16

C. Public Debt Reduction Checkoff and Trust Fund (Title XI
of the bill and new secs. 6097 and 9512 of the Code)

Present Law

The Presidential Election Campaign Fund (“Campaign Fund”)
provides for public financing of a portion of qualified Presidential
election campaign expenditures and certain convention costs (sec.
9001 et seq.). The Campaign Fund is financed through the vol-
untary designation by individual taxpayers on their Federal income
tax returns of $3 of tax liability, which is commonly known as the
Presidential election campaign checkoff (sec. 6096). This checkoff
can be made only by individuals (not corporations) and does not af-
fect the individual’s tax liability.11 The Treasury Department accu-
mulates revenues in the Campaign Fund over a four-year period
and then disburses funds to eligible candidates for President, Vice
President, and conventions during the Presidential election year.!?

Individuals who itemize deductions (as well as corporations) are
allowed a deduction, subject to certain limitations, for contributions
made to qualified charitable organizations or to Federal, State, and
local governments. Instructions to IRS income tax forms inform
taxpayers that they may make a gift to the Federal Government
to reduce the public debt by enclosing with their return a separate
check made payable to the “Bureau of Public Debt.” In addition,
various public laws provide that contributions to specific Federal
entities or programs are regarded as gifts to the United States.
Such contributions to the Bureau of Public Debt and to specific
Federal entities or programs are deductible if the donor itemizes
deductions for the year in which the contribution is made.

Description of Proposal

Individual taxpayers would be allowed to designate an amount
up to 10 percent of their Federal income tax liability for a taxable
year to be earmarked to reduce the Federal public debt. Such a
designation could be made only at the time the taxpayer files his
or her income tax return for a particular taxable year. An individ-
ual’s decision whether or not to make a designation under the pro-
vision would not affect his or her tax liability. If an individual has
no Federal income tax liability for a taxable year—i.e., the individ-
ual owes no Federal income tax after claiming allowable credits
(other than the EITC) and any designation to the Presidential Elec-
tion Campaign Fund—then such individual would not be allowed
to make a designation to reduce the Federal debt on his or her re-
turn for that year.

31 Prior to enactment of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993), indi-
viduals could designate $1 of their Federal income tax liability to the Campaign Fund. For cal-
endar year 1992, 20,5 milion returns, or 18 percent of the total number of individual income
tax returns, designated a total of $29.6 million in contributions to the Campaign Fund. See
Statement of Maurice B. Foley, Deputy Tax Legislative Counsel (Tax Legislation), Department
of the Treasury, before the Ways and Means Subcommittee on Select Revenue Measures, U.S.
House of Representatives, November 16, 1993.

72 A number of States provide checkotfs on their income tax forms to permit taxpayers to fund
State electoral campaigns, private charitable organizations, and State governmental programs.
Some of the State programs require taxpayers to pay additional amounts to exercise the checkoff
option, generally by accepting a smaller refund.



IV. FAMILY REINFORCEMENT ACT (E.R. 11)

A. Refundable Credit for Adoption Expenses (sec. 101 of the
bill and sec. 35 of the Code)

Present Law

Present law does not provide a tax credit for adoption expenses.
The Federal Adoption Assistance program (a Federal outlay pro-
gram) provides financial assistance for the adoption of certain spe-
cial needs children. In general, a special needs child is defined as
a child who (1) according to a State determination, could not or
should not be returned to the home of the natural parents and (2)
could not reasonably be expected to be adopted unless adoption as-
sistance is provided, on account of a specific factor or condition
(such as ethnic background, age, membership in a minority or sib-
ling group, medical condition, or physical, mental or emotional
handicap). Specifically, the program provides assistance for adop-
tion expenses for those special needs children receiving Federally
assisted adoption assistance payments as well as special needs chil-
dren in private and State funded programs. The maximum Federal
reimbursement is $1,000 per special needs child. Reimbursable ex-
penses include those associated directly with the adoption process
such as legal costs, social service review, and transportation costs.

Description of Proposal

The bill would provide taxpayers with a maximum refundable
tax credit of $5,000 per child for gualified adoption expenses paid
or incurred by the taxpayer. Qualified adoption expenses would be
reasonable and necessary adoption fees, court costs, attorneys’ fees
and other expenses that are directly related to the legal adoption
of a child. No credit would be allowed for expenses incurred in con-
nection with the violation of State or Federal law, any surrogate
parenting arrangement, or the adoption of a child of the taxpayer’s
spouse. The credit would be phased out ratably for taxpayers with
adjusted gross income (AGI) above $60,000 and would be fully
phased out at $100,000 of AGI.

To avoid a double benefit, the bill would deny the credit to tax-
payers who may use otherwise qualified adoption expenses as the
basis of another credit or deduction. Also, the credit would not be
allowed for any expenses for which a grant is received under any
Federal, State, or local program. The bill would provide that _cou-
ples who are married at the end of the taxable year must file a
joint return to receive the credit unless they lived apart for the last
six months of the taxable year and the individual claiming the
credit (1) maintained as his or her home a household for the child
for more than one-half the taxable year and (2) furnished over one-
half the cost of maintaining that household in that taxable year.

(33)



10

Computation of inflation adjustment

The inflation adjustment under the bill would be computed by
multiplying the taxpayer’s adjusted basis in the indexed asset by
the ratio of the GDP deflator for the calendar quarter in which the
disposition takes place to the GDP deflator for the calendar quarter
in which the asset was acquired by the taxpayer (or, if later, the
calendar quarter ending on December 31, 1994). The inflation ratio
would be rounded to the nearest one-thousandth. No adjustment
would be made if the inflation ratio is one or less.

Indexing with respect to any asset would end at the time the
asset is treated as disposed of for tax purposes. Thus, with respect
to installment sales, the inflation adjustment to the seller would
not take into account any periods after the sale is made. The pur-
chaser would be entitled to inflation adjustments beginning with
the date of purchase, even though the purchase price is not paid
until a later date.

In computing the inflation ratio, periods of time for which an
asset is not an indexed asset would not be taken into account. For
example, if convertible debt is converted into common stock, the pe-
riod prior to conversion would be disregarded in determining the
inflation ratio applicable to the disposition of the common stock.

Special entities
RICs and REITs

In the case of a regulated investment company (RIC) or a real
estate investment trust (REIT), the indexing adjustments provided
generally would apply in computing the taxable income and the
earnings and profits of the RIC or REIT. The indexing adjust-
ments, however, would not apply in determining whether a cor-
poration qualifies as a RIC or REIT.

In the case of shares held in a RIC or REIT, partial indexing
would be provided by the bill based on the ratio of the value of in-
dexed assets held by the entity to its total assets. This ratio would
be determined every month. However, in the case of a REIT, an ac-
tual valuation would be required only once every three years be-
cause of the cost and difficulty of more frequent valuations. If the
ratio of indexed assets to total assets exceeds 90 percent in any
month, full indexing of the shares would be allowed for that month.
Tf less than 10 percent of the assets are indexed assets in’ any
month, no indexing would be allowed for that month for the shares.

Partnerships and S corporations, etc.

Under the bill, stock in an S corporation or an interest in a part-
nership would not be an indexed asset.5 This rule avoids the com-
plexity that would result in determining the proper measure of the
basis adjustment if indexing were to take into account the fluctuat-
ing basis of the S corporation stock or partnership interest attrib-
utable to earnings ‘and distributions or to the frequently changing
mix of assets (i.e., indexed assets and other assets) of the entity.
Under the bill, the shareholder or partner would receive the benefit

5 An interest in a real estate mortgage investment conduit (“REMIC”) also would not be an
indexed asset, since a REMIC is not treated as a corporation for income tax purposes.



20

Description of Proposal

The bill would increase the $17,500 amount allowed to be ex-
pensed under Code section 179 to $25,000.

Effective Date

The provision would be effective for property placed in service in
taxable years beginning after December 31, 1995.

3. Clarification of definition of principal place of business;
Treatment of storage of product samples (secs. 12003
and 12004 of the bill and sec. 280A of the Code)

Present Law

A taxpayer’s business use of his or her home may give rise to a
deduction for the business portion of expenses related to operating
the home (e.g., a portion of rent or depreciation and repairs). Code
section 280A(c)(1) provides, however, that business deductions gen-
erally are allowed only with respect to a portion of a home that is
used exclusively and regularly in one of the following ways: (1) as
the principal place of business for a trade or business; (2) as a
place of business used to meet with patients, clients, or customers
in the normal course of the taxpayer’s trade or business; or (3) in
connection with the taxpayer’s trade or business, if the portion so
used constitutes a separate structure not attached to the dwelling
unit. In the case of an employee, the Code further requires that the
business use of the home must be for the convenience of the em-
ployer (sec. 280A(c)(1)). These rules apply to houses, apartments,
condominiums, ‘mobile homes, boats, and other similar property
(sec. 280A(A)(1)).

Prior to 1976, expenses attributable to the business use of a resi-
dence were deductible whenever they were “appropriate and help-
ful” to the taxpayer’s business. In 1976, Congress adopted section
280A, in order to provide a narrower scope for the home office de-
duction, but did not define the term “principal place of business.”
In Commissioner v. Soliman, 113 S.Ct. 701 (1993), the Supreme
Court reversed lower court rulings and upheld an Internal Revenue
Service (IRS) interpretation of section 280A that disallowed a home
office deduction for a self-employed anesthesiologist who practiced
at several hospitals but was not provided office space at the hos-
pitals. Although the anesthesiologist used a room in his home ex-
clusively to perform administrative and management activities for
his profession (i.e., he spent two or three hours a day in his home
office on bookkeeping, correspondence, reading medical journals,
and communicating with surgeons, patients, and insurance compa-
nies), the Supreme Court upheld the IRS position that the “prin-
cipal place of business” for the taxpayer was not the home office
but, rather, was at the hospitals where he performed the “essence
of the professional service.” 17 Because the taxpayer did not meet

37 In response to the Supreme Court's decision in Soliman, the IRS revised its Publication
$87, Business Use of Your Home, to more closely follow the comparative analysis used in
Soliman. by focusing, on the following two. peimary actors in determining whether a home office
isa ’s princi ines: relative importance of the activities performed
at cach business beaten ced (2) the amount of time spent at each location.



INTRODUCTION

This pamphlet, prepared hy the staff of the Joint Committee on
Taxation for the use of the Senate Committee on Finance provides
a description of present law and the tax proposals in the House Re-
publican’s proposed “Contract With America” (Contract). The Con-
tract was introduced by the House leadership when the 104th Con-
gress convened on January 4, 1995, and includes four bills which
contain various tax proposals: H.R. 6 (“American Dream Restora-
tion Act”); H.R. 9 (“Job Creation and Wage Enhancement Act”);
H.R. 8 (“Senior Citizens’ Equity Act”); and H.R. 11 (“Family Rein-
forcement Act”).

1 This pamphlet may be cited as follows: Joint Committee on Taxation, Description of Tax Pro-
posals Contained in the “Contract With America” JOS~2~95), February 7, 1995. (This pamphlet
is the same as JCS-1-95, except for the cover and introduction pages.)

@



\

31

Under the proposed regulations, a benefit qualifies as a qualified
accelerated death benefit only if it meets three requirements. First,
the accelerated death benefit can be payable only if the insured be-
comes terminally ill (as described below). Second, the amount of
the benefit must equal or exceed the present value of the reduction
in the death benefit otherwise payable.!® Third, the cash surrender
value and the death benefit payable under the policy must be re-
duced proportionately as a result of the accelerated death benefit.

For purposes of the proposed regulations, an insured is treated
as terminally ill if he or she has an illness that, despite appro-
priate medical care, the insurer reasonably expects to result in
death within 12 months from the payment of the accelerated death

enefit.

Description of Proposal

The bill would provide an exclusion from gross income for any
amount paid or advanced to an individual under a life insurance
contract if the insured under the contract is either (1) terminally
ill or (2) chronically ill and confined to a qualified facility.

For this purpose, an individual would be considered terminally
ill if a physician 19 has certified that the individual has an illness
or physical condition that reasonably can be expected to result in
death within 12 months of the certification.

A “chronically ill individual” would mean any individual who has
been certified by a licensed health care practitioner ?° as (1) being
unable to perform (without substantial assistance) at least two ac-
tivities of daily living for a period of at least 90 days due to a loss
of functional capacity, (2) having a level of disability (as deter-
mined by the Department of the ‘lreasury in consultation with the
Department of Health and Human Services) similar to the level of
disability described in (1), or (3) having a similar level of disability
due to cognitive impairment. The activities of daily living would be
defined as mobility, dressing, toileting and bathing, transferring,
and eating.

A “qualified facility” would be defined as a nursing, rehabilita-
tive, hospice, or adult day care facility (including a hospital, retire-
ment home, nursing home, skilled nursing facility, intermediate
care facility or similar institution) that is licensed under State law
or that is a certified facility for purposes of Medicare or Medicaid.
The home of a chronically ill individual would be a qualified facility
if a licensed health care practitioner certifies that, without home
care, the individual would have to be cared for in a qualified facil-
ity described in the previous sentence.

38 For of determining the present value, the maximum permissible discount rate is
the greater of () the applicable Federal rate that a lies under the discounting rules for
ety and casualty insurance loss reserves, and (2) the interest rate applicable to policy
the contract. Also, the present value is determined assuming that death benefit would
hhaye been paid 12 month after payment ofthe accelerated desth it.
Age, The term “physician” woul have the same meaning as in sec. 1861(r) of the Social Security
26 A licensed health care practitioner would be defined as any physician (as defined in sec.
18616) of the Soial Security’ Ac) and any registered professional turee, licensed social worker,
or other individual who meets such requirements as may be prescribed by the Secretary of the



17

Under the bill, amounts earmarked by taxpayers to reduce the
public debt would be transferred into a Public Debt Reduction
‘Trust Fund (“Trust Fund”), which would be used only to retire or
purchase Federal securities. The bill further would require that, on

tober 1st of each year, the Treasury Department provide Con-
gress with an estimate of the total amount of earmarked funds des-
ignated by taxpayers for debt reduction on their returns for the last
taxable year ending one year before the beginning of the current
session of Congress. Congress would then have the option of enact-
ing specific spending cuts in Federal programs to match the
amounts designated for debt reduction or, otherwise, an across-the-
board sequestration would be triggered in Federal spending for the
fiscal year. Social security payments, net interest payments on Fed-
eral debt, and funding for certain insurance funds (e.g., the Resolu-
tion Trust Corporation, Federal Deposit Insurance Corporation,
Bank Insurance Fund, National Credit Union Administration)
would be exempt from sequestration under the proposal.

Effective Date
The provision would be effective for taxable years ending after

the date of enactment, and would remain in effect until the entire
outstanding Federal public debt is retired. . ° ‘



23

ual is subject to U.S. tax at the normal graduated rates on net tax-
able income that is effectively connected with the conduct of the
U.S. trade or business. U.S. source fixed or determinable annual or
periodic income of a nonresident alien individual (for example, sal-
ary, wages, annuities, compensation, remuneration, and emolu-
ments) that is not effectively connected with the conduct of a U.S.
trade or business generally is subject to tax at a rate of 30 percent
of the gross amount paid. This latter tax generally is collected by
means of withholding (hence this tax is often called a “withholding
tax”), Withholding taxes are often reduced or eliminated in the case
of payments to residents of countries with which the United States
has an income tax treaty.

For purposes of taxing the income of nonresident, alien individ-
uals, the income thresholds for including Social Security and Rail-
road Retirement Tier 1 benefits do not apply. Instead, a fixed per-
centage of any such benefit is included in gross income. Until Janu-
ary 1, 1995, that percentage was 50 percent. Thus, prior to 1995,
a nonresident alien individual t: Seally was subject to U.S. with-
holding tax at an effective rate of 15 percent on the gross amount
of U.S. Social Security benefits. This tax was reduced or eliminated
under some treaties. Although the Omnibus Budget Reconciliation
Act of 1993 increased the inclusion of benefits in some cases for
taxpayers other than nonresident aliens (to up to 85 percent of the
benefits), it did not amend the rule that a nonresident alien indi-
vidual was required to include 50 percent (and only 50 percent) of
these benefits in gross income.

‘The implementing legislation for the General Agreement on Tar-
iffs and Trade (P.L. 103-465) increased from 50 percent to 85 per-
cent the amount of Social Security or Railroad Retirement Tier 1
benefits included in the gross income of a nonresident alien individ-
ual, effective for benefits paid after December 31, 1994, in taxable
years ending after such date. Thus, a nonresident alien individual
may be subject to U.S. withholding tax at an effective rate of 25.5
percent on the gross amount of U.S. Social Security or Railroad Re-
tirement Tier 1 benefits.

Description of Proposal

In general

‘The bill would phase in a repeal of the higher rate of income in-
clusion for taxpayers with provisional incomes in excess of the sec-
ond-tier threshold.

For taxable years beginning in calendar years 1996 through
1999, if the amount of provisional income exceeds the second-tier
threshold, then the amount of the inclusion would be calculated as
under present law, except that the following rates ‘would be sub-
stituted for “85 percent”:

The

percentage

For taxable years beginning in calendar year would be—
1996 . 0 75
1997 . 65
1998 . 60

1999 .



19

Description of Proposal

The bill would gradually increase the present-law unified credit
of $192,800 to $248,300 over a three-year period beginning in 1996.
For decedents dying and gifts made in 1996, the unified credit
would be $229,800 (i.e., the amount that would effectively exempt
$700,000 in taxable transfers from the estate and gift tax). For de-
cedents dying and gifts made in 1997, the unified credit would be
$239,050 (i.e., the amount that would effectively exempt $725,000
in taxable transfers from the estate and gift tax). For decedents
dying and gifts made after 1997, the unified credit would be
$248,300 (i.e., the amount that would effectively exempt $750,000
jn taxable transfers from the estate and gift tax).15 After 1998, the
unified credit would be indexed for inflation each year by multiply-
ing the applicable exclusion amount of $750,000 by a cost of living
adjustment.

Conforming amendments to reflect the increased unified credit
would be made (1) to the 5-percent surtax in order to permit the
proper phase out of the increased unified credit, (2) to the general
filing requirements for an estate tax return under section 6018(a),
and (3) to the amount of the unified credit allowed under section
2102(cX3) with respect to nonresident aliens with U.S. situs prop- ©
erty who are residents of certain treaty countries.

Effective Date

The provision would apply to the estates of decedents dying, and
gifts made, after December 31, 1995.

2. Increase in expensing treatment for small businesses (sec.
12002 of the bill and sec. 179 of the Code)

Present Law

In lieu of depreciation, a taxpayer with a sufficiently small
amount of annual investment may elect to deduct up to $17,500 of
the cost of qualifying property placed in service for the taxable year
(sec. 179).1© In general, qualifying property is defined as depre-
ciable tangible personal property that is purchased for use in the
active conduct of a trade or business. The $17,500 amount is re-
duced (but not below zero) by the amount by which the cost of
qualifying property placed in service during the taxable year ex-
ceeds $200,000. In addition, the amount eligible to be expensed for
a taxable year may not exceed the taxable income of the taxpayer
for the year that is derived from the active conduct of a trade or
business (determined without regard to ‘his 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). ~

1 Because the proposal effectively would exempt $750,000 in cumulative taxable transfers
after 1997, the lowest tax rate at which a tax liability would be incurred under the estate and
gift tax after 1997 is 39 percent (as opposed to 37 percent under present law).

16 ‘The $17,500 amount is increased up to $37,500 for certain property placed in service by
a business located in an enterprise zone (sec. 1397).



82
Effective Date

The provision would apply to taxable years beginning after De-
cember 31, 1995.



14

for the year that is derived from the active conduct of a trade or
busiress (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).

Description of Proposal

For MACRS property placed in service after December 31, 1994,
the bill would allow a taxpayer to elect, on a property-by-property
basis, to determine depreciation deductions under present law or
under a new neutral cost recovery system (NCRS). The following
describes the treatment of property under NCRS.

First, NCRS generally would follow MACRS but would replace
the 200-percent declining balence method of MACRS with the 150-
percent declining balance method.

In addition, depreciation for any taxable year after the year in
which the property is placed in service would be determined by
multiplying the deduction allowable for the property for the taxable
year (determined without regard to this provision) by the “applica-
ble neutral cost recovery ratio” for the year.

In the case of property that would otherwise qualify for the 200-
percent declining balance method (but for the election to use
NCRS), the applicable neutral cost recovery ratio for the year is
first determined by dividing (1) the gross domestic product deflator
for the calendar quarter ending in such taxable year which cor-
responds to the calendar quarter during which the property was
placed in service by the taxpayer by (2) the gross domestic product
deflator for the calendar quarter during which the property was
placed in service by the taxpayer. This ratio is then multiplied by
the number equal to 1.035 to the nth power, where “n” is the num-
ber of full years in the period beginning on the first day of the cal-
endar quarter during which the property was placed in service and
ending on the day before the beginning of the corresponding cal-
endar quarter ending during the taxable year. In the case of other
MACRS property (e.g., longer-lived property and property to which
the alternative depreciation system applies), the applicable neutral
cost recovery ratio for the year is determined by dividing (1) the
gross domestic product deflator for the calendar quarter ending in
such taxable year which corresponds to the calendar quarter during
which the property was placed in service by the taxpayer by (2) the
gross domestic product deflator for the calendar quarter during
which the property was placed in service by the taxpayer. For any
property, the applicable neutral cost recovery ratio may not be less
than 1 and is rounded to the nearest one-thousandth.

The applicable neutral cost recovery ratio is also applied for pur-
poses of determining depreciation under the alternative minimum
tax (including the adjusted current earnings adjustment of the cor-
porate alternative minimum tax).

The application of the applicable neutral cost recovery ratio gen-
erally would not be taken into account for purposes of (1) determin-



6

70¥2, and the minimum distribution rules that apply to IRAs would
not apply to ADS accounts.?

Qualified distributions from an ADS account would not be includ-
ible in gross income, nor subject to the additional 10-percent tax on
early withdrawals. A qualified distribution would be a distribution
that is made after the 5-taxable year period? beginning with the
first taxable year in which the individual made a contribution to
an ADS account, and (2) which is (a) made on or after the date on
which the individual attains age 59¥2, (b) made to a beneficiary (or
to the individual’s estate) on or after the death of the individual,
(c) attributable to the individual’s being disabled, or (d) a qualified
special Re se distribution.

Qualified special purpose distributions would be distributions for
the purchase or acquisition of a principal residence of a first-time
homebuyer, for higher education nses of the taxpayer, the tax-
payer’s spouse, or the taxpayer’s child or grandchild, for medical

nses, or for long-term care insurance premiums.

istributions from an ADS account other than qualified distribu-
tions would be includible in gross income under the rules applica-
ble to distributions from IRAs and subject to the 10-percent tax on
early withdrawals.

Distributions from ADS accounts could be rolled over tax free to
another ADS account. In addition, amounts withdrawn from an
IRA could be rolled over to an ADS account after December 31,
1995, and before January 1, 1998. The amount otherwise includible
in gross income due to the IRA distribution would be included in
gross income ratably over the 4-taxable year period beginning with
the taxable year in which the distribution is made. The early with-
drawal tax would not apply to such rollovers.

Effective Date

The provision would be effective for taxable years beginning after
December 31, 1995.

2 In general, the minimum distribution rules require that distributions from an IRA begin
bectoed than age 70%. Tax penalties are imposed if minimum distributions are not made as

3 In the case of rollover contributions that are not from another ADS account, the 5-year hold-
ing period would begin on the date on which the rollover was made.



29

Effective Date

The provisions generally would be effective for taxable years be-
ginning after December 31, 1995.

Any policy issued before January 1, 1996, which met the require-
ments for long-term care insurance of the State in which the policy
was sitused at the time the policy was issued would be treated as
a qualified long-term care insurance contract, and services provided
under such a policy would be treated as qualified long-term care
services.

Long-term care insurance contracts could be exchanged tax free
for qualified long-term care insurance contracts between the date
of enactment and January 1, 1996. The cancellation of a policy and
reinvestment of the cancellation proceeds in a qualified jongterm
care insurance contract within 60 days would be treated as an ex-
change. Taxable gain would be recognized to the extent money and
property other than a qualified long-term care insurance contract
is received in the exchange.

The issuance of a rider on a life insurance contract providing
long-term care insurance coverage would not be treated as a modi-
fication or material change of such contract for purposes of deter-
mining whether Code section 7702 (relating to the definition of life
insurance contract) or section 7702A (relating to the definition of
modified endowment contract) applies. :



26

electing continuation coverage can be required to pay for such cov-
erage.

Description of Proposals
In general

The bill would provide that long-term care insurance contracts
that meet the requirements of the bill (“qualified long-term care in-
surance contracts”) receive the tax treatment set forth in the bill.
Other long-term care contracts would continue to be subject to
present law.

Similarly, the bill would provide a safe harbor with respect to the
deductibility of certain expenses for long-term care services. Ex-
penses for services that satisfy the requirements of the bill would

e deductible as medical expenses. Expenses for services that do
not satisfy such requirements would continue to be subject to
present law.

Qualified long-term care insurance

In order to receive the tax treatment set forth in the bill, a long-
term care insurance contact would have to meet certain require-
ments (ie., be a “qualified long-term care insurance contact”).
Under the bill, a qualified long-term care insurance contract would
be defined as any insurance contract the meets the following re-
quirements: (1) the only insurance protection provided under such
contract is coverage of qualified long-term care services (as defined
under the bill) and benefits incidental to such coverage; (2) if Medi-
care is the primary payor, the contract does not cover expenses
that are reimbursable under Medicare (or would be reimbursable
but for the application of a deductible or coinsurance amount); (3)
the contract is guaranteed renewable; (4) the contract does not
have any cash surrender value; and (5) all refunds of premiums
(other than refunds on surrender or cancellation of the contract),
and all policyholder dividends or similar amounts under the con-
tract are to be applied as a reduction in future premiums or to in-
crease future benefits. Under the bill, a qualified long-term care
contract could pay benefits either in the form of reimbursement for
expenses or on a per diem or other periodic basis without regard
to expenses.

Except as provided in Treasury regulations, in the case of long-
term care insurance coverage provided by a rider on a life insur-
ance contract, the requirements for a qualified long-term care in-
surance contract under the bill would apply as if the portion of the
contract that provides long-term care insurance were a separate
contract,

Definition of qualified long-term care services

The bill would define “qualified long-term care services” as nec-
essary diagnostic, preventive, therapeutic, rehabilitative, and main-
tenance or personal care services, that (1) are required by a chron-
ically ill individual in a qualified facility, and (2) are provided pur-
suant to a plan of care prescribed by a licensed health care practi-
tioner. A “chronically ill individual” would mean any individual
who has been certified by a licensed health care practitioner as (1)



3

would satisfy the relationship test if the individual is a son; step-
son, daughter, or stepdaughter of the taxpayer, a descendent of a
son or daughter of the taxpayer, or a foster or adopted child of the
taxpayer. A foster child would be defined as an individual whom
the taxpayer cares for as the taxpayer’s own child. An adopted
child would include a child who is legally adopted or who is placed
with the taxpayer by an authorized placement agency for adoption
by the taxpayer. Tf the qualifying child is married at the close of
the taxpayer's taxable year, the taxpayer generally must be enti-
tled to a dependency deduction for the taxable year with respect to
such qualifying child in order to claim the credit.

An individual would satisfy the residency test if the individual _
has the same principal place of abode as the taxpayer for more
than half the taxable year (the entire year for foster children). The
determination of whether the residency requirement is met would
be made under rules similar to those applicable with respect to
whether an individual meets the requirements for head-of-house-
hoid filing status. Thus, for example, certain temporary absences
due to education or illness would be disregarded for purposes of de-
termining whether the child had the same principal place of abode
as the taxpayer for over half the year. Also, the residence would
have to be in the United States. .

An individual would satisfy the age test if the individual has not
attained the age of 18 as of the close of the calendar year in which
the taxable year of the taxpayer begins.

The maximum amount of credit, regardless of the number of
qualifying children, could not exceed an amount equal to the sum
of: (1) the taxpayer's income tax liability (net of applicable credits),
and (2) the taxpayer’s Railroad Retirement Tier 1 tax and Social
Security tax (SECA and the employee and employer share of
FICA), less the taxpayer’s allowable EITC amount. For these pur-
poses, Social Security tax would not include any amounts to the ex-
tent the taxpayer is entitled to a special refund under section
6413(c) (relating to overpayment of certain employment taxes).
Also, any amounts paid pursuant to an agreement under section
3121() (relating to agreements entered into by American employers
with respect to foreign affiliates) would be treated as Social Secu-
rity tax for purposes of this credit.

The bill would provide that couples who are married at the end
of the taxable year must file a joint return to receive the credit un-
less they lived apart for the last six months of the taxable year and
the individual claiming the credit (1) maintained as his or her
home a household for the qualifying child for more than one-half
the taxable year and (2) furnished over one-half the cost of main-
taining that household in that taxable year.

Effective Date

The provision would be effective for taxable years beginning after
December 31, 1995.



I. AMERICAN DREAM RESTORATION ACT (H.R. 6)

A. Family Tax Credit (sec. 2 of the bill and sec. 35 of the
Code)

Present Law

Present law does not provide tax credits based solely on the num-
ber of dependent children. Taxpayers with dependent children,
however, generally are able to claim a personal exemption for each
of these dependents. The total amount of personal exemptions is
subtracted (along with certain other items) from adjusted gross in-
come (AGI) in arriving at taxable income. The amount of each per-
sonal exemption is $2,500 for 1995, and is adjusted annually for in-
flation. The amount of the personal exemption is phased out for
taxpayers with AGI in excess of $114,700 for single taxpayers,
$143,350 for heads of household, and $172,050 for married couples
filing joint returns.

In addition, eligible low-income workers are able to claim a re-
fundable earned income tax credit (EITC). The amount of the credit
an eligible taxpayer may claim depends upon whether the taxpayer
has one, more than one, or no qualifying children, and is deter-
mined by multiplying the credit rate by the taxpayer's earned in-
come up to an earned income threshold. The maximum amount of
the credit is the product of the credit rate and the earned income
threshold. In 1995, the maximum credit is $3,112 for taxpayers
with more than one qualifying child, $2,093 for taxpayers with one
qualifying child, and $314 for taxpayers with no qualifying chil-

ren. For taxpayers with earned income (or AGI, if greater) in ex-
cess of the phaseout threshold, the credit amount is reduced by the
phaseout rate multiplied by the amount of earned income (or AGI,
if greater) in excess of the phaseout threshold. The credit is not al-
lowed if earned income (or AGI, if greater) exceeds the phaseout
limit. In 1995, the phaseout limit is $26,676 for taxpayers with
more than one qualifying child, $24,388 for taxpayers with one
qualifying child, and $9,234 for taxpayers with no qualifying chil-

ren.

Description of Proposal

The bill would provide taxpayers with a maximum refundable
tax credit of $500 for each qualifying child.

The credit would be phased out ratably for taxpayers with AGI
over $200,000, and would be fully phased out at AGI of $250,000.
In calendar years beginning after 1996, the maximum credit
amounts and beginning point of the phaseout range would be in-
dexed annually for inflation.

To be a qualifying child, an individual would have to satisfy a
relationship test, a residency test, and an age test. The individual

(2)



15

ing the adjusted basis of depreciable property® or any interest in
a pass-thru entity (as defined in proposed sec. 1201(d)(2)); (2) deter-
mining earnings and profits; or 8 the recapture provisions of sec-
tions 1245 and 1250.

NCRS would not apply to any property for which the taxpayer
so elects!° or to property placed in service pursuant to certain
churning transactions.

Effectivé Date

The provision would be effective for qualifying property placed in
service after December 31, 1994,

® The additional deductions allowed by the provision would increase the “unrecovered basis”
ofa poseenger automobile to the extent such deductions are not allowed by reason of section

10 ‘Any election, once made, would be irrevocable.



5

C. Establishment of American Dream Savings Accounts (sec. ~
4 of the bill and sec. 408A of the Code)

Present Law

Under present law, an individual may make deductible contribu-
tions to an individual retirement arrangement (IRA) up to the less-
er of $2,000 or the individual’s compensation if the individual is not
an active participant in an employer-sponsored retirement plan
(and, if married, the individual’s spouse also is not an active partic-
ipant in such a plan). If the individual (or the individual’s spouse)
is an active participant in an employer-sponsored retirement plan,
the $2,000 deduction limit is phased out over certain adjusted gross
income (AGI) levels. The limit is phased out between ,000 and
$80,000 of AGI for married taxpayers, and between $25,000 and:

35,000 of AGI for single taxpayers. An individual may make non-
deductible IRA contributions to the extent the individual is not per-
mitted to make deductible IRA contributions. . 7

The amounts held in an IRA, including earnings on contribu-
tions, generally are not subject to tax until withdrawn. Amounts
withdrawn prior to attainment of age 59¥2 are subject to an addi-
tional 10-percent early withdrawal tax, unless the withdrawal is
due to death, disability, or is made in the form of certain periodic
payments. A similar early withdrawal tax applies to distributions

m tax-qualified pension plans, with an additional exception for
distributions used to pay medical expenses that exceed 7.5 percent
of AGI. This exception for distributions to pay extraordinary medi-
cal expenses does not apply to withdrawals from IRAs.

Description of Proposal

The bill would permit individuals to establish and maintain an
American Dream Savings Account (ADS account) to which they can
make nondeductible contributions. Contributions to an ADS ac-
count would be in addition to any contributions that can be made
to an IRA under the present-law rules. An ADS account would be
an IRA which is designated at the time of establishment as an ADS
account. Qualified distributions from an ADS account would not be
includible in income.

The maximum annual contribution that could be made to an
ADS account would be the lesser of $2,000 or the individual’s com-
pensation for the year. In the case of a married couple, the aggre-
gate compensation of the couple would be taken into account in de-
termining the maximum permitted contribution. Thus, for example,
in 1996 both spouses in a married couple could each make an ADS
contribution of $2,000 (for a total contribution by the couple of
$4,000), provided the couple has at least $4,000 in compensation.
The $2,000 contribution limit would be adjusted annually for infla-
tion beginning after 1996. Inflation adjustments would be rounded
to the nearest $50.

Contributions to an ADS account could be made even after the
individual for whom the account is maintained has attained age



21

with patients at his home office and the room was not a separate
structure, a deduction was not available under the second or third
exception under section 280A(c)(1) (described above).

Section 280A(c\2) contains a special rule that allows a home of-
fice deduction for business expenses related to a space within a
home that is used on a regular (even if not exclusive) basis as a
storage unit for the inventory of the taxpayer’s trade or business
of selling products at retail or wholesale, but only if the home is
the sole Eted location of such trade or business.

Description of Proposal

The bill would amend present-law section 280A to specifically
provide that a home office qualifies as the ‘Principal place of busi-
ness” if (1) the office is the location where the taxpayer's essential
administrative or management activities are conducted on a regu-
lar and systematic (and not incidental) basis by the taxpayer, and
(2) the office is necessary because the taxpayer has no other loca-
tion for the performance of the administrative or management ac-
tivities of the business. As under present law, deductions would be
allowed for a home office meeting the above two-part test only if
the office is used exclusively as a place of business by the taxpayer,
and in the case of an employee, only if such exclusive use is for the
convenience of the employer. . oe

In addition, the bill would clarify that the special rule contained
in present-law section 280A(c)(2) permits deductions for expenses
related to a storage area in a taxpayer’s home regularly used for
inventory or product samples (or both) of the taxpayer's trade or
business of selling products at retail or wholesale, provided that
the home is the sole fixed location of such trade or business.

As under present law, home office expenses deductions may not
be claimed if they create (or increase) a net loss from a business
activity, although such deductions may be carried over to subse-
quent taxable years (sec. 280A(c)(5)).

Effective Date
The provision would apply to taxable years beginning after 1995.



[JOINT COMMITTEE PRINT]

DESCRIPTION OF TAX PROPOSALS
CONTAINED IN THE
“CONTRACT WITH AMERICA”
(ELR. 6, H.R. 9, H.R. 8, and H.R. 11)

PREPARED FOR THE USE

OF THE
SENATE COMMITTEE ON FINANCE

By THE STarF

_ OFTHE

JOINT COMMITTEE ON TAXATION

FEBRUARY 7, 1995

U.S. GOVERNMENT PRINTING OFFICE,
87-843 WASHINGTON : 1995 JCS-2-95

For sale by the U.S. Government Printing Office
‘Superintendeitt’6f Documents, Mail Stop: SSOP, Washington, DC 20402-9328
ISBN 0-16-046730-6



8

tions were required to use two dollars of long-term capital loss to
offset each dollar of ordinary income.

Description of Proposal

The bill would alia all taxpayers (both individual and corporate)
a deduction equal to 50 percent of net capital gain for the taxable
year. The bill would repeal the present-law maximum 28-percent
rate. Thus, the effective rate on the net capital gain of an individ-
ual in the highest (ie., 39.6 percent) rate bracket would be 19.8
percent, and the effective rate for a corporation in the 35-percent
bracket would be 17.5 percent.

The bill would repeal the provisions in the Revenue Reconcili-
ation Act of 1993 providing a capital gain exclusion for sales of cer-
tain small business stock.

The bill would reinstate the rule in effect prior to the 1986 Tax
Reform Act that required two dollars of the long-term capital loss
of an individual to offset one dollar of ordinary income. The $3,000
limitation on the deduction of capital losses against ordinary in-
come would continue to apply.

Numerous conforming amendments would be made generally to
reinstitute the capital gains deduction system in effect prior to the
Tax Reform Act of 1986.

Effective Date

The provision generally would apply to taxable years ending
after December 31, 1994.

For a taxpayer’s 1994-95 fiscal year or for the 1995 calendar
year of a taxpayer holding interests in one or more 1994-95 fiscal
year pass-thru entities, the 50-percent capital gains deduction
would apply to the lesser of (1) the net capital gain for the taxable
year, or (2) the net capital gain determined by taking into account
gain or loss properly taken into account for the portion of the tax-
able year on or after January 1, 1995. In the case of a taxpayer
other than « corporation, any net capital gain not eligible for the
50-percent. capital gains deduction would be subject to the present-
law maximum rate of 28 percent. This generally has the effect of
applying the 50-percent deduction to capital assets sold or ex-
changed (or installment payments received) on or after January 1,
1995, and, in the case of noncorporate taxpayers, subjecting gains
from capital assets sold before that date to a maximum rate of 28
percent.

In the case of gain taken into account by a pass-thru entity (ie.,
a RIC, a REIT, an S corporation, a partnership, an estate or trust,
or a common trust fund), the date taken into account by the entity
is the appropriate date for applying the rule in the preceding para-
graph. Thus, gain taken into account by a fiscal-year pass-thru en-
tity in 1994 which an owner takes into account on its calendar-year
1995 income tax return would not be eligible for the new capital
gains deduction.



Il. JOB CREATION AND WAGE ENHANCEMENT ACT
GR, 9)

A. Capital Gains Reforms (Title ID

1. 50-percent capital gains deduction (sec. 1001 of the bill
and secs. 1201 and 1202 of the Code)
Present Law

In general, gain or loss reflected in the value of an asset is not
recognized for income tax purposes until a taxpayer disposes of the
asset. On the sale or exchange of capital assets, the net capital
gain is taxed as ordinary income, except that taxpayers other than
corporations are subject to a maximum marginal rate of 28 percent
of the net capital gain, Net capital gain is the excess of the net
long-term capital gain for the taxable year over the net short-term
capital loss for the year. Gain or loss is treated as long-term if the
asset is held more than one year.

A capital asset generally means any property except (1) inven-
tory, stock in trade, or property held primarily for sale to cus-
tomers in the ordinary course of the taxpayer's trade or business,
(2) depreciable or real property used in the taxpayer's trade or
business, (3) specified literary or artistic property, (4) business ac-
counts or notes receivable, or (5) certain U.S. publications. In addi-
tion, the net gain from the disposition of certain property used in
the taxpayer’s trade or business is treated as long-term capital
gain. Gain from the disposition of depreciable personal property is
not treated as capital gain to the extent of all previous depreciation
allowances. Gain from the disposition of depreciable re: property
is generally not treated as capital ain to the extent of the depre-
ciation allowances in excess of the allowances that would have been
available under the straight-line method.

The Revenue Reconciliation Act of 1993 provided a 50-percent ex-
clusion for gain from the sale of certain small. business stock ac-
quired at original issue and held for at least five years. One-half
of the excluded amount is a minimum tax preference.

Prior to the enactment of the Tax Reform Act of 1986, individ-
uals were allowed a deduction equal to 60 percent of net capital
gain. This resulted in a maximum tax rate of 20 percent on such
gains. Corporations were taxed a maximum rate of 28 percent on
any net capital gain.

‘apital losses are generally deductible in full against capital
gains. In addition, taxpayers other than corporations may deduct
capital losses against up to $3,000 of ordinary income in each year.
Capital losses in excess of the amount deductible are carried for-
ward indefinitely in the case of individuals, and generally carried
back three years and forward five years in the case of corporations.
Prior to the Tax Reform Act of 1986, taxpayers other than corpora-

1)



28

Long-term care services treated as medical care

The bill would provide that expenses for qualified long-term care
services are treated as expenses for medical care for purposes of
the itemized deduction for medical expenses. Thus, under the bill,
a taxpayer would be allowed an itemized deduction for unreim-
bursed expenses that are paid by the taxpayer during any taxable
year for qualified long-term care services that are provided to the
taxpayer, the taxpayer's spouse, or a dependent of the taxpayer, to
the extent that such expenses and other eligible medical expenses
of the taxpayer exceed 7.5 percent of adjusted gross income.

In addition, under the bill, eligible medical expenses for purposes
of the medical expense deduction would, within certain limits, in-
clude premiums paid for qualified long-term care insurance. Eligi-
ble long-term care premiums would be premiums for qualified long-
term care insurance that do not exceed the following amounts:

In the case of an individual with an attained age The limitation
before the close of the taxable year of is

Not more than 40 $200
More than 40 but not more than 50 . 375
More than 50 but not more than 60 . 750
More than 60 but not more than 70 . 2,000
More than 70 2,500

Beginning after 1995, these dollar limits would be indexed for in-
creases in the medical care cost component of the consumer price
index.

Exchanges of life insurance contracts for long-term care in-
surance contracts

The bill would provide that the exchange of a life insurance con-
tract for a qualified long-term care insurance contract is not tax-
able,

Exclusion from income for amounts withdrawn from IRAs
and section 401(k) plans for long-term care insurance

The bill would provide that distributions from individual retire-
ment arrangements (IRAs) and qualified cash or deferred arrange-
ments (sec. 401(k) plans) are excludable from gross income to the
extent used to pay premiums on a qualified long-term care insur-
ance contract. In the case of distributions from a section 401(k)
plan, such tax treatment would apply only to distributions of elec-
tive deferrals. A section 401(k) plan would not fail to be a qualified
cash or deferred arrangement merely because it permits distribu-
tions which are excludable from income under the bill.

Treasury report

The bill would direct the Secretary of the Treasury to submit to
the Congress no later than October 1, 1995, a report detailing the
Treasury’s interpretation of the treatment of long-term care insur-
ance contracts that are not qualified long-term care contracts.



27

being unable to perform (without substantial assistance) at least
two activities of daily living (ADLs) for a period of at least 90 days
due to a loss of functional capacity, (2) having a level of disability
(as determined by the Secretary of the Treasury in consultation
with the Secretary of Health and Human Services) similar to the
level of disability described in (1), or (3) having a similar level of
disability due to cognitive impairment. .

The ADLs would be defined as mobility, dressing, toileting and
bathing, transferring, and eating. A “qualified facility” would be de-
fined as a nursing, rehabilitative, hospice, or adult day care facility
(including a hospital, retirement home, nursing home, skilled nurs-
ing facility, intermediate care facility or similar institution) that is
licensed under State law or that is a certified facility for purposes
of Medicare or Medicaid. The home of a chronically ill individual
would be a qualified facility if a licensed health care practitioner
certifies that, without home care, the individual would have to be
cared for in a qualified facility described in the previous sentence.

A licensed health care practitioner would be defined as any phy-
sician (as defined in sec. 1861(r) of the Social Security Act) and any
registered professional nurse, licensed social worker, or other indi-
vidual who meets such requirements as may be prescribed by the
Secretary of the Treasury.

Insurance company taxation

The bill would generally provide that, for purposes of the Inter-
nal Revenue Code rules relating to taxation of insurance compa-
nies, a qualified long-term care insurance contact would be treated
as accident or health insurance. In determining reserves for insur-
ance company taxation purposes, the reserve method for qualified
long-term insurance contacts would be a 1-year full preliminary
term method.

Continuation coverage

The bill would provide that the health care continuation rules do
not apply to coverage under’a qualified long-term care insurance
contract.

Exclusion for benefits provided under long-term care insur-
ance; exclusion for employer-provided coverage

The bill would provide that benefits paid under a qualified long-
term care insurance contract are excludable from gross income. to
the extent the benefits do not_exceed $200 per day (indexed for in-
flation after 1995). The $200 limit is applied separately to each
qualified long-term care contract. In addition, employer contribu-
tions for qualified long-term care insurance would be excludable
from gross income. In applying the bill’s $200 limit on daily cov-
erage under a qualified long-term care insurance contract for pur-
poses of this exclusion, all contracts provided to the employee by
the same employer would be aggregated. The bill would not permit
qualified long-term care coverage to be provided through a cafeteria
plan.



4

B. Credit to Reduce the Marriage Penalty (sec. 3 of the bill
and new sec. 23 of the Code)

Present Law

A married couple generally is treated as one tax unit that must
pay tax on the unit’s total taxable income. Although married cou-
ples may elect to file separate returns, the rate schedules and pro-
visions are structured so that filing separate returns usually re-
sults in a higher tax than filing joint returns. Other rate schedules
apply to single persons and to single heads of household.

A “marriage penalty” exists when the sum of the tax liabilities
of two unmarried individuals filing their own tax returns (either
single or head of household returns) is less than their tax liability
under a joint return (if the two individuals were to marry). A “mar-
riage bonus” exists when the sum of the tax liabilities of the indi-
viduals is greater than their combined tax liability under a joint re-
turn.

While the size of any marriage penalty or bonus under present
law depends upon the individuals’ incomes, number of dependents,
and itemized deductions, a general rule is that married couples
whose earnings are split relatively evenly (between 50-50 and 70—
30) suffer a marriage penalty. Married couples whose earnings are
jargely attributable to one spouse generally receive a marriage

onus.

Description of Proposal

Married couples who file a joint return and have a larger tax li-
ability than if they were unmarried and filed individual returns
would be eligible for a nonrefundable credit against their income
tax liability. The amount of the credit would be determined by the
Department of the Treasury so that the estimated reduction in rev-
enues to the Treasury would not exceed $2 billion per fiscal year.
In no event would the credit for a particular taxpayer be larger
than the size of the marriage penalty the couple would face without
the provision.

Effective Date

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



18

D. Small Business Incentives (Title XII)

1. Increase in unified estate and gift tax credits (sec. 12001
of the bill and secs. 2001(c), 2010, 2102(c)(3), 2505(a) and
6018(a) of the Code)

Present Law

Application of the estate and gift tax

A gift tax is imposed on lifetime transfers and an estate tax is
imposed on transfers at death. Since 1976, the gift tax and the es-
tate tax have been unified so that a single graduated rate schedule
applies to cumulative taxable transfers made by a taxpayer during
his or her lifetime and at death.13 Under this rate schedule, the
unified estate and gift tax rates begin at 18 percent on the first
$10,000 in cumulative taxable transfers and reach 55 percent on
cumulative taxable transfers over $3 million.

The amount of gift tax payable for any calendar year generally
is determined by multiplying the applicable tax rate (from the uni-
fied rate schedule) by the cumulative lifetime taxable transfers
made by the taxpayer and then subtracting any gift taxes payable
for prior taxable periods. This amount is reduced by any available
unified credit (and other applicable credits) to determine the gift
tax liability for the taxable period.

The amount of estate tax payable generally is determined by
multiplying the applicable tax rate (from the unified rate schedule)
by the cumulative post-1976 taxable transfers made by the tax-
payer and then subtracting any gift taxes payable for prior cal-
endar years (after 1976). This amount is reduced by any. available
unified credit (and other applicable credits) to determine the estate
tax liability.

Unified credit

A unified credit is available with respect to taxable transfers by
gift and at death. Since 1987, the unified credit amount has been
fixed at $192,800, which effectively exempts a total of $600,000 in
cumulative taxable transfers from the estate and gift tax. The ben-
efits of the unified credit (and the graduated estate and gift tax
rates) are phased out by a 5-percent surtax imposed upon cumu-
lative taxable transfers over $10 million and not exceeding
$21,040,000.14

The unified credit was originally enacted in the Tax Reform Act
of 1976. As enacted, the credit was phased in over five years toa
level that effectively exempted $175,625 of taxable transfers from
the estate and gift tax in 1981 (ie., a unified credit of $47,000).
The Economic Recovery Tax Act of 1981 increased the amount of
the unified credit each year between 1982 and 1987, from an effec-
tive exemption of $225,000 in 1982 to an effective exemption of
$600,000 in 1987. The unified credit has not been increased since
1987. .

38 Prior to 1976, separate tax rate schedules applied to the gift tax and the estate tax.
¥4 Thus, if a taxpayer has made cumulative taxable transfers exceeding $21,040,000, his or
her effective transfer tax rate will be 55 percent under present law.



35

B. Refundable Credit for Custodial Care of Certain Elderly
Dependents in T: er’s Home (sec. 201 of the bill and
new sec. 36 of the Code)

Present Law

Generally, present law does not provide for tax credits based
solely on custodial care of parents or grandparents. However, tax-
payers with dependent parents generally are able to claim a per-
sonal exemption for these dependents. The total amount of per-
sonal exemptions is subtracted (along with certain other items)
from adjusted gross income (AGI) in arriving at taxable income,
The amount of each personal exemption is $2,500 for 1995, and is
adjusted annually for inflation. The amount of the personal exemp-
tion is phased out for taxpayers with AGI in excess of $114,700 for
single taxpayers, $143,350 for heads of households, and $172,050
for married couples filing joint returns.

Description of Proposal

The bill would provide taxpayers who maintain a household in-
cluding one or more “qualified persons” with a maximum refund-
able credit of $500 for each qualified person.

To be a “qualified person,” an individual would have to pass a
relationship test, a residency test and a disability test. The individ-
ual would satisfy the relationship test if the individual is a (1) fa-
ther, stepfather, mother or stepmother of either the taxpayer: the
taxpayer’s spouse or the taxpayer’s former spouse, or (2) a father,
stepfather, mother or stepmother of one of the people described in

().

An individual would satisfy the residency test if the individual
has the same principal place of abode as the taxpayer for more
than half of the taxable year.

An individual would satisfy the disability test if the individual is
certified by a physician as being unable to perform at least two ac-
tivities of daily living without substantial assistance from another
individual. A physician would include a doctor of medicine or oste-
opathy who is legally authorized to practice medicine or surgery in
the jurisdiction where the certification takes place.

The activities of daily living would include bathing, dressing,
toileting, transfer, and eating. Bathing would be the overall com-
plex behavior of getting water and cleansing the whole body, in-
cluding turning on the water for the bath, shower, or sponge bath,
getting to, in, and out of a tub or shower, and washing and drying
oneself. Dressing would be the overall complex behavior of getting
clothes from closets and drawers and then getting dressed.
Toileting would be the act of going to the toilet room for bowel or
bladder function, transferring on and off the toilet, cleaning after
elimination, and arranging clothes. Transfer would be the process
of getting in or out of bed or in or out of a chair or wheelchair. Eat-
ing would be the process of getting food from a plate or its equiva-
lent into the mouth.

The bill would provide that an individual would be treated as
maintaining a household for any period only if over one-half the
cost of maintaining a household for such period is furnished by



36

such individual or, if such individual is married, by such individual
and his or her spouse, The bill would also provide that individuals
who are married at the end of the taxable year must file a joint
return to receive the credit unless they lived apart for the last six
months of the taxable year and the individual claiming the credit
(1) maintained as his or her home a household for the qualified
person for more than one-half the taxable year and (2) furnished
over one-half of the cost of maintaining that household in that tax-
able year. Finally, the bill would provide that an individual legally
separated from his or her spouse under a decree of divorce or of
separate maintenance would not be considered married for pur-
poses of this provision.

Effective Date

The provision would be effective for taxable years beginning after
December 31, 1995.

oO

ISBN 0-16-046730-6
90000

9 780160°467301



24

For taxable years beginning after December 31, 1999, Social Se-
curity and Railroad Retirement Tier 1 benefits would be treated as
under the law prior to 1994: if the amount of provisional income
exceeds $25,000 in the case of unmarried taxpayers or $32,000 in
the case of married taxpayers filing joint returns, then the amount
of the inclusion would be the lesser of (1) 50 percent of the tax-
payer's Social Security or Railroad Retirement Tier 1 benefit, or (2)
50 percent of the excess of the taxpayer’s provisional income over
the threshold.

Treatment of nonresident alien individuals

The bill would phase in a reduction in the amount of Social Secu-
rity or Railroad Retirement Tier 1 benefits included in the gross in-
come of a nonresident alien individual. The inclusion percentage for
any taxable year beginning in calendar years 1996 through 1999
would be as given in the table above. For taxable years beginning
after December 31, 1999, the amount of Social Security or Railroad
Retirement Tier 1 benefits included in the gross income of a non-
resident alien individual would be 50 percent.

Effective Date

The provision would be effective for taxable years beginning after
December 31, 1995.



Vv

Page
B. Treatment of Long-Term Care (secs. 301-305,
and 307) 25
C. Tax Treatment of Accelerated Death Benefits
under Life Insurance Contracts (sec. 306) ........... 30
IV. FAMILY REINFORCEMENT Act (H.R. 11) 33
A. Refundable Credit for Adoption Expenses (ee
33
B. Refundable Credit for Custodial Care of Certain
Biderly Dependents in Taxpayer's Home (eee. 35



11

of the indexing adjustment to his or her stock or partnership inter-
est to the extent the corporation or partnership disposes of indexed
assets. Under the bill, any inflation adjustments at the entity
level would flow through to the holders and result in a correspond-
ing increase in the basis of the holder’s interest in the entity.
Foreign corporations

Stock of a foreign corporation generally would not be an indexed
asset. Thus, investors would not be permitted to place nonindexed
assets in a foreign corporation (which generally is not subject to
United States tax) and. in effect, receive an inflation adjustment
for those assets by selling their stock in the foreign corporation at
a later date. However, an exception would be made in the case of
stock of a foreign corporation traded on an established domestic se-
curities market, on the grounds that there would be little potential
for the shareholders to transfer nonindexed assets to such a foreign
corporation to obtain the adjustment. This exception would not
apply to certain foreign corporations that are controlled by U.S. in-
vestors, or that hold substantial amounts of passive assets, or earn
substantial amounts of passive income. An American Depository
Receipt (ADR) for stock in a foreign corporation would be treated
as stock in the foreign corporation and, therefore, the basis in an
ADR would be indexed.

Other rules
Short sales

In the case of a short sale of an indexed asset with a short sale
period in excess of one year, the bill would provide that the amount
realized would be indexed for inflation in the same manner that
the basis would be indexed to the holder of the property. If the tax-
payer (or taxpayer’s spouse) sells short.substantially identical prop-
erty to an asset held by the taxpayer (i.e., sells short “against the
box”) no indexing adjustments would be allowed during the short
sale period.

Limitation on ordinary losses

The bill generally would not apply to assets that give rise to ordi-
nary income or loss because they are not capital assets or trade or
business property to the taxpayer. In addition, in the case of cap-
ital assets or trade or business property the sale of which could re-
sult in an ordinary loss (under sec. 1231), the provision would not
be applied to create or increase the amount of ordinary loss. In-
stead, the amount of ordinary loss determined under that provision
would be limited to the loss that would arise without regard to any
inflation adjustment. Any additional loss created by the inflation
adjustment would be treated as a long-term capital loss notwith-
standing any existing provisions of the Code.

Related parties
The bill would not index the basis of property for sales or disposi-
tions between related persons, except to the extent the basis of

© Similar rules would apply to common trust funds.



13

B. Neutral Cost Recovery (Title II of the bill and secs. 56
and 168 of the Code)

Present Law

Depreciation deductions

Under present law, a taxpayer is allowed depreciation deductions
for the cost of property used in a trade or business. In general, de-
preciation for tangible property placed in service after 1986 is de-
termined under the modified Accelerated Cost Recovery System
(MACRS) enacted as part of the Tax Reform Act of 1986. MACRS
includes a general depreciation system and an alternative deprecia-
tion system.

Under the general MACRS rules, depreciable property is divided
into nine classes based on recovery periods (3-year property, 5-year
property, 7-year property, 10-year property, 15-year property, 20-
year property, 27.5-year residential rental property, 39-year
nonresidential real property and 50-year railroad grading or tunnel
bores). The 200-percent declining balance method of depreciation is
used for 3-year, 5-year, 7-year, and 10-year property; the 150-per-
cent declining balance method is used for 15-year and 20-year prop-
erty and property used in a farming business; and the straight-line
method is used for other property (including real property).

In general, the value of CRS deductions are reduced under
the alternative depreciation system by calculating depreciation
using the straight-line method over the property’s class life.? A
property's class life generally corresponds to its Asset Depreciation
Range (ADR) midpoint life and often is longer than the recovery
period applicable to the general MACRS. (The class lives and recov-
ery periods of some assets are set by statute, regardless of the as-
set’s ADR midpoint life.) The alternative depreciation system ap-
plies to foreign use property, tax-exempt use property, tax-exempt
bond financed property, certain imported property, and property to
which the taxpayer so elects and is used to compute corporate.
earnings and profits. The class lives of the alternative depreciation
system are used for purposes of the corporate and individual alter-
native minimum tax. The alternative minimum tax generally ap-
plies the 150-percent declining balance method to tangible personal
property placed in service after 1993.

Expensing election

In lieu of depreciation, a taxpayer may elect to expense and de-
duct up to $17,500 of the cost of qualifying property placed in serv-
ice for the taxable year. For this purpose, qualifying property gen-
erally is defined as depreciable tangible personal property that is

urchased for use in the active conduct of a trade or business. The
17,500 amount is reduced by the amount by which the cost of
qualifying property placed in service during the taxable year ex-
ceeds $200,000. In addition, the amount eligible to be expensed for
a taxable year may not exceed the taxable income of the taxpayer

eat depreciation deductions for passenger automobiles are also limited under section

® The $17,500 amount is increased to $37,500 for certain property placed in service by an
enterprise zone business.



CONTENTS

INTRODUCTION ..

I, AMERICAN DREAM RESTORATION AcT (H.
A. Family Tax Credit (sec. 2)
B. Credit to Reduce the Marriage Penalty (sec. 3)

c. Establishment of American Dream m Savings Ac-
counts. (sec. 4) ........

II. JoB CREATION AND WAGE ENHANCEMENT ACT (H.R. 9)

A. Capital Gains Reforms (Title I)
1. 50-percent capital gains deduction (sec. 1001)

2. Indexing of basis of certain assets for pur-
Bones of determining -gain or loss (sec.

3. Capital loss deduction allowed with respect
to sale or exchange of (Prineipal residence
(see. 1003) seeenseneeneeseene

B. Neutral Cost Recovery (Title 1. settee
C. Public Debt Reduction Check and Trust Fund

(Title XI
D. Small Business Incentives (Title xID .

1. Increase in unified estate and gift tax credits
(8eC. 12001) o...eseeeesesecesseseseeseseesseessenesee

2. Increase in expense treatment for small busi-
nesses (sec. 12002) ..

3. Clarification of definition of of principal “place
of business; Treatment of storage ¢ of af product
samples (secs. 12008 and 12004) .. ven

TI. SENIOR CITIZENS’ EQUITY ACT (H.R. 8) ...cssssccssssesssseseneeseees

A eal of Increase in Tax on Social Security Ben-
efits (Title IT) o

mw vw HF

wa aa

12
13

16
18

18

19

20
22

22


34

Finally, the bill would provide that an individual legally separated
from his spouse under a decree of divorce or separate maintenance
would not be considered married.

Effective Date

The provision would be effective for taxable years beginning after
December 31, 1995.



III. SENIOR CITIZENS’ EQUITY ACT (ELR. 8)

A. Repeal of Increase in Tax on Social Security Benefits
(sec. 201 of the bill and secs. 86 and 871(a)(3) of the Code)

Present Law

In general .

Under present law, taxpayers receiving Social Security and Rail-
road Retirement: Tier 1 benefits are not required to include any
such benefits in gross income if their “provisional income” does not
exceed $25,000 in the case of unmarried taxpayers or $32,000 in
the case of married taxpayers filing joint returns. For purposes of
these computations, a taxpayer’s provisional income is defined as
adjusted gross income plus tax-exempt interest plus certain foreign
source income plus one-half of the taxpayer’s Social Security or
Railroad Retirement Tier 1 benefit.

Certain taxpayers with provisional income in excess of those
thresholds are required to include in gross income up to 50 percent
of their Social Security or Railroad Retirement Tier 1 benefit.
Under a provision added by the Omnibus Budget Reconciliation Act
of 1993, taxpayers with provisional income in excess of a second-
tier threshold ($34,000 in the case of unmarried taxpayers or
$44,000 in the case of married taxpayers filing joint returns) are
required to include in gross income up to 85 percent of their Social
Security or Railroad Retirement Tier 1 benefit.

If the taxpayer's provisional income exceeds the lower threshold
but does not exceed the second-tier threshold, then the amount of
the inclusion is the lesser of (1) 50 percent of the taxpayer's Social
Security or Railroad Retirement Tier 1 benefit, or (2) 50 percent of
the excess of the taxpayer's provisional income over the lower
threshold.

If the amount of provisional income exceeds the second-tier
threshold, then the amount of the inclusion is the lesser of:

(1) 85 percent of the taxpayer's Social Security or Railroad Re-
tirement Tier 1 benefit, or

(2) the sum of:

(a) 85 percent of the excess of the taxpayer’s provisional in-
come over the second-tier threshold, plus,

(b) the smaller of (i) the amount of benefits that would have
been included if the 50-percent inclusion rule (the rule in the
previous paragraph) were applied, or (ii) one-half of the dif-
ference between the taxpayer’s second-tier threshold and lower

old.

Treatment of nonresident alien individuals

If a nonresident alien individual is engaged in a trade or busi-
ness within the United States during the taxable year, the individ-
(22)



JOINT COMMITTEE ON TAXATION

104TH CONGRESS, 18T SESSION

KENNETH J. KiEs, Chief of Staff
Mary M. Scumrrt, Deputy Chief of Staff (Law)
BERNARD A. ScumitT, Deputy Chief of Staff (Revenue Analysis)

aD



30

C. Tax Treatment of Accelerated Death Benefits under Life
Insurance Contracts (sec. 306 of the bill and sec. 101 of the
ode,

Present Law
Treatment of amounts received under a life insurance con-
‘act

If a contract meets the definition of a life insurance contract,
gross income does not include insurance proceeds that are paid
pursuant to the contract by reason of the death of the insured (sec.
101(a)). In addition, the undistributed investment income (“inside
buildup”) earned on premiums credited under the contract is not
subject to current taxation to the owner of the contract. The exclu-
sion under section 101 applies regardless of whether the death ben-
efits are paid as a lump sum or otherwise.

Amounts received under a life insurance contract (other than a
modified endowment contract) prior to the death of the insured are
includible in the gross income of the recipient to the extent that the
amount received exceeds the taxpayer's investment in the contract
(generally, the aggregate amount of premiums paid less amounts
previously received that were excluded from gross income).

If a contract fails to be treated as a life insurance contract under
section 7702(a), inside buildup on the contract is generally subject

ja.

Requirements for a life insurance contract

To qualify as a life insurance contract for Federal income tax
p ses, a contract must be a life insurance contract under the
applicable State or foreign law and must satisfy either of two alter-
native tests: (1) a cash value accumulation test or (2) a test consist-
ing of a guideline premium requirement and a cash value corridor
requirement (sec. 7702(a)). A contract satisfies the cash value accu-
mulation test if the cash surrender value of the contract may not
at any time exceed the net single premium that would have to be
paid at such time to fund future benefits under the contract. A con-
tract satisfies the guideline premium and cash value corridor tests
if the premiums paid under the contract do not at any time exceed
the greater of the guideline single premium or the sum of the
guideline level premiums, and if the death benefit under the con-
tract is not less than a varying statutory percentage of the cash
surrender value of the contract.

Proposed regulations on accelerated death benefits

The Treasury Department has issued proposed regulations under
which certain “qualified accelerated death benefits” paid by reason
of the terminal illness of an insured are treated as paid by reason
of the death of the insured and therefore qualify for exclusion
under section 101. In addition, the proposed regulations permit an
insurance contract that includes a qualified accelerated death bene-
fit rider to qualify as a life insurance contract under section 7702.
Thus, the proposed regulations provide that including this benefit
would not cause an insurance contract to fail to meet the definition
of a life insurance contract.



25

B. Treatment of Long-Term Care (secs. 301-305, and 30
the bill and secs. 104, 106, 213, 807(d), 1035, and 4980B
new secs. 137 and 818A of the Code)

Present Law

Deduction for medical expenses ,

In determining taxable income for Federal income tax purposes,

a taxpayer is allowed an itemized deduction for unreimbursed ex-

penses that are paid by the taxpayer during the taxable year for

medical care of the taxpayer, the taxpayer’s spouse, or a dependent
of the taxpayer, to the extent that such expenses exceed 7.5 percent
of the adjusted gross income of the taxpayer for such year (sec.

213). For this purpose, expenses paid for medical care generally are

defined as amounts paid: (1) for the diagnosis, cure, mitigation,

treatment, or prevention of disease (including prescription medi-
cines or drugs and insulin), or for the purpose of affecting any
structure or function of the body (other than cosmetic surgery not
related to disease, deformity; or accident); (2) for transportation
primarily for, and essential to, medical care referred to in (1); or
(8) for insurance (including Part B Medicare premiums) covering
medical care referred to in (1) and (2).

Exclusion for amounts received under accident or health in-
surance

Amounts received by a taxpayer under accident or health insur-
ance for personal injuries or sickness generally are excluded from
gross income to the extent that the amounts received are not at-
tributable to medical expenses that were allowed as a deduction for
a prior taxable year (sec. 104).

Treatment of accident or health plans maintained by employ-
ers

Contributions of an employer to an accident. or health plan that
provides compensation (through insurance or otherwise) to an em-
ployee for’personal injuries or sickness of the employee, the em-
ployee’s spouse, or a dependent of the employee, are excluded from
the gross income of the employee (sec. 106). In addition, amovnts
received by an employee under such a plan generally are excluded
from gross income to the extent that the amounts received are
paid, directly or indirectly, to reimburse the employee for expenses
incurred by the employer for the medical care of the employee, the
employee’s spouse, or a dependent of the employee (sec. 105). For
this purpose, expenses incurred for medical care are defined in the
same manner as under the rules regarding the deduction for medi-
cal expenses.

Health care continuation rules

The health care continuation rules require that an employer
must provide qualified beneficiaries the opportunity to continue to
participate for a specified period in the employer's health plan after
the occurrence of certain events (such as termination of employ-
ment) that would have terminated such participation. Individuals



9

2. Indexing of basis of certain assets for purposes of deter-
mining gain or loss (sec. 1002 of the bill and new sec.
1022 of the Code) .

Present Law

Under present law, the amount taken into account in computing
gain or loss from the disposition of any asset is the sales price of
the asset reduced by the taxpayer’s basis in that asset. The tax-
payer’s basis generally is the taxpayer’s cost in the asset adjusted
for depreciation, depletion, and certain other amounts. No adjust-
ment is allowed for inflation.

Description of Proposal
In general

The bill generally would provide for an inflation adjustment to
(i.e., indexing of) the basis of certain assets (called “indexed as-
sets”) for purposes of determining gain or loss upon a sale or other
disposition of such assets. Assets the basis of which would be eligi-
ble for the inflation adjustment generally would include corporate
stock and tangible property that are capital assets or property used
in a trade or business and are held by the taxpayer for more than
one year. The inflation adjustment would be measured by increases
in the Gross Domestic Product (“GDP”) deflator occurring after De-
cember 31, 1994, regardless of whether the asset was acquired by
the taxpayer prior to that date.

Indexed assets

The bill generally would provide for the indexing of corporate
stock. For this purpose, options, warrants, or other contract rights
with respect to stock would not be considered stock. The inflation
adjustment would not apply to stock in an S corporation, or gen-
erally to stock in a foreign corporation.t In addition, no inflation
adjustment would be provided for preferred stock that does not par-
ticipate in corporate growth to any significant extent.

The bill would provide for the indexing of the basis of tangible
property (or any interest therein) that is a capital asset or property
used in a trade or business. An indexed asset would not, however,
include any mortgage or other creditor’s interest in property. In ad-
dition, a lessor’s interest in property subject to a net lease would
not be an indexed asset. No property using neutral cost recovery
would be an indexed asset. (See discussion in Part II.B., below,
“Neutral Cost Recovery.”)

The basis of debt would not be indexed. For example, in the case
of a loan, a precise inflation adjustment would require the lender
to deduct a loss from inflation and the borrower to report a gain.
Similarly, the bill would exclude from indexing intangible assets,
such as options, where there is an option writer and option buyer
who have offsetting inflation adjustments.

+ See further discussion below relating to these entities.

87-843 0- 95 - 2



12

property in the hands of the transferee is a substitute basis (e.g.,
gifts).

Collapsible corporations

Under the bill, indexing would not reduce the amount of ordinary
gain that would be recognized in cases where a corporation is treat-
ed as a collapsible corporation (under sec. 341) with respect to a
distribution or sale of stock.

Effective Date

The provisions would apply to dispositions of property after De-
cember 31, 1994, in taxable years ending after that date.

3. Capital loss deduction allowed with respect to sale or ex-
change of a principal residence (sec. 1003 of the bill and
sec. 165 of the Code)

Present Law

Taxpayers generally may claim as a deduction any loss sustained
during the taxable year and not compensated by insurance or oth-
erwise. In the case of an individual, however, the deduction is lim-
ited to (1) losses incurred in a trade or business, (2) losses incurred
in any transaction entered into for profit though not connected with
a trade or business, and (3) catastrophic losses of property that
arise from fire, storm, shipwreck, or other casualty or from theft.
Deductions for losses from the sale or exchange of capital assets
are subject to the limitations described above. In addition, tax-
payers other than corporations may deduct capital losses against
up to $3,000 of ordinary income each year.

A loss on the sale or exchange of a principal residence is treated
as a nondeductible personal loss. Gain on the sale or exchange of
a principal residence generally is includible in gross income and is
subject to a maximum rate of 28 percent. If an individual pur-
chases a new principal residence within two years of selling the old
residence, gain from the sale of the old residence (if any) is recog-
nized only to the extent that the taxpayer’s adjusted sales price ex-
ceeds the taxpayer’s cost of purchasing the new residence (sec.
1034). A taxpayer also may elect to exclude from gross income up
to $125,000 of gain from the sale of a principal residence if the tax-
payer (1) has attained age 55 before the sale and (2) has used the
residence as a principal residence for three or more years of the
five years preceding the sale of the residence (sec. 121). This elec-
tion may be made only once.

Description of Proposal

The bill would provide that losses from the sale or exchange of
a principal residence would be treated as a deductible capital loss
rather than a nondeductible personal loss.

Effective Date

The provision would be effective for sales and exchanges after
December 31, 1994, in taxable years ending after such date.