TECHNICAL EXPLANATION OF THE

“ECONOMIC SECURITY AND WORKER ASSISTANCE ACT OF 2001”

Prepared by

the Staff of the

JOINT COMMITTEE ON TAXATION

December 19, 2001

JCX-91-01
i

CONTENTS

Page

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

I. SUPPLEMENTAL STIMULUS PAYMENTS (sec. 101 of the bill and sec. 6428 

of the Code)............................................................................................................................... 2

II. INDIVIDUAL PROVISIONS .................................................................................................. 4

A. Accelerate the 25-Percent Rate Bracket to 2002 (sec. 102 of the bill and sec. 1 

of the Code)......................................................................................................................... 4

B. Alternative Minimum Tax Exemption for Individuals (sec. 102(b) of the bill and 

sec. 55 of the Code)............................................................................................................. 5

III. BUSINESS PROVISIONS ....................................................................................................... 6

A. Special Depreciation Allowance for Certain Property (sec. 201 of the bill and 

sec. 168 of the Code)........................................................................................................... 6

B. Temporary Increase in Section 179 Expensing (sec. 202 of the bill and sec. 179 

of the Code)....................................................................................................................... 10

C. Modify Alternative Minimum Tax (sec. 203 of the bill and secs. 56 and 59 of 

the Code)........................................................................................................................... 11

D. Five-Year Carryback of Net Operating Losses (sec. 204 of the bill and secs. 172 

and 56 of the Code)........................................................................................................... 12

E. Treatment of Leasehold Improvements (sec. 205 of the bill and sec. 168 of the Code) . 14

IV. EXTENSIONS OF CERTAIN EXPIRING PROVISIONS................................................... 17

A. Extend Alternative Minimum Tax Relief for Individuals (sec. 301 of the bill and 

sec. 26 of the Code)........................................................................................................... 17

B. Extend Credit for Purchase of Electric Vehicles (sec. 302 of the bill and secs. 30 

and 280F of the Code)....................................................................................................... 19

C. Extend Section 45 Credit for Production of Electricity from Wind, Closed Loop 

Biomass, and Poultry Litter (sec. 303 of the bill and sec. 45 of the Code)....................... 20

D. Extend the Work Opportunity Tax Credit (sec. 304 of the bill and sec. 51 of the Code). 21

E. Extend the Welfare-To-Work Tax Credit (sec. 305 of the bill and sec. 51A of 

the Code)........................................................................................................................... 22

F. Extend Deduction for Qualified Clean-Fuel Vehicle Property and Qualified 

Clean-Fuel Vehicle Refueling Property (sec. 306 of the bill and secs. 179A and 

280F of the Code) ............................................................................................................. 23

G. Taxable Income Limit on Percentage Depletion for Marginal Production (sec. 307 

of the bill and sec. 613A of the Code) .............................................................................. 25

H. Extension of Authority to Issue Qualified Zone Academy Bonds (sec. 308 of the bill 

and sec. 1397E of the Code) ............................................................................................. 27

I. Extension of Increased Coverover Payments to Puerto Rico and the Virgin Islands 

(sec. 309 of the bill and sec. 7652 of the Code)................................................................ 29

J. Tax on Failure to Comply with Mental Health Parity Requirements (sec. 310 of 

the bill and sec. 9812(f) of the Code)................................................................................ 30

K. Suspension of Reduction of Deductions for Mutual Life Insurance Companies 

(sec. 311 of the bill and sec. 809 of the Code).................................................................. 31
ii

L. Extension of Archer Medical Savings Accounts ("MSAs") (sec. 312 of the bill and 

sec. 220 of the Code)......................................................................................................... 33

M. Extension of Tax Incentives for Investment on Indian Reservations (sec. 313 

of the bill and secs. 45A and 168(j) of the Code) ............................................................. 36

N. Extension and Modification of Exceptions under Subpart F for Active Financing 

Income (sec. 314 of the bill and secs. 953 and 954 of the Code) ..................................... 38

O. Repeal of Dyed-Fuel Requirement for Registered Diesel or Kerosene Terminals 

(sec. 315 of the bill and sec. 4101 of the Code)................................................................ 41

V. TEMPORARY ASSISTANCE TO NEEDY FAMILIES PROVISIONS (secs. 321 - 322 

of the bill)................................................................................................................................ 42

A. Reauthorization of TANF Supplemental Grants for Population Increases For 

Fiscal Year 2002............................................................................................................... 42

B. 1-Year Extension of Contingency Fund Under the TANF Program................................ 43

VI. TAX BENEFITS FOR AREA OF NEW YORK CITY DAMAGED IN TERRORIST

ATTACKS ON SEPTEMBER 11, 2001 ................................................................................ 44

A. Special Depreciation Allowance for Certain Property (sec. 401(a) of the bill and 

new sec. 1400L of the Code) ............................................................................................ 44

B. Treatment of Qualified Leasehold Improvement Property (sec. 401(b) of the bill 

and new sec. 1400L of the Code)...................................................................................... 47

C. Increase in Expensing Treatment for Business Property Used in the New York 

Liberty Zone (sec. 401(c) of the bill and new sec. 1400L of the Code) ........................... 49

D. Authorize Issuance of Tax-Exempt Private Activity Bonds for Rebuilding the 

Portion of New York City Damaged in the September 11, 2001, Terrorist Attack 

(sec. 401(d) of the bill and new sec. 1400L of the Code)................................................. 51

E. Extension of Replacement Period for Certain Property Involuntarily Converted 

in the New York Liberty Zone (sec. 401(e) of the bill and new sec. 1400L 

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

VII. RELIEF PROVISIONS FOR VICTIMS OF TERRORIST ATTACKS, PRESIDENTIALLY 

DECLARED DISASTERS, AND CERTAIN OTHER DISASTERS ................................... 57

A. Background ....................................................................................................................... 57

B. Relief Provisions for Victims of Specific Terrorist Attacks ............................................. 60

1. Income taxes of victims of terrorist attacks (sec. 501 of the bill and sec. 692 of the 

Code)........................................................................................................................... 60

2. Exclusion of certain death benefits (sec. 502 of the bill and sec. 101 of the Code) ... 62

3. Estate tax reduction (sec. 503 of the bill and sec. 2201 of the Code)......................... 64

4. Payments by charitable organizations treated as exempt payments (sec. 504 of the bill 

and secs. 501 and 4941 of the Code) .......................................................................... 65

5. Exclusion for certain cancellations of indebtedness (sec. 505 of the bill).................. 67

C. Other Relief Provisions..................................................................................................... 69

1. Exclusion of disaster relief payments (sec. 511 of the bill and new sec. 139 of the 

Code)........................................................................................................................... 69

2. Authority to postpone certain deadlines and required actions (sec. 512 of the 

bill, sec. 7508A of the Code, and new sec. 518 and sec. 4002 of the Employee 

Retirement Income Security Act of 1974).................................................................. 74
iii

3. Application of certain provisions to terroristic or military actions (sec. 513 of the 

bill and secs. 104 and 692 of the Code)...................................................................... 77

4. Clarification that the special deposit rules provided under the Air Transportation 

Safety and Stabilization Act do not apply to employment taxes (sec. 514 of the 

bill and sec. 301 of the Air Transportation Safety and Stabilization Act) .................. 78

5. Treatment of purchase of structured settlements (sec. 515 of the bill and new sec. 

5891 of the Code)........................................................................................................ 78

6. Personal exemption deduction for certain disability trusts (sec. 516 of the bill and 

sec. 642 of the Code)................................................................................................... 80

7. Disclosure of tax information in terrorism and national security investigations 

(sec. 517 of the bill and sec. 6103 of the Code).......................................................... 82

VIII. MISCELLANEOUS AND TECHNICAL PROVISIONS................................................... 89

A. Allowance of Electronic Forms 1099 (sec. 601 of the bill).............................................. 89

B. Discharge of Indebtedness of an S Corporation (sec. 602 of the bill and sec. 108 of 

the Code)........................................................................................................................... 90

C. Limitation on Use of Non-Accrual Experience Method of Accounting (sec. 603 of the 

bill and sec. 448 of the Code) ........................................................................................... 92

D. Expansion of the Exclusion from Income for Qualified Foster Care Payments 

(sec. 604 of the bill and sec. 131 of the Code).................................................................. 94

E. Interest Rate Used in Determining Additional Required Contributions to Defined 

Benefit Plans and PBGC Variable Rate Premiums (sec. 605 of the bill, sec. 412 

of the Code, and secs. 302 and 4006 of ERISA)............................................................... 95

F. Deduction for Classroom Materials (sec. 606 of the bill and sec. 62 of the Code) .......... 98

IX. TAX TECHNICAL CORRECTIONS (secs. 611-618 of the bill).......................................... 99

X. UNEMPLOYMENT ASSISTANCE PROVISIONS (secs. 701-709 of the bill)................. 109

A. Unemployment Assistance.............................................................................................. 109

B. Special Reed Act Transfer in Fiscal Year 2002.............................................................. 110

XI. DISPLACED WORKER HEALTH INSURANCE CREDIT (secs. 801 and 802 of the bill 

and new sec. 6429 of the Code)............................................................................................ 112

XII. EMPLOYMENT AND TRAINING ASSISTANCE AND TEMPORARY HEALTH 

CARE COVERAGE ASSISTANCE (NATIONAL EMERGENCY GRANTS) 

(sec. 901 of the bill).............................................................................................................. 115

XIII. TEMPORARY STATE HEALTH CARE ASSISTANCE (sec. 1001 of the bill) .............117

XIV. NO IMPACT ON SOCIAL SECURITY TRUST FUNDS (sec. 1101 of the bill)............ 118

XV. EMERGENCY DESIGNATION (sec. 1102 of the bill)..................................................... 119
1

INTRODUCTION

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

technical explanation of the “Economic Security and Worker Assistance Act of 2001.”

 

1

 This document may be cited as follows: Joint Committee on Taxation, Technical 

Explanation of the “Economic Security and Worker Assistance Act of 2001” (JCX-91-01), 

December 19, 2001.
2

I. SUPPLEMENTAL STIMULUS PAYMENTS

(sec. 101 of the bill and sec. 6428 of the Code)

Present Law

The Economic Growth and Tax Relief Reconciliation Act of 2001 provided for a rate 

reduction credit for 2001. The credit is computed in the following manner. Taxpayers are 

entitled to a credit in tax year 2001 of 5 percent (the difference between the 15-percent rate and 

the 10-percent rate) of the amount of income that would have been eligible for the new 10-

percent rate. Taxpayers may not receive this credit in excess of their income tax liability 

(determined after nonrefundable credits).

Most eligible taxpayers have received this credit in the form of a check issued by the 

Department of the Treasury. The amount of the check was computed in the same manner as the 

credit, except that it was done on the basis of tax returns filed for 2000 (instead of 2001).

On their tax returns for 2001, taxpayers will reconcile the amount of the credit with the 

check they receive in the following manner. They will complete a worksheet calculating the 

amount of the credit based on their 2001 tax return. They will then subtract from the credit the 

amount of the check they received. For many taxpayers, these two amounts will be the same. If, 

however, the result is a positive number (because, for example, the taxpayer paid no tax in 2000 

but is paying tax in 2001), the taxpayer may claim that amount as a credit against 2001 tax 

liability. If, however, the result is negative (because, for example, the taxpayer paid tax in 2000 

but owes no tax for 2001), the taxpayer is not required to repay that amount to the Treasury. 

Otherwise, the checks have no effect on tax returns filed in 2001; the amount is not includible in 

gross income and it does not otherwise reduce the amount of withholding. In no event may the 

Department of the Treasury issue checks after December 31, 2001. This is designed to prevent 

errors by taxpayers who might claim the full amount of the credit on their 2001 tax returns and 

file those returns early in 2002, at the same time the Treasury check might be mailed to them. 

Payment of the credit (or the check) is treated, for all purposes of the Code,2 as a payment of tax. 

As such, the credit or the check is subject to the refund offset provisions, such as those 

applicable to past-due child support under section 6402 of the Code.

In general, taxpayers eligible for the credit (and the check) are individuals other than 

estates or trusts, nonresident aliens, or dependents. The determination of this status for the 

relevant year is made on the basis of the information filed on the tax return.

Explanation of Provision

The bill provides for new supplemental stimulus payments. Individuals who filed income 

tax returns for 20003 before October 16, 2001 (regardless of whether they had any income tax 

 

2

 A special rule provides that no interest will be paid with respect to the checks.

3

 Taxpayers who did not file an income tax return for 2000 but who do file an income tax 

return for 2001 will continue to be eligible for the rate reduction credit previously enacted, the 
3

liability, any payroll tax liability, or showed any amount as wages) are eligible for this payment. 

The amount of the payment is calculated in the following manner: taxpayers are eligible for the 

maximum payment amount for their filing status ($300 single or married filing separately, $500 

head of household, $600 joint filers) minus the amount (if any) of any previous rebate check 

issued. Thus, for example, if a single person received $100 earlier this year as her rate reduction 

credit, she will receive an additional $200 as a supplemental stimulus payment. Those taxpayers 

who earlier received the full amount for their filing status will receive no supplemental stimulus 

payment.

Dependents and nonresident aliens generally are ineligible for these supplemental 

stimulus payments (as they were for the previous rebates). It is expected that the IRS will send 

notices to affected taxpayers explaining the computation of their supplemental stimulus payment 

amounts and how the taxpayer should properly complete the rebate reconciliation schedule 

contained in the tax return forms package.

Effective Date

The provision is effective on the date of enactment. In order to prevent difficulties that 

could arise in the simultaneous administration of the rebate and supplemental stimulus payment 

provisions, the issuance of checks under the previous rebate provision is required to cease on the 

earlier of the date of enactment of the supplemental stimulus payment provision or December 31, 

2001.

 

amount of which is dependent upon the amount of income subject to the 10-percent rate. They 

are not, however, eligible for this stimulus payment.
4

II. INDIVIDUAL PROVISIONS

A. Accelerate the 25-Percent Rate Bracket to 2002 

(sec. 102 of the bill and sec. 1 of the Code)

Present Law

The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) reduced 

the prior-law 28-percent individual regular income tax rate to 25 percent. This rate reduction is 

phased-in over six years. The rate is 27 percent for taxable years beginning in calendar years 

2001-2003,4 26 percent for taxable years beginning in calendar years 2004-2005, and 25 percent 

for taxable years beginning in calendar years 2006 and thereafter.

Explanation of Provision

The bill provides that the 25-percent rate is effective for taxable years beginning after 

December 31, 2001.

Effective Date

The provision is effective for taxable years beginning after December 31, 2001.

 

4

 A blended rate of 27.5 percent applies in 2001 because of the July 1, 2001 effective date 

of EGTRRA.
5

B. Alternative Minimum Tax Exemption for Individuals

(sec. 102(b) of the bill and sec. 55 of the Code)

Present Law

The alternative minimum tax is the amount by which the tentative minimum tax exceeds 

the regular income tax. An individual’s tentative minimum tax is an amount equal to (1) 26 

percent of the first $175,000 ($87,500 in the case of a married individual filing a separate return) 

of alternative minimum taxable income (“AMTI”) in excess of a phased-out exemption amount 

and (2) 28 percent of the remaining AMTI. The maximum tax rates on net capital gain used in 

computing the tentative minimum tax are the same as under the regular tax. AMTI is the 

individual’s taxable income adjusted to take account of specified preferences and adjustments. 

The exemption amounts are: (1) $45,000 ($49,000 in taxable years beginning before 2005) in the 

case of married individuals filing a joint return and surviving spouses; (2) $33,750 ($35,750 in 

taxable years beginning before 2005) in the case of other unmarried individuals; (3) $22,500 

($24,500 in taxable years beginning before 2005) in the case of married individuals filing a 

separate return; and (4) $22,500 in the case of an estate or trust. The exemption amounts are 

phased out by an amount equal to 25 percent of the amount by which the individual's AMTI 

exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving 

spouses, (2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of 

married individuals filing separate returns or an estate or a trust. These amounts are not indexed 

for inflation.

Explanation of Provision

For 2002 and 2003, the $49,000 exemption amount is increased by $3,200; the $35,750 

exemption amount is increased by $1,600; and the $24,500 exemption amount is increased by 

$1,600.

For 2004, the $49,000 exemption amount is increased by $1,700; the $35,750 exemption 

amount is increased by $850; and the $24,500 exemption amount is increased by $850.

Effective Date

The provision is effective for taxable years beginning after December 31, 2001 and 

before January 1, 2005.
6

III. BUSINESS PROVISIONS

A. Special Depreciation Allowance for Certain Property

(sec. 201 of the bill and sec. 168 of the Code)

Present Law 

Depreciation deductions 

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of 

certain property used in a trade or business or for the production of income. The amount of the 

depreciation deduction allowed with respect to tangible property for a taxable year is determined 

under the modified accelerated cost recovery system (“MACRS”). Under MACRS, different 

types of property generally are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property (generally tangible property 

other than residential rental property and nonresidential real property) range from 3 to 25 years. 

The depreciation methods generally applicable to tangible personal property are the 200-percent 

and 150-percent declining balance methods, switching to the straight-line method for the taxable 

year in which the depreciation deduction would be maximized. 

Section 280F limits the annual depreciation deductions with respect to passenger 

automobiles to specified dollar amounts, indexed for inflation.

Section 167(f)(1) provides that capitalized computer software costs, other than computer 

software to which section 197 applies, are recovered ratably over 36 months. 

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment 

generally may elect to deduct up to $24,000 (for taxable years beginning in 2001 or 2002) of the 

cost of qualifying property placed in service for the taxable year (sec. 179). This amount is 

increased to $25,000 for taxable years beginning in 2003 and thereafter. 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. 

Explanation of Provision

The provision allows an additional first-year depreciation deduction equal to 30 percent 

of the adjusted basis of qualified property. The additional first-year depreciation deduction is 

allowed for both regular tax and alternative minimum tax purposes for the taxable year in which 

the property is placed in service.5 The basis of the property and the depreciation allowances in 

the year of purchase and later years are appropriately adjusted to reflect the additional first-year 

 

5

 The additional first-year depreciation deduction is subject to the general rules regarding 

whether an item is deductible under section 162 or subject to capitalization under section 263 or 

section 263A. 
7

depreciation deduction. A taxpayer is allowed to elect out of the additional first-year 

depreciation for any class of property for any taxable year.

In order for property to qualify for the additional first-year depreciation deduction it must 

meet all of the following requirements. First, the property must be property to which the general 

rules of MACRS6 apply with (1) an applicable recovery period of 20 years or less (except for 

qualified leasehold improvement property7), (2) water utility property (as defined in section 

168(e)(5)), or (3) computer software other than computer software covered by section 197. 

Second, the original use8 of the property must commence with the taxpayer on or after 

September 11, 2001.9 Third, the taxpayer must purchase the property within the applicable time 

period. Finally, the property must be placed in service before January 1, 2005. An extension of 

the place in service date of one year (i.e., January 1, 2006) is provided for certain property with a 

recovery period of ten years or longer and certain transportation property. 10 Transportation 

 

6

 A special rule precludes the additional first-year depreciation deduction for property 

that is required to be depreciated under the alternative depreciation system of MACRS.

7

 Qualified leasehold improvement property (which includes qualified New York Liberty 

Zone leasehold improvement property) means property defined in section 168(e)(6). Section 

168(e)(6) is added by section 205 of the bill. 

8

 The term “original use” means the first use to which the property is put, whether or not 

such use corresponds to the use of such property by the taxpayer. It is intended that, when 

evaluating whether property qualifies as “original use,” the factors used to determine whether 

property qualified as “new section 38 property” for purposes of the investment tax credit would 

apply. See Treasury Regulation 1.48-2. Thus, it is intended that additional capital expenditures 

incurred to recondition or rebuild acquired property (or owned property) would satisfy the 

“original use” requirement. However, the cost of reconditioned or rebuilt property acquired by 

the taxpayer would not satisfy the “original use” requirement. For example, if on February 1, 

2002, a taxpayer buys from X for $20,000 a machine that has been previously used by X. Prior 

to September 11, 2004, the taxpayer makes an expenditure on the property of $5,000 of the type 

that must be capitalized. Regardless of whether the $5,000 is added to the basis of such property 

or is capitalized as a separate asset, such amount would be treated as satisfying the “original use” 

requirement and would be qualified property (assuming all other conditions are met). No part of 

the $20,000 purchase price would qualify for the additional first year depreciation. 

9

 A special rule applies in the case of certain leased property. In the case of any property 

that is originally placed in service by a person and that is sold to the taxpayer and leased back to 

such person by the taxpayer within three months after the date that the property was placed in 

service, the property would be treated as originally placed in service by the taxpayer not earlier 

than the date that the property is used under the leaseback.

10 In order for property to qualify for the extended placed in service date, the property is 

required to have a production period exceeding two years or an estimated production period 

exceeding one year and a cost exceeding $1 million.
8

property is defined as tangible personal property used in the trade or business of transporting 

persons or property.

The applicable time period for acquired property is (1) after September 10, 2001 and 

before September 11, 2004, and no binding written contract for the acquisition is in effect before 

September 11, 2001 or (2) pursuant to a binding written contract which was entered into after 

September 10, 2001, and before September 11, 2004. With respect to property that is 

manufactured, constructed, or produced by the taxpayer for use by the taxpayer, the taxpayer 

must begin the manufacture, construction, or production of the property after September 10, 

2001, and before September 11, 2004. Property that is manufactured, constructed, or produced 

for the taxpayer by another person under a contract that is entered into prior to the manufacture, 

construction, or production of the property is considered to be manufactured, constructed, or 

produced by the taxpayer. For property eligible for the extended placed in service date, a special 

rule limits the amount of costs eligible for the additional first year depreciation. With respect to 

such property, only the portion of the basis that is properly attributable to the costs incurred 

before September 11, 2004 (“progress expenditures”) shall be eligible for the additional first year 

depreciation.11 

The limitation on the amount of depreciation deductions allowed with respect to certain 

passenger automobiles (sec. 280F of the Code) is increased in the first year by $4,600 for 

automobiles that qualify (and do not elect out of the increased first year deduction). The $4,600 

increase is not indexed for inflation.

The following examples illustrate the operation of the provision. 

EXAMPLE 1. -- Assume that on March 1, 2002, a calendar year taxpayer acquires and 

places in service qualified property that costs $1 million. Under the provision, the taxpayer is 

allowed an additional first-year depreciation deduction of $300,000. The remaining $700,000 of 

adjusted basis is recovered in 2002 and subsequent years pursuant to the depreciation rules of 

present law. 

EXAMPLE 2. -- Assume that on March 1, 2002, a calendar year taxpayer acquires and 

places in service qualified property that costs $50,000. In addition, assume that the property 

qualifies for the expensing election under section 179. Under the provision, the taxpayer is first 

allowed a $35,000 deduction under section 179.12 The taxpayer then is allowed an additional 

first-year depreciation deduction of $4,500 based on $15,000 ($50,000 original cost less the 

section 179 deduction of $35,000) of adjusted basis. Finally, the remaining adjusted basis of 

$10,500 ($15,000 adjusted basis less $4,500 additional first-year depreciation) is to be recovered 

in 2002 and subsequent years pursuant to the depreciation rules of present law. 

 

11 For purposes of determining the amount of eligible progress expenditures, it is intended 

that rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply. 

12 A subsequent provision in the bill increases the amount deductible in 2002 under 

section 179 to $35,000.
9

Effective Date

The provision applies to property placed in service after September 10, 2001.
10

B. Temporary Increase in Section 179 Expensing

(sec. 202 of the bill and sec. 179 of the Code)

Present Law

Present law provides that, in lieu of depreciation, a taxpayer with a sufficiently small 

amount of annual investment may elect to deduct up to $24,000 (for taxable years beginning in 

2001 or 2002) of the cost of qualifying property placed in service for the taxable year (sec. 179). 

This amount is increased to $25,000 of the cost of qualified property placed in service for taxable 

years beginning in 2003 and thereafter. 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 $24,000 ($25,000 for taxable years beginning in 2003 and thereafter) 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). No general business credit under 

section 38 is allowed with respect to any amount for which a deduction is allowed under section 

179.

Explanation of Provision

The provision provides that the maximum dollar amount that may be deducted under 

section 179 is increased to $35,000 for property placed in service in taxable years beginning after 

December 31, 2001, and before January 1, 2004.13 The provision increases the present law 

$200,000 limit to $325,000. Thus, under the provision the $35,000 amount is reduced by the 

amount by which the cost of qualifying property placed in service exceeds $325,000. As under 

present law, no general business credit under section 38 is allowed with respect to any amount 

for which a deduction is allowed under section 179. For taxable years beginning after 

December 31, 2003, present law applies (i.e., up to a $25,000 deduction that is reduced by the 

amount of qualifying property placed in service by the taxpayer that exceeds $200,000).

Effective Date

The provision is effective for taxable years beginning after December 31, 2001. 

 

13 As a result of the increased deduction, the maximum dollar amount that may be 

deducted by an enterprise zone business, a renewal community business, or a business located in 

the New York Liberty Zone (see section 401 of the bill) is increased to $70,000 for taxable years 

beginning after December 31, 2001, and before January 1, 2004. See sec. 1397A, sec. 1400J, 

and sec 1400L. 
11

C. Modify Alternative Minimum Tax

(sec. 203 of the bill and secs. 56 and 59 of the Code)

Present Law

Present law imposes an alternative minimum tax (“AMT”) on an individual or a 

corporation to the extent the taxpayer's tentative minimum tax exceeds its regular tax liability. 

The individual tentative minimum tax is computed at rates of 26 and 28 percent on alternative 

minimum taxable income (“AMTI”) in excess of a phased-out exemption amount; the corporate 

tentative minimum tax is computed at a rate of 20 percent on AMTI in excess of a phased-out 

$40,000 exemption amount. Corporations with average gross receipts of less than $7.5million 

are generally exempt from 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. In the case of a corporation, in addition 

to the regular set of adjustments and preferences, there is a second set of adjustments known as 

the "adjusted current earnings" adjustment.

One of the adjustments in computing AMTI is an adjustment for depreciation. In the case 

of property place in service after 1998, the 150-percent declining balance method is used rather 

than the 200-percent declining balance method, using the same recovery periods that are used for 

regular tax purposes. Other adjustments apply to property place in service before 1999.

A taxpayer’s net operating loss deduction may not exceed 90 percent of AMTI 

determined without regard to the deduction. Foreign tax credits cannot reduce a taxpayer’s 

tentative minimum tax by more than 90 percent of the amount of tentative minimum tax that 

would be computed without regard to the foreign tax credit and the net operating loss deduction.

Explanation of Provision

The provision repeals the minimum tax depreciation adjustments.

The provision repeals the 90-percent limitations on the use of the net operating loss 

deduction and foreign tax credits.

Effective Date

The provision applies to taxable years beginning after December 31, 2001. The 

depreciation change applies to property placed in service in those years.
12

D. Five-Year Carryback of Net Operating Losses

(sec. 204 of the bill and secs. 172 and 56 of the Code)

Present Law

A net operating loss (“NOL”) is, generally, the amount by which a taxpayer’s allowable 

deductions exceed the taxpayer’s gross income. A carryback of an NOL generally 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.

In general, an NOL may be carried back two years and carried forward 20 years to offset 

taxable income in such years. Different rules apply with respect to NOLs arising in certain 

circumstances. For example, a three-year carryback applies with respect to NOLs (1) arising 

from casualty or theft losses of individuals, or (2) attributable to Presidentially declared disasters 

for taxpayers engaged in a farming business or a small business. A five-year carryback period 

applies to NOLs from a farming loss (regardless of whether the loss was incurred in a 

Presidentially declared disaster area). Special rules also apply to real estate investment trusts (no 

carryback), specified liability losses (10-year carryback), and excess interest losses (no carryback 

to any year preceding a corporate equity reduction transaction).

The alternative minimum tax rules provide that a taxpayer’s NOL deduction cannot 

reduce the taxpayer’s alternative minimum taxable income (“AMTI”) by more than 90 percent of 

the AMTI.

Explanation of Provision

The provision temporarily extends the general NOL carryback period to five years (from 

two years) for NOLs arising in taxable years ending in 2001 and 2002.14 In addition, the fiveyear carryback period applies to NOLs from these years that qualify under present law for a 

three-year carryback period (i.e., NOLs arising from casualty or theft losses of individuals or 

attributable to certain Presidentially declared disaster areas). 

 

14 The provision does not affect the terms and conditions that the Internal Revenue 

Service may impose on a taxpayer seeking approval for a change in its annual accounting period. 

See e.g., Rev. Proc. 2000-11, 2000-1 C.B. 309, sec. 5.06 (“If the corporation (or consolidated 

group) has a NOL (or consolidated NOL) in the short period required to effect the change, the 

NOL may not be carried back but must be carried over in accordance with the provisions of sec. 

172 beginning with the first taxable year after the short period. However, the short period NOL 

(or consolidated NOL) is carried back or carried over in accordance with sec. 172 if it is either: 

(a) $50,000 or less, or (b) results from a short period of 9 months or longer and is less than the 

NOL (or the consolidated NOL) for a full 12-month period beginning with the first day of the 

short period.”)
13

The provision also allows an NOL deduction attributable to these taxable years to offset 

100 percent of a taxpayer’s AMTI in a carryback year.15 

A taxpayer can elect to forgo the five-year carryback period. The election to forgo the 

five-year carryback period is made in the manner prescribed by the Secretary of the Treasury and 

must be made by the due date of the return (including extensions) for the year of the loss. The 

election is irrevocable. If a taxpayer elects to forgo the five-year carryback period, then the 

losses are subject to the rules that otherwise would apply under section 172 absent the provision.

Effective Date

The provision is effective for net operating losses generated in taxable years ending after 

December 31, 2000.

 

15 Section 172(b)(2) should be appropriately applied in computing AMTI to take proper 

account of the order that the NOL carryovers and carrybacks are used as a result of this 

provision. See section 56(d)(1)(B)(ii). A separate provision (section 203) repeals the 90 percent 

NOL limitation under the AMT rules for taxable years beginning after December 31, 2001.
14

E. Treatment of Leasehold Improvements 

(sec. 205 of the bill and sec. 168 of the Code)

Present Law

Depreciation of leasehold improvements

Depreciation allowances for property used in a trade or business generally are determined 

under the modified Accelerated Cost Recovery System ("MACRS") of section 168. 

Depreciation allowances for improvements made on leased property are determined under 

MACRS, even if the MACRS recovery period assigned to the property is longer than the term of 

the lease (sec. 168(i)(8)).16 This rule applies regardless whether the lessor or lessee places the 

leasehold improvements in service.17 If a leasehold improvement constitutes an addition or 

improvement to nonresidential real property already placed in service, the improvement is 

depreciated using the straight-line method over a 39-year recovery period, beginning in the 

month the addition or improvement was placed in service (secs. 168(b)(3), (c)(1), (d)(2), and 

(i)(6)).18

Treatment of dispositions of leasehold improvements

A lessor of leased property that disposes of a leasehold improvement which was made by 

the lessor for the lessee of the property may take the adjusted basis of the improvement into 

account for purposes of determining gain or loss if the improvement is irrevocably disposed of or 

abandoned by the lessor at the termination of the lease.19 This rule conforms the treatment of 

 

16 The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System 

("ACRS") to institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Act 

of 1981, taxpayers were allowed to depreciate the various components of a building as separate 

assets with separate useful lives. The use of component depreciation was repealed upon the 

adoption of ACRS. The Tax Reform Act of 1986 also denied the use of component depreciation 

under MACRS.

17 Former Code sections 168(f)(6) and 178 provided that in certain circumstances, a 

lessee could recover the cost of leasehold improvements made over the remaining term of the 

lease. These provisions were repealed by the Tax Reform Act of 1986.

18 If the improvement is characterized as tangible personal property, ACRS or MACRS 

depreciation is calculated using the shorter recovery periods and accelerated methods applicable 

to such property. The determination of whether certain improvements are characterized as 

tangible personal property or as nonresidential real property often depends on whether or not the 

improvements constitute a "structural component" of a building (as defined by Treas. Reg. sec. 

1.48-1(e)(1)). See, for example, Metro National Corp., 52 TCM 1440 (1987); King Radio Corp.,

486 F.2d 1091 (10th Cir., 1973); Mallinckrodt, Inc., 778 F.2d 402 (8th Cir., 1985) (with respect 

various leasehold improvements).

19 The conference report describing this provision mistakenly states that the provision 

applies to improvements that are irrevocably disposed of or abandoned by the lessee (rather than 

the lessor) at the termination of the lease.
15

lessors and lessees with respect to leasehold improvements disposed of at the end of a term of 

lease. For purposes of applying this rule, it is expected that a lessor must be able to separately 

account for the adjusted basis of the leasehold improvement that is irrevocably disposed of or 

abandoned. This rule does not apply to the extent section 280B applies to the demolition of a 

structure, a portion of which may include leasehold improvements.20

Explanation of Provision

The provision provides that 15-year property for purposes of the depreciation rules of 

section 168 includes qualified leasehold improvement property. The straight line method is 

required to be used with respect to qualified leasehold improvement property.

Qualified leasehold improvement property is any improvement to an interior portion of a 

building that is nonresidential real property, provided certain requirements are met. The 

improvement must be made under or pursuant to a lease either by the lessee (or sublessee) of that 

portion of the building, or by the lessor of that portion of the building. That portion of the 

building is to be occupied exclusively by the lessee (or any sublessee). The improvement must 

be placed in service more than three years after the date the building was first placed in service.

Qualified leasehold improvement property does not include any improveme nt for which 

the expenditure is attributable to the enlargement of the building, any elevator or escalator, any 

structural component benefiting a common area, or the internal structural framework of the 

building.

A 15-year period is specified as the class life of qualified leasehold improvement 

property for purposes of the alternative depreciation system. Therefore, the general rule that the 

class life for nonresidential real and residential rental property is 40 years does not apply to 

qualified leasehold improvement property.

For purposes of the provision, a commitment to enter into a lease is treated as a lease, and 

the parties to the commitment are treated as lessor and lessee. A lease between related persons is 

not considered a lease for this purpose.

Under the provision, an improvement made by the person who was the lessor of the 

improvement when it was placed in service generally is treated as qualified leasehold 

improvement property only so long as the improvement is held by that person. Exceptions are 

provided under this rule in the case of certain changes in form of business. Under these 

exceptions, property does not cease to be qualified leasehold improvement property under the 

provision by reason of (1) death, (2) a transaction to which section 381 (relating to carryovers in 

certain corporate acquisitions) applies, or (3) a mere change in the form of conducting the trade 

or business so long as the property is retained in the business as qualified leasehold improvement 

property and the taxpayer retains a substantial interest in the business. In the case of property 

that ceases to be treated as leasehold improvement property because the taxpayer fails to retain a 

 

20 Under present law, section 280B denies a deduction for any loss sustained on the 

demolition of any structure.
16

substantial interest in a trade or business in connection with such a mere change in form, the 

remaining adjusted basis of the property is depreciated over 39 years.

Qualified leasehold improvement property is not eligible for the 30 percent expensing 

provided under a separate provision of the bill.

Effective Date

The provision is effective for qualified leasehold improvement property placed in service 

on or after September 11, 2001.
17

IV. EXTENSIONS OF CERTAIN EXPIRING PROVISIONS

A. Extend Alternative Minimum Tax Relief for Individuals

(sec. 301 of the bill and sec. 26 of the Code)

Present Law

Present law provides for certain nonrefundable personal tax credits (i.e., the dependent 

care credit, the credit for the elderly and disabled, the adoption credit, the child tax credit21, the 

credit for interest on certain home mortgages, the HOPE Scholarship and Lifetime Learning 

credits, the IRA credit, and the D.C. homebuyer’s credit). For taxable years beginning after 

2001, these credits (other than the adoption credit, child credit and IRA credit) are allowed only 

to the extent that the individual’s regular income tax liability exceeds the individual’s tentative 

minimum tax, determined without regard to the minimum tax foreign tax credit. The adoption 

credit, child credit, and IRA credit are allowed to the full extent of the individual’s regular tax 

and alternative minimum tax.

For taxable years beginning in 2001, all the nonrefundable personal credits are allowed to 

the extent of the full amount of the individual’s regular tax and alternative minimum tax.

The alternative minimum tax is the amount by which the tentative minimum tax exceeds 

the regular income tax. An individual’s tentative minimum tax is an amount equal to (1) 26 

percent of the first $175,000 ($87,500 in the case of a married individual filing a separate return) 

of alternative minimum taxable income (“AMTI”) in excess of a phased-out exemption amount 

and (2) 28 percent of the remaining AMTI. The maximum tax rates on net capital gain used in 

computing the tentative minimum tax are the same as under the regular tax. AMTI is the 

individual’s taxable income adjusted to take account of specified preferences and adjustments. 

The exemption amounts are: (1) $45,000 ($49,000 in taxable years beginning before 2005) in the 

case of married individuals filing a joint return and surviving spouses; (2) $33,750 ($35,750 in 

taxable years beginning before 2005) in the case of other unmarried individuals; (3) $22,500 

($24,500 in taxable years beginning before 2005) in the case of married individuals filing a 

separate return; and (4) $22,500 in the case of an estate or trust. The exemption amounts are 

phased out by an amount equal to 25 percent of the amount by which the individual's AMTI 

exceeds (1) $150,000 in the case of married individuals filing a joint return and surviving 

spouses, (2) $112,500 in the case of other unmarried individuals, and (3) $75,000 in the case of 

married individuals filing separate returns or an estate or a trust. These amounts are not indexed 

for inflation.

Explanation of Provision

The provision allows an individual to offset the entire regular tax liability and alternative 

minimum tax liability by the personal nonrefundable credits in 2002 and 2003.

 

21 A portion of the child credit may be refundable.
18

Effective Date

The provision is effective for taxable years beginning in 2002 and 2003.
19

B. Extend Credit for Purchase of Electric Vehicles

(sec. 302 of the bill and secs. 30 and 280F of the Code)

Present Law

A 10-percent tax credit is provided for the cost of a qualified electric vehicle, up to a 

maximum credit of $4,000 (sec. 30). A qualified electric vehicle is a motor vehicle that is

powered primarily by an electric motor drawing current from rechargeable batteries, fuel cells, or 

other portable sources of electrical current, the original use of which commences with the 

taxpayer, and that is acquired for the use by the taxpayer and not for resale. The full amount of 

the credit is available for purchases prior to 2002. The credit phases down in the years 2002 

through 2004, and is unavailable for purchases after December 31, 2004.22

Explanation of Provision

The bill defers the phase down of the credit for two years. Taxpayers may claim the full 

amount of the credit for qualified purchases made in 2002 and 2003. Under the bill, the phase 

down of the credit value commences in 2004 and the credit is unavailable for purchases after 

December 31, 2006. A conforming modification is made to section 280F.

Effective Date

The provision is effective on the date of enactment.

 

22 The amount the taxpayer may claim as a depreciation deduction for any passenger 

automobile is limited (sec. 280F). In the case of a passenger vehicle designed to be propelled 

primarily by electricity and built by an original equipment manufacturer, the otherwise 

applicable limitation amounts are tripled. These exceptions from sec. 280F apply to vehicles 

placed in service prior to January 1, 2005.
20

C. Extend Section 45 Credit for Production of Electricity from Wind,

Closed Loop Biomass, and Poultry Litter

(sec. 303 of the bill and sec. 45 of the Code)

Present Law

An income tax credit is allowed for the production of electricity from either qualified 

wind energy, qualified “closed-loop” biomass, or qualified poultry waste facilities (sec. 45).

The credit applies to electricity produced by a wind energy facility placed in service after 

December 31, 1993, and before January 1, 2002, to electricity produced by a closed-loop 

biomass facility placed in service after December 31, 1992, and before January 1, 2002, and to a 

poultry waste facility placed in service after December 31, 1999, and before January 1, 2002. 

The credit is allowable for production during the 10-year period after a facility is originally 

placed in service. In order to claim the credit, a taxpayer must own the facility and sell the 

electricity produced by the facility to an unrelated party. In the case of a poultry waste facility, 

the taxpayer may claim the credit as a lessee/operator of a facility owned by a governmental unit.

Closed-loop biomass is plant matter, where the plants are grown for the sole purpose of 

being used to generate electricity. It does not include 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. Poultry waste means poultry manure 

and litter, including wood shavings, straw, rice hulls, and other bedding material for the 

disposition of manure.

The credit for electricity produced from wind, closed-loop biomass, or poultry waste is a 

component of the general business credit (sec. 38(b)(8)). The 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. For credits arising in taxable years 

beginning after December 31, 1997, an unused general business credit generally may be carried 

back one year and carried forward 20 years (sec. 39). To coordinate the carryback with the 

period of application for this credit, the credit for electricity produced from closed-loop biomass 

facilities may not be carried back to a tax year ending before 1993 and the credit for electricity 

produced from wind energy may not be carried back to a tax year ending before 1994 (sec. 39).

Explanation of Provision

The bill extends the placed in service date for qualified facilities by two years to include 

those facilities placed in service prior to January 1, 2004.

Effective Date

The provision is effective on the date of enactment.
21

D. Extend the Work Opportunity Tax Credit

(sec. 304 of the bill and sec. 51 of the Code)

Present Law

In general

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 equals 40 

percent (25 percent for employment of less than 400 hours) of qualified wages. Generally, 

qualified wages are wages attributable to service rendered by member of a targeted group during 

the one-year period beginning with the day the individual began work for the employer.

The maximum credit per employee is $2,400 (40 percent of the first $6,000 of qualified 

first-year wages). With respect to qualified summer youth employees, the maximum credit is 

$1,200 (40 percent of the first $3,000 of qualified first-year wages).

For purposes of the credit, wages are generally defined as under the Federal 

Unemployment Tax Act, without regard to the dollar cap.

Targeted groups eligible for the credit

The eight targeted groups are: (1) families eligible to receive benefits under the 

Temporary Assistance for Needy Families (“TANF”) Program; (2) high-risk youth; (3) qualified 

ex-felons; (4) vocational rehabilitation referrals; (5) qualified summer youth employees; (6) 

qualified veterans; (7) families receiving food stamps; and (8) persons receiving certain 

Supplemental Security Income (“SSI”) benefits.

The employer's deduction for wages is reduced by the amount of the credit.

Expiration date

The credit is effective for wages paid or incurred to a qualified individual who begins 

work for an employer before January 1, 2002.

Explanation of Provision

The bill extends the work opportunity tax credit for two years (through December 31, 

2003).

Effective Date

The provision is effective for wages paid or incurred to a qualified individual who begins 

work for an employer on or after January 1, 2002, and before January 1, 2004.
22

E. Extend the Welfare-To-Work Tax Credit

(sec. 305 of the bill and sec. 51A of the Code)

Present Law

In general

The welfare-to-work tax credit is available on an elective basis for employers for the first 

$20,000 of eligible wages paid to qualified long-term family assistance 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 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 that is no longer eligible 

for family assistance because of either Federal or State time limits, if they are hired within two 

years after the Federal or State time limits made the family ineligible for family assistance. 

Family assistance means benefits under the Temporary Assistance to Needy Families (“TANF”) 

program.

For purposes of the credit, wages are generally defined under the Federal Unemployment 

Tax Act, without regard to the dollar amount. In addition, wages include the following: (1) 

educational assistance excludable under a section 127 program; (2) the value of excludable 

health plan coverage but not more than the applicable premium defined under section 

4980B(f)(4); and (3) dependent care assistance excludable under section 129.

The employer's deduction for wages is reduced by the amount of the credit.

Expiration date

The welfare to work credit is effective for wages paid or incurred to a qualified individual 

who begins work for an employer before January 1, 2002.

Explanation of Provision

The bill extends the welfare to work credit for two years (through December 31, 2003).

Effective Date

The provision is effective for wages paid or incurred to a qualified individual who begins 

work for an employer on or after January 1, 2002, and before January 1, 2004. 
23

F. Extend Deduction for Qualified Clean-Fuel Vehicle Property

and Qualified Clean-Fuel Vehicle Refueling Property

(sec. 306 of the bill and secs. 179A and 280F of the Code)

Present Law

Certain costs of qualified clean-fuel vehicle property and clean-fuel vehicle refueling 

property may be expensed and deducted when such property is placed in service (sec. 179A).23

Qualified clean-fuel vehicle property includes motor vehicles that use certain clean-burning fuels 

(natural gas, liquefied natural gas, liquefied petroleum gas, hydrogen, electricity and any other 

fuel at least 85 percent of which is methanol, ethanol, any other alcohol or ether). The maximum 

amount of the deduction is $50,000 for a truck or van with a gross vehicle weight over 26,000 

pounds or a bus with seating capacities of at least 20 adults; $5,000 in the case of a truck or van 

with a gross vehicle weight between 10,000 and 26,000 pounds; and $2,000 in the case of any 

other motor vehicle. Qualified electric vehicles do not qualify for the clean-fuel vehicle 

deduction. 

Clean-fuel vehicle refueling property comprises property for the storage or dispensing of 

a clean-burning fuel, if the storage or dispensing is the point at which the fuel is delivered into 

the fuel tank of a motor vehicle. Clean-fuel vehicle refueling property also includes property for 

the recharging of electric vehicles, but only if the property is located at a point where the electric 

vehicle is recharged. Up to $100,000 of such property at each location owned by the taxpayer 

may be expensed with respect to that location. 

The deduction for clean-fuel vehicle property phases down in the years 2002 through 

2004, and is unavailable for purchases after December 31, 2004. The deduction for clean-fuel 

vehicle refueling property is unavailable for property placed in service after December 31, 2004.

Explanation of Provision

The bill defers the phase down of the deduction for clean-fuel vehicle property by two 

years. Taxpayers may claim the full amount of the deduction for qualified vehicles placed in 

service in 2002 and 2003. Under the bill, the phase down of the deduction for clean-fuel 

vehicles commences in 2004 and the deduction is unavailable for purchases after December 31, 

2006. A conforming modification is made to section 280F.

 

23

 The amount the taxpayer may claim as a depreciation deduction for any passenger 

automobile is limited (sec. 280F). In the case of a qualified clean-burning fuel vehicle, the 

limitation of sec. 280F applies only to that portion of the vehicle’s cost not represented by the 

installed qualified clean-burning fuel property. The taxpayer may claim an amount otherwise 

allowable as a depreciation deduction on the installed qualified clean-burning fuel property, 

without regard to the limitation. These exceptions from sec. 280F apply to vehicles placed in 

service prior to January 1, 2005.
24

The provision extends the placed in service date for clean-fuel vehicle refueling property 

by two years. The deduction for clean-fuel vehicle refueling property is available for property 

placed in service prior to January 1, 2007.

Effective Date

The provision is effective on the date of enactment. 
25

G. Taxable Income Limit on Percentage Depletion for Marginal Production

(sec. 307 of the bill and sec. 613A of the Code)

Present Law

In general

Depletion, like depreciation, is a form of capital cost recovery. In both cases, the 

taxpayer is allowed a deduction in recognition of the fact that an asset -- in the case of depletion 

for oil or gas interests, the mineral reserve itself -- is being expended in order to produce income. 

Certain costs incurred prior to drilling an oil or gas property are recovered through the depletion 

deduction. These include costs of acquiring the lease or other interest in the property and 

geological and geophysical costs (in advance of actual drilling). Depletion is available to any 

person having an economic interest in a producing property.

Two methods of depletion are allowable under the Code: (1) the cost depletion method, 

and (2) the percentage depletion method (secs. 611-613). Under the cost depletion method, the 

taxpayer deducts that portion of the adjusted basis of the depletable property which is equal to 

the ratio of units sold from that property during the taxable year to the number of units remaining 

as of the end of taxable year plus the number of units sold during the taxable year. Thus, the 

amount recovered under cost depletion may never exceed the taxpayer's basis in the property.

Under the percentage depletion method, generally, 15 percent of the taxpayer's gross 

income from an oil- or gas-producing property is allowed as a deduction in each taxable year 

(sec. 613A(c)). The amount deducted generally may not exceed 100 percent of the net income 

from that property in any year (the "net-income limitation") (sec. 613(a)). The Taxpayer Relief 

Act of 1997 suspended the 100-percent-of-net-income limitation for production from marginal 

wells for taxable years beginning after December 31, 1997, and before January 1, 2000. The 

limitation subsequently was extended to include taxable years beginning before January 1, 2002. 

Additionally, the percentage depletion deduction for all oil and gas properties may not exceed 65 

percent of the taxpayer's overall taxable income (determined before such deduction and adjusted 

for certain loss carrybacks and trust distributions) (sec. 613A(d)(1)).24 Because percentage 

depletion, unlike cost depletion, is computed without regard to the taxpayer's basis in the 

depletable property, cumulative depletion deductions may be greater than the amount expended 

by the taxpayer to acquire or develop the property.

A taxpayer is required to determine the depletion deduction for each oil or gas property 

under both the percentage depletion method (if the taxpayer is entitled to use this method) and 

the cost depletion method. If the cost depletion deduction is larger, the taxpayer must utilize that 

method for the taxable year in question (sec. 613(a)).

 

24 Amounts disallowed as a result of this rule may be carried forward and deducted in 

subsequent taxable years, subject to the 65-percent taxable income limitation for those years. 
26

Limitation of oil and gas percentage depletion to independent producers and royalty 

owners

Generally, only independent producers and royalty owners (as contrasted to integrated oil 

companies) are allowed to claim percentage depletion. Percentage depletion for eligible 

taxpayers is allowed only with respect to up to 1,000 barrels of average daily production of 

domestic crude oil or an equivalent amount of domestic natural gas (sec. 613A(c)). For 

producers of both oil and natural gas, this limitation applies on a combined basis. 

In addition to the independent producer and royalty owner exception, certain sales of 

natural gas under a fixed contract in effect on February 1, 1975, and certain natural gas from 

geopressured brine, are eligible for percentage depletion, at rates of 22 percent and 10 percent, 

respectively. These exceptions apply without regard to the 1,000-barrel-per-day limitation and 

regardless of whether the producer is an independent producer or an integrated oil company.

Explanation of Provision

The provision extends the period when the 100-percent net-income limit is suspended to 

include taxable years beginning in 2002 and 2003.

Effective Date

The provision is effective on the date of enactment.
27

H. Extension of Authority to Issue Qualified Zone Academy Bonds

(sec. 308 of the bill and sec. 1397E of the Code)

Present Law

Tax-exempt bonds

Interest on State and local governmental bonds generally is excluded from gross income 

for Federal income tax purposes if the proceeds of the bonds are used to finance direct activities 

of these governmental units or if the bonds are repaid with revenues of the governmental units. 

Activities that can be financed with these tax-exempt bonds include the financing of public 

schools (sec. 103).

Qualified zone academy bonds

As an alternative to traditional tax-exempt bonds, States and local governments are given 

the authority to issue “qualified zone academy bonds” ("QZABs") (sec. 1397E). A total of $400 

million of qualified zone academy bonds may be issued annually in calendar years 1998 through 

2001. The $400 million aggregate bond cap 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 authority to qualified zone academies within such State. 

Financial institutions that hold qualified zone academy bonds are entitled to a 

nonrefundable tax credit in an amount equal to a credit rate multiplied by the face amount of the 

bond. A taxpayer holding a qualified zone academy bond on the credit allowance date is entitled 

to a credit. The credit is includable in gross income (as if it were a taxable interest payment on 

the bond), and may be claimed against regular income tax and AMT liability.

The Treasury Department sets the credit rate at a rate estimated to allow issuance of 

qualified zone academy bonds without discount and without interest cost to the issuer. The 

maximum term of the bond is determined by the Treasury Department, so that the present value 

of the obligation to repay the bond is 50 percent of the face value of the bond.

“Qualified zone academy bonds” are defined as any bond issued by a State or local 

government, provided that (1) at least 95 percent of the proceeds are used for the purpose of 

renovating, providing equipment to, developing course materials for use at, or training teachers 

and other school personnel in a “qualified zone academy” and (2) private entities have promised 

to contribute to the qualified zone academy certain equipment, technical assistance or training, 

employee services, or other property or services with a value equal to at least 10 percent of the 

bond proceeds.

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 

zones enterprise community designated under the Code, or (b) it is reasonably expected that at 
28

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.

Explanation of Provision

The provision authorizes issuance of up to $400 million of qualified zone academy bonds 

annually in calendar years 2002 and 2003. 

Effective Date

The provision is effective on the date of enactment.
29

I. Extension of Increased Coverover Payments to Puerto Rico and the Virgin Islands

(sec. 309 of the bill and sec. 7652 of the Code)

Present Law

A $13.50 per proof gallon25 excise tax is imposed on distilled spirits produced in, or 

imported or brought into, the United States. The excise tax does not apply to distilled spirits that 

are exported from the United States or to distilled spirits that are consumed in U.S. possessions 

(e.g., Puerto Rico and the Virgin Islands).

The Code provides for coverover (payment) of $13.25 per proof gallon of the excise tax 

imposed on rum imported (or brought) into the United States (without regard to the country of 

origin) to Puerto Rico and the Virgin Islands during the period July 1, 1999 through December 

31, 2001. Effective on January 1, 2002, the coverover rate is scheduled to return to its 

permanent level of $10.50 per proof gallon. 

Amounts covered over to Puerto Rico and the Virgin Islands are deposited into the 

treasuries of the two possessions for use as those possessions determine.

Explanation of Provision

The provision extends the $13.25-per-proof-gallon coverover rate for two additional 

years, through December 31, 2003.

Effective Date

The provision is effective on the date of enactment.

 

25 A proof gallon is a liquid gallon consisting of 50 percent alcohol.
30

J. Tax on Failure to Comply with Mental Health Parity Requirements

(sec. 310 of the bill and sec. 9812(f) of the Code)

Prior Law

The Mental Health Parity Act of 1996 amended ERISA and the Public Health Service 

Act to provide that group health plans that provide both medical and surgical benefits and mental 

health benefits cannot impose aggregate lifetime or annual dollar limits on mental health benefits 

that are not imposed on substantially all medical and surgical benefits. The provisions of the 

Mental Health Parity Act are effective with respect to plan years beginning on or after January 1, 

1998, but do not apply to benefits for services furnished on or after September 30, 2001.

The Taxpayer Relief Act of 1997 added to the Internal Revenue Code the requirements 

imposed under the Mental Health Parity Act, and imposed an excise tax on group health plans 

that fail to meet the requirements. The excise tax is equal to $100 per day during the period of 

noncompliance and is imposed on the employer sponsoring the plan if the plan fails to meet the 

requirements. The maximum tax that can be imposed during a taxable year cannot exceed the 

lesser of 10 percent of the employer’s group health plan expenses for the prior year or $500,000. 

No tax is imposed if the Secretary determines that the employer did not know, and exercising 

reasonable diligence would not have known, that the failure existed.

The excise tax is applicable with respect to plan years beginning on or after January 1, 

1998, and expired with respect to benefits for services provided on or after September 30, 2001.

Explanation of Provision

The excise tax on failures to comply with mental health parity requirements is extended 

to apply to benefits for services provided during 2002 and 2003.

Effective Date

The provision is effective with respect to plan years beginning after December 31, 2000.
31

K. Suspension of Reduction of Deductions for Mutual Life Insurance Companies (sec. 311 of 

the bill and sec. 809 of the Code)

Prior and Present Law

In general, a corporation may not deduct amounts distributed to shareholders with respect 

to the corporation’s stock. The Deficit Reduction Act of 1984 added a provision to the rules 

governing insurance companies that was intended to remedy the failure of prior law to 

distinguish between amounts returned by mutual life insurance companies to policyholders as 

customers, and amounts distributed to them as owners of the mutual company.

Under the provision, section 809, a mutual life insurance company is required to reduce 

its deduction for policyholder dividends by the company’s differential earnings amount. If the 

company’s differential earnings amount exceeds the amount of its deductible policyholder 

dividends, the company is required to reduce its deduction for changes in its reserves by the 

excess of its differential earnings amount over the amount of its deductible policyholder 

dividends. The differential earnings amount is the product of the differential earnings rate and 

the average equity base of a mutual life insurance company.

The differential earnings rate is based on the difference between the average earnings rate 

of the 50 largest stock life insurance companies and the earnings rate of all mutual life insurance 

companies. The mutual earnings rate applied under the provision is the rate for the second 

calendar year preceding the calendar year in which the taxable year begins. Under present law, 

the differential earnings rate cannot be a negative number.

A company’s equity base equals the sum of: (1) its surplus and capital increased by 50 

percent of the amount of any provision for policyholder dividends payable in the following 

taxable year; (2) the amount of its nonadmitted financial assets; (3) the excess of its statutory 

reserves over its tax reserves; and (4) the amount of any mandatory security valuation reserves, 

deficiency reserves, and voluntary reserves. A company’s average equity base is the average of 

the company’s equity base at the end of the taxable year and its equity base at the end of the 

preceding taxable year.

A recomputation or “true-up” in the succeeding year is required if the differential 

earnings amount for the taxable year either exceeds, or is less than, the recomputed differential 

earnings amount. The recomputed differential earnings amount is calculated taking into account 

the average mutual earnings rate for the calendar year (rather than the second preceding calendar 

year, as above). The amount of the true-up for any taxable year is added to, or deducted from, 

the mutual company’s income for the succeeding taxable year.

Explanation of Provision

The provision provides a zero rate for both the differential earnings rate and recomputed 

differential earnings rate ("true-up") for a life insurance company's taxable years beginning in 

2001, 2002, or 2003, under the rules requiring reduction in certain deductions of mutual life 

insurance companies (sec. 809).
32

Effective Date

The provision is effective for taxable years beginning after December 31, 2000.
33

L. Extension of Archer Medical Savings Accounts ("MSAs")

(sec. 312 of the bill and sec. 220 of the Code) 

Present Law

In general

Within limits, contributions to a an Archer medical savings account ("MSA") are 

deductible in determining adjusted gross income if made by an eligible individual and are 

excludable from gross income and wages for employment tax purposes if made by the employer 

of an eligible individual. Earnings on amounts in an Archer MSA are not currently taxable. 

Distributions from an Archer MSA for medical expenses are not taxable. Distributions not used 

for medical expenses are taxable. In addition, distributions not used for medical expenses are 

subject to an additional 15-percent tax unless the distribution is made after age 65, death, or 

disability.

Eligible individuals

Archer MSAs are available to employees covered under an employer-sponsored high 

deductible plan of a small employer and self-employed individuals covered under a high 

deductible health plan. 26 An employer is a small employer if it employed, on average, no more 

than 50 employees on business days during either the preceding or the second preceding year. 

An individual is not eligible for an Archer MSA if they are covered under any other health plan 

in addition to the high deductible plan.

Tax treatment of and limits on contributions

Individual contributions to an Archer MSA are deductible (within limits) in determining 

adjusted gross income (i.e., "above the line"). In addition, employer contributions are excludable 

from gross income and wages for employment tax purposes (within the same limits), except that 

this exclusion does not apply to contributions made through a cafeteria plan. In the case of an 

employee, contributions can be made to an Archer MSA either by the individual or by the 

individual's employer. 

The maximum annual contribution that can be made to an Archer MSA for a year is 65 

percent of the deductible under the high deductible plan in the case of individual coverage and 75 

percent of the deductible in the case of family coverage.

Definition of high deductible plan

A high deductible plan is a health plan with an annual deductible of at least $1,600 and 

no more than $2,400 in the case of individual coverage and at least $3,200 and no more than 

$4,800 in the case of family coverage. In addition, the maximum out-of-pocket expenses with 

 

26 Self-employed individuals include more than 2-percent shareholders of S corporations 

who are treated as partners for purposes of fringe benefit rules pursuant to section 1372.
34

respect to allowed costs (including the deductible) must be no more than $3,200 in the case of 

individual coverage and no more than $5,850 in the case of family coverage.27 A plan does not 

fail to qualify as a high deductible plan merely because it does not have a deductible for 

preventive care as required by State law. A plan does not qualify as a high deductible health 

plan if substantially all of the coverage under the plan is for permitted coverage (as described 

above). In the case of a self-insured plan, the plan must in fact be insurance (e.g., there must be 

appropriate risk shifting) and not merely a reimbursement arrangement.

Taxation of distributions

Distributions from an Archer MSA for the medical expenses of the individual and his or 

her spouse or dependents generally are excludable from income.28 However, in any year for 

which a contribution is made to an Archer MSA, withdrawals from an Archer MSA maintained 

by that individual generally are excludable from income only if the individual for whom the 

expenses were incurred was covered under a high deductible plan for the month in which the 

expenses were incurred.29 For this purpose, medical expenses are defined as under the itemized 

deduction for medical expenses, except that medical expenses do not include expenses for 

insurance other than long-term care insurance, premiums for health care continuation coverage, 

and premiums for health care coverage while an individual is receiving unemployment 

compensation under Federal or State law.

Distributions that are not used for medical expenses are includible in income. Such 

distributions are also subject to an additional 15-percent tax unless made after age 65, death, or 

disability.

Cap on taxpayers utilizing Archer MSAs

The number of taxpayers benefiting annually from an Archer MSA contribution is limited 

to a threshold level (generally 750,000 taxpayers). If it is determined in a year that the threshold 

level has been exceeded (called a "cut-off" year) then, in general, for succeeding years during the 

pilot period 1997-2002, only those individuals who (1) made an Archer MSA contribution or had 

an employer Archer MSA contribution for the year or a preceding year (i.e., are active Archer 

MSA participants) or (2) are employed by a participating employer, those individuals are eligible 

for an Archer MSA contribution. In determining whether the threshold for any year has been 

exceeded, Archer MSAs of individuals who were not covered under a health insurance plan for 

the six month period ending on the date on which coverage under a high deductible plan 

 

27

 These dollar amounts are for 2001. These amounts are indexed for inflation in $50 

increments.

28 This exclusion does not apply to expenses that are reimbursed by insurance or 

otherwise.

29 The exclusion still applies to expenses for continuation coverage or coverage while the 

individual is receiving unemployment compensation, even for an individual who is not an 

eligible individual.
35

commences would not be taken into account. 30 However, if the threshold level is exceeded in a 

year, previously uninsured individuals are subject to the same restriction on contributions in 

succeeding years as other individuals. That is, they would not be eligible for an Archer MSA 

contribution for a year following a cut-off year unless they are an active Archer MSA participant 

(i.e., had an Archer MSA contribution for the year or a preceding year) or are employed by a 

participating employer.

The number of Archer MSAs established has not exceeded the threshold level.

End of Archer MSA pilot program

After 2002, no new contributions may be made to Archer MSAs except by or on behalf 

of individuals who previously had Archer MSA contributions and employees who are employed 

by a participating employer. An employer is a participating employer if (1) the employer made 

any Archer MSA contributions for any year to an Archer MSA on behalf of employees or (2) at 

least 20 percent of the employees covered under a high deductible plan made Archer MSA 

contributions of at least $100 in the year 2001.

Self-employed individuals who made contributions to an Archer MSA during the period 

1997-2002 also may continue to make contributions after 2002.

Explanation of Provision

The provision extends the Archer MSA program for another year, through December 31, 

2003.

Effective Date

The provision is effective on the date of enactment.

 

30 Permitted coverage, as described above, does not constitute coverage under a health 

insurance plan for this purpose.
36

M. Extension of Tax Incentives for Investment on Indian Reservations

(sec. 313 of the bill and secs. 45A and 168(j) of the Code)

Present Law

Present law provides the following tax incentives in order to encourage investment on 

Indian reservations.

Indian employment credit

A general business credit is available for an employer of qualified employees that work 

on an Indian reservation. 31 The credit is equal to 20 percent of the excess of qualified wages and 

health insurance costs paid to qualified employees in the current year over the amount paid in 

1993, up to a maximum of $20,000. Wages for which the work opportunity credit is available 

are not qualified wages and are not eligible for the credit. 

Employees generally are qualified employees if they (or their spouse) are enrolled in an 

Indian tribe and live on or near the Indian reservation where they work, perform services that are 

all or substantially all within an Indian reservation, and do not receive wages greater than 

$30,000 (adjusted for inflation after 1994) for the taxable year. The credit is not available for 

employees involved in certain gaming activities or who work in a building that houses certain 

gaming activities. 

The Indian employment credit is not available after December 31, 2003. 

Accelerated depreciation of property on Indian reservations

A special depreciation recovery period is available to qualified Indian reservation 

property. 32 In general, qualified Indian reservation property is property used predominantly in 

the active conduct of a trade or business within an Indian reservation, which is not used outside 

the reservation on a regular basis and was not acquired from a related person. Property used to 

conduct or house certain gaming activities is not qualified Indian reservation property. 

The applicable recovery period for qualified Indian reservation property is as follows:

In the case of: The applicable recovery period is:

3 year property 2 years

5 year property 3 years

7 year property 4 years

10 year property 6 years

15 year property 9 years

 

31 Section 45A.

32 Section 168(j).
37

20 year property 12 years

Nonresidential real property 22 years

Accelerated depreciation of property on Indian reservations is not available for property 

placed in service after December 31, 2003. 

Explanation of Provision

The provision extends for one year (i.e., through December 31, 2004) the Indian 

employment credit and the accelerated depreciation rules for property on Indian reservations.

Effective Date

The provision is effective on the date of enactment.
38

N. Extension and Modification of Exceptions under Subpart F for

Active Financing Income (sec. 314 of the bill and secs. 953 and 954 of the Code)

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”).33

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 

 

33 Temporary exceptions from the subpart F provisions for certain active financing 

income applied only for taxable years beginning in 1998. Those exceptions were modified and 

extended for one year, applicable only for taxable years beginning in 1999. The Tax Relief 

Extension Act of 1999 (P.L. No. 106-170) clarified and extended the temporary exceptions for 

two years, applicable only for taxable years beginning after 1999 and before 2002.
39

qualified business unit (“QBU”) of a CFC from transactions with customers is eligible for the 

exceptions if, among other things, substantially all of the activities in connection with such 

transactions are conducted directly by the CFC or QBU in its home country, and such income is 

treated as earned by the CFC or QBU in its home country for purposes of such country's tax 

laws. Moreover, the exceptions apply to income derived from certain cross border transactions, 

provided that certain requirements are met. Additional exceptions from foreign personal holding 

company income apply for certain income derived by a securities dealer within the meaning of 

section 475 and for gain from the sale of active financing assets.

In the case of insurance, in addition to 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.

In the case of a life insurance or annuity contract, reserves for such contracts are 

determined as follows for purposes of these provisions. The reserves equal the greater of: (1) 

the net surrender value of the contract (as defined in sec. 807(e)(1)(A)), including in the case of 

pension plan contracts; or (2) the amount determined by applying the tax reserve method that 

would apply if the qualifying life insurance company were subject to tax under Subchapter L of 

the Code, with the following modifications. First, there is substituted for the applicable Federal 

interest rate an interest rate determi ned for the functional currency of the qualifying insurance 

company's home country, calculated (except as provided by the Treasury Secretary in order to 

address insufficient data and similar problems) in the same manner as the mid-term applicable 

Federal interest rate (within the meaning of sec. 1274(d)). Second, there is substituted for the 

prevailing State assumed rate the highest assumed interest rate permitted to be used for purposes 

of determining statement reserves in the foreign country for the contract. Third, in lieu of U.S. 

mortality and morbidity tables, mortality and morbidity tables are applied that reasonably reflect 

the current mortality and morbidity risks in the foreign country. Fourth, the Treasury Secretary 

may provide that the interest rate and mortality and morbidity tables of a qualifying insurance 

company may be used for one or more of its branches when appropriate. In no event may the 

reserve for any contract at any time exceed the foreign statement reserve for the contract, 

reduced by any catastrophe, equalization, or deficiency reserve or any similar reserve.

Present law also provides a temporary exception from foreign personal holding company 

income for income from investment of assets equal to 10 percent of reserves (determined for 

purposes of the provision) for contracts regulated in the country in which sold as life insurance or 

annuity contracts. This exception does not apply to investment income with respect to excess 

surplus.
40

Explanation of Provision

 The provision extends 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.

The provision generally retains present law with respect to the determination of an 

insurance company's reserve for a life insurance or annuity contract under these exceptions. The 

provision does, however, permit a taxpayer in certain circumstances, subject to approval by the 

IRS through the ruling process or in published guidance, to establish that the reserve for such 

contracts is the amount taken into account in determining the foreign statement reserve for the 

contract (reduced by catastrophe, equalization, or deficiency reserve or any similar reserve). IRS 

approval is to be based on whether the method, the interest rate, the mortality and morbidity 

assumptions, and any other factors taken into account in determining foreign statement reserves 

(taken together or separately) provide an appropriate means of measuring income for Federal 

income tax purposes. In seeking a ruling, the taxpayer is required to provide the IRS with 

necessary and appropriate information as to the method, interest rate, mortality and morbidity 

assumptions and other assumptions under the foreign reserve rules so that a comparison can be 

made to the reserve amount determined by applying the tax reserve method that would apply if 

the qualifying insurance company were subject to tax under Subchapter L of the Code (with the 

modifications provided under present law for purposes of these exceptions). The IRS also may 

issue published guidance indicating its approval. Present law continues to apply with respect to 

reserves for any life insurance or annuity contract for which the IRS has not approved the use of 

the foreign statement reserve. An IRS ruling request under this provision is subject to the 

present-law provisions relating to IRS user fees.

Effective Date

The provision is effective for taxable years of foreign corporations beginning after 

December 31, 2001, and before January 1, 2007, and for taxable years of U.S. shareholders with 

or within which such taxable years of such foreign corporations end.
41

O. Repeal of Dyed-Fuel Requirement for Registered Diesel or Kerosene Terminals 

(sec. 315 of the bill and sec. 4101 of the Code)

Present Law

Excise taxes are imposed on highway motor fuels, including gasoline, diesel fuel, and 

kerosene, to finance the Highway Trust Fund programs. Subject to limited exceptions, these 

taxes are imposed on all such fuels when they are removed from registered pipeline or barge 

terminal facilities, with any tax-exemptions being accomplished by means of refunds to 

consumers of the fuel.34 One such exception allows removal of diesel fuel or kerosene without 

payment of tax if the fuel is destined for a nontaxable use (e.g., use as heating oil) and is 

indelibly dyed.

Terminal facilities are not permitted to receive and store non-tax-paid motor fuels unless 

they are registered with the Internal Revenue Service. Under present law, a prerequisite to 

registration is that if the terminal offers for sale diesel fuel, it must offer both dyed and undyed 

diesel fuel. Similarly, if the terminal offers for sale kerosene, it must offer both dyed and undyed 

kerosene. This “dyed-fuel mandate” was enacted in 1997, to be effective on July 1, 1998. 

Subsequently, the effective date was delayed until July 1, 2000, and later until January 1, 2002.

Explanation of Provision

The diesel fuel and kerosene dyeing mandate is repealed.

Effective Date

The provision is effective on the date of enactment.

 

34 Tax is imposed before that point if the motor fuel is transferred (other than in bulk) 

from a refinery or if the fuel is sold to an unregistered party while still held in the refinery or 

bulk distribution system (e.g., in a pipeline or terminal facility).
42

V. TEMPORARY ASSISTANCE TO NEEDY FAMILIES PROVISIONS

(secs. 321 - 322 of the bill)

A. Reauthorization of TANF Supplemental Grants for

Population Increases For Fiscal Year 2002

Present Law

The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L. 

104-193) established a separate grant authority for certain states with high population growth 

and/or low federal expenditures per poor person under the preceding welfare program Aid to 

Families with Dependent Children (AFDC). A total of $800 million was appropriated for fiscal 

years 1998 through 2001 to states that qualified under a formula that considered state population 

growth and historical federal AFDC expenditures relative to the number of poor persons in the 

state. Grant amounts per state were determined by a formula, and grew each year a state met the 

qualifying criteria. Authorization and appropriations for the Supplemental Grant program 

expired on September 30, 2001.

A total of 17 states received Supplemental Grants in 2001, totaling $319 million. The 

states were: Alabama, Alaska, Arizona, Arkansas, Colorado, Florida, Georgia, Idaho, Louisiana, 

Mississippi, Montana, Nevada, New Mexico, North Carolina, Tennessee, Texas, and Utah.

Explanation of Provision

The Temporary Assistance for Needy Families (TANF) Supplemental Grant program is 

reauthorized and appropriations are provided for one year (fiscal year 2002) with individual state 

grant amounts frozen at the exact amount received by the state in fiscal year 2001.

Effective Date

The provision is effective upon enactment.
43

B. 1-Year Extension of Contingency Fund Under the TANF Program

Present Law

P.L. 104-193 established a contingency fund, a capped matching grant program for states 

that experience high and increasing unemployment rates or increased food stamp caseloads. A 

total of $1.960 billion was appropriated to the contingency fund for fiscal years 1997 through 

2001. To qualify for contingency funds, a state had to meet one of two criteria of “need”: an 

unemployment rate of at least 6.5 percent during the most recent 3-month period and at least 10 

percent higher than the rate in the corresponding 3-month period in either of the previous 2 

years; or a food stamp caseload at least 10 percent higher in the most recent 3-month period than 

in the corresponding 3-month period in fiscal year 1994 or 1995. (The fiscal year 1994 and 1995 

food stamp participation numbers were adjusted by subtracting those made ineligible for food 

stamp benefits by the 1996 welfare reform law.) A state also had to meet a special maintenance 

of effort requirement – 100 percent of the fiscal year 1994 level of state spending for AFDC and 

related emergency assistance and job training programs – and match any contingency funds it 

receives with state funds. 

Explanation of Provision

The TANF contingency fund is reauthorized for one year.

Effective Date

The provision is effective upon enactment.
44

VI. TAX BENEFITS FOR AREA OF NEW YORK CITY DAMAGED IN

TERRORIST ATTACKS ON SEPTEMBER 11, 2001

A. Special Depreciation Allowance for Certain Property

(sec. 401(a) of the bill and new sec. 1400L of the Code)

Present Law 

Depreciation deductions 

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of 

certain property used in a trade or business or for the production of income. The amount of the 

depreciation deduction allowed with respect to tangible property for a taxable year is determined 

under the modified accelerated cost recovery system (“MACRS”). Under MACRS, different 

types of property generally are assigned applicable recovery periods and depreciation methods. 

The recovery periods applicable to most tangible personal property (generally tangible property 

other than residential rental property and nonresidential real property) range from 3 to 25 years. 

The depreciation methods generally applicable to tangible personal property are the 200-percent 

and 150-percent declining balance methods, switching to the straight-line method for the taxable 

year in which the depreciation deduction would be maximized. In lieu of depreciation, a 

taxpayer with a sufficiently small amount of annual investment may elect to deduct up to 

$24,000 (for taxable years beginning in 2001 or 2002) of the cost of qualifying property placed 

in service for the taxable year (sec. 179). For taxable years beginning in 2003 and thereafter, the 

amount deductible under section 179 is increased to $25,000.

Section 167(f)(1) provides that capitalized computer software costs, other than computer 

software to which section 197 applies, are recovered ratably over 36 months. 

Explanation of Provision

The provision allows an additional first-year depreciation deduction equal to 30 percent 

of the adjusted basis of qualified New York Liberty Zone (“Liberty Zone”) property. The 

additional depreciation deduction is allowed for both regular tax and alternative minimum tax 

purposes for the taxable year in which the property is placed in service.35 The basis of the 

property and the depreciation allowances in the year of purchase and later years are appropriately 

adjusted to reflect the additional first-year depreciation deduction. A taxpayer is allowed to elect 

out of the additional first-year depreciation for any class of property for any taxable year.

 

35 The additional depreciation deduction is subject to the general rules regarding whether 

an item is deductible under section 162 or subject to capitalization under section 263 or section 

263A. 
45

Property qualifies for the additional first-year depreciation deduction if the property is (1) 

property to which MACRS applies except qualified leasehold improvement property36 and any 

railroad grading or tunnel bore, or (2) computer software other than computer software covered 

by section 197 and, substantially all of the use of such property is in the Liberty Zone. In order 

to be qualified Liberty Zone property, the original use37 of the property in the Liberty Zone must 

commence with the taxpayer on or after September 11, 2001.38 A special rule precludes the 

additional first-year depreciation deduction for property that is required to be depreciated under 

the alternative depreciation system of MACRS.39 In addition, property is precluded from the 

additional first year depreciation provided under this provision to the extent such property is 

eligible for additional first year depreciation under section 168(k) (i.e., property is eligible for 

only one 30% additional first year depreciation).40

In addition, property qualifies only if acquired by purchase41 by the taxpayer (1) after 

September 10, 2001 and placed in service on or before December 31, 2006, and no binding 

written contract for the acquisition is in effect before September 11, 2001. For nonresidential 

real property and residential rental property the property must be placed in service on or before 

December 31, 2009 in lieu of December 31, 2006. Finally, property that is manufactured, 

constructed, or produced by the taxpayer for use by the taxpayer qualifies if the taxpayer begins 

 

36 Qualified leasehold improvement property (which includes qualified New York 

Liberty Zone leasehold improvement property) is defined in another provision of the bill. 

Leasehold improvements that do not satisfy the requirements to be treated as “qualified leasehold 

improvement property” are eligible for the 30 percent additional first-year depreciation 

deduction. 

37 Thus, used property may constitute qualified property so long as it has not previously 

been used within the Liberty Zone. In addition, it is intended that additional capital expenditures 

incurred to recondition or rebuild property the original use of which in the Liberty Zone began 

with the taxpayer would satisfy the “original use” requirement. See Treasury Regulation 1.48-2 

Example 5. 

38 A special rule applies in the case of certain leased property. In the case of any 

property that is originally placed in service by a person and that is sold to the taxpayer and leased 

back to such person by the taxpayer within three months after the date that the property was 

placed in service, the property would be treated as originally placed in service by the taxpayer 

not earlier than the date that the property is used under the leaseback.

39 A subsequent part of the provision provides that property, to the extent financed by a 

qualified New York rebuilding bond, is exempted from the general requirement that such 

property be recovered under the alternative depreciation system of MACRS. As such, qualified 

Liberty Zone property financed with such tax-exempt bonds would not be precluded from 

qualifying for additional first year depreciation due to such tax-exempt financing. 

40 See section 201 of the bill.

41 For purposes of this provision, purchase is defined under section 179(d).
46

the manufacture, construction, or production of the property after September 10, 2001, and the 

property is placed in service on or before December 31, 200642 (and all other requirements are 

met). Property that is manufactured, constructed, or produced for the taxpayer by another person 

under a contract that is entered into prior to the manufacture, construction, or production of the 

property is considered to be manufactured, constructed, or produced by the taxpayer.

The Liberty Zone means the area located on or south of Canal Street, East Broadway 

(east of its intersection with Canal Street), or Grand Street (east of its intersection with East 

Broadway) in the Borough of Manhattan in the City of New York, New York.

The following examples illustrate the operation of the provision. 

EXAMPLE 1. -- Assume that on March 1, 2002, a calendar year taxpayer acquires and

places in service qualified property in the Liberty Zone that costs $1 million. Under the 

provision, the taxpayer is allowed an additional first-year depreciation deduction of $300,000. 

The remaining $700,000 of adjusted basis is recovered in 2002 and subsequent years pursuant to 

the depreciation rules of present law. 

EXAMPLE 2. -- Assume that on March 1, 2002, a calendar year taxpayer acquires and 

places in service qualified property in the Liberty Zone that costs $100,000. In addition, assume 

that the property qualifies for the expensing election under section 179. Under the provision, the 

taxpayer is first allowed a $70,000 deduction under section 179.43 The taxpayer then is allowed 

an additional first-year depreciation deduction of 9,000 based on $30,000 ($100,000 original cost 

less the section 179 deduction of $70,000) of adjusted basis. Finally, the remaining adjusted 

basis of $21,000 ($30,000 adjusted basis less $9,000 additional first-year depreciation) is to be 

recovered in 2002 and subsequent years pursuant to the depreciation rules of present law. 

 

42 December 31, 2009 with respect to nonresidential real property and residential rental 

property. 

43 A previous provision of the bill increases the amount allowable as a deduction unders 

section 179 to $35,000. In addition, a subsequent provision provides that property in the Liberty 

Zone is eligible for an additional $35,000 of expensing under section 179. 
47

B. Treatment of Qualified Leasehold Improvement Property

(sec. 401(b) of the bill and new sec. 1400L of the Code)

Present Law

Depreciation of leasehold improvements

Depreciation allowances for property used in a trade or business generally are determined 

under the modified Accelerated Cost Recovery System ("MACRS") of section 168. 

Depreciation allowances for improvements made on leased property are determined under 

MACRS, even if the MACRS recovery period assigned to the property is longer than the term of 

the lease (sec. 168(i)(8)).44 This rule applies regardless whether the lessor or lessee places the 

leasehold improvements in service.45 If a leasehold improvement constitutes an addition or 

improvement to nonresidential real property already placed in service, the improvement is 

depreciated using the straight-line method over a 39-year recovery period, beginning in the 

month the addition or improvement was placed in service (secs. 168(b)(3), (c)(1), (d)(2), and 

(i)(6)).46

Treatment of dispositions of leasehold improvements

A lessor of leased property that disposes of a leasehold improvement which was made by 

the lessor for the lessee of the property may take the adjusted basis of the improvement into 

account for purposes of determining gain or loss if the improvement is irrevocably disposed of or 

abandoned by the lessor at the termination of the lease.47 This rule conforms the treatment of 

 

44 The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System 

("ACRS") to institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Act 

of 1981, taxpayers were allowed to depreciate the various components of a building as separate 

assets with separate useful lives. The use of component depreciation was repealed upon the 

adoption of ACRS. The Tax Reform Act of 1986 also denied the use of component depreciation 

under MACRS.

45 Former Code sections 168(f)(6) and 178 provided that in certain circumstances, a 

lessee could recover the cost of leasehold improvements made over the remaining term of the 

lease. These provisions were repealed by the Tax Reform Act of 1986.

46 If the improvement is characterized as tangible personal property, ACRS or MACRS 

depreciation is calculated using the shorter recovery periods and accelerated methods applicable 

to such property. The determination of whether certain improvements are characterized as 

tangible personal property or as nonresidential real property often depends on whether or not the 

improvements constitute a "structural component" of a building (as defined by Treas. Reg. sec. 

1.48-1(e)(1)). See, for example, Metro National Corp., 52 TCM 1440 (1987); King Radio Corp.,

486 F.2d 1091 (10th Cir., 1973); Mallinckrodt, Inc., 778 F.2d 402 (8th Cir., 1985) (with respect 

various leasehold improvements).

47 The conference report describing this provision mistakenly states that the provision 

applies to improvements that are irrevocably disposed of or abandoned by the lessee (rather than 

the lessor) at the termination of the lease.
48

lessors and lessees with respect to leasehold improvements disposed of at the end of a term of 

lease. For purposes of applying this rule, it is expected that a lessor must be able to separately 

account for the adjusted basis of the leasehold improvement that is irrevocably disposed of or 

abandoned. This rule does not apply to the extent section 280B applies to the demolition of a 

structure, a portion of which may include leasehold improvements.48

Explanation of Provision

The provision provides that 5-year property for purposes of the depreciation rules of 

section 168 includes qualified New York Liberty Zone leasehold improvement property 

(“qualified NYLZ leasehold improvement property”). The term qualified NYLZ leasehold 

improvement property means property defined in section 168(e)(6)49 that is placed in service 

after September 10, 2001 and before January 1, 2007 (and not subject to a binding contract on 

September 10, 2001) in the New York Liberty Zone. The straight-line method is required to be 

used with respect to qualified NYLZ leasehold improvement property. A 9-year period is 

specified as the class life of qualified NYLZ leasehold improvement property for purposes of the 

alternative depreciation system. 

 

48 Under present law, section 280B denies a deduction for any loss sustained on the 

demolition of any structure.

49 Section 168(e)(6) regarding qualified leasehold improvement property is added by 

section 205 of the bill. 
49

C. Increase in Expensing Treatment for Business Property Used in the

New York Liberty Zone (sec. 401(c) of the bill and new sec. 1400L of the Code)

Present Law

Present law provides that, in lieu of depreciation, a taxpayer with a sufficiently small 

amount of annual investment may elect to deduct up to $24,000 (for taxable years beginning in 

2001 or 2002) of the cost of qualifying property placed in service for the taxable year (sec. 179). 

This amount is increased to $25,000 of the cost of qualified property placed in service for taxable 

years beginning in 2003 and thereafter. The $24,000 ($25,000 for taxable years beginning in 

2003 and thereafter) amount is phased-out (but not below zero) by the amount by which the cost 

of qualifying property placed in service during the taxable year exceeds $200,000. 

Additional section 179 incentives are provided with respect to a qualified zone property 

used by a business in an empowerment zone (sec. 1397A). Such a business may elect to deduct 

an additional $20,000 (i.e., a total of $44,000) of the cost of qualified zone property placed in 

service in year 2001. The $20,000 amount is increased to $35,000 for taxable years beginning in 

2002 and thereafter. In addition, the phase-out range is applied by taking into account only 50 

percent of the cost of qualified zone property that is section 179 property.

The amount eligible to be expensed for a taxable year may not exceed the taxable income 

for a taxable year that is derived from the active conduct of a trade or business (determined 

without regard to this provision). Any amount that is not allowed as a deduction because of the 

taxable income limitation may be carried forward to succeeding taxable years (subject to similar 

limitations). No general business credit under section 38 is allowed with respect to any amount 

for which a deduction is allowed under section 179.

Explanation of Provision

The provision increases the amount a taxpayer can deduct under section 179 for 

qualifying property used in the New York Liberty Zone.50 Specifically, the provision increases 

the maximum dollar amount that may be deducted under section 179 by the lesser of (1) $35,000 

or (2) the cost of qualifying property placed in service during the taxable year. This amount is in 

addition to the amount otherwise deductible under section 179.51 

Qualifying property means section 179 property52 purchased and placed in service by the 

taxpayer after September 10, 2001 and before January 1, 2007, where (1) substantially all of its 

use is in the New York Liberty Zone in the active conduct of a trade or business by the taxpayer 

 

50 The “New York Liberty Zone” means the area located on or south of Canal Street, East 

Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with 

East Broadway) in the Borough of Manhattan in the City of New York, New York.

51 Another provision in this bill increases the section 179 amount (and the beginning of 

the phase-out threshold).

52 As defined in section 179(d)(1).
50

in the zone, and (2) the original use of which in the New York Liberty Zone commences with the 

taxpayer after September 10, 2001.

As under present law with respect to empowerment zones, the phase-out range for the 

section 179 deduction attributable to New York Liberty Zone property is applied by taking into 

account only 50 percent of the cost of New York Liberty Zone property that is section 179 

property. Also, no general business credit under section 38 is allowed with respect to any 

amount for which a deduction is allowed under section 179. 
51

D. Authorize Issuance of Tax-Exempt Private Activity Bonds for Rebuilding

the Portion of New York City Damaged in the September 11, 2001, Terrorist Attack

(sec. 401(d) of the bill and new sec. 1400L of the Code)

Present Law

Rules governing issuance of 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). 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.”53 The term "private 

person" includes the Federal Government and all other individuals and entities other than States 

or local governments.

Private activities eligible for financing with tax-exempt private activity bonds

Present law includes several exceptions permitting States or local governments to act as 

conduits providing tax-exempt financing for private activities. Both capital expenditures and 

limited working capital expenditures of charitable organizations described in section 501(c)(3) of 

the Code ("qualified 501(c)(3) bonds") may be financed with tax-exempt bonds.

States or local governments may issue tax-exempt “exempt-facility bonds” to finance 

property for certain private businesses. Business facilities eligible for this financing include 

transportation (airports, ports, local mass commuting, and high speed intercity rail facilities); 

privately owned and/or privately operated public works facilities (sewage, solid waste disposal, 

local district heating or cooling, and hazardous waste disposal facilities); privately owned and/or 

operated low-income rental housing;54 and certain private facilities for the local furnishing of 

electricity or gas. A further provision allows tax-exempt financing for "environmental 

enhancements of hydro-electric generating facilities." Tax-exempt financing also is authorized 

for capital expenditures for small manufacturing facilities and land and equipment for first-time 

farmers ("qualified small-issue bonds"), local redevelopment activities ("qualified redevelopment 

bonds"), and eligible empowerment zone and enterprise community businesses. 

Tax-exempt private activity bonds also may be issued to finance limited non-business 

purposes: certain student loans and mortgage loans for owner-occupied housing (“qualified 

 

53 Interest on private activity bonds (other than qualified 501(c)(3) bonds) is a preference 

item in calculating the alternative minimum tax.

54 Residential rental projects must satisfy low-income tenant occupancy requirements for 

a minimum period of 15 years.
52

mortgage bonds” and “qualified veterans’ mortgage bonds”). Purchasers of houses financed 

with qualified mortgage bonds must be first-time homebuyers satisfying prescribed income 

limits, the purchase prices of the houses is limited, the amount by which interest rates charged to 

homebuyers may exceed the interest paid by issuers is restricted, and a recapture provision 

applies to target the benefit to purchasers having longer-term need for the subsidy provided by 

the bonds. Qualified veterans' mortgage bonds are not subject to these limitations, but these 

bonds may only be issued by five States and may only be used to finance mortgage loans to 

veterans who served on active duty before January 1, 1977.

With the exception of qualified 501(c)(3) bonds, private activity bonds may not be issued 

to finance working capital requirements of private businesses.

In most cases, the aggregate volume of tax-exempt private activity bonds that may be 

issued in a State is restricted by annual volume limits. These annual volume limits are equal to 

$62.50 per resident of the State, or $187.5 million if greater. The volume limits are scheduled to 

increase to the greater of $75 per resident of the State or $225 million in calendar year 2002. 

After 2002, the volume limits will be indexed annually for inflation.

Arbitrage restrictions on tax-exempt bonds

The Federal income tax does not apply to the income of States and local governments 

that is derived from the exercise of an essential governmental function. To prevent these taxexempt entities from issuing more Federally subsidized tax-exempt bonds than is necessary for 

the activity being financed or from issuing such bonds earlier than needed for the purpose of the 

borrowing, 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, profits that are earned during these periods 

or on such investments must be rebated to the Federal Government. Governmental bonds are 

subject to less restrictive arbitrage rules that most private activity bonds.

Miscellaneous additional restrictions on tax-exempt bonds

Several additional restrictions apply to the issuance of tax-exempt bonds. First, private 

activity bonds (other than qualified 501(c)(3) bonds) may not be advance refunded. 

Governmental bonds and qualified 501(c)(3) bonds may be advance refunded one time. An 

advance refunding occurs when the refunded bonds are not retired within 90 days of issuance of 

the refunding bonds.

Issuance of private activity bonds is subject to restrictions on use of proceeds for the 

acquisition of land and existing property, use of proceeds to finance certain specified facilities, 

(e.g., airplanes, skyboxes, other luxury boxes, health club facilities, gambling facilities, and 

liquor stores) and use of proceeds to pay costs of issuance (e.g., bond counsel and underwriter 

fees). Additionally, the term of the bonds generally may not exceed 120 percent of the economic 

life of the property being financed and certain public approval requirements (similar to 

requirements that typically apply under State law to issuance of governmental debt) apply under 
53

Federal law to issuance of private activity bonds. Present law precludes substantial users of 

property financed with private activity bonds from owning the bonds to prevent their deducting 

tax-exempt interest paid to themselves. Finally, owners of most private-activity-bond-financed 

property are subject to special "change-in-use" penalties if the use of the bond-financed property 

changes to a use that is not eligible for tax-exempt financing while the bonds are outstanding.

Explanation of Provision

In general

The provision authorizes issuance during calendar years 2002, 2003, and 2004 of an 

aggregate amount of $15 billion of tax-exempt private activity bonds to finance the construction 

and rehabilitation of nonresidential real property55 and residential rental real property56 in a 

newly designated "Liberty Zone" (the"Zone") of New York City. 57 Property eligible for 

financing with these bonds includes buildings and their structural components, fixed tenant 

improvements,58 and public utility property (e.g., gas, water, electric and telecommunication 

lines). All business addresses located on or south of Canal Street, East Broadway (east of its 

intersection with Canal Street), or Grand Street (east of its intersection with East Broadway) in 

the Borough of Manhattan are considered to be located within the New York Recovery Zone. 

Issuance of bonds authorized under the provision is limited to projects approved by the Governor 

of New York.

If the Governor of New York determines that it is not feasible to use all of the authorized 

bond proceeds for property located in the Zone, up to $7 billion of bond proceeds may be used 

for the construction and rehabilitation of commercial real property (including fixed tenant 

improvements) located outside the Zone and within New York City. 59 Bond-financed property 

located outside the Zone must meet the additional requirements that the project have at least 

 

55 No more than $1.5 billion of the authorized bond amount may be used to finance 

property used for retail sales of tangible property (e.g., department stores, restaurants, etc.) and 

functionally related and subordinate property. The term nonresidential real property includes 

structural components of such property if the taxpayer treats such components as part of the real 

property structure for all Federal income tax purposes (e.g., cost recovery).

56 No more than $3 billion of the authorized bond amount may be used to finance 

residential rental property.

57 Current refundings of outstanding bonds issued under the provision do not count 

against the $15 billion volume limit to the extent that the principal amount of the refunding 

bonds does not exceed the outstanding principal amount of the bonds being refunded. The bonds 

cannot be advance refunded.

58 Fixtures and equipment that could be removed from the designated zone for use 

elsewhere are not eligible for financing with these bonds.

59 Public utility property and residential property located outside the Zone cannot be 

financed with the bonds.
54

100,000 square feet of usable office or other commercial space in a single building or multiple 

adjacent buildings.

Subject to the following exceptions and modifications, issuance of these tax-exempt 

bonds is subject to the general rules applicable to issuance of exempt-facility private activity 

bonds:

(1) Issuance of the bonds is not subject to the aggregate annual State private activity 

bond volume limits (sec. 146);

(2) The restriction on use of private activity bond proceeds to finance land acquisition 

is determined by reference to the $15 billion amount of bonds authorized under 

the provision rather than by reference to individual bond issues (sec. 147(c)); 

(3) The restriction on acquisition of existing property is applied using a minimum 

requirement of 50 percent of the cost of acquiring the building being devoted to 

rehabilitation (sec. 147(d));

(4) The special arbitrage expenditure rules for certain construction bond proceeds 

apply to available construction proceeds of the bonds (sec. 148(f)(4)(C));

(5) The tenant targeting rules applicable to exempt-facility bonds for residential rental 

property (and the corresponding change in use penalties for violation of those 

rules) do not apply to such property financed with the bonds (secs. 142(d) and 

150(b)(2)); 

(6) Repayments of bond-financed loans may not be used to make additional loans, 

but rather must be used to retire outstanding bonds (with the first such retirement 

occurring 10 years after issuance of the bonds);60

(7) Interest on the bonds is not a preference item for purposes of the alternative 

minimum tax preference for private activity bond interest (sec. 57(a)(5)); and

(8) Property financed with these bonds will not be treated as financed with taxexempt bonds under the Code provisions governing cost recovery deductions (and 

the bonus depreciation included in the bill). 

Effective Date

The provision is effective for bonds issued after December 31, 2001 and before January 

1, 2005.

 

60 It is intended that redemptions will occur at least semi-annually beginning at the end 

of 10 years after the bonds are issued; however, amounts of less than $250,000 are not to be 

required to be used to redeem bonds at such intervals. 
55

E. Extension of Replacement Period for Certain Property 

Involuntarily Converted in the New York Liberty Zone 

(sec. 401(e) of the bill and new sec. 1400L of the Code)

Present Law

A taxpayer may elect not to recognize gain with respect to property that is involuntarily 

converted if the taxpayer acquires within an applicable period (the “replacement period”) 

property similar or related in service or use (sec. 1033). If the taxpayer does not replace the 

converted property with property similar or related in service or use, then gain generally is 

recognized. If the taxpayer elects to apply the rules of section 1033, gain on the converted 

property is recognized only to the extent that the amount realized on the conversion exceeds the 

cost of the replacement property. In general, the replacement period begins with the date of the 

disposition of the converted property and ends two years after the close of the first taxable year 

in which any part of the gain upon conversion is realized.61 The replacement period is extended 

to three years if the converted property is real property held for the productive use in a trade or 

business or for investment. 62

Special rules apply for property converted in a Presidentially declared disaster.63 With 

respect to a principal residence that is converted in a Presidentially declared disaster, no gain is 

recognized by reason of the receipt of insurance proceeds for unscheduled personal property that 

was part of the contents of such residence. In addition, the replacement period for the 

replacement of such a principal residence is extended to four years after the close of the first 

taxable year in which any part of the gain upon conversion is realized. With respect to 

investment or business property that is converted in a Presidentially declared disaster, any 

tangible property acquired and held for productive use in a business is treated as similar or 

related in service or use to the converted property.

Explanation of Provision

The provision extends the replacement period to five years for a taxpayer to purchase 

property to replace property that was involuntarily converted within the New York Liberty 

Zone64 as a result of the terrorist attacks that occurred on September 11, 2001. However, the 

five-year period is available only if substantially all of the use of the replacement property is in 

New York City. In all other cases, the present-law replacement period rules continue to apply.

 

61 Section 1033(a)(2)(B).

62 Section 1033(g)(4).

63 Section 1033(h). For this purpose, a “Presidentially declared disaster” means any 

disaster which, with respect to the area in which the property is located, resulted in a subsequent 

determination by the President that such area warrants assistance by the Federal Government 

under the Disaster Relief and Emergency Assistance Act.

64 The “New York Liberty Zone” has the same definition throughout this bill. See e.g.,

note 14, supra.
56

Effective Date

The provision is effective for involuntary conversions in the New York Liberty Zone occurring 

on or after September 11, 2001, as a consequence of the terrorist attacks on such date.
57

VII. RELIEF PROVISIONS FOR VICTIMS OF TERRORIST ATTACKS, 

PRESIDENTIALLY DECLARED DISASTERS, AND CERTAIN OTHER DISASTERS

A. Background

Historically, the Congress has provided Federal tax relief for members of the U.S. Armed 

Forces who serve in combat zones. In addition, the Congress has taken action on several 

occasions to provide Federal tax relief for service members and other individuals whose lives 

have been affected by particular instances of hostile action involving the United States. In 1970, 

the Congress enacted legislation that provided tax relief to individuals who had been removed 

from a U.S. vessel and died while being illegally detained by the Democratic People's Republic 

of Korea during 1968.65 Specifically, the legislation treated these individuals as having served in 

a combat zone for purposes of tax provisions that apply only to individuals serving in designated 

combat zones. Thus, service personnel who were crewmembers of the U.S.S. Pueblo (which 

was illegally detained in 1968 by North Korea), and who died during the detention, were eligible 

for the income tax exclusion (and other special tax rules) available for service personnel who die 

in combat zones.

In 1980, the Congress enacted legislation concerning the American hostages who were 

held captive in Iran between November 4, 1979, and December 31, 1981, and who died as a 

result of injury or disease or physical or mental disability that was incurred or aggravated while 

in captive status.66 The legislation provided that no Federal income tax would be imposed with 

respect to the year in which the individual died or any prior year ending on or after the first day 

the individual was in captive status. This legislation applied to military and civilian personnel of 

the United States, as well as to certain other U.S. taxpayers taken captive outside Iran on or 

before December 31, 1981. Moreover, if there had been any unpaid income tax liability of such 

an individual from years prior to captivity, the liability was forgiven. This total income tax 

exemption for American hostages who died as a result of captive status was available only if 

death occurred within two years after the individual ceased to be in captive status.

In 1984, the Congress enacted legislation after hostile action occurred in Lebanon and 

Grenada involving U.S. military and civilian personnel.67 This legislation provided special 

Federal income tax rules for certain individuals who die while in active service as a member of 

the Armed Forces of the United States or while in the civilian employment of the United States. 

Under the legislation, if death occurs as a result of wounds or injuries incurred outside the United 

States in a terrorist or military action, then no Federal income tax applies with respect to income 

of the individual for the year of death or for any earlier year in the period beginning with the last 

year ending before the year in which the wounds or injuries were incurred (sec. 692(c)). The 

legislation only applies to injuries or wounds that are incurred in a terrorist or military action. 

Thus, for example, the legislation would not have applied with respect to a U.S. serviceperson 

 

65 Pub. L. No. 91-235.

66 Pub. L. No. 96-449.

67 Pub. L. Nos. 98-259 and 98-369.
58

stationed in Lebanon who died as a result of an accidental fall because, if not caused by hostile 

forces, such an injury was not incurred in a terrorist or military action. In order to apply the 

special tax rules provided by the legislation to other hostile actions that occurred before the date 

of enactment (such as the attempt to rescue the American hostages in Iran), the legislation was 

made effective with respect to all taxable years of individuals dying as a result of wounds or 

injuries incurred after December 31, 1979.

The 1984 legislation applies to the year preceding the year in which the wounds or 

injuries were incurred because the Congress determined that forgiveness of income tax only for 

the period from the year of the injuries or wounds to the year of death would have inequitable 

results in certain circumstances. Under such a limitation, a soldier who is killed in a terrorist 

attack on a U.S. base in a foreign country on January 31 would be exempt from income tax only 

on one month's income, while a soldier who is killed in an attack on December 31 would be 

exempt from income tax on an entire year's income. Accordingly, the Congress concluded that it 

is more equitable to extend the tax forgiveness under the provision to income for the year 

preceding the year of injury.

In 1990, the Congress enacted legislation providing limited income tax benefits to 

victims of the terrorist attack that resulted in the downing of Pan American Airways Flight 103 

over Lockerbie, Scotland on December 21, 1988.68 The legislation provided that, in the case of 

any individual whose death was a direct result of the terrorist attack involving Flight 103, the 

income tax provisions of subtitle A of the Internal Revenue Code did not apply with respect to: 

(1) the taxable year that included December 21, 1988; and (2) the prior taxable year. However, 

the income tax benefit in each taxable year was limited to an amount equal to 28 percent of the 

annual rate of basic pay at Level V of the U.S. Executive Schedule as of December 21, 1988. 

This limitation was intended to limit the amount of tax relief to that which was provided to 

personnel of the United States who were on Flight 103, thus providing equal relief to all of the 

victims who were on Flight 103. In addition, the legislation required the President to submit 

recommendations to Congress concerning whether future legislation should be enacted to 

authorize the United States to provide monetary and tax relief as compensation to U.S. citizens 

who are victims of terrorism. The legislation also authorized the President to establish a board to 

develop criteria for compensation and to recommend changes to existing laws to establish a 

single comprehensive approach to victim compensation for terrorist acts.

In 1991, the Congress enacted legislation extending the benefits of the suspension of time 

provisions under section 7508 to any individual (and the spouse of such an individual) who 

performed certain services that preceded the designation of a combat zone with regard to 

Operation Desert Shield.69 The individuals eligible for such benefits included individuals who 

provided services in the Armed Forces of the United States (or in support of the Armed Services) 

if such services were performed in the area designated by the President as the “Persian Gulf 

Desert Shield Area” and such services were performed during the period beginning August 2, 

1990, and ending on the date on which any portion of the area was designated by the President as 

 

68 Pub. L. No. 101-604.

69 Pub. L. No. 102-2.
59

a combat zone. After January 17, 1991 (the date on which the Persian Gulf Desert Shield Area 

became designated as a combat zone by the President), individuals performing such services 

became eligible for the benefits of the present-law tax provisions applicable to service in a 

designated combat zone. An Executive Order terminating the designation of the Persian Gulf 

Desert Shield Area as a combat zone has not been issued.

In 1996, the Congress enacted legislation concerning certain individuals serving in 

portions of former Yugoslavia (i.e., Bosnia and Herzegovina, Croatia, and Macedonia) as part of 

Operation Joint Endeavor and Operation Able Sentry. 70 This legislation provided that such 

service is treated in the same manner as if it were performed in a designated combat zone for 

purposes of the tax provisions applicable to service in a designated combat zone. The legislation 

also made the suspension of time provisions of section 7508 applicable to certain other 

individuals participating in Operation Joint Endeavor. In addition, the legislation increased the 

maximum officer combat pay exclusion from $500 per month to the highest rate of pay 

applicable to enlisted personnel plus the amount of hostile fire/imminent danger pay received by 

the officer.

In 1997, the Congress enacted legislation authorizing procedural tax benefits with regard 

to Presidentially declared disasters in general.71 The legislation provided that the Secretary of 

the Treasury may prescribe regulations under which a period of up to 90 days may be 

disregarded for performing various acts under the Internal Revenue Code, such as filing tax 

returns, paying taxes, or filing a claim for credit or refund of tax, for any taxpayer determined by 

the Secretary to be affected by a Presidentially declared disaster (sec. 7508A). In 2001, the 

Congress amended section 7508A to extend from 90 to 120 the authorized period of days that 

may be disregarded by the Secretary.

 

70 Pub. L. No. 104-117.

71 Pub. L. No. 105-34.
60

B. Relief Provisions for Victims of Specific Terrorist Attacks 

1. Income taxes of victims of terrorist attacks (sec. 501 of the bill and sec. 692 of the Code)

Present Law

An individual in active service as a member of the Armed Forces who dies while serving 

in a combat zone (or as a result of wounds, disease, or injury received while serving in a combat 

zone) is not subject to income tax or self-employment tax for the year of death (as well as for any 

prior taxable year ending on or after the first day the individual served in the combat zone) (sec. 

692(a)(1)). Special computational rules apply in the case of joint returns. Military and civilian 

employees of the United States are entitled to a similar exemption if they die as a result of 

wounds or injury which was incurred outside the United States in terrorist or military action (sec. 

692(c)).

The exemption applies not only to the tax liability of the individual attributable to income 

received before the date of death and reported on the decedent’s final return. The exemption 

applies also to the liability of another person to the extent the liability is attributable to an 

amount received after the individual's death which would have been includable in the individual's 

income for the taxable year in which the date of death falls (determined as if the individual had 

survived).72 For example, the individual’s final wage payment, or interest or dividends payable 

in the year of death with respect to the individual’s assets, are exempt from income tax when 

paid to another person or the individual’s estate after the date of death but before the end of the 

taxable year of the decedent (determined without regard to the death).

This exemption is available for the year of death and for prior taxable years beginning 

with the taxable year prior to the taxable year in which the wounds or injury were incurred. 

Thus, for example, if someone is injured and dies in the year the injury occurred, the exemption 

applies for the year of death and the prior taxable year. Similarly, if someone is injured and dies 

two years later, this exemption is available for the taxable year of death as well as the three prior 

taxable years (i.e., the year preceding the injury, the year of the injury, and the two years 

following the year of the injury). 

Explanation of Provision

Application of relief to victims of September 11, 2001, April 19, 1995, and anthrax attacks

The bill extends relief similar to the present-law treatment of military or civilian 

employees of the United States who die as a result of terrorist or military activity outside the 

United States to individuals who die as a result of wounds or injury which were incurred as a 

result of the terrorist attacks that occurred on September 11, 2001, or April 19, 1995, and 

individuals who die as a result of illness incurred due to an attack involving anthrax that occurs 

on or after September 11, 2001, and before January 1, 2002. Under the bill, such individuals 

generally are exempt from income tax for the year of death and for prior taxable years beginning 

 

72 Treas. Reg. sec. 1.692-1(a)(2)(ii).
61

with the taxable year prior to the taxable year in which the wounds or injury occurred.73 The 

exemption applies to these individuals whether killed in an attack (e.g., in the case of the 

September 11, 2001, attack in one of the four airplanes or on the ground) or in rescue or recovery 

operations.

The provision provides a minimum tax relief benefit of $10,000 to each eligible 

individual regardless of the income tax liability of the individual for the eligible tax years. If an 

eligible individual’s income tax for years eligible for the exclusion under the provision is less 

than $10,000, the individual is treated as having made a tax payment for such individual’s last 

taxable year in an amount equal to the excess of $10,000 over the amount of tax not imposed 

under the provision. 

Subject to rules prescribed by the Secretary, the exemption from tax does not apply to the 

tax attributable to (1) deferred compensation which would have been payable after death if the 

individual had died other than as a specified terrorist victim, or (2) amounts payable in the 

taxable year which would not have been payable in such taxable year but for an action taken 

after September 11, 2001. Thus, for example, the exemption does not apply to amounts payable 

from a qualified plan or individual retirement arrangement to the beneficiary or estate of the 

individual. Similarly, amounts payable only as death or survivor's benefits pursuant to deferred 

compensation preexisting arrangements that would have been paid if the death had occurred for 

another reason are not covered by the exemption. In addition, if the individual's employer makes 

adjustments to a plan or arrangement to accelerate the vesting of restricted property or the 

payment of nonqualified deferred compensation after the date of the particular attack, the 

exemption does not apply to income received as a result of that action. 74 Also, if the individual’s 

beneficiary cashed in savings bonds of the decedent, the exemption does not apply. On the other 

hand, the exemption does apply, for example, to a final paycheck of the individual or dividends 

on stock held by the individual when paid to another person or the individual’s estate after the 

date of death but before the end of the taxable year of the decedent (determined without regard to 

the death). The exemption also applies to payments of an individual’s accrued vacation and 

accrued sick leave.

The provision does not apply to any individual identified by the Attorney General to have 

been a participant or conspirator in any terrorist attack to which the provision applies, or a 

representative of such individual. 

 

73 The bill does not provide relief from self-employment tax liability.

74 Such amounts may, however, be excludable from gross income under the death benefit 

exclusion provided in section 502 of the bill.
62

Simplified refund procedures

It is intended that the Secretary will establish procedures to simplify refunds of these 

amounts, including expanding the directions in Revenue Procedure 85-35 to include specific 

instructions for Form 1041.

Effective Date

The provision is effective for taxable years ending before, on, or after September 11, 

2001.

A special rule extends the period of limitations to permit the filing of a claim for refund 

resulting from this provision until one year after the date of enactment, if that period would 

otherwise have expired before that date.

2. Exclusion of certain death benefits (sec. 502 of the bill and sec. 101 of the Code)

Present Law

In general, gross income includes income from whatever source derived (sec. 61), 

including payments made as a result of the death of an individual. Certain exceptions to this 

general rule of inclusion may apply to such payments in certain cases.

For example, gross income generally does not include the amount of any damages (other 

than punitive damages) received (whether by suit or agreement and whether as lump sums or as 

periodic payments) on account of personal physical injury (including death) or sickness (sec. 

104(a)(2)). Further, gross income does not include amounts received (whether in a single sum or 

otherwise) under a life insurance contract if such amounts are paid by reason of the death of the 

insured (sec. 101(a)).

In addition, gifts are not includable in gross income (sec. 102). However, with very 

limited exceptions, payments made by an employer to, or for the benefit of, an employee are not 

excluded from gross income as gifts (sec. 102(c)). In business contexts in which section 102(c) 

does not apply, payments are excludable as gifts only if objective inquiry demonstrates that the 

payments were made out of “detached and disinterested generosity” and not in return for past or 

future services or from motives of anticipated benefit. 75

Explanation of Provision

The bill generally provides an exclusion from gross income for amounts received if such 

amounts are paid by an employer (whether in a single sum or otherwise76) by reason of the death 

of an employee who dies as a result of wounds or injury which were incurred as a result of the 

 

75

 Comm’r v. Duberstein, 363 U.S. 278 (1960).

76 Thus, for example, payments made over a period of years could qualify for the 

exclusion.
63

terrorist attacks that occurred on September 11, 2001, or April 19, 1995, or as a result of illness 

incurred due to an attack involving anthrax that occurs on or after September 11, 2001, and 

before January 1, 2002. Subject to rules prescribed by the Secretary, the exclusion does not 

apply to amounts that would have been payable if the individual had died for a reason other than 

the attack. For example, the provision does not apply to payments by an employer under a 

nonqualified deferred compensation plan77 to the extent that the amounts would have been 

payable if the death had occurred for another reason. The exclusion does apply, however, to 

death benefits provided under a qualified plan that satisfy the incidental benefit rule. 

For purposes of the exclusion, self-employed individuals are treated as employees. Thus, 

for example, payments by a partnership to the surviving spouse of a partner who died as a result 

of the September 11, 2001, attacks may be excludable under the provision.

The provision does not apply to any individual identified by the Attorney General to have 

been a participant or conspirator in any terrorist attack to which the provision applies, or a 

representative of such individual.

No change to present law is intended as to the deductibility of death benefits paid by the 

employer or otherwise merely because the payments are excludable by the recipient. Thus, it is 

intended that payments excludable from income under the provision are deductible to the same 

extent they would be if they were includable in income. 

The bill is not intended to narrow the scope of any applicable exclusion under present 

law. Accordingly, payments that are not specifically excludable under the bill remain excludable 

to the same extent provided under present law.

In connection with the September 11, 2001, terrorist attacks, insurance companies may 

pay death benefits under a life insurance contract even if the contract terms provide for an 

exclusion for death occurring as a result of an act of terrorism or act of war. It is understood that 

such a death benefit payment would fall within the present-law exclusion (under sec. 101(a)) for 

payments made under the contract if it otherwise meets the requirements of the present-law 

exclusion.

Effective Date 

The provision is effective for taxable years ending before, on, or after September 11, 

2001. 

A special rule extends the period of limitations to permit the filing of a claim for refund 

resulting from this provision until one year after the date of enactment, if that period would 

otherwise have expired before that date.

 

77 The provision does not apply to amounts received under a qualified plan because such 

payments are not made by the employer.
64

3. Estate tax reduction (sec. 503 of the bill and sec. 2201 of the Code)

Present Law

Present law provides a reduction in Federal estate tax for taxable estates of U.S. citizens 

or residents who are active members of the U.S. Armed Forces and who are killed in action 

while serving in a combat zone (sec. 2201). This provision also applies to active service 

members who die as a result of wounds, disease, or injury suffered while serving in a combat 

zone by reason of a hazard to which the service member was subjected as an incident of such 

service.

In general, the effect of section 2201 is to replace the Federal estate tax that would 

otherwise be imposed with a Federal estate tax equal to 125 percent of the maximum State death 

tax credit determined under section 2011(b). Credits against the tax, including the unified credit 

of section 2010 and the State death tax credit of section 2011, then apply to reduce (or eliminate) 

the amount of the estate tax payable.

The reduction in Federal estate taxes under section 2201 is equal in amount to the 

“additional estate tax” with respect to the estates of decedents dying before January 1, 2005. The 

additional estate tax is the difference between the Federal estate tax imposed by section 2001 and 

125 percent of the maximum State death tax credit determined under section 2011(b). With 

respect to the estates of decedents dying after December 31, 2004, section 2201 provides that the 

additional estate tax is the difference between the Federal estate tax imposed by section 2001 and 

125 percent of the maximum state death tax credit determined under section 2011(b) as in effect 

prior to its repeal by the Economic Growth and Tax Relief Reconciliation Act of 2001.

Explanation of Provision

The bill generally treats individuals who die from wounds or injury incurred as a result of 

the terrorist attacks that occurred on September 11, 2001, or April 19, 1995, or as a result of 

illness incurred due to an attack involving anthrax that occurs on or after September 11, 2001, 

and before January 1, 2002, in the same manner as if they were active members of the U.S. 

Armed Forces killed in action while serving in a combat zone or dying as a result of wounds or 

injury suffered while serving in a combat zone for purposes of section 2201. Consequently, the 

estates of these individuals are eligible for the reduction in Federal estate tax provided by section 

2201. The provision does not apply to any individual identified by the Attorney General to have 

been a participant or conspirator in any terrorist attack to which the provision applies, or a 

representative of such individual.

The bill also changes the general operation of section 2201, as it applies to both the 

estates of service members who qualify for special estate tax treatment under present law and to 

the estates of individuals who qualify for the special treatment under the bill. Under the bill, the 

Federal estate tax is determined in the same manner for all estates that are eligible for Federal 

estate tax reduction under section 2201. In addition, the executor of an estate that is eligible for 

special estate tax treatment under section 2201 may elect not to have section 2201 apply to the 

estate. Thus, in the event that an estate may receive more favorable treatment without the 

application of section 2201 in the year of death than it would under section 2201, the executor 
65

may elect not to apply the provisions of section 2201, and the estate tax owed (if any) would be 

determined pursuant to the generally applicable rules.

Under the bill, section 2201 no longer reduces Federal estate tax by the amount of the 

additional estate tax. Instead, the bill provides that the Federal estate tax liability of eligible 

estates is determined under section 2001, using a rate schedule that is equal to 125 percent of the 

present-law maximum State death tax credit amount. This rate schedule is used to compute the 

tax under section 2001(b) (i.e., both the tentative tax under section 2001(b)(1) and the 

hypothetical gift tax under section 2001(b)(2) is computed using this rate schedule). As a result 

of this provision, the estate tax is unified with the gift tax for purposes of section 2201 so that a 

single graduated (but reduced) rate schedule applies to transfers made by the individual at death, 

based upon the cumulative taxable transfers made both during lifetime and at death.

In addition, while the bill provides an alternative reduced rate table for purposes of 

determining the tax under section 2001(b), the amount of the unified credit nevertheless is 

determined as if section 2201 did not apply, based upon the unified credit as in effect on the date 

of death. For example, in the case of victims of the September 11, 2001, terrorist attack, the 

applicable unified credit amount under section 2010(c) would be determined by reference to the 

actual section 2001(c) rate table.

As a conforming amendment, the bill repeals section 2011(d) because it no longer will 

have any application to taxpayers.

Effective Date

The provision applies to estates of decedents dying on or after September 11, 2001, or, in 

the case of victims of the Oklahoma City terrorist attack, estates of decedents dying on or after 

April 19, 1995.

A special rule extends the period of limitations to permit the filing of a claim for refund 

resulting from this provision until one year after the date of enactment, if that period would 

otherwise have expired before that date.

4. Payments by charitable organizations treated as exempt payments (sec. 504 of the bill 

and secs. 501 and 4941 of the Code)

Present Law

In general, organizations described in section 501(c)(3) of the Code are exempt from 

taxation. Contributions to such organizations generally are tax deductible (sec. 170). Section 

501(c)(3) organizations must be organized and operated exclusively for exempt purposes and no 

part of the net earnings of such organizations may inure to the benefit of any private shareholder 

or individual. An organization is not organized or operated exclusively for one or more exempt 

purposes unless the organization serves a public rather than a private interest. Thus, an 

organization described in section 501(c)(3) generally must serve a charitable class of persons that 

is indefinite or of sufficient size. 
66

Tax-exempt private foundations are a type of organization described in section 501(c)(3) 

and are subject to special rules. Private foundations are subject to excise taxes on acts of selfdealing between the private foundation and a disqualified person with respect to the foundation 

(sec. 4941). For example, it is self-dealing if the income or assets of a private foundation are 

transferred to, or used by or for the benefit of a disqualified person, such as a substantial 

contributor to the foundation or a person in control of the foundation, and the benefit is not 

incidental or tenuous. 

Explanation of Provision

In light of the extraordinary distress caused by the attacks on the United States of 

September 11, 2001, and the subsequent attacks involving anthrax, the bill provides that 

organizations described in section 501(c)(3) that make payments by reason of the death, injury, 

wounding, or illness of an individual incurred as a result of the September 11, 2001, attacks, or 

as a result of an attack involving anthrax occurring on or after September 11, 2001, and before 

January 1, 2002, are not required to make a specific assessment of need for the payments to be 

related to the purpose or function constituting the basis for the organization’s exemption. This 

rule applies provided that the organization makes the payments in good faith using a reasonable 

and objective formula which is consistently applied. As under present law, such payments must 

be for public and not private benefit and therefore must serve a charitable class. For example, 

under this standard, a charitable organization that assists families of firefighters killed in the line 

of duty could make a pro-rata distribution to the families of firefighters killed in the attacks, even 

though the specific financial needs of each family are not directly considered. Similarly, if the 

amount of a distribution is based on the number of dependents of a charitable class of persons 

killed in the attacks and this standard is applied consistently among distributions, the specific 

needs of each recipient do not have to be taken into account. However, it would not be 

appropriate for a charity to make pro-rata payments based on the recipients’ living expenses 

before September 11 if the result generally is to provide significantly greater assistance to 

persons in a better position to provide for themselves than to persons with fewer financial 

resources. Although such a distribution might be based on objective criteria, it would not, under 

the statutory standard, be a reasonable formula for distributing assistance in an equitable manner. 

Similarly, although specific assessments of need are not required, the bill does not change the 

other substantive standards for exemption under section 501(c)(3), including the prohibition on 

private inurement and the need for a charitable class. It is impossible to list or anticipate the 

kinds of payments that meet the statutory test, but, in general, charities that make distributions in 

good faith using a reasonable and objective formula will be treated as acting consistently with 

exempt purposes. A charity that makes payments subject to this provision should indicate 

clearly on the charity’s information return, for example by notation at the top of the relevant 

page of the return, that the charity relied on this provision in making distributions. The bill also 

provides that if a private foundation makes payments under the conditions described above, the 

payment is not treated as made to a disqualified person for purposes of section 4941.

For charities making payments in connection with the September 11 attacks or attacks 

involving anthrax, but not in reliance on this provision, present law rules apply. It is expected 

that, because of the severity of distress arising out of the September 11 and anthrax attacks and 

the extensive variety of needs that the thousands of victims and their family members may have, 

a wide array of expenses will be consistent with operation for exclusively charitable purposes. 
67

For instance, payments to permit a surviving spouse with young children to remain at home with 

the children rather than being forced to enter the workplace seem to be appropriate to maintain 

the psychological well-being of the entire family. Similarly, assistance with elementary and 

secondary school tuition to permit a child to remain in the same educational environment seems 

to be appropriate, as does assistance needed for higher education. Assistance with rent or 

mortgage payments for the family’s principal residence or car loans also seems to be appropriate 

to forestall losses of a home or transportation that would cause additional trauma to families 

already suffering. Other types of assistance that the scope of the tragedy makes it difficult to 

anticipate may also serve a charitable purpose.

Effective Date

The provision applies to payments made on or after September 11, 2001.

5. Exclusion for certain cancellations of indebtedness (sec. 505 of the bill)

Present Law

Gross income includes income that is realized by a debtor from the discharge of 

indebtedness, subject to certain exceptions for debtors in Title 11 bankruptcy cases, insolvent 

debtors, certain farm indebtedness, and certain real property business indebtedness (secs. 

61(a)(12) and 108). In cases involving discharges of indebtedness that are excluded from gross 

income (except for discharges of real property business indebtedness), taxpayers generally 

exclude discharge of indebtedness from income but reduce tax attributes by the amount of the 

discharge of indebtedness. The amount of discharge of indebtedness excluded from income by 

an insolvent debtor not in a Title 11 bankruptcy case cannot exceed the amount by which the 

debtor is insolvent. For all taxpayers, the amount of discharge of indebtedness generally is equal 

to the difference between the adjusted issue price of the debt being cancelled and the amount 

used to satisfy the debt. These rules generally apply to the exchange of an old obligation for a 

new obligation, including a modification of indebtedness that is treated as an exchange (a debtfor-debt exchange).

Present law generally requires “applicable entities” to file information returns with the 

Internal Revenue Service regarding any discharge of indebtedness in the amount of $600 or more 

(sec. 6050P). This requirement applies without regard to whether the debtor is subject to tax on 

the discharged indebtedness.78 The term “applicable entities” includes: (1) any financial 

institution (as described in section 581 (relating to banks) or section 591(a) (relating to savings 

institutions)); (2) any credit union; (3) any corporation that is a direct or indirect subsidiary of an 

entity described in (1) or (2) which, by virtue of being affiliated with such entity, is subject to 

supervision and examination by a Federal or State agency regulating such entities; (4) the 

Federal Deposit Insurance Corporation, the Resolution Trust Corporation, the National Credit 

Union Administration, certain other Federal executive agencies, and any successor or subunit of 

any of them; (5) an executive, judicial, or legislative agency (as defined in 31 U.S.C. sec. 

3701(a)(4)); and (6) any other organization a significant trade or business of which is the lending 

 

78 Treas. Reg. sec. 1.6050P-1(a)(3).
68

of money. Failures to file correct information returns with the Internal Revenue Service or to 

furnish statements to taxpayers with respect to these discharges of indebtedness are subject to the 

same general penalty that is imposed with respect to failures to provide other types of 

information returns. Accordingly, the penalty for failure to furnish statements to taxpayers 

generally is $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.

Explanation of Provision

The bill provides that gross income does not include any amount realized from the 

discharge (in whole or in part) of indebtedness if the indebtedness is discharged by reason of the 

death of an individual incurred as a result of the September 11, 2001, attacks, or as a result of a 

terrorist attack involving anthrax occurring on or after September 11, 2001, and before January 

1, 2002. In all cases, the provision applies only if the indebtedness is discharged because the 

individual died as a result of one the attacks. Therefore, except in circumstances that indicate the 

taxpayer was financially dependent upon an individual who died in one of the attacks, it is 

intended that the provision generally applies only if the taxpayer was, or became, an obligor or 

co-obligor with respect to indebtedness of an individual who died as a result of one of the attacks 

(e.g., the surviving spouse or estate of the individual).

The bill also provides that the information return filing requirements that otherwise apply 

to discharges of indebtedness do not apply with respect to any discharge of indebtedness that is 

excluded from gross income under this provision.

Effective Date

This provision applies to discharges made on or after September 11, 2001, and before 

January 1, 2002.
69

C. Other Relief Provisions

1. Exclusion of disaster relief payments (sec. 511 of the bill and new sec. 139 of the Code)

Present Law 

Taxation of disaster relief payments

Gross income includes all income from whatever source derived unless a specific 

exception applies (sec. 61). There is no specific statutory exclusion from income for disaster 

payments. However, various types of disaster payments made to individuals have been excluded 

from gross income under a general welfare exception. 79 The exception has been held to exclude 

from income payments made under legislatively provided social benefit programs for the 

promotion of the general welfare. The general welfare exception generally applies if the 

payments (1) are made from a governmental general welfare fund, (2) are for the promotion of 

the general welfare (on the basis of need and not to all residents), and (3) are made without 

respect to services rendered by the recipient. The exclusion generally applies to payments for 

food, medical, housing, personal property, transportation, and funeral expenses. 

The general welfare exception generally does not apply to payments in the nature of 

income replacement, such as payments to individuals for lost wages or unemployment 

compensation or payments in the nature of income replacement to businesses.80 Income 

replacement payments are includable in gross income, unless another exception applies. 

Disaster relief payments may be excludable under other provisions. For example, 

payments made by charitable relief organizations may be excluded from the gross income of the 

recipients as gifts. Payments made in a business context generally are not treated as gifts. 

Factual issues may arise as to whether a payment in the context of a business relationship is a gift 

or taxable compensation for services. In general, payments made by an employer to, or for the 

benefit of, an employee are not excluded from gross income as gifts (sec. 102(c)).

Under present law, gross income generally does not include payments received as 

damages (other than punitive damages) on account of personal physical injury (including death) 

or sickness (sec. 104(a)(2)). Such payments are excluded from gross income regardless of 

whether received by suit or agreement and whether received as a lump sum or as periodic 

payments.

Section 406 of the Air Transportation Safety and System Stabilization Act provides for 

the payment of compensation for eligible individuals who suffered physical harm or death as a 

result of the terrorist-related aircraft crashes of September 11, 2001. There is no statutory 

provision specifically addressing the taxation of such compensation; however, such 

 

79 Rev. Rul. 98-19, 1998-1 C.B. 840; Rev. Rul. 76-144, 1976-1 C.B. 17.

80 IRS Publication 547 (Casualties, Disasters, and Thefts), page 5 (revised December 

2000); Rev. Rul. 91-55, 1991-2 C.B. 321; Rev. Rul. 73-408, 1973-2 C.B. 15. 
70

compensation may be excludable from income under generally applicable Code provisions (e.g., 

section 104).

Rules relating to charitable organizations

In general, organizations described in section 501(c)(3) of the Code are exempt from 

taxation. Contributions to such organizations generally are tax deductible (sec. 170). Section 

501(c)(3) organizations must be organized and operated exclusively for exempt purposes and no 

part of the net earnings of such organizations may inure to the benefit of any private shareholder 

or individual. An organization is not organized or operated exclusively for one or more exempt 

purposes unless it serves a public rather than a private interest. Thus, an organization described 

in section 501(c)(3) generally must serve a charitable class of persons that is indefinite or of 

sufficient size. 

Tax-exempt private foundations are a type of organization described in section 501(c)(3) 

and are subject to special rules. Private foundations are subject to excise taxes on acts of selfdealing between the private foundation and a disqualified person with respect to the foundation 

(sec. 4941). For example, it is self-dealing if the income or assets of a private foundation are 

transferred to, or used by or for the benefit of a disqualified person, such as a substantial 

contributor to the foundation or a person in control of the foundation, and the benefit is not 

incidental or tenuous. Private foundations also are subject to excise taxes on taxable 

expenditures (sec. 4945). For example, it is a taxable expenditure if a private foundation pays an 

amount that does not further certain charitable purposes, or makes a grant to an individual for 

educational or other similar purposes without following certain procedures.

Explanation of Provision

Taxation of disaster relief payments

The bill clarifies that any amount received as payment under section 406 of the Air 

Transportation Safety and System Stabilization Act is excludable from gross income. In 

addition, the bill provides a specific exclusion from income for qualified disaster relief 

payments. No inference is intended as to the taxability of such payments under present law. In 

addition, the provision is not intended to preclude the exclusion of other types of payments under 

the general welfare exception or other Code provisions.

Qualified disaster relief payments include payments, from any source, to, or for the 

benefit of, an individual to reimburse or pay reasonable and necessary personal, family, living, or 

funeral expenses incurred as a result of a qualified disaster. Personal, family, and living 

expenses are intended to have the same meaning as when used in section 262. Personal expenses 

include personal property expenses.

Qualified disaster relief payments also include payments, from any source, to reimburse 

or pay reasonable and necessary expenses incurred for the repair or rehabilitation of a personal 

residence, or for the repair or replacement of its contents, to the extent that the need for the 

repair, rehabilitation, or replacement is attributable to a qualified disaster. For purposes of 

determining the tax basis of a rehabilitated residence, it is intended that qualified disaster relief 

payments be treated in the same manner as amounts received on an involuntary conversion of a 
71

principal residence under section 121(d)(5) and sections 1033(b) and (h). A residence is not 

precluded from being a personal residence solely because the taxpayer does not own the 

residence; a rented residence can qualify as a personal residence. 

Qualified disaster relief payments also include payments by a person engaged in the 

furnishing or sale of transportation as a common carrier on account of death or personal physical 

injuries incurred as a result of a qualified disaster. Thus, for example, payments made by 

commercial airlines to families of passengers killed as a result of a qualified disaster would be 

excluded from gross income.81

Qualified disaster relief payments also include amounts paid by a Federal, State or local 

government in connection with a qualified disaster in order to promote the general welfare. As 

under the present law general welfare exception, the exclusion does not apply to payments in the 

nature of income replacement, such as payments to individuals of lost wages, unemployment 

compensation, or payments in the nature of business income replacement.

Qualified disaster relief payments do not include payments for any expenses 

compensated for by insurance or otherwise. No change from present law is intended as to the 

deductibility of qualified disaster relief payments, made by an employer or otherwise, merely 

because the payments are excludable by the recipients. Thus, it is intended that payments 

excludable from income under the provision are deductible to the same extent they would be if 

they were includable in income. In addition, in light of the extraordinary circumstances 

surrounding a qualified disaster, it is anticipated that individuals will not be required to account 

for actual expenses in order to qualify for the exclusion, provided that the amount of the 

payments can be reasonably expected to be commensurate with the expenses incurred. 

Particular payments may come within more than one category of qualified disaster relief 

payments; the categories are not intended to be mutually exclusive. Qualified disaster relief 

payments also are excludable for purposes of self-employment taxes and employment taxes. 

Thus, no withholding applies to qualified disaster relief payments. 

Under the bill, a qualified disaster includes a disaster which results from a terroristic or 

military action (as defined in section 692(c)(2), as amended by the bill), a Presidentially declared 

disaster, a disaster which results from an accident involving a common carrier or from any other 

event which would be determined by the Secretary to be of a catastrophic nature, or, for purposes 

of payments made by a Federal, State or local government, a disaster designated by Federal, 

State or local authorities to warrant assistance.

The exclusion from income under section 139 does not apply to any individual identified 

by the Attorney General to have been a participant or conspirator in the terrorist-related aircraft 

crashes of September 11, 2001, or any other terrorist attack, or to a representative of such 

individual.

 

81 The exclusion from income applies irrespective of section 104(a)(2). As previously 

discussed, no inference is intended that payments excludable under section 139 would not be 

otherwise excludable under another Code provision.
72

Rules applicable to charitable organizations making disaster relief payments

Recognizing that employers and employees may also contribute to section 501(c)(3) 

organizations that make disaster relief payments, clarification of the type of disaster relief grants 

such organizations may make consistent with exempt purposes to assist individuals in distress as 

a result of the September 11 attacks, and more generally, may be helpful. Because the bill 

provides a special rule for certain payments made by reason of death, injury, wounding, or illness 

of an individual as a result of the September 11 attacks, and certain attacks involving anthrax, the 

following discussion relates to disaster relief generally.

Generally speaking, a charitable organization must serve a public rather than a private 

interest. Providing assistance to relieve distress for individuals suffering the effects of a disaster 

generally serves a public rather than a private interest if the assistance benefits the community as 

a whole, or if the recipients otherwise lack the resources to meet their physical, mental and 

emotional needs. Such assistance could include cash grants to provide for food, clothing, 

housing, medical care, funeral costs, transportation, education and other needs. All such grants 

must be need-based, taking into account the family’s financial resources and their physical, 

mental and emotional well-being.

Charitable organizations generally are in the best position to determine the type and 

amount of, and appropriate beneficiaries for, disaster relief. Accordingly, it is expected that the 

Secretary will presume that a charity providing cash assistance in good faith to victims (and their 

family members) of a qualified disaster is acting consistent with the requirements of section 

501(c)(3) if the class of beneficiaries is sufficiently large or indefinite and the charity can 

demonstrate that it is applying consistent, objective criteria for assessing need.

In addition to the rules described above that are applicable to all charities, special rules 

apply with respect to disaster relief provided by private foundations controlled by an employer. 

In such cases, clarification of the appropriate treatment of the foundation and the payments may 

be helpful. In general, a private foundation that is established and controlled by an employer 

violates the requirements of section 501(c)(3) if it provides benefits to a class of beneficiaries 

composed exclusively of the employer’s employees, and such benefits are a form of 

compensation. The IRS recently held in a private letter ruling, 82 and in similar rulings, that a 

private foundation that is established, funded and controlled by a particular employer for the 

purpose of providing disaster relief for employees of a particular employer does not qualify as a 

charitable organization under section 501(c)(3), because the foundation is not operated solely for 

charitable purposes and is providing a benefit on behalf of the employer in violation of the 

prohibition on private inurement. Although private letter rulings do not constitute precedent for 

other taxpayers, considerable uncertainty exists regarding IRS’ position relating to employercontrolled private foundations making disaster relief payments to employee-beneficiaries.

If payments in connection with a qualified disaster are made by a private foundation to 

employees (and their family members) of an employer that controls the foundation, the 

presumption that the charity acts consistently with the requirements of section 501(c)(3) applies

 

82 Priv. Ltr. Rul. 199914040.
73

if the class of beneficiaries is large or indefinite and if recipients are selected based on an 

objective determination of need by an independent committee of the private foundation, a 

majority of the members of which are persons other than persons who are in a position to 

exercise substantial influence over the affairs of the controlling employer (determined under 

principles similar to those in effect under section 4958). The presumption does not apply to 

grants made to, or for the benefit of, a disqualified person or member of the selection committee. 

However, the absence of an independent selection committee does not necessarily mean that a 

foundation violates the requirements of section 501(c)(3). Other procedures and standards may 

be adequate substitutes to ensure that any benefit to the employer is incidental and tenuous. 

Similarly, providing need-based payments to employees and their survivors in response to a 

disaster other than a qualified disaster may well further charitable purposes consistent with the 

requirements of section 501(c)(3).

It is intended that an employer-controlled private foundation is not providing an 

inappropriate benefit and is not disqualified from exemption under section 501(c)(3) if it makes a 

payment to an employee or a family member of an employee (who is employed by an employer 

who controls the foundation) that relieves distress caused by a qualified disaster as defined under 

section 139, provided that it awards grants based on an objective determination of need using 

either an independent selection committee or adequate substitute procedures, as described above. 

It is further intended that section 102(c) of the Code, which provides that a transfer from an 

employer to, or for the benefit of, an employee generally is not excludable from income as a gift, 

does not apply to such payments. It is further expected that the Service will reconsider the ruling 

position it has taken to ensure that private foundations established and controlled by employers 

will have appropriate guidance, consistent with the principles outlined above, on the 

circumstances under which they may provide disaster assistance in connection with a qualified 

disaster specifically to the employers’ employees.

It is intended that the making by a private foundation of disaster relief payments that 

qualify for the presumption stated above (1) will not be treated as an act of self-dealing under 

section 4941 merely because the recipient is an employee (or family member of an employee) of 

a disqualified person with respect to the foundation, (2) will be treated as in furtherance of 

section 170(c)(2)(B) purposes, and (3) will be considered to meet the requirements of section 

4945(g) to the extent that they apply. Moreover, contributions to a section 501(c)(3) 

organization administering relief in a manner outlined above (including those made by 

employers and any of their employees) are deductible under the generally applicable rules of 

section 170. Finally, it is confirmed that need-based payments made by an employer-controlled 

foundation to an individual for exclusively charitable purposes generally are excludable from the 

recipients’ income as gifts.83 Thus, such payments made by a foundation to relieve distress 

caused by a qualified disaster are excludable from the recipients’ income regardless of whether 

they fall within the scope of section 139, or any other such provision of the Code providing for 

an exclusion. The IRS is directed to issue prompt guidance to taxpayers relating to the 

requirements applicable to private foundations making disaster assistance payments. The 

principles discussed above should apply to foundations and public charities providing relief in 

response to both the September 11, 2001, disaster and future qualified disasters.

 

83

 See, e.g., Rev. Rul. 99-44, 1999-2 C.B. 549.
74

Effective Date

The provision applies to taxable years ending on or after September 11, 2001.

2. Authority to postpone certain deadlines and required actions (sec. 512 of the bill, sec. 

7508A of the Code, and new sec. 518 and sec. 4002 of the Employee Retirement Income 

Security Act of 1974)

Present Law

In general

In general, the Secretary of the Treasury may prescribe regulations under which a period 

of up to 120 days may be disregarded for performing various acts under the Internal Revenue 

Code, such as filing tax returns, paying taxes, or filing a claim for credit or refund of tax, for any 

taxpayer determined by the Secretary to be affected by a Presidentially declared disaster (sec. 

7508A). 

The suspension of time may apply to the following acts:

(1) Filing any return of income, estate, or gift tax (except employment and 

withholding taxes);

(2) Payment of any income, estate, or gift tax (except employment and withholding 

taxes);

(3) Filing a petition with the Tax Court for redetermination of a deficiency, or for 

review of a decision rendered by the Tax Court;

(4) Allowance of a credit or refund of any tax;

(5) Filing a claim for credit or refund of any tax;

(6) Bringing suit upon any such claim for credit or refund;

(7) Assessment of any tax;

(8) Giving or making any notice or demand for the payment of any tax, or with 

respect to any liability to the United States in respect of any tax;

(9) Collection of the amount of any liability in respect of any tax; 

(10) Bringing suit by the United States in respect of any liability in respect of any tax; 

and
75

(11) Any other act required or permitted under the internal revenue laws specified in 

regulations prescribed by the Secretary of the Treasury. 84

Individuals may, if they choose, perform any of these acts during the period of 

suspension.

On September 13, 2001, the IRS issued Notice 2001-61 providing relief to taxpayers 

affected by the September 11, 2001, terrorist attack. Prior to issuance of this notice, the 

President had declared certain affected areas to be disaster areas. In addition, on September 14, 

2001, the IRS issued Notice 2001-63 providing additional tax relief to taxpayers who found it 

difficult to meet their tax filing and payment obligations.

Employee benefit plans

Questions have arisen about the scope of section 7508A in relation to employee benefit 

plans. Some acts related to employee benefit plans are not clearly covered by the suspension. 

For example, a plan sponsor or plan administrator may be required to provide a notice to plan 

participants or to make a plan contribution, or a plan participant may be required to make a 

benefit election or take a distribution under the plan. In addition, some acts related to employee 

benefit plans may be required or provided for under the Employee Retirement Income Security 

Act ("ERISA") or under the terms of the plan, rather than under the Internal Revenue Code. For 

example, on September 14, 2001, the Department of Labor issued News Release No. 01-36, 

announcing that the Pension and Welfare Benefits Administration, the Internal Revenue Service, 

and the Pension Benefit Guaranty Corporation were extending the deadline for filing Form 5500 

and Form 5500-EZ.

Explanation of Provision

In general 

The bill redrafts section 7508A to expand its scope and to clarify its application. 

Specifically, the bill permits the Secretary to suspend the period of time under this provision for 

up to one year (increased from up to 120 days). The bill also clarifies that interest on 

underpayments may be waived or abated pursuant to section 7508A with respect to either a 

declared disaster or a terroristic or military action. The bill clarifies that the Secretary of the 

Treasury has the authority to postpone actions pursuant to section 7508A in response to a 

terroristic or military action, regardless of whether a disaster area has been declared by the 

President in connection with the action. The bill facilitates the prompt issuance of guidance by 

the Secretary of the Treasury with respect to section 7508A by removing the requirement that 

regulations be published listing the scope of additional actions that may be postponed pursuant to 

section 7508(a)(1)(K); accordingly, the Secretary may provide authoritative guidance via a 

notice or other mechanism of the Secretary’s choice that may be issued more rapidly. It is 

intended that the Secretary construe this authority as broadly as is necessary and appropriate to 

 

84 Treas. Reg. sec. 301.7508A-1(c)(1)(vii) states, with respect to this clause, that it 

encompasses “any other act specified in a revenue ruling, revenue procedure, notice, 

announcement, news release, or other guidance published in the Internal Revenue Bulletin.”
76

respond to specific disasters or terroristic or military actions. The authority to postpone “any ... 

act” is sufficiently broad to encompass, for example, specific deadlines enumerated in the Code,

such as those in section 1031 (relating to the exchange of property held for productive use or 

investment). Similarly, it is intended that the Secretary utilize this authority to address issues 

that arise from the discovery of tax information subsequent to the filing of a tax return that would 

affect the tax liability reported on that return.

Employee benefit plans

The bill expands and clarifies the scope of the deadlines and required actions that may be 

postponed pursuant to section 7508A. The bill provides that the Secretary of the Treasury may 

prescribe a period of up to one year which may be disregarded in determining the date by which 

any action by a pension or other employee benefit plan, or by a plan sponsor, administrator, 

participant, beneficiary or other person would be required or permitted to be completed. The bill 

provides similar authority to the Secretary of Labor and the Pension Benefit Guaranty 

Corporation with respect to actions within their respective jurisdictions.

The bill is not limited to actions under the Internal Revenue Code. Accordingly, actions 

under ERISA or under the terms of the plan come within the scope of this provision. Acts 

performed within the extended period are considered timely under the Internal Revenue Code, 

ERISA, and the plan. In addition, a plan is not treated as operating in a manner inconsistent with 

its terms or in violation of its terms merely because acts provided for under the plan are 

performed during the extended period.

Examples of acts covered by the provision include (1) the filing of a form with the IRS, 

Department of Labor or the Pension Benefit Guaranty Corporation, (2) an employer’s 

contribution to the plan of required quarterly amounts for the current year or the prior year 

minimum funding amounts, (3) the filing of an application for a waiver of the minimum funding 

standard, (4) the payment of premiums to the Pension Benefit Guarantee Corporation, (5) a 

participant’s election of a form of benefits under a plan, (6) the plan administrator’s distribution 

of benefits in accordance with a participant’s election, (7) notice to an employee of eligibility for 

continuation coverage under a group health plan, and (8) an employee’s election of continuation 

coverage.

Effective Date

The provision applies to disasters and terroristic or military actions occurring on or after 

September 11, 2001, with respect to any action of the Secretary of the Treasury, the Secretary of 

Labor, or the Pension Benefit Guaranty Corporation on or after the date of the enactment.
77

3. Application of certain provisions to terroristic or military actions (sec. 513 of the bill and 

secs. 104 and 692 of the Code)

Present Law

Taxation of disability income of U.S. employees related to terrorist activity outside the 

United States

Gross income does not include amounts received by an individual as disability income 

attributable to injuries incurred as a direct result of a terrorist attack (as determined by the 

Secretary of State) which occurred while the individual was performing official duties as an 

employee of the United States outside the United States (sec. 104(a)(5)).

Income tax relief for military and civilian U.S. employees who die as a result of terrorist 

activity outside the United States 

Military and civilian employees of the United States who die as a result of wounds or 

injury incurred outside the United States in a terroristic or military action are not subject to 

income tax for the year of death and for prior taxable years beginning with the taxable year prior 

to the taxable year in which the wounds or injury were incurred. Accordingly, if such an 

individual is injured and dies in the same taxable year, this exemption from income tax is 

available for the taxable year of death as well as the prior taxable year.

Explanation of Provision

Taxation of disability income related to terrorist activity

The bill expands the present-law exclusion from gross income for disability income of 

U.S. civilian employees attributable to a terrorist attack outside the United States to apply to 

disability income received by any individual attributable to a terroristic or military action. 

Income tax relief for individuals who die as a result of terrorist activity 

The bill extends the income tax relief provided under present law to U.S. military and 

civilian personnel who die as a result of terroristic activity or military action outside the United 

States to such personnel regardless of where the terroristic activity or military action occurred.

Effective Date

The provision is effective for taxable years ending on or after September 11, 2001.
78

4. Clarification that the special deposit rules provided under the Air Transportation Safety 

and Stabilization Act do not apply to employment taxes (sec. 514 of the bill and sec. 301 of 

the Air Transportation Safety and Stabilization Act)

Present Law

Section 301 of the Air Transportation Safety and System Stabilization Act85 provides a 

special rule for the deposit of certain taxes. If a deposit of these taxes was required to be made 

after September 10, 2001, and before November 15, 2001, they are treated as timely made if 

deposited by November 15, 2001. The Secretary of the Treasury is given the authority to extend 

this deadline further, but no later than January 15, 2002. For eligible air carriers, the special 

deposit rules are applicable to the excise taxes imposed on air travel. The special deposit rules 

were also applied inadvertently to the deposit of the following employment taxes: both the 

employer and employee portions of FICA, railroad retirement taxes, and income taxes withheld 

by employers from employees.

Explanation of Provision

The applicability of these special deposit rules to employment taxes is repealed. The 

applicability of these special deposit rules to excise taxes is unaffected. It is intended that no 

penalties be imposed with respect to taxes that were not deposited timely in reliance on the 

provisions of the Air Transportation Safety and System Stabilization Act prior to the enactment 

of this provision.

Effective Date

The provision is effective as if included in section 301 of the Air Transportation Safety 

and System Stabilization Act.

5. Treatment of purchase of structured settlements (sec. 515 of the bill and new sec. 5891 of 

the Code)

Present Law

Present law provides tax-favored treatment for structured settlement arrangements for the 

payment of damages on account of personal injury or sickness.

Under present law, an exclusion from gross income is provided for amounts received for 

agreeing to a qualified assignment to the extent that the amount received does not exceed the 

aggregate cost of any qualified funding asset (sec. 130). A qualified assignment means any 

assignment of a liability to make periodic payments as damages (whether by suit or agreement) 

on account of a personal injury or sickness (in a case involving physical injury or physical 

sickness), provided the liability is assumed from a person who is a party to the suit or agreement, 

and the terms of the assignment satisfy certain requirements. Generally, these requirements are 

that (1) the periodic payments are fixed as to amount and time; (2) the payments cannot be 

 

85 Pub. L. No. 107-42.
79

accelerated, deferred, increased, or decreased by the recipient; (3) the assignee's obligation is no 

greater than that of the assignor; and (4) the payments are excludable by the recipient under 

section 104(a)(1) or (2) as workmen’s compensation for personal injuries or sickness, or as 

damages on account of personal physical injuries or physical sickness.

A qualified funding asset means an annuity contract issued by an insurance company 

licensed in the U.S., or any obligation of the United States, provided the annuity contract or 

obligation meets statutory requirements. An annuity that is a qualified funding asset is not 

subject to the rule requiring current inclusion of the income on the contract which generally 

applies to annuity contract holders that are not natural persons (e.g., corporations) (sec. 

72(u)(3)(C)). In addition, when the payments on the annuity are received by the structured 

settlement company and included in income, the company generally may deduct the 

corresponding payments to the injured person, who, in turn, excludes the payments from his or 

her income (sec. 104). Thus, neither the amount received for agreeing to the qualified assignment 

of the liability to pay dama ges, nor the income on the annuity that funds the liability to pay 

damages, generally is subject to tax.

The exclusion for recipients of the periodic payments received under a structured 

settlement arrangement as damages for personal physical injuries or physical sickness can be 

contrasted with the treatment of investment earnings that are not paid as damages. If a recipient 

of damages chooses to receive a lump sum payment (excludable from income under sec. 104), 

and then to invest it himself, generally the earnings on the investment are includable in income. 

For example, if the recipient uses the lump sum to purchase an annuity contract providing for 

periodic payments, then a portion of each payment under the annuity contract is includable in 

income, and the balance is excludable under present-law rules based on the ratio of the 

individual’s investment in the contract to the expected return on the contract (sec. 72(b)).

Present law provides that the payments to the injured person under the qualified 

assignment cannot be accelerated, deferred, increased, or decreased by the recipient (sec. 130). 

Consistent with these requirements, it is understood that contracts under structured settlement 

arrangements generally contain anti-assignment clauses. It is understood, however, that injured 

persons may nonetheless be willing to accept discounted lump sum payments from certain 

“factoring” companies in exchange for their payment streams. The tax effect on the parties of 

these transactions may not be completely clear under present law.

Explanation of Provision

The bill generally imposes an excise tax on any person who acquires certain payment 

rights under a structured settlement arrangement from a structured settlement recipient for 

consideration. The amount of the excise tax is 40 percent of the excess of (1) the undiscounted 

amount of the payments being acquired, over (2) the total amount actually paid to acquire them. 

The 40-percent excise tax does not apply, however, if the transfer is approved in advance 

in a final order, judgment or decree that: (1) finds that the transfer does not contravene any 

Federal or State statute or the order of any court or responsible administrative authority; (2) finds 

that the transfer is in the best interest of the payee, taking into account the welfare and support of 

the payee’s dependents; and (3) is issued under an applicable State statute by a court or is issued 
80

by the responsible administrative authority. Rules are provided for determining the applicable 

State statute.

The provision also provides that the acquisition transaction does not affect the application 

of certain present-law rules, if those rules were satisfied at the time the structured settlement was 

entered into. The rules are section 130 (relating to an exclusion from gross income for personal 

injury liability assignments), section 72 (relating to annuities), sections 104(a)(1) and (2) 

(relating to an exclusion for amounts received under workers’ compensation acts and for 

damages on account of personal physical injuries or physical sickness), and section 461(h) 

(relating to the time of economic performance in determining the taxable year of a deduction).

Effective Date

The provision generally is effective for acquisition transactions entered into on or after 30 

days following enactment. A transition rule applies during the period from that date to July 1, 

2002. Under the transition rule, if no applicable State law (relating to the best interest of the 

payee) applies to a transfer during that period, then the exception from the 40 percent excise tax 

is available without the otherwise required court (or administrative) order, provided certain 

disclosure requirements are met. Under the transition rule, the person acquiring the structured 

settlement payments is required to disclose in advance to the payee: (1) the amounts and due 

dates of the payments to be transferred; (2) the aggregate amount to be transferred; (3) the 

consideration to be received by the payee; (4) the discounted present value of the transferred 

payments; and (5) the expenses to be paid by the payee or deducted from the payee’s proceeds.

The provision providing that the acquisition transaction does not affect the application of 

certain present-law rules is effective for transactions entered into before, on or after the 30th day 

following enactment.

6. Personal exemption deduction for certain disability trusts (sec. 516 of the bill and sec. 

642 of the Code)

Present Law

Present law provides a $300 personal exemption for trusts that are required by their 

governing instruments to currently distribute all of their income. For other trusts, present law 

provides a $100 personal exemption. These deductions are in lieu of the personal exemption that 

generally is provided under section 151 for individuals (sec. 642(b)).

Under present law, a grantor who transfers property to a trust while retaining certain 

powers or interests over the trust is treated as the owner of the trust for income tax purposes 

under the so-called “grantor trust rules” (secs. 671-677). Similarly, a third party who is not 

adverse to the grantor is treated as the owner of the trust under these rules to the extent that the 

third party is granted certain powers over the trust. If a grantor or third party is treated as the 

owner of a trust (a “grantor trust”), the income and deductions of the trust are included directly in 

the taxable income of the grantor or third party. Because the personal exemption under section 

642(b) applies to income that is taxable to a trust (rather than a grantor or third party), the 

personal exemption under section 642(b) does not apply to grantor trusts.
81

Explanation of Provision

The bill provides that certain disability trusts may claim a personal exemption in an 

amount that is based upon the personal exemption provided for individuals under section 151(d), 

rather than the $300 or $100 personal exemption provided under present law. The provision 

applies to taxable disability trusts described in 42 U.S.C. sec. 1396p(c)(2)(B)(iv) (relating to the 

treatment, for purposes of determining eligibility for medical assistance under the Social Security 

Act, of assets transferred to a trust established solely for the benefit of a disabled individual 

under 65 years of age).

The provision only applies to disability trusts the beneficiaries of which have been 

determined by the Commissioner of Social Security to be disabled (other than holders of a 

remainder or reversionary interest in the trust), within the meaning of 42 U.S.C. sec. 1382c(a)(3) 

(relating to the definition of a “disabled individual” for purposes of determining eligibility for 

Supplemental Security Income).

The provision applies if all of the beneficiaries of the trust at the end of the taxable year 

are determined under 42 U.S.C. sec. 1382c(a)(3) to be disabled for some portion of such year. 

Thus, a disability trust may claim the personal exemption under the provision even if one or 

more of the beneficiaries becomes no longer disabled during the taxable year. However, the trust 

may claim the personal exemption for the following taxable year only if such individual or 

individuals are no longer beneficiaries of the trust at the end of the following taxable year (i.e., 

all remaining beneficiaries of the trust at the end of the following taxable year are disabled or 

were disabled during some portion of such year). In the case of a disability trust with a single 

beneficiary, the trust may claim the personal exemption under the provision for the taxable year 

during which the beneficiary becomes no longer disabled, but not for subsequent taxable years.

The personal exemption provided for disability trusts under the provision is equal in 

amount to the section 151(d) personal exemption for unmarried individuals with no dependents 

and is subject to a phaseout, which is determined by reference to the phaseout of the personal 

exemption for such individuals under sec. 151(d)(3)(C)(iii). For purposes of computing the 

phaseout of the personal exemption under the provision, the adjusted gross income of the trust is 

determined by reference to section 67(e) (relating to the determination of adjusted gross income 

of estates and trusts for purposes of computing the 2-percent floor on miscellaneous itemized 

deductions).

The provision does not affect the determination of whether a disability trust is treated as a 

grantor trust under the present-law grantor trust rules, and does not change the inapplicability of 

the personal exemption under section 642(b) to grantor trusts. Thus, the provision does not 

apply to disability trusts that are treated as grantor trusts.

Effective Date

The provision applies to taxable years of disability trusts ending on or after September 

11, 2001.
82

7. Disclosure of tax information in terrorism and national security investigations (sec. 517 

of the bill and sec. 6103 of the Code)

Present Law

In general

Returns and return information are confidential (sec. 6103). A “return” is any tax return, 

information return, declaration of estimated tax, or claim for refund filed under the Code on 

behalf of or with respect to any person. The term return also includes any amendment or 

supplement, including supporting schedules, attachments, or lists, which are supplemental to or 

are part of a filed return. Return information is defined broadly. It includes the following 

information:

• 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;

• whether the taxpayer’s return was, is being, or will be examined or subject to other 

investigation or processing;

• 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 this title for 

any tax, penalty, interest, fine, forfeiture, or other imposition, or offense; 

• any part of any written determination or any background file document relating to such 

written determination which is not open to public inspection under section 6110; 

• any advance pricing agreement entered into by a taxpayer and the Secretary and any 

background information related to the agreement or any application for an advance 

pricing agreement; and

• any agreement under section 7121 (relating to closing agreements), and any similar 

agreement, and any background information related to such agreement or request for such 

agreement (sec. 6103(b)(2)).

The term “return information” does not include data in a form that cannot be associated 

with or otherwise identify, directly or indirectly, a particular taxpayer. “Taxpayer return 

information” means return information which is filed with, or furnished to, the Internal Revenue 

Service by or on behalf of the taxpayer to whom such return information relates.

Section 6103 provides that returns and return information may not be disclosed by the 

IRS, other Federal employees, State employees, and certain others having access to the 

information except as provided in the Internal Revenue Code. Section 6103 contains a number 

of exceptions to this general rule of nondisclosure that authorize disclosure in specifically 

identified circumstances (including nontax criminal investigations) when certain conditions are 

satisfied.
83

Recordkeeping and safeguard requirements also are imposed. These requirements 

establish a system of records to keep track of disclosure requests and disclosures and to ensure 

that the information is securely stored and that access to the information is restricted to 

authorized persons. These conditions and safeguards are intended to ensure that an individual’s 

right to privacy is not unduly compromised and the information is not misused or improperly 

disclosed. The IRS also must submit reports to the Joint Committee on Taxation and to the 

public regarding requests for and disclosures made of returns and return information 90 days 

after the close of the calendar year (sec. 6103(p)(3)). Criminal and civil sanctions apply to the 

unauthorized disclosure or inspection of returns and return information (secs. 7213, 7213A, and 

7431). 

Disclosure of returns and return information for use in nontax criminal investigations - by 

ex parte court order

A Federal agency enforcing a nontax criminal law must obtain an ex parte court order to 

receive a return or taxpayer return information (i.e., that information submitted by or on behalf of 

a taxpayer to the IRS) (sec. 6103(i)(1)).86 Only the Attorney General, Deputy Attorney General, 

Assistant Attorney Generals, United States Attorneys, Independent Counsels, or an attorney in 

charge of an organized crime strike force may authorize an application for the order. 

For a judge or magistrate to grant such an order, the application must demonstrate that:

• there is reasonable cause to believe, based upon information believed to be reliable, 

that a specific criminal act has been committed;

• there is reasonable cause to believe that the return or return information is or may be 

relevant to a matter relating to the commission of such act;

• the return or return information is sought exclusively for use in a Federal criminal 

investigation or proceeding concerning such act; and

• the information sought reasonably cannot be obtained, under the circumstances, from 

another source. 

Pursuant to the ex parte order, the information may be disclosed to officers and 

employees of the Federal agency who are personally and directly engaged in (1) the preparation 

for any judicial or administrative proceeding pertaining to the enforcement of a specifically 

designated Federal criminal statute (not involving tax administration) to which the United States 

or such agency is a party, (2) any investigation which may result in such a proceeding, or (3) any 

Federal grand jury proceeding pertaining to enforcement of such a criminal statute to which the 

United States or such agency is or may be a party.

A Federal agency may obtain, by ex parte court order, the return and return information 

of a fugitive from justice for purposes of locating such individual (sec. 6103(i)(5)). The 

application for an ex parte order must establish that (1) a Federal felony arrest warrant has been 

issued and the taxpayer is a fugitive from justice, (2) the return or return information is sought 

 

86 Return information other than that submitted by the taxpayer may be obtained by ex 

parte court order under this provision as well. 
84

exclusively for locating the fugitive taxpayer, and (3) reasonable cause exists to believe the 

information may be relevant in determining the location of the fugitive. Only the Attorney 

General, Deputy Attorney General, Assistant Attorney Generals, United States Attorneys,

Independent Counsels, or an attorney in charge of an organized crime strike force may authorize 

an application for this order. Once a court grants the application for an ex parte order, the return 

or return information may be disclosed to any Federal agency exclusively for purposes of 

locating the fugitive individual.

Agency request procedure for disclosure of return information other than taxpayer return 

information to the IRS for use in criminal investigations 

For nontax criminal investigations, Federal agencies can obtain return information, other 

than taxpayer return information, without a court order. For nontax criminal purposes, the head 

of a Federal agency and other persons specifically identified by section 6103 may make a written 

request for return information that was not provided to the IRS by the taxpayer or his 

representative (sec. 6103(i)(2)). The written request must contain: 

• the taxpayer’s name, and address; 

• the taxable period for which the information is sought; 

• the statutory authority under which the criminal investigation or judicial, 

administrative or grand jury proceeding is being conducted; and 

• the reasons why such disclosure is or may be relevant to the investigation or 

proceeding. Unlike the requirements for an ex parte order, the requesting agency 

does not have to demonstrate that the information sought is not reasonably available 

elsewhere. 

Disclosure of return information to apprise appropriate officials of criminal activities or 

emergency circumstances

Criminal activities

Section 6103 permits the IRS to disclose return information (other than taxpayer return 

information) that may be evidence of a crime (sec. 6103(i)(3)(A)). The IRS may make the 

disclosure in writing to the head of a Federal agency charged with enforcing the laws to which 

the crime relates. Return information also may be disclosed to apprise Federal law enforcement 

of the imminent flight of any individual from Federal prosecution. The IRS may not disclose 

returns under this provision. 

Emergency circumstances

In cases of imminent danger of death or physical injury to an individual, the IRS may 

disclose return information to Federal and State law enforcement agencies (sec. 6103(i)(3)(B)). 

The statute does not grant authority, however, to disclose return information to local law 

enforcement, such as city, county, or town police. The statute does not permit the IRS to 

disclose return information concerning terrorist activities if there is no imminent danger of death 

or physical injury to an individual.
85

Tax convention information

With limited exceptions, the Code prohibits the disclosure of tax convention information 

(sec. 6105). A tax convention is any: (1) income tax or gift and estate tax convention, or (2) 

other convention or bilateral agreement (including multilateral conventions and agreements and 

any agreement with a possession of the United States) providing for the avoidance of double 

taxation, the prevention of fiscal evasion, nondiscrimination with respect to taxes, the exchange 

of tax relevant information with the United States, or mutual assistance in tax matters. Tax 

convention information is any: (1) agreement entered into with the competent authority of one 

or more foreign governments pursuant to a tax convention; (2) application for relief under a tax 

convention; (3) background information related to such agreement or application; (4) document 

implementing such agreement; and (5) other information exchanged pursuant to a tax convention 

which is treated as confidential or secret under the tax convention. 

The general rule that tax convention information cannot be disclosed does not apply to 

the disclosure of tax convention information to persons or authorities (including courts and 

administrative bodies) that are entitled to disclosure under the tax convention and any generally 

applicable procedural rules regarding applications for relief under a tax convention. It also does 

not apply to the disclosure of tax convention information not relating to a particular taxpayer if 

the IRS determi nes, after consultation with the parties to the tax convention, that such disclosure 

would not impair tax administration.

Explanation of Provision

In general

The bill expands the availability of returns and return information for purposes of 

investigating terrorist incidents, threats, or activities, and for analyzing intelligence concerning 

terrorist incidents, threats, or activities. In general, under the bill, returns and taxpayer return 

information must be obtained pursuant to an ex parte court order. Return information, other than 

taxpayer return information, generally is available upon a written request meeting specific 

requirements. Present-law safeguards, recordkeeping, reporting requirements, and civil and 

criminal penalties for unauthorized disclosures apply to disclosures made pursuant to the bill. 

The bill also permits the disclosure of tax convention information for the same purposes and in 

the same manner that return information is made available under the bill. No disclosures may be 

made under the bill after December 31, 2003.

Disclosure of returns and return information including taxpayer return information - by ex 

parte court order

Ex parte court orders sought by Federal law enforcement and Federal intelligence 

agencies.--The bill permits, pursuant to an ex parte court order, the disclosure of returns and 

return information (including taxpayer return information) to certain officers and employees of a 

Federal law enforcement agency or Federal intelligence agency. These officers and employees 

are required to be personally and directly engaged in any investigation of, response to, or 

analysis of intelligence and counterintelligence information concerning any terrorist incident, 

threat, or activity. These officers and employees are permitted to use this information solely for 
86

their use in the investigation, response, or analysis, and in any judicial, administrative, or grand 

jury proceeding, pertaining to any such terrorist incident, threat, or activity.

The Attorney General, Deputy Attorney General, Associate Attorney General, an 

Assistant Attorney General, or a United States attorney, may authorize the application for the ex 

parte court order to be submitted to a Federal district court judge or magistrate. The Federal 

district court judge or magistrate would grant the order if based on the facts submitted he or she 

determines that:

• there is reasonable cause to believe, based upon information believed to be reliable, 

that the return or return information may be relevant to a matter relating to such 

terrorist incident, threat, or activity; and

• the return or return information is sought exclusively for the use in a Federal 

investigation, analysis, or proceeding concerning any terrorist incident, threat, or 

activity. 

Special rule for ex parte court ordered disclosure initiated by the IRS.--If the Secretary of 

Treasury possesses returns or return information that may be related to a terrorist incident, threat, 

or activity, the Secretary of the Treasury (or his delegate), may on his own initiative, authorize 

an application for an ex parte court order to permit disclosure to Federal law enforcement. In 

order to grant the order, the Federal district court judge or magistrate must determine that there is 

reasonable cause to believe, based upon information believed to be reliable, that the return or 

return information may be relevant to a matter relating to such terrorist incident, threat, or 

activity. Under the bill, the information may be disclosed only to the extent necessary to apprise 

the appropriate Federal law enforcement agency responsible for investigating or responding to a 

terrorist incident, threat, or activity and for officers and employees of that agency to investigate 

or respond to such terrorist incident, threat, or activity. Further, use of the information is limited 

to use in a Federal investigation, analysis, or proceeding concerning a terrorist incident, threat, or 

activity. Because the Department of Justice represents the Secretary of the Treasury in Federal 

district court, the Secretary is permitted to disclose returns and return information to the 

Department of Justice as necessary and solely for the purpose of obtaining the special IRS ex 

parte court order.

Disclosure of return information other than taxpayer return information

Disclosure by the IRS without a request.--The bill permits the IRS to disclose return 

information, other than taxpayer return information, related to a terrorist incident, threat, or 

activity to the extent necessary to apprise the head of the appropriate Federal law enforcement 

agency responsible for investigating or responding to such terrorist incident, threat, or activity. 

As under present law Code section 6103(i)(3)(A), the IRS on its own initiative and without a 

written request may make this disclosure. The head of the Federal law enforcement agency may 

disclose information to officers and employees of such agency to the extent necessary to 

investigate or respond to such terrorist incident, threat, or activity. A taxpayer’s identity is not 

treated as return information supplied by the taxpayer or his or her representative.

Disclosure upon written request of a Federal law enforcement agency.--The bill permits 

the IRS to disclose return information, other than taxpayer return information, to officers and 
87

employees of Federal law enforcement upon a written request satisfying certain requirements. 

The request must: (1) be made by the head of the Federal law enforcement agency (or his 

delegate) involved in the response to or investigation of terrorist incidents, threats, or activities, 

and (2) set forth the specific reason or reasons why such disclosure may be relevant to a terrorist 

incident, threat, or activity. The information is to be disclosed to officers and employees of the 

Federal law enforcement agency who would be personally and directly involved in the response 

to or investigation of terrorist incidents, threats, or activities. The information is to be used by 

such officers and employees solely for such response or investigation.

The bill permits the redisclosure by a Federal law enforcement agency to officers and 

employees of State and local law enforcement personally and directly engaged in the response to 

or investigation of the terrorist incident, threat, or activity. The State or local law enforcement 

agency must be part of an investigative or response team with the Federal law enforcement 

agency for these disclosures to be made.

Disclosure upon request from the Departments of Justice or Treasury for intelligence 

analysis of terrorist activity.--Upon written request satisfying certain requirements discussed 

below, the IRS is to disclose return information (other than taxpayer return information87) to 

officers and employees of the Department of Justice, Department of Treasury, and other Federal 

intelligence agencies, who are personally and directly engaged in the collection or analysis of 

intelligence and counterintelligence or investigation concerning terrorist incidents, threats, or 

activities. Use of the information is limited to use by such officers and employees in such 

investigation, collection, or analysis. 

The written request is to set forth the specific reasons why the information to be disclosed 

is relevant to a terrorist incident, threat, or activity. The request is to be made by an individual 

who is (1) an officer or employee of the Department of Justice or the Department of Treasury, 

(2) appointed by the President with the advice and consent of the Senate, and (3) responsible for 

the collection, and analysis of intelligence and counterintelligence information concerning 

terrorist incidents, threats, or activities. The Director of the United States Secret Service also is 

an authorized requester under the bill. 

Tax convention information

The bill permits the disclosure of tax convention information on the same terms as return 

information may be disclosed under the bill, except that in the case of tax convention information 

provided by a foreign government, no disclosure may be made under this paragraph without the 

written consent of the foreign government.

 

87 A taxpayer’s identity is not treated as having been supplied by the taxpayer or his 

representative.
88

Definitions

The term “terrorist incident, threat, or activity” is statutorily defined to mean an incident, 

threat, or activity involving an act of domestic terrorism or international terrorism, as both of 

those terms were defined in the recently enacted USA PATRIOT Act. 88

Effective Date

The provision is effective for disclosures made on or after the date of enactment.

 

88 18 U.S.C. sec. 2331.
89

VIII. MISCELLANEOUS AND TECHNICAL PROVISIONS

A. Allowance of Electronic Forms 1099

(sec. 601 of the bill)

Present Law 

Many provisions in the Code require entities to file information returns with the IRS and 

to provide copies to taxpayers. For example, employers are required to provide information with 

respect to wages paid to employees, and entities (such as banks and credit unions) that pay 

interest to individuals are also required to provide information with respect to those payments. 

In general, the copies of the information returns that are provided to taxpayers are provided on 

paper via the U.S. mail.

Temporary regulations allow Form W-2 to be furnished electronically on a voluntary 

basis. Under Temp. Treas. Reg. §31.6051-1T(j), a recipient must have affirmatively consented to 

receive the statement electronically and must not have withdrawn that consent before the 

statement is furnished. A similar rule cannot be implemented administratively with respect to 

some information returns, because the Code requires that the copies furnished to individuals 

must be furnished either in person or in a statement sent by first-class mail in a specified 

format. 89

IRS Form 5498 is used to report contributions to an Archer MSA, an Individual 

Retirement Account, or a Coverdell education savings accounts. In addition, distributions from 

these accounts are reported on IRS Form 1099. Under present law, the Secretary has the 

authority to issue rules under which Forms 5498 and 1099 related to these accounts may be 

provided electronically.

Explanation of Provision

The provision removes the statutory impediment to providing copies of specified 

information returns to taxpayers electronically. Accordingly, these copies may be furnished 

electronically to a recipient who has consented to this; the copies may be furnished in a manner 

similar to the one permitted with respect to Form W-2 or in another manner provided by the 

Secretary.

Effective Date

The provision is effective on date of enactment.

 

89 See 6042(c), 6044(e),and 6049(c)(2).
90

B. Discharge of Indebtedness of an S Corporation

(sec. 602 of the bill and sec. 108 of the Code)

Present Law

In general, an S corporation is not subject to the corporate income tax on its items of 

income and loss. Instead, an S corporation passes through its items of income and loss to its 

shareholders. Each shareholder takes into account separately his or her pro rata share of these 

items on their individual income tax returns. To prevent double taxation of these items, each 

shareholder’s basis in the stock of the S corporation is increased by the amount included in 

income (including tax-exempt income) and is decreased by the amount of any losses (including 

nondeductible losses) taken into account. A shareholder may deduct losses only to the extent of 

a shareholder’s basis in his or her stock in the S corporation plus the shareholder’s adjusted basis 

in any indebtedness of the corporation to the shareholder. Any loss that is disallowed by reason 

of lack of basis is “suspended” at the corporate level and is carried forward and allowed in any 

subsequent year in which the shareholder has adequate basis in the stock or debt.

In general, gross income includes income from the discharge of indebtedness. However, 

income from the discharge of indebtedness of a taxpayer in a bankruptcy case or when the 

taxpayer is insolvent (to the extent of the insolvency) is excluded from income.90 The taxpayer 

is required to reduce tax attributes, such as net operating losses, certain carryovers, and basis in 

assets, to the extent of the excluded income.

In the case of an S corporation, the eligibility for the exclusion and the attribute reduction 

are applied at the corporate level. For this purpose, a shareholder’s suspended loss is treated as a 

tax attribute that is reduced. Thus, if the S corporation is in bankruptcy or is insolvent, any 

income from the discharge of indebtedness by a creditor of the S corporation is excluded from

the corporation’s income, and the S corporation reduces its tax attributes (including any 

suspended losses). 

To illustrate these rules, assume that a sole shareholder of an S corporation has zero basis 

in its stock of the corporation. The S corporation borrows $100 from a third party and loses the 

entire $100. Because the shareholder has no basis in its stock, the $100 loss is “suspended” at 

the corporate level. If the $100 debt is forgiven when the corporation is in bankruptcy or is 

insolvent, the $100 income from the discharge of indebtedness is excluded from income, and the 

$100 “suspended” loss should be eliminated in order to achieve a tax result that is consistent with 

the economics of the transactions in that the shareholder has no economic gain or loss from these 

transactions.

Notwithstanding the economics of the overall transaction, the United States Supreme 

Court ruled in the case of Gitlitz v. Commissioner91 that, under present law, income from the 

discharge of indebtedness of an S corporation that is excluded from income is treated as an item 

of income which increases the basis of a shareholder’s stock in the S corporation and allows the 

 

90 Special rules also apply to certain real estate debt and farm debt.

91 531 U.S. 206 (2001).
91

suspended corporate loss to pass thru to a shareholder. Thus, under the decision, an S 

corporation shareholder is allowed to deduct a loss for tax purposes that it did not economically 

incur.

Explanation of Provision

The provision provides that income from the discharge of indebtedness of an S 

corporation that is excluded from the S corporation’s income is not taken into account as an item 

of income by any shareholder and thus does not increase the basis of any shareholder’s stock in 

the corporation.

Effective Date

The provision generally applies to discharges of indebtedness after October 11, 2001. 

The provision does not apply to any discharge of indebtedness before March 1, 2002, pursuant to 

a plan of reorganization filed with a bankruptcy court on or before October 11, 2001.
92

C. Limitation on Use of Non-Accrual Experience Method of Accounting

(sec. 603 of the bill and sec. 448 of the Code)

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 

“non-accrual 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. 

Generally, a cash method taxpayer is not required to include an amount in income until 

received. A taxpayer generally may not use the cash method if purchase, production, or sale of 

merchandise is an income producing factor. Such taxpayers generally are required to keep 

inventories and use an 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 years exceed $5 million. An exception to this $5 million rule 

is provided for qualified personal service corporations. A qualified personal service corporation 

is a corporation (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.

Explanation of Provision

Under the provision, the non-accrual experience method of accounting is available only 

for amounts to be received for the performance of qualified services and for services provided by 

certain small businesses. Amounts to be received for all other services are subject to the general 

rule regarding inclusion in income. Qualified services are services in the fields of health, law, 

engineering, architecture, accounting, actuarial science, performing arts or consulting. As under 

present law, the availability of this method is conditioned on the taxpayer not charging interest or 

a penalty for failure to timely pay the amount charged. 

Under a special rule, the non-accrual experience method of accounting continues to be 

available for the performance of non-qualified services if the average annual gross receipts (as 

defined in sec. 448(c)) of the taxpayer (or any predecessor) does not exceed $5 million. The 

rules of paragraph (2) and (3) of section 448(c) (i.e., the rules regarding the aggregation of 

related taxpayers, taxpayers not in existence for the entire three year period, short taxable years, 

definition of gross receipts, and treatment of predecessors) apply for purposes of determining the 

average annual gross receipts test.
93

The provision requires that the Secretary of the Treasury prescribe regulations to permit a 

taxpayer to use alternative computations or formulas if such alternative computations or formulas 

accurately reflect, based on experience, the amount of its year-end receivables that will not be 

collected. It is anticipated that the Secretary of the Treasury will consider providing safe harbors 

in such regulations that may be relied upon by taxpayers. In addition, the provision also provides 

that the Secretary of the Treasury permit taxpayers to adopt, or request consent of the Secretary 

of the Treasury to change to, an alternative computation or formula that clearly reflects the 

taxpayer’s experience. The provision requires the Secretary of Treasury to approve a request 

provided that the alternative computation or formula clearly reflects the taxpayer’s experience. 

Effective Date

The provision is effective for taxable years ending after date of enactment. Any change 

in the taxpayer’s method of accounting required as a result of the limitation on the use of the 

non-accrual experience method is treated as a voluntary change initiated by the taxpayer with the 

consent of the Secretary of the Treasury. Any resultant section 481(a) adjustment is to be taken 

into account over a period not to exceed the lesser of the number of years the taxpayer has used 

the non-accrual experience method of accounting or four years under principles consistent with 

those in Rev. Proc. 99-49.92

 

92 1999-2 C.B. 725
94

D. Expansion of the Exclusion from Income for Qualified Foster Care Payments 

(sec. 604 of the bill and sec. 131 of the Code)

Present Law

If certain requirements are satisfied, an exclusion from gross income is provided for 

qualified foster care payments paid to a foster care provider by either (1) a State or local 

government; or (2) a tax-exempt placement agency. Qualified foster care payments are amounts 

paid for caring for a qualified foster care individual in the foster care provider’s home and 

difficulty of care payments.93 A qualified foster care 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 local 

government (regardless of the individual’s age at the time of placement); or (2) a tax-exempt 

placement agency licensed by the State or local government (if such individual was under the 

age of 19 at the time of placement).

Explanation of Provision

The bill makes two modifications to the present-law exclusion for qualified foster care 

payments. First, the bill expands the definition of qualified foster care payments to include 

payments by any placement agency that is licensed or certified by a State or local government, or 

an entity designated by a State or local government to make payments to providers of foster care. 

Second, the bill expands the definition of a qualified foster care individual by including foster 

care individuals placed by a qualified foster care placement agency (regardless of the 

individual’s age at the time of placement).

Effective Date

The provision is effective for taxable years beginning after December 31, 2001.

 

93 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 in 

the home of the foster care provider 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.
95

E. Interest Rate Used in Determining Additional Required Contributions to

Defined Benefit Plans and PBGC Variable Rate Premiums

(sec. 605 of the bill, sec. 412 of the Code, and secs. 302 and 4006 of ERISA)

Present Law

In general

ERISA and the Code impose both minimum and maximum94 funding requirements with 

respect to defined benefit pension plans. The minimum funding requirements are designed to 

provide at least a certain level of benefit security by requiring the employer to make certain 

minimum contributions to the plan. The amount of contributions required for a plan year is 

generally the amount needed to fund benefits earned during that year plus that year’s portion of 

other liabilities that are amortized over a period of years, such as benefits resulting from a grant 

of past service credit.

Additional contributions for underfunded plans

Additional contributions are required under a special funding rule if a single-employer 

defined benefit pension plan is underfunded.95 Under the special rule, a plan is considered 

underfunded for a plan year if the value of the plan assets is less than 90 percent of the plan’s 

current liability. 96 The value of plan assets as a percentage of current liability is the plan’s 

“funded current liability percentage.”

If a plan is underfunded, the amount of additional required contributions is based on 

certain elements, including whether the plan has an unfunded liability related to benefits accrued 

before 1988 or 1995 or to changes in the mortality table used to determine contributions, and 

whether the plan provides for unpredictable contingent event benefits (that is, benefits that 

depend on contingencies that are not reliably and reasonably predictable, such as facility 

shutdowns or reductions in workforce). However, the amount of additional contributions cannot 

exceed the amount needed to increase the plan’s funded current liability percentage to 100 

percent.

 

94 The maximum funding requirement for a defined benefit plan is referred to as the full 

funding limitation. Additional contributions are not required if a plan has reached the full 

funding limitation.

95 Plans with no more than 100 participants on any day in the preceding plan year are not 

subject to the special funding rule. Plans with more than 100 but not more than 150 participants 

are generally subject to lower contribution requirements under the special funding rule.

96 Under an alternative test, a plan is not considered underfunded if (1) the value of the 

plan assets is at least 80 percent of current liability and (2) the value of the plan assets was at 

least 90 percent of current liability for each of the two immediately preceding years or each of 

the second and third immediately preceding years.
96

Required interest rate

In general, a plan’s current liability means all liabilities to employees and their 

beneficiaries under the plan. The interest rate used to determine a plan’s current liability must be 

within a permissible range of the weighted average of the interest rates on 30-year Treasury 

securities for the four-year period ending on the last day before the plan year begins.97 The 

permissible range is from 90 percent to 105 percent. As a result of debt reduction, the 

Department of the Treasury does not currently issue 30-year Treasury securities.

Timing of plan contributions

In general, plan contributions required to satisfy the funding rules must be made within 8-

1/2 months after the end of the plan year. If the contribution is made by such due date, the 

contribution is treated as if it were made on the last day of the plan year.

In the case of a plan with a funded current liability percentage of less than 100 percent for 

the preceding plan year, estimated contributions for the current plan year must be made in 

quarterly installments during the current plan year. The amount of each required installment is 

25 percent of the lesser of (1) 90 percent of the amount required to be contributed for the current 

plan year or (2) 100 percent of the amount required to be contributed for the preceding plan 

year.98

PBGC premiums

Because benefits under a defined benefit pension plan may be funded over a period of 

years, plan assets may not be sufficient to provide the benefits owed under the plan to employees 

and their beneficiaries if the plan terminates before all benefits are paid. In order to protect 

employees and their beneficiaries, the Pension Benefit Guaranty Corporation (“PBGC”) 

generally insures the benefits owed under defined benefit pension plans. Employers pay 

premiums to the PBGC for this insurance coverage.

In the case of an underfunded plan, additional PBGC premiums are required based on the 

amount of unfunded vested benefits. These premiums are referred to as “variable rate 

premiums.” In determining the amount of unfunded vested benefits, the interest rate used is 85 

percent of the interest rate on 30-year Treasury securities for the month preceding the month in 

which the plan year begins.

 

97 The interest rate used under the plan must be consistent with the assumptions which 

reflect the purchase rates which would be used by insurance companies to satisfy the liabilities 

under the plan (section 412(b)(5)(B)(iii)(II)).

98 No additional quarterly contributions are due once the plan’s funded current liability 

percentage for the plan year reaches 100 percent.
97

Explanation of Provision

Additional contributions

The provision expands the permissible range of the statutory interest rate used in 

calculating a plan’s current liability for purposes of applying the additional contribution 

requirements for plan years beginning after December 31, 2001, and before January 1, 2004. 

Under the provision, the permissible range is from 90 percent to 120 percent for these years. Use 

of a higher interest rate under the expanded range will affect the plan’s current liability, which 

may in turn affect the need to make additional contributions and the amount of any additional 

contributions.

Because the quarterly contributions requirements are based on current liability for the 

preceding plan year, the provision also provides special rules for applying these requirements for 

plans years beginning in 2002 (when the expanded range first applies) and 2004 (when the 

expanded range no longer applies). In each of those years (“present year”), current liability for 

the preceding year is redetermined, using the permissible range applicable to the present year. 

This redetermined current liability will be used for purposes of the plan’s funded current liability 

percentage for the preceding year, which may affect the need to make quarterly contributions and 

for purposes of determining the amount of any quarterly contributions in the present year, which 

is based in part on the preceding year.

PBGC variable rate premiums

Under the provision, the interest rate used in determining the amount of unfunded vested 

benefits for variable rate premium purposes is increased to 100 percent of the interest rate on 30-

year Treasury securities for the month preceding the month in which the plan year begins.

Effective Date

The provision is effective with respect to plan contributions and PBGC variable rate 

premiums for plan years beginning after December 31, 2001, and before January 1, 2004.
98

F. Deduction for Classroom Materials

(sec. 606 of the bill and sec. 62 of the Code)

Present Law

In general, ordinary and necessary business expenses are deductible (sec. 162). However, 

unreimbursed employee business expenses are deductible only as an itemized deduction and only 

to the extent that the individual’s total miscellaneous deductions (including employee business 

expenses) exceed two percent of adjusted gross income.

An individual’s otherwise allowable itemized deductions may be further limited by the 

overall limitation on itemized deductions, which reduces itemized deductions for taxpayers with 

adjusted gross income in excess of $137,300 (for 2002).99 In addition, miscellaneous itemized 

deductions are not allowable under the alternative minimum tax.

Explanation of Provision

The bill provides an above-the-line deduction for up to $250 annually of expenses paid or 

incurred by an eligible educator for books, supplies (other than nonathletic supplies for courses 

of instruction in health or physical education), computer equipment (including related software 

and services) and other equipment, and supplementary materials used by the eligible educator in 

the classroom. To be eligible for this deduction, the expenses must be otherwise deductible 

under 162 as a trade or business expense. 

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, or 

principal in a school for at least 900 hours during a school year. A school means any school 

which provides elementary education or secondary education, as determined under State law.

Effective Date

The provision is effective for taxable years beginning after December 31, 2001, and 

before January 1, 2004.

 

99 The effect of this overall limitation is phased down beginning in 2006, and is repealed 

for 2010.
99

IX. TAX TECHNICAL CORRECTIONS

(secs. 611-618 of the bill)

Except as otherwise provided, the technical corrections contained in the bill generally are 

effective as if included in the originally enacted related legislation.

Amendments to the Economic Growth and Tax Relief Reconciliation Act of 2001

Section 6428 credit interaction with refundable child tax credit.--The provision treats 

the section 6428 credit (rate reduction) like a nonrefundable personal credit, thus allowing it 

prior to determining the refundable child credit.

Child tax credit.--The provision clarifies that for taxable years beginning in 2001, the 

portion of the child credit that is refundable is determined by referring in Code section 

24(d)(1)(B) to "the aggregate amount of credits allowed by this subpart." This would retain prior 

law that was inadvertently changed by the Act.

Interaction of adoption credit limits.--Under prior law, the maximum adoption tax 

credit was $5,000 ($6,000 in the case of special needs adoptions). Under prior and present law, 

the credit generally is allowed in the year following the year the expenses are paid or incurred, 

except for the year that the adoption becomes final and later years. The Act increased the credit 

amount to $10,000 for taxable years beginning after 2001, but did not include a provision 

describing the dollar limit for amounts paid or incurred in 2001 for adoptions that do not become 

final in 2001. The provision clarifies that expenses paid or incurred in 2001 but allowed as a 

credit in 2002 are subject to the $5,000 (or $6,000) dollar cap in effect immediately prior to the 

enactment of the Act.

Dollar amount of credit for special needs adoptions.-- The provision provides that for 

special needs adoptions that become final after 2002, the $10,000 limit set forth in the Act 

relating to special needs adoptions is determined net of the aggregate credit allowed for that year 

and prior years. 

Employer-provided adoption assistance exclusion with respect to special needs 

adoptions.-- The provision clarifies that the maximum exclusion in the case of a special needs 

adoption is $10,000 (before any AGI phaseout) for all taxable years cumulatively. As under 

prior law, a taxpayer may apply the dollar limits separately to each qualifying adoption. Also, 

the provision deems the employee to have qualified adoption expenses of $10,000 (less any such 

amounts actually paid or incurred with respect to that adoption) in the year a special needs 

adoption becomes final.

Credit for employer expenses for child care assistance.--The provision clarifies that 

recapture tax with respect to this credit is treated like recapture taxes with respect to other credits 

under chapter 1 of the Code. Thus, it would not be treated as a tax for purposes of determining 

the amounts of other credits or determining the amount of alternative minimum tax. 
100

Elimination of marriage penalty in standard deduction.--The provision provides rules 

that were inadvertently omitted providing for separate returns and rounding rules for the standard 

deduction for the transition period years.

Education IRAs; non-application of 10-percent additional tax with respect to 

amounts for which HOPE credit is claimed.--Under the law prior to the Act, taxpayers could 

not claim the HOPE (or Lifetime learning) credit in the same year that they claimed an exclusion 

from income from an education IRA. Taxpayers were permitted to waive the exclusion in order 

to claim the HOPE (or Lifetime learning) credit. For taxpayers electing the waiver, earnings 

from amounts withdrawn from education IRAs and attributable to education expenses for which 

a HOPE (or Lifetime learning) credit was claimed were includable in income, but the additional 

ten percent tax was not applied. Under the Act, taxpayers are permitted to claim the education 

IRA exclusion and claim a HOPE (or Lifetime learning) credit in the same year, provided they 

do not claim both with respect to the same educational expenses. The election to waive the 

education IRA exclusion was thus unnecessary, and was dropped. However, a reference to the 

election was retained (sec. 530(d)(4)(b)(iv)). The reference to the election was intended to 

preserve the rule relating to the non-application of the 10-percent additional tax for education 

IRA earnings that are includable in income solely because the HOPE (or Lifetime learning) 

credit is claimed for those expenses. The provision clarifies the present-law rules to reflect this 

result.

The provision prevents the 10-percent additional tax from applying to a distribution from 

an education IRA (or qualified tuition program) that is used to pay qualified higher education 

expenses, but the taxpayer elects to claim a HOPE or Lifetime Learning credit in lieu of the 

exclusion under section 530 or 529. Thus, the income distributed from the education IRA (or 

qualified tuition program) would be subject to income tax, but not to the 10-percent additional 

tax. 

Transfers in trust.--The provision clarifies that the effect of section 511(e) of the Act 

(effective for gifts made after 2009) is to treat certain transfers in trust as transfers of property by 

gift. The result of the clarification is that the gift tax annual exclusion and the marital and 

charitable deductions may apply to such transfers.

Recovery of taxes claimed as credit (State death tax credit).--The provision eliminates 

as deadwood a reference to the State death tax credit.

Pension-Related Amendments to the Economic Growth and Tax Relief Reconciliation Act 

of 2001

Individual Retirement Arrangements (“IRAs”).-- Under the Act, a qualified employer 

plan may provide for voluntary employee contributions to a separate account that is deemed to 

be an IRA. The provision clarifies that, for purposes of deemed IRAs, the term "qualified 

employer plan" includes the following types of plans maintained by a governmental employer: a 

qualified retirement plan under section 401(a), a qualified annuity plan under section 403(a), a 

tax-sheltered annuity plan under section 403(b), and an eligible deferred compensation plan 

under section 457(b). The provision also clarifies that the Employee Retirement Income Security 
101

Act (“ERISA”) is intended to apply to a deemed IRA in a manner similar to a simplified 

employee pension (“SEP”).

Increase in benefit and contribution limits.--Under the Act, the benefit and 

contribution limits that apply to qualified retirement plans are increased. These increases are 

generally effective for years beginning after December 31, 2001, but the increase in the limit on 

benefits under a defined benefit plan is effective for years ending after December 31, 2001. In 

the case of some plans that incorporate the benefit limits by reference and that use a plan year 

other than the calendar year, the increased benefit limits became effective under the plan 

automatically, causing unintended benefit increases. The provision permits an employer to 

amend such a plan by June 30, 2002, to reduce benefits to the level that applied before enactment 

of the Act without violating the anticutback rules that generally apply to plan amendments.

In connection with the increases in the benefit and contribution limits under the Act, a 

new base period applies in indexing the 2002 dollar amounts for future cost-of-living 

adjustments. The same indexing method applies to the dollar amounts used to determine 

eligibility to participate in a SEP and to determine the proper period for distributions from an 

employee stock ownership plan (“ESOP”). The provision changes these dollar amounts to the 

2002 indexed amounts so that future indexing will operate properly. 

Modification of top-heavy rules.--Under the Act, in determining whether a plan is topheavy, distributions made because of separation from service, death, or disability are taken into 

account for one year after distribution. Other distributions are taken into account for five years. 

The Act also permits distributions from a section 401(k) plan, a tax-sheltered annuity plan, or an 

eligible deferred compensation plan to be made when the participant has a severance from 

employment (rather than separation from service). The provision clarifies that distributions 

made after severance from employment (rather than separation from service) are taken into 

account for only one year in determining top-heavy status.

Elective deferrals not taken into account for deduction limits.--The provision clarifies 

that elective deferrals to a SEP are not subject to the deduction limits and are not taken into 

account in applying the limits to other SEP contributions. The provision also clarifies that the 

combined deduction limit of 25 percent of compensation for qualified defined benefit and 

defined contribution plans does not apply if the only amounts contributed to the defined 

contribution plan are elective deferrals. 

Deduction limits.--Under present law, contributions to a SEP are included in an 

employee’s income to the extent they exceed the lesser of 15 percent of compensation or $40,000 

(for 2002), subject to a reduction in some cases. Under prior law, the annual limitation on the 

amount of deductible contributions to a SEP was 15 percent of compensation. Under the Act, the 

annual limitation on the amount of deductible contributions that can be made to a SEP is 

increased from 15 percent of compensation to 25 percent of compensation. The provision makes 

a conforming change to the rule that limits the amount of SEP contributions that may be made 

for a particular employee. Under the provision, contributions are included in an employee’s 

income to the extent they exceed the lesser of 25 percent of compensation or $40,000 (for 2002), 

subject to a reduction in some cases. 
102

Under present law, the Secretary of the Treasury has the authority to require an employer 

who makes contributions to a SEP to provide simplified reports with respect to such 

contributions. Consistent with present law and the provision, such reports could appropriately 

include information as to compliance with the requirements that apply to SEPs, including the 

contribution limits.

Nonrefundable credit for certain individuals for elective deferrals and IRA 

contributions.--The provision clarifies that the amount of contributions taken into account in 

determining the credit for elective deferrals and IRA contributions is reduced by the amount of a 

distribution from a qualified retirement plan, an eligible deferred compensation plan, or a 

traditional IRA that is includible in income or that consists of after-tax contributions. The 

provision retains the rule that distributions that are rolled over to another retirement plan do not 

affect the credit.

Small business tax credit for new retirement plan expenses.--The provision clarifies 

that the small business tax credit for new retirement plan expenses applies in the case of a plan 

first effective after December 31, 2001, even if adopted on or before that date.

Additional salary reduction catch-up contributions.--Under the Act, an individual 

aged 50 or over may make additional elective deferrals (“catch-up contributions”) to certain 

retirement plans, up to a specified limit. A plan may not permit catch-up deferrals in excess of 

this limit. The provision clarifies that, for this purpose, the limit applies to all qualified 

retirement plans, tax-sheltered annuity plans, SEPs and SIMPLE plans maintained by the same 

employer on an aggregated basis, as if all plans were a single plan. The limit applies also to all 

eligible deferred compensation plans of a government employer on an aggregated basis.

Under the Act, catch-up contributions up to the specified limit are excluded from an 

individual’s income. The provision also clarifies that the total amount that an individual may 

exclude from income as catch-up contributions for a year cannot exceed the catch-up 

contribution limit for that year (and for that type of plan), without regard to whether the 

individual made catch-up contributions under plans maintained by the more than one employer. 

The provision clarifies that an individual who will attain age 50 by the end of the taxable 

year is an eligible participant as of the beginning of the taxable year rather than only at the 

attainment of age 50. The provision also clarifies that a participant in an eligible deferred 

compensation plan of a government employer may make catch-up contributions in an amount 

equal to the greater of the amount permitted under the new catch-up rule and the amount 

permitted under the special catch-up rule for eligible deferred compensation plans.

The provision revises the lists of requirements that do not apply to catch-up contributions 

to reflect other statutory amendments made by the Act and to reflect the fact that catch-up 

contributions can be made only to a qualified defined contribution plan, not to a qualified defined 

benefit plan. The provision also clarifies that the special nondiscrimination rule for mergers and 

acquisitions applies for purposes of the nondiscrimination requirement applicable to catch-up 

contributions.
103

Equitable treatment for contributions of employees to defined contribution plans.--

Under prior law, the limits on contributions to a tax-sheltered annuity plan applied at the time 

contributions became vested. Under the Act, tax-sheltered annuity plans are generally subject to 

the same contribution limits as qualified defined contribution plans, but certain special rules were 

retained.

The provision clarifies that the limits apply to contributions to a tax-sheltered annuity 

plan in the year the contributions are made without regard to when the contributions become 

vested. The provision also clarifies that contributions may be made for an employee for up to 

five years after retirement, based on includible compensation for the last year of service before 

retirement. The provision also restores special rules for ministers and lay employees of churches 

and for foreign missionaries that were inadvertently eliminated.

Under the Act, amounts deferred under an eligible deferred compensation plan are 

generally subject to the same contribution limits as qualified defined contribution plans. The 

provision conforms the definition of compensation used in applying the limits to an eligible 

deferred compensation plan to the definition used for defined contribution plans.

Rollovers of retirement plan and IRA distributions.--Under prior law and under the 

Act, a qualified retirement plan must provide for the rollover of certain distributions directly to a 

qualified defined contribution plan, a qualified annuity plan, a tax-sheltered annuity plan, a 

governmental eligible deferred compensation plan, or a traditional IRA, if the participant elects a 

direct rollover. The provision clarifies that a qualified retirement plan must provide for the direct 

rollover of after-tax contributions only to a qualified defined contribution plan or a traditional 

IRA. The provision also clarifies that, if a distribution includes both pretax and after-tax 

amounts, the portion of the distribution that is rolled over is treated as consisting first of pretax 

amounts.

Employers may disregard rollovers for purposes of cash-out amounts.-- Under prior 

and present law, if a participant in a qualified retirement plan ceases to be employed with the 

employer maintaining 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. Under the Act, a plan may provide that the 

present value of the benefit is determined without regard to the portion of the benefit that is 

attributable to rollover contributions (and any earnings allocable thereto) for purposes of 

determining whether the participant must consent to the cash-out of the benefit. The provision 

clarifies that rollover amounts may be disregarded also in determining whether a spouse must 

consent to the cash-out of the benefit.

Notice of significant reduction in plan benefit accruals.-- Under the Act, notice must 

be provided to participants if a defined benefit plan is amended to provide for a significant 

reduction in the future rate of benefit accrual, including any elimination or reduction of an early 

retirement benefit or retirement-type subsidy. The provision clarifies that the notice requirement 

applies to a defined benefit plan only if the plan is qualified. The provision further clarifies that, 

in the case of an amendment that eliminates an early retirement benefit or retirement-type 

subsidy, notice is required only if the early retirement benefit or retirement-type subsidy is 

significant. The provision also eliminates inconsistencies in the statutory language.
104

Modification of timing of plan valuations.--Under the Act, a plan valuation may be 

made as of any date in the immediately preceding plan year if, as of such date, plan assets are not 

less than 100 percent of the plan’s current liability. Under the Act, a change in funding method 

to use a valuation date in the prior year generally may not be made unless, as of such date, plan 

assets are not less than 125 percent of the plan’s current liability. The provision conforms the 

statutory language to Congressional intent as reflected in the Statement of Managers.

ESOP dividends may be reinvested without loss of dividend deduction.--Under prior 

and present law, a deduction is permitted for a dividend paid with respect to employer stock held 

in an ESOP if the dividend is (1) paid in cash directly to participants or (2) paid to the plan and 

subsequently distributed to the participants in cash no later than 90 days after the close of the 

plan year in which the dividend is paid to the plan. The deduction is allowable for the taxable 

year of the corporation in which the dividend is paid or distributed to the participants.

Under the Act, in addition to the deductions permitted under present law, a deduction is 

permitted for a dividend paid with respect to employer stock that, at the election of the 

participants, is payable in cash directly to participants or paid to the plan and subsequently 

distributed to the participants in cash no later than 90 days after the close of the plan year in 

which the dividend is paid to the plan, or paid to the plan and reinvested in qualifying employer 

securities. Under the provision, the deduction for dividends that are reinvested in qualifying 

employer securities at the election of participants is allowable for the taxable year in which the 

later of the reinvestment or the election occurs. The provision also clarifies that a dividend that 

is reinvested in qualifying employer securities at the participant’s election must be 

nonforfeitable.

Amendments to the Community Renewal Tax Relief Act of 2000

Phaseout of $25,000 amount for certain rental real estate under passive loss rules.--

Present law provides for a phaseout of the $25,000 amount allowed in the case of certain 

deductions and certain credits with respect to rental real estate activities, for taxpayers with 

adjusted gross income exceeding $100,000. The phaseout rule does not apply, or applies 

separately, in the case of the rehabilitation credit, the low-income housing credit, and the 

commercial revitalization deduction. The provision clarifies the operation of the ordering rules 

to reflect the exceptions and separate phaseout rules for these items.

Treatment of missing children.--Present law provides that in the case of a dependent 

child of the taxpayer that is kidnapped, the taxpayer may continue to treat the child as a 

dependent for purposes of the dependency exemption, child credit, surviving spouse filing 

status, and head of household filing status. A similar rule applies under the earned income 

credit. The provision clarifies that, if a taxpayer met the household maintenance requirement of 

the surviving spouse filing status or the head of household filing status, respectively, with respect 

to his or her dependent child immediately before the kidnapping, then the taxpayer would be 

deemed to continue to meet that requirement for purposes of the filing status rule of section 2 of 

the Code until the child would have reached age 18 or is determined to be dead.

Basis of property in an exchange by a corporation involving assumption of 

liabilities.--The provision clarifies that the basis reduction rule of section 358(h) of the Code 
105

gives rise to a basis reduction in the amount of any liability that is assumed by another party as 

part of the exchange in which the property (whose basis exceeds its fair market value) is 

received, so long as the other requirements under section 358(h) apply.

Tax treatment of securities futures contracts.--The provision clarifies that the 

termination (by offset or otherwise) of a securities futures contract is treated in a manner similar 

to a sale or exchange of a securities futures contract for purposes of determining the character of 

any gain or loss from the termination of the contract. Under the provision, any gain or loss from 

the termination of a securities futures contract (other than a dealer securities futures contract) is 

treated as gain or loss from the sale or exchange of property which has the same character as the 

property to which the contract relates has (or would have) in the hands of the taxpayer. 

In addition, the provision clarifies that a securities futures contract to sell generally is 

treated in a manner similar to a short sale of the property to which the contract relates. Under the 

provision, the wash sale rules that are applicable to the closing of a short sale (sec. 1091(e)) also 

apply in a similar manner to the closing of a securities futures contract to sell. Thus, the wash 

sale rules apply to any loss realized on the closing of a securities futures contract to sell if, within 

a period beginning 30 days before the date of such closing and ending 30 days after such date: 

(1) stock that is substantially identical to the stock to which the contract relates is sold; or (2) 

another securities futures contract to sell involving such substantially identical stock is entered 

into. The provision also clarifies that a securities futures contract to sell is treated in a manner 

similar to a short sale for purposes of the special holding period rules in section 1233. Thus, 

subsections (b) and (d) of section 1233 generally apply to the acquisition and closing of a 

securities futures contract.

Amendment to the Tax Relief Extension Act of 1999

Taxable REIT subsidiaries - 100 percent tax on improperly allocated amounts.--The 

provision clarifies that redetermined rents, to which the excise tax applies, are the excess of the 

amount treated by the REIT as rents from real property under Code section 856(d) over the 

amount that would be so treated after reduction under Code section 482 to clearly reflect income 

as a result of services furnished or rendered by a taxable REIT subsidiary of the REIT to a tenant 

of the REIT. Similarly, redetermined deductions are the excess of the amount treated by the 

taxable REIT subsidiary as other deductions over the amount that would be so treated after 

reduction under Code section 482.

Amendments to the Taxpayer Relief Act of 1997

Election to recognize gain on assets held on January 1, 2001; treatment of gain on 

sale of principal residence.--The provision clarifies that the gain to which the mark-to-market 

election applies is included in gross income. Thus, the exclusion of gain on the sale of a 

principal residence under Code section 121 would not apply with respect to an asset for which 

the election to mark to market is made. The provision is consistent with the holding of Rev. Rul. 

2001-57.

Election to recognize gain on assets held on January 1, 2001; treatment of 

disposition of interest in passive activity.--The provision clarifies that the election to mark to 
106

market an interest in a passive activity does not result in the deduction of suspended losses by 

reason of section 469(g)(1)(A). Any gain taken into account by reason of an election with 

respect to any interest in a passive activity is taken into account in determining the passive 

activity loss for the taxable year (as defined in section 469(d)(1)). Section 469(g)(1)(A) may 

apply to a subsequent disposition of the interest in the activity by the taxpayer.

Amendment to the Balanced Budget Act of 1997

Medicare+Choice MSA.--The provision conforms the treatment of the additional tax on 

Medicare+Choice MSAs distributions not used for qualified medical expenses if a minimum 

balance is not maintained to the treatment of the additional tax on Archer MSA distributions not 

used for qualified medical expenses, for purposes of determining whether certain taxes are 

included within regular tax liability under Code section 26(b).

Amendment to other Acts

Advance payments of earned income credit.--The provision corrects a reference in 

section 32(g)(2) to refer to credits allowable under this part (i.e., all tax credits) rather than under 

this subpart (i.e., the refundable credits). The provision is effective as if included in section 474 

of the Tax Reform Act of 1984.

Clarification of permissible extension of limitations period for installment 

agreements.--Uncertainty existed as to whether the permissible extension of the period of 

limitations in the context of installment agreements is governed by reference to an agreement of 

the parties pursuant to section 6502 or by reference to the period of time during which the 

installment agreement is in effect pursuant to sections 6331(k)(3) and (i)(5). A 2000 technical 

correction clarified that the permissible extension of the period of limitations in the context of 

installment agreements is governed by the pertinent provisions of section 6502. The provision 

further clarifies that the elimination of the application of the section 6331(i)(5) rules applies only 

to section 6331(k)(2)(C). The provision modifies section 313(b)(3) of H.R. 5662, the 

Community Renewal Tax Relief Act of 2000 (Pub. Law No. 106-554). This is the further 

technical correction referred to in footnote 185a, Joint Committee on Taxation, General 

Explanation of Tax Legislation Enacted in the 106th Congress (JCS-2-01), April 19, 2001, page 

162. The provision is effective on the date of enactment.

Determination of whether a life insurance contract is a modified endowment 

contract.--The provision clarifies that, for purposes of determining whether a life insurance 

contract is a modified endowment contract, if there is a material change to the contract, 

appropriate adjustments are made in determining whether the contract meets the 7-pay test to 

take into account the cash surrender value under the contract. No reference is needed to the cash 

surrender under the "old contract" (as was provided under section 318(a)(2) of H.R. 5662, the 

Community Renewal Tax Relief Act of 2000 (Pub. Law No. 106-554)) because prior and present 

law provide a definition of cash surrender value for this purpose (by cross reference to section 

7702(f)(2)(A)). It is reiterated that Code section 7702A(c)(3)(ii) is not intended to permit a 

policyholder to engage in a series of "material changes" to circumvent the premium limitations in 

section 7702A. Thus, if there is a material change to a life insurance contract, it is intended that 

the fair market value of the contract be used as the cash surrender value under the provision, if 
107

the amount of the putative cash surrender value of the contract is artificially depressed. For 

example, if there is a material change because of an increase in the face amount of the contract, 

any artificial or temporary reduction in the cash surrender value of the contract is not to be taken 

into account, but rather, it is intended that the fair market value of the contract be used as cash 

surrender value, so that the substance rather than the form of the transaction is reflected. Further, 

as stated in the 1988 Act legislative history to section 7702A,100 in applying the 7-pay test to any 

premiums paid under a contract that has been materially changed, the 7-pay premium for each of 

the first 7 contract years after the change is to be reduced by the product of (1) the cash surrender 

value of the contract as of the date that the material change takes effect (determined without 

regard to any increase in the cash surrender value that is attributable to the amount of the 

premium payment that is not necessary), and (2) a fraction the numerator of which equals the 7-

pay premium for the future benefits under the contract, and the denominator of which equals the 

net single premium for such benefits computed using the same assumptions used in determining 

the 7-pay premium. The provision is effective as if section 318(a) of the Community Renewal 

Tax Relief Act of 2000 (114. Stat. 2763A-645) had not been enacted.

Treatment of settlements under partnership audit rules.--The provision clarifies that 

the partnership audit procedures that apply to settlement agreements entered into by the 

Secretary also apply to settlement agreements entered into by the Attorney General. Under 

present law, when the Secretary enters into a settlement agreement with a partner with respect to 

partnership items, those items convert to nonpartnership items, and the other partners in the 

partnership have a right to request consistent settlement terms. The conversion of the settling 

partner's partnership items to nonpartnership items is the mechanism by which the settling 

partner is removed from the ongoing partnership proceeding. If these rules did not apply to 

settlement agreements entered into by the Attorney General (or his delegate), it is possible that a 

settling partner would inadvertently be bound by the outcome of the partnership proceeding 

rather than the settlement agreement entered into with the Attorney General (or his delegate) 

(sec. 6224(c)(2)). Similar changes are made to related provisions with respect to settlement 

agreements. The provision is effective for settlement agreements entered into after the date of 

enactment.

Disclosure by the Social Security Administration to Federal child support 

enforcement agencies.--Section 6103(l)(8) permits the Social Security Administration (SSA) to 

disclose certain tax information in its possession to State child support enforcement agencies. 

The Office of Child Support Enforcement (OCSE), a Federal agency, oversees child support 

enforcement at the Federal level and acts as a coordinator for most programs involved with child 

support enforcement. OCSE acts as a conduit for the disclosure of tax information from the 

Internal Revenue Service to the various State and local child support enforcement agencies. The 

change to section 6103(l)(8) permits SSA to make disclosures directly to OCSE, which in turn 

would make the disclosures to the State and local child support enforcement agencies. The 

provision is effective on the date of enactment.

 

100 Conference Report to accompany H.R. 4333, the "Technical and Miscellaneous 

Revenue Act of 1988" (H. Rep. No. 100-1104), Oct. 21, 1988, vol. II, p. 105.
108

Clerical amendments

The bill makes a number of clerical and typographical amendments to the Code.

Additional Corrections

Adoption credit and employer-provided adoption assistance exclusion rounding 

rules.--The provision provides uniform rounding rules (to the nearest multiple of $10) for the 

inflation-adjusted dollar limits and income limitations in the adoption credit and the employerprovided adoption assistance exclusion. The provision is effective as if included in the provision 

of the Economic Growth and Tax Reform Reconciliation Act of 2001 to which it relates.

Dependent care credit.--The provision conforms the dollar limit on deemed earned 

income of a taxpayer's spouse who is either (1) a full-time student, or (2) physically or mentally 

incapable of caring for himself, to the dollar limit on employment-related expenses applicable in 

determining the maximum credit amount. The 2001 Act increased the dollar limit on employerrelated expenses to $3,000 for one qualifying individual or $6,000 for two or more qualifying 

individuals annually but did not conform the dollar limit on deemed earned income of a spouse. 

The provision is effective as if included in the provision of the Economic Growth and Tax 

Reform Reconciliation Act of 2001 to which it relates. 
109

X. UNEMPLOYMENT ASSISTANCE PROVISIONS

(secs. 701-709 of the bill)

A. Unemployment Assistance

Present Law 

States set unemployment benefit rules within a broad federal framework. The maximum 

length of benefits is 26 weeks in all but two states. The average duration on unemployment was 

14 weeks in 2001. During fiscal year 2001, 28 percent of recipients used all of their eligibility or 

“exhausted eligibility.”

Under the regular Federal-State Extended Benefits Program, up to an additional 13 weeks 

of benefits are available in states suffering severe economic distress. These benefits become 

available when a state’s “insured” unemployment rate is 5 percent and 120 percent of the 

average over the last two years or, at state option, if the “insured” rate is 6 percent. States also 

may adopt another trigger, a total unemployment rate of 6.5 percent and 110 percent of the 

average over the past two years. The benefits are 50 percent federally-funded. (Regular 

unemployment benefits are funded by state taxes levied on employers.)

Explanation of Provision

The bill provides for up to 13 weeks of temporary extended unemployment benefits for 

eligible displaced workers. These benefits would be available following enactment in any state 

entering into an agreement with the Secretary of Labor to provide such extended benefits. 

Benefits would be available to workers who filed an initial claim for unemployment benefits on 

or after March 15, 2001 (that is, approximately when the current recession began) and who 

remain unable to find work after having exhausted their regular unemployment benefits. 

The provision follows current law regarding certain eligibility rules for receipt of 

extended benefits, for example providing that individuals qualify for the lesser of 13 weeks of 

extended benefits or 50 percent of the length of time they qualified for regular unemployment 

benefits under the laws of their state; to ensure that workers with a strong attachment to the 

workforce qualify, individuals must have worked 20 weeks of full-time insured employment or 

earned the equivalent in insured wages to be eligible for these extended benefits. 

The benefits would be 100 percent federally funded and would be available through 

December 31, 2002 or until a state terminates its agreement, if sooner.

Effective Date

The temporary extended unemployment provision would be effective upon enactment.
110

B. Special Reed Act Transfer in Fiscal Year 2002

Present Law

When three federal accounts in the Unemployment Trust Fund (UTF) reach their 

statutory limits at the end of a federal fiscal year, any excess funds are transferred to the 

individual state accounts in the UTF. These transfers are called “Reed Act” distributions. States 

can use this funding for payment of cash benefits and administrating their unemployment 

compensation and employment services programs. The Balanced Budget Act of 1997 limited 

Reed Act transfers to states to $100 million after each of fiscal years 1999, 2000, and 2001 and 

limited these funds' use to paying administrative expenses of unemployment compensation laws. 

If the Secretary finds that a state is not eligible to receive Reed Act transfers at the 

beginning of a fiscal year, the amount available for transfer to the state instead is transferred to 

the federal unemployment account. If the state becomes eligible during the following one year 

period, the amount which was available for transfer will be transferred from the federal 

unemployment account to the state's account. If the state does not become eligible within one 

year, the amount remains in the federal unemployment account for other uses. If any state has 

borrowed from the federal unemployment account, any amount that would be transferred is 

retained and credited against any balance due to the state. 

Explanation of Provision

The $100 million limit on distributions from excess federal funds available at the end of 

fiscal year 2001 is repealed. The provision also repeals the limitation on the use of funds applied 

to the $100 million special distribution under the Balanced Budget Act of 1997. This limitation 

applied only to special distributions at the end of fiscal years 1999, 2000, and 2001, and with the 

repeal of the underlying special distribution provision is no longer relevant. 

The Secretary of the Treasury will transfer excess federal UTF balances as of the close of 

fiscal year 2001 into the account of each state in the UTF. Each state's share of distributions 

from the $100 million already provided at the beginning of fiscal year 2002 will be subtracted 

from the distribution to each state under this provision. (Thus of the $9.3 billion in excess federal 

funds as of the end of fiscal year 2001, only $9.2 billion will be provided under the bill, 

reflecting the fact that $0.1 billion already has been forwarded to state accounts under the 1997 

Balanced Budget Act provision.) 

At the option of the state, amounts transferred to state accounts may be used for the 

payment of cash benefits to individuals with respect to unemployment, including regular 

unemployment compensation or additions to regular benefits. States also may use these funds to 

support payment of benefits to individuals not otherwise eligible for regular unemployment 

compensation benefits under the laws of the state, such as individuals seeking only part-time 

work or those eligible only under an alternative base period. 

Other than for cash benefits, states may use amounts transferred to their accounts in the 

administration of their public employment laws and public employment offices, including for the 

provision of employment services needed to help individuals return to work. 
111

Effective Date

Transfers under this provision shall be made by December 31, 2001 or, if the date of 

enactment is after December 31, 2001, within 10 days following enactment.
112

XI. DISPLACED WORKER HEALTH INSURANCE CREDIT

(secs. 801 and 802 of the bill and new sec. 6429 of the Code)

Present Law

Under present law, the tax treatment of health insurance expenses depends on the 

individual’s circumstances. In general, employer contributions to an accident or health plan are 

excludable from an employee’s gross income (sec. 106). 

Self-employed individuals are entitled to deduct a portion of the amount paid for health 

insurance expenses for the individual and his or her spouse and dependents. The percentage of 

deductible expenses is 60 percent in 2001, 70 percent in 2002, and 100 percent in 2003 and 

thereafter.

Individuals other than self-employed individuals who purchase their own health 

insurance and itemize deductions may deduct their expenses to the extent that their total medical 

expenses exceed 7.5 percent of adjusted gross income.

Present law does not provide a tax credit for the purchase of health insurance.

The health care continuation rules (commonly referred to as "COBRA" rules, after the 

Consolidated Omnibus Budget Reconciliation Act of 1985 in which they were enacted) require 

that most employer-sponsored group health plans must offer certain covered employees and their 

dependents ("qualified beneficiaries") the option of purchasing continued health coverage in the 

event of loss of coverage resulting from certain qualifying events. These qualifying events 

include: termination or reduction in hours of employment, death, divorce or legal separation, 

enrollment in Medicare, the bankruptcy of the employer, or the end of a child's dependency 

under a parent's health plan. In general, the maximum period of COBRA coverage is 18 months. 

An employer is permitted to charge qualified beneficiaries 102 percent of the applicable 

premium for COBRA coverage. 

Under present law, individuals without access to COBRA are able to purchase individual 

policies on a guarantee issue basis without exclusion of coverage for pre-existing conditions, if 

they had 18 months of creditable coverage under an employer sponsored group health plan, 

governmental plan, or a church plan. Those with access to COBRA are required to exhaust their 

18 months of COBRA prior to accessing the same individual market protections. 

Explanation of Provision

The bill provides a refundable tax credit for 2002 and 2003 for a portion of expenses for 

qualified health insurance of an unemployed taxpayer and his or her spouse and dependents. 

Qualified health insurance is any insurance that constitutes medical care (as defined in sec. 213), 

except insurance substantially all of which is coverage of certain excepted benefits.

101 Thus, for 

 

101 Excepted benefits are: (1) coverage only for accident or disability income or any 

combination thereof; (2) coverage issued as a supplement to liability insurance; (3) liability 

insurance, including general liability insurance and automobile liability insurance; (4) worker’s 

compensation or similar insurance; (5) automobile medical payment insurance; (6) credit-only 
113

example, the credit is available with respect to COBRA continuation coverage, individual 

policies, and group policies, provided the requirements for the credit are otherwise satisfied. The 

credit is available only with respect to amounts paid by the taxpayer. The credit is equal to 60 

percent of the taxpayer’s expenses for qualified health insurance coverage in 2002 and 2003. No 

more than 12 months of coverage are eligible for the credit. 

Eligibility for the credit is determined on a monthly basis. In general, a taxpayer is 

eligible for the credit for a month if, as of the first day of the month, the taxpayer (1) is 

unemployed, (2) is covered by qualified health insurance, and (3) the taxpayer does not have 

other specified coverage. In addition, the period of unemployment must have begun after March 

15, 2001, and before January 1, 2004. In the case of a joint return, the eligibility requirements 

are met if at least one spouse satisfies the requirements. 

An individual is considered unemployed during any period if, during such period, the 

individual (1) is receiving unemployment compensation or (2) is certified by a State agency (or 

any other entity designated by the Secretary of the Treasury) as otherwise being entitled to 

receive unemployment compensation but for the termination of the period during which such 

compensation was payable or an exhaustion of such individual’s rights to such compensation. 

An individual is eligible for the credit for one additional month after the individual is 

reemployed (provided other requirements for the credit are satisfied e.g., the individual does not 

have other specified coverage).

An otherwise eligible taxpayer is not eligible for the credit for a month if, as of the first 

day of the month the individual has other specified covered. Specified coverage is (1) coverage 

under any qualified health insurance if at least 50 percent of the cost of the coverage is paid by 

an employer102 (or former employer) of the individual or his or her spouse or (2) coverage under 

certain governmental health programs.103 Amounts taken into account in determining the credit 

may not be taken into account in determining the amount allowable under the itemized deduction 

 

insurance; (7) coverage for on-site medical clinics; (8) other insurance coverage similar to the 

coverages in (1)-(7) specified in regulations under which benefits for medical care are secondary 

or incidental to other insurance benefits; (9) limited scope dental or vision benefits; (10) benefits 

for long-term care, nursing home care, home health care, community-based care, or any 

combination thereof; and (11) other benefits similar to those in (9) and (10) as specified in 

regulations; (12) coverage only for a specified disease or illness; (13) hospital indemnity or other 

fixed indemnity insurance; and (14) Medicare supplemental insurance.

102 An amount is considered paid by the employer if it is excludable from income. Thus, 

for example, amounts paid for health coverage on a salary reduction basis under an employer 

plan are considered paid by the employer.

103 Specifically, an individual is not eligible for the credit if, as of the first day of the 

month, the individual is (1) entitled to benefits under Medicare Part A, enrolled in Medicare Part 

B, or enrolled in Medicaid or SCHIP (2) enrolled in a health benefits plan under the Federal 

Employees Health Benefit Plan, or (3) entitled to receive benefits under chapter 55 of title 10 of 

the United States Code (relating to military personnel). 
114

for medical expenses or the deduction for health insurance expenses of self-employed 

individuals. Amounts distributed from a medical savings account are not eligible for the credit. 

The credit may be claimed on the taxpayer’s return for 2002 and 2003. In addition, the 

bill provides for payment of the credit on an advance basis (i.e., prior to the filing of the 

taxpayer’s return) pursuant to a program to be established by the Secretary of the Treasury. Such 

program is to provide for making payments on behalf of eligible individuals to providers of 

health insurance. In order to receive the credit on an advance basis, a qualified health insurance 

credit eligibility certificate must be in effect for the taxpayer. A qualified health insurance credit 

eligibility certificate is a statement certified by a State agency (or by any other entity designated 

by the Secretary) which certifies that the individual was unemployed as of the first day of any 

month and provides such information as the Secretary may require.

The bill would provide that any person who receives payments during a calendar year for 

qualified health insurance and claims a reimbursement for an advance credit amount is to file an 

information return with respect to each individual from whom such payments were received and 

amounts advanced. The return is to be in such form as the Secretary may prescribe and is to 

contain the name, address, and taxpayer identification number of the individual, the aggregate of 

the advance credit amounts provides, the number of months for which advance credit amounts 

are provided, and such other information as the Secretary may prescribe. The bill requires that 

similar information be provided to the individual no later than January 31 of the year for which 

the information return is made. 

If the taxpayer receives any advance credit amount, the amount advanced is reconciled on 

the tax return under rules similar to those applied under the advance payment mechanism for the 

earned income credit.

The bill allows guarantee issue and pre-existing condition protections without the 

requirement to exhaust COBRA coverage. Individuals ineligible for COBRA coverage must 

have 12 months of employer creditable coverage to access these protections. 

Effective Date

The credit is effective for taxable years beginning after December 31, 2001.
115

XII. EMPLOYMENT AND TRAINING ASSISTANCE AND TEMPORARY HEALTH 

CARE COVERAGE ASSISTANCE (NATIONAL EMERGENCY GRANTS) 

(sec. 901 of the bill)

Present Law

The Workforce Investment Act authorizes Dislocated Worker Employer and Training 

formula grants to states and National Emergency Grants (NEGs) for a variety of employment and 

training services to unemployed workers who are able to show an attachment to the labor market. 

The NEGs are administered by the Secretary of Labor, and a state must apply to the Department 

for access to NEG funds. The grants are used to assist workers dislocated as a result of plant 

closures and mass layoffs, and may be accessed in times of declared disasters. Currently, the 

grants may be used to support job training and reemployment services and to make certain 

income support payments to individuals enrolled in training. The grants also may be used to 

help pay for supportive services, such as childcare and transportation, to help individuals 

complete training and transition back to work. 

Explanation of Provision

In order to assist local regions and communities suffering due to mass layoffs and plant 

closings including those caused by the September 11th tragedy, the National Emergency Grant 

(NEG) provisions will temporarily expand the NEG program within the Workforce Investment 

Act (WIA) by providing $4 billion to assist dislocated workers during this recovery period. This 

emergency expansion will be maintained for obligation in Fiscal Years 2002, 2003 and 2004.

Under the program, states and outlying areas are eligible for a special NEG if the 

governor of a state or outlying area certifies that a major economic dislocation, such as a plant 

closure, mass layoff, or multiple layoff, including dislocations caused by the terrorist attacks on 

September 11th, contributed importantly to the dislocations. States may provide employment 

and training assistance that includes supportive services, as well as temporary health care 

coverage assistance to dislocated workers. Not less than 30 percent of the cost of assistance 

requested in a grant shall go towards temporary health care coverage assistance. Each state or 

outlying area that requests a grant and meets the grant requirements shall be awarded at least one 

grant. Each state or outlying area shall be awarded a grant or grants of not less than $5,000,000. 

An individual who is a dislocated worker in a state or outlying area in which the Governor has 

made the appropriate certification with regard to the dislocation shall be eligible to receive 

assistance.

Dislocated workers who are receiving employment and training assistance and are not 

already eligible for health care assistance under Medicaid or SCHIP are qualified to receive 

temporary health care coverage assistance consisting of health care coverage premium assistance 

for coverage for themselves, their spouses, their dependents or any combination thereof. 

Allowable uses include but are not limited to temporary health care coverage assistance for 

COBRA premiums or state COBRA equivalents, premium assistance to purchase coverage in the 

individual market, and coverage through the Medicaid or SCHIP infrastructure. 
116

Employment and training assistance provided by the states could be used to provide 

additional weeks of income support for individuals who have used up their unemployment 

compensation or are ineligible for unemployment compensation but are able to demonstrate a 

sufficient attachment to employment -- as long as those individuals are enrolled in training. In 

addition, the funds could be used in order to offer a full array of job search and training services, 

including customized training, placement assistance, relocation expenses and additional 

supportive services.

Effective Date

The funds would be effective upon date of enactment of the legislation and would be 

available for fiscal years 2002, 2003, and 2004. No expenditures would be allowable after June 

30, 2004.
117

XIII. TEMPORARY STATE HEALTH CARE ASSISTANCE 

(sec. 1001 of the bill)

Explanation of Provision

In order to provide immediate relief to states, this provision allocates $4.6 billion directly 

to states to expend on health care services. This section will remain in effect for one year. States 

will not be permitted to use these resources to match other federal expenditures or in any other 

manner that results in an increase of federal spending in excess of the amounts provided under 

this section.
118

XIV. NO IMPACT ON SOCIAL SECURITY TRUST FUNDS

(sec. 1101 of the bill)

Present Law

Present law provides for the transfer of Social Security taxes and certain self-employment 

taxes to the Social Security trust fund. In addition, the income tax collected with respect to a 

portion of Social Security benefits included in gross income is transferred to the Social Security 

trust fund.

Explanation of Provision

The bill provides that the Secretary is to annually estimate the impact of the bill on the 

income and balances of the Social Security trust fund. If the Secretary determines that the bill 

has a negative impact on the income and balances of the fund, then the Secretary is to transfer 

from the general revenues of the Federal government an amount sufficient so as to ensure that 

the income and balances of the Social Security trust funds are not reduced as a result of the bill. 

Such transfers are to be made not less frequently than quarterly.

The bill provides that the provisions of the bill are not to be construed as an amendment 

of title II of the Social Security Act.

Effective Date

The provision is effective on the date of enactment.
119

XV. EMERGENCY DESIGNATION 

(sec. 1102 of the bill)

Present Law

Under the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, 

any legislation that reduces revenues or increases outlays is subject to a pay-as-you-go 

(“PAYGO”) requirement. The PAYGO system tracks legislation that may increase budget 

deficits using a “scorecard” estimated by the Office of Management and Budget. Under PAYGO 

requirements, in order to avoid sequestration, any revenue loss or increase in outlays would need 

to be offset by revenue increases or reductions in direct spending.

If a provision of direct spending or receipts legislation is enacted that the President 

designates as an emergency requirement and that the Congress so designates in statute, the 

amounts of new budget authority, outlays, and receipts in all fiscal years resulting from that 

provision are not taken into account in determining the PAYGO scorecard.

Explanation of Provision

The provision designates any revenue loss, new budget authority, and new outlays under 

the bill in excess of those allowed under the FY 2002 budget resolution as emergency 

requirements pursuant to section 252(e) of the Balanced Budget and Emergency Deficit Control 

Act of 1985.

Effective Date

The provision is effective on the date of enactment.