(c) QUALIFIED ENERGY RESOURCES AND REFINED COAL.—For 

purposes of this section—

‘‘(1) IN GENERAL.—The term ‘qualified energy resources’ 

means—

‘‘(A) wind, 

‘‘(B) closed-loop biomass, 

‘‘(C) open-loop biomass, 

‘‘(D) geothermal energy, 

‘‘(E) solar energy, 

‘‘(F) small irrigation power, and 

‘‘(G) municipal solid waste. 

‘‘(2) CLOSED-LOOP BIOMASS.—The term ‘closed-loop biomass’ 

means any organic material from a plant which is planted exclusively for purposes of being used at a qualified facility to 

produce electricity. 

‘‘(3) OPEN-LOOP BIOMASS.— ‘‘(A) IN GENERAL.—The term ‘open-loop biomass’ 

means—

‘‘(i) any agricultural livestock waste nutrients, or 

‘‘(ii) any solid, nonhazardous, cellulosic waste material which is segregated from other waste materials 

and which is derived from—

‘‘(I) any of the following forest-related resources: mill and harvesting residues, 

precommercial thinnings, slash, and brush, 

‘‘(II) solid wood waste materials, including 

waste pallets, crates, dunnage, manufacturing and 

construction wood wastes (other than pressuretreated, chemically-treated, or painted wood 

wastes), and landscape or right-of-way tree trimmings, but not including municipal solid waste, 

gas derived from the biodegradation of solid waste, 

or paper which is commonly recycled, or 

‘‘(III) agriculture sources, including orchard 

tree crops, vineyard, grain, legumes, sugar, and 

other crop by-products or residues. 

Such term shall not include closed-loop biomass or biomass 

burned in conjunction with fossil fuel (cofiring) beyond 

such fossil fuel required for startup and flame stabilization. 

138

‘‘(B) AGRICULTURAL LIVESTOCK WASTE NUTRIENTS.—

‘‘(i) IN GENERAL.—The term ‘agricultural livestock 

waste nutrients’ means agricultural livestock manure 

and litter, including wood shavings, straw, rice hulls, 

and other bedding material for the disposition of manure. 

‘‘(ii) AGRICULTURAL LIVESTOCK.—The term ‘agricultural livestock’ includes bovine, swine, poultry, and 

sheep. 

‘‘(4) GEOTHERMAL ENERGY.—The term ‘geothermal energy’ 

means energy derived from a geothermal deposit (within the 

meaning of section 613(e)(2)). 

‘‘(5) SMALL IRRIGATION POWER.—The term ‘small irrigation 

power’ means power—

‘‘(A) generated without any dam or impoundment of 

water through an irrigation system canal or ditch, and 

‘‘(B) the nameplate capacity rating of which is not less 

than 150 kilowatts but is less than 5 megawatts. 

‘‘(6) MUNICIPAL SOLID WASTE.—The term ‘municipal solid 

waste’ has the meaning given the term ‘solid waste’ under section 2(27) of the Solid Waste Disposal Act (42 U.S.C. 6903). 

‘‘(7) REFINED COAL.—

‘‘(A) IN GENERAL.—The term ‘refined coal’ means a fuel 

which—

‘‘(i) is a liquid, gaseous, or solid synthetic fuel produced from coal (including lignite) or high carbon fly 

ash, including such fuel used as a feedstock, 

‘‘(ii) is sold by the taxpayer with the reasonable expectation that it will be used for purpose of producing 

steam, 

‘‘(iii) is certified by the taxpayer as resulting (when 

used in the production of steam) in a qualified emission reduction, and 

‘‘(iv) is produced in such a manner as to result in 

an increase of at least 50 percent in the market value 

of the refined coal (excluding any increase caused by 

materials combined or added during the production 

process), as compared to the value of the feedstock coal. 

‘‘(B) QUALIFIED EMISSION REDUCTION.—The term 

‘qualified emission reduction’ means a reduction of at least 

20 percent of the emissions of nitrogen oxide and either sulfur dioxide or mercury released when burning the refined 

coal (excluding any dilution caused by materials combined 

or added during the production process), as compared to 

the emissions released when burning the feedstock coal or 

comparable coal predominantly available in the marketplace as of January 1, 2003.’’. 

(b) EXPANSION OF QUALIFIED FACILITIES.—

(1) IN GENERAL.—Section 45 is amended by redesignating 

subsection (d) as subsection (e) and by inserting after subsection 

(c) the following new subsection: 

‘‘(d) QUALIFIED FACILITIES.—For purposes of this section—

‘‘(1) WIND FACILITY.—In the case of a facility using wind to 

produce electricity, the term ‘qualified facility’ means any facilVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00142 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
139

ity owned by the taxpayer which is originally placed in service 

after December 31, 1993, and before January 1, 2006. 

‘‘(2) CLOSED-LOOP BIOMASS FACILITY.— ‘‘(A) IN GENERAL.—In the case of a facility using closedloop biomass to produce electricity, the term ‘qualified facility’ means any facility—

‘‘(i) owned by the taxpayer which is originally 

placed in service after December 31, 1992, and before 

January 1, 2006, or 

‘‘(ii) owned by the taxpayer which before January 

1, 2006, is originally placed in service and modified to 

use closed-loop biomass to co-fire with coal, with other 

biomass, or with both, but only if the modification is 

approved under the Biomass Power for Rural Development Programs or is part of a pilot project of the Commodity Credit Corporation as described in 65 Fed. Reg. 

63052. 

‘‘(B) SPECIAL RULES.—In the case of a qualified facility 

described in subparagraph (A)(ii)—

‘‘(i) the 10-year period referred to in subsection (a) 

shall be treated as beginning no earlier than the date 

of the enactment of this clause, 

‘‘(ii) the amount of the credit determined under 

subsection (a) with respect to the facility shall be an 

amount equal to the amount determined without regard to this clause multiplied by the ratio of the thermal content of the closed-loop biomass used in such facility to the thermal content of all fuels used in such 

facility, and

‘‘(iii) if the owner of such facility is not the producer of the electricity, the person eligible for the credit 

allowable under subsection (a) shall be the lessee or the 

operator of such facility. 

‘‘(3) OPEN-LOOP BIOMASS FACILITIES.—

‘‘(A) IN GENERAL.—In the case of a facility using openloop biomass to produce electricity, the term ‘qualified facility’ means any facility owned by the taxpayer which—

‘‘(i) in the case of a facility using agricultural livestock waste nutrients—

‘‘(I) is originally placed in service after the 

date of the enactment of this subclause and before 

January 1, 2006, and 

‘‘(II) the nameplate capacity rating of which is 

not less than 150 kilowatts, and 

‘‘(ii) in the case of any other facility, is originally 

placed in service before January 1, 2006. 

‘‘(B) CREDIT ELIGIBILITY.—In the case of any facility described in subparagraph (A), if the owner of such facility 

is not the producer of the electricity, the person eligible for 

the credit allowable under subsection (a) shall be the lessee 

or the operator of such facility. 

‘‘(4) GEOTHERMAL OR SOLAR ENERGY FACILITY.—In the case 

of a facility using geothermal or solar energy to produce electricity, the term ‘qualified facility’ means any facility owned by 

the taxpayer which is originally placed in service after the date 

140

of the enactment of this paragraph and before January 1, 2006. 

Such term shall not include any property described in section 

48(a)(3) the basis of which is taken into account by the taxpayer 

for purposes of determining the energy credit under section 48. 

‘‘(5) SMALL IRRIGATION POWER FACILITY.—In the case of a 

facility using small irrigation power to produce electricity, the 

term ‘qualified facility’ means any facility owned by the taxpayer which is originally placed in service after the date of the 

enactment of this paragraph and before January 1, 2006. 

‘‘(6) LANDFILL GAS FACILITIES.—In the case of a facility producing electricity from gas derived from the biodegradation of 

municipal solid waste, the term ‘qualified facility’ means any 

facility owned by the taxpayer which is originally placed in 

service after the date of the enactment of this paragraph and before January 1, 2006. 

‘‘(7) TRASH COMBUSTION FACILITIES.—In the case of a facility which burns municipal solid waste to produce electricity, the 

term ‘qualified facility’ means any facility owned by the taxpayer which is originally placed in service after the date of the 

enactment of this paragraph and before January 1, 2006. 

‘‘(8) REFINED COAL PRODUCTION FACILITY.—The term ‘refined coal production facility’ means a facility which is placed 

in service after the date of the enactment of this paragraph and 

before January 1, 2009.’’. 

(2) RULES FOR REFINED COAL PRODUCTION FACILITIES.— Subsection (e) of section 45, as so redesignated, is amended by 

adding at the end the following new paragraph: 

‘‘(8) REFINED COAL PRODUCTION FACILITIES.— ‘‘(A) DETERMINATION OF CREDIT AMOUNT.—In the case 

of a producer of refined coal, the credit determined under 

this section (without regard to this paragraph) for any taxable year shall be increased by an amount equal to $4.375 

per ton of qualified refined coal—

‘‘(i) produced by the taxpayer at a refined coal production facility during the 10-year period beginning on 

the date the facility was originally placed in service, 

and 

‘‘(ii) sold by the taxpayer—

‘‘(I) to an unrelated person, and 

‘‘(II) during such 10-year period and such taxable year. 

‘‘(B) PHASEOUT OF CREDIT.—The amount of the increase determined under subparagraph (A) shall be reduced 

by an amount which bears the same ratio to the amount of 

the increase (determined without regard to this subparagraph) as—

‘‘(i) the amount by which the reference price of fuel 

used as a feedstock (within the meaning of subsection 

(c)(7)(A)) for the calendar year in which the sale occurs 

exceeds an amount equal to 1.7 multiplied by the reference price for such fuel in 2002, bears to ‘‘(ii) $8.75. 

‘‘(C) APPLICATION OF RULES.—Rules similar to the 

rules of the subsection (b)(3) and paragraphs (1) through 

(5) and (9) of this subsection shall apply for purposes of deVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00144 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
141

termining the amount of any increase under this paragraph.’’. 

(3) CONFORMING AMENDMENTS.—

(A) Section 45(e), as so redesignated, is amended by 

striking ‘‘subsection (c)(3)(A)’’ in paragraph (7)(A)(i) and inserting ‘‘subsection (d)(1)’’. 

(B) The heading of section 45 and the item relating to 

such section in the table of sections for subpart D of part 

IV of subchapter A of chapter 1 are each amended by inserting before the period at the end ‘‘, etc’’. 

(C) Paragraph (2) of section 45(b) is amended by striking ‘‘The 1.5 cent amount’’ and all that follows through 

‘‘paragraph (1)’’ and inserting ‘‘The 1.5 cent amount in subsection (a), the 8 cent amount in paragraph (1), the $4.375 

amount in subsection (e)(8)(A), and in subsection (e)(8)(B)(i) 

the reference price of fuel used as a feedstock (within the 

meaning of subsection (c)(7)(A)) in 2002’’. 

(c) SPECIAL CREDIT RATE AND PERIOD FOR ELECTRICITY PRODUCED AND SOLD AFTER ENACTMENT DATE.—Section 45(b) is 

amended by adding at the end the following new paragraph: 

‘‘(4) CREDIT RATE AND PERIOD FOR ELECTRICITY PRODUCED

AND SOLD FROM CERTAIN FACILITIES.—

‘‘(A) CREDIT RATE.—In the case of electricity produced 

and sold in any calendar year after 2003 at any qualified 

facility described in paragraph (3), (5), (6), or (7) of subsection (d), the amount in effect under subsection (a)(1) for 

such calendar year (determined before the application of 

the last sentence of paragraph (2) of this subsection) shall 

be reduced by one-half. 

‘‘(B) CREDIT PERIOD.—

‘‘(i) IN GENERAL.—Except as provided in clause (ii), 

in the case of any facility described in paragraph (3), 

(4), (5), (6), or (7) of subsection (d), the 5-year period 

beginning on the date the facility was originally placed 

in service shall be substituted for the 10-year period in 

subsection (a)(2)(A)(ii). 

‘‘(ii) CERTAIN OPEN-LOOP BIOMASS FACILITIES.—In 

the case of any facility described in subsection 

(d)(3)(A)(ii) placed in service before the date of the enactment of this paragraph, the 5-year period beginning 

on the date of the enactment of this Act shall be substituted for the 10-year period in subsection 

(a)(2)(A)(ii).’’. 

(d) COORDINATION WITH OTHER CREDITS.—Section 45(e), as redesignated and amended by this section, is amended by inserting 

after paragraph (8) the following new paragraph: 

‘‘(9) COORDINATION WITH CREDIT FOR PRODUCING FUEL

FROM A NONCONVENTIONAL SOURCE.—The term ‘qualified facility’ shall not include any facility the production from which is 

allowed as a credit under section 29 for the taxable year or any 

prior taxable year.’’. 

(e) COORDINATION WITH SECTION 48.—Section 48(a)(3) (defining energy property) is amended by adding at the end the following 

new sentence: ‘‘Such term shall not include any property which is 

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part of a facility the production from which is allowed as a credit 

under section 45 for the taxable year or any prior taxable year.’’.

(f) ELIMINATION OF CERTAIN CREDIT REDUCTIONS.—Section 

45(b)(3) (relating to credit reduced for grants, tax-exempt bonds, 

subsidized energy financing, and other credits) is amended—

(1) by inserting ‘‘the lesser of 1⁄2 or’’ before ‘‘a fraction’’ in 

the matter preceding subparagraph (A), and 

(2) by adding at the end the following new sentence: ‘‘This 

paragraph shall not apply with respect to any facility described 

in subsection (d)(2)(A)(ii).’’. 

(g) EFFECTIVE DATES.— (1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to 

electricity produced and sold after the date of the enactment of 

this Act, in taxable years ending after such date. 

(2) CERTAIN BIOMASS FACILITIES.—With respect to any facility described in section 45(d)(3)(A)(ii) of the Internal Revenue 

Code of 1986, as added by subsection (b)(1), which is placed in 

service before the date of the enactment of this Act, the amendments made by this section shall apply to electricity produced 

and sold after December 31, 2004, in taxable years ending after 

such date. 

(3) CREDIT RATE AND PERIOD FOR NEW FACILITIES.—The 

amendments made by subsection (c) shall apply to electricity 

produced and sold after December 31, 2004, in taxable years 

ending after such date. 

(4) NONAPPLICATION OF AMENDMENTS TO PREEFFECTIVE

DATE POULTRY WASTE FACILITIES.—The amendments made by 

this section shall not apply with respect to any poultry waste facility (within the meaning of section 45(c)(3)(C), as in effect on 

the day before the date of the enactment of this Act) placed in 

service before January 1, 2004. 

(5) REFINED COAL PRODUCTION FACILITIES.—Section 

45(e)(8) of the Internal Revenue Code of 1986, as added by this 

section, shall apply to refined coal produced and sold after the 

date of the enactment of this Act. 

SEC. 711. CERTAIN BUSINESS RELATED CREDITS ALLOWED AGAINST 

REGULAR AND MINIMUM TAX. 

(a) IN GENERAL.—Subsection (c) of section 38 (relating to limitation based on amount of tax) is amended by redesignating paragraph (4) as paragraph (5) and by inserting after paragraph (3) the 

following new paragraph: 

‘‘(4) SPECIAL RULES FOR SPECIFIED CREDITS.—

‘‘(A) IN GENERAL.—In the case of specified credits—

‘‘(i) this section and section 39 shall be applied 

separately with respect to such credits, and 

‘‘(ii) in applying paragraph (1) to such credits—

‘‘(I) the tentative minimum tax shall be treated 

as being zero, and 

‘‘(II) the limitation under paragraph (1) (as 

modified by subclause (I)) shall be reduced by the 

credit allowed under subsection (a) for the taxable 

year (other than the specified credits). 

‘‘(B) SPECIFIED CREDITS.—For purposes of this subsection, the term ‘specified credits’ includes—

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‘‘(i) for taxable years beginning after December 31, 

2004, the credit determined under section 40, 

‘‘(ii) the credit determined under section 45 to the 

extent that such credit is attributable to electricity or 

refined coal produced—

‘‘(I) at a facility which is originally placed in 

service after the date of the enactment of this paragraph, and 

‘‘(II) during the 4-year period beginning on the 

date that such facility was originally placed in 

service’’. 

(b) CONFORMING AMENDMENTS.—Paragraph (2)(A)(ii)(II) and 

(3)(A)(ii)(II) of section 38(c) are each amended by inserting ‘‘or the 

specified credits’’ after ‘‘employee credit’’. 

(c) EFFECTIVE DATE.—Except as otherwise provided, the amendments made by this section shall apply to taxable years ending after 

the date of the enactment of this Act. 

SEC. 712. INCLUSION OF PRIMARY AND SECONDARY MEDICAL STRATEGIES FOR CHILDREN AND ADULTS WITH SICKLE CELL DISEASE AS MEDICAL ASSISTANCE UNDER THE MEDICAID 

PROGRAM. 

(a) OPTIONAL MEDICAL ASSISTANCE.—

(1) IN GENERAL.—Section 1905 of the Social Security Act 

(42 U.S.C. 1396d) is amended—

(A) in subsection (a)—

(i) by striking ‘‘and’’ at the end of paragraph (26); 

(ii) by redesignating paragraph (27) as paragraph 

(28); and 

(iii) by inserting after paragraph (26), the following: 

‘‘(27) subject to subsection (x), primary and secondary medical strategies and treatment and services for individuals who 

have Sickle Cell Disease; and’’; and 

(B) by adding at the end the following: 

‘‘(x) For purposes of subsection (a)(27), the strategies, treatment, 

and services described in that subsection include the following: 

‘‘(1) Chronic blood transfusion (with deferoxamine chelation) to prevent stroke in individuals with Sickle Cell Disease 

who have been identified as being at high risk for stroke. 

‘‘(2) Genetic counseling and testing for individuals with 

Sickle Cell Disease or the sickle cell trait to allow health care 

professionals to treat such individuals and to prevent symptoms 

of Sickle Cell Disease. 

‘‘(3) Other treatment and services to prevent individuals 

who have Sickle Cell Disease and who have had a stroke from 

having another stroke.’’. 

(2) RULE OF CONSTRUCTION.—Nothing in subsections 

(a)(27) or (x) of section 1905 of the Social Security Act (42 

U.S.C. 1396d), as added by paragraph (1), shall be construed 

as implying that a State medicaid program under title XIX of 

such Act could not have treated, prior to the date of enactment 

of this Act, any of the primary and secondary medical strategies 

and treatment and services described in such subsections as 

medical assistance under such program, including as early and 

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periodic screening, diagnostic, and treatment services under section 1905(r) of such Act. 

(b) FEDERAL REIMBURSEMENT FOR EDUCATION AND OTHER

SERVICES RELATED TO THE PREVENTION AND TREATMENT OF SICKLE

CELL DISEASE.—Section 1903(a)(3) of the Social Security Act (42 

U.S.C. 1396b(a)(3)) is amended—

(1) in subparagraph (D), by striking ‘‘plus’’ at the end and 

inserting ‘‘and’’; and 

(2) by adding at the end the following:

‘‘(E) 50 percent of the sums expended with respect to 

costs incurred during such quarter as are attributable to 

providing—

‘‘(i) services to identify and educate individuals 

who are likely to be eligible for medical assistance 

under this title and who have Sickle Cell Disease or 

who are carriers of the sickle cell gene, including education regarding how to identify such individuals; or 

‘‘(ii) education regarding the risks of stroke and 

other complications, as well as the prevention of stroke 

and other complications, in individuals who are likely 

to be eligible for medical assistance under this title and 

who have Sickle Cell Disease; plus’’. 

(c) DEMONSTRATION PROGRAM FOR THE DEVELOPMENT AND ES- TABLISHMENT OF SYSTEMIC MECHANISMS FOR THE PREVENTION AND

TREATMENT OF SICKLE CELL DISEASE.— (1) AUTHORITY TO CONDUCT DEMONSTRATION PROGRAM.— (A) IN GENERAL.—The Administrator, through the Bureau of Primary Health Care and the Maternal and Child 

Health Bureau, shall conduct a demonstration program by 

making grants to up to 40 eligible entities for each fiscal 

year in which the program is conducted under this section 

for the purpose of developing and establishing systemic 

mechanisms to improve the prevention and treatment of 

Sickle Cell Disease, including through—

(i) the coordination of service delivery for individuals with Sickle Cell Disease; 

(ii) genetic counseling and testing; 

(iii) bundling of technical services related to the 

prevention and treatment of Sickle Cell Disease; 

(iv) training of health professionals; and 

(v) identifying and establishing other efforts related to the expansion and coordination of education, 

treatment, and continuity of care programs for individuals with Sickle Cell Disease. 

(B) GRANT AWARD REQUIREMENTS.—

(i) GEOGRAPHIC DIVERSITY.—The Administrator 

shall, to the extent practicable, award grants under 

this section to eligible entities located in different regions of the United States. 

(ii) PRIORITY.—In awarding grants under this subsection, the Administrator shall give priority to awarding grants to eligible entities that are—

(I) Federally-qualified health centers that have 

a partnership or other arrangement with a comprehensive Sickle Cell Disease treatment center 

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that does not receive funds from the National Institutes of Health; or 

(II) Federally-qualified health centers that intend to develop a partnership or other arrangement 

with a comprehensive Sickle Cell Disease treatment center that does not receive funds from the 

National Institutes of Health. 

(2) ADDITIONAL REQUIREMENTS.—An eligible entity awarded a grant under this subsection shall use funds made available under the grant to carry out, in addition to the activities 

described in paragraph (1)(A), the following activities: 

(A) To facilitate and coordinate the delivery of education, treatment, and continuity of care for individuals 

with Sickle Cell Disease under—

(i) the entity’s collaborative agreement with a community-based Sickle Cell Disease organization or a 

nonprofit entity that works with individuals who have 

Sickle Cell Disease; 

(ii) the Sickle Cell Disease newborn screening program for the State in which the entity is located; and 

(iii) the maternal and child health program under 

title V of the Social Security Act (42 U.S.C. 701 et seq.) 

for the State in which the entity is located. 

(B) To train nursing and other health staff who provide care for individuals with Sickle Cell Disease. 

(C) To enter into a partnership with adult or pediatric 

hematologists in the region and other regional experts in 

Sickle Cell Disease at tertiary and academic health centers 

and State and county health offices. 

(D) To identify and secure resources for ensuring reimbursement under the medicaid program, State children’s 

health insurance program, and other health programs for 

the prevention and treatment of Sickle Cell Disease. 

(3) NATIONAL COORDINATING CENTER.—

(A) ESTABLISHMENT.—The Administrator shall enter 

into a contract with an entity to serve as the National Coordinating Center for the demonstration program conducted under this subsection. 

(B) ACTIVITIES DESCRIBED.—The National Coordinating Center shall—

(i) collect, coordinate, monitor, and distribute data, 

best practices, and findings regarding the activities 

funded under grants made to eligible entities under the 

demonstration program; 

(ii) develop a model protocol for eligible entities 

with respect to the prevention and treatment of Sickle 

Cell Disease; 

(iii) develop educational materials regarding the 

prevention and treatment of Sickle Cell Disease; and 

(iv) prepare and submit to Congress a final report 

that includes recommendations regarding the effectiveness of the demonstration program conducted under 

this subsection and such direct outcome measures as—

(I) the number and type of health care resources utilized (such as emergency room visits, 

146

hospital visits, length of stay, and physician visits 

for individuals with Sickle Cell Disease); and 

(II) the number of individuals that were tested 

and subsequently received genetic counseling for 

the sickle cell trait. 

(4) APPLICATION.—An eligible entity desiring a grant under 

this subsection shall submit an application to the Administrator at such time, in such manner, and containing such information as the Administrator may require. 

(5) DEFINITIONS.—In this subsection: 

(A) ADMINISTRATOR.—The term ‘‘Administrator’’ means 

the Administrator of the Health Resources and Services Administration. 

(B) ELIGIBLE ENTITY.—The term ‘‘eligible entity’’ means 

a Federally-qualified health center, a nonprofit hospital or 

clinic, or a university health center that provides primary 

health care, that—

(i) has a collaborative agreement with a community-based SickleCell Disease organization or a nonprofit entity with experience in working with individuals who have Sickle Cell Disease; and 

(ii) demonstrates to the Administrator that either 

the Federally-qualified health center, the nonprofit hospital or clinic, the university health center, the organization or entity described in clause (i), or the experts 

described in paragraph (2)(C), has at least 5 years of 

experience in working with individuals who have Sickle Cell Disease. 

(C) FEDERALLY-QUALIFIED HEALTH CENTER.—The term 

‘‘Federally-qualified health center’’ has the meaning given 

that term in section 1905(l)(2)(B) of the Social Security Act 

(42 U.S.C. 1396d(l)(2)(B)). 

(6) AUTHORIZATION OF APPROPRIATIONS.—There is authorized to be appropriated to carry out this subsection, $10,000,000 

for each of fiscal years 2005 through 2009. 

(d) EFFECTIVE DATE.—The amendments made by subsections 

(a) and (b) take effect on the date of enactment of this Act and apply 

to medical assistance and services provided under title XIX of the 

Social Security Act (42 U.S.C. 1396 et seq.) on or after that date. 

SEC. 713. CEILING FANS. 

(a) IN GENERAL.—Subchapter II of chapter 99 of the Harmonized Tariff Schedule of the United States is amended by inserting in numerical sequence the following new heading:

‘‘ 9902.84.14 Ceiling fans for permanent 

installation (provided for 

in subheading 8414.51.00) Free No change No change On or before 

12/31/2006 ’’. 

(b) EFFECTIVE DATE.—The amendment made by this section applies to goods entered, or withdrawn from warehouse, for consumption on or after the 15th day after the date of enactment of this Act. 

147

SEC. 714. CERTAIN STEAM GENERATORS, AND CERTAIN REACTOR VESSEL HEADS AND PRESSURIZERS, USED IN NUCLEAR FACILITIES. 

(a) CERTAIN STEAM GENERATORS.—Heading 9902.84.02 of the 

Harmonized Tariff Schedule of the United States is amended by 

striking ‘‘12/31/2006’’ and inserting ‘‘12/31/2008’’. 

(b) CERTAIN REACTOR VESSEL HEADS AND PRESSURIZERS.—

Subchapter II of chapter 99 of the Harmonized Tariff Schedule of 

the United States is amended by inserting in numerical sequence 

the following new heading:

‘‘ 9902.84.03 Reactor vessel heads and 

pressurizers for nuclear 

reactors (provided for in 

subheading 8401.40.00) Free No change No change On or before 

12/31/2008 ’’. 

(c) EFFECTIVE DATE.—

(1) SUBSECTION (a).—The amendment made by subsection 

(a) shall take effect on the date of the enactment of this Act. 

(2) SUBSECTION (b).—The amendment made by subsection 

(b) shall apply to goods entered, or withdrawn from warehouse, 

for consumption on or after the 15th day after the date of the 

enactment of this Act.

TITLE VIII—REVENUE PROVISIONS 

Subtitle A—Provisions to Reduce Tax Avoidance 

Through Individual and Corporate Expatriation 

SEC. 801. TAX TREATMENT OF EXPATRIATED ENTITIES AND THEIR 

FOREIGN PARENTS. 

(a) IN GENERAL.—Subchapter C of chapter 80 (relating to provisions affecting more than one subtitle) is amended by adding at the 

end the following new section: 

‘‘SEC. 7874. RULES RELATING TO EXPATRIATED ENTITIES AND THEIR 

FOREIGN PARENTS. 

‘‘(a) TAX ON INVERSION GAIN OF EXPATRIATED ENTITIES.—

‘‘(1) IN GENERAL.—The taxable income of an expatriated entity for any taxable year which includes any portion of the applicable period shall in no event be less than the inversion gain 

of the entity for the taxable year. 

‘‘(2) EXPATRIATED ENTITY.—For purposes of this subsection—

‘‘(A) IN GENERAL.—The term ‘expatriated entity’ 

means—

‘‘(i) the domestic corporation or partnership referred to in subparagraph (B)(i) with respect to which 

a foreign corporation is a surrogate foreign corporation, and 

‘‘(ii) any United States person who is related (within the meaning of section 267(b) or 707(b)(1)) to a domestic corporation or partnership described in clause 

(i). 

‘‘(B) SURROGATE FOREIGN CORPORATION.—A foreign 

corporation shall be treated as a surrogate foreign corporaVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00151 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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tion if, pursuant to a plan (or a series of related transactions)—

‘‘(i) the entity completes after March 4, 2003, the 

direct or indirect acquisition of substantially all of the 

properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership, 

‘‘(ii) after the acquisition at least 60 percent of the 

stock (by vote or value) of the entity is held—

‘‘(I) in the case of an acquisition with respect 

to a domestic corporation, by former shareholders 

of the domestic corporation by reason of holding 

stock in the domestic corporation, or 

‘‘(II) in the case of an acquisition with respect 

to a domestic partnership, by former partners of 

the domestic partnership by reason of holding a 

capital or profits interest in the domestic partnership, and 

‘‘(iii) after the acquisition the expanded affiliated 

group which includes the entity does not have substantial business activities in the foreign country in which, 

or under the law of which, the entity is created or organized, when compared to the total business activities of 

such expanded affiliated group. 

An entity otherwise described in clause (i) with respect to 

any domestic corporation or partnership trade or business 

shall be treated as not so described if, on or before March 

4, 2003, such entity acquired directly or indirectly more 

than half of the properties held directly or indirectly by 

such corporation or more than half of the properties constituting such partnership trade or business, as the case may 

be. 

‘‘(3) COORDINATION WITH SUBSECTION (b).—Paragraph (1) 

shall not apply to any entity which is treated as a domestic corporation under subsection (b). 

‘‘(b) INVERTED CORPORATIONS TREATED AS DOMESTIC CORPORA- TIONS.—Notwithstanding section 7701(a)(4), a foreign corporation 

shall be treated for purposes of this title as a domestic corporation 

if such corporation would be a surrogate foreign corporation if subsection (a)(2) were applied by substituting ‘80 percent’ for ‘60 percent’. 

‘‘(c) DEFINITIONS AND SPECIAL RULES.—

‘‘(1) EXPANDED AFFILIATED GROUP.—The term ‘expanded affiliated group’ means an affiliated group as defined in section 

1504(a) but without regard to section 1504(b)(3), except that section 1504(a) shall be applied by substituting ‘more than 50 percent’ for ‘at least 80 percent’ each place it appears. 

‘‘(2) CERTAIN STOCK DISREGARDED.—There shall not be 

taken into account in determining ownership under subsection 

(a)(2)(B)(ii)—

‘‘(A) stock held by members of the expanded affiliated 

group which includes the foreign corporation, or 

‘‘(B) stock of such foreign corporation which is sold in 

a public offering related to the acquisition described in subsection (a)(2)(B)(i). 

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‘‘(3) PLAN DEEMED IN CERTAIN CASES.—If a foreign corporation acquires directly or indirectly substantially all of the properties of a domestic corporation or partnership during the 4-

year period beginning on the date which is 2 years before the 

ownership requirements of subsection (a)(2)(B)(ii) are met, such 

actions shall be treated as pursuant to a plan. 

‘‘(4) CERTAIN TRANSFERS DISREGARDED.—The transfer of 

properties or liabilities (including by contribution or distribution) shall be disregarded if such transfers are part of a plan 

a principal purpose of which is to avoid the purposes of this section. 

‘‘(5) SPECIAL RULE FOR RELATED PARTNERSHIPS.—For purposes of applying subsection (a)(2)(B)(ii) to the acquisition of a 

trade or business of a domestic partnership, except as provided 

in regulations, all partnerships which are under common control (within the meaning of section 482) shall be treated as 1 

partnership. 

‘‘(6) REGULATIONS.—The Secretary shall prescribe such regulations as may be appropriate to determine whether a corporation is a surrogate foreign corporation, including regulations—

‘‘(A) to treat warrants, options, contracts to acquire 

stock, convertible debt interests, and other similar interests 

as stock, and 

‘‘(B) to treat stock as not stock. 

‘‘(d) OTHER DEFINITIONS.—For purposes of this section—

‘‘(1) APPLICABLE PERIOD.—The term ‘applicable period’ 

means the period—

‘‘(A) beginning on the first date properties are acquired 

as part of the acquisition described in subsection 

(a)(2)(B)(i), and 

‘‘(B) ending on the date which is 10 years after the last 

date properties are acquired as part of such acquisition. 

‘‘(2) INVERSION GAIN.—The term ‘inversion gain’ means the 

income or gain recognized by reason of the transfer during the 

applicable period of stock or other properties by an expatriated 

entity, and any income received or accrued during the applicable period by reason of a license of any property by an expatriated entity—

‘‘(A) as part of the acquisition described in subsection 

(a)(2)(B)(i), or 

‘‘(B) after such acquisition if the transfer or license is 

to a foreign related person. 

Subparagraph (B) shall not apply to property described in section 1221(a)(1) in the hands of the expatriated entity. 

‘‘(3) FOREIGN RELATED PERSON.—The term ‘foreign related 

person’ means, with respect to any expatriated entity, a foreign 

person which—

‘‘(A) is related (within the meaning of section 267(b) or 

707(b)(1)) to such entity, or 

‘‘(B) is under the same common control (within the 

meaning of section 482) as such entity. 

‘‘(e) SPECIAL RULES.— ‘‘(1) CREDITS NOT ALLOWED AGAINST TAX ON INVERSION

GAIN.—Credits (other than the credit allowed by section 901) 

shall be allowed against the tax imposed by this chapter on an 

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expatriated entity for any taxable year described in subsection 

(a) only to the extent such tax exceeds the product of—

‘‘(A) the amount of the inversion gain for the taxable 

year, and 

‘‘(B) the highest rate of tax specified in section 11(b)(1). 

For purposes of determining the credit allowed by section 901, 

inversion gain shall be treated as from sources within the 

United States. 

‘‘(2) SPECIAL RULES FOR PARTNERSHIPS.—In the case of an 

expatriated entity which is a partnership—

‘‘(A) subsection (a)(1) shall apply at the partner rather 

than the partnership level, 

‘‘(B) the inversion gain of any partner for any taxable 

year shall be equal to the sum of—

‘‘(i) the partner’s distributive share of inversion 

gain of the partnership for such taxable year, plus 

‘‘(ii) gain recognized for the taxable year by the 

partner by reason of the transfer during the applicable 

period of any partnership interest of the partner in 

such partnership to the surrogate foreign corporation, 

and 

‘‘(C) the highest rate of tax specified in the rate schedule applicable to the partner under this chapter shall be 

substituted for the rate of tax referred to in paragraph (1). 

‘‘(3) COORDINATION WITH SECTION 172 AND MINIMUM TAX.—

Rules similar to the rules of paragraphs (3) and (4) of section 

860E(a) shall apply for purposes of subsection (a). 

‘‘(4) STATUTE OF LIMITATIONS.—

‘‘(A) IN GENERAL.—The statutory period for the assessment of any deficiency attributable to the inversion gain of 

any taxpayer for any pre-inversion year shall not expire before the expiration of 3 years from the date the Secretary is 

notified by the taxpayer (in such manner as the Secretary 

may prescribe) of the acquisition described in subsection 

(a)(2)(B)(i) to which such gain relates and such deficiency 

may be assessed before the expiration of such 3-year period 

notwithstanding the provisions of any other law or rule of 

law which would otherwise prevent such assessment. 

‘‘(B) PRE-INVERSION YEAR.—For purposes of subparagraph (A), the term ‘pre-inversion year’ means any taxable 

year if—

‘‘(i) any portion of the applicable period is included 

in such taxable year, and 

‘‘(ii) such year ends before the taxable year in 

which the acquisition described in subsection 

(a)(2)(B)(i) is completed. 

‘‘(f) SPECIAL RULE FOR TREATIES.—Nothing in section 894 or 

7852(d) or in any other provision of law shall be construed as permitting an exemption, by reason of any treaty obligation of the 

United States heretofore or hereafter entered into, from the provisions of this section. 

‘‘(g) REGULATIONS.—The Secretary shall provide such regulations as are necessary to carry out this section, including regulations providing for such adjustments to the application of this secVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00154 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
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tion as are necessary to prevent the avoidance of the purposes of this 

section, including the avoidance of such purposes through—

‘‘(1) the use of related persons, pass-through or other noncorporate entities, or other intermediaries, or 

‘‘(2) transactions designed to have persons cease to be (or 

not become) members of expanded affiliated groups or related 

persons.’’. 

(b) CONFORMING AMENDMENT.—The table of sections for subchapter C of chapter 80 is amended by adding at the end the following new item:

‘‘Sec. 7874. Rules relating to expatriated entities and their foreign 

parents.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years ending after March 4, 2003. 

SEC. 802. EXCISE TAX ON STOCK COMPENSATION OF INSIDERS IN EXPATRIATED CORPORATIONS. 

(a) IN GENERAL.—Subtitle D is amended by inserting after 

chapter 44 end the following new chapter: 

‘‘CHAPTER 45—PROVISIONS RELATING TO EXPATRIATED 

ENTITIES

‘‘Sec. 4985. Stock compensation of insiders in expatriated corporations.

‘‘SEC. 4985. STOCK COMPENSATION OF INSIDERS IN EXPATRIATED 

CORPORATIONS. 

‘‘(a) IMPOSITION OF TAX.—In the case of an individual who is 

a disqualified individual with respect to any expatriated corporation, there is hereby imposed on such person a tax equal to—

‘‘(1) the rate of tax specified in section 1(h)(1)(C), multiplied 

by 

‘‘(2) the value (determined under subsection (b)) of the specified stock compensation held (directly or indirectly) by or for 

the benefit of such individual or a member of such individual’s 

family (as defined in section 267) at any time during the 12-

month period beginning on the date which is 6 months before 

the expatriation date. 

‘‘(b) VALUE.—For purposes of subsection (a)—

‘‘(1) IN GENERAL.—The value of specified stock compensation shall be—

‘‘(A) in the case of a stock option (or other similar 

right) or a stock appreciation right, the fair value of such 

option or right, and 

‘‘(B) in any other case, the fair market value of such 

compensation. 

‘‘(2) DATE FOR DETERMINING VALUE.—The determination of 

value shall be made—

‘‘(A) in the case of specified stock compensation held on 

the expatriation date, on such date, 

‘‘(B) in the case of such compensation which is canceled 

during the 6 months before the expatriation date, on the 

day before such cancellation, and 

‘‘(C) in the case of such compensation which is granted 

after the expatriation date, on the date such compensation 

is granted. 

152

‘‘(c) TAX TO APPLY ONLY IF SHAREHOLDER GAIN RECOGNIZED.— Subsection (a) shall apply to any disqualified individual with respect to an expatriated corporation only if gain (if any) on any stock 

in such corporation is recognized in whole or part by any shareholder by reason of the acquisition referred to in section 

7874(a)(2)(B)(i) with respect to such corporation. 

‘‘(d) EXCEPTION WHERE GAIN RECOGNIZED ON COMPENSA- TION.—Subsection (a) shall not apply to—

‘‘(1) any stock option which is exercised on the expatriation 

date or during the 6-month period before such date and to the 

stock acquired in such exercise, if income is recognized under 

section 83 on or before the expatriation date with respect to the 

stock acquired pursuant to such exercise, and 

‘‘(2) any other specified stock compensation which is exercised, sold, exchanged, distributed, cashed-out, or otherwise 

paid during such period in a transaction in which income, 

gain, or loss is recognized in full. 

‘‘(e) DEFINITIONS.—For purposes of this section—

‘‘(1) DISQUALIFIED INDIVIDUAL.—The term ‘disqualified individual’ means, with respect to a corporation, any individual 

who, at any time during the 12-month period beginning on the 

date which is 6 months before the expatriation date—

‘‘(A) is subject to the requirements of section 16(a) of 

the Securities Exchange Act of 1934 with respect to such 

corporation or any member of the expanded affiliated group 

which includes such corporation, or 

‘‘(B) would be subject to such requirements if such corporation or member were an issuer of equity securities referred to in such section. 

‘‘(2) EXPATRIATED CORPORATION; EXPATRIATION DATE.—

‘‘(A) EXPATRIATED CORPORATION.—The term ‘expatriated corporation’ means any corporation which is an expatriated entity (as defined in section 7874(a)(2)). Such term 

includes any predecessor or successor of such a corporation. 

‘‘(B) EXPATRIATION DATE.—The term ‘expatriation date’ 

means, with respect to a corporation, the date on which the 

corporation first becomes an expatriated corporation. 

‘‘(3) SPECIFIED STOCK COMPENSATION.— ‘‘(A) IN GENERAL.—The term ‘specified stock compensation’ means payment (or right to payment) granted by the 

expatriated corporation (or by any member of the expanded 

affiliated group which includes such corporation) to any 

person in connection with the performance of services by a 

disqualified individual for such corporation or member if 

the value of such payment or right is based on (or determined by reference to) the value (or change in value) of 

stock in such corporation (or any such member). 

‘‘(B) EXCEPTIONS.—Such term shall not include—

‘‘(i) any option to which part II of subchapter D of 

chapter 1 applies, or 

‘‘(ii) any payment or right to payment from a plan 

referred to in section 280G(b)(6). 

‘‘(4) EXPANDED AFFILIATED GROUP.—The term ‘expanded affiliated group’ means an affiliated group (as defined in section 

1504(a) without regard to section 1504(b)(3)); except that section 

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1504(a) shall be applied by substituting ‘more than 50 percent’ 

for ‘at least 80 percent’ each place it appears. 

‘‘(f) SPECIAL RULES.—For purposes of this section—

‘‘(1) CANCELLATION OF RESTRICTION.—The cancellation of a 

restriction which by its terms will never lapse shall be treated 

as a grant.

‘‘(2) PAYMENT OR REIMBURSEMENT OF TAX BY CORPORATION

TREATED AS SPECIFIED STOCK COMPENSATION.—Any payment of 

the tax imposed by this section directly or indirectly by the expatriated corporation or by any member of the expanded affiliated group which includes such corporation—

‘‘(A) shall be treated as specified stock compensation, 

and 

‘‘(B) shall not be allowed as a deduction under any provision of chapter 1. 

‘‘(3) CERTAIN RESTRICTIONS IGNORED.—Whether there is 

specified stock compensation, and the value thereof, shall be determined without regard to any restriction other than a restriction which by its terms will never lapse. 

‘‘(4) PROPERTY TRANSFERS.—Any transfer of property shall 

be treated as a payment and any right to a transfer of property 

shall be treated as a right to a payment. 

‘‘(5) OTHER ADMINISTRATIVE PROVISIONS.—For purposes of 

subtitle F, any tax imposed by this section shall be treated as 

a tax imposed by subtitle A. 

‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes 

of this section.’’. 

(b) DENIAL OF DEDUCTION.—

(1) IN GENERAL.—Paragraph (6) of section 275(a) is amended by inserting ‘‘45,’’ before ‘‘46,’’. 

(2) $1,000,000 LIMIT ON DEDUCTIBLE COMPENSATION REDUCED BY PAYMENT OF EXCISE TAX ON SPECIFIED STOCK COMPENSATION.—Paragraph (4) of section 162(m) is amended by 

adding at the end the following new subparagraph: 

‘‘(G) COORDINATION WITH EXCISE TAX ON SPECIFIED

STOCK COMPENSATION.—The dollar limitation contained in 

paragraph (1) with respect to any covered employee shall be 

reduced (but not below zero) by the amount of any payment 

(with respect to such employee) of the tax imposed by section 4985 directly or indirectly by the expatriated corporation (as defined in such section) or by any member of the 

expanded affiliated group (as defined in such section) 

which includes such corporation.’’. 

(c) CONFORMING AMENDMENTS.—

(1) The last sentence of section 3121(v)(2)(A) is amended by 

inserting before the period ‘‘or to any specified stock compensation (as defined in section 4985) on which tax is imposed by section 4985’’. 

(2) The table of chapters for subtitle D is amended by inserting after the item relating to chapter 44 the following new 

item:

‘‘Chapter 45. Provisions relating to expatriated entities.’’.

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(d) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on March 4, 2003; except that periods before such 

date shall not be taken into account in applying the periods in subsections (a) and (e)(1) of section 4985 of the Internal Revenue Code 

of 1986, as added by this section. 

SEC. 803. REINSURANCE OF UNITED STATES RISKS IN FOREIGN JURISDICTIONS. 

(a) IN GENERAL.—Section 845(a) (relating to allocation in case 

of reinsurance agreement involving tax avoidance or evasion) is 

amended by striking ‘‘source and character’’ and inserting ‘‘amount, 

source, or character’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to any risk reinsured after the date of the enactment of 

this Act. 

SEC. 804. REVISION OF TAX RULES ON EXPATRIATION OF INDIVIDUALS. 

(a) EXPATRIATION TO AVOID TAX.— (1) IN GENERAL.—Subsection (a) of section 877 (relating to 

treatment of expatriates) is amended to read as follows: 

‘‘(a) TREATMENT OF EXPATRIATES.— ‘‘(1) IN GENERAL.—Every nonresident alien individual to 

whom this section applies and who, within the 10-year period 

immediately preceding the close of the taxable year, lost United 

States citizenship shall be taxable for such taxable year in the 

manner provided in subsection (b) if the tax imposed pursuant 

to such subsection (after any reduction in such tax under the 

last sentence of such subsection) exceeds the tax which, without 

regard to this section, is imposed pursuant to section 871. 

‘‘(2) INDIVIDUALS SUBJECT TO THIS SECTION.—This section 

shall apply to any individual if—

‘‘(A) the average annual net income tax (as defined in 

section 38(c)(1)) of such individual for the period of 5 taxable years ending before the date of the loss of United 

States citizenship is greater than $124,000, 

‘‘(B) the net worth of the individual as of such date is $2,000,000 or more, or 

‘‘(C) such individual fails to certify under penalty of 

perjury that he has met the requirements of this title for the 

5 preceding taxable years or fails to submit such evidence 

of such compliance as the Secretary may require. 

In the case of the loss of United States citizenship in any calendar year after 2004, such $124,000 amount shall be increased 

by an amount equal to such dollar amount multiplied by the 

cost-of-living adjustment determined under section 1(f)(3) for 

such calendar year by substituting ‘2003’ for ‘1992’ in subparagraph (B) thereof. Any increase under the preceding sentence 

shall be rounded to the nearest multiple of $1,000.’’. 

(2) REVISION OF EXCEPTIONS FROM ALTERNATIVE TAX.—

Subsection (c) of section 877 (relating to tax avoidance not presumed in certain cases) is amended to read as follows: 

‘‘(c) EXCEPTIONS.— ‘‘(1) IN GENERAL.—Subparagraphs (A) and (B) of subsection 

(a)(2) shall not apply to an individual described in paragraph 

(2) or (3). 

‘‘(2) DUAL CITIZENS.—

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‘‘(A) IN GENERAL.—An individual is described in this 

paragraph if—

‘‘(i) the individual became at birth a citizen of the 

United States and a citizen of another country and 

continues to be a citizen of such other country, and 

‘‘(ii) the individual has had no substantial contacts 

with the United States. 

‘‘(B) SUBSTANTIAL CONTACTS.—An individual shall be 

treated as having no substantial contacts with the United 

States only if the individual—

‘‘(i) was never a resident of the United States (as 

defined in section 7701(b)), 

‘‘(ii) has never held a United States passport, and 

‘‘(iii) was not present in the United States for more 

than 30 days during any calendar year which is 1 of 

the 10 calendar years preceding the individual’s loss of 

United States citizenship. 

‘‘(3) CERTAIN MINORS.—An individual is described in this 

paragraph if—

‘‘(A) the individual became at birth a citizen of the 

United States,

‘‘(B) neither parent of such individual was a citizen of 

the United States at the time of such birth, 

‘‘(C) the individual’s loss of United States citizenship 

occurs before such individual attains age 181⁄2, and 

‘‘(D) the individual was not present in the United 

States for more than 30 days during any calendar year 

which is 1 of the 10 calendar years preceding the individual’s loss of United States citizenship.’’. 

(3) CONFORMING AMENDMENT.—Section 2107(a) is amended 

to read as follows: 

‘‘(a) TREATMENT OF EXPATRIATES.—A tax computed in accordance with the table contained in section 2001 is hereby imposed on 

the transfer of the taxable estate, determined as provided in section 

2106, of every decedent nonresident not a citizen of the United 

States if the date of death occurs during a taxable year with respect 

to which the decedent is subject to tax under section 877(b).’’. 

(b) SPECIAL RULES FOR DETERMINING WHEN AN INDIVIDUAL IS

NO LONGER A UNITED STATES CITIZEN OR LONG-TERM RESIDENT.—

Section 7701 (relating to definitions) is amended by redesignating 

subsection (n) as subsection (o) and by inserting after subsection (m) 

the following new subsection: 

‘‘(n) SPECIAL RULES FOR DETERMINING WHEN AN INDIVIDUAL IS

NO LONGER A UNITED STATES CITIZEN OR LONG-TERM RESIDENT.—

An individual who would (but for this subsection) cease to be treated as a citizen or resident of the United States shall continue to be 

treated as a citizen or resident of the United States, as the case may 

be, until such individual—

‘‘(1) gives notice of an expatriating act or termination of 

residency (with the requisite intent to relinquish citizenship or 

terminate residency) to the Secretary of State or the Secretary 

of Homeland Security, and 

‘‘(2) provides a statement in accordance with section 

6039G.’’. 

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(c) PHYSICAL PRESENCE IN THE UNITED STATES FOR MORE

THAN 30 DAYS.—Section 877 (relating to expatriation to avoid tax) 

is amended by adding at the end the following new subsection: 

‘‘(g) PHYSICAL PRESENCE.—

‘‘(1) IN GENERAL.—This section shall not apply to any individual to whom this section would otherwise apply for any taxable year during the 10-year period referred to in subsection (a) 

in which such individual is physically present in the United 

States at any time on more than 30 days in the calendar year 

ending in such taxable year, and such individual shall be treated for purposes of this title as a citizen or resident of the United 

States, as the case may be, for such taxable year. 

‘‘(2) EXCEPTION.—

‘‘(A) IN GENERAL.—In the case of an individual described in any of the following subparagraphs of this paragraph, a day of physical presence in the United States shall 

be disregarded if the individual is performing services in 

the United States on such day for an employer. The preceding sentence shall not apply if—

‘‘(i) such employer is related (within the meaning 

of section 267 and 707) to such individual, or 

‘‘(ii) such employer fails to meet such requirements 

as the Secretary may prescribe by regulations to prevent the avoidance of the purposes of this paragraph. 

Not more than 30 days during any calendar year may be 

disregarded under this subparagraph. 

‘‘(B) INDIVIDUALS WITH TIES TO OTHER COUNTRIES.—An 

individual is described in this subparagraph if—

‘‘(i) the individual becomes (not later than the close 

of a reasonable period after loss of United States citizenship or termination of residency) a citizen or resident of the country in which—

‘‘(I) such individual was born, 

‘‘(II) if such individual is married, such individual’s spouse was born, or 

‘‘(III) either of such individual’s parents were 

born, and 

‘‘(ii) the individual becomes fully liable for income 

tax in such country. 

‘‘(C) MINIMAL PRIOR PHYSICAL PRESENCE IN THE

UNITED STATES.—An individual is described in this subparagraph if, for each year in the 10-year period ending on 

the date of loss of United States citizenship or termination 

of residency, the individual was physically present in the 

United States for 30 days or less. The rule of section 

7701(b)(3)(D)(ii) shall apply for purposes of this subparagraph.’’. 

(d) TRANSFERS SUBJECT TO GIFT TAX.—

(1) IN GENERAL.—Subsection (a) of section 2501 (relating to 

taxable transfers) is amended by striking paragraph (4), by redesignating paragraph (5) as paragraph (4), and by striking 

paragraph (3) and inserting the following new paragraph: 

‘‘(3) EXCEPTION.—

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‘‘(A) CERTAIN INDIVIDUALS.—Paragraph (2) shall not 

apply in the case of a donor to whom section 877(b) applies 

for the taxable year which includes the date of the transfer. 

‘‘(B) CREDIT FOR FOREIGN GIFT TAXES.—The tax imposed by this section solely by reason of this paragraph 

shall be credited with the amount of any gift tax actually 

paid to any foreign country in respect of any gift which is 

taxable under this section solely by reason of this paragraph.’’. 

(2) TRANSFERS OF CERTAIN STOCK.—Subsection (a) of section 2501 is amended by adding at the end the following new 

paragraph: 

‘‘(5) TRANSFERS OF CERTAIN STOCK.—

‘‘(A) IN GENERAL.—In the case of a transfer of stock in 

a foreign corporation described in subparagraph (B) by a 

donor to whom section 877(b) applies for the taxable year 

which includes the date of the transfer—

‘‘(i) section 2511(a) shall be applied without regard 

to whether such stock is situated within the United 

States, and 

‘‘(ii) the value of such stock for purposes of this 

chapter shall be its U.S.-asset value determined under 

subparagraph (C). 

‘‘(B) FOREIGN CORPORATION DESCRIBED.—A foreign corporation is described in this subparagraph with respect to 

a donor if—

‘‘(i) the donor owned (within the meaning of section 

958(a)) at the time of such transfer 10 percent or more 

of the total combined voting power of all classes of 

stock entitled to vote of the foreign corporation, and 

‘‘(ii) such donor owned (within the meaning of section 958(a)), or is considered to have owned (by applying the ownership rules of section 958(b)), at the time 

of such transfer, more than 50 percent of—

‘‘(I) the total combined voting power of all 

classes of stock entitled to vote of such corporation, 

or 

‘‘(II) the total value of the stock of such corporation. 

‘‘(C) U.S.-ASSET VALUE.—For purposes of subparagraph 

(A), the U.S.-asset value of stock shall be the amount which 

bears the same ratio to the fair market value of such stock 

at the time of transfer as—

‘‘(i) the fair market value (at such time) of the assets owned by such foreign corporation and situated in 

the United States, bears to 

‘‘(ii) the total fair market value (at such time) of all 

assets owned by such foreign corporation.’’. 

(e) ENHANCED INFORMATION REPORTING FROM INDIVIDUALS

LOSING UNITED STATES CITIZENSHIP.—

(1) IN GENERAL.—Subsection (a) of section 6039G is amended to read as follows: 

‘‘(a) IN GENERAL.—Notwithstanding any other provision of law, 

any individual to whom section 877(b) applies for any taxable year 

158

shall provide a statement for such taxable year which includes the 

information described in subsection (b).’’. 

(2) INFORMATION TO BE PROVIDED.—Subsection (b) of section 6039G is amended to read as follows: 

‘‘(b) INFORMATION TO BE PROVIDED.—Information required 

under subsection (a) shall include—

‘‘(1) the taxpayer’s TIN, 

‘‘(2) the mailing address of such individual’s principal foreign residence, 

‘‘(3) the foreign country in which such individual is residing, 

‘‘(4) the foreign country of which such individual is a citizen, 

‘‘(5) information detailing the income, assets, and liabilities 

of such individual, 

‘‘(6) the number of days during any portion of which that 

the individual was physically present in the United States during the taxable year, and 

‘‘(7) such other information as the Secretary may prescribe.’’. 

(3) INCREASE IN PENALTY.—Subsection (d) of section 6039G 

is amended to read as follows: 

‘‘(d) PENALTY.—If—

‘‘(1) an individual is required to file a statement under subsection (a) for any taxable year, and 

‘‘(2) fails to file such a statement with the Secretary on or 

before the date such statement is required to be filed or fails to 

include all the information required to be shown on the statement or includes incorrect information, 

such individual shall pay a penalty of $10,000 unless it is shown 

that such failure is due to reasonable cause and not to willful neglect.’’. 

(4) CONFORMING AMENDMENT.—Section 6039G is amended 

by striking subsections (c), (f), and (g) and by redesignating 

subsections (d) and (e) as subsection (c) and (d), respectively. 

(f) EFFECTIVE DATE.—The amendments made by this section 

shall apply to individuals who expatriate after June 3, 2004. 

SEC. 805. REPORTING OF TAXABLE MERGERS AND ACQUISITIONS. 

(a) IN GENERAL.—Subpart B of part III of subchapter A of 

chapter 61 is amended by inserting after section 6043 the following 

new section: 

‘‘SEC. 6043A. RETURNS RELATING TO TAXABLE MERGERS AND ACQUISITIONS. 

‘‘(a) IN GENERAL.—According to the forms or regulations prescribed by the Secretary, the acquiring corporation in any taxable 

acquisition shall make a return setting forth—

‘‘(1) a description of the acquisition, 

‘‘(2) the name and address of each shareholder of the acquired corporation who is required to recognize gain (if any) as 

a result of the acquisition, 

‘‘(3) the amount of money and the fair market value of other 

property transferred to each such shareholder as part of such 

acquisition, and 

‘‘(4) such other information as the Secretary may prescribe. 

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To the extent provided by the Secretary, the requirements of this section applicable to the acquiring corporation shall be applicable to 

the acquired corporation and not to the acquiring corporation. 

‘‘(b) NOMINEES.—According to the forms or regulations prescribed by the Secretary—

‘‘(1) REPORTING.—Any person who holds stock as a nominee 

for another person shall furnish in the manner prescribed by 

the Secretary to such other person the information provided by 

the corporation under subsection (d). 

‘‘(2) REPORTING TO NOMINEES.—In the case of stock held by 

any person as a nominee, references in this section (other than 

in subsection (c)) to a shareholder shall be treated as a reference 

to the nominee. 

‘‘(c) TAXABLE ACQUISITION.—For purposes of this section, the 

term ‘taxable acquisition’ means any acquisition by a corporation of 

stock in or property of another corporation if any shareholder of the 

acquired corporation is required to recognize gain (if any) as a result of such acquisition. 

‘‘(d) STATEMENTS TO BE FURNISHED TO SHAREHOLDERS.—According to the forms or regulations prescribed by the Secretary, 

every person required to make a return under subsection (a) shall 

furnish to each shareholder whose name is required to be set forth 

in such return a written statement showing—

‘‘(1) the name, address, and phone number of the information contact of the person required to make such return, 

‘‘(2) the information required to be shown on such return 

with respect to such shareholder, and 

‘‘(3) such other information as the Secretary may prescribe. 

The written statement required under the preceding sentence shall 

be furnished to the shareholder on or before January 31 of the year 

following the calendar year during which the taxable acquisition occurred.’’. 

(b) ASSESSABLE PENALTIES.—

(1) Subparagraph (B) of section 6724(d)(1) (relating to definitions) is amended by redesignating clauses (ii) through (xviii) 

as clauses (iii) through (xix), respectively, and by inserting after 

clause (i) the following new clause: 

‘‘(ii) section 6043A(a) (relating to returns relating 

to taxable mergers and acquisitions),’’. 

(2) Paragraph (2) of section 6724(d) is amended by redesignating subparagraphs (F) through (BB) as subparagraphs (G) 

through (CC), respectively, and by inserting after subparagraph 

(E) the following new subparagraph: 

‘‘(F) subsections (b) and (d) of section 6043A (relating 

to returns relating to taxable mergers and acquisitions).’’. 

(c) CLERICAL AMENDMENT.—The table of sections for subpart B 

of part III of subchapter A of chapter 61 is amended by inserting 

after the item relating to section 6043 the following new item:

‘‘Sec. 6043A. Returns relating to taxable mergers and acquisitions.’’.

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to acquisitions after the date of the enactment of this 

Act. 

160

SEC. 806. STUDIES. 

(a) TRANSFER PRICING RULES.—The Secretary of the Treasury 

or the Secretary’s delegate shall conduct a study regarding the effectiveness of current transfer pricing rules and compliance efforts in 

ensuring that cross-border transfers and other related-party transactions, particularly transactions involving intangible assets, service 

contracts, or leases cannot be used improperly to shift income out 

of the United States. The study shall include a review of the contemporaneous documentation and penalty rules under section 6662 of 

the Internal Revenue Code of 1986, a review of the regulatory and 

administrative guidance implementing the principles of section 482 

of such Code to transactions involving intangible property and services and to cost-sharing arrangements, and an examination of 

whether increased disclosure of cross-border transactions should be 

required. The study shall set forth specific recommendations to address all abuses identified in the study. Not later than June 30, 

2005, such Secretary or delegate shall submit to the Congress a report of such study. 

(b) INCOME TAX TREATIES.—The Secretary of the Treasury or 

the Secretary’s delegate shall conduct a study of United States income tax treaties to identify any inappropriate reductions in United 

States withholding tax that provide opportunities for shifting income out of the United States, and to evaluate whether existing 

anti-abuse mechanisms are operating properly. The study shall include specific recommendations to address all inappropriate uses of 

tax treaties. Not later than June 30, 2005, such Secretary or delegate shall submit to the Congress a report of such study. 

(c) EFFECTIVENESS OF CORPORATE EXPATRIATION PROVISIONS.—The Secretary of the Treasury or the Secretary’s delegate 

shall conduct a study of the effectiveness of the provisions of this 

title on corporate expatriation. The study shall include such recommendations as such Secretary or delegate may have to improve 

the effectiveness of such provisions in carrying out the purposes of 

this title. Not later than December 31, 2006, such Secretary or delegate shall submit to the Congress a report of such study.

Subtitle B—Provisions Relating to Tax Shelters 

PART I—TAXPAYER-RELATED PROVISIONS 

SEC. 811. PENALTY FOR FAILING TO DISCLOSE REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Part I of subchapter B of chapter 68 (relating 

to assessable penalties) is amended by inserting after section 6707 

the following new section: 

‘‘SEC. 6707A. PENALTY FOR FAILURE TO INCLUDE REPORTABLE 

TRANSACTION INFORMATION WITH RETURN. 

‘‘(a) IMPOSITION OF PENALTY.—Any person who fails to include 

on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay a penalty in the 

amount determined under subsection (b). 

‘‘(b) AMOUNT OF PENALTY.—

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), the 

amount of the penalty under subsection (a) shall be—

161

‘‘(A) $10,000 in the case of a natural person, and 

‘‘(B) $50,000 in any other case. 

‘‘(2) LISTED TRANSACTION.—The amount of the penalty 

under subsection (a) with respect to a listed transaction shall 

be—

‘‘(A) $100,000 in the case of a natural person, and 

‘‘(B) $200,000 in any other case. 

‘‘(c) DEFINITIONS.—For purposes of this section—

‘‘(1) REPORTABLE TRANSACTION.—The term ‘reportable 

transaction’ means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 

6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion. 

‘‘(2) LISTED TRANSACTION.—The term ‘listed transaction’ 

means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the 

Secretary as a tax avoidance transaction for purposes of section 

6011. 

‘‘(d) AUTHORITY TO RESCIND PENALTY.—

‘‘(1) IN GENERAL.—The Commissioner of Internal Revenue 

may rescind all or any portion of any penalty imposed by this 

section with respect to any violation if—

‘‘(A) the violation is with respect to a reportable transaction other than a listed transaction, and 

‘‘(B) rescinding the penalty would promote compliance 

with the requirements of this title and effective tax administration. 

‘‘(2) NO JUDICIAL APPEAL.—Notwithstanding any other provision of law, any determination under this subsection may not 

be reviewed in any judicial proceeding. 

‘‘(3) RECORDS.—If a penalty is rescinded under paragraph 

(1), the Commissioner shall place in the file in the Office of the 

Commissioner the opinion of the Commissioner with respect to 

the determination, including—

‘‘(A) a statement of the facts and circumstances relating 

to the violation, 

‘‘(B) the reasons for the rescission, and 

‘‘(C) the amount of the penalty rescinded. 

‘‘(e) PENALTY REPORTED TO SEC.—In the case of a person—

‘‘(1) which is required to file periodic reports under section 

13 or 15(d) of the Securities Exchange Act of 1934 or is required 

to be consolidated with another person for purposes of such reports, and 

‘‘(2) which— 

‘‘(A) is required to pay a penalty under this section 

with respect to a listed transaction, 

‘‘(B) is required to pay a penalty under section 6662A 

with respect to any reportable transaction at a rate prescribed under section 6662A(c), or 

‘‘(C) is required to pay a penalty under section 6662(h) 

with respect to any reportable transaction and would (but 

for section 6662A(e)(2)(C)) have been subject to penalty 

under section 6662A at a rate prescribed under section 

6662A(c), 

162

the requirement to pay such penalty shall be disclosed in such reports filed by such person for such periods as the Secretary shall 

specify. Failure to make a disclosure in accordance with the preceding sentence shall be treated as a failure to which the penalty 

under subsection (b)(2) applies. 

‘‘(f) COORDINATION WITH OTHER PENALTIES.—The penalty imposed by this section shall be in addition to any other penalty imposed by this title.’’

(b) CONFORMING AMENDMENT.—The table of sections for part I 

of subchapter B of chapter 68 is amended by inserting after the item 

relating to section 6707 the following:

‘‘Sec. 6707A. Penalty for failure to include reportable transaction information with return.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to returns and statements the due date for which is after 

the date of the enactment of this Act. 

(d) REPORT.—The Commissioner of Internal Revenue shall annually report to the Committee on Ways and Means of the House of 

Representatives and the Committee on Finance of the Senate—

(1) a summary of the total number and aggregate amount 

of penalties imposed, and rescinded, under section 6707A of the 

Internal Revenue Code of 1986, and 

(2) a description of each penalty rescinded under section 

6707(c) of such Code and the reasons therefor.

SEC. 812. ACCURACY-RELATED PENALTY FOR LISTED TRANSACTIONS, 

OTHER REPORTABLE TRANSACTIONS HAVING A SIGNIFICANT TAX AVOIDANCE PURPOSE, ETC. 

(a) IN GENERAL.—Subchapter A of chapter 68 is amended by 

inserting after section 6662 the following new section: 

‘‘SEC. 6662A. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERSTATEMENTS WITH RESPECT TO REPORTABLE TRANSACTIONS. 

‘‘(a) IMPOSITION OF PENALTY.—If a taxpayer has a reportable 

transaction understatement for any taxable year, there shall be 

added to the tax an amount equal to 20 percent of the amount of 

such understatement. 

‘‘(b) REPORTABLE TRANSACTION UNDERSTATEMENT.—For purposes of this section—

‘‘(1) IN GENERAL.—The term ‘reportable transaction understatement’ means the sum of—

‘‘(A) the product of—

‘‘(i) the amount of the increase (if any) in taxable 

income which results from a difference between the 

proper tax treatment of an item to which this section 

applies and the taxpayer’s treatment of such item (as 

shown on the taxpayer’s return of tax), and 

‘‘(ii) the highest rate of tax imposed by section 1 

(section 11 in the case of a taxpayer which is a corporation), and 

‘‘(B) the amount of the decrease (if any) in the aggregate amount of credits determined under subtitle A which 

results from a difference between the taxpayer’s treatment 

of an item to which this section applies (as shown on the 

taxpayer’s return of tax) and the proper tax treatment of 

such item. 

163

For purposes of subparagraph (A), any reduction of the excess 

of deductions allowed for the taxable year over gross income for 

such year, and any reduction in the amount of capital losses 

which would (without regard to section 1211) be allowed for 

such year, shall be treated as an increase in taxable income. 

‘‘(2) ITEMS TO WHICH SECTION APPLIES.—This section shall 

apply to any item which is attributable to—

‘‘(A) any listed transaction, and 

‘‘(B) any reportable transaction (other than a listed 

transaction) if a significant purpose of such transaction is 

the avoidance or evasion of Federal income tax. 

‘‘(c) HIGHER PENALTY FOR NONDISCLOSED LISTED AND OTHER

AVOIDANCE TRANSACTIONS.—Subsection (a) shall be applied by substituting ‘30 percent’ for ‘20 percent’ with respect to the portion of 

any reportable transaction understatement with respect to which the 

requirement of section 6664(d)(2)(A) is not met. 

‘‘(d) DEFINITIONS OF REPORTABLE AND LISTED TRANS- ACTIONS.—For purposes of this section, the terms ‘reportable transaction’ and ‘listed transaction’ have the respective meanings given 

to such terms by section 6707A(c). 

‘‘(e) SPECIAL RULES.— ‘‘(1) COORDINATION WITH PENALTIES, ETC., ON OTHER UN- DERSTATEMENTS.—In the case of an understatement (as defined 

in section 6662(d)(2))—

‘‘(A) the amount of such understatement (determined 

without regard to this paragraph) shall be increased by the 

aggregate amount of reportable transaction understatements for purposes of determining whether such understatement is a substantial understatement under section 

6662(d)(1), and 

‘‘(B) the addition to tax under section 6662(a) shall 

apply only to the excess of the amount of the substantial 

understatement (if any) after the application of subparagraph (A) over the aggregate amount of reportable transaction understatements. 

‘‘(2) COORDINATION WITH OTHER PENALTIES.— ‘‘(A) APPLICATION OF FRAUD PENALTY.—References to 

an underpayment in section 6663 shall be treated as including references to a reportable transaction understatement. 

‘‘(B) NO DOUBLE PENALTY.—This section shall not 

apply to any portion of an understatement on which a penalty is imposed under section 6663. 

‘‘(C) COORDINATION WITH VALUATION PENALTIES.—

‘‘(i) SECTION 6662(E).—Section 6662(e) shall not 

apply to any portion of an understatement on which a 

penalty is imposed under this section. 

‘‘(ii) SECTION 6662(H).—This section shall not apply 

to any portion of an understatement on which a penalty is imposed under section 6662(h). 

‘‘(3) SPECIAL RULE FOR AMENDED RETURNS.—Except as provided in regulations, in no event shall any tax treatment included with an amendment or supplement to a return of tax be 

taken into account in determining the amount of any reportable 

transaction understatement if the amendment or supplement is 

164

filed after the earlier of the date the taxpayer is first contacted 

by the Secretary regarding the examination of the return or 

such other date as is specified by the Secretary.’’. 

(b) DETERMINATION OF OTHER UNDERSTATEMENTS.—Subparagraph (A) of section 6662(d)(2) is amended by adding at the end the 

following flush sentence: 

‘‘The excess under the preceding sentence shall be determined without regard to items to which section 6662A applies.’’. 

(c) REASONABLE CAUSE EXCEPTION.— (1) IN GENERAL.—Section 6664 is amended by adding at 

the end the following new subsection: 

‘‘(d) REASONABLE CAUSE EXCEPTION FOR REPORTABLE TRANSACTION UNDERSTATEMENTS.— 

‘‘(1) IN GENERAL.—No penalty shall be imposed under section 6662A with respect to any portion of a reportable transaction understatement if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good 

faith with respect to such portion. 

‘‘(2) SPECIAL RULES.—Paragraph (1) shall not apply to any 

reportable transaction understatement unless—

‘‘(A) the relevant facts affecting the tax treatment of the 

item are adequately disclosed in accordance with the regulations prescribed under section 6011, 

‘‘(B) there is or was substantial authority for such 

treatment, and 

‘‘(C) the taxpayer reasonably believed that such treatment was more likely than not the proper treatment. 

A taxpayer failing to adequately disclose in accordance with 

section 6011 shall be treated as meeting the requirements of 

subparagraph (A) if the penalty for such failure was rescinded 

under section 6707A(d). 

‘‘(3) RULES RELATING TO REASONABLE BELIEF.—For purposes of paragraph (2)(C)—

‘‘(A) IN GENERAL.—A taxpayer shall be treated as having a reasonable belief with respect to the tax treatment of 

an item only if such belief—

‘‘(i) is based on the facts and law that exist at the 

time the return of tax which includes such tax treatment is filed, and 

‘‘(ii) relates solely to the taxpayer’s chances of success on the merits of such treatment and does not take 

into account the possibility that a return will not be 

audited, such treatment will not be raised on audit, or 

such treatment will be resolved through settlement if it 

is raised. 

‘‘(B) CERTAIN OPINIONS MAY NOT BE RELIED UPON.—

‘‘(i) IN GENERAL.—An opinion of a tax advisor may 

not be relied upon to establish the reasonable belief of 

a taxpayer if—

‘‘(I) the tax advisor is described in clause (ii), 

or 

‘‘(II) the opinion is described in clause (iii). 

‘‘(ii) DISQUALIFIED TAX ADVISORS.—A tax advisor is 

described in this clause if the tax advisor— 

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‘‘(I) is a material advisor (within the meaning 

of section 6111(b)(1)) and participates in the organization, management, promotion, or sale of the 

transaction or is related (within the meaning of 

section 267(b) or 707(b)(1)) to any person who so 

participates, 

‘‘(II) is compensated directly or indirectly by a 

material advisor with respect to the transaction, 

‘‘(III) has a fee arrangement with respect to the 

transaction which is contingent on all or part of 

the intended tax benefits from the transaction 

being sustained, or 

‘‘(IV) as determined under regulations prescribed by the Secretary, has a disqualifying financial interest with respect to the transaction. 

‘‘(iii) DISQUALIFIED OPINIONS.—For purposes of 

clause (i), an opinion is disqualified if the opinion—

‘‘(I) is based on unreasonable factual or legal 

assumptions (including assumptions as to future 

events), 

‘‘(II) unreasonably relies on representations, 

statements, findings, or agreements of the taxpayer 

or any other person, 

‘‘(III) does not identify and consider all relevant facts, or 

‘‘(IV) fails to meet any other requirement as 

the Secretary may prescribe.’’. 

(2) CONFORMING AMENDMENTS.—

(A) Paragraph (1) of section 6664(c) is amended by 

striking ‘‘this part’’ and inserting ‘‘section 6662 or 6663’’. 

(B) The heading for subsection (c) of section 6664 is 

amended by inserting ‘‘FOR UNDERPAYMENTS’’ after ‘‘EXCEPTION’’. 

(d) REDUCTION IN PENALTY FOR SUBSTANTIAL UNDERSTATEMENT OF INCOME TAX NOT TO APPLY TO TAX SHELTERS.—Subparagraph (C) of section 6662(d)(2) (relating to substantial understatement of income tax) is amended to read as follows: 

‘‘(C) REDUCTION NOT TO APPLY TO TAX SHELTERS.—

‘‘(i) IN GENERAL.—Subparagraph (B) shall not 

apply to any item attributable to a tax shelter. 

‘‘(ii) TAX SHELTER.—For purposes of clause (i), the 

term ‘tax shelter’ means—

‘‘(I) a partnership or other entity, 

‘‘(II) any investment plan or arrangement, or 

‘‘(III) any other plan or arrangement, 

if a significant purpose of such partnership, entity, 

plan, or arrangement is the avoidance or evasion of 

Federal income tax.’’. 

(e) CLERICAL AMENDMENTS.—

(1) The heading for section 6662 is amended to read as follows: 

166

‘‘SEC. 6662. IMPOSITION OF ACCURACY-RELATED PENALTY ON UNDERPAYMENTS.’’. 

(2) The table of sections for part II of subchapter A of chapter 68 is amended by striking the item relating to section 6662 

and inserting the following new items:

‘‘Sec. 6662. Imposition of accuracy-related penalty on underpayments. 

‘‘Sec. 6662A. Imposition of accuracy-related penalty on understatements with respect to reportable transactions.’’.

(f) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years ending after the date of the enactment 

of this Act. 

SEC. 813. TAX SHELTER EXCEPTION TO CONFIDENTIALITY PRIVILEGES 

RELATING TO TAXPAYER COMMUNICATIONS. 

(a) IN GENERAL.—Section 7525(b) (relating to section not to 

apply to communications regarding corporate tax shelters) is 

amended to read as follows: 

‘‘(b) SECTION NOT TO APPLY TO COMMUNICATIONS REGARDING

TAX SHELTERS.—The privilege under subsection (a) shall not apply 

to any written communication which is—

‘‘(1) between a federally authorized tax practitioner and—

‘‘(A) any person, 

‘‘(B) any director, officer, employee, agent, or representative of the person, or 

‘‘(C) any other person holding a capital or profits interest in the person, and 

‘‘(2) in connection with the promotion of the direct or indirect participation of the person in any tax shelter (as defined in 

section 6662(d)(2)(C)(ii)).’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to communications made on or after the date of the enactment of this Act. 

SEC. 814. STATUTE OF LIMITATIONS FOR TAXABLE YEARS FOR WHICH 

REQUIRED LISTED TRANSACTIONS NOT REPORTED. 

(a) IN GENERAL.—Section 6501(c) (relating to exceptions) is 

amended by adding at the end the following new paragraph: 

‘‘(10) LISTED TRANSACTIONS.—If a taxpayer fails to include 

on any return or statement for any taxable year any information with respect to a listed transaction (as defined in section 

6707A(c)(2)) which is required under section 6011 to be included with such return or statement, the time for assessment 

of any tax imposed by this title with respect to such transaction 

shall not expire before the date which is 1 year after the earlier 

of—

‘‘(A) the date on which the Secretary is furnished the 

information so required, or 

‘‘(B) the date that a material advisor (as defined in section 6111) meets the requirements of section 6112 with respect to a request by the Secretary under section 6112(b) relating to such transaction with respect to such taxpayer.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years with respect to which the period for assessing a deficiency did not expire before the date of the enactment 

of this Act. 

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SEC. 815. DISCLOSURE OF REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 6111 (relating to registration of tax 

shelters) is amended to read as follows: 

‘‘SEC. 6111. DISCLOSURE OF REPORTABLE TRANSACTIONS. 

‘‘(a) IN GENERAL.—Each material advisor with respect to any 

reportable transaction shall make a return (in such form as the Secretary may prescribe) setting forth—

‘‘(1) information identifying and describing the transaction, 

‘‘(2) information describing any potential tax benefits expected to result from the transaction, and 

‘‘(3) such other information as the Secretary may prescribe. 

Such return shall be filed not later than the date specified by the 

Secretary. 

‘‘(b) DEFINITIONS.—For purposes of this section—

‘‘(1) MATERIAL ADVISOR.—

‘‘(A) IN GENERAL.—The term ‘material advisor’ means 

any person—

‘‘(i) who provides any material aid, assistance, or 

advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying 

out any reportable transaction, and 

‘‘(ii) who directly or indirectly derives gross income 

in excess of the threshold amount (or such other 

amount as may be prescribed by the Secretary) for such 

advice or assistance. 

‘‘(B) THRESHOLD AMOUNT.—For purposes of subparagraph (A), the threshold amount is—

‘‘(i) $50,000 in the case of a reportable transaction 

substantially all of the tax benefits from which are provided to natural persons, and 

‘‘(ii) $250,000 in any other case. 

‘‘(2) REPORTABLE TRANSACTION.—The term ‘reportable 

transaction’ has the meaning given to such term by section 

6707A(c). 

‘‘(c) REGULATIONS.—The Secretary may prescribe regulations 

which provide—

‘‘(1) that only 1 person shall be required to meet the requirements of subsection (a) in cases in which 2 or more persons would otherwise be required to meet such requirements, 

‘‘(2) exemptions from the requirements of this section, and 

‘‘(3) such rules as may be necessary or appropriate to carry 

out the purposes of this section.’’. 

(b) CONFORMING AMENDMENTS.—

(1) The item relating to section 6111 in the table of sections 

for subchapter B of chapter 61 is amended to read as follows:

‘‘Sec. 6111. Disclosure of reportable transactions.’’.

(2) So much of section 6112 as precedes subsection (c) thereof is amended to read as follows: 

‘‘SEC. 6112. MATERIAL ADVISORS OF REPORTABLE TRANSACTIONS 

MUST KEEP LISTS OF ADVISEES, ETC. 

‘‘(a) IN GENERAL.—Each material advisor (as defined in section 

6111) with respect to any reportable transaction (as defined in section 6707A(c)) shall (whether or not required to file a return under 

168

section 6111 with respect to such transaction) maintain (in such 

manner as the Secretary may by regulations prescribe) a list—

‘‘(1) identifying each person with respect to whom such advisor acted as a material advisor with respect to such transaction, and 

‘‘(2) containing such other information as the Secretary 

may by regulations require.’’. 

(3) Section 6112 is amended—

(A) by redesignating subsection (c) as subsection (b), 

(B) by inserting ‘‘written’’ before ‘‘request’’ in subsection 

(b)(1) (as so redesignated), and 

(C) by striking ‘‘shall prescribe’’ in subsection (b)(2) (as 

so redesignated) and inserting ‘‘may prescribe’’. 

(4) The item relating to section 6112 in the table of sections 

for subchapter B of chapter 61 is amended to read as follows:

‘‘Sec. 6112. Material advisors of reportable transactions must keep 

lists of advisees, etc.’’.

(5)(A) The heading for section 6708 is amended to read as 

follows: 

‘‘SEC. 6708. FAILURE TO MAINTAIN LISTS OF ADVISEES WITH RESPECT 

TO REPORTABLE TRANSACTIONS.’’

(B) The item relating to section 6708 in the table of sections 

for part I of subchapter B of chapter 68 is amended to read as 

follows:

‘‘Sec. 6708. Failure to maintain lists of advisees with respect to reportable transactions.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transactions with respect to which material aid, assistance, or advice referred to in section 6111(b)(1)(A)(i) of the Internal Revenue Code of 1986 (as added by this section) is provided 

after the date of the enactment of this Act. 

SEC. 816. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 6707 (relating to failure to furnish information regarding tax shelters) is amended to read as follows: 

‘‘SEC. 6707. FAILURE TO FURNISH INFORMATION REGARDING REPORTABLE TRANSACTIONS. 

‘‘(a) IN GENERAL.—If a person who is required to file a return 

under section 6111(a) with respect to any reportable transaction—

‘‘(1) fails to file such return on or before the date prescribed 

therefor, or 

‘‘(2) files false or incomplete information with the Secretary 

with respect to such transaction, 

such person shall pay a penalty with respect to such return in the 

amount determined under subsection (b). 

‘‘(b) AMOUNT OF PENALTY.—

‘‘(1) IN GENERAL.—Except as provided in paragraph (2), the 

penalty imposed under subsection (a) with respect to any failure 

shall be $50,000. 

‘‘(2) LISTED TRANSACTIONS.—The penalty imposed under 

subsection (a) with respect to any listed transaction shall be an 

amount equal to the greater of—

‘‘(A) $200,000, or 

169

‘‘(B) 50 percent of the gross income derived by such person with respect to aid, assistance, or advice which is provided with respect to the listed transaction before the date 

the return is filed under section 6111. 

Subparagraph (B) shall be applied by substituting ‘75 percent’ 

for ‘50 percent’ in the case of an intentional failure or act described in subsection (a). 

‘‘(c) RESCISSION AUTHORITY.—The provisions of section 

6707A(d) (relating to authority of Commissioner to rescind penalty) 

shall apply to any penalty imposed under this section. 

‘‘(d) REPORTABLE AND LISTED TRANSACTIONS.—For purposes of 

this section, the terms ‘reportable transaction’ and ‘listed transaction’ have the respective meanings given to such terms by section 

6707A(c).’’. 

(b) CLERICAL AMENDMENT.—The item relating to section 6707 

in the table of sections for part I of subchapter B of chapter 68 is 

amended by striking ‘‘tax shelters’’ and inserting ‘‘reportable transactions’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to returns the due date for which is after the date of the 

enactment of this Act. 

SEC. 817. MODIFICATION OF PENALTY FOR FAILURE TO MAINTAIN 

LISTS OF INVESTORS. 

(a) IN GENERAL.—Subsection (a) of section 6708 is amended to 

read as follows: 

‘‘(a) IMPOSITION OF PENALTY.—

‘‘(1) IN GENERAL.—If any person who is required to maintain a list under section 6112(a) fails to make such list available upon written request to the Secretary in accordance with 

section 6112(b) within 20 business days after the date of such 

request, such person shall pay a penalty of $10,000 for each day 

of such failure after such 20th day. 

‘‘(2) REASONABLE CAUSE EXCEPTION.—No penalty shall be 

imposed by paragraph (1) with respect to the failure on any day 

if such failure is due to reasonable cause.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to requests made after the date of the enactment of this 

Act. 

SEC. 818. PENALTY ON PROMOTERS OF TAX SHELTERS. 

(a) PENALTY ON PROMOTING ABUSIVE TAX SHELTERS.—Section 

6700(a) is amended by adding at the end the following new sentence: ‘‘Notwithstanding the first sentence, if an activity with respect 

to which a penalty imposed under this subsection involves a statement described in paragraph (2)(A), the amount of the penalty shall 

be equal to 50 percent of the gross income derived (or to be derived) 

from such activity by the person on which the penalty is imposed.’’

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to activities after the date of the enactment of this Act. 

SEC. 819. MODIFICATIONS OF SUBSTANTIAL UNDERSTATEMENT PENALTY FOR NONREPORTABLE TRANSACTIONS. 

(a) SUBSTANTIAL UNDERSTATEMENT OF CORPORATIONS.—Section 6662(d)(1)(B) (relating to special rule for corporations) is 

amended to read as follows: 

170

‘‘(B) SPECIAL RULE FOR CORPORATIONS.—In the case of 

a corporation other than an S corporation or a personal 

holding company (as defined in section 542), there is a substantial understatement of income tax for any taxable year 

if the amount of the understatement for the taxable year exceeds the lesser of—

‘‘(i) 10 percent of the tax required to be shown on the return for the taxable year (or, if greater, $10,000), 

or 

‘‘(ii) $10,000,000.’’. 

(b) SECRETARIAL LIST.— (1) IN GENERAL.—Section 6662(d) is amended by adding at 

the end the following new paragraph: 

‘‘(3) SECRETARIAL LIST.—The Secretary may prescribe a list 

of positions which the Secretary believes do not meet the 1 or 

more of the standards specified in paragraph (2)(B)(i), section 

6664(d)(2), and section 6694(a)(1). Such list (and any revisions 

thereof) shall be published in the Federal Register or the Internal Revenue Bulletin.’’. 

(2) CONFORMING AMENDMENT.—Paragraph (2) of section 

6662(d) is amended by striking subparagraph (D).

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 820. MODIFICATION OF ACTIONS TO ENJOIN CERTAIN CONDUCT 

RELATED TO TAX SHELTERS AND REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 7408 (relating to action to enjoin promoters of abusive tax shelters, etc.) is amended by redesignating 

subsection (c) as subsection (d) and by striking subsections (a) and 

(b) and inserting the following new subsections: 

‘‘(a) AUTHORITY TO SEEK INJUNCTION.—A civil action in the 

name of the United States to enjoin any person from further engaging in specified conduct may be commenced at the request of the 

Secretary. Any action under this section shall be brought in the district court of the United States for the district in which such person 

resides, has his principal place of business, or has engaged in specified conduct. The court may exercise its jurisdiction over such action 

(as provided in section 7402(a)) separate and apart from any other 

action brought by the United States against such person. 

‘‘(b) ADJUDICATION AND DECREE.—In any action under subsection (a), if the court finds—

‘‘(1) that the person has engaged in any specified conduct, 

and 

‘‘(2) that injunctive relief is appropriate to prevent recurrence of such conduct, 

the court may enjoin such person from engaging in such conduct or 

in any other activity subject to penalty under this title. 

‘‘(c) SPECIFIED CONDUCT.—For purposes of this section, the term 

‘specified conduct’ means any action, or failure to take action, which 

is—

‘‘(1) subject to penalty under section 6700, 6701, 6707, or 

6708, or 

‘‘(2) in violation of any requirement under regulations 

issued under section 330 of title 31, United States Code.’’. 

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(b) CONFORMING AMENDMENTS.—

(1) The heading for section 7408 is amended to read as follows: 

‘‘SEC. 7408. ACTIONS TO ENJOIN SPECIFIED CONDUCT RELATED TO 

TAX SHELTERS AND REPORTABLE TRANSACTIONS.’’

(2) The table of sections for subchapter A of chapter 76 is 

amended by striking the item relating to section 7408 and inserting the following new item:

‘‘Sec. 7408. Actions to enjoin specified conduct related to tax shelters and reportable transactions.’’.

(c) EFFECTIVE DATE.—The amendment made by this section 

shall take effect on the day after the date of the enactment of this 

Act. 

SEC. 821. PENALTY ON FAILURE TO REPORT INTERESTS IN FOREIGN 

FINANCIAL ACCOUNTS. 

(a) IN GENERAL.—Section 5321(a)(5) of title 31, United States 

Code, is amended to read as follows: 

‘‘(5) FOREIGN FINANCIAL AGENCY TRANSACTION VIOLATION.—

‘‘(A) PENALTY AUTHORIZED.—The Secretary of the 

Treasury may impose a civil money penalty on any person 

who violates, or causes any violation of, any provision of 

section 5314. 

‘‘(B) AMOUNT OF PENALTY.—

‘‘(i) IN GENERAL.—Except as provided in subparagraph (C), the amount of any civil penalty imposed 

under subparagraph (A) shall not exceed $10,000. 

‘‘(ii) REASONABLE CAUSE EXCEPTION.—No penalty 

shall be imposed under subparagraph (A) with respect 

to any violation if—

‘‘(I) such violation was due to reasonable 

cause, and 

‘‘(II) the amount of the transaction or the balance in the account at the time of the transaction 

was properly reported. 

‘‘(C) WILLFUL VIOLATIONS.—In the case of any person 

willfully violating, or willfully causing any violation of, 

any provision of section 5314—

‘‘(i) the maximum penalty under subparagraph 

(B)(i) shall be increased to the greater of—

‘‘(I) $100,000, or 

‘‘(II) 50 percent of the amount determined 

under subparagraph (D), and 

‘‘(ii) subparagraph (B)(ii) shall not apply. 

‘‘(D) AMOUNT.—The amount determined under this 

subparagraph is—

‘‘(i) in the case of a violation involving a transaction, the amount of the transaction, or 

‘‘(ii) in the case of a violation involving a failure 

to report the existence of an account or any identifying 

information required to be provided with respect to an 

account, the balance in the account at the time of the 

violation.’’. 

172

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to violations occurring after the date of the enactment 

of this Act. 

SEC. 822. REGULATION OF INDIVIDUALS PRACTICING BEFORE THE DEPARTMENT OF TREASURY. 

(a) CENSURE; IMPOSITION OF PENALTY.—

(1) IN GENERAL.—Section 330(b) of title 31, United States 

Code, is amended—

(A) by inserting ‘‘, or censure,’’ after ‘‘Department’’, and 

(B) by adding at the end the following new flush sentence: 

‘‘The Secretary may impose a monetary penalty on any representative described in the preceding sentence. If the representative was 

acting on behalf of an employer or any firm or other entity in connection with the conduct giving rise to such penalty, the Secretary 

may impose a monetary penalty on such employer, firm, or entity 

if it knew, or reasonably should have known, of such conduct. Such 

penalty shall not exceed the gross income derived (or to be derived) 

from the conduct giving rise to the penalty and may be in addition 

to, or in lieu of, any suspension, disbarment, or censure of the representative.’’. 

(2) EFFECTIVE DATE.—The amendments made by this subsection shall apply to actions taken after the date of the enactment of this Act. 

(b) TAX SHELTER OPINIONS, ETC.—Section 330 of such title 31 

is amended by adding at the end the following new subsection: 

‘‘(d) Nothing in this section or in any other provision of law 

shall be construed to limit the authority of the Secretary of the 

Treasury to impose standards applicable to the rendering of written 

advice with respect to any entity, transaction plan or arrangement, 

or other plan or arrangement, which is of a type which the Secretary determines as having a potential for tax avoidance or evasion.’’. 

PART II—OTHER PROVISIONS 

SEC. 831. TREATMENT OF STRIPPED INTERESTS IN BOND AND PREFERRED STOCK FUNDS, ETC. 

(a) IN GENERAL.—Section 1286 (relating to tax treatment of 

stripped bonds) is amended by redesignating subsection (f) as subsection (g) and by inserting after subsection (e) the following new 

subsection: 

‘‘(f) TREATMENT OF STRIPPED INTERESTS IN BOND AND PREFERRED STOCK FUNDS, ETC.—In the case of an account or entity 

substantially all of the assets of which consist of bonds, preferred 

stock, or a combination thereof, the Secretary may by regulations 

provide that rules similar to the rules of this section and 305(e), as 

appropriate, shall apply to interests in such account or entity to 

which (but for this subsection) this section or section 305(e), as the 

case may be, would not apply.’’. 

(b) CROSS REFERENCE.—Subsection (e) of section 305 is amended by adding at the end the following new paragraph: 

‘‘(7) CROSS REFERENCE.—

‘‘For treatment of stripped interests in certain accounts or entities 

holding preferred stock, see section 1286(f).’’.

173

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to purchases and dispositions after the date of the enactment of this Act. 

SEC. 832. MINIMUM HOLDING PERIOD FOR FOREIGN TAX CREDIT ON 

WITHHOLDING TAXES ON INCOME OTHER THAN DIVIDENDS. 

(a) IN GENERAL.—Section 901 is amended by redesignating subsection (l) as subsection (m) and by inserting after subsection (k) the 

following new subsection:

‘‘(l) MINIMUM HOLDING PERIOD FOR WITHHOLDING TAXES ON

GAIN AND INCOME OTHER THAN DIVIDENDS ETC.—

‘‘(1) IN GENERAL.—In no event shall a credit be allowed 

under subsection (a) for any withholding tax (as defined in subsection (k)) on any item of income or gain with respect to any 

property if—

‘‘(A) such property is held by the recipient of the item 

for 15 days or less during the 31-day period beginning on 

the date which is 15 days before the date on which the 

right to receive payment of such item arises, or 

‘‘(B) to the extent that the recipient of the item is under 

an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in 

substantially similar or related property. 

This paragraph shall not apply to any dividend to which subsection (k) applies. 

‘‘(2) EXCEPTION FOR TAXES PAID BY DEALERS.—

‘‘(A) IN GENERAL.—Paragraph (1) shall not apply to 

any qualified tax with respect to any property held in the 

active conduct in a foreign country of a business as a dealer 

in such property. 

‘‘(B) QUALIFIED TAX.—For purposes of subparagraph 

(A), the term ‘qualified tax’ means a tax paid to a foreign 

country (other than the foreign country referred to in subparagraph (A)) if— 

‘‘(i) the item to which such tax is attributable is 

subject to taxation on a net basis by the country referred to in subparagraph (A), and 

‘‘(ii) such country allows a credit against its net 

basis tax for the full amount of the tax paid to such 

other foreign country. 

‘‘(C) DEALER.—For purposes of subparagraph (A), the 

term ‘dealer’ means—

‘‘(i) with respect to a security, any person to whom 

paragraphs (1) and (2) of subsection (k) would not 

apply by reason of paragraph (4) thereof if such security were stock, and 

‘‘(ii) with respect to any other property, any person 

with respect to whom such property is described in section 1221(a)(1). 

‘‘(D) REGULATIONS.—The Secretary may prescribe such 

regulations as may be appropriate to carry out this paragraph, including regulations to prevent the abuse of the exception provided by this paragraph and to treat other taxes 

as qualified taxes. 

174

‘‘(3) EXCEPTIONS.—The Secretary may by regulation provide 

that paragraph (1) shall not apply to property where the Secretary determines that the application of paragraph (1) to such 

property is not necessary to carry out the purposes of this subsection. 

‘‘(4) CERTAIN RULES TO APPLY.—Rules similar to the rules 

of paragraphs (5), (6), and (7) of subsection (k) shall apply for 

purposes of this subsection. 

‘‘(5) DETERMINATION OF HOLDING PERIOD.—Holding periods 

shall be determined for purposes of this subsection without regard to section 1235 or any similar rule.’’. 

(b) CONFORMING AMENDMENT.—The heading of subsection (k) 

of section 901 is amended by inserting ‘‘ON DIVIDENDS’’ after 

‘‘TAXES’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to amounts paid or accrued more than 30 days after the 

date of the enactment of this Act. 

SEC. 833. DISALLOWANCE OF CERTAIN PARTNERSHIP LOSS TRANSFERS. 

(a) TREATMENT OF CONTRIBUTED PROPERTY WITH BUILT-IN

LOSS.—Paragraph (1) of section 704(c) is amended by striking ‘‘and’’ 

at the end of subparagraph (A), by striking the period at the end 

of subparagraph (B) and inserting ‘‘, and’’, and by adding at the 

end the following: 

‘‘(C) if any property so contributed has a built-in loss—

‘‘(i) such built-in loss shall be taken into account 

only in determining the amount of items allocated to 

the contributing partner, and 

‘‘(ii) except as provided in regulations, in determining the amount of items allocated to other partners, 

the basis of the contributed property in the hands of 

the partnership shall be treated as being equal to its 

fair market value at the time of contribution. 

For purposes of subparagraph (C), the term ‘built-in loss’ means 

the excess of the adjusted basis of the property (determined 

without regard to subparagraph (C)(ii)) over its fair market 

value at the time of contribution.’’. 

(b) SPECIAL RULES FOR TRANSFERS OF PARTNERSHIP INTEREST

IF THERE IS SUBSTANTIAL BUILT-IN LOSS.—

(1) ADJUSTMENT OF PARTNERSHIP BASIS REQUIRED.—Subsection (a) of section 743 (relating to optional adjustment to 

basis of partnership property) is amended by inserting before 

the period ‘‘or unless the partnership has a substantial built-in 

loss immediately after such transfer’’. 

(2) ADJUSTMENT.—Subsection (b) of section 743 is amended 

by inserting ‘‘or which has a substantial built-in loss immediately after such transfer’’ after ‘‘section 754 is in effect’’. 

(3) SUBSTANTIAL BUILT-IN LOSS.—Section 743 is amended 

by adding at the end the following new subsection: 

‘‘(d) SUBSTANTIAL BUILT-IN LOSS.—

‘‘(1) IN GENERAL.—For purposes of this section, a partnership has a substantial built-in loss with respect to a transfer of 

an interest in a partnership if the partnership’s adjusted basis 

in the partnership property exceeds by more than $250,000 the 

fair market value of such property. 

175

‘‘(2) REGULATIONS.—The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of 

paragraph (1) and section 734(d), including regulations aggregating related partnerships and disregarding property acquired 

by the partnership in an attempt to avoid such purposes.’’. 

(4) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.—

(A) IN GENERAL.—Section 743 is amended by adding 

after subsection (d) the following new subsection: 

‘‘(e) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.—

‘‘(1) NO ADJUSTMENT OF PARTNERSHIP BASIS.—For purposes 

of this section, an electing investment partnership shall not be 

treated as having a substantial built-in loss with respect to any 

transfer occurring while the election under paragraph (6)(A) is 

in effect. 

‘‘(2) LOSS DEFERRAL FOR TRANSFEREE PARTNER.—In the 

case of a transfer of an interest in an electing investment partnership, the transferee partner’s distributive share of losses 

(without regard to gains) from the sale or exchange of partnership property shall not be allowed except to the extent that it 

is established that such losses exceed the loss (if any) recognized 

by the transferor (or any prior transferor to the extent not fully 

offset by a prior disallowance under this paragraph) on the 

transfer of the partnership interest. 

‘‘(3) NO REDUCTION IN PARTNERSHIP BASIS.—Losses disallowed under paragraph (2) shall not decrease the transferee 

partner’s basis in the partnership interest. 

‘‘(4) EFFECT OF TERMINATION OF PARTNERSHIP.—This subsection shall be applied without regard to any termination of a 

partnership under section 708(b)(1)(B). 

‘‘(5) CERTAIN BASIS REDUCTIONS TREATED AS LOSSES.—In 

the case of a transferee partner whose basis in property distributed by the partnership is reduced under section 732(a)(2), the 

amount of the loss recognized by the transferor on the transfer 

of the partnership interest which is taken into account under 

paragraph (2) shall be reduced by the amount of such basis reduction.

‘‘(6) ELECTING INVESTMENT PARTNERSHIP.—For purposes of 

this subsection, the term ‘electing investment partnership’ 

means any partnership if—

‘‘(A) the partnership makes an election to have this subsection apply, 

‘‘(B) the partnership would be an investment company 

under section 3(a)(1)(A) of the Investment Company Act of 

1940 but for an exemption under paragraph (1) or (7) of 

section 3(c) of such Act, 

‘‘(C) such partnership has never been engaged in a 

trade or business, 

‘‘(D) substantially all of the assets of such partnership 

are held for investment, 

‘‘(E) at least 95 percent of the assets contributed to such 

partnership consist of money, 

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‘‘(F) no assets contributed to such partnership had an 

adjusted basis in excess of fair market value at the time of 

contribution, 

‘‘(G) all partnership interests of such partnership are 

issued by such partnership pursuant to a private offering 

before the date which is 24 months after the date of the 

first capital contribution to such partnership, 

‘‘(H) the partnership agreement of such partnership has 

substantive restrictions on each partner’s ability to cause a 

redemption of the partner’s interest, and 

‘‘(I) the partnership agreement of such partnership provides for a term that is not in excess of 15 years. 

The election described in subparagraph (A), once made, shall be 

irrevocable except with the consent of the Secretary. 

‘‘(7) REGULATIONS.—The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this 

subsection, including regulations for applying this subsection to 

tiered partnerships.’’. 

(B) INFORMATION REPORTING.—Section 6031 is amended by adding at the end the following new subsection: 

‘‘(f) ELECTING INVESTMENT PARTNERSHIPS.—In the case of any 

electing investment partnership (as defined in section 743(e)(6)), the 

information required under subsection (b) to be furnished to any 

partner to whom section 743(e)(2) applies shall include such information as is necessary to enable the partner to compute the amount 

of losses disallowed under section 743(e).’’. 

(5) SPECIAL RULE FOR SECURITIZATION PARTNERSHIPS.—

Section 743 is amended by adding after subsection (e) the following new subsection: 

‘‘(f) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.—

‘‘(1) NO ADJUSTMENT OF PARTNERSHIP BASIS.—For purposes 

of this section, a securitization partnership shall not be treated 

as having a substantial built-in loss with respect to any transfer. 

‘‘(2) SECURITIZATION PARTNERSHIP.—For purposes of paragraph (1), the term ‘securitization partnership’ means any partnership the sole business activity of which is to issue securities 

which provide for a fixed principal (or similar) amount and 

which are primarily serviced by the cash flows of a discrete pool 

(either fixed or revolving) of receivables or other financial assets 

that by their terms convert into cash in a finite period, but only 

if the sponsor of the pool reasonably believes that the receivables 

and other financial assets comprising the pool are not acquired 

so as to be disposed of.’’

(6) CLERICAL AMENDMENTS.—

(A) The section heading for section 743 is amended to 

read as follows: 

‘‘SEC. 743. SPECIAL RULES WHERE SECTION 754 ELECTION OR SUBSTANTIAL BUILT-IN LOSS.’’

(B) The table of sections for subpart C of part II of subchapter K of chapter 1 is amended by striking the item relating to section 743 and inserting the following new item:

‘‘Sec. 743. Special rules where section 754 election or substantial 

built-in loss.’’.

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(c) ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP

PROPERTY IF THERE IS SUBSTANTIAL BASIS REDUCTION.—

(1) ADJUSTMENT REQUIRED.—Subsection (a) of section 734 

(relating to optional adjustment to basis of undistributed partnership property) is amended by inserting before the period ‘‘or 

unless there is a substantial basis reduction’’. 

(2) ADJUSTMENT.—Subsection (b) of section 734 is amended 

by inserting ‘‘or unless there is a substantial basis reduction’’ 

after ‘‘section 754 is in effect’’. 

(3) SUBSTANTIAL BASIS REDUCTION.—Section 734 is amended by adding at the end the following new subsection: 

‘‘(d) SUBSTANTIAL BASIS REDUCTION.—

‘‘(1) IN GENERAL.—For purposes of this section, there is a 

substantial basis reduction with respect to a distribution if the 

sum of the amounts described in subparagraphs (A) and (B) of 

subsection (b)(2) exceeds $250,000. 

‘‘(2) REGULATIONS.—

‘‘For regulations to carry out this subsection, see section 

743(d)(2).’’.

(4) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.—Section 734 is amended by inserting after subsection (d) the following new subsection: 

‘‘(e) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.—For purposes of this section, a securitization partnership (as defined in section 743(f)) shall not be treated as having a substantial basis reduction with respect to any distribution of property to a partner.’’. 

(5) CLERICAL AMENDMENTS.—

(A) The section heading for section 734 is amended to 

read as follows: 

‘‘SEC. 734. ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP 

PROPERTY WHERE SECTION 754 ELECTION OR SUBSTANTIAL BASIS REDUCTION.’’

(B) The table of sections for subpart B of part II of subchapter K of chapter 1 is amended by striking the item relating to section 734 and inserting the following new item:

‘‘Sec. 734. Adjustment to basis of undistributed partnership property 

where section 754 election or substantial basis reduction.’’.

(d) EFFECTIVE DATES.—

(1) SUBSECTION (a).—The amendment made by subsection 

(a) shall apply to contributions made after the date of the enactment of this Act. 

(2) SUBSECTION (b).—

(A) IN GENERAL.—Except as provided in subparagraph 

(B), the amendments made by subsection (b) shall apply to 

transfers after the date of the enactment of this Act. 

(B) TRANSITION RULE.—In the case of an electing investment partnership which is in existence on June 4, 2004, 

section 743(e)(6)(H) of the Internal Revenue Code of 1986, 

as added by this section, shall not apply to such partnership and section 743(e)(6)(I) of such Code, as so added, 

shall be applied by substituting ‘‘20 years’’ for ‘‘15 years’’. 

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(3) SUBSECTION (c).—The amendments made by subsection 

(c) shall apply to distributions after the date of the enactment 

of this Act. 

SEC. 834. NO REDUCTION OF BASIS UNDER SECTION 734 IN STOCK 

HELD BY PARTNERSHIP IN CORPORATE PARTNER. 

(a) IN GENERAL.—Section 755 is amended by adding at the end 

the following new subsection: 

‘‘(c) NO ALLOCATION OF BASIS DECREASE TO STOCK OF CORPORATE PARTNER.—In making an allocation under subsection (a) of 

any decrease in the adjusted basis of partnership property under 

section 734(b)—

‘‘(1) no allocation may be made to stock in a corporation (or 

any person related (within the meaning of sections 267(b) and 

707(b)(1)) to such corporation) which is a partner in the partnership, and 

‘‘(2) any amount not allocable to stock by reason of paragraph (1) shall be allocated under subsection (a) to other partnership property. 

Gain shall be recognized to the partnership to the extent that the 

amount required to be allocated under paragraph (2) to other partnership property exceeds the aggregate adjusted basis of such other 

property immediately before the allocation required by paragraph 

(2).’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to distributions after the date of the enactment of this 

Act.

SEC. 835. REPEAL OF SPECIAL RULES FOR FASITS. 

(a) IN GENERAL.—Part V of subchapter M of chapter 1 (relating 

to financial asset securitization investment trusts) is hereby repealed. 

(b) CONFORMING AMENDMENTS.—

(1) Paragraph (6) of section 56(g) is amended by striking 

‘‘REMIC, or FASIT’’ and inserting ‘‘or REMIC’’. 

(2) Clause (ii) of section 382(l)(4)(B) is amended by striking 

‘‘a REMIC to which part IV of subchapter M applies, or a 

FASIT to which part V of subchapter M applies,’’ and inserting 

‘‘or a REMIC to which part IV of subchapter M applies,’’. 

(3) Paragraph (1) of section 582(c) is amended by striking 

‘‘, and any regular interest in a FASIT,’’. 

(4) Subparagraph (E) of section 856(c)(5) is amended by 

striking the last sentence. 

(5)(A) Section 860G(a)(1) is amended by adding at the end 

the following new sentence: ‘‘An interest shall not fail to qualify 

as a regular interest solely because the specified principal 

amount of the regular interest (or the amount of interest accrued on the regular interest) can be reduced as a result of the 

nonoccurrence of 1 or more contingent payments with respect to 

any reverse mortgage loan held by the REMIC if, on the startup 

day for the REMIC, the sponsor reasonably believes that all 

principal and interest due under the regular interest will be 

paid at or prior to the liquidation of the REMIC.’’. 

(B) The last sentence of section 860G(a)(3) is amended by 

inserting ‘‘, and any reverse mortgage loan (and each balance 

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179

graph (A)(iii)) shall be treated as an obligation secured by an 

interest in real property’’ before the period at the end. 

(6) Paragraph (3) of section 860G(a) is amended by adding 

‘‘and’’ at the end of subparagraph (B), by striking ‘‘, and’’ at the 

end of subparagraph (C) and inserting a period, and by striking subparagraph (D). 

(7) Section 860G(a)(3), as amended by paragraph (6), is 

amended by adding at the end the following new sentence: ‘‘For 

purposes of subparagraph (A), if more than 50 percent of the obligations transferred to, or purchased by, the REMIC are originated by the United States or any State (or any political subdivision, agency, or instrumentality of the United States or any 

State) and are principally secured by an interest in real property, then each obligation transferred to, or purchased by, the 

REMIC shall be treated as secured by an interest in real property.’’. 

(8)(A) Section 860G(a)(3)(A) is amended by striking ‘‘or’’ at 

the end of clause (i), by inserting ‘‘or’’ at the end of clause (ii), 

and by inserting after clause (ii) the following new clause: 

‘‘(iii) represents an increase in the principal 

amount under the original terms of an obligation described in clause (i) or (ii) if such increase— 

‘‘(I) is attributable to an advance made to the 

obligor pursuant to the original terms of the obligation, 

‘‘(II) occurs after the startup day, and 

‘‘(III) is purchased by the REMIC pursuant to 

a fixed price contract in effect on the startup day.’’. 

(B) Section 860G(a)(7)(B) is amended to read as follows: 

‘‘(B) QUALIFIED RESERVE FUND.—For purposes of subparagraph (A), the term ‘qualified reserve fund’ means any 

reasonably required reserve to—

‘‘(i) provide for full payment of expenses of the 

REMIC or amounts due on regular interests in the 

event of defaults on qualified mortgages or lower than 

expected returns on cash flow investments, or 

‘‘(ii) provide a source of funds for the purchase of 

obligations described in clause (ii) or (iii) of paragraph 

(3)(A). 

The aggregate fair market value of the assets held in any 

such reserve shall not exceed 50 percent of the aggregate 

fair market value of all of the assets of the REMIC on the 

startup day, and the amount of any such reserve shall be 

promptly and appropriately reduced to the extent the 

amount held in such reserve is no longer reasonably required for purposes specified in clause (i) or (ii) of this subparagraph.’’. 

(9) Subparagraph (C) of section 1202(e)(4) is amended by 

striking ‘‘REMIC, or FASIT’’ and inserting ‘‘or REMIC’’. 

(10) Clause (xi) of section 7701(a)(19)(C) is amended—

(A) by striking ‘‘and any regular interest in a FASIT,’’, 

and 

(B) by striking ‘‘or FASIT’’ each place it appears. 

(11) Subparagraph (A) of section 7701(i)(2) is amended by 

striking ‘‘or a FASIT’’. 

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(12) The table of parts for subchapter M of chapter 1 is 

amended by striking the item relating to part V. 

(c) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as provided in paragraph (2), the 

amendments made by this section shall take effect on January 

1, 2005. 

(2) EXCEPTION FOR EXISTING FASITS.—Paragraph (1) shall 

not apply to any FASIT in existence on the date of the enactment of this Act to the extent that regular interests issued by 

the FASIT before such date continue to remain outstanding in 

accordance with the original terms of issuance. 

SEC. 836. LIMITATION ON TRANSFER OR IMPORTATION OF BUILT-IN 

LOSSES. 

(a) IN GENERAL.—Section 362 (relating to basis to corporations) 

is amended by adding at the end the following new subsection: 

‘‘(e) LIMITATIONS ON BUILT-IN LOSSES.—

‘‘(1) LIMITATION ON IMPORTATION OF BUILT-IN LOSSES.—

‘‘(A) IN GENERAL.—If in any transaction described in 

subsection (a) or (b) there would (but for this subsection) be 

an importation of a net built-in loss, the basis of each property described in subparagraph (B) which is acquired in 

such transaction shall (notwithstanding subsections (a) and 

(b)) be its fair market value immediately after such transaction. 

‘‘(B) PROPERTY DESCRIBED.—For purposes of subparagraph (A), property is described in this subparagraph if—

‘‘(i) gain or loss with respect to such property is not 

subject to tax under this subtitle in the hands of the 

transferor immediately before the transfer, and 

‘‘(ii) gain or loss with respect to such property is 

subject to such tax in the hands of the transferee immediately after such transfer. 

In any case in which the transferor is a partnership, the 

preceding sentence shall be applied by treating each partner in such partnership as holding such partner’s proportionate share of the property of such partnership.

‘‘(C) IMPORTATION OF NET BUILT-IN LOSS.—For purposes of subparagraph (A), there is an importation of a net 

built-in loss in a transaction if the transferee’s aggregate 

adjusted bases of property described in subparagraph (B) 

which is transferred in such transaction would (but for this 

paragraph) exceed the fair market value of such property 

immediately after such transaction. 

‘‘(2) LIMITATION ON TRANSFER OF BUILT-IN LOSSES IN SECTION 351 TRANSACTIONS.—

‘‘(A) IN GENERAL.—If—

‘‘(i) property is transferred by a transferor in any 

transaction which is described in subsection (a) and 

which is not described in paragraph (1) of this subsection, and 

‘‘(ii) the transferee’s aggregate adjusted bases of 

such property so transferred would (but for this paragraph) exceed the fair market value of such property 

immediately after such transaction, 

181

then, notwithstanding subsection (a), the transferee’s aggregate adjusted bases of the property so transferred shall not 

exceed the fair market value of such property immediately 

after such transaction. 

‘‘(B) ALLOCATION OF BASIS REDUCTION.—The aggregate 

reduction in basis by reason of subparagraph (A) shall be 

allocated among the property so transferred in proportion 

to their respective built-in losses immediately before the 

transaction. 

‘‘(C) ELECTION TO APPLY LIMITATION TO TRANSFEROR’S

STOCK BASIS.—

‘‘(i) IN GENERAL.—If the transferor and transferee 

of a transaction described in subparagraph (A) both 

elect the application of this subparagraph—

‘‘(I) subparagraph (A) shall not apply, and 

‘‘(II) the transferor’s basis in the stock received 

for property to which subparagraph (A) does not 

apply by reason of the election shall not exceed its 

fair market value immediately after the transfer. 

‘‘(ii) ELECTION.—An election under clause (i) shall 

be included with the return of tax for the taxable year 

in which the transaction occurred, shall be in such 

form and manner as the Secretary may prescribe, and, 

once made, shall be irrevocable.’’. 

(b) COMPARABLE TREATMENT WHERE LIQUIDATION.—Paragraph 

(1) of section 334(b) (relating to liquidation of subsidiary) is amended to read as follows: 

‘‘(1) IN GENERAL.—If property is received by a corporate distributee in a distribution in a complete liquidation to which section 332 applies (or in a transfer described in section 337(b)(1)), 

the basis of such property in the hands of such distributee shall 

be the same as it would be in the hands of the transferor; except 

that the basis of such property in the hands of such distributee 

shall be the fair market value of the property at the time of the 

distribution—

‘‘(A) in any case in which gain or loss is recognized by 

the liquidating corporation with respect to such property, or 

‘‘(B) in any case in which the liquidating corporation 

is a foreign corporation, the corporate distributee is a domestic corporation, and the corporate distributee’s aggregate adjusted bases of property described in section 

362(e)(1)(B) which is distributed in such liquidation would 

(but for this subparagraph) exceed the fair market value of 

such property immediately after such liquidation.’’. 

(c) EFFECTIVE DATES.—

(1) IN GENERAL.—The amendment made by subsection (a) 

shall apply to transactions after the date of the enactment of 

this Act. 

(2) LIQUIDATIONS.—The amendment made by subsection (b) 

shall apply to liquidations after the date of the enactment of 

this Act. 

182

SEC. 837. CLARIFICATION OF BANKING BUSINESS FOR PURPOSES OF 

DETERMINING INVESTMENT OF EARNINGS IN UNITED 

STATES PROPERTY. 

(a) IN GENERAL.—Subparagraph (A) of section 956(c)(2) is 

amended to read as follows: 

‘‘(A) obligations of the United States, money, or deposits with—

‘‘(i) any bank (as defined by section 2(c) of the 

Bank Holding Company Act of 1956 (12 U.S.C. 

1841(c)), without regard to subparagraphs (C) and (G) 

of paragraph (2) of such section), or 

‘‘(ii) any corporation not described in clause (i) 

with respect to which a bank holding company (as defined by section 2(a) of such Act) or financial holding 

company (as defined by section 2(p) of such Act) owns 

directly or indirectly more than 80 percent by vote or 

value of the stock of such corporation;’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall take effect on the date of the enactment of this Act. 

SEC. 838. DENIAL OF DEDUCTION FOR INTEREST ON UNDERPAYMENTS 

ATTRIBUTABLE TO NONDISCLOSED REPORTABLE TRANSACTIONS. 

(a) IN GENERAL.—Section 163 (relating to deduction for interest) is amended by redesignating subsection (m) as subsection (n) 

and by inserting after subsection (l) the following new subsection: 

‘‘(m) INTEREST ON UNPAID TAXES ATTRIBUTABLE TO NONDISCLOSED REPORTABLE TRANSACTIONS.—No deduction shall be allowed under this chapter for any interest paid or accrued under section 6601 on any underpayment of tax which is attributable to the 

portion of any reportable transaction understatement (as defined in 

section 6662A(b)) with respect to which the requirement of section 

6664(d)(2)(A) is not met.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transactions in taxable years beginning after the date 

of the enactment of this Act. 

SEC. 839. CLARIFICATION OF RULES FOR PAYMENT OF ESTIMATED 

TAX FOR CERTAIN DEEMED ASSET SALES. 

(a) IN GENERAL.—Paragraph (13) of section 338(h) (relating to 

tax on deemed sale not taken into account for estimated tax purposes) is amended by adding at the end the following: ‘‘The preceding sentence shall not apply with respect to a qualified stock purchase for which an election is made under paragraph (10).’’. 

(b) EFFECTIVE DATE.—The amendment made by subsection (a) 

shall apply to transactions occurring after the date of the enactment 

of this Act. 

SEC. 840. RECOGNITION OF GAIN FROM THE SALE OF A PRINCIPAL 

RESIDENCE ACQUIRED IN A LIKE-KIND EXCHANGE WITHIN 5 YEARS OF SALE. 

(a) IN GENERAL.—Section 121(d) (relating to special rules for 

exclusion of gain from sale of principal residence) is amended by 

adding at the end the following new paragraph: 

‘‘(10) PROPERTY ACQUIRED IN LIKE-KIND EXCHANGE.—If a 

taxpayer acquired property in an exchange to which section 

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183

change of such property if it occurs during the 5-year period beginning with the date of the acquisition of such property.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to sales or exchanges after the date of the enactment of 

this Act. 

SEC. 841. PREVENTION OF MISMATCHING OF INTEREST AND ORIGINAL 

ISSUE DISCOUNT DEDUCTIONS AND INCOME INCLUSIONS 

IN TRANSACTIONS WITH RELATED FOREIGN PERSONS. 

(a) ORIGINAL ISSUE DISCOUNT.—Section 163(e)(3) (relating to 

special rule for original issue discount on obligation held by related 

foreign person) is amended by redesignating subparagraph (B) as 

subparagraph (C) and by inserting after subparagraph (A) the following new subparagraph:

‘‘(B) SPECIAL RULE FOR CERTAIN FOREIGN ENTITIES.—

‘‘(i) IN GENERAL.—In the case of any debt instrument having original issue discount which is held by 

a related foreign person which is a controlled foreign 

corporation (as defined in section 957) or a passive foreign investment company (as defined in section 1297), 

a deduction shall be allowable to the issuer with respect to such original issue discount for any taxable 

year before the taxable year in which paid only to the 

extent such original issue discount is includible (determined without regard to properly allocable deductions 

and qualified deficits under section 952(c)(1)(B)) during such prior taxable year in the gross income of a 

United States person who owns (within the meaning of 

section 958(a)) stock in such corporation. 

‘‘(ii) SECRETARIAL AUTHORITY.—The Secretary may 

by regulation exempt transactions from the application 

of clause (i), including any transaction which is entered into by a payor in the ordinary course of a trade 

or business in which the payor is predominantly engaged.’’. 

(b) INTEREST AND OTHER DEDUCTIBLE AMOUNTS.—Section 

267(a)(3) is amended—

(1) by striking ‘‘The Secretary’’ and inserting: 

‘‘(A) IN GENERAL.—The Secretary’’, and 

(2) by adding at the end the following new subparagraph: 

‘‘(B) SPECIAL RULE FOR CERTAIN FOREIGN ENTITIES.—

‘‘(i) IN GENERAL.—Notwithstanding subparagraph 

(A), in the case of any item payable to a controlled foreign corporation (as defined in section 957) or a passive foreign investment company (as defined in section 

1297), a deduction shall be allowable to the payor with 

respect to such amount for any taxable year before the 

taxable year in which paid only to the extent that an 

amount attributable to such item is includible (determined without regard to properly allocable deductions 

and qualified deficits under section 952(c)(1)(B)) during such prior taxable year in the gross income of a 

United States person who owns (within the meaning of 

section 958(a)) stock in such corporation. 

‘‘(ii) SECRETARIAL AUTHORITY.—The Secretary may 

by regulation exempt transactions from the application 

184

of clause (i), including any transaction which is entered into by a payor in the ordinary course of a trade 

or business in which the payor is predominantly engaged and in which the payment of the accrued 

amounts occurs within 81⁄2 months after accrual or 

within such other period as the Secretary may prescribe.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to payments accrued on or after the date of the enactment of this Act. 

SEC. 842. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON 

POTENTIAL UNDERPAYMENTS. 

(a) IN GENERAL.—Subchapter A of chapter 67 (relating to interest on underpayments) is amended by adding at the end the following new section: 

‘‘SEC. 6603. DEPOSITS MADE TO SUSPEND RUNNING OF INTEREST ON 

POTENTIAL UNDERPAYMENTS, ETC. 

‘‘(a) AUTHORITY TO MAKE DEPOSITS OTHER THAN AS PAYMENT

OF TAX.—A taxpayer may make a cash deposit with the Secretary 

which may be used by the Secretary to pay any tax imposed under 

subtitle A or B or chapter 41, 42, 43, or 44 which has not been assessed at the time of the deposit. Such a deposit shall be made in 

such manner as the Secretary shall prescribe. 

‘‘(b) NO INTEREST IMPOSED.—To the extent that such deposit is 

used by the Secretary to pay tax, for purposes of section 6601 (relating to interest on underpayments), the tax shall be treated as paid 

when the deposit is made. 

‘‘(c) RETURN OF DEPOSIT.—Except in a case where the Secretary 

determines that collection of tax is in jeopardy, the Secretary shall 

return to the taxpayer any amount of the deposit (to the extent not 

used for a payment of tax) which the taxpayer requests in writing. 

‘‘(d) PAYMENT OF INTEREST.—

‘‘(1) IN GENERAL.—For purposes of section 6611 (relating to 

interest on overpayments), except as provided in paragraph (4), 

a deposit which is returned to a taxpayer shall be treated as a 

payment of tax for any period to the extent (and only to the extent) attributable to a disputable tax for such period. Under 

regulations prescribed by the Secretary, rules similar to the 

rules of section 6611(b)(2) shall apply. 

‘‘(2) DISPUTABLE TAX.—

‘‘(A) IN GENERAL.—For purposes of this section, the 

term ‘disputable tax’ means the amount of tax specified at 

the time of the deposit as the taxpayer’s reasonable estimate 

of the maximum amount of any tax attributable to disputable items. 

‘‘(B) SAFE HARBOR BASED ON 30-DAY LETTER.—In the 

case of a taxpayer who has been issued a 30-day letter, the 

maximum amount of tax under subparagraph (A) shall not 

be less than the amount of the proposed deficiency specified 

in such letter. 

‘‘(3) OTHER DEFINITIONS.—For purposes of paragraph (2)—

‘‘(A) DISPUTABLE ITEM.—The term ‘disputable item’ 

means any item of income, gain, loss, deduction, or credit 

if the taxpayer—

185

‘‘(i) has a reasonable basis for its treatment of such 

item, and 

‘‘(ii) reasonably believes that the Secretary also has 

a reasonable basis for disallowing the taxpayer’s treatment of such item. 

‘‘(B) 30-DAY LETTER.—The term ‘30-day letter’ means 

the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. 

‘‘(4) RATE OF INTEREST.—The rate of interest under this 

subsection shall be the Federal short-term rate determined 

under section 6621(b), compounded daily. 

‘‘(e) USE OF DEPOSITS.—

‘‘(1) PAYMENT OF TAX.—Except as otherwise provided by the 

taxpayer, deposits shall be treated as used for the payment of 

tax in the order deposited. 

‘‘(2) RETURNS OF DEPOSITS.—Deposits shall be treated as 

returned to the taxpayer on a last-in, first-out basis.’’. 

(b) CLERICAL AMENDMENT.—The table of sections for subchapter A of chapter 67 is amended by adding at the end the following new item:

‘‘Sec. 6603. Deposits made to suspend running of interest on potential 

underpayments, etc.’’.

(c) EFFECTIVE DATE.—

(1) IN GENERAL.—The amendments made by this section 

shall apply to deposits made after the date of the enactment of 

this Act. 

(2) COORDINATION WITH DEPOSITS MADE UNDER REVENUE

PROCEDURE 84–58.—In the case of an amount held by the Secretary of the Treasury or his delegate on the date of the enactment of this Act as a deposit in the nature of a cash bond deposit pursuant to Revenue Procedure 84–58, the date that the 

taxpayer identifies such amount as a deposit made pursuant to 

section 6603 of the Internal Revenue Code (as added by this 

Act) shall be treated as the date such amount is deposited for 

purposes of such section 6603. 

SEC. 843. PARTIAL PAYMENT OF TAX LIABILITY IN INSTALLMENT 

AGREEMENTS. 

(a) IN GENERAL.—

(1) Section 6159(a) (relating to authorization of agreements) 

is amended—

(A) by striking ‘‘satisfy liability for payment of’’ and inserting ‘‘make payment on’’, and 

(B) by inserting ‘‘full or partial’’ after ‘‘facilitate’’. 

(2) Section 6159(c) (relating to Secretary required to enter 

into installment agreements in certain cases) is amended in the 

matter preceding paragraph (1) by inserting ‘‘full’’ before ‘‘payment’’. 

(b) REQUIREMENT TO REVIEW PARTIAL PAYMENT AGREEMENTS

EVERY TWO YEARS.—Section 6159 is amended by redesignating subsections (d) and (e) as subsections (e) and (f), respectively, and inserting after subsection (c) the following new subsection: 

‘‘(d) SECRETARY REQUIRED TO REVIEW INSTALLMENT AGREE- MENTS FOR PARTIAL COLLECTION EVERY TWO YEARS.—In the case 

186

of an agreement entered into by the Secretary under subsection (a) 

for partial collection of a tax liability, the Secretary shall review the 

agreement at least once every 2 years.’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to agreements entered into on or after the date of the enactment of this Act. 

SEC. 844. AFFIRMATION OF CONSOLIDATED RETURN REGULATION AUTHORITY. 

(a) IN GENERAL.—Section 1502 is amended by adding at the 

end the following new sentence: ‘‘In carrying out the preceding sentence, the Secretary may prescribe rules that are different from the 

provisions of chapter 1 that would apply if such corporations filed 

separate returns.’’. 

(b) RESULT NOT OVERTURNED.—Notwithstanding the amendment made by subsection (a), the Internal Revenue Code of 1986 

shall be construed by treating Treasury Regulation § 1.1502–

20(c)(1)(iii) (as in effect on January 1, 2001) as being inapplicable 

to the factual situation in Rite Aid Corporation and Subsidiary Corporations v. United States, 255 F.3d 1357 (Fed. Cir. 2001).

(c) EFFECTIVE DATE.—This section, and the amendment made 

by this section, shall apply to taxable years beginning before, on, or 

after the date of the enactment of this Act. 

SEC. 845. EXPANDED DISALLOWANCE OF DEDUCTION FOR INTEREST 

ON CONVERTIBLE DEBT. 

(a) IN GENERAL.—Paragraph (2) of section 163(l) is amended by 

inserting ‘‘or equity held by the issuer (or any related party) in any 

other person’’ after ‘‘or a related party’’. 

(b) CAPITALIZATION ALLOWED WITH RESPECT TO EQUITY OF

PERSONS OTHER THAN ISSUER AND RELATED PARTIES.—Section 

163(l) is amended by redesignating paragraphs (4) and (5) as paragraphs (5) and (6) and by inserting after paragraph (3) the following new paragraph: 

‘‘(4) CAPITALIZATION ALLOWED WITH RESPECT TO EQUITY OF

PERSONS OTHER THAN ISSUER AND RELATED PARTIES.—If the 

disqualified debt instrument of a corporation is payable in equity held by the issuer (or any related party) in any other person (other than a related party), the basis of such equity shall 

be increased by the amount not allowed as a deduction by reason of paragraph (1) with respect to the instrument.’’. 

(c) EXCEPTION FOR CERTAIN INSTRUMENTS ISSUED BY DEALERS

IN SECURITIES.—Section 163(l), as amended by subsection (b), is 

amended by redesignating paragraphs (5) and (6) as paragraphs (6) 

and (7) and by inserting after paragraph (4) the following new 

paragraph: 

‘‘(5) EXCEPTION FOR CERTAIN INSTRUMENTS ISSUED BY

DEALERS IN SECURITIES.—For purposes of this subsection, the 

term ‘disqualified debt instrument’ does not include indebtedness issued by a dealer in securities (or a related party) which 

is payable in, or by reference to, equity (other than equity of the 

issuer or a related party) held by such dealer in its capacity as 

a dealer in securities. For purposes of this paragraph, the term 

‘dealer in securities’ has the meaning given such term by section 

475.’’. 

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(d) CONFORMING AMENDMENT.—Paragraph (3) of section 163(l) 

is amended by striking ‘‘or a related party’’ in the material preceding subparagraph (A) and inserting ‘‘or any other person’’. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to debt instruments issued after October 3, 2004. 

PART III—LEASING 

SEC. 847. REFORM OF TAX TREATMENT OF CERTAIN LEASING ARRANGEMENTS. 

(a) CLARIFICATION OF RECOVERY PERIOD FOR TAX-EXEMPT USE

PROPERTY SUBJECT TO LEASE.—Subparagraph (A) of section 

168(g)(3) (relating to special rules for determining class life) is 

amended by inserting ‘‘(notwithstanding any other subparagraph of 

this paragraph)’’ after ‘‘shall’’. 

(b) LIMITATION ON DEPRECIATION AND AMORTIZATION PERIODS

FOR INTANGIBLES LEASED TO TAX-EXEMPT ENTITY.—

(1) COMPUTER SOFTWARE.—Paragraph (1) of section 167(f) 

is amended by adding at the end the following new subparagraph:

‘‘(C) TAX-EXEMPT USE PROPERTY SUBJECT TO LEASE.—

In the case of computer software which would be tax-exempt use property as defined in subsection (h) of section 

168 if such section applied to computer software, the useful 

life under subparagraph (A) shall not be less than 125 percent of the lease term (within the meaning of section 

168(i)(3)).’’. 

(2) CERTAIN INTERESTS OR RIGHTS ACQUIRED SEPARATELY.—Paragraph (2) of section 167(f) is amended by adding 

at the end the following new sentence: ‘‘If such property would 

be tax-exempt use property as defined in subsection (h) of section 168 if such section applied to such property, the useful life 

under such regulations shall not be less than 125 percent of the 

lease term (within the meaning of section 168(i)(3)).’’. 

(3) SECTION 197 INTANGIBLES.—Section 197(f) (relating to 

special rules) is amended by adding at the end the following 

new paragraph: 

‘‘(10) TAX-EXEMPT USE PROPERTY SUBJECT TO LEASE.—In 

the case of any section 197 intangible which would be tax-exempt use property as defined in subsection (h) of section 168 if 

such section applied to such intangible, the amortization period 

under this section shall not be less than 125 percent of the lease 

term (within the meaning of section 168(i)(3)).’’. 

(c) LEASE TERM TO INCLUDE RELATED SERVICE CONTRACTS.—

Subparagraph (A) of section 168(i)(3) (relating to lease term) is 

amended by striking ‘‘and’’ at the end of clause (i), by redesignating 

clause (ii) as clause (iii), and by inserting after clause (i) the following new clause: 

‘‘(ii) the term of a lease shall include the term of 

any service contract or similar arrangement (whether 

or not treated as a lease under section 7701(e))—

‘‘(I) which is part of the same transaction (or 

series of related transactions) which includes the 

lease, and 

188

‘‘(II) which is with respect to the property subject to the lease or substantially similar property, 

and’’. 

(d) EXPANSION OF SHORT-TERM LEASE EXEMPTION FOR QUALI- FIED TECHNOLOGICAL EQUIPMENT.—Subparagraph (A) of section 

168(h)(3) is amended by adding at the end the following new sentence: ‘‘Notwithstanding subsection (i)(3)(A)(i), in determining a 

lease term for purposes of the preceding sentence, there shall not be 

taken into account any option of the lessee to renew at the fair market value rent determined at the time of renewal; except that the aggregate period not taken into account by reason of this sentence 

shall not exceed 24 months.’’. 

(e) TREATMENT OF CERTAIN INDIAN TRIBAL GOVERNMENTS AS

TAX-EXEMPT ENTITIES.—Section 168(h)(2)(A) is amended by striking ‘‘and’’ at the end of clause (ii), by striking the period at the end 

of clause (iii) and inserting ‘‘, and’’, and by inserting at the end the 

following: 

‘‘(iv) any Indian tribal government described in 

section 7701(a)(40). 

For purposes of applying this subsection, any Indian tribal 

government referred to in clause (iv) shall be treated in the 

same manner as a State.’’

SEC. 848. LIMITATION ON DEDUCTIONS ALLOCABLE TO PROPERTY 

USED BY GOVERNMENTS OR OTHER TAX-EXEMPT ENTITIES. 

(a) IN GENERAL.—Subpart C of part II of subchapter E of chapter 1 (relating to taxable year for which deductions taken) is amended by adding at the end the following new section: 

‘‘SEC. 470. LIMITATION ON DEDUCTIONS ALLOCABLE TO PROPERTY 

USED BY GOVERNMENTS OR OTHER TAX-EXEMPT ENTITIES. 

‘‘(a) LIMITATION ON LOSSES.—Except as otherwise provided in 

this section, a tax-exempt use loss for any taxable year shall not be 

allowed. 

‘‘(b) DISALLOWED LOSS CARRIED TO NEXT YEAR.—Any tax-exempt use loss with respect to any tax-exempt use property which is 

disallowed under subsection (a) for any taxable year shall be treated 

as a deduction with respect to such property in the next taxable 

year. 

‘‘(c) DEFINITIONS.—For purposes of this section—

‘‘(1) TAX-EXEMPT USE LOSS.—The term ‘tax-exempt use loss’ 

means, with respect to any taxable year, the amount (if any) by 

which— 

‘‘(A) the sum of— 

‘‘(i) the aggregate deductions (other than interest) 

directly allocable to a tax-exempt use property, plus 

‘‘(ii) the aggregate deductions for interest properly 

allocable to such property, exceed 

‘‘(B) the aggregate income from such property. 

‘‘(2) TAX-EXEMPT USE PROPERTY.—The term ‘tax-exempt use 

property’ has the meaning given to such term by section 168(h), 

except that such section shall be applied—

‘‘(A) without regard to paragraphs (1)(C) and (3) thereof, and 

‘‘(B) as if property described in—

189

‘‘(i) section 167(f)(1)(B), 

‘‘(ii) section 167(f)(2), and 

‘‘(iii) section 197 intangible, 

were tangible property. 

Such term shall not include property which would (but for this 

sentence) be tax-exempt use property solely by reason of section 

168(h)(6) if any credit is allowable under section 42 or 47 with 

respect to such property. 

‘‘(d) EXCEPTION FOR CERTAIN LEASES.—This section shall not 

apply to any lease of property which meets the requirements of all 

of the following paragraphs: 

‘‘(1) AVAILABILITY OF FUNDS.— 

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this paragraph if (at any time during the 

lease term) not more than an allowable amount of funds 

are— 

‘‘(i) subject to any arrangement referred to in subparagraph (B), or 

‘‘(ii) set aside or expected to be set aside, 

to or for the benefit of the lessor or any lender, or to or for 

the benefit of the lessee to satisfy the lessee’s obligations or 

options under the lease. For purposes of clause (ii), funds 

shall be treated as set aside or expected to be set aside only 

if a reasonable person would conclude, based on the facts 

and circumstances, that such funds are set aside or expected to be set aside. 

‘‘(B) ARRANGEMENTS.—The arrangements referred to in 

this subparagraph include a defeasance arrangement, a 

loan by the lessee to the lessor or any lender, a deposit arrangement, a letter of credit collateralized with cash or 

cash equivalents, a payment undertaking agreement, prepaid rent (within the meaning of the regulations under section 467), a sinking fund arrangement, a guaranteed investment contract, financial guaranty insurance, and any 

similar arrangement (whether or not such arrangement 

provides credit support). 

‘‘(C) ALLOWABLE AMOUNT.— ‘‘(i) IN GENERAL.—Except as otherwise provided in 

this subparagraph, the term ‘allowable amount’ means 

an amount equal to 20 percent of the lessor’s adjusted 

basis in the property at the time the lease is entered 

into. 

‘‘(ii) HIGHER AMOUNT PERMITTED IN CERTAIN

CASES.—To the extent provided in regulations, a higher 

percentage shall be permitted under clause (i) where 

necessary because of the credit-worthiness of the lessee. 

In no event may such regulations permit a percentage 

of more than 50 percent. 

‘‘(iii) OPTION TO PURCHASE.—If under the lease the 

lessee has the option to purchase the property for a 

fixed price or for other than the fair market value of 

the property (determined at the time of exercise), the allowable amount at the time such option may be exercised may not exceed 50 percent of the price at which 

such option may be exercised. 

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‘‘(iv) NO ALLOWABLE AMOUNT FOR CERTAIN ARRANGEMENTS.—The allowable amount shall be zero 

with respect to any arrangement which involves— 

‘‘(I) a loan from the lessee to the lessor or a 

lender, 

‘‘(II) any deposit received, letter of credit 

issued, or payment undertaking agreement entered 

into by a lender otherwise involved in the transaction, or 

‘‘(III) in the case of a transaction which involves a lender, any credit support made available 

to the lessor in which any such lender does not 

have a claim that is senior to the lessor. 

For purposes of subclause (I), the term ‘loan’ shall not 

include any amount treated as a loan under section 

467 with respect to a section 467 rental agreement. 

‘‘(2) LESSOR MUST MAKE SUBSTANTIAL EQUITY INVESTMENT.—

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this paragraph if— 

‘‘(i) the lessor— 

‘‘(I) has at the time the lease is entered into an 

unconditional at-risk equity investment (as determined by the Secretary) in the property of at least 

20 percent of the lessor’s adjusted basis in the 

property as of that time, and 

‘‘(II) maintains such investment throughout 

the term of the lease, and 

‘‘(ii) the fair market value of the property at the 

end of the lease term is reasonably expected to be equal 

to at least 20 percent of such basis. 

‘‘(B) RISK OF LOSS.—For purposes of clause (ii), the fair 

market value at the end of the lease term shall be reduced 

to the extent that a person other than the lessor bears a risk 

of loss in the value of the property. 

‘‘(C) PARAGRAPH NOT TO APPLY TO SHORT-TERM

LEASES.—This paragraph shall not apply to any lease with 

a lease term of 5 years or less. 

‘‘(3) LESSEE MAY NOT BEAR MORE THAN MINIMAL RISK OF

LOSS.— 

‘‘(A) IN GENERAL.—A lease of property meets the requirements of this paragraph if there is no arrangement 

under which the lessee bears— 

‘‘(i) any portion of the loss that would occur if the 

fair market value of the leased property were 25 percent less than its reasonably expected fair market value 

at the time the lease is terminated, or 

‘‘(ii) more than 50 percent of the loss that would 

occur if the fair market value of the leased property at 

the time the lease is terminated were zero.

‘‘(B) EXCEPTION.—The Secretary may by regulations 

provide that the requirements of this paragraph are not met 

where the lessee bears more than a minimal risk of loss. 

191

‘‘(C) PARAGRAPH NOT TO APPLY TO SHORT-TERM

LEASES.—This paragraph shall not apply to any lease with 

a lease term of 5 years or less. 

‘‘(4) PROPERTY WITH MORE THAN 7-YEAR CLASS LIFE.—In the 

case of a lease— 

‘‘(A) of property with a class life (as defined in section 

168(i)(1)) of more than 7 years, other than fixed-wing aircraft and vessels, and 

‘‘(B) under which the lessee has the option to purchase 

the property, 

the lease meets the requirements of this paragraph only if the 

purchase price under the option equals the fair market value of 

the property (determined at the time of exercise). 

‘‘(e) SPECIAL RULES.— 

‘‘(1) TREATMENT OF FORMER TAX-EXEMPT USE PROPERTY.— 

‘‘(A) IN GENERAL.—In the case of any former tax-exempt 

use property— 

‘‘(i) any deduction allowable under subsection (b) 

with respect to such property for any taxable year shall 

be allowed only to the extent of any net income (without 

regard to such deduction) from such property for such 

taxable year, and 

‘‘(ii) any portion of such unused deduction remaining after application of clause (i) shall be treated as a 

deduction allowable under subsection (b) with respect 

to such property in the next taxable year. 

‘‘(B) FORMER TAX-EXEMPT USE PROPERTY.—For purposes of this subsection, the term ‘former tax-exempt use 

property’ means any property which— 

‘‘(i) is not tax-exempt use property for the taxable 

year, but 

‘‘(ii) was tax-exempt use property for any prior taxable year. 

‘‘(2) DISPOSITION OF ENTIRE INTEREST IN PROPERTY.—If 

during the taxable year a taxpayer disposes of the taxpayer’s entire interest in tax-exempt use property (or former tax-exempt 

use property), rules similar to the rules of section 469(g) shall 

apply for purposes of this section. 

‘‘(3) COORDINATION WITH SECTION 469.—This section shall 

be applied before the application of section 469. 

‘‘(4) COORDINATION WITH SECTIONS 1031 AND 1033.—

‘‘(A) IN GENERAL.—Sections 1031(a) and 1033(a) shall 

not apply if—

‘‘(i) the exchanged or converted property is tax-exempt use property subject to a lease which was entered 

into before March 13, 2004, and which would not have 

met the requirements of subsection (d) had such requirements been in effect when the lease was entered 

into, or 

‘‘(ii) the replacement property is tax-exempt use 

property subject to a lease which does not meet the requirements of subsection (d). 

‘‘(B) ADJUSTED BASIS.—In the case of property acquired 

by the lessor in a transaction to which section 1031 or 1033 

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applies, the adjusted basis of such property for purposes of 

this section shall be equal to the lesser of—

‘‘(i) the fair market value of the property as of the 

beginning of the lease term, or 

‘‘(ii) the amount which would be the lessor’s adjusted basis if such sections did not apply to such 

transaction. 

‘‘(f) OTHER DEFINITIONS.—For purposes of this section— 

‘‘(1) RELATED PARTIES.—The terms ‘lessor’, ‘lessee’, and 

‘lender’ each include any related party (within the meaning of 

section 197(f)(9)(C)(i)). 

‘‘(2) LEASE TERM.—The term ‘lease term’ has the meaning 

given to such term by section 168(i)(3). 

‘‘(3) LENDER.—The term ‘lender’ means, with respect to any 

lease, a person that makes a loan to the lessor which is secured 

(or economically similar to being secured) by the lease or the 

leased property. 

‘‘(4) LOAN.—The term ‘loan’ includes any similar arrangement. 

‘‘(g) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes 

of this section, including regulations which— 

‘‘(1) allow in appropriate cases the aggregation of property 

subject to the same lease, and 

‘‘(2) provide for the determination of the allocation of interest expense for purposes of this section.’’. 

(b) CONFORMING AMENDMENT.—The table of sections for subpart C of part II of subchapter E of chapter 1 is amended by adding 

at the end the following new item:

‘‘Sec. 470. Limitation on deductions allocable to property used by 

governments or other tax-exempt entities.’’.

SEC. 849. EFFECTIVE DATE. 

(a) IN GENERAL.—Except as provided in this section, the 

amendments made by this part shall apply to leases entered into 

after March 12, 2004. 

(b) EXCEPTION.— (1) IN GENERAL.—The amendments made by this part shall 

not apply to qualified transportation property. 

(2) QUALIFIED TRANSPORTATION PROPERTY.—For purposes 

of paragraph (1), the term ‘‘qualified transportation property’’ 

means domestic property subject to a lease with respect to which 

a formal application—

(A) was submitted for approval to the Federal Transit 

Administration (an agency of the Department of Transportation) after June 30, 2003, and before March 13, 2004, 

(B) is approved by the Federal Transit Administration 

before January 1, 2006, and 

(C) includes a description of such property and the 

value of such property. 

(3) EXCHANGES AND CONVERSION OF TAX-EXEMPT USE PROPERTY.—Section 470(e)(4) of the Internal Revenue Code of 1986, 

as added by section 848, shall apply to property exchanged or 

converted after the date of the enactment of this Act. 

(4) INTANGIBLES AND INDIAN TRIBAL GOVERNMENTS.—The 

amendments made subsections (b)(2), (b)(3), and (e) of section 

193

847, and the treatment of property described in clauses (ii) and 

(iii) of section 470(c)(2)(B) of the Internal Revenue Code of 1986 

(as added by section 848) as tangible property, shall apply to 

leases entered into after October 3, 2004. 

Subtitle C—Reduction of Fuel Tax Evasion 

SEC. 851. EXEMPTION FROM CERTAIN EXCISE TAXES FOR MOBILE MACHINERY. 

(a) EXEMPTION FROM TAX ON HEAVY TRUCKS AND TRAILERS

SOLD AT RETAIL.—

(1) IN GENERAL.—Section 4053 (relating to exemptions) is 

amended by adding at the end the following new paragraph: 

‘‘(8) MOBILE MACHINERY.—Any vehicle which consists of a 

chassis—

‘‘(A) to which there has been permanently mounted (by 

welding, bolting, riveting, or other means) machinery or 

equipment to perform a construction, manufacturing, processing, farming, mining, drilling, timbering, or similar operation if the operation of the machinery or equipment is 

unrelated to transportation on or off the public highways, 

‘‘(B) which has been specially designed to serve only as 

a mobile carriage and mount (and a power source, where 

applicable) for the particular machinery or equipment involved, whether or not such machinery or equipment is in 

operation, and 

‘‘(C) which, by reason of such special design, could not, 

without substantial structural modification, be used as a 

component of a vehicle designed to perform a function of 

transporting any load other than that particular machinery 

or equipment or similar machinery or equipment requiring 

such a specially designed chassis.’’.

(2) EFFECTIVE DATE.—The amendment made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(b) EXEMPTION FROM TAX ON USE OF CERTAIN VEHICLES.—

(1) IN GENERAL.—Section 4483 (relating to exemptions) is 

amended by redesignating subsection (g) as subsection (h) and 

by inserting after subsection (f) the following new subsection: 

‘‘(g) EXEMPTION FOR MOBILE MACHINERY.—No tax shall be imposed by section 4481 on the use of any vehicle described in section 

4053(8).’’. 

(2) EFFECTIVE DATE.—The amendments made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(c) EXEMPTION FROM TAX ON TIRES.—

(1) IN GENERAL.—Section 4072(b)(2) is amended by adding 

at the end the following flush sentence: ‘‘Such term shall not include tires of a type used exclusively on vehicles described in 

section 4053(8).’’. 

(2) EFFECTIVE DATE.—The amendment made by this subsection shall take effect on the day after the date of the enactment of this Act. 

(d) REFUND OF FUEL TAXES.—

194

(1) IN GENERAL.—Section 6421(e)(2) (defining off-highway 

business use) is amended by adding at the end the following 

new subparagraph: 

‘‘(C) USES IN MOBILE MACHINERY.—

‘‘(i) IN GENERAL.—The term ‘off-highway business 

use’ shall include any use in a vehicle which meets the 

requirements described in clause (ii). 

‘‘(ii) REQUIREMENTS FOR MOBILE MACHINERY.—The 

requirements described in this clause are—

‘‘(I) the design-based test, and 

‘‘(II) the use-based test. 

‘‘(iii) DESIGN-BASED TEST.—For purposes of clause 

(ii)(I), the design-based test is met if the vehicle consists of a chassis—

‘‘(I) to which there has been permanently 

mounted (by welding, bolting, riveting, or other 

means) machinery or equipment to perform a construction, manufacturing, processing, farming, 

mining, drilling, timbering, or similar operation if 

the operation of the machinery or equipment is unrelated to transportation on or off the public highways, 

‘‘(II) which has been specially designed to 

serve only as a mobile carriage and mount (and a 

power source, where applicable) for the particular 

machinery or equipment involved, whether or not 

such machinery or equipment is in operation, and 

‘‘(III) which, by reason of such special design, 

could not, without substantial structural modification, be used as a component of a vehicle designed 

to perform a function of transporting any load 

other than that particular machinery or equipment 

or similar machinery or equipment requiring such 

a specially designed chassis. 

‘‘(iv) USE-BASED TEST.—For purposes of clause 

(ii)(II), the use-based test is met if the use of the vehicle 

on public highways was less than 7,500 miles during 

the taxpayer’s taxable year. This clause shall be applied without regard to use of the vehicle by any organization which is described in section 501(c) and exempt from tax under section 501(a).’’. 

(2) NO TAX-FREE SALES.—Subsection (b) of section 4082 is 

amended by inserting before the period at the end ‘‘and such 

term shall not include any use described in section 

6421(e)(2)(C)’’. 

(3) ANNUAL REFUND OF TAX PAID.—Section 6427(i)(2) (relating to exceptions) is amended by adding at the end the following new subparagraph: 

‘‘(C) NONAPPLICATION OF PARAGRAPH.—This paragraph 

shall not apply to any fuel used solely in any off-highway 

business use described in section 6421(e)(2)(C).’’. 

(4) EFFECTIVE DATE.—The amendments made by this subsection shall apply to taxable years beginning after the date of 

the enactment of this Act. 

195

SEC. 852. MODIFICATION OF DEFINITION OF OFF-HIGHWAY VEHICLE. 

(a) IN GENERAL.—Section 7701(a) (relating to definitions) is 

amended by adding at the end the following new paragraph: 

‘‘(48) OFF-HIGHWAY VEHICLES.—

‘‘(A) OFF-HIGHWAY TRANSPORTATION VEHICLES.—

‘‘(i) IN GENERAL.—A vehicle shall not be treated as 

a highway vehicle if such vehicle is specially designed 

for the primary function of transporting a particular 

type of load other than over the public highway and because of this special design such vehicle’s capability to 

transport a load over the public highway is substantially limited or impaired. 

‘‘(ii) DETERMINATION OF VEHICLE’S DESIGN.—For 

purposes of clause (i), a vehicle’s design is determined 

solely on the basis of its physical characteristics. 

‘‘(iii) DETERMINATION OF SUBSTANTIAL LIMITATION

OR IMPAIRMENT.—For purposes of clause (i), in determining whether substantial limitation or impairment 

exists, account may be taken of factors such as the size 

of the vehicle, whether such vehicle is subject to the licensing, safety, and other requirements applicable to 

highway vehicles, and whether such vehicle can transport a load at a sustained speed of at least 25 miles per 

hour. It is immaterial that a vehicle can transport a 

greater load off the public highway than such vehicle 

is permitted to transport over the public highway. 

‘‘(B) NONTRANSPORTATION TRAILERS AND

SEMITRAILERS.—A trailer or semitrailer shall not be treated 

as a highway vehicle if it is specially designed to function 

only as an enclosed stationary shelter for the carrying on 

of an off-highway function at an off-highway site.’’. 

(c) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the 

amendment made by this section shall take effect on the date 

of the enactment of this Act. 

(2) FUEL TAXES.—With respect to taxes imposed under subchapter B of chapter 31 and part III of subchapter A of chapter 

32, the amendment made by this section shall apply to taxable 

periods beginning after the date of the enactment of this Act. 

SEC. 853. TAXATION OF AVIATION-GRADE KEROSENE. 

(a) RATE OF TAX.—

(1) IN GENERAL.—Subparagraph (A) of section 4081(a)(2) is 

amended by striking ‘‘and’’ at the end of clause (ii), by striking 

the period at the end of clause (iii) and inserting ‘‘, and’’, and 

by adding at the end the following new clause: 

‘‘(iv) in the case of aviation-grade kerosene, 21.8 

cents per gallon.’’. 

(2) COMMERCIAL AVIATION.—Paragraph (2) of section 

4081(a) is amended by adding at the end the following new 

subparagraph: 

‘‘(C) TAXES IMPOSED ON FUEL USED IN COMMERCIAL

AVIATION.—In the case of aviation-grade kerosene which is 

removed from any refinery or terminal directly into the fuel 

tank of an aircraft for use in commercial aviation, the rate 

196

of tax under subparagraph (A)(iv) shall be 4.3 cents per 

gallon.’’. 

(3) CERTAIN REFUELER TRUCKS, TANKERS, AND TANK WAGONS TREATED AS TERMINAL.—

(A) IN GENERAL.—Subsection (a) of section 4081 is 

amended by adding at the end the following new paragraph: 

‘‘(3) CERTAIN REFUELER TRUCKS, TANKERS, AND TANK WAGONS TREATED AS TERMINAL.—

‘‘(A) IN GENERAL.—For purposes of paragraph (2)(C), a 

refueler truck, tanker, or tank wagon shall be treated as 

part of a terminal if—

‘‘(i) such terminal is located within a secured area 

of an airport, 

‘‘(ii) any aviation-grade kerosene which is loaded 

in such truck, tanker, or wagon at such terminal is for 

delivery only into aircraft at the airport in which such 

terminal is located, 

‘‘(iii) such truck, tanker, or wagon meets the requirements of subparagraph (B) with respect to such 

terminal, and 

‘‘(iv) except in the case of exigent circumstances 

identified by the Secretary in regulations, no vehicle 

registered for highway use is loaded with aviationgrade kerosene at such terminal. 

‘‘(B) REQUIREMENTS.—A refueler truck, tanker, or tank 

wagon meets the requirements of this subparagraph with 

respect to a terminal if such truck, tanker, or wagon—

‘‘(i) has storage tanks, hose, and coupling equipment designed and used for the purposes of fueling aircraft, 

‘‘(ii) is not registered for highway use, and 

‘‘(iii) is operated by—

‘‘(I) the terminal operator of such terminal, or 

‘‘(II) a person that makes a daily accounting to 

such terminal operator of each delivery of fuel 

from such truck, tanker, or wagon. 

‘‘(C) REPORTING.—The Secretary shall require under 

section 4101(d) reporting by such terminal operator of—

‘‘(i) any information obtained under subparagraph 

(B)(iii)(II), and 

‘‘(ii) any similar information maintained by such 

terminal operator with respect to deliveries of fuel 

made by trucks, tankers, or wagons operated by such 

terminal operator.’’. 

(B) LIST OF AIRPORTS WITH SECURED TERMINALS.—Not 

later than December 15, 2004, the Secretary of the Treasury 

shall publish and maintain a list of airports which include 

a secured area in which a terminal is located (within the 

meaning of section 4081(a)(3)(A)(i) of the Internal Revenue 

Code of 1986, as added by this paragraph). 

(4) LIABILITY FOR TAX ON AVIATION-GRADE KEROSENE USED

IN COMMERCIAL AVIATION.—Subsection (a) of section 4081 is 

amended by adding at the end the following new paragraph: 

197

‘‘(4) LIABILITY FOR TAX ON AVIATION-GRADE KEROSENE USED

IN COMMERCIAL AVIATION.—For purposes of paragraph (2)(C), 

the person who uses the fuel for commercial aviation shall pay 

the tax imposed under such paragraph. For purposes of the preceding sentence, fuel shall be treated as used when such fuel is 

removed into the fuel tank.’’. 

(5) NONTAXABLE USES.—

(A) IN GENERAL.—Section 4082 is amended by redesignating subsections (e) and (f) as subsections (f) and (g), respectively, and by inserting after subsection (d) the following new subsection: 

‘‘(e) AVIATION-GRADE KEROSENE.—In the case of aviation-grade 

kerosene which is exempt from the tax imposed by section 4041(c) 

(other than by reason of a prior imposition of tax) and which is removed from any refinery or terminal directly into the fuel tank of 

an aircraft, the rate of tax under section 4081(a)(2)(A)(iv) shall be 

zero.’’. 

(B) CONFORMING AMENDMENTS.—

(i) Subsection (b) of section 4082 is amended by 

adding at the end the following new flush sentence: 

‘‘The term ‘nontaxable use’ does not include the use of aviationgrade kerosene in an aircraft.’’. 

(ii) Section 4082(d) is amended by striking paragraph (1) and by redesignating paragraphs (2) and (3) 

as paragraphs (1) and (2), respectively. 

(6) NONAIRCRAFT USE OF AVIATION-GRADE KEROSENE.—

(A) IN GENERAL.—Subparagraph (B) of section 

4041(a)(1) is amended by adding at the end the following 

new sentence: ‘‘This subparagraph shall not apply to aviation-grade kerosene.’’. 

(B) CONFORMING AMENDMENT.—The heading for paragraph (1) of section 4041(a) is amended by inserting ‘‘AND

KEROSENE’’ after ‘‘DIESEL FUEL’’. 

(b) COMMERCIAL AVIATION.—Section 4083 is amended by redesignating subsections (b) and (c) as subsections (c) and (d), respectively, and by inserting after subsection (a) the following new subsection: 

‘‘(b) COMMERCIAL AVIATION.—For purposes of this subpart, the 

term ‘commercial aviation’ means any use of an aircraft in a business of transporting persons or property for compensation or hire by 

air, unless properly allocable to any transportation exempt from the 

taxes imposed by sections 4261 and 4271 by reason of section 4281 

or 4282 or by reason of section 4261(h).’’. 

(c) REFUNDS.—

(1) IN GENERAL.—Paragraph (4) of section 6427(l) is 

amended to read as follows: 

‘‘(4) REFUNDS FOR AVIATION-GRADE KEROSENE.—

‘‘(A) NO REFUND OF CERTAIN TAXES ON FUEL USED IN

COMMERCIAL AVIATION.—In the case of aviation-grade kerosene used in commercial aviation (as defined in section 

4083(b)) (other than supplies for vessels or aircraft within 

the meaning of section 4221(d)(3)), paragraph (1) shall not 

apply to so much of the tax imposed by section 4081 as is 

attributable to—

198

‘‘(i) the Leaking Underground Storage Tank Trust 

Fund financing rate imposed by such section, and 

‘‘(ii) so much of the rate of tax specified in section 

4081(a)(2)(A)(iv) as does not exceed 4.3 cents per gallon. 

‘‘(B) PAYMENT TO ULTIMATE, REGISTERED VENDOR.— With respect to aviation-grade kerosene, if the ultimate purchaser of such kerosene waives (at such time and in such 

form and manner as the Secretary shall prescribe) the right 

to payment under paragraph (1) and assigns such right to 

the ultimate vendor, then the Secretary shall pay the 

amount which would be paid under paragraph (1) to such 

ultimate vendor, but only if such ultimate vendor—

‘‘(i) is registered under section 4101, and 

‘‘(ii) meets the requirements of subparagraph (A), 

(B), or (D) of section 6416(a)(1).’’. 

(2) TIME FOR FILING CLAIMS.—Subparagraph (A) of section 

6427(i)(4) is amended—

(A) by striking ‘‘subsection (l)(5)’’ both places it appears 

and inserting ‘‘paragraph (4)(B) or (5) of subsection (l)’’, 

and 

(B) by striking ‘‘the preceding sentence’’ and inserting 

‘‘subsection (l)(5)’’. 

(3) CONFORMING AMENDMENT.—Subparagraph (B) of section 6427(l)(2) is amended to read as follows: 

‘‘(B) in the case of aviation-grade kerosene—

‘‘(i) any use which is exempt from the tax imposed 

by section 4041(c) other than by reason of a prior imposition of tax, or 

‘‘(ii) any use in commercial aviation (within the 

meaning of section 4083(b)).’’. 

(d) REPEAL OF PRIOR TAXATION OF AVIATION FUEL.—

(1) IN GENERAL.—Part III of subchapter A of chapter 32 is 

amended by striking subpart B and by redesignating subpart C 

as subpart B. 

(2) CONFORMING AMENDMENTS.— (A) Section 4041(c) is amended to read as follows: 

‘‘(c) AVIATION-GRADE KEROSENE.— ‘‘(1) IN GENERAL.—There is hereby imposed a tax upon 

aviation-grade kerosene—

‘‘(A) sold by any person to an owner, lessee, or other operator of an aircraft for use in such aircraft, or 

‘‘(B) used by any person in an aircraft unless there was 

a taxable sale of such fuel under subparagraph (A). 

‘‘(2) EXEMPTION FOR PREVIOUSLY TAXED FUEL.—No tax 

shall be imposed by this subsection on the sale or use of any 

aviation-grade kerosene if tax was imposed on such liquid 

under section 4081 and the tax thereon was not credited or refunded. 

‘‘(3) RATE OF TAX.—The rate of tax imposed by this subsection shall be the rate of tax applicable under section 

4081(a)(2)(A)(iv) which is in effect at the time of such sale or 

use.’’. 

(B) Section 4041(d)(2) is amended by striking ‘‘section 

4091’’ and inserting ‘‘section 4081’’. 

199

(C) Section 4041 is amended by striking subsection (e). 

(D) Section 4041 is amended by striking subsection (i). 

(E) Section 4041(m)(1) is amended to read as follows: 

‘‘(1) IN GENERAL.—In the case of the sale or use of any partially exempt methanol or ethanol fuel the rate of the tax imposed by subsection (a)(2) shall be— 

‘‘(A) after September 30, 1997, and before October 1, 

2005— 

‘‘(i) in the case of fuel none of the alcohol in which 

consists of ethanol, 9.15 cents per gallon, and 

‘‘(ii) in any other case, 11.3 cents per gallon, and 

‘‘(B) after September 30, 2005— 

‘‘(i) in the case of fuel none of the alcohol in which 

consists of ethanol, 2.15 cents per gallon, and 

‘‘(ii) in any other case, 4.3 cents per gallon.’’. 

(F) Sections 4101(a), 4103, 4221(a), and 6206 are each 

amended by striking ‘‘, 4081, or 4091’’ and inserting ‘‘or 

4081’’. 

(G) Section 6416(b)(2) is amended by striking ‘‘4091 

or’’. 

(H) Section 6416(b)(3) is amended by striking ‘‘or 4091’’ 

each place it appears. 

(I) Section 6416(d) is amended by striking ‘‘or to the 

tax imposed by section 4091 in the case of refunds described in section 4091(d)’’. 

(J) Section 6427(j)(1) is amended by striking ‘‘, 4081, 

and 4091’’ and inserting ‘‘and 4081’’. 

(K)(i) Section 6427(l)(1) is amended to read as follows: 

‘‘(1) IN GENERAL.—Except as otherwise provided in this subsection and in subsection (k), if any diesel fuel or kerosene on 

which tax has been imposed by section 4041 or 4081 is used by 

any person in a nontaxable use, the Secretary shall pay (without interest) to the ultimate purchaser of such fuel an amount 

equal to the aggregate amount of tax imposed on such fuel 

under section 4041 or 4081, as the case may be, reduced by any 

payment made to the ultimate vendor under paragraph (4)(B).’’. 

(ii) Paragraph (5)(B) of section 6427(l) is amended by 

striking ‘‘Paragraph (1)(A) shall not apply to kerosene’’ and 

inserting ‘‘Paragraph (1) shall not apply to kerosene (other 

than aviation-grade kerosene)’’. 

(L) Subparagraph (B) of section 6724(d)(1), as amended by section 805, is amended by striking clause (xvi) and 

by redesignating the succeeding clauses accordingly. 

(M) Paragraph (2) of section 6724(d), as amended by 

section 805, is amended by striking subparagraph (X) and 

by redesignating the succeeding subparagraphs accordingly. 

(N) Paragraph (1) of section 9502(b) is amended by 

adding ‘‘and’’ at the end of subparagraph (B) and by striking subparagraphs (C) and (D) and inserting the following 

new subparagraph: 

‘‘(C) section 4081 with respect to aviation gasoline and 

aviation-grade kerosene, and’’. 

(O) The last sentence of section 9502(b) is amended to 

read as follows: 

200

‘‘There shall not be taken into account under paragraph (1) so much 

of the taxes imposed by section 4081 as are determined at the rate 

specified in section 4081(a)(2)(B).’’. 

(P) Subsection (b) of section 9508 is amended by striking paragraph (3) and by redesignating paragraphs (4) and 

(5) as paragraphs (3) and (4), respectively. 

(Q) Section 9508(c)(2)(A) is amended by striking ‘‘sections 4081 and 4091’’ and inserting ‘‘section 4081’’. 

(R) The table of subparts for part III of subchapter A 

of chapter 32 is amended to read as follows:

‘‘Subpart A. Motor and aviation fuels. 

‘‘Subpart B. Special provisions applicable to fuels tax.’’.

(S) The heading for subpart A of part III of subchapter 

A of chapter 32 is amended to read as follows: 

‘‘Subpart A—Motor and Aviation Fuels’’. 

(T) The heading for subpart B of part III of subchapter 

A of chapter 32, as redesignated by paragraph (1), is 

amended to read as follows: 

‘‘Subpart B—Special Provisions Applicable to 

Fuels Tax’’. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to aviation-grade kerosene removed, entered, or sold 

after December 31, 2004. 

(f) FLOOR STOCKS TAX.—

(1) IN GENERAL.—There is hereby imposed on aviationgrade kerosene held on January 1, 2005, by any person a tax 

equal to—

(A) the tax which would have been imposed before such 

date on such kerosene had the amendments made by this 

section been in effect at all times before such date, reduced 

by 

(B) the sum of—

(i) the tax imposed before such date on such kerosene under section 4091 of the Internal Revenue Code 

of 1986, as in effect on such date, and 

(ii) in the case of kerosene held exclusively for such 

person’s own use, the amount which such person would 

(but for this clause) reasonably expect (as of such date) 

to be paid as a refund under section 6427(l) of such 

Code with respect to such kerosene. 

(2) EXCEPTION FOR FUEL HELD IN AIRCRAFT FUEL TANK.—

Paragraph (1) shall not apply to kerosene held in the fuel tank 

of an aircraft on January 1, 2005. 

(3) LIABILITY FOR TAX AND METHOD OF PAYMENT.— (A) LIABILITY FOR TAX.—The person holding the kerosene on January 1, 2005, to which the tax imposed by 

paragraph (1) applies shall be liable for such tax. 

(B) METHOD AND TIME FOR PAYMENT.—The tax imposed by paragraph (1) shall be paid at such time and in 

such manner as the Secretary of the Treasury (or the SecVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00204 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
201

retary’s delegate) shall prescribe, including the nonapplication of such tax on de minimis amounts of kerosene. 

(4) TRANSFER OF FLOOR STOCK TAX REVENUES TO TRUST

FUNDS.—For purposes of determining the amount transferred to 

any trust fund, the tax imposed by this subsection shall be 

treated as imposed by section 4081 of the Internal Revenue 

Code of 1986—

(A) in any case in which tax was not imposed by section 4091 of such Code, at the Leaking Underground Storage Tank Trust Fund financing rate under such section to 

the extent of 0.1 cents per gallon, and 

(B) at the rate under section 4081(a)(2)(A)(iv) of such 

Code to the extent of the remainder. 

(5) HELD BY A PERSON.—For purposes of this subsection, 

kerosene shall be considered as held by a person if title thereto 

has passed to such person (whether or not delivery to the person 

has been made). 

(6) OTHER LAWS APPLICABLE.—All provisions of law, including penalties, applicable with respect to the tax imposed by 

section 4081 of such Code shall, insofar as applicable and not 

inconsistent with the provisions of this subsection, apply with 

respect to the floor stock tax imposed by paragraph (1) to the 

same extent as if such tax were imposed by such section. 

SEC. 854. DYE INJECTION EQUIPMENT. 

(a) IN GENERAL.—Section 4082(a)(2) (relating to exemptions for 

diesel fuel and kerosene) is amended by inserting ‘‘by mechanical injection’’ after ‘‘indelibly dyed’’. 

(b) DYE INJECTOR SECURITY.—Not later than 180 days after the 

date of the enactment of this Act, the Secretary of the Treasury shall 

issue regulations regarding mechanical dye injection systems described in the amendment made by subsection (a), and such regulations shall include standards for making such systems tamper resistant. 

(c) PENALTY FOR TAMPERING WITH OR FAILING TO MAINTAIN

SECURITY REQUIREMENTS FOR MECHANICAL DYE INJECTION SYS- TEMS.— (1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable penalties) is amended by adding after section 6715 the following new section: 

‘‘SEC. 6715A. TAMPERING WITH OR FAILING TO MAINTAIN SECURITY 

REQUIREMENTS FOR MECHANICAL DYE INJECTION SYSTEMS. 

‘‘(a) IMPOSITION OF PENALTY—

‘‘(1) TAMPERING.—If any person tampers with a mechanical 

dye injection system used to indelibly dye fuel for purposes of 

section 4082, such person shall pay a penalty in addition to the 

tax (if any). 

‘‘(2) FAILURE TO MAINTAIN SECURITY REQUIREMENTS.—If 

any operator of a mechanical dye injection system used to indelibly dye fuel for purposes of section 4082 fails to maintain 

the security standards for such system as established by the 

Secretary, then such operator shall pay a penalty in addition to 

the tax (if any). 

‘‘(b) AMOUNT OF PENALTY.—The amount of the penalty under 

subsection (a) shall be—

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‘‘(1) for each violation described in paragraph (1), the greater of—

‘‘(A) $25,000, or 

‘‘(B) $10 for each gallon of fuel involved, and 

‘‘(2) for each—

‘‘(A) failure to maintain security standards described in 

paragraph (2), $1,000, and 

‘‘(B) failure to correct a violation described in paragraph (2), $1,000 per day for each day after which such 

violation was discovered or such person should have reasonably known of such violation. 

‘‘(c) JOINT AND SEVERAL LIABILITY.—

‘‘(1) IN GENERAL.—If a penalty is imposed under this section on any business entity, each officer, employee, or agent of 

such entity or other contracting party who willfully participated 

in any act giving rise to such penalty shall be jointly and severally liable with such entity for such penalty. 

‘‘(2) AFFILIATED GROUPS.—If a business entity described in 

paragraph (1) is part of an affiliated group (as defined in section 1504(a)), the parent corporation of such entity shall be 

jointly and severally liable with such entity for the penalty imposed under this section.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I 

of subchapter B of chapter 68 is amended by adding after the 

item related to section 6715 the following new item:

‘‘Sec. 6715A. Tampering with or failing to maintain security requirements for mechanical dye injection systems.’’.

(d) EFFECTIVE DATE.—The amendments made by subsections 

(a) and (c) shall take effect on the 180th day after the date on which 

the Secretary issues the regulations described in subsection (b). 

SEC. 855. ELIMINATION OF ADMINISTRATIVE REVIEW FOR TAXABLE 

USE OF DYED FUEL. 

(a) IN GENERAL.—Section 6715 is amended by inserting at the 

end the following new subsection: 

‘‘(e) NO ADMINISTRATIVE APPEAL FOR THIRD AND SUBSEQUENT

VIOLATIONS.—In the case of any person who is found to be subject 

to the penalty under this section after a chemical analysis of such 

fuel and who has been penalized under this section at least twice 

after the date of the enactment of this subsection, no administrative 

appeal or review shall be allowed with respect to such finding except 

in the case of a claim regarding—

‘‘(1) fraud or mistake in the chemical analysis, or 

‘‘(2) mathematical calculation of the amount of the penalty.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to penalties assessed after the date of the enactment of 

this Act. 

SEC. 856. PENALTY ON UNTAXED CHEMICALLY ALTERED DYED FUEL 

MIXTURES. 

(a) IN GENERAL.—Section 6715(a) (relating to dyed fuel sold for 

use or used in taxable use, etc.) is amended by striking ‘‘or’’ in paragraph (2), by inserting ‘‘or’’ at the end of paragraph (3), and by inserting after paragraph (3) the following new paragraph: 

203

‘‘(4) any person who has knowledge that a dyed fuel which 

has been altered as described in paragraph (3) sells or holds for 

sale such fuel for any use which the person knows or has reason 

to know is not a nontaxable use of such fuel,’’. 

(b) CONFORMING AMENDMENT.—Section 6715(a)(3) is amended 

by striking ‘‘alters, or attempts to alter,’’ and inserting ‘‘alters, 

chemically or otherwise, or attempts to so alter,’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on the date of the enactment of this Act. 

SEC. 857. TERMINATION OF DYED DIESEL USE BY INTERCITY BUSES. 

(a) IN GENERAL.—Paragraph (3) of section 4082(b) (relating to 

nontaxable use) is amended to read as follows: 

‘‘(3) any use described in section 4041(a)(1)(C)(iii)(II).’’. 

(b) ULTIMATE VENDOR REFUND.—Subsection (b) of section 6427 

is amended by adding at the end the following new paragraph: 

‘‘(4) REFUNDS FOR USE OF DIESEL FUEL IN CERTAIN INTERCITY BUSES.—With respect to any fuel to which paragraph 

(2)(A) applies, if the ultimate purchaser of such fuel waives (at 

such time and in such form and manner as the Secretary shall 

prescribe) the right to payment under paragraph (1) and assigns such right to the ultimate vendor, then the Secretary shall 

pay the amount which would be paid under paragraph (1) to 

such ultimate vendor, but only if such ultimate vendor—

‘‘(A) is registered under section 4101, and 

‘‘(B) meets the requirements of subparagraph (A), (B), 

or (D) of section 6416(a)(1).’’. 

(c) PAYMENT OF REFUNDS.—Subparagraph (A) of section 

6427(i)(4), as amended by this Act, is amended by inserting ‘‘subsections (b)(4) and’’ after ‘‘filed under’’. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to fuel sold after December 31, 2004. 

SEC. 858. AUTHORITY TO INSPECT ON-SITE RECORDS. 

(a) IN GENERAL.—Section 4083(d)(1)(A) (relating to administrative authority), as amended by this Act, is amended by striking 

‘‘and’’ at the end of clause (i) and by inserting after clause (ii) the 

following new clause: 

‘‘(iii) inspecting any books and records and any 

shipping papers pertaining to such fuel, and’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on the date of the enactment of this Act. 

SEC. 859. ASSESSABLE PENALTY FOR REFUSAL OF ENTRY. 

(a) IN GENERAL.—Part I of subchapter B of chapter 68 (relating 

to assessable penalties), as amended by this Act, is amended by inserting after section 6716 the following new section: 

‘‘SEC. 6717. REFUSAL OF ENTRY. 

‘‘(a) IN GENERAL.—In addition to any other penalty provided by 

law, any person who refuses to admit entry or refuses to permit any 

other action by the Secretary authorized by section 4083(d)(1) shall 

pay a penalty of $1,000 for such refusal. 

‘‘(b) JOINT AND SEVERAL LIABILITY.— ‘‘(1) IN GENERAL.—If a penalty is imposed under this section on any business entity, each officer, employee, or agent of 

such entity or other contracting party who willfully participated 

204

in any act giving rise to such penalty shall be jointly and severally liable with such entity for such penalty. 

‘‘(2) AFFILIATED GROUPS.—If a business entity described in 

paragraph (1) is part of an affiliated group (as defined in section 1504(a)), the parent corporation of such entity shall be 

jointly and severally liable with such entity for the penalty imposed under this section. 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown 

that such failure is due to reasonable cause.’’. 

(b) CONFORMING AMENDMENTS.— (1) Section 4083(d)(3), as amended by this Act, is amended—

(A) by striking ‘‘ENTRY.—The penalty’’ and inserting: 

‘‘ENTRY.—

‘‘(A) FORFEITURE.—The penalty’’, and 

(B) by adding at the end the following new subparagraph:

‘‘(B) ASSESSABLE PENALTY.—For additional assessable 

penalty for the refusal to admit entry or other refusal to 

permit an action by the Secretary authorized by paragraph 

(1), see section 6717.’’. 

(2) The table of sections for part I of subchapter B of chapter 68, as amended by this Act, is amended by inserting after 

the item relating to section 6716 the following new item:

‘‘Sec. 6717. Refusal of entry.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on January 1, 2005.

SEC. 860. REGISTRATION OF PIPELINE OR VESSEL OPERATORS REQUIRED FOR EXEMPTION OF BULK TRANSFERS TO REGISTERED TERMINALS OR REFINERIES. 

(a) IN GENERAL.—Section 4081(a)(1)(B) (relating to exemption 

for bulk transfers to registered terminals or refineries) is amended—

(1) by inserting ‘‘by pipeline or vessel’’ after ‘‘transferred in 

bulk’’, and 

(2) by inserting ‘‘, the operator of such pipeline or vessel,’’ 

after ‘‘the taxable fuel’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on March 1, 2005. 

(c) PUBLICATION OF REGISTERED PERSONS.—Beginning on January 1, 2005, the Secretary of the Treasury (or the Secretary’s delegate) shall periodically publish under section 6103(k)(7) of the Internal Revenue Code of 1986 a current list of persons registered under 

section 4101 of such Code who are required to register under such 

section. 

SEC. 861. DISPLAY OF REGISTRATION. 

(a) IN GENERAL.—Subsection (a) of section 4101 (relating to registration) is amended—

(1) by striking ‘‘Every’’ and inserting the following: 

‘‘(1) IN GENERAL.—Every’’, and 

(2) by adding at the end the following new paragraph: 

‘‘(2) DISPLAY OF REGISTRATION.—Every operator of a vessel 

required by the Secretary to register under this section shall 

display proof of registration through an identification device 

205

prescribed by the Secretary on each vessel used by such operator 

to transport any taxable fuel.’’. 

(b) CIVIL PENALTY FOR FAILURE TO DISPLAY REGISTRATION.—

(1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable penalties), as amended by this Act, is 

amended by inserting after section 6717 the following new section: 

‘‘SEC. 6718. FAILURE TO DISPLAY TAX REGISTRATION ON VESSELS. 

‘‘(a) FAILURE TO DISPLAY REGISTRATION.—Every operator of a 

vessel who fails to display proof of registration pursuant to section 

4101(a)(2) shall pay a penalty of $500 for each such failure. With 

respect to any vessel, only one penalty shall be imposed by this section during any calendar month. 

‘‘(b) MULTIPLE VIOLATIONS.—In determining the penalty under 

subsection (a) on any person, subsection (a) shall be applied by increasing the amount in subsection (a) by the product of such amount 

and the aggregate number of penalties (if any) imposed with respect 

to prior months by this section on such person (or a related person 

or any predecessor of such person or related person). 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown 

that such failure is due to reasonable cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I 

of subchapter B of chapter 68, as amended by this Act, is 

amended by inserting after the item relating to section 6717 the 

following new item:

‘‘Sec. 6718. Failure to display tax registration on vessels.’’.

(c) EFFECTIVE DATES.—

(1) SUBSECTION (a).—The amendments made by subsection 

(a) shall take effect on January 1, 2005. 

(2) SUBSECTION (b).—The amendments made by subsection 

(b) shall apply to penalties imposed after December 31, 2004. 

SEC. 862. REGISTRATION OF PERSONS WITHIN FOREIGN TRADE 

ZONES, ETC. 

(a) IN GENERAL.—Section 4101(a), as amended by this Act, is 

amended by redesignating paragraph (2) as paragraph (3), and by 

inserting after paragraph (1) the following new paragraph: 

‘‘(2) REGISTRATION OF PERSONS WITHIN FOREIGN TRADE

ZONES, ETC.—The Secretary shall require registration by any 

person which—

‘‘(A) operates a terminal or refinery within a foreign 

trade zone or within a customs bonded storage facility, or 

‘‘(B) holds an inventory position with respect to a taxable fuel in such a terminal.’’. 

(b) TECHNICAL AMENDMENT.—Section 6718(a), as added by this 

Act, is amended by striking ‘‘section 4101(a)(2)’’ and inserting ‘‘section 4101(a)(3)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on January 1, 2005. 

SEC. 863. PENALTIES FOR FAILURE TO REGISTER AND FAILURE TO REPORT. 

(a) INCREASED PENALTY.—Subsection (a) of section 7272 (relating to penalty for failure to register) is amended by inserting 

206

‘‘($10,000 in the case of a failure to register under section 4101)’’ 

after ‘‘$50’’. 

(b) INCREASED CRIMINAL PENALTY.—Section 7232 (relating to 

failure to register under section 4101, false representations of registration status, etc.) is amended by striking ‘‘$5,000’’ and inserting 

‘‘$10,000’’. 

(c) ASSESSABLE PENALTY FOR FAILURE TO REGISTER.—

(1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable penalties), as amended by this Act, is 

amended by inserting after section 6718 at the end the following new section: 

‘‘SEC. 6719. FAILURE TO REGISTER. 

‘‘(a) FAILURE TO REGISTER.—Every person who is required to 

register under section 4101 and fails to do so shall pay a penalty 

in addition to the tax (if any). 

‘‘(b) AMOUNT OF PENALTY.—The amount of the penalty under 

subsection (a) shall be—

‘‘(1) $10,000 for each initial failure to register, and 

‘‘(2) $1,000 for each day thereafter such person fails to register. 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown 

that such failure is due to reasonable cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part I 

of subchapter B of chapter 68, as amended by this Act, is 

amended by inserting after the item relating to section 6718 the 

following new item:

‘‘Sec. 6719. Failure to register.’’.

(d) ASSESSABLE PENALTY FOR FAILURE TO REPORT.—

(1) IN GENERAL.—Part II of subchapter B of chapter 68 (relating to assessable penalties) is amended by adding at the end 

the following new section: 

‘‘SEC. 6725. FAILURE TO REPORT INFORMATION UNDER SECTION 4101. 

‘‘(a) IN GENERAL.—In the case of each failure described in subsection (b) by any person with respect to a vessel or facility, such 

person shall pay a penalty of $10,000 in addition to the tax (if any). 

‘‘(b) FAILURES SUBJECT TO PENALTY.—For purposes of subsection (a), the failures described in this subsection are—

‘‘(1) any failure to make a report under section 4101(d) on 

or before the date prescribed therefor, and 

‘‘(2) any failure to include all of the information required 

to be shown on such report or the inclusion of incorrect information. 

‘‘(c) REASONABLE CAUSE EXCEPTION.—No penalty shall be imposed under this section with respect to any failure if it is shown 

that such failure is due to reasonable cause.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for part II 

of subchapter B of chapter 68 is amended by adding at the end 

the following new item:

‘‘Sec. 6725. Failure to report information under section 4101.’’.

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to penalties imposed after December 31, 2004.

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SEC. 864. ELECTRONIC FILING OF REQUIRED INFORMATION REPORTS. 

(a) IN GENERAL.—Section 4101(d) is amended by adding at the 

end the following new flush sentence:

‘‘Any person who is required to report under this subsection and 

who has 25 or more reportable transactions in a month shall file 

such report in electronic format.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply on January 1, 2006. 

SEC. 865. TAXABLE FUEL REFUNDS FOR CERTAIN ULTIMATE VENDORS. 

(a) IN GENERAL.—Paragraph (4) of section 6416(a) (relating to 

abatements, credits, and refunds) is amended to read as follows: 

‘‘(4) REGISTERED ULTIMATE VENDOR TO ADMINISTER CRED- ITS AND REFUNDS OF GASOLINE TAX.— ‘‘(A) IN GENERAL.—For purposes of this subsection, if 

an ultimate vendor purchases any gasoline on which tax 

imposed by section 4081 has been paid and sells such gasoline to an ultimate purchaser described in subparagraph 

(C) or (D) of subsection (b)(2) (and such gasoline is for a 

use described in such subparagraph), such ultimate vendor 

shall be treated as the person (and the only person) who 

paid such tax, but only if such ultimate vendor is registered 

under section 4101. 

‘‘(B) TIMING OF CLAIMS.—The procedure and timing of 

any claim under subparagraph (A) shall be the same as for 

claims under section 6427(i)(4), except that the rules of section 6427(i)(3)(B) regarding electronic claims shall not 

apply unless the ultimate vendor has certified to the Secretary for the most recent quarter of the taxable year that 

all ultimate purchasers of the vendor are certified and entitled to a refund under subparagraph (C) or (D) of subsection (b)(2).’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall take effect on January 1, 2005. 

SEC. 866. TWO-PARTY EXCHANGES. 

(a) IN GENERAL.—Subpart C of part III of subchapter A of 

chapter 32, as amended by this Act, is amended by inserting after 

section 4104 the following new section: 

‘‘SEC. 4105. TWO-PARTY EXCHANGES. 

‘‘(a) IN GENERAL.—In a two-party exchange, the delivering person shall not be liable for the tax imposed under of section 

4081(a)(1)(A)(ii). 

‘‘(b) TWO-PARTY EXCHANGE.—The term ‘two-party exchange’ 

means a transaction, other than a sale, in which taxable fuel is 

transferred from a delivering person registered under section 4101 

as a taxable fuel registrant to a receiving person who is so registered 

where all of the following occur: 

‘‘(1) The transaction includes a transfer from the delivering 

person, who holds the inventory position for taxable fuel in the 

terminal as reflected in the records of the terminal operator. 

‘‘(2) The exchange transaction occurs before or contemporaneous with completion of removal across the rack from the terminal by the receiving person. 

‘‘(3) The terminal operator in its books and records treats 

the receiving person as the person that removes the product 

208

across the terminal rack for purposes of reporting the transaction to the Secretary. 

‘‘(4) The transaction is the subject of a written contract.’’. 

(b) CONFORMING AMENDMENT.—The table of sections for subpart C of part III of subchapter A of chapter 32, as amended by of 

this Act, is amended by adding after the last item the following new 

item:

‘‘Sec. 4105. Two-party exchanges.’’.

(c) EFFECTIVE DATE.—The amendment made by this section 

shall take effect on the date of the enactment of this Act. 

SEC. 867. MODIFICATIONS OF TAX ON USE OF CERTAIN VEHICLES. 

(a) PRORATION OF TAX WHERE VEHICLE SOLD.—

(1) IN GENERAL.—Subparagraph (A) of section 4481(c)(2) 

(relating to where vehicle destroyed or stolen) is amended by 

striking ‘‘destroyed or stolen’’ both places it appears and inserting ‘‘sold, destroyed, or stolen’’. 

(2) CONFORMING AMENDMENT.—The heading for section 

4481(c)(2) is amended by striking ‘‘DESTROYED OR STOLEN’’ and 

inserting ‘‘SOLD, DESTROYED, OR STOLEN’’. 

(b) REPEAL OF INSTALLMENT PAYMENT.—

(1) Section 6156 (relating to installment payment of tax on 

use of highway motor vehicles) is repealed. 

(2) The table of sections for subchapter A of chapter 62 is 

amended by striking the item relating to section 6156. 

(c) ELECTRONIC FILING.—Section 4481 is amended by redesignating subsection (e) as subsection (f) and by inserting after subsection (d) the following new subsection: 

‘‘(e) ELECTRONIC FILING.—Any taxpayer who files a return 

under this section with respect to 25 or more vehicles for any taxable period shall file such return electronically.’’. 

(d) REPEAL OF REDUCTION IN TAX FOR CERTAIN TRUCKS.—Section 4483 is amended by striking subsection (f). 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable periods beginning after the date of the enactment of this Act. 

SEC. 868. DEDICATION OF REVENUES FROM CERTAIN PENALTIES TO 

THE HIGHWAY TRUST FUND. 

(a) IN GENERAL.—Subsection (b) of section 9503 (relating to 

transfer to Highway Trust Fund of amounts equivalent to certain 

taxes) is amended by redesignating paragraph (5) as paragraph (6) 

and inserting after paragraph (4) the following new paragraph: 

‘‘(5) CERTAIN PENALTIES.—There are hereby appropriated to 

the Highway Trust Fund amounts equivalent to the penalties 

paid under sections 6715, 6715A, 6717, 6718, 6719, 6725, 7232, 

and 7272 (but only with regard to penalties under such section 

related to failure to register under section 4101).’’. 

(b) CONFORMING AMENDMENTS.—

(1) The heading of subsection (b) of section 9503 is amended by inserting ‘‘AND PENALTIES’’ after ‘‘TAXES’’. 

(2) The heading of paragraph (1) of section 9503(b) is 

amended by striking ‘‘IN GENERAL’’ and inserting ‘‘CERTAIN

TAXES’’. 

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(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to penalties assessed on or after the date of the enactment of this Act. 

SEC. 869. SIMPLIFICATION OF TAX ON TIRES. 

(a) IN GENERAL.—Subsection (a) of section 4071 is amended to 

read as follows: 

‘‘(a) IMPOSITION AND RATE OF TAX.—There is hereby imposed on 

taxable tires sold by the manufacturer, producer, or importer thereof 

a tax at the rate of 9.45 cents (4.725 cents in the case of a biasply 

tire or super single tire) for each 10 pounds so much of the maximum rated load capacity thereof as exceeds 3,500 pounds.’’

(b) BIASPLY AND SUPER SINGLE TIRES.—Section 4072 is amended by adding at the end the following new subsections: 

‘‘(c) BIASPLY.—For purposes of this part, the term ‘biasply tire’’ 

means a pneumatic tire on which the ply cords that extend to the 

beads are laid at alternate angles substantially less than 90 degrees 

to the centerline of the tread. 

‘‘(d) SUPER SINGLE TIRE.—For purposes of this part, the term 

‘super single tire’ means a single tire greater than 13 inches in cross 

section width designed to replace 2 tires in a dual fitment.’’. 

(b) TAXABLE TIRE.—Section 4072, as amended by subsection (a), 

is amended by redesignating subsections (a), (b), (c), and (d) as subsections (b), (c), (d), and (e) respectively, and by inserting before subsection (b) (as so redesignated) the following new subsection: 

‘‘(a) TAXABLE TIRE.—For purposes of this chapter, the term ‘taxable tire’ means any tire of the type used on highway vehicles if 

wholly or in part made of rubber and if marked pursuant to Federal regulations for highway use.’’

(c) EXEMPTION FOR TIRES SOLD TO DEPARTMENT OF DEFENSE.—Section 4073 is amended to read as follows: 

‘‘SEC. 4073. EXEMPTIONS. 

‘‘The tax imposed by section 4071 shall not apply to tires sold 

for the exclusive use of the Department of Defense or the Coast 

Guard.’’. 

(d) CONFORMING AMENDMENTS.—

(1) Section 4071 is amended by striking subsection (c) and 

by moving subsection (e) after subsection (b) and redesignating 

subsection (e) as subsection (c). 

(2) The item relating to section 4073 in the table of sections 

for part II of subchapter A of chapter 32 is amended to read 

as follows:

‘‘Sec. 4073. Exemptions.’’.

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to sales in calendar years beginning more than 30 days 

after the date of the enactment of this Act. 

SEC. 870. TRANSMIX AND DIESEL FUEL BLEND STOCKS TREATED AS 

TAXABLE FUEL. 

(a) IN GENERAL.—Paragraph (3) of section 4083(a) is amended 

to read as follows: 

‘‘(3) DIESEL FUEL.—

‘‘(A) IN GENERAL.—The term ‘diesel fuel’ means—

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‘‘(i) any liquid (other than gasoline) which is suitable for use as a fuel in a diesel-powered highway vehicle, or a diesel-powered train, 

‘‘(ii) transmix, and 

‘‘(iii) diesel fuel blend stocks identified by the Secretary. 

‘‘(B) TRANSMIX.—For purposes of subparagraph (A), the 

term ‘transmix’ means a byproduct of refined products pipeline operations created by the mixing of different specification products during pipeline transportation.’’. 

(b) CONFORMING AMENDMENT.—Subsection (h) of section 6427 

is amended to read as follows: 

‘‘(h) BLEND STOCKS NOT USED FOR PRODUCING TAXABLE

FUEL.—

‘‘(1) GASOLINE BLEND STOCKS OR ADDITIVES NOT USED FOR

PRODUCING GASOLINE.—Except as provided in subsection (k), if 

any gasoline blend stock or additive (within the meaning of section 4083(a)(2)) is not used by any person to produce gasoline 

and such person establishes that the ultimate use of such gasoline blend stock or additive is not to produce gasoline, the Secretary shall pay (without interest) to such person an amount 

equal to the aggregate amount of the tax imposed on such person with respect to such gasoline blend stock or additive. 

‘‘(2) DIESEL FUEL BLEND STOCKS OR ADDITIVES NOT USED

FOR PRODUCING DIESEL.—Except as provided in subsection (k), 

if any diesel fuel blend stock is not used by any person to 

produce diesel fuel and such person establishes that the ultimate use of such diesel fuel blend stock is not to produce diesel 

fuel, the Secretary shall pay (without interest) to such person an 

amount equal to the aggregate amount of the tax imposed on 

such person with respect to such diesel fuel blend stock.’’. 

(c) EFFECTIVE DATE.—The amendment made by this section 

shall apply to fuel removed, sold, or used after December 31, 2004. 

SEC. 871. STUDY REGARDING FUEL TAX COMPLIANCE. 

(a) IN GENERAL.—Not later than January 31, 2005, the Secretary of the Treasury shall submit to the Committee on Finance of 

the Senate and the Committee on Ways and Means of the House of 

Representatives a report regarding compliance with the tax imposed 

under subchapter B of chapter 31 and part III of subchapter A of 

chapter 32 of the Internal Revenue Code of 1986. Such report shall 

include the information, analysis, and recommendations specified in 

subsections (b), (c), and (d). 

(b) TAXABLE FUEL BLENDSTOCKS.—The Secretary shall identify 

chemical products to be added to the list of blendstocks from lab 

analysis of fuel samples collected by the Internal Revenue Service 

which have been blended with taxable fuel but are not treated as 

blendstocks. The Secretary shall include statistics regarding the frequency in which a chemical product has been collected, and whether 

the sample contained an above normal concentration of the chemical 

product. 

(c) WASTE PRODUCTS ADDED TO TAXABLE FUELS.—The report 

shall include a discussion of Internal Revenue Service findings regarding the addition of waste products to taxable fuel and any recommendations to address the taxation of such products. 

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(d) ERRONEOUS CLAIMS OF FUEL TAX EXEMPTIONS.—The report 

shall include a discussion of Internal Revenue Service findings regarding sales of taxable fuel to entities claiming exempt status as 

a State or local government and the frequency of erroneous certifications of tax exempt status. The Secretary, in consultation with 

representatives of State and local governments, shall provide recommendations to address such erroneous claims, including recommendations on the feasibility of a State maintained list of exempt 

governmental entities within the State. 

Subtitle D—Other Revenue Provisions 

SEC. 881. QUALIFIED TAX COLLECTION CONTRACTS. 

(a) CONTRACT REQUIREMENTS.—

(1) IN GENERAL.—Subchapter A of chapter 64 (relating to 

collection) is amended by adding at the end the following new 

section: 

‘‘SEC. 6306. QUALIFIED TAX COLLECTION CONTRACTS. 

‘‘(a) IN GENERAL.—Nothing in any provision of law shall be 

construed to prevent the Secretary from entering into a qualified tax 

collection contract. 

‘‘(b) QUALIFIED TAX COLLECTION CONTRACT.—For purposes of 

this section, the term ‘qualified tax collection contract’ means any 

contract which—

‘‘(1) is for the services of any person (other than an officer 

or employee of the Treasury Department)—

‘‘(A) to locate and contact any taxpayer specified by the 

Secretary, 

‘‘(B) to request full payment from such taxpayer of an 

amount of Federal tax specified by the Secretary and, if 

such request cannot be met by the taxpayer, to offer the taxpayer an installment agreement providing for full payment 

of such amount during a period not to exceed 5 years, and 

‘‘(C) to obtain financial information specified by the 

Secretary with respect to such taxpayer, 

‘‘(2) prohibits each person providing such services under 

such contract from committing any act or omission which employees of the Internal Revenue Service are prohibited from 

committing in the performance of similar services, 

‘‘(3) prohibits subcontractors from—

‘‘(A) having contacts with taxpayers, 

‘‘(B) providing quality assurance services, and 

‘‘(C) composing debt collection notices, and 

‘‘(4) permits subcontractors to perform other services only 

with the approval of the Secretary. 

‘‘(c) FEES.—The Secretary may retain and use—

‘‘(1) an amount not in excess of 25 percent of the amount 

collected under any qualified tax collection contract for the costs 

of services performed under such contract, and 

‘‘(2) an amount not in excess of 25 percent of such amount 

collected for collection enforcement activities of the Internal 

Revenue Service. 

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The Secretary shall keep adequate records regarding amounts so retained and used. The amount credited as paid by any taxpayer 

shall be determined without regard to this subsection. 

‘‘(d) NO FEDERAL LIABILITY.—The United States shall not be 

liable for any act or omission of any person performing services 

under a qualified tax collection contract. 

‘‘(e) APPLICATION OF FAIR DEBT COLLECTION PRACTICES ACT.—

The provisions of the Fair Debt Collection Practices Act (15 U.S.C. 

1692 et seq.) shall apply to any qualified tax collection contract, except to the extent superseded by section 6304, section 7602(c), or by 

any other provision of this title. 

‘‘(f) CROSS REFERENCES.—

‘‘(1) For damages for certain unauthorized collection actions by 

persons performing services under a qualified tax collection contract, see section 7433A. 

‘‘(2) For application of Taxpayer Assistance Orders to persons performing services under a qualified tax collection contract, see section 7811(g).’’.

(2) CONFORMING AMENDMENTS.—

(A) Section 7809(a) is amended by inserting ‘‘6306,’’ before ‘‘7651’’. 

(B) The table of sections for subchapter A of chapter 64 

is amended by adding at the end the following new item:

‘‘Sec. 6306. Qualified tax collection contracts.’’.

(b) CIVIL DAMAGES FOR CERTAIN UNAUTHORIZED COLLECTION

ACTIONS BY PERSONS PERFORMING SERVICES UNDER QUALIFIED

TAX COLLECTION CONTRACTS.—

(1) IN GENERAL.—Subchapter B of chapter 76 (relating to 

proceedings by taxpayers and third parties) is amended by inserting after section 7433 the following new section: 

‘‘SEC. 7433A. CIVIL DAMAGES FOR CERTAIN UNAUTHORIZED COLLECTION ACTIONS BY PERSONS PERFORMING SERVICES 

UNDER QUALIFIED TAX COLLECTION CONTRACTS. 

‘‘(a) IN GENERAL.—Subject to the modifications provided by 

subsection (b), section 7433 shall apply to the acts and omissions of 

any person performing services under a qualified tax collection contract (as defined in section 6306(b)) to the same extent and in the 

same manner as if such person were an employee of the Internal 

Revenue Service. 

‘‘(b) MODIFICATIONS.—For purposes of subsection (a)—

‘‘(1) Any civil action brought under section 7433 by reason 

of this section shall be brought against the person who entered 

into the qualified tax collection contract with the Secretary and 

shall not be brought against the United States. 

‘‘(2) Such person and not the United States shall be liable 

for any damages and costs determined in such civil action. 

‘‘(3) Such civil action shall not be an exclusive remedy with 

respect to such person. 

‘‘(4) Subsections (c), (d)(1), and (e) of section 7433 shall not 

apply.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for subchapter B of chapter 76 is amended by inserting after the item 

relating to section 7433 the following new item:

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‘‘Sec. 7433A. Civil damages for certain unauthorized collection actions by persons performing services under qualified 

tax collection contracts.’’.

(c) APPLICATION OF TAXPAYER ASSISTANCE ORDERS TO PERSONS

PERFORMING SERVICES UNDER A QUALIFIED TAX COLLECTION CONTRACT.—Section 7811 (relating to taxpayer assistance orders) is 

amended by adding at the end the following new subsection: 

‘‘(g) APPLICATION TO PERSONS PERFORMING SERVICES UNDER A

QUALIFIED TAX COLLECTION CONTRACT.—Any order issued or action 

taken by the National Taxpayer Advocate pursuant to this section 

shall apply to persons performing services under a qualified tax collection contract (as defined in section 6306(b)) to the same extent 

and in the same manner as such order or action applies to the Secretary.’’. 

(d) INELIGIBILITY OF INDIVIDUALS WHO COMMIT MISCONDUCT

TO PERFORM UNDER CONTRACT.—Section 1203 of the Internal Revenue Service Restructuring Act of 1998 (relating to termination of 

employment for misconduct) is amended by adding at the end the 

following new subsection: 

‘‘(e) INDIVIDUALS PERFORMING SERVICES UNDER A QUALIFIED

TAX COLLECTION CONTRACT.—An individual shall cease to be permitted to perform any services under any qualified tax collection 

contract (as defined in section 6306(b) of the Internal Revenue Code 

of 1986) if there is a final determination by the Secretary of the 

Treasury under such contract that such individual committed any 

act or omission described under subsection (b) in connection with 

the performance of such services.’’. 

(e) BIENNIAL REPORT.—The Secretary of the Treasury shall biennially submit (beginning in 2005) to the Committee on Finance of 

the Senate and the Committee on Ways and Means of the House of 

Representatives a report with respect to qualified tax collection contracts under section 6306 of the Internal Revenue Code of 1986 (as 

added by this section) which includes—

(1) a complete cost benefit analysis, 

(2) the impact of such contracts on collection enforcement 

staff levels in the Internal Revenue Service, 

(3) the impact of such contracts on the total number and 

amount of unpaid assessments, and on the number and amount 

of assessments collected by Internal Revenue Service personnel 

after initial contact by a contractor, 

(4) the amounts collected and the collection costs incurred 

(directly and indirectly) by the Internal Revenue Service, 

(5) an evaluation of contractor performance, 

(6) a disclosure safeguard report in a form similar to that 

required under section 6103(p)(5) of such Code, and 

(7) a measurement plan which includes a comparison of the 

best practices used by the private collectors with the Internal 

Revenue Service’s own collection techniques) and mechanisms to 

identify and capture information on successful collection techniques used by the contractors which could be adopted by the 

Internal Revenue Service. 

(f) EFFECTIVE DATE.—The amendments made to this section 

shall take effect on the date of the enactment of this Act. 

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SEC. 882. TREATMENT OF CHARITABLE CONTRIBUTIONS OF PATENTS 

AND SIMILAR PROPERTY. 

(a) IN GENERAL.—Subparagraph (B) of section 170(e)(1) is 

amended by striking ‘‘or’’ at the end of clause (i), by adding ‘‘or’’ at 

the end of clause (ii), and by inserting after clause (ii) the following 

new clause: 

‘‘(iii) of any patent, copyright (other than a copyright described in section 1221(a)(3) or 1231(b)(1)(C)), 

trademark, trade name, trade secret, know-how, software (other than software described in section 

197(e)(3)(A)(i)), or similar property, or applications or 

registrations of such property,’’. 

(b) CERTAIN DONEE INCOME FROM INTELLECTUAL PROPERTY

TREATED AS AN ADDITIONAL CHARITABLE CONTRIBUTION.—Section 

170 is amended by redesignating subsection (m) as subsection (n) 

and by inserting after subsection (l) the following new subsection: 

‘‘(m) CERTAIN DONEE INCOME FROM INTELLECTUAL PROPERTY

TREATED AS AN ADDITIONAL CHARITABLE CONTRIBUTION.—

‘‘(1) TREATMENT AS ADDITIONAL CONTRIBUTION.—In the 

case of a taxpayer who makes a qualified intellectual property 

contribution, the deduction allowed under subsection (a) for 

each taxable year of the taxpayer ending on or after the date of 

such contribution shall be increased (subject to the limitations 

under subsection (b)) by the applicable percentage of qualified 

donee income with respect to such contribution which is properly allocable to such year under this subsection. 

‘‘(2) REDUCTION IN ADDITIONAL DEDUCTIONS TO EXTENT OF

INITIAL DEDUCTION.—With respect to any qualified intellectual 

property contribution, the deduction allowed under subsection 

(a) shall be increased under paragraph (1) only to the extent 

that the aggregate amount of such increases with respect to 

such contribution exceed the amount allowed as a deduction 

under subsection (a) with respect to such contribution determined without regard to this subsection. 

‘‘(3) QUALIFIED DONEE INCOME.—For purposes of this subsection, the term ‘qualified donee income’ means any net income 

received by or accrued to the donee which is properly allocable 

to the qualified intellectual property. 

‘‘(4) ALLOCATION OF QUALIFIED DONEE INCOME TO TAXABLE

YEARS OF DONOR.—For purposes of this subsection, qualified 

donee income shall be treated as properly allocable to a taxable 

year of the donor if such income is received by or accrued to the 

donee for the taxable year of the donee which ends within or 

with such taxable year of the donor.

‘‘(5) 10-YEAR LIMITATION.—Income shall not be treated as 

properly allocable to qualified intellectual property for purposes 

of this subsection if such income is received by or accrued to the 

donee after the 10-year period beginning on the date of the contribution of such property. 

‘‘(6) BENEFIT LIMITED TO LIFE OF INTELLECTUAL PROPERTY.—Income shall not be treated as properly allocable to 

qualified intellectual property for purposes of this subsection if 

such income is received by or accrued to the donee after the expiration of the legal life of such property. 

215

‘‘(7) APPLICABLE PERCENTAGE.—For purposes of this subsection, the term ‘applicable percentage’ means the percentage 

determined under the following table which corresponds to a 

taxable year of the donor ending on or after the date of the 

qualified intellectual property contribution:

‘‘Taxable Year of Donor Ending on or After Date of Contribution: Applicable 

Percentage: 

1st ..................................................................................................................... 100

2nd ................................................................................................................... 100

3rd .................................................................................................................... 90

4th .................................................................................................................... 80

5th .................................................................................................................... 70

6th .................................................................................................................... 60

7th .................................................................................................................... 50

8th .................................................................................................................... 40

9th .................................................................................................................... 30

10th .................................................................................................................. 20

11th .................................................................................................................. 10

12th .................................................................................................................. 10.

‘‘(8) QUALIFIED INTELLECTUAL PROPERTY CONTRIBUTION.—

For purposes of this subsection, the term ‘qualified intellectual 

property contribution’ means any charitable contribution of 

qualified intellectual property—

‘‘(A) the amount of which taken into account under this 

section is reduced by reason of subsection (e)(1), and 

‘‘(B) with respect to which the donor informs the donee 

at the time of such contribution that the donor intends to 

treat such contribution as a qualified intellectual property 

contribution for purposes of this subsection and section 

6050L. 

‘‘(9) QUALIFIED INTELLECTUAL PROPERTY.—For purposes of 

this subsection, the term ‘qualified intellectual property’ means 

property described in subsection (e)(1)(B)(iii) (other than property contributed to or for the use of an organization described 

in subsection (e)(1)(B)(ii)). 

‘‘(10) OTHER SPECIAL RULES.—

‘‘(A) APPLICATION OF LIMITATIONS ON CHARITABLE CONTRIBUTIONS.—Any increase under this subsection of the deduction provided under subsection (a) shall be treated for 

purposes of subsection (b) as a deduction which is attributable to a charitable contribution to the donee to which 

such increase relates.

‘‘(B) NET INCOME DETERMINED BY DONEE.—The net income taken into account under paragraph (3) shall not exceed the amount of such income reported under section 

6050L(b)(1). 

‘‘(C) DEDUCTION LIMITED TO 12 TAXABLE YEARS.—Except as may be provided under subparagraph (D)(i), this 

subsection shall not apply with respect to any qualified intellectual property contribution for any taxable year of the 

donor after the 12th taxable year of the donor which ends 

on or after the date of such contribution. 

‘‘(D) REGULATIONS.—The Secretary may issue regulations or other guidance to carry out the purposes of this 

subsection, including regulations or guidance—

216

‘‘(i) modifying the application of this subsection in 

the case of a donor or donee with a short taxable year, 

and 

‘‘(ii) providing for the determination of an amount 

to be treated as net income of the donee which is properly allocable to qualified intellectual property in the 

case of a donee who uses such property to further a 

purpose or function constituting the basis of the donee’s 

exemption under section 501 (or, in the case of a governmental unit, any purpose described in section 

170(c)) and does not possess a right to receive any payment from a third party with respect to such property.’’. 

(c) REPORTING REQUIREMENTS.— (1) IN GENERAL.—Section 6050L (relating to returns relating to certain dispositions of donated property) is amended to 

read as follows: 

‘‘SEC. 6050L. RETURNS RELATING TO CERTAIN DONATED PROPERTY. 

‘‘(a) DISPOSITIONS OF DONATED PROPERTY.— ‘‘(1) IN GENERAL.—If the donee of any charitable deduction 

property sells, exchanges, or otherwise disposes of such property 

within 2 years after its receipt, the donee shall make a return 

(in accordance with forms and regulations prescribed by the 

Secretary) showing—

‘‘(A) the name, address, and TIN of the donor, 

‘‘(B) a description of the property, 

‘‘(C) the date of the contribution, 

‘‘(D) the amount received on the disposition, and 

‘‘(E) the date of such disposition. 

‘‘(2) DEFINITIONS.—For purposes of this subsection—

‘‘(A) CHARITABLE DEDUCTION PROPERTY.—The term 

‘charitable deduction property’ means any property (other 

than publicly traded securities) contributed in a contribution for which a deduction was claimed under section 170 

if the claimed value of such property (plus the claimed 

value of all similar items of property donated by the donor 

to 1 or more donees) exceeds $5,000. 

‘‘(B) PUBLICLY TRADED SECURITIES.—The term ‘publicly 

traded securities’ means securities for which (as of the date 

of the contribution) market quotations are readily available 

on an established securities market. 

‘‘(b) QUALIFIED INTELLECTUAL PROPERTY CONTRIBUTIONS.—

‘‘(1) IN GENERAL.—Each donee with respect to a qualified 

intellectual property contribution shall make a return (at such 

time and in such form and manner as the Secretary may by 

regulations prescribe) with respect to each specified taxable year 

of the donee showing—

‘‘(A) the name, address, and TIN of the donor, 

‘‘(B) a description of the qualified intellectual property 

contributed, 

‘‘(C) the date of the contribution, and 

‘‘(D) the amount of net income of the donee for the taxable year which is properly allocable to the qualified intellectual property (determined without regard to paragraph 

(10)(B) of section 170(m) and with the modifications described in paragraphs (5) and (6) of such section). 

217

‘‘(2) DEFINITIONS.—For purposes of this subsection—

‘‘(A) IN GENERAL.—Terms used in this subsection which 

are also used in section 170(m) have the respective meanings given such terms in such section. 

‘‘(B) SPECIFIED TAXABLE YEAR.—The term ‘specified taxable year’ means, with respect to any qualified intellectual 

property contribution, any taxable year of the donee any 

portion of which is part of the 10-year period beginning on 

the date of such contribution. 

‘‘(c) STATEMENT TO BE FURNISHED TO DONORS.—Every person 

making a return under subsection (a) or (b) shall furnish a copy of 

such return to the donor at such time and in such manner as the 

Secretary may by regulations prescribe.’’. 

(2) CLERICAL AMENDMENT.—The table of sections for subpart A of part II of subchapter A of chapter 61 is amended by 

striking the item relating to section 6050L and inserting the following new item:

‘‘Sec. 6050L. Returns relating to certain donated property.’’.

(d) COORDINATION WITH APPRAISAL REQUIREMENTS.—Subclause (I) of section 170(f)(11)(A)(ii), as added by this Act, is amended by inserting ‘‘subsection (e)(1)(B)(iii) or’’ before ‘‘section 

1221(a)(1)’’. 

(e) ANTI-ABUSE RULES.—The Secretary of the Treasury may 

prescribe such regulations or other guidance as may be necessary or 

appropriate to prevent the avoidance of the purposes of section 

170(e)(1)(B)(iii) of the Internal Revenue Code of 1986 (as added by 

subsection (a)), including preventing—

(1) the circumvention of the reduction of the charitable deduction by embedding or bundling the patent or similar property as part of a charitable contribution of property that includes the patent or similar property, 

(2) the manipulation of the basis of the property to increase 

the amount of the charitable deduction through the use of related persons, pass-thru entities, or other intermediaries, or 

through the use of any provision of law or regulation (including 

the consolidated return regulations), and 

(3) a donor from changing the form of the patent or similar 

property to property of a form for which different deduction 

rules would apply. 

(f) EFFECTIVE DATE.—The amendments made by this section 

shall apply to contributions made after June 3, 2004. 

SEC. 883. INCREASED REPORTING FOR NONCASH CHARITABLE CONTRIBUTIONS. 

(a) IN GENERAL.—Subsection (f) of section 170 (relating to disallowance of deduction in certain cases and special rules) is amended by adding after paragraph (10) the following new paragraph: 

‘‘(11) QUALIFIED APPRAISAL AND OTHER DOCUMENTATION

FOR CERTAIN CONTRIBUTIONS.— ‘‘(A) IN GENERAL.—

‘‘(i) DENIAL OF DEDUCTION.—In the case of an individual, partnership, or corporation, no deduction shall 

be allowed under subsection (a) for any contribution of 

property for which a deduction of more than $500 is 

claimed unless such person meets the requirements of 

218

subparagraphs (B), (C), and (D), as the case may be, 

with respect to such contribution. 

‘‘(ii) EXCEPTIONS.— ‘‘(I) READILY VALUED PROPERTY.—Subparagraphs (C) and (D) shall not apply to cash, property described in section 1221(a)(1), publicly traded securities (as defined in section 6050L(a)(2)(B)), 

and any qualified vehicle described in paragraph 

(12)(A)(ii) for which an acknowledgement under 

paragraph (12)(B)(iii) is provided. 

‘‘(II) REASONABLE CAUSE.—Clause (i) shall not 

apply if it is shown that the failure to meet such 

requirements is due to reasonable cause and not to 

willful neglect. 

‘‘(B) PROPERTY DESCRIPTION FOR CONTRIBUTIONS OF

MORE THAN $500.—In the case of contributions of property 

for which a deduction of more than $500 is claimed, the requirements of this subparagraph are met if the individual, 

partnership or corporation includes with the return for the 

taxable year in which the contribution is made a description of such property and such other information as the 

Secretary may require. The requirements of this subparagraph shall not apply to a C corporation which is not a 

personal service corporation or a closely held C corporation. 

‘‘(C) QUALIFIED APPRAISAL FOR CONTRIBUTIONS OF

MORE THAN $5,000.—In the case of contributions of property for which a deduction of more than $5,000 is claimed, the 

requirements of this subparagraph are met if the individual, partnership, or corporation obtains a qualified appraisal of such property and attaches to the return for the 

taxable year in which such contribution is made such information regarding such property and such appraisal as the 

Secretary may require. 

‘‘(D) SUBSTANTIATION FOR CONTRIBUTIONS OF MORE

THAN $500,000.—In the case of contributions of property for which a deduction of more than $500,000 is claimed, the 

requirements of this subparagraph are met if the individual, partnership, or corporation attaches to the return 

for the taxable year a qualified appraisal of such property. 

‘‘(E) QUALIFIED APPRAISAL.—For purposes of this paragraph, the term ‘qualified appraisal’ means, with respect to 

any property, an appraisal of such property which is treated for purposes of this paragraph as a qualified appraisal 

under regulations or other guidance prescribed by the Secretary. 

‘‘(F) AGGREGATION OF SIMILAR ITEMS OF PROPERTY.—

For purposes of determining thresholds under this paragraph, property and all similar items of property donated 

to 1 or more donees shall be treated as 1 property. 

‘‘(G) SPECIAL RULE FOR PASS-THRU ENTITIES.—In the 

case of a partnership or S corporation, this paragraph shall 

be applied at the entity level, except that the deduction 

shall be denied at the partner or shareholder level. 

‘‘(H) REGULATIONS.—The Secretary may prescribe such 

regulations as may be necessary or appropriate to carry out 

219

the purposes of this paragraph, including regulations that 

may provide that some or all of the requirements of this 

paragraph do not apply in appropriate cases.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to contributions made after June 3, 2004. 

SEC. 884. DONATIONS OF MOTOR VEHICLES, BOATS, AND AIRPLANES. 

(a) IN GENERAL.—Subsection (f) of section 170 (relating to disallowance of deduction in certain cases and special rules), as 

amended by this Act, is amended by inserting after paragraph (11) 

the following new paragraph: 

‘‘(12) CONTRIBUTIONS OF USED MOTOR VEHICLES, BOATS, AND AIRPLANES.— ‘‘(A) IN GENERAL.—In the case of a contribution of a qualified vehicle the claimed value of which exceeds $500— 

‘‘(i) paragraph (8) shall not apply and no deduction shall be allowed under subsection (a) for such contribution unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization that 

meets the requirements of subparagraph (B) and includes the acknowledgement with the taxpayer’s return 

of tax which includes the deduction, and 

‘‘(ii) if the organization sells the vehicle without 

any significant intervening use or material improvement of such vehicle by the organization, the amount 

of the deduction allowed under subsection (a) shall not 

exceed the gross proceeds received from such sale. 

‘‘(B) CONTENT OF ACKNOWLEDGEMENT.—An acknowledgement meets the requirements of this subparagraph if it 

includes the following information: 

‘‘(i) The name and taxpayer identification number 

of the donor. 

‘‘(ii) The vehicle identification number or similar 

number. 

‘‘(iii) In the case of a qualified vehicle to which 

subparagraph (A)(ii) applies—

‘‘(I) a certification that the vehicle was sold in 

an arm’s length transaction between unrelated 

parties, 

‘‘(II) the gross proceeds from the sale, and 

‘‘(III) a statement that the deductible amount 

may not exceed the amount of such gross proceeds. 

‘‘(iv) In the case of a qualified vehicle to which subparagraph (A)(ii) does not apply—

‘‘(I) a certification of the intended use or material improvement of the vehicle and the intended 

duration of such use, and 

‘‘(II) a certification that the vehicle would not 

be transferred in exchange for money, other property, or services before completion of such use or 

improvement. 

‘‘(C) CONTEMPORANEOUS.—For purposes of subparagraph (A), an acknowledgement shall be considered to be 

contemporaneous if the donee organization provides it within 30 days of—

220

‘‘(i) the sale of the qualified vehicle, or

‘‘(ii) in the case of an acknowledgement including 

a certification described in subparagraph (B)(iv), the 

contribution of the qualified vehicle. 

‘‘(D) INFORMATION TO SECRETARY.—A donee organization required to provide an acknowledgement under this 

paragraph shall provide to the Secretary the information 

contained in the acknowledgement. Such information shall 

be provided at such time and in such manner as the Secretary may prescribe. 

‘‘(E) QUALIFIED VEHICLE.—For purposes of this paragraph, the term ‘qualified vehicle’ means any— 

‘‘(i) motor vehicle manufactured primarily for use 

on public streets, roads, and highways, 

‘‘(ii) boat, or 

‘‘(iii) airplane. 

Such term shall not include any property which is described in section 1221(a)(1). 

‘‘(F) REGULATIONS OR OTHER GUIDANCE.—The Secretary shall prescribe such regulations or other guidance as 

may be necessary to carry out the purposes of this paragraph. The Secretary may prescribe regulations or other 

guidance which exempts sales by the donee organization 

which are in direct furtherance of such organization’s charitable purpose from the requirements of subparagraphs 

(A)(ii) and (B)(iv)(II).’’. 

(b) PENALTY FOR FRAUDULENT ACKNOWLEDGMENTS.—

(1) IN GENERAL.—Part I of subchapter B of chapter 68 (relating to assessable penalties), as amended by this Act, is 

amended by inserting after section 6719 the following new section: 

‘‘SEC. 6720. FRAUDULENT ACKNOWLEDGMENTS WITH RESPECT TO DONATIONS OF MOTOR VEHICLES, BOATS, AND AIRPLANES. 

‘‘Any donee organization required under section 170(f)(12)(A) to 

furnish a contemporaneous written acknowledgment to a donor 

which knowingly furnishes a false or fraudulent acknowledgment, 

or which knowingly fails to furnish such acknowledgment in the 

manner, at the time, and showing the information required under 

section 170(f)(12), or regulations prescribed thereunder, shall for 

each such act, or for each such failure, be subject to a penalty equal 

to—

‘‘(1) in the case of an acknowledgment with respect to a 

qualified vehicle to which section 170(f)(12)(A)(ii) applies, the 

greater of—

‘‘(A) the product of the highest rate of tax specified in 

section 1 and the sales price stated on the acknowledgment, 

or 

‘‘(B) the gross proceeds from the sale of such vehicle, 

and 

‘‘(2) in the case of an acknowledgment with respect to any 

other qualified vehicle to which section 170(f)(12) applies, the 

greater of—

‘‘(A) the product of the highest rate of tax specified in 

section 1 and the claimed value of the vehicle, or 

‘‘(B) $5,000.’’. 

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(2) CONFORMING AMENDMENT.—The table of sections for 

part I of subchapter B of chapter 68, as amended by this Act, 

is amended by inserting after the item relating to section 6719 

the following new item:

‘‘Sec. 6720. Fraudulent acknowledgments with respect to donations of 

motor vehicles, boats, and airplanes.’’.

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to contributions made after December 31, 2004. 

SEC. 885. TREATMENT OF NONQUALIFIED DEFERRED COMPENSATION 

PLANS. 

(a) IN GENERAL.—Subpart A of part I of subchapter D of chapter 1 is amended by adding at the end the following new section: 

‘‘SEC. 409A. INCLUSION IN GROSS INCOME OF DEFERRED COMPENSATION UNDER NONQUALIFIED DEFERRED COMPENSATION 

PLANS. 

‘‘(a) RULES RELATING TO CONSTRUCTIVE RECEIPT.—

‘‘(1) PLAN FAILURES.—

‘‘(A) GROSS INCOME INCLUSION.—

‘‘(i) IN GENERAL.—If at any time during a taxable 

year a nonqualified deferred compensation plan—

‘‘(I) fails to meet the requirements of paragraphs (2), (3), and (4), or 

‘‘(II) is not operated in accordance with such 

requirements, 

all compensation deferred under the plan for the taxable year and all preceding taxable years shall be includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and 

not previously included in gross income. 

‘‘(ii) APPLICATION ONLY TO AFFECTED PARTICIPANTS.—Clause (i) shall only apply with respect to all 

compensation deferred under the plan for participants 

with respect to whom the failure relates. 

‘‘(B) INTEREST AND ADDITIONAL TAX PAYABLE WITH RESPECT TO PREVIOUSLY DEFERRED COMPENSATION.—

‘‘(i) IN GENERAL.—If compensation is required to be 

included in gross income under subparagraph (A) for 

a taxable year, the tax imposed by this chapter for the 

taxable year shall be increased by the sum of—

‘‘(I) the amount of interest determined under 

clause (ii), and 

‘‘(II) an amount equal to 20 percent of the compensation which is required to be included in gross 

income. 

‘‘(ii) INTEREST.—For purposes of clause (i), the interest determined under this clause for any taxable 

year is the amount of interest at the underpayment rate 

plus 1 percentage point on the underpayments that 

would have occurred had the deferred compensation 

been includible in gross income for the taxable year in 

which first deferred or, if later, the first taxable year 

in which such deferred compensation is not subject to 

a substantial risk of forfeiture. 

‘‘(2) DISTRIBUTIONS.—

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‘‘(A) IN GENERAL.—The requirements of this paragraph 

are met if the plan provides that compensation deferred 

under the plan may not be distributed earlier than—

‘‘(i) separation from service as determined by the 

Secretary (except as provided in subparagraph (B)(i)), 

‘‘(ii) the date the participant becomes disabled 

(within the meaning of subparagraph (C)), 

‘‘(iii) death, 

‘‘(iv) a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral 

of such compensation, 

‘‘(v) to the extent provided by the Secretary, a 

change in the ownership or effective control of the corporation, or in the ownership of a substantial portion 

of the assets of the corporation, or 

‘‘(vi) the occurrence of an unforeseeable emergency. 

‘‘(B) SPECIAL RULES.—

‘‘(i) SPECIFIED EMPLOYEES.—In the case of any 

specified employee, the requirement of subparagraph 

(A)(i) is met only if distributions may not be made before the date which is 6 months after the date of separation from service (or, if earlier, the date of death of 

the employee). For purposes of the preceding sentence, 

a specified employee is a key employee (as defined in 

section 416(i) without regard to paragraph (5) thereof) 

of a corporation any stock in which is publicly traded 

on an established securities market or otherwise. 

‘‘(ii) UNFORESEEABLE EMERGENCY.—For purposes 

of subparagraph (A)(vi)—

‘‘(I) IN GENERAL.—The term ‘unforeseeable 

emergency’ means a severe financial hardship to 

the participant resulting from an illness or accident of the participant, the participant’s spouse, or 

a dependent (as defined in section 152(a)) of the 

participant, loss of the participant’s property due 

to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of 

events beyond the control of the participant. 

‘‘(II) LIMITATION ON DISTRIBUTIONS.—The requirement of subparagraph (A)(vi) is met only if, 

as determined under regulations of the Secretary, 

the amounts distributed with respect to an emergency do not exceed the amounts necessary to satisfy such emergency plus amounts necessary to pay 

taxes reasonably anticipated as a result of the distribution, after taking into account the extent to 

which such hardship is or may be relieved through 

reimbursement or compensation by insurance or 

otherwise or by liquidation of the participant’s assets (to the extent the liquidation of such assets 

would not itself cause severe financial hardship). 

‘‘(C) DISABLED.—For purposes of subparagraph (A)(ii), 

a participant shall be considered disabled if the participant—

223

‘‘(i) is unable to engage in any substantial gainful 

activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months, or 

‘‘(ii) is, by reason of any medically determinable 

physical or mental impairment which can be expected 

to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than 

3 months under an accident and health plan covering 

employees of the participant’s employer. 

‘‘(3) ACCELERATION OF BENEFITS.—The requirements of this 

paragraph are met if the plan does not permit the acceleration 

of the time or schedule of any payment under the plan, except 

as provided in regulations by the Secretary. 

‘‘(4) ELECTIONS.—

‘‘(A) IN GENERAL.—The requirements of this paragraph 

are met if the requirements of subparagraphs (B) and (C) 

are met. 

‘‘(B) INITIAL DEFERRAL DECISION.—

‘‘(i) IN GENERAL.—The requirements of this subparagraph are met if the plan provides that compensation for services performed during a taxable year may 

be deferred at the participant’s election only if the election to defer such compensation is made not later than 

the close of the preceding taxable year or at such other 

time as provided in regulations. 

‘‘(ii) FIRST YEAR OF ELIGIBILITY.—In the case of the 

first year in which a participant becomes eligible to 

participate in the plan, such election may be made 

with respect to services to be performed subsequent to 

the election within 30 days after the date the participant becomes eligible to participate in such plan. 

‘‘(iii) PERFORMANCE-BASED COMPENSATION.—In the 

case of any performance-based compensation based on 

services performed over a period of at least 12 months, 

such election may be made no later than 6 months before the end of the period. 

‘‘(C) CHANGES IN TIME AND FORM OF DISTRIBUTION.—

The requirements of this subparagraph are met if, in the 

case of a plan which permits under a subsequent election 

a delay in a payment or a change in the form of payment—

‘‘(i) the plan requires that such election may not 

take effect until at least 12 months after the date on 

which the election is made, 

‘‘(ii) in the case of an election related to a payment 

not described in clause (ii), (iii), or (vi) of paragraph 

(2)(A), the plan requires that the first payment with respect to which such election is made be deferred for a 

period of not less than 5 years from the date such payment would otherwise have been made, and 

‘‘(iii) the plan requires that any election related to 

a payment described in paragraph (2)(A)(iv) may not 

224

be made less than 12 months prior to the date of the 

first scheduled payment under such paragraph. 

‘‘(b) RULES RELATING TO FUNDING.— ‘‘(1) OFFSHORE PROPERTY IN A TRUST.—In the case of assets 

set aside (directly or indirectly) in a trust (or other arrangement 

determined by the Secretary) for purposes of paying deferred 

compensation under a nonqualified deferred compensation 

plan, for purposes of section 83 such assets shall be treated as 

property transferred in connection with the performance of services whether or not such assets are available to satisfy claims 

of general creditors—

‘‘(A) at the time set aside if such assets (or such trust 

or other arrangement) are located outside of the United 

States, or 

‘‘(B) at the time transferred if such assets (or such trust 

or other arrangement) are subsequently transferred outside 

of the United States. 

This paragraph shall not apply to assets located in a foreign jurisdiction if substantially all of the services to which the nonqualified deferred compensation relates are performed in such 

jurisdiction. 

‘‘(2) EMPLOYER’S FINANCIAL HEALTH.—In the case of compensation deferred under a nonqualified deferred compensation 

plan, there is a transfer of property within the meaning of section 83 with respect to such compensation as of the earlier of—

‘‘(A) the date on which the plan first provides that assets will become restricted to the provision of benefits under 

the plan in connection with a change in the employer’s financial health, or 

‘‘(B) the date on which assets are so restricted, 

whether or not such assets are available to satisfy claims of 

general creditors. 

‘‘(3) INCOME INCLUSION FOR OFFSHORE TRUSTS AND EM- PLOYER’S FINANCIAL HEALTH.—For each taxable year that assets 

treated as transferred under this subsection remain set aside in 

a trust or other arrangement subject to paragraph (1) or (2), 

any increase in value in, or earnings with respect to, such assets shall be treated as an additional transfer of property under 

this subsection (to the extent not previously included in income). 

‘‘(4) INTEREST ON TAX LIABILITY PAYABLE WITH RESPECT TO

TRANSFERRED PROPERTY.—

‘‘(A) IN GENERAL.—If amounts are required to be included in gross income by reason of paragraph (1) or (2) for 

a taxable year, the tax imposed by this chapter for such taxable year shall be increased by the sum of— 

‘‘(i) the amount of interest determined under subparagraph (B), and 

‘‘(ii) an amount equal to 20 percent of the amounts 

required to be included in gross income. 

‘‘(B) INTEREST.—For purposes of subparagraph (A), the 

interest determined under this subparagraph for any taxable year is the amount of interest at the underpayment 

rate plus 1 percentage point on the underpayments that 

would have occurred had the amounts so required to be included in gross income by paragraph (1) or (2) been includVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00228 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
225

ible in gross income for the taxable year in which first deferred or, if later, the first taxable year in which such 

amounts are not subject to a substantial risk of forfeiture. 

‘‘(c) NO INFERENCE ON EARLIER INCOME INCLUSION OR RE- QUIREMENT OF LATER INCLUSION.—Nothing in this section shall be 

construed to prevent the inclusion of amounts in gross income under 

any other provision of this chapter or any other rule of law earlier 

than the time provided in this section. Any amount included in 

gross income under this section shall not be required to be included 

in gross income under any other provision of this chapter or any 

other rule of law later than the time provided in this section. 

‘‘(d) OTHER DEFINITIONS AND SPECIAL RULES.—For purposes of 

this section—

‘‘(1) NONQUALIFIED DEFERRED COMPENSATION PLAN.—The 

term ‘nonqualified deferred compensation plan’ means any plan 

that provides for the deferral of compensation, other than—

‘‘(A) a qualified employer plan, and 

‘‘(B) any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. 

‘‘(2) QUALIFIED EMPLOYER PLAN.—The term ‘qualified employer plan’ means—

‘‘(A) any plan, contract, pension, account, or trust described in subparagraph (A) or (B) of section 219(g)(5) 

(without regard to subparagraph (A)(iii)), 

‘‘(B) any eligible deferred compensation plan (within 

the meaning of section 457(b)), and 

‘‘(C) any plan described in section 415(m). 

‘‘(3) PLAN INCLUDES ARRANGEMENTS, ETC.—The term ‘plan’ 

includes any agreement or arrangement, including an agreement or arrangement that includes one person. 

‘‘(4) SUBSTANTIAL RISK OF FORFEITURE.—The rights of a 

person to compensation are subject to a substantial risk of forfeiture if such person’s rights to such compensation are conditioned upon the future performance of substantial services by 

any individual. 

‘‘(5) TREATMENT OF EARNINGS.—References to deferred compensation shall be treated as including references to income 

(whether actual or notional) attributable to such compensation 

or such income. 

‘‘(6) AGGREGATION RULES.—Except as provided by the Secretary, rules similar to the rules of subsections (b) and (c) of section 414 shall apply. 

‘‘(e) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes 

of this section, including regulations—

‘‘(1) providing for the determination of amounts of deferral 

in the case of a nonqualified deferred compensation plan which 

is a defined benefit plan, 

‘‘(2) relating to changes in the ownership and control of a 

corporation or assets of a corporation for purposes of subsection 

(a)(2)(A)(v), 

‘‘(3) exempting arrangements from the application of subsection (b) if such arrangements will not result in an improper 

deferral of United States tax and will not result in assets being 

effectively beyond the reach of creditors, 

226

‘‘(4) defining financial health for purposes of subsection 

(b)(2), and 

‘‘(5) disregarding a substantial risk of forfeiture in cases 

where necessary to carry out the purposes of this section.’’. 

(b) TREATMENT OF DEFERRED AMOUNTS.— (1) W–2 FORMS.— (A) IN GENERAL.—Subsection (a) of section 6051 (relating to receipts for employees) is amended by striking ‘‘and’’ 

at the end of paragraph (11), by striking the period at the 

end of paragraph (12) and inserting ‘‘, and’’, and by inserting after paragraph (12) the following new paragraph: 

‘‘(13) the total amount of deferrals for the year under a nonqualified deferred compensation plan (within the meaning of 

section 409A(d)).’’. 

(B) THRESHOLD.—Subsection (a) of section 6051 is 

amended by adding at the end the following: ‘‘In the case 

of the amounts required to be shown by paragraph (13), the 

Secretary may (by regulation) establish a minimum amount 

of deferrals below which paragraph (13) does not apply.’’. 

(2) WAGE WITHHOLDING.—Section 3401(a) (defining wages) 

is amended by adding at the end the following flush sentence: 

‘‘The term ‘wages’ includes any amount includible in gross income of an employee under section 409A and payment of such 

amount shall be treated as having been made in the taxable 

year in which the amount is so includible.’’. 

(3) OTHER REPORTING.—Section 6041 (relating to information at source) is amended by adding at the end the following 

new subsection: 

‘‘(g) NONQUALIFIED DEFERRED COMPENSATION.—Subsection (a) 

shall apply to—

‘‘(1) any deferrals for the year under a nonqualified deferred compensation plan (within the meaning of section 

409A(d)), whether or not paid, except that this paragraph shall 

not apply to deferrals which are required to be reported under 

section 6051(a)(13) (without regard to any de minimis exception), and 

‘‘(2) any amount includible under section 409A and which 

is not treated as wages under section 3401(a).’’. 

(c) CLERICAL AMENDMENT.—The table of sections for such subpart A of part I of subchapter D of chapter 1 is amended by adding 

at the end the following new item:

‘‘Sec. 409A. Inclusion in gross income of deferred compensation 

under nonqualified deferred compensation plans.’’.

(d) EFFECTIVE DATE.—

(1) IN GENERAL.—The amendments made by this section 

shall apply to amounts deferred after December 31, 2004. 

(2) SPECIAL RULES.—

(A) EARNINGS.—The amendments made by this section 

shall apply to earnings on deferred compensation only to 

the extent that such amendments apply to such compensation. 

(B) MATERIAL MODIFICATIONS.—For purposes of this 

subsection, amounts deferred in taxable years beginning before January 1, 2005, shall be treated as amounts deferred 

in a taxable year beginning on or after such date if the plan 

227

under which the deferral is made is materially modified 

after October 3, 2004, unless such modification is pursuant 

to the guidance issued under subsection (f). 

(3) EXCEPTION FOR NONELECTIVE DEFERRED COMPENSATION.—The amendments made by this section shall not apply to 

any nonelective deferred compensation to which section 457 of 

the Internal Revenue Code of 1986 does not apply by reason of 

section 457(e)(12) of such Code, but only if such compensation 

is provided under a nonqualified deferred compensation plan—

(A) which was in existence on May 1, 2004, 

(B) which was providing nonelective deferred compensation described in such section 457(e)(12) on such date, 

and 

(C) which is established or maintained by an organization incorporated on July 2, 1974. 

If, after May 1, 2004, a plan described in the preceding sentence 

adopts a plan amendment which provides a material change in 

the classes of individuals eligible to participate in the plan, this 

paragraph shall not apply to any nonelective deferred compensation provided under the plan on or after the date of the 

adoption of the amendment. 

(e) GUIDANCE RELATING TO CHANGE OF OWNERSHIP OR CONTROL.—Not later than 90 days after the date of the enactment of this 

Act, the Secretary of the Treasury shall issue guidance on what constitutes a change in ownership or effective control for purposes of 

section 409A of the Internal Revenue Code of 1986, as added by this 

section. 

(f) GUIDANCE RELATING TO TERMINATION OF CERTAIN EXISTING

ARRANGEMENTS.—Not later than 60 days after the date of the enactment of this Act, the Secretary of the Treasury shall issue guidance 

providing a limited period during which a nonqualified deferred 

compensation plan adopted before December 31, 2004, may, without 

violating the requirements of paragraphs (2), (3), and (4) of section 

409A(a) of the Internal Revenue Code of 1986 (as added by this section), be amended—

(1) to provide that a participant may terminate participation in the plan, or cancel an outstanding deferral election with 

regard to amounts deferred after December 31, 2004, but only 

if amounts subject to the termination or cancellation are includible in income of the participant as earned (or, if later, when 

no longer subject to substantial risk of forfeiture), and 

(2) to conform to the requirements of such section 409A 

with regard to amounts deferred after December 31, 2004. 

SEC. 886. EXTENSION OF AMORTIZATION OF INTANGIBLES TO SPORTS 

FRANCHISES. 

(a) IN GENERAL.—Section 197(e) (relating to exceptions to definition of section 197 intangible) is amended by striking paragraph 

(6) and by redesignating paragraphs (7) and (8) as paragraphs (6) 

and (7), respectively. 

(b) CONFORMING AMENDMENTS.—

(1)(A) Section 1056 (relating to basis limitation for player 

contracts transferred in connection with the sale of a franchise) 

is repealed. 

228

(B) The table of sections for part IV of subchapter O of 

chapter 1 is amended by striking the item relating to section 

1056. 

(2) Section 1245(a) (relating to gain from disposition of certain depreciable property) is amended by striking paragraph 

(4). 

(3) Section 1253 (relating to transfers of franchises, trademarks, and trade names) is amended by striking subsection (e). 

(c) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the 

amendments made by this section shall apply to property acquired after the date of the enactment of this Act. 

(2) SECTION 1245.—The amendment made by subsection 

(b)(2) shall apply to franchises acquired after the date of the enactment of this Act. 

SEC. 887. MODIFICATION OF CONTINUING LEVY ON PAYMENTS TO 

FEDERAL VENDERS. 

(a) IN GENERAL.—Section 6331(h) (relating to continuing levy 

on certain payments) is amended by adding at the end the following 

new paragraph: 

‘‘(3) INCREASE IN LEVY FOR CERTAIN PAYMENTS.—Paragraph (1) shall be applied by substituting ‘100 percent’ for ‘15 

percent’ in the case of any specified payment due to a vendor 

of goods or services sold or leased to the Federal Government.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall take effect on the date of the enactment of this Act.

SEC. 888. MODIFICATION OF STRADDLE RULES. 

(a) RULES RELATING TO IDENTIFIED STRADDLES.—

(1) IN GENERAL.—Subparagraph (A) of section 1092(a)(2) 

(relating to special rule for identified straddles) is amended to 

read as follows: 

‘‘(A) IN GENERAL.—In the case of any straddle which is 

an identified straddle—

‘‘(i) paragraph (1) shall not apply with respect to 

identified positions comprising the identified straddle, 

‘‘(ii) if there is any loss with respect to any identified position of the identified straddle, the basis of each 

of the identified offsetting positions in the identified 

straddle shall be increased by an amount which bears 

the same ratio to the loss as the unrecognized gain 

with respect to such offsetting position bears to the aggregate unrecognized gain with respect to all such offsetting positions, and 

‘‘(iii) any loss described in clause (ii) shall not otherwise be taken into account for purposes of this title.’’. 

(2) IDENTIFIED STRADDLE.—Section 1092(a)(2)(B) (defining 

identified straddle) is amended—

(A) by striking clause (ii) and inserting the following: 

‘‘(ii) to the extent provided by regulations, the value 

of each position of which (in the hands of the taxpayer 

immediately before the creation of the straddle) is not 

less than the basis of such position in the hands of the 

taxpayer at the time the straddle is created, and’’, and 

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(B) by adding at the end the following new flush sentence: 

‘‘The Secretary shall prescribe regulations which specify the 

proper methods for clearly identifying a straddle as an 

identified straddle (and the positions comprising such 

straddle), which specify the rules for the application of this 

section for a taxpayer which fails to properly identify the 

positions of an identified straddle, and which specify the 

ordering rules in cases where a taxpayer disposes of less 

than an entire position which is part of an identified straddle.’’. 

(3) UNRECOGNIZED GAIN.—Section 1092(a)(3) (defining unrecognized gain) is amended by redesignating subparagraph (B) 

as subparagraph (C) and by inserting after subparagraph (A) 

the following new subparagraph: 

‘‘(B) SPECIAL RULE FOR IDENTIFIED STRADDLES.—For 

purposes of paragraph (2)(A)(ii), the unrecognized gain 

with respect to any identified offsetting position shall be the 

excess of the fair market value of the position at the time 

of the determination over the fair market value of the position at the time the taxpayer identified the position as a position in an identified straddle.’’. 

(4) CONFORMING AMENDMENT.—Section 1092(c)(2) is 

amended by striking subparagraph (B) and by redesignating 

subparagraph (C) as subparagraph (B). 

(b) PHYSICALLY SETTLED POSITIONS.—Section 1092(d) (relating 

to definitions and special rules) is amended by adding at the end 

the following new paragraph: 

‘‘(8) SPECIAL RULES FOR PHYSICALLY SETTLED POSITIONS.—

For purposes of subsection (a), if a taxpayer settles a position 

which is part of a straddle by delivering property to which the 

position relates (and such position, if terminated, would result 

in a realization of a loss), then such taxpayer shall be treated 

as if such taxpayer—

‘‘(A) terminated the position for its fair market value 

immediately before the settlement, and 

‘‘(B) sold the property so delivered by the taxpayer at 

its fair market value.’’. 

(c) REPEAL OF STOCK EXCEPTION.— (1) IN GENERAL.—Paragraph (3) of section 1092(d) (relating 

to definitions and special rules) is amended to read as follows: 

‘‘(3) SPECIAL RULES FOR STOCK.—For purposes of paragraph (1)—

‘‘(A) IN GENERAL.—In the case of stock, the term ‘personal property’ includes stock only if—

‘‘(i) such stock is of a type which is actively traded 

and at least 1 of the positions offsetting such stock is 

a position with respect to such stock or substantially 

similar or related property, or 

‘‘(ii) such stock is of a corporation formed or 

availed of to take positions in personal property which 

offset positions taken by any shareholder. 

‘‘(B) RULE FOR APPLICATION.—For purposes of determining whether subsection (e) applies to any transaction 

with respect to stock described in subparagraph (A)(ii), all 

230

includible corporations of an affiliated group (within the 

meaning of section 1504(a)) shall be treated as 1 taxpayer.’’. 

(2) CONFORMING AMENDMENT.—Section 1258(d)(1) is 

amended by striking ‘‘; except that the term ‘personal property’ 

shall include stock’’. 

(d) HOLDING PERIOD FOR DIVIDEND EXCLUSION.—The last sentence of section 246(c) is amended by inserting: ‘‘, other than a 

qualified covered call option to which section 1092(f) applies’’ before 

the period at the end. 

(e) EFFECTIVE DATE.—The amendments made by this section 

shall apply to positions established on or after the date of the enactment of this Act. 

SEC. 889. ADDITION OF VACCINES AGAINST HEPATITIS A TO LIST OF 

TAXABLE VACCINES. 

(a) IN GENERAL.—Paragraph (1) of section 4132(a) (defining 

taxable vaccine) is amended by redesignating subparagraphs (I), 

(J), (K), and (L) as subparagraphs (J), (K), (L), and (M), respectively, and by inserting after subparagraph (H) the following new 

subparagraph: 

‘‘(I) Any vaccine against hepatitis A.’’

(b) EFFECTIVE DATE.—

(1) SALES, ETC.—The amendments made by subsection (a) 

shall apply to sales and uses on or after the first day of the first 

month which begins more than 4 weeks after the date of the enactment of this Act. 

(2) DELIVERIES.—For purposes of paragraph (1) and section 

4131 of the Internal Revenue Code of 1986, in the case of sales 

on or before the effective date described in such paragraph for 

which delivery is made after such date, the delivery date shall 

be considered the sale date. 

SEC. 890. ADDITION OF VACCINES AGAINST INFLUENZA TO LIST OF 

TAXABLE VACCINES. 

(a) IN GENERAL.—Section 4132(a)(1) (defining taxable vaccine), 

as amended by this Act, is amended by adding at the end the following new subparagraph: 

‘‘(N) Any trivalent vaccine against influenza.’’. 

(b) EFFECTIVE DATE.—

(1) SALES, ETC.—The amendment made by this section 

shall apply to sales and uses on or after the later of—

(A) the first day of the first month which begins more 

than 4 weeks after the date of the enactment of this Act, or 

(B) the date on which the Secretary of Health and 

Human Services lists any vaccine against influenza for 

purposes of compensation for any vaccine-related injury or 

death through the Vaccine Injury Compensation Trust 

Fund. 

(2) DELIVERIES.—For purposes of paragraph (1) and section 

4131 of the Internal Revenue Code of 1986, in the case of sales 

on or before the effective date described in such paragraph for 

which delivery is made after such date, the delivery date shall 

be considered the sale date. 

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SEC. 891. EXTENSION OF IRS USER FEES. 

(a) IN GENERAL.—Section 7528(c) (relating to termination) is 

amended by striking ‘‘December 31, 2004’’ and inserting ‘‘September 

30, 2014’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to requests after the date of the enactment of this Act. 

SEC. 892. COBRA FEES. 

(a) USE OF MERCHANDISE PROCESSING FEE.—Section 13031(f) 

of the Consolidated Omnibus Budget Reconciliation Act of 1985 (19 

U.S.C. 58c(f)) is amended—

(1) in paragraph (1), by aligning subparagraph (B) with 

subparagraph (A); and 

(2) in paragraph (2), by striking ‘‘commercial operations’’ 

and all that follows through ‘‘processing.’’ and inserting ‘‘customs revenue functions as defined in section 415 of the Homeland Security Act of 2002 (other than functions performed by 

the Office of International Affairs referred to in section 415(8) 

of that Act), and for automation (including the Automation 

Commercial Environment computer system), and for no other 

purpose. To the extent that funds in the Customs User Fee Account are insufficient to pay the costs of such customs revenue 

functions, customs duties in an amount equal to the amount of 

such insufficiency shall be available, to the extent provided for 

in appropriations Acts, to pay the costs of such customs revenue 

functions in the amount of such insufficiency, and shall be 

available for no other purpose. The provisions of the first and 

second sentences of this paragraph specifying the purposes for 

which amounts in the Customs User Fee Account may be made 

available shall not be superseded except by a provision of law 

which specifically modifies or supersedes such provisions.’’. 

(b) REIMBURSEMENT OF APPROPRIATIONS FROM COBRA 

FEES.—Section 13031(f)(3) of the Consolidated Omnibus Budget 

Reconciliation Act of 1985 (19 U.S.C. 58c(f)(3)) is amended by adding at the end the following: 

‘‘(E) Nothing in this paragraph shall be construed to preclude 

the use of appropriated funds, from sources other than the fees collected under subsection (a), to pay the costs set forth in clauses (i), 

(ii), and (iii) of subparagraph (A).’’. 

(c) SENSE OF CONGRESS; EFFECTIVE PERIOD FOR COLLECTING

FEES; STANDARD FOR SETTING FEES.—

(1) SENSE OF CONGRESS.—The Congress finds that—

(A) the fees set forth in paragraphs (1) through (8) of 

subsection (a) of section 13031 of the Consolidated Omnibus Budget Reconciliation Act of 1985 have been reasonably related to the costs of providing customs services in 

connection with the activities or items for which the fees 

have been charged under such paragraphs; and 

(B) the fees collected under such paragraphs have not 

exceeded, in the aggregate, the amounts paid for the costs 

described in subsection (f)(3)(A) incurred in providing customs services in connection with the activities or items for 

which the fees were charged under such paragraphs. 

(2) EFFECTIVE PERIOD; STANDARD FOR SETTING FEES.—Section 13031(j)(3) of the Consolidated Omnibus Budget Reconciliation Act of 1985 is amended to read as follows: 

232

‘‘(3)(A) Fees may not be charged under paragraphs (9) and (10) 

of subsection (a) after September 30, 2014. 

‘‘(B)(i) Subject to clause (ii), Fees may not be charged under 

paragraphs (1) through (8) of subsection (a) after September 30, 

2014. 

‘‘(ii) In fiscal year 2006 and in each succeeding fiscal year for 

which fees under paragraphs (1) through (8) of subsection (a) are 

authorized—

‘‘(I) the Secretary of the Treasury shall charge fees under 

each such paragraph in amounts that are reasonably related to 

the costs of providing customs services in connection with the 

activity or item for which the fee is charged under such paragraph, except that in no case may the fee charged under any 

such paragraph exceed by more than 10 percent the amount 

otherwise prescribed by such paragraph; 

‘‘(II) the amount of fees collected under such paragraphs 

may not exceed, in the aggregate, the amounts paid in that fiscal year for the costs described in subsection (f)(3)(A) incurred 

in providing customs services in connection with the activity or 

item for which the fees are charged under such paragraphs; 

‘‘(III) a fee may not be collected under any such paragraph 

except to the extent such fee will be expended to pay the costs 

described in subsection (f)(3)(A) incurred in providing customs 

services in connection with the activity or item for which the fee 

is charged under such paragraph; and 

‘‘(IV) any fee collected under any such paragraph shall be 

available for expenditure only to pay the costs described in subsection (f)(3)(A) incurred in providing customs services in connection with the activity or item for which the fee is charged 

under such paragraph.’’. 

(d) CLERICAL AMENDMENTS.—Section 13031 of the Consolidated 

Omnibus Budget Reconciliation Act of 1985 is amended—

(1) in subsection (a)(5)(B), by striking ‘‘$1.75’’ and inserting 

‘‘$1.75.’’; 

(2) in subsection (b)—

(A) in paragraph (1)(A), by aligning clause (iii) with 

clause (ii); 

(B) in paragraph (7), by striking ‘‘paragraphs’’ and inserting ‘‘paragraph’’; and 

(C) in paragraph (9), by aligning subparagraph (B) 

with subparagraph (A); and 

(3) in subsection (e)(2), by aligning subparagraph (B) with 

subparagraph (A). 

(e) STUDY OF ALL FEES COLLECTED BY DEPARTMENT OF HOMELAND SECURITY.—The Secretary of the Treasury shall conduct a 

study of all the fees collected by the Department of Homeland Security, and shall submit to the Congress, not later than September 30, 

2005, a report containing the recommendations of the Secretary 

on—

(1) what fees should be eliminated; 

(2) what the rate of fees retained should be; and 

(3) any other recommendations with respect to the fees that 

the Secretary considers appropriate. 

233

SEC. 893. PROHIBITION ON NONRECOGNITION OF GAIN THROUGH 

COMPLETE LIQUIDATION OF HOLDING COMPANY. 

(a) IN GENERAL.—Section 332 is amended by adding at the end 

the following new subsection: 

‘‘(d) RECOGNITION OF GAIN ON LIQUIDATION OF CERTAIN HOLD- ING COMPANIES.— ‘‘(1) IN GENERAL.—In the case of any distribution to a foreign corporation in complete liquidation of an applicable holding company—

‘‘(A) subsection (a) and section 331 shall not apply to 

such distribution, and 

‘‘(B) such distribution shall be treated as a distribution 

to which section 301 applies. 

‘‘(2) APPLICABLE HOLDING COMPANY.—For purposes of this 

subsection—

‘‘(A) IN GENERAL.—The term ‘applicable holding company’ means any domestic corporation—

‘‘(i) which is a common parent of an affiliated 

group, 

‘‘(ii) stock of which is directly owned by the distributee foreign corporation, 

‘‘(iii) substantially all of the assets of which consist 

of stock in other members of such affiliated group, and 

‘‘(iv) which has not been in existence at all times 

during the 5 years immediately preceding the date of 

the liquidation. 

‘‘(B) AFFILIATED GROUP.—For purposes of this subsection, the term ‘affiliated group’ has the meaning given 

such term by section 1504(a) (without regard to paragraphs 

(2) and (4) of section 1504(b)). 

‘‘(3) COORDINATION WITH SUBPART F.—If the distributee of 

a distribution described in paragraph (1) is a controlled foreign 

corporation (as defined in section 957), then notwithstanding 

paragraph (1) or subsection (a), such distribution shall be treated as a distribution to which section 331 applies. 

‘‘(4) REGULATIONS.—The Secretary shall provide such regulations as appropriate to prevent the abuse of this subsection, 

including regulations which provide, for the purposes of clause 

(iv) of paragraph (2)(A), that a corporation is not in existence 

for any period unless it is engaged in the active conduct of a 

trade or business or owns a significant ownership interest in 

another corporation so engaged.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to distributions in complete liquidation occurring on or 

after the date of the enactment of this Act. 

SEC. 894. EFFECTIVELY CONNECTED INCOME TO INCLUDE CERTAIN 

FOREIGN SOURCE INCOME. 

(a) IN GENERAL.—Section 864(c)(4)(B) (relating to treatment of 

income from sources without the United States as effectively connected income) is amended by adding at the end the following new 

flush sentence:

‘‘Any income or gain which is equivalent to any item of income or gain described in clause (i), (ii), or (iii) shall be 

treated in the same manner as such item for purposes of 

this subparagraph.’’. 

234

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

SEC. 895. RECAPTURE OF OVERALL FOREIGN LOSSES ON SALE OF 

CONTROLLED FOREIGN CORPORATION. 

(a) IN GENERAL.—Section 904(f)(3) (relating to dispositions) is 

amending by adding at the end the following new subparagraph: 

‘‘(D) APPLICATION TO CERTAIN DISPOSITIONS OF STOCK

IN CONTROLLED FOREIGN CORPORATION.— ‘‘(i) IN GENERAL.—This paragraph shall apply to 

an applicable disposition in the same manner as if it 

were a disposition of property described in subparagraph (A), except that the exception contained in subparagraph (C)(i) shall not apply. 

‘‘(ii) APPLICABLE DISPOSITION.—For purposes of 

clause (i), the term ‘applicable disposition’ means any 

disposition of any share of stock in a controlled foreign 

corporation in a transaction or series of transactions if, 

immediately before such transaction or series of transactions, the taxpayer owned more than 50 percent (by 

vote or value) of the stock of the controlled foreign corporation. Such term shall not include a disposition described in clause (iii) or (iv), except that clause (i) shall 

apply to any gain recognized on any such disposition. 

‘‘(iii) EXCEPTION FOR CERTAIN EXCHANGES WHERE

OWNERSHIP PERCENTAGE RETAINED.—A disposition 

shall not be treated as an applicable disposition under 

clause (ii) if it is part of a transaction or series of 

transactions— 

‘‘(I) to which section 351 or 721 applies, or 

under which the transferor receives stock in a foreign corporation in exchange for the stock in the 

controlled foreign corporation and the stock received is exchanged basis property (as defined in 

section 7701(a)(44)), and 

‘‘(II) immediately after which, the transferor 

owns (by vote or value) at least the same percentage of stock in the controlled foreign corporation 

(or, if the controlled foreign corporation is not in 

existence after such transaction or series of transactions, in another foreign corporation stock in 

which was received by the transferor in exchange 

for stock in the controlled foreign corporation) as 

the percentage of stock in the controlled foreign 

corporation which the taxpayer owned immediately 

before such transaction or series of transactions. 

‘‘(iv) EXCEPTION FOR CERTAIN ASSET ACQUISITIONS.—A disposition shall not be treated as an applicable disposition under clause (ii) if it is part of a 

transaction or series of transactions in which the taxpayer (or any member of a controlled group of corporations filing a consolidated return under section 1501 

which includes the taxpayer) acquires the assets of a 

controlled foreign corporation in exchange for the 

shares of the controlled foreign corporation in a liqVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00238 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
235

uidation described in section 332 or a reorganization 

described in section 368(a)(1). 

‘‘(v) CONTROLLED FOREIGN CORPORATION.—For 

purposes of this subparagraph, the term ‘controlled foreign corporation’ has the meaning given such term by 

section 957. 

‘‘(vi) STOCK OWNERSHIP.—For purposes of this subparagraph, ownership of stock shall be determined 

under the rules of subsections (a) and (b) of section 

958.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to dispositions after the date of the enactment of this 

Act. 

SEC. 896. RECOGNITION OF CANCELLATION OF INDEBTEDNESS INCOME REALIZED ON SATISFACTION OF DEBT WITH PARTNERSHIP INTEREST. 

(a) IN GENERAL.—Paragraph (8) of section 108(e) (relating to 

general rules for discharge of indebtedness (including discharges 

not in title 11 cases or insolvency) is amended to read as follows: 

‘‘(8) INDEBTEDNESS SATISFIED BY CORPORATE STOCK OR

PARTNERSHIP INTEREST.—For purposes of determining income 

of a debtor from discharge of indebtedness, if—

‘‘(A) a debtor corporation transfers stock, or 

‘‘(B) a debtor partnership transfers a capital or profits 

interest in such partnership, 

to a creditor in satisfaction of its recourse or nonrecourse indebtedness, such corporation or partnership shall be treated as 

having satisfied the indebtedness with an amount of money 

equal to the fair market value of the stock or interest. In the 

case of any partnership, any discharge of indebtedness income 

recognized under this paragraph shall be included in the distributive shares of taxpayers which were the partners in the 

partnership immediately before such discharge.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply with respect to cancellations of indebtedness occurring 

on or after the date of the enactment of this Act.

SEC. 897. DENIAL OF INSTALLMENT SALE TREATMENT FOR ALL READILY TRADABLE DEBT. 

(a) IN GENERAL.—Section 453(f)(4)(B) (relating to purchaser 

evidences of indebtedness payable on demand or readily tradable) is 

amended by striking ‘‘is issued by a corporation or a government or 

political subdivision thereof and’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to sales occurring on or after the date of the enactment 

of this Act. 

SEC. 898. MODIFICATION OF TREATMENT OF TRANSFERS TO CREDITORS IN DIVISIVE REORGANIZATIONS. 

(a) IN GENERAL.—Section 361(b)(3) (relating to treatment of 

transfers to creditors) is amended by adding at the end the following new sentence: ‘‘In the case of a reorganization described in 

section 368(a)(1)(D) with respect to which stock or securities of the 

corporation to which the assets are transferred are distributed in a 

transaction which qualifies under section 355, this paragraph shall 

apply only to the extent that the sum of the money and the fair marVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00239 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
236

ket value of other property transferred to such creditors does not exceed the adjusted bases of such assets transferred.’’. 

(b) LIABILITIES IN EXCESS OF BASIS.—Section 357(c)(1)(B) is 

amended by inserting ‘‘with respect to which stock or securities of 

the corporation to which the assets are transferred are distributed 

in a transaction which qualifies under section 355’’ after ‘‘section 

368(a)(1)(D)’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transfers of money or other property, or liabilities assumed, in connection with a reorganization occurring on or after the 

date of the enactment of this Act. 

SEC. 899. CLARIFICATION OF DEFINITION OF NONQUALIFIED PREFERRED STOCK. 

(a) IN GENERAL.—Section 351(g)(3)(A) is amended by adding at 

the end the following: ‘‘Stock shall not be treated as participating 

in corporate growth to any significant extent unless there is a real 

and meaningful likelihood of the shareholder actually participating 

in the earnings and growth of the corporation.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to transactions after May 14, 2003. 

SEC. 900. MODIFICATION OF DEFINITION OF CONTROLLED GROUP OF 

CORPORATIONS. 

(a) IN GENERAL.—Section 1563(a)(2) (relating to brother-sister 

controlled group) is amended by striking ‘‘possessing—’’ and all that 

follows through ‘‘(B)’’ and inserting ‘‘possessing’’. 

(b) APPLICATION OF EXISTING RULES TO OTHER CODE PROVISIONS.—Section 1563(f) (relating to other definitions and rules) is 

amended by adding at the end the following new paragraph: 

‘‘(5) BROTHER-SISTER CONTROLLED GROUP DEFINITION FOR

PROVISIONS OTHER THAN THIS PART.—

‘‘(A) IN GENERAL.—Except as specifically provided in 

an applicable provision, subsection (a)(2) shall be applied 

to an applicable provision as if it read as follows: 

‘‘‘(2) BROTHER-SISTER CONTROLLED GROUP.—Two or more 

corporations if 5 or fewer persons who are individuals, estates, 

or trusts own (within the meaning of subsection (d)(2) stock possessing—

‘‘‘(A) at least 80 percent of the total combined voting 

power of all classes of stock entitled to vote, or at least 80 

percent of the total value of shares of all classes of stock, 

of each corporation, and 

‘‘‘(B) more than 50 percent of the total combined voting 

power of all classes of stock entitled to vote or more than 

50 percent of the total value of shares of all classes of stock 

of each corporation, taking into account the stock ownership of each such person only to the extent such stock ownership is identical with respect to each such corporation.’

‘‘(B) APPLICABLE PROVISION.—For purposes of this 

paragraph, an applicable provision is any provision of law 

(other than this part) which incorporates the definition of 

controlled group of corporations under subsection (a).’’. 

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to taxable years beginning after the date of the enactment of this Act. 

237

SEC. 901. CLASS LIVES FOR UTILITY GRADING COSTS. 

(a) GAS UTILITY PROPERTY.—Section 168(e)(3)(E) (defining 15-

year property), as amended by this Act, is amended by striking 

‘‘and’’ at the end of clause (iv), by striking the period at the end of 

clause (v) and inserting ‘‘, and’’, and by adding at the end the following new clause: 

‘‘(vi) initial clearing and grading land improvements with respect to gas utility property.’’. 

(b) ELECTRIC UTILITY PROPERTY.—Section 168(e)(3) is amended 

by adding at the end the following new subparagraph: 

‘‘(F) 20-YEAR PROPERTY.—The term ‘20-year property’ 

means initial clearing and grading land improvements 

with respect to any electric utility transmission and distribution plant.’’. 

(c) CONFORMING AMENDMENT.—The table contained in section 

168(g)(3)(B), as amended by this Act, is amended by inserting after 

the item relating to subparagraph (E)(v) the following new items:

‘‘(E)(vi) ............................................................................................... 20’’. 

‘‘(F) ..................................................................................................... 25’’.

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to property placed in service after the date of the enactment of this Act. 

SEC. 902. CONSISTENT AMORTIZATION OF PERIODS FOR INTANGIBLES. 

(a) START-UP EXPENDITURES.— (1) ALLOWANCE OF DEDUCTION.—Paragraph (1) of section 

195(b) (relating to start-up expenditures) is amended to read as 

follows: 

‘‘(1) ALLOWANCE OF DEDUCTION.—If a taxpayer elects the 

application of this subsection with respect to any start-up expenditures—

‘‘(A) the taxpayer shall be allowed a deduction for the 

taxable year in which the active trade or business begins in 

an amount equal to the lesser of—

‘‘(i) the amount of start-up expenditures with respect to the active trade or business, or ‘‘(ii) $5,000, reduced (but not below zero) by the 

amount by which such start-up expenditures exceed 

$50,000, and 

‘‘(B) the remainder of such start-up expenditures shall 

be allowed as a deduction ratably over the 180-month period beginning with the month in which the active trade or 

business begins.’’. 

(2) CONFORMING AMENDMENT.—Subsection (b) of section 

195 is amended by striking ‘‘AMORTIZE’’ and inserting ‘‘DE- DUCT’’ in the heading. 

(b) ORGANIZATIONAL EXPENDITURES.—Subsection (a) of section 

248 (relating to organizational expenditures) is amended to read as 

follows: 

‘‘(a) ELECTION TO DEDUCT.—If a corporation elects the application of this subsection (in accordance with regulations prescribed by 

the Secretary) with respect to any organizational expenditures—

‘‘(1) the corporation shall be allowed a deduction for the 

taxable year in which the corporation begins business in an 

amount equal to the lesser of—

238

‘‘(A) the amount of organizational expenditures with respect to the taxpayer, or ‘‘(B) $5,000, reduced (but not below zero) by the 

amount by which such organizational expenditures exceed 

$50,000, and 

‘‘(2) the remainder of such organizational expenditures 

shall be allowed as a deduction ratably over the 180-month period beginning with the month in which the corporation begins 

business.’’. 

(c) TREATMENT OF ORGANIZATIONAL AND SYNDICATION FEES OR

PARTNERSHIPS.— (1) IN GENERAL.—Section 709(b) (relating to amortization of 

organization fees) is amended by redesignating paragraph (2) 

as paragraph (3) and by amending paragraph (1) to read as 

follows: 

‘‘(1) ALLOWANCE OF DEDUCTION.—If a taxpayer elects the 

application of this subsection (in accordance with regulations 

prescribed by the Secretary) with respect to any organizational 

expenses—

‘‘(A) the taxpayer shall be allowed a deduction for the 

taxable year in which the partnership begins business in an 

amount equal to the lesser of—

‘‘(i) the amount of organizational expenses with respect to the partnership, or 

‘‘(ii) $5,000, reduced (but not below zero) by the 

amount by which such organizational expenses exceed 

$50,000, and 

‘‘(B) the remainder of such organizational expenses 

shall be allowed as a deduction ratably over the 180-month 

period beginning with the month in which the partnership 

begins business. 

‘‘(2) DISPOSITIONS BEFORE CLOSE OF AMORTIZATION PERIOD.—In any case in which a partnership is liquidated before 

the end of the period to which paragraph (1)(B) applies, any deferred expenses attributable to the partnership which were not 

allowed as a deduction by reason of this section may be deducted to the extent allowable under section 165.’’. 

(2) CONFORMING AMENDMENT.—Subsection (b) of section 

709 is amended by striking ‘‘AMORTIZATION’’ and inserting ‘‘DE- DUCTION’’ in the heading. 

(d) EFFECTIVE DATE.—The amendments made by this section 

shall apply to amounts paid or incurred after the date of the enactment of this Act. 

SEC. 903. FREEZE OF PROVISIONS REGARDING SUSPENSION OF INTEREST WHERE SECRETARY FAILS TO CONTACT TAXPAYER. 

(a) IN GENERAL.—Section 6404(g) (relating to suspension of interest and certain penalties where Secretary fails to contact taxpayer) is amended by striking ‘‘1-year period (18-month period in 

the case of taxable years beginning before January 1, 2004)’’ both 

places it appears and inserting ‘‘18-month period’’. 

(b) EXCEPTION FOR GROSS MISSTATEMENT.—Section 6404(g)(2) 

(relating to exceptions) is amended by striking ‘‘or’’ at the end of 

subparagraph (C), by redesignating subparagraph (D) as subparagraph (E), and by inserting after subparagraph (C) the following 

new subparagraph: 

239

‘‘(D) any interest, penalty, addition to tax, or additional 

amount with respect to any gross misstatement; or’’. 

(c) EXCEPTION FOR LISTED AND REPORTABLE TRANSACTIONS.—

Section 6404(g)(2) (relating to exceptions), as amended by subsection 

(b), is amended by striking ‘‘or’’ at the end of subparagraph (D), by 

redesignating subparagraph (E) as subparagraph (F), and by inserting after subparagraph (D) the following new subparagraph: 

‘‘(E) any interest, penalty, addition to tax, or additional 

amount with respect to any reportable transaction with respect to which the requirement of section 6664(d)(2)(A) is 

not met and any listed transaction (as defined in 6707A(c)); 

or’’. 

(d) EFFECTIVE DATES.—

(1) IN GENERAL.—Except as provided in paragraph (2), the 

amendments made by this section shall apply to taxable years 

beginning after December 31, 2003. 

(2) EXCEPTION FOR REPORTABLE OR LISTED TRANSACTIONS.—The amendments made by subsection (c) shall apply 

with respect to interest accruing after October 3, 2004. 

SEC. 904. INCREASE IN WITHHOLDING FROM SUPPLEMENTAL WAGE 

PAYMENTS IN EXCESS OF $1,000,000. 

(a) IN GENERAL.—If an employer elects under Treasury Regulation 31.3402(g)–1 to determine the amount to be deducted and withheld from any supplemental wage payment by using a flat percentage rate, the rate to be used in determining the amount to be so deducted and withheld shall not be less than 28 percent (or the corresponding rate in effect under section 1(i)(2) of the Internal Revenue Code of 1986 for taxable years beginning in the calendar year 

in which the payment is made). 

(b) SPECIAL RULE FOR LARGE PAYMENTS.—

(1) IN GENERAL.—Notwithstanding subsection (a), if the 

supplemental wage payment, when added to all such payments 

previously made by the employer to the employee during the calendar year, exceeds $1,000,000, the rate used with respect to 

such excess shall be equal to the maximum rate of tax in effect 

under section 1 of such Code for taxable years beginning in 

such calendar year. 

(2) AGGREGATION.—All persons treated as a single employer 

under subsection (a) or (b) of section 52 of the Internal Revenue 

Code of 1986 shall be treated as a single employer for purposes 

of this subsection. 

(c) CONFORMING AMENDMENT.—Section 13273 of the Revenue 

Reconciliation Act of 1993 (Public Law 103–66) is repealed. 

(d) EFFECTIVE DATE.—The provisions of, and the amendment 

made by, this section shall apply to payments made after December 

31, 2004. 

SEC. 905. TREATMENT OF SALE OF STOCK ACQUIRED PURSUANT TO 

EXERCISE OF STOCK OPTIONS TO COMPLY WITH CONFLICT-OF-INTEREST REQUIREMENTS. 

(a) IN GENERAL.—Section 421 (relating to general rules for certain stock options) is amended by adding at the end the following 

new subsection: 

‘‘(d) CERTAIN SALES TO COMPLY WITH CONFLICT-OF-INTEREST

REQUIREMENTS.—If—

240

‘‘(1) a share of stock is transferred to an eligible person (as 

defined in section 1043(b)(1)) pursuant to such person’s exercise 

of an option to which this part applies, and 

‘‘(2) such share is disposed of by such person pursuant to 

a certificate of divestiture (as defined in section 1043(b)(2)),

such disposition shall be treated as meeting the requirements of section 422(a)(1) or 423(a)(1), whichever is applicable.’’ 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to sales after the date of the enactment of this Act. 

SEC. 906. APPLICATION OF BASIS RULES TO NONRESIDENT ALIENS. 

(a) IN GENERAL.—Section 72 (relating to annuities and certain 

proceeds of endowment and life insurance contracts) is amended by 

redesignating subsection (w) as subsection (x) and by inserting after 

subsection (v) the following new subsection: 

‘‘(w) APPLICATION OF BASIS RULES TO NONRESIDENT ALIENS.—

‘‘(1) IN GENERAL.—Notwithstanding any other provision of 

this section, for purposes of determining the portion of any distribution which is includible in gross income of a distributee 

who is a citizen or resident of the United States, the investment 

in the contract shall not include any applicable nontaxable contributions or applicable nontaxable earnings. 

‘‘(2) APPLICABLE NONTAXABLE CONTRIBUTION.—For purposes of this subsection, the term ‘applicable nontaxable contribution’ means any employer or employee contribution—

‘‘(A) which was made with respect to compensation—

‘‘(i) for labor or personal services performed by an 

employee who, at the time the labor or services were 

performed, was a nonresident alien for purposes of the 

laws of the United States in effect at such time, and

‘‘(ii) which is treated as from sources without the 

United States, and 

‘‘(B) which was not subject to income tax (and would 

have been subject to income tax if paid as cash compensation when the services were rendered) under the laws of the 

United States or any foreign country. 

‘‘(3) APPLICABLE NONTAXABLE EARNINGS.—For purposes of 

this subsection, the term ‘applicable nontaxable earnings’ means 

earnings—

‘‘(A) which are paid or accrued with respect to any employer or employee contribution which was made with respect to compensation for labor or personal services performed by an employee, 

‘‘(B) with respect to which the employee was at the time 

the earnings were paid or accrued a nonresident alien for 

purposes of the laws of the United States, and 

‘‘(C) which were not subject to income tax under the 

laws of the United States or any foreign country. 

‘‘(4) REGULATIONS.—The Secretary shall prescribe such regulations as may be necessary to carry out the provisions of this 

subsection, including regulations treating contributions and 

earnings as not subject to tax under the laws of any foreign 

country where appropriate to carry out the purposes of this subsection.’’

241

(b) BASIS.—Section 83 (relating to property transferred in connection with the performance of services is amended by adding after 

paragraph (3) of subsection (c) the following new paragraph: 

‘‘(4) For purposes of determining an individual’s basis in 

property transferred in connection with the performance of services, rules similar to the rules of section 72(w) shall apply.’’

(c) EFFECTIVE DATE.—The amendments made by this section 

shall apply to distributions on or after the date of the enactment of 

this Act. 

SEC. 907. LIMITATION OF EMPLOYER DEDUCTION FOR CERTAIN ENTERTAINMENT EXPENSES. 

(a) IN GENERAL.—Paragraph (2) of section 274(e) (relating to 

expenses treated as compensation) is amended to read as follows: 

‘‘(2) EXPENSES TREATED AS COMPENSATION.—

‘‘(A) IN GENERAL.—Except as provided in subparagraph 

(B), expenses for goods, services, and facilities, to the extent 

that the expenses are treated by the taxpayer, with respect 

to the recipient of the entertainment, amusement, or recreation, as compensation to an employee on the taxpayer’s return of tax under this chapter and as wages to such employee for purposes of chapter 24 (relating to withholding 

of income tax at source on wages). 

‘‘(B) SPECIFIED INDIVIDUALS.—

‘‘(i) IN GENERAL.—In the case of a recipient who is 

a specified individual, subparagraph (A) and paragraph (9) shall each be applied by substituting ‘to the 

extent that the expenses do not exceed the amount of 

the expenses which’ for ‘to the extent that the expenses’. 

‘‘(ii) SPECIFIED INDIVIDUAL.—For purposes of 

clause (i), the term ‘specified individual’ means any individual who—

‘‘(I) is subject to the requirements of section 

16(a) of the Securities Exchange Act of 1934 with 

respect to the taxpayer, or 

‘‘(II) would be subject to such requirements if 

the taxpayer were an issuer of equity securities referred to in such section.’’

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to expenses incurred after the date of the enactment of 

this Act. 

SEC. 908. RESIDENCE AND SOURCE RULES RELATING TO UNITED 

STATES POSSESSIONS. 

(a) RESIDENCE AND SOURCE RULES.—Subpart D of part III of 

subchapter N of chapter 1 (relating to possessions of the United 

States) is amended by adding at the end the following new section: 

‘‘SEC. 937. RESIDENCE AND SOURCE RULES INVOLVING POSSESSIONS. 

‘‘(a) BONA FIDE RESIDENT.—For purposes of this subpart, section 865(g)(3), section 876, section 881(b), paragraphs (2) and (3) of 

section 901(b), section 957(c), section 3401(a)(8)(C), and section 

7654(a), except as provided in regulations, the term ‘bona fide resident’ means a person—

‘‘(1) who is present for at least 183 days during the taxable 

year in Guam, American Samoa, the Northern Mariana IsVerDate jul 14 2003 20:43 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00245 Fmt 6659 Sfmt 6603 E:\HR\OC\HR755.XXX HR755
242

lands, Puerto Rico, or the Virgin Islands, as the case may be, 

and 

‘‘(2) who does not have a tax home (determined under the 

principles of section 911(d)(3) without regard to the second sentence thereof) outside such specified possession during the taxable year and does not have a closer connection (determined 

under the principles of section 7701(b)(3)(B)(ii)) to the United 

States or a foreign country than to such specified possession. 

For purposes of paragraph (1), the determination as to whether a 

person is present for any day shall be made under the principles of 

section 7701(b). 

‘‘(b) SOURCE RULES.—Except as provided in regulations, for 

purposes of this title—

‘‘(1) except as provided in paragraph (2), rules similar to 

the rules for determining whether income is income from 

sources within the United States or is effectively connected with 

the conduct of a trade or business within the United States 

shall apply for purposes of determining whether income is from 

sources within a possession specified in subsection (a)(1) or effectively connected with the conduct of a trade or business within any such possession, and 

‘‘(2) any income treated as income from sources within the 

United States or as effectively connected with the conduct of a 

trade or business within the United States shall not be treated 

as income from sources within any such possession or as effectively connected with the conduct of a trade or business within 

any such possession. 

‘‘(c) REPORTING REQUIREMENT.—

‘‘(1) IN GENERAL.—If, for any taxable year, an individual 

takes the position for United States income tax reporting purposes that the individual became, or ceases to be, a bona fide 

resident of a possession specified in subsection (a)(1), such individual shall file with the Secretary, at such time and in such 

manner as the Secretary may prescribe, notice of such position. 

‘‘(2) TRANSITION RULE.—If, for any of an individual’s 3 taxable years ending before the individual’s first taxable year ending after the date of the enactment of this subsection, the individual took a position described in paragraph (1), the individual shall file with the Secretary, at such time and in such 

manner as the Secretary may prescribe, notice of such position.’’. 

(b) PENALTY.—Section 6688 is amended—

(1) by inserting ‘‘under section 937(c) or’’ before ‘‘by regulations’’, and 

(2) by striking ‘‘$100’’ and inserting ‘‘$1,000’’. 

(c) CONFORMING AND CLERICAL AMENDMENTS.—

(1) Section 931(d) is amended to read as follows: 

‘‘(d) EMPLOYEES OF THE UNITED STATES.—Amounts paid for 

services performed as an employee of the United States (or any 

agency thereof) shall be treated as not described in paragraph (1) 

or (2) of subsection (a).’’

(2) Section 932 is amended by striking ‘‘at the close of the 

taxable year’’ and inserting ‘‘during the entire taxable year’’ 

each place it appears. 

243

(3) Section 934(b)(4) is amended by striking ‘‘the Virgin Islands or’’ each place it appears. 

(4) Section 935, as in effect before the effective date of its 

repeal, is amended—

(A) by striking ‘‘for the taxable year who’’ in subsection 

(a) and inserting ‘‘who, during the entire taxable year’’, 

(B) by inserting ‘‘bona fide’’ before ‘‘resident’’ in subsection (a)(1), 

(C) in subsection (b)(1)—

(i) by inserting ‘‘(other a bona fide resident of 

Guam during the entire taxable year)’’ after ‘‘United 

States’’ in subparagraph (A), and 

(ii) by inserting ‘‘bona fide’’ before ‘‘resident’’ in 

subparagraph (B), and 

(D) in subsection (b)(2) by striking ‘‘residence and’’. 

(5) Section 957(c) is amended—

(A) in paragraph (2)(B) by striking ‘‘conduct of an active’’ and inserting ‘‘active conduct of a’’, and 

(B) in the last sentence by striking ‘‘derived from 

sources within a possession, was effectively connected with 

the conduct of a trade or business within a possession, or’’. 

(6) The table of sections of subpart D of part III of subchapter N of chapter 1 is amended by adding at the end the following new item:

‘‘Sec. 937. Residence and source rules involving possessions.’’.

(d) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as otherwise provided in this subsection, the amendments made by this section shall apply to 

taxable years ending after the date of the enactment of this Act. 

(2) 183-DAY RULE.—Section 937(a)(1) of the Internal Revenue Code of 1986 (as added by this section) shall apply to taxable years beginning after the date of the enactment of this Act. 

(3) SOURCING.—Section 937(b)(2) of such Code (as so 

added) shall apply to income earned after the date of the enactment of this Act.

SEC. 909. SALES OR DISPOSITIONS TO IMPLEMENT FEDERAL ENERGY 

REGULATORY COMMISSION OR STATE ELECTRIC RESTRUCTURING POLICY. 

(a) IN GENERAL.—Section 451 (relating to general rule for taxable year of inclusion) is amended by adding at the end the following new subsection: 

‘‘(i) SPECIAL RULE FOR SALES OR DISPOSITIONS TO IMPLEMENT

FEDERAL ENERGY REGULATORY COMMISSION OR STATE ELECTRIC

RESTRUCTURING POLICY.—

‘‘(1) IN GENERAL.—In the case of any qualifying electric 

transmission transaction for which the taxpayer elects the application of this section, qualified gain from such transaction 

shall be recognized—

‘‘(A) in the taxable year which includes the date of such 

transaction to the extent the amount realized from such 

transaction exceeds—

‘‘(i) the cost of exempt utility property which is purchased by the taxpayer during the 4-year period beginning on such date, reduced (but not below zero) by 

244

‘‘(ii) any portion of such cost previously taken into 

account under this subsection, and 

‘‘(B) ratably over the 8-taxable year period beginning 

with the taxable year which includes the date of such transaction, in the case of any such gain not recognized under 

subparagraph (A). 

‘‘(2) QUALIFIED GAIN.—For purposes of this subsection, the 

term ‘qualified gain’ means, with respect to any qualifying electric transmission transaction in any taxable year— 

‘‘(A) any ordinary income derived from such transaction which would be required to be recognized under section 1245 or 1250 for such taxable year (determined without regard to this subsection), and 

‘‘(B) any income derived from such transaction in excess of the amount described in subparagraph (A) which is 

required to be included in gross income for such taxable 

year (determined without regard to this subsection). 

‘‘(3) QUALIFYING ELECTRIC TRANSMISSION TRANSACTION.—

For purposes of this subsection, the term ‘qualifying electric 

transmission transaction’ means any sale or other disposition 

before January 1, 2007, of—

‘‘(A) property used in the trade or business of providing 

electric transmission services, or 

‘‘(B) any stock or partnership interest in a corporation 

or partnership, as the case may be, whose principal trade 

or business consists of providing electric transmission services, 

but only if such sale or disposition is to an independent transmission company. 

‘‘(4) INDEPENDENT TRANSMISSION COMPANY.—For purposes 

of this subsection, the term ‘independent transmission company’ 

means—

‘‘(A) an independent transmission provider approved by 

the Federal Energy Regulatory Commission, 

‘‘(B) a person—

‘‘(i) who the Federal Energy Regulatory Commission determines in its authorization of the transaction 

under section 203 of the Federal Power Act (16 U.S.C. 

824b) or by declaratory order is not a market participant within the meaning of such Commission’s rules 

applicable to independent transmission providers, and 

‘‘(ii) whose transmission facilities to which the election under this subsection applies are under the operational control of a Federal Energy Regulatory Commission-approved independent transmission provider 

before the close of the period specified in such authorization, but not later than the close of the period applicable under subsection (a)(2)(B) as extended under 

paragraph (2), or 

‘‘(C) in the case of facilities subject to the jurisdiction 

of the Public Utility Commission of Texas—

‘‘(i) a person which is approved by that Commission as consistent with Texas State law regarding an 

independent transmission provider, or 

245

‘‘(ii) a political subdivision or affiliate thereof 

whose transmission facilities are under the operational 

control of a person described in clause (i). 

‘‘(5) EXEMPT UTILITY PROPERTY.—For purposes of this subsection—

‘‘(A) IN GENERAL.—The term ‘exempt utility property’ 

means property used in the trade or business of—

‘‘(i) generating, transmitting, distributing, or selling electricity, or 

‘‘(ii) producing, transmitting, distributing, or selling natural gas. 

‘‘(B) NONRECOGNITION OF GAIN BY REASON OF ACQUISI- TION OF STOCK.—Acquisition of control of a corporation 

shall be taken into account under this subsection with respect to a qualifying electric transmission transaction only 

if the principal trade or business of such corporation is a 

trade or business referred to in subparagraph (A). 

‘‘(6) SPECIAL RULE FOR CONSOLIDATED GROUPS.—In the case 

of a corporation which is a member of an affiliated group filing 

a consolidated return, any exempt utility property purchased by 

another member of such group shall be treated as purchased by 

such corporation for purposes of applying paragraph (1)(A). 

‘‘(7) TIME FOR ASSESSMENT OF DEFICIENCIES.—If the taxpayer has made the election under paragraph (1) and any gain 

is recognized by such taxpayer as provided in paragraph (1)(B), 

then—

‘‘(A) the statutory period for the assessment of any deficiency, for any taxable year in which any part of the gain 

on the transaction is realized, attributable to such gain 

shall not expire prior to the expiration of 3 years from the 

date the Secretary is notified by the taxpayer (in such manner as the Secretary may by regulations prescribe) of the 

purchase of exempt utility property or of an intention not 

to purchase such property, and 

‘‘(B) such deficiency may be assessed before the expiration of such 3-year period notwithstanding any law or rule 

of law which would otherwise prevent such assessment. 

‘‘(8) PURCHASE.—For purposes of this subsection, the taxpayer shall be considered to have purchased any property if the 

unadjusted basis of such property is its cost within the meaning 

of section 1012. 

‘‘(9) ELECTION.—An election under paragraph (1) shall be 

made at such time and in such manner as the Secretary may 

require and, once made, shall be irrevocable. 

‘‘(10) NONAPPLICATION OF INSTALLMENT SALES TREAT- MENT.—Section 453 shall not apply to any qualifying electric 

transmission transaction with respect to which an election to 

apply this subsection is made.’’. 

(b) EFFECTIVE DATE.—The amendments made by this section 

shall apply to transactions occurring after the date of the enactment 

of this Act, in taxable years ending after such date. 

SEC. 910. EXPANSION OF LIMITATION ON DEPRECIATION OF CERTAIN 

PASSENGER AUTOMOBILES. 

(a) IN GENERAL.—Section 179(b) (relating to limitations) is 

amended by adding at the end the following new paragraph: 

246

‘‘(6) LIMITATION ON COST TAKEN INTO ACCOUNT FOR CERTAIN PASSENGER VEHICLES.— 

‘‘(A) IN GENERAL.—The cost of any sport utility vehicle 

for any taxable year which may be taken into account 

under this section shall not exceed $25,000. 

‘‘(B) SPORT UTILITY VEHICLE.—For purposes of subparagraph (A)— 

‘‘(i) IN GENERAL.—The term ‘sport utility vehicle’ 

means any 4-wheeled vehicle— 

‘‘(I) which is primarily designed or which can 

be used to carry passengers over public streets, 

roads, or highways (except any vehicle operated exclusively on a rail or rails), 

‘‘(II) which is not subject to section 280F, and 

‘‘(III) which is rated at not more than 14,000 

pounds gross vehicle weight. 

‘‘(ii) CERTAIN VEHICLES EXCLUDED.—Such term 

does not include any vehicle which— 

‘‘(I) is designed to have a seating capacity of 

more than 9 persons behind the driver’s seat, 

‘‘(II) is equipped with a cargo area of at least 

6 feet in interior length which is an open area or 

is designed for use as an open area but is enclosed 

by a cap and is not readily accessible directly from 

the passenger compartment, or 

‘‘(III) has an integral enclosure, fully enclosing 

the driver compartment and load carrying device, 

does not have seating rearward of the driver’s seat, 

and has no body section protruding more than 30 

inches ahead of the leading edge of the windshield.’’. 

(b) EFFECTIVE DATE.—The amendment made by this section 

shall apply to property placed in service after the date of the enactment of this Act.

And the Senate agree to the same.

From the Committee on Ways and Means, for consideration of the House bill and the Senate amendment, and 

modifications committed to conference: 

WILLIAM M. THOMAS, 

PHIL CRANE, 

JIM MCCRERY, 

From the Committee on Agriculture, for consideration of 

Title VII of the House bill, and subtitle B of Title XI of the 

Senate amendment, and modifications committed to conference: 

BOB GOODLATTE, 

JOHN BOEHNER, 

CHARLIE STENHOLM, 

From the Committee on Education and the Workforce, for 

consideration of sections 489, 489, 616, 701, and 719 of the 

Senate amendment, and modifications committed to conference: 

JOHN BOEHNER, 

SAM JOHNSON, 

247

From the Committee on Energy and Commerce, for consideration of sections 662 and subtitle A of Title XI of the 

Senate amendment, and modifications committed to conference: 

JOE BARTON, RICHARD BURR, From the Committee on the Judiciary, for consideration of 

sections 422, 442, 1111, 1151, and 1161 of the Senate 

amendment, and modifications committed to conference: 

LAMAR SMITH, For consideration of the House bill and the Senate amendment, and modifications committed to conference: 

TOM DELAY, 

Managers on the Part of the House.

CHUCK GRASSLEY, 

ORRIN HATCH, 

DON NICKLES, 

TRENT LOTT, 

OLYMPIA SNOWE, 

JON KYL, 

CRAIG THOMAS, 

RICK SANTORUM, 

GORDON SMITH, 

JIM BUNNING, 

MITCH MCCONNELL, 

MAX BAUCUS, 

TOM DASCHLE, 

JOHN BREAUX, 

KENT CONRAD, 

JEFF BINGAMAN, 

BLANCHE L. LINCOLN, 

Managers on the Part of the Senate. 

(249)

JOINT EXPLANATORY STATEMENT OF THE COMMITTEE OF 

CONFERENCE 

The managers on the part of the House and the Senate at the 

conference on the disagreeing votes of the two Houses on the 

amendment of the Senate to the bill (H.R. 4520), to amend the Internal Revenue Code of 1986 to remove impediments in such Code 

and make our manufacturing, service, and high-technology businesses and workers more competitive and productive both at home 

and abroad, submit the following joint statement to the House and 

the Senate in explantion of the effect of the action agreed upon by 

the managers and recommended in the accompanying conference 

report: 

The Senate amendment struck all of the House bill after the 

enacting clause and inserted a substitute text. 

The House recedes from its disagreement to the amendment of 

the Senate with an amendment that is a substitute for the House 

bill and the Senate amendment. The differences between the House 

bill, the Senate amendment, and the substitute agreed to in conference are noted below, except for clerical corrections, conforming 

changes made necessary by agreements reached by the conferees, 

and minor drafting and clarifying changes.

CONTENTS 

Page 

Title I—Provisions Relating to Repeal of Exclusion for Extraterritorial Income ....................................................................................................................... 262

A. Repeal of Extraterritorial Income Regime (sec. 101 of the House bill, 

sec. 101 of the Senate amendment, and secs. 114 and 941 through 

943 of the Code) ............................................................................................ 262

B. Deduction Relating to Income Attributable to United States Production Activities (sec. 102 of the House bill, secs. 102 and 103 of the 

Senate amendment, and sec. 11 of the Code) ............................................. 265

C. Reduced Corporate Income Tax Rate for Small Corporations (sec. 103 

of the House bill and sec. 11 of the Code) ................................................... 275

Title II—Provisions Relating to Job Creation Tax Incentives for Manufacturers, Small Businesses, and Farmers .................................................................. 277

A. Section 179 Expensing (sec. 201 of the House bill, sec. 309 of the 

Senate amendment and sec. 179 of the Code) ............................................ 277

B. Depreciation ................................................................................................ 279

1. Recovery period for depreciation of certain leasehold improvements (sec. 211 of the House bill and sec. 168 of the Code) .............. 279

2. Recovery period for depreciation of certain restaurant improvements (sec. 211 of the House bill and sec. 168 of the Code) .............. 281

3. Extended placed in service date for bonus depreciation for certain 

aircraft (excluding aircraft used in the transportation industry) 

(sec. 212 of the House bill, sec. 622 of the Senate amendment, 

and sec. 168 of the Code) ...................................................................... 282

4. Special placed in service rule for bonus depreciation for certain 

property subject to syndication (sec. 213 of the House bill, sec. 

621 of the Senate amendment, and sec. 168 of the Code) .................. 285

C. S Corporation Reform and Simplification (sec. 221–231 of the House 

bill, sec. 654 of the Senate amendment and secs. 1361–1379 and 4975 

of the Code) ................................................................................................... 286

250

1. Members of family treated as one shareholder .................................. 287

2. Increase in number of eligible shareholders to 100 ........................... 288

3. Expansion of bank S corporation eligible shareholders to include 

IRAs ........................................................................................................ 289 

4. Disregard of unexercised powers of appointment in determining 

potential current beneficiaries of ESBT ............................................... 290

5. Transfers of suspended losses incident to divorce, etc ...................... 290

6. Use of passive activity loss and at-risk amounts by qualified subchapter S trust income beneficiaries .................................................... 291

7. Exclusion of investment securities income from passive investment 

income test for bank S corporations ..................................................... 291

8. Treatment of bank director shares ..................................................... 292

9. Relief from inadvertently invalid qualified subchapter S subsidiary 

elections and terminations .................................................................... 294

10. Information returns for qualified subchapter S subsidiaries ......... 294

11. Repayment of loans for qualifying employer securities .................. 294

D. Alternative Minimum Tax Relief ............................................................... 297

1. Repeal limitation on use of foreign tax credit (sec. 241 of the 

House bill, sec. 203 of the Senate amendment, and sec. 59 of 

the Code) ................................................................................................ 297

2. Expansion of exemption from alternative minimum tax for small 

corporations (sec. 242 of the House bill and sec. 55 of the Code) ...... 298

3. Coordinate farmer and fisherman income averaging and the alternative minimum tax (sec. 243 of the House bill and secs. 55 and 

1301 of the Code) ................................................................................... 298

E. Restructuring of Incentives for Alcohol Fuels, Etc .................................. 299

1. Incentives for alcohol and biodiesel fuels (secs. 251 and 252 of 

the House bill, sec. 861 of the Senate amendment, and secs. 4041, 

4081, 4091, 6427, 9503 and new section 6426 of the Code) ............... 299

2. Biodiesel income tax credit (sec. 862 of the bill and new sec. 

40A of the Code) ..................................................................................... 309

F. Exclusion of Incentive Stock Options and Employee Stock Purchase 

Plan Stock Options From Wages (sec. 261 of the House bill and secs. 

421(b), 423(c), 3121(a), 3231, and 3306(b) of the Code) ............................. 310

G. Incentives To Reinvest Foreign Earnings in the United States (sec. 

271 of the House bill, sec. 231 of the Senate amendment, and new 

sec. 965 of the Code) ..................................................................................... 312

H. Other Incentive Provisions ........................................................................ 317

1. Special rules for livestock sold on account of weather-related conditions (sec. 281 of the House bill, sec. 649 of the Senate amendment, and secs. 1033 and 451 of the Code) ......................................... 317

2. Payment of dividends on stock of cooperatives without reducing 

patronage dividends (sec. 282 of the House bill, sec. 648 of the 

Senate amendment, and sec. 1388 of the Code) .................................. 318

3. Manufacturing relating to timber ....................................................... 319

a. Capital gains treatment to apply to outright sales of timber 

by landowner (sec. 283 of the House bill, sec. 333 of the Senate 

amendment, and sec. 631(b) of the Code) ..................................... 319

b. Expensing of reforestation expenditures (sec. 331 of the Senate amendment and secs. 48 and 194 of the Code) ...................... 320

c. Election to treat cutting of timber as a sale or exchange (sec. 

102(b) of the House bill, sec. 332 of the Senate amendment, 

and sec. 631(a) of the Code) ........................................................... 321

d. Modified safe harbor rules for timber REITs (sec. 334 of the 

Senate amendment and sec. 857 of the Code) .............................. 321

4. Net income from publicly traded partnerships treated as qualifying income of regulated investment company (sec. 284 of the 

House bill, sec. 899 of the Senate amendment, and secs. 851(b), 

469(k), 7704(d) and new sec. 851(h) of the Code) ............................... 325

5. Improvements related to real estate investment trusts (sec. 285 

of the House bill and secs. 856, 857 and 860 of the Code) ................. 327

6. Treatment of certain dividends of regulated investment companies 

(sec. 286 of the House bill and secs. 871 and 881 of the Code) .......... 336

7. Taxation of certain settlement funds (sec. 287 of the House bill 

and sec. 468B of the Code) .................................................................... 341

251

8. Expand human clinical trials expenses qualifying for the orphan 

drug tax credit (sec. 288 of the House bill and sec. 45C of the 

Code) ....................................................................................................... 342

9. Simplification of excise tax imposed on bows and arrows (sec. 

289 of the House bill, sec. 305 of the Senate amendment, and 

sec. 4161 of the Code) ............................................................................ 343

10. Reduce rate of excise tax on fishing tackle boxes to three percent 

(sec. 290 of the House bill and sec. 4162 of the Code) ........................ 344

11. Repeal of excise tax on sonar devices suitable for finding fish 

(sec. 291 of the House bill and secs. 4161 and 4162 of the Code) ...... 345

12. Income tax credit for cost of carrying tax-paid distilled spirits 

in wholesale inventories (sec. 292 of the House bill) .......................... 345

13. Suspension of occupational taxes relating to distilled spirits, 

wine, and beer (sec. 293 of the House bill and new sec. 5148 

of the Code) ............................................................................................ 346

14. Modification of unrelated business income limitation on investment in certain small business investment companies (sec. 294 

of the House bill, sec. 642 of the Senate amendment, and sec. 

514 of the Code) ..................................................................................... 348

15. Election to determine taxable income from certain international 

shipping activities using per ton rate (sec. 295 of the House bill 

and new secs. 1352–1359 of the Code) ................................................. 349

16. Charitable contribution deduction for certain expenses in support 

of Native Alaskan subsistence whaling (sec. 296 of the House bill 

and sec. 170 of the Code) ...................................................................... 355

I. General Provisions ....................................................................................... 357

1. Modification to qualified small issue bonds (sec. 301 of the Senate 

amendment and sec. 144 of the Code) ................................................. 357

2. Expensing of investment in broadband equipment (sec. 302 of 

the Senate amendment and new sec. 191 of the Code) ...................... 358

3. Exemption for natural aging process from interest capitalization 

(sec. 303 of the Senate amendment and sec. 263A of the Code) ........ 359

4. Section 355 ‘‘active business test’’ applied to chains of affiliated 

corporations (sec. 304 of the Senate amendment and sec. 355 of 

the Code) ................................................................................................ 360

5. Modification to cooperative marketing rules to include value-added 

processing involving animals (sec. 306 of the Senate amendment 

and sec. 1388 of the Code) .................................................................... 362

6. Extension of declaratory judgment procedures to farmers’ cooperative organizations (sec. 307 of the Senate amendment and sec. 

7428 of the Code) ................................................................................... 363

7. Temporary suspension of personal holding company tax (sec. 308 

of the Senate amendment and sec. 541 of the Code) .......................... 364

8. 5-year NOL carryback for 2003 NOLs if taxpayer elects out of 

bonus depreciation as modified; extend temporary suspension of 

90-percent limit on minimum tax NOLs (sec. 310 of the Senate 

amendment and sec. 172 of the Code) ................................................. 366

9. Manufacturer’s jobs credit (sec. 313 of the Senate amendment) ...... 367

10. Brownfields demonstration program for qualified green building 

and sustainable design projects (sec. 314 of the Senate amendment 

and secs. 142 and 146 of the Code) ...................................................... 368

J. Manufacturing Relating to Films ............................................................... 371

1. Special rules for certain film and television production (sec. 321 

of the Senate amendment and new sec. 181 of the Code) .................. 371

2. Modification of application of income forecast method of depreciation (sec. 322 of the Senate amendment and sec. 167 of the Code) ... 373

Title III—Provisions Relating to Tax Reform and Simplification for United 

States Businesses ................................................................................................. 375

1. Interest expense allocation rules (sec. 301 of the House bill, sec. 

205 of the Senate amendment, and sec. 864 of the Code) .................. 375

2. Recharacterize overall domestic loss (sec. 302 of the House bill, 

sec. 204 of the Senate amendment, and sec. 904 of the Code) ........... 379

3. Foreign tax credit baskets and ‘‘base differences’’ (sec. 303 of the 

House bill, sec. 225 of the Senate amendment, and sec. 904 of 

the Code) ................................................................................................ 381

252

4. Apply look-through rules for dividends from noncontrolled section 

902 corporations (sec. 304 of the House bill, sec. 202 of the Senate 

amendment, and sec. 904 of the Code) ................................................ 385

5. Attribution of stock ownership through partnerships in determining section 902 and 960 credits (sec. 305 of the House bill, 

sec. 213 of the Senate amendment, and sec. 902 of the Code) ........... 386

6. Foreign tax credit treatment of deemed payments under section 

367(d) of the Code (sec. 306 of the House bill, sec. 229 of the 

Senate amendment, and sec. 367(d) of the Code) ............................... 388

7. United States property not to include certain assets of controlled 

foreign corporations (sec. 307 of the House bill, sec. 227 of the 

Senate amendment, and sec. 956 of the Code) .................................... 389

8. Election not to use average exchange rate for foreign tax paid 

other than in functional currency (sec. 308 of the House bill, sec. 

224 of the Senate amendment, and sec. 986 of the Code) .................. 391

9. Eliminate secondary withholding tax with respect to dividends 

paid by certain foreign corporations (sec. 309 of the House bill, 

sec. 215 of the Senate amendment, and sec. 871 of the Code) ........... 392

10. Equal treatment for interest paid by foreign partnerships and 

foreign corporations (sec. 310 of the House bill, sec. 228 of the 

Senate amendment, and sec. 861 of the Code) .................................... 394

11. Look-through treatment of payments between related controlled 

foreign corporations (sec. 311 of the House bill, sec. 222 of the 

Senate amendment, and sec. 954 of the Code) .................................... 395

12. Look-through treatment under subpart F for sales of partnership 

interests (sec. 312 of the House bill, sec. 223 of the Senate amendment, and sec. 954 of the Code) ............................................................ 396

13. Repeal of foreign personal holding company rules and foreign 

investment company rules (sec. 313 of the House bill, sec. 211 

of the Senate amendment, and secs. 542, 551–558, 954, 1246, and 

1247 of the Code) ................................................................................... 397

14. Determination of foreign personal holding company income with 

respect to transactions in commodities (sec. 314 of the House bill, 

sec. 206 of the Senate amendment, and sec. 954 of the Code) ........... 398

15. Modification to treatment of aircraft leasing and shipping income 

(sec. 315 of the House bill, sec. 221 of the Senate amendment, 

and sec. 954 of the Code) ...................................................................... 400

16. Modification of exceptions under subpart F for active financing 

(sec. 316 of the House bill, sec. 226 of the Senate amendment, 

and sec. 954 of the Code) ...................................................................... 404

17. Ten-year foreign tax credit carryover; one-year foreign tax credit 

carryback (sec. 201 of the Senate amendment and sec. 904 of 

the Code) ................................................................................................ 406

18. Expand the subpart F de minimis rule to the lesser of five 

percent of gross income or $5 million (sec. 212 of the Senate 

amendment and sec. 954 of the Code) ................................................. 407

19. Limit application of uniform capitalization rules in the case of 

foreign persons (sec. 214 of the Senate amendment and sec. 263A 

of the Code) ............................................................................................ 408

20. Eliminate the 30-percent tax on certain U.S.-source capital gains 

of nonresident individuals (sec. 216 of the Senate amendment and 

sec. 871 of the Code) .............................................................................. 410

21. Modify FIRPTA rules for real estate investment trusts (sec. 230 

of the Senate amendment and sec. 857 and 897 of the Code) ........... 412

22. Exclusion of certain horse-racing and dog-racing gambling 

winnings from the income of nonresident alien individuals (sec. 

232 of the Senate amendment and sec. 872 of the Code) ................... 413

23. Limitation of withholding on U.S.-source dividends paid to Puerto Rico corporation (sec. 233 of the Senate amendment and sec. 

881 and 1442 of the Code) .................................................................... 415

24. Require Commerce Department report on adverse decisions of 

the World Trade Organization (sec. 234 of the Senate amendment) 416

25. Study of impact of international tax law on taxpayers other 

than large corporations (sec. 235 of the Senate amendment) ............ 417

26. Delay in effective date of final regulations governing exclusion 

of income from international operations of ships and aircraft (sec. 

236 of the Senate amendment and sec. 883 of the Code) ................... 418

253

27. Interest payments deductible where taxpayer could have borrowed without a guarantee (sec. 237 of the Senate amendment 

and sec. 163(j) of the Code) ................................................................... 419

Title IV—Extension of Certain Expiring Provisions ............................................. 419

28. Nonrefundable personal credits allowed against the alternative 

minimum tax (‘‘AMT’’) (sec. 401 of the House bill, sec. 713 of 

the Senate amendment, and sec. 26 of the Code) ............................... 419

29. Extension and modification of the research credit (sec. 402 of 

the House bill, secs. 311 and 312 of the Senate amendment, and 

sec. 41 of the Code) ................................................................................ 420

30. Extension of credit for electricity produced from certain renewable resources (sec. 403 of the House bill, secs. 714 and 8801 

of the Senate amendment, and sec. 45 of the Code) ........................... 421

31. Indian employment tax credit (sec. 404 of the House bill, sec. 

716 of the Senate amendment, and sec. 45A of the Code) ................. 422

32. Extension of the work opportunity tax credit (sec. 405 of the 

House bill, sec. 702 of the Senate amendment, and sec. 51 of 

the Code) ................................................................................................ 423

33. Extension of the welfare-to-work tax credit (sec. 406 of the House 

bill, sec. 702 of the Senate amendment, and sec. 51A of the Code) .. 425

34. Combination and modification of the work opportunity tax credit 

and the welfare-to-work tax credit (sec. 703 of the Senate amendment and sec. 51 of the Code) ............................................................... 427

35. Certain expenses of elementary and secondary school teachers 

(sec. 407 of the House bill, sec. 707 of the Senate amendment, 

and sec. 62 of the Code) ........................................................................ 428

36. Accelerated depreciation for business property on Indian reservations (sec. 408 of the House bill, sec. 717 of the Senate amendment, 

and sec. 168 of the Code) ...................................................................... 429

37. Charitable contributions of computer technology and equipment 

used for educational purposes and of scientific property used for 

research (sec. 409 of the House bill, sec. 706 of the Senate amendment, and sec. 170 of the Code) ............................................................ 430

38. Expensing of environmental remediation costs (sec. 410 of the 

House bill, sec. 708 of the Senate amendment, and sec. 198 of 

the Code) ................................................................................................ 431

39. Availability of Archer medical savings accounts (sec. 411 of the 

House bill and sec. 220 of the Code) .................................................... 431

40. Suspension of 100-percent-of-net-income limitation on percentage 

depletion for oil and gas from marginal wells (sec. 412 of the 

House bill, secs. 715 and 846 of the Senate amendment, and sec. 

613A of the Code) ................................................................................... 433

41. Qualified zone academy bonds (sec. 413 of the House bill, secs. 

612 and 704 of the Senate amendment, and sec. 1397E of the 

Code) ....................................................................................................... 435

42. Tax Incentives for Investment in the District of Columbia (sec. 

414 of the House bill, sec. 711 of the Senate amendment, and 

secs. 1400, 1400A, and 1400C of the Code) ......................................... 436

43. Modifications to New York Liberty Zone bond provisions (sec. 

415 of the House bill, secs. 611 and 709 of the Senate amendment, 

and sec. 1400L of the Code) .................................................................. 436

44. Qualified New York Liberty Zone leasehold improvement election 

out (sec. 709(c) of the Senate amendment) .......................................... 437

45. Disclosures relating to terrorist activities (sec. 416 of the House 

bill and sec. 6103 of the Code) .............................................................. 438

46. Disclosure of return information relating to student loans (sec. 

417 of the House bill, sec. 718 of the Senate amendment, and 

sec. 6103(l) of the Code) ........................................................................ 440

47. Extension of cover over of excise tax on distilled spirits to Puerto 

Rico and Virgin Islands (sec. 418 of the House bill, sec. 705 of 

the Senate amendment, and sec. 7652 of the Code) ........................... 441

48. Joint review of strategic plans and budget for the IRS (sec. 

419 of the House bill and secs. 8021 and 8022 of the Code) .............. 442

49. Extension of parity in the application of certain limits to mental 

health benefits (sec. 420 of the House bill, sec. 701 of the Senate 

amendment, and sec. 9812 of the Code, sec. 712 of ERISA, and 

section 2705 of the PHSA) .................................................................... 442

254

50. Combined employment tax reporting (sec. 421 of the House bill 

and sec. 712 of the Senate amendment) .............................................. 444

51. Deduction for qualified clean-fuel vehicle property (sec. 422 of 

the House bill, sec. 721 of the Senate amendment, and sec. 179 

of the Code) ............................................................................................ 445

52. Credit for qualified electric vehicles (sec. 422 of the House bill, 

sec. 720 of the Senate amendment, and sec. 30 of the Code) ............. 445

53. Repeal of reduction of deductions for mutual life insurance companies (sec. 710 of the Senate amendment and sec. 809 of the 

Code) ....................................................................................................... 446

54. Study of earnings stripping provisions (sec. 163(j) of the Code) .... 447

Title V—Deduction of State and Local General Sales Taxes ............................... 448

A. Deduction of State and Local General Sales Taxes (sec. 501 of the 

House bill and sec. 164 of the Code) ........................................................... 448

Title VI—Fair and Equitable Tobacco Reform ...................................................... 450

A. Tobacco Reform (secs. 701–725 of the House bill and title XI of the 

Senate amendment) ...................................................................................... 450

Title VII—Protection of United States Workers From Competition of Foreign 

Workforces ............................................................................................................ 452

Title VIII—Other Provisions ................................................................................... 452

A. Provisions Relating to Housing .................................................................. 452

1. Treatment of qualified mortgage revenue bonds (sec. 601 of the 

Senate amendment and sec. 143 of the Code) ..................................... 452

2. Premiums for mortgage insurance (sec. 602 of the Senate amendment and secs. 163(h) and 6050H of the Code) ................................... 453

3. Increase in historic rehabilitation credit for residential housing 

for the elderly (sec. 603 of the Senate amendment and secs. 42 

and 47 of the Code) ................................................................................ 455

B. Provisions Relating to Bonds ..................................................................... 456

1. Modification of the authority of Indian tribal governments to issue 

tax-exempt bonds (sec. 613 of the Senate amendment and sec. 

7871 of the Code) ................................................................................... 456

2. Definition of manufacturing facility for qualified small issue bonds 

(sec. 614 of the Senate amendment and sec. 144 of the Code) .......... 457

3. Qualified forest conservation bonds (sec. 615 of the Senate amendment and sec. 142 of the Code) ............................................................. 458

4. Qualified tribal school modernization bonds (sec. 616 of the Senate 

amendment) ........................................................................................... 460

C. Provisions Relating to Depreciation .......................................................... 461

1. 7-year recovery period for certain track facilities (sec. 623 of the 

Senate amendment and sec. 168 of the Code) ..................................... 461

2. Alternative minimum tax and credits (sec. 624 of the Senate 

amendment and secs. 38 and 53 of the Code) ..................................... 462

D. Expansion of Business Credit .................................................................... 463

1. New markets tax credit for Native American reservations (sec. 

631 of the Senate amendment) ............................................................. 463

2. Ready Reserve-National Guard employee credit and Ready Reserve-National Guard replacement employee credit (sec. 632 of the 

Senate amendment) ............................................................................... 465

3. Rural investment tax credit (sec. 633 of the Senate amendment 

and new sec. 42A of the Code) .............................................................. 466

4. Qualified small business rural investment tax credit (sec. 634 

of the Senate amendment and new sec. 42B of the Code) ................. 468

5. Provide a tax credit or maintenance of railroad track (sec. 635 

of the Senate amendment and new sec. 45I of the Code) ................... 469

6. Railroad revitalization and security investment credit (sec. 636 

of the Senate amendment) .................................................................... 470

7. Special allocation of the railroad revitalization and security investment credit for New York city rail projects (sec. 636 of the Senate 

amendment) ........................................................................................... 471

8. Modification of targeted areas and low-income communities designated for new markets tax credit (sec. 637 of the Senate amendment and sec. 45D of the Code) ............................................................ 471

9. Modification of income requirement for census tracts within high 

migration rural counties for new markets tax credit (sec. 638 of 

the Senate amendment and sec. 45D of the Code) ............................. 473

255

10. Provide a tax credit for expenditures on closed captioning technology in movies (sec. 639 of the Senate amendment and new 

sec. 45T of the Code) ............................................................................. 475

E. Miscellaneous Provisions ............................................................................ 476

1. Exclusion of gain or loss on sale or exchange of certain brownfield 

sites from unrelated business taxable income (sec. 641 of the Senate amendment and secs. 512 and 514 of the Code) ........................... 476

2. Civil rights tax relief (sec. 643 of the Senate amendment and 

sec. 62 of the Code) ................................................................................ 483

3. Exclusion from gross income for amounts paid under National 

Health Service Corps loan repayment program (sec. 644 of the 

Senate amendment and sec. 108 of the Code) ..................................... 485

4. Certain expenses of rural letter carriers (sec. 645 of the Senate 

amendment and sec. 162(o) of the Code) ............................................. 486

5. Method of accounting for naval shipbuilders (sec. 646 of the Senate amendment) ..................................................................................... 486

6. Distributions to shareholders from policyholders surplus account 

of life insurance companies (sec. 647 of the Senate amendment 

and sec. 815 of the Code) ...................................................................... 487

7. Motor vehicle dealer transitional assistance (sec. 650 of the Senate 

amendment) ........................................................................................... 489

8. Expansion of designated renewal community area based on 2000 

census data (sec. 651 of the Senate amendment and sec. 1400E 

of the Code) ............................................................................................ 490

9. Reduction of holding period to 12 months for purposes of determining whether horses are section 1231 assets (sec. 652 of the 

Senate amendment and sec. 1231 of the Code) ................................... 491

10. Blue ribbon commission on comprehensive tax reform (sec. 653 

of the Senate amendment) .................................................................... 492

11. Temporary accumulated earnings tax safe harbor (sec. 655 of 

the Senate amendment and sec. 537 of the Code) .............................. 492

12. Tax Treatment of State Ownership of Railroad REIT (sec. 656 

of the Senate amendment and secs. 103, 115, 336 and 337 of 

the Code) ................................................................................................ 494

13. Contribution in aid of construction (sec. 657 of the Senate 

amendment and sec. 118 of the Code) ................................................. 495

14. Credit for purchase and installation of agricultural water conservation systems (sec. 658 of the Senate amendment) ..................... 496

15. Modification of involuntary conversion rules for businesses affected by the September 11th terrorist attacks (sec. 659 of the 

Senate amendment and sec. 1400L of the Code) ................................ 497

16. Repeal of application of below-market loan rules to amounts 

paid to certain continuing care facilities (sec. 660 of the Senate 

amendment and sec. 7872 of the Code) ............................................... 498

17. Maximum capital gain rates of individuals for gold, silver, platinum, and palladium (sec. 661 of the Senate amendment and sec. 

1(h) of the Code) ..................................................................................... 499

18. Inclusion of primary and secondary medical strategies for children and adults with sickle cell disease as medical assistance 

under the medicaid program (sec. 662 of the Senate amendment) ... 500

19. Mortgage payment assistance (secs. 901 and 902 of the Senate 

amendment) ........................................................................................... 502

20. Protection of overtime pay (secs. 489–490 of the Senate amendment and sec. 13 of the Fair Labor Standards Act of 1938) .............. 503

21. Report on acquisitions of goods from foreign sources (sec. 1001 

of the Senate amendment and sec. 43 of the Office of Federal 

Procurement Policy Act) ........................................................................ 504

22. Minimum cost requirement for excess asset transfers (sec. 719 

of the Senate amendment and sec. 420 of the Code) .......................... 505

Title IX—Energy Tax Incentives ............................................................................ 507

A. Credit for Electricity Produced from Certain Sources (sec. 801 of the 

Senate amendment and sec. 45 of the Code) .............................................. 507

B. Alternative Motor Vehicles and Fuels Incentives .................................... 513

1. Alternative motor vehicle credit (sec. 811 of the Senate amendment) ....................................................................................................... 513

2. Modification of credit for electric vehicles (sec. 812 of Senate 

amendment and sec. 30 of the Code) ................................................... 515

256

3. Modifications of deduction for refueling property (sec. 813 of Senate amendment and sec. 179A of the Code) ........................................ 516

4. Credit for retail sale of alternative motor vehicle fuels (sec. 814 

of Senate amendment) ........................................................................... 516

5. Small ethanol producer credit (sec. 815 of the Senate amendment 

and sec. 40 of the Code) ........................................................................ 517

C. Conservation and Energy Efficiency Provisions ....................................... 519

1. Energy efficient new homes (sec. 821 of the Senate amendment) ... 519

2. Energy efficient appliances (sec. 822 of the Senate amendment) .... 521

3. Residential solar hot water, photovoltaics and other energy efficient property (sec. 823 of the Senate amendment) ............................ 523

4. Credit for business installation of qualified fuel cells and stationary microturbine power plants (sec. 824 of the Senate amendment and sec. 48 of the Code) ............................................................... 525

5. Energy efficient commercial building deduction (sec. 825 of the 

Senate amendment) ............................................................................... 526

6. Three-year applicable recovery period for depreciation of qualified 

energy management devices and qualified water submetering devices (secs. 826 and 827 of the Senate amendment and sec. 168 

of the Code) ............................................................................................ 528

7. Energy credit for combined heat and power system property (sec. 

828 of the Senate amendment and sec. 48 of the Code) ..................... 528

8. Energy efficient improvements to existing homes (sec. 829 of the 

Senate amendment) ............................................................................... 530

D. Clean Coal Incentives ................................................................................. 531

1. Credit for production from a clean coal technology unit (secs. 

831 and 834 of the Senate amendment) .............................................. 531

2. Investment credit for clean coal technology units (secs. 832 and 

834 of the Senate amendment) ............................................................. 532

3. Credit for production from advanced clean coal technology (secs. 

833 and 834 of the Senate amendment) .............................................. 534

E. Oil and Gas Provisions ............................................................................... 535

1. Oil and gas production from marginal wells (sec. 841 of the Senate 

amendment and new sec. 451 of the Code) ......................................... 535

2. Natural gas gathering lines treated as seven-year property (sec. 

842 of the Senate amendment and sec. 168 of the Code) ................... 536

3. Expensing of capital costs incurred for production in complying 

with environmental protection agency sulfur regulations for small 

refiners (sec. 843 of the Senate amendment and new sec. 179B 

of the Code) ............................................................................................ 537

4. Credit for small refiners for production of diesel fuel in compliance 

with Environmental Protection Agency sulfur regulations for small 

refiners (sec. 844 of the Senate amendment and new sec. 45H 

of the Code) ............................................................................................ 538

5. Determination of small refiner exception to oil depletion deduction 

(sec. 845 of the Senate amendment and sec. 613A of the Code) ........ 539

6. Suspension of 100-percent-of-net-income limitation on percentage 

depletion for oil and gas from marginal wells (sec. 412 of the 

House bill, sec. 846 of the Senate amendment, and sec. 613A 

of the Code) ............................................................................................ 540

7. Delay rental payments (sec. 847 of the Senate amendment and 

sec. 167 of the Code) .............................................................................. 541

8. Geological and geophysical costs (sec. 848 of the Senate amendment and sec. 167 of the Code) ............................................................. 542

9. Extension and modification of credit for producing fuel from a 

non-coneventional source (sec. 849 of the Senate amendment and 

sec. 29 of the Code) ................................................................................ 543

10. Natural gas distribution lines treated as 15-year property (sec. 

850 of the Senate amendment and sec. 168 of the Code) ................... 546

11. Credit for production of Alaska natural gas (sec. 851 of the 

Senate amendment) ............................................................................... 547

12. Treat certain Alaska pipeline property as seven-year property 

(sec. 852 of the Senate amendment and sec. 168 of the Code) .......... 548

13. Enhanced oil recovery credit for certain gas processing facilities 

(sec. 853 of the Senate amendment and sec. 43 of the Code) ............ 549

257

14. Exempt certain prepayments for natural gas from tax-exempt 

bond arbitrage rules (sec. 854 of the Senate amendment and secs. 

141 and 148 of the Code) ...................................................................... 549

F. Electric Utility Restructuring and Reliability Provisions ........................ 553

1. Modification to special rules for nuclear decommissioning costs 

(sec. 855 of the Senate amendment and sec. 468A of the Code) ........ 553

2. Treatment of certain income of electric cooperatives (sec. 856 of 

the Senate amendment and sec. 501 of the Code) .............................. 556

3. Dispositions of transmission property to implement Federal Energy Regulatory Commission restructuring policy (no reinvestment 

obligation) (sec. 857 of the Senate amendment and sec. 451 of 

the Code) ................................................................................................ 561

G. Additional Provisions ................................................................................. 563

1. GAO Study (sec. 897 of the Senate amendment) ............................... 563

2. Repeal certain excise taxes on rail diesel fuel and inland waterway 

barge fuels (sec. 898 of the Senate amendment and secs. 4041, 

4042, 6421, and 6427 of the Code) ....................................................... 564

3. Increase tax limitation on use of business energy credits (secs. 

851(c) and 899A of the Senate amendment, and sec. 38 of the 

Code) ....................................................................................................... 564

4. Transmission property treated as fifteen-year property (sec. 899C 

of the Senate amendment and sec. 168 of the Code) .......................... 565

5. Qualifying pollution control equipment credit (sec. 899B of the 

Senate amendment) ............................................................................... 566

Title X—Revenue Provisions ................................................................................... 567

A. Provisions to Reduce Tax Avoidance Through Individual and Corporate Expatriation ....................................................................................... 567

1. Tax treatment of expatriated entities and their foreign parents 

(sec. 601 of the House bill, sec. 441 of the Senate amendment, 

and new sec. 7874 of the Code) ............................................................ 567

2. Excise tax on stock compensation of insiders in expatriated corporations (sec. 602 of the House bill, sec. 443 of the Senate amendment, and secs. 162(m), 275(a), and new sec. 4985 of the Code) ....... 575

3. Reinsurance of U.S. risks in foreign jurisdictions (sec. 603 of the 

House bill, sec. 444 of the Senate amendment, and sec. 845(a) 

of the Code) ............................................................................................ 580

4. Revision of tax rules on expatriation of individuals (sec. 604 of 

the House bill, sec. 442 of the Senate amendment, and secs. 877, 

2107, 2501 and 6039G of the Code) ...................................................... 581

5. Reporting of taxable mergers and acquisitions (sec. 605 of the 

House bill, sec. 445 of the Senate amendment, and new sec. 6043A 

of the Code ............................................................................................. 593

6. Studies (sec. 606 of the House bill) ..................................................... 594

B. Provisions Relating to Tax Shelters .......................................................... 595

1. Penalty for failure to disclose reportable transactions (sec. 611 

of the House bill, sec. 402 of the Senate amendment, and new 

sec. 6707A of the Code) ......................................................................... 595

2. Modifications to the accuracy-related penalties for listed transactions and reportable transactions having a significant tax avoidance purpose (sec. 612 of the House bill, sec. 403 of the Senate 

amendment, and new sec. 6662A of the Code) .................................... 599

3. Tax shelter exception to confidentiality privileges relating to taxpayer communications (sec. 613 of the House bill, sec. 406 of the 

Senate amendment, and sec. 7525 of the Code) .................................. 604

4. Statute of limitations for unreported listed transactions (sec. 614 

of the House bill, sec. 416 of the Senate amendment, and sec. 

6501 of the Code) ................................................................................... 605

5. Disclosure of reportable transactions by material advisors (secs. 

615 and 616 of the House bill, secs. 407 and 408 of the Senate 

amendment, and secs. 6111 and 6707 of the Code) ............................ 606

6. Investor lists and modification of penalty for failure to maintain 

investor lists (secs. 615 and 617 of the House bill, secs. 407 and 

409 of the Senate amendment, and secs. 6112 and 6708 of the 

Code) ....................................................................................................... 609

7. Penalty on promoters of tax shelters (sec. 618 of the House bill, 

sec. 415 of the Senate amendment, and sec. 6700 of the Code) ......... 611

258

8. Penalty for aiding and abetting the understatement of tax liability 

(sec. 419 of the Senate amendment and sec. 6701 of the Code) ........ 612

9. Modifications of substantial understatement penalty for nonreportable transactions (sec. 619 of the House bill, sec. 405 of 

the Senate amendment, and sec. 6662 of the Code) ........................... 613

10. Modification of actions to enjoin certain conduct related to tax 

shelters and reportable transactions (sec. 620 of the House bill, 

sec. 410 of the Senate amendment, and sec. 7408 of the Code) ......... 614

11. Penalty on failure to report interests in foreign financial accounts 

(sec. 621 of the House bill, sec. 412 of the Senate amendment, 

and sec. 5321 of Title 31, United States Code) ................................... 614

12. Regulation of individuals practicing before the Department of 

the Treasury (sec. 622 of the House bill, sec. 414 of the Senate 

amendment, and sec. 330 of Title 31, Untied States Code) ............... 616

13. Treatment of stripped bonds to apply to stripped interests in 

bond and preferred stock funds (sec. 631 of the House bill, sec. 

461 of the Senate amendment, and secs. 305 and 1286 of the 

Code) ....................................................................................................... 617

14. Minimum holding period for foreign tax credit with respect to 

withholding taxes on income other than dividends (sec. 632 of 

the House bill, sec. 456 of the Senate amendment, and sec. 901 

of the Code) ............................................................................................ 620

15. Treatment of partnership loss transfers and partnership basis 

adjustments (sec. 633 of the House bill, sec. 469 of the Senate 

amendment, and secs. 704, 734, 743, and 754 of the Code) ............... 621

16. No reduction of basis under section 734 in stock held by partnership in corporate partner (sec. 634 of the House bill, sec. 432 

of the Senate amendment, and sec. 755 of the Code) ......................... 628

17. Repeal of special rules for FASITs (sec. 635 of the House bill, 

sec. 433 of the Senate amendment, and secs. 860H through 860L 

of the Code) ............................................................................................ 629

18. Limitation on transfer and importation of built-in losses (sec. 

636 of the House bill, sec. 431 of the Senate amendment, and 

secs. 362 and 334 of the Code) .............................................................. 634

19. Clarification of banking business for purposes of determining 

investment of earnings in U.S. property (sec. 637 of the House 

bill, sec. 451 of the Senate amendment, and sec. 956 of the Code) ... 636

20. Alternative tax for small insurance companies and modification 

of exemption from tax for small property and casualty insurance 

companies (sec. 638 of the House bill, sec. 493 of the Senate 

amendment, and secs. 501(c)(15) and 831(b) of the Code) ................. 638

21. Denial of deduction for interest on underpayments attributable 

to nondisclosed reportable transactions (sec. 639 of the House bill, 

sec. 417 of the Senate amendment, and sec. 163 of the Code) ........... 639

22. Clarification of rules for payment of estimated tax for certain 

deemed asset sales (sec. 640 of the House bill, sec. 481 of the 

Senate amendment, and sec. 338 of the Code) .................................... 640

23. Exclusion of like-kind exchange property from nonrecognition 

treatment on the sale or exchange of a principal resident (sec. 

641 of the House bill and sec. 492 of the Senate amendment) .......... 641

24. Prevention of mismatching of interest and original issue discount 

deductions and income inclusions in transactions with related foreign persons (sec. 642 of the House bill, sec. 453 of the Senate 

amendment, and secs. 163 and 267 of the Code) ................................ 642

25. Exclusion from gross income for interest on overpayments of 

income tax by individuals (sec. 643 of the House bill) ........................ 644

26. Deposits made to suspend the running of interest on potential 

underpayments (sec. 644 of the House bill, sec. 486 of the Senate 

amendment, and new sec. 6603 of the Code) ...................................... 646

27. Authorize IRS to enter into installment agreements that provide 

for partial payment (sec. 645 of the House bill, sec. 484 of the 

Senate amendment, and sec. 6159 of the Code) .................................. 649

28. Affirmation of consolidated return regulation authority (sec. 646 

of the House bill, sec. 421 of the Senate amendment, and sec. 

1502 of the Code) ................................................................................... 650 

259

29. Reform of tax treatment of certain leasing arrangements and 

limitation on deductions allocable to property used by governments 

or other tax-exempt entities (secs. 647 through 649 of the bill, 

secs. 475 and 476 of the Senate amendment, secs. 167 and 168 

of the Code, and new sec. 470 of the Code) ......................................... 654

30. Clarification of the economic substance doctrine (sec. 401 of the 

Senate amendment and sec. 7701 of the Code) ................................... 663

31. Penalty for understatements attributable to transactions lacking 

economic substance, etc. (sec. 404 of the Senate amendment and 

sec. 6662B of the Code) ......................................................................... 669

32. Understatement of taxpayer’s liability by income tax return preparer (sec. 411 of the Senate amendment) .......................................... 671

33. Frivolous tax submissions (sec. 413 of the Senate amendment 

and sec. 6702 of the Code) .................................................................... 672

34. Authorization of appropriations for tax law enforcement (sec. 

418 of the Senate amendment) ............................................................. 673

35. Declaration by chief executive officer relating to Federal annual 

corporate income tax return (sec. 422 of the Senate amendment) .... 673

36. Denial of deduction for certain fines, penalties, and other 

amounts (sec. 423 of the Senate amendment and sec. 162 of the 

Code) ....................................................................................................... 675

37. Denial of deduction for punitive damages (sec. 424 of the Senate 

amendment and sec. 162 of the Code) ................................................. 677

38. Increase in criminal monetary penalty limitation for the underpayment or overpayment of tax due to fraud (sec. 425 of the Senate 

amendment) ........................................................................................... 678

39. Expanded disallowance of deduction for interest on convertible 

debt (sec. 434 of the Senate amendment and sec. 163 of the Code) .. 679

40. Expand authority to disallow tax benefits under section 269 (sec. 

435 of the Senate amendment and sec. 269 of the Code) ................... 680

41. Modification of coordination rules for controlled foreign corporation and passive foreign investment company regimes (sec. 436 

of the Senate amendment and sec. 1297 of the Code) ........................ 681

C. Reduction of Fuel Tax Evasion .................................................................. 684

1. Exemption from certain excise taxes for mobile machinery vehicles 

and modification of definition of offhighway vehicle (sec. 651 of 

the House bill, sec. 896 of the Senate amendment, and secs. 4053, 

4072, 4082, 4483, 6421, and 7701 of the Code) ................................... 684

2. Taxation of aviation-grade kerosene (sec. 652 of the House bill, 

sec. 871 of the Senate amendment, and secs. 4041, 4081, 4082, 

4083, 4091, 4092, 4093, 4101, and 6427 of the Code) ......................... 687

3. Provide for transfer from Airport and Airway Trust Fund to Highway Trust Fund to adjust for continued highway use of aviation 

fuel (sec. 872 of the Senate amendment and secs. 9502 and 9503 

of the Code) ............................................................................................ 693

4. Mechanical dye injection and related penalties (sec. 653 of the 

House bill, secs. 873, 874 and 875 of the Senate amendment and 

secs. 4082 and 6715 and new sec. 6715A of the Code) ....................... 694

5. Terminate dyed diesel use by intercity buses (sec. 876 of the 

Senate amendment and secs. 4082 and 6427 of the Code) ................ 697

6. Authority to inspect on-site records (sec. 654 of the House bill, 

sec. 877 of the Senate amendment, and sec. 4083 of the Code) ......... 698

7. Assessable penalty for refusal of entry (sec. 878 of the Senate 

amendment and new sec. 6717 of the Code) ....................................... 698

8. Registration of pipeline or vessel operators required for exemption 

of bulk transfers to registered terminals or refineries (sec. 655 

of the House bill, sec. 879 of the Senate amendment, and sec. 

4081 of the Code) ................................................................................... 700

9. Display of registration and penalties for failure to display registration and to register (secs. 656 and 657 of the House bill, secs. 

880 and 882 of the Senate amendment, and secs. 4101, 7232, 

7272 and new secs. 6718 and 6719 of the Code) ................................. 701

10. Registration of persons within foreign trade zones (sec. 881 of 

the Senate amendment and sec. 4101 of the Code) ............................ 702

11. Penalties for failure to report (sec. 657 of the House bill, sec. 

882 of the Senate amendment, and new sec. 6725 of the Code) ........ 702

260

12. Electronic filing of required information reports (sec. 895 of the 

Senate amendment and sec. 4010 of the Code) ................................... 703

13. Information reporting for persons claiming certain tax benefits 

(sec. 883 of the Senate amendment and new sec. 4104 of the 

Code) ....................................................................................................... 704

14. Collection from Customs bond where importer not registered (sec. 

658 of the House bill and sec. 884 of Senate amendment) ................. 705

15. Reconciliation of on-loaded cargo to entered cargo (sec. 885 of 

the Senate amendment) ........................................................................ 706

16. Modification of the use tax on heavy highway vehicles (sec. 659 

of the House bill, sec. 890 of the Senate amendment, and secs. 

4481, 4483 and 6165 of the Code) ........................................................ 707

17. Modification of ultimate vendor refund claims with respect to 

farming (sec. 660 of the House bill, sec. 887 of the Senate amendment, and sec. 6427 of the Code) .......................................................... 708

18. Dedication of revenue from certain penalties to the Highway 

Trust Fund (sec. 661 of the House bill, sec. 891 of the Senate 

amendment, and sec. 9503 of the Code) .............................................. 709

19. Taxable fuel refunds for certain ultimate vendors (sec. 662 of 

the House bill, sec. 888 of the Senate amendment, and secs. 6416 

and 6427 of the Code) ............................................................................ 710

20. Two party exchanges (sec. 663 of the bill and new sec. 4105 

of the Code) ............................................................................................ 711

21. Simplification of tax on tires (sec. 664 of the House bill and 

sec. 4071 of the Code) ............................................................................ 712

22. Tax on sale of diesel fuel whether suitable for use or not in 

a diesel-powered vehicle or train (sec. 886 of the Senate amendment) ....................................................................................................... 713

23. Nonapplication of export exemption to delivery of fuel to motor 

vehicles removed from United States (sec. 892 of the Senate 

amendment) ........................................................................................... 714

24. Taxation of transmix and diesel fuel blend stocks and Treasury 

study on fuel tax compliance (secs. 893, 894 and 895 of the Senate 

amendment and sec. 4083 of the Code) ............................................... 716

D. Nonqualified Deferred Compensation Plans ............................................ 720

1. Treatment of nonqualified deferred compensation plans (sec. 671 

of the House bill, section 671 of the Senate amendment, and new 

sec. 490A and secs. 6040 and 6051 of the Code) ................................. 720

2. Denial of deferral of certain stock option and restricted stock 

gains (sec. 672 of the Senate amendment and sec. 83 of the Code) .. 738

E. Other Revenue Provisions .......................................................................... 739

1. Permit private sector debt collection companies to collect tax debts 

(sec. 681 of the House bill, sec. 487 of the Senate amendment, 

and new sec. 6306 of the Code) ............................................................ 739

2. Modify charitable contribution rules for donations of patents and 

other intellectual property (sec. 682 of the House bill, sec. 494 

of the Senate amendment, and secs. 170 and 6050L of the Code) .... 742

3. Require increased reporting for noncash charitable contributions 

(sec. 683 of the House bill and sec. 170 of the Code) .......................... 745

4. Limit deduction for charitable contributions of vehicles (sec. 684 

of the House bill, sec. 731 of the Senate amendment, and new 

sec. 6720 and sec. 170 of the Code) ...................................................... 747

5. Extend the present-law intangible amortization provisions to acquisitions of sports franchises (sec. 685 of the House bill, sec. 

471 of the Senate amendment, and sec. 197 of the Code) .................. 752

6. Increase continuous levy for certain federal payments (sec. 686 

of the House bill, sec. 734 of the Senate amendment, and sec. 

6331(h) of the Code) ............................................................................... 753

7. Modification of straddle rules (sec. 687 of the House bill, sec. 

64 of the Senate amendment, and sec. 1092 of the Code) .................. 754

8. Add vaccines against Hepatitis A to the list of taxable vaccines 

(sec. 688 of the House bill, sec. 491 of the Senate amendment, 

and sec. 4132 of the Code) .................................................................... 758

9. Add vaccines against influenza to the list of taxable vaccines 

(sec. 689 of the House bill, sec. 732 of the Senate amendment, 

and sec. 4132 of the Code) .................................................................... 759

261

10. Extension of IRS user fees (sec. 690 of the House bill, sec. 482 

of the Senate amendment, and sec. 7528 of the Code) ....................... 759

11. Extension of Customs user fees (Sec. 691 of the House bill and 

sec. 485 of the Senate amendment) ...................................................... 760

12. Prohibition on nonrecognition of gain through complete liquidation of holding company (sec. 452 of the Senate amendment and 

sec. 332 of the Code) .............................................................................. 761

13. Effectively connected income to include certain foreign source 

income (sec. 454 of the Senate amendment and sec. 864 of the 

Code) ....................................................................................................... 762

14. Recapture of overall foreign losses on sale of controlled foreign 

corporation stock (sec. 455 of the Senate amendment and sec. 904 

of the Code) ............................................................................................ 764

15. Application of earnings-stripping rules to partnerships and S 

corporations (sec. 462 of the Senate amendment and sec. 163 of 

the Code) ................................................................................................ 766

16. Recognition of cancellation of indebtedness income realized on 

satisfaction of debt with partnership interest (sec. 463 of the Senate amendment and sec. 108 of the Code) ........................................... 767

17. Denial of installment sale treatment for all readily tradable debt 

(sec. 465 of the Senate amendment and sec. 453 of the Code) .......... 769

18. Modify treatment of transfers to creditors in divisive reorganizations (sec. 466 of the Senate amendment and secs. 357 and 361 

of the Code) ............................................................................................ 770

19. Clarify definition of nonqualified preferred stock (sec. 467 of 

the Senate amendment and sec. 351(g) of the Code) .......................... 771

20. Modify definition of controlled group of corporations (sec. 468 

of the Senate amendment and sec. 1563 of the Code) ........................ 772

21. Establish specific class lives for utility grading costs (sec. 472 

of the Senate amendment and sec. 168 of the Code) .......................... 773

22. Expansion of limitation on expensing of certain passenger automobiles (sec. 473 of the Senate amendment and sec. 179 of the 

Code) ....................................................................................................... 774

23. Provide consistent amortization period for intangibles (sec. 474 

of the Senate amendment and secs. 195, 248, and 709 of the 

Code) ....................................................................................................... 776

24. Doubling of certain penalties, fines, and interest on underpayments related to certain offshore financial arrangements (sec. 483 

of the Senate amendment) .................................................................... 777

25. Whistleblower reforms (sec. 488 of the Senate amendment) .......... 778

26. Increase in age of minor children whose unearned income is 

taxed as if parent’s income (sec. 495 of the Senate amendment 

and sec. 1 of the Code) .......................................................................... 779

27. Modify holding period requirement for qualification for reduced 

tax rate on dividends on preferred stock (sec. 496 of the Senate 

amendment and sec. 1 of the Code) ..................................................... 782

28. Grant Treasury regulatory authority to address foreign tax credit 

transactions involving inappropriate separation of foreign taxes 

from related foreign income (sec. 661A of Senate amendment and 

sec. 901 of the Code) .............................................................................. 783

29. Freeze of provision regarding suspension of interest where Secretary fails to contact taxpayer (sec. 662B of the Senate amendment and sec. 6404(g) of the Code) ...................................................... 784

30. Increase in withholding from supplemental wage payments in 

excess of $1 million (sec. 673 of the Senate amendment and sec. 

13273 of the Revenue Reconciliation Act of 1993) .............................. 785

31. Capital gain treatment on sale of stock acquired from exercise 

of statutory stock options to comply with conflict of interest requirements (sec 674 of the Senate amendment and sec. 421 of 

the Code) ................................................................................................ 786

32. Application of basis rules to nonresident aliens (sec 675 of the 

Senate amendment and new sec. 72(w) and sec. 83 of the Code) ...... 787

33. Residence and source rules related to a United States possession 

(sec. 497 of the Senate amendment and new sec. 937 of the Code) .. 791

34. Include employer provided housing under foreign earned income 

exclusion cap (sec. 632 of the Senate amendment and sec. 911 

of the Code) ............................................................................................ 795

262

1Transition rules delayed the repeal of the FSC rules and the effective date of ETI for transactions before January 1, 2002. An election was provided, however, under which taxpayers could 

adopt ETI at an earlier date for transactions after September 30, 2000. This election allowed 

the ETI rules to apply to transactions after September 30, 2000, including transactions occurring pursuant to pre-existing binding contracts. 

35. Deduction for personal use of company aircraft and other entertainment expenses (sec. 103(b) of the Senate amendment and sec. 

274(e) of the Code) ................................................................................. 797

36. Treatment of contingent payment convertible debt instruments 

(sec. 733 of the Senate Amendment and sec. 1275 of the Code) ........ 799

Title XI—Trade Provisions ...................................................................................... 801

A. Suspension of Duties on Ceiling Fans (sec. 801 of the House bill 

and Chapter 99, II of the harmonized Tariff Schedule of the United 

States) ............................................................................................................ 801

B. Temporary Suspension of Certain Customs Duties ................................. 801

1. Suspension of duties on nuclear steam generators (sec. 802(a) 

of the House bill and Chapter 99, II of the harmonized Tariff 

Schedule of the United States) ............................................................. 801

2. Suspension of Duties on Nuclear Reactor Vessel Heads (sec. 802(b) 

of the House bill and Chapter 99, II of the Harmonized Tariff 

Schedule of the United States .............................................................. 802

Title XII—Tax Complexity Analysis ...................................................................... 802

1. Deduction relating to income attributable to United States production activities (sec. 102 of the House bill, secs. 102 and 103 of 

the Senate amendment, and sec. 11 of the Code) ............................... 803

TITLE I—PROVISIONS RELATING TO REPEAL OF 

EXCLUSION FOR EXTRATERRITORIAL INCOME 

A. REPEAL OF EXTRATERRITORIAL INCOME REGIME

(Sec. 101 of the House bill, sec. 101 of the Senate amendment, and 

secs. 114 and 941 through 943 of the Code) 

PRESENT LAW

Like many other countries, the United States has long provided export-related benefits under its tax law. In the United 

States, for most of the last two decades, these benefits were provided under the foreign sales corporation (‘‘FSC’’) regime. In 2000, 

the European Union succeeded in having the FSC regime declared 

a prohibited export subsidy by the World Trade Organization 

(‘‘WTO’’). In response to this WTO finding, the United States repealed the FSC rules and enacted a new regime, under the FSC 

Repeal and Extraterritorial Income Exclusion Act of 2000.1 The European Union immediately challenged the extraterritorial income 

(‘‘ETI’’) regime in the WTO, and in January of 2002 the WTO Appellate Body held that the ETI regime also constituted a prohibited 

export subsidy under the relevant trade agreements. 

Under the ETI regime, an exclusion from gross income applies 

with respect to ‘‘extraterritorial income,’’ which is a taxpayer’s 

gross income attributable to ‘‘foreign trading gross receipts.’’ This 

income is eligible for the exclusion to the extent that it is ‘‘qualifying foreign trade income.’’ Qualifying foreign trade income is the 

amount of gross income that, if excluded, would result in a reduction of taxable income by the greatest of: (1) 1.2 percent of the foreign trading gross receipts derived by the taxpayer from the transaction; (2) 15 percent of the ‘‘foreign trade income’’ derived by the 

263 

2 ‘‘Foreign trade income’’ is the taxable income of the taxpayer (determined without regard to 

the exclusion of qualifying foreign trade income) attributable to foreign trading gross receipts. 3 ‘‘Foreign sale and leasing income’’ is the amount of the taxpayer’s foreign trade income (with 

respect to a transaction) that is properly allocable to activities that constitute foreign economic 

processes. Foreign sale and leasing income also includes foreign trade income derived by the taxpayer in connection with the lease or rental of qualifying foreign trade property for use by the 

lessee outside the United States. 4This rule also applies to a purchase option, renewal option, or replacement option that is 

included in such contract. For this purpose, a replacement option will be considered enforceable 

against a lessor notwithstanding the fact that a lessor retained approval of the replacement lessee. 

taxpayer from the transaction; 2 or (3) 30 percent of the ‘‘foreign 

sale and leasing income’’ derived by the taxpayer from the transaction.3

Foreign trading gross receipts are gross receipts derived from 

certain activities in connection with ‘‘qualifying foreign trade property’’ with respect to which certain economic processes take place 

outside of the United States. Specifically, the gross receipts must 

be: (1) from the sale, exchange, or other disposition of qualifying 

foreign trade property; (2) from the lease or rental of qualifying foreign trade property for use by the lessee outside the United States; 

(3) for services which are related and subsidiary to the sale, exchange, disposition, lease, or rental of qualifying foreign trade 

property (as described above); (4) for engineering or architectural 

services for construction projects located outside the United States; 

or (5) for the performance of certain managerial services for unrelated persons. A taxpayer may elect to treat gross receipts from a 

transaction as not foreign trading gross receipts. As a result of 

such an election, a taxpayer may use any related foreign tax credits in lieu of the exclusion. 

Qualifying foreign trade property generally is property manufactured, produced, grown, or extracted within or outside the 

United States that is held primarily for sale, lease, or rental in the 

ordinary course of a trade or business for direct use, consumption, 

or disposition outside the United States. No more than 50 percent 

of the fair market value of such property can be attributable to the 

sum of: (1) the fair market value of articles manufactured outside 

the United States; and (2) the direct costs of labor performed outside the United States. With respect to property that is manufactured outside the United States, certain rules are provided to ensure consistent U.S. tax treatment with respect to manufacturers. 

HOUSE BILL

The provision repeals the ETI exclusion. For transactions prior 

to 2005, taxpayers retain 100 percent of their ETI benefits. For 

transactions after 2004, the provision provides taxpayers with 80 

percent of their otherwise-applicable ETI benefits for transactions 

during 2005 and 60 percent of their otherwise-applicable ETI benefits for transactions during 2006. However, the provision provides 

that the ETI exclusion provisions remain in effect for transactions 

in the ordinary course of a trade or business if such transactions 

are pursuant to a binding contract 4 between the taxpayer and an 

unrelated person and such contract is in effect on January 14, 

2002, and at all times thereafter. 

In addition, foreign corporations that elected to be treated for 

all Federal tax purposes as domestic corporations in order to faciliVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00267 Fmt 6601 Sfmt 6602 E:\HR\OC\HR755.XXX HR755
264 

5The deduction also is available to cooperatives engaged in the marketing of agricultural or 

horticultural products. 6 In the case of a short taxable year that ends after the date of enactment and begins before 

January 1, 2007, the Treasury Secretary shall prescribe guidance for determining the amount 

of the deduction, including guidance that limits the amount of the deduction for a short taxable 

year based upon the proportion that the number of days in the short taxable year bears to 365. 

tate the claiming of ETI benefits are allowed to revoke such elections within one year of the date of enactment of the provision 

without recognition of gain or loss, subject to anti-abuse rules. 

Effective date.—The provision is effective for transactions after 

December 31, 2004. 

SENATE AMENDMENT

The provision repeals the exclusion for extraterritorial income. 

However, the provision provides that the extraterritorial income exclusion provisions remain in effect for transactions in the ordinary 

course of a trade or business if such transactions are pursuant to 

a binding contract between the taxpayer and an unrelated person 

and such contract is in effect on September 17, 2003, and at all 

times thereafter. 

The provision permits foreign corporations that have elected to 

be treated as U.S. corporations pursuant to the extraterritorial income exclusion provisions to revoke their elections. Such revocations are effective on the date of enactment of this provision. A corporation revoking its election is treated as a U.S. corporation that 

transfers all of its property to a foreign corporation in connection 

with an exchange described in section 354 of the Code. In general, 

the corporation shall not recognize any gain or loss on such deemed 

transfer. However, a revoking corporation shall recognize any gain 

on any asset held by the corporation if: (1) the basis of such asset 

is determined (in whole or in part) by reference to the basis of such 

asset in the hands of the person from whom the corporation acquired such asset; (2) the asset was acquired by an actual transfer 

(rather than as a result of the U.S. corporation election by the corporation) occurring on or after the first day on which the U.S. corporation election by the corporation was effective; and (3) a principal purpose of the acquisition was the reduction or avoidance of 

tax. 

The provision also provides a deduction for taxable years of 

certain corporations ending after the date of enactment of the provision and beginning before January 1, 2007.5 The amount of the 

deduction for each such taxable year is equal to a specified percentage of the amount that, for the taxable year of a corporation beginning in 2002, was excludable from the gross income of the corporation under the extraterritorial income exclusion provisions or was 

treated by the corporation as exempt foreign trade income of related FSCs from property acquired by the FSCs from the corporation.6 However, this aggregate amount does not include any 

amount attributable to a transaction involving a lease by the corporation unless the corporation manufactured or produced (in 

whole or in part) the leased property. 

The specified percentage to be used in determining the deduction is: 80 percent for calendar years 2004 and 2005; 60 percent for 

calendar year 2006; and 0 percent for calendar years 2007 and 

265 

7This rule also applies to a purchase option, renewal option, or replacement option that is 

included in such contract. For this purpose, a replacement option will be considered enforceable 

against a lessor notwithstanding the fact that a lessor retained approval of the replacement lessee. 

thereafter. For calendar year 2003, the specified percentage is the 

amount that bears the same ratio to 100 percent as the number of 

days after the date of enactment of this provision bears to 365. In 

the case of a corporation with a taxable year that is not the calendar year (i.e., a fiscal year corporation), a special rule is provided 

for determining a weighted average specified percentage based 

upon the calendar years that are included in the taxable year. 

The deduction for a taxable year generally is reduced by the 

specified percentage of exempted FSC income and excluded 

extraterritorial income of the corporation for the taxable year from 

transactions pursuant to a binding contract. 

Effective date.—The provision is effective for transactions occurring after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except that 

under the conference agreement the ETI exclusion provisions remain in effect for transactions in the ordinary course of a trade or 

business if such transactions are pursuant to a binding contract 7

between the taxpayer and an unrelated person and such contract 

is in effect on September 17, 2003, and at all times thereafter. 

Effective date.—The effective date is the same as the House 

bill. 

B. DEDUCTION RELATING TO INCOME ATTRIBUTABLE TO UNITED

STATES PRODUCTION ACTIVITIES

(Sec. 102 of the House bill, secs. 102 and 103 of the Senate amendment, and sec. 11 of the Code) 

PRESENT LAW

A corporation’s regular income tax liability is determined by 

applying the following tax rate schedule to its taxable income. 

TABLE 1.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2004 

Taxable income: Income tax rate: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income. 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income. 

$75,001–$10,000,000 ................................................................................................................ 34 percent of taxable income. 

Over $10,000,000 ....................................................................................................................... 35 percent of taxable income. 

The benefit of the first two graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $100,000 and $335,000. Also, the benefit of 

the 34-percent rate is phased out by a three-percent surcharge for 

corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

266 

8The House bill provides that Secretary shall prescribe rules for the proper allocation of items 

of income, deduction, expense, and loss for purposes of determining income attributable to domestic production activities. Where appropriate, such rules shall be similar to and consistent 

with relevant present-law rules (e.g., secs. 263A and 861). 9Domestic production gross receipts under the House bill include gross receipts of a taxpayer 

derived from any sale, exchange or other disposition of agricultural products with respect to 

which the taxpayer performs storage, handling or other processing activities (other than transportation activities) within the United States, provided such products are consumed in connection with, or incorporated into, the manufacturing, production, growth or extraction of qualifying 

production property (whether or not by the taxpayer). Domestic production gross receipts also 

include gross receipts of a taxpayer derived from any sale, exchange or other disposition of food 

products with respect to which the taxpayer performs processing activities (in whole or in significant part) within the United States. 10 It is intended under the House bill that principles similar to those under the present-law 

extraterritorial income regime apply for this purpose. See Temp. Treas. Reg. sec. 1.927(a)– 

1T(f)(2)(i). For example, this exclusion generally does not apply to property leased by the taxpayer to a related person if the property is held for sublease, or is subleased, by the related 

person to an unrelated person for the ultimate use of such unrelated person. Similarly, the license of computer software to a related person for reproduction and sale, exchange, lease, rental 

or sublicense to an unrelated person for the ultimate use of such unrelated person is not treated 

as excluded property by reason of the license to the related person. 

Under present law, there is no provision that reduces the corporate income tax for taxable income attributable to domestic production activities. 

HOUSE BILL

In general 

The House bill provides that the corporate tax rate applicable 

to qualified production activities income may not exceed 32 percent 

(34 percent for taxable years beginning before 2007) of the qualified 

production activities income. 

Qualified production activities income 

‘‘Qualified production activities income’’ is the income attributable to domestic production gross receipts, reduced by the sum 

of: (1) the costs of goods sold that are allocable to such receipts; (2) 

other deductions, expenses, or losses that are directly allocable to 

such receipts; and (3) a proper share of other deductions, expenses, 

and losses that are not directly allocable to such receipts or another 

class of income.8

DOMESTIC PRODUCTION GROSS RECEIPTS

Under the House bill, ‘‘domestic production gross receipts’’ generally are gross receipts of a corporation that are derived from: (1) 

any sale, exchange or other disposition, or any lease, rental or license, of qualifying production property that was manufactured, 

produced, grown or extracted (in whole or in significant part) by 

the corporation within the United States; 9 (2) any sale, exchange 

or other disposition, or any lease, rental or license, of qualified film 

produced by the taxpayer; or (3) construction, engineering or architectural services performed in the United States for construction 

projects located in the United States. However, domestic production 

gross receipts do not include any gross receipts of the taxpayer derived from property that is leased, licensed or rented by the taxpayer for use by any related person.10

‘‘Qualifying production property’’ under the House bill generally is any tangible personal property, computer software, or 

property described in section 168(f)(4) of the Code. ‘‘Qualified film’’ 

267 

11For purposes of the Senate amendment, ‘‘wages’’ include the sum of the aggregate amounts 

of wages (as defined in section 3401(a) without regard to exclusions for remuneration paid for 

services performed in possessions of the United States) and elective deferrals that the taxpayer 

is required to include on statements with respect to the employment of employees of the taxpayer during the taxpayer’s taxable year. Elective deferrals include elective deferrals as defined 

in section 402(g)(3), amounts deferred under section 457, and, for taxable years beginning after 

December 31, 2005, designated Roth contributions (as defined in section 402A). Any wages taken 

into account for purposes of determining the wage limitation under the Senate amendment cannot also be taken into account for purposes of determining any credit allowable under sections 

30A or 936. 12 ‘‘Modified taxable income’’ under the Senate amendment is taxable income of the taxpayer 

computed without regard to the deduction provided by the Senate amendment. Qualified production activities income is limited to the modified taxable income of the taxpayer. 13For purposes of determining such costs under the Senate amendment, any item or service 

that is imported into the United States without an arm’s length transfer price shall be treated 

as acquired by purchase, and its cost shall be treated as not less than its fair market value 

when it entered the United States. A similar rule shall apply in determining the adjusted basis 

of leased or rented property where the lease or rental gives rise to domestic production gross 

receipts. With regard to property previously exported by the taxpayer for further manufacture, 

Continued 

is any property described in section 168(f)(3) of the Code (other 

than certain sexually explicit productions) if 50 percent or more of 

the total compensation relating to the production of such film 

(other than compensation in the form of residuals and participations) constitutes compensation for services performed in the 

United States by actors, production personnel, directors, and producers. 

Under the House bill, an election under section 631(a) made by 

a corporate taxpayer for a taxable year ending on or before the date 

of enactment to treat the cutting of timber as a sale or exchange, 

may be revoked by the taxpayer without the consent of the IRS for 

any taxable year ending after that date. The prior election (and 

revocation) is disregarded for purposes of making a subsequent 

election. 

Effective date.—The House bill provision is effective for taxable 

years beginning after December 31, 2004. 

SENATE AMENDMENT

In general 

The Senate amendment provides a deduction equal to a portion 

of the taxpayer’s qualified production activities income. For taxable 

years beginning after 2008, the Senate amendment deduction is 

nine percent of such income. For taxable years beginning in 2004, 

2005, 2006, 2007 and 2008, the deduction is five, five, five, six, and 

seven percent of income, respectively. However, the deduction for 

a taxable year is limited to 50 percent of the wages paid by the taxpayer during such taxable year.11 In the case of corporate taxpayers that are members of certain affiliated groups, the deduction 

is determined by treating all members of such groups as a single 

taxpayer. 

Qualified production activities income 

In general, ‘‘qualified production activities income’’ under the 

Senate amendment is the modified taxable income 12 of a taxpayer 

that is attributable to domestic production activities. Income attributable to domestic production activities generally is equal to domestic production gross receipts, reduced by the sum of: (1) the 

costs of goods sold that are allocable to such receipts; 13 (2) other 

268 

the increase in cost or adjusted basis shall not exceed the difference between the fair market 

value of the property when exported and the fair market value of the property when re-imported 

into the United States after further manufacture. 14The Senate amendment provides that the Secretary shall prescribe rules for the proper allocation of items of income, deduction, expense, and loss for purposes of determining income attributable to domestic production activities. Where appropriate, such rules shall be similar to 

and consistent with relevant present-law rules (e.g., secs. 263A and 861). 15For purposes of the domestic/worldwide fraction under the Senate amendment, the value 

of domestic production is the excess of domestic production gross receipts (as defined below) over 

the cost of deductible purchased inputs that are allocable to such receipts. Similarly, the value 

of worldwide production is the excess of worldwide production gross receipts over the cost of deductible purchased inputs that are allocable to such receipts. For purposes of determining the 

domestic/worldwide fraction, purchased inputs include: purchased services (other than employees) used in manufacture, production, growth, or extraction activities; purchased items consumed in connection with such activities; and purchased items incorporated as part of the property being manufactured, produced, grown, or extracted. In the case of corporate taxpayers that 

are members of certain affiliated groups, the domestic/worldwide fraction is determined by treating all members of such groups as a single taxpayer. 16 Under the Senate amendment, domestic production gross receipts include gross receipts of 

a taxpayer derived from any sale, exchange or other disposition of agricultural products with 

respect to which the taxpayer performs storage, handling or other processing activities (but not 

transportation activities) within the United States, provided such products are consumed in connection with, or incorporated into, the manufacturing, production, growth or extraction of qualifying production property (whether or not by the taxpayer). 17For taxable years beginning in 2004 through 2008, the applicable percentage is 25%. For 

taxable years beginning in 2009 through 2012, the applicable percentage is 50%. For taxable 

years beginning after 2012, the applicable percentage is 100%. 18For purposes of the definition of qualified production property under the Senate amendment, property described in section 168(f)(3) or (4) of the Code includes underlying copyrights 

deductions, expenses, or losses that are directly allocable to such 

receipts; and (3) a proper share of other deductions, expenses, and 

losses that are not directly allocable to such receipts or another 

class of income.14

For taxable years beginning before 2013, the Senate amendment provides that qualified production activities income is reduced by virtue of a fraction (not to exceed one), the numerator of 

which is the value of the domestic production of the taxpayer and 

the denominator of which is the value of the worldwide production 

of the taxpayer (the ‘‘domestic/worldwide fraction’’).15 For taxable 

years beginning in 2010, 2011, and 2012, the reduction in qualified 

production activities income by virtue of this fraction is reduced by 

25, 50, and 75 percent, respectively. For taxable years beginning 

after 2012, there is no reduction in qualified production activities 

income by virtue of this fraction. 

Domestic production gross receipts 

Under the Senate amendment, ‘‘domestic production gross receipts’’ are gross receipts of a taxpayer that are derived in the actual conduct of a trade or business from any sale, exchange or 

other disposition, or any lease, rental or license, of qualifying production property that was manufactured, produced, grown or extracted (in whole or in significant part) by the taxpayer within the 

United States or any possession of the United States.16 Such term 

also includes a percentage of gross receipts derived from engineering or architectural services performed in the United States for 

construction projects in the United States.17 Finally, such term includes gross receipts derived by the taxpayer from the use of film 

and videotape property produced in whole or in significant part by 

the taxpayer within the United States. ‘‘Qualifying production 

property’’ generally is any tangible personal property, computer 

software, or property described in section 168(f)(3) or (4) of the 

Code.18 However, qualifying production property does not include: 

269 

and trademarks. In addition, gross receipts from the sale, exchange, lease, rental, license or 

other disposition of property described in section 168(f)(3) or (4) are treated as domestic production gross receipts if more than 50 percent of the aggregate development and production costs 

of such property are incurred by the taxpayer within the United States. For this purpose, property that is acquired by the taxpayer after development or production has commenced, but before such property generates substantial gross receipts, shall be treated as developed or produced by the taxpayer. 19 Under the Senate amendment, qualifying production property does not include extracted 

but unrefined oil or gas, but generally includes primary products of oil and gas that are produced by the taxpayer. Examples of primary products for this purpose include motor fuels, 

chemical feedstocks and fertilizer. However, primary products do not include the output of a natural gas processing plant. Natural gas processing plants generally are located at or near the 

producing gas field that supplies the facility, and the facility serves to separate impurities from 

the natural gas liquids recovered from the field for the purpose of selling the liquids for future 

production and preparation of the natural gas for pipeline transportation. 20The topical and transitory exclusion does not apply to the extent of the gross receipts from 

the use of film and videotape property produced in whole or in significant part by the taxpayer 

within the United States. 21 However, the wage limitation described above is determined at the entity level in computing 

the deduction with respect to qualified production activities income of a passthrough entity. 

(1) consumable property that is sold, leased or licensed as an integral part of the provision of services; (2) oil or gas (other than certain primary products thereof); 19 (3) electricity; (4) water supplied 

by pipeline to the consumer; (5) utility services; and (6) any film, 

tape, recording, book, magazine, newspaper or similar property the 

market for which is primarily topical or otherwise essentially transitory in nature.20

Other rules 

Qualified production activities income of passthrough entities 

(other than cooperatives) 

With respect to domestic production activities of an S corporation, partnership, estate, trust or other passthrough entity (other 

than an agricultural or horticultural cooperative), the deduction 

under the Senate amendment generally is determined at the shareholder, partner or similar level by taking into account at such level 

the proportionate share of qualified production activities income of 

the entity.21 The Senate amendment directs the Secretary to prescribe rules for the application of the deduction to passthrough entities, including reporting requirements and rules relating to restrictions on the allocation of the deduction to taxpayers at the 

partner or similar level. 

Qualified production activities income of agricultural and 

horticultural cooperatives 

With regard to member-owned agricultural and horticultural 

cooperatives formed under Subchapter T of the Code, the Senate 

amendment provides the same treatment of qualified production 

activities income derived from products marketed through cooperatives as it provides for qualified production activities income of 

other taxpayers (i.e., the cooperative may claim a deduction from 

qualified production activities income). In addition, the Senate 

amendment provides that the amount of any patronage dividends 

or per-unit retain allocations paid to a member of an agricultural 

or horticultural cooperative (to which Part I of Subchapter T applies), which is allocable to the portion of qualified production activities income of the cooperative that is deductible under the Senate amendment, is excludible from the gross income of the member. 

270 

22For purposes of the conference agreement, ‘‘wages’’ include the sum of the aggregate 

amounts of wages and elective deferrals that the taxpayer is required to include on statements 

with respect to the employment of employees of the taxpayer during the taxpayer’s taxable year. 

Elective deferrals include elective deferrals as defined in section 402(g)(3), amounts deferred 

In order to qualify, such amount must be designated by the organization as allocable to the deductible portion of qualified production 

activities income in a written notice mailed to its patrons not later 

than the payment period described in section 1382(d). The cooperative cannot reduce its income under section 1382 (e.g., cannot claim 

a dividends-paid deduction) for such amounts. 

Separate application to films and videotape 

Under the Senate amendment, the deduction provided by this 

provision with respect to films and videotape is determined separately with respect to qualified production activities income of the 

taxpayer allocable to each of three markets: theatrical, broadcast 

television, and home video. The Senate amendment provides rules 

for making a separate determination of qualified production activities allocable to each market. 

Alternative minimum tax 

The deduction provided by the Senate amendment is allowed 

for purposes of the alternative minimum tax (including adjusted 

current earnings). The deduction is determined by reference to 

modified alternative minimum taxable income. 

Coordination with ETI repeal 

For purposes of the Senate amendment, domestic production 

gross receipts does not include gross receipts from any transaction 

that produces excluded extraterritorial income pursuant to the 

binding contract exception to the ETI repeal provisions of the Senate amendment. 

Qualified production activities income is determined without 

regard to any deduction provided by the ETI repeal provisions of 

the Senate amendment. 

Effective date.—The Senate amendment provision is effective 

for taxable years ending after the date of enactment. 

CONFERENCE AGREEMENT

In general 

The conference agreement provides a deduction from taxable 

income (or, in the case of an individual, adjusted gross income) that 

is equal to a portion of the taxpayer’s qualified production activities 

income. For taxable years beginning after 2009, the deduction is 

equal to nine percent of the lesser of (1) the qualified production 

activities income of the taxpayer for the taxable year, or (2) taxable 

income (determined without regard to this provision) for the taxable year. For taxable years beginning in 2005 and 2006, the deduction is three percent of income and, for taxable years beginning 

in 2007, 2008 and 2009, the deduction is six percent of income. 

However, the deduction for a taxable year is limited to 50 percent 

of the wages paid by the taxpayer during the calendar year that 

ends in such taxable year.22 In the case of corporate taxpayers that 

271 

under section 457, and, for taxable years beginning after December 31, 2005, designated Roth 

contributions (as defined in section 402A). 23For purposes of determining such costs, any item or service that is imported into the United 

States without an arm’s length transfer price shall be treated as acquired by purchase, and its 

cost shall be treated as not less than its value when it entered the United States. A similar 

rule shall apply in determining the adjusted basis of leased or rented property where the lease 

or rental gives rise to domestic production gross receipts. With regard to property previously 

exported by the taxpayer for further manufacture, the increase in cost or adjusted basis shall 

not exceed the difference between the value of the property when exported and the value of the 

property when re-imported into the United States after further manufacture. Except as provided 

by the Secretary, the value of property for this purpose shall be its customs value (as defined 

in section 1059A(b)(1)). 24The Secretary shall prescribe rules for the proper allocation of items of income, deduction, 

expense, and loss for purposes of determining income attributable to domestic production activities. Where appropriate, such rules shall be similar to and consistent with relevant present-law 

rules (e.g., sec. 263A, in determining the cost of goods sold, and sec. 861, in determining the 

source of such items). Other deductions, expenses or losses that are directly allocable to such 

receipts include, for example, selling and marketing expenses. A proper share of other deductions, expenses, and losses that are not directly allocable to such receipts or another class of 

income include, for example, general and administrative expenses allocable to selling and marketing expenses. 25Domestic production gross receipts include gross receipts of a taxpayer derived from any 

sale, exchange or other disposition of agricultural products with respect to which the taxpayer 

performs storage, handling or other processing activities (other than transportation activities) 

within the United States, provided such products are consumed in connection with, or incorporated into, the manufacturing, production, growth or extraction of qualifying production property (whether or not by the taxpayer). 26For this purpose, construction activities include activities that are directly related to the 

erection or substantial renovation of residential and commercial buildings and infrastructure. 

Substantial renovation would include structural improvements, but not mere cosmetic changes, 

such as painting. 

are members of certain affiliated groups, the deduction is determined by treating all members of such groups as a single taxpayer 

and the deduction is allocated among such members in proportion 

to each member’s respective amount (if any) of qualified production 

activities income. 

Qualified production activities income 

In general, ‘‘qualified production activities income’’ is equal to 

domestic production gross receipts, reduced by the sum of: (1) the 

costs of goods sold that are allocable to such receipts; 23 (2) other 

deductions, expenses, or losses that are directly allocable to such 

receipts; and (3) a proper share of other deductions, expenses, and 

losses that are not directly allocable to such receipts or another 

class of income.24

Domestic production gross receipts 

‘‘Domestic production gross receipts’’ generally are gross receipts of a taxpayer that are derived from: (1) any sale, exchange 

or other disposition, or any lease, rental or license, of qualifying 

production property that was manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the 

United States; 25 (2) any sale, exchange or other disposition, or any 

lease, rental or license, of qualified film produced by the taxpayer; 

(3) any sale, exchange or other disposition electricity, natural gas, 

or potable water produced by the taxpayer in the United States; (4) 

construction activities performed in the United States; 26 or (5) engineering or architectural services performed in the United States 

for construction projects located in the United States. 

However, domestic production gross receipts do not include any 

gross receipts of the taxpayer that are derived from (1) the sale of 

food or beverages prepared by the taxpayer at a retail establishVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00275 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
272 

27The conferees intend that food processing, which generally is a qualified production activity 

under the conference agreement, does not include activities carried out at retail establishment. 

Thus, under the conference agreement while the gross receipts of a meat packing establishment 

are qualified domestic production gross receipts, the activities of a master chef who creates a 

venison sausage for his or her restaurant menu cannot be construed as a qualified production 

activity. 

The conferees recognize that some taxpayers may own facilities at which the predominant activity is domestic production as defined in the conference agreement and other facilities at which 

they engage in the retail sale of the taxpayer’s produced goods and also sell food and beverages. 

For example, assume that the taxpayer buys coffee beans and roasts those beans at a facility, 

the primary activity of which is the roasting and packaging of roasted coffee. The taxpayer sells 

the roasted coffee through a variety of unrelated third-party vendors and also sells roasted coffee at the taxpayer’s own retail establishments. In addition, at the taxpayer’s retail establishments, the taxpayer prepares brewed coffee and other foods. The conferees intend that to the 

extent that the gross receipts of the taxpayer’s retail establishment represent receipts from the 

sale of its roasted coffee beans to customers, the receipts are qualified domestic production gross 

receipts, but to the extent that the gross receipts of the taxpayer’s retail establishment represent receipts from the sale of brewed coffee or food prepared at the retail establishment, the 

receipts are not qualified domestic production gross receipts. However, the conferees intend that, 

in this case, the taxpayer may allocate part of the receipts from the sale of the brewed coffee 

as qualified domestic production gross receipts to the extent of the value of the roasted coffee 

beans used to brew the coffee. The conferees intend that the Secretary provide guidance drawing 

on the principles of section 482 by which such a taxpayer can allocate gross receipts between 

qualified and nonqualified gross receipts. The conferees observe that in this example, the taxpayer’s sales of roasted coffee beans to unrelated third parties would provide a value for the 

beans used in brewing a cup of coffee for retail sale. 

The conferees intend that the disqualification of gross receipts derived from the sale of food 

and beverage prepared by the taxpayer at a retail establishment not be construed narrowly to 

apply only to establishments at which customers dine on premises. The receipts of a facility that 

prepares food and beverage solely for take out service would not be qualified production gross 

receipts. Likewise, the conferees intend that the disqualification of gross receipts derived from 

the sale of food and beverages prepared by the taxpayer need not be limited to retail establishments primarily engaged in the dining trade. For example, if a taxpayer operates a supermarket 

and as part of the supermarket the taxpayer operates an in-store bakery, the same allocation 

described above would apply to determine the extent to which the taxpayer’s gross receipts represent qualified domestic production gross receipts. 28The conference agreement provides that domestic production gross receipts include the gross 

receipts from the production in the United States of electricity, gas, and potable water, but excludes the gross receipts from the transmission or distribution of electricity, gas, and potable 

water. Thus, in the case of a taxpayer who owns a facility for the production of electricity, 

whether the taxpayer’s facility is part of a regulated utility or an independent power facility, 

the taxpayer’s gross receipts from the production of electricity at that facility are qualified domestic production gross receipts. However, to the extent that the taxpayer is an integrated producer that generates electricity and delivers electricity to end users, any gross receipts properly 

attributable to the transmission of electricity from the generating facility to a point of local distribution and any gross receipts properly attributable to the distribution of electricity to final 

customers are not qualified domestic production gross receipts. For example, assume taxpayer 

A owns a wind turbine that generates electricity and taxpayer B owns a high-voltage transmission line that passes near taxpayer A’s wind turbine and ends near the system of local distribution lines of taxpayer C. Taxpayer A sells the electricity produced at the wind turbine to 

taxpayer C and contracts with taxpayer B to transmit the electricity produced at the wind turbine to taxpayer C who sells the electricity to his or her customers using taxpayer C’s distribution network. The gross receipts received by taxpayer A for the sale of electricity produced at 

the wind turbine constitute qualifying domestic production gross receipts. The gross receipts of 

taxpayer B from transporting taxpayer A’s electricity to taxpayer C are not qualifying domestic 

production gross receipts. Likewise the gross receipts of taxpayer C from distributing the electricity are not qualifying domestic production gross receipts. Also, if taxpayer A made direct 

sales of electricity to customers in taxpayer C’s service area and taxpayer C receives remuneration for the distribution of electricity, the gross receipts of taxpayer C are not qualifying domestic production gross receipts. If taxpayers A, B, and C are all related taxpayer, then taxpayers 

A, B, and C must allocate gross receipts to production activities, transmission activities, and 

distribution activities in a manner consistent with the preceding example. 

The conference agreement provides that the same principles apply in the case of the natural 

gas and water supply industries. In the case of natural gas, production activities generally are 

all activities involved in extracting natural gas from the ground and processing the gas into 

pipeline quality gas. Such activities would produce qualifying domestic production gross receipts. 

However gross receipts of a taxpayer attributable to transmission of pipeline quality gas from 

a natural gas field (or from a natural gas processing plant) to a local distribution company’s 

citygate (or to another customer) are not qualified domestic production gross receipts. Likewise 

gas purchased by a local gas distribution company and distributed from the citygate to the local 

customers does not give rise to domestic production gross receipts. 

In the case of the production of potable water the conferees intend that activities involved in 

the production of potable water include the acquisition, collection, and storage of raw water (unment,27 or (2) the transmission or distribution of electricity, natural 

gas, or potable water.28 In addition, domestic production gross reVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00276 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
273 

treated water). It also includes the transportation of raw water to a water treatment facility 

and treatment of raw water at such a facility. However, any gross receipts from the storage of 

potable water after the water treatment facility or delivery of potable water to customers does 

not give rise to qualifying domestic production gross receipts. The conferees intend that a taxpayer that both produces potable water and distributes potable water will properly allocate 

gross receipts across qualifying and non-qualifying activities. 29 It is intended that principles similar to those under the present-law extraterritorial income 

regime apply for this purpose. See Temp. Treas. Reg. sec. 1.927(a)–1T(f)(2)(i). For example, this 

exclusion generally does not apply to property leased by the taxpayer to a related person if the 

property is held for sublease, or is subleased, by the related person to an unrelated person for 

the ultimate use of such unrelated person. Similarly, the license of computer software to a related person for reproduction and sale, exchange, lease, rental or sublicense to an unrelated person for the ultimate use of such unrelated person is not treated as excluded property by reason 

of the license to the related person. 30The conferees intend that the nature of the material on which properties described in section 168(f)(3) are embodied and the methods and means of distribution of such properties shall 

not affect their qualification under this provision. 31To the extent that a taxpayer has included an estimate of participations and/or residuals 

in its income forecast calculation under section 167(g), such taxpayer must use the same estimate of participations and/or residuals for purposes of determining total compensation. 32 It is intended that the Secretary will provide appropriate rules governing the determination 

of total compensation for services performed in the United States. 

ceipts do not include any gross receipts of the taxpayer derived 

from property that is leased, licensed or rented by the taxpayer for 

use by any related person.29

‘‘Qualifying production property’’ generally includes any tangible personal property, computer software, or sound recordings. 

‘‘Qualified film’’ includes any motion picture film or videotape 30

(including live or delayed television programming, but not including certain sexually explicit productions) if 50 percent or more of 

the total compensation relating to the production of such film (including compensation in the form of residuals and participations 31) 

constitutes compensation for services performed in the United 

States by actors, production personnel, directors, and producers.32

Other rules 

Qualified production activities income of passthrough entities 

(other than cooperatives) 

With respect to domestic production activities of an S corporation, partnership, estate, trust or other passthrough entity (other 

than an agricultural or horticultural cooperative), although the 

wage limitation is applied first at the entity level, the deduction 

under the conference agreement generally is determined at the 

shareholder, partner or similar level by taking into account at such 

level the proportionate share of qualified production activities income of the entity. The Secretary is directed to prescribe rules for 

the application of the conference agreement to passthrough entities, including reporting requirements and rules relating to restrictions on the allocation of the deduction to taxpayers at the partner 

or similar level. 

For purposes of applying the wage limitation at the level of a 

shareholder, partner, or similar person, each person who is allocated qualified production activities income from a passthrough entity also is treated as having been allocated wages from such entity 

in an amount that is equal to the lesser of: (1) such person’s allocable share of wages, as determined under regulations prescribed 

by the Secretary; or (2) twice the appropriate deductible percentage 

of qualified production activities income that actually is allocated 

to such person for the taxable year. 

274 

33For this purpose, agricultural or horticultural products also include fertilizer, diesel fuel and 

other supplies used in agricultural or horticultural production that are manufactured, produced, 

grown, or extracted by the cooperative. 

Qualified production activities income of agricultural and 

horticultural cooperatives 

With regard to member-owned agricultural and horticultural 

cooperatives formed under Subchapter T of the Code, the conference agreement provides the same treatment of qualified production activities income derived from agricultural or horticultural 

products that are manufactured, produced, grown, or extracted by 

cooperatives,33 or that are marketed through cooperatives, as it 

provides for qualified production activities income of other taxpayers (i.e., the cooperative may claim a deduction from qualified 

production activities income). 

In addition, the conference agreement provides that the 

amount of any patronage dividends or per-unit retain allocations 

paid to a member of an agricultural or horticultural cooperative (to 

which Part I of Subchapter T applies), which is allocable to the portion of qualified production activities income of the cooperative that 

is deductible under the conference agreement, is deductible from 

the gross income of the member. In order to qualify, such amount 

must be designated by the organization as allocable to the deductible portion of qualified production activities income in a written 

notice mailed to its patrons not later than the payment period described in section 1382(d). The cooperative cannot reduce its income 

under section 1382 (e.g., cannot claim a dividends-paid deduction) 

for such amounts. 

Alternative minimum tax 

The deduction provided by the conference agreement is allowed 

for purposes of computing alternative minimum taxable income (including adjusted current earnings). The deduction in computing alternative minimum taxable income is determined by reference to 

the lesser of the qualified production activities income (as determined for the regular tax) or the alternative minimum taxable income (in the case of an individual, adjusted gross income as determined for the regular tax) without regard to this deduction. 

Timber cutting 

Under the conference agreement, an election made for a taxable year ending on or before the date of enactment, to treat the 

cutting of timber as a sale or exchange, may be revoked by the taxpayer without the consent of the IRS for any taxable year ending 

after that date. The prior election (and revocation) is disregarded 

for purposes of making a subsequent election. 

Exploration of fundamental tax reform 

The conferees acknowledge that Congress has not reduced the 

statutory corporate income tax rate since 1986. According to the 

Organisation of Economic Cooperation and Development (‘‘OECD’’), 

the combined corporate income tax rate, as defined by the OECD, 

in most instances is lower than the U.S. corporate income tax 

275 

34Organisation of Economic Cooperation and Development, Table 1.5, Tax Data Base Statistics, Tax Policy and Administration, Summary Tables (2003). 

rate.34 Higher corporate tax rates factor into the United States’ 

ability to attract and retain economically vibrant industries, which 

create good jobs and contribute to overall economic growth. 

This legislation was crafted to repeal an export tax benefit that 

was deemed inconsistent with obligations of the United States 

under the Agreement on Subsidies and Countervailing Measures 

and other international trade agreements. This legislation replaces 

the benefit with tax relief specifically designed to be economically 

equivalent to a 3-percentage point reduction in U.S.-based manufacturing. 

The conferees recognize that manufacturers are a segment of 

the economy that has faced significant challenges during the nation’s recent economic slowdown. The conferees recognize that trading partners of the United States retain subsidies for domestic 

manufacturers and exports through their indirect tax systems. The 

conferees are concerned about the adverse competitive impact of 

these subsidies on U.S. manufacturers. 

These concerns should be considered in the context of the benefits of a unified top tax rate for all corporate taxpayers, including 

manufacturing, in terms of efficiency and fairness. The conferees 

also expect that the tax-writing committees will explore a unified 

top corporate tax rate in the context of fundamental tax reform. 

Effective date.—The conference agreement is effective for taxable years beginning after December 31, 2004. 

C. REDUCED CORPORATE INCOME TAX RATE FOR SMALL

CORPORATIONS

(Sec. 103 of the House bill and sec. 11 of the Code) 

PRESENT LAW

A corporation’s regular income tax liability is determined by 

applying the following tax rate schedule to its taxable income. 

TABLE 1.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2004 

Taxable income: Income tax rate: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income. 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income. 

$75,001–$10,000,000 ................................................................................................................ 34 percent of taxable income. 

Over $10,000,000 ....................................................................................................................... 35 percent of taxable income. 

The benefit of the first two graduated rates described above is 

phased out by a five-percent surcharge for corporations with taxable income between $100,000 and $335,000. Also, the benefit of 

the 34-percent rate is phased out by a three-percent surcharge for 

corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

276 

HOUSE BILL

Under the House bill, a corporation’s regular income tax liability is determined by applying the following tax rate schedules to 

its taxable income. 

TABLE 2.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2013 AND THEREAFTER 

Taxable income: Income tax rate: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income. 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income. 

$75,001–$20,000,000 ................................................................................................................ 32 percent of taxable income. 

Over $20,000,000 ....................................................................................................................... 35 percent of taxable income. 

The benefit of the graduated rates described above is phased 

out by a three-percent surcharge for corporations with taxable income between $20 million and $40,341,667; a corporation with taxable income of $40,341,667 or more effectively is subject to a flat 

rate of 35 percent. 

TABLE 3.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2011–2012 

Taxable income: Income tax rate: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income. 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income. 

$75,001–$5,000,000 .................................................................................................................. 32 percent of taxable income. 

$5,000,001–$10,000,000 ........................................................................................................... 34 percent of taxable income. 

Over $10,000,000 ....................................................................................................................... 35 percent of taxable income. 

The benefit of the first three graduated rates described above 

is phased out by a five-percent surcharge for corporations with taxable income between $5,000,000 and $7,205,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

TABLE 4.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2008–2010 

Taxable income: Income tax rate: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income. 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income. 

$75,001–$1,000,000 .................................................................................................................. 32 percent of taxable income. 

$1,000,001–$10,000,000 ........................................................................................................... 34 percent of taxable income. 

Over $10,000,000 ....................................................................................................................... 35 percent of taxable income 

The benefit of the first three graduated rates described above 

is phased out by a five-percent surcharge for corporations with taxable income between $1,000,000 and $1,605,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

TABLE 5.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2005–2007 

Taxable income: Income tax rate: 

$0–$50,000 .................................................................................................. 15 percent of taxable income. 

277 

35Pub. L. No. 108–27, sec. 202 (2003). 36 Additional section 179 incentives are provided with respect to a qualified property used by 

a business in the New York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec. 1397A), 

or a renewal community (sec. 1400J). 

TABLE 5.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES FOR 2005–2007—Continued 

Taxable income: Income tax rate: 

$50,001–$75,000 ......................................................................................... 25 percent of taxable income. 

$75,001–$1,000,000 .................................................................................... 33 percent of taxable income. 

$1,000,001–$10,000,000 ............................................................................. 34 percent of taxable income. 

Over $10,000,000 ......................................................................................... 35 percent of taxable income. 

The benefit of the first three graduated rates described above 

is phased out by a five-percent surcharge for corporations with taxable income between $1,000,000 and $1,420,000. Also, the benefit 

of the 34-percent rate is phased out by a three-percent surcharge 

for corporations with taxable income between $15 million and 

$18,333,333; a corporation with taxable income of $18,333,333 or 

more effectively is subject to a flat rate of 35 percent. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

TITLE II—PROVISIONS RELATING TO JOB CREATION TAX 

INCENTIVES FOR MANUFACTURERS, SMALL BUSINESSES, 

AND FARMERS 

A. SECTION 179 EXPENSING

(Sec. 201 of the House bill, sec. 309 of the Senate amendment and 

sec. 179 of the Code) 

PRESENT LAW

Present law provides that, in lieu of depreciation, a taxpayer 

with a sufficiently small amount of annual investment may elect to 

deduct such costs. The Jobs and Growth Tax Relief Reconciliation 

Act (JGTRRA) of 2003 35 increased the amount a taxpayer may deduct, for taxable years beginning in 2003 through 2005, to $100,000 

of the cost of qualifying property placed in service for the taxable 

year.36 In general, qualifying property is defined as depreciable 

tangible personal property (and certain computer software) that is 

purchased for use in the active conduct of a trade or business. The 

$100,000 amount is reduced (but not below zero) by the amount by 

which the cost of qualifying property placed in service during the 

taxable year exceeds $400,000. The $100,000 and $400,000 

amounts are indexed for inflation. 

Prior to the enactment of JGTRRA (and for taxable years beginning in 2006 and thereafter) a taxpayer with a sufficiently small 

amount of annual investment could elect to deduct up to $25,000 

278 

37Sec. 179(c)(1). 38 Under Treas. Reg. sec. 1.179–5, applicable to property placed in service in taxable years 

ending after Jan. 25, 1993 (but not including property placed in service in taxable years beginning after 2002 and before 2006), a taxpayer may make the election on the original return 

(whether or not the return is timely), or on an amended return filed by the due date (including 

extensions) for filing the return for the tax year the property was placed in service. If the taxpayer timely filed an original return without making the election, the taxpayer may still make 

the election by filing an amended return within six months of the due date of the return (excluding extensions). 39Sec. 179(c)(2). 40 Id. Under Prop. and Temp. Treas. Reg. sec. 179–5T, applicable to property placed in service 

in taxable years beginning after 2002 and before 2006, a taxpayer is permitted to make or revoke an election under section 179 without the consent of the Commissioner on an amended 

Federal tax return for that taxable year. This amended return must be filed within the time 

prescribed by law for filing an amended return for the taxable year. T.D. 9146, Aug. 3, 2004. 

of the cost of qualifying property placed in service for the taxable 

year. The $25,000 amount was reduced (but not below zero) by the 

amount by which the cost of qualifying property placed in service 

during the taxable year exceeds $200,000. In general, qualifying 

property is defined as depreciable tangible personal property that 

is purchased for use in the active conduct of a trade or business. 

The amount eligible to be expensed for a taxable year may not 

exceed the taxable income for a taxable year that is derived from 

the active conduct of a trade or business (determined without regard to this provision). Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to succeeding taxable years (subject to similar limitations). 

No general business credit under section 38 is allowed with respect 

to any amount for which a deduction is allowed under section 179. 

Under present law, an expensing election is made under rules 

prescribed by the Secretary.37 Applicable Treasury regulations provide that an expensing election generally is made on the taxpayer’s 

original return for the taxable year to which the election relates.38

Prior to the enactment of JGTRRA (and for taxable years beginning in 2006 and thereafter), an expensing election may be revoked only with consent of the Commissioner.39 JGTRRA permits 

taxpayers to revoke expensing elections on amended returns without the consent of the Commissioner with respect to a taxable year 

beginning after 2002 and before 2006.40

HOUSE BILL

The provision extends the increased amount that a taxpayer 

may deduct, and other changes that were made by JGTRRA, for an 

additional two years. Thus, the provision provides that the maximum dollar amount that may be deducted under section 179 is 

$100,000 for property placed in service in taxable years beginning 

before 2008 ($25,000 for taxable years beginning in 2008 and thereafter). In addition, the $400,000 amount applies for property placed 

in service in taxable years beginning before 2008 ($200,000 for taxable years beginning in 2008 and thereafter). The provision extends, through 2007 (from 2005), the indexing for inflation of both 

the maximum dollar amount that may be deducted and the 

$400,000 amount. The provision also includes off-the-shelf computer software placed in service in taxable years beginning before 

2008 as qualifying property. The provision permits taxpayers to revoke expensing elections on amended returns without the consent 

of the Commissioner with respect to a taxable year beginning beVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00282 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
279 

41 As a result of the reduced phase-out percentage, the deductible amount in the New York 

Liberty Zone, an enterprise zone or a renewal community is correspondingly increased. See sec. 

1400L(f), sec. 1397A and sec. 1400J. 

fore 2008. The Committee expects that the Secretary will prescribe 

regulations to permit a taxpayer to make an expensing election on 

an amended return without the consent of the Commissioner. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

The provision provides that the $100,000 amount ($25,000 for 

taxable years beginning in 2006 and thereafter) is reduced (but not 

below zero) by only one half of the amount by which the cost of 

qualifying property placed in service during the taxable year exceeds $400,000 ($200,000 for taxable years beginning 2006 and 

thereafter).41

For example, under the provision, if in 2004 an eligible taxpayer places in service qualifying property costing $500,000, the 

$100,000 amount is reduced by $50,000 (i.e., one half the amount 

by which the $500,000 cost of qualifying property placed in service 

during the taxable year exceeds $400,000). Thus, the maximum 

amount eligible for section 179 expensing by this taxpayer for 2004 

is $50,000. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2002. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

B. DEPRECIATION

1. Recovery period for depreciation of certain leasehold improvements (sec. 211 of the House bill and sec. 168 of the Code) 

PRESENT LAW

In general 

A taxpayer generally must capitalize the cost of property used 

in a trade or business and recover such cost over time through annual deductions for depreciation or amortization. Tangible property 

generally is depreciated under the modified accelerated cost recovery system (‘‘MACRS’’), which determines depreciation by applying 

specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property 

(sec. 168). The cost of nonresidential real property is recovered 

using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the midmonth placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed 

in service is based on the number of months the property was in 

service, and property placed in service at any time during a month 

is treated as having been placed in service in the middle of the 

month. 

280 

42Sec. 168(i)(8). The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System 

(‘‘ACRS’’) to institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Tax 

Act of 1981, taxpayers were allowed to depreciate the various components of a building as separate assets with separate useful lives. The use of component depreciation was repealed upon the 

adoption of ACRS. The Tax Reform Act of 1986 also denied the use of component depreciation 

under MACRS. 43Former sections 168(f)(6) and 178 provided that, in certain circumstances, a lessee could recover the cost of leasehold improvements made over the remaining term of the lease. The Tax 

Reform Act of 1986 repealed these provisions. 44Secs. 168(b)(3), (c), (d)(2), and (i)(6). If the improvement is characterized as tangible personal property, ACRS or MACRS depreciation is calculated using the shorter recovery periods, 

accelerated methods, and conventions applicable to such property. The determination of whether 

improvements are characterized as tangible personal property or as nonresidential real property 

often depends on whether or not the improvements constitute a ‘‘structural component’’ of a 

building (as defined by Treas. Reg. sec. 1.48–1(e)(1)). See, e.g., Metro National Corp v. Commissioner, 52 TCM (CCH) 1440 (1987); King Radio Corp Inc. v. U.S., 486 F.2d 1091 (10th Cir. 

1973); Mallinckrodt, Inc. v. Commissioner, 778 F.2d 402 (8th Cir. 1985) (with respect to various 

leasehold improvements). 45Pub. L. No. 107–147, sec. 101 (2002), as amended by Pub. L. No. 108–27, sec. 201 (2003). 

Depreciation of leasehold improvements 

Depreciation allowances for improvements made on leased 

property are determined under MACRS, even if the MACRS recovery period assigned to the property is longer than the term of the 

lease.42 This rule applies regardless of whether the lessor or the 

lessee places the leasehold improvements in service.43 If a leasehold improvement constitutes an addition or improvement to nonresidential real property already placed in service, the improvement is depreciated using the straight-line method over a 39-year 

recovery period, beginning in the month the addition or improvement was placed in service.44

Qualified leasehold improvement property 

The Job Creation and Worker Assistance Act of 2002 45

(‘‘JCWAA’’), as amended by JGTRRA, generally provides an additional first-year depreciation deduction equal to either 30 percent 

or 50 percent of the adjusted basis of qualified property placed in 

service before January 1, 2005. Qualified property includes qualified leasehold improvement property. For this purpose, qualified 

leasehold improvement property is any improvement to an interior 

portion of a building that is nonresidential real property, provided 

certain requirements are met. The improvement must be made 

under or pursuant to a lease either by the lessee (or sublessee), or 

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

placed in service more than three years after the date the building 

was first placed in service. Qualified leasehold improvement property does not include any improvement for which the expenditure 

is attributable to the enlargement of the building, any elevator or 

escalator, any structural component benefiting a common area, or 

the internal structural framework of the building. 

Treatment of dispositions of leasehold improvements 

A lessor of leased property that disposes of a leasehold improvement that was made by the lessor for the lessee of the property may take the adjusted basis of the improvement into account 

for purposes of determining gain or loss if the improvement is irrevocably disposed of or abandoned by the lessor at the termination 

of the lease. This rule conforms the treatment of lessors and lessees 

281 

46Qualified leasehold improvement property continues to be eligible for the additional firstyear depreciation deduction under sec. 168(k). 47Sec. 168(k). 

with respect to leasehold improvements disposed of at the end of 

a term of lease. 

HOUSE BILL

The House bill provides a statutory 15-year recovery period for 

qualified leasehold improvement property placed in service before 

January 1, 2006.46 The provision requires that qualified leasehold 

improvement property be recovered using the straight-line method. 

Qualified leasehold improvement property is defined as under 

present law for purposes of the additional first-year depreciation 

deduction,47 with the following modification. If a lessor makes an 

improvement that qualifies as qualified leasehold improvement 

property, such improvement does not qualify as qualified leasehold 

improvement property to any subsequent owner of such improvement. An exception to the rule applies in the case of death and certain transfers of property that qualify for non-recognition treatment. 

Effective date.—The House bill provision is effective for property placed in service after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

2. Recovery period for depreciation of certain restaurant improvements (sec. 211 of the House bill and sec. 168 of the Code) 

PRESENT LAW

A taxpayer generally must capitalize the cost of property used 

in a trade or business and recover such cost over time through annual deductions for depreciation or amortization. Tangible property 

generally is depreciated under the modified accelerated cost recovery system (‘‘MACRS’’), which determines depreciation by applying 

specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property 

(sec. 168). The cost of nonresidential real property is recovered 

using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the midmonth placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed 

in service is based on the number of months the property was in 

service, and property placed in service at any time during a month 

is treated as having been placed in service in the middle of the 

month. 

HOUSE BILL

The House bill provides a statutory 15-year recovery period for 

qualified restaurant property placed in service before January 1, 

282 

48Qualified restaurant property would become eligible for the additional first-year depreciation deduction under sec. 168(k) by virtue of the assigned 15-year recovery period. 49The additional first-year depreciation deduction is subject to the general rules regarding 

whether an item is deductible under section 162 or subject to capitalization under section 263 

or section 263A. 50 However, the additional first-year depreciation deduction is not allowed for purposes of computing earnings and profits. 

2006.48 For purposes of the provision, qualified restaurant property 

means any improvement to a building if such improvement is 

placed in service more than three years after the date such building was first placed in service and more than 50 percent of the 

building’s square footage is devoted to the preparation of, and seating for, on-premises consumption of prepared meals. The provision 

requires that qualified restaurant property be recovered using the 

straight-line method. 

Effective date.—The House bill provision is effective for property placed in service after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

3. Extended placed in service date for bonus depreciation for certain aircraft (excluding aircraft used in the transportation industry) (sec. 212 of the House bill, sec. 622 of the Senate 

amendment, and sec. 168 of the Code) 

PRESENT LAW

In general 

A taxpayer is allowed to recover, through annual depreciation 

deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’). Under MACRS, different types of property generally 

are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property 

range from three to 25 years. The depreciation methods generally 

applicable to tangible personal property are the 200-percent and 

150-percent declining balance methods, switching to the straightline method for the taxable year in which the depreciation deduction would be maximized. 

Thirty-percent additional first year depreciation deduction 

JCWAA allows an additional first-year depreciation deduction 

equal to 30 percent of the adjusted basis of qualified property.49

The amount of the additional first-year depreciation deduction is 

not affected by a short taxable year. The additional first-year depreciation deduction is allowed for both regular tax and alternative 

minimum tax purposes for the taxable year in which the property 

is placed in service.50 The basis of the property and the depreciation allowances in the placed-in-service year and later years are apVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00286 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
283 

51 A taxpayer may elect out of the 50-percent additional first-year depreciation (discussed 

below) for any class of property and still be eligible for the 30-percent additional first-year depreciation. 52 A special rule precludes the additional first-year depreciation deduction for any property 

that is required to be depreciated under the alternative depreciation system of MACRS. 53The term ‘‘original use’’ means the first use to which the property is put, whether or not 

such use corresponds to the use of such property by the taxpayer. 

If, in the normal course of its business, a taxpayer sells fractional interests in property to unrelated third parties, then the original use of such property begins with the first user of each 

fractional interest (i.e., each fractional owner is considered the original user of its proportionate 

share of the property). 54 In order for property to qualify for the extended placed-in-service date, the property must 

be subject to section 263A and have an estimated production period exceeding two years or an 

estimated production period exceeding one year and a cost exceeding $1 million. 55Property does not fail to qualify for the additional first-year depreciation merely because 

a binding written contract to acquire a component of the property is in effect prior to September 

11, 2001. 56For purposes of determining the amount of eligible progress expenditures, it is intended 

that rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply. 

propriately adjusted to reflect the additional first-year depreciation 

deduction. In addition, there are generally no adjustments to the 

allowable amount of depreciation for purposes of computing a taxpayer’s alternative minimum taxable income with respect to property to which the provision applies. A taxpayer is allowed to elect 

out of the additional first-year depreciation for any class of property for any taxable year.51

In order for property to qualify for the additional first-year depreciation deduction, it must meet all of the following requirements. First, the property must be (1) property to which MACRS 

applies with an applicable recovery period of 20 years or less, (2) 

water utility property (as defined in section 168(e)(5)), (3) computer 

software other than computer software covered by section 197, or 

(4) qualified leasehold improvement property (as defined in section 

168(k)(3)).52 Second, the original use 53 of the property must commence with the taxpayer on or after September 11, 2001. Third, the 

taxpayer must acquire the property within the applicable time period. Finally, the property must be placed in service before January 

1, 2005. 

An extension of the placed-in-service date of one year (i.e., January 1, 2006) is provided for certain property with a recovery period of ten years or longer and certain transportation property.54

Transportation property is defined as tangible personal property 

used in the trade or business of transporting persons or property. 

The applicable time period for acquired property is (1) after 

September 10, 2001 and before January 1, 2005, but only if no 

binding written contract for the acquisition is in effect before September 11, 2001, or (2) pursuant to a binding written contract 

which was entered into after September 10, 2001, and before January 1, 2005.55 With respect to property that is manufactured, constructed, or produced by the taxpayer for use by the taxpayer, the 

taxpayer must begin the manufacture, construction, or production 

of the property after September 10, 2001. For property eligible for 

the extended placed-in-service date, a special rule limits the 

amount of costs eligible for the additional first year depreciation. 

With respect to such property, only the portion of the basis that is 

properly attributable to the costs incurred before January 1, 2005 

(‘‘progress expenditures’’) is eligible for the additional first-year depreciation.56

284 

57Property does not fail to qualify for the additional first-year depreciation merely because 

a binding written contract to acquire a component of the property is in effect prior to May 6, 

2003. However, no 50-percent additional first-year depreciation is permitted on any such component. No inference is intended as to the proper treatment of components placed in service under 

the 30-percent additional first-year depreciation provided by the JCWAA. 58For purposes of determining the amount of eligible progress expenditures, it is intended 

that rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply. 59For this purpose, it is intended that the term ‘‘purchase’’ be interpreted as it is defined in 

sec. 179(d)(2). 

Fifty-percent additional first year depreciation 

JGTRRA provides an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property. 

Qualified property is defined in the same manner as for purposes 

of the 30-percent additional first-year depreciation deduction provided by the JCWAA except that the applicable time period for acquisition (or self construction) of the property is modified. Property 

eligible for the 50-percent additional first-year depreciation deduction is not eligible for the 30-percent additional first-year depreciation deduction. 

In order to qualify, the property must be acquired after May 

5, 2003 and before January 1, 2005, and no binding written contract for the acquisition can be in effect before May 6, 2003.57 With 

respect to property that is manufactured, constructed, or produced 

by the taxpayer for use by the taxpayer, the taxpayer must begin 

the manufacture, construction, or production of the property after 

May 5, 2003. For property eligible for the extended placed-in-service date (i.e., certain property with a recovery period of ten years 

or longer and certain transportation property), a special rule limits 

the amount of costs eligible for the additional first-year depreciation. With respect to such property, only progress expenditures 

properly attributable to the costs incurred before January 1, 2005 

are eligible for the additional first-year depreciation.58

HOUSE BILL

Due to the extended production period, the House bill provides 

criteria under which certain non-commercial aircraft can qualify for 

the extended placed-in-service date. Qualifying aircraft are eligible 

for the additional first-year depreciation deduction if placed in 

service before January 1, 2006. In order to qualify, the aircraft 

must: 

(1) Be acquired by the taxpayer during the applicable time 

period as under present law; 

(2) Meet the appropriate placed-in-service date requirements; 

(3) Not be tangible personal property used in the trade or 

business of transporting persons or property (except for agricultural or firefighting purposes); 

(4) Be purchased 59 by a purchaser who, at the time of the 

contract for purchase, has made a nonrefundable deposit of the 

lesser of ten percent of the cost or $100,000; and 

(5) Have an estimated production period exceeding four 

months and a cost exceeding $200,000. 

Effective date.—The House bill provision is effective as if included in the amendments made by section 101 of JCWAA, which 

applies to property placed in service after September 10, 2001. 

285 

However, because the property described by the provision qualifies 

for the additional first-year depreciation deduction under present 

law if placed in service prior to January 1, 2005, the provision will 

modify the treatment only of property placed in service during calendar year 2005. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

for the effective date. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

4. Special placed in service rule for bonus depreciation for certain 

property subject to syndication (sec. 213 of the House bill, sec. 

621 of the Senate amendment, and sec. 168 of the Code) 

PRESENT LAW

Section 101 of JCWAA provides generally for 30-percent additional first-year depreciation, and provides a binding contract rule 

in determining property that qualifies for it. The requirements that 

must be satisfied in order for property to qualify include that (1) 

the original use of the property must commence with the taxpayer 

on or after September 11, 2001, and (2) the taxpayer must acquire 

the property (i) after September 10, 2001 and before January 1, 

2005, but only if no binding written contract for the acquisition is 

in effect before September 11, 2001, or (ii) pursuant to a binding 

contract which was entered into after September 10, 2001, and before January 1, 2005. In addition, JCWAA provides a special rule 

in the case of certain leased property. In the case of any property 

that is originally placed in service by a person and that is sold to 

the taxpayer and leased back to such person by the taxpayer within three months after the date that the property was placed in 

service, the property is treated as originally placed in service by 

the taxpayer not earlier than the date that the property is used 

under the leaseback. JCWAA did not specifically address the syndication of a lease by the lessor. 

The Working Families Tax Relief Act of 2004 (‘‘H.R. 1308’’) included a technical correction regarding the syndication of a lease 

by the lessor. The technical correction provides that if property is 

originally placed in service by a lessor (including by operation of 

the special rule for self-constructed property), such property is sold 

within three months after the date that the property was placed in 

service, and the user of such property does not change, then the 

property is treated as originally placed in service by the taxpayer 

not earlier than the date of such sale. 

JGTRRA provides an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property. 

Qualified property is defined in the same manner as for purposes 

of the 30-percent additional first-year depreciation deduction provided by the JCWAA except that the applicable time period for acquisition (or self construction) of the property is modified. Property 

286 

60The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of technical corrections. 61The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of technical corrections. 

with respect to which the 50-percent additional first-year depreciation deduction is claimed is not also eligible for the 30-percent additional first-year depreciation deduction. In order to qualify, the 

property must be acquired after May 5, 2003 and before January 

1, 2005, and no binding written contract for the acquisition can be 

in effect before May 6, 2003. With respect to property that is manufactured, constructed, or produced by the taxpayer for use by the 

taxpayer, the taxpayer must begin the manufacture, construction, 

or production of the property after May 5, 2003. 

HOUSE BILL 60

The House bill provides that if property is originally placed in 

service by a lessor (including by operation of the special rule for 

self-constructed property), such property is sold within three 

months after the date that the property was placed in service, and 

the user of such property does not change, then the property is 

treated as originally placed in service by the taxpayer not earlier 

than the date of such sale. The provision also provides a special 

rule in the case of multiple units of property subject to the same 

lease. In such cases, property will qualify as placed in service on 

the date of sale if it is sold within three months after the final unit 

is placed in service, so long as the period between the time the first 

and last units are placed in service does not exceed 12 months. 

Effective date.—The House bill provision is generally effective 

as if included in the amendments made by section 101 of JCWAA 

(i.e., generally for property placed in service after September 10, 

2001, in taxable years ending after that date). However, the special 

rule in the case of multiple units of property subject to the same 

lease applies to property sold after June 4, 2004. 

SENATE AMENDMENT 61

The Senate amendment is the same as the House bill, except 

for the effective date. 

Effective date.—The Senate amendment is effective for sales occurring after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with the following modification. The clauses that were duplicative of the provisions enacted as part of H.R. 1308 were removed. Thus, the conference agreement provision provides only for the special rule in 

the case of multiple units of property subject to the same lease. 

C. S CORPORATION REFORM AND SIMPLIFICATION

(Secs. 221–231 of the House bill, sec. 654 of the Senate amendment 

and secs. 1361–1379 and 4975 of the Code) 

In general, an S corporation is not subject to corporate-level income tax on its items of income and loss. Instead, an S corporation 

passes through its items of income and loss to its shareholders. The 

287 

62 If a qualified retirement plan (other than an employee stock ownership plan) or a charity 

holds stock in an S corporation, the interest held is treated as an interest in an unrelated trade 

or business, and the plan or charity’s share of the S corporation’s items of income, loss, or deduction, and gain or loss on the disposition of the S corporation stock, are taken into account in 

computing unrelated business taxable income. 

shareholders take into account separately their shares of these 

items on their individual income tax returns. To prevent double 

taxation of these items when the stock is later disposed of, each 

shareholder’s basis in the stock of the S corporation is increased by 

the amount included in income (including tax-exempt income) and 

is decreased by the amount of any losses (including nondeductible 

losses) taken into account. A shareholder’s loss may be deducted 

only to the extent of his or her basis in the stock or debt of the 

S corporation. To the extent a loss is not allowed due to this limitation, the loss generally is carried forward with respect to the shareholder. 

1. Members of family treated as one shareholder 

PRESENT LAW

A small business corporation may elect to be an S corporation 

with the consent of all its shareholders, and may terminate its election with the consent of shareholders holding more than 50 percent 

of the stock. A ‘‘small business corporation’’ is defined as a domestic 

corporation which is not an ineligible corporation and which has (1) 

no more than 75 shareholders, all of whom are individuals (and 

certain trusts, estates, charities, and qualified retirement plans) 62

who are citizens or residents of the United States, and (2) only one 

class of stock. For purposes of the 75-shareholder limitation, a husband and wife are treated as one shareholder. An ‘‘ineligible corporation’’ means a corporation that is a financial institution using 

the reserve method of accounting for bad debts, an insurance company, a corporation electing the benefits of the Puerto Rico and 

possessions tax credit, or a Domestic International Sales Corporation (‘‘DISC’’) or former DISC. 

HOUSE BILL

The bill provides an election to allow all members of a family 

be treated as one shareholder in determining the number of shareholders in the corporation (for purposes of section 1361(b)(1)(A)). 

A family is defined as the common ancestor and all lineal descendants of the common ancestor, as well as the spouses, or 

former spouses, of these individuals. An individual shall not be a 

common ancestor if, as of the later of the time of the election or 

the effective date of this provision, the individual is more than 

three generations removed from the youngest generation of shareholders who would (but for this rule) be members of the family. For 

purposes of this rule, a spouse or former spouse is treated as in the 

same generation as the person to whom the individual is (or was) 

married. 

Except as provided by Treasury regulations, the election for a 

family may be made by any family member and remains in effect 

until terminated. 

288 

63 If a qualified retirement plan (other than an employee stock ownership plan) or a charity 

holds stock in an S corporation, the interest held is treated as an interest in an unrelated trade 

or business, and the plan or charity’s share of the S corporation’s items of income, loss, or deduction, and gain or loss on the disposition of the S corporation stock, are taken into account in 

computing unrelated business taxable income. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill, except that the number of generations is increased from three 

to six. 

The conferees wish to clarify that members of a family may be 

treated as one shareholder, for the purpose of determining the 

number of shareholders, whether a family member holds stock directly or is treated as a shareholder (under section 1361(c)(2)(B)) 

by reason being a beneficiary of an electing small business trust or 

qualified subchapter S trust. 

2. Increase in number of eligible shareholders to 100 

PRESENT LAW

A small business corporation may elect to be an S corporation 

with the consent of all its shareholders, and may terminate its election with the consent of shareholders holding more than 50 percent 

of the stock. A ‘‘small business corporation’’ is defined as a domestic 

corporation which is not an ineligible corporation and which has (1) 

no more than 75 shareholders, all of whom are individuals (and 

certain trusts, estates, charities, and qualified retirement plans) 63

who are citizens or residents of the United States, and (2) only one 

class of stock. For purposes of the 75-shareholder limitation, a husband and wife are treated as one shareholder. An ‘‘ineligible corporation’’ means a corporation that is a financial institution using 

the reserve method of accounting for bad debts, an insurance company, a corporation electing the benefits of the Puerto Rico and 

possessions tax credit, or a Domestic International Sales Corporation (‘‘DISC’’) or former DISC. 

HOUSE BILL

The bill increases the maximum number of eligible shareholders from 75 to 100. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

289 

64 Under the bill, the present-law rules treating S corporation stock held by a qualified retirement plan (other than an employee stock ownership plan) or a charity as an interest in an unrelated trade or business apply to an IRA holding S corporation stock of a bank. 

3. Expansion of bank S corporation eligible shareholders to include 

IRAs 

PRESENT LAW

An individual retirement account (‘‘IRA’’) is a trust or account 

established for the exclusive benefit of an individual and his or her 

beneficiaries. There are two general types of IRAs: traditional 

IRAs, to which both deductible and nondeductible contributions 

may be made, and Roth IRAs, contributions to which are not deductible. Amounts held in a traditional IRA are includible in income when withdrawn (except to the extent the withdrawal is a return of nondeductible contributions). Amounts held in a Roth IRA 

that are withdrawn as a qualified distribution are not includible in 

income; distributions from a Roth IRA that are not qualified distributions are includible in income to the extent attributable to 

earnings. A qualified distribution is a distribution that (1) is made 

after the five-taxable year period beginning with the first taxable 

year for which the individual made a contribution to a Roth IRA, 

and (2) is made after attainment of age 591⁄2, on account of death 

or disability, or is made for first-time homebuyer expenses of up to 

$10,000. 

Under present law, an IRA cannot be a shareholder of an S 

corporation. 

Certain transactions are prohibited between an IRA and the 

individual for whose benefit the IRA is established, including a sale 

of property by the IRA to the individual. If a prohibited transaction 

occurs between an IRA and the IRA beneficiary, the account ceases 

to be an IRA, and an amount equal to the fair market value of the 

assets held in the IRA is deemed distributed to the beneficiary. 

HOUSE BILL

The bill allows an IRA (including a Roth IRA) to be a shareholder of a bank that is an S corporation, but only to the extent 

of bank stock held by the IRA on the date of enactment of the provision.64

The bill also provides an exemption from prohibited transaction treatment for the sale by an IRA to the IRA beneficiary of 

bank stock held by the IRA on the date of enactment of the provision. Under the bill, a sale is not a prohibited transaction if: (1) the 

sale is pursuant to an S corporation election by the bank; (2) the 

sale is for fair market value (as established by an independent appraiser) and is on terms at least as favorable to the IRA as the 

terms would be on a sale to an unrelated party; (3) the IRA incurs 

no commissions, costs, or other expenses in connection with the 

sale; and (4) the stock is sold in a single transaction for cash not 

later than 120 days after the S corporation election is made. 

Effective date.—The provision takes effect on date of enactment. 

290 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

4. Disregard of unexercised powers of appointment in determining 

potential current beneficiaries of ESBT 

PRESENT LAW

An electing small business trust (‘‘ESBT’’) holding stock in an 

S corporation is taxed at the maximum individual tax rate on its 

ratable share of items of income, deduction, gain, or loss passing 

through from the S corporation. An ESBT generally is an electing 

trust all of whose beneficiaries are eligible S corporation shareholders. For purposes of determining the maximum number of 

shareholders, each person who is entitled to receive a distribution 

from the trust (‘‘potential current beneficiary’’) is treated as a 

shareholder during the period the person may receive a distribution from the trust. 

An ESBT has 60 days to dispose of the S corporation stock 

after an ineligible shareholder becomes a potential current beneficiary to avoid disqualification. 

HOUSE BILL

Under the bill, powers of appointment to the extent not exercised are disregarded in determining the potential current beneficiaries of an electing small business trust. 

The bill increases the period during which an ESBT can dispose of S corporation stock, after an ineligible shareholder becomes 

a potential current beneficiary, from 60 days to one year. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

5. Transfers of suspended losses incident to divorce, etc. 

PRESENT LAW

Under present law, any loss or deduction that is not allowed 

to a shareholder of an S corporation, because the loss exceeds the 

shareholder’s basis in stock and debt of the corporation, is treated 

as incurred by the S corporation with respect to that shareholder 

in the subsequent taxable year. 

291 

HOUSE BILL

Under the bill, if a shareholder’s stock in an S corporation is 

transferred to a spouse, or to a former spouse incident to a divorce, 

any suspended loss or deduction with respect to that stock is treated as incurred by the corporation with respect to the transferee in 

the subsequent taxable year. 

Effective date.—The provision applies to transfers after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

6. Use of passive activity loss and at-risk amounts by qualified subchapter S trust income beneficiaries 

PRESENT LAW

Under present law, the share of income of an S corporation 

whose stock is held by a qualified subchapter S trust (‘‘QSST’’), 

with respect to which the beneficiary makes an election, is taxed 

to the beneficiary. However, the trust, and not the beneficiary, is 

treated as the owner of the S corporation stock for purposes of determining the tax consequences of the disposition of the S corporation stock by the trust. A QSST generally is a trust with one individual income beneficiary for the life of the beneficiary. 

HOUSE BILL

Under the bill, the beneficiary of a qualified subchapter S trust 

is generally allowed to deduct suspended losses under the at-risk 

rules and the passive loss rules when the trust disposes of the S 

corporation stock. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

7. Exclusion of investment securities income from passive investment income test for bank S corporations 

PRESENT LAW

An S corporation is subject to corporate-level tax, at the highest corporate tax rate, on its excess net passive income if the corporation has (1) accumulated earnings and profits at the close of 

the taxable year and (2) gross receipts more than 25 percent of 

which are passive investment income. 

292 

65 Notice 97–5, 1997–1 C.B. 352, sets forth guidance relating to passive investment income on 

banking assets. 66 Another provision of the bill increases the maximum number of shareholders to 100. 67Sec. 1361(c)(4). Treasury regulations provide that buy-sell and redemption agreements are 

disregarded in determining whether a corporation’s outstanding shares confer identical distribution and liquidation rights unless (1) a principal purpose of the agreement is to circumvent the 

one class of stock requirement and (2) the agreement establishes a purchase price that, at the 

Excess net passive income is the net passive income for a taxable year multiplied by a fraction, the numerator of which is the 

amount of passive investment income in excess of 25 percent of 

gross receipts and the denominator of which is the passive investment income for the year. Net passive income is defined as passive 

investment income reduced by the allowable deductions that are directly connected with the production of that income. Passive investment income generally means gross receipts derived from royalties, 

rents, dividends, interest, annuities, and sales or exchanges of 

stock or securities (to the extent of gains). Passive investment income generally does not include interest on accounts receivable, 

gross receipts that are derived directly from the active and regular 

conduct of a lending or finance business, gross receipts from certain 

liquidations, or gain or loss from any section 1256 contract (or related property) of an options or commodities dealer.65

In addition, an S corporation election is terminated whenever 

the S corporation has accumulated earnings and profits at the close 

of each of three consecutive taxable years and has gross receipts for 

each of those years more than 25 percent of which are passive investment income. 

HOUSE BILL

The bill provides that, in the case of a bank (as defined in section 581), a bank holding company (as defined in section 2(a) of the 

Bank Holding Company Act of 1956), or a financial holding company (as defined in section 2(p) of that Act), interest income and 

dividends on assets required to be held by the bank or holding company are not treated as passive investment income for purposes of 

the S corporation passive investment income rules. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

8. Treatment of bank director shares 

PRESENT LAW

An S corporation may have no more than 75 shareholders and 

may have only one outstanding class of stock.66

An S corporation has one class of stock if all outstanding 

shares of stock confer identical rights to distribution and liquidation proceeds. Differences in voting rights are disregarded.67

293 

time the agreement is entered into, is significantly in excess of, or below, the fair market value 

of the stock. Treas. Reg. sec. 1.1361–1(l). 68 12 U.S.C. secs. 71–72. 69See Private Letter Ruling 200217048 (January 24, 2002) describing such an agreement and 

holding that it creates a second class of stock. Nonetheless, the ruling concluded that the election to be an S corporation was inadvertently invalid and that an amended agreement did not 

create a second class of stock so that the corporation’s election was validated. 

National banking law requires that a director of a national 

bank own stock in the bank and that a bank have at least five directors.68 A number of States have similar requirements for Statechartered banks. Apparently, it is common practice for a bank director to enter into an agreement under which the bank (or a holding company) will reacquire the stock upon the director’s ceasing 

to hold the office of director, at the price paid by the director for 

the stock.69

HOUSE BILL

Under the bill, restricted bank director stock is not taken into 

account as outstanding stock in applying the provisions of subchapter S. Thus, the stock is not treated as a second class of stock; 

a director is not treated as a shareholder of the S corporation by 

reason of the stock; the stock is disregarded in allocating items of 

income, loss, etc. among the shareholders; and the stock is not 

treated as outstanding for purposes of determining whether an S 

corporation holds 100 percent of the stock of a qualified subchapter 

S subsidiary. 

Restricted bank director stock is stock in a bank (as defined in 

section 581), a bank holding company (within the meaning of section 2(a) of the Bank Holding Company Act of 1956), or a financial 

holding company (as defined in section 2(p) of that Act), registered 

with the Federal Reserve System, if the stock is required to be held 

by an individual under applicable Federal or State law in order to 

permit the individual to serve as a director of the bank or holding 

company and which is subject to an agreement with the bank or 

holding company (or corporation in control of the bank or company) 

pursuant to which the holder is required to sell the stock back 

upon ceasing to be a director at the same price the individual acquired the stock. 

A distribution (other than a payment in exchange for the stock) 

with respect to the restricted stock is includible in the gross income 

of the director and is deductible by the S corporation for the taxable year that includes the last day of the director’s taxable year 

in which the distribution is included in income. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the provision in the 

House bill. 

294 

9. Relief from inadvertently invalid qualified subchapter S subsidiary elections and terminations 

PRESENT LAW

Under present law, inadvertent invalid subchapter S elections 

and terminations may be waived. 

HOUSE BILL

The bill allows inadvertent invalid qualified subchapter S subsidiary elections and terminations to be waived by the IRS. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill, effective for elections and terminations after December 31, 

2004. 

10. Information returns for qualified subchapter S subsidiaries 

PRESENT LAW

Under present law, a corporation all of whose stock is held by 

an S corporation is treated as a qualified subchapter S subsidiary 

if the S corporation so elects. The assets, liabilities, and items of 

income, deduction, and credit of the subsidiary are treated as assets, liabilities, and items of the parent S corporation. 

HOUSE BILL

The bill provides authority to the Secretary to provide guidance regarding information returns of qualified subchapter S subsidiaries. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill. 

11. Repayment of loans for qualifying employer securities 

PRESENT LAW

An employee stock ownership plan (an ‘‘ESOP’’) is a defined 

contribution plan that is designated as an ESOP and is designed 

to invest primarily in qualifying employer securities. For purposes 

of ESOP investments, a ‘‘qualifying employer security’’ is defined 

as: (1) publicly traded common stock of the employer or a member 

of the same controlled group; (2) if there is no such publicly traded 

295 

70Sec. 4975. 71Sec. 4975(d)(3). An ESOP that borrows money to purchase employer stock is referred to as 

a ‘‘leveraged’’ ESOP. 72Treas. Reg. sec. 54.4975–7(b)(5). 73Sec. 404(k)(5)(B). 

common stock, common stock of the employer (or member of the 

same controlled group) that has both voting power and dividend 

rights at least as great as any other class of common stock; or (3) 

noncallable preferred stock that is convertible into common stock 

described in (1) or (2) and that meets certain requirements. In 

some cases, an employer may design a class of preferred stock that 

meets these requirements and that is held only by the ESOP. Special rules apply to ESOPs that do not apply to other types of qualified retirement plans, including a special exemption from the prohibited transaction rules. 

Certain transactions between an employee benefit plan and a 

disqualified person, including the employer maintaining the plan, 

are prohibited transactions that result in the imposition of an excise tax.70 Prohibited transactions include, among other transactions, (1) the sale, exchange or leasing of property between a plan 

and a disqualified person, (2) the lending of money or other extension of credit between a plan and a disqualified person, and (3) the 

transfer to, or use by or for the benefit of, a disqualified person of 

the income or assets of the plan. However, certain transactions are 

exempt from prohibited transaction treatment, including certain 

loans to enable an ESOP to purchase qualifying employer securities.71 In such a case, the employer securities purchased with the 

loan proceeds are generally pledged as security for the loan. Contributions to the ESOP and dividends paid on employer securities 

held by the ESOP are used to repay the loan. The employer securities are held in a suspense account and released for allocation to 

participants’ accounts as the loan is repaid. 

A loan to an ESOP is exempt from prohibited transaction 

treatment if the loan is primarily for the benefit of the participants 

and their beneficiaries, the loan is at a reasonable rate of interest, 

and the collateral given to a disqualified person consists of only 

qualifying employer securities. No person entitled to payments 

under the loan can have the right to any assets of the ESOP other 

than (1) collateral given for the loan, (2) contributions made to the 

ESOP to meet its obligations on the loan, and (3) earnings attributable to the collateral and the investment of contributions described in (2).72 In addition, the payments made on the loan by the 

ESOP during a plan year cannot exceed the sum of those contributions and earnings during the current and prior years, less loan 

payments made in prior years. 

An ESOP of a C corporation is not treated as violating the 

qualification requirements of the Code or as engaging in a prohibited transaction merely because, in accordance with plan provisions, a dividend paid with respect to qualifying employer securities held by the ESOP is used to make payments on a loan (including payments of interest as well as principal) that was used to acquire the employer securities (whether or not allocated to participants).73 In the case of a dividend paid with respect to any employer security that is allocated to a participant, this relief does not 

296 

74Sec. 404(k)(2)(B). 75Sec. 1361(c)(6). 

apply unless the plan provides that employer securities with a fair 

market value of not less than the amount of the dividend is allocated to the participant for the year which the dividend would have 

been allocated to the participant.74

Effective for taxable years beginning after December 31, 1997, 

a qualified retirement plan (including an ESOP) may be a shareholder of an S corporation.75 As a result, an S corporation may 

maintain an ESOP. 

HOUSE BILL

Under the provision, an ESOP maintained by an S corporation 

is not treated as violating the qualification requirements of the 

Code or as engaging in a prohibited transaction merely because, in 

accordance with plan provisions, a distribution made with respect 

to S corporation stock that constitutes qualifying employer securities held by the ESOP is used to make payments on a loan that 

was used to acquire the securities (whether or not allocated to participants). This relief does not apply in the case of a distribution 

with respect to S corporation stock that is allocated to a participant 

unless the plan provides that stock with a fair market value of not 

less than the amount of such distribution is allocated to the participant for the year which the distribution would have been allocated 

to the participant. 

Effective date.—The provision is effective for distributions 

made with respect to S corporation stock after December 31, 2004. 

SENATE AMENDMENT

The Senate amendment is the same as House bill (other than 

the effective date). 

Effective date.—The provision is effective on January 1, 1998. 

CONFERENCE AGREEMENT

The conference agreement contains the provision in the House 

bill and Senate amendment, with a modification of the effective 

date. Thus, an ESOP maintained by an S corporation is not treated 

as violating the qualification requirements of the Code or as engaging in a prohibited transaction merely because, in accordance with 

plan provisions, a distribution made with respect to S corporation 

stock that constitutes qualifying employer securities held by the 

ESOP is used to make payments on a loan (including payments of 

interest as well as principal) that was used to acquire the securities (whether or not allocated to participants). This relief does not 

apply in the case of a distribution with respect to S corporation 

stock that is allocated to a participant unless the plan provides 

that stock with a fair market value of not less than the amount of 

such distribution is allocated to the participant for the year which 

the distribution would have been allocated to the participant. 

Effective date.—The provision is effective for distributions 

made with respect to S corporation stock after December 31, 1997. 

297 

D. ALTERNATIVE MINIMUM TAX RELIEF

1. Repeal limitation on use of foreign tax credit (sec. 241 of the 

House bill, sec. 203 of the Senate amendment, and sec. 59 of 

the Code) 

PRESENT LAW

In general 

Under present law, taxpayers are subject to an alternative 

minimum tax (‘‘AMT’’), which is payable, in addition to all other 

tax liabilities, to the extent that it exceeds the taxpayer’s regular 

income tax liability. The tax is imposed at a flat rate of 20 percent, 

in the case of corporate taxpayers, on alternative minimum taxable 

income (‘‘AMTI’’) in excess of an exemption amount that phases 

out. AMTI is the taxpayer’s taxable income increased for certain 

tax preferences and adjusted by determining the tax treatment of 

certain items in a manner that limits the tax benefits resulting 

from the regular tax treatment of such items. 

Foreign tax credit 

Taxpayers are permitted to reduce their AMT liability by an 

AMT foreign tax credit. The AMT foreign tax credit for a taxable 

year is determined under principles similar to those used in computing the regular tax foreign tax credit, except that (1) the numerator of the AMT foreign tax credit limitation fraction is foreign 

source AMTI and (2) the denominator of that fraction is total 

AMTI. Taxpayers may elect to use as their AMT foreign tax credit 

limitation fraction the ratio of foreign source regular taxable income to total AMTI. 

The AMT foreign tax credit for any taxable year generally may 

not offset a taxpayer’s entire pre-credit AMT. Rather, the AMT foreign tax credit is limited to 90 percent of AMT computed without 

any AMT net operating loss deduction and the AMT foreign tax 

credit. For example, assume that a corporation has $10 million of 

AMTI, has no AMT net operating loss deduction, and has no regular tax liability. In the absence of the AMT foreign tax credit, the 

corporation’s tax liability would be $2 million. Accordingly, the 

AMT foreign tax credit cannot be applied to reduce the taxpayer’s 

tax liability below $200,000. Any unused AMT foreign tax credit 

may be carried back two years and carried forward five years for 

use against AMT in those years under the principles of the foreign 

tax credit carryback and carryover rules set forth in section 904(c). 

HOUSE BILL

The House bill repeals the 90-percent limitation on the utilization of the AMT foreign tax credit. 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

Same as House bill. 

298 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill and Senate amendment. 

2. Expansion of exemption from alternative minimum tax for small 

corporations (sec. 242 of the House bill and sec. 55 of the Code) 

PRESENT LAW

Corporations with average gross receipts of less than $7.5 million for the prior three taxable years are exempt from the corporate 

AMT. The $7.5 million threshold is reduced to $5 million for the 

corporation’s first 3-taxable year period. 

HOUSE BILL

The House bill increases the amount of average gross receipts 

that an exempt corporation may receive from $7.5 million to $20 

million. 

Effective date.—The provision applies to taxable years beginning after December 31, 2005. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the provision in the 

House bill. 

3. Coordinate farmer and fisherman income averaging and the alternative minimum tax (sec. 243 of the House bill and secs. 55 

and 1301 of the Code) 

PRESENT LAW

An individual taxpayer engaged in a farming business (as defined by section 263A(e)(4)) may elect to compute his or her current 

year regular tax liability by averaging, over the prior three-year period, all or portion of his or her taxable income from the trade or 

business of farming. Because farmer income averaging reduces the 

regular tax liability, the AMT may be increased. Thus, the benefits 

of farmer income averaging may be reduced or eliminated for farmers subject to the AMT. 

HOUSE BILL

The House bill provides that, in computing AMT, a farmer’s 

regular tax liability is determined without regard to farmer income 

averaging. Thus, a farmer receives the full benefit of income averaging because averaging reduces the regular tax while the AMT (if 

any) remains unchanged. 

Effective date.—The provision applies to taxable years beginning after December 31, 2003. 

SENATE AMENDMENT

No provision. 

299 

76The alcohol fuels credit is unavailable when, for any period before January 1, 2008, the tax 

rates for gasoline and diesel fuels drop to 4.3 cents per gallon. 77 A special fuel includes any liquid (other than gasoline) that is suitable for use in an internal 

combustion engine. 78 In the case of any alcohol (other than ethanol) with a proof that is at least 150 but less 

than 190, the credit is 45 cents per gallon (the ‘‘low-proof blender amount’’). For ethanol with 

a proof that is at least 150 but less than 190, the low-proof blender amount is 38.52 cents for 

sales or uses during calendar year 2004, and 37.78 cents for calendar years 2005, 2006, and 

2007. 

CONFERENCE AGREEMENT

The conference agreement extends the benefits of income averaging to fishermen. The provision also includes the provision in the 

House bill relating to the AMT, applicable to both farmers and fishermen. 

Effective date.—Taxable years beginning after December 31, 

2003. 

E. RESTRUCTURING OF INCENTIVES FOR ALCOHOL FUELS, ETC. 

1. Incentives for alcohol and biodiesel fuels (secs. 251 and 252 of 

the House bill, sec. 861 of the Senate amendment, and secs. 

4041, 4081, 4091, 6427, 9503 and new section 6426 of the 

Code) 

PRESENT LAW

Alcohol fuels income tax credit 

The alcohol fuels credit is the sum of three credits: the alcohol 

mixture credit, the alcohol credit, and the small ethanol producer 

credit. Generally, the alcohol fuels credit expires after December 

31, 2007.76

A taxpayer (generally a petroleum refiner, distributor, or marketer) who mixes ethanol with gasoline (or a special fuel 77) is an 

‘‘ethanol blender.’’ Ethanol blenders are eligible for an income tax 

credit of 52 cents per gallon of ethanol used in the production of 

a qualified mixture (the ‘‘alcohol mixture credit’’). A qualified mixture means a mixture of alcohol and gasoline (or of alcohol and a 

special fuel) sold by the blender as fuel or used as fuel by the 

blender in producing the mixture. The term alcohol includes methanol and ethanol but does not include (1) alcohol produced from petroleum, natural gas, or coal (including peat), or (2) alcohol with a 

proof of less than 150. Businesses also may reduce their income 

taxes by 52 cents for each gallon of ethanol (not mixed with gasoline or other special fuel) that they sell at the retail level as vehicle 

fuel or use themselves as a fuel in their trade or business (‘‘the alcohol credit’’). The 52-cents-per-gallon income tax credit rate is 

scheduled to decline to 51 cents per gallon during the period 2005 

through 2007. For blenders using an alcohol other than ethanol, 

the rate is 60 cents per gallon.78

A separate income tax credit is available for small ethanol producers (the ‘‘small ethanol producer credit’’). A small ethanol producer is defined as a person whose ethanol production capacity 

does not exceed 30 million gallons per year. The small ethanol producer credit is 10 cents per gallon of ethanol produced during the 

taxable year for up to a maximum of 15 million gallons. 

300 

79These fuels are also subject to an additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. See secs. 4041(d) and 4081(a)(2)(B). In addition, the 

basic fuel tax rate will drop to 4.3 cents per gallon beginning on October 1, 2005. 80These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. These special rates will terminate after September 30, 2007 

(sec. 4081(c)(8)). 81Treas. Reg. sec. 48.4081–6(c). A certificate from the buyer assures that the gasoline will be 

used to produce gasohol within 24 hours after purchase. A copy of the registrant’s letter of registration cannot be used as a gasohol blender’s certificate. 

The credits that comprise the alcohol fuels tax credit are includible in income. The credit may not be used to offset alternative 

minimum tax liability. The credit is treated as a general business 

credit, subject to the ordering rules and carryforward/carryback 

rules that apply to business credits generally. 

Excise tax reductions for alcohol mixture fuels 

In general 

Generally, motor fuels tax rates are as follows: 79

Gasoline ...................................................................................................................................... 18.3 cents per gallon. 

Diesel fuel and kerosene ............................................................................................................ 24.3 cents per gallon. 

Special motor fuels .................................................................................................................... 18.3 cents per gallon 

generally. 

Alcohol-blended fuels are subject to a reduced rate of tax. The 

benefits provided by the alcohol fuels income tax credit and the excise tax reduction are integrated such that the alcohol fuels credit 

is reduced to take into account the benefit of any excise tax reduction. 

Gasohol 

Registered ethanol blenders may forgo the full income tax credit and instead pay reduced rates of excise tax on gasoline that they 

purchase for blending with ethanol. Most of the benefit of the alcohol fuels credit is claimed through the excise tax system. 

The reduced excise tax rates apply to gasohol upon its removal 

or entry. Gasohol is defined as a gasoline/ethanol blend that contains 5.7 percent ethanol, 7.7 percent ethanol, or 10 percent ethanol. For the calendar year 2004, the following reduced rates apply 

to gasohol: 80

5.7 percent ethanol .................................................................................................................... 15.436 cents per gallon. 

7.7 percent ethanol .................................................................................................................... 14.396 cents per gallon. 

10.0 percent ethanol .................................................................................................................. 13.200 cents per gallon. 

Reduced excise tax rates also apply when gasoline is purchased 

for the production of ‘‘gasohol.’’ When gasoline is purchased for 

blending into gasohol, the rates above are multiplied by a fraction 

(e.g., 10/9 for 10-percent gasohol) so that the increased volume of 

motor fuel will be subject to tax. The reduced tax rates apply if the 

person liable for the tax is registered with the IRS and (1) produces 

gasohol with gasoline within 24 hours of removing or entering the 

gasoline or (2) gasoline is sold upon its removal or entry and such 

person has an unexpired certificate from the buyer and has no reason to believe the certificate is false.81

301 

82These reduced rates terminate after September 30, 2007. Included in these rates is the 0.05- 

cent-per-gallon Leaking Underground Storage Tank Trust Fund tax imposed on such fuel. (sec. 

4041(b)(2)). 83These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund (sec. 4041(d)(1)). 84These rates include the additional 0.1 cent-per-gallon excise tax to fund the Leaking Underground Storage Tank Trust Fund. 85This rate includes the additional 0.1 cent-per-gallon tax for the Leaking Underground Storage Tank Trust fund. 86Secs. 4041(k)(1) and 4091(c). 

Qualified methanol and ethanol fuels 

Qualified methanol or ethanol fuel is any liquid that contains 

at least 85 percent methanol or ethanol or other alcohol produced 

from a substance other than petroleum or natural gas. These fuels 

are taxed at reduced rates.82 The rate of tax on qualified methanol 

is 12.35 cents per gallon. The rate on qualified ethanol in 2004 is 

13.15 cents. From January 1, 2005, through September 30, 2007, 

the rate of tax on qualified ethanol is 13.25 cents. 

Alcohol produced from natural gas 

A mixture of methanol, ethanol, or other alcohol produced from 

natural gas that consists of at least 85 percent alcohol is also taxed 

at reduced rates.83 For mixtures not containing ethanol, the applicable rate of tax is 9.25 cents per gallon before October 1, 2005. In 

all other cases, the rate is 11.4 cents per gallon. After September 

30, 2005, the rate is reduced to 2.15 cents per gallon when the mixture does not contain ethanol and 4.3 cents per gallon in all other 

cases. 

Blends of alcohol and diesel fuel or special motor fuels 

A reduced rate of tax applies to diesel fuel or kerosene that is 

combined with alcohol as long as at least 10 percent of the finished 

mixture is alcohol. If none of the alcohol in the mixture is ethanol, 

the rate of tax is 18.4 cents per gallon. For alcohol mixtures containing ethanol, the rate of tax in 2004 is 19.2 cents per gallon and 

19.3 cents per gallon for 2005 through September 30, 2007. Fuel 

removed or entered for use in producing a 10 percent diesel-alcohol 

fuel mixture (without ethanol), is subject to a tax of 20.44 cents per 

gallon. The rate of tax for fuel removed or entered for use to 

produce a 10 percent diesel-ethanol fuel mixture is 21.333 cents per 

gallon for 2004 and 21.444 cents per gallon for the period January 

1, 2005, through September 30, 2007.84

Special motor fuel (nongasoline) mixtures with alcohol also are 

taxed at reduced rates. 

Aviation fuel 

Noncommercial aviation fuel is subject to a tax of 21.9 cents 

per gallon.85 Fuel mixtures containing at least 10 percent alcohol 

are taxed at lower rates.86 In the case of 10 percent ethanol mixtures, for any sale or use during 2004, the 21.9 cents is reduced 

by 13.2 cents (for a tax of 8.7 cents per gallon), for 2005, 2006, and 

2007 the reduction is 13.1 cents (for a tax of 8.8 cents per gallon) 

and is reduced by 13.4 cents in the case of any sale during 2008 

or thereafter. For mixtures not containing ethanol, the 21.9 cents 

302 

87Sec. 4091(c)(1). 88Sec. 9503(b)(4)(E). 89Sec. 9503(b)(4)(F). 90Sec. 4081(b); Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). ‘‘Taxable fuels’’ are gasoline, diesel and kerosene (sec. 4083). Biodiesel, although suitable for use as a fuel in a diesel-powered 

highway vehicle or diesel-powered train, contains less than four percent normal paraffins and, 

therefore, is not treated as diesel fuel under the applicable Treasury regulations. Treas. Reg. 

secs. 48.4081–1(c)(2)(i) and (ii), and 48.4081–1(b); Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). 

is reduced by 14 cents for a tax of 7.9 cents. These reduced rates 

expire after September 30, 2007.87

When aviation fuel is purchased for blending with alcohol, the 

rates above are multiplied by a fraction (10/9) so that the increased 

volume of aviation fuel will be subject to tax. 

Refunds and payments 

If fully taxed gasoline (or other taxable fuel) is used to produce 

a qualified alcohol mixture, the Code permits the blender to file a 

claim for a quick excise tax refund. The refund is equal to the difference between the gasoline (or other taxable fuel) excise tax that 

was paid and the tax that would have been paid by a registered 

blender on the alcohol fuel mixture being produced. Generally, the 

IRS pays these quick refunds within 20 days. Interest accrues if 

the refund is paid more than 20 days after filing. A claim may be 

filed by any person with respect to gasoline, diesel fuel, or kerosene 

used to produce a qualified alcohol fuel mixture for any period for 

which $200 or more is payable and which is not less than one 

week. 

Ethyl tertiary butyl ether (ETBE) 

Ethyl tertiary butyl ether (‘‘ETBE’’) is an ether that is manufactured using ethanol. Unlike ethanol, ETBE can be blended with 

gasoline before the gasoline enters a pipeline because ETBE does 

not result in contamination of fuel with water while in transport. 

Treasury regulations provide that gasohol blenders may claim the 

income tax credit and excise tax rate reductions for ethanol used 

in the production of ETBE. The regulations also provide a special 

election allowing refiners to claim the benefit of the excise tax rate 

reduction even though the fuel being removed from terminals does 

not contain the requisite percentages of ethanol for claiming the excise tax rate reduction. 

Highway Trust Fund 

With certain exceptions, the taxes imposed by section 4041 (relating to retail taxes on diesel fuels and special motor fuels) and 

section 4081 (relating to tax on gasoline, diesel fuel and kerosene) 

are credited to the Highway Trust Fund. In the case of alcohol 

fuels, 2.5 cents per gallon of the tax imposed is retained in the 

General Fund.88 In the case of a taxable fuel taxed at a reduced 

rate upon removal or entry prior to mixing with alcohol, 2.8 cents 

of the reduced rate is retained in the General Fund.89

Biodiesel 

If biodiesel is used in the production of blended taxable fuel, 

the Code imposes tax on the removal or sale of the blended taxable 

fuel.90 In addition, the Code imposes tax on any liquid other than 

303 

As a result, biodiesel alone is not a taxable fuel for purposes of section 4081. As noted above, 

however, tax is imposed upon the removal or entry of blended taxable fuel made with biodiesel. 91Sec. 4041. The tax imposed under section 4041 also will not apply if an exemption from 

tax applies. 92 Rev. Rul. 2002–76, 2002–46 I.R.B. 841 (2002). 93Sec. 9503(c)(4) and 9503(c)(5). 94The Sport Fish Restoration Account also is funded with receipts from an ad valorem manufacturers excise tax on sport fishing equipment. 

gasoline sold for use or used as a fuel in a diesel-powered highway 

vehicle or diesel-powered train unless tax was previously imposed 

and not refunded or credited.91 If biodiesel that was not previously 

taxed or exempt is sold for use or used as a fuel in a diesel-powered 

highway vehicle or a diesel-powered train, tax is imposed.92 There 

are no reduced excise tax rates for biodiesel. 

Taxes from gasoline and special motor fuels used in motorboats and 

gasoline used in the nonbusiness use of small-engine outdoor 

power equipment 

The Aquatic Resources Trust Fund is funded by a portion of 

the receipts from the excise tax imposed on motorboat gasoline and 

special motor fuels, as well as small-engine fuel taxes, that are first 

deposited into the Highway Trust Fund. As a result, transfers to 

the Aquatic Resources Trust Fund are governed in part by Highway Trust Fund provisions.93

A total tax rate of 18.4 cents per gallon is imposed on gasoline 

and special motor fuels used in motorboats. Of this rate, 0.1 cent 

per gallon is dedicated to the Leaking Underground Storage Tank 

Trust Fund. Of the remaining 18.3 cents per gallon, the Code currently transfers 13.5 cents per gallon from the Highway Trust 

Fund to the Aquatics Resources Trust Fund and Land and Water 

Conservation Fund. The remainder, 4.8 cents per gallon, is retained in the General Fund. In addition, the Sport Fish Restoration 

Account of the Aquatics Resources Trust Fund receives 13.5 cents 

per gallon of the revenues from the tax imposed on gasoline used 

as a fuel in the nonbusiness use of small-engine outdoor power 

equipment. The balance of 4.8 cents per gallon is retained in the 

General Fund.94

HOUSE BILL

Overview 

The provision eliminates reduced rates of excise tax for alcoholblended fuels and imposes the full rate of excise tax on alcoholblended fuels (18.4 cents per gallon on gasoline blends and 24.4 

cents per gallon of diesel blended fuel). In place of reduced rates, 

the provision permits the section 40 alcohol mixture credit, with 

certain modifications, to be applied against excise tax liability. The 

credit may be taken against the tax imposed on taxable fuels (by 

section 4081). To the extent a person does not have section 4081 

liability, the provision allows taxpayers to file a claim for payment 

equal to the amount of the credit for the alcohol used to produce 

an eligible mixture. Under certain circumstances, a tax is imposed 

if an alcohol fuel mixture credit is claimed with respect to alcohol 

used in the production of any alcohol mixture, which is subsequently used for a purpose for which the credit is not allowed or 

changed into a substance that does not qualify for the credit. The 

304 

provision eliminates the General Fund retention of certain taxes on 

alcohol fuels, and credits these taxes to the Highway Trust Fund. 

Alcohol fuel mixture excise tax credit and payment provisions 

Alcohol fuel mixture excise tax credit 

The provision eliminates the reduced rates of excise tax for alcohol-blended fuels and taxable fuels used to produce an alcohol 

fuel mixture. Under the provision, the full rate of tax for taxable 

fuels is imposed on both alcohol fuel mixtures and the taxable fuel 

used to produce an alcohol fuel mixture. 

In lieu of the reduced excise tax rates, the provision provides 

that the alcohol mixture credit provided under section 40 may be 

applied against section 4081 excise tax liability (hereinafter referred to as ‘‘the alcohol fuel mixture credit’’). The credit is treated 

as a payment of the taxpayer’s tax liability received at the time of 

the taxable event. The alcohol fuel mixture credit is 52 cents for 

each gallon of alcohol used by a person in producing an alcohol fuel 

mixture for sale or use in a trade or business of the taxpayer. The 

credit declines to 51 cents per gallon after calendar year 2004. For 

mixtures not containing ethanol (renewable source methanol), the 

credit is 60 cents per gallon. As discussed further below, the excise 

tax credit is refundable in order to provide a benefit equivalent to 

the reduced tax rates, which are being repealed under the provision. 

For purposes of the alcohol fuel mixture credit, an ‘‘alcohol fuel 

mixture’’ is a mixture of alcohol and gasoline or alcohol and a special fuel which is sold for use or used as a fuel by the taxpayer producing the mixture. Alcohol for this purpose includes methanol, 

ethanol, and alcohol gallon equivalents of ETBE or other ethers 

produced from such alcohol. It does not include alcohol produced 

from petroleum, natural gas, or coal (including peat), or alcohol 

with a proof of less than 190 (determined without regard to any 

added denaturants). Special fuel is any liquid fuel (other than gasoline) which is suitable for use in an internal combustion engine. 

The benefit obtained from the excise tax credit is coordinated with 

the alcohol fuels income tax credit. For refiners making an alcohol 

fuel mixture with ETBE, the mixture is treated as sold to another 

person for use as a fuel only upon removal from the refinery. The 

excise tax credit is available through December 31, 2010. 

Payments with respect to qualified alcohol fuel mixtures 

To the extent the alcohol fuel mixture credit exceeds any section 4081 liability of a person, the Secretary is to pay such person 

an amount equal to the alcohol fuel mixture credit with respect to 

such mixture. These payments are intended to provide an equivalent benefit to replace the partial exemption for fuels to be blended 

with alcohol and alcohol fuels being repealed by the provision. If 

claims for payment are not paid within 45 days, the claim is to be 

paid with interest. The provision also provides that in the case of 

an electronic claim, if such claim is not paid within 20 days, the 

claim is to be paid with interest. If claims are filed electronically, 

the claimant may make a claim for less than $200. 

305 

The provision does not apply with respect to alcohol fuel mixtures sold after December 31, 2010. 

Alcohol fuel subsidies borne by General Fund 

The provision eliminates the requirement that 2.5 and 2.8 

cents per gallon of excise taxes be retained in the General Fund 

with the result that the full amount of tax on alcohol fuels is credited to the Highway Trust Fund. The provision also authorizes the 

full amount of fuel taxes to be appropriated to the Highway Trust 

Fund without reduction for amounts equivalent to the excise tax 

credits allowed for alcohol fuel mixtures, and the Trust Fund is not 

required to reimburse any payments with respect to qualified alcohol fuel mixtures. 

Motorboat and small engine fuel taxes 

The provision eliminates the General Fund retention of the 4.8 

cents per gallon of the taxes imposed on gasoline and special motor 

fuels used in motorboats and gasoline used as a fuel in the nonbusiness use of small-engine outdoor power equipment. 

Effective dates 

The provisions generally are effective for fuel sold or used after 

September 30, 2004. The repeal of the General Fund retention of 

the 2.5/2.8 cents per gallon of tax regarding alcohol fuels is effective for taxes imposed after September 30, 2003. The repeal of the 

4.8 cents per gallon General Fund retention of the taxes imposed 

on fuels used in motorboats and small engine equipment is effective for taxes imposed after September 30, 2006. The provision regarding the crediting of the full amount of tax to the Highway 

Trust Fund without regard to credits and payments is effective for 

taxes received after September 30, 2004, and payments made after 

September 30, 2004. 

SENATE AMENDMENT

Alcohol fuels 

The Senate amendment is similar to the House bill with respect to alcohol fuels, except that it also provides that outlay payments are available for neat alcohol used as fuel. In addition, the 

Senate amendment also extends the alcohol fuels income tax credit 

(sec. 40) through December 31, 2010. The Senate amendment requires importers and producers of alcohol to be registered with the 

Secretary. Finally, the provision extends the temporary additional 

duty on ethanol through January 1, 2011. 

Biodiesel fuels 

The Senate amendment creates a refundable excise tax credit 

for biodiesel fuel mixtures similar to that created for alcohol fuel 

mixtures. The excise tax credit for biodiesel mixtures is 50 cents 

for each gallon of biodiesel used by the taxpayer in producing a 

qualified biodiesel mixture for sale or use in a trade or business of 

the taxpayer. A qualified biodiesel mixture is a mixture of biodiesel 

and diesel fuel (determined without regard to any use of kerosene) 

that is (1) sold for use or used by the taxpayer producing such mixVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00309 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
306 

ture as a fuel, or (2) removed from the refinery by a person producing the mixture. In the case of agri-biodiesel, the credit is $1.00 

per gallon. No credit is allowed unless the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) 

from the producer of the biodiesel that identifies the product produced and the percentage of biodiesel and agri-biodiesel in the 

product. The Senate amendment also provides for outlay payments 

for biodiesel, not in a mixture, used as a fuel. 

The credit is not available for any sale or use for any period 

after December 31, 2006. Credits and outlay payments are paid out 

of the General Fund, rather than the Highway Trust Fund. The excise tax credit is coordinated with the income tax credit for biodiesel such that credit for the same biodiesel cannot be claimed for 

both income and excise tax purposes. 

The Senate amendment requires importers and producers of 

biodiesel to be registered with the Secretary. 

Motorboat and small engine fuel taxes 

The Senate amendment does not change the General Fund’s 

retention of the 4.8 cents per gallon imposed on motorboat and 

small engine fuel. 

Effective date 

The provisions generally are effective for fuel sold or used after 

September 30, 2004. The repeal of the General Fund retention of 

the 2.5/2.8 cents per gallon regarding alcohol fuels is effective for 

fuel sold or used after September 30, 2003. The Secretary is to provide electronic filing instructions by September 30, 2004. The extension of the section 40 alcohol fuels credit is effective on the date 

of enactment. The requirement that producers and importers of alcohol and biodiesel be registered is effective April 1, 2005. 

CONFERENCE AGREEMENT

Overview 

The conference agreement generally follows the Senate amendment. The conference agreement does not include outlay payments 

for neat alcohol and 100 percent biodiesel fuels. The conference 

agreement does not change the temporary duty on ethanol. In addition, the conference agreement does not change the General Fund’s 

retention of the 4.8 cents per gallon imposed on motorboat and 

small engine fuel. 

The conference agreement eliminates reduced rates of excise 

tax for most alcohol-blended fuels and imposes the full rate of excise tax on most alcohol-blended fuels (18.3 cents per gallon on gasoline blends and 24.3 cents per gallon of diesel blended fuel). In 

place of reduced rates, the conference agreement creates two new 

excise tax credits: the alcohol fuel mixture credit and the biodiesel 

mixture credit. The sum of these credits may be taken against the 

tax imposed on taxable fuels (by section 4081). The conference 

agreement allows taxpayers to file a claim for payment equal to the 

amount of these credits for biodiesel or alcohol used to produce an 

eligible mixture. 

307 

95The provision does not change the present-law treatment of fuels blended with alcohol derived from natural gas (under sec. 4041(m)), or alcohol derived from coal or peat (under sec. 

4041(b)(2)). The provision does not change the taxes imposed to fund the Leaking Underground 

Storage Tank Trust Fund. 96Sec. 4083(a)(1). Under present law, dyed fuels are taxable fuels that have been exempted 

from tax. 97The excise tax credit uses the same definitions as the biodiesel fuels income tax credit. 

Under certain circumstances, a tax is imposed if an alcohol fuel 

mixture credit or biodiesel fuel mixture credit is claimed with respect to alcohol or biodiesel used in the production of any alcohol 

or biodiesel mixture, which is subsequently used for a purpose for 

which the credit is not allowed or changed into a substance that 

does not qualify for the credit. 

The conference agreement eliminates the General Fund retention of certain taxes on alcohol fuels, and credits these taxes to the 

Highway Trust Fund. The Highway Trust Fund is credited with 

the full amount of tax imposed on alcohol and biodiesel fuel mixtures. 

The conference agreement also extends the present-law alcohol 

fuels income tax credit through December 31, 2010. 

Alcohol fuel mixture excise tax credit 

The provision eliminates the reduced rates of excise tax for 

most alcohol-blended fuels.95 Under the provision, the full rate of 

tax for taxable fuels is imposed on both alcohol fuel mixtures and 

the taxable fuel used to produce an alcohol fuel mixture. 

In lieu of the reduced excise tax rates, the provision provides 

for an excise tax credit, the alcohol fuel mixture credit. The alcohol 

fuel mixture credit is 51 cents for each gallon of alcohol used by 

a person in producing an alcohol fuel mixture for sale or use in a 

trade or business of the taxpayer. For mixtures not containing ethanol (renewable source methanol), the credit is 60 cents per gallon. 

For purposes of the alcohol fuel mixture credit, an ‘‘alcohol fuel 

mixture’’ is a mixture of alcohol and a taxable fuel that (1) is sold 

by the taxpayer producing such mixture to any person for use as 

a fuel or (2) is used as a fuel by the taxpayer producing the mixture. Alcohol for this purpose includes methanol, ethanol, and alcohol gallon equivalents of ETBE or other ethers produced from such 

alcohol. It does not include alcohol produced from petroleum, natural gas, or coal (including peat), or alcohol with a proof of less 

than 190 (determined without regard to any added denaturants). 

Taxable fuel is gasoline, diesel, and kerosene.96 A mixture that includes ETBE or other ethers produced from alcohol produced by 

any person at a refinery prior to a taxable event is treated as sold 

at the time of its removal from the refinery (and only at such time) 

to another person for use as a fuel. 

The excise tax credit is coordinated with the alcohol fuels income tax credit and is available through December 31, 2010. 

Biodiesel mixture excise tax credit 

The provision provides an excise tax credit for biodiesel mixtures.97 The credit is 50 cents for each gallon of biodiesel used by 

the taxpayer in producing a qualified biodiesel mixture for sale or 

use in a trade or business of the taxpayer. A qualified biodiesel 

mixture is a mixture of biodiesel and diesel fuel that (1) is sold by 

308 

the taxpayer producing such mixture to any person for use as a 

fuel, or (2) is used as a fuel by the taxpayer producing such mixture. In the case of agri-biodiesel, the credit is $1.00 per gallon. No 

credit is allowed unless the taxpayer obtains a certification (in such 

form and manner as prescribed by the Secretary) from the producer 

of the biodiesel that identifies the product produced and the percentage of biodiesel and agri-biodiesel in the product. 

The credit is not available for any sale or use for any period 

after December 31, 2006. This excise tax credit is coordinated with 

the income tax credit for biodiesel such that credit for the same 

biodiesel cannot be claimed for both income and excise tax purposes. 

Payments with respect to qualified alcohol and biodiesel fuel mixtures 

To the extent the alcohol fuel mixture credit exceeds any section 4081 liability of a person, the Secretary is to pay such person 

an amount equal to the alcohol fuel mixture credit with respect to 

such mixture. Thus, if the person has no section 4081 liability, the 

credit is totally refundable. These payments are intended to provide an equivalent benefit to replace the partial exemption for fuels 

to be blended with alcohol and alcohol fuels being repealed by the 

provision. Similar rules apply to the biodiesel fuel mixture credit. 

If claims for payment are not paid within 45 days, the claim 

is to be paid with interest. The provision also provides that in the 

case of an electronic claim, if such claim is not paid within 20 days, 

the claim is to be paid with interest. If claims are filed electronically, the claimant may make a claim for less than $200. The Secretary is to describe the electronic format for filing claims by December 31, 2004. 

The payment provision does not apply with respect to alcohol 

fuel mixtures sold after December 31, 2010, and biodiesel fuel mixtures sold after December 31, 2006. 

Alcohol and biodiesel fuel subsidies borne by General Fund 

The provision eliminates the requirement that 2.5 and 2.8 

cents per gallon of excise taxes be retained in the General Fund 

with the result that the full amount of tax on alcohol fuels is credited to the Highway Trust Fund. The provision also authorizes the 

full amount of fuel taxes to be appropriated to the Highway Trust 

Fund without reduction for amounts equivalent to the excise tax 

credits allowed for alcohol or biodiesel fuel mixtures and the Highway Trust Fund is not required to reimburse the General Fund for 

any credits or payments taken or made with respect to qualified alcohol fuel mixtures or biodiesel fuel mixtures. 

Registration requirement 

Every person producing or importing biodiesel or alcohol is required to register with the Secretary. 

Alcohol fuels income tax credit 

The provision extends the alcohol fuels credit (sec. 40) through 

December 31, 2010. 

309 

Effective dates 

The provisions generally are effective for fuel sold or used after 

December 31, 2004. The repeal of the General Fund retention of 

the 2.5/2.8 cents per gallon regarding alcohol fuels is effective for 

fuel sold or used after September 30, 2004. The Secretary is to provide electronic filing instructions by December 31, 2004. The registration requirement is effective April 1, 2005. 

2. Biodiesel income tax credit (sec. 862 of the bill and new sec. 40A 

of the Code) 

PRESENT LAW

No income tax credit or excise tax rate reduction is provided 

for biodiesel fuels under present law. However, a 52-cents-per-gallon income tax credit (the ‘‘alcohol fuels credit’’) is allowed for ethanol and methanol (derived from renewable sources) when the alcohol is used as a highway motor fuel. Registered blenders may forgo 

the full income tax credit and instead pay reduced rates of excise 

tax on gasoline that they purchase for blending with alcohol. These 

present law provisions are scheduled to expire in 2007. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

In general 

The Senate amendment provides a new income tax credit for 

biodiesel and qualified biodiesel mixtures, the biodiesel fuels credit. 

The biodiesel fuels credit is the sum of the biodiesel mixture credit 

plus the biodiesel credit and is treated as a general business credit. 

The amount of the biodiesel fuels credit is includable in gross income. The biodiesel fuels credit is coordinated to take into account 

benefits from the biodiesel excise tax credit and payment provisions 

discussed above. The credit may not be carried back to a taxable 

year ending before or on September 30, 2004. The provision does 

not apply to fuel sold or used after December 31, 2006. 

Biodiesel is monoalkyl esters of long chain fatty acids derived 

from plant or animal matter that meet (1) the registration requirements established by the Environmental Protection Agency under 

section 211 of the Clean Air Act and (2) the requirements of the 

American Society of Testing and Materials D6751. Agri-biodiesel is 

biodiesel derived solely from virgin oils including oils from corn, 

soybeans, sunflower seeds, cottonseeds, canola, crambe, rapeseeds, 

safflowers, flaxseeds, rice bran, mustard seeds, or animal fats. 

Biodiesel may be taken into account for purposes of the credit 

only if the taxpayer obtains a certification (in such form and manner as prescribed by the Secretary) from the producer or importer 

of the biodiesel which identifies the product produced and the percentage of the biodiesel and agri-biodiesel in the product. 

Biodiesel mixture credit 

The biodiesel mixture credit is 50 cents for each gallon of biodiesel used by the taxpayer in the production of a qualified bioVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00313 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
310 

98Sec. 421. For purposes of the individual alternative minimum tax, the transfer of stock pursuant to an incentive stock option is generally treated as the transfer of stock pursuant to a 

nonstatutory option. Sec. 56(b)(3). 

diesel mixture. For agri-biodiesel, the credit is $1.00 per gallon. A 

qualified biodiesel mixture is a mixture of biodiesel and diesel fuel 

that is (1) sold by the taxpayer producing such mixture to any person for use as a fuel, or (2) is used as a fuel by the taxpayer producing such mixture. The sale or use must be in the trade or business of the taxpayer and is to be taken into account for the taxable 

year in which such sale or use occurs. No credit is allowed with respect to any casual off-farm production of a qualified biodiesel mixture. 

Biodiesel credit 

The biodiesel credit is 50 cents for each gallon of 100 percent 

biodiesel which is not in a mixture with diesel fuel and which during the taxable year is (1) used by the taxpayer as a fuel in a trade 

or business or (2) sold by the taxpayer at retail to a person and 

placed in the fuel tank of such person’s vehicle. For agri-biodiesel, 

the credit is $1.00 per gallon. 

Later separation or failure to use as fuel 

In a manner similar to the treatment of alcohol fuels, a tax is 

imposed if a biodiesel fuels credit is claimed with respect to biodiesel that is subsequently used for a purpose for which the credit 

is not allowed or that is changed into a substance that does not 

qualify for the credit. 

Effective date 

The biodiesel fuel income tax credit provision is effective for 

fuel produced, and sold or used after September 30, 2004, in taxable years ending after such date. 

CONFERENCE AGREEMENT

The conference agreement generally follows the Senate amendment, except for the effective date. 

Effective date.—The provision is effective for fuel produced, and 

sold or used after December 31, 2004, in taxable years ending after 

such date. 

F. EXCLUSION OF INCENTIVE STOCK OPTIONS AND EMPLOYEE STOCK

PURCHASE PLAN STOCK OPTIONS FROM WAGES

(Sec. 261 of the House bill and secs. 421(b), 423(c), 3121(a), 3231, 

and 3306(b) of the Code) 

PRESENT LAW

Generally, when an employee exercises a compensatory option 

on employer stock, the difference between the option price and the 

fair market value of the stock (i.e., the ‘‘spread’’) is includible in income as compensation. In the case of an incentive stock option or 

an option to purchase stock under an employee stock purchase plan 

(collectively referred to as ‘‘statutory stock options’’), the spread is 

not included in income at the time of exercise.98

311 

99Secs. 3101, 3111 and 3301. 100Secs. 3121 and 3306. 101 Notice 2002–47, 2002–28 I.R.B. 97. 102The provision also provides a similar exclusion under the Railroad Retirement Tax Act. 

If the statutory holding period requirements are satisfied with 

respect to stock acquired through the exercise of a statutory stock 

option, the spread, and any additional appreciation, will be taxed 

as capital gain upon disposition of such stock. Compensation income is recognized, however, if there is a disqualifying disposition 

(i.e., if the statutory holding period is not satisfied) of stock acquired pursuant to the exercise of a statutory stock option. 

Federal Insurance Contribution Act (‘‘FICA’’) and Federal Unemployment Tax Act (‘‘FUTA’’) taxes (collectively referred to as 

‘‘employment taxes’’) are generally imposed in an amount equal to 

a percentage of wages paid by the employer with respect to employment.99 The applicable Code provisions100 do not provide an exception from FICA and FUTA taxes for wages paid to an employee 

arising from the exercise of a statutory stock option. 

There has been uncertainty in the past as to employer withholding obligations upon the exercise of statutory stock options. On 

June 25, 2002, the IRS announced that until further guidance is 

issued, it would not assess FICA or FUTA taxes, or impose Federal 

income tax withholding obligations, upon either the exercise of a 

statutory stock option or the disposition of stock acquired pursuant 

to the exercise of a statutory stock option.101

HOUSE BILL

The House bill provides specific exclusions from FICA and 

FUTA wages for remuneration on account of the transfer of stock 

pursuant to the exercise of an incentive stock option or under an 

employee stock purchase plan, or any disposition of such stock. 

Thus, under the House bill, FICA and FUTA taxes do not apply 

upon the exercise of a statutory stock option.102 The House bill also 

provides that such remuneration is not taken into account for purposes of determining Social Security benefits. 

Additionally, the House bill provides that Federal income tax 

withholding is not required on a disqualifying disposition, nor 

when compensation is recognized in connection with an employee 

stock purchase plan discount. Present law reporting requirements 

continue to apply. 

Effective date.—The House bill is effective for stock acquired 

pursuant to options exercised after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

312 

103Secs. 951–964. 104Secs. 1291–1298. 105Secs. 901, 902, 960, 1291(g). 

G. INCENTIVES TO REINVEST FOREIGN EARNINGS IN THE UNITED

STATES

(Sec. 271 of the House bill, sec. 231 of the Senate amendment, and 

new sec. 965 of the Code) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, 

whether derived in the United States or abroad. Income earned by 

a domestic parent corporation from foreign operations conducted by 

foreign corporate subsidiaries generally is subject to U.S. tax when 

the income is distributed as a dividend to the domestic corporation. 

Until such repatriation, the U.S. tax on such income generally is 

deferred, and U.S. tax is imposed on such income when repatriated. 

However, under anti-deferral rules, the domestic parent corporation may be taxed on a current basis in the United States with respect to certain categories of passive or highly mobile income 

earned by its foreign subsidiaries, regardless of whether the income 

has been distributed as a dividend to the domestic parent corporation. The main anti-deferral provisions in this context are the controlled foreign corporation rules of subpart F 103 and the passive 

foreign investment company rules.104 A foreign tax credit generally 

is available to offset, in whole or in part, the U.S. tax owed on foreign-source income, whether earned directly by the domestic corporation, repatriated as a dividend from a foreign subsidiary, or included in income under the anti-deferral rules.105

HOUSE BILL

Under the provision, certain dividends received by a U.S. corporation from a controlled foreign corporation are eligible for an 85- 

percent dividends-received deduction. At the taxpayer’s election, 

this deduction is available for dividends received either: (1) during 

the first six months of the taxpayer’s first taxable year beginning 

on or after the date of enactment of the bill; or (2) during any sixmonth or shorter period after the date of enactment of the bill, during the taxpayer’s last taxable year beginning before such date. 

Dividends received after the election period will be taxed in the 

normal manner under present law. 

The deduction applies only to dividends and other amounts included in gross income as dividends (e.g., amounts described in section 1248(a)). The deduction does not apply to items that are not 

included in gross income as dividends, such as subpart F inclusions 

or deemed repatriations under section 956. Similarly, the deduction 

does not apply to distributions of earnings previously taxed under 

subpart F, except to the extent that the subpart F inclusions result 

from the payment of a dividend by one controlled foreign corporation to another controlled foreign corporation within a certain chain 

of ownership during the election period. This exception enables 

multinational corporate groups to qualify for the deduction in conVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00316 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
313 

nection with the repatriation of earnings from lower-tier controlled 

foreign corporations. 

The deduction is subject to a number of limitations. First, it 

applies only to repatriations in excess of the taxpayer’s average repatriation level over three of the five most recent taxable years 

ending on or before March 31, 2003, determined by disregarding 

the highest-repatriation year and the lowest-repatriation year 

among such five years (the ‘‘base-period average’’). In addition to 

actual dividends, deemed repatriations under section 956 and distributions of earnings previously taxed under subpart F are included in the base-period average. 

Second, the amount of dividends eligible for the deduction is limited to the greatest of: (1) $500 million; (2) the amount of earnings shown as permanently invested outside the United States on 

the taxpayer’s most recent audited financial statement which is 

certified on or before March 31, 2003; or (3) in the case of an applicable financial statement that fails to show a specific amount of 

such earnings, but that does show a specific amount of tax liability 

attributable to such earnings, the amount of such earnings determined in such manner as the Treasury Secretary may prescribe. 

Third, dividends qualifying for the deduction must be invested 

in the United States pursuant to a plan approved by the senior 

management and board of directors of the corporation claiming the 

deduction. 

No foreign tax credit (or deduction) is allowed for foreign taxes 

attributable to the deductible portion of any dividend received during the taxable year for which an election under the provision is 

in effect. For this purpose, the taxpayer may specifically identify 

which dividends are treated as carrying the deduction and which 

are not; in the absence of such identification, a pro rata amount of 

foreign tax credits will be disallowed with respect to every dividend 

received during the taxable year. 

In addition, the income attributable to the nondeductible portion of a qualifying dividend may not be offset by net operating 

losses, and the tax attributable to such income generally may not 

be offset by credits (other than foreign tax credits and AMT credits) 

and may not reduce the alternative minimum tax otherwise owed 

by the taxpayer. No deduction under sections 243 or 245 is allowed 

for any dividend for which a deduction is allowed under the provision. 

Effective date.—The House bill provision is effective for a taxpayer’s first taxable year beginning on or after the date of enactment of the bill, or the taxpayer’s last taxable year beginning before such date, at the taxpayer’s election. 

SENATE AMENDMENT

Under the provision, certain actual and deemed dividends received by a U.S. corporation from a controlled foreign corporation 

are subject to tax at a reduced rate of 5.25 percent. For corporations taxed at the top corporate income tax rate of 35 percent, this 

rate reduction is equivalent to an 85-percent dividends-received deduction. This rate reduction is available only for the first taxable 

year of an electing taxpayer ending 120 days or more after the date 

of enactment of the provision. 

314 

106 If the taxpayer has fewer than 5 taxable years ending on or before December 31, 2002, 

then the base period consists of all such taxable years, with none disregarded. 107The election is to be made on a timely filed return (including extensions) for the taxable 

year with respect to which the deduction is claimed. 

The reduced rate applies only to repatriations in excess of the 

taxpayer’s average repatriation level over 3 of the 5 most recent 

taxable years ending on or before December 31, 2002, determined 

by disregarding the highest-repatriation year and the lowest-repatriation year among such 5 years.106 The taxpayer may designate 

which of its dividends are treated as meeting the base-period average level and which of its dividends are treated as comprising the 

excess. 

In order to qualify for the reduced rate, dividends must be described in a ‘‘domestic reinvestment plan’’ approved by the taxpayer’s senior management and board of directors. This plan must 

provide for the reinvestment of the repatriated dividends in the 

United States, ‘‘including as a source for the funding of worker hiring and training; infrastructure; research and development; capital 

investments; or the financial stabilization of the corporation for the 

purposes of job retention or creation.’’ 

The provision disallows 85 percent of the foreign tax credits attributable to dividends subject to the reduced rate and removes 85 

percent of the underlying income from the taxpayer’s foreign tax 

credit limitation fraction under section 904. In addition, any expenses, losses, or deductions of the taxpayer may not be used to reduce the tax on dividends qualifying for the benefits of the provision. 

In the case of an affiliated group, an election under the provision is made by the common parent on a group-wide basis, and all 

members of the group are treated as a single taxpayer. The election 

applies to all controlled foreign corporations with respect to which 

an electing taxpayer is a United States shareholder. 

Effective date.—The Senate amendment provision is effective 

for the first taxable year of an electing taxpayer ending 120 days 

or more after the provision’s date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with modifications. 

Under the conference agreement, certain dividends received by 

a U.S. corporation from controlled foreign corporations are eligible 

for an 85-percent dividends-received deduction. At the taxpayer’s 

election, this deduction is available for dividends received either 

during the taxpayer’s first taxable year beginning on or after the 

date of enactment of the bill, or during the taxpayer’s last taxable 

year beginning before such date.107 Dividends received after the 

election period will be taxed in the normal manner under present 

law. The conferees emphasize that this is a temporary economic 

stimulus measure, and that there is no intent to make this measure permanent, or to ‘‘extend’’ or enact it again in the future. 

The deduction applies only to cash dividends and other cash 

amounts included in gross income as dividends, such as cash 

amounts treated as dividends under sections 302 or 304 (but not 

to amounts treated as dividends under Code sections 78, 367, or 

315 

108 However, to the extent that the taxpayer actually receives cash in an inbound liquidation 

that is described in Code section 332 and treated as a dividend under Code section 367(b), such 

amount is treated as a dividend for these purposes. The conferees note that a deemed liquidation effectuated by means of a ‘‘check the box’’ election under the entity classification regulations 

will not involve an actual receipt of cash that is reinvested in the United States as required 

for purposes of this provision. 109Thus, indebtedness between such controlled foreign corporations is disregarded for purposes of this determination. 110 A corporation that was spun off from another corporation during the five-year period is 

treated for this purpose as having been in existence for the same period that such other corporation has been in existence. The pre-spin-off dividend history of the two corporations is generally 

allocated between them on the basis of their interests in the dividend-paying controlled foreign 

corporations immediately after the spin-off. In other cases involving companies entering and 

exiting corporate groups, the principles of Code section 41(f)(3)(A) and (B) apply. 

1248).108 The deduction does not apply to items that are not included in gross income as dividends, such as subpart F inclusions 

or deemed repatriations under section 956. Similarly, the deduction 

does not apply to distributions of earnings previously taxed under 

subpart F, except to the extent that the subpart F inclusions result 

from the payment of a dividend by one controlled foreign corporation to another controlled foreign corporation within a certain chain 

of ownership during the election period, with the result that cash 

travels through a chain of controlled foreign corporations to the 

taxpayer within the election period. The amount of dividends eligible for the deduction is reduced by any increase in related-party indebtedness on the part of a controlled foreign corporation between 

October 3, 2004 and the close of the taxable year for which the deduction is being claimed, determined by treating all controlled foreign corporations with respect to which the taxpayer is a U.S. 

shareholder as one controlled foreign corporation.109 This rule is intended to prevent a deduction from being claimed in cases in which 

the U.S. shareholder directly or indirectly (e.g., through a related 

party) finances the payment of a dividend from a controlled foreign 

corporation. In such a case, there may be no net repatriation of 

funds, and thus it would be inappropriate to provide the deduction. 

The deduction is subject to a number of general limitations. 

First, it applies only to repatriations in excess of the taxpayer’s average repatriation level over three of the five most recent taxable 

years ending on or before June 30, 2003, determined by disregarding the highest-repatriation year and the lowest-repatriation 

year among such five years (the ‘‘base-period average’’). If the taxpayer has fewer than five such years, then all taxable years ending 

on or before June 30, 2003 are included in the base period.110 Repatriation levels are determined by reference to base-period tax returns as filed, including any amended returns that were filed on 

or before June 30, 2003. U.S. shareholders that file a consolidated 

tax return are treated as one U.S. shareholder for all purposes of 

this dividends-received deduction provision. Thus, all such shareholders are aggregated in determining the base-period average (as 

are all controlled foreign corporations). In addition to cash dividends, dividends of property, deemed repatriations under section 

956, and distributions of earnings previously taxed under subpart 

F are included in the base-period average. 

Second, the amount of dividends eligible for the deduction is limited to the greatest of: (1) $500 million; (2) the amount of earnings shown as permanently invested outside the United States on 

the taxpayer’s most recent audited financial statement which is 

316 

111This rule refers to elements of Accounting Principles Board Opinion 23 (‘‘APB 23’’), which 

provides an exception to the general rule of comprehensive recognition of deferred taxes for temporary book-tax differences. The exception is for temporary differences related to undistributed 

earnings of foreign subsidiaries and foreign corporate joint ventures that meet the indefinite reversal criterion in APB 23. 112 In the absence of such a specification, a pro rata amount of foreign tax credits will be disallowed with respect to every dividend repatriated during the taxable year. 113These expenses, losses, and deductions may, however, have the effect of reducing other income of the taxpayer. 

certified on or before June 30, 2003; 111 or (3) in the case of an applicable financial statement that does not show a specific amount 

of such earnings, but that does show a specific amount of tax liability attributable to such earnings, the amount of such earnings determined by grossing up the tax liability at a 35-percent rate. If 

there is no applicable financial statement, or if such statement does 

not show a specific earnings or tax liability amount, then the $500 

million limit applies. This $500 million amount is divided among 

corporations that are members of a controlled group, using a 50- 

percent standard of common control. The two financial statement 

amounts described above are divided among the U.S. shareholders 

that are included on such statements. 

Third, in order to qualify for the deduction, dividends must be 

described in a domestic reinvestment plan approved by the taxpayer’s senior management and board of directors. This plan must 

provide for the reinvestment of the repatriated dividends in the 

United States, including as a source for the funding of worker hiring and training, infrastructure, research and development, capital 

investments, and the financial stabilization of the corporation for 

the purposes of job retention or creation. The conferees note that 

this list of permitted uses is not exclusive. The reinvestment plan 

cannot, however, designate repatriated funds for use as payment 

for executive compensation. Dividends with respect to which the 

deduction is not being claimed are not required to be included in 

any domestic reinvestment plan. 

No foreign tax credit (or deduction) is allowed for foreign taxes 

attributable to the deductible portion of any dividend. For this purpose, the taxpayer may specifically identify which dividends are 

treated as carrying the deduction and which dividends are not.112

In other words, the taxpayer is allowed to choose which of its dividends are treated as meeting the base-period repatriation level 

(and thus carry foreign tax credits, to the extent otherwise allowable), and which of its dividends are treated as comprising the excess eligible for the deduction (and thus entail proportional disallowance of any associated foreign tax credits). The deduction 

itself will have the effect of appropriately reducing the taxpayer’s 

foreign tax credit limitation. 

Deductions are disallowed for expenses that are properly allocated and apportioned to the deductible portion of any dividend. 

The income attributable to the nondeductible portion of a 

qualifying dividend may not be offset by expenses, losses, or deductions, and the tax attributable to such income generally may not 

be offset by credits (other than foreign tax credits and AMT credits).113 The tax on this amount also cannot reduce the alternative 

minimum tax that otherwise would be owed by the taxpayer. However, the deduction available under this provision is not treated as 

a preference item for purposes of computing the AMT. Thus, the 

317 

deduction is allowed in computing alternative minimum taxable income notwithstanding the fact that it may not be deductible in 

computing earnings and profits. No deduction under sections 243 

or 245 is allowed for any dividend for which a deduction is allowed 

under the provision. 

Effective date.—The provision is effective only for a taxpayer’s 

first taxable year beginning on or after the date of enactment of the 

bill, or the taxpayer’s last taxable year beginning before such date, 

at the taxpayer’s election. The deduction available under the provision is not allowed for dividends received in any taxable year beginning one year or more after the date of enactment. 

H. OTHER INCENTIVE PROVISIONS

1. Special rules for livestock sold on account of weather-related conditions (sec. 281 of the House bill, sec. 649 of the Senate 

amendment, and secs. 1033 and 451 of the Code) 

PRESENT LAW

Generally, a taxpayer realizes gain to the extent the sales price 

(and any other consideration received) exceeds the taxpayer’s basis 

in the property. The realized gain is subject to current income tax 

unless the gain is deferred or not recognized under a special tax 

provision. 

Under section 1033, gain realized by a taxpayer from an involuntary conversion of property is deferred to the extent the taxpayer 

purchases property similar or related in service or use to the converted property within the applicable period. The taxpayer’s basis 

in the replacement property generally is the cost of such property 

reduced by the amount of gain not recognized. 

The applicable period for the taxpayer to replace the converted 

property begins with the date of the disposition of the converted 

property (or if earlier, the earliest date of the threat or imminence 

of requisition or condemnation of the converted property) and ends 

two years after the close of the first taxable year in which any part 

of the gain upon conversion is realized (the ‘‘replacement period’’). 

Special rules extend the replacement period for certain real property and principal residences damaged by a Presidentially declared 

disaster to three years and four years, respectively, after the close 

of the first taxable year in which gain is realized. 

Section 1033(e) provides that the sale of livestock (other than 

poultry) that is held for draft, breeding, or dairy purposes in excess 

of the number of livestock that would have been sold but for 

drought, flood, or other weather-related conditions is treated as an 

involuntary conversion. Consequently, gain from the sale of such 

livestock could be deferred by reinvesting the proceeds of the sale 

in similar property within a two-year period. 

In general, cash-method taxpayers report income in the year it 

is actually or constructively received. However, section 451(e) provides that a cash-method taxpayer whose principal trade or business is farming who is forced to sell livestock due to drought, flood, 

or other weather-related conditions may elect to include income 

from the sale of the livestock in the taxable year following the taxable year of the sale. This elective deferral of income is available 

318 

only if the taxpayer establishes that, under the taxpayer’s usual 

business practices, the sale would not have occurred but for 

drought, flood, or weather-related conditions that resulted in the 

area being designated as eligible for Federal assistance. This exception is generally intended to put taxpayers who receive an unusually high amount of income in one year in the position they would 

have been in absent the weather-related condition. 

HOUSE BILL

The House bill extends the applicable period for a taxpayer to 

replace livestock sold on account of drought, flood, or other weather-related conditions from two years to four years after the close of 

the first taxable year in which any part of the gain on conversion 

is realized. The extension is only available if the taxpayer establishes that, under the taxpayer’s usual business practices, the sale 

would not have occurred but for drought, flood, or weather-related 

conditions that resulted in the area being designated as eligible for 

Federal assistance. In addition, the Secretary of the Treasury is 

granted authority to further extend the replacement period on a regional basis should the weather-related conditions continue longer 

than three years. Also, for property eligible for the provision’s extended replacement period, the provision provides that the taxpayer can make an election under section 451(e) until the period 

for reinvestment of such property under section 1033 expires. 

Effective date.—The House bill provision is effective for any 

taxable year with respect to which the due date (without regard to 

extensions) for the return is after December 31, 2002. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

that it also permits the taxpayer to replace compulsorily or involuntarily converted livestock with other farm property if, due to 

drought, flood, or other weather-related conditions, it is not feasible 

for the taxpayer to reinvest the proceeds in property similar or related in use to the livestock so converted. 

Effective date.—The Senate amendment provision is effective 

for taxable years beginning after December 31, 2001. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except for the effective date. 

Effective date.—The conference agreement provision is effective 

for any taxable year with respect to which the due date (without 

regard to extensions) for the return is after December 31, 2002. 

2. Payment of dividends on stock of cooperatives without reducing 

patronage dividends (sec. 282 of the House bill, sec. 648 of the 

Senate amendment, and sec. 1388 of the Code) 

PRESENT LAW

Under present law, cooperatives generally are entitled to deduct or exclude amounts distributed as patronage dividends in accordance with Subchapter T of the Code. In general, patronage 

dividends are comprised of amounts that are paid to patrons (1) on 

319 

114Treas. Reg. sec. 1.1388–1(a)(1). 

the basis of the quantity or value of business done with or for patrons, (2) under a valid and enforceable obligation to pay such 

amounts that was in existence before the cooperative received the 

amounts paid, and (3) which are determined by reference to the net 

earnings of the cooperative from business done with or for patrons. 

Treasury Regulations provide that net earnings are reduced by 

dividends paid on capital stock or other proprietary capital interests (referred to as the ‘‘dividend allocation rule’’).114 The dividend 

allocation rule has been interpreted to require that such dividends 

be allocated between a cooperative’s patronage and nonpatronage 

operations, with the amount allocated to the patronage operations 

reducing the net earnings available for the payment of patronage 

dividends. 

HOUSE BILL

The House bill provides a special rule for dividends on capital 

stock of a cooperative. To the extent provided in organizational documents of the cooperative, dividends on capital stock do not reduce 

patronage income and do not prevent the cooperative from being 

treated as operating on a cooperative basis. 

Effective date.—The House bill provision is effective for distributions made in taxable years ending after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

Effective date.—The Senate amendment provision is effective 

for distributions made in taxable years ending after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

3. Manufacturing relating to timber 

a. Capital gains treatment to apply to outright sales of timber by landowner (sec. 283 of the House bill, sec. 333 of 

the Senate amendment, and sec. 631(b) of the Code) 

PRESENT LAW

Under present law, a taxpayer disposing of timber held for 

more than one year is eligible for capital gains treatment in three 

situations. First, if the taxpayer sells or exchanges timber that is 

a capital asset (sec. 1221) or property used in the trade or business 

(sec. 1231), the gain generally is long-term capital gain; however, 

if the timber is held for sale to customers in the taxpayer’s business, the gain will be ordinary income. Second, if the taxpayer disposes of the timber with a retained economic interest, the gain is 

eligible for capital gain treatment (sec. 631(b)). Third, if the taxpayer cuts standing timber, the taxpayer may elect to treat the cutVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00323 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
320 

ting as a sale or exchange eligible for capital gains treatment (sec. 

631(a)). 

HOUSE BILL

Under the House bill, in the case of a sale of timber by the 

owner of the land from which the timber is cut, the requirement 

that a taxpayer retain an economic interest in the timber in order 

to treat gains as capital gain under section 631(b) does not apply. 

Outright sales of timber by the landowner will qualify for capital 

gains treatment in the same manner as sales with a retained economic interest qualify under present law, except that the usual tax 

rules relating to the timing of the income from the sale of the timber will apply (rather than the special rule of section 631(b) treating the disposal as occurring on the date the timber is cut). 

Effective date.—The provision is effective for sales of timber 

after December 31, 2004. 

SENATE AMENDMENT

The provision in the Senate amendment is the same as House 

bill. 

Effective date.—The provision is effective for sales of timber 

after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the House 

bill and Senate amendment. 

Effective date.—The provision is effective for sales of timber 

after December 31, 2004. 

b. Expensing of reforestation expenditures (sec. 331 of the 

Senate amendment and secs. 48 and 194 of the Code) 

PRESENT LAW

Section 194 provides for an 84-month amortization period for 

up to $10,000 of qualified reforestation expenditures. Section 48(b) 

provides a 10-percent credit on up to $10,000 of qualified amortizable basis in timber property. The amount amortized under section 

194 is reduced by one half of the amount of credit claimed under 

section 48(b). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment permits up to $10,000 of qualified reforestation expenditures to be deducted in the year paid or incurred 

(i.e., expensed). The Senate amendment permits qualified reforestation expenditures above $10,000 to be amortized over 84 months. 

The Senate amendment also repeals the reforestation tax credit. 

Effective date.—Expenditures paid or incurred after the date of 

enactment. 

321 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment provision. 

c. Election to treat cutting of timber as a sale or exchange 

(sec. 102(b) of the House bill, sec. 332 of the Senate 

amendment, and sec. 631(a) of the Code) 

PRESENT LAW

Under present law, a taxpayer may elect to treat the cutting 

of timber as a sale or exchange of the timber. If an election is 

made, the gain or loss is recognized in an amount equal to the difference between the fair market value of the timber and the basis 

of the timber. An election, once made, is effective for the taxable 

year and all subsequent taxable years, unless the IRS, upon a 

showing of undue hardship by the taxpayer, permits the revocation 

of the election. If an election is revoked, a new election may be 

made only with the consent of the IRS. 

HOUSE BILL

Under the House bill, an election made by a corporation for a 

taxable year ending on or before the date of enactment, to treat the 

cutting of timber as a sale or exchange, may be revoked by the taxpayer without the consent of the IRS for any taxable year ending 

after that date. The prior election (and revocation) is disregarded 

for purposes of making a subsequent election. 

Effective date.—The provision applies to taxable years ending 

after the date of enactment. 

SENATE AMENDMENT

The provision is the same as the House bill, except the provision applies to all taxpayers. 

Effective date.—The provision applies to taxable years ending 

after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the Senate 

amendment. 

d. Modified safe harbor rules for timber REITs (sec. 334 of 

the Senate amendment and sec. 857 of the Code) 

PRESENT LAW

In general 

Under present law, real estate investment trusts (‘‘REITs’’) are 

subject to a special taxation regime. Under this regime, a REIT is 

allowed a deduction for dividends paid to its shareholders. As a result, REITs generally do not pay tax on distributed income. REITs 

are generally restricted to earning certain types of passive income, 

primarily rents from real property and interests on mortgages secured by real property. 

322 

115Sec. 1221(a)(l). 116Thus, the 100-percent tax on prohibited transactions helps to ensure that the REIT is a 

passive entity and may not engage in ordinary retailing activities such as sales to customers 

of condominium units or subdivided lots in a development project. 117See, e.g., PLR 200052021, PLR 199945055, PLR 19927021, PLR 8838016. A private letter 

ruling may be relied upon only by the taxpayer to which the ruling is issued. However, such 

rulings provide an indication of administrative practice. 118 Certain securities that are within a safe-harbor definition of ‘‘straight debt’’ are not taken 

into account for purposes of the limitation to no more than 10 percent of the value of an issuer’s 

outstanding securities. 

To qualify as a REIT, a corporation must satisfy a number of 

requirements, among which are four tests: organizational structure, 

source of income, nature of assets, and distribution of income. 

Income or loss from prohibited transactions 

A 100-percent tax is imposed on the net income of a REIT from 

‘‘prohibited transactions’’. A prohibited transaction is the sale or 

other disposition of property held for sale in the ordinary course of 

a trade or business,115 other than foreclosure property.116 A safe 

harbor is provided for certain sales of rent-producing real property. 

To qualify for the safe harbor, three criteria generally must be met. 

First, the REIT must have held the property for at least four years 

for rental purposes. Second, the aggregate expenditures made by 

the REIT during the four-year period prior to the date of the sale 

must not exceed 30 percent of the net selling price of the property. 

Third, either (i) the REIT must make seven or fewer sales of property during the taxable year or (ii) the aggregate adjusted basis of 

the property sold must not exceed 10 percent of the aggregate 

bases of all the REIT’s assets at the beginning of the REIT’s taxable year. In the latter case, substantially all of the marketing and 

development expenditures with respect to the property must be 

made through an independent contractor. 

Certain timber income 

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

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

the REIT. The Internal Revenue Service has issued private letter 

rulings in particular instances stating that the income from the 

sale of the trees can qualify as REIT real property income because 

the uncut timber and the timberland on which the timber grew is 

considered real property and the sale of uncut trees can qualify as 

capital gain derived from the sale of real property.117

Limitation on investment in other entities 

A REIT is limited in the amount that it can own in other corporations. Specifically, a REIT cannot own securities (other than 

Government securities and certain real estate assets) in an amount 

greater than 25 percent of the value of REIT assets. In addition, 

it cannot own such securities of any one issuer representing more 

than five percent of the total value of REIT assets or more than 

10 percent of the voting securities or 10 percent of the value of the 

outstanding securities of any one issuer. Securities for purposes of 

these rules are defined by reference to the Investment Company 

Act of 1940.118

323 

119 Certain corporations are not eligible to be a TRS, such as a corporation which directly or 

indirectly operates or manages a lodging facility or a health care facility or directly or indirectly 

provides to any other person rights to a brand name under which any lodging facility or health 

care facility is operated. Sec. 856(l)(3). 120 If the excise tax applies, the item is not also reallocated back to the TRS under section 

482. 121The timberland acquisition expenditures that are excluded for this purpose are those expenditures that are related to timberland other than the specific timberland that is being sold 

under the safe harbor, but costs of which may be combined with costs of such property in the 

same ‘‘management block’’ under Treas. Reg. sec. 1.611–3(d). Any specific timberland being sold 

must meet the requirement that it has been held for at least four years by the REIT in order 

to qualify for the safe harbor. 

Special rules for taxable REIT subsidiaries 

Under an exception to the general rule limiting REIT securities ownership of other entities, a REIT can own stock of a taxable 

REIT subsidiary (‘‘TRS’’), generally, a corporation other than a 

REIT 119 with which the REIT makes a joint election to be subject 

to special rules. A TRS can engage in active business operations 

that would produce income that would not be qualified income for 

purposes of the 95-percent or 75-percent income tests for a REIT, 

and that income is not attributed to the REIT. Transactions between a TRS and a REIT are subject to a number of specified rules 

that are intended to prevent the TRS (taxable as a separate corporate entity) from shifting taxable income from its activities to the 

pass-through entity REIT or from absorbing more than its share of 

expenses. Under one rule, a 100-percent excise tax is imposed on 

rents, deductions, or interest paid by the TRS to the REIT to the 

extent such items would exceed an arm’s length amount as determined under section 482.120

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the provision, a sale of a real estate asset by a REIT 

will not be a prohibited transaction if the following six requirements are met: 

(1) The asset must have been held for at least four years 

in the trade or business of producing timber; 

(2) The aggregate expenditures made by the REIT (or a 

partner of the REIT) during the four-year period preceding the 

date of sale that are includible in the basis of the property 

(other than timberland acquisition expenditures 121) and that 

are directly related to the operation of the property for the production of timber or for the preservation of the property for use 

as timberland must not exceed 30 percent of the net selling 

price of the property; 

(3) The aggregate expenditures made by the REIT (or a 

partner of the REIT) during the four-year period preceding the 

date of sale that are includible in the basis of the property and 

that are not directly related to the operation of the property for 

the production of timber or the preservation of the property for 

use as timberland must not exceed five percent of the net selling price of the property; 

(4) The REIT either (a) does not make more than seven 

sales of property (other than sales of foreclosure property or 

324 

sales to which 1033 applies) or (b) the aggregate adjusted 

bases (as determined for purposes of computing earnings and 

profits) of property sold during the year (other than sales of 

foreclosure property or sales to which 1033 applies) does not 

exceed 10 percent of the aggregate bases (as determined for 

purposes of computing earnings and profits) of property of all 

assets of the REIT as of the beginning of the year; 

(5) Substantially all of the marketing expenditures with 

respect to the property are made by persons who are independent contractors (as defined by section 856(d)(3)) with respect to the REIT and from whom the REIT does not derive 

any income; and 

(6) The sales price on the sale of the property cannot be 

based in whole or in part on income or profits of any person, 

including income or profits derived from the sale of such properties. 

Capital expenditures counted towards the 30-percent limit are 

those expenditures that are includible in the basis of the property 

(other than timberland acquisition expenditures), and that are directly related to operation of the property for the production of timber, or for the preservation of the property for use as timberland. 

These capital expenditures are those incurred directly in the operation of raising timber (i.e., silviculture), as opposed to capital expenditures incurred in the ownership of undeveloped land. In general, these capital expenditures incurred directly in the operation 

of raising timber include capital expenditures incurred by the REIT 

to create an established stand of growing trees. A stand of trees is 

considered established when a target stand exhibits the expected 

growing rate and is free of non-target competition (e.g., hardwoods, 

grasses, brush, etc.) that may significantly inhibit or threaten the 

target stand survival. The costs commonly incurred during stand 

establishment are: (1) site preparation including manual or mechanical scarification, manual or mechanical cutting, disking, bedding, shearing, raking, piling, broadcast and windrow/pile burning 

(including slash disposal costs as required for stand establishment); 

(2) site regeneration including manual or mechanical hardwood 

coppice; (3) chemical application via aerial or ground to eliminate 

or reduce vegetation; (4) nursery operating costs including personnel salaries and benefits, facilities costs, cone collection and 

seed extraction, and other costs directly attributable to the nursery 

operations (to the extent such costs are allocable to seedlings used 

by the REIT); (5) seedlings including storage, transportation and 

handling equipment; (6) direct planting of seedlings; and (7) initial 

stand fertilization, up through stand establishment. Other examples of capital expenditures incurred directly in the operation of 

raising timber include construction cost of road to be used for managing the timber land (including for removal of logs or fire protection), environmental costs (i.e., habitat conservation plans), and 

any other post stand establishment capital costs (e.g., ‘‘mid-term 

fertilization costs).’’ 

Capital expenditures counted towards the five-percent limit are 

those capital expenditures incurred in the ownership of undeveloped land that are not incurred in the direct operation of raising 

timber (i.e., silviculture). This category of capital expenditures inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00328 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
325 

122Sec. 852(b). 123Sec. 851(a). 124Sec. 851(b). 125Sec. 851(b)(2). 

cludes: (1) expenditures to separate the REIT’s holdings of land 

into separate parcels; (2) costs of granting leases or easements to 

cable, cellular or similar companies; (3) costs in determining the 

presence or quality of minerals located on the land; (4) costs incurred to defend changes in law that would limit future use of the 

land by the REIT or a purchaser from the REIT; (5) costs incurred 

to determine alternative uses of the land (e.g., recreational use); 

and (6) development costs of the property incurred by the REIT 

(e.g., engineering, surveying, legal, permit, consulting, road construction, utilities, and other development costs for use other than 

to grow timber). 

Costs that are not includible in the basis of the property are 

not counted towards either the 30-percent or five-percent requirements. 

Effective date.—The provision is effective for taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

4. Net income from publicly traded partnerships treated as qualifying income of regulated investment company (sec. 284 of the 

House bill, sec. 899 of the Senate amendment, and secs. 851(b), 

469(k), 7704(d) and new sec. 851(h) of the Code) 

PRESENT LAW

Treatment of RICs 

A regulated investment company (‘‘RIC’’) generally is treated 

as a conduit for Federal income tax purposes. In computing its taxable income, a RIC deducts dividends paid to its shareholders to 

achieve conduit treatment.122 In order to qualify for conduit treatment, a RIC must be a domestic corporation that, at all times during the taxable year, is registered under the Investment Company 

Act of 1940 as a management company or as a unit investment 

trust, or has elected to be treated as a business development company under that Act.123 In addition, the corporation must elect RIC 

status, and must satisfy certain other requirements.124

One of the RIC qualification requirements is that at least 90 

percent of the RIC’s gross income is derived from dividends, interest, payments with respect to securities loans, and gains from the 

sale or other disposition of stock or securities or foreign currencies, 

or other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to its business of 

investing in such stock, securities, or currencies.125 Income derived 

from a partnership is treated as meeting this requirement only to 

the extent such income is attributable to items of income of the 

partnership that would meet the requirement if realized by the 

RIC in the same manner as realized by the partnership (the ‘‘lookVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00329 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
326 

126Sec. 851(b). 127Sec. 851(b)(3). 128Sec. 851(d). 129Sec. 7704(a), (c), and (d). 130Sec. 469. 131Sec. 469(k). 

through’’ rule for partnership income).126 Under present law, no 

distinction is made under this rule between a publicly traded partnership and any other partnership. 

The RIC qualification rules include limitations on the ownership of assets and on the composition of the RIC’s assets.127 Under 

the ownership limitation, at least 50 percent of the value of the 

RIC’s total assets must be represented by cash, government securities and securities of other RICs, and other securities; however, in 

the case of such other securities, the RIC may invest no more than 

five percent of the value of the total assets of the RIC in the securities of any one issuer, and may hold no more than 10 percent of 

the outstanding voting securities of any one issuer. Under the limitation on the composition of the RIC’s assets, no more than 25 percent of the value of the RIC’s total assets may be invested in the 

securities of any one issuer (other than Government securities), or 

in securities of two or more controlled issuers in the same or similar trades or businesses. These limitations generally are applied at 

the end of each quarter.128

Treatment of publicly traded partnerships 

Present law provides that a publicly traded partnership means 

a partnership, interests in which are traded on an established securities market, or are readily tradable on a secondary market (or the 

substantial equivalent thereof). In general, a publicly traded partnership is treated as a corporation, but an exception to corporate 

treatment is provided if 90 percent or more of its gross income is 

interest, dividends, real property rents, or certain other types of 

qualifying income.129

A special rule for publicly traded partnerships applies under 

the passive loss rules. The passive loss rules limit deductions and 

credits from passive trade or business activities.130 Deductions attributable to passive activities, to the extent they exceed income 

from passive activities, generally may not be deducted against 

other income. Deductions and credits that are suspended under 

these rules are carried forward and treated as deductions and credits from passive activities in the next year. The suspended losses 

from a passive activity are allowed in full when a taxpayer disposes 

of his entire interest in the passive activity to an unrelated person. 

The special rule for publicly traded partnerships provides that the 

passive loss rules are applied separately with respect to items attributable to each publicly traded partnership.131 Thus, income or 

loss from the publicly traded partnership is treated as separate 

from income or loss from other passive activities. 

HOUSE BILL

The House bill modifies the 90-percent test with respect to income of a RIC to include net income derived from an interest in 

a publicly traded partnership. The House bill also modifies the 

327 

look-through rule for partnership income of a RIC so that it applies 

only to income from a partnership other than a publicly traded 

partnership. 

The House bill provides that the limitation on ownership and 

the limitation on composition of assets that apply to other investments of a RIC also apply to RIC investments in publicly traded 

partnership interests. 

The House bill provides that the special rule for publicly traded partnerships under the passive loss rules (requiring separate 

treatment) applies to a RIC holding an interest in a publicly traded 

partnership, with respect to items attributable to the interest in 

the publicly traded partnership. 

Effective date.—The House bill provision is effective for taxable 

years beginning after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment. In addition, the conference agreement provides that 

net income from an interest in a publicly traded partnership is 

used for purposes of both the numerator and denominator of the 

90-percent test. As under present law, the conference agreement 

also provides that gains from the sale or other disposition of interests in publicly traded partnerships constitute qualifying income of 

regulated investment companies. 

5. Improvements related to real estate investment trusts (sec. 285 

of the House bill and secs. 856, 857 and 860 of the Code) 

PRESENT LAW

In general 

Real estate investment trusts (‘‘REITs’’) are treated, in substance, as pass-through entities under present law. Pass-through 

status is achieved by allowing the REIT a deduction for dividends 

paid to its shareholders. REITs are generally restricted to investing 

in passive investments primarily in real estate and securities. 

A REIT must satisfy four tests on a year-by-year basis: organizational structure, source of income, nature of assets, and distribution of income. Whether the REIT meets the asset tests is generally 

measured each quarter. 

Organizational structure requirements 

To qualify as a REIT, an entity must be for its entire taxable 

year a corporation or an unincorporated trust or association that 

would be taxable as a domestic corporation but for the REIT provisions, and must be managed by one or more trustees. The beneficial ownership of the entity must be evidenced by transferable 

shares or certificates of ownership. Except for the first taxable year 

for which an entity elects to be a REIT, the beneficial ownership 

of the entity must be held by 100 or more persons, and the entity 

may not be so closely held by individuals that it would be treated 

328 

132 A REIT is not treated as providing services that produce impermissible tenant services income if such services are provided by an independent contractor from whom the REIT does not 

derive or receive any income. An independent contractor is defined as a person who does not 

own, directly or indirectly, more than 35 percent of the shares of the REIT. Also, no more than 

35 percent of the total shares of stock of an independent contractor (or of the interests in net 

assets or net profits, if not a corporation) can be owned directly or indirectly by persons owning 

35 percent or more of the interests in the REIT. 133 Rents for certain personal property leased in connection with the rental of real property 

are treated as rents from real property if the fair market value of the personal property does 

not exceed 15 percent of the aggregate fair market values of the real and personal property. 134Sec. 856(d)(2)(B). 135Sec. 856(d)(8). 

as a personal holding company if all its adjusted gross income constituted personal holding company income. A REIT is required to 

comply with regulations to ascertain the actual ownership of the 

REIT’s outstanding shares. 

Income requirements 

In order for an entity to qualify as a REIT, at least 95 percent 

of its gross income generally must be derived from certain passive 

sources (the ‘‘95-percent income test’’). In addition, at least 75 percent of its income generally must be from certain real estate 

sources (the ‘‘75-percent income test’’), including rents from real 

property (as defined) and gain from the sale or other disposition of 

real property, and income and gain derived from foreclosure property. 

Qualified rental income 

Amounts received as impermissible ‘‘tenant services income’’ 

are not treated as rents from real property.132 In general, such 

amounts are for services rendered to tenants that are not ‘‘customarily furnished’’ in connection with the rental of real property.133

Rents from real property, for purposes of the 95-percent and 

75-percent income tests, generally do not include any amount received or accrued from any person in which the REIT owns, directly or indirectly, 10 percent or more of the vote or value.134 An 

exception applies to rents received from a taxable REIT subsidiary 

(‘‘TRS’’) (described further below) if at least 90 percent of the leased 

space of the property is rented to persons other than a TRS or certain related persons, and if the rents from the TRS are substantially comparable to unrelated party rents.135

Certain hedging instruments 

Except as provided in regulations, a payment to a REIT under 

an interest rate swap or cap agreement, option, futures contract, 

forward rate agreement, or any similar financial instrument, entered into by the trust in a transaction to reduce the interest rate 

risks with respect to any indebtedness incurred or to be incurred 

by the REIT to acquire or carry real estate assets, and any gain 

from the sale or disposition of any such investment, is treated as 

income qualifying for the 95-percent income test. 

Tax if qualified income tests not met 

If a REIT fails to meet the 95-percent or 75-percent income 

tests but has set out the income it did receive in a schedule and 

any error in the schedule is not due to fraud with intent to evade 

329 

136Prior to 1999, the rule had applied to the amount by which 95 percent of the income exceeded the items subject to the 95 percent test. 137The ratio of the REIT’s net to gross income is applied to the excess amount, to determine 

the amount of tax (disregarding certain items otherwise subject to a 100-percent tax). In effect, 

the formula seeks to require that all of the REIT net income attributable to the failure of the 

income tests will be paid as tax. Sec. 857(b)(5). 138Sec. 1361(c)(5), without regard to paragraph (B)(iii) thereof. 139Sec. 856(c)(7). 

tax, then the REIT does not lose its REIT status provided that the 

failure to meet the 95-percent or 75-percent test is due to reasonable cause and not due to willful neglect. If the REIT qualifies for 

this relief, the REIT must pay a tax measured by the greater of the 

amount by which 90 percent136 of the REIT’s gross income exceeds 

the amount of items subject to the 95-percent test, or the amount 

by which 75 percent of the REIT’s gross income exceeds the 

amount of items subject to the 75-percent test.137

Asset requirements 

75-percent asset test 

To satisfy the asset requirements to qualify for treatment as 

a REIT, at the close of each quarter of its taxable year, an entity 

must have at least 75 percent of the value of its assets invested in 

real estate assets, cash and cash items, and government securities 

(the ‘‘75-percent asset test’’). The term real estate asset is defined 

to mean real property (including interests in real property and 

mortgages on real property) and interests in REITs. 

Limitation on investment in other entities 

A REIT is limited in the amount that it can own in other corporations. Specifically, a REIT cannot own securities (other than 

Government securities and certain real estate assets) in an amount 

greater than 25 percent of the value of REIT assets. In addition, 

it cannot own such securities of any one issuer representing more 

than 5 percent of the total value of REIT assets or more than 10 

percent of the voting securities or 10 percent of the value of the 

outstanding securities of any one issuer. Securities for purposes of 

these rules are defined by reference to the Investment Company 

Act of 1940. 

‘‘Straight debt’’ exception 

Securities of an issuer that are within a safe-harbor definition 

of ‘‘straight debt’’ (as defined for purposes of subchapter S)138 are 

not taken into account in applying the limitation that a REIT may 

not hold more than 10 percent of the value of outstanding securities of a single issuer, if: (1) the issuer is an individual; (2) the only 

securities of such issuer held by the REIT or a taxable REIT subsidiary of the REIT are straight debt; or (3) the issuer is a partnership and the trust holds at least a 20 percent profits interest in the 

partnership. 

Straight debt for purposes of the REIT provision139 is defined 

as a written or unconditional promise to pay on demand or on a 

specified date a sum certain in money if (i) the interest rate (and 

interest payment dates) are not contingent on profits, the borVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00333 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
330 

140 Certain corporations are not eligible to be a TRS, such as a corporation which directly or 

indirectly operates or manages a lodging facility or a health care facility, or directly or indirectly 

provides to any other person rights to a brand name under which any lodging facility or health 

care facility is operated. Sec. 856(l)(3). 141 If the excise tax applies, then the item is not reallocated back to the TRS under section 

482. 

rower’s discretion, or similar factors, and (ii) there is no convertibility (directly or indirectly) into stock. 

Certain subsidiary ownership permitted with income treated 

as income of the REIT 

Under one exception to the rule limiting a REIT’s securities 

holdings to no more than 10 percent of the vote or value of a single 

issuer, a REIT can own 100 percent of the stock of a corporation, 

but in that case the income and assets of such corporation are 

treated as income and assets of the REIT. 

Special rules for taxable REIT subsidiaries 

Under another exception to the general rule limiting REIT securities ownership of other entities, a REIT can own stock of a taxable REIT subsidiary (‘‘TRS’’), generally, a corporation other than 

a real estate investment trust140 with which the REIT makes a 

joint election to be subject to special rules. A TRS can engage in 

active business operations that would produce income that would 

not be qualified income for purposes of the 95-percent or 75-percent 

income tests for a REIT, and that income is not attributed to the 

REIT. For example, a TRS could provide noncustomary services to 

REIT tenants, or it could engage directly in the active operation 

and management of real estate (without use of an independent contractor); and the income the TRS derived from these nonqualified 

activities would not be treated as disqualified REIT income. Transactions between a TRS and a REIT are subject to a number of specified rules that are intended to prevent the TRS (taxable as a separate corporate entity) from shifting taxable income from its activities to the pass-through entity REIT or from absorbing more than 

its share of expenses. Under one rule, a 100-percent excise tax is 

imposed on rents to the extent that the amount of the rents would 

be reduced on distribution, apportionment, or allocation under section 482 to clearly reflect income as a result of services furnished 

by a TRS of the REIT to a tenant of the REIT.141

The 100 percent excise tax does not apply to amounts received 

directly or indirectly by a REIT from a TRS that would be excluded 

from unrelated taxable income if received by an organization described in section 511(a)(2). Such amounts are defined in section 

512(b)(3). 

Rents paid by a TRS to a REIT generally are treated as rents 

from real property if at least 90 percent of the leased space of the 

property is rented to persons other than the REIT’s TRSs and other 

than persons related to the REIT. In such a case, the rent paid by 

the TRS to the REIT is treated as rent from real property only to 

the extent that it is substantially comparable to rents from other 

tenants of the REIT’s property for comparable space. 

331 

142Secs. 856(c)(6) and 857(b)(5). 

Income distribution requirements 

A REIT is generally required to distribute 90 percent of its income before the end of its taxable year, as deductible dividends 

paid to shareholders. This rule is similar to a rule for regulated investment companies (‘‘RICs’’) that requires distribution of 90 percent of income. If a REIT declares certain dividends after the end 

of its taxable year but before the time prescribed for filing its return for that year and distributes those amounts to shareholders 

within the 12 months following the close of that taxable year, such 

distributions are treated as made during such taxable year for this 

purpose. As described further below, a REIT can also make certain 

‘‘deficiency dividends’’ after the close of the taxable year after a determination that it has not distributed the correct amount for qualification as a REIT. 

Consequences of failure to meet requirements 

A REIT loses its status as a REIT, and becomes subject to tax 

as a C corporation, if it fails to meet specified tests regarding the 

sources of its income, the nature and amount of its assets, its structure, and the amount of its income distributed to shareholders. 

If a REIT fails to meet the source of income requirements, but 

has set out the income it did receive in a schedule and any error 

in the schedule is not due to fraud with intent to evade tax, then 

the REIT does not lose its REIT status, provided that the failure 

to meet the 95-percent or 75-percent test is due to reasonable cause 

and not to willful neglect. If the REIT qualifies for this relief, the 

REIT must pay the disallowed income as a tax to the Treasury.142

Failure to satisfy the asset test is excused if the REIT eliminates the discrepancy within 30 days. Failure to meet distribution 

requirements may also be excused if the REIT was unable to meet 

such requirement by reason of distributions previously made to 

meet the requirements of section 4981. 

There are no similar provisions that allow a REIT to pay a 

penalty and avoid disqualification in the case of other qualification 

failures. 

A REIT may make a deficiency dividend after a determination 

is made that it has not distributed the correct amount of its income, and avoid disqualification. The Code provides only for determinations involving a controversy with the IRS and does not provide for a REIT to make such a distribution on its own initiative. 

Deficiency dividends may be declared on or after the date of ‘‘determination’’. A determination is defined to include only (i) a final decision by the Tax Court or other court of competent jurisdiction, (ii) 

a closing agreement under section 7121, or (iii) under Treasury regulations, an agreement signed by the Secretary and the REIT. 

HOUSE BILL

The provision makes a number of modifications to the REIT 

rules. 

332 

143The present law rules that limit qualified interest income to amounts the determination 

of which do not depend, in whole or in part, on the income or profits of any person, continue 

to apply to such contingent interest. See, e.g., secs. 856(c)(2)(G), 856(c)(3)(G) and 856(f). 

Straight debt modification 

The provision modifies the definition of ‘‘straight debt’’ for purposes of the limitation that a REIT may not hold more than 10 percent of the value of the outstanding securities of a single issuer, to 

provide more flexibility than the present law rule. In addition, except as provided in regulations, neither such straight debt nor certain other types of securities are considered ‘‘securities’’ for purposes of this rule. 

Straight debt securities 

As under present law, ‘‘straight-debt’’ is still defined by reference to section 1361(c)(5), without regard to subparagraph (B)(iii) 

thereof (limiting the nature of the creditor). 

Special rules are provided permitting certain contingencies for 

purposes of the REIT provision. Any interest or principal shall not 

be treated as failing to satisfy section 1361(c)(5)(B)(i) solely by reason of the fact that the time of payment of such interest or principal is subject to a contingency, but only if one of several factors 

applies. The first type of contingency that is permitted is one that 

does not have the effect of changing the effective yield to maturity, 

as determined under section 1272, other than a change in the annual yield to maturity, but only if (i) any such contingency does not 

exceed the greater of 1⁄4 of one percent or five percent of the annual 

yield to maturity, or (ii) neither the aggregate issue price nor the 

aggregate face amount of the debt instruments held by the REIT 

exceeds $1,000,000 and not more than 12 months of unaccrued interest can be required to be prepaid thereunder. 

Also, the time or amount of any payment is permitted to be 

subject to a contingency upon a default or the exercise of a prepayment right by the issuer of the debt, provided that such contingency is consistent with customary commercial practice.143

The provision eliminates the present law rule requiring a REIT 

to own a 20 percent equity interest in a partnership in order for 

debt to qualify as ‘‘straight debt’’. The bill instead provides new 

‘‘look-through’’ rules determining a REIT partner’s share of partnership securities, generally treating debt to the REIT as part of 

the REIT’s partnership interest for this purpose, except in the case 

of otherwise qualifying debt of the partnership. 

Certain corporate or partnership issues that otherwise would 

be permitted to be held without limitation under the special 

straight debt rules described above will not be so permitted if the 

REIT holding such securities, and any of its taxable REIT subsidiaries, holds any securities of the issuer which are not permitted securities (prior to the application of this rule) and have an aggregate 

value greater than one percent of the issuer’s outstanding securities. 

Other securities 

Except as provided in regulations, the following also are not 

considered ‘‘securities’’ for purposes of the rule that a REIT cannot 

333 

144The provision does not modify any of the standards of section 482 as they apply to REITs 

and to TRSs. 145 Although a REIT could itself provide such service and receive the income without receiving 

any disqualified income, in that case the REIT itself would be bearing the cost of providing the 

service. Under the present law exception for a TRS providing such service, there is no explicit 

requirement that the TRS be reimbursed for the full cost of the service. 

own more than 10 percent of the value of the outstanding securities 

of a single issuer: (i) any loan to an individual or an estate, (ii) any 

section 467 rental agreement, (as defined in section 467(d)), other 

than with a person described in section 856(d)(2)(B), (iii) any obligation to pay rents from real property, (iv) any security issued by 

a State or any political subdivision thereof, the District of Columbia, a foreign government, or any political subdivision thereof, or 

the Commonwealth of Puerto Rico, but only if the determination of 

any payment received or accrued under such security does not depend in whole or in part on the profits of any entity not described 

in this category, or payments on any obligation issued by such an 

entity, (v) any security issued by a real estate investment trust; 

and (vi) any other arrangement that, as determined by the Secretary, is excepted from the definition of a security. 

Safe harbor testing date for certain rents 

The provision provides specific safe-harbor rules regarding the 

dates for testing whether 90 percent of a REIT property is rented 

to unrelated persons and whether the rents paid by related persons 

are substantially comparable to unrelated party rents. These testing rules are provided solely for purposes of the special provision 

permitting rents received from a TRS to be treated as qualified 

rental income for purposes of the income tests.144

Customary services exception 

The provision prospectively eliminates the safe harbor allowing 

rents received by a REIT to be exempt from the 100 percent excise 

tax if the rents are for customary services performed by the TRS 145

or are from a TRS and are described in section 512(b)(3). Instead, 

such payments are free of the excise tax if they satisfy the present 

law safe-harbor that applies if the REIT pays the TRS at least 150 

percent of the cost to the TRS of providing any services. 

Hedging rules 

The rules governing the tax treatment of arrangements engaged in by a REIT to reduce certain interest rate risks are prospectively generally conformed to the rules included in section 

1221. Also, the defined income of a REIT from such a hedging 

transaction is excluded from gross income for purposes of the 95- 

percent of gross income requirement. 

95-percent of gross income requirement 

The provision prospectively amends the tax liability owed by 

the REIT when it fails to meet the 95-percent of gross income test 

by applying a taxable fraction based on 95 percent, rather than 90 

percent, of the REIT’s gross income. 

334 

146Sec. 856(c)(4)(B)(iii). These rules do not apply to securities of a TRS, or to securities that 

qualify for the 75 percent asset test of section 856(c)(4)(A), such as real estate assets, cash items 

(including receivables), or Government securities. 147 A REIT might satisfy the requirements without a disposition, for example, by increasing 

its other assets in the case of the 5 percent rule; or by the issuer modifying the amount or value 

of its total securities outstanding in the case of the 10 percent rule. 

Consequences of failure to meet REIT requirements 

Under the provision, a REIT may avoid disqualification in the 

event of certain failures of the requirements for REIT status, provided that (1) the failure was due to reasonable cause and not willful neglect, (2) the failure is corrected, and (3) except for certain 

failures not exceeding a specified de minimis amount, a penalty 

amount is paid. 

Certain de minimis asset failures of 5-percent or 10-percent 

tests 

One requirement of present law is that, with certain exceptions, (i) not more than 5 percent of the value of total REIT assets 

may be represented by securities of one issuer, and (ii) a REIT may 

not hold securities possessing more than 10 percent of the total voting power or 10 percent of the total value of the outstanding securities of any one issuer.146 The requirements must be satisfied each 

quarter. 

The provision provides that a REIT will not lose its REIT status for failing to satisfy these requirements in a quarter if the failure is due to the ownership of assets the total value of which does 

not exceed the lesser of (i) one percent of the total value of the 

REIT’s assets at the end of the quarter for which such measurement is done or (ii) 10 million dollars; provided in either case that 

the REIT either disposes of the assets within six months after the 

last day of the quarter in which the REIT identifies the failure (or 

such other time period prescribed by the Treasury), or otherwise 

meets the requirements of those rules by the end of such time period.147

Larger asset test failures (whether of 5-percent or 10-percent 

tests, or of 75-percent or other asset tests) 

Under the provision, if a REIT fails to meet any of the asset 

test requirements for a particular quarter and the failure exceeds 

the de minimis threshold described above, then the REIT still will 

be deemed to have satisfied the requirements if: (i) following the 

REIT’s identification of the failure, the REIT files a schedule with 

a description of each asset that caused the failure, in accordance 

with regulations prescribed by the Treasury; (ii) the failure was 

due to reasonable cause and not to willful neglect, (iii) the REIT 

disposes of the assets within 6 months after the last day of the 

quarter in which the identification occurred or such other time period as is prescribed by the Treasury (or the requirements of the 

rules are otherwise met within such period), and (iv) the REIT 

pays a tax on the failure. 

The tax that the REIT must pay on the failure is the greater 

of (i) $50,000, or (ii) an amount determined (pursuant to regulations) by multiplying the highest rate of tax for corporations under 

section 11, by the net income generated by the assets for the period 

335 

beginning on the first date of the failure and ending on the date 

the REIT has disposed of the assets (or otherwise satisfies the requirements). 

Such taxes are treated as excise taxes, for which the deficiency 

provisions of the excise tax subtitle of the Code (subtitle F) apply. 

Conforming reasonable cause and reporting standard for failures of income tests 

The provision conforms the reporting and reasonable cause 

standards for failure to meet the income tests to the new asset test 

standards. However, the provision does not change the rule under 

section 857(b)(5) that for income test failures, all of the net income 

attributed to the disqualified gross income is paid as tax. 

Other failures 

The bill adds a provision under which, if a REIT fails to satisfy 

one or more requirements for REIT qualification, other than the 

95-percent and 75-percent gross income tests and other than the 

new rules provided for failures of the asset tests, the REIT may retain its REIT qualification if the failures are due to reasonable 

cause and not willful neglect, and if the REIT pays a penalty of 

$50,000 for each such failure. 

Taxes and penalties paid deducted from amount required to 

be distributed 

Any taxes or penalties paid under the provision are deducted 

from the net income of the REIT in determining the amount the 

REIT must distribute under the 90-percent distribution requirement. 

Expansion of deficiency dividend procedure 

The provision expands the circumstances in which a REIT may 

declare a deficiency dividend, by allowing such a declaration to 

occur after the REIT unilaterally has identified a failure to pay the 

relevant amount. Thus, the declaration need not await a decision 

of the Tax Court, a closing agreement, or an agreement signed by 

the Secretary of the Treasury. 

Effective date 

The provision is generally effective for taxable years beginning 

after December 31, 2000. 

However, some of the provisions are effective for taxable years 

beginning after the date of enactment. These are: the new ‘‘look 

through’’ rules determining a REIT partner’s share of partnership 

securities for purposes of the ‘‘straight debt’’ rules; the provision 

changing the 90-percent of gross income reference to 95 percent, for 

purposes of the tax liability if a REIT fails to meet the 95-percent 

of gross income test; the new hedging definition; the rule modifying 

the treatment of rents with respect to customary services; and the 

new rules for correction of certain failures to satisfy the REIT requirements. 

SENATE AMENDMENT

No provision. 

336 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

6. Treatment of certain dividends of regulated investment companies (sec. 286 of the House bill and secs. 871 and 881 of the 

Code) 

PRESENT LAW

Regulated investment companies 

A regulated investment company (‘‘RIC’’) is a domestic corporation that, at all times during the taxable year, is registered under 

the Investment Company Act of 1940 as a management company 

or as a unit investment trust, or has elected to be treated as a business development company under that Act (sec. 851(a)). 

In addition, to qualify as a RIC, a corporation must elect such 

status and must satisfy certain tests (sec. 851(b)). These tests include a requirement that the corporation derive at least 90 percent 

of its gross income from dividends, interest, payments with respect 

to certain securities loans, and gains on the sale or other disposition of stock or securities or foreign currencies, or other income derived with respect to its business of investment in such stock, securities, or currencies. 

Generally, a RIC pays no income tax because it is permitted 

to deduct dividends paid to its shareholders in computing its taxable income. The amount of any distribution generally is not considered as a dividend for purposes of computing the dividends paid 

deduction unless the distribution is pro rata, with no preference to 

any share of stock as compared with other shares of the same class 

(sec. 562(c)). For distributions by RICs to shareholders who made 

initial investments of at least $10,000,000, however, the distribution is not treated as non-pro rata or preferential solely by reason 

of an increase in the distribution due to reductions in administrative expenses of the company. 

A RIC generally may pass through to its shareholders the 

character of its long-term capital gains. It does this by designating 

a dividend it pays as a capital gain dividend to the extent that the 

RIC has net capital gain (i.e., net long-term capital gain over net 

short-term capital loss). These capital gain dividends are treated as 

long-term capital gain by the shareholders. A RIC generally also 

can pass through to its shareholders the character of tax-exempt 

interest from State and local bonds, but only if, at the close of each 

quarter of its taxable year, at least 50 percent of the value of the 

total assets of the RIC consists of these obligations. In this case, 

the RIC generally may designate a dividend it pays as an exemptinterest dividend to the extent that the RIC has tax-exempt interest income. These exempt-interest dividends are treated as interest 

excludable from gross income by the shareholders. 

U.S. source investment income of foreign persons 

In general 

The United States generally imposes a flat 30-cent tax, collected by withholding, on the gross amount of U.S.-source investment income payments, such as interest, dividends, rents, royalties 

337 

or similar types of income, to nonresident alien individuals and foreign corporations (‘‘foreign persons’’) (secs. 871(a), 881, 1441, and 

1442). Under treaties, the United States may reduce or eliminate 

such taxes. Even taking into account U.S. treaties, however, the 

tax on a dividend generally is not entirely eliminated. Instead, 

U.S.-source portfolio investment dividends received by foreign persons generally are subject to U.S. withholding tax at a rate of at 

least 15 percent. 

Interest 

Although payments of U.S.-source interest that is not effectively connected with a U.S. trade or business generally are subject 

to the 30-cent withholding tax, there are exceptions to that rule. 

For example, interest from certain deposits with banks and other 

financial institutions is exempt from tax (secs. 871(i)(2)(A) and 

881(d)). Original issue discount on obligations maturing in 183 

days or less from the date of original issue (without regard to the 

period held by the taxpayer) is also exempt from tax (sec. 871(g)). 

An additional exception is provided for certain interest paid on 

portfolio obligations (secs. 871(h) and 881(c)). ‘‘Portfolio interest’’ 

generally is defined as any U.S.-source interest (including original 

issue discount), not effectively connected with the conduct of a U.S. 

trade or business, (i) on an obligation that satisfies certain registration requirements or specified exceptions thereto (i.e., the obligation is ‘‘foreign targeted’’), and (ii) that is not received by a 10-cent 

shareholder (secs. 871(h)(3) and 881(c)(3)). With respect to a registered obligation, a statement that the beneficial owner is not a 

U.S. person is required (secs. 871(h)(2), (5) and 881(c)(2)). This exception is not available for any interest received either by a bank 

on a loan extended in the ordinary course of its business (except 

in the case of interest paid on an obligation of the United States), 

or by a controlled foreign corporation from a related person (sec. 

881(c)(3)). Moreover, this exception is not available for certain contingent interest payments (secs. 871(h)(4) and 881(c)(4)). 

Capital gains 

Foreign persons generally are not subject to U.S. tax on gain 

realized on the disposition of stock or securities issued by a U.S. 

person (other than a ‘‘U.S. real property holding corporation,’’ as 

described below), unless the gain is effectively connected with the 

conduct of a trade or business in the United States. This exemption 

does not apply, however, if the foreign person is a nonresident alien 

individual present in the United States for a period or periods aggregating 183 days or more during the taxable year (sec. 871(a)(2)). 

A RIC may elect not to withhold on a distribution to a foreign person representing a capital gain dividend. (Treas. Reg. sec. 1.1441– 

3(c)(2)(D)). 

Gain or loss of a foreign person from the disposition of a U.S. 

real property interest is subject to net basis tax as if the taxpayer 

were engaged in a trade or business within the United States and 

the gain or loss were effectively connected with such trade or business (sec. 897). In addition to an interest in real property located 

in the United States or the Virgin Islands, U.S. real property interests include (among other things) any interest in a domestic corVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00341 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
338 

148The Economic Growth and Tax Relief Reconciliation Act of 2001 (‘‘EGTRRA’’) repealed the 

estate tax for estates of decedents dying after December 31, 2009. However, EGTRRA included 

a ‘‘sunset’’ provision, pursuant to which EGTRRA’s provisions (including estate tax repeal) do 

not apply to estates of decedents dying after December 31, 2010. 

poration unless the taxpayer establishes that the corporation was 

not, during a 5-year period ending on the date of the disposition 

of the interest, a U.S. real property holding corporation (which is 

defined generally to mean a corporation the fair market value of 

whose U.S. real property interests equals or exceeds 50 percent of 

the sum of the fair market values of its real property interests and 

any other of its assets used or held for use in a trade or business). 

Estate taxation 

Decedents who were citizens or residents of the United States 

are generally subject to Federal estate tax on all property, wherever situated.148 Nonresidents who are not U.S. citizens, however, 

are subject to estate tax only on their property which is within the 

United States. Property within the United States generally includes debt obligations of U.S. persons, including the Federal government and State and local governments (sec. 2104(c)), but does 

not include either bank deposits or portfolio obligations, the interest on which would be exempt from U.S. income tax under section 

871 (sec. 2105(b)). Stock owned and held by a nonresident who is 

not a U.S. citizen is treated as property within the United States 

only if the stock was issued by a domestic corporation (sec. 2104(a); 

Treas. Reg. sec. 20.2104–1(a)(5)). 

Treaties may reduce U.S. taxation on transfers by estates of 

nonresident decedents who are not U.S. citizens. Under recent treaties, for example, U.S. tax may generally be eliminated except insofar as the property transferred includes U.S. real property or business property of a U.S. permanent establishment. 

HOUSE BILL

In general 

Under the House bill, a RIC that earns certain interest income 

that would not be subject to U.S. tax if earned by a foreign person 

directly may, to the extent of such income, designate a dividend it 

pays as derived from such interest income. A foreign person who 

is a shareholder in the RIC generally would treat such a dividend 

as exempt from gross-basis U.S. tax, as if the foreign person had 

earned the interest directly. Similarly, a RIC that earns an excess 

of net short-term capital gains over net long-term capital losses, 

which excess would not be subject to U.S. tax if earned by a foreign 

person, generally may, to the extent of such excess, designate a dividend it pays as derived from such excess. A foreign person who is 

a shareholder in the RIC generally would treat such a dividend as 

exempt from gross-basis U.S. tax, as if the foreign person had realized the excess directly. The House bill also provides that the estate of a foreign decedent is exempt from U.S. estate tax on a 

transfer of stock in the RIC in the proportion that the assets held 

by the RIC are debt obligations, deposits, or other property that 

would generally be treated as situated outside the United States if 

held directly by the estate. 

339 

Interest-related dividends 

Under the House bill, a RIC may, under certain circumstances, 

designate all or a portion of a dividend as an ‘‘interest-related dividend,’’ by written notice mailed to its shareholders not later than 

60 days after the close of its taxable year. In addition, an interestrelated dividend received by a foreign person generally is exempt 

from U.S. gross-basis tax under sections 871(a), 881, 1441 and 

1442. 

However, this exemption does not apply to a dividend on 

shares of RIC stock if the withholding agent does not receive a 

statement, similar to that required under the portfolio interest 

rules, that the beneficial owner of the shares is not a U.S. person. 

The exemption does not apply to a dividend paid to any person 

within a foreign country (or dividends addressed to, or for the account of, persons within such foreign country) with respect to 

which the Treasury Secretary has determined, under the portfolio 

interest rules, that exchange of information is inadequate to prevent evasion of U.S. income tax by U.S. persons. 

In addition, the exemption generally does not apply to dividends paid to a controlled foreign corporation to the extent such 

dividends are attributable to income received by the RIC on a debt 

obligation of a person with respect to which the recipient of the dividend (i.e., the controlled foreign corporation) is a related person. 

Nor does the exemption generally apply to dividends to the extent 

such dividends are attributable to income (other than short-term 

original issue discount or bank deposit interest) received by the 

RIC on indebtedness issued by the RIC-dividend recipient or by 

any corporation or partnership with respect to which the recipient 

of the RIC dividend is a 10-percent shareholder. However, in these 

two circumstances the RIC remains exempt from its withholding 

obligation unless the RIC knows that the dividend recipient is such 

a controlled foreign corporation or 10-percent shareholder. To the 

extent that an interest-related dividend received by a controlled 

foreign corporation is attributable to interest income of the RIC 

that would be portfolio interest if received by a foreign corporation, 

the dividend is treated as portfolio interest for purposes of the de 

minimis rules, the high-tax exception, and the same country exceptions of subpart F (see sec. 881(c)(5)(A)). 

The aggregate amount designated as interest-related dividends 

for the RIC’s taxable year (including dividends so designated that 

are paid after the close of the taxable year but treated as paid during that year as described in section 855) generally is limited to the 

qualified net interest income of the RIC for the taxable year. The 

qualified net interest income of the RIC equals the excess of: (1) 

the amount of qualified interest income of the RIC; over (2) the 

amount of expenses of the RIC properly allocable to such interest 

income. 

Qualified interest income of the RIC is equal to the sum of its 

U.S.-source income with respect to: (1) bank deposit interest; (2) 

short term original issue discount that is currently exempt from 

the gross-basis tax under section 871; (3) any interest (including 

amounts recognized as ordinary income in respect of original issue 

discount, market discount, or acquisition discount under the provisions of sections 1271–1288, and such other amounts as regulations 

340 

may provide) on an obligation which is in registered form, unless 

it is earned on an obligation issued by a corporation or partnership 

in which the RIC is a 10-percent shareholder or is contingent interest not treated as portfolio interest under section 871(h)(4); and (4) 

any interest-related dividend from another RIC. 

If the amount designated as an interest-related dividend is 

greater than the qualified net interest income described above, the 

portion of the distribution so designated which constitutes an interest-related dividend will be only that proportion of the amount so 

designated as the amount of the qualified net interest income bears 

to the amount so designated. 

Short-term capital gain dividends 

Under the House bill, a RIC also may, under certain circumstances, designate all or a portion of a dividend as a ‘‘shortterm capital gain dividend,’’ by written notice mailed to its shareholders not later than 60 days after the close of its taxable year. 

For purposes of the U.S. gross-basis tax, a short-term capital gain 

dividend received by a foreign person generally is exempt from U.S. 

gross-basis tax under sections 871(a), 881, 1441 and 1442. This exemption does not apply to the extent that the foreign person is a 

nonresident alien individual present in the United States for a period or periods aggregating 183 days or more during the taxable 

year. However, in this circumstance the RIC remains exempt from 

its withholding obligation unless the RIC knows that the dividend 

recipient has been present in the United States for such period. 

The aggregate amount qualified to be designated as short-term 

capital gain dividends for the RIC’s taxable year (including dividends so designated that are paid after the close of the taxable 

year but treated as paid during that year as described in sec. 855) 

is equal to the excess of the RIC’s net short-term capital gains over 

net long-term capital losses. The short-term capital gain includes 

short-term capital gain dividends from another RIC. As provided 

under present law for purposes of computing the amount of a capital gain dividend, the amount is determined (except in the case 

where an election under sec. 4982(e)(4) applies) without regard to 

any net capital loss or net short-term capital loss attributable to 

transactions after October 31 of the year. Instead, that loss is 

treated as arising on the first day of the next taxable year. To the 

extent provided in regulations, this rule also applies for purposes 

of computing the taxable income of the RIC. 

In computing the amount of short-term capital gain dividends 

for the year, no reduction is made for the amount of expenses of 

the RIC allocable to such net gains. In addition, if the amount designated as short-term capital gain dividends is greater than the 

amount of qualified short-term capital gain, the portion of the distribution so designated which constitutes a short-term capital gain 

dividend is only that proportion of the amount so designated as the 

amount of the excess bears to the amount so designated. 

As under present law for distributions from REITs, the House 

bill provides that any distribution by a RIC to a foreign person 

shall, to the extent attributable to gains from sales or exchanges 

by the RIC of an asset that is considered a U.S. real property interest, be treated as gain recognized by the foreign person from the 

341 

sale or exchange of a U.S. real property interest. The House bill 

also extends the special rules for domestically-controlled REITs to 

domestically-controlled RICs. 

Estate tax treatment 

Under the House bill, a portion of the stock in a RIC held by 

the estate of a nonresident decedent who is not a U.S. citizen is 

treated as property without the United States. The portion so 

treated is based upon the proportion of the assets held by the RIC 

at the end of the quarter immediately preceding the decedent’s 

death (or such other time as the Secretary may designate in regulations) that are ‘‘qualifying assets’’. Qualifying assets for this purpose are bank deposits of the type that are exempt from gross-basis 

income tax, portfolio debt obligations, certain original issue discount obligations, debt obligations of a domestic corporation that 

are treated as giving rise to foreign source income, and other property not within the United States. 

Effective date 

The House bill provision generally applies to dividends with respect to taxable years of RICs beginning after December 31, 2004. 

With respect to the treatment of a RIC for estate tax purposes, the 

House bill provision applies to estates of decedents dying after December 31, 2004. With respect to the treatment of RICs under section 897 (relating to U.S. real property interests), the House bill 

provision is effective after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except the 

conference agreement only applies: (1) to dividends with respect to 

taxable years of RICs beginning after December 31, 2004 and before January 1, 2008; (2) with respect to the treatment of a RIC 

for estate tax purposes, to estates of decedents dying after December 31, 2004 and before January 1, 2008; and (3) with respect to 

the treatment of RICs under section 897 (relating to U.S. real property interests), after December 31, 2004 and before January 1, 

2008. 

7. Taxation of certain settlement funds (sec. 287 of the House bill 

and sec. 468B of the Code) 

PRESENT LAW

In general, section 468B provides that a payment to a designated settlement fund that extinguishes a tort liability of the taxpayer will result in a deduction to the taxpayer. A designated settlement fund means a fund which is established pursuant to a 

court order, extinguishes the taxpayer’s tort liability, is managed 

and controlled by persons unrelated to the taxpayer, and in which 

the taxpayer does not have a beneficial interest in the trust. 

Generally, a designated or qualified settlement fund is taxed 

as a separate entity at the maximum trust rate on its modified inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00345 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
342 

come. Modified income is generally gross income less deductions for 

administrative costs and other incidental expenses incurred in connection with the operation of the settlement fund. 

The cleanup of hazardous waste sites is sometimes funded by 

environmental ‘‘settlement funds’’ or escrow accounts. These escrow 

accounts are established in consent decrees between the Environmental Protection Agency (‘‘EPA’’) and the settling parties under 

the jurisdiction of a Federal district court. The EPA uses these accounts to resolve claims against private parties under Comprehensive Environmental Response, Compensation and Liability Act of 

1980 (‘‘CERCLA’’). 

Present law provides that nothing in any provision of law is to 

be construed as providing that an escrow account, settlement fund, 

or similar fund is not subject to current income tax. 

HOUSE BILL

The House bill provides that certain settlement funds established in consent decrees for the sole purpose of resolving claims 

under CERCLA are to be treated as beneficially owned by the 

United States government and therefore not subject to Federal income tax. 

To qualify the settlement fund must be: (1) established pursuant to a consent decree entered by a judge of a United States District Court; (2) created for the receipt of settlement payments for 

the sole purpose of resolving claims under CERCLA; (3) controlled 

(in terms of expenditures of contributions and earnings thereon) by 

the government or an agency or instrumentality thereof; and (4) 

upon termination, any remaining funds will be disbursed to such 

government entity and used in accordance with applicable law. For 

purposes of the provision, a government entity means the United 

States, any State of political subdivision thereof, the District of Columbia, any possession of the United States, and any agency or instrumentality of the foregoing. 

Effective date.—The House bill provision is effective for taxable 

years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

8. Expand human clinical trials expenses qualifying for the orphan 

drug tax credit (sec. 288 of the House bill and sec. 45C of the 

Code) 

PRESENT LAW

Taxpayers may claim a 50-percent credit for expenses related 

to human clinical testing of drugs for the treatment of certain rare 

diseases and conditions, generally those that afflict less than 

200,000 persons in the United States. Qualifying expenses are 

those paid or incurred by the taxpayer after the date on which the 

drug is designated as a potential treatment for a rare disease or 

343 

149Sec. 4161(b)(1)(A). 150Sec. 4161(b)(2). 151Sec. 4161(b)(1)(B). 

disorder by the Food and Drug Administration (‘‘FDA’’) in accordance with section 526 of the Federal Food, Drug, and Cosmetic Act. 

HOUSE BILL

The House bill expands qualifying expenses to include those 

expenses related to human clinical testing paid or incurred after 

the date on which the taxpayer files an application with the FDA 

for designation of the drug under section 526 of the Federal Food, 

Drug, and Cosmetic Act as a potential treatment for a rare disease 

or disorder, if certain conditions are met. Under the provision, 

qualifying expenses include those expenses paid or incurred after 

the date on which the taxpayer files an application with the FDA 

for designation as a potential treatment for a rare disease or disorder, if the drug receives FDA designation before the due date (including extensions) for filing the tax return for the taxable year in 

which the application was filed with the FDA. As under present 

law, the credit may only be claimed for such expenses related to 

drugs designated as a potential treatment for a rare disease or disorder by the FDA in accordance with section 526 of such Act. 

Effective date.—The provision is effective for expenditures paid 

or incurred after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

9. Simplification of excise tax imposed on bows and arrows (sec. 

289 of the House bill, sec. 305 of the Senate amendment, and 

sec. 4161 of the Code) 

PRESENT LAW

The Code imposes an excise tax of 11 percent on the sale by 

a manufacturer, producer or importer of any bow with a draw 

weight of 10 pounds or more.149 An excise tax of 12.4 percent is imposed on the sale by a manufacturer or importer of any shaft, 

point, nock, or vane designed for use as part of an arrow which 

after its assembly (1) is over 18 inches long, or (2) is designed for 

use with a taxable bow (if shorter than 18 inches).150 No tax is imposed on finished arrows. An 11-percent excise tax also is imposed 

on any part of an accessory for taxable bows and on quivers for use 

with arrows (1) over 18 inches long or (2) designed for use with a 

taxable bow (if shorter than 18 inches).151

HOUSE BILL

The provision increases the draw weight for a taxable bow 

from 10 pounds or more to a peak draw weight of 30 pounds or 

344 

152Draw weight is the maximum force required to bring the bowstring to a full-draw position 

not less than 261⁄4 inches, measured from the pressure point of the hand grip to the nocking 

position on the bowstring. 153 A credit or refund may be obtained when an item was taxed and it is used in the manufacture or production of another taxable item. Sec. 6416(b)(3). As arrow components and finished 

arrows are both taxable, in lieu of a refund of the tax paid on components, the provision suspends the application of sec. 6416(b)(3) and permits the taxpayer to reduce the tax due on the 

finished arrow by the amount of the previous tax paid on the components used in the manufacture of such arrow. 

more.152 The provision also imposes an excise tax of 12 percent on 

arrows generally. An arrow for this purpose is defined as a taxable 

arrow shaft to which additional components are attached. The 

present law 12.4-percent excise tax on certain arrow components is 

unchanged by the bill. In the case of any arrow comprised of a 

shaft or any other component upon which tax has been imposed, 

the amount of the arrow tax is equal to the excess of (1) the arrow 

tax that would have been imposed but for this exception, over (2) 

the amount of tax paid with respect to such components.153 Finally, 

the provision subjects certain broadheads (a type of arrow point) to 

an excise tax equal to 11 percent of the sales price instead of 12.4 

percent. 

Effective date.—The provision is effective for articles sold by 

the manufacturer, producer or importer after December 31, 2004. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

Effective date.—The provision is effective for articles sold by 

the manufacturer, producer or importer 30 days after the date of 

enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment with the effective date of the Senate amendment. 

Effective date.—The conference agreement follows the Senate 

amendment. 

10. Reduce rate of excise tax on fishing tackle boxes to three percent (sec. 290 of the House bill and sec. 4162 of the Code) 

PRESENT LAW

A 10-percent manufacturer’s excise tax is imposed on specified 

sport fishing equipment. Examples of taxable equipment include 

fishing rods and poles, fishing reels, artificial bait, fishing lures, 

line and hooks, and fishing tackle boxes. Revenues from the excise 

tax on sport fishing equipment are deposited in the Sport Fishing 

Account of the Aquatic Resources Trust Fund. Monies in the fund 

are spent, subject to an existing permanent appropriation, to support Federal-State sport fish enhancement and safety programs. 

HOUSE BILL

The provision repeals the excise tax on fishing tackle boxes. 

Effective date.—The provision is effective for articles sold by 

the manufacturer, producer, or importer after December 31, 2004. 

345 

154Sec. 4161(a)(1). 155Sec. 4161(a)(2). 156Sec. 4162(b). 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with modifications. Under the provision as modified, the rate of excise tax imposed on fishing tackle boxes is reduced to three percent. 

11. Repeal of excise tax on sonar devices suitable for finding fish 

(sec. 291 of the House bill and secs. 4161 and 4162 of the Code) 

PRESENT LAW

In general, the Code imposes a 10-percent tax on the sale by 

the manufacturer, producer, or importer of specified sport fishing 

equipment.154 A three percent rate, however, applies to the sale of 

electric outboard motors and sonar devices suitable for finding 

fish.155 Further, the tax imposed on the sale of sonar devices suit- able for finding fish is limited to $30. A sonar device suitable for 

finding fish does not include any device that is a graph recorder, 

a digital type, a meter readout, a combination graph recorder or 

combination meter readout.156

Revenues from the excise tax on sport fishing equipment are 

deposited in the Sport Fishing Account of the Aquatic Resources 

Trust Fund. Monies in the fund are spent, subject to an existing 

permanent appropriation, to support Federal-State sport fish enhancement and safety programs. 

HOUSE BILL

The provision repeals the excise tax on all sonar devices suitable for finding fish. 

Effective date.—The provision is effective for articles sold by 

the manufacturer, producer, or importer after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

12. Income tax credit for cost of carrying tax-paid distilled spirits 

in wholesale inventories (sec. 292 of the House bill) 

PRESENT LAW

As is true of most major Federal excise taxes, the excise tax 

on distilled spirits is imposed at a point in the chain of distribution 

before the product reaches the retail (consumer) level. Tax on domestically produced and/or bottled distilled spirits arises upon production (receipt) in a bonded distillery and is collected based on removals from the distillery during each semi-monthly period. Distilled spirits that are bottled before importation into the United 

346 

157Distilled spirits that are imported in bulk and then bottled domestically qualify as domestically bottled distilled spirits. 

States are taxed on removal from the first U.S. warehouse where 

they are landed (including a warehouse located in a foreign trade 

zone). 

No tax credits are allowed under present law for business costs 

associated with having tax-paid products in inventory. Rather, excise tax that is included in the purchase price of a product is treated the same as the other components of the product cost, i.e., deductible as a cost of goods sold. 

HOUSE BILL

The provision creates a new income tax credit for eligible 

wholesale distributors of distilled spirits. An eligible wholesaler is 

any person who holds a permit under the Federal Alcohol Administration Act as a wholesaler of distilled spirits. 

The credit is calculated by multiplying the number of cases of 

bottled distilled spirits by the average tax-financing cost per case 

for the most recent calendar year ending before the beginning of 

such taxable year. A case is 12 80-proof 750-milliliter bottles. The 

average tax-financing cost per case is the amount of interest that 

would accrue at corporate overpayment rates during an assumed 

60-day holding period on an assumed tax rate of $22.83 per case 

of 12 750-milliliter bottles. 

The credit only applies to domestically bottled distilled spirits 157 purchased directly from the bottler of such spirits. The credit 

is in addition to present-law rules allowing tax included in inventory costs to be deducted as a cost of goods sold. 

The credit cannot be carried back to a taxable year beginning 

before January 1, 2005. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

13. Suspension of occupational taxes relating to distilled spirits, 

wine, and beer (sec. 293 of the House bill and new sec. 5148 

of the Code) 

PRESENT LAW

Under present law, special occupational taxes are imposed on 

producers and others engaged in the marketing of distilled spirits, 

wine, and beer. These excise taxes are imposed as part of a broader 

Federal tax and regulatory engine governing the production and 

marketing of alcoholic beverages. The special occupational taxes 

are payable annually, on July 1 of each year. The present tax rates 

are as follows: 

347 

158 A reduced rate of tax in the amount of $500 is imposed on small proprietors. Secs. 5081(b), 

5091(b). 159Secs. 5114, 5124. 160Sec. 5146. 161Sec. 5603. 162Sec. 5117. For example, purchases from a proprietor of a distilled spirits plant at his principal business office would be covered under item (2) since such a proprietor is not subject to 

the special occupational tax on account of sales at his principal business office. Sec. 5113(a). 

Purchases from a State-operated liquor store would be covered under item (3). Sec. 5113(b). 163Sec. 5117(b). 164Sec. 5687. 165Sec. 7302. 

Producers: 158

Distilled spirits and wines (sec. 5081) ............. $1,000 per year, per 

premise. 

Brewers (sec. 5091) ............................................ $1,000 per year, per 

premise. 

Wholesale dealers (sec. 5111): Liquors, wines, or beer $500 per year. 

Retail dealers (sec. 5121): Liquors, wines, or beer ........ $250 per year. 

Nonbeverage use of distilled spirits (sec. 5131) ............. $500 per year. 

Industrial use of distilled spirits (sec. 5276) .................. $250 per year. 

The Code requires every wholesale or retail dealer in liquors, 

wine or beer to keep records of their transactions.159 A delegate of 

the Secretary of the Treasury is authorized to inspect the records 

of any dealer during business hours.160 There are penalties for failing to comply with the recordkeeping requirements.161

The Code limits the persons from whom dealers may purchase 

their liquor stock intended for resale. Under the Code, a dealer 

may only purchase from: 

(1) A wholesale dealer in liquors who has paid the special occupational tax as such dealer to cover the place where such purchase 

is made; or 

(2) A wholesale dealer in liquors who is exempt, at the place 

where such purchase is made, from payment of such tax under any 

provision chapter 51 of the Code; or 

(3) A person who is not required to pay special occupational tax 

as a wholesale dealer in liquors.162

In addition, a limited retail dealer (such as a charitable organization selling liquor at a picnic) may lawfully purchase distilled 

spirits for resale from a retail dealer in liquors.163

Violation of this restriction is punishable by $1,000 fine, imprisonment of one year, or both.164 A violation also makes the alcohol subject to seizure and forfeiture.165

HOUSE BILL

Under the provision, the special occupational taxes on producers and marketers of alcoholic beverages are suspended for a 

three-year period, July 1, 2004 through June 30, 2007. Present law 

recordkeeping and registration requirements continue to apply, 

notwithstanding the suspension of the special occupation taxes. In 

addition, during the suspension period, it shall be unlawful for any 

dealer to purchase distilled spirits for resale from any person other 

than a wholesale dealer in liquors who is subject to the recordkeeping requirements, except that a limited retail dealer may purchase distilled spirits for resale from a retail dealer in liquors, as 

permitted under present law. 

348 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill except as follows. Under the provision as modified, the three-year suspension 

period is July 1, 2005 through June 30, 2008. 

14. Modification of unrelated business income limitation on investment in certain small business investment companies (sec. 294 

of the House bill, sec. 642 of the Senate amendment, and sec. 

514 of the Code) 

PRESENT LAW

In general, an organization that is otherwise exempt from Federal income tax is taxed on income from a trade or business regularly carried on that is not substantially related to the organization’s exempt purposes. Certain types of income, such as rents, royalties, dividends, and interest, generally are excluded from unrelated business taxable income except when such income is derived 

from ‘‘debt-financed property.’’ Debt-financed property generally 

means any property that is held to produce income and with respect to which there is acquisition indebtedness at any time during 

the taxable year. 

In general, income of a tax-exempt organization that is produced by debt-financed property is treated as unrelated business 

income in proportion to the acquisition indebtedness on the incomeproducing property. Acquisition indebtedness generally means the 

amount of unpaid indebtedness incurred by an organization to acquire or improve the property and indebtedness that would not 

have been incurred but for the acquisition or improvement of the 

property. Acquisition indebtedness does not include, however, (1) 

certain indebtedness incurred in the performance or exercise of a 

purpose or function constituting the basis of the organization’s exemption, (2) obligations to pay certain types of annuities, (3) an obligation, to the extent it is insured by the Federal Housing Administration, to finance the purchase, rehabilitation, or construction of 

housing for low and moderate income persons, or (4) indebtedness 

incurred by certain qualified organizations to acquire or improve 

real property. 

Special rules apply in the case of an exempt organization that 

owns a partnership interest in a partnership that holds debt-financed income-producing property. An exempt organization’s share 

of partnership income that is derived from such debt-financed property generally is taxed as debt-financed income unless an exception 

provides otherwise. 

HOUSE BILL

The House bill modifies the debt-financed property provisions 

by excluding from the definition of acquisition indebtedness any indebtedness incurred by a small business investment company liVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00352 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
349 

censed under the Small Business Investment Act of 1958 that is 

evidenced by a debenture (1) issued by such company under section 

303(a) of said Act, and (2) held or guaranteed by the Small Business Administration. The exclusion shall not apply during any period that any exempt organization (other than a governmental unit) 

owns more than 25 percent of the capital or profits interest in the 

small business investment company, or exempt organizations (including governmental units other than any agency or instrumentality of the United States) own, in the aggregate, 50 percent or 

more of the capital or profits interest in such company. 

Effective date.—The provision is effective for small business investment companies formed after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill except 

that the Senate amendment does not contain any individual or aggregate ownership percentage limitations with respect to exempt 

organizations or government units. 

Effective date.—The provision is effective for acquisitions made 

on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, modified to 

apply to small business investment companies licensed after (rather than formed after) the date of enactment. 

Effective date.—The conference agreement provision is effective 

for debt incurred after the date of enactment by small business investment companies licensed after the date of enactment. 

15. Election to determine taxable income from certain international 

shipping activities using per ton rate (sec. 295 of the House bill 

and new secs. 1352–1359 of the Code) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, including income from shipping operations, whether derived in the 

United States or abroad. In order to mitigate double taxation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce or eliminate the U.S. tax owed on such income, 

subject to certain limitations. 

Generally, the United States taxes foreign corporations only on 

income that has a sufficient nexus to the United States. Thus, a 

foreign corporation is generally subject to U.S. tax only on income, 

including income from shipping operations, which is ‘‘effectively 

connected’’ with the conduct of a trade or business in the United 

States (sec. 882). Such ‘‘effectively connected income’’ generally is 

taxed in the same manner and at the same rates as the income of 

a U.S. corporation. 

The United States imposes a four percent tax on the amount 

of a foreign corporation’s U.S. gross transportation income (sec. 

887). Transportation income includes income from the use (or hiring or leasing for use) of a vessel and income from services directly 

related to the use of a vessel. Fifty percent of the transportation 

350 

166The ‘‘corporate income percentage’’ is the least aggregate share, expressed as a percentage, 

of any item of income or gain of an electing corporation, or an electing group (i.e., a controlled 

group of which one or more members is an electing entity) of which such corporation is a member from qualifying shipping activities that would otherwise be required to be reported on the 

U.S. Federal income tax return of an electing corporation during any taxable period. A ‘‘controlled group’’ is any group of trusts and business entities whose members would be treated as 

a single employer under the rules of section 52(a) (without regard to paragraphs (1) and (2)) 

and section 52(b)(1)). 167The ‘‘daily notional taxable income’’ from the operation of a qualifying vessel is 40 cents 

for each 100 tons of the net tonnage of the vessel (up to 25,000 net tons), and 20 cents for each 

100 tons of the net tonnage of the vessel, in excess of 25,000 net tons. 168 ‘‘U.S. foreign trade’’ means the transportation of goods or passengers between a place in 

the United States and a foreign place or between foreign places. As a general rule, the temporary operation in the U.S. domestic trade (i.e., the transportation of goods or passengers between places in the United States) of any qualifying vessel is disregarded. However, a vessel 

income attributable to transportation that either begins or ends 

(but not both) in the United States is treated as U.S. source gross 

transportation income. The tax does not apply, however, to U.S. 

gross transportation income that is treated as income effectively 

connected with the conduct of a U.S. trade or business. U.S. gross 

transportation income is not treated as effectively connected income unless (1) the taxpayer has a fixed place of business in the 

United States involved in earning the income, and (2) substantially 

all the income is attributable to regularly scheduled transportation. 

The taxes imposed by section 882 and 887 on income from 

shipping operations may be limited by an applicable U.S. income 

tax treaty or by an exemption of a foreign corporation’s international shipping operations income in instances where a foreign 

country grants an equivalent exemption (sec. 883). 

Under present law, there is no provision that provides an alternative to the corporate income tax for taxable income attributable 

to international shipping activities. 

HOUSE BILL

In general 

The provision generally allows corporations to elect a ‘‘tonnage 

tax’’ on their taxable income from certain shipping activities in lieu 

of the U.S. corporate income tax. Accordingly, a corporation’s income from qualifying shipping activities is no longer taxable under 

sections 11, 55, 882, 887 or 1201(a) under the regime, and electing 

entities are only subject to tax at the maximum corporate income 

tax rate on a notional amount based on the net tonnage of a corporation’s qualifying vessels. However, a foreign corporation is not 

subject to tax under the tonnage tax regime to the extent its income from qualifying shipping activities is subject to an exclusion 

for certain shipping operations by foreign corporations pursuant to 

section 883(a)(1) or pursuant to a treaty obligation of the United 

States. 

Taxable income from qualifying shipping activities 

Generally, the taxable income of an electing corporation from 

qualifying shipping activities is the corporate income percentage 166

of the sum of the taxable income from each of its qualifying vessels. 

The taxable income from each qualifying vessel is the product of (1) 

the daily notional taxable income 167 from the operation of the 

qualifying vessel in United States foreign trade,168 and (2) the 

351 

that is no longer used for operations in U.S. foreign trade (unless such non-use is on a temporary basis) ceases to be a qualifying vessel when such non-use begins. 169 If there are multiple operators of a vessel, the taxable income of such vessel must be allocated among such persons on the basis of their ownership and charter interests or another basis 

that Treasury may prescribe in regulations. 170 ‘‘Qualifying shipping assets’’ means any qualifying vessel and other assets which are used 

in core qualifying activities. 171 ‘‘Corporate loss percentage’’ means the greatest aggregate share, expressed as a percentage, of any item of loss, deduction or credit of an electing corporation or electing group of which 

such corporation is a member from qualifying shipping activities that would otherwise be required to be reported on the U.S. Federal income tax return of an electing corporation during 

any taxable period. 

number of days during the taxable year that the electing entity operated such vessel as a qualifying vessel in U.S. foreign trade.169

A ‘‘qualifying vessel’’ is described as a self-propelled U.S.-flag vessel 

of not less than 10,000 deadweight tons used in U.S. foreign trade. 

An entity’s qualifying shipping activities consist of its (1) core 

qualifying activities, (2) qualifying secondary activities, and (3) 

qualifying incidental activities. Generally, core qualifying activities 

are activities from operating vessels in U.S. foreign trade and other 

activities of an electing entity and an electing group that are an integral part of the business of operating qualifying vessels in U.S. 

foreign trade. Qualifying secondary activities generally consist of 

the active management or operation of vessels in U.S. foreign trade 

and provisions for vessel, container and cargo-related facilities or 

such other activities as may be prescribed by the Secretary (which 

are not core activities), and may not exceed 20 percent of the aggregate gross income derived from electing entities and other members 

of its electing group from their core qualifying activities. Qualifying 

incidental activities are activities that are incidental to core qualifying activities and are not qualifying secondary activities. The aggregate gross income from qualifying incidental activities cannot 

exceed one-tenth of one percent of the aggregate gross income from 

the core qualifying activities of the electing entities and other 

members of its electing group. 

Items not subject to corporate income tax 

Generally, gross income from an electing entity does not include the corporate income percentage of an entity’s (1) income 

from qualifying shipping activities in U.S. foreign trade, (2) income 

from money, bank deposits and other temporary investments which 

are reasonably necessary to meet the working capital requirements 

of its qualifying shipping activities, and (3) income from money or 

other intangible assets accumulated pursuant to a plan to purchase 

qualifying shipping assets.170 Generally, the corporate loss percentage 171 of each item of loss, deduction, or credit is disallowed with 

respect to any activity the income from which is excluded from 

gross income under the provision. The corporate loss percentage of 

an electing entity’s interest expense is disallowed in the ratio that 

the fair market value of its qualifying shipping assets bears to the 

fair market value of its total assets. 

Allocation of credits, income, and deductions 

No deductions are allowed against the taxable income of an 

electing corporation from qualifying shipping activities, and no 

credit is allowed against the tax imposed under the tonnage tax reVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00355 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
352 

gime. No deduction is allowed for any net operating loss attributable to the qualifying shipping activities of a corporation to the 

extent that such loss is carried forward by the corporation from a 

taxable year preceding the first taxable year for which such corporation was an electing corporation. For purposes of the provision, 

section 482 applies to a transaction or series of transactions between an electing entity and another person or between an entity’s 

qualifying shipping activities and other activities carried on by it. 

The qualifying shipping activities of an electing entity shall be 

treated as a separate trade or business activity from all other activities conducted by the entity. 

Qualifying shipping assets 

If an electing entity sells or disposes of qualifying shipping assets in an otherwise taxable transaction, at the election of the entity no gain is recognized if replacement qualifying shipping assets 

are acquired during a limited replacement period except to the extent that the amount realized upon such sale or disposition exceeds 

the cost of the replacement qualifying shipping assets. In the case 

of replacement qualifying shipping assets purchased by an electing 

entity which results in the nonrecognition of any part of the gain 

realized as the result of a sale or other disposition of qualifying 

shipping assets, the basis is the cost of such replacement property 

decreased in the amount of gain not recognized. If the property 

purchased consists of more than one piece of property, the basis is 

allocated to the purchased properties in proportion to their respective costs. 

The election not to recognize gain on the disposition and replacement of qualifying shipping assets is not available if the replacement qualifying shipping assets are acquired from a related 

person except to the extent that the related person (as defined 

under section 267(b) or 707(b)(1)) acquired the replacement qualifying shipping assets from an unrelated person during a limited replacement period. 

Election 

Generally, any qualifying entity may elect into the tonnage tax 

regime by filing an election with the qualifying entity’s income tax 

return for the first taxable year to which the election applies. However, a qualifying entity, which is a member of a controlled group, 

may only make an election into the tonnage tax regime if all qualifying entities that are members of the controlled group make such 

an election. Once made, an election is effective for the taxable year 

in which it was made and for all succeeding taxable years of the 

entity until the election is terminated. An election may be terminated if the entity ceases to be a qualifying entity or if the election 

is revoked. In the event that a qualifying entity elects into the tonnage tax regime and subsequently revokes the election, such entity 

is barred from electing back into the regime until the fifth taxable 

year after the termination is effective, unless the Secretary of the 

Treasury consents to the election. 

A qualifying entity means a trust or business entity that (1) 

operates one or more qualifying vessels and (2) meets the ‘‘shipping 

353 

172 An entity is generally treated as operating any vessel owned by or chartered to the entity. 

However, an entity is treated as operating a vessel that it has chartered out on bareboat basis 

only if: (1) the vessel is temporarily surplus to the entity’s requirements and the term of the 

charter does not exceed three years or (2) the vessel is bareboat chartered to a member of a 

controlled group which includes such entity or to an unrelated third party that sub-bareboats 

or time charters the vessel to a member of such controlled group (including the owner). Special 

rules apply in an instance in which an electing entity temporarily ceases to operate a qualifying 

vessel. 173The daily notional shipping income from the operation of a qualifying vessel is 40 cents 

for each 100 tons of the net tonnage of the vessel (up to 25,000 net tons), and 20 cents for each 

100 tons of the net tonnage of the vessel, in excess of 25,000 net tons. 

activity requirement.’’ 172 The shipping activity requirement is met 

for a taxable year only by an entity that meets one of the following 

requirements: (1) in the first taxable year of its election into the 

tonnage tax regime, for the preceding taxable year on average at 

least 25 percent of the aggregate tonnage of the qualifying vessels 

which were operated by the entity were owned by the entity or 

bareboat chartered to the entity; (2) in the second or any subsequent taxable year of its election into the tonnage tax regime, in 

each of the two preceding taxable years on average at least 25 percent of the aggregate tonnage of the qualifying vessels which were 

operated by the entity were owned by the entity or bareboat chartered to the entity; or (3) requirements (1) or (2) above would be 

met if the 25 percent average tonnage requirement was applied on 

an aggregate basis to the controlled group of which such entity is 

a member, and vessel charters between members of the controlled 

group were disregarded. 

Effective date.—The provision is effective for taxable years beginning after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with modifications. 

In general 

The proposal generally allows corporations to elect a ‘‘tonnage 

tax’’ in lieu of the corporate income tax on taxable income from certain shipping activities. Accordingly, an electing corporation’s gross 

income does not include its income from qualifying shipping activities, and electing corporations are only subject to tax on these activities at the maximum corporate income tax rate on their notional 

shipping income, which is based on the net tonnage of the corporation’s qualifying vessels. An electing corporation is treated as a separate trade or business activity distinct from all other activities 

conducted by such corporation. 

Notional shipping income 

An electing corporation’s notional shipping income for the taxable year is the sum of the following amounts for each of the qualifying vessels it operates: (1) the daily notional shipping income 173

from the operation of the qualifying vessel in United States foreign 

354 

174 ‘‘United States foreign trade’’ means the transportation of goods or passengers between a 

place in the United States and a foreign place or between foreign places. The temporary use 

in the United States domestic trade (i.e., the transportation of goods or passengers between 

places in the United States) of any qualifying vessel is deemed to be the use in the United 

States foreign trade of such vessel, if such use does not exceed 30 days in a taxable year. 175Special rules apply in the case of multiple operators of a vessel. 176 An electing group means any group that would be treated as a single employer under subsection (a) or (b) of section 52 if paragraphs (1) and (2) of section 52(a) did not apply. 177 It is intended that the operation of a lighter-aboard-ship be treated as the operation of a 

vessel and not the operation of a barge. 

trade,174 and (2) the number of days during the taxable year that 

the electing corporation operated such vessel as a qualifying vessel 

in United States foreign trade.175 However, in the case of a qualifying vessel any of the income of which is not included in gross income, the amount of notional shipping income from such vessel is 

equal to the notional shipping income from such vessel (determined 

without regard to this provision) that bears the same ratio as the 

gross income from the operation of such vessel in the United States 

foreign trade bears to the sum of such gross income and the income 

so excluded. Generally, a ‘‘qualifying vessel’’ is described as a selfpropelled U.S.-flag vessel of not less than 10,000 deadweight tons 

used exclusively in U.S. foreign trade. 

Items not subject to corporate income tax 

Generally, a corporate member of an electing group 176 does not 

include in gross income its income from qualifying shipping activities. Qualifying shipping activities consist of (1) core qualifying activities, (2) qualifying secondary activities, and (3) qualifying incidental activities. All of an electing entity’s core qualifying activities 

are excluded from gross income. However, only a portion of an 

electing corporation’s secondary and incidental activities are treated as qualifying income and thus, are excluded from gross income. 

Core qualifying activities consist of the operation of qualifying 

vessels.177 Secondary activities generally consist of (1) the active 

management or operation of vessels in U.S. foreign trade; (2) the 

provision of vessels, barge, container or cargo-related facilities or 

services; and (3) other activities of the electing corporation and 

other members of its electing group that are an integral part of its 

business of operating qualifying vessels in United States foreign 

trade. Secondary activities do not include any core qualifying activities. In addition, any activities that would otherwise constitute 

core qualifying activities of a corporation, who is a member of an 

electing group but is not an electing corporation, are treated as 

qualifying secondary activities. Incidental activities are activities 

that are incidental to core qualifying activities and are not qualifying secondary activities. 

Denial of credits, income and deductions 

Each item of loss, deduction, or credit of any taxpayer is disallowed with respect to the income that is excluded from gross income under the proposal. An electing corporation’s interest expense 

is disallowed in the ratio that the fair market value of its qualifying vessels bears to the fair market value of its total assets; special rules apply for disallowing interest expense in the context of 

an electing group. 

355 

178 A person is generally treated as operating and using any vessel owned by or chartered to 

it and that is used as a qualifying vessel during such period. Special rules apply in the case 

of pass-through entities, and special rules apply in an instance in which an electing entity temporarily ceases to operate a qualifying vessel due to dry-docking, surveying, inspection, repairs 

and the like. 

No deductions are allowed against the notional shipping income of an electing corporation, and no credit is allowed against 

the notional tax imposed under the tonnage tax regime. No deduction is allowed for any net operating loss attributable to the qualifying shipping activities of a corporation to the extent that such 

loss is carried forward by the corporation from a taxable year preceding the first taxable year for which such corporation was an 

electing corporation. 

Dispositions of qualifying vessels 

Generally, if an qualifying vessel operator sells or disposes of 

a qualifying vessel in an otherwise taxable transaction, at the election of the operator no gain is recognized if a replacement qualifying vessel is acquired during a limited replacement period except 

to the extent that the amount realized upon such sale or disposition exceeds the cost of the replacement qualifying vessels. Generally, in the case of the replacement of a qualifying vessel that results in the nonrecognition of any part of the gain under the rule 

above, the basis of the replacement vessel is the cost of such replacement property decreased in the amount of gain not recognized. 

Generally, a qualifying vessel operator is a corporation that (1) 

operates one or more qualifying vessels and (2) meets certain requirements with respect to its shipping activities.178 Special rules 

apply in determining whether corporate partners in pass-through 

entities are treated as qualifying vessel operators. 

Election 

Generally, any qualifying vessel operator may elect into the 

tonnage tax regime and such election is made in the form prescribed by Treasury. An election is only effective if made before the 

due date (including extensions) for filing the corporation’s return 

for such taxable year. However, a qualifying vessel operator, which 

is a member of a controlled group, may only make an election into 

the tonnage tax regime if all qualifying vessel operators that are 

members of the controlled group make such an election. Once 

made, an election is effective for the taxable year in which it was 

made and for all succeeding taxable years of the entity until the 

election is terminated. 

Effective date 

The provision is effective for taxable years beginning after the 

date of enactment. 

16. Charitable contribution deduction for certain expenses in support of Native Alaskan subsistence whaling (sec. 296 of the 

House bill and sec. 170 of the Code) 

PRESENT LAW

In computing taxable income, individuals who do not elect the 

standard deduction may claim itemized deductions, including a deVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00359 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
356 

179Treas. Reg. sec. 1.170A–1(g). 

duction (subject to certain limitations) for charitable contributions 

or gifts made during the taxable year to a qualified charitable organization or governmental entity. Individuals who elect the standard 

deduction may not claim a deduction for charitable contributions 

made during the taxable year. 

No charitable contribution deduction is allowed for a contribution of services. However, unreimbursed expenditures made incident to the rendition of services to an organization, contributions 

to which are deductible, may constitute a deductible contribution.179 Specifically, section 170(j) provides that no charitable contribution deduction is allowed for traveling expenses (including 

amounts expended for meals and lodging) while away from home, 

whether paid directly or by reimbursement, unless there is no significant element of personal pleasure, recreation, or vacation in 

such travel. 

HOUSE BILL

The House bill allows individuals to claim a deduction under 

section 170 not exceeding $10,000 per taxable year for certain expenses incurred in carrying out sanctioned whaling activities. The 

deduction is available only to an individual who is recognized by 

the Alaska Eskimo Whaling Commission as a whaling captain 

charged with the responsibility of maintaining and carrying out 

sanctioned whaling activities. The deduction is available for reasonable and necessary expenses paid by the taxpayer during the taxable year for: (1) the acquisition and maintenance of whaling boats, 

weapons, and gear used in sanctioned whaling activities; (2) the 

supplying of food for the crew and other provisions for carrying out 

such activities; and (3) the storage and distribution of the catch 

from such activities. It is intended that the Secretary shall require 

that the taxpayer substantiate deductible expenses by maintaining 

appropriate written records that show, for example, the time, place, 

date, amount, and nature of the expense, as well as the taxpayer’s 

eligibility for the deduction, and that such substantiation be provided as part of the taxpayer’s income tax return, to the extent provided by the Secretary. 

For purposes of the provision, the term ‘‘sanctioned whaling activities’’ means subsistence bowhead whale hunting activities conducted pursuant to the management plan of the Alaska Eskimo 

Whaling Commission. 

Effective date.—The provision is effective for contributions 

made after December 31, 2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the House bill provision, 

modified to provide that the Secretary shall issue guidance regarding substantiation of amounts claimed as deductible whaling expenses. 

357 

I. GENERAL PROVISIONS

1. Modification to qualified small issue bonds (sec. 301 of the Senate amendment and sec. 144 of the Code) 

PRESENT LAW

Qualified small-issue bonds are tax-exempt State and local 

government bonds used to finance private business manufacturing 

facilities (including certain directly related and ancillary facilities) 

or the acquisition of land and equipment by certain farmers. In 

both instances, these bonds are subject to limits on the amount of 

financing that may be provided, both for a single borrowing and in 

the aggregate. In general, no more than $1 million of small-issue 

bond financing may be outstanding at any time for property of a 

business (including related parties) located in the same municipality or county. Generally, this $1 million limit may be increased 

to $10 million if all other capital expenditures of the business in 

the same municipality or county are counted toward the limit over 

a six-year period that begins three years before the issue date of 

the bonds and ends three years after such date. Outstanding aggregate borrowing is limited to $40 million per borrower (including related parties) regardless of where the property is located. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment increases the maximum allowable 

amount of total capital expenditures by an eligible business or a related party in the same municipality or county during the six-year 

measurement period from $10 million to $20 million. As under 

present law, no more than $10 million of bond financing may be 

outstanding at any time for property of an eligible business (including related parties) located in the same municipality or county. 

Other present-law limits (e.g., the $40 million per borrower limit) 

continue to apply. 

Effective date.—The provision is effective for bonds issued after 

the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except with respect to the effective date. The conference agreement 

increases the maximum allowable amount of total capital expenditures by an eligible business (or related party) in the same municipality or county from $10 million to $20 million for bonds issued 

after September 30, 2009. 

Effective date.—The provision is effective for bonds issued after 

September 30, 2009. 

358 

180 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

2. Expensing of investment in broadband equipment (sec. 302 of 

the Senate amendment and new sec. 191 of the Code) 

PRESENT LAW

Under present law, a taxpayer generally must capitalize the 

cost of property used in a trade or business and recover such cost 

over time through annual deductions for depreciation or amortization. Tangible property generally is depreciated under the Modified 

Accelerated Cost Recovery System (MACRS) of section 168, which 

determines depreciation by applying specific recovery periods, 

placed-in-service conventions, and depreciation methods to the cost 

of various types of depreciable property. 

Personal property is classified under MACRS based on the 

property’s ‘‘class life’’ unless a different classification is specifically 

provided in section 168. The class life applicable for personal property is the asset guideline period (midpoint class life as of January 

1, 1986). Based on the property’s classification, a recovery period 

is prescribed under MACRS. In general, there are six classes of recovery periods to which personal property can be assigned. For example, personal property that has a class life of four years or less 

has a recovery period of three years, whereas personal property 

with a class life greater than four years but less than 10 years has 

a recovery period of five years. The class lives and recovery periods 

for most property are contained in Revenue Procedure 87–56.180

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that the taxpayer may elect 

to treat qualified broadband expenditures paid or incurred during 

the one-year period beginning after the date of enactment as a deduction in the taxable year in which the equipment is placed in 

service. 

Qualified expenditures are expenditures incurred with respect 

to equipment with which the taxpayer offers current generation 

broadband services to qualified subscribers. In addition, qualified 

expenditures include qualified expenditures incurred by the taxpayer with respect to qualified equipment with which the taxpayer 

offers next generation broadband services to qualified subscribers. 

Current generation broadband services are defined as the transmission of signals at a rate of at least 1 million bits per second to 

the subscriber and at a rate of at least 128,000 bits per second 

from the subscriber. Next generation broadband services are defined as the transmission of signals at a rate of at least 22 million 

bits per second to the subscriber and at a rate of at least 5 million 

bits per second from the subscriber. 

Qualified subscribers for the purposes of the current generation broadband deduction include nonresidential subscribers in 

rural or underserved areas that are not in a saturated market. A 

saturated market is defined as a census tract in which current generation broadband services have been provided by a single provider 

359 

to 85 percent or more of the total number of potential residential 

subscribers residing within such census tracts. For the purposes of 

the next generation broadband deduction, qualified subscribers include nonresidential subscribers in rural or underserved areas or 

any residential subscriber. In the case of a taxpayer who incurs expenditures for equipment capable of serving both subscribers in 

qualifying areas and other areas, qualifying expenditures are determined by multiplying otherwise qualifying expenditures by the 

ratio of the number of potential qualifying subscribers to all potential subscribers the qualifying equipment would be capable of serving. 

Qualifying equipment must be capable of providing broadband 

services a majority of the time during periods of maximum demand. Qualifying equipment is equipment that extends from (1) 

the last point of switching to the outside of the building in which 

the subscriber is located, (2) the customer side of a mobile telephone switching office to a transmission/reception antenna (including the antenna) of the subscriber, (3) the customer side of the 

headend to the outside of the building in which the subscriber is 

located, or (4) a transmission/reception antenna to a transmission/ 

reception antenna on the outside of the building used by the subscriber. Any packet switching equipment deployed in connection 

with other qualifying equipment is qualifying equipment, regardless of location, provided that it is the last such equipment in a series as part of transmission of a signal to a subscriber or the first 

in a series in the transmission of a signal from a subscriber. Also, 

multiplexing and demultiplexing equipment are qualified equipment. 

A rural area is any census tract which is not within 10 miles 

of any incorporated or census designated place with a population 

of more than 25,000 and which is not within a county with a population density of more than 500 people per square mile. An underserved area is any census tract located in an empowerment zone 

or enterprise community or any census tract in which the poverty 

level is greater than or equal to 30 percent and in which the median family income is less than 70 percent of the greater of metropolitan area median family income or Statewide median family income. A residential subscriber is any individual who purchases 

broadband service to be delivered to his or her dwelling. 

Effective date.—The provision is effective for expenditures incurred after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

3. Exemption for natural aging process from interest capitalization 

(sec. 303 of the Senate amendment and sec. 263A of the Code) 

PRESENT LAW

Section 263A provides uniform rules for capitalization of certain costs. In general, section 263A requires the capitalization of 

the direct costs and an allocable portion of the indirect costs of real 

or tangible personal property produced by a taxpayer or real or perVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00363 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
360 

181Sec. 263A(f). 182 It is intended that, for purposes of the provision, the natural aging process begin when 

the distilled spirits are placed in charred barrels to lie for an extended period of time to allow 

such product to obtain its color, much of its distinctive flavor, and to mellow. The natural aging 

process concludes when the distilled spirits are removed from the barrel. 

sonal property that is acquired by a taxpayer for resale. Costs attributable to producing or acquiring property generally must be 

capitalized by charging such costs to basis or, in the case of property which is inventory in the hands of the taxpayer, by including 

such costs in inventory. 

Special rules apply for the allocation of interest expense to 

property produced by the taxpayer.181 In general, interest paid or 

incurred during the production period of certain types of property 

that is allocable to the production of the property must be capitalized. Property subject to the interest capitalization requirement includes property produced by the taxpayer for use in its trade or 

business or in an activity for profit, but only if it (1) is real property, (2) has an estimated production period exceeding two years 

(one year if the cost of the property exceeds $1 million), or (3) has 

a class life of 20 years or more (as defined under section 168). The 

production period of property for this purpose begins when construction or production is commenced and ends when the property 

is ready to be placed in service or is ready to be held for sale. For 

example, in the case of property such as tobacco, wine, or whiskey 

that is aged before it is sold, the production period includes the 

aging period. Activities such as planning or design generally do not 

cause the production period to begin. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that for purposes of determining the production period for purposes of capitalization of interest expense under section 263A(f) that the production period for 

distilled spirits shall be determined without regard to any period 

allocated to the natural aging process.182

Effective date.—The Senate amendment applies to production 

periods beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

4. Section 355 ‘‘active business test’’ applied to chains of affiliated 

corporations (sec. 304 of the Senate amendment and sec. 355 

of the Code) 

PRESENT LAW

A corporation generally is required to recognize gain on the 

distribution of property (including stock of a subsidiary) to its 

shareholders as if such property had been sold for its fair market 

value. An exception to this rule applies if the distribution of the 

stock of a controlled corporation satisfies the requirements of secVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00364 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
361 

183Section 355(b). 184Section 355(b)(2)(A). 185 Rev. Proc. 2003–3, sec. 4.01(30), 2003–1 I.R.B. 113. 186 Rev. Proc. 96–30, sec. 4.03(5), 1996–1 C.B. 696; Rev. Proc. 77–37, sec. 3.04, 1977–2 C.B. 

568. 

tion 355 of the Code. To qualify for tax-free treatment under section 355, both the distributing corporation and the controlled corporation must be engaged immediately after the distribution in the 

active conduct of a trade or business that has been conducted for 

at least five years and was not acquired in a taxable transaction 

during that period.183 For this purpose, a corporation is engaged in 

the active conduct of a trade or business only if (1) the corporation 

is directly engaged in the active conduct of a trade or business, or 

(2) the corporation is not directly engaged in an active business, 

but substantially all of its assets consist of stock and securities of 

a corporation it controls that is engaged in the active conduct of a 

trade or business.184

In determining whether a corporation satisfies the active trade 

or business requirement, the IRS position for advance ruling purposes is that the value of the gross assets of the trade or business 

being relied on must ordinarily constitute at least 5 percent of the 

total fair market value of the gross assets of the corporation directly conducting the trade or business.185 However, if the corporation is not directly engaged in an active trade or business, then the 

IRS takes the position that the ‘‘substantially all’’ test requires that 

at least 90 percent of the fair market value of the corporation’s 

gross assets consist of stock and securities of a controlled corporation that is engaged in the active conduct of a trade or business.186

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the bill, the active business test is determined by reference to the relevant affiliated group. For the distributing corporation, the relevant affiliated group consists of the distributing corporation as the common parent and all corporations affiliated with 

the distributing corporation through stock ownership described in 

section 1504(a)(1)(B) (regardless of whether the corporations are includible corporations under section 1504(b)), immediately after the 

distribution. The relevant affiliated group for a controlled corporation is determined in a similar manner (with the controlled corporation as the common parent). 

Effective date.—The bill applies to distributions after the date 

of enactment, with three exceptions. The bill does not apply to distributions (1) made pursuant to an agreement which is binding on 

the date of enactment and at all times thereafter, (2) described in 

a ruling request submitted to the IRS on or before the date of enactment, or (3) described on or before the date of enactment in a 

public announcement or in a filing with the Securities and Exchange Commission. The distributing corporation may irrevocably 

elect not to have the exceptions described above apply. 

The bill also applies to any distribution prior to the date of enactment, but solely for the purpose of determining whether, after 

362 

187For example, a holding company taxpayer that had distributed a controlled corporation in 

a spin-off prior to the date of enactment, in which spin-off the taxpayer satisfied the ‘‘substantially all’’ active business stock test of present law section 355(b)(2)(A) immediately after the 

distribution, would not be deemed to have failed to satisfy any requirement that it continue that 

same qualified structure for any period of time after the distribution, solely because of a restructuring that occurs after the date of enactment and that would satisfy the requirements of new 

section 355(b)(2)(A). 

the date of enactment, the taxpayer continues to satisfy the requirements of section 355(b)(2)(A).187

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

5. Modification to cooperative marketing rules to include valueadded processing involving animals (sec. 306 of the Senate 

amendment and sec. 1388 of the Code) 

PRESENT LAW

Under present law, cooperatives generally are treated similarly 

to pass-through entities in that the cooperative is not subject to 

corporate income tax to the extent the cooperative timely pays patronage dividends. Farmers’ cooperatives are tax-exempt and include cooperatives of farmers, fruit growers, and like organizations 

that are organized and operated on a cooperative basis for the purpose of marketing the products of members or other producers and 

remitting the proceeds of sales, less necessary marketing expenses, 

on the basis of either the quantity or the value of products furnished by them (sec. 521). Farmers’ cooperatives may claim a limited amount of additional deductions for dividends on capital stock 

and patronage-based distributions of nonpatronage income. 

In determining whether a cooperative qualifies as a tax-exempt 

farmers’ cooperative, the IRS has apparently taken the position 

that a cooperative is not marketing certain products of members or 

other producers if the cooperative adds value through the use of 

animals (e.g., farmers sell corn to a cooperative which is fed to 

chickens that produce eggs sold by the cooperative). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that marketing products of 

members or other producers includes feeding products of members 

or other producers to cattle, hogs, fish, chickens, or other animals 

and selling the resulting animals or animal products. 

Effective date.—The Senate amendment provision is effective 

for taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

363 

188For disputes involving the initial or continuing qualification of an organization described 

in sections 501(c)(3), 509(a), or 4942(j)(3), declaratory judgment actions may be brought in the 

U.S. Tax Court, a U.S. district court, or the U.S. Court of Federal Claims. For all other Federal 

tax declaratory judgment actions, proceedings may be brought only in the U.S. Tax Court. 

6. Extension of declaratory judgment procedures to farmers’ cooperative organizations (sec. 307 of the Senate amendment and sec. 

7428 of the Code) 

PRESENT LAW

In limited circumstances, the Code provides declaratory judgment procedures, which generally permit a taxpayer to seek judicial review of an IRS determination prior to the issuance of a notice 

of deficiency and prior to payment of tax. Examples of declaratory 

judgment procedures that are available include disputes involving 

the initial or continuing classification of a tax-exempt organization 

described in section 501(c)(3), a private foundation described in section 509(a), or a private operating foundation described in section 

4942(j)(3), the qualification of retirement plans, the value of gifts, 

the status of certain governmental obligations, or eligibility of an 

estate to pay tax in installments under section 6166.188 In such 

cases, taxpayers may challenge adverse determinations by commencing a declaratory judgment action. For example, where the 

IRS denies an organization’s application for recognition of exemption under section 501(c)(3) or fails to act on such application, or 

where the IRS informs a section 501(c)(3) organization that it is 

considering revoking or adversely modifying its tax-exempt status, 

present law authorizes the organization to seek a declaratory judgment regarding its tax exempt status. 

Declaratory judgment procedures are not available under 

present law to a cooperative with respect to an IRS determination 

regarding its status as a farmers’ cooperative under section 521. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment extends the declaratory judgment procedures to cooperatives. Such a case may be commenced in the U.S. 

Tax Court, a U.S. district court, or the U.S. Court of Federal 

Claims, and such court would have jurisdiction to determine a cooperative’s initial or continuing qualification as a farmers’ cooperative described in section 521. 

Effective date.—The Senate amendment provision is effective 

for pleadings filed after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

364 

189The 15-percent rate applies to dividends received in taxable years beginning before January 1, 2009. Dividends received on or after that date are scheduled to be taxed at the rates applicable to ordinary income, which range up to 35 percent (39.6 percent for taxable years beginning after December 31, 2010). 190 If the recipient corporation owns less than 20 percent of the distributing corporation, the 

dividends-received deduction is 70 percent. If the recipient corporation owns less than 80 percent but at least 20 percent of the distributing corporation, the dividends-received deduction is 

80 percent. If the recipient corporation owns 80 percent or more of the distributing corporation, 

the dividends received deduction is generally 100 percent. 191This is the 35 percent tax rate, applied to the 30 percent of the dividend that is taxable 

after a 70 percent dividends-received deduction. 192This rate is scheduled to return to the highest individual tax rate when the lower dividend 

tax rate expires. 

7. Temporary suspension of personal holding company tax (sec. 308 

of the Senate amendment and sec. 541 of the Code) 

PRESENT LAW

Under present law, a tax is imposed on the taxable income of 

corporations. The rates are as follows: 

TABLE 1.—MARGINAL FEDERAL CORPORATE INCOME TAX RATES 

If taxable income is: Then the income tax rate is: 

$0–$50,000 ................................................................................................................................ 15 percent of taxable income 

$50,001–$75,000 ....................................................................................................................... 25 percent of taxable income 

$75,001–$10,000,000 ................................................................................................................ 34 percent of taxable income 

Over $10,000,000 ....................................................................................................................... 35 percent of taxable income 

The first two graduated rates described above are phased out 

by a five-percent surcharge for corporations with taxable income 

between $100,000 and $335,000. Also, the application of the 34-percent rate is phased out by a three-percent surcharge for corporations with taxable income between $15 million and $18,333,333. 

When a corporation distributes its after-tax earnings to individual shareholders as dividends, a tax is imposed on the shareholders at rates up to 15 percent.189 If a corporation receives a dividend from another corporation, the recipient corporation is entitled 

to a dividends-received deduction that excludes a significant part 

of the dividend from the recipient’s income. The percentage of a 

dividend received that is deducted varies from 70 percent to 100 

percent, depending on the level of ownership of the recipient corporation in the distributing corporation.190 Thus, with a 70 percent 

dividends received deduction, the tax rate imposed on a dividend 

received by a corporation in the 35-percent tax bracket is 10.5 percent.191 For corporations at lower rate brackets, the tax rates on 

these dividends are lower. 

In addition to the regular corporate income tax, a corporate 

level penalty tax, the ‘‘personal holding company tax’’ is currently 

imposed at 15 percent 192 on certain corporate earnings of personal 

holding companies that are not distributed to shareholders. The 

personal holding company tax was originally enacted to prevent socalled ‘‘incorporated pocketbooks’’ that could be formed by individuals to hold assets that could have been held directly by the individuals, such as passive investment assets, and retain the income 

at corporate rates that were then significantly lower than individual tax rates. 

Corporations are personal holding companies only if they are 

closely held and have substantial passive income. A corporation is 

365 

193Section 547. 

closely held if, at any time during the last half of the taxable year, 

more than 50 percent of the value of the stock of the corporation 

is owned, directly or indirectly, by five or fewer individuals (determined with the application of specified attribution rules). A corporation has substantial passive income if at least 60 percent of the 

corporation’s adjusted ordinary gross income (as defined for this 

purpose) is ‘‘personal holding company income,’’ generally, income 

from interest, dividends, rents, royalties, compensation for use of 

corporate property by certain shareholders, and income under contracts giving someone other than the corporation the right to designate the individual service provider. Numerous adjustments 

apply in specified situations where there are specified indicia that 

the income is active rather than passive. 

A corporation that otherwise would be subject to personal holding company tax can distribute, or can agree to be deemed to have 

distributed, its modified taxable income and avoid the tax. A corporation may make such an actual dividend distribution during its 

taxable year or, up to a specified limited amount, until the 15th 

day of the third month following the close of its taxable year. In 

addition, if an election is filed with its return for the year, its 

shareholders may agree to include a deemed amount in their income as if a dividend had been paid (‘‘consent dividend’’). A corporation may also make a ‘‘deficiency dividend’’ distribution within 

90 days following a determination by the IRS or a court that personal holding company tax liability is due. That distribution can 

eliminate the personal holding company tax itself, though interest 

(and penalties, if any) with respect to such tax would still be owed 

to the IRS.193

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision repeals the personal holding company tax until 

2009, the period of time the 15 percent rate on dividends received 

by individuals is scheduled to be in effect. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

The provision would be treated, for purposes of section 303 of 

the Jobs and Growth Tax Relief Reconciliation Act of 2003 as enacted by Title III of that Act (relating to lower rates on capital 

gains and dividends), so that the provision terminates when those 

provisions terminate (currently scheduled to be for taxable years 

beginning after December 31, 2008). 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

366 

8. 5-year NOL carryback for 2003 NOLs if taxpayer elects out of 

bonus depreciation as modified; extend temporary suspension 

of 90-percent limit on minimum tax NOLs (sec. 310 of the Senate amendment and sec. 172 of the Code) 

PRESENT LAW

In general, a net operating loss (‘‘NOL’’) may be carried back 

two years and carried forward 20 years to offset taxable income in 

such years. The Job Creation and Worker Assistance Act of 2002 

(‘‘JCWAA’’) provides a temporary extension of the general NOL 

carryback period to five years (from two years) for NOLs arising in 

taxable years ending in 2001 and 2002. 

The alternative minimum tax (‘‘AMT’’) rules provide that a taxpayer’s NOL deduction cannot reduce the taxpayer’s alternative 

minimum taxable income (‘‘AMTI’’) by more than 90 percent of the 

AMTI (determined without regard to the NOL deduction). JCWAA 

also provides that an NOL deduction attributable to NOL 

carrybacks arising in taxable years ending in 2001 and 2002, as 

well as NOL carryforwards to these taxable years, may offset 100 

percent of a taxpayer’s AMTI. 

JCWAA provides generally for an elective 30-percent additional 

first-year depreciation deduction. The requirements that must be 

satisfied in order for property to qualify include that (1) the original use of the property must commence with the taxpayer on or 

after September 11, 2001, (2) the taxpayer must acquire the property after September 10, 2001 and before September 11, 2004, and 

(3) no binding written contract for the acquisition of the property 

is in effect before September 11, 2001 (or, in the case of self-constructed property, manufacture, construction, or production of the 

property does not begin before September 11, 2001). 

The Jobs and Growth Tax Relief Reconciliation Act of 2003 

(‘‘JGTRRA’’) provides an elective additional first-year depreciation 

deduction equal to 50 percent of the adjusted basis of qualified 

property. Qualified property is defined in the same manner as for 

purposes of the 30-percent additional first-year depreciation deduction provided by the JCWAA except that the applicable time period 

for acquisition (or self construction) of the property is modified. 

Property with respect to which the 50-percent additional first-year 

depreciation deduction is claimed is not also eligible for the 30-percent additional first-year depreciation deduction. In order to qualify, the property must be acquired after May 5, 2003 and before 

January 1, 2005. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment extends the application of the five-year 

carryback period to NOLs arising in taxable years ending in 2003, 

provided that the taxpayer elects not to apply the bonus depreciation provisions of section 168(k). Under the provision, taxpayers 

with taxable years ending during January are permitted to apply 

the provision to tax years ending during January of 2004 rather 

367 

than tax years ending during January of 2003. The provision also 

allows an NOL deduction attributable to NOL carrybacks arising 

in taxable years ending in 2003, as well as NOL carryforwards to 

these taxable years, to offset 100 percent of a taxpayer’s AMTI. 

Effective date.—The Senate amendment applies to net operating losses for taxable years ending after December 31, 2002. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

9. Manufacturer’s jobs credit (sec. 313 of the Senate amendment) 

PRESENT LAW

There is no present law credit for a manufacturer’s employment of eligible Trade Adjustment Act (‘‘TAA’’) recipients. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 50-percent tax credit for W– 

2 wages paid by the taxpayer to eligible TAA recipients (as defined 

in sec. 35(c)(2) of the Code). The credit may not exceed 50 percent 

of the lesser of: (1) the excess of the W–2 wages paid by the taxpayer during the taxable year over the W–2 wages paid by the taxpayer during the preceding taxable year, (2) the W–2 wages paid 

by the taxpayer during the taxable year to any employee who is an 

eligible TAA recipient for any month during such taxable year, or 

(3) 22.4 percent of the W–2 wages paid by the taxpayer during the 

taxable year. The amount of W–2 wages taken into account with 

respect to any employee for any taxable year shall not exceed 

$50,000. 

The otherwise allowable credit is limited if the value of the 

taxpayer’s non-domestic production increased from the preceding 

taxable year. In such case, the credit is (1) reduced to zero for taxpayers whose value of domestic production does not exceed that 

from the preceding taxable year, or (2) reduced by a percentage 

equal to the non-domestic share of the increase in the value of 

worldwide production from the preceding taxable year. 

A taxpayer eligible for the credit is any taxpayer that has domestic production gross receipts for the taxable year and the preceding taxable year, and is not treated at any time during the taxable year as an inverted domestic corporation under section 7874 

of the Senate amendment. 

Effective date.—The provision applies to taxable years beginning after December 31, 2003, and before January 1, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

368 

194 Secs. 141(e) and 142(a). 195 Residential rental projects must satisfy low-income tenant occupancy requirements for a 

minimum period of 15 years. 

10. Brownfields demonstration program for qualified green building 

and sustainable design projects (sec. 314 of the Senate amendment and secs. 142 and 146 of the Code) 

PRESENT LAW

In general 

Interest on debt incurred by States or local governments is excluded from income if the proceeds of the borrowing are used to 

carry out governmental functions of those entities or the debt is repaid with governmental funds. Interest on bonds that nominally 

are issued by States or local governments, but the proceeds of 

which are used (directly or indirectly) by a private person and payment of which is derived from funds of such a private person is taxable unless the purpose of the borrowing is approved specifically in 

the Code or in a non-Code provision of a revenue Act. These bonds 

are called ‘‘private activity bonds.’’ The term ‘‘private person’’ includes the Federal Government and all other individuals and entities other than States or local governments. 

Private activities eligible for financing with tax-exempt private activity bonds 

Present law includes several exceptions permitting States or 

local governments to act as conduits providing tax-exempt financing for private activities. For example, interest on bonds issued to 

benefit section 501(c)(3) organizations is generally tax-exempt 

(‘‘qualified 501(c)(3) bonds’’). Both capital expenditures and limited 

working capital expenditures of section 501(c)(3) organizations may 

be financed with qualified 501(c)(3) bonds. 

In addition, States or local governments may issue tax-exempt 

‘‘exempt-facility bonds’’ to finance property for certain private businesses.194 Business facilities eligible for this financing include 

transportation (airports, ports, local mass commuting, and high 

speed intercity rail facilities); privately owned and/or privately operated public works facilities (sewage, solid waste disposal, local 

district heating or cooling, hazardous waste disposal facilities, and 

public educational facilities); privately owned and/or operated lowincome rental housing;195 and certain private facilities for the local 

furnishing of electricity or gas. A further provision allows tax-exempt financing for ‘‘environmental enhancements of hydro-electric 

generating facilities.’’ Tax-exempt financing also is authorized for 

capital expenditures for small manufacturing facilities and land 

and equipment for first-time farmers (‘‘qualified small-issue 

bonds’’), local redevelopment activities (‘‘qualified redevelopment 

bonds’’), and eligible empowerment zone and enterprise community 

businesses. Tax-exempt private activity bonds also may be issued 

to finance limited non-business purposes: certain student loans and 

mortgage loans for owner-occupied housing (‘‘qualified mortgage 

bonds’’ and ‘‘qualified veterans’ mortgage bonds’’). 

Generally, tax-exempt private activity bonds are subject to restrictions that do not apply to other bonds issued by State or local 

369 

196Sec. 146. 197The LEED (‘‘Leadership in Energy and Environmental Design’’) Green Building Rating 

System is a voluntary, consensus-based national standard for developing high-performance sustainable buildings. Registration is the first step toward LEED certification. Actual certification 

requires that the applicant project satisfy a number of requirements. Commercial buildings, as 

defined by standard building codes are eligible for certification. Commercial occupancies include, 

but are not limited to, offices, retail and service establishments, institutional buildings (e.g. libraries, schools, museums, churches, etc.), hotels, and residential buildings of four or more habitable stories. 198For this purpose, a brownfield site is defined by section 101(39) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (42 U.S.C. 9601), including a 

site described in subparagraph (D)(ii)(II)(aa) thereof (relating to a site that is contaminated by 

petroleum or a petroleum product excluded from the definition of ‘hazardous substance’ under 

section 101). 

governments. For example, most tax-exempt private activity bonds 

are subject to annual volume limits on the aggregate face amount 

of such bonds that may be issued.196

HOUSE BILL

No provision. 

SENATE AMENDMENT

In general 

The Senate amendment creates a new category of exempt-facility bond, the qualified green building and sustainable design 

project bond (‘‘qualified green bond’’). A qualified green bond is defined as any bond issued as part of an issue that finances a project 

designated by the Secretary, after consultation with the Administrator of the Environmental Protection Agency (the ‘‘Administrator’’) as a green building and sustainable design project that 

meets the following eligibility requirements: (1) at least 75 percent 

of the square footage of the commercial buildings that are part of 

the project is registered for the U.S. Green Building Council’s 

LEED 197 certification and is reasonably expected (at the time of 

designation) to meet such certification; (2) the project includes a 

brownfield site; 198 (3) the project receives at least $5 million dollars in specific State or local resources; and (4) the project includes 

at least one million square feet of building or at least 20 acres of 

land. 

Under the provision, qualified green bonds are not subject to 

the State bond volume limitations. Rather, there is a national limitation of $2 billion of qualified green bonds that the Secretary may 

allocate, in the aggregate, to qualified green building and sustainable design projects. Qualified green bonds may be currently refunded if certain conditions are met, but cannot be advance refunded. The authority to issue qualified green bonds terminates 

after September 30, 2009. 

Application and designation process 

The provision requires the submission of an application that 

meets certain requirements before a project may be designated for 

financing with qualified green bonds. In addition to the eligibility 

requirements listed above, each project application must demonstrate that the net benefit of the tax-exempt financing provided 

will be allocated for (i) the purchase, construction, integration or 

other use of energy efficiency, renewable energy and sustainable 

370 

199The term ‘‘rural State’’ means any State that has (1) a population of less than 4.5 million 

according to the 2000 census; (2) a population density of less than 150 people per square mile 

according to the 2000 census; and (3) increased in population by less than half the rate of the 

national increase between the 1990 and 2000 censuses. 

design features of the project, (ii) compliance with LEED certification standards, and/or (iii) the purchase, remediation, foundation 

construction, and preparation of the brownfield site. The application also must demonstrate that the project is expected, based on 

independent analysis, to provide the equivalent of at least 1,500 

full-time permanent employees (150 full-time employees in rural 

States) when completed and the equivalent of at least 1,000 construction employees (100 full-time employees in rural States). In 

addition, each project application shall contain a description of: (1) 

the amount of electric consumption reduced as compared to conventional construction; (2) the amount of sulfur dioxide daily emissions 

reduced compared to coal generation; (3) the amount of gross installed capacity of the project’s solar photovoltaic capacity measured in megawatts; and (4) the amount of the project’s fuel cell energy generation, measured in megawatts. 

Under the Senate Amendment, each project must be nominated by a State or local government within 180 days of enactment 

of this Act and such State or local government must provide written assurances that the project will satisfy certain eligibility requirements. Within 60 days after the end of the application period, 

the Secretary, after consultation with the Administrator, will designate the qualified green building and sustainable design projects 

eligible for financing with qualified green bonds. At least one of the 

projects must be in or within a ten-mile radius of an empowerment 

zone (as defined under section 1391 of the Code) and at least one 

project must be in a rural State.199 No more than one project is 

permitted in a State. A project shall not be designated for financing 

with qualified green bonds if such project includes a stadium or 

arena for professional sports exhibitions or games. 

The provision requires the Secretary, after consultation with 

the Administrator, to ensure that the projects designated shall, in 

the aggregate: (1) reduce electric consumption by more than 150 

megawatts annually as compared to conventional construction; (2) 

reduce daily sulfur dioxide emissions by at least 10 tons compared 

to coal generation power; (3) expand by 75 percent the domestic 

solar photovoltaic market in the United States (measured in 

megawatts) as compared to the expansion of that market from 2001 

to 2002; and (4) use at least 25 megawatts of fuel cell energy generation. 

Each project must certify to the Secretary, no later than 30 

days after the completion of the project, that the net benefit of the 

tax-exempt financing was used for the purposes described in the 

project application. In addition, no bond proceeds can be used to 

provide any facility the principal business of which is the sale of 

food or alcoholic beverages for consumption on the premises. 

Special rules 

The provision requires each issuer to maintain, on behalf of 

each project, an interest bearing reserve account equal to one percent of the net proceeds of any qualified green bond issued for such 

371 

project. Not later than five years after the date of issuance, the 

Secretary, after consultation with the Administrator, shall determine whether the project financed with the proceeds of qualified 

green bonds has substantially complied with the requirements and 

goals described in the project application. If the Secretary, after 

such consultation, certifies that the project has substantially complied with the requirements and goals, amounts in the reserve account, including all interest, shall be released to the project. If the 

Secretary determines that the project has not substantially complied with such requirements and goals, amounts in the reserve account, including all interest, shall be paid to the United States 

Treasury. 

Effective date.—The provision is effective for bonds issued after 

December 31, 2004, and before October 1, 2009. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

J. MANUFACTURING RELATING TO FILMS

1. Special rules for certain film and television production (sec. 321 

of the Senate amendment and new sec. 181 of the Code) 

PRESENT LAW

The modified Accelerated Cost Recovery System (‘‘MACRS’’) 

does not apply to certain property, including any motion picture 

film, video tape, or sound recording, or to any other property if the 

taxpayer elects to exclude such property from MACRS and the taxpayer properly applies a unit-of-production method or other method 

of depreciation not expressed in a term of years. Section 197 does 

not apply to certain intangible property, including property produced by the taxpayer or any interest in a film, sound recording, 

video tape, book or similar property not acquired in a transaction 

(or a series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. 

Thus, the recovery of the cost of a film, video tape, or similar property that is produced by the taxpayer or is acquired on a ‘‘standalone’’ basis by the taxpayer may not be determined under either 

the MACRS depreciation provisions or under the section 197 amortization provisions. The cost recovery of such property may be determined under section 167, which allows a depreciation deduction 

for the reasonable allowance for the exhaustion, wear and tear, or 

obsolescence of the property. A taxpayer is allowed to recover, 

through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. 

Section 167(g) provides that the cost of motion picture films, sound 

recordings, copyrights, books, and patents are eligible to be recovered using the income forecast method of depreciation. 

HOUSE BILL

No provision. 

372 

200 An election to deduct such costs shall be made in such manner as prescribed by the Secretary and by the due date (including extensions of time) for filing the taxpayer’s return of tax 

for the taxable year in which production costs of such property are first incurred. An election 

may not be revoked without the consent of the Secretary. The Committee intends that, in the 

absence of specific guidance by the Secretary, deducting qualifying costs on the appropriate tax 

return shall constitute a valid election. 201Thus, a qualifying film that is co-produced is limited to $15 million of deduction. The benefits of this provision shall be allocated among the owners of a film in a manner that reasonably 

reflects each owner’s proportionate investment in and economic interest in the film. 202The term compensation does not include participations and residuals. 203For this purpose, a production is treated as commencing on the first date of principal photography. 

SENATE AMENDMENT

The Senate amendment permits qualifying film and television 

productions to elect to deduct certain production expenditures in 

the year the expenditure is incurred in lieu of capitalizing the cost 

and recovering it through depreciation allowances.200

The provision limits the amount of production expenditures 

that may be expensed to $15 million for each qualifying production.201 An additional $5 million of production expenditures may be 

deducted (up to $20 million in total) if a significant amount of the 

production expenditures are incurred in areas eligible for designation as a low-income community or eligible for designation by the 

Delta Regional Authority as a distressed county or isolated area of 

distress. Expenditures in excess of $15 million ($20 million in distressed areas) are required to be recovered over a three-year period 

using the straight-line method beginning in the month such property is placed in service. 

The provision defines a qualified film or television production 

as any production of a motion picture (whether released 

theatrically or directly to video cassette or any other format); miniseries; scripted, dramatic television episode; or movie of the week 

if at least 75 percent of the total compensation expended on the 

production are for services performed in the United States.202 With 

respect to property which is one or more episodes in a television 

series, only the first 44 episodes qualify under the provision. Qualified property does not include sexually explicit productions as defined by section 2257 of title 18 of the U.S. Code. 

Effective date.—The Senate amendment is effective for qualified productions commencing after the date of enactment and sunsets for qualifying productions commencing after December 31, 

2008. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except that the provision does not apply to qualified productions the 

aggregate cost of which exceeds the $15 million threshold. The 

threshold is increased to $20 million if a significant amount of the 

production expenditures are incurred in areas eligible for designation as a low-income community or eligible for designation by the 

Delta Regional Authority as a distressed county or isolated area of 

distress. 

Effective date.—The provision is effective for qualified productions commencing after the date of enactment and before January 

1, 2009.203

373 

2. Modification of application of income forecast method of depreciation (sec. 322 of the Senate amendment and sec. 167 of the 

Code) 

PRESENT LAW

The modified Accelerated Cost Recovery System (‘‘MACRS’’) 

does not apply to certain property, including any motion picture 

film, video tape, or sound recording, or to any other property if the 

taxpayer elects to exclude such property from MACRS and the taxpayer properly applies a unit-of-production method or other method 

of depreciation not expressed in a term of years. Section 197 does 

not apply to certain intangible property, including property produced by the taxpayer or any interest in a film, sound recording, 

video tape, book or similar property not acquired in a transaction 

(or a series of related transactions) involving the acquisition of assets constituting a trade or business or substantial portion thereof. 

Thus, the recovery of the cost of a film, video tape, or similar property that is produced by the taxpayer or is acquired on a ‘‘standalone’’ basis by the taxpayer may not be determined under either 

the MACRS depreciation provisions or under the section 197 amortization provisions. The cost recovery of such property may be determined under section 167, which allows a depreciation deduction 

for the reasonable allowance for the exhaustion, wear and tear, or 

obsolescence of the property. A taxpayer is allowed to recover, 

through annual depreciation deductions, the cost of certain property used in a trade or business or for the production of income. 

Section 167(g) provides that the cost of motion picture films, sound 

recordings, copyrights, books, and patents are eligible to be recovered using the income forecast method of depreciation. 

Income forecast method of depreciation 

Under the income forecast method, a property’s depreciation 

deduction for a taxable year is determined by multiplying the adjusted basis of the property by a fraction, the numerator of which 

is the income generated by the property during the year and the 

denominator of which is the total forecasted or estimated income 

expected to be generated prior to the close of the tenth taxable year 

after the year the property was placed in service. Any costs that 

are not recovered by the end of the tenth taxable year after the 

property was placed in service may be taken into account as depreciation in such year. 

The adjusted basis of property that may be taken into account 

under the income forecast method only includes amounts that satisfy the economic performance standard of section 461(h). In addition, taxpayers that claim depreciation deductions under the income forecast method are required to pay (or receive) interest 

based on a recalculation of depreciation under a ‘‘look-back’’ method. 

The ‘‘look-back’’ method is applied in any ‘‘recomputation year’’ 

by (1) comparing depreciation deductions that had been claimed in 

prior periods to depreciation deductions that would have been 

claimed had the taxpayer used actual, rather than estimated, total 

income from the property; (2) determining the hypothetical overpayment or underpayment of tax based on this recalculated depreVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00377 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
374 

204 Associated Patentees, Inc. v. Commissioner, 4 T.C. 979 (1945). 

ciation; and (3) applying the overpayment rate of section 6621 of 

the Code. Except as provided in Treasury regulations, a ‘‘recomputation year’’ is the third and tenth taxable year after the taxable 

year the property was placed in service, unless the actual income 

from the property for each taxable year ending with or before the 

close of such years was within 10 percent of the estimated income 

from the property for such years. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment clarifies that, solely for purposes of 

computing the allowable deduction for property under the income 

forecast method of depreciation, participations and residuals may 

be included in the adjusted basis of the property beginning in the 

year such property is placed in service, but only if such participations and residuals relate to income to be derived from the property 

before the close of the tenth taxable year following the year the 

property is placed in service (as defined in section 167(g)(1)(A)). For 

purposes of the provision, participations and residuals are defined 

as costs the amount of which, by contract, varies with the amount 

of income earned in connection with such property. The provision 

also clarifies that the income from the property to be taken into account under the income forecast method is the gross income from 

such property. 

The provision also grants authority to the Treasury Department to prescribe appropriate adjustments to the basis of property 

(and the look-back method) to reflect the treatment of participations and residuals under the provision. 

In addition, the provision clarifies that, in the case of property 

eligible for the income forecast method that the holding in the Associated Patentees 204 decision will continue to constitute a valid 

method. Thus, rather than accounting for participations and residuals as a cost of the property under the income forecast method 

of depreciation, the taxpayer may deduct those payments as they 

are paid as under the Associated Patentees decision. This may be 

done on a property-by-property basis and shall be applied consistently with respect to a given property thereafter. The provision also 

clarifies that distribution costs are not taken into account for purposes of determining the taxpayer’s current and total forecasted income with respect to a property. 

Effective date.—The Senate amendment applies to property 

placed in service after date of enactment. No inference is intended 

as to the appropriate treatment under present law. It is intended 

that the Treasury Department and the IRS expedite the resolution 

of open cases. In resolving these cases in an expedited and balanced manner, the Treasury Department and IRS are encouraged 

to take into account the principles of the provision. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

375 

205 However, exceptions to the fungibility principle are provided in particular cases, some of 

which are described below. 

TITLE III—PROVISIONS RELATING TO TAX REFORM AND 

SIMPLIFICATION FOR UNITED STATES BUSINESSES 

1. Interest expense allocation rules (sec. 301 of the House bill, sec. 

205 of the Senate amendment, and sec. 864 of the Code) 

PRESENT LAW

In general 

In order to compute the foreign tax credit limitation, a taxpayer must determine the amount of its taxable income from foreign sources. Thus, the taxpayer must allocate and apportion deductions between items of U.S.-source gross income, on the one 

hand, and items of foreign-source gross income, on the other. 

In the case of interest expense, the rules generally are based 

on the approach that money is fungible and that interest expense 

is properly attributable to all business activities and property of a 

taxpayer, regardless of any specific purpose for incurring an obligation on which interest is paid.205 For interest allocation purposes, 

the Code provides that all members of an affiliated group of corporations generally are treated as a single corporation (the socalled ‘‘one-taxpayer rule’’) and allocation must be made on the 

basis of assets rather than gross income. 

Affiliated group 

In general 

The term ‘‘affiliated group’’ in this context generally is defined 

by reference to the rules for determining whether corporations are 

eligible to file consolidated returns. However, some groups of corporations are eligible to file consolidated returns yet are not treated as affiliated for interest allocation purposes, and other groups 

of corporations are treated as affiliated for interest allocation purposes even though they are not eligible to file consolidated returns. 

Thus, under the one-taxpayer rule, the factors affecting the allocation of interest expense of one corporation may affect the sourcing 

of taxable income of another, related corporation even if the two 

corporations do not elect to file, or are ineligible to file, consolidated returns. 

Definition of affiliated group—consolidated return rules 

For consolidation purposes, the term ‘‘affiliated group’’ means 

one or more chains of includible corporations connected through 

stock ownership with a common parent corporation which is an includible corporation, but only if: (1) the common parent owns directly stock possessing at least 80 percent of the total voting power 

and at least 80 percent of the total value of at least one other includible corporation; and (2) stock meeting the same voting power 

and value standards with respect to each includible corporation (excluding the common parent) is directly owned by one or more other 

includible corporations. 

Generally, the term ‘‘includible corporation’’ means any domestic corporation except certain corporations exempt from tax under 

376 

206One such exception is that the affiliated group for interest allocation purposes includes section 936 corporations that are excluded from the consolidated group. 

section 501 (for example, corporations organized and operated exclusively for charitable or educational purposes), certain life insurance companies, corporations electing application of the possession 

tax credit, regulated investment companies, real estate investment 

trusts, and domestic international sales corporations. A foreign corporation generally is not an includible corporation. 

Definition of affiliated group—special interest allocation rules 

Subject to exceptions, the consolidated return and interest allocation definitions of affiliation generally are consistent with each 

other.206 For example, both definitions generally exclude all foreign 

corporations from the affiliated group. Thus, while debt generally 

is considered fungible among the assets of a group of domestic affiliated corporations, the same rules do not apply as between the 

domestic and foreign members of a group with the same degree of 

common control as the domestic affiliated group. 

Banks, savings institutions, and other financial affiliates 

The affiliated group for interest allocation purposes generally 

excludes what are referred to in the Treasury regulations as ‘‘financial corporations’’ (Treas. Reg. sec. 1.861–11T(d)(4)). These include 

any corporation, otherwise a member of the affiliated group for consolidation purposes, that is a financial institution (described in section 581 or section 591), the business of which is predominantly 

with persons other than related persons or their customers, and 

which is required by State or Federal law to be operated separately 

from any other entity which is not a financial institution (sec. 

864(e)(5)(C)). The category of financial corporations also includes, 

to the extent provided in regulations, bank holding companies (including financial holding companies), subsidiaries of banks and 

bank holding companies (including financial holding companies), 

and savings institutions predominantly engaged in the active conduct of a banking, financing, or similar business (sec. 864(e)(5)(D)). 

A financial corporation is not treated as a member of the regular affiliated group for purposes of applying the one-taxpayer rule 

to other non-financial members of that group. Instead, all such financial corporations that would be so affiliated are treated as a 

separate single corporation for interest allocation purposes. 

HOUSE BILL

In general 

The provision modifies the present-law interest expense allocation rules (which generally apply for purposes of computing the foreign tax credit limitation) by providing a one-time election under 

which the taxable income of the domestic members of an affiliated 

group from sources outside the United States generally is determined by allocating and apportioning interest expense of the domestic members of a worldwide affiliated group on a worldwidegroup basis (i.e., as if all members of the worldwide group were a 

single corporation). If a group makes this election, the taxable income of the domestic members of a worldwide affiliated group from 

377 

207For purposes of determining the assets of the worldwide affiliated group, neither stock in 

corporations within the group nor indebtedness (including receivables) between members of the 

group is taken into account. It is anticipated that the Treasury Secretary will adopt regulations 

addressing the allocation and apportionment of interest expense on such indebtedness that follow principles analogous to those of existing regulations. Income from holding stock or indebtedness of another group member is taken into account for all purposes under the present-law rules 

of the Code, including the foreign tax credit provisions. 208 Although the interest expense of a foreign subsidiary is taken into account for purposes 

of allocating the interest expense of the domestic members of the electing worldwide affiliated 

group for foreign tax credit limitation purposes, the interest expense incurred by a foreign subsidiary is not deductible on a U.S. return. 209The provision expands the definition of an affiliated group for interest expense allocation 

purposes to include certain insurance companies that are generally excluded from an affiliated 

group under section 1504(b)(2) (without regard to whether such companies are covered by an 

election under section 1504(c)(2)). 210 Indirect ownership is determined under the rules of section 958(a)(2) or through applying 

rules similar to those of section 958(a)(2) to stock owned directly or indirectly by domestic partnerships, trusts, or estates. 

sources outside the United States is determined by allocating and 

apportioning the third-party interest expense of those domestic 

members to foreign-source income in an amount equal to the excess 

(if any) of (1) the worldwide affiliated group’s worldwide third-party 

interest expense multiplied by the ratio which the foreign assets of 

the worldwide affiliated group bears to the total assets of the 

worldwide affiliated group,207 over (2) the third-party interest expense incurred by foreign members of the group to the extent such 

interest would be allocated to foreign sources if the provision’s principles were applied separately to the foreign members of the 

group.208

For purposes of the new elective rules based on worldwide 

fungibility, the worldwide affiliated group means all corporations in 

an affiliated group (as that term is defined under present law for 

interest allocation purposes) 209 as well as all controlled foreign corporations that, in the aggregate, either directly or indirectly,210

would be members of such an affiliated group if section 1504(b)(3) 

did not apply (i.e., in which at least 80-percent of the vote and 

value of the stock of such corporations is owned by one or more 

other corporations included in the affiliated group). Thus, if an affiliated group makes this election, the taxable income from sources 

outside the United States of domestic group members generally is 

determined by allocating and apportioning interest expense of the 

domestic members of the worldwide affiliated group as if all of the 

interest expense and assets of 80-percent or greater owned domestic corporations (i.e., corporations that are part of the affiliated 

group under present-law section 864(e)(5)(A) as modified to include 

insurance companies) and certain controlled foreign corporations 

were attributable to a single corporation. 

In addition, if an affiliated group elects to apply the new elective rules based on worldwide fungibility, the present-law rules regarding the treatment of tax-exempt assets and the basis of stock 

in nonaffiliated 10-percent owned corporations apply on a worldwide affiliated group basis. 

The common parent of the domestic affiliated group must 

make the worldwide affiliated group election. It must be made for 

the first taxable year beginning after December 31, 2008, in which 

a worldwide affiliated group exists that includes at least one foreign corporation that meets the requirements for inclusion in a 

worldwide affiliated group. Once made, the election applies to the 

378 

211See Treas. Reg. sec. 1.904–4(e)(2). 

common parent and all other members of the worldwide affiliated 

group for the taxable year for which the election was made and all 

subsequent taxable years, unless revoked with the consent of the 

Secretary of the Treasury. 

Financial institution group election 

The provision allows taxpayers to apply the present-law bank 

group rules to exclude certain financial institutions from the affiliated group for interest allocation purposes under the worldwide 

fungibility approach. The provision also provides a one-time ‘‘financial institution group’’ election that expands the present-law bank 

group. Under the provision, at the election of the common parent 

of the pre-election worldwide affiliated group, the interest expense 

allocation rules are applied separately to a subgroup of the worldwide affiliated group that consists of (1) all corporations that are 

part of the present-law bank group, and (2) all ‘‘financial corporations.’’ For this purpose, a corporation is a financial corporation if 

at least 80 percent of its gross income is financial services income 

(as described in section 904(d)(2)(C)(i) and the regulations thereunder) that is derived from transactions with unrelated persons.211

For these purposes, items of income or gain from a transaction or 

series of transactions are disregarded if a principal purpose for the 

transaction or transactions is to qualify any corporation as a financial corporation. 

The common parent of the pre-election worldwide affiliated 

group must make the election for the first taxable year beginning 

after December 31, 2008, in which a worldwide affiliated group includes a financial corporation. Once made, the election applies to 

the financial institution group for the taxable year and all subsequent taxable years. In addition, the provision provides anti-abuse 

rules under which certain transfers from one member of a financial 

institution group to a member of the worldwide affiliated group 

outside of the financial institution group are treated as reducing 

the amount of indebtedness of the separate financial institution 

group. The provision provides regulatory authority with respect to 

the election to provide for the direct allocation of interest expense 

in circumstances in which such allocation is appropriate to carry 

out the purposes of the provision, prevent assets or interest expense from being taken into account more than once, or address 

changes in members of any group (through acquisitions or otherwise) treated as affiliated under this provision. 

Effective date.—The House bill provision is effective for taxable 

years beginning after December 31, 2008. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

379 

2. Recharacterize overall domestic loss (sec. 302 of the House bill, 

sec. 204 of the Senate amendment, and sec. 904 of the Code) 

PRESENT LAW

The United States provides a credit for foreign income taxes 

paid or accrued. The foreign tax credit generally is limited to the 

U.S. tax liability on a taxpayer’s foreign-source income, in order to 

ensure that the credit serves the purpose of mitigating double taxation of foreign-source income without offsetting the U.S. tax on 

U.S.-source income. This overall limitation is calculated by prorating a taxpayer’s pre-credit U.S. tax on its worldwide income between its U.S.-source and foreign-source taxable income. The ratio 

(not exceeding 100 percent) of the taxpayer’s foreign-source taxable 

income to worldwide taxable income is multiplied by its pre-credit 

U.S. tax to establish the amount of U.S. tax allocable to the taxpayer’s foreign-source income and, thus, the upper limit on the foreign tax credit for the year. 

In addition, this limitation is calculated separately for various 

categories of income, generally referred to as ‘‘separate limitation 

categories.’’ The total amount of the foreign tax credit used to offset 

the U.S. tax on income in each separate limitation category may 

not exceed the proportion of the taxpayer’s U.S. tax which the taxpayer’s foreign-source taxable income in that category bears to its 

worldwide taxable income. 

If a taxpayer’s losses from foreign sources exceed its foreignsource income, the excess (‘‘overall foreign loss,’’ or ‘‘OFL’’) may offset U.S.-source income. Such an offset reduces the effective rate of 

U.S. tax on U.S.-source income. 

In order to eliminate a double benefit (that is, the reduction of 

U.S. tax previously noted and, later, full allowance of a foreign tax 

credit with respect to foreign-source income), present law includes 

an OFL recapture rule. Under this rule, a portion of foreign-source 

taxable income earned after an OFL year is recharacterized as 

U.S.-source taxable income for foreign tax credit purposes (and for 

purposes of the possessions tax credit). Unless a taxpayer elects a 

higher percentage, however, generally no more than 50 percent of 

the foreign-source taxable income earned in any particular taxable 

year is recharacterized as U.S.-source taxable income. The effect of 

the recapture is to reduce the foreign tax credit limitation in one 

or more years following an OFL year and, therefore, the amount 

of U.S. tax that can be offset by foreign tax credits in the later year 

or years. 

Losses for any taxable year in separate foreign limitation categories (to the extent that they do not exceed foreign income for the 

year) are apportioned on a proportionate basis among (and operate 

to reduce) the foreign income categories in which the entity earns 

income in the loss year. A separate limitation loss recharacterization rule applies to foreign losses apportioned to foreign income 

pursuant to the above rule. If a separate limitation loss was apportioned to income subject to another separate limitation category 

and the loss category has income for a subsequent taxable year, 

then that income (to the extent that it does not exceed the aggregate separate limitation losses in the loss category not previously 

recharacterized) must be recharacterized as income in the separate 

380 

limitation category that was previously offset by the loss. Such recharacterization must be made in proportion to the prior loss apportionment not previously taken into account. 

A U.S.-source loss reduces pre-credit U.S. tax on worldwide income to an amount less than the hypothetical tax that would apply 

to the taxpayer’s foreign-source income if viewed in isolation. The 

existence of foreign-source taxable income in the year of the U.S.- 

source loss reduces or eliminates any net operating loss carryover 

that the U.S.-source loss would otherwise have generated absent 

the foreign income. In addition, as the pre-credit U.S. tax on worldwide income is reduced, so is the foreign tax credit limitation. 

Moreover, any U.S.-source loss for any taxable year is apportioned 

among (and operates to reduce) foreign income in the separate limitation categories on a proportionate basis. As a result, some foreign 

tax credits in the year of the U.S.-source loss must be credited, if 

at all, in a carryover year. Tax on U.S.-source taxable income in 

a subsequent year may be offset by a net operating loss 

carryforward, but not by a foreign tax credit carryforward. There 

is currently no mechanism for recharacterizing such subsequent 

U.S.-source income as foreign-source income. 

For example, suppose a taxpayer generates a $100 U.S.-source 

loss and earns $100 of foreign-source income in Year 1, and pays 

$30 of foreign tax on the $100 of foreign-source income. Because 

the taxpayer has no net taxable income in Year 1, no foreign tax 

credit can be claimed in Year 1 with respect to the $30 of foreign 

taxes. If the taxpayer then earns $100 of U.S.-source income and 

$100 of foreign-source income in Year 2, present law does not recharacterize any portion of the $100 of U.S.-source income as foreign-source income to reflect the fact that the previous year’s $100 

U.S.-source loss reduced the taxpayer’s ability to claim foreign tax 

credits. 

HOUSE BILL

The provision applies a re-sourcing rule to U.S.-source income 

in cases in which a taxpayer’s foreign tax credit limitation has been 

reduced as a result of an overall domestic loss. Under the provision, a portion of the taxpayer’s U.S.-source income for each succeeding taxable year is recharacterized as foreign-source income in 

an amount equal to the lesser of: (1) the amount of the 

unrecharacterized overall domestic losses for years prior to such 

succeeding taxable year, and (2) 50 percent of the taxpayer’s U.S.- 

source income for such succeeding taxable year. 

The provision defines an overall domestic loss for this purpose 

as any domestic loss to the extent it offsets foreign-source taxable 

income for the current taxable year or for any preceding taxable 

year by reason of a loss carryback. For this purpose, a domestic 

loss means the amount by which the U.S.-source gross income for 

the taxable year is exceeded by the sum of the deductions properly 

apportioned or allocated thereto, determined without regard to any 

loss carried back from a subsequent taxable year. Under the provision, an overall domestic loss does not include any loss for any taxable year unless the taxpayer elected the use of the foreign tax 

credit for such taxable year. 

381 

212Subject to certain exceptions, dividends paid by a 10/50 company in taxable years beginning after December 31, 2002 are subject to either a look-through approach in which the dividend is attributed to a particular limitation category based on the underlying earnings which 

gave rise to the dividend (for post-2002 earnings and profits), or a single-basket limitation approach for dividends from all 10/50 companies that are not passive foreign investment compaContinued 

Any U.S.-source income recharacterized under the provision is 

allocated among and increases the various foreign tax credit separate limitation categories in the same proportion that those categories were reduced by the prior overall domestic losses, in a manner similar to the recharacterization rules for separate limitation 

losses. 

It is anticipated that situations may arise in which a taxpayer 

generates an overall domestic loss in a year following a year in 

which it had an overall foreign loss, or vice versa. In such a case, 

it would be necessary for ordering and other coordination rules to 

be developed for purposes of computing the foreign tax credit limitation in subsequent taxable years. The provision grants the Secretary of the Treasury authority to prescribe such regulations as 

may be necessary to coordinate the operation of the OFL recapture 

rules with the operation of the overall domestic loss recapture rules 

added by the provision. 

Effective date.—The provision applies to losses incurred in taxable years beginning after December 31, 2006. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

3. Foreign tax credit baskets and ‘‘base differences’’ (sec. 303 of the 

House bill, sec. 225 of the Senate amendment, and sec. 904 of 

the Code) 

PRESENT LAW

In general 

The United States taxes its citizens and residents on their 

worldwide income. Because the countries in which income is earned 

also may assert their jurisdiction to tax the same income on the 

basis of source, foreign-source income earned by U.S. persons may 

be subject to double taxation. In order to mitigate this possibility, 

the United States provides a credit against U.S. tax liability for foreign income taxes paid, subject to a number of limitations. The foreign tax credit generally is limited to the U.S. tax liability on a taxpayer’s foreign-source income, in order to ensure that the credit 

serves its purpose of mitigating double taxation of cross-border income without offsetting the U.S. tax on U.S.-source income. 

The foreign tax credit limitation is applied separately to the 

following categories of income: (1) passive income, (2) high withholding tax interest, (3) financial services income, (4) shipping income, (5) certain dividends received from noncontrolled section 902 

foreign corporations (‘‘10/50 companies’’),212 (6) certain dividends 

382 

nies (for pre-2003 earnings and profits). Under the conference agreement, these dividends are 

subject to a look-through approach, irrespective of when the underlying earnings and profits 

arose. 213See, e.g., sec. 56(g)(4)(C)(iii)(IV) (relating to certain dividends from corporations eligible for 

the sec. 936 credit); sec. 245(a)(10) (relating to certain dividends treated as foreign source under 

treaties); sec. 865(h)(1)(B) (relating to certain gains from stock and intangibles treated as foreign 

source under treaties); sec. 901(j)(1)(B) (relating to income from certain specified countries); and 

sec. 904(g)(10)(A) (relating to interest, dividends, and certain other amounts derived from U.S.- 

owned foreign corporations and treated as foreign source under treaties). 214Treas. Reg. sec. 1.904–4(e)(3)(i) and (2)(i). 215Treas. Reg. sec. 1.904–4(e)(3)(ii). 216Treas. Reg. sec. 1.904–6. 

from a domestic international sales corporation or former domestic 

international sales corporation, (7) taxable income attributable to 

certain foreign trade income, (8) certain distributions from a foreign sales corporation or former foreign sales corporation, and (9) 

any other income not described in items (1) through (8) (so-called 

‘‘general basket’’ income). In addition, a number of other provisions 

of the Code and U.S. tax treaties effectively create additional separate limitations in certain circumstances.213

Financial services income 

In general, the term ‘‘financial services income’’ includes income received or accrued by a person predominantly engaged in the 

active conduct of a banking, insurance, financing, or similar business, if the income is derived in the active conduct of a banking, 

financing or similar business, or is derived from the investment by 

an insurance company of its unearned premiums or reserves ordinary and necessary for the proper conduct of its insurance business 

(sec. 904(d)(2)(C)). The Code also provides that financial services 

income includes income, received or accrued by a person predominantly engaged in the active conduct of a banking, insurance, financing, or similar business, of a kind which would generally be insurance income (as defined in section 953(a)), among other items. 

Treasury regulations provide that a person is predominantly 

engaged in the active conduct of a banking, insurance, financing, 

or similar business for any year if for that year at least 80 percent 

of its gross income is ‘‘active financing income.’’ 214 The regulations 

further provide that a corporation that is not predominantly engaged in the active conduct of a banking, insurance, financing, or 

similar business under the preceding definition can derive financial 

services income if the corporation is a member of an affiliated 

group (as defined in section 1504(a), but expanded to include foreign corporations) that, as a whole, meets the regulatory test of 

being ‘‘predominantly engaged.’’ 215 In determining whether an affiliated group is ‘‘predominantly engaged,’’ only the income of members of the group that are U.S. corporations, or controlled foreign 

corporations in which such U.S. corporations own (directly or indirectly) at least 80 percent of the total voting power and value of 

the stock, are counted. 

‘‘Base difference’’ items 

Under Treasury regulations, foreign taxes are allocated and 

apportioned to the same limitation categories as the income to 

which they relate.216 In cases in which foreign law imposes tax on 

an item of income that does not constitute income under U.S. tax 

383 

217Treas. Reg. sec. 1.904–6(a)(1)(iv). 218See Treas. Reg. sec. 1.904–4(e). 

principles (a ‘‘base difference’’ item), the tax is treated as imposed 

on income in the general limitation category.217

HOUSE BILL

In general 

The provision generally reduces the number of foreign tax 

credit limitation categories to two: passive category income and 

general category income. Other income is included in one of the two 

categories, as appropriate. For example, shipping income generally 

falls into the general limitation category, whereas high withholding 

tax interest generally could fall into the passive income or the general limitation category, depending on the circumstances. Dividends from a domestic international sales corporation or former domestic international sales corporation, income attributable to certain foreign trade income, and certain distributions from a foreign 

sales corporation or former foreign sales corporation all are assigned to the passive income limitation category. The provision 

does not affect the separate computation of foreign tax credit limitations under special provisions of the Code relating to, for example, treaty-based sourcing rules or specified countries under section 

901(j). 

Financial services income 

In the case of a member of a financial services group or any 

other person predominantly engaged in the active conduct of a 

banking, insurance, financing or similar business, the provision 

treats income meeting the definition of financial services income as 

general category income. Under the provision, a financial services 

group is an affiliated group that is predominantly engaged in the 

active conduct of a banking, insurance, financing or similar business. For this purpose, the definition of an affiliated group under 

section 1504(a) is applied, but expanded to include certain insurance companies (without regard to whether such companies are 

covered by an election under section 1504(c)(2)) and foreign corporations. In determining whether such a group is predominantly 

engaged in the active conduct of a banking, insurance, financing, 

or similar business, only the income of members of the group that 

are U.S. corporations or controlled foreign corporations in which 

such U.S. corporations own (directly or indirectly) at least 80 percent of total voting power and value of the stock are taken into account. 

The provision does not alter the present law interpretation of 

what it means to be a ‘‘person predominantly engaged in the active 

conduct of a banking, insurance, financing, or similar business.’’ 218

Thus, other provisions of the Code that rely on this same concept 

of a ‘‘person predominantly engaged in the active conduct of a 

banking, insurance, financing, or similar business’’ are not affected 

by the provision. For example, under the ‘‘accumulated deficit rule’’ 

of section 952(c)(1)(B), subpart F income inclusions of a U.S. shareholder attributable to a ‘‘qualified activity’’ of a controlled foreign 

corporation may be reduced by the amount of the U.S. shareVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00387 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
384 

219See H.R. Rep. No. 99–841, 99th Cong., 2d Sess. II–621 (1986); Staff of the Joint Committee 

on Taxation, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986, at 984 

(1987). 

holder’s pro rata share of certain prior year deficits attributable to 

the same qualified activity. In the case of a qualified financial institution, qualified activity consists of any activity giving rise to foreign personal holding company income, but only if the controlled 

foreign corporation was predominantly engaged in the active conduct of a banking, financing, or similar business in both the year 

in which the corporation earned the income and the year in which 

the corporation incurred the deficit. Similarly, in the case of a 

qualified insurance company, qualified activity consists of activity 

giving rise to insurance income or foreign personal holding company income, but only if the controlled foreign corporation was predominantly engaged in the active conduct of an insurance business 

in both the year in which the corporation earned the income and 

the year in which the corporation incurred the deficit. For this purpose, ‘‘predominantly engaged in the active conduct of a banking, 

insurance, financing, or similar business’’ is defined under present 

law by reference to the use of the term for purposes of the separate 

foreign tax credit limitations.219 The present-law meaning of ‘‘predominantly engaged’’ for purposes of section 952(c)(1)(B) remains 

unchanged under the provision. 

The provision requires the Treasury Secretary to specify the 

treatment of financial services income received or accrued by passthrough entities that are not members of a financial services group. 

The Committee expects these regulations to be generally consistent 

with regulations currently in effect. 

‘‘Base difference’’ items 

Creditable foreign taxes that are imposed on amounts that do 

not constitute income under U.S. tax principles are treated as imposed on general limitation income. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2006. Taxes paid or accrued in a taxable year beginning before January 1, 2007, and carried to any subsequent taxable year are treated as if this provision were in effect 

on the date such taxes were paid or accrued. Thus, such taxes are 

assigned to one of the two foreign tax credit limitation categories, 

as appropriate. The Treasury Secretary is given authority to provide by regulations for the allocation of income with respect to 

taxes carried back to pre-effective-date years (in which more than 

two limitation categories are in effect). 

SENATE AMENDMENT

Under the provision, creditable foreign taxes that are imposed 

on amounts that do not constitute income under U.S. tax principles 

are treated as imposed either on general limitation income or on 

financial services income, at the taxpayer’s election. Once made, 

this election applies to all such taxes and is revocable only with the 

consent of the Secretary. 

Effective date.—The provision is effective for taxable years ending after date of enactment. 

385 

220Dividends paid by a 10/50 company in taxable years beginning before January 1, 2003 are 

subject to a separate foreign tax credit limitation for each 10/50 company. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with a modification relating to base differences. As in the House bill, creditable 

foreign taxes that are imposed on amounts that do not constitute 

income under U.S. tax principles are treated as imposed on general 

limitation income, as of the general effective date of the House bill 

provision. The conference agreement adds a provision under which 

any such taxes arising in taxable years beginning after December 

31, 2004, but before January 1, 2007 (when the number of limitation categories is reduced to two), are treated as imposed on either 

general limitation income or financial services income, at the taxpayer’s election. Once made, this election applies to all such taxes 

for the taxable years described above and is revocable only with the 

consent of the Treasury Secretary. 

4. Apply look-through rules for dividends from noncontrolled section 902 corporations (sec. 304 of the House bill, sec. 202 of the 

Senate amendment, and sec. 904 of the Code) 

PRESENT LAW

U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. In general, the amount of foreign tax credits 

that may be claimed in a year is subject to a limitation that prevents taxpayers from using foreign tax credits to offset U.S. tax on 

U.S.-source income. Separate limitations are also applied to specific 

categories of income. 

Special foreign tax credit limitations apply in the case of dividends received from a foreign corporation in which the taxpayer 

owns at least 10 percent of the stock by vote and which is not a 

controlled foreign corporation (a so-called ‘‘10/50 company’’). Dividends paid by a 10/50 company that is not a passive foreign investment company out of earnings and profits accumulated in taxable 

years beginning before January 1, 2003 are subject to a single foreign tax credit limitation for all 10/50 companies (other than passive foreign investment companies).220 Dividends paid by a 10/50 

company that is a passive foreign investment company out of earnings and profits accumulated in taxable years beginning before 

January 1, 2003 continue to be subject to a separate foreign tax 

credit limitation for each such 10/50 company. Dividends paid by 

a 10/50 company out of earnings and profits accumulated in taxable years after December 31, 2002 are treated as income in a foreign tax credit limitation category in proportion to the ratio of the 

10/50 company’s earnings and profits attributable to income in 

such foreign tax credit limitation category to its total earnings and 

profits (a ‘‘look-through’’ approach). 

For these purposes, distributions are treated as made from the 

most recently accumulated earnings and profits. Regulatory authority is granted to provide rules regarding the treatment of distributions out of earnings and profits for periods prior to the taxpayer’s acquisition of such stock. 

386 

221This look-through treatment also applies to dividends that a controlled foreign corporation 

receives from a 10/50 company and then distributes to a U.S. shareholder. 222 It is anticipated that the Treasury Secretary will reconsider the operation of the foreign 

tax credit regulations to ensure that the high-tax income rules apply appropriately to dividends 

treated as passive category income because of inadequate substantiation. 

HOUSE BILL

The provision generally applies the look-through approach to 

dividends paid by a 10/50 company regardless of the year in which 

the earnings and profits out of which the dividend is paid were accumulated.221 If the Treasury Secretary determines that a taxpayer 

has inadequately substantiated that it assigned a dividend from a 

10/50 company to the proper foreign tax credit limitation category, 

the dividend is treated as passive category income for foreign tax 

credit basketing purposes.222

Effective date.—The provision is effective for taxable years beginning after December 31, 2002. The provision also provides transition rules regarding the use of pre-effective-date foreign tax credits associated with a 10/50-company separate limitation category in 

post-effective-date years. Look-through principles similar to those 

applicable to post-effective-date dividends from a 10/50 company 

apply to determine the appropriate foreign tax credit limitation category or categories with respect to carrying forward foreign tax 

credits into future years. The provision allows the Treasury Secretary to issue regulations addressing the carryback of foreign tax 

credits associated with a dividend from a 10/50 company to pre-effective-date years. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

5. Attribution of stock ownership through partnerships in determining section 902 and 960 credits (sec. 305 of the House bill, 

sec. 213 of the Senate amendment, and sec. 902 of the Code) 

PRESENT LAW

Under section 902, a domestic corporation that receives a dividend from a foreign corporation in which it owns 10 percent or 

more of the voting stock is deemed to have paid a portion of the 

foreign taxes paid by such foreign corporation. Thus, such a domestic corporation is eligible to claim a foreign tax credit with respect 

to such deemed-paid taxes. The domestic corporation that receives 

a dividend is deemed to have paid a portion of the foreign corporation’s post-1986 foreign income taxes based on the ratio of the 

amount of the dividend to the foreign corporation’s post-1986 undistributed earnings and profits. 

Foreign income taxes paid or accrued by lower-tier foreign corporations also are eligible for the deemed-paid credit if the foreign 

corporation falls within a qualified group (sec. 902(b)). A ‘‘qualified 

group’’ includes certain foreign corporations within the first six 

tiers of a chain of foreign corporations if, among other things, the 

387 

223 Under section 901(b)(5), an individual member of a partnership or a beneficiary of an estate or trust generally may claim a direct foreign tax credit with respect to the amount of his 

or her proportionate share of the foreign taxes paid or accrued by the partnership, estate, or 

trust. This rule does not specifically apply to corporations that are either members of a partnership or beneficiaries of an estate or trust. However, section 702(a)(6) provides that each partner 

(including individuals or corporations) of a partnership must take into account separately its 

distributive share of the partnership’s foreign taxes paid or accrued. In addition, under section 

703(b)(3), the election under section 901 (whether to credit the foreign taxes) is made by each 

partner separately. 224 1971–1 C.B. 211. 225T.D. 8708, 1997–1 C.B. 137. 

product of the percentage ownership of voting stock at each level 

of the chain (beginning from the domestic corporation) equals at 

least five percent. In addition, in order to claim indirect credits for 

foreign taxes paid by certain fourth-, fifth-, and sixth-tier corporations, such corporations must be controlled foreign corporations 

(within the meaning of sec. 957) and the shareholder claiming the 

indirect credit must be a U.S. shareholder (as defined in sec. 

951(b)) with respect to the controlled foreign corporations. The application of the indirect foreign tax credit below the third tier is 

limited to taxes paid in taxable years during which the payor is a 

controlled foreign corporation. Foreign taxes paid below the sixth 

tier of foreign corporations are ineligible for the indirect foreign tax 

credit. 

Section 960 similarly permits a domestic corporation with subpart F inclusions from a controlled foreign corporation to claim 

deemed-paid foreign tax credits with respect to foreign taxes paid 

or accrued by the controlled foreign corporation on its subpart F income. 

The foreign tax credit provisions in the Code do not specifically 

address whether a domestic corporation owning 10 percent or more 

of the voting stock of a foreign corporation through a partnership 

is entitled to a deemed-paid foreign tax credit.223 In Rev. Rul. 71– 

141,224 the IRS held that a foreign corporation’s stock held indirectly by two domestic corporations through their interests in a domestic general partnership is attributed to such domestic corporations for purposes of determining the domestic corporations’ eligibility to claim a deemed-paid foreign tax credit with respect to the 

foreign taxes paid by such foreign corporation. Accordingly, a general partner of a domestic general partnership is permitted to claim 

deemed-paid foreign tax credits with respect to a dividend distribution from the foreign corporation to the partnership. 

However, in 1997, the Treasury Department issued final regulations under section 902, and the preamble to the regulations 

states that ‘‘[t]he final regulations do not resolve under what circumstances a domestic corporate partner may compute an amount 

of foreign taxes deemed paid with respect to dividends received 

from a foreign corporation by a partnership or other pass-through 

entity.’’ 225 In recognition of the holding in Rev. Rul. 71–141, the 

preamble to the final regulations under section 902 states that a 

‘‘domestic shareholder’’ for purposes of section 902 is a domestic 

corporation that ‘‘owns’’ the requisite voting stock in a foreign corporation rather than one that ‘‘owns directly’’ the voting stock. At 

the same time, the preamble states that the IRS is still considering 

under what other circumstances Rev. Rul. 71–141 should apply. 

Consequently, uncertainty remains regarding whether a domestic 

388 

corporation owning 10 percent or more of the voting stock of a foreign corporation through a partnership is entitled to a deemed-paid 

foreign tax credit (other than through a domestic general partnership). 

HOUSE BILL

The provision clarifies that a domestic corporation is entitled 

to claim deemed-paid foreign tax credits with respect to a foreign 

corporation that is held indirectly through a foreign or domestic 

partnership, provided that the domestic corporation owns (indirectly through the partnership) 10 percent or more of the foreign 

corporation’s voting stock. No inference is intended as to the treatment of such deemed-paid foreign tax credits under present law. 

The provision also clarifies that both individual and corporate partners (or estate or trust beneficiaries) may claim direct foreign tax 

credits with respect to their proportionate shares of taxes paid or 

accrued by a partnership (or estate or trust). 

Effective date.—The provision applies to taxes of foreign corporations for taxable years of such corporations beginning after the 

date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

6. Foreign tax credit treatment of deemed payments under section 

367(d) of the Code (sec. 306 of the House bill, sec. 229 of the 

Senate amendment, and sec. 367(d) of the Code) 

PRESENT LAW

In the case of transfers of intangible property to foreign corporations by means of contributions and certain other nonrecognition transactions, special rules apply that are designed to mitigate 

the tax avoidance that may arise from shifting the income attributable to intangible property offshore. Under section 367(d), the 

outbound transfer of intangible property is treated as a sale of the 

intangible for a stream of contingent payments. The amounts of 

these deemed payments must be commensurate with the income 

attributable to the intangible. The deemed payments are included 

in gross income of the U.S. transferor as ordinary income, and the 

earnings and profits of the foreign corporation to which the intangible was transferred are reduced by such amounts. 

The Taxpayer Relief Act of 1997 (the ‘‘1997 Act’’) repealed a 

rule that treated all such deemed payments as giving rise to U.S.- 

source income. Because the foreign tax credit is generally limited 

to the U.S. tax imposed on foreign-source income, the prior-law rule 

reduced the taxpayer’s ability to claim foreign tax credits. As a result of the repeal of the rule, the source of payments deemed received under section 367(d) is determined under general sourcing 

rules. These rules treat income from sales of intangible property for 

389 

226Secs. 865(d), 862(a). 227Sec. 904(d). 228Sec. 904(d)(3). 229Secs. 951–964. 230Sec. 951(a)(1)(B). 

contingent payments the same as royalties, with the result that the 

deemed payments may give rise to foreign-source income.226

The 1997 Act did not address the characterization of the 

deemed payments for purposes of applying the foreign tax credit 

separate limitation categories.227 If the deemed payments are 

treated like proceeds of a sale, then they could fall into the passive 

category; if the deemed payments are treated like royalties, then 

in many cases they could fall into the general category (under lookthrough rules applicable to payments of dividends, interest, rents, 

and royalties received from controlled foreign corporations).228

HOUSE BILL

The provision specifies that deemed payments under section 

367(d) are treated as royalties for purposes of applying the separate limitation categories of the foreign tax credit. 

Effective date.—The provision is effective for amounts treated 

as received on or after August 5, 1997 (the effective date of the relevant provision of the 1997 Act). 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

7. United States property not to include certain assets of controlled 

foreign corporations (sec. 307 of the House bill, sec. 227 of the 

Senate amendment, and sec. 956 of the Code) 

PRESENT LAW

In general, the subpart F rules 229 require U.S. shareholders 

with a 10-percent or greater interest in a controlled foreign corporation (‘‘U.S. 10-percent shareholders’’) to include in taxable income their pro rata shares of certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’) when such income is earned, whether or not the earnings are distributed currently to the shareholders. In addition, the U.S. 10-percent shareholders of a controlled foreign corporation are subject to U.S. tax 

on their pro rata shares of the controlled foreign corporation’s earnings to the extent invested by the controlled foreign corporation in 

certain U.S. property in a taxable year.230

A shareholder’s income inclusion with respect to a controlled 

foreign corporation’s investment in U.S. property for a taxable year 

is based on the controlled foreign corporation’s average investment 

in U.S. property for such year. For this purpose, the U.S. property 

held (directly or indirectly) by the controlled foreign corporation 

must be measured as of the close of each quarter in the taxable 

390 

231Sec. 956(a). 232Secs. 956 and 959. 233Secs. 951(a)(1)(B) and 959. 234Sec. 956(c)(1). 235Sec. 956(c)(2). 

year.231 The amount taken into account with respect to any property is the property’s adjusted basis as determined for purposes of 

reporting the controlled foreign corporation’s earnings and profits, 

reduced by any liability to which the property is subject. The 

amount determined for inclusion in each taxable year is the shareholder’s pro rata share of an amount equal to the lesser of: (1) the 

controlled foreign corporation’s average investment in U.S. property as of the end of each quarter of such taxable year, to the extent that such investment exceeds the foreign corporation’s earnings and profits that were previously taxed on that basis; or (2) the 

controlled foreign corporation’s current or accumulated earnings 

and profits (but not including a deficit), reduced by distributions 

during the year and by earnings that have been taxed previously 

as earnings invested in U.S. property.232 An income inclusion is required only to the extent that the amount so calculated exceeds the 

amount of the controlled foreign corporation’s earnings that have 

been previously taxed as subpart F income.233

For purposes of section 956, U.S. property generally is defined 

to include tangible property located in the United States, stock of 

a U.S. corporation, an obligation of a U.S. person, and certain intangible assets including a patent or copyright, an invention, model 

or design, a secret formula or process or similar property right 

which is acquired or developed by the controlled foreign corporation 

for use in the United States.234

Specified exceptions from the definition of U.S. property are 

provided for: (1) obligations of the United States, money, or deposits with persons carrying on the banking business; (2) certain export property; (3) certain trade or business obligations; (4) aircraft, 

railroad rolling stock, vessels, motor vehicles or containers used in 

transportation in foreign commerce and used predominantly outside of the United States; (5) certain insurance company reserves 

and unearned premiums related to insurance of foreign risks; (6) 

stock or debt of certain unrelated U.S. corporations; (7) moveable 

property (other than a vessel or aircraft) used for the purpose of 

exploring, developing, or certain other activities in connection with 

the ocean waters of the U.S. Continental Shelf; (8) an amount of 

assets equal to the controlled foreign corporation’s accumulated 

earnings and profits attributable to income effectively connected 

with a U.S. trade or business; (9) property (to the extent provided 

in regulations) held by a foreign sales corporation and related to 

its export activities; (10) certain deposits or receipts of collateral or 

margin by a securities or commodities dealer, if such deposit is 

made or received on commercial terms in the ordinary course of the 

dealer’s business as a securities or commodities dealer; and (11) 

certain repurchase and reverse repurchase agreement transactions 

entered into by or with a dealer in securities or commodities in the 

ordinary course of its business as a securities or commodities dealer.235

391 

236Sec. 986(a)(1). 

HOUSE BILL

The House bill adds two new exceptions from the definition of 

U.S. property for determining current income inclusion by a U.S. 

10-percent shareholder with respect to an investment in U.S. property by a controlled foreign corporation. 

The first exception generally applies to securities acquired and 

held by a controlled foreign corporation in the ordinary course of 

its trade or business as a dealer in securities. The exception applies 

only if the controlled foreign corporation dealer: (1) accounts for the 

securities as securities held primarily for sale to customers in the 

ordinary course of business; and (2) disposes of such securities (or 

such securities mature while being held by the dealer) within a period consistent with the holding of securities for sale to customers 

in the ordinary course of business. 

The second exception generally applies to the acquisition by a 

controlled foreign corporation of obligations issued by a U.S. person 

that is not a domestic corporation and that is not (1) a U.S. 10-percent shareholder of the controlled foreign corporation, or (2) a partnership, estate or trust in which the controlled foreign corporation 

or any related person is a partner, beneficiary or trustee immediately after the acquisition by the controlled foreign corporation of 

such obligation. 

Effective date.—The House bill provision is effective for taxable 

years of foreign corporations beginning after December 31, 2004, 

and for taxable years of United States shareholders with or within 

which such taxable years of such foreign corporations end. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

8. Election not to use average exchange rate for foreign tax paid 

other than in functional currency (sec. 308 of the House bill, 

sec. 224 of the Senate amendment, and sec. 986 of the Code) 

PRESENT LAW

For taxpayers that take foreign income taxes into account 

when accrued, present law provides that the amount of the foreign 

tax credit generally is determined by translating the amount of foreign taxes paid in foreign currencies into a U.S. dollar amount at 

the average exchange rate for the taxable year to which such taxes 

relate.236 This rule applies to foreign taxes paid directly by U.S. 

taxpayers, which taxes are creditable in the year paid or accrued, 

and to foreign taxes paid by foreign corporations that are deemed 

paid by a U.S. corporation that is a shareholder of the foreign corporation, and hence creditable in the year that the U.S. corporation 

receives a dividend or has an income inclusion from the foreign corporation. This rule does not apply to any foreign income tax: (1) 

392 

237Sec. 986(a)(2). 238 Electing taxpayers translate foreign income tax payments pursuant to the same presentlaw rules that apply to taxpayers that are required to translate foreign income taxes using the 

exchange rates as of the time such taxes are paid. 

that is paid after the date that is two years after the close of the 

taxable year to which such taxes relate; (2) of an accrual-basis taxpayer that is actually paid in a taxable year prior to the year to 

which the tax relates; or (3) that is denominated in an inflationary 

currency (as defined by regulations). 

Foreign taxes that are not eligible for translation at the average exchange rate generally are translated into U.S. dollar 

amounts using the exchange rates as of the time such taxes are 

paid. However, the Secretary is authorized to issue regulations that 

would allow foreign tax payments to be translated into U.S. dollar 

amounts using an average exchange rate for a specified period.237

HOUSE BILL

For taxpayers that are required under present law to translate 

foreign income tax payments at the average exchange rate, the 

House bill provides an election to translate such taxes into U.S. 

dollar amounts using the exchange rates as of the time such taxes 

are paid, provided the foreign income taxes are denominated in a 

currency other than the taxpayer’s functional currency.238 Any election under the provision applies to the taxable year for which the 

election is made and to all subsequent taxable years unless revoked 

with the consent of the Secretary. The House bill authorizes the 

Secretary to issue regulations that apply the election to foreign income taxes attributable to a qualified business unit. 

Effective date.—The House bill provision is effective with respect to taxable years beginning after December 31, 2004. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

Effective date.—The Senate amendment provision is effective 

with respect to taxable years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. In addition, the conference agreement provides 

that the election does not apply to regulated investment companies 

that take into account income on an accrual basis. Instead, the conference agreement provides that foreign income taxes paid or accrued by a regulated investment company with respect to such income are translated into U.S. dollar amounts using the exchange 

rate as of the date the income accrues. 

9. Eliminate secondary withholding tax with respect to dividends 

paid by certain foreign corporations (sec. 309 of the House bill, 

sec. 215 of the Senate amendment, and sec. 871 of the Code) 

PRESENT LAW

Nonresident individuals who are not U.S. citizens and foreign 

corporations (collectively, foreign persons) are subject to U.S. tax on 

income that is effectively connected with the conduct of a U.S. 

393 

trade or business; the U.S. tax on such income is calculated in the 

same manner and at the same graduated rates as the tax on U.S. 

persons (secs. 871(b) and 882). Foreign persons also are subject to 

a 30-percent gross basis tax, collected by withholding, on certain 

U.S.-source passive income (e.g., interest and dividends) that is not 

effectively connected with a U.S. trade or business. This 30-percent 

withholding tax may be reduced or eliminated pursuant to an applicable tax treaty. Foreign persons generally are not subject to 

U.S. tax on foreign-source income that is not effectively connected 

with a U.S. trade or business. 

In general, dividends paid by a domestic corporation are treated as being from U.S. sources and dividends paid by a foreign corporation are treated as being from foreign sources. Thus, dividends 

paid by foreign corporations to foreign persons generally are not 

subject to withholding tax because such income generally is treated 

as foreign-source income. 

An exception from this general rule applies in the case of dividends paid by certain foreign corporations. If a foreign corporation 

derives 25 percent or more of its gross income as income effectively 

connected with a U.S. trade or business for the three-year period 

ending with the close of the taxable year preceding the declaration 

of a dividend, then a portion of any dividend paid by the foreign 

corporation to its shareholders will be treated as U.S.-source income and, in the case of dividends paid to foreign shareholders, will 

be subject to the 30-percent withholding tax (sec. 861(a)(2)(B)). This 

rule is sometimes referred to as the ‘‘secondary withholding tax.’’ 

The portion of the dividend treated as U.S.-source income is equal 

to the ratio of the gross income of the foreign corporation that was 

effectively connected with its U.S. trade or business over the total 

gross income of the foreign corporation during the three-year period 

ending with the close of the preceding taxable year. The U.S.- 

source portion of the dividend paid by the foreign corporation to its 

foreign shareholders is subject to the 30-percent withholding tax. 

Under the branch profits tax provisions, the United States 

taxes foreign corporations engaged in a U.S. trade or business on 

amounts of U.S. earnings and profits that are shifted out of the 

U.S. branch of the foreign corporation. The branch profits tax is 

comparable to the second-level taxes imposed on dividends paid by 

a domestic corporation to its foreign shareholders. The branch profits tax is 30 percent of the foreign corporation’s ‘‘dividend equivalent amount,’’ which generally is the earnings and profits of a U.S. 

branch of a foreign corporation attributable to its income effectively 

connected with a U.S. trade or business (secs. 884(a) and (b)). 

If a foreign corporation is subject to the branch profits tax, 

then no secondary withholding tax is imposed on dividends paid by 

the foreign corporation to its shareholders (sec. 884(e)(3)(A)). If a 

foreign corporation is a qualified resident of a tax treaty country 

and claims an exemption from the branch profits tax pursuant to 

the treaty, the secondary withholding tax could apply with respect 

to dividends it pays to its shareholders. Several tax treaties (including treaties that prevent imposition of the branch profits tax), 

however, exempt dividends paid by the foreign corporation from the 

secondary withholding tax. 

394 

239Sec. 861(a)(1). 240Treas. Reg. sec. 1.861–2(a)(2). 241Sec. 884(f)(1). 

HOUSE BILL

The provision eliminates the secondary withholding tax with 

respect to dividends paid by certain foreign corporations. 

Effective date.—The provision is effective for payments made 

after December 31, 2004. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

10. Equal treatment for interest paid by foreign partnerships and 

foreign corporations (sec. 310 of the House bill, sec. 228 of the 

Senate amendment, and sec. 861 of the Code) 

PRESENT LAW

In general, interest income from bonds, notes or other interestbearing obligations of noncorporate U.S. residents or domestic corporations is treated as U.S.-source income.239 Other interest (e.g., 

interest on obligations of foreign corporations and foreign partnerships) generally is treated as foreign-source income. However, 

Treasury regulations provide that a foreign partnership is a U.S. 

resident for purposes of this rule if at any time during its taxable 

year it is engaged in a trade or business in the United States.240

Therefore, any interest received from such a foreign partnership is 

U.S.-source income. 

Notwithstanding the general rule described above, in the case 

of a foreign corporation engaged in a U.S. trade or business (or 

having gross income that is treated as effectively connected with 

the conduct of a U.S. trade or business), interest paid by such U.S. 

trade or business is treated as if it were paid by a domestic corporation (i.e., such interest is treated as U.S.-source income).241

HOUSE BILL

The House bill treats interest paid by foreign partnerships in 

a manner similar to the treatment of interest paid by foreign corporations. Thus, interest paid by a foreign partnership is treated 

as U.S.-source income only if the interest is paid by a U.S. trade 

or business conducted by the partnership or is allocable to income 

that is treated as effectively connected with the conduct of a U.S. 

trade or business. The House bill applies only to foreign partnerships that are predominantly engaged in the active conduct of a 

trade or business outside the United States. 

Effective date.—This House bill provision is effective for taxable years beginning after December 31, 2003. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

395 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

11. Look-through treatment of payments between related controlled 

foreign corporations (sec. 311 of the House bill, sec. 222 of the 

Senate amendment, and sec. 954 of the Code) 

PRESENT LAW

In general, the rules of subpart F (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation to include certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’) on a current 

basis for U.S. tax purposes, regardless of whether the income is 

distributed to the shareholders. 

Subpart F income includes foreign base company income. One 

category of foreign base company income is foreign personal holding company income. For subpart F purposes, foreign personal 

holding company income generally includes dividends, interest, 

rents and royalties, among other types of income. However, foreign 

personal holding company income does not include dividends and 

interest received by a controlled foreign corporation from a related 

corporation organized and operating in the same foreign country in 

which the controlled foreign corporation is organized, or rents and 

royalties received by a controlled foreign corporation from a related 

corporation for the use of property within the country in which the 

controlled foreign corporation is organized. Interest, rent, and royalty payments do not qualify for this exclusion to the extent that 

such payments reduce the subpart F income of the payor. 

HOUSE BILL

Under the provision, dividends, interest, rents, and royalties 

received by one controlled foreign corporation from a related controlled foreign corporation are not treated as foreign personal holding company income to the extent attributable or properly allocable 

to non-subpart-F income of the payor. For these purposes, a related 

controlled foreign corporation is a controlled foreign corporation 

that controls or is controlled by the other controlled foreign corporation, or a controlled foreign corporation that is controlled by 

the same person or persons that control the other controlled foreign 

corporation. Ownership of more than 50 percent of the controlled 

foreign corporation’s stock (by vote or value) constitutes control for 

these purposes. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

396 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

Senate amendment provision. 

12. Look-through treatment under subpart F for sales of partnership interests (sec. 312 of the House bill, sec. 223 of the Senate 

amendment, and sec. 954 of the Code) 

PRESENT LAW

In general, the subpart F rules (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation to include in income currently for U.S. tax purposes certain types of income of the controlled foreign corporation, 

whether or not such income is actually distributed currently to the 

shareholders (referred to as ‘‘subpart F income’’). Subpart F income 

includes foreign personal holding company income. Foreign personal holding company income generally consists of the following: 

(1) dividends, interest, royalties, rents, and annuities; (2) net gains 

from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate 

mortgages investment conduits (‘‘REMICs’’); (3) net gains from 

commodities transactions; (4) net gains from foreign currency 

transactions; (5) income that is equivalent to interest; (6) income 

from notional principal contracts; and (7) payments in lieu of dividends. Thus, if a controlled foreign corporation sells a partnership 

interest at a gain, the gain generally constitutes foreign personal 

holding company income and is included in the income of 10-percent U.S. shareholders of the controlled foreign corporation as subpart F income. 

HOUSE BILL

The provision treats the sale by a controlled foreign corporation of a partnership interest as a sale of the proportionate share 

of partnership assets attributable to such interest for purposes of 

determining subpart F foreign personal holding company income. 

This rule applies only to partners owning directly, indirectly, or 

constructively at least 25 percent of a capital or profits interest in 

the partnership. Thus, the sale of a partnership interest by a controlled foreign corporation that meets this ownership threshold constitutes subpart F income under the provision only to the extent 

that a proportionate sale of the underlying partnership assets attributable to the partnership interest would constitute subpart F 

income. The Treasury Secretary is directed to prescribe such regulations as may be appropriate to prevent the abuse of this provision. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

397 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

13. Repeal of foreign personal holding company rules and foreign 

investment company rules (sec. 313 of the House bill, sec. 211 

of the Senate amendment, and secs. 542, 551–558, 954, 1246, 

and 1247 of the Code) 

PRESENT LAW

Income earned by a foreign corporation from its foreign operations generally is subject to U.S. tax only when such income is 

distributed to any U.S. persons that hold stock in such corporation. 

Accordingly, a U.S. person that conducts foreign operations through 

a foreign corporation generally is subject to U.S. tax on the income 

from those operations when the income is repatriated to the United 

States through a dividend distribution to the U.S. person. The income is reported on the U.S. person’s tax return for the year the 

distribution is received, and the United States imposes tax on such 

income at that time. The foreign tax credit may reduce the U.S. tax 

imposed on such income. 

Several sets of anti-deferral rules impose current U.S. tax on 

certain income earned by a U.S. person through a foreign corporation. Detailed rules for coordination among the anti-deferral rules 

are provided to prevent the U.S. person from being subject to U.S. 

tax on the same item of income under multiple rules. 

The Code sets forth the following anti-deferral rules: the controlled foreign corporation rules of subpart F (secs. 951–964); the 

passive foreign investment company rules (secs. 1291–1298); the 

foreign personal holding company rules (secs. 551–558); the personal holding company rules (secs. 541–547); the accumulated earnings tax rules (secs. 531–537); and the foreign investment company 

rules (secs. 1246–1247). 

HOUSE BILL

The provision: (1) eliminates the rules applicable to foreign 

personal holding companies and foreign investment companies; (2) 

excludes foreign corporations from the application of the personal 

holding company rules; and (3) includes as subpart F foreign personal holding company income personal services contract income 

that is subject to the present-law foreign personal holding company 

rules. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable 

years of foreign corporations end. 

SENATE AMENDMENT

The Senate amendment provision is the same as the House bill 

provision. 

398 

242For hedging transactions entered into on or after January 31, 2003, Treasury regulations 

provide that gains or losses from a commodities hedging transaction generally are excluded from 

the definition of foreign personal holding company income if the transaction is with respect to 

the controlled foreign corporation’s business as a producer, processor, merchant or handler of 

commodities, regardless of whether the transaction is a hedge with respect to a sale of commodities in the active conduct of a commodities business by the controlled foreign corporation. The 

regulations also provide that, for purposes of satisfying the requirements for exclusion from the 

definition of foreign personal holding company income, a producer, processor, merchant or handler of commodities includes a controlled foreign corporation that regularly uses commodities in 

a manufacturing, construction, utilities, or transportation business (Treas. Reg. sec. 1.954– 

2(f)(2)(v)). However, the regulations provide that a controlled foreign corporation is not a producer, processor, merchant or handler of commodities (and therefore would not satisfy the requirements for exclusion) if its business is primarily financial (Treas. Reg. sec. 1.954–2(f)(2)(v)). 243Treasury regulations provide that substantially all of a controlled foreign corporation’s 

business is as an active producer, processor, merchant or handler of commodities if: (1) the sum 

of its gross receipts from all of its active sales of commodities in such capacity and its gross 

receipts from all of its commodities hedging transactions that qualify for exclusion from the definition of foreign personal holding company income, equals or exceeds (2) 85 percent of its total 

receipts for the taxable year (computed as though the controlled foreign corporation was a domestic corporation) (Treas. Reg. sec. 1.954–2(f)(2)(iii)(C)). 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

14. Determination of foreign personal holding company income with 

respect to transactions in commodities (sec. 314 of the House 

bill, sec. 206 of the Senate amendment, and sec. 954 of the 

Code) 

PRESENT LAW

Subpart F foreign personal holding company income 

Under the subpart F rules, U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation (‘‘U.S. 

10-percent shareholders’’) are subject to U.S. tax currently on certain income earned by the controlled foreign corporation, whether 

or not such income is distributed to the shareholders. The income 

subject to current inclusion under the subpart F rules includes, 

among other things, ‘‘foreign personal holding company income.’’ 

Foreign personal holding company income generally consists of 

the following: dividends, interest, royalties, rents and annuities; 

net gains from sales or exchanges of (1) property that gives rise to 

the foregoing types of income, (2) property that does not give rise 

to income, and (3) interests in trusts, partnerships, and real estate 

mortgage investment conduits (‘‘REMICs’’); net gains from commodities transactions; net gains from foreign currency transactions; income that is equivalent to interest; income from notional principal 

contracts; and payments in lieu of dividends. 

With respect to transactions in commodities, foreign personal 

holding company income does not consist of gains or losses which 

arise out of bona fide hedging transactions that are reasonably necessary to the conduct of any business by a producer, processor, 

merchant, or handler of a commodity in the manner in which such 

business is customarily and usually conducted by others.242 In addition, foreign personal holding company income does not consist of 

gains or losses which are comprised of active business gains or 

losses from the sale of commodities, but only if substantially all of 

the controlled foreign corporation’s business is as an active producer, processor, merchant, or handler of commodities.243

399 

244Sec. 1221(a)(7). 245Sec. 1221(b)(2)(A). 246Sec. 1221(a)(7) and (b)(2)(B). 

Hedging transactions 

Under present law, the term ‘‘capital asset’’ does not include 

any hedging transaction which is clearly identified as such before 

the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations 

prescribe).244 The term ‘‘hedging transaction’’ means any transaction entered into by the taxpayer in the normal course of the taxpayer’s trade or business primarily: (1) to manage risk of price 

changes or currency fluctuations with respect to ordinary property 

which is held or to be held by the taxpayer; (2) to manage risk of 

interest rate or price changes or currency fluctuations with respect 

to borrowings made or to be made, or ordinary obligations incurred 

or to be incurred, by the taxpayer; or (3) to manage such other 

risks as the Secretary may prescribe in regulations.245

HOUSE BILL

The House bill modifies the requirements that must be satisfied for gains or losses from a commodities hedging transaction to 

qualify for exclusion from the definition of subpart F foreign personal holding company income. Under the House bill, gains or 

losses from a transaction with respect to a commodity are not 

treated as foreign personal holding company income if the transaction satisfies the general definition of a hedging transaction 

under section 1221(b)(2). For purposes of the House bill, the general definition of a hedging transaction under section 1221(b)(2) is 

modified to include any transaction with respect to a commodity 

entered into by a controlled foreign corporation in the normal 

course of the controlled foreign corporation’s trade or business primarily: (1) to manage risk of price changes or currency fluctuations 

with respect to ordinary property or property described in section 

1231(b) which is held or to be held by the controlled foreign corporation; or (2) to manage such other risks as the Secretary may 

prescribe in regulations. Gains or losses from a transaction that 

satisfies the modified definition of a hedging transaction are excluded from the definition of foreign personal holding company income only if the transaction is clearly identified as a hedging transaction in accordance with the hedge identification requirements 

that apply generally to hedging transactions under section 

1221(b)(2).246

The House bill also changes the requirements that must be 

satisfied for active business gains or losses from the sale of commodities to qualify for exclusion from the definition of foreign personal holding company income. Under the House bill, such gains or 

losses are not treated as foreign personal holding company income 

if substantially all of the controlled foreign corporation’s commodities are comprised of: (1) stock in trade of the controlled foreign 

corporation or other property of a kind which would properly be included in the inventory of the controlled foreign corporation if on 

hand at the close of the taxable year, or property held by the controlled foreign corporation primarily for sale to customers in the orVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00403 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
400 

247For purposes of determining whether substantially all of the controlled foreign corporation’s commodities are comprised of such property, it is intended that the 85-percent requirement provided in the current Treasury regulations (as modified to reflect the changes made by 

the House bill) continue to apply. 

dinary course of the controlled foreign corporation’s trade or business; (2) property that is used in the trade or business of the controlled foreign corporation and is of a character which is subject to 

the allowance for depreciation under section 167; or (3) supplies of 

a type regularly used or consumed by the controlled foreign corporation in the ordinary course of a trade or business of the controlled foreign corporation.247

For purposes of applying the requirements for active business 

gains or losses from commodities sales to qualify for exclusion from 

the definition of foreign personal holding company income, the 

House bill also provides that commodities with respect to which 

gains or losses are not taken into account as foreign personal holding company income by a regular dealer in commodities (or financial instruments referenced to commodities) are not taken into account in determining whether substantially all of the dealer’s commodities are comprised of the property described above. 

Effective date.—The House bill provision is effective with respect to transactions entered into after December 31, 2004. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

15. Modifications to treatment of aircraft leasing and shipping income (sec. 315 of the House bill, sec. 221 of the Senate amendment, and sec. 954 of the Code) 

PRESENT LAW

In general, the subpart F rules (secs. 951–964) require U.S. 

shareholders with a 10-percent or greater interest in a controlled 

foreign corporation (‘‘CFC’’) to include currently in income for U.S. 

tax purposes certain income of the CFC (referred to as ‘‘subpart F 

income’’), without regard to whether the income is distributed to 

the shareholders (sec. 951(a)(1)(A)). In effect, the Code treats the 

U.S. 10-percent shareholders of a CFC as having received a current 

distribution of their pro rata shares of the CFC’s subpart F income. 

The amounts included in income by the CFC’s U.S. 10-percent 

shareholders under these rules are subject to U.S. tax currently. 

The U.S. tax on such amounts may be reduced through foreign tax 

credits. 

Subpart F income includes foreign base company shipping income (sec. 954(f)). Foreign base company shipping income generally 

includes income derived from the use of an aircraft or vessel in foreign commerce, the performance of services directly related to the 

use of any such aircraft or vessel, the sale or other disposition of 

any such aircraft or vessel, and certain space or ocean activities 

(e.g., leasing of satellites for use in space). Foreign commerce genVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00404 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
401 

248 ‘‘Active-leasing expenses’’ are section 162 expenses properly allocable to rental income 

other than (1) deductions for compensation for personal services rendered by the lessor’s shareholders or a related person, (2) deductions for rents, (3) section 167 and 168 expenses, and (4) 

deductions for payments to independent contractors with respect to leased property. Treas. Reg. 

sec. 1.954–2(c)(2)(iii). 249Generally, ‘‘adjusted leasing profit’’ is rental income less the sum of (1) rents paid or incurred by the CFC with respect to such rental income; (2) section 167 and 168 expenses with 

respect to such rental income; and (3) payments to independent contractors with respect to such 

rental income. Treas. Reg. sec. 1.954–2(c)(2)(iv). 

erally involves the transportation of property or passengers between a port (or airport) in the U.S. and a port (or airport) in a 

foreign country, two ports (or airports) within the same foreign 

country, or two ports (or airports) in different foreign countries. In 

addition, foreign base company shipping income includes dividends 

and interest that a CFC receives from certain foreign corporations 

and any gains from the disposition of stock in certain foreign corporations, to the extent the dividends, interest, or gains are attributable to foreign base company shipping income. Foreign base company shipping income also includes incidental income derived in 

the course of active foreign base company shipping operations (e.g., 

income from temporary investments in or sales of related shipping 

assets), foreign exchange gain or loss attributable to foreign base 

company shipping operations, and a CFC’s distributive share of 

gross income of any partnership and gross income received from 

certain trusts to the extent that the income would have been foreign base company shipping income had it been realized directly by 

the corporation. 

Subpart F income also includes foreign personal holding company income (sec. 954(c)). For subpart F purposes, foreign personal 

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

dividends, interest, royalties, rents and annuities; (2) net gains 

from the sale or exchange of (a) property that gives rise to the preceding types of income, (b) property that does not give rise to income, and (c) interests in trusts, partnerships, and real estate 

mortgage investment conduits (‘‘REMICs’’); (3) net gains from commodities transactions; (4) net gains from foreign currency transactions; (5) income that is equivalent to interest; (6) income from 

notional principal contracts; and (7) payments in lieu of dividends. 

Subpart F foreign personal holding company income does not 

include rents and royalties received by a CFC in the active conduct 

of a trade or business from unrelated persons (sec. 954(c)(2)(A)). 

The determination of whether rents or royalties are derived in the 

active conduct of a trade or business is based on all the facts and 

circumstances. However, the Treasury regulations provide certain 

types of rents are treated as derived in the active conduct of a 

trade or business. These include rents derived from property that 

is leased as a result of the performance of marketing functions by 

the lessor if the lessor (through its own officers or employees located in a foreign country) maintains and operates an organization 

in such country that regularly engages in the business of marketing, or marketing and servicing, the leased property and that is 

substantial in relation to the amount of rents derived from the 

leasing of such property. An organization in a foreign country is 

substantial in relation to rents if the active leasing expenses 248

equal at least 25 percent of the adjusted leasing profit.249

402 

Also generally excluded from subpart F foreign personal holding company income are rents and royalties received by the CFC 

from a related corporation for the use of property within the country in which the CFC was organized (sec. 954(c)(3)). However, rent 

and royalty payments do not qualify for this exclusion to the extent 

that such payments reduce subpart F income of the payor. 

HOUSE BILL

The provision repeals the subpart F rules relating to foreign 

base company shipping income. The bill also amends the exception 

from foreign personal holding company income applicable to rents 

or royalties derived from unrelated persons in an active trade or 

business by providing a safe harbor for rents derived from leasing 

an aircraft or vessel in foreign commerce. Such rents are excluded 

from foreign personal holding company income if the active leasing 

expenses comprise at least 10 percent of the profit on the lease. 

This provision is to be applied in accordance with existing regulations under section 954(c)(2)(A) by comparing the lessor’s ‘‘active 

leasing expenses’’ for its pool of leased assets to its ‘‘adjusted leasing profit.’’ 

The safe harbor will not prevent a lessor from otherwise showing that it actively carries on a trade or business. In this regard, 

the requirements of section 954(c)(2)(A) will be met if a lessor regularly and directly performs active and substantial marketing, remarketing, management and operational functions with respect to 

the leasing of an aircraft or vessel (or component engines). This 

will be the case regardless of whether the lessor engages in marketing of the lease as a form of financing (versus marketing the 

property as such) or whether the lease is classified as a finance 

lease or operating lease for financial accounting purposes. If a lessor acquires, from an unrelated or related party, a ship or aircraft 

subject to an existing FSC or ETI lease, the requirements of section 

954(c)(2)(A) will be satisfied if, following the acquisition, the lessor 

performs active and substantial management, operational, and remarketing functions with respect to the leased property. If such a 

lease is transferred to a CFC lessor, it will no longer be eligible for 

FSC or ETI benefits. 

An aircraft or vessel is considered to be leased in foreign commerce if it is used for the transportation of property or passengers 

between a port (or airport) in the United States and one in a foreign country or between foreign ports (or airports), provided the 

aircraft or vessel is used predominantly outside the United States. 

An aircraft or vessel will be considered used predominantly outside 

the United States if more than 50 percent of the miles during the 

taxable year are traversed outside the United States or the aircraft 

or vessel is located outside the United States more than 50 percent 

of the time during such taxable year. 

It is expected that the Secretary of the Treasury will issue 

timely guidance to make conforming changes to existing regulations, including guidance that aircraft or vessel leasing activity 

that satisfies the requirements of section 954(c)(2)(A) shall also satisfy the requirements for avoiding income inclusion under section 

956 and section 367(a). 

403 

It is anticipated that taxpayers now eligible for the benefits of 

the ETI exclusion (or the FSC provisions pursuant to the FSC Repeal and Extraterritorial Income Exclusion Act of 2000), will find 

it appropriate, as matter of sound business judgment, to restructure their business operations to take into account the tax law 

changes brought about by the bill. It is noted that courts have recognized the validity of structuring operations for the purpose of obtaining the benefit of tax regimes expressly intended by Congress. 

It is intended that structuring or restructuring of operations for the 

purposes of adapting to the repeal of the ETI exclusion (or the FSC 

regime) will be considered to serve a valid business purpose and 

will not constitute tax avoidance, where the restructured operations conform to the requirements expressly mandated by Congress for obtaining tax benefits that remain available. For example, 

it is intended that a restructuring undertaken to transfer aircraft 

subject to existing FSC or ETI leases to a CFC lessor, to take advantage of the amendments made by this bill, would serve a valid 

business purpose and would not constitute tax avoidance, for purposes of determining whether a particular tax treatment (such as 

nonrecognition of gain) applies to such restructuring. It is intended, 

for example, that if such a restructuring meets the other requirements necessary to qualify as a ‘‘reorganization’’ under section 368, 

the transaction will also be deemed to meet the ‘‘business purpose’’ 

requirements under section 368, and thus, qualify as a reorganization under that section. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable 

years of foreign corporations end. 

SENATE AMENDMENT

The provision provides that ‘‘qualified leasing income’’ derived 

from or in connection with the leasing or rental of any aircraft or 

vessel is not treated as foreign personal holding company income 

or foreign base company shipping income of a controlled foreign 

corporation. The provision defines ‘‘qualified leasing income’’ as 

rents or gains derived in the active conduct of a leasing trade or 

business with respect to which the controlled foreign corporation 

conducts substantial activity, provided that the leased property is 

used by the lessee or other end-user in foreign commerce and predominantly outside the United States, and such lessee or other 

end-user is not related to the controlled foreign corporation (within 

the meaning of sec. 954(d)(3)). 

In determining whether an aircraft or vessel is used in foreign 

commerce, it is intended that foreign commerce encompass the use 

of an aircraft or vessel in the transportation of property or passengers: (1) between an airport or port in the United States (including for this purpose any possession of the United States) and 

an airport or port in a foreign country; (2) between an airport or 

port in a foreign country and another in the same country; or (3) 

between an airport or port in a foreign country and another in a 

different foreign country. It is intended that an aircraft or vessel 

be considered as used predominantly outside the United States if 

more than 70 percent of its miles traveled during the taxable year 

404 

are traveled outside the United States, or if the aircraft or vessel 

is located outside the United States for more than 70 percent of the 

time during the taxable year. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2006, and taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with the following clarifications. First, the terms ‘‘aircraft or vessels’’ include 

engines that are leased separately from an aircraft or vessel. Second, if a lessor acquires (from a related or unrelated party) or aircraft or vessel subject to an existing lease, the requirements of section 954(c)(2)(A) are satisfied if, following the acquisition, the lessor 

performs active and substantial management, operational, and remarketing functions with respect to the leased property. However, 

if an existing FSC or ETI lease is transferred to a CFC lessor, the 

lease will no longer be eligible for FSC or ETI benefits. 

16. Modification of exceptions under subpart F for active financing 

(sec. 316 of the House bill, sec. 226 of the Senate amendment, 

and sec. 954 of the Code) 

PRESENT LAW

Under the subpart F rules, U.S. shareholders with a 10-percent or greater interest in a controlled foreign corporation (‘‘CFC’’) 

are subject to U.S. tax currently on certain income earned by the 

CFC, whether or not such income is distributed to the shareholders. The income subject to current inclusion under the subpart 

F rules includes, among other things, foreign personal holding company income and insurance income. In addition, 10-percent U.S. 

shareholders of a CFC are subject to current inclusion with respect 

to their shares of the CFC’s foreign base company services income 

(i.e., income derived from services performed for a related person 

outside the country in which the CFC is organized). 

Foreign personal holding company income generally consists of 

the following: (1) dividends, interest, royalties, rents, and annuities; (2) net gains from the sale or exchange of (a) property that 

gives rise to the preceding types of income, (b) property that does 

not give rise to income, and (c) interests in trusts, partnerships, 

and real estate mortgage investment conduits (‘‘REMICs’’); (3) net 

gains from commodities transactions; (4) net gains from foreign 

currency transactions; (5) income that is equivalent to interest; (6) 

income from notional principal contracts; and (7) payments in lieu 

of dividends. 

Insurance income subject to current inclusion under the subpart F rules includes any income of a CFC attributable to the 

issuing or reinsuring of any insurance or annuity contract in connection with risks located in a country other than the CFC’s country of organization. Subpart F insurance income also includes income attributable to an insurance contract in connection with risks 

located within the CFC’s country of organization, as the result of 

an arrangement under which another corporation receives a subVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00408 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
405 

250Temporary exceptions from the subpart F provisions for certain active financing income applied only for taxable years beginning in 1998. Those exceptions were modified and extended 

for one year, applicable only for taxable years beginning in 1999. The Tax Relief Extension Act 

of 1999 (Pub. L. No. 106–170) clarified and extended the temporary exceptions for two years, 

applicable only for taxable years beginning after 1999 and before 2002. The Job Creation and 

Worker Assistance Act of 2002 (Pub. L. No. 107–147) extended the temporary exceptions for five 

years, applicable only for taxable years beginning after 2001 and before 2007, with a modification relating to insurance reserves. 

stantially equal amount of consideration for insurance of other 

country risks. Investment income of a CFC that is allocable to any 

insurance or annuity contract related to risks located outside the 

CFC’s country of organization is taxable as subpart F insurance income (Treas. Reg. sec. 1.953–1(a)). 

Temporary exceptions from foreign personal holding company 

income, foreign base company services income, and insurance income apply for subpart F purposes for certain income that is derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business (so-called ‘‘active 

financing income’’).250

With respect to income derived in the active conduct of a banking, financing, or similar business, a CFC is required to be predominantly engaged in such business and to conduct substantial 

activity with respect to such business in order to qualify for the exceptions. In addition, certain nexus requirements apply, which provide that income derived by a CFC or a qualified business unit 

(‘‘QBU’’) of a CFC from transactions with customers is eligible for 

the exceptions if, among other things, substantially all of the activities in connection with such transactions are conducted directly by 

the CFC or QBU in its home country, and such income is treated 

as earned by the CFC or QBU in its home country for purposes of 

such country’s tax laws. Moreover, the exceptions apply to income 

derived from certain cross border transactions, provided that certain requirements are met. Additional exceptions from foreign personal holding company income apply for certain income derived by 

a securities dealer within the meaning of section 475 and for gain 

from the sale of active financing assets. 

In the case of insurance, in addition to temporary exceptions 

from insurance income and from foreign personal holding company 

income for certain income of a qualifying insurance company with 

respect to risks located within the CFC’s country of creation or organization, temporary exceptions from insurance income and from 

foreign personal holding company income apply for certain income 

of a qualifying branch of a qualifying insurance company with respect to risks located within the home country of the branch, provided certain requirements are met under each of the exceptions. 

Further, additional temporary exceptions from insurance income 

and from foreign personal holding company income apply for certain income of certain CFCs or branches with respect to risks located in a country other than the United States, provided that the 

requirements for these exceptions are met. 

HOUSE BILL

The House bill modifies the present-law temporary exceptions 

from subpart F foreign personal holding company income and foreign base company services income for income derived in the active 

406 

251Section 904(a). 

conduct of a banking, financing, or similar business. For purposes 

of determining whether a CFC or QBU has conducted directly in 

its home country substantially all of the activities in connection 

with transactions with customers, the House bill provides that an 

activity is treated as conducted directly by the CFC or QBU in its 

home country if the activity is performed by employees of a related 

person and: (1) the related person is itself an eligible CFC the 

home country of which is the same as that of the CFC or QBU; (2) 

the activity is performed in the home country of the related person; 

and (3) the related person is compensated on an arm’s length basis 

for the performance of the activity by its employees and such compensation is treated as earned by such person in its home country 

for purposes of the tax laws of such country. For purposes of determining whether a CFC or QBU is eligible to earn active financing 

income, such activity may not be taken into account by any CFC 

or QBU (including the employer of the employees performing the 

activity) other than the CFC or QBU for which the activities are 

performed. 

Effective date.—The House bill provision is effective for taxable 

years of foreign corporations beginning after December 31, 2004, 

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

taxable years of foreign corporations end. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

17. Ten-year foreign tax credit carryover; one-year foreign tax credit carryback (sec. 201 of the Senate amendment and sec. 904 

of the Code) 

PRESENT LAW

U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. The amount of foreign tax credits that may be 

claimed in a year is subject to a limitation that prevents taxpayers 

from using foreign tax credits to offset U.S. tax on U.S.-source income. The amount of foreign tax credits generally is limited to a 

portion of the taxpayer’s U.S. tax which portion is calculated by 

multiplying the taxpayer’s total U.S. tax by a fraction, the numerator of which is the taxpayer’s foreign-source taxable income (i.e., 

foreign-source gross income less allocable expenses or deductions) 

and the denominator of which is the taxpayer’s worldwide taxable 

income for the year.251

In addition, this limitation is calculated separately for various 

categories of income, generally referred to as ‘‘separate limitation 

categories.’’ The total amount of the foreign tax credit used to offset 

the U.S. tax on income in each separate limitation category may 

not exceed the proportion of the taxpayer’s U.S. tax which the taxVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00410 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
407 

payer’s foreign-source taxable income in that category bears to its 

worldwide taxable income. 

The amount of creditable taxes paid or accrued (or deemed 

paid) in any taxable year which exceeds the foreign tax credit limitation is permitted to be carried back to the two immediately preceding taxable years (to the earliest year first) and carried forward 

five taxable years (in chronological order) and credited (not deducted) to the extent that the taxpayer otherwise has excess foreign tax credit limitation for those years. Excess credits that are 

carried back or forward are usable only to the extent that there is 

excess foreign tax credit limitation in such carryover or carryback 

year. Consequently, foreign tax credits arising in a taxable year are 

utilized before excess credits from another taxable year may be carried forward or backward. In addition, excess credits are carried 

forward or carried back on a separate limitation basis. Thus, if a 

taxpayer has excess foreign tax credits in one separate limitation 

category for a taxable year, those excess credits may be carried 

back and forward only as taxes allocable to that category, notwithstanding the fact that the taxpayer may have excess foreign tax 

credit limitation in another category for that year. If credits cannot 

be so utilized, they are permanently disallowed. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision extends the excess foreign tax credit 

carryforward period to twenty years and limits the carryback period to one year. 

Effective date.—The extension of the carryforward period is effective for excess foreign tax credits that may be carried to any taxable years ending after the date of enactment of the provision; the 

limited carryback period is effective for excess foreign tax credits 

arising in taxable years beginning after the date of enactment of 

the provision. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, with 

the modification that the foreign tax credit carryforward period is 

extended to 10 years. 

18. Expand the subpart F de minimis rule to the lesser of five per- cent of gross income or $5 million (sec. 212 of the Senate 

amendment and sec. 954 of the Code) 

PRESENT LAW

Under the rules of subpart F (secs. 951–964), U.S. 10-percent 

shareholders of a controlled foreign corporation are required to include in income currently for U.S. tax purposes certain types of income of the controlled foreign corporation, whether or not such income is actually distributed currently to the shareholders (referred 

to as ‘‘subpart F income’’). Subpart F income includes foreign base 

company income and certain insurance income. Foreign base company income includes five categories of income: foreign personal 

408 

holding company income, foreign base company sales income, foreign base company services income, foreign base company shipping 

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

Under a de minimis rule, if the gross amount of a controlled foreign corporation’s foreign base company income and insurance income for a taxable year is less than the lesser of five percent of the 

controlled foreign corporation’s gross income or $1 million, then no 

part of the controlled foreign corporation’s gross income is treated 

as foreign base company income or insurance income (sec. 

954(b)(3)(A)). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision expands the subpart F de minimis rule to provide that, if the gross amount of a controlled foreign corporation’s 

foreign base company income and insurance income for a taxable 

year is less than the lesser of five percent of the controlled foreign 

corporation’s gross income or $5 million, then no part of the controlled foreign corporation’s gross income is treated as foreign base 

company income or insurance income. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after December 31, 2004, and taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

19. Limit application of uniform capitalization rules in the case of 

foreign persons (sec. 214 of the Senate amendment and sec. 

263A of the Code) 

PRESENT LAW

Taxpayers generally may not currently deduct the costs incurred in producing property or acquiring property for resale. In 

general, the uniform capitalization rules require that a portion of 

the direct and indirect costs of producing property or acquiring 

property for resale be capitalized or included in the cost of inventory (sec. 263A). Consequently, such costs must be recovered 

through an offset to the sales price if the property is produced for 

sale, or through depreciation or amortization if the property is produced for the taxpayer’s own use in a business or investment activity. The purpose of this requirement is to match the costs of producing or acquiring goods with the revenues realized from their 

sale or use in the business or investment activity. 

The uniform capitalization rules apply to foreign corporations, 

whether or not engaged in business in the United States. In the 

case of a foreign corporation carrying on a U.S. trade or business, 

for example, the uniform capitalization rules apply for purposes of 

computing the corporation’s U.S. effectively connected taxable inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00412 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
409 

252Treas. Prop. Reg. sec. 1.964–1(c)(1)(ii)(B). 

come, as well as computing its effectively connected earnings and 

profits for purposes of the branch profits tax. 

When a foreign corporation is not engaged in a trade or business in the United States, its taxable income and earnings and 

profits may nonetheless be relevant under the Code. For example, 

the subpart F income of a controlled foreign corporation may be 

currently includible on the return of a U.S. shareholder of the controlled foreign corporation. Regardless of whether or not a foreign 

corporation is U.S.-controlled, its accumulated earnings and profits 

must be computed in order to determine the amount of taxable 

dividends and the indirect foreign tax credit carried by distributions from the foreign corporation to any domestic corporation that 

owns at least 10 percent of its voting stock. 

The earnings and profits surplus or deficit of any foreign corporation for any taxable year generally is determined according to 

rules substantially similar to those applicable to domestic corporations. However, proposed regulations provide that, for purposes of 

computing a foreign corporation’s earnings and profits, the amount 

of expenses that must be capitalized into inventory under the uniform capitalization rules may not exceed the amount capitalized in 

keeping the taxpayer’s books and records.252 For this purpose, the 

taxpayer’s books and records must be prepared in accordance with 

U.S. generally accepted accounting principles for purposes of reflecting in the financial statements of a domestic corporation the 

operations of its foreign affiliates. This proposed regulation applies 

only for purposes of determining a foreign corporation’s earnings 

and profits and does not apply for purposes of determining subpart 

F income or income effectively connected with a U.S. trade or business of a foreign corporation. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides that, in lieu of the uniform capitalization rules, costs incurred in producing property or acquiring property for resale are capitalized using U.S. generally accepted accounting principles (i.e., the method used to ascertain income, profit, or loss for purposes of reports or statements to shareholders, 

partners, other proprietors, or beneficiaries, or for credit purposes) 

for purposes of determining a U.S.-owned foreign corporation’s 

earnings and profits and subpart F income. The uniform capitalization rules continue to apply to foreign corporations for purposes of 

determining income effectively connected with a U.S. trade or business and the related earnings and profits therefrom. Any change 

in the taxpayer’s method of accounting required as a result of this 

provision is treated as a voluntary change initiated by the taxpayer 

and is deemed made with the consent of the Secretary of the Treasury (i.e., no application for change in method of accounting is required to be filed with the Secretary). Any resultant section 481(a) 

adjustment required to be taken into account is to be taken into 

account in the first year. 

410 

253 Nonresident individuals are subject to the 30-percent gross withholding tax, for example, 

with respect to gains from the sale or exchange of intangible property if the payments are contingent on the productivity, use, or disposition of the property. Secs. 871(a)(1)(D) and 881(a)(4). 

Effective date.—The provision applies to taxable years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

20. Eliminate the 30-percent tax on certain U.S.-source capital 

gains of nonresident individuals (sec. 216 of the Senate amendment and sec. 871 of the Code) 

PRESENT LAW

In general, resident aliens are taxed in the same manner as 

U.S. citizens. Nonresident aliens are subject to (1) U.S. tax on income from U.S. sources that are effectively connected with a U.S. 

trade or business, and (2) a 30-percent withholding tax on the gross 

amount of certain types of passive income derived from U.S. 

sources, such as interest, dividends, rents, and other fixed or determinable annual or periodical income (sec. 871(a)(1)). Bilateral income tax treaties may modify these tax rules. 

Income derived from the sale of personal property other than 

inventory property generally is sourced based on the residence of 

the seller (sec. 865(a)). Thus, nonresident aliens generally are not 

taxable on capital gains because the gains generally are considered 

to be foreign-source income.253

Special rules apply in the case of sales of personal property by 

certain foreign persons. In this regard, an individual who is otherwise treated as a nonresident is treated as a U.S. resident for purposes of sourcing income from the sale of personal property if the 

individual has a tax home in the United States (sec. 

865(g)(1)(A)(i)(II)). An individual’s U.S. tax home generally is the 

place where the individual has his or her principal place of business. For example, if a nonresident individual with a tax home in 

the United States sells stocks or other securities for a gain, the individual will be treated as a U.S. resident with respect to the sale 

such that the gain will be treated as U.S.-source income potentially 

subject to U.S. tax. 

Under the special capital gains tax of section 871(a)(2), a nonresident individual who is physically present in the United States 

for 183 days or more during a taxable year is subject to a 30-percent tax on the excess of U.S.-source capital gains over U.S.-source 

capital losses. This 30-percent tax is not a withholding tax. The tax 

under section 871(a)(2) does not apply to gains and losses subject 

to the gross 30-percent withholding tax under section 871(a)(1) or 

to gains effectively connected with a U.S. trade or business. Capital 

gains and losses are taken into account only to the extent that they 

would be recognized and taken into account if such gains and 

losses were effectively connected with a U.S. trade or business. 

Capital loss carryovers are not taken into account. 

As a practical matter, the special rule under section 871(a)(2) 

applies only in a very limited set of cases. In order for the rule to 

411 

254See the American Law Institute, Federal Income Tax Project, International Aspects of 

United States Income Taxation, Proposals of the American Law Institute on United States Taxation of Foreign Persons and of the Foreign Income of United States Persons, at 112–113 (1987) 

(recommending that sec. 871(a)(2) be eliminated and stating ‘‘[u]nder Section 7701(b), enacted 

in 1984, an individual physically present in the U.S. for 183 days in a calendar year is considered a resident, taxable at net income rates on all of his income; and accordingly the justification for Section 871(a)(2) no longer exists.’’ [footnotes omitted]). 255 It should be noted that there also is a difference with respect to the year over which the 

183-day rule is measured for purposes of the substantial presence test and the rule under sec. 

871(a)(2). The sec. 871(a)(2) tax applies to 183 days or more of presence in the United States 

during the taxable year, while the substantial presence test under sec. 7701(b) applies to 183 

days or more of presence in the United States during the calendar year. In most cases, however, 

a nonresident individual’s taxable year is the calendar year. Secs. 7701(b)(9) and 871(a)(2). 

apply, two conditions must be satisfied: (1) the individual must 

spend at least 183 days in the United States during a taxable year 

without being treated as a U.S. resident, and (2) the individual’s 

capital gains must be from U.S. sources. If these conditions are satisfied, then the 30-percent tax applies to the excess of U.S.-source 

capital gains over U.S.-source capital losses. However, section 

871(a)(2) generally is not applicable because if the individual 

spends 183 days or more in the United States in most cases he or 

she would be treated as a U.S. resident, or if not treated as a U.S. 

resident, would generally not have U.S.-source capital gains. 

An individual who is not a citizen and who spends 183 days 

or more in the United States during a calendar year generally 

would be treated as a U.S. resident under the substantial presence 

test of section 7701(b). Thus, in most cases, the individual who 

spends at least 183 days in the United States would not be subject 

to section 871(a)(2).254 However, under the substantial presence 

test under section 7701(b), certain days of physical presence in the 

United States are not counted for purposes of meeting the 183-day 

rule. This includes days spent in the United States in which the 

individual regularly commutes to employment (or self-employment) 

in the United States from Canada or Mexico; the individual is in 

transit between two points outside the United States and is physically present in the United States for less than 24 hours; the individual is temporarily present in the United States as a regular 

member of the crew of a foreign vessel engaged in transportation 

between the United States and a foreign country or U.S. possession; and certain exempt individuals. These exceptions from counting physical presence in the United States do not apply, however, 

for purposes of the special rule under section 871(a)(2). Thus, it is 

possible in certain cases for an individual to be present in the 

United States for at least 183 days without being treated as a U.S. 

resident under the substantial presence test of section 7701(b).255

Even if an individual spends at least 183 days in the United 

States but is not treated as a U.S. resident under section 7701(b), 

the nonresident individual’s capital gains generally will be treated 

as foreign-source income and, thus, not subject to section 871(a)(2). 

In this regard, capital gains generally are from foreign sources if 

the individual is a nonresident, and from U.S. sources if the individual is a U.S. resident. Under a special rule, an individual is 

treated as a U.S. resident for sales of personal property (including 

sales giving rise to capital gains) if the individual has a tax home 

in the United States. This rule applies even if the individual is 

treated as a nonresident for other U.S. tax purposes. An individual’s capital gains would be treated as U.S.-source income and poVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00415 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
412 

256The individual’s income also could be treated as U.S.-source income under sec. 865(e)(2) 

if the individual derives income from the sale of personal property that is attributable to an 

office or other fixed place of business that the individual maintains in the United States. However, sec. 871(a)(2) would not apply if the income is effectively connected with a U.S. trade or 

business, or if the sale qualifies for the exception from U.S.-source treatment as a result of a 

material participation in the sale by a foreign office of the taxpayer. 257 Under Article 13(5) of the U.S. model income tax treaty, subject to certain exceptions, the 

capital gains of a nonresident individual are exempt from U.S. taxation. 

tentially subject to section 871(a)(2) if the individual is treated as 

a U.S. resident under this special rule.256

Even in the limited cases in which the special rule under section 871(a)(2) could potentially apply, a tax treaty might prevent 

its application.257

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision repeals the special tax on certain capital gains 

of nonresident aliens under section 871(a)(2). 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

21. Modify FIRPTA rules for real estate investment trusts (sec. 230 

of the Senate amendment and secs. 857 and 897 of the Code) 

PRESENT LAW

A real estate investment trust (‘‘REIT’’) is a U.S. entity that 

derives most of its income from passive real estate-related investments. A REIT must satisfy a number of tests on an annual basis 

that relate to the entity’s organizational structure, the source of its 

income, and the nature of its assets. If an electing entity meets the 

requirements for REIT status, the portion of its income that is distributed to its investors each year generally is treated as a dividend deductible by the REIT, and includible in income by its investors. In this manner, the distributed income of the REIT is not 

taxed at the entity level. The distributed income is taxed only at 

the investor level. A REIT generally is required to distribute 90 

percent of its income to its investors before the end of its taxable 

year. 

Special U.S. tax rules apply to gains of foreign persons attributable to dispositions of interests in U.S. real property, including 

certain transactions involving REITs. The rules governing the imposition and collection of tax on such dispositions are contained in 

a series of provisions that were enacted in 1980 and that are collectively referred to as the Foreign Investment in Real Property Tax 

Act (‘‘FIRPTA’’). 

In general, FIRPTA provides that gain or loss of a foreign person from the disposition of a U.S. real property interest is taken 

into account for U.S. tax purposes as if such gain or loss were effectively connected with a U.S. trade or business during the taxable 

413 

year. Accordingly, foreign persons generally are subject to U.S. tax 

on any gain from a disposition of a U.S. real property interest at 

the same rates that apply to similar income received by U.S. persons. For these purposes, the receipt of a distribution from a REIT 

is treated as a disposition of a U.S. real property interest by the 

recipient to the extent that it is attributable to a sale or exchange 

of a U.S. real property interest by the REIT. These capital gains 

distributions from REITs generally are subject to withholding tax 

at a rate of 35 percent (or a lower treaty rate). In addition, the recipients of these capital gains distributions are required to file Federal income tax returns in the United States, since the recipients 

are treated as earning income effectively connected with a U.S. 

trade or business. 

In addition, foreign corporations that have effectively connected income generally are subject to the branch profits tax at a 

30-percent rate (or a lower treaty rate). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision removes from treatment as effectively connected 

income for a foreign investor a capital gain distribution from a 

REIT, provided that (1) the distribution is received with respect to 

a class of stock that is regularly traded on an established securities 

market located in the United States and (2) the foreign investor 

does not own more than five percent of the class of stock at any 

time during the taxable year within which the distribution is received. 

Thus, a foreign investor is not required to file a U.S. Federal 

income tax return by reason of receiving such a distribution. The 

distribution is to be treated as a REIT dividend to that investor, 

taxed as a REIT dividend that is not a capital gain. Also, the 

branch profits tax no longer applies to such a distribution. 

Effective date.—The provision applies to taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

22. Exclusion of certain horse-racing and dog-racing gambling 

winnings from the income of nonresident alien individuals (sec. 

232 of the Senate amendment and sec. 872 of the Code) 

PRESENT LAW

Under section 871, certain items of gross income received by a 

nonresident alien from sources within the United States are subject 

to a flat 30-percent withholding tax. Gambling winnings received 

by a nonresident alien from wagers placed in the United States are 

U.S.-source and thus generally are subject to this withholding tax, 

unless exempted by treaty. Currently, several U.S. income tax treaties exempt U.S.-source gambling winnings of residents of the other 

treaty country from U.S. withholding tax. In addition, no withholding tax is imposed under section 871 on the non-business gamVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00417 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
414 

258 In pari-mutuel wagering (common in horse racing), odds and payouts are determined by 

the aggregate bets placed. The money wagered is placed into a pool, the party maintaining the 

pool takes a percentage of the total, and the bettors effectively bet against each other. Pari-mutuel wagering may be contrasted with fixed-odds wagering (common in sports wagering), in 

which odds (or perhaps a point spread) are agreed to by the bettor and the party taking the 

bet and are not affected by the bets placed by other bettors. 

bling income of a nonresident alien from wagers on the following 

games (except to the extent that the Secretary determines that collection of the tax would be administratively feasible): blackjack, 

baccarat, craps, roulette, and big–6 wheel. Various other (non-gambling-related) items of income of a nonresident alien are excluded 

from gross income under section 872(b) and are thereby exempt 

from the 30-percent withholding tax, without any authority for the 

Secretary to impose the tax by regulation. In cases in which a withholding tax on gambling winnings applies, section 1441(a) of the 

Code requires the party making the winning payout to withhold 

the appropriate amount and makes that party responsible for 

amounts not withheld. 

With respect to gambling winnings of a nonresident alien resulting from a wager initiated outside the United States on a parimutuel 258 event taking place within the United States, the source 

of the winnings, and thus the applicability of the 30-percent U.S. 

withholding tax, depends on the type of wagering pool from which 

the winnings are paid. If the payout is made from a separate foreign pool, maintained completely in a foreign jurisdiction (e.g., a 

pool maintained by a racetrack or off-track betting parlor that is 

showing in a foreign country a simulcast of a horse race taking 

place in the United States), then the winnings paid to a nonresident alien generally would not be subject to withholding tax, 

because the amounts received generally would not be from sources 

within the United States. However, if the payout is made from a 

‘‘merged’’ or ‘‘commingled’’ pool, in which betting pools in the 

United States and the foreign country are combined for a particular event, then the portion of the payout attributable to wagers 

placed in the United States could be subject to withholding tax. 

The party making the payment, in this case a racetrack or off-track 

betting parlor in a foreign country, would be responsible for withholding the tax. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides an exclusion from gross income under 

section 872(b) for winnings paid to a nonresident alien resulting 

from a legal wager initiated outside the United States in a parimutuel pool on a live horse or dog race in the United States, regardless of whether the pool is a separate foreign pool or a merged 

U.S.-foreign pool. 

Effective date.—The provision is effective for wagers made after 

the date of enactment of the provision. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

415 

259The term ‘‘United States’’ does not include its possessions. Sec. 7701(a)(9). 260The usual method of effecting a mitigation of the flat 30 percent rate—an income tax treaty providing for a lower rate—is not possible in the case of a possession. See S. Rep. No. 1707, 

89th Cong., 2d Sess. 34 (1966). 261The 10 percent withholding rate may be subject to exemption or elimination if the dividend 

is paid out of income that is subject to certain tax incentives offered by Puerto Rico. These tax 

incentives may also reduce the rate of underlying Puerto Rico corporate tax to a flat rate of between two and seven percent. 

23. Limitation of withholding on U.S.-source dividends paid to 

Puerto Rico corporation (sec. 233 of the Senate amendment and 

secs. 881 and 1442 of the Code) 

PRESENT LAW

In general, dividends paid by corporations organized in the 

United States 259 to corporations organized outside of the United 

States and its possessions are subject to U.S. income tax withholding at the flat rate of 30 percent. The rate may be reduced or 

eliminated under a tax treaty. Dividends paid by U.S. corporations 

to corporations organized in certain U.S. possessions are subject to 

different rules.260 Corporations organized in the U.S. possessions of 

the Virgin Islands, Guam, American Samoa or the Northern Mariana Islands are not subject to withholding tax on dividends from 

corporations organized in the United States, provided that certain 

local ownership and activity requirements are met. Each of those 

possessions have adopted local internal revenue codes that provide 

a zero rate of withholding tax on dividends paid by corporations organized in the possession to corporations organized in the United 

States. 

Under the tax laws of Puerto Rico, which is also a U.S. possession, a 10 percent withholding tax is imposed on dividends paid by 

Puerto Rico corporations to non-Puerto Rico corporations.261 Dividends paid by corporations organized in the United States to Puerto Rico corporations are subject to U.S. withholding tax at a 30 percent rate. Under Puerto Rico law, Puerto Rico corporations may 

elect to credit their U.S. income taxes against their Puerto Rico income taxes. Creditable income taxes include the 30 percent dividend withholding tax and the underlying U.S. corporate tax attributable to the dividends. However, a Puerto Rico corporation’s tax 

credit for U.S. income taxes may be limited because the sum of the 

U.S. withholding tax and the underlying U.S. corporate tax generally exceeds the amount of Puerto Rico corporate income tax imposed on the dividend. Consequently, Puerto Rico corporations with 

subsidiaries organized in the United States may be subject to some 

degree of double taxation on their U.S. subsidiaries’ earnings. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision lowers the withholding income tax rate on U.S. 

source dividends paid to a corporation created or organized in 

Puerto Rico from 30 percent to 10 percent, to create parity with the 

generally applicable 10 percent withholding tax imposed by Puerto 

Rico on dividends paid to U.S. corporations. The lower rate applies 

only if the same local ownership and activity requirements are met 

416 

that are applicable to corporations organized in other possessions 

receiving dividends from corporations organized in the United 

States. 

Effective date.—The provision is effective for dividends paid 

after date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

modifications. Under the provision as modified, if the generally applicable withholding tax rate imposed by Puerto Rico on dividends 

paid to U.S. corporations increases to greater than 10 percent, the 

U.S. withholding rate on dividends to Puerto Rico corporations reverts to 30 percent. 

24. Require Commerce Department report on adverse decisions of 

the World Trade Organization (sec. 234 of the Senate amendment) 

PRESENT LAW

The Secretary of Commerce does not have an obligation to 

transmit any future report to the Senate Committee on Finance 

and the House of Representatives Committee on Ways and Means, 

in consultation with the United States Trade Representative, regarding whether dispute settlement panels or the Appellate Body 

of the World Trade Organization have (1) added to or diminished 

the rights of the United States by imposing obligations and restrictions on the use of antidumping, countervailing, or safeguard measures not agreed to under the World Trade Organization Antidumping Agreement, the Agreement on Subsidies and Countervailing Measures, or the Agreement on Safeguards; (2) appropriately applied the standard of review contained in Article 17.6 of 

the Antidumping Agreement; or (3) exceeded its authority or terms 

of reference. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision requires that by no later than March 31, 2004, 

the Secretary of Commerce, in consultation with the United States 

Trade Representative, shall transmit a report to the Senate Committee on Finance and the House of Representatives Committee on 

Ways and Means regarding whether dispute settlement panels or 

the Appellate Body of the World Trade Organization have (1) added 

to or diminished the rights of the United States by imposing obligations and restrictions on the use of antidumping, countervailing, or 

safeguard measures not agreed to under the World Trade Organization Antidumping Agreement, the Agreement on Subsidies and 

Countervailing Measures, or the Agreement on Safeguards; (2) appropriately applied the standard of review contained in Article 17.6 

of the Antidumping Agreement; or (3) exceeded its authority or 

terms of reference. 

Effective date.—The provision is effective on the date of enactment. 

417 

262Sec. 901. 263Secs. 901, 904. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

25. Study of impact of international tax law on taxpayers other 

than large corporations (sec. 235 of the Senate amendment) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which U.S. persons (including domestic corporations) generally are 

taxed on all income, whether derived in the United States or 

abroad. In contrast, foreign persons (including foreign corporations) 

are subject to U.S. tax only on U.S.-source income and income that 

has a sufficient nexus to the United States. The United States generally provides a credit to U.S. persons for foreign income taxes 

paid or accrued.262 The foreign tax credit generally is limited to the 

U.S. tax liability on a taxpayer’s foreign-source income, in order to 

ensure that the credit serves its purpose of mitigating double taxation of foreign-source income without offsetting the U.S. tax on 

U.S.-source income.263

Within this basic framework, there are a variety of rules that 

affect the U.S. taxation of cross-border transactions. Detailed rules 

govern the determination of the source of income and the allocation 

and apportionment of expenses between foreign-source and U.S.- 

source income. Such rules are relevant not only for purposes of determining the U.S. taxation of foreign persons (because foreign persons are subject to U.S. tax only on income that is from U.S. 

sources or otherwise has sufficient U.S. nexus), but also for purposes of determining the U.S. taxation of U.S. persons (because the 

U.S. tax on a U.S. person’s foreign-source income may be reduced 

or eliminated by foreign tax credits). Authority is provided for the 

reallocation of items of income and deductions between related persons in order to ensure the clear reflection of the income of each 

person and to prevent the avoidance of tax. Although U.S. tax generally is not imposed on a foreign corporation that operates abroad, 

several anti-deferral regimes apply to impose current U.S. tax on 

certain income from foreign operations of certain U.S.-owned foreign corporations. 

A cross-border transaction potentially gives rise to tax consequences in two (or more) countries. The tax treatment in each 

country generally is determined under the tax laws of the respective country. However, an income tax treaty between the two countries may operate to coordinate the two tax regimes and mitigate 

the double taxation of the transaction. In this regard, the United 

States’ network of bilateral income tax treaties includes provisions 

affecting both U.S. and foreign taxation of both U.S. persons with 

foreign income and foreign persons with U.S. income. 

HOUSE BILL

No provision. 

418 

SENATE AMENDMENT

The provision requires the Secretary of the Treasury or the 

Secretary’s delegate to conduct a study of the impact of Federal 

international tax rules on taxpayers other than large corporations, 

including the burdens placed on such taxpayers in complying with 

such rules. In addition, not later than 180 days after the date of 

the enactment of this provision, the Secretary shall report to the 

Committee on Finance of the Senate and the Committee on Ways 

and Means of the House of Representatives the results of the study 

conducted as a result of this provision, including any recommendations for legislative or administrative changes to reduce the compliance burden on taxpayers other than large corporations and for 

such other purposes as the Secretary determines appropriate. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

26. Delay in effective date of final regulations governing exclusion 

of income from international operations of ships and aircraft 

(sec. 236 of the Senate amendment and sec. 883 of the Code) 

PRESENT LAW

Section 883 generally provides an exemption from gross income 

for earnings of a foreign corporation derived from the international 

operation of ships and aircraft if an equivalent exemption from tax 

is granted by the applicable foreign country to corporations organized in the United States. 

Treasury has issued regulations implementing the rules of section 883 that are effective for taxable years beginning 30 days or 

more after August 26, 2003. The regulations provide, in general, 

that a foreign corporation organized in a qualified foreign country 

and engaged in the international operation of ships or aircraft shall 

exclude qualified income from gross income for purposes of United 

States Federal income taxation, provided that the corporation can 

satisfy certain ownership and related documentation requirements. 

The proposed rules explain when a foreign country is a qualified 

foreign country and what income is considered to be qualified income. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision delays the effective date for the Treasury regulations so that they apply to taxable years of foreign corporations 

seeking qualified foreign corporation status beginning after December 31, 2004. 

Effective date.—The provision is effective after date of enactment. 

419 

264 A portion of the child credit may be refundable. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except the regulations apply to taxable years of foreign corporations 

seeking qualified foreign corporation status beginning after September 24, 2004. 

27. Interest payments deductible where taxpayer could have borrowed without a guarantee (sec. 237 of the Senate amendment 

and sec. 163(j) of the Code) 

PRESENT LAW

Present law provides rules to limit the ability of U.S. corporations to reduce the U.S. tax on their U.S.-source income through 

earnings stripping transactions. These rules limit the deductibility 

of interest paid to certain related parties (‘‘disqualified interest’’), 

if the payor’s debt-equity ratio exceeds 1.5 to 1 and the payor’s net 

interest expense exceeds 50 percent of its ‘‘adjusted taxable income’’ 

(generally taxable income computed without regard to deductions 

for net interest expense, net operating losses, and depreciation, amortization, and depletion). 

Disqualified interest for these purposes also may include interest paid to unrelated parties in certain cases in which a related 

party guarantees the debt. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the provision, a foreign related-party guarantee does not 

trigger the earnings stripping rules to the extent of the amount of 

debt that the taxpayer establishes (to the satisfaction of the Treasury Secretary) that it could have borrowed without the guarantee. 

Effective date.—The provision is effective for guarantees issued 

on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

TITLE IV—EXTENSION OF CERTAIN EXPIRING PROVISIONS 

28. Nonrefundable personal credits allowed against the alternative 

minimum tax (‘‘AMT’’) (sec. 401 of the House bill, sec. 713 of 

the Senate amendment, and sec. 26 of the Code) 

PRESENT LAW

Present law provides for certain nonrefundable personal tax 

credits (i.e., the dependent care credit, the credit for the elderly 

and disabled, the adoption credit, the child tax credit,264 the credit 

for interest on certain home mortgages, the HOPE Scholarship and 

420 

265The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 266The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

Lifetime Learning credits, the credit for savers, and the D.C. firsttime homebuyer credit). 

For taxable years beginning before 2006, all the nonrefundable 

personal credits are allowed to the extent of the full amount of the 

individual’s regular tax and alternative minimum tax. 

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

the adoption credit, child credit and credit for savers) are allowed 

only to the extent that the individual’s regular income tax liability 

exceeds the individual’s tentative minimum tax, determined without regard to the minimum tax foreign tax credit. The adoption 

credit, child credit, and IRA credit are allowed to the full extent of 

the individual’s regular tax and alternative minimum tax. 

HOUSE BILL 265

The House bill allows all nonrefundable personal credits 

against the AMT. 

Effective date.—Taxable years beginning in 2004 and 2005. 

SENATE AMENDMENT 266

The Senate amendment allows all nonrefundable personal 

credits against the AMT. 

Effective date.—Taxable years beginning in 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

29. Extension and modification of the research credit (sec. 402 of 

the House bill, secs. 311 and 312 of the Senate amendment, 

and sec. 41 of the Code) 

PRESENT LAW

Section 41 provides for a research tax credit equal to 20 percent of the amount by which a taxpayer’s qualified research expenses for a taxable year exceed its base amount for that year. 

Taxpayers may elect an alternative incremental research credit regime in which the taxpayer is assigned a three-tiered fixed-base 

percentage and the credit rate likewise is reduced. Under the alternative credit regime, a credit rate of 2.65 percent applies to the extent that a taxpayer’s current-year research expenses exceed a base 

amount computed by using a fixed-base percentage of one percent 

but do not exceed a base amount computed by using a fixed-base 

percentage of 1.5 percent. A credit rate of 3.2 percent applies to the 

extent that a taxpayer’s current-year research expenses exceed a 

base amount computed by using a fixed-base percentage of 1.5 percent but do not exceed a base amount computed by using a fixedbase percentage of two percent. A credit rate of 3.75 percent applies to the extent that a taxpayer’s current-year research expenses 

421 

267The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 268The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

exceed a base amount computed by using a fixed-base percentage 

of two percent. 

The research tax credit generally applies to amounts paid or 

incurred before January 1, 2006. 

HOUSE BILL 267

The House bill extends the present-law research credit to 

qualified amounts paid or incurred before January 1, 2006. 

Effective date.—The provision is effective for amounts paid or 

incurred after June 30, 2004. 

SENATE AMENDMENT 268

The Senate amendment is the same as the House bill with respect to extension of the present-law research credit. In addition, 

the Senate amendment makes the following modifications: 

(4) Increases the credit rates of the alternative incremental 

credit to three percent, four percent, and five percent. 

(5) Creates a third alternative for taxpayers, the alternative simplified credit. The taxpayer may elect to claim a 

credit equal to 12 percent of qualified research expenses in excess of 50 percent of the average qualified research expenses 

for the preceding three taxable years. 

(6) Permits taxpayers to claim a credit equal to 20 percent 

of amounts paid to certain research consortia. 

The provision also permits taxpayers to include 100 percent of 

contract research expenses (rather than 65 percent) if the contractor is an eligible small business, a college or university, or a 

Federal laboratory. 

Effective date.—With respect to extension of the present-law 

research credit, the provision is effective for amounts paid or incurred after the date of enactment. 

With respect to the increase in the alternative incremental 

credit and the alternative simplified credit, the provisions are effective for taxable years beginning after December 31, 2004. 

With respect to payments to research consortia and certain 

contract research, the provisions are effective for amounts paid or 

incurred after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

Senate amendment provision. 

30. Extension of credit for electricity produced from certain renewable resources (sec. 403 of the House bill, secs. 714 and 801 of 

the Senate amendment, and sec. 45 of the Code) 

PRESENT LAW

An income tax credit is allowed for the production of electricity 

from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, 

422 

269The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 270The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

or qualified poultry waste facilities. The amount of the credit is 1.8 

cents per kilowatt hour for 2004. The credit amount is indexed for 

inflation. 

The credit applies to electricity produced by a wind energy facility placed in service after December 31, 1993, and before January 1, 2006, to electricity produced by a closed-loop biomass facility 

placed in service after December 31, 1992, and before January 1, 

2006, and to a poultry waste facility placed in service after December 31, 1999, and before January 1, 2006. The credit is allowable 

for production during the 10-year period after a facility is originally 

placed in service. 

HOUSE BILL 269

Extends the placed-in-service date for wind facilities and 

closed-loop biomass facilities to facilities placed in service after December 31, 1993 (December 31, 1992 in the case of closed-loop biomass facilities) and before January 1, 2006. Does not extend the 

placed-in-service date for poultry waste facilities. 

Effective date.—The provision is effective for facilities placed in 

service after December 31, 2003. 

SENATE AMENDMENT 270

With respect to extension of the present-law credit, the Senate 

amendment extends the placed-in-service date for wind, closed-loop 

biomass, and poultry waste facilities to facilities placed in service 

prior to January 1, 2007. 

(The Senate amendment would also expand the definition of 

qualified facilities and make certain other modifications to the operation of credit. These expansions and modifications are described 

later in this document.) 

Effective date.—With respect to the extension of the placed-inservice dates, the provision is generally effective for facilities 

placed in service after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

Senate amendment provision with respect to the extension of 

present law, but it does make modifications to present law that are 

described later in this document. 

31. Indian employment tax credit (sec. 404 of the House bill, sec. 

716 of the Senate amendment, and sec. 45A of the Code) 

PRESENT LAW

In general, a credit against income tax liability is allowed to 

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

with respect to certain employees. The credit is equal to 20 percent 

of the excess of eligible employee qualified wages and health insurVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00426 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
423 

271The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 272The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

ance costs during the current year over the amount of such wages 

and costs incurred by the employer during 1993. The credit is an 

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

wages and qualified employee health insurance costs (up to $20,000 

per employee) are eligible for the credit only to the extent that the 

sum of such costs exceeds the sum of comparable costs paid during 

1993. No deduction is allowed for the portion of the wages equal 

to the amount of the credit. 

Qualified wages means wages paid or incurred by an employer 

for services performed by a qualified employee. A qualified employee means any employee who is an enrolled member of an Indian tribe or the spouse of an enrolled member of an Indian tribe, 

who performs substantially all of the services within an Indian reservation, and whose principal place of abode while performing such 

services is on or near the reservation in which the services are performed. An employee will not be treated as a qualified employee for 

any taxable year of the employer if the total amount of wages paid 

or incurred by the employer with respect to such employee during 

the taxable year exceeds an amount determined at an annual rate 

of $30,000 (adjusted for inflation after 1993). 

The wage credit is available for wages paid or incurred on or 

after January 1, 1994, in taxable years that begin before January 

1, 2006. 

HOUSE BILL 271

The provision extends the Indian employment credit incentive 

for one year (to taxable years beginning before January 1, 2006). 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT 272

Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

32. Extension of the work opportunity tax credit (sec. 405 of the 

House bill, sec. 702 of the Senate amendment, and sec. 51 of 

the Code) 

PRESENT LAW

Work opportunity tax credit 

Targeted groups eligible for the credit 

The work opportunity tax credit is available on an elective 

basis for employers hiring individuals from one or more of eight 

targeted groups. The eight targeted groups are: (1) certain families 

eligible to receive benefits under the Temporary Assistance for 

424 

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

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

stamps; and (8) persons receiving certain Supplemental Security 

Income (SSI) benefits. 

A qualified ex-felon is an individual certified as: (1) having 

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

member of an economically disadvantaged family; and (3) having a 

hiring date within one year of release from prison or conviction. 

Qualified wages 

Generally, qualified wages are defined as cash wages paid by 

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

Calculation of the credit 

The credit equals 40 percent (25 percent for employment of 400 

hours or less) of qualified first-year wages. Generally, qualified 

first-year wages are qualified wages (not in excess of $6,000) attributable to service rendered by a member of a targeted group during 

the one-year period beginning with the day the individual began 

work for the employer. Therefore, the maximum credit per employee is $2,400 (40 percent of the first $6,000 of qualified firstyear wages). With respect to qualified summer youth employees, 

the maximum credit is $1,200 (40 percent of the first $3,000 of 

qualified first-year wages). 

Minimum employment period 

No credit is allowed for qualified wages paid to employees who 

work less than 120 hours in the first year of employment. 

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

An employer cannot claim the work opportunity tax credit with 

respect to wages of any employee on which the employer claims the 

welfare-to-work tax credit. 

Other rules 

The work opportunity tax credit is not allowed for wages paid 

to a relative or dependent of the taxpayer. Similarly wages paid to 

replacement workers during a strike or lockout are not eligible for 

the work opportunity tax credit. Wages paid to any employee during any period for which the employer received on-the-job training 

program payments with respect to that employee are not eligible 

for the work opportunity tax credit. The work opportunity tax credit generally is not allowed for wages paid to individuals who had 

previously been employed by the employer. In addition, many other 

technical rules apply. 

Expiration 

The credit is effective for wages paid or incurred to a qualified 

individual who begins work for an employer before January 1, 

2006. 

425 

273The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 274The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’),which included a number of extensions to expiring 

provisions. 

HOUSE BILL 273

The House bill extends the WOTC for two years (through December 31, 2005). 

Effective date.—Wages paid or incurred for individuals beginning work after December 31, 2003. 

SENATE AMENDMENT 274

The Senate amendment permanently extends the WOTC. 

The Senate amendment also makes the following modifications 

to the WOTC: 

(1) repeals the requirement that a qualified ex-felon be a 

member of an economically disadvantaged family for purposes 

of eligibility for the tax credit; 

(2) expands the category of vocational rehabilitation referrals to include certain individuals who have a physical or mental disability that constitutes a substantial handicap to employment and who are receiving vocational services or have 

completed an individual work plan developed by a private employment network as defined under section 1148(f) of the Social 

Security Act qualify as members of the vocational rehabilitation referral targeted group. 

(3) increases the age limit for qualified food stamp recipients. Therefore a food stamp recipient is an individual aged 18 

but not aged 40 certified as being a member of a family either 

currently or recently receiving assistance under an eligible food 

stamp program. 

(4) increases the age limit for high-risk youths. Therefore 

a high-risk youth is an individual aged 18 but not aged 40 having a principal place of abode within an empowerment zone, 

enterprise community, or renewal community. 

Effective date.—The extension is effective for wages paid or incurred for individuals beginning work after December 31, 2003. 

The modifications are effective for wages paid or incurred for individuals beginning work after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

33. Extension of the welfare-to-work tax credit (sec. 406 of the 

House bill, sec. 702 of the Senate amendment, and sec. 51A of 

the Code) 

PRESENT LAW

Welfare-to-work tax credit 

Targeted group eligible for the credit 

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

to employers of qualified long-term family assistance recipients. 

426 

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

a family that has received family assistance for at least 18 consecutive months ending on the hiring date; (2) members of a family that 

has received such family assistance for a total of at least 18 months 

(whether or not consecutive) after August 5, 1997 (the date of enactment of the welfare-to-work tax credit) if they are hired within 

2 years after the date that the 18-month total is reached; and (3) 

members of a family who are no longer eligible for family assistance because of either Federal or State time limits, if they are 

hired within 2 years after the Federal or State time limits made 

the family ineligible for family assistance. 

Qualified wages 

Qualified wages for purposes of the welfare-to-work tax credit 

are defined more broadly than the work opportunity tax credit. Unlike the definition of wages for the work opportunity tax credit 

which includes simply cash wages, the definition of wages for the 

welfare-to-work tax credit includes cash wages paid to an employee 

plus amounts paid by the employer for: (1) educational assistance 

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

the employee, but not more than the applicable premium defined 

under section 4980B(f)(4); and (3) dependent care assistance excludable under section 129. The employer’s deduction for wages is 

reduced by the amount of the credit. 

Calculation of the credit 

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

to employers of qualified long-term family assistance recipients 

during the first two years of employment. The maximum credit is 

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

percent of the first $10,000 of qualified second-year wages. Qualified first-year wages are defined as qualified wages (not in excess 

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

individual began work for the employer. Qualified second-year 

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

during the one-year period beginning immediately after the first 

year of that individual’s employment for the employer. The maximum credit is $8,500 per qualified employee. 

Minimum employment period 

No credit is allowed for qualified wages paid to a member of 

the targeted group unless they work at least 400 hours or 180 days 

in the first year of employment. 

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

An employer cannot claim the work opportunity tax credit with 

respect to wages of any employee on which the employer claims the 

welfare-to-work tax credit. 

427 

275The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 276The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 277The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 278The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

Other rules 

The welfare-to-work tax credit incorporates directly or by reference many of these other rules contained on the work opportunity tax credit. 

Expiration 

The welfare to work credit is effective for wages paid or incurred to a qualified individual who begins work for an employer 

before January 1, 2006. 

HOUSE BILL 275

The House bill extends the WWTC for two years (through December 31, 2005). 

Effective date.—The provision is effective for wages paid or incurred for individuals beginning work after December 31, 2003. 

SENATE AMENDMENT 276

The Senate amendment permanently extends the WWTC. 

Effective date.—Wages paid or incurred for individuals beginning work after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

34. Combination and modification of the work opportunity tax credit and the welfare-to-work tax credit (sec. 703 of the Senate 

amendment and sec. 51 of the Code) 

PRESENT LAW

Same as items 5 and 6, above. 

HOUSE BILL 277

No provision. 

SENATE AMENDMENT 278

The Senate amendment combines and modifies the work opportunity and welfare-to-work tax credits with the following modifications: 

The combined credit uses the WOTC definition of wages; in the 

case of first-year wages for long-term family assistance recipients 

the maximum credit is increased to $4,000 (40 percent of the first 

$10,000 of qualified first-year wages); 

The combined credit uses the WOTC definition for the minimum employment period (i.e., the combined credit is not allowed 

428 

279The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 

for qualified wages paid to employees who work less than 120 

hours in the first year of employment). 

Effective date.—The provision is effective for wages paid or incurred for individuals beginning work after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

35. Certain expenses of elementary and secondary school teachers 

(sec. 407 of the House bill, sec. 707 of the Senate amendment, 

and sec. 62 of the Code) 

PRESENT LAW

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

business expenses are deductible only as an itemized deduction and 

only to the extent that the individual’s total miscellaneous deductions (including employee business expenses) exceed two percent of 

adjusted gross income. An individual’s otherwise allowable itemized 

deductions may be further limited by the overall limitation on 

itemized deductions, which reduces itemized deductions for taxpayers with adjusted gross income in excess of $142,700 (for 2004). 

In addition, miscellaneous itemized deductions are not allowable 

under the alternative minimum tax. 

Certain expenses of eligible educators are allowed an abovethe-line deduction. Specifically, for taxable years beginning prior to 

January 1, 2006, an above-the-line deduction is allowed for up to 

$250 annually of expenses paid or incurred by an eligible educator 

for books, supplies (other than nonathletic supplies for courses of 

instruction in health or physical education), computer equipment 

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

supplementary materials used by the eligible educator in the classroom. To be eligible for this deduction, the expenses must be otherwise deductible under section 162 as a trade or business expense. 

A deduction is allowed only to the extent the amount of expenses 

exceeds the amount excludable from income under section 135 (relating to education savings bonds), section 529(c)(1) (relating to 

qualified tuition programs), and section 530(d)(2) (relating to 

Coverdell education savings accounts). 

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in a school for at least 

900 hours during a school year. A school means any school which 

provides elementary education or secondary education, as determined under State law. 

The above-the-line deduction for eligible educators is not allowed for taxable years beginning after December 31, 2005. 

HOUSE BILL 279

The House bill allows the above-the-line deduction for taxable 

years beginning prior to January 1, 2006. 

429 

280The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

Effective date.—The provision is effective for taxable years beginning in 2004 and 2005. 

SENATE AMENDMENT 280

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

36. Accelerated depreciation for business property on Indian reservations (sec. 408 of the House bill, sec. 717 of the Senate 

amendment, and sec. 168 of the Code) 

PRESENT LAW

With respect to certain property used in connection with the 

conduct of a trade or business within an Indian reservation, depreciation deductions under section 168(j) will be determined using the 

following recovery periods: 

Years 

3-year property ....................................................................................................... 2 

5-year property ....................................................................................................... 3 

7-year property ....................................................................................................... 4 

10-year property ..................................................................................................... 6 

15-year property ..................................................................................................... 9 

20-year property ..................................................................................................... 12 

Nonresidential real property ................................................................................. 22 

‘‘Qualified Indian reservation property’’ eligible for accelerated 

depreciation includes property which is (1) used by the taxpayer 

predominantly in the active conduct of a trade or business within 

an Indian reservation, (2) not used or located outside the reservation on a regular basis, (3) not acquired (directly or indirectly) by 

the taxpayer from a person who is related to the taxpayer (within 

the meaning of section 465(b)(3)(C)), and (4) described in the recovery-period table above. In addition, property is not ‘‘qualified Indian reservation property’’ if it is placed in service for purposes of 

conducting gaming activities. Certain ‘‘qualified infrastructure 

property’’ may be eligible for the accelerated depreciation even if located outside an Indian reservation, provided that the purpose of 

such property is to connect with qualified infrastructure property 

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

The depreciation deduction allowed for regular tax purposes is 

also allowed for purposes of the alternative minimum tax. The accelerated depreciation for Indian reservations is available with respect to property placed in service on or after January 1, 1994, and 

before January 1, 2006. 

430 

281The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 282The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 283The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 284The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

HOUSE BILL 281

The provision extends eligibility for the special depreciation periods to property placed in service before January 1, 2006. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT 282

Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

37. Charitable contributions of computer technology and equipment 

used for educational purposes and of scientific property used 

for research (sec. 409 of the House bill, sec. 706 of the Senate 

amendment, and sec. 170 of the Code) 

PRESENT LAW

A deduction for charitable contributions of computer technology 

and equipment and of scientific property used for research generally is limited to the taxpayer’s basis in the property. However, 

certain corporations may claim a deduction in excess of basis for 

a qualified computer contribution or a qualified research contribution. To be eligible for the enhanced deduction, the contributed 

property must be constructed by the taxpayer, among other requirements. The enhanced deduction for qualified computer contributions expires for contributions made during any taxable year 

beginning after December 31, 2005. 

HOUSE BILL 283

The House bill extends the enhanced deduction for qualified 

computer contributions to contributions made during any taxable 

year beginning before January 1, 2006. 

Effective date.—Taxable years beginning after December 31, 

2003. 

SENATE AMENDMENT 284

The Senate amendment expands the enhanced deduction for 

qualified computer contributions and qualified research contributions to apply to property assembled by the taxpayer as well as 

property constructed by the taxpayer. 

The extension of the enhanced deduction for qualified computer 

contributions is the same as the House bill. 

431 

285The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 286The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

38. Expensing of environmental remediation costs (sec. 410 of the 

House bill, sec. 708 of the Senate amendment, and sec. 198 of 

the Code) 

PRESENT LAW

Taxpayers can elect to treat certain environmental remediation 

expenditures that would otherwise be chargeable to capital account 

as deductible in the year paid or incurred. The deduction applies 

for both regular and alternative minimum tax purposes. The expenditure must be incurred in connection with the abatement or 

control of hazardous substances at a qualified contaminated site (so 

called ‘‘brownfields’’). 

Eligible expenditures are those paid or incurred before January 

1, 2006. 

HOUSE BILL 285

The House bill extends the present law expensing provision for 

two years (through December 31, 2005). 

Effective date.—The provision is effective for expenses paid or 

incurred after December 31, 2003. 

SENATE AMENDMENT 286

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

Senate amendment provision. 

39. Availability of Archer medical savings accounts (sec. 411 of the 

House bill and sec. 220 of the Code) 

PRESENT LAW

In general 

Within limits, contributions to an Archer medical savings account (‘‘Archer MSA’’) are deductible in determining adjusted gross 

income if made by an eligible individual and are excludable from 

gross income and wages for employment tax purposes if made by 

the employer of an eligible individual. Earnings on amounts in an 

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

Distributions not used for medical expenses are includible in gross 

432 

287Self-employed individuals include more than two-percent shareholders of S corporations 

who are treated as partners for purposes of fringe benefit rules pursuant to section 1372. 288These dollar amounts are for 2004. These amounts are indexed for inflation, rounded to 

the nearest $50. 

income. In addition, distributions not used for medical expenses are 

subject to an additional 15-percent tax unless the distribution is 

made after age 65, death, or disability. 

Eligible individuals 

Archer MSAs are available to employees covered under an employer-sponsored high deductible plan of a small employer and selfemployed individuals covered under a high deductible health 

plan.287 An employer is a small employer if it employed, on average, no more than 50 employees on business days during either the 

preceding or the second preceding year. An individual is not eligible for an Archer MSA if he or she is covered under any other 

health plan in addition to the high deductible plan. 

Tax treatment of and limits on contributions 

Individual contributions to an Archer MSA are deductible 

(within limits) in determining adjusted gross income (i.e., ‘‘abovethe-line’’). In addition, employer contributions are excludable from 

gross income and wages for employment tax purposes (within the 

same limits), except that this exclusion does not apply to contributions made through a cafeteria plan. In the case of an employee, 

contributions can be made to an Archer MSA either by the individual or by the individual’s employer. 

The maximum annual contribution that can be made to an Archer MSA for a year is 65 percent of the deductible under the high 

deductible plan in the case of individual coverage and 75 percent 

of the deductible in the case of family coverage. 

Definition of high deductible plan 

A high deductible plan is a health plan with an annual deduct- ible of at least $1,700 and no more than $2,600 in the case of individual coverage and at least $3,450 and no more than $5,150 in the 

case of family coverage. In addition, the maximum out-of-pocket expenses with respect to allowed costs (including the deductible) must 

be no more than $3,450 in the case of individual coverage and no 

more than $6,300 in the case of family coverage.288 A plan does not 

fail to qualify as a high deductible plan merely because it does not 

have a deductible for preventive care as required by State law. A 

plan does not qualify as a high deductible health plan if substantially all of the coverage under the plan is for permitted coverage 

(as described above). In the case of a self-insured plan, the plan 

must in fact be insurance (e.g., there must be appropriate risk 

shifting) and not merely a reimbursement arrangement. 

Cap on taxpayers utilizing Archer MSAs and expiration of pilot program 

The number of taxpayers benefiting annually from an Archer 

MSA contribution is limited to a threshold level (generally 750,000 

taxpayers). The number of Archer MSAs established has not exceeded the threshold level. 

433 

289The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 290The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

After 2005, no new contributions may be made to Archer MSAs 

except by or on behalf of individuals who previously made (or had 

made on their behalf) Archer MSA contributions and employees 

who are employed by a participating employer. 

Trustees of Archer MSAs are generally required to make reports to the Treasury by August 1 regarding Archer MSAs established by July 1 of that year. If any year is a cut-off year, the Secretary is required to make and publish such determination by October 1 of such year. 

The reports required by MSA trustees for 2004 are treated as 

timely if made within 90 days after October 4, 2004. In addition, 

the determination of whether 2004 is a cut-off year and the publication of such determination is to be made within 120 days of October 4, 2004. If 2004 is a cut-off year, the cut-off date will be the 

last day of such 120-day period. 

HOUSE BILL 289

The House bill extends Archer MSAs through December 31, 

2005. 

Effective date.—The provision is effective for January 1, 2004. 

SENATE AMENDMENT 290

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

Senate amendment provision. 

40. Suspension of 100-percent-of-net-income limitation on percentage depletion for oil and gas from marginal wells (sec. 412 of 

the House bill, secs. 715 and 846 of the Senate amendment, 

and sec. 613A of the Code) 

PRESENT LAW

Overview of depletion 

Depletion, like depreciation, is a form of capital cost recovery. 

In both cases, the taxpayer is allowed a deduction in recognition of 

the fact that an asset—in the case of depletion for oil or gas interests, the mineral reserve itself—is being expended in order to 

produce income. Certain costs incurred prior to drilling an oil or 

gas property are recovered through the depletion deduction. These 

include costs of acquiring the lease or other interest in the property 

and geological and geophysical costs (in advance of actual drilling). 

Depletion is available to any person having an economic interest in a producing property. An economic interest is possessed in 

every case in which the taxpayer has acquired by investment any 

interest in minerals in place, and secures, by any form of legal relationship, income derived from the extraction of the mineral, to 

434 

291Treas. Reg. sec. 1.611–1(b)(1). 292Secs. 611–613. 293Sec. 613A. 294Sec. 613A(c). 295Sec. 613(a). 296The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 297The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

which it must look for a return of its capital.291 Thus, for example, 

both working interests and royalty interests in an oil- or gas-producing property constitute economic interests, thereby qualifying 

the interest holders for depletion deductions with respect to the 

property. A taxpayer who has no capital investment in the mineral 

deposit does not possess an economic interest merely because it 

possesses an economic or pecuniary advantage derived from production through a contractual relation. 

Cost depletion 

Two methods of depletion are currently allowable under the 

Code: (1) the cost depletion method, and (2) the percentage depletion method.292 Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property 

which is equal to the ratio of units sold from that property during 

the taxable year to the number of units remaining as of the end 

of the taxable year plus the number of units sold during the taxable year. Thus, the amount recovered under cost depletion may 

never exceed the taxpayer’s basis in the property. 

Percentage depletion and related income limitations 

The Code generally limits the percentage depletion method for 

oil and gas properties to independent producers and royalty owners.293 Generally, under the percentage depletion method, 15 percent of the taxpayer’s gross income from an oil- or gas-producing 

property is allowed as a deduction in each taxable year.294 The 

amount deducted generally may not exceed 100 percent of the net 

income from that property in any year (the ‘‘net-income limitation’’).295 The 100-percent net-income limitation for marginal wells 

has been suspended for taxable years beginning after December 31, 

1997, and before January 1, 2006. 

HOUSE BILL 296

The provision extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 

1, 2006. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

SENATE AMENDMENT 297

The Senate amendment extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 1, 2007. 

Effective date.—Same as the House bill. 

435 

298The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 299The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

CONFERENCE AGREEMENT

The conference agreement does not contain the House bill or 

Senate amendment provision. 

41. Qualified zone academy bonds (sec. 413 of the House bill, secs. 

612 and 704 of the Senate amendment, and sec. 1397E of the 

Code) 

PRESENT LAW

Generally, ‘‘qualified zone academy bonds’’ are bonds issued by 

a State or local government, provided that at least 95 percent of 

the proceeds are used for one or more qualified purposes with respect to a ‘‘qualified zone academy’’ and private entities have promised to contribute to the qualified zone academy certain equipment, 

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

bond proceeds. Qualified purposes with respect to any qualified 

zone academy are: (1) rehabilitating or repairing the public school 

facility in which the academy is established; (2) providing equipment for use at such academy; (3) developing course materials for 

education at such academy, and (4) training teachers and other 

school personnel. A total of $400 million of qualified zone academy 

bonds may be issued annually in calendar years 1998 through 

2005. 

HOUSE BILL 298

The House bill authorizes $400 million of qualified zone academy bonds to be issued in 2004 and 2005. 

Effective date.—The House bill provision is effective for obligations issued after the date of enactment. 

SENATE AMENDMENT 299

The Senate amendment expands the qualified purposes for 

which qualified zone academy bonds may be issued to include construction of the public school facility in which the qualified zone 

academy is established, and the acquisition of land on which the 

facility is to be constructed. 

The Senate amendment authorizes $400 million of qualified 

zone academy bonds to be issued in 2004 and 2005. 

Effective date.—The Senate amendment is effective for obligations issued after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

436 

300The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 301The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

42. Tax Incentives for Investment in the District of Columbia (sec. 

414 of the House bill, sec. 711 of the Senate amendment, and 

secs. 1400, 1400A, and 1400C of the Code) 

PRESENT LAW

Certain economically depressed census tracts within the District of Columbia are designated as the District of Columbia Enterprise Zone (the ‘‘D.C. Zone’’) within which businesses and individual residents are eligible for special tax incentives. The designation expires on December 31, 2005. 

First-time homebuyers of a principal residence in the District 

of Columbia are eligible for a nonrefundable tax credit of up to 

$5,000 of the amount of the purchase price. The credit expires for 

property purchased after December 31, 2005. 

HOUSE BILL 300

The House bill extends the D.C. Zone designation and related 

tax incentives for two years, and extends the first-time homebuyer 

credit for two years. 

Effective date.—The provision takes effect on the date of enactment, except that the provision relating to tax-exempt financing incentives, which applies to obligations issued after December 31, 

2003. 

SENATE AMENDMENT 301

Same as the House bill. 

Effective date.—The provision takes effect on January 1, 2004, 

except that the provision relating to tax-exempt financing incentives applies to obligations issued after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

43. Modifications to New York Liberty Zone bond provisions (sec. 

415 of the House bill, secs. 611 and 709 of the Senate amendment, and sec. 1400L of the Code) 

PRESENT LAW

An aggregate of $8 billion in tax-exempt private activity bonds 

is authorized for the purpose of financing the construction and repair of infrastructure in New York City (‘‘Liberty Zone bonds’’). The 

bonds must be issued before January 1, 2010. 

Certain bonds used to fund facilities located in New York City 

are permitted one additional advance refunding before January 1, 

2006 (‘‘advance refunding bonds’’). In addition to satisfying other 

requirements, the bond refunded must be (1) a State or local bond 

that is a general obligation of New York City, (2) a State or local 

bond issued by the New York Municipal Water Finance Authority 

437 

302On July 8, 2002, the IRS issued Notice 2002–42, which provides that bonds issued by the 

Municipal Assistance Corporation for the City of New York are eligible for the advance refunding provisions of section 1400L(e) if they otherwise satisfy the requirements of that section. 303The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 304The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

or Metropolitan Transportation Authority of the City of New York, 

or (3) a qualified 501(c)(3) bond which is a qualified hospital bond 

issued by or on behalf of the State of New York or the City of New 

York.302 The maximum amount of advance refunding bonds is $9 

billion. 

HOUSE BILL 303

The House bill provision extends authority to issue Liberty 

Zone bonds through December 31, 2009. 

Effective date.—The provision is effective for bonds issued after 

the date of enactment and before January 1, 2010. 

SENATE AMENDMENT 304

The Senate amendment extends authority to issue Liberty 

Zone bonds through December 31, 2009, and extends the additional 

advance refunding authority through December 31, 2005. The Senate amendment provides that bonds issued by the Municipal Assistance Corporation are eligible for advance refunding. 

Effective date.—The provisions extending authority to issue 

Liberty Zone bonds and an additional advance refunding are effective on the date of enactment. The provision relating to the advance refunding of bonds of the Municipal Assistance Corporation 

is effective as if included in the amendments made by section 301 

of the Job Creation and Worker Assistance Act of 2002. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

44. Qualified New York Liberty Zone leasehold improvement election out (sec. 709(c) of the Senate amendment) 

PRESENT LAW

Qualified New York Liberty Zone leasehold improvements 

placed in service after September 10, 2001 and before January 1, 

2007 are depreciable over five years (rather than 39 years) using 

the straight line method of depreciation. There is no election out 

of this provision. 

Liberty Zone leasehold improvements that are eligible for a 

five-year recovery period are not also eligible for the 30-percent 

first-year bonus depreciation under section 168(k) or 1400L(b). A 

taxpayer may elect out of bonus depreciation. The election out is 

made at the property class level. Section 168(k)(2)(C)(iii) provides 

that the election applies to all property in the class or classes for 

which the election out is made that is placed in service for the tax 

year of the election. 

438 

305The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 306The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 307Sec. 6103(i)(7)(A). 308Sec. 6103(i)(7)(A)(ii). 

HOUSE BILL 305

No provision. 

SENATE AMENDMENT 306

The Senate amendment permits a taxpayer to elect out of the 

five-year recovery period for qualified New York Liberty Zone 

leasehold improvement property under rules similar to section 

168(k)(2)(C)(iii). 

Effective date.—The Senate amendment is effective as if included in the amendments made by section 301 of the Job Creation 

and Worker Assistance Act of 2002. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

45. Disclosures relating to terrorist activities (sec. 416 of the House 

bill and sec. 6103 of the Code) 

PRESENT LAW

In connection with terrorist activities, the IRS is permitted to 

disclose return information, other than taxpayer return information, to officers and employees of Federal law enforcement upon a 

written request. The Code requires the request to be made by the 

head of the Federal law enforcement agency (or his delegate) involved in the response to or investigation of terrorist incidents, 

threats, or activities, and set forth the specific reason or reasons 

why such disclosure may be relevant to a terrorist incident, threat, 

or activity. Disclosure of the information is permitted to officers 

and employees of the Federal law enforcement agency who are personally and directly involved in the response to or investigation of 

terrorist incidents, threats, or activities. The information is to be 

used by such officers and employees solely for such response or investigation.307 A taxpayer’s identity is not treated as taxpayer return information for purposes of disclosures to law enforcement 

agencies regarding terrorist activities. 

The Code permits the head of the Federal law enforcement 

agency to redisclose the information to officers and employees of 

State and local law enforcement personally and directly engaged in 

the response to or investigation of the terrorist incident, threat, or 

activity. The State or local law enforcement agency is required to 

be part of an investigative or response team with the Federal law 

enforcement agency for these disclosures to be made.308

The Code also allows the IRS to disclose return information 

(other than taxpayer return information) upon the written request 

of an officer or employee of the Department of Justice or Treasury 

who is appointed by the President with the advice and consent of 

439 

309Sec. 6103(i)(7)(B). 310Sec. 6103(i)(3)(C). 311The House bill predated the enactment of H.R. 1308, Pub. L. No. 108-311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 

the Senate, or who is the Director of the U.S. Secret Service, if 

such individual is responsible for the collection and analysis of intelligence and counterintelligence concerning any terrorist incident, 

threat, or activity.309 Taxpayer identity information for this purpose is not considered taxpayer return information. Such written 

request is required to set forth the specific reason or reasons why 

such disclosure may be relevant to a terrorist incident, threat, or 

activity. Disclosures under this authority are permitted to be made 

to those officers and employees of the Department of Justice, 

Treasury, and Federal intelligence agencies who are personally and 

directly engaged in the collection or analysis of intelligence and 

counterintelligence information or investigation concerning any terrorist incident, threat, or activity. Such disclosures are permitted 

solely for the use of such officers and employees in such investigation, collection, or analysis. 

The IRS, on its own initiative, is permitted to disclose in writing return information (other than taxpayer return information) 

that may be related to a terrorist incident, threat, or activity to the 

extent necessary to apprise the head of the appropriate investigating Federal law enforcement agency.310 Taxpayer identity information for this purpose is not considered taxpayer return information. The head of the agency is permitted to redisclose such information to officers and employees of such agency to the extent 

necessary to investigate or respond to the terrorist incident, threat, 

or activity. 

If taxpayer return information is sought, the disclosure is required to be made pursuant to the ex parte order of a Federal district court judge or magistrate. 

No disclosures may be made under these provisions after December 31, 2005. 

HOUSE BILL 311

The House bill provision extends all disclosure authority relating to terrorist activities through December 31, 2005. The House 

bill provision permits the disclosure of taxpayer identity upon receiving a proper written request from the head of a Federal law enforcement agency. 

Effective date.—The House bill generally applies to disclosures 

made on or after the date of enactment. The provision permitting 

the disclosure of taxpayer identity upon receiving a proper written 

request from the head of a Federal law enforcement agency is effective as if included in section 201 of the Victims of Terrorism Tax 

Relief Act of 2001. 

SENATE AMENDMENT

No provision. 

440 

312Sec. 6103. 313Sec. 6103(l)(13). 314Pub. L. No. 108–311 (2004). 315Sec. 6103(c). 316Department of Treasury, Report to the Congress on Scope and Use of Taxpayer Confidentiality and Disclosure Provisions, Volume I: Study of General Provisions (October 2000) at 91. 317Department of Treasury, General Explanations of the Administration’s Fiscal Year 2004 

Revenue Proposals (February 2003) at 133. 318The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 319The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

46. Disclosure of return information relating to student loans (sec. 

417 of the House bill, sec. 718 of the Senate amendment, and 

sec. 6103(l) of the Code) 

PRESENT LAW

Present law prohibits the disclosure of returns and return information, except to the extent specifically authorized by the 

Code.312 An exception is provided for disclosure to the Department 

of Education (but not to contractors thereof) of a taxpayer’s filing 

status, adjusted gross income and identity information (i.e., name, 

mailing address, taxpayer identifying number) to establish an appropriate repayment amount for an applicable student loan.313 The 

Department of Education disclosure authority is scheduled to expire after December 31, 2005.314

An exception to the general rule prohibiting disclosure is also 

provided for the disclosure of returns and return information to a 

designee of the taxpayer.315 Because the Department of Education 

utilizes contractors for the income-contingent loan verification program, the Department of Education obtains taxpayer information 

by consent under section 6103(c), rather than under the specific exception.316 The Department of Treasury has reported that the Internal Revenue Service processes approximately 100,000 consents 

per year for this purpose.317

HOUSE BILL 318

The House bill extends the disclosure authority relating to the 

disclosure of return information to carry out income-contingent repayment of student loans. No disclosures can be made after December 31, 2005. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT 319

Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

441 

320The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 321The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

47. Extension of cover over of excise tax on distilled spirits to Puerto Rico and Virgin Islands (sec. 418 of the House bill, sec. 705 

of the Senate amendment, and sec. 7652 of the Code) 

PRESENT LAW

A $13.50 per proof gallon (a proof gallon is a liquid gallon consisting of 50 percent alcohol) excise tax is imposed on distilled spirits produced in or imported into the United States. 

The Code provides for cover over (payment) to Puerto Rico and 

the Virgin Islands of the excise tax imposed on rum imported into 

the United States, without regard to the country of origin. The 

amount of the cover over is limited under section 7652(f) to $10.50 

per proof gallon ($13.25 per proof gallon during the period July 1, 

1999 through December 31, 2003). 

Thus, tax amounts attributable to rum produced in Puerto Rico 

are covered over to Puerto Rico. Tax amounts attributable to rum 

produced in the Virgin Islands are covered over to the Virgin Islands. Tax amounts attributable to rum produced in neither Puerto 

Rico nor the Virgin Islands are divided and covered over to the two 

possessions under a formula. All of the amounts covered over are 

subject to the limitation. 

Section 305 of H.R. 1308, Pub. L. No. 108-311 (the ‘‘Working 

Families Tax Relief Act of 2004’’) temporarily suspended the $10.50 

per proof gallon limitation on the amount of excise taxes on rum 

covered over to Puerto Rico and the Virgin Islands. That law extended the cover over amount of $13.25 per proof gallon for rum 

brought into the United States after December 31, 2003, and before 

January 1, 2006. After December 31, 2005, the cover over amount 

reverts to $10.50 per proof gallon. 

HOUSE BILL 320

The provision temporarily suspends the $10.50 per proof gallon 

limitation on the amount of excise taxes on rum covered over to 

Puerto Rico and the Virgin Islands. Under the provision, the cover 

over amount of $13.25 per proof gallon is extended for rum brought 

into the United States after December 31, 2003, and before January 1, 2006. After December 31, 2005, the cover over amount reverts to $10.50 per proof gallon. 

Effective date.—The provision applies to articles brought into 

the United States after December 31, 2003. 

SENATE AMENDMENT 321

Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill and 

the Senate amendment provision. 

442 

322The joint review is required to include two members of the majority and one member of 

the minority of the Senate Committees on Finance, Appropriations, and Governmental Affairs, 

and of the House Committees on Ways and Means, Appropriations, and Government Reform and 

Oversight. 323Sec. 8021(f). 324Sec. 8022(3)(C). 325The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 

48. Joint review of strategic plans and budget for the IRS (sec. 419 

of the House bill and secs. 8021 and 8022 of the Code) 

PRESENT LAW

The Joint Committee on Taxation is required to conduct a joint 

review 322 of the strategic plans and budget of the IRS from 1999 

through 2004.323 The joint review required in 2004 is considered as 

timely if conducted before June 1, 2005. The Joint Committee was 

required to provide an annual report 324 from 1999 through 2003 

with respect to: 

Strategic and business plans for the IRS; 

Progress of the IRS in meeting its objectives; 

The budget for the IRS and whether it supports its objectives; 

Progress of the IRS in improving taxpayer service and compliance; 

Progress of the IRS on technology modernization; and 

The annual filing season. 

With respect to the annual report for the joint review required in 

2004, the report must cover the matters addressed in the joint review. 

HOUSE BILL 325

The Joint Committee on Taxation is required to conduct a joint 

review before June 1, 2005, and to provide an annual report with 

respect to such joint review. The content of the annual report is the 

matters addressed in the joint review. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

49. Extension of parity in the application of certain limits to mental health benefits (sec. 420 of the House bill, sec. 701 of the 

Senate amendment, sec. 9812 of the Code, sec. 712 of ERISA, 

and section 2705 of the PHSA) 

PRESENT LAW

The Mental Health Parity Act of 1996 amended the Employee 

Retirement Income Security Act of 1974 (‘‘ERISA’’) and the Public 

Health Service Act (‘‘PHSA’’) to provide that group health plans 

that provide both medical and surgical benefits and mental health 

benefits cannot impose aggregate lifetime or annual dollar limits 

443 

326Pub. L. No. 108–311 (2004). 327The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 328The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

on mental health benefits that are not imposed on substantially all 

medical and surgical benefits. The provisions of the Mental Health 

Parity Act were initially effective with respect to plan years beginning on or after January 1, 1998, for a temporary period. Since enactment, the mental health parity requirements in ERISA and the 

PHSA have been extended on more than one occasion and were 

most recently extended to apply with respect to benefits for services furnished before January 1, 2006, by the Working Families 

Tax Relief Act of 2004 (‘‘WFTRA’’).326

The Taxpayer Relief Act of 1997 added to the Code the requirements imposed under the Mental Health Parity Act, and imposed 

an excise tax on group health plans that fail to meet the requirements. The excise tax is equal to $100 per day during the period 

of noncompliance and is generally imposed on the employer sponsoring the plan if the plan fails to meet the requirements. The 

maximum tax that can be imposed during a taxable year cannot exceed the lesser of 10 percent of the employer’s group health plan 

expenses for the prior year or $500,000. No tax is imposed if the 

Secretary determines that the employer did not know, and exercising reasonable diligence would not have known, that the failure 

existed. 

The mental health parity requirements in the Code were initially effective with respect to plan years beginning on or after January 1, 1998, for a temporary period. Since enactment, the mental 

health parity requirements in the Code have been extended on 

more than one occasion and were most recently extended to apply 

with respect to benefits for services furnished before January 1, 

2006, by the WFTRA. 

HOUSE BILL 327

The House bill extends the Code provisions relating to mental 

health parity to benefits for services furnished on or after the date 

of enactment and before January 1, 2006. The excise tax on failures 

to meet the requirements imposed by the Code provisions does not 

apply after December 31, 2003, and before the date of enactment. 

Effective date.—The provision is effective for benefits for services furnished on or after December 31, 2003. 

SENATE AMENDMENT 328

The Senate amendment extends the ERISA and PHSA provisions relating to mental health parity to benefits for services furnished before January 1, 2006. The Senate amendment also extends the Code provisions relating to mental health parity to benefits for services furnished on or after the date of enactment and before January 1, 2006. The excise tax on failures to meet the requirements imposed by the Code provisions does not apply after 

December 31, 2003, and before the date of enactment. 

444 

329The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 330The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

Effective date.—The Senate amendment provision extending 

the Code provision applies to benefits for services furnished on or 

after December 31, 2003. The ERISA and PHSA provisions apply 

to benefits for services furnished on or after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

50. Combined employment tax reporting (sec. 421 of the House bill 

and sec. 712 of the Senate amendment) 

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. 

The Taxpayer Relief Act of 1997 permits implementation of a 

limited demonstration project to assess the feasibility and desirability of expanding combined Federal and State reporting. As enacted, it was limited to the sharing of information between the 

State of Montana and the IRS, but any State may participate in 

a combined reporting program under present law. However, the 

project is limited to employment tax reporting. In addition, it is 

limited to disclosure of the name, address, TIN, and signature of 

the taxpayer. The authority for the demonstration project expired 

on the date five years after the date of enactment (August 5, 2002). 

The Working Families Tax Relief Act of 2004 expanded to all 

States the authority to participate in a combined Federal and State 

employment tax reporting program. The authority for this expanded program expires December 31, 2005. 

HOUSE BILL 329

The House bill provision extends the demonstration project 

through December 31, 2005. 

Effective date.—The House bill provision takes effect on the 

date of enactment. 

SENATE AMENDMENT 330

The Senate amendment provides permanent authority for any 

State to participate in a combined Federal and State employment 

tax reporting program, provided that the program has been approved by the Secretary. 

Effective date.—The Senate amendment takes effect on the 

date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

445 

331The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 332The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

51. Deduction for qualified clean-fuel vehicle property (sec. 422 of 

the House bill, sec. 721 of the Senate amendment, and sec. 179 

of the Code) 

PRESENT LAW

Certain costs of qualified clean-fuel vehicles may be expensed 

and deducted when such property is placed in service. Qualified 

clean-fuel vehicle property includes motor vehicles that use certain 

clean-burning fuels (natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, electricity and any other fuel at least 85 

percent of which is methanol, ethanol, any other alcohol or ether). 

The maximum amount of the deduction is $50,000 for a truck or 

van with a gross vehicle weight over 26,000 pounds or a bus with 

seating capacities of at least 20 adults; $5,000 in the case of a 

truck or van with a gross vehicle weight between 10,000 and 

26,000 pounds; and $2,000 in the case of any other motor vehicle. 

The deduction is one quarter of the otherwise allowable amount in 

2006, and is unavailable for purchases after December 31, 2006. 

HOUSE BILL 331

The House bill repeals the phase down of the allowable deduction for clean-fuel vehicles in 2004 and 2005. Thus, a taxpayer who 

purchases a qualifying vehicle may claim 100 percent of the otherwise allowable deduction for vehicles purchased in 2004 and 2005. 

For vehicles purchased in 2006 the deduction remains at 25 percent of the otherwise allowable amount as under present law. 

Effective date.—The provision is effective for vehicles placed in 

service after December 31, 2003. 

SENATE AMENDMENT 332

The Senate amendment repeals the phase down for each of 

2004, 2005, and 2006. 

(Other sections of the Senate amendment create new credits 

for the purchase of certain vehicles that would be qualified cleanfuel vehicles under present law. These modifications are not described in this document.) 

Effective date.—The provision is effective for vehicles placed in 

service after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

52. Credit for qualified electric vehicles (sec. 422 of the House bill, 

sec. 720 of the Senate amendment, and sec. 30 of the Code) 

PRESENT LAW

A ten-percent tax credit is provided for the cost of a qualified 

electric vehicle, up to a maximum credit of $4,000. A qualified elecVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00449 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
446 

333The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 334The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 335Pub. L. No. 108–218. 

tric vehicle generally is a motor vehicle that is powered primarily 

by an electric motor drawing current from rechargeable batteries, 

fuel cells, or other portable sources of electrical current. The full 

amount of the credit is available for purchases prior to 2006. The 

credit is reduced for purchases in 2006, and is unavailable for purchases after December 31, 2006. 

HOUSE BILL 333

The House bill repeals the phase down of allowable tax credit 

for electric vehicles in 2004 and 2005. Thus, a taxpayer who purchases a qualifying vehicle may claim 100 percent of the otherwise 

allowable credit for vehicles purchased in 2004 and 2005. For vehicles purchased in 2006 the credit remains at 25 percent of the otherwise allowable amount as under present law. 

Effective date.—The provision is effective for vehicles placed in 

service after December 31, 2003. 

SENATE AMENDMENT 334

The Senate amendment repeals the phase down for each of 

2004, 2005, and 2006. 

(Other sections of the Senate amendment modify the credit. 

These modifications are not described in this document.) 

Effective date.—The provision is effective for vehicles placed in 

service after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill or 

the Senate amendment provision. 

53. Repeal of reduction of deductions for mutual life insurance companies (sec. 710 of the Senate amendment and sec. 809 of the 

Code) 

PRESENT LAW

The Pension Funding Equity Act of 2004 335 repealed the rule 

requiring reduction in certain deductions of a mutual life insurance 

company (sec. 809), effective for taxable years beginning after 2004. 

For taxable years beginning in 2004, under section 809, a mutual life insurance company is required to reduce its deduction for 

policyholder dividends by the company’s differential earnings 

amount. If the company’s differential earnings amount exceeds the 

amount of its deductible policyholder dividends, the company is required to reduce its deduction for changes in its reserves by the excess of its differential earnings amount over the amount of its deductible policyholder dividends. The differential earnings amount is 

the product of the differential earnings rate and the average equity 

base of a mutual life insurance company. 

447 

The differential earnings rate is based on the difference between the average earnings rate of the 50 largest stock life insurance companies and the earnings rate of all mutual life insurance 

companies. The mutual earnings rate applied under the provision 

is the rate for the second calendar year preceding the calendar year 

in which the taxable year begins. Under present law, the differential earnings rate cannot be a negative number. 

A company’s equity base equals the sum of: (1) its surplus and 

capital increased by 50 percent of the amount of any provision for 

policyholder dividends payable in the following taxable year; (2) the 

amount of its nonadmitted financial assets; (3) the excess of its 

statutory reserves over its tax reserves; and (4) the amount of any 

mandatory security valuation reserves, deficiency reserves, and voluntary reserves. A company’s average equity base is the average of 

the company’s equity base at the end of the taxable year and its 

equity base at the end of the preceding taxable year. 

A recomputation or ‘‘true-up’’ in the succeeding year is required if the differential earnings amount for the taxable year either exceeds, or is less than, the recomputed differential earnings 

amount. The recomputed differential earnings amount is calculated 

taking into account the average mutual earnings rate for the calendar year (rather than the second preceding calendar year, as 

above). The amount of the true-up for any taxable year is added 

to, or deducted from, the mutual company’s income for the succeeding taxable year. 

For taxable years beginning in 2001, 2002, or 2003, the differential earnings amount is treated as zero for purposes of computing both the differential earnings amount and the recomputed 

differential earnings amount (true-up). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision repeals the rule requiring reduction in certain 

deductions of a mutual life insurance company (sec. 809) for taxable years beginning in 2004. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

54. Study of earnings stripping provisions (sec. 163(j) of the Code) 

PRESENT LAW

Present law provides rules to limit the ability of U.S. corporations to reduce the U.S. tax on their U.S.-source income through 

certain earnings stripping transactions. These rules limit the deductibility of interest paid to certain related parties (‘‘disqualified 

interest’’), if the payor’s debt-equity ratio exceeds 1.5 to 1 and the 

payor’s net interest expense exceeds 50 percent of its ‘‘adjusted taxable income’’ (generally taxable income computed without regard to 

448 

deductions for net interest expense, net operating losses, and depreciation, amortization, and depletion). Disqualified interest for 

these purposes also may include interest paid to unrelated parties 

in certain cases in which a related party guarantees the debt. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement requires the Treasury Department 

to conduct a study of the earnings stripping rules, including a 

study of the effectiveness of these rules in preventing the shifting 

of income outside the United States, whether any deficiencies in 

these rules have the effect of placing U.S.-based businesses at a 

competitive disadvantage relative to foreign-based businesses, the 

impact of earnings stripping activities on the U.S. tax base, whether laws of foreign countries facilitate the stripping of earnings out 

of the United States, and whether changes to the earnings stripping rules would affect jobs in the United States. This study is to 

include specific recommendations for improving these rules and is 

to be submitted to the Congress not later than June 30, 2005. 

Effective date.—The provision is effective on the date of enactment. 

TITLE V—DEDUCTION OF STATE AND LOCAL GENERAL 

SALES TAXES 

A. DEDUCTION OF STATE AND LOCAL GENERAL SALES TAXES

(Sec. 501 of the House bill and sec. 164 of the Code) 

PRESENT LAW

An itemized deduction is permitted for certain State and local 

taxes paid, including individual income taxes, real property taxes, 

and personal property taxes. No itemized deduction is permitted for 

State or local general sales taxes. 

HOUSE BILL

The provision provides that, at the election of the taxpayer, an 

itemized deduction may be taken for State and local general sales 

taxes in lieu of the itemized deduction provided under present law 

for State and local income taxes. The allowable deduction would be 

determined under tables prescribed by the Secretary. The tables 

would be based on the average consumption of taxpayers on a 

State-by-State basis, and would take into account filing status, 

number of dependents, adjusted gross income, and rates of State 

and local general sales taxes. 

The term ‘general sales tax’ means a tax imposed at one rate 

with respect to the sale at retail of a broad range of classes of 

items. However, in the case of items of food, clothing, medical supplies, and motor vehicles, the fact that the tax does not apply with 

449 

respect to some or all of such items is not taken into account in 

determining whether the tax applies with respect to a broad range 

of classes of items, and the fact that the rate of tax applicable with 

respect to some or all of such items is lower than the general rate 

of tax is not taken into account in determining whether the tax is 

imposed at one rate. Except in the case of a lower rate of tax applicable with respect to food, clothing, medical supplies, or motor vehicles, no deduction is allowed for any general sales tax imposed with 

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

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

the general rate, such excess shall be disregarded and the general 

rate is treated as the rate of tax. 

A compensating use tax with respect to an item is treated as 

a general sales tax, provided such tax is complementary to a general sales tax and a deduction for sales taxes is allowable with respect to items sold at retail in the taxing jurisdiction that are similar to such item. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003, and prior to January 1, 2006. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with the following modification. 

Rather than requiring that taxpayers use tables prescribed by 

the Secretary to determine their allowable sales tax deduction, taxpayers would instead have two options with respect to the determination of the sales tax deduction amount. Taxpayers would be 

able to deduct the total amount of general State and local sales 

taxes paid by accumulating receipts showing general sales taxes 

paid. Alternatively, taxpayers may use tables created by the Secretary of the Treasury. The tables are to be based on average consumption by taxpayers on a State-by-State basis, taking into account filing status, number of dependents, adjusted gross income 

and rates of State and local general sales taxation. Taxpayers who 

use the tables created by the Secretary may, in addition to the 

table amounts, deduct eligible general sales taxes paid with respect 

to the purchase of motor vehicles, boats and other items specified 

by the Secretary. Sales taxes for items that may be added to the 

tables would not be reflected in the tables themselves. 

The IRS is currently in the process of finalizing tax forms for 

2004. The Code has not contained an itemized deduction for State 

and local sales taxes for a number of years. Developing the tables 

required by the provision will in general require a significant 

amount of time and effort. The conferees anticipate that IRS will 

do the best they can to reasonably and accurately implement this 

statutory provision in order to effectuate the deduction for the 2005 

filing season. 

450 

336Pub. L. No. 97–218 (1982). 

TITLE VI—FAIR AND EQUITABLE TOBACCO REFORM 

A. TOBACCO REFORM

(Secs. 701–725 of the House bill and title XI of the Senate amendment) 

PRESENT LAW

The current tobacco program has two main components: a supply management component and a price support component. In addition, in 1982, Congress passed the ‘‘No-Net-Cost Tobacco Program 

Act’’ 336 that assured the tobacco program would run at no-net-cost 

to the Federal government. 

Supply management 

The supply management component limits and stabilizes the 

quantity of tobacco marketed by farmers. This is achieved through 

marketing quotas. The Secretary of Agriculture raises or lowers the 

national marketing quota on an annual basis. The Secretary establishes the national marketing quota for each type of tobacco based 

upon domestic and export demand, but at a price above the government support price. The purpose of matching supply with demand 

is to keep the price of tobacco high. There is a secondary market 

in tobacco quota. Tobacco growers who do not have sufficient quota 

may purchase or rent one. 

Support price 

Given the numerous variables that affect tobacco supply and 

demand, marketing quotas alone have not always been able to 

guarantee tobacco prices. Therefore, in addition to marketing 

quotas, Federal support prices are established and guaranteed 

through the mechanism of nonrecourse loans available on each 

farmer’s marketed crop. The loan price for each type of tobacco is 

announced each year by the Department of Agriculture using the 

formula specified in the law to calculate loan levels. This system 

guarantees minimum prices for the different types of tobacco. 

The national loan price on 2004 crop flue-cured tobacco is $1.69 per pound; the burley loan price is $1.873 per pound. 

No-net-cost assessment 

In 1982, Congress passed the ‘‘No-Net-Cost Tobacco Program 

Act.’’ The purpose of this program is to ensure that the nonrecourse 

loan program is run at no-net-cost to the Federal government. 

When tobacco is not contracted, it is sold at an auction sale 

barn. At the auction sale barn, each lot of tobacco goes to the highest bidder, unless that bid does not exceed the government’s loan 

price. When the bid does not exceed this price, the farmer may 

choose to be paid the loan price by a cooperative, with money borrowed from the Commodity Credit Corporation (‘‘CCC’’). In such 

cases, the tobacco is consigned to the cooperative (known as a price 

stabilization cooperative), which redries, packs, and stores the tobacco as collateral for the CCC. The cooperative, acting as an agent 

for the CCC, later sells the tobacco, with the proceeds going to 

451 

repay the loan plus interest. If the cooperative does not recover the 

cost of the loan plus interest, the Secretary of Agriculture assesses 

growers, purchasers and importers of tobacco in order to repay the 

difference. All growers, purchasers and importers of tobacco participate in paying these assessments, regardless of whether or not 

they participate in the loan program. 

The no-net-cost assessment on 2004 crop flue-cured is $0.10 

per pound; the burley assessment is $0.02 per pound. The no-netcost assessment funds are deposited in an escrow account that is 

held to reimburse the government for any financial losses resulting 

from tobacco loan operations. 

Currently, over 80 percent of growers market their tobacco 

through contracts with tobacco companies, and thus these growers 

do not participate in the loan program. However, they must still 

pay the no-net-cost assessment when the Secretary levies it. The 

remaining 20 percent of growers market their tobacco through the 

auction system, and are eligible for participation in the loan program. Of this group, over 60 percent have consistently participated 

in the loan program during the past several years. 

HOUSE BILL

The House bill repeals the Federal tobacco support program, 

including marketing quotas and nonrecourse marketing loans. The 

House bill also provides quota holders $7.00 per pound based on 

their 2002 quota allotment paid in equal installments over five 

years. Additionally, the House bill provides producers transition 

payments of $3.00 per pound based on their 2002 quota levels paid 

in equal installments over five years. The House bill caps payments 

to quota holders and growers at $9.6 billion over fiscal years 2005 

through 2009. The House bill applies to the 2005 and subsequent 

crops of tobacco. 

Effective date.—The House bill is effective on the date of enactment. 

SENATE AMENDMENT

The Senate amendment ends the current Federal tobacco program. The Senate amendment also provides quota holders $8.00 

per pound based on their 2002 quota levels paid over a 10-year period. Additionally, the Senate amendment provides tobacco growers 

with $4.00 per pound based on their 2002 quota levels, paid over 

a 10-year period. The payments are funded by assessments on tobacco companies. The Senate amendment also restricts tobacco production to traditional tobacco producing counties and provides 

poundage and acreage limitations on how much tobacco can be produced in the future as determined by production boards for each 

type of tobacco. The Senate amendment applies to the 2004 and 

subsequent crops of tobacco. 

Additionally, the Senate amendment gives the Food and Drug 

Administration regulatory authority over the content and marketing of tobacco products. 

Effective date.—The Senate amendment is effective on the date 

of enactment. 

452 

CONFERENCE AGREEMENT

The conference agreement repeals all aspects of the Federal tobacco support program, including marketing quotas and nonrecourse marketing loans. The conference agreement provides eligible quota holders $7 per pound on their basic quota allotment paid 

in equal installments over 10 years. Additionally, the conference 

agreement provides eligible producers transition payments of $3 

per pound based on their effective quota paid in equal installments 

over 10 years. 

The Managers intend the payments to producers and quota 

holders to be made as quickly and effectively as possible. The Managers expect the Secretary to evaluate and consider the utilization 

of the proven financial and administrative expertise of the Phase 

II settlement system to achieve effective and prompt payment. The 

Managers further expect the Secretary to use the facilities of the 

Farm Service Agency to furnish information relating to accelerated 

payment options offered by financial institutions. 

Manufacturers and importers of tobacco products will pay a 

quarterly assessment into a newly formed Tobacco Trust Fund. 

These assessments will be on the following classes of tobacco: Cigarettes, Snuff, Chewing Tobacco, Pipe Tobacco, Roll-your-own tobacco, and Cigars. Assessment allocations will then be divided into 

manufacturers’ and importers’ market share. Funds from the Tobacco Trust Fund will be used to provide payments to quota holders and eligible producers as well as pay for program losses incurred by the U.S. Department of Agriculture. 

The conference agreement applies to the 2005 and subsequent 

crops of tobacco. 

Effective date.—The conference agreement is effective on the 

date of enactment. 

TITLE VII—PROTECTION OF UNITED STATES WORKERS 

FROM COMPETITION OF FOREIGN WORKFORCES 

The Senate amendment contained a provision relating to protection of United States workers from competition of foreign 

workforces. The conference agreement does not include the Senate 

amendment provision. 

TITLE VIII—OTHER PROVISIONS 

A. PROVISIONS RELATING TO HOUSING

1. Treatment of qualified mortgage revenue bonds (sec. 601 of the 

Senate amendment and sec. 143 of the Code) 

PRESENT LAW

Under present law, qualified mortgage bonds are tax-exempt 

bonds used to finance owner-occupied residences. Among other requirements, these bonds are subject to income and purchase price 

limitations, as well as a requirement that the homebuyer not have 

an ownership interest in the principal residence in the preceding 

three years. 

Generally, in order for a bond to be a qualified mortgage bond, 

the mortgagor’s family income cannot exceed 115 percent of the apVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00456 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
453 

plicable median family income. Adjustments are made for targeted 

area residences, for areas that have high housing costs in relation 

to income, and for family size. Further, 95 percent or more of the 

net proceeds of qualified mortgage bonds must be used to finance 

residences for first-time homebuyers. Exceptions are made for financing of targeted area residences, qualified home improvement 

loans, and qualified rehabilitation loans. 

A residence financed with a mortgage funded by qualified 

mortgage bonds may not have a purchase price in excess of 90 percent of the average area purchase price for that residence. Adjustments are made for residences located in certain low-income or economically distressed areas, and for the number of families for 

which a residence is designed. 

Part or all of the interest subsidy provided by qualified mortgage bonds is recaptured if the borrower experiences substantial 

increases in income and disposes of the subsidized residence within 

nine years after purchase. The annual volume limitations imposed 

on most qualified private activity bonds limits the aggregate face 

amount of qualified mortgage bonds that may be issued. In addition, repayments of mortgage principal received after 10 years from 

the date of issue must be used to retire outstanding bonds (the ‘‘10- 

year rule’’). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment suspends the 10-year rule for one year 

for outstanding bonds, allowing repayments of principal received 

during this period to be used to finance new mortgage loans rather 

than retiring outstanding bonds. The Senate amendment repeals 

the 10-year rule for bonds originally issued after the date of enactment. 

Effective date.—The provision repeals the 10-year rule for 

bonds issued after the date of enactment and suspends the 10-year 

rule for outstanding bonds for a one-year period beginning on the 

date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Premiums for mortgage insurance (sec. 602 of the Senate amendment and secs. 163(h) and 6050H of the Code) 

PRESENT LAW

Present law provides that qualified residence interest is deductible notwithstanding the general rule that personal interest is 

nondeductible (sec. 163(h)). 

Qualified residence interest is interest on acquisition indebtedness and home equity indebtedness with respect to a principal and 

a second residence of the taxpayer. The maximum amount of home 

equity indebtedness is $100,000. The maximum amount of acquisition indebtedness is $1 million. Acquisition indebtedness means 

454 

debt that is incurred in acquiring constructing, or substantially improving a qualified residence of the taxpayer, and that is secured 

by the residence. Home equity indebtedness is debt (other than acquisition indebtedness) that is secured by the taxpayer’s principal 

or second residence, to the extent the aggregate amount of such 

debt does not exceed the difference between the total acquisition indebtedness with respect to the residence, and the fair market value 

of the residence. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provision provides that premiums paid 

or accrued for qualified mortgage insurance by a taxpayer during 

the taxable year in connection with acquisition indebtedness on a 

qualified residence of the taxpayer are treated as qualified residence interest and thus deductible. The amount allowable as a deduction under the provision is phased out ratably by 10 percent for 

each $1,000 by which the taxpayer’s adjusted gross income exceeds 

$100,000 ($500 and $50,000, respectively, in the case of a married 

individual filing a separate return). Thus, the deduction is not allowed if the taxpayer’s adjusted gross income exceeds $110,000 

($55,000 in the case of married individual filing a separate return). 

For this purpose, qualified mortgage insurance means the 

Home Loan Guaranty Program of the Department of Veterans Affairs, and mortgage insurance provided by the Federal Housing Administration, or the Rural Housing Administration, and private 

mortgage insurance (defined in section 2 of the Homeowners Protection Act of 1998). 

Amounts paid for qualified mortgage insurance that are properly allocable to periods after the close of the taxable year are 

treated as paid in the period to which it is allocated. No deduction 

is allowed for the unamortized balance if the mortgage is paid before its term (except in the case of qualified mortgage insurance 

provided by the Department of Veterans Affairs or Rural Housing 

Administration). 

Reporting rules apply under the provision. 

Effective date.—The Senate amendment provision is effective 

for amounts paid or accrued after the date of enactment in taxable 

years beginning after December 31, 2004, and ending before January 1, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

455 

3. Increase in historic rehabilitation credit for residential housing 

for the elderly (sec. 603 of the Senate amendment and secs. 42 

and 47 of the Code) 

PRESENT LAW

Rehabilitation credit 

Present law provides a credit for rehabilitation expenditures 

(sec. 47). A 20-percent credit is provided for rehabilitation expenditures with respect to a certified historic structure. For this purpose, 

a certified historic structure means any building that is listed in 

the National Register, or that is located in a registered historic district and is certified by the Secretary of the Interior to the Secretary of the Treasury as being of historic significance to the district. 

A building is treated as having been substantially rehabilitated 

only if the rehabilitation expenditures during the 24-month period 

selected by the taxpayer and ending within the taxable year exceed 

the greater of the adjusted basis of the building (and its structural 

components), or $5,000. The taxpayer’s depreciable basis in the 

property is reduced by any rehabilitation credit claimed. 

Low-income housing credit 

The low-income housing tax credit (sec. 42) may be claimed 

over a 10-year period for the cost of rental housing occupied by tenants having incomes below specified levels. The credit percentage 

for newly constructed or substantially rehabilitated housing that is 

not Federally subsidized is adjusted monthly by the Internal Revenue Service so that the 10 annual installments have a present 

value of 70 percent of the total qualified expenditures. The credit 

percentage for new substantially rehabilitated housing that is Federally subsidized and for existing housing that is substantially rehabilitated is calculated to have a present value of 30 percent of 

qualified expenditures. The aggregate credit authority provided annually to each State is $1.75 per resident, except in the case of 

projects that also receive financing with proceeds of tax-exempt 

bonds issued subject to the private activity bond volume limit and 

certain carry-over amounts. The $1.75 per resident cap is indexed 

for inflation. 

Qualified basis with respect to which the credit may be computed is generally determined as the portion of the eligible basis 

of the qualified low-income building attributable to the low-income 

rental units. Qualified basis generally is the taxpayer’s depreciable 

basis in a qualified low-income building. In the case of a taxpayer 

who claims the rehabilitation credit for a qualified low-income 

building, the taxpayer’s depreciable basis in the building is reduced 

by the amount of the rehabilitation credit claimed. In addition, eligible basis is reduced by any Federal grant received with respect 

to the building. A qualified low-income building is a building that 

meets certain compliance criteria and is depreciable under the 

modified accelerated cost recovery system (‘‘MACRS’’). 

HOUSE BILL

No provision. 

456 

337The Senate amendment also repeals a transition rule to the Tax Reform Act of 1986 permitting the taxpayers who own the property described as the Warrior Hotel, Ltd., the first two 

floors of the Martin Hotel, and the 105,000 square foot warehouse constructed in 1910, all in 

Sioux City, Iowa, to use ACRS depreciation, in lieu of MACRS depreciation. This change enables 

such property to qualify for the provision. 

SENATE AMENDMENT

The Senate amendment increases the present-law 20-percent 

credit for historic rehabilitation expenses to 25 percent in the case 

of rehabilitation expenses incurred with respect to a building which 

is also a low-income housing credit property in which substantially 

all of the tenants, both those tenants in rent-restricted units and 

in other residential units, are age 65 or greater. The Senate 

amendment permits the 25-percent rehabilitation credit to be 

claimed with respect to all parts of the building, not only those 

parts on which the taxpayer also claims the low-income housing 

credit.337

Effective date.—The Senate amendment provision is effective 

for property placed in service after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

B. PROVISIONS RELATING TO BONDS

1. Modification of the authority of Indian tribal governments to 

issue tax-exempt bonds (sec. 613 of the Senate amendment and 

sec. 7871 of the Code) 

PRESENT LAW

Under present law, the interest on bonds issued by an Indian 

tribal government is tax-exempt if substantially all of the proceeds 

of are to be used in the exercise of an essential government function. The term essential government function does not include any 

function that is not customarily performed by State or local governments with general taxing powers. In addition, Indian tribal governments are prohibited from issuing private activity bonds, with 

the exception of bonds issued to finance certain manufacturing facilities. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment expands the tax-exemption for Indian 

tribal government bonds to include obligations 95 percent or more 

of the proceeds of which are used to finance any facility located on 

an Indian reservation. The tax-exemption does not include any obligations used to finance any portion of a building in which class II 

or class III gaming (as defined in section 4 of the Indian Gaming 

Regulatory Act) is conducted or housed. 

For purposes of the Senate amendment, an Indian reservation 

means: (1) a reservation as defined in section 4(10) of the Indian 

Child Welfare Act of 1978, and (2) lands held under the provisions 

457 

of the Alaska Native Claims Settlement Act by a Native corporation as defined in section 3(m) of that Act. 

Effective date.—The provision is effective for bonds issued after 

the date of enactment and before January 1, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Definition of manufacturing facility for qualified small issue 

bonds (sec. 614 of the Senate amendment and sec. 144 of the 

Code) 

PRESENT LAW

Qualified small-issue bonds are bonds used to finance private 

business manufacturing facilities or the acquisition of land and 

equipment by certain farmers. Generally, no more than $1 million 

of small-issue bond financing may be outstanding at any time for 

property of a business (including related parties) in the same municipality or county. This $1 million limit may be increased to $10 

million if all other capital expenditures of the business (including 

related parties) in the same municipality or county over a six-year 

period are counted toward the limit. In addition, 95 percent or 

more of the net proceeds of qualified small-issue bonds must be 

used for the acquisition, construction, reconstruction, or improvement of land or property of a character subject to the allowance for 

depreciation, or to redeem a prior issue that was used for those 

purposes. 

Under present law, a manufacturing facility is defined as any 

facility used in the manufacturing or production of tangible personal property. Facilities that are directly related and ancillary to 

a manufacturing facility may be financed with small-issue bonds if 

such facilities are located on the same site as the manufacturing 

facility and no more than 25 percent of the net proceeds of the 

bonds are used to finance such facilities. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment expands the definition of manufacturing facilities eligible for small-issue bond financing to include facilities: (1) used in the manufacture or development of software 

products or processes, if it takes more than six months to manufacture or develop such products or processes, such manufacture or 

development could not with due diligence be reasonably expected to 

occur in less than six months, and the software product or process 

comprises programs, routines, and attendant documentation developed and maintained for use in computer and telecommunications 

technology; and (2) used in the manufacture or development of any 

biobased product or bioenergy, if it takes more than six months to 

manufacture or develop and the manufacture or development could 

not with due diligence be reasonably expected to occur in less than 

six months. The term biobased product means a commercial or inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00461 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
458 

dustrial product which utilizes biological products or renewable domestic agricultural or forestry materials. The term bioenergy 

means biomass used in the production of energy, including liquid, 

solid, or gaseous fuels, electricity, and heat. 

The Senate amendment expands the definition of eligible facilities to include directly and functionally related offices and research 

and development facilities located on the same site as the manufacturing facilities. Such office and research and development facilities 

may not constitute more than 40 percent of the net proceeds of the 

issue used to finance the facility. 

Effective date.—The provision is effective for bonds issued after 

the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

3. Qualified forest conservation bonds (sec. 615 of the Senate 

amendment and sec. 142 of the Code) 

PRESENT LAW

Tax-exempt bonds 

In general 

Interest on debt incurred by States or local governments is excluded from income if the proceeds of the borrowing are used to 

carry out governmental functions of those entities or the debt is repaid with governmental funds. Interest on bonds that nominally 

are issued by States or local governments, but the proceeds of 

which are used (directly or indirectly) by a private person and payment of which is derived from funds of such a private person is taxable unless the purpose of the borrowing is approved specifically in 

the Code or in a non-Code provision of a revenue Act. These bonds 

are called ‘‘private activity bonds.’’ The term ‘‘private person’’ includes the Federal Government and all other individuals and entities other than States or local governments. 

Private activities eligible for financing with tax-exempt private activity bonds 

Present law includes several exceptions permitting States or 

local governments to act as conduits providing tax-exempt financing for private activities. Generally, interest on bonds issued to 

benefit section 501(c)(3) organizations is tax-exempt (‘‘qualified 

501(c)(3) bonds’’). In addition, States or local governments may 

issue tax-exempt ‘‘exempt-facility bonds’’ to finance property for 

certain private businesses. Business facilities eligible for this financing include transportation (airports, ports, local mass commuting, and high speed intercity rail facilities); privately owned 

and/or privately operated public works facilities (sewage, solid 

waste disposal, local district heating or cooling, hazardous waste 

disposal facilities and public educational facilities); privately owned 

and/or operated low-income rental housing; and certain private facilities for the local furnishing of electricity or gas. 

459 

Tax-exempt private activity bonds are subject to restrictions 

that generally do not apply to other bonds issued by State or local 

governments. In most cases, the aggregate face amount of tax-exempt private activity bonds that may be issued is restricted by annual volume limits. Moreover, most tax-exempt private activity 

bonds are subject to a term-to-maturity rule. Under that rule, the 

average maturity of most tax-exempt private activity bonds cannot 

exceed 120–percent of the economic life of the property being financed. 

Section 501(c)(3) organizations generally may not obtain the 

benefits of exempt facility bonds for debt issued and used to acquire forests and forest lands. In addition, qualified 501(c)(3) bonds 

may not be issued to acquire forests and forest lands to the extent 

such lands are used to finance a trade or business that is unrelated 

to the exempt purposes of the organization. Whether income derived by a section 501(c)(3) organization from timber harvesting is 

unrelated trade or business income depends upon a variety of factors. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that qualified forest conservation bonds are treated as exempt facility bonds. Qualified forest 

conservation bonds are bonds issued for a qualified organization if 

95 percent or more of the net proceeds of such bonds are used for 

qualified project costs, including acquisition of forests and forest 

land, capitalized interest, and credit enhancement fees that constitute qualified guarantee fees (within the meaning of section 148 

of the Code). The costs of acquiring forests and forest land are 

qualified project costs if such land is acquired by a qualified organization from an unrelated party and at the time of acquisition or 

immediately thereafter such land is subject to a conservation restriction. Among other requirements, a qualified organization must 

be a nonprofit organization more than half the value of which consists of forests and forest land acquired with the proceeds of qualified forest conservation bonds. 

The volume limitation on tax-exempt private activity bonds 

does not apply to qualified forest conservation bonds. Rather, the 

maximum aggregate face amount of qualified forest conservation 

bonds that may be issued is $1.5 billion, to be allocated by the Secretary of Treasury among qualified organizations. For purposes of 

the term-to-maturity rule, the land and timber acquired with qualified forest conservation bonds shall have an economic life of 35 

years. 

The Senate amendment provides that certain timber harvesting income derived by a qualified organization from forest 

lands acquired with proceeds from the qualified forest conservation 

bonds is excludable from income to the extent such income is used 

to pay debt service on the bonds and satisfies other conservation 

restrictions. 

460 

Effective date.—The provision is effective for bonds issued on 

or after the date that is 180 days after the date of enactment and 

before December 31, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not contain the Senate amendment provision. 

4. Qualified tribal school modernization bonds (sec. 616 of the Senate amendment) 

PRESENT LAW

Under present law, the interest on bonds issued by an Indian 

tribal government is tax-exempt if substantially all of the proceeds 

are to be used in the exercise of an essential government function. 

The term essential government function does not include any function that is not customarily performed by State or local governments with general taxing powers. In addition, Indian tribal governments are prohibited from issuing private activity bonds, with 

the exception of bonds issued for certain manufacturing facilities. 

There is no present law provision that permits Indian tribal 

governments to issue tax-credit bonds. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment authorizes the Secretary of the Interior to establish a program under which eligible Indian tribes may 

issue qualified tribal school modernization bonds (‘‘tribal school 

bonds’’). A tribal school bond means any bond issued under the program if: (1) 95 percent of the proceeds of the issue are used for the 

construction, rehabilitation, or repair of a school facility funded by 

the Bureau of Indian Affairs of the Department of the Interior or 

for the acquisition of land on which such a school facility is to be 

constructed; (2) the bond is issued by an Indian tribe; (3) the issuer 

designates the bond for purposes of the program; and (4) the term 

of each bond that is part of such an issue does not exceed 15 years. 

For purposes of the provision, the term Indian tribe has the same 

meaning as the term Indian tribal government under section 

7701(a)(40) of the Code (including the application of section 

7871(d)) and any consortium of tribes approved by the Secretary of 

the Interior. 

Under the provision, the holder of a tribal school bond receives 

a nonrefundable tax credit, in lieu of interest. The amount of the 

credit allowed is included in the holder’s gross income as interest 

income. Unused credits may be carried forward to the succeeding 

taxable year. 

The Senate amendment authorizes the Secretary of the Interior to establish an escrow fund to secure repayment of tribal 

school bonds. Principal payments on tribal school bonds may only 

be made from amounts in the escrow fund and such bonds are not 

guaranteed by the United States, the issuing Indian tribe, or the 

tribal school for which the bond was issued. 

461 

The Senate amendment establishes a national limitation of 

$200 million on the amount of tribal school bonds that may be designated in each of the years 2005 and 2006. The authority to issue 

tribal school bonds shall be allocated to Indian tribes by the Secretary of the Interior. 

Effective date.—The provision is effective on the date of enactment with respect to bonds issued after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

C. PROVISIONS RELATING TO DEPRECIATION

1. 7-year recovery period for certain track facilities (sec. 623 of the 

Senate amendment and sec. 168 of the Code) 

PRESENT LAW

A taxpayer generally must capitalize the cost of property used 

in a trade or business and recover such cost over time through annual deductions for depreciation or amortization. Tangible property 

generally is depreciated under the modified accelerated cost recovery system (‘‘MACRS’’), which determines depreciation by applying 

specific recovery periods, placed-in-service conventions, and depreciation methods to the cost of various types of depreciable property 

(sec. 168). The cost of nonresidential real property is recovered 

using the straight-line method of depreciation and a recovery period of 39 years. Nonresidential real property is subject to the midmonth placed-in-service convention. Under the mid-month convention, the depreciation allowance for the first year property is placed 

in service is based on the number of months the property was in 

service, and property placed in service at any time during a month 

is treated as having been placed in service in the middle of the 

month. Land improvements (such as roads and fences) are recovered over 15 years. An exception exists for the theme and amusement park industry, whose assets are assigned a recovery period of 

seven years. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a statutory 7-year recovery 

period for permanent motorsports racetrack complexes. For this 

purpose, motorsports racetrack complexes include land improvements and support facilities but do not include transportation 

equipment, warehouses, administrative buildings, hotels, or motels. 

Effective date.—The Senate amendment is effective for property placed in service after date of enactment and before January 

1, 2008. No inference is intended with respect to the treatment of 

expenses incurred prior to the effective date. 

462 

338 Special rules apply to the empowerment zone employment credit and the New York Liberty Zone business credit. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

the following modification to the effective date provisions. 

Effective date.—The conference agreement is effective for property placed in service after the date of enactment and before January 1, 2008. The conference agreement also excludes racetrack facilities placed in service after the date of enactment from the definition of theme and amusement facilities classified under Asset 

Class 80.0. The conferees do not intend for this provision to create 

any inference as to the treatment of property placed in service on 

or before the date of enactment. Accordingly, the conferees do not 

intend for the provision to affect the interpretation of the scope of 

Asset Class 80.0 for assets placed in service prior to the date of enactment. The conferees strongly urge the Secretary to resolve expeditiously any taxpayer disputes with respect to the scope of Class 

80.0. 

2. Alternative minimum tax and credits (sec. 624 of the Senate 

amendment and secs. 38 and 53 of the Code) 

PRESENT LAW

Election to Increase Minimum Tax Credit Limitation in Lieu of 

Bonus Depreciation 

Under present law, corporations are entitled to a minimum tax 

credit for the minimum tax imposed in prior taxable years. The 

amount of the credit is limited to the excess of the taxpayer’s regular tax over the tentative minimum tax (‘‘minimum tax credit limitation’’). 

Under present law, certain property is allowed an additional 

depreciation allowance for the taxable year placed in service. This 

additional allowance is known as ‘‘bonus depreciation’’. Bonus depreciation is a temporary provision. 

Use of General Business Credits Against the Alternative Minimum 

Tax 

Under present law, the general business credit for any taxable 

year is limited to the excess of the taxpayer’s income tax over the 

tentative minimum tax (or, if greater, 25 percent of the regular tax 

liability in excess of $25,000).338

HOUSE BILL

No provision. 

SENATE AMENDMENT

Election to Increase Minimum Tax Credit Limitation in Lieu of 

Bonus Depreciation 

The Senate amendment provides an election by a corporation 

to increase its minimum tax credit limitation for a taxable year by 

one half of the bonus depreciation amount. If a corporation makes 

an election for any taxable year, no bonus depreciation is allowed 

463 

339Section 45D was added by section 121(a) of the Community Renewal Tax Relief Act of 

2000, P.L. No. 106–554 (December 21, 2000). 

with respect to any property placed in service by the corporation 

for the taxable year. The bonus depreciation amount for a taxable 

year is an amount (not in excess of $25 million) equal to 30 percent 

of the aggregate bonus depreciation that would have been allowable but for the election. Any minimum tax credit allowable by reason of the election may be refundable to the extent it exceeds the 

corporation’s tax liability. 

Effective date.—Taxable years ending after December 31, 2003. 

Use of General Business Credits Against the Alternative Minimum 

Tax 

The Senate amendment provides that the general business 

credit for any taxable year beginning in 2004 shall not be less than 

50 percent of the lesser of (1) the amount of credit that would be 

allowed if the tentative minimum tax were zero for the taxable 

year or (2) the current year business credit. In no event shall the 

credit be less than the amount otherwise allowable under present 

law. 

Effective date.—Taxable years beginning in 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the provisions in 

the Senate amendment. 

D. EXPANSION OF BUSINESS CREDIT

1. New markets tax credit for Native American reservations (sec. 

631 of the Senate amendment) 

PRESENT LAW

Section 45D provides a new markets tax credit for qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership, that is a qualified community development entity (‘‘CDE’’).339 The amount of the credit allowed to the 

investor (either the original purchaser or a subsequent holder) is 

(1) a five-percent credit for the year in which the equity interest 

is purchased from the CDE and for each of the following two years, 

and (2) a six-percent credit on each anniversary date thereafter for 

the following four years. The credit is determined by applying the 

applicable percentage (five or six percent) to the amount paid to 

the CDE for the investment at its original issue, and is available 

to the taxpayer who holds the qualified equity investment on the 

date of the initial investment or on the respective anniversary 

dates. The credit is recaptured if at any time during the seven-year 

period that begins on the date of the initial issue of the investment 

the entity ceases to be a qualified CDE, the proceeds of the investment cease to be used as required, or the interest is redeemed. 

A qualified CDE is any domestic corporation or partnership: (1) 

whose primary mission is serving or providing investment capital 

for low-income communities or low-income persons; (2) that maintains accountability to residents of low-income communities by 

their representation on any governing board or any advisory board 

464 

of the CDE; and (3) that is certified by the Secretary as being a 

qualified CDE. A qualified equity investment means stock or a 

similar equity interest acquired directly from a CDE for cash. Substantially all of the investment proceeds must be used by the CDE 

to make qualified low-income community investments. For this 

purpose, qualified low-income community investments include: (1) 

capital or equity investments in, or loans to, qualified active businesses located in low-income communities; (2) certain financial 

counseling and other services to businesses and residents in lowincome communities; (3) the purchase from another CDE of any 

loan made by such entity that is a qualified low-income community 

investment; or (4) an equity investment in, or loan to, another 

CDE. 

A ‘‘low-income community’’ is defined as a census tract with either (1) a poverty rate of at least 20 percent or (2) median family 

income which does not exceed 80 percent of the greater of metropolitan area median family income or statewide median family income (for a non-metropolitan census tract, does not exceed 80 percent of statewide median family income). The Secretary may designate any area within any census tract as a low-income community provided that (1) the boundary is continuous, (2) the area (if 

it were a census tract) would otherwise satisfy the poverty rate or 

median income requirements, and (3) an inadequate access to investment capital exists in the area. 

A qualified active business is defined as a business that satisfies, with respect to a taxable year, the following requirements: (1) 

at least 50 percent of the total gross income of the business is derived from the active conduct of trade or business activities in lowincome communities; (2) a substantial portion of the tangible property of such business is used in a low-income community; (3) a substantial portion of the services performed for such business by its 

employees is performed in a low-income community; and (4) less 

than five percent of the average of the aggregate unadjusted bases 

of the property of such business is attributable to certain financial 

property or to certain collectibles. 

The maximum annual amount of qualified equity investments is capped at $2.0 billion per year for calendar years 2004 and 2005, 

and $3.5 billion per year for calendar years 2006 and 2007. 

No special rules apply to investments in community development entities that serve or provide investment capital with respect 

to low-income Native American reservations. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides special new markets tax credit rules for qualified equity investments in a ‘‘reservation development entity.’’ In general, the present-law requirements applicable 

to the new markets tax credit apply for purposes of the new credit, 

with special requirements established to define the qualified investment entity (i.e., for purposes of this credit, the present-law 

‘‘community development entity’’ is replaced with ‘‘reservation development entity’’). Under the Senate amendment, a reservation 

465 

development entity is a domestic corporation or partnership if: (A) 

the primary mission of the entity is serving, or providing investment capital for, low-income reservations; (B) the entity maintains 

accountability to residents of low-income reservations through their 

representation on any governing board or any advisory board of the 

entity; and (C) the entity is certified by the Secretary as being a 

reservation development entity. A low-income reservation means 

an Indian reservation (as defined in section 168(j)(6)) that has a 

poverty rate of at least 40 percent. 

The maximum annual amount of qualified equity investments in reservation development entities is $50 million for each of calendar years 2004 through 2007. The limitation shall be allocated 

by the Secretary among reservation development entities selected 

by the Secretary, giving priority to any entity with a record of having successfully provided capital or technical assistance to disadvantaged businesses or communities, or that intends to make 

qualified low-income reservation investments in one or more unrelated businesses. 

The Senate amendment provides that not later than January 

31 of 2007 and 2010, the Comptroller General of the United States 

shall, pursuant to an audit, report to Congress on the new credit 

program, including all reservation development entities that receive an allocation under the program. In addition, the Senate 

amendment authorizes the Secretary to award a grant of not more 

than one million dollars to the First Nations Oweesta Corporation, 

and authorizes appropriations of one million dollars for fiscal years 

2004 through 2014. 

Effective date.—The provision is effective for investments made 

after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

2. Ready Reserve-National Guard employee credit and Ready Reserve-National Guard replacement employee credit (sec. 632 of 

the Senate amendment) 

PRESENT LAW

There is no employer tax credit for wages paid to Ready Reserve and National Guard employees called to active duty, or for 

wages paid to their replacements. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides an employer credit for wages 

paid to Ready Reserve-National Guard employees called to active 

duty. A Ready Reserve-National Guard employee means an employee who is a member of the Ready Reserve of a reserve component of an Armed Force of the United States as described in sections 10142 and 10101 of title 10, United States Code. The credit 

equals 50 percent of the compensation paid while the employee is 

466 

called up to active duty up to a maximum of $30,000 of compensation. Special rules allowing refundability of the credit, up to the 

amount of employer payroll taxes, apply to employers of first responders called up to active duty. Qualified first responders are 

persons employed as a law enforcement official, a firefighter, or a 

paramedic, and who are Ready Reserve-National Guard employees. 

In addition, for ‘‘small business employers’’ of Ready ReserveNational Guard employees called up to active duty, the Senate 

amendment creates a replacement employee credit equal to 50 percent of the wages paid to any replacement employee up to a maximum credit of $6,000. Small business employers are employers 

that employ an average of 50 or fewer employees on business days 

during the taxable year. For small business manufacturing employers, the credit rate is increased to 100 percent and the maximum 

credit is increased to $20,000. 

Self-employed contract workers called to active duty are eligible for the self employed portion of the credit, but businesses purchasing the services of contract workers are not eligible for the replacement employee credit. 

The credits could be carried back 3 years and carried forward 

20 years. Rules similar to section 280C apply to deny a deduction 

for the amount of the credits. 

Effective date.—The provision is effective for investments made 

after September 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

3. Rural investment tax credit (sec. 633 of the Senate amendment 

and new sec. 42A of the Code) 

PRESENT LAW

There is no present-law provision specifically targeted to encourage investment in high-migration rural areas. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The proposal provides a tax credit that may be claimed by 

owners of certain rural residential property (i.e., qualified rural investment buildings). The credit is claimed annually, generally for 

a period of ten years. Taxpayers are eligible for a maximum 

present-value tax credit equal to 70 percent of the eligible basis of 

a new building and qualified rehabilitation expenses (30 percent in 

the case of an existing building). 

A qualified rural investment building is defined as any building that is part of a qualified rural investment project at all times 

during the credit period. A qualified rural investment project is defined as any investment project of one or more buildings; (1) located in a qualifying county (and, if necessary to the project, a contiguous county); and (2) selected by the State in which the county 

is located, according to the State’s qualified rural investment plan. 

467 

Rehabilitation expenditures are treated as a separate building for 

purposes of the credit. A qualifying county is defined as a county 

which: (1) is located outside a metropolitan statistical area (as defined by the Office of Management and Budget); and (2) during the 

20-year period ending with the year the most recent census was 

conducted, has experienced a net out-migration of inhabitants of 

the county of at least 10-percent of the population of the county. 

Generally, the credit and compliance periods are each ten years 

and the credit period for an existing building may not begin before 

the credit period for the related rehabilitation expenditures. 

For purposes of this credit, the eligible basis of any qualified 

rural investment building shall be determined under rules similar 

to the rules of section 42 (the ‘‘low income rental housing credit’’) 

except that: (1) the determination of the adjusted basis of any 

building shall be made at the beginning of the credit period; and 

(2) such basis shall include development costs properly attributable 

to such building. Development costs are limited to: (1) site preparation costs; (2) State and local impact fees; (3) reasonable development fees; (4) professional fees related to basis items; (5) construction financing costs related to basis items other than land; and (6) 

on-site and adjacent improvements required by State or local governments. 

Generally, any building eligible for the credit must receive an 

allocation of rural investment credit authority from the State rural 

investment credit agency in whose jurisdiction the building is located. The aggregate amount of such credits allocated within a 

State is limited by the State’s annual rural investment credit ceiling. The ceiling for each calendar year is the sum of: (1) the unused 

State rural investment credit ceiling (if any) of such State for the 

preceding calendar year; (2) $185,000 for each qualifying county of 

the State; (3) the amount of State rural investment credit ceiling 

returned in the calendar year; and (4) the amount (if any) allocated 

to the State by the Secretary of the Treasury from the pool of 

unallocated rural investment credits unused by other States. The 

allocation is made by a formula provided in the statute. The 

$185,000 amount is indexed for inflation. At least 10 percent of 

each State’s rural investment credit ceiling is set aside for projects 

in which a qualified non-profit organization is to materially participate (within the meaning of section 469(h) of the Code) in the development and operation of the project throughout the compliance 

period. A qualified non-profit organization generally means any organization if: (1) the organization is described in section 501(c) and 

exempt from tax under 501(a); (2) it is determined by the State 

rural investment credit agency not to be affiliated with or controlled by a for-profit organization; and (3) one or more of its exempt purposes includes the fostering of rural investment. 

Effective date.—The provision is effective for expenditures 

made in taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate Amendment. 

468 

4. Qualified small business rural investment tax credit (sec. 634 of 

the Senate amendment and new sec. 42B of the Code) 

PRESENT LAW

There is no present-law provision specifically targeted to encourage rural small business investment. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 30-percent tax credit for 

certain qualified expenditures paid or incurred by qualified rural 

small businesses. A qualified taxpayer’s maximum credit for any 

taxable year may not exceed the lesser of: (1) $5,000; or (2) $25,000 

minus the sum of the taxpayer’s previous qualified rural small 

business investment credit claimed for all prior taxable years. For 

purposes of this credit, qualified expenditures are defined as expenditures normally associated with starting or expanding a business and included in a qualified business plan, including costs for 

capital, plant and equipment, inventory expenses, and wages but 

not including interest costs. In the case of a qualified rural small 

business with respect to which a small business rural investment 

credit was claimed in any previous years, qualified expenditures for 

each taxable year are limited to qualified small business expenditures for the year only to the extent that those total expenditures 

exceed the total expenditures for the immediately preceding taxable year. For example, assume Taxpayer A incurs qualified expenditures of $3000, in year 1, $0 in year 2, and $4,000 in year 3. 

Taxpayer A will be eligible for a qualified rural investment tax 

credit of $900 in year 1, $0 in year 2, and $1,200 in year 3. 

A qualified rural small business is defined as any person, if 

such person; (1) employed not more than five full-time employees 

during the taxable year; (2) materially and substantially participates in management; (3) is located in a qualifying county; and (4) 

submitted a qualified business plan with respect to which an allocation of a rural investment tax credit was received. For these purposes, an employee is considered full-time if such employee is employed at least 30 hours per week for 20 or more calendar weeks 

in the taxable year. A qualifying county is defined as a county 

which: (1) is located outside a metropolitan statistical area (as defined by the Office of Management and Budget); and (2) during the 

20-year period ending with the year the most recent census was 

conducted, has experienced a net out-migration of inhabitants of 

the county of at least 10-percent of the population of the county. 

A qualified business plan is a business plan which: (1) has been approved by the rural investment credit agency with jurisdiction over 

the qualifying county in which the qualified rural small business 

is located pursuant to such agency’s rural investment plan; and (2) 

meets such requirements as the agency may specify. 

Any otherwise allowable deduction or credit is reduced by the 

amount of this credit. 

469 

Effective date.—The provision is effective for expenditures 

made in taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate Amendment. 

5. Provide a tax credit for maintenance of railroad track (sec. 635 

of the Senate amendment and new sec. 45I of the Code) 

PRESENT LAW

There is no provision that provides for a railroad track maintenance tax credit. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 30-percent business tax 

credit for qualified railroad track maintenance expenditures paid or 

incurred in a taxable year by eligible taxpayers. The credit is limited to the product of $3,500 times the number of miles of railroad 

track owned or leased by an eligible taxpayer as of the close of its 

taxable year. Qualified railroad track maintenance expenditures 

are defined as amounts expended (whether or not chargeable to a 

capital account) for maintaining railroad track (including roadbed, 

bridges, and related track structures) owned or leased as of January 1, 2005, by a Class II or Class III railroad. An eligible taxpayer 

is defined as: (1) any Class II or Class III railroad; and (2) any person who transports property using the rail facilities of a Class II 

or Class III railroad or who furnishes railroad-related property or 

services to such person. The taxpayer’s basis in railroad track is reduced by the amount of the credit allowed. No portion of the credit 

may be carried back to any taxable year beginning before January 

1, 2005. Other rules apply. 

This credit applies to qualified railroad track maintenance expenditures paid or incurred during taxable years beginning after 

December 31, 2004, and before January 1, 2008. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment provision with the following modification. The conference agreement 

increases the credit percentage from 30-percent to 50-percent. In 

addition, the conference agreement clarifies that each mile of railroad track may be taken into account only once, either by the 

owner of such mile or by the owner’s assignee, in computing the 

per-mile limitation. 

470 

6. Railroad revitalization and security investment credit (sec. 636 

of the Senate amendment) 

PRESENT LAW

There is no provision in present law for railroad revitalization. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 50-percent business tax 

credit for qualified project expenditures paid or incurred in a taxable year by eligible taxpayers. Qualified project expenditures generally are defined as expenditures (whether or not chargeable to a 

capital account) for: (1) planning; (2) environmental review and environmental impact mitigation; (3) track and track structure rehabilitation, relocation, improvement and development; (4) railroad 

safety and security improvements; (5) communications and signaling improvements; (6) intercity passenger rail equipment acquisition; and (7) rail station and intermodal facilities development. 

Such expenditures are limited to expenditures for a project with respect to intercity passenger rail transportation (as defined in 49 

U.S.C. 24102) that is included in a State rail plan. 

The railroad revitalization and security investment credit is 

subject to a national cap of $165 million per calendar year. The annual national cap is allocated pro rata to the States based on each 

State’s share of the national total of: (1) railroad and public road 

grade crossings on intercity passenger rail routes; (2) intercity passenger train miles; and (3) intercity embarkations and disembarkations for each passenger. Any credit allocations unused for a calendar year will be carried-over and allocated between those States 

that used their allocation for the calendar year and requested a 

share of the carryover. All projects must have an allocation to 

claim the credit. 

The taxpayer’s basis in such property is reduced by the amount 

of the credit allowed. No portion of the credit may be carried back 

to any taxable year beginning before January 1, 2005. A credit 

under this section may be transferred (but no more than once) if 

the taxpayer is a tax-exempt entity or if the credit exceeds the taxpayer’s tax liability for the year. Other rules apply. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

471 

340Section 45D was added by section 121(a) of the Community Renewal Tax Relief Act of 

2000, P.L. No. 106–554 (December 21, 2000). 

7. Special allocation of the railroad revitalization and security investment credit for New York city rail projects (sec. 636 of the 

Senate amendment) 

PRESENT LAW

There is no provision in present law that provides a special allocation of the railroad revitalization and security investment credit. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides an additional allocation of $200 million dollars to New York City for qualified project expenditures within the New York Liberty Zone (as defined in Code section 

1400L(h). This allocation is in addition to the allocation allowed 

under the general railroad revitalization and security investment 

credit, described above. Under a special rule, the $200 million will 

be allocated as follows: (1) $100 million to projects designated by 

the mayor of New York City; and (2) $100 million to projects designated by the Governor of New York. Qualified project expenditures are limited to expenditures for improvements to subway systems, for commuter rail systems, for rail links to airports, and for 

public infrastructure improvements in the vicinity of rail or subway 

stations. The taxpayer’s basis in such property is reduced by the 

amount of the credit for which this credit is allowed. No portion of 

the credit may be carried back to any taxable year beginning before 

January 1, 2005. A credit under this section may be transferred 

(but no more than once) if the taxpayer is a tax-exempt entity or 

if the credit exceeds the taxpayer’s tax liability for the year. Other 

rules apply. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

8. Modification of targeted areas and low-income communities designated for new markets tax credit (sec. 637 of the Senate 

amendment and sec. 45D of the Code) 

PRESENT LAW

Section 45D provides a new markets tax credit for qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership, that is a qualified community development entity (‘‘CDE’’).340 The amount of the credit allowable to 

the investor (either the original purchaser or a subsequent holder) 

is (1) a five-percent credit for the year in which the equity interest 

is purchased from the CDE and for each of the following two years, 

472 

and (2) a six-percent credit for each of the following four years. The 

credit is determined by applying the applicable percentage (five or 

six percent) to the amount paid to the CDE for the investment at 

its original issue, and is available for a taxable year to the taxpayer who holds the qualified equity investment on the date of the 

initial investment or on the respective anniversary date that occurs 

during the taxable year. The credit is recaptured if at any time 

during the seven-year period that begins on the date of the original 

issue of the investment the entity ceases to be a qualified CDE, the 

proceeds of the investment cease to be used as required, or the equity investment is redeemed. 

A qualified CDE is any domestic corporation or partnership: (1) 

whose primary mission is serving or providing investment capital 

for low-income communities or low-income persons; (2) that maintains accountability to residents of low-income communities by 

their representation on any governing board of or any advisory 

board to the CDE; and (3) that is certified by the Secretary as 

being a qualified CDE. A qualified equity investment means stock 

(other than nonqualified preferred stock) in a corporation or a capital interest in a partnership that is acquired directly from a CDE 

for cash, and includes an investment of a subsequent purchaser if 

such investment was a qualified equity investment in the hands of 

the prior holder. Substantially all of the investment proceeds must 

be used by the CDE to make qualified low-income community investments. For this purpose, qualified low-income community investments include: (1) capital or equity investments in, or loans to, 

qualified active low-income community businesses; (2) certain financial counseling and other services to businesses and residents 

in low-income communities; (3) the purchase from another CDE of 

any loan made by such entity that is a qualified low-income community investment; or (4) an equity investment in, or loan to, another CDE. 

A ‘‘low-income community’’ is defined as a population census 

tract with either (1) a poverty rate of at least 20 percent or (2) median family income which does not exceed 80 percent of the greater 

of metropolitan area median family income or statewide median 

family income (for a non-metropolitan census tract, does not exceed 

80 percent of statewide median family income). The Secretary may 

designate any area within any census tract as a low-income community provided that (1) the boundary is continuous, (2) the area 

(if it were a census tract) would otherwise satisfy the poverty rate 

or median income requirements, and (3) an inadequate access to investment capital exists in the area. 

A qualified active low-income community business is defined as 

a business that satisfies, with respect to a taxable year, the following requirements: (1) at least 50 percent of the total gross income of the business is derived from the active conduct of trade or 

business activities in any low-income community; (2) a substantial 

portion of the tangible property of such business is used in a lowincome community; (3) a substantial portion of the services performed for such business by its employees is performed in a lowincome community; and (4) less than five percent of the average of 

the aggregate unadjusted bases of the property of such business is 

attributable to certain financial property or to certain collectibles. 

473 

341 12. U.S.C. 4702(17) (used to define ‘‘low-income’’ for purposes of 12. U.S.C. 4702(20)). 

The maximum annual amount of qualified equity investments 

is capped at $2.0 billion per year for calendar years 2004 and 2005, 

and at $3.5 billion per year for calendar years 2006 and 2007. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment modifies the Secretary’s authority to 

designate certain areas as low-income communities to provide that 

the Secretary shall prescribe regulations to designate ‘‘targeted 

populations’’ as low-income communities for purposes of the new 

markets tax credit. For this purpose, a ‘‘targeted population’’ is defined by reference to section 103(20) of the Riegle Community Development and Regulatory Improvement Act of 1994 (12 U.S.C. 

4702(20)) to mean individuals, or an identifiable group of individuals, including an Indian tribe, who (A) are low-income persons; or 

(B) otherwise lack adequate access to loans or equity investments. 

Under the Senate amendment, ‘‘low-income’’ means (1) for a targeted population within a metropolitan area, less than 80 percent 

of the area median family income; and (2) for a targeted population 

within a non-metropolitan area, less than the greater of 80 percent 

of the area median family income or 80 percent of the statewide 

non-metropolitan area median family income.341 Under the Senate 

amendment, a targeted population is not required to be within any 

census tract. 

Effective date.—The provision is effective for designations made 

after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

respect to targeted population designations, modified to provide 

that a population census tract with a population of less than 2,000 

shall be treated as a low-income community for purposes of the 

credit if such tract is within an empowerment zone, the designation 

of which is in effect under section 1391, and is contiguous to one 

or more low-income communities. 

Effective date.—The targeted population provision is effective 

for designations made after the date of enactment. The low-population provision is effective for investments made after the date of 

enactment. 

9. Modification of income requirement for census tracts within high 

migration rural counties for new markets tax credit (sec. 638 

of the Senate amendment and sec. 45D of the Code) 

PRESENT LAW

Section 45D provides a new markets tax credit for qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership, that is a qualified community develVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00477 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
474 

342Section 45D was added by section 121(a) of the Community Renewal Tax Relief Act of 

2000, P.L. No. 106–554 (December 21, 2000). 

opment entity (‘‘CDE’’).342 The amount of the credit allowable to 

the investor (either the original purchaser or a subsequent holder) 

is (1) a five-percent credit for the year in which the equity interest 

is purchased from the CDE and for each of the following two years, 

and (2) a six-percent credit for each of the following four years. The 

credit is determined by applying the applicable percentage (five or 

six percent) to the amount paid to the CDE for the investment at 

its original issue, and is available for the taxable year to the taxpayer who holds the qualified equity investment on the date of the 

initial investment or on the respective anniversary date that occurs 

during the taxable year. The credit is recaptured if at any time 

during the seven-year period that begins on the date of the original 

issue of the investment the entity ceases to be a qualified CDE, the 

proceeds of the investment cease to be used as required, or the equity investment is redeemed. 

A qualified CDE is any domestic corporation or partnership: (1) 

whose primary mission is serving or providing investment capital 

for low-income communities or low-income persons; (2) that maintains accountability to residents of low-income communities by 

their representation on any governing board of or any advisory 

board to the CDE; and (3) that is certified by the Secretary as 

being a qualified CDE. A qualified equity investment means stock 

(other than nonqualified preferred stock) in a corporation or a capital interest in a partnership that is acquired directly from a CDE 

for cash, and includes an investment of a subsequent purchaser if 

such investment was a qualified equity investment in the hands of 

the prior holder. Substantially all of the investment proceeds must 

be used by the CDE to make qualified low-income community investments. For this purpose, qualified low-income community investments include: (1) capital or equity investments in, or loans to, 

qualified active low-income community businesses; (2) certain financial counseling and other services to businesses and residents 

in low-income communities; (3) the purchase from another CDE of 

any loan made by such entity that is a qualified low-income community investment; or (4) an equity investment in, or loan to, another CDE. 

A ‘‘low-income community’’ is defined as a population census 

tract with either (1) a poverty rate of at least 20 percent or (2) median family income which does not exceed 80 percent of the greater 

of metropolitan area median family income or statewide median 

family income (for a non-metropolitan census tract, does not exceed 

80 percent of statewide median family income). The Secretary may 

designate any area within any census tract as a low-income community provided that (1) the boundary is continuous, (2) the area 

(if it were a census tract) would otherwise satisfy the poverty rate 

or median income requirements, and (3) an inadequate access to investment capital exists in the area. 

A qualified active low-income community business is defined as 

a business that satisfies, with respect to a taxable year, the following requirements: (1) at least 50 percent of the total gross income of the business is derived from the active conduct of trade or 

475 

business activities in any low-income community; (2) a substantial 

portion of the tangible property of such business is used in a lowincome community; (3) a substantial portion of the services performed for such business by its employees is performed in a lowincome community; and (4) less than five percent of the average of 

the aggregate unadjusted bases of the property of such business is 

attributable to certain financial property or to certain collectibles. 

The maximum annual amount of qualified equity investments 

is capped at $2.0 billion per year for calendar years 2004 and 2005, 

and at $3.5 billion per year for calendar years 2006 and 2007. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment modifies the low-income test for high 

migration rural counties. Under the Senate amendment, in the 

case of a population census tract located within a high migration 

rural county, low income is defined by reference to 85 percent 

(rather than 80 percent) of statewide median family income. For 

this purpose, a high migration rural county is any county that, during the 20-year period ending with the year in which the most recent census was conducted, has a net out-migration of inhabitants 

from the county of at least 10 percent of the population of the county at the beginning of such period. 

Effective date.—The provision is effective as if included in the 

amendment made by section 121(a) of the Community Renewal Tax 

Relief Act of 2000. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

10. Provide a tax credit for expenditures on closed captioning technology in movies (sec. 639 of the Senate amendment and new 

sec. 45T of the Code) 

PRESENT LAW

There is no provision that allows a tax credit for expenditures 

made for closed captioning technology in motion pictures. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 50-percent business tax 

credit (the ‘‘motion picture accessibility credit’’) for certain qualified 

expenditures made in a taxable year by an eligible taxpayer. Qualified expenditures are defined as amounts paid or incurred for making motion pictures accessible to deaf or hard-of-hearing individuals through the use of captioning technology. An eligible taxpayer 

is defined as a taxpayer who is in the business of showing motion 

pictures to the public in theaters or producing or distributing those 

motion pictures. The taxpayer’s basis in property with respect to 

476 

which the credit is allowed is reduced by the amount of the credit 

allowed. No deduction or credit is permitted under any other provision of Chapter 1 (Normal Taxes and Surtaxes) of Subtitle A (Income Taxes) of the Code for the amount of any motion picture accessibility credit allowed. No portion of the credit may be carried 

back to any taxable year beginning before January 1, 2004. Other 

rules apply. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

E. MISCELLANEOUS PROVISIONS

1. Exclusion of gain or loss on sale or exchange of certain 

brownfield sites from unrelated business taxable income (sec. 

641 of the Senate amendment and secs. 512 and 514 of the 

Code) 

PRESENT LAW

In general, an organization that is otherwise exempt from Federal income tax is taxed on income from a trade or business regularly carried on that is not substantially related to the organization’s exempt purposes. Gains or losses from the sale, exchange, or 

other disposition of property, other than stock in trade, inventory, 

or property held primarily for sale to customers in the ordinary 

course of a trade or business, generally are excluded from unrelated business taxable income. Gains or losses are treated as unrelated business taxable income, however, if derived from ‘‘debt-financed property.’’ Debt-financed property generally means any 

property that is held to produce income and with respect to which 

there is acquisition indebtedness at any time during the taxable 

year. 

In general, income of a tax-exempt organization that is produced by debt-financed property is treated as unrelated business 

income in proportion to the acquisition indebtedness on the incomeproducing property. Acquisition indebtedness generally means the 

amount of unpaid indebtedness incurred by an organization to acquire or improve the property and indebtedness that would not 

have been incurred but for the acquisition or improvement of the 

property. Acquisition indebtedness does not include: (1) certain indebtedness incurred in the performance or exercise of a purpose or 

function constituting the basis of the organization’s exemption; (2) 

obligations to pay certain types of annuities; (3) an obligation, to 

the extent it is insured by the Federal Housing Administration, to 

finance the purchase, rehabilitation, or construction of housing for 

low and moderate income persons; or (4) indebtedness incurred by 

certain qualified organizations to acquire or improve real property. 

Special rules apply in the case of an exempt organization that 

owns a partnership interest in a partnership that holds debt-financed property. An exempt organization’s share of partnership inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00480 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
477 

343For purposes of the provision, a person is related to another person if (1) such person bears 

a relationship to such other person that is described in section 267(b) (determined without regard to paragraph (9)), or section 707(b)(1), determined by substituting 25 percent for 50 percent 

each place it appears therein; or (2) if such other person is a nonprofit organization, if such person controls directly or indirectly more than 25 percent of the governing body of such organization. 

come that is derived from debt-financed property generally is taxed 

as debt-financed income unless an exception provides otherwise. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

In general 

The Senate amendment provides an exclusion from unrelated 

business taxable income for the gain or loss from the qualified sale, 

exchange, or other disposition of a qualifying brownfield property 

by an eligible taxpayer. The exclusion from unrelated business taxable income generally is available to an exempt organization that 

acquires, remediates, and disposes of the qualifying brownfield 

property. In addition, the Senate amendment provides an exception 

from the debt-financed property rules for such properties. 

In order to qualify for the exclusions from unrelated business 

income and the debt-financed property rules, the eligible taxpayer 

is required to: (a) acquire from an unrelated person real property 

that constitutes a qualifying brownfield property; (b) pay or incur 

a minimum level of eligible remediation expenditures with respect 

to the property; and (c) transfer the remediated site to an unrelated person in a transaction that constitutes a sale, exchange, or 

other disposition for purposes of Federal income tax law.343

Qualifying brownfield properties 

Under the Senate amendment, the exclusion from unrelated 

business taxable income applies only to real property that constitutes a qualifying brownfield property. A qualifying brownfield 

property means real property that is certified, before the taxpayer 

incurs any eligible remediation expenditures (other than to obtain 

a Phase I environmental site assessment), by an appropriate State 

agency (within the meaning of section 198(c)(4)) in the State in 

which the property is located as a brownfield site within the meaning of section 101(39) of the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) (as in 

effect on the date of enactment of the proposal). The Senate amendment provision requires that the taxpayer’s request for certification 

include a sworn statement of the taxpayer and supporting documentation of the presence of a hazardous substance, pollutant, or 

contaminant on the property that is complicating the expansion, redevelopment, or reuse of the property given the property’s reasonably anticipated future land uses or capacity for uses of the property (including a Phase I environmental site assessment and, if applicable, evidence of the property’s presence on a local, State, or 

Federal list of brownfields or contaminated property) and other environmental assessments prepared or obtained by the taxpayer. 

478 

344 In general, a person is potentially liable under section 107 of CERCLA if: (1) it is the 

owner and operator of a vessel or a facility; (2) at the time of disposal of any hazardous substance it owned or operated any facility at which such hazardous substances were disposed of; 

(3) by contract, agreement, or otherwise it arranged for disposal or treatment, or arranged with 

a transporter for transport for disposal or treatment, of hazardous substances owned or possessed by such person, by any other party or entity, at any facility or incineration vessel owned 

or operated by another party or entity and containing such hazardous substances; or (4) it accepts or accepted any hazardous substances for transport to disposal or treatment facilities, incineration vessels or sites selected by such person, from which there is a release, or a threatened 

release which causes the incurrence of response costs, of a hazardous substance. 42 U.S.C. sec. 

9607(a) (2004). 

Eligible taxpayer 

An eligible taxpayer with respect to a qualifying brownfield 

property is an organization exempt from tax under section 501(a) 

that acquired such property from an unrelated person and paid or 

incurred a minimum amount of eligible remediation expenditures 

with respect to such property. The exempt organization (or the 

qualifying partnership of which it is a partner) is required to pay 

or incur eligible remediation expenditures with respect to a qualifying brownfield property in an amount that exceeds the greater of: 

(a) $550,000; or (b) 12 percent of the fair market value of the property at the time such property is acquired by the taxpayer, determined as if the property were not contaminated. 

An eligible taxpayer does not include an organization that is: 

(1) potentially liable under section 107 of CERCLA with respect to 

the property; (2) affiliated with any other person that is potentially 

liable thereunder through any direct or indirect familial relationship or any contractual, corporate, or financial relationship (other 

than a contractual, corporate, or financial relationship that is created by the instruments by which title to a qualifying brownfield 

property is conveyed or financed by a contract of sale of goods or 

services); or (3) the result of a reorganization of a business entity 

which was so potentially liable.344

Qualified sale, exchange, or other disposition 

Under the Senate amendment, a sale, exchange, or other disposition of a qualifying brownfield property shall be considered as 

qualified if such property is transferred by the eligible taxpayer to 

an unrelated person, and within one year of such transfer the taxpayer has received a certification (a ‘‘remediation certification’’) 

from the Environmental Protection Agency or an appropriate State 

agency (within the meaning of section 198(c)(4)) in the State in 

which the property is located that, as a result of the taxpayer’s remediation actions, such property would not be treated as a qualifying brownfield property in the hands of the transferee. A taxpayer’s request for a remediation certification shall be made no 

later than the date of the transfer and shall include a sworn statement by the taxpayer certifying that: (1) remedial actions that comply with all applicable or relevant and appropriate requirements 

(consistent with section 121(d) of CERCLA) have been substantially 

completed, such that there are no hazardous substances, pollutants 

or contaminants that complicate the expansion, redevelopment, or 

reuse of the property given the property’s reasonably anticipated 

future land uses or capacity for uses of the property; (2) the reasonably anticipated future land uses or capacity for uses of the property are more economically productive or environmentally beneVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00482 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
479 

345For this purpose, use of the property as a landfill or other hazardous waste facility shall 

not be considered more economically productive or environmentally beneficial. 346For these purposes, substantial completion means any necessary physical construction is 

complete, all immediate threats have been eliminated, and all long-term threats are under control. 347 Cleanup cost-cap or stop-loss coverage is coverage that places an upper limit on the costs 

of cleanup that the insured may have to pay. Re-opener or regulatory action coverage is coverage 

for costs associated with any future government actions that require further site cleanup, including costs associated with the loss of use of site improvements. 

ficial than the uses of the property in existence on the date the 

property was certified as a qualifying brownfield property; 345 (3) a 

remediation plan has been implemented to bring the property in 

compliance with all applicable local, State, and Federal environmental laws, regulations, and standards and to ensure that remediation protects human health and the environment; (4) the remediation plan, including any physical improvements required to remediate the property, is either complete or substantially complete, 

and if substantially complete,346 sufficient monitoring, funding, institutional controls, and financial assurances have been put in 

place to ensure the complete remediation of the site in accordance 

with the remediation plan as soon as is reasonably practicable after 

the disposition of the property by the taxpayer; and (5) public notice and the opportunity for comment on the request for certification (in the same form and manner as required for public participation required under section 117(a) of CERCLA (as in effect on 

the date of enactment of the provision)) was completed before the 

date of such request. Public notice shall include, at a minimum, 

publication in a major local newspaper of general circulation. 

A copy of each of the requests for certification that the property was a brownfield site, and that it would no longer be a qualifying brownfield property in the hands of the transferee, shall be 

included in the tax return of the eligible taxpayer (and, where applicable, of the qualifying partnership) for the taxable year during 

which the transfer occurs. 

Eligible remediation expenditures 

Under the Senate amendment, eligible remediation expenditures means, with respect to any qualifying brownfield property: (1) 

expenditures that are paid or incurred by the taxpayer to an unrelated person to obtain a Phase I environmental site assessment of 

the property; (2) amounts paid or incurred by the taxpayer after receipt of the certification that the property is a qualifying brownfield 

property for goods and services necessary to obtain the remediation 

certification; and (3) expenditures to obtain remediation cost-cap or 

stop-loss coverage, re-opener or regulatory action coverage, or similar coverage under environmental insurance policies,347 or to obtain financial guarantees required to manage the remediation and 

monitoring of the property. Eligible remediation expenditures include expenditures to (1) manage, remove, control, contain, abate, 

or otherwise remediate a hazardous substance, pollutant, or contaminant on the property; (2) obtain a Phase II environmental site 

assessment of the property, including any expenditure to monitor, 

sample, study, assess, or otherwise evaluate the release, threat of 

release, or presence of a hazardous substance, pollutant, or contaminant on the property, or (3) obtain environmental regulatory 

certifications and approvals required to manage the remediation 

480 

348For this purpose, professional liability insurance is coverage for errors and omissions by 

public and private parties dealing with or managing contaminated land issues, and includes coverage under policies referred to as owner-controlled insurance. Owner/operator liability coverage 

is coverage for those parties that own the site or conduct business or engage in cleanup operations on the site. Legal defense coverage is coverage for lawsuits associated with liability 

claims against the insured made by enforcement agencies or third parties, including by private 

parties. 349The provision authorizes the Secretary of the Treasury to issue guidance regarding the 

treatment of government-provided funds for purposes of determining eligible remediation expenditures. 350For example, rent income from leasing the property does not qualify under the proposal. 351Depreciation or section 198 amounts that the taxpayer had not used to determine its unrelated business taxable income are not treated as gain that is ordinary income under sections 

1245 or 1250 (secs. 1.1245–2(a)(8) and 1.1250–2(d)(6)), and are not recognized as gain or ordinary income upon the sale, exchange, or disposition of the property. Thus, an exempt organization would not be entitled to a double benefit resulting from a section 198 expense deduction 

and the proposed exclusion from gain with respect to any amounts it deducts under section 198. 

and monitoring of the hazardous substance, pollutant, or contaminant on the property. Eligible remediation expenditures do not include (1) any portion of the purchase price paid or incurred by the 

eligible taxpayer to acquire the qualifying brownfield property; (2) 

environmental insurance costs paid or incurred to obtain legal defense coverage, owner/operator liability coverage, lender liability 

coverage, professional liability coverage, or similar types of coverage; 348 (3) any amount paid or incurred to the extent such 

amount is reimbursed, funded or otherwise subsidized by: (a) 

grants provided by the United States, a State, or a political subdivision of a State for use in connection with the property; (b) proceeds of an issue of State or local government obligations used to 

provide financing for the property, the interest of which is exempt 

from tax under section 103; or (c) subsidized financing provided (directly or indirectly) under a Federal, State, or local program in connection with the property; or (4) any expenditure paid or incurred 

before the date of enactment of the proposal.349

Qualified gain or loss 

The Senate amendment generally excludes from unrelated 

business taxable income the exempt organization’s gain or loss 

from the sale, exchange, or other disposition of a qualifying 

brownfield property. Income, gain, or loss from other transfers does 

not qualify under the provision.350 The amount of gain or loss excluded from unrelated business taxable income is not limited to or 

based upon the increase or decrease in value of the property that 

is attributable to the taxpayer’s expenditure of eligible remediation 

expenditures. Further, the exclusion does not apply to an amount 

treated as gain that is ordinary income with respect to section 1245 

or section 1250 property, including any amount deducted as a section 198 expense that is subject to the recapture rules of section 

198(e), if the taxpayer had deducted such amount in the computation of its unrelated business taxable income.351

Special rules for qualifying partnerships 

In general 

In the case of a tax-exempt organization that is a partner of 

a qualifying partnership that acquires, remediates, and disposes of 

a qualifying brownfield property, the Senate amendment provision 

applies to the tax-exempt partner’s distributive share of the qualiVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00484 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
481 

352The provision’s exclusions do not apply to a tax-exempt partner’s gain or loss from the taxexempt partner’s sale, exchange, or other disposition of its partnership interest. Such transactions continue to be governed by present-law. 353The provision subjects a tax-exempt partner to tax on gain previously excluded by the partner (plus interest) if a property subsequently becomes ineligible for exclusion under the qualifying partnership’s multiple-property election. 

fying partnership’s gain or loss from the disposition of the property.352 A qualifying partnership is a partnership that (1) has a 

partnership agreement that satisfies the requirements of section 

514(c)(9)(B)(vi) at all times beginning on the date of the first certification received by the partnership that one of its properties is a 

qualifying brownfield property; (2) satisfies the requirements of the 

proposal if such requirements are applied to the partnership (rather than to the eligible taxpayer that is a partner of the partnership); and (3) is not an organization that would be prevented from 

constituting an eligible taxpayer by reason of it or an affiliate being 

potentially liable under CERCLA with respect to the property. 

The exclusion is available to a tax-exempt organization with 

respect to a particular property acquired, remediated, and disposed 

of by a qualifying partnership only if the exempt organization is a 

partner of the partnership at all times during the period beginning 

on the date of the first certification received by the partnership 

that one of its properties is a qualifying brownfield property, and 

ending on the date of the disposition of the property by the partnership.353

Under the Senate amendment, the Secretary shall prescribe 

such regulations as are necessary to prevent abuse of the requirements of the provision, including abuse through the use of special 

allocations of gains or losses, or changes in ownership of partnership interests held by eligible taxpayers. 

Certifications and multiple property elections 

If the property is acquired and remediated by a qualifying 

partnership of which the exempt organization is a partner, it is intended that the certification as to status as a qualified brownfield 

property and the remediation certification will be obtained by the 

qualifying partnership, rather than by the tax-exempt partner, and 

that both the eligible taxpayer and the qualifying partnership will 

be required to make available such copies of the certifications to 

the IRS. Any elections or revocations regarding the application of 

the eligible remediation expenditure rules to multiple properties 

(as described below) acquired, remediated, and disposed of by a 

qualifying partnership must be made by the partnership. A tax-exempt partner is bound by an election made by the qualifying partnership of which it is a partner. 

Special rules for multiple properties 

The eligible remediation expenditure determinations generally 

are made on a property-by-property basis. An exempt organization 

(or a qualifying partnership of which the exempt organization is a 

partner) that acquires, remediates, and disposes of multiple qualifying brownfield properties, however, may elect to make the eligible 

remediation expenditure determinations on a multiple-property 

basis. In the case of such an election, the taxpayer satisfies the eligible remediation expenditures test with respect to all qualifying 

482 

354 If the taxpayer fails to satisfy the averaging test for the properties subject to the election, 

then the taxpayer may not apply the exclusion on a separate property basis with respect to any 

of such properties. 355The provision subjects a taxpayer to tax on gain previously excluded (plus interest) in the 

event a site subsequently becomes ineligible for gain exclusion under the multiple-property election. 

brownfield properties acquired during the election period if the average of the eligible remediation expenditures for all such properties exceeds the greater of: (a) $550,000; or (b) 12 percent of the 

average of the fair market value of the properties, determined as 

of the dates they were acquired by the taxpayer and as if they were 

not contaminated. If the eligible taxpayer elects to make the eligible remediation expenditure determination on a multiple property 

basis, then the election shall apply to all qualifying sales, exchanges, or other dispositions of qualifying brownfield properties 

the acquisition and transfer of which occur during the period for 

which the election remains in effect.354

An acquiring taxpayer makes a multiple-property election with 

its timely filed tax return (including extensions) for the first taxable year for which it intends to have the election apply. A timely 

filed election is effective as of the first day of the taxable year of 

the return in which the election is included or a later day in such 

taxable year selected by the taxpayer. An election remains effective 

until the earliest of a date selected by the taxpayer, the date which 

is eight years after the effective date of the election, the effective 

date of a revocation of the election, or, in the case of a partnership, 

the date of the termination of the partnership. 

A taxpayer may revoke a multiple-property election by filing a 

statement of revocation with a timely filed tax return (including extensions). A revocation is effective as of the first day of the taxable 

year of the return in which the revocation is included or a later day 

in such taxable year selected by the eligible taxpayer or qualifying 

partnership. Once a taxpayer revokes the election, the taxpayer is 

ineligible to make another multiple-property election with respect 

to any qualifying brownfield property subject to the revoked election.355

Debt-financed property 

The Senate amendment provides that debt-financed property, 

as defined by section 514(b), does not include any property the gain 

or loss from the sale, exchange, or other disposition of which is excluded by reason of the provisions of the proposal that exclude such 

gain or loss from computing the gross income of any unrelated 

trade or business of the taxpayer. Thus, gain or loss from the sale, 

exchange, or other disposition of a qualifying brownfield property 

that otherwise satisfies the requirements of the provision is not 

taxed as unrelated business taxable income merely because the 

taxpayer incurred debt to acquire or improve the site. 

Effective date.—The Senate amendment provision applies to 

gain or loss on the sale, exchange, or other disposition of a property 

acquired by the taxpayer after December 31, 2004. 

483 

356Sec. 104(a)(2). 357Sec. 265(a)(1). 358Sec. 212. 359Sec. 67. 360Sec. 68. 361 Kenseth v. Commissioner, 114 T.C. 399 (2000), aff’d 259 F.3d 881 (7th Cir. 2001); Coady 

v. Commissioner, 213 F.3d 1187 (9th Cir. 2000); Benci-Woodward v. Commissioner, 219 F.3d 941 

(9th Cir. 2000); Baylin v. United States, 43 F.3d 1451 (Fed. Cir. 1995). 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, 

modified to provide a termination date of December 31, 2009. The 

conference agreement provision applies to gain or loss on the sale, 

exchange, or other disposition of property that is acquired by the 

eligible taxpayer or qualifying partnership during the period beginning January 1, 2005, and ending December 31, 2009. Property acquired during the five-year acquisition period need not be disposed 

of by the termination date in order to qualify for the exclusion. For 

purposes of the multiple property election, gain or loss on property 

acquired after December 31, 2009, is not eligible for the exclusion 

from unrelated business taxable income, although properties acquired after the termination date (but during the election period) 

are included for purposes of determining average eligible remediation expenditures. 

Effective date.—The conference agreement provision applies to 

gain or loss on property that is acquired after December 31, 2004. 

2. Civil rights tax relief (sec. 643 of the Senate amendment and sec. 

62 of the Code) 

PRESENT LAW

Under present law, gross income generally does not include the 

amount of any damages (other than punitive damages) received 

(whether by suit or agreement and whether as lump sums or as 

periodic payments) by individuals on account of personal physical 

injuries (including death) or physical sickness.356 Expenses relating 

to recovering such damages are generally not deductible.357

Other damages are generally included in gross income. The related expenses to recover the damages, including attorneys’ fees, 

are generally deductible as expenses for the production of income,358 subject to the two-percent floor on itemized deductions.359

Thus, such expenses are deductible only to the extent the taxpayer’s total miscellaneous itemized deductions exceed two percent 

of adjusted gross income. Any amount allowable as a deduction is 

subject to reduction under the overall limitation of itemized deductions if the taxpayer’s adjusted gross income exceeds a threshold 

amount.360 For purposes of the alternative minimum tax, no deduction is allowed for any miscellaneous itemized deduction. 

In some cases, claimants will engage an attorney to represent 

them on a contingent fee basis. That is, if the claimant recovers 

damages, a prearranged percentage of the damages will be paid to 

the attorney; if no damages are recovered, the attorney is not paid 

a fee. The proper tax treatment of contingent fee arrangements 

with attorneys has been litigated in recent years. Some courts 361

have held that the entire amount of damages is income and that 

the claimant is entitled to a miscellaneous itemized deduction subVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00487 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
484 

362 Cotnam v. Commissioner, 263 F.2d 119 (5th Cir. 1959); Estate of Arthur Clarks v. United 

States, 202 F.3d 854 (6th Cir. 2000); Srivastava v. Commissioner, 220 F.3d 353 (5th Cir. 2000). 

In some of these cases, such as Cotnam, State law has been an important consideration in determining that the claimant has no claim of right to the recovery. 

ject to both the two-percent floor as an expense for the production 

of income for the portion paid to the attorney and to the overall 

limitation on itemized deductions. Other courts have held that the 

portion of the recovery that is paid directly to the attorney is not 

income to the claimant, holding that the claimant has no claim of 

right to that portion of the recovery.362

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides an above-the-line deduction 

for attorneys’ fees and costs paid by, or on behalf of, the taxpayer 

in connection with any action involving a claim of unlawful discrimination, certain claims against the Federal Government, or a 

private cause of action under the Medicare Secondary Payer statute. The amount that may be deducted above-the-line may not exceed the amount includible in the taxpayer’s gross income for the 

taxable year on account of a judgment or settlement (whether by 

suit or agreement and whether as lump sum or periodic payments) 

resulting from such claim. 

Under the proposal, ‘‘unlawful discrimination’’ means an act 

that is unlawful under certain provisions of any of the following: 

the Civil Rights Act of 1991; the Congressional Accountability Act 

of 1995; the National Labor Relations Act; the Fair Labor Standards Act of 1938; the Age Discrimination in Employment Act of 

1967; the Rehabilitation Act of 1973; the Employee Retirement Income Security Act of 1974; the Education Amendments of 1972; the 

Employee Polygraph Protection Act of 1988; the Worker Adjustment and Retraining Notification Act; the Family and Medical 

Leave Act of 1993; chapter 43 of Title 38 of the United States Code; 

the Revised Statutes; the Civil Rights Act of 1964; the Fair Housing Act; the Americans with Disabilities Act of 1990; any provision 

of Federal law (popularly known as whistleblower protection provisions) prohibiting the discharge of an employee, discrimination 

against an employee, or any other form of retaliation or reprisal 

against an employee for asserting rights or taking other actions 

permitted under Federal law; or any provision of Federal, State or 

local law, or common law claims permitted under Federal, State, or 

local law providing for the enforcement of civil rights or regulating 

any aspect of the employment relationship, including claims for 

wages, compensation, or benefits, or prohibiting the discharge of an 

employee, discrimination against an employee, or any other form of 

retaliation or reprisal against an employee for asserting rights or 

taking other actions permitted by law. 

Effective date.—The Senate amendment provision applies to 

fees and costs paid after December 31, 2002, with respect to any 

judgment or settlement occurring after such date. 

485 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment except for the effective date. 

Effective date.—The conference agreement applies to fees and 

costs paid after the date of enactment with respect to any judgment 

or settlement occurring after such date. 

3. Exclusion from gross income for amounts paid under National 

Health Service Corps loan repayment program (sec. 644 of the 

Senate amendment and sec. 108 of the Code) 

PRESENT LAW

The National Health Service Corps Loan Repayment Program 

(the ‘‘NHSC Loan Repayment Program’’) provides education loan 

repayments to participants on condition that the participants provide certain services. In the case of the NHSC Loan Repayment 

Program, the recipient of the loan repayment is obligated to provide medical services in a geographic area identified by the Public 

Health Service as having a shortage of health-care professionals. 

Loan repayments may be as much as $35,000 per year of service 

plus a tax assistance payment of 39 percent of the repayment 

amount. 

States may also provide for education loan repayment programs for persons who agree to provide primary health services in 

health professional shortage areas. Under the Public Health Service Act, such programs may receive Federal grants with respect to 

such repayment programs if certain requirements are satisfied. 

Generally, gross income means all income from whatever 

source derived including income for the discharge of indebtedness. 

However, gross income does not include discharge of indebtedness 

income if: (1) the discharge occurs in a Title 11 case; (2) the discharge occurs when the taxpayer is insolvent; (3) the indebtedness 

discharged is qualified farm indebtedness; or (4) except in the case 

of a C corporation, the indebtedness discharged is qualified real 

property business indebtedness. 

Because the loan repayments provided under the NHSC Loan 

Repayment Program or similar State programs under the Public 

Health Service Act are not specifically excluded from gross income, 

they are gross income to the recipient. There is also no exception 

from employment taxes (FICA and FUTA) for such loan repayments. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision excludes from gross income and employment 

taxes education loan repayments provided under the NHSC Loan 

Repayment Program and State programs eligible for funds under 

the Public Health Service Act. The provision also provides that 

such repayments are not taken into account as wages in determining benefits under the Social Security Act. 

486 

363Section 162(o). 364Sec. 460(a). 365Pub. Law No. 100–203 (1987). 

Effective date.—The provision is effective with respect to 

amounts received in taxable years beginning after December 31, 

2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

4. Certain expenses of rural letter carriers (sec. 645 of the Senate 

amendment and sec. 162(o) of the Code) 

PRESENT LAW

The deductible automobile expenses of rural letter carriers 

equal the reimbursements that such carriers receive from the U.S. 

Postal Service. Carriers are not allowed to document their actual 

costs and claim itemized deductions for costs in excess of reimbursements,363 nor are carriers required to include in income reimbursements in excess of their actual costs. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the Senate amendment, if the reimbursements a rural 

letter carrier receives from the U.S. Postal Service fall short of the 

carrier’s actual costs, the costs in excess of reimbursements qualify 

as a miscellaneous itemized deduction subject to the two-percent 

floor. Reimbursements in excess of their actual costs continue not 

to be required to be included in gross income. 

Effective date.—The provisions is effective for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

5. Method of accounting for naval shipbuilders (sec. 646 of the Senate amendment) 

PRESENT LAW

Generally, taxpayers must use the percentage-of-completion 

method to determine taxable income from long-term contracts.364

Under sec. 10203(b)(2)(B) of the Revenue Act of 1987,365 an exception exists for certain ship construction contracts, which may be accounted for using the 40/60 percentage-of-completion/ capitalized 

cost method (‘‘PCCM’’). Under the 40/60 PCCM, 60 percent of a taxpayer’s long-term contract income is exempt from the requirement 

to use the percentage-of-completion method while 40 percent remains subject to the requirement. The exempt 60 percent of longterm contract income must be reported by consistently using the 

taxpayer’s exempt contract method. Permissible exempt contract 

methods include the percentage of completion method, the exemptVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00490 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
487 

366Treas. Reg. 1.460–4(c)(1). 

contract percentage-of-completion method, and the completed contract method.366

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that qualified naval ship contracts may be accounted for using the 40/60 PCCM during the first 

five taxable years of the contract. The cumulative reduction in tax 

resulting from the provision over the five-year period is recaptured 

and included in the taxpayer’s tax liability in the sixth year. Qualified naval ship contracts are defined as any contract or portion 

thereof that is for the construction in the United States of one ship 

or submarine for the Federal Government if the taxpayer reasonably expects the acceptance date will occur no later than nine years 

after the construction commencement date. 

Effective date.—The Senate amendment is effective for contracts with respect to which the construction commencement date 

occurs after date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

the following modification. The provision specifies that the construction commencement date is the date on which the physical 

fabrication of any section or component of the ship or submarine 

begins in the taxpayer’s shipyard. 

Effective date.—The provision is effective for contracts with respect to which the construction commencement date occurs after 

date of enactment. 

6. Distributions to shareholders from policyholders surplus account 

of life insurance companies (sec. 647 of the Senate amendment 

and sec. 815 of the Code) 

PRIOR AND PRESENT LAW

Under the law in effect from 1959 through 1983, a life insurance company was subject to a three-phase taxable income computation under Federal tax law. Under the three-phase system, a 

company was taxed on the lesser of its gain from operations or its 

taxable investment income (Phase I) and, if its gain from operations exceeded its taxable investment income, 50 percent of such 

excess (Phase II). Federal income tax on the other 50 percent of the 

gain from operations was deferred, and was accounted for as part 

of a policyholder’s surplus account and, subject to certain limitations, taxed only when distributed to stockholders or upon corporate dissolution (Phase III). To determine whether amounts had 

been distributed, a company maintained a shareholders surplus account, which generally included the company’s previously taxed income that would be available for distribution to shareholders. Distributions to shareholders were treated as being first out of the 

488 

shareholders surplus account, then out of the policyholders surplus 

account, and finally out of other accounts. 

The Deficit Reduction Act of 1984 included provisions that, for 

1984 and later years, eliminated further deferral of tax on amounts 

(described above) that previously would have been deferred under 

the three-phase system. Although for taxable years after 1983, life 

insurance companies may not enlarge their policyholders surplus 

account, the companies are not taxed on previously deferred 

amounts unless the amounts are treated as distributed to shareholders or subtracted from the policyholders surplus account (sec. 

815). 

Under present law, any direct or indirect distribution to shareholders from an existing policyholders surplus account of a stock 

life insurance company is subject to tax at the corporate rate in the 

taxable year of the distribution. Present law (like prior law) provides that any distribution to shareholders is treated as made (1) 

first out of the shareholders surplus account, to the extent thereof, 

(2) then out of the policyholders surplus account, to the extent 

thereof, and (3) finally, out of other accounts. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provision suspends for a stock life insurance company’s taxable years beginning after December 31, 

2003, and before January 1, 2006, the application of the rules imposing income tax on distributions to shareholders from the policyholders surplus account of a life insurance company (sec. 815). The 

provision also reverses the order in which distributions reduce the 

various accounts, so that distributions would be treated as first 

made out of the policyholders surplus account, to the extent thereof, and then out of the shareholders surplus account, and lastly out 

of other accounts. 

Effective date.—The Senate amendment provision is effective 

for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, with 

a modification. 

The conference agreement provision suspends for a stock life 

insurance company’s taxable years beginning after December 31, 

2004, and before January 1, 2007, the application of the rules imposing income tax on distributions to shareholders from the policyholders surplus account of a life insurance company (sec. 815). The 

conference agreement includes the Senate amendment provision reversing the order in which distributions reduce the various accounts, so that distributions would be treated as first made out of 

the policyholders surplus account, to the extent thereof, and then 

out of the shareholders surplus account, and lastly out of other accounts. 

Effective date.—The conference agreement provision is effective 

for taxable years beginning after December 31, 2004. 

489 

367Sec. 1031(a)(1). 

7. Motor vehicle dealer transitional assistance (sec. 650 of the Senate amendment) 

PRESENT LAW

Under present law, no gain or loss is recognized on the exchange of property used in a trade or business or held for investment if the property is exchanged solely for property of like 

kind.367 To qualify for nonrecognition treatment, the replacement 

property must be identified within 45 days and the exchange must 

be completed within 180 days after the transfer of the exchanged 

property. The basis of the replacement property is determined by 

reference to the basis of the exchanged property. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides an election (on either an 

original or amended return) to defer the gain on termination payments received by a taxpayer from a motor vehicle manufacturer 

on account of the termination of a motor vehicle sales and service 

agreement, provided the proceeds are reinvested within two years 

in property used in a domestic motor vehicle dealership. Under the 

provision, a dealership in which the proceeds are reinvested within 

two years is treated as like kind replacement property under sec. 

1031, without regard to the time limitations on identification of 

and acquisition of such replacement property under present law. 

The provision extends the statute of limitations for assessment of 

any deficiency attributable to gain on termination payments until 

three years after the taxpayer notifies the Secretary of the likekind replacement property or an intention not to replace. 

The Senate amendment applies only with respect to termination payments from a motor vehicle manufacturer who announced in December 2000 that it would phase out the motor vehicle brand to which the agreement relates. 

Effective date.—The Senate amendment is effective for 

amounts received after December 12, 2000, in taxable years ending 

after that date. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

490 

368Section 1400E was added by section 101(a) of the Community Renewal Tax Relief Act of 

2000, P.L. No. 106–554 (December 21, 2000). 

8. Expansion of designated renewal community area based on 2000 

census data (sec. 651 of the Senate amendment and sec. 1400E 

of the Code) 

PRESENT LAW

Section 1400E provides for the designation of certain communities as renewal communities.368 An area designated as a renewal 

community is eligible for the following tax incentives: (1) a zeropercent rate for capital gain from the sale of qualifying assets; (2) 

a 15-percent wage credit to employers for the first $10,000 of qualified wages; (3) a ‘‘commercial revitalization deduction’’ that allows 

taxpayers (to the extent allocated by the appropriate State agency) 

to deduct either (a) 50 percent of qualifying expenditures for the 

taxable year in which a qualified building is placed in service, or 

(b) all of the qualifying expenditures ratably over a 10-year period 

beginning with the month in which such building is placed in service; (4) an additional $35,000 of section 179 expensing for qualified 

property; and (5) an expansion of the work opportunity tax credit 

with respect to individuals who live in a renewal community. 

To be designated as a renewal community, a nominated area 

was required to meet the following criteria: (1) each census tract 

must have a poverty rate of at least 20 percent; (2) in the case of 

an urban area, at least 70 percent of the households have incomes 

below 80 percent of the median income of households within the 

local government jurisdiction; (3) the unemployment rate is at least 

1.5 times the national unemployment rate; and (4) the area is one 

of pervasive poverty, unemployment, and general distress. There 

are no geographic size limitations placed on renewal communities. 

Instead, the boundary of a renewal community must be continuous. 

In addition, the renewal community must have a minimum population of 4,000 if the community is located within a metropolitan 

statistical area (at least 1,000 in all other cases), and a maximum 

population of not more than 200,000. The population limitations do 

not apply to any renewal community that is entirely within an Indian reservation. 

The designations of renewal communities were required to be 

made by December 31, 2001, using 1990 census data to determine 

relevant populations and poverty rates. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment permits the Secretary of Housing and 

Urban Development to expand a renewal community to include: (1) 

any census tract that at the time such community was nominated, 

satisfied the requirements for inclusion in such community but for 

the failure of such tract to satisfy one or more of the population 

and poverty rate requirements using 1990 census data, and that 

satisfies all failed population and poverty rate requirements using 

2000 census data; or (2) an area that is adjacent to at least one 

491 

other area designated as a renewal community and that has a population less than the generally applicable population requirement, 

if the area is one of pervasive poverty, unemployment, and general 

distress that is within the jurisdiction of one or more local governments and the boundary of the area is continuous, or the area contains a population of less than 100 people. 

Effective date.—The provision is effective as if included in the 

amendments made by section 101 of the Community Renewal Tax 

Relief Act of 2000. 

CONFERENCE AGREEMENT

The conference agreement modifies the Senate amendment to 

authorize the Secretary of Housing and Urban Development, at the 

request of all of the governments that nominated a renewal community, to add a contiguous census tract to a renewal community 

in the following circumstances. First, the renewal community, including any tract to be added, would have met the renewal community eligibility requirements at the time of the community’s original 

nomination, and any tract to be added has a poverty rate using 

2000 census data that exceeds the poverty rate of such tract using 

1990 census data. Second, a tract may be added to a renewal community even if the addition of such tract to such community would 

have caused the community to fail one or more eligibility requirements when originally nominated using 1990 census data, provided 

that: (1) the renewal community after the inclusion of such tract 

does not have a population that exceeds 200,000 using either 1990 

or 2000 census data; (2) such tract has a poverty rate of at least 

20 percent using 2000 census data; and (3) such tract has a poverty 

rate using 2000 census data that exceeds the poverty rate of such 

tract using 1990 census data. Census tracts that did not have a 

poverty rate determined by the Bureau of the Census using 1990 

data may be added to an existing renewal community without satisfying requirement (3) above. Third, a tract may be added to an 

existing renewal community if such tract: (1) has no population 

using 2000 census data or no poverty rate for such tract is determined by the Bureau of the Census using 2000 census data; (2) 

such tract is one of general distress; and (3) the renewal community, including such tract, is within the jurisdiction of one or more 

local governments and has a continuous boundary. 

Effective date.—The conference agreement provision is effective 

as if included in the amendments made by section 101 of the Community Renewal Tax Relief Act of 2000. 

9. Reduction of holding period to 12 months for purposes of determining whether horses are section 1231 assets (sec. 652 of the 

Senate amendment and sec. 1231 of the Code) 

PRESENT LAW

Under present law, gain from the sale or exchange of horses 

held for draft, breeding, or sporting purposes qualify for long-term 

capital gain if the horse has been held for 24 months or more. 

HOUSE BILL

No provision. 

492 

369 Under present law, corporate income is taxed at graduated rates ranging from 15 percent 

to 35 percent. A corporation is also entitled to a dividends-received deduction of at least 70 percent for dividends received from other corporations. Thus, the maximum corporate rate on dividends received from other corporations is 10.5 percent. Individual income is generally taxed at 

graduated rates up to 35 percent. However, dividends are taxed at a maximum rate of 15 percent. The maximum individual rates are scheduled to return to 39.6 percent on dividends as 

well as on other ordinary income after the year 2009. 

SENATE AMENDMENT

The Senate amendment reduces the holding period for horses 

to 12 months or more. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the provision in the 

Senate amendment. 

10. Blue ribbon commission on comprehensive tax reform (sec. 653 

of the Senate amendment) 

PRESENT LAW

Under present law, there is no specially-appointed commission 

designated to study and report on comprehensive tax reform. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment establishes a commission to study and 

report on comprehensive tax reform. Members of the commission 

are to be appointed by Congressional leadership and the President. 

Effective date.—Members must be appointed by October 30, 

2004. The report is due no later than 18 months after all members 

are appointed. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

11. Temporary accumulated earnings tax safe harbor (sec. 655 of 

the Senate amendment and sec. 537 of the Code) 

PRESENT LAW

Present law imposes an accumulated earnings tax on the accumulated taxable income of a corporation that is formed or availed 

of for the purpose of avoiding the income tax with respect to its 

shareholders or the shareholders of any other corporation, by permitting earnings and profits to accumulate instead of being distributed.369

The accumulated earnings tax is in addition to the regular corporate level tax and is imposed at the maximum rate that would 

be imposed on a dividend to an individual shareholder. A corporation is generally permitted to accumulate an exempted amount of 

$250,000 ($150,000 in the case of certain service corporations); the 

493 

370Sec. 533. 371Treas. Reg. sec. 1.533–1(a). 372Treas. Reg. secs. 1.537–1, 1.537–2 and 1.537–3. 373See, e.g., Bardahl Manufacturing Corp., 24 TCM 1030 (1965); Bardahl International Corp., 

25 TCM 935 (1966); Empire Steel Castings, Inc., 33 TCM 155 (1974); Alma-Piston Co. v. Commissioner, 579 F.2d 1000 (6th Cir. 1978); C.E. Hooper, Inc. 76–1 USTC par. 9185 (Ct. Cl. 1976). 

tax is then imposed on accumulated taxable income above that 

amount. 

The fact that earnings and profits are permitted to accumulate 

beyond the reasonable needs of the business is determinative of the 

purpose to avoid tax with respect to shareholders, unless the corporation by the preponderance of the evidence shall prove to the 

contrary. If a corporation is a ‘‘mere holding or investment company,’’ that fact is prima facie evidence of the prohibited purpose.370 Treasury regulations provide that even in cases of accumulation of earnings beyond the reasonable needs of the business or 

where a corporation is a mere holding or investment company, such 

facts are not absolutely conclusive against the taxpayer if the taxpayer satisfies the Commissioner that the corporation was neither 

formed not availed of for the purpose of avoiding income tax with 

respect to shareholders.371

The determination whether earnings and profits have been accumulated beyond the reasonable needs of the business is based on 

facts and circumstances. The reasonable needs of the business include ‘‘reasonably anticipated’’ needs of the business.372 Some 

courts have applied a business cycle approach in determining the 

basic working capital needs of a business, to which additional reasonably anticipated future needs may be added. Disputes have arisen regarding the choice of business cycle and the proper addition 

of future needs.373

HOUSE BILL

No provision. 

SENATE AMENDMENT

The bill provides that the reasonably anticipated needs of a 

business for any taxable year shall include working capital for the 

business in an amount which is not less than the sum of the cost 

of goods, operating expenses, and interest expense which the business incurred during the preceding taxable year. Any amounts incurred as part of a plan a principal purpose of which is to increase 

the limitation under this provision is not taken into account. 

Effective date.—The provision applies to taxable years beginning after December 31, 2003 and before January 1, 2009. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

494 

374Sec. 115. 375Sec. 103. 376Secs. 141–150. 

12. Tax Treatment of State Ownership of Railroad REIT (sec. 656 

of the Senate amendment and secs. 103, 115, 336 and 337 of 

the Code) 

PRESENT LAW

A real estate investment trust (‘‘REIT’’) is an electing entity 

that is engaged primarily in passive real estate activities (as specifically defined) and that, among other requirements, must have 

at least 100 shareholders. If a qualified entity elects REIT status, 

it can be taxed essentially as a pass-through entity, since it can obtain a deduction for amounts distributed to its shareholders and it 

is required to distribute at least 90 percent of its income to shareholders annually. 

If an entity does not qualify to be treated as a REIT, it would 

generally be treated as a regular C corporation subject to tax under 

subchapter C of the Code and section 11 at the corporate entity 

level, unless it elected to be taxed as a partnership or disregarded 

entity under Treasury regulations. Even if it made such an election, the C corporation would be treated as if it had liquidated and 

distributed its assets to shareholders, with a resulting corporate 

tax on the excess of fair market value over basis of any corporate 

assets. A C corporation that becomes a tax-exempt entity also must 

pay corporate tax on the excess of the fair market value over the 

basis of its assets. 

A State or local government is not subject to Federal income 

tax on income from an activity that is an essential governmental 

function.374

Interest on a State or local bond is excluded from gross income, 

with certain exceptions.375 Special rules are also provided as requirements for tax exemption for State and local bonds.376

HOUSE BILL

No provision. 

SENATE AMENDMENT

The bill provides that a qualified railroad corporation that is 

a REIT that meets certain qualified activity requirements (described further below) and that becomes 100 percent owned by a 

State after December 31, 2003 and before December 31, 2005, will 

not be treated as a taxable C corporation, but will be taxed as if 

its income from the qualified activities accrued directly to the 

State. To the extent its described railroad activities qualify under 

present law as essential governmental functions, income from such 

activities shall be tax exempt under section 115 of the Code. 

Under the bill, no gain or loss shall be recognized from the 

deemed conversion of such a REIT to a C corporation which is taxexempt, and no change in the basis of the property of the entity 

shall occur. 

495 

Also, any obligation issued by an entity described above is 

treated as an obligation of a State for purposes of applying the tax 

exempt bond provisions. 

A qualified railroad corporation that is a REIT must be a nonoperating Class III railroad, and substantially all of its activities 

must consist of the ownership, leasing, and operation by such corporation of facilities, equipment, and other property used by the 

corporation or other persons in railroad transportation. 

Effective date.—The bill applies on and after the date a State 

becomes the owner of all the outstanding stock of a qualified corporation, provided that the State becomes the owner of all the voting stock of the corporation on or before December 31, 2003 and becomes the owner of all the outstanding stock of the corporation on 

or before December 31, 2005. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

13. Contribution in aid of construction (sec. 657 of the Senate 

amendment and sec. 118 of the Code) 

PRESENT LAW

Section 118(a) provides that gross income of a corporation does 

not include a contribution to its capital. In general, section 118(b) 

provides that a contribution to the capital of a corporation does not 

include any contribution in aid of construction or any other contribution as a customer or potential customer and, as such, is includible in gross income of the corporation. However, for any 

amount of money or property received by a regulated public utility 

that provides water or sewerage disposal services, such amount 

shall be considered a contribution to capital (excludible from gross 

income) so long as such amount: (1) is a contribution in aid of construction, and (2) is not included in the taxpayer’s rate base for 

rate-making purposes. If the contribution is in property other than 

water or sewerage disposal facilities, the amount is generally excludible from gross income only if the amount is expended to acquire or construct water or sewerage disposal facilities within a 

specified time period. A contribution in aid of construction does not 

include a customer connection fee or amounts paid as service 

charges for starting or stopping services. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment clarifies that water and sewer service 

laterals (amounts paid to connect the customer’s water service line 

or sewer lateral line to the utility’s distribution or collection system, or to extend a main water or sewer line to provide service to 

a customer) received by a regulated public utility that provides 

water or sewerage disposal services is considered a contribution to 

capital and excludible from gross income of such utility. 

496 

Effective date.—The Senate amendment provision is effective 

for contributions made after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

14. Credit for purchase and installation of agricultural water conservation systems (sec. 658 of the Senate amendment) 

PRESENT LAW

There is no provision that provides for a credit for agricultural 

water systems. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 30-percent credit (not to exceed $500 per acre) for water conservation system expenses for taxpayers who normally derive at least 50 percent of their gross income from land. The term ‘water conservation system expenses’ 

means expenses for the purchase and installation of a water conservation system but only if (1) the land served by the water conservation system is entirely in a county or county-equivalent area 

which has received, in the taxable year the expenses were paid or 

incurred or in any of the three preceding taxable years, a primarycounty designation due to drought by the Secretary of Agriculture, 

and (2) such system is certified as saving at least 5 percent more 

irrigation water than the irrigation system which was used on such 

land immediately prior to the installation of such water conservation system. 

The term ‘water conservation system’ means (1) new or replacement irrigation equipment and machinery, including sprinklers, pipes, siphons, nozzles, pumps, motors, and engines, and (2) 

computer systems for irrigation and water management. 

The irrigation water savings shall be determined and certified 

under regulations prescribed jointly by the Natural Resources Conservation Service of the Department of Agriculture and the Bureau 

of Reclamation of the Department of the Interior. Such regulations 

shall include a list of individuals or organizations qualified to make 

such certification. 

No deduction is allowed with respect to any expenses taken 

into account in determining the credit, and any increase in the 

basis of any property which would result from such expense shall 

be reduced by the amount of credit allowed for such expense. 

Effective date.—The credit is available for expenses incurred 

after date of enactment with respect to systems completed after December 31, 2004 and prior to January 1, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

497 

15. Modification of involuntary conversion rules for businesses affected by the September 11th terrorist attacks (sec. 659 of the 

Senate amendment and sec. 1400L of the Code) 

PRESENT LAW

Generally, a taxpayer realizes gain to the extent the sales price 

(and any other consideration received) exceeds the taxpayer’s basis 

in the property. The realized gain is subject to current income tax 

unless the gain is deferred or not recognized under a special tax 

provision. 

Under section 1033, gain realized by a taxpayer from an involuntary conversion of property is deferred to the extent the taxpayer 

purchases property similar or related in service or use to the converted property within the applicable period. The taxpayer’s basis 

in the replacement property generally is the same as the taxpayer’s 

basis in the converted property, decreased by the amount of any 

money or loss recognized on the conversion, and increased by the 

amount of any gain recognized on the conversion. 

The applicable period for the taxpayer to replace the converted 

property begins with the date of the disposition of the converted 

property (or if earlier, the earliest date of the threat or imminence 

of requisition or condemnation of the converted property) and ends 

two years after the close of the first taxable year in which any part 

of the gain upon conversion is realized (the ‘‘replacement period’’). 

Special rules extend the replacement period for certain real property and principal residences damaged by a Presidentially declared 

disaster to three years and four years, respectively, after the close 

of the first taxable year in which gain is realized. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides special rules for property 

which is compulsorily or involuntarily converted as a result of the 

terrorist attacks on September 11, 2001, in the New York Liberty 

Zone. The special rules provide that a corporation which is a member of an affiliated group filing a consolidated tax return shall be 

treated as satisfying the repurchase requirement of section 1033 

with respect to such property to the extent the requirement is satisfied by another member of the corporation’s affiliated group. In 

addition, the provision extends the replacement period for such 

property to five years after the close of the first taxable year in 

which gain is realized, if substantially all the use of the replacement property is in New York City. 

Effective date.—The Senate amendment is effective for involuntary conversions occurring on or after September 11, 2001. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

498 

377Sec. 7872. 378 A ‘‘qualified continuing care facility’’ is defined as one or more facilities (1) which are designed to provide services under continuing care contracts, and (2) substantially all of the residents of which are covered by continuing care contracts. However, a facility is not a qualified 

continuing care facility unless substantially all facilities which are used to provide services that 

are required to be provided under a continuing care contract are owned or operated by the borrower. In addition, nursing homes do not constitute continuing care facilities (sec. 7872(g)(4)). 379 A ‘‘continuing care contract’’ is defined as a written contract between an individual and 

a qualified continuing care facility under which (1) the individual or individual’s spouse may 

use a qualified continuing care facility for their life or lives, (2) the individual or individual’s 

spouse (a) will first reside in a separate, independent living unit with additional facilities outside such unit for the providing of meals and other personal care, and (b) then will be provided 

long-term and skilled nursing care as the health of such individual or individual’s spouse requires, and (3) no additional substantial payment is required if such individual or individual’s 

spouse requires increased personal care services or long-term and skilled nursing care. 380 Rev. Rul. 2003–118, 2003–47 I.R.B. 1095. 

16. Repeal of application of below-market loan rules to amounts 

paid to certain continuing care facilities (sec. 660 of the Senate 

amendment and sec. 7872 of the Code) 

PRESENT LAW

Certain loans that bear interest at a below-market interest 

rate are treated as loans bearing interest at the market rate accompanied by a payment or payments from the lender to the borrower which are characterized in accordance with the substance of 

the particular transaction (e.g., gift, compensation, dividend, 

etc.).377 The market rate of interest for purposes of the below-market loan rules is assumed to be 100 percent of the applicable Federal rate (‘‘AFR’’) at the time the loan is made in the case of a term 

loan or, in the case of a demand loan, 100 percent of the AFR in 

effect over the time that the loan is outstanding. 

In general, the below-market loan rules apply to (1) loans 

where the foregone (i.e., below-market) interest is in the nature of 

a gift, (2) loans between an employee and an employer or between 

an independent contractor and one for whom the independent contractor provides services, (3) loans between a corporation and a 

shareholder of the corporation, (4) loans of which one of the principal purposes of the interest arrangement is the avoidance of Federal tax, (5) to the extent provided in Treasury regulations, any 

other below-market loans if the interest arrangement of such loan 

has a significant effect on any Federal tax liability of either the 

lender or borrower, and (6) loans to any qualified continuing care 

facility pursuant to a continuing care contract. 

In the case of loans made to qualified continuing care facilities,378 an exception from the below-market loan rules is provided 

for any loan as of the calendar year in which the lender has attained age 65, provided the loan is made by the lender to the qualified continuing care facility pursuant to a continuing care contract.379 However, the exception applies only to the extent that the 

principal amount of the loan, when added to the aggregate outstanding amount of all other previous loans between the lender (or 

the lender’s spouse) and any qualified continuing care facility, does 

not exceed $90,000. This amount is indexed for inflation, and the 

amount for calendar year 2004 is $154,500.380

With regard to continuing care facilities that are not qualified 

continuing care facilities, the IRS takes the position that loans 

made to such facilities by residents are not subject to the belowmarket loan rules until and unless Treasury regulations are issued 

499 

381Tech. Adv. Mem. 9521001 (Dec. 7, 1994). 

that treat such loans as having a significant effect on any Federal 

tax liability of either the facility or the resident.381

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment repeals the application of the belowmarket loan rules to loans that are made to any qualified continuing care facility pursuant to a continuing care contract, without 

regard to the principal amount of the loan (including the aggregate 

outstanding amount of any other previous loans between the resident or resident’s spouse and any qualified continuing care facility). 

The Senate amendment also clarifies that the determination of 

whether a facility is a qualified continuing care facility is to be 

made on an annual basis at the end of each calendar year, rather 

than only when the continuing care contract is entered into. In addition, the Senate amendment modifies the definition of a continuing care contract to (1) not exclude contracts that require additional substantial payment for increased personal care services required by the resident or resident’s spouse, and (2) provide authority for the Treasury to issue guidance that limits such definition to 

contracts that provide to the resident or resident’s spouse only facilities, care and services that are customarily offered by continuing 

care facilities. The Senate amendment also clarifies that the definition of a qualified continuing care facility requires substantially all 

of the independent living unit residents of the facility to be covered 

by continuing care contracts. 

The Senate amendment does not affect the present-law application of the below-market loan rules to loans made to any continuing care facility that is not a qualified continuing care facility. 

Effective date.—The Senate amendment provision applies to 

calendar years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

17. Maximum capital gain rates of individuals for gold, silver, platinum, and palladium (sec. 661 of the Senate amendment and 

sec. 1(h) of the Code) 

PRESENT LAW

Under present law, the net capital gain of an individual is generally taxed at a maximum rate of 15 percent (five percent for gain 

otherwise taxed at the 10- or 15-percent rate). However, the maximum tax rate for individuals from the sale or exchange of a collectible is 28 percent. Gold, silver, platinum or palladium bullion 

is defined as a collectible for this purpose. 

HOUSE BILL

No provision. 

500 

SENATE AMENDMENT

Under the Senate amendment, gold, silver, platinum and palladium bullion is not treated as a ‘‘collectible’’ for purposes of applying the individual capital gain rates. Thus, gain or loss from the 

sale of the bullion will qualify for the lower five- and 15-percent 

capital gain rates. 

Effective date.—Taxable years beginning after December 31, 

2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the provision in the 

Senate amendment. 

18. Inclusion of primary and secondary medical strategies for children and adults with sickle cell disease as medical assistance 

under the medicaid program (sec. 662 of the Senate amendment) 

PRESENT LAW

Medicaid programs are generally operated by the States, in 

part with funds received from the Federal government. Within 

broad Federal guidelines, States can design the scope and availability of Medicaid benefits. Medicaid law requires States to provide certain services including, for example, hospital and physician 

services. Federal funds are available for additional optional services if States choose to include them in their Medicaid plans. Within Federal guidelines, States may limit the amount, duration of any 

Medicaid service. Under present law, States may have covered 

some of the primary and secondary medical strategies, treatments, 

and services for Sickle Cell Disease, however such services are not 

specifically listed in the Medicaid statute as either mandatory or 

optional services. 

The Federal government shares in States’ Medicaid service 

costs by means of a statutory formula designed to provide a higher 

Federal matching rate to States with lower per capita incomes. The 

Federal share is referred to as the Federal Medical Assistance Percentage (‘‘FMAP’’). For some Medicaid services and activities, such 

as costs associated with program administration, the FMAP rate is 

set in statute. Because Medicaid is an individual entitlement, there 

is no annual ceiling on Federal expenditures; however, in order to 

continue receiving Federal payments, States must contribute their 

share of the matching funds. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment amends Title XIX of the Social Security Act to add primary and secondary medical strategies, treatment and services for individuals who have Sickle Cell Disease as 

a new optional medical assistance category under the Medicaid program. Such strategies, treatment, and services include: (1) chronic 

blood transfusion (with deferoxamine chelation) to prevent stroke 

501 

in individuals with Sickle Cell Disease who have been identified as 

being at high risk for stroke; (2) genetic counseling, testing, and 

treatment for individuals with Sickle Cell Disease or the Sickle 

Cell trait; and (3) other treatment and services to prevent individuals who have Sickle Cell Disease and who have had a stroke having another stroke. The amendment sets the FMAP rate at 50 percent for costs attributable to providing: (1) services to identify and 

educate likely Medicaid enrollees who have or are carriers of Sickle 

Cell Disease; or (2) education regarding the risks of stroke and 

other complications, as well as the prevention of stroke and complications for likely Medicaid enrollees with Sickle Cell Disease. 

The Senate amendment also authorizes an appropriation in the amount of $10,000,000 for each of fiscal years 2005 through 2009 

for a demonstration program under which the Administrator of the 

Health Resources and Services Administration (through the Bureau of Primary Health Care and the Maternal Child Health Bureau) would make grants up to 40 eligible entities in each such fiscal year for the development and establishment of systemic mechanisms for the prevention and treatment of the Sickle Cell Disease. 

Eligible entities include Federally-qualified health centers as defined in the Medicaid statute; nonprofit hospitals or clinics, or university health centers that provide primary health care that: (1) 

have a collaborative agreement with a community-based Sickle Cell 

Disease organization or a nonprofit entity with experience in working with individuals who have the Sickle Cell Disease; and (2) demonstrate that they have at least five years of experience in working 

with individuals who have the Sickle Cell Disease. Systematic 

mechanisms for the prevention and treatment of the Sickle Cell 

Disease include: (1) coordination of service delivery for individuals 

with the disease; (2) genetic counseling and testing; (3) bundling of 

technical services related to the prevention and treatment of the 

disease; (4) training health professionals; and (5) identifying and 

establishing efforts related to the expansion and coordination of 

education, treatment, and continuity of care programs for individuals with the disease. 

In awarding such grants to eligible entities, the Administrator 

of Health Resources and Services Administration is to take into 

consideration geographic diversity and to give priority to: (1) Federally-qualified health centers that have a partnership or other arrangement with a comprehensive Sickle Cell Disease treatment 

center and does not receive funds from the National Institutes of 

Health; or (2) Federally-qualified health centers that intend to develop a partnership or other arrangement with a comprehensive 

Sickle Cell Disease treatment center, and that does not receive 

funds from the National Institutes of Health. Eligible entities that 

are awarded grants are required to use the funds for the following 

activities: (1) to facilitate and coordinate the delivery of education, 

treatment, and continuity of care under: (a) the entity’s collaborative agreement with a community-based Sickle Cell Disease organization or a nonprofit entity that works with individuals who have 

Sickle Cell Disease; (b) the Sickle Cell Disease newborn screening 

program for the State in which the entity is located; and (c) the 

Maternal and Child Health program for the State in which the entity is located; (2) to train nursing and other health staff who proVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00505 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
502 

vide care for individuals with Sickle Cell Disease; (3) to enter into 

a partnership with adult or pediatric hematologists in the region 

and other regional experts in the Sickle Cell Disease at tertiary or 

academic health centers and State and county health offices; and 

(4) to identify and secure resources for ensuring reimbursement 

under the Medicaid program, State children’s health insurance program, and other health programs for the prevention and treatment 

of Sickle Cell Disease. 

The Senate amendment also requires the Administrator of 

Health Resources and Services Administration to enter into a contract with an entity and to serve as a National Coordinating Center 

for the demonstration program. The center is to: (1) collect, coordinate, monitor and distribute data, best practices, and findings regarding the activities funded under grants made to eligible entities 

under the demonstration program; (2) develop a model protocol for 

eligible entities with respect to prevention and treatment of the 

disease; (3) develop educational materials regarding the prevention 

and treatment of the disease; and (4) submit a written report to 

Congress. The written report to Congress should include recommendations on the effectiveness of the demonstration program 

direct outcome measures, such as the number and type of health 

care resources utilized (such as emergency room visits, hospital visits, length of stay, and physician visits for individuals with Sickle 

Cell Disease) and the number of individuals that were tested and 

subsequently received genetic counseling for the sickle cell trait. 

Effective date.—The Senate amendment is effective on the date 

of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment provision. 

19. Mortgage payment assistance (secs. 901 and 902 of the Senate 

amendment) 

PRESENT LAW

There is no provision in present law that authorizes the Secretary of Housing and Urban Development to award low-interest 

loans to individuals adversely affected by international economic 

activity to enable such individuals to make mortgage payments 

with respect to their primary residences. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment requires the Secretary of Housing and 

Urban Development (the ‘‘Secretary’’) to establish a program for 

awarding low-interest loans to eligible individuals to enable such 

individuals to continue making mortgage payments with respect to 

their primary residences. The provision provides that the Secretary 

shall issue regulations no later than six weeks after the date of enactment to implement this program. 

503 

382See, sections 6, 7, and 13 of the FLSA, 29 U.S.C. sections 206, 207, and 213 (2004). 383 69 Fed. Reg. 22,122 (April 23, 2004). 

An individual eligible to receive a loan under the program 

must be: (1) a worker that is adversely affected by international 

economic activity, as determined by the Secretary; (2) a borrower 

on a loan that requires monthly mortgage payments with respect 

to the primary residence of the individual; and (3) enrolled in a 

training or assistance program. The amount of a loan provided 

under the program cannot exceed the aggregate amount of monthly 

mortgage payments the borrower would owe during a 12-month period. In addition, a loan provided under the program must have an 

applicable interest rate of four percent and must provide for 

monthly repayments over a five-year period. The provision authorizes appropriations of $10 million for each 

of the years 2005 through 2009 to carry out the purposes of the 

provision. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

20. Protection of overtime pay (secs. 489–490 of the Senate amendment and sec. 13 of the Fair Labor Standards Act of 1938) 

PRESENT LAW

The Fair Labor Standards Act of 1938 (‘‘FLSA’’) establishes 

minimum wage and overtime pay requirements that apply to employees, subject to certain exemptions.382 On April 23, 2004, the 

Department of Labor issued revised regulations implementing exemptions from the FLSA minimum wage and overtime pay requirements.383 Among other changes, the regulations increased the salary threshold for employees to be exempt from these requirements. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment contains provisions relating to the authority of the Secretary of Labor to issue regulations implementing 

the overtime pay requirement and the effect of recently issued regulations. 

Under the Senate amendment, the Secretary of Labor may not 

issue any regulation that exempts from the overtime pay requirement any employee who earns less than $23,660 per year. In addition, the Secretary of Labor may not issue any regulation concerning the right to overtime pay that is not as protective, or more 

protective, of the overtime pay rights of employees in certain specified occupations or job classifications (as listed in the provision) as 

the protections provided for such employees under the regulations 

in effect on March 31, 2003. Any portion of a regulation issued 

after March 31, 2003, that modifies the overtime pay requirement 

504 

in a manner that is inconsistent with the provisions of the Senate 

amendment will have no force or effect as it relates to the occupation or job classification involved. 

The Senate amendment also provides that, notwithstanding 

the Administrative Procedures Act or any other provision of law, 

any portion of the Labor regulations issued on April 23, 2004, that 

exempts from the overtime pay requirement any employee who 

would not otherwise be exempt if the regulations in effect on March 

31, 2003, remained in effect, will have no force or effect. In addition, the portion of the regulations (as in effect on March 31, 2003) 

that would prevent any employee from being exempt shall remain 

in effect. Nonetheless, the increased salary requirements provided 

for in the regulations issued on April 23, 2004, will remain in effect. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provisions. 

21. Report on acquisitions of goods from foreign sources (sec. 1001 

of the Senate amendment and sec. 43 of the Office of Federal 

Procurement Policy Act) 

PRESENT LAW

Public Law 93–400, ‘‘The Office of Federal Procurement Policy 

Act’’, as amended, created the Office of Federal Procurement Policy 

(‘‘OFPP’’) in 1974 and placed it in the Office of Management and 

Budget (‘‘OMB’’). The OFPP was created, among other purposes, to 

provide Government-wide procurement policies which are to be followed by Executive agencies in procurement activities. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that, not later than 60 days 

after the end of each fiscal year, each executive agency is to submit 

to the Congress a report on the acquisitions that were made of articles, materials, or supplies by the agency in that fiscal year from 

sources outside the United States. The report is to separately include the following information: (1) the dollar value of any articles, 

materials, or supplies that were manufactured outside the United 

States; (2) an itemized list of all waivers granted with respect to 

such articles, materials, or supplies under the Buy American Act; 

and (2) a summary of the (a) the total procurement funds expended 

on articles, materials and supplies manufactured outside the 

United States and (b) the total procurement funds expended on articles, materials, and supplies manufactured outside the Untied 

States. The agency is to make the report publicly available by posting the report on the Internet. 

The reporting requirement does not apply to any procurement 

for national security purposes entered into by: (1) the Department 

505 

384Sec. 420. 385The value of plan assets for this purpose is the lesser of fair market value or actuarial 

value. 

of Defense or any agency or entity thereof; (2) the Departments of 

the Army, Navy, and Air Force or any agency or entity of any of 

the military departments; (3) the Department of Homeland Security; (4) the Department of Energy or any agency or entity thereof, 

with respect to the national security programs of the Department 

of Energy; or (5) any element of the intelligence community. 

The Senate amendment also provides that, not later than 60 

days after the end of each fiscal year ending after the date of enactment, the Secretary of Commerce is to submit to Congress a report 

on the acquisitions by foreign governments of articles, materials, or 

supplies that were manufactured or extracted in the United States 

in that fiscal year. The report is to indicate the dollar value of such 

articles, materials, or supplies and is to be made publicly available 

by posting on the Internet. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

22. Minimum cost requirement for excess asset transfers (sec. 719 

of the Senate amendment and sec. 420 of the Code) 

PRESENT LAW

Defined benefit plan assets generally may not revert to an employer prior to termination of the plan and satisfaction of all plan 

liabilities. In addition, a reversion may occur only if the plan so 

provides. A reversion prior to plan termination may constitute a 

prohibited transaction and may result in plan disqualification. Any 

assets that revert to the employer upon plan termination are includible in the gross income of the employer and subject to an excise tax. The excise tax rate is 20 percent if the employer maintains a replacement plan or makes certain benefit increases in connection with the termination; if not, the excise tax rate is 50 percent. Upon plan termination, the accrued benefits of all plan participants are required to be 100-percent vested. 

A pension plan may provide medical benefits to retired employees through a separate account that is part of such plan. A qualified transfer of excess assets of a defined benefit plan to such a 

separate account within the plan may be made in order to fund retiree health benefits.384 A qualified transfer does not result in plan 

disqualification, is not a prohibited transaction, and is not treated 

as a reversion. Thus, transferred assets are not includible in the 

gross income of the employer and are not subject to the excise tax 

on reversions. No more than one qualified transfer may be made 

in any taxable year. No qualified transfer may be made after December 31, 2013. 

Excess assets generally means the excess, if any, of the value 

of the plan’s assets385 over the greater of (1) the accrued liability 

506 

386 In the case of plan years beginning before January 1, 2004, excess assets generally means 

the excess, if any, of the value of the plan’s assets over the greater of (1) the lesser of (a) the 

accrued liability under the plan (including normal cost) or (b) 170 percent of the plan’s current 

liability (for 2003), or (2) 125 percent of the plan’s current liability. The current liability full 

funding limit was repealed for years beginning after 2003. Under the general sunset provision 

of EGTRRA, the limit is reinstated for years after 2010. 387Treas. Reg. sec. 1.420–1(a). 

under the plan (including normal cost) or (2) 125 percent of the 

plan’s current liability.386 In addition, excess assets transferred in 

a qualified transfer may not exceed the amount reasonably estimated to be the amount that the employer will pay out of such account during the taxable year of the transfer for qualified current 

retiree health liabilities. No deduction is allowed to the employer 

for (1) a qualified transfer or (2) the payment of qualified current 

retiree health liabilities out of transferred funds (and any income 

thereon). 

Transferred assets (and any income thereon) must be used to 

pay qualified current retiree health liabilities for the taxable year 

of the transfer. Transferred amounts generally must benefit pension plan participants, other than key employees, who are entitled 

upon retirement to receive retiree medical benefits through the separate account. Retiree health benefits of key employees may not be 

paid out of transferred assets. 

Amounts not used to pay qualified current retiree health liabilities for the taxable year of the transfer are to be returned to the 

general assets of the plan. These amounts are not includible in the 

gross income of the employer, but are treated as an employer reversion and are subject to a 20-percent excise tax. 

In order for a transfer to be qualified, accrued retirement benefits under the pension plan generally must be 100-percent vested 

as if the plan terminated immediately before the transfer (or in the 

case of a participant who separated in the one-year period ending 

on the date of the transfer, immediately before the separation). 

In order for a transfer to be qualified, the transfer must meet 

the minimum cost requirement. To satisfy the minimum cost requirement, an employer generally must maintain retiree health 

benefits at the same level for the taxable year of the transfer and 

the following four years (referred to as the cost maintance period). 

The applicable employer cost during the cost maintenance period 

cannot be less than the higher of the applicable employer costs for 

each of the two taxable years preceding the taxable year of the 

transfer. The applicable employer cost is generally determined by 

dividing the current retiree health liabilities by the number of individuals provided coverage for applicable health benefits during the 

year. The Secretary is directed to prescribe regulations as may be 

necessary to prevent an employer who significantly reduces retiree 

health coverage during the period from being treated as satisfying 

the minimum cost requirement. 

Under Treasury regulations,387 the minimum cost requirement 

is not satisfied if the employer significantly reduces retiree health 

coverage during the cost maintenance period. Under the regulations, an employer significantly reduces retiree health coverage for 

a year (beginning after 2001) during the cost maintenance period 

if either (1) the employer-initiated reduction percentage for that 

taxable year exceeds 10 percent, or (2) the sum of the employerVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00510 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
507 

388Treas. Reg. sec. 1.420–1(b)(1). 389Treas. Reg. sec. 1.420–1(b)(2). 

initiated reduction percentages for that taxable year and all prior 

taxable years during the cost maintenance period exceeds 20 percent.388 The employer-initiated reduction percentage is percentage 

of the number of individuals receiving coverage for applicable 

health benefits as of the day before the first day of the taxable year 

over the total number of such individuals whose coverage for applicable health benefits ended during the taxable year by reason of 

employer action.389

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that an eligible employer does 

not fail the minimum cost requirement if, in lieu of any reduction 

of health coverage permitted by Treasury regulations, the employer 

reduces applicable employer cost by an amount not in excess of the 

reduction in costs which would have occurred if the employer had 

made the maximum permissible reduction in retiree health coverage under such regulations. An employer is an eligible employer 

if, for the preceding taxable year, the qualified current retiree 

health liabilities of the employer were at least five percent of gross 

receipts. 

In applying such regulations to any subsequent taxable year, 

any reduction in applicable employer cost under the proposal is 

treated as if it were an equivalent reduction in retiree health coverage. 

Effective date.—The provision is effective for taxable years ending after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

TITLE IX—ENERGY TAX INCENTIVES 

A. CREDIT FOR ELECTRICITY PRODUCED FROM CERTAIN SOURCES

(Sec. 801 of the Senate amendment and sec. 45 of the Code) 

PRESENT LAW

An income tax credit is allowed for the production of electricity 

from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, 

or qualified poultry waste facilities (sec. 45). The amount of the 

credit is 1.5 cents per kilowatt-hour (indexed for inflation) of electricity produced. The amount of the credit is 1.8 cents per kilowatthour for 2004. The credit is reduced for grants, tax-exempt bonds, 

subsidized energy financing, and other credits. 

The credit applies to electricity produced by a wind energy facility placed in service after December 31, 1993, and before January 1, 2006, to electricity produced by a closed-loop biomass facility 

placed in service after December 31, 1992, and before January 1, 

508 

2006, and to a poultry waste facility placed in service after December 31, 1999, and before January 1, 2006. The credit is allowable 

for production during the 10-year period after a facility is originally 

placed in service. In order to claim the credit, a taxpayer must own 

the facility and sell the electricity produced by the facility to an unrelated party. In the case of a poultry waste facility, the taxpayer 

may claim the credit as a lessee/operator of a facility owned by a 

governmental unit. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Extension of placed in service date for existing facilities 

The Senate amendment extends the placed in service date for 

wind facilities, closed-loop biomass facilities, and poultry waste facilities to facilities placed in service after December 31, 1993 (December 31, 1992, in the case of closed-loop biomass facilities and 

December 31, 1999, in the case of poultry waste facilities) and before January 1, 2007. 

Modification of credit amount 

The Senate amendment modifies the credit rate applicable to 

electricity produced from after December 31, 2004 from facilities 

placed in service after December 31, 2004 to be 1.8 cents per kilowatt hour and repeals the indexing of the credit amount. 

Additional qualifying facilities 

The Senate amendment also defines six new qualifying energy 

resources: open-loop biomass including agricultural livestock waste 

nutrients, geothermal energy, solar energy, municipal biosolids and 

sludge, small irrigation, and municipal solid waste. 

Open-loop biomass is defined as any solid, nonhazardous, cellulosic waste material which is segregated from other waste materials and which is derived from any of forest-related resources, 

solid wood waste materials, or agricultural sources. Eligible forestrelated resources are mill residues, other than spent chemicals 

from pulp manufacturing, precommercial thinnings, slash, and 

brush. Solid wood waste materials include waste pallets, crates, 

dunnage, manufacturing and construction wood wastes (other than 

pressure-treated, chemically-treated, or painted wood wastes), and 

landscape or right-of-way tree trimmings. Agricultural sources include orchard tree crops, vineyard, grain, legumes, sugar, and other 

crop by-products or residues. However, qualifying open-loop biomass does not include municipal solid waste (garbage), gas derived 

from biodegradation of solid waste, or paper that is commonly recycled. In addition, open-loop biomass does not include closed-loop 

biomass or any biomass burned in conjunction with fossil fuel (cofiring) beyond such fossil fuel required for start up and flame stabilization. 

Agricultural livestock waste nutrients are defined as agricultural livestock manure and litter, including bedding material for 

the disposition of manure. 

509 

Geothermal energy is energy derived from a geothermal deposit which is a geothermal reservoir consisting of natural heat 

which is stored in rocks or in an aqueous liquid or vapor (whether 

or not under pressure). 

Municipal biosolids and sludge are the residue or solids removed by a municipal wastewater treatment facility. Sludge is the 

recycled residue byproduct created in the treatment of commercial, 

industrial, municipal, or navigational wastewater, but not including residues from incineration. 

A small irrigation power facility is a facility that generates 

electric power through an irrigation system canal or ditch without 

any dam or impoundment of water. The installed capacity of a 

qualified facility is less than five megawatts. 

Qualifying open-loop biomass facilities, other than qualifying 

agricultural livestock waste nutrient facilities are facilities using 

open-loop biomass to produce electricity that are placed in service 

prior to January 1, 2005. Qualifying agricultural livestock waste 

nutrient facilities are facilities using agricultural livestock waste 

nutrients to produce electricity that are placed in service after December 31, 2004 and before January 1, 2007. Qualifying geothermal energy facilities are facilities using geothermal deposits to 

produce electricity that are placed in service after December 31, 

2004 and before January 1, 2007. Qualifying solar energy facilities 

are facilities using solar energy to generate electricity that are 

placed in service December 31, 2004 and before January 1, 2007. 

Qualifying municipal biosolids and sludge facilities are facilities 

using municipal biosolids or sludge to generate electricity that are 

originally placed in service after December 31, 2004, and before 

January 1, 2007. Qualifying small irrigation power facilities are facilities using small irrigation power systems to generate electricity 

that are originally placed in service after December 31, 2004 and 

before January 1, 2007. Qualifying municipal solid waste facilities 

are facilities or units incinerating municipal solid waste placed in 

service after December 31, 2004 and before January 1, 2007. 

In the case of qualifying open-loop biomass facilities placed in 

service prior to January 1, 2005, taxpayers may claim a credit of 

1.2 cents per kilowatt hour, rather than 1.8 cents per kilowatt hour 

for the five-year period beginning on January 1, 2005. the otherwise allowable credit for a three-year period. For a facility placed 

in service after the date of enactment, the three-year period commences when the facility is placed in service. 

In addition, the Senate amendment modifies present law to 

provide that qualifying closed-loop biomass facilities include any facility originally placed in service before December 31, 1992 and 

modified to use closed-loop biomass to co-fire with coal, with other 

biomass, or both, before January 1, 2007. The amount of credit the 

taxpayer may claim credit is adjusted for the thermal value of the 

qualifying closed-loop biomass relative to the thermal value of the 

closed-loop biomass and the coal. The ten-year credit period for 

such a qualifying facility commences no earlier than January 1, 

2005. 

510 

Credit claimants and treatment of other subsidies 

In the case of qualifying open-loop biomass facilities and qualifying closed-loop biomass facilities modified to use closed-loop biomass to co-fire with coal, the Senate amendment permits a lessee 

operator to claim the credit in lieu of the owner of the facilities. 

The Senate amendment provides that certain persons (public 

utilities, electric cooperatives, rural electric cooperatives, and Indian tribes) may sell, trade, or assign to any taxpayer any credits 

that would otherwise be allowable to that person, if that person 

were a taxpayer, for production of electricity from a qualified facility owned by such person. However, any credit sold, traded, or assigned may only be sold, traded, or assigned once. Subsequent 

trades are not permitted. In addition, any credits that would otherwise be allowable to such person, to the extent provided by the Administrator of the Rural Electrification Administration, may be applied as a prepayment to certain loans or obligations undertaken 

by such person under the Rural Electrification Act of 1936. 

The Senate amendment repeals the present-law reduction in 

allowable credit for facilities financed with tax-exempt bonds or 

with certain loans received under the Rural Electrification Act of 

1936. 

Effective date.—The Senate amendment is generally is effective 

for electricity sold from qualifying facilities after December 31, 

2004. For electricity produced from qualifying open-loop biomass facilities originally placed in service prior to the date of enactment, 

the provision is effective January 1, 2005. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

modifications. 

Extension of placed in service date for existing facilities 

The conference agreement does not include the provisions of 

the Senate amendment with respect to the extension of placed in 

service dates for qualifying wind, closed-loop, and poultry waste facilities. 

Modification of placed in service date for existing facilities 

The conference agreement includes the Senate amendment provision with respect to qualifying closed-loop biomass facilities modified to use closed-loop biomass to co-fire with coal, to co-fire with 

other biomass, or to co-fire with coal and other biomass, with the 

modification that the 10-year credit period begin no earlier than 

the date of enactment of the provision. 

Additional qualifying resource and facilities 

The conference agreement also defines five new qualifying resources for the production of electricity: open-loop biomass (including agricultural livestock waste nutrients), geothermal energy, 

solar energy, small irrigation power, and municipal solid waste. 

Two different qualifying facilities use municipal solid waste as a 

qualifying resource: landfill gas facilities and trash combustion faVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00514 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
511 

390 If a geothermal facility or solar facility claims credit for any year under section 45 of the 

Code, the facility is precluded from claiming any investment credit under section 48 of the Code 

in the future. 

cilities. In addition, the conference agreement defines refined coal 

as a qualifying resource. 

Qualifying open-loop biomass facilities are facilities using biomass to produce electricity that are placed in service prior to January 1, 2006. Qualifying agricultural livestock waste nutrient facilities are facilities using agricultural livestock waste nutrients to 

produce electricity that are placed in service after the date of enactment and before January 1, 2006. The installed capacity of a 

qualified agricultural livestock waste nutrient facility is not less 

than 150 kilowatts. 

Qualifying geothermal energy facilities are facilities using geothermal deposits to produce electricity that are placed in service 

after the date of enactment and before January 1, 2006. Qualifying 

solar energy facilities are facilities using solar energy to generate 

electricity that are placed in service after the date of enactment 

and before January 1, 2006. A qualifying geothermal energy facility 

or solar energy facility may not have claimed any credit under sec. 

48 of the Code.390

A qualified small irrigation power facility is a facility originally 

placed in service after the date of enactment and before January 

1, 2006. A small irrigation power facility is a facility that generates 

electric power through an irrigation system canal or ditch without 

any dam or impoundment of water. The installed capacity of a 

qualified facility is not less than 150 kilowatts and less than five 

megawatts. 

Landfill gas is defined as methane gas derived from the biodegradation of municipal solid waste. Trash combustion facilities 

are facilities that burn municipal solid waste (garbage) to produce 

steam to drive a turbine for the production of electricity. Qualifying 

landfill gas facilities and qualifying trash combustion facilities include facilities used to produce electricity placed in service after the 

date of enactment and before January 1, 2006. 

Refined coal is a qualifying liquid, gaseous, or solid synthetic 

fuel produced from coal (including lignite) or high-carbon fly ash, 

including such fuel used as a feedstock. A qualifying fuel is a fuel 

that when burned emits 20 percent less SO2 and nitrogen oxides 

than the burning of feedstock coal or comparable coal predominantly available in the marketplace as of January 1, 2003, and if 

the fuel sells at prices at least 50 percent greater than the prices 

of the feedstock coal or comparable coal. In addition, to be qualified 

refined coal the fuel must be sold by the taxpayer with the reasonable expectation that it will be used for the primary purpose of producing steam. A qualifying refined coal facility is a facility producing refined coal that is placed in service after the date of enactment and before January 1, 2009. 

Credit period and credit rates 

In general, as under present law, taxpayers may claim the 

credit at a rate of 1.5 cents per kilowatt-hour (indexed for inflation 

and currently 1.8 cents per kilowatt-hour) for 10 years of production commencing on the date the facility is placed in service. In the 

512 

case of open-loop biomass facilities, (including agricultural livestock 

waste nutrients), geothermal energy, solar energy, small irrigation 

power, landfill gas facilities, and trash combustion facilities the 10- 

year credit period is reduced to five years commencing on the date 

the facility is placed in service. In general, for facilities placed in 

service prior to January 1, 2005, the credit period commences on 

January 1, 2005. In the case of a closed-loop biomass facilities 

modified to co-fire with coal, to co-fire with other biomass, or to cofire with coal and other biomass, the credit period shall begin no 

earlier than the date of enactment. 

In the case of open-loop biomass facilities (including agricultural livestock waste nutrients), small irrigation power, landfill gas 

facilities, and trash combustion facilities, the otherwise allowable 

credit amount is reduced by one half. 

An alternative credit applies for the production of refined coal. A qualified refined coal facility may claim credit at a rate of $4.375 

per ton (indexed for inflation after 1992) of refined coal sold to a 

unrelated person. As is the case for facilities that produce electricity, the credit a taxpayer may claim for the production of refined coal is phased out as the market price of refined coal exceeds 

certain threshold levels. The threshold is defined by reference to 

the price of feedstock fuel used to produce refined coal. Thus if a 

producer of refined coal uses Powder River Basin coal as a feedstock, the threshold price is determined by reference to prices of 

Powder River Basin coal. If the producer uses Appalachian coal, 

the threshold price is determined by reference to prices of Appalachian coal. 

Credit claimants and treatment of other subsidies 

A lessee or operator may claim the credit in lieu of the owner 

of the qualifying facility in the case of qualifying open-loop biomass 

facilities originally placed in service on or before the date of enactment and in the case of a closed-loop biomass facilities modified to 

co-fire with coal, to co-fire with other biomass, or to co-fire with 

coal and other biomass. 

In addition, for all qualifying facilities, other than closed-loop 

biomass facilities modified to co-fire with coal, to co-fire with other 

biomass, or to co-fire with coal and other biomass, any reduction 

in credit by reason of grants, tax-exempt bonds, subsidized energy 

financing, and other credits cannot exceed 50 percent. In the case 

of closed-loop biomass facilities modified to co-fire with coal, to cofire with other biomass, or to co-fire with coal and other biomass, 

there is no reduction in credit by reason of grants, tax-exempt 

bonds, subsidized energy financing, and other credits. 

The amendments made by the conference report do not apply 

with respect to any poultry waste facility placed in service prior to 

January 1, 2005. Such facilities placed in service after December 

31, 2004 generally may qualify for credit as animal livestock waste 

nutrient facilities. 

No facility that previously claimed or currently claims credit 

under section 29 of the Code is a qualifying facility for purposes of 

section 45. 

Effective date.—The provision is effective for electricity produced and sold from qualifying facilities after the date of enactVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00516 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
513 

391 A hybrid-electric vehicle may qualify as a clean-fuel vehicle under present law. 

ment in taxable years ending after the date of enactment. With respect to open-loop biomass facilities placed in service prior to January 1, 2005, the provisions are effective for electricity produced and 

sold after December 31, 2004. 

B. ALTERNATIVE MOTOR VEHICLES AND FUELS INCENTIVES

1. Alternative motor vehicle credit (sec. 811 of Senate amendment) 

PRESENT LAW

Certain costs of qualified clean-fuel vehicle may be expensed 

and deducted when such property is placed in service (sec. 179A). 

Qualified clean-fuel vehicle property includes motor vehicles that 

use certain clean-burning fuels (natural gas, liquefied natural gas, 

liquefied petroleum gas, hydrogen, electricity and any other fuel at 

least 85 percent of which is methanol, ethanol, any other alcohol 

or ether).391 The maximum amount of the deduction is $50,000 for 

a truck or van with a gross vehicle weight over 26,000 pounds or 

a bus with seating capacities of at least 20 adults; $5,000 in the 

case of a truck or van with a gross vehicle weight between 10,000 

and 26,000 pounds; and $2,000 in the case of any other motor vehicle. Qualified electric vehicles do not qualify for the clean-fuel vehicle deduction. The deduction allowed is 25 percent of the otherwise 

allowable amount in 2006, and is unavailable for purchases after 

December 31, 2006. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Fuel cell motor vehicles 

The Senate amendment provides a credit for the purchase of 

qualified fuel cell motor vehicles. The base credit for the purchase 

of new qualified fuel cell motor vehicles ranges between $4,000 and 

$40,000 depending upon the weight class of the vehicle. For automobiles and light trucks, the otherwise allowable credit amount 

($4,000) is increased by an amount from $1,000 to $4,000 if the vehicle meets certain fuel economy increases compared to a stated 

standard. Credit may not be claimed for qualified fuel cell motor 

vehicles purchased after December 31, 2011. 

Hybrid motor vehicles 

The Senate amendment provides a credit for the purchase of 

qualified hybrid motor vehicles. The base credit for the purchase of 

a new qualified hybrid motor vehicle ranges from $250 to $10,000 

depending upon the weight of the vehicle and the maximum power 

available from the vehicle’s rechargeable energy storage system. 

For automobiles and light trucks, the otherwise allowable credit 

amount ($250 to $1,000) is increased by an amount from $500 to 

$3,000 if the vehicle meets certain fuel economy increases. For 

heavy duty hybrid motor vehicles, the otherwise allowable credit 

($1,000 to $10,000) is increased depending upon the vehicle’s 

514 

weight and provided the vehicle meets certain 2007 (and beyond) 

emissions standards. The amount of credit is increased by between 

$2,500 and $10,000 for vehicles placed in service in 2004; is increased by between $2,500 and $10,000 for vehicles placed in service in 2004, is increased by between $2,000 and $8,000 for vehicles 

placed in service in 2005, and is increased by between $1,500 and 

$6,000 for vehicles placed in service in 2006. Credit may not be 

claimed for qualified hybrid motor vehicles purchased after December 31, 2006. 

Alternative fuel motor vehicles 

The Senate amendment provides a credit for the purchase of 

qualified alternative fuel motor vehicles. The base credit for the 

purchase of a new alternative fuel motor vehicle equals 40 percent 

of the incremental cost of such vehicle. The otherwise allowable 

credit for 40 percent of the incremental cost is increased by an additional 30 percent of the incremental cost of the vehicle if the vehicle meets certain emissions standards. For computation of the 

credit, the incremental cost of the vehicle may not exceed between 

$5,000 and $40,000 (resulting in a maximum total credit of between $3,500 and $28,000) depending upon the weight of the vehicle. For this purpose, incremental cost generally is defined as the 

amount of the increase of the manufacturer’s suggested retail price 

of such a vehicle compared to the manufacturer’s suggested retail 

price of a comparable gasoline or diesel model. Qualifying alternative fuel motor vehicles are vehicles that operate only on qualifying alternative fuels and are incapable of operating on gasoline 

or diesel (except in the extent gasoline or diesel fuel is part of a 

qualified mixed fuel). Qualifying alternative fuels are compressed 

natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, and any liquid mixture consisting of at least 85 percent methanol. 

Taxpayers purchasing certain mixed-fuel vehicles also may 

claim the alternative fuel motor vehicle credit, at a reduced rate. 

A mixed-fuel vehicle is a vehicle with gross weight of seven tons 

or more and is certified by the manufacturer as being able to operate on a combination of alternative fuel and a petroleum-based 

fuel. A qualifying mixed-fuel vehicle must use at least 75 percent 

alternative fuel (a ‘‘75/25 mixed-fuel vehicle’’) or 90 percent alternative fuel (a ‘‘90/10 mixed-fuel vehicle’’) and be incapable of operating on a mixture containing less than 75 percent alternative fuel 

in the case of a 75/25 vehicle (less than 90 percent alternative fuel 

in the case of a 90/10 vehicle). A taxpayer purchasing a 75/25 

mixed-fuel vehicle may claim 70 percent of the otherwise allowable 

credit. A taxpayer purchasing a 90/10 mixed-fuel vehicle may claim 

90 percent of the otherwise allowable credit. 

Credit may not be claimed for qualified alternative fuel motor 

vehicles purchased after December 31, 2006. The taxpayer’s basis 

in the property is reduced by the amount of credit claimed. 

Provisions of general application 

The Senate amendment provides that unused credits may be 

carried forward for 20 years and three years (but not into taxable 

years beginning before January 1, 2005). 

515 

If a tax-exempt person purchases or leases a qualifying vehicle, 

the seller or lessor may claim the credit. 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Modification of credit for electric vehicles (sec. 812 of Senate 

amendment and sec. 30 of the Code) 

PRESENT LAW

A 10-percent tax credit is provided for the cost of a qualified 

electric vehicle, up to a maximum credit of $4,000 (sec. 30). A 

qualified electric vehicle is a motor vehicle that is powered primarily by an electric motor drawing current from rechargeable batteries, fuel cells, or other portable sources of electrical current, the 

original use of which commences with the taxpayer, and that is acquired for the use by the taxpayer and not for resale. The full 

amount of the credit is available for purchases prior to 2006. The 

credit allowed is 25 percent of the otherwise allowable amount for 

2006, and is unavailable for purchases after December 31, 2006. 

There is no carry forward or carryback of the credit for electric vehicles. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment modifies the present-law credit for 

electric vehicles to provide that the credit for qualifying vehicles 

generally ranges between $3,500 and $40,000 depending upon the 

weight of the vehicle and, for certain vehicles, the driving range of 

the vehicle. In the case of property purchased by tax-exempt persons, the seller may claim the credit. The taxpayer would be ineligible for the deduction allowable under present-law section 179A 

for a qualified battery electric vehicle on which a credit is allowable. The provision would repeal the reduce rate of credit for vehicles purchased in 2006, permitting taxpayer to claim the full 

amount of credit otherwise allowable for 2006. The taxpayer would 

be able to carry forward unused credits for 20 years or carry unused credits back for three years (but not carried back to taxable 

years beginning before the January 1, 2005). 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

516 

3. Modifications of deduction for refueling property (sec. 813 of Senate amendment and sec. 179A of the Code) 

PRESENT LAW

Certain costs of qualified clean-fuel vehicle refueling property 

may be expensed and deducted when such property is placed in 

service (sec. 179A). Up to $100,000 of such property at each location owned by the taxpayer may be expensed with respect to that 

location. Natural gas, liquefied natural gas, liquefied petroleum 

gas, hydrogen, electricity and any other fuel at least 85 percent of 

which is methanol, ethanol, or any other alcohol or ether comprise 

clean-burning fuels. 

The deduction is unavailable for property placed in service 

after December 31, 2006. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provision permits taxpayers to claim a 

50-percent credit for the cost of installing clean-fuel vehicle refueling property to be used in a trade or business of the taxpayer or 

installed at the principal residence of the taxpayer. In the case of 

retail clean-fuel vehicle refueling property the allowable credit may 

not exceed $30,000. In the case of residential clean-fuel vehicle refueling property the allowable credit may not exceed $1,000. The 

taxpayer’s basis in the property is reduced by the amount of the 

credit and the taxpayer may not claim deductions under section 

179A with respect to property for which the credit is claimed. 

In the case of refueling property installed on property owned 

or used by a tax-exempt person, the taxpayer that installs the 

property may claim the credit. To be eligible for the credit, the 

property must be placed in service before January 1, 2007 (before 

January 1, 2012 in the hydrogen refueling property). The credit allowable in the taxable year cannot exceed the difference between 

the taxpayer’s regular tax (reduced by certain other credits) and 

the taxpayer’s tentative minimum tax. The taxpayer may carry forward unused credits for 20 years. 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

4. Credit for retail sale of alternative motor vehicle fuels (sec. 814 

of Senate amendment) 

PRESENT LAW

There is no retail credit for the sale of alternative motor vehicle fuels. However, a 52-cents-per-gallon income tax credit is allowed for alcohol fuels for 2003 and 2004 (51 cents for 2005–2007). 

The alcohol fuels credit may be claimed as a reduction in excise tax 

517 

payments. Such tax payments generally are made before the retail 

level. In the case of ethanol, the Code provides a separate 10-centsper-gallon credit for small producers. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment permits taxpayers to claim a credit 

equal to the gasoline gallon equivalent of 50 cents per gallon of alternative fuel sold in 2005 and 2006. Qualifying alternative fuels 

are compressed natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, any liquid mixture consisting of at least 85 

percent methanol, and any liquid mixture consisting of at least 85 

percent ethanol. The credit may be claimed for sales prior to January 1, 2007. Under the provision, the credit is part of the general 

business credit. 

Effective date.—The Senate amendment is effective for fuel 

sold at retail after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

5. Small ethanol producer credit (sec. 815 of the Senate amendment 

and sec. 40 of the Code) 

PRESENT LAW

Small ethanol producer credit 

Present law provides several tax benefits for ethanol and methanol produced from renewable sources (e.g., biomass) that are used 

as a motor fuel or that are blended with other fuels (e.g., gasoline) 

for such a use. In the case of ethanol, a separate 10-cents-per-gallon credit is provided for small producers, defined generally as persons whose production does not exceed 15 million gallons per year 

and whose production capacity does not exceed 30 million gallons 

per year. The small producer credit is part of the alcohol fuels tax 

credit under section 40 of the Code. The alcohol fuels tax credits 

are includible in income. This credit, like tax credits generally, may 

not be used to offset alternative minimum tax liability. The credit 

is treated as a general business credit, subject to the ordering rules 

and carryforward/carryback rules that apply to business credits 

generally. The alcohol fuels tax credit is scheduled to expire after 

December 31, 2007. 

Taxation of cooperatives and their patrons 

Under present law, cooperatives in essence are treated as passthrough entities in that the cooperative is not subject to corporate 

income tax to the extent the cooperative timely pays patronage 

dividends. Under present law (sec. 38(d)(4)), the only excess credits 

that may be passed through to cooperative patrons are the rehabilitation credit (sec. 47), the energy property credit (sec. 48(a)), and 

the reforestation credit (sec. 48(b)). 

518 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment makes several modifications to the 

rules governing the small producer ethanol credit. First, the provision liberalizes the definition of an eligible small producer to include persons whose production capacity does not exceed 60 million 

gallons. Second, the provision allows cooperatives to elect to pass 

through the small ethanol producer credits to its patrons. The credit is apportioned pro rata among patrons of the cooperative on the 

basis of the quantity or value of the business done with or for such 

patrons for the taxable year. An election to pass through the credit 

is made on a timely filed return for the taxable year and is irrevocable for such taxable year. 

Third, the provision repeals the rule that includes the small 

producer credit in income of taxpayers claiming it. Finally, the provision provides that the small producer ethanol credit is not treated 

as derived from a passive activity under the Code rules restricting 

credits and deductions attributable to such activities. 

Effective date.—The provision is effective for taxable years ending after date of enactment. 

CONFERENCE AGREEMENT

The conference agreement allows cooperatives to elect to pass 

the small ethanol producer credit through to their patrons. Specifically, the credit is to be apportioned among patrons eligible to 

share in patronage dividends on the basis of the quantity or value 

of business done with or for such patrons for the taxable year. The 

election must be made on a timely filed return for the taxable year, 

and once made, is irrevocable for such taxable year. 

The amount of the credit not apportioned to patrons is included in the organization’s credit for the taxable year of the organization. The amount of the credit apportioned to patrons is to be 

included in the patron’s credit for the first taxable year of each patron ending on or after the last day of the payment period for the 

taxable year of the organization, or, if earlier, for the taxable year 

of each patron ending on or after the date on which the patron receives notice from the cooperative of the apportionment. 

If the amount of the credit shown on the cooperative’s return 

for a taxable year is in excess of the actual amount of the credit 

for that year, an amount equal to the excess of the reduction in the 

credit over the amount not apportioned to patrons for the taxable 

year is treated as an increase in the cooperative’s tax. The increase 

is not treated as tax imposed for purposes of determining the 

amount of any tax credit or for purposes of the alternative minimum tax. 

The conference agreement does not contain any of the other 

modifications from the Senate amendment. 

Effective date.—The provision is effective for taxable years ending after date of enactment. 

519 

C. CONSERVATION AND ENERGY EFFICIENCY PROVISIONS

1. Energy efficient new homes (sec. 821 of the Senate amendment) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed 

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

energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for the construction of new energy-efficient homes. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a credit to an eligible contractor of an 

amount equal to the aggregate adjusted bases of all energy-efficient 

property installed in a qualified new energy-efficient home during 

construction. The credit cannot exceed $1,000 ($2,000) in the case 

of a new home that has a projected level of annual heating and 

cooling costs that is 30 percent (50 percent) less than a comparable 

dwelling constructed in accordance with the latest standards of 

chapter 4 of the International Energy Conservation Code approved 

by the Department of Energy before the construction of such qualifying new home and any applicable Federal minimum efficiency 

standards for equipment. 

The eligible contractor is the person who constructed the home, 

or in the case of a manufactured home, the producer of such home. 

Energy efficiency property is any energy-efficient building envelope 

component (insulation materials or system specifically and primarily designed to reduce heat loss or gain, and exterior windows, 

including skylights, and doors) and any energy-efficient heating or 

cooling equipment or system that can, individually or in combination with other components, meet the standards for the home. 

520 

To qualify as an energy-efficient new home, the home must be: 

(1) a dwelling located in the United States, (2) the principal residence of the person who acquires the dwelling from the eligible 

contractor or manufacturer, and (3) certified to have a projected 

level of annual heating and cooling energy consumption that meets 

the standards for either the 30-percent or 50-percent reduction in 

energy usage. The home may be certified according to a componentbased method, an energy performance based method, a guaranteebased method, or, in the case of a qualifying new home which is 

a manufactured home, by a method prescribed by the Administrator of the Environmental Protection Agency under the Energy 

Star Labeled Homes program. Manufactured homes certified by a 

method prescribed by the Administrator of the Environmental Protection Agency under the Energy Star Labeled Homes program are 

eligible for the $1,000 credit provided criteria (1) and (2) are met. 

A component-based method of certification is a method which 

uses the applicable technical energy efficiency specifications or ratings (including product labeling requirements) for the energy efficient building envelope component or energy efficient heating or 

cooling equipment. The Secretary shall, in consultation with the 

Administrator of the Environmental Protection Agency, develop 

prescriptive component-based packages which are equivalent in energy performance to properties which qualify under the performance-based method. The certification under the component-based 

method shall be provided by a local building regulatory authority, 

a utility, or a home energy rating organization. 

A performance-based method of certification is a method which 

calculates projected energy usage and cost reductions in the qualifying new home in relation to a new home heated by the same fuel 

type and constructed in accordance with (1) the latest standards of 

chapter 4 of the International Energy Conservation Code approved 

by the Department of Energy before the construction of such qualifying new home, and (2) any applicable Federal minimum efficiency 

standards for equipment. Computer software shall be used in support of a performance-based method certification under clause. 

Such software shall meet procedures and methods for calculating 

energy and cost savings in regulations promulgated by the Secretary of Energy. The certification under the performance-based 

method shall be provided by an individual recognized by an organization recognized by the Secretary for such purposes. 

A guarantee-based method of certification is a method that 

guarantees in writing to the homeowner energy savings of either 

30 percent or 50 percent over the 2000 International Energy Conservation Code for heating and cooling costs. The guarantee shall 

be provided for a minimum of 2 years and shall fully reimburse the 

homeowner any heating and cooling costs in excess of the guaranteed amount. Computer software shall be selected by the provider 

of the guarantee to support the guarantee-based method certification. Such software shall meet procedures and methods for calculating energy and cost savings in regulations promulgated by the 

Secretary of Energy. The certification under the guarantee-based 

method shall be provided by an individual recognized by an organization recognized by the Secretary for such purposes. 

521 

In prescribing regulations for performance-based and guarantee-based certification methods, the Secretary shall prescribe 

procedures for calculating annual energy usage and cost reductions 

for heating and cooling and for the reporting of the results. Such 

regulations shall provide that any calculation procedures be fuel 

neutral such that the same energy efficiency measures allow a 

qualifying new home to be eligible for the credit under this section 

regardless of whether such home uses a gas or oil furnace or boiler 

or an electric heat pump, and require that any computer software 

allow for the printing of the Federal tax forms necessary for the 

credit under this section and for the printing of forms for disclosure 

to the homebuyer. Other rules apply relating to the form of the certification and the manner in which it is provided to the buyer of 

the home. 

In the case of a qualifying new home which is a manufactured 

home, certification of compliance with energy efficiency standards 

shall be provided by a manufactured home primary inspection 

agency. 

The credit will be part of the general business credit. No credits attributable to energy efficient homes may be carried back to 

any taxable year ending on or before the effective date of the credit. 

No deduction shall be allowed for that portion of expenses for a 

qualifying new home otherwise allowable as a deduction for the 

taxable year which is equal to the amount of the credit for such 

taxable year. 

Effective date.—The credit applies to homes whose construction 

is substantially completed after December 31, 2004, and which are 

purchased during the period beginning on December 31, 2004, and 

ending on December 31, 2007 (December 31, 2005 in the case of the 

$1,000 credit). 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Energy efficient appliances (sec. 822 of the Senate amendment) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed 

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

energy to generate electricity, to heat or cool a structure, or to provide solar process heat; or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of: (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

522 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for the manufacture of energyefficient appliances. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a credit for the production of certain energy-efficient clothes washers and refrigerators. The credit equals 

$50 per appliance for (1) energy-efficient clothes washers produced 

before December 31, 2007 with a modified energy factor (‘‘MEF’’) of 

1.42 MEF or greater, and (2) refrigerators produced before December 31, 2005 that consume 10 percent fewer kilowatt-hours per 

year than the energy conservation standards promulgated by the 

Department of Energy that took effect on July 1, 2001. The credit 

equals $100 for (1) energy-efficient clothes washers produced before 

December 31, 2007 with a MEF of 1.5 or greater, and (2) refrigerators produced before December 31, 2007 that consume at least 

15 percent fewer kilowatt-hours per year (at least 20 percent less 

for production in 2007) than the energy conservation standards 

promulgated by the Department of Energy that took effect on July 

1, 2001. The credit is $150 for refrigerators produced before January 1, 2007 that consume at least 20 percent fewer kilowatt-hours 

per year than the energy conservation standards promulgated by 

the Department of Energy that took effect on July 1, 2001. A refrigerator must be an automatic defrost refrigerator-freezer with an internal volume of at least 16.5 cubic feet to qualify for the credit. 

A clothes washer is any residential clothes washer, including a residential style coin operated washer, that satisfies the relevant efficiency standard. 

For each category of appliances (e.g., washers that meet the 

$50 standard, washers that meet the $100 standard, refrigerators 

that meet the $50 standard, refrigerators that meet the $100 

standard, and refrigerators that meet the $150 standard), only production in excess of average production for each such category during calendar years 2001–2003 would be eligible for the credit. 

The taxpayer may not claim credits in excess of $60 million for 

all taxable years, and may not claim credits in excess of $30 million 

with respect to appliances that only qualify for the $50 credit. Additionally, the credit allowed for all appliances may not exceed two 

percent of the average annual gross receipts of the taxpayer for the 

three taxable years preceding the taxable year in which the credit 

is determined. 

The credit would be part of the general business credit. 

523 

EFFECTIVE DATE

The credit applies to appliances produced after December 31, 

2004, and prior to January 1, 2008. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

3. Residential solar hot water, photovoltaics and other energy efficient property (sec. 823 of the Senate amendment) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed 

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

energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law personal tax credit for energy efficient 

residential property. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a personal tax credit for the purchase 

of qualified wind energy property, qualified photovoltaic property, 

and qualified solar water heating property that is used exclusively 

for purposes other than heating swimming pools and hot tubs. The 

credit is equal to 15 percent for solar water heating property and 

photovoltaic property, and 30 percent for wind energy property. 

The maximum credit for each of these systems of property is 

$2,000. The provision also provides a 30 percent credit for the purchase of qualified fuel cell power plants. The credit for any fuel cell 

may not exceed $500 for each 0.5 kilowatt of capacity. 

524 

Qualifying solar water heating property means an expenditure 

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

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

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

Qualified photovoltaic property is property that uses solar energy 

to generate electricity for use in a dwelling unit. Qualified wind energy property is property that uses wind energy to generate electricity for use in a dwelling unit located in the United States and 

used as a principal residence by the taxpayer. A qualified fuel cell 

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

assembly and associated balance of plant components that converts 

a fuel into electricity using electrochemical means, and which has 

an electricity-only generation efficiency of greater than 30 percent 

and that generates at least 0.5 kilowatts of electricity. The qualified fuel cell power plant must be installed on or in connection with 

a dwelling unit located in the United States and used by the taxpayer as a principal residence. 

The provision also provides a credit for the purchase of other 

qualified energy efficient property, as described below: 

Electric heat pump water heater with an energy factor of at 

least 1.7. The maximum credit is $150 per unit. 

Advanced natural gas, oil, propane furnace, or hot water boiler 

that achieves at least 95 percent annual fuel utilization efficiency. 

The maximum credit is $125 per unit. 

Advanced natural gas, oil, propane water heater that has an 

energy factor of at least 0.80 in the standard Department of Energy 

test procedure. The maximum credit is $150 per unit. 

Natural gas, oil, propane water heater that has an energy factor of at least 0.65 but less than 0.80 in the standard Department 

of Energy test procedure. The maximum credit is $50 per unit. 

Advanced main air circulating fan used in a new natural gas, 

propane, or oil-fired furnace, including main air circulating fans 

that use a brushless permanent magnet motor or another type of 

motor which achieves similar or higher efficiency at half and full 

speed, as determined by the Secretary. The maximum credit is $50. 

Advanced combination space and water heating system that 

has a combined energy factor of at least 0.80 and a combined annual fuel utilization efficiency (AFUE) of at least 78 percent in the 

standard Department of Energy test procedure. The maximum 

credit is $150. 

Combination space and water heating system that has a combined energy factor of at least 0.65 but less than 0.80 and a combined annual fuel utilization efficiency (AFUE) of at least 78 percent in the standard Department of Energy test procedure. The 

maximum credit is $50. 

Geothermal heat pumps that have an EER of at least 21. The 

maximum credit is $250 per unit. 

The credit is nonrefundable, and the depreciable basis of the 

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

labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit are eligible expenditures. The credit is allowed against the regular and alternative 

minimum tax. 

525 

Certain equipment safety requirements need to be met to qualify for the credit. Special proration rules apply in the case of jointly 

owned property, condominiums, and tenant-stockholders in cooperative housing corporations. With the exception of wind energy property, if less than 80 percent of the property is used for nonbusiness 

purposes, only that portion of expenditures that is used for nonbusiness purposes is taken into account. 

EFFECTIVE DATE

The credit applies to expenditures after December 31, 2004, 

and prior to January 1, 2008. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

4. Credit for business installation of qualified fuel cells and stationary microturbine power plants (sec. 824 of the Senate 

amendment and sec. 48 of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed 

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

energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

There is no present-law credit for fuel cell or microturbine 

power plant property. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a 30 percent business energy credit for 

the purchase of qualified fuel cell power plants for businesses. A 

qualified fuel cell power plant is an integrated system comprised of 

a fuel cell stack assembly and associated balance of plant components that converts a fuel into electricity using electrochemical 

means, and which has an electricity-only generation efficiency of 

greater than 30 percent and generates at least 0.5 kilowatts of electricity. The credit for any fuel cell may not exceed $500 for each 

0.5 kilowatts of capacity. 

526 

Additionally, the provision provides a 10 percent credit for the 

purchase of qualifying stationary microturbine power plants. A 

qualified stationary microturbine power plant is an integrated system comprised of a gas turbine engine, a combustor, a recuperator 

or regenerator, a generator or alternator, and associated balance of 

plant components which converts a fuel into electricity and thermal 

energy. Such system also includes all secondary components located between the existing infrastructure for fuel delivery and the 

existing infrastructure for power distribution, including equipment 

and controls for meeting relevant power standards, such as voltage, 

frequency and power factors. Such system must have an electricityonly generation efficiency of not less that 26 percent at International Standard Organization conditions and a capacity of less 

than 2,000 kilowatts. The credit is limited to the lesser of 10 percent of the basis of the property or $200 for each kilowatt of capacity. 

The credit is nonrefundable. The taxpayer’s basis in the property is reduced by the amount of the credit claimed. 

Effective date.—The credit for businesses applies to property 

placed in service after December 31, 2004, and before January 1, 

2008 (January 1, 2007 in the case of microturbines), under rules 

similar to rules of section 48(m) of the Code (as in effect on the day 

before the date of enactment of the Revenue Reconciliation Act of 

1990). 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

5. Energy efficient commercial building deduction (sec. 825 of Senate amendment) 

PRESENT LAW

No special deduction is currently provided for expenses incurred for energy-efficient commercial building property. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a deduction equal to energy-efficient 

commercial building property expenditures made by the taxpayer. 

Energy-efficient commercial building property expenditures are defined as amounts paid or incurred for energy-efficient property installed in connection with the construction or reconstruction of 

property: (1) which is depreciable property; (2) which is located in 

the United States, and (3) which is the type of structure to which 

the Standard 90.1–2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America (‘‘ASHRAE/IESNA’’) is applicable. The deduction is limited to an amount equal to $2.25 per 

square foot of the property for which such expenditures are made. 

The deduction is allowed in the year in which the property is 

placed in service. 

527 

Energy-efficient commercial building property generally means 

any property that reduces total annual energy and power costs 

with respect to the lighting, heating, cooling, ventilation, and hot 

water supply systems of the building by 50 percent or more in comparison to a building which minimally meets the requirements of 

Standard 90.1–2001 of ASHRAE/IESNA. Because of the requirement that, in order to qualify, a building must fall within the scope 

of the ASHRAE/IESNA Standard 90.1–2001, residential rental 

property that is less than four stories does not qualify. 

Certain certification requirements must be met in order to 

qualify for the deduction. The Secretary, in consultation with the 

Secretary of Energy, will promulgate regulations that describe 

methods of calculating and verifying energy and power costs using 

qualified computer software. The methods for calculation shall be 

fuel neutral, such that the same energy efficiency features shall 

qualify a building for the deduction under this subsection regardless of whether the heating source is a gas or oil furnace or boiler 

or an electric heat pump. 

The Secretary shall prescribe procedures for the inspection and 

testing for compliance of buildings that are comparable, given the 

difference between commercial and residential buildings, to the requirements in the Mortgage Industry National Home Energy Rating Standards. Individuals qualified to determine compliance shall 

only be those recognized by one or more organizations certified by 

the Secretary for such purposes. 

For energy-efficient commercial building property expenditures 

made by a public entity, such as public schools, the Secretary shall 

promulgate regulations that will allow the value of the deduction 

(determined without regard to the tax-exempt status of such entity) 

to be allocated to the person primarily responsible for designing the 

property in lieu of the public entity. 

In the case of lighting systems, until such time as the Secretary issues final regulations, a partial deduction shall be allowed 

for a reduction in Lighting Power Density of 40 percent (50 percent 

in the case of a warehouse) of the minimum requirements in Table 

9.3.1.1 or Table 9.3.1.2 of ASHRAE/IESNA Standard 90.1–2001. A 

pro-rated partial deduction is allowed in the case of a lighting system that reduces lighting power density between 25 percent and 40 

percent. Certain lighting level and lighting control requirements 

must also be met in order to qualify for the partial lighting deductions. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2004 for expenditures in connection 

with a building whose construction is completed on or before December 31, 2009. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

528 

6. Three-year applicable recovery period for depreciation of qualified energy management devices and qualified water submetering devices (secs. 826 and 827 of the Senate amendment 

and sec. 168 of the Code) 

PRESENT LAW

No special recovery period is currently provided for depreciation of qualified energy management devices or water submetering 

devices. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a three-year recovery period 

for qualified energy management devices placed in service by any 

taxpayer who is a supplier of electric energy or is a provider of electric energy services. A qualified energy management device is any 

energy management device that is used by the taxpayer to measure 

and record electricity usage data on a time-differentiated basis in 

at least four separate time segments per day, and to provide such 

data on at least a monthly basis to both consumers and the taxpayer. 

Additionally, the Senate amendment provides a three-year recovery period for qualified water submetering devices placed in 

service by any taxpayer who is an eligible resupplier. An eligible 

resupplier is any taxpayer who purchases and installs qualified 

water submetering devices in every unit in any multi-unit property. 

A qualified water submetering device is any water submetering device that is used by the taxpayer to measure and record water 

usage data and to provide such data on at least a monthly basis 

to both consumers and the taxpayer. 

Effective date.—The provision is effective for any qualified energy management device or water submetering device placed in 

service after December 31, 2004, and before January 1, 2008. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

7. Energy credit for combined heat and power system property (sec. 

828 of the Senate amendment and sec. 48 of the Code) 

PRESENT LAW

A nonrefundable, 10-percent business energy credit is allowed 

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

energy to generate electricity, to heat or cool a structure, or to provide solar process heat, or (2) used to produce, distribute, or use 

energy derived from a geothermal deposit, but only, in the case of 

electricity generated by geothermal power, up to the electric transmission stage. 

The business energy tax credits are components of the general 

business credit (sec. 38(b)(1)). The business energy tax credits, 

529 

when combined with all other components of the general business 

credit, generally may not exceed for any taxable year the excess of 

the taxpayer’s net income tax over the greater of (1) 25 percent of 

net regular tax liability above $25,000 or (2) the tentative minimum tax. For credits arising in taxable years beginning after December 31, 1997, an unused general business credit generally may 

be carried back one year and carried forward 20 years (sec. 39). 

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present-law credit for combined heat and power 

(‘‘CHP’’) property. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides a 10-percent credit for the 

purchase of CHP property. 

CHP property is property: (1) that uses the same energy source 

for the simultaneous or sequential generation of electrical power, 

mechanical shaft power, or both, in combination with the generation of steam or other forms of useful thermal energy (including 

heating and cooling applications); (2) that has an electrical capacity 

of not more than 15 megawatts or a mechanical energy capacity of 

no more than 2000 horsepower or an equivalent combination of 

electrical and mechanical energy capacities; (3) that produces at 

least 20 percent of its total useful energy in the form of thermal 

energy that is not used to produce electrical or mechanical power, 

and produces at least 20 percent of its total useful energy in the 

form of electrical or mechanical power (or a combination thereof); 

and (4) the energy efficiency percentage of which exceeds 60 percent. CHP property does not include property used to transport the 

energy source to the generating facility or to distribute energy produced by the facility. 

Additionally, the Senate amendment provides that systems 

whose fuel source is at least 90 percent bagasse and that would 

qualify for the credit but for the failure to meet the efficiency 

standard are eligible for a credit that is reduced in proportion to 

the degree to which the system fails to meet the efficiency standard. For example, a system that would otherwise be required to 

meet the 60-percent efficiency standard, but which only achieves 

30-percent efficiency, would be permitted a credit equal to one-half 

of the otherwise allowable credit (i.e., a 5-percent credit). 

Effective date.—The credit applies to property placed in service 

after December 31, 2004, and before January 1, 2007. 

530 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

8. Energy efficient improvements to existing homes (sec. 829 of the 

Senate amendment) 

PRESENT LAW

A taxpayer may exclude from income the value of any subsidy 

provided by a public utility for the purchase or installation of an 

energy conservation measure. An energy conservation measure 

means any installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the 

management of energy demand with respect to a dwelling unit (sec. 

136). 

There is no present law credit for energy efficiency improvements to existing homes. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision would provide a 10-percent nonrefundable credit 

for the purchase of qualified energy efficiency improvements. The 

maximum credit for a taxpayer with respect to the same dwelling 

for all taxable years is $300. Unused credits may be carried forward to succeeding taxable years. 

A qualified energy efficiency improvement would be any energy 

efficiency building envelope component that is certified to meet or 

exceed the latest prescriptive criteria for such component in the 

International Energy Conservation Code approved by the Department of Energy before the installation of such component, or any 

combination of energy efficiency measures that is certified to 

achieve at least a 30-percent reduction in heating and cooling energy usage for the dwelling and that is installed in or on a dwelling 

that (1) is located in the United States; (2) is owned and used by 

the taxpayer as the taxpayer’s principal residence; (3) has not been 

treated as a qualifying new home for purposes of the energy-efficient new homes credit. Additionally, the original use of such component or combination of measures commences with the taxpayer, 

and such component or combination of measures can reasonably be 

expected to remain in use for at least five years. 

Building envelope components are: (1) insulation materials or 

systems which are specifically and primarily designed to reduce the 

heat loss or gain for a dwelling, and (2) exterior windows (including 

skylights) and doors. 

Homes shall be certified according to a component-based method or a performance-based method. The component-based method 

shall be based on applicable energy-efficiency ratings, including 

current product labeling requirements. Certification by the component method shall be provided by a third party, such as a local 

building regulatory authority, a utility, a manufactured home primary inspection agency, or a home energy rating organization. The 

531 

performance-based method shall be based on a comparison of the 

projected energy consumption of the dwelling in its original condition and after the completion of energy efficiency measures. The 

performance-based method of certification shall be conducted by an 

individual or organization recognized by the Secretary of the Treasury for such purposes. 

In prescribing regulations for performance-based certification 

methods, the Secretary shall prescribe procedures for calculating 

annual energy usage and cost reductions for heating and cooling 

and for the reporting of the results. Such regulations shall provide 

that any calculation procedures be fuel neutral such that the same 

energy efficiency measures allow a qualifying new home to be eligible for the credit under this section regardless of whether such 

home uses a gas or oil furnace or boiler or an electric heat pump, 

and require that any computer software allow for the printing of 

the Federal tax forms necessary for the credit under this section 

and for the printing of forms for disclosure to the owner of the 

dwelling. 

The taxpayer’s basis in the property would be reduced by the 

amount of the credit. Special rules would apply in the case of condominiums and tenant-stockholders in cooperative housing corporations. 

The credit is allowed against the regular and alternative minimum tax. 

Effective date.—The credit is effective for qualified energy efficiency improvements installed after December 31, 2004, and before 

January 1, 2007. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

D. CLEAN COAL INCENTIVES

1. Credit for production from a clean coal technology unit (secs. 831 

and 834 of Senate amendment) 

PRESENT LAW

Present law does not provide a production credit for electricity 

generated at units that use coal as a fuel. However, an income tax 

credit is allowed for the production of electricity from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, or qualified poultry waste units placed in service prior to January 1, 2006 (sec. 45). 

The credit allowed equals 1.5 cents per kilowatt-hour of electricity 

sold. The 1.5-cent figure is indexed for inflation and equals 1.8 

cents for 2004. The credit is allowable for production during the 10- 

year period after a unit is originally placed in service. The production tax credit is a component of the general business credit (sec. 

38(b)(1)). 

HOUSE BILL

No provision. 

532 

SENATE AMENDMENT

The Senate amendment provides a production credit for electricity produced from certain units that have been retrofitted, repowered, or replaced with a clean coal technology during the tenyear period beginning on January 1, 2005. The value of the credit 

is 0.34 cents per kilowatt-hour of electricity produced and is indexed for inflation for calendar years after 2005. 

A qualifying clean coal technology unit must meet certain capacity standards, thermal efficiency standards, and emissions 

standards for SO2, nitrous oxides, particulate emissions, and source 

emissions standards as provided in the Clean Air Act. To be a 

qualified clean coal technology unit, the taxpayer must receive a 

certificate from the Secretary of the Treasury. The Secretary may 

grant certificates to units only to the point that 4,000 megawatts 

of electricity production capacity qualifies for the credit. However, 

no qualifying unit would be eligible if the unit’s capacity exceeded 

300 megawatts. 

Certain persons (public utilities, electric cooperatives, Indian 

tribes, and the Tennessee Valley Authority) are eligible to obtain 

certifications from the Secretary for these credits and sell, trade, or 

assign the credit to any taxpayer. However, any credit sold, traded, 

or assigned may only be sold, traded, or assigned once. Subsequent 

trades are not permitted. 

Effective date.—The Senate amendment is effective for production after December 31, 2004, in taxable years ending after such 

date. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Investment credit for clean coal technology units (secs. 832 and 

834 of Senate amendment) 

PRESENT LAW

Present law does not provide an investment credit for electricity generating units that use coal as a fuel. However, a nonrefundable, 10-percent investment tax credit (‘‘business energy 

credit’’) is allowed for the cost of new property that is equipment 

(1) that uses solar energy to generate electricity, to heat or cool a 

structure, or to provide solar process heat, or (2) that is used to 

produce, distribute, or use energy derived from a geothermal deposit, but only, in the case of electricity generated by geothermal 

power, up to the electric transmission stage (sec. 48). The business 

energy tax credit is a component of the general business credit (sec. 

38(b)(1)). 

HOUSE BILL

No provision. 

533 

SENATE AMENDMENT

In general 

The Senate amendment provides a 10-percent investment tax 

credit for qualified investments in advanced clean coal technology 

units. Certain persons (public utilities, electric cooperatives, Indian 

tribes, and the Tennessee Valley Authority) will be eligible to obtain certifications from the Secretary of the Treasury (as described 

below) for these credits and sell, trade, or assign the credit to any 

taxpayer. However, any credit sold, traded, or assigned may only 

be sold, traded, or assigned once. Subsequent trades are not permitted. 

Qualifying advanced clean coal technology units 

Qualifying advanced clean coal technology units must utilize 

advanced pulverized coal or atmospheric fluidized bed combustion 

technology, pressurized fluidized bed combustion technology, integrated gasification combined cycle technology, or some other technology certified by the Secretary of Energy. Any qualifying advanced clean coal technology unit must meet certain capacity 

standards, thermal efficiency standards, and emissions standards 

for SO2, nitrous oxides, particulate emissions, and source emissions 

standards as provided in the Clean Air Act. In addition, a qualifying advanced clean coal technology unit must meet certain carbon 

emissions requirements. 

If the advanced clean coal technology unit is an advanced pulverized coal or atmospheric fluidized bed combustion technology 

unit, a pressurized fluidized bed combustion technology unit, or an 

integrated gasification combined cycle technology unit and if the 

unit uses a design coal with a heat content of not more than 9,000 

Btu per pound, the unit must have a carbon emission rate less 

than 0.60 pound of carbon per kilowatt hour of electricity produced. 

If the advanced clean coal technology unit is an advanced pulverized coal or atmospheric fluidized bed combustion technology unit, 

a pressurized fluidized bed combustion technology unit, or an integrated gasification combined cycle technology unit and if the unit 

uses a design coal with a heat content greater than 9,000 Btu per 

pound, the unit must have a carbon emission rate less than 0.54 

pound of carbon per kilowatt hour of electricity produced. In the 

case of an advanced clean coal technology unit that uses another 

eligible technology and if the unit uses a design coal with a heat 

content of not more than 9,000 Btu per pound, the unit must have 

a carbon emission rate less than 0.51 pound of carbon per kilowatt 

hour of electricity produced. In the case of an advanced clean coal 

technology unit that uses another eligible technology and if the 

unit uses a design coal with a heat content greater than 9,000 Btu 

per pound, the unit must have a carbon emission rate less than 

0.459 pound of carbon per kilowatt hour of electricity produced. 

Allocation of credits 

To be a qualified investment in advanced clean coal technology, 

the taxpayer must receive a certificate from the Secretary of the 

Treasury. The Secretary may grant certificates to investments only 

to the point that 4,000 megawatts of electricity production capacity 

534 

qualifies for the credit. From the potential pool of 4,000 megawatts 

of capacity, not more than 1,000 megawatts in total and not more 

than 500 megawatts in years prior to 2009 shall be allocated to 

units using advanced pulverized coal or atmospheric fluidized bed 

combustion technology. From the potential pool of 4,000 megawatts 

of capacity, not more than 500 megawatts in total and not more 

than 250 megawatts in years prior to 2009 shall be allocated to 

units using pressurized fluidized bed combustion technology. From 

the potential pool of 4,000 megawatts of capacity, not more than 

2,000 megawatts in total and not more than 1,000 megawatts in 

years prior to 2009 and not more than 1,500 megawatts in year 

prior to 2013 shall be allocated to units using integrated gasification combined cycle technology, with or without fuel or chemical 

co-production. From the potential pool of 4,000 megawatts of capacity, not more than 500 in total and not more than 250 megawatts 

in years prior to 2009 shall be allocated to any other technology 

certified by the Secretary of Energy. 

Effective date.—The Senate amendment is effective for periods 

after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

3. Credit for production from advanced clean coal technology (secs. 

833 and 834 of the Senate amendment) 

PRESENT LAW

Present law does not provide a production credit for electricity 

generated at units that use coal as a fuel. However, an income tax 

credit is allowed for the production of electricity from either qualified wind energy, qualified ‘‘closed-loop’’ biomass, or qualified poultry waste units placed in service prior to January 1, 2006 (sec. 45). 

The credit allowed equals 1.5 cents per kilowatt-hour of electricity 

sold. The 1.5-cent figure is indexed for inflation and equals 1.8 

cents for 2004. The credit is allowable for production during the 10- 

year period after a unit is originally placed in service. The production tax credit is a component of the general business credit (sec. 

38(b)(1)). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

In general 

The Senate amendment creates a production credit for electricity produced from any qualified advanced clean coal technology 

electricity generation unit that qualifies for the investment credit 

for qualifying clean coal technology units, as described above. Certain persons (public utilities, electric cooperatives, Indian tribes, 

and the Tennessee Valley Authority) will be eligible to obtain certifications from the Secretary of the Treasury (as described below) 

for each of these credits and sell, trade, or assign the credit to any 

535 

392 Each 3,413 Btu of heat content of the fuel or chemical is treated as equivalent to one kilowatt-hour of electricity. 

taxpayer. However, any credit sold, traded, or assigned may only 

be sold, traded, or assigned once. Subsequent trades are not permitted. 

Value of production credit for electricity produced from qualifying 

advanced clean coal technology 

The taxpayer may claim a production credit on the sum of each 

kilowatt-hour of electricity produced and the heat value of other 

fuels or chemicals produced by the taxpayer at the unit.392 The taxpayer may claim the production credit for the 10-year period commencing with the date the qualifying unit is placed in service (or 

the date on which a conventional unit was retrofitted or repowered). The value of the credit varies depending upon the year the 

unit is placed in service, whether the unit produces solely electricity or electricity and fuels or chemicals, and the rated thermal 

efficiency of the unit. In addition, the value of the credit is reduced 

for the second five years of eligible production. The maximum value 

of the production credit from any qualifying unit during the first 

five years of production is $0.014 per kilowatt-hour and the minimum value is $0.001. During the second five years of production 

from a qualifying unit, the maximum value of the production credit 

is $0.0115 and the minimum value is $0.001. The value of the credit is indexed for inflation for calendar years after 2005. 

Effective date.—The Senate amendment is effective for production after December 31, 2004, in taxable years ending after such 

date. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

E. OIL AND GAS PROVISIONS

1. Oil and gas production from marginal wells (sec. 841 of the Senate amendment and new sec. 45I of the Code) 

PRESENT LAW

There is no credit for the production of oil and gas from marginal wells. The costs of such production may be recovered under 

the Code’s depreciation and depletion rules and in other cases as 

a deduction for ordinary and necessary business expenses. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment would create a new, $3-per-barrel 

credit for the production of crude oil and a $0.50 credit per 1,000 

cubic feet of qualified natural gas production. In both cases, the 

credit is available only for production from a ‘‘qualified marginal 

well.’’ A qualified marginal well is defined as domestic well: (1) proVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00539 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
536 

393 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

duction from which is treated as marginal production for purposes 

of the Code percentage depletion rules; or (2) that during the taxable year had average daily production of not more than 25 barrel 

equivalents and produces water at a rate of not less than 95 percent of total well effluent. Production from any well during any period in which such well is not in compliance with applicable Federal pollution prevention, control, and permit requirements is not 

considered a qualified marginal well during such period. The maximum amount of production on which credit could be claimed is 

1,095 barrels or barrel equivalents. 

The credit is not available to production occurring if the ref- erence price of oil exceeds $18 ($2.00 for natural gas). The credit 

is reduced proportionately as for reference prices between $15 and 

$18 ($1.67 and $2.00 for natural gas). Reference prices are determined on a one-year look-back basis. 

In the case of production from a qualified marginal well which 

is eligible for the credit allowed under section 29 for the taxable 

year, no marginal well credit is allowable unless the taxpayer 

elects not to claim the credit under section 29 with respect to the 

well. The credit is treated as a general business credit. 

Effective date.—The Senate amendment is effective for production in taxable years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement modifies the Senate amendment. 

The conference agreement does not include the Federal pollution 

prevention, control, and permit requirement provisions of the Senate amendment. The conference agreement treats the credit as part 

of the general business credit; however, unused credits can be carried back for up to five years rather than the generally applicable 

carryback period of one year. The credit is indexed for inflation for 

taxable years beginning in a calendar year after 2005. 

Effective date—The provision is effective for production in taxable years beginning after December 31, 2004. 

2. Natural gas gathering lines treated as seven-year property (sec. 

842 of the Senate amendment and sec. 168 of the Code) 

PRESENT LAW

The applicable recovery period for assets placed in service 

under the Modified Accelerated Cost Recovery System is based on 

the ‘‘class life of the property.’’ The class lives of assets placed in 

service after 1986 are generally set forth in Revenue Procedure 87– 

56.393 Revenue Procedure 87–56 includes two asset classes that 

could describe natural gas gathering lines owned by nonproducers 

of natural gas. Asset class 46.0, describing pipeline transportation, 

provides a class life of 22 years and a recovery period of 15 years. 

Asset class 13.2, describing assets used in the exploration for and 

production of petroleum and natural gas deposits, provides a class 

life of 14 years and a depreciation recovery period of seven years. 

The uncertainty regarding the appropriate recovery period of natural gas gathering lines has resulted in litigation between taxVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00540 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
537 

394Duke Energy v. Commissioner, 172 F.3d 1255 (10th Cir. 1999), rev’g 109 T.C. 416 (1997). 

Saginaw Bay Pipeline Co. v. United States, 2003 FED App. 0259P (6th Cir.) rev’g 124 F. Supp. 

2d 465 (E.D. Mich. 2001). See also True v. United States, 97–2 U.S. Tax Cas. (CCH) par. 50,946 

(D. Wyo. 1997). 395 Clajon Gas Co., L.P. v. Commissioner, 119 T.C. 197 (2002). 

payers and the IRS. The 10th Circuit Court of Appeals and the 6th 

Circuit Court of Appeals have held that natural gas gathering lines 

owned by nonproducers falls within the scope of Asset class 13.2 

(i.e., seven-year recovery period).394 The Tax Court has held that 

natural gas gathering lines owned by nonproducers falls within the 

scope of Asset class 46.0 (i.e., 15-year recovery period).395

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment establishes a statutory seven-year recovery period and a class life of 14 years for natural gas gathering 

lines. A natural gas gathering line is defined to include any pipe, 

equipment, and appurtenance that is (1) determined to be a gathering line by the Federal Energy Regulatory Commission, or (2) 

used to deliver natural gas from the wellhead or a common point 

to the point at which such gas first reaches (a) a gas processing 

plant, (b) an interconnection with an interstate transmission line, 

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

a direct interconnection with a local distribution company, a gas 

storage facility, or an industrial consumer. 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004, in taxable years 

ending after that date. No inference is intended as to the proper 

treatment of natural gas gathering lines placed in service before 

the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

3. Expensing of capital costs incurred for production in complying 

with environmental protection agency sulfur regulations for 

small refiners (sec. 843 of the Senate amendment and new sec. 

179B of the Code) 

PRESENT LAW

Taxpayers generally may recover the costs of investments in 

refinery property through annual depreciation deductions. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment permits small business refiners to immediately deduct as an expense up to 75 percent of the costs paid 

or incurred for the purpose of complying with the Highway Diesel 

Fuel Sulfur Control Requirements of the Environmental Protection 

538 

Agency (‘‘EPA’’). Costs qualifying for the deduction are those costs 

paid or incurred with respect to any facility of a small business refiner during the period beginning on January 1, 2003 and ending 

on the earlier of the date that is one year after the date on which 

the taxpayer must comply with the applicable EPA regulations or 

December 31, 2009. 

For these purposes a small business refiner is a taxpayer who 

is in the business of refining petroleum products and employs not 

more than 1,500 employees directly in refining and has less than 

205,000 barrels per day (average) of total refinery capacity. The deduction is reduced, pro rata, for taxpayers with capacity in excess 

of 155,000 barrels per day. 

Effective date.—The Senate amendment is effective for expenses paid or incurred after December 31, 2002, in taxable years 

ending after that date. 

CONFERENCE AGREEMENT

The conference agreement includes the Senate amendment provision. With respect to the definition of a small business refiner, 

the conferees intend that, in any case in which refinery throughput or retained production of the refinery differs substantially from 

its average daily output or refined product, capacity be measured 

by reference to the average daily output of refined product. 

4. Credit for small refiners for production of diesel fuel in compliance with Environmental Protection Agency sulfur regulations 

for small refiners (sec. 844 of Senate amendment and new sec. 

45H of the Code) 

PRESENT LAW

Present law does not provide a credit for the production of lowsulfur diesel fuel. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that a small business refiner 

may claim credit equal to five cents per gallon for each gallon of 

low sulfur diesel fuel produced during the taxable year that is in 

compliance with the Highway Diesel Fuel Sulfur Control Requirements of the Environmental Protection Agency (‘‘EPA’’). The total 

production credit claimed by the taxpayer is limited to 25 percent 

of the capital costs incurred to come into compliance with the EPA 

diesel fuel requirements. Costs qualifying for the credit are those 

costs paid or incurred with respect to any facility of a small business refiner during the period beginning on January 1, 2003 and 

ending on the earlier of the date that is one year after the date on 

which the taxpayer must comply with the applicable EPA regulations or December 31, 2009. The taxpayer’s basis in property with 

respect to which the credit applies is reduced by the amount of production credit claimed. 

539 

In the case of a qualifying small business refiner that is owned 

by a cooperative, the cooperative is allowed to elect to pass any production credits to patrons of the organization. 

For these purposes a small business refiner is a taxpayer who 

is in the business of refining petroleum products, employs not more 

than 1,500 employees directly in refining, and has less than 

205,000 barrels per day (average) of total refinery capacity. The 

credit is reduced, pro rata, for taxpayers with capacity in excess of 

155,000 barrels per day. 

Effective date.—The Senate amendment is effective for expenses paid or incurred after December 31, 2002, in taxable years 

ending after that date. 

CONFERENCE AGREEMENT

The conference agreement includes the Senate amendment provision with modification as follows. The conference agreement 

makes the low sulfur diesel fuel credit a qualified business credit 

under section 169(c). Therefore, if any portion of the credit has not 

been allowed to the taxpayer as a general business credit (sec. 38) 

for any taxable year, an amount equal to that portion may be deducted by the taxpayer in the first taxable year following the last 

taxable year for which such portion could have been allowed as a 

credit under the carryback and carryforward rules (sec. 39). With 

respect to the definition of a small business refiner, the conferees 

intend that, in any case where refinery through-put or retained 

production of the refinery differs substantially from its average 

daily output of refined product, capacity be measured by reference 

to the average daily output of refined product. 

5. Determination of small refiner exception to oil depletion deduction (sec. 845 of the Senate amendment and sec. 613A of the 

Code) 

PRESENT LAW

Present law classifies oil and gas producers as independent 

producers or integrated companies. The Code provides numerous 

special tax rules for operations by independent producers. One such 

rule allows independent producers to claim percentage depletion 

deductions rather than deducting the costs of their asset, a producing well, based on actual production from the well (i.e., cost depletion). 

A producer is an independent producer only if its refining and 

retail operations are relatively small. For example, an independent 

producer may not have refining operations the runs from which exceed 50,000 barrels on any day in the taxable year during which 

independent producer status is claimed. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment increases the current 50,000-barrelper-day limitation to 60,000. In addition, the provision changes the 

refinery limitation on claiming independent producer status from a 

540 

396Treas. Reg. sec. 1.611–1(b)(1). 397Secs. 611–613. 

limit based on actual daily production to a limit based on average 

daily production for the taxable year. Accordingly, the average 

daily refinery run for the taxable year may not exceed 60,000 barrels. For this purpose, the taxpayer calculates average daily production by dividing total production for the taxable year by the 

total number of days in the taxable year. 

Effective date.—The Senate amendment is effective for taxable 

years ending after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

6. Suspension of 100-percent-of-net-income limitation on percentage 

depletion for oil and gas from marginal wells (sec. 412 of the 

House bill, sec. 846 of the Senate amendment, and sec. 613A 

of the Code) 

PRESENT LAW

Overview of depletion 

Depletion, like depreciation, is a form of capital cost recovery. 

In both cases, the taxpayer is allowed a deduction in recognition of 

the fact that an asset—in the case of depletion for oil or gas interests, the mineral reserve itself—is being expended in order to 

produce income. Certain costs incurred prior to drilling an oil or 

gas property are recovered through the depletion deduction. These 

include costs of acquiring the lease or other interest in the property 

and geological and geophysical costs (in advance of actual drilling). 

Depletion is available to any person having an economic interest in a producing property. An economic interest is possessed in 

every case in which the taxpayer has acquired by investment any 

interest in minerals in place, and secures, by any form of legal relationship, income derived from the extraction of the mineral, to 

which it must look for a return of its capital.396 Thus, for example, 

both working interests and royalty interests in an oil- or gas-producing property constitute economic interests, thereby qualifying 

the interest holders for depletion deductions with respect to the 

property. A taxpayer who has no capital investment in the mineral 

deposit does not possess an economic interest merely because it 

possesses an economic or pecuniary advantage derived from production through a contractual relation. 

Cost depletion 

Two methods of depletion are currently allowable under the 

Code: (1) the cost depletion method, and (2) the percentage depletion method.397 Under the cost depletion method, the taxpayer deducts that portion of the adjusted basis of the depletable property 

which is equal to the ratio of units sold from that property during 

the taxable year to the number of units remaining as of the end 

of taxable year plus the number of units sold during the taxable 

541 

398Sec. 613A. 399Sec. 613A(c). 400Sec. 613(a). 401The House bill predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the ‘‘Working 

Families Tax Relief Act of 2004’’), which included a number of extensions to expiring provisions. 402The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a number of extensions to expiring 

provisions. 

year. Thus, the amount recovered under cost depletion may never 

exceed the taxpayer’s basis in the property. 

Percentage depletion and related income limitations 

The Code generally limits the percentage depletion method for 

oil and gas properties to independent producers and royalty owners.398 Generally, under the percentage depletion method, 15 percent of the taxpayer’s gross income from an oil- or gas-producing 

property is allowed as a deduction in each taxable year.399 The 

amount deducted generally may not exceed 100 percent of the net 

income from that property in any year (the ‘‘net-income limitation’’).400 The 100-percent net-income limitation for marginal wells 

has been suspended for taxable years beginning after December 31, 

1997, and before January 1, 2006. 

HOUSE BILL 401

The provision extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 

1, 2006. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

SENATE AMENDMENT 402

The Senate amendment extends the suspension of the net-income limitation for marginal wells for taxable years beginning before January 1, 2007. 

Effective date.—Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement does not contain the House bill or 

Senate amendment provision. 

7. Delay rental payments (sec. 847 of the Senate amendment and 

sec. 167 of the Code) 

PRESENT LAW

Present law generally requires costs associated with inventory 

and property held for resale to be capitalized rather than currently 

deducted as they are incurred. (sec. 263). Oil and gas producers 

typically contract for mineral production in exchange for royalty 

payments. If mineral production is delayed, these contracts provide 

for ‘‘delay rental payments’’ as a condition of their extension. A 

delay rental is an amount paid for the privilege of deferring development of the property and which could have been avoided by 

abandonment of the lease, or by commencement of development of 

operations or by obtaining production. The Treasury Department 

542 

has taken the position that the uniform capitalization rules of section 263A require delay rental payments to be capitalized. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that delay rental payments 

incurred in connection with the development of oil or gas be amortized over two years. In the case of abandoned property, remaining 

basis may no longer be recovered in the year of abandonment of a 

property as all basis is recovered over the two-year amortization 

period. 

Effective date.—The Senate amendment is effective for 

amounts paid or incurred in taxable years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

8. Geological and geophysical costs (sec. 848 of the Senate amendment and sec. 167 of the Code) 

PRESENT LAW

Under present law, geological and geophysical expenditures are 

costs incurred by a taxpayer for the purpose of obtaining and accumulating data that will serve as the basis for the acquisition and 

retention of mineral properties by taxpayers exploring for minerals. 

Capital expenditures are not currently deductible as ordinary and 

necessary expenses, but are allocated to the cost of the property 

(sec. 263). Courts have held that geological and geophysical costs 

are capital, and therefore are allocable to the cost of property acquired or retained. The costs attributable to such exploration are 

allocable to the cost of the property acquired or retained. In the 

case of abandoned property, exploration expenditures are allowable 

as a loss when such property is abandoned. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that geological and geophysical costs incurred in connection with domestic oil and gas exploration be amortized over two years. In the case of abandoned 

property, remaining basis may no longer be recovered in the year 

of abandonment of a property as all basis is recovered over the twoyear amortization period. 

Effective date.—The Senate amendment is effective for costs 

paid or incurred in taxable years beginning after December 31, 

2004. 

543 

403The value of the section 29 credit for production in 2003 was $6.40 per barrel of oil equivalent. The $3.00 credit for gas from a tight formation is not adjusted for inflation. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

9. Extension and modification of credit for producing fuel from a 

non-conventional source (sec. 849 of the Senate amendment 

and sec. 29 of the Code) 

PRESENT LAW

An income tax credit is allowed for certain fuels produced from 

‘‘non-conventional sources’’ and sold to unrelated parties. The 

amount of the credit is equal to $3 (generally adjusted for inflation 403) per barrel or Btu oil barrel equivalent (sec. 29). Qualified 

fuels must be produced within the United States, and include: oil 

produced from shale and tar sands; gas produced from 

geopressured brine, Devonian shale, coal seams, tight formations 

(‘‘tight sands’’), or biomass; and liquid, gaseous, or solid synthetic 

fuels produced from coal (including lignite). 

The credit applies to fuels produced from wells drilled or facilities placed in service after December 31, 1979, and before January 

1, 1993. An exception extends the January 1, 1993 expiration date 

for facilities producing gas from biomass and synthetic fuel from 

coal if the facility producing the fuel is placed in service before July 

1, 1998, pursuant to a binding contract entered into before January 

1, 1997. 

The credit applies to qualified fuels produced and sold before 

January 1, 2003 (in the case of non-conventional sources subject to 

the January 1, 1993, expiration date) or January 1, 2008 (in the 

case of biomass gas and synthetic fuel facilities eligible for the extension period). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Extension of placed in service date for certain new facilities 

For new wells or facilities producing qualifying fuels that are 

oil from shale or tar sands, and gas from geopressured brine, Devonian shale, coal seams, a tight formation, or biomass, the credit can 

be claimed for production from such new facilities placed in service 

after December 31, 2004 and before January 1, 2007. The credit 

may be claimed for the three-year period beginning on the date 

such well or facility is placed in service. For all qualifying wells 

and facilities the value of the credit is $3.00 per barrel or Btu 

equivalent for production in 2003 and is indexed for inflation commencing with the credit amount for 2004. 

Extension and modification for ‘‘refined coal’’ 

The Senate amendment provides a credit for production of ‘‘refined coal’’ from facilities placed in service after December 31, 2004, 

544 

and before January 1, 2007. Credit may be claimed for fuel produced during the five-year period beginning on the date such facility is placed in service. The amount of the credit is $3.00 per barrel 

or Btu equivalent for production in 2003 and is indexed for inflation commencing with the credit amount for 2004. Refined coal is 

a fuel that is a liquid, gaseous, or solid synthetic fuel produced 

from coal (including lignite) or high-carbon fly ash, including such 

fuel used as a feedstock. A facility qualifies for the credit only if 

it produces refined coal that: (1) when burned emits 20 percent less 

SO2 and nitrogen oxides than the burning of feedstock coal or comparable coal predominantly available in the marketplace as of January 1, 2004, and (2) sells at prices at least 50 percent greater than 

the prices of the feedstock coal or comparable coal. However, no 

fuel produced at a qualifying advanced clean coal technology unit 

(as defined elsewhere) is a qualifying fuel. 

Expansion for ‘‘viscous oil’’ 

The Senate amendment provides a credit for production of certain viscous oil produced at wells placed in service after December 

31, 2004, and before January 1, 2007. ‘‘Viscous oil’’ is domestic 

crude oil produced from any property if the crude oil has a weighted average gravity of 22 degrees API or less (corrected to 60 degrees Fahrenheit). The credit may be claimed for fuel produced 

during the three-year period beginning on the date such well is 

placed in service. The amount of the credit is $3.00 per barrel or 

Btu equivalent for production in 2003 and is indexed for inflation 

commencing with the credit amount for 2004. The Senate amendment provides that qualifying sales to related parties for consumption not in the immediate vicinity of the wellhead qualify for the 

credit. 

Credit for coalmine methane gas 

The Senate amendment provides a credit for production of 

‘‘coalmine methane gas’’ captured or extracted from a coalmine and 

sold after December 31, 2004, and before January 1, 2007. The 

amount of the credit is $3.00 (indexed for inflation from 2002) per 

barrel or Btu oil for gas utilized, captured or sold during the applicable period. Qualifying coalmine gas is any methane gas liberated 

during coal mining operations or extracted up to ten years in advance of coal mining operations as part of a specific plan to mine 

a coal deposit. In the case of coalmine methane gas that is captured 

in advance of coal mining operations, the credit is allowed only 

after the date the coal extraction occurs in the immediate area 

where the coalmine methane gas was removed. The capture or extraction of coalmine gas from coal mining operations is required to 

be in compliance with applicable State and Federal pollution prevention, control, and permit requirements in order to qualify for 

the credit. 

Expansion for agricultural and animal wastes 

The Senate amendment adds facilities producing liquid, gaseous, or solid fuels from agricultural and animal wastes (including 

such fuels when used as feedstocks) placed in service after December 31, 2004, and before January 1, 2007, to the list of qualified 

545 

404The daily average is computed as total production divided by the total number of days the 

well or facility was in production during the year. Days before the date the project is placed 

in service are not taken into account in determining the daily average. 

facilities for purposes of the non-conventional fuel credit. The credit 

may be claimed for fuel produced during the three-year period beginning on the date such facility is placed in service. The amount 

of the credit is $3.00 per barrel or Btu equivalent for production 

in 2003 and is indexed for inflation commencing with the credit 

amount for 2004. Agricultural and animal waste includes by-products, packaging, and any materials associated with processing, 

feeding, selling, transporting, or disposal of agricultural or animal 

products or wastes. 

Extension of credit for certain existing facilities 

The Senate amendment extends the present law credit ($3.00 

indexed for inflation from 1979) through December 31, 2005, for 

production from existing facilities producing coke, coke gas, or natural gas and by-products produced by coal gasification from lignite. 

For persons (or subsidiaries of such persons) engaged in furnishing 

electric energy, or providing telephone service, to persons in rural 

areas, any credit claimed for this purpose may be applied as a prepayment of any loan, debt, or other obligation to the extent provided by the Secretary of Agriculture and to the extent provided by 

the Secretary of Energy, as a prepayment not to exceed 50 percent 

of any obligation incurred pursuant to an asset purchase agreement entered into with the Secretary and dated October 7, 1988. 

Such credit is not considered income for these purposes. 

Daily limit 

Under the Senate amendment, with respect to qualifying facilities placed in service under the extended placed in service dates, 

a taxpayer would not be able to claim any credit for production in 

excess of a daily average 404 of 200,000 cubic feet of natural gas or 

barrel of oil equivalent (200,000 cubic feet is equivalent to approximately 35.4 barrels of oil) of such gas with respect to: (1) oil produced from shale and tar sands and (2) gas produced from 

geopressured brine, Devonian shale, coal seams, or a tight formation. Days before the date the project is placed in service are not 

taken into account in determining such average. 

New phaseout adjustment 

In the case of fuels sold after 2003, with the exception of fuel 

produced at existing facilities and for any gas from a tight formation: (1) the dollar amount of the credit is $3.00 indexed for inflation from 2002 (without regard to a phaseout adjustment), and (2) 

the threshold for purposes of the phaseout of the credit is increased 

from $23.50 to $35.00 (indexed for inflation from 2002). 

General business credit 

The provision adds section 29 to the list of general business 

credits and re-labels present section 29 of the Code as new Code 

section 45R. 

546 

405 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

Study of coalbed methane gas 

The Senate amendment provides that the Secretary of Treasury undertake a study of the effect of section 29 on the production 

of coalbed methane. The study should estimate the total amount of 

credit claimed annually and in aggregate related to the production 

of coalbed methane since the date of enactment of section 29. The 

study should report the annual value of the credit allowable for 

coalbed methane compared to the average annual wellhead price of 

natural gas (per thousand cubic feet of natural gas). The study 

should estimate the incremental increase in production of coalbed 

methane that has resulted from the enactment of section 29. The 

study should also estimate the cost to the Federal government, in 

terms of the net tax benefits claimed, per thousand cubic feet of incremental coalbed methane produced annually and in aggregate 

since the enactment of section 29. 

Effective date 

In general, except as provided below, the provision is effective 

for fuel sold from qualifying facilities after December 31, 2004, in 

taxable years ending after such date. 

For existing facilities, the provision is effective for fuel sold 

after December 31, 2002, in taxable years ending after such date. 

For application of the general business credit, the provision is 

effective for taxable years ending after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

10. Natural gas distribution lines treated as 15-year property (sec. 

850 of the Senate amendment and sec. 168 of the Code) 

PRESENT LAW

The applicable recovery period for assets placed in service 

under the Modified Accelerated Cost Recovery System is based on 

the ‘‘class life of the property.’’ The class lives of assets placed in 

service after 1986 are generally set forth in Revenue Procedure 87– 

56.405 Natural gas distribution pipelines are assigned a 20-year recovery period and a class life of 35 years. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment establishes a statutory 15-year recovery period and a class life of 35 years for natural gas distribution 

lines. 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004, in taxable years 

ending after such date. 

547 

406 Natural gas entering a gas processing facility is not considered to have entered a pipeline. 

Rather, the credit applies only to pipeline quality gas at the time of entry into the pipeline. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

11. Credit for production of Alaska natural gas (sec. 851 of Senate 

amendment) 

PRESENT LAW

Present law does not provide a credit for conventional production of natural gas or delivery of fuels to a pipeline. However, certain fuels produced from ‘‘non-conventional sources’’ and sold to unrelated parties are eligible for an income tax credit equal to $3 

(generally adjusted for inflation) per barrel or Btu oil barrel equivalent (sec. 29). Qualified fuels must be produced within the United 

States. 

Qualified fuels include: 

(1) gas produced from geopressured brine, Devonian shale, 

coal seams, tight formations (‘‘tight sands’’), or biomass; and 

(2) liquid, gaseous, or solid synthetic fuels produced from 

coal (including lignite). 

In general, the credit is available only with respect to fuels 

produced from wells drilled or facilities placed in service after December 31, 1979, and before January 1, 1993. An exception extends 

the January 1, 1993 expiration date for facilities producing gas 

from biomass and synthetic fuel from coal if the facility producing 

the fuel is placed in service before July 1, 1998, pursuant to a binding contract entered into before January 1, 1997. 

The credit may be claimed for qualified fuels produced and sold 

before January 1, 2003 (in the case of non-conventional sources 

subject to the January 1, 1993 expiration date) or January 1, 2008 

(in the case of biomass gas and synthetic fuel facilities eligible for 

the extension period). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides a credit per million British thermal 

units (Btu) of natural gas for Alaska natural gas entering a pipeline 406 during the 25-year period beginning the later of January 1, 

2010 or the initial date for the interstate transportation of Alaska 

natural gas. Taxpayers may claim the credit against both the regular and minimum tax. 

The credit amount for any month is a maximum of 52 cents 

per million Btu of natural gas. The credit phases out as the reference price of Alaska natural gas rises above 83 cents per million 

Btu, at a rate of one cent of credit lost per each cent by which the 

reference price of Alaska natural gas exceeds 83 cents per million 

Btu. The credit is not available if the reference price of Alaska natural gas rises above $1.35 per million Btu. The 52-cent and 83-cent 

548 

407 In practice, the $1.35-figure also is indexed for inflation, as $1.35 is the sum of the 52- 

cent credit and the 83-cent price. The bill provides that the Secretary can compute the inflation 

adjustment factor for a calendar year in the fourth quarter of the preceding year. For example, 

the adjustment for 2006 is calculated as the 2005 GDP deflator over the 2004 GDP deflator, 

where the 2004 GDP deflator is the value of the GDP deflator on June 30, 2004 (as determined 

by the latest available revision from the Department of Commerce prior to October 1, 2004). 

Likewise, the 2005 deflator is the value of the GDP deflator on June 30, 2005. 408 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

figures are indexed for inflation after 2004, with the first adjustment for calendar year 2006.407

The bill provides that the Secretary of the Treasury calculate 

the reference price of Alaska natural gas as the average price of 

natural gas delivered in the lower 48 States less certain transportation costs and gas processing costs. Alaska natural gas is any gas 

derived from an area of the State of Alaska lying north of 64 degrees North latitude, but not including the Alaska National Wildlife Refuge. 

The credit is part of the general business credit. 

Effective date.—The proposal is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

12. Treat certain Alaska pipeline property as seven-year property 

(sec. 852 of the Senate amendment and sec. 168 of the Code) 

PRESENT LAW

The applicable recovery period for assets placed in service 

under the Modified Accelerated Cost Recovery System is based on 

the ‘‘class life of the property.’’ The class lives of assets placed in 

service after 1986 are generally set forth in Revenue Procedure 87– 

56.408 Asset class 46.0, describing assets used in the private, commercial, and contract carrying of petroleum, gas and other products 

by means of pipes and conveyors, are assigned a class life of 22 

years and a recovery period of 15 years. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment establishes a statutory seven-year recovery period and a class life of 22 years for any Alaska natural 

gas pipeline. The term ‘‘Alaska natural gas pipeline’’ is defined as 

any natural gas pipeline system (including the pipe, trunk lines, related equipment, and appurtenances used to carry natural gas, but 

not any gas processing plant) located in the State of Alaska that 

has a capacity of more than 500 billion Btu of natural gas per day 

and is placed in service after December 31, 2012. A taxpayer who 

places an otherwise qualifying system in service before January 1, 

2013 may elect to treat the system as placed in service on January 

1, 2013, thus qualifying for the seven-year recovery period. 

Effective date.—The Senate amendment is effective for property placed in service after December 31, 2004. 

549 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

the following modification. In order to qualify for the seven-year recovery period, otherwise qualifying property must be placed in 

service after December 31, 2013. A taxpayer who places an otherwise qualifying system in service before January 1, 2014 may elect 

to treat the system as placed in service on January 1, 2014, thus 

qualifying for the seven-year recovery period. 

Effective date.—The provision is effective for property placed in 

service after December 31, 2004. 

13. Enhanced oil recovery credit for certain gas processing facilities 

(sec. 853 of the Senate amendment and sec. 43 of the Code) 

PRESENT LAW

The taxpayer may claim a credit equal to 15 percent of enhanced oil recovery costs. Qualified enhanced oil recovery costs include costs of depreciable tangible property that is part of an enhanced oil recovery project, intangible drilling and development 

costs with respect to an enhanced oil recovery project, and tertiary 

injectant expenses incurred with respect to an enhanced oil recovery project. The credit is phased out when oil prices exceed a 

threshold amount. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that expenses in connection 

with the construction of any qualifying natural gas processing 

plant capable of processing two trillion British thermal units of 

Alaskan natural gas into a natural gas pipeline system on a daily 

basis are qualified enhanced oil recovery costs eligible for the enhanced oil recovery credit. A qualifying natural gas processing 

plant also must produce carbon dioxide for re-injection into a producing oil or gas field. 

Effective date.—The provision is effective for costs paid or incurred in taxable years beginning after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

14. Exempt certain prepayments for natural gas from tax-exempt 

bond arbitrage rules (sec. 854 of the Senate amendment and 

secs. 141 and 148 of the Code) 

PRESENT LAW

Interest on bonds issued by States or local governments to finance activities carried out or paid for by those entities generally 

is exempt from income tax. Restrictions are imposed on the ability 

of States or local governments to invest the proceeds of these bonds 

for profit (the ‘‘arbitrage restrictions’’). One such restriction limits 

the use of bond proceeds to acquire ‘‘investment-type property.’’ The 

550 

409Treas. Reg. sec. 1.148–1(e)(2)(iii). 

term investment-type property includes the acquisition of property 

in a transaction involving a prepayment if a principal purpose of 

the prepayment is to receive an investment return from the time 

the prepayment is made until the time payment otherwise would 

be made. A prepayment can produce prohibited arbitrage profits 

when the discount received for prepaying the costs exceeds the 

yield on the tax-exempt bonds. In general, prohibited prepayments 

include all prepayments that are not customary in an industry by 

both beneficiaries of tax-exempt bonds and other persons using taxable financing for the same transaction. 

On August 4, 2003, the Treasury Department issued final regulations deeming to be customary, and not in violation of the arbitrage rules, certain prepayments for natural gas and electricity.409

Generally, a qualified prepayment under the regulations requires 

that 90 percent of the natural gas or electricity purchased with the 

prepayment be used for a qualifying use. Generally, natural gas is 

used for a qualifying use if it is to be (1) furnished to retail gas 

customers of the issuing municipal utility who are located in the 

natural gas service area of the issuing municipal utility, however, 

gas used to produce electricity for sale is not included under this 

provision, (2) used by the issuing municipal utility to produce electricity that will be furnished to retail electric service area customers of the issuing utility, (3) used by the issuing municipal utility to produce electricity that will be sold to a utility owned by a 

governmental person and furnished to the service area retail electric customers of the purchaser, (4) sold to a utility that is owned 

by a governmental person if the requirements of (1), (2), or (3) are 

satisfied by the purchasing utility (treating the purchaser as the 

issuing utility) or (5) used to fuel the pipeline transportation of the 

prepaid gas supply. Electricity is used for a qualifying use if it is 

to be (1) furnished to retail service area electric customers of the 

issuing municipal utility or (2) sold to a municipal utility and furnished to retail electric customers of the purchaser who are located 

in the electricity service area of the purchaser. Both governmental 

gas and electric utilities may take advantage of this regulatory provision. 

State and local bonds may be classified as either governmental 

bonds or private activity bonds. Governmental bonds are bonds the 

proceeds of which are primarily used to finance governmental functions or the debt is repaid with governmental funds. Private activity bonds are bonds where the State or local government serves as 

a conduit providing financing to private businesses or individuals. 

The exclusion from income for State and local bonds does not apply 

to private activity bonds, unless the bonds are issued for certain 

purposes permitted by the Code. Section 141(D) of the Code provides that the term ‘‘private activity bond’’ includes any bond 

issued as part of an issue if the amount of the proceeds of the issue 

which are to be used (directly or indirectly) for the acquisition by 

a governmental unit of nongovernmental output property exceeds 

the lesser of five percent of such proceeds or $5 million. ‘‘Nongovernmental output property’’ generally means any property (or 

interest therein) which before such acquisition was used (or held 

551 

for use) by a person other than a governmental unit in connection 

with an output facility (other than a facility for the furnishing of 

water). An exception applies to output property which is to be used 

in connection with an output facility 95 percent or more of the output of which will be consumed in (1) a qualified service area of the 

governmental unit acquiring the property, or (2) a qualified annexed area of such unit. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

In general 

The provision creates a safe harbor exception to the general 

rule that tax-exempt bond-financed prepayments violate the arbitrage restrictions. The term ‘‘investment type property’’ does not include a prepayment under a qualified natural gas supply contract. 

The provision also provides that such prepayments are not treated 

as private loans for purposes of the private business tests. 

Under the provision, a prepayment financed with tax-exempt 

bond proceeds for the purpose of obtaining a supply of natural gas 

for service area customers of a governmental utility is not treated 

as the acquisition of investment-type property. A contract is a 

qualified natural gas contract if the volume of natural gas secured 

for any year covered by the prepayment does not exceed the sum 

of (1) the average annual natural gas purchased (other than for resale) by customers of the utility within the service area of the utility (‘‘retail natural gas consumption’’) during the testing period, 

and (2) the amount of natural gas that is needed to fuel transportation of the natural gas to the governmental utility. The testing 

period is the 5-calendar-year period immediately preceding the calendar year in which the bonds are issued. A retail customer is one 

who does not purchase natural gas for resale. Natural gas used to 

generate electricity by a utility owned by a governmental unit is 

counted as retail natural gas consumption if the electricity was sold 

to retail customers within the service area of the governmental 

electric utility. 

Adjustments 

The volume of gas permitted by the general rule is reduced by 

natural gas otherwise available on the date of issuance. Specifically, the amount of natural gas permitted to be acquired under a 

qualified natural gas contract for any period is to be reduced by 

natural gas held by the utility on the date of issuance of the bonds 

and natural gas that the utility has a right to acquire for the prepayment period (determined as of the date of issuance). For purposes of the preceding sentence, applicable share means, with respect to any period, the natural gas allocable to such period if the 

gas were allocated ratably over the period to which the prepayment 

relates. 

For purposes of the safe harbor, if after the close of the testing 

period and before the issue date of the bonds (1) the government 

utility enters into a contract to supply natural gas (other than for 

552 

resale) for a commercial person for use at a property within the 

service area of such utility and (2) the gas consumption for such 

property was not included in the testing period or the ratable 

amount of natural gas to be supplied under the contract is significantly greater than the ratable amount of gas supplied to such 

property during the testing period, then the amount of gas permitted to be purchased may be increased to accommodate the contract. 

The average annual retail natural gas consumption calculation 

for purposes of the safe harbor, however, is not to exceed the annual amount of natural gas reasonably expected to be purchased 

(other than for resale) by persons who are located within the service area of such utility and who, as of the date of issuance of the 

issue, are customers of such utility. 

Intentional acts 

The safe harbor does not apply if the utility engages in intentional acts to render (1) the volume of natural gas covered by the 

prepayment to be in excess of that needed for retail natural gas 

consumption, and (2) the amount of natural gas that is needed to 

fuel transportation of the natural gas to the governmental utility. 

Definition of service area 

Service area is defined as (1) any area throughout which the 

governmental utility provided (at all times during the testing period) in the case of a natural gas utility, natural gas transmission 

or distribution service, or in the case of an electric utility, electric 

distribution service; (2) limited areas contiguous to such areas; and 

(3) any area recognized as the service area of the governmental 

utility under State or Federal law. Contiguous areas are limited to 

any area within a county contiguous to the area described in (1) 

in which retail customers of the utility are located if such area is 

not also served by another utility providing the same service. 

Ruling request for higher prepayment amounts 

Upon written request, the Secretary may allow an issuer to 

prepay for an amount of gas greater than that allowed by the safe 

harbor based on objective evidence of growth in gas consumption 

or population that demonstrates that the amount permitted by the 

exception is insufficient. 

Nongovernmental output property restrictions 

A qualified natural gas supply contract as defined in the Senate amendment is not nongovernmental output property for purposes of subsection (d) of section 141. Subsection (d) of section 141 

does not apply to prepayment contracts for natural gas or electricity that either under the Treasury regulations or statutory safe 

harbor are not investment-type property for purposes of the arbitrage rules under section 148. No inference is intended regarding 

the application of subsection 141(d) to prepayment contracts not 

covered by the statutory safe harbor or Treasury regulations. 

553 

410 As originally enacted in 1984, a qualified fund paid tax on its earnings at the top corporate 

rate and, as a result, there was no present-value tax benefit of making deductible contributions 

to a qualified fund. Also, as originally enacted, the funds in the trust could be invested only 

in certain low risk investments. Subsequent amendments to the provision have reduced the rate 

of tax on a qualified fund to 20 percent and removed the restrictions on the types of permitted 

investments that a qualified fund can make. 411Taxpayers are required to include in gross income customer charges for decommissioning 

costs (sec. 88). 

Effective date 

The provision is effective for obligations issued after December 

31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

F. ELECTRIC UTILITY RESTRUCTURING AND RELIABILITY PROVISIONS

1. Modification to special rules for nuclear decommissioning costs 

(sec. 855 of the Senate amendment and sec. 468A of the Code) 

PRESENT LAW

Overview 

Special rules dealing with nuclear decommissioning reserve 

funds were adopted by Congress in the Deficit Reduction Act of 

1984 (‘‘1984 Act’’), when tax issues regarding the time value of 

money were addressed generally. Under general tax accounting 

rules, a deduction for accrual basis taxpayers is deferred until 

there is economic performance for the item for which the deduction 

is claimed. However, the 1984 Act contains an exception under 

which a taxpayer responsible for nuclear powerplant decommissioning may elect to deduct contributions made to a qualified nuclear decommissioning fund for future decommissioning costs. Taxpayers who do not elect this provision are subject to general tax accounting rules. 

Qualified nuclear decommissioning fund 

A qualified nuclear decommissioning fund (a ‘‘qualified fund’’) 

is a segregated fund established by a taxpayer that is used exclusively for the payment of decommissioning costs, taxes on fund income, management costs of the fund, and for making investments. 

The income of the fund is taxed at a reduced rate of 20 percent for 

taxable years beginning after December 31, 1995.410

Contributions to a qualified fund are deductible in the year 

made to the extent that these amounts were collected as part of the 

cost of service to ratepayers (the ‘‘cost of service requirement’’).411

Funds withdrawn by the taxpayer to pay for decommissioning costs 

are included in the taxpayer’s income, but the taxpayer also is entitled to a deduction for decommissioning costs as economic performance for such costs occurs. 

Accumulations in a qualified fund are limited to the amount 

required to fund decommissioning costs of a nuclear powerplant for 

the period during which the qualified fund is in existence (generally post-1984 decommissioning costs of a nuclear powerplant). 

For this purpose, decommissioning costs are considered to accrue 

554 

412Treas. reg. sec. 1.468A–6. 413Treas. reg. sec. 1.468A–6(f). 414These funds are generally referred to as ‘‘nonqualified funds.’’ 

ratably over a nuclear powerplant’s estimated useful life. In order 

to prevent accumulations of funds over the remaining life of a nuclear powerplant in excess of those required to pay future decommissioning costs of such nuclear powerplant and to ensure that 

contributions to a qualified fund are not deducted more rapidly 

than level funding (taking into account an appropriate discount 

rate), taxpayers must obtain a ruling from the IRS to establish the 

maximum annual contribution that may be made to a qualified 

fund (the ‘‘ruling amount’’). In certain instances (e.g., change in estimates), a taxpayer is required to obtain a new ruling amount to 

reflect updated information. 

A qualified fund may be transferred in connection with the 

sale, exchange or other transfer of the nuclear powerplant to which 

it relates. If the transferee is a regulated public utility and meets 

certain other requirements, the transfer will be treated as a nontaxable transaction. No gain or loss will be recognized on the transfer of the qualified fund and the transferee will take the transferor’s basis in the fund.412 The transferee is required to obtain a 

new ruling amount from the IRS or accept a discretionary determination by the IRS.413

Nonqualified nuclear decommissioning funds 

Federal and State regulators may require utilities to set aside 

funds for nuclear decommissioning costs in excess of the amount allowed as a deductible contribution to a qualified fund. In addition, 

taxpayers may have set aside funds prior to the effective date of 

the qualified fund rules.414 The treatment of amounts set aside for 

decommissioning costs prior to 1984 varies. Some taxpayers may 

have received no tax benefit while others may have deducted such 

amounts or excluded such amounts from income. Since 1984, taxpayers have been required to include in gross income customer 

charges for decommissioning costs (sec. 88), and a deduction has 

not been allowed for amounts set aside to pay for decommissioning 

costs except through the use of a qualified fund. Income earned in 

a nonqualified fund is taxable to the fund’s owner as it is earned. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Repeal of cost of service requirement 

The Senate amendment repeals the cost of service requirement 

for deductible contributions to a nuclear decommissioning fund. 

Thus, all taxpayers, including unregulated taxpayers, would be allowed a deduction for amounts contributed to a qualified fund. 

Permit contributions to a qualified fund for pre-1984 decommissioning costs 

The Senate amendment also repeals the limitation that a 

qualified fund only accumulate an amount sufficient to pay for a 

555 

415The ability to transfer property into a qualified fund under this special rule is available 

only to the extent the taxpayer has not obtained a new ruling amount incorporating the repeal 

of the limitation that a qualified fund only accumulate an amount sufficient to pay for decommissioning costs of a nuclear powerplant incurred during the period that the fund is in existence 

(generally post-1984 decommissioning costs). 416 A taxpayer recognizes no gain or loss on the contribution of property to a qualified fund 

under this special rule. The qualified fund will take a transferred (carryover) basis in such property. Correspondingly, a taxpayer’s deduction (over the estimated life of the nuclear powerplant) 

is to be based on the adjusted tax basis of the property contributed rather than the fair market 

value of such property. 

nuclear powerplant’s decommissioning costs incurred during the 

period that the qualified fund is in existence (generally post-1984 

decommissioning costs). Thus, any taxpayer is permitted to accumulate an amount sufficient to cover the present value of 100 percent of a nuclear powerplant’s estimated decommissioning costs in 

a qualified fund. The Senate amendment does not change the requirement that contributions to a qualified fund not be deducted 

more rapidly than level funding. 

Exception to ruling amount for certain decommissioning costs 

The Senate amendment permits a taxpayer to make contributions to a qualified fund in excess of the ruling amount in one circumstance. Specifically, a taxpayer is permitted to contribute up to 

the present value of the amount required to fund a nuclear powerplant’s decommissioning costs which under present law section 

468A(d)(2)(A) is not permitted to be accumulated in a qualified 

fund (generally pre-1984 decommissioning costs).415 It is anticipated that an amount that is permitted to be contributed under 

this special rule shall be determined using the estimate of total decommissioning costs used for purposes of determining the taxpayer’s most recent ruling amount. Any amount transferred to the 

qualified fund under this special rule that has not previously been 

deducted or excluded from gross income is allowed as a deduction 

over the remaining useful life of the nuclear powerplant.416 If a 

qualified fund that has received amounts under this rule is transferred to another person, the transferor will be permitted a deduction for any remaining deductible amounts at the time of transfer. 

Contributions to a qualified fund after useful life of powerplant 

The Senate amendment also allows deductible contributions to 

a qualified fund subsequent to the end of a nuclear powerplant’s 

estimated useful life. Such payments are permitted to the extent 

they do not cause the assets of the qualified fund to exceed the 

present value of the taxpayer’s allocable share (current or former) 

of the nuclear decommissioning costs of such nuclear powerplant. 

Clarify treatment of transfers of qualified funds 

The Senate amendment clarifies the Federal income tax treatment of the transfer of a qualified fund. No gain or loss would be 

recognized to the transferor or the transferee as a result of the 

transfer of a qualified fund in connection with the transfer of the 

power plant with respect to which such fund was established. 

Effective date. 

The Senate amendment is effective for taxable years beginning 

after December 31, 2002. 

556 

417 Announcement 96–24, ‘‘Proposed Examination Guidelines Regarding Rural Electric Cooperatives,’’ 1996–16 I.R.B. 35. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

2. Treatment of certain income of electric cooperatives (sec. 856 of 

the Senate amendment and sec. 501 of the Code) 

PRESENT LAW

In general 

Under present law, an entity must be operated on a cooperative basis in order to be treated as a cooperative for Federal income 

tax purposes. Although not defined by statute or regulation, the 

two principal criteria for determining whether an entity is operating on a cooperative basis are: (1) ownership of the cooperative 

by persons who patronize the cooperative; and (2) return of earnings to patrons in proportion to their patronage. The Internal Revenue Service requires that cooperatives must operate under the following principles: (1) subordination of capital in control over the cooperative undertaking and in ownership of the financial benefits 

from ownership; (2) democratic control by the members of the cooperative; (3) vesting in and allocation among the members of all excess of operating revenues over the expenses incurred to generate 

revenues in proportion to their participation in the cooperative (patronage); and (4) operation at cost (not operating for profit or below 

cost).417

In general, cooperative members are those who participate in 

the management of the cooperative and who share in patronage 

capital. As described below, income from the sale of electric energy 

by an electric cooperative may be member or non-member income 

to the cooperative, depending on the membership status of the purchaser. A municipal corporation may be a member of a cooperative. 

For Federal income tax purposes, a cooperative generally computes its income as if it were a taxable corporation, with one exception-the cooperative may exclude from its taxable income distributions of patronage dividends. In general, patronage dividends are 

the profits of the cooperative that are rebated to its patrons pursuant to a pre-existing obligation of the cooperative to do so. The rebate must be made in some equitable fashion on the basis of the 

quantity or value of business done with the cooperative. 

Except for tax-exempt farmers’ cooperatives, cooperatives that 

are subject to the cooperative tax rules of subchapter T of the Code 

(sec. 1381, et seq.) are permitted a deduction for patronage dividends from their taxable income only to the extent of net income 

that is derived from transactions with patrons who are members of 

the cooperative (sec. 1382). The availability of such deductions from 

taxable income has the effect of allowing the cooperative to be 

treated like a conduit with respect to profits derived from transactions with patrons who are members of the cooperative. 

Cooperatives that qualify as tax-exempt farmers’ cooperatives 

are permitted to exclude patronage dividends from their taxable income to the extent of all net income, including net income that is 

557 

418See Rev. Rul. 83–135, 1983–2 C.B. 149. 419 Rev. Rul. 72–36, 1972–1 C.B. 151. 

derived from transactions with patrons who are not members of the 

cooperative, provided the value of transactions with patrons who 

are not members of the cooperative does not exceed the value of 

transactions with patrons who are members of the cooperative (sec. 

521). 

Taxation of electric cooperatives exempt from subchapter T 

In general, the cooperative tax rules of subchapter T apply to 

any corporation operating on a cooperative basis (except mutual 

savings banks, insurance companies, other tax-exempt organizations, and certain utilities), including tax-exempt farmers’ cooperatives (described in sec. 521(b)). However, subchapter T does not 

apply to an organization that is ‘‘engaged in furnishing electric energy, or providing telephone service, to persons in rural areas’’ (sec. 

1381(a)(2)(C)). Instead, electric cooperatives are taxed under rules 

that were generally applicable to cooperatives prior to the enactment of subchapter T in 1962. Under these rules, an electric cooperative can exclude patronage dividends from taxable income to the 

extent of all net income of the cooperative, including net income derived from transactions with patrons who are not members of the 

cooperative.418

Tax exemption of rural electric cooperatives 

Section 501(c)(12) provides an income tax exemption for rural 

electric cooperatives if at least 85 percent of the cooperative’s income consists of amounts collected from members for the sole purpose of meeting losses and expenses of providing service to its 

members. The IRS takes the position that rural electric cooperatives also must comply with the fundamental cooperative principles 

described above in order to qualify for tax exemption under section 

501(c)(12).419 The 85-percent test is determined without taking into 

account any income from qualified pole rentals and cancellation of 

indebtedness income from the prepayment of a loan under sections 

306A, 306B, or 311 of the Rural Electrification Act of 1936 (as in 

effect on January 1, 1987). The exclusion for cancellation of indebtedness income applies to such income arising in 1987, 1988, or 

1989 on debt that either originated with, or is guaranteed by, the 

Federal Government. 

The receipt by a rural electric cooperative of contributions in 

aid of construction and connection charges is taken into account for 

purposes of applying the 85-percent test. 

Rural electric cooperatives generally are subject to the tax on 

unrelated trade or business income under section 511. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Treatment of income from open access transactions 

The Senate amendment provides that income received or accrued by a rural electric cooperative from any ‘‘open access transVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00561 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
558 

420 Under the Senate amendment, references to FERC are treated as including references to 

the Public Utility Commission of Texas or the Rural Utilities Service. 

action’’ (other than income received or accrued directly or indirectly 

from a member of the cooperative) is excluded in determining 

whether a rural electric cooperative satisfies the 85-percent test for 

tax exemption under section 501(c)(12). The term ‘‘open access 

transaction’’ is defined as 

(1) The provision or sale of electric energy transmission 

services or ancillary services on a nondiscriminatory open access basis: (i) pursuant to an open access transmission tariff 

filed with and approved by the Federal Energy Regulatory 

Commission (‘‘FERC’’) (including acceptable reciprocity tariffs), 

but only if (in the case of a voluntarily filed tariff) the cooperative files a report with FERC within 90 days of enactment of 

this provision relating to whether or not the cooperative will 

join a regional transmission organization (‘‘RTO’’); or (ii) under 

an RTO agreement approved by FERC (including an agreement providing for the transfer of control-but not ownershipof transmission facilities); 420

(2) The provision or sale of electric energy distribution services 

or ancillary services on a nondiscriminatory open access basis to 

end-users served by distribution facilities owned by the cooperative 

or its members; or (3) The delivery or sale of electric energy on a 

nondiscriminatory open access basis, provided that such electric energy is generated by a generation facility that is directly connected 

to distribution facilities owned by the cooperative (or its members) 

which owns the generation facility. 

For purposes of the 85-percent test, the Senate amendment 

also provides that income received or accrued by a rural electric cooperative from any ‘‘open access transaction’’ is treated as an 

amount collected from members for the sole purpose of meeting 

losses and expenses if the income is received or accrued indirectly 

from a member of the cooperative. 

Treatment of income from nuclear decommissioning transactions 

The Senate amendment provides that income received or accrued by a rural electric cooperative from any ‘‘nuclear decommissioning transaction’’ also is excluded in determining whether a 

rural electric cooperative satisfies the 85-percent test for tax exemption under section 501(c)(12). The term ‘‘nuclear decommissioning transaction’’ is defined as— 

(1) Any transfer into a trust, fund, or instrument established to pay any nuclear decommissioning costs if the transfer 

is in connection with the transfer of the cooperative’s interest 

in a nuclear powerplant or nuclear powerplant unit; 

(2) Any distribution from a trust, fund, or instrument established to pay any nuclear decommissioning costs; or 

(3) Any earnings from a trust, fund, or instrument established to pay any nuclear decommissioning costs. 

Treatment of income from asset exchange or conversion transactions 

The Senate amendment provides that gain realized by a taxexempt rural electric cooperative from a voluntary exchange or inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00562 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
559 

voluntary conversion of certain property is excluded in determining 

whether a rural electric cooperative satisfies the 85-percent test for 

tax exemption under section 501(c)(12). This provision only applies 

to the extent that: (1) the gain would qualify for deferred recognition under section 1031 (relating to exchanges of property held for 

productive use or investment) or section 1033 (relating to involuntary conversions); and (2) the replacement property that is acquired 

by the cooperative pursuant to section 1031 or section 1033 (as the 

case may be) constitutes property that is used, or to be used, for 

the purpose of generating, transmitting, distributing, or selling 

electricity or natural gas. 

Treatment of cancellation of indebtedness income from prepayment 

of certain loans 

The Senate amendment provides that income from the prepayment of any loan, debt, or obligation of a tax-exempt rural electric 

cooperative that is originated, insured, or guaranteed by the Federal Government under the Rural Electrification Act of 1936 is excluded in determining whether the cooperative satisfies the 85-percent test for tax exemption under section 501(c)(12). 

Treatment of income from load loss transactions 

Tax-exempt rural electric cooperatives.—The Senate amendment provides that income received or accrued by a tax-exempt 

rural electric cooperative from a ‘‘load loss transaction’’ is treated 

under 501(c)(12) as income collected from members for the sole purpose of meeting losses and expenses of providing service to its 

members. Therefore, income from load loss transactions is treated 

as member income in determining whether a rural electric cooperative satisfies the 85-percent test for tax exemption under section 

501(c)(12). The bill also provides that income from load loss transactions does not cause a tax-exempt electric cooperative to fail to 

be treated for Federal income tax purposes as a mutual or cooperative company under the fundamental cooperative principles described above. 

The term ‘‘load loss transaction’’ is generally defined as any 

wholesale or retail sale of electric energy (other than to a member 

of the cooperative) to the extent that the aggregate amount of such 

sales during a seven-year period beginning with the ‘‘start-up year’’ 

does not exceed the reduction in the amount of sales of electric energy during such period by the cooperative to members. The ‘‘startup year’’ is defined as the calendar year which includes the date 

of enactment of this provision or, if later, at the election of the cooperative: (1) the first year that the cooperative offers nondiscriminatory open access; or (2) the first year in which at least 10 percent of the cooperative’s sales of electric energy are to patrons who 

are not members of the cooperative. 

The Senate amendment also excludes income received or accrued by rural electric cooperatives from load loss transactions 

from the tax on unrelated trade or business income. 

Taxable electric cooperatives.—The Senate amendment provides 

that the receipt or accrual of income from load loss transactions by 

taxable electric cooperatives is treated as income from patrons who 

are members of the cooperative. Thus, income from a load loss 

560 

421 Under the conference agreement, references to FERC are treated as including references 

to the Public Utility Commission of Texas. 

transaction is excludible from the taxable income of a taxable electric cooperative if the cooperative distributes such income pursuant 

to a pre-existing contract to distribute the income to a patron who 

is not a member of the cooperative. The Senate amendment also 

provides that income from load loss transactions does not cause a 

taxable electric cooperative to fail to be treated for Federal income 

tax purposes as a mutual or cooperative company under the fundamental cooperative principles described above. 

Effective date 

The Senate amendment provision is effective for taxable years 

beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

the following modifications. 

Treatment of income from open access transactions 

Income received or accrued by a rural electric cooperative 

(other than income received or accrued directly or indirectly from 

a member of the cooperative) from the provision or sale of electric 

energy transmission services or ancillary services on a nondiscriminatory open access basis under an open access transmission tariff 

approved or accepted by FERC or under an independent transmission provider agreement approved or accepted by FERC (including an agreement providing for the transfer of control—but not 

ownership—of transmission facilities) 421 is excluded in determining whether a rural electric cooperative satisfies the 85-percent 

test for tax exemption under section 501(c)(12). 

In addition, income is excluded for purposes of the 85-percent 

test if it is received or accrued by a rural electric cooperative (other 

than income received or accrued directly or indirectly from a member of the cooperative) from the provision or sale of electric energy 

distribution services or ancillary services, provided such services 

are provided on a nondiscriminatory open access basis to distribute 

electric energy not owned by the cooperative: (1) to end-users who 

are served by distribution facilities not owned by the cooperative or 

any of its members; or (2) generated by a generation facility that 

is not owned or leased by the cooperative or any of its members 

and that is directly connected to distribution facilities owned by the 

cooperative or any of its members. 

Treatment of cancellation of indebtedness income from prepayment 

of certain loans 

The conference agreement does not include this provision. 

Treatment of income from load loss transactions 

For purposes of this provision, the ‘‘start-up year’’ is defined in 

the conference agreement as the first year that the cooperative offers nondiscriminatory open access or, if later and at the election 

561 

of the cooperative, the calendar year that includes the date of enactment of this provision. 

Effective date 

The conference agreement provision is effective for taxable 

years beginning after the date of enactment and before January 1, 

2007. 

3. Dispositions of transmission property to implement Federal Energy Regulatory Commission restructuring policy (no reinvestment obligation) (sec. 857 of the Senate amendment and sec. 

451 of the Code) 

PRESENT LAW

Generally, a taxpayer recognizes gain to the extent the sales 

price (and any other consideration received) exceeds the seller’s 

basis in the property. The recognized gain is subject to current income tax unless the gain is deferred or not recognized under a special tax provision. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment permits a taxpayer to elect to recognize gain from a qualifying electric transmission transaction ratably over an eight-year period beginning in the year of sale. 

A qualifying electric transmission transaction is the sale or 

other disposition of property used by the taxpayer in the trade or 

business of providing electric transmission services, or any stock or 

partnership interest in a corporation or partnership whose principal trade or business consists of providing electrical services. In 

order to qualify, the transaction must occur before January 1, 2008 

and the sale or disposition must be to an independent transmission 

company. 

In general, an independent transmission company is defined 

as: (1) a regional transmission organization approved by the Federal Energy Regulatory Commission (‘‘FERC’’); (2) a person (i) who 

the FERC determines under section 203 of the Federal Power Act 

(or by declaratory order) is not a ‘‘market participant’’ and (ii) 

whose transmission facilities are placed under the operational control of a FERC-approved independent transmission provider before 

the close of the period specified in such authorization, but not later 

than January 1, 2008; or (3) in the case of facilities subject to the 

jurisdiction of the Public Utility Commission of Texas, a person 

which is approved by that Commission as consistent with Texas 

State law regarding an independent transmission organization. 

An electing taxpayer is required to attach a statement to that 

effect in the tax return for the taxable year in which the transaction takes place in such manner as the Secretary shall prescribe. 

The election shall be binding for that taxable year and all subsequent taxable years. Finally, the provision provides that the installment sale rules shall not apply to any qualifying electric transVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00565 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
562 

422The applicable period for a taxpayer to reinvest the proceeds is four years after the close 

of the taxable year in which the qualifying electric transmission transaction occurs. 423For example, a regional transmission organization, an independent system operator, or an 

independent transmission company. 

mission transaction for which a taxpayer elects the application of 

this provision. 

Effective date.—The Senate amendment is effective for transactions occurring after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

the following modifications. The provision permits taxpayers to 

elect to recognize gain from qualifying electric transmission transactions ratably over an eight-year period beginning in the year of 

sale if the amount realized from such sale is used to purchase exempt utility property within the applicable period 422 (the ‘‘reinvestment property’’). If the amount realized exceeds the amount used 

to purchase reinvestment property, any realized gain shall be recognized to the extent of such excess in the year of the qualifying 

electric transmission transaction. Any remaining realized gain is 

recognized ratably over the eight-year period. 

A qualifying electric transmission transaction is the sale or 

other disposition of property used by the taxpayer in the trade or 

business of providing electric transmission services, or an ownership interest in such an entity, to an independent transmission 

company prior to January 1, 2007. In general, an independent 

transmission company is defined as: (1) an independent transmission provider 423 approved by the FERC; (2) a person (i) who the 

FERC determines under section 203 of the Federal Power Act (or 

by declaratory order) is not a ‘‘market participant’’ and (ii) whose 

transmission facilities are placed under the operational control of 

a FERC-approved independent transmission provider before the 

close of the period specified in such authorization, but not later 

than January 1, 2007; or (3) in the case of facilities subject to the 

jurisdiction of the Public Utility Commission of Texas, (i) a person 

which is approved by that Commission as consistent with Texas 

State law regarding an independent transmission organization, or 

(ii) a political subdivision, or affiliate thereof, whose transmission 

facilities are under the operational control of an organization described in (i). 

Exempt utility property is defined as: (1) property used in the 

trade or business of generating, transmitting, distributing, or selling electricity or producing, transmitting, distributing, or selling 

natural gas, or (2) stock in a controlled corporation whose principal 

trade or business consists of the activities described in (1). 

If a taxpayer is a member of an affiliated group of corporations 

filing a consolidated return, the proposal permits the reinvestment 

property to be purchased by any member of the affiliated group (in 

lieu of the taxpayer). 

If a taxpayer elects the application of the provision, then the 

statutory period for the assessment of any deficiency, for any taxable year in which any part of the gain eligible for the provision 

is realized, attributable to such gain shall not expire prior to the 

expiration of three years from the date the Secretary of the TreasVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00566 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
563 

424The provision also provides that the installment sale rules shall not apply to any qualifying 

electric transmission transaction for which a taxpayer elects the application of this provision. 

ury is notified by the taxpayer of the reinvestment property or an 

intention not to reinvest. 

An electing taxpayer is required to attach a statement to that 

effect in the tax return for the taxable year in which the transaction takes place in the manner as the Secretary shall prescribe. 

The election shall be binding for that taxable year and all subsequent taxable years.424 In addition, an electing taxpayer is required to attach a statement that identifies the reinvestment property in the manner as the Secretary shall prescribe. 

Effective date.—The provision is effective for transactions occurring after the date of enactment, in taxable years ending after 

such date. 

G. ADDITIONAL PROVISIONS

1. GAO Study (sec. 897 of the Senate amendment) 

PRESENT LAW

Present law does not require study of the present law provisions relating to clean fuel vehicles and electric vehicles. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment directs the Comptroller General to undertake an ongoing analysis of the (1) effectiveness of the amendment’s alternative motor vehicles, fuel incentives, and conservation 

and energy efficiency provisions and (2) the recipients of the tax 

benefits contained in those provisions, including an identification of 

the recipients by income and other appropriate measurements. The 

analysis must quantify the effectiveness of the provisions by examining and comparing the Federal Government’s forgone revenue to 

the aggregate amount of energy actually conserved and tangible environmental benefits gained as a result of the provisions. 

The Senate amendment directs the Comptroller General to report the required analysis to Congress not later than December 31, 

2004 and annually thereafter. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

564 

2. Repeal certain excise taxes on rail diesel fuel and inland waterway barge fuels (sec. 898 of the Senate amendment and secs. 

4041, 4042, 6421, and 6427 of the Code) 

PRESENT LAW

Under present law, diesel fuel used in trains is subject to a 4.4- 

cents-per gallon excise tax. Revenues from 4.3 cents per gallon of 

this excise tax are retained in the General Fund of the Treasury. 

The remaining 0.1 cent per gallon is deposited in the Leaking Underground Storage Tank (‘‘LUST’’) Trust Fund. 

Similarly, fuels used in barges operating on the designated inland waterways system are subject to a 4.3-cents-per-gallon General Fund excise tax. This tax is in addition to the 20.1-cents-pergallon tax rates that are imposed on fuels used in these barges to 

fund the Inland Waterways Trust Fund and the Leaking Underground Storage Tank Trust Fund. 

In both cases, the 4.3-cents-per-gallon excise tax rates are permanent. The LUST Trust Fund tax is scheduled to expire after 

March 31, 2005. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The 4.3-cents-per-gallon General Fund excise tax rate on diesel 

fuel used in trains and fuels used in barges operating on the designated inland waterways system is repealed. The 0.1 cent per gallon tax for the LUST Trust Fund is unchanged by the provision. 

Effective date.—The Senate amendment is effective on October 

1, 2004. 

CONFERENCE AGREEMENT

The conference agreement repeals the 4.3-cents-per-gallon General Fund excise tax rates on diesel fuel used in trains and fuels 

used in barges operating on the designated inland waterways system over a prescribed phase-out period. The 4.30-cent-per-gallon 

tax is reduced by 1 cent per gallon for the first six months of calendar year 2005 (January 1, 2005 through June 30, 2005). The reduction is 2 cents per gallon from July 1, 2005 through December 

31, 2006, and 4.3 cents/gallon thereafter. Thus, the tax would be 

fully repealed effective January 1, 2007. The 0.1 cent per gallon tax 

for the LUST Trust Fund is unchanged by the provision. 

Effective date.—The provision is effective on January 1, 2005. 

3. Increase tax limitation on use of business energy credits (secs. 

851(c) and 899A of the Senate amendment, and sec. 38 of the 

Code) 

PRESENT LAW

Generally, business tax credits may not exceed the excess of the 

taxpayer’s income tax liability over the tentative minimum tax (or, 

if greater, 25 percent of the regular tax liability). Credits in excess 

565 

425The term ‘‘original use’’ means the first use to which the property is put, whether or not 

such use corresponds to the use of such property by the taxpayer. It is intended that, when evalContinued 

of the limitation may be carried back one year and carried over for 

up to 20 years. 

The tentative minimum tax is an amount equal to specified rates 

of tax imposed on the excess of the alternative minimum taxable 

income over an exemption amount. To the extent the tentative minimum tax exceeds the regular tax, a taxpayer is subject to the alternative minimum tax. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment treats the tentative minimum tax as 

being zero for purposes of determining the tax liability limitation 

with respect to (1) the Alaska natural gas credit, (2) for taxable 

years beginning after December 31, 2004, the alcohol fuels credit 

determined under section 40; and (3) the section 45 credit for electricity produced from a facility (placed in service after the date of 

enactment) during the first four years of production beginning on 

the date the facility is placed in service. 

Effective date.—The provision is effective for taxable years ending after the date of enactment of the Act. 

CONFERENCE AGREEMENT

The conference agreement includes the provision in the Senate 

amendment relating to the credits under sections 40 and 45. 

4. Transmission property treated as fifteen-year property (sec. 

899C of the Senate amendment and sec. 168 of the Code) 

PRESENT LAW

The applicable recovery period for assets placed in service 

under the Modified Accelerated Cost Recovery System is based on 

the ‘‘class life of the property.’’ The class lives of assets placed in 

service after 1986 are generally set forth in Revenue Procedure 87– 

56. Assets used in the transmission and distribution of electricity 

for sale and related land improvements are assigned a 20-year recovery period and a class life of 30 years. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment establishes a statutory 15-year recovery period and a class life of 30 years for certain assets used in the 

transmission of electricity for sale and related land improvements. 

For purposes of the provision, section 1245 property used in the 

transmission of electricity for sale at 69 kilovolts and above, the 

original use 425 of which commences after the date of enactment, 

will qualify for the new recovery period. 

566 

uating whether property qualifies as ‘‘original use,’’ the factors used to determine whether property qualified as ‘‘new section 38 property’’ for purposes of the investment tax credit would 

apply. See Treasury Regulation 1.48–2. Thus, it is intended that additional capital expenditures 

incurred to recondition or rebuild acquired property (or owned property) would satisfy the ‘‘original use’’ requirement. However, the cost of reconditioned or rebuilt property acquired by the taxpayer would not satisfy the ‘‘original use’’ requirement. For example, if on August 11, 2005, a 

taxpayer buys from RCM for $200,000 transmission lines that have been previously used by 

RCM. Subsequent to the purchase, the taxpayer makes an expenditure on the property of 

$50,000 of the type that must be capitalized. Regardless of whether the $50,000 is added to the 

basis of such property or is capitalized as a separate asset, such amount would be treated as 

satisfying the ‘‘original use’’ requirement and would be eligible for the reduced recovery period. 

No part of the $200,000 purchase price qualifies for the reduced recovery period. 426Sec. 46. 427Sec. 38(b)(1). 428 Rules similar to the rules of section 48(m) of the Internal Revenue Code of 1986 (as in 

effect on the day before the date of enactment of the Revenue Reconciliation Act of 1990) apply. 

Effective date.—The Senate amendment is effective for property placed in service after the date of enactment and prior to July 

1, 2006. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

5. Qualifying pollution control equipment credit (sec. 899B of the 

Senate amendment) 

PRESENT LAW

The investment credit is the sum of three credits: (1) the rehabilitation credit, (2) the energy credit, and (3) the reforestation 

credit.426 The investment credit is part of the general business 

credit.427

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment adds a credit for qualifying pollution 

control equipment to the investment credit. The qualifying pollution control equipment credit provides a 15-percent tax credit for 

qualifying pollution control equipment placed-in-service at a qualifying facility during the taxable year. Qualifying pollution control 

equipment means any technology that is installed in or on a qualifying facility to reduce air emissions of any pollutant regulated by 

the Environmental Protection Agency under the Clean Air Act. A 

qualifying facility is a facility that produces not less than 1,000,000 

gallons of ethanol during the taxable year. A qualifying facility includes any facility that produces ethanol. For depreciation purposes, the basis of qualifying pollution control equipment would be 

reduced by 50 percent of the value of the credit. 

Effective date.—The credit would be available for property 

placed-in-service after December 31, 2003, in taxable years ending 

after such date.428

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

567 

TITLE X—REVENUE PROVISIONS 

A. PROVISIONS TO REDUCE TAX AVOIDANCE THROUGH INDIVIDUAL

AND CORPORATE EXPATRIATION

1. Tax treatment of expatriated entities and their foreign parents 

(sec. 601 of the House bill, sec. 441 of the Senate amendment, 

and new sec. 7874 of the Code) 

PRESENT LAW

Determination of corporate residence 

The U.S. tax treatment of a multinational corporate group depends significantly on whether the parent corporation of the group 

is domestic or foreign. For purposes of U.S. tax law, a corporation 

is treated as domestic if it is incorporated under the law of the 

United States or of any State. All other corporations (i.e., those incorporated under the laws of foreign countries) are treated as foreign. 

U.S. taxation of domestic corporations 

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, 

whether derived in the United States or abroad. In order to mitigate the double taxation that may arise from taxing the foreignsource income of a domestic corporation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce or eliminate the U.S. tax owed on such income, subject to certain limitations. 

Income earned by a domestic parent corporation from foreign 

operations conducted by foreign corporate subsidiaries generally is 

subject to U.S. tax when the income is distributed as a dividend 

to the domestic corporation. Until such repatriation, the U.S. tax 

on such income generally is deferred, and U.S. tax is imposed on 

such income when repatriated. However, certain anti-deferral regimes may cause the domestic parent corporation to be taxed on a 

current basis in the United States with respect to certain categories of passive or highly mobile income earned by its foreign 

subsidiaries, regardless of whether the income has been distributed 

as a dividend to the domestic parent corporation. The main antideferral regimes in this context are the controlled foreign corporation rules of subpart F (secs. 951–964) and the passive foreign investment company rules (secs. 1291–1298). A foreign tax credit is 

generally available to offset, in whole or in part, the U.S. tax owed 

on this foreign-source income, whether repatriated as an actual 

dividend or included under one of the anti-deferral regimes. 

U.S. taxation of foreign corporations 

The United States taxes foreign corporations only on income 

that has a sufficient nexus to the United States. Thus, a foreign 

corporation is generally subject to U.S. tax only on income that is 

‘‘effectively connected’’ with the conduct of a trade or business in 

the United States. Such ‘‘effectively connected income’’ generally is 

taxed in the same manner and at the same rates as the income of 

a U.S. corporation. An applicable tax treaty may limit the imposiVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00571 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
568 

tion of U.S. tax on business operations of a foreign corporation to 

cases in which the business is conducted through a ‘‘permanent establishment’’ in the United States. 

In addition, foreign corporations generally are subject to a 

gross-basis U.S. tax at a flat 30-percent rate on the receipt of interest, dividends, rents, royalties, and certain similar types of income 

derived from U.S. sources, subject to certain exceptions. The tax 

generally is collected by means of withholding by the person making the payment. This tax may be reduced or eliminated under an 

applicable tax treaty. 

U.S. tax treatment of inversion transactions 

Under present law, a U.S. corporation may reincorporate in a 

foreign jurisdiction and thereby replace the U.S. parent corporation 

of a multinational corporate group with a foreign parent corporation. These transactions are commonly referred to as inversion 

transactions. Inversion transactions may take many different 

forms, including stock inversions, asset inversions, and various 

combinations of and variations on the two. Most of the known 

transactions to date have been stock inversions. In one example of 

a stock inversion, a U.S. corporation forms a foreign corporation, 

which in turn forms a domestic merger subsidiary. The domestic 

merger subsidiary then merges into the U.S. corporation, with the 

U.S. corporation surviving, now as a subsidiary of the new foreign 

corporation. The U.S. corporation’s shareholders receive shares of 

the foreign corporation and are treated as having exchanged their 

U.S. corporation shares for the foreign corporation shares. An asset 

inversion reaches a similar result, but through a direct merger of 

the top-tier U.S. corporation into a new foreign corporation, among 

other possible forms. An inversion transaction may be accompanied 

or followed by further restructuring of the corporate group. For example, in the case of a stock inversion, in order to remove income 

from foreign operations from the U.S. taxing jurisdiction, the U.S. 

corporation may transfer some or all of its foreign subsidiaries directly to the new foreign parent corporation or other related foreign 

corporations. 

In addition to removing foreign operations from the U.S. taxing 

jurisdiction, the corporate group may derive further advantage 

from the inverted structure by reducing U.S. tax on U.S.-source income through various earnings stripping or other transactions. 

This may include earnings stripping through payment by a U.S. 

corporation of deductible amounts such as interest, royalties, rents, 

or management service fees to the new foreign parent or other foreign affiliates. In this respect, the post-inversion structure enables 

the group to employ the same tax-reduction strategies that are 

available to other multinational corporate groups with foreign parents and U.S. subsidiaries, subject to the same limitations (e.g., 

secs. 163(j) and 482). 

Inversion transactions may give rise to immediate U.S. tax 

consequences at the shareholder and/or the corporate level, depending on the type of inversion. In stock inversions, the U.S. shareholders generally recognize gain (but not loss) under section 367(a), 

based on the difference between the fair market value of the foreign corporation shares received and the adjusted basis of the doVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00572 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
569 

mestic corporation stock exchanged. To the extent that a corporation’s share value has declined, and/or it has many foreign or taxexempt shareholders, the impact of this section 367(a) ‘‘toll charge’’ 

is reduced. The transfer of foreign subsidiaries or other assets to 

the foreign parent corporation also may give rise to U.S. tax consequences at the corporate level (e.g., gain recognition and earnings 

and profits inclusions under secs. 1001, 311(b), 304, 367, 1248 or 

other provisions). The tax on any income recognized as a result of 

these restructurings may be reduced or eliminated through the use 

of net operating losses, foreign tax credits, and other tax attributes. 

In asset inversions, the U.S. corporation generally recognizes 

gain (but not loss) under section 367(a) as though it had sold all 

of its assets, but the shareholders generally do not recognize gain 

or loss, assuming the transaction meets the requirements of a reorganization under section 368. 

HOUSE BILL

The bill applies special tax rules to corporations that undertake certain defined inversion transactions. For this purpose, an inversion is a transaction in which, pursuant to a plan or a series 

of related transactions: (1) a U.S. corporation becomes a subsidiary 

of a foreign-incorporated entity or otherwise transfers substantially 

all of its properties to such an entity after March 4, 2003; (2) the 

former shareholders of the U.S. corporation hold (by reason of holding stock in the U.S. corporation) 60 percent or more (by vote or 

value) of the stock of the foreign-incorporated entity after the 

transaction; and (3) the foreign-incorporated entity, considered together with all companies connected to it by a chain of greater than 

50-percent ownership (i.e., the ‘‘expanded affiliated group’’) does not 

conduct substantial business activities in the entity’s country of incorporation compared to the total worldwide business activities of 

the expanded affiliated group. 

In such a case, any applicable corporate-level ‘‘toll charges’’ for 

establishing the inverted structure are not offset by tax attributes 

such as net operating losses or foreign tax credits. Specifically, any 

applicable corporate-level income or gain required to be recognized 

under sections 304, 311(b), 367, 1001, 1248, or any other provision 

with respect to the transfer of controlled foreign corporation stock 

or the transfer or license of other assets by a U.S. corporation as 

part of the inversion transaction or after such transaction to a related foreign person is taxable, without offset by any tax attributes 

(e.g., net operating losses or foreign tax credits). This rule does not 

apply to certain transfers of inventory and similar property. These 

measures generally apply for a 10-year period following the inversion transaction. 

In determining whether a transaction meets the definition of 

an inversion under the provision, stock held by members of the expanded affiliated group that includes the foreign incorporated entity is disregarded. For example, if the former top-tier U.S. corporation receives stock of the foreign incorporated entity (e.g., so-called 

‘‘hook’’ stock), the stock would not be considered in determining 

whether the transaction meets the definition. Similarly, if a U.S. 

parent corporation converts an existing wholly owned U.S. subsidiary into a new wholly owned controlled foreign corporation, the 

570 

429 It is expected that the Treasury Secretary will issue regulations applying the term ‘‘substantially all’’ in this context and will not be bound in this regard by interpretations of the term 

in other contexts under the Code. 

stock of the new foreign corporation would be disregarded. Stock 

sold in a public offering related to the transaction also is disregarded for these purposes. 

Transfers of properties or liabilities as part of a plan a principal purpose of which is to avoid the purposes of the provision are 

disregarded. In addition, the Treasury Secretary is granted authority to prevent the avoidance of the purposes of the provision, including avoidance through the use of related persons, pass-through 

or other noncorporate entities, or other intermediaries, and through 

transactions designed to qualify or disqualify a person as a related 

person or a member of an expanded affiliated group. Similarly, the 

Treasury Secretary is granted authority to treat certain non-stock 

instruments as stock, and certain stock as not stock, where necessary to carry out the purposes of the provision. 

Under the provision, inversion transactions include certain 

partnership transactions. Specifically, the provision applies to 

transactions in which a foreign-incorporated entity acquires substantially all of the properties constituting a trade or business of 

a domestic partnership, if after the acquisition at least 60 percent 

of the stock of the entity is held by former partners of the partnership (by reason of holding their partnership interests), provided 

that the other terms of the basic definition are met. For purposes 

of applying this test, all partnerships that are under common control within the meaning of section 482 are treated as one partnership, except as provided otherwise in regulations. In addition, the 

modified ‘‘toll charge’’ provisions apply at the partner level. 

A transaction otherwise meeting the definition of an inversion 

transaction is not treated as an inversion transaction if, on or before March 4, 2003, the foreign-incorporated entity had acquired directly or indirectly more than half of the properties held directly 

or indirectly by the domestic corporation, or more than half of the 

properties constituting the partnership trade or business, as the 

case may be. 

Effective date.—The provision applies to taxable years ending 

after March 4, 2003. 

SENATE AMENDMENT

In general 

The provision defines two different types of corporate inversion 

transactions and establishes a different set of consequences for 

each type. Certain partnership transactions also are covered. 

Transactions involving at least 80 percent identity of stock ownership 

The first type of inversion is a transaction in which, pursuant 

to a plan or a series of related transactions: (1) a U.S. corporation 

becomes a subsidiary of a foreign-incorporated entity or otherwise 

transfers substantially all of its properties to such an entity; 429 (2) 

the former shareholders of the U.S. corporation hold (by reason of 

holding stock in the U.S. corporation) 80 percent or more (by vote 

571 

430Since the top-tier foreign corporation is treated for all purposes of the Code as domestic, 

the shareholder-level ‘‘toll charge’’ of sec. 367(a) does not apply to these inversion transactions. 

However, with respect to inversion transactions completed before 2004, regulated investment 

companies and certain similar entities are allowed to elect to recognize gain as if sec. 367(a) 

did apply. 

or value) of the stock of the foreign-incorporated entity after the 

transaction; and (3) the foreign-incorporated entity, considered together with all companies connected to it by a chain of greater than 

50 percent ownership (i.e., the ‘‘expanded affiliated group’’), does 

not have substantial business activities in the entity’s country of 

incorporation, compared to the total worldwide business activities 

of the expanded affiliated group. The provision denies the intended 

tax benefits of this type of inversion by deeming the top-tier foreign 

corporation to be a domestic corporation for all purposes of the 

Code.430

Except as otherwise provided in regulations, the provision does 

not apply to a direct or indirect acquisition of the properties of a 

U.S. corporation no class of the stock of which was traded on an 

established securities market at any time within the four-year period preceding the acquisition. In determining whether a transaction would meet the definition of an inversion under the provision, stock held by members of the expanded affiliated group that 

includes the foreign incorporated entity is disregarded. For example, if the former top-tier U.S. corporation receives stock of the foreign incorporated entity (e.g., so-called ‘‘hook’’ stock), the stock 

would not be considered in determining whether the transaction 

meets the definition. Stock sold in a public offering (whether initial 

or secondary) or private placement related to the transaction also 

is disregarded for these purposes. Acquisitions with respect to a domestic corporation or partnership are deemed to be ‘‘pursuant to a 

plan’’ if they occur within the four-year period beginning on the 

date which is two years before the ownership threshold under the 

provision is met with respect to such corporation or partnership. 

Transfers of properties or liabilities as part of a plan a principal purpose of which is to avoid the purposes of the provision are 

disregarded. In addition, the Treasury Secretary is granted authority to prevent the avoidance of the purposes of the provision, including avoidance through the use of related persons, pass-through 

or other noncorporate entities, or other intermediaries, and through 

transactions designed to qualify or disqualify a person as a related 

person, a member of an expanded affiliated group, or a publicly 

traded corporation. Similarly, the Treasury Secretary is granted 

authority to treat certain non-stock instruments as stock, and certain stock as not stock, where necessary to carry out the purposes 

of the provision. 

Transactions involving greater than 50 percent but less than 80 percent identity of stock ownership 

The second type of inversion is a transaction that would meet 

the definition of an inversion transaction described above, except 

that the 80-percent ownership threshold is not met. In such a case, 

if a greater-than-50-percent ownership threshold is met, then a second set of rules applies to the inversion. Under these rules, the inversion transaction is respected (i.e., the foreign corporation is 

572 

treated as foreign), but: (1) any applicable corporate-level ‘‘toll 

charges’’ for establishing the inverted structure may not be offset 

by tax attributes such as net operating losses or foreign tax credits; 

(2) the accuracy-related penalty is increased; and (3) section 163(j), 

relating to ‘‘earnings stripping’’ through related-party debt, is 

strengthened. These measures generally apply for a 10-year period 

following the inversion transaction. In addition, inverting entities 

are required to provide information to shareholders or partners and 

the IRS with respect to the inversion transaction. 

With respect to ‘‘toll charges,’’ any applicable corporate-level 

income or gain required to be recognized under sections 304, 

311(b), 367, 1001, 1248, or any other provision with respect to the 

transfer of controlled foreign corporation stock or other assets by 

a U.S. corporation as part of the inversion transaction or after such 

transaction to a related foreign person is taxable, without offset by 

any tax attributes (e.g., net operating losses or foreign tax credits). 

To the extent provided in regulations, this rule will not apply to 

certain transfers of inventory and similar transactions conducted in 

the ordinary course of the taxpayer’s business. 

The 20-percent penalty for negligence or disregard of rules or 

regulations, substantial understatement of income tax, and substantial valuation misstatement is increased to 30 percent with respect to taxpayers related to the inverted entity. In addition, the 

40-percent penalty for gross valuation misstatement is increased to 

50 percent with respect to such taxpayers. 

The ‘‘earnings stripping’’ rules of section 163(j), which deny or 

defer deductions for certain interest paid to foreign related parties, 

are strengthened for inverted corporations. With respect to such 

corporations, the provision eliminates the debt-equity threshold 

generally applicable under section 163(j) and reduces the 50-percent thresholds for ‘‘excess interest expense’’ and ‘‘excess limitation’’ to 25 percent. 

In cases in which a U.S. corporate group acquires subsidiaries 

or other assets from an unrelated inverted corporate group, the 

provisions described above generally do not apply to the acquiring 

U.S. corporate group or its related parties (including the newly acquired subsidiaries or assets) by reason of acquiring the subsidiaries or assets that were connected with the inversion transaction. 

The Treasury Secretary is given authority to issue regulations appropriate to carry out the purposes of this provision and to prevent 

its abuse. 

Partnership transactions 

Under the provision, both types of inversion transactions include certain partnership transactions. Specifically, both parts of 

the provision apply to transactions in which a foreign-incorporated 

entity acquires substantially all of the properties constituting a 

trade or business of a domestic partnership (whether or not publicly traded), if after the acquisition at least 80 percent (or more 

than 50 percent but less than 80 percent, as the case may be) of 

the stock of the entity is held by former partners of the partnership 

(by reason of holding their partnership interests), and the ‘‘substantial business activities’’ test is not met. For purposes of determining whether these tests are met, all partnerships that are 

573 

431 Acquisitions with respect to a domestic corporation or partnership are deemed to be ‘‘pursuant to a plan’’ if they occur within the four-year period beginning on the date which is two 

years before the ownership threshold under the provision is met with respect to such corporation 

or partnership. 432Since the top-tier foreign corporation is treated for all purposes of the Code as domestic, 

the shareholder-level ‘‘toll charge’’ of sec. 367(a) does not apply to these inversion transactions. 

under common control within the meaning of section 482 are treated as one partnership, except as provided otherwise in regulations. 

In addition, the modified ‘‘toll charge’’ provisions apply at the partner level. 

Effective date 

The regime applicable to transactions involving at least 80 percent identity of ownership applies to inversion transactions completed after March 20, 2002. The rules for inversion transactions 

involving greater-than-50-percent identity of ownership apply to inversion transactions completed after 1996 that meet the 50-percent 

test and to inversion transactions completed after 1996 that would 

have met the 80-percent test but for the March 20, 2002 date. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment with modifications. 

In general 

The provision defines two different types of corporate inversion 

transactions and establishes a different set of consequences for 

each type. Certain partnership transactions also are covered. 

Transactions involving at least 80 percent identity of stock ownership 

The first type of inversion is a transaction in which, pursuant 

to a plan 431 or a series of related transactions: (1) a U.S. corporation becomes a subsidiary of a foreign-incorporated entity or otherwise transfers substantially all of its properties to such an entity 

in a transaction completed after March 4, 2003; (2) the former 

shareholders of the U.S. corporation hold (by reason of holding 

stock in the U.S. corporation) 80 percent or more (by vote or value) 

of the stock of the foreign-incorporated entity after the transaction; 

and (3) the foreign-incorporated entity, considered together with all 

companies connected to it by a chain of greater than 50 percent 

ownership (i.e., the ‘‘expanded affiliated group’’), does not have substantial business activities in the entity’s country of incorporation, 

compared to the total worldwide business activities of the expanded 

affiliated group. The provision denies the intended tax benefits of 

this type of inversion by deeming the top-tier foreign corporation 

to be a domestic corporation for all purposes of the Code.432

In determining whether a transaction meets the definition of 

an inversion under the proposal, stock held by members of the expanded affiliated group that includes the foreign incorporated entity is disregarded. For example, if the former top-tier U.S. corporation receives stock of the foreign incorporated entity (e.g., so-called 

‘‘hook’’ stock), the stock would not be considered in determining 

whether the transaction meets the definition. Similarly, if a U.S. 

574 

parent corporation converts an existing wholly owned U.S. subsidiary into a new wholly owned controlled foreign corporation, the 

stock of the new foreign corporation would be disregarded. Stock 

sold in a public offering related to the transaction also is disregarded for these purposes. 

Transfers of properties or liabilities as part of a plan a principal purpose of which is to avoid the purposes of the proposal are 

disregarded. In addition, the Treasury Secretary is granted authority to prevent the avoidance of the purposes of the proposal, including avoidance through the use of related persons, pass-through or 

other noncorporate entities, or other intermediaries, and through 

transactions designed to qualify or disqualify a person as a related 

person or a member of an expanded affiliated group. Similarly, the 

Treasury Secretary is granted authority to treat certain non-stock 

instruments as stock, and certain stock as not stock, where necessary to carry out the purposes of the proposal. 

Transactions involving at least 60 percent but less than 80 percent 

identity of stock ownership 

The second type of inversion is a transaction that would meet 

the definition of an inversion transaction described above, except 

that the 80-percent ownership threshold is not met. In such a case, 

if at least a 60-percent ownership threshold is met, then a second 

set of rules applies to the inversion. Under these rules, the inversion transaction is respected (i.e., the foreign corporation is treated 

as foreign), but any applicable corporate-level ‘‘toll charges’’ for establishing the inverted structure are not offset by tax attributes 

such as net operating losses or foreign tax credits. Specifically, any 

applicable corporate-level income or gain required to be recognized 

under sections 304, 311(b), 367, 1001, 1248, or any other provision 

with respect to the transfer of controlled foreign corporation stock 

or the transfer or license of other assets by a U.S. corporation as 

part of the inversion transaction or after such transaction to a related foreign person is taxable, without offset by any tax attributes 

(e.g., net operating losses or foreign tax credits). This rule does not 

apply to certain transfers of inventory and similar property. These 

measures generally apply for a 10-year period following the inversion transaction. 

Under the proposal, inversion transactions include certain 

partnership transactions. Specifically, the proposal applies to transactions in which a foreign-incorporated entity acquires substantially all of the properties constituting a trade or business of a domestic partnership, if after the acquisition at least 60 percent of 

the stock of the entity is held by former partners of the partnership 

(by reason of holding their partnership interests), provided that the 

other terms of the basic definition are met. For purposes of applying this test, all partnerships that are under common control within the meaning of section 482 are treated as one partnership, except as provided otherwise in regulations. In addition, the modified 

‘‘toll charge’’ proposals apply at the partner level. 

A transaction otherwise meeting the definition of an inversion 

transaction is not treated as an inversion transaction if, on or before March 4, 2003, the foreign-incorporated entity had acquired directly or indirectly more than half of the properties held directly 

575 

433 Nonstatutory stock options refer to stock options other than incentive stock options and 

employee stock purchase plans, the taxation of which is determined under sections 421–424. 434 If an individual receives a grant of a nonstatutory option that has a readily ascertainable 

fair market value at the time the option is granted, the excess of the fair market value of the 

option over the amount paid for the option is included in the recipient’s gross income as ordinary 

income in the first taxable year in which the option is either transferable or not subject to a 

substantial risk of forfeiture. 435 Under section 83, such amount is includable in gross income in the first taxable year in 

which the rights to the stock are transferable or are not subject to substantial risk of forfeiture. 

or indirectly by the domestic corporation, or more than half of the 

properties constituting the partnership trade or business, as the 

case may be. 

Effective date 

The provision applies to taxable years ending after March 4, 

2003. 

2. Excise tax on stock compensation of insiders in expatriated corporations (sec. 602 of the House bill, sec. 443 of the Senate 

amendment, and secs. 162(m), 275(a), and new sec. 4985 of the 

Code) 

PRESENT LAW

The income taxation of a nonstatutory 433 compensatory stock 

option is determined under the rules that apply to property transferred in connection with the performance of services (sec. 83). If 

a nonstatutory stock option does not have a readily ascertainable 

fair market value at the time of grant, which is generally the case 

unless the option is actively traded on an established market, no 

amount is included in the gross income of the recipient with respect to the option until the recipient exercises the option.434 Upon 

exercise of such an option, the excess of the fair market value of 

the stock purchased over the option price is generally included in 

the recipient’s gross income as ordinary income in such taxable 

year.435

The tax treatment of other forms of stock-based compensation 

(e.g., restricted stock and stock appreciation rights) is also determined under section 83. The excess of the fair market value over 

the amount paid (if any) for such property is generally includable 

in gross income in the first taxable year in which the rights to the 

property are transferable or are not subject to substantial risk of 

forfeiture. 

Shareholders are generally required to recognize gain upon 

stock inversion transactions. An inversion transaction is generally 

not a taxable event for holders of stock options and other stockbased compensation. 

HOUSE BILL

In general 

Under the House bill, specified holders of stock options and 

other stock-based compensation are subject to an excise tax upon 

certain inversion transactions. The provision imposes a 15-percent 

excise tax on the value of specified stock compensation held (directly or indirectly) by or for the benefit of a disqualified individual, or a member of such individual’s family, at any time during 

576 

436 An expanded affiliated group is an affiliated group (under section 1504) except that such 

group is determined without regard to the exceptions for certain corporations and is determined 

applying a greater than 50 percent threshold, in lieu of the 80-percent test. 437 An officer is defined as the president, principal financial officer, principal accounting officer 

(or, if there is no such accounting officer, the controller), any vice-president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions. 438 Under the provision, any transfer of property is treated as a payment and any right to 

a transfer of property is treated as a right to a payment. 

the 12-month period beginning six months before the corporation’s 

expatriation date. Specified stock compensation is treated as held 

for the benefit of a disqualified individual if such compensation is 

held by an entity, e.g., a partnership or trust, in which the individual, or a member of the individual’s family, has an ownership 

interest. 

Disqualified individuals 

A disqualified individual is any individual who, with respect to 

a corporation, is, at any time during the 12-month period beginning 

on the date which is six months before the expatriation date, subject to the requirements of section 16(a) of the Securities and Exchange Act of 1934 with respect to the corporation, or any member 

of the corporation’s expanded affiliated group,436 or would be subject to such requirements if the corporation (or member) were an 

issuer of equity securities referred to in section 16(a). Disqualified 

individuals generally include officers (as defined by section 

16(a)),437 directors, and 10-percent-or-greater owners of private and 

publicly-held corporations. 

Application of excise tax 

The excise tax is imposed on a disqualified individual of an expatriated corporation (as defined in the bill) only if gain (if any) is 

recognized in whole or part by any shareholder by reason of a corporate inversion transaction as previously defined in the bill. 

Specified stock compensation 

Specified stock compensation subject to the excise tax includes 

any payment 438 (or right to payment) granted by the expatriated 

corporation (or any member of the corporation’s expanded affiliated 

group) to any person in connection with the performance of services 

by a disqualified individual for such corporation (or member of the 

corporation’s expanded affiliated group) if the value of the payment 

or right is based on, or determined by reference to, the value or 

change in value of stock of such corporation (or any member of the 

corporation’s expanded affiliated group). In determining whether 

such compensation exists and valuing such compensation, all restrictions, other than a non-lapse restriction, are ignored. Thus, the 

excise tax applies, and the value subject to the tax is determined, 

without regard to whether the specified stock compensation is subject to a substantial risk of forfeiture or is exercisable at the time 

of the inversion transaction. 

Specified stock compensation includes compensatory stock and 

restricted stock grants, compensatory stock options, and other 

forms of stock-based compensation, including stock appreciation 

rights, phantom stock, and phantom stock options. Specified stock 

577 

compensation also includes nonqualified deferred compensation 

that is treated as though it were invested in stock or stock options 

of the expatriating corporation (or member). For example, the provision applies to a disqualified individual’s nonqualified deferred 

compensation if company stock is one of the actual or deemed investment options under the nonqualified deferred compensation 

plan. 

Specified stock compensation includes a compensation arrangement that gives the disqualified individual an economic stake substantially similar to that of a corporate shareholder. A payment directly tied to the value of the stock is specified stock compensation. 

The excise tax does not apply if a payment is simply triggered by 

a target value of the corporation’s stock or where a payment depends on a performance measure other than the value of the corporation’s stock. Similarly, the tax does not apply if the amount of 

the payment is not directly measured by the value of the stock or 

an increase in the value of the stock. For example, an arrangement 

under which a disqualified individual would be paid a cash bonus 

equal to $10,000 for every $1 increase in the share price of the corporation’s stock is subject to the provision because the direct connection between the compensation amount and the value of the corporation’s stock gives the disqualified individual an economic stake 

substantially similar to that of a shareholder. By contrast, an arrangement under which a disqualified individual would be paid a 

cash bonus of $500,000 if the corporation’s stock increased in value 

by 25 percent over two years or $1,000,000 if the stock increased 

by 33 percent over two years is not specified stock compensation, 

even though the amount of the bonus generally is keyed to an increase in the value of the stock. 

The excise tax applies to any specified stock compensation previously granted to a disqualified individual but cancelled or cashedout within the six-month period ending with the expatriation date, 

and to any specified stock compensation awarded in the six-month 

period beginning with the expatriation date. As a result, for example, if a corporation cancels outstanding options three months before the inversion transaction and then reissues comparable options 

three months after the transaction, the tax applies both to the cancelled options and the newly granted options. It is intended that 

the Secretary issue guidance to avoid double counting with respect 

to specified stock compensation that is cancelled and then regranted during the applicable 12-month period. 

Specified stock compensation subject to the tax does not include a statutory stock option or any payment or right from a 

qualified retirement plan or annuity, tax-sheltered annuity, simplified employee pension, or SIMPLE. In addition, under the provision, the excise tax does not apply to any stock option that is exercised during the six-month period before the expatriation date or 

to any stock acquired pursuant to such exercise, if income is recognized under section 83 on or before the expatriation date with respect to the stock acquired pursuant to such exercise. The excise 

tax also does not apply to any specified stock compensation that is 

exercised, sold, exchanged, distributed, cashed out, or otherwise 

paid during such period in a transaction in which income, gain, or 

loss is recognized in full. 

578 

Determination of amount subject to tax 

For specified stock compensation held on the expatriation date, 

the amount of the tax is determined based on the value of the compensation on such date. The tax imposed on specified stock compensation cancelled during the six-month period before the expatriation date is determined based on the value of the compensation 

on the day before such cancellation, while specified stock compensation granted after the expatriation date is valued on the date 

granted. Under the provision, the cancellation of a non-lapse restriction is treated as a grant. 

The value of the specified stock compensation on which the excise tax is imposed is the fair value in the case of stock options (including warrants or other similar rights to acquire stock) and stock 

appreciation rights and the fair market value for all other forms of 

compensation. For purposes of the tax, the fair value of an option 

(or a warrant or other similar right to acquire stock) or a stock appreciation right is determined using an appropriate option-pricing 

model, as specified or permitted by the Secretary, that takes into 

account (1) the stock price at the valuation date; (2) the exercise 

price under the option; (3) the remaining term of the option; (4) the 

volatility of the underlying stock and the expected dividends on it; 

and (5) the risk-free interest rate over the remaining term of the 

option. Options that have no intrinsic value (or ‘‘spread’’) because 

the exercise price under the option equals or exceeds the fair market value of the stock at valuation nevertheless have a fair value 

and are subject to tax under the provision. The value of other 

forms of compensation, such as phantom stock or restricted stock, 

is the fair market value of the stock as of the date of the expatriation transaction. The value of any deferred compensation that can 

be valued by reference to stock is the amount that the disqualified 

individual would receive if the plan were to distribute all such deferred compensation in a single sum on the date of the expatriation 

transaction (or the date of cancellation or grant, if applicable). It 

is expected that the Secretary issue guidance on valuation of specified stock compensation, including guidance similar to the guidance 

issued under section 280G, except that the guidance would not permit the use of a term other than the full remaining term and would 

be modified as necessary or appropriate to carry out the purposes 

of the provision. Pending the issuance of guidance, it is intended 

that taxpayers can rely on the guidance issued under section 280G 

(except that the full remaining term must be used and recalculation is not permitted). 

Other rules 

The excise tax also applies to any payment by the expatriated 

corporation or any member of the expanded affiliated group made 

to an individual, directly or indirectly, in respect of the tax. Whether a payment is made in respect of the tax is determined under all 

of the facts and circumstances. Any payment made to keep the individual in the same after-tax position that the individual would 

have been in had the tax not applied is a payment made in respect 

of the tax. This includes direct payments of the tax and payments 

to reimburse the individual for payment of the tax. It is expected 

that the Secretary issue guidance on determining when a payment 

579 

is made in respect of the tax and that such guidance include certain factors that give rise to a rebuttable presumption that a payment is made in respect of the tax, including a rebuttable presumption that if the payment is contingent on the inversion transaction, 

it is made in respect to the tax. Any payment made in respect of 

the tax is includible in the income of the individual, but is not deductible by the corporation. 

To the extent that a disqualified individual is also a covered 

employee under section 162(m), the $1,000,000 limit on the deduction allowed for employee remuneration for such employee is reduced by the amount of any payment (including reimbursements) 

made in respect of the tax under the provision. As discussed above, 

this includes direct payments of the tax and payments to reimburse 

the individual for payment of the tax. 

The payment of the excise tax has no effect on the subsequent 

tax treatment of any specified stock compensation. Thus, the payment of the tax has no effect on the individual’s basis in any specified stock compensation and no effect on the tax treatment for the 

individual at the time of exercise of an option or payment of any 

specified stock compensation, or at the time of any lapse or forfeiture of such specified stock compensation. The payment of the 

tax is not deductible and has no effect on any deduction that might 

be allowed at the time of any future exercise or payment. 

Under the provision, the Secretary is authorized to issue regulations as may be necessary or appropriate to carry out the purposes of the provision. 

Effective date 

The provision is effective as of March 4, 2003, except that periods before March 4, 2003, are not taken into account in applying 

the excise tax to specified stock compensation held or cancelled 

during the six-month period before the expatriation date. 

SENATE AMENDMENT

The Senate amendment follows the House bill except that excise tax is equal to 20 percent of the value of the specified stock 

compensation. Under the Senate amendment, the excise tax does 

not apply to executives of the expanded affiliated group. 

Effective date.—The Senate amendment is effective as of July 

11, 2002, except that periods before July 11, 2002, are not taken 

into account in applying the excise tax to specified stock compensation held or cancelled during the six-month period before the expatriation date. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill except that 

the excise tax is imposed at a rate equal to the maximum rate of 

tax on the adjusted net capital gain of an individual (i.e., the rate 

of the excise tax would be 15 percent for 2005 through 2008 and 

20 percent for taxable years beginning after December 31, 2008). 

580 

439Sec. 845(a). 440See S. Rep. No. 97–494, 97th Cong., 2d Sess., 337 (1982) (describing provisions relating 

to the repeal of modified coinsurance provisions). 441The authority to allocate, recharacterize or make other adjustments was granted in connection with the repeal of provisions relating to modified coinsurance transactions. 

3. Reinsurance of U.S. risks in foreign jurisdictions (sec. 603 of the 

House bill, sec. 444 of the Senate amendment, and sec. 845(a) 

of the Code) 

PRESENT LAW

In the case of a reinsurance agreement between two or more 

related persons, present law provides the Treasury Secretary with 

authority to allocate among the parties or recharacterize income 

(whether investment income, premium or otherwise), deductions, 

assets, reserves, credits and any other items related to the reinsurance agreement, or make any other adjustment, in order to reflect 

the proper source and character of the items for each party.439 For 

this purpose, related persons are defined as in section 482. Thus, 

persons are related if they are organizations, trades or businesses 

(whether or not incorporated, whether or not organized in the 

United States, and whether or not affiliated) that are owned or 

controlled directly or indirectly by the same interests. The provision may apply to a contract even if one of the related parties is 

not a domestic company.440 In addition, the provision also permits 

such allocation, recharacterization, or other adjustments in a case 

in which one of the parties to a reinsurance agreement is, with respect to any contract covered by the agreement, in effect an agent 

of another party to the agreement, or a conduit between related 

persons. 

HOUSE BILL

The bill clarifies the rules of section 845, relating to authority 

for the Treasury Secretary to allocate items among the parties to 

a reinsurance agreement, recharacterize items, or make any other 

adjustment, in order to reflect the proper source and character of 

the items for each party. The bill authorizes such allocation, recharacterization, or other adjustment, in order to reflect the proper 

source, character or amount of the item. It is intended that this authority 441 be exercised in a manner similar to the authority under 

section 482 for the Treasury Secretary to make adjustments between related parties. It is intended that this authority be applied 

in situations in which the related persons (or agents or conduits) 

are engaged in cross-border transactions that require allocation, recharacterization, or other adjustments in order to reflect the proper 

source, character or amount of the item or items. No inference is 

intended that present law does not provide this authority with respect to reinsurance agreements. 

No regulations have been issued under section 845(a). It is expected that the Treasury Secretary will issue regulations under 

section 845(a) to address effectively the allocation of income 

(whether investment income, premium or otherwise) and other 

items, the recharacterization of such items, or any other adjustment necessary to reflect the proper amount, source or character 

of the item. 

581 

442 Under present law, an individual’s U.S. residency is considered terminated for U.S. Federal 

tax purposes when the individual ceases to be a lawful permanent resident under the immigration law (or is treated as a resident of another country under a tax treaty and does not waive 

the benefits of such treaty). 443For this purpose, however, U.S.-source income has a broader scope than it does typically 

in the Code. 

Effective date.—The provision is effective for any risk reinsured 

after the date of enactment of the provision. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

Effective date.—The provision is effective for any risk reinsured 

after April 11, 2002. 

CONFERENCE AGREEMENT

The Conference agreement follows the House bill. 

4. Revision of tax rules on expatriation of individuals (sec. 604 of 

the House bill, sec. 442 of the Senate amendment, and secs. 

877, 2107, 2501 and 6039G of the Code) 

PRESENT LAW

In general 

U.S. citizens and residents generally are subject to U.S. income 

taxation on their worldwide income. The U.S. tax may be reduced 

or offset by a credit allowed for foreign income taxes paid with respect to foreign source income. Nonresident aliens are taxed at a 

flat rate of 30 percent (or a lower treaty rate) on certain types of 

passive income derived from U.S. sources, and at regular graduated 

rates on net profits derived from a U.S. trade or business. The estates of nonresident aliens generally are subject to estate tax on 

U.S.-situated property (e.g., real estate and tangible property located within the United States and stock in a U.S. corporation). 

Nonresident aliens generally are subject to gift tax on transfers by 

gift of U.S.-situated property (e.g., real estate and tangible property 

located within the United States, but excluding intangibles, such as 

stock, regardless of where they are located). 

Income tax rules with respect to expatriates 

For the 10 taxable years after an individual relinquishes his or 

her U.S. citizenship or terminates his or her U.S. residency 442 with 

a principal purpose of avoiding U.S. taxes, the individuals is subject to an alternative method of income taxation than that generally applicable to nonresident aliens (the ‘‘alternative tax regime’’). Generally, the individual is subject to income tax only on 

U.S.-source income 443 at the rates applicable to U.S. citizens for 

the 10-year period. 

An individual who relinquishes citizenship or terminates residency is treated as having done so with a principal purpose of tax 

avoidance and is generally subject to the alternative tax regime if: 

(1) the individual’s average annual U.S. Federal income tax liability for the five taxable years preceding citizenship relinquishment 

or residency termination exceeds $100,000; or (2) the individual’s 

net worth on the date of citizenship relinquishment or residency 

582 

444The income tax liability and net worth thresholds under section 877(a)(2) for 2004 are 

$124,000 and $622,000, respectively. See Rev. Proc. 2003–85, 2003–49 I.R.B. 1184. 

termination equals or exceeds $500,000. These amounts are adjusted annually for inflation.444 Certain categories of individuals 

(e.g., dual residents) may avoid being deemed to have a tax avoidance purpose for relinquishing citizenship or terminating residency 

by submitting a ruling request to the IRS regarding whether the 

individual relinquished citizenship or terminated residency principally for tax reasons. 

Anti-abuse rules are provided to prevent the circumvention of 

the alternative tax regime. 

Estate tax rules with respect to expatriates 

Special estate tax rules apply to individual’s who relinquish 

their citizenship or long-term residency within the 10 years prior 

to the date of death, unless he or she did not have a tax avoidance 

purpose (as determined under the test above). Under these special 

rules, certain closely-held foreign stock owned by the former citizen 

or former long-term resident is includible in his or her gross estate 

to the extent that the foreign corporation owns U.S.-situated assets. 

Gift tax rules with respect to expatriates 

Special gift tax rules apply to individual’s who relinquish their 

citizenship or long-term residency within the 10 years prior to the 

date of death, unless he or she did not have a tax avoidance purpose (as determined under the rules above). The individual is subject to gift tax on gifts of U.S.-situated intangibles made during the 

10 years following citizenship relinquishment or residency termination. 

Information reporting 

Under present law, U.S. citizens who relinquish citizenship 

and long-term residents who terminate residency generally are required to provide information about their assets held at the time 

of expatriation. However, this information is only required once. 

HOUSE BILL

In general 

The bill provides: (1) objective standards for determining 

whether former citizens or former long-term residents are subject 

to the alternative tax regime; (2) tax-based (instead of immigrationbased) rules for determining when an individual is no longer a U.S. 

citizen or long-term resident for U.S. Federal tax purposes; (3) the 

imposition of full U.S. taxation for individuals who are subject to 

the alternative tax regime and who return to the United States for 

extended periods; (4) imposition of U.S. gift tax on gifts of stock of 

certain closely-held foreign corporations that hold U.S.-situated 

property; and (5) an annual return-filing requirement for individuals who are subject to the alternative tax regime, for each of the 

583 

445These provisions reflect recommendations contained in Joint Committee on Taxation, Review of the Present Law Tax and Immigration Treatment of Relinquishment of Citizenship and 

Termination of Long-Term Residency, (JCS–2–03), February 2003. 

10 years following citizenship relinquishment or residency termination.445

Objective rules for the alternative tax regime 

The bill replaces the subjective determination of tax avoidance 

as a principal purpose for citizenship relinquishment or residency 

termination under present law with objective rules. Under the bill, 

a former citizen or former long-term resident would be subject to 

the alternative tax regime for a 10-year period following citizenship 

relinquishment or residency termination, unless the former citizen 

or former long-term resident: (1) establishes that his or her average 

annual net income tax liability for the five preceding years does not 

exceed $124,000 (adjusted for inflation after 2004) and his or her 

net worth does not exceed $2 million, or alternatively satisfies limited, objective exceptions for dual citizens and minors who have 

had no substantial contact with the United States; and (2) certifies 

under penalties of perjury that he or she has complied with all U.S. 

Federal tax obligations for the preceding five years and provides 

such evidence of compliance as the Secretary of the Treasury may 

require. 

The monetary thresholds under the bill replace the present-law 

inquiry into the taxpayer’s intent. In addition, the bill eliminates 

the present-law process of IRS ruling requests. 

If a former citizen exceeds the monetary thresholds, that person is excluded from the alternative tax regime if he or she falls 

within the exceptions for certain dual citizens and minors (provided 

that the requirement of certification and proof of compliance with 

Federal tax obligations is met). These exceptions provide relief to 

individuals who have never had substantial connections with the 

United States, as measured by certain objective criteria, and eliminate IRS inquiries as to the subjective intent of such taxpayers. 

In order to be excepted from the application of the alternative 

tax regime under the bill, whether by reason of falling below the 

net worth and income tax liability thresholds or qualifying for the 

dual-citizen or minor exceptions, the former citizen or former longterm resident also is required to certify, under penalties of perjury, 

that he or she has complied with all U.S. Federal tax obligations 

for the five years preceding the relinquishment of citizenship or 

termination of residency and to provide such documentation as the 

Secretary of the Treasury may require evidencing such compliance 

(e.g., tax returns, proof of tax payments). Until such time, the individual remains subject to the alternative tax regime. It is intended 

that the IRS will continue to verify that the information submitted 

was accurate, and it is intended that the IRS will randomly audit 

such persons to assess compliance. 

Termination of U.S. citizenship or long-term resident status for U.S. 

Federal income tax purposes 

Under the bill, an individual continues to be treated as a U.S. 

citizen or long-term resident for U.S. Federal tax purposes, including for purposes of section 7701(b)(10), until the individual: (1) 

584 

446Secs. 7701(b)(3)(D), 7701(b)(5) and 7701(b)(7)(B)–(D). 447 An individual has such a relationship to a foreign country if the individual becomes a citizen or resident of the country in which (1) the individual becomes fully liable for income tax 

or (2) the individual was born, such individual’s spouse was born, or either of the individual’s 

parents was born. 448 An individual has a minimal prior physical presence in the United States if the individual 

was physically present for no more than 30 days during each year in the ten-year period ending 

on the date of loss of United States citizenship or termination of residency. However, an individual is not treated as being present in the United States on a day if (1) the individual is a 

teacher or trainee, a student, a professional athlete in certain circumstances, or a foreign government-related individual or (2) the individual remained in the United States because of a 

medical condition that arose while the individual was in the United States. Sec. 7701(b)(3)(D)(ii). 

gives notice of an expatriating act or termination of residency (with 

the requisite intent to relinquish citizenship or terminate residency) to the Secretary of State or the Secretary of Homeland Security, respectively; and (2) provides a statement in accordance with 

section 6039G. 

Sanction for individuals subject to the individual tax regime who 

return to the United States for extended periods 

The alternative tax regime does not apply to any individual for 

any taxable year during the 10-year period following citizenship relinquishment or residency termination if such individual is present 

in the United States for more than 30 days in the calendar year 

ending in such taxable year. Such individual is treated as a U.S. 

citizen or resident for such taxable year and therefore is taxed on 

his or her worldwide income. 

Similarly, if an individual subject to the alternative tax regime 

is present in the United States for more than 30 days in any calendar year ending during the 10-year period following citizenship 

relinquishment or residency termination, and the individual dies 

during that year, he or she is treated as a U.S. resident, and the 

individual’s worldwide estate is subject to U.S. estate tax. Likewise, if an individual subject to the alternative tax regime is 

present in the United States for more than 30 days in any year 

during the 10-year period following citizenship relinquishment or 

residency termination, the individual is subject to U.S. gift tax on 

any transfer of his or her worldwide assets by gift during that taxable year. 

For purposes of these rules, an individual is treated as present 

in the United States on any day if such individual is physically 

present in the United States at any time during that day. The 

present-law exceptions from being treated as present in the United 

States for residency purposes 446 generally do not apply for this 

purpose. However, for individuals with certain ties to countries 

other than the United States 447 and individuals with minimal 

prior physical presence in the United States,448 a day of physical 

presence in the United States is disregarded if the individual is 

performing services in the United States on such day for an unrelated employer (within the meaning of sections 267 and 707(b)), 

who meets the requirements the Secretary of the Treasury may 

prescribe in regulations. No more than 30 days may be disregarded 

during any calendar year under this rule. 

585 

Imposition of gift tax with respect to stock of certain closely held foreign corporations 

Gifts of stock of certain closely-held foreign corporations by a 

former citizen or former long-term resident who is subject to the alternative tax regime are subject to gift tax under this bill, if the 

gift is made within the 10-year period after citizenship relinquishment or residency termination. The gift tax rule applies if: (1) the 

former citizen or former long-term resident, before making the gift, 

directly or indirectly owns 10 percent or more of the total combined 

voting power of all classes of stock entitled to vote of the foreign 

corporation; and (2) directly or indirectly, is considered to own 

more than 50 percent of (a) the total combined voting power of all 

classes of stock entitled to vote in the foreign corporation, or (b) the 

total value of the stock of such corporation. If this stock ownership 

test is met, then taxable gifts of the former citizen or former longterm resident include that proportion of the fair market value of 

the foreign stock transferred by the individual, at the time of the 

gift, which the fair market value of any assets owned by such foreign corporation and situated in the United States (at the time of 

the gift) bears to the total fair market value of all assets owned by 

such foreign corporation (at the time of the gift). 

This gift tax rule applies to a former citizen or former longterm resident who is subject to the alternative tax regime and who 

owns stock in a foreign corporation at the time of the gift, regardless of how such stock was acquired (e.g., whether issued originally 

to the donor, purchased, or received as a gift or bequest). 

Annual return 

The bill requires former citizens and former long-term residents to file an annual return for each year following citizenship 

relinquishment or residency termination in which they are subject 

to the alternative tax regime. The annual return is required even 

if no U.S. Federal income tax is due. The annual return requires 

certain information, including information on the permanent home 

of the individual, the individual’s country of residence, the number 

of days the individual was present in the United States for the 

year, and detailed information about the individual’s income and 

assets that are subject to the alternative tax regime. This requirement includes information relating to foreign stock potentially subject to the special estate tax rule of section 2107(b) and the gift tax 

rules of this bill. 

If the individual fails to file the statement in a timely manner 

or fails correctly to include all the required information, the individual is required to pay a penalty of $5,000. The $5,000 penalty 

does not apply if it is shown that the failure is due to reasonable 

cause and not to willful neglect. 

Effective date 

The provision applies to individuals who relinquish citizenship 

or terminate long-term residency after June 3, 2004. 

586 

SENATE AMENDMENT

In general 

The provision generally subjects certain U.S. citizens who relinquish their U.S. citizenship and certain long-term U.S. residents 

who terminate their U.S. residence to tax on the net unrealized 

gain in their property as if such property were sold for fair market 

value on the day before the expatriation or residency termination. 

Gain from the deemed sale is taken into account at that time without regard to other Code provisions; any loss from the deemed sale 

generally would be taken into account to the extent otherwise provided in the Code. Any net gain on the deemed sale is recognized 

to the extent it exceeds $600,000 ($1.2 million in the case of married individuals filing a joint return, both of whom relinquish citizenship or terminate residency). The $600,000 amount is increased 

by a cost of living adjustment factor for calendar years after 2002. 

Individuals covered 

Under the provision, the mark-to-market tax applies to U.S. 

citizens who relinquish citizenship and long-term residents who 

terminate U.S. residency. An individual is a long-term resident if 

he or she was a lawful permanent resident for at least eight out 

of the 15 taxable years ending with the year in which the termination of residency occurs. An individual is considered to terminate 

long-term residency when either the individual ceases to be a lawful permanent resident (i.e., loses his or her green card status), or 

the individual is treated as a resident of another country under a 

tax treaty and the individual does not waive the benefits of the 

treaty. 

Exceptions from the mark-to-market tax are provided in two 

situations. The first exception applies to an individual who was 

born with citizenship both in the United States and in another 

country; provided that (1) as of the expatriation date the individual 

continues to be a citizen of, and is taxed as a resident of, such 

other country, and (2) the individual was not a resident of the 

United States for the five taxable years ending with the year of expatriation. The second exception applies to a U.S. citizen who relinquishes U.S. citizenship before reaching age 18 and a half, provided 

that the individual was a resident of the United States for no more 

than five taxable years before such relinquishment. 

Election to be treated as a U.S. citizen 

Under the provision, an individual is permitted to make an irrevocable election to continue to be taxed as a U.S. citizen with respect to all property that otherwise is covered by the expatriation 

tax. This election is an ‘‘all or nothing’’ election; an individual is 

not permitted to elect this treatment for some property but not for 

other property. The election, if made, would apply to all property 

that would be subject to the expatriation tax and to any property 

the basis of which is determined by reference to such property. 

Under this election, the individual would continue to pay U.S. income taxes at the rates applicable to U.S. citizens following expatriation on any income generated by the property and on any gain 

realized on the disposition of the property. In addition, the property 

587 

would continue to be subject to U.S. gift, estate, and generationskipping transfer taxes. In order to make this election, the taxpayer would be required to waive any treaty rights that would preclude the collection of the tax. 

The individual also would be required to provide security to ensure payment of the tax under this election in such form, manner, 

and amount as the Secretary of the Treasury requires. The amount 

of mark-to-market tax that would have been owed but for this election (including any interest, penalties, and certain other items) 

shall be a lien in favor of the United States on all U.S.-situs property owned by the individual. This lien shall arise on the expatriation date and shall continue until the tax liability is satisfied, the 

tax liability has become unenforceable by reason of lapse of time, 

or the Secretary is satisfied that no further tax liability may arise 

by reason of this provision. The rules of section 6324A(d)(1), (3), 

and (4) (relating to liens arising in connection with the deferral of 

estate tax under section 6166) apply to liens arising under this provision. 

Date of relinquishment of citizenship 

Under the provision, an individual is treated as having relinquished U.S. citizenship on the earliest of four possible dates: (1) 

the date that the individual renounces U.S. nationality before a 

diplomatic or consular officer of the United States (provided that 

the voluntary relinquishment is later confirmed by the issuance of 

a certificate of loss of nationality); (2) the date that the individual 

furnishes to the State Department a signed statement of voluntary 

relinquishment of U.S. nationality confirming the performance of 

an expatriating act (again, provided that the voluntary relinquishment is later confirmed by the issuance of a certificate of loss of 

nationality); (3) the date that the State Department issues a certificate of loss of nationality; or (4) the date that a U.S. court cancels 

a naturalized citizen’s certificate of naturalization. 

Deemed sale of property upon expatriation or residency termination 

The deemed sale rule of the provision generally applies to all 

property interests held by the individual on the date of relinquishment of citizenship or termination of residency. Special rules apply 

in the case of trust interests, as described below. U.S. real property 

interests, which remain subject to U.S. tax in the hands of nonresident noncitizens, generally are excepted from the provision. 

Regulatory authority is granted to the Treasury to except other 

types of property from the provision. 

Under the provision, an individual who is subject to the markto-market tax is required to pay a tentative tax equal to the 

amount of tax that would be due for a hypothetical short tax year 

ending on the date the individual relinquished citizenship or terminated residency. Thus, the tentative tax is based on all income, 

gain, deductions, loss, and credits of the individual for the year 

through such date, including amounts realized from the deemed 

sale of property. The tentative tax is due on the 90th day after the 

date of relinquishment of citizenship or termination of residency. 

588 

449 Application of the provision is not limited to an interest that meets the definition of property under section 83 (relating to property transferred in connection with the performance of 

services). 

Retirement plans and similar arrangements 

Subject to certain exceptions, the provision applies to all property interests held by the individual at the time of relinquishment 

of citizenship or termination of residency. Accordingly, such property includes an interest in an employer-sponsored retirement plan 

or deferred compensation arrangement as well as an interest in an 

individual retirement account or annuity (i.e., an IRA).449 However, 

the provision contains a special rule for an interest in a ‘‘qualified 

retirement plan.’’ For purposes of the provision, a ‘‘qualified retirement plan’’ includes an employer-sponsored qualified plan (sec. 

401(a)), a qualified annuity (sec. 403(a)), a tax-sheltered annuity 

(sec. 403(b)), an eligible deferred compensation plan of a governmental employer (sec. 457(b)), or an IRA (sec. 408). The special retirement plan rule applies also, to the extent provided in regulations, to any foreign plan or similar retirement arrangement or program. An interest in a trust that is part of a qualified retirement 

plan or other arrangement that is subject to the special retirement 

plan rule is not subject to the rules for interests in trusts (discussed below). 

Under the special rule, an amount equal to the present value 

of the individual’s vested, accrued benefit under a qualified retirement plan is treated as having been received by the individual as 

a distribution under the plan on the day before the individual’s relinquishment of citizenship or termination of residency. It is not intended that the plan would be deemed to have made a distribution 

for purposes of the tax-favored status of the plan, such as whether 

a plan may permit distributions before a participant has severed 

employment. In the case of any later distribution to the individual 

from the plan, the amount otherwise includible in the individual’s 

income as a result of the distribution is reduced to reflect the 

amount previously included in income under the special retirement 

plan rule. The amount of the reduction applied to a distribution is 

the excess of: (1) the amount included in income under the special 

retirement plan rule over (2) the total reductions applied to any 

prior distributions. However, under the provision, the retirement 

plan, and any person acting on the plan’s behalf, will treat any 

later distribution in the same manner as the distribution would be 

treated without regard to the special retirement plan rule. 

It is expected that the Treasury Department will provide guidance for determining the present value of an individual’s vested, 

accrued benefit under a qualified retirement plan, such as the individual’s account balance in the case of a defined contribution plan 

or an IRA, or present value determined under the qualified joint 

and survivor annuity rules applicable to a defined benefit plan (sec. 

417(e)). 

Deferral of payment of tax 

Under the provision, an individual is permitted to elect to defer 

payment of the mark-to-market tax imposed on the deemed sale of 

the property. Interest is charged for the period the tax is deferred 

589 

at a rate two percentage points higher than the rate normally applicable to individual underpayments. Under this election, the 

mark-to-market tax attributable to a particular property is due 

when the property is disposed of (or, if the property is disposed of 

in whole or in part in a nonrecognition transaction, at such other 

time as the Secretary may prescribe). The mark-to-market tax attributable to a particular property is an amount that bears the 

same ratio to the total mark-to-market tax for the year as the gain 

taken into account with respect to such property bears to the total 

gain taken into account under these rules for the year. The deferral 

of the mark-to-market tax may not be extended beyond the individual’s death. 

In order to elect deferral of the mark-to-market tax, the individual is required to provide adequate security to the Treasury to 

ensure that the deferred tax and interest will be paid. Other security mechanisms are permitted provided that the individual establishes to the satisfaction of the Secretary that the security is adequate. In the event that the security provided with respect to a 

particular property subsequently becomes inadequate and the individual fails to correct the situation, the deferred tax and the interest with respect to such property will become due. As a further condition to making the election, the individual is required to consent 

to the waiver of any treaty rights that would preclude the collection 

of the tax. 

The deferred amount (including any interest, penalties, and 

certain other items) shall be a lien in favor of the United States 

on all U.S.-situs property owned by the individual. This lien shall 

arise on the expatriation date and shall continue until the tax liability is satisfied, the tax liability has become unenforceable by 

reason of lapse of time, or the Secretary is satisfied that no further 

tax liability may arise by reason of this provision. The rules of section 6324A(d)(1), (3), and (4) (relating to liens arising in connection 

with the deferral of estate tax under section 6166) apply to liens 

arising under this provision. 

Interests in trusts 

Under the provision, detailed rules apply to trust interests 

held by an individual at the time of relinquishment of citizenship 

or termination of residency. The treatment of trust interests depends on whether the trust is a qualified trust. A trust is a qualified trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or 

more U.S. persons have the authority to control all substantial decisions of the trust. 

Constructive ownership rules apply to a trust beneficiary that 

is a corporation, partnership, trust, or estate. In such cases, the 

shareholders, partners, or beneficiaries of the entity are deemed to 

be the direct beneficiaries of the trust for purposes of applying 

these provision. In addition, an individual who holds (or who is 

treated as holding) a trust instrument at the time of relinquishment of citizenship or termination of residency is required to disclose on his or her tax return the methodology used to determine 

his or her interest in the trust, and whether such individual knows 

590 

(or has reason to know) that any other beneficiary of the trust uses 

a different method. 

Nonqualified trusts.—If an individual holds an interest in a 

trust that is not a qualified trust, a special rule applies for purposes of determining the amount of the mark-to-market tax due 

with respect to such trust interest. The individual’s interest in the 

trust is treated as a separate trust consisting of the trust assets 

allocable to such interest. Such separate trust is treated as having 

sold its net assets as of the date of relinquishment of citizenship 

or termination of residency and having distributed the assets to the 

individual, who then is treated as having recontributed the assets 

to the trust. The individual is subject to the mark-to-market tax 

with respect to any net income or gain arising from the deemed 

distribution from the trust. 

The election to defer payment is available for the mark-to-market tax attributable to a nonqualified trust interest. Interest is 

charged for the period the tax is deferred at a rate two percentage 

points higher than the rate normally applicable to individual underpayments. A beneficiary’s interest in a nonqualified trust is determined under all the facts and circumstances, including the trust 

instrument, letters of wishes, and historical patterns of trust distributions. 

Qualified trusts.—If an individual has an interest in a qualified trust, the amount of unrealized gain allocable to the individual’s trust interest is calculated at the time of expatriation or residency termination. In determining this amount, all contingencies 

and discretionary interests are assumed to be resolved in the individual’s favor (i.e., the individual is allocated the maximum amount 

that he or she could receive). The mark-to-market tax imposed on 

such gains is collected when the individual receives distributions 

from the trust, or if earlier, upon the individual’s death. Interest 

is charged for the period the tax is deferred at a rate two percentage points higher than the rate normally applicable to individual 

underpayments. 

If an individual has an interest in a qualified trust, the individual is subject to the mark-to-market tax upon the receipt of distributions from the trust. These distributions also may be subject 

to other U.S. income taxes. If a distribution from a qualified trust 

is made after the individual relinquishes citizenship or terminates 

residency, the mark-to-market tax is imposed in an amount equal 

to the amount of the distribution multiplied by the highest tax rate 

generally applicable to trusts and estates, but in no event will the 

tax imposed exceed the deferred tax amount with respect to the 

trust interest. For this purpose, the deferred tax amount is equal 

to (1) the tax calculated with respect to the unrealized gain allocable to the trust interest at the time of expatriation or residency 

termination, (2) increased by interest thereon, and (3) reduced by 

any mark-to-market tax imposed on prior trust distributions to the 

individual. 

If any individual’s interest in a trust is vested as of the expatriation date (e.g., if the individual’s interest in the trust is noncontingent and non-discretionary), the gain allocable to the individual’s trust interest is determined based on the trust assets allocable to his or her trust interest. If the individual’s interest in the 

591 

trust is not vested as of the expatriation date (e.g., if the individual’s trust interest is a contingent or discretionary interest), the 

gain allocable to his or her trust interest is determined based on 

all of the trust assets that could be allocable to his or her trust interest, determined by resolving all contingencies and discretionary 

powers in the individual’s favor. In the case where more than one 

trust beneficiary is subject to the expatriation tax with respect to 

trust interests that are not vested, the rules are intended to apply 

so that the same unrealized gain with respect to assets in the trust 

is not taxed to both individuals. 

Mark-to-market taxes become due if the trust ceases to be a 

qualified trust, the individual disposes of his or her qualified trust 

interest, or the individual dies. In such cases, the amount of markto-market tax equals the lesser of (1) the tax calculated under the 

rules for nonqualified trust interests as of the date of the triggering 

event, or (2) the deferred tax amount with respect to the trust interest as of that date. 

The tax that is imposed on distributions from a qualified trust 

generally is deducted and withheld by the trustees. If the individual does not agree to waive treaty rights that would preclude 

collection of the tax, the tax with respect to such distributions is 

imposed on the trust, the trustee is personally liable for the tax, 

and any other beneficiary has a right of contribution against such 

individual with respect to the tax. Similar rules apply when the 

qualified trust interest is disposed of, the trust ceases to be a qualified trust, or the individual dies. 

Coordination with present-law alternative tax regime 

The provision provides a coordination rule with the presentlaw alternative tax regime. Under the provision, the expatriation 

income tax rules under section 877, and the expatriation estate and 

gift tax rules under sections 2107 and 2501(a)(3) (described above), 

do not apply to a former citizen or former long-term resident whose 

expatriation or residency termination occurs on or after February 

5, 2003. 

Treatment of gifts and inheritances from a former citizen or former 

long-term resident 

Under the provision, the exclusion from income provided in 

section 102 (relating to exclusions from income for the value of 

property acquired by gift or inheritance) does not apply to the 

value of any property received by gift or inheritance from a former 

citizen or former long-term resident (i.e., an individual who relinquished U.S. citizenship or terminated U.S. residency), subject to 

the exceptions described above relating to certain dual citizens and 

minors. Accordingly, a U.S. taxpayer who receives a gift or inheritance from such an individual is required to include the value of 

such gift or inheritance in gross income and is subject to U.S. tax 

on such amount. Having included the value of the property in income, the recipient would then take a basis in the property equal 

to that value. The tax does not apply to property that is shown on 

a timely filed gift tax return and that is a taxable gift by the 

former citizen or former long-term resident, or property that is 

shown on a timely filed estate tax return and included in the gross 

592 

U.S. estate of the former citizen or former long-term resident (regardless of whether the tax liability shown on such a return is reduced by credits, deductions, or exclusions available under the estate and gift tax rules). In addition, the tax does not apply to property in cases in which no estate or gift tax return is required to 

be filed, where no such return would have been required to be filed 

if the former citizen or former long-term resident had not relinquished citizenship or terminated residency, as the case may be. 

Applicable gifts or bequests that are made in trust are treated as 

made to the beneficiaries of the trust in proportion to their respective interests in the trust. 

Information reporting 

The provision provides that certain information reporting requirements under present law (sec. 6039G) applicable to former 

citizens and former long-term residents also apply for purposes of 

the provision. 

Immigration rules 

The provision amends the immigration rules that deny tax-motivated expatriates reentry into the United States by removing the 

requirement that the expatriation be tax-motivated, and instead 

denies former citizens reentry into the United States if the individual is determined not to be in compliance with his or her tax 

obligations under the provision’s expatriation tax provisions (regardless of the subjective motive for expatriating). For this purpose, the provision permits the IRS to disclose certain items of return information of an individual, upon written request of the Attorney General or his delegate, as is necessary for making a determination under section 212(a)(10)(E) of the Immigration and Nationality Act. Specifically, the provision would permit the IRS to 

disclose to the agency administering section 212(a)(10)(E) whether 

such taxpayer is in compliance with section 877A and identify the 

items of noncompliance. Recordkeeping requirements, safeguards, 

and civil and criminal penalties for unauthorized disclosure or inspection would apply to return information disclosed under this 

provision. 

Effective date 

The provision generally is effective for U.S. citizens who relinquish citizenship or long-term residents who terminate their residency on or after February 5, 2003. The provisions relating to gifts 

and inheritances are effective for gifts and inheritances received 

from former citizens and former long-term residents on or after 

February 5, 2003, whose expatriation or residency termination occurs on or after such date. The provisions relating to former citizens under U.S. immigration laws are effective on or after the date 

of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

593 

450 Recently issued temporary regulations under section 6043 (relating to information reporting with respect to liquidations, recapitalizations, and changes in control) impose information 

reporting requirements with respect to certain taxable inversion transactions, and proposed regulations would expand these requirements more generally to taxable transactions occurring 

after the proposed regulations are finalized. 451 In the case of a nominee, the nominee must furnish the information to the shareholder 

in the manner prescribed by the Treasury Secretary. 

5. Reporting of taxable mergers and acquisitions (sec. 605 of the 

House bill, sec. 445 of the Senate amendment, and new sec. 

6043A of the Code) 

PRESENT LAW

Under section 6045 and the regulations thereunder, brokers 

(defined to include stock transfer agents) are required to make information returns and to provide corresponding payee statements 

as to sales made on behalf of their customers, subject to the penalty provisions of sections 6721–6724. Under the regulations issued 

under section 6045, this requirement generally does not apply with 

respect to taxable transactions other than exchanges for cash (e.g., 

stock inversion transactions taxable to shareholders by reason of 

section 367(a)).450

HOUSE BILL

Under the bill, if gain or loss is recognized in whole or in part 

by shareholders of a corporation by reason of a second corporation’s 

acquisition of the stock or assets of the first corporation, then the 

acquiring corporation (or the acquired corporation, if so prescribed 

by the Treasury Secretary) is required to make a return containing: 

(1) A description of the transaction; 

(2) The name and address of each shareholder of the acquired corporation that recognizes gain as a result of the transaction (or would recognize gain, if there was a built-in gain on 

the shareholder’s shares); 

(3) The amount of money and the value of stock or other 

consideration paid to each shareholder described above; and 

(4) Such other information as the Treasury Secretary may 

prescribe. 

Alternatively, a stock transfer agent who records transfers of 

stock in such transaction may make the return described above in 

lieu of the second corporation. 

In addition, every person required to make a return described 

above is required to furnish to each shareholder (or the shareholder’s nominee 451) whose name is required to be set forth in such 

return a written statement showing: 

(1) The name, address, and phone number of the information contact of the person required to make such return; 

(2) The information required to be shown on that return; 

and 

(3) Such other information as the Treasury Secretary may 

prescribe. 

This written statement is required to be furnished to the 

shareholder on or before January 31 of the year following the calendar year during which the transaction occurred. 

594 

The present-law penalties for failure to comply with information reporting requirements are extended to failures to comply with 

the requirements set forth under this bill. 

Effective date.—The provision is effective for acquisitions after 

the date of enactment. 

SENATE AMENDMENT

Same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows both the House bill and the 

Senate amendment. 

6. Studies (sec. 606 of the House bill) 

PRESENT LAW

Due to the variation in tax rates and tax systems among countries, a multinational enterprise, whether U.S.-based or foreignbased, may have an incentive to shift income, deductions, or tax 

credits in order to arrive at a reduced overall tax burden. Such a 

shifting of items could be accomplished by establishing artificial, 

non-arm’s-length prices for transactions between group members. 

Under section 482, the Treasury Secretary is authorized to reallocate income, deductions, or credits between or among two or 

more organizations, trades, or businesses under common control if 

he determines that such a reallocation is necessary to prevent tax 

evasion or to clearly reflect income. Treasury regulations adopt the 

arm’s-length standard as the standard for determining whether 

such reallocations are appropriate. Thus, the regulations provide 

rules to identify the respective amounts of taxable income of the related parties that would have resulted if the parties had been uncontrolled parties dealing at arm’s length. Transactions involving 

intangible property and certain services may present particular 

challenges to the administration of the arm’s-length standard, because the nature of these transactions may make it difficult or impossible to compare them with third-party transactions. 

In addition to the statutory rules governing the taxation of foreign income of U.S. persons and U.S. income of foreign persons, bilateral income tax treaties limit the amount of income tax that may 

be imposed by one treaty partner on residents of the other treaty 

partner. For example, treaties often reduce or eliminate withholding taxes imposed by a treaty country on certain types of income (e.g., dividends, interest and royalties) paid to residents of the 

other treaty country. Treaties also contain provisions governing the 

creditability of taxes imposed by the treaty country in which income was earned in computing the amount of tax owed to the other 

country by its residents with respect to such income. Treaties further provide procedures under which inconsistent positions taken 

by the treaty countries with respect to a single item of income or 

deduction may be mutually resolved by the two countries. 

HOUSE BILL

The bill requires the Treasury Secretary to conduct and submit 

to the Congress three studies. The first study will examine the efVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00598 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
595 

452On February 27, 2003, the Treasury Department and the IRS released final regulations 

regarding the disclosure of reportable transactions. In general, the regulations are effective for 

transactions entered into on or after February 28, 2003. 

The discussion of present law refers to the new regulations. The rules that apply with respect 

to transactions entered into on or before February 28, 2003, are contained in Treas. Reg. sec. 

1.6011–4T in effect on the date the transaction was entered into. 453The regulations clarify that the term ‘‘substantially similar’’ includes any transaction that 

is expected to obtain the same or similar types of tax consequences and that is either factually 

similar or based on the same or similar tax strategy. Further, the term must be broadly construed in favor of disclosure. Treas. Reg. sec. 1.6011–4(c)(4). 454Treas. Reg. sec. 1.6011–4(b)(2). 

fectiveness of the transfer pricing rules of section 482, with an emphasis on transactions involving intangible property. The second 

study will examine income tax treaties to which the United States 

is a party, with a view toward identifying any inappropriate reductions in withholding tax or opportunities for abuse that may exist. 

The third study will examine the impact of the provisions of this 

bill on inversion transactions. 

Effective date.—The tax treaty study required under the provision is due no later than June 30, 2005. The transfer pricing study 

required under the provision is due no later than June 30, 2005. 

The inversions study required under the provision is due no later 

than December 31, 2005. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except the inversions study required under the provision is due no later than 

December 31, 2006. 

B. PROVISIONS RELATING TO TAX SHELTERS

1. Penalty for failure to disclose reportable transactions (sec. 611 

of the House bill, sec. 402 of the Senate amendment, and new 

sec. 6707A of the Code) 

PRESENT LAW

Regulations under section 6011 require a taxpayer to disclose 

with its tax return certain information with respect to each ‘‘reportable transaction’’ in which the taxpayer participates.452

There are six categories of reportable transactions. The first 

category is any transaction that is the same as (or substantially 

similar to) 453 a transaction that is specified by the Treasury Department as a tax avoidance transaction whose tax benefits are 

subject to disallowance under present law (referred to as a ‘‘listed 

transaction’’).454

The second category is any transaction that is offered under 

conditions of confidentiality. In general, a transaction is considered 

to be offered to a taxpayer under conditions of confidentiality if the 

advisor who is paid a minimum fee places a limitation on disclosure by the taxpayer of the tax treatment or tax structure of the 

transaction and the limitation on disclosure protects the confidenVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00599 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
596 

455Treas. Reg. sec. 1.6011–4(b)(3). 456Treas. Reg. sec. 1.6011–4(b)(4). 457Treas. Reg. sec. 1.6011–4(b)(5). Rev. Proc. 2003–24, 2003–11 I.R.B. 599, exempts certain 

types of losses from this reportable transaction category. 458The significant book-tax category applies only to taxpayers that are reporting companies 

under the Securities Exchange Act of 1934 or business entities that have $250 million or more 

in gross assets. 459Treas. Reg. sec. 1.6011–4(b)(6). Rev. Proc. 2003–25, 2003–11 I.R.B. 601, exempts certain 

types of transactions from this reportable transaction category. 460Treas. Reg. sec. 1.6011–4(b)(7). 461Section 6664(c) provides that a taxpayer can avoid the imposition of a section 6662 accuracy-related penalty in cases where the taxpayer can demonstrate that there was reasonable 

cause for the underpayment and that the taxpayer acted in good faith. Regulations under sections 6662 and 6664 provide that a taxpayer’s failure to disclose a reportable transaction is a 

strong indication that the taxpayer failed to act in good faith, which would bar relief under section 6664(c). 

tiality of that advisor’s tax strategies (irrespective if such terms are 

legally binding).455

The third category of reportable transactions is any transaction 

for which (1) the taxpayer has the right to a full or partial refund 

of fees if the intended tax consequences from the transaction are 

not sustained or, (2) the fees are contingent on the intended tax 

consequences from the transaction being sustained.456

The fourth category of reportable transactions relates to any 

transaction resulting in a taxpayer claiming a loss (under section 

165) of at least (1) $10 million in any single year or $20 million 

in any combination of years by a corporate taxpayer or a partnership with only corporate partners; (2) $2 million in any single year 

or $4 million in any combination of years by all other partnerships, 

S corporations, trusts, and individuals; or (3) $50,000 in any single 

year for individuals or trusts if the loss arises with respect to foreign currency translation losses.457

The fifth category of reportable transactions refers to any 

transaction done by certain taxpayers 458 in which the tax treatment of the transaction differs (or is expected to differ) by more 

than $10 million from its treatment for book purposes (using generally accepted accounting principles) in any year.459

The final category of reportable transactions is any transaction 

that results in a tax credit exceeding $250,000 (including a foreign 

tax credit) if the taxpayer holds the underlying asset for less than 

45 days.460

Under present law, there is no specific penalty for failing to 

disclose a reportable transaction; however, such a failure can jeopardize a taxpayer’s ability to claim that any income tax understatement attributable to such undisclosed transaction is due to reasonable cause, and that the taxpayer acted in good faith.461

HOUSE BILL

In general 

The House bill creates a new penalty for any person who fails 

to include with any return or statement any required information 

with respect to a reportable transaction. The new penalty applies 

without regard to whether the transaction ultimately results in an 

understatement of tax, and applies in addition to any accuracy-related penalty that may be imposed. 

597 

462The House bill provides that, except as provided in regulations, a listed transaction means 

a reportable transaction, which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011. For 

this purpose, it is expected that the definition of ‘‘substantially similar’’ will be the definition 

used in Treas. Reg. sec. 1.6011–4(c)(4). However, the Secretary may modify this definition (as 

well as the definitions of ‘‘listed transaction’’ and ‘‘reportable transactions’’) as appropriate. 463This does not limit the ability of a taxpayer to challenge whether a penalty is appropriate 

(e.g., a taxpayer may litigate the issue of whether a transaction is a reportable transaction (and 

thus subject to the penalty if not disclosed) or not a reportable transaction (and thus not subject 

to the penalty)). 

Transactions to be disclosed 

The House bill does not define the terms ‘‘listed transaction’’ 462 or ‘‘reportable transaction,’’ nor does it explain the type 

of information that must be disclosed in order to avoid the imposition of a penalty. Rather, the House bill authorizes the Treasury 

Department to define a ‘‘listed transaction’’ and a ‘‘reportable 

transaction’’ under section 6011. 

Penalty rate 

The penalty for failing to disclose a reportable transaction is $10,000 in the case of a natural person and $50,000 in any other 

case. The amount is increased to $100,000 and $200,000, respectively, if the failure is with respect to a listed transaction. The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the IRS Commissioner or his delegate can rescind (or abate) the penalty only if rescinding the penalty would 

promote compliance with the tax laws and effective tax administration. The decision to rescind a penalty must be accompanied by a 

record describing the facts and reasons for the action and the 

amount rescinded. There will be no taxpayer right to judicially appeal a refusal to rescind a penalty.463 The IRS also is required to 

submit an annual report to Congress summarizing the application 

of the disclosure penalties and providing a description of each penalty rescinded under this provision and the reasons for the rescission. 

Effective date 

The House bill provision is effective for returns and statements 

the due date for which is after the date of enactment. 

SENATE AMENDMENT

In general 

The Senate amendment is the same as the House bill, with 

certain modifications. 

Transactions to be disclosed 

Like the House bill, the Senate amendment does not define the 

terms ‘‘listed transaction’’ or ‘‘reportable transaction’’ but, rather, 

authorizes the Treasury Department to define a ‘‘listed transaction’’ 

and a ‘‘reportable transaction’’ under section 6011. 

Penalty rate 

Under the Senate amendment, the penalty for failing to dis- close a reportable transaction generally is $50,000. The amount is 

increased to $100,000 if the failure is with respect to a listed transVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00601 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
598 

464 A reportable avoidance transaction is a reportable transaction with a significant tax avoidance purpose. 

action. For large entities and high net worth individuals, the penalty amount is doubled (i.e., $100,000 for a reportable transaction 

and $200,000 for a listed transaction). 

The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the penalty can be rescinded 

(or abated) only if: (1) the taxpayer on whom the penalty is imposed has a history of complying with the Federal tax laws, (2) it 

is shown that the violation is due to an unintentional mistake of 

fact, (3) imposing the penalty would be against equity and good 

conscience, and (4) rescinding the penalty would promote compliance with the tax laws and effective tax administration. The authority to rescind the penalty can only be exercised by the IRS 

Commissioner personally or the head of the Office of Tax Shelter 

Analysis. Thus, the penalty cannot be rescinded by a revenue 

agent, an Appeals officer, or any other IRS personnel. The decision 

to rescind a penalty must be accompanied by a record describing 

the facts and reasons for the action and the amount rescinded. 

There will be no taxpayer right to appeal a refusal to rescind a 

penalty. The IRS also is required to submit an annual report to 

Congress summarizing the application of the disclosure penalties 

and providing a description of each penalty rescinded under this 

provision and the reasons for the rescission. 

A ‘‘large entity’’ is defined as any entity with gross receipts in 

excess of $10 million in the year of the transaction or in the preceding year. A ‘‘high net worth individual’’ is defined as any individual whose net worth exceeds $2 million, based on the fair market value of the individual’s assets and liabilities immediately before entering into the transaction. 

A public entity that is required to pay a penalty for failing to 

disclose a listed transaction (or is subject to an understatement 

penalty attributable to a non-disclosed listed transaction, a non-disclosed reportable avoidance transaction,464 or a transaction that 

lacks economic substance) must disclose the imposition of the penalty in reports to the Securities and Exchange Commission for such 

period as the Secretary shall specify. The provision applies without 

regard to whether the taxpayer determines the amount of the penalty to be material to the reports in which the penalty must appear, and treats any failure to disclose a transaction in such reports as a failure to disclose a listed transaction. A taxpayer must 

disclose a penalty in reports to the Securities and Exchange Commission once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when 

paid). In addition, the Secretary is required to make public the 

name of any person that is required to pay a penalty for failing to 

disclose a listed transaction (or is subject to an understatement 

penalty attributable to a non-disclosed listed transaction, a non-disclosed reportable avoidance transaction, or a transaction that lacks 

economic substance), as well as the amount of such penalty. 

599 

Effective date 

The Senate amendment provision is effective for returns and 

statements the due date for which is after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with the following modifications. 

In determining whether to rescind (or abate) the penalty for 

failing to disclose a reportable transaction on the grounds that 

doing so would promote compliance with the tax laws and effective 

tax administration, the conferees intend that the IRS Commissioner take into account whether: (1) the person on whom the penalty is imposed has a history of complying with the tax laws; (2) 

the violation is due to an unintentional mistake of fact; and (3) imposing the penalty would be against equity and good conscience. 

In addition, the conference agreement provides that a public 

entity that is required to pay a penalty for failing to disclose a listed transaction (or is subject to an understatement penalty attributable to a non-disclosed listed transaction or a non-disclosed reportable avoidance transaction) must disclose the imposition of the 

penalty in reports to the Securities and Exchange Commission for 

such period as the Secretary shall specify. This requirement applies 

without regard to whether the taxpayer determines the amount of 

the penalty to be material to the reports in which the penalty must 

appear, and treats any failure to disclose a transaction in such reports as a failure to disclose a listed transaction. A taxpayer must 

disclose a penalty in reports to the Securities and Exchange Commission once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when 

paid). However, the taxpayer is only required to report the penalty 

one time. The conference agreement further provides that this requirement also applies to a public entity that is subject to a gross 

valuation misstatement penalty under section 6662(h) attributable 

to a non-disclosed listed transaction or non-disclosed reportable 

avoidance transaction. 

2. Modifications to the accuracy-related penalties for listed transactions and reportable transactions having a significant tax 

avoidance purpose (sec. 612 of the House bill, sec. 403 of the 

Senate amendment, and new sec. 6662A of the Code) 

PRESENT LAW

The accuracy-related penalty applies to the portion of any underpayment that is attributable to (1) negligence, (2) any substantial understatement of income tax, (3) any substantial valuation 

misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income tax liability exceeds that reported by 

the taxpayer by the greater of 10 percent of the correct tax or 

$5,000 ($10,000 in the case of corporations), then a substantial understatement exists and a penalty may be imposed equal to 20 percent of the underpayment of tax attributable to the understateVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00603 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
600 

465Sec. 6662. 466Sec. 6662(d)(2)(B). 467Sec. 6662(d)(2)(C). 468Sec. 6664(c). 469Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 470The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meanings as 

used for purposes of the penalty for failing to disclose reportable transactions. 

ment.465 The amount of any understatement generally is reduced 

by any portion attributable to an item if (1) the treatment of the 

item is or was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were adequately disclosed 

and there was a reasonable basis for its tax treatment.466

Special rules apply with respect to tax shelters.467 For understatements by non-corporate taxpayers attributable to tax shelters, 

the penalty may be avoided only if the taxpayer establishes that, 

in addition to having substantial authority for the position, the taxpayer reasonably believed that the treatment claimed was more 

likely than not the proper treatment of the item. This reduction in 

the penalty is unavailable to corporate tax shelters. 

The understatement penalty generally is abated (even with respect to tax shelters) in cases in which the taxpayer can demonstrate that there was ‘‘reasonable cause’’ for the underpayment 

and that the taxpayer acted in good faith.468 The relevant regulations provide that reasonable cause exists where the taxpayer ‘‘reasonably relies in good faith on an opinion based on a professional 

tax advisor’s analysis of the pertinent facts and authorities [that] 

. . . unambiguously concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld 

if challenged’’ by the IRS.469

HOUSE BILL

In general 

The House bill modifies the present-law accuracy related penalty by replacing the rules applicable to tax shelters with a new accuracy-related penalty that applies to listed transactions and reportable transactions with a significant tax avoidance purpose 

(hereinafter referred to as a ‘‘reportable avoidance transaction’’).470

The penalty rate and defenses available to avoid the penalty vary 

depending on whether the transaction was adequately disclosed. 

Disclosed transactions 

In general, a 20-percent accuracy-related penalty is imposed on 

any understatement attributable to an adequately disclosed listed 

transaction or reportable avoidance transaction. The only exception 

to the penalty is if the taxpayer satisfies a more stringent reasonable cause and good faith exception (hereinafter referred to as the 

‘‘strengthened reasonable cause exception’’), which is described 

below. The strengthened reasonable cause exception is available 

only if the relevant facts affecting the tax treatment are adequately 

disclosed, there is or was substantial authority for the claimed tax 

treatment, and the taxpayer reasonably believed that the claimed 

tax treatment was more likely than not the proper treatment. 

601 

471For this purpose, any reduction in the excess of deductions allowed for the taxable year 

over gross income for such year, and any reduction in the amount of capital losses which would 

(without regard to section 1211) be allowed for such year, shall be treated as an increase in 

taxable income. 472See the previous discussion regarding the penalty for failing to disclose a reportable transaction. 

Undisclosed transactions 

If the taxpayer does not adequately disclose the transaction, 

the strengthened reasonable cause exception is not available (i.e., 

a strict-liability penalty applies), and the taxpayer is subject to an 

increased penalty equal to 30 percent of the understatement. 

Determination of the understatement amount 

The penalty is applied to the amount of any understatement 

attributable to the listed or reportable avoidance transaction without regard to other items on the tax return. For purposes of this 

provision, the amount of the understatement is determined as the 

sum of (1) the product of the highest corporate or individual tax 

rate (as appropriate) and the increase in taxable income resulting 

from the difference between the taxpayer’s treatment of the item 

and the proper treatment of the item (without regard to other 

items on the tax return),471 and (2) the amount of any decrease in 

the aggregate amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such item. 

Except as provided in regulations, a taxpayer’s treatment of an 

item shall not take into account any amendment or supplement to 

a return if the amendment or supplement is filed after the earlier 

of when the taxpayer is first contacted regarding an examination 

of the return or such other date as specified by the Secretary. 

Strengthened reasonable cause exception 

A penalty is not imposed under the provision with respect to 

any portion of an understatement if it shown that there was reasonable cause for such portion and the taxpayer acted in good faith. 

Such a showing requires (1) adequate disclosure of the facts affecting the transaction in accordance with the regulations under section 6011,472 (2) that there is or was substantial authority for such 

treatment, and (3) that the taxpayer reasonably believed that such 

treatment was more likely than not the proper treatment. For this 

purpose, a taxpayer will be treated as having a reasonable belief 

with respect to the tax treatment of an item only if such belief (1) 

is based on the facts and law that exist at the time the tax return 

(that includes the item) is filed, and (2) relates solely to the taxpayer’s chances of success on the merits and does not take into account the possibility that (a) a return will not be audited, (b) the 

treatment will not be raised on audit, or (c) the treatment will be 

resolved through settlement if raised. 

A taxpayer may (but is not required to) rely on an opinion of 

a tax advisor in establishing its reasonable belief with respect to 

the tax treatment of the item. However, a taxpayer may not rely 

on an opinion of a tax advisor for this purpose if the opinion (1) 

is provided by a ‘‘disqualified tax advisor,’’ or (2) is a ‘‘disqualified 

opinion.’’ 

602 

473 Under the House bill, the term ‘‘material advisor’’ (defined below in connection with the 

new information filing requirements for material advisors) means any person who provides any 

material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, or carrying out any reportable transaction, and who derives gross income in excess 

of $50,000 in the case of a reportable transaction substantially all of the tax benefits from which 

are provided to natural persons ($250,000 in any other case). 474This situation could arise, for example, when an advisor has an arrangement or understanding (oral or written) with an organizer, manager, or promoter of a reportable transaction 

that such party will recommend or refer potential participants to the advisor for an opinion regarding the tax treatment of the transaction. 475 An advisor should not be treated as participating in the organization of a transaction if 

the advisor’s only involvement with respect to the organization of the transaction is the rendering of an opinion regarding the tax consequences of such transaction. However, such an advisor may be a ‘‘disqualified tax advisor’’ with respect to the transaction if the advisor participates 

in the management, promotion or sale of the transaction (or if the advisor is compensated by 

a material advisor, has a fee arrangement that is contingent on the tax benefits of the transaction, or as determined by the Secretary, has a continuing financial interest with respect to 

the transaction). 

Disqualified tax advisor 

A disqualified tax advisor is any advisor who (1) is a material 

advisor 473 and who participates in the organization, management, 

promotion or sale of the transaction or is related (within the meaning of section 267(b) or 707(b)(1)) to any person who so participates, 

(2) is compensated directly or indirectly 474 by a material advisor 

with respect to the transaction, (3) has a fee arrangement with respect to the transaction that is contingent on all or part of the intended tax benefits from the transaction being sustained, or (4) as 

determined under regulations prescribed by the Secretary, has a 

disqualifying financial interest with respect to the transaction. 

Organization, management, promotion or sale of a transaction.—A material advisor is considered as participating in the 

‘‘organization’’ of a transaction if the advisor performs acts relating 

to the development of the transaction. This may include, for example, preparing documents (1) establishing a structure used in connection with the transaction (such as a partnership agreement), (2) 

describing the transaction (such as an offering memorandum or 

other statement describing the transaction), or (3) relating to the 

registration of the transaction with any federal, state or local government body.475 Participation in the ‘‘management’’ of a transaction means involvement in the decision-making process regarding 

any business activity with respect to the transaction. Participation 

in the ‘‘promotion or sale’’ of a transaction means involvement in 

the marketing or solicitation of the transaction to others. Thus, an 

advisor who provides information about the transaction to a potential participant is involved in the promotion or sale of a transaction, as is any advisor who recommends the transaction to a potential participant. 

Disqualified opinion 

An opinion may not be relied upon if the opinion (1) is based 

on unreasonable factual or legal assumptions (including assumptions as to future events), (2) unreasonably relies upon representations, statements, finding or agreements of the taxpayer or any 

other person, (3) does not identify and consider all relevant facts, 

or (4) fails to meet any other requirement prescribed by the Secretary. 

603 

Coordination with other penalties 

Any understatement upon which a penalty is imposed under 

the House bill is not subject to the accuracy-related penalty under 

section 6662. However, such understatement is included for purposes of determining whether any understatement (as defined in 

sec. 6662(d)(2)) is a substantial understatement as defined under 

section 6662(d)(1). 

The penalty imposed under the House bill shall not apply to 

any portion of an understatement to which a fraud penalty is applied under section 6663. 

Effective date 

The House bill provision is effective for taxable years ending 

after the date of enactment. 

SENATE AMENDMENT

In general 

The Senate amendment is the same as the House bill, with 

certain modifications. 

Disclosed transactions 

The Senate amendment is the same as the House bill with regard to accuracy-related penalties for understatements attributable 

to an adequately disclosed listed transaction or reportable avoidance transaction. 

Undisclosed transactions 

Like the House bill, the Senate amendment provides that a 

taxpayer is subject to an increased accuracy-related penalty equal 

to 30 percent of the understatement, and the strengthened reasonable cause exception is not available (i.e., a strict-liability penalty 

applies), if the taxpayer does not adequately disclose the transaction. 

Under the Senate amendment, a public entity that is required 

to pay the 30-percent penalty also must disclose the imposition of 

the penalty in reports to the SEC for such periods as the Secretary 

shall specify. The disclosure to the SEC applies without regard to 

whether the taxpayer determines the amount of the penalty to be 

material to the reports in which the penalty must appear, and any 

failure to disclose such penalty in the reports is treated as a failure 

to disclose a listed transaction. A taxpayer must disclose a penalty 

in reports to the SEC once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when paid). 

The Senate amendment also provides that, once the 30-percent 

penalty has been included in the Revenue Agent Report, the penalty cannot be compromised for purposes of a settlement without 

approval of the Commissioner personally or the head of the Office 

of Tax Shelter Analysis. Furthermore, the IRS is required to submit an annual report to Congress summarizing the application of 

this penalty and providing a description of each penalty compromised under this provision and the reasons for the compromise. 

604 

476 Under the Senate amendment, the term ‘‘material advisor’’ (defined below in connection 

with the new information filing requirements for material advisors) means any person who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, 

selling, implementing, insuring or carrying out any reportable transaction, and who derives 

gross income in excess of $50,000 in the case of a reportable transaction substantially all of the 

tax benefits from which are provided to natural persons ($250,000 in any other case). 

Disqualified tax advisor 

The Senate amendment provides that a disqualified tax advisor also includes ad advisor who has an arrangement with respect 

to the transaction which provides that contractual disputes between the taxpayer and the advisor are to be settled by arbitration 

or which limits damages by reference to fees paid to the advisor for 

such transaction. 

Determination of the understatement amount 

The Senate amendment is the same as the House bill with regard to determining the amount of an understatement that is subject to this provision. 

Strengthened reasonable cause exception 

The Senate amendment is the same as the House bill with regard to the reasonable cause exception to accuracy-related penalties under this provision.476

Coordination with other penalties 

The Senate amendment is the same as the House bill with regard to coordination between the penalty imposed under this provision and other penalties. 

Effective date 

The Senate amendment provision is effective for taxable years 

ending after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except the 

conference agreement also provides that any understatement upon 

which a penalty is imposed under the conference agreement is not 

subject to the valuation misstatement penalties under sections 

6662(e) or 6662(h). 

3. Tax shelter exception to confidentiality privileges relating to taxpayer communications (sec. 613 of the House bill, sec. 406 of 

the Senate amendment, and sec. 7525 of the Code) 

PRESENT LAW

In general, a common law privilege of confidentiality exists for 

communications between an attorney and client with respect to the 

legal advice the attorney gives the client. The Code provides that, 

with respect to tax advice, the same common law protections of 

confidentiality that apply to a communication between a taxpayer 

and an attorney also apply to a communication between a taxpayer 

and a federally authorized tax practitioner to the extent the communication would be considered a privileged communication if it 

605 

477Sec. 6501(a). 478For this purpose, a return that is filed before the date on which it is due is considered 

to be filed on the required due date (sec. 6501(b)(1)). 479Sec. 6501(e). 480Sec. 6501(c). 481The term ‘‘listed transaction’’ has the same meaning as described in a previous provision 

regarding the penalty for failure to disclose reportable transactions. 

were between a taxpayer and an attorney. This rule is inapplicable 

to communications regarding corporate tax shelters. 

HOUSE BILL

The House bill modifies the rule relating to corporate tax shelters by making it applicable to all tax shelters, whether entered 

into by corporations, individuals, partnerships, tax-exempt entities, 

or any other entity. Accordingly, communications with respect to 

tax shelters are not subject to the confidentiality provision of the 

Code that otherwise applies to a communication between a taxpayer and a federally authorized tax practitioner. 

Effective date.—The House bill provision is effective with respect to communications made on or after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

4. Statute of limitations for unreported listed transactions (sec. 614 

of the House bill, sec. 416 of the Senate amendment, and sec. 

6501 of the Code) 

PRESENT LAW

In general, the Code requires that taxes be assessed within 

three years 477 after the date a return is filed.478 If there has been 

a substantial omission of items of gross income that totals more 

than 25 percent of the amount of gross income shown on the return, the period during which an assessment must be made is extended to six years.479 If an assessment is not made within the required time periods, the tax generally cannot be assessed or collected at any future time. Tax may be assessed at any time if the 

taxpayer files a false or fraudulent return with the intent to evade 

tax or if the taxpayer does not file a tax return at all.480

HOUSE BILL

The House bill extends the statute of limitations with respect 

to a listed transaction if a taxpayer fails to include on any return 

or statement for any taxable year any information with respect to 

a listed transaction 481 which is required to be included (under section 6011) with such return or statement. The statute of limitations 

with respect to such a transaction will not expire before the date 

which is one year after the earlier of (1) the date on which the Secretary is furnished the information so required, or (2) the date that 

a material advisor (as defined in 6111) satisfies the list mainteVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00609 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
606 

482 If the Treasury Department lists a transaction in a year subsequent to the year in which 

a taxpayer entered into such transaction and the taxpayer’s tax return for the year the transaction was entered into is closed by the statute of limitations prior to the date the transaction 

became a listed transaction, this provision does not re-open the statute of limitations with respect to such transaction for such year. However, if the purported tax benefits of the transaction 

are recognized over multiple tax years, the provision’s extension of the statute of limitations 

shall apply to such tax benefits in any subsequent tax year in which the statute of limitations 

had not closed prior to the date the transaction became a listed transaction. 483Sec. 6111(a). 484The tax shelter ratio is, with respect to any year, the ratio that the aggregate amount of 

the deductions and 350 percent of the credits, which are represented to be potentially allowable 

to any investor, bears to the investment base (money plus basis of assets contributed) as of the 

close of the tax year. 485Sec. 6111(c). 486Sec. 6111(d). 

nance requirements (as defined by section 6112) with respect to a 

request by the Secretary. For example, if a taxpayer engaged in a 

transaction in 2005 that becomes a listed transaction in 2007 and 

the taxpayer fails to disclose such transaction in the manner required by Treasury regulations, then the transaction is subject to 

the extended statute of limitations.482

Effective date.—The House bill provision is effective for taxable 

years with respect to which the period for assessing a deficiency 

did not expire before the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

5. Disclosure of reportable transactions by material advisors (secs. 

615 and 616 of the House bill, secs. 407 and 408 of the Senate 

amendment, and secs. 6111 and 6707 of the Code) 

PRESENT LAW

Registration of tax shelter arrangements 

An organizer of a tax shelter is required to register the shelter 

with the Secretary not later than the day on which the shelter is 

first offered for sale.483 A ‘‘tax shelter’’ means any investment with 

respect to which the tax shelter ratio 484 for any investor as of the 

close of any of the first five years ending after the investment is 

offered for sale may be greater than two to one and which is: (1) 

required to be registered under Federal or State securities laws, (2) 

sold pursuant to an exemption from registration requiring the filing of a notice with a Federal or State securities agency, or (3) a 

substantial investment (greater than $250,000 and involving at 

least five investors).485

Other promoted arrangements are treated as tax shelters for 

purposes of the registration requirement if: (1) a significant purpose of the arrangement is the avoidance or evasion of Federal income tax by a corporate participant; (2) the arrangement is offered 

under conditions of confidentiality; and (3) the promoter may receive fees in excess of $100,000 in the aggregate.486

In general, a transaction has a ‘‘significant purpose of avoiding 

or evading Federal income tax’’ if the transaction: (1) is the same 

607 

487Treas. Reg. sec. 301.6111–2(b)(2). 488Treas. Reg. sec. 301.6111–2(b)(3). 489Treas. Reg. sec. 301.6111–2(b)(4). 490The regulations provide that the determination of whether an arrangement is offered 

under conditions of confidentiality is based on all the facts and circumstances surrounding the 

offer. If an offeree’s disclosure of the structure or tax aspects of the transaction are limited in 

any way by an express or implied understanding or agreement with or for the benefit of a tax 

shelter promoter, an offer is considered made under conditions of confidentiality, whether or not 

such understanding or agreement is legally binding. Treas. Reg. sec. 301.6111–2(c)(1). 491Sec. 6707. 492The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 

as or substantially similar to a ‘‘listed transaction,’’ 487 or (2) is 

structured to produce tax benefits that constitute an important 

part of the intended results of the arrangement and the promoter 

reasonably expects to present the arrangement to more than one 

taxpayer.488 Certain exceptions are provided with respect to the 

second category of transactions.489

An arrangement is offered under conditions of confidentiality 

if: (1) an offeree has an understanding or agreement to limit the 

disclosure of the transaction or any significant tax features of the 

transaction; or (2) the promoter knows, or has reason to know, that 

the offeree’s use or disclosure of information relating to the transaction is limited in any other manner.490

Failure to register tax shelter 

The penalty for failing to timely register a tax shelter (or for 

filing false or incomplete information with respect to the tax shelter registration) generally is the greater of one percent of the aggregate amount invested in the shelter or $500.491 However, if the 

tax shelter involves an arrangement offered to a corporation under 

conditions of confidentiality, the penalty is the greater of $10,000 

or 50 percent of the fees payable to any promoter with respect to 

offerings prior to the date of late registration. Intentional disregard 

of the requirement to register increases the penalty to 75 percent 

of the applicable fees. Section 6707 also imposes (1) a $100 penalty on the promoter 

for each failure to furnish the investor with the required tax shelter identification number, and (2) a $250 penalty on the investor 

for each failure to include the tax shelter identification number on 

a return. 

HOUSE BILL

Disclosure of reportable transactions by material advisors 

The House bill repeals the present law rules with respect to 

registration of tax shelters. Instead, the House bill requires each 

material advisor with respect to any reportable transaction (including any listed transaction) 492 to timely file an information return 

with the Secretary (in such form and manner as the Secretary may 

prescribe). The return must be filed on such date as specified by 

the Secretary. 

The information return will include (1) information identifying 

and describing the transaction, (2) information describing any potential tax benefits expected to result from the transaction, and (3) 

such other information as the Secretary may prescribe. It is expected that the Secretary may seek from the material advisor the 

608 

493See the previous discussion regarding the disclosure requirements under new section 

6707A. 494The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 495The Secretary’s present-law authority to postpone certain tax-related deadlines because of 

Presidentially-declared disasters (sec. 7508A) will also encompass the authority to postpone the 

reporting deadlines established by the provision. 

same type of information that the Secretary may request from a 

taxpayer in connection with a reportable transaction.493

A ‘‘material advisor’’ means any person (1) who provides material aid, assistance, or advice with respect to organizing, managing, 

promoting, selling, implementing, or carrying out any reportable 

transaction, and (2) who directly or indirectly derives gross income 

for such assistance or advice in excess of $250,000 ($50,000 in the 

case of a reportable transaction substantially all of the tax benefits 

from which are provided to natural persons) or such other amount 

as may be prescribed by the Secretary. 

The Secretary may prescribe regulations which provide (1) that 

only one material advisor has to file an information return in cases 

in which two or more material advisors would otherwise be required to file information returns with respect to a particular reportable transaction, (2) exemptions from the requirements of this 

section, and (3) other rules as may be necessary or appropriate to 

carry out the purposes of this section (including, for example, rules 

regarding the aggregation of fees in appropriate circumstances). 

Penalty for failing to furnish information regarding reportable 

transactions 

The House bill repeals the present-law penalty for failure to 

register tax shelters. Instead, the House bill imposes a penalty on 

any material advisor who fails to file an information return, or who 

files a false or incomplete information return, with respect to a reportable transaction (including a listed transaction).494 The amount 

of the penalty is $50,000. If the penalty is with respect to a listed 

transaction, the amount of the penalty is increased to the greater 

of (1) $200,000, or (2) 50 percent of the gross income of such person 

with respect to aid, assistance, or advice which is provided with respect to the transaction before the date the information return that 

includes the transaction is filed. Intentional disregard by a material advisor of the requirement to disclose a listed transaction increases the penalty to 75 percent of the gross income. 

The penalty cannot be waived with respect to a listed transaction. As to reportable transactions, the penalty can be rescinded 

(or abated) only in exceptional circumstances.495 All or part of the 

penalty may be rescinded only if rescinding the penalty would promote compliance with the tax laws and effective tax administration. The decision to rescind a penalty must be accompanied by a 

record describing the facts and reasons for the action and the 

amount rescinded. There will be no right to judicially appeal a refusal to rescind a penalty. The IRS also is required to submit an 

annual report to Congress summarizing the application of the disclosure penalties and providing a description of each penalty rescinded under this provision and the reasons for the rescission. 

609 

496Sec. 6112. 497Treas. Reg. sec. 301.6112–1. 498 A special rule applies the list maintenance requirements to transactions entered into after 

February 28, 2000 if the transaction becomes a listed transaction (as defined in Treas. Reg. 

1.6011–4) after February 28, 2003. 499Treas. Reg. sec. 301.6112–1(c)(1). 500Treas. Reg. sec. 301.6112–1(c)(2) and (3). 

Effective date 

The House bill provision requiring disclosure of reportable 

transactions by material advisors applies to transactions with respect to which material aid, assistance or advice is provided after 

the date of enactment. 

The House bill provision imposing a penalty for failing to disclose reportable transactions applies to returns the due date for 

which is after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the Senate amendment also includes in the definition of a ‘‘material advisor’’ any person who provides material aid, assistance, or 

advice with respect to insuring any reportable transaction (and 

who derives gross income for such assistance or advice in excess of 

the amounts specified in the House bill). 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

6. Investor lists and modification of penalty for failure to maintain 

investor lists (secs. 615 and 617 of the House bill, secs. 407 and 

409 of the Senate amendment, and secs. 6112 and 6708 of the 

Code) 

PRESENT LAW

Investor lists 

Any organizer or seller of a potentially abusive tax shelter 

must maintain a list identifying each person who was sold an interest in any such tax shelter with respect to which registration was 

required under section 6111 (even though the particular party may 

not have been subject to confidentiality restrictions).496 Recently 

issued regulations under section 6112 contain rules regarding the 

list maintenance requirements.497 In general, the regulations apply 

to transactions that are potentially abusive tax shelters entered 

into, or acquired after, February 28, 2003.498

The regulations provide that a person is an organizer or seller 

of a potentially abusive tax shelter if the person is a material advisor with respect to that transaction.499 A material advisor is defined as any person who is required to register the transaction 

under section 6111, or expects to receive a minimum fee of (1) 

$250,000 for a transaction that is a potentially abusive tax shelter 

if all participants are corporations, or (2) $50,000 for any other 

transaction that is a potentially abusive tax shelter.500 For listed 

transactions (as defined in the regulations under section 6011), the 

minimum fees are reduced to $25,000 and $10,000, respectively. 

610 

501Treas. Reg. sec. 301.6112–1(b). 502Sec. 6112(c)(2). 503The term ‘‘material advisor’’ has the same meaning as when used in connection with the 

requirement to file an information return under section 6111. 504The terms ‘‘reportable transaction’’ and ‘‘listed transaction’’ have the same meaning as previously described in connection with the taxpayer-related provisions. 505 In no event will failure to maintain a list be considered reasonable cause for failing to 

make a list available to the Secretary. 

A potentially abusive tax shelter is any transaction that (1) is 

required to be registered under section 6111, (2) is a listed transaction (as defined under the regulations under section 6011), or (3) 

any transaction that a potential material advisor, at the time the 

transaction is entered into, knows is or reasonably expects will become a reportable transaction (as defined under the new regulations under section 6011).501

The Secretary is required to prescribe regulations which provide that, in cases in which two or more persons are required to 

maintain the same list, only one person would be required to maintain the list.502

Penalty for failing to maintain investor lists 

Under section 6708, the penalty for failing to maintain the list 

required under section 6112 is $50 for each name omitted from the 

list (with a maximum penalty of $100,000 per year). 

HOUSE BILL

Investor lists 

Each material advisor 503 with respect to a reportable transaction (including a listed transaction) 504 is required to maintain a 

list that (1) identifies each person with respect to whom the advisor 

acted as a material advisor with respect to the reportable transaction, and (2) contains other information as may be required by 

the Secretary. In addition, the provision authorizes (but does not 

require) the Secretary to prescribe regulations which provide that, 

in cases in which two or more persons are required to maintain the 

same list, only one person would be required to maintain the list. 

Penalty for failing to maintain investor lists 

The provision modifies the penalty for failing to maintain the 

required list by making it a time-sensitive penalty. Thus, a material advisor who is required to maintain an investor list and who 

fails to make the list available upon written request by the Secretary within 20 business days after the request will be subject to 

a $10,000 per day penalty. The penalty applies to a person who 

fails to maintain a list, maintains an incomplete list, or has in fact 

maintained a list but does not make the list available to the Secretary. The penalty can be waived if the failure to make the list 

available is due to reasonable cause.505

Effective date 

The House bill provision requiring a material advisor to maintain an investor list applies to transactions with respect to which 

material aid, assistance or advice is provided after the date of enactment. The House bill provision imposing a penalty for failing to 

611 

506Sec. 6700. 

maintain investor lists applies to requests made after the date of 

enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. In addition, the Senate amendment clarifies that, for purposes of section 

6112, the identity of any person is not privileged under the common law attorney-client privilege (or, consequently, the section 

7525 federally authorized tax practitioner confidentiality provision). 

Effective date.—The Senate amendment provision clarifying 

that the identity of any person is not privileged for purposes of section 6112 is effective as if included in the amendments made by 

section 142 of the Deficit Reduction Act of 1984. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

7. Penalty on promoters of tax shelters (sec. 618 of the House bill, 

sec. 415 of the Senate amendment, and sec. 6700 of the Code) 

PRESENT LAW

A penalty is imposed on any person who organizes, assists in 

the organization of, or participates in the sale of any interest in, 

a partnership or other entity, any investment plan or arrangement, 

or any other plan or arrangement, if in connection with such activity the person makes or furnishes a qualifying false or fraudulent 

statement or a gross valuation overstatement.506 A qualified false 

or fraudulent statement is any statement with respect to the allowability of any deduction or credit, the excludability of any income, 

or the securing of any other tax benefit by reason of holding an interest in the entity or participating in the plan or arrangement 

which the person knows or has reason to know is false or fraudulent as to any material matter. A ‘‘gross valuation overstatement’’ 

means any statement as to the value of any property or services 

if the stated value exceeds 200 percent of the correct valuation, and 

the value is directly related to the amount of any allowable income 

tax deduction or credit. 

The amount of the penalty is $1,000 (or, if the person establishes that it is less, 100 percent of the gross income derived or to 

be derived by the person from such activity). A penalty attributable 

to a gross valuation misstatement can be waived on a showing that 

there was a reasonable basis for the valuation and it was made in 

good faith. 

HOUSE BILL

The House bill modifies the penalty amount to equal 50 percent of the gross income derived by the person from the activity for 

which the penalty is imposed. The new penalty rate applies to any 

activity that involves a statement regarding the tax benefits of participating in a plan or arrangement if the person knows or has reason to know that such statement is false or fraudulent as to any 

612 

material matter. The enhanced penalty does not apply to a gross 

valuation overstatement. 

Effective date.—The House bill provision is effective for activities occurring after the date of enactment. 

SENATE AMENDMENT

The Senate amendment modifies the penalty amount to equal 

100 percent of the gross income derived by the person from the activity for which the penalty is imposed. The new penalty rate applies to (1) each instance of any activity that involves a statement 

(including a gross valuation overstatement) regarding the tax benefits of participating in a plan or arrangement if the person knows 

or has reason to know that such statement is false or fraudulent 

as to any material matter, (2) each instance in which income was 

derived from such activity, and (3) each person who participated in 

such activity. In addition, the Senate amendment imposes joint and 

several liability upon all persons who are subject to a penalty for 

such activity. The Senate amendment also provides that the payment of a penalty under this provision, or the payment of any 

amount to settle or avoid the imposition of such a penalty, is not 

deductible for tax purposes. 

Effective date.—The Senate amendment provision is effective 

for activities occurring after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

8. Penalty for aiding and abetting the understatement of tax liability (sec. 419 of the Senate amendment and sec. 6701 of the 

Code) 

PRESENT LAW

A penalty is imposed on a person who: (1) aids or assists in or 

advises with respect to a tax return or other document; (2) knows 

(or has reason to believe) that such document will be used in connection with a material tax matter; and (3) knows that this would 

result in an understatement of tax of another person. In general, 

the amount of the penalty is $1,000. If the document relates to the 

tax return of a corporation, the amount of the penalty is $10,000. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment expands the scope of this penalty in 

several ways. First, it applies the penalty to aiding or assisting 

with respect to tax liability. Second, it applies the penalty to each 

instance of aiding or abetting. Third, it increases the amount of the 

penalty to a maximum of 100 percent of the gross income derived 

(or to be derived) from the aiding or abetting. Fourth, if more than 

one person is liable for the penalty, all such persons are jointly and 

severally liable for the penalty. Fifth, the penalty, as well as 

613 

507Sec. 6662(a) and (d)(1)(A). 

amounts paid to settle or avoid the imposition of the penalty, is not 

deductible for tax purposes. 

Effective date.—The Senate amendment provision is effective 

for activities after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

9. Modifications of substantial understatement penalty for nonreportable transactions (sec. 619 of the House bill, sec. 405 of 

the Senate amendment, and sec. 6662 of the Code) 

PRESENT LAW

An accuracy-related penalty equal to 20 percent applies to any 

substantial understatement of tax. A ‘‘substantial understatement’’ 

exists if the correct income tax liability for a taxable year exceeds 

that reported by the taxpayer by the greater of 10 percent of the 

correct tax or $5,000 ($10,000 in the case of most corporations).507

HOUSE BILL

The House bill modifies the definition of ‘‘substantial’’ for corporate taxpayers. Under the House bill, a corporate taxpayer has 

a substantial understatement if the amount of the understatement 

for the taxable year exceeds the lesser of (1) 10 percent of the tax 

required to be shown on the return for the taxable year (or, if 

greater, $10,000), or (2) $10 million. 

Effective date.—The House bill provision is effective for taxable 

years beginning after date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill with regard to modifying the definition of ‘‘substantial’’ for corporate taxpayers. 

In addition, the Senate amendment elevates the standard that 

a taxpayer must satisfy in order to reduce the amount of an understatement for undisclosed items. With respect to the treatment of 

an item whose facts are not adequately disclosed, a resulting understatement is reduced only if the taxpayer had a reasonable belief that the tax treatment was more likely than not the proper 

treatment. 

The Senate amendment also authorizes (but does not require) 

the Secretary to publish a list of positions for which it believes 

there is not substantial authority or there is no reasonable belief 

that the tax treatment is more likely than not the proper treatment 

(without regard to whether such positions affect a significant number of taxpayers). The list shall be published in the Federal Register or the Internal Revenue Bulletin. 

Effective date.—The Senate amendment provision is effective 

for taxable years beginning after the date of enactment. 

614 

508Sec. 7408. 509Sec. 6707, as amended by other provisions of this bill. 510Sec. 6708, as amended by other provisions of this bill. 511 31 U.S.C. sec. 5314. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except the 

conference agreement also modifies the requirement of the Secretary to prescribe a list of positions that do not have substantial 

authority, and authorizes (but does not require) the Secretary to 

publish such list. 

10. Modification of actions to enjoin certain conduct related to tax 

shelters and reportable transactions (sec. 620 of the House bill, 

sec. 410 of the Senate amendment, and sec. 7408 of the Code) 

PRESENT LAW

The Code authorizes civil actions to enjoin any person from 

promoting abusive tax shelters or aiding or abetting the understatement of tax liability.508

HOUSE BILL

The House bill expands this rule so that injunctions may also 

be sought with respect to the requirements relating to the reporting of reportable transactions 509 and the keeping of lists of investors by material advisors.510 Thus, under the House bill, an injunction may be sought against a material advisor to enjoin the advisor 

from (1) failing to file an information return with respect to a reportable transaction, or (2) failing to maintain, or to timely furnish 

upon written request by the Secretary, a list of investors with respect to each reportable transaction. 

Effective date.—The House bill provision is effective on the day 

after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the Senate amendment also permits injunctions to be sought with 

respect to violations of any of the rules under Circular 230, which 

regulates the practice of representatives of persons before the Department of the Treasury. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

11. Penalty on failure to report interests in foreign financial accounts (sec. 621 of the House bill, sec. 412 of the Senate 

amendment, and sec. 5321 of Title 31, United States Code) 

PRESENT LAW

The Secretary must require citizens, residents, or persons 

doing business in the United States to keep records and file reports 

when that person makes a transaction or maintains an account 

with a foreign financial entity.511 In general, individuals must fulfill this requirement by answering questions regarding foreign acVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00618 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
615 

512 31 U.S.C. sec. 5321(a)(5). 513 31 U.S.C. sec. 5322. 514 A Report to Congress in Accordance with Sec. 361(b) of the Uniting and Strengthening 

America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 

2001, April 26, 2002. 515Sec. 361(b) of the USA PATRIOT Act of 2001 (Pub. L. 107–56). 

counts or foreign trusts that are contained in Part III of Schedule 

B of the IRS Form 1040. Taxpayers who answer ‘‘yes’’ in response 

to the question regarding foreign accounts must then file Treasury 

Department Form TD F 90–22.1. This form must be filed with the 

Department of the Treasury, and not as part of the tax return that 

is filed with the IRS. 

The Secretary may impose a civil penalty on any person who 

willfully violates this reporting requirement. The civil penalty is 

the amount of the transaction or the value of the account, up to a 

maximum of $100,000; the minimum amount of the penalty is 

$25,000.512 In addition, any person who willfully violates this reporting requirement is subject to a criminal penalty. The criminal 

penalty is a fine of not more than $250,000 or imprisonment for not 

more than five years (or both); if the violation is part of a pattern 

of illegal activity, the maximum amount of the fine is increased to 

$500,000 and the maximum length of imprisonment is increased to 

10 years.513

On April 26, 2002, the Secretary submitted to the Congress a 

report on these reporting requirements.514 This report, which was 

statutorily required,515 studies methods for improving compliance 

with these reporting requirements. It makes several administrative 

recommendations, but no legislative recommendations. A further 

report was required to be submitted by the Secretary to the Congress by October 26, 2002. 

HOUSE BILL

The House bill adds an additional civil penalty that may be imposed on any person who violates this reporting requirement (without regard to willfulness). This new civil penalty is up to $5,000. 

The penalty may be waived if any income from the account was 

properly reported on the income tax return and there was reasonable cause for the failure to report. 

Effective date.—The House bill provision is effective with respect to failures to report occurring on or after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the maximum additional civil penalty for a non-willful act is up to 

$10,000. In addition, the Senate amendment increases the presentlaw penalty for willful behavior to the greater of $100,000 or 50 

percent of the amount of the transaction or account. 

Effective date.—The Senate amendment provision is effective 

with respect to failures to report occurring on or after the date of 

enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

616 

516 31 U.S.C. sec. 330. 

12. Regulation of individuals practicing before the Department of 

the Treasury (sec. 622 of the House bill, sec. 414 of the Senate 

amendment, and sec. 330 of Title 31, United States Code) 

PRESENT LAW

The Secretary is authorized to regulate the practice of representatives of persons before the Department of the Treasury.516

The Secretary is also authorized to suspend or disbar from practice 

before the Department a representative who is incompetent, who is 

disreputable, who violates the rules regulating practice before the 

Department, or who (with intent to defraud) willfully and knowingly misleads or threatens the person being represented (or a person who may be represented). The rules promulgated by the Secretary pursuant to this provision are contained in Circular 230. 

HOUSE BILL

The House bill makes two modifications to expand the sanctions that the Secretary may impose pursuant to these statutory 

provisions. First, the House bill expressly permits censure as a 

sanction. Second, the House bill permits the imposition of a monetary penalty as a sanction. If the representative is acting on behalf 

of an employer or other entity, the Secretary may impose a monetary penalty on the employer or other entity if it knew, or reasonably should have known, of the conduct. This monetary penalty on 

the employer or other entity may be imposed in addition to any 

monetary penalty imposed directly on the representative. These 

monetary penalties are not to exceed the gross income derived (or 

to be derived) from the conduct giving rise to the penalty. These 

monetary penalties may be in addition to, or in lieu of, any suspension, disbarment, or censure of such individual. 

The House bill also confirms the present-law authority of the 

Secretary to impose standards applicable to written advice with respect to an entity, plan, or arrangement that is of a type that the 

Secretary determines as having a potential for tax avoidance or 

evasion. 

Effective date.—The House bill modifications to expand the 

sanctions that the Secretary may impose are effective for actions 

taken after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill (except 

for several technical drafting modifications). 

Effective date.—The Senate amendment modifications to expand the sanctions that the Secretary may impose are effective for 

actions taken after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

617 

517 Helvering v. Horst, 311 U.S. 112 (1940). 518Depending on the facts, the IRS also could determine that a variety of other Code-based 

and common law-based authorities could apply to income stripping transactions, including: (1) 

sections 269, 382, 446(b), 482, 701, or 704 and the regulations thereunder; (2) authorities that 

recharacterize certain assignments or accelerations of future payments as financings; (3) business purpose, economic substance, and sham transaction doctrines; (4) the step transaction doctrine; and (5) the substance-over-form doctrine. See Notice 95–53, 1995–2 C.B. 334 (accounting 

for lease strips and other stripping transactions). 519 However, in Estate of Stranahan v. Commissioner, 472 F.2d 867 (6th Cir. 1973), the court 

held that where a taxpayer sold a carved-out interest of stock dividends, with no personal obligation to produce the income, the transaction was treated as a sale of an income interest. 520Sec. 1286. 521Sec. 1286(e). 

13. Treatment of stripped bonds to apply to stripped interests in 

bond and preferred stock funds (sec. 631 of the House bill, sec. 

461 of the Senate amendment, and secs. 305 and 1286 of the 

Code) 

PRESENT LAW

Assignment of income in general 

In general, an ‘‘income stripping’’ transaction involves a transaction in which the right to receive future income from income-producing property is separated from the property itself. In such 

transactions, it may be possible to generate artificial losses from 

the disposition of certain property or to defer the recognition of taxable income associated with such property. 

Common law has developed a rule (referred to as the ‘‘assignment of income’’ doctrine) whereby if the right to receive income is 

transferred without an accompanying transfer of the underlying 

property, the transfer is not respected. A leading judicial decision 

relating to the assignment of income doctrine involved a case in 

which a taxpayer made a gift of detachable interest coupons before 

their due date while retaining the bearer bond. The U.S. Supreme 

Court ruled that the donor was taxable on the entire amount of interest when paid to the donee on the grounds that the transferor 

had ‘‘assigned’’ to the donee the right to receive the income.517

In addition to general common law assignment of income principles, specific statutory rules have been enacted to address certain 

specific types of stripping transactions, such as transactions involving stripped bonds and stripped preferred stock (which are discussed below).518 However, there are no specific statutory rules 

that address stripping transactions with respect to common stock 

or other equity interests (other than preferred stock).519

Stripped bonds 

Special rules are provided with respect to the purchaser and 

‘‘stripper’’ of stripped bonds.520 A ‘‘stripped bond’’ is defined as a 

debt instrument in which there has been a separation in ownership 

between the underlying debt instrument and any interest coupon 

that has not yet become payable.521 In general, upon the disposition of either the stripped bond or the detached interest coupons, 

the retained portion and the portion that is disposed of each is 

treated as a new bond that is purchased at a discount and is payable at a fixed amount on a future date. Accordingly, section 1286 

treats both the stripped bond and the detached interest coupons as 

individual bonds that are newly issued with original issue discount 

618 

522Sec. 1286(a). 523Sec. 1286(b). Similar rules apply in the case of any person whose basis in any bond or coupon is determined by reference to the basis in the hands of a person who strips the bond. 524Special rules are provided with respect to stripping transactions involving tax-exempt obligations that treat OID (computed under the stripping rules) in excess of OID computed on the 

basis of the bond’s coupon rate (or higher rate if originally issued at a discount) as income from 

a non-tax-exempt debt instrument (sec. 1286(d)). 525Sec. 305(e)(5). 526Sec. 305(e)(1). 

(‘‘OID’’) on the date of disposition. Consequently, section 1286 effectively subjects the stripped bond and the detached interest coupons 

to the general OID periodic income inclusion rules. 

A taxpayer who purchases a stripped bond or one or more 

stripped coupons is treated as holding a new bond that is issued 

on the purchase date with OID in an amount that is equal to the 

excess of the stated redemption price at maturity (or in the case 

of a coupon, the amount payable on the due date) over the ratable 

share of the purchase price of the stripped bond or coupon, determined on the basis of the respective fair market values of the 

stripped bond and coupons on the purchase date.522 The OID on 

the stripped bond or coupon is includible in gross income under the 

general OID periodic income inclusion rules. 

A taxpayer who strips a bond and disposes of either the 

stripped bond or one or more stripped coupons must allocate the 

taxpayer’s basis, immediately before the disposition, in the bond 

(with the coupons attached) between the retained and disposed 

items.523 Special rules apply to require that interest or market discount accrued on the bond prior to such disposition must be included in the taxpayer’s gross income (to the extent that it had not 

been previously included in income) at the time the stripping occurs, and the taxpayer increases the basis in the bond by the 

amount of such accrued interest or market discount. The adjusted 

basis (as increased by any accrued interest or market discount) is 

then allocated between the stripped bond and the stripped interest 

coupons in relation to their respective fair market values. Amounts 

realized from the sale of stripped coupons or bonds constitute income to the taxpayer only to the extent such amounts exceed the 

basis allocated to the stripped coupons or bond. With respect to retained items (either the detached coupons or stripped bond), to the 

extent that the price payable on maturity, or on the due date of the 

coupons, exceeds the portion of the taxpayer’s basis allocable to 

such retained items, the difference is treated as OID that is required to be included under the general OID periodic income inclusion rules.524

Stripped preferred stock 

‘‘Stripped preferred stock’’ is defined as preferred stock in 

which there has been a separation in ownership between such 

stock and any dividend on such stock that has not become payable.525 A taxpayer who purchases stripped preferred stock is required to include in gross income, as ordinary income, the amounts 

that would have been includible if the stripped preferred stock was 

a bond issued on the purchase date with OID equal to the excess 

of the redemption price of the stock over the purchase price.526

This treatment is extended to any taxpayer whose basis in the 

stock is determined by reference to the basis in the hands of the 

619 

527Sec. 305(e)(3). 528 2002–43 I.R.B. 753. 529 2002–9 I.R.B. 572. 

purchaser. A taxpayer who strips and disposes the future dividends 

is treated as having purchased the stripped preferred stock on the 

date of such disposition for a purchase price equal to the taxpayer’s 

adjusted basis in the stripped preferred stock.527

HOUSE BILL

The House bill authorizes the Treasury Department to promulgate regulations that, in appropriate cases, apply rules that are 

similar to the present-law rules for stripped bonds and stripped 

preferred stock to direct or indirect interests in an entity or account substantially all of the assets of which consist of bonds (as 

defined in section 1286(e)(1)), preferred stock (as defined in section 

305(e)(5)(B)), or any combination thereof. The House bill applies 

only to cases in which the present-law rules for stripped bonds and 

stripped preferred stock do not already apply to such interests. 

For example, such Treasury regulations could apply to a transaction in which a person effectively strips future dividends from 

shares in a money market mutual fund (and disposes either the 

stripped shares or stripped future dividends) by contributing the 

shares (with the future dividends) to a custodial account through 

which another person purchases rights to either the stripped 

shares or the stripped future dividends. However, it is intended 

that Treasury regulations issued under the House bill would not 

apply to certain transactions involving direct or indirect interests 

in an entity or account substantially all the assets of which consist 

of tax-exempt obligations (as defined in section 1275(a)(3)), such as 

a tax-exempt bond partnership described in Rev. Proc. 2002–68,528

modifying and superceeding Rev. Proc. 2002–16.529

No inference is intended as to the treatment under the 

present-law rules for stripped bonds and stripped preferred stock, 

or under any other provisions or doctrines of present law, of interests in an entity or account substantially all of the assets of which 

consist of bonds, preferred stock, or any combination thereof. The 

Treasury regulations, when issued, would be applied prospectively, 

except in cases to prevent abuse. 

Effective date.—The House bill provision is effective for purchases and dispositions occurring after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

620 

14. Minimum holding period for foreign tax credit with respect to 

withholding taxes on income other than dividends (sec. 632 of 

the House bill, sec. 456 of the Senate amendment, and sec. 901 

of the Code) 

PRESENT LAW

In general, U.S. persons may credit foreign taxes against U.S. 

tax on foreign-source income. The amount of foreign tax credits 

that may be claimed in a year is subject to a limitation that prevents taxpayers from using foreign tax credits to offset U.S. tax on 

U.S.-source income. Separate limitations are applied to specific categories of income. 

As a consequence of the foreign tax credit limitations of the 

Code, certain taxpayers are unable to utilize their creditable foreign taxes to reduce their U.S. tax liability. U.S. taxpayers that are 

tax-exempt receive no U.S. tax benefit for foreign taxes paid on income that they receive. 

Present law denies a U.S. shareholder the foreign tax credits 

normally available with respect to a dividend from a corporation or 

a regulated investment company (‘‘RIC’’) if the shareholder has not 

held the stock for more than 15 days (within a 30-day testing period) in the case of common stock or more than 45 days (within a 

90-day testing period) in the case of preferred stock (sec. 901(k)). 

The disallowance applies both to foreign tax credits for foreign 

withholding taxes that are paid on the dividend where the dividend-paying stock is held for less than these holding periods, and 

to indirect foreign tax credits for taxes paid by a lower-tier foreign 

corporation or a RIC where any of the required stock in the chain 

of ownership is held for less than these holding periods. Periods 

during which a taxpayer is protected from risk of loss (e.g., by purchasing a put option or entering into a short sale with respect to 

the stock) generally are not counted toward the holding period requirement. In the case of a bona fide contract to sell stock, a special rule applies for purposes of indirect foreign tax credits. The 

disallowance does not apply to foreign tax credits with respect to 

certain dividends received by active dealers in securities. If a taxpayer is denied foreign tax credits because the applicable holding 

period is not satisfied, the taxpayer is entitled to a deduction for 

the foreign taxes for which the credit is disallowed. 

HOUSE BILL

The House bill expands the present-law disallowance of foreign 

tax credits to include credits for gross-basis foreign withholding 

taxes with respect to any item of income or gain from property if 

the taxpayer who receives the income or gain has not held the 

property for more than 15 days (within a 30-day testing period), exclusive of periods during which the taxpayer is protected from risk 

of loss. The House bill does not apply to foreign tax credits that are 

subject to the present-law disallowance with respect to dividends. 

The House bill also does not apply to certain income or gain that 

is received with respect to property held by active dealers. Rules 

similar to the present-law disallowance for foreign tax credits with 

respect to dividends apply to foreign tax credits that are subject to 

the House bill. In addition, the House bill authorizes the Treasury 

621 

530Sec. 721. 531Sec. 723. 532Sec. 722. 533Sec. 704(c)(1)(A). 534If there is an insufficient amount of an item to allocate to the noncontributing partners, 

Treasury regulations allow for curative or remedial allocations to remedy this insufficiency. 

Treas. Reg. sec. 1.704–3(c) and (d). 

Department to issue regulations providing that the House bill does 

not apply in appropriate cases. 

Effective date.—The House bill provision is effective for 

amounts that are paid or accrued more than 30 days after the date 

of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment provision, except the 30-day testing period is 

changed to a 31-day testing period. 

In addition, the conferees intend that the Secretary will prescribe regulations to adapt the holding period and hedging rules of 

section 901(k) to property other than stock. It is anticipated that 

such regulations will provide that credits are not disallowed merely 

because a taxpayer eliminates its risk of loss from interest rate or 

currency fluctuations. In addition, it is intended that such regulations might permit other hedging activities, such as hedging of 

credit risk, provided that the taxpayer does not hedge most of its 

risk of loss with respect to the property unless there has been a 

meaningful and unanticipated change in circumstances. 

15. Treatment of partnership loss transfers and partnership basis 

adjustments (sec. 633 of the House bill, sec. 469 of the Senate 

amendment, and secs. 704, 734, 743, and 754 of the Code) 

PRESENT LAW

Contributions of property 

Under present law, if a partner contributes property to a partnership, generally no gain or loss is recognized to the contributing 

partner at the time of contribution.530 The partnership takes the 

property at an adjusted basis equal to the contributing partner’s 

adjusted basis in the property.531 The contributing partner increases its basis in its partnership interest by the adjusted basis 

of the contributed property.532 Any items of partnership income, 

gain, loss and deduction with respect to the contributed property 

are allocated among the partners to take into account any built-in 

gain or loss at the time of the contribution.533 This rule is intended 

to prevent the transfer of built-in gain or loss from the contributing 

partner to the other partners by generally allocating items to the 

noncontributing partners based on the value of their contributions 

and by allocating to the contributing partner the remainder of each 

item.534

If the contributing partner transfers its partnership interest, 

the built-in gain or loss will be allocated to the transferee partner 

622 

535Treas. Reg. sec. 1.704–3(a)(7). 536Sec. 743(a). 537Sec. 743(b). 538Sec. 731(a) and (b). 539Sec. 732(b). 540Sec. 732(a). 541Sec. 732 (a)(1) and (c). 542Sec. 732(d). 

as it would have been allocated to the contributing partner.535 If 

the contributing partner’s interest is liquidated, there is no specific 

guidance preventing the allocation of the built-in loss to the remaining partners. Thus, it appears that losses can be ‘‘transferred’’ 

to other partners where the contributing partner no longer remains 

a partner. 

Transfers of partnership interests 

Under present law, a partnership does not adjust the basis of 

partnership property following the transfer of a partnership interest unless the partnership has made a one-time election under section 754 to make basis adjustments.536 If an election is in effect, 

adjustments are made with respect to the transferee partner to account for the difference between the transferee partner’s proportionate share of the adjusted basis of the partnership property and 

the transferee’s basis in its partnership interest.537 These adjustments are intended to adjust the basis of partnership property to 

approximate the result of a direct purchase of the property by the 

transferee partner. Under these rules, if a partner purchases an interest in a partnership with an existing built-in loss and no election under section 754 is in effect, the transferee partner may be 

allocated a share of the loss when the partnership disposes of the 

property (or depreciates the property). 

Distributions of partnership property 

With certain exceptions, partners may receive distributions of 

partnership property without recognition of gain or loss by either 

the partner or the partnership.538 In the case of a distribution in 

liquidation of a partner’s interest, the basis of the property distributed in the liquidation is equal to the partner’s adjusted basis in 

its partnership interest (reduced by any money distributed in the 

transaction).539 In a distribution other than in liquidation of a 

partner’s interest, the distributee partner’s basis in the distributed 

property is equal to the partnership’s adjusted basis in the property immediately before the distribution, but not to exceed the 

partner’s adjusted basis in the partnership interest (reduced by any 

money distributed in the same transaction).540

The determination of the basis of individual properties distributed by a partnership is dependent on the adjusted basis of the 

properties in the hands of the partnership.541 If a partnership interest is transferred to a partner and the partnership has not elected to adjust the basis of partnership property, a special basis rule 

provides for the determination of the transferee partner’s basis of 

properties that are later distributed by the partnership.542 Under 

this rule, in determining the basis of property distributed by a 

partnership within 2 years following the transfer of the partnership 

interest, the transferee may elect to determine its basis as if the 

623 

543Treas. Reg. sec. 1.732–1(d)(4). 544Sec. 734(a). 545Sec. 734(b). 546 It is intended that a corporation succeeding to attributes of the contributing corporate partner under section 381 shall be treated in the same manner as the contributing partner. 

partnership had adjusted the basis of the distributed property 

under section 743(b) on the transfer. The special basis rule also applies to distributed property if, at the time of the transfer, the fair 

market value of partnership property other than money exceeds 

110 percent of the partnership’s basis in such property and a liquidation of the partnership interest immediately after the transfer 

would have resulted in a shift of basis to property subject to an allowance of depreciation, depletion or amortization.543

Adjustments to the basis of the partnership’s undistributed 

properties are not required unless the partnership has made the 

election under section 754 to make basis adjustments.544 If an election is in effect under section 754, adjustments are made by a partnership to increase or decrease the remaining partnership assets to 

reflect any increase or decrease in the adjusted basis of the distributed properties in the hands of the distributee partner (or gain or 

loss recognized by the distributee partner).545 To the extent the adjusted basis of the distributed properties increases (or loss is recognized) the partnership’s adjusted basis in its properties is decreased by a like amount; likewise, to the extent the adjusted basis 

of the distributed properties decrease (or gain is recognized), the 

partnership’s adjusted basis in its properties is increased by a like 

amount. Under these rules, a partnership with no election in effect 

under section 754 may distribute property with an adjusted basis 

lower than the distributee partner’s proportionate share of the adjusted basis of all partnership property and leave the remaining 

partners with a smaller net built-in gain or a larger net built-in 

loss than before the distribution. 

HOUSE BILL

Contributions of property 

Under the provision, a built-in loss may be taken into account 

only by the contributing partner and not by other partners. Except 

as provided in regulations, in determining the amount of items allocated to partners other than the contributing partner, the basis 

of the contributed property is treated as the fair market value at 

the time of contribution. Thus, if the contributing partner’s partnership interest is transferred or liquidated, the partnership’s adjusted basis in the property is based on its fair market value at the 

time of contribution, and the built-in loss is eliminated.546

Transfers of partnership interests 

The provision provides generally that the basis adjustment 

rules under section 743 are mandatory in the case of the transfer 

of a partnership interest with respect to which there is a substantial built-in loss (rather than being elective as under present law). 

For this purpose, a substantial built-in loss exists if the partnership’s adjusted basis in its property exceeds by more than $250,000 

the fair market value of the partnership property. 

624 

547Section 3(a)(1)(A) of the Act provides, ′′when used in this title, ‘investment company’ means 

any issuer which is or hold itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.′′ 

Thus, for example, assume that partner A sells his 25-percent 

partnership interest to B for its fair market value of $1 million. 

Also assume that, immediately after the transfer, the fair market 

value of partnership assets is $4 million and the partnership’s adjusted basis in the partnership assets is $4.3 million. Under the 

bill, section 743(b) applies, so that an adjustment is required to the 

adjusted basis of the partnership assets with respect to B. As a result, B would recognize no gain or loss if the partnership immediately sold all its assets for their fair market value. 

The bill provides that an electing investment partnership is 

not treated as having a substantial built-in loss, and thus is not 

required to make basis adjustments to partnership property, in the 

case of a transfer of a partnership interest. In lieu of the partnership basis adjustments, a partner-level loss limitation rule applies. 

Under this rule, the transferee partner’s distributive share of losses 

(determined without regard to gains) from the sale or exchange of 

partnership property is not allowed, except to the extent it is established that the partner’s share of such losses exceeds the loss recognized by the transferor partner. In the event of successive transfers, the transferee partner’s distributive share of such losses is not 

allowed, except to the extent that it is established that such losses 

exceed the loss recognized by the transferor (or any prior transferor 

to the extent not fully offset by a prior disallowance under this 

rule). Losses disallowed under this rule do not decrease the transferee partner’s basis in its partnership interest. Thus, on subsequent disposition of its partnership interest, the partner’s gain is 

reduced (or loss increased) because the basis of the partnership interest has not been reduced by such losses. The provision is applied 

without regard to any termination of a partnership under section 

708(b)(1)(B). In the case of a basis reduction to property distributed 

to the transferee partner in a nonliquidating distribution, the 

amount of the transferor’s loss taken into account under this rule 

is reduced by the amount of the basis reduction. 

For this purpose, an electing investment partnership means a 

partnership that satisfies the following requirements: (1) it makes 

an election under the provision that is irrevocable except with the 

consent of the Secretary; (2) it would be an investment company 

under section 3(a)(1)(A) of the Investment Company Act of 1940 547

but for an exemption under paragraph (1) or (7) of section 3(c) of 

that Act; (3) it has never been engaged in a trade or business; (4) 

substantially all of its assets are held for investment; (5) at least 

95 percent of the assets contributed to it consist of money; (6) no 

assets contributed to it had an adjusted basis in excess of fair market value at the time of contribution; (7) all partnership interests 

are issued by the partnership pursuant to a private offering and 

during the 24-month period beginning on the date of the first capital contribution to the partnership; (8) the partnership agreement 

has substantive restrictions on each partner’s ability to cause a redemption of the partner’s interest, and (9) the partnership agreement provides for a term that is not in excess of 15 years. 

625 

The provision requires an electing investment partnership to 

furnish to any transferee partner the information necessary to enable the partner to compute the amount of losses disallowed under 

this rule. 

Distributions of partnership property 

The provision provides that a basis adjustment under section 

734(b) is required in the case of a distribution with respect to 

which there is a substantial basis reduction. A substantial basis reduction means a downward adjustment of more than $250,000 that 

would be made to the basis of partnership assets if a section 754 

election were in effect. 

Thus, for example, assume that A and B each contributed $2.5 million to a newly formed partnership and C contributed $5 million, and that the partnership purchased LMN stock for $3 million 

and XYZ stock for $7 million. Assume that the value of each stock 

declined to $1 million. Assume LMN stock is distributed to C in liquidation of its partnership interest. Under present law, the basis 

of LMN stock in C’s hands is $5 million. Under present law, C 

would recognize a loss of $4 million if the LMN stock were sold for 

$1 million. 

Under the provision, there is a substantial basis adjustment 

because the $2 million increase in the adjusted basis of LMN stock 

(described in section 734(b)(2)(B)) is greater than $250,000. Thus, 

the partnership is required to decrease the basis of XYZ stock 

(under section 734(b)(2)) by $2 million (the amount by which the 

basis of LMN stock was increased), leaving a basis of $5 million. 

If the XYZ stock were then sold by the partnership for $1 million, 

A and B would each recognize a loss of $2 million. 

Effective date 

The provision applies to contributions, distributions and transfers (as the case may be) after the date of enactment. 

In the case of an electing investment partnership in existence 

on June 4, 2004, the requirement that the partnership agreement 

have substantive restrictions on redemptions does not apply, and 

the requirement that the partnership agreement provide for a term 

not exceeding 15 years is modified to permit a term not exceeding 

20 years. 

SENATE AMENDMENT

Under the provision, adjustments to the basis of partnership 

property in the event of a partnership distribution or the transfer 

of a partnership interest are required, not elective as under present 

law. However, the basis adjustments are elective, as under present 

law, in the case of the transfer of a partnership interest by reason 

of the partner’s death. Any election made by a partnership under 

section 754 that is in effect when the provision becomes effective 

is treated as an election to adjust the basis of partnership property 

with respect to the transferee partner in the case of a transfer of 

a partnership interest upon the death of a partner. The provision 

repeals the special rule of section 732(d) for determining the transferee partner’s basis in property that is later distributed by the 

partnership in cases in which the partnership did not have a secVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00629 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
626 

tion 754 election in effect with respect to the transfer of the partnership interest. 

Effective date.—The provision requiring partnership basis adjustments applies to transfers and distributions after the date of 

enactment. 

The provision repealing section 732(d) applies generally to 

transfers after the date of enactment, except that it applies to distributions made after the date which is 2 years following the date 

of enactment in the case of any transfer to which section 732(d) applies that is made on or before the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement generally follows the House bill, 

with modifications. 

The conference agreement modifies the qualification requirements for electing investment partnerships that are subject to a 

partner-level loss limitation rule in lieu of the requirement of partnership basis adjustments following certain transfers of partnership interests. Specifically, the conference agreement requires that 

all partnership interests be issued by such a partnership pursuant 

to a private offering prior to the date that is 24 months after the 

date of the first capital contribution to the partnership. The conferees intend that ‘‘dry’’ closings in which partnership interests are 

issued without the contribution of capital not start the running of 

the 24-month period. 

It is intended that in applying the requirement (with respect 

electing investment partnerships) that the partnership agreement 

have substantive restrictions on each partner’s ability to cause a 

redemption, the following are illustrative examples of substantive 

restrictions: a violation of Federal or State law (such as ERISA or 

the Bank Holding Company Act); and imposition of a Federal excise tax on, or a change in the Federal tax-exempt status of, a taxexempt partner. 

The conferees understand that electing investment partnerships will generally include venture capital funds, buyout funds, 

and funds of funds. These funds are formed to raise capital from 

investors pursuant to a private offering and to make investments 

during the limited term of the partnership with the intention of 

holding the investments for capital appreciation. 

With respect to the requirement that an electing investment 

partnership furnish to any transferee partner the information necessary to enable the partner to compute the amount of losses disallowed under this rule, it is expected that in some cases the transferor of the partnership interest will furnish information relating 

to the amount of its loss to the transferee partner. It is intended 

that the requirement that the electing investment partnership furnish necessary information to the transferee partner be administered by the Treasury Secretary in a manner that (to the greatest 

extent feasible) minimizes the need for the partnership to furnish 

information to the transferee partner that the transferee partner 

has obtained from the transferor. 

The conference agreement adds an exception for securitization 

partnerships to the rules requiring partnership basis adjustments 

in the case of transfers of partnership interests and distributions 

627 

548See Treas. Reg. sec. 1.860G–2(a)(3), providing that a sponsor’s belief is not reasonable if 

the sponsor actually knows or has reason to know that the requirement is not met, or if the 

requirement is later discovered not to have been met. 549See Rev. Proc. 2001–36, 2001–1 C.B. 1326. Definitional requirements of a master-feeder 

structure include that there is a portfolio of assets that is treated as a partnership for Federal 

tax purposes and that is registered as an investment company under the Investment Company 

Act of 1940, each partner of which is a feeder fund that is a registered investment company 

(RIC) for Federal tax purposes, or is an investment advisor, principal underwriter, or manager 

of the portfolio. The conferees believe that these restrictions (and other applicable restrictions) 

serve to limit potential avoidance of the section 704(c) provision of the conference agreement 

through use of the aggregate method in the case of master-feeder structures. 

of property to a partner. The exceptions provide that a 

securitization partnership is not treated as having a substantial 

built-in loss in the case of a transfer of a partnership interest, or 

as having a substantial basis reduction in the case of a partnership 

distribution, and thus is not required to make basis adjustments to 

partnership property. Partnership basis adjustments remain elective for such a partnership. Unlike in the case of an electing investment partnership, the partner-level loss limitation rule does not 

apply in the case of a securitization partnership. For this purpose, 

a securitization partnership is any partnership the sole business 

activity of which is to issue securities that provide for a fixed principal (or similar) amount and that are primarily serviced by the 

cash flows of a discrete pool (either fixed or revolving) of receivables or other financial assets that by their terms convert into cash 

in a finite period, but only if the sponsor of the pool reasonably believes that the receivables and other financial assets comprising 

the pool are not acquired so as to be disposed of. It is intended that 

rules similar to those applicable to sponsors of REMICs apply in 

determining whether the sponsor’s belief is reasonable.548 It is not 

intended that the rules requiring partnership basis adjustments on 

transfers or distributions be avoided through dispositions of pool 

assets. 

It is intended that an electing investment partnership or 

securitization partnership that subsequently fails to meet the definition of an electing investment partnership or of a securitization 

partnership will be subject to the partnership basis adjustment 

rules of the provision with respect to the first transfer of a partnership interest (and, in the case of a securitization partnership, the 

first distribution) that occurs after the partnership ceases to meet 

the applicable definition and to each subsequent transfer (and distribution, in the case of a securitization partnership). 

It is not intended that the rules of the conference agreement 

provisions be avoided through the use of tiered partnerships. 

It is not intended that the provision relating to contributions 

of built-in loss property limit the ability of master-feeder structures 

to apply an aggregate method for making allocations under section 

704(c) to the extent the aggregate method is permitted under 

present law.549

Effective date.—The conference agreement follows the House 

bill. 

628 

550Sec. 721(a). 551Sec. 731(a) and (b). 552Sec. 732(b). 553Sec. 754. 

16. No reduction of basis under section 734 in stock held by partnership in corporate partner (sec. 634 of the House bill, sec. 

432 of the Senate amendment, and sec. 755 of the Code) 

PRESENT LAW

In general 

Generally, a partner and the partnership do not recognize gain 

or loss on a contribution of property to the partnership.550 Similarly, a partner and the partnership generally do not recognize gain 

or loss on the distribution of partnership property.551 This includes 

current distributions and distributions in liquidation of a partner’s 

interest. 

Basis of property distributed in liquidation 

The basis of property distributed in liquidation of a partner’s 

interest is equal to the partner’s tax basis in its partnership interest (reduced by any money distributed in the same transaction).552

Thus, the partnership’s tax basis in the distributed property is adjusted (increased or decreased) to reflect the partner’s tax basis in 

the partnership interest. 

Election to adjust basis of partnership property 

When a partnership distributes partnership property, the basis 

of partnership property generally is not adjusted to reflect the effects of the distribution or transfer. However, the partnership is 

permitted to make an election (referred to as a 754 election) to adjust the basis of partnership property in the case of a distribution 

of partnership property.553 The effect of the 754 election is that the 

partnership adjusts the basis of its remaining property to reflect 

any change in basis of the distributed property in the hands of the 

distributee partner resulting from the distribution transaction. 

Such a change could be a basis increase due to gain recognition, 

or a basis decrease due to the partner’s adjusted basis in its partnership interest exceeding the adjusted basis of the property received. If the 754 election is made, it applies to the taxable year 

with respect to which such election was filed and all subsequent 

taxable years. 

In the case of a distribution of partnership property to a partner with respect to which the 754 election is in effect, the partnership increases the basis of partnership property by (1) any gain recognized by the distributee partner and (2) the excess of the adjusted basis of the distributed property to the partnership immediately before its distribution over the basis of the property to the 

distributee partner, and decreases the basis of partnership property by (1) any loss recognized by the distributee partner and (2) 

the excess of the basis of the property to the distributee partner 

over the adjusted basis of the distributed property to the partnership immediately before the distribution. 

629 

554Sec. 755(a). 555Sec. 755(b). 556Sections 860H through 860L. 

The allocation of the increase or decrease in basis of partnership property is made in a manner that has the effect of reducing 

the difference between the fair market value and the adjusted basis 

of partnership properties.554 In addition, the allocation rules require that any increase or decrease in basis be allocated to partnership property of a like character to the property distributed. For 

this purpose, the two categories of assets are (1) capital assets and 

depreciable and real property used in the trade or business held for 

more than one year, and (2) any other property.555

HOUSE BILL

The provision provides that in applying the basis allocation 

rules to a distribution in liquidation of a partner’s interest, a partnership is precluded from decreasing the basis of corporate stock 

of a partner or a related person. Any decrease in basis that, absent 

the provision, would have been allocated to the stock is allocated 

to other partnership assets. If the decrease in basis exceeds the 

basis of the other partnership assets, then gain is recognized by the 

partnership in the amount of the excess. 

Effective date.—The provision applies to distributions after the 

date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

for the effective date. 

Effective date.—The provision applies to distributions after 

February 13, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

Effective date.—The conference agreement follows the House 

bill. 

17. Repeal of special rules for FASITs (sec. 635 of the House bill, 

sec. 433 of the Senate amendment, and secs. 860H through 

860L of the Code) 

PRESENT LAW

Financial asset securitization investment trusts 

In 1996 Congress created a new type of statutory entity called 

a ‘‘financial asset securitization trust’’ (‘‘FASIT’’) that facilitates the 

securitization of debt obligations such as credit card receivables, 

home equity loans, and auto loans.556 A FASIT generally is not taxable; the FASIT’s taxable income or net loss flows through to the 

owner of the FASIT. 

The ownership interest of a FASIT generally is required to be 

entirely held by a single domestic C corporation. In addition, a 

FASIT generally may hold only qualified debt obligations, and certain other specified assets, and is subject to certain restrictions on 

its activities. An entity that qualifies as a FASIT can issue one or 

630 

557Once an election to be a FASIT is made, the election applies from the date specified in 

the election and all subsequent years until the entity ceases to be a FASIT. If an election to 

be a FASIT is made after the initial year of an entity, all of the assets in the entity at the time 

of the FASIT election are deemed contributed to the FASIT at that time and, accordingly, any 

gain (but not loss) on such assets will be recognized at that time. 

more classes of instruments that meet certain specified requirements and treat those instruments as debt for Federal income tax 

purposes. Instruments issued by a FASIT bearing yields to maturity over five percentage points above the yield to maturity on specified United States government obligations (i.e., ‘‘high-yield interests’’) must be held, directly or indirectly, only by domestic C corporations that are not exempt from income tax. 

Qualification as a FASIT 

To qualify as a FASIT, an entity must: (1) make an election 

to be treated as a FASIT for the year of the election and all subsequent years; 557 (2) have assets substantially all of which (including 

assets that the FASIT is treated as owning because they support 

regular interests) are specified types called ‘‘permitted assets;’’ (3) 

have non-ownership interests be certain specified types of debt instruments called ‘‘regular interests’’; (4) have a single ownership interest which is held by an ‘‘eligible holder’’; and (5) not qualify as 

a regulated investment company (‘‘RIC’’). Any entity, including a 

corporation, partnership, or trust may be treated as a FASIT. In 

addition, a segregated pool of assets may qualify as a FASIT. 

An entity ceases qualifying as a FASIT if the entity’s owner 

ceases being an eligible corporation. Loss of FASIT status is treated as if all of the regular interests of the FASIT were retired and 

then reissued without the application of the rule that deems regular interests of a FASIT to be debt. 

Permitted assets 

For an entity or arrangement to qualify as a FASIT, substantially all of its assets must consist of the following ‘‘permitted assets’’: (1) cash and cash equivalents; (2) certain permitted debt instruments; (3) certain foreclosure property; (4) certain instruments 

or contracts that represent a hedge or guarantee of debt held or 

issued by the FASIT; (5) contract rights to acquire permitted debt 

instruments or hedges; and (6) a regular interest in another 

FASIT. Permitted assets may be acquired at any time by a FASIT, 

including any time after its formation. 

‘‘Regular interests’’ of a FASIT 

‘‘Regular interests’’ of a FASIT are treated as debt for Federal 

income tax purposes, regardless of whether instruments with similar terms issued by non-FASITs might be characterized as equity 

under general tax principles. To be treated as a ‘‘regular interest’’, 

an instrument must have fixed terms and must: (1) unconditionally 

entitle the holder to receive a specified principal amount; (2) pay 

interest that is based on (a) fixed rates, or (b) except as provided 

by regulations issued by the Treasury Secretary, variable rates permitted with respect to REMIC interests under section 

860G(a)(1)(B)(i); (3) have a term to maturity of no more than 30 

years, except as permitted by Treasury regulations; (4) be issued to 

631 

the public with a premium of not more than 25 percent of its stated 

principal amount; and (5) have a yield to maturity determined on 

the date of issue of less than five percentage points above the applicable Federal rate (‘‘AFR’’) for the calendar month in which the 

instrument is issued. 

Permitted ownership holder 

A permitted holder of the ownership interest in a FASIT generally is a non-exempt (i.e., taxable) domestic C corporation, other 

than a corporation that qualifies as a RIC, REIT, REMIC, or cooperative. 

Transfers to FASITs 

In general, gain (but not loss) is recognized immediately by the 

owner of the FASIT upon the transfer of assets to a FASIT. Where 

property is acquired by a FASIT from someone other than the 

FASIT’s owner (or a person related to the FASIT’s owner), the 

property is treated as being first acquired by the FASIT’s owner for 

the FASIT’s cost in acquiring the asset from the non-owner and 

then transferred by the owner to the FASIT. 

Valuation rules.—In general, except in the case of debt instruments, the value of FASIT assets is their fair market value. Similarly, in the case of debt instruments that are traded on an established securities market, the market price is used for purposes of 

determining the amount of gain realized upon contribution of such 

assets to a FASIT. However, in the case of debt instruments that 

are not traded on an established securities market, special valuation rules apply for purposes of computing gain on the transfer of 

such debt instruments to a FASIT. Under these rules, the value of 

such debt instruments is the sum of the present values of the reasonably expected cash flows from such obligations discounted over 

the weighted average life of such assets. The discount rate is 120 

percent of the AFR, compounded semiannually, or such other rate 

that the Treasury Secretary shall prescribe by regulations. 

Taxation of a FASIT 

A FASIT generally is not subject to tax. Instead, all of the 

FASIT’s assets and liabilities are treated as assets and liabilities 

of the FASIT’s owner and any income, gain, deduction or loss of the 

FASIT is allocable directly to its owner. Accordingly, income tax 

rules applicable to a FASIT (e.g., related party rules, sec. 871(h), 

sec. 165(g)(2)) are to be applied in the same manner as they apply 

to the FASIT’s owner. The taxable income of a FASIT is calculated 

using an accrual method of accounting. The constant yield method 

and principles that apply for purposes of determining original issue 

discount (‘‘OID’’) accrual on debt obligations whose principal is subject to acceleration apply to all debt obligations held by a FASIT 

to calculate the FASIT’s interest and discount income and premium 

deductions or adjustments. 

Taxation of holders of FASIT regular interests 

In general, a holder of a regular interest is taxed in the same 

manner as a holder of any other debt instrument, except that the 

regular interest holder is required to account for income relating to 

632 

the interest on an accrual method of accounting, regardless of the 

method of accounting otherwise used by the holder. 

Taxation of holders of FASIT ownership interests 

Because all of the assets and liabilities of a FASIT are treated 

as assets and liabilities of the holder of a FASIT ownership interest, the ownership interest holder takes into account all of the 

FASIT’s income, gain, deduction, or loss in computing its taxable 

income or net loss for the taxable year. The character of the income 

to the holder of an ownership interest is the same as its character 

to the FASIT, except tax-exempt interest is included in the income 

of the holder as ordinary income. 

Although the recognition of losses on assets contributed to the 

FASIT is not allowed upon contribution of the assets, such losses 

may be allowed to the FASIT owner upon their disposition by the 

FASIT. Furthermore, the holder of a FASIT ownership interest is 

not permitted to offset taxable income from the FASIT ownership 

interest (including gain or loss from the sale of the ownership interest in the FASIT) with other losses of the holder. In addition, 

any net operating loss carryover of the FASIT owner shall be computed by disregarding any income arising by reason of a disallowed 

loss. Where the holder of a FASIT ownership interest is a member 

of a consolidated group, this rule applies to the consolidated group 

of corporations of which the holder is a member as if the group 

were a single taxpayer. 

HOUSE BILL

The House bill repeals the special rules for FASITs. The House 

bill provides a transition period for existing FASITs, pursuant to 

which the repeal of the FASIT rules generally does not apply to 

any FASIT in existence on the date of enactment to the extent that 

regular interests issued by the FASIT prior to such date continue 

to remain outstanding in accordance with their original terms. 

For purposes of the REMIC rules, the House bill also modifies 

the definitions of REMIC regular interests, qualified mortgages, 

and permitted investments so that certain types of real estate loans 

and loan pools can be transferred to, or purchased by, a REMIC. 

Specifically, the provision modifies the present-law definition of a 

REMIC ‘‘regular interest’’ to provide that an interest in a REMIC 

does not fail to qualify as a regular interest solely because the specified principal amount of such interest or the amount of interest accrued on such interest could be reduced as a result of the nonoccurrence of one or more contingent payments with respect to one or 

more reverse mortgages loans, as defined below, that are held by 

the REMIC, provided that on the startup day for the REMIC, the 

REMIC sponsor reasonably believes that all principal and interest 

due under the interest will be paid at or prior to the liquidation 

of the REMIC. For this purpose, a reasonable belief concerning ultimate payment of all amounts due under an interest is presumed 

to exist if, as of the startup day, the interest receives an investment grade rating from at least one nationally recognized statistical rating agency. 

In addition, the provision makes three modifications to the 

present-law definition of a ‘‘qualified mortgage.’’ First, the provision 

633 

modifies the definition to include an obligation principally secured 

by real property which represents an increase in the principal 

amount under the original terms of an obligation, provided such increase: (1) is attributable to an advance made to the obligor pursuant to the original terms of the obligation; (2) occurs after the 

REMIC startup day; and (3) is purchased by the REMIC pursuant 

to a fixed price contract in effect on the startup day. Second, the 

provision modifies the definition to generally include reverse mortgage loans and the periodic advances made to obligors on such 

loans. For this purpose, a ‘‘reverse mortgage loan’’ is defined as a 

loan that: (1) is secured by an interest in real property; (2) provides 

for one or more advances of principal to the obligor (each such advance giving rise to a ‘‘balance increase’’), provided such advances 

are principally secured by an interest in the same real property as 

that which secures the loan; (3) may provide for a contingent payment at maturity based upon the value or appreciation in value of 

the real property securing the loan; (4) provides for an amount due 

at maturity that cannot exceed the value, or a specified fraction of 

the value, of the real property securing the loan; (5) provides that 

all payments under the loan are due only upon the maturity of the 

loan; and (6) matures after a fixed term or at the time the obligor 

ceases to use as a personal residence the real property securing the 

loan. Third, the provision modifies the definition to provide that, if 

more than 50 percent of the obligations transferred to, or purchased by, the REMIC are (1) originated by the United States or 

any State (or any political subdivision, agency, or instrumentality 

of the United States or any State) and (2) principally secured by 

an interest in real property, then each obligation transferred to, or 

purchased by, the REMIC shall be treated as secured by an interest in real property. 

In addition, the provision modifies the present-law definition of 

a ‘‘permitted investment’’ to include intangible investment property 

held as part of a reasonably required reserve to provide a source 

of funds for the purchase of obligations described above as part of 

the modified definition of a ‘‘qualified mortgage.’’ 

Effective date.—Except as provided by the transition period for 

existing FASITs, the House bill is effective January 1, 2005. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

for the effective date. 

Effective date.—Except as provided by the transition period for 

existing FASITs, the Senate amendment is effective on February 

14, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill provision. 

634 

558Sec. 351. 559Sec. 358. 560Secs. 334(b) and 362(a) and (b). 561The Senate amendment also applies to transfers from a tax-exempt organization where 

gain or loss would not be subject to tax if the property were sold by the organization. 

18. Limitation on transfer and importation of built-in losses (sec. 

636 of the House bill, sec. 431 of the Senate amendment, and 

secs. 362 and 334 of the Code) 

PRESENT LAW

Generally, no gain or loss is recognized when one or more persons transfer property to a corporation in exchange for stock and 

immediately after the exchange such person or persons control the 

corporation.558 The transferor’s basis in the stock of the controlled 

corporation is the same as the basis of the property contributed to 

the controlled corporation, increased by the amount of any gain (or 

dividend) recognized by the transferor on the exchange, and reduced by the amount of any money or property received, and by the 

amount of any loss recognized by the transferor.559

The basis of property received by a corporation, whether from 

domestic or foreign transferors, in a tax-free incorporation, reorganization, or liquidation of a subsidiary corporation is the same as 

the adjusted basis in the hands of the transferor, adjusted for gain 

or loss recognized by the transferor.560

HOUSE BILL

The House bill provides that if a residual interest (as defined 

in section 860G(a)(2)) in a real estate mortgage investment conduit 

(‘‘REMIC’’) is contributed to a corporation and the transferee corporation’s adjusted basis in the REMIC residual interest would 

(but for the provision) exceed the fair market value of the REMIC 

residual interest immediately after the contribution, the transferee 

corporation’s adjusted basis in the REMIC residual interest is limited to the fair market value of the REMIC residual interest immediately after the contribution, regardless of whether the fair market value of the REMIC residual interest is less than, equal to, or 

greater than zero (i.e., the provision may result in the transferee 

corporation having a negative adjusted basis in the REMIC residual interest). 

Effective date.—The House bill provision applies to transactions after the date of enactment. 

SENATE AMENDMENT

Importation of built-in losses 

The Senate Amendment provides that if a net built-in loss is 

imported into the U.S in a tax-free organization or reorganization 

from persons not subject to U.S. tax, the basis of each property so 

transferred is its fair market value.561 A similar rule applies in the 

case of the tax-free liquidation by a domestic corporation of its foreign subsidiary. 

Under the Senate amendment, a net built-in loss is treated as 

imported into the U.S. if the aggregate adjusted bases of property 

received by a transferee corporation exceed the fair market value 

635 

of the properties transferred. Thus, for example, if in a tax-free incorporation, some properties are received by a corporation from 

U.S. persons subject to tax, and some properties are received from 

foreign persons not subject to U.S. tax, this provision applies to 

limit the adjusted basis of each property received from the foreign 

persons to the fair market value of the property. In the case of a 

transfer by a partnership (either domestic or foreign), this provision applies as if the properties had been transferred by each of the 

partners in proportion to their interests in the partnership. 

Limitation on transfer of built-in losses in section 351 transactions 

The Senate amendment provides that if the aggregate adjusted 

bases of property contributed by a transferor (or by a control group 

of which the transferor is a member) to a corporation exceed the 

aggregate fair market value of the property transferred in a taxfree incorporation, the transferee’s aggregate basis of the properties 

is limited to the aggregate fair market value of the transferred 

property. Under the Senate Amendment, any required basis reduction is allocated among the transferred properties in proportion to 

their built-in-loss immediately before the transaction. In the case 

of a transfer in which the transferor owns at least 80 percent of 

the vote and value of the stock of the transferee corporation, any 

basis reduction required by the provision is made to the stock received by the transferor and not to the assets transferred. 

Effective date 

The Senate amendment provision applies to transactions after 

December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, with 

modifications to the limitation on transfer of built-in losses in section 351 transactions. The conference agreement eliminates the 

provision that requires a basis reduction to be made to stock received by the transferor (rather than to the assets transferred) in 

the case of a transfer in which the transferor owns at least 80 percent of the vote and value of the stock of the transferee corporation. 

Thus, the provision that limits the transferee’s aggregate basis in 

the transferred property to the aggregate fair market value of the 

transferred property generally applies, regardless of the ownership 

percentage of the transferor in the stock of the transferee corporation. 

In addition, the conference agreement permits the transferor 

and transferee to elect to limit the basis in the stock received by 

the transferor to the aggregate fair market value of the transferred 

property, in lieu of limiting the basis in the assets transferred. 

Such election shall be included with the tax returns of the transferor and transferee for the taxable year in which the transaction 

occurs and, once made, shall be irrevocable. 

636 

562Secs. 951–964. 563Sec. 951(a)(1)(B). 564Sec. 956(a). 565Secs. 956 and 959. 566Secs. 951(a)(1)(B) and 959. 567Sec. 956(c)(1). 

19. Clarification of banking business for purposes of determining 

investment of earnings in U.S. property (sec. 637 of the House 

bill, sec. 451 of the Senate amendment, and sec. 956 of the 

Code) 

PRESENT LAW

In general, the subpart F rules 562 require the U.S. 10-percent 

shareholders of a controlled foreign corporation to include in income currently their pro rata shares of certain income of the controlled foreign corporation (referred to as ‘‘subpart F income’’), 

whether or not such earnings are distributed currently to the 

shareholders. In addition, the U.S. 10-percent shareholders of a 

controlled foreign corporation are subject to U.S. tax currently on 

their pro rata shares of the controlled foreign corporation’s earnings to the extent invested by the controlled foreign corporation in 

certain U.S. property.563

A shareholder’s current income inclusion with respect to a controlled foreign corporation’s investment in U.S. property for a taxable year is based on the controlled foreign corporation’s average 

investment in U.S. property for such year. For this purpose, the 

U.S. property held (directly or indirectly) by the controlled foreign 

corporation must be measured as of the close of each quarter in the 

taxable year.564 The amount taken into account with respect to any 

property is the property’s adjusted basis as determined for purposes of reporting the controlled foreign corporation’s earnings and 

profits, reduced by any liability to which the property is subject. 

The amount determined for current inclusion is the shareholder’s 

pro rata share of an amount equal to the lesser of: (1) the controlled foreign corporation’s average investment in U.S. property as 

of the end of each quarter of such taxable year, to the extent that 

such investment exceeds the foreign corporation’s earnings and 

profits that were previously taxed on that basis; or (2) the controlled foreign corporation’s current or accumulated earnings and 

profits (but not including a deficit), reduced by distributions during 

the year and by earnings that have been taxed previously as earnings invested in U.S. property.565 An income inclusion is required 

only to the extent that the amount so calculated exceeds the 

amount of the controlled foreign corporation’s earnings that have 

been previously taxed as subpart F income.566

For purposes of section 956, U.S. property generally is defined 

to include tangible property located in the United States, stock of 

a U.S. corporation, an obligation of a U.S. person, and certain intangible assets including a patent or copyright, an invention, model 

or design, a secret formula or process or similar property right 

which is acquired or developed by the controlled foreign corporation 

for use in the United States.567

Specified exceptions from the definition of U.S. property are 

provided for: (1) obligations of the United States, money, or deposVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00640 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
637 

568Sec. 956(c)(2). 569 286 F.3d 324 (6th Cir. 2002), rev’g 113 T.C. 169 (1999). 

its with persons carrying on the banking business; (2) certain export property; (3) certain trade or business obligations; (4) aircraft, 

railroad rolling stock, vessels, motor vehicles or containers used in 

transportation in foreign commerce and used predominantly outside of the United States; (5) certain insurance company reserves 

and unearned premiums related to insurance of foreign risks; (6) 

stock or debt of certain unrelated U.S. corporations; (7) moveable 

property (other than a vessel or aircraft) used for the purpose of 

exploring, developing, or certain other activities in connection with 

the ocean waters of the U.S. Continental Shelf; (8) an amount of 

assets equal to the controlled foreign corporation’s accumulated 

earnings and profits attributable to income effectively connected 

with a U.S. trade or business; (9) property (to the extent provided 

in regulations) held by a foreign sales corporation and related to 

its export activities; (10) certain deposits or receipts of collateral or 

margin by a securities or commodities dealer, if such deposit is 

made or received on commercial terms in the ordinary course of the 

dealer’s business as a securities or commodities dealer; and (11) 

certain repurchase and reverse repurchase agreement transactions 

entered into by or with a dealer in securities or commodities in the 

ordinary course of its business as a securities or commodities dealer.568

With regard to the exception for deposits with persons carrying 

on the banking business, the U.S. Court of Appeals for the Sixth 

Circuit in The Limited, Inc. v. Commissioner 569 concluded that a 

U.S. subsidiary of a U.S. shareholder was ‘‘carrying on the banking 

business’’ even though its operations were limited to the administration of the private label credit card program of the U.S. shareholder. Therefore, the court held that a controlled foreign corporation of the U.S. shareholder could make deposits with the subsidiary (e.g., through the purchase of certificates of deposit) under 

this exception, and avoid taxation of the deposits under section 956 

as an investment in U.S. property. 

HOUSE BILL

The House bill provides that the exception from the definition 

of U.S. property under section 956 for deposits with persons carrying on the banking business is limited to deposits with persons 

at least 80-percent of the gross income of which is derived in the 

active conduct of a banking business from unrelated persons. For 

purposes of applying the House bill, the deposit recipient and all 

persons related to the deposit recipient are treated as one person 

in applying the 80-percent test. 

No inference is intended as to the meaning of the phrase ‘‘carrying on the banking business’’ under present law. 

Effective date.—The House bill provision is effective on the 

date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the Senate amendment applies the 80-percent test by reference to 

638 

570 A special rule provides that a mutual property and casualty insurance company is eligible 

to be exempt from Federal income tax under the provision if (a) its gross receipts for the taxable 

year do not exceed $150,000, and (b) the premiums received for the taxable year are greater 

than 35 percent of its gross receipts, provided certain requirements are met. The requirements 

are that no employee of the company or member of the employee’s family is an employee of another company that is exempt from tax under section 501(c)(15) (or would be, but for this rule). 

financial services income (as defined in section 904(d)(2)(C)(ii) rather than the active conduct of a banking business. 

Effective date.—The Senate amendment provision is effective 

on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement provides that the exception from the 

definition of U.S. property under section 956 for deposits with persons carrying on the banking business is limited to deposits with: 

(1) any bank (as defined by section 2(c) of the Bank Holding Company Act of 1956 (12 U.S.C. 1841(c), without regard to paragraphs 

(C) and (G) of paragraph (2) of such section); or (2) any other corporation with respect to which a bank holding company (as defined 

by section 2(a) of such Act) or financial holding company (as defined by section 2(p) of such Act) owns directly or indirectly more 

than 80 percent by vote or value of the stock of such corporation. 

No inference is intended as to the meaning of the phrase ‘‘carrying on the banking business’’ under present law. 

Effective date.—The conference agreement provision is effective 

on the date of enactment. 

20. Alternative tax for small insurance companies and modification 

of exemption from tax for small property and casualty insurance companies (sec. 638 of the House bill, sec. 493 of the Senate amendment, and secs. 501(c)(15) and 831(b) of the Code) 

PRESENT LAW

A property and casualty insurance company generally is subject to tax on its taxable income (sec. 831(a)). The taxable income 

of a property and casualty insurance company is determined as the 

sum of its underwriting income and investment income (as well as 

gains and other income items), reduced by allowable deductions 

(sec. 832). 

A property and casualty insurance company may elect to be 

taxed only on taxable investment income if its net written premiums or direct written premiums (whichever is greater) do not exceed $1.2 million (sec. 831(b)). For purposes of determining the 

amount of a company’s net written premiums or direct written premiums under this rule, premiums received by all members of a controlled group of corporations (as defined in section 831(b)) of which 

the company is a part are taken into account (including foreign and 

tax-exempt corporations). 

A property and casualty insurance company is eligible to be exempt from Federal income tax if (a) its gross receipts for the taxable year do not exceed $600,000, and (b) the premiums received 

for the taxable year are greater than 50 percent of its gross receipts.570 For purposes of determining gross receipts, the gross receipts of all members of a controlled group of corporations of which 

639 

571The provision preserves the transition rule that was provided under section 206(e) of the 

Pension Funding Equity Act of 2004 (Pub. L. No. 108–218) relating to companies in receivership 

or liquidation. 572Sec. 163(a). 573The definitions of these transactions are the same as those previously described in connection with the provision elsewhere in this bill to modify the accuracy-related penalty for listed 

and certain reportable transactions. 

the company is a part are taken into account (including gross receipts of foreign and tax-exempt corporations). 

HOUSE BILL

Under the provision, the $1.2 million ceiling on net written 

premiums or direct written premiums for purposes of the election 

to be taxed only on taxable investment income is increased to $1.89 

million, and is indexed for taxable years beginning in a calendar 

year after 2004. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

SENATE AMENDMENT

The Senate amendment follows the House bill, except that the 

$1.89 million amount is indexed for taxable years beginning in a 

calendar year after 2005. In addition, the Senate amendment modifies one of the present-law requirements for a property and casualty insurance company to eligible to be exempt from Federal income tax by requiring that the premiums received for the taxable 

year be greater than 60 percent of its gross receipts (rather than 

50 percent as under present law). 

Effective date.—The provision is effective for taxable years beginning after December 31, 2004.571

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision or the Senate amendment provision. 

21. Denial of deduction for interest on underpayments attributable 

to nondisclosed reportable transactions (sec. 639 of the House 

bill, sec. 417 of the Senate amendment, and sec. 163 of the 

Code) 

PRESENT LAW

In general, corporations may deduct interest paid or accrued 

within a taxable year on indebtedness.572 Interest on indebtedness 

to the Federal government attributable to an underpayment of tax 

generally may be deducted pursuant to this provision. 

HOUSE BILL

The House bill disallows any deduction for interest paid or accrued within a taxable year on any portion of an underpayment of 

tax that is attributable to an understatement arising from an undisclosed listed transaction or from an undisclosed reportable 

avoidance transaction (other than a listed transaction).573

640 

Effective date.—The House bill provision is effective for underpayments attributable to transactions entered into in taxable years 

beginning after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the Senate amendment also disallows any deduction for interest 

paid or accrued within a taxable year on any portion of an underpayment of tax that is attributable to an understatement arising 

from a transaction that lacks economic substance. 

Effective date.—The Senate amendment provision is effective 

for underpayments attributable to transactions entered into in taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

22. Clarification of rules for payment of estimated tax for certain 

deemed asset sales (sec. 640 of the House bill, sec. 481 of the 

Senate amendment, and sec. 338 of the Code) 

PRESENT LAW

In certain circumstances, taxpayers can make an election 

under section 338(h)(10) to treat a qualifying purchase of 80 percent of the stock of a target corporation by a corporation from a corporation that is a member of an affiliated group (or a qualifying 

purchase of 80 percent of the stock of an S corporation by a corporation from S corporation shareholders) as a sale of the assets of 

the target corporation, rather than as a stock sale. The election 

must be made jointly by the buyer and seller of the stock and is 

due by the 15th day of the ninth month beginning after the month 

in which the acquisition date occurs. An agreement for the purchase and sale of stock often may contain an agreement of the parties to make a section 338(h)(10) election. 

Section 338(a) also permits a unilateral election by a buyer corporation to treat a qualified stock purchase of a corporation as a 

deemed asset acquisition, whether or not the seller of the stock is 

a corporation (or an S corporation is the target). In such a case, the 

seller or sellers recognize gain or loss on the stock sale (including 

any estimated taxes with respect to the stock sale), and the target 

corporation recognizes gain or loss on the deemed asset sale. 

Section 338(h)(13) provides that, for purposes of section 6655 

(relating to additions to tax for failure by a corporation to pay estimated income tax), tax attributable to a deemed asset sale under 

section 338(a)(1) shall not be taken into account. 

HOUSE BILL

The bill clarifies section 338(h)(13) to provide that the exception for estimated tax purposes with respect to tax attributable to 

a deemed asset sale does not apply with respect to a qualified stock 

purchase for which an election is made under section 338(h)(10). 

Under the bill if a transaction eligible for the election under 

section 338(h)(10) occurs, estimated tax would be determined based 

641 

on the stock sale unless and until there is an agreement of the parties to make a section 338(h)(10) election. 

If at the time of the sale there is an agreement of the parties 

to make a section 338(h)(10) election, then estimated tax is computed based on an asset sale, computed from the date of the sale. 

If the agreement to make a section 338(h)(10) election is concluded after the stock sale, such that the original computation was 

based on a stock sale, estimated tax is recomputed based on the 

asset sale election. 

No inference is intended as to present law. 

Effective date.—The bill is effective for qualified stock purchase 

transactions that occur after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The Conference agreement follows the House bill and the Senate amendment. 

23. Exclusion of like-kind exchange property from nonrecognition 

treatment on the sale or exchange of a principal residence (sec. 

641 of the House bill and sec. 492 of the Senate amendment) 

PRESENT LAW

A taxpayer may 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. There are no special rules relating to the sale 

or exchange of a principal residence that was acquired in a likekind exchange within the prior five years. 

HOUSE BILL

The House bill provides that the exclusion for gain on the sale 

or exchange of a principal residence does not apply if the principal 

residence was acquired in a like-kind exchange in which any gain 

was not recognized within the prior five years. 

Effective date.—Sales or exchanges of principal residences after 

the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

642 

574Sec. 163(e)(1). 575Sec. 163(e)(3). 576Treas. Reg. sec. 1.163–12(b)(3). In the case of a PFIC, the regulations further require that 

the person owing the amount at issue have in effect a qualified electing fund election pursuant 

to section 1295 with respect to the PFIC. 577Sec. 267(a)(2). 

24. Prevention of mismatching of interest and original issue discount deductions and income inclusions in transactions with 

related foreign persons (sec. 642 of the House bill, sec. 453 of 

the Senate amendment, and secs. 163 and 267 of the Code) 

PRESENT LAW

Income earned by a foreign corporation from its foreign operations generally is subject to U.S. tax only when such income is 

distributed to any U.S. person that holds stock in such corporation. 

Accordingly, a U.S. person that conducts foreign operations through 

a foreign corporation generally is subject to U.S. tax on the income 

from such operations when the income is repatriated to the United 

States through a dividend distribution to the U.S. person. The income is reported on the U.S. person’s tax return for the year the 

distribution is received, and the United States imposes tax on such 

income at that time. However, certain anti-deferral regimes may 

cause the U.S. person to be taxed on a current basis in the United 

States with respect to certain categories of passive or highly mobile 

income earned by the foreign corporations in which the U.S. person 

holds stock. The main anti-deferral regimes are the controlled foreign corporation rules of subpart F (secs. 951–964), the passive foreign investment company rules (secs. 1291–1298), and the foreign 

personal holding company rules (secs. 551–558). 

As a general rule, there is allowed as a deduction all interest 

paid or accrued within the taxable year with respect to indebtedness, including the aggregate daily portions of original issue discount (‘‘OID’’) of the issuer for the days during such taxable 

year.574 However, if a debt instrument is held by a related foreign 

person, any portion of such OID is not allowable as a deduction to 

the payor of such instrument until paid (‘‘related-foreign-person 

rule’’). This related-foreign-person rule does not apply to the extent 

that the OID is effectively connected with the conduct by such foreign related person of a trade or business within the United States 

(unless such OID is exempt from taxation or is subject to a reduced 

rate of taxation under a treaty obligation).575 Treasury regulations 

further modify the related-foreign-person rule by providing that in 

the case of a debt owed to a foreign personal holding company 

(‘‘FPHC’’), controlled foreign corporation (‘‘CFC’’) or passive foreign 

investment company (‘‘PFIC’’), a deduction is allowed for OID as of 

the day on which the amount is includible in the income of the 

FPHC, CFC or PFIC, respectively.576

In the case of unpaid stated interest and expenses of related 

persons, where, by reason of a payee’s method of accounting, an 

amount is not includible in the payee’s gross income until it is paid 

but the unpaid amounts are deductible currently by the payor, the 

amount generally is allowable as a deduction when such amount is 

includible in the gross income of the payee.577 With respect to stated interest and other expenses owed to related foreign corporations, 

643 

578Treas. Reg. sec. 1.267(a)–3(b)(1), –3(c). 579Treas. Reg. sec. 1.267(a)–3(c)(4). 580Section 413 of the conference agreement repeals the foreign personal holding company regime, effective for taxable years of foreign corporations beginning after December 31, 2004, and 

taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end. 

Treasury regulations provide a general rule that requires a taxpayer to use the cash method of accounting with respect to the deduction of amounts owed to such related foreign persons (with an 

exception for income of a related foreign person that is effectively 

connected with the conduct of a U.S. trade or business and that is 

not exempt from taxation or subject to a reduced rate of taxation 

under a treaty obligation).578 As in the case of OID, the Treasury 

regulations additionally provide that in the case of stated interest 

owed to a FPHC, CFC, or PFIC, a deduction is allowed as of the 

day on which the amount is includible in the income of the FPHC, 

CFC or PFIC.579

HOUSE BILL

The provision provides that deductions for amounts accrued 

but unpaid (whether by U.S. or foreign persons) to related FPHCs, 

CFCs, or PFICs are allowable only to the extent that the amounts 

accrued by the payor are, for U.S. tax purposes, currently includible in the income of the direct or indirect U.S. owners of the related foreign corporation under the relevant inclusion rules.580 Deductions that have accrued but are not allowable under this provision are allowed when the amounts are paid. 

For purposes of determining the amount of the deduction allowable, the extent that an amount attributable to OID or an item 

is includible in the income of a U.S. person is determined without 

regard to (1) properly allocable deductions of the related foreign 

corporation, and (2) qualified deficits of the related foreign corporation under section 952(c)(1)(B). Properly allocable deductions of the 

related foreign corporation are those expenses, losses, and other deductible amounts of the related foreign corporation that are properly allocated or apportioned, under the principles of section 

954(b)(5), to the relevant income item of the related foreign corporation. 

The provision grants the Secretary regulatory authority to exempt transactions from these rules, including any transactions entered into by the payor in the ordinary course of a trade or business in which the payor is predominantly engaged, and (in the case 

of items other than OID) in which the payment of the accrued 

amounts occurs shortly after its accrual. 

Effective date.—The provision is effective for payments accrued 

on or after date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

644 

The following examples illustrate the operation of this provision. Assume the following facts. A U.S. parent corporation owns 

60 percent of the stock of a CFC. An unrelated foreign corporation 

owns the remaining 40 percent interest in the CFC. The U.S. parent accrues an expense item of 100 to the CFC. The parent would 

be entitled to a current deduction of 100 for the accrued amount, 

before taking into account this provision. The item constitutes 

gross foreign base company income in the hands of the CFC. The 

item is the only gross income item of the CFC that has the potential to result in the CFC having subpart F income, and has not 

been paid by the end of the taxable year of the parent. The CFC 

has deductions of 60 that are properly allocated or apportioned to 

the 100 of gross foreign base company income under the principles 

of section 954(b)(5), resulting in 40 (100 ¥ 60) of net foreign base 

company income. The CFC has earnings and profits for its taxable 

year in excess of 40, and has 40 of subpart F income. Under these 

facts, the U.S. parent is allowed a current deduction of 60 (100 × 

60%) under the provision. 

If, in the example above, the CFC has deductions of 100 (or 

more) properly allocated or apportioned to the sole item of 100 of 

gross foreign base company income under the principles of section 

954(b)(5), and has no other income or deductions, the same deduction is allowed to the U.S. parent. Under these circumstances, the 

parent is allowed a deduction of 60, whether the CFC has positive 

earnings and profits for its taxable year or has a deficit in earnings 

and profits for such year. 

If the CFC’s item of net foreign base company income is positive, and the earnings and profits limitation of section 952(c)(1)(A) 

reduces what would otherwise be a U.S. shareholder’s pro rata 

share of the CFC’s subpart F income, then the deduction will also 

be reduced under the provision. For example, assume the facts in 

the first example above, in which the CFC has deductions of 60 

that are properly allocated or apportioned to the item of 100 of 

gross foreign base company income under the principles of section 

954(b)(5), resulting in 40 of net foreign base company income. Further assume that, due solely to other losses, the CFC’s earnings 

and profits for its taxable year are 10 instead of 40. In that case, 

the CFC’s subpart F income is limited to 10, and only six is includible in the gross income of the U.S. parent as its pro rata share 

of subpart F income. Under the provision, the U.S. parent is allowed a current deduction in that case of 42 ((10 + 60) × 60%). The 

conferees intend that, if as a result of such other losses, the CFC 

has no earnings and profits for its taxable year or has a deficit in 

earnings and profits for such year, the U.S. parent is instead allowed a current deduction of 36 ((0 + 60) × 60%). 

25. Exclusion from gross income for interest on overpayments of income tax by individuals (sec. 643 of the House bill) 

PRESENT LAW

Overpayment interest 

Interest is included in the list of items that are required to be 

included in gross income (sec. 61(a)(4)). Interest on overpayments 

of Federal income tax is required to be included in taxable income 

645 

in the same manner as any other interest that is received by the 

taxpayer. 

Cash basis taxpayers are required to report overpayment interest as income in the period the interest is received. Accrual basis 

taxpayers are required to report overpayment interest as income 

when all events fixing the right to the receipt of the overpayment 

interest have occurred and the amount can be estimated with reasonable accuracy. Generally, this occurs on the date the appropriate IRS official signs the pertinent schedule of overassessments. 

Underpayment interest 

A corporate taxpayer is allowed to currently take into account 

interest paid on underpayments of Federal income tax as an ordinary and necessary business expense. Typically, this results in a 

current deduction. However, the deduction may be deferred if the 

interest is required to be capitalized or may be disallowed if and 

to the extent it is determined to be a cost of earning tax exempt 

income under section 265. 

Section 163(h) of the Code prohibits the deduction of personal 

interest by taxpayers other than corporations. Noncorporate taxpayers, including individuals, generally are not allowed to deduct 

interest on the underpayment of Federal income taxes. 

Temporary regulations provide that personal interest includes 

interest paid on underpayments of individual Federal, State or 

local income taxes, regardless of the source of the income generating the tax liability. This is consistent with the statement in the 

General Explanation of the Tax Reform Act of 1986 that ‘‘(p)ersonal 

interest also includes interest on underpayments of individual Federal, State, or local income taxes notwithstanding that all or a portion of the income may have arisen in a trade or business, because 

such taxes are not considered derived from conduct of a trade or 

business.’’ The validity of the temporary regulation has been 

upheld in those Circuits that have considered the issue, including 

the Fourth, Sixth, Eighth, and Ninth Circuits. 

Personal interest also includes interest that is paid by a trust, 

S corporation, or other pass-through entity on underpayments of 

State or local income taxes. Personal interest does not include interest that is paid with respect to sales, excise or similar taxes that 

are incurred in connection with a trade or business or an investment activity. 

HOUSE BILL

The bill excludes overpayment interest that is paid to individual taxpayers on overpayments of Federal income tax from gross 

income. Interest excluded under the provision is not considered disqualified income that could limit the earned income credit. Interest 

excluded under the provision also is not considered in determining 

what portion of a taxpayer’s social security or tier 1 railroad retirement benefits are subject to tax (sec. 86), whether a taxpayer has 

sufficient taxable income to be required to file a return (sec. 

6012(d)), or for any other computation in which interest exempt 

from tax is otherwise required to be added to adjusted gross income. 

646 

The exclusion from income of overpayment interest does not 

apply if the Secretary determines that the taxpayer’s principal purpose for overpaying his or her tax is to take advantage of the exclusion. 

For example, a taxpayer prepares his return without taking 

into account significant itemized deductions of which he is, or 

should be, aware. Before the expiration of the statute of limitations, the taxpayer files an amended return claiming these 

itemized deductions and requesting a refund with interest. Unless 

the taxpayer can establish a principal purpose for originally overpaying the tax other than collecting excludible interest, the Secretary may determine that the principal purpose of waiting to 

claim the deductions on an amended return was to earn interest 

that would be excluded from income. In that case, the interest on 

the overpayment could not be excluded from income. 

It is expected that the Secretary will indicate whether the interest is eligible to be excluded from income on the Form 1099 it 

provides that taxpayer for taxable year in which the underpayment 

interest is paid. 

Effective date.—Interest received in calendar years beginning 

after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision. 

26. Deposits made to suspend the running of interest on potential 

underpayments (sec. 644 of the House bill, sec. 486 of the Senate amendment, and new sec. 6603 of the Code)) 

PRESENT LAW

Generally, interest on underpayments and overpayments continues to accrue during the period that a taxpayer and the IRS dispute a liability. The accrual of interest on an underpayment is suspended if the IRS fails to notify an individual taxpayer in a timely 

manner, but interest will begin to accrue once the taxpayer is properly notified. No similar suspension is available for other taxpayers. 

A taxpayer that wants to limit its exposure to underpayment 

interest has a limited number of options. The taxpayer can continue to dispute the amount owed and risk paying a significant 

amount of interest. If the taxpayer continues to dispute the amount 

and ultimately loses, the taxpayer will be required to pay interest 

on the underpayment from the original due date of the return until 

the date of payment. 

In order to avoid the accrual of underpayment interest, the 

taxpayer may choose to pay the disputed amount and immediately 

file a claim for refund. Payment of the disputed amount will prevent further interest from accruing if the taxpayer loses (since 

there is no longer any underpayment) and the taxpayer will earn 

interest on the resultant overpayment if the taxpayer wins. HowVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00650 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
647 

ever, the taxpayer will generally lose access to the Tax Court if it 

follows this alternative. Amounts paid generally cannot be recovered by the taxpayer on demand, but must await final determination of the taxpayer’s liability. Even if an overpayment is ultimately determined, overpaid amounts may not be refunded if they 

are eligible to be offset against other liabilities of the taxpayer. 

The taxpayer may also make a deposit in the nature of a cash 

bond. The procedures for making a deposit in the nature of a cash 

bond are provided in Rev. Proc. 84–58. 

A deposit in the nature of a cash bond will stop the running 

of interest on an amount of underpayment equal to the deposit, but 

the deposit does not itself earn interest. A deposit in the nature of 

a cash bond is not a payment of tax and is not subject to a claim 

for credit or refund. A deposit in the nature of a cash bond may 

be made for all or part of the disputed liability and generally may 

be recovered by the taxpayer prior to a final determination. However, a deposit in the nature of a cash bond need not be refunded 

to the extent the Secretary determines that the assessment or collection of the tax determined would be in jeopardy, or that the deposit should be applied against another liability of the taxpayer in 

the same manner as an overpayment of tax. If the taxpayer recovers the deposit prior to final determination and a deficiency is later 

determined, the taxpayer will not receive credit for the period in 

which the funds were held as a deposit. The taxable year to which 

the deposit in the nature of a cash bond relates must be designated, but the taxpayer may request that the deposit be applied 

to a different year under certain circumstances. 

HOUSE BILL

In general 

The provision allows a taxpayer to deposit cash with the IRS 

that may subsequently be used to pay an underpayment of income, 

gift, estate, generation-skipping, or certain excise taxes. Interest 

will not be charged on the portion of the underpayment that is deposited for the period that the amount is on deposit. Generally, deposited amounts that have not been used to pay a tax may be withdrawn at any time if the taxpayer so requests in writing. The withdrawn amounts will earn interest at the applicable Federal rate to 

the extent they are attributable to a disputable tax. 

The Secretary may issue rules relating to the making, use, and 

return of the deposits. 

Use of a deposit to offset underpayments of tax 

Any amount on deposit may be used to pay an underpayment 

of tax that is ultimately assessed. If an underpayment is paid in 

this manner, the taxpayer will not be charged underpayment interest on the portion of the underpayment that is so paid for the period the funds were on deposit. 

For example, assume a calendar year individual taxpayer deposits $20,000 on May 15, 2005, with respect to a disputable item 

on its 2004 income tax return. On April 15, 2007, an examination 

of the taxpayer’s year 2004 income tax return is completed, and the 

taxpayer and the IRS agree that the taxable year 2004 taxes were 

648 

underpaid by $25,000. The $20,000 on deposit is used to pay 

$20,000 of the underpayment, and the taxpayer also pays the remaining $5,000. In this case, the taxpayer will owe underpayment 

interest from April 15, 2005 (the original due date of the return) 

to the date of payment (April 15, 2007) only with respect to the 

$5,000 of the underpayment that is not paid by the deposit. The 

taxpayer will owe underpayment interest on the remaining $20,000 

of the underpayment only from April 15, 2005, to May 15, 2005, the 

date the $20,000 was deposited. 

Withdrawal of amounts 

A taxpayer may request the withdrawal of any amount of deposit at any time. The Secretary must comply with the withdrawal 

request unless the amount has already been used to pay tax or the 

Secretary properly determines that collection of tax is in jeopardy. 

Interest will be paid on deposited amounts that are withdrawn at 

a rate equal to the short-term applicable Federal rate for the period 

from the date of deposit to a date not more than 30 days preceding 

the date of the check paying the withdrawal. Interest is not payable to the extent the deposit was not attributable to a disputable 

tax. 

For example, assume a calendar year individual taxpayer receives a 30-day letter showing a deficiency of $20,000 for taxable 

year 2004 and deposits $20,000 on May 15, 2006. On April 15, 

2007, an administrative appeal is completed, and the taxpayer and 

the IRS agree that the 2004 taxes were underpaid by $15,000. 

$15,000 of the deposit is used to pay the underpayment. In this 

case, the taxpayer will owe underpayment interest from April 15, 

2005 (the original due date of the return) to May 15, 2006, the date 

the $20,000 was deposited. Simultaneously with the use of the 

$15,000 to offset the underpayment, the taxpayer requests the return of the remaining amount of the deposit (after reduction for the 

underpayment interest owed by the taxpayer from April 15, 2005, 

to May 15, 2006). This amount must be returned to the taxpayer 

with interest determined at the short-term applicable Federal rate 

from the May 15, 2006, to a date not more than 30 days preceding 

the date of the check repaying the deposit to the taxpayer. 

Limitation on amounts for which interest may be allowed 

Interest on a deposit that is returned to a taxpayer shall be allowed for any period only to the extent attributable to a disputable 

item for that period. A disputable item is any item for which the 

taxpayer (1) has a reasonable basis for the treatment used on its 

return and (2) reasonably believes that the Secretary also has a 

reasonable basis for disallowing the taxpayer’s treatment of such 

item. 

All items included in a 30-day letter to a taxpayer are deemed 

disputable for this purpose. Thus, once a 30-day letter has been 

issued, the disputable amount cannot be less than the amount of 

the deficiency shown in the 30-day letter. A 30-day letter is the 

first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals. 

649 

Deposits are not payments of tax 

A deposit is not a payment of tax prior to the time the deposited amount is used to pay a tax. Similarly, withdrawal of a deposit 

will not establish a period for which interest was allowable at the 

short-term applicable Federal rate for the purpose of establishing 

a net zero interest rate on a similar amount of underpayment for 

the same period. 

Effective date.—Deposits made after date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

27. Authorize IRS to enter into installment agreements that provide for partial payment (sec. 645 of the House bill, sec. 484 

of the Senate amendment, and sec. 6159 of the Code) 

PRESENT LAW

The Code authorizes the IRS to enter into written agreements 

with any taxpayer under which the taxpayer is allowed to pay 

taxes owed, as well as interest and penalties, in installment payments if the IRS determines that doing so will facilitate collection 

of the amounts owed (sec. 6159). An installment agreement does 

not reduce the amount of taxes, interest, or penalties owed. Generally, during the period installment payments are being made, 

other IRS enforcement actions (such as levies or seizures) with respect to the taxes included in that agreement are held in abeyance. 

Prior to 1998, the IRS administratively entered into installment agreements that provided for partial payment (rather than 

full payment) of the total amount owed over the period of the 

agreement. In that year, the IRS Chief Counsel issued a memorandum concluding that partial payment installment agreements 

were not permitted. 

HOUSE BILL

The provision clarifies that the IRS is authorized to enter into 

installment agreements with taxpayers which do not provide for 

full payment of the taxpayer’s liability over the life of the agreement. The provision also requires the IRS to review partial payment installment agreements at least every two years. The primary 

purpose of this review is to determine whether the financial condition of the taxpayer has significantly changed so as to warrant an 

increase in the value of the payments being made. 

Effective date.—Installment agreements entered into on or 

after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

650 

581Sec. 1501. 582Sec. 1502. 583 Regulations issued under the authority of section 1502 are considered to be ‘‘legislative’’ 

regulations rather than ‘‘interpretative’’ regulations, and as such are usually given greater deference by courts in case of a taxpayer challenge to such a regulation. See, S. Rep. No. 960, 70th 

Cong., 1st Sess. at 15 (1928), describing the consolidated return regulations as ‘‘legislative in 

character’’. The Supreme Court has stated that ‘‘. . . legislative regulations are given controlling 

weight unless they are arbitrary, capricious, or manifestly contrary to the statute.’’ Chevron, 

U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 (1984) (involving an 

environmental protection regulation). For examples involving consolidated return regulations, 

see, e.g., Wolter Construction Company v. Commissioner, 634 F.2d 1029 (6th Cir. 1980); Garvey, 

Inc. v. United States, 1 Ct. Cl. 108 (1983), aff’d 726 F.2d 1569 (Fed. Cir. 1984), cert. denied, 

469 U.S. 823 (1984). Compare, e.g., Audrey J. Walton v. Commissioner, 115 T.C. 589 (2000), describing different standards of review. The case did not involve a consolidated return regulation. 584 255 F.3d 1357 (Fed. Cir. 2001), reh’g denied, 2001 U.S. App. LEXIS 23207 (Fed. Cir. Oct. 

3, 2001). 585Prior to this decision, there had been a few instances involving prior laws in which certain 

consolidated return regulations were held to be invalid. See, e.g., American Standard, Inc. v. United States, 602 F.2d 256 (Ct. Cl. 1979), discussed in the text infra. See also Union Carbide 

Corp. v. United States, 612 F.2d 558 (Ct. Cl. 1979), and Allied Corporation v. United States, 

685 F. 2d 396 (Ct. Cl. 1982), all three cases involving the allocation of income and loss within 

a consolidated group for purposes of computation of a deduction allowed under prior law by the 

Code for Western Hemisphere Trading Corporations. See also Joseph Weidenhoff v. Commissioner, 32 T.C. 1222, 1242–1244 (1959), involving the application of certain regulations to the 

excess profits tax credit allowed under prior law, and concluding that the Commissioner had 

applied a particular regulation in an arbitrary manner inconsistent with the wording of the regulation and inconsistent with even a consolidated group computation. Cf. Kanawha Gas & Utilities Co. v. Commissioner, 214 F.2d 685 (1954), concluding that the substance of a transaction 

was an acquisition of assets rather than stock. Thus, a regulation governing basis of the assets 

of consolidated subsidiaries did not apply to the case. See also General Machinery Corporation 

v. Commissioner, 33 B.T.A. 1215 (1936); Lefcourt Realty Corporation, 31 B.T.A. 978 (1935); 

Helvering v. Morgans, Inc., 293 U.S. 121 (1934), interpreting the term ‘‘taxable year.’’ 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

28. Affirmation of consolidated return regulation authority (sec. 

646 of the House bill, sec. 421 of the Senate amendment, and 

sec. 1502 of the Code) 

PRESENT LAW

An affiliated group of corporations may elect to file a consolidated return in lieu of separate returns. A condition of electing to 

file a consolidated return is that all corporations that are members 

of the consolidated group must consent to all the consolidated return regulations prescribed under section 1502 prior to the last day 

prescribed by law for filing such return.581

Section 1502 states: ‘‘The Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of 

any affiliated group of corporations making a consolidated return 

and of each corporation in the group, both during and after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such manner as clearly to reflect 

the income-tax liability and the various factors necessary for the 

determination of such liability, and in order to prevent the avoidance of such tax liability.’’ 582

Under this authority, the Treasury Department has issued extensive consolidated return regulations.583

In the recent case of Rite Aid Corp. v. United States, 584 the 

Federal Circuit Court of Appeals addressed the application of a 

particular provision of certain consolidated return loss disallowance 

regulations, and concluded that the provision was invalid.585 The 

651 

586Treas. Reg. sec. 1.1502–20(c)(1)(iii). 587Treasury Regulation section 1.1502–20, generally imposing certain ‘‘loss disallowance’’ 

rules on the disposition of subsidiary stock, contained other limitations besides the ‘‘duplicated 

loss’’ rule that could limit the loss available to the group on a disposition of a subsidiary’s stock. 

Treasury Regulation section 1.1502–20 as a whole was promulgated in connection with regulations issued under section 337(d), principally in connection with the so-called General Utilities 

repeal of 1986 (referring to the case of General Utilities & Operating Company v. Helvering, 296 

U.S. 200 (1935)). Such repeal generally required a liquidating corporation, or a corporation acquired in a stock acquisition treated as a sale of assets, to pay corporate level tax on the excess 

of the value of its assets over the basis. Treasury regulation section 1.1502–20 principally reflected an attempt to prevent corporations filing consolidated returns from offsetting income 

with a loss on the sale of subsidiary stock. Such a loss could result from the unique upward 

adjustment of a subsidiary’s stock basis required under the consolidated return regulations for 

subsidiary income earned in consolidation, an adjustment intended to prevent taxation of both 

the subsidiary and the parent on the same income or gain. As one example, absent a denial 

of certain losses on a sale of subsidiary stock, a consolidated group could obtain a loss deduction 

with respect to subsidiary stock, the basis of which originally reflected the subsidiary’s value 

at the time of the purchase of the stock, and that had then been adjusted upward on recognition 

of any built-in income or gain of the subsidiary reflected in that value. The regulations also contained the duplicated loss factor addressed by the court in Rite Aid. The preamble to the regulations stated: ‘‘it is not administratively feasible to differentiate between loss attributable to 

built-in gain and duplicated loss.’’ T.D. 8364, 1991–2 C.B. 43, 46 (Sept. 13, 1991). The government also argued in the Rite Aid case that duplicated loss was a separate concern of the regulations. 255 F.3d at 1360. 588For example, the court stated: ‘‘The duplicated loss factor . . . addresses a situation that 

arises from the sale of stock regardless of whether corporations file separate or consolidated returns. With I.R.C. secs. 382 and 383, Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the parent’s loss on the sale of stock under I.R.C. sec. 

165.’’ 255 F.3d 1357, 1360 (Fed. Cir. 2001). 589S. Rep. No. 960, 70th Cong., 1st Sess. 15 (1928). Though not quoted by the court in Rite 

Aid, the same Senate report also indicated that one purpose of the consolidated return authority 

was to permit treatment of the separate corporations as if they were a single unit, stating ‘‘The 

mere fact that by legal fiction several corporations owned by the same shareholders are separate 

entities should not obscure the fact that they are in reality one and the same business owned 

by the same individuals and operated as a unit.’’ S. Rep. No. 960, 70th Cong., 1st Sess. 29 

(1928). 590 American Standard, Inc. v. United States, 602 F.2d 256, 261 (Ct. Cl. 1979). That case did 

not involve the question of separate returns as compared to a single return approach. It involved 

the computation of a Western Hemisphere Trade Corporation (‘‘WHTC’’) deduction under prior 

Continued 

particular provision, known as the ‘‘duplicated loss’’ provision, 586

would have denied a loss on the sale of stock of a subsidiary by a 

parent corporation that had filed a consolidated return with the 

subsidiary, to the extent the subsidiary corporation had assets that 

had a built-in loss, or had a net operating loss, that could be recognized or used later.587

The Federal Circuit Court opinion contained language discussing the fact that the regulation produced a result different 

than the result that would have obtained if the corporations had 

filed separate returns rather than consolidated returns.588

The Federal Circuit Court opinion cited a 1928 Senate Finance 

Committee Report to legislation that authorized consolidated return regulations, which stated that ‘‘many difficult and complicated 

problems, . . . have arisen in the administration of the provisions 

permitting the filing of consolidated returns’’ and that the committee ‘‘found it necessary to delegate power to the commissioner 

to prescribe regulations legislative in character covering them.’’ 589

The Court’s opinion also cited a previous decision of the Court of 

Claims for the proposition, interpreting this legislative history, that 

section 1502 grants the Secretary ‘‘the power to conform the applicable income tax law of the Code to the special, myriad problems 

resulting from the filing of consolidated income tax returns;’’ but 

that section 1502 ‘‘does not authorize the Secretary to choose a 

method that imposes a tax on income that would not otherwise be 

taxed.’’ 590

652 

law (which deduction would have been computed as a percentage of each WHTC’s taxable income if the corporations had filed separate returns), in a case where a consolidated group included several WHTCs as well as other corporations. The question was how to apportion income 

and losses of the admittedly consolidated WHTCs and how to combine that computation with 

the rest of the group’s consolidated income or losses. The court noted that the new, changed 

regulations approach varied from the approach taken to a similar problem involving public utilities within a group and previously allowed for WHTCs. The court objected that the allocation 

method adopted by the regulation allowed non-WHTC losses to reduce WHTC income. However, 

the court did not disallow a method that would net WHTC income of one WHTC with losses 

of another WHTC, a result that would not have occurred under separate returns. Nor did the 

court expressly disallow a different fractional method that would net both income and losses of 

the WHTCs with those of other corporations in the consolidated group. The court also found that 

the regulation had been adopted without proper notice. 591 Rite Aid, 255 F.3d at 1360. 592See Temp. Reg. Sec. 1.1502–20T(i)(2), Temp. Reg. Sec. 1.337(d)–2T, and Temp. Reg. Sec. 

1.1502–35T. The Treasury Department has also indicated its intention to continue to study all 

the issues that the original loss disallowance regulations addressed (including issues of furthering single entity principles) and possibly issue different regulations (not including the particular approach of Treas. Reg. Sec. 1.1502–20(c)(1)(iii)) on the issues in the future. See, e.g. Notice 2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); T.D. 8984, 67 F.R. 11034 (March 12, 2002); 

REG–102740–02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002–18, 2002–12 I.R.B. 644 

(March 25, 2002); REG–131478–02, 67 F.R. 65060 (October 18, 2002); T.D. 9048, 68 F.R. 12287 

(March 14, 2003); and T.D. 9118, REG–153172–03 (March 17, 2004). 

The Federal Circuit Court construed these authorities and applied them to invalidate Treas. Reg. Sec. 1.1502–20(c)(1)(iii), stating that: ‘‘The loss realized on the sale of a former subsidiary’s assets after the consolidated group sells the subsidiary’s stock is not 

a problem resulting from the filing of consolidated income tax returns. The scenario also arises where a corporate shareholder sells 

the stock of a non-consolidated subsidiary. The corporate shareholder could realize a loss under I.R.C. sec. 1001, and deduct the 

loss under I.R.C. sec. 165. The subsidiary could then deduct any 

losses from a later sale of assets. The duplicated loss factor, therefore, addresses a situation that arises from the sale of stock regardless of whether corporations file separate or consolidated returns. 

With I.R.C. secs. 382 and 383, Congress has addressed this situation by limiting the subsidiary’s potential future deduction, not the 

parent’s loss on the sale of stock under I.R.C. sec. 165.’’ 591

The Treasury Department has announced that it will not continue to litigate the validity of the duplicated loss provision of the 

regulations, and has issued interim regulations that permit taxpayers for all years to elect a different treatment, though they may 

apply the provision for the past if they wish.592

HOUSE BILL

The provision confirms that, in exercising its authority under 

section 1502 to issue consolidated return regulations, the Treasury 

Department may provide rules treating corporations filing consolidated returns differently from corporations filing separate returns. 

Thus, under the statutory authority of section 1502, the Treasury Department is authorized to issue consolidated return regulations utilizing either a single taxpayer or separate taxpayer approach or a combination of the two approaches, as Treasury deems 

necessary in order that the tax liability of any affiliated group of 

corporations making a consolidated return, and of each corporation 

in the group, both during and after the period of affiliation, may 

be determined and adjusted in such manner as clearly to reflect the 

income-tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such 

liability. 

653 

593Treas. Reg. sec. 1.1502–20(c)(1)(iii). 594The provision is not intended to overrule the current Treasury Department regulations, 

which allow taxpayers in certain circumstances for the past to follow Treasury Regulations Section 1.1502–20(c)(1)(iii), if they choose to do so. Temp. Reg. Sec. 1.1502–20T(i)(2). 595See, e.g., Notice 2002–11, 2002–7 I.R.B. 526 (Feb. 19, 2002); Temp. Reg. Sec. 1.337(d)–2T, 

(T.D. 8984, 67 F.R. 11034 (March 12, 2002) and T.D. 8998, 67 F.R. 37998 (May 31, 2002)); REG– 

102740–02, 67 F.R. 11070 (March 12, 2002); see also Notice 2002–18, 2002–12 I.R.B. 644 (March 

25, 2002); REG–131478–02, 67 F.R. 65060 (October 18, 2002); Temp. Reg. Sec. 1.1502–35T (T.D. 

9048, 68 F.R. 12287 (March 14, 2003)); and T.D. 9118, REG–153172–03 (March 17, 2004). In 

exercising its authority under section 1502, the Secretary is also authorized to prescribe rules 

that protect the purpose of General Utilities repeal using presumptions and other simplifying 

conventions. 

Rite Aid is thus overruled to the extent it suggests that the 

Secretary is required to identify a problem created from the filing 

of consolidated returns in order to issue regulations that change 

the application of a Code provision. The Secretary may promulgate 

consolidated return regulations to change the application of a tax 

code provision to members of a consolidated group, provided that 

such regulations are necessary to clearly reflect the income tax liability of the group and each corporation in the group, both during 

and after the period of affiliation. 

The provision nevertheless allows the result of the Rite Aid 

case to stand with respect to the type of factual situation presented 

in the case. That is, the bill provides for the override of the regulatory provision that took the approach of denying a loss on a 

deconsolidating disposition of stock of a consolidated subsidiary 593

to the extent the subsidiary had net operating losses or built in 

losses that could be used later outside the group.594

Retaining the result in the Rite Aid case with respect to the 

particular regulation section 1.1502–20(c)(1)(iii) as applied to the 

factual situation of the case does not in any way prevent or invalidate the various approaches Treasury has announced it will apply 

or that it intends to consider in lieu of the approach of that regulation, including, for example, the denial of a loss on a stock sale if 

inside losses of a subsidiary may also be used by the consolidated 

group, and the possible requirement that inside attributes be adjusted when a subsidiary leaves a group.595

Effective date.—The provision is effective for all years, whether 

beginning before, on, or after the date of enactment of the provision. No inference is intended that the results following from this 

provision are not the same as the results under present law. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The Conference agreement follows the House bill and the Senate Amendment. 

654 

596Frank Lyon Co. v. United States, 435 U.S. 561, 583–84 (1978). 597Sec. 168(g)(3)(A). Under present law, section 168(g)(3)(C) states that the recovery period 

of ‘‘qualified technological equipment’’ is five years. 598Sec. 168(h)(1). 

29. Reform of tax treatment of certain leasing arrangements and 

limitation on deductions allocable to property used by governments or other tax-exempt entities (secs. 647 through 649 of 

the bill, secs. 475 and 476 of the Senate amendment, secs. 167 

and 168 of the Code, and new sec. 470 of the Code) 

PRESENT LAW

Overview of depreciation 

A taxpayer is allowed to recover, through annual depreciation 

deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’). Under MACRS, different types of property generally 

are assigned applicable recovery periods and depreciation methods 

based on such property’s class life. The recovery periods applicable 

to most tangible personal property (generally tangible property 

other than residential rental property and nonresidential real property) range from 3 to 25 years and are significantly shorter than 

the property’s class life, which is intended to approximate the economic useful life of the property. In addition, the depreciation 

methods generally applicable to tangible personal property are the 

200-percent and 150-percent declining balance methods, switching 

to the straight-line method for the taxable year in which the depreciation deduction would be maximized. 

Characterization of leases for tax purposes 

In general, a taxpayer is treated as the tax owner and is entitled to depreciate property leased to another party if the taxpayer 

acquires and retains significant and genuine attributes of a traditional owner of the property, including the benefits and burdens of 

ownership. No single factor is determinative of whether a lessor 

will be treated as the owner of the property. Rather, the determination is based on all the facts and circumstances surrounding the 

leasing transaction. 

A sale-leaseback transaction is respected for Federal tax purposes if ‘‘there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or 

regulatory realities, is imbued with tax-independent considerations, 

and is not shaped solely by tax-avoidance features that have meaningless labels attached.’’ 596

Recovery period for tax-exempt use property 

Under present law, ‘‘tax-exempt use property’’ must be depreciated on a straight-line basis over a recovery period equal to the 

longer of the property’s class life or 125 percent of the lease 

term.597 For purposes of this rule, ‘‘tax-exempt use property’’ is 

tangible property that is leased (other than under a short-term 

lease) to a tax-exempt entity.598 For this purpose, the term ‘‘taxVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00658 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
655 

599Sec. 168(h)(2). 600Sec. 7701(e) provides that a service contract will not be respected, and instead will be 

treated as a lease of property, if such contract is properly treated as a lease taking into account 

all relevant factors. The relevant factors include, among others, the service recipient controls 

the property, the service recipient is in physical possession of the property, the service provider 

does not bear significant risk of diminished receipts or increased costs if there is nonperformance, the property is not used to concurrently provide services to other entities, and the contract 

price does not substantially exceed the rental value of the property. 601Sec. 168(h)(1)(C). 602Sec. 168(h)(3). However, the exception does not apply if part or all of the qualified technological equipment is financed by a tax-exempt obligation, is sold by the tax-exempt entity (or 

related party) and leased back to the tax-exempt entity (or related party), or the tax-exempt 

entity is the United States or any agency or instrumentality of the United States. 603Sec. 168(g)(3)(C). 604Sec. 168(i)(2). 

exempt entity’’ includes Federal, State and local governmental 

units, charities, and, foreign entities or persons.599

In determining the length of the lease term for purposes of the 

125-percent calculation, several special rules apply. In addition to 

the stated term of the lease, the lease term includes options to 

renew the lease or other periods of time during which the lessee 

could be obligated to make rent payments or assume a risk of loss 

related to the leased property. 

Tax-exempt use property does not include property that is used 

by a taxpayer to provide a service to a tax-exempt entity. So long 

as the relationship between the parties is a bona fide service contract, the taxpayer will be allowed to depreciate the property used 

in satisfying the contract under normal MACRS rules, rather than 

the rules applicable to tax-exempt use property.600 In addition, 

property is not treated as tax-exempt use property merely by reason of a short-term lease. In general, a short-term lease means any 

lease the term of which is less than three years and less than the 

greater of one year or 30 percent of the property’s class life.601

Also, tax-exempt use property generally does not include qualified technological equipment that meets the exception for leases of 

high technology equipment to tax-exempt entities with lease terms 

of five years or less.602 The recovery period for qualified technological equipment that is treated as tax-exempt use property, but 

is not subject to the high technology equipment exception, is five 

years.603

The term ‘‘qualified technological equipment’’ is defined as 

computers and related peripheral equipment, high technology telephone station equipment installed on a customer’s premises, and 

high technology medical equipment.604 In addition, tax-exempt use 

property does not include computer software because it is intangible property. 

HOUSE BILL

Overview 

The House bill modifies the recovery period of certain property 

leased to a tax-exempt entity, alters the definition of lease term for 

all property leased to a tax-exempt entity, expands the short-term 

lease exception for qualified technological equipment, and establishes rules to limit deductions associated with leases to tax-exempt 

entities if the leases do not satisfy specified criteria. 

656 

605The House bill defines a tax-exempt entity as under present law. Thus, it includes Federal, 

State, local, and foreign governmental units, charities, foreign entities or persons. 606 A service contract involving property that previously was leased to the tax-exempt entity 

is not part of the same transaction as the preceding leasing arrangement (and, thus, is not included in the lease term of such arrangement) if the service contract was not included in the 

terms and conditions, or contemplated at the inception, of the preceding leasing arrangement. 607For purposes of the House bill, a service contract does not include an arrangement for the 

provision of services if the leased property or substantially similar property is not utilized to 

provide such services. For example, if at the conclusion of a lease term, a tax-exempt lessee purchases property from the taxpayer and enters into an agreement pursuant to which the taxpayer 

maintains the property, the maintenance agreement will not be included in the lease term for 

purposes of the 125-percent computation. 

Modify the recovery period of certain property leased to a tax-exempt 

entity 

The House bill modifies the recovery period for qualified technological equipment and computer software leased to a tax-exempt 

entity 605 to be the longer of the property’s assigned class life (or 

assigned useful life in the case of computer software) or 125 percent of the lease term. The House bill does not apply to short-term 

leases, as defined under present law with a modification described 

below for short-term leases of qualified technological equipment. 

Modify definition of lease term 

In determining the length of the lease term for purposes of the 

125-percent calculation, the House bill provides that the lease term 

includes all service contracts (whether or not treated as a lease 

under section 7701(e)) and other similar arrangements that follow 

a lease of property to a tax-exempt entity and that are part of the 

same transaction (or series of transactions) as the lease.606

Under the House bill, service contracts and other similar arrangements include arrangements by which services are provided 

using the property in exchange for fees that provide a source of repayment of the capital investment in the property.607

This requirement applies to all leases of property to a tax-exempt entity. 

Expand short-term lease exception for qualified technological equipment 

For purposes of determining whether a lease of qualified technological equipment to a tax-exempt entity satisfies the presentlaw 5-year short-term lease exception for leases of qualified technological equipment, the House bill provides that the term of the 

lease does not include an option or options of the lessee to renew 

or extend the lease, provided the rents under the renewal or extension are based upon fair market value determined at the time of 

the renewal or extension. The aggregate period of such renewals or 

extensions not included in the lease term under this provision may 

not exceed 24 months. In addition, this provision does not apply to 

any period following the failure of a tax-exempt lessee to exercise 

a purchase option if the result of such failure is that the lease renews automatically at fair market value rents. 

Limit deductions for certain leases of property to tax-exempt parties 

The House bill also provides that if a taxpayer leases property 

to a tax-exempt entity, the taxpayer may not claim deductions for 

a taxable year from the lease transaction in excess of the taxVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00660 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
657 

608Deductions related to a lease of tax-exempt use property include any depreciation or amortization expense, maintenance expense, taxes or the cost of acquiring an interest in, or lease 

of, property. In addition, this provision applies to interest that is properly allocable to tax-exempt use property, including interest on any borrowing by a related person, the proceeds of 

which were used to acquire an interest in the property, whether or not the borrowing is secured 

by the leased property or any other property. 609See Sec. 469(g). 610 Even if a transaction satisfies each of the following requirements, the taxpayer will be 

treated as the owner of the leased property only if the taxpayer acquires and retains significant 

and genuine attributes of an owner of the property under the present-law tax rules, including 

the benefits and burdens of ownership. 611For purposes of this requirement, the adjusted basis of property acquired by the taxpayer 

in a like-kind exchange or involuntary conversion to which section 1031 or section 1033 applies 

is equal to the lesser of (1) the fair market value of the property as of the beginning of the lease 

term, or (2) the amount that would be the taxpayer’s adjusted basis if section 1031 or section 

1033 did not apply to such acquisition. 612 Arrangements to monetize lease obligations include defeasance arrangements, loans by the 

tax-exempt entity (or an affiliate) to the taxpayer (or an affiliate) or any lender, deposit agreements, letters of credit collateralized with cash or cash equivalents, payment undertaking agreements, prepaid rent (within the meaning of the regulations under section 467), sinking fund arrangements, guaranteed investment contracts, financial guaranty insurance, or any similar arrangements. 

payer’s gross income from the lease for that taxable year. This provision does not apply to certain transactions involving property 

with respect to which the low-income housing credit or the rehabilitation credit is allowable. 

This provision applies to deductions or losses related to a lease 

to a tax-exempt entity and the leased property.608 Any disallowed 

deductions are carried forward and treated as deductions related to 

the lease in the following taxable year subject to the same limitations. Under rules similar to those applicable to passive activity 

losses (including the treatment of dispositions of property in which 

less than all of the gain or loss from the disposition is recognized),609 a taxpayer generally is permitted to deduct previously 

disallowed deductions and losses when the taxpayer completely disposes of its interest in the property. 

A lease of property to a tax-exempt party is not subject to the 

deduction limitations of this provision if the lease satisfies all of 

the following requirements: 610

(1) Tax-exempt lessee does not monetize its lease obligations 

In general, the tax-exempt lessee may not monetize its lease 

obligations (including any purchase option) in an amount that exceeds 20 percent of the taxpayer’s adjusted basis 611 in the leased 

property at the time the lease is entered into.612 Specifically, a 

lease does not satisfy this requirement if the tax-exempt lessee 

monetizes such excess amount pursuant to an arrangement, setaside, or expected set-aside, that is to or for the benefit of the taxpayer or any lender, or is to or for the benefit of the tax-exempt 

lessee, in order to satisfy the lessee’s obligations or options under 

the lease. This determination shall be made at all times during the 

lease term and shall include the amount of any interest or other 

income or gain earned on any amount set aside or subject to an arrangement described in this provision. For purposes of determining 

whether amounts have been set aside or are expected to be set 

aside, amounts are treated as set aside or expected to be set aside 

only if a reasonable person would conclude that the facts and cirVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00661 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
658 

613 It is anticipated under the House bill that the customary and budgeted funding by taxexempt entities of current obligations under a lease through unrestricted accounts or funds for 

general working capital needs will not be considered arrangements, set-asides, or expected setasides under this requirement. 614For purposes of this requirement, the adjusted basis of property acquired by the taxpayer 

in a like-kind exchange or involuntary conversion to which section 1031 or section 1033 applies 

is equal to the lesser of (1) the fair market value of the property as of the beginning of the lease 

term, or (2) the amount that would be the taxpayer’s adjusted basis if section 1031 or section 

1033 did not apply to such acquisition. 615The taxpayer’s at-risk equity investment shall include only consideration paid, and personal liability incurred, by the taxpayer to acquire the property. Cf. Rev. Proc. 2001–28, 2001– 

2 C.B. 1156. 

cumstances indicate that such amounts are set aside or expected 

to be set aside.613

The Secretary may provide by regulations that this requirement is satisfied, even if a tax-exempt lessee monetizes its lease 

obligations or options in an amount that exceeds 20 percent of the 

taxpayer’s adjusted basis in the leased property, in cases in which 

the creditworthiness of the tax-exempt lessee would not otherwise 

satisfy the taxpayer’s customary underwriting standards. Such 

credit support would not be permitted to exceed 50 percent of the 

taxpayer’s adjusted basis in the property. In addition, if the lease 

provides the tax-exempt lessee an option to purchase the property 

for a fixed purchase price (or for other than the fair market value 

of the property determined at the time of exercise of the option), 

such credit support at the time that such option may be exercised 

would not be permitted to exceed 50 percent of the purchase option 

price. 

Certain lease arrangements that involve circular cash flows or 

insulation of the taxpayer’s equity investment from the risk of loss 

fail this requirement without regard to the amount in which the 

tax-exempt lessee monetizes its lease obligations or options. Thus, 

a lease does not satisfy this requirement if the tax-exempt lessee 

enters into an arrangement to monetize in any amount its lease obligations or options if such arrangement involves (1) a loan (other 

than an amount treated as a loan under section 467 with respect 

to a section 467 rental agreement) from the tax-exempt lessee to 

the taxpayer or a lender, (2) a deposit that is received, a letter of 

credit that is issued, or a payment undertaking agreement that is 

entered into by a lender otherwise involved in the transaction, or 

(3) in the case of a transaction that involves a lender, any credit 

support made available to the taxpayer in which any such lender 

does not have a claim that is senior to the taxpayer. 

(2) Taxpayer makes and maintains a substantial equity investment in the leased property 

The taxpayer must make and maintain a substantial equity investment in the leased property. For this purpose, a taxpayer generally does not make or maintain a substantial equity investment 

unless (1) at the time the lease is entered into, the taxpayer initially makes an unconditional at-risk equity investment in the 

property of at least 20 percent of the taxpayer’s adjusted basis 614

in the leased property at that time,615 (2) the taxpayer maintains 

such equity investment throughout the lease term, and (3) at all 

times during the lease term, the fair market value of the property 

at the end of the lease term is reasonably expected to be equal to 

659 

616 Cf. Rev. Proc. 2001–28, sec. 4.01(2), 2001–1 C.B. 1156. The fair market value of the property must be determined without regard to inflation or deflation during the lease term and after 

subtracting the cost of removing the property. 617 Examples of arrangements by which a tax-exempt lessee might assume or retain a risk 

of loss include put options, residual value guarantees, residual value insurance, and service contracts. However, leases do not fail to satisfy this requirement solely by reason of lease provisions 

that require the tax-exempt lessee to pay a contractually stipulated loss value to the taxpayer 

in the event of an early termination due to a casualty loss, a material default by the tax-exempt 

lessee (excluding the failure by the tax-exempt lessee to enter into an arrangement described 

above), or other similar extraordinary events that are not reasonably expected to occur at lease 

inception. 618For purposes of this requirement, residual value protection provided to the taxpayer by a 

manufacturer or dealer of the leased property is not treated as borne by the tax-exempt lessee 

if the manufacturer or dealer provides such residual value protection to customers in the ordinary course of its business. 

at least 20 percent of such basis.616 For this purpose, the fair market value of the property at the end of the lease term is reduced 

to the extent that a person other than the taxpayer bears a risk 

of loss in the value of the property. 

This requirement does not apply to leases with lease terms of 

5 years or less. 

(3) Tax-exempt lessee does not bear more than a minimal risk 

of loss 

The tax-exempt lessee generally may not assume or retain 

more than a minimal risk of loss, other than the obligation to pay 

rent and insurance premiums, to maintain the property, or other 

similar conventional obligations of a net lease.617 For this purpose, 

a tax-exempt lessee assumes or retains more than a minimal risk 

of loss if, as a result of obligations assumed or retained by, on behalf of, or pursuant to an agreement with the tax-exempt lessee, 

the taxpayer is protected from either (1) any portion of the loss 

that would occur if the fair market value of the leased property 

were 25 percent less than the leased property’s reasonably expected 

fair market value at the time the lease is terminated, or (2) an aggregate loss that is greater than 50 percent of the loss that would 

occur if the fair market value of the leased property were zero at 

lease termination.618 In addition, the Secretary may provide by regulations that this requirement is not satisfied where the tax-exempt lessee otherwise retains or assumes more than a minimal 

risk of loss. Such regulations shall be prospective only. 

This requirement does not apply to leases with lease terms of 

5 years or less. 

Coordination with like-kind exchange and involuntary conversion rules 

Under this provision, neither the like-kind exchange rules (sec. 

1031) nor the involuntary conversion rules (sec. 1033) apply if either (1) the exchanged or converted property is tax-exempt use 

property subject to a lease that was entered into prior to the effective date of this provision and the lease would not have satisfied 

the requirements of this provision had such requirements been in 

effect when the lease was entered into, or (2) the replacement property is tax-exempt use property subject to a lease that does not 

meet the requirements of this provision. 

660 

619 Conversely, however, a lease of property that is not tax-exempt use property does not become subject to this provision solely by reason of requisition or seizure by the Federal government in national emergency circumstances. 620 If a lease entered into on or before March 12, 2004, is transferred in a transaction that 

does not materially alter the terms of such lease, the bill shall not apply to the lease as a result 

of such transfer. 

Other rules 

This provision continues to apply throughout the lease term to 

property that initially was tax-exempt use property, even if the 

property ceases to be tax-exempt use property during the lease 

term.619 In addition, this provision is applied before the application 

of the passive activity loss rules under section 469. 

This provision does not alter the treatment of any Qualified 

Motor Vehicle Operating Agreement within the meaning of section 

7701(h). In the case of any such agreement, the second and third 

requirements provided by this provision (relating to taxpayer equity investment and tax-exempt lessee risk of loss, respectively) 

shall be applied without regard to any terminal rental adjustment 

clause. 

Effective date 

The House bill provision generally is effective for leases entered into after March 12, 2004.620 However, the House bill provision does not apply to property located in the United States that 

is subject to a lease with respect to which a formal application (1) 

was submitted for approval to the Federal Transit Administration 

(an agency of the Department of Transportation) after June 30, 

2003, and before March 13, 2004, (2) is approved by the Federal 

Transit Administration before January 1, 2005, and (3) includes a 

description and the fair market value of such property. 

The House bill provisions relating to coordination with the 

like-kind exchange and involuntary conversion rules are effective 

with respect to property that is exchanged or converted after the 

date of enactment. 

No inference is intended regarding the appropriate present-law 

tax treatment of transactions entered into prior to the effective 

date of the House bill provision. In addition, it is intended that the 

House bill provision shall not be construed as altering or supplanting the present-law tax rules providing that a taxpayer is 

treated as the owner of leased property only if the taxpayer acquires and retains significant and genuine attributes of an owner 

of the property, including the benefits and burdens of ownership. 

The House bill provision also is not intended to affect the scope of 

any other present-law tax rules or doctrines applicable to purported 

leasing transactions. 

SENATE AMENDMENT

Overview 

The Senate amendment is similar to the House bill in that it 

modifies the recovery period of certain property leased to a tax-exempt entity, alters the definition of lease term for all property 

leased to a tax-exempt entity, and establishes rules to limit deductions associated with leases to tax-exempt entities if the leases do 

not satisfy specified criteria. 

661 

Modify the recovery period of certain property leased to a tax-exempt 

entity 

The Senate amendment provision that modifies the recovery 

period for qualified technological equipment and computer software 

leased to a tax-exempt entity is the same as the House bill provision. 

Modify definition of lease term 

The Senate amendment provision that modifies the definition 

of a lease term is the same as the House bill provision. 

Expand short-term lease exception for qualified technological equipment 

The Senate amendment does not include the House bill provision that excludes certain renewals and extensions of up to 24 

months from the determination of whether a lease of qualified technological equipment to a tax-exempt entity satisfies the presentlaw 5–year short-term lease exception for leases of qualified technological equipment. 

Limit deductions for certain leases of property to tax-exempt parties 

The Senate amendment is similar to the House bill in that it 

limits a taxpayer’s deductions for a taxable year from a lease transaction with a tax-exempt entity to the taxpayer’s gross income from 

the lease for that taxable year. However, the Senate amendment 

does not exclude transactions involving property with respect to 

which the rehabilitation credit is allowable. 

Like the House bill, the Senate amendment provides that a 

lease of property to a tax-exempt party is not subject to the deduction limitations of this provision if the lease satisfies a series of requirements similar to that provided in the House bill, with the following modifications: 

(1) Leased property is not financed with tax-exempt bonds 

or Federal funds 

The Senate amendment provides that the leased property must 

not have been directly or indirectly financed with tax-exempt bonds 

that are outstanding when the lease is entered into, or with Federal funds. This requirement is not included in the House bill. 

For example, a lease of rolling stock to a municipality would 

be subject to the Senate amendment if the proceeds of the municipality’s general obligation bond were used to finance the acquisition of the rolling stock (in whole or part) and the bond is outstanding when the lease is entered into. 

The Senate amendment permits the Secretary to provide a de 

minimis exception from this requirement. 

(2) Tax-exempt lessee does not monetize its lease obligations 

The Senate amendment is similar to the House bill in that it 

provides that the tax-exempt lessee may not monetize its lease obligations in an amount that exceeds 20 percent of the taxpayer’s adjusted basis in the leased property at the time the lease is entered 

into. However, the Senate amendment also permits the Secretary 

to identify arrangements (in addition to those specified in the provision) to which the requirement applies. 

662 

(3) Taxpayer makes and maintains a substantial equity investment in the leased property 

The Senate amendment is similar to the House bill in that it 

requires the taxpayer to make and maintain a substantial equity 

investment in the leased property. However, the Senate amendment does not generally exclude from the application of this requirement leases with lease terms of 5 years or less. Instead, the 

Senate amendment provides that, with respect to short-term leases 

as defined under present law, the taxpayer is required to make a 

substantial equity investment, but is not required to maintain a 

substantial equity investment, and the leased property is not required to be reasonably expected to equal 20 percent of the taxpayer’s adjusted basis at the time the lease is entered into. 

(4) Tax-exempt lessee does not bear more than a minimal 

risk of loss 

The Senate amendment is similar to the House bill in that it 

provides that the tax-exempt lessee generally may not assume or 

retain more than a minimal risk of loss with respect to the lease. 

However, the Senate amendment does not exclude from the application of this requirement leases with lease terms of 5 years or 

less. 

(5) Lease of certain property does not include a fixed-price 

purchase option of the tax-exempt lessee 

The Senate amendment provides that the tax-exempt lessee 

may not have an option to purchase the leased property for any 

stated purchase price other than the fair market value of the property (as determined at the time of exercise of the option). This requirement does not apply to property with a class life (as defined 

in section 168(i)(1)) of seven years or less. This requirement is not 

included in the House bill. 

(6) Lease meets any other requirement prescribed in regulations 

The Senate amendment requires the lease to meet any other 

requirements that the Secretary prescribes by regulations. This requirement is not included in the House bill. 

Coordination with like-kind exchange and involuntary conversion rules 

The Senate amendment does not include the House bill provisions that coordinate the like-kind exchange and involuntary conversion rules with the deduction limitation provision. 

Effective date 

The Senate amendment provision generally is effective for 

leases entered into after November 18, 2003. However, with respect 

to tax-exempt use property that is leased to a foreign tax-exempt 

entity or person in a transaction entered into on or before November 18, 2003, the Senate amendment provision is effective for taxable years beginning after January 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with the following modifications. 

663 

621 In the case of computer software and intangible assets, this rule is applied by substituting 

useful life and amortization period, respectively, for class life. 

Definition of tax-exempt entity 

The conference agreement expands the present-law definition 

of tax-exempt entity for this purpose to include certain Indian tribal governments in addition to Federal, State, local, and foreign governmental units, charities, foreign entities or persons. 

Modify the recovery period of certain property leased to a tax-exempt 

entity 

The conference agreement also modifies the recovery period for 

certain intangibles leased to a tax-exempt entity to be the no less 

than 125 percent of the lease term.621 The conference agreement 

modification does not apply to short-term leases, as defined under 

present law with a modification described below for short-term 

leases of qualified technological equipment. 

Limit deductions for leases of property to tax-exempt parties 

The conference agreement provides an additional requirement 

that must be satisfied to avoid the deduction limitations for certain 

leases of property to tax-exempt parties. This requirement provides 

that the tax-exempt lessee may not have an option to purchase the 

leased property for any stated purchase price other than the fair 

market value of the property (as determined at the time of exercise 

of the option). This requirement does not apply to (1) property with 

a class life (as defined in section 168(i)(1)) of seven years or less, 

or (2) any fixed-wing aircraft or vessels (i.e., ships). 

Effective date 

The conference agreement modifies the Federal Transit Administration approval deadline to January 1, 2006. 

In addition, the conference agreement provides that the provisions relating to intangible assets and Indian tribal governments 

are effective for leases entered into after October 3, 2004. 

30. Clarification of the economic substance doctrine (sec. 401 of the 

Senate amendment and sec. 7701 of the Code) 

PRESENT LAW

In general 

The Code provides specific rules regarding the computation of 

taxable income, including the amount, timing, source, and character of items of income, gain, loss and deduction. These rules are 

designed to provide for the computation of taxable income in a 

manner that provides for a degree of specificity to both taxpayers 

and the government. Taxpayers generally may plan their transactions in reliance on these rules to determine the federal income 

tax consequences arising from the transactions. 

In addition to the statutory provisions, courts have developed 

several doctrines that can be applied to deny the tax benefits of tax 

motivated transactions, notwithstanding that the transaction may 

satisfy the literal requirements of a specific tax provision. The common-law doctrines are not entirely distinguishable, and their appliVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00667 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
664 

622See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. 

(CCH) 2189 (1997), cert. denied 526 U.S. 1017 (1999). 623 Closely related doctrines also applied by the courts (sometimes interchangeable with the 

economic substance doctrine) include the ‘‘sham transaction doctrine’’ and the ‘‘business purpose 

doctrine’’. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960) (denying interest deductions 

on a ‘‘sham transaction’’ whose only purpose was to create the deductions). 624 ACM Partnership v. Commissioner, 73 T.C.M. at 2215. 625 ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 626 ‘‘The casebooks are glutted with [economic substance] tests. Many such tests proliferate because they give the comforting illusion of consistency and precision. They often obscure rather 

than clarify.’’ Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988). 

cation to a given set of facts is often blurred by the courts and the 

IRS. Although these doctrines serve an important role in the administration of the tax system, invocation of these doctrines can be 

seen as at odds with an objective, ‘‘rule-based’’ system of taxation. 

Nonetheless, courts have applied the doctrines to deny tax benefits 

arising from certain transactions.622

A common-law doctrine applied with increasing frequency is 

the ‘‘economic substance’’ doctrine. In general, this doctrine denies 

tax benefits arising from transactions that do not result in a meaningful change to the taxpayer’s economic position other than a purported reduction in federal income tax.623

Economic substance doctrine 

Courts generally deny claimed tax benefits if the transaction 

that gives rise to those benefits lacks economic substance independent of tax considerations—notwithstanding that the purported 

activity actually occurred. The tax court has described the doctrine 

as follows: ‘‘The tax law . . . requires that the intended transactions have economic substance separate and distinct from economic benefit achieved solely by tax reduction. The doctrine of economic substance becomes applicable, and a judicial remedy is warranted, where a taxpayer seeks to claim tax benefits, unintended 

by Congress, by means of transactions that serve no economic purpose other than tax savings.’’ 624

Business purpose doctrine 

Another common law doctrine that overlays and is often considered together with (if not part and parcel of) the economic substance doctrine is the business purpose doctrine. The business purpose test is a subjective inquiry into the motives of the taxpayer— 

that is, whether the taxpayer intended the transaction to serve 

some useful non-tax purpose. In making this determination, some 

courts have bifurcated a transaction in which independent activities with non-tax objectives have been combined with an unrelated 

item having only tax-avoidance objectives in order to disallow the 

tax benefits of the overall transaction.625

Application by the courts 

Elements of the doctrine 

There is a lack of uniformity regarding the proper application 

of the economic substance doctrine.626 Some courts apply a conjunctive test that requires a taxpayer to establish the presence of both 

economic substance (i.e., the objective component) and business 

purpose (i.e., the subjective component) in order for the transaction 

665 

627See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993) (‘‘The threshold 

question is whether the transaction has economic substance. If the answer is yes, the question 

becomes whether the taxpayer was motivated by profit to participate in the transaction.’’) 628See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d 89, 91–92 (4th Cir. 1985) (‘‘To 

treat a transaction as a sham, the court must find that the taxpayer was motivated by no business purposes other than obtaining tax benefits in entering the transaction, and, second, that 

the transaction has no economic substance because no reasonable possibility of a profit exists.’’); 

IES Industries v. United States, 253 F.3d 350, 358 (8th Cir. 2001) (‘‘In determining whether a 

transaction is a sham for tax purposes [under the Eighth Circuit test], a transaction will be 

characterized as a sham if it is not motivated by any economic purpose out of tax considerations 

(the business purpose test), and if it is without economic substance because no real potential 

for profit exists’’ (the economic substance test).’’) As noted earlier, the economic substance doctrine and the sham transaction doctrine are similar and sometimes are applied interchangeably. 

For a more detailed discussion of the sham transaction doctrine, see, e.g., Joint Committee on 

Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 3801 

of the Internal Revenue Service Restructuring and Reform Act of 1998 (including Provisions Relating to Corporate Tax Shelters) (JCS–3–99) at 182. 629See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247; James v. Commissioner, 899 

F.2d 905, 908 (10th Cir. 1995); Sacks v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (‘‘Instead, the consideration of business purpose and economic substance are simply more precise 

factors to consider. . . . We have repeatedly and carefully noted that this formulation cannot 

be used as a ‘rigid two-step analysis’.’’). 630 293 U.S. 465 (1935). 631See, e.g., Knetsch, 364 U.S. at 361; Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966) 

(holding that an unprofitable, leveraged acquisition of Treasury bills, and accompanying prepaid 

interest deduction, lacked economic substance); Ginsburg v. Commissioner, 35 T.C.M. (CCH) 860 

(1976) (holding that a leveraged cattle-breeding program lacked economic substance). 632See, e.g., Goldstein v. Commissioner, 364 F.2d at 739–40 (disallowing deduction even 

though taxpayer had a possibility of small gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94 T.C. 738, 768 (1990) (stating, ‘‘potential for gain . . . is infinitesimally nominal and vastly insignificant when considered in comparison with the claimed deductions’’). 633See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d at 94 (the economic substance inquiry requires an objective determination of whether a reasonable possibility of profit from the 

transaction existed apart from tax benefits); Compaq Computer Corp. v. Commissioner, 277 F.3d 

at 781 (applied the same test, citing Rice’s Toyota World); IES Industries v. United States, 253 

F.3d at 354 (the application of the objective economic substance test involves determining 

whether there was a ‘‘reasonable possibility of profit . . . apart from tax benefits.’’). 

to survive judicial scrutiny.627 A narrower approach used by some 

courts is to conclude that either a business purpose or economic 

substance is sufficient to respect the transaction).628 A third approach regards economic substance and business purpose as ‘‘simply more precise factors to consider’’ in determining whether a 

transaction has any practical economic effects other than the creation of tax benefits.629

Profit potential 

There also is a lack of uniformity regarding the necessity and 

level of profit potential necessary to establish economic substance. 

Since the time of Gregory v. Helvering,630 several courts have denied tax benefits on the grounds that the subject transactions 

lacked profit potential.631 In addition, some courts have applied the 

economic substance doctrine to disallow tax benefits in transactions 

in which a taxpayer was exposed to risk and the transaction had 

a profit potential, but the court concluded that the economic risks 

and profit potential were insignificant when compared to the tax 

benefits.632 Under this analysis, the taxpayer’s profit potential 

must be more than nominal. Conversely, other courts view the application of the economic substance doctrine as requiring an objective determination of whether a ‘‘reasonable possibility of profit’’ 

from the transaction existed apart from the tax benefits.633 In 

these cases, in assessing whether a reasonable possibility of profit 

exists, it is sufficient if there is a nominal amount of pre-tax profit 

as measured against expected net tax benefits. 

666 

634 If the tax benefits are clearly contemplated and expected by the language and purpose of 

the relevant authority, it is not intended that such tax benefits be disallowed if the only reason 

for such disallowance is that the transaction fails the economic substance doctrine as defined 

in this provision. 635See, e.g., Treas. Reg. 1.269–2, stating that characteristic of circumstances in which a deduction otherwise allowed will be disallowed are those in which the effect of the deduction, credit, or other allowance would be to distort the liability of the particular taxpayer when the essential nature of the transaction or situation is examined in the light of the basic purpose or plan 

which the deduction, credit, or other allowance was designed by the Congress to effectuate. 636See, e.g., Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938) (‘‘A given result at the 

end of a straight path is not made a different result because reached by following a devious 

path.’’). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment clarifies and enhances the application 

of the economic substance doctrine. The Senate amendment provides that, in a case in which a court determines that the economic 

substance doctrine is relevant to a transaction (or a series of transactions), such transaction (or series of transactions) has economic 

substance (and thus satisfies the economic substance doctrine) only 

if the taxpayer establishes that (1) the transaction changes in a 

meaningful way (apart from Federal income tax consequences) the 

taxpayer’s economic position, and (2) the taxpayer has a substantial non-tax purpose for entering into such transaction and the 

transaction is a reasonable means of accomplishing such purpose.634

The Senate amendment does not change current law standards 

used by courts in determining when to utilize an economic substance analysis.635 Also, the Senate amendment does not alter the 

court’s ability to aggregate, disaggregate or otherwise recharacterize a transaction when applying the doctrine.636 The Senate 

amendment provides a uniform definition of economic substance, 

but does not alter the flexibility of the courts in other respects. 

Conjunctive analysis 

The Senate amendment clarifies that the economic substance 

doctrine involves a conjunctive analysis—there must be an objective inquiry regarding the effects of the transaction on the taxpayer’s economic position, as well as a subjective inquiry regarding 

the taxpayer’s motives for engaging in the transaction. Under the 

Senate amendment, a transaction must satisfy both tests—i.e., it 

must change in a meaningful way (apart from Federal income tax 

consequences) the taxpayer’s economic position, and the taxpayer 

must have a substantial non-tax purpose for entering into such 

transaction (and the transaction is a reasonable means of accomplishing such purpose)—in order to satisfy the economic substance 

doctrine. This clarification eliminates the disparity that exists 

among the circuits regarding the application of the doctrine, and 

modifies its application in those circuits in which either a change 

in economic position or a non-tax business purpose (without having 

both) is sufficient to satisfy the economic substance doctrine. 

667 

637See, e.g., Treas. reg. sec. 1.269–2(b) (stating that a distortion of tax liability indicating the 

principal purpose of tax evasion or avoidance might be evidenced by the fact that ‘‘the transaction was not undertaken for reasons germane to the conduct of the business of the taxpayer’’). 

Similarly, in ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189 (1997), the court stated: 

‘‘Key to [the determination of whether a transaction has economic substance] is that the transaction must be rationally related to a useful nontax purpose that is plausible in light of the 

taxpayer’s conduct and useful in light of the taxpayer’s economic situation and intentions. Both 

the utility of the stated purpose and the rationality of the means chosen to effectuate it must 

be evaluated in accordance with commercial practices in the relevant industry. A rational relationship between purpose and means ordinarily will not be found unless there was a reasonable 

expectation that the nontax benefits would be at least commensurate with the transaction 

costs.’’ [citations omitted] 

See also Martin McMahon Jr., Economic Substance, Purposive Activity, and Corporate Tax 

Shelters, 94 Tax Notes 1017, 1023 (Feb. 25, 2002) (advocates ‘‘confining the most rigorous application of business purpose, economic substance, and purposive activity tests to transactions outside the ordinary course of the taxpayer’s business—those transactions that do not appear to 

contribute to any business activity or objective that the taxpayer may have had apart from tax 

planning but are merely loss generators.’’); Mark P. Gergen, The Common Knowledge of Tax 

Abuse, 54 SMU L. Rev. 131, 140 (Winter 2001) (‘‘The message is that you can pick up tax gold 

if you find it in the street while going about your business, but you cannot go hunting for it.’’). 638 However, if the tax benefits are clearly contemplated and expected by the language and 

purpose of the relevant authority, such tax benefits should not be disallowed solely because the 

transaction results in a favorable accounting treatment. An example is the repealed foreign 

sales corporation rules. 639This includes tax deductions or losses that are anticipated to be recognized in a period subsequent to the period the financial accounting benefit is recognized. For example, FAS 109 in 

some cases permits the recognition of financial accounting benefits prior to the period in which 

the tax benefits are recognized for income tax purposes. 640 Claiming that a financial accounting benefit constitutes a substantial non-tax purpose fails 

to consider the origin of the accounting benefit (i.e., reduction of taxes) and significantly diminishes the purpose for having a substantial non-tax purpose requirement. See, e.g., American 

Electric Power, Inc. v. U.S., 136 F. Supp. 2d 762, 791–92 (S.D. Ohio, 2001) (‘‘AEP’s intended 

use of the cash flows generated by the [corporate-owned life insurance] plan is irrelevant to the 

subjective prong of the economic substance analysis. If a legitimate business purpose for the use 

of the tax savings ‘were sufficient to breathe substance into a transaction whose only purpose 

was to reduce taxes, [then] every sham tax-shelter device might succeed,’ ’’ citing Winn-Dixie v. 

Commissioner, 113 T.C. 254, 287 (1999)). 641See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 

Non-tax business purpose 

The Senate amendment provides that a taxpayer’s non-tax purpose for entering into a transaction (the second prong in the analysis) must be ‘‘substantial,’’ and that the transaction must be ‘‘a 

reasonable means’’ of accomplishing such purpose. Under this formulation, the non-tax purpose for the transaction must bear a reasonable relationship to the taxpayer’s normal business operations 

or investment activities.637

In determining whether a taxpayer has a substantial non-tax 

business purpose, an objective of achieving a favorable accounting 

treatment for financial reporting purposes will not be treated as 

having a substantial non-tax purpose.638 Furthermore, a transaction that is expected to increase financial accounting income as 

a result of generating tax deductions or losses without a corresponding financial accounting charge (i.e., a permanent book-tax 

difference) 639 should not be considered to have a substantial nontax purpose unless a substantial non-tax purpose exists apart from 

the financial accounting benefits.640

By requiring that a transaction be a ‘‘reasonable means’’ of accomplishing its non-tax purpose, the Senate amendment reiterates 

the present-law ability of the courts to bifurcate a transaction in 

which independent activities with non-tax objectives are combined 

with an unrelated item having only tax-avoidance objectives in 

order to disallow the tax benefits of the overall transaction.641

668 

642Thus, a ‘‘reasonable possibility of profit’’ will not be sufficient to establish that a transaction has economic substance. 

Profit potential 

Under the Senate amendment, a taxpayer may rely on factors 

other than profit potential to demonstrate that a transaction results in a meaningful change in the taxpayer’s economic position; 

the Senate amendment merely sets forth a minimum threshold of 

profit potential if that test is relied on to demonstrate a meaningful 

change in economic position. If a taxpayer relies on a profit potential, however, the present value of the reasonably expected pre-tax 

profit must be substantial in relation to the present value of the 

expected net tax benefits that would be allowed if the transaction 

were respected.642 Moreover, the profit potential must exceed a 

risk-free rate of return. In addition, in determining pre-tax profit, 

fees and other transaction expenses and foreign taxes are treated 

as expenses. 

In applying the profit potential test to a lessor of tangible property, depreciation, applicable tax credits (such as the rehabilitation 

tax credit and the low income housing tax credit), and any other 

deduction as provided in guidance by the Secretary are not taken 

into account in measuring tax benefits. 

Transactions with tax-indifferent parties 

The Senate amendment also provides special rules for transactions with tax-indifferent parties. For this purpose, a tax-indifferent party means any person or entity not subject to Federal income tax, or any person to whom an item would have no substantial impact on its income tax liability. Under these rules, the form 

of a financing transaction will not be respected if the present value 

of the tax deductions to be claimed is substantially in excess of the 

present value of the anticipated economic returns to the lender. 

Also, the form of a transaction with a tax-indifferent party will not 

be respected if it results in an allocation of income or gain to the 

tax-indifferent party in excess of the tax-indifferent party’s economic gain or income or if the transaction results in the shifting 

of basis on account of overstating the income or gain of the tax-indifferent party. 

Other rules 

The Secretary may prescribe regulations which provide (1) exemptions from the application of the Senate amendment, and (2) 

other rules as may be necessary or appropriate to carry out the 

purposes of the Senate amendment. 

No inference is intended as to the proper application of the economic substance doctrine under present law. In addition, except 

with respect to the economic substance doctrine, the Senate amendment shall not be construed as altering or supplanting any other 

common law doctrine (including the sham transaction doctrine), 

and the Senate amendment shall be construed as being additive to 

any such other doctrine. 

669 

643Sec. 6662. 644Sec. 6662(d)(2)(C). 645Sec. 6664(c). 646Treas. Reg. sec. 1.6662–4(g)(4)(i)(B); Treas. Reg. sec. 1.6664–4(c). 

Effective date 

The Senate amendment provision applies to transactions entered into after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

31. Penalty for understatements attributable to transactions lacking economic substance, etc. (sec. 404 of the Senate amendment and sec. 6662B of the Code) 

PRESENT LAW

An accuracy-related penalty applies to the portion of any underpayment that is attributable to (1) negligence, (2) any substantial understatement of income tax, (3) any substantial valuation 

misstatement, (4) any substantial overstatement of pension liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income tax liability exceeds that reported by 

the taxpayer by the greater of 10 percent of the correct tax or 

$5,000 ($10,000 in the case of corporations), then a substantial understatement exists and a penalty may be imposed equal to 20 percent of the underpayment of tax attributable to the understatement.643 The amount of any understatement is reduced by any portion attributable to an item if (1) the treatment of the item is supported by substantial authority, or (2) facts relevant to the tax 

treatment of the item were adequately disclosed and there was a 

reasonable basis for its tax treatment. 

Special rules apply with respect to tax shelters.644 For understatements by non-corporate taxpayers attributable to tax shelters, 

the penalty may be avoided only if the taxpayer establishes that, 

in addition to having substantial authority for the position, the taxpayer reasonably believed that the treatment claimed was more 

likely than not the proper treatment of the item. This reduction in 

the penalty is unavailable to corporate tax shelters. 

The penalty generally is abated (even with respect to tax shelters) in cases in which the taxpayer can demonstrate that there 

was ‘‘reasonable cause’’ for the underpayment and that the taxpayer acted in good faith.645 The relevant regulations provide that 

reasonable cause exists where the taxpayer ‘‘reasonably relies in 

good faith on an opinion based on a professional tax advisor’s analysis of the pertinent facts and authorities [that] . . . unambiguously 

concludes that there is a greater than 50-percent likelihood that 

the tax treatment of the item will be upheld if challenged’’ by the 

IRS.646

HOUSE BILL

No provision. 

670 

647Thus, unlike the new accuracy-related penalty under section 6662A (which applies only to 

listed and reportable avoidance transactions), the new penalty under this provision applies to 

any transaction that lacks economic substance. 648The provision provides that a transaction has economic substance only if: (1) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and (2) the transaction has a substantial non-tax purpose for entering into such 

transaction and is a reasonable means of accomplishing such purpose. 649The provision provides that the form of a transaction that involves a tax-indifferent party 

will not be respected in certain circumstances. 650For this purpose, any reduction in the excess of deductions allowed for the taxable year 

over gross income for such year, and any reduction in the amount of capital losses that would 

(without regard to section 1211) be allowed for such year, would be treated as an increase in 

taxable income. 

SENATE AMENDMENT

The Senate amendment imposes a penalty for an understatement attributable to any transaction that lacks economic substance 

(referred to in the statute as a ‘‘non-economic substance transaction 

understatement’’).647 The penalty rate is 40 percent (reduced to 20 

percent if the taxpayer adequately discloses the relevant facts in 

accordance with regulations prescribed under section 6011). No exceptions (including the reasonable cause or rescission rules) to the 

penalty would be available under the Senate amendment (i.e., the 

penalty is a strict-liability penalty). 

A ‘‘non-economic substance transaction’’ means any transaction 

if (1) the transaction lacks economic substance (as defined in the 

earlier Senate amendment provision regarding the economic substance doctrine),648 (2) the transaction was not respected under the 

rules relating to transactions with tax-indifferent parties (as described in the earlier Senate amendment provision regarding the 

economic substance doctrine),649 or (3) any similar rule of law. For 

this purpose, a similar rule of law would include, for example, an 

understatement attributable to a transaction that is determined to 

be a sham transaction. 

For purposes of the Senate amendment, the calculation of an 

‘‘understatement’’ is made in the same manner as in the separate 

Senate amendment provision relating to accuracy-related penalties 

for listed and reportable avoidance transactions (new sec. 6662A). 

Thus, the amount of the understatement under the Senate amendment provision would be determined as the sum of (1) the product 

of the highest corporate or individual tax rate (as appropriate) and 

the increase in taxable income resulting from the difference between the taxpayer’s treatment of the item and the proper treatment of the item (without regard to other items on the tax return),650 and (2) the amount of any decrease in the aggregate 

amount of credits which results from a difference between the taxpayer’s treatment of an item and the proper tax treatment of such 

item. In essence, the penalty will apply to the amount of any understatement attributable solely to a non-economic substance 

transaction. 

Except as provided in regulations, the taxpayer’s treatment of 

an item will not take into account any amendment or supplement 

to a return if the amendment or supplement is filed after the earlier of the date the taxpayer is first contacted regarding an examination of such return or such other date as specified by the Secretary. 

671 

A public entity that is required to pay a penalty under the 

Senate amendment (regardless of whether the transaction was disclosed) must disclose the imposition of the penalty in reports to the 

SEC for such periods as the Secretary shall specify. The disclosure 

to the SEC applies without regard to whether the taxpayer determines the amount of the penalty to be material to the reports in 

which the penalty must appear, and any failure to disclose such 

penalty in the reports is treated as a failure to disclose a listed 

transaction. A taxpayer must disclose a penalty in reports to the 

SEC once the taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if earlier, when paid). 

Prior to this penalty being asserted in the first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review in the IRS Office of Appeals (e.g., a Revenue Agent 

Report), the IRS Chief Counsel or his delegate at the IRS National 

Office must approve the inclusion in writing. Once a penalty (regardless of whether the transaction was disclosed) has been included in the Revenue Agent Report, the penalty cannot be compromised for purposes of a settlement without approval of the Commissioner personally or the head of the Office of Tax Shelter Analysis. Furthermore, the IRS is required to submit an annual report 

to Congress summarizing the application of this penalty and providing a description of each penalty compromised under the Senate 

amendment and the reasons for the compromise. 

Any understatement to which a penalty is imposed under the 

Senate amendment will not be subject to the accuracy-related penalty under section 6662 or under new 6662A (accuracy-related penalties for listed and reportable avoidance transactions). However, 

an understatement under the Senate amendment would be taken 

into account for purposes of determining whether any understatement (as defined in sec. 6662(d)(2)) is a substantial understatement 

as defined under section 6662(d)(1). The penalty imposed under the 

Senate amendment will not apply to any portion of an understatement to which a fraud penalty is applied under section 6663. 

Effective date.—The Senate amendment provision applies to 

transactions entered into after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

32. Understatement of taxpayer’s liability by income tax return 

preparer (sec. 411 of the Senate amendment) 

PRESENT LAW

An income tax return preparer who prepares a return with respect to which there is an understatement of tax that is due to an 

undisclosed position for which there was not a realistic possibility 

of being sustained on its merits, or a frivolous position, is liable for 

a penalty of $250, provided the preparer knew or reasonably should 

have known of the position. An income tax return preparer who 

prepares a return and engages in specified willful or reckless conduct with respect to preparing such a return is liable for a penalty 

of $1,000. 

672 

651 Because in general the Tax Court is the only pre-payment forum available to taxpayers, 

it deals with most of the frivolous, groundless, or dilatory arguments raised in tax cases. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment alters the standards of conduct that 

must be met to avoid imposition of the first penalty by replacing 

the realistic possibility standard with a requirement that there be 

a reasonable belief that the tax treatment of the position was more 

likely than not the proper treatment. The Senate amendment also 

replaces the not frivolous standard with the requirement that there 

be a reasonable basis for the tax treatment of the position, increases the present-law $250 penalty to $1,000, and increases the 

present-law $1,000 penalty to $5,000. 

Effective date.—Documents prepared after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

33. Frivolous tax submissions (sec. 413 of the Senate amendment 

and sec. 6702 of the Code) 

PRESENT LAW

The Code provides that an individual who files a frivolous income tax return is subject to a penalty of $500 imposed by the IRS 

(sec. 6702). The Code also permits the Tax Court 651 to impose a 

penalty of up to $25,000 if a taxpayer has instituted or maintained 

proceedings primarily for delay or if the taxpayer’s position in the 

proceeding is frivolous or groundless (sec. 6673(a)). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision modifies the IRS-imposed penalty by increasing 

the amount of the penalty to up to $5,000 and by applying it to all 

taxpayers and to all types of Federal taxes. 

The provision also modifies present law with respect to certain 

submissions that raise frivolous arguments or that are intended to 

delay or impede tax administration. The submissions to which this 

provision applies are requests for a collection due process hearing, 

installment agreements, offers-in-compromise, and taxpayer assistance orders. First, the provision permits the IRS to dismiss such 

requests. Second, the provision permits the IRS to impose a penalty 

of up to $5,000 for such requests, unless the taxpayer withdraws 

the request after being given an opportunity to do so. 

The provision requires the IRS to publish a list of positions, arguments, requests, and submissions determined to be frivolous for 

purposes of these provisions. 

673 

652Sec. 6062. 653Sec. 7206. 654Pursuant to 18 U.S.C. 3571, the maximum fine for an individual convicted of a felony is 

$250,000. 

Effective date.—Submissions made and issues raised after the 

date on which the Secretary first prescribes the required list of 

frivolous positions. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

34. Authorization of appropriations for tax law enforcement (sec. 

418 of the Senate amendment) 

PRESENT LAW

There is no explicit authorization of appropriations to the IRS 

to be used to combat abusive tax avoidance transactions. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision includes an authorization of an additional $300 

million to the IRS to be used to combat abusive tax avoidance 

transactions. 

Effective date.—Date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

35. Declaration by chief executive officer relating to Federal annual 

corporate income tax return (sec. 422 of the Senate amendment) 

PRESENT LAW

The Code requires 652 that the income tax return of a corporation must be signed by either the president, the vice-president, the 

treasurer, the assistant treasurer, the chief accounting officer, or 

any other officer of the corporation authorized by the corporation 

to sign the return. 

The Code also imposes 653 a criminal penalty on any person 

who willfully signs any tax return under penalties of perjury that 

that person does not believe to be true and correct with respect to 

every material matter at the time of filing. If convicted, the person 

is guilty of a felony; the Code imposes a fine of not more than 

$100,000 654 ($500,000 in the case of a corporation) or imprisonment of not more than three years, or both, together with the costs 

of prosecution. 

HOUSE BILL

No provision. 

674 

655With respect to foreign corporations, it is intended that the rules for signing this declaration generally parallel the present-law rules for signing the return. See Treas. Reg. sec. 1.6062– 

1(a)(3). 656The provision does, however, apply to the income tax returns of mutual fund management 

companies and advisors. 

SENATE AMENDMENT

The provision requires that a corporation’s Federal income tax 

return include a declaration signed under penalties of perjury by 

the chief executive officer of the corporation that the corporation 

has in place processes and procedures to ensure that the return 

complies with the Internal Revenue Code and that the CEO was 

provided reasonable assurance of the accuracy of all material aspects of the return. This declaration is part of the income tax return. The provision is in addition to the requirement of present law 

as to the signing of the income tax return itself. Because a CEO’s 

duties generally do not require a detailed or technical understanding of the corporation’s tax return, it is anticipated that this 

declaration of the CEO will be more limited in scope than the declaration of the officer required to sign the return itself. 

The Secretary of the Treasury shall prescribe the matters to 

which the declaration of the CEO applies. It is intended that the 

declaration help insure that the preparation and completion of the 

corporation’s tax return be given an appropriate level of care. For 

example, it is anticipated that the CEO would declare that processes and procedures have been implemented to ensure that the return complies with the Internal Revenue Code and all regulations 

and rules promulgated thereunder. Although appropriate processes 

and procedures can vary for each taxpayer depending on the size 

and nature of the taxpayer’s business, in every case the CEO 

should be briefed on all material aspects of the corporation’s tax return by the corporation’s chief financial officer (or another person 

authorized to sign the return under present law). 

If the corporation does not have a chief executive officer, the 

IRS may designate another officer of the corporation; otherwise, no 

other person is permitted to sign the declaration. It is intended 

that the IRS issue general guidance, such as a revenue procedure, 

to: (1) address situations when a corporation does not have a chief 

executive officer; and (2) define who the chief executive officer is, 

in situations (for example) when the primary official bears a different title, when a corporation has multiple chief executive officers, or when the corporation is a foreign corporation and the CEO 

is not a U.S. resident.655 It is intended that, in every instance, the 

highest ranking corporate officer (regardless of title) sign this declaration. 

The provision does not apply to the income tax returns of mutual funds; 656 they are required to be signed as under present law. 

Effective date.—Federal tax returns for taxable years ending 

after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

675 

657S. Rep. 91–552, 91st Cong, 1st Sess., 273–74 (1969), referring to Tank Truck Rentals, Inc. 

v. Commissioner, 356 U.S. 30 (1958). 658The bill does not affect amounts paid or incurred in performing routine audits or reviews 

such as annual audits that are required of all organizations or individuals in a similar business 

sector, or profession, as a requirement for being allowed to conduct business. However, if the 

government or regulator raised an issue of compliance and a payment is required in settlement 

of such issue, the bill would affect that payment. 659The bill provides that such amounts are nondeductible under chapter 1 of the Internal Revenue Code. 

36. Denial of deduction for certain fines, penalties, and other 

amounts (sec. 423 of the Senate amendment and sec. 162 of the 

Code) 

PRESENT LAW

Under present law, no deduction is allowed as a trade or business expense under section 162(a) for the payment of a fine or similar penalty to a government for the violation of any law (sec. 

162(f)). The enactment of section 162(f) in 1969 codified existing 

case law that denied the deductibility of fines as ordinary and necessary business expenses on the grounds that ‘‘allowance of the deduction would frustrate sharply defined national or State policies 

proscribing the particular types of conduct evidenced by some governmental declaration thereof.’’ 657

Treasury regulation section 1.162–21(b)(1) provides that a fine 

or similar penalty includes an amount: (1) paid pursuant to conviction or a plea of guilty or nolo contendere for a crime (felony or 

misdemeanor) in a criminal proceeding; (2) paid as a civil penalty 

imposed by Federal, State, or local law, including additions to tax 

and additional amounts and assessable penalties imposed by chapter 68 of the Code; (3) paid in settlement of the taxpayer’s actual 

or potential liability for a fine or penalty (civil or criminal); or (4) 

forfeited as collateral posted in connection with a proceeding which 

could result in imposition of such a fine or penalty. Treasury regulation section 1.162–21(b)(2) provides, among other things, that 

compensatory damages (including damages under section 4A of the 

Clayton Act (15 U.S.C. 15a), as amended) paid to a government do 

not constitute a fine or penalty. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The bill modifies the rules regarding the determination whether payments are nondeductible payments of fines or penalties 

under section 162(f). In particular, the bill generally provides that 

amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government in relation to the violation of any law or the investigation or inquiry into the potential 

violation of any law 658 are nondeductible under any provision of 

the income tax provisions.659 The bill applies to deny a deduction 

for any such payments, including those where there is no admission of guilt or liability and those made for the purpose of avoiding 

676 

660The bill does not affect the treatment of antitrust payments made under section 4 of the 

Clayton Act, which will continue to be governed by the provisions of section 162(g). 661Thus, for example, the bill would not apply to payments made by one private party to another in a lawsuit between private parties, merely because a judge or jury acting in the capacity 

as a court directs the payment to be made. The mere fact that a court enters a judgement or 

directs a result in a private dispute does not cause a payment to be made ‘‘at the direction of 

a government’’ for purposes of the provision. 662Similarly, a payment to a charitable organization benefitting a broader class than the persons or property actually harmed, or to be paid out without a substantial quantitative relationship to the harm caused, would not qualify as restitution. Under the provision, such a payment 

not deductible under section 162 would also not be deductible under section 170. 

further investigation or litigation. An exception applies to payments that the taxpayer establishes are restitution.660

The bill is intended to apply only where a government (or other 

entity treated in a manner similar to a government under the bill) 

is a complainant or investigator with respect to the violation or potential violation of any law.661

It is intended that a payment will be treated as restitution 

only if substantially all of the payment is required to be paid to the 

specific persons, or in relation to the specific property, actually 

harmed by the conduct of the taxpayer that resulted in the payment. Thus, a payment to or with respect to a class substantially 

broader than the specific persons or property that were actually 

harmed (e.g., to a class including similarly situated persons or 

property) does not qualify as restitution.662 Restitution is limited 

to the amount that bears a substantial quantitative relationship to 

the harm caused by the past conduct or actions of the taxpayer 

that resulted in the payment in question. If the party harmed is 

a government or other entity, then restitution includes payment to 

such harmed government or entity, provided the payment bears a 

substantial quantitative relationship to the harm. However, restitution does not include reimbursement of government investigative or litigation costs, or payments to whistleblowers. 

Amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, any self-regulatory entity that regulates a financial market or other market that is a qualified board 

or exchange under section 1256(g)(7), and that is authorized to impose sanctions (e.g., the National Association of Securities Dealers) 

are likewise subject to the provision if paid in relation to a violation, or investigation or inquiry into a potential violation, of any 

law (or any rule or other requirement of such entity). To the extent 

provided in regulations, amounts paid or incurred to, or at the direction of, any other nongovernmental entity that exercises selfregulatory powers as part of performing an essential governmental 

function are similarly subject to the provision. The exception for 

payments that the taxpayer establishes are restitution likewise applies in these cases. 

No inference is intended as to the treatment of payments as 

nondeductible fines or penalties under present law. In particular, 

the Senate amendment is not intended to limit the scope of 

present-law section 162(f) or the regulations thereunder. 

Effective date.—The bill is effective for amounts paid or incurred on or after April 28, 2003; however the proposal does not 

apply to amounts paid or incurred under any binding order or 

agreement entered into before such date. Any order or agreement 

requiring court approval is not a binding order or agreement for 

677 

663Sec. 162(a). 664Sec. 162(c). 665Sec. 162(f). 666Sec. 162(g). 667Sec. 104(a). 668Sec. 104(a)(2). 

this purpose unless such approval was obtained on or before April 

27, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

37. Denial of deduction for punitive damages (sec. 424 of the Senate amendment and sec. 162 of the Code) 

PRESENT LAW

In general, a deduction is allowed for all ordinary and necessary expenses that are paid or incurred by the taxpayer during 

the taxable year in carrying on any trade or business.663 However, 

no deduction is allowed for any payment that is made to an official 

of any governmental agency if the payment constitutes an illegal 

bribe or kickback or if the payment is to an official or employee of 

a foreign government and is illegal under Federal law.664 In addition, no deduction is allowed under present law for any fine or 

similar payment made to a government for violation of any law.665

Furthermore, no deduction is permitted for two-thirds of any damage payments made by a taxpayer who is convicted of a violation 

of the Clayton antitrust law or any related antitrust law.666

In general, gross income does not include amounts received on 

account of personal physical injuries and physical sickness.667 However, this exclusion does not apply to punitive damages.668

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment denies any deduction for punitive damages that are paid or incurred by the taxpayer as a result of a judgment or in settlement of a claim. If the liability for punitive damages is covered by insurance, any such punitive damages paid by 

the insurer are included in gross income of the insured person and 

the insurer is required to report such amounts to both the insured 

person and the IRS. 

Effective date.—The Senate amendment provision is effective 

for punitive damages that are paid or incurred on or after the date 

of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

678 

669Section 7206 states that making fraudulent or false statements under the Code is a felony. 

In addition, this offense is a felony pursuant to the classification guidelines of 18 U.S.C. 

3559(a)(5). 

38. Increase in criminal monetary penalty limitation for the underpayment or overpayment of tax due to fraud (sec. 425 of the 

Senate amendment) 

PRESENT LAW

Attempt to evade or defeat tax 

In general, section 7201 imposes a criminal penalty on persons 

who willfully attempt to evade or defeat any tax imposed by the 

Code. Upon conviction, the Code provides that the penalty is up to 

$100,000 or imprisonment of not more than five years (or both). In 

the case of a corporation, the Code increases the monetary penalty 

to a maximum of $500,000. 

Willful failure to file return, supply information, or pay tax 

In general, section 7203 imposes a criminal penalty on persons 

required to make estimated tax payments, pay taxes, keep records, 

or supply information under the Code who willfully fails to do so. 

Upon conviction, the Code provides that the penalty is up to 

$25,000 or imprisonment of not more than one year (or both). In 

the case of a corporation, the Code increases the monetary penalty 

to a maximum of $100,000. 

Fraud and false statements 

In general, section 7206 imposes a criminal penalty on persons 

who make fraudulent or false statements under the Code. Upon 

conviction, the Code provides that the penalty is up to $100,000 or 

imprisonment of not more than three years (or both). In the case 

of a corporation, the Code increases the monetary penalty to a 

maximum of $500,000. 

Uniform sentencing guidelines 

Under the uniform sentencing guidelines established by 18 

U.S.C. 3571, a defendant found guilty of a criminal offense is subject to a maximum fine that is the greatest of: (a) the amount specified in the underlying provision, (b) for a felony 669 $250,000 for an 

individual or $500,000 for an organization, or (c) twice the gross 

gain if a person derives pecuniary gain from the offense. This Title 

18 provision applies to all criminal provisions in the United States 

Code, including those in the Internal Revenue Code. For example, 

for an individual, the maximum fine under present law upon conviction of violating section 7206 is $250,000 or, if greater, twice the 

amount of gross gain from the offense. 

HOUSE BILL

No provision. 

679 

SENATE AMENDMENT

Attempt to evade or defeat tax 

The bill increases the criminal penalty under section 7201 of the Code for individuals to $250,000 and for corporations to 

$1,000,000. The bill increases the maximum prison sentence to ten 

years. 

Willful failure to file return, supply information, or pay tax 

The bill increases the criminal penalty under section 7203 of 

the Code from a misdemeanor to a felony and increases the maximum prison sentence to ten years. 

Fraud and false statements 

The bill increases the criminal penalty under section 7206 of the Code for individuals to $250,000 and for corporations to 

$1,000,000. Increases the maximum prison sentence to five years. 

The bill provides that in no event shall the amount of the monetary 

penalty under this provision be less than the amount of the underpayment or overpayment attributable to fraud. 

Effective date 

Underpayments and overpayments attributable to actions occurring after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

39. Expanded disallowance of deduction for interest on convertible 

debt (sec. 434 of the Senate amendment and sec. 163 of the 

Code) 

PRESENT LAW

Whether an instrument qualifies for tax purposes as debt or 

equity is determined under all the facts and circumstances based 

on principles developed in case law. If an instrument qualifies as 

equity, the issuer generally does not receive a deduction for dividends paid and the holder generally includes such dividends in income (although corporate holders generally may obtain a dividendsreceived deduction of at least 70 percent of the amount of the dividend). If an instrument qualifies as debt, the issuer may receive a 

deduction for accrued interest and the holder generally includes interest in income, subject to certain limitations. 

Original issue discount (‘‘OID’’) on a debt instrument is the excess of the stated redemption price at maturity over the issue price 

of the instrument. An issuer of a debt instrument with OID generally accrues and deducts the discount as interest over the life of 

the instrument even though interest may not be paid until the instrument matures. The holder of such a debt instrument also generally includes the OID in income as it accrues. 

Under present law, no deduction is allowed for interest or OID 

on a debt instrument issued by a corporation (or issued by a partnership to the extent of its corporate partners) that is payable in 

680 

670Sec. 163(l), enacted in the Taxpayer Relief Act of 1997, Pub. L. No. 105–34, sec. 1005(a). 671Sec. 163(l)(3)(B). 672Sec. 163(l)(3)(C). 

equity of the issuer or a related party (within the meaning of sections 267(b) and 707(b)), including a debt instrument a substantial 

portion of which is mandatorily convertible or convertible at the 

issuer’s option into equity of the issuer or a related party.670 In addition, a debt instrument is treated as payable in equity if a substantial portion of the principal or interest is required to be determined, or may be determined at the option of the issuer or related 

party, by reference to the value of equity of the issuer or related 

party.671 A debt instrument also is treated as payable in equity if 

it is part of an arrangement that is designed to result in the payment of the debt instrument with or by reference to such equity, 

such as in the case of certain issuances of a forward contract in 

connection with the issuance of debt, nonrecourse debt that is secured principally by such equity, or certain debt instruments that 

are paid in, converted to, or determined with reference to the value 

of equity if it may be so required at the option of the holder or a 

related party and there is a substantial certainty that option will 

be exercised.672

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment expands the present-law disallowance 

of interest deductions on certain convertible or equity-linked corporate debt that is payable in, or by reference to the value of, equity. Under the Senate amendment, the disallowance is expanded 

to include interest on corporate debt that is payable in, or by reference to the value of, any equity held by the issuer (or by any related party) in any other person, without regard to whether such 

equity represents more than a 50-percent ownership interest in 

such person. However, the Senate amendment does not apply to 

debt that is issued by an active dealer in securities (or by a related 

party) if the debt is payable in, or by reference to the value of, equity that is held by the securities dealer in its capacity as a dealer 

in securities. 

Effective date.—The Senate amendment provision applies to 

debt instruments that are issued after February 13, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except the conference agreement applies to debt instruments that are 

issued after October 3, 2004. 

40. Expand authority to disallow tax benefits under section 269 

(sec. 435 of the Senate amendment and sec. 269 of the Code) 

PRESENT LAW

Section 269 provides that if a taxpayer acquires, directly or indirectly, control (defined as at least 50 percent of vote or value) of 

681 

673Sec. 269(a)(1). 674Sec. 269(a)(2). 

a corporation, and the principal purpose of the acquisition is the 

evasion or avoidance of Federal income tax by securing the benefit 

of a deduction, credit, or other allowance that would not otherwise 

have been available, the Secretary may disallow the tax benefits.673

Similarly, if a corporation acquires, directly or indirectly, property 

of another corporation (not controlled, directly or indirectly, by the 

acquiring corporation or its stockholders immediately before the acquisition), the basis of such property is determined by reference to 

the basis in the hands of the transferor corporation, and the principal purpose of the acquisition is the evasion or avoidance of Federal income tax by securing a tax benefit that would not otherwise 

have been available, the Secretary may disallow such tax benefits.674

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment expands section 269 by repealing the 

requirement that the acquisition of property be from a corporation 

not controlled by the acquirer. Thus, under the Senate amendment, 

section 269 disallows the tax benefits of (1) any acquisition of stock 

sufficient to obtain control of a corporation (as under present law), 

and (2) any acquisition by a corporation of property from a corporation in which the basis of such property is determined by reference 

to the basis in the hands of the transferor corporation, if the principal purpose of such acquisition is the evasion or avoidance of Federal income tax. 

Effective date.—The Senate amendment applies to stock and 

property acquired after February 13, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

41. Modification of coordination rules for controlled foreign corporation and passive foreign investment company regimes (sec. 436 

of the Senate amendment and sec. 1297 of the Code) 

PRESENT LAW

The United States employs a ‘‘worldwide’’ tax system, under 

which domestic corporations generally are taxed on all income, 

whether derived in the United States or abroad. Income earned by 

a domestic parent corporation from foreign operations conducted by 

foreign corporate subsidiaries generally is subject to U.S. tax when 

the income is distributed as a dividend to the domestic corporation. 

Until such repatriation, the U.S. tax on such income generally is 

deferred. However, certain anti-deferral regimes may cause the domestic parent corporation to be taxed on a current basis in the 

United States with respect to certain categories of passive or highly 

mobile income earned by its foreign subsidiaries, regardless of 

682 

675Secs. 951–964. 676Secs. 1291–1298. 677Secs. 901, 902, 960, 1291(g). 678Secs. 951–964. 679Secs. 951(b), 957, 958. 680Sec. 951(a). 681Sec. 954. 682Sec. 953. 683Sec. 952(a)(3)–(5). 684Sec. 954. 685Secs. 951(a)(1)(B), 956. 

whether the income has been distributed as a dividend to the domestic parent corporation. The main anti-deferral regimes in this 

context are the controlled foreign corporation rules of subpart F 675

and the passive foreign investment company rules.676 Deferral of 

U.S. tax is considered appropriate, on the other hand, with respect 

to most types of active business income earned abroad. A foreign 

tax credit generally is available to offset, in whole or in part, the 

U.S. tax owed on foreign-source income, whether earned directly by 

the domestic corporation, repatriated as an actual dividend, or included under one of the anti-deferral regimes.677

Subpart F,678 applicable to controlled foreign corporations and 

their shareholders, is the main anti-deferral regime of relevance to 

a U.S.-based multinational corporate group. A controlled foreign 

corporation generally is defined as any foreign corporation if U.S. 

persons own (directly, indirectly, or constructively) more than 50 

percent of the corporation’s stock (measured by vote or value), taking into account only those U.S. persons that own at least 10 percent of the stock (measured by vote only).679 Under the subpart F 

rules, the United States generally taxes the U.S. 10-percent shareholders of a controlled foreign corporation on their pro rata shares 

of certain income of the controlled foreign corporation (referred to 

as ‘‘subpart F income’’), without regard to whether the income is 

distributed to the shareholders.680

Subpart F income generally includes passive income and other 

income that is readily movable from one taxing jurisdiction to another. Subpart F income consists of foreign base company income,681 insurance income,682 and certain income relating to international boycotts and other violations of public policy.683 Foreign 

base company income consists of foreign personal holding company 

income, which includes passive income (e.g., dividends, interest, 

rents, and royalties), as well as a number of categories of non-passive income, including foreign base company sales income, foreign 

base company services income, foreign base company shipping income and foreign base company oil-related income.684

In effect, the United States treats the U.S. 10-percent shareholders of a controlled foreign corporation as having received a current distribution out of the corporation’s subpart F income. In addition, the U.S. 10-percent shareholders of a controlled foreign corporation are required to include currently in income for U.S. tax 

purposes their pro rata shares of the corporation’s earnings invested in U.S. property.685

The Tax Reform Act of 1986 established an additional anti-deferral regime, for passive foreign investment companies. A passive 

foreign investment company generally is defined as any foreign corporation if 75 percent or more of its gross income for the taxable 

683 

686Sec. 1297. 687Sec. 1293–1295. 688Sec. 1291. 689Sec. 1296. 

year consists of passive income, or 50 percent or more of its assets 

consists of assets that produce, or are held for the production of, 

passive income.686 Alternative sets of income inclusion rules apply 

to U.S. persons that are shareholders in a passive foreign investment company, regardless of their percentage ownership in the 

company. One set of rules applies to passive foreign investment 

companies that are ‘‘qualified electing funds,’’ under which electing 

U.S. shareholders currently include in gross income their respective 

shares of the company’s earnings, with a separate election to defer 

payment of tax, subject to an interest charge, on income not currently received.687 A second set of rules applies to passive foreign 

investment companies that are not qualified electing funds, under 

which U.S. shareholders pay tax on certain income or gain realized 

through the company, plus an interest charge that is attributable 

to the value of deferral.688 A third set of rules applies to passive 

foreign investment company stock that is marketable, under which 

electing U.S. shareholders currently take into account as income 

(or loss) the difference between the fair market value of the stock 

as of the close of the taxable year and their adjusted basis in such 

stock (subject to certain limitations), often referred to as ‘‘marking 

to market.’’ 689

Under section 1297(e), which was enacted in 1997 to address 

the overlap of the passive foreign investment company rules and 

subpart F, a controlled foreign corporation generally is not also 

treated as a passive foreign investment company with respect to a 

U.S. shareholder of the corporation. This exception applies regardless of the likelihood that the U.S. shareholder would actually be 

taxed under subpart F in the event that the controlled foreign corporation earns subpart F income. Thus, even in a case in which a 

controlled foreign corporation’s subpart F income would be allocated to a different shareholder under the subpart F allocation 

rules, a U.S. shareholder would still qualify for the exception from 

the passive foreign investment company rules under section 

1297(e). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision adds an exception to section 1297(e) for U.S. 

shareholders that face only a remote likelihood of incurring a subpart F inclusion in the event that a controlled foreign corporation 

earns subpart F income, thus preserving the potential application 

of the passive foreign investment company rules in such cases. 

Effective date.—The provision is effective for taxable years of 

foreign corporations beginning after February 13, 2003, and for taxable years of U.S. shareholders with or within which such taxable 

years of such foreign corporations end. 

684 

690Secs. 4051, 4071, 4481, 4041 and 4081. 691See Treas. Reg. sec. 48.4061–1(d)). 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

C. REDUCTION OF FUEL TAX EVASION

1. Exemption from certain excise taxes for mobile machinery vehicles and modification of definition of offhighway vehicle (sec. 

651 of the House bill, sec. 896 of the Senate amendment, and 

secs. 4053, 4072, 4082, 4483, 6421, and 7701 of the Code) 

PRESENT LAW

Under present law, the definition of a ‘‘highway vehicle’’ affects 

the application of the retail tax on heavy vehicles, the heavy vehicle use tax, the tax on tires, and fuel taxes.690 Section 4051 of the 

Code provides for a 12-percent retail sales tax on tractors, heavy 

trucks with a gross vehicle weight (‘‘GVW’’) over 33,000 pounds, 

and trailers with a GVW over 26,000 pounds. Section 4071 provides 

for a tax on highway vehicle tires that weigh more than 40 pounds, 

with higher rates of tax for heavier tires. Section 4481 provides for 

an annual use tax on heavy vehicles with a GVW of 55,000 pounds 

or more, with higher rates of tax on heavier vehicles. All of these 

excise taxes are paid into the Highway Trust Fund. 

Federal excise taxes are also levied on the motor fuels used in 

highway vehicles. Gasoline is subject to a tax of 18.4 cents per gallon, of which 18.3 cents per gallon is paid into the Highway Trust 

Fund and 0.1 cent per gallon is paid into the Leaking Underground 

Storage Tank (‘‘LUST’’) Trust Fund. Highway diesel fuel is subject 

to a tax of 24.4 cents per gallon, of which 24.3 cents per gallon is 

paid into the Highway Trust Fund and 0.1 cent per gallon is paid 

into the LUST Trust Fund. 

The Code does not define a ‘‘highway vehicle.’’ For purposes of 

these taxes, Treasury regulations define a highway vehicle as any 

self-propelled vehicle or trailer or semitrailer designed to perform 

a function of transporting a load over the public highway, whether 

or not also designed to perform other functions. Excluded from the 

definition of highway vehicle are (1) certain specially designed mobile machinery vehicles for non-transportation functions (the ‘‘mobile machinery exception’’); (2) certain vehicles specially designed 

for off-highway transportation for which the special design substantially limits or impairs the use of such vehicle to transport loads 

over the highway (the ‘‘off-highway transportation vehicle’’ exception); and (3) certain trailers and semi-trailers specially designed to 

function only as an enclosed stationary shelter for the performance 

of non-transportation functions off the public highways.691

The mobile machinery exception applies if three tests are met: 

(1) the vehicle consists of a chassis to which jobsite machinery (unrelated to transportation) has been permanently mounted; (2) the 

chassis has been specially designed to serve only as a mobile carriage and mount for the particular machinery; and (3) by reason of 

such special design, the chassis could not, without substantial 

685 

692Prop. Treas. Reg. sec. 48.4051–1(a), 67 Fed. Reg. 38913, 38914–38915 (2002). 693Prop. Treas. Reg. sec. 48.4051–1(a)(2)(i). 694Prop. Treas. Reg. sec. 48.4051–1(a)(2)(ii). 

structural modification, be used to transport a load other than the 

particular machinery. An example of a mobile machinery vehicle is 

a crane mounted on a truck chassis that meets the forgoing factors. 

On June 6, 2002, the Treasury Department put forth proposed 

regulations that would eliminate the mobile machinery exception.692 The other exceptions from the definition of highway vehicle 

would continue to apply with some modifications. Under the proposed regulations, the chassis of a mobile machinery vehicle would 

be subject to the retail sales tax on heavy vehicles unless the vehicle qualified under the off-highway transportation vehicle exception. Also, under the proposed regulations, mobile machinery vehicles may be subject to the heavy vehicle use tax. In addition, the 

tax credits, refunds, and exemptions from tax may not be available 

for the fuel used in these vehicles. 

On June 6, 2002, the Treasury Department put forth proposed 

regulations that would modify the off-highway transportation vehicle exception.693 Under the proposed regulations, a vehicle is not 

treated as a highway vehicle if it is specially designed for the primary function of transporting a particular type of load other than 

over the public highway and because of this special design its capability to transport a load over the public highway is substantially 

limited or impaired. A vehicle’s design is determined solely on the 

basis of its physical characteristics. In determining whether substantial limitation or impairment exists, account may be taken of 

factors such as the size of the vehicle, whether it is subject to the 

licensing, safety, and other requirements applicable to highway vehicles, and whether it can transport a load at a sustained speed of 

at least 25 miles per hour. Under the proposed regulation, it is not 

material that a vehicle can transport a greater load off the public 

highway than it is permitted to transport over the public highway. 

The proposed regulation provides an exception to the definition 

of a highway vehicle for nontransportation trailers and 

semitrailers.694 Under the proposed regulation, a trailer or 

semitrailer is not treated as a highway vehicle if it is specially designed to function only as an enclosed stationary shelter for the 

carrying on of an offhighway function at an offhighway site. For example, a trailer that is capable only of functioning as an office for 

an offhighway construction operation is not a highway vehicle. 

HOUSE BILL

The provision codifies the present-law mobile machinery exemption for purposes of three taxes: the retail tax on heavy vehicles, the heavy vehicle use tax, and the tax on tires. Thus, if a vehicle can satisfy the three-part test, it will not be treated as a highway vehicle and will be exempt from these taxes. 

For purposes of the fuel excise tax, the three-part design test 

is codified and a use test is added by the provision. Specifically, in 

addition to the three-part design test, the vehicle must not have 

traveled more than 7,500 miles over public highways during the 

owner’s taxable year. Refunds of fuel taxes are permitted on an anVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00689 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
686 

695Prop. Treas. Reg. sec. 48.4051–1(c), Example (3). 

nual basis only. For purposes of this rule, a person’s taxable year 

is his taxable year for income tax purposes. 

Effective date.—The provision generally is effective after the 

date of enactment. As to the fuel taxes, the provision is effective 

for taxable years beginning after the date of enactment. 

SENATE AMENDMENT

The Senate amendment provides that mobile machinery vehicles are subject to tax as highway vehicles. The provision provides 

for the recovery of taxes paid (other than fuel taxes) over a twoyear period if such vehicle travels less than 5,000 miles per year. 

Fuel taxes for mobile machinery vehicles must be paid and then a 

refund sought if the mileage requirement is met. Refunds of fuel 

taxes are permitted on an annual basis only. Like the House bill, 

for purposes of this rule, a person’s taxable year is his taxable year 

for income tax purposes. Vehicles owned by an organization described in section 501(c), exempt from tax under section 501(a), 

need only satisfy the three-part design test to recover taxes paid 

with respect to such vehicles. 

Effective date.—The provision generally is effective after the 

date of enactment. As to the fuel taxes, the provision is effective 

for taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. Vehicles 

owned by an organization described in section 501(c), exempt from 

tax under section 501(a), need only satisfy the three-part design 

test to recover taxes paid with respect to such vehicles. 

The conference agreement adopts the definition of an 

offhighway transportation vehicle and a nontransportation trailer 

and semitrailer described in Proposed Treasury Regulation section 

48.4051–1(a)(2). 

For example, as provided in the proposed regulations,695 Vehicle C consists of a truck chassis on which an oversize body designed 

to transport and apply liquid agricultural chemicals on farms has 

been installed. It is capable of transporting a load over the public 

highway. It is 132 inches in width, which is considerably in excess 

of standard highway vehicle width. For travel on uneven and soft 

terrain, it is equipped with oversize wheels with high-flotation 

tires, and nonstandard axles, brakes, and transmission. It has a 

special fuel and carburetor air filtration system that enable it to 

perform efficiently in an environment of dirt and dust. It is not 

able to maintain a speed of 25 miles per hour for more than one 

mile while fully loaded. Because Vehicle C is a self-propelled vehicle capable of transporting a load over the public highway, it would 

meet the general definition of a highway vehicle. However, its considerable physical characteristics for transporting its load other 

than over the public highway, when compared with its physical 

characteristics for transporting the load over the public highway, 

establish that it is specially designed for the primary function of 

transporting its load other than over the public highway. Further, 

the physical characteristics for transporting its load other than 

687 

696Sec. 4093(a). 697 A rack is a mechanism capable of delivering taxable fuel into a means of transport other 

than a pipeline or vessel. Treas. Reg. sec. 48.4081–1(b). 698Sec. 4091(a)(1). 699Sec. 4091(a)(2). 700Sec. 4091(b). This rate includes a 0.1 cent per gallon Leaking Underground Storage Tank 

(‘‘LUST’’) Trust Fund tax. The LUST Trust Fund tax is set to expire after March 31, 2005, with 

the result that on April 1, 2005, the tax rate is scheduled to be 21.8 cents per gallon. Secs. 

4091(b)(3)(B) and 4081(d)(3). Beginning on October 1, 2007, the rate of tax is reduced to 4.3 

cents per gallon. Sec. 4091(b)(3)(A). 701Sec. 4092(b). The 4.4 cent rate includes 0.1 cent per gallon that is attributable to the LUST 

Trust Fund financing rate. A full exemption, discussed below, applies to aviation fuel that is 

sold for use in commercial aviation as fuel supplies for vessels or aircraft, which includes use 

by certain foreign air carriers and for the international flights of domestic carriers. Secs. 

4092(a), 4092(b), and 4221(d)(3). 702Secs. 4092(b) and 4041(c)(2). 703 Notice 88–132, sec. III(D). See also, Form 637—Application for Registration (For Certain 

Excise Tax Activities). A bond may be required as a condition of registration. 

over the public highway substantially limit its capability to transport a load over the public highway. Therefore, Vehicle C is an 

offhighway vehicle and is not treated as a highway vehicle. 

Effective date.—Generally effective after the date of enactment. 

As to the fuel taxes, effective for taxable years beginning after the 

date of enactment. 

2. Taxation of aviation-grade kerosene (sec. 652 of the House bill, 

sec. 871 of the Senate amendment, and secs. 4041, 4081, 4082, 

4083, 4091, 4092, 4093, 4101, and 6427 of the Code) 

PRESENT LAW

In general 

Aviation fuel is kerosene and any liquid (other than any product taxable under section 4081) that is suitable for use as a fuel 

in an aircraft.696 Unlike other fuels that generally are taxed upon 

removal from a terminal rack,697 aviation fuel is taxed upon sale 

of the fuel by a producer or importer.698 Sales by a registered producer to another registered producer are exempt from tax, with the 

result that, as a practical matter, aviation fuel is not taxed until 

the fuel is used at the airport (or sold to an unregistered person). 

Use of untaxed aviation fuel by a producer is treated as a taxable 

sale.699 The producer or importer is liable for the tax. The rate of 

tax on aviation fuel is 21.9 cents per gallon.700

The tax on aviation fuel is reported by filing Form 720—Quarterly Federal Excise Tax Return. Generally, semi-monthly deposits 

are required using Form 8109B—Federal Tax Deposit Coupon or by 

depositing the tax by electronic funds transfer. 

Partial exemptions 

In general, aviation fuel sold for use or used in commercial 

aviation is taxed at a reduced rate of 4.4 cents per gallon.701 Commercial aviation means any use of an aircraft in a business of 

transporting persons or property for compensation or hire by air 

(unless the use is allocable to any transportation exempt from certain excise taxes).702

In order to qualify for the 4.4 cents per gallon rate, the person 

engaged in commercial aviation must be registered with the Secretary 703 and provide the seller with a written exemption certificate stating the airline’s name, address, taxpayer identification 

688 

704Sec. 4092(a). 705 ‘‘Trade’’ includes the transportation of persons or property for hire. Treas. Reg. sec. 

48.4221–4(b)(8). 706Secs. 4041(f)(2), 4041(g), 4041(h), 4041(l), and 4092. 707Sec. 4092(c). 708Sec. 4091(d). 

number, registration number, and intended use of the fuel. A person that is registered as a buyer of aviation fuel for use in commercial aviation generally is assigned a registration number with a ‘‘Y’’ 

suffix (a ‘‘Y’’ registrant), which entitles the registrant to purchase 

aviation fuel at the 4.4 cents per gallon rate. 

Large commercial airlines that also are producers of aviation 

fuel qualify for registration numbers with an ‘‘H’’ suffix. As producers of aviation fuel, ‘‘H’’ registrants may buy aviation fuel tax 

free pursuant to a full exemption that applies to sales of aviation 

fuel by a registered producer to a registered producer. If the ‘‘H’’ 

registrant ultimately uses such untaxed fuel in domestic commercial aviation, the H registrant is liable for the aviation fuel tax at 

the 4.4 cents per gallon rate. 

Exemptions 

Aviation fuel sold by a producer or importer for use by the 

buyer in a nontaxable use is exempt from the excise tax on sales 

of aviation fuel.704 To qualify for the exemption, the buyer must 

provide the seller with a written exemption certificate stating the 

buyer’s name, address, taxpayer identification number, registration 

number (if applicable), and intended use of the fuel. 

Nontaxable uses include: (1) use other than as fuel in an aircraft (such as use in heating oil); (2) use on a farm for farming purposes; (3) use in a military aircraft owned by the United States or 

a foreign country; (4) use in a domestic air carrier engaged in foreign trade or trade between the United States and any of its possessions;705 (5) use in a foreign air carrier engaged in foreign trade 

or trade between the United States and any of its possessions (but 

only if the foreign carrier’s country of registration provides similar 

privileges to United States carriers); (6) exclusive use of a State or 

local government; (7) sales for export, or shipment to a United 

States possession; (8) exclusive use by a nonprofit educational organization; (9) use by an aircraft museum exclusively for the procurement, care, or exhibition of aircraft of the type used for combat or 

transport in World War II, and (10) use as a fuel in a helicopter 

or a fixed-wing aircraft for purposes of providing transportation 

with respect to which certain requirements are met.706

A producer that is registered with the Secretary may sell aviation fuel tax-free to another registered producer.707 Producers include refiners, blenders, wholesale distributors of aviation fuel, 

dealers selling aviation fuel exclusively to producers of aviation 

fuel, the actual producer of the aviation fuel, and with respect to 

fuel purchased at a reduced rate, the purchaser of such fuel. 

Refunds and credits 

A claim for refund of taxed aviation fuel held by a registered 

aviation fuel producer is allowed 708 (without interest) if: (1) the 

aviation fuel tax was paid by an importer or producer (the ‘‘first 

producer’’) and the tax has not otherwise been credited or refunded; 

689 

709Treas. Reg. sec. 48.4091–3(b). 710Treas. Reg. sec. 48.4091–3(d)(1). 711Sec. 6427(l)(1). 712Treas. Reg. sec. 40.6302(c)–1(a)(3). 713Sec. 34. 714See sec. 4081(a)(1)(B). 

(2) the aviation fuel was acquired by a registered aviation fuel producer (the ‘‘second producer’’) after the tax was paid; (3) the second 

producer files a timely refund claim with the proper information; 

and (4) the first producer and any other person that owns the fuel 

after its sale by the first producer and before its purchase by the 

second producer have met certain reporting requirements.709 Refund claims should contain the volume and type of aviation fuel, 

the date on which the second producer acquired the fuel, the 

amount of tax that the first producer paid, a statement by the 

claimant that the amount of tax was not collected nor included in 

the sales price of the fuel by the claimant when the fuel was sold 

to a subsequent purchaser, the name, address, and employer identification number of the first producer, and a copy of any required 

statement of a subsequent seller (subsequent to the first producer 

but prior to the second producer) that the second producer received. 

A claim for refund is filed on Form 8849, Claim for Refund of Excise Taxes, and may not be combined with any other refunds.710

A payment is allowable to the ultimate purchaser of taxed 

aviation fuel if the aviation fuel is used in a nontaxable use.711 A 

claim for payment may be made on Form 8849 or on Form 720, 

Schedule C. A claim made on Form 720, Schedule C, may be netted 

against the claimant’s excise tax liability.712 Claims for payment 

not so taken may be allowable as income tax credits 713 on Form 

4136, Credit for Federal Tax Paid on Fuels. 

HOUSE BILL

The provision changes the incidence of taxation of aviation fuel 

from the sale of aviation fuel to the removal of aviation fuel from 

a refinery or terminal, or the entry into the United States of aviation fuel. Sales of not previously taxed aviation fuel to an unregistered person also are subject to tax. 

Under the provision, the full rate of tax—21.9 cents per gallon—is imposed upon removal of aviation fuel from a refinery or 

terminal (or entry into the United States). Aviation fuel may be removed at a reduced rate—either 4.4 or zero cents per gallon—only 

if the aviation fuel is: (1) removed directly into the wing of an aircraft (i) that is registered with the Secretary as a buyer of aviation 

fuel for use in commercial aviation (e.g., a ‘‘Y’’ registrant under current law), (ii) that is a foreign airline entitled to the present law 

exemption for aviation fuel used in foreign trade, or (iii) for a taxexempt use; or (2) removed or entered as part of an exempt bulk 

transfer.714 An exempt bulk transfer is a removal or entry of aviation fuel transferred in bulk by pipeline or vessel to a terminal or 

refinery if the person removing or entering the aviation fuel, the 

operator of such pipeline or vessel, and the operator of such terminal or refinery are registered with the Secretary. 

Under a special rule, the provision treats certain refueler 

trucks, tankers, and tank wagons as a terminal if certain requireVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00693 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
690 

715The provision requires that if such delivery of information is provided to a terminal operator (or if a terminal operator collects such information), that the terminal operator provide such 

information to the Secretary. 716For example, X is a commercial airline subsidiary of airline Y. If Y sells fuel to X, X can 

waive its right to a refund to Y as the ultimate vendor. Y would then be entitled to file for a 

refund or net the refund against its excise tax liability. 

ments are met. For the special rule to apply, a qualifying truck, 

tanker, or tank wagon must be loaded with aviation fuel from a 

terminal: (1) that is located within an airport, and (2) from which 

no vehicle licensed for highway use is loaded with aviation fuel, except in exigent circumstances identified by the Secretary in regulations. It is intended that a terminal is located within an airport if 

the terminal is located in a secure facility on airport grounds. For 

example, if an access road runs between a terminal and an airport’s runways, and the terminal, like the runways, is physically located on airport grounds and is part of a secure facility, it is intended that under the provision the terminal is located within the 

airport. It is intended that an exigent circumstance under which 

loading a vehicle registered for highway use with fuel would not 

disqualify a terminal under the special rule would include, for example, the unloading of fuel from bulk storage tanks into highway 

vehicles in order to repair the storage tanks. 

In order to qualify for the special rule, a refueler truck, tanker, 

or tank wagon must: (1) deliver the aviation fuel directly into the 

wing of the aircraft at the airport where the terminal is located; 

(2) have storage tanks, hose, and coupling equipment designed and 

used for the purposes of fueling aircraft; (3) not be registered for 

highway use; and (4) be operated by the terminal operator (who operates the terminal rack from which the fuel is unloaded) or by a 

person that makes a daily accounting to such terminal operator of 

each delivery of fuel from such truck, tanker, or tank wagon.715

The provision does not change the applicable rates of tax under 

present law, 21.9 cents per gallon for use in noncommercial aviation, 4.4 cents per gallon for use in commercial aviation, and zero 

cents per gallon for use by domestic airlines in an international 

flight, by foreign airlines, or other nontaxable use. The provision 

imposes liability for the tax on aviation fuel removed from a refinery or terminal directly into the wing of an aircraft for use in commercial aviation on the person receiving the fuel, in which case, 

such person self-assesses the tax on a return. The provision does 

not change present-law nontaxable uses of aviation fuel, or change 

the persons or the qualifications of persons who are entitled to purchase fuel at a reduced rate, except that a producer is not permitted to purchase aviation fuel at a reduced rate by reason of 

such persons’ status as a producer. 

Under the provision, a refund is allowable to the ultimate vendor of aviation fuel if such ultimate vendor purchases fuel tax paid 

and subsequently sells the fuel to a person qualified to purchase 

at a reduced rate and who waives the right to a refund. In such 

a case, the provision permits an ultimate vendor to net refund 

claims against any excise tax liability of the ultimate vendor, in a 

manner similar to the present law treatment of ultimate purchaser 

payment claims.716

As under present law, if previously taxed aviation fuel is used 

for a nontaxable use, the ultimate purchaser may claim a refund 

691 

717 Alternatively, if the aviation fuel in the example is for use in noncommercial aviation, the 

fuel is taxed at 21.9 cents per gallon upon delivery into the wing. Self-assessment of the tax 

would not apply in such case. 

for the tax previously paid. If previously taxed aviation fuel is used 

for a taxable non aircraft use, the fuel is subject to the tax imposed 

on kerosene (24.4 cents per gallon) and a refund of the previously 

paid aviation fuel tax is allowed. Claims by the ultimate vendor or 

the purchaser that are not taken as refund claims may be allowable as income tax credits. 

For example, for an airport that is not served by a pipeline, 

aviation fuel generally is removed from a terminal and transported 

to an airport storage facility for eventual use at the airport. In such 

a case, the aviation fuel will be taxed at 21.9 cents per gallon upon 

removal from the terminal. At the airport, if the fuel is purchased 

from a vendor by a person registered with the Secretary to use fuel 

in commercial aviation, the purchaser may buy the fuel at a reduced rate (generally, 4.4 cents per gallon for domestic flights and 

zero cents per gallon for international flights) and waive the right 

to a refund. The ultimate vendor generally may claim a refund for 

the difference between 21.9 cents per gallon of tax paid upon removal and the rate of tax paid to the vendor by the purchaser. To 

obtain a zero rate upon purchase, a registered domestic airline 

must certify to the vendor at the time of purchase that the fuel is 

for use in an international flight; otherwise, the airline must pay 

the 4.4 cents per gallon rate and file a claim for refund to the Secretary if the fuel is used for international aviation. If a zero rate 

is paid and the fuel subsequently is used in domestic and not international travel, the domestic airline is liable for tax at 4.4 cents 

per gallon. A foreign airline eligible under present law to purchase 

aviation fuel tax-free would continue to purchase such fuel tax-free. 

As another example, for an airport that is served by a pipeline, 

aviation fuel generally is delivered to the wing of an aircraft either 

by a refueling truck or by a ‘‘hydrant’’ that runs directly from the 

pipeline to the airplane wing. If a refueling truck that is not licensed for highway use loads fuel from a terminal located within 

the airport (and the other requirements of the provision for such 

truck and terminal are met), and delivers the fuel directly to the 

wing of an aircraft for use in commercial aviation, the aviation fuel 

is taxed at 4.4 cents per gallon upon delivery to the wing and the 

person receiving the fuel is liable for the tax, which such person 

would be able to self-assess on a return.717 If fuel is loaded into a 

refueling truck that does not meet the requirements of the provision, then the fuel is treated as removed from the terminal into the 

refueling truck and tax of 21.9 cents per gallon is paid on such removal. The ultimate vendor is entitled to a refund of the difference 

between 21.9 cents per gallon paid on removal and the rate paid 

by a commercial airline purchaser (assuming the purchaser waived 

the refund right). If fuel is removed from a terminal directly to the 

wing of an aircraft registered to use fuel in commercial aviation by 

a hydrant or similar device, the person removing the aviation fuel 

is liable for a tax of 4.4 cents per gallon (or zero in the case of an 

international flight or qualified foreign airline) and may self-assess 

such tax on a return. 

692 

718The conferees intend that the following airports, subject to verification by the Secretary, 

be included on the Secretary’s initial list of airports that include a secured area in which a terminal is located. The airports are listed by airport name, and the terminal with respect to the 

airport is identified by terminal control number. In maintaining the list of qualified airports, 

the Secretary has the discretion to add or remove airports from the list. Ted Stevens International Airport, T–91–AK–4520; William B. Hartsfield Atlanta International Airport, T–58– 

GA–2512; William B. Hartsfield Atlanta International Airport, T–58–GA–2513; William B. 

Hartsfield Atlanta International Airport, T–58–GA–2536; Bradley International Airport, T–06– 

CT–1271; Nashville Metropolitan Airport, T–62–TN–2222; Logan International Airport, T–04– 

MA–1171; Baltimore/Washington International Airport, T–52–MD–1569; Cleveland Hopkins 

International Airport, T–31–OH–3109; Charlotte/Douglas International Airport, T–56–NC–2032; 

Colorado Springs Airport, T–84–CO–4108; Cincinnati/Northern Kentucky International Airport, 

T–61–KY–3277; Dallas Love Field Airport, T–75–TX–2663; Ronald Reagan National Airport, T– 

54–VA–1686; Denver International Airport, T–84–CO–4111; Dallas Fort Worth International 

Airport, T–75–TX–2673; Wayne County Metropolitan Airport, T–38–MI–3018; Newark Liberty 

International Airport, T–22–NJ–1532; Fort Lauderdale/Hollywood International Airport; T–65– 

FL–2158; Piedmont Triad International Airport, T–56–NC–2038; Honolulu International Airport, T–91–HI–4570; Dulles International Airport, T–54–VA–1676; George Bush Intercontinental Airport, T–76–TX–2818; Mid Continent Airport, T–43–KS–3653; John F. Kennedy International Airport, T–11–NY–1334; McCarren International Airport, T–86–NV–4355; Kansas City 

International Airport, T–43–MO–3723; Orlando International Airport, T–59–FL–2111; Midway 

Airport, T–36–IL–3376; Memphis International Airport, T–62–TN–2212; General Mitchell International Airport, T–39–WI–3092; Minneapolis–St. Paul International Airport, T–41–MN–3419; 

Minneapolis–St. Paul International Airport, T–41–MN–3420; Minneapolis–St. Paul International Airport, T–41–MN–3421; Louis Armstrong New Orleans International Airport, T–72– 

LA–2356; Oakland International Airport, T–94–CA–4702; Eppley Airfield, T–47–NE–3608; Ontario International Airport, T–33–CA–4792; O’Hare International Airport, T–36–IL–3325; PortUnder the provision, a floor stocks tax applies to aviation fuel 

held by a person (if title for such fuel has passed to such person) 

on October 1, 2004. The tax is equal to the amount of tax that 

would have been imposed before October 1, 2004, if the provision 

was in effect at all times before such date, reduced by the tax imposed by section 4091, as in effect on the day before the date of enactment. The Secretary shall determine the time and manner for 

payment of the tax, including the nonapplication of the tax on de 

minimis amounts of aviation fuel. Under the provision, 0.1 cents 

per gallon of such tax is transferred to the LUST Trust Fund. The 

remainder is transferred to the Airport and Airway Trust Fund. 

Effective date.—Effective for aviation fuel removed, entered, or 

sold after September 30, 2004. 

SENATE AMENDMENT

The Senate amendment is similar to the House bill, except 

that refueler trucks, tankers, and tank wagons are not subject to 

special rules, and there is no provision for liability for, and self-assessment of, tax by the person receiving fuel removed from a refinery or terminal directly into the wing of an aircraft (whether by refueling vehicle or otherwise). 

Effective date.—Effective for aviation fuel removed, entered, or 

sold after September 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with the following modifications. The rule that permits certain refueler trucks 

to be treated as a terminal for purposes of the provision is modified 

to require that, in addition to the requirements specified in the 

House bill, a qualifying truck, tanker, or tank wagon must be loaded with aviation fuel from a terminal that is located within a secured area of an airport. The Secretary is required to publish, by 

December 15, 2004, and maintain a list of airports that include a 

secured area in which a terminal is located.718 In addition, the conVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00696 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
693 

land International Airport, T–91–OR–4450; Philadelphia International Airport, T–23–PA–1770; 

Sky Harbor International Airport, T–86–AZ–4302; Pittsburgh International Airport, T–23–PA– 

1766; Raleigh/Durham International, T–56–NC–2045; Reno Cannon International Airport, T– 

86–NV–4352; San Diego International Airport, T–33–CA–4788; San Antonio International Airport, pending; Seattle Tacoma International Airport, T–91–WA–4425; San Francisco International Airport, T–94–CA–4701; San Jose Municipal Airport, T–77–CA–4650; Salt Lake City 

International Airport, T–84–UT–4207; John Wayne Airport/Orange County, T–33–CA–4772; 

Lambert International Airport, T–43–MO–3722; Tampa/St. Petersburg International Airport, T– 

59–FL–2110. 719Sec. 4093(a). 720Sec. 4091(b). This rate includes a 0.1 cent per gallon Leaking Underground Storage Tank 

(‘‘LUST’’) Trust Fund tax. The LUST Trust Fund tax is set to expire after March 31, 2005, with 

the result that on April 1, 2005, the tax rate is scheduled to be 21.8 cents per gallon. Secs. 

4091(b)(3)(B) & 4081(d)(3). Beginning on October 1, 2007, the rate of tax is reduced to 4.3 cents 

per gallon. Sec. 4091(b)(3)(A). 

ference agreement modifes the requirement that in order to qualify 

for the special rule, a refueler truck, tanker, or tank wagon must 

deliver the aviation fuel directly into the wing of the aircraft at the 

airport where the terminal is located to a requirement that a refueler truck, tanker, or tank wagon be loaded with aviation fuel for 

delivery into aircraft at the airport where the terminal is located. 

The conference agreement modifies the floor stocks tax. Under 

the conference agreement, a floor stocks tax applies to aviation fuel 

held by a person (if title for such fuel has passed to such person) 

on January 1, 2005. The tax is equal to the amount of tax that 

would have been imposed before January 1, 2005, if the proposal 

was in effect at all times before such date, reduced by (1) the tax 

imposed by section 4091, as in effect on the day before such date 

and, (2) in the case of kerosene held exclusively for the holder’s 

own use, the amount which such holder would reasonably expect 

under the proposal to be paid as a refund for a nontaxable use with 

respect to the kerosene. The tax does not apply to kerosene held 

in the fuel tank of an aircraft on January 1, 2005. The Secretary 

shall determine the time and manner for payment of the tax, including the nonapplication of the tax on de minimis amounts of 

aviation fuel. Under the conference agreement, 0.1 cents per gallon 

of such tax is transferred to the LUST Trust Fund. The remainder 

is transferred to the Airport and Airway Trust Fund. 

The conferees expect the Secretary to delay the due date of the 

excise tax return with respect to aviation fuel for the quarter beginning on January 1, 2005. It is intended that the requirement of 

semi-monthly deposits of aviation fuel taxes continue unchanged. 

Effective date.—Effective for aviation-grade kerosene removed, 

entered, or sold after December 31, 2004. 

3. Provide for transfer from Airport and Airway Trust Fund to 

Highway Trust Fund to adjust for continued highway use of 

aviation fuel (sec. 872 of the Senate amendment and secs. 9502 

and 9503 of the Code) 

PRESENT LAW

Aviation fuel is kerosene and any liquid (other than any product taxable under section 4081) that is suitable for use as a fuel 

in an aircraft.719 In general, the rate of tax on aviation fuel is 21.9 

cents per gallon.720 Aviation fuel sold for use or used in commercial 

694 

721Sec. 4092(b). The 4.4 cent rate includes 0.1 cent per gallon that is attributable to the LUST 

Trust Fund financing rate. A full exemption, discussed below, applies to aviation fuel that is 

sold for use in commercial aviation as fuel supplies for vessels or aircraft, which includes use 

by certain foreign air carriers and for the international flights of domestic carriers. Secs. 

4092(a), 4092(b), & 4221(d)(3). 722 Sec. 4092. 723Sec. 9502(b). 724Sec. 9503(b). 725Sec. 4081(a)(1)(A). If such fuel is used for a nontaxable purpose, the purchaser is entitled 

to a refund of tax paid, or in some cases, an income tax credit. See sec. 6427. 726Dyeing is not a requirement, however, for certain fuels under certain conditions, i.e., diesel 

fuel or kerosene exempted from dyeing in certain States by the EPA under the Clean Air Act, 

aviation-grade kerosene as determined under regulations prescribed by the Secretary, kerosene 

received by pipeline or vessel and used by a registered recipient to produce substances (other 

than gasoline, diesel fuel or special fuels), kerosene removed or entered by a registrant to 

produce such substances or for resale, and (under regulations) kerosene sold by a registered distributor who sells kerosene exclusively to ultimate vendors that resell it (1) from a pump that 

is not suitable for fueling any diesel-powered highway vehicle or train, or (2) for blending with 

heating oil to be used during periods of extreme or unseasonable cold. Sec. 4082(c), (d). 

aviation is taxed at a reduced rate of 4.4 cents per gallon.721 Certain sales of aviation fuel are exempt from tax.722

Taxes received for aviation fuel, except for the LUST Trust 

Fund financing rate, are appropriated to the Airport and Airway 

Trust Fund.723 Such appropriation occurs even if aviation fuel is 

used for non aviation purposes. 

Taxes received on taxable fuel for transportation purposes generally are appropriated to the Highway Trust Fund.724

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision directs the Secretary to transfer from the Airport 

and Airway Trust Fund to the Highway Trust Fund annually an 

amount equivalent to amounts received in the Airport and Airway 

Trust Fund which are attributable to fuel that is used primarily for 

highway transportation purposes. The Secretary is directed to 

transfer 11 percent of such amount to the Mass Transit Account. 

Effective date.—Effective on October 1, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

4. Mechanical dye injection and related penalties (sec. 653 of the 

House bill, secs. 873, 874 and 875 of the Senate amendment 

and secs. 4082 and 6715 and new sec. 6715A of the Code) 

PRESENT LAW

Statutory rules 

Gasoline, diesel fuel and kerosene are generally subject to excise tax upon removal from a refinery or terminal, upon importation into the United States, and upon sale to unregistered persons 

unless there was a prior taxable removal or importation of such 

fuels.725 However, a tax is not imposed upon diesel fuel or kerosene 

if all of the following are met: (1) the Secretary determines that the 

fuel is destined for a nontaxable use, (2) the fuel is indelibly dyed 

in accordance with regulations prescribed by the Secretary,726 and 

695 

727Sec. 4082(a). 728Sec. 4082(b) 729Sec. 4082(e). 730Sec. 6715(a). 731Sec. 6715(a). 732Sec. 6715(b). 733Sec. 6715(d). 734Sec. 6715(c)(1). 735Treas. Reg. secs. 48.4082–1, –2. 736 In March 2000, the IRS withdrew its Notice of Proposed Rulemaking PS–6–95 (61 F.R. 

10490 (1996)) relating to dye injection systems. Announcement 2000–42, 2000–1 C.B. 949. The 

proposed regulation established standards for mechanical dye injection equipment and required 

terminal operators to report nonconforming dyeing to the IRS. See also Treas. Reg. sec. 48.4082– 

1(c), (d). 737Treas. Reg. sec. 48.4081–2(c). 

(3) the fuel meets marking requirements prescribed by the Secretary.727 A nontaxable use is defined as (1) any use that is exempt 

from the tax imposed by section 4041(a)(1) other than by reason of 

a prior imposition of tax, (2) any use in a train, or (3) certain uses 

in buses for public and school transportation, as described in section 6427(b)(1) (after application of section 6427(b)(3)).728

The Secretary is required to prescribe necessary regulations relating to dyeing, including specifically the labeling of retail diesel 

fuel and kerosene pumps.729

A person who sells dyed fuel (or holds dyed fuel for sale) for 

any use that such person knows (or has reason to know) is a taxable use, or who willfully alters or attempts to alter the dye in any 

dyed fuel, is subject to a penalty.730 The penalty also applies to any 

person who uses dyed fuel for a taxable use (or holds dyed fuel for 

such a use) and who knows (or has reason to know) that the fuel 

is dyed.731 The penalty is the greater of $1,000 per act or $10 per 

gallon of dyed fuel involved. In determining the amount of the penalty, the $1,000 is increased by the product of $1,000 and the number of prior penalties imposed upon such person (or a related person or predecessor of such person or related person).732 The penalty 

may be imposed jointly and severally on any business entity, each 

officer, employee, or agent of such entity who willfully participated 

in any act giving rise to such penalty.733 For purposes of the penalty, the term ‘‘dyed fuel’’ means any dyed diesel fuel or kerosene, 

whether or not the fuel was dyed pursuant to section 4082.734

Regulations 

The Secretary has prescribed certain regulations under this 

provision, including regulations that specify the allowable types 

and concentration of dye, that the person claiming the exemption 

must be a taxable fuel registrant, that the terminal must be an approved terminal (in the case of a removal from a terminal rack), 

and the contents of the notice to be posted on diesel fuel and kerosene pumps.735 However, the regulations do not prescribe the time 

or method of adding the dye to taxable fuel.736 Diesel fuel is usually dyed at a terminal rack by either manual dyeing or mechanical 

injection. The regulations also provide that a terminal operator is 

jointly and severally liable for unpaid tax if undyed diesel fuel or 

kerosene is removed and the terminal operator provides any person 

with documentation that such fuel is dyed.737

696 

738The operator remains liable under current Treas. Reg. sec. 48.4081–2(c) for any unpaid tax 

on removed undyed fuel. 

HOUSE BILL

With respect to terminals that offer dyed fuel, the provision 

eliminates manual dyeing of fuel and requires dyeing by a mechanical system. Not later than 180 days after enactment of this provision, the Secretary of the Treasury is to prescribe regulations establishing standards for tamper resistant mechanical injector dyeing. Such standards shall be reasonable, cost-effective, and establish levels of security commensurate with the applicable facility. 

The provision adds an additional set of penalties for violation of the new rules. A penalty, equal to the greater of $25,000 or $10 

for each gallon of fuel involved, applies to each act of tampering 

with a mechanical dye injection system. The person committing the 

act is also responsible for any unpaid tax on removed undyed fuel. 

A penalty of $1,000 is imposed upon the operator of a mechanical 

dye injection system for each failure to maintain the security 

standards for such system.738 An additional penalty of $1,000 is 

imposed upon such operator for each day any such violation remains uncorrected after the first day such violation has been or 

reasonably should have been discovered. For purposes of the daily 

penalty, a violation may be corrected by shutting down the portion 

of the system causing the violation. If any of these penalties are 

imposed on any business entity, each officer, employee, or agent of 

such entity or other contracting party who willfully participated in 

any act giving rise to such penalty shall be jointly and severally 

liable with such entity for such penalty. If such business entity is 

part of an affiliated group, the parent corporation of such entity 

shall be jointly and severally liable with such entity for the penalty. 

Effective date.—The provision is effective 180 days after the 

date that the Secretary issues the required regulations. The Secretary must issue such regulations no later than 180 days after enactment. 

SENATE AMENDMENT

The Senate amendment contains a mechanical dyeing provision similar to the provision in the House bill, except that the Secretary of the Treasury is to prescribe regulations establishing 

standards by June 30, 2004. 

The Senate amendment also contains two additional provisions 

not in the House bill. 

The Senate amendment denies administrative appeal or review 

for repeat offenders (more than two violations) of present law after 

a chemical analysis of the fuel, except in the case of a claim regarding fraud or mistake in the chemical analysis or error in the mathematical calculation of the amount of penalty. 

The Senate amendment also extends present-law penalties to 

any person who knows that the strength or composition of any dye 

or marking in any dyed fuel has been altered, chemically or otherwise, and who sells (or holds for sale) such fuel for any use that 

the person knows or has reason to know is a taxable use of such 

fuel. 

697

739Sec. 4081. 739aSec. 4041(a)(1)(B) and sec. 4041(a)(1)(C)(III)(i). 

Effective date.—Penalties relating to mechanical dyeing systems are effective 180 days after the regulations are issued. The 

prohibition of certain administrative review is effective for penalties assessed after date of enactment. The extension of present 

law penalties is effective on date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with respect 

to mechanical dye injection systems and related penalties. The conference agreement follows the Senate amendment with respect to 

denying administrative review to repeat offenders and extending 

present law penalties to any person who knows that the strength 

or composition of any dye or marking in any dyed fuel has been altered, chemically or otherwise, and who sells (or holds for sale) 

such fuel for any use that the person knows or has reason to know 

is a taxable use of such fuel. 

5. Terminate dyed diesel use by intercity buses (sec. 876 of the 

Senate amendment and secs. 4082 and 6427 of the Code) 

PRESENT LAW

A manufacturer’s tax of 24.4 cents per gallon applies to diesel 

fuel.739 Diesel fuel that is to be used for a nontaxable purpose will 

not be taxed upon removal from the terminal if it is dyed to indicate its nontaxable purpose. Use in an intercity bus is a nontaxable 

use for purposes of the manufacturers tax on diesel fuel. However, 

diesel fuel is subject to a retail backup tax. The retail tax is 7.4 

cents per gallon for intercity buses, but only applies if no tax was 

imposed on the diesel under the manufacturers tax.739a Thus, dyed 

diesel removed from the terminal is exempt from the manufacturers tax but a tax of 7.3 cents per gallon (plus .1 for LUST) is imposed on the delivery of the dyed fuel into the fuel supply tank of 

the intercity bus. The operator of the bus is liable for the tax. 

Under present law, intercity bus operators also may buy fully 

taxed undyed diesel and seek a refund of the difference between 

the 24.4 cents per gallon rate and the 7.3 cents per gallon rate. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment eliminates the ability of intercity buses 

to buy dyed diesel and self-assess the 7.4 cents per gallon. Under 

the provision, operators of such buses must buy clear fuel and seek 

a refund of the difference between 24.4 and 7.4 cents per gallon of 

tax on diesel fuel. The provision permits refund claimants to obtain 

interest if they file their refund claims electronically and the Secretary does not pay such claims within 20 days. The provision also 

permits ultimate vendors to make such refund claims if the bus operator assigns its right to claim a refund to the ultimate vendor. 

698

739b ‘‘Taxable fuel’’ means gasoline, diesel fuel, and kerosene. Sec. 4083(a). 740Sec. 4083(c)(1)(A). 741Treas. Reg. sec. 48.4083–1(c)(1). 

Effective date.—The provision is effective for fuel sold after September 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except 

the conference agreement does not include the provision that 

deems credit card issuers the ultimate vendor for purchases made 

by credit card. 

Effective date.—The provision is effective for fuel sold after January 1, 2005. 

6. Authority to inspect on-site records (sec. 654 of the House bill, 

sec. 877 of the Senate amendment, and sec. 4083 of the Code) 

PRESENT LAW

The IRS is authorized to inspect any place where taxable 

fuel 739b is produced or stored (or may be stored). The inspection is 

authorized to: (1) examine the equipment used to determine the 

amount or composition of the taxable fuel and the equipment used 

to store the fuel; and (2) take and remove samples of taxable fuel. 

Places of inspection include, but are not limited to, terminals, fuel 

storage facilities, retail fuel facilities or any designated inspection 

site.740

In conducting the inspection, the IRS may detain any receptacle that contains or may contain any taxable fuel, or detain any 

vehicle or train to inspect its fuel tanks and storage tanks. The 

scope of the inspection includes the book and records kept at the 

place of inspection to determine the excise tax liability under section 4081.741

HOUSE BILL

The provision expands the scope of the inspection to include 

any books, records, or shipping papers pertaining to taxable fuel located in any authorized inspection location. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment. 

7. Assessable penalty for refusal of entry (sec. 878 of the Senate 

amendment and new sec. 6717 of the Code) 

PRESENT LAW

The Internal Revenue Service is authorized to inspect any 

place where taxable fuel is produced or stored (or may be stored). 

699 

742Sec. 4083(c)(1)(A). 743Treas. Reg. sec. 48.4083–1(b)(2). 744Sec. 4083(c); Treas. Reg. sec. 48.4083–1(b)(1). 745Sec. 4083(c)(3) and 7342. 746Sec. 6671. 

As part of the inspection, the Internal Revenue Service is authorized to: (1) examine the equipment used to determine the amount 

or composition of the taxable fuel and the equipment used to store 

the fuel; and (2) take and remove samples of taxable fuel. Places 

of inspection, include, but are not limited to, terminals, fuel storage 

facilities, retail fuel facilities or any designated inspection site.742

In conducting the inspection, the Internal Revenue Service 

may detain any receptacle that contains or may contain any taxable fuel, or detain any vehicle or train to inspect its fuel tanks and 

storage tanks. The scope of the inspection includes the book and 

records kept to determine the excise tax liability under section 

4081.743 The Internal Revenue Service is authorized to establish inspection sites. A designated inspection site includes any State highway inspection station, weigh station, agricultural inspection station, mobile station or other location designated by the Internal 

Revenue Service.744

Any person that refuses to allow an inspection is subject to a 

penalty in the amount of $1,000 for each refusal.745 The IRS is not 

able to assess this penalty in the same manner as it would a tax. 

It must first seek the assistance of the Department of Justice to 

obtain a judgment. Assessable penalties are payable upon notice 

and demand by the Secretary and are assessed and collected in the 

same manner as taxes.746

HOUSE BILL

No provision. 

SENATE AMENDMENT

In addition to the $1,000 penalty under present law, the Senate amendment imposes an assessable penalty with respect to the 

refusal of entry. The assessable penalty is $1,000 for such refusal. 

The penalty will not apply if it is shown that such failure is due 

to reasonable cause. If the penalty is imposed on a business entity, 

the proposal provides for joint and several liability with respect to 

each officer, employee, or agent of such entity or other contracting 

party who willfully participated in the act giving rise to the penalty. If the business entity is part of an affiliated group, the parent 

corporation also will be jointly and severally liable for the penalty. 

Effective date.—The provision is effective on October 1, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except for effective date. 

Effective date.—The provision is effective on January 1, 2005. 

700 

747Sec. 4081(a)(1)(A). 748Sec. 4081(a)(1)(B). The sale of a taxable fuel to an unregistered person prior to a taxable 

removal or entry of the fuel is subject to tax. Sec. 4081(a)(1)(A). 749Treas. Reg. sec. 48.4081–3(e)(2). 750Treas. Reg. sec. 48.4081–3(b). 

8. Registration of pipeline or vessel operators required for exemption of bulk transfers to registered terminals or refineries (sec. 

655 of the House bill, sec. 879 of the Senate amendment, and 

sec. 4081 of the Code) 

PRESENT LAW

In general, gasoline, diesel fuel, and kerosene (‘‘taxable fuel’’) 

are taxed upon removal from a refinery or a terminal.747 Tax also 

is imposed on the entry into the United States of any taxable fuel 

for consumption, use, or warehousing. The tax does not apply to 

any removal or entry of a taxable fuel transferred in bulk (a ‘‘bulk 

transfer’’) to a terminal or refinery if both the person removing or 

entering the taxable fuel and the operator of such terminal or refinery are registered with the Secretary.748

Present law does not require that the vessel or pipeline operator that transfers fuel as part of a bulk transfer be registered in 

order for the transfer to be exempt. For example, a registered refiner may transfer fuel to an unregistered vessel or pipeline operator who in turn transfers fuel to a registered terminal operator. 

The transfer is exempt despite the intermediate transfer to an unregistered person. 

In general, the owner of the fuel is liable for payment of tax 

with respect to bulk transfers not received at an approved terminal 

or refinery.749 The refiner is liable for payment of tax with respect 

to certain taxable removals from the refinery.750

HOUSE BILL

The provision requires that for a bulk transfer of a taxable fuel 

to be exempt from tax, any pipeline or vessel operator that is a 

party to the bulk transfer be registered with the Secretary. Transfer to an unregistered party will subject the transfer to tax. 

The Secretary is required to publish periodically a list of all 

registered persons that are required to register. 

Effective date.—(Effective on October 1, 2004, except that the 

Secretary is required to publish the list of registered persons beginning on July 1, 2004. 

SENATE AMENDMENT

Similar to the House bill, except that with respect to a bulk 

transfer on which no tax is paid, the Senate amendment imposes 

a penalty on any person who knowingly transfers taxable fuel in 

bulk to an unregistered person. The penalty is the greater of 

$10,000 or $1 per gallon and is increased for multiple prior violations. No penalty is imposed upon a showing by the taxpayer of 

reasonable cause. 

Effective date.—Effective on October 1, 2004, except that the 

Secretary is required to publish the list of persons required to register by June 30, 2004. 

701 

751Sec. 4101; Treas. Reg. sec. 48.4101–1(a) and (c)(1). 752Sec. 7272(a). 753Sec. 7232. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, modified to 

provide that the Secretary shall periodically publish a current list 

of persons required to register under the authority of section 

6103(k)(7). 

Effective date.—(Effective on March 1, 2005, except that the 

Secretary is required to publish the list of persons required to register beginning on January 1, 2005. 

9. Display of registration and penalties for failure to display registration and to register (secs. 656 and 657 of the House bill, 

secs. 880 and 882 of the Senate amendment, and secs. 4101, 

7232, 7272 and new secs. 6718 and 6719 of the Code) 

PRESENT LAW

Blenders, enterers, pipeline operators, position holders, refiners, terminal operators, and vessel operators are required to register with the Secretary with respect to fuels taxes imposed by sections 4041(a)(1) and 4081.751 A non-assessable penalty for failure 

to register is $50.752 A criminal penalty of $5,000, or imprisonment 

of not more than five years, or both, together with the costs of prosecution also applies to a failure to register and to certain false 

statements made in connection with a registration application.753

HOUSE BILL

The provision requires that every operator of a vessel who is 

required to register with the Secretary display on each vessel used 

by the operator to transport fuel, proof of registration through an 

electronic identification device prescribed by the Secretary. A failure to display such proof of registration results in a penalty of $500 

per month per vessel. The amount of the penalty is increased for 

multiple prior violations. No penalty is imposed upon a showing by 

the taxpayer of reasonable cause. 

The provision imposes a new assessable penalty for failure to 

register of $10,000 for each initial failure, plus $1,000 per day that 

the failure continues. No penalty is imposed upon a showing by the 

taxpayer of reasonable cause. In addition, the provision increases 

the present-law non-assessable penalty for failure to register from 

$50 to $10,000 and the present law criminal penalty for failure to 

register from $5,000 to $10,000. 

Effective date.—(The provision requiring display of registration 

is effective on October 1, 2004. The provision relating to penalties 

is effective for penalties imposed after September 30, 2004. 

SENATE AMENDMENT

The Senate amendment is similar to House bill, except that 

the increase in the penalty for multiple prior violations for failure 

to display proof of registration is determined differently. 

702 

754Sec. 4101; Treas. Reg. sec. 48.4101–1(a) & (c)(1). 755Sec. 4010(d); Treas. Reg. sec. 48.4101–2. The reports are required to be filed by the end 

of the month following the month to which the report relates. 756 An approved terminal is a terminal that is operated by a taxable fuel registrant that is 

a terminal operator. Treas. Reg. sec. 48.4081–1(b). 

Effective date.—Effective on October 1, 2004, except that the 

penalties for failure to register are effective for failures pending or 

occurring after September 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill except that 

the identification device is not required to be electronic. 

Effective date.—The provision requiring display of registration 

is effective on January 1, 2005. The provision relating to penalties 

is effective for penalties imposed after December 31, 2004. 

10. Registration of persons within foreign trade zones (sec. 881 of 

the Senate amendment and sec. 4101 of the Code) 

PRESENT LAW

Blenders, enterers, pipeline operators, position holders, refiners, terminal operators, and vessel operators are required to register with the Secretary with respect to fuels taxes imposed by sections 4041(a)(1) and 4081.754

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Secretary shall require registration by any person that operates a terminal or refinery within a foreign trade zone or within 

a customs bonded storage facility, or holds an inventory position 

with respect to a taxable fuel in such a terminal. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. It is 

intended that the Secretary shall establish a date by which persons 

required to register under the provision must be registered. 

Effective date.—Effective on January 1, 2005. 

11. Penalties for failure to report (sec. 657 of the House bill, sec. 

882 of the Senate amendment, and new sec. 6725 of the Code) 

PRESENT LAW

A fuel information reporting program, the Excise Summary 

Terminal Activity Reporting System (‘‘ExSTARS’’), requires terminal operators and bulk transport carriers to report monthly on 

the movement of any liquid product into or out of an approved terminal.755 Terminal operators file Form 720–TO—Terminal Operator Report, which shows the monthly receipts and disbursements 

of all liquid products to and from an approved terminal.756 Bulk 

transport carriers (barges, vessels, and pipelines) that receive liquid product from an approved terminal or deliver liquid product to 

an approved terminal file Form 720–CS—Carrier Summary Report, 

703 

757Sec. 6721(a). 758Sec. 4101(d); Treas. Reg. sec. 48.4101–2. The reports are required to be filed by the end 

of the month following the month to which the report relates. 759 An approved terminal is a terminal that is operated by a taxable fuel registrant that is 

a terminal operator. Treas. Reg. sec. 48.4081–1(b). 

which details such receipts and disbursements. In general, the penalty for failure to file a report or a failure to furnish all of the required information in a report is $50 per report.757

HOUSE BILL

The provision imposes a new assessable penalty for failure to 

file a report or to furnish information required in a report required 

by the ExSTARS system. The penalty is $10,000 per failure with 

respect to each vessel or facility (e.g., a terminal or other facility) 

for which information is required to be furnished. No penalty is imposed upon a showing by the taxpayer of reasonable cause. 

Effective date.—Effective for penalties imposed after September 

30, 2004. 

SENATE AMENDMENT

Similar to House bill, except for technical wording differences. 

Effective date.—Effective for failures pending or occurring after 

September 30, 2004. The electronic reporting provision is effective 

on October 1, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

Effective date.—Effective for penalties imposed after December 

31, 2004. 

12. Electronic filing of required information reports (sec. 895 of the 

Senate amendment and sec. 4010 of the Code) 

PRESENT LAW

A fuel information reporting program, the Excise Summary 

Terminal Activity Reporting System (‘‘ExSTARS’’), requires terminal operators and bulk transport carriers to report monthly on 

the movement of any liquid product into or out of an approved terminal.758 Terminal operators file Form 720–TO—Terminal Operator Report, which shows the monthly receipts and disbursements 

of all liquid products to and from an approved terminal.759 Bulk 

transport carriers (barges, vessels, and pipelines) that receive liquid product from an approved terminal or deliver liquid product to 

an approved terminal file Form 720–CS—Carrier Summary Report, 

which details such receipts and disbursements. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment requires information reporting with respect to taxable fuels removed, entered, or transferred from any refinery, pipeline, or vessel that is registered. The proposal also requires that any person who must report under the ExSTARs sysVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00707 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
704 

760The 52-cents-per-gallon credit is scheduled to decline to 51 cents per gallon beginning in 

calendar year 2005. The credit is scheduled to expire after the earlier of (1) expiration of the 

Highway Trust Fund excise taxes or (2) December 31, 2007. 761 Ethanol produced by certain ‘‘small producers’’ is eligible for an additional producer tax 

credit of 10 cents per gallon. Eligible small producers are defined as persons whose production 

capacity does not exceed 30 million gallons and whose annual production does not exceed 15 

million gallons. 

tems and who has 25 or more reportable transactions in a month 

to report in electronic format. 

Effective date.—Effective on October 1, 2005. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment except that the conference agreement does not adopt the information 

reporting requirement with respect to taxable fuels removed, entered, or transferred from any refinery, pipeline, or vessel that is 

registered. 

Effective date.—Effective on January 1, 2006. 

13. Information reporting for persons claiming certain tax benefits 

(sec. 883 of the Senate amendment and new sec. 4104 of the 

Code) 

PRESENT LAW

The Code provides an income tax credit for each gallon of ethanol and methanol derived from renewable sources (e.g., biomass) 

used or sold as a fuel, or used to produce a qualified alcohol fuel 

mixture, such as gasohol. The amount of the credit is equal to 52 

cents per gallon (ethanol) 760 and 60 cents per gallon (methanol).761

This tax credit is provided to blenders of the alcohols with other 

taxable fuels, or to the retail sellers of unblended alcohol fuels. 

Part or all of the benefits of the income tax credit may be claimed 

through reduced excise taxes paid, either in reduced-tax sales or by 

expedited blender refunds on fully taxed sales of gasoline to obtain 

the benefit of the reduced rates. The amount of the income tax 

credit determined with respect to any alcohol is reduced to take 

into account any benefit provided by the reduced excise tax rates. 

To obtain a partial refund on fully taxed gasoline, the following requirements apply: (1) the claim must be for gasohol sold or used 

during a period of at least one week, (2) the claim must be for at 

least $200, and (3) the claim must be filed by the last day of the 

first quarter following the earliest quarter included in the claim. If 

the blender cannot meet these requirements, the blender must 

claim a credit on the blender’s income tax return. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment requires persons claiming the Code 

benefits related to alcohol fuels and biodiesel fuels to provide such 

information related to such benefits and the coordination of such 

benefits as the Secretary may require to ensure the proper administration and use of such benefits. The Secretary may deny, revoke 

705 

762Sec. 4081(a)(1)(A)(iii). 763 19 C.F.R. sec. 141.3 (2004). 

or suspend the registration of any person to enforce this requirement. 

Effective date.—The provision is effective October 1, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. Persons claiming excise tax benefits are to file quarterly information 

returns, rather than monthly. 

Effective date.—The provision is effective January 1, 2004. 

14. Collection from Customs bond where importer not registered 

(sec. 658 of the House bill and sec. 884 of Senate amendment) 

PRESENT LAW

Typically, gasoline, diesel fuel, and kerosene are transferred by 

pipeline or barge in large quantities (‘‘bulk’’) to terminal storage facilities that geographically are located closer to destination retail 

markets. A fuel is taxed when it ‘‘breaks bulk,’’ i.e., when it is removed from the refinery or terminal, typically by truck or rail car, 

for delivery to a smaller wholesale facility or a retail outlet. The 

party liable for payment of the taxes is the ‘‘position holder,’’ i.e., 

the person shown on the records of the terminal facility as owning 

the fuel. 

Tax is also imposed on the entry into the United States of any 

taxable fuel for consumption, use, or warehousing.762 This tax does 

not apply to any entry of a taxable fuel transferred in bulk to a 

terminal or refinery if the person entering the taxable fuel and the 

operator of such terminal or refinery are registered. The ‘‘enterer’’ 

is liable for the tax. An enterer generally means the importer of 

record (under customs law) with respect to the taxable fuel. However, if the importer of record is acting as an agent (a broker for 

example), the person for whom the agent is acting is the enterer. 

If there is no importer of record for taxable fuel entered into the 

United States, the owner of the taxable fuel at the time it is 

brought into the United States is the enterer. An importer’s liability for Customs duties includes a liability for any internal revenue 

taxes that attach upon the importation of merchandise unless otherwise provided by law or regulation.763

As a part of the entry documentation, the importer, consignee, 

or an authorized agent usually is required to file a bond with Customs. The bond, among other things, guarantees that proper entry 

summary, with payment of estimated duties and taxes when due, 

will be made for imported merchandise and that any additional duties and taxes subsequently found to be due will be paid. 

As a condition of permitting anyone to be registered with the 

IRS, under section 4101 of the Code, the Secretary may require 

that such person give a bond in such sum as the Secretary determines appropriate. 

On July 31, 2004, the Department of Treasury issued regulations providing that effective September 28, 2004, importers and 

enterers are jointly and severally liable for the tax on imported fuel 

706 

764Sec. 343(a) of Pub. L. No. 107–210 (2002). 

if the importer is not the enterer and the enterer is not registered 

with the Secretary. 

HOUSE BILL

Under the provision, the importer of record is jointly and severally liable for the tax imposed upon entry of fuel into the United 

States if, under regulations, any other person that is not registered 

with the Secretary as a taxable fuel registrant is liable for such 

tax. If the importer of record is liable for the tax and such tax is 

not paid on or before the last date prescribed for payment, the Secretary may collect such tax from the Customs bond posted with respect to the importation of the taxable fuel to which the tax relates. 

For purposes of determining the jurisdiction of any court of the 

United States or any agency of the United States, any action by the 

Secretary to collect the tax from the Customs bond is treated as an 

action to collect tax from a bond authorized by section 4101 of the 

Code, not as an action to collect from a bond relating to the importation of merchandise. 

Effective date.—The provision is effective for fuel entered after 

September 30, 2004. 

SENATE AMENDMENT

Under the Senate amendment, for fuel entering the United 

States (other than transfers in bulk) for consumption, use, or 

warehousing, the proposal provides that the tax is immediately due 

and payable at the time of entry, if the enterer is not registered 

with the IRS. Upon the failure to pay tax or post bond, the Customs Service is authorized under the proposal to deny entry of the 

shipment into the United States. The Secretary also may seize the 

fuel on which the tax is due or detain the vehicle transporting such 

fuel until such tax is paid. If no tax has been paid or bond filed 

within five days of the seizure, the Secretary may sell the fuel. 

Effective date.—The provision is effective upon date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not contain the House bill or 

Senate amendment provisions. 

15. Reconciliation of on-loaded cargo to entered cargo (sec. 885 of 

the Senate amendment) 

PRESENT LAW

The Trade Act of 2002 directed the Secretary to promulgate 

regulations pertaining to the electronic transmission to the Bureau 

of Customs and Border Patrol (‘‘Customs’’) of information pertaining to cargo destined for importation into the United States or 

exportation from the United States, prior to such importation or exportation.764 The Department of the Treasury issued final regulations on October 31, 2002. The regulations require the advance and 

accurate presentation of certain manifest information prior to lading at the foreign port and encourage the presentation of this inforVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00710 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
707 

765 19 CFR sec. 4.7(b)(2). 766 19 CFR sec. 4.7(b)(4)(i)(A). 767Sec. 4481. 768Sec. 6156. 

mation electronically. Customs must receive from the carrier the 

vessel’s Cargo Declaration (Customs Form 1302) or the electronic 

equivalent within 24 hours before such cargo is laden aboard the 

vessel at the foreign port.765 Certain carriers of bulk cargo, however, are exempt from these filing requirements. Such bulk cargo 

includes that composed of free flowing articles such as oil, grain, 

coal, ore and the like, which can be pumped or run through a chute 

or handled by dumping.766 Thus, taxable fuels are not covered by 

the Cargo Declaration requirement. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment requires that, not later than one year 

after the date of enactment, the Secretary of Homeland Security, 

together with the Secretary, promulgate regulations providing for 

the transmission to the Internal Revenue Service of information 

pertaining to cargo of taxable fuels destined for importation into 

the United States, prior to such importations. The provision requires that imports of taxable fuels be subject to the Cargo Declaration and electronic reporting requirements. 

Effective date.—The provision is effective upon date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

16. Modification of the use tax on heavy highway vehicles (sec. 659 

of the House bill, sec. 890 of the Senate amendment, and secs. 

4481, 4483 and 6165 of the Code) 

PRESENT LAW

An annual use tax is imposed on heavy highway vehicles, at 

the rates below.767

Under 55,000 pounds .......................................... No tax. 

55,000–75,000 pounds ......................................... $100 plus $22 per 1,000 pounds over 55,000. 

Over 75,000 pounds ............................................. $550. 

The annual use tax is imposed for a taxable period of July 1 

through June 30. Generally, the tax is paid by the person in whose 

name the vehicle is registered. In certain cases, taxpayers are allowed to pay the tax in installments.768 State governments are required to receive proof of payment of the use tax as a condition of 

vehicle registration. 

Exemptions and reduced rates are provided for certain ‘‘transit-type buses,’’ trucks used for fewer than 5,000 miles on public 

highways (7,500 miles for agricultural vehicles), and logging 

708 

769See generally, sec. 4483. 770Sec. 4483(f): Treas. Reg. sec. 41.4483–7(a). 

trucks.769 Any highway motor vehicle that is issued a base plate 

by Canada or Mexico and is operated on U.S. highways is subject 

to the highway use tax whether or not the vehicles are required to 

be registered in the United States. The tax rate for Canadian and 

Mexican vehicles is 75 percent of the rate that would otherwise be 

imposed.770

HOUSE BILL

The House bill eliminates the ability to pay the tax in installments. It also eliminates the reduced rates for Canadian and Mexican vehicles. The provision requires taxpayers with 25 or more vehicles for any taxable period to file their returns electronically. Finally, the provision permits proration of tax for vehicles sold during 

the taxable period. 

Effective date.—The provision is effective for taxable periods 

beginning after the date of enactment. 

SENATE AMENDMENT

The Senate amendment eliminates the ability to pay the tax in 

installments and allows no proration of the tax unless the vehicle 

is destroyed, stolen, or sold. It also eliminates the reduced rates for 

Canadian and Mexican vehicles. In addition, under regulations to 

be prescribed by the Secretary, every taxpayer that pays the heavy 

highway vehicle use tax to receive and display on the vehicle an 

electronic identification device as prescribed by the Secretary. The 

device is to be received and displayed not later than one month 

after the due date of the return of tax with respect to each taxable 

period. 

Effective date.—The Senate amendment is generally effective 

for taxable periods beginning after the date of enactment. Requires 

the Secretary to issue regulations regarding electronic identification devices no later than October 1, 2005. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

17. Modification of ultimate vendor refund claims with respect to 

farming (sec. 660 of the House bill, sec. 887 of the Senate 

amendment, and sec. 6427 of the Code) 

PRESENT LAW

In general, the Code provides that, if diesel fuel, kerosene, or 

aviation fuel on which tax has been imposed is used by any person 

in a nontaxable use, the Secretary is to refund (without interest) 

the amount of tax imposed. The refund is made to the ultimate 

purchaser of the taxed fuel. However, in the case of diesel fuel or 

kerosene used on a farm for farming purposes or by a State or local 

government, refund payments are paid to the ultimate, registered 

vendors (‘‘ultimate vendors’’) of such fuels. 

709 

HOUSE BILL

In the case of diesel fuel or kerosene used on a farm for farming purposes, the House bill provision limits ultimate vendor claims 

for refund to sales of such fuel in amounts less than 250 gallons 

per farmer per claim. 

Effective date.—The provision is effective for fuels sold for nontaxable use after the date of enactment. 

SENATE AMENDMENT

The Senate amendment provision is the same as the House bill 

except the limit on ultimate vendor claims is amounts less than 

500 gallons per farmer per claim. 

CONFERENCE AGREEMENT

The conference agreement does not include the House bill provision or the Senate amendment provision. 

18. Dedication of revenue from certain penalties to the Highway 

Trust Fund (sec. 661 of the House bill, sec. 891 of the Senate 

amendment, and sec. 9503 of the Code) 

PRESENT LAW

Present law does not dedicate to the Highway Trust Fund any 

penalties assessed and collected by the Secretary. 

HOUSE BILL

The provision dedicates to the Highway Trust Fund amounts 

equivalent to the penalties paid under sections 6715 (relating to 

dyed fuel sold for use or used in taxable use), 6715A (penalty for 

tampering or failing to maintain security requirements for mechanical dye injection systems), 6717 (penalty for failing to display tax 

registration on vessels), 6718 (penalty for failing to register under 

section 4101), 6725 (penalty for failing to report information required by the Secretary), 7232 (penalty for failing to register and 

false representations of registration status), and 7272 (but only 

with regard to penalties related to failure to register under section 

4101). 

Effective date.—The provision is effective for penalties assessed 

after October 1, 2004. 

SENATE AMENDMENT

The Senate amendment similarly dedicates certain penalties to 

the Highway Trust Fund. 

Effective date.—The provision is effective for penalties assessed 

after October 1, 2004. 

CONFERENCE AGREEMENT

The conference agreement generally follows the House bill and 

the Senate amendment by dedicating certain penalties to the Highway Trust Fund. The conference agreement dedicates to the Highway Trust Fund amounts equivalent to the penalties paid under 

sections 6715 (relating to dyed fuel sold for use or used in taxable 

use), 6715A (penalty for tampering with or failing to maintain seVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00713 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
710 

curity requirements for mechanical dye injection systems), 6717 

(assessable penalty for refusal of entry), 6718 (penalty for failing 

to display tax registration on vessels), 6719 (assessable penalty for 

failure to register), 6725 (penalty for failing to report information 

required by the Secretary), 7232 (penalty for failing to register and 

false representations of registration status), and 7272 (but only 

with regard to penalties related to failure to register under section 

4101). 

Effective date.—The provision is effective for penalties assessed 

on or after the date of enactment. 

19. Taxable fuel refunds for certain ultimate vendors (sec. 662 of 

the House bill, sec. 888 of the Senate amendment, and secs. 

6416 and 6427 of the Code) 

PRESENT LAW

The Code provides that, in the case of gasoline on which tax 

has been paid and sold to a State or local government, to a nonprofit educational organization, for supplies for vessels or aircraft, 

for export, or for the production of special fuels, a wholesale distributor that sells the gasoline for such exempt purposes is treated 

as the person who paid the tax and thereby is the proper claimant 

for a credit or refund of the tax paid. In the case of undyed diesel 

fuel or kerosene used on a farm for farming purposes or by a State 

or local government, a credit or payment is allowable only to the 

ultimate, registered vendors (‘‘ultimate vendors’’) of such fuels. 

In general, refunds are paid without interest. However, in the 

case of overpayments of tax on gasoline, diesel fuel, or kerosene 

that is used to produce a qualified alcohol mixture and for refunds 

due ultimate vendors of diesel fuel or kerosene used on a farm for 

farming purposes or by a State or local government, the Secretary 

is required to pay interest on certain refunds. The Secretary must 

pay interest on refunds of $200 or more ($100 or more in the case 

of kerosene) due to the taxpayer arising from sales over any period 

of a week or more, if the Secretary does not make payment of the 

refund within 20 days. 

HOUSE BILL

The provision provides that for sales of gasoline to a State or 

local government or to a nonprofit educational organization for its 

exclusive use on which tax has been imposed, the provision conforms the payment of refunds to that procedure established under 

present law in the case of diesel fuel or kerosene. That is, the ultimate vendor claims the refund. 

For claims for refund of tax paid on diesel fuel or kerosene sold 

to State and local governments and for claims for refund of tax 

paid on gasoline sold to State and local governments or to a nonprofit educational organization and for which the ultimate purchaser utilized a credit card, the provision deems the person extending the credit to the ultimate purchaser to be the ultimate vendor. That is, the credit card company administers claims for refund 

and is responsible for supplying documentation required from ultimate vendors. 

Effective date.—The provision is effective October 1, 2004. 

711 

771Sec. 6416(b)(2)(C) or (D). 772 A ‘‘terminal’’ is a storage and distribution facility that is supplied by pipeline or vessel, 

and from which fuel may be removed at a rack. A ‘‘rack’’ is a mechanism capable of delivering 

taxable fuel into a means of transport other than a pipeline or vessel. 773Such person has a contractual agreement with the terminal operator to store and provide 

services with respect to the fuel. A ‘‘terminal operator’’ is any person who owns, operates, or 

otherwise controls a terminal. A terminal operator can also be a position holder if that person 

owns fuel in its terminal. 774 In the provision, this person is referred to as the ‘‘delivering person.’’ 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment, with modifications. For sales of gasoline to a State or 

local government for the exclusive use of a State or local government or to a nonprofit educational organization for its exclusive use 

on which tax has been imposed, claims for credits or refund are 

made by the ultimate vendor. 

The conference agreement provides that the rules for vendor 

refunds apply to claims made under this provision, except that the 

rules regarding electronic claims shall not apply unless the ultimate vendor has certified to the Secretary for the most recent 

quarter of the taxable year that all ultimate purchasers of the vendor are State or local governments or to a nonprofit educational organizations.771

The conference agreement does not include the House bill or 

Senate amendment provisions that deem the person extending 

credit via a credit card to the ultimate purchaser to be the ultimate 

vendor for purposes of refund claims. 

Effective date.—The provision is effective on January 1, 2005. 

20. Two party exchanges (sec. 663 of the bill and new sec. 4105 of 

the Code) 

PRESENT LAW

Most fuel is taxed when it is removed from a registered terminal.772 The party liable for payment of this tax is the ‘‘position 

holder.’’ The position holder is the person reflected on the records 

of the terminal operator as holding the inventory position in the 

fuel.773

It is common industry practice for oil companies to serve customers of other oil companies under exchange agreements, e.g., 

where Company A’s terminal is more conveniently located for 

wholesale or retail customers of Company B. In such cases, the exchange agreement party (Company B in the example) owns the fuel 

when the motor fuel is removed from the terminal and sold to B’s 

customer. 

HOUSE BILL

The provision permits two registered parties to switch position 

holder status in fuel within a registered terminal (thereby relieving 

the person originally owning the fuel774 of tax liability as the position holder) if all of the following occur: 

712 

(1) The transaction includes a transfer from the original 

owner, i.e., the person who holds the original inventory position for taxable fuel in the terminal as reflected in the records 

of the terminal operator prior to the transaction. 

(2) The exchange transaction occurs before or at the same 

time as completion of removal across the rack from the terminal by the receiving person or its customer. 

(3) The terminal operator in its books and records treats 

the receiving person as the person that removes the product 

across a terminal rack for purposes of reporting the transaction 

to the Internal Revenue Service. 

(4) The transaction is the subject of a written contract. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and Senate 

amendment. 

21. Simplification of tax on tires (sec. 664 of the House bill and sec. 

4071 of the Code) 

PRESENT LAW

A graduated excise tax is imposed on the sale by a manufacturer (or importer) of tires designed for use on highway vehicles 

(sec. 4071). The tire tax rates are as follows: 

Tire Weight Tax Rate 

Not more than 40 lbs ............................................................... No tax. 

More than 40 lbs., but not more than 70 lbs ......................... 15 cents/lb. in excess of 40 lbs. 

More than 70 lbs., but not more than 90 lbs ......................... $4.50 plus 30 cents/lb. in excess of 70 lbs. 

More than 90 lbs. ..................................................................... $10.50 plus 50 cents/lb. in excess of 90 lbs. 

No tax is imposed on the recapping of a tire that previously 

has been subject to tax. Tires of extruded tiring with internal wire 

fastening also are exempt. 

The tax expires after September 30, 2005. 

HOUSE BILL

The House bill modifies the excise tax applicable to tires. The 

House bill replaces the present-law tax rates based on the weight 

of the tire with a tax rate based on the load capacity of the tire. 

In general, the tax is 9.4 cents for each 10 pounds of tire load capacity in excess of 3,500 pounds. In the case of a biasply tire, the 

tax rate is 4.7 cents for each 10 pounds of tire load capacity in excess of 3,500 pounds. 

The House bill modifies the definition of tires for use on highway vehicles to include any tire marked for highway use pursuant 

to certain regulations promulgated by the Secretary of Transportation. The provision also exempts from tax any tire sold for the 

713 

exclusive use of the United States Department of Defense or the 

United States Coast Guard. 

Tire load capacity is the maximum load rating labeled on the 

tire pursuant to regulations promulgated by the Secretary of 

Transportation. A biasply tire is any tire manufactured primarily 

for use on piggyback trailers. 

Effective date.—The provision is effective for sales in calendar 

years beginning more than 30 days after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill with the following modifications. The conference agreement modifies the rate 

of tax applicable to 9.45 cents for each 10 pounds of tire load capacity in excess of 3,500 pounds. In the case of a biasply tire, the conference agreement modifies the tax rate is 4.725 cents for each 10 

pounds of tire load capacity in excess of 3,500 pounds. The conference agreement also imposes tax at a rate of is 4.725 cents for 

each 10 pounds of tire load capacity in excess of 3,500 pounds an 

any super single tire. A super single tire is a single tire greater 

than 13 inches in cross section width designed to replace two tires 

in a dual fitment. The conference agreement provides that a 

biasply tire means a pneumatic tire on which the ply cords that extend to the beads are laid at alternate angles substantially less 

than 90 degrees to the centerline of the tread. 

Nothing in the amendments made by this section shall be construed to have any effect on subsection (d) of section 48.4701–1 of 

Title 26, Code of Federal Regulations (relating to recapped and 

retreaded tires). The conferees expect that the Secretary will prescribe regulations implementing the amendment to section 4071 

but that such regulations will not affect subsection (d). The conferees believe no tax should be imposed on the recapping of a tire 

that previously has been subject to tax. 

Effective date.—The provision is effective for sales in calendar 

years beginning more than 30 days after the date of enactment. 

22. Tax on sale of diesel fuel whether suitable for use or not in a 

diesel-powered vehicle or train (sec. 886 of the Senate amendment) 

PRESENT LAW

Under section 4081(a)(1), an excise tax is imposed upon (1) the 

removal of any taxable fuel from a refinery or terminal, (2) the 

entry of any taxable fuel into the United States, or (3) the sale of 

any taxable fuel to any person who is not a taxable fuel registrant 

under section 4101, unless there was a prior taxable removal or 

entry. 

Under section 4083(a), taxable fuel includes diesel fuel. Diesel 

fuel includes any liquid, other than gasoline, that without further 

processing or blending, is suitable for use as a fuel in a diesel-powVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00717 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
714 

775Sec. 4083(a)(3). 776Sec. 4081(b). 777Treas. Reg. sec. 48.4081–3(g)(1). 778Treas. Reg. sec. 48.4081–1(c)(1)(i). 779Treas. Reg. sec. 48.4081–3(g)(2). 

ered highway vehicle or train.775 A liquid is suitable for this use 

if the liquid has practical and commercial fitness for use in the propulsion engine of a diesel-powered highway vehicle or diesel-powered train. A liquid may possess this practical and commercial fitness even though the specified use is not the liquid’s predominant 

use. However, a liquid does not possess this practical and commercial fitness solely by reason of its possible or rare use as a fuel in 

the propulsion engine of a diesel-powered highway vehicle or diesel-powered train. 

A tax is imposed on the removal or sale of blended taxable fuel 

by the blender thereof.776 Tax is computed on the difference between the total number of gallons of blended taxable fuel removed 

or sold and the number of gallons of previously taxed taxable fuel 

used to produce the blended taxable fuel.777 Blended taxable fuel 

means any taxable fuel that is produced outside the bulk transfer/ 

terminal system by mixing (1) taxable fuel with respect to which 

tax has been imposed under section 4041(a)(1) or 4081(a) (other 

than taxable fuel for which a credit or payment has been allowed); 

and (2) any other liquid on which tax has not been imposed under 

section 4081.778

The blender (the person making the blended taxable fuel) is 

liable for the tax on the increased volume. In addition, on and after 

April 2, 2003, a person that sells any liquid that is used to produce 

blended taxable fuel is jointly and severally liable for the tax on 

the removal or sale of that blended taxable fuel if the liquid is a 

liquid on which tax has not been imposed under section 4081; and 

is sold by that person as gasoline, diesel fuel, or kerosene that has 

been taxed under section 4081.779

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision modifies the definition of diesel fuel to include 

any liquid which is sold as or offered for sale as a fuel in a dieselpowered highway vehicle or diesel-powered train. 

Effective date.—The provision is effective on the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

23. Nonapplication of export exemption to delivery of fuel to motor 

vehicles removed from United States (sec. 892 of the Senate 

amendment) 

PRESENT LAW

A manufacturer’s excise tax is imposed upon 

715 

780Sec. 4081(a)(1). 781Secs. 6421(c) and 4221(a)(2). 782 Rev. Rul. 69–150. 783See, Ammex Inc. v. United States, 52 Fed. Cl. 303 (2002) (on cross-motions for summary 

judgment, the court found that plaintiff established standing to proceed to trial pursuant to sec. 

6421(c) respecting its gasoline purchases only); and Ammex Inc. v. United States, 2002 U.S. Dist. 

LEXIS 25771 (E.D. Mich. July 31, 2002) (granting defendant’s motion for summary judgment), 

reconsideration denied, Ammex, Inc. v. United States, 2002 U.S. Dist. LEXIS 22893 (E.D. Mich. 

Oct. 22, 2002). Although the Claims Court ruled that Ammex had standing to challenge the excise tax on gasoline, it subsequently held that Ammex was not entitled to a payment pursuant 

to sec. 6421(c) because it failed to prove at trial that it did not pass the tax on to its customers. 

Ammex Inc. v. United States, 2003 U.S. Claims LEXIS 63 (Fed. Cl. Mar. 26, 2003). 

(1) The removal of any taxable fuel from a refinery or terminal; 

(2) The entry of any taxable fuel into the United States for 

consumption, use or warehousing; or 

(3) The sale of any taxable fuel to any person who is not 

registered, unless there was a prior taxable removal or 

entry.780

The term ‘‘taxable fuel’’ means gasoline, diesel fuel and kerosene. 

Special provisions under the Code provide for a refund of tax 

to any person who sells gasoline to another for exportation.781 Section 6421(c) provides ‘‘If gasoline is sold to any person for any purpose described in paragraph (2), (3), (4), or (5) of section 4221(a), 

the Secretary shall pay (without interest) to such person an 

amount equal to the product of the number of gallons so sold multiplied by the rate at which tax was imposed on such gasoline by section 4081.’’ Section 4221 provides, in pertinent part, ‘‘Under regulations prescribed by the Secretary, no tax shall be imposed under 

this chapter . . . on the sale by the manufacturer . . . of an article—. . . for export, or for resale by the purchaser to a second purchaser for export . . . but only if such exportation or use is to occur 

before any other use . . .’’ 

It is the IRS administrative position that the exemption from 

manufacturers excise tax by reason of exportation does not apply 

to the sale of motor fuel pumped into a fuel tank of a vehicle that 

is to be driven, or shipped, directly out of the United States.782

A duty-free sales facility that meets certain conditions may sell 

and deliver for export from the customs territory of the United 

States duty-free merchandise. Duty-free merchandise is merchandise sold by a duty-free sales facility on which neither Federal duty 

nor Federal tax has been assessed pending exportation from the 

customs territory of the United States. The statutes covering dutyfree facilities do not contain any limitation on what goods may 

qualify for duty-free treatment. 

The United States Court of Federal Claims (‘‘Claims Court’’) 

and a District Court in Michigan have taken different positions on 

whether fuel sold from a duty-free facility and placed into the tank 

of an automobile that is then driven out of the country is exported 

fuel.783 Both cases involved the same duty-free facility, which is 

near the Canadian border and is configured in such a way that 

anyone leaving the facility must depart the United States and 

enter into Canada. The District Court agreed with the IRS position 

that such fuel is not exported, while the Claims Court reached the 

opposite conclusion. The Claims Court concluded that the act of exportation began with the consumer’s purchase and that the fuel 

necessarily enters into the stream of exportation at the moment it 

716 

784Sec. 4083(a). 785Treas. Reg. sec. 48.4081–1(c)(3)(ii). The term ‘‘gasoline blendstocks’’ means alkylate; butane; catalytically cracked gasoline; coker gasoline; ethyl tertiary butyl ether (ETBE); hexane; 

hydrocrackate; isomerate; methyl tertiary butyl ether (MTBE); mixed xylene (not including any 

separated isomer of xylene); natural gasoline; pentane; pentane mixture; polymer gasoline; raffinate; reformate; straight-run gasoline; straight-run naphtha; tertiary amyl methyl ether 

(TAME); tertiary butyl alcohol (gasoline grade) (TBA); thermally cracked gasoline; toluene; and 

transmix containing gasoline. Treas. Reg. sec. 48.4081–1(c)(3)(i). 786Sec. 4083(a)(3). 

is placed into the fuel supply tank and the customer drives into 

Canada. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision reaffirms the long-standing IRS position taken 

in Rev. Rul. 69–150 and restates present law by amending the 

Code definition of export to exclude the delivery of a taxable fuel 

into a fuel tank of a motor vehicle that is shipped or driven out of 

the United States. It also imposes a tax on the sale of taxable fuel 

at a duty-free sales enterprise unless there was a prior taxable removal, or entry of such fuel. 

Effective date.—The provision applies to sales or deliveries 

made after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

24. Taxation of transmix and diesel fuel blend stocks and Treasury 

study on fuel tax compliance (secs. 893, 894 and 895 of the 

Senate amendment and sec. 4083 of the Code) 

PRESENT LAW

Definition of taxable fuels 

A ‘‘taxable fuel’’ is gasoline, diesel fuel (including any liquid, 

other than gasoline, which is suitable for use as a fuel in a dieselpowered highway vehicle or train), and kerosene.784

Under the regulations, ‘‘gasoline’’ includes all products commonly or commercially known or sold as gasoline and suited for use 

as a motor fuel, and that have an octane rating of 75 or more. Gasoline also includes, to the extent provided in regulations, gasoline 

blendstocks and products commonly used as additives in gasoline. 

The term ‘‘gasoline blendstocks’’ does not include any product that 

cannot be blended into gasoline without further processing or fractionation (‘‘off-spec gasoline’’).785

Diesel fuel is any liquid (other than gasoline) that is suitable 

for use as a fuel in a diesel-powered highway vehicle or diesel-powered train.786 By regulation, diesel fuel does not include kerosene, 

gasoline, No. 5 and No. 6 fuel oils (as described in ASTM Specification D 396), or F–76 (Fuel Naval Distillates MIL–F–16884) any liquid that contains less than four percent normal parafins, or any 

liquid that has a distillation range of 125 degrees Fahrenheit or 

717 

787Treas. Reg. sec. 48.4081–1(c)(2)(ii). 788Treas. Reg. sec. 48.4081–1(b). 789Sec. 4081(a)(1). 790Sec. 4081(a)(1)(B). 

less, sulfur content of 10 ppm or less and minimum color of +27 

Saybolt (these are known as ‘‘excluded liquids’’).787

By regulation, kerosene is defined as the kerosene described in 

ASTM Specification D 3699 (No. 1–K and No. 2–K), ASTM Specification D 1655 (kerosene-type jet fuel), and military specifications 

MIL–DTL–5624T (Grade JP–5) and MIL–DTL–83133E (Grade JP– 

8). Kerosene does not include any liquid that is an excluded liquid.788

Taxable events and exemptions 

An excise tax is imposed upon (1) the removal of any taxable 

fuel from a refinery or terminal, (2) the entry of any taxable fuel 

into the United States, or (3) the sale of any taxable fuel to any 

person who is not registered with the IRS to receive untaxed fuel, 

unless there was a prior taxable removal or entry.789 The tax does 

not apply to any removal or entry of taxable fuel transferred in 

bulk to a terminal or refinery if the person removing or entering 

the taxable fuel and the operator of such terminal or refinery are 

registered with the Secretary.790

Gasoline exemptions 

If certain conditions are met, the removal, entry, or sale of gasoline blendstocks is not taxable. Generally, the exemption from tax 

applies if a gasoline blendstock is not used to produce finished gasoline or is received at an approved terminal or refinery. No tax is 

imposed on nonbulk removals from a terminal or refinery, or 

nonbulk entries into the United States or on any gasoline 

blendstocks if the person liable for the tax is a gasoline registrant, 

has an unexpired notification certificate, knows of no false information in the certificate, and has verified the accuracy of the notification certificate. The sale of a gasoline blendstock that was not subject to tax on nonbulk removal or entry is taxable unless the seller 

has an unexpired certificate from the buyer and has no reason to 

believe that any information in the certificate is false. No tax is imposed on, or purchaser certification required for, off-spec gasoline. 

Diesel fuel and kerosene exemptions 

Diesel fuel and kerosene that is to be used for a nontaxable 

purpose will not be taxed upon removal from the terminal if it is 

dyed to indicate its nontaxable purpose. Undyed aviation-grade 

kerosene also is exempt from tax at the rack if it is destined for 

use as a fuel in an aircraft. The tax does not apply to diesel fuel 

asserted to be ‘‘not suitable for use’’ or kerosene asserted to qualify 

as an excluded liquid. 

Feedstock kerosene that a registered industrial user receives 

by pipeline or vessel also is exempt from the dyeing requirement. 

A kerosene feedstock user is defined as a person that receives kerosene by bulk transfer for its own use in the manufacture or production of any substance (other than gasoline, diesel fuel or special 

fuels subject to tax). Thus, for example, kerosene is used for a feedVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00721 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
718 

791Treas. Reg. sec. 406011(a)–1(a); Form 720, Quarterly Federal Excise Tax Return. 792Treas. Reg. 40.6302(c)–1(a). 793Treas. Reg. 40.6011(a)–1(b). 

stock purpose when it is used as an ingredient in the production 

of paint and is not used for a feedstock purpose when it is used to 

power machinery at a factory where paint is produced. The person 

receiving the kerosene must be registered with the IRS and provide 

a certificate noting that the kerosene will be used for a feedstock 

purpose in order for the exemption to apply. 

Information and tax return reporting 

The IRS collects data under the ExSTARS reporting system 

that tracks all removals across the terminal rack regardless of 

whether or not the product is technically excluded from the definition of gasoline, diesel or blendstocks. ExSTARS reporting identifies the position holder at the time of removal. Below the rack, no 

information is gathered for exempt or excluded products or uses. 

Taxpayers file quarterly excise tax returns showing only net 

taxable gallons.791 Taxpayers do not account for gallons they claim 

to be exempt on such returns. Although the return is a quarterly 

return, the excise taxes are paid in semimonthly deposits.792 If deposits are not made as required, a taxpayer may be required to file 

returns on a monthly or semimonthly basis instead of quarterly.793

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment creates a new category of taxable liquids, ‘‘reportable liquids’’. A reportable liquid is any petroleumbased liquid other than a taxable fuel. For purposes of the imposition of tax, the provision treats ‘‘reportable liquids’’ in a manner 

similar to taxable fuels. Tax is imposed upon the removal, entry, 

or sale of such liquids, unless the removal, entry, or sale is (1) to 

a registered person who certifies that such liquid will not be used 

as a fuel or in the production of a fuel, or (2) the sale is to the ultimate purchaser of such liquid. Under the provision, the current exclusions for distillates not suitable for use in a highway vehicle, excluded liquids, and gasoline blendstocks requiring further processing (off-spec gasoline) are eliminated. The provision also provides that dyed diesel (a taxable fuel) also is taxable unless removed by a taxable fuel registrant (a person registered with the 

Secretary under section 4101). 

The provision authorizes the Secretary to pay (without interest) an amount equal to the tax imposed, if a person establishes 

that the ultimate use of a gasoline blendstock, or additive, was not 

to produce gasoline. Similarly, if tax is imposed on a reportable liquid and the person establishes that the liquid was not used to 

produce a taxable, fuel, the Secretary is authorized to pay (without 

interest) an amount equal to the tax imposed on such person with 

respect to the reportable liquid. 

Taxpayers are to file a monthly fuel excise tax return. Not earlier than January 1, 2005, such filings shall be in electronic form 

719 

794Persons not liable for tax, will make their reports in the same manner as taxpayers who 

file fuel excise tax returns as described above. 

as prescribed by the Secretary. In addition, under the provision, 

the Secretary is to require that all persons removing refined product, whether a taxable product or an untaxed product, over the terminal rack to report such products on an excise tax return. The return is to specifically identify the class of product and its quantity.794

Effective date.—The provision is effective for fuel sold or used 

after September 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement adds two new categories to the definition of diesel fuel. Under the conference agreement, diesel fuel 

means: (1) any liquid (other than gasoline) which is suitable for use 

as a fuel in a diesel-powered highway vehicle, or a diesel-powered 

train; (2) transmix; and (3) diesel fuel blend stocks as identified by 

the Secretary. Transmix means a by-product of refined products 

pipeline operations created by the mixing of different specification 

products during pipeline transportation. Transmix generally results 

when one fuel, such as diesel fuel, is placed in a pipeline followed 

by another taxable fuel, such as kerosene. The mixture created between the two fuels when it is neither all diesel fuel nor all kerosene, is an example of a transmix. Under the conference agreement, all transmix is taxable as diesel fuel, regardless of whether 

it contains gasoline. 

Under the conference agreement, it is intended that the re-refining of tax-paid transmix into gasoline, diesel fuel or kerosene 

qualify as a nontaxable off-highway business use of such transmix, 

for purposes of the refund and payment provisions relating to nontaxable uses of diesel fuel. 

Not later than January 31, 2005, the Secretary shall submit to 

the Committee on Finance of the Senate and the Committee on 

Ways and Means of the House of Representatives a report regarding fuel tax compliance, which shall include information, and analysis as specified below, and recommendations to address the issues 

identified. 

The Secretary is to identify chemical products that should be 

added to the list of blendstocks. The Secretary is to identify those 

chemical products, as identified by lab analysis of fuel samples 

taken by the IRS, that have been blended with taxable fuel but are 

not currently treated as a blendstock. The report should indicate, 

to the extent possible, any statistics as to the frequency in which 

such chemical product has been discovered, and whether the samples contained above-normal concentrations of such chemical product. The report also shall include a discussion of IRS findings regarding the addition of waste products to taxable fuel and any recommendations to address the taxation of such products. The report 

shall include a discussion of IRS findings regarding sales of taxable 

fuel to entities claiming exempt status as a State or local government. Such discussion shall include the frequency of erroneous certifications as to exempt status determined on audit. The Secretary 

shall consult with representatives of State and local governments 

720 

795See, e.g., Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (6th 

Cir. 1952); Rev. Rul. 60–31, 1960–1 C.B. 174. 

in providing recommendations to address this issue, including the 

feasibility of State maintained lists of their exempt governmental 

entities. 

Effective date.—The provision regarding the taxation of 

transmix and diesel fuel blendstocks is effective for fuel removed, 

sold, or used after December 31, 2004. The requirement for a 

Treasury study is effective on the date of enactment. 

D. NONQUALIFIED DEFERRED COMPENSATION PLANS

1. Treatment of nonqualified deferred compensation plans (sec. 671 

of the House bill, section 671 of the Senate amendment, and 

new sec. 409A and secs. 6040 and 6051 of the Code) 

PRESENT LAW

In general 

The determination of when amounts deferred under a nonqualified deferred compensation arrangement are includible in the 

gross income of the individual earning the compensation depends 

on the facts and circumstances of the arrangement. A variety of tax 

principles and Code provisions may be relevant in making this determination, including the doctrine of constructive receipt, the economic benefit doctrine,795 the provisions of section 83 relating generally to transfers of property in connection with the performance 

of services, and provisions relating specifically to nonexempt employee trusts (sec. 402(b)) and nonqualified annuities (sec. 403(c)). 

In general, the time for income inclusion of nonqualified deferred compensation depends on whether the arrangement is unfunded or funded. If the arrangement is unfunded, then the compensation is generally includible in income when it is actually or 

constructively received. If the arrangement is funded, then income 

is includible for the year in which the individual’s rights are transferable or not subject to a substantial risk of forfeiture. 

Nonqualified deferred compensation is generally subject to social security and Medicare taxes when the compensation is earned 

(i.e., when services are performed), unless the nonqualified deferred 

compensation is subject to a substantial risk of forfeiture. If nonqualified deferred compensation is subject to a substantial risk of 

forfeiture, it is subject to social security and Medicare tax when the 

risk of forfeiture is removed (i.e., when the right to the nonqualified deferred compensation vests). Amounts deferred under a 

nonaccount balance plan that are not reasonably ascertainable are 

not required to be taken into account as wages subject to social security and Medicare taxes until the first date that such amounts 

are reasonably ascertainable. Social security and Medicare tax 

treatment is not affected by whether the arrangement is funded or 

unfunded, which is relevant in determining when amounts are includible in income (and subject to income tax withholding). 

In general, an arrangement is considered funded if there has 

been a transfer of property under section 83. Under that section, 

a transfer of property occurs when a person acquires a beneficial 

721 

796Treas. Reg. sec. 1.83–3(e). This definition in part reflects previous IRS rulings on nonqualified deferred compensation. 797Treas. Reg. secs. 1.451–1 and 1.451–2. 

ownership interest in such property. The term ‘‘property’’ is defined 

very broadly for purposes of section 83.796 Property includes real 

and personal property other than money or an unfunded and unsecured promise to pay money in the future. Property also includes 

a beneficial interest in assets (including money) that are transferred or set aside from claims of the creditors of the transferor, for 

example, in a trust or escrow account. Accordingly, if, in connection 

with the performance of services, vested contributions are made to 

a trust on an individual’s behalf and the trust assets may be used 

solely to provide future payments to the individual, the payment of 

the contributions to the trust constitutes a transfer of property to 

the individual that is taxable under section 83. On the other hand, 

deferred amounts are generally not includible in income if nonqualified deferred compensation is payable from general corporate 

funds that are subject to the claims of general creditors, as such 

amounts are treated as unfunded and unsecured promises to pay 

money or property in the future. 

As discussed above, if the arrangement is unfunded, then the 

compensation is generally includible in income when it is actually 

or constructively received under section 451.797 Income is constructively received when it is credited to an individual’s account, set 

apart, or otherwise made available so that it may be drawn on at 

any time. Income is not constructively received if the taxpayer’s 

control of its receipt is subject to substantial limitations or restrictions. A requirement to relinquish a valuable right in order to 

make withdrawals is generally treated as a substantial limitation 

or restriction. 

Rabbi trusts 

Arrangements have developed in an effort to provide employees 

with security for nonqualified deferred compensation, while still allowing deferral of income inclusion. A ‘‘rabbi trust’’ is a trust or 

other fund established by the employer to hold assets from which 

nonqualified deferred compensation payments will be made. The 

trust or fund is generally irrevocable and does not permit the employer to use the assets for purposes other than to provide nonqualified deferred compensation, except that the terms of the trust 

or fund provide that the assets are subject to the claims of the employer’s creditors in the case of insolvency or bankruptcy. 

As discussed above, for purposes of section 83, property includes a beneficial interest in assets set aside from the claims of 

creditors, such as in a trust or fund, but does not include an unfunded and unsecured promise to pay money in the future. In the 

case of a rabbi trust, terms providing that the assets are subject 

to the claims of creditors of the employer in the case of insolvency 

or bankruptcy have been the basis for the conclusion that the creation of a rabbi trust does not cause the related nonqualified deferred compensation arrangement to be funded for income tax purVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00725 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
722 

798This conclusion was first provided in a 1980 private ruling issued by the IRS with respect 

to an arrangement covering a rabbi; hence the popular name ‘‘rabbi trust.’’ Priv. Ltr. Rul. 

8113107 (Dec. 31, 1980). 799 Rev. Proc. 92–64, 1992–2 C.B. 422, modified in part by Notice 2000–56, 2000–2 C.B. 393. 800 A plan includes an agreement or arrangement, including an agreement or arrangement 

that includes one person. 801 As under section 83, the rights of a person to compensation are subject to a substantial 

risk of forfeiture if the person’s rights to such compensation are conditioned upon the performance of substantial services by any individual. 802Key employees are defined in section 416(i) and generally include officers having annual compensation greater than $130,000 (adjusted for inflation and limited to 50 employees), five 

percent owners, and one percent owners having annual compensation from the employer greater 

than $150,000. 

poses.798 As a result, no amount is included in income by reason 

of the rabbi trust; generally income inclusion occurs as payments 

are made from the trust. 

The IRS has issued guidance setting forth model rabbi trust 

provisions.799 Revenue Procedure 92–64 provides a safe harbor for 

taxpayers who adopt and maintain grantor trusts in connection 

with unfunded deferred compensation arrangements. The model 

trust language requires that the trust provide that all assets of the 

trust are subject to the claims of the general creditors of the company in the event of the company’s insolvency or bankruptcy. 

Since the concept of rabbi trusts was developed, arrangements 

have developed which attempt to protect the assets from creditors 

despite the terms of the trust. Arrangements also have developed 

which attempt to allow deferred amounts to be available to individuals, while still purporting to meet the safe harbor requirements 

set forth by the IRS. 

HOUSE BILL

Under the House bill, all amounts deferred under a nonqualified deferred compensation plan 800 for all taxable years are 

currently includible in gross income to the extent not subject to a 

substantial risk of forfeiture 801 and not previously included in 

gross income, unless certain requirements are satisfied. If the requirements of the provision are not satisfied, in addition to current 

income inclusion, interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have 

occurred had the compensation been includible in income when 

first deferred, or if later, when not subject to a substantial risk of 

forfeiture. Actual or notional earnings on amounts deferred are also 

subject to the provision. 

Under the provision, distributions from a nonqualified deferred 

compensation plan may be allowed only upon separation from service (as determined by the Secretary), death, a specified time (or 

pursuant to a fixed schedule), change in control in a corporation (to 

the extent provided by the Secretary), occurrence of an unforeseeable emergency, or if the participant becomes disabled. A nonqualified deferred compensation plan may not allow distributions 

other than upon the permissible distribution events and may not 

permit acceleration of a distribution, except as provided in regulations by the Secretary. 

In the case of a specified employee, distributions upon separation from service may not be made earlier than six months after 

the date of the separation from service. Specified employees are key 

employees 802 of publicly-traded corporations. 

723 

Amounts payable at a specified time or pursuant to a fixed 

schedule must be specified under the plan at the time of deferral. 

Amounts payable upon the occurrence of an event are not treated 

as amounts payable at a specified time. For example, amounts payable when an individual attains age 65 are payable at a specified 

time, while amounts payable when an individual’s child begins college are payable upon the occurrence of an event. 

Distributions upon a change in the ownership or effective control of a corporation, or in the ownership of a substantial portion 

of the assets of a corporation, may only be made to the extent provided by the Secretary. It is intended that the Secretary use a similar, but more restrictive, definition of change in control as is used 

for purposes of the golden parachute provisions of section 280G 

consistent with the purposes of the provision. The provision requires the Secretary to issue guidance defining change of control 

within 90 days after the date of enactment. 

An unforeseeable emergency is defined as a severe financial 

hardship to the participant resulting from a sudden and unexpected illness or accident of the participant, the participant’s 

spouse, or a dependent (as defined in 152(a)) of the participant; loss 

of the participant’s property due to casualty; or other similar extraordinary and unforeseeable circumstances arising as a result of 

events beyond the control of the participant. The amount of the distribution must be limited to the amount needed to satisfy the emergency plus taxes reasonably anticipated as a result of the distribution. Distributions may not be allowed to the extent that the hardship may be relieved through reimbursement or compensation by 

insurance or otherwise, or by liquidation of the participant’s assets 

(to the extent such liquidation would not itself cause a severe financial hardship). 

A participant is considered disabled if he or she (i) is unable 

to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months; or (ii) is, by reason on any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months, receiving income replacement 

benefits for a period of not less than three months under an accident and health plan covering employees of the participant’s employer. 

As previously discussed, except as provided in regulations by 

the Secretary, no accelerations of distributions may be allowed. For 

example, changes in the form of a distribution from an annuity to 

a lump sum are not permitted. The provision provides the Secretary authority to provide, through regulations, limited exceptions 

to the general rule that no accelerations can be permitted. It is intended that exceptions be provided only in limited cases where the 

accelerated distribution is required for reasons beyond the control 

of the participant. For example, it is anticipated that an exception 

could be provided in order to comply with Federal conflict of interest requirements or court-approved settlements. 

The provision requires that the plan must provide that compensation for services performed during a taxable year may be deVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00727 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
724 

ferred at the participant’s election only if the election to defer is 

made no later than the close of the preceding taxable year, or at 

such other time as provided in Treasury regulations. For example, 

it is expected that Treasury regulations provide that, in appropriate circumstances, elections to defer incentive bonuses earned 

over a period of several years may be made after the beginning of 

the service period, as long as such elections may in no event be 

made later than 12 months before the earliest date on which such 

incentive bonus is initially payable. The Secretary may consider 

other factors in determining the appropriate election period, such 

as when the amount of the bonus payment is determinable. It is 

expected that Treasury regulations will not permit any election to 

defer any bonus or other compensation if the timing of such election would be inconsistent with the purposes of the provision. 

Under the provision, in the first year that an employee becomes eligible for participation in a nonqualified deferred compensation 

plan, the election may be made within 30 days after the date that 

the employee is initially eligible. 

The time and form of distributions must be specified at the 

time of initial deferral. A plan could specify the time and form of 

payments that are to be made as a result of a distribution event 

(e.g., a plan could specify that payments upon separation of service 

will be paid in lump sum within 30 days of separation from service) 

or could allow participants to elect the time and form of payment 

at the time of the initial deferral election. If a plan allows participants to elect the time and form of payment, such election is subject to the rules regarding initial deferral elections under the provision. 

Under the provision, a plan may allow changes in the time and 

form of distributions subject to certain requirements. A nonqualified deferred compensation plan may allow a subsequent election to delay the timing or form of distributions only if: (1) the plan 

requires that such election cannot be effective for at least 12 

months after the date on which the election is made; (2) except in 

the case of elections relating to distributions on account of death, 

disability or unforeseeable emergency, the plan requires that the 

additional deferral with respect to which such election is made is 

for a period of not less than five years from the date such payment 

would otherwise have been made; and (3) the plan requires that an 

election related to a distribution to be made upon a specified time 

may not be made less than 12 months prior to the date of the first 

scheduled payment. It is expected that in limited cases, the Secretary will issue guidance, consistent with the purposes of the provision, regarding to what extent elections to change a stream of 

payments are permissible. 

If impermissible distributions or elections are made, or if the 

nonqualified deferred compensation plan allows impermissible distributions or elections, all amounts deferred under the plan (including amounts deferred in prior years) are currently includible in income to the extent not subject to a substantial risk of forfeiture and 

not previously included in income. In addition, interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the compensation been 

725 

includible in income when first deferred, or if later, when not subject to a substantial risk of forfeiture. 

Under the provision, in the case of assets set aside (directly or 

indirectly) in a trust (or other arrangement determined by the Secretary) for purposes of paying nonqualified deferred compensation, 

such assets are treated as property transferred in connection with 

the performance of services under section 83 (whether or not such 

assets are available to satisfy the claims of general creditors) at the 

time set aside if such assets are located outside of the United 

States or at the time transferred if such assets are subsequently 

transferred outside of the United States. Any subsequent increases 

in the value of, or any earnings with respect to, such assets are 

treated as additional transfers of property. Interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the amounts been includible in income for the taxable year in which first deferred or, if 

later, the first taxable year not subject to a substantial risk of forfeiture. It is expected that the Secretary will provide rules for identifying the deferrals to which assets set aside are attributable, for 

situations in which assets equal to less than the full amount of deferrals are set aside. The Secretary has authority to exempt arrangements from the provision if the arrangements do not result 

in an improper deferral of U.S. tax and will not result in assets 

being effectively beyond the reach of creditors. 

Under the provision, a transfer of property in connection with 

the performance of services under section 83 also occurs with respect to compensation deferred under a nonqualified deferred compensation plan if the plan provides that upon a change in the employer’s financial health, assets will be restricted to the payment 

of nonqualified deferred compensation. The transfer of property occurs as of the earlier of when the assets are so restricted or when 

the plan provides that assets will be restricted. It is intended that 

the transfer of property occurs to the extent that assets are restricted or will be restricted with respect to such compensation. For 

example, in the case of a plan that provides that upon a change 

in the employer’s financial health, a trust will become funded to 

the extent of all deferrals, all amounts deferred under the plan are 

treated as property transferred under section 83. If a plan provides 

that deferrals of certain individuals will be funded upon a change 

in financial health, the transfer of property would occur with respect to compensation deferred by such individuals. Any subsequent increases in the value of, or any earnings with respect to, 

such assets are treated as additional transfers of property. Interest 

at the underpayment rate plus one percentage point is imposed on 

the underpayments that would have occurred had the amounts 

been includible in income for the taxable year in which first deferred or, if later, the first taxable year not subject to a substantial 

risk of forfeiture. 

A nonqualified deferred compensation plan is any plan that 

provides for the deferral of compensation other than a qualified employer plan or any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan. A qualified employer plan means a qualified retirement plan, tax-deferred annuVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00729 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
726 

803 A qualified employer plan also includes a section 501(c)(18) trust. 804 A governmental deferred compensation plan that is not an eligible deferred compensation 

plan is not a qualified employer plan. 805 It is intended that the exception be similar to that under Treas. Reg. sec. 31.3121(v)(2)– 

1(e)(4). 

ity, simplified employee pension, and SIMPLE.803 A governmental 

eligible deferred compensation plan (sec. 457) is also a qualified 

employer plan under the provision.804 Plans subject to section 457, 

other than governmental eligible deferred compensation plans, are 

subject to both the requirements of section 457 and the provision. 

For example, in addition to the requirements of the provision, an 

eligible deferred compensation plan of a tax-exempt employer 

would still be required to meet the applicable dollar limits under 

section 457. 

Interest imposed under the provision is treated as interest on 

an underpayment of tax. Income (whether actual or notional) attributable to nonqualified deferred compensation is treated as additional deferred compensation and is subject to the provision. The 

provision is not intended to prevent the inclusion of amounts in 

gross income under any provision or rule of law earlier than the 

time provided in the provision. Any amount included in gross income under the provision is not required to be included in gross income under any provision of law later than the time provided in 

the provision. The provision does not affect the rules regarding the 

timing of an employer’s deduction for nonqualified deferred compensation. 

The provision requires annual reporting to the Internal Revenue Service of amounts deferred. Such amounts are required to be 

reported on an individual’s Form W–2 for the year deferred even 

if the amount is not currently includible in income for that taxable 

year. Under the provision, the Secretary is authorized, through regulations, to establish a minimum amount of deferrals below which 

the reporting requirement does not apply. The Secretary may also 

provide that the reporting requirement does not apply with respect 

to amounts of deferrals that are not reasonably ascertainable. It is 

intended that the exception for amounts not reasonably ascertainable only apply to nonaccount balance plans and that amounts be 

required to be reported when they first become reasonably ascertainable.805

The provision provides the Secretary authority to prescribe 

regulations as are necessary to carry out the purposes of provision, 

including regulations: (1) providing for the determination of 

amounts of deferral in the case of defined benefit plans; (2) relating 

to changes in the ownership and control of a corporation or assets 

of a corporation; (3) exempting from the provisions providing for 

transfers of property arrangements that will not result in an improper deferral of U.S. tax and will not result in assets being effectively beyond the reach of creditors; (4) defining financial health; 

and (5) disregarding a substantial risk of forfeiture. 

It is intended that substantial risk of forfeitures may not be 

used to manipulate the timing of income inclusion. It is intended 

that substantial risks of forfeiture should be disregarded in cases 

in which they are illusory or are used inconsistent with the purposes of the provision. For example, if an executive is effectively 

727 

806 An officer is defined as the president, principal financial officer, principal accounting officer 

(or, if there is no such accounting officer, the controller), any vice-president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions. 

able to control the acceleration of the lapse of a substantial risk of 

forfeiture, such risk of forfeiture should be disregarded and income 

inclusion should not be postponed on account of such restriction. 

Effective date.—The House bill is effective for amounts deferred 

after June 3, 2004. The provision does not apply to amounts deferred after June 3, 2004, and before January 1, 2005, pursuant to 

an irrevocable election or binding arrangement made before June 

4, 2004. Earnings on amounts deferred before the effective date are 

subject to the provision to the extent that such amounts deferred 

are subject to the provision. 

It is intended that amounts further deferred under a subsequent election with respect to amounts originally deferred before 

June 4, 2004, are subject to the requirements of the provision. 

No later than 90 days after the date of enactment, the Secretary shall issue guidance providing a limited period of time during which an individual participating in a nonqualified deferred 

compensation plan adopted before June 4, 2004, may, without violating the requirements of the provision, terminate participation or 

cancel an outstanding deferral election with regard to amounts 

earned after June 3, 2004, if such amounts are includible in income 

as earned. 

SENATE AMENDMENT

The Senate amendment follows the House bill with the following modifications. 

Under the Senate amendment, if the requirements of the provision are not satisfied, in addition to current income inclusion, interest at the underpayment rate is imposed on the underpayments 

that would have occurred had the compensation been includible in 

income when first deferred, or if later, when not subject to a substantial risk of forfeiture. The amount required to be included in 

income is also subject to an additional 10-percent tax. 

Under the Senate amendment, in the case of an individual 

who, with respect to a corporation, is subject to the requirements 

of section 16(a) of the Securities Act of 1934, distributions upon a 

change in control may not be made earlier than one year after the 

date of the change in control of the corporation. Such individuals 

include officers (as defined by section 16(a)),806 directors, or 10-percent owners of publicly-held corporations. Under the provision, distributions made to such individuals within one year of the change 

in control (‘‘applicable payments’’) are treated as excess parachute 

payments under section 280G (even if the payment would not otherwise be treated as an excess parachute payment) and therefore 

subject to the excise tax under section 4999. As under present law, 

no deduction is allowed for any amount treated as an excess parachute payment. 

If, absent the provision, an applicable payment is a payment 

in the nature of compensation contingent on a change in control, 

section 280G is applied as if the provision had not been enacted 

728 

(i.e., the applicable payments continue to be taken into account 

under section 280G). Any resulting excess parachute payment is 

also subject to the excise tax under section 4999 (in addition to the 

tax imposed by the provision). Under the provision, an applicable 

payment that, absent the provision, is not a payment in the nature 

of compensation contingent on a change in control is required to be 

taken into account in determining if the present value of the payments in the nature of compensation contingent on a change in 

control equal or exceed three times the base amount. Any resulting 

excess parachute payment is also subject to the excise tax under 

section 4999 (in addition to the tax imposed by the provision). Applicable payments do not include payments made upon death or if 

the participant becomes disabled. Treasury regulations shall prescribe rules to prevent a deduction from being disallowed more 

than once. 

Under the Senate amendment, unforeseeable emergency also 

includes hardship of a beneficiary. Unforeseeable emergency is defined as severe financial hardship of the participant or beneficiary 

resulting from a sudden and unexpected illness or accident of the 

participant or beneficiary, the participant’s or beneficiary’s spouse 

or the participant’s or beneficiary’s dependent (as defined in 

152(a)); loss of the participant’s or beneficiary’s property due to casualty; or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the 

participant or beneficiary. Distributions are not allowed to the extent that the hardship may be relieved by liquidation of the participant’s or beneficiary’s assets. 

Under the Senate amendment, participants must be limited to 

one subsequent election. 

The Senate amendment includes restrictions on investment options. Under the Senate amendment, investment options (including 

phantom or notional investment options) which a participant may 

elect under the nonqualified deferred compensation plan must be 

comparable to those which may be elected by participants of the 

qualified defined contribution plan of the employer that has the 

fewest investment options. It is intended that the investment options of the nonqualified deferred compensation plan may be less 

favorable or more limited than those of the qualified defined contribution employer plan. The Committee intends that open brokerage windows, hedge funds, and investments in which the employer 

guarantees a rate of return above what is commercially available 

are prohibited. If there is no qualified defined contribution employer plan, the investment options of the nonqualified deferred 

compensation plan must meet the requirements prescribed by the 

Secretary regarding permissible investment options. It is intended 

that in cases where there is no such qualified defined contribution 

employer plan, the Secretary issue rules limiting the available investment options. 

The Senate amendment includes an exception to the provision 

requiring assets set aside outside of the U.S. for purposes of paying 

deferred compensation to be treated as property transferred in connection with the performance of services. The provision does not 

apply to assets located in a foreign jurisdiction if substantially all 

of the services to which the nonqualified deferred compensation reVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00732 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
729 

807 A plan includes an agreement or arrangement, including an agreement or arrangement 

that includes one person. Amounts deferred also include actual or notional earnings. 808 As under section 83, the rights of a person to compensation are subject to a substantial 

risk of forefeiture if the person’s rights to such compensation are conditioned upon the performance of substantial services by any individual. 809 It is intended that Treasury regulations will provide guidance regarding when an amount 

is deferred. It is intended that timing of an election to defer is not determinative of when the 

deferral is made. 810These consequences apply under the provision to amounts deferred after the effective date 

of the provision. 

lates are performed in such foreign jurisdiction. The provision is 

specifically intended to apply to foreign trusts and arrangements 

that effectively shield from the claims of general creditors any assets intended to satisfy nonqualified deferred compensation arrangements. 

The Senate amendment does not apply to a plan meeting the 

requirements of section 457(e)(12) if the plan was in existence as 

of May 1, 2004, and was providing nonelective deferred compensation described in section 457(e)(12) on such date. If the plan has 

a material change in the class of individuals eligible to participate 

in the plan after May 1, 2004, the exception does not apply to compensation provided under the plan after the date of such change. 

The Senate amendment does not include an exception from the 

reporting requirement for deferrals that are not reasonable ascertainable. 

Effective date.—The provision is effective for amounts deferred 

in taxable years beginning after December 31, 2004. 

Not later than 90 days after the date of enactment, the Secretary is directed to issue guidance providing a limited period during which an individual participating in a nonqualified deferred 

compensation plan adopted on or before December 31, 2004, may, 

without violating the provision, terminate participation or cancel 

an outstanding deferral election with regard to amounts earned 

after December 31, 2004, if such amounts are includible in income 

as earned. 

CONFERENCE AGREEMENT

In general 

The conference agreement follows the House bill with the following modifications. Under the conference agreement, all amounts 

deferred under a nonqualified deferred compensation plan 807 for 

all taxable years are currently includible in gross income to the extent not subject to a substantial risk of forfeiture 808 and not previously included in gross income, unless certain requirements are 

satisfied.809 If the requirements of the provision are not satisfied, 

in addition to current income inclusion, interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the compensation been includible in income when first deferred, or if later, when not subject 

to a substantial risk of forfeiture. The amount required to be included in income is also subject to a 20-percent additional tax.810

Current income inclusion, interest, and the additional tax 

apply only with respect to the participants with respect to whom 

the requirements of the provision are not met. For example, suppose a plan covering all executives of an employer (including those 

730 

811Key employees are defined in section 416(i) and generally include officers having annual 

compensation greater than $130,000 (adjusted for inflation and limited to 50 employees), five 

percent owners, and one percent owners having annual compensation from the employer greater 

than $150,000. 

subject to section 16(a) of the Securities and Exchange Act of 1934) 

allows distributions to individuals subject to section 16(a) upon a 

distribution event that is not permitted under the provision. The 

individuals subject to section 16(a), rather than all participants of 

the plan, would be required to include amounts deferred in income 

and would be subject to interest and the 20-percent additional tax. 

Permissible distributions 

In general 

Under the provision, distributions from a nonqualified deferred 

compensation plan may be allowed only upon separation from service (as determined by the Secretary), death, a specified time (or 

pursuant to a fixed schedule), change in control of a corporation (to 

the extent provided by the Secretary), occurrence of an unforeseeable emergency, or if the participant becomes disabled. A nonqualified deferred compensation plan may not allow distributions 

other than upon the permissible distribution events and, except as 

provided in regulations by the Secretary, may not permit acceleration of a distribution. 

Separation from service 

In the case of a specified employee who separates from service, 

distributions may not be made earlier than six months after the 

date of the separation from service or upon death. Specified employees are key employees 811 of publicly-traded corporations. 

Specified time 

Amounts payable at a specified time or pursuant to a fixed 

schedule must be specified under the plan at the time of deferral. 

Amounts payable upon the occurrence of an event are not treated 

as amounts payable at a specified time. For example, amounts payable when an individual attains age 65 are payable at a specified 

time, while amounts payable when an individual’s child begins college are payable upon the occurrence of an event. 

Change in control 

Distributions upon a change in the ownership or effective control of a corporation, or in the ownership of a substantial portion 

of the assets of a corporation, may only be made to the extent provided by the Secretary. It is intended that the Secretary use a similar, but more restrictive, definition of change in control as is used 

for purposes of the golden parachute provisions of section 280G 

consistent with the purposes of the provision. The provision requires the Secretary to issue guidance defining change of control 

within 90 days after the date of enactment. 

Unforeseeable emergency 

An unforeseeable emergency is defined as a severe financial 

hardship to the participant: (1) resulting from an illness or accident 

731 

of the participant, the participant’s spouse, or a dependent (as defined in sec. 152(a)); (2) loss of the participant’s property due to 

casualty; or (3) other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the 

participant. The amount of the distribution must be limited to the 

amount needed to satisfy the emergency plus taxes reasonably anticipated as a result of the distribution. Distributions may not be 

allowed to the extent that the hardship may be relieved through 

reimbursement or compensation by insurance or otherwise, or by 

liquidation of the participant’s assets (to the extent such liquidation would not itself cause a severe financial hardship). 

Disability 

A participant is considered disabled if he or she (1) is unable 

to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months; or (2) is, by reason of any medically determinable physical or mental impairment which can be expected to result in death or can be expected to last for a continuous 

period of not less than 12 months, receiving income replacement 

benefits for a period of not less than three months under an accident and health plan covering employees of the participant’s employer. 

Prohibition on acceleration of distributions 

As mentioned above, except as provided in regulations by the 

Secretary, no accelerations of distributions may be allowed. In general, changes in the form of distribution that accelerate payments 

are subject to the rule prohibiting acceleration of distributions. 

However, it is intended that the rule against accelerations is not 

violated merely because a plan provides a choice between cash and 

taxable property if the timing and amount of income inclusion is 

the same regardless of the medium of distribution. For example, 

the choice between a fully taxable annuity contract and a lumpsum payment may be permitted. It is also intended that the Secretary provide rules under which the choice between different 

forms of actuarially equivalent life annuity payments is permitted. 

It is intended that the Secretary will provide other, limited, exceptions to the prohibition on accelerated distributions, such as 

when the accelerated distribution is required for reasons beyond 

the control of the participant and the distribution is not elective. 

For example, it is anticipated that an exception could be provided 

if a distribution is needed in order to comply with Federal conflict 

of interest requirements or a court-approved settlement incident to 

divorce. It is intended that Treasury regulations provide that a 

plan would not violate the prohibition on accelerations by providing 

that withholding of an employee’s share of employment taxes will 

be made from the employee’s interest in the nonqualified deferred 

compensation plan. It is also intended that Treasury regulations 

provide that a plan would not violate the prohibition on accelerations by providing for a distribution to a participant to pay income 

taxes due upon a vesting event subject to section 457(f), provided 

that such amount is not more than an amount equal to the income 

732 

812 Under the provision, in the first year that an employee becomes eligible for participation 

in a nonqualified deferred compensation plan, the election may be made within 30 days after 

the date that the employee is initially eligible. 

tax withholding that would have been remitted by the employer if 

there had been a payment of wages equal to the income includible 

by the participant under section 457(f). It is also intended that 

Treasury regulations provide that a plan would not violate the prohibition on accelerations by providing for automatic distributions of 

minimal interests in a deferred compensation plan upon permissible distribution events for purposes of administrative convenience. For example, a plan could provide that upon separation from 

service of a participant, account balances less than $10,000 will be 

automatically distributed (except in the case of specified employees). 

Requirements with respect to elections 

The provision requires that a plan must provide that compensation for services performed during a taxable year may be deferred at the participant’s election only if the election to defer is 

made no later than the close of the preceding taxable year, or at 

such other time as provided in Treasury regulations.812 In the case 

of any performance-based compensation based on services performed over a period of at least 12 months, such election may be 

made no later than six months before the end of the service period. 

It is not intended that the provision override the constructive receipt doctrine, as constructive receipt rules continue to apply. It is 

intended that the term ‘‘performance-based compensation’’ will be 

defined by the Secretary to include compensation to the extent that 

an amount is: (1) variable and contingent on the satisfaction of 

preestablished organizational or individual performance criteria 

and (2) not readily ascertainable at the time of the election. For the 

purposes of the provision, it is intended that performance-based 

compensation may be required to meet certain requirements similar to those under section 162(m), but would not be required to 

meet all requirements under that section. For example, it is expected that the Secretary will provide that performance criteria 

would be considered preestablished if it is established in writing no 

later than 90 days after the commencement of the service period, 

but the requirement of determination by the compensation committee of the board of directors would not be required. It is expected that the Secretary will issue guidance providing coordination rules, as appropriate, regarding the timing of elections in the 

case when the fiscal year of the employer and the taxable year of 

the individual are different. It is expected that Treasury regulations will not permit any election to defer any bonus or other compensation if the timing of such election would be inconsistent with 

the purposes of the provision. 

The time and form of distributions must be specified at the 

time of initial deferral. A plan could specify the time and form of 

payments that are to be made as a result of a distribution event 

(e.g., a plan could specify that payments upon separation of service 

will be paid in lump sum within 30 days of separation from service) 

or could allow participants to elect the time and form of payment 

at the time of the initial deferral election. If a plan allows particiVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00736 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
733 

pants to elect the time and form of payment, such election is subject to the rules regarding initial deferral elections under the provision. It is intended that multiple payout events are permissible. 

For example, a participant could elect to receive 25 percent of their 

account balance at age 50 and the remaining 75 percent at age 60. 

A plan could also allow participants to elect different forms of payment for different permissible distribution events. For example, a 

participant could elect to receive a lump-sum distribution upon disability, but an annuity at age 65. 

Under the provision, a plan may allow changes in the time and 

form of distributions subject to certain requirements. A nonqualified deferred compensation plan may allow a subsequent election to delay the timing or form of distributions only if: (1) the plan 

requires that such election cannot be effective for at least 12 

months after the date on which the election is made; (2) except in 

the case of elections relating to distributions on account of death, 

disability or unforeseeable emergency, the plan requires that the 

additional deferral with respect to which such election is made is 

for a period of not less than five years from the date such payment 

would otherwise have been made; and (3) the plan requires that an 

election related to a distribution to be made upon a specified time 

may not be made less than 12 months prior to the date of the first 

scheduled payment. It is expected that in limited cases, the Secretary will issue guidance, consistent with the purposes of the provision, regarding to what extent elections to change a stream of 

payments are permissible. The Secretary may issue regulations regarding elections with respect to payments under nonelective, supplemental retirement plans. 

Foreign trusts 

Under the provision, in the case of assets set aside (directly or 

indirectly) in a trust (or other arrangement determined by the Secretary) for purposes of paying nonqualified deferred compensation, 

such assets are treated as property transferred in connection with 

the performance of services under section 83 (whether or not such 

assets are available to satisfy the claims of general creditors) at the 

time set aside if such assets (or trust or other arrangement) are located outside of the United States or at the time transferred if such 

assets (or trust or other arrangement) are subsequently transferred 

outside of the United States. Any subsequent increases in the value 

of, or any earnings with respect to, such assets are treated as additional transfers of property. Interest at the underpayment rate plus 

one percentage point is imposed on the underpayments that would 

have occurred had the amounts set aside been includible in income 

for the taxable year in which first deferred or, if later, the first taxable year not subject to a substantial risk of forfeiture. The amount 

required to be included in income is also subject to an additional 

20-percent tax. 

It is expected that the Secretary will provide rules for identifying the deferrals to which assets set aside are attributable, for 

situations in which assets equal to less than the full amount of deferrals are set aside. The provision does not apply to assets located 

in a foreign jurisdiction if substantially all of the services to which 

the nonqualified deferred compensation relates are performed in 

734 

813The provision does not apply to a plan meeting the requirements of section 457(e)(12) if 

the plan was in existence as of May 1, 2004, was providing nonelective deferred compensation 

described in section 457(e)(12) on such date, and is established or maintained by an organization 

incorporated on July 2, 1974. If the plan has a material change in the class of individuals eligisuch foreign jurisdiction. The provision is specifically intended to 

apply to foreign trusts and arrangements that effectively shield 

from the claims of general creditors any assets intended to satisfy 

nonqualified deferred compensation arrangements. The Secretary 

has authority to exempt arrangements from the provision if the arrangements do not result in an improper deferral of U.S. tax and 

will not result in assets being effectively beyond the reach of creditors. 

Triggers upon financial health 

Under the provision, a transfer of property in connection with 

the performance of services under section 83 also occurs with respect to compensation deferred under a nonqualified deferred compensation plan if the plan provides that upon a change in the employer’s financial health, assets will be restricted to the payment 

of nonqualified deferred compensation. An amount is treated as restricted even if the assets are available to satisfy the claims of general creditors. For example, the provision applies in the case of a 

plan that provides that upon a change in financial health, assets 

will be transferred to a rabbi trust. 

The transfer of property occurs as of the earlier of when the 

assets are so restricted or when the plan provides that assets will 

be restricted. It is intended that the transfer of property occurs to 

the extent that assets are restricted or will be restricted with respect to such compensation. For example, in the case of a plan that 

provides that upon a change in the employer’s financial health, a 

trust will become funded to the extent of all deferrals, all amounts 

deferred under the plan are treated as property transferred under 

section 83. If a plan provides that deferrals of certain individuals 

will be funded upon a change in financial health, the transfer of 

property would occur with respect to compensation deferred by 

such individuals. The provision is not intended to apply when assets are restricted for a reason other than change in financial 

health (e.g., upon a change in control) or if assets are periodically 

restricted under a structured schedule and scheduled restrictions 

happen to coincide with a change in financial status. Any subsequent increases in the value of, or any earnings with respect to, restricted assets are treated as additional transfers of property. Interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the 

amounts been includible in income for the taxable year in which 

first deferred or, if later, the first taxable year not subject to a substantial risk of forfeiture. The amount required to be included in 

income is also subject to an additional 20-percent tax. 

Definition of nonqualified deferred compensation plan 

A nonqualified deferred compensation plan is any plan that 

provides for the deferral of compensation other than a qualified employer plan or any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan.813 A qualified emVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00738 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
735 

ble to participate in the plan after May 1, 2004, the provision applies to compensation provided 

under the plan after the date of such change. 814 A qualified employer plan also includes a section 501(c)(18) trust. 

ployer plan means a qualified retirement plan, tax-deferred annuity, simplified employee pension, and SIMPLE.814 A qualified governmental excess benefit arrangement (sec. 415(m)) is a qualified 

employer plan. An eligible deferred compensation plan (sec. 457(b)) 

is also a qualified employer plan under the provision. A tax-exempt 

or governmental deferred compensation plan that is not an eligible 

deferred compensation plan is not a qualified employer plan. The 

application of the provision is not limited to arrangements between 

an employer and employee. 

For purposes of the provision, it is not intended that the term 

‘‘nonqualified deferred compensation plan’’ include an arrangement 

taxable under section 83 providing for the grant of an option on 

employer stock with an exercise price that is not less than the fair 

market value of the underlying stock on the date of grant if such 

arrangement does not include a deferral feature other than the feature that the option holder has the right to exercise the option in 

the future. The provision is not intended to change the tax treatment of incentive stock options meeting the requirements of 422 or 

options granted under an employee stock purchase plan meeting 

the requirements of section 423. 

It is intended that the provision does not apply to annual bonuses or other annual compensation amounts paid within 21⁄2

months after the close of the taxable year in which the relevant 

services required for payment have been performed. 

Other rules 

Interest imposed under the provision is treated as interest on 

an underpayment of tax. Income (whether actual or notional) attributable to nonqualified deferred compensation is treated as additional deferred compensation and is subject to the provision. The 

provision is not intended to prevent the inclusion of amounts in 

gross income under any provision or rule of law earlier than the 

time provided in the provision. Any amount included in gross income under the provision is not be required to be included in gross 

income under any provision of law later than the time provided in 

the provision. The provision does not affect the rules regarding the 

timing of an employer’s deduction for nonqualified deferred compensation. 

Treasury regulations 

The provision provides the Secretary authority to prescribe 

regulations as are necessary to carry out the purposes of provision, 

including regulations: (1) providing for the determination of 

amounts of deferral in the case of defined benefit plans; (2) relating 

to changes in the ownership and control of a corporation or assets 

of a corporation; (3) exempting from the provisions providing for 

transfers of property arrangements that will not result in an improper deferral of U.S. tax and will not result in assets being effectively beyond the reach of creditors; (4) defining financial health; 

and (5) disregarding a substantial risk of forfeiture. It is intended 

that substantial risk of forfeitures may not be used to manipulate 

736 

815 It is intended that the exception be similar to that under Treas. Reg. sec. 31.3121(v)(2)– 

1(e)(4). 

the timing of income inclusion. It is intended that substantial risks 

of forfeiture should be disregarded in cases in which they are illusory or are used in a manner inconsistent with the purposes of the 

provision. For example, if an executive is effectively able to control 

the acceleration of the lapse of a substantial risk of forfeiture, such 

risk of forfeiture should be disregarded and income inclusion 

should not be postponed on account of such restriction. The Secretary may also address in regulations issues relating to stock appreciation rights. 

Aggregation rules 

Under the provision, except as provided by the Secretary, employer aggregation rules apply. It is intended that the Secretary 

issue guidance providing aggregation rules as are necessary to 

carry out the purposes of the provision. For example, it is intended 

that aggregation rules would apply in the case of separation from 

service so that the separation from service from one entity within 

a controlled group, but continued service for another entity within 

the group, would not be a permissible distribution event. It is also 

intended that aggregation rules would not apply in the case of 

change in control so that the change in control of one member of 

a controlled group would not be a permissible distribution event for 

participants of a deferred compensation plan of another member of 

the group. 

Reporting requirements 

Amounts required to be included in income under the provision 

are subject to reporting and Federal income tax withholding requirements. Amounts required to be includible in income are required to be reported on an individual’s Form W–2 (or Form 1099) 

for the year includible in income. 

The provision also requires annual reporting to the Internal 

Revenue Service of amounts deferred. Such amounts are required 

to be reported on an individual’s Form W–2 (or Form 1099) for the 

year deferred even if the amount is not currently includible in income for that taxable year. It is expected that annual reporting of 

annual amounts deferred will provide the IRS greater information 

regarding such arrangements for enforcement purposes. It is intended that the information reported would provide an indication 

of what arrangements should be examined and challenged. Under 

the provision, the Secretary is authorized, through regulations, to 

establish a minimum amount of deferrals below which the reporting requirement does not apply. The Secretary may also provide 

that the reporting requirement does not apply with respect to 

amounts of deferrals that are not reasonably ascertainable. It is intended that the exception for amounts not reasonably ascertainable 

only apply to nonaccount balance plans and that amounts be required to be reported when they first become reasonably ascertainable.815

737 

816There is no inference that all subsequent deferral elections under plans that are not materially modified are permissible under present law. 

Effective date 

The provision is effective for amounts deferred in taxable years 

beginning after December 31, 2004. Earnings on amounts deferred 

before the effective date are subject to the provision to the extent 

that such amounts deferred are subject to the provision. 

Amounts deferred in taxable years beginning before January 1, 

2005, are subject to the provision if the plan under which the deferral is made is materially modified after October 3, 2004. The addition of any benefit, right or feature is a material modification. The 

exercise or reduction of an existing benefit, right, or feature is not 

a material modification. For example, an amendment to a plan on 

November 1, 2004, to add a provision that distributions may be allowed upon request if participants are required to forfeit 10 percent 

of the amount of the distribution (i.e., a ‘‘haircut’’) would be a material modification to the plan so that the rules of the provision 

would apply to the plan. Similarly, accelerating vesting under a 

plan after October 3, 2004, would be a material modification. A 

change in the plan administrator would not be a material modification. As another example, amending a plan to remove a distribution provision (e.g., to remove a ‘‘haircut’’) would not be considered 

a material modification. 

Operating under the terms of a deferred compensation arrangement that complies with current law and is not materially 

modified after October 3, 2004, with respect to amounts deferred 

before January 1, 2005, is permissible, as such amounts would not 

be subject to the requirements of the provision. For example, subsequent deferrals with respect to amounts deferred before January 1, 

2005, under a plan that is not materially modified after October 3, 

2004, would be subject to present law and would not be subject to 

the provision.816 No inference is intended that all deferrals before 

the effective date are permissible under present law. It is expected 

that the IRS will challenge pre-effective date deferral arrangements that do not comply with present law. 

For purposes of the effective date, an amount is considered deferred before January 1, 2005, if the amount is earned and vested 

before such date. To the extent there is no material modification 

after October 3, 2004, present law applies with respect to vested 

rights. 

No later than 60 days after the date of enactment, the Secretary shall issue guidance providing a limited period of time during which a nonqualified deferred compensation plan adopted before December 31, 2004, may, without violating the requirements 

of the provision relating to distributions, accelerations, and elections be amended (1) to provide that a participant may terminate 

participation in the plan, or cancel an outstanding deferral election 

with respect to amounts deferred after December 31, 2004, if such 

amounts are includible in income of the participant as earned, or 

if later, when not subject to a substantial risk of forfeiture, and (2) 

to conform with the provision with respect to amounts deferred 

after December 31, 2004. It is expected that the Secretary may provide exceptions to certain requirements of the provision during the 

738 

transition period (e.g., the rules regarding timing of elections) for 

plans coming into compliance with the provision. Moreover, it is expected that the Secretary will provide a reasonable time, during 

the transition period but after the issuance of guidance, for plans 

to be amended and approved by the appropriate parties in accordance with this provision. 

2. Denial of deferral of certain stock option and restricted stock 

gains (sec. 672 of the Senate amendment and sec. 83 of the 

Code) 

PRESENT LAW

Section 83 applies to transfers of property in connection with 

the performance of services. Under section 83, if, in connection with 

the performance of services, property is transferred to any person 

other than the person for whom such services are performed, the 

excess of the fair market value of such property over the amount 

(if any) paid for the property is includible in income at the first 

time that the property is transferable or not subject to substantial 

risk of forfeiture. 

Stock granted to an employee (or other service provider) is subject to the rules that apply under section 83. When stock is vested 

and transferred to an employee, the excess of the fair market value 

of the stock over the amount, if any, the employee pays for the 

stock is includible in the employee’s income for the year in which 

the transfer occurs. 

The income taxation of a nonqualified stock option is determined under section 83 and depends on whether the option has a 

readily ascertainable fair market value. If the nonqualified option 

does not have a readily ascertainable fair market value at the time 

of grant, no amount is includible in the gross income of the recipient with respect to the option until the recipient exercises the option. The transfer of stock on exercise of the option is subject to the 

general rules of section 83. That is, if vested stock is received on 

exercise of the option, the excess of the fair market value of the 

stock over the option price is includible in the recipient’s gross income as ordinary income in the taxable year in which the option 

is exercised. If the stock received on exercise of the option is not 

vested, the excess of the fair market value of the stock at the time 

of vesting over the option price is includible in the recipient’s income for the year in which vesting occurs unless the recipient 

elects to apply section 83 at the time of exercise. 

Other forms of stock-based compensation are also subject to 

the rules of section 83. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the Senate amendment, gains attributable to stock options (including exercises of stock options), vesting of restricted 

stock, and other compensation based on employer securities (including employer securities) cannot be deferred by exchanging such 

amounts for a right to receive a future payment. Except as proVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00742 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
739 

817Sec. 7801(a). 818GAO/GGD–97–129R Issues Affecting IRS’ Collection Pilot (July 18, 1997). 

vided by the Secretary, if a taxpayer exchanges (1) an option to 

purchase employer securities, (2) employer securities, or (3) any 

other property based on employer securities for a right to receive 

future payments, an amount equal to the present value of such 

right (or such other amount as the Secretary specifies) is required 

to be included in gross income for the taxable year of the exchange. 

The provision applies even if the future right to payment is treated 

as an unfunded and unsecured promise to pay. The provision applies when there is in substance an exchange, even if the transaction is not formally structured as an exchange. 

The provision is not intended to imply that such practices result in permissive deferral of income under present law. 

Effective date.—The Senate amendment applies to exchanges 

after December 31, 2004. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment. 

E. OTHER REVENUE PROVISIONS

1. Permit private sector debt collection companies to collect tax 

debts (sec. 681 of the House bill, sec. 487 of the Senate amendment, and new sec. 6306 of the Code) 

PRESENT LAW

In fiscal years 1996 and 1997, the Congress earmarked $13 

million for IRS to test the use of private debt collection companies. 

There were several constraints on this pilot project. First, because 

both IRS and OMB considered the collection of taxes to be an inherently governmental function, only government employees were 

permitted to collect the taxes.817 The private debt collection companies were utilized to assist the IRS in locating and contacting taxpayers, reminding them of their outstanding tax liability, and suggesting payment options. If the taxpayer agreed at that point to 

make a payment, the taxpayer was transferred from the private 

debt collection company to the IRS. Second, the private debt collection companies were paid a flat fee for services rendered; the 

amount that was ultimately collected by the IRS was not taken 

into account in the payment mechanism. 

The pilot program was discontinued because of disappointing 

results. GAO reported 818 that IRS collected $3.1 million attributable to the private debt collection company efforts; expenses were 

also $3.1 million. In addition, there were lost opportunity costs of 

$17 million to the IRS because collection personnel were diverted 

from their usual collection responsibilities to work on the pilot. The 

pilot program results were disappointing because ‘‘IRS’ efforts to 

design and implement the private debt collection pilot program 

were hindered by limitations that affected the program’s results.’’ 

The limitations included the scope of work permitted to the private 

debt collection companies, the number and type of cases referred to 

the private debt collection companies, and the ability of IRS’ comVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00743 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
740 

819TIRNO–03–H–0001 (February 14, 2003), at www.procurement.irs.treas.gov. The basic request for information is 104 pages, and there are 16 additional attachments. 820GAO–04–492 Tax Debt Collection: IRS Is Addressing Critical Success Factors for Contracting Out but Will Need to Study the Best Use of Resources (May 2004). 821Private collection agencies. 822Page 19 of the May 2004 GAO report. 823 31 U.S.C. sec. 3718. 824 31 U.S.C. sec. 3718(f). 825The provision generally applies to any type of tax imposed under the Internal Revenue 

Code. It is anticipated that the focus in implementing the provision will be: (a) taxpayers who 

have filed a return showing a balance due but who have failed to pay that balance in full; and 

(b) taxpayers who have been assessed additional tax by the IRS and who have made several 

voluntary payments toward satisfying their obligation but have not paid in full. 826 An amount of tax reported as due on the taxpayer’s tax return is considered to be selfassessed. If the IRS determines that the assessment or collection of tax will be jeopardized by 

delay, it has the authority to assess the amount immediately (sec. 6861), subject to several procedural safeguards. 

puter systems to identify, select, and transmit collection cases to 

the private debt collectors. 

The IRS has in the last several years expressed renewed interest in the possible use of private debt collection companies; for example, IRS recently revised its extensive Request for Information 

concerning its possible use of private debt collection companies.819

GAO recently reviewed IRS’ planning and preparation for the use 

of private debt collection companies.820 GAO identified five broad 

factors critical to the success of using private debt collection companies to collect taxes. GAO concluded: ‘‘If Congress does authorize 

PCA 821 use, IRS’s planning and preparations to address the critical success factors for PCA contracting provide greater assurance 

that the PCA program is headed in the right direction to meet its 

goals and achieve desired results. Nevertheless, much work and 

many challenges remain in addressing the critical success factors 

and helping to maximize the likelihood that a PCA program would 

be successful.’’ 822

In general, Federal agencies are permitted to enter into contracts with private debt collection companies for collection services 

to recover indebtedness owed to the United States.823 That provision does not apply to the collection of debts under the Internal 

Revenue Code.824

The President’s fiscal year 2004 and 2005 budget proposals 

proposed the use of private debt collection companies to collect Federal tax debts. 

HOUSE BILL

The bill permits the IRS to use private debt collection companies to locate and contact taxpayers owing outstanding tax liabilities of any type 825 and to arrange payment of those taxes by the 

taxpayers. There must be an assessment pursuant to section 6201 

in order for there to be an outstanding tax liability. An assessment 

is the formal recording of the taxpayer’s tax liability that fixes the 

amount payable. An assessment must be made before the IRS is 

permitted to commence enforcement actions to collect the amount 

payable. In general, an assessment is made at the conclusion of all 

examination and appeals processes within the IRS.826

Several steps are involved in the deployment of private debt 

collection companies. First, the private debt collection company 

741 

827Several portions of the provision require that the IRS disclose confidential taxpayer information to the private debt collection company. Section 6103(n) permits disclosure for ‘‘the providing of other services . . . for purposes of tax administration.’’ Accordingly, no amendment to 

section 6103 is necessary to implement the provision. It is intended, however, that the IRS vigorously protect the privacy of confidential taxpayer information by disclosing the least amount 

of information possible to contractors consistent with the effective operation of the provision. 828The private debt collection company is not permitted to accept payment directly. Payments 

are required to be processed by IRS employees. 829 It is assumed that there will be competitive bidding for these contracts by private sector 

tax collection agencies and that vigorous bidding will drive the overhead costs down. 

contacts the taxpayer by letter.827 If the taxpayer’s last known address is incorrect, the private debt collection company searches for 

the correct address. Second, the private debt collection company 

telephones the taxpayer to request full payment.828 If the taxpayer 

cannot pay in full immediately, the private debt collection company 

offers the taxpayer an installment agreement providing for full 

payment of the taxes over a period of as long as five years. If the 

taxpayer is unable to pay the outstanding tax liability in full over 

a five-year period, the private debt collection company obtains financial information from the taxpayer and will provide this information to the IRS for further processing and action by the IRS. 

The bill specifies several procedural conditions under which 

the provision would operate. First, provisions of the Fair Debt Collection Practices Act apply to the private debt collection company. 

Second, taxpayer protections that are statutorily applicable to the 

IRS are also made statutorily applicable to the private sector debt 

collection companies. In addition, taxpayer protections that are 

statutorily applicable to IRS employees are also made statutorily 

applicable to employees of private sector debt collection companies. 

Third, subcontractors are prohibited from having contact with taxpayers, providing quality assurance services, and composing debt 

collection notices; any other service provided by a subcontractor 

must receive prior approval from the IRS. In addition, it is intended that the IRS require the private sector debt collection companies to inform every taxpayer they contact of the availability of 

assistance from the Taxpayer Advocate. 

The bill creates a revolving fund from the amounts collected by 

the private debt collection companies. The private debt collection 

companies will be paid out of this fund. The bill prohibits the payment of fees for all services in excess of 25 percent of the amount 

collected under a tax collection contract.829

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

that it: (1) sunsets the provision in five years; (2) provides that, if 

the taxpayer cannot pay in full immediately, the private debt collection company may offer the taxpayer an installment agreement 

providing for full payment of the taxes over three years; (3) provides that up to 25 percent of amount collected may be used for 

IRS collection enforcement activities; (4) and requires Treasury to 

provide a biennial report to Congress. 

742 

830 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, with the addition of two provisions from the Senate amendment: (1) the conference agreement provides that up to 25 percent of amount collected may be used for IRS collection enforcement activities; and (2) 

the conference agreement requires Treasury to provide a biennial 

report to Congress. The conferees expect that, consistent with best 

management practices and sound tax administration principles, the 

Secretary will utilize this new debt collection provision to the maximum extent feasible. 

The conferees expect that activities conducted by any person 

under a qualified tax collection contract will be in compliance with 

the Fair Debt Collection Practices Act, as required by new section 

6306(e) of the Code. Accordingly, the conferees anticipate that the 

Secretary will not impose requirements that would violate this provision of the Code. The conferees believe that this new debt collection provision will protect both taxpayers’ rights and the confidentiality of tax information. 

2. Modify charitable contribution rules for donations of patents and 

other intellectual property (sec. 682 of the House bill, sec. 494 

of the Senate amendment, and secs. 170 and 6050L of the 

Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization.830 In 

the case of non-cash contributions, the amount of the deduction 

generally equals the fair market value of the contributed property 

on the date of the contribution. 

For certain contributions of property, the taxpayer is required 

to reduce the deduction amount by any gain, generally resulting in 

a deduction equal to the taxpayer’s basis. This rule applies to contributions of: (1) property that, at the time of contribution, would 

not have resulted in long-term capital gain if the property was sold 

by the taxpayer on the contribution date; (2) tangible personal 

property that is used by the donee in a manner unrelated to the 

donee’s exempt (or governmental) purpose; and (3) property to or 

for the use of a private foundation (other than a foundation defined 

in section 170(b)(1)(E)). 

Charitable contributions of capital gain property generally are 

deductible at fair market value. Capital gain property means any 

capital asset or property used in the taxpayer’s trade or business 

the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term 

capital gain. Contributions of capital gain property are subject to 

different percentage limitations than other contributions of property. Under present law, certain copyrights are not considered capVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00746 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
743 

831See sec. 1221(a)(3), 1231(b)(1)(C). 832Sec. 170(f)(3). 833Sec. 1011(b) and Treas. Reg. sec. 1.1011–2. 834Sec. 170(f)(8). 835Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly traded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and TIN of such appraiser; and (6) such additional information as the Secretary prescribes in such regulations. 836 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 837Treas. Reg. sec. 1.170A–13(c)(3). 

ital assets, in which case the charitable deduction for such copyrights generally is limited to the taxpayer’s basis.831

In general, a charitable contribution deduction is allowed only 

for contributions of the donor’s entire interest in the contributed 

property, and not for contributions of a partial interest.832 If a taxpayer sells property to a charitable organization for less than the 

property’s fair market value, the amount of any charitable contribution deduction is determined in accordance with the bargain 

sale rules.833 In general, if a donor receives a benefit or quid pro 

quo in return for a contribution, any charitable contribution deduction is reduced by the amount of the benefit received. For contributions of $250 or more, no charitable contribution deduction is allowed unless the donee organization provides a contemporaneous 

written acknowledgement of the contribution that describes and 

provides a good faith estimate of the value of any goods or services 

provided by the donee organization in exchange for the contribution.834

Taxpayers are required to obtain a qualified appraisal for donated property with a value of $5,000 or more, and to attach the 

appraisal to the tax return in certain cases.835 Under Treasury regulations, a qualified appraisal means an appraisal document that, 

among other things, (1) relates to an appraisal that is made not 

earlier than 60 days prior to the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed under section 170; 836 (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) 

the fair market value of such property on the date of contribution 

and the specific basis for the valuation; (c) a statement that such 

appraisal was prepared for income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer 

identification number (‘‘TIN’’) of such appraiser; and (4) does not 

involve an appraisal fee that violates certain prescribed rules.837

HOUSE BILL

The provision provides that if a taxpayer contributes a patent 

or other intellectual property (other than certain copyrights or inventory) to a charitable organization, the taxpayer’s initial charitable deduction is limited to the lesser of the taxpayer’s basis in 

744 

838The net income taken into account by the taxpayer may not exceed the amount of qualified 

donee income reported by the donee to the taxpayer and the IRS under the provision’s substantiation and reporting requirements. 

the contributed property or the fair market value of the property. 

In addition, the taxpayer is permitted to deduct, as a charitable deduction, certain additional amounts in the year of contribution or 

in subsequent taxable years based on a specified percentage of the 

qualified donee income received or accrued by the charitable donee 

with respect to the contributed property. For this purpose, ‘‘qualified donee income’’ includes net income received or accrued by the 

donee that properly is allocable to the intellectual property itself 

(as opposed to the activity in which the intellectual property is 

used). 

The amount of any additional charitable deduction is calculated as a sliding-scale percentage of qualified donee income received or accrued by the charitable donee that properly is allocable 

to the contributed property to the applicable taxable year of the 

donor, determined as follows: 

Taxable year of donor Deduction permitted for such taxable year 

1st year ending on or after contribution .................................. 100 percent of qualified donee income 

2nd year ending on or after contribution ................................. 100 percent of qualified donee income 

3rd year ending on or after contribution .................................. 90 percent of qualified donee income 

4th year ending on or after contribution .................................. 80 percent of qualified donee income 

5th year ending on or after contribution .................................. 70 percent of qualified donee income 

6th year ending on or after contribution .................................. 60 percent of qualified donee income 

7th year ending on or after contribution .................................. 50 percent of qualified donee income 

8th year ending on or after contribution .................................. 40 percent of qualified donee income 

9th year ending on or after contribution .................................. 30 percent of qualified donee income 

10th year ending on or after contribution ................................ 20 percent of qualified donee income 

11th year ending on or after contribution ................................ 10 percent of qualified donee income 

12th year ending on or after contribution ................................ 10 percent of qualified donee income 

Taxable years thereafter ............................................................ No deduction permitted 

An additional charitable deduction is allowed only to the extent that the aggregate of the amounts that are calculated pursuant to the sliding-scale exceed the amount of the deduction claimed 

upon the contribution of the patent or intellectual property. 

No charitable deduction is permitted with respect to any revenues or income received or accrued by the charitable donee after 

the expiration of the legal life of the patent or intellectual property, 

or after the tenth anniversary of the date the contribution was 

made by the donor. 

The taxpayer is required to inform the donee at the time of the 

contribution that the taxpayer intends to treat the contribution as 

a contribution subject to the additional charitable deduction provisions of the provision. In addition, the taxpayer must obtain written substantiation from the donee of the amount of any qualified 

donee income properly allocable to the contributed property during 

the charity’s taxable year.838 The donee is required to file an annual information return that reports the qualified donee income 

and other specified information relating to the contribution. In instances where the donor’s taxable year differs from the donee’s taxable year, the donor bases its additional charitable deduction on 

the qualified donee income of the charitable donee properly alloVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00748 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
745 

cable to the donee’s taxable year that ends within the donor’s taxable year. 

Under the provision, additional charitable deductions are not 

available for patents or other intellectual property contributed to a 

private foundation (other than a private operating foundation or 

certain other private foundations described in section 170(b)(1)(E)). 

Under the provision, the Secretary may prescribe regulations 

or other guidance to carry out the purposes of the provision, including providing for the determination of amounts to be treated as 

qualified donee income in certain cases where the donee uses the 

donated property to further its exempt activities or functions, or as 

may be necessary or appropriate to prevent the avoidance of the 

purposes of the provision. 

Effective date.—Effective for contributions made after June 3, 

2004. 

SENATE AMENDMENT

The Senate amendment is similar to the House bill, except 

that the taxpayer’s initial deduction is equal to: the lesser of the 

taxpayer’s basis in the contributed property or the fair market 

value of the property (as in the House bill) or, if greater, the lesser 

of 5 percent of the fair market value of the contributed property or 

$1 million. Additional charitable deductions are available as in the 

House bill, except that such additional deductions are not required 

to be offset by the initial deductible amount. 

The Senate amendment imposes a processing fee (credited to 

the Exempt Organizations unit with the IRS) equal to 1 percent of 

the claimed deductible amount for contributions of applicable intellectual property. 

With respect to applicable intellectual property contributions, 

the Senate amendment increases the present law thresholds that 

trigger application of penalties for substantial and gross valuation 

misstatements. The substantial misstatement penalty applies if the 

taxpayer’s claimed value exceeds the correct amount by 50 percent 

or more; the gross misstatement penalty applies if the taxpayer’s 

claimed value exceeds the correct amount by 100 percent or more. 

The Senate amendment requires that the Secretary shall prescribe guidance on appraisal standards for charitable contributions 

of intellectual property. 

Effective date.—Contributions after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

Effective date.—Effective for contributions made after June 3, 

2004. 

3. Require increased reporting for noncash charitable contributions 

(sec. 683 of the House bill and sec. 170 of the Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00749 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
746 

839 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 840Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly tranded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and taxpayer identification number of such appraiser; and (6) such additional information as the Secretary prescribes 

in such regulations. 841 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 842Treas. Reg. sec. 1.170A–13(c)(3). 

payer, the property contributed, and the donee organization.839 In 

the case of non-cash contributions, the amount of the deduction 

generally equals the fair market value of the contributed property 

on the date of the contribution. 

In general, if the total charitable deduction claimed for non- cash property exceeds $500, the taxpayer must file IRS Form 8283 

(Noncash Charitable Contributions) with the IRS. C corporations 

(other than personal service corporations and closely-held corporations) are required to file Form 8283 only if the deduction claimed 

exceeds $5,000. 

Taxpayers are required to obtain a qualified appraisal for donated property (other than money and publicly traded securities) 

with a value of more than $5,000.840 Corporations (other than a 

closely-held corporation, a personal service corporation, or an S corporation) are not required to obtain a qualified appraisal. Taxpayers are not required to attach a qualified appraisal to the taxpayer’s return, except in the case of contributed art-work valued at 

more than $20,000. Under Treasury regulations, a qualified appraisal means an appraisal document that, among other things, (1) 

relates to an appraisal that is made not earlier than 60 days prior 

to the date of contribution of the appraised property and not later 

than the due date (including extensions) of the return on which a 

deduction is first claimed under section 170; 841 (2) is prepared, 

signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) the fair market value of 

such property on the date of contribution and the specific basis for 

the valuation; (c) a statement that such appraisal was prepared for 

income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer identification number 

of such appraiser; and (4) does not involve an appraisal fee that 

violates certain prescribed rules.842

HOUSE BILL

The provision requires increased donor reporting for certain 

charitable contributions of property other than cash, inventory, or 

publicly traded securities. The provision extends to all C corporations the present law requirement, applicable to an individual, 

closely-held corporation, personal service corporation, partnership, 

or S corporation, that the donor must obtain a qualified appraisal 

of the property if the amount of the deduction claimed exceeds 

747 

843 Charitable deductions are provided for income, estate, and gift tax purposes. Secs. 170, 

2055, and 2522, respectively. 

$5,000. The provision also provides that if the amount of the contribution of property other than cash, inventory, or publicly traded 

securities exceeds $500,000, then the donor (whether an individual, 

partnership, or corporation) must attach the qualified appraisal to 

the donor’s tax return. For purposes of the dollar thresholds under 

the provision, property and all similar items of property donated to 

one or more donees are treated as one property. 

The provision provides that a donor that fails to substantiate 

a charitable contribution of property, as required by the Secretary, 

is denied a charitable contribution deduction. If the donor is a partnership or S corporation, the deduction is denied at the partner or 

shareholder level. The denial of the deduction does not apply if it 

is shown that such failure is due to reasonable cause and not to 

willful neglect. 

The provision provides that the Secretary may prescribe such 

regulations as may be necessary or appropriate to carry out the 

purposes of the provision, including regulations that may provide 

that some or all of the requirements of the provision do not apply 

in appropriate cases. 

Effective date.—Effective for contributions made after June 3, 

2004. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill, except that 

appraisals are not required for charitable contributions of certain 

vehicles that are sold by the donee organization without a significant intervening use or material improvement of the vehicle by 

such organization, and for which the organization provides an acknowledgement to the donor containing a certification that the vehicle was sold in an arm’s length transaction between unrelated 

parties, and providing the gross sales proceeds from the sale, and 

a statement that the donor’s deductible amount may not exceed the 

amount of such gross proceeds. 

Effective date.—Effective for contributions made after June 3, 

2004. 

4. Limit deduction for charitable contributions of vehicles (sec. 684 

of the House bill, sec. 731 of the Senate amendment, and new 

sec. 6720 and sec. 170 of the Code) 

PRESENT LAW

In general, a deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization.843 In 

the case of non-cash contributions, the amount of the deduction 

generally equals the fair market value of the contributed property 

on the date of the contribution. 

748 

844Pub. L. No. 98–369, sec. 155(a)(1) through (6) (1984) (providing that not later than December 31, 1984, the Secretary shall prescribe regulations requiring an individual, a closely held 

corporation, or a personal service corporation claiming a charitable deduction for property (other 

than publicly traded securities) to obtain a qualified appraisal of the property contributed and 

attach an appraisal summary to the taxpayer’s return if the claimed value of such property (plus 

the claimed value of all similar items of property donated to one or more donees) exceeds 

$5,000). Under Pub. L. No. 98–369, a qualified appraisal means an appraisal prepared by a 

qualified appraiser that includes, among other things, (1) a description of the property appraised; (2) the fair market value of such property on the date of contribution and the specific 

basis for the valuation; (3) a statement that such appraisal was prepared for income tax purposes; (4) the qualifications of the qualified appraiser; (5) the signature and TIN of such appraiser; and (6) such additional information as the Secretary prescribes in such regulations. 845 In the case of a deduction first claimed or reported on an amended return, the deadline 

is the date on which the amended return is filed. 

For certain contributions of property, the taxpayer is required 

to determine the deductible amount by subtracting any gain from 

fair market value, generally resulting in a deduction equal to the 

taxpayer’s basis. This rule applies to contributions of: (1) property 

that, at the time of contribution, would not have resulted in longterm capital gain if the property was sold by the taxpayer on the 

contribution date; (2) tangible personal property that is used by the 

donee in a manner unrelated to the donee’s exempt (or governmental) purpose; and (3) property to or for the use of a private 

foundation (other than a foundation defined in section 

170(b)(1)(E)). 

Charitable contributions of capital gain property generally are 

deductible at fair market value. Capital gain property means any 

capital asset or property used in the taxpayer’s trade or business 

the sale of which at its fair market value, at the time of contribution, would have resulted in gain that would have been long-term 

capital gain. Contributions of capital gain property are subject to 

different percentage limitations than other contributions of property. 

A taxpayer who donates a used automobile to a charitable 

donee generally deducts the fair market value (rather than the taxpayer’s basis) of the automobile. A taxpayer who donates a used 

automobile generally is permitted to use an established used car 

pricing guide to determine the fair market value of the automobile, 

but only if the guide lists a sales price for an automobile of the 

same make, model and year, sold in the same area, and in the 

same condition as the donated automobile. Similar rules apply to 

contributions of other types of vehicles and property, such as boats. 

Charities are required to provide donors with written substan- tiation of donations of $250 or more. Taxpayers are required to report non-cash contributions totaling $500 or more and the method 

used for determining fair market value. 

Taxpayers are required to obtain a qualified appraisal for do- nated property with a value of $5,000 or more, and to attach the 

appraisal to the tax return in certain cases.844 Under Treasury regulations, a qualified appraisal means an appraisal document that, 

among other things, (1) relates to an appraisal that is made not 

earlier than 60 days prior to the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed under section 170; 845 (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) 

the fair market value of such property on the date of contribution 

749 

846Treas. Reg. sec. 1.170A–13(c)(3). 847 Rev. Rul. 67–461, 1967–2 C.B. 125. 

and the specific basis for the valuation; (c) a statement that such 

appraisal was prepared for income tax purposes; (d) the qualifications of the qualified appraiser; and (e) the signature and taxpayer 

identification number (‘‘TIN’’) of such appraiser; and (4) does not 

involve an appraisal fee that violates certain prescribed rules.846

Appraisal fees paid by an individual to determine the fair market value of donated property are deductible as miscellaneous expenses subject to the 2 percent of adjusted gross income limit.847

HOUSE BILL

The provision allows a charitable deduction for contributions of 

vehicles for which the taxpayer claims a deduction of more than 

$250 only if the taxpayer obtains a qualified appraisal of the vehicle. The provision applies to automobiles and other types of motor 

vehicles manufactured primarily for use on public streets, roads, 

and highways; boats; and aircraft. The provision does not affect 

contributions of inventory property. The definition of qualified appraisal generally follows the definition contained in present law, 

subject to additional regulations or guidance provided by the Secretary. The qualified appraisal of a donated vehicle must be obtained by the taxpayer by the time the contribution is made. Under 

the provision, the Secretary shall prescribe such regulations or 

other guidance as may be necessary to carry out the purposes of 

the provision. 

Effective date.—Effective for contributions made after June 3, 

2004. 

SENATE AMENDMENT

Under the Senate amendment, the amount of deduction for 

charitable contributions of vehicles (generally including automobiles, boats, and airplanes for which the claimed value exceeds 

$500 and excluding inventory property) depends upon the use of 

the vehicle by the donee organization. If the donee organization 

sells the vehicle without any significant intervening use or material 

improvement of such vehicle by the organization, the amount of the 

deduction shall not exceed the gross proceeds received from the 

sale. 

The proposal imposes new substantiation requirements for contributions of vehicles for which the claimed value exceeds $500 (excluding inventory). A deduction is not allowed unless the taxpayer 

substantiates the contribution by a contemporaneous written acknowledgement by the donee. The acknowledgement must contain 

the name and taxpayer identification number of the donor and the 

vehicle identification number (or similar number) of the vehicle. In 

addition, if the donee sells the vehicle without performing a significant intervening use or material improvement of such vehicle, the 

acknowledgement must provide a certification that the vehicle was 

sold in an arm’s length transaction between unrelated parties, and 

state the gross proceeds from the sale and that the deductible 

amount may not exceed such gross proceeds. In all other cases, the 

acknowledgement must contain a certification of the intended use 

750 

or material improvement of the vehicle and the intended duration 

of such use, and a certification that the vehicle will not be transferred in exchange for money, other property, or services before 

completion of such use or improvement. The donee must notify the 

Secretary of the information contained in an acknowledgement, in 

a time and manner provided by the Secretary. An acknowledgement is considered contemporaneous if provided within 30 days of 

sale of a vehicle that is not significantly improved or materially 

used by the donee, or, in all other cases, within 30 days of the contribution. 

A penalty applies if a donee organization knowingly furnishes 

a false or fraudulent acknowledgement, or knowingly fails to furnish an acknowledgement in the manner, at the time, and showing 

the required information. In the case of an acknowledgement provided within 30 days of sale of a vehicle which is not significantly 

used or materially improved by the donee, the penalty is the greater of the value of the tax benefit to the donor or the gross proceeds 

from the sale of the vehicle. For all other acknowledgements, the 

penalty is the greater of the value of the tax benefit to the donor 

or the claimed value of the vehicle or $5,000. 

The Senate amendment provides that the Secretary shall prescribe such regulations or other guidance as may be necessary to 

carry out the purposes of the proposal. 

Effective date.—Contributions after June 30, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except that the penalty on the donee organization for knowingly furnishing a false or fraudulent acknowledgement is determined differently. With respect to a qualified vehicle sold without a significant intervening use or material improvement, the penalty is the 

greater of the gross proceeds from the sale of the vehicle or the 

product of the highest rate of tax specified in section 1 and the 

sales price stated on the acknowledgement. For all other acknowledgements, the penalty is the greater of $5,000 or the product of 

the highest rate of tax specified in section 1 and the claimed value 

of the vehicle. 

The conference agreement also provides that the Secretary 

may prescribe regulations or other guidance that exempts sales of 

vehicles that are in direct furtherance of the donee’s charitable purposes from the requirement that the donor may not deduct an 

amount in excess of the gross proceeds from the sale, and the requirement that the donee certify that the vehicle will not be transferred in exchange for money, other property, or services before 

completion of a significant use or material improvement by the 

donee. The conferees intend that such guidance may be appropriate, for example, if an organization directly furthers its charitable purposes by selling automobiles to needy persons at a price 

significantly below fair market value. 

The conferees intend that in providing guidance on the provision, the Secretary shall strictly construe the requirement of significant use or material improvement. To meet the significant use 

test, an organization must actually use the vehicle to substantially 

further the organization’s regularly conducted activities and the 

751 

use must be significant. A donee will not be considered to significantly use a qualified vehicle if, under the facts and circumstances, 

the use is incidental or not intended at the time of the contribution. 

Whether a use is significant also depends on the frequency and duration of use. With respect to the material improvement test, the 

conferees intend that a material improvement would include major 

repairs to a vehicle, or other improvements to the vehicle that improve the condition of the vehicle in a manner that significantly increases the vehicle’s value. Cleaning the vehicle, minor repairs, and 

routine maintenance are not considered a material improvement. 

Example 1.—As part of its regularly conducted activities, an 

organization delivers meals to needy individuals. The use requirement would be met if the organization actually used a donated 

qualified vehicle to deliver food to the needy. Use of the vehicle to 

deliver meals substantially furthers a regularly conducted activity 

of the organization. However, the use also must be significant, 

which depends on the nature, extent, and frequency of the use. If 

the organization used the vehicle only once or a few times to deliver meals, the use would not be considered significant. If the organization used the vehicle to deliver meals every day for one year 

the use would be considered significant. If the organization drove 

the vehicle 10,000 miles while delivering meals, such use likely 

would be considered significant. However, use of a vehicle in such 

an activity for one week or for several hundreds of miles generally 

would not be considered a significant use. 

Example 2.—An organization uses a donated qualified vehicle 

to transport its volunteers. The use would not be significant merely 

because a volunteer used the vehicle over a brief period of time to 

drive to or from the organization’s premises. On the other hand, if 

at the time the organization accepts the contribution of a qualified 

vehicle, the organization intends to use the vehicle as a regular 

and ongoing means of transport for volunteers of the organization, 

and such vehicle is so used, then the significant use test likely 

would be met. 

Example 3.—The following example is a general illustration of 

the provision. A taxpayer makes a charitable contribution of a used 

automobile in good running condition and that needs no immediate 

repairs to a charitable organization that operates an elder care facility. The donee organization accepts the vehicle and immediately 

provides the donor a written acknowledgment containing the name 

and TIN of the donor, the vehicle identification number, a certification that the donee intends to retain the vehicle for a year or 

longer to transport the facility’s residents to community and social 

events and deliver meals to the needy, and a certification that the 

vehicle will not be transferred in exchange for money, other property, or services before completion of such use by the organization. 

A few days after receiving the vehicle, the donee organization commences to use the vehicle three times a week to transport some of 

its residents to various community events, and twice a week to deliver food to needy individuals. The organization continues to regularly use the vehicle for these purposes for approximately one year 

and then sells the vehicle. Under the provision, the donee’s use of 

the vehicle constitutes a significant intervening use prior to the 

752 

848Sec. 197. 849Sec. 197(e)(6). 850P.D.B. Sports, Ltd. v. Comm., 109 T.C. 423 (1997). 

sale by the organization, and the donor’s deduction is not limited 

to the gross proceeds received by the organization. 

Effective date.—Effective for contributions made after December 31, 2004. 

5. Extend the present-law intangible amortization provisions to acquisitions of sports franchises (sec. 685 of the House bill, sec. 

471 of the Senate amendment, and sec. 197 of the Code) 

PRESENT LAW

The purchase price allocated to intangible assets (including 

franchise rights) acquired in connection with the acquisition of a 

trade or business generally must be capitalized and amortized over 

a 15-year period.848 These rules were enacted in 1993 to minimize 

disputes regarding the proper treatment of acquired intangible assets. The rules do not apply to a franchise to engage in professional 

sports and any intangible asset acquired in connection with such 

a franchise.849 However, other special rules apply to certain of 

these intangible assets. 

Under section 1056, when a franchise to conduct a sports enterprise is sold or exchanged, the basis of a player contract acquired as part of the transaction is generally limited to the adjusted basis of such contract in the hands of the transferor, increased by the amount of gain, if any, recognized by the transferor 

on the transfer of the contract. Moreover, not more than 50 percent 

of the consideration from the transaction may be allocated to player 

contracts unless the transferee establishes to the satisfaction of the 

Commissioner that a specific allocation in excess of 50 percent is 

proper. However, these basis rules may not apply if a sale or exchange of a franchise to conduct a sports enterprise is effected 

through a partnership.850 Basis allocated to the franchise or to 

other valuable intangible assets acquired with the franchise may 

not be amortizable if these assets lack a determinable useful life. 

In general, section 1245 provides that gain from the sale of certain property is treated as ordinary income to the extent depreciation or amortization was allowed on such property. Section 

1245(a)(4) provides special rules for recapture of depreciation and 

deductions for losses taken with respect to player contracts. The 

special recapture rules apply in the case of the sale, exchange, or 

other disposition of a sports franchise. Under the special recapture 

rules, the amount recaptured as ordinary income is the amount of 

gain not to exceed the greater of (1) the sum of the depreciation 

taken plus any deductions taken for losses (i.e., abandonment 

losses) with respect to those player contracts which are initially acquired as a part of the original acquisition of the franchise or (2) 

the amount of depreciation taken with respect to those player contracts which are owned by the seller at the time of the sale of the 

sports franchise. 

753 

851 Notice and demand is the notice given to a person liable for tax stating that the tax has 

been assessed and demanding that payment be made. The notice and demand must be mailed 

to the person’s last known address or left at the person’s dwelling or usual place of business 

(Code sec. 6303). 852 Code sec. 6331. 853 Code secs. 6335–6343. 854 Code sec. 6331(h). 

HOUSE BILL

The House bill extends the 15-year recovery period for intangible assets to franchises to engage in professional sports and any 

intangible asset acquired in connection with the acquisition of such 

a franchise (including player contracts). Thus, the same rules for 

amortization of intangibles that apply to other acquisitions under 

present law will apply to acquisitions of sports franchises. The provision also repeals the special rules under section 1245(a)(4) and 

makes other conforming changes. 

Effective date.—The House bill is effective for property acquired after the date of enactment. The amendment to section 

1245(a)(4) applies to franchises acquired after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

6. Increase continuous levy for certain federal payments (sec. 686 

of the House bill, sec. 734 of the Senate amendment, and sec. 

6331(h) 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 851 by the IRS, 

the IRS may then collect the tax by levy upon all property and 

rights to property belonging to the person,852 unless there is an explicit statutory restriction on doing so. A levy is the seizure of the 

person’s property or rights to property. Property that is not cash 

is sold pursuant to statutory requirements.853

A continuous levy is applicable to specified Federal payments.854 This includes any Federal payment for which eligibility 

is not based on the income and/or assets of a payee. Thus, a Federal payment to a vendor of goods or services to the government 

is subject to continuous levy. This continuous levy attaches up to 

15 percent of any specified payment due the taxpayer. 

HOUSE BILL

The bill permits a levy of up to 100 percent of a Federal payment to a vendor of goods or services to the Federal Government. 

Effective date.—Date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill. 

754 

855Sec. 1092. 856 However, if the option written by the taxpayer is a qualified covered call option that is 

in-the-money, then (1) any loss with respect to such option is treated as long-term capital loss 

if, at the time such loss is realized, gain on the sale or exchange of the offsetting stock held 

by the taxpayer would be treated as long-term capital gain, and (2) the holding period of such 

stock does not include any period during which the taxpayer is the grantor of the option (sec. 

1092(f)). 

CONFERENCE AGREEMENT

The conference agreement follows the House bill and the Senate amendment. 

7. Modification of straddle rules (sec. 687 of the House bill, sec. 464 

of the Senate amendment, and sec. 1092 of the Code) 

PRESENT LAW

Straddle rules 

In general 

A ‘‘straddle’’ generally refers to offsetting positions (sometimes 

referred to as ‘‘legs’’ of the straddle) with respect to actively traded 

personal property. Positions are offsetting if there is a substantial 

diminution in the risk of loss from holding one position by reason 

of holding one or more other positions in personal property. A ‘‘position’’ is an interest (including a futures or forward contract or option) in personal property. When a taxpayer realizes a loss with respect to a position in a straddle, the taxpayer may recognize that 

loss for any taxable year only to the extent that the loss exceeds 

the unrecognized gain (if any) with respect to offsetting positions 

in the straddle.855 Deferred losses are carried forward to the succeeding taxable year and are subject to the same limitation with 

respect to unrecognized gain in offsetting positions. 

Positions in stock 

The straddle rules generally do not apply to positions in stock. 

However, the straddle rules apply where one of the positions is 

stock and at least one of the offsetting positions is: (1) an option 

with respect to the stock, (2) a securities futures contract (as defined in section 1234B) with respect to the stock, or (3) a position 

with respect to substantially similar or related property (other than 

stock) as defined in Treasury regulations. In addition, the straddle 

rules apply to stock of a corporation formed or availed of to take 

positions in personal property that offset positions taken by any 

shareholder. 

Although the straddle rules apply to offsetting positions that 

consist of stock and an option with respect to stock, the straddle 

rules generally do not apply if the option is a ‘‘qualified covered call 

option’’ written by the taxpayer.856 In general, a qualified covered 

call option is defined as an exchange-listed option that is not deepin-the-money and is written by a non-dealer more than 30 days before expiration of the option. 

The stock exception from the straddle rules has been largely 

curtailed by statutory amendment and regulatory interpretation. 

Under proposed Treasury regulations, the application of the stock 

755 

857Prop. Treas. Reg. sec. 1.1092(d)–2(c). 858Sec. 1092(c)(2)(B). 859Priv. Ltr. Rul. 199925044 (Feb. 3, 1999). 860 A costless collar generally is comprised of the purchase of a put option and the sale of a 

call option with the same trade dates and maturity dates and set such that the premium paid 

substantially equals the premium received. The collar can be considered as economically similar 

to a short position in the stock. 

exception essentially would be limited to offsetting positions involving direct ownership of stock and short sales of stock.857

Unbalanced straddles 

When one position with respect to personal property offsets 

only a portion of one or more other positions (‘‘unbalanced straddles’’), the Secretary is directed to prescribe by regulations the 

method for determining the portion of such other positions that is 

to be taken into account for purposes of the straddle rules.858 To 

date, no such regulations have been promulgated. 

Unbalanced straddles can be illustrated with the following example: Assume the taxpayer holds two shares of stock (i.e., is long) 

in XYZ corporation—share A with a $30 basis and share B with a 

$40 basis. When the value of the XYZ stock is $45 per share, the 

taxpayer pays a $5 premium to purchase a put option on one share 

of the XYZ stock with an exercise price of $40. The issue arises as 

to whether the purchase of the put option creates a straddle with 

respect to share A, share B, or both. Assume that, when the value 

of the XYZ stock is $100, the put option expires unexercised. Taxpayer incurs a loss of $5 on the expiration of the put option, and 

sells share B for a $60 gain. On a literal reading of the straddle 

rules, the $5 loss would be deferred because the loss ($5) does not 

exceed the unrecognized gain ($70) in share A, which is also an offsetting position to the put option—notwithstanding that the taxpayer recognized more gain than the loss through the sale of share 

B. This problem is exacerbated when the taxpayer has a large portfolio of actively traded personal property that may be offsetting the 

loss leg of the straddle. 

Although Treasury has not issued regulations to address unbalanced straddles, the IRS issued a private letter ruling in 1999 

that addressed an unbalanced straddle situation.859 Under the 

facts of the ruling, a taxpayer entered into a costless collar with respect to a portion of the shares of a particular stock held by the 

taxpayer.860 Other shares were held in an account as collateral for 

a loan and still other shares were held in excess of the shares used 

as collateral and the number of shares specified in the collar. The 

ruling concluded that the collar offset only a portion of the stock 

(i.e., the number of shares specified in the costless collar) because 

that number of shares determined the payoff under each option 

comprising the collar. The ruling further concluded that: ‘‘In the 

absence of regulations under section 1092(c)(2)(B), we conclude that 

it is permissible for Taxpayer to identify which shares of Corporation stock are part of the straddles and which shares are used as 

collateral for the loans using appropriately modified versions of the 

methods of section 1.1012–1(c)(2) and (3) [providing rules for adequate identification of shares of stock sold or transferred by a taxpayer] or section 1.1092(b)–3T(d)(4) [providing requirements and 

756 

861Sec. 243. The amount of the deduction is 70 percent of dividends received if the recipient 

owns less than 20 percent (by vote and value) of stock of the payor. If the recipient owns 20 

percent or more of the stock, the deduction is increased to 80 percent. If the recipient owns 80 

percent or more of the stock, the deduction is further increased to 100 percent for qualifying 

dividends. 862Sec. 246(c). 863Sec. 246(c)(4). 864 However, to the extent provided by Treasury regulations, taxpayers are not permitted to 

identify offsetting positions of a straddle if the fair market value of the straddle position already 

held by the taxpayer at the creation of the straddle is less than its adjusted basis in the hands 

of the taxpayer. 865For this purpose, ‘‘unrecognized gain’’ is the excess of the fair market value of an identified 

position that is part of an identified straddle at the time the taxpayer incurs a loss with respect 

to another identified position in the identified straddle, over the fair market value of such position when the taxpayer identified the position as a position in the identified straddle. 

methods for identification of positions that are part of a section 

1092(b)(2) identified mixed straddle]’’. 

Holding period for dividends-received deduction 

If an instrument issued by a U.S. corporation is classified for 

tax purposes as stock, a corporate holder of the instrument generally is entitled to a dividends-received deduction for dividends received on that instrument.861 The dividends-received deduction is 

allowed to a corporate shareholder only if the shareholder satisfies 

a 46-day holding period for the dividend-paying stock (or a 91-day 

holding period for certain dividends on preferred stock).862 The 

holding period must be satisfied for each dividend over a period 

that is immediately before and immediately after the taxpayer becomes entitled to receive the dividend. The 46- or 91-day holding 

period generally does not include any time during which the shareholder is protected (other than by writing a qualified covered call) 

from the risk of loss that is otherwise inherent in the ownership 

of any equity interest.863

HOUSE BILL

Straddle rules 

The House bill modifies the straddle rules in three respects: (1) 

permits taxpayers to identify offsetting positions of a straddle; (2) 

provides a special rule to clarify the present-law treatment of certain physically settled positions of a straddle; and (3) repeals the 

stock exception from the straddle rules. 

Identified straddles 

Under the House bill, taxpayers generally are permitted to 

identify the offsetting positions that are components of a straddle 

at the time the taxpayer enters into a transaction that creates a 

straddle, including an unbalanced straddle.864 If there is a loss 

with respect to any identified position that is part of an identified 

straddle, the general straddle loss deferral rules do not apply to 

such loss. Instead, the basis of each of the identified positions that 

offset the loss position in the identified straddle is increased by an 

amount that bears the same ratio to the loss as the unrecognized 

gain (if any) with respect to such offsetting position bears to the 

aggregate unrecognized gain with respect to all positions that offset 

the loss position in the identified straddle.865 Any loss with respect 

to an identified position that is part of an identified straddle cannot otherwise be taken into account by the taxpayer or any other 

757 

866For example, although the provision does not require taxpayers to identify any positions 

of a straddle as an identified straddle, it may be necessary to provide rules requiring all balanced offsetting positions to be included in an identified straddle if a taxpayer elects to identify 

any of the offsetting positions as an identified straddle. 867 It is intended that Treasury regulations defining substantially similar or related property 

for this purpose will continue to apply subsequent to repeal of the stock exception and generally 

will constitute the exclusive definition of a straddle with respect to offsetting positions involving 

stock. See Prop. Treas. Reg. sec. 1.1092(d)–2(b). However, the general straddles rules regarding 

substantial diminution in risk of loss will continue to apply to stock of corporations formed or 

availed of to take positions in personal property that offset positions taken by the shareholder. 

person to the extent that the loss increases the basis of any identified positions that offset the loss position in the identified straddle. 

In addition, the provision provides the Secretary authority to 

issue regulations that would specify (1) the proper methods for 

clearly identifying a straddle as an identified straddle (and identifying positions as positions in an identified straddle), (2) the application of the identified straddle rules for a taxpayer that fails to 

properly identify the positions of an identified straddle,866 and (3) 

provide an ordering rule for dispositions of less than an entire position that is part of an identified straddle. 

Physically settled straddle positions 

The House bill also clarifies the present-law straddle rules 

with respect to taxpayers that settle a position that is part of a 

straddle by delivering property to which the position relates. Specifically, the provision clarifies that the present-law straddle loss 

deferral rules treat as a two-step transaction the physical settlement of a straddle position that, if terminated, would result in the 

realization of a loss. With respect to the physical settlement of such 

a position, the taxpayer is treated as having terminated the position for its fair market value immediately before the settlement. 

The taxpayer then is treated as having sold at fair market value 

the property used to physically settle the position. 

Stock exception repeal 

The House bill also eliminates the exception from the straddle 

rules for stock (other than the exception relating to qualified covered call options). Thus, offsetting positions comprised of actively 

traded stock and a position with respect to substantially similar or 

related property generally constitute a straddle.867

Dividends-received deduction holding period 

The House bill also modifies the required 46- or 91-day holding 

period for the dividends-received deduction by providing that the 

holding period does not include any time during which the shareholder is protected from the risk of loss otherwise inherent in the 

ownership of any equity interest if the shareholder obtains such 

protection by writing an in-the-money call option on the dividendpaying stock. 

Effective date 

The House bill provision is effective for positions established on 

or after the date of enactment that substantially diminish the risk 

of loss from holding offsetting positions (regardless of when such 

offsetting position was established). 

758 

868Sec. 4131. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

the Senate amendment also limits the present-law qualified covered call option exception to options traded on a national securities 

exchange that is registered with the Securities and Exchange Commission. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

8. Add vaccines against Hepatitis A to the list of taxable vaccines 

(sec. 688 of the House bill, sec. 491 of the Senate amendment, 

and sec. 4132 of the Code) 

PRESENT LAW

A manufacturer’s excise tax is imposed at the rate of 75 cents 

per dose 868 on the following vaccines routinely recommended for 

administration to children: diphtheria, pertussis, tetanus, measles, 

mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, varicella (chicken pox), rotavirus gastroenteritis, and streptococcus pneumoniae. The tax applied to any vaccine that is a combination of vaccine components equals 75 cents times the number 

of components in the combined vaccine. 

Amounts equal to net revenues from this excise tax are deposited in the Vaccine Injury Compensation Trust Fund to finance 

compensation awards under the Federal Vaccine Injury Compensation Program for individuals who suffer certain injuries following 

administration of the taxable vaccines. This program provides a 

substitute Federal, ‘‘no fault’’ insurance system for the State-law 

tort and private liability insurance systems otherwise applicable to 

vaccine manufacturers. All persons immunized after September 30, 

1988, with covered vaccines must pursue compensation under this 

Federal program before bringing civil tort actions under State law. 

HOUSE BILL

The House bill adds any vaccine against hepatitis A to the list 

of taxable vaccines. 

Effective date.—The provision is effective for vaccines sold beginning on the first day of the first month beginning more than 

four weeks after the date of enactment. 

SENATE AMENDMENT

The Senate amendment adds any vaccine against hepatitis A 

to the list of taxable vaccines. The Senate amendment also makes 

a conforming amendment to the trust fund expenditure purposes. 

Effective date.—The provision is effective for vaccines sold beginning on the first day of the first month beginning more than 

four weeks after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement includes the House bill provision. 

759 

869Sec. 4131. 870Sec. 7528. 

9. Add vaccines against influenza to the list of taxable vaccines 

(sec. 689 of the House bill, sec. 732 of the Senate amendment, 

and sec. 4132 of the Code) 

PRESENT LAW

A manufacturer’s excise tax is imposed at the rate of 75 cents 

per dose 869 on the following vaccines routinely recommended for 

administration to children: diphtheria, pertussis, tetanus, measles, 

mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, varicella (chicken pox), rotavirus gastroenteritis, and streptococcus pneumoniae. The tax applied to any vaccine that is a combination of vaccine components equals 75 cents times the number 

of components in the combined vaccine. 

Amounts equal to net revenues from this excise tax are deposited in the Vaccine Injury Compensation Trust Fund to finance 

compensation awards under the Federal Vaccine Injury Compensation Program for individuals who suffer certain injuries following 

administration of the taxable vaccines. This program provides a 

substitute Federal, ‘‘no fault’’ insurance system for the State-law 

tort and private liability insurance systems otherwise applicable to 

vaccine manufacturers. All persons immunized after September 30, 

1988, with covered vaccines must pursue compensation under this 

Federal program before bringing civil tort actions under State law. 

HOUSE BILL

The House bill adds any trivalent vaccine against influenza to 

the list of taxable vaccines. 

Effective date.—The provision is effective for vaccines sold or 

used beginning on the later of the first day of the first month beginning more than four weeks after the date of enactment or the 

date on which the Secretary of Health and Human Services lists 

any such vaccine for purpose of compensation for any vaccine-related injury or death through the Vaccine Injury Compensation 

Trust Fund. 

SENATE AMENDMENT

The Senate amendment is identical to the House bill. 

CONFERENCE AGREEMENT

The conference agreement includes the provision of the House 

bill and the Senate amendment. 

10. Extension of IRS user fees (sec. 690 of the House bill, sec. 482 

of the Senate amendment, and sec. 7528 of the Code) 

PRESENT LAW

The IRS generally charges a fee for requests for a letter ruling, 

determination letter, opinion letter, or other similar ruling or determination.870 These user fees are authorized by statute through 

December 31, 2004. 

760 

871Pub. L. No. 99–272. 872Pub. L. No. 107–296. 873Sec. 201, 117 Stat. 1335. 

HOUSE BILL

The House bill extends the statutory authorization for these 

user fees through September 30, 2014. 

Effective date.—Requests made after the date of enactment. 

SENATE AMENDMENT

The Senate amendment is the same as the House bill, except 

that it extends the statutory authorization for these user fees 

through September 30, 2013. 

CONFERENCE AGREEMENT

The conference agreement follows the House bill. 

11. Extension of Customs user fees (sec. 691 of the House bill and 

sec. 485 of the Senate amendment) 

PRESENT LAW

Section 13031 of the Consolidated Omnibus Budget Reconciliation Act of 1985 (‘‘COBRA’’) 871 authorized the Secretary of the 

Treasury to collect certain service fees. Section 412 of the Homeland Security Act of 2002 872 authorized the Secretary of the Treasury to delegate such authority to the Secretary of Homeland Security. Provided for under 19 U.S.C. 58c, these fees include: processing fees for air and sea passengers, commercial trucks, rail cars, 

private aircraft and vessels, commercial vessels, dutiable mail 

packages, barges and bulk carriers, merchandise, and Customs 

broker permits. COBRA was amended on several occasions but 

most recently by P.L. No. 108–121, which extended authorization 

for the collection of these fees through March 1, 2005.873

HOUSE BILL

The House bill extends the passenger and conveyance processing fees and the merchandise processing fees authorized under 

COBRA through September 30, 2014. For fiscal years after September 30, 2005, the Secretary is to charge fees in amounts that 

are reasonably related to the costs of providing customs services in 

connection with the activity or item for which the fee is charged. 

The House bill also includes a sense of the Congress regarding 

the extent to which fees are related to the costs of providing customs services in connection with the activities or items for which 

the fees have been charged under such paragraphs. The House bill 

further provides that the Secretary conduct a study of all the fees 

collected by the Department of Homeland Security. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

The Senate amendment extends the fees authorized under the 

COBRA through September 30, 2013. 

761 

CONFERENCE AGREEMENT

The conference agreement follows the House bill provision. 

12. Prohibition on nonrecognition of gain through complete liquidation of holding company (sec. 452 of the Senate amendment 

and sec. 332 of the Code) 

PRESENT LAW

A U.S. corporation owned by foreign persons is subject to U.S. 

income tax on its net income. In addition, the earnings of the U.S. 

corporation are subject to a second tax, when dividends are paid to 

the corporation’s shareholders. 

In general, dividends paid by a U.S. corporation to nonresident 

alien individuals and foreign corporations that are not effectively 

connected with a U.S. trade or business are subject to a U.S. withholding tax on the gross amount of such income at a rate of 30 percent. The 30-percent withholding tax may be reduced pursuant to 

an income tax treaty between the United States and the foreign 

country where the foreign person is resident. 

In addition, the United States imposes a branch profits tax on 

U.S. earnings of a foreign corporation that are shifted out of a U.S. 

branch of the foreign corporation. The branch profits tax is comparable to the second-level taxes imposed on dividends paid by a 

U.S. corporation to foreign shareholders. The branch profits tax is 

30 percent (subject to possible income tax treaty reduction) of a foreign corporation’s dividend equivalent amount. The ‘‘dividend 

equivalent amount’’ generally is the earnings and profits of a U.S. 

branch of a foreign corporation attributable to its income effectively 

connected with a U.S. trade or business. 

In general, U.S. withholding tax is not imposed with respect to 

a distribution of a U.S. corporation’s earnings to a foreign corporation in complete liquidation of the subsidiary, because the distribution is treated as made in exchange for stock and not as a dividend. 

In addition, detailed rules apply for purposes of exempting foreign 

corporations from the branch profits tax for the year in which it 

completely terminates its U.S. business conducted in branch form. 

The exemption from the branch profits tax generally applies if, 

among other things, for three years after the termination of the 

U.S. branch, the foreign corporation has no income effectively connected with a U.S. trade or business, and the U.S. assets of the terminated branch are not used by the foreign corporation or a related 

corporation in a U.S. trade or business. 

Regulations under section 367(e) provide that the Commissioner may require a domestic liquidating corporation to recognize 

gain on distributions in liquidation made to a foreign corporation 

if a principal purpose of the liquidation is the avoidance of U.S. 

tax. Avoidance of U.S. tax for this purpose includes, but is not limited to, the distribution of a liquidating corporation’s earnings and 

profits with a principal purpose of avoiding U.S. tax. 

HOUSE BILL

No provision. 

762 

874Secs. 871(b) and 882. 875Sec. 864(c). 876Sec. 864(c)(4). 877Sec. 864(c)(4)(B). 

SENATE AMENDMENT

The provision treats as a dividend any distribution of earnings 

by a U.S. holding company to a foreign corporation in a complete 

liquidation, if the U.S. holding company was in existence for less 

than five years. 

Effective date.—The provision is effective for distributions occurring on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

13. Effectively connected income to include certain foreign source 

income (sec. 454 of the Senate amendment and sec. 864 of the 

Code) 

PRESENT LAW

Nonresident alien individuals and foreign corporations (collectively, foreign persons) are subject to U.S. tax on income that is effectively connected with the conduct of a U.S. trade or business; the 

U.S. tax on such income is calculated in the same manner and at 

the same graduated rates as the tax on U.S. persons.874 Foreign 

persons also are subject to a 30-percent gross-basis tax, collected by 

withholding, on certain U.S.-source income, such as interest, dividends and other fixed or determinable annual or periodical 

(‘‘FDAP’’) income, that is not effectively connected with a U.S. trade 

or business. This 30-percent withholding tax may be reduced or 

eliminated pursuant to an applicable tax treaty. Foreign persons 

generally are not subject to U.S. tax on foreign-source income that 

is not effectively connected with a U.S. trade or business. 

Detailed rules apply for purposes of determining whether income is treated as effectively connected with a U.S. trade or business (so-called ‘‘U.S.-effectively connected income’’).875 The rules 

differ depending on whether the income at issue is U.S.-source or 

foreign-source income. Under these rules, U.S.-source FDAP income, such as U.S.-source interest and dividends, and U.S.-source 

capital gains are treated as U.S.-effectively connected income if 

such income is derived from assets used in or held for use in the 

active conduct of a U.S. trade or business, or from business activities conducted in the United States. All other types of U.S.-source 

income are treated as U.S.-effectively connected income (sometimes 

referred to as the ‘‘force of attraction rule’’). 

In general, foreign-source income is not treated as U.S.-effectively connected income.876 However, foreign-source income, gain, 

deduction, or loss generally is considered to be effectively connected 

with a U.S. business only if the person has an office or other fixed 

place of business within the United States to which such income, 

gain, deduction, or loss is attributable and such income falls into 

one of three categories described below.877 For these purposes, income generally is not considered attributable to an office or other 

763 

878Sec. 864(c)(5). 879Sec. 864(c)(4)(B)(i). 880Sec. 864(c)(4)(B)(ii). 881Sec. 864(c)(4)(D)(i). 882Sec. 864(c)(4)(B)(iii). 883Secs. 861–865. 884See Bank of America v. United States, 680 F.2d 142 (Ct. Cl. 1982). 885Treas. Reg. sec. 1.864–5(b)(2)(ii). 

fixed place of business within the United States unless such office 

or fixed place of business is a material factor in the production of 

the income, and such office or fixed place of business regularly carries on activities of the type that generate such income.878

The first category consists of rents or royalties for the use of 

patents, copyrights, secret processes, or formulas, good will, trademarks, trade brands, franchises, or other similar intangible properties derived in the active conduct of the U.S. trade or business.879

The second category consists of interest or dividends derived in the 

active conduct of a banking, financing, or similar business within 

the United States, or received by a corporation whose principal 

business is trading in stocks or securities for its own account.880

Notwithstanding the foregoing, foreign-source income consisting of 

dividends, interest, or royalties is not treated as effectively connected if the items are paid by a foreign corporation in which the 

recipient owns, directly, indirectly, or constructively, more than 50 

percent of the total combined voting power of the stock.881 The 

third category consists of income, gain, deduction, or loss derived 

from the sale or exchange of inventory or property held by the taxpayer primarily for sale to customers in the ordinary course of the 

trade or business where the property is sold or exchanged outside 

the United States through the foreign person’s U.S. office or other 

fixed place of business.882 Such amounts are not treated as effectively connected if the property is sold or exchanged for use, consumption, or disposition outside the United States and an office or 

other fixed place of business of the taxpayer in a foreign country 

materially participated in the sale or exchange. 

The Code provides sourcing rules for enumerated types of income, including interest, dividends, rents, royalties, and personal 

services income.883 For example, interest income generally is 

sourced based on the residence of the obligor. Dividend income generally is sourced based on the residence of the corporation paying 

the dividend. Thus, interest paid on obligations of foreign persons 

and dividends paid by foreign corporations generally are treated as 

foreign-source income. 

Other types of income are not specifically covered by the Code’s 

sourcing rules. For example, fees for accepting or confirming letters 

of credit have been sourced under principles analogous to the interest sourcing rules.884 In addition, under regulations, payments in 

lieu of dividends and interest derived from securities lending transactions are sourced in the same manner as interest and dividends, 

including for purposes of determining whether such income is effectively connected with a U.S. trade or business.885 Moreover, income 

from notional principal contracts (such as interest rate swaps) generally is sourced based on the residence of the recipient of the inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00767 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
764 

886Treas. Reg. sec. 1.863–7(b)(3). 887Sec. 904(a). 888Sec. 904(f). 

come, but is treated as U.S.-source effectively connected income if 

it arises from the conduct of a United States trade or business.886

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the provision, each category of foreign-source income 

that is treated as effectively connected with a U.S. trade or business is expanded to include economic equivalents of such income 

(i.e., economic equivalents of certain foreign-source (1) rents and 

royalties, (2) dividends and interest, and (3) income on sales or exchanges of goods in the ordinary course of business). Thus, such 

economic equivalents are treated as U.S.-effectively connected income in the same circumstances that foreign-source rents, royalties, dividends, interest, or certain inventory sales are treated as 

U.S.-effectively connected income. For example, foreign-source interest and dividend equivalents are treated as U.S.-effectively connected income if the income is attributable to a U.S. office of the 

foreign person, and such income is derived by such foreign person 

in the active conduct of a banking, financing, or similar business 

within the United States, or the foreign person is a corporation 

whose principal business is trading in stocks or securities for its 

own account. 

Effective date.—The provision is effective for taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

14. Recapture of overall foreign losses on sale of controlled foreign 

corporation stock (sec. 455 of the Senate amendment and sec. 

904 of the Code) 

PRESENT LAW

U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. The amount of foreign tax credits that may be 

claimed in a year is subject to a limitation that prevents taxpayers 

from using foreign tax credits to offset U.S. tax on U.S.-source income. The amount of foreign tax credits generally is limited to a 

portion of the taxpayer’s U.S. tax which portion is calculated by 

multiplying the taxpayer’s total U.S. tax by a fraction, the numerator of which is the taxpayer’s foreign-source taxable income (i.e., 

foreign-source gross income less allocable expenses or deductions) 

and the denominator of which is the taxpayer’s worldwide taxable 

income for the year.887 Separate limitations are applied to specific 

categories of income. 

Special recapture rules apply in the case of foreign losses for 

purposes of applying the foreign tax credit limitation.888 Under 

these rules, losses for any taxable year in a limitation category 

765 

889Sec. 904(f)(1). 890Sec. 904(f)(3). 891 Coordination rules apply in the case of losses recaptured under the branch loss recapture 

rules. Sec. 367(a)(3)(C). 892Sec. 864(e) and Temp. Treas. Reg. sec. 1.861–9T. 

which exceed the aggregate amount of foreign income earned in 

other limitation categories (a so-called ‘‘overall foreign loss’’) are recaptured by resourcing foreign-source income earned in a subsequent year as U.S.-source income.889 The amount resourced as 

U.S.-source income generally is limited to the lesser of the amount 

of the overall foreign losses not previously recaptured, or 50 percent of the taxpayer’s foreign-source income in a given year (the 

‘‘50-percent limit’’). Taxpayers may elect to recapture a larger percentage of such losses. 

A special recapture rule applies to ensure the recapture of an 

overall foreign loss where property which was used in a trade or 

business predominantly outside the United States is disposed of 

prior to the time the loss has been recaptured.890 In this regard, 

dispositions of trade or business property used predominantly outside the United States are treated as resulting in the recognition 

of foreign-source income (regardless of whether gain would otherwise be recognized upon disposition of the assets), in an amount 

equal to the lesser of the excess of the fair market value of such 

property over its adjusted basis, or the amount of unrecaptured 

overall foreign losses. Such foreign-source income is resourced as 

U.S.-source income without regard to the 50-percent limit. For example, if a U.S. corporation transfers its foreign branch business 

assets to a foreign corporation in a nontaxable section 351 transaction, the taxpayer would be treated for purposes of the recapture 

rules as having recognized foreign-source income in the year of the 

transfer in an amount equal to the excess of the fair market value 

of the property disposed over its adjusted basis (or the amount of 

unrecaptured foreign losses, if smaller). Such income would be recaptured as U.S.-source income to the extent of any prior 

unrecaptured overall foreign losses.891

Detailed rules apply in allocating and apportioning deductions 

and losses for foreign tax credit limitation purposes. In the case of 

interest expense, such amounts generally are apportioned to all 

gross income under an asset method, under which the taxpayer’s 

assets are characterized as producing income in statutory or residual groupings (i.e., foreign-source income in the various limitation 

categories or U.S.-source income).892 Interest expense is apportioned among these groupings based on the relative asset values in 

each. Taxpayers may elect to value assets based on either tax book 

value or fair market value. 

Each corporation that is a member of an affiliated group is required to apportion its interest expense using apportionment fractions determined by reference to all assets of the affiliated group. 

For this purpose, an affiliated group generally is defined to include 

only domestic corporations. Stock in a foreign subsidiary, however, 

is treated as a foreign asset that may attract the allocation of U.S. 

interest expense for these purposes. If tax basis is used to value assets, the adjusted basis of the stock of certain 10-percent or greater 

owned foreign corporations or other non-affiliated corporations 

766 

must be increased by the amount of earnings and profits of such 

corporation accumulated during the period the U.S. shareholder 

held the stock, for purposes of the interest apportionment. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the provision, the special recapture rule for overall foreign losses that currently applies to dispositions of foreign trade or 

business assets applies to the disposition of stock in a controlled 

foreign corporation controlled by the taxpayer. Thus, a disposition 

of controlled foreign corporation stock by a controlling shareholder 

results in the recognition of foreign-source income in an amount 

equal to the lesser of the fair market value of the stock over its adjusted basis, or the amount of prior unrecaptured overall foreign 

losses. Such income is resourced as U.S.-source income for foreign 

tax credit limitation purposes without regard to the 50-percent 

limit. 

Although the provision generally extends to all dispositions of 

such stock, regardless of whether gain or loss is recognized on the 

transfer, exceptions are made for certain internal restructurings. 

Contributions to corporations or partnerships under sections 351 

and 721, respectively, and certain stock and asset reorganizations 

do not trigger recapture of overall foreign losses, provided that the 

transferor’s underlying indirect interest in the disposed controlled 

foreign corporation does not change. However, any gain recognized 

in connection with a transaction meeting any of these exceptions, 

such as boot, triggers recapture of overall foreign losses to the extent of such gain. 

Effective date.—The provision applies to dispositions after the 

date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

modifications. Under the provision as modified, a disposition of controlled foreign corporation stock in a transaction in which the taxpayer or a member of its consolidated group acquires the assets of 

the controlled foreign corporation in a liquidation under section 332 

or a reorganization does not trigger the recapture of overall foreign 

losses. Any gain recognized in connection with a transaction meeting this exception triggers recapture of overall foreign losses to the 

extent of such gain. 

15. Application of earnings-stripping rules to partnerships and S 

corporations (sec. 462 of the Senate amendment and sec. 163 

of the Code) 

PRESENT LAW

Present law provides rules to limit the ability of U.S. corporations to reduce the U.S. tax on their U.S.-source income through 

earnings stripping transactions. Section 163(j) specifically addresses earnings stripping involving interest payments, by limiting the 

deductibility of interest paid to certain related parties (‘‘disqualified 

767 

893This interest also may include interest paid to unrelated parties in certain cases in which 

a related party guarantees the debt. 894Prop. Treas. reg. sec. 1.163(j)–3(b)(3). 895Prop. Treas. reg. sec. 1.163(j)–2(c)(5). 896Prop. Treas. reg. sec. 1.163(j)–1(a)(i). 897This rule currently is contained in Prop. Treas. reg. sec. 1.163(j)–2(c)(5). 

interest’’),893 if the payor’s debt-equity ratio exceeds 1.5 to 1 and 

the payor’s net interest expense exceeds 50 percent of its ‘‘adjusted 

taxable income’’ (generally taxable income computed without regard to deductions for net interest expense, net operating losses, 

and depreciation, amortization, and depletion). Disallowed interest 

amounts can be carried forward indefinitely. In addition, excess 

limitation (i.e., any excess of the 50-percent limit over a company’s 

net interest expense for a given year) can be carried forward three 

years. 

The present-law earnings stripping provision does not apply to 

partnerships. Proposed Treasury regulations provide that a corporate partner’s proportionate share of the liabilities of a partnership is treated as debt of the corporate partner for purposes of applying the earnings stripping limitation to its own interest payments.894 In addition, interest paid or accrued by a partnership is 

treated as interest expense of a corporate partner, with the result 

that a deduction for the interest expense may be disallowed if that 

expense would be disallowed under the earnings stripping rules if 

paid by the corporate partner itself.895 The proposed regulations 

also provide that the earnings stripping rules do not apply to subchapter S corporations.896 Thus, under present law and the proposed regulations, a partnership or S corporation generally is allowed a deduction for interest paid or accrued on indebtedness that 

it issues that otherwise would be disallowed under the earnings 

stripping rules in the case of a subchapter C corporation. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment incorporates a rule attributing partnership debt to a corporate partner for purposes of applying the 

earnings stripping rules to the corporation.897

Effective date.—The Senate amendment provision generally is 

effective for taxable years beginning on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

16. Recognition of cancellation of indebtedness income realized on 

satisfaction of debt with partnership interest (sec. 463 of the 

Senate amendment and sec. 108 of the Code) 

PRESENT LAW

Under present law, a corporation that transfers shares of its 

stock in satisfaction of its debt must recognize cancellation of inVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00771 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
768 

898Sec. 108(e)(8). 899 E.g., Motor Mart Trust v. Commissioner, 4 T.C. 931 (1945), aff’d, 156 F.2d 122 (1st Cir. 

1946), acq. 1947–1 C.B. 3; Capento Sec. Corp. v. Commissioner, 47 B.T.A. 691 (1942), nonacq. 

1943 C.B. 28, aff’d, 140 F.2d 382 (1st Cir. 1944); Tower Bldg. Corp. v. Commissioner, 6 T.C. 

125 (1946), acq. 1947–1 C.B. 4; Alcazar Hotel, Inc. v. Commissioner, 1 T.C. 872 (1943), acq. 1943 

C.B. 1. 900Sec. 108(a). 901See, e.g., Fulton Gold Corp. v. Commissioner, 31 B.T.A. 519 (1934); American Seating Co. 

v. Commissioner, 14 B.T.A. 328, aff’d in part and rev’d in part, 50 F.2d 681 (7th Cir. 1931); 

Hiatt v. Commissioner, 35 B.T.A. 292 (1937); Hotel Astoria, Inc. v. Commissioner, 42 B.T.A. 759 

(1940); Rev. Rul. 91–31, 1991–1 C.B. 19. 

debtedness income in the amount that would be realized if the debt 

were satisfied with money equal to the fair market value of the 

stock.898 Prior to enactment of this present-law provision in 1993, 

case law provided that a corporation did not recognize cancellation 

of indebtedness income when it transferred stock to a creditor in 

satisfaction of debt (referred to as the ‘‘stock-for-debt exception’’).899

When cancellation of indebtedness income is realized by a partnership, it generally is allocated among the partners in accordance 

with the partnership agreement, provided the allocations under the 

agreement have substantial economic effect. A partner who is allocated cancellation of indebtedness income is entitled to exclude it 

if the partner qualifies for one of the various exceptions to recognition of such income, including the exception for insolvent taxpayers 

or that for qualified real property indebtedness of taxpayers other 

than subchapter C corporations.900 The availability of each of these 

exceptions is determined at the partner, rather than the partnership, level. 

In the case of a partnership that transfers to a creditor a capital or profits interest in the partnership in satisfaction of its debt, 

no Code provision expressly requires the partnership to realize cancellation of indebtedness income. Thus, it is unclear whether the 

partnership is required to recognize cancellation of indebtedness income under either the case law that established the stock-for-debt 

exception or the present-law statutory repeal of the stock-for-debt 

exception. It also is unclear whether any requirement to recognize 

cancellation of indebtedness income is affected if the cancelled debt 

is nonrecourse indebtedness.901

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that when a partnership 

transfers a capital or profits interest in the partnership to a creditor in satisfaction of partnership debt, the partnership generally 

recognizes cancellation of indebtedness income in the amount that 

would be recognized if the debt were satisfied with money equal to 

the fair market value of the partnership interest. The Senate 

amendment applies without regard to whether the cancelled debt 

is recourse or nonrecourse indebtedness. Any cancellation of indebtedness income recognized under the Senate amendment is allocated 

solely among the partners who held interests in the partnership 

immediately prior to the satisfaction of the debt. 

769 

902Sec. 453. 903Sec. 453(f)(3). Instead, the receipt of such indebtedness is treated as a receipt of payment. 

Under the Senate amendment, no inference is intended as to 

the treatment under present law of the transfer of a partnership 

interest in satisfaction of partnership debt. 

Effective date.—The Senate amendment is effective for cancellations of indebtedness occurring on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement includes the Senate amendment. 

17. Denial of installment sale treatment for all readily tradable 

debt (Sec. 465 of the Senate amendment and sec. 453 of the 

Code) 

PRESENT LAW

Under present law, taxpayers are permitted to recognize as 

gain on a disposition of property only that proportion of payments 

received in a taxable year which is the same as the proportion that 

the gross profit bears to the total contract price (the ‘‘installment 

method’’).902 However, the installment method is not available if 

the taxpayer sells property in exchange for a readily tradable evidence of indebtedness that is issued by a corporation or a government or political subdivision.903

No similar provision under present law prohibits the use of the 

installment method where the taxpayer sells property in exchange 

for readily tradable indebtedness issued by a partnership or an individual. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment denies installment sale treatment with 

respect to all sales in which the taxpayer receives indebtedness 

that is readily tradable under present-law rules, regardless of the 

nature of the issuer. For example, if the taxpayer receives readily 

tradable debt of a partnership in a sale, the partnership debt is 

treated as payment on the installment note, and the installment 

method is unavailable to the taxpayer. 

Effective date.—The Senate amendment provision is effective 

for sales occurring on or after date of enactment. 

CONFERENCE AGREEMENT

The conference agreement includes the Senate amendment. 

770 

18. Modify treatment of transfers to creditors in divisive reorganizations (sec. 466 of the Senate amendment and secs. 357 and 

361 of the Code) 

PRESENT LAW

Section 355 of the Code permits a corporation (‘‘distributing’’) 

to separate its businesses by distributing a controlled subsidiary 

(‘‘controlled’’) tax-free, if certain conditions are met. In cases where 

the distributing corporation contributes property to the controlled 

corporation that is to be distributed, no gain or loss is recognized 

if the property is contributed solely in exchange for stock or securities of the controlled corporation (which are subsequently distributed to distributing’s shareholders). The contribution of property to 

a controlled corporation that is followed by a distribution of its 

stock and securities may qualify as a reorganization described in 

section 368(a)(1)(D). That section also applies to certain transactions that do not involve a distribution under section 355 and 

that are considered ‘‘acquisitive’’ rather than ‘‘divisive’’ reorganizations. 

The contribution in the course of a divisive section 368(a)(1)(D) 

reorganization is also subject to the rules of section 357(c). That 

section provides that the transferor corporation will recognize gain 

if the amount of liabilities assumed by controlled exceeds the basis 

of the property transferred to it. 

Because the contribution transaction in connection with a section 355 distribution is a reorganization under section 368(a)(1)(D), 

it is also subject to certain rules applicable to both divisive and acquisitive reorganizations. One such rule, in section 361(b), states 

that a transferor corporation will not recognize gain if it receives 

money or other property and distributes that money or other property to its shareholders or creditors. The amount of property that 

may be distributed to creditors without gain recognition is unlimited under this provision. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The bill limits the amount of money plus the fair market value 

of other property that a distributing corporation can distribute to 

its creditors without gain recognition under section 361(b) to the 

amount of the basis of the assets contributed to a controlled corporation in a divisive reorganization. In addition, the bill provides 

that acquisitive reorganizations under section 368(a)(1)(D) are no 

longer subject to the liabilities assumption rules of section 357(c). 

Effective date.—The bill is effective for transactions on or after 

the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

771 

19. Clarify definition of nonqualified preferred stock (sec. 467 of the 

Senate amendment and sec. 351(g) of the Code) 

PRESENT LAW

The Taxpayer Relief Act of 1997 amended sections 351, 354, 

355, 356, and 1036 to treat ‘‘nonqualified preferred stock’’ as boot 

in corporate transactions, subject to certain exceptions. For this 

purpose, preferred stock is defined as stock that is ‘‘limited and 

preferred as to dividends and does not participate in corporate 

growth to any significant extent.’’ Nonqualified preferred stock is 

defined as any preferred stock if (1) the holder has the right to require the issuer or a related person to redeem or purchase the 

stock, (2) the issuer or a related person is required to redeem or 

purchase, (3) the issuer or a related person has the right to redeem 

or repurchase, and, as of the issue date, it is more likely than not 

that such right will be exercised, or (4) the dividend rate varies in 

whole or in part (directly or indirectly) with reference to interest 

rates, commodity prices, or similar indices, regardless of whether 

such varying rate is provided as an express term of the stock (as 

in the case of an adjustable rate stock) or as a practical result of 

other aspects of the stock (as in the case of auction stock). For this 

purpose, clauses (1), (2), and (3) apply if the right or obligation may 

be exercised within 20 years of the issue date and is not subject 

to a contingency which, as of the issue date, makes remote the likelihood of the redemption or purchase. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision clarifies the definition of nonqualified preferred 

stock to ensure that stock for which there is not a real and meaningful likelihood of actually participating in the earnings and profits of the corporation is not considered to be outside the definition 

of stock that is limited and preferred as to dividends and does not 

participate in corporate growth to any significant extent. 

As one example, instruments that are preferred on liquidation 

and that are entitled to the same dividends as may be declared on 

common stock do not escape being nonqualified preferred stock by 

reason of that right if the corporation does not in fact pay dividends either to its common or preferred stockholders. As another 

example, stock that entitles the holder to a dividend that is the 

greater of seven percent or the dividends common shareholders receive does not avoid being preferred stock if the common shareholders are not expected to receive dividends greater than seven 

percent. 

No inference is intended as to the characterization of stock 

under present law that has terms providing for unlimited dividends 

or participation rights but, based on all the facts and circumstances, is limited and preferred as to dividends and does not 

participate in corporate growth to any significant extent. 

Effective date.—The provision is effective for transactions after 

May 14, 2003. 

772 

904 Component members are also limited to one alternative minimum tax exemption and one 

accumulated earnings credit. 905Sec. 1563(a)(2). The Supreme Court held in United States v. Vogel Fertilizer, 455 US 16 

(1982), that Treas. Reg. Sec. 1.1563–1(a)(3), as it was then written, was invalid insofar as it 

would require an individual’s stock to be taken into account, for purposes of the 80-percent 

brother-sister corporation ownership test, where that individual did not own stock in each of 

the corporations in the asserted controlled group. In that case, one corporation was owned 77.49 

percent by one shareholder and 22.51 by an unrelated shareholder. The 77.49 percent shareholder of that first corporation also owned 87.5 percent of the voting stock and more than 90 

percent of the value of the stock of a second corporation. The Supreme Court held the corporations were not a controlled group, even though they would have been one had the then applicable Treasury regulations been considered valid in their application to the case. The Treasury 

regulations were subsequently changed to conform to the Supreme Court decision. T.D. 8179, 

53 F.R. 6603 (March 2, 1988). 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

20. Modify definition of controlled group of corporations (sec. 468 

of the Senate amendment and sec. 1563 of the Code) 

PRESENT LAW

Under present law, a tax is imposed on the taxable income of 

corporations. The rates are as follows: 

MARGINAL FEDERAL CORPORATE INCOME TAX RATES 

If taxable income is: Then the income tax rate is: 

$0–$50,000 ............................................................................... 15 percent of taxable income. 

$50,001–$75,000 ...................................................................... 25 percent of taxable income. 

$75,001–$10,000,000 ............................................................... 34 percent of taxable income. 

Over $10,000,000 ...................................................................... 35 percent of taxable income. 

The first two graduated rates described above are phased out 

by a five-percent surcharge for corporations with taxable income 

between $100,000 and $335,000. Also, the application of the 34-percent rate is phased out by a three-percent surcharge for corporations with taxable income between $15 million and $18,333,333. 

The component members of a controlled group of corporations 

are limited to one amount in each of the taxable income brackets 

shown above.904 For this purpose, a controlled group of corporations means a parent-subsidiary controlled group and a brother-sister controlled group. 

A brother-sister controlled group means two or more corporations if five or fewer persons who are individuals, estates or trusts 

own (or constructively own) stock possessing (1) at least 80 percent 

of the total combined voting power of all classes of stock entitled 

to vote and at least 80 percent of the total value of all stock, and 

(2) more than 50 percent of percent of the total combined voting 

power of all classes of stock entitled to vote or more than 50 percent of the total value of all stock, taking into account the stock 

ownership of each person only to the extent the stock ownership is 

identical with respect to each corporation.905

HOUSE BILL

No provision. 

773 

906 As one example, the provision does not change the present law standards relating to deferred compensation, contained in subchapter D of the Code, that refer to section 1563. 907 1987–2 C.B. 674 (as clarified and modified by Rev. Proc. 88–22, 1988–1 C.B. 785). 

SENATE AMENDMENT

Under the provision, a brother-sister controlled group means 

two or more corporations if five or fewer persons who are individuals, estates or trusts own (or constructively own) stock possessing 

more than 50 percent of the total combined voting power of all 

classes of stock entitled to vote, or more than 50 percent of the 

total value of all stock, taking into account the stock ownership of 

each person only to the extent the stock ownership is identical with 

respect to each corporation. 

The provision applies only for purposes of section 1561, currently relating to corporate tax brackets, the accumulated earnings 

credit, and the minimum tax. The provision does not affect other 

Code sections or other provisions that utilize or refer to the section 

1563 brother-sister corporation controlled group test for other purposes.906

Effective date.—The provision applies to taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

21. Establish specific class lives for utility grading costs (sec. 472 

of the Senate amendment and sec. 168 of the Code) 

PRESENT LAW

A taxpayer is allowed a depreciation deduction for the exhaustion, wear and tear, and obsolescence of property that is used in 

a trade or business or held for the production of income. For most 

tangible property placed in service after 1986, the amount of the 

depreciation deduction is determined under the modified accelerated cost recovery system (‘‘MACRS’’) using a statutorily prescribed 

depreciation method, recovery period, and placed in service convention. For some assets, the recovery period for the asset is provided 

in section 168. In other cases, the recovery period of an asset is determined by reference to its class life. The class lives of assets 

placed in service after 1986 are generally set forth in Revenue Procedure 87–56.907 If no class life is provided, the asset is allowed a 

7-year recovery period under MACRS. 

Assets that are used in the transmission and distribution of 

electricity for sale are included in asset class 49.14, with a class life 

of 30 years and a MACRS recovery period of 20 years. The cost of 

initially clearing and grading land improvements are specifically 

excluded from asset class 49.14. Prior to adoption of the accelerated 

cost recovery system, the IRS ruled that an average useful life of 

84 years for the initial clearing and grading relating to electric 

transmission lines and 46 years for the initial clearing and grading 

relating to electric distribution lines, would be accepted. However, 

the result in this ruling was not incorporated in the asset classes 

included in Rev. Proc. 87–56 or its predecessors. Accordingly such 

774 

908The limitation is commonly referred to as the ‘‘luxury automobile depreciation limitation.’’ 

For passenger automobiles (subject to the such limitation) placed in service in 2002, the maximum amount of allowable depreciation is $7,660 for the year in which the vehicle was placed 

in service, $4,900 for the second year, $2,950 for the third year, and $1,775 for the fourth and 

later years. This limitation applies to the combined depreciation deduction provided under 

present law for depreciation, including section 179 expensing and the temporary 30 percent additional first year depreciation allowance. For luxury automobiles eligible for the 50% additional 

first depreciation allowance, the first year limitation is increased by an additional $3,050. 

costs are depreciated over a 7-year recovery period under MACRS 

as assets for which no class life is provided. 

A similar situation exists with regard to gas utility pipelines 

and related storage facilities. Such assets are included in asset 

class 49.24, with a class life of 22 years and a MACRS recovery period of 15 years. Initial clearing and grade improvements are specifically excluded from the asset class, and no separate asset class 

is provided for such costs. Accordingly such costs are depreciated 

over a 7-year recovery period under MACRS as assets for which no 

class life is provided. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment assigns a class life to depreciable electric and gas utility clearing and grading costs incurred to locate 

transmission and distribution lines and pipelines. The provision includes these assets in the asset classes of the property to which the 

clearing and grading costs relate (generally, asset class 49.14 for 

electric utilities and asset class 49.24 for gas utilities, giving these 

assets a recovery period of 20 years and 15 years, respectively). 

Effective date.—The Senate amendment is effective for property placed in service after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

22. Expansion of limitation on expensing of certain passenger automobiles (sec. 473 of the Senate amendment and sec. 179 of the 

Code) 

PRESENT LAW

A taxpayer is allowed to recover, through annual depreciation 

deductions, the cost of certain property used in a trade or business 

or for the production of income. The amount of the depreciation deduction allowed with respect to tangible property for a taxable year 

is determined under the modified accelerated cost recovery system 

(‘‘MACRS’’). Under MACRS, passenger automobiles generally are 

recovered over five years. However, section 280F limits the annual 

depreciation deduction with respect to certain passenger automobiles.908

For purposes of the depreciation limitation, passenger automobiles are defined broadly to include any 4-wheeled vehicles that 

are manufactured primarily for use on public streets, roads, and 

highways and which are rated at 6,000 pounds unloaded gross veVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00778 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
775

909Sec. 280F(d)(5). Exceptions are provided for any ambulance, hearse, or any vehicle used 

by the taxpayer directly in the trade or business of transporting persons or property for compensation or hire. 910Pub. L. No. 108–27, sec. 202 (2003). 911 Additional section 179 incentives are provided with respect to a qualified property used by 

a business in the New York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec. 1397A), 

or a renewal community (sec. 1400J). 

hicle weight or less.909 In the case of a truck or a van, the depreciation limitation applies to vehicles that are rated at 6,000 pounds 

gross vehicle weight or less. Sports utility vehicles are treated as 

a truck for the purpose of applying the section 280F limitation. 

In lieu of depreciation, a taxpayer with a sufficiently small 

amount of annual investment may elect to expense such investment (sec. 179). The Jobs and Growth Tax Relief Reconciliation Act 

(JGTRRA) of 2003 910 increased the amount a taxpayer may deduct, for taxable years beginning in 2003 through 2005, to $100,000 of 

the cost of qualifying property placed in service for the taxable 

year.911 In general, qualifying property is defined as depreciable 

tangible personal property that is purchased for use in the active 

conduct of a trade or business. The $100,000 amount is reduced 

(but not below zero) by the amount by which the cost of qualifying 

property placed in service during the taxable year exceeds 

$400,000. Prior to the enactment of JGTRRA (and for taxable years 

beginning in 2006 and thereafter) a taxpayer with a sufficiently 

small amount of annual investment may elect to deduct up to 

$25,000 of the cost of qualifying property placed in service for the 

taxable year. The $25,000 amount is reduced (but not below zero) 

by the amount by which the cost of qualifying property placed in 

service during the taxable year exceeds $200,000. Passenger automobiles subject to section 280F are eligible for section 179 expensing only to the extent of the applicable limits contained in section 

280F. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment limits the ability of taxpayers to claim 

deductions under section 179 for certain vehicles not subject to section 280F to $25,000. The provision applies to sport utility vehicles 

rated at 14,000 pounds gross vehicle weight or less (in place of the 

present law 6,000 pound rating). For this purpose, a sport utility 

vehicle is defined to exclude any vehicle that: (1) is designed for 

more than nine individuals in seating rearward of the driver’s seat; 

(2) is equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet 

in interior length; or (3) has an integral enclosure, fully enclosing 

the driver compartment and load carrying device, does not have 

seating rearward of the driver’s seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.

The following example illustrates the operation of the provision. 

Example.—Assume that during 2004, on a date which is after 

the date of enactment a calendar year taxpayer acquires and places 

776

912Sec. 195 913Secs. 248 and 709. 914Treas. Reg. sec. 1.195–1. 

in service a sport utility vehicle subject to the provision that costs 

$70,000. In addition, assume that the property otherwise qualifies 

for the expensing election under section 179. Under the provision, 

the taxpayer is first allowed a $25,000 deduction under section 179. 

The taxpayer is also allowed an additional first-year depreciation 

deduction (sec. 168(k)) of $22,500 based on $45,000 ($70,000 original cost less the section 179 deduction of $25,000) of adjusted basis. 

Finally, the remaining adjusted basis of $22,500 ($45,000 adjusted 

basis less $22,500 additional first-year depreciation) is eligible for 

an additional depreciation deduction of $4,500 under the general 

depreciation rules (automobiles are five-year recovery property). 

The remaining $18,000 of cost ($70,000 original cost less $52,000 

deductible currently) would be recovered in 2006 and subsequent 

years pursuant to the general depreciation rules. 

Effective date.—The Senate amendment is effective for property placed in service after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

23. Provide consistent amortization period for intangibles (sec. 474 

of the Senate amendment and secs. 195, 248, and 709 of the 

Code) 

PRESENT LAW

At the election of the taxpayer, start-up expenditures912 and 

organizational expenditures913 may be amortized over a period of 

not less than 60 months, beginning with the month in which the 

trade or business begins. Start-up expenditures are amounts that 

would have been deductible as trade or business expenses, had 

they not been paid or incurred before business began. Organizational expenditures are expenditures that are incident to the creation of a corporation (sec. 248) or the organization of a partnership (sec. 709), are chargeable to capital, and that would be eligible 

for amortization had they been paid or incurred in connection with 

the organization of a corporation or partnership with a limited or 

ascertainable life. 

Treasury regulations914 require that a taxpayer file an election 

to amortize start-up expenditures no later than the due date for 

the taxable year in which the trade or business begins. The election 

must describe the trade or business, indicate the period of amortization (not less than 60 months), describe each start-up expenditure incurred, and indicate the month in which the trade or business began. Similar requirements apply to the election to amortize 

organizational expenditures. A revised statement may be filed to 

include start-up and organizational expenditures that were not included on the original statement, but a taxpayer may not include 

as a start-up expenditure any amount that was previously claimed 

as a deduction. 

Section 197 requires most acquired intangible assets (such as 

goodwill, trademarks, franchises, and patents) that are held in conVerDate jul 14 2003 00:32 Oct 28, 2004 Jkt 096542 PO 00000 Frm 00780 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
777

nection with the conduct of a trade or business or an activity for 

the production of income to be amortized over 15 years beginning 

with the month in which the intangible was acquired. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment modifies the treatment of start-up and 

organizational expenditures. A taxpayer would be allowed to elect 

to deduct up to $5,000 of start-up and $5,000 of organizational expenditures in the taxable year in which the trade or business begins. However, each $5,000 amount is reduced (but not below zero) 

by the amount by which the cumulative cost of start-up or organizational expenditures exceeds $50,000, respectively. Start-up and 

organizational expenditures that are not deductible in the year in 

which the trade or business begins would be amortized over a 15-

year period consistent with the amortization period for section 197 

intangibles. 

Effective date.—The Senate amendment is effective for start-up 

and organizational expenditures incurred after the date of enactment. Start-up and organizational expenditures that are incurred 

on or before the date of enactment would continue to be eligible to 

be amortized over a period not to exceed 60 months. However, all 

start-up and organizational expenditures related to a particular 

trade or business, whether incurred before or after the date of enactment, would be considered in determining whether the cumulative cost of start-up or organizational expenditures exceeds 

$50,000. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

24. Doubling of certain penalties, fines, and interest on underpayments related to certain offshore financial arrangements (sec. 

483 of the Senate amendment) 

PRESENT LAW

The Code contains numerous civil penalties, such as the delinquency, accuracy-related and fraud penalties. These civil penalties 

are in addition to any interest that may be due. 

In January 2003, Treasury announced the Offshore Voluntary 

Compliance Initiative (‘‘OVCI’’) running through April 15, 2003, to 

encourage the voluntary disclosure of previously unreported income 

placed by taxpayers in offshore accounts and accessed through 

credit card or other financial arrangements. The taxpayer will pay 

back taxes, interest and certain accuracy-related and delinquency 

penalties.

A taxpayer’s timely, voluntary disclosure of a substantial unreported tax liability has long been an important factor in deciding 

whether the taxpayer’s case should ultimately be referred for criminal prosecution. The voluntary disclosure must be truthful, timely, 

and complete. A voluntary disclosure does not guarantee immunity 

from prosecution.

778 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Increases by a factor of two the total amount of civil penalties, 

interest and fines applicable for taxpayers who would have been eligible to participate in either the OVCI or the Treasury Department’s voluntary disclosure initiative but did not participate in either program. 

Effective date.—Taxpayers’ open tax years on or after date of 

enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

25. Whistleblower reforms (sec. 488 of the Senate amendment) 

PRESENT LAW

Under section 7623, the IRS is authorized to pay such sums as 

deemed necessary for: ‘‘(1) detecting underpayments of tax; and (2) 

detecting and bringing to trial and punishment persons guilty of 

violating the internal revenue laws or conniving at the same.’’ 

Amounts are paid based on a percentage of tax, fines, and penalties 

(but not interest) actually collected based on the information provided. For specific information that caused the investigation and 

resulted in recovery, the IRS administratively has set the reward 

in an amount not to exceed 15 percent of the amounts recovered. 

For information, although not specific, that nonetheless caused the 

investigation and was of value in the determination of tax liabilities, the reward is not to exceed 10 percent of the amount recovered. For information that caused the investigation, but had no direct relationship to the determination of tax liabilities, the reward 

is not to exceed one percent of the amount recovered. The reward 

ceiling is $10 million (for payments made after November 7, 2002), 

and the reward floor is $100. No reward will be paid if the recovery 

was so small as to call for payment of less than $100 under the 

above formulas. Both the ceiling and percentages can be increased 

with a Special Agreement. The Code permits the IRS to disclose return information pursuant to a contract for tax administration 

services (sec. 6103(n)). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment creates a reward program for actions 

in which the tax, penalties, interest, additions to tax, and additional amounts in dispute exceed $20,000, and, if the taxpayer is 

an individual, the individual’s gross income exceeds $200,000 for 

any taxable year. 

Generally, the Senate amendment establishes a reward floor of 

15 percent of the collected proceeds (including penalties, interest, 

779 

915Sec. 6012(a)(1)(C). Other filing requirements apply to dependents who are married, elderly, 

or blind. See, Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents, at 3, Table 1 (2003). 916 A taxpayer generally need not file a return if he or she has gross income in an amount 

less than the standard dedcution (and, if allowable to the taxpyer, the personal exemption 

amount). An individual who may be claimed as a dependent of another taxpyaer is not eligible 

to claim the dependency exemption relating to that individual. Sec. 151(d)(2). For taxable years 

beginning in 2004, the standard deduction amount for an individual who may be claimed as a 

dependent by another taxpyer may not exceed the greater of $800 or the sum of $250 and the 

individual’s earned income. 

additions to tax and additional amounts) if the IRS proceeds with 

an administrative or judicial action based on information brought 

to the IRS’s attention by an individual. The Senate amendment 

permits awards of lesser amounts (but no less than 10 percent) if 

the action was based principally on allegations (other than information provided by the individual) resulting from a judicial or administrative hearing, government report, hearing, audit, investigation, or from the news media. The Senate amendment caps the 

available reward at 30 percent of the collected proceeds. Any determination regarding a reward may be appealed to the U.S. Tax 

Court. 

The Senate amendment creates a Whistleblower Office within 

the IRS to administer this reward program. The Whistleblower Office is funded with amounts equal to rewards made. The Whistleblower Office may seek the assistance from the individual providing information or from his legal representative, and may reimburse the costs incurred by any legal representative out of the 

funds of the Whistleblower Office. To the extent the disclosure of 

returns or return information is required to render such assistance, 

the disclosure must be pursuant to an IRS tax administration contract. 

Effective date.—Information provided on or after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

26. Increase in age of minor children whose unearned income is 

taxed as if parent’s income (sec. 495 of the Senate amendment 

and sec. 1 of the Code) 

PRESENT LAW

Filing requirements for children 

A single unmarried individual eligible to be claimed as a dependent on another taxpayer’s return generally must file an individual income tax return if he or she has: (1) earned income only 

over $4,850 (for 2004); (2) unearned income only over the minimum 

standard deduction amount for dependents ($800 in 2004); or (3) 

both earned income and unearned income totaling more than the 

smaller of (a) $4,850 (for 2004) or (b) the larger of (i) $800 (for 

2004), or (ii) earned income plus $250.915 Thus, if a dependent 

child has less than $800 in gross income, the child does not have 

to file an individual income tax return for 2004.916

780 

917Sec. 1(g). 918Sec. 1(g)(4) and sec. 911(d)(2). 919Sec. 1(h) 920Sec. 1(g)(4). 

A child who cannot be claimed as a dependent on another person’s tax return (e.g., because the support test is not satisfied by 

any other person) is subject to the generally applicable filing requirements. That is, such an individual generally must file a return if the individual’s gross income exceeds the sum of the standard deduction and the personal exemption amounts applicable to 

the individual. 

Taxation of unearned income under section 1(g) 

Special rules (generally referred to as the ‘‘kiddie tax’’) apply 

to the unearned income of a child who is under age 14.917 The 

kiddie tax applies if: (1) the child has not reached the age of 14 by 

the close of the taxable year; (2) the child’s unearned income was 

more than $1,600 (for 2004); and (3) the child is required to file a 

return for the year. The kiddie tax applies regardless of whether 

the child may be claimed as a dependent on the parent’s return. 

For these purposes, unearned income is income other than 

wages, salaries, professional fees, or other amounts received as 

compensation for personal services actually rendered.918 For children under age 14, net unearned income (for 2004, generally unearned income over $1,600) is taxed at the parent’s rate if the parent’s rate is higher than the child’s rate. The remainder of a child’s 

taxable income (i.e., earned income, plus unearned income up to 

$1,600 (for 2004), less the child’s standard deduction) is taxed at 

the child’s rates, regardless of whether the kiddie tax applies to the 

child. In general, a child is eligible to use the preferential tax rates 

for qualified dividends and capital gains.919

The kiddie tax is calculated by computing the ‘‘allocable parental tax.’’ This involves adding the net unearned income of the child 

to the parent’s income and then applying the parent’s tax rate. A 

child’s ‘‘net unearned income’’ is the child’s unearned income less 

the sum of (1) the minimum standard deduction allowed to dependents ($800 for 2004), and (2) the greater of (a) such minimum 

standard deduction amount or (b) the amount of allowable itemized 

deductions that are directly connected with the production of the 

unearned income.920 A child’s net unearned income cannot exceed 

the child’s taxable income. 

The allocable parental tax equals the hypothetical increase in 

tax to the parent that results from adding the child’s net unearned 

income to the parent’s taxable income. If a parent has more than 

one child subject to the kiddie tax, the net unearned income of all 

children is combined, and a single kiddie tax is calculated. Each 

child is then allocated a proportionate share of the hypothetical increase, based upon the child’s net unearned income relative to the 

aggregate net unearned income of all of the parent’s children subject to the tax. 

Special rules apply to determine which parent’s tax return and 

rate is used to calculate the kiddie tax. If the parents file a joint 

return, the allocable parental tax is calculated using the income reported on the joint return. In the case of parents who are married 

781 

921Sec. 1(g)(5); Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents, at 6 (2003). 922The child must attach to the return Form 8615, Tax for Children Under Age 14 With Investment Income of More Than $1,500 (2003). 923 Internal Revenue Service, Publication 929, Tax Rules 

but file separate returns, the allocable parental tax is calculated 

using the income of the parent with the greater amount of taxable 

income. In the case of unmarried parents, the child’s custodial parent is the parent whose taxable income is taken into account in determining the child’s liability. If the custodial parent has remarried, the stepparent is treated as the child’s other parent. Thus, if 

the custodial parent and stepparent file a joint return, the kiddie 

tax is calculated using that joint return. If the custodial parent and 

stepparent file separate returns, the return of the one with the 

greater taxable income is used. If the parents are unmarried but 

lived together all year, the return of the parent with the greater 

taxable income is used.921

Unless the parent elects to include the child’s income on the 

parent’s return (as described below) the child files a separate return to report the child’s income.922 In this case, items on the parent’s return are not affected by the child’s income. The total tax 

due from a child is the greater of: 

(1) The sum of (a) the tax payable by the child on the 

child’s earned income plus (b) the allocable parental tax on the 

child’s unearned income, or 

(2) The tax on the child’s income without regard to the 

kiddie tax provisions. 

Parental election to include child’s dividends and interest on parent’s return 

Under certain circumstances, a parent may elect to report a 

child’s dividends and interest on the parent’s return. If the election 

is made, the child is treated as having no income for the year and 

the child does not have to file a return. The parent makes the election on Form 8814, Parents’ Election To Report Child’s Interest and 

Dividends. The requirements for the parent’s election are that: 

(1) The child has gross income only from interest and dividends (including capital gains distributions and Alaska Permanent Fund Dividends); 923

(2) Such income is more than the minimum standard deduction amount for dependents ($800 in 2004) and less than 10 

times that amount ($8000 in 2004); 

(3) No estimated tax payments for the year were made in 

the child’s name and taxpayer identification number; 

(4) No backup withholding occurred; and 

(5) The child is required to file a return if the parent does 

not make the election. 

Only the parent whose return must be used when calculating 

the kiddie tax may make the election. The parent includes in income the child’s gross income in excess of twice the minimum 

standard deduction amount for dependents (i.e., the child’s gross 

income in excess of $1,600 for 2004). This amount is taxed at the 

parent’s rate. The parent also must report an additional tax liability equal to the lesser of: (1) $80 (in 2004), or (2) 10 percent of the 

782 

924 Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents, at 7 

(2003). 925 Internal Revenue Service, Publication 929, Tax Rules for Children and Dependents, at 7 

(2003). 926Sec. 1(g)(7)(B). 927Sec. 73(a). 928Sec. 6201(c). 929Sec. 1(h)(1)(C). 

child’s gross income exceeding the child’s standard deduction ($800 

in 2004). 

Including the child’s income on the parent’s return can affect 

the parent’s deductions and credits that are based on adjusted 

gross income, as well as income-based phaseouts, limitations, and 

floors.924 In addition, certain deductions that the child would have 

been entitled to take on his or her own return are lost.925 Further, 

if the child received tax-exempt interest from a private activity 

bond, that item is considered a tax preference of the parent for alternative minimum tax purposes.926

Taxation of compensation for services under section 1(g) 

Compensation for a child’s services is considered the gross income of the child, not the parent, even if the compensation is not 

received or retained by the child (e.g., is the parent’s income under 

local law).927 If the child’s income tax is not paid, however, an assessment against the child will be considered as also made against 

the parent to the extent the assessment is attributable to amounts 

received for the child’s services.928

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment increases the age of minors to which 

the kiddie tax provisions apply from under 14 to under 18. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

27. Modify holding period requirement for qualification for reduced 

tax rate on dividends on preferred stock (sec. 496 of the Senate 

amendment and sec. 1 of the Code) 

PRESENT LAW

Section 1(h)(11) provides that if a taxpayer receives ‘‘qualified 

dividend income,’’ the dividend income is taxed as net capital gain. 

The maximum rate of tax on qualified dividend income therefore 

generally is 15 percent.929 Dividends are treated as qualified dividend income only if certain conditions, including holding period requirements, are satisfied. The holding period requirements under 

section 1(h)(11) are defined by reference, with modifications, to the 

holding period requirements under section 246(c) for qualification 

for the dividends received deduction. A dividend paid on a share of 

783 

930Secs. 1(h)(11)(B)(iii)(I), 246(c)(1)(A). 931Secs. 1(h)(11)(B)(iii)(I), 246(c)(2). 932The Senate amendment predated the enactment of H.R. 1308, Pub. L. No. 108–311 (the 

‘‘Working Families Tax Relief Act of 2004’’), which included a technical correction to the holding 

period requirements under sections 1(h)(11) and 246(c) (increasing from 120 to 121 days and 

from 180 to 181 days the periods during which the stock holding requirements are tested). 

common stock is qualified dividend income only if, among other requirements, the recipient holds the share for more than 60 days 

during the 121-day period beginning on the date that is 60 days before the date on which the share becomes ex-dividend with respect 

to the dividend.930 A dividend paid on a share of preferred stock 

is qualified dividend income only if the recipient holds the share for 

more than 90 days during the 181-day period beginning 90 days before the ex-dividend date.931

HOUSE BILL

No provision. 

SENATE AMENDMENT 932

The Senate amendment changes the holding period requirement for treatment as qualified dividend income for dividends paid 

on preferred stock. Under the Senate amendment, stock must be 

held for more than 120 days during the 240-day period beginning 

120 days before the ex-dividend date. 

Effective date.—The Senate amendment provision applies to 

taxable years beginning after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

28. Grant Treasury regulatory authority to address foreign tax 

credit transactions involving inappropriate separation of foreign taxes from related foreign income (sec. 661A of Senate 

amendment and sec. 901 of the Code) 

PRESENT LAW

The United States provides a credit for foreign income taxes 

paid or accrued. For purposes of the foreign tax credit, the taxpayer 

‘‘is the person on whom foreign law imposes legal liability for such 

tax.’’ Treas. Reg. sec. 1.901–2(f)(1). Thus, if a U.S. corporation owns 

a foreign partnership, the U.S. corporation can claim foreign tax 

credits for the tax that is imposed on it as a partner in the foreign 

entity. This is true even if the U.S. corporation elects to treat the 

foreign entity as a corporation for U.S. tax purposes. If the foreign 

entity does not meet the definition of a controlled foreign corporation or does not generate income that is subject to current inclusion 

under the rules of an anti-deferral regime, the income generated by 

the foreign entity may never be reported on a U.S. return, despite 

the fact that the U.S. corporation can claim credits for taxes imposed on that income. 

The Treasury Department and the IRS have expressed concern 

about transactions that involve inappropriate foreign tax credit results, including the second class of transactions described in Notice 

784 

933 1998–1 C.B. 334. 934 Notice 2004–19, 2004–11 I.R.B. 606. 935 If the return is filed before the due date, for this purpose it is considered to have been 

filed on the due date. 936Sec. 6404(g). This provision was added to the Code by sec. 3305 of the IRS Restructuring 

and Reform Act of 1998 (Pub. L. No. 105–206, July 22, 1998). 

98–5.933 The tax benefits claimed in these transactions are inconsistent with the purposes of the foreign tax credit provisions.934

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision expands existing regulatory authority to provide 

Treasury and the IRS additional mechanisms to address the second 

class of transactions described in Notice 98–5 as well as other abusive foreign tax credit schemes that involve the inappropriate separation of foreign taxes from the related foreign income in cases 

where foreign taxes are imposed on any person with respect to income of an entity. 

The regulations may provide for: (1) the disallowance of a credit for all or a portion of the foreign taxes; or (2) for the allocation 

of the foreign taxes among the participants in the transaction in 

a manner that is more consistent with the underlying economics of 

the transaction. 

Effective date.—The provision is effective for transactions entered into after the date of enactment. 

CONFERENCE AGREEMENT

No provision. 

29. Freeze of provision regarding suspension of interest where Secretary fails to contact taxpayer (sec. 662B of the Senate 

amendment and sec. 6404(g) of the Code) 

PRESENT LAW

In general, interest and penalties accrue during periods for 

which taxes were unpaid without regard to whether the taxpayer 

was aware that there was tax due. The Code suspends the accrual 

of certain penalties and interest after 1 year after the filing of the 

tax return 935 if the IRS has not sent the taxpayer a notice specifically stating the taxpayer’s liability and the basis for the liability 

within the specified period.936 With respect to taxable years beginning before January 1, 2004, the one-year period is increased to 18 

months. Interest and penalties resume 21 days after the IRS sends 

the required notice to the taxpayer. The provision is applied separately with respect to each item or adjustment. The provision does 

not apply where a taxpayer has self-assessed the tax. The suspension only applies to taxpayers who file a timely tax return. The provision applies only to individuals and does not apply to the failure 

to pay penalty, in the case of fraud, or with respect to criminal penalties. 

785 

937This includes any substantial omission of items to which the six-year statute of limitations 

applies (sec. 6051(e)), gross valuation misstatements (sec. 6662(h)), and similar provisions. 938 It is intended that this provision apply retroactively to the period beginning January 1, 

2004 and ending on the date of enactment. The due date for returns for the taxable period beginning January 1, 2004 is generally April 15, 2005; April 15, 2005 is therefore the date from 

which the 12-month period that must pass under present-law prior to the commencement of suspension is calculated. Consequently, suspension of interest would generally not begin until April 

15, 2006. Accordingly, the provision has no actual retroactive effect. 939 A reportable avoidance transaction is a reportable transaction with a significant tax avoidance purpose. 940Sec. 13273 of the Revenue Reconciliation Act of 1993. 941Sec. 101(c)(11) of the Economic Growth and Tax Relief Reconciliation Act of 2001. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment makes the 18-month rule the permanent rule. The Senate amendment also adds gross 

misstatements 937 and listed and reportable transactions to the list 

of provisions to which the suspension of interest rules do not apply. 

Effective date.—The Senate amendment is effective for taxable 

years beginning after December 31, 2003,938 except that the addition of listed and reportable transactions applies to interest accruing after May 5, 2004. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment, except: (1) the provision relating to reportable transactions is made 

applicable only to reportable avoidance transactions; 939 and (2) 

that the addition of listed and reportable avoidance transactions 

applies to interest accruing after October 3, 2004. 

30. Increase in withholding from supplemental wage payments in 

excess of $1 million (sec. 673 of the Senate amendment and 

sec. 13273 of the Revenue Reconciliation Act of 1993) 

PRESENT LAW

An employer must withhold income taxes from wages paid to 

employees; there are several possible methods for determining the 

amount of income tax to be withheld. The IRS publishes tables 

(Publication 15, ‘‘Circular E’’) to be used in determining the amount 

of income tax to be withheld. The tables generally reflect the income tax rates under the Code so that withholding approximates 

the ultimate tax liability with respect to the wage payments. In 

some cases, ‘‘supplemental’’ wage payments (e.g., bonuses or commissions) may be subject to withholding at a flat rate,940 based on 

the third lowest income tax rate under the Code (25 percent for 

2005).941

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the Senate amendment, once annual supplemental wage 

payments to an employee exceed $1 million, any additional suppleVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00789 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
786 

942Sec. 421. 

mental wage payments to the employee in that year are subject to 

withholding at the highest income tax rate (35 percent for 2004 

and 2005), regardless of any other withholding rules and regardless 

of the employee’s Form W–4. 

This rule applies only for purposes of wage withholding; other 

types of withholding (such as pension withholding and backup 

withholding) are not affected. 

Effective date.—The provision is effective with respect to payments made after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment except that the conference agreement is effective for payments made 

after December 31, 2004. 

31. Capital gain treatment on sale of stock acquired from exercise 

of statutory stock options to comply with conflict of interest requirements (sec. 674 of the Senate amendment and sec. 421 of 

the Code) 

PRESENT LAW

Statutory stock options 

Generally, when an employee exercises a compensatory option 

on employer stock, the difference between the option price and the 

fair market value of the stock (i.e., the ‘‘spread’’) is includible in income as compensation. Upon such exercise, an employer is allowed 

a corresponding compensation deduction. In the case of an incentive stock option or an option to purchase stock under an employee 

stock purchase plan (collectively referred to as ‘‘statutory stock options’’), the spread is not included in income at the time of exercise.942

If an employee disposes of stock acquired upon the exercise of 

a statutory option, the employee generally is taxed at capital gains 

rates with respect to the excess of the fair market value of the 

stock on the date of disposition over the option price, and no compensation expense deduction is allowable to the employer, unless 

the employee fails to meet a holding period requirement. The employee fails to meet this holding period requirement if the disposition occurs within two years after the date the option is granted 

or one year after the date the option is exercised. The gain upon 

a disposition that occurs prior to the expiration of the applicable 

holding period(s) (a ‘‘disqualifying disposition’’) does not qualify for 

capital gains treatment. In the event of a disqualifying disposition, 

the income attributable to the disposition is treated by the employee as income received in the taxable year in which the disposition occurs, and a corresponding deduction is allowable to the employer for the taxable year in which the disposition occurs. 

Sale of property to comply with conflict of interest requirements 

The Code provides special rules for recognizing gain on sales 

of property which are required in order to comply with certain conflict of interest requirements imposed by the Federal GovernVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00790 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
787 

943Sec. 1043. 944Secs. 72 and 402. 

ment.943 Certain executive branch Federal employees (and their 

spouses and minor or dependent children) who are required to divest property in order to comply with conflict of interest requirements may elect to postpone the recognition of resulting gains by 

investing in certain replacement property within a 60-day period. 

The basis of the replacement property is reduced by the amount of 

the gain not recognized. Permitted replacement property is limited 

to any obligation of the United States or any diversified investment 

fund approved by regulations issued by the Office of Government 

Ethics. The rule applies only to sales under certificates of divestiture issued by the President or the Director of the Office of Government Ethics. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the Senate amendment, an eligible person who, in order 

to comply with Federal conflict of interest requirements, is required 

to sell shares of stock acquired pursuant to the exercise of a statutory stock option is treated as satisfying the statutory holding period requirements, regardless of how long the stock was actually 

held. An eligible person generally includes an officer or employee 

of the executive branch of the Federal Government (and any spouse 

or minor or dependent children whose ownership in property is attributable to the officer or employee). Because the sale is not treated as a disqualifying disposition, the individual is afforded capital 

gain treatment on any resulting gains. Such gains are eligible for 

deferral treatment under section 1043. 

The employer granting the option is not allowed a deduction 

upon the sale of the stock by the individual. 

Effective date.—The Senate amendment is effective for sales 

after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment. 

32. Application of basis rules to nonresident aliens (sec. 675 of the 

Senate amendment and new sec. 72(w) and sec. 83 of the Code) 

PRESENT LAW

Distributions from retirement plans 

Distributions from retirement plans are includible in gross income under the rules relating to annuities 944 and, thus, are generally includible in income, except to the extent the amount received represents investment in the contract (i.e., the participant’s 

basis). The participant’s basis includes amounts contributed by the 

participant on an after-tax basis, together with certain amounts 

contributed by the employer, minus the aggregate amount (if any) 

previously distributed to the extent that such amount was excludable from gross income. Amounts contributed by the employer are 

788 

945Sec. 72(f). 946 Rev. Rul. 58-236, 1958–1 C.B. 37. 947Sec. 402(b)(2). 948Sec. 402(b)(4). 949Sec. 83(a). 950Treas. Reg. sec. 1.61–2(d)(i). 

included in the calculation of the participant’s basis only to the extent that such amounts were includible in the gross income of the 

participant, or to the extent that such amounts would have been 

excludable from the participant’s gross income if they had been 

paid directly to the participant at the time they were contributed.945

Employer contributions to retirement plans and other payments for labor or personal services performed outside the United 

States by a nonresident alien generally are not treated as U.S. 

source income. Such contributions, therefore, generally would not 

be includible in the nonresident alien’s gross income if they had 

been paid directly to the nonresident alien at the time they were 

contributed. Consequently, the amounts of such contributions generally are includible in the employee’s basis and are not taxed by 

the United States if a distribution is made when the employee is 

a U.S. citizen or resident.946

Earnings on contributions are not included in basis unless previously includible in income. In general, in the case of a nonexempt 

trust, earnings are includible in income when distributed or made 

available.947 In the case of highly compensated employees, the 

amount of the vested accrued benefit under the trust (other than 

the employee’s investment in the contract) is generally required to 

be included in income annually (to the extent not previously includible). That is, earnings, as well as contributions, that are part of 

the vested accrued benefit are currently includible in income.948

Property transferred in connection with the performance of services 

The Code contains rules governing the amount and timing of 

income and deductions attributable to transfers of property in connection with the performance of services. If, in connection with the 

performance of services, property is transferred to any person other 

than the person for whom such services are performed, in general, 

an amount is includible in the gross income of the person performing the services (the ‘‘service provider’’) for the taxable year in 

which the property is first vested (i.e., transferable or not subject 

to a substantial risk of forfeiture).949 The amount includible in the 

service provider’s income is the excess of the fair market value of 

the property over the amount (if any) paid for the property. Basis 

in such property includes any amount that is included in income 

as a result of the transfer.950

U.S. income tax treaties 

Under the 1996 U.S. Model Income Tax Treaty (‘‘U.S. Model’’) 

and some U.S. income tax treaties in force, retirement plan distributions beneficially owned by a resident of a treaty country in 

consideration for past employment generally are taxable only by 

the individual recipient’s country of residence. Under the U.S. 

Model treaty and some U.S. income tax treaties, this exclusive residence-based taxation rule is limited to the taxation of amounts that 

789 

were not previously included in taxable income in the other country. For example, if a treaty country had imposed tax on a resident 

individual with respect to some portion of a retirement plan’s earnings, subsequent distributions to that person while a resident of 

the United States would not be taxable in the United States to the 

extent the distributions were attributable to such previously taxed 

amounts. 

Compensation of employees of foreign governments or international 

organizations 

Under section 893, wages, fees, and salaries of any employee 

of a foreign government or international organization (including a 

consular or other officer or a nondiplomatic representative) received 

as compensation for official services to the foreign government or 

international organization generally are excluded from gross income when (1) the employee is not a citizen of the United States, 

or is a citizen of the Republic of the Philippines (whether or not 

a citizen of the United States); (2) in the case of an employee of 

a foreign government, the services are of a character similar to 

those performed by employees of the United States in foreign countries; and (3) in the case of an employee of a foreign government, 

the foreign government grants an equivalent exemption to employees of the United States performing similar services in such foreign 

country. The Secretary of State certifies the names of the foreign 

countries which grant an equivalent exclusion to employees of the 

United States performing services in those countries, and the character of those services. 

The exclusion does not apply to employees of controlled commercial entities or employees of foreign governments whose services are primarily in connection with commercial activity (whether 

within or outside the United States) of the foreign government. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment modifies the present-law rules under 

which certain contributions and earnings that have not been previously taxed are treated as basis (under sec. 72). Under the Senate 

amendment, employee or employer contributions are not included 

in basis if: (1) the employee was a nonresident alien at the time 

the services were performed with respect to which the contribution 

was made; (2) the contribution is with respect to compensation for 

labor or personal services from sources without the United States; 

and (3) the contribution was not subject to income tax under the 

laws of the United States or any foreign country. 

The Senate amendment authorizes the Secretary of the Treasury to issue regulations to carry out the purposes of the Senate 

amendment, including regulations treating contributions as not 

subject to income tax under the laws of any foreign country under 

appropriate circumstances. 

Effective date.—The Senate amendment is effective for distributions occurring on or after the date of enactment. 

790 

951Sec. 872. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

modifications. 

Under the conference agreement, employee or employer contributions are not included in basis (under sec. 72) if: (1) the employee was a nonresident alien at the time the services were performed with respect to which the contribution was made; (2) the 

contribution is with respect to compensation for labor or personal 

services from sources without the United States; and (3) the contribution was not subject to income tax (and would have been subject to income tax if paid as cash compensation when the services 

were rendered) under the laws of the United States or any foreign 

country. 

Additionally, earnings on employer or employee contributions 

are not included in basis if: (1) the earnings are paid or accrued 

with respect to any employer or employee contributions which were 

made with respect to compensation for labor or personal services; 

(2) the employee was a nonresident alien at the time the earnings 

were paid or accrued; and (3) the earnings were not subject to income tax under the laws of the United States or any foreign country. 

The conference agreement does not change the rules applicable 

to calculation of basis with respect to contributions or earnings 

while an employee is a U.S. resident. 

There is no inference that this conference agreement applies in 

any case to create tax jurisdiction with respect to wages, fees, and 

salaries otherwise exempt under section 893. Similarly, there is no 

inference that the conference agreement applies where contrary to 

an agreement of the United States that has been validly authorized 

by Congress (or in the case of a treaty, ratified by the Senate), and 

which provides an exemption for income. 

Most U.S. tax treaties specifically address the taxation of pension distributions. The U.S. Model treaty provides for exclusive residence-based taxation of pension distributions to the extent such 

distributions were not previously included in taxable income in the 

other country. For purposes of the U.S. Model treaty, the United 

States treats any amount that has increased the recipient’s basis 

(as defined in section 72) as having been previously included in 

taxable income. The following example illustrates how the conference agreement could affect the amount of a distribution that 

may be taxed by the United States pursuant to a tax treaty. 

Assume the following facts. A, a nonresident alien individual, 

performs services outside the United States, in A’s country of residence, country Z. A’s employer makes contributions on behalf of A 

to a pension plan established in country Z. For U.S. tax purposes, 

no portion of the contributions or earnings are included in A’s income (and would not be included in income if the amounts were 

paid as cash compensation when the services were performed) because such amounts relate to services performed without the 

United States.951 Later in time, A retires and becomes a permanent resident of the United States. 

791 

952Section 7701(a)(30) defines a citizen or resident of the United States as ‘‘U.S. persons.’’ 

Under the conference agreement, the employer contributions to 

the pension plan would not be taken into account in determining 

A’s basis if A was not subject to income tax on the contributions 

by a foreign country and the contributions would have been subject 

to tax by a foreign country if the contributions had been paid to 

A as cash compensation when the services were performed. Thus, 

in those circumstances, A would be subject to U.S. tax on the distribution of all of the contributions, as such distributions are made. 

However, if the contributions would not have been subject to tax 

in the foreign country if they had been paid to A as cash compensation when the services were performed, under the conference agreement, the contributions would be included in A’s basis. Earnings 

that accrued while A was a nonresident alien would not result in 

basis if not taxed under U.S. or foreign law. Earnings that accrued 

while A was a permanent resident of the United States would be 

subject to present-law rules. This result generally is consistent 

with the treatment of pension distributions under the U.S. Model 

treaty. 

The conference agreement authorizes the Secretary of the 

Treasury to issue regulations to carry out the purposes of the conference agreement, including regulations treating contributions as 

not subject to income tax under the laws of any foreign country 

under appropriate circumstances. For example, Treasury could provide that foreign income tax that was merely nominal would not 

satisfy the ‘‘subject to income tax’’ requirement. 

The conference agreement also changes the rules for determining basis in property received in connection for the performance 

of services in the case of an individual who was a nonresident alien 

at the time of the performance of services, if the property is treated 

as income from sources outside the United States. In that case, the 

individual’s basis in the property does not include any amount that 

was not subject to income tax (and would have been subject to income tax if paid as cash compensation when the services were performed) under the laws of the United States or any foreign country. 

Effective date.—The conference agreement is effective for distributions occurring on or after the date of enactment. No inference 

is intended that the earnings subject to the conference agreement 

are included in basis under present law. 

33. Residence and source rules related to a United States possession (sec. 497 of the Senate amendment and new sec. 937 of 

the Code) 

PRESENT LAW

In general 

Generally, U.S. citizens are subject to U.S. income taxation on 

their worldwide income. Thus, all income earned by U.S. citizens 

is subject to U.S. income tax, regardless of its source. 

The U.S. income taxation of alien individuals varies depending 

on whether they are resident or non-resident aliens. A resident 

alien is generally taxed in the same manner as a U.S. citizen.952

In contrast, a nonresident alien is generally subject to U.S. tax only 

792 

on certain gross U.S. source income at a flat 30 percent rate (unless such rate is eliminated or reduced by treaty) and on net income that has a sufficient nexus to the United States at the graduated rates applicable to U.S. citizens and residents under section 

1. 

An alien is considered a resident of the United States if the individual: (1) has entered the United States as a lawful permanent 

resident and is such a resident at any time during the calendar 

year, (2) is present in the United States for a substantial period of 

time (the so-called ‘‘substantial presence test’’), or (3) makes an 

election to be treated as a resident of the United States (sec. 

7701(b)). An alien who does not meet the definition of a ‘‘resident 

alien’’ is considered to be a non-resident alien for U.S. income tax 

purposes. 

Under the substantial presence test, an alien individual is generally treated as a resident alien if he or she is present in the 

United States for 31 days during the taxable year and the sum of 

the number of days on which such individual was present in the 

United States (when multiplied by the applicable multiplier) during 

the current year and the preceding two calendar years equals or 

exceeds 183 days. The applicable multiplier for: the current year is 

one; the first preceding year is one-third; and the second preceding 

year is one-sixth. 

An alien individual who meets the above test may nevertheless 

be a nonresident if he or she (1) is present in the United States 

for fewer than 183 days during the current year; (2) has a tax 

home in a foreign country during the year; and (3) has a closer connection to that country than to the United States. 

For purposes of the substantial presence test, the United 

States includes the states and the District of Columbia, but does 

not include U.S. possessions. An individual is present in the United 

States for a particular day if he or she is physically present in the 

United States during any time during such day. However, in certain circumstances an individual’s presence in the United States is 

ignored, including presence in the United States as a result of certain medical emergencies. 

U.S. income taxation of residents of U.S. possessions 

Generally, special U.S. income tax rules apply with respect to 

U.S. persons who are bona fide residents of certain U.S. possessions (i.e., Puerto Rico, Virgins Islands, Guam, Northern Mariana 

Islands and American Samoa) and who have possession source income or income effectively connected to the conduct of a trade or 

business within a possession. 

Generally, a bona fide resident of a U.S. possession (regardless 

of whether the individual is a U.S. citizen or alien) is determined 

using the principles of a subjective, facts-and-circumstances test set 

forth in the regulations under section 871. Prior to the adoption of 

present-law section 7701(b), this subjective test was used to determine whether an alien individual was a resident of the United 

States. Under these rules, an individual is generally a resident of 

the United States if an individual (1) is actually present in the 

793 

953Treas. Reg. sec. 1.871–2(b). 954 A U.S. possession with a mirror income tax code is ‘‘a United States possession * * * that 

administers income tax laws that are identifical (except for the substitution of the name of the 

possession or territory for the term ‘United States’ where appropriate) to those in the United 

States.’’ Treas. Reg. sec. 7701(b)–1(d)(1). 955Treas. Reg. sec. 1.863–6. 

United States, and (2) is not a mere transient or sojourner.953

Whether individuals are transients is determined by their intentions with regard to the length and nature of their stay. However, 

the regulations provide that section 7701(b) (discussed above) provides the basis for determining whether an alien individual is a 

resident of a U.S. possession with a mirror income tax code.954

Pursuant to regulations, the principles that generally apply for 

determining income from sources within and without the United 

States also generally apply in determining income from sources 

within and without a U.S. possession.955 The Code and regulations 

do not indicate how to determine whether income is effectively connected with the conduct of a trade or business within a U.S. possession. However, section 864(c) provides rules for determining whether income is effectively connected to a trade or business conducted 

within the United States. 

Information reporting 

Section 7654(e) provides that Treasury may require information reporting with respect to individuals that may take advantage 

of certain special U.S. income tax rules with respect to U.S. possessions. Section 6688 provides that an individual may be subject to 

a $100 penalty if the individual fails to furnish the information required by regulations issued pursuant to section 7654(e). 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision provides the term ‘‘bona fide resident’’ means a 

person who satisfies a test, determined by the Secretary, similar to 

the substantial presence test of section 7701(b)(3) with respect to 

Guam, American Samoa, the Northern Mariana Islands, Puerto 

Rico, or the Virgin Islands. 

The provision also requires bona fide residents of the Virgin Islands to file an informational income tax return with the United 

States and imposes a penalty for the failure to file such a return. 

Effective date.—The provision is effective for taxable years ending after the date of enactment. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment with 

modifications. 

The conferees understand that certain U.S. citizens and residents are claiming that they are exempt from U.S. income tax on 

their worldwide income based on a position that they are bona fide 

residents of the Virgin Islands or another possession. However, 

these individuals often do not spend a significant amount of time 

in the particular possession during a taxable year and, in some 

794 

cases, continue to live and work in the United States. Under the 

Virgin Island’s Economic Development Program, many of these 

same individuals secure a reduction of up to 90 percent of their 

Virgin Islands income tax liability on income they take the position 

is Virgin Islands source or effectively connected with the conduct 

of a Virgin Islands trade or business. The conferees are also aware 

that taxpayers are taking the position that income earned for services performed in the United States is Virgin Islands source or that 

their U.S. activities generate income effectively connected with the 

conduct of a Virgin Islands trade or business. 

The conferees believe that the various exemptions from U.S. 

tax provided to residents of possessions should not be available to 

individuals who continue to live and work in the United States. 

The conferees also believe that the special U.S. income tax rules 

applicable to residents in a possession need to be rationalized. The 

conferees are further concerned that the general rules for determining whether income is effectively connected with the conduct of 

a trade or business in a possession present numerous opportunities 

for erosion of the U.S. tax base. 

Generally, the provision provides that the term ‘‘bona fide resident’’ means a person who meets a two-part test with respect to 

Guam, American Samoa, the Northern Mariana Islands, Puerto 

Rico, or the Virgin Islands, as the case may be, for the taxable 

year. First, an individual must be present in the possession for at 

least 183 days in the taxable year. Second, an individual must (i) 

not have a tax home outside such possession during the taxable 

year and (ii) not have a closer connection to the United States or 

a foreign country during such year. 

The provision also grants authority to Treasury to create exceptions to these general rules as appropriate. The conferees intend 

for such exceptions to cover, in particular, persons whose presence 

outside a possession for extended periods of time lacks a tax avoidance purpose, such as military personnel, workers in the fisheries 

trade, and retirees who travel outside the possession for certain 

personal reasons. 

An individual is present in a possession for a particular day if 

he is physically present in such possession during any time during 

such day. In certain circumstances an individual’s presence outside 

a possession is ignored (e.g., certain medical emergencies) as provided under the principles of section 7701(b). 

The provision provides that a taxpayer must file a notice in the 

first taxable year they claim bona fide residence in a possession. 

The provision imposes a penalty of $1000 for the failure to file such 

notice or to comply with any filing required by regulation under 

section 7654(e). 

The provision generally codifies the existing rules for determining when income is considered to be from sources within a possession by providing that, as a general rule, for all purposes of the 

Code, the principles for determining whether income is U.S. source 

are applicable for purposes of determining whether income is possession source. In addition, the provision provides that the principles for determining whether income is effectively connected with 

the conduct of a U.S. trade or business are applicable for purposes 

of determining whether income is effectively connected to the conVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00798 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
795 

duct of a possession trade or business. However, the provision further provides that except as provided in regulations any income 

treated as U.S. source income or as effectively connected with the 

conduct of a U.S. trade or business is not treated as income from 

within any possession or as effectively connected with a trade or 

business within any such possession. 

The provision also grants authority to the Secretary of the 

Treasury to create exceptions to these general rules regarding possession source income and income effectively connected with a possession trade or business as appropriate. The conferees anticipate 

that this authority will be used to continue the existing treatment 

of income from the sale of goods manufactured in a possession. The 

conferees also intend for this authority to be used to prevent abuse, 

for example, to prevent U.S. persons from avoiding U.S. tax on appreciated property by acquiring residence in a possession prior to 

its disposition. 

No inference is intended as to the present-law rules for determining (1) bona fide residence in a possession, (2) whether income 

is possession source, and (3) whether income is effectively connected with the conduct of a trade or business within a possession. 

Effective date.—Generally, the provision is effective for taxable 

years ending after the date of enactment. The first prong of the 

two-part residency test (i.e., the 183-day test) is effective for taxable years beginning after date of enactment. The general effective 

date applies with respect to the second prong of such test. The rule 

providing that income treated as U.S. source income or as effectively connected with the conduct of a U.S. trade or business is not 

treated as income from within any possession or as effectively connected with the conduct of a trade or business within any such possession is effective for income earned after date of enactment. 

34. Include employer provided housing under foreign earned income exclusion cap (sec. 632 of the Senate amendment and sec. 

911 of the Code) 

PRESENT LAW

U.S. citizens generally are subject to U.S. income tax on all 

their income, whether derived in the United States or elsewhere. 

A U.S. citizen who earns income in a foreign country also may be 

taxed on such income by that foreign country. However, the United 

States generally cedes the primary right to tax income derived by 

a U.S. citizen from sources outside the United States to the foreign 

country where such income is derived. Accordingly, a credit against 

the U.S. income tax imposed on foreign source income is generally 

available for foreign taxes paid on that income, to the extent of the 

U.S. tax otherwise owed on such income. If the foreign income tax 

rate is lower than the U.S. income tax rate, then the United States 

generally provides a credit up to the amount of the foreign tax and 

imposes a residual tax to the extent of the difference. 

U.S. citizens living abroad may be eligible to exclude from 

their income for U.S. tax purposes certain foreign earned income 

and foreign housing costs, in which case no residual U.S. tax is imposed to the extent of such exclusion, regardless of the foreign tax 

rate. In order to qualify for these exclusions, an individual must be 

796 

956Only U.S. citizens may qualify under the bona fide residence test. However, resident aliens 

of the United States who are citizens of foreign countries that have a treaty with the United 

States may qualify for section 911 exclusions under the bona fide residence test by application 

of a nondiscrimination provision. 

either: (1) a U.S. citizen who is a bona fide resident of a foreign 

country for an uninterrupted period that includes an entire taxable 

year; 956 or (2) a U.S. citizen or resident present overseas for 330 

days out of any 12-consecutive-month period. In addition, the taxpayer must have his or her tax home in a foreign country. 

The foreign earned income exclusion generally applies to income earned from sources outside the United States as compensation for personal services rendered by the taxpayer. The maximum 

exclusion amount for foreign earned income is $80,000 per taxable 

year for 2002 and thereafter. For taxable years beginning after 

2007, the maximum exclusion amount is indexed for inflation. 

The exclusion for housing costs applies to reasonable expenses, 

other than deductible interest and taxes, paid or incurred by or on 

behalf of the taxpayer for housing in a foreign country but only to 

the extent the housing costs exceed a base housing amount. The 

base housing amount is equal to 16 percent of the annual salary 

earned by a GS–14, Step 1 U.S. government employee. In the case 

of housing costs that are not paid or reimbursed by the taxpayer’s 

employer, the amount that would be excludible is treated instead 

as a deduction. 

The combined foreign earned income exclusion and housing 

cost exclusion may not exceed the taxpayer’s total foreign earned 

income for the taxable year. The taxpayer’s foreign tax credit is reduced by the amount of such credit that is attributable to excluded 

income. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The provision applies the annual foreign earned income exclusion cap to the combined value of foreign earned income and employer-provided housing amounts. 

The present-law provision providing indexation for inflation for 

tax years beginning after 2007 remains unchanged. The present 

law provision imposing an additional foreign earned income cap on 

exclusions and deductions also remains unchanged. 

Effective date.—The provision is effective for taxable years beginning after December 31, 2003. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

797 

957Sec. 274(a). 958Sec. 274(e)(2). 959Sec. 274(e)(9). 960Treas. Reg. sec. 1.61–21. 961Treas. Reg. sec. 1.61–21(g). 962Treas. Reg. sec. 1.61–21(b)(6). 963Sutherland Lumber-Southwest, Inc. v. Comm., 114 T.C. 197 (2000), aff’d, 255 F.3d 495 (8th 

Cir. 2001), acq., AOD 2002–02 (Feb. 11, 2002). 

35. Deduction for personal use of company aircraft and other entertainment expenses (sec. 103(b) of the Senate amendment and 

sec. 274(e) of the Code) 

PRESENT LAW

Under present law, no deduction is allowed with respect to (1) 

an activity generally considered to be entertainment, amusement 

or recreation, unless the taxpayer establishes that the item was directly related to (or, in certain cases, associated with) the active 

conduct of the taxpayer’s trade or business, or (2) a facility (e.g., 

an airplane) used in connection with such activity.957 The Code includes a number of exceptions to the general rule disallowing deductions of entertainment expenses. Under one exception, the deduction disallowance rule does not apply to expenses for goods, 

services, and facilities to the extent that the expenses are reported 

by the taxpayer as compensation and wages to an employee.958 The 

deduction disallowance rule also does not apply to expenses paid or 

incurred by the taxpayer for goods, services, and facilities to the extent that the expenses are includible in the gross income of a recipient who is not an employee (e.g., a nonemployee director) as 

compensation for services rendered or as a prize or award.959 The 

exceptions apply only to the extent that amounts are properly reported by the company as compensation and wages or otherwise includible in income. In no event can the amount of the deduction exceed the amount of the actual cost, even if a greater amount is includible in income. 

Except as otherwise provided, gross income includes compensation for services, including fees, commissions, fringe benefits, and 

similar items. In general, an employee or other service provider 

must include in gross income the amount by which the fair value 

of a fringe benefit exceeds the amount paid by the individual. 

Treasury regulations provide rules regarding the valuation of 

fringe benefits, including flights on an employer-provided aircraft.960 In general, the value of a non-commercial flight is determined under the base aircraft valuation formula, also known as the 

Standard Industry Fare Level formula or ‘‘SIFL’’.961 If the SIFL 

valuation rules do not apply, the value of a flight on a companyprovided aircraft is generally equal to the amount that an individual would have to pay in an arm’s-length transaction to charter 

the same or a comparable aircraft for that period for the same or 

a comparable flight.962

In the context of an employer providing an aircraft to employees for nonbusiness (e.g., vacation) flights, the exception for expenses treated as compensation has been interpreted as not limiting the company’s deduction for operation of the aircraft to the 

amount of compensation reportable to its employees,963 which can 

result in a deduction multiple times larger than the amount reVerDate Aug 04 2004 22:31 Oct 27, 2004 Jkt 096542 PO 00000 Frm 00801 Fmt 6601 Sfmt 6601 E:\HR\OC\HR755.XXX HR755
798 

964 An officer is defined as the president, principal financial officer, principal accounting officer 

(or, if there is no such accounting officer, the controller), any vice-president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function, or any other person who performs similar policymaking functions. 

quired to be included in income. In many cases, the individual including amounts attributable to personal travel in income directly 

benefits from the enhanced deduction, resulting in a net deduction 

for the personal use of the company aircraft. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

Under the Senate amendment, in the case of covered employees, the exceptions to the general entertainment expense disallowance rule for expenses treated as compensation or includible in income apply only to the extent of the amount of expenses treated 

as compensation or includible in income. Covered employees are defined as under section 162(m)(3) and include the chief executive officer (or individual acting in such capacity) and the four highestcompensated officers of publicly-traded corporations. No deduction 

is allowed with respect to expenses for (1) a nonbusiness activity 

generally considered to be entertainment, amusement or recreation, or (2) a facility (e.g., an airplane) used in connection with 

such activity to the extent that such expenses exceed the amount 

treated as compensation or includible in income to the covered employee. For example, a company’s deduction attributable to aircraft 

operating costs for a covered employee’s vacation use of a company 

aircraft is limited to the amount reported as compensation to the 

employee. As under present law, the amount of the deduction cannot exceed the actual cost. 

The provision is intended to overturn Sutherland LumberSouthwest, Inc. v. Commissioner with respect to covered employees. 

As under present law, the exceptions apply only if amounts are 

properly reported by the company as compensation and wages or 

otherwise includible in income. 

Effective date.—The Senate amendment is effective for expenses incurred after the date of enactment and before January 1, 

2006. 

CONFERENCE AGREEMENT

The conference agreement follows the Senate amendment except that the provision applies with respect to individuals who, 

with respect to an employer or other service recipient, are subject 

to the requirements of section 16(a) of the Securities and Exchange 

Act of 1934, or would be subject to such requirements if the employer or service recipient were an issuer of equity securities referred to in section 16(a). Such individuals generally include officers (as defined by section 16(a)),964 directors, and 10-percent-orgreater owners of private and publicly-held companies. 

Effective date.—The conference agreement is effective for 

amounts deferred after the date of enactment. 

799 

965Treas. reg. sec. 1.1275–4. 966Treas. reg. sec. 1.1275–4(a)(4). 967Treas. reg. sec. 1.1275–4(a)(5). 968Treas. reg. sec. 1.1275–4(b). 

36. Treatment of contingent payment convertible debt instruments 

(sec. 733 of the Senate Amendment and sec. 1275 of the Code) 

PRESENT LAW

Under present law, a taxpayer generally deducts the amount 

of interest paid or accrued within the taxable year on indebtedness 

issued by the taxpayer. In the case of original issue discount 

(‘‘OID’’), the issuer of a debt instrument generally accrues and deducts, as interest, the OID over the life of the obligation, even 

though the amount of the OID may not be paid until the maturity 

of the instrument. 

The amount of OID with respect to a debt instrument is equal 

to the excess of the stated redemption price at maturity over the 

issue price of the debt instrument. The stated redemption price at 

maturity includes all amounts that are payable on the debt instrument by maturity. The amount of OID with respect to a debt instrument is allocated over the life of the instrument through a series of adjustments to the issue price for each accrual period. The 

adjustment to the issue price is determined by multiplying the adjusted issue price (i.e., the issue price increased or decreased by adjustments prior to the accrual period) by the instrument’s yield to 

maturity, and then subtracting any payments on the debt instrument (other than non-OID stated interest) during the accrual period. Thus, in order to compute the amount of OID and the portion 

of OID allocable to a particular period, the stated redemption price 

at maturity and the time of maturity must be known. Issuers of 

debt instruments with OID accrue and deduct the amount of OID 

as interest expense in the same manner as the holders of such instruments accrue and include in gross income the amount of OID 

as interest income. 

Treasury regulations provide special rules for determining the 

amount of OID allocated to a period with respect to certain debt 

instruments that provide for one or more contingent payments of 

principal or interest.965 The regulations provide that a debt instrument does not provide for contingent payments merely because it 

provides for an option to convert the debt instrument into the stock 

of the issuer, into the stock or debt of a related party, or into cash 

or other property in an amount equal to the approximate value of 

such stock or debt.966 The regulations also provide that a payment 

is not a contingent payment merely because of a contingency that, 

as of the issue date of the debt instrument, is either remote or incidental.967

In the case of contingent payment debt instruments that are 

issued for money or publicly traded property,968 the regulations 

provide that interest on a debt instrument must be taken into account (as OID) whether or not the amount of any payment is fixed 

or determinable in the taxable year. The amount of OID that is 

taken into account for each accrual period is determined by constructing a comparable yield and a projected payment schedule for 

the debt instrument, and then accruing the OID on the basis of the 

800 

969Treas. reg. sec. 1.1275–4(b)(4)(i)(A). 970 Rev. Rul. 2002–31, 2002–1 C.B. 1023. 971 Under the bill, a contingent convertible debt instrument is defined as a debt instrument 

that: (1) is convertible into stock of the issuing corporation, or a corporation in control of, or 

controlled by, the issuing corporation; and (2) provides for contingent payments. 

comparable yield and projected payment schedule by applying rules 

similar to those for accruing OID on a noncontingent debt instrument (the ‘‘noncontingent bond method’’). If the actual amount of 

a contingent payment is not equal to the projected amount, appropriate adjustments are made to reflect the difference. The comparable yield for a debt instrument is the yield at which the issuer 

would be able to issue a fixed-rate noncontingent debt instrument 

with terms and conditions similar to those of the contingent payment debt instrument (i.e., the comparable fixed-rate debt instrument), including the level of subordination, term, timing of payments, and general market conditions.969

With respect to certain debt instruments that are convertible 

into the common stock of the issuer and that also provide for contingent payments (other than the conversion feature)—often referred to as ‘‘contingent convertible’’ debt instruments—the IRS has 

stated that the noncontingent bond method applies in computing 

the accrual of OID on the debt instrument.970 In applying the noncontingent bond method, the IRS has stated that the comparable 

yield for a contingent convertible debt instrument is determined by 

reference to a comparable fixed-rate nonconvertible debt instrument, and the projected payment schedule is determined by treating the issuer stock received upon a conversion of the debt instrument as a contingent payment. 

HOUSE BILL

No provision. 

SENATE AMENDMENT

The Senate amendment provides that, in the case of a contingent convertible debt instrument,971 any Treasury regulations 

which require OID to be determined by reference to the comparable 

yield of a noncontingent fixed-rate debt instrument shall be applied 

as requiring that such comparable yield be determined by reference 

to a noncontingent fixed-rate debt instrument which is convertible 

into stock. For purposes of applying the Senate amendment, the 

comparable yield shall be determined without taking into account 

the yield resulting from the conversion of a debt instrument into 

stock. Thus, the noncontingent bond method in the Treasury regulations shall be applied in a manner such that the comparable yield 

for contingent convertible debt instruments shall be determined by 

reference to comparable noncontingent fixed-rate convertible (rather than nonconvertible) debt instruments. 

Effective date.—The Senate amendment provision is effective 

for debt instruments issued on or after date of enactment. 

CONFERENCE AGREEMENT

The conference agreement does not include the Senate amendment provision. 

801 

TITLE XI—TRADE PROVISIONS 

A. SUSPENSION OF DUTIES ON CEILING FANS

(Sec. 801 of the House bill and Chapter 99, II of the Harmonized 

Tariff Schedule of the United States) 

PRESENT LAW

A 4.7-percent ad valorem customs duty is collected on imported 

ceiling fans from all sources. 

HOUSE BILL

The House bill suspends the present customs duty applicable 

to ceiling fans through December 31, 2006. 

Effective date.—The provision is effective on the fifteenth day 

after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the House bill provision. 

B. TEMPORARY SUSPENSION OF CERTAIN CUSTOMS DUTIES

1. Suspension of duties on nuclear steam generators (sec. 802(a) of 

the House bill and Chapter 99, II of the Harmonized Tariff 

Schedule of the United States) 

PRESENT LAW

Nuclear steam generators, as classified under heading 

9902.84.02 of the Harmonized Tariff Schedule of the United States, 

enter the United States duty free until December 31, 2006. After 

December 31, 2006, the duty on nuclear steam generators returns 

to the column 1 rate of 5.2 percent under subheading 8402.11.00 

of the Harmonized Tariff Schedule of the United States. 

HOUSE BILL

The House bill extends the present-law suspension of customs 

duty applicable to nuclear steam generators through December 31, 

2008. 

Effective date.—The provision is effective on the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the House bill provision. 

802 

2. Suspension of duties on nuclear reactor vessel heads (sec. 802(b) 

of the House bill and Chapter 99, II of the Harmonized Tariff 

Schedule of the United States) 

PRESENT LAW

According to section 5202 of the Trade Act of 2002, nuclear reactor vessel heads are classified under subheading 8401.40.00 of 

the Harmonized Tariff Schedule of the United States and enter the 

United States with a column 1 duty rate of 3.3 percent. 

HOUSE BILL

The House bill temporarily suspends the present customs duty 

applicable to nuclear reactor vessel heads for column 1 countries 

through December 31, 2008. 

Effective date.—The provision is effective on the fifteenth day 

after the date of enactment. 

SENATE AMENDMENT

No provision. 

CONFERENCE AGREEMENT

The conference agreement includes the House bill provision 

with a modification. The conference agreement also temporarily 

suspends the customs duty applicable to nuclear reactor pressurizers. 

XII. TAX COMPLEXITY ANALYSIS 

The following tax complexity analysis is provided pursuant to 

section 4022(b) of the Internal Revenue Service Reform and Restructuring Act of 1998, which requires the staff of the Joint Committee on Taxation (in consultation with the Internal Revenue 

Service (‘‘IRS’’) and the Treasury Department) to provide a complexity analysis of tax legislation reported by the House Committee 

on Ways and Means, the Senate Committee on Finance, or a Conference Report containing tax provisions. The complexity analysis 

is required to report on the complexity and administrative issues 

raised by provisions that directly or indirectly amend the Internal 

Revenue Code and that have widespread applicability to individuals or small businesses. For each such provision identified by the 

staff of the Joint Committee on Taxation, a summary description 

of the provision is provided along with an estimate of the number 

and type of affected taxpayers, and a discussion regarding the relevant complexity and administrative issues. 

Following the analysis of the staff of the Joint Committee on 

Taxation are the comments of the IRS and the Treasury Department regarding each of the provisions included in the complexity 

analysis, including a discussion of the likely effect on IRS forms 

and any expected impact on the IRS. 

803 

1. Deduction relating to income attributable to United States production activities (sec. 102 of the House bill, secs. 102 and 103 

of the Senate amendment, and sec. 11 of the Code) 

Summary description of provision 

The conference agreement provides a deduction attributable to 

certain qualified production activities in the United States of a C 

corporation, S corporation, partnership, or sole proprietorship. Such 

activities generally include: (1) manufacturing, production, growth 

or extraction of certain tangible personal property, computer software, property described in section 168(f)(3) or (4) of the Code, and 

electricity, natural gas, or potable water produced by the taxpayer; 

(2) construction; and (3) engineering or architectural services. 

The amount of the deduction in taxable years beginning in 

2005, 2006, 2007, 2008, 2009, and 2010 and thereafter generally is 

three, three, six, six, six, and nine percent, respectively. The deduction is limited for a taxable year to 50 percent of the wages paid 

by the taxpayer during such taxable year. In addition, the deduction cannot exceed the lesser of the taxpayer’s taxable income (computed without regard to the deduction) or the taxpayer’s qualified 

production activities income. 

The bill is effective for taxable years beginning after 2004. 

Number of affected taxpayers 

It is estimated that the provision will affect more than 10 percent of small businesses. 

Discussion 

It is anticipated that small businesses engaged in qualified 

production activities will need to keep additional records due to 

this provision, and that extensive additional regulatory guidance 

will be necessary to effectively implement the provision. It is anticipated that the provision will result in an increase in disputes between small businesses and the IRS. Reasons for such disputes include the complexity of the provision and the inherent incentive for 

small businesses and other taxpayers to characterize their activities as qualified production activities to claim the deduction under 

the provision. 

The provision likely will increase the tax preparation costs for 

most small businesses that are, or may be, engaged in qualified 

production activities. Small businesses will have to perform additional analysis and make subjective determinations concerning 

whether their activities constitute qualified production activities 

and, thus, whether income attributable to such activities qualifies 

for the deduction allowed under the provision. In this regard, the 

provision does not provide detailed definitions of the activities that 

produce income eligible for the deduction, and it will be difficult for 

the Treasury Secretary to define qualified production activities administratively. It should be noted that a similar provision in the 

Canadian tax laws was found to be highly complex and difficult to 

administer, which led to numerous disputes and litigation between 

affected taxpayers and the Canadian tax authorities. Canada recently repealed the provision and provided a general reduction in 

corporate tax rates. 

804 

For income that is determined to be eligible for the deduction 

under the provision, small businesses will be required to perform 

additional and complex calculations to determine the amount of the 

deduction under the provision. Because the deduction is based upon 

modified taxable income rather than gross income, small businesses will be required to undertake complicated calculations to determine the amount of costs that are allocable to gross income from 

qualified production activities. In many cases, small businesses 

would not have been required otherwise to perform these calculations but for the provision. 

The wage limitation on the deduction is likely to impact small 

businesses disproportionately. After undertaking the calculations 

and analyses to determine the amount of their potential deduction, 

many small business will find that such amount is significantly reduced, or eliminated together, by the wage limitation. 

Under the provision, it may be necessary for small businesses 

to make certain allocations of income that are not required under 

present law, particularly with respect to businesses that have both 

income that is directly attributable to qualified production activities and income that is attributable to processes associated with 

qualified production activities (e.g., vertically integrated manufacturers that also engage in the selling, storage, and installation of 

manufactured goods). To the extent the reduction under the provision is not based upon income from processes associated with qualified production activities, taxpayers that engage in such processes 

will be required to allocate their aggregate income between qualified production activities and processes associated with qualified 

production activities. In general, it is expected that the multiple 

calculations and analyses required by this provision will lead to intentional or inadvertent noncompliance among small businesses, as 

well as other taxpayers. 

Due to the detailed calculations required by the pvosion, it is 

anticipated that the Secretary of the Treasury will have to make 

appropriate revisions to several types of income tax forms, schedules, spreadsheets and instructions. 

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817 

From the Committee on Ways and Means, for consideration of the House bill and the Senate amendment, and 

modifications committed to conference: 

WILLIAM M. THOMAS, PHIL CRANE, JIM MCCRERY, From the Committee on Agriculture, for consideration of 

Title VII of the House bill, and subtitle B of Title XI of the 

Senate amendment, and modifications committed to conference: 

BOB GOODLATTE, JOHN BOEHNER, CHARLIE STENHOLM, From the Committee on Education and the Workforce, for 

consideration of sections 489, 490, 616, 701, and 719 of the 

Senate amendment, and modifications committed to conference: 

JOHN BOEHNER, SAM JOHNSON, From the Committee on Energy and Commerce, for consideration of section 662 and subtitle A of Title XI of the Senate amendment, and modifications committed to conference: 

JOE BARTON, 

RICHARD BURR, 

From the Committee on the Judiciary, for consideration of 

sections 422, 442, 1111, 1151, and 1161 of the Senate 

amendment, and modifications committed to conference: 

LAMAR SMITH, 

For consideration of the House bill and the Senate amendment, and modifications committed to conference: 

TOM DELAY, 

Managers on the Part of the House. 

CHUCK GRASSLEY, 

ORRIN HATCH, 

DON NICKLES, 

TRENT LOTT, 

OLYMPIA SNOWE, 

JON KYL, 

CRAIG THOMAS, 

RICK SANTORUM, 

GORDON SMITH, 

JIM BUNNING, 

MITCH MCCONNELL, 

MAX BAUCUS, 

TOM DASCHLE, 

JOHN BREAUX, 

KENT CONRAD, 

JEFF BINGAMAN, 

BLANCHE L. LINCOLN, 

Managers on the Part of the Senate. 

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