TECHNICAL EXPLANATION OF H.R. 2884, THE

“VICTIMS OF TERRORISM TAX RELIEF ACT OF 2001,” 

AS CONSIDERED BY THE HOUSE ON DECEMBER 13, 2001

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

December 13, 2001

JCX-86-01
i

CONTENTS

Page

I. BACKGROUND......................................................................................................................... 2

II. DESCRIPTION OF H.R. 2884, THE “VICTIMS OF TERRORISM TAX RELIEF ACT 

OF 2001”................................................................................................................................... 5

A. Relief Provisions for Victims of Specific Terrorist Attacks .................................................. 5

1. Income taxes of victims of terrorist attacks (sec. 101 of the bill and sec. 692 of 

 the Code)............................................................................................................................. 5

2. Exclusion of certain death benefits (sec. 102 of the bill and sec. 101 of the Code) ........... 6

3. Estate tax reduction (sec. 103 of the bill and sec. 2201 of the Code)................................. 8

4. Payments by charitable organizations treated as exempt payments (sec. 104 of 

 the bill and secs. 501 and 4941 of the Code) .................................................................... 10

B. General Relief for Victims of Disasters and Terroristic or Military Actions ...................... 12

1. Exclusion of disaster relief payments (sec. 201 of the bill and new sec. 139 of

 the Code)........................................................................................................................... 12

2. Authority to postpone certain deadlines and required actions (sec. 202 of the bill, 

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

 Income Security Act of 1974)........................................................................................... 17

3. Application of certain provisions to terroristic or military actions (sec. 203 of the

 bill and secs. 104 and 692 of the Code)............................................................................ 20

4. Clarification of due date for airline excise tax deposits (sec. 204 of the bill and 

 sec. 301 of the Air Transportation Safety And Stabilization Act) .................................... 21

5. Treatment of purchase of structured settlements (sec. 205 of the bill and 

 new sec. 5891 of the Code)............................................................................................... 21

6. Personal exemption deduction for certain disability trusts (sec. 206 of the bill 

 and sec. 642 of the Code).................................................................................................. 23

C. Tax Benefits for Area of New York City Damaged in Terrorist Attacks on 

September 11, 2001.............................................................................................................. 25

1. Special depreciation allowance for certain property (sec. 301(a) of the bill and 

 new sec. 1400L of the Code) ............................................................................................ 25

2. Treatment of qualified leasehold improvement property (sec. 301(b) of the bill 

 and new sec. 1400L of the Code)...................................................................................... 27

3. Increase in expensing treatment for business property used in the New York 

 Liberty Zone (sec. 301(c) of the bill and new sec. 1400L of the Code) ........................... 29

4. 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. 301(d) 

 of the bill and new sec. 1400L of the Code)...................................................................... 31

5. Extension of replacement period for certain property involuntarily converted in

 the New York Liberty Zone (sec. 301(e) of the bill and new sec. 1400L of the Code).... 35

D. Disclosure of Tax Information in Terrorism and National Security Investigations 

(sec. 401 of the bill and sec. 6103 of the Code)................................................................... 37

E. No Impact on Social Security Trust Funds (sec. 501 of the bill)........................................ 44
1

INTRODUCTION

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

technical explanation of H.R. 2884, the “Victims of Terrorism Tax Relief Act of 2001,” as 

Considered by the House on December 13, 2001. 

 

1

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

Explanation of H.R. 2884, the “Victims of Terrorism Tax Relief Act of 2001,”as Considered by 

the House on December 13, 2001(JCX-86-01), December 13, 2001.
2

I. 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 1968.2 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.3 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.4 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 

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 

 

2

 Pub. L. No. 91-235.

3

 Pub. L. No. 96-449.

4

 Pub. L. Nos. 98-259 and 98-369.
3

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, 1988.5 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.6 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 

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 

 

5

 Pub. L. No. 101-604.

6

 Pub. L. No. 102-2.
4

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. 7 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.8 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.

 

7

 Pub. L. No. 104-117.

8

 Pub. L. No. 105-34.
5

II. DESCRIPTION OF H.R. 2884, THE

 “VICTIMS OF TERRORISM TAX RELIEF ACT OF 2001”

A. Relief Provisions for Victims of Specific Terrorist Attacks 

1. Income taxes of victims of terrorist attacks (sec. 101 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 includible in the individual's 

income for the taxable year in which the date of death falls (determined as if the individual had 

survived).9 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 

 

9

 Treas. Reg. sec. 1.692-1(a)(2)(ii).
6

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 

with the taxable year prior to the taxable year in which the wounds or injury occurred.10 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 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. 

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. 102 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 includible 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) 

 

10 The bill does not provide relief from self-employment tax liability.
7

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. 11

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 otherwise12) 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 

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 plan13 to the extent that the amounts would have been 

payable if the death had occurred for another reason. 

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 includible 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 

 

11

 Comm’r v. Duberstein, 363 U.S. 278 (1960).

12 Thus, for example, payments made over a period of years could qualify for the 

exclusion.

13 The provision does not apply to amounts received under a qualified plan because such 

payments are not made by the employer.
8

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.

3. Estate tax reduction (sec. 103 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 
9

2201. The provision applies regardless of whether the individual was killed in the attack itself 

(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 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 

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.
10

4. Payments by charitable organizations treated as exempt payments (sec. 104 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. 

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 and the payments further a public rather than 

a private interest. Therefore, as under present law, payments 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, payments 

that do not further public purposes are not permitted. The bill does not change the substantive 
11

standards for exemption under section 501(c)(3), including the prohibition on private inurement. 

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. 

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.
12

B. General Relief for Victims of Disasters and Terroristic or Military Actions

1. Exclusion of disaster relief payments (sec. 201 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. 14 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.15 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 

 

14 Rev. Rul. 98-19, 1998-1 C.B. 840; Rev. Rul. 76-144, 1976-1 C.B. 17.

15 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. 
13

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.16 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.

 

16 Tax benefits provided under the bill are not to be considered as being received from a 

collateral source for purposes of section 402(4) of the Air Transportation Safety and System 

Stabilization Act. 
14

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 

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.17

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. 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.

 

17 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.
15

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.

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, 18 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 

 

18 Priv. Ltr. Rul. 199914040.
16

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 

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 ma kes 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.19 Thus, such payments made by a foundation to relieve distress 

 

19

 See, e.g., Rev. Rul. 99-44, 1999-2 C.B. 549.
17

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.

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. 202 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; 
18

(10) Bringing suit by the United States in respect of any liability in respect of any tax; 

and

(11) Any other act required or permitted under the internal revenue laws specified in 

regulations prescribed by the Secretary of the Treasury. 20

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 

 

20 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.”
19

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 

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.
20

3. Application of certain provisions to terroristic or military actions (sec. 203 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. The 

bill is not intended to apply to amounts that would have been payable even if the individual had 

not become disabled as a result of a terrorist 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.
21

4. Clarification of due date for airline excise tax deposits (sec. 204 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 Act21 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. 205 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 

accelerated, deferred, increased, or decreased by the recipient; (3) the assignee's obligation is no 

 

21 Pub. L. No. 107-42.
22

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 damages, 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 
23

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 on or after the 30th day 

following enactment.

6. Personal exemption deduction for certain disability trusts (sec. 206 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.
24

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 disability trusts described in certain subsections of 42 U.S.C. sec. 1396p (relating to 

liens, adjustments, transfers of assets, and the treatment of trust amounts for purposes of 

determining eligibility for benefits under Medicaid State plans).

The provision only applies to disability trusts the beneficiaries of which are 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), and only if such beneficiaries are 

receiving government disability benefits based upon a determination of disability under 42 

U.S.C. sec. 1382c(a)(3).

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.
25

C. Tax Benefits for Area of New York City Damaged

 in Terrorist Attacks on September 11, 2001 

1. Special depreciation allowance for certain property (sec. 301(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.22 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.

Property qualifies for the additional first-year depreciation deduction if the property is (1) 

property to which MACRS applies except qualified leasehold improvement property23 and any 

 

22 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. 

23 Qualified leasehold improvement property is defined in a subsequent provision. 

Leasehold improvements that do not satisfy the requirements to be treated as “qualified leasehold 
26

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 use24 of the property in the Liberty Zone must 

commence with the taxpayer on or after September 11, 2001.25 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.26

In addition, property qualifies only if acquired by purchase27 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 

the manufacture, construction, or production of the property after September 10, 2001, and the 

property is placed in service on or before December 31, 200628 (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.

 

improvement property” are eligible for the 30 percent additional first-year depreciation 

deduction. 

24 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 2. However, it is intended that additional capital expenditures incurred to recondition 

or rebuild property the original use of which in the Liberty Zone did not begin with the taxpayer 

would not satisfy the “original use” requirement.

25 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.

26 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. 

27 For purposes of this provision, purchase is defined under section 179(d).

28 December 31, 2009 with respect to nonresidential real property and residential rental 

property. 
27

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 $59,000 deduction under section 179.29 The taxpayer then is allowed 

an additional first-year depreciation deduction of $12,300 based on $41,000 ($100,000 original 

cost less the section 179 deduction of $59,000) of adjusted basis. Finally, the remaining adjusted 

basis of $28,700 ($41,000 adjusted basis less $12,300 additional first-year depreciation) is to be 

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

2. Treatment of qualified leasehold improvement property (sec. 301(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)).30 This rule applies regardless whether the lessor or lessee places the 

 

29 A subsequent provision provides that property in the Liberty Zone is eligible for an 

additional $35,000 of expensing under section 179. 

30 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.
28

leasehold improvements in service.31 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)).32

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.33 This rule conforms the treatment of 

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.34

Explanation of Provision

The provision provides that 5-year property for purposes of the depreciation rules of 

section 168 includes qualified leasehold improvement property place in service after September 

10, 2001 and before January 1, 2007. The straight-line method is required to be used with 

respect to qualified leasehold improvement property.

 

31 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.

32 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).

33 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.

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

demolition of any structure.
29

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

building that is nonresidential real property if such building is located in the New York Liberty 

Zone, 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 improvement for which 

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

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

building.

A 9-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. 

3. Increase in expensing treatment for business property used in the New York Liberty 

Zone (sec. 301(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 
30

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.35 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 the present-law rules of section 179. 

Qualifying property means section 179 property36 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 

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. 

 

35 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.

36 As defined in section 179(d)(1).
31

4. 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. 301(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.”37 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;38 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. 

 

37 Interest on private activity bonds (other than qualified 501(c)(3) bonds) is a preference 

item in calculating the alternative minimum tax.

38 Residential rental projects must satisfy low-income tenant occupancy requirements for 

a minimum period of 15 years.
32

Tax-exempt private activity bonds also may be issued to finance limited non-business 

purposes: certain student loans and mortgage loans for owner-occupied housing (“qualified 

mortgage bonds” and “qualified veterans’ mortgage bonds”). 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 than 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 
33

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 

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

The provision authorizes issuance of $15 billion of tax-exempt private activity bonds to 

finance the construction and rehabilitation of commercial39 and residential rental40 real property 

in a newly designated Liberty Zone ("Zone") of New York City. 41 Property eligible for 

financing with these bonds includes buildings and their structural components, fixed tenant 

improvements,42 and public utility property (e.g., gas, water, electric and telecommunication 

lines), all as designated by the Governor of New York. Bonds authorized under the provision for 

the Zone may be issued during the period January 1, 2002 through December 31, 2004. The 

Zone is defined as 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.

If the Governor 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 nonresidential real property (including fixed tenant 

improvements) located outside the Zone and within New York City. 43 Bond-financed property 

 

39 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. 

40 No more than $3 billion of the authorized bond amount may be used to finance 

residential rental property. 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)).

41 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 or extend 

the weighted average maturity of the refunding bonds beyond 120 percent of the economic life of 

the property financed with the bonds. The bonds may not be advance refunded.

42 Fixtures and equipment that can be removed from the Zone for use elsewhere are not 

be eligible for financing with these bonds.

43 Public utility property and residential property located outside the Zone may not be 

financed with the bonds.
34

located outside the Zone is required to meet the additional requirement that the project have at 

least 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 construction proceeds of the bonds (sec. 148(f)(4)(C));

(5) Loan repayments may not be used to originate new loans;44

(6) 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

(7) Property located within the Zone that is financed with proceeds of these bonds 

(but not such property that is located outside the Zone) is not considered taxexempt bond financed property to the extent of such financing and is eligible for 

cost recovery deductions computed under the general MACRS system and the 

bonus depreciation provided under the provision (to the extent that the property 

otherwise qualifies for these benefits). 

Effective Date

The provision is effective for bonds issued during the period January 1, 2002 through 

December 31, 2004.

 

44 All loan repayments are required to be used to redeem bonds. Redemptions must 

occur at least semi-annually beginning after expiration of the 10-year period immediately 

following issuance of the original bonds to which the repayments relate (unless the aggregate 

amount of repayments which have not been used to redeem bonds does not exceed $250,000).
35

5. Extension of replacement period for certain property involuntarily converted in the New 

York Liberty Zone (sec. 301(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.45 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. 46

Special rules apply for property converted in a Presidentially declared disaster.47 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 

Zone48 as a result of the terrorist attacks that occurred on September 11, 2001. However, the 

five-year period is available but 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.

 

45 Section 1033(a)(2)(B).

46 Section 1033(g)(4).

47 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.

48 The “New York Liberty Zone” has the same definition throughout this bill. See e.g.,

note 14, supra.
36

Effective Date

The provision is effective for property in the New York Liberty Zone involuntarily 

converted as a result of the terrorist attacks occurring on September 11, 2001.
37

D. Disclosure of Tax Information in Terrorism and

National Security Investigations

(sec. 401 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 
38

identified circumstances (including nontax criminal investigations) when certain conditions are 

satisfied.

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)).49 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.

 

49 Return information other than that submitted by the taxpayer may be obtained by ex 

parte court order under this provision as well. 
39

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 

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 
40

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.

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 determines, 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 
41

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 

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 
42

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

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 information50) 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 

 

50 A taxpayer’s identity is not treated as having been supplied by the taxpayer or his 

representative.
43

provided by a foreign government, no disclosure may be made under this paragraph without the 

written consent of the foreign government.

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. 51

Effective Date

The provision is effective for disclosures made on or after the date of enactment.

 

51 18 U.S.C. sec. 2331.
44

E. No Impact on Social Security Trust Funds 

(sec. 501 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.