DESCRIPTION OF THE

THE TAXPAYER REFUND ACT OF 1999

Scheduled for Markup

by the

SENATE COMMITTEE ON FINANCE

on July 20, 1999

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

July 16, 1999

JCX-46-99
(i)

CONTENTS

Page

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

I. BROAD-BASED TAX RELIEF PROVISION -- REDUCTION IN THE

15-PERCENT REGULAR INDIVIDUAL INCOME TAX RATE ........... 2

II. FAMILY TAX RELIEF PROVISIONS ................................. 4

A. Election to Calculate Combined Tax as Individuals for a Married Couple

Filing a Joint Return .............................................. 4

B. Marriage Penalty Relief Relating to the Earned Income Credit ............. 6

C. Expand the Exclusion From Income for Certain Foster Care Payments ....... 8

D. Increase and Expand the Dependent Care Credit ........................ 10

E. Tax Credit for Employer-Provided Child Care Facilities ................. 12

F. Modify Individual Alternative Minimum Tax ........................... 14

III. RETIREMENT AND INDIVIDUAL SAVINGS TAX RELIEF

PROVISIONS ..................................................... 18

A. Individual Savings Provisions ...................................... 18

1. Individual retirement arrangements (“IRAs”) ........................ 18

2. Creation of individual development accounts ........................ 22

B. Expanding Coverage .............................................. 24

1. Option to treat elective deferrals as after-tax contributions ............. 24

2. Increase elective contribution limits ............................... 26

3. Plan loans for subchapter S shareholders, partners, and sole proprietors . . 27

4. Elective deferrals are not taken into account for purposes of deduction

limits ....................................................... 28

5. Reduce PBGC premium for small and new plans ..................... 29

6. Eliminate IRS user fee for requests regarding new plans ............... 30

7. SAFE annuities and trusts ....................................... 31

8. Compensation limit not to apply to SIMPLE 401(k) plans .............. 34
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(ii)

C. Enhancing Fairness for Women ..................................... 36

1. Additional salary reduction catch-up contributions ................... 36

2. Equitable treatment for contributions of employees to defined

contribution plans ............................................. 38

3. Clarification of tax treatment of division of section 457 plan benefits upon

divorce ..................................................... 40

4. Modification of safe harbor relief for hardship withdrawals from 401(k)

plans ....................................................... 41

D. Increasing Portability for Participants ................................ 43

1. Rollovers of retirement plan and IRA distributions ................... 43

2. Waiver of 60-day rule ......................................... 47

3. Treatment of forms of distribution ................................ 47

4. Rationalization of restrictions on distributions ....................... 49

5. Purchase of service credit in governmental pension plans .............. 50

6. Employers may disregard rollovers for purposes of cash-out rules ....... 51

E. Strengthening Pension Security And Enforcement ........................ 52

1. Phase in repeal of 150 percent of current liability funding limit; deduction

for contributions to fund termination liability ........................ 52

2. Extension of PBGC missing participants program .................... 53

3. Repeal 100 percent of compensation limit for defined benefit

multiemployer plans ........................................... 54

4. Excise tax relief for sound pension funding ......................... 55

5. Notice of significant reduction in benefit accruals .................... 56

6. Investment of employee contributions in 401(k) plans ................. 59

F. Encouraging Retirement Education ................................... 61

1. Periodic pension benefit statements ............................... 61

2. Treatment of employer-provided retirement advice ................... 62

G. Reducing Regulatory Burdens ....................................... 64

1. Flexibility in nondiscrimination and coverage rules ................... 64

2. Modification of timing of plan valuations ........................... 65

3. Rules for substantial owner benefits in terminated plans ............... 65

4. ESOP dividends may be reinvested without loss of dividend deduction ... 66

5. Notice and consent period regarding distributions .................... 67
Page

(iii)

6. Repeal transition rule relating to certain highly compensated employees ... 68

7. Employees of tax-exempt entities ................................. 69

8. Provisions relating to plan amendments ............................ 70

9. Extension to international organizations of moratorium on application

of certain nondiscrimination rules applicable to State and local

government plans ............................................. 70

10. Annual report dissemination ..................................... 71

11. Clarification of exclusion for employer-provided transit passes ......... 71

IV. EDUCATION TAX RELIEF ......................................... 73

A. Eliminate Marriage Penalty and 60-Month Limit on Student Loan Interest

Deduction ...................................................... 73

B. Allow Tax-Free Distributions From State and Private Prepaid Education

Plans .......................................................... 75

C. Eliminate Tax on Awards Under the National Health Service Corps

Scholarship Program and F. Edward Hebert Armed Forces Health

Professions Scholarship and Financial Assistance Program................ 79

D. Exclusion for Employer-Provided Educational Assistance ................ 81

E. Liberalize Tax-Exempt Financing Rules for Public School Construction ...... 83

V. HEALTH CARE TAX RELIEF PROVISIONS .......................... 87

A. Above-the-Line Deduction for Health Insurance Expenses ................. 87

B. Provisions Relating to Long-Term Care Insurance ....................... 90

C. Additional Personal Exemption for Caretakers ......................... 93

D. Add Certain Vaccines Against Streptococcus Pneumoniae to the List of

Taxable Vaccines ................................................ 95

VI. SMALL BUSINESS TAX RELIEF PROVISIONS ....................... 96

A. Accelerate 100-Percent Self-Employed Health Insurance Deduction ......... 96

B. Increase Section 179 Expensing ..................................... 97
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(iv)

C. Repeal of Temporary Federal Unemployment Surtax ..................... 98

D. Coordinate Farmer Income Averaging and the Alternative Minimum Tax ..... 99

VII. ESTATE AND GIFT TAX RELIEF ................................... 100

A. Reduce Estate, Gift, and Generation-Skipping Transfer Taxes .............. 100

B. Expand Estate Tax Rule for Conservation Easements ..................... 102

C. Increase Annual Gift Exclusion ..................................... 104

D. Simplification of Generation-Skipping Transfer (“GST”) Tax .............. 105

1. Retroactive allocation of the GST tax exemption ..................... 105

2. Severing of trusts holding property having an inclusion ratio of greater

than zero .................................................... 106

3. Modification of certain valuation rules ............................. 107

4. Relief from late elections ....................................... 107

5. Substantial compliance ......................................... 109

VIII. TAX-EXEMPT ORGANIZATION PROVISIONS ....................... 111

A. Provide Tax Exemption for Organizations Created by a State to Provide

Property and Casualty Insurance Coverage for Property for Which Such

Coverage Is Otherwise Unavailable .................................. 111

B. Modify Section 512(b)(13) ......................................... 115

C. Tax-Free Withdrawals From IRAs for Charitable Purposes ............... 117

D. Provide Exclusion for Mileage Reimbursements by Charitable Organizations . . 119

E. Charitable Contribution Deduction for Certain Expenses in Support of Native

Alaskan Subsistence Whaling ....................................... 121

F. Simplify Lobbying Expenditure Limitations ............................ 122

G. Charitable Giving Proposals ....................................... 124

IX. INTERNATIONAL TAX RELIEF .................................... 126
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(v)

A. Allocate Interest Expense on Worldwide Basis ......................... 126

B. Look-Through Rules to Apply to Dividends from Noncontrolled Section 902

Corporations .................................................... 131

C. Subpart F Treatment of Pipeline Transportation Income and Income From

Transmission of High Voltage Electricity .............................. 133

D. Prohibit Disclosure of APAs and APA Background Files ................. 135

E. Exempt Certain Sales of Frequent-Flyer and Similar Reduced-Fare Air

Transportation Rights from Aviation Excise Taxes ...................... 141

X. HOUSING AND REAL ESTATE TAX RELIEF ......................... 142

A. Increase Low-Income Housing Tax Credit Per Capita Amount ............. 142

B. Tax Credit for Renovating Historic Homes ............................ 145

C. Provisions Relating to REITs ....................................... 147

D. Increase State Volume Limits on Tax-Exempt Private Activity Bonds ........ 152

XI. MISCELLANEOUS PROVISIONS ................................... 154

A. Repeal Certain Excise Taxes on Rail Diesel Fuel and Inland Waterway Barge

Fuels .......................................................... 154

B. Tax Treatment of Alaska Native Settlement Trusts ....................... 155

C. Allow Corporations to Take Certain Minimum Tax Credits Against Minimum

Tax ........................................................... 157

D. Allow Net Operating Losses From Oil and Gas Properties to be Carried

Back for Up to Five Years ......................................... 158

E. Allow Geological and Geophysical Costs to be Deducted Currently ......... 159

F. Allow Certain Oil and Gas “Delay Rental Payments” To Be Deducted

Currently ....................................................... 162

G. Simplify the Active Trade or Business Requirement for Tax-Free Spin-offs ... 163
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H. Increase the Maximum Dollar Amount of Reforestation Expenditures

Eligible for Amortization and Credit ................................. 165

I. Modify Excise Tax on Arrow Components and Accessories ............... 167

J. Increase Joint Committee on Taxation Refund Review Threshold to $2

Million ........................................................ 168

XII. EXTENSION OF EXPIRING PROVISIONS ............................ 169

A. Extension of Research Tax Credit ................................... 169

B. Extend Exceptions Under Subpart F for Active Financing Income ........... 172

C. Extend Suspension of Income Limitation on Percentage Depletion from

Marginal Oil and Gas Wells ........................................ 174

D. Extend the Work Opportunity Tax Credit .............................. 175

E. Extend the Welfare-to-Work Tax Credit ............................... 176

F. Extend and Modify Tax Credit for Electricity Produced by Wind and

Closed-Loop Biomass Facilities .................................... 177

G. Extend Exemption From Diesel Dyeing Requirement for Certain Areas

in Alaska ....................................................... 178

H. Expensing of Environmental Remediation Expenditures ................... 179

XIII. REVENUE OFFSET PROVISIONS ................................... 180

A. Modify Foreign Tax Credit Carryover Rules ........................... 180

B. Information Returns Relating to the Discharge of Indebtedness by Certain

Entities ........................................................ 181

C. Increase Elective Withholding Rate for Nonperiodic Distributions from

Deferred Compensation Plans ...................................... 182

D. Extension of IRS User Fees ........................................ 184

E. Treatment of Excess Pension Assets Used for Retiree Health Benefits ....... 185
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F. Clarify the Tax Treatment of Income and Losses on Derivatives ............ 188

G. Loophole Closers ................................................ 190

1. Limit use of non-accrual experience method of accounting to amounts to

be received for performance of qualified professional services ......... 190

2. Impose limitation on prefunding of certain employee benefits ........... 191

3. Modify installment method and prohibit its use by accrual method

taxpayers .................................................... 192

4. Limit conversion of character of income from constructive ownership

transactions .................................................. 194

5. Denial of charitable contribution deduction for transfers associated with

split-dollar insurance arrangements ............................... 195

6. Modify estimated tax rules for closely held REITs .................... 199

7. Prohibited allocations of stock in an ESOP of an S corporation .......... 200

8. Modify anti-abuse rules related to assumption of liabilities ............. 202

9. Require consistent treatment and provide basis allocation rules for transfers

of intangibles in certain nonrecognition transactions .................. 202

10. Modify treatment of closely-held REITS ........................... 203

11. Distributions by a partnership to a corporate partner of stock in another

corporation .................................................. 205

XIV. TAX TECHNICAL CORRECTIONS ................................... 209
1

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

Taxpayer Refund Act of 1999 (JCX-46-99) July 16, 1999.

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INTRODUCTION

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

description of the provisions in the Taxpayer Refund Act of 1999. The Senate Committee on

Finance is scheduled to mark up these proposals beginning on July 20, 1999.

This document contains descriptions of the following provisions in the Chairman’s Mark:

(1) broad-based tax relief provisions, (2) family tax relief provisions, (3) retirement savings tax

relief provisions, (4) education tax relief provisions, (5) health care tax relief provisions, (6) small

business tax relief provisions, (7) estate and gift tax relief provisions, (8) tax-exempt organization

provisions, (9) international tax relief provisions, (10) housing and real estate tax relief provisions,

(11) miscellaneous provisions, (12) extension of expired and expiring provisions, (13) revenue

offset provisions, and (14) tax technical correction provisions.
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I. BROAD-BASED TAX RELIEF -- REDUCTION IN THE

15-PERCENT REGULAR INDIVIDUAL INCOME TAX RATE 

Present Law

Income tax rate structure

To determine regular income tax liability, a taxpayer generally must apply the tax rate

schedules (or the tax tables) to his or her taxable income. The rate schedules are broken into

several ranges of income, known as income brackets, and the marginal tax rate increases as a

taxpayer's income increases. The income bracket amounts are indexed for inflation. Separate rate

schedules apply based on an individual's filing status. In order to limit multiple uses of a graduated

rate schedule within a family, the net unearned income of a child under age 14 is taxed as if it were

the parent's income. For 1999, the individual regular income tax rate schedules are shown below.

Table 1.–Federal Individual Income Tax Rates for 1999

If taxable income is: Then income tax equals:

Single individuals

$0-25,750 ............................ 15 percent of taxable income

$25,750-$62,450 ...................... $3,862.50, plus 28% of the amount over $25,750

$62,450-$130,250 ..................... $14,138.50 plus 31% of the amount over $62,450

$130,250-$283,150 .................... $35,156.50 plus 36% of the amount over $130,250

Over $283,150 ........................ $90,200.50 plus 39.6% of the amount over $283,150

Heads of households

$0-$34,550 ........................... 15 percent of taxable income

$34,550-$89,150 ...................... $5,182.50 plus 28% of the amount over $34,550

$89,150-$144,400 ..................... $20,470.50 plus 31% of the amount over $89,150

$144,400-$283,150 .................... $37,598 plus 36% of the amount over $144,400

Over $283,150 ........................ $87,548 plus 39.6% of the amount over $283,150

Married individuals filing joint returns

$0-$43,050 ........................... 15 percent of taxable income

$43,050-$104,050 ..................... $6,457.50 plus 28% of the amount over $43,050

$104,050-$158,550 .................... $23,537.50 plus 31% of the amount over $104,050

$158,550-$283,150 .................... $40,432.50 plus 36% of the amount over $158,550

Over $283,150 ........................ $85,288.50 plus 39.6% of the amount over $283,150

Description of Proposal
-3-

The proposal would reduce the lowest individual regular income tax rate from 15 percent to

14 percent. This rate reduction would not apply to the capital gains tax rates. The proposal would

also increase the size of the otherwise applicable 14-percent rate bracket by $2,000 ($4,000 for a

married couple filing a joint return) beginning in 2005 and by $2,500 ($5,000 for a married couple

filing a joint return) beginning in 2007.

Effective Date

The proposal to reduce the rate from 15 percent to 14 percent would be effective for taxable

years beginning after December 31, 2000. The proposal to increase the size of the rate bracket

would be effective for taxable years beginning after December 31, 2004.
2

 This is not true for the 39.6-percent rate. The beginning point of this rate bracket is the

same for all taxpayers regardless of filing status. 

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II. FAMILY TAX RELIEF PROVISIONS

A. Election to Calculate Combined Tax as Individuals

for a Married Couple Filing a Joint Return

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 couples may elect to file separate returns, the rate schedules and

provisions are structured so that filing separate returns usually results in a higher tax than filing a

joint return. Other rate schedules apply to single persons and to single heads of households.

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 "marriage bonus" exists when the sum

of the tax liabilities of the individuals is greater than their combined tax liability under a joint

return.

While the size of any marriage penalty or bonus under present law depends upon the

individuals' incomes, number of dependents, and itemized deductions, as a general rule married

couples whose incomes are split more evenly than 70-30 suffer a marriage penalty. Married

couples whose incomes are largely attributable to one spouse generally receive a marriage bonus.

Under present law, the size of the standard deduction and the tax bracket breakpoints follow

certain customary ratios across filing statuses. The standard deduction and tax bracket breakpoints

for single filers are roughly 60 percent of those for joint filers.2 With these ratios, unmarried

individuals have standard deductions whose sum exceeds the standard deduction they would

receive as a married couple filing a joint return. Thus, their taxable income as joint filers may

exceed the sum of their taxable incomes as unmarried individuals.

Description of Proposal

Under the proposal, married taxpayers would have the option to calculate separate taxable

income for each spouse and to be taxed as two single individuals on the same return. The tax due

would be calculated by applying the tax rates for single individuals to the separate taxable incomes. 

Under the proposal, the two spouses would elect to either use a standard deduction or to itemize

their deductions. Thus, one spouse would not be permitted itemize deductions while the other

spouse claimed a standard deduction. If a married couple elects to compute taxable income

separately and claim the standard deduction, the applicable standard deduction for each spouse

would be the standard deduction for single individuals. Under the proposal, one tax liability is

calculated on a separate basis, all tax credits and payments of tax are applied as if the couple is
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filing a joint return.

Income from the performance of services (e.g., wages, salaries, and pensions) would be

treated as the income of the spouse who performed the services. Income from property would be

divided between the spouses in accordance with their respective ownership rights in such property. 

Jointly owned assets would be divided evenly.

Deductions generally would be allocated to the spouse treated as having the income to

which the deduction relates. Special rules would apply for certain deductions. The deduction for

contributions to an individual retirement arrangement would be allocated to the spouse for whom

the contribution is made. The deduction for alimony would be allocated to the spouse who has the

liability to pay the alimony. The deduction for contributions to medical savings accounts would be

allocated to the spouse with respect to whose employment or self employment the account relates.

Each spouse would be entitled to claim one personal exemption. Exemptions for

dependents would be allocated based on each spouse’s relative income.

All credits would be determined as if the spouses had filed a joint return. The credit

amounts would then be applied against the combined tax liability of the couple.

The Secretary of the Treasury would be directed to prescribe such regulations as may be

necessary or appropriate to carry out the provisions of the proposal.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2004.
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B. Marriage Penalty Relief 

Relating to the Earned Income Credit

Present Law

Certain eligible low-income workers are entitled to claim a refundable earned income

credit (“EIC”) on their income tax return. A refundable credit is a credit that not only reduces an

individual’s tax liability but allows refunds to the individual in excess of income tax liability. The

amount of the credit an eligible individual may claim depends upon whether the individual has one,

more than one, or no qualifying children, and is determined by multiplying the credit rate by the

individual’s earned income up to an earned income amount. In the case of a married individual

who files a joint return with his or her spouse, the income for purposes of these tests is the

combined income of the couple. The maximum amount of the credit is the product of the credit rate

and the earned income amount. The credit is phased out above certain income levels. For

individuals with earned income (or modified AGI, if greater) in excess of the beginning of the

phase-out range, the maximum credit amount is reduced by the phase-out rate multiplied by the

earned income (or modified AGI, if greater) in excess of the beginning of the phase-out range. For

individuals with earned income (or modified AGI, if greater) in excess of the end of the phase-out

range, no credit is allowed.

The parameters of the credit for 1999 are provided in the following table.

Earned Income Credit Parameters (1999)

Two or more

qualifying

children

One qualifying

child

No qualifying

children

Credit rate (percent) ................

Earned income amount ..............

Maximum credit ...................

40.00

$9,540

$3,816

34.00

$6,800

$2,312

7.65

$4,530

$347

Phase-out begins ...................

Phase-out rate (percent) ..............

$12,460

21.06

$12,460

15.98

$5,670

7.65

Phase-out ends .................... $30,580 $26,928 $10,200

Description of Proposal

The proposal would increase the beginning point of the phase out of the EIC for married

couples filing a joint return by $2,000. Because the rate of the phase out is not changed by the

proposal, the end-point of the phase-out ranges would also be increased by $2,000. The effect of

the increase in the beginning point of the phase-out is to increase the EIC for taxpayers in the phaseout range by an amount up to $2,000 times the phase-out rate. For example, for couples with two or

more qualifying children, the maximum increase in the EIC as a result of the proposal would be
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$2,000 times 21.06 percent, or $421.20. The $2,000 amount would be indexed for inflation.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2004.
3

 A difficulty of care payment is a payment designated by the person making such payment

as compensation for providing the additional care of a qualified foster care individual which is

required by reason of a physical, mental, or emotional handicap of such individual and with

respect to which the State has determined that there is a need for additional compensation.

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C. Expand the Exclusion from Income for Certain Foster Care Payments

Present Law

Generally, a foster care provider may exclude qualified foster care payments, (including

difficulty of care payments) from gross income if certain requirements are satisfied.3 First, such

payments must be paid to the foster care providers by either (1) a State or political subdivision of a

State; or (2) a tax-exempt placement agency. Second, the payments, including difficulty of care

payments, must be paid to the foster care provider for the care of a “qualified foster individual” in

the foster care provider’s home. A qualified foster individual is an individual living in a foster

care family home in which the individual was placed by: (1) an agency of the State or a political

subdivision of a State; or (2) a tax-exempt placement agency if such individual was under the age of

19 at the time of placement. Third, the exclusion of foster care payments generally applies to

qualified foster care payments for five or fewer foster care individuals over the age of 19 in a

foster home. In the case of difficulty of care payments, the exclusion applies to payments for ten or

fewer foster care individuals under the age of 19 in a foster home and to payments for five or fewer

foster care individuals at least age 19 in a foster home.

Description of Proposal

The proposal would make two principal modifications to the exclusion. First, the proposal

would expand the list of persons eligible to make qualified foster care payments. Therefore, the

exclusion would apply to qualified payments made pursuant to a foster care program of a State or

local government which are paid by either: (1) a State or political subdivision of a State; or (2) a

qualified foster care placement agency, whether taxable or tax-exempt. Second, the proposal

would expand the list of persons eligible to place foster care individuals to allow placements by

either: (1) a State or a political subdivision of a State; or (2) a qualified foster care placement

agency, whether taxable or tax-exempt. For these purposes, a qualified foster care placement

agency would be defined as any placement agency which is licensed or certified by: (1) a State or

political subdivision of a State; or (2) an entity designated by a State or political subdivision

thereof, for the foster care program of such State or political subdivision to make payments to

providers of foster care.

The proposal would allow State and local governments to employ both tax-exempt and

taxable entities to administer their foster care programs more efficiently; however, it would not

extend the exclusion to payments outside such foster care programs (e.g., payments to a foster care

provider from friends or relatives of a foster care individual in the provider’s care).

Effective Date
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The proposal would be effective for taxable years beginning after December 31, 1999.
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D. Increase and Expand the Dependent Care Credit

Present Law

In general

A taxpayer who maintains a household which includes one or more qualifying individuals

may claim a nonrefundable credit against income tax liability for up to 30 percent of a limited

amount of employment-related dependent care expenses. Eligible employment-related expenses are

limited to $2,400 if there is one qualifying individual or $4,800 if there are two or more qualifying

individuals. Generally, a qualifying individual is a dependent under the age of 13 or a physically or

mentally incapacitated dependent or spouse. No credit is allowed for any qualifying individual

unless a valid taxpayer identification number (“TIN”) has been provided for that individual. A

taxpayer is treated as maintaining a household for a period if the taxpayer (or the taxpayer's spouse,

if married) provides more than one-half the cost of maintaining the household for that period. In the

case of married taxpayers, the credit is not available unless they file a joint return.

Employment-related dependent care expenses are expenses for the care of a qualifying

individual incurred to enable the taxpayer to be gainfully employed, other than expenses incurred

for an overnight camp. For example, amounts paid for the services of a housekeeper generally

qualify if such services are performed at least partly for the benefit of a qualifying individual;

amounts paid for a chauffeur or gardener do not qualify.

Expenses that may be taken into account in computing the credit generally may not exceed an

individual's earned income or, in the case of married taxpayers, the earned income of the spouse

with the lesser earnings. Thus, if one spouse has no earned income, generally no credit is allowed.

The 30-percent credit rate is reduced, but not below 20 percent, by 1 percentage point for

each $2,000 (or fraction thereof) of adjusted gross income (“AGI”) above $10,000.

Interaction with employer-provided dependent care assistance

For purposes of the dependent care credit, the maximum amounts of employment-related

expenses ($2,400/$4,800) are reduced to the extent that the taxpayer has received employerprovided dependent care assistance that is excludable from gross income (sec. 129). The exclusion

for dependent care assistance is limited to $5,000 per year and does not vary with the number of

children.

Description of Proposal

The proposal would make two changes to the dependent care tax credit. First, the maximum

credit percentage would be increased from 30 percent to 50 percent for taxpayers with AGI of

$30,000 or less. The 50-percent credit rate would be decreased by one percentage point for each

$1,000 of AGI, or fraction thereof, between $30,001 and $59,000. The credit percentage would be
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20 percent for taxpayers with AGI of $59,001 or greater. Second, the maximum amount of eligible

employment-related expenses ($2,400/$4,800).

The present-law reduction of the dependent care credit for employer-provided dependent

care assistance would not be changed.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
4An employer may claim the welfare-to-work tax credit on the eligible wages of certain

long-term family assistance recipients. For purposes of the welfare-to-work credit, eligible wages

includes amounts paid by the employer for dependent care assistance. 

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E. Tax Credit for Employer-Provided Child Care Facilities

Present Law

Generally, present law does not provide a tax credit to employers for supporting child care

or child care resource and referral services.4 An employer, however, may be able to claim such

expenses as deductions for ordinary and necessary business expenses. Alternatively, the employer

may be required to capitalize the expenses and claim depreciation deductions over time.

Description of Proposal

Employer tax credit for supporting employee child care

Under the proposal, taxpayers would receive a tax credit equal to 25 percent of qualified

expenses for employee child care. These expenses would include costs incurred: (1) to acquire,

construct, rehabilitate or expand property that is to be used as part of a taxpayer's qualified child

care facility; (2) for the operation of a taxpayer's qualified child care facility, including the costs of

training and continuing education for employees of the child care facility; or (3) under a contract

with a qualified child care facility to provide child care services to employees of the taxpayer. To

be a qualified child care facility, the principal use of the facility must be for child care, and the

facility must be duly licensed by the State agency with jurisdiction over its operations. Also, if the

facility is owned or operated by the taxpayer, at least 30 percent of the children enrolled in the

center (based on an annual average or the enrollment measured at the beginning of each month) must

be children of the taxpayer's employees. If a taxpayer opens a new facility, it must meet the

30-percent employee enrollment requirement within two years of commencing operations. If a new

facility failed to meet this requirement, the credit would be subject to recapture.

To qualify for the credit, the taxpayer must offer child care services, either at its own

facility or through third parties, on a basis that does not discriminate in favor of highly compensated

employees.

Employer tax credit for child care resource and referral services

Under the proposal, a taxpayer would be entitled to a tax credit equal to 10 percent of

expenses incurred to provide employees with child care resource and referral services.
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Other rules

Total credits that may be claimed under this proposal would be capped at $150,000 per

year. Any amounts for which the taxpayer may otherwise claim a tax deduction would be reduced

by the amount of these credits. Similarly, if the credits are taken for expenses of acquiring,

constructing, rehabilitating, or expanding a facility, the taxpayer's basis in the facility would be

reduced by the amount of the credits.

Effective Date

The credits would be effective for taxable years beginning after December 31, 2000.
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F. Modify Individual Alternative Minimum Tax

Present Law

In general

Present law imposes a minimum tax (“AMT”) on an individual to the extent the taxpayer's

minimum tax liability exceeds his or her regular tax liability. The AMT is imposed on individuals

at rates of (1) 26 percent on the first $175,000 of alternative minimum taxable income (“AMTI”) in

excess of a phased-out exemption amount and (2) 28 percent on the remaining AMTI. The

exemptions amounts are $45,000 in the case of married individuals filing a joint return and

surviving spouses; $33,750 in the case of other unmarried individuals; and $22,500 in the case of

married individuals filing a separate return. These exemption amounts are phased-out by an amount

equal to 25 percent of the amount that the individual's AMTI exceeds a threshold amount. These

threshold amounts are $150,000 in the case of married individuals filing a joint return and surviving

spouses; $112,500 in the case of other unmarried individuals; and $75,000 in the case of married

individuals filing a separate return, estates, and trusts. The exemption amounts, the threshold phaseout amounts, and the $175,000 break-point amount are not indexed for inflation. The lower capital

gains rates applicable to the regular tax apply for purposes of the AMT.

AMTI is the taxpayer's taxable income increased by certain preference items and adjusted

by determining the tax treatment of certain items in a manner that negates the deferral of income

resulting from the regular tax treatment of those items.

Preference items in computing AMTI

The minimum tax preference items are:

(1) The excess of the deduction for percentage depletion over the adjusted basis of the

property at the end of the taxable year. This preference does not apply to percentage depletion

allowed with respect to oil and gas properties.

(2) The amount by which excess intangible drilling costs arising in the taxable year exceed

65 percent of the net income from oil, gas, and geothermal properties. This preference does not

apply to an independent producer to the extent the preference would not reduce the producer’s

AMTI by more than 40 percent.

(3) Tax-exempt interest income on private activity bonds (other than qualified 501(c)(3)

bonds) issued after August 7, 1986.

(4) Accelerated depreciation or amortization on certain property placed in service before

January 1, 1987.

(5) Forty-two percent of the amount excluded from income under section 1202 (relating to
5

 Given the passage of section 469 by the Tax Reform Act of 1986 (relating to the

deductibility of losses from passive activities), these provisions are largely "deadwood."

-15-

gains on the sale of certain small business stock).

In addition, losses from any tax shelter, farm, or passive activities are denied.5

Adjustments in computing AMTI

The adjustments that individuals must make in computing AMTI are:

(1) Depreciation on property placed in service after 1986 and before January 1, 1999, must

be computed by using the generally longer class lives prescribed by the alternative depreciation

system of section 168(g) and either (a) the straight-line method in the case of property subject to the

straight-line method under the regular tax or (b) the 150-percent declining balance method in the

case of other property. Depreciation on property placed in service after December 31, 1998, is

computed by using the regular tax recovery periods and the AMT methods described in the previous

sentence.

(2) Mining exploration and development costs must be capitalized and amortized over a 10-

year period.

(3) Taxable income from a long-term contract (other than a home construction contract) must

be computed using the percentage of completion method of accounting.

(4) The amortization deduction allowed for pollution control facilities placed in service

before January 1, 1999 (generally determined using 60-month amortization for a portion of the cost

of the facility under the regular tax), must be calculated under the alternative depreciation system

(generally, using longer class lives and the straight-line method). The amortization deduction

allowed for pollution control facilities placed in service after December 31, 1998, is calculated

using the regular tax recovery periods and the straight-line method.

(5) Miscellaneous itemized deductions are not allowed.

(6) Itemized deductions for State, local, and foreign real property taxes, State and local

personal property taxes, and State, local, and foreign income, war profits, and excess profits taxes

are not allowed.

(7) Medical expenses are allowed only to the extent they exceed 10 percent of the taxpayer's

adjusted gross income (AGI).

(8) Standard deductions and personal exemptions are not allowed.

(9) The amount allowable as a deduction for circulation expenditures must be capitalized
6

 No adjustment is required if the taxpayer materially participates in the activity that

relates to the research and experimental expenditures.

7

 For 1998 only, the nonrefundable personal credits were not limited by the tentative

minimum tax, and the refundable child credit was not reduced by the minimum tax.

-16-

and amortized over a 3-year period.

(10) The amount allowable as a deduction for research and experimental expenditures must

be capitalized and amortized over a 10-year period.6

(11) The regular tax rules relating to incentive stock options do not apply.

Other rules

The combination of the taxpayer's net operating loss carryover and foreign tax credits

cannot reduce the taxpayer's AMT liability by more than 90 percent of the amount determined

without these items.

The various nonrefundable credits allowed under the regular tax generally are allowed only

to the extent that the individual’s regular tax exceeds the tentative minimum tax. The earned income

credit and the child credit of those taxpayers with three or more qualified children are refundable

credits and may offset the taxpayer's tentative minimum tax. However, a taxpayer must reduce these

refundable credits by the taxpayer’s AMT.7

If an individual is subject to AMT in any year, the amount of tax exceeding the taxpayer's

regular tax liability is allowed as a credit (the “AMT credit”) in any subsequent taxable year to the

extent the taxpayer's regular tax liability exceeds his or her tentative minimum tax in such

subsequent year. For individuals, the AMT credit is allowed only to the extent the taxpayer's AMT

liability is a result of adjustments that are timing in nature. Most individual AMT adjustments

relate to itemized deductions and personal exemptions and are not timing in nature.

Description of Proposal

The proposal would allow an individual to offset the entire regular tax liablity (without

regard to the minimum tax) by the nonrefundable personal credits, and would repeal the provision

reducing the refundable child credit by the AMT.

The proposal would also allow the deduction for personal exemptions in computing AMT.

Effective Dates

The provisions relating to the limit on personal credits and the offset of the refundable child

credit would be effective for taxable years beginning after December 31, 1998.
-17-

The provision relating to the deduction for personal exemptions would be effective for

taxable years beginning after December 31, 2004.
-18-

III. RETIREMENT AND INDIVIDUAL SAVINGS TAX RELIEF PROVISIONS

A. Individual Savings Provisions

1. Individual retirement arrangements (“IRAs”)

In general

There are two general types of individual retirement arrangements (“IRAs”) under present

law: traditional IRAs, to which both deductible and nondeductible contributions may be made, and

Roth IRAs. The Federal income tax rules regarding each type of IRA (and IRA contribution)

differs.

Traditional IRAs

Under present law, an individual may make deductible contributions to an IRA up to the

lesser of $2,000 or the individual’s compensation if the individual and the individual’s spouse are

not active participants in an employer-sponsored retirement plan. In the case of a married couple,

deductible IRA contributions of up to $2,000 can be made for each spouse (including, for example,

a homemaker who does not work outside the home), if the combined compensation of both spouses

is at least equal to the contributed amount. 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 for

taxpayers with adjusted gross income (“AGI”) over certain levels for the taxable year.

The AGI phase-out limits for taxpayers who are active participants in employer-sponsored

plans are as follows.

Single Taxpayers

Taxable years beginning in: Phase-out range

1998 ................................................ $30,000-40,000

1999 ................................................ 31,000-41,000

2000 ................................................ 32,000-42,000

2001 ................................................ 33,000-43,000

2002 ................................................ 34,000-44,000

2003 ................................................ 40,000-50,000

2004 ................................................ 45,000-55,000

2005 and thereafter ..................................... 50,000-60,000
-19-

Joint Returns

Taxable years beginning in: Phase-out range

1998 ................................................ $50,000-60,000

1999 ................................................ 51,000-61,000

2000 ................................................ 52,000-62,000

2001 ................................................ 53,000-63,000

2002 ................................................ 54,000-64,000

2003 ................................................ 60,000-70,000

2004 ................................................ 65,000-75,000

2005 ................................................ 70,000-80,000

2006 ................................................ 75,000-85,000

2007 and thereafter ..................................... 80,000-100,000

If the individual is not an active participant in an employer-sponsored retirement plan, but

the individual’s spouse is, the $2,000 deduction limit is phased out for taxpayers with AGI between

$150,000 and $160,000.

To the extent an individual cannot or does not make deductible contributions to an IRA or

contributions to a Roth IRA, the individual may make nondeductible contributions to an traditional

IRA.

Amounts held in a traditional IRA are includible in income when withdrawn (except to the

extent the withdrawal is a return of nondeductible contributions). Includible amounts withdrawn

prior to attainment of age 59-1/2 are subject to an additional 10-percent early withdrawal tax,

unless the withdrawal is due to death or disability, is made in the form of certain periodic

payments, is used to pay medical expenses in excess of 7.5 percent of AGI, is used to purchase

health insurance of an unemployed individual, is used for education expenses, or is used for firsttime homebuyer expenses of up to $10,000.

Roth IRAs

Individuals with AGI below certain levels may make nondeductible contributions to a Roth

IRA. The maximum annual contribution that may be made to a Roth IRA is the lesser of $2,000 or

the individual’s compensation for the year. The contribution limit is reduced to the extent an

individual makes contributions to any other IRA for the same taxable year. As under the rules

relating to IRAs generally, a contribution of up to $2,000 for each spouse may be made to a Roth

IRA provided the combined compensation of the spouses is at least equal to the contributed amount.

The maximum annual contribution that can be made to a Roth IRA is phased out for single

individuals with AGI between $95,000 and $110,000 and for joint filers with AGI between

$150,000 and $160,000.
8

 Early distribution of converted amounts may also accelerate income inclusion of

converted amounts that are taxable under the 4-year rule applicable to 1998 conversions.

-20-

Taxpayers with modified AGI of $100,000 or less generally may convert a traditional IRA

into an Roth IRA. The amount converted is includible in income as if a withdrawal had been made,

except that the 10-percent early withdrawal tax does not apply and, if the conversion occurred in

1998, the income inclusion may be spread ratably over 4 years. Married taxpayers who file

separate returns cannot convert a traditional IRA into a Roth IRA.

Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not includible

in income, nor subject to the additional 10-percent tax on early withdrawals. A qualified

distribution is a distribution that (1) is made after the 5-taxable year period beginning with the first

taxable year for which the individual made a contribution to a Roth IRA, and (2) which is made

after attainment of age 59-1/2, on account of death or disability, or is made for first-time homebuyer

expenses of up to $10,000.

Distributions from a Roth IRA that are not qualified distributions are includible in income

to the extent attributable to earnings, and subject to the 10-percent early withdrawal tax (unless an

exception applies).8 The same exceptions to the early withdrawal tax that apply to IRAs apply to

Roth IRAs.

Description of Proposal

Increase in annual contribution limits

The proposal would increase the annual contribution limit for traditional IRAs and Roth

IRAs in $1,000 annual increments, beginning in 2001, until the limit reaches $5,000 in 2005. 

Thereafter, the limit would be indexed for inflation in $100 increments.

Increase in AGI limits for deductible IRA contributions

Under the proposal, the AGI phase-out limits for active participants in an employersponsored plan would be increased annually by $2,000 ($4,000 in the case of married taxpayers

filing a joint return) for 2001-2003 and by $2,500 ($5,000 in the case of married taxpayers filing a

joint return) for 2004-2008. After 2008, the income limits would be indexed for inflation. These

increases would be in addition to the amount of the increases scheduled under present law. Thus,

the phase-out limits would be as follows for taxable years beginning in 2001-2009.
-21-

Single Returns

Taxable years beginning in: Phase-out range

2001 ................................................ $35,000-45,000

2002 ................................................ 38,000-48,000

2003 ................................................ 46,000-56,000

2004 ................................................ 53,500-63,500

2005 ................................................ 61,000-71,000

2006 ................................................ 63,500-73,500

2007 ................................................ 66,000-76,000

2008 ................................................ 68,500-78,500

Joint Returns

Taxable years beginning in: Phase-out range

2001 ................................................ $57,000-67,000

2002 ................................................ 62,000-72,000

2003 ................................................ 72,000-82,000

2004 ................................................ 82,000-92,000

2005 ................................................ 92,000-102,000

2006 ................................................ 102,000-112,000

2007 ................................................ 112,000-132,000

2008 ................................................ 117,000-137,000

The present-law income phase-out range for an individual who is not an active participant,

but whose spouse is, would remain at $150,000 to $160,000.

AGI limits for Roth IRAs

The proposal would repeal the Roth IRA contribution AGI phase-out limits. The proposal

would also increase the AGI limit on conversions of traditional IRAs to Roth IRAs to $1 million. 

This $1 million limit would apply to all taxpayers, including married taxpayers filing separate

returns.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
9

 Matching contributions (and earnings) would be accounted for separately from individual

IDA contributions (and earnings).

-22-

2. Creation of individual development accounts

Present Law

There are no tax benefits to encourage financial institutions to match savings of low-income

individuals.

Description of Proposal

In general

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

individuals could contribute. In addition, the proposal would provide a tax credit for certain

matching contributions made to an IDA by the financial institution maintaining the IDA. Eligible

individuals would be individuals who are: (1) at least 18 years of age; (2) a citizen or legal

resident of the United States; and (3) a member of a household eligible for the earned income

credit, Temporary Assistance for Needy Families (“TANF”), or with family gross income of 60

percent or less of area median gross income and net worth of $10,000 or less. 

Contributions to an IDA by eligible individuals

Only eligible individuals would be allowed to contribute to an IDA. Contributions to IDAs

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

income.

Matching contributions

The proposal would provide a tax credit to financial institutions that make matching

contributions to IDAs of individuals.9 The tax credit would equal 85 percent of matching

contributions of up to a maximum annual credit of $300 per eligible individual. The credit would

be available in each year that a matching contribution is made. Financial institutions could reduce

Federal tax deposits by the amount of the credit.

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

of the eligible individual.

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

purpose other than a qualified purpose, the matching contribution attributable to such individual
10 The financial institution would be required to adjust tax deposits to take into account

forfeitures of matching contributions.

-23-

contribution would be forfeited.10 Matching contributions could be withdrawn only for qualified

purposes.

A qualified purpose distribution would be a distribution used for (1) certain educational

expenses, (2) first-time homebuyer expenses, and (3) business start-up expenses.

Effect on means-tested programs

Any amounts in the IDA would not be taken into account for certain Federal means-tested

programs.

Effective Date

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

with respect to such IDAs after December 31, 2000, and before January 1, 2006.
11 Early distributions of converted amounts may also accelerate income inclusion of

converted amounts that are taxable under the 4-year rule applicable to 1998 conversions.

-24-

B. Expanding Coverage

1. Option to treat elective deferrals as after-tax contributions

Present Law

A qualified cash or deferred arrangement (“section 401(k) plan”) or a tax-sheltered annuity

(“section 403(b) annuity”) may permit a participant to elect to have the employer make payments as

contributions to the plan or to the participant directly in cash. Contributions made to the plan at the

election of a participant are elective deferrals. Elective deferrals must be nonforfeitable and are

subject to an annual dollar limitation (sec. 402(g)) and distribution restrictions. In addition,

elective deferrals under a section 401(k) plan are subject to special nondiscrimination rules. 

Elective deferrals (and earnings attributable thereto) are not includible in a participant’s gross

income until distributed from the plan.

Individuals with adjusted gross income below certain levels generally may make

nondeductible contributions to a Roth IRA and may convert a deductible or nondeductible IRA into

a Roth IRA. Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not

includible in income, nor subject to the additional 10-percent tax on early withdrawals. A

qualified distribution is a distribution that (1) is made after the 5-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 59-1/2, is made on account of death or disability, or is a qualified

special purpose distribution (i.e., for first-time homebuyer expenses of up to $10,000). A

distribution from a Roth IRA that is not a qualified distribution is includible in income to the extent

attributable to earnings, and is subject to the 10-percent tax on early withdrawals (unless an

exception applies).11

Description of Proposal

A section 401(k) plan or a section 403(b) annuity would be permitted to include a

“qualified plus contribution program” that would permit a participant to elect to have all or a

portion of the participant’s elective deferrals under the plan treated as designated plus

contributions. Designated plus contributions would be elective deferrals that the participant

designates as not excludable from the participant’s gross income.

The annual dollar limitation on a participant’s designated plus contributions would be the

section 402(g) annual limitation on elective deferrals, reduced by the participant’s elective

deferrals that the participant does not designate as designated plus contributions. Designated plus

contributions would be treated as any other elective deferral for purposes of nonforfeitability

requirements and distribution restrictions. Under a section 401(k) plan, designated plus
12 A qualified special purpose distributions, as defined under the rules relating to Roth

IRAs, would not qualify as a tax-free distribution from a designated plus contributions account.

-25-

contributions also would be treated as any other elective deferral for purposes of the special

nondiscrimination requirements.

The plan would be required to establish a separate account, and maintain separate

recordkeeping, for a participant’s designated plus contributions (and earnings allocable thereto). A

qualified distribution from a participant’s designated plus contributions account would not be

includible in the participant’s gross income. A qualified distribution would be a distribution that is

made after the end of a specified nonexclusion period and that is (1) made on or after the date on

which the participant attains age 59-1/2, (2) made to a beneficiary (or to the estate of the

participant) on or after the death of the participant, or (3) attributable to the participant’s being

disabled.12 The nonexclusion period would be the 5-year-taxable period beginning with the earlier

of (1) the first taxable year for which the participant made a designated plus contribution to any

designated plus contribution account established for the participant under the plan, or (2) if the

participant has made a rollover contribution to the designated plus contribution account that is the

source of the distribution from a designated plus contribution account established for the participant

under another plan, the first taxable year for which the participant made a designated plus

contribution to the previously established account.

A distribution from a designated plus contributions account that is a corrective distribution

of an elective deferral (and income allocable thereto) that exceeds the section 402(g) annual limit

on elective deferrals would not be a qualified distribution.

A participant would be permitted to roll over a distribution from a designated plus

contributions account only to another designated plus contributions account or a Roth IRA of the

participant.

The Secretary of the Treasury would be directed to require the plan administrator of each

section 401(k) plan or section 403(b) annuity that permits participants to make designated plus

contributions to make such returns and reports regarding designated plus contributions to the

Secretary, plan participants and beneficiaries, and other persons that the Secretary may designate.

Effective Date

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

2. Increase elective contribution limits

Present Law

Under present law, under certain salary reduction arrangements, an employee may elect to

have the employer make payments as contributions to a plan on behalf of the employee, or to the
13 Another provision of the proposal would increase the 33-1/3 percentage of

compensation limit to 100 percent.

-26-

employee directly in cash. Contributions made at the election of the employee are called elective

deferrals.

The maximum annual amount of elective deferrals that an individual may make to a qualified

cash or deferred arrangement (a “section 401(k) plan”), a tax-sheltered annuity (“section 403(b)

annuity”) or a salary reduction simplified employee pension plan (“SEP”) is $10,000 (for 1999). 

The maximum annual amount of elective deferrals that an individual may make to a SIMPLE plan is

$6,000. These limits are indexed for inflation in $500 increments.

The maximum annual deferral under a deferred compensation plan of a State or local

government or a tax-exempt organization (a “section 457 plan”) is the lesser of (1) $8,000 (for

1999) or (2) 33-1/3 percent of compensation. The $8,000 dollar limit is increased for inflation in

$500 increments. Under a special catch-up rule, the section 457 plan may provide that, for one or

more of the participant’s last 3 years before retirement, the otherwise applicable limit is increased

to the lesser of (1) $15,000 or (2) the sum of the otherwise applicable limit for the year plus the

amount by which the limit applicable in preceding years of participation exceeded the deferrals for

that year.

Description of Proposal

Beginning in 2001, the proposal would increase the dollar limit on annual elective deferrals

under section 401(k) plans, section 403(b) annuities and salary reduction SEPs in $1,000 annual

increments until the limits reach $15,000 in 2005. Beginning in 2001, the proposal would increase

the maximum annual elective deferrals that could be made to a SIMPLE plan in $1,000 annual

increments until the limit reaches $10,000 in 2004. The $15,000 and $10,000 dollar limits would

be indexed in $500 increments, as under present law.

Section 457 plans

The proposal would increase the dollar limit on deferrals under a section 457 plan to

$9,000 in 2001, $10,000 in 2002, $11,000 in 2003, and $12,000 in 2004. After 2004, the limit

would be indexed $500 increments. The limit would be twice the otherwise applicable dollar limit

in the three years prior to retirement.13

Effective Date

The proposal would be effective for years beginning after December 31, 2000, with a

delayed effective date for plans maintained pursuant to a collective bargaining agreement.

3. Plan loans for subchapter S shareholders, partners, and sole proprietors
14 Title I of the Employee Retirement Income Security Act of 1974, as amended

(“ERISA”) also contains prohibited transaction rules. The Code and ERISA provisions are

substantially similar, although not identical. 

15 Certain transactions involving a plan and Subchapter S shareholders are permitted.

-27-

Present Law

The Internal Revenue Code prohibits certain transactions (“prohibited transactions”)

between a qualified plan and a disqualified person in order to prevent persons with a close

relationship to the qualified plan from using that relationship to the detriment of plan participants

and beneficiaries.14 Certain types of transactions are exempted from the prohibited transaction

rules, including loans from the plan to plan participants, if certain requirements are satisfied. In

addition, the Department of Labor can grant an administrative exemption from the prohibited

transaction rules if she finds the exemption is administratively feasible, in the interest of the plan

and plan participants and beneficiaries, and protective of the rights of participants and beneficiaries

of the plan. Pursuant to this exemption process, the Secretary of Labor grants exemptions both with

respect to specific transactions and classes of transactions.

The statutory exemptions to the prohibited transaction rules do not apply to transactions in

which the plan makes a loan to an owner-employee.15 Thus, owner-employees wishing to engage in

such a transaction with a plan must obtain an administrative exemption. For purposes of these

rules, an owner-employee means (1) a sole proprietor, (2) a partner who owns more than 10

percent of either the capital interest or the profits interest in the partnership, (3) an employee or

officer of a Subchapter S corporation who owns more than the corporation, and (4) the owner of an

individual retirement arrangement (“IRA”). The term owner-employee also includes certain family

members of an owner-employee and certain corporations owned by an owner-employee.

Under the Internal Revenue Code, a two-tier excise tax is imposed on disqualified persons

who engage in a prohibited transaction. The first level tax is equal to 15 percent of the amount

involved in the transaction. The second level tax is imposed if the prohibited transaction is not

corrected within a certain period, and is equal to 100 percent of the amount involved.

Description of Proposal

The proposal would generally eliminate the special present-law rules relating to plan loans

made to an owner-employee. Thus, the general statutory exemption would apply to such

transactions. Present law would apply with respect to IRAs.

Effective Date

The proposal would be effective with respect to transactions entered into after December

31, 2000.
-28-

4. Elective deferrals not taken into account for purposes of deduction limits

Present Law

Employer contributions to one or more qualified retirement plans are deductible subject to

certain limits. In general, the deduction limit depends on the kind of plan.

In the case of a defined benefit pension plan or a money purchase pension plan, the

employer generally may deduct the amount necessary to satisfy the minimum funding cost of the plan

for the year. If a defined benefit pension plan has more than 100 participants, the maximum amount

deductible is at least equal to the plan’s unfunded current liabilities.

In the case of a profit-sharing or stock bonus plan, the employer generally may deduct an

amount equal to 15 percent of compensation of the employees covered by the plan for the year.

If an employer sponsors both a defined benefit pension plan and a defined contribution plan

that covers some of the same employees (or a money purchase pension plan and another kind of

defined contribution plan), the total deduction for all plans for a plan year generally is limited to the

greater of (1) 25 percent of compensation or (2) the contribution necessary to meet the minimum

funding requirements of the defined benefit pension plan for the year (or the amount of the plan’s

unfunded current liabilities, in the case of a plan with more than 100 participants).

For purposes of the deduction limits, employee elective deferral contributions to a section

401(k) plan are treated as employer contributions and, thus, are subject to the generally applicable

deduction limits.

Subject to certain exceptions, nondeductible contributions are subject to a 10-percent excise

tax.

Description of Proposal

Under the proposal, elective deferral contributions would not be subject to the deduction

limits, and the application of a deduction limitation to any other employer contribution to a

qualified retirement plan would not take into account elective deferral contributions.

Effective Date

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

5. Reduce PBGC premiums for small and new plans

Present Law
-29-

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides 

insurance protection for participants and beneficiaries under certain defined benefit pension plans

by guaranteeing certain basic benefits under the plan in the event the plan is terminated with

insufficient assets to pay benefits promised under the plan. The guaranteed benefits are funded in

part by premium payments from employers who sponsor defined benefit plans. The amount of the

required annual PBGC premium for a single-employer plan is generally a flat rate premium of $19

per participant and an additional variable rate premium based on a charge of $9 per $1,000 of

unfunded vested benefits. Unfunded vested benefits under a plan generally means (1) the unfunded

current liability for vested benefits under the plan, over (2) the value of the plan’s assets, reduced

by any credit balance in the funding standard account. No variable rate premium is imposed for a

year if contributions to the plan were at least equal to the full funding limit.

The PBGC guarantee is phased in ratably in the case of plans that have been in effect for

less than 5 years, and with respect to benefit increases from a plan amendment that was in effect for

less than 5 years before termination of the plan.

Description of Proposal

Reduced flat-rate premiums for new plans of small employers

Under the proposal, for the first five plan years of a new single-employer plan of a small

employer, the flat-rate PBGC premium would be $5 per plan participant.

A small employer would be a contributing sponsor that, on the first day of the plan year, has

100 or fewer employees. For this purpose, all employees of the members of the controlled group of

the contributing sponsor would be taken into account. In the case of a plan to which more than one

unrelated contributing sponsor contributes, employees of all contributing sponsors (and their

controlled group members) would be taken into account in determining whether the plan is a plan of

a small employer.

A new plan would mean a defined benefit plan maintained by a contributing sponsor if,

during the 36-month period ending on the date of adoption of the plan, such contributing sponsor 

(or controlled group member or a predecessor of either) has not established or maintained a plan

subject to PBGC coverage with respect to which benefits were accrued for substantially the same

employees as are in the new plan.

Reduced variable PBGC premium for new and small employer plans

The proposal would provide that the variable premium is phased in for “new defined

benefit plans” over a six-year period starting with the plan’s first plan year. The amount of the

variable premium would be a percentage of the variable premium otherwise due, as follows: 0

percent of the otherwise applicable variable premium in the first plan year; 20 percent in the

second plan year; 40 percent in the third plan year; 60 percent in the fourth plan year; 80 percent in

the fifth plan year; and 100 percent in the sixth plan year (and thereafter). 
16 User fees are statutorily authorized; however, the IRS sets the dollar amount of the fee

applicable to any particular type of request.

-30-

A new defined benefit plan would be defined as under the flat-rate premium proposal

relating to new small employer plans.

Effective Date

The proposals relating to new plans would be effective for plans established after

December 31, 2000. The proposal reducing the PBGC variable premium for small plans would be

effective for years after December 31, 2000.

6. Eliminate IRS user fees for requests regarding new plans

Present Law

An employer that maintains a retirement plan for the benefit of its employees may request

from the Internal Revenue Service (“IRS”) a determination as to whether the form of the plan

satisfies the requirements applicable to tax-qualified plans (sec. 401(a)), as well as other rulings

and opinions concerning the plan. In order to obtain from the IRS a determination letter on the

qualified status of the plan, a ruling or an opinion, the employer must pay a user fee. For example,

the user fee for a determination letter request may range from $125 to $1,250, depending upon the

scope of the request and the type and format of the plan.16

Description of Proposal

No user fee would be required for any determination letter, ruling, or opinion with respect

to a new retirement plan. For purposes of the proposal, a new retirement plan would be a plan

maintained by one or more employers that (1) have not made a prior request for a determination

letter, ruling, or opinion with respect to the plan or any predecessor plan, and (2) have not

established or maintained a qualified plan with respect to which contributions were made, or

benefits accrued for service, in the 3 most recent taxable years ending prior to the first taxable year

in which the request is made.

Effective Date

The proposal would be effective for determination letter requests made after December 31,

2000.

7. SAFE annuities and trusts

Present Law
-31-

A small business may establish a simplified defined contribution retirement plan called a

savings incentive match plan for employees (“SIMPLE”) retirement plan. An employer is eligible

to adopt a SIMPLE plan if the employer employs 100 or fewer employees who received at least

$5,000 in compensation during the preceding year and does not maintain another retirement plan.

A SIMPLE plan may be either an individual retirement arrangement for each employee

(“SIMPLE IRA”) or part of a qualified cash or deferred arrangement (a “SIMPLE 401(k)”). A

SIMPLE IRA is not subject to the nondiscrimination rules or top-heavy rules generally applicable

to qualified plans. Similarly, a SIMPLE 401(k) is deemed to satisfy the special nondiscrimination

tests applicable to 401(k) plans and is not subject to the top-heavy rules. The other qualified plan

rules apply to a SIMPLE 401(k), however.

SIMPLE plans are subject to special contribution rules. Employees may elect during the

60-day period preceding a plan year to make elective contributions under a SIMPLE plan of up to

$6,000 during the plan year. The $6,000 dollar limit is adjusted for cost-of-living increases in

$500 increments. 

An employer that maintains a SIMPLE plan generally is required to match each employee’s

elective contributions on a dollar-for-dollar basis up to 3 percent of the employee’s compensation. 

As an alternative to a matching contribution for any year, an employer may make a nonelective

contribution on behalf of each eligible employee equal to 2 percent of the employee’s

compensation.

Under a SIMPLE IRA, the compensation limit does not apply for purposes of the required

employer matching contribution. If the employer satisfies the contribution requirement by making a

nonelective contribution, however, the amount of compensation taken into account for each

participant to determine the amount of the required employer contribution may not exceed the

compensation limit.

Under a SIMPLE 401(k), the compensation limit applies for purposes of the matching

contribution as well as the nonelective contribution.

No contributions other than employee elective contributions and required employer

contributions may be made to a SIMPLE plan. All contributions under a SIMPLE plan must be fully

vested.

Present law does not provide for a simplified defined benefit plan similar to the SIMPLE

plan.

Description of Proposal

A small business would be permitted to establish a simplified retirement plan called the

secure assets for employees (“SAFE”) plan. The SAFE plan would combine the features of a

defined benefit plan and a defined contribution plan.
-32-

Employer and employee eligibility and vesting

An employer would be eligible to adopt a SAFE plan if the employer employs 100 or fewer

employees who received at least $5,000 in compensation during the preceding year and does not

maintain another retirement plan other than a plan that provides only for elective deferrals or

matching contributions, an eligible deferred compensation plan of a tax-exempt organization or a

State or local government (“section 457 plan”), or a collectively bargained plan.

Each employee whose compensation was at least $5,000 in any 2 preceding consecutive

years and in the current year generally would be eligible to participate. All benefits under a SAFE

plan would be fully vested at all times.

Benefits and funding

A SAFE plan would provide a fully funded minimum defined benefit. For each year of

participation, a participant generally would accrue a minimum annual benefit at retirement equal to

3 percent of the participant’s compensation for the year. The employer would be permitted to elect

to provide a benefit of 2 percent, 1 percent, or 0 percent of compensation for any year for all

participants if the employer notifies the participants of such lower percentage within a reasonable

period before the beginning of the year. Benefits under a SAFE plan would be subject to the annual

limitation on compensation that may be taken into account under a qualified plan ($160,000 in

1999).

An employer would be permitted to count up to 10 years of service performed by a

participant before the adoption of a SAFE plan (“prior service year”) if the same number of prior

service years is available to all employees eligible to participate in the SAFE plan for the first plan

year. Prior service years would be taken into account by doubling the amount of the contribution

the employer would otherwise make for each participant with prior service years, beginning with

the first year the SAFE plan is in effect. A participant’s prior service years would not include any

years in which a participant was an active participant in any defined benefit plan maintained by the

employer or received less than $5,000 in compensation from the employer.

Each year the employer would be required to contribute to the SAFE plan on behalf of each

participant an amount sufficient to provide the annual benefit accrued for the year payable at age 65,

using specified actuarial assumptions (including an interest rate not less than 3 percent and not

greater than 5 percent per year). A SAFE plan would be funded either through an individual

retirement annuity for each employee (“SAFE Annuity”) or through a trust (a “SAFE Trust”). 

Under a SAFE Trust, each participant would have an account to which actual investment

returns would be credited. If a participant’s account balance were less than the total of past

employer contributions credited with a specified interest rate (not less than 3 percent and not

greater than 5 percent per year), the employer would be required to make up the shortfall. If the

investment returns in a participant’s account exceed the specified interest rate, the participant

would be entitled to the larger account balance. Permissible investments of a SAFE Trust would
-33-

be securities that are readily tradable on an established securities market and insurance company

products that are regulated by State law.

Under a SAFE Annuity, each year the employer would be required to contribute the amount

necessary to purchase an annuity that provides the benefit accrual for the year.

The required contributions to a SAFE plan would be deductible under the rules applicable

to qualified defined benefit plans. An excise tax would apply if the employer fails to make the

required contribution for the year.

Benefits under a SAFE plan would not be guaranteed by the Pension Benefit Guaranty

Corporation.

Distributions

A SAFE plan would be permitted to provide for distributions at any time. Distributions

from a SAFE plan would be subject to tax under the present-law rules applicable to distributions

from qualified plans, except that a distribution prior to the participant’s attainment of age 59-1/2

generally would be subject to an additional tax equal to 20 percent of the amount distributed.

A SAFE plan would be required to provide for payment of benefits in the form of a single

life annuity payable at age 65 or any actuarially equivalent form of benefit. A SAFE plan would

not be subject to the joint and survivor annuity requirements applicable to other defined benefit

pension plans.

Nondiscrimination requirements and other rules

A SAFE plan would not be subject to the nondiscrimination rules, the top-heavy plan rules,

or the limitations on benefits or contributions applicable to qualified retirement plans. Simplified

reporting and disclosure requirements would apply to SAFE plans.

Effective Date

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

8. Compensation limit not to apply to SIMPLE 401(k) plans

Present Law

The annual compensation of each participant that may be taken into account under a

qualified retirement plan for purposes of determining contributions and benefits, applying the

deduction rules, and nondiscrimination testing is limited to $160,000 (for 1999). The compensation

limit is indexed for cost-of-living adjustments in $10,000 increments.
-34-

A small business may establish a simplified retirement plan called a savings incentive

match plan for employees (“SIMPLE”) retirement plan. An employer is eligible to adopt a

SIMPLE plan if the employer employs 100 or fewer employees who received at least $5,000 in

compensation during the preceding year and does not maintain another retirement plan. 

A SIMPLE plan may be either an individual retirement arrangement for each employee

(“SIMPLE IRA”) or part of a qualified cash or deferred arrangement (a “SIMPLE 401(k)”). A

SIMPLE IRA is not subject to the nondiscrimination rules or top-heavy rules generally applicable

to qualified plans. Similarly, a SIMPLE 401(k) is deemed to satisfy the special nondiscrimination

tests applicable to 401(k) plans and is not subject to the top-heavy rules. The other qualified plan

rules apply to a SIMPLE 401(k), however.

SIMPLE plans are subject to special contribution rules. Employees may elect during the

60-day period preceding a plan year to make elective contributions under a SIMPLE plan of up to

$6,000 during the plan year. The $6,000 dollar limit is adjusted for cost-of-living increases in

$500 increments. 

An employer that maintains a SIMPLE plan generally is required to match each employee’s

elective contributions on a dollar-for-dollar basis up to 3 percent of the employee’s compensation. 

As an alternative to a matching contribution for any year, an employer may make a nonelective

contribution on behalf of each eligible employee equal to 2 percent of the employee’s

compensation.

Under a SIMPLE-IRA, the compensation limit does not apply for purposes of the required

employer matching contribution. If the employer satisfies the contribution requirement by making a

nonelective contribution, however, the amount of compensation taken into account for each

participant to determine the amount of the required employer contribution may not exceed the

compensation limit.

Under a SIMPLE-401(k), the compensation limit applies for purposes of the matching

contribution as well as the nonelective contribution.

No contributions other than employee elective contributions and required employer

contributions may be made to a SIMPLE plan.

Description of Proposal

The application of the compensation limit would be the same for a SIMPLE-401(k) and a

SIMPLE-IRA. Thus, the compensation limit would apply for purposes of the nonelective

contribution but not for the matching contribution.

Effective Date

The proposal would be effective for years beginning after December 31, 2000.
17 The various dollar limits on contributions described below would be increased under

other provisions in the proposal.

18 For a more detailed description of the contribution limits for IRAs, see the discussion of

present law in part III.A., above.

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C. Enhancing Fairness for Women

1. Additional salary reduction catch-up contributions

Present Law17

Elective deferral limitations

Under present law, under certain salary reduction arrangements, an employee may elect to

have the employer make payments as contributions to a plan on behalf of the employee, or to the

employee directly in cash. Contributions made at the election of the employee are called elective

deferrals. 

The maximum annual amount of elective deferrals that an individual may make to a qualified

cash or deferred arrangement (a “401(k) plan”), a tax-sheltered annuity (“section 403(b) annuity”)

or a salary reduction simplified employee pension plan (“SEP”) is $10,000 (for 1999). The

maximum annual amount of elective deferrals that an individual may make to a SIMPLE plan is

$6,000. These limits are indexed for inflation in $500 increments.

Section 457 plans

The maximum annual deferral under a deferred compensation plan of a State or local

government or a tax-exempt organization (a “section 457 plan”) is the lesser of (1) $8,000 (for

1999) or (2) 33-1/3 percent of compensation. The $8,000 dollar limit is increased for inflation in

$500 increments. Under a special catch-up rule, the section 457 plan may provide that, for one or

more of the participant’s last 3 years before retirement, the otherwise applicable limit is increased

to the lesser of (1) $15,000 or (2) the sum of the otherwise applicable limit for the year plus the

amount by which the limit applicable in preceding years of participation exceeded the deferrals for

that year. 

IRAs18

Under present law, individuals may make contributions annually of up to $2,000 to a

traditional IRA or a Roth IRA. The maximum deductible contribution to a traditional IRA is

phased-out for active participants in an employer-sponsored retirement plan with adjusted gross

income above certain levels. The ability to make contributions to a Roth IRA is also phased out

above certain income levels.
19 In the case of a section 457 plans, this catch-up rule would not apply during the

participant’s last 3 years before retirement (in those years, the regularly applicable dollar limit is

doubled).

20 Another provision in the proposal would provide that elective contributions are

deductible without regard to the otherwise applicable deduction limits.

-36-

Description of Proposal

The proposal would provide that individuals who have attained age 50 would be permitted

to make additional catch-up elective contributions to employer-sponsored retirement plans and

additional catch-up IRA contributions.

In the case of employer-sponsored retirement plans, the proposal would apply to elective

deferrals under a section 401(k) plan, section 403(b) annuity, SIMPLE, or section 457 plan. 

Additional contributions could be made by an individual who has attained age 50 before the end of

the plan year and with respect to whom no other elective deferrals may otherwise be made to the

plan for the year because of the application of any limitation of the Code (e.g., the annual limit on

elective deferrals) or of the plan. Under the proposal, the additional amount of elective

contributions that could be made by an eligible individual participating in such a plan would be the

lesser of (1) the applicable percent of the maximum dollar amount of elective deferrals otherwise

excludable from the gross income of the participant for the year (under sec. 402(g))or (2) the

participant’s compensation for the year reduced by any other elective deferrals of the participant

for the year.19 The applicable percent would be 10 percent in 2001, and would increase by 10

percentage points until the applicable percent is 50 in 2005 and thereafter. The following examples

illustrate the application of the proposal, after the catch-up is fully phased in.

Example 1: Employee A is a highly compensated employee who is over 50 and who

participates in a section 401(k) plan sponsored by A’s employer. The maximum annual

deferral limit (without regard to the proposal) is $10,000. After application of the special

nondiscrimination rules applicable to section 401(k) plans, the maximum elective deferral

A may make for the year is $8,000. Under the proposal, A would be able to make

additional catch-up salary reduction contributions of $5,000.

Example 2: Employee B, who is over 50, is a participant in a section 401(k) plan. B’s

compensation for the year is $30,000. The maximum annual deferral limit (without regard

to the proposal) is $10,000. Under the terms of the plan, the maximum permitted deferral is

10 percent of compensation or, in B’s case, $3,000. Under the proposal, B can contribute

up to $8,000 for the year ($3,000 under the normal operation of the plan, and an additional

$5,000 under the proposal).

Catch-up contributions made under the proposal would not be subject to any other

contribution limits and would not be taken into account in applying other contribution limits. In

addition, such contributions would not be subject to applicable nondiscrimination rules.20
-37-

An employer would be permitted to make matching contributions with respect to catch-up

contributions. Any such matching contributions would be subject to the normally applicable rules.

In the case of IRAs, the otherwise maximum contribution limit (before application of the

AGI phase-out limits) for an individual who has attained age 50 before the end of the taxable year

would be increased by 50 percent.

Effective Date

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

2. Equitable treatment for contributions of employees to defined contribution plans

Present Law

Present law imposes limits on the contributions that may be made to tax-favored retirement

plans. 

Defined contribution plans

In the case of a tax-qualified defined contribution plan, the limit on annual additions that can

be made to the plan on behalf of an employee is the lesser of $30,000 (for 1999) or 25 percent of

the employee’s compensation (sec. 415(c)). Annual additions include employer contributions,

including contributions made at the election of the employee (i.e., employee elective deferrals),

after-tax employee contributions, and any forfeitures allocated to the employee. For this purpose,

compensation means taxable compensation of the employee, plus elective deferrals, and similar

salary reduction contributions.

Tax-sheltered annuities

In the case of a tax-sheltered annuity (a “section 403(b) annuity”), the annual contribution

generally cannot exceed the lesser of the exclusion allowance or the section 415(c) defined

contribution limit. The exclusion allowance for a year is equal to 20 percent of the employee’s

includible compensation, multiplied by the employee’s years of service, minus excludable

contributions for prior years under qualified plans, tax-sheltered annuities or section 457 plans of

the employer. 

In addition to this general rule, employees of nonprofit educational institutions, hospitals,

home health service agencies, health and welfare service agencies, and churches may elect

application of one of several special rules that increase the amount of the otherwise permitted

contributions. The election of a special rule is irrevocable; an employee may not elect to have

more than one special rule apply. 
21 Another provision of the proposal would increase the defined contribution plan dollar

limit.

-38-

Under one special rule, in the year the employee separates from service, the employee may

elect to contribute up to the exclusion allowance, without regard to the 25 percent of compensation

limit under section 415. Under this rule, the exclusion allowance is determined by taking into

account no more than 10 years of service.

Under a second special rule, the employee may contribute up to the lesser of: (1) the

exclusion allowance; (2) 25 percent of the participant’s includible compensation; or (3) $15,000.

Under a third special rule, the employee may elect to contribute up to the section 415(c)

limit, without regard to the exclusion allowance. If this option is elected, then contributions to

other plans of the employer are also taken into account in applying the limit.

For purposes of determining the contribution limits applicable to section 403(b) annuities,

includible compensation means the amount of compensation received from the employer for the

most recent period which may be counted as a year of service under the exclusion allowance. In

addition, includible compensation includes elective deferrals and similar salary reduction amounts.

Section 457 plans

Compensation deferred under an eligible deferred compensation plan of a tax-exempt or

State and local governmental employer (a “section 457 plan”) is not includible in gross income

until paid or made available. In general, the maximum permitted annual deferral under such a plan

is the lesser of (1) $8,000 (in 1999) or (2) 33-1/3 percent of compensation. The $8,000 limit is

increased for inflation in $500 increments.

Description of Proposal

Increase in defined contribution plan limit

The proposal would increase the 25 percent of compensation limitation on annual additions

under a defined contribution plan to 100 percent.21

Conforming limits on tax-sheltered annuities

The proposal would repeal the exclusion allowance applicable to contributions to taxsheltered annuities. Thus, such annuities would be subject to the limits applicable to tax-qualified

plans.

Section 457 plans

The proposal would increase the 33-1/3 percent of compensation limitation on deferrals
-39-

under a section 457 plan to 100 percent of compensation.

Effective Date

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

3. Clarification of tax treatment of division of section 457 plan benefits upon divorce

Present Law

Under present law, benefits provided under a qualified retirement plan for a participant may

not be assigned or alienated to creditors of the participant, except in very limited circumstances.

One exception to the prohibition on assignment or alienation rule is a qualified domestic relations

order (“QDRO”). A QDRO is a domestic relations order that creates or recognizes a right of an

alternate payee to any plan benefit payable with respect to a participant, and that meets certain

procedural requirements.

Under present law, amounts distributed from a qualified plan generally are taxable to the

participant in the year of distribution. However, if amounts are distributed to the spouse (or former

spouse) of the participant by reason of a QDRO, the benefits are taxable to the spouse (or former

spouse). Amounts distributed pursuant to a QDRO to an alternate payee other than the spouse (or

former spouse) are taxable to the plan participant.

 Section 457 of the Internal Revenue Code provides rules for deferral of compensation by

an individual participating in an eligible deferred compensation plan (“section 457 plan”) of a taxexempt or State and local government employer. The QDRO rules do not apply to section 457

plans.

Description of Proposal

The proposal would apply the taxation rules for qualified plan distributions pursuant to a

QDRO to distributions made pursuant to a domestic relations order from a section 457 plan. In

addition, a section 457 plan would not be treated as violating the restrictions on distributions from

such plans due to payments to an alternate payee under a QDRO.

Effective Date

The proposal would be effective for transfers, distributions and payments made after

December 31, 2000.

4. Modification of safe harbor relief for hardship withdrawals from 401(k) plans

Present Law
22 Treas. Reg. sec. 1.401(k)-1.

-40-

Elective deferrals under a qualified cash or deferred arrangement (a “section 401(k) plan”)

may not be distributable prior to the occurrence of one or more specified events. One event upon

which distribution is permitted is the financial hardship of the employee. Applicable Treasury

regulations22 provide that a distribution is made on account of hardship only if the distribution is

made on account of an immediate and heavy financial need of the employee and is necessary to

satisfy the heavy need.

The Treasury regulations provide a safe harbor under which a distribution may be deemed

necessary to satisfy an immediate and heavy financial need. One requirement of this safe harbor is

that the employee be prohibited from making elective contributions and employee contributions to

the plan and all other plans maintained by the employer for at least 12 months after receipt of the

hardship distribution.

Description of Proposal

The Secretary of the Treasury would be directed to revise the applicable regulations to

reduce from 12 months to 6 months the period during which an employee must be prohibited from

making elective contributions and employee contributions in order for a distribution to be deemed

necessary to satisfy an immediate and heavy financial need.

Effective Date

The proposal would be effective for years beginning after December 31, 2000.
23 A “traditional” IRA refers to IRAs other than Roth IRAs or SIMPLE IRAs. All

references to IRAs refers only to traditional IRAs.

24 An eligible rollover distribution may either be rolled over by the distributee within 60

days of the date of the distribution or, as described below, directly rolled over by the distributing

plan.

-41-

D. Increasing Portability for Participants

1. Rollovers of retirement plan and IRA distributions

Present Law

In general

Present law permits the rollover of funds from a tax-favored retirement plan to another taxfavored retirement plan. The rules that apply depend on the type of plan involved. Similarly, the

rules regarding the tax treatment of amounts that are not rolled over depend on the type of plan

involved.

Distributions from qualified plans

Under present law, an “eligible rollover distribution” from a tax-qualified employersponsored retirement plan may be rolled over tax free to a traditional individual retirement

arrangement (“IRA”)23 or another qualified plan.24 An “eligible rollover distribution” means any

distribution to an employee of all or any portion of the balance to the credit of the employee in a

qualified plan, except the term does not include (1) any distribution which is one of a series of

substantially equal periodic payments made (a) for the life (or life expectancy) of the employee or

the joint lives (or joint life expectancies) of the employee and the employee’s designated

beneficiary, or (b) for a specified period of 10 years or more, (2) any distribution to the extent

such distribution is required under the minimum distribution rules, and (3) certain hardship

distributions. The maximum amount that can be rolled over is the amount of the distribution

includible in income, i.e., after-tax employee contributions cannot be rolled over. Qualified plans

are not required to accept rollovers.

Distributions from tax-sheltered annuities

Eligible rollover distributions from a tax-sheltered annuity (“section 403(b) annuity”) may

be rolled over into an IRA or another section 403(b) annuity. Distributions from a section 403(b)

annuity cannot be rolled over into a tax-qualified plan. Section 403(b) annuities are not required to

accept rollovers.
-42-

IRA distributions

Distributions from a traditional IRA, other than minimum required distributions, can be

rolled over into another IRA. In general, distributions from an IRA cannot be rolled over into a

qualified plan or section 403(b) annuity. An exception to this rule applies in the case of so-called

“conduit IRAs.” Under the conduit IRA rule, amounts can be rolled from a qualified plan into an

IRA and then subsequently rolled back to another qualified plan if the amounts in the IRA are

attributable solely to rollovers from a qualified plan. Similarly, an amount may be rolled over from

a section 403(b) annuity to an IRA and subsequently rolled back into a section 403(b) annuity if the

amounts in the IRA are attributable solely to rollovers from a section 403(b) annuity.

Distributions from section 457 plans

A “section 457 plan” is an eligible deferred compensation plan of a State or local

government or tax-exempt employer that meets certain requirements. In some cases, different rules

apply under section 457 to governmental plans and plans of tax-exempt employers. For example,

governmental section 457 plans are like qualified plans in that plan assets are required to be held in

a trust for the exclusive benefit of plan participants and beneficiaries. In contrast, benefits under a

section 457 plan of a tax-exempt employer are unfunded, like nonqualified deferred compensation

plans of private employers.

Section 457 benefits can be transferred to another section 457 plan. Distributions from a

section 457 plan cannot be rolled over to another section 457 plan, a qualified plan, a section

403(b) annuity, or an IRA.

Rollovers by surviving spouses

A surviving spouse that receives an eligible rollover distribution may roll over the

distribution into an IRA, but not a qualified plan or section 403(b) annuity.

Direct rollovers and withholding requirements

Qualified plans and section 403(b) annuities are required to provide that a plan participant

has the right to elect that an eligible rollover distribution be directly rolled over to another eligible

retirement plan. If the plan participant does not elect the direct rollover option, then withholding is

required on the distribution at a 20-percent rate.

Notice of eligible rollover distribution

The plan administrator of a qualified plan or a section 403(b) annuity is required to provide

a written explanation of rollover rules to individuals who receive a distribution eligible for

rollover. In general, the notice is to be provided within a reasonable period of time before making

the distribution and is to include an explanation of (1) the provisions under which the individual

may have the distribution directly rolled over to another eligible retirement plan, (2) the provision
25 Hardship distributions from governmental section 457 plans would be considered

eligible rollover distributions.

-43-

that requires withholding if the distribution is not directly rolled over, (3) the provision under

which the distribution may be rolled over within 60 days of receipt, and (4) if applicable, certain

other rules that may apply to the distribution. The Treasury Department has provided more specific

guidance regarding timing and content of the notice.

Taxation of distributions

As is the case with the rollover rules, different rules regarding taxation of benefits apply to

different types of tax-favored arrangements. In general, distributions from a qualified plan, section

403(b) annuity, or IRA are includible in income in the year received. In certain cases, distributions

from qualified plans are eligible for capital gains treatment and averaging. These rules do not

apply to distributions from another type of plan. Distributions from a qualified plan, IRA, and

section 403(b) annuity generally are subject to an additional 10-percent early withdrawal tax if

made before age 59-1/2. There are a number of exceptions to the early withdrawal tax. Some of

the exceptions apply to all three types of plans, and others apply only to certain types of plans. For

example, the 10-percent early withdrawal tax does not apply to IRA distributions for educational

expenses, but does apply to similar distributions from qualified plans and section 403(b) annuities. 

Benefits under a section 457 plan are generally includible in income when paid or made available. 

The 10-percent early withdrawal tax does not apply to section 457 plans.

Description of Proposal

In general

The proposal would provide that eligible rollover distributions from qualified retirement

plans, section 403(b) annuities, and governmental section 457 plans generally could be rolled over

to any of such plans or arrangements.25 Similarly, distributions from an IRA generally could be

rolled over into a qualified plan, section 403(b) annuity, or governmental section 457 plan. The

direct rollover and withholding rules would be extended to distributions from a section 457 plan,

and such plans would be required to provide the written notification regarding eligible rollover

distributions. The rollover notice (with respect to all plans) would be required to include a

description of the provisions under which distributions from the plan to which the distribution is

rolled over may be subject to restrictions and tax consequences different than those applicable to

distributions from the distributing plan. Qualified plans, section 403(b) annuities, and section 457

plans would not be required to accept rollovers.

Some special rules would apply in certain cases. A distribution from a qualified plan

would not be eligible for capital gains or averaging treatment if there was a rollover to the plan

that would not have been permitted under present law. Thus, in order to preserve capital gains and

averaging treatment for a qualified plan distribution that is rolled over, the rollover would have to

be made to a “conduit IRA” as under present law, and then rolled back into a qualified plan. 
-44-

Amounts distributed from a section 457 plan would be subject to the early withdrawal tax to the

extent the distribution consists of amounts attributable to rollovers from another type of plan. 

Section 457 plans would be required to separately account for such amounts. The proposal would

also provide that benefits in governmental section 457 plans are includible in income when paid.

Rollover of after-tax contributions

The proposal would provide that employee after-tax contributions could be rolled over into

another qualified plan or a traditional IRA. In the case of a rollover from a qualified plan to

another qualified plan, the rollover could be accomplished only through a direct rollover. In

addition, a qualified plan could not accept rollovers of after-tax contributions unless the plan

provides separate accounting for such contributions (and earnings thereon). After-tax contributions

(including nondeductible contributions to an IRA) could not be rolled over from an IRA into a

qualified plan, tax-sheltered annuity, or section 457 plan.

In the case of a distribution from a traditional IRA that is rolled over into an eligible

rollover plan that is not an IRA, the distribution would be attributed first to amounts other than

after-tax contributions.

Expansion of spousal rollovers

The proposal would provide that surviving spouses could roll over distributions to a

qualified plan, section 403(b) annuity, or governmental section 457 plan in which the spouse

participates.

Treasury regulations

The Secretary would be directed to prescribe rules necessary to carry out the provisions. 

Such rules may include, for example, reporting requirements and mechanisms to address mistakes

relating to rollovers. It is anticipated that the IRS will develop forms to assist individuals who roll

over after-tax contributions to an IRA in keeping track of such contributions. Such forms could, for

example, expand Form 8606 - Nondeductible IRAs, to include information regarding after-tax

contributions.

Effective Date

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

2. Waiver of 60-day rule

Present Law
26 A similar provision is contained in Title I of ERISA.

27 Treas. Reg. sec. 1.411(d)-4, Q&A-2(a)(3)(i).

-45-

Under present law, amounts received from an IRA or qualified plan may be rolled over tax

free if the rollover is made within 60 days of the date of the distribution. The Secretary does not

have the authority to waive the 60-day requirement.

Description of Proposal

The proposal would provide that the Secretary may waive the 60-day rollover period if the

failure to waive such requirement would be against equity or good conscience, including cases of

casualty, disaster, or other events beyond the reasonable control of the individual subject to such

requirement. 

Effective Date

The proposal would apply to distributions made after December 31, 2000.

3. Treatment of forms of distribution

Present Law

An amendment of a qualified retirement plan may not decrease the accrued benefit of a plan

participant. An amendment is treated as reducing an accrued benefit if, with respect to benefits

accrued before the amendment is adopted, the amendment has the effect of either (1) eliminating or

reducing an early retirement benefit or a retirement-type subsidy, or (2) except as provided by

Treasury regulations, eliminating an optional form of benefit (sec. 411(d)(6)).26

The prohibition against the elimination of an optional form of benefit applies to plan

mergers, spinoffs, transfers, and transactions amending or having the effect of amending a plan or

plans to transfer plan benefits. For example, if Plan A, a profit-sharing plan that provides for

distribution of benefits in annual installments over ten or twenty years, is merged with Plan B, a

profit-sharing plan that provides for distribution of benefits in annual installments over life

expectancy at the time of retirement, the merged plan must preserve the ten- or twenty-year

installment option with respect to benefits accrued under Plan A as of the date of the merger and the

installments over life expectancy with respect to benefits accrued under Plan B as of the date of the

merger. Similarly, for example, if a participant’s benefit under a defined contribution plan is

transferred to another defined contribution plan maintained by the same or a different employer, the

optional forms of benefit available with respect to the participant’s accrued benefit under the

transferor plan must be preserved.27

Description of Proposal
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A defined contribution plan to which benefits are transferred would not be treated as

reducing a participant’s or beneficiary’s accrued benefit even though it does not provide all of the

forms of distribution previously available under the transferor plan if (1) the plan receives from

another defined contribution plan a direct transfer of the participant’s or beneficiary’s benefit

accrued under the transferor plan, or the plan results from a merger or other transaction that has the

effect of a direct transfer (including consolidations of benefits attributable to different employers

within a multiple employer plan), (2) the terms of both the transferor plan and the transferee plan

authorize the transfer, (3) the transfer occurs pursuant to a voluntary election by the participant or

beneficiary that is made after the participant or beneficiary received a notice describing the

consequences of making the election, (4) if the transferor plan provides for an annuity as the normal

form of distribution in accordance with the joint and survivor annuity rules (sec. 417), the

participant’s spouse (if any) consents to the transfer in a manner similar to the consent required by

section 417, and (5) the transferee plan allows the participant or beneficiary to receive distribution

of his or her benefit under the transferee plan in the form of a single sum distribution.

In addition, except to the extent provided by the Secretary of the Treasury in regulations, a

defined contribution plan would not be treated as reducing a participant’s accrued benefit if (1) a

plan amendment eliminates a form of distribution previously available under the plan, (2) a single

sum distribution is available to the participant at the same time or times as the form of distribution

eliminated by the amendment, and (3) the single sum distribution is based on the same or greater

portion of the participant’s accrued benefit as the form of distribution eliminated by the amendment.

The Secretary would be directed to issue, not later than December 31, 2001, final

regulations under section 411(d)(6) implementing the provisions of the proposal.

Furthermore, the proposal would authorize the Secretary of the Treasury to provide by

regulations that the prohibitions against eliminating or reducing an early retirement benefit, a

retirement-type subsidy, or an optional form of benefit would not apply to plan amendments that do

not adversely affect the rights of participants in a material manner but that do eliminate or reduce

early retirement benefits, retirement-type subsidies, and optional forms of benefit that create

significant burdens and complexities for a plan and its participants.

It would be intended that the factors to be considered in determining whether an amendment

has a materially adverse effect on a participant would include (1) all of the participant’s early

retirement benefits, retirement-type subsidies, and optional forms of benefits that are reduced or

eliminated by the amendment, (2) the extent to which early retirement benefits, retirement-type

subsidies, and optional forms of benefit in effect with respect to a participant after the amendment

effective date provide rights that are comparable to the rights that are reduced or eliminated by the

plan amendment, (3) the number of years before the participant attains normal retirement age under

the plan (or early retirement age, as applicable), (4) the size of the participant’s benefit that is

affected by the plan amendment, in relation to the amount of the participant’s compensation, and (5)

the number of years before the plan amendment is effective.

Effective Date
28 Rev. Rul. 79-336, 1979-2 C.B. 187.

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

4. Rationalization of restrictions on distributions

Present Law

Elective deferrals under a qualified cash or deferred arrangement (“section 401(k) plan”),

tax-sheltered annuity (“section 403(b) annuity”), or an eligible deferred compensation plan of a taxexempt organization or State or local government (“section 457 plan”), may not be distributable

prior to the occurrence of one or more specified events. These permissible distributable events

include “separation from service.” 

A separation from service occurs only upon a participant’s death, retirement, resignation or

discharge, and not when the employee continues on the same job for a different employer as a result

of the liquidation, merger, consolidation or other similar corporate transaction. A severance from

employment occurs when a participant ceases to be employed by the employer that maintains the

plan. Under a so-called “same desk rule,” a participant’s severance from employment does not

necessarily result in a separation from service.28

In addition to separation from service and other events, a section 401(k) plan that is

maintained by a corporation may permit distributions to certain employees who experience a

severance from employment with the corporation that maintains the plan but does not experience a

separation from service because the employee continues on the same job for a different employer as

a result of a corporate transaction. If the corporation disposes of substantially all of the assets used

by the corporation in a trade or business, a distributable event occurs with respect to the accounts

of the employees who continue employment with the corporation that acquires the assets. If the

corporation disposes of its interest in a subsidiary, a distributable event occurs with respect to the

accounts of the employees who continue employment with the subsidiary.

Description of Proposal

The proposal would modify the distribution restrictions applicable to section 401(k) plans,

section 403(b) annuities, and section 457 plans to provide that distribution may occur upon

severance from employment rather than separation from service. In addition, the provisions for

distribution from a section 401(k) plan based upon a corporation’s disposition of its assets or a

subsidiary would be repealed; this special rule would no longer be necessary under the proposal. 

Effective Date

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

5. Purchase of service credit under governmental pension plans
-48-

Present Law

A qualified retirement plan maintained by a State or local government employer may

provide that a participant may make after-tax employee contributions in order to purchase

permissive service credit, subject to certain limits (sec. 415). Permissive service credit means

credit for a period of service recognized by the governmental plan only if the employee voluntarily

contributes to the plan an amount (as determined by the plan) that does not exceed the amount

necessary to fund the benefit attributable to the period of service and that is in addition to the

regular employee contributions, if any, under the plan.

In the case of any repayment of contributions and earnings to a governmental plan with

respect to an amount previously refunded upon a forfeiture of service credit under the plan (or

another plan maintained by a State or local government employer within the same State), any such

repayment is not taken into account for purposes of the section 415 limits on contributions and

benefits. Also, service credit obtained as a result of such a repayment is not considered permissive

service credit for purposes of the section 415 limits.

A participant may not use a rollover or direct transfer of benefits from a tax-sheltered

annuity (“section 403(b) annuity”) or an eligible deferred compensation plan of a tax-exempt

organization of a State or local government (“section 457 plan”) to purchase permissive service

credits or repay contributions and earnings with respect to a forfeiture of service credit.

Description of Proposal

A participant in a State or local governmental plan would not be required to include in

gross income a direct trustee-to-trustee transfer to a governmental defined benefit plan from a

section 403(b) annuity or a section 457 plan if the transferred amount is used (1) to purchase

permissive service credits under the plan, or (2) to repay contributions and earnings with respect to

an amount previously refunded under a forfeiture of service credit under the plan (or another plan

maintained by a State or local government employer within the same State).

Effective Date

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

6. Employers may disregard rollovers for purposes of cash-out rules

Present Law

If an qualified retirement plan participant ceases to be employed by the employer that

maintains the plan, the plan may distribute the participant’s nonforfeitable accrued benefit without

the consent of the participant and, if applicable, the participant’s spouse, if the present value of the

benefit does not exceed $5,000. If such an involuntary distribution occurs and the participant

subsequently returns to employment covered by the plan, then service taken into account in
29 A similar provision is contained in Title I of ERISA.

30 Other provisions of the proposal would expand the kinds of plans to which benefits may

be rolled over.

-49-

computing benefits payable under the plan after the return need not include service with respect to

which a benefit was involuntarily distributed unless the employee repays the benefit.29

Generally, a participant may roll over an involuntary distribution from a qualified plan to an

IRA or to another qualified plan.30

Description of Proposal

A plan would be permitted to provide that the present value of a participant’s nonforfeitable

accrued benefit is determined without regard to the portion of such benefit that is attributable to

rollover contributions (and any earnings allocable thereto).

Effective Date

The proposal would be effective for distributions after December 31, 2000.
31 The minimum funding requirements, including the full funding limit, are also contained

in title I of ERISA.

32 As originally enacted in the Pension Protection Act of 1997, the current liability full

funding limit was 150 percent of current liability. The Taxpayer Relief Act of 1997 increased the

current liability full funding limit to 155 percent in 1999 and 2000, and adopted the scheduled

increases described in the text.

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E. Strengthening Pension Security And Enforcement

1. Phase in repeal of 150 percent of current liability funding limit; deduction for contributions

to fund termination liability

Present Law

Under present law, defined benefit pension plans are subject to minimum funding

requirements designed to ensure that pension plans have sufficient assets to pay benefits. A defined

benefit pension plan is funded using one of a number of acceptable actuarial cost methods. 

No contribution is required under the minimum funding rules in excess of the full funding

limit. The full funding limit is generally defined as the excess, if any, of (1) the lesser of (a) the

accrued liability under the plan (including normal cost) or (b) 155 percent of the plan’s current

liability, over (2) the value of the plan’s assets (sec. 412(c)(7)).31 In general, current liability is

all liabilities to plan participants and beneficiaries accrued to date, whereas the accrued liability

full funding limit is based on projected benefits. The current liability full funding limit is scheduled

to increase as follows: 160 percent for plan years beginning in 2001 or 2002, 165 percent for plan

years beginning in 2003 and 2004, and 170 percent for plan years beginning in 2005 and

thereafter.32 In no event is a plan’s full funding limit less than 90 percent of the plan’s current

liability over the value of the plan’s assets.

An employer sponsoring a defined benefit pension plan generally may deduct amounts

contributed to satisfy the minimum funding standard for the plan year. Contributions in excess of the

full funding limit generally are not deductible. Under a special rule, an employer that sponsors a

defined benefit pension plan (other than a multiemployer plan) which has more than 100

participants for the plan year may deduct amounts contributed of up to 100 percent of the plan’s

unfunded current liability. 

Description of Proposal

Current liability full funding limit

The proposal would gradually increase and then repeal the current liability full funding

limit. The current liability full funding limit would be 160 percent of current liability for plan years

beginning in 2001, 165 percent for plan years beginning in 2002, and 170 percent for plan years
33 The PBGC termination insurance program does not cover plans of professional service

employers that have fewer than 25 participants.

-51-

beginning in 2003. The current liability full funding limit would be repealed for plan years

beginning in 2004 and thereafter.

Deduction for contributions to fund termination liability

Under the proposal, the special rule allowing a deduction for unfunded current liability

generally would be extended to all defined benefit pension plans, i.e., the provision would apply to

multiemployer plans and plans with 100 or fewer participants. The special rule would not apply to

plans not covered by the PBGC termination insurance program. 33 

The proposal would also modify the rule by providing that the deduction is for up to 100

percent of unfunded termination liability, determined as if the plan terminated at the end of the plan

year. In the case of a plan with less than 100 participants for the plan year, termination liability

would not include the liability attributable to benefit increases for highly compensated employees

resulting from a plan amendment which was made or became effective, whichever is later, within

the last two years.

Effective Date

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

2. Extension of PBGC missing participants program

Present Law

The plan administrator of a defined benefit pension plan that is subject to Title IV of

ERISA, is maintained by a single employer, and terminates under a standard termination is required

to distribute the assets of the plan. With respect to a participant whom the plan administrator

cannot locate after a diligent search, the plan administrator satisfies the distribution requirement

only by purchasing irrevocable commitments from an insurer to provide all benefit liabilities under

the plan or transferring the participant’s designated benefit to the Pension Benefit Guaranty

Corporation (“PBGC”), which holds the benefit of the missing participant as trustee until the PBGC

locates the missing participant and distributes the benefit. 

The PBGC missing participant program is not available to multiemployer plans or defined

contribution plans and other plans not covered by Title IV of ERISA.

Description of Proposal
34 Another provision of the proposal would increase this limit to 100 percent of

compensation.

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The proposal would direct the PBGC to prescribe for terminating multiemployer plans rules

similar to the present-law missing participant rules applicable to terminating single employer plans

that are subject to Title IV of ERISA.

Effective Date

The proposal would be effective for distributions from terminating plans that occur after the

PBGC has adopted final regulations implementing the proposal.

3. Repeal 100 percent of compensation limit for defined benefit multiemployer plans

Present Law

Under present law, limits apply to contributions and benefits under qualified plans (sec.

415). The limits on contributions and benefits under qualified plans are based on the type of plan.

Under a defined benefit plan, the maximum annual benefit payable at retirement is generally

the lesser of (1) 100 percent of average compensation for the highest three years, or (2) $130,000

(for 1999). The dollar limit is adjusted for cost-of-living increases in $5,000 increments. The

dollar limit is reduced in the case of retirement before the social security retirement age and

increases in the case of retirement after the social security retirement age. 

A special rule applies to governmental defined benefit plans. In the case of such plans, the

defined benefit dollar limit is reduced in the case of retirement before age 62 and increased in the

case of retirement after age 65. In addition, there is a floor on early retirement benefits. Pursuant

to this floor, the minimum benefit payable at age 55 is $75,000.

In the case of a defined contribution plan, the limit on annual is additions if the lesser of (1)

25 percent of compensation34 or (2) $30,000 (for 1999). In applying the limits on contributions and

benefits, plans of the same employer are aggregated.

Description of Proposal

Under the proposal, the 100 percent of compensation defined benefit plan limit would not

apply to multiemployer plans. In addition, except in applying the defined benefit plan dollar

limitation, multiemployer plans would not be aggregated with other plans maintained by an

employer contributing to the multiemployer plan in applying the limits on contributions and benefits.

The proposal would also apply the special rules for defined benefit plans of governmental

employers to multiemployer plans.
35 As originally enacted in the Pension Protection Act of 1997, the current liability full

funding limit was 150 percent of current liability. The Taxpayer Relief Act of 1997 increased the

current liability full funding limit to 155 percent in 1999 and 2000, and adopted the scheduled

increases described in the text.

-53-

Effective Date

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

4. Excise tax relief for sound pension funding

Present Law

Under present law, defined benefit pension plans are subject to minimum funding

requirements designed to ensure that pension plans have sufficient assets to pay benefits. A defined

benefit pension plan is funded using one of a number of acceptable actuarial cost methods. 

No contribution is required under the minimum funding rules in excess of the full funding

limit. The full funding limit is generally defined as the excess, if any, of (1) the lesser of (a) the

accrued liability under the plan (including normal cost) or (b) 155 percent of the plan’s current

liability, over (2) the value of the plan’s assets (sec. 412(c)(7)). In general, current liability is all

liabilities to plan participants and beneficiaries accrued to date, whereas the accrued liability full

funding limit is based on projected benefits. The current liability full funding limit is scheduled to

increase as follows: 160 percent for plan years beginning in 2001 or 2002, 165 percent for plan

years beginning in 2003 and 2004, and 170 percent for plan years beginning in 2005 and

thereafter.35 In no event is a plan’s full funding limit less than 90 percent of the plan’s current

liability over the value of the plan’s assets.

An employer sponsoring a defined benefit pension plan generally may deduct amounts

contributed to satisfy the minimum funding standard for the plan year. Contributions in excess of the

full funding limit generally are not deductible. Under a special rule, an employer that sponsors a

defined benefit pension plan (other than a multiemployer plan) which has more than 100

participants for the plan year may deduct amounts contributed of up to 100 percent of the plan’s

unfunded current liability. 

Present law also provides that contributions to defined contribution plans are deductible,

subject to certain limitations.

Subject to certain exceptions, an employer that makes nondeductible contributions to a plan

is subject to an excise tax equal to 10 percent of the amount of the nondeductible contributions for

the year. The 10-percent excise tax does not apply to contributions to certain terminating defined

benefit plans. The 10-percent excise tax also does not apply to contributions of up to 6 percent of

compensation to a defined contribution plan for employer matching and employee elective

deferrals. 
36 Treas. Reg. sec. 1.411(d)-6.

-54-

Description of Proposal

Under the proposal, in determining the amount of nondeductible contributions, the employer

could elect not to take into account contributions to a defined benefit pension plan except to the

extent they exceed the accrued liability full funding limit. Thus, if an employer elects, contributions

in excess of the current liability full funding limit would not be subject to the excise tax on

nondeductible contributions. An employer making such an election for a year could not take

advantage of the present-law exceptions for certain terminating plans and certain contributions to

defined contribution plans.

Effective Date

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

5. Notice of significant reduction in plan benefit accruals

Present Law

Section 204(h) of Title I of ERISA provides that a defined benefit pension plan or a money

purchase pension plan may not be amended so as to provide for a significant reduction in the rate of

future benefit accrual, unless, after adoption of the plan amendment and not less than 15 days before

the effective date of the plan amendment, the plan administrator provides a written notice (“section

204(h) notice”), setting forth the plan amendment (or a summary of the amendment written in a

manner calculated to be understood by the average plan participant) and its effective date. The plan

administrator must provide the section 204(h) notice to each plan participant, each alternate payee

under an applicable qualified domestic relations order (“QDRO”), and each employee organization

representing participants in the plan. The applicable Treasury regulations36 provide, however, that

a plan administrator need not provide the section 204(h) notice to any participant or alternate payee

whose rate of future benefit accrual is reasonably expected not to be reduced by the amendment, nor

to an employee organization that does not represent a participant to whom the section 204(h) notice

must be provided. In addition, the regulations provide that the rate of future benefit accrual is

determined without regard to optional forms of benefit, early retirement benefits, retirement-type

subsidiaries, ancillary benefits, and certain other rights and features.

A covered amendment generally will not become effective with respect to any participants

and alternate payees whose rate of future benefit accrual is reasonably expected to be reduced by

the amendment but who do not receive a section 204(h) notice. An amendment will become

effective with respect to all participants and alternate payees to whom the section 204(h) notice

was required to be provided if the plan administrator (1) has made a good faith effort to comply

with the section 204(h) notice requirements, (2) has provided a section 204(h) notice to each

employee organization that represents any participant to whom a section 204(h) notice was required
37 The proposal also would modify the present-law notice requirement contained in section

204(h) of Title I of ERISA to provide that an applicable pension plan may not be amended to

provide for a significant reduction in the rate of future benefit accrual unless the plan administrator

complies with a notice requirement similar to the notice requirement that the proposal would add

to the Internal Revenue Code.

-55-

to be provided, (3) has failed to provide a section 204(h) notice to no more than a de minimis

percentage of participants and alternate payees to whom a section 204(h) notice was required to be

provided, and (4) promptly upon discovering the oversight, provides a section 204(h) notice to

each omitted participant and alternate payee.

The Internal Revenue Code does not require any notice concerning a plan amendment that

provides for a significant reduction in the rate of future benefit accrual.

Description of Proposal

The proposal would add to the Internal Revenue Code a requirement that the plan

administrator of a defined benefit pension plan furnish a written notice concerning a plan

amendment that provides for a significant reduction in the rate of future benefit accrual, including

any elimination or reduction of an early retirement benefit or retirement-type subsidy.37 The notice

would be required to set forth the plan amendment and its effective date and provide sufficient

information (as defined in Treasury regulations) to allow participants to understand how the

amendment generally would affect different classes of employees. The plan administrator would be

required to provide the notice not less than 30 days before the effective date of the plan amendment.

The plan administrator would be required to provide this notice to each participant and

alternate payee to whom the amendment applies, and to each employee organization representing

such individuals. The plan administrator would not be required to provide this notice to any

participant who has less than 1 year of participation in the plan or who is entitled to receive the

greater of the participant’s accrued benefit under the amended plan formula or under the formula as

in effect immediately prior to the amendment effective date. 

If the amendment would provide for a significant change in the manner in which accrued

benefits are determined under the plan, or would require an affected participant or affected

alternate payee to choose between 2 or more benefit formulas, the plan administrator would be

required to provide an additional notice to each affected participant and affected alternate payee

within 6 months after the effective date of the amendment. For purposes of the proposal, an affected

participant or alternate payee generally would be a participant or alternate payee to whom the

significant reduction in the rate of future benefit accrual would be reasonably expected to apply. A

participant who has less than 1 year of participation in the plan, or who is entitled to receive the

greater of the participant’s accrued benefit under the amended plan formula or under the formula as

in effect immediately prior to the amendment effective date, would not be an affected participant. 
-56-

The plan administrator would be required to provide in this additional notice (1) the

individual’s accrued benefit (and if the amendment would add the option of an immediate lump sum

distribution, the present value of the accrued benefit) as of the amendment effective date,

determined under the terms of the plan in effect immediately before the effective date, (2) the

individual’s accrued benefit as of the amendment effective date, determined under the terms of the

plan in effect on the amendment effective date and without regard to any minimum accrued benefit

that may not be decreased by the amendment (sec. 411(d)(6)), and (3) either (a) sufficient

information (as defined in Treasury regulations) for the individual to compute his or her projected

accrued benefit or to acquire information necessary to compute such projected accrued benefit, or

(b) a determination of the individual’s projected accrued benefit with a disclosure of the

assumptions (which must be reasonable in the aggregate) used by the plan in determining the

projected accrued benefit. For purposes of this additional notice, an individual’s accrued benefit

and projected accrued benefit would be computed as if the accrued benefit were in the form of a

single life annuity at normal retirement age, taking into account any early retirement subsidy.

With respect to a plan amendment that would require a participant or alternate payee to

choose between 2 or more benefit formulas, the Secretary of the Treasury, after consultation with

the Secretary of Labor, would be authorized to require additional information to be provided in the

notices and to require either of the notices to be provided at a different time.

The proposal generally would impose on a plan administrator that fails to comply with the

notice requirement an excise tax equal to $100 per day per omitted participant and alternate payee. 

For failures due to reasonable cause and not to willful neglect, the total excise tax imposed during a

taxable year of the employer would not exceed $500,000. Furthermore, in the case of a failure due

to reasonable cause and not to willful neglect, the Secretary of the Treasury would be authorized to

waive the excise tax to the extent that the payment of the tax would be excessive relative to the

failure involved.

Effective Date

The proposal would be effective for plan amendments taking effect on or after the date of

enactment with a delayed effective date for a plan maintained pursuant to a collective bargaining

agreement. The period for providing any notice required under the proposal would not end before

the last day of the 3-month period following the date of enactment. Prior to the issuance of

Treasury regulations, a plan would be treated as meeting the requirements of the proposal if the

plan makes a good faith effort to comply with such requirements.

6. Investment of employee contributions in 401(k) plans

Present Law

The Employee Retirement Income Security Act of 1974, as amended (“ERISA”) prohibits

certain employee benefit plans from acquiring securities or real property of the employer who

sponsors the plan if, after the acquisition, the fair market value of such securities and property
-57-

exceeds 10 percent of the fair market value of plan assets. The 10-percent limitation does not apply

to any “eligible individual account plans” that specifically authorize such investments. Generally,

eligible individual account plans are defined contribution plans, including plans containing a cash

or deferred arrangement (“401(k) plans”).

The term “eligible individual account plan” does not include the portion of a plan that

consists of elective deferrals (and earnings on the elective deferrals) made under section 401(k) if

elective deferrals equal to more than 1 percent of any employee's eligible compensation are

required to be invested in employer securities and employer real property. Eligible compensation

is compensation that is eligible to be deferred under the plan. The portion of the plan that consists

of elective deferrals (and earnings thereon) is still treated as an individual account plan, and the

10-percent limitation does not apply, as long as elective deferrals (and earnings thereon) are not

required to be invested in employer securities or employer real property.

The rule excluding elective deferrals (and earnings thereon) from the definition of

individual account plan does not apply if individual account plans are a small part of the

employer's retirement plans. In particular, that rule does not apply to an individual account plan for

a plan year if the value of the assets of all individual account plans maintained by the employer do

not exceed 10 percent of the value of the assets of all pension plans maintained by the employer

(determined as of the last day of the preceding plan year). Multiemployer plans are not taken into

account in determining whether the value of the assets of all individual account plans maintained by

the employer exceed 10 percent of the value of the assets of all pension plans maintained by the

employer. The rule excluding elective deferrals (and earnings thereon) from the definition of

individual account plan does not apply to an employee stock ownership plan as defined in section

4975(e)(7) of the Internal Revenue Code.

The rule excluding elective deferrals (and earnings thereon) from the definition of

individual account plan applies to elective deferrals for plan years beginning after December 31,

1998 (and earnings thereon). It does not apply with respect to earnings on elective deferrals for

plan years beginning before January 1, 1999.

Description of Proposal

The proposal would modify the effective date of the rule excluding certain elective

deferrals (and earnings thereon) from the definition of individual account plan by providing that the

rule does not apply to any elective deferral used to acquire an interest in the income or gain from

employer securities or employer real property acquired (1) before January 1, 1999, or (2) after

such date pursuant to a written contract which was binding on such date and at all times thereafter.

Effective Date

The proposal would be effective as if included in the section of the Taxpayer Relief Act of

1997 that contained the rule excluding certain elective deferrals (and earnings thereon).
38 A multiple employer plan is a plan that is maintained by 2 or more unrelated employers

but that is not maintained pursuant to a collective-bargaining agreement (sec. 413(c)).

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F. Encouraging Retirement Education

1. Periodic pension benefit statements

Present Law

Title I of ERISA provides that a pension plan administrator must furnish a benefit statement

to any participant or beneficiary who makes a written request for such a statement. This statement

must indicate, on the basis of the latest available information, (1) the participant’s or beneficiary’s

total accrued benefit, and (2) the participant’s or beneficiary’s vested accrued benefit or the

earliest date on which the accrued benefit will become vested. A participant or beneficiary is not

entitled to receive more than 1 benefit statement during any 12-month period. The plan

administrator must furnish the benefit statement no later than 60 days after receipt of the request or,

if later, 120 days after the close of the immediately preceding plan year.

In addition, the plan administrator must furnish a benefit statement to each participant whose

employment terminates or who has a 1-year break in service. For purposes of this benefit statement

requirement, a “1-year break in service” is a calendar year, plan year, or other 12-month period

designated by the plan during which the participant does not complete more than 500 hours of

service for the employer. A participant is not entitled to receive more than 1 benefit statement with

respect to consecutive breaks in service. The plan administrator must provide a benefit statement

required upon termination of employment or a break in service no later than 180 days after the end

of the plan year in which the termination of employment or break in service occurs.

Description of Proposal

A plan administrator of a defined contribution plan generally would be required to furnish a

benefit statement to each participant at least once annually and to a beneficiary upon written

request. 

In addition to providing a benefit statement to a beneficiary upon written request, the plan

administrator of a defined benefit plan generally would be required either (1) to furnish a benefit

statement at least once every 3 years to each participant who has a vested accrued benefit and who

is employed by the employer at the time the plan administrator furnishes the benefit statements to

participants, or (2) to annually furnish written, electronic, telephonic, or other appropriate notice to

each participant of the availability of and the manner in which the participant may obtain the benefit

statement.

The plan administrator of a multiemployer plan or a multiple employer plan would be

required to furnish a benefit statement only upon written request of a participant or beneficiary.38
39 The exclusion does not apply with respect to graduate-level courses.

-59-

The plan administrator would be required to write the benefit statement in a manner

calculated to be understood by the average plan participant and would be permitted to furnish the

statement in written, electronic, telephonic, or other appropriate form.

Effective Date

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

2. Treatment of employer-provided retirement advice

Present Law

Under present law, certain employer-provided fringe benefits are excludable from gross

income (sec. 132) and wages for employment tax purposes. These excludable fringe benefits

include working condition fringe benefits and de minimis fringes. In general, a working condition

fringe benefit is any property or services provided by an employer to an employee to the extent that,

if the employee paid for such property or services, such payment would be allowable as a

deduction as a business expense. A de minimis fringe benefit is any property or services provided

by the employer the value of which, after taking into account the frequency with which similar

fringes are provided, is so small as to make accounting for it unreasonable or administratively

impracticable.

In addition, if certain requirements are satisfied, up to $5,250 annually of employerprovided educational assistance is excludable from gross income (sec. 127) and wages. This

exclusion expires with respect to courses beginning after May 31, 2000.39 Education not

excludable under section 127 may be excludable as a working condition fringe.

There is no specific exclusion under present law for employer-provided retirement planning

services. However, such services may be excludable as employer-provided educational assistance

or a fringe benefit.

Description of Proposal

The proposal would provide that qualified retirement planning services provided to an

employee and his or her spouse are excludable from income and wages. The exclusion would not

apply with respect to highly compensated employees unless the services are available on

substantially the same terms to each member of the group of employees normally provided

education and information regarding the employer’s pension plan. The exclusion would not be

limited to information regarding the plan but would include, for example, information regarding

how the plan relates to retirement income planning as a whole. 

Effective Date
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The proposal would be effective with respect to taxable years beginning after December 31,

2000.
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G. Reducing Regulatory Burdens

1. Flexibility in nondiscrimination and coverage rules

Present Law

A plan is not a qualified retirement plan if the contributions or benefits provided under the

plan discriminate in favor of highly compensated employees (sec. 401(a)(4)). The applicable

Treasury regulations set forth the exclusive rules for determining whether a plan satisfies the

nondiscrimination requirement. These regulations state that the form of the plan and the effect of the

plan in operation determine whether the plan is nondiscriminatory and that intent is irrelevant. 

Prior to 1994, a plan’s compliance with the nondiscrimination rules was based upon the facts and

circumstances surrounding the design and operation of the plan.

Similarly, a plan is not a qualified retirement plan if the plan does not benefit a minimum

number of employees (sec. 410(b)). A plan satisfies this minimum coverage requirement if and

only if it satisfies one of the tests specified in the applicable Treasury regulations. Prior to 1989, a

plan’s compliance with the coverage rules was based partially on the facts and circumstances

surrounding the design of the plan.

Description of Proposal

The Secretary of the Treasury would be directed to provide by regulation applicable to

years beginning after December 31, 2000, that a plan would be deemed to satisfy the

nondiscrimination requirements of section 401(a)(4) if the plan satisfies the pre-1994 facts and

circumstances test, satisfies the conditions prescribed by the Secretary to appropriately limit the

availability of such test, and is submitted to the Secretary for a determination of whether it satisfies

such test (to the extent provided by the Secretary).

Similarly, a plan would comply with the minimum coverage requirement of section 410(b)

if the plan satisfies the pre-1989 coverage rules, is submitted to the Secretary for a determination of

whether it satisfies the pre-1989 coverage rules (to the extent provided by the Secretary), and

satisfies conditions prescribed by the Secretary by regulation that appropriately limit the

availability of the pre-1989 coverage rules.

Effective Date

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

condition of availability prescribed by the Secretary to appropriately limit the availability of

flexibility in the nondiscrimination and coverage rules would not apply before the first year

beginning not less than 120 days after the date on which such condition is prescribed.
40 As under present law, the Secretary could require that a valuation be made more

frequently in particular cases.

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2. Modification of timing of plan valuations

Present Law

Under present law, in the case of plans subject to the minimum funding rules, a plan

valuation is generally required annually. The Secretary may require that a valuation be made more

frequently in particular cases.

Prior to the Retirement Protection Act of 1994, plan valuations generally were required at

least once every three years.

Description of Proposal

The proposal would allow an employer to elect to use the prior year’s plan valuation in

certain cases. The election could be made only with respect to a defined benefit plan with assets of

at least 125 percent of current liability (determined as of the valuation date for the preceding year). 

If the prior year’s valuation is used, it would have to be adjusted, as provided in regulations, to

reflect significant differences in participants. An election made under the proposal could be

revoked only with the consent of the Secretary. In any event, a plan valuation would be required

once every three years.40

Effective Date

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

3. Rules for substantial owner benefits in terminated plans

Present Law

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides

participants and beneficiaries in a defined benefit pension plan with certain minimal guarantees as

to the receipt of benefits under the plan in case of plan termination. The employer sponsoring the

defined benefit pension plan is required to pay premiums to the PBGC to provide insurance for the

guaranteed benefits. In general, the PBGC will guarantee all basic benefits which are payable in

periodic installments for the life (or lives) of the participant and his or her beneficiaries and are

non-forfeitable at the time of plan termination. The amount of the guaranteed benefit is subject to

certain limitations. One limitation is that the plan (or an amendment to the plan which increases

benefits) must be in effect for 60 months before termination for the PBGC to guarantee the full

amount of basic benefits for a plan participant, other than a substantial owner. In the case of a

substantial owner, the guaranteed basic benefit is phased in over 30 years beginning with

participation in the plan. A substantial owner is one who owns, directly or indirectly, more than 10
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percent of the voting stock of a corporation or all the stock of a corporation. Special rules

restricting the amount of benefit guaranteed and the allocation of assets also apply to substantial

owners.

Description of Proposal

The proposal would provide that the 60 month phase-in of guaranteed benefits would apply

to a substantial owner with less than 50 percent ownership interest. For a substantial owner with a

50 percent or more ownership interest (“majority owner”), the phase-in would depend on the

number of years the plan has been in effect. The majority owner’s guaranteed benefit would be

limited so that it could not be more than the amount phased in over 60 months for other participants.

The rules regarding allocation of assets would apply to substantial owners, other than majority

owners, in the same manner as other participants.

Effective Date

The proposal would be effective for plan terminations with respect to which notices of

intent to terminate are provided, or for which proceedings for termination are instituted by the

PBGC after December 31, 2000.

4. ESOP dividends may be reinvested without loss of dividend deduction

Present Law

An employer is entitled to deduct certain dividends paid in cash during the employer’s

taxable year with respect to stock of the employer that is held by an employee stock ownership plan

(“ESOP”). The deduction is allowed with respect to dividends that, in accordance with plan

provisions, are (1) paid in cash directly to the plan participants or their beneficiaries, (2) paid to

the plan and subsequently distributed to the participants or beneficiaries in cash no later than 90

days after the close of the plan year in which the dividends are paid to the plan, or (3) used to make

payments on loans (including payments of interest as well as principal) that were used to acquire

the employer securities (whether or not allocated to participants) with respect to which the

dividend is paid.

Description of Proposal

In addition to the deductions permitted under present law for dividends paid with respect to

employer securities that are held by an ESOP, an employer would be entitled to deduct dividends

that, at the election of plan participants or their beneficiaries, are (1) payable in cash directly to

plan participants or beneficiaries, (2) paid to the plan and subsequently distributed to the

participants or beneficiaries in cash no later than 90 days after the close of the plan year in which

the dividends are paid to the plan, or (3) paid to the plan and reinvested in qualifying employer

securities.
41 Similar provisions are contained in Title I of ERISA.

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Effective Date

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

5. Notice and consent period regarding distributions

Present Law

Notice and consent requirements apply to certain distributions from qualified retirement

plans. These requirements relate to the content and timing of information that a plan must provide

to a participant prior to a distribution, and to whether the plan must obtain the participant’s consent

to the distribution. The nature and extent of the notice and consent requirements applicable to a

distribution depend upon the value of the participant’s vested accrued benefit and whether the joint

and survivor annuity requirements (sec. 417) apply to the participant.41

If the present value of the participant’s vested accrued benefit exceeds $5,000, the plan may

not distribute the participant’s benefit without the written consent of the participant. The

participant’s consent to a distribution is not valid unless the participant has received from the plan

a notice that contains a written explanation of (1) the material features and the relative values of the

optional forms of benefit available under the plan, (2) the participant’s right, if any, to have the

distribution directly transferred to another retirement plan or IRA, and (3) the rules concerning the

taxation of a distribution. If the joint and survivor annuity requirements apply to the participant, this

notice also must contain a written explanation of (1) the terms and conditions of the qualified joint

and survivor annuity (“QJSA”), (2) the participant’s right to make, and the effect of, an election to

waive the QJSA, (3) the rights of the participant’s spouse with respect to a participant’s waiver of

the QJSA, and (4) the right to make, and the effect of, a revocation of a waiver of the QJSA. The

plan generally must provide this notice to the participant no less than 30 and no more than 90 days

before the date distribution commences.

If the participant’s vested accrued benefit does not exceed $5,000, the terms of the plan may

provide for distribution without the participant’s consent. The plan generally is required, however,

to provide to the participant a notice that contains a written explanation of (1) the participant’s

right, if any, to have the distribution directly transferred to another retirement plan or IRA, and (2)

the rules concerning the taxation of a distribution. The plan generally must provide this notice to

the participant no less than 30 and no more than 90 days before the date distribution commences.

Description of Proposal

A qualified retirement plan would be required to provide the applicable distribution notice

no less than 30 days and no more than 12 months before the date distribution commences. The

Secretary of the Treasury would be directed to modify the applicable regulations to reflect the

extension of the notice period to 12 months and to provide that the description of a participant’s
42 An employee includes a self-employed individual.

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right, if any, to defer receipt of a distribution shall also describe the consequences of failing to

defer such receipt.

Effective Date

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

6. Repeal transition rule relating to certain highly compensated employees

Present Law

Under present law, for purposes of the rules relating to qualified plans, a highly

compensated employee is generally defined as an employee42 who (1) was a 5-percent owner of

the employer at any time during the year or the preceding year or (2) either (a) had compensation

for the preceding year in excess of $80,000 (for 1999) or (b) at the election of the employer, had

compensation in excess of $80,000 for the preceding year and was in the top 20 percent of

employees by compensation for such year. 

Under a rule enacted in the Tax Reform Act of 1986, a special definition of highly

compensated employee applies for purposes of the nondiscrimination rules relating to qualified

cash or deferred arrangements (“section 401(k) plans”) and matching contributions. This special

definition applies to an employer incorporated on December 15, 1924, that meets certain specific

requirements.

Description of Proposal

The proposal would repeal the special definition of highly compensated employee under the

Tax Reform Act of 1986. Thus, the present-law definition would apply.

Effective Date

The proposal would be effective for plan years beginning after December 31, 1999.

7. Employees of tax-exempt entities

Present Law

The Tax Reform Act of 1986 provided that nongovernmental tax-exempt employers were

not permitted to maintain a qualified cash or deferred arrangement (“section 401(k) plan”). This

prohibition was repealed, effective for years beginning after December 31, 1996, by the Small

Business Job Protection Act of 1996.
43 Treas. Reg. sec. 1.410(b)-6(g).

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 Treasury regulations provide that, for purposes of nondiscrimination testing under section

410(b), a section 401(k) plan or a section 401(m) plan that is provided under the same general

arrangement as the section 401(k) plan, the employer may treat as excludable those employees of a

tax-exempt entity who could not participate in the arrangement due to the prohibition on

maintenance of a section 401(k) plan by such entities. Such employees could be disregarded only if

more than 95 percent of the employees who could participate in the section 401(k) plan benefit

under the plan for the plan year.43

Tax-exempt charitable organizations may maintain a tax-sheltered annuity (a “section

403(b) annuity”) that allows employees to make salary reduction contributions.

Description of Proposal

The proposal would direct the Treasury Department to revise its regulations under section

410(b) to provide that employees of a tax-exempt charitable organization who are eligible to make

salary reduction contributions under a section 403(b) annuity may be treated as excludable

employees for purposes of testing a section 401(k) plan, or a section 401(m) plan that is provided

under the same general arrangement as the section 401(k) plan of the employer if (1) no employee

of such tax-exempt entity is eligible to participate in the section 401(k) or 401(m) plan and (2)

more than 95 percent of the employees who are not employees of the charitable employer are

eligible to participate in such section 401(k) plan or section 401(m) plan.

The revised regulations are to be effective for years beginning after December 31, 1996.

Effective Date

The proposal would be effective on the date of enactment.

8. Provisions relating to plan amendments

Present Law

Plan amendments to reflect amendments to the law generally must be made by the time

prescribed by law for filing the income tax return of the employer for the employer’s taxable year in

which the change in law occurs.

Description of Proposal

Any amendments to a plan or annuity contract required to be made by the proposal would

not be required to be made before the last day of the first plan year beginning on or after January 1,

2003. In the case of a governmental plan, the date for amendments would be extended to the first

plan year beginning on or after January 1, 2005.
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Effective Date

The provision would be effective on the date of enactment.

9. Extension to international organizations of moratorium on application of certain

nondiscrimination rules applicable to State and local government plans

Present Law

A qualified retirement plan maintained by a State or local government is exempt from the

rules concerning nondiscrimination (sec. 401(a)(4)) and minimum participation (sec. 401(a)(26)). 

A governmental plan maintained by an international organization that is exempt from taxation by

reason of the International Organizations Immunities Act is not exempt from the nondiscrimination

and minimum participation rules.

Description of Proposal

A governmental plan maintained by a tax-exempt international organization would be

exempt from the nondiscrimination and minimum participation rules.

Effective Date

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

10. Annual report dissemination

Present Law

Title I of ERISA generally requires the plan administrator of each employee pension benefit

plan and each employee welfare benefit plan to file an annual report concerning the plan with the

Secretary of Labor within 7 months after the end of the plan year. Within 9 months after the end of

the plan year, the plan administrator generally must provide to each participant, and to each

beneficiary receiving benefits under the plan, a summary of the annual report filed with the

Secretary of Labor for the plan year.

Description of Proposal

Within 9 months after the end of each plan year, the plan administrator would be required to

make available for examination a summary of the annual report filed with the Secretary of Labor for

the plan year. In addition, the plan administrator would be required to furnish the summary to a

participant, or to a beneficiary receiving benefits under the plan, upon request.

Effective Date
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The proposal would be effective for reports for years beginning after December 31, 1998.

11. Clarification of exclusion for employer-provided transit passes

Present Law

Qualified transportation fringe benefits provided by an employer are excluded from an

employee’s gross income and wages. Qualified transportation fringe benefits include parking,

transit passes, and vanpool benefits. Up to $175 per month (for 1999) of employer-provided

parking is excludable from income and up to $65 (for 1999) per month of employer-provided

transit and vanpool benefits are excludable from income. 

Qualified transportation benefits generally include a cash reimbursement by an employer to

an employee. However, in the case of transit passes, a cash reimbursement is considered a

qualified transportation fringe benefit only if a voucher or similar item which may be exchanged

only for a transit pass is not readily available for direct distribution by the employer to the

employee.

No amount is includible in the gross income of an employee merely because the employee is

offered a choice between cash and any qualified transportation benefit (or a choice among such

benefits).

Description of Proposal

The proposal would repeal the rule providing that cash reimbursements for transit benefits

are excludable from income only if a voucher or similar item which may be exchanged only for a

transit pass is not readily available for direct distribution by the employer.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999. 
44 The maximum allowable deduction for 1998 was $1,000.

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IV. EDUCATION TAX RELIEF

A. Eliminate Marriage Penalty and 60-Month Limit on Student Loan Interest Deduction

Present Law

Certain individuals who have paid interest on qualified education loans may claim an

above-the-line deduction for such interest expenses, subject to a maximum annual deduction limit

(sec. 221). The deduction is allowed only with respect to interest paid on a qualified education

loan during the first 60 months in which interest payments are required. Required payments of

interest generally do not include nonmandatory payments, such as interest payments made during a

period of loan forbearance. Months during which interest payments are not required because the

qualified education loan is in deferral or forbearance do not count against the 60-month period. No

deduction is allowed to an individual if that individual is claimed as a dependent on another

taxpayer's return for the taxable year.

A qualified education loan generally is defined as any indebtedness incurred solely to pay

for certain costs of attendance (including room and board) of a student (who may be the taxpayer,

the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was

incurred) who is enrolled in a degree program on at least a half-time basis at (1) an accredited

post-secondary educational institution defined by reference to section 481 of the Higher Education

Act of 1965, or (2) an institution conducting an internship or residency program leading to a degree

or certificate from an institution of higher education, a hospital, or a health care facility conducting

postgraduate training.

The maximum allowable deduction per taxpayer return is $1,500 in 1999, $2,000 in 2000,

and $2,500 in 2001 and thereafter.44 The deduction is phased out ratably for individual taxpayers

with modified adjusted gross income of $40,000-$55,000 and $60,000-$75,000 for joint returns. 

The income ranges will be indexed for inflation after 2002.

Description of Proposal

The proposal would increase the beginning point of the income phaseout for the student loan

interest deduction for individual taxpayers from $40,000 to $50,000. For taxpayers filing joint

returns, the proposal would increase the beginning point of the income phaseout to twice the

beginning point of the income phaseouts applicable to single taxpayers. Thus, beginning in 2000,

the deduction would be phased out ratably for individual taxpayers with modified adjusted gross

income of $50,000-$65,000 and for taxpayers filing joint returns with modified adjusted gross

income of $100,000-$115,000.
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The proposal also would repeal both the limit on the number of months during which

interest paid on a qualified education loan is deductible and the restriction that nonmandatory

payments of interest are not deductible.

Effective Date

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

1999. The proposal repealing the 60-month limit on deductible student loan interest would be

effective for interest paid on qualified education loans after December 31, 1999.
45 “Eligible educational institutions” are defined the same for purposes of education IRAs

(described in II.1., above) and qualified State tuition programs.

46 Distributions from qualified State tuition programs are treated as representing a pro-rata

share of the principal (i.e., contributions) and accumulated earnings in the account.

47 Sections 529(c)(2), (c)(4), and (c)(5), and section 530(d)(3) provide special estate and

gift tax rules for contributions made to, and distributions made from, qualified State tuition

programs and education IRAs.

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B. Allow Tax-free Distributions From State and Private Education Programs

Present Law

Section 529 provides tax-exempt status to "qualified State tuition programs," meaning

certain programs established and maintained by a State (or agency or instrumentality thereof) under

which persons may (1) purchase tuition credits or certificates on behalf of a designated beneficiary

that entitle the beneficiary to a waiver or payment of qualified higher education expenses of the

beneficiary, or (2) make contributions to an account that is established for the purpose of meeting

qualified higher education expenses of the designated beneficiary of the account (a “savings account

plan”). The term "qualified higher education expenses" generally has the same meaning as does the

term for purposes of education IRAs (as described above) and, thus, includes expenses for tuition,

fees, books, supplies, and equipment required for the enrollment or attendance at an eligible

educational institution45, as well as certain room and board expenses for any period during which

the student is at least a half-time student.

No amount is included in the gross income of a contributor to, or beneficiary of, a qualified

State tuition program with respect to any distribution from, or earnings under, such program, except

that (1) amounts distributed or educational benefits provided to a beneficiary (e.g., when the

beneficiary attends college) are included in the beneficiary's gross income (unless excludable under

another Code section) to the extent such amounts or the value of the educational benefits exceed

contributions made on behalf of the beneficiary, and (2) amounts distributed to a contributor (e.g.,

when a parent receives a refund) are included in the contributor's gross income to the extent such

amounts exceed contributions made on behalf of the beneficiary.46

A qualified State tuition program is required to provide that purchases or contributions only

be made in cash.47 Contributors and beneficiaries are not allowed to directly or indirectly direct

the investment of contributions to the program (or earnings thereon). The program is required to

maintain a separate accounting for each designated beneficiary. A specified individual must be

designated as the beneficiary at the commencement of participation in a qualified State tuition

program (i.e., when contributions are first made to purchase an interest in such a program), unless

interests in such a program are purchased by a State or local government or a tax-exempt charity

described in section 501(c)(3) as part of a scholarship program operated by such government or

charity under which beneficiaries to be named in the future will receive such interests as
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scholarships. A transfer of credits (or other amounts) from one account benefitting one designated

beneficiary to another account benefitting a different beneficiary is considered a distribution (as is

a change in the designated beneficiary of an interest in a qualified State tuition program), unless the

beneficiaries are members of the same family. For this purpose, the term "member of the family"

means persons described in paragraphs (1) through (8) of section 152(a)--e.g., sons, daughters,

brothers, sisters, nephews and nieces, certain in-laws--and any spouse of such persons or of the

original beneficiary. Earnings on an account may be refunded to a contributor or beneficiary, but

the State or instrumentality must impose a more than de minimis monetary penalty unless the refund

is (1) used for qualified higher education expenses of the beneficiary, (2) made on account of the

death or disability of the beneficiary, or (3) made on account of a scholarship received by the

designated beneficiary to the extent the amount refunded does not exceed the amount of the

scholarship used for higher education expenses.

To the extent that a distribution from a qualified State tuition program is used to pay for

qualified tuition and related expenses (as defined in sec. 25A(f)(1)), the distributee (or another

taxpayer claiming the distributee as a dependent) may claim the HOPE credit or Lifetime Learning

credit under section 25A with respect to such tuition and related expenses (assuming that the other

requirements for claiming the HOPE credit or Lifetime Learning credit are satisfied and the

modified AGI phaseout for those credits does not apply).

Description of Proposal

Qualified tuition program

The proposal would expand the definition of “qualified tuition program” to include certain

prepaid tuition programs established and maintained by one or more eligible educational

institutions (which may be private institutions) that satisfy the requirements under section 529 (other

than the present-law State sponsorship rule). In the case of a qualified tuition program maintained

by one or more private educational institutions, persons would be able to purchase tuition credits

or certificates on behalf of a designated beneficiary as set forth in section 529(b)(1)(A)(i), but

would not be able to make contributions to an account described in section 529(b)(1)(A)(ii) (socalled “savings account plans”).

Exclusion from gross income

Under the proposal, an exclusion from gross income would be provided for distributions

made in taxable years beginning after December 31, 1999, from qualified State tuition programs to

the extent that the distribution is used to pay for qualified higher education expenses. This

exclusion from gross income would be extended to distributions from qualified tuition programs

established and maintained by an entity other than a State or agency or instrumentality thereof, for

distributions made in taxable years after December 31, 2003. 

Coordination of education provisions
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The proposal also would allow a taxpayer to claim a HOPE credit or Lifetime Learning

credit for a taxable year and to exclude from gross income amounts distributed (both the principal

and the earnings portions) from a qualified tuition program and/or an education individual

retirement account on behalf of the same student as long as the distributions are not used for the

same expenses for which a credit was claimed.

Definition of qualified higher education expenses

Under the proposal, the definition of “qualified higher education expenses” would be

modified to mean: (1) tuition and fees required for the enrollment or attendance of a designated

beneficiary at an eligible education institution; and (2) expenses for books, supplies, and equipment

incurred in connection with such enrollment or attendance (but not in excess of the allowance for

books and supplies determined by the educational institution for purposes of federal financial

assistance programs). The proposal also would provide that “qualified higher education expenses”

shall not include expenses for education involving sports, games, or hobbies unless this education

is part of the student’s degree program or is taken to acquire or improve job skills of the individual. 

The proposal would not change the definition of “qualified higher education expenses” with respect

to expenses for room and board.

Rollovers for benefit of same beneficiary

The proposal would clarify that a transfer of credits (or other amounts) from one qualified

tuition program for the benefit of a designated beneficiary to another qualified tuition program for

the benefit of the same beneficiary will not be considered a distribution for a maximum of one such

transfer in each 1-year period.

Member of family

The proposal would provide that, for purposes of tax-free rollovers and changes of

designated beneficiaries, a “member of the family” includes first cousins of such beneficiary.

Effective Date

The proposal permitting the establishment of qualified tuition programs maintained by one

or more private educational institutions would be effective for taxable years beginning after

December 31, 1999. The exclusion from gross income for certain distributions from qualified State

tuition programs under section 529 would be effective for distributions made in taxable years

beginning after December 31, 1999. In the case of a qualified tuition program established and

maintained by an entity other than a State or agency or instrumentality thereof, the proposal

allowing an exclusion from gross income for certain distributions would be effective for

distributions made in taxable years beginning after December 31, 2003. The proposal coordinating

distributions from qualified tuition programs and education individual retirement accounts with the

HOPE and Lifetime Learning credits would be effective for distributions made after December 31,

1999. The proposal modifying the definition of qualified higher education expenses is effective for
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amounts paid for education furnished after December 31, 1999. The provisions allowing rollovers

for the same beneficiary and including first cousins as a member of the family would be effective

for taxable years beginning after December 31, 1999.
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C. Eliminate Tax on Awards Under National Health Service Corps Scholarship Program and

F. Edward Hebert Armed Forces Health Professions Scholarship

and Financial Assistance Program

Present Law

Section 117 excludes from gross income amounts received as a qualified scholarship by an

individual who is a candidate for a degree and used for tuition and fees required for the enrollment

or attendance (or for fees, books, supplies, and equipment required for courses of instruction) at a

primary, secondary, or post-secondary educational institution. The tax-free treatment provided by

section 117 does not extend to scholarship amounts covering regular living expenses, such as room

and board. In addition to the exclusion for qualified scholarships, section 117 provides an

exclusion from gross income for qualified tuition reductions for certain education provided to

employees (and their spouses and dependents) of certain educational organizations.

Section 117(c) specifically provides that the exclusion for qualified scholarships and

qualified tuition reductions does not apply to any amount received by a student that represents

payment for teaching, research, or other services by the student required as a condition for

receiving the scholarship or tuition reduction.

The National Health Service Corps Scholarship Program (the “NHSC Scholarship

Program”) and the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial

Assistance Program (the “Armed Forces Scholarship Program”) provide education awards to

participants on condition that the participants provide certain services. In the case of the NHSC

Program, the recipient of the scholarship is obligated to provide medical services in a geographic

area (or to an underserved population group or designated facility) identified by the Public Health

Service as having a shortage of health-care professionals. In the case of the Armed Forces

Scholarship Program, the recipient of the scholarship is obligated to serve a certain number of

years in the military at an armed forces medical facility. Because the recipients of scholarships in

both of these programs are required to perform services in exchange for the education awards, the

awards used to pay higher education expenses are taxable income to the recipient.

Description of Proposal

The proposal would provide that amounts received by an individual under the NHSC

Scholarship Program or the Armed Forces Scholarship Program would be eligible for tax-free

treatment as qualified scholarships under section 117, without regard to any service obligation by

the recipient. As with other qualified scholarships under section 117, the tax-free treatment would

not apply to amounts received by students for regular living expenses, including room and board.

Effective Date

The proposal would be effective for education awards received under the NHSC

Scholarship Program and the Armed Forces Scholarship Program after December 31, 1993.
48 These rules also apply in the event that section 127 expires and is not reinstated. 

49 In the case of an employee, education expenses (if not reimbursed by the employer) may

be claimed as an itemized deduction only if such expenses, along with other miscellaneous

deductions, exceed 2 percent of the taxpayer's AGI. The 2-percent floor limitation is disregarded

in determining whether an item is excludable as a working condition fringe benefit. 

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D. Exclusion for Employer-Provided Educational Assistance

Present Law

Educational expenses paid by an employer for its employees are generally deductible to the

employer.

Employer-paid educational expenses are excludable from the gross income and wages of an

employee if provided under a section 127 educational assistance plan or if the expenses qualify as

a working condition fringe benefit under section 132. Section 127 provides an exclusion of $5,250

annually for employer-provided educational assistance. The exclusion does not apply to graduate

courses. The exclusion for employer-provided educational assistance expires with respect to

courses beginning on or after June 1, 2000.

In order for the exclusion to apply, certain requirements must be satisfied. The educational

assistance must be provided pursuant to a separate written plan of the employer. The educational

assistance program must not discriminate in favor of highly compensated employees. In addition,

not more than 5 percent of the amounts paid or incurred by the employer during the year for

educational assistance under a qualified educational assistance plan can be provided for the class

of individuals consisting of more than 5-percent owners of the employer (and their spouses and

dependents).

Educational expenses that do not qualify for the section 127 exclusion may be excludable

from income as a working condition fringe benefit.48 In general, education qualifies as a working

condition fringe benefit if the employee could have deducted the education expenses under section

162 if the employee paid for the education. In general, education expenses are deductible by an

individual under section 162 if the education (1) maintains or improves a skill required in a trade

or business currently engaged in by the taxpayer, or (2) meets the express requirements of the

taxpayer's employer, applicable law or regulations imposed as a condition of continued

employment. However, education expenses are generally not deductible if they relate to certain

minimum educational requirements or to education or training that enables a taxpayer to begin

working in a new trade or business.49
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Description of Proposal
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The proposal would make the exclusion for employer-provided educational assistance

permanent. The proposal would also extend the exclusion to graduate education, effective for

courses beginning on or after January 1, 2000.

Effective Date

The provision would generally be effective with respect to educational assistance provided

after May 30, 2000. The exclusion with respect to graduate-level courses would be effective for

courses beginning on or after January 1, 2000.
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E. Liberalize Tax-Exempt Financing Rules for Public School Construction

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 (sec. 103). Like other activities carried out and paid for by

States and local governments, the construction, renovation, and operation of public schools is an

activity eligible for financing with the proceeds of tax-exempt bonds.

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

The Code includes several exceptions permitting States or local governments to act as

conduits providing tax-exempt financing for private activities. Both capital expenditures and

limited working capital expenditures of charitable organizations described in section 501(c)(3) of

the Code -- including elementary, secondary, and post-secondary schools -- may be financed with

tax-exempt private activity bonds ("qualified 501(c)(3) bonds").

States or local governments may issue tax-exempt “exempt-facility bonds” to finance

property for certain private businesses. Businesses 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, and hazardous waste disposal facilities); privately-owned and/or operated

low-income rental housing; 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 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.

Finally, tax-exempt private activity bonds may be issued to finance limited non-business

purposes: student loans and mortgage loans for owner-occupied housing (“qualified mortgage

bonds” and “qualified veterans’ mortgage bonds”).
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In most cases, the volume of tax-exempt private activity bonds is restricted by aggregate

annual limits imposed on bonds issued by issuers within each State. These annual volume limits

equal $50 per resident of the State, or $150 million if greater. The annual State private activity

bond volume limits are scheduled to increase to the greater of $75 per resident of the State or $225

million in calendar year 2007. The increase will be phased in ratably beginning in calendar year

2003. This increase was enacted by the Tax and Trade Relief Extension Act of 1998. Qualified

501(c)(3) bonds are among the tax-exempt private activity bonds that are not subject to these

volume limits.

Private activity tax-exempt bonds may not be used to finance schools owned or operated by

private, for-profit businesses.

Arbitrage restrictions on tax-exempt bonds

The Federal income tax does not apply to income of States and local governments that is

derived from the exercise of an essential governmental function. To prevent these tax-exempt

entities from issuing more Federally subsidized tax-exempt bonds than is necessary for the activity

being financed or from issuing such bonds earlier than necessary, the Code includes arbitrage

restrictions limiting the ability to profit from investment of tax-exempt bond proceeds. In general,

arbitrage profits may be earned only during specified periods (e.g., defined “temporary periods”)

before funds are needed for the purpose of the borrowing or on specified types of investments (e.g.,

“reasonably required reserve or replacement funds”). Subject to limited exceptions, investment

profits that are earned during these periods or on such investments must be rebated to the Federal

Government.

The Code includes three exceptions applicable to education-related bonds. First, issuers of

all types of tax-exempt bonds are not required to rebate arbitrage profits if all of the proceeds of the

bonds are spent for the purpose of the borrowing within six months after issuance. In the case of

governmental bonds (including bonds to finance public schools) the six-month expenditure

exception is treated as satisfied if at least 95 percent of the proceeds is spent within six months and

the remaining five percent is spent within 12 months after the bonds are issued.

Second, in the case of bonds to finance certain construction activities, including school

construction and renovation, the six-month period is extended to 24 months for construction

proceeds. Arbitrage profits earned on construction proceeds are not required to be rebated if all

such proceeds (other than certain retainage amounts) are spent by the end of the 24-month period

and prescribed intermediate spending percentages are satisfied.

Third, governmental bonds issued by “small” governments are not subject to the rebate

requirement. Small governments are defined as general purpose governmental units that issue no

more than $5 million of tax-exempt governmental bonds in a calendar year. The $5 million limit is

increased to $10 million if at least $5 million of the bonds are used to finance public schools.

Restriction on Federal guarantees of tax-exempt bonds
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Unlike interest on State or local government bonds, interest on Federal debt (e.g., Treasury

bills) is taxable. Generally, interest on State and local government bonds that are Federally

guaranteed does not qualify for tax-exemption. This restriction was enacted in 1984. The 1984

legislation included exceptions for housing bonds and for certain Federal insurance programs that

were in existence when the restriction was enacted.

Qualified zone academy bonds

As an alternative to traditional tax-exempt bonds, certain States and local governments are

given the authority to issue “qualified zone academy bonds.” Under present law, a total of $400

million of qualified zone academy bonds may be issued in each of 1998 and 1999. The $400

million aggregate bond authority is allocated each year to the States according to their respective

populations of individuals below the poverty line. Each State, in turn, allocates the credit to

qualified zone academies within such State. A State may carry over any unused allocation into

subsequent years.

Certain financial institutions (i.e., banks, insurance companies, and corporations actively

engaged in the business of lending money) that hold qualified zone academy bonds are entitled to a

nonrefundable tax credit in an amount equal to a credit rate (set monthly by Treasury Department

regulation at 110 percent of the applicable Federal rate for the month in which the bond is issued)

multiplied by the face amount of the bond (sec. 1397E). The credit rate applies to all such bonds

issued in each month. A taxpayer holding a qualified zone academy bond on the credit allowance

date (i.e., each one-year anniversary of the issuance of the bond) is entitled to a credit. The credit

amount is includible in gross income (as if it were a taxable interest payment on the bond), and

credit may be claimed against regular income tax and alternative minimum tax liability.

“Qualified zone academy bonds” are defined as bonds issued by a State or local

government, provided that: (1) at least 95 percent of the proceeds is used for the purpose of

renovating, providing equipment to, developing course materials for use at, or training teachers and

other school personnel in a “qualified zone academy;” and (2) private entities have promised to

contribute to the qualified zone academy certain equipment, technical assistance or training,

employee services, or other property or services with a value equal to at least 10 percent of the

bond proceeds.

A school is a “qualified zone academy” if (1) the school is a public school that provides

education and training below the college level, (2) the school operates a special academic 

program in cooperation with businesses to enhance the academic curriculum and increase

graduation and employment rates, and (3) either (a) the school is located in an empowerment zone

or a designated enterprise community, or (b) it is reasonably expected that at least 35 percent of the

students at the school will be eligible for free or reduced-cost lunches under the school lunch

program established under the National School Lunch Act.

Description of Proposals
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Increase amount of governmental bonds that may be issued by governments qualifying 

for the “small governmental unit” arbitrage rebate exception

The additional amount of governmental bonds for public schools that small governmental

units may issue without being subject to the arbitrage rebate requirement would be increased from

$5 million to $10 million. Thus, these governmental units could issue up to $15 million of

governmental bonds in a calendar year provided that at least $10 million of the bonds were used for

public schools.

Allow issuance of tax-exempt private activity bonds for public school facilities

The private activities for which tax-exempt bonds may be issued would be expanded to

include elementary and secondary public school facilities which are owned by private, for-profit

corporations pursuant to public-private partnership agreements with a State or local educational

agency. The school facilities for which these bonds were issued would be required to be operated

by a public educational agency as part of a system of public schools. Issuance of these bonds

would be subject to an annual per-State volume limit equal to the greater of $10 per resident ($5

million, if greater) in lieu of the present-law State private activity bond volume limits.

Permit limited Federal guarantees of school construction bonds by the Federal Housing

Finance Board

The Federal Housing Finance Board would be permitted to guarantee (through the 12

regional Federal Home Loan Banks in its system) up to $500 million per year of governmental

bonds 95 percent of more of the proceeds of which are used for public school construction.

Effective Dates

The proposals would be effective for bonds issued after December 31, 1999.
50 The deduction would only apply to health insurance that constitutes medical care; it

would not apply to medical expenses. The deduction would apply to self-insured arrangements

(provided such arrangements constitute insurance, e.g., there is appropriate risk-shifting) and

coverage under employer plans treated as insurance under section 104. Another provision of the

proposal would provide a similar deduction for qualified long-term care insurance expenses.

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V. HEALTH CARE TAX RELIEF PROVISIONS

A. Above-the-Line Deduction for Health Insurance Expenses

Present Law

Under present law, the tax treatment of health insurance expenses depends on the

individual’s circumstances. Self-employed individuals may deduct a portion of health insurance

expenses for the individual and his or her spouse and dependents. The deductible percentage of

health insurance expenses of a self-employed individual is 60 percent in 1999 through 2001; 70

percent in 2002; and 100 percent in 2003 and thereafter. The deduction for health insurance

expenses of self-employed individuals is not available for any month in which the taxpayer is

eligible to participate in a subsidized health plan maintained by the employer of the taxpayer or the

taxpayer's spouse. The deduction applies to qualified long-term care insurance premiums treated as

medical expenses under the itemized deduction for medical expenses, described below.

Employees can exclude from income 100 percent of employer-provided health insurance.

Individuals who itemize deductions may deduct their health insurance expenses only to the

extent that the total medical expenses of the individual exceed 7.5 percent of adjusted gross income

(sec. 213). Subject to certain dollar limitations, premiums for qualified long-term care insurance

are treated as medical expenses for purposes of the itemized deduction for medical expenses (sec.

213). The amount of qualified long-term care insurance premiums that may be taken into account

for 1999 is as follows: $210 in the case of an individual 40 years old or less; $400 in the case of an

individual who is more than 40 but not more than 50; $800 in the case of an individual who is more

than 50 but not more than 60; $2,120 in the case of an individual who is more than 60 but not more

than 70; and $2,660 in the case of an individual who is more than 70. These dollar limits are

indexed for inflation.

Description of Proposal

The proposal would provide an above-the-line deduction for a percentage of the amount

paid during the year for insurance which constitutes medical care (as defined under sec. 213, other

than long-term care insurance treated as medical care under sec. 213) for the taxpayer and his or

her spouse and dependents.50 The deductible percentage would be: 25 percent in 2001 through

2003; 50 percent in 2004 through 2005; and 100 percent in 2006 and thereafter.
51 This rule would be applied separately with respect to qualified long-term care

insurance.

52 Excludable employer contributions to a health flexible spending arrangement or medical

savings account (including salary reduction contributions) would also be considered amounts paid

by the employer for health insurance that constitutes medical care.

53 The deduction would be available with respect to premiums for health care continuation

coverage, provided the requirements for the deduction are otherwise met.

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The deduction would not be available to an individual for any month in which the individual

is covered under an employer-sponsored health plan if the at least 50 percent of the cost of the

coverage is paid or incurred by the employer.51 For purposes of this rule, any amounts amounts

excludable from the gross income of the employee under the exclusion for employer-provided

health coverage would be treated as paid or incurred by the employer; thus, for example, health

insurance purchased by an employee through a cafeteria plan with salary reduction amounts would

be considered to be paid for by the employer.52 In determining whether the 50-percent threshold is

met, all health plans of the employer in which the employee participates would be treated as a

single plan. If the employer pays for less than 50 percent of the cost of all health plans in which the

individual participates, the deduction would be available only with respect to each plan with

respect to which the employer subsidy is less than 50 percent. Cost would be determined as under

the health care continuation rules. The following examples illustrate the application of the 50-

percent rule.

Example 1: Employee A participates in an employer-sponsored health plan. The annual

cost for single coverage is $3,000, and the annual additional cost for coverage for A’s spouse and

dependents is $1,000. The employer pays 100 percent of the cost of individual coverage, but does

not pay any additional amount for family coverage. A chooses family coverage. The total amount

the employer pays for the insurance is $3,000, which is 75 percent of the total cost of the coverage

($4,000). Thus, the deduction would not be available.

Example 2: Employee B participates in two employer-sponsored health plans. One plan

provides major medical coverage. The cost of this plan is $2,000 per year. The employer pays for

half the cost of this plan ($1,000). The second plan provides only dental coverage. The cost of the

dental plan is $300 per year, which is paid by the employee. The total cost of the health plans in

which B participates is $2,300. The employer pays for less than 50 percent of this total cost. B

may deduct the cost of the dental coverage; but not B’s share of the premium for the major medical

plan, because the employer pays for at least 50 percent of the cost of that plan. 

The deduction would not be available to individuals enrolled in Medicare, Medicaid, the

Federal Employees Benefit Program, 53 Champus, VA, Indian Health Service, or Children’s Health

Insurance programs.
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Under the proposal, employers would be required to report information regarding employee

health care coverage, such as whether the employee is covered under a health insurance or longterm care insurance plan, and the total cost of such coverage.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
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B. Provisions Relating to Long-term Care Insurance

Present Law

Tax treatment of health insurance and long-term care insurance

Under present law, the tax treatment of health insurance expenses depends on the

individual’s circumstances. Self-employed individuals may deduct a portion of health insurance

expenses for the individual and his or her spouse and dependents. The deductible percentage of

health insurance expenses of a self-employed individual is 60 percent in 1999 through 2001; 70

percent in 2002; and 100 percent in 2003 and thereafter. The deduction for health insurance

expenses of self-employed individuals is not available for any month in which the taxpayer is

eligible to participate in a subsidized health plan maintained by the employer of the taxpayer or the

taxpayer's spouse. The deduction applies to qualified long-term care insurance premiums treated as

medical expenses under the itemized deduction for medical expenses, described below.

Employees can exclude from income 100 percent of employer-provided health insurance or

qualified long-term care insurance.

Individuals who itemize deductions may deduct their health insurance expenses only to the

extent that the total medical expenses of the individual exceed 7.5 percent of adjusted gross income

(sec. 213). Subject to certain dollar limitations, premiums for qualified long-term care insurance

are treated as medical expenses for purposes of the itemized deduction for medical expenses (sec.

213). The amount of qualified long-term care insurance premiums that may be taken into account

for 1999 is as follows: $210 in the case of an individual 40 years old or less; $400 in the case of an

individual who is more than 40 but not more than 50; $800 in the case of an individual who is more

than 50 but not more than 60; $2,120 in the case of an individual who is more than 60 but not more

than 70; and $2,660 in the case of an individual who is more than 70. These dollar limits are

indexed for inflation.

Cafeteria plans

Under present law, compensation generally is includible in gross income when actually or

constructively received. An amount is constructively received by an individual if it is made

available to the individual or the individual has an election to receive such amount. Under one

exception to the general principle of constructive receipt, amounts are not included in the gross

income of a participant in a cafeteria plan described in section 125 of the Code solely because the

participant may elect among cash and certain employer-provided qualified benefits under the plan. 

This constructive receipt exception is not available if the individual is permitted to revoke a benefit

election during a period of coverage in the absence of a change in family status or certain other

events.

In general, qualified benefits are certain specified benefits that are excludable from an

employee’s gross income by reason of a specific provision of the Code. Thus, employer-provided
54 Elective contributions under a qualified cash or deferred arrangement that is part of a

cafeteria plan are subject to employment taxes.

55The deduction would only apply to insurance that constitutes medical care; it would not

apply to long-term care insurance expenses. The deduction would apply to self-insured

arrangements (provided such arrangements constitute insurance, e.g., there is appropriate riskshifting) and coverage under employer plans treated as insurance under section 104. Another

provision of the proposal would provide a similar deduction for health insurance expenses.

56This rule would be applied separately with respect to health insurance.

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accident or health coverage, group-term life insurance coverage (whether or not subject to tax by

reason of being in excess of the dollar limit on the exclusion for such insurance), and benefits under

dependent care assistance programs may be provided through a cafeteria plan. The cafeteria plan

exception from the principle of constructive receipt generally also applies for employment tax

(FICA and FUTA) purposes.54

Long-term care insurance cannot be provided under a cafeteria plan.

Flexible spending arrangements

A flexible spending arrangement (“FSA”) is a reimbursement account or other arrangement

under which an employer pays or reimburses employees for medical expenses or certain other

nontaxable employer-provided benefits, such as dependent care. An FSA may be part of a cafeteria

plan and may be funded through salary reduction. FSAs may also be provided by an employer

outside a cafeteria plan. FSAs are commonly used, for example, to reimburse employees for

medical expenses not covered by insurance. Qualified long-term care services cannot be provided

through an FSA.

Description of Proposal

Deduction for qualified long-term care insurance expenses

The proposal would provide an above-the-line deduction for a percentage of the amount

paid during the year for long-term care insurance which constitutes medical care (as defined under

sec. 213) for the taxpayer and his or her spouse and dependents.55 The deductible percentage

would be: 25 percent in 2001 through 2003; 50 percent in 2004 through 2005; and 100 percent in

2006 and thereafter.

The deduction would not be available to an individual for any month in which the individual

is covered under an employer-sponsored health plan if at least 50 percent of the cost of the

coverage is paid or incurred by the employer.56 For purposes of this rule, an employer any amounts

excludable from the gross income of the employee with respect to qualified long-term care

insurance would be treated as paid or incurred by the employer. In determining whether the 50-
57Excludable employer contributions to a flexible spending arrangement or a cafeteria plan

for qualified long-term care insurance or services would be considered an amount paid by the

employer for long-term care insurance. 

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percent threshold is met, all plans of the employer providing long-term care in which the employee

participates would be treated as a single plan. If the employer pays less than 50 percent of the cost

of all long-term care plans in which the individual participates, the deduction would be available

only with respect to each plan with respect to which the employer pays for less than 50 percent of

the cost. Cost would be determined as under the health care continuation rules.

Under the proposal, employers would be required to report information regarding employee

health care coverage, such as whether the employee is covered under a health insurance or longterm care insurance plan, and the total cost of such coverage.

The proposal would provide that qualified long-term care insurance is a qualified benefit

under a cafeteria plan. The proposal would also provide that qualified long-term care services can

be provided under an FSA.57

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2000.
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C. Additional Personal Exemption for Caretakers

Present Law

Generally, present law does not provide for an additional personal exemption based solely

on the custodial care of parents or grandparents. However, taxpayers with dependent parents

generally are able to claim a personal exemption for each of these dependents, if they satisfy five

tests: (1) a member of household or relationship test; (2) a citizen test; (3) a joint return test; (4) a

gross income test; and (5) a support test. The taxpayer is also required to list each dependent’s tax

identification number (the TIN”) on the tax return.

 The total amount of personal 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 $2,750 for 1999, and is adjusted annually for inflation. The total amount of the personal

exemptions is phased out for taxpayers with AGI in excess of $126,600 for single taxpayers,

$158,300 for heads of household, and $189,950 for married couples filing joint returns. For 1999,

the point at which a taxpayer’s personal exemptions are completely phased-out is $249,100 for

single taxpayers, $280,800 for heads of households, and $312,450 for married couples filing joint

returns.

Description of Proposal

The proposal would provide taxpayers who maintain a household including one or more

"qualified persons" with an additional personal exemption in computing income tax liability for

each qualified person.

To be a "qualified person," an individual would have to satisfy: (1) a relationship test, (2) a

residency test, (3) a disability test, and (4) an identification test. The individual would satisfy the

relationship test if the individual was the father or mother of: (a) the taxpayer, (b) the taxpayer's

spouse, or (c) a former spouse of the taxpayer. A stepfather, stepmother, and ancestors of the

father or mother would be treated as a father or mother for these purposes.

An individual would satisfy the residency test if the individual had the same principal place

of abode as the taxpayer for the taxpayer's entire taxable year.

An individual would satisfy the disability test if the individual was certified before the due

date of the return for the taxable year (without extensions) by a licensed physician as being unable

for period of at least 180 consecutive days to perform at least 2 activities of daily living (“ADLs”)

without substantial assistance from another individual, due to a loss of functional capacity. As with

the present-law rules relating to long-term care, ADLs would be eating, toileting, transferring,

bathing, dressing, and continence. Substantial assistance would include hands-on assistance (that

is, the physical assistance of another person without which the individual is unable to perform the

ADL) and stand-by assistance (that is, the presence of another person within arm’s reach of the
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individual that is necessary to prevent, by physical intervention, injury to the individual when

performing the ADL).

As an alternative to the 2-ADL test described above, an individual would be considered to

have long-term care needs if he or she were certified by a licensed physician as (a) requiring

substantial supervision for at least 6 months to be protected from threats to health and safety due to

severe cognitive impairment and (b) being unable for at least 6 months to perform at least one or

more ADLs or to engage in age appropriate activities as determined under regulations prescribed

by the Secretary of the Treasury in consultation with the Secretary of Health and Human Services.

An individual would satisfy the identification test if the individual's name and taxpayer

identification number (TIN) were included on the taxpayer's return for the taxable year.

The proposal would provide that a taxpayer is treated as maintaining a household for any

period only if over one-half of the cost of maintaining a household for such period is furnished by

such taxpayer or, if such taxpayer is married, by such taxpayer and the taxpayer’s spouse. The

proposal would also provide that taxpayers who are married at the end of the taxable year must file

a joint return to receive the credit unless they lived apart from their respective spouse 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 the entire taxable year and (2) furnished over

one-half of the cost of maintaining that household in that taxable year. Finally, the proposal would

provide that a taxpayer legally separated from the taxpayer’s spouse under a decree of divorce or

of separate maintenance would not be considered married for purposes of this provision.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
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D. Add Certain Vaccines Against Streptococcus Pneumoniae

to the List of Taxable Vaccines

Present Law

A manufacturer’s excise tax is imposed at the rate of 75 cents per dose (sec. 4131) 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), and rotavirus gastroenteritis. The tax applies 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.

Description of Proposal

The proposal would add conjugate streptococcus pneumoniae vaccines to the list of taxable

vaccines. The proposal also would change the effective date enacted in Public Law 105-277 and

certain other conforming amendments to expenditure purposes to enable certain payments to be

made from the Trust Fund.

The proposal also would reduce the rate of tax applicable to all taxable vaccines from 75

cents per dose to 25 cents per dose for sales of vaccines after December 31, 2004.

In addition, the General Accounting Office (“GAO”) would be directed to report to the

House Committee on Ways and Means and the Senate Committee on Finance on the operation and

management of expenditures from the Vaccine Injury Compensation Trust Fund and to advise the

Committees on the adequacy of the Vaccine Injury Compensation Trust Fund to meet future claims

under the Federal Vaccine Injury Compensation Program. The GAO would report its findings to the

House Committee on Ways and Means and the Senate Committee on Finance within one year from

the date of enactment.

Effective Date

The proposal to include conjugate streptococcus pneumoniae vaccines would be effective

for vaccine purchases beginning on the day after the date on which the Centers for Disease Control

make final recommendation for routine administration of conjugated streptococcus pneumoniae

vaccines to children. No floor stocks tax would be collected for amounts held for sale on that date. 
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The addition of conjugate streptococcus pneumoniae vaccines to the list of taxable vaccines would

be contingent upon the inclusion in this legislation of the modifications to Public Law 105-277.

The proposal to reduce the rate of tax to 25 cents per dose would be effective for sales after

December 31, 2004. No floor stocks refunds would be permitted for vaccines held on December

31, 2004.
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VI. SMALL BUSINESS TAX RELIEF PROVISIONS

A. Accelerate 100-Percent Self-Employed Health Insurance Deduction

Present Law

Under present law, the tax treatment of health insurance expenses depends on the

individual’s circumstances. Self-employed individuals may deduct a portion of health insurance

expenses for the individual and his or her spouse and dependents. The deductible percentage of

health insurance expenses of a self-employed individual is 60 percent in 1999 through 2001, 70

percent in 2002, and 100 percent in 2003 and thereafter. The deduction for health insurance

expenses of self-employed individuals is not available for any month in which the taxpayer is

eligible to participate in a subsidized health plan maintained by the employer of the taxpayer or the

taxpayer's spouse.

Employees can exclude from income 100 percent of employer-provided health insurance.

Individuals who itemize deductions may deduct their health insurance expenses only to the

extent that the total medical expenses of the individual exceed 7.5 percent of adjusted gross income

(sec. 213). Subject to certain dollar limitations, premiums for qualified long-term care insurance

are treated as medical expenses for purposes of the itemized deduction for medical expenses (sec.

213). The amount of qualified long-term care insurance premiums that may be taken into account

for 1999 are as follows: $210 in the case of an individual 40 years old or less; $400 in the case of

an individual who is over 40 but not more than 50; $800 in the case of an individual who is more

than 50 but not more than 60; $2,120 in the case of an individual who is more than 60 but not more

than 70; and $2,660 in the case of an individual who is more than 70. These dollar limits are

indexed for inflation.

The self-employed health deduction also applies to qualified long-term care insurance

premiums treated as medical care for purposes of the itemized deduction for medical expenses.

Description of Proposal

Beginning in 2000, the proposal would increase the deduction for health insurance expenses

(and qualified long-term care insurance expenses) of self-employed individuals to 100 percent.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999. 
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B. Increase Section 179 Expensing

Present Law

Present law provides that, in lieu of depreciation, a taxpayer with a sufficiently small

amount of annual investment may elect to deduct up to $19,000 (for taxable years beginning in

1999) of the cost of qualifying property placed in service for the taxable year (sec. 179). 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 $19,000 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. In addition, 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).

The $19,000 amount is increased to $25,000 for taxable years beginning in 2003 and

thereafter. The increase is phased in as follows: for taxable years beginning in 2000, the amount is

$20,000; for taxable years beginning in 2001 or 2002, the amount is $24,000; and for taxable years

beginning in 2003 and thereafter, the amount is $25,000.

Description of Proposal

The proposal would provide that the maximum dollar amount that may be deducted under

section 179 is increased to $30,000 for taxable years beginning in 2000 and thereafter, without the

present-law phase-in rule.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
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C. Repeal of Temporary Federal Unemployment Surtax

Present Law

The Federal Unemployment Tax Act (“FUTA”) imposes a 6.2-percent gross tax rate on the

first $7,000 paid annually by covered employers to each employee. Employers in States with

programs approved by the Federal Government and with no delinquent Federal loans may credit

5.4-percentage points against the 6.2-percent tax rate, making the minimum, net Federal

unemployment tax rate 0.8 percent. Since all States have approved programs, 0.8 percent is the

Federal tax rate that generally applies. This Federal revenue finances administration of the

unemployment system, half of the Federal-State extended benefits program, and a Federal account

for State loans. The States use the revenue turned back to them by the 5.4-percent credit to finance

their regular State programs and half of the Federal-State extended benefits program.

In 1976, Congress passed a temporary surtax of 0.2 percent of taxable wages to be added to

the permanent FUTA tax rate. Thus, the current 0.8-percent FUTA tax rate has two components: a

permanent tax rate of 0.6 percent, and a temporary surtax rate of 0.2 percent. The temporary surtax

subsequently has been extended through 2007.

Description of Proposal

The proposal would repeal the temporary FUTA surtax after December 31, 2004.

Effective Date

The provision would be effective for labor performed on or after January 1, 2005.
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D. Coordinate Farmer Income Averaging and the Alternative Minimum Tax

Present Law

An individual taxpayer may elect to compute his or her current year tax liability by

averaging, over the prior three-year period, all or portion of his or her taxable income from the

trade or business of farming. The averaging election is not coordinated with the alternative

minimum tax. Thus, some farmers may become subject to the alternative minimum tax solely as a

result of the averaging election.

Description of Proposal 

The proposal would coordinate farmer income averaging with the alternative minimum tax. 

Under the proposed coordination, a farmer would owe alternative minimum tax only to the extent he

or she would have owed alternative minimum tax had averaging not been elected. This result

would be achieved by excluding the impact of the election to average farm income from the

calculation of both regular tax and tentative minimum tax, solely for the purpose of determining

alternative minimum tax.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
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VII. ESTATE AND GIFT TAX RELIEF

A. Reduce Estate, Gift, and Generation-Skipping Transfer Taxes

Present Law

A gift tax is imposed on lifetime transfers and an estate tax is imposed on transfers at death. 

The gift tax and the estate tax are 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. 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. In addition, a 5-percent surtax is

imposed on cumulative taxable transfers between $10 million and the amount necessary to phase

out the benefits of the graduated rates.

A unified credit is available with respect to taxable transfers by gift and at death. The

unified credit amount effectively exempts from tax a total of $650,000 in 1999, $675,000 in 2000

and 2001, $700,000 in 2002 and 2003, $850,000 in 2004, $950,000 in 2005, and $1 million in

2006 and thereafter.

A generation-skipping transfer (“GST”) tax generally is imposed on transfers, either

directly or through a trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a

generation more than one generation below that of the transferor). Transfers subject to the GST tax

include direct skips, taxable terminations, and taxable distributions. The GST tax is imposed at the

top estate and gift tax rate (which, under present law is 55 percent) on cumulative generationskipping transfers in excess of $1 million.

The basis of property acquired or passing from a decedent is its fair market value on the

date of the decedent’s death (or, if the alternative valuation date is elected, the earlier of six months

or the date the property is sold or distributed by the estate). This step up (or step down) in basis

eliminates the recognition of any income on the appreciation of the property that occurred prior to

the decedent’s death, and it also has the effect of eliminating any tax benefit from any unrealized

loss.

Description of Proposal

Beginning in 2001, the 5-percent surtax, which phases out the graduated rates, and the rates

in excess of 50 percent would be repealed. Beginning in 2004, the unified credit would be

replaced with a unified exemption. Beginning in 2007, the unified exemption amount would be

increased from $1 million to $1.5 million.

Effective Date

The 5-percent surtax and the rates in excess of 50 percent would be repealed for estates of

decedents dying and gifts and generation-skipping transfers made after December 31, 2000. The
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unified credit would be replaced with a unified exemption for estates of decedents dying and gifts

made after December 31, 2003. The unified exemption amount would be increased to $1.5 million

for estates of decedents dying and gifts made after December 31, 2006.
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B. Expand Estate Tax Rule for Conservation Easements

Present Law

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

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

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

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

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

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

value of any retained development right).

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

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

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

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

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

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

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

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

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

not qualify as a conservation purpose.

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

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

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

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

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

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

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

retained by the decedent or donor.

Description of Proposal

The proposal would expand the rule for conservation easements by increasing to 50 miles

the distance within which the land must be situated from a metropolitan area, national park, or

wilderness area in order to be a qualified conservation easement. The proposal also would clarify

that the date for determining easement compliance is the date on which the donation was made.

Effective Date

The proposal to clarify the date for determining easement compliance would be effective

for estates of decedents dying after December 31, 1997. The proposal to expand the distance rule

would be effective for estates of decedents dying after December 31, 1999.
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C. Increase Annual Gift Exclusion

Present Law

An annual exclusion of $10,000 of transfers of present interests in property is provided for

each donee. If the non-donor spouse consents to split the gift with the donor spouse, the annual

exclusion is $20,000 for each donee. Unlimited transfers between spouses are permitted without

imposition of a gift tax. In the case of gifts made after 1998, the $10,000 amount is increased by a

cost-of-living adjustment.

Description of Proposal

Beginning in 2001 and through 2003, the annual gift tax exclusion would be increased to

$15,000 for each donee. Beginning in 2004 and thereafter, the annual gift tax exclusion would be

increased to $20,000 for each donee.

Effective Date

The annual gift tax exclusion would be increased to $15,000, for each donee, for gifts made

after December 31, 2000, and before January 1, 2004. The annual gift tax exclusion would then be

increased to $20,000, for each donee, for gifts made after December 31, 2003.
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D. Simplification of Generation-Skipping Transfer (“GST”) Tax

1. Retroactive allocation of the GST tax exemption

Present Law

A GST tax generally is imposed on transfers, either directly or through a trust or similar

arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation below

that of the transferor). Transfers subject to the GST tax include direct skips, taxable terminations,

and taxable distributions. An exemption of $1 million (indexed beginning in 1999) is provided for

each person making generation-skipping transfers. The exemption may be allocated by a transferor

(or his or her executor) to transferred property.

A direct skip is any transfer subject to estate or gift tax of an interest in property to a skip

person. A skip person may be a natural person or certain trusts. All persons assigned to the second

or more remote generation below the transferor are skip persons (e.g., grandchildren and greatgrandchildren). Trusts are skip persons if (1) all interests in the trust are held by skip persons, or

(2) no person holds an interest in the trust and at no time after the transfer may a distribution

(including distributions and terminations) be made to a non-skip person.

A taxable termination is a termination (by death, lapse of time, release of power, or

otherwise) of an interest in property held in trust unless, immediately after such termination, a nonskip person has an interest in the property, or unless at no time after the termination may a

distribution (including a distribution upon termination) be made from the trust to a skip person. A

taxable distribution is a distribution from a trust to a skip person (other than a taxable termination

or direct skip). If a transferor allocates GST tax exemption to a trust prior to the taxable

termination or taxable distribution, GST tax may be avoided. 

A transferor will likely not allocate GST tax exemption to a trust that the transferor expects

will benefit only non-skip persons. However, if a taxable termination occurs because, for example,

the transferor’s child unexpectedly dies such that the trust terminates in favor of the transferor’s

grandchild, and GST tax exemption had not been allocated to the trust, then GST tax would be due

even if the transferor had unused GST tax exemption.

Description of Proposal

The proposal would allow the retroactive allocation of GST exemption when there is an

unnatural order of death. Under the provision, if a lineal descendant of the transferor predeceases

the transferor, then the transferor may allocate any unused GST exemption to any previous transfer

or transfers to the trust on a chronological basis. The proposal would permit a transferor to

retroactively allocate GST exemption to a trust where a beneficiary (a) is a non-skip person, (b) is

a lineal descendant of the transferor’s grandparent or a grandparent of the transferor’s spouse, (c) is

a generation younger than the generation of the transferor, and (d) dies before the transferor. 

Exemption would be allocated under this rule retroactively, and the applicable fraction and
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inclusion ratio would be determined based on the value of the property on the date the property was

transferred to a trust.

Effective Date

The proposal would apply to deaths of non-skip persons occurring after the date of

enactment.

2. Severing of trusts holding property having an inclusion ratio of greater than zero

Present Law

A generation-skipping transfer tax (“GST tax”) generally is imposed on transfers, either

directly or through a trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a

generation more than one generation below that of the transferor). Transfers subject to the GST tax

include direct skips, taxable terminations, and taxable distributions. An exemption of $1 million is

provided for each person making generation-skipping transfers. The exemption may be allocated

by a transferor (or his or her executor) to transferred property.

If the value of transferred property exceeds the amount of the GST exemption allocated to

that property, then the GST tax generally is determined by multiplying a flat tax rate equal to the

highest estate tax rate (which is currently 55 percent) by the “inclusion ratio” and the value of the

taxable property at the time of the taxable event. The “inclusion ratio” is the number one minus the

“applicable fraction.” The applicable fraction is a fraction calculated by dividing the amount of the

GST exemption allocated to the property by the value of the property.

Under Treas. Reg. 26.2654-1(b), a trust may be severed into two or more trusts (e.g., one

with an inclusion ratio of zero and one with an inclusion ration of one) only if (1) the trust is

severed according to a direction in the governing instrument or (2) the trust is severed pursuant to

the trustee’s discretionary powers, but only if certain other conditions are satisfied (e.g., the

severance occurs or a reformation proceeding begins before the estate tax return is due). Under

current Treasury regulations, however, a trustee cannot sever a trust that is subject to the GST tax

after the trust has been created.

Description of Proposal

The proposal would allow a trust to be severed in a “qualified severance.” A qualified

severance is defined as the division of a single trust and the creation of two or more trusts if (1) the

single trust was divided on a fractional basis, and (2) the terms of the new trusts, in the aggregate,

provide for the same succession of interests of beneficiaries as are provided in the original trust. If

a trust has an inclusion ratio of greater than zero and less than one, a severance is a qualified

severance only if the single trust is divided into two trusts, one of which receives a fractional share

of the total value of all trust assets equal to the applicable fraction of the single trust immediately

before the severance. In such case, the trust receiving such fractional share shall have an inclusion
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ratio of zero and the other trust shall have an inclusion ratio of one. Under the proposal, a trustee

could elect to sever a trust in a qualified severance at any time.

Effective Date

The proposal would be effective for severances of trusts occurring after the date of

enactment.

3. Modification of certain valuation rules

Present Law

Under present law, the inclusion ratio is determined using gift tax values for allocations of

GST tax exemption made on timely filed gift tax returns. The inclusion ratio generally is

determined using estate tax values for allocations of GST tax exemption made to transfers at death. 

Treas. Reg. 26.2642-5(b) provides that, with respect to taxable terminations and taxable

distributions, the inclusion ratio becomes final on the later of the period of assessment with respect

to the first transfer using the inclusion ratio or the period for assessing the estate tax with respect to

the transferor’s estate.

Description of Proposal

The proposal would provide that, in connection with timely and automatic allocations of

GST transfer tax, the value of the property for purposes of determining the inclusion ratio shall be

its finally determined gift tax value or estate tax value depending on the circumstances of the

transfer. In the case of an allocation deemed to be made at the conclusion of an estate tax inclusion

period, the value for purposes of determining the inclusion ratio shall be its value at that time.

Effective Date

The provision would be effective as though included in the amendments made by section

1431 of the Tax Reform Act of 1986.

4. Relief from late elections

Present Law

A GST tax generally is imposed on transfers, either directly or through a trust or similar

arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation below

that of the transferor). Transfers subject to the GST tax include direct skips, taxable terminations,

and taxable distributions. An exemption of $1 million is provided for each person making

generation-skipping transfers. The exemption may be allocated by a transferor (or his or her

executor) to transferred property.
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A direct skip is any transfer subject to estate or gift tax of an interest in property to a skip

person. A skip person may be a natural person or certain trusts. All persons assigned to the second

or more remote generation below the transferor are skip persons (e.g., grandchildren and greatgrandchildren). Trusts are skip persons if (1) all interests in the trust are held by skip persons, or

(2) no person holds an interest in the trust and at no time after the transfer may a distribution

(including distributions and terminations) be made to a non-skip person.

A taxable termination is a termination (by death, lapse of time, release of power, or

otherwise) of an interest in property held in trust unless, immediately after such termination, a nonskip person has an interest in the property, or unless at no time after the termination may a

distribution (including a distribution upon termination) be made from the trust to a skip person. A

taxable distribution is a distribution from a trust to a skip person (other than a taxable termination

or direct skip).

The tax rate on generation-skipping transfers is a flat rate of tax equal to the maximum estate

and gift tax rate in effect at the time of the transfer (55 percent under present law) multiplied by the

“inclusion ratio.” The inclusion ratio with respect to any property transferred in a generationskipping transfer indicates the amount of “GST exemption” allocated to a trust. The allocation of

GST exemption reduces the 55-percent tax rate on a generation-skipping transfer.

If an individual makes a direct skip during his or her lifetime, any unused GST exemption is

automatically allocated to a direct skip to the extent necessary to make the inclusion ratio for such

property equal to zero. An individual may elect out of the automatic allocation for lifetime direct

skips.

Under present law, an election to allocate GST tax exemption to a specific transfer may be

made at any time up to the time for filing the transferor’s estate tax return. If an allocation is made

on a gift tax return filed timely with respect to the transfer to trust that is not a direct skip, then the

value on the date of transfer to trust is used for determining GST tax exemption allocation. 

However, if the allocation relating to a such transfer is not made on a timely-filed gift tax return,

then the value on the date of allocation must be used. There is no statutory provision allowing

relief for an inadvertent failure to make an election on a timely-filed gift tax return to allocate GST

tax exemption. Current Treasury regulations may permit relief from failure to make an election only

if relief is requested, under certain circumstances, within 6 months of the date of the failure.

Description of Proposal

The proposal would authorize and direct the Treasury Secretary to grant extensions of time

to make the election to allocate GST tax exemption and to grant exceptions to the time requirement. 

When such relief is granted, the value on the date of transfer to a trust is used for determining GST

tax exemption allocation.

In determining whether to grant relief for late elections, the Treasury Secretary is directed

to consider all relevant circumstances, including evidence of intent contained in the trust instrument

or instrument of transfer and such other factors as the Treasury Secretary deems relevant. For
58 No inference is intended with respect to the application of a rule of substantial

compliance prior to enactment of this provision.

59 No inference is intended with respect to the application of a rule of substantial

compliance prior to enactment of this provision.

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purposes of determining whether to grant relief, the time for making the allocation (or election)

would be treated as if not expressly prescribed by statute.

Effective Date

The proposal to provide relief from late elections would apply to requests pending on, or

filed after, the date of enactment.58

5. Substantial compliance

Present Law

Under present law, there is no statutory rule which provides that substantial compliance

with the statutory and regulatory requirements for allocating GST tax exemption will suffice to

establish that GST tax exemption was allocated to a particular transfer or trust.

Description of Proposal

The proposal would provide that substantial compliance with the statutory and regulatory

requirements for allocating GST tax exemption would suffice to establish that GST tax exemption

was allocated to a particular transfer or a particular trust. If a taxpayer demonstrates an intent to

have an inclusion ratio of zero with respect to a particular transfer or trust, then so much of the

transferor’s unused GST tax exemption will be allocated to the extent it produces, when possible, a

zero inclusion ratio. In determining whether there has been substantial compliance, all relevant

circumstances would be considered, including evidence of intent contained in the trust instrument or

instrument of transfer and such other factors as the Treasury Secretary deems appropriate.

Effective Date

 The substantial compliance provisions would take effect on the date of enactment and

would apply to allocations made prior to such date for purposes of determining the tax

consequences of generation-skipping transfers with respect to which the period of time for filing

claims for refund has not expired.59
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VIII. TAX-EXEMPT ORGANIZATION PROVISIONS

A. Provide Tax Exemption for Organizations Created by a State to Provide

Property and Casualty Insurance Coverage for Property

for Which Such Coverage Is Otherwise Unavailable

Present Law

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

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

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

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

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

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

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

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

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

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

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

basis.

Certain insurance risk pools have qualified for tax exemption under Code section 501(c)(6).

In general, these organizations (1) assign any insurance policies and administrative functions to

their member organizations (although they may reimburse their members for amounts paid and

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

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

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

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

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

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

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

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

subdivision thereof.

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

requirements.

Health coverage for high-risk individuals

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

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

certain high-risk individuals, provided certain criteria are satisfied. The organization may provide
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coverage for medical care either by issuing insurance itself or by entering into an arrangement with

a health maintenance organization ("HMO").

High-risk individuals eligible to receive medical care coverage from the organization must

be residents of the State who, due to a pre-existing medical condition, are unable to obtain health

coverage for such condition through insurance or an HMO, or are able to acquire such coverage

only at a rate that is substantially higher than the rate charged for such coverage by the organization. 

The State must determine the composition of membership in the organization. For example, a State

could mandate that all organizations that are subject to insurance regulation by the State must be

members of the organization.

The provision further requires the State or members of the organization to fund the

liabilities of the organization to the extent that premiums charged to eligible individuals are

insufficient to cover such liabilities. Finally, no part of the net earnings of the organization can

inure to the benefit of any private shareholder or individual.

Workers' compensation reinsurance organizations

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

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

compensation insurance losses, and that satisfies certain other conditions. A State must require that

the membership of the organization consist of all persons who issue insurance covering workers'

compensation losses in such State, and all persons and governmental entities who self-insure

against such losses. In addition, the organization must operate as a nonprofit organization by

returning surplus income to members or to workers' compensation policyholders on a periodic

basis and by reducing initial premiums in anticipation of investment income.

State workmen’s compensation act companies

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

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

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

additional requirements. The workmen's compensation insurance must be required by State law, or

be insurance with respect to which State law provides significant disincentives if it is not

purchased by an employer (such as loss of exclusive remedy or forfeiture of affirmative defenses

such as contributory negligence). The organization must provide workmen's compensation to any

employer in the State (for employees in the State or temporarily assigned out-of-State) seeking such

insurance and meeting other reasonable requirements. The State must either extend its full faith and

credit to the initial debt of the organization or provide the initial operating capital of such

organization. For this purpose, the initial operating capital can be provided by providing the

proceeds of bonds issued by a State authority; the bonds may be repaid through exercise of the

State's taxing authority, for example. For periods after the date of enactment, either the assets of the

organization must revert to the State upon dissolution, or State law must not permit the dissolution

of the organization absent an act of the State legislature. Should dissolution of the organization

become permissible under applicable State law, then the requirement that the assets of the
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organization revert to the State upon dissolution applies. Finally, the majority of the board of

directors (or comparable oversight body) of the organization must be appointed by an official of the

executive branch of the State or by the State legislature, or by both.

Description of Proposal

The proposal would provide tax-exempt status for any association created before January 1,

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

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

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

certain requirements are met.

Under the proposal, no part of the net earnings of the association may inure to the benefit of

any private shareholder or individual. Except as provided in the case of dissolution, no part of the

assets of the association may be used for, or diverted to, any purpose other than: (1) to satisfy, in

whole or in part, the liability of the association for, or with respect to, claims made on policies

written by the association; (2) to invest in investments authorized by applicable law; (3) to pay

reasonable and necessary administration expenses in connection with the establishment and

operation of the association and the processing of claims against the association; or (4) to make

remittances pursuant to State law to be used by the State to provide for the payment of claims on

policies written by the association, purchase reinsurance covering losses under such policies, or to

support governmental programs to prepare for or mitigate the effects of natural catastrophic events. 

Under the proposal, it would be required that the State law governing the association permit the

association to levy assessments on insurance companies authorized to sell property and casualty

insurance in the State, or on property and casualty insurance policyholders with insurable interests

in property located in the State to fund deficits of the association, including the creation of reserves. 

Under the proposal, it would be required that the plan of operation of the association be subject to

approval by the chief executive officer or other official of the State, by the State legislature, or

both. In addition, it would be required that the assets of the association revert upon dissolution to

the State, the State’s designee, or an entity designated by the State law governing the association, or

that State law not permit the dissolution of the association.

The proposal would provide a special rule in the case of any entity or fund created before

January 1, 1999, pursuant to State law and organized and operated exclusively to receive, hold, and

invest remittances from an association exempt from tax under the proposal, to make disbursements

to pay claims on insurance contracts issued by the association, and to make disbursements to

support governmental programs to prepare for or mitigate the effects of natural catastrophic events. 

The special rule would provide that the entity or fund may elect to be disregarded as a separate

entity and be treated as part of the association exempt from tax under the proposal, from which it

receives such remittances. The election would be required to be made no later than 30 days

following the date on which the association is determined to be exempt from tax under the proposal,

and would be effective as of the effective date of that determination.

An organization described in the proposal would be treated as having unrelated business

taxable income (“UBIT”) in the amount of its taxable income (computed as if the organization were
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not exempt from tax under the proposal), if at the end of the immediately preceding taxable year, the

organization’s net equity exceeded 15 percent of the total coverage in force under insurance

contracts issued by the organization and outstanding at the end of that preceding year.

Under the proposal, no income or gain would be recognized solely as a result of the change

in status to that of an association exempt from tax under the proposal.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
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B. Modify Section 512(b)(13)

Present Law

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

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

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

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

In the case of a stock subsidiary, “control” means ownership by vote or value of more than 50

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

than 50 percent of the profits, capital or beneficial interests. In addition, present law applies the

constructive ownership rules of section 318 for purposes of section 512(b)(13). Thus, a parent

exempt organization is deemed to control any subsidiary in which it holds more than 50 percent of

the voting power or value, directly (as in the case of a first-tier subsidiary) or indirectly (as in the

case of a second-tier subsidiary).

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

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

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

increases any net unrelated loss) of the controlled entity.

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

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

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

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

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

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

that permits optional accelerated payments).

Description of Proposal

The proposal would provide that the general rule of section 512(b)(13), which includes 

interest, rent, annuity, or royalty payments made by a controlled entity to a tax-exempt organization

in the latter organization’s UBI, applies only to the portion of payments received in a taxable year

that exceed the amount of the specified payment which would have been paid if such payment had

been determined under the principles of section 482. Thus, if a payment of rent by a controlled

subsidiary to its tax-exempt parent organization exceeds fair market value, the excess amount of

such payment over fair market value (as determined in accordance with section 482) would be

included in the parent organizations’s UBI. In addition, the proposal would impose a 20 percent

penalty on the excess amount of any such payment.

The proposal would provide relief for payments under contracts which, on the date of

enactment of the proposal, are subject to the binding contract transition rule of the 1997 Act, but for
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which the transition rule would expire prior to the effective date of the proposal, by extending the

transition rule until December 31, 1999. 

Effective Date

The proposal providing an exception from the general rule of section 512(b)(13) for

interest, rent, annuity, or royalty payments from controlled subsidiaries that do not exceed fair

market value generally would apply to payments received or accrued in taxable years beginning

after December 31, 1999. 
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C. Tax-free Withdrawals from IRAs for Charitable Purposes

Present Law

Under present law, individuals may make deductible contributions to a traditional

individual retirement arrangement (“IRA”). Amounts in an IRA are includible in income when

withdrawn (except to the extent the withdrawal represents a return of after-tax contributions). 

Includible amounts withdrawn before attainment of age 59-1/2 are subject to an additional 10-

percent early withdrawal tax, unless an exception applies.

Generally, a taxpayer who itemizes deductions may deduct cash contributions to charity, as

well as the fair market value of contributions of property. The amount of the deduction otherwise

allowable for the taxable year with respect to a charitable contribution may be reduced, depending

on the type of property contributed, the type of charitable organization to which the property is

contributed, and the income of the taxpayer. 

For donations of cash by individuals, total deductible contributions to public charities may

not exceed 50 percent of a taxpayer’s adjusted gross income (“AGI”) for a taxable year. To the

extent a taxpayer has not exceeded the 50-percent limitation, contributions of cash to private

foundations and certain other nonprofit organizations and contributions of capital gain property to

public charities generally may be deducted up to 30 percent of the taxpayer’s AGI. If a taxpayer

makes a contribution in one year which exceeds the applicable 50-percent or 30-percent limitation,

the excess amount of the contribution may be carried over and deducted during the next five taxable

years.

In addition to the percentage limitations imposed specifically on charitable contributions,

present law imposes a reduction on most itemized deductions, including charitable contribution

deductions, for taxpayers with adjusted gross income in excess of a threshold amount, which is

indexed annually for inflation. The threshold amount for 1999 is $126,600 ($63,300 for married

individuals filing separate returns). For those deductions that are subject to the limit, the total

amount of itemized deductions is reduced by 3 percent of AGI over the threshold amount, but not by

more than 80 percent of itemized deductions subject to the limit. The effect of this reduction may be

to limit a taxpayer’s ability to deduct some of his or her charitable contributions. 

Description of Proposal

The proposal would provide an exclusion from gross income for qualified charitable

distributions from an IRA: (1) to a charitable organization to which deductible contributions can be

made; (2) to a charitable remainder annuity trust or charitable remainder unitrust; (3) to a pooled

income fund (as defined in sec. 642(c)(5)); or (4) for the issuance of a charitable gift annuity. The

exclusion would apply with respect to distributions described in (2), (3), or (4) only if no person

holds an income interest in the trust, fund, or annuity attributable to such distributions other than the

IRA owner, his or her spouse, or a charitable organization.
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In determining the amount includible in gross income by reason of a payment from a

charitable remainder annuity trust or charitable remainder unitrust to which a qualified charitable

distribution from an IRA was made, the taxpayer would be required to treat as ordinary income (as

described in sec. 664(b)(1)) the portion of the distribution from the IRA to the trust which would

have been includible in income but for the proposal. Similarly, in determining the amount

includible in gross income by reason of a payment from a charitable gift annuity purchased with a

qualified charitable distribution from an IRA, the taxpayer would not be permitted to treat the

portion of the distribution from the IRA used to purchase the annuity as an investment in the annuity

contract. 

A qualified charitable distribution would be treated as any distribution from an IRA which

is made after age 70-1/2, and which is made directly to the charitable organization or to a

charitable remainder annuity trust, charitable remainder unitrust, or charitable gift annuity (as

described above).

The amount otherwise allowable as a deduction to the individual for the year as charitable

contributions would be reduced by the amount of qualified charitable distributions.

Effective Date

The proposal would be effective with respect to distributions after December 31, 2000. 
60Treasury Regulation section 1.170A-1(g) allows taxpayers to deduct only their own

unreimbursed expenses incurred in performing services for a qualified charitable organization, and

not expenses incident to a third party's performance of services. See Davis v. United States, 495

U.S. 472 (1990). 

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D. Provide Exclusion for Mileage Reimbursements by Charitable Organizations

Present Law

In computing taxable income, individuals who do not elect the standard deduction may

claim itemized deductions, including a deduction (subject to certain limitations) for charitable

contributions or gifts made during the taxable year to a qualified charitable organization or

governmental entity (sec. 170). Individuals who elect the standard deduction may not claim a

deduction for charitable contributions made during the taxable year.

No charitable contribution deduction is allowed for a contribution of services. However,

unreimbursed expenditures made incident to providing donated services to a qualified charitable

organization--such as out-of-pocket transportation expenses necessarily incurred in performing

donated services--may constitute a deductible contribution (Treas. Reg. sec. 1.170A-1(g)).60

However, no charitable contribution deduction is allowed for traveling expenses (including

expenses 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 (sec. 170(j)). Moreover, a taxpayer may not deduct as a charitable contribution

out-of-pocket expenditures incurred on behalf of a charity if such expenditures are made for the

purposes of influencing legislation (sec. 170(f)(6)).

For purposes of computing the charitable contribution deduction for the use of a passenger

automobile (including vans, pickups, and panel trucks) in connection with providing donated

services to a qualified charitable organization, the standard mileage rate is 14 cents per mile (sec.

170(i)). Volunteer drivers who are reimbursed for mileage expenses have taxable income to the

extent the reimbursement exceeds 14 cents per mile.

Description of Proposal

Under the proposal, reimbursement by an entity or organization described in section 170(c)

(including public charities and private foundations) for the costs of using an automobile in

connection with providing donated services would be excludable from the gross income of the

volunteer, provided that (1) reimbursement does not exceed the rate prescribed for business use,

and (2) applicable recordkeeping requirements are satisfied. The proposal would not permit a

volunteer to exclude a reimbursement from income if the volunteer claims a deduction or credit

with respect to his or her automobile transportation expenses incurred in connection with providing

donated services.

Effective Date
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The proposal would be effective for taxable years beginning after December 31, 1999.
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E. Charitable Contribution Deduction for Certain Expenses 

Incurred in Support of Native Alaskan Subsistence Whaling

Present Law

In computing taxable income, individuals who do not elect the standard deduction may

claim itemized deductions, including a deduction (subject to certain limitations) for charitable

contributions or gifts made during the taxable year to a qualified charitable organization or

governmental entity (sec. 170). Individuals who elect the standard deduction may not claim a

deduction for charitable contributions made during the taxable year.

No charitable contribution deduction is allowed for a contribution of services. However,

unreimbursed expenditures made incident to the rendition of services to an organization,

contributions to which are deductible, may constitute a deductible contribution (Treas. Reg. sec.

1.170A-1(g)). Specifically, section 170(j) provides that no charitable contribution deduction is

allowed for traveling expenses (including amounts expended for meals and lodging) while away

from home, whether paid directly or by reimbursement, unless there is no significant element of

personal pleasure, recreation, or vacation in such travel.

Description of Proposal

The proposal would allow individuals to claim a deduction under section 170 not

exceeding $7,500 per taxable year for certain expenses incurred in carrying out sanctioned whaling

activities. The deduction would be available only to an individual who is recognized by the Alaska

Eskimo Whaling Commission as a whaling captain charged with the responsibility of maintaining

and carrying out sanctioned whaling activities. The proposal would allow a deduction for

reasonable and necessary expenses paid by the taxpayer during the taxable year for (1) the

acquisition and maintenance of whaling boats, weapons, and gear used in sanctioned whaling

activities, (2) the supplying of food for the crew and other provisions for carrying out such

activities, and (3) storage and distribution of the catch from such activities.

For purposes of the proposal, 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 proposal would be effective for taxable years ending after December 31, 1999.
61 A few cases provide some guidance on this issue. See Seasongood v. Commissioner,

227 F.2d 907 (6th Cir. 1955); Christian Echoes National Ministry, Inc. v. United States, 470 F.2d

849 (10th Cir. 1972), cert. denied, 414 U.S. 864 (1973); Haswell v. United States, 500 F.2d 1133

(Ct. Cl. 1974)). 

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F. Simplify Lobbying Expenditure Limitations

Present Law

An organizations does not qualify for tax-exempt status as a charitable organization under

section 501(c)(3) unless no substantial part of its activities constitutes carrying on propaganda or

otherwise attempting to influence legislation (commonly referred to as “lobbying”). For purposes

of determining whether legislative activities are a substantial part of a public charity’s overall

functions, a public charity may elect either the “substantial part” test or the “expenditure” test.

The substantial part test uses a facts and circumstances approach to measure the permissible

level of legislative activities. Because there is no statutory or regulatory guidance, it is not clear

whether the determination is based on the organization’s activities, or its expenditures, or both.61

As an alternative to the substantial part test, the expenditure test permits public charities to

elect to be governed by specific expenditure limitations on their lobbying activities under section

501(h). The expenditure test establishes two expenditure limits: one restricts the total amount of

lobbying expenditures the public charity can make, the other restricts grass roots lobbying

expenditures as a subset of total lobbying expenditures. A public charity’s total lobbying

expenditures for a year are the sum of its expenditures for direct lobbying and its expenditures for

grass roots lobbying.

Direct lobbying is defined as an attempt to influence legislation through communication with

a member or staff of a legislative body or with any other government official or employee who may

participate in the formulation of legislation. The communication will constitute direct lobbying

only if such communication “refers to specific legislation” and reflects a view on such legislation

(Treas. Reg. sec. 56.4911-2(b)(1)(ii)). Grass roots lobbying is defined as an attempt to influence

legislation through a communication with members of the public that seeks to affect their opinions

about the legislation (Treas. Reg. sec. 56.4911-2(b)(2)(i)). The communication must refer to

specific legislation, reflect a view on the legislation, and encourage the recipient of the

communication to take action with respect to the legislation.

Under the expenditure test, a public charity will be denied exemption under section

501(c)(3) because of lobbying activities only if it “normally” either (1) makes total lobbying

expenditures in excess of the “lobbying ceiling amount” or (2) makes grass roots expenditures in

excess of the “grass roots ceiling amount” (sec. 501(h)(1)). The lobbying ceiling amount is 150

percent of the organization’s “lobbying nontaxable amount” and the grass roots ceiling amount is

150 percent of the “grass roots nontaxable amount.” The lobbying nontaxable amount is the lesser

of $1 million or an amount determined as a percentage of an organization’s exempt purpose
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expenditures. The grass roots nontaxable amount is 25 percent of the organization’s lobbying

nontaxable amount for that taxable year. A public charity that has elected the expenditure test and

that exceeds either or both of these limitations is subject to a 25 percent tax on the greater of the

two excess lobbying expenditures.

Description of Proposal

The proposal would remove the separate percentage limitation on grass roots lobbying

expenditures. Consequently, public charities would be subject to an expenditure limitation only on

their total lobbying expenditures.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
62 Beginning in 1982, non-itemizers were allowed a deduction for charitable contributions

in addition to the standard deduction. The maximum charitable contribution deduction for nonitemizers was $25 for 1982 and 1983, and $75 for 1984. For 1985, 50 percent of the amount

contributed was deductible, without a dollar cap. For 1986, the full amount of contributions was

deductible, subject to the limitations generally applicable to charitable deductions under section

170. Beginning in 1987, the charitable contribution deduction for non-itemizers was no longer

effective. 

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G. Charitable Giving Proposals

Present Law

Generally, a taxpayer who itemizes deductions may deduct cash contributions to charity

made within a taxable year (generally, January 1-December 31 for calendar-year taxpayers), as

well as the fair market value of contributions of property. The amount of the deduction otherwise

allowable for the taxable year with respect to a charitable contribution may be reduced, depending

on the type of property contributed, the type of charitable organization to which the property is

contributed, and the income of the taxpayer. Taxpayers who do not itemize their deductions are not

permitted to claim charitable contribution deductions.62

For donations of cash by individuals, total deductible contributions to public charities,

private operating foundations, and certain types of private non-operating foundations may not

exceed 50 percent of a taxpayer’s “contribution base,” which is typically the taxpayer’s adjusted

gross income (“AGI”), for a taxable year (sec. 170(b)(1)). To the extent a taxpayer has not

exceeded the 50-percent limitation, contributions of cash to private foundations and certain other

charitable organizations and contributions of capital gain property to public charities generally may

be deducted up to 30 percent of the taxpayer’s contribution base. If a taxpayer makes a contribution

in one year which exceeds the applicable 50-percent or 30-percent limitation, the excess amount of

the contribution may be carried over and deducted during the next five taxable years.

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

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

170(b)(2)).

Description of Proposal

Deadline for contributions to low-income schools extended until return filing date

The proposal would allow taxpayers to claim a charitable contribution deduction for

donations to public, private, and parochial low-income elementary and secondary schools made

after the end of the taxable year and on or before the date for filing the taxpayer’s Federal income

tax return. For example, under the proposal, a calendar-year taxpayer could make a contribution to

a qualifying school on March 23, 2001, and claim a charitable contribution deduction for that gift
63 The taxpayer would not be permitted to claim a deduction for the same gift on his or her

2001 Federal income tax return filed in 2002.

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on his or her Federal income tax return for the year 2000 filed on April 15, 2001.63 For purposes of

the proposal, a low-income school would be defined as one where more than 50 percent of the

students qualify for free or reduced price lunches. 

Charitable contribution deduction for non-itemizers

For 2000 and 2001, the proposal would allow taxpayers who do not itemize their

deductions to claim an above-the-line deduction for charitable contributions. The deduction would

be limited to $50 for individual taxpayers and $100 for taxpayers filing joint returns.

Increase AGI percentage limits for individuals

The proposal would phase up the percentage limitations applicable to charitable

contributions by individuals. Beginning in 2002, the proposal would increase the 50-percent and

30-percent limitations by 2 percent per year until the limitations are equal to 60 percent and 40

percent, respectively, in 2006. In 2007, the limitations would be increased to 70 percent and 50

percent, respectively.

Increase AGI percentage limits for corporations

The proposal would phase up the percentage limitation applicable to charitable

contributions by corporations. Beginning in 2002, the proposal would increase the 10-percent

limitation by 2 percent per year until the limitation is equal to 20 percent in 2006.

Effective Date

The proposal extending the deadline for contributions to certain low-income schools would

be effective for taxable years beginning after December 31, 1999. The proposal permitting nonitemizers to claim a charitable contribution deduction would be effective for taxable years 2000

and 2001. The proposals increasing the percentage limitations for individual and corporate

taxpayers would be effective for taxable years beginning after December 31, 2001. 
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TITLE IX. INTERNATIONAL TAX RELIEF PROVISIONS

A. Allocate Interest Expense on Worldwide Basis

Present Law

In general

In order to compute the foreign tax credit limitation, a taxpayer must determine the amount

of 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. Generally, it is left to the Treasury to provide detailed rules for the allocation

and apportionment of expenses.

In the case of interest expense, regulations 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. (Exceptions to the fungibility concept are recognized or required, however, in particular

cases, some of which are described below.) The Code provides that for interest allocation

purposes all members of an affiliated group of corporations generally are to be treated as a single

corporation (the so-called "one-taxpayer rule"), and that allocation must be made on the basis of

assets rather than gross income.

Affiliated group

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. (See, e.g., Treas. Reg. sec. 1.861-11T(g).)

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 the common parent owns directly at least 80 percent

of the total voting power of all classes of stock and at least 80 percent of the total value of all

outstanding stock of at least one other includible corporation. In addition, for each such other

includible corporation (except the common parent), stock possessing at least 80 percent of the total

voting power of all classes of its stock and at least 80 percent of the total value of all of its

outstanding stock must be directly owned by one or more other includible corporations.
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Generally the term "includible corporation" means any domestic corporation except certain

corporations exempt from tax under 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. For example, both definitions 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 rule does not apply as

between the domestic and foreign members of a group with the same degree of common control as

the domestic affiliated group. Moreover, Congress in 1986 expressly considered and rejected a rule

that would have accomplished a result more consistent with worldwide fungibility by taking foreign

members' indebtedness into account when allocating the interest expense of the domestic members

(H. Rept. 99-841, II-605 (1986)). In practice, the limit in the degree of fungibility recognized by

present law can reduce the foreign tax credit limitations that otherwise would apply if the principle

of fungibility were extended to foreign and domestic members of a commonly controlled group.

The statutory definition of affiliation for purposes of group-wide allocation of interest

expenses expressly provides for two exceptions from the definition of affiliation for consolidation

purposes, one of which contracts the affiliated group and the other of which expands it.

Banks, savings institutions and other financial affiliates

Under the first-mentioned exception, the affiliated group for interest allocation purposes

generally excludes what are referred to in the 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, subsidiaries of banks and

bank 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 nonfinancial 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.

Section 936 corporations
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Under the second exception referred to above, the affiliated group for interest allocation

purposes includes any corporation that has elected the application of the possession tax credit for

the taxable year, if the corporation would be excluded solely for this reason from the affiliated

group as defined for consolidation purposes (sec. 864(e)(5)(A)).

Description of Proposal

Worldwide affiliated group election

The proposal would modify the present-law interest expense allocation rules under section

864(e) 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 would be determined by

allocating and apportioning all interest expense of the domestic members of the worldwide

affiliated group on a worldwide-group basis. The election would provide taxpayers with the

option either to apply fungibility principles on a worldwide basis or to continue to apply present

law. For purposes of the new elective rules based on worldwide fungibility, the affiliated group

(as that term is used under present law for interest expense allocation purposes) would be

expanded to include life insurance companies (without regard to whether such companies are

covered by an election under section 1504(c)(2)) and foreign corporations that would be included

in the affiliated group under section 1504 if they were domestic corporations (i.e., foreign

corporations in which members of the affiliated group own stock possessing at least 80 percent of

the foreign corporation’s vote and value). Thus, subject to certain exceptions described below, the

taxable income from sources outside the United States of the domestic members of an electing

worldwide affiliated group would be determined by allocating and apportioning interest expense as

if all of the interest expense and assets of 80-percent or greater owned domestic and foreign

corporations were attributable to a single corporation.

The general rules under present law would apply to the electing worldwide affiliated group

as if it were an affiliated group as defined under present law for interest expense allocation

purposes. Thus, among other things, the allocation and apportionment of interest expense would

continue to be made on the basis of assets (rather than gross income), but would include the assets

of the foreign members of the worldwide affiliated group. 

Although the interest expense of an 80-percent owned foreign subsidiary would be taken

into account for purposes of allocating the interest expense of the domestic members of the group

for foreign tax credit limitation purposes, the interest expense incurred by a foreign subsidiary

would not be deductible on a U.S. return. After calculating the interest expense allocation of the

domestic members based on the worldwide affiliated group, the interest expense preliminarily

allocable to foreign-source income would be reduced (but not below zero) by the interest expense

taken into account in determining the allocation that was incurred by a foreign corporation to the

extent that such interest would be allocated to foreign sources if the proposal's principles were

applied separately to the foreign members of the group.

Financial institution group election
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With respect to affiliated groups that elect to apply the new worldwide fungibility principle,

the proposal would provide a one-time election to expand the bank group rules of present law (sec.

864(e)(5)(B)-(D)). At the election of the common parent of an affiliated group that elects to apply

the worldwide approach to the interest expense allocation rules, the worldwide approach could be

applied separately to a subgroup of the affiliated group consisting of the present-law bank group

and all members of the worldwide affiliated group that are predominantly engaged in a banking,

insurance, financing, or similar business. For this purpose, a corporation would be predominantly

engaged in such a business if at least 80 percent of its gross income is "financial services income" 

(as described in section 904(d)(2)(C)(ii) and the regulations thereunder). As is true under present

law, to qualify for inclusion in a financial institution group, the financial services income of the

corporation must be predominantly from business with unrelated persons.

The financial institution group rules, if elected, would apply to all members of the affiliated

group that are considered to be predominantly engaged in the active conduct of a banking,

insurance, financing, or similar business. The election would be available only for the first year in

which an affiliated group includes a corporation that satisfies the expanded definition of a financial

institution but would not qualify as such under the present-law bank group rules. Once made, the

election would apply to all corporations that qualify as financial institutions under the expanded

definition for the taxable year and all subsequent years. Anti-abuse rules would apply under which

certain transfers of funds between a member of the financial institution group and another member

of the affiliated group that is not a member of the financial institution group would result in

treatment of a portion of the interest expense of the financial institution group as interest expense of

the non-financial institution group.

Regulatory authority

The Treasury Secretary would be granted authority to prescribe rules to carry out the

purposes of the proposal, including rules (1) to address changes in members of an affiliated group

(including acquisitions or other business combinations of affiliated groups in which one group has

made an election to apply the worldwide approach and the other group applies current law); (2) to

prevent assets and interest expense from being taken into account more than once; and (3) to

provide for direct allocation of interest expense in circumstances where such allocation would be

appropriate to carry out the purposes of the proposal.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2002.
64 A controlled foreign corporation in which the taxpayer owns at least 10 percent of the

stock by vote is treated as a 10/50 company with respect to any distribution out of earnings and

profits for periods when it was not a controlled foreign corporation. 

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B. Look-Through Rules to Apply to Dividends from

Noncontrolled Section 902 Corporations

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. Separate

limitations are 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”).64 Dividends 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. Dividends paid by a 10/50 company that is not a passive

foreign investment company in taxable years beginning after December 31, 2002, 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). 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 in taxable years beginning after December 31, 2002, 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 earnings and profits attributable to income in

such foreign tax credit limitation category to the total earnings and profits (a so-called

“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.

Description of Proposal

The proposal would simplify the application of the foreign tax credit limitation by applying

the look-through approach to all 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. 

The proposal would provide a transition rule under which pre-effective date foreign tax

credits associated with a 10/50 company separate limitation category can be carried forward into

post-effective date years. Under the proposal, look-through principles similar to those applicable to

post-effective date dividends from a 10/50 company would apply to determine the appropriate
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foreign tax credit limitation category or categories with respect to the foreign tax credit

carryforward.

The proposal also would provide a default rule in cases in which taxpayers are unable to

obtain the necessary information to apply the look-through rules with respect to dividends from a

10/50 company. In such cases, the proposal would treat the dividend (or a portion thereof) from

such 10/50 company as a dividend that would not be subject to the look-through rules.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 2002.
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C. Subpart F Treatment of Pipeline Transportation Income

and Income from Transmission of High Voltage Electricity

Present Law

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

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

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

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

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

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

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

Foreign base company services income includes income from services performed (1) for or

on behalf of a related party and (2) outside the country of the CFC’s incorporation (sec. 954(e)). 

Treasury regulations provide that the services of the foreign corporation will be treated as

performed for or on behalf of the related party if, for example, a party related to the foreign

corporation furnishes substantial assistance to the foreign corporation in connection with the

provision of services (Treas. Reg. sec. 1.954-4(b)(1)(iv)).

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

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

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

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

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

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

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

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

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

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

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

Description of Proposal

The proposal would exempt income derived in connection with the performance of services

which are directly related to the transmission of high voltage electricity from the definition of

foreign base company services income. Thus, the income of a CFC that owns a high voltage

transmission line for the purpose of providing electricity generated by a related party to a third

party outside the CFC's country of incorporation would not constitute foreign base company

services income. No inference would be intended as to the treatment of such income under present

law.

The proposal also would provide an additional exception to the definition of foreign base

company oil related income. Under the proposal, foreign base company oil related income would
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not include income derived from a source within a foreign country in connection with the pipeline

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

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

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

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

foreign country.

Effective Date

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

2002, and taxable years of U.S. shareholders with or within which such taxable years of CFCs end.
65 Sec. 6103(b)(2)(A).

66 Sec. 6110(c) provides for the deletion of identifying information, trade secrets,

confidential commercial and financial information and other material. 

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D. Prohibit Disclosure of APAs and APA Background Files

Present Law

Section 6103

Under section 6103, returns and return information are confidential and cannot be disclosed

unless authorized by the Internal Revenue Code.

Return information is defined broadly. Return information includes:

C a taxpayer's identity, the nature, source or amount of income, payments, receipts,

deductions, exemptions, credits, assets, liabilities, net worth, tax liability, tax

withheld, deficiencies, overassessments, or tax payments; 

C whether the taxpayer's return was, is being, or will be examined or subject to

other investigation or processing; or 

C any other data, received by, recorded by, prepared by, furnished to, or collected

by the Secretary with respect to a return or with respect to the determination of

the existence, or possible existence, of liability (or the amount thereof) of any

person under Title 26 for any tax, penalty, interest, fine, forfeiture, or other

imposition, or offense.65

Section 6110 and the Freedom of Information Act 

With certain exceptions, section 6110 makes the text of any written determination the IRS

issues available for public inspection. A written determination is any ruling, determination letter,

technical advice memorandum, or Chief Counsel advice. Once the IRS makes the written

determination publicly available, the background file documents associated with such written

determination are available for public inspection upon written request. The Code defines

“background file documents” as any written material submitted in support of the request. 

Background file documents also include any communications between the IRS and persons outside

the IRS concerning such written determination that occur before the IRS issues the determination. 

Before making them available for public inspection, section 6110 requires the IRS to delete

specific categories of sensitive information from the written determination and background file

documents.66 It also provides judicial and administrative procedures to resolve disputes over the

scope of the information the IRS will disclose. In addition, Congress has also wholly exempted
67 Sec. 6110(l).

68 Sec. 6103(b)(2)(B) (“The term ‘return information’ means . . . any part of any written

determination or any background file document relating to such written determination (as such

terms are defined in section 6110(b)) which is not open to public inspection under section 6110").

69 Unless published promptly and offered for sale, an agency must provide for public

inspection and copying: (1) final opinions as well as orders made in the adjudication of cases; (2)

statements of policy and interpretations not published in the Federal Register; (3) administrative

staff manuals and instructions to staff that affect a member of the public; and (4) agency records

which have been or the agency expects to be, the subject of repetitive FOIA requests. 5 U.S.C.

sec. 552(a)(2). An agency must also publish in the Federal Register: the organizational structure

of the agency and procedures for obtaining information under the FOIA; statements describing the

functions of the agency and all formal and informal procedures; rules of procedure, descriptions of

forms and statements describing all papers, reports and examinations; rules of general

applicability and statements of general policy; and amendments, revisions and repeals of the

foregoing. 5 U.S.C. sec. 552(a)(1). All other agency records can be sought by FOIA request;

however, some records may be exempt from disclosure.

70 Exemption 3 of the FOIA provides that an agency is not required to disclose matters that

are:

 (3) specifically exempted from disclosure by statute (other than section 552b of

this title) provided that such statute (A) requires that the matters be withheld from

the public in such a manner as to leave no discretion on the issue, or (B) establishes

particular criteria for withholding or refers to particular types of matters to be

withheld; . . .

5 U.S.C. § 552(b)(3).

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certain matters from section 6110's public disclosure requirements.67 Any part of a written

determination or background file that is not disclosed under section 6110 constitutes “return

information.”68

The Freedom of Information Act (“FOIA”) lists categories of information that an agency

must make available for public inspection.69 It establishes a presumption that records in the

possession of agencies and departments of the executive branch of the U.S. Government are

accessible to the public. The FOIA, however, also provides nine exemptions from public

disclosure. One of those exemptions is for matters specifically exempted from disclosure by a

statute other than the FOIA if the exempting statute meets certain requirements.70 Section 6103

qualifies as an exempting statute under this FOIA provision. Thus, returns and return information

that section 6103 deems confidential are exempt from disclosure under the FOIA.
71 Sec. 6110(m).

72

 BNA v. IRS, Nos. 96-376, 96-2820, and 96-1473 (D.D.C.). The Bureau of National

Affairs, Inc. (BNA) publishes matters of interest for use by its subscribers. BNA contends that

APAs are not return information as they are prospective in application. Thus at the time they are

entered into they do not relate to “the determination of the existence, or possible existence, of

liability or amount thereof . . .”

73 The IRS contended that information received or generated as part of the APA process 

pertains to a taxpayer’s liability and therefore was return information as defined in sec.

6103(b)(2)(A). Thus, the information was subject to section 6103's restrictions on the

dissemination of returns and return information. Rev. Proc. 91-22, sec. 11, 1991-1 C.B. 526, 534

and Rev. Proc. 96-53, sec. 12, 1996-2 C.B. 375, 386. 

74 IR 1999-05.

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Section 6110 is the exclusive means for the public to view IRS written determinations.71 If

section 6110 covers the written determination, the public cannot use the FOIA to obtain that

determination.

Advance Pricing Agreements

The Advanced Pricing Agreement (“APA”) program is an alternative dispute resolution

program conducted by the IRS, which resolves international transfer pricing issues prior to the

filing of the corporate tax return. Specifically, an APA is an advance agreement establishing an

approved transfer pricing methodology entered into among the taxpayer, the IRS, and a foreign tax

authority. The IRS and the foreign tax authority generally agree to accept the results of such

approved methodology. Alternatively, an APA also may be negotiated between just the taxpayer

and the IRS; such an APA establishes an approved transfer pricing methodology for U.S. tax

purposes. The APA program focuses on identifying the appropriate transfer pricing methodology; it

does not determine a taxpayer’s tax liability. Taxpayers voluntarily participate in the program.

To resolve the transfer pricing issues, the taxpayer submits detailed and confidential

financial information, business plans and projections to the IRS for consideration. Resolution

involves an extensive analysis of the taxpayer’s functions and risks. Since its inception in 1991, the

APA program has resolved more than 180 APAs, and approximately 195 APA requests are

pending.

Currently pending in the U.S. District Court for the District of Columbia are three

consolidated lawsuits asserting that APAs are subject to public disclosure under either section

6110 or the FOIA.72 Prior to this litigation and since the inception of the APA program, the IRS

held the position that APAs were confidential return information protected from disclosure by

section 6103.73 On January 11, 1999, the IRS conceded that APAs are “rulings” and therefore are

“written determinations” for purposes of section 6110.74 Although the court has not yet issued a
75 This information was previously released in IRS Publication 3218, “IRS Report on

Application and Administration of I.R.C. Section 482."

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ruling in the case, the IRS announced its plan to publicly release both existing and future APAs. 

The IRS then transmitted existing APAs to the respective taxpayers with proposed deletions. It has

received comments from some of the affected taxpayers. Where appropriate, foreign tax authorities

have also received copies of the relevant APAs for comment on the proposed deletions. No APAs

have yet been released to the public.

Some taxpayers assert that the IRS erred in adopting the position that APAs are subject to

section 6110 public disclosure. Several have sought to participate as amici in the lawsuit to block

the release of APAs. They are concerned that release under section 6110 could expose them to

expensive litigation to defend the deletion of the confidential information from their APAs. They

are also concerned that the section 6110 procedures are insufficient to protect the confidentiality of

their trade secrets and other financial and commercial information.

Description of Proposal

The proposal would provide that APAs and related background information are confidential

return information and are not written determinations as that term is defined in section 6110.

The proposal would also statutorily require an annual report by the Treasury Department on

APAs. The annual report would contain the following information:

C Information about the structure, composition, and operation of the APA program

office;

C A copy of each current model APA;

C Statistics regarding the amount of time to complete new and renewal APAs;

C The number of APA applications filed during such year;

C The number of APAs executed cumulatively to date and for the year;

C The number of APA renewals issued for the year;

C The number of pending APA requests;

C The number of pending APA renewals;

C The number of APAs executed and pending (including renewals and renewal

requests) that are unilateral, bilateral and multilateral, respectively;

C The number of APAs revoked or canceled, and the number of withdrawals from

the APA program for the year; 

C The number of finalized new APAs and renewals by industry;75 and 

General descriptions of:

C the nature of the relationships between the related organizations, trades, or

businesses covered by APAs;
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C the related organizations, trades, or businesses whose prices or results are tested

to determine compliance with the transfer pricing methodology prescribed in the

APA;

C the covered transactions and the functions performed and risks assumed by the

related organizations, trades or businesses involved; 

C methodologies used to evaluate tested parties and transactions and the

circumstances leading to the use of those methodologies;

C critical assumptions;

C sources of comparables;

C comparable selection criteria and the rationale used in determining such criteria;

C the nature of adjustments to comparables or tested parties;

C the nature of any range agreed to, including information such as whether no range

was used and why, whether an inter-quartile range was used, or whether there

was a statistical narrowing of the comparables;

C adjustment mechanisms provided to rectify results that fall outside of the agreed

upon APA range;

C the various term lengths for APAs, including rollback years, and the number of

APAs with each such term length; 

C the nature of documentation required; and

C approaches for sharing of currency or other risks.

The first report would cover the period January 1, 1991, through the calendar year including

the date of enactment. The IRS user fee otherwise required to be paid for an APA would be

increased by $500. The Secretary would have the authority to provide an appropriate reduction in

the IRS user fee for small businesses with respect to an APA. While the proposal statutorily

requires an annual report, the proposal is not intended to discourage the Treasury Department from

issuing other forms of guidance, such as regulations or revenue rulings, consistent with the

confidentiality provisions of the Code.

Effective Date

The proposal would be effective on the date of enactment; accordingly, no APAs or related

background file documents would be released to the public after the date of enactment. The first

annual Treasury Department report would be required to be published no later than March 30,

2000.
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E. Exempt Certain Sales of Frequent-Flyer and Similar Reduced-Fare

Air Transportation Rights from Aviation Excise Taxes

Present Law

An 7.5-percent excise tax is imposed on the sale by an air transportation provider of the

right to frequent-flyer or similar reduced-fare air transportation. Like the aviation excise taxes

imposed on the purchase of actual air transportation, this tax is imposed on all amounts paid for the

right to air transportation if the right can be used for transportation to, from, or within the United

States. In both cases, tax is imposed without regard to whether the purchase occurs within the

United States or elsewhere. Further, the tax generally is imposed without regard to whether the

rights ultimately are used for travel (to, from, or within United States or between two or more

points in foreign countries) or expire without use.

Description of Proposal

The proposal would exempt from the 7.5-percent tax, air transportation rights sold which

are credited to accounts of persons having a mailing address outside the United States. Mailing

addresses would be those listed on the records of the operator of the frequent-flyer or similar

program.

Effective Date

The proposal would apply to air transportation rights sold after December 31, 1999.
76 For example, constitutional home rule cities in Illinois are guaranteed their

proportionate share of the $1.25 amount, based on their population relative to that of the State as a

whole.

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X. HOUSING AND REAL ESTATE TAX RELIEF

A. Increase Low-Income Housing Tax Credit Cap

Present Law

In general, a maximum 70-percent present value tax credit, claimed over a 10-year period is

allowed 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 total

qualified expenditures.

To claim low-income housing credits, project owners must receive an allocation of credit

from a State or local housing credit agency. However, no allocation is required for buildings at

least 50 percent financed with the proceeds of tax-exempt bonds that received an allocation

pursuant to the private activity bond volume limitation of Code section 146. Such projects must,

however, satisfy the requirements for allocation under the State’s qualified allocation plan and meet

other requirements. 

A building generally must be placed in service during the calendar year in which it receives

an credit allocation. However, a housing credit agency can make a binding commitment, not later

than the year in which the building is placed in service, to allocate a specified credit dollar amount

to such building beginning in a specified later year. In addition, a project can receive a “carryover

allocation” if the taxpayer’s basis in the project as of the close of the calendar year the allocation is

made is more than 10 percent of the taxpayer’s reasonably expected basis in the project, and the

building is placed in service not later than the close of the second calendar year following the

calendar year in which the allocation is made. For purposes of the 10-percent test, basis means the

taxpayer’s adjusted basis in land and depreciable real property, whether or not these amounts are

includible in eligible basis. Finally, an allocation of credit for increases in qualified basis may

occur in years subsequent to the year the project is placed in service.

Authority to allocate credits remains at the State (as opposed to local) government level

unless State law provides otherwise.76 Generally, credits may be allocated only from volume

authority arising during the calendar year in which the building is placed in service, except in the

case of: (1) credits claimed on additions to qualified basis; (2) credits allocated in a later year

pursuant to an earlier binding commitment made no later than the year in which the building is

placed in service; and (3) carryover allocations. 
77 A State's population, for these purposes, is the most recent estimate of the State's

population released by the Bureau of the Census before the beginning of the year to which the

limitation applies. Also, for these purposes, the District of Columbia and the U.S. possessions

(i.e., Puerto Rico, the Virgin Islands, Guam, the Northern Marianas and American Samoa) are

treated as States.

78 The unused State housing credit ceiling is the amount (if positive) of the previous year's

annual credit limitation plus credit returns less the credit actually allocated in that year.

79 Credit returns are the sum of any amounts allocated to projects within a State which fail

to become a qualified low-income housing project within the allowable time period plus any

amounts allocated to a project within a State under an allocation which is canceled by mutual

consent of the housing credit agency and the allocation recipient.

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Each State annually receives low-income housing credit authority equal to $1.25 per State

resident for allocation to qualified low-income projects.77 In addition to this $1.25 per resident

amount, each State’s “housing credit ceiling” includes the following amounts: (1) the unused State

housing credit ceiling (if any) of such State for the preceding calendar year;78 (2) the amount of the

State housing credit ceiling (if any) returned in the calendar year;79 and (3) the amount of the

national pool (if any) allocated to such State by the Treasury Department. 

The national pool consists of States’ unused housing credit carryovers. For each State, the

unused housing credit carryover for a calendar year consists of the excess (if any) of the unused

State housing credit ceiling for such year over the excess (if any) of the aggregate housing credit

dollar amount allocated for such year over the sum of $1.25 per resident and the credit returns for

such year. The amounts in the national pool are allocated only to a State which, with respect to the

previous calendar year allocated its entire housing credit ceiling for the preceding calendar year,

and requested a share in the national pool not later than May 1, of the calendar year. The national

pool allocation to qualified States is made on a pro rata basis equivalent to the fraction that a

State’s population enjoys relative to the total population of all qualified States for that year.

The present-law stacking rule provides that a State is treated as using its annual allocation

of credit authority ($1.25 per State resident) and any returns during the calendar year followed by

any unused credits carried forward from the preceding year’s credit ceiling and finally any

applicable allocations from the National pool. 

Description of Proposal

The proposal would make several changes to the low-income housing credit. First, the

$1.25 per capita cap for each State would be increased to $1.25 per capita or $2 million,

whichever is greater. Second, the $1.25 per capita element of the credit cap would be increased to

$1.75 per capita This increase would be phased-in by increasing the credit cap by 10 cents per

capita each year for five years. The credit cap would be: $1.35 in calendar year 2001; $1.45 in

calendar 2002; $1.55 in calendar year 2003; $1.65 in calendar year 2004; and $1.75 in calendar
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year 2005. Third, the stacking rule would be modified so that each State would be treated as using

its allocation of the unused State housing credit ceiling (if any) from the preceding calendar before

the current year’s allocation of credit (including any credits returned to the State) and then finally

any National pool allocations.

Effective Date

The proposal would be effective for calendar years beginning after December 31, 2000.
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B. Tax Credit for Renovating Historic Homes

Present Law

Present law provides an income tax credit for certain expenditures incurred in rehabilitating

certified historic structures and certain nonresidential buildings placed in service before 1936

(Code sec. 47). The amount of the credit is determined by multiplying the applicable rehabilitation

percentage by the basis of the property that is attributable to qualified rehabilitation expenditures.

The applicable rehabilitation percentage is 20 percent for certified historic structures and 10

percent for qualified rehabilitated buildings (other than certified historic structures) that were

originally placed in service before 1936.

A nonresidential building is eligible for the 10-percent credit only if the building is

substantially rehabilitated and a specific portion of the existing structure of the building is retained

in place upon completion of the rehabilitation. A residential or nonresidential building is eligible

for the 20-percent credit that applies to certified historic structures only if the building is

substantially rehabilitated (as determined under the eligibility rules for the 10-percent credit). In

addition, the building must be listed in the National Register or the building must be located in a

registered historic district and must be certified by the Secretary of the Interior as being of

historical significance to the district.

Description of Proposal

The proposal would permit a taxpayer to claim a 20-percent credit for qualified

rehabilitation expenditures made with respect to a qualified historic home which the taxpayer

subsequently occupies as his or her principal residence for at least five years. The total credit

which could be claimed by the taxpayer would be limited to $20,000.

The proposal would apply to (1) structures listed in the National Register; (2) structures

located in a registered national, State, or local historic district, and certified by the Secretary of the

Interior as being of historic significance to the district, but only if the median income of the historic

district is less than twice the State median income; (3) any structure designated as being of historic

significance under a State or local statute, if such statute is certified by the Secretary of the Interior

as achieving the purpose of preserving and rehabilitating buildings of historic significance.

For this purpose, a building generally would be considered substantially rehabilitated if the

qualified rehabilitation expenditures incurred during a 24-month measuring period exceed the

greater of (1) the adjusted basis of the building as of the later of the first day of the 24-month period

or the beginning of the taxpayer's holding period for the building, or (2) $5,000. In the case of

structures in empowerment zones, in enterprise communities, in a census tract in which 70 percent

of families have income which is 80 percent or less of the State median family income, and areas of

chronic distress as designated by the State and approved by the Secretary of Housing and Urban

Development only the $5,000 expenditure requirement would apply. In addition, for all structures,
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at least 5 percent of the rehabilitation expenditures would have to be allocable to the exterior of the

structure.

To qualify for the credit, the rehabilitation must be certified by a State or local government

subject to conditions specified by the Secretary of the Interior.

If a taxpayer ceases to maintain the structure as his or her personal residence within five

years from the date of the rehabilitation, the credit would be recaptured on a pro rata basis.

Effective Date

The proposal would be effective for expenditures paid or incurred beginning after

December 31, 1999.
80 15 U.S.C. 80a-1 and following.

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C. Provisions Relating to REITs

Present Law

Real estate investment trust (“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 restricted to investing in passive investments primarily in real

estate and securities. Specifically, a REIT is required to receive at least 95 percent of its income

from real property rents and from securities. Amounts received as impermissible “tenant services

income” are not treated as rents from real property. In general, such amounts are for services

rendered to tenants that are not “customarily furnished” in connection with the rental of real

property. Special rules permit amounts to be received from certain “foreclosure property,” treated

as such for 3 years after the property is acquired by the REIT in foreclosure after a default (or

imminent default) on a lease of such property or on indebtedness which such property secured.

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 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.

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 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 of any corporate issuer. Under an exception to this rule, 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. Securities for purposes of these rules are defined by

reference to the Investment Company Act of 1940.80

A REIT is generally required to distribute 95 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. Both

REITS and RICs can make certain “deficiency dividends” after the close of the taxable year, and

have these treated as made before the end of the year. The regulations applicable to REITS state

that a distribution will be treated as a “deficiency dividend” and thus as made before the end of the

prior taxable year, only to the extent the earnings and profits for that year exceed the amount of

distributions actually made during the taxable year.
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A REIT that has been or has combined with a C corporation will be disqualified if, as of the

end of its taxable year, it has accumulated earnings and profits from a non-REIT year. A similar

rule applies to regulated investment companies (“RICs”). In the case of a REIT, any distribution

made in order to comply with this requirement is treated a being first from pre-REIT accumulated

earnings and profits. RICs do not have a similar ordering rule.

In the case of a RIC, under a provision entitled “procedures similar to deficiency dividend

procedures”, any distribution made within a specified period after determination that the investment

company did not qualify as a RIC for the taxable year will, “for purposes of applying [the earnings

and profits rule that forbids a RIC to have non-RIC earnings and profits] to subsequent taxable

years,” be treated as applying to the RIC for the non-RIC year. The REIT rules do not specify any

particular separate treatment of distributions made after the end of the taxable year for purposes of

the earnings and profits rule. Treasury regulations under the REIT provisions state that

“distribution procedures similar to those ... for regulated investment companies apply to non-REIT

earnings and profits of a real estate investment trust.”

Description of Proposal

Taxable REIT subsidiaries

Under the proposal, a REIT generally could not own more than 10 percent of the total value

of securities of a single issuer, in addition to the present law limit of the REIT’s ownership to no

more than 10 percent of the outstanding voting securities of a single issuer.

For purposes of the new 10 percent value test, securities would generally be defined to

exclude safe harbor debt owned by a REIT (as defined for purposes of section 1361(c)(5)(B)(i)

and (ii)) if the REIT (and any taxable REIT subsidiary of such REIT) owns no other securities of

the issuer. In the case of a REIT that owns securities of a partnership, safe harbor debt would be

excluded from the definition of securities only if the REIT owns at least 20 percent or more of the

profits interest in the partnership. The purpose of the partnership rule requiring a 20 percent profits

interest is to assure that if the partnership produces income that would be disqualified income to the

REIT, the REIT will be treated as receiving a significant portion of that income directly, even

though it may also derive qualified interest income through its safe harbor debt interest.

An exception to the limitations on ownership of securities of a single issuer would apply in

the case of a “taxable REIT subsidiary” that meets certain requirements. To qualify as a taxable

REIT subsidiary, both the REIT and the subsidiary corporation must join in an election. In

addition, any corporation (other than a REIT) of which a taxable REIT subsidiary owns, directly or

indirectly, more than 35 percent of the vote or value is automatically treated as a taxable REIT

subsidiary. Securities (as defined in the Investment Company Act of 1940) of taxable REIT

subsidiaries could not exceed 25 percent of the total value of a REIT’s assets.

A taxable REIT subsidiary would be able to engage in certain business activities that under

present law could disqualify the REIT because, but for the proposal, the taxable REIT subsidiary’s

activities and relationship with the REIT could prevent certain income from qualifying as rents
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from real property. Specifically, the subsidiary could provide services to tenants of REIT property

(even if such services were not considered services customarily furnished in connection with the

rental of real property), and could manage or operate properties generally, without causing amounts

received or accrued directly or indirectly by REIT for such activities to fail to be treated as rents

from real property.

However, the subsidiary could not directly or indirectly operate or manage a lodging or

healthcare facility. Nevertheless, it could lease a qualified lodging facility (e.g, a hotel) from the

REIT (provided no gambling revenues were derived by the hotel or on its premises); and the rents

paid would be treated as rents from real property so long as the lodging facility was operated by an

independent contractor for a fee. The subsidiary could bear all expenses of operating the facility

and receive all the net revenues, minus the independent contractor’s fee.

For purposes of the rule that an independent contractor may operate a qualified lodging

facility, an independent contractor will qualify so long as, at the time it enters into the management

agreement with the taxable REIT subsidiary, it is actively engaged in the trade or business of

operating qualified lodging facilities for any person who is not related to the REIT or the taxable

REIT subsidiary. The REIT may receive income from such an independent contractor with respect

to certain pre-existing leases.

Also, the subsidiary generally could not provide to any person rights to any brand name

under which hotels or healthcare facilities are operated. An exception applies to rights provided to

an independent contractor to operate or manage a lodging facility, if the rights are held by the

subsidiary as licensee or franchisee, and the lodging facility is owned by the subsidiary or leased to

it by the REIT.

Interest paid by a taxable REIT subsidiary to the related REIT would be subject to the

earnings stripping rules of section 163(j). Thus the taxable REIT subsidiary could not deduct

interest in any year that would exceed 50 percent of the subsidiary’s adjusted gross income.

If any amount of interest, rent, or other deductions of the taxable REIT subsidiary for

amounts paid to the REIT is determined to be other than at arm’s length (“redetermined” items) , an

excise tax of 100% would be imposed on the portion that was excessive. “Safe harbors” would be

provided for certain rental payments where the amounts are de minimis, there is specified evidence

that charges to unrelated parties are substantially comparable, certain charges for services from the

taxable REIT subsidiary are separately stated, or the subsidiary’s gross income from the service is

not less than 150 percent of the subsidiary’s direct cost in furnishing the service.

In determining whether rents are arm’s length rents, the fact that such rents do not meet the

requirements of the specified safe harbors shall not be taken into account. In addition, rent received

by a REIT shall not fail to qualify as rents from real property by reason of the fact that all or any

portion of such rent is redetermined for purposes of the excise tax.
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The Commissioner of Internal Revenue is to conduct a study to determine how many taxable

REIT subsidiaries are in existence and the aggregate amount of taxes paid by such subsidiaries. 

The Commissioner shall submit a report to the Congress describing the results of such study.

Health Care REITS

The proposal would permit a REIT to own and operate a health care facility for at least two

years, and treat it as permitted “foreclosure” property, if the facility is acquired by the termination

or expiration of a lease of the property. Extensions of the 2 year period could be granted.

Conformity with regulated investment company rules

The REIT distribution requirements would be modified to conform to the rules for regulated

investment companies. Specifically, a REIT would be required to distribute only 90 percent, rather

than 95 percent, of its income.

Definition of independent contractor

If any class of stock of the REIT or the person being tested as an independent contractor is

regularly traded on an established securities market, only persons who directly or indirectly own 5

percent or more of such class of stock shall be counted in determining whether the 

35 percent ownership limitations have been exceeded.

Modification of earnings and profits rules for RICs and REITS

The rule allowing a RIC to make a distribution after a determination that it had failed RIC

status, and thus meet the requirement of no non-RIC earnings and profits in subsequent years, would

be modified to clarify that, when reason for the determination is that the RIC had non-RIC earnings

and profits in the initial year, the procedure would apply to permit RIC qualification in the initial

year to which such determination applied, in addition to subsequent years.

The RIC earnings and profits rules would also be modified to provide an ordering rule

similar to the REIT rule, treating a distribution to meet the requirements of no non-RIC earnings and

profits as coming first from the earliest earnings and profits accumulated in any year for which the

RIC did not qualify as a RIC.

The rule regarding ordering of REIT distributions to cure a failure to distribute non-REIT

earnings and profits would be included as part of the REIT deficiency dividend procedure, thereby

providing that all REIT distributions (including those made after the end of a taxable year under a

deficiency dividend procedure) will be deemed to come from accumulated earnings and profits first

if made for the purpose of curing such failure.

Effective Date
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The proposal would generally be effective for taxable years beginning after December 31,

2000. The proposal with respect to modification of earnings and profits rules would be effective

for distributions after December 31, 2000.

In the case of the provisions relating to permitted ownership of securities of an issuer,

special transition rules apply. The new rules forbidding a REIT to own more than 10 percent of the

value of securities of a single issuer would not apply to a REIT with respect to securities held

directly or indirectly by such REIT on July 12, 1999, or acquired pursuant to the terms of a written

binding contract in effect on that date and at all times thereafter until the acquisition. Also,

securities received in a tax-free exchange or reorganization, with respect to or in exchange for such 

grandfathered securities would be grandfathered. This transition would cease to apply to securities

of a corporation as of the first day after July 12, 1999 on which such corporation engages in a

substantial new line of business, or acquires any substantial asset, other than pursuant to a binding

contract in effect on such date and at all times thereafter, or in a reorganization or transaction in

which gain or loss is not recognized by reason of section 1031 or 1033 of the Code. If a

corporation makes an election to become a taxable REIT subsidiary, effective before January 1,

2004 and at a time when the REIT’s ownership is grandfathered under these rules, the election

would be treated as a reorganization under section 368(a)(1)(A) of the Code.
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D. Increase State Volume Limits on Tax-Exempt Private Activity Bonds

Present Law

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

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

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

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

specified in the Internal Revenue Code. Private activity bonds on which interest may be tax-exempt

include bonds for privately operated transportation facilities (airports, docks and wharves, mass

transit, and high speed rail facilities), privately owned and/or provided municipal services (water,

sewer, solid waste disposal, and certain electric and heating facilities), economic development

(small manufacturing facilities and redevelopment in economically depressed areas), and certain

social programs (low-income rental housing, qualified mortgage bonds, student loan bonds, and

exempt activities of charitable organizations described in sec. 501(c)(3)).

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

issue for most of these purposes in each calendar year is limited by State-wide volume limits. The

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

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

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

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

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

and enterprise community bonds).

The current annual volume limits that apply to private activity tax-exempt bonds increase to

$75 per resident of each State or $225 million, if greater, beginning in calendar year 2007. The

increase is, ratably phased in, beginning with $55 per capita or $165 million, if greater, in calendar

year 2003.

Description of Proposal

The proposal would increase the present-law annual State private activity bond volume

limits to $75 per resident of each State or $225 million (if greater) beginning in calendar year

2005. The increase would be phased-in as follows, beginning in calendar year 2001:

Calendar Year Volume Limit

2001 $55 per resident ($165 million if greater)

2002 $60 per resident ($180 million if greater)

2003 $65 per resident ($195 million if greater)

2004 $70 per resident ($210 million if greater)

Effective Date
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The volume limit increases would be effective beginning in calendar year 2001 and be fully

effective in calendar year 2005 and thereafter.
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XI. MISCELLANEOUS PROVISIONS

A. Repeal Certain Excise Taxes

on Rail Diesel Fuel and Inland Waterway Barge Fuels

Present Law

Under present law, diesel fuel used in trains is subject to a 4.3-cents-per gallon General

Fund excise tax. Similarly, fuels used in barges operating on the designated inland waterways

system is subject to a 4.3-cents-per-gallon General Fund excise tax. In both cases, the 4.3-centsper-gallon excise tax rates are permanent. 

Description of Proposal

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 would be repealed. 

Effective Dates

The proposal would be effective on October 1, 2000.
81 43 U.S.C. 1601 et. seq.

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B. Tax Treatment of Alaska Native Settlement Trusts

Present Law

An Alaska Native Settlement Corporation (“ANC”) may establish a Settlement Trust

(“Trust”) under section 39 of the Alaska Native Claims Settlement Act (“ANCSA”) 81 and transfer

money or other property to such Trust for the benefit of beneficiaries who constitute all or a class of

the shareholders of the ANC, to promote the health, education and welfare of the beneficiaries and

preserve the heritage and culture of Alaska Natives.

 With certain exceptions, once an ANC has made a conveyance to a Trust, the assets

conveyed shall not be subject to attachment, distraint, or sale or execution of judgement, except

with respect to the lawful debts and obligations of the Trust. 

The Internal Revenue Service has indicated that contributions to a Trust constitute

distributions to the beneficiary-shareholders at the time of the contribution and are treated as

dividends to the extent of earnings and profits as provided under section 301 of the Code. The

Trust and its beneficiaries are taxed according to the rules of Subchapter J of the Code.

Description of Proposal

An Alaska Native Corporation may establish a Trust under section 39 of ANCSA and if the

Trust makes an election for its first taxable year ending after December 31, 1999, no amount will be

includible in the gross income of a beneficiary of such Trust by reason of a contribution to the Trust

. In addition, unless the Trust fails to meet all the requirements of the provision, the Trust will be

permitted to accumulate up to 45 percent of its income each year without tax to the trust or the

beneficiaries on that income. 

 The earnings and profits of the ANC would not be reduced by the amount of a contribution

to the Trust. However, the ANC earnings and profits would be reduced (up to the amount of the

contribution) as distributions are thereafter made by the Trust that would exceed the Trusts’s total

undistributed net income for all prior years during which an election is in effect plus the Trust’s

distributable net income for the current year, computed under Subchapter J. 

An electing Trust must distribute at least 55 percent of its adjusted taxable income for the

year. If the Trust fails to meet this distribution requirement, tax at trust rates is imposed on the

amount of the failure. 

Every distribution by the Trust to beneficiaries would be taxable as ordinary income to the

beneficiaries. Reporting to beneficiaries for the future could be made on form 1099 rather than on

form K-1. Distributions to beneficiaries would be subject to withholding to the extent such
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distributions, on an annualized basis, exceed the sum of the standard deduction and the personal

exemption. 

 Certain additional restrictions apply. If the beneficial interests in the Trust may be sold or

exchanged to a person in a manner that would not be permitted under ANCSA if the interests were

Settlement Common Stock (generally, to a person other than an Alaska Native), then all assets of the

Trust that have not been distributed at the end of the taxable year of the Trust become subject to an

excise tax; thereafter all amounts retained that were subject to that tax are treated as corpus under

subchapter J. Also, if the shares of the ANC may be sold or exchanged to a person in such a

manner, the Trust may continue in existence without an excise tax only if no new contributions are

made to the Trust and the beneficial interests in the Trust cannot be sold or exchanged in such a

manner. 

Apart from these rules, the Trust and its beneficiaries would be taxed according to the

provisions of subchapter J of the Code.

Effective Date

The provision would be effective for taxable years of Settlement Trusts, and contributions

to such Trusts, after December 31, 1999.
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C. Allow Corporations to Take Certain Minimum Tax Credits Against Minimum Tax

Present Law

Present law imposes an alternative minimum tax (“AMT”) on a corporation to the extent its

tentative minimum tax exceeds its regular tax liability.

If a corporation is subject to the AMT in one year, it is allowed a credit (“AMT credit”) in

a future year in the amount of the AMT imposed. The AMT credit is allowed only to the extent that

the regular tax exceeds the tentative minimum tax in a subsequent year. The credit carryforward

period is unlimited.

Description of Proposal

The proposal would allow a corporation with long-term AMT credits to use the AMT

credit to offset a portion of its tentative minimum tax. The portion so allowed would be the least of

: (1) the amount of the corporation’s long-term minimum tax credit; (2) 50 percent of the

corporation’s tentative minimum tax; or (3) the amount by which the corporation’s tentative

minimum tax exceeds its regular tax for the taxable year.

Under the proposal, an AMT credit would be a long-term minimum tax credit if the credit is

attributable to the adjusted net minimum tax of the corporation for a taxable year that began after

1986 and ended before the fifth taxable year immediately preceding the taxable year for which the

determination is being made. 

Effective Date

The proposal would apply to taxable years beginning after December 31, 2003.
82 A taxpayer could elect to forgo the carryback of an NOL.

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D. Allow Net Operating Losses From Oil and Gas Properties

To Be Carried Back for Up to Five Years

Present Law

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

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

carried forward 20 years to offset taxable income in such years.82 A carryback of an NOL results in

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

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

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

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

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

Description of Proposal

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

losses. The carryforward period would remain 20 years. An “eligible oil and gas loss” would be

defined as the lesser of (1) the amount which would be the taxpayer’s NOL for the taxable year if

only income and deductions attributable to operating mineral interests in oil and gas wells were

taken into account, or (2) the amount of such net operating loss for such taxable year. In calculating

the amount of a taxpayer’s NOL carrybacks, the portion of the NOL that would be attributable to an

eligible oil and gas loss would be treated as a separate NOL and taken into account after the

remaining portion of the NOL for the taxable year.

Effective Date

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

1998.
83 Treas. Reg. sec. 1.263(a)-(1)(b).

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

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

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

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

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

86 1977-1 C.B. 76.

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E. Allow Geogological and Geophysical Costs To Be Deducted Currently

Present Law

In general

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

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

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

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

by the taxpayer or (2) to adapt property to a new or different use.83

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

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

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

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

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

nature and are not deductible as ordinary and necessary business expenses.84 Accordingly, the

costs attributable to such exploration are allocable to the cost of the property acquired or retained.85

The term "property" includes an economic interest in a tract or parcel of land notwithstanding that a

mineral deposit has not been established or proven at the time the costs are incurred.

Revenue Ruling 77-188

In Revenue Ruling 77-18886 (hereinafter referred to as the "1977 ruling"), the Internal

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

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

following elements:

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

conduct an exploration program in one or more identifiable project areas. Each

project area encompasses a territory that the taxpayer determines can be explored

advantageously in a single integrated operation. This determination is made after
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analyzing certain variables such as the size and topography of the project area to be

explored, the existing information available with respect to the project area and

nearby areas, and the quantity of equipment, the number of personnel, and the amount

of money available to conduct a reasonable exploration program over the project

area.

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

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

geological and geophysical exploration techniques that are designed to yield data

that will afford a basis for identifying specific geological features with sufficient

mineral potential to merit further exploration.

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

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

project area is subdivided into as many small projects as there are areas of interest

located and identified within the original project area. If the circumstances permit a

detailed exploratory survey to be conducted without an initial reconnaissance-type

survey, the project area and the area of interest will be coextensive.

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

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

conducted with respect to each area of interest. For this purpose, the taxpayer

engages in more intensive geological and geophysical exploration employing

methods that are designed to yield sufficiently accurate sub-surface data to afford a

basis for a decision to acquire or retain properties within or adjacent to a particular

area of interest or to abandon the entire area of interest as unworthy of development

by mine or well.

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

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

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

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

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

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

be allocated equally among the various areas of interest.

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

that does not relate exclusively to any particular property within a particular area of interest, an oil

or gas property is acquired or retained within or adjacent to that area of interest, the entire G&G

exploration expenditures, including those incurred prior to the identification of the particular area

of interest but allocated thereto, are to be allocated to the property as a capital cost under section

263(a). 

If, however, from the data obtained by the exploratory operations no areas of interest are

located and identified by the taxpayer within the original project area, then the 1977 ruling states
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that the entire amount of the G&G costs related to the exploration is deductible as a loss under

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

source of mineral production.

Description of Proposal

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

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

Effective Date

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

after December 31, 1999.
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F. Allow Certain Oil and Gas “Delay Rental Payments”

To Be Deducted Currently

Present Law

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

to be capitalized rather than currently deducted as they are incurred. (sec. 2634). Oil and gas

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

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

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

section 263A require delay rental payments to be capitalized.

Description of Proposal

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

Effective Date

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

December 31, 1999.

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

from the proposal as to the proper treatment of pre-effective date delay rental payments.
87 Rev. Proc. 99-3, sec. 4.01(33), 1999-1 I.R.B. 111

88 Rev. Proc. 86-41, sec. 4.03(4), 1986-2 C.B. 716; Rev. Proc. 77-37, sec. 3.04, 1977-2

C.B. 568. 

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G. Simplify the Active Trade or Business Requirement for Tax-Free Spin-offs

Present Law

A corporation generally is required to recognize gain on the distribution of property to its

shareholders as if such property had been sold for its fair market value. An exception to this rule is

where the distribution of the stock of a controlled corporation satisfies the requirements of section

355 of the Code. Among the requirements of section 355 is that, immediately after the distribution,

both the distributing corporation and the controlled corporation must be engaged in the active

conduct of a trade or business. 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) if the corporation is not engaged in an active trade or business, then 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.

In determining whether a corporation is engaged in the active conduct of a trade or business,

the IRS position for advance ruling purposes is that the value of the gross assets of the trade or

business must constitute at least five percent of the total fair market value of the gross assets of the

corporation directly conducting the trade or business.87 However, if the corporation is not directly

engaged in an active trade or business, then the “substantially all” test requires that at least 90

percent of the 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.88

Description of Proposal

The proposal would simplify the active trade or business requirement by eliminating the

“substantially all” test, and instead, applying the active trade or business requirement on an

affiliated group basis. In applying the active trade or business test to an affiliated group, each

separate affiliated group (immediately after the distribution) must satisfy the requirement. For the

distributing corporation, the separate affiliated group would consist of the distributing corporation

as the common parent and all corporations connected 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)). The separate affiliated group for a controlled

corporation would be determined in a similar manner (with the controlled corporation as the

common parent).

Effective Date

The proposal would be effective for distributions after the date of enactment.
89 Under the half-year convention, all reforestation expenditures are considered to be

incurred on the first day of the first month of the second half of the taxable year. Thus, an

amortization deduction equal to 6/84 of the expenditures for the year is allowed in the first and

eighth years and an amortization deduction equal to 1/7 (12/84) of such expenditures is allowed in

the second through seventh years. 

90 Sec. 301(a) of the Multiemployer Pension Plan Amendments Act of 1980.

91 Treas. Reg. sec. 1.194-3(a).

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H. Increase the Maximum Dollar Amount of Reforestation Expenditures

Eligible for Amortization and Credit

Present Law

Amortization of reforestation costs (sec. 194)

A taxpayer may elect to amortize up to $10,000 ($5,000 in the case of a separate return by a

married individual) of qualifying reforestation expenditures incurred during the taxable year with

respect to qualifying timber property. Amortization is taken over 84 months (7 years) and is subject

to a mandatory half-year convention.89 In the case of an individual, the amortization deduction is

allowed in determining adjusted gross income (an above-the-line deduction) rather than as an

itemized deduction. The amount eligible for amortization has not been increased since the election

was added to the Code in 1980.90

Qualifying reforestation expenditures are the direct costs a taxpayer incurs in connection

with the forestation or reforestation of a site by planting or seeding, and include costs for the

preparation of the site, the cost of the seed or seedlings, and the cost of the labor and tools

(including depreciation of long lived assets such as tractors and other machines) used in the

reforestation activity. Qualifying reforestation expenditures do not include expenditures that would

otherwise be deductible and do not include costs for which the taxpayer has been reimbursed under

a governmental cost sharing program, unless the amount of the reimbursement is also included in the

taxpayer’s gross income.

Qualifying timber property includes any woodlot or other site that is located in the United

States that will contain trees in significant commercial quantities and that is held by the taxpayer for

the planting, cultivating, caring for, and cutting of trees for sale or use in the commercial production

of timber products. The regulations require that the site consist of at least one acre that is devoted

to such activities.91 A taxpayer may hold qualifying timber property in fee or by lease. Where the

property is held by one person for life with the remainder to another person, the life tenant is

considered the owner of the property for this purpose.
92 Sec. 1245(b)(7); Treas. Reg. sec. 1.194-1(c).

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Reforestation amortization is subject to recapture as ordinary income on sale of qualifying

timber property within 10 years of the year in which the qualifying reforestation expenditures were

incurred.92

Reforestation tax credit (sec. 48(b))

A tax credit is allowed equal to 10 percent of the reforestation expenditures incurred during

the year that are properly elected to be amortized. An amount allowed as a credit is subject to

recapture if the qualifying timber property to which the expenditure relates is disposed of within 5

years.

Description of Proposal

The proposal would increase the amount of reforestation expenditures eligible for 7-year

amortization and the reforestation credit from $10,000 to $25,000 per taxable year (from $5,000 to

$12,500 in the case of a separate return by a married individual).

For taxable years beginning in 2000 through 2003, no limit would apply to the amount

eligible for 7-year amortization.

Effective Date

The proposal would be effective for expenditures paid or incurred in taxable years

beginning after December 31, 1999.
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I. Modify Excise Tax on Arrow Components and Accessories

Present Law

An 12.4 percent excise tax 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 (1) is over 18 inches long, or

(2) is designed for use with a taxable bow (if shorter than 18 inches). An 11-percent tax is

imposed on certain bows and on certain accessories for taxable bows and arrows.

Description of Proposal

The proposal would make two modifications to the excise tax on arrows and arrow

accessories. First, the proposal would extend the 12.4-percent tax on arrow components to inserts

and outserts designed for use with taxable arrows. Inserts and outserts would be defined as

articles used to attach a point to an arrow shaft. Second, the bill would reclassify “broadheads,” or

arrow points designed for hunting fish or large animals, as arrow accessories subject to the 11-

percent tax rather than arrow points subject to the 12.4-percent tax (as under present law).

Effective Date

 The proposal would apply to sales by manufacturers beginning on the first day of the first

calendar quarter that begins more than 30 days after enactment.
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J. Increase Joint Committee on Taxation Refund Review Threshold to $2 Million

Present Law

No refund or credit in excess of $1,000,000 of any income tax, estate or gift tax, or certain

other specified taxes, may be made until 30 days after the date a report on the refund is provided to

the Joint Committee on Taxation (sec. 6405). A report is also required in the case of certain

tentative refunds. Additionally, the staff of the Joint Committee on Taxation conducts post-audit

reviews of large deficiency cases and other select issues.

Description of Proposal

The proposal would increase the threshold above which refunds must be submitted to the

Joint Committee on Taxation for review from $1,000,000 to $2,000,000. The staff of the Joint

Committee on Taxation would continue to exercise its existing statutory authority to conduct a

program of expanded post-audit reviews of large deficiency cases and other select issues, and the

IRS is expected to cooperate fully in this expanded program.

Effective Date

The proposal would be effective on the date of enactment, except that the higher threshold

would not apply to a refund or credit with respect to which a report was made before the date of

enactment.
93 A special rule is designed to gradually recompute a start-up firm's fixed-base

percentage based on its actual research experience. Under this special rule, a start-up firm will be

assigned a fixed-base percentage of 3 percent for each of its first five taxable years after 1993 in

which it incurs qualified research expenditures. In the event that the research credit is extended

beyond the scheduled expiration date, a start-up firm's fixed-based percentage for its sixth through

tenth taxable years after 1993 in which it incurs qualified research expenditures will be a

phased-in ratio based on its actual research experience. For all subsequent taxable years, the

taxpayer's fixed-based percentage will be its actual ratio of qualified research expenditures to

gross receipts for any five years selected by the taxpayer from its fifth through tenth taxable years

after 1993 (sec. 41(c)(3)(B)). 

-161-

XII. EXTENSION OF EXPIRING PROVISIONS

A. Extension of Research Tax Credit

Present Law

General rule

Section 41 provides for a research tax credit equal to 20 percent of the amount by which a

taxpayer's qualified research expenditures for a taxable year exceeded its base amount for that year.

The research tax credit expired and generally does not apply to amounts paid or incurred after June

30, 1999.

A 20-percent research tax credit also applied to the excess of (1) 100 percent of corporate

cash expenditures (including grants or contributions) paid for basic research conducted by

universities (and certain nonprofit scientific research organizations) over (2) the sum of (a) the

greater of two minimum basic research floors plus (b) an amount reflecting any decrease in

nonresearch giving to universities by the corporation as compared to such giving during a

fixed-base period, as adjusted for inflation. This separate credit computation is commonly referred

to as the “university basic research credit” (see sec. 41(e)).

Computation of allowable credit

Except for certain university basic research payments made by corporations, the research

tax credit applies only to the extent that the taxpayer's qualified research expenditures for the

current taxable year exceed its base amount. The base amount for the current year generally is

computed by multiplying the taxpayer's “fixed-base percentage” by the average amount of the

taxpayer's gross receipts for the four preceding years. If a taxpayer both incurred qualified research

expenditures and had gross receipts during each of at least three years from 1984 through 1988, then

its “fixed-base percentage” is the ratio that its total qualified research expenditures for the

1984-1988 period bears to its total gross receipts for that period (subject to a maximum ratio of

.16). All other taxpayers (so-called “start-up firms”) are assigned a fixed-base percentage of 3

percent.93
94 Under a special rule, 75 percent of amounts paid or incurred by a taxpayer to a research

consortium for qualified research is treated as qualified research expenses eligible for the

research credit (rather than 65 percent under the general rule under sec. 41(b)(3) governing

contract research expenses) if (1) such research consortium is a tax-exempt organization that is

described in section 501(c)(3) (other than a private foundation) or section 501(c)(6) and is

organized and operated primarily to conduct scientific research, and (2) such qualified research is

conducted by the consortium on behalf of the taxpayer and one or more persons not related to the

taxpayer. 

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In computing the credit, a taxpayer's base amount may not be less than 50 percent of its

current-year qualified research expenditures.

Alternative incremental research credit regime

Taxpayers are allowed to elect an alternative incremental research credit regime. If a

taxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tiered

fixed-base percentage (that is lower than the fixed-base percentage otherwise applicable under

present law) and the credit rate likewise is reduced. Under the alternative credit regime, a credit

rate of 1.65 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 1 percent (i.e., the base amount equals 1

percent of the taxpayer's average gross receipts for the four preceding years) but do not exceed a

base amount computed by using a fixed-base percentage of 1.5 percent. A credit rate of 2.2 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 fixed-base percentage of 2 percent. A credit rate of 2.75 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 2 percent. An election to be subject to this alternative incremental credit

regime applies to the taxable year in which the election is made and all subsequent years (in the

event that the credit subsequently is extended by Congress) unless revoked with the consent of the

Secretary of the Treasury.

Eligible expenditures

Qualified research expenditures eligible for the research tax credit consist of: (1)

“in-house” expenses of the taxpayer for wages and supplies attributable to qualified research; (2)

certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts

paid by the taxpayer for qualified research conducted on the taxpayer's behalf (so-called “contract

research expenses”).94

To be eligible for the credit, the research must not only satisfy the requirements of

present-law section 174 but must be undertaken for the purpose of discovering information that is

technological in nature, the application of which is intended to be useful in the development of a

new or improved business component of the taxpayer, and must pertain to functional aspects,

performance, reliability, or quality of a business component.
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Expenditures attributable to research that is conducted outside the United States do not enter

into the credit computation. In addition, the credit is not available for research in the social

sciences, arts, or humanities, nor is it available for research to the extent funded by any grant,

contract, or otherwise by another person (or governmental entity).

Relation to deduction

Deductions allowed to a taxpayer under section 174 (or any other section) are reduced by

an amount equal to 100 percent of the taxpayer's research tax credit determined for the taxable year. 

Taxpayers may alternatively elect to claim a reduced research tax credit amount under section 41 in

lieu of reducing deductions otherwise allowed (sec. 280C(c)(3)).

Description of Proposal

The research tax credit would be extended for five years--i.e., generally, for the period July

1, 1999 through June 30, 2004.

In addition, the credit rate applicable under the alternative incremental credit would be

increased by one percentage point per step, that is, from 1.65 percent to 2.65 percent when a

taxpayer's current-year research expenses exceed a base amount of 1 percent but do not exceed a

base amount of 1.5 percent; from 2.2 percent to 3.2 percent when a taxpayer's current-year research

expenses exceed a base amount of 1.5 percent but do not exceed a base amount of 2 percent; and

from 2.75 percent to 3.75 percent when a taxpayer's current-year research expenses exceed a base

amount of 2 percent.

Effective Date

Extension of the research credit would be effective for qualified research expenditures paid

or incurred during the period July 1, 1999, through June 30, 2004. The increase in the credit rate

under the alternative incremental credit would be effective for taxable years beginning after June

30, 1999.
95 Temporary exceptions from the subpart F provisions for certain active financing income

applied only for taxable years beginning in 1998. Those exceptions were extended and modified as

part of the present-law provision.

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B. Extend Exceptions Under Subpart F for Active Financing Income

Present Law

Under the subpart F rules, 10-percent U.S. shareholders of 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 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 substantially 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

(Prop. 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”). These exceptions are applicable only

for taxable years beginning in 1999.95

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,
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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 a temporary exception 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, certain 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.

Description of Proposal

The proposal would extend for five years the present-law temporary exceptions from

subpart F foreign personal holding company income, foreign base company services income, and

insurance income 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.

Effective Date

The proposal would be effective for taxable years of a foreign corporation beginning after

December 31, 1999, and before January 1, 2005, and for taxable years of U.S. shareholders with or

within which such taxable years of such foreign corporation end.
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C. Extend Suspension of Income Limitation on Percentage

Depletion from Marginal Oil and Gas Wells

Present Law

The Code permits taxpayers to recover their investments in oil and gas wells through

depletion deductions. In the case of certain properties, the deductions may be determined using the

percentage depletion method. Among the limitations that apply in calculating percentage depletion

deductions is a restriction that, for oil and gas properties, the amount deducted may not exceed 100

percent of the net income from that property in any year (sec. 613(a)).

Special percentage depletion rules apply to oil and gas production from “marginal”

properties (sec. 613A(c)(6)). Marginal production is defined as domestic crude oil and natural gas

production from stripper well property or from property substantially all of the production from

which during the calendar year is heavy oil. Stripper well property is property from which the

average daily production is 15 barrel equivalents or less, determined by dividing the average daily

production of domestic crude oil and domestic natural gas from producing wells on the property for

the calendar year by the number of wells. Heavy oil is domestic crude oil with a weighted average

gravity of 20 degrees API or less (corrected to 60 degrees Farenheit). Under one such special rule,

the 100-percent-of-net-income limitation does not apply to domestic oil and gas production from

marginal properties during taxable years beginning after December 31, 1997, and before January 1,

2000.

Description of Proposal

The proposal would extend the present-law rule suspending the 100-percent-of-net-income

limitation with respect to oil and gas production from marginal wells to include taxable years

beginning after December 31, 1999, and before January 1, 2005.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.
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D. Extend the Work Opportunity Tax Credit

Present Law

The work opportunity tax credit (“WOTC”) is available on an elective basis for employers

hiring individuals from one or more of eight targeted groups. The credit generally is equal to a

percentage of qualified wages. The credit percentage is 25 percent for employment of at least 120

hours but less than 400 hours and 40 percent for employment of 400 hours or more. Qualified

wages consist of wages attributable to service rendered by a member of a targeted group during the

one-year period beginning with the day the individual begins work for the employer.

Generally, no more than $6,000 of wages during the first year of employment is permitted to

be taken into account with respect to any individual. Thus, the maximum credit per individual is

$2,400. With respect to qualified summer youth employees, the maximum credit is 40 percent of up

to $3,000 of qualified first-year wages, for a maximum credit of $1,200. The credit is only effective

for wages paid to, or incurred with respect to, qualified individuals who began work for the

employer before July 1, 1999.

The employer's deduction for wages is reduced by the amount of the credit.

Description of Proposal

The proposal would extend the WOTC for five years (through June 30, 2004).

Effective Date

Generally, the proposal would be effective for wages paid to, or incurred with respect to,

qualified individuals who begin work for the employer on or after July 1, 1999, and before July 1,

2004.
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E. Extend the Welfare-To-Work Tax Credit

Present Law

The Code provides a tax credit to employers on the first $20,000 of eligible wages paid to

qualified long-term family assistance (“TANF”) recipients during the first two years of

employment. The credit is 35 percent of the first $10,000 of eligible wages in the first year of

employment and 50 percent of the first $10,000 of eligible wages in the second year of employment. 

The maximum credit is $8,500 per qualified employee.

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 family assistance for a total of at least 18 months (whether or

not consecutive) after August 5, 1997 (the date of enactment of this 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.

Eligible wages include cash wages paid to an employee plus amounts paid by the employer

for the following: (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 welfare to work credit is effective for wages paid or incurred to a qualified individual

who begins work for an employer on or after January 1, 1998, and before June 30, 1999.

Description of Proposal

The proposal would extend the welfare-to-work credit for five years, so that the credit

would be available for eligible individuals who begin work for an employer before July 1, 2004.

Effective Date

The proposal would be effective for wages paid or incurred to a qualified individual who

begins work for an employer on or after July 1, 1999, and before July 1, 2004.
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F. Extend and Modify Tax Credit for Electricity Produced

by Wind and Closed-Loop Biomass Facilities

Present Law

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

energy or qualified “closed-loop” biomass facilities (sec. 45).

The credit applies to electricity produced by a qualified wind energy facility placed in

service after December 31, 1993, and before July 1, 1999, and to electricity produced by a

qualified closed-loop biomass facility placed in service after December 31, 1992, and before July

1, 1999. The credit is allowable for production during the 10-year period after a facility is

originally placed in service.

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

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

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

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

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

unrelated party.

The credit for electricity produced from wind or closed-loop biomass is a component of the

general business credit (sec. 28(b)(1)). This credit, 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. An unused general business credit generally may be

carried back 3 taxable years and carried forward 15 taxable years (sec. 39).

Description of Proposal

The proposal would extend the present-law tax credit for five years, for facilities placed in

service before July 1, 2004. The proposal also would modify the tax credit to include electricity

produced from poultry litter, also for facilities placed in service before July 1, 2004. The credit

for electricity produced from poultry litter would be available to the lessor/operator of a qualified

facility that was owned by a governmental entity.

Effective Date

The extension of the tax credit for electricity produced from wind and closed-loop biomass

would be effective for facilities placed in service after June 30, 1999. The modification to include

electricity produced from poultry litter would be effective for facilities placed in service after

December 31, 1999.
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G. Extend Exemption From Diesel Dyeing Requirement

for Certain Areas in Alaska

Present Law

An excise tax totaling 24.4 cents per gallon is imposed on diesel fuel. The diesel fuel tax is

imposed on removal of the fuel from a pipeline or barge terminal facility (i.e., at the “terminal

rack”). Present law provides that tax is imposed on all diesel fuel removed from terminal facilities

unless the fuel is destined for a nontaxable use and is indelibly dyed pursuant to Treasury

Department regulations.

In general, the diesel fuel tax does not apply to non-transportation uses of the fuel. Offhighway business uses are included within this non-transportation use exemption. This exemption

includes use on a farm for farming purposes and as fuel powering off-highway equipment (e.g., oil

drilling equipment). Use as heating oil also is exempt. (Most fuel commonly referred to as heating

oil is diesel fuel.) The tax also does not apply to fuel used by State and local governments, to

exported fuels, and to fuels used in commercial shipping. Fuel used by intercity buses and trains is

partially exempt from the diesel fuel tax.

A similar dyeing regime exists for diesel fuel under the Clean Air Act. That Act prohibits 

the use on highways of diesel fuel with a sulphur content exceeding prescribed levels. This “high

sulphur” diesel fuel is required to be dyed by the EPA.

The State of Alaska generally is exempt from the Clean Air Act dyeing regime for a period

established by the U.S. Environmental Protection Agency (urban areas) or permanently (remote

areas). Diesel fuel used in Alaska is exempt from the excise tax dyeing requirements for periods

when the EPA requirements do not apply.

Description of Proposal

The proposal would make the excise tax exemption for Alaska urban areas permanent (i.e.,

independent of the EPA rules).

Effective Date

The proposal would be effective on the date of enactment.
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H. Expensing of Environmental Remediation Expenditures 

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 (sec. 198).

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.

A “qualified contaminated site” generally is any property that (1) is held for use in a trade

or business, for the production of income, or as inventory; (2) is certified by the appropriate State

environmental agency to be located within a targeted area; and (3) contains (or potentially contains)

a hazardous substance (so-called “brownfields”). Targeted areas are defined as: (1) empowerment

zones and enterprise communities as designated under present law; (2) sites announced before

February, 1997, as being subject to one of the 76 Environmental Protection Agency (“EPA”)

Brownfields Pilots; (3) any population census tract with a poverty rate of 20 percent or more; and

(4) certain industrial and commercial areas that are adjacent to tracts described in (3) above. 

However, sites that are identified on the national priorities list under the Comprehensive

Environmental Response, Compensation, and Liability Act of 1980 cannot qualify as targeted areas.

Eligible expenditures are those paid or incurred in taxable year’s ending before January 1,

2001.

Description of Proposal

The proposal would extend the expiration date for eligible expenditures to include those

paid or incurred in taxable years ending before July 1, 2004.

In addition, the proposal would eliminate the targeted area requirement, thereby, expanding

eligible sites to include any site containing (or potentially containing) a hazardous substance that is

certified by the appropriate State environmental agency.

Effective Date

The proposal to extend the expiration date would be effective upon the date of enactment. 

The proposal to expand the class of eligible sites would be effective for expenditures paid or

incurred after December 31, 2000. 
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XIII. REVENUE OFFSET PROVISIONS

A. Modify Foreign Tax Credit Carryover Rules

Present Law

U.S. persons may credit foreign taxes against U.S. tax on foreign-source income. The

amount of foreign tax credits that can 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 foreign

tax credit limitations are applied to specific categories of 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 two years and forward five

years. The amount carried over may be used as a credit in a carryover year to the extent the

taxpayer otherwise has excess foreign tax credit limitation for such year. The separate foreign tax

credit limitations apply for purposes of the carryover rules.

Description of Proposal

The proposal would reduce the carryback period for excess foreign tax credits from two

years to one year. The proposal also would extend the excess foreign tax credit carryforward

period from five years to seven years.

Effective Date

The proposal would apply to foreign tax credits arising in taxable years beginning after

December 31, 1999.
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B. Information Returns Relating to the Discharge of Indebtedness by Certain Entities

Present Law

Under section 61(a)(12), a taxpayer’s gross income includes income from the discharge of

indebtedness. Section 6050P requires “applicable entities” to file information returns with the IRS

regarding any discharge of indebtedness of $600 or more.

The information return must set forth the name, address, and taxpayer identification number

of the person whose debt was discharged, the amount of debt discharged, the date on which the debt

was discharged, and any other information that the IRS requires to be provided. The information

return must be filed in the manner and at the time specified by the IRS. The same information also

must be provided to the person whose debt is discharged by January 31 of the year following the

discharge.

“Applicable entities” include: (1) the FDIC, the RTC, the National Credit Union

Administration, and any successor or subunit of any of them; (2) any financial institution (as

described in sec. 581 (relating to banks) or sec. 591(a) (relating to savings institutions)); (3) any

credit union; (4) any corporation that is a direct or indirect subsidiary of an entity described in (2)

or (3) which, by virtue of being affiliated with such entity, is subject to supervision and

examination by a Federal or State agency regulating such entities; and (5) an executive, judicial, or

legislative agency (as defined in 31 U.S.C. sec. 3701(a)(4)).

The penalties for failure to file correct information reports with the IRS and to furnish

statements to taxpayers are similar to those imposed with respect to a failure to provide other

information returns. For example, the penalty for failure to furnish statements to taxpayers is

generally $50 per failure, subject to a maximum of $100,000 for any calendar year. These penalties

are not applicable if the failure is due to reasonable cause and not to willful neglect.

Description of Proposal

The proposal would require that information reporting on discharges of indebtedness also

be done by any organization a significant trade or business of which is the lending of money (such

as finance companies and credit card companies whether or not affiliated with financial

institutions).

Effective Date

The proposal would be effective with respect to discharges of indebtedness after December

31, 1999.
96All IRA distributions are treated as if includible in income for purposes of this rule. 

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C. Increase Elective Withholding Rate for Nonperiodic Distributions

 from Deferred Compensation Plans

Present Law

Present law provides that income tax withholding is required on designated distributions

from employer compensation plans (whether or not such plans are tax qualified), individual

retirement arrangements (“IRAs”), and commercial annuities unless the payee elects not to have

withholding apply. A designated distribution does not include any payment (1) that is wages, (2) the

portion of which it is reasonable to believe is not includible in gross income,96 (3) that is subject to

withholding of tax on nonresident aliens and foreign corporations (or would be subject to such

withholding but for a tax treaty), or (4) that is a dividend paid on certain employer securities (as

defined in sec. 404(k)(2)).

Tax is generally withheld on the taxable portion of any periodic payment as if the payment

is wages to the payee. A periodic payment is a designated distribution that is an annuity or similar

periodic payment.

In the case of a nonperiodic distribution, tax generally is withheld at a flat 10-percent rate

unless the payee makes an election not to have withholding apply. A nonperiodic distribution is any

distribution that is not a periodic distribution. Under current administrative rules, an individual

receiving a nonperiodic distribution can designate an amount to be withheld in addition to the

10-percent otherwise required to be withheld.

Under present law, in the case of a nonperiodic distribution that is an eligible rollover

distribution, tax is withheld at a 20-percent rate unless the payee elects to have the distribution

rolled directly over to an eligible retirement plan (i.e., an IRA, a qualified plan (sec. 401(a)) that is

a defined contribution plan permitting direct deposits of rollover contributions, or a qualified

annuity plan (sec. 403(a)). In general, an eligible rollover distribution includes any distribution to

an employee of all or any portion of the balance to the credit of the employee in a qualified plan or

qualified annuity plan. An eligible rollover distribution does not include any distribution that is part

of a series of substantially equal periodic payments made (1) for the life (or life expectancy) of the

employee or for the joint lives (or joint life expectancies) of the employee and the employee's

designated beneficiary, or (2) over the a specified period of 10 years or more. An eligible rollover

distribution also does not include any distribution required under the minimum distribution rules of

section 401(a)(9), hardship distributions from section 401(k) plans, or the portion of a distribution

that is not includible in income. The payee of an eligible rollover distribution can only elect not to

have withholding apply by making the direct rollover election.
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Description of Proposal

Under the proposal, the withholding rate for nonperiodic distributions would be increased

from 10 percent to 15 percent. As under present law, unless the distribution was an eligible

rollover distribution, the payee could elect not to have withholding apply. The proposal would not

modify the 20-percent withholding rate that applies to any distribution that is an eligible rollover

distribution.

Effective Date

The proposal would be effective for distributions made after December 31, 1999.
97 An Act to provide that members of the Armed Forces performing services for the

peacekeeping efforts in Bosnia and Herzegovina, Croatia, and Macedonia shall be entitled to tax

benefits in the same manner as if such services were performed in a combat zone, and for other

purposes (March 20, 1996).

98 These user fees were originally enacted in section 10511 of the Revenue Act of 1987

(Public Law 100-203, December 22, 1987).

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D. Extension of IRS User Fees

Present Law

The IRS provides written responses to questions of individuals, corporations, and

organizations relating to their tax status or the effects of particular transactions for tax purposes. 

The IRS generally charges a fee for requests for a letter ruling, determination letter, opinion letter,

or other similar ruling or determination. Public Law 104-11797 extended the statutory authorization

for these user fees98 through September 30, 2003.

Description of Proposal

The proposal would extend the statutory authorization for these user fees through September

30, 2009. The proposal would also move the statutory authorization for these fees into the Internal

Revenue Code.

Effective Date

The proposal would be effective on the date of enactment.
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E. Treatment of Excess Pension Assets Used for Retiree Health Benefits

Present Law

Defined benefit pension plan assets generally may not revert to an employer prior to the

termination of the plan and the satisfaction of all plan liabilities. A reversion prior to plan

termination may constitute a prohibited transaction and may result in disqualification of the plan.

Certain limitations and procedural requirements apply to a reversion upon plan termination. 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, which may be as high as 50 percent of

the reversion, varies depending upon whether or not the employer maintains a replacement plan or

makes certain benefit increases. 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 section 401(h)

account that is a part of such plan. A qualified transfer of excess assets of a defined benefit pension

plan (other than a multiemployer plan) into a section 401(h) account that is a part of such plan does

not result in plan disqualification and is not treated as a reversion to the employer or a prohibited

transaction. Therefore, the transferred assets are not includible in the gross income of the employer

and are not subject to the excise tax on reversions.

Qualified transfers are subject to amount and frequency limitations, use requirements,

deduction limitations, vesting requirements and minimum benefit requirements. 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 more than one qualified transfer with respect to any plan may

occur in any taxable year. 

The transferred assets (and any income thereon) must be used to pay qualified current

retiree health liabilities (either directly or through reimbursement) for the taxable year of the

transfer. Transferred amounts generally must benefit all pension plan participants, other than key

employees, who are entitled upon retirement to receive retiree medical benefits through the section

401(h) account. Retiree health benefits of key employees may not be paid (directly or indirectly)

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 at the end of the taxable year 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. 

No deduction is allowed for (1) a qualified transfer of excess pension assets into a section

401(h) account, (2) the payment of qualified current retiree health liabilities out of transferred

assets (and any income thereon) or (3) a return of amounts not used to pay qualified current retiree

health liabilities to the general assets of the pension plan.

In order for the 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.
99Similar provisions regarding transfers of excess defined benefit pension plan assets to

retiree health accounts are contained in title I of the Employee Retirement Income Security Act

(“ERISA”).

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The minimum benefit requirement requires each group health plan under which applicable

heath benefits are provided to provide substantially the same level of applicable health benefits for

the taxable year of the transfer and the following 4 taxable years. The level of benefits that must be

maintained is based on benefits provided in the year immediately preceding the taxable year of the

transfer. Applicable health benefits are health benefits or coverage that are provided to (1) retirees

who, immediately before the transfer, are entitled to receive such benefits upon retirement and who

are entitled to pension benefits under the plan and (2) the spouses and dependents of such retirees.

The provision permitting a qualified transfer of excess pension assets to pay qualified

current retiree health liabilities expires for taxable years beginning after December 31, 2000.99

Description of Proposal

The present-law provision permitting qualified transfers of excess defined benefit pension

plan assets to provide retiree health benefits under a section 401(h) account would be extended

through September 30, 2009. In addition, the present-law minimum benefit requirement would be

replaced by the minimum cost requirement that applied to qualified transfers before December 9,

1994, to section 401(h) accounts. Therefore, each group health plan or arrangement under which

applicable health benefits are provided would be required to provide a minimum dollar level of

retiree health expenditures for the taxable year of the transfer and the following 4 taxable years. 

The minimum dollar level would be the higher of the applicable employer costs for each of the 2

taxable years immediately preceding the taxable year of the transfer. The applicable employer cost

for a taxable year would be determined by dividing the employer’s qualified current retiree health

liabilities by the number of individuals to whom coverage for applicable health benefits was

provided during the taxable year.

Effective Date

The proposal generally would be effective with respect to qualified transfers of excess

defined benefit pension plan assets to section 401(h) accounts after December 31, 2000, and before

October 1, 2009. The replacement of the present-law minimum benefit requirement with the

minimum cost requirement generally would be effective for qualified transfers occurring on or after

the date of enactment. The minimum benefit requirement would continue to apply to qualified

transfers before the date of enactment. An employer would be permitted to satisfy the minimum

benefit requirement with respect to a qualified transfer that occurs on or after the date of enactment

during the portion of the cost maintenance period of such transfer that overlaps the benefit

maintenance period of a qualified transfer that occurs before the date of enactment. For example,

suppose an employer (with a calendar year taxable year) made a qualified transfer in 1998. The

minimum benefit requirement must be satisfied for calendar years 1998, 1999, 2000, 2001, and

2002. Suppose the employer also makes a qualified transfer in 2000. Then, the employer would be
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permitted to satisfy the minimum benefit requirement in 2000, 2001, and 2002, and would be

required to satisfy the minimum cost requirement in 2003 and 2004.
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F. Clarify the Tax Treatment of Income and Losses on Derivatives

Present Law

Capital gain treatment applies to gain on the sale or exchange of a capital asset. Capital

assets include property other than (1) stock in trade or other types of assets includible in inventory,

(2) property used in a trade or business that is real property or property subject to depreciation, (3)

accounts or notes receivable acquired in the ordinary course of a trade or business, or (4) certain

copyrights (or similar property) and U.S. government publications. Gain or loss on such assets

generally is treated as ordinary, rather than capital, gain or loss. Certain other Code sections also

treat gains or losses as ordinary. For example, the gains or losses of securities dealers or certain

electing commodities dealers or electing traders in securities or commodities that are subject to

“mark-to-market” accounting are treated as ordinary (sec. 475).

Under case law in a number of Federal courts prior to 1988, business hedges generally

were treated as giving rise to ordinary, rather than capital, income or loss. In 1988, the U.S.

Supreme Court rejected this interpretation in Arkansas Best v. Commissioner, 485 U.S. 212 (1988),

which, relying on the statutory definition of a capital asset described above, held that a loss

realized on a sale of stock was capital even though the stock was purchased for a business, rather

than an investment, purpose.

In 1993, the Treasury Department issued temporary regulations, which were finalized in

1994, that require ordinary character treatment for most business hedges and provide timing rules

requiring that gains or losses on hedging transactions be taken into account in a manner that matches

the income or loss from the hedged item or items. The regulations apply to hedges that meet a

standard of “risk reduction” with respect to ordinary property held (or to be held) or certain

liabilities incurred (or to be incurred) by the taxpayer and that meet certain identification and other

requirements (Treas. reg. sec. 1.1221-2).

Description of Proposal

The proposal would add three categories to the list of assets gain or loss on which is treated

as ordinary (sec. 1221). The new categories would be: (1) commodities derivative financial

instruments entered into by derivative dealers; (2) hedging transactions; and (3) supplies of a type

regularly consumed by the taxpayer in the ordinary course of a taxpayer’s trade or business.

In defining a hedging transaction, the proposal generally would codify the approach taken by

the Treasury regulations, but would modify the rules. The “risk reduction” standard of the

regulations would be broadened to one of “risk management” with respect to ordinary property held

(or to be held) or certain liabilities incurred (or to be incurred). In addition, the Treasury Secretary

would be granted authority to treat transactions that manage other risks as hedging transactions. As

under the Treasury regulations, the transaction would have to be identified as a hedge of specified

property. Authority would be provided for Treasury regulations that would address improperly
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identified or non-identified hedging transactions. The Treasury Secretary also would be given

authority to apply these rules to related parties.

Effective Date

The proposal would be effective for any instrument held, acquired or entered into, any

transaction entered into, and supplies held or acquired on or after the date of enactment.
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G. Loophole Closers

1. Limit use of non-accrual experience method of accounting to amounts to be received for

the performance of qualified personal services

Present Law

An accrual method taxpayer generally must recognize income when all the events have

occurred that fix the right to receive the income and the amount of the income can be determined

with reasonable accuracy. An accrual method taxpayer may deduct the amount of any receivable

that was previously included in income that becomes worthless during the year.

Accrual method taxpayers are not required to include in income amounts to be received for

the performance of services which, on the basis of experience, will not be collected (the “nonaccrual experience method”). The availability of this method is conditioned on the taxpayer not

charging interest or a penalty for failure to timely pay the amount charged.

A cash method taxpayer is not required to include an amount in income until it is received. 

A taxpayer may not use the cash method if purchase, production, or sale of merchandise is a

material income producing factor. Such taxpayers are generally required to keep inventories and

use the accrual method of accounting. In addition, corporations (and partnerships with corporate

partners) generally may not use the cash method of accounting if their average annual gross receipts

exceed $5 million. An exception to this $5 million rule is provided for qualified personal service

corporations, which are corporations (1) substantially all of whose activities involve the

performance of services in the fields of health, law, engineering, architecture, accounting, actuarial

science, performing arts or consulting and (2) substantially all of the stock of which is owned by

current or former employees performing such services, their estates or heirs. Qualified personal

service corporations are allowed to use the cash method without regard to whether their average

annual gross receipts exceed $5 million.

Description of Proposal

The proposal would limit the use of the non-accrual experience method to amounts that are

to be received for the performance of qualified personal services. Amounts to be received for the

performance of all other services would be subject to the general rule regarding inclusion in

income. Qualified personal services are personal services in the fields of health, law, engineering,

architecture, accounting, actuarial science, performing arts or consulting. As under present law, the

availability of the non-accrual experience method would be conditioned on the taxpayer not

charging interest or a penalty for failure to timely pay the amount.

Effective Date

The proposal would be effective for taxable years ending after the date of enactment. Any

change in the taxpayer’s method of accounting necessitated as a result of the proposal would be
100 1998-51 I.R.B. 16.

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treated as a voluntary change initiated by the taxpayer with the consent of the Secretary of the

Treasury. Any required section 481(a) adjustment would be taken into account over a period not to

exceed four years under principles consistent with those in Rev. Proc. 98-60.100

2. Impose limitation on prefunding of certain employee benefits

Present Law

Under present law, contributions to a welfare benefit fund generally are deductible when

paid, but only to the extent permitted under the rules of Code sections 419 and 419A. The amount

of an employer's deduction in any year for contributions to a welfare benefit fund cannot exceed the

fund's qualified cost for the year. The term qualified cost means the sum of (1) the amount that

would be deductible for benefits provided during the year if the employer paid them directly and

was on the cash method of accounting, and (2) within limits, the amount of any addition to a

qualified asset account for the year. A qualified asset account includes any account consisting of

assets set aside for the payment of disability benefits, medical benefits, supplemental unemployment

compensation or severance pay benefits, or life insurance benefits. The account limit for a qualified

asset account for a taxable year is generally the amount reasonably and actuarially necessary to fund

claims incurred but unpaid (as of the close of the taxable year) for benefits with respect to which

the account is maintained and the administrative costs incurred with respect to those claims.

Specific additional reserves are allowed for future provision of post-retirement medical and life

insurance benefits.

The present-law deduction limits for contributions to welfare benefit funds do not apply in

the case of certain 10-or-more employer plans. A plan is a 10-or-more employer plan if (1) more

than one employer contributes to it, (2) no employer is normally required to contribute more than 10

percent of the total contributions under the plan by all employers, and (3) the plan does not maintain

experience-rating arrangements with respect to individual employers.

If any portion of a welfare benefit fund reverts to the benefit of an employer that maintains

the fund, an excise tax equal to 100 percent of the reversion is imposed on the employer.

Description of Proposal

Under the proposal, the present-law exception to the deduction limit for 10-or-more

employer plans would be limited to plans that provide only medical benefits, disability benefits and

group-term life insurance benefits which do not provide for any cash surrender value or other

money that can be paid, assigned, borrowed or pledged for collateral for a loan. The exception

would no longer be available with respect to plans that provide supplemental unemployment

compensation, severance pay and life insurance (other than group-term life) benefits. Thus, the

generally applicable deduction limits (secs. 419 and 419A) would apply to plans providing these

benefits.
101 The net proceeds equal the gross loan proceeds less the direct expenses of obtaining the

loan.

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In addition, if any portion of a welfare benefit fund attributable to contributions that are

deductible pursuant to the 10-or-more employer exception (and earnings thereon) is used for a

purpose other than that for which the contributions were made (including cash payments to

employees upon termination of the fund), such portion would be treated as reverting to the benefit of

the employers maintaining the fund and would be subject to the imposition of the 100-percent excise

tax.

No inference would be intended with respect to the validity of any 10-or-more employer

arrangement under the provisions of present law.

Effective Date

The proposal would be effective with respect to contributions paid or accrued on or after

June 9, 1999, in taxable years ending after such date.

3. Modify installment method and prohibit its use by accrual method taxpayers

Present Law

An accrual method taxpayer is generally required to recognize income when all the events

have occurred that fix the right to the receipt of the income and the amount of the income can be

determined with reasonable accuracy. The installment method of accounting provides an exception

to this general principle of income recognition by allowing a taxpayer to defer the recognition of

income from the disposition of certain property until payment is received. Sales to customers in the

ordinary course of business are not eligible for the installment method, except for sales of property

that is used or produced in the trade or business of farming and sales of timeshares and residential

lots if an election to pay interest under section 453(l)(2)(B)) is made.

A pledge rule provides that if an installment obligation is pledged as security for any

indebtedness, the net proceeds101 of such indebtedness are treated as a payment on the obligation,

triggering the recognition of income. Actual payments received on the installment obligation

subsequent to the receipt of the loan proceeds are not taken into account until such subsequent

payments exceed the loan proceeds that were treated as payments. The pledge rule does not apply

to sales of property used or produced in the trade or business of farming, to sales of timeshares and

residential lots where the taxpayer elects to pay interest under section 453(l)(2)(B), or to

dispositions where the sales price does not exceed $150,000.

An additional rule requires the payment of interest on the deferred tax that is attributable to

most large installment sales.

Description of Proposal
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Prohibit use of installment method for accrual method dispositions

The proposal generally would prohibit the use of the installment method of accounting for

dispositions of property that would otherwise be reported for Federal income tax purposes using an

accrual method of accounting. The proposal would not change present law regarding the

availability of the installment method for dispositions of property used or produced in the trade or

business of farming. The proposal also would not change present law regarding the availability of

the installment method for dispositions of timeshares or residential lots if the taxpayer elects to pay

interest under section 453(l).

The proposal does not change the ability of a cash method taxpayer to use the installment

method. For example, a cash method individual owns all of the stock of a closely held accrual

method corporation. This individual sells his stock for cash, a ten year note, and a percentage of

the gross revenues of the company for next ten years. The proposal would not change the ability of

this individual to use the installment method in reporting the gain on the sale of the stock.

Modify pledge rule

The proposal would also modify the pledge rule to provide that entering into any

arrangement that gives the taxpayer the right to satisfy an obligation with an installment note will be

treated in the same manner as the direct pledge of the installment note. For example, a taxpayer

disposes of property for an installment note. The disposition is properly reported using the

installment method. The taxpayer only recognizes gain as it receives the deferred payment.

However, were the taxpayer to pledge the installment note as security for a loan, it would be

required to treat the proceeds of such loan as a payment on the installment note, and recognize the

appropriate amount of gain. Under the proposal, the taxpayer would also be required to treat the

proceeds of a loan as payment on the installment note to the extent the taxpayer had the right to “put”

or repay the loan by transferring the installment note to the taxpayer’s creditor. Other arrangements

that have a similar effect would be treated in the same manner.

The proposed modification of the pledge rule would only apply to installment sales where

the pledge rule of present law applies. Accordingly, the proposal would not apply to installment

method sales made by a dealer in timeshares and residential lots where the taxpayer elects to pay

interest under section 453(l)(2)(B), to sales of property used or produced in the trade or business of

farming, or to dispositions where the sales price does not exceed $150,000, since such sales are not

subject to the pledge rule under present law.

Effective Date

The proposal would be effective for installment sales entered into on or after the date of

enactment. 

4. Limit conversion of character of income from constructive ownership transactions
102 Section 1234A, as amended by the Taxpayer Relief Act of 1997.

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Present Law

The maximum individual income tax rate on ordinary income and short-term capital gain is

39.6 percent, while the maximum individual income tax rate on long-term capital gain generally is

20 percent. Long-term capital gain means gain from the sale or exchange of a capital asset held

more than one year. For this purpose, gain from the termination of a right with respect to property

which would be a capital asset in the hands of the taxpayer is treated as capital gain.102

A pass-thru entity (such as a partnership) generally is not subject to Federal income tax. 

Rather, each owner includes its share of a pass-thru entity’s income, gain, loss, deduction or credit

in its taxable income. Generally, the character of the item is determined at the entity level and

flows through to the owners. Thus, for example, the treatment of income by a partnership as

ordinary income, short-term capital gain, or long-term capital gain retains its character when

reported by each of the partners.

Investors may enter into forward contracts, notional principal contracts, and other similar

arrangements with respect to property that provides the investor with the same or similar economic

benefits as owning the property directly but with potentially different tax consequences (as to the

character and timing of any gain).

Description of Proposal

The proposal would limit the amount of long-term capital gain a taxpayer could recognize

from certain derivative contracts (“constructive ownership transaction”) with respect to certain

financial assets. The amount of long-term capital gain would be limited to the amount of such gain

the taxpayer would have had if the taxpayer held the financial asset directly during the term of the

derivative contract. Any gain in excess of this amount would be treated as ordinary income. An

interest charge would be imposed on the amount of gain that is treated as ordinary income.

A taxpayer would be treated as having entered into a constructive ownership transaction if

the taxpayer (1) holds a long position under a notional principal contract with respect to a financial

asset, (2) enters into a forward contract to acquire a financial asset, (3) is the holder of a call

option, and the grantor of a put option, with respect to a financial asset, and the options have

substantially equal strike prices and substantially contemporaneous maturity dates, or (4) to the

extent provided in regulations, enters into one or more transactions, or acquires one or more other

positions, that have substantially the same effect as any of the transactions described.

A “financial asset” would be defined as (1) any equity interest in a pass-thru entity, and (2)

to the extent provided in regulations, any debt instrument and any stock in a corporation that is not a

pass-thru entity. A “pass-thru entity” would be defined as (1) a regulated investment company, (2)

a real estate investment trust, (3) a real estate mortgage investment conduit, (4) an S corporation,
103 The accrual rate would be the applicable Federal rate on the day the constructive

ownership transaction closed.

104

 United States v. American Bar Endowment, 477 U.S. 105 (1986). Treas. Reg. sec.

1.170A-1(h). 

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(5) a partnership, (6) a trust, (7) a common trust fund, (8) a passive foreign investment company,

(9) a foreign personal holding company, and (10) a foreign investment company.

The interest charge is the amount of interest that would be imposed under section 6601 had

the recharacterized gain been included in the taxpayer’s income during the term of the constructive

ownership transaction. The recharacterized gain is treated as having accrued at a constant rate103

during the term of the constructive ownership transaction. 

A taxpayer would be treated as holding a long position under a notional principal contract

with respect to a financial asset if the person (1) has the right to be paid (or receive credit for) all

or substantially all of the investment yield (including appreciation) on the financial asset for a

specified period, and (2) is obligated to reimburse (or provide credit) for all or substantially all of

any decline in the value of the financial asset. A forward contract is a contract to acquire in the

future (or provide or receive credit for the future value of) any financial asset.

Effective Date

This proposal would apply to transactions entered into on or after July 12, 1999.

5. Denial of charitable contribution deduction for transfers associated with split-dollar

insurance arrangements

Present Law

Under present law, in computing taxable income, a taxpayer who itemizes deductions

generally is allowed to deduct charitable contributions paid during the taxable year. The amount of

the deduction allowable for a taxable year with respect to any charitable contribution depends on

the type of property contributed, the type of organization to which the property is contributed, and

the income of the taxpayer (secs. 170(b) and 170(e)). A charitable contribution is defined to mean

a contribution or gift to or for the use of a charitable organization or certain other entities (sec.

170(c)). The term “contribution or gift” is not defined by statute, but generally is interpreted to

mean a voluntary transfer of money or other property without receipt of adequate consideration and

with donative intent. If a taxpayer receives or expects to receive a quid pro quo in exchange for a

transfer to charity, the taxpayer may be able to deduct the excess of the amount transferred over the

fair market value of any benefit received in return, provided the excess payment is made with the

intention of making a gift.104
105 The proposal is similar to H.R. 630, introduced by Mr. Archer for himself and for Mr.

Rangel (106th Cong., 1st Sess.).

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In general, no charitable contribution deduction is allowed for a transfer to charity of less

than the taxpayer’s entire interest (i.e., a partial interest) in any property (sec. 170(f)(3)). In

addition, no deduction is allowed for any contribution of $250 or more unless the taxpayer obtains

a contemporaneous written acknowledgment from the donee organization that includes a description

and good faith estimate of the value of any goods or services provided by the donee organization to

the taxpayer in consideration, whole or part, for the taxpayer’s contribution (sec. 170(f)(8)).

Description of Proposal

Deduction denial

The proposal105 would restate present law to provide that no charitable contribution

deduction is allowed for purposes of Federal tax, for a transfer to or for the use of an organization

described in section 170(c) of the Internal Revenue Code, if in connection with the transfer (1) the

organization directly or indirectly pays, or has previously paid, any premium on any “personal

benefit contract” with respect to the transferor, or (2) there is an understanding or expectation that

any person will directly or indirectly pay any premium on any “personal benefit contract” with

respect to the transferor. It would be intended that an organization be considered as indirectly

paying premiums if, for example, another person pays premiums on its behalf.

A personal benefit contract with respect to the transferor would be any life insurance,

annuity, or endowment contract, if any direct or indirect beneficiary under the contract is the

transferor, any member of the transferor’s family, or any other person (other than a section 170(c)

organization) designated by the transferor. For example, such a beneficiary would include a trust

having a direct or indirect beneficiary who is the transferor or any member of the transferor’s

family, and would include an entity that is controlled by the transferor or any member of the

transferor’s family. It would be intended that a beneficiary under the contract include any

beneficiary under any side agreement relating to the contract. If a transferor contributes a life

insurance contract to a section 170(c) organization and designates one or more section 170(c)

organizations as the sole beneficiaries under the contract, generally, it would not be intended that

the deduction denial rule under the proposal apply. If, however, there is an outstanding loan under

the contract upon the transfer of the contract, then the transferor would be considered as a

beneficiary. The fact that a contract also has other direct or indirect beneficiaries (persons who are

not the transferor or a family member, or designated by the transferor) would not prevent it from

being a personal benefit contract. The proposal would not be intended to affect situations in which

an organization pays premiums under a legitimate fringe benefit plan for employees.

It would be intended that a person be considered as an indirect beneficiary under a contract

if, for example, the person receives or will receive any economic benefit as a result of amounts

paid under or with respect to the contract. For this purpose, as described below, an indirect
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beneficiary would not be intended to include a person that benefits exclusively under a bona fide

charitable gift annuity (within the meaning of sec. 501(m)).

Under the proposal, an individual’s family would consist of the individual’s grandparents,

the grandparents of the individual’s spouse, the lineal descendants of such grandparents, and any

spouse of such a lineal descendant.

In the case of a charitable gift annuity, if the charitable organization purchases an annuity

contract issued by an insurance company to fund its obligation to pay the charitable gift annuity, a

person receiving payments under the charitable gift annuity would not be treated as an indirect

beneficiary, provided certain requirements are met. The requirements are that (1) the charitable

organization possess all of the incidents of ownership (within the meaning of Treas. Reg. sec.

20.2042-1(c)) under the annuity contract purchased by the charitable organization; (2) the charitable

organization be entitled to all the payments under the contract; and (3) the timing and amount of

payments under the contract be substantially the same as the timing and amount of payments to each

person under the organization’s obligation under the charitable gift annuity (as in effect at the time

of the transfer to the charitable organization).

In the case of a charitable gift annuity obligation that is issued under the laws of a State that

requires, in order for the charitable gift annuity to be exempt from insurance regulation by that State,

that each beneficiary under the charitable gift annuity be named as a beneficiary under an annuity

contract issued by an insurance company authorized to transact business in that State, then the

foregoing requirements (1) and (2) would be treated as if they are met, provided that certain

additional requirements are met. The additional requirements are that the State law requirement

was in effect on February 8, 1999, each beneficiary under the charitable gift annuity is a bona fide

resident of the State at the time the charitable gift annuity was issued, the only persons entitled to

payments under the annuity contract issued by the insurance company are persons entitled to

payments under the charitable gift annuity when it was issued, and (as required by clause (iii) of

subparagraph (D) of the proposal) the timing and amount of payments under the annuity contract to

each person are substantially the same as the timing and amount of payments to the person under the

charitable organization’s obligation under the charitable gift annuity (as in effect at the time of the

transfer to the charitable organization).

In the case of a charitable remainder annuity trust or charitable remainder unitrust (as

defined in section 664(d)) that holds a life insurance, endowment or annuity contract issued by an

insurance company, a person would not be treated as an indirect beneficiary under the contract held

by the trust, solely by reason of being a recipient of an annuity or unitrust amount paid by the trust,

provided that the trust possesses all of the incidents of ownership under the contract and is entitled

to all the payments under such contract. No inference would be intended as to the applicability of

other provisions of the Code with respect to the acquisition by the trust of a life insurance,

endowment or annuity contract, or the appropriateness of such an investment by a charitable

remainder trust.

Nothing in the proposal would be intended to suggest that a life insurance, endowment, or

annuity contract would be a personal benefit contract, solely because an individual who is a
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recipient of an annuity or unitrust amount paid by a charitable remainder annuity trust or charitable

remainder unitrust uses such a payment to purchase a life insurance, endowment or annuity contract,

and a beneficiary under the contract is the recipient, a member of his or her family, or another

person he or she designates.

Excise tax

The proposal would impose on any organization described in section 170(c) of the Code an

excise tax, equal to the amount of the premiums paid by the organization on any life insurance,

annuity, or endowment contract, if the premiums are paid in connection with a transfer for which a

deduction is not allowable under the deduction denial rule of the proposal (without regard to when

the transfer to the charitable organization was made). The excise tax would not apply if all of the

direct and indirect beneficiaries under the contract (including any related side agreement) are

organizations described in section 170(c). Under the proposal, payments would be treated as made

by the organization, if they are made by any other person pursuant to an understanding or

expectation of payment. The excise tax is to be applied taking into account rules ordinarily

applicable to excise taxes in chapter 41 or 42 of the Code (e.g., statute of limitation rules).

Reporting

The proposal would require that the charitable organization annually report the amount of

premiums that is paid during the year and that is subject to the excise tax imposed under the

proposal, and the name and taxpayer identification number of each beneficiary under the life

insurance, annuity or endowment contract to which the premiums relate, as well as other

information required by the Secretary of the Treasury. For this purpose, it would be intended that a

beneficiary include any beneficiary under any side agreement to which the section 170(c)

organization is a party (or of which it is otherwise aware). Penalties applicable to returns required

under Code section 6033 apply to returns under this reporting requirement. Returns required under

this proposal are to be furnished at such time and in such manner as the Secretary shall by forms or

regulations require.

Regulations

The proposal would provide for the promulgation of regulations necessary or appropriate to

carry out the purposes of the proposal, including regulations to prevent the avoidance of the

purposes of the proposal. For example, it would be intended that regulations prevent avoidance of

the purposes of the proposal by inappropriate or improper reliance on the limited exceptions

provided for certain beneficiaries under bona fide charitable gift annuities and for certain

noncharitable recipients of an annuity or unitrust amount paid by a charitable remainder trust.

Effective Date

The deduction denial proposal would apply to transfers after February 8, 1999 (as provided

in H.R. 630). The excise tax proposal would apply to premiums paid after the date of enactment. 
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The reporting proposal would apply to premiums paid after February 8, 1999 (determined as if the

excise tax imposed under the proposal applied to premiums paid after that date).

No inference would be intended that a charitable contribution deduction is allowed under

present law with respect to a charitable split-dollar insurance arrangement. The proposal would

not change the rules with respect to fraud or criminal or civil penalties under present law; thus,

actions constituting fraud or that are subject to penalties under present law would still constitute

fraud or be subject to the penalties after enactment of the proposal.

6. Modify estimated tax rules for closely held REITs

Present Law

If a person has a direct interest or a partnership interest in income producing assets (such as

securities generally, or mortgages) that produce income throughout the year, that person’s estimated

tax payments must reflect the quarterly amounts expected from the asset.

However, a dividend distribution of earnings from a REIT is considered for estimated tax

purposes when the dividend is paid. Some corporations have established closely held REITS that

hold property (e.g. mortgages) that if held directly by the controlling entity would produce income

throughout the year. The REIT may make a single distribution for the year, timed such that it need

not be taken into account under the estimated tax rules as early as would be the case if the assets

were directly held by the controlling entity. The controlling entity thus defers the payment of

estimated taxes.

Description of Proposal

 In the case of a REIT that is closely held, any person owning at least 10 percent of the vote

or value of the REIT would required to accelerate the recognition of year-end dividends

attributable to the closely held REIT for purposes of such person’s estimated tax payments. A

closely held REIT would be defined as one in which at least 50 percent of the vote or value is

owed by five or fewer persons. Attribution rules would apply to determine ownership.

Effective Date

The proposal would be effective for estimated tax payments due on or after September 15,

1999.

7. Prohibited allocations of stock in an ESOP of an S corporation

Present Law

The Small Business Job Protection Act of 1996 allowed qualified retirement plan trusts

described in section 401(a) to own stock in an S corporation. That Act treated the plan’s share of
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the S corporation’s income (and gain on the disposition of the stock) as includible in full in the

trust’s unrelated business taxable income (“UBTI”).

The Tax Relief Act of 1997 repealed the provision treating items of income or loss of an S

corporation as UBTI in the case of an employee stock ownership plan (“ESOP”). Thus, the income

of an S corporation allocable to an ESOP is not subject to current taxation. 

Present law provides a deferral of income on the sales of certain employer securities to an

ESOP (sec. 1042). A 50-percent excise tax is imposed on certain prohibited allocations of

securities acquired by an ESOP in a transaction to which section 1042 applies. In addition, such

allocations are currently includible in the gross income of the individual receiving the prohibited

allocation.

Description of Proposal

Under the proposal, if there is a prohibited allocation of stock in an ESOP sponsored by an

S corporation: (1) an excise tax would be imposed on the employer equal to 50 percent of the

amount of the prohibited allocation; and (2) the value of the stock allocated would be includible in

the gross income of the employee receiving the prohibited allocation. For purposes of this rule, a

prohibited allocation would be an allocation to an individual who, at any time during the year, is

either a member of a “deemed 20-percent shareholder group” or is a “deemed 10-percent

shareholder” if such shareholders and shareholder groups own, in the aggregate, at least 50 percent

of the outstanding stock in the corporation.

An individual would be a member of a “deemed 20-percent shareholder group” if the

deemed-owned shares of the individual and his or her family members together equal or exceed 20

percent of the outstanding stock of the corporation. An individual would be a deemed 10-percent

shareholder if no family members of the individual own stock in the S corporation and if the

individual’s deemed-owned shares equal or exceed 10 percent of the outstanding stock of the

corporation.

“Deemed-owned shares” would mean: (1) stock allocated to the account of the individual

under the ESOP, (2) the individual’s share of unallocated stock held by the ESOP, and (3) stock in

such corporation represented by any synthetic equity interest. An individual’s share of unallocated

stock held by an ESOP would be determined in the same manner as the most recent allocation of

stock under the terms of the plan.

For purposes of determining whether deemed 20-percent shareholder groups and deemed

10-percent shareholders together own 50 percent or more of the outstanding stock of the

corporation, deemed-owned shares and shares owned directly by an individual would be taken into

account. For purposes of the proposal, outstanding stock of an S corporation would include stock

represented by any synthetic equity interest. Family members would include the spouse of an

individual, the lineal ascendents and descendants of the individual and his or her spouse, and

siblings of the individual and his or her spouse.
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The following example illustrates the proposal. 

S Corp has 100 outstanding shares. There are no synthetic equity interests in S Corp. 

Shareholder A, who is unrelated to any other shareholders of the S corporation, has 25

shares of stock allocated to his account in S Corp’s ESOP. Shareholder A owns 20 shares

of stock directly. Shareholder B has 10 shares of stock allocated to her account in the S

Corp ESOP, and owns 30 shares directly. B’s husband and B’s son each have 5 shares of

stock allocated to their account in the ESOP. A is a “deemed 10 percent shareholder.” B,

her husband and her son are a “deemed 20-percent shareholder group.” A and B’s “deemed

20-percent shareholder group” own 50 percent or more of the outstanding stock of S Corp. 

Thus, if an allocation of stock is made for the year under the ESOP to A, B, B’s husband or

B’s son, such allocation would be a prohibited allocation.

Effective Date

The proposal would be effective with respect to ESOPs of S corporations established after

July 14, 1999.

8. Modify anti-abuse rules related to assumption of liabilities

Present Law

Generally, no gain or loss is recognized if property is exchanged for stock of a controlled

corporation. The transferor may recognize gain to the extent other property (“boot”) is received by

the transferor. The assumption of liabilities by the transferee generally is not treated as boot

received by the transferor. The assumption of a liability is treated as boot to the transferor,

however, “[i]f, taking into consideration the nature of the liability and the circumstances in the light

of which the arrangement for the assumption or acquisition was made, it appears that the principal

purpose of the taxpayer...was a purpose to avoid Federal income tax on the exchange, or...if not

such purpose, was not a bona fide business purpose.” Sec. 357(b). Thus, this exception requires

that the principal purpose of having the transferee assume the liability was the avoidance of tax on

the exchange.

The transferor's basis in the stock of the transferee received in the exchange is reduced by

the amount of any liability assumed, but generally increased in the amount of any gain recognized by

the transferor on the exchange. However, a liability that would give rise to a future deduction is not

considered a liability for purposes of basis reductions. Similar rules apply in connection with

certain tax-free reorganizations.

Description of Proposal

The proposal would delete the limitation that the assumption of liabilities anti-abuse rule

only applies to tax avoidance on the exchange itself, and would change “the principal purpose”

standard to “a principal purpose.” A taxpayer may have “a principal purpose” of tax avoidance
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even though it is outweighed by other purposes (taken together or separately). In addition, a

modification to the basis rule would be made to require a decrease in the transferor's basis in the

transferee's stock when a liability, the payment of which would give rise to a deduction, is treated

as boot under the anti-abuse rule.

Effective Date

The proposal would be effective for assumptions of liabilities on or after July 15, 1999.

9. Require consistent treatment and provide basis allocation rules for transfers of intangibles

in certain nonrecognition transactions

Present Law

Generally, no gain or loss is recognized if one or more persons transfer property to a

corporation solely in exchange for stock in the corporation and, immediately after the exchange such

person or persons are in control of the corporation. Similarly, no gain or loss is recognized in the

case of a contribution of property in exchange for a partnership interest. Neither the Internal

Revenue Code nor the regulations provide the meaning of the requirement that a person “transfer

property” in exchange for stock (or a partnership interest). The Internal Revenue Service interprets

the requirement consistent with the “sale or other disposition of property” language in the context of

a taxable disposition of property. See, e.g., Rev. Rul. 69-156, 1969-1 C.B. 101. Thus, a transfer of

less than “all substantial rights” to use property will not qualify as a tax-free exchange and stock

received will be treated as payments for the use of property rather than for the property itself.

These amounts are characterized as ordinary income. However, the Claims Court has rejected the

Service's position and held that the transfer of a nonexclusive license to use a patent (or any transfer

of “something of value”) could be a “transfer” of “property” for purposes of the nonrecognition

provision. See E.I. DuPont de Nemours & Co. v. U.S., 471 F.2d 1211 (Ct. Cl. 1973).

Description of Proposal

The proposal would treat a transfer of an interest in intangible property constituting less

than all of the substantial rights of the transferor in the property as a transfer of property for

purposes of the nonrecognition provisions regarding transfers of property to controlled

corporations and partnerships. Consistent reporting by the transferor and transferee would be

required. Furthermore, in the case of a transfer of less than all of the substantial rights, the

transferor would be required to allocate the basis of the intangible between the retained rights and

the transferred rights based upon respective fair market values.

The proposal would not apply to transactions that are properly structured as licenses of

intangibles. No inference is intended as to the treatment of these or similar transactions prior to the

effective date.

Effective Date
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The proposal would be effective for transfers on or after the date of enactment.

10. Modify treatment of closely-held REITs

Present Law

In general, a real estate investment trust (“REIT”) is an entity that receives most of its

income from passive real estate related investments and that receives pass-through treatment for

income that is distributed to shareholders. If an electing entity meets the qualifications for REIT

status, the portion of its income that is distributed to the investors each year generally is taxed to the

investors without being subjected to tax at the REIT level.

A REIT must satisfy a number of tests on a year-by-year basis that relate to the entity's: (1)

organizational structure; (2) source of income; (3) nature of assets; and (4) distribution of income.

Under the organizational structure test, 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.

Generally, no more than 50 percent of the value of the REIT's stock can be owned by five or fewer

individuals during the last half of the taxable year. Certain attribution rules apply in making this

determination. No similar rule applies to corporate ownership of a REIT. Certain transactions

have been structured to attempt to achieve special tax benefits for an entity that controls a REIT. 

Description of Proposal

The proposal would impose as an additional requirement for REIT qualification that, except

for the first taxable year for which an entity elects to be a REIT, no one person (e.g., no one

corporation) can own stock of a REIT possessing 50 percent or more of the combined voting power

of all classes of voting stock or 50 percent or more of the total value of shares of all classes of

stock of the REIT. For purposes of determining a person's stock ownership, rules similar to

attribution rules for REIT qualification under present law would apply (secs. 856(d)(5) and

856(h)(3)). The proposal would not apply to ownership by a REIT of 50 percent or more of the

stock (vote or value) of another REIT.

An exception would apply for a limited period to certain “incubator REITs”. An incubator

REIT would be a corporation that elects to be treated as an incubator REIT and that meets all the

following other requirements. (1) it has only voting common stock outstanding,

(2) not more than 50 percent of the corporation’s real estate assets consist of mortgages, (3) from

not later than the beginning of the last half of the second taxable year, at least 10 percent of the

corporation’s capital is provided by lenders or equity investors who are unrelated to the

corporation’s largest shareholder, (4), the corporation must annually increase the value of real

estate assets by at least 10 percent, (5) the directors of the corporation must adopt a resolution

setting forth an intent to engage in a going public transaction, and (6) no predecessor entity
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(including any entity from which the electing incubator REIT acquired assets in a transaction in

which gain or loss was not recognized in whole or in part) had elected incubator REIT status.

The new ownership requirement would not apply to an electing incubator REIT until the end

of the REIT’s third taxable year; and could be extended for an additional two taxable years if the

REIT so elects. However, a REIT cannot elect the additional two year extension unless the REIT

agrees that if it does not engage in a going public transaction by the end of the extended eligibility

period, it shall pay Federal income taxes for the two years of the extended period as if it had not

made an incubator REIT election and had ceased to qualify as a REIT for those two taxable years. 

In such case, the corporation shall file appropriate amended returns within 3 months of the close of

the extended eligibility period. Interest would be payable, but no substantial underpayment

penalties would apply except in cases where there is a finding that incubator REIT status was

elected for a principal purpose other than as part of a reasonable plan to engage in a going public

transaction. Notification of shareholders and any other person whose tax position would reasonably

be expected to be affected is also required.

If an electing incubator REIT does not elect to extend its initial 2-year extended eligibility

period and has not engaged in a going public transaction by the end of such period, it must satisfy

the new control requirements as of the beginning of its fourth taxable year (i.e., immediately after

the close of the last taxable year of the two-year initial extension period) or it will be required to

notify its shareholders and other persons that may be affected by its tax status, and pay Federal

income tax as a corporation that has ceased to qualify as a REIT at that time.

If the Secretary of the Treasury determines that an incubator REIT election was filed for a

principal purpose other than as part of a reasonable plan to undertake a going public transaction, an

excise tax of $20,000 would be imposed on each of the corporation’s directors for each taxable

year for which the election was in effect.

A going public transaction would be defined as either (1) a public offering of shares of

stock of the incubator REIT, (2) a transaction, or series of transactions, that result in the incubator

REIT stock being regularly traded on an established securities market (as defined in section 897)

and being held by shareholders unrelated to persons who held such stock before it began to be so

regularly traded, or (3) any transaction resulting in ownership of the REIT by 200 or more persons

(excluding the largest single shareholder) who in the aggregate own least 50 percent of the stock of

the REIT. Attribution rules apply in determining ownership of stock.

Effective Date

The proposal would be effective for entities electing REIT status for taxable years ending 

after July 14, 1999. Any entity that elects REIT status for a taxable year including July 14, 1999,

and which is both a controlled entity and has significant business assets or activities on such date,

will not be subject to the proposal.

 Under this rule, a controlled entity with significant business assets or activities on July 14,

1999, can be grandfathered even if it makes its first REIT election after that date with its return for
106In a similar situation involving the purchase of stock of a subsidiary corporation as

replacement property following an involuntary conversion, the Code generally requires the basis

of the assets held by the subsidiary to be reduced to the extent that the basis of the stock in the

replacement corporation itself is reduced (sec. 1033). 

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the taxable year including that date. In such a case, the significant assets in place on July 14, 1999,

must be real estate assets that would be qualified real estate assets for purposes of the REIT asset

rules. The assets and activities in place on that date must also be of a type that would produce

qualified real estate-related income for a REIT. 

11. Distributions by a partnership to a corporate partner of stock in another corporation

Present Law

Present law generally provides that no gain or loss is recognized on the receipt by a

corporation of property distributed in complete liquidation of another corporation in which it holds

80 percent of the stock (by vote and value) (sec. 332). The basis of property received by a

corporate distributee in the distribution in complete liquidation of the 80-percent-owned subsidiary

is a carryover basis, i.e., the same as the basis in the hands of the subsidiary (provided no gain or

loss is recognized by the liquidating corporation with respect to the distributed property) (sec.

334(b)).

Present law provides two different rules for determining a partner's basis in distributed

property, depending on whether or not the distribution is in liquidation of the partner's interest in

the partnership. Generally, a substituted basis rule applies to property distributed to a partner in

liquidation. Thus, the basis of property distributed in liquidation of a partner's interest is equal to

the partner's adjusted basis in its partnership interest (reduced by any money distributed in the same

transaction) (sec. 732(b)).

By contrast, generally, a carryover basis rule applies to property distributed to a partner

other than in liquidation of its partnership interest, subject to a cap (sec. 732(a)). Thus, in a

non-liquidating distribution, the distributee partner's basis in the 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 its partnership interest (reduced by any money distributed in the same

transaction). In a non-liquidating distribution, the partner's basis in its partnership interest is

reduced by the amount of the basis to the distributee partner of the property distributed and is

reduced by the amount of any money distributed (sec. 733).

If corporate stock is distributed by a partnership to a corporate partner with a low basis in

its partnership interest, the basis of the stock is reduced in the hands of the partner so that the stock

basis equals the distributee partner's adjusted basis in its partnership interest. No comparable

reduction is made in the basis of the corporation's assets, however. The effect of reducing the stock

basis can be negated by a subsequent liquidation of the corporation under section 332.106
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Description of Proposal

In general

The proposal would provide for a basis reduction to assets of a corporation, if stock in that

corporation is distributed by a partnership to a corporate partner. The reduction would apply if,

after the distribution, the corporate partner controls the distributed corporation.

Amount of the basis reduction

Under the proposal, the amount of the reduction in basis of property of the distributed

corporation generally would equal the amount of the excess of (1) the partnership’s adjusted basis

in the stock of the distributed corporation immediately before the distribution, over (2) the

corporate partner’s basis in that stock immediately after the distribution.

The proposal would, however, limit the amount of the basis reduction in two respects. 

First, the amount of the basis reduction could not exceed the amount by which (1) the sum of the

aggregate adjusted bases of the property and the amount of money of the distributed corporation

exceeds (2) the corporate partner’s adjusted basis in the stock of the distributed corporation. Thus,

for example, if the distributed corporation has cash of $300 and other property with a basis of $600

and the corporate partner’s basis in the stock of the distributed corporation is $400, then the amount

of the basis reduction could not exceed $500 (i.e., ($300+$600) - $400 = $500).

Second, the amount of the basis reduction could not exceed the adjusted basis of the

property of the distributed corporation. Thus, the basis of property (other than money) of the

distributed corporation could not be reduced below zero under the proposal, even though the total

amount of the basis reduction would otherwise be greater.

The proposal would provide that the corporate partner recognizes long-term capital gain to

the extent the amount of the basis reduction does exceed the basis of the property (other than money)

of the distributed corporation. For example, if the amount of the basis reduction were $400, and the

distributed corporation has money of $200 and other property with an adjusted basis of $300, then

the corporate partner would recognize a $100 capital gain under the proposal. The corporate

partner’s basis in the stock of the distributed corporation would also be increased by $100 in this

example, under the proposal.

Partnership distributions resulting in control

The basis reduction generally would apply with respect to a partnership distribution of

stock if the corporate partner controls the distributed corporation immediately after the distribution

or at any time thereafter. For this purpose, the term control would mean ownership of stock meeting

the requirements of section 1504(a)(2) (generally, an 80-percent vote and value requirement). The

proposal would apply to reduce the basis of any property held by the distributed corporation

immediately after the distribution, or, if the corporate partner does not control the distributed
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corporation at that time, then at the time the corporate partner first has such control. The proposal

would not apply to any distribution if the corporate partner does not have control of the distributed

corporation immediately after the distribution and establishes that the distribution was not part of a

plan or arrangement to acquire control. Under the proposal, a corporation would be treated as

receiving a distribution of stock from a partnership, if the corporation acquires stock other than in a

distribution from a partnership and the basis of the stock is determined in whole or in part by

reference to the partnership rules limiting the basis of the stock to a partner’s basis in his

partnership interest (secs. 732(a)(2) or 732(b)).

Effective Date

The proposal would be effective for distributions made after July 14, 1999.
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XIV. TAX TECHNICAL CORRECTIONS

The following technical corrections provisions would be adopted. Except as otherwise

provided, the technical corrections generally would be effective as if included in the originally

enacted related legislation.

Amendments related to Tax and Trade Relief Extension Act of 1998

Exempt organizations.–The proposed change would clarify that nonexempt charitable trusts

and nonexempt private foundations are subject to the public disclosure requirements of section

6104(d).

Capital gains.–The proposed change would provide that if (1) a charitable remainder trust

sold section 1250 property after July 28, 1997, and before January 1, 1998, (2) the property was

held more than one year but not more than 18 months, and (3) the capital gain is distributed after

December 31, 1997, then any capital gain attributable to depreciation will be taxed at 25 percent

(rather than 28 percent). Treasury has published a notice (Notice 99-17, 1999-14 I.R.B., April 5,

1999) providing that the gain is taxed at 25 percent.

Vaccine Trust Fund.–In the 1998 Act, the tax on vaccines against rotavirus gastroenteritis

and the technical correction regarding the Vaccine Injury Compensation Trust Fund expenditure

purposes were inadvertently included twice, once in the spending title and once in the revenue title. 

In addition, in the spending title, the effective date of the substantive change to the expenditure

program is drafted erroneously, such that claims to the Trust Fund for this new expenditure purpose

cannot be paid. The proposed changes would clarify that intended vaccine tax and Trust Fund

provisions regarding program spending authority are those included in the revenue title, and would

modify the revenue title provisions as necessary to allow spending for the new purpose created

elsewhere in the Act.

Amendments related to Internal Revenue Service Restructuring and Reform Act of 1998

IRS restructuring.--When the Office of the Chief Inspector was replaced by the Treasury

Inspector General for Tax Administration (TIGTA) under the IRS Restructuring and Reform Act of

1998, Inspection’s responsibilities were assigned to the TIGTA. TIGTA personnel are Treasury,

rather than IRS, personnel. TIGTA personnel still need to make investigative disclosures to carry

out the duties they took over from Inspection and their additional tax administration responsibilities. 

However, section 6103(k)(6) refers only to “internal revenue” personnel. The proposed change

would clarify that section 6103(k)(6) permits TIGTA personnel to make investigative disclosures.

Compliance.--Section 3509 of the IRS Restructuring and Reform Act of 1998 expanded the

disclosure rules of section 6110 to also cover Chief Counsel advice (sec. 6110(i)). This is a

conforming change related to ongoing investigations. The proposed change would add to section

6110(g)(5)(A) after the words technical advice memorandum, “or Chief Counsel advice.”
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Amendments related to Taxpayer Relief Act of 1997

Roth IRAs.--Code section 3405 provides for withholding with respect to designated

distributions from certain tax-favored arrangements, including IRAs. In general, section

3405(e)(1)(B)(ii) excludes from the definition of a designated distribution the portion of any

distribution which it is reasonable to believe is excludable from gross income. However, all

distributions from IRAs are treated as includible in income. The exception was consistent with

prior law when all IRA distributions were taxable, but does not account for the tax-free nature of

certain Roth IRA distributions. The proposed change would extend the exception to Roth IRAs.

Transportation benefits.--Under present law, salary reduction amounts are generally treated

as compensation for purposes of the limits on contributions and benefits under qualified plans. In

addition, an employer can elect whether or not to include such amounts for nondiscrimination

testing purposes. The IRS Reform Act permitted employers to offer a cash option in lieu of

qualified transportation benefits. The proposed change would treat salary reduction amounts used

for qualified transportation benefits the same as other salary reduction amounts for purposes of

defining compensation under the qualified plan rules.

Tax Court jurisdiction.--The Tax Court recently held that its jurisdiction pursuant to section

7436 extends only to employment status, not to the amount of employment tax in dispute (Henry

Randolph Consulting v. Comm’r, 112 T.C. #1, Jan. 6, 1999). The proposed change would provide

that the Tax Court also has jurisdiction over the amount.

Amendments to other Acts

Worthless securities.--Section 165(g)(3) provides a special rule for worthless securities of

an affiliated corporation. The test for affiliation in section 165(g)(3)(A) is the 80-percent vote test

for affiliated groups under section 1504(a) that was in effect prior to 1984. When section 1504(a)

was amended in the Deficit Reduction Act of 1984 to adopt the vote and value test of present law,

no corresponding change was made to section 165(g)(3)(A), even though the test had been the same

until then. The proposed change would conform the affiliation test of section 165(g)(3)(A) to the

test in section 1504(a)(2), effective for taxable years beginning after December 31, 1984.

Work opportunity tax credit.–Section 51(d)(2) refers to eligibility for the work opportunity

tax credit with respect to certain welfare recipients without taking into account the enactment of the

temporary assistance for needy families (“TANF”) program. The proposed changes would

conform references in the work opportunity tax credit to the operation of TANF, effective as if

included in the amendments made by section 1201 of the Small Business Job Protection Act of

1996.

IRAs for nonworking spouses.--Section 1427 of the Small Business Job Protection Act of

1996 expanded the IRA deduction for nonworking spouses. The maximum permitted IRA

contributions is generally limited by the individual’s earned income. However, under present law,

it is possible for a nonworking (or lesser earning) spouse to make IRA contributions in excess of

the couple’s combined earned income. The following example illustrates present law.
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Example: Suppose H and W retire in the middle of January, 1999. In that year, H

earns $1,000 and W earns $500. Both are active participants in an employersponsored retirement plan. Their modified AGI is $60,000. They make no Roth

IRA contributions. Before application of the income phase-out rules, the maximum

deductible IRA contribution that H can make is $1,000 (sec. 219(b)(1)). After

application of the income phase-out rule in section 219(g), H’s maximum

contribution is $200, and H contributes that amount to an IRA. Under 408(o)(2)(B),

H can make nondeductible contributions of $800 ($1,000 - $200).

W’s maximum permitted deductible contribution under section 219(c)(1)(B), before

the income phase-out, is $1,300 (the sum of H and W’s earned income ($1,500), less

H’s deductible IRA contribution ($200)). Under the income phase-out, W’s

deductible contribution is limited to $200, and she can make a nondeductible

contribution of $1,000 ($1,300 - $200).

The total permitted contributions for H and W are $2,300 ($1,000 for H plus $1,300

for W). The combined contribution should be limited to $1,500, their combined

earned income.

The proposed change would provide that the contributions for the spouse with the lesser

income cannot exceed the combined earned income of the spouses. The proposed change would be

effective as if included with section 1427 of the Small Business Job Protection Act of 1996 (i.e.,

for taxable years beginning after December 31, 1996).

Insurance.--The legislative history of section 7702A(a) (enacted in the Technical and

Miscellaneous Revenue Act of 1988) indicated that if a life insurance contract became a modified

endowment contract (“MEC”), then the MEC status could not be eliminated by exchanging the MEC

for another contract. Section 7702A(a)((2), however, arguably might be read to allow a

policyholder to exchange a MEC for a contract that does not fail the 7-pay test of section 7702A(b),

then exchange the second contract for a third contract, which would not literally have been received

in exchange for a contract that failed to meet the 7-pay test. The proposed change would clarify

section 7702A(a)(2) to correspond to the legislative history, effective as if enacted with the

Technical and Miscellaneous Revenue Act of 1988 (generally, for contracts entered into on or after

June 21, 1988).

Insurance.--Under section 7702A, if a life insurance contract that is not a modified

endowment contract is actually or deemed exchanged for a new life insurance contract, then the 7-

pay limit under the new contract is first be computed without reference to the premium paid using

the cash surrender value of the old contract, and then would be reduced by 1/7 of the premium paid

taking into account the cash surrender value of the old contract. For example, if the old contract had

a cash surrender value of $14,000 and the 7-pay premium on the new contract would equal $10,000

per year but for the fact that there was an exchange, the 7-pay premium on the new contract would

equal $8,000 ($10,000 - $14,000/7). However, section 7702a(c)(3)(A) arguably might be read to

suggest that if the cash surrender value on the new contract was $0 in the first two years (due to

surrender charges), then the 7-pay premium might be $10,000 in this example, unintentionally
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permitting policyholders to engage in a series of “material changes” to circumvent the premium

limitations in section 7702A. The proposed change would clarify section 7702A(c)(3)(A) to refer

to the cash surrender value of the old contract, effective as if enacted with the Technical and

Miscellaneous Revenue Act of 1988 (generally, for contracts entered into on or after June 21,

1988).

Definition of lump-sum distribution.--Section 1401(b) of the Small Business Job Protection

Act of 1996 Act repealed 5-year averaging for lump-sum distributions. The definition of lump-sum

distribution was preserved for other provisions, primarily those relating to NUA in employer

securities. The definition was moved from section 402(d)(4)(A) to section 402(e)(4)(D)(i). This

definition included the following sentence: “A distribution of an annuity contract from a trust or

annuity plan referred to in the first sentence of this subparagraph shall be treated as a lump sum

distribution.” The proposed change would add this language back into the definition of lump-sum

distribution, effective as if included with section 1401 of the Small Business Job Protection Act of

1996. The sentence is relevant to section 401(k)(10)(B), which permits certain distributions if

made as a “lump-sum distribution.”

Losses from section 1256 contracts.--Section 6411 allows tentative refunds for NOL

carrybacks, business credit carrybacks and, for corporations only, capital loss carrybacks. 

Individuals normally cannot carry back a capital loss. However, section 1212(c) does allow a

carryback of section 1256 losses, if elected by the taxpayer. The proposed change would amend

section 6411(a) by including a reference to section 1212(c), effective as if included with section

504 of the Economic Recovery Tax Act of 1981.

Clerical changes

Individual.--Section 67(f), as enacted in 1988, has a cross reference to “the last sentence of

section 162(a).” Additional “last sentences” were later added at the end of section 162(a) in 1992

and 1997. The proposed change would correct the reference in section 67(f).

Excess contributions.--The proposed change would modify the heading for section

408(d)(5) to “Distributions of excess contributions after due date for taxable year and certain

excess rollover contributions.”

Qualified State tuition programs.--Under section 529(e)(3)(B) (enacted in the Small

Business Job Protection Act of 1996), qualified higher education expenses include room and board

expenses of a designated beneficiary who is enrolled at least half-time in a degree program,

regardless of whether the qualified state tuition program is a prepaid (i.e., guaranteed) program or a

savings program. Therefore, the proposed change would delete the words “under guaranteed

plans” from the heading of section 529(e)(3)(B).

S corporations.--Sections 678(e) and 6103(e)(1)(D)(v) refer to “an electing small business

corporation under subchapter S of chapter 1.” The reference was inadvertently not changed to “S

corporation” when the Subchapter S Revision Act was enacted in 1982, and the proposed change

would correct the reference.
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Foreign–Military FSCs.--The Tax Reform Act of 1976 added section 995(b)(3)(B), limiting

DISC benefits relating to “military property,” which is defined by reference to a list under the

“Military Security Act of 1954.” That Act properly was titled the “Mutual Security Act of 1954,”

and it had been repealed and superseded by the “International Security Assistance and Arms Export

Control Act of 1976" (signed into law June 30, 1976). Section 923 (relating to FSCs) also refers

to the definition in section 995(b)(3)(B). Treasury regulations correctly reference the International

Security Assistance and Arms Export Control Act of 1976. The proposed change would name the

correct Act in the statute.

Private foundation excise taxes.--Section 4946 provides a definition of “government

official” for purposes of determining acts of self-dealing under section 4941. In section 

4946(c)(3)(B), the definition refers to “compensation at the lowest rate prescribed for GS-16 . . .”. 

The proposed change would change this language so that it refers to compensation at the lowest 

rate prescribed for Senior Executive Service (SES) positions.
 ERRATA for JCX-46-99

Joint Committee on Taxation

July 20, 1999

1. On page 5, line 2, “one” should be “once.”

2. On page 11, the last sentence in the carryover paragraph at the top of the page should

read as follows: “Second, the maximum amount of eligible employment-related expenses

($2,400/$4,800) would be indexed for inflation beginning in 2001.”

3. On page 20, in the first sentence in the Description of Proposal, “2005” should read

“2003.”

4. On page 27, the sentence under Effective Date should read as follows: “The proposal

would be effective for years beginning after December 31, 2000.”

5. On page 37, the following should be added at the end of the first sentence of the second

full paragraph: “(maintained by a State or local government).”

6. On page 116, in the Effective Date, strike the words “in taxable years beginning.”